A

report on

for

Industrial Economics & Management

Lab
submitted to
Ms. Kiran Raghuvanshi
Lecturer (Economics)
Marudhar Engg. College
Bikaner

submitted by
Rohan Sharma
BE (Electrical) Final Year
Marudhar Engg. College
Bikaner
 PROJECT PLANNING BY ROHAN SHARMA

Acknowledgment

Economics is a social science and it is important in our social life,

political life, economic life and daily life. It is based on the pillar of a
country that is progressing in the economic field, or whose people are
growing in the economic field. Study of Economics is very important for
everyone. We should know about the operations of markets, the price
formation, employment, cost of living, public spending, the role of central
banks etc. We must be economic literate.

I enunciate my indebtedness to Ms. Kiran Raghuvanshi (Lecturer

Economics) for her priceless guidance in the study of Industrial
Economics & Management and also for her worthwhile suggestions in
carrying out this report on Project Planning, which will be helpful for me in
future too.

ROHAN SHARMA

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Contents

Sr. No. Topic Name Page No.

1 Project Planning 4

2 Project Planning Steps 5

3 Network Analysis 10

4 PERT 12

5 CPM 16

6 Project Evaluation 19

7 Labor Legislation Plant Location 20

8 Investment Decisions 21

9 Theory of Investment 27

10 Cost Theory 28

11 Market Structure 30

12 Bibliography 35

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PROJECT PLANNING
Definition:-
Planning a project is where the Project Manager must bring together the complete
understanding of the project's requirements with a deep understanding of all the elements that are
required to conduct a successful project. In many ways, it is the centerpiece for the Project
Manager's skills. Of course, it all counts for nothing unless it leads to a successful project.

Planning, estimating and resourcing may be viewed as separate issues, but they need to
be conducted in parallel as they directly affect each other.

• Planning is the definition of work to be done, including resource requirements,

dependencies and timing.
• Estimating is the calculation of the amount of time and effort that will be required per type
of resource for each part of the work to be done.
• Resourcing is the allocation of actual resources (usually the project's workforce) to the
plan.

The availability of resources will always be limited. Resources may be required in greater
quantities than are available or have competing demands on their time. It may be necessary to
make compromises or move work between different potential resources to make best use of the
resources available. As these practical adjustments are made, there will inevitably be an impact on
the duration and timing of tasks. It may also affect the project's predicted costs.

Need of Project Planning:-

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The key to a successful project is in the planning. Creating a project plan is the first thing you
should do when undertaking any kind of project.
Often project planning is ignored in favour of getting on with the work. However, many people
fail to realize the value of a project plan in saving time, money and many problems.

Project planning Steps:

Project planning is a discipline for stating how to complete a project within a certain timeframe,
usually with defined stages, and with designated resources. One view of project planning divides
the activity into:

• Setting objectives
• Identifying deliverables
• Planning the schedule
• Making supporting plans
1. Project Goals :- A project is successful when the needs of the stakeholders have
been met. A stakeholder is anybody directly or indirectly impacted by the project.
As a first step it is important to identify the stakeholders in your project. It is not always
easy to identify the stakeholders of a project, particularly those impacted indirectly.
Examples of stakeholders are the project sponsor, the customer who receives the
deliverables, the users of the project outputs, the project manager and project team etc.
Once you understand who the stakeholders are, the next step is to establish their
needs. The best way to do this is by conducting stakeholder interviews. Take time during
the interviews to draw out the true needs that create real benefits. Often stakeholders will
talk about needs that aren't relevant and don't deliver benefits. These can be recorded and
set as a low priority.
The next step once you have conducted all the interviews and have a comprehensive
list of needs is to prioritise them. From the prioritised list create a set of goals that can be
easily measured. A technique for doing this is to review them against the SMART principle.
This way it will be easy to know when a goal has been achieved.
Once you have established a clear set of goals they should be recorded in the project
plan. It can be useful to also include the needs and expectations of your stakeholders.
This is the most difficult part of the planning process completed. It's time to move on
and look at the project deliverables.

2. Project Deliverable:- Using the goals you have defined in step 1, create a list of things
the project needs to deliver in order to meet those goals. Specify when and how each item
must be delivered.
Add the deliverables to the project plan with an estimated delivery date. More accurate
delivery dates will be established during the scheduling phase, which is next.

3. Project Schedule:- Create a list of tasks that need to be carried out for each
deliverable identified in step 2. For each task identify the following:
• The amount of effort (hours or days) required to complete the task
• The resource who will carryout the task

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Once you have established the amount of effort for each task, you can workout the effort
required for each deliverable and an accurate delivery date. Update your deliverables
section with the more accurate delivery dates.
At this point in the planning you could choose to use a software package such as
Microsoft Project to create your project schedule. Alternatively use one of the many free
templates available. Input all of the deliverables, tasks, durations and the resources who
will complete each task.
A common problem discovered at this point is when a project has an imposed delivery
deadline from the sponsor that is not realistic based on your estimates. If you discover that
this is the case you must contact the sponsor immediately. The options you have in this
situation are:
• Renegotiate the deadline (project delay)
• Employ additional resources (increased cost)
• Reduce the scope of the project (less delivered)
Use the project schedule to justify pursuing one of these options.

