MBA Final Project

PROJECT MANAGEMENT
(MBA666)
Raghu Nandan Sengupta
Industrial & Management Department
Indian Institute of Technology Kanpur
Project Management Dr. R. N. Sengupta, IME Dept., IIT 1

Kanpur, INDIA
Few rules for the classes
• Class/group assignments: 30%, Quizzes: 20%, Mid-
semester examination: 20%, Final Examination: 25%,
Attendance: 05%.
• All quizzes, examination are closed notes/books.
• In case a student is absent during any class/group
assignment, quiz , mid-semester, final examination then
it will be re-conducted as per PG norms.
• No mobiles in class.
• Be exactly on time or do not be in class.

Kanpur, INDIA
Syllabus of Project Management
Introduction to Project Management, Generation and Screening of
Project Ideas, Project Appraisal/Evaluation, Risk Management in
Project Management, AHP, DEA, Utility Analysis, Decision Trees,
Cost Benefit Analysis, Project Characteristics, Project Life Cycle,
Valuing Projects, Cash Flow Problems, Credit Risk in Project
Finance, GANTT charts, Precedence diagrams, PERT, CPM,
Resource levelling, Crashing of Jobs, GERT, AND gateways, OR
gateways, Q-GERT.

Kanpur, INDIA
References
1) Chandra, P., Projects, Tata McGraw-Hill Education, 2009, ISBN: 0070077932 | ISBN:
9780070077935
2) Gatti, S., (2008), Project Finance in Theory and Practice, Academic Press, ISBN: 978-0-12-373699-
4.
3) Levy, F. K. and Wiest, J. D., A Management Guide to PERT/CPM, Prentice Hall, 1969, ISBN-10:
0135485118 | ISBN-13: 9780135485118.
4) Lewis, R., Project Management, McGraw-Hill, 2006, ISBN 0-07-147160-X.
5) Moder, J. J. and Phillips, C. R., Project Management With CPM, PERT and Precedence
Diagramming, Van Nostrand Reinhold,1983, ISBN-10: 0442254156 | ISBN-13: 978-0442254155.
6) Morris, P. W. G., and Pinto, J. K., The Wiley Guide to Managing Projects, 2004, JohnWiley & Sons,
ISBN: 9780471233022.
7) Phillips, J., PMP Project Management Professional Study Guide, McGraw-Hill, 2003. ISBN 0-07-
223062-2.
8) Pritsker, A. A. B., Modeling and analysis using Q-GERT networks, John Wiley & Sons Inc, 1979,
ISBN: 0470266481 | ISBN: 9780470266489.
9) Project Management Institute, A Guide to the PMBOK, Project Management Institute, 2008, ISBN:
978-1-933890-51-7.

Kanpur, INDIA
Few points regarding the teaching
methodology for Project Management
 Examples solved are marked with numbers, 1, 2, etc.
 Apart from that other small problems are also given in the ppt
slides.
 Assignment to be solved are marked with numbers, 1, 2, etc.
 Reading has to be done as required from the reference list given.
 Cases/caselets will be given and have to be analyzed
accordingly.
 Class timings are: (i) Tuesday: 1030-1200 hours (IST) in C2 and
(ii) Thursday 1200-1330 hours (IST) in C2
 Meeting the instructor can be scheduled as required

Kanpur, INDIA
What are Projects
General Introduction: For most organizations and societies,
projects are the principal means for changing our world. Whether
we are talking about building the latest G4 network Smartphone,
designing a new composite material passenger aircraft, planning a
major fund-raising event, engineering and constructing an oil and
gas platform, or developing a high-speed rail network, the goal is
to create something of value to address a business opportunity or
prevent the loss of competitive advantage. Thus projects represent
human accomplishments; sometimes on a grand scale (the Hoover
Dam or Space Station Freedom) and sometimes through small,
incremental changes (the creation of “new and improved”
household products).

Kanpur, INDIA
Difference between Production
and Projects
 In manufacturing theory distinction is made between engineering and
production
 Engineering comprise both product and production engineering.
 These two cycles are repeated for every new or updated product
specifications or production process specifications.
 The production can be repeated continuously, in batches, or just once.
 If production is continuous, it is referred to as a production line where
operations are continuously repeated.
 If production is only one piece, it is referred to as one-of-a-kind
production. Thus this one-of-kind production is actually a project, where
the focus is on the unique product made only once in contrast to the
repetitive manufacturing making a large number of the same product.

Kanpur, INDIA
A typical Production Cycle

Kanpur, INDIA
Special characteristics of Projects
Projects operate outside the bounds of an organization’s normal
processes and offer an exciting alternative to many of the
repetitive, on-going systems within a firm. Thus projects are
different from other forms of organizational processes.
All projects share the following characteristics:
• They are complex and unique.
• They have a clear goal or set of goals.
• They are limited by budget, schedule, and resources.
• They are customer focused.

Kanpur, INDIA
What is Project Management
“the application of knowledge, skills,
tools, and techniques to project
activities to meet the project
requirements.”

Kanpur, INDIA
What is Project Management
• Several techniques apply to project planning activities
(e.g., scope management, risk management, work
breakdown structures, and cost estimation),
scheduling processes (network development,
precedence diagrams, Gantt and PERT charts), and
means for controlling projects (earned value
management).
• Taken together, however, they represent a powerful
suite of tools and means for becoming successful at
managing projects.
Kanpur, INDIA
Two schools of Project
Management
• One school emphasizes methods and techniques
for planning and control. This can be referred to
as task perspective.
• Other emphasizes organization and human
relationships. This can be referred to as
organizational perspective.

Kanpur, INDIA
Methods of Project Management
• Scope Management
• Risk Management
• Work breakdown structure
• Cost Estimation, RIO, EV, IRR, etc.
• GANTT Chart, AHP, DEA, etc.
• PERT (Program Evaluation and Review Technique) is based on networks with
stochastic activity durations
• CPM (Critical Path Method) technique is concerned with determining the optimal
duration of a project where the duration of each single activity is known without
uncertainty
• Generalized Evaluation Review Technique (GERT)
• Queueing Generalized Evaluation Review Technique (Q-GERT)
Note: The main difference is that PERT uses stochastic estimates for activity
durations whilst the CPM considers activity duration as a deterministic value

Kanpur, INDIA
Changing philosophy of Project
Management
 Initial focus was on obtaining control through
more detailed planning and monitoring.
 Present focus is on human relationship/cultural
issues involved in a project. Thus team building
and team composition has become important
factors for the success of the project execution.
 Risk management is also considered a very
important aspect of focus to obtain success in the
completion of a project.
Kanpur, INDIA
Brief history of Project
Management
 Development of the network scheduling
techniques during the 1950s, and the
breakthrough came with the US Polaris project.
This is the so called PERT method
 Independently the CPM technique was developed
in the US by E.L. DuPont de Nemours while
exploring potential applications for their newly
acquired Univac computers

Kanpur, INDIA
Important for Project
Management
 With respect to cost and schedule systems
criteria for performance measurement, it is
important to note two important principles
which are:
Breaking the project scope down to
manageable units of work (work breakdown).
Controlling progress using the earned value
concept

Kanpur, INDIA
Management
 Another important achievement for the project
management community was the development of the
PMI’s A Guide to the Project Management Body of
Knowledge (PMBOK Guide) first published in 1987
and last revised in 2008 (PMI 2008).
 It is an American National Standards Institute (ANSI)
<https://www.ansi.org/> standard and serves as the
major reference document for good practice in project
management throughout the world.

Kanpur, INDIA
Management
 As you remember we had mentioned that now a days
organization focus is the main thrust area of Project
Management study.
 Hence today it is equally important to address how you
can motivate project personnel to collaborate and to
develop ownership for the different objectives of the
project.
 Hence team building and team composition has become
important factors for the success of the project
execution.
Kanpur, INDIA
Management
 Risk management is today also considered
important to obtain successful project results.
 Risk assessment has to be done and contingencies
have to be allocated.
 It is important to forecast as accurately as possible
all potential deviations in the project and to
provide adequate contingencies against it.

Kanpur, INDIA
Management
 In spite of efforts from our side, cost and schedule overruns still
occur.
 Thus rather than forecast, contingency planning is more important.
 Reason being risks and variations are normal and cannot be fully
avoided, thus it is important that we develop project management
competence to manage the risk and variations as they occur.
 Hence many organizations have realized that too tight control
prevents creativity and that less focus on detailed plans can
encourage creativity and lead to better and more effective project
execution.

Kanpur, INDIA
What is new in Project
Management
 Considering all these, researchers have
focused on one new approach which
has found wide application for
development of information systems is
agile project management.

Kanpur, INDIA
Agile Project Management
 Agile project management is a method of project management applying a
team approach.
 The scope of the project is allowed to change rapidly and frequently, and
this is obtained by strong focus on stakeholder involvement and
communications.
 In the agile environment, projects are the business, while in the traditional
environment, the triple constraint of scope, resources and schedule, is the
main focus.
 In an agile strategy, the project manager takes an outward-facing
perspective to facilitate the integration of the project and the business.
 Focus is on delivering business results rather than staying within preset
boundaries, as the original project boundaries will quickly diverge from
the business reality in an uncertain environment.
Kanpur, INDIA
Good example for Agile Project
Management
• In the software industry, agile project
management is used applying a method called
Scrum.
• In Scrum the basic development unit is a
sprint.
• Each sprint is preceded by a planning meeting,
where the tasks for the sprint are identified.

Kanpur, INDIA
Good example for Agile Project
Management
 During a sprint the project team will create parts of
the finished product. Scrum teams consist of three
core roles:
Product owner representing the voice of the
customer
Development team responsible for delivering
finished parts of the final product
Scrum master facilitating the process and
enforcing the Scrum rules.

Kanpur, INDIA
Success of Project Management
 Project success must be defined in terms of the elements that
characterize the very nature of the project: for example, time
(adherence to schedule), cost (adherence to budget),
quality/functionality, and customer satisfaction. Project
success follows a quadruple constraint, consisting of:
 Time
 Cost
 Quality and Functionality
 Client Satisfaction

Kanpur, INDIA
 One should note that a distinction has to be made between:
 Key performance indicators: Key performance indicators
are parameters, indicators or values that can be measured to
evaluate whether a project is successful or not. As a
consequence of this, key performance indicators can only be
measured after a project has been completed.
 Success factors: Success factors are conditions or factors
that must be present for a project to be successful. Such
factors may be observed and influenced during project
execution.

Kanpur, INDIA
 Project success must be related to objectives or
goals.
 An interesting question is, however, whether there
is any difference between project success and
project management success.
 Hence the question is, can an unsuccessful project
be successfully managed? Vice versa, could
unsuccessful project management lead to a
successful project?
Kanpur, INDIA
 A perfect project management organization is no
guaranty for a successful project. Opposite,
unsuccessful project management may complete a
project successfully.
 An example of the latter is the oil platform Statfjord A
in the North Sea. When it was towed to field, it was
over two years late and at the end the final cost was
almost three times of the first estimated cost.
 Still this platform has performed well, produced oil and
generated revenue far beyond what was expected.
Kanpur, INDIA
Project Organizational Maturity
 As the project work model is being deployed in
industry, it becomes increasingly important to
understand how well an organization is able to
handle projects or how mature the organization is
with respect to project management.
 This is referred to as project management
maturity (PMM) or organizational project
management maturity.

Kanpur, INDIA
 The company can obtain an impression of how well it is
doing compared to best practice.
 A best practice represents an industrially accepted best
way of achieving a given goal.
 Benchmarking and best practice definitions within the
manufacturing industry have for a long time been
regarded as a good approach to enhance competitiveness.
 Within project management, project management maturity
measurement is a tool to achieve continuous improvement
and organizational learning.
Kanpur, INDIA
 Measurement of project management maturity
will help a company to understand what processes
influence competitiveness and what processes
need further development and improvement.
 Thus project management maturity measurement
becomes a strategic tool for developing project
management competence and building a project
culture characterized by excellence.

Kanpur, INDIA
Project Organizational Maturiy
 For each capability there is a measurable result.
 This measurement is the basis for the determination of
the project organization project management maturity.
 For the measurement, key performance indicators
(KPIs) are used.
 A KPI differs from a success criterion.
 A success criterion is used to decide whether a goal is
met or not.
 A KPI is used to indicate the performance of a process.

Kanpur, INDIA
Examples for Project
Organizational Maturity
 Apple’s <https://www.apple.com/> and
<https://en.wikipedia.org/wiki/Apple_Inc.> creation of the new iPad and the
thousands of applications that can be used with either it or their best-selling iPod
products.
 Bechtel’s <http://www.bechtel.com/> and <https://en.wikipedia.org/wiki/Bechtel>
construction of a large-scale chemical refining plant in South Africa.
 The West Coast High-speed Route Modernization rail renovation project in the
UK, designed to update the most heavily traveled passenger and freight rail
network in Britain <https://en.wikipedia.org/wiki/High-
speed_rail_in_the_United_Kingdom>.
 Chile’s rescue operation to free 33 miners trapped a half mile below the surface
following the catastrophic collapse of a mine
<https://en.wikipedia.org/wiki/2010_Copiap%C3%B3_mining_accident>.

Kanpur, INDIA
Examples for Project
Organizational Maturity
 The subsea installations for producing oil and gas at the Ormen Lange field in
Norway <https://en.wikipedia.org/wiki/Ormen_Lange_(gas_field)>.
 A World Bank project to reclaim nearly 3 million acres of poor soil for farming in
the Uttar Pradesh state in India
<http://www.worldbank.org/en/news/feature/2006/10/18/india-in-uttar-pradesh-
farmers-green-their-barren-lands>.
 Development of Chevrolet’s Volt electric car <http://www.chevrolet.com/> and
<https://en.wikipedia.org/wiki/Chevrolet_Volt>.
 The Droid™ operating system for Smart phones
<https://en.wikipedia.org/wiki/Android_(operating_system)>.
 The reconfiguration of Cummins’ diesel engine assembly line to streamline their
manufacturing processes <http://www.cummins.com/> and
<http://www.cumminseurope.com/cummins-darlington-plant-celebrates-50-years-
of-engine-production/>.

Kanpur, INDIA
 Project success must always be measured against
goals or objectives.
 However, there are normally several sets of
objectives.

Kanpur, INDIA
Project Mission and Objectives

Kanpur, INDIA
Project Management Objectives
 There are normally three sets of
objectives (project results) derived from
the mission for any project and they are:
Project objectives
Business objectives
Social objectives

Kanpur, INDIA
Project Management Objectives
 The objectives would normally include a precise definition
of the scope of work, the schedule and a budget.
 Successfully completion of project: How successful is the
project with respect to the end user.
 Successful use of project results: Whether the
results/experience obtained/gained can be emulated in future.
 Successful influence of project on society: How beneficial
is the project for the society in the long run. Remember this
is different from successful completion and its positive effect
to the end user.

Kanpur, INDIA
Classification of Projects
 Small, large and mega.
 ICT, construction, research.
 Engineering & construction, research &
development

Kanpur, INDIA
Classification of Projects
 Engineering & construction
 No uncertainty as to whether the project objectives can
be technically met or not.
 Uncertainty connected to resource consumption,
schedule, scope of work, etc.
 Research & development
 Can be broken down into product development,
systems development, organizational development, and
new knowledge development.

Kanpur, INDIA
Functions of Management
Planning
Control Organizational Organization

Goal
Leadership

Kanpur, INDIA
Characteristics of Project
Management
• A person heads the project and the cross
functional, goal oriented view point
embodies the characteristics of the project
• The focal point of the project management is
the project manager
• Due to its multi functional work the cross
functional areas reflect the work focus as
desired in the project
Kanpur, INDIA
Management
• The project manager is responsible for
integrating the whole work
• The project manager negotiates with the
functional managers
• The project manager focuses on delivering
a particular product/service at a certain
time

Kanpur, INDIA
Management
• The project manager has two chain of command
• Responsibility, awards, etc., are shared amongst
members of the project management team
• Projects can originate at different places but the
goal is the same
• Project management sets into motion different
other functions not directly related tp project
management

Kanpur, INDIA
When to use Project Management
• Unfamiliarity
• Magnitude of the effort
• Changing environment
• Interrelatedness
• Reputation of the organization

Kanpur, INDIA
Different forms of Project
Management
• Basic Project Management
• Program Management
• New Venture Management
• Product Management

Kanpur, INDIA
Management
• Attributes
• Environment and boundary
• Objectives
• Structure of the system
• Inputs, Processes and Outputs
• Constraints and conflicts

Kanpur, INDIA
Stages of Project Management
• Systems concept
• System Definition and Preliminary design
• Detailed design and development
• System production and fabrication
• Detailed design and development
• System operation and support

Kanpur, INDIA
Project Management
Development Cycle
• Project life cycle
• Managing the project life cycle
• System Development Cycle
– Conception phase
– Definition phase
– Execution phase
– Operation Phase

Kanpur, INDIA
Project Management
Development Cycle
• Labour
• Facilities
• Time
• Knowledge
• Technology

Kanpur, INDIA
Project Management
Development Cycle
• Conception: Project Initiation
• Project Feasibility
– The use should state the needs very clearly
– Ask a set of questions to the user to understand
his/her needs clearly
– Conduct research to understand the need
– Give the restated needs to user
– Keep in mind needs do change
Kanpur, INDIA
Project Management
Development Cycle
• Feasibility
– The use should state the needs very clearly
– Ask a set of questions to the user to understand
his/her needs clearly
– Conduct research to understand the need
– Give the restated needs to user
– Keep in mind needs do change

Kanpur, INDIA
Project Life Cycles
 A project life cycle represents the stages of a project’s
development.
 Life cycles are critical for managing projects because
they help us understand the logic behind its
development and make it easier to plan for resource
needs and schedule appropriate points to measure
project progress and assess its status.
 It is also a way of reducing the complexity of the project
task and making the project better manageable.

Kanpur, INDIA
Project Stages
 Starting the project
 Organizing and preparing
 Carrying out the project work
 Closing the project

Kanpur, INDIA
Project Life Cyle

Kanpur, INDIA
Project life cycle
Cumulative
Cost Concept Planning Execution Termination
Time

Kanpur, INDIA
Project life cycle
Introduction Growth Maturity Stagnation Decline
Cost
Time

Kanpur, INDIA
Project life cycle
Phases
1) Conceptualisation
2) Planning
3) Execution
4) Termination

Kanpur, INDIA
Project life cycle
Stages under Conceptualisation
1) Concept
a) Trigger an event in the sense some one comes up
with an idea.
b) Capture the concept and try to visualize it.
c) Clarification of the concept in terms of the project
d) Elaboration of the concept
e) Evaluation of the concept

Kanpur, INDIA
Project life cycle
Stages under Planning
1) Design
a) Make the basic design
b) Develop a performance criteria according to which the project is evaluated
c) Design and development of the concept for the project
d) Evaluate the design and get multiple feedbacks
2) Plan
a) Make a base plan on which to build up the project
b) Develop targets and milestone, i.e., when to finish a certain portion of the project or at which stage
of the project would one like to reach at a certain time
c) Plan the development of how one would proceed with the project
d) Concretize the evaluation criteria
3) Allocation
a) Develop a plan for allocation of resources both manpower, money, time etc.
b) Plan the allocation in detail
c) Concretize evaluation criteria for the allocation

Kanpur, INDIA
Project life cycle
Stages under Execution
1) Control
a) Modification of targets and milestones
b) Allocation modification
c) Evaluation modification
d) Evaluation control

Kanpur, INDIA
Project life cycle
Stages under Termination
1) Deliver
a) Basic deliverable condition
b) Deliverable modification if required and necessary
c) Modification of performance criteria
d) Deliver evaluation
e) Evaluation control
2) Review
a) Basic review
b) Review development
c) Review evaluation
3) Support
a) Basic maintenance and liability perception
b) Development of support criteria
c) Support evaluation

Kanpur, INDIA
Stages of Project Life Cycle
 Conceptualization
 Planning
 Execution
 Termination

Kanpur, INDIA
Project Execution Mode
 Splitting the project into a number of
phases forms the basis for a project
execution model. Such a model will in
addition include:
Decision gates
Acceptance Gates

Kanpur, INDIA
Project Phases and Decision
Gates

Kanpur, INDIA
Project Life Cycle

Kanpur, INDIA
Project Capital Value Process

Kanpur, INDIA
Management of a Project
“is a discipline which now transcends its earlier, more mechanistic
focus. It is now about defining and delivering successful projects to
clients--projects which give optimal value. It is developing fast,
evolving in a Total Quality, process improvement environment
towards new levels of performance which demand new work styles
and new attitudes. Technology, finance, environmental responsibility
and commercial astuteness figure prominently in this new era, as of
course does management itself. Project management
professionalism--project managers acting professionally in their
clients' best interests--is increasingly significant.”

