3. Ram Setu
It is a bridge, built by Rama's army of
monkeys across the sea, under the leadership
of Hanuman
and
Under the engineering supervision of Nal.
Nal, the engineer, was also a monkey !
He was the son of 'Visvakarma', the engineer
of Gods in the heaven.
4. DEFINITIONS
According to Harrison, “ Project is a non
routine, non repetitive, one-off undertaking,
with well defined time, financial and technical
performance goal;”
According to Project Management Institute
(PMI), “Project can be defined as a temporary
endeavor undertaken to accomplish a unique
objective at goal.”
5. CHARACTERISTICS OF PROJECT
Objectivity or temporariness
Uniqueness (Non-routine activity)
Multidisciplinary (Demands team work)
Involve focused Resources
Life cycle with definite time limit
Risk and uncertainty
Change (In response to environment)
6. TYPES OF PROJECTS
Construction projects
Research projects
Reengineering projects
Procurement projects
Business implementation projects
Miscellaneous types
7. Project vis-à-vis Normal Business
Operation
Projects have a start, a middle and an end making them
different from operational activities which are performed
regularly over time
The temporary nature of projects stands in contrast with
normal business operations, which are repetitive,
permanent, or semi-permanent functional activities to
produce products or services.
It is typically created once, it is temporary, and it is
specific.
8. 8
Projects versus Operations
Projects
Performed by people
Constrained by limited
resources
Planned, executed and
controlled
Temporary
Unique
Operations
Performed by people
Constrained by limited
resources
Planned, executed and
controlled
Ongoing
Repetitive
9. Five functions of Project
There are five functions of project based
management:
Organisation, scope,
And
Quality , Cost and Time.
These are an enhanced version of the traditional
quality, cost and time model adding the
organisational context and the scope of the
project.
A project also consumes resources (whether people, cash,
materials, or time), and it has funding limits.
10. Project Organizations
A project organization is a temporary thing. It will only exist
from the projects start until its end. Organization structures are
Functional Organization.
This is most suited where
- Solution of technical problems is important.
- Integration of different functional units’ work is not necessary.
- Stable environment.
-Success depends on application of narrow technical know-how.
Project Organization
This is most suited when
- A small, self-sufficient and full-time team is required where the team
leader is like an entrepreneur. Leader has full responsibility over the
project.
- Functional units are stable, provide support to project teams.
Matrix Organization
This is a hybrid form that combines both characteristics of
functional and project organization forms.
11. What is Project Scope ?
The project scope is the definition of what the project
is supposed to accomplish and the budget (of time
and money) that has been created to achieve these
objectives.
It is absolutely imperative that any change to the
scope of the project have a matching change in
budget, either time or resources.
12. IDEA GENERATION
OR
IDENTIFICATION OF INVESTMENT OPPORTUNITIES
Idea generation is the process of grouping logical thoughts
based on either
Significant technological breakthrough,
Or
Combining existing fields of technology or offerings which
can cater to a presently unmet need or to serve a market where
demand exceeds supply through better quality or lower prices.
13. IMPORTANCE
OF
IDEA GENERATION
Important for continuous growth of
organization.
Survival in the competitive market.
Contribution towards development of society.
14. New Concept Ideation 14
Generate high impact ideas
for high-impact problems/opportunities
Convert best ideas into
high impact projects
Profitable
Growth
Ideation
Convert best projects into
high impact products
Idea
Prioritization
Project
Management
Identify high impact
problems/opportunities
Voice of
the
Customer
Integrate with
the business
objectives
Ideation Journey
15. New Concept Ideation 15
Ideation
Input Ideas:
• Many
• Crazy
• Stupid
• Bad
• Random
Output Ideas:
• Few
• New
• Different
• Good
• Out-of-the-box
Project
Management
Ideation is a
formal,
structured
process
Output ideas
ready to start
development
projects.
Transform
Inputs to
Outputs
Transform
Inputs to
Outputs
What is
Ideation?
16. To Handle Ideation Challenge
The Stage-Gate model enables detailed project
portfolios control through
Gradual budget allocation
Prioritization of resources
Project Risk Management
... because bad projects are hard to
Eliminate!
Why
you
need
Tool
Benefits
Process
16
17. A Typical Stage-Gate concept
applied to a Development
IDEAS MARKET
Technology Development Product Development
Idea Concept Application Stages
Gates
How
to
Tool
Challenge
Benefits
17
18. 18
Four Goals of an Ideation Process:
To stimulate large improvements in -
1. Quality and volume of new ideas,
- (More good ideas per minute.)
2. Idea-to-project hit-rate,
- (More good ideas end up in products).
3. Cross-linking of ideas to create new opportunities,
- (Generate many new ideas in parallel – feed off each other.)
4. Visibility of plans, activities, results, and methods,
- (Target Low hanging fruits. Visibility in improvements is
a motivator by itself)
Need systematic idea
generation and prioritization
processes.
Need systematic idea
generation and
prioritization processes.
19. Screening of Project Alternatives
Preliminary Screening:
Compatibility with the Promoters
It matches with the abilities of the promoter
It is accessible to him
It offers him the prospect of high return
Consistency with Government Priorities
The project idea must be feasible given the given national
goals and government regulatory framework.
Availability of inputs
Capital requirement and other technical material requirements
are within the manageable limits.
20. Screening……
Adequacy of the Market
The size of the present market should be adequate with
reasonable potential for growth
Reasonableness of Cost
Cost structure of the proposed project should be such as to
generate acceptable profit with the expected price.
Acceptability of Risk level
Associated risk quotient from technological changes or from
substitutes should be reasonable.
21. Streamlining the process of
Preliminary Screening
Translated into a project rating index,
Using suitable project rating factors
Building weightage for each factors to indicate relative
importance
5 point rating scale is used to rate each factors
Factor scores are derived through multiplications
Finally the factor scores are added to get the total score
(project rating index) for each project.
22. Example of a Project Rating
Index
Factor Factor
weight
Ratings Total
Score
5 4 3 2 1
Entrepreneur’s vision and
firm’s strength
0.25 √ 1.25
Consistency with government
priorities
0.10 √ 0.20
Input requirements-Capital
need and Know-how access
0.15 √ 0.45
Size of the market- present
and future potentials
0.20 √ 0.80
Cost structure of the product
and its profit potentials
0.20 √ 0.60
Risk quotient in terms of the
project’s sustainability
0.10 √ 0.20
Rating Index = 3.50
23. Project Management Basics
No matter what the type of project, project
management typically follows the same
pattern:
Defining &
Initiation
Planning
Execution
Monitoring &
Control
Closure
24. The Project Management Process
The project management process means planning the work and then
working the plan.
