Unit no.04 project economics

Unit IV – Project economics

By, Prof. R. P. Kodam

Introduction to project economics

Contribution of construction industry in economy

Difference Cost, price and value

simple and compound interest,

profit, Annuities Demand, demand schedule,

law of demand, demand curve, elasticity of demand, supply, supply schedule, supply curve,

elasticity of supply Equilibrium, Equilibrium price, Equilibrium amount,

factors affecting price determination. Law of Diminishing Marginal Utility, Law of substitution

Concept of Cost of Capital, Time value of money ,Sources of Project Finances – concepts of

Debt Capital and Equity Capital. Types of Capital – Fixed and working. Equity shares and debenture capital

Contents

3/24/2017 Prof. R. P. Kodam JSPM's ICOER pune

Introduction to Project Economics Economics is the study of flow of finance from

production to consumption of goods & services Economics is also an art as well as science that studies

those activities of social, real & normal human beings which are related to worth

Construction activity touches every aspect of economics Construction industry gives employment to million

workers directly or indirectly It consist of benefit cost analysis budgeting, accounting

and different technique of applied Economics. Following fig. shows how construction influences to the

industries & overall economic development directly indirectly


Contribution of construction industry in economy


DEFINATION OF ECONOMICS BY A. Marshall : its is the study of mankind in the ordinary

business of life it examines that part of individual and social action which is most closely connected with the attainment and with the use of material requisites of well begin

By L. Robbins: economics is a science which studies human behavior as a relationship between ends and scarce means which have alternative uses

By J. M. Keynes: It is the study of the administration of scarce resources and of the determinants of income and employment

In short economics can be defined as a social science concerned with the proper uses and allocation of resources for the achievement and maintenance of growth with stability


Types of economy Micro economy: It offers the detailed treatment of individual

decisions about particular commodities. i.e. the study of households decision whether he prefers bungalow to flat and developers decision whether to construct a bungalow scheme or apartment

Macro economy: It emphasizes the interaction in the economy as

a whole. It treats all the goods as consumer goods and the study the interaction between households decision and developers decision


Conti…. Command economy: It is a society/ market where the government makes

all decisions about production and consumption

Free economy: it is the scarcity market where government do not

intervene Mixed economy : It is society/market where government and privates

sector interact in solving economic problem. Our country, India is following mixed economy


Principles Every project should completed

within stipulated time and resources The main objectives of project

economics is satisfaction of customer and contractor

The resources which is most scare has to monitored first

Quality should be achieved with optimum utilization of resources


Importance of economy in construction industry

the construction of multistoried buildings The direct businesses associated


DifferenceCOST

the cost of your product/service is the effort/amount you spent to produce it

PRICE is the financial

reward for providing the product/service

VALUE is defined from

the customers sight of view and represents their appraisal of the worth of the product/service for him/her


Simple InterestSimple Interest

IT is a quick method of calculating the interest charge on a loan.

In return, the bank pays you INTEREST based on the INTEREST RATE.

Simple interest is interest paid only on the PRINCIPAL.

When you first deposit money in a savings account, your deposit is called PRINCIPAL.


Simple Interest Formula

Interest (I) = PinAmount,(A) = P(1+ i n )

i = rate of interest P = principal amount A = Future sum of money paid n = the time in years (no. of years)

CHECK, INTREST = AMOUNT - PRINICIPAL


Example Suppose you deposit Rs 400 in a savings account.

The interest rate is 5% per year. Find the interest earned in 6 years. Find the total of principal plus interest.

SOLUTIONS A= P(1+ i n) Formula

P = 400, i = 0.05 = 5%, n = 6 (in years) 400 x 0.05 = 20 = interest on one year 400 x 0.05 x 6 = 120 = interest on Rs 400 over 6 years 400 + 120 = Rs 520 = amount in account after 6

years.3/24/2017 Prof. R. P. Kodam JSPM's ICOER pune

At what % will Rs. 26435 amount to 31,722 in 4years

Ans :- r = 5%

Deposited at a bank fetches Rs.13440 after 5yrs. At 12% simple rate of interest find the principal amount

Ans :- P = 8400 Rs.3/24/2017 Prof. R. P. Kodam JSPM's ICOER pune

Compound Interest

Compound Interest is when the bank pays interest on the Principal and the Interest already earned.