Kanpur, INDIA
Project Management Stake
Holders
 A stakeholder is a person or an organization
actively involved in the project or having an
interest in or conflict of interest with the
project execution or the project end result.
 There are three obvious stakeholders: the
project owner, the project organization and
the society.

Kanpur, INDIA
Project Owner
 The project owner can be split into
three stakeholders:
Sponsor
Owner
User

Kanpur, INDIA
Schematic diagram of Project
Stake Holders

Kanpur, INDIA
Project Management
 The base organization which is the permanent organization of
the project’s personnel
 The base organization is an indirect stakeholder since it will
frequently define frame conditions and policies for the
execution of the project.
 Project management comprises the project manager or leader,
the management group and possibly a project office.
 The project team consists of all personnel working on the
project.
 Contractors are all external suppliers of goods and services to
the project.
Kanpur, INDIA
Risk in Project Management
 An example can serve to illustrate the concept of risk management in Project
Management.
 Assume that we are constructing a house. We are about to pour concrete for
the ground floor.
 We have already ordered the concrete for June 10. However, it might be that
the piping installations for the floor may not be finished in time for this.
 Let us assume that there is a 90 % probability that the piping will be finished
in time and that the pouring of concrete can start as planned on June 10.
 In the case that the pouring of concrete must be cancelled or postponed, there
is a cancellation fee of INR 2,000.The probability that the fee will apply is 10
%, and the consequence is INR 2,000.The risk associated with this decision
(pour concrete on June 10) is thus 2000*0.10 = INR 200

Kanpur, INDIA
Risk in Project Management
 The technical and economic risk of a
project fall into four categories:
Scope of work
Quality
Schedule
Cost

Kanpur, INDIA
Uncertainty and Risk in Project
Management

Kanpur, INDIA
Types of Risks in Project
Management
 Operational risk: Connected to internal circumstances in
the project and can be controlled by the project team.
 Strategic risk: It is the prospective impact on earnings
or capital from adverse business decisions, improper
implementation of decisions or lack of responsiveness
to industry changes.
 Contextual risk: It is connected to circumstances
outside the project that may influence the scope of
work and the performance of the organization.

Kanpur, INDIA
Project Management Risk
 Broadly speaking, project risk management requires us to
ask the following questions:
 What is likely to happen (the probability and impact)?
 What can be done to minimize the probability or impact
of these events?
 What cues will signal the need for such action (i.e., what
clues should I actively be looking for)?
 What are the likely outcomes of these problems and my
anticipated responses?

Kanpur, INDIA
Risk Management in Projects
 Risk management follows a four-stage
process:
Risk identification
Analysis of Probability and Consequences
Risk Mitigation Strategies
Control and Documentation

Kanpur, INDIA
Risk Identification
 Financial Risk
 Technical Risk
 Commercial Risk
 Contractual or Legal Risk

Kanpur, INDIA
Risk Impact Matrix for Project
Management

Kanpur, INDIA
Strategies when Risk is there in
Project
 Accept Risk as it is
 Minimize Risk to the maximum possible
extent
 Share Risk with other parties involved in the
Project Management work
 Transfer Risk to other parties (who may not be
a part of the project management work)

Kanpur, INDIA
Project Management Decision
Process

Kanpur, INDIA
Model

Kanpur, INDIA
Model
 There are three different decision problems dependent
on the result of the non-controllable factors:
The results are known with certainty. Such problems
are called decision under certainty.
The probability distribution of the result is known.
Such problems are called decision under risk.
The probability distribution of the results is
unknown. Such problems are called decision under
uncertainty

Kanpur, INDIA
Expected Value Concept
 A commonly applied technique for solving project management
decision problems is the expected value concept.
 The expected value concept assumes that we know the potential
results of the project with associated probabilities.
 Hence by multiplying each potential result by its probability and
aggregating, we obtain an expected value for the total project.
 This is the average value we would obtain if we were able to
execute the project a large number of times.
 The value is not necessarily the value of one specific result. It is
just a reference value for taking the best decision by comparing
alternatives.

Kanpur, INDIA
Decision Tree Modeling in
Project Management
 For complicated project we use the concept of
Decision Tree concept.
 Here the concept of probability and
conditional probability is brought in to the
picture to have a good understanding about the
expected value as well s the risk of the
project.

Kanpur, INDIA
Decision Tree Analysis in Project
Management
9
5
2 10
11
6
1 3 12
7
13
4
8
14

Kanpur, INDIA
Decision Tree Analysis
The key steps in decision tree analysis are as follows
• Identify the problem and alternatives.
• Delineate the decision tree.
• Specify the probabilities and monetary outcomes.
• Evaluate the various decision alternatives.
• Remember the decision points, also called decision forks,
denoted by D, and the alternative actions are available for
experimentation and actions are possible at these points, while
the chance points, called chance forks, denoted by C, are the
points where the outcomes are dependent on a chance process
and the likely outcomes at these points.
Kanpur, INDIA
You as the CEO of a company (which manufactures
three different ratings of electrical motors) have the
following information in front of you
1) Motor rating 75 KW with a certain unknown demand,
d1 (remember this is in units)

Kanpur, INDIA
You have the SP for these ratings
as Rs. 15,000 for 75 KW, Rs.
35,000 for 150 KW and Rs.
50,000 for 200 KW

Kanpur, INDIA
You are interested in finding these numbers, d1, d2 and d3 in order to
find your total sales value. To ascertain these numbers you give this
task to an industrial marketing firm and they supply you with the
following information
1) The optimistic demand for 75 KW is 300 with a chance of 7/10,
while the pessimistic demand is 200 with a chance of 3/10
2) The optimistic demand for 150 KW is 210 with a chance of 5/15,
while the pessimistic demand is 100 with a chance of 10/15
3) The optimistic demand for 200 KW is 90 with a chance of 1/5, while
the pessimistic demand is 30 with a chance of 4/5

Kanpur, INDIA
Probabilistic scenario
7
300 units with chance of
10
3
75KW 200 units with chance of
10
5
150 KW 15
10
1 15
200 KW 90 units with chance of
5
4
5

Kanpur, INDIA
For the probabilistic decision process the
value/units for any particular rating of motor
would be found by the expected value, which
can be calculated by no*co+np*cp

Kanpur, INDIA
Thus
 d1 = {300*(7/10)+200*(3/10)} units of 75 KW
motor
 d2 = {210*(5/15)+100*(10/15)} units of 150
KW motor
 d3 = {90*(1/5)+30*(4/5)} units of 200 KW
motor

Kanpur, INDIA
• Hence expected sales figure is
[{300*(7/10)+200*(3/10)}*15000
+{210*(5/15)+100*(10/15)}*3500
0 + {90*(1/5)+30*(4/5)}*50000]

Kanpur, INDIA
Probabilistic versus Deterministic
w1
p1 w2 1 w
p2
p3 w3
p4
w4

Kanpur, INDIA
Decision Tree Analysis (Examples)
Let us consider two different examples in the area
of Decision Tree Analysis
• Example # 01: Simple problem with
unconditional probability
• Example # 02: Simple problem with
conditional probability
..\..\..\Consultancy\VLFM\VLFM_01_Decision_T
rees.docx

Kanpur, INDIA
Decision Tree Analysis (Utility Analysis)
Utility analysis
Consider the same type of construction project is being
undertaken by more than one company, who we will
consider are the investors. Now different investors
(considering they are investing their money, time,
energy, skill, etc.) have different attributes and risk
perception for the same project
That is to say, each investor has with him/her an
opportunity set. This opportunity set is specific to that
person only.

Kanpur, INDIA
Consider a shop floor manager has two
different machines, A and B, (both
doing the same operation) with him/her.
The outcomes for the two different
machines are given

Kanpur, INDIA
A B
Outcome value(i) P[i] Outcome value(i) P[i]
15 1/3 20 1/3
10 1/3 12 1/3
15 1/3 8 1/3
In reality what would a person do if he or she has two outcome sets
in front of him/her.
For A we have the expected value of outcome as 13.33 and for B also
it is 13.33

Kanpur, INDIA
A B
Outcome value(i) P[i] Outcome value(i) P[i]
15 ½ 20 1/3
10 ¼ 12 1/3
15 ¼ 8 1/3
Now for A we have the expected value of outcome as 13.75 and for B
it is still 13.33.

Kanpur, INDIA
Outcome Team X Team Y
Wins 40 45
Draws 20 5
Losses 10 20
Case I Case II
Outcome Points Outcome Points
Win 2 Win 5
Draw 1 Draw 1
Lose 0 Lose 0

Kanpur, INDIA
Case I
Team A = 100; Team B = 95, which means A
> B, i.e., A is ranked higher than B.
Case II
Team A = 220; Team B = 230, which means
B > A, i.e., B is ranked higher than A.

Kanpur, INDIA
On a general nomenclature we should have
the expected value or utility given by
N (W )
E[U ]   U (W )
W  N (W )
W
here U(W) is the utility function which is a
function of the wealth, W, while N(W) is the
number of outcomes with respect to a certain
level of income W.

Kanpur, INDIA
Remember in general utility values
cannot be negative, but many function
may give negative values.
For analysis to make the problem
simple we may consider the value to
be zero even though in actuality it is
negative.
Kanpur, INDIA
Consider an example where a single individual is facing the same set of outcomes at any
instant of time but we try to analyze his/her expected value addition or utility separately
based on two different utility functions
1) U[W(1)] = W(1) +1
2) U[W(2)] = W(2)2 + W(2)
Outcome W(1) U[W(1)] P(W(1) W(2) U[W(2)] P(W(2)
15 1.5 2.5 0.15 1.5 3.75 0.15
20 2.0 3.0 0.20 2.0 6.00 0.20
25 2.5 3.5 0.25 2.5 8.75 0.25
10 3.0 4.0 0.10 3.0 12.00 0.10
5 0.5 1.5 0.05 0.5 0.75 0.05
25 5.0 6.0 0.25 5.0 30.00 0.25
Accordingly we have E[U(1)] = 3.825 and E[U(2)] = 12.69. So we can have a different
decision depending on the form of utility function we are using.

Kanpur, INDIA
Now we have two different utility functions used one at a time for two different decisions
1) U[W(1)] = W(1) - 5 and
2) U[W(2)] = 2*W(2)-W(2)1.25
Outcome W U[W(1)] U[W(2)] Decision (A) Decision (B)
8 4 0 2.34 Yes No
3 5 0 2.52 No Yes
4 6 1 2.60 No Yes
6 7 2 2.61 Yes No
9 8 3 2.54 Yes No
5 9 4 2.41 No Yes
For utility function U[W(1)]

U(A,1)=0*8/(8+6+9)+2*6/(8+6+9)+3*9/(8+6+9)=1.69
U(B,1)=0*3/(3+4+5)+1*4/(3+4+5)+4*5/(3+4+5)=2.00
For utility function U[W(2)]

U(A,2)=2.34*8/(8+6+9)+2.61*6/(8+6+9)+2.54*9/(8+6+9)2.50
U(B,2)=2.52*3/(3+4+5)+2.60*4/(3+4+5)+2.41*5/(3+4+5) 2.50

Kanpur, INDIA
Example # 03: A venture capitalist is considering two

possibilities of investment. The first alternative is
buying government treasury bills which cost Rs.
6,00,000. While the second alternative has three
possible outcomes, the cost of which are Rs.10,00,000,
Rs. 5,00,000 and Rs. 1,00,000 respectively. The
corresponding probabilities are 0.2, 0.4 and 0.4
respectively. If we consider the power utility function
U(W)=W1/2, then the first alternative has a utility value
of Rs.776 while the second has an expected utility value
of Rs. 609. Hence the first alternative is preferred.

Kanpur, INDIA
Would the above problem give a
different answer if we used an
utility function of the form U(W)
= W1/2 + c (where c is a positive o
a negative constant)?

Kanpur, INDIA
In a span of 6 days the price of a security fluctuates and a person
makes his/her transactions only at the following prices. We
assume U[P] = ln(P)
Day P U[P] Number of Outcomes Probability
1 1000 6.91 35 0.35
2 975 6.88 20 0.20
3 950 6.86 10 0.10
4 1050 6.96 15 0.15
5 925 6.83 05 0.05
6 1025 6.93 15 0.15
Expected utility is 6.91
If U[P]= P0.25, then expected utility is 33.63

Kanpur, INDIA
Utility Analysis (Important properties)
General properties of utility functions
1) Non-satiation: The first restriction placed on
utility function is that it is consistent with
more being preferred to less. This means
that between two certain investments we
always take the one with the largest outcome,
i.e., U(W+1) > U(W) for all values of W. Thus
dU(W)/dW > 0

Kanpur, INDIA
2) If we consider the investors or the
decision makers perception of absolute
risk, then we have the concept/property
of (i) risk aversion, (ii) risk neutrality
and (iii) risk seeking. Let us consider
an example now

Kanpur, INDIA
Invest Prob Do not invest Prob
2 ½ 1 1
0 ½
Price for investing is 1 and it is a fair gamble,
in the sense its value is exactly equal to the
decision of not investing

Kanpur, INDIA
Thus
 U(I1)*P(I1) + U(I2)*P(I2) < U(DI)*1
 risk averse
 U(I1)*P(I1) + U(I2)*P(I2) = U(DI)*1
 risk neutral
 U(I1)*P(I1) + U(I2)*P(I2) > U(DI)*1
 risk seeker

Kanpur, INDIA
Another characteristic by which to classify a
risk averse, risk neutral and risk seeker person
is
 d2U(W)/dW2 = U(W) < 0 risk averse
 d2U(W)/dW2 = U(W) = 0 risk neutral
 d2U(W)/dW2 = U(W) > 0 risk seeker

Kanpur, INDIA
Utility curves
U (W )

Kanpur, INDIA
(Utility Analysis and Marginal Utility)
Marginal Utility Function
 Marginal utility function looks like a concave
function  risk averse
 Marginal utility function looks neither like a
concave nor like a convex function  risk
neutral
 Marginal utility function looks like a convex
function  risk seeker

Kanpur, INDIA
Marginal Utility Rate
 Marginal utility rate is increasing at a
decreasing rate  risk averse
 Marginal utility rate is increasing at a constant
rate  risk neutral
 Marginal utility rate is increasing at a
increasing rate  risk seeker

Kanpur, INDIA
Risk avoider
U (W )
W1 W1  1 W1  2
W

Kanpur, INDIA
Risk neutral
U (W )
W1 W1  1 W1  2 W

Kanpur, INDIA
Risk seeker
U (W )
W1 W1  1 W1  2 W

Kanpur, INDIA
Few other important concepts
Condition Definition Implication
Risk aversion Reject a U(W) < 0
fair gamble
Risk neutrality Indifference to U(W) = 0
a fair gamble
Risk seeking Select a U(W) > 0
fair gamble

Kanpur, INDIA
Utility Analysis
(Other concepts, i.e., A(W))
3) Absolute risk aversion property of utility
function where by absolute risk aversion we
mean
A(W) = - [d2U(W)/dW2]/[dU(W)/dW]
= - U(W)/U(W)

Kanpur, INDIA
Utility Analysis
• Assume an investor has wealth of amount W and a
security with an outcome represented by Z, which is a
random variable.
• Assume Z is a fair gamble, such that E[Z] = 0 and V[Z] =
2Z and the utility function is U(W).
• If WC is the wealth such that we can write this as a
decision process having two chooses, i.e.,
Choice A Choice B
W+Z WC

Kanpur, INDIA
Utility Analysis
• Now if the person is indifferent between decision/choice
A and decision/choice B, then we must have E[A] =
E[B], i.e., E[U(W+Z)] = E[U(WC)] = U(WC)*1
• The person is willing to give maximum of (W – W C) to
avoid risk, i.e., the absolute risk (say ) = (W- WC).
• Expanding U(W+Z) in a Taylors series around W and we
would get the answer.
Assignment # 01: This is an assignment and for the proof
check any good book in economics or game theory which
has utility as a part of it

Kanpur, INDIA
Utility Analysis
For the three different types of persons
 Decreasing absolute risk aversion
 A(W) = dA(W)/d(W) < 0
 Constant absolute risk aversion
 A(W) = dA(W)/d(W) = 0
 Increasing absolute risk aversion
 A(W) = dA(W)/d(W) > 0

Kanpur, INDIA
Utility Analysis
Condition Definition Property
1) Decreasing As wealth A(W) < 0
absolute risk increases the amount
aversion held in risk assets
increases
2) Constant As wealth A(W) = 0
remains the same
3) Increasing As wealth A(W) > 0
decreases

Kanpur, INDIA
Utility Analysis
(Other concepts, i.e., R(W))
4) Relative risk aversion property of utility
function where by relative risk aversion we
mean
R(W) = - W * [d2U(W)/dW2]/[dU(W)/dW]
= - W * U(W)/U(W)

Kanpur, INDIA
Utility Analysis
• Consider the same example as the previous
prove but now with /= (W- WC)/W, which is
the per cent of money the person will give up in
order to avoid the gamble and E[Z]=1.
• Z represented the outcome per rupee invested.
• Therefore for W invested we obtain W*Z
amount of money. On the other hand we have a
sure investment of WC.

Kanpur, INDIA
Utility Analysis
• For the investor to be indifferent between the two
decision processes we must have: E[U(W*Z)] =
E[U(WC)]
• Consider now E(U(W*Z)] and expanding it in a
Taylors series around W and we would get our
result
Assignment # 02: This is an assignment and for the
proof check any good book in economics or game
theory which has utility as a part of it

Kanpur, INDIA
Utility Analysis
For the three different types of persons
 Decreasing relative risk aversion
 R(W) = dR(W)/dW < 0
 Constant relative risk aversion
 R(W) = dR(W)/dW = 0
 Increasing relative risk aversion
 R(W) = dR(W)/dW > 0

Kanpur, INDIA
Utility Analysis
Condition Definition Property
1) Decreasing As wealth increases R(W) < 0
relative risk the % held in risky
aversion assets increases
2) Constant As wealth increases R(W) = 0
aversion assets remains the
same
3) Increasing As wealth increases R(W) > 0
aversion assets decreases

Kanpur, INDIA
Examples of Utility Functions
Some useful utility functions
1) Quadratic: U(W) = W – b*W2 (b is a
positive constant)
2) Logarithmic: U(W) = ln(W)
3) Exponential: U(W) = - e-aW ( a is a positive
constant)
4) Power: c*Wc (c  1 and c  0)

Kanpur, INDIA
U(W) = W – b*W2
Then:
 A(W)=4*b2/(1- 2*b*W)2
 R(W)=2*b/(1- 2*b*W)2
Hence we use this utility function for people
with
(i) increasing absolute risk aversion and
(ii) increasing relative risk aversion.

Kanpur, INDIA
W W-b*W^2 A(W) A'(W) R(W) R'(W)
2.00 3.00 -0.25 0.06 -0.50 -0.13
3.00 5.25 -0.20 0.04 -0.60 -0.08
4.00 8.00 -0.17 0.03 -0.67 -0.06
5.00 11.25 -0.14 0.02 -0.71 -0.04
6.00 15.00 -0.13 0.02 -0.75 -0.03
7.00 19.25 -0.11 0.01 -0.78 -0.02
8.00 24.00 -0.10 0.01 -0.80 -0.02
9.00 29.25 -0.09 0.01 -0.82 -0.02
10.00 35.00 -0.08 0.01 -0.83 -0.01
11.00 41.25 -0.08 0.01 -0.85 -0.01

Kanpur, INDIA

Kanpur, INDIA
U(W) = ln(W)
Then:
 A(W) = - 1/W2
 R(W) = 0
We use this utility function for people with
(i) decreasing absolute risk aversion and
(ii) constant relative risk aversion

Kanpur, INDIA
W ln(W) A(W) A'(W) R(W) R'(W)
1.00 0.00 -1.00 -1.00 -1.00 0.00
2.00 0.69 -0.50 -0.25 -1.00 0.00
3.00 1.10 -0.33 -0.11 -1.00 0.00
4.00 1.39 -0.25 -0.06 -1.00 0.00
5.00 1.61 -0.20 -0.04 -1.00 0.00
6.00 1.79 -0.17 -0.03 -1.00 0.00
7.00 1.95 -0.14 -0.02 -1.00 0.00
8.00 2.08 -0.13 -0.02 -1.00 0.00
9.00 2.20 -0.11 -0.01 -1.00 0.00
10.00 2.30 -0.10 -0.01 -1.00 0.00
Kanpur, INDIA

Kanpur, INDIA
U(W) = - e-aW
Then:
 A(W) = 0
 R(W) = a
(i) constant absolute risk aversion and
(ii) increasing relative risk aversion.

