Planning

This phase is concerned with the articulation of

broad investment strategy and the generation and
preliminary screening of project proposals.

The investment strategy of the firm delineates the
broad areas or types of investment the firm plans to
undertake. This provides the framework which
shapes guides and circumscribes the identification
of individual project opportunities.
To begin with, a preliminary project analysis is done. A
prelude to the full blown feasibility study, this is meant
to access:

Whether the project prima facie worthwhile to justify a
feasibility study.
What aspects of the project are critical to its viability
and hence warrant an in depth investigation.
Analysis
If the preliminary screening suggests that the
project is prima facie worthwhile a detailed
analysis of the marketing, technical, financial,
economic and ecological aspect is undertaken.
The focus of this phase is on gathering, preparing
and summarizing relevant information about
various project proposals which are being
considered for inclusion in capital budget.
Based on the information developed in this
analysis, the stream of cost benefit associated with
the project can be defined.
Selection
This often overlap analysis.
It addresses the question:
Is the project worthwhile?
A wide range of criteria have been suggested to judge the
worthwhile ness of the project. They are divided into
non-discounting criteria- payback period and the
accounting rate of return. and discounting criteria-net
present value, internal rate of return and benefit cost
ratio.

Criteria Accept Reject
Pay back period
(PBR)
PBR less than target
period
PBR greater than
target period
Accounting Rate of
Return (ARR)
ARR greater than
target rate
ARR less than target
rate
Net present Value
(NPV)
NPV greater than Zero NPV less than Zero
Internal Rate of
Return (IRR)
IRR greater than cost
of capital
IRR less than cost of
capital
Benefit-Cost ratio
(BCR)
BCR greater than 1 BCR less than 1
To apply the various appraisal criteria suitable cutoff
values (hurdle rate, target rate and cost of capital) have
to be specified. These are essentially function of the
mix of financing and the level of project risk.
Despite a wide range of tools and techniques for risk
analysis (sensitivity analysis, scenario analysis, Monte
Carlo analysis, decision tree analysis etc.,) risk analysis
remains the most intractable part of the project
evaluation exercise.
Financing
Once a project is selected, suitable financing arrangements have to be
made. The two broad sources of finance for a project are equity and
debt. Equity(referred to as shareholders funds on balance sheets in
India) consists of paid-up capital, share premium, and retained
earnings. Debt(referred to as loan funds on balance sheets in India)
consists of terms loans, debentures, and working capital advances.
Flexibility, risk, income, control, and taxes (referred to by the acronym
FRICT) are the key business considerations that influence the capital
structure (debt-equity ratio) decision and the choice of specific
instruments of financing.
Implentation
The Implementation phase for an industrial project, which involves
setting up of manufacturing facilities, consists of several stages
(1) project and engineering designs,
(2)negotiations and contracting,
(3)construction,
(4) training and
(5)plant commissioning.
What is done in these stages is briefly described below:

Stage Concerned with
Project and engineering designs Site probing and prospecting, preparation of
blueprints, and plant designs, plant engineering,
selection of specific machineries and equipment.
Negotiations and contracting Negotiating and drawing up of legal contracts with
respect to project financing acquisition of
technology, construction of building and civil
works, provision of utilities, supply of machinery
and equipment, marketing arrangements, etc.
Construction Site preparation, construction of buildings and
civil works, erection and installation of machinery
and equipment.
Training Training of engineers, technicians , and
workers.(This can proceed simultaneously along
with the construction work)
Plant commissioning Start up of the plant. (This is a brief but technically
crucial stage in the project development cycle.)
Translating an investment proposal into a concrete project is a complex , time
consuming, and risk-fraught task. Delays in implementation, which are
common, can lead to substantial cost overruns. For expeditious
implementation at a reasonable cost, the following are helpful:
1. Adequate Formulation of projects A major reason for the delay is inadequate
formulation of projects. Put differently, if the necessary homework in terms of
preliminary studies and comprehensive and detailed formulation of the project
is not done, many surprises and shocks are likely to spring on the way. Hence ,
the need for adequate formulation of the project cannot be over-emphasised.

2. Use of the Principle of Responsibility Accounting Assigning specific
responsibilities to project managers for completing the project with in the
defined time-frame and cost limits is helpful in expeditious execution and cost
control.

3. Use of Network Techniques For project planning and control two basic
techniques are available - PERT (Programme Evaluation Review Technique)
and CPM ( Critical Path Methods). These techniques have, of late, merged and
are being referred to by a common terminology, that is network techniques.
With the help of these techniques, monitoring becomes easier.