7 steps of planning
1. Clearly define the project objective.
2. Divide and subdivide the project scope into major “pieces”
3. Define the specific activities for each piece (WBS)
4. Graphically portray the activities that need to be performed from
each work package in order to accomplish the project objective – in
the form of network diagram.
5. Make a time estimate for how long it will take to complete each
activity
– and the resources needed.
6. Make a cost estimate for each activity.
7. Calculate a project schedule and budget to determine whether the
project can be completed within the required time, with the allotted
funds, and with the available resources.
25. 25
Project Management
Role of Project Management
Identifying requirements
Establishing clear and achievable objectives
Balancing the competing demands for quality,
scope, time and cost
26. Work Breakdown Structure
It is foundation of project planning
It defines tasks that can be completed independent of other tasks,
facilitating resource allocation, assignment of responsibilities and
measurement and control of the project
It is followed by
identification of dependencies and
estimation of activity durations
It can be used to identity the tasks in the CPM and PERT
26
27. darla/smbs/vit 27
Project Planning
Resource Availability and/or Limits
Due date, late penalties, early completion
incentives
Budget
Activity Information
Identify all required activities
Estimate the resources required (time) to complete
each activity
Immediate predecessor(s) to each activity needed to
create interrelationships
28. darla/smbs/vit 28
Project Network
• Network analysis is the general name given to
certain specific techniques which can be used for
the planning, management and control of
projects
29. Project Network
• Activity
– A task or a certain amount of work required in the
project
– Requires time to complete
– Represented by an arrow
• Dummy Activity
– Indicates only precedence relationships
– Does not require any time of effort
29
30. darla/smbs/vit 30
Event
Signals the beginning or ending of an activity
Designates a point in time
Represented by a circle (node)
Network
Shows the sequential relationships among
activities using nodes and arrows
Project Network
31. Project Network
Activity-on-node (AON)
nodes represent activities, and arrows show
precedence relationships
Activity-on-arrow (AOA)
arrows represent activities and nodes are
events for points in time
31
32. darla/smbs/vit 32
Graph or bar chart with a bar for each project activity that shows passage of time
Provides visual display of project schedule
Gantt Chart
33. darla/smbs/vit 33
History of CPM/PERT
Critical Path Method (CPM)
E I Du Pont de Nemours & Co. (1957) for
construction of new chemical plant and
maintenance shut-down
Deterministic task times
Activity-on-node network construction
Repetitive nature of jobs
34. PERT
Project Evaluation and Review Technique (PERT)
U S Navy (1958) for the POLARIS missile program
Multiple task time estimates (probabilistic nature)
Activity-on-arrow network construction
Non-repetitive jobs (R & D work)
34
35. Arrows and Nodes in
Project Network
Use of nodes and arrows (PERT)
Arrows An arrow leads from tail to head
directionally to indicate ACTIVITY, a time
consuming effort that is required to perform a
part of the work.
Nodes A node is represented by a circle to
indicate EVENT, a point in time where one or
more activities start and/or finish.
35
36. Arrows - as Activities in PERT
Activities are pieces of Work that
consumes time. May or may not consume
resources ( Waiting is an Activity which
does not consume resources).
Used in PERT as Activity on Arrow
(AOA).
36
37. Nodes- as Activity in CPM
Nodes are used to denote Activities in CPM
networking and the Arrow is used to denote
the inter relationship and the approach is called
AON (Activity on Node).
37
38. darla/smbs/vit 38
AOA Project Network for House
3
2 0
1
3
1 1
1
1 2 4 6 7
3
5
Lay
foundation
Design house
and obtain
financing
Order and
receive
materials
Dummy
Finish
work
Select
carpet
Select
paint
Build
house
AON Project Network for House
1
3
2
2
4
3
3
1 5
1
6
1
7
1
Start
Design house and
obtain financing
Order and receive
materials
Select paint
Select carpet
Lay foundations Build house
Finish work
39. darla/smbs/vit 39
Situations in network diagram
A
B
C
A must finish before either B or C can start
A
B
C
both A and B must finish before C can start
D
C
B
A
both A and B must finish before either of C or D can
start
A
C
B
D
Dummy
A must finish before B can start
both A and C must finish before D can start
40. darla/smbs/vit 40
Concurrent Activities
2 3
Lay foundation
Order material
(a) Incorrect precedence
relationship
(b) Correct precedence
relationship
3
4
2
Dummy
Lay
foundation
Order material
1
2 0
41. 41
PERT/CPM Chart
Task. A project has been defined to contain the following list of activities along
with their required times for completion:
Activity
No
Activity Expected
completion time
Dependency
1. Requirements collection 5 -
2. Screen design 6 1
3. Report design 7 1
4. Database design 2 2,3
5. User documentation 6 4
6. Programming 5 4
7. Testing 3 6
8. Installation 1 5,7
a. Draw a Network chart for the activities.
b. Calculate the earliest expected completion time.
c. Show the critical path.
42. 42
PERT/CPM Chart (cont’d)
Network chart for the activities.
Using information from the table, show the sequence of activities.
1
2
3
4
5
6
8
7
43. 43
PERT/CPM Chart (cont’d)
1
2
3
4
5
6
8
7
b. Calculate the earliest expected completion time.
1. Using information from the table, indicate expected completion time for each activity.
5
6
7
2
6
5 3
1
2. Calculate earliest expected completion time for each activity (TE) and the entire project.
Hint: the earliest expected completion time for a given activity is determined by summing the
expected completion time of this activity and the earliest expected completion time of the immediate
predecessor.
Rule: if two or more activities precede an activity, the one with the largest TE is used in
calculation (e.g., for activity 4, we will use TE of activity 3 but not 2 since 12 > 11).
TE = 5
TE = 11
TE = 12
TE = 14
TE = 20
TE = 19 TE = 22
TE = 23
44. 44
PERT/CPM Chart (the end)
1
2
3
4
5
6
8
7
5
6
2
6
5 3
1
TE = 5
TE = 11
TE = 12
TE = 14
TE = 20
TE = 19 TE = 22
TE = 23
c. Show the critical path.
The critical path represents the shortest time, in which a project can be completed. Any activity
on the critical path that is delayed in completion, delays the entire project. Activities not on the
critical path contain slack time and allow the project manager some flexibility in scheduling.
45. darla/smbs/vit 45
Network example
Illustration of network analysis of a minor redesign of a product and its associated packaging.
The key question is: How long will it take to complete this project ?
47. darla/smbs/vit 47
Questions to prepare activity network
Is this a Start Activity?
Is this a Finish Activity?
