PM 0012 PROJECT FINANCE AND BUDGETING

Q1 Write short notes on:

Project cost estimation
Role of project sponsors
Trade credit
Importance of project budget
Answer: Project cost estimation
The cost of the project is the money required to complete the project. Costestimation is very
important for the planning and execution of any project sothat appropriate finances can be
allocated at the right time. However, attimes, the overall cost may go beyond the budgeted cost
due to projectdelays. If the demand for money cannot be met at that time, then theproject might
have to be shelved. Therefore, it is important to use judgementand experience along with
application of scientific principles and techniquesto estimate the cost of a project.
Project cost estimation helps in determining the financial viability of a project and provides
answers to the following questions:
How much money is needed to complete a particular project?
How much profit can be made?
What is the project risk and how much money should be held in reserve?
What will be the cost of capital required for the Project?
Whether Fixed assets/Working Capital components will be indigenous or involve any
imports (if so, Forex related issues should be kept in mind)
Role of Project Sponsors
The responsibilities of project sponsors are as follows:
Selling and marketing the project within the organisation in order to convince the
employees that the project will provide benefits to them
Coordinating with the project manager and providing their business expertise and
guidance to him/her
Acting as the link between the project, the business community and top management of
organisation
Acting as arbitrators and make decisions for which project managers are not authorised
Ensuring that the business needs are satisfied by adopting the project
Launching the project effectively
Managing changes in the project such as change of organizational policy, adverse
business conditions etc. effectively
Managing project risks effectively
Preparing a proper plan for starting and completing a project
Approving key project deliverables
Conducting project reviews and monitoring its whole process
Solving issues that are not under the control of the project manager
Resolving conflicts as well as other issues that can act as a roadblock in the successful
completion of the project

Trade credit
Trade credit is one of the traditional and common methods of raising short term capital from the
market. It is an arrangement in which the supplier allows the buyer to pay for goods and services
at a later date in future. The decision to provide trade credit depends on the mutual understanding
of both the buyer and the supplier. The supplier takes the decision to extend trade credit after
taking into consideration creditworthiness, goodwill and record of previous transactions of the
buyer. In some cases, trade credittransactions can be done through exchange of goods instead of
cash. Forexample, the supplier may provide raw material, machines, finished goods, and services
to the buyer instead of cash.
Importance of project budget
Project budget is an important part of project management in the following ways:
Cost control: Budgeting a project enables a project manager to get all details and increased
control of the project. When different tasks are budgeted individually, it helps the project
manager to check where the problem occurred in case anything goes wrong.
Financial focus: In a project budget, different activities involved in the project are budgeted
separately. This enables the project manager to keep a watch on the in-flow and out-flow of
funds. It also enables the employees who perform these activities to know the budget in smaller
increments and frequently reminds them about the importance of adherence to budgets. This
helps in getting frequent feedback on the budget and managing it accordingly.
Apart from this, the budgeting helps in healthy growth of the project because it:
Helps in controlling the cost of project
Facilitates better coordination in the project team
Ensures availability of funds when needed
Keeps the project team prepared to face future uncertainties
2 Answer the following questions:
1. What is a Letter of Intent (LOI)? What is its purpose?
2. What are the basic features of EPC (Engineering, Procurement and Construction)
contracts? Give any 4 advantages of entering into an EPC contract?
1. a. Define LOI
b. List any 4 purposes of LOI
2. a. briefly explain the 3 basic features of EPC contracts
b. List any 4 advantages of entering into EPC contracts
Answer: A Letter Of Intent (LOI) may be defined as an agreement between two ormore parties
to do business together before signing the contract. It signifies an intention to do the business at
later date. It is the first step in negotiation of a commercial transaction to agree upon the business
terms of the transaction.
The main purposes of an LOI are as follows:
For clarifying the key points of a complex transaction
For official declaration of negotiation between the parties

 For verifying certain issues regarding payments done for someone else, for example
credit card payments
For providing safety in case of a deal collapsing during negotiation

The basic features of EPC contracts are as follows:

A single point of responsibility: In an EPC contract, the contractor is responsible for all
designing, engineering, procuring, constructing and testing activities. Therefore, in case of any
problem, the project company will look for only the contractor to fix the problem and give
compensation if required.
A fixed completion date: The time period is fixed for completion of the facility after the
commencement of the EPC contract. If this date is not met, the contractor is liable to pay delay
liquidated damages (DLDs). DLDs compensate the project company for loss and damage
suffered due to late completion of construction.
A fixed contract price: The contractor is liable for risk of cost overruns and also the benefit of
any cost savings. The contractor has a limited authority to claim extra money for the delays made
by the project company by ordering variations in the work.
The main advantages of entering into an EPC contract are as follows:
Reduced stress for owner of the project
Single-point responsibility reduces the opportunity for claims by the contractor
Strict standard of performance
Use of lump sum pricing method which provides the employer greater certainty in overall
cost as well as in the timing of payments
Reduces completion risk
Ready availability of post-commissioning services
Awareness of cost at the start of the project
Owner protected against changing prices for materials, labour etc.
3 Explain the different key project documents.
Description of key project documents
Answer: Key project documents
Business case: It is a kind of agreement or contract or a decision analysisreport which signifies
that the project has been approved forcommencement. It is managed between two parties for
offering of services.In the business case, the resources involved in the project along with itscost
and schedule are mentioned.
Project plan: It is essential for effective management of the project. Whilethe business case
provides only the basic information, a project planprovides more extensive information about the
project. It helps to know theallocation of resources to the project, the objectives of the project
and theproject schedule created through Critical Path Method and CPM Schedulingtechniques. It
also provides information that the project manager and theclient have agreed to work with each
other on certain parameters.

Project charter: It is a statement that defines the objectives, requirements, and targets of a
project. It also provides a preliminary delineation of rolesand responsibilities of the members of
the project team, identifies the mainstakeholders, and defines the authority of the project
manager. It is prepared by the project manager or the senior management of the project company.
Requirement definitions: It is an important project document in which requirements of the
project are specified and are used to update the plan and the schedule of the project. This
document basically aligns theinformation provided in the business case and the project plan. In
case of discrepancies in the information provided in the two documents, therequirements are
reviewed. After reviewing and defining the requirements of the project, they are approved and
the project gets started.
Design specification documents: These documents are important to meetthe standards related to
design specification. These documents establishcohesion among team members regarding the
project specifications like thetype of product, packaging, and design of project, etc.
4 Write short notes on:
Developments in financing of construction projects in India.
Importance of cost of capital in project selection.
Principles employed by organisations to manage working capital
Answer: Developments in financing of construction projects in India
Indian construction is in a nascent stage as compared to other developed countries, such as US or
UK. India lacks in basic constructions, such as highways, airports and seaports. The Indian
government is striving to address the problem by encouraging the private sector to invest in
construction projects.Some important developments in financing of construction projects in India
are

Importance of Cost of Capital in Project Selection

The cost of capital plays a crucial role in project management. Capital is an integral part of a
project as adequate amount of capital enables an organisation to complete the project on time.
The organisation raises capital from various sources, such as debts, equities, joint ventures and
loans. The capital cannot be raised without cost, for example, if an organisation takes a loan from
different banks for a project, it needs to pay a certain percentageof interest to the bank. Similarly,
the organisation needs to pay dividend to equity investors. The cost of capital is the minimum

rate of return a project must yield, so that the investors who have invested in the project in the
form of shares, debentures and loans are satisfied. If an organisation finances a project from its
own savings, opportunity cost is involved as the same amount of capital can be invested in other
projects that may yield some return. Therefore, the organisation needs to ensure that the return
from a project is more than the cost of capital invested in the project. The cost of capital of each
different source is called specific cost of capital.
Organisations employ certain principles for managing their working capital. These principles are:
Principle of risk variation: It helps in determining the relationship between risk and
profitability associated with working capital management. In the present context, risk refers to
the ability of an organisation to pay -off its current liabilities. If the working capital increases by
raising short-term loans then the risk for the organisation may increase and profitability may
decrease.
Principle of cost of capital: It helps in determining the relationship between the cost of capital
and degree of risk. According to this principle, there is an inverse relationship between the two.
For example, if the debt capital increases, the cost of capital goes down, but the risk of paying
return at the time of loss increases. On the other hand, if the equity capital increases, the cost of
capital also increases, but the risk of paying return at the time of loss decreases. This happens
because the organisation does not need to pay dividends on equity at the time of loss.
Principle of equity position: According to this principle, every investment in the current asset
should be justified by an organisations equity position. This implies that any amount invested in
the current asset should contribute to the net worth of an organisation.
Principle of maturity payment: States that an organisation should frame its policies in such a
way so that its cash inflow would be sufficient to meet cash outflow. This facilitates the timely
payment of short-term debts, which in turn enhances the goodwill and creditworthiness of an
organisation.
5 What are the problems associated with BOOT projects.
Explanation of the main problems associated with BOOT projects
Conclusion
Answer: Problems in BOOT Projects
Although BOOT model is beneficial for certain projects, there are many risksand problems
associated with it and may act as a constraint in theimplementation of these projects. The main
problems associated with BOOTprojects are as follows:
There are problems with BOOT projects in reaching the constructionstage. There may be many
reasons for this. One of those reasons maybe unavailability of experienced developers. If the
developer is notexperienced enough, then the project may face many problems in itscompletion.
The other reason may be absence of equity investors. Thisreason may create financial problems
for the project. The workability ofcorporate and financial structures may also act as an obstacle
for BOOTprojects to reach the construction stage. Therefore, a well organized structure is very
essential for successful completion of these projects.

