Project Management

(For Praj Industries)

Rajesh Dhake
Agenda

„ Pictorial Illustration
„ Concepts (Definition, Examples,
Characteristics, Taxonomy)
„ Project Development Life Cycle (Stages)
„ Project – Basic Concepts
„ Project Manager
Wind Turbine Project Progress- Visual
Wind Turbine Project Progress- Visual
Wind Turbine Project Progress- Visual
Wind Turbine Project Progress- Visual
Wind Turbine Project Progress- Visual
Wind Turbine Project Progress- Visual
Wind Turbine Project Progress- Visual
Wind Turbine Project Progress- Visual
Time to think
‰ Project
Concepts
Definition
Example
Characteristics
Taxonomy
Project - Definition
„ “A Project is a temporary endeavor undertaken to
accomplish a unique purpose”
„ “ A project is any undertaking with a defined starting
point and defined objectives by which completion is
identified: … PMI
„ “A combination of human and non-human resources
pooled together in a temporary organisation to achieve a
specific purpose” … PMI
Examples of Project

„ Personal
‰ Planning a wedding, planning a trip
‰ Painting a house, furniture work
„ Entertainment
‰ Making a movie or a serial
„ Events
‰ Filmfare / IIFA / Grammy Awards
‰ Exhibitions, Fares
‰ Workshops, Seminars, Conferences
Examples of Project

„ Educational
‰ Admissions for BBA/BFT course
‰ Conducting examinations
„ Infrastructural
‰ Build a tunnel (Katraj), dam, bridge (flyovers)
‰ Golden Quadrilateral, Pune Mumbai Expressway
„ Industrial
‰ New Product Development (TATA Nano)
‰ New Production Facility (General Motors,
Talegaon)
Examples of Project

„ Financial Services
‰ Raising money through IPO / Public Issue
‰ Launching a New MF Scheme
‰ Setup new branch for a bank
‰ Loan syndication
CHARACTERISTICS

„ Mission or Set of Objectives - fixed mission / set of

objectives, a project is completed as soon as the mission is
accomplished
„ Uniqueness - no two projects are exactly similar
„ Life span - cannot continue endlessly
„ Life cycle - The project lives between the two cut-off points
and the time-span is known as Project life cycle (introduction,
growth, maturity, decay)
„ Single entity-one responsibility center
„ One Time Activity – non-repetitive
„ Team work – it calls for team work
CHARACTERISTICS

„ Risk & Uncertainty - depends on how it has passed

through various life-cycle phases, many changes throughout
its life, uncertainty of the next stage
„ Customer Specific – Made to order, customer stipulates
various requirements
„ Unity in diversity - Variety
„ Subcontracting – Hit is inevitable and is done to a high
level
Project Classification (Taxonomy)

1. Sectoral
„ Agriculture & Allied
„ Irrigation & Power
„ Industry & Mining
„ Transport & Communication
„ Social Services
Project Classification (Taxonomy)

2. Ownership
„ Private Sector
„ Public Sector
„ Joint Sector
„ International
Project Classification (Taxonomy)

3. Industrial – Need for Project (NBMEIDRR)

„ New
„ Balancing
„ Modernization
„ Expansion
„ Integration
„ Diversification
„ Replacement
„ Rehabilitation
 Categories of Projects
i. New projects - for setting up new units
ii. Balancing projects – take care of capacity
imbalances
iii. Modernization projects - It can be for any one or
more than one of the following objects
a. Changing obsolete machinery
b. Enlarging the product mix/product range to meet
changing requirements of the market
c. Reducing the manufacturing cost or for improving the
quality of the product
d. Changing the requirement of raw material (shifting from
present raw material to some other raw material)
Categories of Projects
iv. Expansion projects - For increasing the
capacity of existing units
v. Background integration projects – For
manufacturing certain products which are
being used as raw material by the existing
unit.
vi. Forward Integration projects – for
manufacturing certain products which
require the products of the existing unit as
raw material
Categories of Projects
vii. Diversification projects - For
manufacturing new products by existing
units
viii. Replacement projects – replacing old /
depreciated / worn out assets with new
assets
ix. Rehabilitation projects - for reviving sick
units and making them viable to compete
with normal / healthy units
Project Classification (Taxonomy)

4. Size (Investment)
„ Mega Scale (Above 1000 crores)
„ Large Scale (Between 100 crores & 1000 crores)
„ Medium Scale Between (10 crores & 100 crores)
„ Small Scale (Below 10 crores)
Project Classification (Taxonomy)

5. Level of Technology
„ High Tech (Space, Nuclear, Nanotechnology)
„ Conventional (Steel, Sugar, Cement)
„ Low Tech (Soaps, Detergents)
6. Service Oriented (FI Classification)
„ Welfare
„ R&D
„ Social
„ Educational
Project Classification (Taxonomy)

7. Speed of Execution
„ Normal (Adequate time is allowed)
„ Crash (Additional costs to gain time)
„ Disaster (Emergency / Urgent)
8. Techno-economic
„ Factor Intensity Oriented (Capital Intensive /
Labour Intensive)
„ Causation Oriented (Demand / Raw Material
Based)
Plan, Programme, Project, Work Package
National / Corporate plan with targets for growth (three
years roll-on-plan of NEG-Micon)

