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Name: Abhishek Jain Roll No.

: 511035358

Master of Business Administration-MBA Semester 3


Project Financing & Budgeting – PM0012
(Book ID: 1238)
Assignment Set- 1 (60 Marks)
Q.1 Describe the types of tools and techniques used in cost management
Ans: Types of Tools and Techniques
We have many tools and techniques used in Cost Management. Let us now discuss on some of the
tools and techniques of Cost Management. They are:
Cost aggregation
Reserve analysis
Expert judgment
Historical relationships
Funding limit reconciliation
Cost performance baseline
Project funding baseline
Cost aggregation: Individual costs are aggregated in many different ways for budgeting purposes,
including at the deliverable, work package, summary activity, or other classification levels.
Reserve analysis: Reserves are time or cost buffers in the project schedule or budget that help the
project counter or respond to uncertainties. Reserve analysis monitors these buffers and will reduce,
use, or eliminate them based on the current situation.
Expert judgment: Expert judgment is based upon the experience and knowledge of subject matter
experts. It is used to assess and evaluate the inputs and the information the experts contain.
Historical relationships: A historical relationship refers to the characteristics of the current and past
projects that can be used to develop models that aid in budgeting.
Funding limit reconciliation: Funding limit reconciliation matches the project's planned need for
funding with the organization’s ability to provide that funding. It can be thought of as "resource
leveling" for finances because it reschedules activities to make sure that the budget for the
scheduled activities does not exceed the available budget for that period. For instance, if the
estimated cost for scheduled activities in the second month of a project is estimated to be Rs 50,000,
but the organization can only provide funding for Rs 40,000 then there is Rs 10,000 of work that has to
be rescheduled to another month.
Cost performance baseline: The cost performance baseline is a duration-phased budget that is used
for project cost management, monitoring, and reporting. Though they are both derived from the
same source, the project budget and project cost baseline are not interchangeable terms. The cost
baseline is a component of the project performance baseline.

Q.2 Describe various types of financial risks.


Ans: Commercial risks are those that are innate in the projects. They are also called project risks. The
lenders who are engaged in the limited recourse of a project need a specific flow of cash for the
project liability term. They also need project revenues which are allocated to risks, and are mitigated
by the company or sponsors. For example, to make sure that there are sufficient project revenues to
service project debt, lenders can include it in the project liability documentation provision. This
includes:
Risks related to the development, construction, operation and maintenance of assets, and
searching an adequate market for the project output.
Broader risks which is related to changes in the interest rate, inflation, currency risks, price
movements of raw materials, and energy inputs.

Q.3 If there is an initial investment of rupees 2000 and 3 years of positive cash flow of rupees 700
each. The discount rate is 10%. What is the present value of each cash flow?
Ans:
NPV = Present value of net cash flows

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Name: Abhishek Jain Roll No.: 511035358

Where:
Ct = the net cash receipt at the end of year‘t‘
Io = the initial investment outlay
r = the discount rate/the required minimum rate of return on investment
n = the project/investment's duration in years
Year Cash Flow
Y1 2000
Y2 700
Y3 700
Y4 700
NPV = (0 + 578.51 + 525.92 + 478.11) – 2000
= -417.46

Q.4 What is credit risk appraisal? Explain the 5C’s of credit analysis
Ans: Credit appraisal involves analysis of liquidity position/ financial soundness of the company.
Although, the analysis also covers understanding growth trends in revenues and earnings, and profit
margins, more emphasis is required to be placed on liquidity-both long term and short term. Credit
analysis or credit appraisal typically involves micro-analysis of the key financial statements i.e.
Income Statement, Balance Sheet and Cash flow Statement. The important parameters that are to
be looked while analyzing liquidity are:
a) Debt Equity Ratio
b) Total Debt to Total Assets
c) Current Ratio and Quick Ratio
d) Sales to Working capital Ratio
e) Inventory Turnover Ratio
Along with the above mentioned ratios, one needs to look at aspects like aging schedule of
debtors, quality of inventory (fast-moving, slow-moving and obsolete). Credit risk analysis or credit
appraisal basically revolves around the premise of ability of borrower to service its debt through cash
flows. Primary cash flows are those that are generated through operations while secondary
cashflows are cash & cash equivalents plus marketable securities.
While analyzing credit risk of the borrower, the bank/ credit rating agency needs to consider even
the future growth potential of the business and incorporate in its judgment, those issues that can
possibly put business at risk. For this one needs to understand the future growth strategy & business
outlook and how the company wants to move ahead with its plans. The potential impact of any
future growth initiatives can be critical today as it may put additional stress on current profitability
and liquidity of the business.

