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UNIT -II capital budgeting.pptx my college
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- 2. CAPITAL BUDGETING PROCESS •Capital budgeting is the process of evaluating(checking) and selecting long-term investment projects or capital expenditures (funds used by a company to acquire, upgrade, and maintain physical assets such as property, plants, buildings, technology, or equipment). • It involves analyzing the potential profitability of projects (the amount of financial gain it could generate if all costs are considered) to determine which ones are worth pursuing and allocating financial resources accordingly. • Capital budgeting decisions are important for businesses as they involve significant financial commitments(A financial commitment is a promise to pay for certain expenses, either in the present or in the future. It can also refer to the amount of money that is commited to be spent over a period of time) and can impact the company's future growth and profitability.
- 3. CAPITAL BUDGETING PROCESS •Capital budgeting involves making long-term investment decisions that affect financial results over many years. • It is the process of evaluating projects that require large cash outlays. Key steps include calculating the net investment amount, which is cash outflows minus inflows, and determining the payback period to evaluate whether the investment will be recouped in a reasonable time period. • The document provides examples of how to calculate net investment amounts and payback periods for various capital budgeting scenarios that involve assets with different costs, depreciation(the decrease in the value of assets) methods, and tax implications.
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- 5. CAPITAL BUDGETING PROCESS •Planning: The planning phase involves investment strategy(Techniques) and the generation(where to get) and first screening(view) of project proposals. The investment strategy offers the framework that shapes, guides the of individual project opportunities. • Analysis: If the preliminary screening proposes that the project is worth(good) investing, a detailed analysis of the marketing, technical, financial, economic, and ecological aspects is conducted. • Selection: The selection process, the matter whether the project worth investing. Several criteria has been seen and advised to judge the value of a project. There are two general categories. • Non-Discounting criteria. • Discounting criteria.
- 6. CAPITAL BUDGETING PROCESS 4.Financing: After choosing a project, proper financing must be made. Equity and debt are two major sources of Finance for a project. Equity and debt are two ways to raise money for a business. Equity is when a company sells a portion of its ownership in exchange for capital. Debt is when a company borrows money from a lender or investor. Flexibility, risk, income, control and taxes are the vital business considerations that influence the capital structure decision and the choice of specific instruments of Financing. 5. Implementation: The implementation phase for an industrial project, which involves the establishing manufacturing facilities has several stages: • I. Project and engineering designs • II. Negotiations and contracting • III. Construction • IV. Training • V. Plant commissioning
- 7. 6. Review: Oncethe project is commissioned, a review phase has to be done. Performance review should be done occasionally to compare the actual performance with the projected performance. In this stage, feedback is beneficial in several ways: • I. It focuses on realistic assumptions. (socha hua, something that you accept is true even though you have no proof). • II. It provides experience, which will be valuable in future decision making. • III. It recommends corrective action. • IV. It promotes the need for caution among project sponsors.
- 8. GENERATION AND SCREENINGOF PROJECT IDEAS • Generation and Screening of a project idea begins when someone with specialized knowledge or expertise or some other competence feels that he can offer a product or service • Which can cater to a presently unmet need and demand • To serve a market where demand exceeds supply • Which can effectively compete with similar products or services due to its better quality/price etc. • An organization has to identify investment opportunities which are feasible and promising before taking a full fledged(an analysis that is completely developed or trained) project analysis to know which projects merit further examination and appraisal.
- 9. Tasks involved inGeneration and Screening of a project idea
- 10. 1) Generation ofideas – • A panel is formed for the purpose of identifying investment opportunities. • It involves the following tasks which must be carried out in order to come up with a creative idea – • (a) SWOT analysis –a framework for identifying and analyzing an organization's strengths, weaknesses, opportunities and threats. Identifying opportunities that can be profitably exploited. • (b) Determination of objectives – Setting up operational objectives like cost reduction, productivity improvement, increase in capacity utilization, improvement in contribution margin(shows how much additional revenue is generated by making each additional unit of a product after the company has reached the breakeven point)(the point at which a business's total costs and total revenue are equal. This means that the business is neither making a profit nor incurring a loss)). • (c) Creating Good environment – A good organizational atmosphere motivates employees to be more creative and encourages techniques like brainstorming, group discussion etc. which results in development of creative and innovative ideas.