Health program, educational program, science and

technology program (100 MW of Wind Farms in 2006-07)
Power plants, school, hospitals, housing projects (5 MW
Wind Farm to be completed by Dec 2006 for XYZ company)

Water supply and distribution package, power supply and

distribution package (Supply, Installation and Commissioning of
750 KW, WEG for XYZ)

Award of water supply contract, construction of

foundation (Tower Procured, Transported and Erected)
Excavation, laying of cable, preparation of drawings,
preparation of specifications (Foundation for tower completed)
Project – Basic Concepts
Concepts

¾ Project Management
„ What makes project management different is its approach to task
which besides its specifications , is fully bound by time , cost and
performance targets
¾ Success of project
„ It must get completed
„ Must be completed within budget
„ Must be completed within allocated time
„ Must perform to satisfaction
Concepts
‰ Terminology
¾ Goal
¾ Project Scope
¾ Objective
¾ Tasks
¾ Activity
¾ Duration
Concepts

¾ Goal
„ What exactly needs to be done
¾ Project Scope
„ Documented set of standards and criteria that the customer
defines as successful completion
¾ Objective
„ A combination of tasks that concern specific functional groups
or structural areas
Concepts

¾ Task
„ A combination of activities that lead to the achievement of a
definable result
¾ Activity
„ A time-consuming piece of work with a definite beginning and
end
¾ Duration
„ The elapsed time from the beginning to the end of an activity,
task or objective
Concepts

¾ Project Constraints
Project Development Cycle
Project Development Cycle

1.Conception Phase: germination of project idea

„ ideas to be put in black and white and compared
„ Neither to be avoided / truncated nor to go for implementation
plans
2.Definition Phase: develop the idea in to a detailed document
„ Suitable for customer and/or financial and other agencies
„ May cover specifications,time frame,financing etc
3. Planning and Organising Phase: Project Execution Plan
„ Overlaps with other phases
„ Project infrastructure,System design and engineering,Manpower
,Schedules and Budgets,Licensing if any and Govt. clearances,
Finance, PMIS and procedure,Identification of PM,
Project Development Cycle

Conditions for purchase and contracts,Site preparation,Work

packaging etc.
„ Does not limit to paperwork and thinking but field work also
„ Decisions taken here relate to project basics
4. Implementation phase: Above 80 % volume of project work
„ Detailed specifications, Consultants, Design and drawings,
Procurement,Construction,Installation and commissioning etc
„ All techniques of project management applied essentially for fast
track completion
„ Meticulous coordination and control
Project Development Cycle

Sub-phases of project implementation

Sub Months
Phase Description
1 2 3 4 5 6 7 8

1 Detailed Specifications

Design, Engineering
2

3 Procurement

4 Installation and comm.

Project Development Cycle

5. Project Clean-up Phase: handing over

„ Document,O&M manuals are catalogued and handed over
„ Contractual obligations fulfilled
„ Accounts closed
Project Manager
Role of A Project Manager
„ Role of a PM has not acquired importance although the outcome
of a project largely depends on PM
¾ Issues
„ In a project the scope gets cleared after a long time; scope for
change
„ Constituents are independent bodies not accountable to the PM
„ No previous experience available in most of the casesRole:
¾ Role
„ PM should project the uncertainties and mange the same
„ Introduce unity in diversity
„ Specialty of a PM would consist of identifying and installing
viable systems for regulation and control and intervene only
when needed
Programs and Projects

„ Government sector run efforts as programs

„ Industrial sector describe efforts as projects
„ Policies, Procedures and Guidelines regulate programs
and projects
Category of projects
„ Individual projects
„ Staff projects
„ Special projects
„ Matrix or Aggregate projects
Programs and Projects
Project Management may be defined as the process of achieving
project objectives through the traditional organizational structure
and specialties of individuals
A project manager must:
„ Set objectives
„ Establish plans
„ Organize resources
„ Staff
„ Set up controls
„ Issue directives
„ Motivate personnel
„ Apply innovation for alternative actions
„ Remain flexible
Product vs. Project Management

„ Project manager focuses on the end date of his project,

where as Product manager focuses on the product life
Product vs. Project Management
Organizational Structure
Developing work integration positions
Developing work integration positions
Line-Staff Organization

Divisional Manager

Legend
Project
Formal Authority Flow
Manager
Formal or Informal
Authority or
Information Flow

Department Department
Manager Manager

Line-staff Organization
Matrix Organizational form
General Manager

Engineering
Functional Responsibility Operations Financial Others

Project MGR. Project Responsibility

X

Project MGR.
Y

Project MGR.
Z

Pure matrix structure

Selecting Organizational form
Selecting Organizational form
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The multidimensional marix

Selecting Organizational form

¾ One-Time Undertaking
„ Definable in terms of a specific goal
„ Infrequent unique, or unfamiliar to the present organization
„ Complex with respect to interdependence of detailed tasks
„ Critical to the company
Selecting Organizational form

¾ Basic Factor
¾ Project size
¾ Project length
¾ Experience with project management organization
¾ Philosophy and visibility of upper-level management
¾ Project location
¾ Available resources
¾ Unique aspects of the project
Selecting Organizational form
„ Range of Alternatives
TOOLS AND TECHNIQUES FOR
PROJECT MANAGEMENT
„ Techniques are scientific part but there is also art and politics of
management
„ Techniques provide only as to what is to be done but how very much
depends on additional knowledge and experience
Some effective techniques employed :
„ Project selection --- Cost benefit analysis, Risk and sensitivity analysis
„ Project execution --- Work break down structure (WBS)
„ Project scheduling and coordination -- Bar charts, PERT/CPM
„ Project cost -- Budgetary control
TOOLS AND TECHNIQUES FOR
PROJECT MANAGEMENT
„ Network systems and computers have caught
the imagination of project managers due to
the volume, varieties and complexities

