Project Analysis & Management PDF

INFOLINK UNIVERSITY COLLEGE Project Analysis & Management Instructor: Ashenafi N.(Ass.Pro.) 1  Chapter One GENERAL INTRODUCTION 2  GENERAL INTRODUCTION 3 OBJECTIVES After studying this chapter, you should be able to:  Define...

INFOLINK UNIVERSITY COLLEGE Project Analysis & Management Instructor: Ashenafi N.(Ass.Pro.) 1  Chapter One GENERAL INTRODUCTION 2  GENERAL INTRODUCTION 3 OBJECTIVES After studying this chapter, you should be able to:  Define project and project Management  State the features of a project LEARNING  Differentiate Projects and Plans What is a Project? 4  In order to understand project management, it is essential to first define the term project. In fact, there is no universally accepted definition for the word project that can serve for all situations.  In this chapter, however, a project is defined as ◼ “… a temporary endeavor involving a connected sequence of activities and a range of resources, which is designed to achieve a specific and unique outcome, which operates within time, cost and quality constraints and which is often used to introduce change (Lake). Conti… 5  Turner defines a project as “…. An endeavor in which human, (or machine) material and financial resources are organized in a novel way, to undertake a unique scope of work, of given specification, within constraints of cost and time, so as to deliver beneficial change defined by qualitative and quantitative objects. Conti… 6 Conti… 7  According to Kerzner, a project can be considered to be any series of activities and tasks that: ◼ Have a specific objective to be completed within cer tain specifications ◼ Have defined start and end dates ◼ Have funding limits (if applicable) ◼ Consume human and non-human resources (i.e., money, people, equipment) ◼ Are multifunctional (i.e., cut across several functional lines) Conti… 8  Successful project management can then be defined as having achieved the project objectives: ◼ Within time ◼ Within cost ◼ At the desired performance/technology level/ ◼ While utilizing the assigned resources effectively and efficiently ◼ Accepted by the customer Conti… 9  According to Maylor Harvey, a project can be defined as a non- repetitive activity. This needs to be augmented by other characteristics:  It is goal oriented.  It is being pursued with a practical end or goal in mind.  It has a practical set of constraints-usually centered around time and resource  The output of the project is measurable  Something has been changed through the project being carried out Conti… 10  The purpose of a project is to meet the stakeholders’ needs and expectations.  It is therefore a fundamental requirement for the project manager to establish  Who are the stakeholders and analyze their needs expectations to define, at the outset, the project’s scope of work and objectives. Features of a project 11  A project is a sequence of unique, complex, and connected activities having one goal or purpose and that must be completed by a specific time, within budget, and according to specification.  Sequence of activities: A project comprises a number of activities that must be completed in some specified order, or sequence.  Unique activities: The activities in a project must be unique. A project has never happened before, and it will never happen again under the same conditions. Conti… 12  Complex activities: The activities that make up the project are not simple, repetitive acts, such as painting the house, washing the car, or loading the delivery truck. They are complex. For example, designing an intuitive user interface to an application system is a complex activity.  Connected Activities: Connectedness implies that there is a logical or technical relationship between pairs of activities. There is an order to the sequence in which the activities that make up the project must be completed. They are considered connected because the output from one activity is the input to another. Conti… 13  One goal: Projects must have a single goal. Very large or complex projects may be divided into several subprojects, each of which is a project in its own right. This division makes for better management control.  Specified Time: Projects have a specified completion date. This date can be self-imposed by management or externally specified by a customer or government agency. The deadline is beyond the control of anyone working on the project. The project is over whether or not the project work has been completed. Conti… 14  Within Budget: Projects also have resource limits, such as a limited amount of people, money, or machines that are dedicated to the project. Senior management can change the number of resources, but that luxury is not available to the project manager.  According to Specification: The customer, or the recipient of the project's deliverables, expects a certain level of functionality and quality from the project. These expectations can be self-imposed, such as the specification of the project completion date, or customer-specified, such as producing the sales report on a weekly basis. Project Parameters 22  During a project's life, management focuses on three basic parameters: quality, cost, and time. Traditionally, it is said that a successfully managed project is the one that is completed at the specified level of quality, on or before the deadline, and within the budget.  Depicted in the next power point is the interrelationship among the traditional parameters measuring project success. Conti… 23 Project Vs. Program 25  A project is normally originated from a plan which can be a national plan or corporate plan.  In many cases the term project is used for what should be termed as program or work package.  Some people use the term ‘project’ and ‘program’ interchangeably. However, there is a quite difference between the two. Conti… 26  Program in general is a groups of related projects that are managed in a coordinated ways to achieve certain objective. Any development plan can be considered as a program  A program is thus,  larger in scope,  activity oriented  not necessarily time bound and  its objectives are broader Conti… 27  Example, ◼ The national goal: Poverty Eradication ◼ Strategy: Increase productivity (in all sectors) ◼ Development program: Increase agricultural productivity  This may result in a number of projects like,  Constructionof dams (irrigation infrastructure)  Upgrading the skill of agricultural practices  Construction of training centers  Health program may have a number of projects like,  Construction of hospitals  Training of health officers  Expansion of health centres  Program and Projects hierarchy 28 Plan : National, Regional or company plan with development target Program: Specific program within the frame of national or regional plan (health, education) Project: School project, Power plant or housing project Work Package : Water supply and distribution package, Power supply and distribution package Task: Award of water supply contract, Construction of foundation Activity Classification of Project 29  Project can come in many size and form. They may be very simple or complex. Major project types are two. These are,  Revenue project: Are those which can be carried out within the normal organizational structure and normally will be completed within the a single accounting period.  