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IGNOU MBA MS-52 Solved Assignment 2011

Course Code : MS - 52

Course Title : Project Management

Assignment Code : MS-52/SEM - I /2011

Coverage : All Blocks

Note: Answer all the questions and send them to the Coordinator of the Study Centre you are attached

with.

Q1. What are the phases of a Project Development Cycle? Give the salient tasks under each phase.Solution : The Project Life Cycle refers to a logical sequence of activities to accomplish the projects

goals or objectives. Regardless of scope or complexity, any project goes through a series of stages during

its life. There is first an Initiation or Birth phase, in which the outputs and critical success factors are

defined, followed by a Planning phase, characterized by breaking down the project into smaller

parts/tasks, an Execution phase, in which the project plan is executed, and lastly a Closure or Exit phase,

that marks the completion of the project. Project activities must be grouped into phases because by doing

so, the project manager and the core team can efficiently plan and organize resources for each activity,

and also objectively measure achievement of goals and justify their decisions to move ahead, correct, or

terminate. It is of great importance to organize project phases into industry-specific project cycles. Why?

Not only because each industry sector involves specific requirements, tasks, and procedures when it

comes to projects, but also because different industry sectors have different needs for life cycle

management methodology. And paying close attention to such details is the difference between doing

things well and excelling as project managers.

Diverse project management tools and methodologies prevail in the different project cycle phases. Lets

take a closer look at whats important in each one of these stages:

1)Initiation

In this first stage, the scope of the project is defined along with the approach to be taken to deliver the

desired outputs. The project manager is appointed and in turn, he selects the team members based on theirskills and experience. The most common tools or methodologies used in the initiation stage are Project

Charter, Business Plan, Project Framework (or Overview), Business Case Justification, and Milestones

Reviews.

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2)Planning

The second phase should include a detailed identification and assignment of each task until the end of the

project. It should also include a risk analysis and a definition of a criteria for the successful completion of

each deliverable. The governance process is defined, stake holders identified and reporting frequency and

channels agreed. The most common tools or methodologies used in the planning stage are Business Plan

and Milestones Reviews.

3)Execution and controlling

The most important issue in this phase is to ensure project activities are properly executed and controlled.

During the execution phase, the planned solution is implemented to solve the problem specified in the

project's requirements. In product and system development, a design resulting in a specific set of product

requirements is created. This convergence is measured by prototypes, testing, and reviews. As the

execution phase progresses, groups across the organization become more deeply involved in planning for

the final testing, production, and support. The most common tools or methodologies used in the execution

phase are an update of Risk Analysis and Score Cards, in addition to Business Plan and Milestones

Reviews.

4)Closure

In this last stage, the project manager must ensure that the project is brought to its proper completion. The

closure phase is characterized by a written formal project review report containing the following

components: a formal acceptance of the final product by the client, Weighted Critical Measurements

(matching the initial requirements specified by the client with the final delivered product), rewarding the

team, a list of lessons learned, releasing project resources, and a formal project closure notification to

higher management. No special tool or methodology is needed during the closure phase.

Q2. What are the traditional methods of financial evaluation of the projects? Give a comparative

analysis of these methods.

Solution :The project evaluation process involves more than just determining a project's expected revenues andprofitability; it also involves a study of the key factors that affect a project and their financial impact onthe project. In addition, a project evaluation includes strategic evaluation, economic evaluation and socialimpact evaluation

FINANCIAL EVALUATION

The financial evaluation of a commercial project mainly involves estimating the return on investment and

the profitability of the project. However, the financial evaluation of non-commercial projects involve theidentification of the most efficient way of delivering the desired project outputs and ensuring that theproject outputs result in significant benefits to the community.

Financial appraisal includes the compilation of the list of alternative projects and the associated streamsof costs and benefits. The financial evaluation is conducted using the cash flow rather than accountingprofits method. The accuracy of the evaluation will ultimately depend on:The quality of the estimates on which the cash flows are basedThe identification of all relevant cash flows and

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The exclusion of all non-cash items.

FACTORS FOR MEASURING PROJECT CASH FLOWS

When calculating the financial costs and project cash flows, the following factors must be kept in mind incremental analysis, sunk costs, accrual accounting and cash flows, incidental effects and opportunitycosts.

INCREMENTAL ANALYSIS

According to this principle, the cash flows have to be measured in incremental terms. Only thoserevenues or expenditures that are likely to occur as a direct result of the project should be included whendetermining the cash flows. A project's incremental cash flows should be ascertained through the withand without principle, i.e. to determine the cash flows of the firm including and excluding the project.Project Cash Flow Cash flow for the firm Cash flow for the firm for year (T) = with the project for yearwithout the project for the year (T)-(T)

The idea behind the incremental analysis concept is to illustrate only the additional impact created by aproject. Cash flows that would have occurred irrespective of the project are extraneous to the analysis andshould be excluded.

Example

If a department currently owns a vehicle fleet and is considering selling it and leasing vehicles instead,

the incremental costs and benefits of doing so can be compared. If the net present value of the proposal is

positive, then the proposal should be accepted. If the current situation is being compared with more than

one alternative, the proposals can be ranked by dividing the net present value by the initial investment.

The proposal which should be accepted is that with the highest ratio of net present value to Investment.

SUNK COSTS

Sunk costs refer to non-recoverable costs incurred in the past or committed before the evaluation of aproject. These costs have to be ignored when conducting a financial evaluation of a project.

