Project Planning and Analysis

Project Identification Analysis Course Content:

Concept of Project

Search for Business Idea

Project Identification

Project Planning Formulation and Analysis

Project Screening and Presentation of Projects for Decision-Making

Socio-economic Consideration in Project formulation

Social infrastructure Projects for Sustainable Development

Investment Opportunities.

Concept and features of Project

A Project is a unique endeavor to produce a set of deliverables within clearly specified time, cost and quality

constraints.

Trying to manage a Project without Project management is like trying to play a football game without a game

plan.

Gillinger defines “project” as the whole complex of activities involved in using resources to gain benef its.

Project management institute, USA defined project as “a system involving the co-ordination of a number of

separate department entities throughout organization, in a way it must be completed with prescribed schedules

and time constraints”.

Project is a unique process of a set of coordinated and controlled activities with start and finish dates,

undertaken to achieve an objective conforming to specific requirements, including constraints of time, cost,

quality and resources.

It is a planned set of activities

It has scope

It has time, cost, quality and resource constraints.

Features of Project

CHARACTERISTICS OF PROJECT

(1) Objectives : A project has a set of objectives or a mission. Once the objectives are achieved the project is treated as

completed.

(2) Life cycle : A project has a life cycle. The life cycle consists of five stages i.e. conception stage, definition stage,

planning & organizing stage, implementation stage and commissioning stage.

(3) Uniqueness : Every project is unique and no two projects are similar. Setting up a cement plant and construction of a

highway are two different projects having unique features.

(4) Team Work : Project is a team work and it normally consists of diverse areas. There will be personnel specialized in

their respective areas and co-ordination among the diverse areas calls for team work.

(5)Complexity : A project is a complex set of activities relating to diverse areas.

(6) Risk and uncertainty : Risk and uncertainty go hand in hand with project. A risk-free, it only means that the element is

not apparently visible on the surface and it will be hidden underneath.

(7) Customer specific nature : A project is always customer specific. It is the customer who decides upon the product to

be produced or services to be offered and hence it is the responsibility of any organization to go for projects/services

that are suited to customer needs.

(8) Change : Changes occur through out the life span of a project as a natural outcome of many environmental factors.

The changes may vary from minor changes (which may have very little impact on the project), to major changes (which

may have a big impact or even may change the very nature of the project).

(9) Optimality : A project is always aimed at optimum utilization of resources for the overall development of the

economy.

(10)Sub-contracting : A high level of work in a project is done through contractors. The more the complexity of the

project, the more will be the extent of contracting.

(11) Unity in diversity : A project is a complex set of thousands of varieties. The varieties are in terms of technology,

equipment and materials, machinery and people, work, culture and others.

Types of Project Motorway and expressway.

Metro, subway and other mass transit systems.

Dams.

Railway network and service – both passenger and cargo.

Power plants and other charged utilities.

Port and terminals.

Airports and terminals.

Mines and natural resource explorations.

Large new industrial undertakings – [no expansion and extensions.

Large residential and commercial buildings.

Project Management Project management is an organized venture for managing projects, involves scientific application of modern

tools and techniques in planning, financing, implementing, monitoring, controlling and coordinating unique

activities or task produce desirable outputs in accordance with the determined objectives with in the constraints

of time and cost. Project Management is causing a planned undertaking to happen.

Role of Project Manager: Takes ownership of the whole project

Is proactive not reactive

Adequately plans the project

Is Authoritative (NOT Authoritarian)

Is Decisive

Is a Good Communicator

Manages by data and facts not uniformed optimism

Leads by example

Has sound Judgement

Is a Motivator

Is Diplomatic

Can Delegate

Project Identification First step in strategic planning process.

Identification of a new project is a complex problem. Project selection process starts with the generation of

project ideas. In order to select the most promising project, the entrepreneur needs to generate a few ideas

about the possible project one can undertake. The project ideas as a process of identification of a project begins

with an analytical survey of the economy (also known as pre-investment surveys). The surveys and studies will

give us ideas. The process of project selection consists of following stages:

- Idea Generation

- Environmental Appraisal

- Corporate Appraisal

- Scouting for project ideas

- Preliminary screening

- Project rating index

- Sources of positive Net Present Value

- Entrepreneur qualities

Step-1 Project Idea Screening

Project selection process starts with the generation of a project idea. Ideas are based on technological breakthrough s

and most of the project ideas are variants of present products or services. To stimulate the flow of ideas, the following

are helpful:

1. SWOT Analysis :- SWOT is an acronym for strengths, weaknesses, opportunities and threats. SWOT analysis

represents conscious, deliberate and systematic effort by an organization to identify opportunities that can be profitably

exploited by it. Periodic SWOT analysis facilitates the generation of ideas. Operational objectives of a firm may be one or

more of the following:

Cost reduction

Productivity improvement

Increase in capacity utilization

Improvement in contribution margin

2. Fostering a conducive climate :- To tap the creativity of people and to harness their entrepreneurial skills, a conducive

organization climate has to be fostered. Two conspicuous examples of organization which have been exceptionally

successful in tapping the creativity of employees are:

The Bell Telephone Laboratory: It has succeeded in harnessing creativity by providing an unconstrained

environment

3M Corporation: It has effectively nurtured the entrepreneurial skills of its employees as sources of idea

generation.

The project ideas can be generated from various internal and external sources. These are : -

Knowledge of market, products, services and potential customer choice.

Emerging trends in demand for particular product.

Scope for producing substitute product.

Market survey & research.

Making visits to trade and exhibitions, Going through Professional magazines.

Government guidelines & policy.

Ideas given by the experienced person and by personal experience

3. Clear articulation of objectives: A clear articulations and prioritization of objectives helps in channelizing the efforts

of employees and prods them to think more imaginatively. The operational objectives of a firm may be one or more of

the following:

Cost reduction

Productivity improvement

Increase in capacity utilization

Improvement in contribution margin

Expansion into promising fields

Step-2 Environment Appraisal An entrepreneur or a firm systematically appraise the environment and assess its competitive abilities. For the

purposes of monitoring, the business environment may be divided into six broad sectors. The key elements of

the environment are as follow :

1. Economic Sector

• State of the economy

• Overall rate of growth

• Cyclical fluctuations

• Inflation rate

• Growth rate of primary, secondary and territory sector

• Growth rate of world economy

• Trade surplus and deficits

• Balance of Payment

2. Government Sector

• Industrial policy

• Government program and projects

• Tax structure

• EXIM policy

• Financing norms

• Subsidies incentives and concessions

• Monetary policy

3. Technological Sector

• Emergence of new technologies

• Access to technical know-how, foreign as well as indigenous

4. Socio-demographic Sector

• Population trends

• Age shifts in population

• Income distribution

• Educational profile

• Employment of women

• Attitudes toward consumption and investment

5. Competition Sector

• Number of firms in the industry and the market share of the top few

• Degree of homogeneity and differentiation among the products

• Comparison with substitutes in term of quality and price

• Marketing polices and practices, Entry barrier

6. Supplier Sector

• Availability and cost of raw material, energy, capital

Step-3 Corporate Appraisal

A realistic appraisal of corporate strengths and weaknesses is essential for identifying investment opportunities

which can be profitably exploited. The broad areas of corporate appraisal and the important aspects to be

considered under them are as follows:

1. Marketing and distribution:

Market image

Product line

Market share

Distribution network

Customer loyalty

Marketing and distribution costs

2. Production and Operations:

Condition and capacity of plant and machinery

Availability of raw materials, sub-assemblies and power

Degree of vertical integration

Locational advantage

Cost structure

3. Research and Development

Research capabilities of the firm

Track record of new product developments

Laboratories and testing facilities

Coordination between research and operations

4. Corporate Resources and Personnel

Corporate image

Clout with governmental and regulatory agencies

Dynamism of top management

Competence and commitment of employees

State of industrial relations

5. Finance and Accounting:

Financial leverage and borrowing capacity

Cost of capital

Tax situation

Relations with shareholders and creditors

Accounting and control system

Cash flows and liquidity

Step- 4 Tools for identifying Investment opportunities Most popular tools that are helpful in identifying promising investment opportunities are:

1. Porter Model: Porter’s five force model

2. Life cycle approach

3. Experience curve

1. Porter model: Profit Potential of Industries

Michael Porter has argued that the profit potential of an industry depends on the combined strength of the following

five basic competitive forces:

1. Threat of new entrants

2. Rivalry among existing firms

3. Pressure from substitute products

4. Bargaining power of buyers

5. Bargaining power of sellers.

2. Project Life cycle

Economists believe that most products evolve through a life cycle which has 4 stages:

1. Pioneering stage: Technology or product is relatively new, Lured by promising prospects, many entrepreneurs

enter the field. Keen and chaotic competition. Only a few entrants may survive this stage. Investment in this

stage may have a low return and negative NPV.

2. Rapid Growth stage: Once the period of chaotic developments is over, the rapid growth stage arrives. Thanks to

a relatively orderly growth during this period, firms which survive the intense competition of the pioneering

stage, witness significant expansion in their sales and profits. Investment in this stage is likely to earn a high

return and generate positive NPV.

3. Maturity and Stabilization stage: After enjoying an above average rate of growth, the industry enters the

maturity and stabilization stage. During this stage, when the industry is more or less fully developed, its growth

rate is comparable to that of the economy as a whole. Investment in this stage may earn average return and is

NPV- neutral.

