Entrepreneurship (Project identification)

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Entrepreneurship-Project identification

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Entrepreneurship (Project identification)

  1. 1. Ms. SONAM KAPIL (Lecturer MIT, MIET GROUP Meerut) Page 1 UNIT – II (Project Identification) PROJECT  A Project is a combination of human and non-human resources put together in a temporary organization to achieve a specified purpose.  Project is a system involving co-coordination of a number of interrelated activities to achieve a specific objective. PROJECT CYCLE Project cycle has five stages – identification, formulation, appraisal, implementation and monitoring and evaluation. (i) Identification: Identification could be from several sources: progressive farmers, entrepreneurs, technical experts, local leaders, bankers, mass media, extension agencies and national policies and plans. (ii) Formulation: Preparation of feasibility study is the first step in analysis. Advanced techniques of project planning like Programme Evaluation and Review Techniques (PERT) and Critical path Method (CPM) are used in capital intensive and complex project and those with longer gestation period (the period between starting of implementation of the project and income generation). (ii) Appraisal: After preparation, every project is appraised by an independent agency. This includes analysis and scrutiny of each and every aspect, details and assumptions made in the project. Generally banks have to undertake the appraisal of project before financing. The appraisal is also assigned to specialized agencies in case of complex project. The appraisal is conducted from several aspects like technical, financial, commercial, managerial, economic, distributive and environmental. Even within financial appraisal, there are various types of analysis. (iv) Implementation: Implementation basically means translating the proposal into a ground level project. The phases of the implementation are: a) Pre development phase: this involves getting registration, licenses and loan disbursement, b) Development phase: construction of structures and starting up of production, and c) Operational phase :starts with production and concludes when the economic life of the project comes to an end. (v) Monitoring and Evaluation: The final phase in project cycle is the monitoring and evaluation. Monitoring keeps track of the project, usually done by collecting certain performance indicators about
  2. 2. Ms. SONAM KAPIL (Lecturer MIT, MIET GROUP Meerut) Page 2 the project to check whether the project is performing according to the plan, identifying problem areas and finding possible solutions. There are two types of monitoring which banks undertake: a) Desk monitoring based on collected data and b) Field monitoring, based on actual field visit. Evaluation is conducted for the purpose of learning lessons of success and failure from the project. There are several organizations (like NABARD or training establishments) which conduct such evaluation studies and publish them for wider circulation. PROJECT IDENTIFICATION Project identification is the first step of a new venture. A right direction may enable an entrepreneur to scale new height. Otherwise, he has to undergo a number of hurdles in his way. It is therefore, very crucial to entrepreneurs to identify project. Project identification is concerned with collection, compilation and analysis of economic data for the eventual purpose of locating possible opportunities for investment. STEP 1 : SEARCH OF NEW IDEA / GENERATION OF IDEAS / SEARCH OF BUSINESS OPPORTUNITY: The search for promising project idea is the first step towards establishing a successful venture. Identification of such opportunities requires imagination, sensitivity to environmental changes and realistic assessment of what the firm can do. Entrepreneur takes the help many tools to generate new ideas like: (i) SWOT Analysis: SWOT is an acronym for Strength, Weaknesses, Opportunities and Strength. On analyzing these factors one can come up with new ideas on:  Cost Reduction  Productivity improvement  Increase in capacity utilization  Improvement in contribution margin  Expansion into promising fields
  3. 3. Ms. SONAM KAPIL (Lecturer MIT, MIET GROUP Meerut) Page 3 (ii) Brainstorming: It is probably the most well known and widely used for creative idea generation. It is an unstructured process for generating all possible ideas within a limited time frame through the spontaneous contributions of participants. The participants can be the entrepreneur’s family members, friends, business partners, hired experts etc. (iii) Other constrains:  Analyse the performance of Existing Industries  Examine the inputs and outputs of various Industries  Review Imports and Exports  Study Plan Outlays and Government Guidelines  Look at the suggestions of Financial Institutions and Developmental Agencies  Investigate Local Materials and Resources  Analyse Economic and Social Trends Internal factors Strengths  Political support  Funding available  Market experience  Strong leadership  Any foreign collaboration  Industrial contacts Weaknesses  Project is very complex  Likely to be costly(huge investment)  Lack of experience  Lack of trained personnel.  Inability to forecast market trends. Externa l factors Opportunities  Project may improve local economy  Competitor weakness.  Project will boost company's public image  Government & other incentives.  New technology(create new market) Threats  Environmental constraints  Time delays  New Technology( make the previous product outdated)  National and global economic conditions.  Stiff competition in market.