Example

Firm A has hired a consultant to assess the viability of outsourcing its credit collections and to list thepossible agencies to which it can outsource its collections. Firm A spent $121,000 on consultant's feesprior to the evaluation of proposals. It further estimated that other costs like legal fees, stamp duty etc. forsetting up an outsourcing contract would be $240,500 and the present value of cost savings fromoutsourcing will be $320,450. On the basis of the available information, the management of the companyargued that since it had already incurred $121,000 for assessing the viability of the project, it would be awaste not to proceed with outsourcing, while the staff argued that the firm should not proceed furtherbecause the project would never recover the initial outlay of $121,000. In this case, both the argumentsare invalid, as $121,000 is the sunk cost and thus irrelevant for calculating the project costs. Theoutsourcing project will have an NPV of $79,950 ($320,450 $240,500).

OPPORTUNITY COSTS

Each and every resource utilized by a project entails a cost, irrespective of whether the resource ispurchased for the project or already owned by the firm. If the resource is already owned by the firm, theopportunity cost of the resource must be charged to the project. The opportunity cost of a resource is thepresent value of net cash flows that can be derived from it if it were to be put to its best alternative use.Suppose a project requires land that is already owned by the firm. Though the cost of the land is a sunk

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cost and needs to be ignored, its opportunity cost, i.e., the income it would have generated had it been putto its next best use must be considered.

ACCRUAL ACCOUNTING AND CASH FLOWS

All costs and benefits are to be measured in terms of cash flows than in terms of accrual accounting

whereby income and expenditure are recognized when the transaction is entered into rather than when

payment or receipt takes place. This implies that all non-cash charges like depreciation and provisions

that are deducted for the purpose of determining profit after tax must be added back to profit after tax to

arrive at the net cash flow.

INCIDENTAL EFFECTS

All incidental effects of a project on the rest of the firm's activities must be considered. The proposed

project may have a beneficial or detrimental effect on the revenue stream of other product lines of the

firm. Such impact must be quantified and considered when ascertaining the net cash flows.

POST TAX PRINCIPLE

For the purpose of appraisal, the cash flows of a project must be defined in post tax terms. Cash flows can

be defined in three ways. Each of the methods of cash flow estimation depends on different viewpoints

regarding who provides the capital for a project whether it is only equity shareholders or both equity

shareholders and long term lenders or the total fund providers (including long term and short term). The

post tax cash flows under the three viewpoints would be different.

CASH FLOWS FROM LONG TERM FUNDS POINT OF VIEW

This method is based on the assumption that funds invested in a project come from both equityshareholders and long term lenders. When calculating net cash flows using this method, the interest paid

on long term loans is excluded. The rationale for this approach is that the net cash flows are defined fromthe viewpoint of suppliers of long term funds. Hence, the post tax cost of funds is used as the interest ratefor discounting. The post tax cost of long term funds obviously includes the post tax cost of long termdebt. Therefore, if the interest on long-term debt is considered for the purpose of determining net cashflows, an error due to double counting would occur.

CASH FLOWS FROM LONG TERM FUNDS POINT OF VIEW Contd..

Example

Suppose a project has the following cash outlays and sources of finance:(Rs. in millions) Plant & Machinery 230Working Capital 126Sources of Finance

Equity 135Long term loans 120Trade Credit 44Commercial Banks 57

The life of the project is 8 years. Plant & Machinery is to be depreciated on a written down value methodat the rate of 15% per annum. Annual sales are expected to remain constant over the period at Rs. 340million. Cost of sales (including depreciation but excluding interest) is expected to be Rs. 180 million ayear.

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The company is under the 40% tax bracket. At the end of the 8 years, plant & machinery will fetch avalue equal to their book value and the investment in working capital will be fully recovered. The rate ofinterest on long-term loans is 15% p.a. The loans are repayable in six equal installments starting from theend of the third year. Short term advances from commercial banks which will carry an interest of 16%p.a. will be maintained at Rs. 57 million. They will be fully liquidated at the end of 8 years. Trade creditwould also be uniformly maintained at Rs. 44 million and will be fully paid at the end of 8 years.

Operating flow = Profit after tax (PAT) + Depreciation + Other non cash charges +Interest on long term (1 T)Terminal Flow = Net salvage value of fixed assets + Net recovery of working capitalMargin

CASH FLOWS FROM EQUITY FUNDS POINT OF VIEW

When cash flows are computed from the equity funds point of view, only the funds contributed by theequity holders towards the project are considered as an initial investment. The operating cash flowincludes profit after taxes, depreciation, other non-cash charges and preference dividend. The terminalflow will be equal to the net salvage value of fixed assets and the net salvage value of current assets

minus repayment of term loans, redemption of preference capital, repayment of working capital advances,and retirement of trade credit and other dues.

CASH FLOWS FROM TOTAL FUNDS POINT OF VIEW

When cash flows are computed from the total funds point of view, the funds contributed by all thesuppliers of funds towards the project are considered for the calculation of the initial investment. Theoperating cash flows are calculated by adding profit after taxes, depreciation, non-cash charges, intereston long term borrowing (1-T) and interest on short term borrowing (1-T). The terminal flow will be equalto the net salvage value of fixed assets and net recovery of WC margin.

CHOICE OF DISCOUNT RATEThe next step in the financial evaluation phase is the determination of an appropriate discount rate. Thedetermination of an appropriate discount rate is necessary for establishing the financial feasibility of aproject. Most of the appraisal criteria used these days are time adjusted or discounted criteria, like netpresent value (NPV), benefit cost ratio (BCR) and internal rate of return (IRR). All these require the useof a risk-adjusted discount rate to determine the actual returns from the project (Refer Exhibit II). Themost commonly used method for determining the discount rate makes use of theoretical models like thecapital asset pricing model (CAPM)[6] and the weighted-average cost of capital (WACC) model.The CAPM is used to ascertain the relevant cost of equity for a given level of risk. This is then combinedwith the cost of debt funds in proportion to their respective weights in the total funds used to finance theproject. This combined approach is known as the WACC.WACC =

SVx Ke +DVx Kd x (1-Tc)Where:Ke = Cost of EquityKd = Cost of Debt

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S = the market value of the firm's equityD = the market value of the firm's debtV = S + DS/V = percentage of financing in terms of equityD/V = percentage of financing in terms of debtTc = the corporate tax rate

APPRAISAL CRITERIA

After determining the cash flows of a project, one must assess its viability. This can be achieved throughthe use of discounted criteria or non-discounted criteria.