Review
Once the project is commissioned, the review phase has to be set in
motion. Performance review should be done periodically to compare
actual performance with projected performance. A feedback device, it
is useful in several ways:
(1) It throws light on how realistic were the assumptions underlying
the project;
(2) It provides a documented log of experience that is highly valuable
in future decision making;
(3) It suggest corrective action to be taken in the light of actual
performance;
(4) It helps in uncovering judgmental biases;
(5) It induces a desired caution among project sponsors.
Levels of Decision Making
In addition to looking at the various phases of capital budgeting,
researches have also examined different levels of decision making.
Gordon, Miller , and Mintzberg, for example, defined three levels of
decision making: operating , administrative , and strategic. The key
characteristics of decisions at these levels are described below:
Operating
decisions
Administrative
decisions
Strategic
decisions
Where the
decision is taken
Lower level
Management
Middle level
Management
Top level
Management
How structured is
the decision
Routine Semi-structured Unstructured
What is the level
of resource
commitment
Minor resource Moderate resource Major resource
What is the time
horizon
Short-term Medium-term Long-term
The 3 levels of decision making can be readily applied to capital
budgeting decision. Examples are given below:

Operating capital budgeting decision :Minor office equipment
Administrative capital budgeting decision :Balancing equipment
Strategic capital budgeting decision : Diversification project


While the methods and techniques covered in this are applicable to all
levels of capital budgeting decisions, our discussion will mainly be
oriented towards administrative and Strategic capital budgeting
decision.
Facets of Project Analysis


The important facets of project analysis are:
1. Market analysis
2.Technical analysis
3.Financial analysis
4.Economic analysis
5.Ecological analysis
Market analysis
Market analysis is concerned primarily with 2 questions:

1. what would be the aggregate demand of the proposed product/service in
the future?

2. what would be the market share of the project under appraisal?

To answer the above questions, the market analyst requires a wide Varity of
information & appropriate forecasting methods. The kind of information
required are :
o Consumption trends in the past and present consumption level.
o past and present supply position
o Production possibilities and constraints

o Imports and Exports
o Structure of competition
o Cost of structure
o Elasticity of demand
o Consumer behavior, intentions, motivations, attitudes, preferences,
and requirements.
o Distribution channel and marketing polices in use.
o Administrative , technical and legal constraints

Technical Analysis
Analysis of the technical and engineering aspects of a project needs to
be done continually when a project is formulated. Technical analysis
seeks to determine whether the prerequisites for the successful
commissioning of the project have been considered & reasonably good
choices have been made with respect to location, size, process, etc. The
important questions raised in technical analysis are:
1.Whether the preliminary tests & studies have been done or provided
for?
2. Whether the availability of raw materials, power, & other inputs has
been established?
3.Whether the selected scale of operation is optimal.
4. Whether the production of process chosen is suitable.?
5. Whether the equipment & machines chosen are appropriate?


6. Whether the auxiliary equipments & supplementary engineering
works have been provided for?
7.Whether provision has been made for the treatment of effluents?
8. Whether the proposed layout of the site , buildings, & plant is
sound?
9.Whether work schedules have been realistically drawn up?
10. Whether the technology proposed to be employed is appropriate
from the social point of view?


Financial Analysis
Financial analysis seeks to ascertain whether the
proposed project will be financially viable in the sense
of being able to meet the burden of servicing debt &
whether the proposed project will satisfy the return
expectations of those who provide the capital.The
aspects which have to be looked into while conducting
financial analysis are:
1. Investment outlay & cost of project.
2. Means of financing
3. Cost of capital


4. Projected profitability
5.Break-even point
6. Cash flows of the project
7. Investment worthwhileness judged in terms of
various criteria of merit
8 Projected financial position
9. Level of risk


Economic Analysis
Economic analysis also referred to as social cost benefit
analysis , is concerned with judging a project from the
larger social point of view. In such an evaluation the
focus is on the social costs & benefits of a project
which often be different from its monetary costs &
benefits. The questions sought to be answered in
social cost of benefit analysis are:
1. What are the direct economic benefits & costs of the
project measured in terms of shadow process and not
in terms of market prices.
2. What would be the impact of the project on the
distribution of income in the society?
3. What would be the impact of the project on the
level of saving & investment in the society?
4. What would be the contribution of the project
towards the fulfillment of certain merit wants like self-
suffiency, employment & social order?

Ecological Analysis
In recent years , environmental concerns have
assumed a great deal of significance and rightly so.
Ecological analysis should be done particularly for
major projects which have significant ecological
implications & environment-polluting industries.
The key questions raised in ecological analysis are:
1. What is the likely damage caused by the projects to
the environment.
2. What is the cost of restoration measures required to
ensure that the damage to the environment is
contained within acceptable limits?

