UNIVERSITY OF ARTS AND TECHNOLOGY OF BYUMBA

FACULTY OF AMRE

DEPARTMENT AGRIBUSINESS

MODULE HANDOUT

PROJECT MANAGEMENT
MODULE CODE: ...........................

Prepared by

Mr. NDAYISHIMIYE Leonard

Assistant Lecturer

PhD Scholar in Economics at IMAU -CHINA

Postgraduate Certificate of Learning and Teaching in Higher Education

E-mail: ndayishimiyeleonard@[Link]

ndayishimiyeleonard1@[Link]
Course objective

The objective of this course is to familiarize the student with the procedures of establishing a new
project and with the tools and techniques of managing the project effectively.
Course content

CHAPTER ONE: General introduction

CHAPTER TWO: Principles of project management

CHAPTER THREE: Project cycle

CHAPTER FOUR: Feasibility study

CHAPTER FIVE: Project management techniques

CHAPTER SIX: Investment decision

CHAPTER1: INTRODUCTION TO PROJECT MANAGEMENT

Introduction
Realization of these objectives requires systematic planning and careful
implementation. To this effect, application of knowledge, skill, tools and techniques
in the project environment, refers to project management. Project management in
recent years has proliferated, reaching new heights of sophistication. It has emerged
as a distinct area of management practices to meet the challenges of new economic
environment, globalization process, rapid technological advancement, and quality
concerns of the stakeholders.

Project Definition
Project in general refers to a new endeavor with specific objective and varies so
widely that it is very difficult to precisely define it. Some of the commonly quoted
definitions are as follows. Project is a temporary endeavor undertaken to create a
unique product or service or result. (AMERICAN National Standard ANSI/PMI99-
001-2004)

Project is a unique process, consist of a set of coordinated and controlled

activities with start and finish dates, undertaken to achieve an objective confirming
to specific requirements, including the constraints of time cost and resource.
Examples of project include Developing a watershed, Creating irrigation facility,
Developing new variety of a crop, Developing new breed of an animal, Developing
agroprocessing centre, Construction of farm building, sting of a concentrated feed
plant etc. It may be noted that each of these projects differ in composition, type,
scope, size and time.

Project Characteristics
Despite above diversities, projects share the following common characteristics.
-Unique in nature.
-Have definite objectives (goals) to achieve.
-Requires set of resources.
- Have a specific time frame for completion with a definite start and finish.
-Involves risk and uncertainty.
-Requires cross-functional teams and interdisciplinary approach.

Project Performance Dimensions

Three major dimensions that define the project performance are scope, time, and
resource. These parameters are interrelated and interactive. The relationship
generally represented as an equilateral triangle. The relationship is shown in figure
1.

Time Cost

Scope

Figure 1. Project performance dimensions

It is evident that any change in any one of dimensions would affect the other.
For example, if the scope is enlarged, project would require more time for
completion and the cost would also go up. If time is reduced the scope and cost
would also be required to be reduced. Similarly any change in cost would be
reflected in scope and time. Successful completion of the project would require
accomplishment of specified goals within scheduled time and budget. In recent
years a forth dimension, stakeholder satisfaction, is added to the project. However,
the other school of management argues that this dimension is an inherent part of the
scope of the project that defines the specifications to which the project is required
to be implemented. Thus the performance of a project is measured by the degree to
which these three parameters (scope, time and cost) are achieved.

Mathematically
Performance = f (Scope, Cost, Time)
In management literature, this equilateral triangle is also referred as the
“Quality triangle” of the project

In this project management course unit, we shall learn some of the specific skills, approaches, and
tools you'll need to run projects successfully. The tools are divided into the following categories:
• Integration Management—Ties all the other processes together. Includes the coordination,
consolidation, and integrative processes necessary to successfully execute a project.

• Scope Management—includes all the efforts to articulate and identify the features and
functions of a product. Includes the identification of requirements, deliverables, tasks, and
activities required to produce the product of the project.

• Time Management—Includes all the processes required to estimate effort duration and
sequence in order to complete the project in a timely manner.

• Cost Management—all costs are planned for and estimated in this process. This
process also includes project cost baselines and processes to control project budgets.

• Quality Management—Processes required to achieve project deliverables that meet quality

objectives for an organization.

• Human Resource Management—Process required to organize the project team.

• Communications Management—the process of creating, collecting, and disseminating project

information.

• Risk Management—Includes planning for how an organization will conduct risk management.
This includes analyzing, prioritizing, and responding to risks.

• Procurement Management—The processes needed to either purchase or acquire the

needed products or services from outside the project team.

Definitions
1. What is a Project?
Several economists and bankers have defined a project in different ways.
• As “the smallest unit of investment activity to be considered in the case of programming.”
• Or by WB- “As an approval for a capital investment to develop facilities to provide goods
and services.”
Project is any item of investment activity or appraisal for investment which:
➢ Can separately be evaluated
➢ Has a set of activities involved in using resources to gain benefits.
➢ Has definite aim and objectives of producing a flow of output
➢ Has specific period of time.

A project should be understood in terms of economic development behavior:

➢ Purposefulness
➢ Minimum size
 ➢ Specific location
➢ Something qualitatively new
➢ Setting in motion a sequence of further development moves

A project is an instrument/practical intervention designed to link policy and programme objectives

to problems faced by a particular group of beneficiaries. A project is time bound and is designed
to deliver measurable benefits to a specified target group.
A project is a set of activities that must be coordinated and managed to achieve a specified
objective”.

Projects are one-off pieces of work that are completed within a fixed timescale. And they usually
contain a great deal of risk, uncertainty, and complexity that needs to be managed.

A project is a scientifically evolved one-off piece of work plan devised to

use four
The specific
basicresources
attributes to achieve specific objective(s) within a specified
are:
period of time.

➢ a course of action-work plan

➢ specific resources
➢ specific objectives and;
➢ definite time perspective
Basic components of a project
OBJECTIVE

SIZE INTERNAL RATE OF RETURN

A SCHEME

ORGANISATION SOCIAL BENEFITS

Why is the concept of projects important?

(i) The concept of projects is interlinked with all socio-economic and cultural activities.
 (ii) Projects are the “cutting edge” of development.
(iii)Poor implementation of development programmes can be traced to poor preparation
and implementation of projects.
(iv) The coordination of many different people, the completion of many tasks in a precise
sequence, and the expenditure of a great deal of time and money of en enterprise or
entrepreneur require the concept and understanding of projects in order to succeed.
(v) They become the catalytic agents of economic development.
(vi) They initiate the process of development, production,
(vii) Employment, income generation and so on.
(viii) They have consequences, which are long-term in nature.
(ix) Projects provide the framework of the future activities enterprises.
Characteristics of a Project
Though various connotations have been given to the concept of a project, they have four basic
characteristics:

• a project is a unique undertaking: each one will differ from every other in some respect
• projects have specific objectives (or goals) to achieve
• projects require resources
• projects have budgets
• projects have schedules
• projects require the effort of people
• Measures of quality will apply.

In short, “the project is an economic activity with well-defined objectives and having a specific
beginning and end.” It should be amenable to planning, financing and implementation as a unit
where both costs and returns are measurable.
A well planned project which should be neat, clear-cut and specific also includes:
• A correct consideration of alternatives,
• Identification of key issues,
• Broad participation, compactness and enforceability. It should be, neat, clear-cut and of
course, specific.
From the point of view of resource allocation, a project can be
Considered as: “A proposal involving capital investment for the purpose of developing facilities
to provide goods and services”.
The goods or services, which the project seeks to provide, differ widely. A project may
involve:
• the establishment of a new manufacturing plant
 • the provision of additional educational facilities to a particular age group in the
community.
• Or it may aim at developing infrastructure facilities for the marketing of agricultural
commodities.
• Construction of a community hospital
• Establishing a tourist site
• Construction of a road
• Etc.

Whatever the nature, a project will involve:

• Allocation and consumption of resources on one hand;
• Generation of resources, goods, or services, on the other.
Project Levels
Project work in its broadest sense takes place at three levels:
• At the national level, where national investment plans are formulated, priorities among
sectors are established, and the macroeconomic framework of policies for economic growth is put
in place.
• At the sector level, where priorities for investment within each sector are determined and
the issues and problems affecting the development of the sector are addressed.

• At the project level, where individual projects are identified, prepared, and implemented
and attention is given to their technical, economic, financial, social, institutional, and other
dimensions.
Classification of Project
Project classification helps in graphically expressing and highlighting the essential features of a
project be it quantifiable or non-quantifiable, be it any potential sector be it capital-intensive or
labour-intensive, whether it will involve small or large-scale investment. In a very broad sense, a
project includes all activities, which are aimed at:
1. Increasing production of goods and/or services,
2. Increasing the capacity of the existing projects, and
Classifications:
1. Quantifiable and Non-Quantifiable Projects
• Quantifiable projects –eg: industrial development, power generation, mineral development
• Non-quantifiable project-eg: projects involving health, education and defense.
2. Sectoral Projects
Under this classification, projects fall into any one of the following sectors:
(i) Agriculture & agriculture related sector
 (ii) Irrigation and Power sector
(iii)Industry and Mining sector
(iv) Transport and Communication sector
(v) Social Service Sector
(vi) Miscellaneous.

This system of classification has been found useful in resource

allocation at macro-level.
3. Techno-Economic Projects
Projects are sometimes classified on the basis of their techno- economic
Characteristics, useful in facilitating the process of feasibility appraisal:
(i) Capital intensive or labour intensive projects depending upon whether large
scale investment in plant and machinery or human resources
(ii) Demand-based or raw materials based projects-Causation-oriented classification
depending on availability or none-availability of certain goods, services, skills, etc.
(iii) Large –scale, medium scale, or small-scale projects depending on size of total project
investment.
4. Financial Institutions Classification
Classification of the projects according to their age and experience and the purpose for which the
project is being taken up. They are as follows:
(i) New Projects
(ii) Expansion Projects
(iii)Modernization Projects
(iv) Diversification Projects
(v) The projects listed above are generally profit-oriented.
5. Services Projects
(i) Welfare Projects
(ii) Service Projects
(iii)Research and Development Projects
(iv) Educational Projects

Project Classification

There is no standard classification of the projects. However considering project goals, these can
be classified into two broad groups, industrial and developmental. Each of these groups can be
further classified considering nature of work (repetitive, non-repetitive), completion time (long
term, shot term etc), cost (large, small, etc.), level of risk (high, low, no-risk), mode of operation
( build, build-operate-transfer etc).

Industrial projects also referred as commercial projects, which are undertaken to provide goods
or services for meeting the growing needs of the customers and providing attractive returns to the
investors/stake holders. Following the background, these projects are further grouped into two
categories i.e., demand based and resource / supply based. The demand based projects are designed
to satisfy the customers’ felt as well the latent needs such as complex fertilizers, agro-processing
infrastructure etc. The resource/ supply based projects are those which take advantage of the
available resources like land, water, agricultural produce, raw material, minerals and even human
resource. Projects triggered by successful R&D are also considered as supply based. Examples of
resource based projects include food product units, metallurgical industries, oil refineries etc.
Examples of projects based on human resource (skilled) availability include projects in IT sector,
Clinical Research projects in bio services and others.
Development projects are undertaken to facilitate the promotion and acceleration of overall
economic development. These projects act as catalysts for economic development providing a
cascading effect. Development projects cover sectors like irrigation, agriculture, infrastructure
health and education.

The essential differences between Industrial projects and Developmental project

aresumerised in the following table 1.

Table 1. Difference between Industrial and Developmental Projects

Dimension Industrial Project Developmental Project

Scale of Project Limited Large
Promoters Entrepreneurs or corporates Government, Public
Sectors,
NGOs
Investment --- High
Gestation Period --- High
Profitabilty High, Considered on IRR ( Modest, Considered on
Internal Rate of Return) ERR
(Economic Rate of Return)
Finance Stringent debt equity norms Operates on higher
debtequity norms
Source of fund National stock markets and International organizations
from domestic financial like World Bank,
institutions IMF,ADB,DFID and
others mostly as loan ,yet
times providing for some
grants.
Interest rates and Market rate and the Very low for borrowed
repayment period: repayment period is funds and the repayment
period extends up to 25
generally years and even beyond.
7 to 10 years

Project management
Project management is a distinct area of management that helps in handling
projects. It has three key features to distinguish it from other forms of management
and they include: a project manager, the project team and the project management
system. The project management system comprises organization structure,
information processing and decision making and the procedures that facilitate
integration of horizontal and vertical elements of the project organization. The
project management system focuses on integrated planning and control.

Benefits of Project Management Approach

The rationale for following project management approach is as follows.
• Project management approach will help in handling complex, costly
and risky assignments by providing interdisciplinary approach in
handling the assignments.
Example: R&D organizations.
• Project management approaches help in handling assignments in a
specified time frame with definite start and completion points
.Example handling customer orders by Industries involved in
production of capital goods.
• Project management approaches provide task orientation to
personnel in an Organization in handling assignments. Example:
Organizations in IT sector handling software development
assignments for clients.
CHAPTER2: PRINCIPLES OF PROJECT MANAGEMENT
1) Principles of project management help us to:

• Learn how to start every project on the right foot.