  4. 4. Ms. SONAM KAPIL (Lecturer MIT, MIET GROUP Meerut) Page 4  Explore the Possibility of Reviving Sick Units STEP 2 : SELECTION OF BUSINESS OPPORTUNITY/ SHORT LISTING IDEAS /PRELIMINARY SCREENING: The entrepreneur might have searched a number of business opportunities and there is a need to select the best one idea which can be carried on to achieve the objective of entrepreneur. Below mention points helps the entrepreneur to select the best idea: 1. Compatibility with the Promoter The idea must be compatible with the interest, personality, and resources of the entrepreneur. According to Murphy, a real opportunity has three characteristics: i) It fits the personality of the entrepreneur (abilities, training etc) ii) It is accessible to him iii) It offers him the rapid growth and high returns 2. Consistency with Governmental Priorities: i) Is the project consistent with national goals and priorities? ii) Are there any environmental effect contrary to governmental regulation? iii) Can the foreign requirements of the project be easily accommodated? iv) Will there be any difficulty in obtaining the licenses for the project? 3. Availability of Inputs: i) Are the capital requirements of the project within manageable limits? ii) Can the technical know-how required for the project can be obtained? iii) Are the raw materials required for the project available domestically at reasonable cost? iv) Is the power supply for the project reasonably obtainable from external sources? 4. Adequacy of the market i) Total present domestic market ii) Competitors and their market shares iii) Export market iv) Quality-price profile of the product vis-à-vis competitive product v) Sales and distribution system
  5. 5. Ms. SONAM KAPIL (Lecturer MIT, MIET GROUP Meerut) Page 5 vi) Projected increase in consumption vii) Patent protection 5. Acceptability of Risk Level i) Vulnerability to business cycles ii) Technological Changes iii) Competition from substitutes iv) Competition from Imports v) Governmental control over price 6. Socio-Demographic Sector i) Population trends ii) Income distribution iii) Educational Framework iv) Attitudes toward consumption and investment STEP : 3 ASSESSMENT OF VIABILITY / PROJECT APPRAISAL / FEASIBILITY STUDY During the process of project appraisal a feasibility study may be undertaken to establish the justification of the identified project in all of its relevant dimensions, including its technical, economic and financial viability, environmental compliance and social acceptability; as well as its conformity with the national development objectives and priorities and the relevant policy, legal and regulatory framework. Feasibility study is to initially identify the following aspects: i. Technical soundness of the project ii. Administrative feasibility of the project iii. The economic and financial viability of the project proposal iv. Considerations of customs and traditions of project benefactors, issues of compatibility The results of a feasibility study influences decisions to commit or not commit scarce resources to a given project . (I) MARKET ANALYSIS Market analysis is concerned primarily with two questions:
  6. 6. Ms. SONAM KAPIL (Lecturer MIT, MIET GROUP Meerut) Page 6  What would be the aggregate demand of the proposed product/service in the future?  What would be the market share? To answer the above questions, the market analyst requires a wide variety of information and appropriate forecasting methods. The kinds of information required are:  Consumption trends in the past and the present consumption level  Past and present supply position  Production possibilities and constraints  Imports and exports  Structure of competition  Cost structure  Elasticity of demand  Consumer behaviour, intentions, motivations, attitudes, preferences, and requirements  Distribution channels and marketing policies in use  Administrative, technical, and legal constraints (II) TECHNICAL ANALYSIS Analysis of the technical and engineering aspects of a project needs to be done continually when a project is formulated. The important questions raised in technical analysis are:  Whether the preliminary tests and studies have been done?  Whether the availability of raw materials, power, and other inputs has been established?  Whether the selected scale of operation is optimal?  Whether the production process chosen is suitable?  Whether the equipment and machines chosen are appropriate?  Whether the auxiliary equipments and supplementary engineering works have been provided for?  Whether provision has been made for the treatment of effluents?  Whether the proposed layout of the site, buildings, and plant is sound?  Whether work schedules have been realistically drawn up?  Whether the technology proposed to be employed is appropriate from the social point of view? (III) FINANCIAL ANALYSIS
  7. 7. Ms. SONAM KAPIL (Lecturer MIT, MIET GROUP Meerut) Page 7 The primary aim of financial analysis is to determine whether the project satisfies the investment criteria of generating acceptable level of profitability. The aspects which have to be looked into while conducting financial analysis are:  Investment outlay and cost of project  Sources of financing  Cost of capital  Projected profitability  Break-even point  Cash flows of the project  Projected financial position  Level of risk (IV) ECONOMIC ANALYSIS Economic analysis, also referred to as social cost benefit analysis, is concerned with judging a project from the larger social point of view. The questions to be answered in social cost benefit analysis are:  What are the direct economic benefits and costs of the project measured in terms of shadow (efficiency) prices and not in terms of market prices?  What would be the impact of the project on the distribution of income in the society?  What would be the impact of the project on the level of savings and investment in the society?  What would be the contribution of the project towards the fulfillment of certain merit wants like self- sufficiency, employment, and social order? (V) ECOLOGICAL ANALYSIS Ecological analysis should be done particularly for major projects which have significant ecological implications (like power plants and irrigation schemes) and environment-polluting industries (like bulk drugs, chemicals, and leather processing). The key questions raised in ecological analysis are:  What is the likely damage caused by the project to the environment?  What is the cost of restoration measures required to ensure that the damage to the environment is contained within acceptable limit PROJECT FINANCING:
