BBA VI Sem

Subject: Project Planning and Evaluation

Subject Code: BBA 304
Unit 1

Lec 1- Overview
Project
Project means planned set of interrelated tasks to be executed over a fixed period and within
certain cost and other limitations. Projects can include a variety of different things, such as
designing new software to increase efficiency, building a bridge, creating a new product, or even
expanding sales into a new territory.

Project management
Project management is when a company applies its human and financial resources to plan and
execute a specific task. There are various stages involved in this.
The first stage is project initiation. The company works with its clients to gather information. The next
stage is project planning. In this stage a written project charter is drafted. Example using PM tools, such
as PERT and CPM, because the project is large and complicated.
The third stage of PM is the execution stage. This is the stage in which the resources are distributed.
Relevant project information and assignments are given to team members.

Capital Investment
The word investment refers to the expenditure which is required to be made in connection with
the acquisition and the development of long-term facilities including fixed assets. It is the act of
placing capital into a project or business with the intent of making a profit on the initial placing
of capital. This is one of the most important decisions taken by management.

Procedure

1) Organization of Investment Proposal.

2) Screening the Proposals.
3) Evaluation of Projects
4) Establishing Priorities
5) Final Approval
6) Evaluation

Types of Investment
1) Simple Classification
2) Strategic Classification
3) Purposive Classification

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Simple Classification

 Physical Assets
 Monetary Assets
 Intangible Assets

Strategic Classification

 Strategic Investment
 Tactical Investment

Purposive Classification (For planning and control)

 Mandatory Investment
 Replacement Investment
 Expansion Investment
 Diversification Investment
 R and D Investment
 Miscellaneous Investment

Technical Analysis
It means to ensure that the project is technically feasible in the sense that all the inputs required
to set up the project are available and to facilitate the most optimal formulation of the project in
terms of technology, size, location and so on.

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

PERT
PERT( Program Evaluation and Review Technique) is a statistical tool, used in project
management, which has been designed to analyze and represent the tasks involved in completing
a given project.

CPM
In project management, a critical path is the sequence of project network activities which add up
to the longest overall duration, regardless if that longest duration has float or not. This
determines the shortest time possible to complete the project.

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Lec 2 -Project Planning Overview: Capital Investments: Importance and
Difficulties
Project
Project means planned set of interrelated tasks to be executed over a fixed period and within
certain cost and other limitations. Projects can include a variety of different things, such as
designing new software to increase efficiency, building a bridge, creating a new product, or even
expanding sales into a new territory.

Project management
Project management is when a company applies its human and financial resources to plan and
execute a specific task. There are three stages.
The first stage is project initiation. The company works with its clients to gather information
The next stage is project planning. In this stage, a written project charter is drafted. Example
using PM tools, such as PERT and CPM.
The third stage of PM is the execution stage. This is the stage in which the resources are
distributed. Relevant project information and assignments are given to team members.

Capital Investment-Meaning & Definition

The word investment refers to the expenditure which is required to be made in connection with
the acquisition and the development of long-term facilities including fixed assets.
It is the act of placing capital into a project or business with the intent of making a profit on the
initial placing of capital. The term Capital Investment has two usages in business. Firstly, CI
refers to money used by a business to purchase fixed assets. Secondly, Capital Investment refers
to money invested in a business with the understanding that the money will be used to purchase
fixed assets, rather than used to cover the business' day-to-day operating expenses.

Importance of capital Investment/Capital budgeting

The following motives will clearly explain why capital investment is very important for a firm:

1) Expansion-Capital investment is directed towards expansion of the level of operations.

It is done through acquisition of fixed assets by purchasing property and plant facilities,
which in turn ensures proper investment and balancing in investment.

2) Replacement- After maturity period when firm's growth slows down, it is required to
replace some outdated or worn-out assets, i.e. machinery, equipment, vehicles, etc. Thus
a firm can return into its full-fledged production and generate desired benefits.

3) Renewal-As an alternative to replacement, renewal may involve rebuilding, overhauling

or retrofitting an existing asset. It certainly increases the productions and profits of a firm.