Time adjusted or discounted criteria includeNet present value.Internal rate of return.Benefit-cost ratio or profitability index.

Traditional or Non-discounted criteria include

Accounting rate of return.

Payback period.

Certain assumptions are made when appraising projects using the criteria given above. They are:The risk of all project proposals under consideration does not differ from the risk of the existing projectsof the firm.The firm has certain criteria for evaluating the projects. Based on the criteria, the investment decisionwill be either to accept or to reject the proposal.DISCOUNTED CASH FLOW/TIME ADJUSTED TECHNIQUES

This method requires cash flows to be discounted at a certain rate known as the cost of capital. Thistechnique recognizes the fact that cash flows occurring at different time periods and in different amounts

can be compared only when they are expressed in terms of a common denominator i.e. present value.Thus, in this method, all the cash inflows are discounted at an appropriate discount rate and the presentvalue so determined is compared with the present value of cash outflows.

NET PRESENT VALUE

Where,NPV = Net present valueCFt = Cash flow at the end of year (t = 0n)(cash inflow has a positive sign and cash outflow has a negative sign)n = Life of the project (number of years)k = Discount rateThe decision rule associated with NPV criteria is to accept all proposals with an NPV greater than zero.

This indicates accepting all projects that add value after providing a return, consistent with the cost ofcapital and risk. Where two or more projects are mutually exclusive, then the project with the highestNPV should be chosen.

Merits of NPV criterion

The merits are:

It recognizes the importance of the time value of money.It takes into consideration the benefits accruing over the entire life of the project.It follows the principle of shareholder's wealth maximization.

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Demerits of NPV criterion

The main drawbacks of this method are:In some cases it may be difficult to determine the appropriate discount rate. The choice of an appropriatediscount rate is important because the relative desirability of the project will change with the change indiscount rate.

This method favors the project with the higher NPV. In some cases, the project with a higher NPV mayinvolve a higher initial outlay which may exceed the budgeted investment outlay for the project.This method may not give satisfactory results when the two projects in question have different economiclives.One of the basic assumptions of NPV is that all the intermediate cash flows are re-invested at a rate equalto the cost of capital. However, if this assumption is invalid, the net present value has to be modifiedtaking into account the re-investment rate.

The steps involved in the calculation of the Modified Net Present Value are given below.

a) The terminal value of intermediate cash flows calculated at the new re-investment rate:

Where,TV = Terminal ValueCFt = Cash inflow at year endr'= re-investment rate

b) The Modified Net Present Value is calculated in the following manner:Where,

NPVn = Modified net present valueTV = Terminal Valuek = Cost of capitalI = Investment outlay

NET PRESENT VALUE Contd..

The evaluation criteria used by the NPV method are:The project is accepted when the NPV is positive.The project is rejected when the NPV is negative.The project reaches the point of indifference when the NPV is zero.For more than one mutually exclusive project, the one with the highest NPV must be selected.

BENEFIT-COST RATIO

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The Benefit Cost Ratio (BCR) is a time-adjusted capital budgeting technique. Also known as theprofitability index, it measures the present value of returns per rupee invested. BCR is defined as the ratioof the present value of benefits to the initial investment. It is represented as follows:

Where,BCR = Benefit-cost ratioPVB = Present value of benefitsI = Initial investmentThe decision rule associated with BCR criteria is to accept all proposals with a BCR greater than one. Ifthe BCR is equal to one, the firm is indifferent to the project. If two or more projects are mutuallyexclusive, then the project with the higher BCR should be chosen.There is another measure - Net Benefit Cost Ratio (NBCR) linked to BCR. It is the ratio between NPVand initial investment

Three decision rules associated with NBCR criterion are If NBCR is greater than zero, the project is accepted. If the NBCR is equal to zero, the firm is indifferent to the project. If the NBCR is less than zero, the project is rejected.

Merits of BCR Criterion

BCR, like NPV criterion, also considers the time value of money when evaluating projects. It also takesinto account all the benefits accruing over the life of the project. It is superior to the NPV measure in thesense that it evaluates the project in relative terms rather than absolute terms.

Demerits of BCR Criterion

This criterion may assign a similar ranking to two different projects.The evaluation criteria used by the BCR method are: The project is accepted when the BCR is greater than one. The project is rejected when the BCR is less than one. The project reaches the point of indifference when the BCR is equal to one.For more than one mutually exclusive project one with the highest BCR must be selected.

INTERNAL RATE OF RETURN METHOD

The second time-adjusted criterion for the appraisal of a project is the internal rate of return. This refers tothe rate of return that is earned by a project. It equals the present value of cash inflows with the presentvalue of cash outflows i.e. it is the discount rate at which the NPV of the project is zero.If the IRR of a project is greater than the cost of capital, the project should be accepted. In this case, thecost of capital is also called the hurdle rate. The IRR is represented by the following formula:

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Where CFt = Cash inflows at different time periodsr = internal rate of returnn = Life of the projectTo develop a better understanding of the calculation of the IRR, take a look at the following examples:Firm XYZ Ltd. is planning to invest Rs 65,000 in its new project. This project is expected to last for 5years. Its estimated cash flows are Rs 12,500, Rs 15,300, Rs 16,700, Rs 13,400 and Rs 14,300 for the yearone, two, three, four and five respectively.