Q.5 Classify projects based on the ways they influence investment decision process.
Ans: Classification of Investment Projects: Investment projects are classified into three categories on
the basis, of the way they influence the investment decision process: independent projects, mutually
exclusive projects and contingent projects.
Independent projects
An independent project is one, where the acceptance or rejection does not directly eliminate other
projects from consideration or affect the likelihood of their selection. For example, if management
plans to introduce a new product line, as well as, replace a machine which is currently producing a
different product. These two projects can be considered independent of each other, if there are
sufficient resources to adopt both, provided, they meet the firm’s investment criteria.
Mutually exclusive projects
The mutually exclusive projects are projects that cannot be followed at the same time. The
acceptance of one prevents the substitute proposal from accepting. Most of them have ‘either or’
decisions. You will not be able to follow more than one project at the same time. The evaluation is
done on a separate basis so that one that brings the highest value to the company is chosen.
Contingent projects

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Name: Abhishek Jain Roll No.: 511035358
A contingent project is one where the acceptance or rejection depends on the decision to accept
or reject multiple numbers of other projects. Such projects may be complementary or substitutes. Let
us take the example of bio fuel plant cultivation in a large scale and the decision to set up a bio fuel
manufacturing unit. In this case, the projects are complementary to each other. The cash flows of
the plant cultivation will be enhanced by the existence of a nearby manufacturing plant.
Conversely, the cash flows of the manufacturing unit will be enhanced by the existence of a nearby
cultivation farm.

Q.6 List the advantages and disadvantage of project finance.


Ans: The major advantages of project finance are:
Allows the promoters to undertake projects without exhausting their ability to borrow amount for
traditional projects.
Limits financial risks to a project to the amount of equity invested.
Enables raising more debts as lenders are sure that cash flows from the project will not be
siphoned off for other corporate uses.
Provides stronger incentives for careful project evaluation and risk assessment.
Facilitates the projects to undergo careful technical and economic review.
Eliminates the dependency on alternative nature of funding a project.
Facilitates the arrangement of liability financing and credit improvement, accessible to the
project but unavailable to the project sponsor.
Enables the diversification of the project sponsor’s investments to reduce political risk.
Gives more incentive for the lender to cooperate in an atmosphere of a troubled loan.
Enables to have prolonged credit opportunities.
Matches specific assets with specific liabilities.
The major disadvantages of project finance are:
Complexity of the process due to the increase in the number of parties and the transaction cost.
Expensive as the project development and diligence process is a costly affair.
Litigious with regard to negotiations.
Complexity due to lengthy documentation.
Requires broad risk analysis and evaluation to be performed.
Requires qualified people for performing the complicated procedures of project finance.
Obligations regarding the trust fund account need to clearly specify.
Higher level of control which might be exercised by the banks, which might bring conflict with
the businesses or contracts.

Project Planning & Scheduling – PM0011 Page 3 of 7


Name: Abhishek Jain Roll No.: 511035358

Master of Business Administration-MBA Semester 3

Project Financing & Budgeting – PM0012


(Book ID: 1238)

Assignment Set- 2 (60 Marks)

Q.1 Explain Break-even analysis?


Ans: Break Even Analysis1
The break-even point or break even analysis is the specific point at which, gains equal the losses. A
break-even point describe the time when, an investment makes a positive return. It is at this point
that the total costs become equivalent to the total amount of revenues. At this point, there is no loss
or profit incurred. This point is crucial for everyone who manages the business. Because, breakeven
point is the lowest limit of profit where there are set prices and determined margins.
The Break-Even Chart
The break even chart is the pictorial representation of the costs at different stages of activity. This is
the point at which there is neither profit nor is loss incurred. In figure 4.2, the line OA stands for the
dissimilarity in income, at different stages of production activity. Line OB stands for the total of fixed
costs in the business. As there is an increase in the output, uneven costs are incurred. In such a case,
the total of the costs also increase.