  8. 8. Ms. SONAM KAPIL (Lecturer MIT, MIET GROUP Meerut) Page 8 Finance is supposed to be the most important ingredient of a project without which a project cannot move an inch. Finance is needed to convert the ideas into feasible project which in turn will generate finance. Finance is needed not only to complete a project but also to manage it on day-to-day basis.  Short-term finance is needed to cover the day to day running of the business. It will be paid back in a short period of time, so less risky for lenders. The main types of short-term finance are:  Overdraft  Suppliers credit  Working capital  Long-term finance tends to be spent on large projects that will pay back over a longer period of time. More risky so lenders tend to ask for some form of insurance or security if the company is unable to repay the loan. A mortgage is an example of secured long-term finance. The main types of long-term finance that are available for to a business are:  Mortgages  Bank loans  Share issue  Debentures  Retained profits  Hire purchase  Internal finance comes from the trading of the business. Examples of internal finance are:  Day to day cash from sales to customers.  Money loaned from trade suppliers through extended credit.  Reductions in the amount of stock held by the business.  Disposal (sale) of any surplus assets no longer needed (e.g. selling a company car). Internal finance tends to be the cheapest form of finance since a business does not need to pay interest on the money. However it may not be able to generate the sums of money the business is looking for, especially for larger uses of finance.  External finance comes from individuals or organisations that do not trade directly with the business e.g. banks. Examples of external finance are:  An overdraft from the bank.
  9. 9. Ms. SONAM KAPIL (Lecturer MIT, MIET GROUP Meerut) Page 9  A loan from a bank.  The sale of new shares through IPOs. CAPITAL STRUCRURE The capital structure of a company refers as long-term finances used by the firm. The decision regarding the capital is based on the objective of achieving the maximization of shareholders wealth. Factors Determining Capital Structure (1) Minimization of Risk:  Capital structure must be consistent with business risk.  It should result in a certain level of financial risk. (2) Control: It should reflect the management’s philosophy of control over the firm. (3) Flexibility : It refers to the ability of the firm to meet the requirements of the changing situations. (4) Profitability: It should be profitable from the equity shareholders point of view. (5) Solvency: The use of excessive debt may threaten the solvency of the company. (6) Return: The project should provide satisfactory and timely return. OWNER FUND/ OWNERS CAPITAL: Capital contributed by the owner or entrepreneur of a business, by means of savings or inheritance, is known as own capital or equity. Sources(Capital mix) Amount Cost Percentage of total capital Owners fund 25,000,000 12% 7.14 Equity share 75,000,000 15% 21.43 Preference shares 50,00,000 16% 14.29 Borrowed fund: Debenture 40,00,000 14% 11.43 Term loans 1,000,00,000 18% 28.58 Leasing finance 30,00,000 18% 8.57 Other advances 30,00,000 15% 8.57 3,50,00,000 100
  10. 10. Ms. SONAM KAPIL (Lecturer MIT, MIET GROUP Meerut) Page 10 Owner's capital refers to the sum of the business resources owned by the business owners. It is calculated through the subtraction of assets from liabilities. When a business pays all its debts, the amount remaining belongs to the business owner and it is the one that is referred to as Owners Capital or Owners Equity Shares: A unit of ownership that represent equal proportion of company’s capital. It entitles its holder (the shareholder) to an equal claim on the company's profits and losses. Two major types of shares are : (1) ordinary shares (common stock), which entitle the shareholder to share in the earnings of the company as and when they occur, and to vote at the company's annual general meetings and other official meetings. (2) preference shares (preferred stock) which entitle the shareholder to a fixed periodic income (interest) but generally do not give him or her voting rights. BORROWED FUNDS: Funds which are granted by another person or institution are called borrowed capital, and this must usually be paid back with interest. The ratio between debt and equity is named leverage. It has to be optimized as a high leverage can bring a higher profit but create solvency risk. The firm may borrow funds from a large number of sources, such as banks, financial institutions, public or by issuing bonds or debentures. (i) A debenture : the term is used for a medium- to long-term debt instrument used by large companies to borrow money. A debenture is like a certificate of loan or a loan bond that the company is liable to pay a specified amount with interest and although the money raised by the debentures becomes a part of the company's capital structure, it does not become share capital. (ii) A term loan: is a monetary loan that is repaid in regular payments over a set period of time. Asset based short-term loan payable in a fixed number of equal instalments over the term of the loan. Term loans are generally provided as working capital for acquiring income producing assets (machinery, equipment, inventory) that generate the cash flows for repayment of the loan. (iii) A financial lease: is one method a business can use to acquire equipment with payment structured over time. At the end of the lease, if the lessee doesn't want to purchase based on a predetermined residual value, the asset is returned to the lessor.