What Activity Precedes this?
What Activity Follows this?
What Activity is Concurrent with this?
49. 49
CPM calculation
Path
A connected sequence of activities leading from
the starting event to the ending event
Critical Path
The longest path (time); determines the project
duration
Critical Activities
All of the activities that make up the critical path
50. darla/smbs/vit 50
Forward Pass
Earliest Start Time (ES)
earliest time an activity can start
ES = maximum EF of immediate predecessors
Earliest finish time (EF)
earliest time an activity can finish
earliest start time plus activity time
EF= ES + t
51. Backward Pass
Latest Start Time (LS)
Latest time an activity can start without
delaying critical path time
LS= LF - t
Latest finish time (LF)
latest time an activity can be completed
without delaying critical path time
LS = minimum LS of immediate
predecessors 51
53. Market and Demand Analysis
In most cases first step in project analysis is to
find out
What is the likely aggregate demand for the product or
service, and
What share of the market will the proposed project
enjoy
In order to get a “feel” for the relationship
between the product and its market, data based
situational analysis is to be carried out.
This is often referred to as the 3C Analysis which includes data
based analysis of Market Environment from the interpretation of
the inputs received from Customer, Company and Competition.
54. Market and Demand Analysis
example
Project: Launching a new Mobile Handset
Who are the potential buyers of mobile?
What is the total market size of mobiles and the industries growth?
Define market segmentation of the total mobile market and where does
the new one falls?
Who are the present and potential competitors?
What are the USPs of the new mobile to get the customers switching
loyalty?
What are the price and warranty strategy to ensure acceptance?
What channels of distribution are most suited for the offerings?
What are the prospects of immediate sales?
55. Primary and Secondary
Information
Information may be obtained from primary and secondary
information.
Secondary information is information that has been gathered in
some other contexts and is already available.
Examples
Census of India- provides information on population, demographic characteristics
house-hold size and composition etc. –by GOI
Economic Survey- provides latest information on individual production, wholesale
prices, consumer prices, inflation, exports, etc. – by Finance Ministry
Guidelines to Industries- provides information on various industry sector – by
Ministry of Industries
Monthly studies of Production of selected industries- provides all-India data on
production, number of units installed, capacity available etc.- by Central Statistical
Organization
Monthly bulletin of Reserve Bank of India- provides information on production
indices, inflation, balance of payments, exchange rates etc.- by RBI
56. Secondary Information-contd.
Industry- Specific Sources
Automobile- Annual Reports of Indian Automobile
Manufacturers by IAMA
Metallurgical- Iron and Steel Control Bulletin (Quarterly by
Ministry of Steel and Mines
Textiles- Indian Textile Bulletin by Textile Commissioner,
Mumbai
Electrical and Electronics- Annual Report of Indian Electrical
Manufacturers Association
- Electronics Information and
Planning (Monthly) by Information,
Planning and Analysis Group of
Electronics Commission, New Delhi
Cement- by Cement Manufacturers Association, India etc.
57. Evaluation of Secondary Information
While secondary information is available economically and
readily, its reliability, accuracy and relevance for the purpose
under consideration must be carefully examined. The
following points are important.
For what purpose the information was collected
When the information was collected and when was it published
What was the target population from which the data was
collected for the secondary information
How representative was the sample
How accurately was the information edited, tabulated and
analysed
Was the statistical analysis properly applied and the data was
sufficient to be statistically sufficient
How relevant the information for the purpose it is to be used
58. Primary Information
Secondary information often does not provide a
comprehensive basis for market and demand analysis. It needs
to be supplemented with primary information gathered through
a market survey, specific to the project being appraised.
The market survey may be a census survey or a sample survey.
In the census survey the entire population is covered and are
generally used for intermediate goods and investment goods
when such goods are used by a small number of firms. But
they become generally prohibitively expensive.
Due to this market survey in practice is typically a sample
survey
59. Steps in Sample Survey
Typically a sample survey consists of the following steps:
Define the target population–
Target population may be divided into various segments.
Mobile customers can be segmented into various age groups
and also with the various income bracket.
Select the Sampling Scheme and Sample Size—
Sampling can be Simple sampling, Random sampling or could
be stratified sampling. Sample size has a bearing on the
reliability of the estimates-larger the sample size, greater the
reliability.
Develop the questionnaire–
Industry and trade market surveys generally involve more
technical and specialised questions than the consumer surveys
60. Steps..
Obtain information—
Personal interviews generally ensure a high rate of response
and more dependable inputs.
Scrutinize the information gathered—
to eliminate data which are internally inconsistent.
Analyze and Interpret the information—
Results of data based on sample survey will have to be
extrapolated to the target population. For this purpose
appropriate inflationary factors based on the ratio of the size of
the target population to the size of the sample studies, will
have to be used.
61. Key steps in Market Demand Analysis
and their Inter-relationships
Situational
Analysis and
specification
of Objectives
Collection
of
Secondary
Information
Conduct of
Market
Survey
Characterization
of the Market
Demand
Forecasting
Market
Planning
62. Objective of Market Survey
From the Market survey, one or more of the
following information are gathered
Total Demand and rate of growth of demand.
Demand in different segments of the market
Income and price elasticity of the demand
Motives for buying
Satisfaction with the existing products
Unsatisfied needs
Customer loyalty to the brand
Attitude towards alternate products
63. Demand Forecasting
After gathering information about various aspects
of the market and demand from Primary and
Secondary sources, an attempt may be made to
estimate future demand.
“Demand Forecasting is the art of
predicting demand for a product or a
service at some future date on the basis of
certain present and past behaviour
patterns of some related events.”
64. Characteristics of a Good Demand
Forecasting
Accuracy
Simplicity
Economy
Timeliness
Availability
65. Demand Forecasting - Methods
Qualitative Methods– depends on the judgment of the expert.
Jury of Executive Method
Delphi Method
Time Series Projection Method- based on the historical time series .
Trend Projection Method
Exponential smoothing method
Moving average method
Causal Methods-seek to develop forecasts on the basis of cause-effect
relationship specified in an explicit quantitative manner.
Chain Ratio Method
Consumption level method
End use method
Leading Indicator method
66. Jury of Executive Method
This involves soliciting the opinions of group
of managers on expected future sales and
combining them into a Sales forecast.
This is a subjective estimate provided by the experts.
This is an expeditious method but it’s reliability
depends on the efficiency of the subjective estimates of
the experts on the variety of factors including economic,
competitive , customer preferences and technological
changes.
67. Delphi Method
This method is used for eliciting the opinions of a group of
experts. It avoids face-to-face group meetings; opinions are
sought either through mails or any other mode of impersonal
communications.