Figure 1: Break Even Chart


Break-even analysis is one of the most effective tools, which are used in studying the connection
between the fixed costs, variable costs, and the returns. Break-even analysis measures the
production volume at a specific price provided, which is essential for covering all the expenses.
Fixed costs do not have direct association with the level of production. Fixed costs include reduction
on machinery, costs of interest, taxes, and the overhead costs. Even if the business has a result,
which is equal to zero or has a high output, the level of these fixed costs will be the same. The
examples of fixed costs include rental and rates, depreciation, research and development,
marketing costs, and administration costs.
Variable costs vary in direct association with the volume of result. This include the cost of sold
commodities and the production costs like labor, electricity expenses, feed, fuel, veterinary, and

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Name: Abhishek Jain Roll No.: 511035358
irrigation. They also include other expenses that are associated directly with the production of a
good or an asset. Total Variable Costs (TVC) is the total of the uneven costs for the specific
production level or the output. The average variable costs are the variable costs for a unit of output,
or TVC divided by units of output.
Returns are the performance gauge used in order to assess the competence of an investment or to
make a comparison regarding the efficiency of a number of different savings. For example, a
marketing person makes a comparison between two different products by dividing the revenue
each product produces.
Semi-Variable Costs
The calculation of the difference between the fixed and variable costs is the most convenient
method of dividing the business expenses. Some of the costs have a stable nature. But, there will be
an increase in these costs while the results reach a certain stage. For example, when a particular
business produces lower level of result and sales, it will not need the costs that are related to
functions like human resource management and resource finance management. But, when there is
a growth in the business, the business will require more reserves. If there is a rise in the production,
there will also be an increase in the transport and warehousing. In such cases, we say that the cost is
partially fixed and variable.
Benefits of Break-Even Analysis
The main prominent benefit of break even analysis is that it describes the association between
expense, production volume, and returns. It also shows the changes in the association between
fixed and variable costs, product prices, revenues and so on. The concept of break even analysis is
useful, when it is used along with partial budgeting and capital budgeting methods. It also shows the
lowest amount possible in a business, so that you can prevent mistakes in the project.
Limitations of Break-Even Analysis
All benefits mentioned above do not mean that break even analysis is devoid of any limitations.
Some of the limitations of break even analysis include:
Inappropriateness to the analysis of a multiple projects, at a single stretch.
Difficulty to categorize a cost as variable or fixed.
Tendency to make use of break-even analysis, often after a change in the cost and income
functions.

Q.2 Write short note on:


a. Payback period
b. Discounted cash flow
Ans:
a. Payback period is the period in which the total investment in permanent assets pays back itself.
This method lists the various investments that are ranked according to the length of their pay-
back period and the investment with a shortest payback period is preferred. The payback
period can be ascertained in the following manner:
Payback period = Investment / (Cash Flow/year)

b. Discounted Cash Flow (DCF) is a method to estimate the project, company or assets investment
opportunity by means of the conception of time value for money. In DFC method, the project‘s
value is the future estimated cash flows discounted at a rate that reflect the risk of the projected
cash flow. A common practice is to use the DCF method to value companies or projects. There
are three major discounted cash flow analyses for project evaluation and selection. They are:
Internal Rate of Return (IRR)
Net Present Value (NPV)
Profitability Index (PI)
DFC is based on free cash flow which is a reliable method to cut through the unpredictability
and guesstimates involved in reported earnings. The free cash flow models examine the money
left for investors regardless of the cash outlay whether counted as an expense or turned into an
asset on the balance sheet. The DFC model applies as a sanity check.

Q.3 List the various criterions to be considered before identifying a project for investment.
Ans: Criteria for Selecting a Project
The task of identifying suitable projects for an investment involves in-depth study and appraisal. The
following are the criteria’s that one needs to look into before identifying a project:

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Name: Abhishek Jain Roll No.: 511035358
Investment size: The investment cost of the proposed project must enable it to provide an
acceptable profit with a competitive price. The factors like cost of input materials, wage costs,
factory overhead expenses, general administration expenses, selling/distribution expenses,
service charges and economies of scale has to be analyzed.
Technology to be used: The new evolving technologies and new methods/processes of
production have to be identified. The impact on the cost structure of the company’s product has
to be analyzed.
Market size: The market size must be sufficient enough to offer satisfactory sales volume support
production. There must also be rapid growth potential and high return on investment. The
competitors and their shares in the market must be examined. The barriers to enter new units
have to be examined and after identifying the project.
Equipment: The equipments required for running the project has to be considered. The
organization estimates the cost required for purchasing these equipment.
Location: The location for setting up the project has to be identified and the cost for setting up
the location has to be estimated. If an entrepreneur is starting a new business, he/she has to
identify and finalize the location for the project before undertaking the project.