4) Other importance- There are certain other importance of capital investment which
include

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a) Plan for securing funds

b) Retain a competitive position in the market

c) Sales and cash forecast

d) Sales guarantee

e) Comparative study of alternative projects and launching new products

Difficulties in capital investment

1) Measurement problems-Identifying and measuring the costs and benefits of a
capital expenditure proposal tends to be difficult. This is more so when a capital
expenditure has a bearing o some other activities of the company like cutting into sales of
some existing product or has some intangible consequences like improving the morale of
workers.
2) Uncertainty- A capital expenditure decision involves costs and benefits that extend
into future. It is impossible to predict exactly what will happen in future. Hence, there is
usually a great deal of uncertainty characterizing the costs and benefits of a capital
expenditure decision.
3) Temporal Spread-The costs and benefits associated with a capital expenditure
decision are spread out over a long period of time, usually 10-20 years for industrial
projects and 20-50 years for infrastructural projects. Such a temporal spread creates some
problems in estimating discount rates and establishing equivalence.

Lec 3- Types of Capital Investments

Types of Capital Investment

1) Simple Classification
2) Strategic Classification
3) Purposive Classification

Simple Classification

 Physical Assets
 Monetary Assets
 Intangible Assets

Strategic Classification

 Strategic Investment
 Tactical Investment

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Purposive Classification (For planning and control)

 Mandatory Investment
 Replacement Investment
 Expansion Investment
 Diversification Investment
 R and D Investment
 Miscellaneous Investment

1) Simple Classification

Physical Assets- Physical Assets are tangible investments like land, building, plant
and machinery, building etc.

Monetary Assets-A monetary asset is an asset whose value is stated in or convertible

into a fixed amount of cash. Examples of monetary assets are deposits, bonds, equity
shares etc. The term can be defined to exclude any assets that cannot be readily
converted into cash (such as long-term investments or notes receivable). All monetary
assets are considered to be current assets, and are reported as such on a company's
balance sheet.

In an inflationary environment, monetary assets decline in value, unless they are

invested in interest-bearing or appreciating assets that provide returns matching or
exceeding the rate of inflation.

Longer-term assets such as fixed assets are not considered to be monetary assets,
since their values decline over time.

Intangible Assets-An intangible asset is an asset that is not physical in nature. Corporate
intellectual property, including items such as patents, trademarks, copyrights and
business methodologies, are intangible assets, as are goodwill and brand recognition.

2) Strategic Classification

Strategic Investment-It has a significant impact on the direction of the firm.

Tactical Investment–It is meant to implement a current strategy as efficiently as possible.

Purposive Classification (For planning and control)

Mandatory Investment-It is required to comply with statutory requirements. E.g. pollution
controls equipments, firefighting equipment etc.

Replacement Investment- The replacement decisions aim at to improve operating efficiency

and to reduce cost. Generally all types of plant and machinery require replacement either because

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of the economic life of the plant or machinery is over or because it has become technologically
outdated.
Expansion Investment- Existing successful firms may experience growth in demand of their
product line. If such firms experience shortage or delay in the delivery of their products due
to inadequate production facilities, they may consider proposal to add capacity to existing
product line.
Diversification Investment- These decisions require evaluation of proposals to diversify into
new product lines, new markets etc. for reducing the risk of failure by dealing in different
products or by operating in several markets.

R and D Investment Research and development is not free to a company. It is a cost/benefit

operation. Well-managed firms go to great lengths to develop good capital budgeting proposals
that provide value to the firm and the economy at large. So these are meant to develop new
products or processes.

Miscellaneous Investment-These represent that category which includes items like landscaped
gardens, recreational facilities etc.

Lec 4- Levels of Decision Making, Procedure of capital investment

Decision Making Levels in Capital Budgeting
For planning and control process, three levels of decision making have been identified:

1. Strategic capital budgeting

2. Administrative capital budgeting
3. Operating capital budgeting

Capital budgeting decisions could be categorized into these three decision levels.

1. Strategic capital budgeting - This involves large investments such as acquisition of

a new business or expansion in a new line of business. Strategic investments are unique
and unstructured and involve simple or complex options, and they cast a significant
influence on the direction and value of the business. Top management, therefore,
generally handles such investments.
2. Administrative capital budgeting- This involves medium-size investments such
as expenditure on expansion of existing line of business. Administrative capital budgeting
decisions are semi-structured in nature, and they may also involve some options, such as
option to delay. Generally, the senior management is assigned the responsibility of
handling these decisions.
3. Operating capital budgeting- This may include routine minor expenditures, such
as expenditure on office equipment. The lower or the middle level management can
easily handle the operating capital budgeting decisions.