4. Decline stage: With the satiation of demand, encroachment of new products, and changes in consumer

preferences, the industry eventually enters the decline stage, relative to the economy as a whole. In this stage,

which may continue indefinitely, the industry may grow slightly during prosperous periods, stagnate during

normal periods, and decline during recessionary periods. Investment in this stage may earn meagre returns and

produce negative NPV.

3. The Experience Curve

The experience curve is a useful tool for planning investments aimed at reducing costs to ensure long term

survival and profitability of the firm.

It shows how the cost per unit behaves with respect to the accumulated volume of production.

In general, the cost per unit declines with the accumulated volume of production.

Factors that contribute to decline in unit cost with respect to the accumulated volume of production:

1. Learning effects: With more and more of production, labor skills improve and productivity increases, leading to

lower costs.

2. Technological improvements: Increased volume makes it possible to deploy improved production techniques

and processes that lower costs.

3. Economies of Scale: As the capacity increases, the cost per unit decreases this is due to economies of scale.

Step-5 Scouting for Project Ideas Good project ideas are the key to success and are elusive. So a wide variety of sources should be tapped to

identify them. Following are some suggestions in this regard:

1. Analyze the performance of existing industries

2. Examine the inputs and outputs of various industries

3. Review imports and exports

4. Study plan outlays and governmental guidelines

5. Investigate local materials and resources

6. Analyze economic and social trends

7. Study new technological developments

8. Draw clues from consumption abroad

9. Explore the possibility of reviving sick units

10. Identify unfulfilled psychological needs

11. Attend trade fairs, stimulate creativity for generating new product ideas

Step-6 Preliminary Screening Preliminary screening is required to eliminate ideas that are not promising. For this following aspects are talked

about:

Compatibility with the promoter: The idea must be compatible with the interest, personality and resources of

the entrepreneur. It should offer him the prospect of rapid growth and high return on the invested capital.

Consistency with Governmental Priorities: the project idea must be feasible given the national goals and

governmental regulatory framework. It should not have any environmental effects contrary to government

regulations. Questions like: will there be any difficulty in obtaining the license for the project?, Can the foreign

exchange requirements of the project be easily accommodated? Are to be asked and answered b efore selecting

any project.

Availability of inputs: the resources and inputs required for the project must be reasonably assured. Following

questions should be answered:

- Are the capital requirements of the project within manageable limits?

- Can the technical know how required for the project be obtained?

- Is the power supply for the project reasonably obtainable from external sources and captive power sources?

- Indian businesses in past have faced several problems like shortage of raw material, power, foreign exchange

etc. but now in recent times the situation has improved since power generation has increased significantly,

foreign exchange is now available easily, supplies of certain basic industrial raw materials have been

augumented substantially.

Adequacy of the Market: The size of the present market must offer the prospect of adequate sales volume.

Further, there should be a potential for growth and a reasonable return on investment. To judge the adequacy

of the market the following factors have to be examined:

- Total present domestic market

- Competitors and their market shares

- Export markets

- Quality- price profile of the product with respect to competitive product

- Sales and distribution system

- Projected increase in consumption

- Barriers to entry of new units.

- Patent protection

- Economic, social and demographic trends favorable to increased consumption.

From the point of view of entrepreneurs, the Indian economy unlike most developed , western economies, is not a

“share shift” economy wherein the growth in demand for a product is likely to be at the demand for others.

Reasonableness of cost: The cost structure of the proposed project must enable it to realize an acceptable profit

with a price. Following should be examined in this regard:

- Cost of material inputs

- Labor costs

- Factory overheads

- General administrative expenses

- Selling and distribution costs

- Service costs

- Economies of scale

Acceptability of risk levels: The desirability of a project is critically dependent on the risk characterizing it. To

assess risk following factors should be considered:

- Vulnerability to business cycles

- Technological changes

- Competition from substitutes

- Competition from imports

- Governmental control over price and distribution

Step-7 Project Rating index When a firm evaluates a large number of project ideas regularly, it may be helpful to streamline the process of

preliminary screening. For this purpose, a preliminary evaluation may be translated into a project rating index.

Following steps are involved in project rating index:

- Identify the factors relevant for project rating

- Assign weights to these factors

- Rate the project proposal on various factors, using a suitable rating scale (a 5- point or 7- point rating scale is

used)

- For each factor, multiply the factor rating with the factor weight to get the factor score

- Add all the factor scores to get the overall project rating index

Once a project rating index is determined, it is compared with a pre-determined hurdle value to judge whether the

project is worthwhile or not.

Step-8 Sources of NPV Imperfections in real markets i.e. product and factor markets lead to entry barriers which cause positive NPVs.

Hence, an understanding of entry barriers is helpful in identifying positive NPV projects. There are 6 main entry

barriers that result in positive NPV projects:

1. Economies of scale: Substantial economies of scale represents larger size of existing firms. The more

pronounced economies of scale the greater is the cost advantage of the existing firms. This economies of scale

serve as an entry barrier since the greater the capital requirement for the new entrant the higher is the

restriction to entry. This is true for: petroleum refining, mineral extraction, iron and steel and aluminium.

2. Product differentiation: basis of product differentiation can be on the basis of:

- Effective advertising and superior marketing

- Exceptional services

- Innovative product features

- High quality and dependability

3. Cost advantage: it may act as an entry barrier because of following reason:

- Accumulated experience and comparative edge on the learning curve

- Monopolistic access to low cost materials

- A favorable location

- More effective cost control and cost reduction

4. Marketing Reach: A penetrating marketing reach is an important source of competitive advantage:

- Avon products markets its products through a worldwide network of 1,300,000 independent sales

representatives. Avon’s competitors find it almost impossible to replicate this. Thanks to such a nonpareil

marketing network, Avon has been able to earn superior returns in a highly competitive industry.

- The breadth and depth of Hindustan lever’s distribution network is miles ahead of its competitors. Such a

marketing reach has contributed to the superior returns earned by Hindustan lever.

5. Technological Edge: technological superiority enables a firm to enjoy excellent returns. Firms like IBM and

Xerox earned superior returns over extended periods of time to the technological edge they had over their

rivals. On the Indian scene, firms like Dr. Reddy’s Laboratory and hero Honda have performed well because of

their technological strength.

6. Government Policy: A government policy which shelters a firm from the onslaught of competition enables it

to earn superior returns. Government policies that create entry barriers include the following:

- Restrictive licensing

- Import restrictions

- High tariff walls

- Environmental controls

- Special tax reliefs

Step-9 Entrepreneurial Qualities Willingness to make sacrifices

Leadership

Decisiveness

Confidence in the project

Marketing orientation

Strong ego

Open mindedness

Project Formulation Project formulation is an investigating process which precedes investment decision. The purpose is to present

relevant facts before the decision-makers to enable them to decide as to whether to go ahead signal should be

given for the project or not.

It explains the objectives, goals and justification for the acceptance of the project.

It involves the identification of investment options by the enterprise.

It is a process involving the joint effort of a team of experts including the economists, the financial analysis and

specialists in various fields.

A well formulated project provides a medium which out across scientific, social and positional prejudices and

provides a common meeting ground for all those who have a contribution to make successful implementation of

a project.

Stages in Project formulation: Feasibility analysis

Techno-economic analysis

Project design and network analysis

Input analysis

Financial analysis

Socio-cost benefit analysis

Project appraisal

Stage-1 Feasibility Analysis

Feasibility analysis is the first stages in the process of project development.

Purpose: To examine the desirability of investing in pre-investment studies. For this purpose it is essential to

examine project idea in the light of the available internal (inputs, resources & outputs) and external constraints

(environment).

When a project idea is taken up for developmental three situations can arise:

a. The project may appear to be feasible, project may turn out to be not feasible or the available data may not be

adequate for arriving at reasonable decision regarding further investment. In the last mentioned case,

investment in pre-investment studies will obviously have to be adequate for arriving at reasonable decision

regarding further investment. In the last mentioned case, investment in pre-investment studies will obviously

have to e deferred till such time is adequate date regarding the project feasibility is available. The project

sponsoring body will therefore have to invest in collection additional data and refer the investment decision for

the time being.

b. In the second situation when the project is found to e not feasibl e, further investment in the project idea is

completely ruled out.

c. In the third situation, when the project idea is found to be feasible, the decision-makers can proceed to invest

further resources in pre-investment studies and design development.

Stage-2 Techno-Economic Analysis

Techno-economic analysis is primarily concerned with the identification of project demand potential and the

selection of the optimal technology which can be used to achieve the project objectives.

The analysis provides necessary material on which the project design can be based.

It also indicates whether the economy is in position to absorb the output of the project or not.

Stage-3 Project Design and Network Analysis Project design is the heart of the project entity.

It defines the individual activities which go into the corpus of the project and their inter-relationship with each

other.

It identifies the flow of events, which must take place before a project can start yielding the results for which it

has been set up.

The inter-relationship between various constituent activities of a project in most conveniently expressed in the

form of a network diagram.

Project design and network analysis are concerned primarily with the development of the detailed work plans of

the project and its time profile, and the presentation of this plan is form of a detailed drawing network.