The Balance is the Principal PLUS the Interest.

The Balance becomes the Principal on which the bank figures the next interest payment when doing Compound Interest.


Compound Interest Formula You can find a balance using compound interest in

one step with the compound interest formula. An INTEREST PERIOD is the length of time over

which interest is calculated. The Interest Period can be a year or less than a

year.A = P (1 + i)n

A = the final balance or amount at end of “n” periodP = is the principali = the interest rate for each interest period

n = the number of interest periods.3/24/2017 Prof. R. P. Kodam JSPM's ICOER pune

Compound Interest Example


Profit A financial benefit that is realized when the

amount of revenue gained from a business activity exceeds the expenses, costs and taxes needed to sustain the activity. Any profit that is gained goes to the business's owners, who may or may not decide to spend it on the business.

Profit may refer to: Profit : the difference between the purchase

price and the costs of bringing to marketProfit can be classified as Gross profit Net profit residue


AnnuityAn annuity is series of equal payments occurring at equal period of time . It may also Be said as equal payments or uniform series .In certain business dealings, equal payments are made at the end of equal period of Time and all such accumulate payments are allowed to earn compound interest .

Periods may be any lengths – year or month etc but periods should be equal length

Higher purchase payments , installments buying , LIC Premium payments are made by this method

Kind of annuities:1.Capital recovery annuity2.present worth annuity3.sinking fund annuity4.compound annuity


Capital Recovery Annuity :-This is applied in case of debt payments where this initial debt or capital is recovered in uniform or equal periodic payments.

Formula for capital recovery annuity

CRF = i (1+i))n/(1+i)n - 1

i= compound interest rate

n = no of interest period

Capital Recovery Annuity


Present Worth Annuity

This is applied to premium and all other retirements plan. These are usually known as premium annuities and other future provisions.

Formula for present worth annuity

PW = D [(1+i))n - 1/i(1+i)n ]D= periodical payment ammounti= compound interest raten = no of interest period


This is applied to define sum required to be

called at future date by setting aside at equal interval of time amount so that these equal period payment while earning compound interest total up the desired amount at the desire future date

Formula for sinking fund factor Sinking fund factor = i

/(1+i)n - 1


n = no of interest period

Sinking Fund Annuity


Compound Amount Annuity

In this a person deposits equal amount at the end of number of periods and each amount is allowed to earn compound interest per period. This is used in saving deposits scheme cumulative time deposits scheme

Formula for compound amount annuity Compound amount

annuity = (1+i)n - 1/ i


n = no of interest period 3/24/2017 Prof. R. P. Kodam JSPM's ICOER pune

Supply

Definition of Supply: supply is quantity of goods sellers wish to sell at each conceivable price.

Determination of price

The determinates of supply Cost factors of production State of technology Factors outside the economic sphere Tax and subsidy


Law of Supply :

The law of supply holds that other things equal, as the price of a good rises, its quantity supplied will rise, and vice versa.

Example :


S

price

quantity

Price of a cement Quantity supplied per week

250 100300 150350 200

250

300

350

100 200150

Supply curve Relationship between the quantity of a good that producers are willing to sell and the price of the good.


The Supply Curve

The supply curve, labeled S in the figure, shows how the quantity of a good offered for sale changes as the price of the good changes. The supply curve is upward sloping: The higher the price, the more firms are able and willing to produce and sell.

If production costs fall, firms can produce the same quantity at a lower price or a larger quantity at the same price. The supply curve then shifts to the right (from S to S’).

A Change in Supply Versusa Change in Quantity Supplied

To summarize:Change in price of a good or service leads to

Change in quantity supplied(Movement along the curve).

Change in costs, input prices, technology, or prices of related goods and services

leads to

Change in supply(Shift of curve).


Elasticity of Supply If small rise or fall in the price leads to

large decrease or increase in supply respectively, the supply is called as elastic supply.

