INVESTMENT AND REPLACEMENT ANALYSIS*

PROJECT FEASABILITY ANALYSIS*

WHAT IS A PROJECTHOW DO WE DEFINE A PROJECT

In economic sense, a Project is an activity which is under taken to generate additional production and resources of an economy.

A project is defined as one time major activity demanding the commitment of varied skills and resources to achieve a specific goal.

Project includes both setting up of a new unit or substantial expansion of existing units of production.

Project is thus a combination of human and non-human resources integrated together in a time bound temporary organization to achieve a specific objective. *

CHARACTERISTICS OF A PROJECT:Project is a one time activity which will never be repeated in exactly the same manner.

A project has a definite start and finish i.e., a project is executed in a definite time bound schedule.

A project demands the investment (current outlay) and the benefits are spread for a number of future periods.

A project has a definable goals or end results that can be defined in terms of cost, schedule and performance requirements.

Once the project goals are achieved, the project team will be either disbanded or re-constituted for another new project.

Project passes through several distinct activities which constitute a project life cycle.

A project passes through*

PROJECT IDENTIFICATION:An entrepreneur has a wide choice of projects. The various aspects of the choice of the project include:The productMarketTechnologyEquipmentScale of ProductionTime of phasing, andLocation

The selection of the project involves a detailed analysis of the environment in which it operates.

Both objective as well as subjective analysis of various factors have an influence on the selection of a project.

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SOURCES OF PROJECT IDEAS:Success of a project depends upon sound selection and planned execution of the project work.A variety of sources are tapped to stimulate the generation of project ideas.The various sources of project ideas are:Thorough analysis of performance of existing industries.Examination of inputs and outputs required for various industries.Examination of imports and exports.Have a knowledge of guidelines and government development plansGuidelines and suggestions given by the financial institutions and other promotional agencies.Investigate local materials and resources. (cont)*

SOURCES OF PROJECT IDEAS: .. (cont.)7.Analyze economic and social trendsExploring the possibilities and reviving sick unitsStudy of changes in technology and keeping pace with the technological development.Trend analysis and study of consumption pattern of foreign marketsIdentification of un-fulfilled psychological needsAnalysis of demand and supply gapParticipate in seminars/ conferences and attend trade fairs, industrial exhibitions to provide an access to new products and new technology.

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PROJECT IDENTIFICATION FOR EXISTING INDUSTRIES:An existing company that seeks to identify new project opportunities should undertake SWOT analysis to evaluate its strengths and weaknesses, opportunities and threats in the external environment.

The SWOT analysis will provide the basis for the corporate strategy to be followed and indicate major areas of thrust. These include:

Expansion of existing capacity b) Enhancing the existing product range c) Vertical and horizontal integration d) Related diversification e) Mergers and acquisitions.

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SWOT ANALYSISIt is a strategic planning method used to evaluate the Strengths, Weaknesses, Opportunities and Threats involved in a project or in business ventures:

Strengths:Characteristics of business or team that give it an advantage over others in industry.

Weaknesses: Are the characteristics that place the firm at a disadvantage relative to others.

Opportunities: External chances that make greater sales or profits in the environment.

Threats: External elements in the environment that could cause trouble for the business.*

PROJECT FEASABILITY:A project involves a large amount of investment and it is a one-time activity and the investment cannot be reversed

2.It is essential to evaluate the project thoroughly in all aspects before the investment decision is made.

3.The project is said to be feasible, if the project is sound from MARKETING, TECHNICAL AND ECONOMIC points of view..*

Market FeasibilityDemand pattern for the product & market share of proposed productPROJECT FEASABILITYEconomic FeasibilityCost Benefit Ratio,Social Cost Benefit analysisTechnical FeasibilityProduction Technology , process selection. capacity of plant, location, layout selection of plant & machineryFinancial FeasibilityCost of project & means of finance. Profitability, cash flows and risk analysisVARIOUS ASPECTS OF FEASIBILITY IS REPRESENTED BELOW:*

PROJECT FEASABILITY:MARKET FEASABILITY ( Appraisal):Marketing appraisal is concerned with determination of the aggregate demand for the proposed product, and market share of the project under appraisal it is going to capture.If there is no significant demand (exists) and there is no positive sign of increasing trend, then the projects market feasibility does not exist.Hence there is no point in continuation of the project.

TECHNICAL FEASABILITY ( Appraisal):Technical & engineering analysis of the proposed project is done continually when the project is formulated.Technical appraisal seeks to determine whether the pre-requisite for the successful commissioning of the project have been considered and reasonably good choices have been made with respect to location, size, and processes, etc. It also helps to locate sources of suppliers of raw materials and fixing up of the final cost of the project. (cont.)