Capital Project: Are those which can not be carried out within the normal organizational structure and are normally stretched over a number of accounting periods.  In practice many projects fall between these two broad categories Conti… 31  In general projects be it revenue or capital can be classified from different perspectives. a) On the basis of time horizon project can be Long term projects: Power plant project Medium term projects: Construction of a factory Short term project: Exhibition,trade fair Conti… 32 b) On the basis of the type of output: Project producing tangible Products: Oil mill Project providing services: Telecom project, Education etc. c) On the basis of the scope of the project: International project: Euro tunnel project National Project: Eth Hydro power project Regional Project: Elementary school project d) Based on the economic sector: Agricultural project: Irrigation project Industry project: Cement Project Service sector project: Bank projects Conti… 33 e) On the basis of technology: Capital intensive project: Brewery project Labour intensive project: Textile industry project f) Based on location: Rural Projects Urban project g) On the basis of the nature of the project Independent project: Hospital, Hydroelectric power Complementary project: Airport project, Run Way and airport services are different projects which are complementary to each other.  Chapter Two PROJECT CYCLE 35  PROJECT CYCLE 36 OBJECTIVES After pursuing this chapter, you should be able to:  Define Project Cycle  Describe the World Bank Project Cycle L EARNING  Explain European Aid Project CycleApproach An Overview of Project cycle 37  A project passes through a number of life cycles called project cycle. ◼ What is project cycle?  Project Cycle: Is the various stage through which project proceed from inception to implementation. It is a stage which project advance from inception to maturity stage.  Conti… 38  Some authors (Choudhury 2005) presents the projects life cycle in to the life cycle curve ◼ Inception (concept, definition, organizing etc.) ◼ Maturity ( implementation ) ◼ Decay (clean up) Decay (Clean Level Inception up ) of effort Maturity or Implementation Time Conti… 39  A project cycle covers all the steps necessary to bring a project to the point where its technical, economic and financial feasibilities have been established and it is ready for appraisal.  Each stage follows the proceeding one and leads to the next  These different phases are identified by different institutions and authors. Some of the phases as identified by different authors are: The Baum Cycle (World Bank Procedures) 40  Baum (1970) model is the first basic model of a project cycle which has been adopted by the World Bank.  According to this model a project cycle consists of the following five stages ◼ Identification ◼ Preparation ◼ Appraisal and Selection ◼ Implementation ◼ Evaluation  Later in 1978, the author has added additional two stages called “Negotiation” and "Evaluation”. The European Commission/Europe Aid Approach 41  This approach consists of six phases and has been considered as the most recent approach developed as guidelines for development projects ◼ Programming ◼ Identification ◼ Appraisal ◼ Financing ◼ Implementation ◼ Evaluation The UNIDO Project Cycle 42  The UNIDO has established a project cycle comprising the following three distinct phases: ◼ 1. The pre - investment phase ◼ 2. The investment phase, and ◼ 3. The operating phase Conti… 43  However, in most literature and guide books the stages or phases of projects are divided into six phases and this approach are preferred in this discussion: ◼ Identification ◼ Pre-feasibility study ◼ Feasibility study ◼ Selectionand project design ◼ Implementation ◼ Ex-post evaluation I. Identification 44  Project starts by generating potential idea that can be converted into a meaningful project. It involves finding project’s idea, which could contribute towards achieving specified business/development objectives.  In many cases many projects start as a simple idea and later on it may grown up into a full-fledged project.  Identification of promising investment (projects) oppor tunities requires ◼ imagination, ◼ sensitivity to environmental changes, ◼ And a realistic assessment of what the firm can do Conti… 46  Generally, the idea for project may come from the following sources  From the need to make profitable use of available resources ( this is for resources based projects)  Market based projects arise from an identified demand in home or overseas market  Need based project may arise from the need of community (company) to make available some basic materials (services) requirements. Conti… 47 Project ideas can also emanate from government policy and plans From technical specialists like, entrepreneurs and local leaders are also common sources of projects. ◼ Technical specialists and entrepreneurs can identify many areas where they feel new investment might be profitable. Conti… 48  In general, the sources of project ideas can be broadly classified into, 1. Macro-level  National policies, strategies, sectoral, sub-sectoral or regional plans  General surveys which includes resource potential surveys, regional studies, master plan and statistical publications, which indicate directly or indirectly investment opportunities. Conti… 49  Constraints on the development process due to shortage of essential infrastructure facilities  Unusual events such as,  droughts,  floods,  earth – quakes, hostilities, etc.  From multilateral or bilateral development agencies and as a result of regional or international agreements in which the country participate.  Conti… 50 2. Micro Level:  The identification of unsatisfied demand or needs  The need to remove shortages in  essential materials,  services or  facilities that constrain development efforts;  The initiative of private or public enterprises in response to incentives provided by the government;  The necessity to complement or expand investments previously undertaken. And the suggestions of financial institutions and development agencies Study of new Technological Development II. Pre feasibility study 51 ❖ After we have identified project ideas the next step is project preparation and analysis. Project preparation includes both Pre-feasibility and Feasibility studies Once a project idea is identified a preliminary project analysis will be done ( i.e., pre-feasibility study). Which means the project idea must be elaborated in sort of study. Conti… 53  Some of the main components examined during the pre-feasibility study include:  Availabilityof adequate market (or beneficiaries)  project growth potential  investment costs, operational cost and distribution costs  demand and supply factors; and  social and environmental considerations  If the project is appeared to be sound the next stage is a feasibility stage III. Feasibility study 54  Pre – feasibility study should be viewed as an intermediate stage.  A feasibility study should provide all data necessary for an investment decision ◼ The commercial, ◼ Technical, ◼ Financial, ◼ Economic and ◼ Environment  for an investment project should be defined and critically examined. Conti… 57  Finally, the feasibility report should include (but not limited) the following analysis: ◼ Market analysis ◼ Technical analysis ◼ Organizational analysis ◼ Financial analysis ◼ Social – economic analysis, and ◼ Environmental analysis IV. Selection (project appraisal) 58  The feasibility study would enable the project analyst to select the most likely project out of several alternative projects. Selection follows, and often overlaps with the feasibility analysis.  