Kanpur, INDIA
W U(W) A(W) A'(W) R(W) R'(W)
2.00 -1.65 -0.25 0.00 0.50 0.25
3.00 -2.12 -0.25 0.00 0.75 0.25
4.00 -2.72 -0.25 0.00 1.00 0.25
5.00 -3.49 -0.25 0.00 1.25 0.25
6.00 -4.48 -0.25 0.00 1.50 0.25
7.00 -5.75 -0.25 0.00 1.75 0.25
8.00 -7.39 -0.25 0.00 2.00 0.25
9.00 -9.49 -0.25 0.00 2.25 0.25
10.00 -12.18 -0.25 0.00 2.50 0.25
11.00 -15.64 -0.25 0.00 2.75 0.25

Kanpur, INDIA

Kanpur, INDIA
U(W) = c*Wc
Then:
 A(W) = (c-1)/W2
 R(W) = 0.
(i) decreasing absolute risk aversion
(ii) constant relative risk aversion.

Kanpur, INDIA
W U(W) A(W) A'(W) R(W) R'(W)
2.00 0.30 0.38 -0.19 -0.75 0.00
3.00 0.33 0.25 -0.08 -0.75 0.00
4.00 0.35 0.19 -0.05 -0.75 0.00
5.00 0.37 0.15 -0.03 -0.75 0.00
6.00 0.39 0.13 -0.02 -0.75 0.00
7.00 0.41 0.11 -0.02 -0.75 0.00
8.00 0.42 0.09 -0.01 -0.75 0.00
9.00 0.43 0.08 -0.01 -0.75 0.00
10.00 0.44 0.08 -0.01 -0.75 0.00
11.00 0.46 0.07 -0.01 -0.75 0.00
Kanpur, INDIA

Kanpur, INDIA
Utility Function (An Example)
Example # 04:Suppose U(W) = W1/4 and we are required to
find the properties of this utility function and also draw the
utility function graph.
Now

Kanpur, INDIA
Let us find absolute risk aversion and relative risk aversion
properties of this particular utility function.

Kanpur, INDIA
Now from the two equations we easily see that:
1. We have decreasing absolute risk aversion property,
i.e., as the amount of wealth (W) increases the
amount held in risky assets also increases.
2. We have constant relative risk aversion property, i.e.,
as the amount of wealth (W) increases the % held in
risky assets remains the same.

Kanpur, INDIA
Now the U(W) looks like as shown in the graph.

Kanpur, INDIA
The actual value of expected utility is of no
use, except when comparing with other
alternatives. Hence we use an important
concept of certainty equivalent, which is the
amount of certain wealth (risk free) that has
the utility level exactly equal to this expected
utility value.
We define U(C) = E[U(W)], where C is the
certainty value

Kanpur, INDIA
How is this value of C useful
 Suppose that we have a decision process with a
set of outcomes, their probabilities and the
corresponding utility values. In case we want to
compare this decision process we can find the
certainty equivalent so that comparison is easier.
 To find the exact form of the utility function for a
person who is not clear about the form of utility
function he/she uses.

Kanpur, INDIA
Example # 05: Suppose you face two options. Under
option # 1 you toss a coin and if head comes you win
Rs. 10, while if tail appears you win Rs. 0. Under
option # 2 you get an amount of Rs. M. Also assume
that your utility function is of the form U(W) = W –
0.04*W2. It means that after you win any amount the
utility you get from the amount you won.
For the first option the expected utility value would be
Rs. 3, while the second option has an expected utility of
Rs. M – 0.04*M2. To find the certainty equivalent we
should have U(M) = M – 0.04*M2 = 3. Thus M = 3.49,
i.e., C = 3.49, as U(3.49) = E[U(W)]

Kanpur, INDIA
The above example illustrates that you would be
indifferent between option # 1 and option # 2.
Now suppose if you face a different situation
where you have option # 1 as before but a
different option # 2 where you get Rs. 5. Then
obviously you would choose option # 2 here, as
U(5) = (5 - 0.04*52) = 4 > 3.49.
For the venture capital problem the certainty
value for the option # 2 is Rs. 370881, as
U(370881) = (370881)0.5 = 609

Kanpur, INDIA
 A risk averse person will select a
equivalent certain event rather than the
gamble
 A risk neutral person will be indifferent
between the equivalent certain event and
the gamble
 A risk seeking person will select the
gamble rather than the equivalent certain
event

Kanpur, INDIA
A B
Expected Value

Kanpur, INDIA
• A and B are wealth values, i.e., values of W. Also for
ease of our analysis we consider that U(W)=W.
• Form a lottery such that it has an outcome of A with
probability p and the other outcome is B with a
probability (1-p).
• Change the values of p and ask the investor how much
certain wealth (C) he/she will have in place of the
lottery. Thus C varies with p.
• Now the expected value of lottery is {p*A+(1-p)*B}. A
risk averse person will have C < {p*A+(1-p)*B}.
• Plot the values of C and you already have the expected
values of the lottery.

Kanpur, INDIA
• How would you find the explicit form of the utility
function of a person. Suppose you know that it is of the
form U(W) = - e –aW.
• You ask the person that given a lottery which has a 50-50
chance of winning Rs. 1,000,000 or Rs. 4,00,000. In order
to buy this lottery what was he/she willing to pay.
• Suppose the answer is Rs. 5,00,000 (say for example),
then it means that the person is indifferent between a
certain equivalent amount of Rs. 5,00,000 and the lottery
(which is a fair gamble).
• Hence: 1*(- e-500000*a)= 0.5*(-e-1000000*a) + 0.5*(-e-400000*a).
• Solving through iteration process we can find a.

Kanpur, INDIA
Utility Analysis (Axioms)
Axioms of utility functions
1) An investor can always say whether A = B, A> B or A <
B
2) If A > B and B > C, then A > C
3) Consider X = Y. Then assume we combine with X with
another decision Z, such that X is with P(X) = p and Z is
with P(Z) =1-p. On the same lines we have the same
decision Z with Y, such that Y is with P(Y) = p and Z is
with P(Z) = 1-p. The X+Z = Y+Z
4) For every gamble there is a certainty equivalent such
that a person is indifferent between the gamble and the
certainty equivalent

Kanpur, INDIA
Comparison of MV and Utility Analysis
Comparison between mean-variance and utility function
The utility function used is (U(W)=W-bW2), which is quadratic
Consider we have three assets and the prices are as follows
No A B C R(A) R(B) R(C) P(i)
1 100 105 80 --- --- --- 1/5
2 110115 90 1.10 1.09 1.13 1/5
3 115120 95 1.05 1.04 1.06 1/5
4 120 125 105 1.04 1.04 1.11 1/5
5 125 130 130 1.04 1.04 1.24 1/5

Kanpur, INDIA
Then:
R A  1.06 ; RB  1.05; RC  1.14
 A  0.025 ;  B  0.022;  C  0.052
W A  114 ;WB  119;WC  100
If risk less interest (in terms of total return) is 0.5, then using mean-
variance analysis we rank the assets as
    
B RB  R f /  B  25.0  A R A  R f /  A  22.4    
 
C   RC  R f  /  C  12.3
Using quadratic utility function U(W) = W – b*W2, with b = -0.002 we

rank the assets as
B [U(B) = 90.68] > A [U(A) = 88.01] > C [U(C) = 80.00]

Kanpur, INDIA
Consider the following example with two different sets of outcomes. The
utility function is U[W] = W2 + W
Outcome Outcome W U[W] P(W)
Scenario 1 Scenario 2
15 20 1.5 3.75 (15+20)/212
20 12 2.0 6.00 (20+12)/212
25 25 2.5 8.75 (25+25)/212
10 17 3.0 12.00 (10+17)212
5 8 3.5 15.75 (5+8)/212
25 30 4.0 20.00 (25+30)/212
Accordingly we have to calculate the expected utility value

Kanpur, INDIA
Investment and Utility Analysis
Deterministic vs Probabilistic b1
h1
w1
1  h1 0
p1 w2
p2
p3 w3
h4 b4
p4
w4
1  h4 0

Kanpur, INDIA
People have other criteria for
investment/project/portfolio solutions
and they are
 Geometric mean return
 Safety first criteria
 Stochastic dominance
 Analysis in terms of characteristics of
the return distribution

Kanpur, INDIA
Geometric mean return
For the selection process we consider the
maximum GM has:
 The highest probability of reaching or
exceeding any given wealth level in the
shortest possible time.
 The highest probability of exceeding any
given wealth level over any given period
of time
Kanpur, INDIA
Ri,j = ith possible return on the jth portfolio.
p1, j pn, j
RG , j  (1  R1, j )  ......  (1  Rn, j ) 1
pi,j = probability of ith outcome for jth portfolio.

Then choose the maximum of the GM values

Kanpur, INDIA
Example # 06: Consider we have the following
combinations of assets A, B and C in the following ratios
(weights) to form a portfolio P. The returns are 10, 20, 30
respectively.
A B C
1 0.20 0.20 0.60
2 1/3 1/3 1/3
3 0.25 0.25 0.50
• RP,1 = (1+0.10)0.20*(1+0.20)0.20*(1+0.30)0.60 – 1 = 0.237
• RP,2 = (1+0.10)1/3*(1+0.20)1/3*(1+0.30)1/3 – 1 = 0.197
• RP,3 = (1+0.10)0.25*(1+0.20)0.25*(1+0.30)0.50 – 1 = 0.222
Note: Hence choose scenario # 1

Kanpur, INDIA
 Maximizing GM return is equivalent to
maximizing the expected value of log
utility function
 Projects/Investment/Portfolios that
maximize the GM return are also mean-
variance efficient if returns are log-
normally distributed

Kanpur, INDIA
Safety first principle
Under safety first principle the basic
tenet is that the decision maker is
unable or unwilling to consider the
utility theorem for making his/her
decision process. Under this
methodology people make their
decision placing more importance to
bad outcomes
Kanpur, INDIA
Few Project Investment Process (Concepts)
Safety first principles (rules)

 Min Pr[RP<RL]
 Max RL
 Max R P

Kanpur, INDIA
If returns are normally distributed then the optimal
portfolio would be the one where RL was the maximum
number of SD away from the mean
Let us consider an example for Min P[Rp < RL].
Remember we consider the returns are normally
distributed and the suffix P denotes the portfolio while
RL means a fixed level of return (5).
A B C
RP 10 14 17
P 5 4 8
Diff from 5% -1*A -2.25* B -1.5*C

Kanpur, INDIA
2 * A 2 * B
RL RA RB

Kanpur, INDIA
In order to determine how many SDs, RL

lies below the mean we calculate RL minus
the mean return divided by the SD. Thus
we have
 RL  RP   RP  RL 
min   max 
 P   P 
 RP  RF 
This is equivalent to max  
 P 

Kanpur, INDIA
Even though for our example we have

simplified our assumption by considering
only normal distribution, but this would
hold for any distributions having first and
second moments.

Kanpur, INDIA
According to Tchebychev (Chebyshev)

inequality for any random variable X, such
that E(X) and V(X) exists, then
 X  E X   1  RP  RP  1
Pr  t   2  Pr  K   2
 VX   t
   P  K

Kanpur, INDIA
As we are interested in lower limit hence

we simply it and have
 RP  RP  1
Pr   K   2
 P  K
 RP  RP RL  RP   P2
Pr    
    RL  RP 
2
 P P

Kanpur, INDIA
The right hand side of the inequality is is

exactly equal to the decision process # 1
under safety first principle we have
considered previously
 RP  RP RL  RP   P2
Pr    
    RL  RP 
2
 P P
Pr  RP  RL 

Kanpur, INDIA
For the second criterion we have

max RL
s.t.: Pr(RP < RL)  
We are given  (say 0.05), then we should
have
 RP  RP RL  RP 
Pr     0.05
 P P 

Kanpur, INDIA
`
  0.05
z RB

Kanpur, INDIA
RP P*
RL , 4
R L ,3
RL , 2
RL,1
P

Kanpur, INDIA
The criterion is max RP such that

Pr(RP  RL) = , here  is predertermined
depending on the investors own
constraints. Thus with the condition we
have RP  RL  z * P

Kanpur, INDIA
A2
RP A1
B2
B1
RL
P

Kanpur, INDIA
Safety First Principle (Example)
Example # 07: Considering we have projects A, B,
C and D and we need to rank them using the
concept of safety first principle. The information is
as follows

Kanpur, INDIA
As per safety first principle we have: min {RP,jRL}
where: (i) i = 1, 2,….., m, (number of projects) and (ii)
j = 1, 2,….., n (number of jobs/activities/financial
decisions in each project).
Thus:

Kanpur, INDIA

Kanpur, INDIA
Stochastic Dominance
• First-order stochastic dominance
• Second-order stochastic
dominance
• Third-order stochastic dominance

Kanpur, INDIA
Stochastic Dominance
• Assume W is the wealth level, s.t., the set of wealth
can be designated by {W1, W2, ....}.
• Let the utility function be U(W), which is
strongly/weakly increasing.
• Consider the gamble/lotteries/project investment
decisions are represented by their cumulative
distribution functions say for example F, G.

Kanpur, INDIA
First-order stochastic dominance

• A lottery F dominates G then the
decision maker prefers F to G
regardless of what U(W) is, as long as
it is
– Weakly increasing (i.e., U(Wi)  U(Wj),
where Wi  Wj)

Kanpur, INDIA

• F dominates G iff
• Simply stated it means that every

individual with increasing utility
function prefers FW to GW regardless of
his/her risk preferences.
Kanpur, INDIA

• F dominates G iff FW(W)GW(W)
• This definition requires that FW gives
more wealth than GW realization by
realization.

Kanpur, INDIA
Second-order stochastic dominance

• A lottery F dominates G if the decision
maker prefers F to G as long as he/she
is
– Risk averse
– U(W) is weakly increasing (i.e., U(Wi) 
U(Wj), where Wi  Wj)

Kanpur, INDIA
Third-order stochastic dominance

• F

Kanpur, INDIA
Decision Analysis Revisited
You are the owner of a company manufacturing shoes
and the company has been in an expansion phase. In
order to meet the demand of the customers you are
planning to test market any one of the three brands of
shoes (A, B and C) in any one of the three cities of
India, namely Calcutta, Bhubaneshwar and Ranchi. You
know that for an amount of investment, W, in Calcutta
the return, U(W), is given by W2-0.5*W. For
Bhubaneshwar it is W2-0.75*W, while for Ranchi it is
W2-W.

Kanpur, INDIA
Decision Analysis Revisited
The proportions of the total investment, where the total
amount of investment is Rs.5,00,000, for the test
marketing phase for brands A, B and C in the three
cities would be (i) 0.4, 0.4, 0.2 in Calcutta (ii) 0.3, 0.3,
0.4 in Bhubaneshwar and (iii) 0.2, 0.4, 0.5 in Ranchi.
The probabilities, which you guess from historical data,
of outcomes for brand A, B and C in the three cities are
(i) 0.1, 0.2, 0.7, (ii) 0.5, 0.4, 0.1 and (iii) 1/3, 1/3, 1/3
respectively

Kanpur, INDIA
Project Management Control
 In any project there are three factors (also
called project control variables) that need to be
planned and controlled:
Scope of work
Time
Cost

Kanpur, INDIA
Project Management Basic
Planning Technique
 Open creative techniques: Exploits the creativity in organizations
seeking new and non-traditional solutions. They are based on experts
that are motivated to creative thinking. The most widely used
technique is brainstorming.
 Forecasting techniques: This method is based on development trends
over time. Under this there are two methods which are: explorative
techniques and normative techniques.
 Organization development methods: In this method we try to involve
the whole or a special part of the organization in creating ideas. One
of the best known techniques is the Strength Weakness Opportunity
Threat (SWOT) analysis.

Kanpur, INDIA
Project Management Evaluation
 After planning we need to evaluate a project
and they are:
Direct evaluation methods
Criteria-based evaluation methods

Kanpur, INDIA
Project Management Evaluation
 Technical evaluation could be related to functionality,
quality, reliability, etc.
 It is often necessary to measure these factors in
economic units.
 The most commonly used direct evaluation methods
are:
Check list
Pair wise ranking

Kanpur, INDIA
Evaluation of Complex Project
Management
 For more complex problems, a method developed by
Saaty (1980) can be applied.
 The method is called Analytical Hierarchy Process
(AHP).
 It uses a hierarchy of criteria that each alternative should
be evaluated against.
 We first have to assign priorities to each criterion in the
hierarchy. This is done using pair wise comparisons.
 Next we develop a set of matrices where all alternatives
are compared to each other for each criterion.
Kanpur, INDIA
Analytic Hierarchy Process(AHP)
 The Analytic Hierarchy Process (AHP) is a

structured technique for organizing and
analyzing complex decisions.
 It was developed by Thomas L. Saaty in the
1970s.
 Application in group decision making.

Kanpur, INDIA
Wide range of applications exists:

 Selecting a car for purchasing
 Deciding upon a place to visit for
vacation
 Deciding upon an MBA program
after graduation

Kanpur, INDIA
AHP algorithm is basically composed of two steps:

1. Determine the relative weights of the decision
criteria
2. Determine the relative rankings (priorities) of
alternatives
Note: Both qualitative and quantitative
information can be compared by using informed
judgments to derive weights and priorities.

Kanpur, INDIA
Analytic Hierarchy Process(AHP) (Example)
Example # 08
 Objective: Selecting a car
 Criteria: Style, Cost, Fuel-economy
 Alternatives: Civic , i20 , Escort,
Alto

Kanpur, INDIA
S e le c t in g
a N ew C ar
S t y le C ost FuelE conom y
Civic i20 Escort Alto

Alternative courses of action

Kanpur, INDIA
Ranking Scale for Criteria and Alternatives

Kanpur, INDIA
Ranking of criteria
Style Cost Fuel Economy

Style 1 1/2 3
Cost 2 1 4
Fuel Economy 1/3 1/4 1

Kanpur, INDIA
Ranking of priorities
• Consider [Ax = maxx] where
 A is the comparison matrix of size n×n, for n criteria, also called the priority matrix.
 x is the Eigenvector of size n×1, also called the priority vector.
 maxis the Eigenvalue.
• To find the ranking of priorities, namely the Eigen Vector X:

1) Normalize the column entries by dividing each entry by the sum of the column.
2) Take the overall row averages.
Row
Normalized 0.30 0.28 0.37
1 0.5 3 Column Sums
Sums
averages 0.32
A= 2 1 4 0.60 0.57 0.51 X= 0.56
0.33 0.25 1.0 0.10 0.15 0.12 0.12
Priority vector
Column sums 3.33 1.75 8.00 1.00 1.00 1.00

Kanpur, INDIA
Analytic Hierarchy Process(AHP) Ranking of priorities
Criteria weights
• Style 0.32
• Cost 0.56
• Fuel Economy 0.12
Selecting a New Car

1.00

0.32 0.56 0.12

Kanpur, INDIA
Checking for Consistency
 The next stage is to calculate a Consistency Ratio

(CR) to measure how consistent the judgments
have been relative to large samples of purely
random judgments.
 AHP evaluations are based on the aasumption that
the decision maker is rational, i.e., if A is preferred
to B and B is preferred to C, then A is preferred to
C.
 If the CR is greater than 0.1 the judgments are
untrustworthy because they are too close for
comfort to randomness and the exercise is
valueless or must be repeated.
Kanpur, INDIA
Calculation of Consistency Ratio
• The next stage is to calculate max so as to lead to the
Consistency Index and the Consistency Ratio.
• Consider [Ax = max x] where x is the Eigenvector.
A x Ax x
1 0.5 3 0.32 0.98 0.32

0.56 1.68 = max
0.56
2 1 4 =
0.12
0.12 0.36
0.333 0.25 1.0
• λmax=average{0.98/0.32, 1.68/0.56, 0.36/0.12}=3.04

• Consistency index , CI is found by CI=(λmax-n)/(n-1)=(3.04-3)/
(3-1)= 0.02

Kanpur, INDIA
C.R. = C.I./R.I. where R.I. is the random index
n 1 2 3 4 5 6 7
R.I. 0 0 .52 .88 1.11 1.25 1.35
C.I. = 0.02
n=3
R.I. = 0.50(from table)
So, C.R. = C.I./R.I. = 0.02/0.52 = 0.04
C.R. ≤ 0.1 indicates sufficient consistency for decision.