Project design and network analysis make available to the project formulation team a clear picture of the work

elements of the project and also their sequential relationship.

It presents the way for detailed identification and quantification of the project inputs, an essential step in the

development of the financial and cost-benefit profile of the project.

Stage-4 Input analysis The objective is to identify and quantify the project inputs and to assess the feasibility of a sustained supply of

these inputs all through the effective life span of the project.

Resources are consumed in project constituent activities.

The best method of identifying the project inputs is to identify these activities determine the resources which

each activity will consume individual requirements.

Input analysis uses the network plans for developing the input characteristics of the project. If thereafter

proceeds to evaluate the availability of the inputs both in quantitative as well as qualitative terms.

Resources require for a successful implementation of a project include not only the material inputs but also

human resources which are necessary both for the setting up of the project as also its successful normalization

run.

Resources requirements estimates form the basis of costs estimates of the project and are, therefore, essential

for developing the financial profile and cost-benefit profile of the project.

Stage-5 Financial Analysis

Objective of financial analysis is to develop the project from the financial angle and to identify these

characteristics.

Financial analysis concerns itself with the estimation of the project costs, estimation of project funds

requirements

Involves appraisal of the financial characteristics of the project to establish the relative merits and demerits of

the project as compared to other investment opportunities.

Reduces investment proposition in diverse fields of human activity to one common scale, thereby s implifying the

project is developing project financial forecasts.

Stage-6 Social cost benefit Analysis

In judging the overall worthiness of the project, the effect of the project on society as a whole is very essential.

While financial analysis evaluates a project from the profitability point of view, social cost benefit analysis views

it from the point of view of national viability.

The cost-benefit analysis takes into account not only the direct costs and benefits which will accrue to the

project implementing body but also total costs which all entities connected with the project will have to bear

and the benefits which well be enjoyed by all such entities.

The idea here is to evaluate the project in terms of absolute costs and benefits rather than in terms apparent

costs and benefits.

Stage-7 Pre-Investment Appraisal Pre investment appraisal is the process of consolidating the results of feasibility analysis, the techno-economic

analysis, the design and network analysis, the input analysis, the financial analysis and the cost benefit analysis,

so as to give the investment proposition a final and formal shape.

It naturally involves selection of appraisal format, the material which should go into pre -investment report and

the form of presentation of various conclusions.

The sum total of the pre-investment appraisal is to present the project idea in a form in which the project

sponsoring body, the project implementing body and the outside agencies can take investment decision

regarding the proposals.

Social-Cost Benefit Analysis It is a methodology for evaluating investment projects from social point of view.

SCBA seeks to assess the utility of a project to society as a whole. It attempts to separate all the expected

changes viz. economic, social and environmental likely to arise as a result of implementing the project.

These can be represented as inputs and outputs of a project and a price can be put to each of these input an

output.

Since both inputs and outputs are spread over a number of years, it is necessary to combine the costs and

benefits stream that arise over the economic life of the project.

The National Rehabilitation and Resettlement Policy of 2007 has introduced the concept of Social Impact

Assessment (SIA) of Projects.

While undertaking a social impact assessment, the appropriate Government shall, inter alia , take into

consideration the impact that the project will have on public and community properties, assets and

infrastructure; particularly, roads, public transport, drainage, sanitation, sources of safe drinking water, sources

of drinking water for cattle, community ponds, grazing land, plantations; public utilities, such as post offices, fair

price shops, etc.; food storage, godowns, electricity supply, health care facilities, schools and

educational/training facilities, places of worship, land for traditional tribal institutions, burial and cremation

grounds, etc.

Rationale for SCBA

1. Market imperfections: Market prices, which form the basis for computing the monetary costs and benefits

from the point of view of project sponsor, reflect social values only under conditions of perfect competition,

which are rarely, if ever, realized by developing countries. When imperfections obtain, market prices do not

reflect social values.

The common market imperfections found in developing countries are:

i. Rationing: of a commodity means control over its price and distribution. The price paid by a consumer under

rationing is often significantly less than the price that would prevail in a competitive market.

ii. Prescription of minimum wage rates: When minimum wage rates are prescribed, the wages paid to labor are

usually more than what the wages would be in a competitive labor market free from such wage legislations.

iii. Foreign Exchange Regulation: The official rate of foreign exchange in most of the developing countries, which

exercise close regulation over foreign exchange, is less than the rate that would prevail in the absence of foreign

exchange regulation. This is why foreign exchange usually commands premium in unofficial transactions.

2. Externalities: A project may have beneficial external effects.

For example, it may create certain infrastructural facilities like roads which benefit the neighbouring areas. Such benefits

are considered in SCBA, though they are ignored in assessing the monetary benefits to the project sponsors because

they do not receive any monetary compensation from those who enjoy this external benefit created by the project.

A project may have a harmful external effect like environmental pollution.

In SCBA, the cost of such environmental pollution is relevant, though the project sponsors do not incur any monetary

costs. It may be emphasized that externalities are relevant in SCBA because in such analysis all costs and benef its,

irrespective to whom they accrue and whether they are paid for or not, are relevant.

3. Taxes and subsidies: From the private point of view, taxes are definite monetary costs and subsidies are definite

monetary gains. From the social point of view, however, taxes and subsidies are regarded as transfer payments and

hence considered irrelevant.

4. Concern for redistribution: A private firm does not bother how its benefits are distributed across various groups in

the society. The society is concerned about the distribution of benefits across different groups. A rupee of benefit going

to a poor section is considered more valuable than a rupee of benefit going to an affluent section.

5. Merit wants: Goals and preferences not expressed in the market place, but believed by policy makers to be in the

larger social interest, may be referred to as merit wants.

For example, the government may prefer to promote adult education or a balanced nutrition program for school -going

children even though these are not sought by consumers in the market place.

While merit wants are not relevant from the private point of view, they are important from the social point of view.

6. Concern for savings: Unconcerned about how its benefits are divided between consumption and savings, a private

firm does not put differential valuation on savings and consumption. From a social point of view, however, the division

of benefits between consumption and savings (which leads to investment) is relevant particularly in capital-scarce

developing countries.

A rupee of benefits saved is deemed more valuable than a rupee of benefits consumed. The concern of society for

savings and investment is duly reflected in SCBA wherein a higher valuation is placed on savings and lower valuation is

put on consumption.

Social-Cost Benefit Analysis

It covers five distinct issues:

1. Assessing the desirability of projects in the public, as opposed to the private sector.

2. Identification of costs and benefits.

3. Measurement of costs and benefits.

4. The effect of (risk and uncertainty) time in investment appraisal.

5. Presentation of results– the investment criterion.

Two Principal Approaches for SCBA The UNIDO approach

The Little-Mirrlees approach

These approaches are discussed in detail in upcoming sections.

UNITED NATIONS INDUSTRIAL DEVELOPMENT ORGANISATION APPROACH

(UNIDO)

The UNIDO method of project appraisal involves five stages:

1. Calculation of financial profitability of the project measured at market prices

2. Obtaining the net benefit of project measured in terms of economic (efficiency) prices.

3. Adjustment for the impact of the project on savings and investment.

4. Adjustment for the impact of the project on income distribution.

5. Adjustment for the impact of project on merit goods and demerit goods whose social values differ from their

economic values.

UNIDO Approach- 1 1. Calculation of financial profitability of the project measured at market prices:

A project financial evaluation tells you whether a project will contribute to your company's overall goals or be a

drain on your resources.

For a financial evaluation to help you decide whether to proceed with a project, you have to first establish your

overall goals.

Decide whether the project has to immediately make a contribution to the bottom line or whether you are

taking a longer-term view.

Decide how profitable it has to be compared with other attractive projects you could undertake or whether a

marginally profitable project makes sense because it achieves other positive goals.

The financial evaluation gives you a financial result, but you have to decide whether that result is attractive

enough to proceed with the project.

To get the total financing costs, you have to take the projected costs of the project as you would incur them and

add them to a theoretical loan at the current interest rate for such financing.

UNIDO Approach: Step-2

2. Obtaining the net benefit of project measured in terms of economic (efficiency)/ Shadow prices:

The UNIDO approach suggests three sources of shadow pricing, depending on the impact of the project on

national economy. A project as it uses and produces resources may for any given input or output:

Increase or decrease the total consumption in the economy: The basis of shadow pricing here is

consumer willingness to pay.

Decrease or increase production in the economy: The basis of shadow pricing here is the cost of production.

Decrease imports or increase imports or Increase exports or decrease exports: Here, the basis of shadow pricing

is the foreign exchange value.

Shadow pricing of tradable inputs and outputs: For fully traded goods, the shadow price is the border price,

translated in domestic currency at market exchange rate. The above definition of a fully traded good implies

that domestic changes in demand or supply affect just the level of imports or exports.

Non-tradable inputs and outputs: A good is non-tradable when the following conditions are satisfied: I) its

import price is greater than its domestic cost of production and (ii) its export price is less than its domestic cost

of production.

On the output side, if the impact of the project is to increase the consumption of the product in the economy,

the measure of value is the marginal consumers’ willingness to pay; if the impact of the project is to substitute

other production of the same non-tradable in the economy, the measure of value is the saving in cost of

production.