- 11. 2) Monitoring theEnvironment – • An Organization should systematically monitor the environment and assess its competitive abilities in order to profitably exploit opportunities present in the environment. The key sectors of the environment that are to be studied are :- • (a) Economic Sector – • State of economy • Overall rate of Growth • Growth of primary, secondary and tertiary sectors • Inflation rate(the rate of increase in prices over a given period of time). • Linkage with world economy • BOP situation(The balance of payments (BOP) :-The BOP shows how much money is moving in and out of a country • Trade Surplus/Deficit (A "trade surplus" means a country exports more goods and services than it imports, resulting in a positive trade balance, while a "trade deficit" means a country imports more goods and services than it exports, leading to a negative trade balance)
- 12. (b) Government Sector– • Industrial policy • Government programmes and projects • Tax framework • Subsidies, incentives, concessions • Import and export policies • Financing norms • (c) Technological Sector – • State of technology • Emergence of new technology • Receptiveness of the industry(Receptiveness of the industry" means the extent to which a particular industry is open to accepting and embracing new ideas, concepts, or changes)
- 13. • (d) Socio-demographicsector – • Population trends • Income distribution • Educational profile • Employment of women • Attitude towards consumption and investment • (e) Competition Sector – • No. of firms and their market share • Degree of homogeneity and production differentiation(Homogeneous product refers to a product of which all units are identical in all respects. Product differentiation is a situation when different producers in the market try to differentiate their product with respect to size weight packaging • Entry barriers • Marketing policies and prices • Comparison with substitutes in terms of quality/price/appeal etc. • (f) Supplier Sector – Availability and cost of raw material, energy and money
- 14. 3) Corporate Appraisal •It involves identification of corporate strengths and weaknesses. The important aspects that are to be considered are:- • (a) Market and Distribution – • Market Image • Market share • Marketing and Distribution cost • Product line • Distribution Network • Customer loyalty
- 15. • (b) Productionand Operations – • Condition and capacity of plant and machinery • Availability of raw materials and power • Degree of vertical integration • Location advantage • Cost structure – Fixed and Variable costs • (c) Research and Development – • Research capabilities of a firm • Track record of new product developments • Laboratories and testing facilities • Coordination between research and other departments of the organization
- 16. • d) CorporateResources and Personnel – • Corporate Image • Clout with government and regulatory agencies • Dynamism of top management • Competence and commitment of employees • State of industrial relations • (e) Finance and Accounting – • Financial leverage and borrowing capacity • Cost of capital • Tax situation • Relations with shareholders and creditors • Accounting and control system • Cash flows and liquidity
- 17. (4) Looking forProject Ideas • Various sources to look for good project ideas include:- • Trade fairs and exhibitions • Studying Government plans and guidelines • Suggestion of financial institutions and development agencies • Investigating local materials and resources • Analyzing performance of existing industries • Analyzing social and economic trends • Analyzing new technological developments • Studying the consumption pattern of people abroad • Stimulating creativity to produce new ideas • Reducing exports and imports
- 18. (5) Preliminary Screening– • It refers to elimination of project ideas which are not promising. The factors to be considered while screening for ideas are:- • ♦ Compatibility with the promoter – The idea must be consistent with the interest, personality and resources of entrepreneur(a person who makes money by starting or running businesses, especially when this involves taking financial risks). • ♦ Consistency with Government priorities – The idea must be feasible with national goals and government regulations. • ♦ Availability of inputs – Availability of power, raw material, capital requirements, technology. • ♦ Adequacy of Market – Growth in market, prospect of adequate sale, reasonable Return on Investment. • ♦ Reasonableness of cost – The project must be able to make reasonable profits with respect to the costs involved. • ♦ Acceptability of risk level – The desirability of the project also depends upon risks involved in executing it. In order to access risk the following factors must be considered:- • -Project`s vulnerability( a weakness or flaw within a project that could potentially be exploited, causing negative consequences or harm to the project's goals, due to design issues, implementation errors, or external factors, leaving it susceptible to adverse effects or disruptions) to business cycles. • -Change technology • -Competition from substitutes • -Government`s control over price and distribution • -Competition from imports
- 19. (6) Project RatingIndex • It is a tool used for evaluating large number of project ideas. It helps in streamlining the process of preliminary screening. Hence a preliminary evaluation may be converted in project rating index. • Steps to calculate project rating index. • I. Identifying the factors relevant for project rating • II. Assigning weights to these factors according to their relative importance(FW) • III. Rate the project proposal on various factors using suitable rating scale (FR) • (5 point scale or 7 point scale) • IV. For each factor multiply the factor rating with factor weight to get factor scores • (FR X FW = FS) • V. All the factor scores are added to get the overall project rating index. • Organization determines a cut off value and the project below this cut off value are rejected.