  11. 11. Ms. SONAM KAPIL (Lecturer MIT, MIET GROUP Meerut) Page 11 Factors Determining Capital Structure (i) Type and size of the enterprise. (ii) Future prospects of enterprise. (iii) Financial soundness of entrepreneur. (iv) Volume of capital required. (v) Cost of capital and cost of its procurement. (vi) Pay-back period of the project. (vii) Availability of alternative sources. (viii) Rate of return on investment. (ix) Reputation of the entrepreneur. (x) Risk involved in the project. (xi) Flexibility needed in the capital structure. COST OF CAPITAL  Capital refers to the funds invested in a business. The capital is generated from different sources such as equity shares, preference shares, and debt.  All capital has a cost. However, it varies from one sources of capital to another, from one company to another and from one period of time to another.  Cost of capital to the company's is cost of collecting funds. This is equal to the average rate of return that an investor in a company will expect for providing funds.  It is the minimum rate of return that the project must earn to keep the value of the company intact.  The cost of capital in always expressed in terms of percentage Importance of Cost of Capital (i) Acceptance or rejection of an investment project depends on the cost that the company has to pay for financing it. (ii) Good financial management select such projects, which are expected to earn returns, which are higher than the cost of capital. (iii) In capital expenditure decisions, finance managers accept the project, where the cost of capital equals to the rate of return offered by the project. (iv) The cost of capital is a guideline for determining the optimum capital structure of a company.
  12. 12. Ms. SONAM KAPIL (Lecturer MIT, MIET GROUP Meerut) Page 12 CAPITALIZATION The entire amount of fund to be invested in an enterprise is known as capital. The capital requirement of an organization usually depends on the size of the unit, nature of project, volume of production, technology, nature of product etc. Capitalization derived from the word capital and in common practice it refers to the total amount of capital employed in business. The portion of capital utilized to create physical infrastructure i.e. creation or purchase or procurement of fixed asset assets shall be known as fixed capital, in which usually a huge amount of money is blocked or a long time, known as blocked capital. The amount of capital utilized to run the enterprise on day to day basis i.e. in the payment of salaries, rent, wages etc. is known as working capital (Working capital=current assets- current liabilities) The entrepreneur has to ensure that adequate amount of capital is inducted into the business. There should not be inadequacy of capital as well as surplus capital. Both inadequate as well as surplus capital is harmful for the financial health of an enterprise. The word capitalization refers to the cost required to buy an asset. This includes the price to get a particular asset. Capitalization can also be referred to as the long term financing required by a firm. The financing modes can be stock or preferred stock. It can also be retained earnings or long term debt. If the firm is capitalized with little or without long term debt is considered to have financed conservatively. Capitalization is also referred to as financial structure, capital structure or total capitalization. A company can include various assets that can be bought and sold. This determines the shares of the company. This share can be multiplied with the number of shares in the company gives the capitalization of the company. Companies are categorized based on the capitalization. If the capitalization is above $10 billion, the company falls under large-cap. If it is between $2 billion and $10 billion, the company is a mid-cap company. If it is between $250 million and $2 billion, the company can be called small-cap. Those companies which have a capitalization below $250million are commonly known as a micro-cap. Broad Interpretation According to this Capitalization implies the process of determining the plan of financing. It includes the determination of the quantity of finance for a company and also decision about the quality of the financing. In this sense capitalization includes: 1- Estimation of total amount of capital to be raised. 2- Determining the type of securities to be issued. 3- Determining the composition of various securities. Narrow Interpretation
  13. 13. Ms. SONAM KAPIL (Lecturer MIT, MIET GROUP Meerut) Page 13 According to this capitalization implies the process of determining the quantity of funds to run its business. According to this view the decisions regarding the form or composition of capital fall under the capital structure Definition According to GESTENBERG “Capitalizations mean the total accounting value of all the capital regularly employed in the business.” Stages of Capitalization Over Capitalization:- In simple words, Over Capitalization means existence of excess capital as compared to the level of activity and requirements. If the entrepreneur raises excess capital than the required amount in relation to the rate of earning, it is considered to be over capitalization. Excess of amount of capital may lead to idleness of fund, misutilization of fund, lower rate of return on the investment etc. How Over capitalized can be identified:  Actual rate of earning < Current rate of earning  Real value of business < Book value of business  Real value of shares < Book value of shares Advantages of over capitalization  The management is assured of adequate capital for present operations.  Ample capital has a beneficial effect on an organization’s morale.  Ample capital gives added flexibility and latitude to the corporations operations.  The profit rates tend to discourage possible competitors.  For public utility companies when the price of service is based upon a fair ‘Return to capital’ High capitalization may be advantageous. Disadvantages  Over capitalization may induce failure and the failure of the company may bring an unhealthy economic Situation.