In Delphi method experts responses are summarized without
disclosing the identity of the experts and sent back to the
experts along with a questionnaire meant to probe further the
reasons for extreme views expressed in the first round.
The process continues for one or more rounds till a reasonable
agreement emerges in the views of the experts.
68. Time series Projection
-- Trend Projection Method
Trend Projection Method involves
a) determining the trend of consumption by analyzing past consumption
statistics
b) projecting future consumption by extrapolating the trend
Most commonly used relationship is the linear relationship
Yt = b + mx
“Yt” is the demand for year “t”
“t” is the time variable
“b” is the intercept of the relationship and
“m” is the slope of the relationship
To estimate “m” and “b” of the linear relationship, the least
square method is used.
72. Moving Average Method
In the Moving Average Method of Sales Forecasting the
Forecast for the next period is equal to the average of the sales
for several preceding periods.
yt+yt-1+……+ yt-n+1
Ft+1=---------------------------
n
Where Ft+1 is the Forecast for the next period, yt is the
Sales for the current period and n is the period over which the
averaging is done.
73. Exponential Smoothing Methods
This method provides an exponentially
weighted moving average of all previously
observed values.
Appropriate for data with no predictable
upward or downward trend.
The aim is to estimate the current level and use
it as a forecast of future value.
74. Exponential Smoothing Method
In Exponential Smoothing forecasts are modified in the light
of the observed errors.
If the Forecast value for the year t is Ft and is less than the
actual value of yt, then the Forecast for the year t+1, Ft+1 will
be = Ft + α.е t,
where α is the Smoothing parameters (which lies
between 0 and 1)
and е t is the error in the forecast for the year t and is
given by yt-Ft
This makes the exponential smoothing equation as
Ft+1 = Ft + α.(yt- Ft)
or, t
t
t F
y
F )
1
(
1
75. Simple Exponential Smoothing Method
The implication of exponential smoothing can
be better seen if the previous equation is
expanded by replacing Ft with its components
as follows:
This makes the Exponential smoothing forecast as
the old forecast plus an adjustment for the error
that occurred in the last forecast.
1
2
1
1
1
1
)
1
(
)
1
(
]
)
1
(
)[
1
(
)
1
(
t
t
t
t
t
t
t
t
t
F
y
y
F
y
y
F
y
F
76. Simple Exponential Smoothing Method
If this substitution process is repeated by
replacing Ft-1 by its components, Ft-2 by its
components, and so on the result is:
Therefore, Ft+1 is the weighted moving average
of all past observations.
1
1
3
3
2
2
1
1 )
1
(
)
1
(
)
1
(
)
1
( y
y
y
y
y
F t
t
t
t
t
t
77. Problem Sums
The demand for a product in each of the last
five months is shown below.
Month 1 2 3 4 5
Demand ('00s) 13 17 19 23 24
· Use a two month moving average to generate a forecast for
demand in month 6.
· Apply exponential smoothing with a smoothing constant of
0.9 to generate a forecast for demand for demand in month 6.
· Which of these two forecasts do you prefer and why?
78. Causal Methods-
Chain Ratio Method
The potential sales of a product may be estimated by applying
a series of factors to a measure of aggregate demand.
This is a simple analytical approach for demand estimation.
Demand Forecasting of Shaving Blade
Male population in country 150 million
Proportion of adult male using shaving blades 0.60
Male population using shaving blades 90 million
Number of times using per years 100
Total shaving done per year 9000 million
Proportion of shaving done with stainless steel 0.4
Average number of shaving per stainless steel blade 6
Number of stainless steel blades used per year (9000mil x0.40) / 6
= 600 mil
Proportion of market the firm can capture 0.20
Potential sales 120 mil
79. Consumption level method
This method is used for those products that are directly
consumed. This method measures the consumption level on
the basis of elasticity coefficients. The important ones are
Income Elasticity: This reflects the responsiveness of demand
to variations in income. It is calculated as:
E1 = [Q2 - Q1/ I2- I1] X [I1+I2/ Q2 +Q1]
Where
E1 = Income elasticity of demand
Q1 = quantity demanded in the base year
Q2 = quantity demanded in the following year
I1 = income level in the base year
I2 = income level in the following year
80. Consumption Level Method–
Price Elasticity
Price Elasticity: This reflects the responsiveness of demand to
variations in price. It is calculated as:
EP = [Q2 - Q1/ P2- P1] X [P1+P2/ Q2 +Q1]
Where EP = Price elasticity of demand
Q1 = quantity demanded in the base year
Q2 = quantity demanded in the following year
P1 = price level in the base year
P2 = price level in the following year
81. Other Causal Methods
End use method:
This method forecasts the demand of the intermediate products,
based on the consumption coefficient and the projected output
level of the consuming industries (e.g. Automotive sheet
consumption to no. of cars produced in Maruti, Huyndai, TATA ).
Leading indicator method:
This method uses the identification of the leading indicators which
change ahead of the lagging variables. Changes in the leading
indicators may be used to predict the changes in the lagging
variables (e.g. Urbanization to sale of AC).
Econometric method:
An advanced forecasting tool, it is a mathematical expression of
economic relationships derived from economic theory.
82. Technical Analysis
The broad purpose of Technical analysis is
to ensure that the project is technically feasible in the sense
that all the inputs required to set up the project are available
to facilitate the most optimum formulation of the project in
terms of technology, size , location etc.
Technical analysis consists of ( Example-Car project)
Manufacturing process/technology
Material Inputs and Utilities
Product mix, plant capacity, location, and site
Machinery & equipment, civil works
Environmental considerations
Project charts and layouts
83. Technology and Process selection
Appropriateness depends on the followings:-
Customer segments targeted decides the choice of technology.
Appropriate technology here refers to those methods of production
which are suitable to local economic , social and cultural conditions
and are convenient to implement.
Tying up with for the Technical know-how needed for the process,
which may be either through
Technology licensing,
Outright purchase,
Joint venture arrangement
Availability and appropriateness of the input material and utilities,
which include power, water, fuels etc.
84. Choice of Technology
For manufacturing a product or services often two or more
alternative technologies are available. The choice of
technology is influenced by a variety of considerations:-
Plant capacity :- Plant capacity requirements guide the selection of appropriate
technology.
Investment outlay :- Investment outlay is guided by the technology adopted
and ultimately impacts on the cost and viability of the
project.
Principal inputs :- Choice of technology depends on the principal inputs
availability at a cost effective manner.
Product mix :- Technology chosen must be judged in terms of the total
products to be produced including saleable by-products and
effluents.