- 20. 7) Sources ofthe Net Present Value • In order to select a profitable and feasible project, a project manager must carry out a fundamental analysis of the product and factor market to know about entry barriers which lead to positive net present value. There are six entry barriers which result in a positive NPV project. They are – • Economies of scale • Product differentiation • Cost advantage • Marketing reach • Technological edge • Government policy
- 21. (8)Entrepreneurial skills • Anindividual must possess the following traits and qualities in order to be a successful entrepreneur • He must be Willing to make sacrifices • He must be a good Leader • He must be able to make quick and rational decisions • He must have confidence in the project • He must able to exploit market opportunities • He must have strong ego in order to survive ups and downs of a business
- 22. Market and Demandanalysis • Market and demand Analysis is conducted to know about the aggregate demand for the product or service and the market share that the proposed project will enjoy. • Market and demand Analysis involves the following activities : – • (A) Situational analysis and specification of objectives. • (B) Collection of secondary information • (C) Conduct of Market Survey . • D) Characterization of Market. • (E) Demand forecasting • (F) Market Planning
- 23. (A) Situational analysisand specification of objectives • Situational analysis :- • (a) The preferences and purchasing power of customer • (b) Action and strategies of the competitors • (c) Practices of middle man • Specification of objectives helps the organization to move towards a particular direction. The objectives to be focused on are: • (a) Potential buyer • (b) Total demand • (c) Break up of demand • (d) Type of distribution channel • (e) Prices and warranties
- 24. (B) Collection ofsecondary information • Secondary data is available in the market. It is not conducted by researcher himself. A researcher may use the following sources :- • Census survey • National sample survey reports • 5 years plans • India year book • Economic survey reports • Political survey reports • Annual survey of industries • Annual bulletin of export and import • Stock exchange directory • Monthly bulletins of RBI • Publications of advertising agencies • Industry potential surveys
- 25. (C) Conduct ofMarket Survey • The market for the product or service is described in terms of the following factors based on the information collected through market surveys and secondary sources. These factors are :- • Effective demand in the past/present and future • Breakdown of demand • Methods of distribution and sales promotion • Types of consumer • Listing of supply and competition • Government policies • Price
- 26. (D) Characterization ofMarket These factors are :- • Effective demand in the past/present and future • Breakdown of demand • Methods of distribution and sales promotion • Types of consumer • Listing of supply and competition • Government policies • Price
- 27. (E) Demand forecasting •(E) Demand forecasting → • It refers to estimation of future demand for a product or service. Forecasting methods may be broadly divided into three categories :- • Qualitative methods, • Time series projection methods and • causal methods :- • Qualitative Methods → • (i) Jury of executive opinion method → a forecasting method where a group of high-level experts or managers within a company collectively make predictions about the future. • Advantages • It considers a variety of factors • Cheap method for developing demand forecasting • Disadvantages • The managers may be bias (against one group of people) • The reliability of the technique is always in question(the ability of the test to be repeated and yield and get same results)
- 28. • (ii) DelphiMethod → Researchers are collecting the thoughts answer of a group of specialists on a particular topic by sending them a question through the mail, allowing them to respond at their own place and convenience, rather than gathering them in person for a discussion. • Steps • (a) A Group of experts are sent questionns and asked to express their views. • (b) The responses received are summarized and another question based on this response is sent back, not revealing( not disclosing) the identity of the experts. • (c) The process is continued till a reasonable agreement comes.