• Master the planning, execution, and control of your projects.
• Discover the secrets of effective communication and change management.
• Identify project warning signals and learn to keep your projects on track.
• Understand the benefits of using the right tools, resources, and people.
• Learn how to give a superstar project handover.

Principles of project management give an opportunity to understand and to learn

useful methods and tools to realize the principles while managing a project.

1. A project management should satisfy three conditions. First it should complete all project
objectives within due date/time. Second, a project should be completed within original budget.
Third, it should maintain a standard of quality that satisfies stakeholders.

2. Project management should be based on good planning. A detailed and precise plan is the
essential factor for successfully managing a project. Planning should also accommodate changes
in environment. A person in charge of the project should continuously update his/her plan in line
with recent changes.

3. Project team members should share a sense of urgency. As managing a project is an endeavor
against limited time and budget, team members should make concerted efforts to complete a
project. A system should be in place to continuously remind team members of deadlines and
objectives.

4. Transparent communication is indispensable. A project manager and team members should be

crystal clear about the expected final outcome of a project and this is impossible without good
communication. Any hint of vagueness about project objectives should be eliminated through good
communication.

5. A project manager who is given balanced responsibility and authority is a must for a successful
project. A project manager with many responsibilities but not sufficient authority or a project
manager with little responsibilities but too much mandate both negatively impacts upon project
outcome.

6. Successful management of a project cannot be guaranteed without the best staff. A project
manager should be allowed to let go less than average people from project team members. Presence
of the good workforce can compensate for lack of time or money. Needless to say, a project
manager should foster an environment where team members have necessary tools and training.

7. The project status should be closely followed and shared among project team members.
Important issues, progress and assumptions should be recorded and shared. Poor documentation is
the same as no progress has been made with the project. Regular reviews of project status can
enhance project quality and pin down problems before they get out of hand.

14 Key Principles for PM Success

1. Project managers must focus on three dimensions of project success. Simply put, project
success means completing all project deliverables on time, within budget, and to a level of
qualitythat is acceptable to sponsors and stakeholders. The project manager must keep the
team’s attention focused on achieving these broad goals.
2. Planning is everything — and ongoing. On one thing all PM texts and authorities agree:
The single most important activity that project managers engage in is planning — detailed,
systematic, team-involved plans are the only foundation for project success. And when
 real-world events conspire to change the plan, project managers must make a new one to
reflect the changes. So planning and re-planning must be a way of life for project managers.
3. Project managers must feel, and transmit to their team members, a sense of urgency.
Because projects are finite endeavors with limited time, money, and other resources
available, they must be kept moving toward completion. Since most team members have
lots of other priorities, it’s up to the project manager to keep their attention on project
deliverables and deadlines. Regular status checks, meetings, and reminders are essential.
4. Successful projects use a time-tested, proven project life cycle. We know what works.
Models such as the standard ISD model and others described in this text can help ensure
that professional standards and best practices are built into our project plans. Not only do
these models typically support quality, they help to minimize rework. So when time or
budget pressures seem to encourage taking short cuts, it’s up to the project manager to
identify and defend the best project life cycle for the job.
5. All project deliverables and all project activities must be visualized and communicated
in vivid detail. In short, the project manager and project team must early on create a tangible
picture of the finished deliverables in the minds of everyone involved so that all effort is
focused in the same direction. Avoid vague descriptions at all costs; spell it out, picture it,
prototype it, and make sure everyone agrees to it.
6. Deliverables must evolve gradually, in successive approximations. It simply costs too
much and risks too much time spent in rework to jump in with both feet and begin building
all project deliverables. Build a little at a time, obtain incremental reviews and approvals,
and maintain a controlled evolution.
7. Projects require clear approvals and sign-off by sponsors. Clear approval points,
accompanied by formal sign-off by sponsors, SMEs, and other key stakeholders, should be
demarcation points in the evolution of project deliverables. It’s this simple: anyone who
has the power to reject or to demand revision of deliverables after they are complete must
be required to examine and approve them as they are being built.
8. Project success is correlated with thorough analyses of the need for project deliverables.
Our research has shown that when a project results in deliverables that are designed to meet
a thoroughly documented need, then there is a greater likelihood of project success. So
managers should insist that there is a documented business need for the project before they
agree to consume organizational resources in completing it.
9. Project managers must fight for time to do things right. In our work with project managers
we often hear this complaint: “We always seem to have time to do the project over; I just
wish we had taken the time to do it right in the first place!” Projects must have available
enough time to “do it right the first time.” And project managers must fight for this time
 by demonstrating to sponsors and top managers why it’s necessary and how time spent will
result in quality deliverables.
10. Project manager responsibility must be matched by equivalent authority. It’s not enough
to be held responsible for project outcomes; project managers must ask for and obtain
enough authority to execute their responsibilities. Specifically, managers must have the
authority to acquire and coordinate resources, request and receive SME cooperation, and
make appropriate, binding decisions which have an impact on the success of the project.
11. Project sponsors and stakeholders must be active participants, not passive customers.
Most project sponsors and stakeholders rightfully demand the authority to approve project
deliverables, either wholly or in part. Along with this authority comes the responsibility to
be an active participant in the early stages of the project (helping to define deliverables),
to complete reviews of interim deliverables in a timely fashion (keeping the project
moving), and to help expedite the project manager’s access to SMEs, members of the target
audience, and essential documentation.
12. Projects typically must be sold, and resold. There are times when the project manager must
function as salesperson to maintain the commitment of stakeholders and sponsors. With
project plans in hand, project managers may need to periodically remind people about the
business need that is being met and that their contributions are essential to help meet this
need.
13. Project managers should acquire the best people they can and then do whatever it takes
to keep the garbage out of their way. By acquiring the best people — the most skilled, the
most experienced, the best qualified — the project manager can often compensate for too
little time or money or other project constraints. Project managers should serve as an
advocate for these valuable team members, helping to protect them from outside
interruptions and helping them acquire the tools and working conditions necessary to apply
their talents.
14. Top management must actively set priorities. In today’s leaner, self-managing
organizations, it is not uncommon for project team members to be expected to play active
roles on many project teams at the same time. Ultimately, there comes a time when
resources are stretched to their limits and there are simply too many projects to be
completed successfully. In response, some organizations have established a Project Office
comprised of top managers from all departments to act as a clearinghouse for projects and
project requests. The Project Office reviews the organization’s overall mission and
strategies, establishes criteria for project selection and funding, monitors resource
workloads, and determines which projects are of high enough priority to be approved. In
this way top management provides the leadership necessary to prevent multi-project log
jams.
2) THE ROLE OF PROJECT MANAGER

(i) Definition

In general, the project manager is responsible for the overall success of the project. In some
companies, this person might be called a Project Coordinator, or a Team Leader, however, the key
aspect is that the person is responsible for ensuring the success of the project.

The project Manager’s role follows the project cycle-beginning with project definition and
building the project schedule. If the project begins and you find out later that you are not clear on
scope, the project manager is the one who is accountable. If your project is executing a poor
schedule, the project manager is accountable.

The work around defining the project means that you understand and gain agreement on the overall
objectives, scope, risk, approach, budget, etc. It also includes defining or adopting the specific
project management procedures that will be used to manage the project.

This does not mean that the project manager must do all this work themselves. There may be an
entire team of people helping to create the Project Charter and schedule. However, if something
does not go right, the project manager is accountable.

(ii) Process Responsibilities

Once the project starts, the project manager must successfully manage and control the work,
including:

• Identifying, tracking managing and resolving project issues

• Proactively disseminating project information to all stakeholders

• Identifying, managing and mitigating project risk

• Ensuring that the solution is of acceptable quality

• Proactively managing scope to ensure that only what was agreed to is delivered, unless
changes are approved through scope management

• Defining and collecting metrics to give a sense for how the project is progressing and
whether the deliverables produced are acceptable

• Managing the overall schedule to ensure work is assigned and completed on time and
within budget

Again, this does not mean that the project manager physically does all of this, but they must make
sure it happens. If the project has problems, or scope creep, or faces risks, or is not setting
expectations correctly, then the project manager is the person held accountable.

To manage the project management processes, a person (project manager) should:

  Be well organized;

 have great follow-up skills;

 be process oriented;(understand the scope)

 be able to undertake many functions (multi-task) at the same time.

 have a logical thought process;

 be able to determine root causes of shortfalls/problems and define solutions;

 have good analytical ability;

 be a good estimator and budget manager and;

 have good self-discipline.

iii) People Responsibilities

In addition to process skills, a project manager must have good people management skills. This
includes:

• Having the discipline and general management skills to make sure that people follow the
standard processes and procedures

• Establishing leadership skills to get the team to willingly follow your direction. Leadership
is about communicating a vision and getting the team to accept it and strive to get there
together.

• Setting reasonable, challenging and clear expectations for people, and holding them
accountable for meeting the expectations. This includes providing good performance
feedback to team members

• Team building skills so that the people work together well, and feel motivated to work hard
for the sake of the project and their other team members. The larger your team and the
longer the project, the more important it is to have good team-building skills.

• Proactive verbal and written communicator skills, including good, active listening skills.

If the team has poor morale and is missing deadlines, the PM needs to try to resolve it. If team
members don't understand exactly what they need to do and when it is due, then the PM is
responsible.

(iii) Multiple Roles

Depending on the size and complexity of the project, the project manager may take on other
responsibilities in addition to managing the work. For instance, the project manager may assist
with gathering business requirements. Or they may help design a database management system or
they may write some of the project documentation. Project management is a particular role that a
person fills, even if the person who is the project manager is working in other roles as well.

For instance, a project manager might manage the project for 45% of their time, perform business
analysis for 25%, work on design for 15% and write documentation for 15%. This does not mean
that one of the responsibilities of a project manager role is to spend 15% of their time on design.
Instead, it just means that the project is not large enough to need a full-time project manager. The
project manager spends the rest of their time in other project roles such as Business Analyst,
Designer and Technical Writer. Depending on the size of your projects and the way your company
is organized, a project manager’ time may be allocated one of three ways.

• They may have a full time role on a large project.

• They may have project management responsibilities for multiple projects, each of which is
less than full time, but the combination of which adds up to a full-time role.

• They may fill multiple roles, each of which requires a certain level of skill and
responsibility. On one project, for instance, they may be both a project manager and an
analyst.

(iv) Having Project Manager Accountable but not irresponsible

In some organizations, the project manager is accountable for the success of the project, but does
not have the right level of responsibility. Managing the team in a matrix organization is an example
of that. You are asked to manage a project utilizing people that you do not have direct management
responsibility for. In other cases, you may find that your ability to resolve issues is hampered
because you are not high enough in the organization to get an issue resolved quickly. In other
instances, you may find that your ability to be innovative and flexible is constrained by
organizational policies and inertia.

All of these cases can be causes for frustration. One way to deal with this is to define roles and
responsibilities as a part of the Project Charter. This can help set and manage expectations. For
instance, if you have no budget or expense approval authority, then note that up front, along with
a process for expense approval. That way, if problems do arise later, everyone knows who has the
right level of authority to resolve them. If the project manager does not have the authority, it is
important to know who does, and what process is needed to gain action.

For most project managers, the frustration level is not caused so

much by lack of power as much as it is caused by ambiguity.
CHAPTER 3. PROJECT IDENTIFICATION, FORMULATION AND
ANALYSIS

Introduction

A project in the economic sense directly or indirectly adds to the economy of the
Nation. However an introspection of the project performance clearly indicates that
the situation is far from satisfactory. Most of the major and critical projects in public
sector that too in crucial sectors like irrigation, agriculture, and infrastructure are
plagued by tremendous time and cost overruns. Even in the private sector the
performance is not all that satisfactory as is evident from the growing sickness in
industry and rapid increase in non-performing assets (NPAS) of Banks and
Financial Institutions. The reasons for time and cost over runs are several and they
can be broadly classified under-technical, financial, procedural and managerial.
Most of these problems mainly stem from inadequate project formulation and
haphazard implementation.

Project Identification
Project identification is an important step in project formulation. These are
conceived with the objective of meeting the market demand, exploiting natural
resources or creating wealth. The project ideas for developmental projects come
mainly from the national planning process, where as industrial projects usually stem
from identification of commercial prospects and profit potential.

As projects are a means to achieving certain objectives, there may be several

alternative projects that will meat these objectives. It is important to indicate all the
other alternatives considered with justification in favour of the specific project
proposed for consideration.

Sectoral studies, opportunity studies, support studies, project identification

essentially focuses on screening the number of project ideas that come up based on
information and data available and based on expert opinions and to come up with a
limited number of project options which are promising.

Project Formulation
Project Formulation Concept
“Project Formulation” is the processes of presenting a project idea in a form in
which it can be subjected to comparative appraisals for the purpose of determining
in definitive terms the priority that should be attached to a project under sever
resource constraints. Project Formulation involves the following steps (Figure 1).