4. Supporting Plans:- Supporting plans may include those related to human resources,
communication methods, and risk management.
For example, a Computer hardware and software project planning within an
enterprise is often done using a project planning guide that describes the process that the
enterprise feels has been successful in the past.
The project plans are detailed, actionable descriptions of how the solution will
actually be built during the Developing, Stabilizing, and Deploying phases of the project.
They describe the major pieces of work that must be completed, such as development,
test, training, deployment, and end-user support. Core team members and subteam leads
prepare these plans, with each role taking major responsibility for his or her area (for
example, the Test Role prepares the test plan). Program Management is responsible for
rolling up all of the individual plans into the Master Project Plan.
The following sections describe several key plans that you will need to prepare for
a Sybase Database migration project: the Development Plan, the Test Plan, the Training
Plan, the Deployment Plan, and the Support Plan.

Development Plans
The development plan describes how the development team (or database and client
development teams, if you have divided the work) will migrate the database and clients. The
plan provides information concerning the tools, methodologies, best practices, sequences of
events, resources, and schedules for each aspect of the development effort. The key tasks to
document in the plan, in order, are:

1. Define team roles. See discussion of functional development teams in the "Creating the
Team" section in Chapter 2, "Envisioning Phase."
2. Identify team resources — name the members of each team and assign responsibilities.
3. Train any team members in need of specific training.

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The rest of the development plan will be divided into three distinct parts, each addressing
an aspect of development that may be carried out by a different group of developers: database
migration plan; application rehosting or redirection plan, and staging environment development
plan. In most cases, the activities described in each plan will be performed simultaneously by
the teams.

Application Rehosting and Redirection Plan

The second part of the development plan addresses the rehosting or redirection of
applications that are associated with the database being migrated to SQL Server 2000. There
are often many such associated applications.

Your plan should identify each application to be rehosted or redirected and include the
steps that are outlined in the following list to be applied to each application. Each application
scheduled for migration should be considered a separate subproject.

Staging Environment Development Plan

Members of the team will have previously designed and built the development and test
environments. Most of the technologies involved with that development will also be used in the
staging and production environments. The staging environment should include components
that are exact or representative copies of the entire production environment, including:
database, database server, client server and applications, and the physical network that
interconnects the database tiers.

Test Plan

The test plan covers the test strategy for client applications, how the test environment is
configured, and how the team will test the migrated database and support scripts. It describes
the tools, methodologies, best practices, events, resources, and schedule for the test effort.

Developing the Test Plan

The test plan should address the following areas. Many of these items are described in
more detail later in this guide:

• Test strategy and scope

• Phases or categories of testing
• Testing resources
• Testing schedules that detail the sequence of tasks that the test team will follow to
accomplish the testing
• Any dependencies that test cases have on each other and other resources (for
example, technical documentation, facilities, and so on)

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Creating Test Cases

Test cases should be based on usage scenarios. The test cases include:

• Setup instructions, if necessary

• Step-by-step instructions for executing the tests
• Expected results

Try to reuse test cases from existing system documentation. If there are no existing test
cases, it may be necessary to develop new test cases.

Unit Testing

Unit testing ensures that the individual components that comprise the solution work as
expected. In a Sybase database migration project, unit testing will encompass testing that
stored procedures, triggers, and tables (and their data) have been transferred correctly, and
work as they did before the migration. The Sybase Migration Toolkit provides facilities that can
help with these tasks.

If the client has also been migrated (instead of retargeted), developers will unit-test each
component of the client as it is migrated.

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Steps of Project Planning

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NETWORK ANALYSIS
Introduction:-

Network analysis is the general name given to certain specific techniques which can be used for
the planning, management and control of projects. One definition of a project (from the Project
Management Institute) is

A project is a temporary endeavour undertaken to create a "unique" product or service.

This definition serves to highlight some essential features of a project

• it is temporary - it has a beginning and an end

• it is "unique" in some way

With regard to the use of the word unique I personally prefer to use the idea of "non-repetitive" or
"non-routine", e.g. building the very first Boeing Jumbo jet was a project - building them now is a
repetitive/routine manufacturing process, not a project.

We can think of many projects in real-life, e.g. building the Channel tunnel, building the London
Eye, developing a new drug, etc

Typically all projects can be broken down into:

• separate activities (tasks/jobs) - where each activity has an associated duration or

completion time (i.e. the time from the start of the activity to its finish)
• precedence relationships - which govern the order in which we may perform the
activities, e.g. in a project concerned with building a house the activity "erect all four
walls" must be finished before the activity "put roof on" can start .

And the problem is to bring all these activities together in a coherent fashion to complete the
project.

Two different techniques for network analysis were developed independently in the late
1950's - these were:

• PERT (for Program Evaluation and Review Technique);

• CPM (for Critical Path Management).

PERT was developed to aid the US Navy in the planning and control of its Polaris missile program .
This was a project to build a strategic weapons system, namely the first submarine launched
intercontinental ballistic missile, at the time of the Cold War between the USA and Russia. Military
doctrine at that time emphasised 'MAD - mutually assured destruction', namely if the other side
struck first then sufficient nuclear weapons would remain to obliterate their homeland. That way
peace was preserved. By the late 1950s the USA believed (or more importantly believed that the
Russians believed) that American land based missiles and nuclear bombers were vulnerable to a

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first strike. Hence there was a strategic emphasis on completing the Polaris project as quickly as
possible, cost was not an issue. However no one had ever build a submarine launched
intercontinental ballistic missile before, so dealing with uncertainty was a key issue. PERT has the
ability to cope with uncertain activity completion times (e.g. for a particular activity the most likely
completion time is 4 weeks but it could be any time between 3 weeks and 8 weeks).