Procedure of Capital Investment/Budgeting

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 1) Organization of Investment Proposal.
2) Screening the Proposals.
3) Evaluation of Projects
4) Establishing Priorities
5) Final Approval
6) Evaluation

1) Organization of Investment Proposal- The first step in capital budgeting process is the
conception of a profit making idea. The proposals may originate at any level of
management. The management collects all the investment proposals and reviews them in
the light of financial and risk policies of the organization in order to send them to the
capital expenditure planning committee for consideration.
2) Screening the Proposals- In large organisations, a capital expenditure planning
committee is established for the screening of various proposals received by it from the heads of
various departments and the line officers of the company. The committee screens the various
proposals within the long-range policy-frame work of the organization. It is to be ascertained by
the committee whether the proposals are within the selection criterion of the firm or not.
3) Evaluation of Projects- The next step in capital budgeting process is to evaluate the
different proposals in term of the cost of capital, the expected returns from alternative
investment opportunities and the life of the assets with any of the following evaluation
techniques:-
• Accounting Rate of return Method
• Pay-back Method
• Return on investment Method
• Discounted Cash Flow Method.
4) Establishing Priorities- After proper screening of the proposals, uneconomic or
unprofitable proposals are dropped. The profitable projects or in other words accepted
projects are then put in priority. It facilitates their acquisition or construction according to
the sources available and avoids unnecessary and costly delays. Generally, priority is
fixed in the following order.
• Safety projects or projects necessary to carry on the legislative requirements
• Projects which maintain the present efficiency of the firm
• Projects for supplementing the income
• Projects for the expansion of new product
5) Final Approval-Proposals finally recommended by the committee are sent to the top
management along with the detailed report, both of the capital expenditure and of sources
of funds to meet them. The management affirms its final seal to proposals taking in view
the urgency, profitability and the available financial resources. Projects are then sent to
the budget committee for incorporating them in the capital budget.
6) Evaluation-Last but not the least important step in the capital budgeting process is an
evaluation of the project after it has been fully implemented. Budget proposals and
the net investment in the projects are compared periodically and on the basis of such
evaluation, the budget figures may be reviewed and presented in a more realistic way.

Lec 5-Phases of Capital Budgeting

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Phases of Capital Budgeting
1) Planning
2) Analysis
3) Selection
4) Financing
5) Implementation
6) Review

1) Planning-The planning phase of a firm’s capital budgeting process is concerned with

preliminary screening of project proposals. The investment strategies of the firm describe the
wide areas or types of investments the firm plants to undertake. Once a project proposal is
recognized, it needs to be examined. To start with, a preliminary project analysis is done. This
exercise is meant to judge whether
a) the project is prima-facie worthwhile
b) what aspect of the project are grave to its visibility and thus warrant an in – depth
investigation
2) Analysis-If the preliminary screening proposes that the project is prima facie
meaningful, a detailed analysis of the marketing, technical, financial, economic, and
ecological aspects is undertaken. The center of this phase of capital budgeting is on
gathering and preparing relevant information about various project proposals which are
being considered for inclusion in the capital budget. Based on the information developed
in this analysis, the flow of costs and benefits with the project can be defined.
3) Selection-It addresses whether the project is worthwhile or not? A broad range of
appraisal criteria are taken. They are usually divided into two broad categories.
a) non discounting techniques
b) discounting techniques
The main non-discounting techniques include payback period and accounting rate of return The
main discounting techniques include NPV, IRR and benefit cost ratio. A project may be selected
or rejected on the basis of these techniques.
4) Financing- This phase is concerned with suitable financing arrangements. Basically
there are 2 broad sources of finance- equity and debt. The choice of an appropriate source
depends upon the number of factors such as nature of company, business, earning of the
company, condition of money market, attitude of investor etc.
Debt is the liability on business hence interest has to be paid while equity consist of shareholders
or owners funds on which payment of dividends depends upon the availability of profits.

5) Implementation-The implementation phase for business project involves setting up of

industrial facilities that consists of several stages such as
a) project and engineering designs
b) negotiations and contracting
c) construction
d) training of engineers and
e) plant commissioning
f) Start up of the plant

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 6) Review-Performance review should be done from time to time to evaluate actual
performance with probable performance. A feedback device can be useful in several
ways.
a) It throws light on how realistic were the suppositions underlying the project;
b) It provides a documented record of experience that is extremely valuable in future
decision making;
c) It proposes corrective action to be taken in the light of actual presentation;
d) It helps in finding judgmental biases;

e) It encourages a desired warning among project sponsors.