- 29. • (iii) Timeseries Projection Method → It involves analysis of historical time series. • (i) Trend Projection Method → It works on a linear relationship Yt = a + bt Where Yt = demand for a year t = time variable a = intercept of relationship b = slope of relationship
- 30. • i) Exponentialsmoothing method → In this method forecasts are modified in the light of observed errors using relationship – • Ft + 1 = Ft + d et • Where Ft + 1 = forecast for the year t+1 • d = smoothing parameter • et = is the error in the forecast for the year t • (iii) Moving Average Method → In this method forecast for next period is equal to the average of sales in several preceeding(previous) years.
- 31. Casual Method • Ituses the phenomenon of change in one parameter due to the change in another parameter to develop a cause effect relationship. • (i) Chain Ratio Method – Under this method the potential sales of a product may be estimated by applying a series of factors to a measure of aggregate demand. It uses a simple analytical approach for estimating demand. Its reliability depends upon the ratio and rates used in the process, one ratio leads to another. • (ii) Consumption level Method – It is used for products which are directly consumed. Consumption level is estimated on the basis of elasticity co-efficient for a product. • (iii) End user Method – It is suitable to estimate demand of intermediate products and it involves following steps – • Identifying the possible uses of product • Identifying the consumption co-efficient of the product for various uses. • Projecting the output level for consuming industries • Deriving the demand for the product.
- 32. • (iv) Bassdiffusion Method – It was developed by Frank Bass . Under this method sales is estimated OTB of – • p = co-efficient of innovation • (Probability of people to buy the product because it is innovative) • q = co-efficient of imitation • (Probability of people to buy the product as others have bought it) • The two main question that an analyst has to answer are : Is the product innovative? and Are people buying the product? • (v) Leading indicator method – There are Leading variables which change ahead of other variables called lagging variables. For e.g. Change in level of urbanization used to predict change in demand for cars. • • (vi) Econometric method – It involves estimating quantitative relationships derived from economic theory.
- 33. (F) Market Planning •For the market planning it should cover all aspects related to product, price, place and promotion. It involves the following steps:- •
- 34. Market planning andmarket research process in project management • In project management, • Market planning:-the process of selecting a project's target market, identifying their needs and desires, and developing strategies to reach them. Market research:-is the systematic collection and analysis of data about that market for planning , allowing for a good project approach that will satisfy the customer need and market trends.
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- 37. Technical analysis (TA)in project management • Technical analysis (TA) in project management is the use of data, patterns, and indicators to analyze the past and predict the future of a project. It can help identify risks, optimize outcomes, and make better decisions. • Technical analysis of a project is concerned primarily with: • 1. Material Inputs and Utilities • 2. Manufacturing Process/Technology • 3. Product Mix • 4. Plant Capacity • 5. Location and Site Development • 6. Machineries and equipment • 7. Structures and Civil works • 8. Projects Charts and Layouts Technical Analysis of a Project
- 38. 1) Material input& utilities • 1) Material input & utilities – • It involves defining the requirements for materials and utilities, specifying their properties and setting up a supply channel. • Material input & utilities may be classified into the following: Raw materials – Agricultural products, Mineral Products, Livestock, Forest Products, Marine Products Processed Industrial Materials/Components – Base metals, semi-processed materials, manufactured parts, small component. • Auxiliary materials and factory supplies – chemicals, additives, packaging material, paint, oil, grease, cleaning materials • Utilities – power, water, steam, fuel. • The following must be kept in mind while taking decisions regarding material, inputs and utilities: • 1. Physical properties of the material • 2. Transportation, Handling and Storage costs • 3. Quantity available from Domestic/Foreign sources. • 4. Past and future trends in prices
- 39. (2) Manufacturing process/Technology •It is one of the most important decisions in technical analysis of a project. It is the task of the project manager to select that process or technology that is easy to acquire, use, appropriate for the project and feasible(go) with budget and technical requirements of the proposed project. • The choice of technology is influenced by the following considerations: • Plant Capacity • Material Inputs • Production cost • Product mix • Technological Obsolescence.(when a technology becomes less useful or desirable because newer technology is available). • Ease of adoption
- 40. (3) Product MixAND ((4) Plant capacity (3) Product Mix:- It is essential to choose an effective product mix as different customers have different taste, preferences and needs. The choice of product mix is usually guided by market requirements. A project manager must keepin mind the quality of products and flexibility in production while taking product mix decisions. • (4) Plant capacity –It refers to the volume or no. of units that can be manufactured during given time period. It is also known as production capacity. It is the task of the project manager to determine the feasible normal capacity and nominal maximum capacity for the project. • Feasible Normal Capacity – It refers to the capacity attainable under normal working condition. It is calculated keeping in mind the following factors: • Installed capacity (machinery and equipment) • Technical conditions of the plan • Normal stoppages • Holidays, shift patterns • Downtime for maintenance etc.
