Session 01-08

Overview: Decision making and

Project Appraisal

Sunny Kumar Singh

Assistant Professor,
K-212, Department of Economics & Finance,
BITS Pilani, Hyderabad Campus,
Phone:  +91 - 40 66 303 698
Mobile: +91 - 8009976001
Email: [email protected]

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Plan of the Presentation
_____________________________________________________________
Topics

 Decision Making and Project Appraisal

 Capital Expenditure
 Phases of Capital Budgeting
 Facets of Project Appraisal
 Feasibility Study
 Strategic Management Process
 Generation and Screening of Project idea

 Questions & Answers / Discussions?

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 The Statue of Unity Cost Rs 2,989 Crore. Here's What Else That Money Could
Have Bought
The statue could have instead funded two new IIT campuses, five IIM campuses and six ISRO missions to Mars.

Renting vs buying a house: Figures

don’t lie
3 min read . Updated: 27 Jun 2018, 12:19 PM IST Lisa
Pallavi Barbora
Personal preferences aside, the economic logic does not
support the buy option for real estate even today

Is Mumbai-Ahmedabad bullet train

really worth the cost?
For a country which runs nearly 10,000
trains every day to ferry more than 23
million passengers, equivalent to Australia's
entire population, a bullet train that will
carry a few thousand people could hardly be
called a sign of 'development'.
Karan Dhar        Last Updated: September 15, 2017
 | 14:09 IST
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Lives versus livelihoods: cost-benefit
analysis of lockdown needs to be done before
opening up

Are the mitigation efforts (population

level social distancing by restricting
economic activity and the mobility of people)
undertaken to slow the spread of COVID-
19 worth the economic cost?

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Decision Making Examples: Project
Appraisal
 Education Loan vs. Self-finance
 Buying vs. Renting Home/Vehicle
 Statue of Unity vs. Health/Education
Investment
 Government Literacy Program
 Infrastructure Project (Bullet Train): Public
vs. Private Players

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Decision Making: Project Appraisal
 Decision Making under Resource Constraint
 Individual’s objective vs. Society’s Objective
(Growth vs. Equity)
 Analysis of a Project (By Whom)
 Private
 Investor
 Lender
 Government Agency
 Public-Private Partnership (Examples – DND, Mumbai
Metro)

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Decision Making: Project Appraisal
 Tools for Analysis
 Capital Budgeting (Private Investors)
It is the process of evaluating and selecting long-
term investments consistent with the firm’s
goal of shareholders wealth maximization.
 Cost-benefit Analysis (Government Program)
It is a program/project assessment method that
quantifies in monetary terms the value, net social
benefits, of all program /project consequences for all
members of the society.

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Decision Making: Project Appraisal

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Capital Investments: Importance and
Difficulties
 Importance of Capital Expenditure Decision
 Long-Term Effects
 Irreversibility
 Substantial Outlays
 Decision making Difficulties in Capital
Expenditure
 Measurement Problem and Uncertainty
 Types of Capital Investment
 Physical, Monetary, and Intangible Investments
 Strategic (Truck to Car) and Tactical Investments
 Mandatory (BS-VI), Replacement (Robots), Expansion
(BITS) and Diversification Investments (ABG into Film)

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Phases of Capital Budgeting

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Phases of Capital Budgeting:
Implementation Stage

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Facets of Project Analysis
 Market Analysis
 Technical Analysis
 Financial Analysis
 Economic Analysis
 Ecological Analysis

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Facets of Project Analysis

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Key Issues in Project Analysis

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Key Issues in Major Investment
Decisions
 Convincing Investment Story
 Careful Risk Assessment
 Employing Discounted Cash Flow to judge
financial attractiveness of projects
 Financing Mix (Debt-Equity ratio to reduce
overall cost of capital)
 Impact on Short-term EPS (Key Indicator of
Firm Performance)
 Options or Flexibility (To delay, To expand, To
expand or contract the project)

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Project Feasibility Study: A Schematic
Diagram

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Strategy and Resources Allocation of a
Project