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PROJECT FEASABILITY: (cont)FINANCIAL & ECONOMIC FEASABILITY ( Appraisal):Financial appraisal analysis whether proposed project will be financially viable in the sense that it is able to meet the burden of servicing the debts and whether the project will satisfy the return expectations of those who have invested capital.

Various aspects that are considered in financial appraisal are:Cost of ProjectMeans of financeProfitability & breakeven pointFinancial StatementsCriteria for evaluation of projectsRisk Analysis.

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TYPES OF INVESTMENT(CAPITAL INVESTMENT)(CAPITAL FINANCING)*

Introduction to Capital Financing:Capital financing and allocation are challenging and difficult functions that take place at the highest levels of an organization.

Capital plays a significant role in engineering and business projects.

The method by which the capital is obtained and weather it is EQUITY or BORROWED capital can be of great importance to the overall economy of a project.*

DIFFERENCES BETWEEN SOURSES OF BORROWED CAPITAL AND EQUITYBORROWED CAPITAL: i.e. Loans , Bonds, etc.When borrowed capital is used:-Interest must be paid to the suppliers of the capitalDebt must be repaid at a specified time.Suppliers of the capital do not share in the profits resulting from the use of the capital.Borrower pledges some sort of security to ensure that the money will be repaid.Sometimes, the terms of the loan may place limitations on the use to which the funds may be put, or restrictions may be put on further borrowing.Interest paid for the use of borrowed funds is a tax deductable expense for the firm.

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DIFFERENCES BETWEEN SOURSES OF BORROWED CAPITAL AND EQUITYEQUITY CAPITAL: i.e. Stock (shares), Retained earnings, depreciation funds, etc.When equity capital is used:-It is supplied and used by its owners in the hope that a profit will be earned.There is no assurance that a profit will, in fact, be earned or the invested capital will be recovered.There are no limitations placed on the use of the funds, except those placed by the owners themselves.

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TYPES OF BUSINESS ORGANIZATIONS:INDIVIDUAL OWNERSHIP: It is the simplest and oldest type of business organization.An individual uses his or her own capital to establish a business and is the sole owner.Thus the individual owner controls the enterprise, is entitled to any benefits and profits that accrue and must assume any losses that occur.Limitations:The organization ceases upon the death of the owner.Because life is uncertain, life of the organization is uncertain.Equity funds for expansion must , in general, come from after-tax profits.It is difficult for such an organization to obtain borrowed capital, particularly large amounts and for extended periods of time, owing to the uncerataininty of the organization.*

TYPES OF BUSINESS ORGANIZATIONS:THE CORPORATION:The corporation is a fictitious being, recognized by the law, that can pursue almost any type of business transaction like any real person..It operates under a charter that is granted by the state.It is endowed by this charter with certain rights and privileges, such as perpetual life without regard to any change in the persons of its owners, the stakeholders, etc. It is limited in its field of action by the provisions of its charter. In order to enter new fields of expertise, it must apply for a revision of its charter or obtain a new one.The capital of the corporation is acquire through sale of stock (shares).The purchasers of the stock are part owners, stockholders.In this way, ownership may be spread throughout the world.Stockholders are entitled to share in the profits, are not liable for the debts of the corporation.Life of the corporation is continuous/ indefinite, long term investments can be made.*

TYPES OF BUSINESS ORGANIZATIONS:THE PARTNERSHIP:Two or more persons become partners and pool their resources so that the required capital will be obtained.ADVANTAGES:It is bound by few legal requirements as to its functioningDissolution of the partnership may take place at anytime by mere agreement of the partners.Two persons of differing talents may enter into business and do the work they can best handle, e.g. one partner is a technician and the other is a salesman. DISADVANTAGES:Amount of capital that can be accumulated is limited.Life of partnership is determined by the lives of the individual partners. When any partner dies, the partnership automatically ends.There may be serious disagreement among the partners.Each member of the partnership is liable for all the debts of the partnership. This disadvantage is on of the most serious one.

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FINANCING WITH DEBT CAPITAL: LONG-TERM BONDSA Bond is essentially a long term note given to the lender by the borrower, stipulating the terms of repayment & other conditions. In return for the money loaned, the corporation has to repay the loan and interest upon it at a specific rate.The holder of the bond has no say in the affairs of the business.He only gets interest on the bond, and does not have any share in the profits.Bond issue value is called FACE VALUE or PAR VALUE. This amount is to be repaid to the lender at the end of a specific time period.When face value has been repaid, the bond is said to have been retired or redeemed.The interest rate quoted on the bond is called bond rate. Periodic interest payment due is computed as the face value times the bond interest rate per period.

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BOND RETIREMENT:Bonds represent debt. It has to be repaid in the following manner:(a) Interest on them has to be paid periodically (b) When the bonds become due the principal amount must be repaid to the bondholder.

2.For this, normally, a systematic program is adopted for repayment of a bond when it becomes due.