PROJECT FORMULATION
↓
OPPORTUNITY STUDIES/Support Studies
↓
IDENTIFICATION OF PRODUCT/SERVICE
↓
PREFEASIBILITY STUDY
↓
FEASIBILITY STUDY
(TECHNO ECONOMIC FEASIBILITY)
↓
PROJECT APPRAISAL
↓
DETAILED PROJECT REPORT

Figure 1. Project Formulation –Schematic view

Opportunity Studies
An opportunity study identifies investment opportunities and is normally
undertaken at macro level by agencies involved in economic planning and
development. In general opportunity studies there are three types of study – Area
Study, sectoral and Sub-sectoral Studies and Resource Based Studies. Opportunity
Studies and Support studies provide sound basis for project identification.

Pre feasibility Studies / Opportunity Studies

A pre-feasibility study should be viewed as an intermediate stage between a project
opportunity study and a detailed feasibility study, the difference being primarily the
extent of details of the information obtained. It is the process of gathering facts and
opinions pertaining to the project. This information is then vetted for the purpose
of tentatively determining whether the project idea is worth pursuing furthering. Pre
feasibility study lays stress on assessing market potential, magnitude of investment,
, technical feasibility, financial analysis, risk analysis etc. The breadth and depth
of pre feasibility depend upon the time available and the confidence of the decision
maker. Pre feasibility studies help in preparing a project profile for presentation to
various stakeholders including funding agencies to solicit their support to the
project. It also throws light on aspects of the project that are critical in nature and
necessitate further investigation through functional support studies.

Support studies are carried out before commissioning pre feasibility or a

feasibility study of projects requiring large-scale investments. These studies also
form an integral part of the feasibility studies. They cover one or more critical
aspects of project in detail. The contents of the Support Study vary depending on
the nature of the study and the project contemplated. Since it relates to a vital aspect
of the project the conclusions should be clear enough to give a direction to the
subsequent stage of project preparation.

Feasibility Study
 Feasibility Study forms the backbone of Project Formulation and presents a
balanced picture incorporating all aspects of possible concern. The study
investigates practicalities, ways of achieving objectives, strategy options,
methodology, and predict likely outcome, risk and the consequences of each course
of action. It becomes the foundation on which project definition and rationale will
be based so that the quality is reflected in subsequent project activity. A well
conducted study provides a sound base for decisions, clarifications of objectives,
logical planning, minimal risk, and a successful cost effective project. Assessing
feasibility of a proposal requires understanding of the STEEP factors. These are as
under Social, Technological, Ecological, Economic, and Political.

A feasibility study is not an end in itself but only a means to arrive at an investment
decision. The preparation of a feasibility study report is often made difficulty by
the number of alternatives (regarding the choice of technology, plant capacity,
location, financing etc.) and assumptions on which the decisions are made. The
project feasibility studies focus on

- Economic and Market Analysis

- Technical Analysis
- Market Analysis
- Financial Analysis
- Economic Benefits
- Project Risk and Uncertainty
- Management Aspects

Economic and Market Analysis

In the recent years the market analysis has undergone a paradigm shift. The demand
forecast and projection of demand supply gap for products / services can no longer
be based on extrapolation of past trends using statistical tools and techniques. One
has to look at multiple parameters that influence the market. Demand projections
are to be made keeping in view all possible developments. Review of the projects
executed over the years suggests that many projects have failed not because of
technological and financial problems but mainly because of the fact that the projects
ignored customer requirements and market forces.

In market analysis a number of factors need to be considered covering – product

specifications, pricing, channels of distribution, trade practices, threat of substitutes,
domestic and international competition, opportunities for exports etc. It should aim
at providing analysis of future market scenario so that the decision on project
investment can be taken in an objective manner keeping in view the market risk and
uncertainty.
Technical Analysis
Technical analysis is based on the description of the product and specifications and
also the requirements of quality standards. The analysis encompasses available
alternative technologies, selection of the most appropriate technology in terms of
optimum combination of project components, implications of the acquisition of
technology, and contractual aspects of licensing. Special attention is given to
technical dimensions such as in project selection. The technology chosen should
also keep in view the requirements of raw materials and other inputs in terms of
quality and should ensure that the cost of production would be competitive. In brief
the technical analysis included the following aspects.

Technology - Availability

- Alternatives
- Latest / state-of-art
- Other implications
Plant capacity - Market demand
- Technological parameters
Inputs - Raw materials
- Components
- Power
- Water
- Fuel
- Others
Availability skilled man power
\Location
Logistics
Environmental consideration – pollution, etc.,
Requirement buildings/ foundation
Other relevant details
Environmental Impact Studies:
All most all projects have some impact on environment. Current concern of
environmental quality requires the environmental clearance for all projects.
Therefore environ impact analysis needs to be undertaken before commencement of
feasibility study.

Objectives of Environmental Impact Studies:

• To identify and describe the environmental resources/values (ER/Vs) or the
environmental attributes (EA) which will be affected by the project (in a
quantified manner as far as possible).
• To describe, measure and assess the environmental effects that the proposed
project will have on the ER/Vs.
• To describe the alternatives to the proposed project which could accomplish
the same results but with a different set of environmental effects
 The environmental impact studies would facilitate providing necessary remedial
measures in terms of the equipments and facilities to be provided in the project to
comply with the environmental regulation specifications.

Financial Analysis

The Financial Analysis, examines the viability of the project from financial or
commercial considerations and indicates the return on the investments. Some of the
commonly used techniques for financial analysis are as follows.

• Pay-back period.
• Return on Investment (ROI)
• Net Present Value (NPV)
• Profitability Index(PI)/Benefit Cost Ratio
• Internal Rate of Return (IRR)

Pay-back Period

This is the simplest of all methods and calculates the time required to recover the
initial project investment out of the subsequent cash flow. It is computed by
dividing the investment amount by the sum of the annual returns (income –
expenditure) until it is equal to the capital cost.

Example1. (Uniform annual return)

A farmer has invested about Rs. 20000/- in constructing a fish pond and gets
annual net return of Rs.5000/- (difference between annual income and expenditure).
The pay back period for the project is 4 years (20000/ 5000).

Example 2.(Varying annual return)

In a project Rs.100,000/- an initial investment of establishing a horticultural
orchard. The annual cash flow is as under.

Time Annual Annual Annual return Cumulative

Income Expenditure return
st
1 Year 60,000 30,000 30,000 30,000
2nd Year 70,000 30,000 40,000 70,000
3rd Year 85,000 25,000 60,000 130,000
Pay-back period = Two and half years

The drawback in this method is that it ignores any return received after the
payback period and assumes equal value for the income and expenditure irrespective
of the time.
 It is also possible that projects with high return on investments beyond the
pay-back period may not get the deserved importance i.e., two projects having same
pay-back period – one giving no return and the other providing large return after
pay-back period will be treated equally, which is logically not correct.

Return on Investment (ROI);

The ROI is the annual return as percentage of the initial investment and is
computed by dividing the annual return with investment. It is calculation is simple
when the return is uniform. For example the ROI of the fish ponds is (5000/ 10000)
X 100 = 50%. When the return is not uniform the average of annual returns over a
period is used. For horticultural orchard average return is (1,30,000/3) = 43333. ROI
= (43333/100000) X 100 = 43.3 %.

Computation of ROI also suffers from similar limitation as of pay-back period. It

does not differentiate between two projects one yielding immediate return (lift
irrigation project) and another project where return is received after some gestation
period say about 2-3 years (developing new variety of crop).

Both the pay-back period and ROI are simple ones and more suited for quick
analysis of the projects and sometimes provide inadequate measures of project
viability. It is desirable to use these methods in conjunction with other discounted
cash flow methods such as Net Present Value (NPV), Internal Rate of Return (IRR)
and Benefit-Cost ratio.

Discounted Cash Flow Analysis:

The principle of discounting is the reverse of compounding and takes the
value of money over time. To understand his let us take an example of compounding
first. Assuming return of 10 %, Rs 100 would grow to Rs110/- in the first year and
Rs 121 in the second year. In a reverse statement, at a discount rate of 10% the return
of Rs.110 in the next year is equivalent to Rs100 at present. In other words the
present worth of next years return at a discount rate 10 % is only Rs.90.91 i.e.,
(100/110) Similarly Rs121 in the second year worth Rs 100/- at present or the
present value of a return after two years is Rs. 82.64 (100/121). These values
Rs.90.91 and rs.82.64 are known as present value of of future annual return of
Rs.100 in first and second year respectively. Mathematically, the formula for
computing present value (PV) of a cash flow “Cn” in “nth” year at a discount rate of
“d” is as follows;

PV= Cn / (1+d)n
The computed discount factor tables are also available for ready reference.
In the financial analysis the present value is computed for both investment and
returns. The results are presented in three different measures ie. NPV, B-C Ratio,
and IRR.

Net Present Value (NPV)

 Net Present Value is considered as one of the important measure for deciding
the financial viability of a project. The sum of discounted values of the stream of
investments in different years of project implementation gives present value of the
cost (say C). Similarly sum of discounted returns yields the present value of benefits
(say B). The net present value (NPV) of the project is the difference between these
two values (B- C). Higher the value of NPV is always desirable for a project.

Benefit-Cost Ratio (B-C Ratio) or Profitability Index (PI);

The B-C Ratio also referred as Profitability Index (PI), reflect the
profitability of a project and computed as the ratio of total present value of the
returns to the total present value of the investments (B/C). Higher the ratio better is
the return.

Internal Rate of Return (IRR):

Internal Rate of Return (IRR) indicates the limit or the rate of discount at which
the project total present value of return (B) equals to total present value of
investments ( C ) i.e. B-C = Zero. In other words it is the discount rate at which the
NPV of the project is zero. The IRR is computed by iteration i.e. Computing NPV
at different discount rate till the value is nearly zero.

It is desirable to have projects with higher IRR.

Risk and Uncertainty

Risk and Uncertainty are associated with every project. Risk is related to
occurrence of adverse consequences and is quantifiable. It is analysed through
probability of occurrences. Where as uncertainty refers to inherently unpredictable
dimensions and is assessed through sensitivity analysis. It is therefore necessary to
analyse these dimensions during formulation and appraisal phase of the programme.
Factors attributing to risk and uncertainties of a project are grouped under the
following;

• Technical –relates to project scope, change in technology, quality and

quantity of inputs, activity times, estimation errors etc.
• Economical- pertains to market, cost, competitive environment, change in
policy, exchange rate etc.
• Socio-political- includes dimensions such as labour, stakeholders etc.
• Environmental – factors could be level of pollution, environmental
degradation etc.

Economic Benefits:

Apart from the financial benefits (in terms of Return on Investment) the economic
benefits of the project are also analyzed in the feasibility study. The economic
benefits include employment generation, economic development of the area where
the project is located, foreign exchange savings in case of import substitutes or
earning of foreign exchange in case of export oriented projects and others.
Management Aspects:
Management aspects are becoming very important in project feasibility studies.
The management aspects cover the background of promoters, management
philosophy, the organization set up and staffing for project implementation phase as
well as operational phase, the aspects of decentralization and delegation, systems
and procedures, the method of execution and finally the accountability.

Time Frame for Project Implementation:

The feasibility study also presents a broad time frame for project implementation.
The time frame influences preoperative expenses and cost escalations which will
impact the profitability and viability of the project.

Feasibility Report:

Based on the feasibility studies the Techno economic feasibility report or the
project report is prepared to facilitate project evaluation and appraisal and
investment decisions.

Project Appraisal
The project appraisal is the process of critical examination and analysis of the
proposal in totality. The appraisal goes beyond the analysis presented in the
feasibility report. At this stage, if required compilation of additional information and
further analysis of project dimensions are undertaken. At the end of the process an
appraisal note is prepared for facilitating decision on the project implementation.

The appraisal process generally concentrates on the following aspects.

• Market Appraisal: Focusing on demand projections, adequacy of marketing
infrastructure and competence of the key marketing personnel.
• Technical Appraisal: Covering product mix, Capacity, Process of
manufacture engineering know-how and technical collaboration, Raw
materials and consumables, Location and site, Building, Plant and
equipments, Manpower requirements and Breakeven point.
• Environmental Appraisal: Impact on land use and micro-environment,
commitment of natural resources, and Government policy.
• Financial Appraisal: Capital, rate of return, specifications, contingencies,
cost projection, capacity utilization, and financing pattern.
• Economic Appraisal: Considered as a supportive appraisal it reviews
economic rate of return, effective rate of protection and domestic resource
cost.
• Managerial Appraisal: Focuses on promoters, organization structure,
managerial personnel, and HR management.
 • Social Cost Benefit Analysis (SCBA): Social Cost Benefit Analysis
is a methodology for evaluating projects from the social point of view and
focuses on social cost and benefits of a project. There often tend to differ
from the costs incurred in monetary terms and benefits earned in monetary
terms by the project SCBA may be based on UNIDO method or the Little-
Mirriles (L-M) approach. Under UNIDO method the net benefits of the
project are considered in terms of economic (efficiency) prices also referred
to as shadow prices. As per the L-M approach the outputs and inputs of a
project are classified into (1) traded goods and services (2) Non traded goods
and services; and (3) Labor. All over the world including India currently
the focus is on Economic Rate of Return (ERR) based on SCBA assume
importance in project formulation and investment decisions.