Risk of technology change :- Technology selection should consider the
likelihood of obsolescence in near future.
Ease of absorption :- This plays an important role in a developing country
where ease of availability of the trained people for the
technology may not be easy.
85. Material Inputs and Utilities
An important aspect of technical analysis is concerned
with defining the materials and inputs required,
specifying their properties in some detail, ease of
availability and setting up their supply program.
Material inputs and utilities may be classified into four
broad categories :
Raw material :- can be processed or can be the base
material
Processed industrial materials and components :- which
are important inputs for the project.
Auxiliary materials and factory supplies :- Which are other
than basic material required for
processing, e.g. chemicals, additives,
packaging material etc.
Utilities :- Power, water, steam etc. availability, which has
a bearing on selection of location, technology,
plant capacity etc.
86. Product Capacity. Plant Capacity,
Plant Location, Layout etc.
Which focuses on
Choosing the optimum product mix including variation in the size,
quality and broad range of customer
Plant Capacity which is technically attainable and optimum for the
market targeted.; include machinery and equipment selection
Plant location to make most cost effective and customer proximity,
specially for Service sector projects.
Plant structures and Layout , which incorporates the basis for
detailed project engineering and estimation of investment and
production costs.
87. Machinery, Equipment and Civil works
Requirement of machineries and equipment is dependent on
production technology and plant capacity.
For a process oriented project (petrochemical etc.)
machineries and equipment at subsequent stages should be
balanced.
Apart from the base equipment instruments, controls, internal
transportation systems and other support systems are also
provisioned.
Spare parts, tools etc. are also considered.
In selecting the machineries and equipment certain constraints
should be borne in mind:
Power availability constraints need to be considered while selecting power
intensive equipment.
Transportation and erection of the heavy equipment to remote areas are considered.
Selection of sophisticated equipment depends on the ability of the operator available
etc.
89. Environment Considerations
Environmental impacts of projects are considered to be one of
the most adverse impacts of industrializations. This has forced
government machineries to impose various rules and
regulations to control environmental impacts of the projects.
Issues which are considered at the Project planning stages are
Types of effluents and emissions generated
Steps to be taken for proper treatment and disposal of effluents and emissions
Complying with all the statutory requirements of standards and monitori g of the
same on a continuous basis.
90. Project schedules and
implementations
Once data is available on the principal dimensions of the project, project
charts and layouts may be prepared. The important charts and layout
drawings are:
General functional layout
Material flow diagram
Production line diagram
Transportation layout
Utility layout
Organizational layout etc.
As part of technical analysis , a project implementation schedule is also
prepared.
The work schedule reflects the plan of work concerning installation as well as initial
operation.
91. Project Evaluation basics..
There are three basic questions of a Project Appraisal exercise:
Can the goods and services be produced?
Can the goods and services be sold?
Can a satisfactory return be earned from the investment made in the
project?
To judge a project from the financial angle, we need
information about the following :
Cost of project
Means of Financing
Estimates of sales and production
Cost of production
Working capital requirement and financing
Profitability projections
Break-even point
Projected cash flow statement
Projected Balance-sheet
92. Cost of Project
The cost of project represents the sum of all items of outlay
associated with a project which are supported by long-term
funds. It is the sum of outlays on the followings:
Land and site development
Building and civil works
Plant and Machinery
Technical Know-how and Engineering fees
Expenses on Foreign technicians and training of Indian technicians abroad, if any
Miscellaneous fixed assets
Preliminary and Capital issue expenses
Pre-operative expenses
Provision for contingencies
Margin money for working capital
Initial cash losses
93. Land and Site Development
This includes
basic cost of land,
premium payable on lease hold,
cost of leveling and development,
cost of laying approach roads,
cost of boundary walls & gates,
cost of tube wells etc.
94. Building and Civil Works
This includes buildings for the main plant and equipment,
building for auxiliary services like work shops, laboratory etc.,
godowns, warehouses, quarters for staff etc.
The cost of buildings and civil works depends on the kinds of
structures required.
Once the kinds of structures required are specified,
cost estimates are based on the plinth area and
rates for various types of structures.
95. Plant and Machinery
The cost of plant and machinery is the most significant
component of the project cost.
This includes the cost of imported machinery and its allied cost,
cost of indigenous machinery, cost of stores and spares and
installation and foundation charges.
The cost of the plant and machinery is based on the
latest available quotation adjusted for possible
escalation.
96. Technical Know-how and
Engineering Fees
Often it is necessary to engage technical consultants or
collaborators from India and/or abroad for advice and help in
various technical matters like
preparation of the project report,
choice of technology,
selection of the plant and machinery,
and so on.
So the amount payable for obtaining the technical
know-how and engineering services for setting up
the project is an important component of the
project cost.
97. Expenses on foreign technicians and training
of Indian technicians abroad
Often it is necessary to engage technical consultants or
collaborators from India and/or abroad for advice and
help in
various technical matters like preparation of the project report,
choice of technology,
selection of the plant and machinery,
and so on.
So the amount payable for obtaining the technical know-
how and engineering services for setting up the project is
an important component of the project cost.
98. Expenses on foreign technicians and training
of Indian technicians for setting up and
supervising trial runs
Services of foreign technicians may be required in India
for setting up the project and supervising the trial runs.
Expenses on their travel, boarding, and lodging
along with their salaries and allowances are shown
here.
Similarly expenses on Indian technicians who
require training abroad must also be included here.
99. Miscellaneous fixed assets
Fixed assets which are not part of the direct
manufacturing process may be referred to as
miscellaneous fixed assets. They include items like
furniture,
office machinery and equipment,
tools,
vehicles,
railway sidings,
diesel generating sets,
transformers,
boilers, piping systems,
laboratory equipment etc.
Expenses incurred for the procurement or use of patents,
licenses, trade marks, copyrights, etc and deposits made
with electricity board may also be included here.
100. Preliminary and capital issue expenses
Expenses incurred for
identifying the project,
conducting market survey,
preparing feasibility report,
drafting memorandum and
articles of association and
incorporating the company
are referred to as preliminary expenses.
101. Pre-operative expenses
Some revenue expenses incurred till the commencement of
commercial production are referred to as pre-operative
expenses. This includes
establishment expenses,
rent, rates and taxes,
travelling expenses,
interest and
commitment charges on borrowings,
insurance charges,
mortgage expenses,
interest on deferred payments,
start-up expenses, and
miscellaneous expenses.
102. Provision for contingencies
A provision for contingencies is made to provide for
certain unforeseen expenses and price increases over and
above the normal inflation rate which is already
incorporated in the cost estimates.
103. Margin money for working capital
The principal support for working capital is provided by
commercial banks and trade creditors.