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Strategy and Resources Allocation of a
Project

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Grand or Corporate Strategy

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Grand or Corporate Strategy

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Growth Strategy: Concentration
Strategy

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Growth Strategy: Concentration
Strategy

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Concentration Strategy: Coca Cola
Example

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Strategies, Principle Motivations, and
Likely Outcomes

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Portfolio Strategy: BCG Matrix

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BCG Matrix: Pattern of Capital
Allocation

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BCG Matrix: Nestle Example

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Business level Strategy

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Business Level Strategy
 A strategy that seeks to determine how an
organization should compete in each of its
businesses (strategic business units).
 Low-cost provider: Based on exploiting economies of scale,
improving capacity utilization, tight control across entire
value chain, enhancing productivity of R&D, simplifying
product/service design etc.. Examples: Indigo, Walmart,
McDonald etc.
 Differentiation – Based on Quality, Customer Services,
Design, Unique features, Image of prestige or exclusivity
etc.. Examples: Apple, IBM, HP, Mercedes etc.
 Focus/Niche: Most effective when consumers have
distinctive preferences or requirements. Examples: Rolls
Royce, Harley-Davidson (Diff. Focused), Ikea (Cost Focused)

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Strategy of Cost Leadership: Dell
Computer

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Strategic Planning and Capital
Budgeting

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Generation of Project Ideas
 Success Mantra: Right business at right time
 Stimulating the flow of ideas
 SWOT Analysis
 Clear articulation of operational objectives
 Cost reduction, Productivity Improvement, Increase in
capacity utilization, Improvement in contribution
margin or Expansion into promising field
 Fostering a Conducive Climate
 To tap creativity and entrepreneurial urges
 Creativity (3M Corporation), Suggestion Scheme (HUL)

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Monitoring the External Environment:
Business Environment
 Economic Sector
 State of the economy; Overall rate of growth; Growth rate
of primary, secondary, and tertiary sectors; Cyclical
fluctuations; Linkages with the world economy
 Government Sector
 Industrial policy; Government programs and projects; Tax
framework; Subsidies, incentives, and concessions; Import
and export policies; Financing norms
 Technological Sector
 Emergence of new technologies; Access to technical know-
how, foreign as well as indigenous; Receptiveness on the
part of industry

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Monitoring the External Environment:
Business Environment
 Socio-demographic Sector
 Population trends; Age shifts in population; Income
distribution; Educational profile; Employment of women;
Attitudes toward consumption and investment
 Competition Sector
 Number of firms in the industry and the market share of the
top few; Degree of homogeneity and differentiation among
products; Entry barriers; Comparison with substitutes in
terms of quality, price, and functional performance;
Marketing policies and practices
 Supplier Sector
 Availability and cost of raw materials and sub-assemblies;
Availability and cost of energy; Availability and cost of money

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Corporate Appraisal
 A realistic appraisal of corporate strengths and
weakness is essential for identification of
investment opportunities which can be
profitably exploited.
 The broad areas of corporate appraisals are:
 Marketing and Distribution
 Market image; Product line; Market share; Distribution
network; Customer loyalty; Marketing and distribution costs
 Production and Operations
 Condition and capacity of plant and machinery; Availability
of raw materials, sub-assemblies, and power; Degree of
vertical integration; Locational advantages; Cost structure

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Corporate Appraisal
 The broad areas of corporate appraisals are:
 Research and Development
 Research capabilities of the firm; Track record of new
product developments; Laboratories and testing facilities;
Coordination between research and operations
 Corporate Resources and Personnel
 Corporate image; Clout with governmental and regulatory
agencies; Dynamism of top management; Competence and
commitment of employees; State of industrial relations
 Finance and Accounting
 Financial leverage and borrowing capacity; Cost of capital ;
Tax situation; Relations with shareholders and creditors;
Accounting and control system; Cash flows and liquidity

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Tools for Identifying Investment
Opportunities: Porter Model

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Tools for Identifying Investment
Opportunities: Porter Model