On the input side, if the impact of the project is to reduce the availability of the input to other users, their

willingness to pay for the input represents social value; if the project’s input requirement is met by additional

production of it, the production cost of it is the measure of social value.

Externalities (external effect): An externality is a special class of good which has the following characteristics:

It is not deliberately created by the project sponsor but is an incidental outcome of legitimate economic activity,

It is beyond the control of the persons who are affected by it, for better or for worse.

It is not traded in the market place.

Beneficial external effects are:

(i) An oil company drilling in its own fields may generate useful information about oil potential in the neighboring fields.

(ii) The approach roads built by a company may improve the transport system in that area.

Harmful external effects are:

1. A factory may cause environmental pollution by emitting large volume of smoke and dirt. People living in the

neighborhood may be exposed to health hazards and put to inconvenience.

2. The location of an airport in a certain area may raise noise levels considerably in the neighborhood.

UNIDO Approach: Step-3 & 4 3. Measuring the value of a project in terms of its contribution to savings and income redistribution:

We first Measure the income gained or lost by individual groups within the society.

The UNIDO approach seeks to identify income gains and losses by the following: (i) Project, (ii) Other private business,

(iii) Government, (iv) Workers, (v) Consumers, (vi) External sector.

The gain or loss to an individual group within the society due to the project is equal to the difference between shadow

price and market price of each input or output in the case of physical resources or then difference between price paid

and value received in the case of financial transaction.

Value of savings of a rupee is the present value of additional consumption stream

Value of savings of a rupee is the present value of the additional consumption stream produced when that rupee of

savings is invested at the margin.

The additional stream of consumption generated by a rupee of investment depends on the marginal productivity of

capital and the rate of reinvestment from additional income.

If the marginal productivity of capital is r and the rate of reinvestment from additional income a, the additional stream

of consumption generated by a rupee of investment can be worked out.

The consumption stream starts with r (1 – a) and grows annually at the rate of ar forever. Its present value when

discounted at the social discount rate k is:-

Income distribution impact

Governments regard redistribution of income in favor of economically weaker sections or economically

backward regions as a socially desirable objective.

Due to practical difficulties in pursuing the objective of redistribution entirely through the tax, subsidy, and

transfer measures of the government,

Investment projects are also considered as instruments for income redistribution and their contribution toward

this goal is considered in their evaluation.

This calls for suitably weighing the net gain or loss by each groups, measured earlier, to reflect the relative value

of income for different groups and summing them.

UNIDO Approach: Step-5

Adjustment for merit and demerit goods This is done to reflect the difference between the economic value and social value of resources.

This difference exists in the case of merit goods and demerit goods.

A merit good is one for which the social value exceeds the economic value.

For example, a country placing higher social value than economic value on production of oil since it reduces

dependence on foreign supplies.

A demerit good, the social value of the good is less than its economic value.

For example, a country may regard alcoholic products having social value less than economic value.

The procedure for adjusting for the difference between social value and economic value is as follows:

(i) Estimate the economic value.

(ii) Calculate the adjustment factor as difference between the ratio of social value to economic value and unity.

(iii) Multiply the economic value by the adjustment factor to obtain the adjustment.

(iv) Add the adjustment to the net present value of the project.

Little-Mirrlees Approach

Also known as L-M approach.

It assumes that a country can buy and sell any quantity of a particular good at a given world price.

Hence, all traded inputs and outputs are valued at their international prices (CIF for imports and FOB for

exports) which is the opportunity cost/value of the particular good to the country.

Every input is treated as a forex outgo and every output is treated as a forex inflow.

All non-tradable inputs are valued at accounting prices.

These costs are broken up into tradable goods and other non-traded goods. Following this chain of production,

commodities that are either exported or imported are determined for application of accounting prices.

The theory assumes that non-tradeables form an insignificant part of operating costs

Difference between LM approach and UNIDO approach

UNIDO Approach LM approach

Opportunity Cost: Relevant cost in SCBA The opportunity cost is the cost of alternative foregone due to a particular course of action.

Example: The opportunity cost of self-employment is the salary for the best job he could have obtained. But if he

does not have any job opportunity other than the self-employment, there is no opportunity cost for the self-

employment.

In the opportunity cost analysis pertaining to the national profitability analysis it is not the commercial

profitability but the net contribution to the national objective that is considered.

Example, the situation of a commercial bank having to consider applications for loan by two projects – a textile

retail shop in an existing commercial areas in a city and an agricultural development scheme – and that the

loanable funds with the bank is sufficient only finance any one of these two competing projects. Assume,

further, that the commercial profitability of the textile shop is relatively high and that of the agricultural project

is low but it will increase the output of some important agriculture commodity. In this situation the lending

institution should prefer the agricultural project because though it is commercially less viable than the textile

shop, it will make a higher contribution to the national output. Even if the proposed textile shop is not opened,

the total textile output or sale will not be affected but if the agricultural project is not assisted, it will adversely

affect the total output. It clearly shows that in the national profitability analysis, application of the opportunity

cost principle is very essential.

Social-Economic viability of a project can be judged on the basis of its

net contribution to: Aggregate consumption and economic growth

Generation of employment

Income distribution

Foreign exchange earnings/savings

Self-reliance

Development of backward regions

Development of small-scale and ancillary industries

Backward and forward linkages and development of other industries/sectors

Developments of infrastructure

Development/Improvement and transfer to technology

Improvement of quality and productivity

Improvement in the quality of life and national well-being.

Social infrastructure Projects for Sustainable Development

1. It measures costs and benefits in terms of

domestic rupees.

1. It measures costs and benefits in terms of international prices/ border

prices.

2. The UNIDO approach measures costs and

benefits in terms of consumption.

2. The Little-Mirrlees approach measures costs

and benefits in terms of uncommitted social income.

3. The stage-by-stage analysis by the UNIDO

approach focuses on efficiency, savings and

redistribution considerations in different stages.

3. The Little-Mirlees approach, tends to view these considerations together.

In case of public projects like irrigation projects, power projects, transport projects or other infrastructural

projects or social overhead projects, National profitability (i.e. the net socio economic benefits) considerations

are more important than commercial profitability consideration.

Even in respect of projects sponsored by private entrepreneurs, national profitability analysis is important,

particularly in developing countries, because of the need to optimize the utilization of scarce resource from the

societal point of view.

Large infrastructure projects can lead to economic and social benefits to masses if they are planned and

executed in an inclusive, socially responsible and environmentally sound manner.

The core idea of sustainable development is development that meets the need of the present without

compromising the ability of future generation to meet their own needs. The World Commission on Environ ment

and Development added that “Sustainable Development is a process of change in which the exploitation of the

resources, the direction of investments, the orientation of technology and institutional change are all in

harmony…”

Investment Opportunities

India is one of the fastest growing economies in the world and has emerged as a key destination for foreign

investors in recent years.

Economic reforms initiated in 1991 have grown in scope and scale and yielded increasingly salutary dividends.

First is the steady improvement in India’s relative position in the global economy, reflected in New Delhi’s

growing influence in international institutions and negotiating free trade areas (with ASEAN(association of

south-east Asian nations), EU).

Second is the improved efficiency in the economy and adoption of international “best practices” in the

production of a range of goods and services.

A third outcome is India ranking amongst the top 10 investment destinations since 2007-08, attracting US$ 195

billion in FDI and US$ 97 billion in FII over the past 5 years.

India’s GDP has also grown at around 7.9 per cent between 2003 and 2012. This trend, according to the

International Monetary Fund (IMF)1, is likely to continue for the next five years with an average GDP growth

rate of 7.7 per cent per annum till 2017.

India’s GDP for 2013, valued at US$ 1.9 trillion at current prices is the 10th largest in the world.

The government has set a target of 8 per cent during the current Five Year Plan (2012-2017), based on the

demonstrated ability to sustain national economic growth despite the global financial crisis, Euro zone woes and

the resultant slack external demand in recent years.

India is a favorable demography for higher growth: India supports one of the largest populations in the world,

and one of the youngest. 50% of its population is below the age of 25 and 2/3rd below the age of 35. About 65

per cent of Indians are in the working age group of 15 to 64 years, giving the country a significant edge in terms

of cost competitiveness and low labor costs. Moreover, India’s labor force has a strong knowledge base with a

significant English-speaking population, making it a top destination for multinational corporations that are

looking to expand their overseas operations for market and talent.

The Indian consumer market will grow 2.5 times by 2025: Consumer spending in India grew from US$ 549 billion

to US$ 1.06 trillion between 2006 and 2011, putting India on the path to becoming one of the world’s largest

consumer markets by 2025. India’s consumption is expected to rise 7.3 per cent annually over the next 20 years.

By 2040, nine out of every ten Indians will belong to ‘the global middle class group’ with daily expenditures

ranging between US$ 10 and US$ 100 per person in today’s purchasing power parity terms.

Foreign Direct Investment in India: Trends in India’s FDI are an endorsement of its status as a preferred

investment destination amongst global investors. India's strengths span telecommunications, information

technology, auto components, chemicals, apparels, pharmaceuticals, and jewelry. India’s steady economic

liberalization and its embrace of the global economy have been key factors in attracting FDI. The government

recently opened up multi-brand retail and civil aviation markets to 51 and 49 per cent FDI respectively and with

more reforms expected in insurance and pension sectors, among others, India will continue to offer compelling

opportunities to the global investment community.