Kanpur, INDIA
Analytic Hierarchy Process(AHP) Ranking
alternatives
Priority vector
Style Civic i20 Alto
Escort
Civic 1 1/4 4 1/6 0.13
i20 4 1 4 1/4 0.24
Escort 1/4 1/4 1 1/5 0.07
Alto 6 4 5 1 0.56
Cost Civic i20 Escort Alto

Civic 1 2 5 1 0.38
i20 1/2 1 3 2 0.29
Escort 1/5 1/3 1 1/4 0.07
0.26
Alto 1 1/2 4 1
Kanpur, INDIA
Ranking alternatives
Priority Vector
Miles/gallon Priority Vector
Fuel Economy Civic 34 .30

i20 27 .24
Escort 24 .21
Alto 28 .25
1.0
113
Note: Since fuel economy is a
quantitative measure, fuel consumption
ratios can be used to determine the
relative ranking of alternatives.
Kanpur, INDIA
Selecting a New Car
1.00

0.32 0.56 0.12
Civic 0.13 Civic 0.38 Civic 0.30

i20 0.24 i20 0.29 i20 0.24
Escort 0.07 Escort 0.07 Escort 0.21
Alto 0.56 Alto 0.26 Alto 0.25

Kanpur, INDIA
Civic .13 .38 .30 .32 .28

i20 .24 .29 .24 .25
x
.56 =
Escort .07 .07 .21 .07
Alto .12 .34
.56 .26 .25
Priority matrix Criteria Weights

Kanpur, INDIA
Including Cost as a Decision Criteria
Adding “cost” as a a new criterion is very difficult in AHP.
A new column and a new row will be added in the evaluation matrix.
However, whole evaluation should be repeated since addition of a new
criterion might affect the relative importance of other criteria as well!
Instead one may think of normalizing the costs directly and calculate the
cost/benefit ratio for comparing alternatives!
Normalized Cost/Benefits
Cost Benefits Ratio
Cost
• CIVIC $12k 0.22 0.28 0.78
• i20 $15K 0.28 0.25 1.12
• ESCORT $ 9K 0.17 0.07 2.42
• Alto $18K 0.33 0.34 0.97

Kanpur, INDIA
• The “ESCORT” is the winner with the

highest benefit to cost ratio and we
rank it 1st ,
• Then at 2nd position i20,
• At 3rd is Alto,
• While at 4th position is Civic.

Kanpur, INDIA
More about AHP: Pros and Cons
Pros
•It allows multi criteria decision making.
•It is applicable when it is difficult to formulate criteria
evaluations, i.e., it allows qualitative evaluation as well as
quantitative evaluation.
•It is applicable for group decision making environments
Cons
•There are hidden assumptions like consistency.
Repeating evaluations is cumbersome.
•Difficult to ue when the number of criteria or alternatives is high,
i.e., more than 7.
•Difficult to add a new criterion or alternative
•Difficult to take out an existing criterion or alternative, since the
best alternative might differ if the worst one is excluded.

Kanpur, INDIA
Profitability Analysis for Project
Management
 Calculation of profitability of investment projects
is based on the project’s cash flow.
 The cash flow shows the difference between all
ingoing and outgoing payments over time.
 There are three different types of outgoing
payments:
 Investments (capital expenditures - CAPEX)
 Operating expenditures (OPEX)
 Taxes
Kanpur, INDIA
Cost calculation in Project
Management
 Consider
 C0 is the initial cost of the project
 r is the interest rate for the project calculated per year
 n is the time in years
 Then the total price is given by S=C 0(1+r/100)n
 If they are to be calculated on a yearly basis we have
Ci= C0(1+ri/100)i
 Hence total cost is TC= C1(1+r1/100)1+
C2(1+r2/100)2+….+ Cn(1+rn/100)n
Kanpur, INDIA
Cost calculation concepts in
Project Management
 Discounting factor
 Net Present Value (NPV)
 Fixed Discounting rate (r)
 Variable Discounting rate (ri)
 Internal rate of return (IRR)
 Payback time
 Return on investment
 Discounted return on investment

Kanpur, INDIA
Discounting factor

Kanpur, INDIA
Discounting factor

Kanpur, INDIA
Net Present Value (NPV)
 Consider we have Ct and rt as the amount received and
interest rate at time t for t=0,…,T (time for the cash
flow)
 NPVt=0 = {C0/(1+r0)0 + C1/(1+r1)1 + ….. + CT/(1+rT)T}
 In general, the cost (Ct) and benefit (Rt) may be
separated if required such that NPVt=0 = [{-C0/(1+r0,C)0 +
R0/(1+r0,R)0}+ {-C1/(1+r1,C)1 + R1/(1+r1,R)1} + ……. + {-
CT/(1+rT,C)T + RT/(1+rT,R)T}]

Kanpur, INDIA
Fixed Discounting rate (r)
 A fixed discounting rate is a rate where the interest rate
does not fluctuate during the fixed rate period of the
loan. This allows for accurate prediction of the future
payments.
 Concept of variable interest rate is when the interest rate
changes depending on the economic conditions.
 A fixed discounting rate is based on the assumption
about the average discount rate over the fixed rate
period.

Kanpur, INDIA
 For example, when the interest rate is historically low,
fixed rates are normally higher than variable rates
because interest rates are more likely to rise during the
fixed rate period.
 Conversely, when interest rates are historically high,
lenders normally offer a discount to borrowers to fix
their interest rate over time, as rates are more likely to
fall during the fixed rate period.
 Example being MIBID vs MIBOR or LIBID vs LIBOR

Kanpur, INDIA
 NPVt=0 = {C0/(1+r)0 + C1/(1+r)1 +

….. + CT/(1+r)T}
 NPVt=0 = [{-C0/(1+r)0 + R0/(1+r)0}
+ {-C1/(1+r)1 + R1/(1+r)1} + ….. +
{-CT/(1+r)T + RT/(1+r)T}]

Kanpur, INDIA
Variable Discounting rate (ri)
 NPVt=0 = {C0/(1+r0)0 + C1/(1+r1)1 + ….. + CT/

(1+rT)T}
 NPVt=0 = [{-C0/(1+r0,C)0 + R0/(1+r0,R)0}+ {-C1/
(1+r1,C)1 + R1/(1+r1,R)1} + ……. + {-CT/
(1+rT,C)T + RT/(1+rT,R)T}]

Kanpur, INDIA
Internal rate of return (IRR)
 Internal rate of return (IRR) is used to measure

the profitability of potential project investments.
 IRR is a discount rate that makes the NPV of all
cash flows from a particular project equal to
zero.
 IRR calculations rely on the same formula as
NPV does, i.e., {I0/(1+irr)0 + I1/(1+irr)1 + ……. +
IT/(1+irr)T} = 0

Kanpur, INDIA
Interest Rates
 n-year zero rate/n-year zero/n-year spot rate:
Interest rate earned on project investment that
starts today and ends n years from hence.
 Note
a) There is NO intermediate project payments
b) In case intermediate payments are made they
would be considered accordingly

Kanpur, INDIA
Project Cost and Yield from Project
 How do you calculate the price of a project, if
time to maturity is T years and it pays
semiannual or quarterly or monthly returns?
 Remember the zero rate for different maturities
of project is used to calculate the value of
projects at different times which are not equal
 The yield from a project bearing some payback
is the discount rate that equates the cash flows
on the project to its market value.

Kanpur, INDIA
Project Pricing
Maturity Zero Rate

(years) (% cont comp)
0.5 5.0
1.0 5.8
1.5 6.4
2.0 6.8

Kanpur, INDIA
Project Pricing
Example # 10: Consider where we have

a two year project with a initial value of
INR 100 crores and it provides a rate of
6% per annum with the return from the
project being paid semi-annually. We
are to find the project price as of today

Kanpur, INDIA
Project Pricing
To calculate the project price we discount each
cash flow at the appropriate zero rate
 6  0.050.5  6  0.0581.0  6  0.0641.5
 e   e   e
2 2 2
 6  0.0682.0
 100 10  e
7
 2

Kanpur, INDIA
Yield from Project
• The yield of the project (y) is the discount rate that
makes the present value of the cash flows of the
project equal to the market price of the project.
• Suppose that the market price of the bond in our
example equals to its theoretical price as calculated.
• Then the yield of the project (y) is given by solving:
(6/2)exp(-y*0.5) + (6/2)exp(- y*1.0) + (6/2)exp(-
y*1.5) + (100*107+6/2)exp(-y*2.0) = (6/2)exp(-
0.050*0.5) + (6/2)exp(-0.058*1.0) + (6/2)exp(-
0.064*1.5) + (100*107+6/2)exp(-0.068*2.0).

Kanpur, INDIA
Yield from Project
 Use Newton-Raphson method or Runge-Kutta
method etc.
 Newton Raphson method
a) Start with any value x0 for solving f(x)=0.
b) Use successively xi+1=xi-f(xi)/f’(xi) to find x1, x2, x3,. ….
and so on.

Kanpur, INDIA
Par Yield of the project
 The par yield of the project (c)for a certain
maturity is the rate that causes the project price to
equal its face value (which we consider as the initial
value which is 100*107).
 In our example we solve
c 0.050.5 c 0.0581.0 c 0.0641.5
e  e  e
2 2 2
 c  0.0682.0
 100  10  e
7
 100  107
 2

Kanpur, INDIA
Continuous Compounding vis-à-vis Other Rates
of Compounding
If
 rc is the continuous compounding rate.
 rm is the equivalent rate with compounding m times per annum.
 n is the number of years.
 m is the number of times of compounding for r m.
 rm 
rc  m log e 1  
 m
Note: Proof the above simple formulae. This is not an assignment for
class but do the proof yourself and for any queries get in touch with
the instructor

Kanpur, INDIA
Determining the Zero Curve (Example # 11)
Project Time to Annual Project
Principal Maturity Coupon Price
(INR) (years) (INR) (INR)
100 0.25 0 97.5
100 0.50 0 94.9
100 1.00 0 90.0
100 1.50 8 96.0
100 2.00 12 101.6

Kanpur, INDIA
Determining the Zero Curve
 We assume that ½ of the stated

coupon is assumed to be paid every
six months (i.e., ½ year duration)

Kanpur, INDIA
The Bootstrapping the Zero Curve
 An amount (100.0-97.5)=2.5 can be earned

on 97.5 during 3 months.
 The 3-month rate is 4 times (2.5/97.5) or
10.256% with quarterly compounding
 This is 10.127% with continuous
compounding

Kanpur, INDIA
 An amount (100.0-94.9)=5.1 can be earned

on 94.9 during 6 months.
10.748% with semi annual compounding
compounding

Kanpur, INDIA
 An amount (100.0-90.0)=10.0 can be

earned on 90.0 during 12 months.
11.111% with annual compounding
compounding

Kanpur, INDIA
The Bootstrap Method
To calculate the 1.5 year rate we solve
 8  0.104690.5  8  0.105361.0
 e   e
2 2
 8  R1.5
 100  e  96
 2
and R = 0.10681 or 10.681%

Kanpur, INDIA
The Bootstrap Method
To calculate the 2.0 year rate we solve
 12  0.104690.5  12  0.105361.0
 e   e
 2  2 
 12  0.106811.5  12   R2.0
  e  100  e  101.6
2  2
and R = 0.10808 or 10.808%

Kanpur, INDIA
Continuously Compounded Zero Rates
Maturity (yrs) Zero Rate (Continuous

Compounding
0.25 10.127
0.50 10.469
1.00 10.536
1.50 10.681
2.00 10.808

Kanpur, INDIA
Zero Curve Calculated from the Data
Zero
Rate (%)
10.68 10.808
10.469 10.53 1
6
10.127
Maturity (yrs)

Kanpur, INDIA
Forward Rates
A forward interest rate is the interest

rate implied by current zero rates for a
specified future time period

Kanpur, INDIA
Calculation of Forward Rates
Zero Rate for Forward Rate

an n -year Investment for n th Year
Year ( n ) (% per annum) (% per annum)
1 10.0
2 10.5 11.0
3 10.8 11.4
4 11.0 11.6
5 11.1 11.5

Kanpur, INDIA
Formula for Forward Rates
 Suppose that the zero rates for

maturities T1 and T2 are R1 and R2
respectively, with both rates
continuously compounded.
 The forward rate for the period between
times T1 and T2 is {(R2T2 – R1T1)/(T2–
T1)}
Kanpur, INDIA
Sloping of the different rates curves, when
Yield curve upward sloping
Rate
FR
ZR
PY
Maturity
Kanpur, INDIA
Sloping of the different rates curves when
Yield curve is downward sloping
Rate
PY
ZR
FR
Maturity

Kanpur, INDIA
Instantaneous Forward Rate
• The instantaneous forward rate for a maturity T
is the forward rate that applies for a very short
time period starting at T. It is R  T R
T
where R is the T-year rate
Assignment # 03: This is an assignment and
for the proof check any good book in finance

Kanpur, INDIA
Forward Rate Agreement
A forward rate agreement (FRA) is a

forward contract where the parties agree
that a certain interest rate will apply to a
certain principal during a specified future
time period

Kanpur, INDIA
Duration/Payback time
• Duration/payback time of a project is a measure of
how long on average the one has to wait before
receiving cash payments from the project.
• Hence a project paying no payments and that
matures in n years has a duration of n years.
• However we can say that a project paying some
returns maturing in n years has a duration LESS
than n.

Kanpur, INDIA
• Duration of a project that provides cash flow c i at time t i
is n
 ci e 
 yti
 ti 
i 1 

B 
where B is its price of the project and y is its yield
(continuously compounded).
• Note the term in the bracket is the ratio of the present
value of the payment of project at time ti to the project
price/cost.

Kanpur, INDIA
• This leads to
B
  Dy
B
Assignment # 04: This is an

assignment and for the proof check
any good book in finance
Kanpur, INDIA
Return on investment (ROI)
 The concept of return on investment (ROI)

is a sort of calculating the efficiency of the
investment, i.e., ROI=(O/P)/(I/P).
 ROI= {C0/(1+r0)0 + C1/(1+r1)1 + ….. + CT/
(1+rT)T}/I0
 ROI = [{-C0/(1+r0,C)0 + R0/(1+r0,R)0}+ {-C1/
(1+r1,C)1 + R1/(1+r1,R)1} + ……. + {-CT/
(1+rT,C)T + RT/(1+rT,R)T}]/I0
Kanpur, INDIA
Discounted return on investment (DROI)
 The concept of discounted return on investment

(DROI) is a sort of calculating the efficiency of the
investment, i.e., ROI=(O/P)/(I/P) based on the fact that
the discounting factor is considered
 DROI= {C0/(1+r0)0 + C1/(1+r1)1 + ….. + CT/(1+rT)T}/I0
 DROI = [{-C0/(1+r0,C)0 + R0/(1+r0,R)0}+ {-C1/(1+r1,C)1 +
R1/(1+r1,R)1} + ……. + {-CT/(1+rT,C)T + RT/(1+rT,R)T}]/I0
 Here the interest are discounted considering the tax,
interest payment, risk free interest (rf), etc.

Kanpur, INDIA
Risk Analysis
For an outcome (be it financial or a project), if
we are assured that it is sure to give us a tangible
benefit then we are not concerned about the
chance that it will not happen and the
corresponding probability that we will be denied
any benefit from that outcome. But in reality we
know that in maximum of the cases we have to
face the game of chance and hence be aware of
the probabilistic return of the outcome.
Kanpur, INDIA
Risk Analysis
For an outcome, which is random or probabilistic
we denote it by X. Corresponding to this r.v. we
have an average/mean of this outcome, which is
termed as the expected value, denoted by E[X].
Simultaneously along with the average return we
are also concerned about the cost involved in the
outcome. This cost or the uncertainty we face
regarding the outcome is know as the risk

Kanpur, INDIA
Risk Analysis
Risk is usually denoted by the variance, 2=E[X -
E(X)]2. There are other quantifiable ways of
denoting this risk but for all practical purposes the
second moment of a r.v. suffices to quantify this
risk. Other measures of risk may be the skewness
and kurtosis, which are found out by using the
third and fourth moment respectively, i.e., E[X -
E(X)]3 and E[X - E(X)]4

Kanpur, INDIA
Risk Analysis
If we have X as a discrete variable then we have
E[ X ]   xi f ( xi ) V [ X ]   {xi  E[ X ]}2 f ( xi )
i i
If we have X as a continuous variable then we have

 
E[ X ]   xf ( x)dx V [ X ]   {x  E[ X ]}2 f ( x)dx
 

Kanpur, INDIA
Risk Analysis
Project C
Project B
Return
Project A+B+C+D Project D
Project A
Risk

Kanpur, INDIA
Risk Analysis
We discuss the portfolio theory as applied to managing financial assets. This concept
will be utilized when we consider the idea of managing a conglomeration of projects.
According to Markowitz’s theory we know that riskness can be characterized by the
variance. This variance along with covariances determines the return from the portfolio
(a set of assets/securities or a set of different projects). We know the general form of the
optimization problem.
Now the question is how do we reduce/minimize the collective risk of the set of
assets/projects. The method of reducing is know as diversification which can be
highlighted by a very simple example.
For ease of understanding, consider a hypothetical example, where we have n number
of assets/projects, denoted by i =1, 2,….., n, such that
1) The prices of assets/projects are moving in such a way that their respective prices are
almost uncorrelated or the correlation is very low.
2) The return of each asset/project has an average value (mean) of m.
3) The variance (risk) of each asset/project is 2.
4) Weights of each asset/project considered in the portfolio (the set of projects) is assumed
to be of equal proportion, i.e.,wi = 1/n for each i.

Kanpur, INDIA
Risk Analysis
1 n 2
1 n 
rP   ri  r  m  P2  2   2 
n i 1 n i 1 n
2
P

Kanpur, INDIA
Introduction to Project Portfolio approaches
In order for diversification to be most

effective we must assume:
 Projects in the same industry tend to be
correlated.
 Projects in different industries are not
correlated.

Kanpur, INDIA
CAPM
In order to do away with the enormous
amount of calculation which is required
when you are combining a large number of
financial assets, we use a proxy which
subsumes that the expected value of any
particular financial asset can be replicated
by the market. By market we mean the
market index.
Kanpur, INDIA
CAPM
Considering that there is only one variable which
regulates the price movement of any particular asset we
consider that risk to be denoted by i (i = 1, 2,…., n) for
any particular ith asset, such that.
ri  r f   i (rm  r f )   i
Assuming normal distribution for the returns and also
considering i ~ N(0,2,i), we have, after taking
expectation
ri  r f   i ( rm  r f )

Kanpur, INDIA
CAPM
n
Few results  
P  wi  i  i2   i2 m
2
  2,i
i 1
The first term (in the second formulae) is the systematic risk, i.e.,
the risk associated with the market as a whole, while the second
term is the nonsystematic risk or specific risk. The first risk cannot
be diversified but the second risk can be diversified.
Similarly for the portfolio we have the following form for the
variance in terms of systematic risk and unsystematic risk.
n
2
P   P2 m
2
  wi2 2,i
i 1

Kanpur, INDIA
CAPM
Assumptions
1) No transaction costs or administrative costs
2) Projects/assets are infinitely divisible
3) Absence of personal tax
4) Project managers/Investors make decisions based on return and risk of
projects/portfolios
5) Investors transaction cannot affect the price of any single project/asset
6) Unlimited short selling is allowed
7) Unlimited riskless lending and borrowing is allowed
8) Investors define relevant period in exactly the same manner
9) Investors have identical expectation wrt necessary inputs to the
project/portfolio decision
10) All projects/assets are marketable

Kanpur, INDIA
CAPM
CAPM can be used as a pricing model. Consider we have the initial

investment in the project as P0 (known) and the future value as Pt
(unknow). Then we immediately have
Pt  P0
 r f   (rm  r f )
P0
Pt
Thus P0 
1  r f   (rm  r f )
It is interesting to compare the second equation (for the probabilistic case)

with the deterministic case. For the deterministic case we have to discount
the future payments at an interest rate rf, using the factor 1/(1+rf). In the
probabilistic case we have the equivalent factor as 1 /{1  r f   ( rm  r f )}

Kanpur, INDIA
Linearity of Pricing
The price of two assets/projects is the linear sum of those two
assets/projects. Thus if we have
Pt , A Pt , B
P0, A  P 
1  r f   A (rm  r f ) 0, B 1  r f   B (rm  r f )
Then we must have
Pt , A  Pt , B
P0, A  P0, B  
1  r f   A B (rm  r f )
Remember:  A B   A   B

Kanpur, INDIA
Certainty Equivalent Form
Given an/a asset/project with initial invest of P0 (known) and final return
of Pt (unknown), we have
cov[{( Pt / P0 )  1}, rm ]
  2
m
Then with simple substitution we have

1 cov( Pt , rm )( rm  r f )
P0  [ Pt  ]
(1  r f ) 2
m
The term in the bracket is known as the certainty equivalent of Q.

Kanpur, INDIA
Project Choice
A firm can use CAPM as a basis for deciding which projects it should
carry out/execute. Suppose you have a project with an initial investment of
P0 (known) and the final return as Pt (unknown). Then NPV is given by
1 cov( Pt , rm )( rm  r f )
NPV   P0  [ Pt  ]
(1  r f ) 2
m
Now if we have a set of different projects and we have to choose one from
that set then how do we decide which project to choose.
Just find the project for which NPV is maximum.
For an investor he/she can either select a firm based on the NPV of the
project that the particular firm has under taken or consider the project (i.e.,
the firm) which results in maximum expansion of the efficient frontier.
Note: These two selection criterion are equivalent.