  14. 14. Ms. SONAM KAPIL (Lecturer MIT, MIET GROUP Meerut) Page 14  The ethical atmosphere of a business is not improved by over capitalization.  Due to over capitalization, there may be an inability to pay interest on bonds.  Decline in the value of securities.  Injury to credit worthiness Effects of over capitalization Adverse effects of over capitalization can be classified into the following categories: I. On the company  The market price of the equity shares fall which reduces the credit standing of the company.  Due to poor profitability it cannot internally finance the projects.  To The company fails maintain the dividend rate  Due to the reduced credit standing the marketability of future issues of capital is jeopardized II. On the company  They do not get fair return on their investment.  The market price of the shares of an over capitalization concern falls. III. On the society  If such unit enjoys monopoly, they exploit consumers and employers.  The productivity of such unit is less. Thus scarce resources are poorly employed.  For survival, they trouble the government for assistance and concessions. This increase the quantum of public expenditure. Under capitalization: If an entrepreneur invests inadequate or less amount of capital than the required in relation to the earning capacity, it is termed as under capitalization. Under capitalization is an indication of effective and proper utilization of funds employed in the business. It also indicates sound financial position and good management of company. Inadequate investment will lead to shortage of fund, adjustment of fund, delay or stoppage of works due to scarcity of fund, delay and default in payment to outsiders, loss of reputation, higher rate of return etc. How Under-capitalized can be identified:  Actual rate of earning > Current rate of earning  Real value of business > Book value of business  Real value of shares > Book value of shares
  15. 15. Ms. SONAM KAPIL (Lecturer MIT, MIET GROUP Meerut) Page 15 Reasons leading to under capitalization  Scarcity of fund  Non availability of external debt.  Lack of creditworthiness,  Over evaluation of investment proposals  Excessive financial control.  Strict management of finance Benefits of under capitalization  Best possible utilization of fund.  Rate of return is comparatively high in relation to similar industries.  Increase in the market value of equity shares  Increase in book value  Increase in earnings per share( EPS)  Increase in reputation  Reduced dependence on external finance  Higher dividend for investors  Possibility of higher resources and surplus. Demerits of Under-capitalization.  All the time there will be financial adjustment  Higher rate of profit will attract competition.  There may be more demand of bonus  Higher profits will attract higher taxes.  It will create more speculation in the stock market PROJECT FORMULATION Project formulation is done to ensure the best utilisation of minimum possible resource to yield the maximum possible results. Project formulation lays the foundation for the final selection of an investment proposal after a comparative analysis of all the investment proposal selected doe the purpose.  Project involves step by step investigation and development of project idea.  It provides a controlled mechanism for restricting expenditure on project development.  Project formulation is a process involving the joint efforts of a team of experts. Each member of the team should be familiar with the broad strategy, objectives and other ingredients of the project.  Project team should consist of experts in major substantive fields of the project.  A well-formulated feasibility report provides a medium, for successful implementation of a project.