Unit-2

Market and Technical Analysis

Topics to be covered: Market and Demand Analysis: Market survey, Demand Forecasting, Uncertainties in Demand Forecasting;

Technical analysis: Product mix, Plant capacity, Materials and inputs, Machinery and Equipment.

Project Costing and Finance: Cost of project, Cost of Production, break-even analysis, means of Financing

Project, Tax aspects in Project Finance, role of Financial institution in Project Finance.

Forecasting Predicting the future

Qualitative forecast methods:-

Subjective

Quantitative forecast methods:-

Based on Mathematical Formulas

Depend on:-

Time Frame

Demand behavior

Causes of behavior

How is Forecasting different from prediction?

Forecast is an estimate of future events and trends and is arrived at by systematically combining past data and

projecting it forward in a predetermined manner.

Prediction is an estimate of future events and trends in a subjective manner without taking into account the past

data. The subjective considerations may not emerge from any predetermined analysis or approach.

Why market and demand analysis is important in project analysis?

As an essential part of project formulation and appraisal, Market and Demand analysis is vital so that capacity

and facility location can be planned and implemented in line with the market requirements.

Market and Demand Analysis is concerned with two broad issues:

1. What is the likely aggregate demand for the product/service?

2. What share of the market will the proposed project enjoy?

Longer-term forecasting is also undertaken to determine trends in technology development so as to choose the

technology for backing up and funding its research and development.

Market and Demand Analysis Market and demand analysis of various types are undertaken to meet specific requirements of planning and

decision making.

For example, short-term decisions in production planning, distribution etc. and selling individual products would

require short-term forecast, up to one year time horizon, which must he fairly accurate for specific product

items. For long-term planning, time horizon being four to five years, information required from demand analysis

would be for broad product groups for facilitating choice of technology, machine tools and other hardware and

their location.

Market and demand analysis are carried out by the project manager in the process of evaluating a project idea.

There are six steps in the market and demand analysis: 1. Situational analysis and objectives specification

2. Collection of data

3. Market Survey

4. Market Description

5. Demand Forecasting

6. Market Planning.

The market and demand analysis helps the project manager to understand how the firm’s abilities can be synchronized

with market requirements.

Market analysis studies market needs and consumer preferences for a given project idea and demand analysis aims at

calculating the aggregated demand for a particular product or service.

1. Situational Analysis and Specification of objectives

To get a “feel” for the relationship between the product and it’s market, the project analyst may informally talk

to customers, competitors, middlemen and other in the industry.

Look at the experience of the company to learn about the purchasing power of customer, action & strategies of

competitors.

The objectives of market & Demand analysis, to answer the following question : (how to market the new air

cooler over conventional air coolers…)

Who are the buyers of air cooler?

What is the total current demand for air coolers?

What price will the customer be willing to pay for the improved air cooler?

What price & warranty will ensure its acceptance?

What are the prospects of immediate sales?

How can potential customers be convinced about the superiority of the new cooler?

2. Collection of Secondary information

Secondary Information is information that has been gathered in some other context and is already available.

This information helps in answering questions that were asked in previous point.

Secondary information provides the base and starting point for the Market & Demand Analysis.

General Sources of Secondary Information: Census of India (last census done in 2011), National Sample Survey

Report, Plan Reports, Economic Survey etc.

Industry Specific Sources of Secondary Information

Evaluation of Secondary Information: The reliability, accuracy, and relevance for the purpose must be carefully

examined properly. Questions like the following are asked to judge the reliability of the information

- Who gathered the information?

- What was the objective?

- When was the information gathered?

- When was it published?

- How was the sample chosen? Etc.

3. Conduct of Market Survey Secondary information alone is not very useful, it has to be supplemented with primary information gathered

through a market survey, that may be a census survey or a sample survey.

Census survey are employed principally for intermediate goods & investment goods when such goods are used

by a small number of firms.

In a census survey, the entire population is covered (where population refers to the totality of all units under

consideration in a specific study).

Some Problems that a market researcher has to come across in India:

- Heterogeneity of the Country

- Multiplicity of the Languages

- Design of Questionnaire

Steps in a Sample Survey:

Define the Target Population

Select the Sampling Scheme and Sample Size

Develop the Questionnaire

Recruit and Train the Field Investigators

Obtain Information as Per the Questionnaire from the Sample of Respondents

Scrutinizes the Information Gathered

Analyze and interpret the Information

4. Characterization of the Market Based on the information gathered from secondary sources and through the market survey, the market for the product

may be described in terms of:

Effective Demand in the Past and Present is defined as: Production + Imports – Exports – Change in stock level

Breakdown of Demand: The aggregate market demand my be broken down into demand for different segments

of the market:

Nature of Product

Consumer Groups: can be classified as industrial consumers and domestic consumers, income wise

classification can also be done.

Geographical Division

Price: manufacturer’s price quoted as FOB price, landed price for imported goods, average wholesale price,

average retail price.

Methods of Distribution and Sales Promotion

Consumers

Supply and Competition

Government Policy

5. Demand Forecasting After gathering information about various aspects of the market and demand from primary and secondary sources, an

attempt may be made to estimate future demand.

Methods used are:

1. Qualitative methods: These methods rely essentially on the judgment of experts to translate qualitative

information into quantitative estimates.

- Used to generate forecasts if historical data are not available (e.g., introduction of new product).

- Qualitative methods are:

Jury of Executive Method

Delphi Method

2. Time Series Projection Methods: these methods generate forecasts on the basis of an analysis of the historical time

series. Important methods are:

Trend Projection method

Exponential smoothening method

Moving average method

3. Casual methods: More analytical than the preceding methods, casual methods seek to develop forecasts on the basis

of cause-effect relationships specified in an explicit, quantitative manner. Important casual methods are:

Chain ratio method

Consumption level method

End use method

Leading indicator method

Econometric method

Jury of Executive Opinion Method Rationale

Upper-level management has best information on latest product developments and future product

launches

Approach

Small group of upper-level managers collectively develop forecasts – Opinion of Group

Main advantages

Combine knowledge and expertise from various functional areas

People who have best information on future developments generate the forecasts

Main drawbacks

Expensive, Subjective in nature.

No individual responsibility for forecast quality.

Risk that few people dominate the group.

Reliability is questionable.

Typical applications

Short-term and medium-term demand forecasting

Delphi Method

Rationale:

1. Eliciting the opinions of a group of experts with the help of mail survey.

2. Anonymous written responses encourage honesty and avoid that a group of experts are dominated by only a few

members

Main advantages

Generate consensus

Can forecast long-term trend without availability of historical data

Main drawbacks

Slow process

Experts are not accountable for their responses

Little evidence that reliable long-term forecasts can be generated with Delphi or other methods

Typical application

- Long-term forecasting

- Technology forecasting

Time Series Projection Methods

These methods generate forecasts on the basis of an analysis of the historical time series.

Assume that what has occurred in the past will continue to occur in the future

Relate the forecast to only one factor - time

The important time series projection methods are:

Trend Projection Method.

Exponential Smoothing Method.

Moving Average Method.

Trend Projection Method

Exponential smoothing

This is a widely used forecasting technique in retailing, even though it has not proven to be especially accurate.

Exponential smoothing is a technique that can be applied to time series data, either to produce smoothed data

for presentation, or to make forecasts. The time series data themselves are a sequence of observations. The

observed phenomenon may be an essentially random process, or it may be an orderly, but noisy, process.

Whereas in the simple moving average the past observations are weighted equally, exponential smoothing

assigns exponentially decreasing weights over time.

Exponential smoothing, forecasts are modified in the light of observed errors.

If the forecast value for year t,

Ft is less than the actual value for year t,

St the forecast for the year t+1, Ft + 1

Ft + 1 = Ft + α et

Where,

Ft + 1 = forecast for year

α = smoothing parameter, lies between 0 and 1

et = error in the forecast for year t = St - Ft

The range of possible values is zero and one.

If you select a value of close to 1, that means you are attaching a large weight to the most recent observation.

This is not indicated if your series is very erratic (swings widely from period to period).

Exponential smoothing is a technique for manipulating data from a series of chronological observations to

downplay the effects of random variation.

Mathematical modeling, the creation of a numerical simulation for a data set, often treats observed data as the

sum of two or more components, one of which is random error, the differences between the observed value

and the underlying true value.

When properly applied, smoothing techniques minimize the effect of the random variation, making it easier to

see the underlying phenomenon — a benefit both in presenting the data and in making forecasts of future

values.

They are referred to as "smoothing" techniques because they remove jagged ups and downs associated with

random variation and leave behind a smoother line or curve when the data is graphed.

The disadvantage of smoothing techniques is that when improperly used they can also smooth away important

trends or cyclical changes within the data as well as the random variation, and thereby distort any predictions

they offer.

Moving average method

Causal Methods

Causal methods seek to develop forecasts on the basis of cause-effects relationships specified in an explicit,

quantitative manner.

Chain Ratio Method

Consumption Level Method

End Use Method

Leading Indicator Method

Econometric Method

Consumption Level Method Useful for a product which is directly consumed, this method estimates consumption level on the basis of elasticity

coefficients, the important ones being the income elasticity of demand and the price elasticity of demand.