Some packages:
„ PRISM

„ MS PROJECTS

„ PRIMA-VERA
Aspects of Appraisal
Aspects of Appraisal

¾ Context
„ Project Identification
‰ Raw materials,local skills,Import-Export policy,Domestic
demand,Development plans,Capacity utilisation , Price trends,New
process /Product Development,Technological developments
abroad,Ancillary supply etc.
„ Project Selection And Preparation Of Project Reports
‰ Benefit of discussion with finance experts/dept/agencies
Aspects of Appraisal

‰ If beneficial ,information on prescribed format

‰ DPRs

„ Project Appraisal
‰ Examining viability before sanction /approval
‰ Repay principal and interest within a reasonable period
‰ Available surplus to serve equity (ROI)
‰ Viability
„ Project Implementation And Follow Up
‰ Prompt disbursement,close supervision and follow up not only during implementation but
also afterwards
Aspects of Appraisal

„ Project Appraisal :
 Project Appraisal – An Overview
Commercial Appraisal
Technical Appraisal
Marketing
1. Manufacturing 1. Demand-Techniques of
Process/technology forecasting
2. Technical arrangements a Import substitution
3. Size of the plant b Past trend method
4. Product-mix c End-use method
5. Selection of plant and d Correlation &
machinery regression
6. Procurement of plant e Export market
and machinery 2. Supply-depth of
7. Plant layout competition
8. Location of the project 3. Pricing policy
a Land 4. Life cycle of the
b Raw material product
c Market 5. Brand name for the
d Labor product
e Utilities such as 6. Packing and transport
water, power, fuel 7. Distribution channels
etc. 8. sales promotion
f Effluent disposal a Salesman
g Transportation b Advertising
h Community c Servicing
infrastructure 9. Source of market
i Development of information
other industries 10. Publications useful to
9. Schedule of project study various aspects of
implementation making
Economic Appraisal Social
Financial Appraisal Management Appraisal
Cost-Benefit Analysis
1. Capital cost projects 1. Ratios for economic 1. Qualities of an
a. Land and site appraisal entrepreneur
developments 2. Economic rate of return a Honesty & integrity
b. Buildings a OECD method b Involvement in the
c. Plant and machinery b UNIDO method project
d. Engineering and 3. Exchange rate of the c Financial resources
consultancy fees project or domestic d Competence
e. Miscellaneous fixed resources cost e Risk taking
assets 4. Comparative study of f Initiative
f. Preliminary and pre- financial rate of return and g Intelligence
operative expenses economic rate of return h Drive & energy
g. Provision for i Self confidence
contingencies j Frank-less
h. Margin money for k Patience
working capital 2. Various forms of
2. Sources of finance organization
3. Financial projections a Proprietary concern
a Profitability b Partnership firms
estimates c Corporate sector
b Cash flow estimates i. Board of
c Projected balance Directors
sheets ii. Committee of
4. Ratio analysis Board
a Debt-equity ratio iii. Chief Executive
b Current ratio iv. Other
c Debt-service Executives
coverage ratio 3. Organization set up
d Margin of security 4. Management problems
e Other rations
5. Break-even point
6. Discounted cash flow
techniques
a Net present value
b Internal rate return
Aspects of Appraisal
1. Technical Appraisal :
To ensure that necessary physical facilities required will
be available and best possible alternative is selected to
procure them
‰ Process/Technology
‰ Selection and procurement of plant and machinery
‰ Location and layout
‰ Product Mix
‰ Schedule of project implementation
„ PERT or CPM helps in overall project management
„ Evaluation of schedule is necessary for estimation of capital cost,
preparation of cash flow and profitability estimate etc.
Aspects of Appraisal

2. Commercial Appraisal/Marketing : To ensure

marketability
„ Demand: Product/Service,uses,the consumers, consumption
pattern,export potential etc
„ Supply: Production capacity,capacity utilisation, imports etc.
„ Distribution: Channels of distribution,cost of distribution,mode
of transport
„ Pricing: Price trends,duties and taxes etc
„ External: Govt. policies, Plan layouts etc
Aspects of Appraisal
Demand forecasting :
1. Import substitution
i. Obtained past trends in imports
ii. Obtained details of other units (c.i.f.) and duties and / check the
competitiveness of the price at which indigenous product is to be marketed
iii. Ascertain the channels and cost of distribution
iv. Ascertain the product specifications and quality
2. Past trend Method
i. Determine whether the product is indigenously manufactured and/or imported
ii. Determine whether the product is exported
iii. Work out apparent consumption over a period of time (production plus
imports minus exports)
iv. Determine the growth rate in apparent consumption
v. Determine the growth rate, estimate domestic demand for future
vi. Determine the growth rate in exports (if any) and applying the growth rate,
estimate the future exports
vii. Add the domestic and export demand estimated above
Aspects of Appraisal