It addresses the question ◼ is the project worthwhile?  A wide range of appraisal criteria have been developed to judge the benefits of a project. The criteria are divided into two broad categories. ◼ non-discounting criteria and ◼ discounting criteria. Conti… 59  After a project has been prepared, it is appropriate to forward for a critical review (external review)  This provides an opportunity to re-examine every aspect of the project plan to assess whether the proposal is appropriate and sound before large sums are committed  Projects, appraisals cover the following aspects, a) Technical – here the appraisal concentrate in verifying whether the proposal will work in the way suggested or not. Conti… 60  b) Financial – this will try to see  if money needed for the project have been calculated property,  their sources are all identified,  and reasonable plans for their repayment are made where necessary.  c) Commercial –  the way the necessary inputs for the project are supplied  and the arrangements for the supply of the products are verified Conti… 61  d) Incentive – whether things are arranged in such a way that all those whose participation is required will find it in their interest to take part in the project, at least to the extent envisaged in the plan.  e) Economic – the appraisal here tries to see whether what is proposed is good from the perspective of the national economic development.  The effects (positive and negative) are taken into account and check if all are correctly valued Conti… 62  f) Managerial – this aspect of the appraisal examines if the capacity exists for operating the project and see if those responsible ones can operate it satisfactorily.  Moreover, it tries to see if the responsible are given sufficient power and scope to do what is required.  g) Organizational – the appraisal examines the project how it is organized internally and externally. Conti… 63  This helps to see if arrangement and its organization allow the proposals to be carried out properly and to allow for change as the project develops.  These issues are the subjects of specialized appraisal report. And on the basis of this report, financial decisions are made – whether to go ahead with the project or not. V. Implementation 64  The objective of any effort in project planning and analysis is to have a project that can be implemented to the benefit of the society.  After the project prepared and evaluated the next step is implementing the project. Implementation is the most important part of the project cycle.  In this stage, ◼ funds are actually disbursed to star t the project and keep running ◼ contracts are signed Conti… 65  A major priority during this stage is to ensure that the project is carried out in the way and within the period that was planned.  During the project implementation stage, the following important points should be considered: ◼ Allthe stages of implementation should be completed with in the time schedule allotted. Conti… 66  The output stream should be the same as contemplated. The physical targets are to be realized with in the financial allocation.  Project analysts (manager) must keep an eye over changes in ◼ technology, ◼ taste, ◼ price, ◼ profitability etc.  In the case of private investments, profitability is to be so insured that investment funds are expected from within. Conti… 67  However, problems frequently occur when the economic and financial environment at implementation differs from the situation expected during appraisal.  For example, price or political environment may change.  Due to these facts, project implementation must be flexible and original proposals are modified frequently to capture these changes. Conti… 68  Generally, project analysts divide the implementation phase into three time periods  The investment phase, where the major investments are made. This may extend from three to five years.  The development phase which may also extend from three to five years.  The project life. Conti… 69  The implementation phase for an industrial project consists of several stages: (i) project and engineering designs, (ii) negotiations and contracting, (iii) construction (iv) training, and (v) plant commissioning. VI. Ex-post evaluation 70  The final phase in the project cycle is evaluation.  Once a project has been carried out the actual progress with the plans should be evaluated in order to judge whether the decisions and actions taken were responsible and useful.  However, evaluation is not limited only to completed projects. Conti… 71  Ongoing projects could also be evaluated to find solutions for problems when the project is in trouble.  The evaluation may be done by, ◼ the project management, ◼ the sponsoring agency, ◼ or other bodies.  Moreover, evaluation should be under taken when a project is terminated or is well into routine operation. Conti… 72  Some of the benefits which can be obtained from evaluation are,  The reality of the assumptions that were made will be evaluated;  It provides an experience that is highly valuable in future decision making  It suggests corrective action to be taken in the light of actual performance;  It helps in uncovering judgment biases;  It induces a desired caution among project sponsors. Conti… 73  Generally, weakness and strengths should carefully be noted so as to serve as important lessons for future project analysis undertaking.  Chapter Three PROJECT IDENTIFICATION 75  PROJECT IDENTIFICATION 76 After completing this chapter, you should be able to: OBJECTIVES  Explain the Project Idea  Describe the sources of Project Ideas: Macro and Micro sources LEARNING Conti… 77  The search for promising project idea is the first step towards establishing a successful venture.  As traditional saying goes ◼ “ the key to success lies in getting into the right business at the right time”  Identification of meaningful project idea requires, ◼ Imagination ◼ Sensitivity to environmental changes ◼ Realistic assessment of what a firm or organization can do Conti… 78  While the notion of identification is simple it is difficult to develop methods or procedure for accomplishing it  However, there are cer tain broad guidelines which are helpful in the generation and screening of project ideas Conti… 79  Project identification commonly follows the following procedure ◼ 1. Generation of ideas ◼ 2. Monitoring the environment ◼ 3. Corporate appraisal (self-assessment) ◼ 4. Preliminary screening ◼ 5. Project rating index 3.1. Generation of ideas 80  Most of the new projects ideas are a result of  Once specialized technical knowledge or  Marketing expertise or  Some other competence Conti… 81  To stimulate the flow of project idea the following are helpful i. Analysis of Strength, Weaknesses, Opportunities and Threats (SWOT): ◼ SWOT analysis represents a conscious and deliberate , and dynamic effort by an organization to identify opportunities that can be exploited ◼ Periodic SWOT analysis facilitates the generation of new idea Conti… 82 ii. Clear articulation of objectives The operational objectives of the organization may help to generate ideas The operational objective of business firm for example, ◼ Cost reduction ◼ Productivity improvement ◼ Increase in capacity ◼ Expansion and growth Can be helpful in generating the project idea MACRO AND MICRO SOURCES  Projects are expected to contribute towards the attainment of specified development objectives.  