CPM was developed in the 1950's as a result of a joint effort by the DuPont Company and
Remington Rand Univac. As these were commercial companies cost was an issue, unlike the
Polaris project mentioned above. In CPM the emphasis is on the trade-off between the cost of the
project and its overall completion time (e.g. for certain activities it may be possible to decrease their
completion times by spending more money - how does this affect the overall completion time of the
project?)

Modern commercial software packages tend to blur the distinction between PERT and CPM and
include options for uncertain activity completion times and project completion time/project cost
trade-off analysis. Note here that many such packages exist for doing network analysis.

There is no clear terminology in the literature and you will see this area referred to by the phrases:
network analysis, PERT, CPM, PERT/CPM, critical path analysis and project planning.

Network analysis is a vital technique in PROJECT MANAGEMENT. It enables us to take a

systematic quantitative structured approach to the problem of managing a project through to
successful completion. Moreover, as will become clear below, it has a graphical representation
which means it can be understood and used by those with a less technical background.

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PERT- PROGRAM EVALUATION & REVIEW TECHNIQUE

Complex projects require a series of activities, some of which must be performed
sequentially and others that can be performed in parallel with other activities. This collection of
series and parallel tasks can be modeled as a network.
In 1957 the Critical Path Method (CPM) was developed as a network model for project
management. CPM is a deterministic method that uses a fixed time estimate for each activity.
While CPM is easy to understand and use, it does not consider the time variations that can have a
great impact on the completion time of a complex project.
The Program Evaluation and Review Technique (PERT) is a network model that allows for
randomness in activity completion times. PERT was developed in the late 1950's for the U.S.
Navy's Polaris project having thousands of contractors. It has the potential to reduce both the time
and cost required to complete a project.
The Network Diagram
In a project, an activity is a task that must be performed and an event is a milestone
marking the completion of one or more activities. Before an activity can begin, all of its predecessor
activities must be completed. Project network models represent activities and milestones by arcs
and nodes. PERT originally was an activity on arc network, in which the activities are represented
on the lines and milestones on the nodes. Over time, some people began to use PERT as an
activity on node network. For this discussion, we will use the original form of activity on arc.
The PERT chart may have multiple pages with many sub-tasks. The following is a very simple
example of a PERT diagram:

PERT Chart
The milestones generally are numbered so that the ending node of an activity has a higher
number than the beginning node. Incrementing the numbers by 10 allows for new ones to be
inserted without modifying the numbering of the entire diagram. The activities in the above diagram
are labeled with letters along with the expected time required to complete the activity.
Steps in the PERT Planning Process

PERT planning involves the following steps:-

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1. Identify the specific activities and milestones.

2. Determine the proper sequence of the activities.
3. Construct a network diagram.
4. Estimate the time required for each activity.
5. Determine the critical path.
6. Update the PERT chart as the project progresses.

1. Identify Activities and Milestones

The activities are the tasks required to complete the project. The milestones are the events
marking the beginning and end of one or more activities. It is helpful to list the tasks in a table that
in later steps can be expanded to include information on sequence and duration.

2. Determine Activity Sequence

This step may be combined with the activity identification step since the activity sequence is
evident for some tasks. Other tasks may require more analysis to determine the exact order in
which they must be performed.

3. Construct the Network Diagram

Using the activity sequence information, a network diagram can be drawn showing the sequence of
the serial and parallel activities. For the original activity-on-arc model, the activities are depicted by
arrowed lines and milestones are depicted by circles or "bubbles".

If done manually, several drafts may be required to correctly portray the relationships among
activities. Software packages simplify this step by automatically converting tabular activity
information into a network diagram.

4. Estimate Activity Times

Weeks are a commonly used unit of time for activity completion, but any consistent unit of time can
be used.

A distinguishing feature of PERT is its ability to deal with uncertainty in activity completion times.
For each activity, the model usually includes three time estimates:

• Optimistic time - generally the shortest time in which the activity can be completed. It is
common practice to specify optimistic times to be three standard deviations from the mean
so that there is approximately a 1% chance that the activity will be completed within the
optimistic time.
• Most likely time - the completion time having the highest probability. Note that this time is
different from the expected time.

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• Pessimistic time - the longest time that an activity might require. Three standard deviations
from the mean is commonly used for the pessimistic time.

PERT assumes a beta probability distribution for the time estimates. For a beta distribution, the
expected time for each activity can be approximated using the following weighted average:

Expected time = (Optimistic + 4 x Most likely + Pessimistic) / 6

This expected time may be displayed on the network diagram.

To calculate the variance for each activity completion time, if three standard deviation times were
selected for the optimistic and pessimistic times, then there are six standard deviations between
them, so the variance is given by:

[(Pessimistic - Optimistic) / 6]2

5. Determine the Critical Path

The critical path is determined by adding the times for the activities in each sequence and
determining the longest path in the project. The critical path determines the total calendar time
required for the project. If activities outside the critical path speed up or slow down (within limits),
the total project time does not change. The amount of time that a non-critical path activity can be
delayed without delaying the project is referred to as slack time.