- 41. • The feasiblenormal capacity is the actual production capacity of a plant and usually depends upon the • following factors: • Technical Requirements • Input Constraints • Cost of Investment • Market Conditions • Resources of the company • Government policy • Nominal Maximum Capacity – It refers to capacity that is technically obtainable through use of machines. • It is usually the capacity guaranteed by the supplier of machinery.
- 42. (5) Location &Site • – Location refers to a area within the city and while site means a specific piece of land where project would be set-up. For the purpose of site selection a assessment of the demand, size of plant and input requirements is conducted which involves examining the following • factors: • Land to Markets distance • Availability of raw materials • Availability of Labour • Existing Infrastructure i.e. roads, electricity, power, water supply • Cost of land • Government Policies • Miscellaneous other factors like • Climatic conditions • General living conditions • Proximity to auxiliary inputs / units • Ease of Waste disposal and dumping
- 43. (6) Machinery &Equipment Machinery and Equipment requirement depends upon the production technology and plant capacity of the proposed project. While conducting a technical analysis of a project the following steps must be used to select machinery and equipment: • Steps to select machinery and equipment for a project- • Estimate levels of production over time • Define various machining and operations • Calculate machine hours required for each type of operations • Select equipment and machinery for each function • Types of Machinery and equipment – • 1. Plant equipment (process) • 2. Mechanical equipment • 3. Electrical equipment • 4. Instruments • 5. Controls and Internal Transportation System • 6. Spare parts and Tools
- 44. (7) Structure andCivil Works • Technical analysis of a project for buildings, structures and civil works involves preparation and development of site which includes: • grading and leveling of land, demolition of existing structures, relocation of pipeline, cables, roads, reclamation of sewers and drainage connections for utilities , arranging for electricity, water etc. • Buildings & structures – It involves construction of • factory buildings, ancillary buildings, administrative area, residential quarters, non factory buildings – cafe, medical center • Outdoor works – It involves • supply & distribution of utilities, handling and treatment of emission, wastes, outdoor lighting, transportation, boundary, fence, barriers, gates, doors, security posts • Environment Aspect – • The project must comply with all environmental rules and regulations • All waste must be disposed-off properly • Eco-friendly standards must be adopted in the production process
- 45. (8)Projects Charts andLayouts Technical Analysis of a Project Once the project manager has sufficient data related to market size, plant capacity, production technology, machinery and equipment, buildings etc. He prepares charts and layouts for the proposed project. Project charts and layouts help to complete project efficiently. • The efficiency of a manufacturing operation also depends on the layout of the plant and machinery. • A well-designed plant layout can help cut down on manufacturing expenses by saving both money and time. • Plant layout involves organizing the machines, equipment, and other physical facilities on the factory premises. • It can be described as a method of strategically placing machines, processes, and plant services within the factory to achieve the highest possible production of top-notch quality goods at the lowest possible total cost of production”. • When planning the design, it’s important to take into account the following factors: • Nature of industry • Volume of production • Type of product d) Location • Material Handling • Type of equipment • Factory building • Service facilities • Lighting and ventilation