Kanpur, INDIA
Work Breakdown Structure in
Project Management
 Work Breakdown Structure (WBS) is a process
that sets a project’s scope by breaking down its
overall mission into a cohesive set of
synchronous, increasingly specific tasks.
 Any project is just a collection of a number of
discrete steps, or activities, that collectively add
up to the overall deliverable.

Kanpur, INDIA
Work Breakdown Structure in
Project Management
 The WBS lays out the individual building blocks
that will construct the project.
 This process is critical because for most of us,
planning a project can be an intimidating
experience.
 The WBS helps us create a necessary structure to
the project by outlining the individual steps
needed to succeed.

Kanpur, INDIA
Schematic Expression of WBS
 Stage 1: Give a detailed list of work which are
primary
 Stage 2: Break down all the primary work into
secondary
 Stage 3: Break down all the secondary work in to
tertiary

Kanpur, INDIA
Schematic Diagram of WBS

Kanpur, INDIA
Cost Estimation in Project
Management
 A cost estimate is a forecast for the total final cots of executing
the project.
 The main purpose of the cost estimate is to provide a baseline
or reference for cost control, i.e., to control that the resource
spending in the project is kept within the cost frame used for
assessing the feasibility of the project.
 Cost estimation involves two important aspects:
 The estimate is an approximate calculation
 The estimate contains uncertainty

Kanpur, INDIA
Cost Estimation Methods
 There are, in principle, two types of estimating methods:
 Synthetic methods: In this method we estimate the costs
without break down, and only use the characteristics of the
system. This means that synthetic methods may be used in
the early phases for ball park estimates, and that analytical
methods find their application in developing control
estimates.
 Analytical methods: In this method we estimate the resource
consumption by breaking the total system down on
subsystems and estimating the resources for each of these.

Kanpur, INDIA
Cost structure and contingency
allowance

Kanpur, INDIA
Project Management Scheduling
 It is the process of converting project goals into an
achievable methodology for their completion.
 It creates a timetable and the network logic that relates
project activities to each other in a coherent fashion.
 Scheduling is critical because the goal of project
management is to complete a set of goals in a specified
time frame.
 The more efficient we are at creating a project schedule,
the more likely we are to satisfy this key success
criterion.
Kanpur, INDIA
Activity Duration in Project
Management
 Typically, there are two ways to determine
activity durations:
 Deterministic: Assumes that sufficient knowledge is
available to develop a reasonably accurate time
estimate for project activities, refer to CPM
 Stochastic: Assumes that knowledge is in sufficient to
develop any reasonably accurate time estimate for
project activities, refer to PERT

Kanpur, INDIA
 There are three terms connected to scheduling
that we need to define:
 Activity – which is a set of work items requiring
resources to be executed
 Event – which is a point in time when an activity starts
or finishes
 Milestone – which is a planned observable event
connected to a defined result

Kanpur, INDIA
 There are two ways to represent a
schedule:
Gantt chart (bar chart)
Network

Kanpur, INDIA
GANTT Chart in Project
Management

Kanpur, INDIA
GANTT Chart in Project
Management
 The main advantage of a Gantt chart is that it is
easy to read and understand.
 It communicates well, even to persons not
familiar with schedules.
 Originally, it did not show precedence
relationships between the activities, but modern
software packages have corrected this deficiency.

Kanpur, INDIA
Precedence Diagram in Project
Management
 Precedence diagramming is a schematic
display of the project sequential
activities and the logical relationships
between them.

Kanpur, INDIA
Precedence Diagram in Project
Management
 Creating a precedence diagram, or network, is crucial for several
reasons, including:
 Networks clearly illustrate the interdependence of all tasks or
work packages to each other and to the overall project.
 Networks help us identify those tasks that are dependent on other
activities. This information tells us which activities must be
highly coordinated to ensure smooth completion.
 Networks allow us to determine when the project will be
completed.
 Networks help with overall master scheduling of organizational
resources because they show us times when personnel must be
fully committed to project activities.

Kanpur, INDIA
Project planning
Initial planning
Job Alternative Job Dept. Time
Identification description (Days)
A (1,2) Forecasting sales Sales 14
B (2,4) Pricing Sales Sales 03
C (2,3) Preparing Production Production 07
Schedule
D (3,4) Costing the Accouting 04
Production
E (4,5) Preparing the budget Treasurer 10

Kanpur, INDIA
Project Graph
Depending on the nomenclature we have two different
ways of depicting an/a activity/job/task, i.e., either using
a node or an arc.
Node Arc
Hence we have Activity on Arc (AOA) and Activity on

Node (AON) depiction of projects.

Kanpur, INDIA
PERT Example (AON Network Diagrams)
A C
edge or arc
Node A represents Activity A Node C represents Activity C
The edge or arc represents the precedence relationship

between the two activities

Kanpur, INDIA
PERT Example (AOA Network Diagrams)
Activity A
1 2
edge or arc
Node 1 represents the Node 2 represents the

beginning of Activity A ending of Activity A
The edge or arc represents Activity A

Kanpur, INDIA
AOA and AON Diagram (Shown together)

Kanpur, INDIA
A B C
E
A C
F

Kanpur, INDIA
A B
1 2 3 D
C D
B
A 3
1 2
C 4

Kanpur, INDIA
A
F
C
H
B E
D G

Kanpur, INDIA
B G
2 3 K
7
C Q
H 8
A
A F O
L
D 11
4 6 10
1 R
I P
J M S
E
5 9
N

Kanpur, INDIA
The project network began on more than one node and ended on a
single node. Other variants are:
B E Beginning with one

A D node and ending with
more than one node
C F
Beginning with more

A E than one node and
C D ending with more
B F than one node

Kanpur, INDIA
The Start and Finish boxes tie the network off at its ends and give one a
sense that the network has defined points in time at which the project
begins and ends. The use of such a convention is not necessary and will
generally be avoided.
A E
Start C D
Finish
B F

Kanpur, INDIA
A C
1 2 A 2 4
1 E
A 2 D
B 3 5
1 B
3

Kanpur, INDIA
C
2 4
A F
1 H
E 6 7
B
3 D G
5

Kanpur, INDIA
• Note that in the problem the work begins on a single node and ended on a single node.
• When constructing Network diagrams using the AOA approach, this convention is
followed--network diagrams begin on a single node and end on a single node.
• Note also a second convention in AOA Network diagram construction. Two nodes are
connected by one and only one activity (edge or arc). Thus,
Act. I.P. No, and why not? Rather, this is preferred and why?
A __ A C
B __ A C
C A,B
D B B d1
B D
D

Kanpur, INDIA
Finally, a third convention. An arc cannot emanate from or terminate at more
than one node.
Act. I.P. No, and why not?
A __
B __ D
C A,B A
NO!
D A C
E B
B
E
D
A d1
Rather, this is preferred and why?
C
d2
B
E

Kanpur, INDIA
PERT Example (AON and AOA Network Diagrams)
Immediate Description Predecessor

Activity
A build internal components ___
B modify roof and floor ___
C construct collection stack A
D pour concrete and install frame B
E build hi-temp burner C
F install control system C
G install air-pollution control device D,E
H inspect and test F,G

Kanpur, INDIA
Rule for AOA
 Based on our discussion so far, we can indicate some of
the rules for drawing an AOA network:
 The network should be connected without any cycle
 It should have unique start and finish events
 Events should be numbered so that for any activity the
finish event has a higher number than the start event
 An activity may be represented by one arc only
 Two activities may not have identical start and finish
events

Kanpur, INDIA
Important Points Regarding
Activity Network
 Prior to constructing an activity
network, there are some simple rules of
thumb you need to become familiar
with as you develop the network
diagram. These rules are very helpful in
understanding the logic of activity
networks
Kanpur, INDIA
Activity Network
1. Some determination of activity precedence ordering must
be done prior to creating the network. That is, all activities
must be logically linked to each other; those that precede
and other, subsequent activities.
2. Network diagrams usually flow from left to right.
3. An activity cannot begin until all preceding connected
activities have been completed.
4. Arrows on networks indicate precedence and logical flow.
Arrows can cross over each other, although it is helpful for
clarity’s sake to limit this effect when possible.

Kanpur, INDIA
Activity Network
5. Each activity should have a unique identifier associated
with it (number, letter, code, etc.). For simplicity, these
identifiers should occur in ascending order; each one
should be larger than the identifiers of preceding
activities.
6. Looping, or recycling through activities, is not permitted.
7. Although not required, it is common to start a project
from a single beginning node, even in the case when
multiple start points are possible. A single node point also
is typically used as a project end indicator.

Kanpur, INDIA
Simple Example of Precedence
Diagram (Network)
 A–B –F– H–J
 A–C –E–H–J
 A–C –E–G–J
 A–D–I–J
 Similarly for others starting with B, C,
E, F, G, H, I, J
Kanpur, INDIA
Diagram (Network)

Kanpur, INDIA
Diagram (Network)
 We also know the estimated duration for each of the
activities in the project network and can apply them to
determine the time necessary to complete each path.
Thus:
Path A – B – F – H – J = 4 + 4 + 4 + 2 + 4 = 18 days
Path A – C – E – H – J = 4 + 2 + 2 + 2 + 4 = 14 days
Path A – C – E – G – J = 4 + 2 + 2 + 2 + 4 = 14 days
Path A – D – I – J = 4 + 5 + 3 + 4 = 16 days

Kanpur, INDIA
Diagram (Network)

Kanpur, INDIA
Diagram (Network)
 Once we have completed the backward pass, we can determine
individual activity float, for each task as well as for each path through
the network.
 Again, float informs us of the amount of time an activity can be
delayed and still not delay the overall project.
 To illustrate the implications of float, suppose that Activity C is
delayed and cannot start until 3 days after the original schedule.
 What are the implications of this delay on the overall project? None!
With 4 days of float for Activity C, a delay of 3 days will not affect
the overall length of the project or delay its completion.

Kanpur, INDIA
Diagram (Network)
 One other important point to remember about activity float is that it is
determined as a result of performing the forward and backward
passes through the network.
 Until we have done the calculations for ES, EF, LS, and LF, we
cannot be certain which activities have float associated with them and
which do not.
 Using this information to determine the project critical path suggests
that the critical path is the network path with no activity float
associated with it.

Kanpur, INDIA
Diagram (Network)
 In our project example, we can determine the
critical path by linking the nodes with no float:
A – B – F – H – J. We can also determine the
float for individual path float; that is, the
linkage of each node within a noncritical path.
For example, the path A – D – I – J has 4 days
of float.

Kanpur, INDIA
Project Graph
4
B, 3 days E, 10 days
4
A, 14 days
1 2 D, 4 days 5
5
C, 7 days
3

Kanpur, INDIA
Project Graph
(Critical Path)
4
4
A, 14 days
1 2 D, 4 days 5
5
C, 7 days
3

Kanpur, INDIA
Project planning
Main drawbacks of CPM, PERT
1) They do not consider any feedback loop
or re-evaluation loop which is very
essential for any projects.
2) They only consider end to start (E to S)
relationship between any two consecutive
tasks or activities which are dependent on
one another.
Kanpur, INDIA
Project planning
Looping not allowed

Kanpur, INDIA
Precedence Relationship
E to E, E to S, S to E and S to S relationship
E to E
E to S
A B
S to S
S to E

Kanpur, INDIA

Kanpur, INDIA
 Finish-to-start relationship (FS): The Activity B may not
start until x days after activity A has finished. By letting
x = 0, the precedence relationship becomes “B may start
as soon as A is finished”.
 Start-to-start relationship (SS). The Activity B may not
start until x days after the start of activity A.
 Finish-to-finish relationship (FF). The Activity B may
not finish earlier than x days after activity A is finished.
 Start-to-finish relationship (SF). The Activity B may not
finish earlier than x days after activity A has started.
Kanpur, INDIA
 In order to perform a forward scheduling

we have to “normalize” the FS, FF and SF
time relationships to a SS relationship.
Correspondingly, to perform a backward
scheduling we “normalize” the time
relationships FS, SS and SF to a FF
relationship.

Kanpur, INDIA
Rules for calculating Precedence
Relationship
Type Forward Backward
FS dA+x dB+x
SS x dB+x-dA
FF dA+x- dB x
SF x- dB x-dA

Kanpur, INDIA
Relationship
 The time relationships (a time intervalfor
example number of days) can both be a lower
bound or an upper bound on the time that
separates the start/finish of two next following
activities.
 Furthermore, time points and time relationships
can both be positive or negative depending on we
calculate forward or backward in time or reverse
the time axis.
Kanpur, INDIA
Relationship
 There may be two approaches to assign time
interval to networks:
 Time interval is a lower or upper bound on event times
of activities, i.e. a time relationships
 Time interval is the duration of an activity, i.e. an
attribute.

Kanpur, INDIA
PERT
 PERT was originally conceived in the late 1950’s
as a joint venture of the U.S. Navy and Booz
Allen Hamilton for the Polaris missile program.
 This technique uses probabilistic estimation; that
is, it assigns likely probabilities to a range of
estimates for each activity that reflect the
uncertainties inherent in the estimation process.

Kanpur, INDIA
PERT
 PERT estimates recognize that for any activity duration, there are
three important estimates:
 Optimistic time (a) – the time an activity will take if everything
happens as planned. In estimating the duration for a, there should
be only a 1% chance (1/100) that the activity time will be <a.
 Most likely time (m) – the most realistic time to complete the
activity.
 Pessimistic time (b) – the time an activity will take if nothing
happens as planned; that is, if everything goes wrong or conditions
are most unfavorable. In estimating the duration for b, there
should be only a 1% chance (1/100) that the activity time will be
>b.
Kanpur, INDIA
PERT
 The logic for this assumption is based on the
understanding that to achieve a probability
distribution with a 99% confidence interval,
observations should lie within three standard
deviations of the mean in either direction.
 A spread of six standard deviations from tail to
tail in the probability distribution, then, accounts
for 99.7% of the possible activity duration
alternatives.
Kanpur, INDIA
PERT Distribution

Kanpur, INDIA
Beta Distribution (v/s Triangular distribution)

Kanpur, INDIA
PERT Calculation
 The beta distribution suggests that the formulae for deriving
E(T) and Var(T) are:
 ET = (a + 4m + b)/6
 Var(T) = {(tb-ta)/6}2
Where
 ET= Expected time for activity

 a= Most optimistic time to complete the activity
 m= Most likely time to complete the activity, the mode of
the distribution
 b= Most pessimistic time to complete the activity
Kanpur, INDIA
PERT Calculation
 The expected number of days required to finish a project is the sum of
the number of days required for each activity/job/task. Remember here
the time required for each activity/job/task must be its respective E(t i),
where i=1,…..,m (the number of the activity/job/task)
 The critical path length is also calculated using the respective expected
time for each activity/job/task, i.e., E(CP) = {E(t 1) + E(t2) + …….
+E(tK)}, where 1, 2, …, K are the jobs/activities/tasks on the critical
path.
 Remember for finding out the variance of the total project we simply
add the variances of the activities/jobs/tasks and not the standard
deviation. The important assumption which helps us to add the
variances, is that the activities/jobs/tasks are independent. Thus Var(CP)
= {Var(t1) + Var(t2) + ….. + Var(tk)}, where 1, 2, …, K are the
jobs/activities/tasks on the critical path.

Kanpur, INDIA
PERT
 Remember we can have multiple critical paths
for a project.
 Then also the question arises which
activities/jobs/tasks should we concentrate on so
as to reduce the project time.
 Definitely the easiest method is to reduce the
timing for a common activity/job/task. But there
are methods by which we can find the best
combination of activities/jobs/tasks.
Kanpur, INDIA
PERT
5
5
3
2
2
5
4 6 8 9
1 3 2
2
1
3
3 4 7
2 3

Kanpur, INDIA
PERT
For the project illustrated above we can reduce any one

of the following
 8-9
 1-2 and 1-3
 5-8, 6-7 and 4-7
 1-2, 3-5, 3-6 and 3-4
 2-5, 3-5, 3-6, 4-6 and 4-7

Kanpur, INDIA
PERT
 We must find the amount of slack which is available for
each activity/job/task.
 For the critical path slack is not available for any of the
activity/job/task.
 For the non-critical path slacks may be available for an/a
activity/job/task. This means, if due to unavoidable
circumstances we face some problem we can absorb the
delay by utilizing these slacks. It may not affect the over
all duration of the job, but will definitely increases the
cost of the project.
Kanpur, INDIA
Critical Path and slack available
4
4
A, 14 days
1 2 D, 4 days 5
5
C, 7 days
3

Kanpur, INDIA
Critical Path and slack available
Slack available for activities/jobs/tasks are as

follows:
1) A: 0
2) B: 8
3) C: 0
4) D: 0
5) E: 0

Kanpur, INDIA
Early and late start for an activity/job/task
Given the early and late start date of any activity/job/task we can
find the amount of slack for that activity/job/task, as LS-ES or LF-
EF, i.e.,
 TS = LS –ES or TS = LF- EF
 FS(i)=earliest of all ES(j)-EF(i); here j is the set of all
activities/jobs/tasks which are immediate successors to the
activity/job/task i.
 Thus the total slack (TS) for the path would simply be the addition
of the slacks of the corresponding activities/jobs/tasks.
 Free slack (FS) is the actual number of days which we may have for
us to use as a cushion in case of emergencies.
 Remember we always have {FS  TS}, and there may be cases
where an/a activity/job/task can have TS but no FS.

Kanpur, INDIA
PERT
We have briefly mentioned about early start, late
start, early finish and late finish, but what do
they actually mean
 ES = is the earliest possible time when an
activity/job/task can start
 EF = ES+t
 LS= is the latest possible time when an
activity/job/task can start without pushing the
project duration
 LF=LS+t
Kanpur, INDIA
PERT (Example # 13)
4
3
3
10 6
3 5
1
4
14
2 3
7

Kanpur, INDIA
PERT (Forward pass method)
Activity 1-2 (t=14) ES=0; EF=0+14=14
Activity 1-4 (t=3) ES=0; EF=0+3=3
Activity 2-4 (t=3) ES=14; EF=14+3=17
Activity 2-3 (t=7) ES=14; EF=14+7=21
Activity 3-5 (t=4) ES=21; EF=21+4=25
Activity 4-5 (t=3) ES=17; EF=17+3=20
Activity 5-6 (t=10) ES=25; EF=25+10=35

Kanpur, INDIA
PERT (Backward pass method)
Activity 5-6 (t=10) LF=35; LS=35-10=25
Activity 4-5 (t=3) LF=25; LS=25-3=22
Activity 3-5 (t=4) LF=25; LS=25-4=21
Activity 2-3 (t=7) LF=21; LS=21-7=14
Activity 2-4 (t=3) LF=22; LS=22-3=19
Activity 1-4 (t=3) LF=22; LS=22-3=19
Activity 1-2 (t=14) LF=14; LS=14-14=0

Kanpur, INDIA
PERT
Activity 1-2 (t=14) TS=0
Activity 5-6 (t=10) ES=0

Kanpur, INDIA
PERT
4
3
3
10
3 5 6
1 4
14
5 3
7

Kanpur, INDIA
PERT
Free slack (FS) for any activity/job/task is defined as the cushion
which is available without affecting the early start time of any
other activity/job/slack.
FS(i)=earliest of all ES(j)-EF(i)
Here j is the set of all activities/jobs/tasks which are immediate
successors to the activity/job/task i.
Activity 1-2 (t=14) FS=14-14=0
Activity 1-4 (t=3) FS=17-3=14
Activity 2-4 (t=3) FS=17-17=0
Activity 2-3 (t=7) FS=21-21=0
Activity 3-5 (t=4) FS=25-25=0
Activity 4-5 (t=3) FS=25-20=5
Activity 5-6 (t=10) ES=35-35=0
Kanpur, INDIA
Forward and Backward
Scheduling

Kanpur, INDIA
GANTT CHART
 We must know the dependence between
jobs/activities/tasks.
 We must know the respective jobs/activitys/tasks early
start time and late start time, remembering that there are
external factors which may affect the start and end time
of jobs/activities/tasks.
 This chart gives us an over all picture of the number of
days which will be required to finish a project.