If the critical path is not immediately obvious, it may be helpful to determine the following four
quantities for each activity:

• ES - Earliest Start time

• EF - Earliest Finish time
• LS - Latest Start time
• LF - Latest Finish time

These times are calculated using the expected time for the relevant activities. The earliest start and
finish times of each activity are determined by working forward through the network and
determining the earliest time at which an activity can start and finish considering its predecessor
activities. The latest start and finish times are the latest times that an activity can start and finish
without delaying the project. LS and LF are found by working backward through the network. The
difference in the latest and earliest finish of each activity is that activity's slack. The critical path
then is the path through the network in which none of the activities have slack.

The variance in the project completion time can be calculated by summing the variances in the
completion times of the activities in the critical path. Given this variance, one can calculate the
probability that the project will be completed by a certain date assuming a normal probability
distribution for the critical path. The normal distribution assumption holds if the number of activities
in the path is large enough for the central limit theorem to be applied.

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Since the critical path determines the completion date of the project, the project can be accelerated
by adding the resources required to decrease the time for the activities in the critical path. Such a
shortening of the project sometimes is referred to as project crashing.

6. Update as Project Progresses

Make adjustments in the PERT chart as the project progresses. As the project unfolds, the
estimated times can be replaced with actual times. In cases where there are delays, additional
resources may be needed to stay on schedule and the PERT chart may be modified to reflect the
new situation.

Benefits of PERT

PERT is useful because it provides the following information:

• Expected project completion time.

• Probability of completion before a specified date.
• The critical path activities that directly impact the completion time.
• The activities that have slack time and that can lend resources to critical path activities.
• Activities start and end dates.

Limitations

The following are some of PERT's weaknesses:

• The activity time estimates are somewhat subjective and depend on judgement. In cases
where there is little experience in performing an activity, the numbers may be only a guess.
In other cases, if the person or group performing the activity estimates the time there may
be bias in the estimate.
• Even if the activity times are well-estimated, PERT assumes a beta distribution for these
time estimates, but the actual distribution may be different.
• Even if the beta distribution assumption holds, PERT assumes that the probability
distribution of the project completion time is the same as the that of the critical path.
Because other paths can become the critical path if their associated activities are delayed,
PERT consistently underestimates the expected project completion time.

The underestimation of the project completion time due to alternate paths becoming critical is
perhaps the most serious of these issues. To overcome this limitation, Monte Carlo simulations can
be performed on the network to eliminate this optimistic bias in the expected project completion
time.

CPM - CRITICAL PATH METHOD

In 1957, DuPont developed a project management method designed to address the
challenge of shutting down chemical plants for maintenance and then restarting the plants once the

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maintenance had been completed. Given the complexity of the process, they developed the Critical
Path Method (CPM) for managing such projects.

CPM provides the following benefits:

• Provides a graphical view of the project.
• Predicts the time required to complete the project.
• Shows which activities are critical to maintaining the schedule and which are not.

CPM models the activities and events of a project as a network. Activities are depicted as
nodes on the network and events that signify the beginning or ending of activities are depicted as
arcs or lines between the nodes. The following is an example of a CPM network diagram:

CPM Diagram

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Steps in CPM Project Planning:-

• Specify the individual activities.
• Determine the sequence of those activities.
• Draw a network diagram.
• Estimate the completion time for each activity.
• Identify the critical path (longest path through the network)
• Update the CPM diagram as the project progresses.

1. Specify the Individual Activities

From the work breakdown structure, a listing can be made of all the activities in the project. This
listing can be used as the basis for adding sequence and duration information in later steps.

2. Determine the Sequence of the Activities

Some activities are dependent on the completion of others. A listing of the immediate predecessors
of each activity is useful for constructing the CPM network diagram.

3. Draw the Network Diagram

Once the activities and their sequencing have been defined, the CPM diagram can be drawn. CPM
originally was developed as an activity on node (AON) network, but some project planners prefer to
specify the activities on the arcs.

4. Estimate Activity Completion Time

The time required to complete each activity can be estimated using past experience or the
estimates of knowledgeable persons. CPM is a deterministic model that does not take into account
variation in the completion time, so only one number is used for an activity's time estimate.

5. Identify the Critical Path

The critical path is the longest-duration path through the network. The significance of the critical
path is that the activities that lie on it cannot be delayed without delaying the project. Because of its
impact on the entire project, critical path analysis is an important aspect of project planning.
The critical path can be identified by determining the following four parameters for each
activity:

ES - earliest start time: the earliest time at which the activity can start given that its precedent
activities must be completed first.

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EF - earliest finish time, equal to the earliest start time for the activity plus the time required to
complete the activity.

LF - latest finish time: the latest time at which the activity can be completed without delaying the
project.

LS - latest start time, equal to the latest finish time minus the time required to complete the activity.

The slack time for an activity is the time between its earliest and latest start time, or
between its earliest and latest finish time. Slack is the amount of time that an activity can be
delayed past its earliest start or earliest finish without delaying the project.

The critical path is the path through the project network in which none of the activities have
slack, that is, the path for which ES=LS and EF=LF for all activities in the path. A delay in the
critical path delays the project. Similarly, to accelerate the project it is necessary to reduce the total
time required for the activities in the critical path.