The IRR can be calculated using the following formula:

Using the trial and error method, different rates are substituted in the formula to find out which value canequalize the two sides of the formula. Let us first substitute r with 4%; then the left hand side of theequation changes to:

By using 4%, the value derived after solving the equation is less than Rs 65000. Hence, we take 3%.

By using 3%, the value derived after solving the equation is more than Rs 65000. It is therefore clear thatthe actual IRR lies somewhere between 3% and 4%. Using interpolation, we find out a single value of

IRR. The actual IRR calculated using interpolation is 3.67%. When the payback period is given, the IRRcan be calculated as follows:

Where PB = Payback period

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DFr = Discount factor for interest rate rDFrL = Discount factor for lower interest rateDFrH = Discount factor for higher interest rate.

NET PRESENT VALUE Contd..

Suppose a project's payback period is 3.52 years. Its initial investment is Rs 75000 and its average annual

cash flows are Rs 21300. Then discount factors closer to3.52 are 3.605 at 12% and 3.517 at 13%. From this we can assume that the IRR is between 12% and 13%.We can calculate the actual IRR with the help of the above formula.

The merits of this criterion are:

It takes into account the time value of money.It considers all cash flows.

Drawbacks of this method are:

It involves complicated calculations.It gives multiple rates of return when there is a series of changes in cash flows i.e. cash inflows andoutflows.In case of mutually exclusive projects, the IRR method might accept a project with higher IRR but with arelatively low NPV. This is because the IRR assumes that all the cash inflows are again invested in theproject at the internal rate of return.

The evaluation criteria for the project using the IRR method are:

The project is accepted when the IRR is greater than the cost of capital or required rate of return.

The project is rejected when the IRR is less than the cost of capital or required rate of return.The project reaches the point of indifference when the IRR is equal to the cost of capital or the requiredrate of return.When there are mutually exclusive projects, the one with the highest IRR must be selected.

MULTIPLE RATES OF RETURN

Projects do not always have cash inflows every year. Sometimes, negative cash flows or cash outflowsoccur, particularly when projects involve heavy investments or have long gestation periods. This situationis the basic reason for the realization of multiple rates of return.Let IRR be r. Equation to calculate internal rate of return for the cash flow streams given above will be

= (1 + r)2 + 7(1 + r) 12 = 0

=

=r2 5r + 6 = 0

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= (r 2)(r 3) = 0= r = 2 or 3As there are changes in signs, there are two roots of the equation. So, there are two internal rates of returnfor the project. Which one should be taken for the appraisal becomes difficult for appraiser to difficult?MODIFIED INTERNAL RATE OF RETURN (MIRR)

Even though NPV is a better method conceptually than the IRR method, most managers prefer IRR over

NPV since IRR is a percentage measure. A percentage measure that overcomes the shortcomings ofregular IRR is known as modified internal rate of return (MIRR).The procedure for calculating MIRR is given below:Step 1: Calculate the present value of the costs (PVC) associated with the project, using the cost of capital(r) as the discount rate:

Step 2: Calculate the terminal value (TV) of the cash inflows expected from the project:

Step 3: Obtain MIRR by solving the following equation:PVC = TV/(1 + MIRR)n

The following examples demonstrate the calculation of MIRR.Example I

Pentagon Limited is evaluating a project that has the following cash flows:YEAR 0 1 2 3 4 5 6

CashFlow (Rs. inmillion)-120 -80 20 60 80 100 120

The cost of capital for Pentagon is 15 percent. The present value of costs is:120 + 80/(1+0.15) = 189.6The terminal value of cash inflows is:20(1.15)4 + 60(1.15)3 + 80(1.15)2 + 100(1.15)1+ 120

= 34.98 + 91.26 + 105.76 + 115 + 120 = 467The MIRR is obtained as follows:189.6 = 467/(1+MIRR)6(1+MIRR)6 = 2.4631 + MIRR = (2.463)1/6 = 1.162MIRR = 0.162 = 16.2%

The MIRR method is superior to the IRR method. MIRR assumes that the project cash flows arereinvested at the cost of capital whereas the regular IRR assumes that the project cash flows are

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reinvested at the project's own IRR. Since reinvestment at the cost of capital (or some other explicit rate)is more realistic than reinvestment at IRR, MIRR reflects the true profitability of a project. In addition,the problem of multiple rates does not exist with MIRR. However, for choosing among mutuallyexclusive projects of different size, the NPV method is better than the MIRR method because it measuresthe contribution of each project to the value of the firm.

The evaluation criteria under the MIRR method are:The project is accepted when the MIRR is greater than the cost of capital or the required rate of return.The project is rejected when the MIRR is less than the cost of capital or the required rate of return.The project reaches the point of indifference when the MIRR is equal to the cost of capital or therequired rate of return.When there are mutually exclusive projects, the one with the highest MIRR must be selected.

TRADITIONAL OR NON-DISCOUNTED CRITERIA

When evaluating a project's viability, traditional or non-discounted criteria generally use accountingprofits rather than cash flows.

AVERAGE RATE OF RETURN METHOD

This method is also known as the accounting rate of return as it considers the accounting profits of a firmover a period of time. ARR is represented as follows:ARR = average annual income x 100/average investment throughout the life of theProject

Consider the following example:

Two machines, P and Q, with an estimated salvage value of Rs 2500 have an initial cost of Rs 36500 andan estimated life of 5 years. Depreciation is charged on the basis of the straight line method.The merit of this criterion is that it is easy to calculate and understand. However, the demerit of thismethod is that it uses accounting profits instead of cash flows.