Project identifications endeavors should be seen as an integral part of the macro-planning exercise.  Project identifications need to be carried out within national, regional, and sectoral development framework and existing policies including pricing, taxation, and subsidy. Conti…  Impossible to prepare an exhaustive list of sources – much depends on the experience and imagination of those entrusted with the task of initiating development projects.  We can distinguish two levels where project ideas are born: macro sources and micro sources. MACRO SOURCES  Major Macro Sources:  Federal/Central or Regional Governments  Bilateral and Multilateral Agreements  International Development Agencies Conti… Other Macro Sources:  National policies, strategies, and priorities ar ticulated by government from time to time.  National, sectoral, sub-sectoral, or regional plans and strategies (supplemented by special opportunity studies).  General surveys, resource potential surveys, regional studies, master plan and statistical publications, which indicate directly or indirectly investment opportunities.  MICRO SOURCES 102  Micro sources of project ideas includes  Privateand Public Enterprises;  Local Groups or Organizations;  Consumer Groups and Associations;  Financial Institutions/Credit Associations;  Cooperatives, Farmers’ Unions, etc;  New Technology Suppliers, and even individuals. Conti… Driving forces behind:  Identification of unsatisfied demand or needs;  Existence of unused or underutilized natural or human resources and the perception of opportunities for their efficient use;  Need to remove shortages in essential materials, services, or facilities that constrain development efforts;  Initiatives in response to incentives provided by the government;  Necessity to complement or expand investments previously undertaken;  Desire of local groups (or organizations) to enhance their economic status and improve their welfare. 3.2. Monitoring the environment 83  The organization must systematically monitor the environment in which it will operate  In other words the organization is expected to monitor the following key environmental factors in relation to each of identified ideas  1. Economic aspects ❖ State of the economy ❖ Possible fluctuation in the economy ❖ The degree of integration with the world economy Conti… 84 2. National policy ◼ Sectoral policy ◼ Government program ◼ Tax policy ◼ Government support ◼ Financial policy 3. Technological factor Availability of technology Accessibility of the available technology Conti… 85 4. Socio demographic factor Population size and distribution Education level 5. The nature of competition (for business firms) Number of firms in the industry Nature of entry 6. Nature of input supply Availability Cost of raw material 3.3. Self assessment and scouting the project idea 86  A realistic appraisal of the organization’s strength and weakness is essential to select the best idea that can be realized as a successful venture.  To screen the project idea in terms of this aspect the following suggestions are helpful Conti… 87 ▪ A. Analyze the industry (sector) and the organization in terms of, ▪ Its capacity (i.e., whether the organization has the capacity to implement or to put into practice the proposed idea) ▪ Analyze the project in term of the benefit (profit) that it will provide to the society (firm) Conti… 88 ▪ B. Examine the input or resources requirement and firms ability to make it available ▪ C. Review its innovativeness ▪ D. Study government plan, outlays, and guidelines: This analysis is important because; ◼ It will help to see if the idea is in line with the government priority area ◼ To check if there are guideline that need to be followed if the project idea is acceptable. ▪ E. Suggestion of financial institutions and development agencies. (that is investigating priority area of development agencies) 3.4. Preliminary screening 89  In some case it is possible to have a long list of project ideas.  In such cases some kind of preliminary screening is required to eliminate ideas which are not promising.  For that purpose the following aspects could be looked into  A. Compatibility with the promoter: The idea should be compatible with ◼ thevision, ◼ mission, ◼ and goal of the promoter Conti… 90 In business venture, it should be compatible with the owner’s objective. In other words, It has to fit with the personality of the owner Acceptable to the firm’s owner It offers the prospect of rapid growth and high return  B. Consistence with government priority: Evaluate the project idea in terms of the government priority. Here we ask questions like, Is the project consistent with the national goal and priority? Are there any environmental effect? Will there be any difficulty to obtain permission? Conti… 91  C. Availability of inputs  D. Adequacy of the market  E. Cost of the project  F. Acceptability of risk level: The desirability of the project idea depends upon the level of risk associated with it  When a large number of project ideas are evaluated, it may be helpful to streamline the process of preliminary screening. 3.5. Project rating index 92  For that purpose a preliminary evaluation may be translated into a project rating index.  Steps involved in the process of the project rating index are, ◼ Identify factors relevant for project rating ◼ Assign weight to those factors (the weight are suppose to reflect their relative importance) ◼ Rate the proposed idea on various factors using a suitable rating scale (typically a 5-7 point scale is used) ◼ For each factor, multiply the factor rating with the factor weight to get the factor score ◼ Add all the factor score to get the overall project rating index  Factor VG G A P VP Factor Factors weight 5 4 3 2 1 score Input availability 0.25 X 0.75 93 Technical know how 0.1 X 0.40 Reasonableness of cost 0.05 X 0.20 Adequacy of market 0.15 X 0.30 Complementary relationship 0.05 X 0.20 Stability 0.1 X 0.5 Dependency on firm’s 0.2 X 0.2 strength Consistency with government 0.1 X 0.1 policy Total 1.00 3.15  Group Assignment (50%) - Project Proposal Writing 105 This is a group assignment and you form a group containing 4-5 members and take any one of the following project ideas and write a project proposal.  