Income elasticity of demand— The income elasticity of demand reflects the responsiveness of demand to variations in

income. It is measured as follows:

Price Elasticity: it refers to the responsiveness of demand to variation in prices. The price elasticity of demand is a useful

tool in demand analysis. The future volume of demand may be estimated on the basis of the price elasticity coefficient

and expected price change. The price elasticity coefficient may also be used to study the impact of variable price that

may obtain in future on the economic viability of the project. In using the price elasticity measure, however, the

following considerations should be borne in mind:

1. The price elasticity coefficient is applicable to only small variations.

2. The price elasticity measure is based on the assumption that the structure and behavior remain constant.

End Use Method

Suitable for estimating demand for intermediate products

Also called as consumption coefficient method

Steps

1. Identify the possible uses of the products

2. Define the consumption coefficient of the product for various uses

3. Project the output levels for the consuming industries

4. Derive the demand for the project

The key inputs required for the application of the end-use method are:

1. Projected output levels of consuming industries (units)

2. Consumption coefficients.

It may be difficult to estimate the projected output levels of consuming industries (units).

More important, the consumption coefficients may vary from one period to another in the wake of

technological changes and improvements in the methods of manufacturing.

Hence, the end-use method should be used judiciously.

Leading Indicator Method Leading indicators are variables which change ahead of other variables, the lagging variables. Hence, observed

changes in leading indicators may be used to predict the changes in lagging variables. For example, the change in

the level of urbanization a leading indicator may be used to predict the change in the demand for air

conditioners a lagging variable.

Two basic steps are involved in using the leading indicator method:

Identify the appropriate leading indicator(s).

Establish the relationship between the leading indicator(s) and the variable to be forecast.

Merit:

It does not require a forecast of an explanatory variable.

Demerit:

1. It may be difficult to find an appropriate leading indicator(s).

2. The lead-lag relationship may not remain stable over time. In view of these problems this method has limited

use.

Econometric Method

An advanced forecasting tool,

It is a mathematical expression of economic relationships derived from economic theory.

The primary objective of econometric analysis is to forecast the future behavior of the economic variables

incorporated in the model.

Two types of econometric models are employed: the single equation model and the simultaneous equation

model.

The single equation model assumes that one variable, the dependent variable (also referred to as the explained

variable), is influenced by one or more independent variables (also referred to as the explanatory variables).

An example of the single equation model is given below:

Chain

Ratio Methods

The potential sales of a product may be estimated by applying a series of factors to a measure of aggregate

demand.

It uses a simple analytical approach to demand estimation.

Uncertainties in Demand Forecasting Data about past and present markets: The analysis of past and present market, which serves as the springboard for the

projection exercise, may be vitiated by the following inadequacies of data:

Lack of standardization: Data pertaining to market features like product, price, quantity, cost, income etc. may

not reflect uniform concepts and measures.

Few observations: Not enough observations may be available to conduct meaningful analysis.

Influence of abnormal factors: Some of the observations may be influenced by abnormal factors like war or

natural calamity.

Methods of forecasting: Methods used for demand forecasting are characterized by following limitations.

Inability to handle unquantifiable factors: Most of the forecasting methods, quantitative in nature, cannot

handle unquantifiable factors which sometimes can be of immense significance.

Unrealistic assumptions: Each forecasting method is based on certain assumptions. For example, the trend

projection method is based on the ‘mutually compensation effects’ premise and the end-use method is based on

the constancy of technical coefficients. Uncertainty arises when the assumptions underlying the chosen method

tend to be unrealistic and erroneous.

Excessive data requirement: In general, the more advanced a method, the greater the data requirement. For

example, to use an econometric model one has to forecast the future values of explanatory variables in order to

project the explained variable. Clearly, predicting the future value of explanatory variables is a difficult and

uncertain exercise.

Environmental changes: The environment in which a business functions is characterized by numerous uncertainties. The

important sources of uncertainty are mentioned below:

Technological changes: A technological advancement may create a new product which performs the same

function more efficiently and economically, thereby cutting into the market for the existing product. For

example, electronic watches have encroached on the market for mechanical watches.

Shift in government policy: Granting of licenses to new companies, particularly foreign companies, may alter the

market situation significantly.; banning the import of a certain product may create a sheltered market for the

existing producers; liberalizing the import of some product may lead to stiff competition in the market place;

relaxation of price and distribution controls may widen the market considerably.

Developments on the international scene: Developments on the international scene may have a profound effect

on industries. The most classic example of recent times is the OPEC price hike, which led to near stagnation in

the Indian automobile industry.

Discovery of new source of raw material: Discovery of new sources of raw materials, particularly hydrocarbons,

can have a significant impact on the market situation of several products.

Vagaries of monsoon: Monsoon is somewhat unpredictable. The behavior of monsoon influences, directly or

indirectly, the demand for a wise range of products.

Coping With Uncertainties

Conduct analysis with data based on uniform and standard definitions.

Ignore the abnormal or out-of-ordinary observations.

Critically evaluate the assumptions of the forecasting methods and choose a method which is appropriate to the

situation.

Adjust the projections derived from quantitative analysis in the light of a due consideration of unquantifiable

influences.

Monitor the environment imaginatively to identify important changes.

Consider likely alternative scenarios and their impact on market and competition.

Conduct sensitivity analysis to assess the impact on the size of demand for unfavorable and favorable variations

of the determining factors from their most likely levels.

Market planning Current marketing situation

- Market, Competition, Distribution, PEST.

Opportunity and issue analysis - SWOT

Objectives- Break even, % market share…

Marketing strategy- target segment, positioning, 4 Ps

Action program- Quarter 1, Q2, Q3….

Technical Analysis

Technical analysis implies the adequacy of the proposed plant and equipment to prescribed norms. It should be ensured

whether the required know how is available with the entrepreneur.

Analysis of technical and engineering aspects is done continually when a project is being examined and formulated.

Other types of analyses are dependent and closely intertwined with technical analysis.

The following inputs concerned in the project should also be taken into consideration:

Availability of Land and site.

Availability of Water, Power, transport, communication facilities.

Availability of servicing facilities like machine shop, electric repair shop etc.

Coping with anti-pollution law.

Availability of work force.

Availability of required raw material as per quantity and quality.

Production and Technology, Choice of technology.

Product Mix, Plant capacity.

Machinery and Equipment.

Materials and inputs There is an intimate relationship between the study of materials and inputs and other aspects of project

formulation concerned with location, technology, and equipment.

Materials and inputs may be classified into 4 broad categories:

1. Raw materials— Raw materials (processed and /or semi-processed) may be classified into four types:

(i) agricultural products,

(ii) mineral products,

(iii) livestock and forest products,

(iv) marine products

2. Processed industrial materials and components— Processed industrial materials and components (base metals,

semi-processed materials, manufactured parts, components, and sub-assembly represent an important input for a

number of industries. In studying them the following questions need to be answered:

In the case of industrial materials, What are their properties?, How dependable are the supplies?

What is the total requirement of the project? , What has been the past trend in prices?

What quantity would be available from domestic source?, What is the likely future behavior of prices?

What quantity would be available from foreign sources?

3. Auxiliary materials and factory supplies:

In addition to the basic raw materials and processed industrial materials and components, a manufacturing project

requires various auxiliary materials and factory supplies, like:

Chemicals, Additives, Packaging materials, Paints, Varnishes, Oils, Grease, Cleaning materials, etc.

The requirements of such auxiliary materials and supplies should be taken into account in the feasibility study.

4. Utilities:

A broad assessment of utilizes (power, water, steam, fuel, etc.) may be made at the time of input study though a

detailed assessment can be made only after formulating the project with respect to location, technology, and plant

selection.

Since the successful operation of a project critically depends on adequate availability of utilities the following points

should be raised whiled conducting the input study:

1. What quantities are required?

2. What are the sources of supply?

3. What would be the potential availability?

4. What are the likely shortages/bottlenecks?

5. What measures may be taken to augment supplies.

Product Mix The choice of product mix is guided primarily by market requirements.

In the production of most of the items variations in size and quality are aimed the production of most of the

items, variations in size and quality are aimed at satisfying a broad range of customers. For example, production

of shoes to different customers.

Sometimes slight variations in quality can enable a company to expand its market and enjoy higher profitability.

For example, a toilet soap manufacturing unit may by minor variation in raw material, packaging, and sales

promotion offer a high profit margin soap to consumers in upper-income brackets.

While planning the production facilities of the firm, some flexibility with respect to the product mix must be

sought. Such flexibility enables the firm to alter its product mix in response to changing market conditions and

enhances the power of the firm to survive and grow under different situations. The degree of flexibility chosen

may be based on a careful analysis of the additional investment requirements for different degrees of flexibility.

Plant Capacity Plant capacity refers to the volume or number of units that can be manufactured during a given period.

Several factors have a bearing on the capacity decision:

Technological requirement: For many industrial projects, particularly in process type industries, there is a

certain minimum economic size determined by the technological factor. For example, a cement plant should

have a capacity of at least 300 tonnes per day in order to use the rotary kiln method otherwise, it has to employ

the vertical shaft method which is suitable for lower capacity.

Market conditions: The anticipated market for the product/service has an important bearing on plant capacity.