The evaluation criteria using this method are:

The project is accepted when the actual ARR is greater than the required ARR.The project is rejected when the actual ARR is less than the required ARR.When there are mutually exclusive projects, the one with the highestARR but more than the cut off ARR must be selected

PAYBACK PERIOD METHOD:This is the most commonly and widely used method for the appraisal of capital investment decisionsregarding projects. This criterion evaluates a project on the basis of the speed with which it recovers itsinitial investment. It can be computed in two ways: When the cash inflows after tax (CFAT) are the sameevery year the following formula is used:Payback period = Initial investment /CFAT

The major advantages of this criterion are:

Like ARR it is easy to calculate PB.

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It takes into account cash flows (and is hence superior to ARR).It helps identify projects which can earn quick returns (useful in industries where rapid technologicalchange is common).

This criterion has the following drawbacks:

It does not consider the cash flows after the payback period.

It does not consider the timing of cash flows.It does not show whether or not the project that has been accepted is going to maximize the wealth of thestakeholders.

The evaluation criteria for this method are:

The project is accepted when the actual payback period is less than the required or predeterminedpayback period.The project is rejected when the actual payback period is greater than the required or predeterminedpayback period.When there are mutually exclusive projects, the one with the lowest payback period but less than cut offpayback period must be selected.

DISCOUNTED PAYBACK PERIOD METHODUnlike the payback method, this criterion takes into account the discounted cash flows of a project. In thismethod, cash flows are discounted at the cost of capital, which shows the time value of money as well asthe riskiness of the cash flows. The decision rule for this criterion is to accept the project with lesspayback period or when the accumulated discounted cash flows are equal to the initial investment.

The discounted payback period is measured as follows:

The evaluation criteria for this method are:

The project is accepted when the actual discounted payback period is less than the required orpredetermined payback period.

The project is rejected when the actual discounted payback period is greater than the required orpredetermined payback period.Where there are mutually exclusive projects, the one with the least discounted payback period but lessthan the cut off payback period must be selected.

APPRAISAL TECHNIQUES IN PRACTICE FOR VARIOUS TYPES OF PROJECTS

The most commonly used method for conducting a financial appraisal of small projects requiring lessfinancial investments is the payback method.

For larger projects, the average rate of return is commonly used as the principal criterion and thepayback period is used as a supplementary criterion.Discounted cash flow (DCF) techniques are now being increasingly used to evaluate large investments.

Many other criterias are used for evaluating investments: profit per rupee invested (calculates the actual

profit earned in terms of each rupee invested); cost saving per unit of product (calculates the amount of

savings on the cost of production per unit); and investment required to replace a worker (calculates the

additional amount required to replace an existing worker).

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CAVEATS FOR IMPROVED FINANCIAL EVALUATION

The appraisal criteria for evaluating projects should be standardized. The use of many methods makescomparison between projects difficult.The approach followed for evaluating projects must be clearly defined. Vague qualitative phrases shouldbe substituted by quantitative measures wherever possible. This is necessary to promote understandingand avoid confusion.

Discounted cash flow techniques should receive greater emphasis. They are theoretically superior andpractically feasible.To sum up, the evaluation must be carried out in explicit, well defined, preferably standardized terms andshould be based on sound economic principles. Investment decision-making must be based on a carefuland sound evaluation of the available data.

CONCLUSION

The selection of a technique essentially depends on whether the projects are independent or mutuallyexclusive and whether or not capital rationing is applied to them. Firms generally use the discounted cashflow method as the primary evaluation technique and conventional methods as secondary techniques forevaluating a single project. Project evaluation techniques help a firm maximize wealth by determining theright project to be undertaken from the various alternatives available to the firm. The finance managers of

a firm are responsible for choosing a project evaluation technique that would best suit the organization'srequirements.

Q3. Discuss the usefulness of matrix organization in project management. Also explain the recent

trend in organization design.

Solution : Matrix Management is a type of organizational management in which people with similarskills are pooled for work assignments. For example, allengineers may be in one engineering departmentand report to an engineering manager, but these same engineers may be assigned to different projects andreport to a project manager while working on that project. Therefore, each engineer may have to workunder several managers to get their job done.

The matrix

Some organizations fall somewhere between the fully functional and pure matrix. These organizations are

defined in the Guide to the Project Management Body of Knowledge (PMBOK) 4th Edition as composite.

For example, even a fundamentally functional or matrix organization may create a special project team to

handle a critical project.

Whereas project-centered organizations (like those in engineering, construction or the aerospace

industries) have structures built around project teams as their functional units, matrix organizations follow

the traditional structures, with some adjustments to their hierarchy to support project units

There are a lot of different styles of matrix organizations. In each, the end goal is to create harmony

between all the needs of the manager, but the means to reach that end are different. The three main kinds

of matrix structures are the weak matrix, the strong matrix, and the balanced matrix. In this article, the

advantages and disadvantages of the weak matrix structure type will be examined.

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Weak Matrix Organization Structure

When a project manager is assigned to oversee a group that is organized in this manner, it can be a

complicated task. The project manager has to facilitate all aspects of theproject. They actively plan and

assess the project's progress, but don't really have any sway when it comes to the employees. Thereforethey must rely on the tools available to the actual managers to really control the workers.

Employees in this organization are not attached to temporary management staff, or to temporary projects,

because it is another manager entirely who is responsible forpromotions. These "functional managers"

and the work they assign becomes the primary goal of employees, and any other projects and managers

take a back seat. This means that the project manager has to combat strong apathy from his workers in

order to be successful.

What's worse, since the project manager has no actual authority on the project, the only thing truly in his

power in the case of a failing project is to report the negative results to a functional manager. The project

manager hopes that the functional manager will straighten out and refocus the employees on the project,but this doesn't always happen.

However, don't forget, functional managers must aspire to the responsibility for overseeing work

performance in his/her functional area. So that the workers engaged in the current project's tasks don't

decrease the productivity of the functional unit as a whole. A result this significantly occurs between

functional managers, project managers, and individual workers.