6. Update CPM Diagram

As the project progresses, the actual task completion times will be known and the network diagram
can be updated to include this information. A new critical path may emerge, and structural changes
may be made in the network if project requirements change.

CPM Limitations:-
CPM was developed for complex but fairly routine projects with minimal uncertainty in the project
completion times. For less routine projects there is more uncertainty in the completion times, and
this uncertainty limits the usefulness of the deterministic CPM model. An alternative to CPM is the
PERT project planning model, which allows a range of durations to be specified for each activity.

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PROJECT EVALUATION
Evaluations serve many purposes. Before assessing a program, it is critical to consider who is
most likely to need and use the information that will be obtained and for what purposes. Listed
below are some of the most common reasons to conduct evaluations. These reasons cut across
the three types of evaluation just mentioned. The degree to which the perspectives of the most
important potential users are incorporated into an evaluation design will determine the usefulness
of the effort.

Administrators are often most interested in keeping track of program activities and documenting the
nature and extent of service delivery. The type of information they seek to collect might be called a
"management information system" (MIS). An evaluation for project management monitors the
routines of program operations. It can provide program staff or administrators with information on
such items as participant characteristics, program activities, allocation of staff resources, or
program costs. Analyzing information of this type (a kind of process evaluation) can help program
staff to make short-term corrections ensuring, for example, that planned program activities are
conducted in a timely manner. This analysis can also help staff to plan future program direction
such as determining resource needs for the coming school year.

Operations data are important for responding to information requests from constituents, such as
funding agencies, school boards, boards of directors, or community leaders. Also, descriptive
program data are one of the bases upon which assessments of program outcome are built it does
not make sense to conduct an outcome study if results can not be connected to specific program
activities. An MIS also can keep track of students when the program ends to make future follow-up
possible.

Project Evaluation is a step-by-step process of collecting, recording and organizing information

about project results, including short-term outputs (immediate results of activities, or project
deliverables), and immediate and longer-term project outcomes (changes in behaviour, practice or
policy resulting from the project).

Common rationales for conducting an evaluation are:

• response to demands for accountability;

• demonstration of effective, efficient and equitable use of financial and other resources;
• recognition of actual changes and progress made;
• identification of success factors, need for improvement or where expected outcomes are
unrealistic;
• validation for project staff and partners that desired outcomes are being achieved.

The project planning stage is the best time to identify desired outcomes and how they will be
measured. This will guide future planning, as well as ensure that the data required to measure
success is available when the time comes to evaluate the project.

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LABOUR LEGISLATION PLANT LOCATION

Laws concerning worker privacy, workplace violence and security, prevailing wages, drug and
alcohol testing, employee discharge, child labor, hours worked, wage payments, and plant closings
were among major pieces of legislation enacted or revised during the year.

Overtime wages: The State overtime law of Kentucky was amended to exclude workers
employed by third-party employers or agencies other than the families or households using those
workers’ services when such workers provide in-home companionship services for sick, elderly, or
convalescing persons. These workers are among persons
considered exempt from entitlement to overtime compensation.

Child labor: The daily and weekly hours of work permitted for minors working during
nonschool periods in agricultural packing sheds located in a specific county of California were
amended.

State departments of labor: The Connecticut labor commissioner is now empowered to

subpoena people and records deemed necessary to investigate complaints related to employee
personnel, along with medical records kept by private-sector employers, but records obtained by
such a subpoena are exempt from disclosure.

Discharge of employees: At many places, employers are required to submit written

reports within 30 days to the local Emergency Medical Service agency director when an
emergency medical technician-paramedic is terminated or suspended for disciplinary cause or
reason or when the emergency medical technician-paramedic resigns following notice of an
impending investigation.

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INVESTMENT DECISIONS
Capital budgeting is vital in marketing decisions. Decisions on investment, which take time to
mature, have to be based on the returns which that investment will make. Unless the project is for
social reasons only, if the investment is unprofitable in the long run, it is unwise to invest in it now.

Often, it would be good to know what the present value of the future investment is, or how long it
will take to mature (give returns). It could be much more profitable putting the planned investment
money in the bank and earning interest, or investing in an alternative project.

Typical investment decisions include the decision to build another grain silo, cotton gin or cold
store or invest in a new distribution depot. At a lower level, marketers may wish to evaluate
whether to spend more on advertising or increase the sales force, although it is difficult to measure
the sales to advertising ratio.

Capital budgeting versus current expenditures

A capital investment project can be distinguished from current expenditures by two features:

a) such projects are relatively large

b) a significant period of time (more than one year) elapses between the investment outlay and the
receipt of the benefits..

As a result, most medium-sized and large organisations have developed special procedures and
methods for dealing with these decisions. A systematic approach to capital budgeting implies:

a) the formulation of long-term goals

b) the creative search for and identification of new investment opportunities

c) classification of projects and recognition of economically and/or statistically dependent proposals

d) the estimation and forecasting of current and future cash flows

e) a suitable administrative framework capable of transferring the required information to the

decision level

f) the controlling of expenditures and careful monitoring of crucial aspects of project execution

g) a set of decision rules which can differentiate acceptable from unacceptable alternatives is
required.

The last point (g) is crucial and this is the subject of later sections of the chapter.