If the market for the product is likely to be very strong, a plant of higher capacity is preferable. If the market is

likely to be uncertain, it might be advantageous to start with a smaller capacity. If the market, starting from a

small base, is expected to grow rapidly, the initial capacity may be higher than the initial level of demand further

additions to capacity may be affected with the growth of market.

Resources of the firm: The resources, both managerial and financial, available to a firm define a limit on its

capacity decision. Obviously, a firm cannot choose a scale of operations be yond its financial resources and

managerial capability.

Choice

of Technology

The choice of technology is influenced by a variety of considerations:

1. Principal inputs (Raw material): The choice of technology depends on the principal inputs available for the

project. In some cases, the raw materials available influences the technology chosen. For example, the quality of

limestone determines whether the wet or dry process should be used for a cement plant.

2. Investment outlay and production cost: The effect of alternative technologies of investment outlay and

production cost over a period of time should be carefully assessed.

3. Experience by other units: The technology adopted must be proven by successful use by other units, preferably

in India.

4. Product mix: The technology chosen must be judged in terms of the total product-mix generated by it, including

saleable by-products.

5. Based on Latest developments: The technology adopted must be based on latest development in order to

ensure that the likelihood of technological obsolescence in the near future, at least, is minimized.

6. Ease of absorption: The ease with which a particular technology can be absorbed can influence the choice of

technology. Sometimes a high-level technology may be beyond the absorptive capacity of a developing country

which may lack trained personnel to handle that technology.

Machinery and Equipment The requirement of machinery and equipment is dependent on:

Production Technology and Plant Capacity.

Type of project.

For a process-oriented industry, like a petrochemical unit, machinery and equipment required should be such

that the various stages have to be matched well.

The choice of machinery and equipment for a manufacturing industry is somewhat wider as various machines

can perform the same function with varying degrees of accuracy. For example, the configuration of machines

required for the manufacture of refrigerators could take various forms.

To determine the kinds of machinery and equipment requirement for a manufacturing industry, the following

procedure may be followed:

1. Estimate the likely levels of production over time.

2. Define the various machining and other operations.

3. Calculate the machine hours required for each type of operation.

4. Select machinery and equipment required for each function.

The equipment required for the project may be classified into the following types:

(i) Plant equipment, (ii) Mechanical equipment,

(iii) Electrical equipment

(iv) Internal Transportation System, (v) Other Machinery and Equipment.

In addition to the machinery and equipment, a list should be prepared of spare parts and tools required.

This may be divided into:

i. spare parts and tools to be purchased with original equipment

ii. spare parts and tools required for operational wear and tear.

Constraints in selecting machinery and equipment: In selecting the machinery and equipment, certain constraints should

be borne in mind:

There may be a limited availability of power to set up an electricity intensive plant like, for example, a large

electric furnace

There may be difficulty in transporting a heavy equipment to a remote location;

Workers may not be able to operate, at least in the initial periods, certain sophisticated equipment such as

numerically controlled machines

The import policy of the government may preclude the import of certain types of machinery and equipment.

For whom is it important to understand project finance?

Project Costing and Finance A large number of companies who are in the business of project design, engineering, procurement and

construction, use cost data for arriving at the price of the project as they have to participate in competitive

bidding for securing future business.

Cost of project represents the total of all items of outlay associated with a project which are supported by long-

term funds.

It is the sum of outlays on the following:

- Land and site development

- Building and civil works

- Plant and machinery

- Technical know-how and engineering fees

- Expenses on foreign technicians and training of Indian technicians abroad

- Miscellaneous fixed assets

- Preliminary and capital issue expenses

- Pre-operative expenses

- Margin money for working capital

- Initial cash losses: initial cash losses are not disclosed to maintain the project’s attractiveness. So a provision

should be maintained for initial cash losses.

Land and site development: The cost includes:

- Basic cost of land including conveyance and other allied charges

- Premium payable on leasehold and conveyance charges

- Cost of levelling and development

- Cost of laying approach roads and internal roads

- Cost of gates

- Cost of tube wells

Building and civil works: The cost includes:

- Buildings for the main plant and equipment

- Buildings for auxiliary services like steam supply, workshops, laboratory, water supply, etc

- Godowns, warehouses, and open yard facilities

- Quarters for essential staff

- Non-factory buildings like canteen, guest houses, time office, excise house, etc

- Garages

- Sewers, drainage, etc

- Other civil engineering works.

Plant and Machinery: It includes:

- Cost of imported machinery: It includes FOB (free on board) value, shipping, freight, insurance cost, import duty,

clearing, loading, unloading and transportation charges.

- Cost of indigenous machinery: It includes sakes tax, octroi, and other taxes, if any, railway freight and transport

charges to the site

- Cost of stores and spares

- Foundation and installation charges

Miscellaneous Fixed Assets:

They are not part of the direct manufacturing process may be referred to as miscellaneous fixed assets. It includes:

- furniture, office machinery and equipment

- Tools, vehicles, railway siding, Expenses on procurement of use of patents, licenses, trade marks , copyrights, etc

- Diesel generation sets, transformers, boilers

- Piping system, laboratory equipments

Preliminary expenses includes:

- Expenses incurred for identifying the project, conducting market survey

- Preparing the feasibility report, drafting MOA and AOA

- Incorporating the company

Capital issue expenses include:

- Expenses of Raising of capital from public

- Underwriting commission

- Brokerage, fees to managers and registrars

- Printing and postage expenses

- Advertising and publicity expenses

- Listing fees

- Stamp duty

Pre-operative Expenses: It includes:

Expenses incurred till the commencement of commercial production

- Establishment expenses

- Rent, rates and taxes, start-up expenses

- Travelling expenses, interest on deferred payments

- Interest and commitment charges on borrowings

- Insurance charges, miscellaneous expenses

Provision for contingencies

Margin money for Working Capital: it is that part of working capital requirement that comes from long-term

sources. This is utilized for meeting over-runs in capital cost. This leads to a working capital problem when the

project is commissioned. To avoid this problem, financial institutions stipulate that a portion of the loan amount,

equal to the margin money for working capital, be blocked initially so that it can be release d when the project is

completed.

Means of Financing project

Share capital: Equity and Preference shares

Term loans: provided by financial institutions and commercial banks. They show secured borrowings for

financing new projects as well as for the expansion , modernization, renovation, etc. they are available as Indian

currency term loans (given for financing land, building, civil works etc.) and foreign currency term loans (given

for meeting the foreign currency expenditures towards the import of equipment and technical know-how).

Debenture capital: Non-convertible debentures maturity period ranging from 5 to 9 years. Convertible

debentures are converted wholly or partly into equity shares. Conversion period and prices are announced in

advance

Deferred credit

Incentive sources

Miscellaneous sources

Break-even Point

Break-even analysis is used to determine the point at which revenue received equals the costs associated with receiving

the revenue.

Break-even analysis calculates what is known as a margin of safety, the amount that revenues exceed the break-even

point. This is the amount that revenues can fall while still staying above the break-even point.

Break-even analysis is a supply-side analysis; it only analyzes the costs of the sales.

It does not analyze how demand may be affected at different price levels.

The break-even point is the point at which gains equal losses. Reaching the break-even point is a business's first step

toward profitability.

The break-even point for a project is calculated with reference to the year when the project is expected to reach its

target level of capacity utilization, which is usually the third of the fourth operating year.

1. Equity Capital This is the contribution made by the owners of business, the equity shareholders, w ho enjoy the rewards and

bear the risks of ownership. However, their liabilities, limited to their capital contribution. From the point of

view of the issuing film, equity capital offers, two important advantages: (i) It represents permanent capital.

Hence there is no liability for repayment. (ii) It does not involve any fixed obligation for payment of dividend.

The disadvantages of raising funds by way of equity capital are:

The cost of equity capital is high because equity dividend is not tax-deductible expenses.

The cost of issuing equity capital is high.

2. Preference Capital

A hybrid form of financing, preference capital partakes some characteristics of equity capital and some

attributes of debt capital.

It is similar, to equity capital because preference dividend, like equity dividend, is not a tax-deductible payment.

It resembles debt capital because the rate of preference dividend is fixed.

Typically, when preference dividend is skipped it is payable in future because of the cumulative feature

associated with it. The near-fixity of preference dividend payment renders preference capital somewhat

unattractive in general as a source of finance. It is, however, attractive when the promoters do not want a

reduction in their share: share of equity and yet there is need for widening the net worth base (net worth

consists of equity and preference capital) to satisfy the requirements of financial institutions. In addition to the

conventional preference shares, a company may issue Cumulative Convertible

Preference Shares (CCPS). These shares carry a dividend rate of 10 per cent (which; if unpaid, cumulates) and are

compulsory convertible into equity shares between three and five years from the date of issue.

3. Debenture Capital

In the last few years, debenture capital has emerged as an important source for project financing.

There are three types of debentures that are commonly used in India:

Non- Convertible Debentures (NCDs),

Partially Convertible Debentures (PCDs), and

Fully Convertible Debentures (FCDs).

Akin to promissory, NCDs are used by companies for raising debt that is generally retired over a period of 5 to 10

years. They are secured by a charge on the assets of the issuing company. PCDs are partly convertible into equity

shares as per pre-determined terms of conversion. The unconverted portion of PCDs remains like NCDs.