3. End use method

i. Determine the end-uses of the product under review
ii. Determine consumption norms in each of the end-uses identified
iii. Determine present and future growth of the end-uses
iv. On the basis of the norms of consumption, determine present
and future demand for the product
4. Correlation and Regression
i. A relatively independent variables may in someway determine the
demand for a relatively dependant variable. These techniques are
used in such circumstances to project the demand
Aspects of Appraisal

5. Export market
i. Volume of World trade for the product under review
ii. Import – Export countries
iii. Trends in international price
iv. Duties and Tariffs in different countries
v. Channels of distribution
vi. Any others
Aspects of Appraisal
Aspects of Marketing
1. Market structure
i. Which are the main user industries for the firm’s products?
ii. Which are the subsidiary user industries?
iii. What changes are occurring in the user industries to induce a change
in demand?
iv. What changes are occurring in the non-user industries to induce a
new demand?
v. What is the user industry’s structure, organization and geographical
division for the sale of firm’s product?
vi. What is the size of the total market for the firm’s product? What are
the changes in the size of the market during last few years? Is it
growing, steady or shrinking? Is there any significant trend
suggesting a shift in demand?
vii. What proportion of existing demand is met from imported sources?
viii. Whether the firm is able to enter into a contract to supply its
product to any user industry?
ix. What are the export possibilities? Which are the main export
markets for the product?
Aspects of Appraisal

2. Depth of competition
i. Who are the main suppliers to the market?
ii. What are the strengths and weaknesses of existing manufacturers?
iii.What is the likelihood of other manufacturers entering the field
with similar products?
iv. What is the extent of brand recognition/ preferences or insistence
on competitive brands? What is the number of brands-nations,
regional and local? What are the characteristics of the leading
brands?
v. What steps will be necessary for the proposed unit to cope with
existing manufacturers?
Aspects of Appraisal
3. Pricing policy
i. Taking note of all item of cost, at what price (ex-factory) can the
product be marketed?
ii. What are the taxes and duties levied on the product for the domestic
market?
iii. What are the margins/discounts that have to be given to the trade?
iv. Adding distribution costs and taxes/duties, at what price can the
products or substitute?
v. What are prices of imported products and similar domestic products
or substitutes?
vi. What type of pricing would be appropriate for this product keeping
in view the depth of competition and existing price?
vii. In the light of existing trade customs, what would be policy in areas
such as credit facilities and acceptance of returned goods?
Aspects of Appraisal

4. Life cycle of the product

i. Introduction, growth, maturity, decline
ii. A manufacturer introducing a product should know the stage
iii. Products with short lifecycle should have high profit margins and
low break-even points
Aspects of Appraisal

5. Packaging and transportation

i. What type of packing will be necessary for the product and how
does it compare with that of competitors in terms of attributes of
protection, convenience, attractiveness, easy identification,
economy and adaptability to retail outlets?
ii. How do the firm’s packing and physical transport methods
compare with those of competitors in terms of cost, speed,
liability to damage and liability to pilferage?
6. Distribution channels
i. What are the normal channels through which the consumers are
accustomed to get this type of product?
ii. What is usual arrangement made by competitors to sell this kind
of product to retailers?
Aspects of Appraisal

iii. If the product is to be distributed directly through retailers, what

kind of retail stores are best suited and likely to sell it?
iv. Is it better to sell through wholesalers or through retailers or
directly to consumers or users?
v. Is it necessary to have exclusive dealership arrangements for
various areas? Some of the channels of distribution are illustrated
in chart on the next page:-
‰ User - Consumers
‰ Retailers – Consumers
‰ Wholesalers-Retailers-Consumers
‰ Distributors-Wholesalers-Retailers-Consumers
Aspects of Appraisal

7. Sales, Advertising
i. To what type of advertising media are consumers/users or
potential consumers/users exposed to?
ii. What method of advertising and sales promotion are used by
competitors?
iii. What will be cost of advertising and sales promotion?
Aspects of Appraisal

8. Servicing
i. Installation
ii. Education for use
iii. Repairs and replacement of parts
iv. Provision of accessory equipments
v. Periodic testing and adjustments
Aspects of Appraisal
3. Financial Appraisal : To ensure pattern of financing and
viability
a) Capital cost
(i) Land and site development
(ii) Buildings
(iii) Plant and Machinery
(iv) Engineering and Consultancy
(v) Miscellaneous fixed assets
(vi) Preliminary and pre-operative expenses
(vii) Provision for contingencies
(viii) Margin money for working capital
Aspects of Appraisal
b) Sources of finance
„ Shares
„ Debentures
„ Term loans from FIs
„ ECBs
„ Foreign investments
„ Supplier credits
„ Leasing
„ Internal accruals
c) Financial projections
(i) Profitability estimates
(ii) Cash-flow estimates
(iii) Projected balance sheet
Aspects of Appraisal

d) Ratio analysis
„ Safety ratios (death-equity, current ratio, BEV, IRR)
„ Profitability ratio (PBIT, PBILD, EPS, ROI etc.)
„ Turnover ratios (WIP holding ratio, FG holding ratio, RM holding ratio,
Capital turnover ratio etc.)
„ Operating ratios (RM to total cost, Salaries and Wages to total cost etc)
e) Break-even point
f) Discounted cash flow - NPV/IRR
Aspects of Appraisal