However, a certain part of the working capital
requirement has to come from long-term sources of
finance.
Referred to as the ‘margin money for working capital’, this is an
important element of the project cost.
104. Initial cash losses
Most of the projects incur cash losses in the initial
years. Yet, promoters typically do not disclose the initial
cash losses because they want the project to appear
attractive to the financial institutions and investing public.
Failure to make a provision for such cash losses in the project
cost generally affects the liquidity position and impairs the
operations.
105. Means of Financing
To meet the cost of project the following
means of finance are available:
Share capital
Term loans
Debenture capital
Deferred credit
Incentive sources
Miscellaneous sources
106. Share capital
There are two types of share capital-
Equity capital and
Preference capital.
Equity capital
represents the contribution made by the owners of the business,
the equity shareholders, who enjoy the rewards and bear risks
of ownership. Equity capital being the risk capital carries no
fixed rate of dividend.
Preference capital
represents the contribution made by preference shareholders
and the dividend paid on it is generally fixed. Preference
Capital at times are for redeemable after a certain period.
107. Term Loans
Term loans are provided by financial institutions and
commercial banks represents secured borrowings which
are a very important source for financing new projects as
well as expansion, modernization, and renovation schemes
of existing firms. There are two broad types of term loans
available in India:
Rupee term loans and
Foreign currency term loans.
108. Others
Debenture capital
Debentures are instruments for raising debt capital. There are two broad types of
debentures:
convertible debentures and
non convertible debentures.
Convertible debentures as the name implies, are debentures which are
convertible, wholly or partly, in to equity shares. The conversion period and
price are announced in advance.
Deferred credit
Many a time the suppliers of plant and machinery offer a deferred credit
facility under which payment for the purchase of plant and machinery can be
made over a period of time.
Incentive sources
The government and its agencies may provide financial support as incentive to
certain types of promoters or for setting up of industrial units in certain
locations. These incentives may be in the form of seed capital assistance, capital
subsidy or tax exemption for a certain period.
109. Miscellaneous sources
A small portion of project finance may come from
miscellaneous sources like
unsecured loans,
public deposits, and
leasing and hire purchase finance.
Unsecured loans are typically provided by the promoters to
bridge the gap between the promoter’s contribution and the
equity capital the promoters can subscribe to.
Public deposits represent unsecured borrowings from the
public at large.
Leasing and hire purchase finance represent a form of
borrowing different form the conventional term loans and
debenture capital.
110. Planning the Means of Finance
Guidelines and considerations:
Norms of Regulatory bodies and Financial Institutions
Means of finance is generally laid down by the regulatory bodies or
conform certain norms laid down by Government and Financial
Institutions of the country to impart prudence to project financing
decisions.
Key Business Considerations
Key Business considerations which are relevant for the project
financing decision are
Cost of Fund – Cost of Debt fund is lower than the cost of Equity funds.
Risk – Business risk arises from fluctuations in demand and variability of
prices and costs.
- Financial risk represents the risks arising from financial leverage
(Debt-equity ratio).
Risks borne by the Equity shareholders should not be unduly high. Firms exposed to high
degree of Business risk should have low financial risk and vice-versa.
Control - Promoters control on the means of financing is preferred.
Flexibility- Firms should have reserve borrowing powers to enable it to raise debt
capital in future to meet unforeseen future needs.
111. Working Capital Requirement and its
Financing
Working Capital consists of
Stock (Raw Material, WIP, Finished Goods, and Maintenance spares)
Debtors
Operating expenses in Cash/Bank
The principal source of Working Capital finances are
Working Capital advances provided by commercial banks
Trade credits
Accruals and provisions
Long term source of financing
There are limits to obtaining Working Capital advances from
commercial banks. They are
Aggregate permissible bank finance is specified as per the norms of the lending
Bank
Against each current assets a certain amount of margin money has to be provided by
the firm.
112. Tandon Committee recommendation
Working Capital Financing
Tandon Committee has recommended maximum permissible
amount of bank finance for Working Capital (second out of
the three methods being most commonly applied) as
at least 25% of Current Assets must be supported by long-term sources
of finance.
Margin requirements vary with the types of Current Assets,
e.g.,
Raw Material- 10-25%
WIP - 20-40%
Finished Goods- 30-50%
Debtors - 30-50%
113. Estimates of Sales & Production
Sales Revenue
Starting point for Profitability projections is the forecast of
Sales Revenue. Considerations for this as follows:-
Capacity Utilization—Capacity utilization is generally considered as 40-50% of the
installed capacity in the first year, 50-80% in the second year and 80-90% from the
third year onwards
Stock- It is generally assumed that production as equal to sales and ignore any
adjustments for stock.
Selling price is taken as net of excise.
Selling price may be taken at present selling price. It is generally assumed that
changes in selling price will be matched by proportionate changes in cost of
production.
114. Estimates of Production
Cost of Production
Cost of Production are
Material Cost- includes cost of raw material, chemicals, components and
consumable stores required for production. The present costs of various material
inputs is considered; in other words, the factor of inflation is ignored.
Utilities – consists of power, water and fuel. Requirements are determined on the
basis of the norms specified by the collaborators, consultants etc., or the
consumption standards in the industry, whichever is higher.
Labor- is the cost of all the manpower employed in the factory. In estimating
remuneration rates, the prevailing rates in the industry/area should be taken into
account. The number of supervisory personnel and administrative staff may be
calculated on the basis of the general norms prevailing in the industry.
Factory overheads- the expenses on repairs and maintenance, rent, taxes, insurance
etc. are collectively referred to as factory overheads.
115. Profitability Projections
The estimates of Working results may be prepared as follows:
A Cost of production
B Total administrative expenses
C Total sales expenses
D Royalty and Know-how payable
E Total Cost of Product (A+B+C+D)
F Expected sales
G Gross profit before interest (F-E)
H Total financial expenses
I Depreciation
J Operating profit ( G-H-I)
K Other income
L Preliminary Expenses written off
M Profit/ Loss before Taxation ( J+K-L)
N Provision for Taxation
O Profit after Tax (M-N)
Less Dividend on Preference Capital/ Equity Capital
P Retained Profit (PAT- Dividend Pay out)
Add Depreciation & Preliminary Expenses Written off
Q Net Cash Accrual
116. Projected Cash Flow Statement
Source of Funds
Share Issue
Profit before Taxation with Interest added back
Depreciation provision for the year
Development Rebate reserve
Increase in secured medium and long term borrowings for the project
Increase in Unsecured loans and Deposits
Increase in Bank borrowing for Working Capital etc.