Lec 6- Facets of Project Analysis

Facets of Project Analysis

The project analysis mainly covers- market analysis, technical analysis, financial analysis and
economic and ecological analysis. These are detailed below:
1) Market Analysis-Market analysis is concerned primarily with two
questions of aggregate demand and market share for the business in
future. To answer the above questions, the following information is
required:

 Present Supply position and forecast

 Production possibilities and constraints

 Other competing projects in the state

 Consumption trends in the past and the present consumption level

 Import and export

 Structure of competition

 Costs structure

 Elasticity of demand

 Consumer behavior, intentions, motivations

 Distribution channels and marketing policies in use

 Administrative, technical and legal constraints

2) Technical Analysis -Technical and engineering analysis seeks to determine

whether the prerequisite for the successful commissioning of the project

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 have been considered and reasonably good choices have been made with
respect to location, size, process etc. This includes
 Availability of material, power and other inputs

 Availability of fuel, water, and other facilities

 Scale of operation and technology- is it suitable?

 Work schedules
 Proposed layout of building, sight etc.
3) Financial Analysis - Financial analysis seeks to ascertain whether the
proposed project will be financially viable and give satisfactory returns to
the investor. The main aspects that are looked into while conducting
financial appraisal are:

 Investment outlay and capital cost of project;

 Means of financing including interest rates and repayment schedules

 Cost of capital

 Projected profitability

 Cash flows of the project

 Projected financial position

 Level of risk in the project

4) Economic Analysis- Economic analysis, also referred to as social cost

benefit analysis, is concerned with judging a project from the larger
social point of view. It includes impact of the project on distribution
of the income, saving and investment. T h u s , i t i n c l u d e s
o Direct economic benefits and costs of the project
m e a s u r e d i n t e r m s o f efficiency.

o Impact of the project on the level of savings and investment in the society

o Contribution of the project towards the fulfillment of certain merit

like self sufficiency, employment and social order

5)Ecological Analysis-Environment is another issue which needs special attention,

particularly for large projects such as power projects. The major issues are:

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  Damage caused by the project to the environment.
 Cost of restoration measures.

Lecture 7-, Feasibility Study, Objectives of Capital Budgeting

Feasibility Study-A feasibility study looks at the viability of an idea with an emphasis on
identifying potential problems and attempts to answer one main question: Will the idea work and
should you proceed with it?
It involves analysis of the following aspects

Technical aspect-It includes

 Location
 Size of the plant
 Raw material and labour
 Infrastructure
 Effluent treatment and discharge

Commercial aspect
It includes

 Size of market
 Volume of demand
 Margin of profit
 Degree of competition

Financial aspect
It includes
 Total estimated cost of the project
 Financing of the project
 Existing investment
 Projected cash flow

Socio economic aspect-It includes

 Development of technology
 Development of infrastructure
 Development of backward areas
 Employment generation

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 Project report-After the feasibility study and project appraisal the findings and
recommendations are presented in a report known as project report.

Capital budgeting-It means long term planning for making and financing proposed
capital outlays. Capital budgeting is a process of making decisions regarding investments in
fixed assets which are not meant for sale such as land, building, machinery or furniture.

Objectives and need of capital budgeting

1) Capital expenditure plans involve a huge investment in fixed assets. Hence they maintain
firm’s competitive position.
2) Capital expenditure once approved represents long-term investment that cannot be
reserved or withdrawn without sustaining a loss. Hence they are planned carefully.
3) Preparation of capital budget plans involve forecasting of several years profits in advance
in order to judge the profitability of projects.
4) Control over expenditure is facilitated.
5) Successful capital budgeting leads to maximization of organizational effectiveness.
6) Equity shareholders provide venture capital required to start a business firm and appoint
the management of the company. Hence it is the duty of the management to promote
welfare of equity shareholders.
7) Besides the objective of maximizing the wealth of shareholders, maximization of profit
has also been suggested goals of capital budgeting. But this goal suffers from several
limitations.
Lec 8-Techniques of Capital Budgeting
1) ARR
2) Payback period
3) Net present value (NPV)
4) Internal rate of return (IRR)
5) Profitability index
1) ARR-The yearly after tax income as a percentage of investment is known as
accounting rate of return.
2) Payback Period- Expected number of years required to recover a project’s
cost. This method ignores the time value of money
Net Present Value-cash outflows and cash inflows associated with each project are
ascertained. This method considers the time value of money.
Internal Rate of Return-The rate at which the sum of discounted cash inflows
equals the sum of discounted cash outflows is known as IRR.
Profitability Index (PI)- The profitability index, or PI, method compares the present
value of future cash inflows. with the initial investment on a relative basis. In this
method, a project with a PI greater than 1 is accepted, but a project is rejected when its PI
is less than 1.