  16. 16. Ms. SONAM KAPIL (Lecturer MIT, MIET GROUP Meerut) Page 16 Project formulation is defined as “taking a first look carefully and critically at a project idea by an entrepreneur to build up an all-round beneficial to the project after carefully weighing its various components.” In short Project Formulation is a process whereby the entrepreneur makes an objective and independent assessment of the various aspects of an investment proposition of a project idea for determining its total impact and also its liabilities. Stages of Project Formulation 1. Feasibility analysis 2. Techno-Economic Analysis 3. Project Design and Network Analysis 4. Input Analysis 5. Financial Analysis 6. Cost-Benefit Analysis 7. Pre-Investment Analysis Feasibility Analysis: •First stage in project formulation •Examination to see whether to go in for a detailed investment proposal or not •Screening for internal and external constraints Conclusion could be •The project idea seems to be feasible •The project idea is not a feasible one •Unable to arrive at a conclusion for want of adequate data Techno-Economic Analysis: Screens the idea to-Estimate of potential of the demand for goods/services Choice of optimal technology
  17. 17. Ms. SONAM KAPIL (Lecturer MIT, MIET GROUP Meerut) Page 17 This analysis gives the project a platform for preparation of detailed project design Project Design and Network Analysis: •It is the heart of the project entity •It defines the sequence of events of the project •Time is allocated for each activity •It is presented in a form of a network drawing •It helps to identify project inputs, finance needed and cost-benefit profile of the project Input Analysis: •Its assesses the input requirements during the construction and operation of the project •It defines the inputs required for each activity •Inputs include materials, human resources •It evaluates the feasibility of the project from the point of view of the availability of necessary resources •This aids in assessing the project cost Financial Analysis: •It involves estimating the project costs, operating cost and fund requirements •It helps in comparing various project proposals on a common scale •Analytical tools used are discounted cash flow, cost-volume-profit relationship and ratio analysis •Investment decisions involve commitment of resources in future, with a long time horizon •It needs caution and foresight in developing financial forecasts Cost- Benefit Analysis: •The overall worth of a project is considered •The project design forms the basis of evaluation •It considers costs that all entities have to bear and the benefit connected to it
  18. 18. Ms. SONAM KAPIL (Lecturer MIT, MIET GROUP Meerut) Page 18 Pre-investment Analysis: •The results obtained in previous stages are consolidated to arrive at clear conclusions •Helps the project-sponsoring body, the project-implementing body and the external consulting agencies to accept/reject the proposal PROJECT EVALUATION Project evaluation refers to the systematic collection, analysis and use of information to answer questions about a project. It involves the analysis of costs, outcome or impact, implementation as well as the need for the project. In general terms it checks: (i) Methods for controlling the cost, time, quality and performance characteristics of a project, from the initial planning to post completion assessment, are sound and effectively applied; (ii) Management information is prompt, adequate and accurate; (iii) Assets and interests are properly controlled and safeguarded from all losses; (iv) There are adequate safeguards against fraud, error and impropriety; (v) Material losses due to waste or inefficiency are identified and recovered; (vi) Information on which costs and cash flow projections are based provide a sound basis for the funding of the project; (vii) Internal guidance and other established policies and procedures are followed. 1) Project appraisal (Project Financial Evaluation) There are some important methods to determine the return of investment, which are very essential criteria for taking a decision to a start a project: (a) Investment and Cash Flow Concept Cash flow statement is the basis for financial analysis. In the initial period there is a negative cash flow because of investment in capital assets, but after the project takes off, the cash flow becomes positive due to the increased income.
  19. 19. Ms. SONAM KAPIL (Lecturer MIT, MIET GROUP Meerut) Page 19 The period from start of the project till its winding up is known as project life and will vary from project to project. Generally, projects with more than 20 years life are analyzed for financial cost and benefits for 20 years only, as the benefits accruing after that have a negligible present value. (b) Return on investment (ROI): ROI is defined as the ratio of profit to initial capital. The figure is compared to the cost of the capital. If the project does not yield the desired ROI, it is not accepted. If there are a number of projects under consideration, then they are ranked on the basis of ROI and the project with the best ROI or those above the desired ROI is/are selected. Average Rate of Returns = (Annual net income/Average Investment)*100 Average investment =Initial investment + Scrap value/Life of assets (c) Discounted Cash Flow Technique  A project normally having long life, the cash flow spans over a long period. Since the value of money will not be the same in all years, the cash flow of all future years cannot be treated equally.  The difference in the 'value' of money arises mainly due to its capacity to earn if it is invested today. This is known as 'time value of money' .  Time value of money is estimated by 'discounting' the future cash flows to their present value. One can 'reduce' future benefits and cost streams to their 'present worth' or 'present value' with the technique called discounted cash flow technique. d = 1 (1 )n r where, d = discount factor for Re. 1 and r is the rate of interest n= Number of periods which could be years or months Thus, the discount factor at 10 % per annum after one year will be d = 1 1 1 1 1 1 (1 0.1) (1.1)10 1 100        = 0.909 This discount factor of 0.909 means that Re. 1 which going to be received after 1 year will have its ‘Present value’ as Rs. 0.909 today. This computation can be done by using discount tables. (d) Measures of Financial Viability -- NPV, BCR and IRR