When this happens, the unfortunate loser is typically the project manager. In this kind of matrix

organization, the project manager is usually a weak figure that holds little sway over his crew.

Advantages and disadvantages

The advantages of a matrix include:

Individuals can be chosen according to the needs of the project.

The use of a project team which is dynamic and able to view problems in a different way as

specialists have been brought together in a new environment.

Project managers are directly responsible for completing the project within a specific deadline

and budget.

Whilst the disadvantages include:

A conflict of loyalty between line managers and project managers over the allocation of

resources.

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Projects can be difficult to monitor if teams have a lot of independence.

Costs can be increased if more managers (ie project managers) are created through the use of

project teams.

New Organizational Logic

EMERGING TRENDS IN ORGANIZATIONAL STRUCTURE

Except for the matrix organization, all the structures described above focus on the vertical organization;

that is, who reports to whom, who has responsibility and authority for what parts of the organization, and

so on. Such vertical integration is sometimes necessary, but may be a hindrance in rapidly changing

environments. A detailed organizational chart of a large corporation structured on the traditional model

would show many layers of managers; decision making flows vertically up and down the layers, but

mostly downward. In general terms, this is an issue of interdependence.

In any organization, the different people and functions do not operate completely independently. To a

greater or lesser degree, all parts of the organization need each other. Important developments in

organizational design in the last few decades of the twentieth century and the early part of the twenty-first

century have been attempts to understand the nature of interdependence and improve the functioning of

organizations in respect to this factor. One approach is to flatten the organization, to develop the

horizontal connections and de-emphasize vertical reporting relationships. At times, this involves simply

eliminating layers of middle management. For example, some Japanese companieseven very large

manufacturing firmshave only four levels of management: top management, plant management,

department management, and section management. Some U.S. companies also have drastically reduced

the number of managers as part of a downsizing strategy; not just to reduce salary expense, but also to

streamline the organization in order to improve communication and decision making.

In a virtual sense, technology is another means of flattening the organization. The use of computer

networks and software designed to facilitate group work within an organization can speed

communications and decision making. Even more effective is the use of intranets to make company

information readily accessible throughout the organization. The rapid rise of such technology has made

virtual organizations and boundarlyless organizations possible, where managers, technicians, suppliers,

distributors, and customers connect digitally rather than physically.

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A different perspective on the issue of interdependence can be seen by comparing the organic model of

organization with the mechanistic model. The traditional, mechanistic structure is characterized as highly

complex because of its emphasis on job specialization, highly formalized emphasis on definite procedures

and protocols, and centralized authority and accountability. Yet, despite the advantages of coordination

that these structures present, they may hinder tasks that are interdependent. In contrast, the organic model

of organization is relatively simple because it de-emphasizes job specialization, is relatively informal, and

decentralizes authority. Decision-making and goal-setting processes are shared at all levels, and

communication ideally flows more freely throughout the organization.

A common way that modern business organizations move toward the organic model is by the

implementation of various kinds of teams. Some organizations establish self-directed work teams as the

basic production group. Examples include production cells in a manufacturing firm or customer service

teams in an insurance company. At other organizational levels, cross-functional teams may be

established, either on an ad hoc basis (e.g., for problem solving) or on a permanent basis as the regular

means of conducting the organization's work. Aid Association for Lutherans is a large insurance

organization that has adopted the self-directed work team approach. Part of the impetus toward the

organic model is the belief that this kind of structure is more effective for employee motivation. Various

studies have suggested that steps such as expanding the scope of jobs, involving workers in problem

solving and planning, and fostering open communications bring greater job satisfaction and better

performance.

Saturn Corporation, a subsidiary of General Motors (GM), emphasizes horizontal organization. It was

started with a "clean sheet of paper," with the intention to learn and incorporate the best in business

practices in order to be a successful U.S. auto manufacturer. The organizational structure that it adopted is

described as a set of nested circles, rather than a pyramid. At the center is the self-directed production

cell, called a Work Unit. These teams make most, if not all, decisions that affect only team members.

Several such teams make up a wider circle called a Work Unit Module. Representatives from each team

form the decision circle of the module, which makes decisions affecting more than one team or other

modules. A number of modules form a Business Team, of which there are three in manufacturing.

Leaders from the modules form the decision circle of the Business Team. Representatives of each

Business Team form the Manufacturing Action Council, which oversees manufacturing. At all levels,

decision making is done on a consensus basis, at least in theory. The president of Saturn, finally, reports

to GM headquarters.

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The other major benefit to using EV is the ability to evaluate the performance of a project at any point

during the project's life cycle, not just at the completion of a project. How many times have you come to

the end of a project and learned that the project performance did not meet expectations? By the end of the

project it is too late to take any corrective action. Earned Value allows project managers to evaluate and

monitor their project through out the project life cycle, which will allow for better project control.

Key Components to Earned Value

There are three key components to EV that are used when evaluating projects for EVM.

Project Budget - The budget has two values that are used for EV, which are;

o Budgeted Cost of Work Schedule (BCWS) - BCWS is the baseline cost up to the current date.

o Actual Cost of Work Performed (ACWP) - ACWP are the actual cost required to complete all or some

portion of the tasks to the current date.

o Project Schedule - The project schedule has two values that are used for EV, which are;

Scheduled Time for Work Performed (STWP)

Actual Time of Work Performed (ATWP)

o Value of Work Performed - This is the value earned (reported percent complete) by the work

performed and is referred to as the Budgeted Cost of Work Performed (BCWP).

Earned Value Graph

The final outcome of an EV analysis is a three line graph showing cost over time for a project, which

helps visualizes the key values used in EV. The three lines indicated are the BCWS, ACWP, and BCWP

as described above. From reading the graph you can determine project variances as identified in Figure 1.

.