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Lec 9-Capital Structure, Factors determining capital structure, Capital
structure practice in India

Capital structure- Capital structure presents the mix between different sources of finance
basically long term sources of finance, eg. Equity, preference, debentures, bonds, retained earnings etc.

The term capitalization is used for the total long term sources of finance. For example, capital structure of
the company consists of Rs. 1,00,000 in equity, Rs. 1,00,000 in preference shares, and Rs. 5,00,000 in
retained earnings.

It means composition or make up of the amount of long term financing. In optimum capital
structure, the value of equity share is maximum while the average cost of capital is minimum.
The value of equity share mainly depends upon earning per share, so as long as ROI is more than
the cost of borrowing, each rupee of extra borrowing pushes up the earning per share which in
turn pushes up the market value of the share. However each extra rupee borrowing increases the
risk, therefore in spite of increasing EPS, Market Value of equity may fall because investors
taking it as more risky investment.

Factors determining capital structure

1. Trading on equity- If the rate of return (ROI) on total capital employed is more than
the rate of interest on debentures or rate of dividend on preference shares, it is said that
company is trading on equity.
If the company is trading on equity then the funds can be raised by using the mix of
debentures, preference shares and equity so that the company may be in position to pay
higher rate of return on equity funds.

2. Retaining Control-As we know that preference shareholders and debenture

holders have not much say in management of the company while equity shareholders
do not want to lose their grip over the affairs of the company so they will prefer
preference shares or debentures over the equity.
3. Nature of enterprise- Business enterprise which have stability in their earnings or
enjoy monopoly regarding their product may go for preference/debentures since they
will have adequate profits to meet the cost of fixed dividend
4. Legal requirements- Promoters of the company have also to keep in view the legal
requirements while deciding capital structure.
5. Purpose of Financing- If the funds are required for some productive purpose like
for purchase of new machinery, company can afford to raise the funds by issue of
debentures. On the other hands, if the funds are required for non productive purpose
then the company should raise the funds by issue of equity shares.
6. Period of finance- In case, funds are required for 8-10 years, company should go
for debentures because in case the funds are issued by shares, their repayment after 8-
10 years will be subject to certain legal restrictions/compliance.
7. Size of company- Company with small size have to rely considerably upon the
owner’s fund for financing.

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 8. Govt. Policies- Change in lending policy of financial institution may completely
change the financial pattern of the company. Policies made by SEBI, can afford the
capital structure decisions. Besides this, the monetary and fiscal policies of the
government also affect the capital structure decisions.
9.Others-Flexibility, risk, cost of financing, asset structure etc.

Capital structure practice in India

Several research and theories have been conducted regarding the choice of capital structure.
These studies revealed the following:-

Capital structure and cost of capital:- In traditional view, that the cost of capital is
affected by the debt and equity mix, still holds good. The earlier studies conducted by Bhatt and
Pandey revealed that corporate managers generally prefer borrowings to owned funds because of
advantage of lower cost and no dilution of existing management control over the company, but
recent study conducted by Babu and Jain, it has been found that the firms in India are now
showing almost an equal perforce for debt and equity in designing their capital structure.

Share valuation- According to the study conducted by Prasanna Chandra, a significant

relationship existed between the share price and the variables like return, risk, growth, leverage
etc. Thus the leverage or the debt equity mix in the capital structure is also one of the important
factors affecting the value of a share of the firm.