Kanpur, INDIA
GANTT CHART
Early Start Schedule
JOB DESCRIPTION DAYS
Clear for construction
Concrete forms
Reinforcement
Pour concrete
Clear grade
Sewer lines

Kanpur, INDIA
GANTT CHART
Late Start Schedule
JOB DESCRIPTION DAYS
Clear for construction
Concrete forms
Reinforcement
Pour concrete
Clear grade
Sewer lines

Kanpur, INDIA
PERT Calculations
 Based on the Central Limit Theorem (CLT) the
project duration may be assumed to follow a
normal distribution.
 This can be used to answer to important
questions:
 What is the probability that the project will finish
within a given deadline?
 What deadline should be set if the probability of
meeting it should be at least x%?

Kanpur, INDIA
PERT Calculations
• The probability that the total project time, T, will
be less than D can be expressed P(T D)= Ф[{D-
E(T)}/sqrt{V(T)}], where
• E(T) is the expected value of the total project
duration, T
• Var(T) is the variance (s2) of the total project
duration.
• Ф is the normal distribution (0,1).

Kanpur, INDIA
PERT Calculations
• We want to fix the deadline D that can
be obtained with a probability 
• T~NT{E(T),Var(T)}
• Considering CLT to be true one can use
the following equation Ф[{D-
E(T)}/SD(T)]=, here SD(T)=Var(T)

Kanpur, INDIA
Project Graph with expected time and standard deviation
4
B, 3, 1 E, 10, 3
A, 14, 4
1 2 D, 4, 2 5
C, 7, 1.5
3

Kanpur, INDIA
 If we are given the respective expected times and the

standard deviations for the activities/jobs/tasks, can we
know the critical path for certainty? The answer is NO.
 If we are lucky then a simple calculation as we have
done in the earlier case can solve the problem to provide
us with the critical path and the respective critical
activities/jobs/tasks.
 In case we cannot, then we use simulation to find the
critical path and the corresponding critical
activities/jobs/tasks.
Kanpur, INDIA
Activity Expected time Standard deviation Variance

(1,2) 06 02 04
(1,3) 12 03 09
(2,4) 13 02 04
(3,4) 05 01 01
(4,5) 04 01 01
(3,5) 16 04 16

Kanpur, INDIA
• The longest path is 1-3-5 and the expected time or the critical path time is
12+16=28 and the corresponding variance is 9+16=25.
• This implies the job may take anything between 28-5=23 to 28+5=33
number of days.
• The next longest path (1-2-4-5) has a length of 23 and the corresponding
variance is 9, which implies that the maximum and the minimum time
required along this path is 23+3=26 and 23-3=20 respectively.
• What if due to some external circumstances the standard deviations for the
paths 1-2, 2-4 and 4-5 are 4, 8 and 3 respectively. Then the new sum of
variances for this path is 16+64+9=89.
• In which case the maximum time required along the path 1-2-4-5 is
32.4333. Now can we say which is the critical path and the corresponding
critical activities/jobs/tasks?

Kanpur, INDIA
Expected time and standard deviation for project
E(t)-SD(t) E(t) E(t)+SD(t)

Kanpur, INDIA
1) In maximum of the projects we are first given the due date or

completion date, i.e., at which date we have to complete the job and
then deciding what is the project we decide the activities/jobs/tasks
and the find out the critical path and whether we can finish the
project within that due/completion date.
2) In case we are assume the expected time and variance of each and
every activity/job/task we find what proportion of the project would
be finished within that due/completion date.
3) Criticality index: I say for example we run a simulation study for
1,00,000 times and if an/a activity/job/task is on the critical path
30,000 number of time then we say the criticality index for that
activity/job/task is 0.3.

Kanpur, INDIA
Project planning
 Remember that we usually plan a project
considering man hour days, hence it is important to
evaluate the cost structure of each individual
activity/job/task and then extrapolate it to find the
total cost of the project
 Simplistically TC = {t1*c1+t2*c2+….+tn*cn}
 Here tis are the time periods for an/a
activity/job/task and we must consider all of them.
Here cis are the corresponding costs per unit time.

Kanpur, INDIA
Project Graph (Critical Path)
• Critical path is 1-2-3-4-5, which is 14+03+04+10=31 days
• Now if costs per unit day for the paths, 1-2, 2-3, 2-4, 3-4 and 4-5
are 05, 10, 10, 15 and 25 respectively, then the total cost is
14*05+03*10+03*10+04*15+010*25=440
4
4
A, 14 days
1 2 D, 4 days 5
C, 3 days
3

Kanpur, INDIA
Simple costing methods for a project
Two different scenarios considering there is a penalty of 20 (some

monetary unit) per day for over shooting the stipulated time
duration of the project which is 31 days.
1) Due to some unavoidable circumstances the time duration for
activity B increases to 4 days from 3 days, then the incremental cost
is 1*10 and from this we can find the percentage increase in the cost
of the whole project. As there is no over shooting of the time
duration we only incur an additional cost of 10. Hence % increase
of cost is 10/440=2.3%
2) Due to some unavoidable circumstances the time duration for
activity C increases to 4 days from 3 days, then the incremental cost
is 1*10+1*20 and from this we can find that the percentage increase
in the cost of the whole project is 30/440=6.8%.

Kanpur, INDIA
Costing methods for a project
We must remember here that we are considering the E to S criteria for

denoting the number of days. If that had not been the case then the
incremental cost structure would have been much more difficult to
calculate.
You can consider different hypothetical cases where we can use a
combination of different depiction of the duration of days for an
activity/job/task, i.e., E to E, E to S, S to E and S to S.
Comment
1) For a E to E depiction of the number of days (only) is it true that the total
number of days for a project would change?
2) For a E to S depiction of the number of days (only) is it true that the total
3) For a S to E depiction of the number of days (only) is it true that the total
4) For a S to S depiction of the number of days (only) is it true that the total

Kanpur, INDIA
Costing methods for a project
Remember we are considering a linear cost structure,

i.e., an increase in the number of days has a linear
increase in the cost of the activity/job/task and hence the
TC of the project can be considered to be varying
linearly. Calculating the marginal cost function for the
project is relatively easy.
If the cost structure of the activity/job/task varies non-
linearly with the number of days, then we face a lot of
problem and depicting the marginal cost function for the
project is quite complicated.

Kanpur, INDIA
Some methodologies
1) Strength Weakness Opportunities Threat (SWOT): For

this we analyze the characteristics of the project related
to the four main evaluation criterion stated above.
2) We may be interested in resource allocation and then
concentrate on resource leveling.
3) We may be interested in only resource allocation and not
on resource leveling.

Kanpur, INDIA
t-SD(t) t D t+SD(t)

Kanpur, INDIA
Chance of completion of a project with the due date D
 Given the due date say D, we may wish to calculate how probable
is it that the project will be completed within that due date, i.e.,
Pr[X  D] = Pr[{X-E(t)}/SD(t)  {D-E(t)}/SD(t)]. Thus
considering E(t)=50, SD(t)=10 and D=50, we have Pr[Z0]=0.5,
i.e., there is a 50% chance that the project will be completed within
the due date of 50. In other words we can also state that out of 100
cases of the same project being taken up time and again with the
same E(t), SD(t) and due date, D, we will have 50 cases where the
job will be finished within the due date.
 We can also find the change in probability that the job will be
completed within the due dates given by the two values, D 1 and D2,
i.e., P[Z  z1] and P[Z  z2], these z1 and z2 are for different values
of D, i.e., z1={D1-E(t)}/SD(t) and z2={D2-E(t)}/SD(t)

Kanpur, INDIA
Cost or penalty to be paid considering due date D
The penalty structure for a project is as follows,

considering the due date as 60
1) Less than 60% complete penalty is Rs. 15 lakhs
2) Between 61-69% complete penalty is Rs. 6 lakhs

Kanpur, INDIA
Penalty
% complete

Kanpur, INDIA
The penalty structure need not be a step wise function as shown in

the precious slide. It can be a continuous function also.
Penalty
% complete

Kanpur, INDIA
PERT (Example # 14)
Consider the following table of activities and this has immediate predecessor(s)
(I.P.), optimistic, most likely, most pessimistic, E(t i) and var(ti) for each activity
ACT I.P. Optimistic (a) Most Likely (m) Pessimistic(b) E(t i) var(ti)
A __ 01 02 03 02 04/36
B __ 02 03 04 03 04/36
C A 01 02 03 02 04/36
D B 02 04 06 04 16/36
E C 01 04 07 04 36/36
F C 01 02 09 03 64/36
G D,E 03 04 11 05 64/36
H F,G 01 02 03 02 04/36

Kanpur, INDIA
PERT
F
A C 3
2 2 H
E 2
4
B D G
3 4 5

Kanpur, INDIA
PERT
A-C-F-H; A-C-E-G-H; and B-D-G-H. Summing the

E(ti) on each path yield time through each path of 9,
15, and 14 weeks, respectively. With an E(t) = 15 for
A-C-E-G-H, this path is defined as the critical path
(CP) being the path that governs the completion time
of the project . Despite the beta distribution of each
activity, the assumption is made that the number of
activities on the CP is sufficient for it to be normally
distributed with a variance equal to the sum of the
variances of its activities only, var(t) = 112/36 = 3.11

Kanpur, INDIA
PERT
C
4
A 2 F
E H
1 6 7
B 3 5 G
D

Kanpur, INDIA
PERT
 Given E(t) = 15 weeks and Var(t) = 3.11, what is the
probability of the project requiring in excess of 16 weeks to
complete?
 Pr{X 16} = 1 – Pr{X < 16} = 1 - Pr[Z < {(16 – 15)/1.76} =
(1 - 0.716)
 One should remember that 1.76 is the square root of 3.11, the
standard deviation of the expected completion time
 The assumption is that summing up a sufficient number of
activities following a beta distribution yield a result which
approximates or a approaches a variable which is normally
distributed Xt~N(x,t,2x,t), where x,t = E(t) and 2x,t = Var(t)

Kanpur, INDIA
Activity Network Diagram

Kanpur, INDIA

Kanpur, INDIA
 The critical activities for this project is: A – C – D – F – H.
 For the overall project variance, the value is (σ p2) = (1.78 + 1.00
+ 4.00 + 0.69 +0 .25) = 7.72
 Thus the project standard deviation (σp) is found as: 2.78 weeks
 This information is useful for assessing the probability of on-
time project completion because PERT estimates make two
more assumptions:
 Total project completion times follow a normal probability
distribution
 The activity times are stochastically independent

Kanpur, INDIA
 As a result, the normal, bell curve can be used to represent project
completion dates.
 Normal distribution here implies that there is 50% likelihood that
project completion time will be less than 30 weeks and a 50% chance
that it will be greater than 30 weeks.
 With this information we are able to determine the probability that
our project will be finished on or before a particular time.
 Suppose, for example, that it is critical to our company that project
finishes before 32 weeks. Although the schedule calls for a 30 week
completion schedule, remember that our estimates are based on
probabilities.

Kanpur, INDIA
 Therefore, if we wanted to determine the probability
that the project would finish no later than 32 weeks, we
would need to determine the appropriate area under the
normal curve that corresponds to a completion date on
or before week 32.
 We can use a standard normal equation to determine this
probability.
 The standard normal equation is represented as Z =
(Due date – Expected date of completion)/ σp= (32 –
30)/2.78 = 0.72
Kanpur, INDIA
Crashing of Jobs
 Under some circumstances, it may be necessary to find ways to
accelerate the completion of a project. There are a number of reasons
why we may need to speed up the project, including:
 The initial schedule was too optimistic. In order to complete the
project on time, we are forced to find ways to speed the project.
 Market needs change and the project is in demand earlier than
anticipated. Perhaps we learn that a competitor is working on a
similar product and intends to introduce it earlier than our original
schedule. Because profit and market share come to the first
company to get the project to market, it makes sense to accelerate
our project..

Kanpur, INDIA
Crashing of Jobs
The project has slipped considerably behind
schedule. In order to catch up and meet our
milestones, we have to speed up development.
The contracts provide incentives to avoid schedule
slippage. For example, suppose we were faced with
stiff penalties for every day a project was delayed?
We have a strong motivation to ensure that the
project comes in on time or early.

Kanpur, INDIA
Time Cost Trade Off

Kanpur, INDIA
Resource Leveling and Resource
Allocation

Kanpur, INDIA
Cumulative Resource
Requirement Curve

Kanpur, INDIA
Resource Constraints
 Resource constraints create two types of problems:
 Resource leveling: The problem is to obtain the best
possible smooth resource profile over time. The project
deadline is fixed, but the resource (capacity) level might
be adjusted.
 Resource allocation: The problem is to obtain the
shortest possible project duration. There is a given limit
for the available resources (capacity limit) which cannot
be exceeded. However, the project duration might be
adjusted to accommodate this.

Kanpur, INDIA
 The solution algorithms for these types of
problems fall into two major categories:
 Decision based: Which are algorithms where the
solutions are justified because they appear as
reasonable.
 Optimization based: Which are algorithms seeking a
mathematical optimal solution according to given
optimization criteria.

Kanpur, INDIA
 The classical theory gives two
approaches to scheduling activities in a
resource constrained network:
Serial
Parallel

Kanpur, INDIA
 Serial
 The serial method ranks the activities according to a chosen
criterion.
 Then they are scheduled one by one in the ranked sequence.
 The resource requirement is compared to the available
resources.
 If there are not sufficient resources available, the activity is
gradually moved to a later position until the resource limit is
not exceeded.
 If necessary, the project deadline will be extended.

Kanpur, INDIA
 Parallel
The parallel method splits the total project time into
a number of intervals.
Within each interval, the serial method is applied for
scheduling.
If an activity cannot be scheduled due to lack of
resources, it is postponed to the succeeding period.
There may be different priorities criteria for
different periods.

Kanpur, INDIA
Crashing of Jobs (Example # 15)
Symbol Normal Crash Slope
Time/Cost Time/Cost
A 09/10 06/16 02
B 08/09 05/18 03
C 05/07 04/08 01
D 08/09 06/19 05
E 07/07 03/15 02
F 05/05 05/05 N/A
G 05/08 02/32 08

Kanpur, INDIA
Crashing of Jobs
Symbol ES EF LS LF Cost
A 00 09 00 09 10
B 00 08 02 10 09
C 09 14 12 17 07
D 09 17 09 17 09
E 08 15 10 17 07
F 14 19 17 22 05
G 17 22 17 22 08

Kanpur, INDIA
Crashing of Jobs
2 C (5) 4
A (9) F (5)
1
D (8) 6
B (8) G (5)
3 5
E (7)

Kanpur, INDIA
Crashing of Jobs
Symbol Time TS FS
A 09 00 00
B 08 02 00
C 05 03 00
D 08 00 00
E 07 02 02
F 05 03 03
G 05 00 00
 Days: 22 (A-D-G)
 Cost is 55 (A+B+C+D+E+F+G)
Kanpur, INDIA
Crashing of Jobs
2 C (5) 4
A (8) F (5)
1
D (8) 6
B (8) G (5)
3 5
E (7)

Kanpur, INDIA
Crashing of Jobs
Symbol Time TS FS
A 08 00 00
B 08 02 00
C 05 03 00
D 08 00 00
E 07 02 02
F 05 03 03
G 05 00 00
 Days: 22-1=21 (A ( by 1 day)-D-G)
 Cost is 55+2=57 (A( by 2 units)+B+C+D+E+F+G)
Kanpur, INDIA
Crashing of Jobs
2 C (5) 4
A (7) F (5)
1
D (8) 6
B (8) G (5)
3 5
E (7)

Kanpur, INDIA
Crashing of Jobs
Symbol Time TS FS
A 07 00 00
B 08 02 00
C 05 03 00
D 08 00 00
E 07 02 02
F 05 03 03
G 05 00 00
 Days: 21-1=20 (A ( by 1 day)-D-G)/(B-E-G)
 Cost is 57+2=59 (A( by 2 units)+B+C+D+E+F+G)
Kanpur, INDIA
Crashing of Jobs
2 C (5) 4
A (6) F (5)
1
D (8) 6
B (8) G (5)
3 5
E (6)

Kanpur, INDIA
Crashing of Jobs
Symbol Time TS FS
A 06 00 00
B 08 02 00
C 05 03 00
D 08 00 00
E 06 02 02
F 05 03 03
G 05 00 00
 Days: 20-1=19 (A ( by 1 day)-D-G)/(B-E( by 1 day)-G)
 Cost is 59+2+2=63 (A( by 2 units)+B+C+D+E( by 2 units)+F+G)

Kanpur, INDIA
Crashing of Jobs
2 C (5) 4
A (6) F (5)
1
D (8) 6
B (8) G (4)
3 5
E (6)

Kanpur, INDIA
Crashing of Jobs
Symbol Time TS FS
A 06 00 00
B 08 02 00
C 05 03 00
D 08 00 00
E 06 02 02
F 05 03 03
G 04 00 00
 Days: 19-1=18 (A-D-G( by 1 day))/(B-E-G( by 1 day))
 Cost is 63+8=71 (A+B+C+D+E+F+G( by 8 units))

Kanpur, INDIA
Crashing of Jobs
2 C (5) 4
A (6) F (5)
1
D (8) 6
B (8) G (3)
3 5
E (6)

Kanpur, INDIA
Crashing of Jobs
Symbol Time TS FS
A 06 00 00
B 08 02 00
C 05 03 00
D 08 00 00
E 06 02 02
F 05 03 03
G 03 00 00
 Days: 18-1=17 (A-D-G( by 1 day))/(B-E-G( by 1 day))

Kanpur, INDIA
Crashing of Jobs
2 C (5) 4
A (6) F (5)
1
D (8) 6
B (8) G (2)
3 5
E (6)

Kanpur, INDIA
Crashing of Jobs
Symbol Time TS FS
A 06 00 00
B 08 02 00
C 05 03 00
D 08 00 00
E 06 02 02
F 05 03 03
G 02 00 00
 Days: 17-1=16 (A-D-G( by 1 day)/(B-E-G( by 1 day)/A-C-F)

Kanpur, INDIA
Crashing of Jobs
2 C (4) 4
A (6) F (5)
1
D (7) 6
B (8) G (2)
3 5
E (5)

Kanpur, INDIA
Crashing of Jobs
SymbolTime TS FS
A 06 00 00
B 08 02 00
C 04 03 00
D 07 00 00
E 05 02 02
F 05 03 03
G 02 00 00
 Days: 16-1=15 (A-D( by 1 day)-G/(B-E( by 1 day)-G/A-C( by 1 day)-F)
 Cost is 87+1+5+2= (A+B+C( by 1 units)+D( by 5 units)+E( by 2 units)
+F+G)

Kanpur, INDIA
Project Management
• Suppose we had a project with only eight activities.
• The table shows our calculated normal activity
durations and costs and crashed durations and their
costs.
• We wish to determine which activities are the
optimal candidates for crashing.
• Assume that the project costs listed include both
fixed and variable costs for each activity.

Kanpur, INDIA
Project Management
Project activities and costs (normal vs. crashed)
Normal Crashed
Activity
Duration Cost Duration Cost
A 5 days $ 1,000 3 days $ 1,500
B 7 days $ 700 6 days $1,000
C 3 days $ 2,500 2 days $ 4,000
D 5 days $ 1,500 5 days $ 1,500
E 9 days $ 3,750 6 days $ 9,000
F 4 days $ 1,600 3 days $ 2,500
G 6 days $ 2,400 $ 3,000

4 days
H 8 days $ 9,000 5 days $ 15,000
Total costs $ 22,450 $ 37,500

Kanpur, INDIA
Project Management
Fully crashed Activity

Kanpur, INDIA
Project Management
Project Cost by Duration
Duration Total costs
27 days $ 22,450
26 days $ 22,700
25 days $ 22,950
24 days $ 24,700
23 days $ 26,450
22 days $ 28,200
21 days $ 30,200
20 days $ 32,200
19 days $ 34,200

Kanpur, INDIA
Project Management
 The fully crashed project network is shown above
 Critical path is unchanged through fully crashing all activities
 The association of costs to project duration is graphed in the
next figure
 As each project activity has been crashed in order, the overall
project budget increases
 Past crashing activities A, E, and H, there is little incentive to
crash any of the other project tasks.
 The overall length of the project cannot shrink below 19 days

Kanpur, INDIA
Project Management
 Additional crashing merely adds costs to the budget
 Optimal crash strategy for this project is to crash only activities
A, E, and H for a total cost of $11,750 and a revised project
cost of $34,200.
 Decision to crash a project should be carefully considered for
its benefits and drawbacks.
 There is always a significant cost associated with activity
acceleration.
 If the reasons for crashing are sufficiently compelling, the
overall project duration can often be shortened significantly.

Kanpur, INDIA
Project Management
Cost vs. days saved in a fully-crashed project

Kanpur, INDIA
Project Control Techniques
• Volume (resource consumption)
• Time (schedule)
• Number of units completed (bill of quantities
finished)
• Earned person hours
• Earned (monetary) value

Kanpur, INDIA
• Monitoring the status of a project using S-curves
becomes a simple tracking problem.
• At the conclusion of each given time period (week,
month, or quarter), we simply total the cumulative
project budget expenditures to date and compare
them with the anticipated spending patterns.
• Any significant deviations between actual and
planned budget spent reveal a potential problem area.