Figure

In this example looking at the data date the project is behind where it should be as indicated by the

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variance between BCWP and BCWS, and the project is over budget as indicated by the variance between

the ACWP and BCWS.

Responding to Earned Value

Earned Value is great, but they are not more than performance indicators and don't tell the whole story,

make decisions, or take action on a project, so that is where the project manager must intervene and

regain control over the project. The project manager should not only question cost and schedule

overruns, but should also question cost and schedule underruns as identified below.

Cost / Budget Variances

A positive variance indicates that the project is ahead of schedule or under budget. Positive variances

might enable you to reallocate money and resources from tasks or projects with positive variances to tasks

or projects with negative variances.

A negative variance indicates that the project is behind schedule or over budget and you need to take

action. If a task or project has a negative CV, you might have to increase your budget or accept reduced

profit margins.

Q5. Explain the concept of CYBERNETICS applied to project management.

Solution:In project management field, there are few things that can cause a project to require the controlperformance, costs or time.

Performance: Unexpected technical problems arise. Insufficient resources are available when needed. Insurmountable technical difficulties are present.

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Quality or reliability problems occur. Client requires changes in system specifications. Inter functional complications arise. Technological breakthroughs affect the project.

Cost:

Technical difficulties require more resources. The scope of the work increases. Initial bids or estimates were too low. Reporting was poor or untimely. Budgeting was inadequate. Corrective control was not exercised in time. Input price changes occurred.

Time: Technical difficulties took longer than planned to solve. Initial time estimates were optimistic. Task sequencing was incorrect.

Required inputs of material, personnel, or equipment were unavailable when needed. Necessary preceding tasks were incomplete. Customer-generated change orders required rework. Governmental regulations were altered.

And these are only a few of the relatively mechanistic problems that project control can occur.Actually, there are no purely mechanistic problems on projects. All problems have a human element, too.For example, humans, by action or inaction, set in motion a chain of events that leads to a failure tobudget adequately, creates a quality problem, leads the project down to a technically difficult path, or failsto note a change in government regulations. If, by chance, some of these or other things happen (as aresult of human action or not), humans are affected by them. Frustration, pleasure, determination,hopelessness, anger and may other emotions arise during the course of a project. They affect the work of

the individuals who feel them for better or worse. It is over this welter of confusion, emotion, fallibility,and general cussedness that the PM tries to exert control.

All of these problems, always combinations of the human and mechanistic, call for intervention andcontrol by the project manager. There are infinite slips especially in projects where the technology ordeliverables are new and unfamiliar, and project managers, like most managers, find control is a difficultfunction to perform. There are several reasons why this is so. One of the main reasons is that projectmanagers, again like most managers, do not discover problems. In systems as complex as projects, thetask of defining the problems is formidable, and thus knowing what to control is not a simple task.Another reason control is difficult is because, in spite of an almost universal need to blame some personfor any trouble, it is often almost impossible to know if a problem resulted from human error or from therandom application of Murphys Law.

Project managers also find it tough to exercise control because the project team, even on large projects, isan in-group. It is we while outsiders are they. It is usually hard to criticize friends, to subject themto control. Further, many project managers see control as an ad-hoc process. Each need to exercise controlis seen as a unique event, rather than as one instance of an ongoing and recurring process. Whitten offersthe observation that projects are drifting out of control if the achievement of milestones is threatened. Healso offers some guidelines on how to resolve this problem and bring the project back in control.

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Because control of projects is such a mixture of feeling and fact of human and mechanism, of causationand random chance, we must approach the subject in an extremely orderly way. This why we start byexamining the general purposes of control. Then we consider the basic structure of the process of control.We do this by describing control theory in the form of a cybernetic control loop. While most projectsoffer little opportunity for the actual application of automatic feedback loops, the system provides us witha comprehensive but reasonably simple illustration of all the elements necessary to control any system.

From this model, we then turn to the types of control that are most often applied to projects.The design of control systems is discussed as are the impacts that various types of controls tend to haveon the humans being controlled. The specific requirement of balance in a control system is alsocovered, as are two special control problems: control of creative activities, and control of change.

The process of controlling a project (or any system) is far more complex than simply waiting forsomething to go wrong and the, if possible, fixing it. We must decide at what points in the project wewill try to exert control, what is to be controlled, how it will be measured, how much deviation from planwill be tolerated before we act, what kinds of interventions should be used, and how to spot and correctpotential deviations before they occur. In order to keep these and other such issues sorted out, it is helpfulto begin a consideration of control with a brief exposition on the theory of control, No matter what ourpurpose in controlling a project, there are three basic types of control mechanisms we can use: cybernetic

control, go/no-go control and post-control. We will describe the first type and briefly discuss theinformation requirements of each. While few cybernetic control systems are used for project control, wewill describe them here because they clearly delineate the elements that must be present in any controlsystem, as well as the information requirements of control systems.

Cybernetic control

Cybernetic or steering control is by far the most common type of control system.The key feature of cybernetic control is its automatic operation. Consider the diagrammatic model of acybernetic control system shown in figure 1. As Figure 1 shows, a system is operating with inputs beingsubjected to a process that transforms them into outputs. It is this system that we wish to control. In orderto do so, we must monitor the system output.This function is performed by sensors that measure one or more aspects of the output, presumably those

aspects one wishes to control. Measurements taken by a sensor are transmitted to the comparator, whichcompares them with a set of predetermined standards.The difference between actual and standard is sent to the decision maker, which determines whether ornot the difference is of sufficient size to deserve correction. If the difference islarge enough to warrant action, a signal is sent to the effectors, which acts on the process or on the inputsto produce outputs that conform more closely to the standard.