4. Economic Appraisal
„ Social cost-benefit analysis
‰ Ratios for economic appraisal
‰ Economic rate of return
‰ Exchange rate of the project
‰ Comparative study of financial rate of return and economic rate of return
Aspects of Appraisal

5. Management Appraisal :
„ Qualities of an entrepreneur
„ Various forms of organization
„ Organizational set up
„ Management problems
Project – Selection &
Evaluation
Break Even Point, Discounted Cash
Flow Techniques, NPV and IRR
Break Even Point, Discounted Cash Flow Techniques,
NPV and IRR

¾ Break - Even Point

„ Fixed Cost
„ Variable Cost
„ Selling Price
„ Contribution and Break- even Point
¾ Discounted Cash Flow Techniques-
„ NPV
„ IRR
Break - Even Point

„ It is that level of activity where total cost equals total revenue so

that the firm neither earns profit nor suffers any loss
„ It is the point at which the total contribution is just equal to the
fixed costs .
SALE

. S”’ TOTAL COST

PROFIT
.
AMOUNT (Rs.) C” C’’
. BEP
LOSS
C’ . S’
FIXED EXPENSES
VARIABLE EXP

S’
OUTPUT (Units)
Break - Even Point

Fixed Cost :
„ Cost that has to be incurred by a unit irrespective of the level of
production
„ Items of expenditure generally included:
1. Salaries and wages
2. R&M
3. Administrative and Misc.
4. Fixed portion of selling expenses
5. Fixed Royalty and Know-how payments
6. Interest on term debt
7. Depreciation
Break - Even Point
Variable Cost :
„ Cost that varies with the level of production; It is presumed that
it changes in the same proportion in which the level of
production changes
„ Items generally included are :
1. RM
2.Purchases
3.Consumables and spares
4.Packing materials
5. Power and fuel
6.Royalty linked to sales
7.Variable selling exp.
8. Interest on Working capital
Break - Even Point
Selling price :
„ The price at which the unit is selling its product.

„ Units having multi-products ,it is presumed that the same

product-mix will be continued.
Contribution :
„ Difference between sale price and variable cost is called
contribution.
Break-even Point :
„ The level of production at which the contribution recovers entire
fixed cost is called break-even point
BEP = Fixed Cost = FC
SP -- VC Contribution
Break - Even Point

Break-even Point can be expressed in terms of :

a) volume of production, or
b) a percentage of installed capacity ,or
c) amount of sales
Break - Even Point
Example of Break-even-Point-Anita Jewels Ltd.
(Rs. In lakhs)
Based on the year of normal level of
production (III year-production at
A. Variable Cost 93.75% of installed capacity)
Raw materials 5.25
Consumable stores 4.50
Power, Fuel, Water, etc. 1.15
Selling expenses 1.50
Interest on working capital 0.95
13.35
Break - Even Point

B. Fixed Cost (Including semi-fixed cost)

Repairs and maintenance 0.75
Wages and salaries 4.86
Rent, Insurance, etc. 0.75
Depreciation 2.92
Administrative expenses 1.30
Interest on term loans 3.13
13.71
C. Sales Realization 41.25
D. Contribution (C-A) 27.90
Break - Even Point

Break-even point
Fixed Cost
(in terms of volume of production) = x 75 lakhs jewels
Contribution

= 13.71
x 75 lakhs jewels
27.90

= 36.85 lakhs jewels

Break - Even Point

Break-even point
Fixed Cost
(in terms of percentage of = x 93.75
Contribution
installed capacity)
= 13.71
x 93.75
27.90

= 46.07% of installed capacity

.
Break - Even Point

Break-even point
(in terms of amount of sales) = Fixed Cost
x Rs. 41.25 lakhs
Contribution
= 13.71
x Rs. 41.25 lakhs
27.90

= Rs.20.27 lakhs
Break - Even Point

It may be observed from the above that the figures of break-even

point are coming in various terms as under:-
B.E.P. in terms of volume of production = 36.85 lakhs jewels
B.E.P. in terms of percentage of installed capacity = 46.07%
B.E.P. in term of amount of sales = Rs.20.27 lakhs
The above figures can be cross-checked as under with the help of total
capacity of the unit at 80 lakhs jewels and sale price of Rs.0.55 per
jewel:-
Total capacity-80 lakhs jewels
B.E.P. in terms of installed capacity = 46.07%
Production at B.E.P. = 80 lakhs jewels x (46.07/100)
Break - Even Point

= 36.85 lakhs jewels

Amount of sales at B.E.P. = 36.85 lakhs jewels x sale price
= 36.85 lakhs jewels x Rs.0.55
= Rs.20.77 lakhs

As the unit illustrated above is manufacturing watch jewels for which

demand is ensured and it is not likely to face any difficulty regarding
procurements of raw materials and other necessary inputs, the break-
even point at 46.07% of installed capacity can be considered highly
satisfactory for this unit
Discounted Cash Flow Techniques

A project should earn sufficient return which should be at least

equal to the cost of the funds invested in it ; Alternative
proposals are evaluated with the following methods:

a) Pay Back Method

b) Average Rate of Return Method
c) Net Present Value Method
d) Internal Rate of Return
Discounted Cash Flow Techniques

¾ Pay Back Method:

„ To ascertain the period required for recovering the entire
investment made in the project
„ The length of time required for total cash inflow to recover the
original investment is called the pay-back period.
An example : Original investment : Rs. 1000
Year Cash flow of each year Cumulative cash inflow
1 100 100
2 150 250
3 250 500
4 300 800
5 300 1100
Discounted Cash Flow Techniques