On the other hand if large change in the price brings only a small change in supply , it is called as inelastic supply


The following fig gives method used to calculate elastic supply


SS’ is the supply curve

calculate elastic supply SS’ is the supply curve. Consider three points on it

A, B, C and draw tangents to the curve through these points. The tangents touches the X axis at points E and F whereas touches the Y axis at the points D and G. the tangents through B passes through the origin. The price elasticity of supply at given point is measured by the distance along the tangents to horizontal axis divided by the distance along it on the vertical axis


Demand Definition of demand: demand is quantity

of goods buyer wish to purchase at each conceivable price.


Law of Demando The law of demand holds that other things equal, as the price of a good or service

rises, its quantity demanded falls.o The reverse is also true: as the price of a good or service falls, its quantity demanded

increaseso Assumption :

o No change in consumer’s incomeo No change in consumer’s preferences o No change in fashiono No change in price of related good



Price of a commodity Quantity demanded per week

5 100

3 150

1 200

D

price

quantity

1

3

5

100 200150

The Demand Curve

The demand curve, labeled D, shows how the quantity of a good demanded by consumers depends on its price. The demand curve is downward sloping; holding other things equal, consumers will want to purchase more of a good as its price goes down. The quantity demanded may also depend on other variables, such as income, the weather, and the prices of other goods. For most products, the quantity demanded increases when income rises. A higher income level shifts the demand curve to the right (from D to D’). 3/24/2017 Prof. R. P. Kodam JSPM's ICOER pune


Demand curve :

Relationship between the quantity of a good that consumers are willing to buy and the price of the good.

A Change in Demand Versus a Change in Quantity Demanded

To summarize:Change in price of a good or service leads to

Change in quantity demanded(Movement along the curve).

Change in income, preferences, orprices of other goods or services

leads to

Change in demand(Shift of curve).


The Demand Curve

Shifting the Demand Curve

If the market price were held constant, we would expect to see an increase in the quantity demanded as a result of consumers’ higher incomes.

Because this increase would occur no matter what the market price, the result would be a shift to the right of the entire demand curve.

Elasticity of Demand• As per the law of demand as the price of commodity changes, the demand also changes. For some commodities, the rate of change of demand is rapid while for the others it is slow.

•A Small change in price may lead to great change in demand (elastic demand) while for other It is unaffected e.g. though the price of salt increase, the quantity demanded remains the same (inelastic demand).

•The rate at which demand for commodity changes, when its price changes, is known as the elastic demand


Equilibrium In economics, an equilibrium is a

situation in which: there is no inherent tendency to

change, quantity demanded equals quantity

supplied, and the market just clears.


Market Equilibrium

The operation of the market depends on the interaction between buyers and sellers.

An equilibrium is the condition that exists when quantity supplied and quantity demanded are equal.

At equilibrium, there is no tendency for the market price to change.


To determine the equilibrium price, you have to figure out at what price the demand and supply curves intersect. This is easiest to see visually on the graph below. The Supply and Demand curves intersect at P* and Q*, which are the equilibrium price and quantity.


Equation and Example

Equilibrium

Equilibrium occurs at a price of $3 and a quantity of 30 units.


Factors Affecting Price Decisions

Internal Factors1.Marketing Objectives2.Marketing Mix Strategy3.Product Cost4.Organizational considerations

External Factors1.Nature of the market & demand2.Competition3.Environmental factors (economy, resellers, government)

PricingDecisions


Before making policy, strategy and technique of determining price of goods or services, a marketer should consider both internal and external environmental factors of the firm that affect the pricing.

All the elements of marketing mix have close relationship with environmental factors. Among them, pricing is perhaps a very sensitive as well as explosive power.

Business firm itself, consumers or customers , channel members, competitors, government and economy are the major factors that play significant role at different stages in the process of pricing. These factors can be discussed as follows:

Factors Affecting Price Determination


http://marketinglord.blogspot.in/2012/06/factors-affecting-price-determination.html

1. Internal or controllable pricing factorsUnder the internal organization factors include the objective of the business firm, production and distribution cost, marketing mix, nature of products, firm's expectations and reputation, etc. They are called internal pricing determinants and can be controlled by marketer.


a. Organization's objectivesThe objectives of a marketing organization greatly influence pricing. A manufacturing company, at the introductory stage of its new product, determines low price to bring them to markets. But some other firms may determine high introductory price of their products to recover their investment or to get expected return from the investment. Whatever the objective of the company may be, it affects price determination.

b. Cost of manufacturing and marketingThe manufacturing and distribution cost greatly as well as directly affects pricing. If the cost for production and distribution is high, it becomes impossible to determine low price.