Key issues in the Project Analysis:

Market Analysis Potential Market
Market share
Technical Analysis Technical Viability
Sensible choices

Financial Analysis Risk
Return
Economic Analysis Benefits & costs in shadow prices
Other Impacts
Ecological Analysis Environmental Damage
Restoration Measures





Feasibility study:

Generation of ideas
Initial screening
Is the idea prima facie
promising?
Plan feasibility analysis
Conduct financial
analysis
Conduct economic and
ecological analysis
Is the project
worthwhile?
Prepare funding proposal
Conduct technical
analysis
Conduct market
analysis
Objectives of capital budgeting
Finance theory rests on the premise that managers
should manage the firms resources with the objective
of enhancing the firms market value.
Common Weakness capital budgeting
1. Poor alignment between strategy and capital
budgeting.

2. Deficiencies in analytical techniques.
a. the base case is poorly identified.
b. risk is treated inadequately
c. options are not properly evaluated.
d. there is lack of uniformity in assumptions
e. side effects are ignored.

3. no linkage between compensation and financial
measures.





4.Reverse financing engineering.

5. week integration between capital budgeting and
Expense budgeting.

6. inadequate post audits.
Generation of ideas
1. stimulating the flow of ideas:
SWOT analysis
Clear articulation of objectives like cost reduction,
productivity improvement, increase in capacity
utilization, improvement in contribution margin,
expansion in promising field.
Fostering a conducive climate.
2. Monitoring the environment:
a. economic sector like state of econ0omy, overall
rate of growth, growth rate of primary secondary and
tertiary sectors, cyclic fluctuations, linkage with world
economy, trade surplus/deficit balance of payment
situation.

b.Governmental sectors: like industrial policy,
government program and projects, tax framework,
subsidies, incentives and concessions, import and
export policies, financing norms, lending conditions
of financial institutions and commercial banks.
c. Technological sector like emergence of new
technologies, access to technical know-how, foreign as
well as indigenous, receptiveness on the part of
industry.
D. Socio demographic sector: population trends, age
shift in population, income distribution, educational
profile, employment of women and attitude towards
consumption and investment.


e. competition sector: number of firms in the industry
and the market share of the top few, degree of
homogeneity and differentiation among products,
entry barrier, comparison with substitutes in terms of
quality, price, appeal and functional performance and
marketing policies and practices.
f. supplier sector: availability and cost of raw material
and sub assemblies, availability and cost of energy and
availability of cost of money.

Scouting for project ideas
Good ideas are key to the success of a project. However
they are elusive. So a wide variety of sources should be
tapped to identify them.
Analyze the performance of the existing industry.
Examine the input and outputs of various industries.
Review imports and exports.
Study plan outlay and governmental guidelines.
Look at the suggestions of financial institutions and
development agencies.
Investigate local materials and resources.




Analyze economic and social trends.
Study new technological developments.
Explore the possibilities of reviewing sick units.
Identify unfulfilled psychological needs.
Attend trade fairs.
Hope that chance factor will favor you.
Primiliminary screening

Compatibility with the promoter
Consistency with governmental priorities.
Availability of inputs.
Adequacy of market.
Reasonableness cost.
Acceptability of risk level.
Technical analysis
Manufacturing process/technology: choice of technology and
appropriateness of technology.
Technical arrangements
Materials and inputs.
Product mix
Plant capacity.
Location and site.
Machineries and equipments.
Structure and civil works.
Environmental aspects.
Project charts and layout.
Project implementation schedule.
Need for considering alternatives.
Cost of Capital
It is the total of all items of outlay associated with a project
which are supported by long-term funds. It is the sum of
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.
Means of Finance
Share Capital:
Equity capital-contribution of owners of business
and equity shareholders who enjoy the rewards and
bear the risk of ownership. This no fixed rate of
dividend.
Preference capital- contribution made by preference
shareholders and the dividend paid is generally fixed.
Term Loans:
These are provided by the financial institutions and
commercial banks, these are important source and
sometimes major source of financing a new project.
These loans are provided for new projects as well as for
expansion, modernization and renovation schemes.

There are two types of terms loans in India 1. rupee
terms loan given for land, building, plant and
machinery and 2. foreign currency term loan given for
foreign currency expenditure towards import of
equipments and technical; Know-how.
Debenture Capital:
These are investments for raising debt capital. There are
two types of debentures. 1. non convertible
debentures-they carry fixed rate of interest and have
maturity period of 5 to 9 years. 2. convertible
debentures- these are wholly are partly covetable into
equity shares. The conversion period and price are
announced in advance.

Deferred credit:
Many suppliers of the plant and machinery offer a
deferred credit facility under which payment for the
purchase of the plant and machinery can be made over
a period of time.
Incentive sources:
the government and its agencies may provide financial
support as an incentive to certain type of promoters
for setting up industrial units in certain locations like
capital subsidy or tax exemption for a certain period.
Miscellaneous sources:
A small portion of the project finance can come from
miscellaneous sources like unsecured loans, public
deposits and leasing and hire purchase finance.