Comparison of Two Projects by Pay Back Method

Year Project A-Original Investment Project B-Original Investment
Rs.1000 Rs.1000
Annual Cash Annual Cash Cumulative
Cumulative
Inflow Inflow
1 200 200 100 100
2 400 600 150 250
3 300 900 200 450
4 100 1000 250 700
5 - - 300 1000
6 - - 250 1250
7 - - 250 1500
8 - - 150 1650
9 - - 100 1750
Pay Back Period 4 years 5 years
Discounted Cash Flow Techniques

„ It ignores the time value of money

„ Does not take in to account the income which may be
received beyond the payback period
¾ Average Rate of Return Method :
„ An average of the annual net operating profits (after
depreciation)for the entire life of the project is taken
and rate of return on original investment and average
investment is calculated
 Discounted Cash Flow Techniques
Comparison of Three Projects by
Average Rate of Return Method
(Amount in Rs.)
Net Operating profit
Project A Project B Project C
(after depreciation)
Year I 300 50 300
Year II 400 150 300
Year III 400 200 300
Year IV 200 800 300
Year V 200 300 300
Year VI - - 300

Total Profit 1500 1500 1800

Life of project 5 years 5 years 6 years

Average annual profit 300 300 300
Original investment 2000 2000 2000
Return on Original Investment 15% 15% 15%
Return on Avg. Investment
(presuming Avg. Investment at Rs.1000) 30% 30% 30%
Discounted Cash Flow Techniques

¾ Time Value of Money -- Discounting Technique :

„ Value of money received in future is not equivalent to
the value of money invested today.
Discounted Cash Flow Techniques

¾ An illustration :
„ If Rs. 100 is invested at the annual interest of 10% :
(Compounding increase of the present value in future)
Rs. 100 today is equal to
Rs 110 after one year (Rs.100 + Rs 10 of interest)
Rs.121 after two years ( Rs.110 + Rs.11 of interest)
Rs.133.1 after three years (Rs.121 + Rs.12.1 of interest)
(Opposite of compounding is discounting)
Rs.110 after 1 year is equal to Rs. 100 toady,
or Rs.1 after I year is equal to Rs.100/110 = Rs.0.909 today ,or
Rs.1 after 2 years is equal to Rs.100/121 = Rs. 0.826 today, or
Rs.1 after 3 years is equal to Rs. 100/133.1= Rs.0.751 today
Discounted Cash Flow Techniques

„ If rate of return is 10 % ,0.909,0.826 and 0.751 are the

discounting factors to know the present value of future sums
after 1,2,3 years respectively.
„ While calculating present value of future sum, take the
discounting factor from discounting tables according to the
period and rate of return and multiply the future sum by
discounting factor to get the PV.
„ Mathematically future value can be calculated by using the
following formula:
Future value = PV x (1+r)n
r represents rate of interest per period (year)
n represents number of period(Years)
Discounted Cash Flow Techniques

¾ Net Present Value Method :

„ Cash flows of all the years during the expected life of the project are
discounted at a pre-determined cut-off rate and NPV is obtained
„ Cut-off rate should be either equal to or or more than the cost of
funds
„ A positive NPV at the cut-off rate indicates that the investment in the
project gives profits greater than the marginal investment rate or cost
of capital and hence the proposal can be accepted
„ If NPV is Zero it indicates that the total earnings from the project are
equal to marginal investment rate.
„ If NPV is negative it indicates that total earnings from the project are
less than the marginal investment rate or cost of capital
Discounted Cash Flow Techniques

Comparison of Two Projects by Net Present Value Method

Project A Project B
Investment in Discounting Present Investment in Discounting Present
0 year & Cash factor at 15% value 0 year & cash factor at value
inflow in other inflow in other 15%
year years
Year -1000 - -1000 -1000 - -1000
Year 1 +300 0.870 +261.0 +200 0.870 +174.0
Year 2 +400 0.756 +302.4 +300 0.756 +226.8
Year 3 +400 0.658 +263.2 +500 0.658 +329.0
Year 4 +300 0.572 +171.6 +400 0.572 +228.8
Year 5 +300 0.497 +149.1 +300 0.497 +149.1

Total
+1700 +1147.3 +1700 +1107.7
inflow
Total
-1000 -1000 -1000 -1000.0
Outflow
Net
Present +147.3 +107.7
Value
Discounted Cash Flow Techniques

If projects X and Y are having initial investment of Rs.5000 and Rs.10,000

respectively, then NPV is:
(Amount in Rs.)
Project X Project Y
Present value of investments (Costs) -5,000 -10,000
Present value of cash inflows (benefits) +6,000 +11,000
Net Present value +1,000 +1,000
Discounted Cash Flow Techniques
If we see the absolute figure of net present value, project Y appears better
than project X. But in fact project X is better because in project X, an
investment of Rs.5,000 provides a new present value of Rs.1,000, whereas in
project Y, an investment of twice that amount provides a net present value of
only Rs.1000. In such a situation, profitability index should be calculated by
using the following formula to compare the two projects having different
investment outlays:-
Present value of cash inflows
Profitability Index = Present value of cash outflows
6,000
Profitability Index of Project X = 5,000 =1.20
11,000
Profitability Index of Project Y = 10,000 =1.10