.


c. Other marketing mix components

The other components of marketing mix i.e. product, place and promotion prepared by a business organization all affect pricing. The nature of products does not only make it possible bust also make it is essential to determine price of the product. Similarly, reputation or goodwill of organization also affect price determination. Likewise promotion cost also affects pricing decision


2. External or independent pricing factorsThe external factors include customers, channel members, competitors, government, economic condition of country etc. These are independent factors and cannot be controlled by marketer.

a. Consumers and marketConsumers and target markets also affect pricing of products. Those who determine price should pay careful attention to the elements of buying behavior and methods. More attention should be given to the characteristics of target market, condition of the products, consumers' perception, thought and attitudes towards the price and quality of the products etc.3/24/2017 Prof. R. P. Kodam JSPM's ICOER pune

b. Channel membersPricing is also affected by the members of distribution channel. The necessity and objective of channel members matching with pricing policy of the marketer can make distribution possible. The discount given to wholesalers or retailers is the important component in the profit to middlemen. So, the price determiner should get knowledge about the distributors' attitude towards the price and what price will they sell the products to consumers. Without written agreement, manufacturers cannot provide authority or direct the middlemen to fix final price, but can give suggestions.


c. CompetitionPrice of most of products is determine by considering the competition in market price. The company with having large market share becomes the price leader. When it increases or decreases price of its products, other company also do the same or adopt the same policy. But if there is no domination or influence of any single company in the market, the marketer analyses and evaluates the prices of all main competitor companies, collects reactions and draws conclusion. In this way, competition among manufacturers affects price determination.


d. Government

Government policy and decisions also affect pricing. The government of each country have their own policy, decisions, rules and regulations. Price should be determined considering price control policy of government, sale tax, income tax policy etc. Prices of some products are controlled by government direction and the government itself determines prices of some products.


Utility

Total utility: total amount of satisfaction or pleasure a person get from consuming a certain amount of goods or services. Reading a book give pleasure to Riya, which can be quantified

as 20 utils. Reading three books give pleasure to Riya as 50 utils.

Marginal utility: the amount of satisfaction or pleasure a person get from consuming 1 more unit of the product. Reading the first book give pleasure to Riya 20 utils. Reading

the second book give pleasure to Riya 17 utils. Reading the thrid book give pleasure to Riya 13 utils.

Marginal Utility (MU) = Change of total utility (TU)/Change in quantity of product consumed (Q)


The law of diminishing marginal utility

The more the product a person consume, the less desirable the person is for that product. The first plate of rice provides great utility for the eater. The

second plate also provides utility for the eater but less than the previous plate. The third plate provides even less utility than the second plate.

When marginal utility decreases and still remain positive, the total utility increases. However, when marginal utility decreases below zero level (negative), the total utility starts falling down. The 10th plate of rice will provide negative utility for the

eater. 3/24/2017 Prof. R. P. Kodam JSPM's ICOER pune

The law of diminishing marginal utility


Law of substitution Purchasing dozens of banana, if unit price of it

seems to be high , then we may think less number of banana or banana of small size and less price. Similarly in revers way price of dozen is less, we may think of purchasing another fruit which will match our budget. Thus we are continuously substituting one commodity with another with money as bridge and aiming at maximum satisfaction this principle is called as law of substitution.


CapitalDefinition of capital :Capital is life line of any project. It can be in the form such as money, land, property .capital can be define as a wealth which created over a period of time

Cost of Capital:The loan/ capital providers like bank, share holders etc. want to suitably compensated for investing funds in the project. This expectation is known as cost of capital and the expression in the terms of percentage . It is the discount rate used for converting the expected cash flow into its present value.


Need for capital Capital require for following purposes: To promotes a business To conduct business operation smoothly To expand the diversity To meet contingencies (sudden fall in sales,

natural calamities) To pay taxes To pay interest to shareholders. To replace the assets like plants and machinery To support welfare programs To wind up the business


Types of capital


Unit no.04 project economics

Education

Transcript of Unit no.04 project economics