TOTAL of A
Disposition of Funds
Capital Expenditure for the project
Increase in Working Capital ( Current Assets other than cash - Current Liabilities
other than Bank Borrowings)
Decrease in Unsecured loans and Bank Borrowings for Working Capital
Taxation
Dividends (Equity & Preference Capital)
TOTAL of B
- Opening Balance of Cash in Hand/ Bank
- Add, Net Surplus / Deficit (A-B)
- Closing Balance of Cash in Hand and at Bank
117. Cash Flow Problem Sums
Balance Sheet of X at the end of the first year is as follows:-
The projected Income Statement and the distribution of earnings for the 2nd
year is given below:-
Sales- 400 Depreciation -20 Interest- 20 Tax – 30 Dividends- 10
COG sold- 300 PBIT - 80 PBT - 60 PAT– 30 Retained
Earnings - 20
Liabilities Rs Assets Rs
Share Capital 100 Fixed Assets 180
Reserves and Surplus 20 Investments -
Secured Loans 80 Current Assets 180
Unsecured Loans 50 Cash- 20
Current Liabilities 90 Receivables-80
Provisions 20 Inventories- 80
360 360
118. Problem Sums
During the second year the firm plans to raise a secured loan of 20, repay a
previous term loan to the extent of 5 and increase unsecured loans by 10.
Current Liabilities and Provisions are expected to remain unchanged.
Firm plans to acquire fixed assets worth 30 and increase inventories by 10.
Receivables are increased by 15.
Other Assets would remain unchanged excepting Cash.
The Firm plans to pay 10 by way of Equity Dividend.
Prepare the projected Cash Flow Statement:-
119. Solutions
Source of Funds
PBIT 80
Depreciation 20
Increase in Secured Loans 15
Increase in Unsecured Loans 10
TOTAL (A) 125
Disposition of Funds
Capital Expenditure 30
Increase in Working Capital (10+15) 25
Interest 20
Taxation 30
Dividends - Equity 10
TOTAL (B) 115
Opening Balance of Cash 20
Net Surplus/ Deficit (A-B) 10
Closing Balance of Cash in Hand/Bank 30
121. WACC
'Weighted Average Cost Of Capital - WACC‘
Company’s assets are financed by either debt or equity. WACC is the
average of the costs of these sources of financing, each of which is
weighted by its respective use. By taking a weighted average, we can
see how much interest the company has to pay for every Re. it
finances.
A firm's WACC is the overall required return on the firm as a whole
and is often used internally to determine the economic feasibility of
expansionary opportunities and mergers.
All capital sources - common stock, preferred stock, bonds and any
other long-term debt - are included in a WACC calculation. All else
equal, the WACC of a firm increases as the beta and rate of return on
equity increases, as an increase in WACC notes a decrease in valuation
and a higher risk.
122. WACC- Example
WACC can calculated as
WACC= WE x rE + Wp x rp + WD x rD (1-tc)
Where WE, Wp , and WD are the proportion of Equity, Preference and
Debt and rE, rp, rD are the component costs of Equity, Preference and
Debt and tc is the corporate Tax rates.
Example:
The cost of Equity, Preference and Debt of BPP Ltd. are 16%, 14% and
12% respectively and the market value proportions of these sources of
finance are 0.60, 0.05 and 0.35 respectively.
The Tax rate is 30%.
Then WACC= 0.60x 16 + 0.05x 14 + 0.35x 12 (1-0.30) = 13.24%
123. Weighted Marginal Cost of
Capital
Weighted average cost of Capital does not remain same at
different magnitude of financing. In fact it tends to rise as the
firm seeks more and more capital.
As the suppliers provide more capital the rate of return required by
them tends to increase.
There is generally a Breaking point beyond which the cost of
new capital change, given the Capital structure of the firm.
These levels can be established using the following
relationship.
BPj = TFj/Wj
Where, BPj is the Breaking point
124. Cost of Equity: CAPM Approach
Several approaches are used to estimate the cost of Equity. The
Capital Asset Pricing Model approach perhaps the most
popular in practice.
Logic of the CAPM approach
Investors are risk averse. So they require a higher expected return to
bear higher risk. Total Risk can be decomposed in the following two
components.
Total Risk = Unique Risk + Market Risk
Unique Risk of a security represents that portion of its risk wich stems
from Firm-specific factors like the development of a new product, a
labor strike or the emergence of a new competitor.
Market Risk of a security represents that portion of its risk which is
attributable to economy wide factors like growth rate of GNP, the level
of Government spending, Interest rate structure, and inflation rate.
CAPM suggests that investors are compensated only for
bearing the systematic risk.
125. Beta Value for Stock
When examining a particular equity, an often-used measurement of risk is what we in the
finance world call beta.
βstock is the beta coefficient for the stock, meaning it is the covariance between the stock and
the market divided by the variance of the market. We will assume the beta is 1.25.
Rmarket is the return expected from the market, but related to businesses that are.
α is a constant that measures excess return for given level of risk
Now we put together these three numbers using the capital asset pricing model:
RRR= RFR + βstock (Rmarket – RFR)
RRR = 4 + 1.25 (6)
RRR = 11.5%
Where:
RRR = the required rate of return, or expected return
RFR = the risk free rate
βstock = beta of the stock
Rmarket = return of the market as a whole
(Rmarket – RFR) = the market risk premium, or the return above the risk-free rate to
accommodate additional unsystematic risk
126. Capital Structure
Capital Structure
The Capital Structure of a firm is the mix of different sources of finance
used by the firm to finance its operations.
Optimal Capital Structure
The capital structure or combination of Debt and equity at which the
WACC is minimum and it leads to maximum value of the firm.
Sources of Capital
Debt
Bank Loans
Corporate Bonds
Debentures
Shareholders Money
Equity Shares
Preference Shares
Retained Earnings
127. Importance of Capital Structure
Capital Structure affects the value of the firm either by
affecting
Cost of the Capital
Expected Earning
Or both
Capital Structure decision is relevant to the valuation of the
firm.
In other words, a change in the financial leverage will lead to a
corresponding change in the overall cost of capital as well as the total
value of the firm.
If therefore the degree of financial leverage as measured by the ratio of
debt to equity is increased, the WACC will decline, while the value of
the firm as well as the market price of share will increase and vice
versa.
128. Planning the Capital Structure Important Considerations –
Return:
ability to generate maximum returns to the shareholders, i.e. maximize
EPS and market price per share.
Cost:
minimizes the cost of capital (WACC). Debt is cheaper than equity due to tax
shield on interest & no benefit on dividends.
Risk:
insolvency risk associated with high debt component.