As profitability index of project X is more that that of project Y, it can be

concluded that project X is better that project Y. Higher the profitability
index better is the project.
Discounted Cash Flow Techniques

¾ Internal Rate of Return:

„ To find out the rate of return of a project ,estimated net cash
flows of each year are discounted at various rates till a rate is
obtained at which the sum of positive present values is equal to
the sum of negative present values or the NPV comes to
Zero.Such a rate is called IRR.
„ IRR is that rate of discount which would equate the PV of
investments (cash outflows ) to the present value of benefits
(cash inflows)over the life of the project.
Discounted Cash Flow Techniques
(Amount in Rs.)
Cash Discounting Present Discounti Present Discounti Present
flow factor at value at -ng factor value at -ng factor value at
15% 15% (1x2) at 20% 20% (1x4) at 25% 25% (1x6)
(1) (2) (3) (4) (5) (6) (7)
Year 0 -1000 - -1000 - -1000 - -1000
Year 1 +300 0.870 +261.0 0.833 +249.9 0.800 +240.0
Year 2 +400 0.756 +302.4 0.694 +277.6 0.640 +256.0
Year 3 +400 0.658 +263.2 0.579 +231.6 3.512 +204.8
Year 4 +300 0.572 +171.6 0.482 +144.6 0.410 +123.0
Year 5 +300 0.497 +149.1 0.402 +120.6 0.328 +98.4
Net
Present =147.3 =24.3 -77.8
Value

As the net present value comes positive at 20 per cent and negative at 25 per cent, the
internal rate of return should be between 20% and 25%
In order to arrive at internal rate of return, the following interpolation formula can be
used:-
Discounted Cash Flow Techniques
Interpolation formula
Net present value at the
Internal rate Lower Difference lower discount rate
of return discount + between the two x
Absolute difference
run discount between the net present
rates value at the two
discount rates
24.3
= 20 + 5 x 24.3+ 77.8
24.3
= 20 + 5 x 102.1

= 20 + 1.19

= 21.19 or say 21%

Discounted Cash Flow Techniques

To test the validity of the above formula, if we discount the cash flow
at 21%, the net present value will be almost negligible as under:-
Cash flow Discounting factor at 21% Present value
Year 0 -1000 - -1000
Year 1 +300 0.826 +247.8
Year 2 +400 0.683 +273.2
Year 3 +400 0.564 +225.6
Year 4 +300 0.467 +140.1
Year 5 +300 0.386 +115.8
Net Present Value +2.5

The present value of 2.5 is too small and can be ignored. The internal
rate of return for above example comes to 21%
Discounted Cash Flow Techniques

¾ Information needed for calculation of NPV and IRR:

„ Life of the project
„ Cash outflow (amount of investment for capital expand working
capital)
„ Cash inflow (benefits of the project)
„ Residual or terminal value of the project
„ Net cash receipt and calculation of IRR
„ Pre-determined cut-off rate
„ Cost of capital
Case Study
 Anita Jewels Ltd.
Solution to the Case Study of Financial
I Year II Year III Year IV Year V Year VI Year VII Year VIII Year IX Year X Year

Installed Capacity (Nos.) 80 lakhs 80 lakhs 80 lakhs 80 lakhs 80 lakhs 80 lakhs 80 lakhs 80 lakhs 80 lakhs 80 lakhs
Procution (Nos.) 30 48 75 75 75 75 75 75 75 75
% of production to installed capacity 37.50% 60.00% 93.75% 93.75% 93.75% 93.75% 93.75% 93.75% 93.75% 93.75%
A. Sales realisation 16.50 26.40 41.25 41.25 41.25 41.25 41.25 41.25 41.25 41.25
Cost of Prodcution
1. Raw materials 2.10 3.36 5.25 5.25 5.25 5.25 5.25 5.25 5.25 5.25
2. Consumales 1.80 2.88 4.50 4.50 4.50 4.50 4.50 4.50 4.50 4.50
3. Power, Fuel, Water, etc. 0.46 0.74 1.15 1.15 1.15 1.15 1.15 1.15 1.15 1.15
4. Repairs & maintenance 0.45 0.60 0.75 0.90 1.05 1.20 1.50 1.50 1.65 1.80
5. Wages & salaries 2.70 3.87 4.86 5.35 5.89 6.48 7.13 7.84 8.62 9.48
6. Rent, insurance, etc. 0.75 0.75 0.75 0.75 0.75 0.75 0.75 0.75 0.75 0.75
7. Depreciation 2.92 2.92 2.92 2.92 2.92 2.92 2.92 2.92 2.92 2.92
B. Total manufacturing expenses
11.18 15.12 20.18 20.82 21.51 22.25 23.05 23.91 24.84 25.85
(Total of items from 1 to 7)
8. Administrative expenses 1.10 1.20 1.30 1.40 1.50 1.60 1.70 1.80 1.90 2.00
9. Selling expenses 0.60 0.96 1.50 1.50 1.50 1.50 1.50 1.50 1.50 1.50
C. Total Admn. & Selling expenses
1.70 2.16 2.80 2.90 3.00 3.10 3.20 3.30 3.40 3.50
(Total of item 8 & 9)
10. Interest on term loan 3.75 3.63 3.13 2.63 2.13 1.63 1.13 0.60 0.13 -
11. Interest on bank borrowings 0.45 0.66 0.95 0.95 0.95 0.95 0.95 0.95 0.95 0.95
D. Total financial expenses
4.20 4.29 4.08 3.58 3.08 2.58 2.08 1.55 1.08 0.95
(Total of item No.10 & 11)
E. Total cost of production (B+C+D) 17.08 21.57 27.06 27.30 27.59 27.93 28.33 28.76 29.32 30.30
Net operating profit (A-E) (-) 0.58 4.83 14.19 13.95 13.66 13.32 12.92 12.49 11.93 10.95
Preliminary expenses
Written off 0.16 0.16 0.16 0.16 0.16 0.16 0.16 0.16 0.16 0.16
Taxation - - - - 0.70 7.06 7.43 7.18 6.86 6.30
Dividend - - - - 2.70 2.70 2.70 2.70 2.70 2.70
C/F loss / net surplus (-) 0.74 4.67 14.03 11.09 10.10 2.80 2.63 2.45 2.21 1.79
Cumulative Surplus (-) 0.74 3.93 17.96 29.05 39.15 41.95 44.58 47.03 49.24 51.03
Discounting Tables (Present Value of Re.1 Receivables at the End of Each Year)