CHAPTER4: PROJECT CYCLE

(a) Project Inception and Identification

Project Life Cycle

Every project, from conception to completion, passes through various phases of a
life cycle synonym to life cycle of living beings. There is no universal consensus on
the number of phases in a project cycle. An understanding of the life cycle is
important to successful completion of the project as it facilitates to understand the
logical sequence of events in the continuum of progress from start to finish. Typical
project consists of four phases- Conceptualization, Planning, Execution and
Termination. Each phase is marked by one or more deliverables such as Concept
note, Feasibility report, Implementation Plan, HRD plan, Resource allocation plan,
Evaluation report etc.

Conceptualization Phase
Conception phase, starting with the seed of an idea, it covers identification
of the product / service, Pre-feasibility, Feasibility studies and Appraisal and
Approval. The project idea is conceptualized with initial considerations of all
possible alternatives for achieving the project objectives. As the idea becomes
established a proposal is developed setting out rationale, method, estimated costs,
benefits and other details for appraisal of the stakeholders. After reaching a broad
consensus on the proposal the feasibility dimensions are analyzed in detail.

Planning Phase
In this phase the project structure is planned based on project appraisal and
approvals. Detailed plans for activity, finance, and resources are developed and
integrated to the quality parameters. In the process major tasks need to be performed
in this phase are

• Identification of activities and their sequencing

• Time frame for execution
 • Estimation and budgeting
• Staffing
A Detailed Project Report (DPR) specifying various aspects of the project is
finalized to facilitate execution in this phase.

Execution Phase
This phase of the project witnesses the concentrated activity where the plans
are put into operation. Each activity is monitored, controlled and coordinated to
achieve project objectives. Important activities in this phase are

• Communicating with stakeholders

• Reviewing progress
• Monitoring cost and time
• Controlling quality
• Managing changes

Termination Phase
This phase marks the completion of the project wherein the agreed deliverables are installed and
project is put in to operation with arrangements for follow-up and evaluation.
Life Cycle path
The life cycle of a project from start to completion follows either a “S” shaped path or a “J “ shaped
path (Figure 2 and 3). In “S” shape path the progress is slow at the starting and terminal phase and
is fast in the implementation phase. For example, implementation of watershed project. At the
beginning detailed sectoral planning and coordination among various implementing agencies etc.
makes progress slow and similarly towards termination, creating institutional arrangement for
transfer and maintenance of assets to the stakeholders progresses slowly.

Many organizations do not employ full-time Project Managers and it is common to pull together a
project team to address a specific need. While most people do not have formal skills in a project
methodology, taking a role in a project team can be an excellent learning opportunity and can
improve a person's career profile.

Project management in the modern sense began in the early 1950s, although it has its roots much
further back in the latter years of the 19th century. The need for project management was driven
by businesses that realized the benefits of organizing work around projects and the critical need to
communicate and co-ordinate work across departments and professions. One of the first major
uses of project management as we know it today was to manage the US space program. The
government, military and corporate world have now adopted this practice.

As you move ahead in your career, you are likely to face more complex and difficult challenges.
Some of these may involve:

• The coordination of many different people,

 • The completion of many tasks in a precise sequence, and;
• The expenditure of a great deal of time and money.

You can do this well, or you can do it badly.

• If you do this well, you'll complete your projects on time, and with minimal wastage of
resources. This will build your reputation as a competent, successful manager.
• If you do this badly, you'll lose this reputation, and your career will most-likely stall. This
is why you need to learn how to manage projects well.

There are a series of project management approaches and tools to help you reduce these risks, and
create an effective platform to deliver the project objectives. These are designed to improve the
project's overall success, and to capture the knowledge that’s gained every time a project is
completed.

In other ways, a project goes through six phases during its life:

1. Project Identification/Definition:

This involves problem identification and means to address the problem through the
development of:
• Concept definition goals & objectives
• Consideration of possible ways of achieving these objectives.

2. Project Initiation

• Everything that is needed to set-up the project before work can start.

3. Project Planning

• Detailed plans of how the work will be carried out including-

-time,
-cost and;
- Resource estimates.

4. Project Execution

• Doing the work to deliver the product, service or desired outcome.

5. Project Monitoring & Control

 • Ensuring that a project stays on track and taking corrective action to ensure it does.

6. Project Closure

• Formal acceptance of the deliverables and disbanding of all the elements that were
required to run the project.

A Project Management Team has the responsibility to oversee the activities of the entire
project cycle

(b) Analysis of stages of Project Cycle

The Planning Cycle brings together all aspects of planning into a coherent, unified process and:

• Ensures your plans are fully considered, focused, practical & cost-effective.
• Ensures that you learn from any mistakes you make, and feed this back into future planning
and Decision Making.
• Ensures that planning is a cycle, is likely to succeed. This evaluation may be cost or number
based, or may use other analytical tools. This analysis may show that your plan may cause
unwanted consequences, may cost too much, or may simply not work.
• In this case you should cycle back to an earlier stage or abandon the plan altogether - the
outcome of the planning process may be that it is best to do nothing!
• Finally, you should feedback what you have learned with one plan into the nex

The Planning Cycle is shown in figure 1:

Planning using this cycle will help you to plan and manage ongoing projects up to a certain
level of complexity. For projects involving many people over a long period of time, more
formal methodologies and approaches are necessary.

The stages in this planning process are explained below:

1. Analysis of Opportunities

The first thing to do is to spot what needs to be done. One approach to this is to examine your
current position, and decide how you can improve it. There are a number of techniques that will
help you to do this:

• Risk Analysis: This helps you to spot project risks, weaknesses in your organization or
operation, and identify the risks to which you are exposed. From this you can plan to
neutralize some risks.

• Understanding pressures for change: Alternatively, other people (e.g. clients) may be
pressing you to change the way you do things; environment may be changing, and you may
need to anticipate or respond to this or Pressures from changes in the economy, new
legislation, competition, changes in people's attitudes, new technologies, or changes in
government.
 • SWOT Analysis: This is a formal analysis of your strengths and weaknesses, and of the
opportunities and threats that you face.

2. Identifying the Aim of Your Plan

Once you have completed a realistic analysis of the opportunities for change, the next step is to
decide precisely what the aim of your plan is. Deciding and defining an aim sharpens the focus of
your plan, and helps you to avoid wasting effort on irrelevant side issues.

The aim is best expressed in a simple single sentence. This ensures that it is clear and sharp in your
mind.

If you are having difficulty in formulating the aim of your plan, ask yourself:

• What do I want the future to be?

• What benefit do I want to give to my customers?
• What returns do I seek?
• What standards am I aiming at?
• What values do I and my organization believe in?

You can present this aim as a 'Vision Statement' or 'Mission Statement'. Vision Statements express
the benefit that an organization will provide to its customers. For example, the vision statement
for Mind Tools™ is: 'To enrich the quality of our customer’s lives by providing the tools to help
them to think in the most productive and effective way possible'. While this is wordy, it explains
what this site aims to do.

Mission statements give concrete expression to the Vision statement, explaining how it is to be
achieved. The mission statement for this site is: 'To provide a well structured accessible, concise
survey of the best and most appropriate mind tools available.

3. Exploring Options

By this stage you should know where you are and what you want to do. The next thing to do is to
work out how to do it. The creativity tools section of this site explains a wide range of powerful
creativity tools that will help you to generate options.

At this stage it is best to spend a little time generating as many options as possible, even though it
is tempting just to grasp the first idea that comes to mind. By taking a little time to generate as
many ideas as possible you may come up with less obvious but better solutions. Just as likely, you
may improve your best ideas with parts of other ideas.
4. Selecting the Best Option

Once you have explored the options available to you, it is time to decide which one to use. If you
have the time and resources available, then you might decide to evaluate all options, carrying out
detailed planning, costing, risk assessment, etc. for each. Normally you will not have this luxury.

Two useful tools for selecting the best option are Grid Analysis and Decision Trees. Grid Analysis
helps you to decide between different options where you need to consider a number of different
factors. Decision Trees help you to think through the likely outcomes of following different
courses of action

(Home work:-Read about Grid Analysis and Decision Trees).

5. Detailed Planning

By the time you start detailed planning, you should have a good picture of where you are, what
you want to achieve and the range of options available to you. You may well have selected one of
the options as the most likely to yield the best results.

Detailed planning is the process of working out the most efficient and effective ways of achieving
the aim that you have defined. It is the process of determining who will do what, when, where,
how and why, and at what cost.

When drawing up the plan, techniques such as use of Gantt Charts and Critical Path Analysis can
be immensely helpful in working out priorities, deadlines and the allocation of resources.(to be
seen later-but you could read forward).

While you are concentrating on the actions that need to be performed, ensure that you also think
about the control mechanisms that you will need to monitor performance. These will include the
activities such as reporting, quality assurance, cost control, etc. that are needed to spot and correct
any deviations from the plan.

A good plan will:

• State the current situation

• Have a clear aim
• Use the resources available
• Detail the tasks to be carried out, whose responsibility they are, and their priorities and
deadlines.
• Detail control mechanisms that will alert you to difficulties in achieving the plan.
 • Identify risks, and plan for contingencies. This allows you to make a rapid and effective
response to crises, perhaps at a time when you are at low ebb or are confused following a
setback.
• Consider transitional arrangements - how will you keep things going while you implement
the plan?

6. Evaluation of the Plan and its Impact

Once you have worked out the details of your plan, the next stage is to review it to decide whether
it is worth implementing. Here you must be objective - however much work you have carried out
to reach this stage, the plan may still not be worth implementing.

This is frustrating after the hard work of detailed planning. It is, however, much better to find this
out now than when you have invested time, resources and personal standing in the success of the
plan. Evaluating the plan now gives you the opportunity to either investigate other options that
might be more successful, or to accept that no plan is needed or should be carried out.

Depending on the circumstances, the following techniques can be helpful in evaluating a plan:

• Plus/Minus/Interesting (PMI):
This is a good, simple technique for 'weighing the pros and cons' of a decision. It involves
listing the plus points in the plan in one column, the minus points in a second column, and
the implications and points of uncertainty of the plan in a third column. Each point can be
allocated a positive or negative score.

• Cost /Benefit Analysis:

This is useful for confirming that the plan makes financial sense. This involves adding up
all the costs involved with the plan, and comparing them with the expected benefits.

• Force/Field Analysis
Similar to PMI, Force Field Analysis helps you to get a good overall view of all the forces
for and against your plan. This allows you to see where you can make adjustments that will
make the plan more likely to succeed.

• Cashflow Forecasting Where a decision has mainly financial implications, such as in

business and marketing planning, preparation of a Cash Flow Forecast can be extremely
useful. It allows you to assess the effect of time on costs and revenue. It also helps in
assessing the size of the greatest negative and positive cash flows associated with a plan.
When it is set up on a spreadsheet package, a good Cash Flow Forecast also functions as
 an extremely effective model of the plan. It gives you an easy basis for investigating the
effect of varying your assumptions.

• Thinking Hats: This is a very good technique to use to get a rounded view of your plan and
its implications. It provides a context within which you can examine a plan rationally,
emotionally, optimistically, pessimistically and creatively.

Any analysis of your plan must be tempered by common sense.

If your analysis shows that the plan either will not give sufficient benefit, then either return to an
earlier stage in the planning cycle or abandon the process altogether.

7. Implementing Change

Once you have completed your plan and decided that it will work satisfactorily, it is time to
implement it. Your plan will explain how! It should also detail the controls that you will use to
monitor the execution of the plan.

8. Closing the Plan

Once you have achieved a plan, you can close the project. At this point is often worth carrying out
an evaluation of the project to see whether there are any lessons that you can learn. This should
include an evaluation of your project planning to see if this could be improved.

If you are going to be carrying out many similar projects, it may be worth developing and
improving an Aide Memoire. This is a list of headings and points to consider during planning.
Using it helps you to ensure that you do not forget lessons learned in the past.

Key points to remember

The Planning Cycle is a process that helps you to make good, well-considered, robust plans.

The first step, the analysis of opportunities, helps you to base the plan firmly in reality. The second,
definition of the aim, gives your plan focus.

The third stage is to generate as many different ways for achieving this aim as possible. By
spending time looking for these you may find a better solution than the obvious one, or may be
able to improve the obvious solution with parts of other ones.

Next select the best approach, and make a detailed plan showing how to implement it. Evaluate
this plan to make sure that it will be worth implementing. If it is not, return to an earlier stage and
either improve the plan or make a different one. If no plan looks like producing enough benefit to
justify the cost, make no changes at all.

Once you have selected a course of action, and have proved that it is viable, carry it out. Once it is
finished, examine it and draw whatever lessons you can from it. Feed this back into future
planning.

CHAPTER5 PROJECT PLANNING

Introduction and definitions

The planning, implementation and management of project activities is made up of a sequence of

stages, which constitute a project cycle.
The main aim of a manager is to maximize the output of the organization through functions of
management
• Planning,
• Organization,
• Staffing,
• Directing and;
• Controlling
The manager needs management skills to carry out project planning. One of the skills is
Technical skill-ie-the ability to use tools, techniques, and specialized knowledge to carry out a
method, process, or procedure.