Due to the complicated structure of BOOT projects, it becomes difficultto maintain the project
until the end. It requires commitment and interest,which may be lost as the project proceeds due
to longer concessionperiod. In addition, detailed planning, time and money are
requiredthroughout the concession period, to maintain these projects and it maybe difficult to
invest these in the project.
Many risks are associated with BOOT projects. BOOT projects haveelemental and global risks.
Elemental risks are associated with elementsof the BOOT projects while global risks are not
associated with theelements of the project. In BOOT projects, the global risks are
allocatedthrough the concession agreement while elemental risks are allocatedthrough the
construction, operation and finance contracts. BOOTprojects are also associated with risks of
market price, financing,technology, revenue collection and political issues. Some physical
riskssuch as damage to work in progress, damage to plant and equipmentand injury to third
persons are also associated with BOOT projects.
6 Explain the different types of management contracts (a type of PPP).
List the types of management contracts
Explain each type of management contract
Answer: The different types of management contracts are:
Supply or service contract: It is a type of management contract, which involves supply of raw
materials, equipment, labour, etc. by a private concessionaire to a public entity. The appointment
of private agencies by the concerned authorities for maintaining cleanliness in the railway station
isan example of such type of contract. In a supply or service contract, the private concessionaire
has the freedom to enter into supply and/or service contracts with other entities for supplying the
desired equipment, labour, power and energy to the government entity. The project of Integrated
Solid Waste Management at Dehradun, which was carried out by Dehradun Nagar Nigam, is an
example of Service Contract. However, if the private agencies want to provide services directly
to the end users or customers, they are required to enter into an operating agreement with the
public entities or other concerned parties.
Maintenance management contract: It is a type of management contract in which a private
sector entity is contracted by a public sector entity for the maintenance of a facility or a service.
For example, contracts by the local authorities and government for management and
maintenance of wastewater are maintenance management contracts. Such contracts are also used
by transport operators for ensuring proper handling and management of assets. Under a
maintenance management contract, ownership of the service or facility is retained by the public
entity. However, as per the requirement of the project, the private entity is allowed to invest its
capital in the facility or contract.
Operational management contract: It is a type of management contract in which a private
sector entity is contracted by a public entity for rendering and maintaining a particular service.
Such type of contract is often used by the government to increase the efficiency and effectiveness
of the public facilities.

Turnkey projects: It is one of the most traditional types of PPP, which is used by the
government for developing and maintaining various public infrastructural facilities. Turnkey
projects are also known as design-build projects. In such type of project, private entities have to
make a bid for designing or building a facility for a fixed fee, rate or cost. The bids are made
after giving due consideration to the risk involved in design and construction stages. The private
entity, who wins the bid, is offered the contract by the concerned public authority. Turnkey
projects are often used by the government for the supply, erection and commissioning of boilers,
transmission lines, power plants, etc.
Lease/Affermage: It is a type of PPP in which the services and infrastructural facilities are
operated and maintained by an operator(leaseholder). In a lease/affermage, the operator usually
does not make any significant investment in the facility. However, these models are mostly used
in combination with other PPP models like Build-Rehabilitate-Operate- Transfer (BROT). In
such a case, the duration of contract period increases and therefore, the private sector needs to
make significant investments.