A cybernetic control system that acts to reduce deviations from standard is called a negative feedbackloop. If the system output moves away from the standard in one direction, the control mechanism acts tomove it in the opposite direction. The speed or force with which the control operates is, in general,proportional to the size of the deviation from the standard. The precise way in which the deviation iscorrected depends on the nature of the operating system and the design of the controller. Figure 2

illustrates three different response patterns. Response path A is direct and rapid, while path B is moregradual. Path C shows oscillations of decreasing amplitude. An aircraft suddenly deflected from a stableflight path would tend to recover by following pattern C.

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Types of cybernetic control systems

Cybernetic controls come in three varieties, or orders, differing in the sophistication with which standards

are set. Figure 1 show a simple, first order control system, a goal seeking device. The standard is set andthere is no provision made for altering it except by intervention from the outside. The common thermostatis a time-worn example of a first order controller. One sets the standard temperature and the heating andair-conditioning systems operate to maintain it.

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Figure 3 show a second-order control system. This device can alter the system standards according tosome predetermined set of rules or program. The complexity of second-order systems can vary widely.The addition of a clock to a thermostat to allow it to maintain different standards during day and nightmakes the thermostat a second-order controller. Am interactive computer program may alter its responsesaccording to a complex set of pre-programmed rules, but it is still only a second-order system. Manyindustrial projects involve second-order controllers for example, robot installations, flexible

manufacturing systems, and automated record keeping or inventory systems.

A third-order control system (Figure 4) can change its goals without specific preprogramming. It canreflect on system performance and decide to act in ways that are not contained in its instructions. Third-order systems have reflective consciousness and, thus, must contain humans. Note that a second-ordercontroller can be programmed to recognize patterns and to react to patterns in specific ways. Suchsystems are said to learn. Third order systems can learn without explicit preprogramming and thereforecan alter their actions on the basis of thought or whim. An advantage of third-order controllers is that theycan deal with the unforeseen and unexpected. A disadvantage is that, because they contain humanelements, they may lack predictability and reliability. Third order systems are of great interest to the PMfor reasons we now discuss.

Information requirements for cybernetic controllersIn order to establish total control over a system, a controller must be able to take a counter-action forevery action the system can take. This statement is a rough paraphrase of Ashbys Law of RequisiteVariety. This implies that the PM\ controller is aware of the systems full capabilities. For complexsystems, particularly those containing a human element, this is simply not possible. Thus we need astrategy to aid the PM in developing a control system.One such strategy is to use a cost\benefit approach to control to control those aspects of the system forwhich the expected benefits of control are greater than the expected costs. We are reminded of a firm thatmanufactured saw blades. It set up a project to reduce scrap losses for the high-cost steel from which the

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blades were made. At the end of the one year project, the firm had completed the project cost $ 9700,savings $4240. (Of course, if the savings were to be repeated for several years, the rate of return on theproject would be acceptable. The president of the firm, however, thought that the savings would declineand disappear when the project ended.)

Relatively few elements of a project (as opposed to the elements of a system that operates more or less

continuously) are subject to automatic control. An examination of the details of an action plan will revealwhich of the projects tasks are largely mechanistic and represent continuous types of systems. If suchsystems exist, and if they operate across a sufficient time period to justify the initial expense of creatingan automatic control, then a cybernetic controller is useful.

Given the decisions about what to control, the information requirements of a cybernetic controller areeasy to describe, if not to meet. First, the PM must decide precisely what characteristics of an output(interim output or final output) are to be controlled. Second, standards must be set for each characteristic.Third, sensors must be acquired that will measure those characteristics at the desired level of precision.Fourth, these measurements must be transformed into a signal that can be compared to a standard signal.Fifth, the difference between the two is sent to the decision maker, which detects it, if it is sufficientlylarge, and sixth, transmits a signal to the effectors that causes the operating system to react in a way that

will counteract the deviation from standard. If the control system is designed to allow the effectors to takeone or more of several actions, an additional piece of information is needed. There must be built-incriteria that instruct the effectors on which action(s) to take.

Knowledge of cybernetic control is important because all control systems are merely variants, extensionsor non-automatic modifications of such controls. Because most projects have relatively few mechanisticelements that can be subjected to classic cybernetic controls, this concept of control is best applied totracking the system and automatically notifying the project manager when things threaten to get out ofcontrol.

Q6. The following information is given for a projectActivity : A B C D E F G

Immediate Predecessor : - A A C B,D D E,F

Time (Weeks) : 6 3 7 2 4 3 7

a) Draw the network

b) Identify Critical Path

c) Calculate the project completion time

d) Calculate the Float of each activityolution : The following information is given for a project

Activity : A B C D E F G

Immediate Predecessor : - A A C B,D D E,F

Time (Weeks) : 6 3 7 2 4 3 7

c) Draw the network

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d) Identify Critical Path

All possible paths are :

ABEG - sum of durations = 6+3+4+7 = 20

ACDFG Sum of durations = 6+7+2+3+7 = 25

ACDD1EG sum of durations = 6+7+2+0+4+7 = 26

Path with maximum duration = critical path = ACDD1EG

or

For critical activities LS = ES / Slack =0 ;

1 2

3

4 5

6 7

(A,6

)

(B,3

)

(C,

7)

(D,2)

(F,3

)

(D1,0)

(E,4

)

(G,7)

Activity Duration Earliest

Start (ES)

Earliest

Finish(EF)

Latest

start(LS)

Latest

Finish(LF)

Slack

(Float)

A 6 0 6 0 6 0

B 3 6 9 12 15 6

C 7 6 13 6 13 0D 2 13 15 13 15 0

D1 0 15 15 15 15 0

E 4 15 19 15 19 0

F 3 15 18 16 19 1

G 7 19 26 19 26 0

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i.e Critical Path = ACDD1EG

c ) Project Completion time = 26 weeks

d) Float for each activity ( last column from table above)

ignou mba project managemnt

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