  20. 20. Ms. SONAM KAPIL (Lecturer MIT, MIET GROUP Meerut) Page 20 Financial viability is measured by net present value, benefit cost ratio, internal rate of return and debt service coverage ratios.  Net Present Value (NPV) representing wealth creation by the Project, is calculated by taking the discounted sum of the stream of cash flows during the project life. NPV = 1 2 3 ... Invst. (1 ) (1 ) (1 ) n n CC C r r r        where , C = Cash Flows for different periods, r = Discount Rate and Invest. = Initial Investment NPV represents the difference between the present value of the cost and benefit streams. A project is considered viable if the NPV is positive at a given discount rate and vice-versa.  Benefit Cost Ratio (BCR): BCR is the ratio of discounted value of benefit and discount value of cost. BCR = Benefits - Disbenefits- Maintenance and operation cost Total cost of project- The salvage value Profitability Index: It is also called present value profitability index or benefit cost ratio. Profitability Index=(Present value of gross cash inflows/Initial cash outlay) Present value index=(Present value of operating inflows/Present value of Net Investment)*100 The project is viable when BCR is one or more than one and is unviable when it is less than one.  Internal Rate of Return (IRR): IRR represents the returns internally generated by the project. This is also the rate which makes the net present value equal to 0. The calculation of IRR is a process of trial and error. Normally, the process starts with the minimum discount rate and as the discount rate is increased the NPV will come down and becomes 0 or negative. If NPV is positive at one rate and negative at the immediate next rate (for example if NPV is positive at 20% discount rate and is negative at 25%), ‘Interpolation Method’ could be used for finding out the exact IRR by the following formula. Exact IRR by interpolation method = L + (H – L) × (NPV at L) {(NPV at L) – (NPV at H)}
  21. 21. Ms. SONAM KAPIL (Lecturer MIT, MIET GROUP Meerut) Page 21 Where, IRR = Internal Rate of Return; L = Lower discount rate where NPV was positive; H = Higher discount rate at which NPV was negative. The project is considered viable if the IRR is more than the acceptable rate for the entrepreneur which could be the opportunity cost for his funds. In case of agricultural and rural development projects generally the prescribed IRR for viability is 15% in India and other developing countries. 2) Network Analysis (Project Time consumption evaluation): Rough estimate of Time Taken by the project to complete is calculated with the help of:  CPM (Critical Path Method) Network analysis technique used in complex project plans with a large number of activities. CPM diagrams consist of (1) all activities, (2) time required for their completion, (3) and how each activity is related to the previous and next activity. A sequence of activities is called a 'path,' and the longest-path in the diagram is the critical path. It is 'critical' because all activities on it must be completed in the designated time, otherwise the whole project will be delayed.  PERT(Program Evaluation Review Technique) A PERT chart is a project management tool used to schedule, organize, and coordinate tasks within a project. PERT stands for Program Evaluation Review Technique, a methodology developed by the U.S. Navy in the 1950s to manage the Polaris submarine missile program. This method use three estimate for an act (1) Optimistic time (a): This is the situation in which every activity look positive and every activities are completed on time. (2) Pessimistic time (b): This is the situation in which every activity look difficult and cannot be completed on time. (3) Most likely Time (m): This situation is not so positive or negative. It has equal probability to complete the project on time. 3) Project demand analysis: As an essential part of project formulation and appraisal, market and demand analysis vital so that capacity and facility location can be planned. Demand analysis is the art of predicting demand for a product or a
  22. 22. Ms. SONAM KAPIL (Lecturer MIT, MIET GROUP Meerut) Page 22 service at some future date on the basis of certain present and past behaviour patterns of some related events. Demand forecasting for a product is technique of estimating its demand in the immediate or distant future. METHODS OF DEMAND FORECASTING METHODS OF DEMAND FORECASTING OPINION POLLING METHODS STATISTICAL METHODS Consumer survey method Trend Projection Method Expert opinion Method (Delphi technique) Collective opinion method Barometric Technique Regression Method Simultaneous Equation Method Graphical Method Least square Method Moving average method
  23. 23. Ms. SONAM KAPIL (Lecturer MIT, MIET GROUP Meerut) Page 23 Preliminary project report 1. Introduction a. Information about the entrepreneur: Name _________________Date of birth________________ Address_________________________ Age_____________ _________________________Gender__________ _________________________ Presently monthly income: Rs _______________________ Educational qualification : __________________________ Special Training, if any : __________________________ Work experience : __________________________ Category: SC/ST/Ex-military/NRI/physically handicapped / General/:____________ b. Information about the product /project: Product: __________________________________________ Location of the project : ______________________________ Type of organization: ________________________________ Name of the firm: ___________________________________ 2. Market potential (Under this section the entrepreneur has to mention the area over which his product may be sold. He has to mention the present demand of the product in the area division-wise with the quantity & supply position and value in tabular form. At the end, the entrepreneur has to make a conclusion in favor of the product showing a good market scope in that area.) 3. Basis of presumption (The entrepreneur has to mention following details) a. The average working hour per day, month and year b. When the plant will operate in its full capacity has to mention. c. What will be the payback period of the loan? d. How much percentage of margin money shall be provided by the promoter may be stated.(entrepreneur invest 30% to 35 % of the entire fund from the his own pocket & the rest may be obtained on loans from bank or financial institution. e. The rate of interest for a long term loan as well as working capital may be stated.