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Porter’s Five Forces: PC Industry
Example
In the PC market there is hardly any product differentiation,
switching cost high, and capital required to set up is huge.
Intel’s microprocessor chips are used in approx. 80% of
personal computers. Microsoft operating system are used in
90% of computers. Microsoft and Intel control the majority
of PC supplier market. For PC buyers personal computer is
becoming commodity like item. More and more people are
building their own computer system. Every big company
like HP, DELL, HCL, Lenovo fights and wants to be market
leader. With lack of differentiation, major players are
fighting for the price. Product that are similar functions to
PC includes PDA (Personal digital assistant), Smart phone,
Palm tops (Handheld PC).

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Tools for Identifying Investment
Opportunities: Product Life Cycle
Approach

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Tools for Identifying Investment
Opportunities: Product Life Cycle
Approach

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Tools for Identifying Investment
Opportunities: Experience Curve

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Scouting for Project Ideas
 Sources to identify good project:
 Analyze performance of Existing Industry (Profit, Capacity
Utilization, Risk)
 Examine the Inputs and Outputs of Various Industries
(Ease of Obtaining Inputs, Scope for integration)
 Review Imports and Exports (Potential for Import
Substitution, export possibilities)
 Government Guidelines (Potential demand for goods and
services required by different sectors, Guidelines to
Industries, GoI – Information about Structure & Location,
Production Performance, Capacity, Export and future scope
of various industries)

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Scouting for Project Ideas
 Sources to identify good project:
 Follow up Financial Institutions Scheme (Scheme by SIDBI,
IDBI, State Finance Corporation, FICCI etc.)
 Investigate Local Material and Resources ( Raw material,
Infrastructure, Labor Skill )
 Analyze Economics and Social Trends (Mall Culture, Eating
Out, Health Product etc.)
 Study New Technological Developments (examine R&D in
Product/Process for profitable commercialization)
 Identify Unfulfilled Psychological Needs (esp. FMCG sector)

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Preliminary Screening
 Preliminary screening aspects:
 Compatibility with the promoter (to get funds)
 Consistency with governmental priorities (National Goals,
Regulations, Licensing, Envi. Reg. etc.)
 Availability of inputs (Raw material availability, Technical
Knowhow, Power supply etc.)
 Adequacy of market (Market Share and Competitors,
Sales and distribution, Future consumption projection,
Entry Barrier, Socio-economic Trends etc.)
 Reasonableness of cost (Input Cost, Marketing Cost,
Service Cost etc.)
 Acceptability of risk level (Scope of Competition,
Business cycle, Shift in consumer preferences etc.)

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Project Rating Index
 Steps involved in determining the project
rating index:
 Identify factors relevant for project rating
 Assign weights, based on relative importance, to
these factors
 Rate the project proposal on various factors, using
a suitable rating scale (5-point scale or 7-point
scale)
 Multiply factor weight with rating to get factor score
 Add all the factor scores to get the overall project
rating index

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Project Rating Index: Example

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Sources of Positive Net Present Value
 There are six main entry barriers that result
in positive NPV projects:
 Economies of Scale
 Product Differentiation
 Cost Advantage
 Marketing Reach
 Technological Edge
 Government Policy

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Plan for the Next Session

 Market and Demand Analysis

 Read: Chapter 4, Prasanna Chandra (2014)

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Weaknesses in Capital Budgeting
 Poor Alignment between Strategy (based on
vision and mission) and Capital Budgeting
 Deficiency in Analytical Techniques
 The base case is poorly identified (What happens
to the firm without the project)
 Risk is treated inadequately (Scenario Analysis)
 Options are not properly evaluated
 Weak integration between capital budgeting
and expense budgeting

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Dedication

When you share your wealth with others, your own wealth shrinks.
When you share your knowledge with others, your own knowledge increases.
~ Chanakyā

These slides are dedicated to you all. You are free

to use it and to distribute it to any student of
economics; but for heaven’s sake, though you all
are students of a business school, do not make
any business out of it!

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