“PLANNING IS THE CENTRAL FUNCTION OF MANAGEMENT.”

FUNCTIONS OF MANAGEMENT

PLANNING

EVALUATING
ORGANISING

DIRECTING STAFFING
Project planning

Project Planning is part of project management, which relates to the use of different project
planning tools and schedules to plan and subsequently report progress within the project
environment such as:

• Timetables and Action Plans, for simple projects

• Gantt charts or critical path analysis, for complex projects

1. Scheduling Simple Projects

Simple projects involve only one or a few people over a short time. Typically, simple projects will
have few tasks dependent on other tasks, and will be relatively simple and easy to coordinate.
Examples:

• Managing a workshop session,

• implementing a marketing plan for family maize harvest

Key points:

• Appropriate Timetables and Action Plans are often sufficient to coordinate and implement
simple projects. These should be explained and negotiated with project staff to improve the
plans and get staff understanding, input and buy-in.
• It will often be enough to create a work-back schedule, starting from the date by which the
project must be completed, and listing all of the tasks in reverse order with due dates for
each.
• During the project these will contain sufficient control points and deliveries to monitor
project progress and take any appropriate remedial action.
• Whatever the size of your project, ensure that you have agreed its scope with its sponsor
(the person who wants it done) before you start planning. This will help you to resist
changes to its scope (known as "scope creep"), which will seriously affect your plans, once
you have started working.

(i) Estimating Time Accurately

Accurate time estimation is a skill essential to good project management. It is important to get
time estimates right for two main reasons:
 • It sets deadlines for delivery of projects, and hence reliability of managers

• They determine the pricing of contracts and hence their profitability.

Note:

• Usually people vastly underestimate the amount of time needed to implement projects,
particularly when they are not familiar with the task(s) to be carried out.
• They forget to take into account unexpected events or unscheduled high priority work.
• People also often simply fail to allow for the full complexity involved with a project.

In this section discusses how to estimate time on small projects. Time estimates are important
inputs into the other techniques used to organize and structure medium and large sized projects
(Gantt charts and Critical Path Analysis).

How to Estimate time

The first stage in estimating time accurately is to fully understand what you need to achieve. Start
by reviewing the tasks in detail so that there are no unknowns. Inevitably it is difficult, tricky and
takes the greatest amount of time to solve:

• List all tasks in full detail. Simple techniques such as Drill-Down are useful for this.
• Make your best guess at how long each task will take to complete.
• Ensure that within your estimate you also allow time for project management,
detailed project planning, liaison with outside bodies, meetings, quality assurance
and any supporting documentation necessary.
• Also make sure that you have allowed time for:

- Other high urgency tasks to be carried out which will have priority over this
one
- Accidents and emergencies
- Internal meetings
- Holidays and sickness in essential staff
- Contact with other customers, perhaps to arrange the next job
- Breakdowns in equipment
- Missed deliveries by suppliers
- Interruptions
 - Quality control rejections

These factors may double (or more than double) the length of time needed to complete a project.

If the accuracy of time estimates is critical, you may find it effective to develop a systematic
approach to including these factors. If possible, base this on past experience.

Key points:

• You can lose a great deal of credibility by underestimating the length of time needed to
implement a project. If you underestimate time, not only do you miss deadlines, you also
put other project workers under unnecessary stress. Projects will become seriously
unprofitable, and other tasks cannot be started.
• The first step towards making good time estimates is to fully understand the problem to be
solved.
• You can then prepare a detailed list of tasks that must be achieved. This list should include
all the administrative tasks and meetings you need to carry out as well as the work itself.
• Finally, allow time for all the expected and unexpected disruptions and delays to work that
will inevitably happen. A Planning Process for Middle-Sized Projects.

2. SWOT ANALYSIS

SWOT Analysis is a powerful technique for understanding your Strengths and Weaknesses, and
for looking at the Opportunities and Threats you face.

• Helps organization carve a sustainable niche in the market,

• Helps develop position that takes best advantage of talents, abilities and opportunities.

• Helps uncover opportunities that are well placed to exploit.

By understanding the strengths, weaknesses and opportunities of organization or business,

management can:

• Manage and eliminate threats that would otherwise catch you unawares.
• Helps craft a strategy that helps you distinguish yourself from your competitors, so that
you can compete successfully in your market.

How to Use the Tool

To carry out a SWOT Analysis, look at the figure below and then answer the following questions:

Example of marketing company below:

Strengths-you capitalize; Opportunities-you invest; weaknesses-you shore-up/support them to

grow; identify and rectify.

Generate ides by matching strengths with opportunities; weaknesses with threats

Internal: customer, employee, capabilities, resources, process

External: Provides competitive secondary data on environment, industry.

Strengths:
 • What advantages does your company have?
• What do you do better than anyone else?
• What unique or lowest-cost resources do you have access to?
• What do people in your market see as your strengths?
• What factors mean that you "get the sale"?

Consider this from an internal perspective, and from the point of view of your customers and
people in your market. Be realistic and if you are having any difficulty with this, try writing down
a list of your characteristics. Some of these will hopefully be strengths.

In looking at your strengths, think about them in relation to your competitors - for example, if all
your competitors provide high quality products, then a high quality production process is not
strength in the market, it is a necessity.

Weaknesses:

• What could you improve?

• What should you avoid?
• What are people in your market likely to see as weaknesses?
• What factors lose you sales?

Again, consider this from an internal and external basis: Do other people seem to perceive
weaknesses that you do not see? Are your competitors doing any better than you? It is best to be
realistic now, and face any unpleasant truths as soon as possible.

Opportunities:

• Where are the good opportunities facing you?

• What are the interesting trends you are aware of?

Useful opportunities can come from such things as:

• Changes in technology and markets on both a broad and narrow scale.

• Changes in government policy related to your field.
• Changes in social patterns, population profiles, lifestyle changes.
• Local events.

A useful approach for looking at opportunities is to look at your strengths and ask yourself whether
these open up any opportunities.
Alternatively, look at your weaknesses and ask yourself whether you could create opportunities by
eliminating them.

Threats:

• What obstacles do you face?

• What are your competitors doing that is worrying you?
• Are the required specifications for your products or services changing?
• Is changing technology threatening your position?
• Do you have bad debt or cash-flow problems?
• Could any of your weaknesses seriously threaten your business?

Strengths and weaknesses are often internal to your organization.

Opportunities and threats often relate to external factors.

For this reason the SWOT Analysis is sometimes called Internal-External Analysis and the SWOT
Matrix is sometimes called an Internal-External Matrix Analysis Tool.

SWOT can be used in two ways – as a simple icebreaker helping people get together and "kick
off" strategy formulation, or in a more sophisticated way as a serious strategy tool. If you're using
it as a serious tool, make sure you're rigorous in the way you apply it:

• Only accept precise, verifiable statements ("Cost advantage of US$10/ton in sourcing raw
material x", rather than "Good value for money").
• Use most significant factors, and prioritize them.
• Carried through to later stages in the strategy formation process the options generated
• Apply it at the right level – for example, at product or product line level, rather than at the
much vaguer whole company level.

Supplement it with other option-generation tools – none is likely to be completely comprehensive.

Exercise: You have secured funds to start a medium size Maize Mill processing industry or
Secondary school. Apply a SWOT Analysis to determine whether you will be competitive in the
market and draw conclusions.
CHAPTER 6: Project scheduling and Management Techniques

Introduction

Project management involves decision making for the planning, organizing, coordination,
monitoring and control of a number of interrelated time bound activities. Project Manager
therefore, often depends on tools and techniques that are effective enough not only for
drawing up the best possible initial plan but also capable of projecting instantaneously the
impact of deviations so as to initiate necessary corrective measures. The search for an
effective tool has resulted in development of a variety of techniques. These project
management techniques can be classified under two broad categories i.e., Bar Charts and
Networks.

Bar Charts

Bar charts are the pictorial representation of various tasks required to be performed for
accomplishment of the project objectives. These charts have formed the basis of
development of many other project management techniques.

Gantt Chart

Henry L Gantt (1861 – 1919) around 1917 developed a system of bar charts for scheduling
and reporting progress of a project. These charts latter were known as Gantt Charts. It is
a pictorial representation specifying the start and finish time for various tasks to be
performed in a project on a horizontal time-scale. Each project is broken down to
physically identifiable and controllable units, called the Tasks

Networks

The network is a logical extension of Gantt’s milestone chart incorporating the

modifications so as to illustrate interrelationship between and among all the milestones
in an entire project. The two best-known techniques for network analysis are Programme
Evaluation and review Technique (PERT) and Critical Path Method (CPM). These two
techniques were developed almost simultaneously during 1956-1958. PERT was
developed for US navy for scheduling the research and development activities for Polaris
missiles programme. CPM was developed by E.I. du Pont de Nemours & Company as an
application to construction project. Though these two methods were developed
simultaneously they have striking similarity and the significant difference is that the time
estimates for activities is assumed deterministic in CPM and probabilistic in PERT. There is
also little distinction in terms of application of these concepts. PERT is used where
emphasis is on scheduling and monitoring the project and CPM is used where emphasis is
on optimizing resource allocation. However, now-a-days the two techniques are used
synonymously in network analysis and the differences are considered to be historical.
Both CPM and PERT describe the work plan of project where arrows and circles
respectively indicate the activities and events in the project. This arrow or network
diagram includes all the activities and events that should be completed to reach the
project objectives. The activities and events are laid in a planned sequence of their
accomplishments

1.3.1 Programme Evaluation and Review Technique (PERT)

The PERT technique is a method of minimizing trouble spots, programme bottlenecks,

delays and interruptions by determining critical activities before they occur so that various
activities in the project can be coordinated.

PERT terminology
Some of the terms frequently used in PERT are as follows.
Activity: A recognizable work item of a project requiring time and resource for its
completion.

Dummy Activity: An activity that indicates precedence relationship and requires no time
nor resource.

Critical Activity: Activities on the critical path having zero slack / float time.

Critical Path: The longest time path connecting the critical activities in the project
network. The total time on this path is the shortest duration of the project.

Event: An instantaneous point in time signifying completion or beginning of an activity.

Burst Event: An event which gives rise to more than one activity.

Merge Event: The event which occurs only when more than one activity are accomplished.

Expected Time: The weighted average of the estimated optimistic, most likely and
pessimistic time duration of a project activity:

To + 4 TM + T

Expected Time (TE ) = ------------------------

where To is the Optimistic time, TM is the Most likely time

T is the Pessimistic time

Earliest Start Time (EST): The earliest possible time at which the event can occur. The EST
also denotes the Earliest Start Time (EST) of an activity as activities emanate from
events. The EST of an activity is the time before which it can not commence without
affecting the immediate preceding activity.

Latest Start Time (LST): The latest time at which the event can take place. Also referred as
the Latest Start Time (LST) indicating the latest time at which an activity can begin
without delaying the project completion time.

Slack: The amount of spare time available between completion of an activity and
beginning of next activity.

Steps For Network Analysis

The six steps of network analysis are as follows.

1. Prepare the list of activities

2. Define the inter relationship among the activities.
3. Estimate the activity duration
4. Assemble the activities in the form of a flow diagram
5. Draw the network
6. Analyze the network i.e. compute EST and LST; identify critical events, critical path and
critical activities.

Step1: Prepare the list of activities

An activity in a project is the lowest level of resource consuming, time-bound work
having a specified beginning and endpoint. It should be quantifiable, measurable, costable,
and discrete. The total project is subdivided into activities and each activity is given an
alphabetical symbol / code. When the number of activities is more than 26, alphanumeric
or multi -alphabet codes can be used. This involves a detailed delineation of the activities
to be performed to complete the project. There is no limit to the number of activities to
which the project should be splitted. However, it is advisable to limit the number to the
minimum required from managerial consideration for avoiding unnecessary complexity.
In a simple project it may be easier to identify the activity. In complex projects project
activities are identified by splitting it into different hierarchical levels (sub-projects). For
example in the activities of a watershed project could be broken down in to sub-projects
such as agricultural sub-projects, Soil & water conservation sub-projects, Aforestation sub-
project etc. For each of these subprojects the activities could be identified. Depending on
the size and nature of the project sub-projects could be further divided into sub-sub
project.
For illustration of the process, a simple example of creating facility for lift irrigation
in a farm would be used in the following text. Some of the assumptions are as under.
1. It is assumed that the competent authority has approved the project and
the project scheduling starts with the activity of “Site selection”.

2. Irrigation would be provided from a newly dug well.

3. Field channels from the well would be laid after its digging.
4. Suitable pump would be procured and installed for lifting water.
5. Specification for the pump is finalized based on the groundwater
prospecting data before digging.

6. Pump and other inputs would not be procured until the site is selected.
7. Pump would be installed after digging the well.