1. Five star hotel  2. Leather processing factory  3. waste recycle project  4. small scale solar energy technology project  5. a railway project  6. franchising soft drinks factory project  7. supermarket with mail service project and others based on the group interes (Use the guide line provided) Late submission Date: Reflections  CHAPTER FOUR CAPITAL BUDGETING AND INVESTMENT DECISION CAPITAL BUDGETINGAND INVESTMENTDECISION OBJECTIVES LEARNING Introduction to capital budgeting ▪ The aim of this chapter is about the ranking of projects for the decision of whether or not they should be accepted for inclusion in the capital budget. ▪ The term capital refers to the fixed assets used in production, while a budget is a detailed plan of projected cash flows during some future period. Thus, the capital budget of a firm outlines the planned expenditures for fixed assets, and ▪ Capital budgeting is the whole process of analyzing projects whose returns are expected to extend beyond the period of one year and deciding which project should be included in the capital project. Conti... ▪ Capital budgeting expenditures include expenditures for land, building, equipment, and for permanent additions to working capital associated with plant expansion, for advertising and promotion campaigns, and for research development programs. ▪ Capital budgeting is a sound procedure to evaluate, compare, and select projects. ▪ It is the process of identifying and selecting investments in long- lived assets, or assets expected to produce benefits over more than one year. Feature of capital Investments It requires large cash outlays. It involves commitment of large amount of funds. It influences long-term profitability of the firm. A wrong decision could result in heavy losses. It cannot be changed once a firm has committed itself to a capital expediters. It cannot reverse its decision without incurring a heavy loss. It requires attention of top managements and special skills and efforts as capital investment decision affect the mix and direction of business and therefore top management mustover see them. Conti...  It is a difficult decisions and require careful assessment of demand, supply, customer’s attitudes and competitor’s reaction etc estimating costand benefits. Types of Capital Expenditure  1. Cost Reduction Projects (Replacement projects) The cost reduction objective may be achieved through the replacement of old plants or fixed assets with new ones. The benefits from cost reduction projects are reflected in terms of costsavings.  2. Revenue Expansion Projects: its main purpose is to increase the volume of sales (revenue). Conti...  3. Non-Revenue Producing (Mandatory) Investments: are safety and/or environmental protection projects that are necessary for complying with government orders, labor agreements, or insurance policyterms.  Investment Analytical Tools/Capital budgeting decisions rules (Techniques) ▪ Generally, the project evaluation techniques are classified into two categories. ▪ I. The traditional technique /Non discounted cash flowTechniques: 1. Pay backrule 2. Accounting Rate of Return (ARR) ▪ II. Discounted cash flow Techniques: 1. Net present value (NPV) 2. Profitability index (PI) 3. Internal rate of return (IRR) I. The traditional technique /Non discounted cash flow Techniques: ▪ I. Pay Back period Method: It is also termed as "Pay- out period" or Pay-off period. ❑ Under this method the focus is on the recovery of original investment at the earliest possible. ▪It determines the number of years to recoup the original cash out flow, disregarding the salvage value and interest. Conti... ❑ The decision rule under the Pay Backmethod ◼ Accept the project if project’s PB< standard PB ◼ Reject the project if project’s PB> standardPB ▪ Calculation of Pay-back Period: Pay-back period can be calculated into the following two different situations: i) In the case of equal cash inflows: Pay back period = Cashoutlays(Initial Investments) Annual Cash inflows  Illustration: A project requires initial investment of Br. 40,000 and it will generate an annual cash inflows of Br. 10,000 for 6 years. Youare required to find out pay-back period.  Solution: Calculation of Pay-back period : Pay back period = Br. 40,000 = 4 years Br. 10,000 ❑ Pay-back period is 4 years, i.e., the investment is fully recovered in 4 years. ▪Decision rule: Shorter is the payback period better is the project (ii) In the case of uneven or unequal cash inflows: ▪ In the case of uneven or unequal cash inflows, the Pay-back period is determined with the help of cumulative cash inflow. It can be calculated by adding up the cash inflows until the total is equal to the initial investment.  Illustration: From the following information you are required to calculate pay-back period: A project requires initial investment of Br. 40,000 and generate cash inflows of Br. 16,000, Br. 14,000, Br. 8,000 and Br.6,000 in the first, second,third, and fourth year respectively. Solution: ▪ Calculation Pay-back Period with the help of "Cumulative Cash Inflows" Conti... Year Annual cash inflows Br. Cumulative cash inflows Br. 1 16,000 16,000 2 14,000 30,000 3 8,000 38,000 4 6,000 44,000 Cont.  1. Unequal cash flows  Payback= year before full recovery + unrecovered cost at start of year Cash flow during year ▪ Decision rule: Shorter is the payback period better is the project Conti…  The above Table shows that at the end of 4th years the cumulative cash inflows exceeds the investment of Br. 40,000. Thus the pay- back period is as follows:  Pay Back Period= 3 years + Br.40,000 - Br.38,000 Br.6,000 = 3 years + Br.2,000 Br.6,000 = 3.33 years Conti...  Illustration: From the following information advice the management as to which project is preferable based on pay-back period. Two projects X and Y, each project require an investment of Br30,000. The standard cutoff period for the companyis 5 years.  (Net profit before depreciation and after tax) Year Project X Project Y 1 10,000 8,000 2 10,000 8,000 3 4,000 14,000 4 6,000 6,000 5 8,000 7,000 Conti... Solution: Calculation of Pay-backPeriod ▪ Project X = ▪ Br.10,000 + Br.10,000 + Br.4,000+Br.6,000 = Br 30,000 is recovered in 4th Year ▪ Project Y= ▪ Br8,000 + Br8,000 + Br14,000 = Br30,000 is recovered in 3rd Year ▪ The Pay-back period of project X and Y are 4 years and 3 years respectively and thus project Y should be preferred because it has a shorter pay-back period. Conti...  Advantage of payback period It is simple to understand and easy to calculate It facilitates to determine the liquidity and solvency of a firm It enables the firm to select an investment which yields a quick return on cash funds It used as a method of ranking competitiveprojects Conti…  Weaknesses of Payback: It Ignores the time value of money. This method does not consider income beyond the pay-back period It does not measure the profitability of aproject 2. Accounting Rate of Return orAverage Rate of Return (ARR) method /ROI ▪ This method focuses on the average net income generated in a project in relation to the project's average investment outlay. ▪ Here, instead of taking the annual cash flows, we take the annual profits into account. ▪ TheARR is found out by dividing the average profit after- tax by  the average investments.  ARR = Average profit after tax × 100 Average investment Conti… ▪ Average profit after tax = Total of profit after taxes Number of years ▪ Average investment would be equal to the Original investment plus salvage value divided by Two ▪ Average cost of Investment= Original costs or Inv’t+ salvagevalue 2 Conti…  Illustration: Consider the project that has the original investment of Br. 70,000 Br, the life of 4 years, and the salvage value of Br. 6,000 at the end of year 4. The straight line method of depreciation is used. Income before depreciation and taxes are Br. 40,000 for year 1, Br. 42,000 for year 2, Br. 36,000 for year 3, and Br.50,000 for year 4.  