The classification of investment projects

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a) By project size

Small projects may be approved by departmental managers. More careful analysis and Board of
Directors' approval is needed for large projects of, say, half a million dollars or more.

b) By type of benefit to the firm

· an increase in cash flow

· a decrease in risk
· an indirect benefit (showers for workers, etc).

c) By degree of dependence

· mutually exclusive projects (can execute project A or B, but not both)

· complementary projects: taking project A increases the cash flow of project B.
· substitute projects: taking project A decreases the cash flow of project B.

d) By degree of statistical dependence

· Positive dependence
· Negative dependence
· Statistical independence.

e) By type of cash flow

· Conventional cash flow: only one change in the cash flow sign

e.g. -/++++ or +/----, etc

· Non-conventional cash flows: more than one change in the cash flow sign,

e.g. +/-/+++ or -/+/-/++++, etc.

The economic evaluation of investment proposals

The analysis stipulates a decision rule for:

I) Accepting
II) Rejecting
III) Investment projects
IV) The time value of money

Recall that the interaction of lenders with borrowers sets an equilibrium rate of interest. Borrowing
is only worthwhile if the return on the loan exceeds the cost of the borrowed funds. Lending is only
worthwhile if the return is at least equal to that which can be obtained from alternative opportunities
in the same risk class.

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The interest rate received by the lender is made up of:

i) The time value of money: the receipt of money is preferred sooner rather than later. Money can
be used to earn more money. The earlier the money is received, the greater the potential for
increasing wealth. Thus, to forego the use of money, you must get some compensation.

ii) The risk of the capital sum not being repaid. This uncertainty requires a premium as a hedge
against the risk, hence the return must be commensurate with the risk being undertaken.

iii) Inflation: money may lose its purchasing power over time. The lender must be compensated for
the declining spending/purchasing power of money. If the lender receives no compensation, he/she
will be worse off when the loan is repaid than at the time of lending the money.

a) Future values/compound interest

Future value (FV) is the value in dollars at some point in the future of one or more investments.

FV consists of:
i) the original sum of money invested, and
ii) the return in the form of interest.

The general formula for computing Future Value is as follows:

FVn = Vo (l + r)n

where:
Vo is the initial sum invested
r is the interest rate
n is the number of periods for which the investment is to receive interest.

Thus we can compute the future value of what Vo will accumulate to in n years when it is
compounded annually at the same rate of r by using the above formula.

b) Net present value (NPV)

The NPV method is used for evaluating the desirability of investments or projects.

where:

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Ct = the net cash receipt at the end of year t

Io = the initial investment outlay
r = the discount rate/the required minimum rate of return on investment
n = the project/investment's duration in years.

The discount factor r can be calculated using:

c) Annuities

N.B. Introduce students to annuity tables from any recognised published source.

A set of cash flows that are equal in each and every period is called an annuity.

d) Perpetuities

A perpetuity is an annuity with an infinite life. It is an equal sum of money to be paid in each period
forever.

where:
C is the sum to be received per period
r is the discount rate or interest rate

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e) The internal rate of return (IRR)

Refer students to the tables in any recognised published source.

· The IRR is the discount rate at which the NPV for a project equals zero. This rate means that the
present value of the cash inflows for the project would equal the present value of its outflows.

· The IRR is the break-even discount rate.

· The IRR is found by trial and error.

where r = IRR
IRR of an annuity:

where:

Q (n,r) is the discount factor

Io is the initial outlay
C is the uniform annual receipt (C1 = C2 =....= Cn).

Elements of a decision
A quantitative decision problem involves six parts:

a) An objective that can be quantified Sometimes referred to as 'choice criterion' or 'objective

function', e.g. maximisation of profit or minimisation of total costs.

b) Constraints Many decision problems have one or more constraints, e.g. limited raw materials,
labour, etc. It is therefore common to find an objective that will maximise profits subject to defined
constraints.

c) A range of alternative courses of action under consideration. For example, in order to minimise
costs of a manufacturing operation, the available alternatives may be:

i) to continue manufacturing as at present

ii) to change the manufacturing method
iii) to sub-contract the work to a third party.

d) Forecasting of the incremental costs and benefits of each alternative course of action.

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e) Application of the decision criteria or objective function, e.g. the calculation of expected profit or
contribution, and the ranking of alternatives.

f) Choice of preferred alternatives.

Relevant costs for decision making

The costs which should be used for decision making are often referred to as "relevant costs". CIMA
defines relevant costs as 'costs appropriate to aiding the making of specific management
decisions'.

To affect a decision a cost must be: -

a) Future: Past costs are irrelevant, as we cannot affect them by current decisions and they are
common to all alternatives that we may choose.

b) Incremental: Meaning, expenditure which will be incurred or avoided as a result of making a

decision. Any costs which would be incurred whether or not the decision is made are not said to be
incremental to the decision.

c) Cash flow: Expenses such as depreciation are not cash flows and are therefore not relevant.
Similarly, the book value of existing equipment is irrelevant, but the disposal value is relevant.

d) Common costs: Costs which will be identical for all alternatives are irrelevant, e.g. rent or rates
on a factory would be incurred whatever products are produced.

e) Sunk costs: Another name for past costs, which are always irrelevant, e.g. dedicated fixed
assets, development costs already incurred.

f) Committed costs: A future cash outflow that will be incurred anyway, whatever decision is taken
now, e.g. contracts already entered into which cannot be altered.
Opportunity cost

Relevant costs may also be expressed as opportunity costs. An opportunity cost is the benefit
foregone by choosing one opportunity instead of the next best alternative.