With above assumptions, the activities of the project are listed in Table 1. It may
be noted the list is not exhaustive. The list would be different with different set of
assumption or the perception of the project manager. More activities could be added to
the list or some of the activities could be further subdivided. The number of activities in
this example has been delineated and limited to only six numbers with objective of
simplicity and to demonstrate the process of networking

Table 1. List of activity

Sr. No Activity Symbol / Code

1. Site selection
A
2. Digging well B
3. Laying field channels C

4. Procurement of Pump D

5. Installation of pump E

6. Test run F

Step 2: Define the inter relationship among the activities

The relationship among the activities could be defined by specifying the preceding
and succeeding activity. Preceding activity for an activity is its immediate predecessor, i.e.
the activity that needs to be completed before the start of the new activity. In the given
example, selection of the site precedes digging of well. In other words the site needs to be
selected before digging of the well. Thus the activity “Selection of site” becomes
proceeding activity to the activity of “Digging the well” Succeeding activity is the one that
immediately starts after completion of the activity. “Digging well” is the succeeding activity
to “Selection of site”.

In PERT the interrelationship is generally defined using the preceding activity.

Only the terminating activities will not have any preceding activity. And all other activities
must appear at least once as a preceding activity in the table. The inter relationship among
the activities listed in the example is as in Table 2.

Table 2. Interrelationship of activities

Sr. No Activity Symbol Preceding

activity

1. Site selection A ----

2. Digging well B A
3. Laying field channels C B
4. Procurement of Pump D A
5. Installation of pump E B, D
6. Test run F C, E

Step 3: Estimation of activity time

The activity time is the time, which is actually expected to be expended in carrying
out the activity. In deterministic cases as in CPM one time estimate is used. In probabilistic
cases as in PERT, the activity time has some kind of probabilistic distribution and is the
weighted average of three time estimates ( Optimistic time, Pessimistic time and Most
likely time) for each activity. The expected time for each activity is computed as following:

To + 4 TM + T

Expected Time (TE ) = ------------------------

6
where To is the Optimistic time,(minimum time assuming every thing goes
well) TM is the Most likely time, (modal time required under normal
circumstances)

T is the Pessimistic time, (maximum time assuming every thing goes wrong)

Example: Estimation of estimated time for the activity “Site selection”

For this activity the tree time estimates i.e., Optimistic, Most likely and Pessimistic
times are 4, 6 and 14 days respectively.

i.e. TO = 4, TM = 6, and TP = 14.

TE = 4 + 4*6 + 14 = 4+24+14 = 42 = 7 days
6 6 6

Three time estimates, optimistic, pessimistic and most likely, could the decided on
past experiences in execution of similar activities or from the feedback from individuals
with relevance experience. The three time estimates and computed estimated time for
the project activities are given in Table 3.

Table 3. Activity time estimates

Time (Days)

Optimis Most Pessimis Estimate

Sr. Activity Symb Precedin
tic likely tic time d
No ol g activity
Time time TM TP ti
TO me
TE
1. Site selection A ---- 4 6 14 7
2. Digging well B A 2 3 4 3
3. Laying field channels C B 7 16 19 15
4. Procurement of Pump D A 4 7 10 7
5. Installation of pump E D, B 3 4 11 5
6. Test run F C, E 1 2 3 2

Network Diagram
Having decided on activities, their relationship and duration (estimated time of
the activity), next step is to draw the network diagram of the project. PERT network is a
schematic model that depicts the sequential relationship among the activities that must
be completed to accomplish the project.

Step 4: Assemble the activities in the form of a flow chart.

In a flow chart the activity and its duration is shown in a box. The boxes are connected
with lines according to the preceding and succeeding activity relationship. The flow charts
do not give details like start and completion time of each activity until unless it is super
imposed on a calendar. It also does not facilitate computation of various slacks. However,
the critical path for the project can be identified by comparing the various path lengths
(sum of activity time, from start to finish, on any path). The longest path in the chart is the
critical path. The flow diagram for the project considered for illustration is as in Figure 5 .

START

A 7

B 3 D 7

C 15 E 5

F 2

FINISH

Figure 5. The flow diagram

Path I A-B-E-F 7+3+5+2 = 17

Path II A-B-C-F 7+3+15+2 = 27

Path III A-D-E-F 7+7+5+2 = 21
Path II i.e., A-B-C-F being the longest path (27 days) is the Critical path .
Step 5: Draw the network
This graphical representation of the project shows the precedence relationship among
the activities. An arrow generally represents activities in the diagram while a circle
represents event. Each activity starts with an event and end in an event. Activities in a
project are performed either sequentially i.e. one after another or they are undertaken
concurrently i.e. simultaneously. To draw the network it requires the knowledge of
specifying which activities must be completed before other activities can be started, which
activities can be performed in parallel, and which activities immediately succeed other
activities. Some of the common combination of activity in a project is as follows,
 A B Activity D cannot begin until both A & C are
completed. But B can start after A is complete.
The activity Z, represented by dashed arrow, is
Z a dummy activity (Explained bellow). It specifies
C D the inter relation ship.

Dummy Activity:
For example in a project Crop 2 is to be raised in same plot of land after harvesting
of Crop 1. The activities and there inter relation could be as under

Sl No Activity Code Preceding activity

1 Harvesting of Crop-1 A -
2 Sale of Crop – 1 B A
3 Raising nursery of Crop-2 C -
4 Transplanting Crop-2 D A, C

The network diagram of the above project would be as follows

 A B

Z
D
C

The activity “Z”, represented by dashed arrow in the diagram, is a dummy activity.
This does not consume any resource i.e. have zero time and zero cost. This only represents
the logical relation among the activities.

Rules for Drawing the Network:

1. Each activity is represented by one and only one arrow in the network
2. All the arrows must run from left to right.
3. Dotted line arrows represent dummy activities.
4. A circle represents an event.
5. Every activity starts and ends with an event.
6. No two activities can be identified by the same head and tail event.

7. Do not use dummy activity unless required to reflect the logic.

8. Avoid Looping and crossing of activity arrows by repositioning.
9. Every Activity, except the first and the last, must have at least one preceding and
one succeeding activity.

10. Danglers, isolated activities must be avoided.

11. For coding use alphabets for all activities including the dummy activity and
numbers for events.

EST
12. Standard representation of the event :
Event
Code
LST

The network diagram for the project detailed in Table 4 is as follows (Figure 6)..
 C

Figure 6. Activity inter-

relationship

Network Analysis
Introduction
Network analysis helps the manager to calculate the duration and identify critical
activities in a project. Critical activities are those activities, which determine the overall
duration of the project. The duration of the project is not necessarily the simple
arithmetical sum of the individual activity durations because several activities occur
concurrently in the project. Project duration would be equal to the sum of all individual
activity durations only when all the activities in the project are sequential. The starting and
finishing time for each individual activity is calculated through the network analysis. These
computations provide a strong base for determining the work schedule. The network
analysis includes the following.

a. Event numbering
b. Computation of the Earliest Start Time (EST)
c. Computation of the Latest Start Time (LST)
d. Computation of Earliest Finish Time (EFT)
e. Computation of the Latest Finish Time (LFT)
f. Identification of Critical Path
g. Computation of Slack or Float

Event Numbering
It is common practice to number every event in the network so that they are not
duplicated, every event is identified with a reference number in the network and every
activity is identified by its preceding and succeeding event numbers. There are two
systems in vogue for numbering events:

1. Random numbering system

2. Sequential numbering system
Random numbering system; In this system, events of a network are numbered randomly,
thereby avoiding the difficulty in numbering extra events due to insertion of new jobs.

Sequential numbering system: In this system the events are numbered successively from
the beginning to the end of the network. For any individual job, the head (succeeding)
event must bear a higher number than the tail (preceding) event.

Fulkerson has reduced this sequential numbering to the following routine;

1. Find the initial event and number it ‘1’ (An initial event is one which has arrows
emerging from it but none entering it).
2. Now delete all the arrows emerging from the already numbered event(s). This will
create at least one new initial event.

3. Number all the new initial events ‘2’, ‘3’ and so on till the final event is reached
(the final event is one which has no arrows emerging from it).

The complete sequential numbering system described above is inconvenient when

extra jobs have to be inserted. Extra jobs often mean extra events; when these events are
numbered, all the events following them must be renumbered. One way to overcome this
difficulty is to use tens only like 10 for the first event, 20 for the second event and so on.
The event numbering of the network diagram for the project below (Table 1) is shown in
figure 1.

Table 1. Lift Irrigation in the farm.

Activity
Sr. No Symbol Preceding activity Time (Days)
1. Site selection A ---- 7
2. Digging well B A 3
3. Laying field channels C B 15
4. Procurement of Pump D A 7
5. Installation of pump E D, B 3
6. Test run F C, E 2
 3
C
B
F
A Z
1 2 5 6
E
D

Step 6: Computing Earliest Start Time (EST) and Latest Start Time (LST)

The EST represents the time before which the activity cannot begin and
LST refers to the latest time by which the activity must begin. The EST and LST
are computed in two phases. The EST is calculated first in the forward pass
beginning from the start event. For the start event the EST is always set to zero
so that it can be scaled to any convenient calendar date at a later stage. The EST
at the last event is generally considered to be the project duration i.e. the
minimum time required for project completion. Therefore, EST and LST are equal
at the end event. LST for other events is then calculated through backward pass
starting from the end event. Steps involved in computation are listed below.

EST LST

Through forward pass Through backward pass

Calculation begins from start event Calculation stars from end event

Proceeds from left to right Proceeds from right to left

At start event EST is Zero At end event LST equals to EST

Adding the activity time to EST Subtracting the activity time from LST

At a merge event take maximum value At a burst event take minimum value

Example: Computation of EST

EST of an activity = EST of preceding activity + Activity duration
EST at start event 1 (for activity A) is Zero. To compute EST at event number 2, add 7 i.e.
the duration of activity A to zero. This is also the EST for both activities B and D starting
from event 2. Continuing, EST at event 3 is 10 i.e. (7+3). At event 4, being a merge event,
will have two estimates of EST (considering Dummy activity Z and activity D). It is 10 (10+0)
and 14 (7+7). In cases where there is more than one estimate the maximum the estimates
is considered. In this exercise maximum of 10 and 14 i.e. 14 is the EST at event 4. It is also
EST of activity E. EST for the network is computed figure 2 and table2 .

EST 10
3
C
B
1
A 3 5
0 7 25 F 27
1 2 Z 5 6
0 2
7
D
E
7
14 3
4

Figure 2. Computation of EST

Example: Computation of LST

LST of an activity = LST of succeeding activity – Activity duration
Computation of LST starts from the end event of the project and proceeds backward. At
the end event the LST is equal to the EST In this example at the event 6, the LST is equal to
the EST and it is 27. At event 5, the LST is 27-2=25. Similarly at event 4 it is 25-3=22. Event
3 being a burst event (i.e. more than one activity emanating from this event) will have two
estimates of LST and in such cases only the minimum value of the LST is considered.
Accordingly at event 3, the two estimates are 22-0=22 and 25-15=10. Minimum of these
two values 10 is the LST at event 3. Similarly at event 2 it is the minimum of 10-3=7 and
22-7=15 i.e. 7. Accordingly at event 1, LST is 7-7=0 which is equal to the EST at the start
event. Both the EST and LST values for the project activities are presented in figure 3 . and
table 2 .

Table 2. The EST and LST of activities

Event EST Event LST

No. No.

1 0 6 27
2 0+7 = 7 5 27-2 = 25
3 7+3 = 10 4 25-3= 22
4 Max. (7+7=14, 10+0=10) = 10 3 Min.(25-15=10,25-0=25) =10
5 Max. (10+15=25, 14+3=17) = 25 2 Min. (10-3=7, 22-7=15) = 15
6 25+2 = 27 1 7-7=0
 10
3
1
B C
3 1
0 A 7 2 F 2
1 2 z 0 6
5 2 2
0 7 7 2
D
E
7 14 3
4 2

Figure 3. The EST and LST of activities

Computation of the Earliest Finish Time (EFT) and the Latest Finish Time (LFT)
The EFT for each activity is calculated starting from the first activity, which

commences after the start event. It is given by

EFT of an activity + EST of preceding activity + activity duration.

The calculation of LFT starts from the last activity of the network or from the computed LST and
is given by,
LFT = Latest Starting Time (LST) of succeeding event

The various computed for the project is given in table 3.

Table 3. Computed times for the activities

Sl No Activity Duration EST LST EFT LFT

1 A 7 0 0 7 7
2 B 3 7 7 10 10
3 C 15 10 10 25 25
4 D 7 7 15 14 22
5 E 3 14 22 17 25
6 F 2 25 25 27 27

CHAPTER7: INVESTMENT DECISION

The investment decision is the most important when it comes to the creation of value. Capital
investment is the allocation of capital to investment proposals whose benefits are to be realized in
the future. The investment decision then determines the total amount of assets held by the firm,
the composition of these assets, and business-risk complexion of the firm as perceived by suppliers
of capital. Using an appropriate acceptance criterion or required rate of return is fundamental to
the investment decision. Because of the paramount and integrative importance of this issue, we
shall pay considerable attention to determine the appropriate required rate of return for an
investment project for a division of a company, for the company as a whole, and for a prospective
acquisition. In addition to selecting new investments, a firm must manage existing assets
efficiently.