Determine the accounting rate of return if income tax rate on the project is 40 percent. Conti... Solution: ▪ Average investment = (70,000+6000)/2 = Br.38,000 ▪ Annual depreciation = (70,000-6,000)/4 = Br.16,000 ▪ Then compute the new profit for each year during the four years. Conti... Year 1 Year 2 Year 3 Year 4 Income before depr. & taxes 40,000 42,000 36,000 50,000 Less: Annual depreciation 16,000 16,000 16,000 16,000 Income before taxes 24,000 26,000 20,000 34,000 Less: Income taxes (40%) 9,600 10,400 8,000 13,600 Net profit 14,400 15,600 12,000 20,400 Conti...  Then we compute the average Net Profit during the four years.  Average net profit =  (14,400+15,600+12,000+ 20,400)/4 = Br.15,600  Hence, ARR = Average Annual net profit= Average cost of investment Br15, 600 Br 38,000 = 0.41 or 41%. Conti... ▪ This is to mean that for an average of Br.1 invested in this project, there is an average return of 41 cents in the form of net profit per year over the entire four years of the life of theproject.  The decision rule under the ARR method: The ARR is compared to the predetermined rate. The project will be accepted if the actual ARR is higher than the desired ARR. Otherwise it will be rejected ◼ Assume in previous case that the desired ARR was 30%. Since the actual ARR is $, 41% the project is accepted. Conti... Advantage Easy to understand and calculate Give more weight age to future receipt  Disadvantage Ignores the time value of money Does not use cashflows No objective way to determine the minimum acceptable rate of return. II.The Discounted Cash flow Criteria (Techniques)  These techniques employ the time value of moneyconcept.  1. Net Present Value It is the difference b/n the present value of investments cash inflows (market value) and the present value of its cash outflows (its cost). NPV is the measure of how much value is created or added today by undertaking an investment. The capital budgeting process can be viewed as a search for investments with positiveNPVs. NPV= - CF0 + CF1 + …..+ CFn 0 1 n Conti... ▪ To use this method properly, the following procedures are followed. Find the present value of each cash flow, including both inflows and out flows using the cost of capital of the project for discounting. Sum the discounted cash inflows and the discounted cash outflows separately. Obtain the difference between the sum of the cash inflows and outflows. Decision rule for the NPV method: In general, the decision rule is: Accept the project if the net present value is positive Reject the project if the net present value is negative If the NPV is zero, it is a matter of indifference ▪ If the projects, on the other hand, are mutually exclusive, the one with the higher positive NPV should be accepted leading to the rejection of the projects with lower positive NPV. Conti... ▪ If the project has a positive NPV, it is generating more cash than needed to service its debts and to provide the required rate of return to the shareholders, and this excess cash accrues solely to the firm's shareholders. Conti... ▪ Illustration: Assume that a given project is expected to have an initial investment and project life of Br.40,000 and 5 years respectively. The annual after-tax cash flow is estimated at Br.12,000 for each one of the five years. Using the required rate of return of 10 percent.  Required: A. What is the net presentvalue (NPV) of theproject? B. How do you judge the acceptability of this project?  Solution. In the case of this project, there are annuity cash inflows of 12,000 every year for five years and single cash out flow of 40,000 at time zero. Conti...  The present value of the annuity cash outflows is:  Present value of annuity = (12,000) Annuity factor)  The annuity factor is 3.791 PVA = (12,000) (3.791) = 45,492Birr ▪ PV of Cash out flows = 40,000Birr NPV = PV of inflows lessPV of outflows = 45,492 - 40,000 = 5,492Birr Conti... ▪ Since the project makes the net present value (NPV) of positive 5,492Birr, it should be accepted. ❑ Consequently, the wealth of the shareholders would increase by 5,492Birr in total as the result of accepting and running this project Conti...  Illustration: Consider the following mutually exclusive project alternatives, together with their cash flows Alternative Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 A (80,000) 20,000 25,000 25,000 30,000 20,000 B (100,000) 25,000 20,000 30,000 35,000 40,000 Conti... ▪ The required rate of return on both projects is 12 percent. Then, evaluate these projects using the net presentvalue method.  Solution. As you can see the cash flows from both projects are not in annuity forms. Thecashflows are irregular for both projects. ▪ Hence, we need to discount each of the cash flows individually. Thenthe individual discounted cashflows areadded. Present value table Conti...  The net present value (NPV) for project A is: Year Cash flows Discount Factor (12%) Present Values 1 20,000 0.893 17,860 2 25,000 0.797 19,925 3 25,000 0.712 17,800 4 30,000 0.636 19,080 5 20,000 0.567 11,340 Present values of cash inflows (sum) 86,005 Present values of cash outflows 80,000 Net Present Value (NPV) 6,005 Birr Conti...  The net present value (NPV) for project B is: Year Cash flows Discount Factor (12%) Present Values 1 25,000 0.893 22,325 2 20,000 0.797 15,940 3 30,000 0.712 21,360 4 35,000 0.636 22,260 5 40,000 0.567 22,680 Present values of cash inflows (sum) 104,565 Present values of cash outflows 100,000 Net Present Value (NPV) 4,565 Birr  2. Profitability Index (PI) ❖ PI, method compares the present value of future cash inflows with the initial investment on a relative basis. Therefore, the PI is the ratio of the present value of cash flows (PVCF) to the initial investment of the project. PI= PV of future cash flows Initial Investment ❑ PI shows the profitability of any project, or the present value per dollar of initial cost. ❖ In this method, a project with a PI greater than 1 is accepted, but a project is rejected when its PI is lessthan 1. Conti... ❖ Note that the PI method is closely related to the NPV approach. ◼ In fact, ifthe net present value of a project is positive, the PI will be greater than 1. ◼ if the net present value is negative, the project will have a PI of less than 1. Acceptance rule: ❑ Accept if PI > 1. ❑ Reject if PI < 1. ❑ May Accept if PI = 1 ❑ When PI is greater than one, then the project will have positive net present value. Cont. ⚫ Example: To illustrate the calculation of these measures, let us consider a project, which is being evaluated by a firm that has a cost of capital of 12 percent. In this regard, assume that the initial investment on the project amounts to Birr 100,000 and the estimated cash flows over its economic life are as given below: Required: PI?  PI= PV of future cash flows = 114456.3 = 1.145  Initial Investment 100000 3. Internal Rate of Return(IRR) ❖ It is a return generated by a firm by accepting a project. It is the discount rate which equates the present value expected cash flows with the initial investment outlays. In other words, IRR is a method of ranking investment project proposals using the rate of return on an asset (investment). ❖ At IRR, the sum of the present values of all cashinflows is equal to the sum of the present values of all cashoutflows. ❖ That is: PV (cashinflows) = PV (cashoutflows). In other words, it is the rate at which the net present value of the investment is zero. Computing the Internal Rate of Return  a) Uniform Cash Inflows over the Life of the Project ❖ In this case, the present value table of an annuity can be used to calculate the IRR since the cash inflows are in annuityform. ❖ The following steps can be followed to calculate IRR for constant cash inflows.  