Lec 10- Capital Allocation Framework: Financing of Projects

Principles of capital allocation framework
1)Main criteria-Profitability, risk and growth

2) Investment option
a) Replacement and modernization-has been discussed
b) Expansion-has been discussed
c) Vertical integration- The steps that a product goes through in being transformed from
raw materials to a finished product in the possession of the customer constitute the
various stages of production. When a firm diversifies closer to the sources of raw
materials in the stages of production, it is following a backward vertical integration
strategy. Forward diversification occurs when firms move closer to the consumer in terms
of the production stages.
d) Concentric diversification-Concentric diversification occurs when a firm adds related
products or markets. The goal of such diversification is to achieve strategic fit. Strategic
fit allows an organization to achieve synergy.
e) Conglomerate diversification-Conglomerate diversification occurs when a firm
diversifies into areas that are unrelated to its current line of business. Synergy may result
through the application of management expertise or financial resources, but the primary
purpose of conglomerate diversification is improved profitability of the acquiring firm.
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 One of the most common reasons for pursuing a conglomerate growth strategy is that
opportunities in a firm's current line of business are limited. Finding an attractive
investment opportunity requires the firm to consider alternatives in other types of
business.
f) Horizontal diversification-Horizontal integration occurs when a firm enters a new
business (either related or unrelated) at the same stage of production as its current
operations.

3) Portfolio Planning Models

Portfolio planning tools have been developed to guide the process of strategic planning and
resource allocation.
Three such tools are :-
a) BCG Matrix
b) The General Electric Stoplight matrix &
c) The Mckinsey matrix
a) BCG Matrix-Developed by Boston Consulting Group, the BCG matrix classifies the
various businesses in a firm portfolio on the basis of relative market share and relative
market growth rate .
The BCG matrix consists of four cells with market share on horizontal axis and market growth
rate on the vertical axis.

The BCG matrix classifies businesses in four categories as described below :

 Stars : Business which enjoy a high market share and high growth rate are referred to as
stars. Though they earn high profits, they require additional commitment of funds
because of the need to make further investment for expanding their production and sales
As growth declines and additional investment need diminishes, stars become cash cows .

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  Question Marks : Business with high growth potential but low present market share are
called question marks . Additional resources are required to improve their market share
and potentially convert them into stars . There is no guarantee that this would happen -
that is why they are called question marks .
 Cash Cows : Business which enjoy relatively high market share but low growth are called
cash cows. They generate substantial profits but their investment requirement are modest.
The cash surplus provided them are available for use elsewhere in the business.
 Dogs : Business with low market share and limited growth potential are referred to as
dogs . Since the prospects for such products are bleak, it is advisable to phase them out
rather continue with them.
From the above description it is broadly clear that cash cows generate funds and dogs if divested
release funds. On the other hand, stars and question mark require further commitment of funds .
b) General electric Stoplight Matrix-The General Electric company is highly admired for
the sophistication, maturity and quality of its planning system . It uses 3*3 matrix called
the General Electric's Stoplight Matrix to guide the allocation of resources. This matrix
calls for evaluating the business of a firm in two key issues:
 Business strength
 Industry Attractiveness
The commitment of resources to various business is guided by how they are related in terms of
above two dimensions.

c) Mckinsey matrix-Mckinsey Matrix very much similar to General Electric Matrix , the
Mckinsey Matrix has two dimensins viz., competitive position and industry attractiveness
d) Space-Strategic position and action evaluation-Space considers four dimensions.
a) Competitive advantage
b) Financial strength
c) Industry strength
d) Environment stability

Financing of projects
A business requires funds to purchase fixed assets like land and building, plant and machinery,
furniture etc. These assets may be regarded as the foundation of a business. The capital required
for these assets is called fixed capital. A part of the working capital is also of a permanent nature.
Funds required for this part of the working capital and for fixed capital is called long term
finance.

Purpose of long term finance:

Long term finance is required for the following purposes:

1. To Finance fixed assets-Business requires fixed assets like machines, building, furniture etc.
Finance required to buy these assets is for a long period, because such assets can be used for a
long period and are not for resale.

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2. To finance the permanent part of working capital-Business is a continuing activity. It must
have a certain amount of working capital which would be needed again and again. This part of
working capital is of a fixed or permanent nature. This requirement is also met from long term
funds.
3. To finance growth and expansion of business-Expansion of business requires investment of
a huge amount of capital permanently or for a long period.