3.Normally, a corporation periodically sets aside definite sums of money, that with the interest they earn, will accumulate to the amount needed to retire the bonds at the time they become due.*

EXAMPLE OF A BOND RETIREMENT PLAN:A bond of Rs.100,000 is issued for 10 years, paying 10% nominal interest in semi-annual payments. It must be retired by use of a sinking fund that earns8% compounded semi annually.The semi-annual cost for retirement for this Rs.100,000 bond is as follows: Here: F = Rs.100,000 i = 8 % per year = 4 % per year period N = 10 x 2 = 20 periods, A = F ( A/F, i, N) Therefore, A = 100,000 ( 0.0336) = Rs. 3360 per half year.This amount of Rs. 3360 is deposited six monthly in a sinking fund ( at 8% nominal interest rate, paid semi annually to generate Rs. 100000 after 10 yrs. In addition, the semi annual interest on bond must be paid, which is calculated as follows: Interest = Rs.100,000 X 0.1/2 = Rs.5000.Total semi-annual cost to corporation = Rs.3360 + Rs.5000 = Rs.8360Annual cost = Rs.8360 x 2 = Rs. 16720Total cost for interest and retirement of the entire bond over 20 periods(10 years) will be : Rs. 8360 x 20 = Rs. 167, 160.*

EXAMPLE OF A BOND RETIREMENT PLAN:A bond of Rs.100,000 is issued for 10 years, paying 10% nominal interest in semi-annual payments. It must be retired by use of a sinking fund that earns8% compounded semi annually. The semi-annual cost for retirement for this Rs.100,000 bond will be as follows: A = F ( A/F, i, N) Here: F = Rs.100,000 i = 8 % per year = 4 % per year period N = 10 x 2 = 20 periods, Therefore, A = 100,000 ( 0.0336) = Rs. 3360 per half year.This amount of Rs. 3360 is deposited six monthly in a sinking fund ( at 8% nominal interest rate, paid semi annually to generate Rs. 100000 after 10 yrs. In addition, the semi annual interest on bond must be paid, which is calculated as follows: Interest = Rs.100,000 X 0.1/2 = Rs.5000.Total semi-annual cost to corporation = Rs.3360 + Rs.5000 = Rs.8360Annual cost = Rs.8360 x 2 = Rs. 16720Total cost for interest and retirement of the entire bond over 20 periods(10 years) will be : Rs. 8360 x 20 = Rs. 167, 160.*

FINANCING WITH EQUITY CAPITAL: COMMON STOCKCOMMON STOCK:The issuance of common stock is an important source of new capital generation.Other sources of equity capital include preferred stock, retained earnings and depreciation reserves.Valuation of a share of common stock is a complex issue and is not as straight forward as placing value on a bond.The value of common stock must be a measure of the earnings that will be received by its owner.It is dependent on several factors, but can be summed up under two headings: dividends and market price.The market price will be effected by dividends, as well as by general economic conditions, future prospects of corporation, the money market, speculation, etc --- which may bring about a price that is not a true measure of the actual worth of a stock.*

VALUATION OR CURRENT VALUE OF COMMON STOCK (SHARE):

The owner of a share is entitled to receive cash dividends, as well as the price of the share at the time it was sold.Let the cash dividend received during the year k = DivkThe current value (Po) of a share can be approximated by the PW of future cash receipts during an nyear ownership period: Po = Div 1 + Div 2 + .. + Div n + Pn (1 + ea) (1 + ea)(1 + ea) (1 + ea)

Where: ea = rate of return per year (%) required by the stockholder Po = current value of the share of common stock Pn = selling price of a share of stock at the end of n years.

Assumption: (i) Po = Pn & (ii) dividends are constant over the life of the corporation.

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ESTIMATION OF RATE OF RETURN PER SHARE :The current price of a share of common stock equals the PW of an infinite series of dividend receipts that remain constant in amount:

Po = Div (P/A, ea , ) = Div eaThus, if the current selling price of a share of common stock is known and the annual dividend for the past year is also known, the return to equity (common stock) is estimated to be:

ea = Div PoWhen the future price of the share is assumed to grow at a rate of g ( expressed as a decimal) each year, the return of the equity can be approximated as: ea = Div + g Po

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PREFERRED STOCK:Preferred stock owners have certain additional privileges & restrictions not available to the holder of common stock holder.These are:Preferred stock owners are guaranteed a dividend on their stock (usually a % of its par value), before the holders of the common stock may receive any return.In case of dissolution of the corporation, the assets may be used to satisfy the claims of the preferred stock holders, before those of common stock holders.Preferred stock holders may have voting rights also.Selection to Board of Directors, if dividends are not paid for a certain period.Dividend rate is fixed. In many areas it is like long term bonds. Market value is less likely to fluctuate.*

END OF LECTURE*