Step 1: Find the critical value of discount factor,  Critical value of discount factor = Initialinvestment Annual Cash inflow Conti...  Step 2: Find the IRR ❖ Illustration: assume that a project has a net investment of 26,030 Birr and annual net cash inflows of 5000Birr for seven years. What is the IRRof this project?  Solution: Critical value of discountfactor = 26,030 = 5.206 5,000 Conti... ❖ After determining the critical value of discount factor, we look for the value that is equal to this critical value of discount factor in the present value of annuity table across the line corresponding to 7 years (i.e n =7). ❖ The critical value of discount factor of 5.206 appears in the 8 percent, column on the line/row of 7 years. Therefore, the IRR is 8 percent. Conti...  Computing the Internal Rate of Return  b) Irregular Cash Inflows over the Life of the Project ❖ In this case the Internal Rate of Return can be found out by Trial andErrorMethod. ❖ First, compute the present value of the cash flow from an investment, using an arbitrarily selected interest rate, for example 10%. Conti... ❖ Then compare the present value so obtained with the investment cost. If the present value is higher than the cost of capital, try a higher interest rate and go through the procedure again. ❖ On the other hand if the calculated present value of the expected cash inflows is lower than the present value of cash outflows, a lower rate should be tried. ❖ This process will be repeated until and unless the Net Present Value becomes zero. Conti...  Illustration: ❖ The cost of a project is Br. 32,400. It is expected to generate cash inflows of Br. 16,000, Br.14,000 and Br. 12,000 through it three year life period. Calculate the Internal Rate of Return of the Project. Solution:  To begin with let us try a rate of 18% and calculate the present value of cash inflows on this rate. The following table will give the calculations: Year Cash DF18% PV DF16% PV DF14% PV Inflows 1 16000 0.847 13552 0.862 13792 0.877 14032 2 14000 0.718 10052 0.743 10404 0.769 10766 3 12000 0.609 7305 0.641 7692 0.675 8100 ❖ PV of Cash inflows 30912 31886 32898 ❖ Less value of Cof 32400 32400 32400 NPV = (-) (-)1488 (-)514 (+)498 Conti... ❖ From the above table of Calculation is can be observed that the real rate lies in between 14% and 16%. ❖ Therefore let us select 15% as the internal rate to ascertain its applicability Conti... Year Cash inflows DF15% PV 1 16000 0.870 13920 2 14000 0.756 10584 3 12000 0.658 7896  PV of Cash inflows = 32400 Less value of cash outflows = 32400 Net Present Value = 0  Thus, the net present value at 15% rate is zero. It indicates that the present value of cash inflows is equal to the present value of cash outflows.  Thusinternal rate of return 15% for the project under review. …cont’d  Decision Rule: oAccept the project if the IRR is greater than the cost of capital, oReject the project if the IRR is less than the cost of capital, and oThe decision maker will be indifferent if the IRR is equal to the cost of capital.  Chapter Five Project Planning and Organization ❖ Project Management include Planning, Organizing, Directing and Controlling activities. ❖ Beside these basic function it also involves motivating the most expensive and important resource of the project –the people. ❖ Planning involves deciding what has to be done when and by whom. ❖ The resource need to be organized through activities such as procurement and recruitment. Coti…  Directing (authorizing) the planned activities towards a coherent objective is also a major management role.  The activities also need Control to ensure that they fit within the limit (financial, time) set.  Project Planning  In project management the first function happened to be project planning. Project Planning  The project planning will try to address questions like, ◼ What need to happen ( what has to be done)? ◼ Who is going to do it? ◼ When each activity will be done?  The plan is the basis for estimating the resource requirement  Plan as a working tool used to help decision making and guide future activity. Con ti…  In many instances people might be so involved in the plan that the project objective are forgotten and the planning becoming an end in itself rather than a means to an end.  The process of project Planning  The project planning process are consists of the following activities  1. Identification of essential activities: This involves listing of all relevant activities need to be implemented Con ti…  Work-Break down structure ◼ Itrepresents a systematic and logical breakdown of the project’s activities into component parts. ◼ It involves dividing the project’s activities into its major parts with each of those being further divided into sub parts. ◼ This is continued until we reach a manageable unit of work for which responsibility can be defined.  Work breakdown structure helps Con ti…  2. Determine logical sequence of activities: All identified and listed activities will be ordered in appropriate logical sequence.  3. Estimation of time and resource requirement: For each activity the estimation of time (starting and completion) required is carried out.  The resource requirement for each activity and the responsible person for its implementation is determined.  4. Present the plan in systematic and transparent form Area of planning (What do we plan)  The comprehensive project planning covers the following area  A) Planning the project work: The activity related to the project must be spelt out in detail. They should be properly scheduled and sequenced.  B) Planning the manpower: The man power requirement for the project must be estimated and the responsibility for carrying out the project work must be allocated. Conti…  C) Planning the financial resources (Money): The estimated expenditure for each planned activity and resource must be budgeted.  D) Planning the information system: The information flow and required information for monitoring the projects progress must be planned (defined ahead). Project Organization  The traditional form of organization is a functional division of management and a well-defined hierarchical structure. Typically, a firm is organized into various departments such as, ◼ Production Department ◼ Purchasing Department ◼ Marketing ◼ Finance ◼ Personnel ◼ Engineering (maintenance) ◼ Research and Development Conti…  Some of these departments have a line function and other a staff function. ◼ Linemanagers have the principal responsibility for achieving the goal of the firm and are vested with decision making authority. ◼ Staff Managers primarily serve in an advisory capacity (supportive function).  Within the staff department they enjoy administrative power.  The traditional form of organization is quite appropriate for handling established operations.  