Kanpur, INDIA
Simple S-curve of project status

Kanpur, INDIA
• The problem with S-Curves is that the interpretation of their visual
information is not always easy or obvious.
• For example, does the USD10,000 shortfall in the example represent
a delay in the project or simply a more efficient process that
artificially deflates the overall project expenditures to date?
• Likewise, positive variance is not always a sign of project progress.
In fact, a team may have a serious problem with over-expenditures
that could be interpreted as strong progress on the project when in
reality it signals nothing more than their inefficient use of project
capital resources.

Kanpur, INDIA
• The bottom line is this: Simply evaluating a project’s status according
to its performance on time versus budget expenditures may easily lead
us into making inaccurate assumptions about project performance.
• In short, because S-Curves only link time to budget expenditures, we
have no way of knowing the true status of the project and so must use
dollars spent as a surrogate.
• What we need is a means to determine how the project is actually doing
besides just how much money has been spent.
• We need a way of assessing the value the project has generated to date.
• Earned Value Management (EVM) is just such a method for assessing
project status.

Kanpur, INDIA
Earned Value Project
Key concepts related to Earned Value Management
• Earned Value Management (EVM)
• Planned Value (PV)
• Earned Value (EV)
• Actual Cost (AC)
• Schedule Variance (SV)
• Cost Variance (CV)
• Schedule Performance Index (SPI)
• Cost Performance Index (CPI)

Kanpur, INDIA
Costs: Tools and Techniques
Earned Value Management (EVM)
 Is a commonly used method of performance measurement.
 It integrates project scope, cost, and schedule measures to help the
project management team assess and measure project performance
and progress.
 It is a project management technique that requires the formation of an
integrated baseline against which performance can be measured for
the duration of the project.
 The principles of EVM can be applied to all projects, in any industry.
 EVM develops and monitors three key dimensions for each work
package and control account

Kanpur, INDIA
Planned Value (PV)
 Is the authorized budget assigned to the work to be accomplished for
an activity or work breakdown structure (WBS) component.
 It includes the detailed authorized work, plus the budget for such
authorized work, allocated by phase over the life of the project.
 The total of the PV is sometimes referred to as the performance
measurement baseline (PMB).
 The total planned value for the project (when completed) is also
known as Budget At Completion (BAC).

Kanpur, INDIA
Earned Value (EV)
 Is the value of work performed, expressed in terms of the approved budget
assigned to that work for an activity or work breakdown structure component.
 It is the authorized work that has been completed, plus the authorized budget
for such completed work.
 The EV being measured must be related to the PV baseline (PMB), and the
EV measured cannot be greater than the authorized PV budget for a
component.
 The term EV is often used to describe the percentage completion of a project.
 A progress measurement criteria should be established for each WBS
component to measure work in progress.
 Project managers monitor EV, both incrementally to determine current status
and cumulatively to determine the long-term performance trends.

Kanpur, INDIA
Actual cost (AC)
 Actual Value (AC) is the total cost actually incurred and recorded in
accomplishing work performed for an activity or work breakdown
structure component.
 It is the total cost incurred in accomplishing the work that the EV
measured.
 The AC has to correspond in definition to whatever was budgeted for
in the PV and measured in the EV (e.g., direct hours only, direct costs
only, or all costs including indirect costs).
 The AC will have no upper limit;tgus whatever is spent to achieve the
EV will be measured.

Kanpur, INDIA
Schedule Variance (SV)
 Schedule variance (SV) is a measure of schedule performance on a
project.
 The EVM schedule variance is a useful metric in that it can indicate a
project falling behind its baseline schedule.
 The EVM schedule variance will ultimately equal zero when the
project is completed because all of the planned values will have been
earned.
 EVM and SV are best used in conjunction with critical path
methodology (CPM) scheduling and risk management and it is
calculated using the following equation which is SV = EV – PV.

Kanpur, INDIA
Cost Variance (CV)
 It is a measure of cost performance on a project.
 The cost variance at the end of the project will be the difference between the
budget at completion (BAC) and the actual amount spent.
 CV is particularly critical because it indicates the relationship of physical
performance to the costs spent and CV= EV – AC
 Any negative CV is often non-recoverable to the project.
 The SV and CV values can be converted to efficiency indicators to reflect the cost
and schedule performance of any project for comparison against all other projects
or within a portfolio of projects.
 The variances and indices are useful for determining project status and providing a
basis for estimating project cost and schedule outcome.

Kanpur, INDIA
Schedule Performance Index (SPI)
 Is a measure of progress achieved compared to progress planned on a
project. It is sometimes used in conjunction with the cost performance
index (CPI) to forecast the final project completion estimates.
 An SPI value less than 1.0 indicates less work was completed than
was planned, while if the value is greater than 1.0 then it indicates
that more work was completed than was planned.
 Since the SPI measures all project work, the performance on the
critical path must also be analyzed to determine whether the project
will finish ahead of or behind its planned finish date.
 The SPI is equal to the ratio of the EV to the PV and it is calculated
using the following equation which is SPI = EV/PV.

Kanpur, INDIA
Cost Performance Index (CPI)
 It is a measure of the value of work completed compared to the
actual cost or progress made on the project.
 It is considered the most critical EVM metric and measures the
cost efficiency for the work completed.
 A CPI value less than 1.0 indicates a cost overrun for work
completed while a CPI value greater than 1.0 indicates a cost
under run of performance to date.
 The CPI is calculated using the following equation which is
CPI = EV/AC.

Kanpur, INDIA
Earned Value Project (Figure # 01)

Kanpur, INDIA
Earned Value Project (Figure # 02)

Kanpur, INDIA
Earned Value Project
Earned value and project status slippage

Kanpur, INDIA
GERT
 Activity networks employing PERT or CPM are by far the most
common forms of precedence diagramming in use today.
 However, they do suffer from some important limitations,
particularly in certain setting such as R&D projects, where their
underlying assumptions reflect the complexities of individual
project settings.
 For example, situations such as multiple branching (i.e., success
or failure of a project), probabilistic branching, and repeating
activities via feedback loops, which are frequently found in
experimental or R&D project settings cannot be modeled in
PERT/CPM networks.

Kanpur, INDIA
GERT
 As a result, Graphical Evaluation and Review
Technique (GERT) was developed to offer an alternative
diagram modeling option for projects that are faced with
these additional complexities.
 GERT creates a visual method for rendering network
logic to precedence diagramming with the added
flexibility to demonstrate network complexities.

Kanpur, INDIA
GERT
 Hence one uses GERT when one wants to analyze
terminal networks that
Contains activities that have a probability of
occurrence associated with them, and we intend to
find the probability that the node is realized.
Treats the plausibility that the time to perform an
activity is not a constant but a random variable,
and we intend to find the conditional moment
generating function of the elapsed time required to
traverse between any two nodes.
Kanpur, INDIA
GERT
 In GERT the branches of the network
are described by two or more
parameters which are:
Probability that the branch is
traversed
The time take (or other attribute(s))
to traverse the branch if it is taken
Kanpur, INDIA
GERT
 Components of Stochastic networks are:
Directed branches (arcs, edges, transmittances,
etc.)
Logical Nodes (vertices)
 A directed branch has one emanating node (to
be described later) and one terminating node
(to be described later).
(pa, ta)
Kanpur, INDIA
OR and AND statements
 Exclusive OR is a logical operation that outputs true only
when inputs differ (one is true, the other is false)
 The truth table of A XOR B shows that it outputs true (value
of 1) whenever the inputs differ
 I/P (A) I/P (B) O/P
0 0 0
1 0 1
0 1 1
1 1 0

Kanpur, INDIA
 Inclusive OR (also known as alternation), is a logical
operation that outputs true if and only if one or more of its
operands is true.
 The truth table of A OR B shows that it outputs true (value
of 1) whenever one of the input is true
 I/P (A) I/P (B) O/P
0 0 0
1 0 1
0 1 1
1 1 1
Kanpur, INDIA
 AND, is a logical operation that outputs true if and only if
both operands are true.
 The truth table of A AND B shows that it outputs true (value
of 1) whenever both of the input is true
 I/P (A) I/P (B) O/P
0 0 0
1 0 0
0 1 0
1 1 1

Kanpur, INDIA
GERT (I/P Logical Relationship)
Name Symbol Characteristics
Exclusive OR

Kanpur, INDIA
GERT (I/P Logical Relationship)

Kanpur, INDIA
GERT (O/P Logical Relationship)

Kanpur, INDIA
GERT

Kanpur, INDIA
GERT (Steps)
1) Convert a qualitative description of the
system/problem to a model in network
form
2) Collect the necessary data to describe the
branches of the network
3) Obtain an equivalent one branch function
between two nodes of the network

Kanpur, INDIA
GERT (Steps)
4. Convert the equivalent function into the
following two performance measure of the
network:
 The probability that a specific node is realized
 The mgf of the time associated with an equivalent
network
5. Make inference concerning the system under
study obtained in 4 above

Kanpur, INDIA
GERT Diagram/Example

Kanpur, INDIA
GERT
 It is important to note, however, some of the inherent
disadvantages in the use of GERT precedence diagrams.
 First, GERT typically employs AOA formats, which we
have previously noted are not at all common with
modern project management techniques or
nomenclature (e.g., the use of dummy variables).
 Thus, with some few exceptions, GERT is not supported
by common project management software.

Kanpur, INDIA
GERT
 Further, GERT networks can become extremely
cumbersome and complicated depending upon the size
of the project, the number of activities, expected
feedback loops, probabilistic conditions that must be
modeled, and so forth.
 Thus, although purporting to offer a more accessible,
visual treatment of project networks, GERT can actually
quickly become unwieldy and obfuscate the
visualization of a project’s network activities.

Kanpur, INDIA
GERT
 Space mission consisting of

two (02) vehicles
 Both vehicles must be
successfully launched

Kanpur, INDIA
GERT

Kanpur, INDIA
GERT
 Space mission consisting of

two (02) vehicles
 At least one of the vehicle
must be successfully launched

Kanpur, INDIA
GERT

Kanpur, INDIA
GERT
 One of the niceties of GERT is

its usefulness at many level
within a problem area

Kanpur, INDIA
GERT

Kanpur, INDIA
GERT (discussion of diagram)
 AND node plays a predominant role in the
activities up to and including the terminal
countdown.
 This is due to the fact that all activities must
be performed before lift off
 After the terminal count down either
possibilities are presented

Kanpur, INDIA
 Successful node is an EXCLUSIVE OR node due to the
reason that successful launch can happen in two
mutually exclusive ways which are:
Proper operation during boost phase
Unsuccessful orbit after boost phase with orbit
correction achieved
 The dotted lines represents the process where it signifies
activities that do not contribute to the successful launch

Kanpur, INDIA

Kanpur, INDIA
GERT (Basic Network Analysis)
1) All six nodes behave in the same manner if
only one branch is received at the I/P side
and one branch is emitted at the O/P side
2) Thus if two branches are in series and they
are being considered then the node type have
no effect on the equivalent one branch
network

Kanpur, INDIA

Kanpur, INDIA

Kanpur, INDIA

Kanpur, INDIA

Kanpur, INDIA

Kanpur, INDIA

Kanpur, INDIA

Kanpur, INDIA

Kanpur, INDIA

Kanpur, INDIA

Kanpur, INDIA

Kanpur, INDIA

Kanpur, INDIA

Kanpur, INDIA

Kanpur, INDIA

Kanpur, INDIA
GERT

Kanpur, INDIA
GERT

Kanpur, INDIA
GERT

Kanpur, INDIA
GERT

Kanpur, INDIA
GERT

Kanpur, INDIA
GERT

Kanpur, INDIA
GERT

Kanpur, INDIA
GERT

Kanpur, INDIA
GERT

Kanpur, INDIA
GERT

Kanpur, INDIA
GERT

Kanpur, INDIA
GERT

Kanpur, INDIA
GERT

Kanpur, INDIA
GERT

Kanpur, INDIA
GERT

Kanpur, INDIA
GERT

Kanpur, INDIA
GERT

Kanpur, INDIA
GERT

Kanpur, INDIA
GERT (Topographical equation)

Kanpur, INDIA
GERT

Kanpur, INDIA
Q-GERT
 Q-GERT is a modification of the traditional GERT approach in that it
recognizes special circumstances where multiple numbers of the
project teams or activities must be taken into consideration
simultaneously.
 Q-GERT gets its name from special queuing options which it has
available for modeling situations in which queues build up prior to
project activities.
 Further, Q-GERT allows the modeler to assign unique network
“attributes” (i.e., activity times, nodal branching probabilities) to each
individual projects and then process these projects through a single
generalized network.

Kanpur, INDIA
CPM
• ES: Earliest possible commencement time for a project activity
• ES calculation beginning at the initial node(s) of a project’s network
diagram, conduct a forward pass where: ESj = ESi + ti
0 A B C 7 C 9 D
ES=3,t=4
ES=0,t=3 ES=7,t=2
2 5
9=7+2
What if? 3 B
0=0+0 0+3=3 3+4=7
4 ESB + tB = 7
? D
ESD =
7 C 5 ESC + tC = 9
2 Kanpur, INDIA
MAX
3. CPM Example
A. Starts, Finishes, Slacks
• E(arly)F(inish) -- earliest possible time a project’s activity can be completed.
EF calculation -- beginning at the initial node(s) of a project’s network

diagram , conduct a forward pass where
0 A EF 3 iB
3 i = ES + ti7 7 C 9 9 D 14
3 4 2 5
3=0+3 7=3+4 9=7+2 14 = 9 + 5

Kanpur, INDIA
3. CPM Example
• E(arly) S(tarts), E(arly F(inishes) for Milwaukee Foundry .
F EF
4 7 ES
A 2 C
0 2 4
3
2 2
H
E 13 15
4 8
2
0 B 3 D 7 4
3
3 4
G
8 13
Project Management Dr. R. N. Sengupta, IME Dept., IIT 5 500

Kanpur, INDIA
3. CPM Example
•L(ate) F(inish) -- latest possible time an activity can be completed without
delaying the completion time of the project.
LF calculation -- beginning at the final node, conduct a backward pass
through the network’s paths where
0
A 3 B 7 C 9 D 14
LF
3 3i = LFj 4- t7j 2 9 5 14
3=7- 7=9-2 9 = 14 - 5
4
C
2 9
B LFC -tC = 7
A LFB =
3 4 ? D LFD -tD =9
Project Management 5 Dept.,
Dr. R. N. Sengupta, IME 14 IIT MIN
501
Kanpur, INDIA
3. CPM Example
LS calculation -- beginning with the final node(s) of the network make a

backward pass through the network where
L(ate) S(tart) -- the latest possible time and activity can begin without
delaying the completion time of the project.
LSi = LFi - ti
A B C D
0 3 3 3 4 7 7 2 9 9 14
5
0=3-3 3 = 7 -4 7 = 9 -2 9 = 14 -5

Kanpur, INDIA
3. CPM Example
• E(arly) S(tarts)/ F(inishes) and L(ate) S(tarts)/F(inishes) for Milwaukee
Foundry .
4 F 7
0 A 2 2 C 4 EF
10 3 13
0 2 2 2 2 4
ES
13 H 15
4 E 8
B 13 2 15
0 3 3 D 7
4 4 8
1 LS
3 4 4 4 8
LF
8 G 13
8 5 13
Kanpur, INDIA
3. CPM Example
A2. Starts, Finishes, Slacks
• E(arly)S(tart) -- earliest possible commencement time for a project activity.
ES calculation -- beginning at the initial node(s) of a project’s network
diagram, conduct a forward pass where:
ESj = ESi + ti
0 A3 3 B4 7 C2 4 9 D
5
1 2 3
ESj
0=0+0 3=0+3 7=3+4 9=7+2

node # 3
2 B4
9 D5 ESB + tB = 7
What if? 3
7
Project Management
C2
4
ESD =
Dr. R. N. Sengupta, IME Dept., IIT MAX
ESC + tC = 9
504
Kanpur, INDIA
3. CPM Example
• E(arly)F(inish) -- earliest possible time a project’s activity can be completed.

• EF calculation -- beginning at the initial node(s) of a project’s network
diagram , conduct a forward pass where:
0 1 0 A
EFi =3ES2i + t3i B4 7 C 2
9 D5
3 7 4 9
3
EFi ESj
3=0+3 7=3+4 9=7+2

3 4 3
node # D4
7/6 7 F5 12 6 12 G3
What if? 5
4 E2
3 4
critical path
Kanpur, INDIA
3. CPM Example
• E(arly) S(tarts), E(arly F(inishes) for Milwaukee Foundry .
EFi ESj
C2
22 44
2 4
node # A 2
F3
7/13 H2
0 13 1515
1 E4 7
6
B3 D4 G5
33
8/7
8
3 5
critical path
Kanpur, INDIA
3. CPM Example
• L(ate) F(inish) -- latest possible time an activity can be completed
without delaying the completion time of the project.
LF calculation -- beginning at the final node, conduct a backward pass
through the network’s paths where:
EFi
LFi
ESi
node #
LFi
B4 C2
=
0 A3 3 4 D5 14
1 2 5
0 3 7 9 14
7=9-2
0=3-3 3=7-4 9 = 14 - 5 14 = 14 - 0
What if?
B4
C2 9 4LFj LFB = LFC -tC = 7
2 3 LFD -tD =9
Project Management
? D5
14- tj5
Dr. R. N. Sengupta, IME Dept., IIT
Kanpur, INDIA
MIN
507
3. CPM Example
• L(ate) S(tart) -- the latest possible time and activity can begin without
delaying the completion time of the following activity.
LS calculation -- beginning with the final node(s) of the network make a
backward pass through the network where:
EFi
LFi
ESi
LSj
node #
LSi = LFi - ti
B4 C2 D5 5
2 3 4 14 14
A3 3 3 7 7 9 9
1 3=7-4 7 = 9 -2 9 = 14 -5
0 0
9 4
0=3-3
C2
What if? B4 3
L LF
LFD -tD =
C
2 7/9 D5
5
Project Management 14
Dr. R. N. Sengupta, IME Dept., IIT 508
Kanpur, INDIA
3. CPM Example
• E(arly) S(tarts)/ F(inishes) and L(ate) S(tarts)/F(inishes) for Milwaukee

Foundry .
C2
22 44 4
2 4
A 2
F3
22
10/4
H2
00 0 15
7/13
13
1
15
E4 6 7
0 B3 D4 G5 1313 1515
3 3
8/7
8
3 5
44 88 critical path

Kanpur, INDIA
3. CPM Example
• T(otal) S(lack) -- the amount of time an activity’s completion can be

delayed without delaying the project’s completion where,
TSi = LFi - ESi - ti and where i = the ith activity.
• F(ree) S(lack) -- the amount of time an activity’s completion can be

delayed without delaying the commencement of the next activity where,
FSi = ESj - ESi - ti and where i = the ith activity and j = the jth
activity.