Control:
avoid dilution of management control, (debt preferred to new equity)
Flexible:
altering capital structure without much costs & delays, to raise funds
whenever required.
Capacity:
ability to generate profits to pay interest and principal.
129. Value of a firm depends upon earnings of a firm and its cost
of capital (i.e. WACC).
Earnings are a function of investment decisions, operating
efficiencies, & WACC is a function of its capital structure.
Value of firm is derived by capitalizing the earnings by its
cost of capital (WACC). Value of Firm = Earnings / WACC
Thus, value of a firm varies due to changes in the earnings
of a company or its cost of capital, or both.
Capital structure cannot affect the total earnings of a firm
(EBIT), but it can affect the residual shareholders’ earnings.
Value of a Firm – directly co-related with the
maximization of shareholders’ wealth.
130. Particulars Rs.
Sales (A) 10,000
(-) Cost of goods sold (B) 4,000
Gross Profit (C = A - B) 6,000
(-) Operating expenses (D) 2,500
Operating Profit (EBIT) (E = C - D) 3,500
(-) Interest (F) 1,000
EBT (G = E - F) 2,500
(-) Tax @ 30% (H) 750
PAT (I = G - H) 1,750
(-) Preference Dividends (J) 750
Profit for Equity Shareholders (K = I - J) 1,000
No. of Equity Shares (L) 200
Earning per Share (EPS) (K/L) 5
An illustration of
Income Statement
131. ASSUMPTIONS –
Firms use only two sources of funds –
equity & debt.
No change in investment decisions of
the firm, i.e. no change in total assets.
100 % dividend payout ratio, i.e. no
retained earnings.
Business risk of firm is not affected by
the financing mix.
No corporate or personal taxation.
Investors expect future profitability of
the firm.
Capital Structure Theories
132. Project Selection
Project selection is the process of evaluating
individual projects or groups of projects, and then
choosing to implement some set of them so that the
objectives of the parent organization will be achieved
Managers often use decision-aiding models to extract
the relevant issues of a problem from the details in
which the problem is embedded
Models represent the problem’s structure and can be
useful in selecting and evaluating projects
Chapter 2-1
133. Criteria for Project Selection
Models
Realism - reality of manager’s decision
Capability- able to simulate different scenarios and optimize the decision
Flexibility - provide valid results within the range of conditions
Ease of Use - reasonably convenient, easy execution, and easily
understood
Cost - Data gathering and modeling costs should be low relative to the cost
of the project
Easy Computerization - must be easy and convenient to gather, store and
manipulate data in the model
Chapter 2-2
134. Nature of Project Selection
Models
2 Basic Types of Models
Numeric
Nonnumeric
Two Critical Facts:
Models do not make decisions - People do!
All models, however sophisticated, are only partial
representations of the reality the are meant to reflect
Chapter 2-3
135. Nonnumeric Models
Sacred Cow - project is suggested by a senior and powerful official in
the organization
Operating Necessity - the project is required to keep the system
running
Competitive Necessity - project is necessary to sustain a competitive
position
Product Line Extension - projects are judged on how they fit with
current product line, fill a gap, strengthen a weak link, or extend the line in
a new desirable way.
Comparative Benefit Model - several projects are considered and
the one with the most benefit to the firm is selected
Chapter 2-4
136. Numeric Models:
Profit/Profitability
Payback period - initial fixed investment/estimated annual cash
inflows from the project
Average Rate of Return - average annual profit/average
investment
Discounted Cash Flow - Present Value Method
Internal Rate of Return - Finds rate of return that equates
present value of inflows and outflows
Profitability Index - NPV of all future expected cash flows/initial
cash investment
Chapter 2-5
137. 137
What is The Time Value of
Money?
A Re. received today is worth more than a Re.
received tomorrow
This is because a dollar received today can be
invested to earn interest
The amount of interest earned depends on the rate
of return that can be earned on the investment
Time value of money quantifies the value of a
Re. through time
138. 138
Uses of Time Value of Money
Time Value of Money, or TVM, is a concept that is
used in all aspects of finance including:
Project Evaluation to accept/reject decisions for project
management
Financial analysis of firms
And many others!
139. 139
Formulas
Common formulas that are used in TVM calculations:*
Present value of a lump sum:
PV = CFt / (1+r)t OR PV = FVt / (1+r)t
Future value of a lump sum:
FVt = CF0 * (1+r)t OR FVt = PV * (1+r)t
Present value of a cash flow stream:
n
PV = S [CFt / (1+r)t]
t=0
140. 140
Formulas (continued)
Future value of a cash flow stream:
n
FV = S [CFt * (1+r)n-t]
t=0
Present value of an annuity:
PVA = PMT * {[1-(1+r)-t]/r}
Future value of an annuity:
FVAt = PMT * {[(1+r)t –1]/r}
141. Numeric Models: Scoring
Unweighted 0-1 Factor Model
Unweighted Factor Scoring Model
Weighted Factor Scoring Model
Constrained Weighted Factor Scoring Model
Goal Programming with Multiple Objectives
Chapter 2-6
142. Risk Versus Uncertainty
Analysis Under Uncertainty - The Management of
Risk
The difference between risk and uncertainty
Risk - when the decision maker knows the probability
of each and every state of nature and thus each and
every outcome. An expected value of each alternative
action can be determined
Uncertainty - when a decision maker has information
that is not complete and therefore cannot determine the
expected value of each alternative
Chapter 2-7
143. Risk Analysis
Principal contribution of risk analysis is to
focus the attention on understanding the nature
and extent of the uncertainty associated with
some variables used in a decision making
process
Usually understood to use financial measures
in determining the desirability of an
investment project
Chapter 2-8
144. Risk Analysis
Probability distributions are determined or subjectively
estimated for each of the “uncertain” variables
The probability distribution for the rate of return (or
net present value) is then found by simulation
Both the expectation and its variability are important
criteria in the evaluation of a project
Chapter 2-9
146. Information Base for Selections
Accounting Data
Measurements
Subjective vs. Objective
Quantitative vs. Qualitative
Reliable vs. Unreliable
Valid vs. Invalid
Technological Shock
Chapter 2-11
147. Decision Tree Analysis
A graphical tool for describing
(1) the actions available to the
decision-maker,
(2) the events that can occur,
and
(3) the relationship between the
actions and events.
(4) Each decision tree has two
types of nodes;
Decision nodes are
represented as Squares and
Probability nodes are
represented as Circles
148. The branches leaving each round node
represent the different states of nature
while the branches leaving each square
node represent the different decision
alternatives.
At the end of each limb of a tree are the
payoffs attained from the series of
branches making up that limb.
Decision Tree Branches