Chapter Six Project Direction  Project Direction ◼ Once plan, and appropriate organizational arrangement is established the stage is set for the smooth take off. ◼ The sailing may not always be smooth. ◼ In many cases a project will face difficulty at the beginning of its implementation. ◼ It will take quite a long time before it will gate some sort of stability. ◼ Project direction refers to the use of authority to carry out the activities of the project on the desired time. Conti… ❖ Authorizing the implementation of the plan would constitute project direction. ❖ When plan and schedule are authorized they become working document and ❖ Depending on the importance attached to them it can even become work orders ❖ Which means executing body or individuals will be compelled to strictly follow the plan. ❖ In general, if authorization is not there, plan and schedule may not work and the whole effort will be changed into unnecessary paper work. Conti…  This means plan, system, and procedure would not produce any result unless they are authorized for implementation.  The project manager will be authorized to spell out the details and issue directives for realization of the same.  The project manager need to provide direction related to the following issues. ◼ Scope of the work ◼ Specifications of results of completed works. ◼ Division of work (Imported, local department, contract, etc.) Conti… ◼ Schedule of work ◼ Budget for work ◼ System and procedure of work ◼ Coordination of work ◼ Authority and accountability of work ◼ Control of work  It can be issued formally in the project manual (through work shop or meetings)  Chapter Seven Project Monitoring & Evaluation  The concept of project Monitoring and Evaluation are used in many ways.  We can think of M&E as a part of continuous ◼ observation ◼ information gathering ◼ supervision (control) ◼ and assessment.  The Need for Monitoring and Evaluation  There are many reasons for carrying out project M&E  Project managers and other stakeholders need to know to what extent their project is meeting its objectives  M&E build greater transparency and accountability in terms of use of project resources  Information generated through M&E provide project staff with a clearer basis for decision-making  Future project planning and development is improved when guided by lessons learned from project experience Monitoring (Project Control)  What is Monitoring? ◼ Monitoring represents an on-going activity to track project progress against planned tasks. ◼ Monitoring implies observing and controlling the project’s activities. ◼ As soon as the project is launched, control or monitoring becomes the dominant concern of the project management. Conti…  Once the kick off phase is over, planning and control becomes closely intertwined in an integrated managerial process.  The goal of monitoring  To ensure that the implementation is proceeding as per the plan  To provide records of input use, activities and results  To warn of deviation from the initial objective Conti…  In general, project manager must compare the  time,  cost and  performance of the project  With the budget, time and the tasks defined in the approved project plan.  This must be done in an integrated manner at regular intervals, not in a haphazard, arbitrary way. Conti…  What should be monitored? A regular comparison of performance against target  Volume of work being completed  Quality of work being completed  Costs and expenditures compared to the plan  Attitudes of people working on the project and others who are involved with the project,  A search for the cause of deviation  Cohesiveness and co-operation of team members What monitoring should accomplish?  Communicate project status and changes to other project team members  Inform management (and clients) about the status of the project  Provide the justification for making project adjustments Criteria for Successful Project Control  Use the project plan as the primary guide for coordinating your project.  Consistently monitor and update the plan.  Remember that quality communication is a key to control.  Monitor progress on the project against the plan on a regular basis.  Adapt the project schedule, budget and/or work plan as necessary to keep the project on track.  Document project progress and changes and communicate them to team members.  Project evaluation  Project evaluation represents a systematic and objective assessment of ongoing or completed projects in terms of their design, implementation and results.  In addition, evaluations usually deal with strategic issues such as ◼ project relevance, ◼ effectiveness, ◼ efficiency in the light of specified objectives, ◼ Project impact and sustainability. Conti…  Periodic evaluations of ongoing projects are conducted at regular interval. ◼ to review implementation progress, ◼ to predict project's likely effects and ◼ to highlight necessary adjustments in project design  Terminal evaluations(or final evaluations) are evaluations carried out at the end of a project. It is carried out  to provide an overall assessment of project performance and effects/impact,  to assess the extent to which the project has succeeded in meeting their objectives and their potential sustainability. Types of Evaluations  The type of evaluation you undertake to improve your programs depends on what you want to learn about the program.  In general, there are two main categories of evaluations of development projects: ◼ 1. Formative evaluations ◼ 2. Summative evaluations  1. Formative evaluations: This is also called process evaluations. Conti…  It examine the development of the project and may lead to changes in the way the project is structured and carried out.  These types of evaluations are often called interim evaluations.  One of the most commonly used formative evaluations is the midterm evaluation.  In general, formative evaluations are process oriented and involve a systematic collection of information to assist decision- making during implementation of a project. Conti…  Questions typically asked in those evaluations include:  To what extent do the activities and strategies correspond with the plan? If they are not in harmony, ◼ Why are there changes? ◼ Are the changes justified?  To what extent did the project follow the timeline presented in the work plan?  Are activities carried out by the appropriate personnel?  To what extent are project actual costs in line with initial budget allocations? Conti…  To what extent is the project moving toward the anticipated goals and objectives of the project?  Which of the activities or strategies are more effective in moving toward achieving the goals and objectives?  What barriers were identified? How and to what extent were they dealt with?  What are the main strengths and weaknesses of the project?  To what extent are the project beneficiaries satisfied with project services? Conti…  2. Summative evaluations: This is also called outcome or impact evaluations (terminal evaluation).  Summative evaluations are usually carried out as a program is ending or after completion of a project in order to “sum up” the achievements, impact and lessons learned.  Such evaluation look at what a project has actually accomplished in terms of its stated goals. Conti…  Summative evaluation addresses questions like,  To what extent did the project meet its overall goals and objectives?  What impact did the project have on the lives of beneficiaries?  Was the project equally effective for all beneficiaries?  What components were the most effective?  What significant unintended impacts did the project have?  Is the project replicable?  Is the project sustainable?