  24. 24. Ms. SONAM KAPIL (Lecturer MIT, MIET GROUP Meerut) Page 24 f. The cost of land and building has to be mentioned as per the prevailing rates.it the factory shall be placed in rented shed, it should be mentioned. 4. Implementation schedule (Under this the entrepreneur has to mention the time to be taken for the completion of the project.) eg. a. Preparation of project report, selection of site………………………1 month b. Section of loans……………………………………………………………………..3 month c. Construction of building Procurement of building Equipment’s and installation………………………………………………….6 months d. Arrangements of utilities(water, electricity etc………………………3 months e. Procurement of raw material………………………………………………..1 month f. Commission of plant & trial production………………………………..2 months Total time required 16 months. 5. Production target (The entrepreneur has to mention the production programme of the unit per annum.) Items Total quantity per year sales volume capacity utilization A 35 tonne 900,000 100% 6. Technical details. (The entrepreneur has to mention all the technical details of his project such as manufacturing process, quality and standard, power requirement, pollution control measures, energy conservation measures Etc.) 7. Financial details (Here the entrepreneur has to mention the amount of investment needed on various items to arrive at the total capital required for the project) Fixed capital a. Land & building ( area and value) b. Machinery and equipment’s (Description of mach., no. required, price, total value, name &add of the suppliers) c. Miscellaneous fixed assets (tools, furniture, office expenses in Rs{Total assets =A+B+C} ) d. Preliminary & preparative expenses Working capital: a. Raw material: s.no items Total monthly req. in qty. Value in Rs. sources 1 …………… ………………. ……………. ………….. Total working capital req./month………………….Rs……………….. b. Salaries & wages of labour/staff per month (Mention the name of the post, no. of persons needed & salary payable/month and then total in Rs) c. Utilities : per month s.no particulars Monthly req. in Qty. Monthly expenses in Rs. 1 Electricity ……………… ………………..
  25. 25. Ms. SONAM KAPIL (Lecturer MIT, MIET GROUP Meerut) Page 25 The electricity charged is calculated: Total horse power of machineries x .75 =kW per hour, per day= 8 hrs Per month= 25 days x 8 hrs = 200 hrs Total electricity charges shall be based on that. d. contingent expenses (Rent, transportation expense, telephone, postage and stationery etc. in Rs and Total working capital per month= A+B+C+D…………) 8. Total capital investment/ cost of the project a. Working capital p.m x 3 = Rs………….. b. Fixed capital = Rs…………. c. Preliminary expense = Rs…………. Total cost of the project = Rs…………. 9. Cost of production per annum a. Working capital p. m x 12 = Rs………… b. Depreciation = Rs………… c. Interest per annum on the total investment@15% = Rs……….. Total cost = Rs………… 10. Turnover per annum S.no Items Qty Value in Rs _____________________________________________________________ 1 A 35 tonnes ………………. 2 B 65 tonnes ………………. ____________________________________________________________________________ Total ………………….. ____________________________________________________________________________ 11. Profits Before tax Turnover per annum in Rs. – cost of production per annum=profit before tax 12. Break-even point (BEP) Total fixed cost BEP= ---------------------------- X 100 Total fixed cost + profit 13. Profitability ratio Profitability = Profit ---------------------- x 100 Turnover 14. Rate of return on investment Profit R = -------------------------- X 100 Total investment Name and address of the referees: 1. ___________________________ 2. ___________________________ 3. ___________________________
  26. 26. Ms. SONAM KAPIL (Lecturer MIT, MIET GROUP Meerut) Page 26 Signature of the applicant Place ____________ Date _____________ ___________________________________________________________________

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