Investment decision most commonly known as capital budgeting decision or long term assets mix
decisions. Capital budgeting is the most crucial financial decision for a firm, which includes
selection of an asset or investment proposal and whose benefits are likely to be available in future
over the lifetime of project. The assets can be either new or old. The first aspect of capital
budgeting is the choice of the assets among various alternatives available. The acceptance of assets
depends upon the benefits and returns associated with it.

Importance of capital budgeting

Capital budgeting is a process used to determine whether a firm’s proposed investments or

projects are worth undertaking or not. The process of allocating budget for fixed investment
opportunities is crucial because they are generally long lived and not easily reversed once they are
made.

So we can say that this is a strategic asset allocation process and management needs to use capital
budgetingtechniques to determine which project will yield more return over a period of time.

CAPITAL BUDGETING TECHNIQUES

These are:

• The Net Present Value (NPV)

• The Internal Rate of Return (IRR) also known as the yield on the investment
• Pay Back Period (PBP)

a) Future values/compound interest

Future value (FV) is the value in dollars at some point in the future of one or more investments.
FV consists of:

i) The original sum of money invested, and

ii) the return in the form of interest.

The general formula for computing Future Value is as follows:

FVn = Vo (l + r)n

where

Vo is the initial sum invested

r is the interest rate
n is the number of periods for which the investment is to receive interest.

Thus we can compute the future value of what Vo will accumulate to in n years when it is
compounded annually at the same rate of r by using the above formula.

Now attempt exercise 6.1.

Exercise 6.1 Future values/compound interest

i) What is the future value of $10 invested at 10% at the end of 1 year?
ii) What is the future value of $10 invested at 10% at the end of 5 years?

We can derive the Present Value (PV) by using the formula:

FVn = Vo(I + r)n

By denoting Vo by PV we obtain:

FVn = PV (I + r)n

by dividing both sides of the formula by (I + r)n we derive:

Rationale for the formula:

As you will see from the following exercise, given the alternative of earning 10% on his money,
an individual (or firm) should never offer (invest) more than $10.00 to obtain $11.00 with certainty
at the end of the year.
Now attempt exercise 6.2

Exercise 6.2 Present value

i) What is the present value of $11.00 at the end of one year?

ii) What is the PV of $16.10 at the end of 5 years?

b) Net present value (NPV)

Net Present Value measures the difference between present value of future cash inflows generated
by a project and cash outflows during a specific period of time. With a help of net present value
we can figure out an investment that is expected to generate positive cash flows.
In order to calculate net present value (NPV), we first estimate the expected future cash flows from
a project under consideration. The next step is to calculate the present value of these cash flows by
applying the discounted cash flow (DCF) valuation procedures. Once we have the estimated
figures then we will estimate NPV as the difference between present value of cash inflows and the
cost of investment.

The calculation of net present value is useful when a business has to identify a viable investment
[Link] calculation of NPV is based on expected future cash flows of a project. For
example, if cash flows occur at the beginning of the period, the first value should be added to the
NPV result, should not include in the values arguments.

NPV Formula: The NPV method is used for evaluating the desirability of investments or projects.

NPV=Present Value of Future Cash Inflows – Cash Outflows (Investment Cost)

where:

Ct = the net cash receipt at the end of year t

Io = the initial investment outlay
r = the discount rate/the required minimum rate of return on investment
n = the project/investment's duration in years.

Decision rule:
 (1) All projects (investment) with positive net present value should be accepted
because they add value to the firm as the PVof their cash inflows exceeds the
PV of the cash outflows;
(2) All project with negative NPV should be rejected because they reduce the
value of the firm as the PV of their cash inflows exceeds that of outlays
(3) The firm would be indifferent if NPV is zero. It simply the break-even point
and undertaking the investment would neither reduce nor increase the value of
the firm.

In summary: accept an investment if its NPV>0 and reject if its NPV<0

Exercise 6.3 Net present value

A firm intends to invest $10,000 in a project that may provide the following cash flow:

Year-1: Expected to generate $4,000 in the first year.

Year-2: Expected to generate $5,000 in the second year.

Year-3: Expected to generate $5,000 in the third year

Year-4: Expected to generate $2,000 in the fourth year.

Year-5: Expected to generate $2,000 in the fifth year

Should the firm go ahead with the project if the discount rate is 10%?

Year Expected Cash Discounted Cash Flow

Flow Value

Year – 1 $4,000 4,000/(1.1) to power of 1 = $3,636

Year – 2 $5,000 5,000/(1.21) to power of 2 = $4,132

Year – 3 $5,000 5,000/(1.331) to power of 3 = $3,756

Year – 4 $2,000 2,000/(1.464) to power of 4 = $1,366

Year – 5 $2,000 2,000/(1.610) to power of 5 = $1,242

Total NPV = $14,132 - $10,000 = $4,132

Advantage of the NPV technique

 1) The technique takes into account the time value of money by discounting the cash flows to
their present worth using an appropriate discount rate.
2) It also uses cash flow information, which is relevant for the overall objective of the firm,
wealth maximization. Therefore, decisions reached using the NPV are consistent with the
objective of the firm.
3) It gives an absolute value indicating what the investment would add to the overall value of
the firm in the real terms. It is not vague. It is also unique as non single investment can
have more than on value of NPV. It therefore provides a clear decision criterion.

Disadvantages of the NPV technique

The major disadvantage attributed to the NPV technique over time has been the difficulty in
actually determining it, arising out of the complexity of estimating cash flows and then computing
it, especially when long periods are involved. Regarding the complexity of estimating cash flows,
this problem is not unique to NPV alone. It affects all techniques that rely on cash flow information
to evaluate investments.

As regards the complexity in calculations, this problem has been significantly eclipsed by the
introduction of computer software that would provide the NPV of an investment very quickly if
the information were fed into the computer.

C. The internal rate of return (IRR)

Internal Rate of Return is another important technique used in Capital Budgeting Analysis to
access the viability of an investment proposal. This is considered to be most important alternative
to Net Present Value (NPV). IRR is “The Discount rate at which the costs of investment equal to
the benefits of the investment. Or in other words IRR is the Required Rate that equates the NPV
of an investment zero.

NPV and IRR methods will always result identical accept/reject decisions for independent projects.
The reason is that whenever NPV is positive, IRR must exceed Cost of Capital. However this is
not true in case of mutually exclusive projects.

wherer = IRR

IRR of an annuity:

where:
Q (n,r) is the discount factor
Io is the initial outlay
C is the uniform annual receipt (C1 = C2 =....= Cn).

Example:

What is the IRR of an equal annual income of $20 per annum which accrues for 7 years and costs
$120?

=6

From the tables = 4%

Economic rationale for IRR:

If IRR exceeds cost of capital, project is worthwhile, i.e. it is profitable to undertake. Now attempt
exercise 6.4

Exercise 6.4 Internal rate of return

Find the IRR of this project for a firm with a 20% cost of capital:

YEAR CASH FLOW

0 -10,000

1 8,000

2 6,000

a) Try 20%
b) Try 27%
c) Try 29%

The acceptance criteria: using the IRR decision rule, the investments are accepted or rejected by
comparing IRR with the Required Rate of Return (RRR) by the investor. The IRR by the investor
represents the minimum rate of return that should be earned in order to justify the commitment of
funds into the investment. It follows that projects with IRR that exceeds the RRR will be accepted.
They have positive NPV and hence increase the wealth of the firm.
Investments whose IRR is lower than the RRR are rejected. They have negative NPV and hence
reduce the wealth of the firm if accepted. In other words;
Accept investment if IRR>RRR and reject if IRR<RRR. It follows that under normal
circumstances, the NPV and IRR decision techniques should give the same and consistent signals
for the acceptance or rejection of an investment. An investment accepted by NPV should be
accepted by IRR and vice-versa. We shall later discuss conditions under which a conflict between
the two may rise.

Advantages of IRR

It has all the advantages earlier associated with the NPV. In addition, it has been argued that IRR
as a concept is easier to understand by investor. The higher the IRR from the investment as
compared to the required rate of return by the investor, the better the investment and vice-versa.
The proposition is attractive but we shall later argue that this relative measure of wealth could be
misleading.

Disadvantages of IRR
1) I it is relative measure of wealth and this could be misleading to the investor.
2) Some investment, especially those with outlays re-occuring mid-way in
their lives may have may have more than one IRR. When IRR is not unique,
then confusion arises as to which rate should be taken as the appropriate
IRR.
3) Like in (2) above, some investors may not have a rate that equates the
present value of benefits to those outlays.

The payback period (PP)

The CIMA defines payback as 'the time it takes the cash inflows from a capital investment project
to equal the cash outflows, usually expressed in years'. When deciding between two or more
competing projects, the usual decision is to accept the one with the shortest payback.

Payback is often used as a "first screening method". By this, we mean that when a capital
investment project is being considered, the first question to ask is: 'How long will it take to pay
back its cost?' The company might have a target payback, and so it would reject a capital project
unless its payback period was less than a certain number of years.

Example 1:
Years 0 1 2 3 4 5

Project A 1,000,000 250,000 250,000 250,000 250,000 250,000

For a project with equal annual receipts:

= 4 years

Example 2: when the cash flow are different

A firm intends to invest $10,000 in a project that may provide the following cash flow:

Year-1: Expected to generate $4,000 in the first year.

Year-2: Expected to generate $5,000 in the second year.

Year-3: Expected to generate $5,000 in the third year

Year-4: Expected to generate $2,000 in the fourth year.

Year-5: Expected to generate $2,000 in the fifth year

The payback period is calculated by adding the discounted amounts every year until you meet or
exceed the amount spend i.e. $10,000 in the example):

Year Discounted Cash Payback

Flow Value Amount

Year – 1 4,000/(1.1) to power of 1 = $3,636 $3,636

Year – 2 5,000/(1.21) to power of 2 = $4,132 $7,768

Year – 3 5,000/(1.331) to power of 3 = $3,756 $11,524

Year – 4 2,000/(1.464) to power of 4 = $1,366 $12,890

Year – 5 2,000/(1.610) to power of 5 = $1,242 $14,132

Total NPV = $14,132 - $10,000 = $4,132 Payback in 3 years

As seen in the above example, payback period is in year 3.
Disadvantages of the payback method:

It ignores the timing of cash flows within the payback period, the cash flows after the end of
payback period and therefore the total project return.

It ignores the time value of money. This means that it does not take into account the fact that $1
today is worth more than $1 in one year's time. An investor who has $1 today can either consume
it immediately or alternatively can invest it at the prevailing interest rate, say 30%, to get a return
of $1.30 in a year's time.

It is unable to distinguish between projects with the same payback period.

It may lead to excessive investment in short-term projects.

Advantages of the payback method:

Payback can be important: long payback means capital tied up and high investment risk. The
method also has the advantage that it involves a quick, simple calculation and an easily understood
concept.

TUTORIAL PROBLEMS AND WORKED OUT PROBLEMS

Simple Interest
Illustration: 1

If you invest Rs 10,000 (P0) in a bank at simple interest of 7% (i) per annum, what will
be the amount at the end of three (n) years?
Solution
Future Value, FVn = P0 + SI = P0 + P0(i)(n) = 10,000 + 10,000(0.07)(3) = 12,100
Illustration 2:
2,000 (P0) is deposited in a bank for two (n) years at simple interest of 6% (i). How
much will be the balance at the end of 2 years?
Solution

Required balance is given by

FVn = P0 + P0(i)(n) = 2,000 + 2000 (0.06)( 2) = 2,000 + 240 = ` 2,240.
Illustration 3:
Find the rate of interest if the amount owed after 6 (n) months is ` 1,050 (A), borrowed
amount being ` 1,000 (P0).
Solution
We know
 FVn = P0 + P0(i)(n)
i.e. 1,050 = 1,000 + 1,000(i)(6/12)
Or 1,050-1,000 = 500(i)

Therefore (i) = 50/500 = 0.10

i.e. (i) = 10%

Present Value
Illustration 4: What is the present value of Re. 1 to be received after 2 years compounded
annually at 10%?

Solution

Here FV n = 1, i = 0.1

PV= FV/(1+i)n
Required Present Value = FV n (1+i) −n
1/(1.1)2
FV n =1 /1.21
=0.8264 = Re. 0.83

Thus, Re. 0.83 shall grow to Re. 1 after 2 years at 10% compounded annually.

Discount (or) present value technique: -

Illustration 5: You have an opportunity to buy a debenture today and you will get back Rs,
1000 after one year. What will you be willing to pay for the debenture today if your time
performance for money is 10% per annum?
PV0= FVn /(1+i)n
PV0= 1000/(1+.10)=909.09
Present value Vo = Future value (Vn) x DFin

1000 x 0.90909
909.0900
Illustration8: Present Value Series of Payment
ILLUSTRATION6: Calculate present value of the following cash flows assuming a discount rate
of 10%

Year Cash flow

 1 5000

2 10000

3 10000

4 3000

5 2000

Solution

Year Cash Flow Present value Present value of

Factor (10%) cash flow

1 5000 0.909 4545

2 10000 0.8264 8264

3 10000 0.751 7510

4 3000 0.683 2049

5 2000 0.620 1240

Total present value of cash flow = 23604

Payback period
Illustration9
If the cash flows are equivalent, how the payback period is to be calculated?
The cost of the project is Rs.100,000. The annual earnings of the project is Rs.20,000.
Calculate the payback period.