Kanpur, INDIA
3. CPM Example
•
A. Starts, Finishes., Slacks
T(otal) S(lacks) and F(ree) S(lacks) for Milwaukee Foundry .
20
4 F
0 A 2 C
3 13
2 2 2
TS
4
FS =0=15-1
=0=15-
ES
0
B
3 TS =8-4-4=0
H
FSEE=8-4-4=0
D H 4 E
13 H
2 15
4 8 4 8
3 4
TS
FS =1=8-4-3
=1=8-4-3
=1=4-3-0
D
G
LF
=0=3-3-0
8
B D 5 13
B Project Management Dr. R. N. Sengupta, IME Dept., IIT
Kanpur, INDIA
511
3. CPM Example
•
Shared Slack -- the slack in a project along a “non-critical” segment of a
21
path which all activities on that non-critical segment share. Consider the
lower path for Milwaukee Foundry.
B G
0 3 D 8
3 4 4 8 5 13
TSB = 1 TSD = 1 TSG = 0

FSB = 0 FSD = 1 FSG = 0
The slack of one time period along this non-critical path segment is
shared between activities B and D, i.e., 7 time periods of activities are
scheduled over an 8 time period segment.
8 time periods (TPs)* *Other variations
are possible if the
one TP of slock is
A -- 3 TPs B -- 4 TPs divided up.
A -- 3TPs B -- 4TPs
A -- 3TPs Kanpur, INDIA
B -- 4TPs
3. CPM Example
22
• Nested Slacks -- when one segment of a non-critical path is imbedded in
another segment of a non-critical path, the “free slack” of the terminal
activity in the imbedded non-critical segment will not necessarily be 0.
Activity I.P.
0C
8
13 8D
20
7 15
E
25
A __
5
B A
__
S=5,
TS=5,FS=0FS=0
C
A10
010 TS,FS B= 5 D C
10
15
25
E D
TS,FS=0 TS,FS=0
on-critical path and is nes
Kanpur, INDIA
3. CPM Example
23
Activity I.P.
0C
813 8
D20
7 15
E
25
A __
5
B A
__
S=5,
TS=5,FS=0 FS=2
C
F20
017 TS,FS B
10= 3 D
E
C
D,F
15
25 F __
S=3,AFS=0 TS,FS=0
010
A-B 10is the one critical pat
S,FS=0
TS,FS=0
Project Management Dr. R. N. Sengupta, IME Dept., IIT
Kanpur, INDIA
514
3. CPM Example
•
A2. Starts, Finishes., Slacks
T(otal) S(lacks) and F(ree) S(lacks) for Milwaukee Foundry .
23b
early start
TSC = 4 - 2 - 2 = 0
FSC = 4 - 2 - 2 = 0
2 C 2 4
2
2
4
4
A 2 2 F3
2
10/8
0
4 H2
15
15
13
1 7/13
0
0 E 4
6 7
0
13
13 15
TSB = 4 - 0 - 3 = 1
FSB = 3 - 0 - 3 = 0
B3 3 D4 G5
3
7/8
8
3 5
4 8
late finish
4 8
TSD = 8 - 3 - 4 = 1
FSD = 8 - 3 - 4 = 1

Kanpur, INDIA
3. CPM Example
•
Shared Slack -- the slack in a project along a “non-critical” segment of
a path which all activities on that non-critical segment share. Consider
23c
23
the lower path for Milwaukee Foundry.
1 4 D4 8
2 B 3 5
3
4 5 TSD = 1 8
TSB = 1 FSD = 1
FSB = 0
C8
0 TSC = 0
4 FSC = 0
0
The slack of one time period along this non-critical path segment is
shared between activities B and D, i.e., 7 time periods of activities are
scheduled over an 8 time period segment.
8 time periods (TPs)* *Other variations
are possible if the
one TP of slock is
B -- 3 TPs D -- 4 TPs divided up.
B -- 3TPs D -- 4TPs
B -- 3TPs Kanpur, INDIA
D -- 4TPs
3. CPM Example
23d
TS=5, 7FS=0
Activity I.P.
S=5,CFS=0
8 28D 15
13 20 E = 54
TS,FS 5
A
B
C
__
A
__
5
25
D C
010 25 E D
A 10
TS,FS=0 10
3 B 15
TS,FS=0
T S,FS=0
10
NOTE: Path C-D-E
Kanpur, INDIA
517
3. CPM Example
23e
TS=5,
28D 7FS=2
17
4
Activity I.P.
13 17 20 E = 3
TS,FS A __
=5,CFS=0
8 5 B
C
A
__
0TS=3,F
10 10 FS=01525 5
25 D
E
C
D,F
__
A B
F
TS,FS=010
20 10
3
TS,FS=0
A-B is the one critical pat
Kanpur, INDIA
3. CPM Example
24
B. Resource Allocation Scheduling (ES)
Activity
*A TP1TP3
TP2
11K
11K
(2) TP5
TP4 TP7
TP6
TP9
TP8 TP10
TP11 TP14
TP13
TP12 TP1
B
*C (3)
10K10K
10K
(2)13K
13K
D
*E (4)
(4) 12K
12K
12K
14K
14K12k
14K
14K
*GF (3)
(5) 10K 10K
10K 16K
16K 16K
16K16K
*H (2)212123
2536
3 636
36314
6
1 16
4
1 16
6 16
16 168K
88K
88K
21426590
126
162
198 228
212 260
244 276
292
300
308
ivity
2K D Cost
--
G 48K
($22,000)
-- 80K
Kanpur, INDIA
519
3. CPM Example
25
B. Resource Allocation Scheduling (LS)
Activity
*A TP1TP3
TP2
11K
11K
(2) TP5
TP4 TP7
TP6
TP9
TP8 TP10
TP11 TP14
TP13
TP12 TP1
B
*C (3)
(2)10K
10K10K
13K
13K
D
*E (4)
(4) 12K
12K
14K
14K12k
12K
14K
14K
*GF (3)
(5) 16K
16K10K
16K
16K 10K
10K
16K
*H (2)112123
2326
2 626
26226
6
2 16
6
1 16
6 2626268K
88K
88K
11325578
104
130
156 198
182 240
214 266
292
300
308
ivity
2K D Cost
--
G 48K
($22,000)
-- 80K
Kanpur, INDIA
520
3. CPM Example
B. Resource Allocation Scheduling 26
Early/Late Start Resource Allocation Schedules
Cu
m.
P
roj.
C
ost
s
Project Time Periods
4. CPM Example
CPM with Crashing --a
• It is sometime necessary to accelerate the completion time of a project.
27
This usually leads to greater cost in completing the project than what
might have otherwise been the case because of opportunity costs
incurred as the result of diverting resources away from other pursuits.
As a result of this increase in cost, it is incumbent upon project
managers to reduce the completion time of the project in the most cost
effective way possible. The following guidelines are designed to
achieve that end.
1) Reduce duration times of critical activities only.
2) Do not reduce the duration time of critical activity such that its path length (in time)
falls below the lengths (in time) of other paths in the network.
3) Reduce critical activity duration times on the basis of the least costly first and in case
of a tie, the least costly activity closest to the completion node(s) of the project.
4) When two or more critical paths exist, reduce the length (in time) of all critical paths
simultaneously.
5) Given two or more critical paths and a cost tie between a joint activity and a subset of
disjoint activities on the same critical path, generally reduce the duration time of the
one joint to the most paths.
6) Note, if Management
Project reducing a joint activity
Dr. R.means thatIME
N. Sengupta, more critical
Dept., IIT paths emerge that what
522
would otherwise be the case, reduce disjoint
Kanpur, activities.
INDIA
4. CPM Example
CPM with Crashing --b
• Consider the crashing of the Milwaukee Foundry Project
28
Act. N.T. C.T. N.C. C.C. U.C.C.
*A 2 1 22K 23K 1K
B 3 1 30K 34K 2K
*C 2 1 26K 27K 1K
D 4 3 48K 49K 1K
*E 4 1 56K 59K 1K
F 3 2 30K 30.5K 0.5K
*G 5 2 80K 86K 2K
*H 2 1 16K 19K 3K
* - Critical Path
An inspection of Milwaukee Foundry’s project network identifies the
following three paths and of duration,
A-C-F-H : 9
*A -Project
C - EManagement
- G -H : 15 Dr. R. N. Sengupta, IME Dept., IIT 523
B - D - G - H : 14 Kanpur, INDIA
4. CPM Example
ACT N.T. C.T. N.C. C.C.
CPM with Crashing --c
U.C.C.
29
*A 2
B
*C 2 1
1 22K 23K
3 2 1 1 30K 34K
1 26K 27K
1
1K
2K 5
1K 6
3K
3K
Act. E has the lowest U.C.C.
and closest to the final node of
the network-- crash one time
period and two CPs emerge.
2
D 4 3 3 48K 49K 1K 3 2K
*E 4 3 2 1 1 56K 59K 1K 1 1K One can now reduce Acts. E &
D or G. Reduce G, three time
F 3 2 30K 30.5K 0.5K periods. It is A joint activity.
*G
*H
5 2
2 1
2 80K 86K
1 16K 19K 3
2K 2
3K 4
6K
3K
Now E & D can be reduced one
time period for the same U.C.C.
4
308 K 18K as G.
 - - SECOND CRITICAL PATH
1 Now reduce H by one time unit.

A- C - F- H : 9 8
*A - C - E - G -H : 15 14
5 Now reduce C & B by one time
unit.
B - D - G - H : 14 14
A- C - F- H
*A - Project
C - EManagement
123456 6
: 9 9 9 9 8 7 7
- G -H : 15 14 11Dr.
10R. N.
9 Sengupta,
8 7 IME Dept., IIT
Finally, reduce E & B by one
time unit.
524
B - D - G - H : 14 14 11 10 9 Kanpur,
8 7 INDIA
4. CPM Example
CPM with Crashing --d ( Summary)
• Why would reduce Activity E in crashing step one ( 1 ) and by
30
only one time unit?
• Why do you reduce Activity G and not Activities E & D in 2
and by three time units?
• Why do you now reduce Activities E & D in 3 and by only one
time unit?
• Why do you reduce Activity H in 4 ?
• Why do you now reduce E & B in 5 but by only one time unit?
• Why do you now reduce C & B in 6 and how do you know
now that you have crashed the project down to the minimum
possible completion time?
• Why were Activities A & F never reduced?
• Why should we concern ourselves with crashing a project by
always reducing the least costly activities first?
Kanpur, INDIA
5. PERT Simulation—motivation
--non-stochasticity/stochasticity & non-critical paths--
Reconsider General Foundry of Milwaukee
33
• The E(ti) for each activity in this reduced version of General Foundy’s PERT table has
been entered into the project’s network diagram.
•
•
ACT I.P. (a) (m) (b) E(ti) var(ti) F
A __ 1 2 3 2 4/36
• B __ 2 3 4 3 4/36 3
• C A 1 2 3 2 4/36 A C
• D B 2 4 6 4 16/36 2 2 E H
• E C 1 4 7 4 36/36 2
• F C 1 2 9 3 64/36
B 4
• G D,E 3 4 11 5 64/36 D
• H F,G 1 2 3 2 4/36 3 4 G
• Inspection of the network discloses three paths thru the project: 5
• A-C-F-H; A-C-E-G-H; and B-D-G-H. Summing the E(ti) on each path yields
the time thru each path to be 9, 15, and 14 weeks, respectively. With an E(t) = 15 for
A-C-E-G-H, this path is defined as the critical path (CP) having a path variance of 3.11
(112.36). The other paths however, also have variances of 2.11 for A-C-F-H and 2.44 for
B-D-G-H. We assume all three paths to be normally distributed.
• Implications of assuming non-stochasticity on the (two) non-critical paths--
how serious?
• How
Projectstrong is the assumption
Management ofN.non-stochasticity
Dr. R. Sengupta, IME Dept.,in
IITthis case? 526
Kanpur, INDIA
5. PERT Simulation--motivation
--independence of/interdependence between paths--
Reconsider General Foundry of Milwaukee
34
F
A C 3
E H A C
2 2 4 2 2 2 H
E 2
4
B G B D
D F G
3 5 3 4
3 4 5
Digraph with independent paths Digraph with interdependent paths
Project Management
Which
Dr. R. N. Sengupta, IME Dept., IIT 527
Kanpur, INDIA
PERT Simulation
CASE 1 CASE 2
ACT I.P. (a) (m) (b) E(ti) Var(ti) ACT I.P. (a) (m) (b) E(ti) var(ti)
A __ 1 2 3 2 04/36 ACT I.P. (a) (m) (b) E(ti) var(ti)
A __ 1 2 3 2 04/36A __ 1 2 3 2 04/36
B __ 2 3 4 3 04/36 B __ .1 3 5.9 3 33.604/36
C A 1 2 3 2 04/36 A 1 2 3 2 4/36
D B 2 4 6 4 16/36
E C 1 4 7 4 36/36
F C 1 2 9 3 64/36
G D,E 3 4 11 5 64/36
H F,G 1 2 3 2 4/36
The PERT table above merely replicates
the results of a previous page–paths
A-C-F-H; A-C-E-G-H; and B-D-G-H have
E(t)s of 9, 15, and 14 weeks with variances
of 2.11, 3.11, and 2.44, respectively.

Kanpur, INDIA
PERT Simulation
 Independent paths/non-stochastic non-critical paths assumptions in play
 E(t) = 15; CP ≡ A – C – E – G - H; Pr(X < 17) = 87.16%, A-C-F-H:
9, σ2 = 2.11; A-C-E-G-H: 15, σ2 = 3.11; and B-D-G-H: 14, σ2 = 2.44
 Independent paths/non-stochastic non-critical paths assumptions NOT in
play
 Simulation: E(t) = 15.19; Pr(X < 17) = 86.10%, A-C-F-H:
9, σ2 = 2.11; A-C-E-G-H: 15, σ2 = 3.11; and B-D-G-H: 14, σ2 = 2.44
 Independent paths/non-stochastic non-critical paths assumptions NOT in
play
 E(t) = 15.39; Pr(X < 17) = 82.51%; A-C-F-H: 9, σ2 = 2.11; A-C-E-
G-H: 15, σ2 = 3.11; and B-D-G-H: 14, σ2 = 4.513

Kanpur, INDIA
Resource Constraints in Project Scheduling
• The basic PERT/CPM procedures which
produce a detailed project schedule are limited
in the sense that resource availabilities are not
considered in the scheduling process.
• It is important to note in discussing the subject
of resource constraints here that time/cost
trade-off procedures are not included.

Kanpur, INDIA
Resource Constraints in Project Scheduling
• Resource Loading Diagram: Gives us a period to
period resource implications of a particular project
schedule and provide the basis of improved
scheduling decisions

Kanpur, INDIA
Laddering Effect

Kanpur, INDIA
Critical Chain
 Network scheduling is a powerful technique which is
widely used.
 It is simple to use, and handles precedence relationships
between activities in an effective way. It is normally
used in large projects, but also many smaller projects
may benefit from network scheduling tools.
 A disadvantage is that resource constraints are difficult
to handle.

Kanpur, INDIA
Critical Chain
 Normally, we schedule under the assumption of
unlimited resources, and then try to adapt this schedule
to the resource constraints.
 Goldratt (1997) published a theory in 1997 allowing
scheduling taking resource constraints directly into
account.
 The technique is called critical chain and is based on his
Theory of constraints.

Kanpur, INDIA
Theory of Constraints
 The theory of constraints was first published by
Goldratt (1985) looking at the manufacturing industry.
 He was studying bottlenecks in the production, and
claimed that there are always only a few bottlenecks,
and that these bottlenecks limit the capacity of the
whole factory.
 His approach is to focus on these bottlenecks and see to
that they never are “drying in”.
 To prevent the bottlenecks from drying in, he places
buffers in front of the bottlenecks.
Kanpur, INDIA
 The bottlenecks also pace the feeding of products into
the production line.
 The bottlenecks are denoted drums.
 They pace the speed of feeding products. From the
drum there is a rope to the first operation in the
production line.
 In front of the bottleneck is the buffer preventing it from
drying in.

Kanpur, INDIA

Kanpur, INDIA
 Goldratt claims that an hour lost in a bottleneck,
represents a lost production hour for the whole
production line or factory.
 An hour saved in a non-bottleneck is an illusion
since in any case we have access capacity on this
resource.
 This is the same theory that Goldratt introduced in
1997 for scheduling projects.

Kanpur, INDIA
 In many ways, it resembles network
scheduling. However, Goldratt schedules
activities under resource constraints directly.
 His critical chain is the longest path of
resource-constrained activities through the
network.
 Time and resources are handled in a single
pass.
Kanpur, INDIA
Critical Chain Scheduling
 Critical chain scheduling is done in four steps:
Determine critical resource
Exploit this resource by avoiding idle time on
it
Schedule all other activities based on the
critical resource
Explore the possibilities of extending the
availability of the critical resource

Kanpur, INDIA
Critical Chain

Kanpur, INDIA
Project Termination
• Misidentifying systematic errors
• Misapplying or misinterpreting appropriate
lessons based on events
• Failing to pass along lessons learned
conclusions

Kanpur, INDIA
Project Termination
• The conclusion of a project involves a
tremendous amount of paperwork needed to
document and record processes, close out
resource accounts, and, when necessary, track
contractual agreements and the completed legal
terms and conditions. Some of the more important
elements in this phase are:

Kanpur, INDIA
Project Termination
• Documentation
• Legal
• Cost
• Personnel

Kanpur, INDIA

MBA Final Project

Diunggah oleh

Informasi Dokumen

Hak Cipta

Format Tersedia

Bagikan dokumen Ini

Bagikan atau Tanam Dokumen

Opsi Berbagi

Apakah menurut Anda dokumen ini bermanfaat?

Apakah konten ini tidak pantas?

Hak Cipta:

Format Tersedia

MBA Final Project

Diunggah oleh

Hak Cipta:

Format Tersedia

PROJECT MANAGEMENT

Project Management Dr. R. N. Sengupta, IME Dept., IIT 1

Project Management Dr. R. N. Sengupta, IME Dept., IIT 2

Project Management Dr. R. N. Sengupta, IME Dept., IIT 3

Project Management Dr. R. N. Sengupta, IME Dept., IIT 4

Project Management Dr. R. N. Sengupta, IME Dept., IIT 5

Project Management Dr. R. N. Sengupta, IME Dept., IIT 6

Project Management Dr. R. N. Sengupta, IME Dept., IIT 7

Project Management Dr. R. N. Sengupta, IME Dept., IIT 8

Project Management Dr. R. N. Sengupta, IME Dept., IIT 9

Project Management Dr. R. N. Sengupta, IME Dept., IIT 10

Project Management Dr. R. N. Sengupta, IME Dept., IIT 12

Project Management Dr. R. N. Sengupta, IME Dept., IIT 13

Project Management Dr. R. N. Sengupta, IME Dept., IIT 15

Project Management Dr. R. N. Sengupta, IME Dept., IIT 16

Project Management Dr. R. N. Sengupta, IME Dept., IIT 17

Project Management Dr. R. N. Sengupta, IME Dept., IIT 19

Project Management Dr. R. N. Sengupta, IME Dept., IIT 20

Project Management Dr. R. N. Sengupta, IME Dept., IIT 21

Project Management Dr. R. N. Sengupta, IME Dept., IIT 23

Project Management Dr. R. N. Sengupta, IME Dept., IIT 24

Project Management Dr. R. N. Sengupta, IME Dept., IIT 25

Project Management Dr. R. N. Sengupta, IME Dept., IIT 26

Project Management Dr. R. N. Sengupta, IME Dept., IIT 29

Project Management Dr. R. N. Sengupta, IME Dept., IIT 31

Project Management Dr. R. N. Sengupta, IME Dept., IIT 32

Project Management Dr. R. N. Sengupta, IME Dept., IIT 33

Project Management Dr. R. N. Sengupta, IME Dept., IIT 34

Project Management Dr. R. N. Sengupta, IME Dept., IIT 35

Project Management Dr. R. N. Sengupta, IME Dept., IIT 36

Project Management Dr. R. N. Sengupta, IME Dept., IIT 37

Project Management Dr. R. N. Sengupta, IME Dept., IIT 38

Project Management Dr. R. N. Sengupta, IME Dept., IIT 39

Project Management Dr. R. N. Sengupta, IME Dept., IIT 40

Control Organizational Organization

Project Management Dr. R. N. Sengupta, IME Dept., IIT 41

Project Management Dr. R. N. Sengupta, IME Dept., IIT 43

Project Management Dr. R. N. Sengupta, IME Dept., IIT 44

Project Management Dr. R. N. Sengupta, IME Dept., IIT 45

Project Management Dr. R. N. Sengupta, IME Dept., IIT 46

Project Management Dr. R. N. Sengupta, IME Dept., IIT 47

Project Management Dr. R. N. Sengupta, IME Dept., IIT 48

Project Management Dr. R. N. Sengupta, IME Dept., IIT 49

Project Management Dr. R. N. Sengupta, IME Dept., IIT 50

Project Management Dr. R. N. Sengupta, IME Dept., IIT 52

Project Management Dr. R. N. Sengupta, IME Dept., IIT 53

Project Management Dr. R. N. Sengupta, IME Dept., IIT 54

Project Management Dr. R. N. Sengupta, IME Dept., IIT 55

Project Management Dr. R. N. Sengupta, IME Dept., IIT 56

Introduction Growth Maturity Stagnation Decline

Project Management Dr. R. N. Sengupta, IME Dept., IIT 57

Project Management Dr. R. N. Sengupta, IME Dept., IIT 58

Project Management Dr. R. N. Sengupta, IME Dept., IIT 59

Project Management Dr. R. N. Sengupta, IME Dept., IIT 60

Project Management Dr. R. N. Sengupta, IME Dept., IIT 61

Project Management Dr. R. N. Sengupta, IME Dept., IIT 62

Project Management Dr. R. N. Sengupta, IME Dept., IIT 63

Project Management Dr. R. N. Sengupta, IME Dept., IIT 64

Project Management Dr. R. N. Sengupta, IME Dept., IIT 65

Project Management Dr. R. N. Sengupta, IME Dept., IIT 66

Project Management Dr. R. N. Sengupta, IME Dept., IIT 67

Project Management Dr. R. N. Sengupta, IME Dept., IIT 68

Project Management Dr. R. N. Sengupta, IME Dept., IIT 69

Project Management Dr. R. N. Sengupta, IME Dept., IIT 70