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THEORY OF INVESTMENT

"If only we knew more about the determinants of investment! But, unfortunately, our knowledge in
this direction is still very meager. One might well ask, what is wrong with the theory of investment?
Or, perhaps, what is wrong with the subject matter itself! For one thing, this variable, -- the pivot of
modern macroeconomics -- has apparently lived a somewhat nomadic life among the various
chapters of economic theory. Perhaps it has not stayed long enough in any one place. Perhaps it
has been ill-treated."
(Trygve Haavelmo, A Study in the Theory of Investment, 1960)

Introduction:
Investment is the change in capital stock during a period. Consequently, unlike capital, investment
is a flow term and not a stock term. This means that while capital is measured at a point in time,
while investment can only be measured over a period of time. If we ask "what is capital right now?",
we might get an answer along the lines of $10 trillion. But if we ask "what is investment right now?",
this cannot be answered. The quantity of a flow always depends on the period in consideration.
Thus, we can answer "what is investment this month?" (and might be told it is $10 million) or "what
is investment this year?" (and might be told $1 billion).

We can calculate the investment flow in a period as the difference between the capital stock at the
end of the period and the capital stock at the beginning of the period. Thus, the investment flow at
time period t can be defined as:

It = Kt - Kt-1

where: Kt is the stock of capital at the end of period t and

Kt-1 is the stock of capital at the end of period t-1 (and
thus at the beginning of period t).

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COST THEORY
Leaning heavily on work developed by the relatively unknown Wilhelm Launhardt, Alfred Weber
formulated a least cost theory of industrial location which tries to explain and predict the locational
pattern of the industry at a macro-scale. It emphasizes that firms seek a site of minimum transport
and labour cost.

The point for locating an industry that minimizes costs of transportation and labor requires analysis
of three factors:

Material Index

The point of optimal transportation based on the costs of distance to the "material index" - the ratio
of weight to intermediate products (raw materials) to finished product.

In one scenario, the weight of the final product is less than the weight of the raw material going into
making the product -- the weight loosing industry. For example, in the copper industry, it would be
very expensive to haul raw materials to the market for processing, so manufacturing occurs near
the raw materials. (Besides mining, other primary activities (or extractive industries) are considered
material oriented: timber mills, furniture manufacture, most agricultural activities, etc.. Often located
in rural areas, these businesses may employ most of the local population. As they leave, entire
cities lose their economic base.)

In the other, the final product is heavier than the raw materials that require transport. Usually this is
a case of some ubiquitous raw material, such as water, being incorporated into the product. This is
called the weight-gaining industry.

Labor

The labor distortion: sources of lower cost labor may justify greater transport distances and
become the primary determinant in production.

A. UNSKILLED LABOR –industries such as the garment industry require cheap unskilled laborers
to complete activities that are not mechanized. They are often termed "ubiquitous" meaning they
can be found everywhere. Its pull is due to low wages, little unionization and young employees.

B. SKILLED LABOR - High tech firms, such as those located in Silicon Valley, require exceptionally
skilled professionals. Skilled labor is often difficult to find.

Agglomeration and deglomeration

Agglomeration is the phenomenon of spatial clustering, or a concentration of firms in a relatively

small area. The clustering and linkages allow individual firms to enjoy both internal and external
economies. Auxiliary industries, specialized machines or services used only occasionally by larger
firms tend to be located in agglomeration areas, not just to lower costs but to serve the bigger
populations.

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Deglomeration occurs when companies and services leave because of the diseconomies of
industries’ excessive concentration. Firms who can achieve economies by increasing their scale of
industrial activities benefit from agglomeration. However, after reaching an optimal size, local
facilities may become over-taxed, lead to an offset of initial advantages and increase in PC. Then
the force of agglomeration may eventually be replaced by other forces which promote
deglomeration.

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MARKET STRUCTURE
In economic terms, it's the number, size, kind and distribution of buyers and sellers. For investor
relations practitioners, the markets globally are moving to a participant model and away from
classic NYSE-style auctions, thanks to trading automation and market regulation requiring
transparency.

Since the number, size, kind and distribution of participants determine how the buyside and
sellside interact with equities, and therefore how equities are owned or traded, it's crucial for IROs
to possess basic comprehension of their stocks' market structure.

Perfect competition (PC) is a market structure where there a large number of buyers and sellers
such that no individual buyer or seller can influence demand, supply or price. All firms sell
homogeneous products. The firm is a price taker. It faces a perfectly price elastic horizontal
demand curve, as shown in Figure 1(a). Marginal revenue (MR) equals average revenue (AR)
which is also equal to price. There is perfect information and free entry and exit into the market due
to perfect mobility of resources.

On the other hand, there are many buyers but only one seller in monopoly. The monopoly sells a
unique product which has no close substitutes. It is a price maker and can affect price or output but
not both. It faces a price inelastic demand curve, as shown in Figure 1(b). AR lies above MR.
There is imperfect knowledge due to market failure. Strong barriers are also present.