Payback period = Average Annual Earnings / Initial Investment

= 100,000 / 20,000 = 5 years
It is obviously understood that, Rs.20,000 of annual earnings (cash inflows) requires 5 years
time period to get back the original volume of the investment.
Illustration10
If the cash flows are not equivalent, how the payback period is to be calculated?
The cost of the project is Rs.100,000. The annual earnings of the project are as follows

The ultimate aim of determining the cumulative cash inflows to find out how many number
o f years taken by the firm to recover the initial investment.

The next step under this method is to determine the cumulative cash flows

The uncollected portion of the investment is Rs,10,000. This Rs.10,000 is collected from the
4th year Net income / cash inflows of the enterprise. During the 4th year the total earnings
amounted Rs.20,000 but the amount required to recover is only Rs.10,000. For earning
Rs.20,000 one full year is required but the amount required to collect it back is amounted
Rs.10,000. How many months the firm may require to collect Rs.10,000 out of the entire
earnings Rs.20,000.
Payback period consists of two different components
Payback period for the major portion of the investment collection in full course - E.g.: 3 years

Payback period for the left /uncollected portion of the investment

For the second category 0.5 years
= 10000/20000 = 0.5 years
Total payback period= 3 Years +.5 year = 3.5 years
Illustration11

A project costs Rs.200,000 and yields and an annual cash inflow of Rs.40,000 for 7 years.
Calculate payback period
First step is identify the nature of the annual cash inflows
In this problem, the annual cash inflows are equivalent throughout life period of the project
Pay Back Period = 200,000/ 40,000 = 5years

Illustration12

Calculate the payback period for a project which requires a cash outlay of Rs.20,000 and
generates cash inflows of Rs 4,000 Rs.8,000 Rs. 6,000 and Rs. 4,000 in the first, second, third,
and fourth year respectively

First step is to identify the nature of the cash inflows

The cash inflows are not equivalent/constant

Cost of the project is to be recovered Rs.20,000. The project takes 3 full year‘s time period to
recover the major portion of the initial investment which amounted Rs.18,000 out of Rs.20,000

The remaining amount of the initial investment is recovered only during the fourth year.

The left portion Rs.2,000 has to be recovered only from the fourth year cash inflows of
Rs.4,000.

Pay Back Period = Pay Back period of the major portion + Pa y Back period of the remaining
portion
Pay Back period of the major portion = 3 years
Illustration13
A project cost Rs. 500000 and yield annually a profit Rs. 80000, after depreciation at 12% per
annum but before tax 50%. Calculate payback period.
Profit before tax = 80000
(-) before tax 50% (80000 x 50/100) = 40000
---------

40000
(+) 12% after dep (500000x 12/100) 60000

---------
Cash in flow 100000

----------
5000
ℎ 00

Payback period = = 5 years payback period

ℎ 100000
Improvement of Traditional Appraoch To Payback Period:
PPP

a) PPPI = × 100

Investment cost
b) Post payback profitability = Annual cash inflow (estimated life-payback period)

Illustration14
Calculate post payback profitability index. Initial outlay Rs. 50000, Annual cash flow(after tax
before depreciation) Rs. 10000, Estimated life 8 years.

5000
ℎ 0

Payback period = = = 5 yrs

ℎ 10000

Post payback profitability = 10000 (8-5) = 10000 x 3 = 30000

 PPPI =3000050000 x 100 = 60%

Discounted payback period

Illustration15
Calculate discounted payback period from the information given below.
Cost of project = Rs. 600000
Life of project = 5 years
Annual cash inflows Rs. 200000 for each year

Cutoff rate 10%

Years Cash inflow PV@10% Present Cumulative

Values cash in flow

1 200000 0.909 181800 181800

2 200000 0.826 165200 347000

3 200000 0.751 150200 497200

4 200000 0.683 136600 633800

5 200000 0.620 124000 757800

600000 - 497200
102800
136600 × 12

Discounted payback period = 3 yrs and 9 months

Illustration 16
From the following particulars, compute:
1. Payback period.

2. Post pay-back profitability and post pay-back profitability index. (a)

Cash Outflow Rs. 100,000

 Annual cash inflow Rs. 25,000
(After tax before depreciation)
Estimate Life 6 years

(b) Cash Outflow Rs. 100,000

Annual cash inflow
(After tax depreciation)
First five Years Rs. 20,000
Next five Years Rs. 8,000

Estimated Life 10 Years

Salvage Value Rs. 16,000

Solution

(a) (i) Pay-back period

Initial investment/ Annual cash inflows

100,000/ 25,000
= 4 Years
(ii) Post pay-back profitability

=Cash inflow (Estimated life – Pay-back period)

=25,000 (6 – 4)
=Rs. 50,000 (iii) Post
pay-back profitability index

50,000/10
00,000*10
0
50%
=

Illustration 17
A company has two alternative proposals. The details are as follows:
Proposal I Proposal II

Automatic Machine Ordinary Machine

Cost of the machine Rs. 220,000 Rs. 60,000

 Estimated life 5½ years 8 years

Estimated sales p.a. Rs. 150,000 Rs. 150,000

Costs : Material 50,000 50,000

Labour cost 12,000 60,000

Variable Overheads 24,000 20,000

Compute the profitability of the proposals under the return on investment method.

Solution
Profitability Statement
Automatic Ordinary
Machine Machine
Cost of the machine Rs. 220,000 Rs. 60,000

Life of the machine 5½ years 8 years

Rs. Rs.
Estimated Sales (A) 150,000 150,000

Less : Cost : Material 50,000 50,000

Labour 12,000 60,000

Variable overheads 24,000 20,000

Depreciation (1) 40,000 7,500
Total Cost (B) 126,000 137,500

Profit (A) – (B) 24,000 12,500

Working:
(1) Depreciation = Cost ÷ Life

Automatic machine = 220,000 ÷ 5½ = 40,000

Ordinary machine = 60,000 ÷ 8 = 7,500
Average profit

Return on investment = Original investment

× 100
24,000/220,000*100= 10.9%
Automatic machine 12,500/60,000*100= 20.8%
10.9% < 20.8% Ordinary Machine is more profitable than the automatic
machine.

Average Rate of Return method (ARR)

Illustration 18

Calculate the average rate of return for Projects X and Y from the following

If the required rate of return is 10% which project should be undertaken?

Average Rate of Return = Average Annual Income /original investment X100

The first step is to find out the average annual income of the two different projects X and Y

Average Annual Income Total income throughout the Project / Life of the Project

Average Annual Income (Project X) = Rs. 12,000 / 4 years = Rs. 3,000

 Average Annual Income (Project Y) = Rs. 20,000 / 5 years = Rs. 4,000

The next step is to find out the Average rate of return:

Average rate of return (Project X) = Rs. 3,000 / Rs.40,000 X100 =7.5%

Average rate of return (Project Y) = Rs.4,000/ Rs. 60,000 X 100 = 6.66%

Both the projects are lesser than the given required rate of return. These two projects are not
advisable to invest only due to lesser accounting rate of return.

Investment and depreciation

Illustration20

Given the Solow model

▪ Consumption function: c = (1–s)y

(per worker)
▪ saving (per worker) = y – c
▪ = y – (1–s)y
▪ National income identity is y = c + i
▪ Investment is I= Y-C
▪  = the rate of depreciation
▪ = the fraction of the capital stock that wears out each period
▪ The basic idea:
▪ Investment makes
the capital stock bigger,
▪ depreciation makes it smaller
▪ Change in capital stock = investment – depreciation
▪ k = i – k
▪ k = s f(k) – k
Assume:

▪ s = 0.3
▪  = 0.1
 ▪ initial value of k = 4.0
y = f (k ) = k 1 / 2

Approaching the Steady State:

A Numerical Example

Year k y c i dk k

1 4.000 2.000 1.400 0.600 0.400 0.200

2 4.200 2.049 1.435 0.615 0.420 0.195

3 4.395 2.096 1.467 0.629 0.440 0.189

As
4 4.584 2.141 1.499 0.642 0.458 0.184

10 5.602 2.367 1.657 0.710 0.560 0.150

25 7.351 2.706 1.894 0.812 0.732 0.080

100 8.962 2.994 2.096 0.898 0.896 0.002

¥ 9.000 3.000 2.100 0.900 0.900 0.000

Net present value method

(NPV) Illustration 21

Calculate the NPV of 2 projects and suggest which of 2 projects should be accepted assuming
a discount rate 10%

Particular Project X‘ Project Y‘

Initial investment 20000 30000

Estimate life 5 yrs 5 yrs

Scrap value 1000 2000

75
The profit before dep. & Tax, cash flows are as follows

Year 1 2 3 4 5

Project X 5000 10000 10000 3000 2000

Project Y 20000 10000 5000 3000 2000

Solution

Project ‘X’

[Link]. Cash inflow PV @ 10% PV of cash inflows

1 5000 0.909 4545

2 10000 0.826 8260

3 10000 0.751 7510

4 3000 0.683 2049

5 2000 0.620 1240

6 1000 (scrap value) 0.620 620

76
 Total PV of cash in 24224
Flows

NPV = PV cash of inflow- PV of cash outflows =

24224 - 20000 NPV = 4224

Project Y

[Link]. Cash in flow PV@ 10% PV of cash inflows

1 20000 0.909 18180

2 10000 0.826 8260

3 5000 0.751 3755

4 3000 0.683 2049

5 2000 0.620 1240

6 2000 (scrap value) 0.620 1240

Total PV of cash 34724

Inflows

77
NPV = PV of cash inflow - PV of cash outflows
NPV = 34724 – 30000

NPV = 4724
Comment:

NPV of project y is higher than the NPV of project x. Hence, it is suggested that project y
should be selected.

Illustration22
A company is considering investment in a project that cost Rs. 200,000 the project has an
expected life of 5 years and zero solvage (scrap) value. The company uses straight line method
of depreciation (40,000), Tax Rate is 40%

Year Earning before dept & PV @

Tax 10%

1 70000 .909

2 80000 .826

3 120000 .751

4 90000 .683

5 60000 .620

You are require to calculate the Net present value @ 10 % and advice the company
Solution

78
Year Earnings Dept Earning Tax Earning +(Dept) Cash
Year Before after Tax in flow
before Tax

Tax

1 70000 40000 30000 12000 18000 58000

2 80000 40000 40000 16000 24000 64000

3 120000 40000 80000 32000 48000 88000

4 90000 40000 50000 20000 30000 70000

5 60000 40000 20000 8000 12000 52000

Total cash Inflow 332000

[Link]. Cash in flow PV @ 10% PV of cash inflow

79
 1 58000 0.909 52722

2 64000 0.826 52864

3 88000 0.751 66088

4 70000 0.683 47810

5 52000 0.620 32240

Total PV of cash in 251724

Flow

NPV = PV of cash inflow – PV of cash outflow

251724 – 200000

51724

Profitability Index Method (or) Benefit cost Ratio: -

ILLUSTRATION23
Initial cash outlay of a project Rs. 50000, cash flows 20000, 15000, 25000, 10000 for 4 years
Rate of Discount 10% calculate Profitability index
Illustration24

Year Cash in flow Discount Rate PV cash in

10% flow

80
 1 20000 0.909 18180

2 15000 0.826 12390

3 25000 0.751 18775

4 10000 0.683 6830

PV of cash inflow 56175

PI (Gross) = present value of cash inflows

Present value of cash outflows/ Initial Investment

56175/50000=1.1235

PI (net) = NPV (Net Present Value)

Initial investment

6175/
50000

= 0.1235

81
Internal Rate of Return Method (IRR)

Illustration

Initial outlay Rs. 50000, life of an asset 5 years Annual cash flow Rs. 12500, Calculate IRR

5000
Initial
outlay 0

Present value Factor = Annual = =4

cash
flow 12500

Present value of annuity table 8 % approximately

IRR=8%
Illustration

When the annual cash flows over the life of the asset

Initial investment Rs. 60000, Life of the Assets 4 years

1st year - 15000

2nd year – 20000
3rd year – 30000
4th year -20000
Calculate the IRR

Discount 10% 12% 14% 15%

Year Annual PVF P PVF P PVF P. PVF P

82
 cash value value VALUE Value
time

1 15000 .909 13635 .892 13380 .877 13155 .869 13055

2 20000 .826 16520 .797 15940 .769 15380 .756 15120

3 30000 .751 22530 .711 21330 .674 20220 .657 19710

4 20000 .683 13660 .635 12700 .592 11840 .571 11420

66345 63350 60595 59285

Workings:
15% = 715= (60000 – 59285)
14% = 595 =(60595 – 60000)

14+ 595/715+595(15-14)
14+0.45 (1)
IRR = 14.45 %

83