Q.4. A firm’s market value of liability is 400 Rs. And the market value of equity is 600Rs. Cost of liability
is 7% and corporate tax 30% & cost of equity is 15%. What will be the weighted average cost of
capital?
Ans: Weighted Average Cost of Capital (WACC)

Where,
Re = Cost of equity = 15%
Rd = Cost of debt = 7%
E = Market value of the firm's equity = 600 Rs
D = Market value of the firm's debt = 400 Rs
V=E+D = 600 + 400 = 1000 Rs
E/V = Percentage of financing that is equity = 600/1000 = 0.6
D/V = Percentage of financing that is debt = 400/1000 = 0.4
Tc = Corporate tax rate = 30%

So, WACC = 0.6 * 15% + 0.4 * 7% * (1-30%)


 WACC = 10.96%

Q.5 Explain & compare Finance & Budget concept.


Ans: Terms “Budget‟ and “Finance‟ might seem to be same, they are entirely different. Budget is an
ordinary estimate of a person’s or organization’s income and expenses for an explicit period in the
future. With the help of a budget, an individual/firm is able to look at the amount of money they can
use during a particular period. The process of budgeting can be carried out by persons or by firms to
assess whether they can continue with the proposed revenue and costs.
Finance is the providing of funds or capital for any particular kind of expenses. It can be described
as a process of channeling of finances from savers to users in a variety of forms such as credit, loans
and invested funds.
For example, imagine that you are in the process of starting a firm. You borrow money in the form of
loans or other credit to invest in the firm. The borrowed amount is regarded as finance. Once you
borrow the money from various financial organizations, you make a forecast of the income and
expenditures the firm is going to have for a specific period. This amount which is assigned is the
budget of the firm. The Table 1 shown below gives the comparison between budget and finance.
Table 1 Comparison between Finance and Budget
Budget Finance
Finance is to plan long-term sources and uses
of funds, assess the effectiveness of programs
Budgets are estimate to match revenues
and departments, and focus financial
against expenditure.
resources on programs that help attain the
organization’s aim.

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Name: Abhishek Jain Roll No.: 511035358
The Budgeting procedure usually involves
routine review of annual expenditures. Budget Finance identifies and evaluates the particular
centre directors are provided with directions areas where the funds are being overspent.
regarding the limits of spending, estimated They also check whether these funds were
increases and the introducing of new spent on programs which are not worth.
programs.
Finance concentrates on allocating resources
Budget considers day-to-day operating needs, efficiently, building long-range plans for new
like staff, supplies, utilities, and benefits. funds, ensuring that funds aim to meet the
goals and priorities of a strategic plan.
Finance, in contrast, normally provide two or
Traditional budgets generally give data for the more years of history and a three- to five-year
budget year and the previous year. projection of future expenditures, based upon
strategic documents.
Finance ask, what will you achieve with the
Traditional budgets asks and answers the
level of funding requested for the next five
question, how is your organization going to
years, and how does that compare to other
spend its funds on a project next year?
alternatives for the same goal or service?
Finance addresses critical issues. For example,
when new funding will be needed, the cost of
alternatives for improving the performance of
Budgets address the direct operating needs of
a project, the long-range impact of reducing
the project.
the funds or providing more funds, and the
total annual capital and operating costs to
fully implement and support technology.
Finance show whether the funds are being
Budgets affect what happens during the used effectively, what funds are used for, what
coming year and show categorical spending they will accomplish and most importantly,
only. what affect the money will have on the
organization.

Q.6 Total cost of project is 250,000Cr. Expected return of project amount is 42,000 Cr. What is the
shortest payback period?
Ans: Payback Period PP = The Cost of Cash Inflows / Annual Cash Inflows
Here, Cost of Cash Inflows = 250,000 Cr., Annual Cash Inflows = 42,000 Cr.
So, PP = 250,000/42,000 = 5.95 Years

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