Price Price

AR=MR AR
MR

Fig 1(a) Demand curve for PC Fig. 1(b) Demand curve for monopoly

When evaluating which is a more desirable market structure, we should consider their economic
efficiency. Resources are said to be allocated efficiently when no one can be made better off
without making one other person worse off. From society’s point of view, this occurs at the socially
ideal level of output. Efficiency in allocation of resources is known as pareto optimality or pareto
efficiency. This can be attained when both productive and allocative efficiency are achieved

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Productive efficiency requires that whatever output is being produced, it is being produced at the
lowest possible costs. A firm is said to be productive efficient if it produces at the minimum point of
its long-run average cost (LRAC) curve. Under this situation, there is efficient allocation of
resources, all economies of scale are realized and all diseconomies of scale are avoided. When
the firm allocates resources at the most efficient manner possible, full productive efficiency is
attained.

PC firms can achieve at productive efficiency as it can produce at the P=AR=minimum point of
LRAC=minimum point of short run average cost curve at long run equilibrium. Refer to Fig. 2(a).
Under such a situation, it incurs the lowest cost possible and utilities plant size at the optimum.
Consumers pay the lowest possible price possible as only normal profits can be made in the long
run.

However, the monopolist can make supernormal profits in the long run. But it can never achieve
productive efficiency as it can never produce at the minimum point of its LRAC. Instead, it always
produces at the falling portion of LRAC, when it is making normal profits. Refer to Fig. 2(b). Hence,
it can never achieve optimum level of output. Equilibrium price is at OPe and equilibrium output is
at OQe, which is less than the optimal level. There is excess capacity.

Price
Price

LRAC
LRAC
Pe

AR=MR
AR
MR

Fig 2(a): Long run equilibrium in PC Fig. 2(b):Long runequilibrium in

economy

Harvey Leibenstein states that the term x-inefficiency is associated with inefficiency such as
overstuffing, inability to keep up-to-date technologically and to the slack management of monopoly
firms. This means that the firm produces at a cost greater than the lowest possible costs. Due to
absence of competition from rivals, the monopolist may not be forced to produce at the lowest
possible costs. Hence, x-inefficiency may result in productive inefficiency.

Market Analysis:-

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The goal of a market analysis is to determine the attractiveness of a market and to understand its
evolving opportunities and threats as they relate to the strengths and weaknesses of the firm.

David A. Aaker outlined the following dimensions of a market analysis:

• Market size (current and future)
• Market growth rate
• Market profitability
• Industry cost structure
• Distribution channels
• Market trends
• Key success factors
The size of the market can be evaluated based on present sales and on potential sales if the use of
the product were expanded. The following are some information sources for determining market
size:

• government data
• trade associations
• financial data from major players
• customer surveys
• Market Growth Rate

A simple means of forecasting the market growth rate is to extrapolate historical data into the
future. While this method may provide a first-order estimate, it does not predict important turning
points. A better method is to study growth drivers such as demographic information and sales
growth in complementary products. Such drivers serve as leading indicators that are more accurate
than simply extrapolating historical data.

Important inflection points in the market growth rate sometimes can be predicted by constructing a
product diffusion curve. The shape of the curve can be estimated by studying the characteristics of
the adoption rate of a similar product in the past.

Ultimately, the maturity and decline stages of the product life cycle will be reached. Some leading
indicators of the decline phase include price pressure caused by competition, a decrease in brand
loyalty, the emergence of substitute products, market saturation, and the lack of growth drivers.
Market Profitability

While different firms in a market will have different levels of profitability, the average profit potential
for a market can be used as a guideline for knowing how difficult it is to make money in the market.
Michael Porter devised a useful framework for evaluating the attractiveness of an industry or

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market. This framework, known as Porter's five forces, identifies five factors that influence the
market profitability:
• Buyer power
• Supplier power
• Barriers to entry
• Threat of substitute products
• Rivalry among firms in the industry
• Industry Cost Structure

The cost structure is important for identifying key factors for success. To this end, Porter's value
chain model is useful for determining where value is added and for isolating the costs.

The cost structure also is helpful for formulating strategies to develop a competitive advantage. For
example, in some environments the experience curve effect can be used to develop a cost
advantage over competitors.
Distribution Channels

The following aspects of the distribution system are useful in a market analysis:

Existing distribution channels - can be described by how direct they are to the customer.

Trends and emerging channels - new channels can offer the opportunity to develop a competitive
advantage.

Channel power structure - for example, in the case of a product having little brand equity, retailers
have negotiating power over manufacturers and can capture more margin.
Market Trends

Changes in the market are important because they often are the source of new opportunities and
threats. The relevant trends are industry-dependent, but some examples include changes in price
sensitivity, demand for variety, and level of emphasis on service and support. Regional trends also
may be relevant.

Key Success Factors-

The key success factors are those elements that are necessary in order for the firm to achieve its
marketing objectives. A few examples of such factors include:
I. Access to essential unique resources
II. Ability to achieve economies of scale
III. Access to distribution channels
IV. Technological progress

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It is important to consider that key success factors may change over time, especially as the product
progresses through its life cycle.

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Bibliography:-

Industrial Economics & Management : T.N. Chhabra

www.google.com

www.answers.com

www.netmba.com

www.search.yahoo.com

www.iupindia.org

www.economicswebinstitue.org

www.mbaalliances.com

www.bussinessmanagement.com

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