Percentage
Year
10 11 12 13 14 15 16 17 18 19 20

1 0.909 0.901 0.893 0.885 0.877 0.870 0.862 0.855 0.847 0.840 0.833
2 0.826 0.812 0.797 0.783 0.769 0.756 0.743 0.731 0.718 0.706 0.694
3 0.751 0.731 0.712 0.693 0.675 0.658 0.641 0.624 0.609 0.593 0.579
4 0.683 0.659 0.636 0.613 0.592 0.572 0.552 0.534 0.516 0.499 0.482
5 0.621 0.593 0.567 0.543 0.519 0.497 0.476 0.456 0.437 0.419 0.402

6 0.564 0.535 0.507 0.480 0.456 0.432 0.410 0.390 0.370 0.352 0.335
7 0.513 0.482 0.452 0.425 0.400 0.376 0.354 0.333 0.314 0.296 0.279
8 0.467 0.434 0.404 0.376 0.351 0.327 0.305 0.285 0.266 0.249 0.233
9 0.424 0.391 0.361 0.333 0.308 0.284 0.263 0.243 0.225 0.209 0.194
10 0.386 0.352 0.322 0.295 0.270 0.247 0.227 0.208 0.191 0.176 0.162

11 0.350 0.317 0.287 0.261 0.237 0.215 0.195 0.178 0.162 0.148 0.135
12 0.319 0.286 0.257 0.231 0.208 0.187 0.168 0.152 0.137 0.124 0.112
13 0.290 0.258 0.229 0.204 0.182 0.163 0.145 0.130 0.116 0.104 0.093
14 0.263 0.232 0.205 0.181 0.160 0.141 0.125 0.111 0.099 0.088 0.078
15 0.239 0.209 0.183 0.160 0.140 0.123 0.108 0.095 0.084 0.074 0.065

16 0.218 0.188 0.163 0.141 0.123 0.107 0.093 0.081 0.071 0.062 0.054
17 0.198 0.170 0.146 0.125 0.108 0.093 0.080 0.069 0.060 0.052 0.045
18 0.180 0.153 0.130 0.111 0.095 0.081 0.069 0.059 0.051 0.044 0.038
19 0.164 0.138 0.116 0.098 0.083 0.070 0.060 0.051 0.043 0.037 0.031
20 0.149 0.124 0.104 0.087 0.073 0.061 0.051 0.043 0.037 0.031 0.026
Discounting Tables (Present Value of Re.1 Receivables at the End of Each Year)

Percentage
Year
21 22 23 24 25 26 27 28 29 30

1 0.829 0.820 0.813 0.806 0.800 0.794 0.787 0.781 0.775 0.769
2 0.683 0.672 0.661 0.650 0.640 0.630 0.620 0.610 0.601 0.592
3 0.564 0.551 0.537 0.524 0.512 0.500 0.488 0.477 0.466 0.455
4 0.467 0.451 0.437 0.423 0.410 0.397 0.384 0.373 0.361 0.350
5 0.386 0.370 0.355 0.341 0.328 0.315 0.301 0.291 0.280 0.269

6 0.319 0.303 0.289 0.275 0.262 0.250 0.238 0.227 0.217 0.207
7 0.263 0.249 0.239 0.222 0.210 0.198 0.188 0.178 0.168 0.159
8 0.218 0.204 0.191 0.179 0.168 0.157 0.148 0.139 0.130 0.123
9 0.180 0.167 0.155 0.144 0.134 0.125 0.116 0.108 0.101 0.094
10 0.149 0.137 0.126 0.116 0.107 0.099 0.092 0.085 0.078 0.073

11 0.123 0.112 0.103 0.094 0.086 0.079 0.072 0.066 0.061 0.056
12 0.102 0.092 0.083 0.076 0.069 0.062 0.057 0.052 0.047 0.043
13 0.084 0.075 0.068 0.061 0.055 0.050 0.045 0.040 0.037 0.033
14 0.069 0.062 0.055 0.049 0.044 0.039 0.035 0.032 0.028 0.025
15 0.057 0.051 0.045 0.040 0.035 0.031 0.028 0.025 0.022 0.020
Discussion