FCDs, are converted wholly into equity shares as per pre-determined terms of conversion. Hence FCDs may be

regarded as delayed equity instruments.

4. Rupee Term Loans

Provided by financial institutions and commercial banks, rupee term loans which represent secured borrowings

are a very important source for financing new projects as well as expansion, modernization, and renovation

schemes of existing units. These loans are generally repayable over a period of 8-10 years which includes a

moratorium period of l-3 years.

5. Foreign Currency Terms Loans

Financial institutions provide foreign currency term loans for-meeting the foreign currency expenditures

towards import of plant, machinery, equipment and also towards payment of foreign technical know-how fees.

Under the general scheme, the periodical liability towards interest and principal remains in the

currency/currencies of the loan/ and is translated into rupees at the then prevailing rate of exchange for making

payments to the financial institution. Apart from approaching financial institutions (which typically serve as

intermediaries between foreign agencies and Indian borrowers), companies can directly obtain foreign currency

loans from international lenders. More and more companies appear to be doing so presently.

6. Euro issues

Beginning with Reliance Industries’ Global Depository Receipts issue of approximately $150 ml in May 1992, a

number of companies have been making euro issues. They have employed two types of securities: Global

Depository Receipts (GDRs) and Euro convertible Bonds (ECBs).

Denominated in US dollars, a GDR is a negotiable certificate that represents the publicly traded local currency

(Indian Rupee) equity shares of a non-US (Indian) company. (Of course, in. theory, a GDR may represent a debt

security; in practice it rarely does so.) GDRs are issued by the Depository Bank (such as the Bank of New York)

against the local currency shares (such as Rupee shares) which are delivered to the depository’s local custodian

banks. GDRs trade freely in the overseas markets.

A Euro convertible Bond (ECB) is an equity-linked debt security. The holder of an ECB has the option to convert it

into equity shares at a pre-determined conversion ratio during a specified period. ECBs are regarded as

advantageous by the issuing company because:

They carry a lower rate of interest compared to a straight debt security,

They do not lead to dilution of earnings per share in the near future, and

They carry very few restrictive covenants.

7. Deferred Credit

Many a time the suppliers of machinery provide deferred credit facility under which payment for the purchase

of machinery is made over a period of time. The interest rate on deferred credit and the period of payment vary

rather widely. Normally, the supplier of machinery when he offers deferred credit facility insists that the bank

guarantee should be furnished by the buyer.

8. Bills Rediscounting Scheme

Operated by the IDBI, the bills rediscounting scheme is meant to promote the sale of indigenous machinery on

deferred payment basis. Under this scheme, the seller realizes the sale proceeds by discounting the bills or

promissory notes accepted by the buyer with a commercial bank which in turn rediscounts them with the IDBI.

This scheme is meant primarily for balancing equipment and machinery required for expansion, modernization,

and replacement schemes.

9. Suppliers’ Line of Credit

Administered by the ICICI, the Suppliers’ Line of Credit is somewhat similar to the IDBI’s Bill Rediscounting

Scheme. Under this arrangement, ICICI directly pays to the machinery manufacturer against usance bills duly

accepted or guaranteed by the bank of the purchaser.

10. Seed Capital Assistance Financial institutions, through what may be labeled broadly as the ‘Seed Capital

Assistance scheme, seek to supplement the resources of the promoters and of medium scale industrial units

which are eligible for assistance from All-India financial institutions and/ or state-level financial institutions.

Broadly 3 schemes have been formulated:

(i) Special Seed Capital Assistance Scheme The quantum of assistance under this scheme is Rs 0.2 million or 20 per cent

of the project cost, whichever is lower. This scheme is administered by the State Financial Corporations.

(ii) Seed Capital Assistance Scheme The assistance order this scheme is applicable to projects costing not more than

Rs.20 million. The assistance per project is restricted to Rs 1.5 million. The assistance is provided by IDBI through state

level financial institutions. In special cases, the IDBI may provide the assistance directly.

(iii) Risk Capital Foundation Scheme Under this scheme, the Risk Capital Foundation, an autonomous foundation set up

and funded by the IFCI, offers assistance to promoters of projects costing between Rs.20 million and Rs.150 million. The

ceiling on the assistance provided between Rs.1.5 million and Rs.4 million depending on the number of applicant

promoters.

11. Government Subsidies Previously the central government as well as the state governments provided subsidies to industrial units

located in backward areas. The central subsidy has been discontinued but the state subsidies continue. The state

subsidies vary between 5 per cent to 25 percent of the fixed capital investment in the project, subject to a

ceiling varying between Rs 0.5 million and Rs 2.5 million depending on the location.

12. Sales Tax Deferments and Exemptions To attract industries, the states provide incentives, inter alia, in the form of sales tax deferments and sales tax

exemptions. Under the sales tax deferment scheme, the payment of sales tax on the sale of finished goods may

be deferred for a period ranging between five to twelve years. Essentially, it implies that the pro ject gets an

interest free loan, represented by the quantum of sales tax deferred, during the deferent period.

Under the sales tax exemption scheme, some states exempt the payment of sales tax applicable on purchases of

raw materials, consumables, packing, and processing materials from within the state which are used for

manufacturing purposes. The period of exemption ranges from three to nine years depending upon the state

and the specific location of the project within the state.

13. Unsecured Loans and Deposits

Unsecured loans are typically provided by the promoters to fill the gap between the promoters’ contribution

required by financial institutions and the equity capital subscribed by the promoters. These loans are subsidiary

to the institutional loans. The rate of interest chargeable on these loans is less than the rate of interest on the

institutional loans. Finally these loans cannot be taken back without the prior approval of financial institutions.

Deposits from public, referred to as public deposits, represent unsecured borrowing of two to three years’

duration. Many existing companies prefer to raise public deposits instead of term loans from financial

institutions because restrictive covenants do not accompany public deposits. However, it may not be possible

for a new company to raise public deposits. Further, it may be difficult for it to repay public deposits within

three years.

14. Foreign Currency Loans Apart from rupee term loans, financial institutions provide foreign currency loans.

This assistance is now provided only for the import of capital equipment (as per the liberalized exchange risk

management system, foreign currency required for other purposes has to be purchased from authorized dealers

at market rates).

On foreign currency loans sanctioned under the general scheme, the interest rate charged is typically a floating

rate as determined by the lenders, (the foreign agency that has given a line of credit to the financial institution

for onward lending) and the risk of exchange rate fluctuation is born by the borrower.

On foreign currency loans sanctioned under the Exchange Risk Administration Scheme, the principal repayment

obligations of the borrower are rupee tied at the rate of exchange prevailing on the dates of disbursement. O n

such rupee-tied loan liability, the borrower pays by way of servicing his loan a composite, cost every quarter.

The composite cost consists of three elements: (i) the interest portion which is arrived on the basis of the

weighted average interest cost of the various components of the currency pool, (ii) the spread of the financial

institutions, and (iii) the exchange risk premium. The ‘composite cost’ is a variable rate determined at six -

monthly intervals. It has a floor and a cap. Both the floor and the cap as well as the rate of interest applicable for

the period is reviewed and announced from time to time.

15. Leasing and Hire Purchase Finance

With the emergence of scores of finance companies engaged in the business of leasing and hire purchase

finance, it may be possible to get a portion, albeit a small portion, of the assets financed under a lease or a hire

purchase arrangement. Typically, a project is financed partly by financial institutions and partly through the

resources raised from the capital market. Hence, in finalising the financing scheme for a project, you should bear

in mind the norms and policies of financial institutions and the guidelines of Securities Exchange Board of India

and the requirements of the Securities Contracts Regulation Act (SCRA).

16. Public Deposit

Public deposits have been a peculiar feature or industrial finance in India.

Companies have been receiving public deposits for a long time in order to meet their medium-term and long-

term requirements for finance. This system was very popular in the cotton textile mills or Bombay, Ahmedabad

and Sholapur and in the tea gardens or Assam and Bengal. In recent years, the method or raising finance

through the public deposits has again become popular for various reasons. Rates or interest offered by the

companies are higher than those offered by banks. At the same time the cost of deposits to the company is less

than the cost or borrowings from banks.

While accepting public deposits, a company must follow the provisions or the companies Act and the directions

issued by the Reserve bank of India. According to the companies (Acceptance of Deposits Rules, 1975 as

amended in 1984) Act, no company can receive secure and unsecured deposits in excess of 10% and 25%

respectively of paid up share capital plus free reserves. The Central Government has laid down that no company

shall invite a deposit unless an advertisement, including a statement showing the financial position of the

company, has been issued in the prescribed form. Under the new rul e, deposits can be renewed. The rate of

interest payable on deposits must not exceed 15% per annum. In order to repay the deposits maturing in a

particular year, the company must deposit 110% or the deposits with a scheduled bank or in specified securities .

17. Bank Credit Commercial banks in the country serve as the single largest source or short-term finance to business firms. They

provide it in the form of Outright Loans. Cash credit, and Lines of Credit.

Unit-2 Questions

1. What types of information are required for market and demand analysis?

2. Discuss the steps involved in constructing and using an econometric model.

3. What are the sources of uncertainties in demand forecasting? Discuss them.

4. “Often secondary information is not adequate for market and demand analysis”. Comment.

5. What aspects are considered in technical analysis?

6. What factors have a bearing on choice of technology?