Building Economics and

Value Management

Dr. Sarbesh Mishra

Finance Area, NICMAR
Hyderabad – 500 084.
 About Myself
Name : Dr Sarbesh Mishra

Qualifications 1. B.Com (Hons) 2. Post-

graduate in Commerce
3. M.Phil in Commerce
4. Ph.D. (Commerce)

Experience : Joined University of Delhi, as a

Lecturer in Commerce in 2001 and continued till 2005
and then joined
Army Institute of Management, NOIDA as Senior
Faculty, Finance prior to current appointment at
NICMAR.

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 Related to Cost (Thoughts)
 The most successful man in the life is the
man who has the best information.
Benjamin Disraeli, 19th. Century PM of England

 Even if you’re on right track, you’ll get run

over if you just sit there.
Will Rogers, Certified Cost Analyst
 He who controls the past controls future.
George Orwell, Certified Public Accountant

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Contd….
 You can’t get caught up in things that
you can’t control…….we can’t control
our selling price. We can control our
cost of manufacturing. We can control
our efficiencies. We can control our
waste.
Steven Appleton, CEO of Micro Technology
 If you don’t know where you’re going, it
doesn’t matter how you get there.
Prof. Sarbesh Mishra, NICMAR, Hyderabad

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Capital Expenditure (CAPEX)
Expenditure expended for the
purpose of obtaining long term
advantage for the business.
Examples
 Expenditure incurred in increasing the

quality fixed assets e.g. Purchase of

additional furniture, Plant, Building
for permanent use in Business.

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Revenue Expenditure
“An expenditure that arises out of and in
the course of regular business of a
concern is termed as revenue
expenditure”.
Example
Expenditure incurred in the normal course of
running the business e.g. expenses of
administration, maintaining of facilities viz.
Electricity, Telephone etc. cost incurred in
manufacturing & selling the products, repairs,
Depreciation, Interest on loan.
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Importance of Investment Decision
 Influence the firm’s growth in long-
term
 They affect the risk of the firm
 They involve commitment of large
volume of funds
 They are irreversible, or reversible at
substantial loss
 They are among most difficult
decisions to make.

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Investment Evaluation Criteria
 Estimation of Cash flows.

 Estimation of required rate of

return (Opportunity cost of
capital)

 Application of decision rule for

making the choice

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Cash Flows
 Cash inflows or outflows occur at three
stages of capital investment project
1. Project Initiation (For beginning operations,
Working Capital needs, Replacement of asset)
2. Project Operation (Operating Expenditure,
Addl. Working capital need, inflow of cash generated by
the investment)
3. Final Project Disposal (Cash inflows or
outflows related to investment’s disposal, Cash inflows
from the release of working capital no longer committed
to the investment)

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Investment appraisal Techniques
Traditional Techniques
 Payback Period Method

 Accounting Rate of return Method

Discounted Cash flow Technique

1. Net Present Value method (NPV)

2. Internal Rate of Return Method (IRR)

3. Profitability Index Method (PI)

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Traditional Techniques
Payback Period Method
 Payback is the number of years required to
recover the original cash outlay invested in a
project.

Payback = Initial Investment

Annual Average Cash Flows

Project would be accepted if its payback period

is less than the maximum or standard payback
period set by management.

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Accounting Rate of Return (ARR)
 This measures the profitability of an
investment.

ARR = Average Income

Average Investment

Projects with higher ARR over the minimum

rate established by the management will be
accepted.

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DCF Techniques
 It explicitly recognizes the time value of
money.

 Cash flows arising at different time periods

differ in their value and are comparable
when their present values are found out.

 The compound interest rate is used for

discounting cash flows is also called as the
discount rate.

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Net Present Value Method (NPV)
 Cash flows of the invested projects should
be forecasted based on realistic
assumptions.
 Appropriate discount rate should
identified to discount the forecasted cash
flows.
 Present value of cash flows should be
calculated using the opportunity cost of
capital as the discount rate.
 Net Present Value is found out by
subtracting present value of cash inflows.
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NPV Formula

n
Ct
NPV = Ʃ - C0
t=1 (1+k)t
C1, C2 ….. Represent cash inflow in year 1,2 ….,
k is the opportunity cost of capital
C0 is the initial cost of investment
n is the expected life of the investment
* k is assumed to be known and is constant

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Acceptance Rule
1. Accept the project when NPV is positive

2. Reject the project when NPV is negative

3. May accept the project when NPV is zero.

Higher the NPV, the better it is.

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Risk Analysis as a measure
of cost control
Uncertainty arises from the lack of previous
experience and knowledge. Attached factors
are:
1. Date of Completion
2. Level of capital outlay required
3. Level of selling price
4. Level of sales volume
5. Level of revenue
6. Level of Operating Costs
7. Taxation Rules
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Probability and Expected Values
 The probability of a particular outcome
of an event is simply the proportion of
times this outcome would occur if the
events were repeated a great number of
times.
 Expected Values – It results from the
multiplication of each possible outcome
of an event by the probability of that
outcome occurring.

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Risk Adjusted Discounted Rate
 The capital asset pricing model (CAPM) has
provided an approach to determine project
required rate of return with risk
consideration.
 A measure of risk developed in the portfolio
theory is beta (β).
RADR = Rf + Ri (K0 – Rf)
Rf = Risk free rate
K0 = Cost of Capital
Ri = Risk index of the project

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Value Management / Earned Value Analysis
Today’s Situation:

 Need for accurate and consistent status information

 Numerous complex (and interrelated) projects

 Projects with many WBS activities

 Virtual offices

 Diverse technology platforms

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Room For Improvement
70% of projects are:

 Over budget
 Behind schedule

52% of all projects finish at 189%

of their initial budget

And some, after huge investments of

time and money, are simply
never complete

Source:The Standish Group

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Enter Earned Value Analysis (EVA)
“Earned Value Analysis” is:
 an industry standard way to:
 measure a project’s progress,

 forecast its completion date and final cost, and

 provide schedule and budget variances along the way.

 By integrating three measurements, it provides

consistent, numerical indicators with which you
can evaluate and compare projects.

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Value Management technique…
VM technique involves 3 main steps:
An awareness of value for the organization/
department,
1- Setting up measures/an estimate of value.
2- Monitoring methods, and
3- Controlling methods.
A strong focus on the objectives and targets .
A strong focus on deliverables “ maximizing
innovative
and practical outcomes”. WHAT- WHY- WHAT-
WHY…
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The Formula…

Satisfaction of Needs
Value = --------------------------------------------
Use of resources( Staff , $,time ,
etc.)

 As long as the level of satisfaction of needs is higher

than the used resources ( staff, $, time, etc ), then
the value is in the positive side.

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Implementation of EVA
 EVA works best when work is
‘compartmentalized’.

 Compartmentalization is best achieved with

a well-planned Work Breakdown Structure.

 So, how do I create a WBS for a really

complex project?
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How am I gonna eat this elephant?

Obviously in small bites.

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Proper WBS Design
 One WBS per program
 Deliverable-oriented
 Work not in the WBS is out-of-scope

 Each descending level represents more detail

 Full (and accurate) definition is key

 Defined deliverable(s)
 Timeframe for delivery of product
 Total cost (direct and indirect) to deliver
product

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 THANK
YOU
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