Factors determining long-term financial requirements

The amount required to meet the long term capital needs of a company depend upon many
factors. These are :
1) Nature of Business-The nature and character of a business determines the amount of fixed
capital. A manufacturing company requires land, building, machines etc. So it has to invest a
large amount of capital for a long period. But a trading concern dealing in, say, washing
machines will require a smaller amount of long term fund because it does not have to buy
building or machines.
2) Nature of goods produced-If a business is engaged in manufacturing small and simple
articles it will require a smaller amount of fixed capital as compared to one manufacturing heavy
machines or heavy consumer items like cars, refrigerators etc. which will require more fixed
capital.
3) Technology used-In heavy industries like steel the fixed capital investment is larger than in
case of a business producing plastic jars using simple technology or producing goods using
labour intensive technique.

Lec 11- Means of Financing, Equity Capital, Preference Capital, Internal

Accruals
The main sources of long term finance are as follows:
1) Shares -Share capital denotes the amount of capital raised by the issue of shares by a
company. It is collected through the issue of shares and remains with the company till its
liquidation.

Share capital is owned capital of the company, since it is the money of the shareholders and the
shareholders are the owners of the company. The total share capital is divided into small parts
and each part is called a share. Share is the smallest part of the total capital of a company.

Types of shares
There are two types of shares.

1) Equity shares- The shares that do not carry any preferential right are called equity shares. In
other words, equity shares are that part of the share capital of the company which are not
preference shares.

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2)Preference Shares-Preference Shares means shares which fulfill the following two conditions.

It carries Preferential right in respect of dividend at fixed amount or at fixed rate.

It also carries preferential right in regard to payment of capital on winding up of the company.

Distinguish between Equity shares & Preference shares.

1) Equity shareholders have voting rights but preference shareholders do not have this right.
2) Dividend on equity shares fluctuates but preference shareholders get fixed rate of
dividend.
3) Equity shareholders do not have preference in getting dividend and repayment of capitals
at the time of winding up of the company but preference shareholders have the
preference.
4) Equity shareholders are the owners of the company while preference shareholders are not
the owners of the company.
5) Equity shares are more risky as compared to preference shares.

Types of Preference Shares

1) Non cumulative and cumulative-A non-cumulative or simple preference shares gives right to
fixed percentage dividend of profit each year. In case no dividend is declared in any year because
of absence of profit, the holders of preference shares get nothing nor can they claim unpaid
dividend in the subsequent years. Cumulative preference shares however give the right to the
preference shareholders to demand the unpaid dividend in any year during the subsequent year or
years when the profits are available for distribution. In this case dividends which are not paid in
any year are accumulated and are paid out when the profits are available.

2) Redeemable and non redeemable-Redeemable Preference shares are preference shares which
have to be repaid by the company after the term for which the preference shares have been
issued. Irredeemable preference shares means preference shares need not repaid by the company
except on winding up of the company. However, under the Indian Companies Act, a company
cannot issue irredeemable preference shares.

3)Participating Preference Share and non-participating preference shares- Participating

Preference shares are entitled to a preferential dividend at a fixed rate with the right to participate
further in the profits either along with or after payment of certain rate of dividend on equity
shares. A non-participating share is one which does not have such right to participate in the
profits of the company after the dividend and capital have been paid to the preference
shareholders.
4) Convertible and non convertible preference shares-The holders of convertible shares have the
right to get their shares converted into equity shares within a certain period. Non convertible
preferential shares do not carry the right of conversion into equity shares.

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2) Internal accruals-In includes retained earnings and depreciation. The company may not
distribute the whole of its profits among its shareholders. It may retain a part of the profits and
utilize it as capital.

Lec 12 Term Loans, Debentures, Working Capital Requirement and its

Financing
3)Term loan- Many industrial development banks, cooperative banks and commercial banks
grant medium term loans for a period of three to five years.

The merits of long-term borrowing from banks are as follows:

o It is a flexible source of finance as loans can be repaid when the need is met.
o Finance is available for a definite period, hence it is not a permanent burden.
o Banks keep the financial operations of their clients secret.
o Less time and cost is involved as compared to issue of shares, debentures etc.

4) Debentures-Debenture is a long-term debt instrument issued by the

company under its common seal, to the debenture holder showing the
indebtedness of the company. The capital raised by the company is the
borrowed capital; that is why the debenture holders are the creditors of the
company. Debentures are secured by a charge on assets, although unsecured
debentures can also be issued. They do not carry voting rights
Types of Debentures

Registered Debentures
These are the debentures that are registered with the company. The amount of such debentures is
payable only to those debenture holders whose name appears in the register of the company.

Bearer Debentures
These are the debentures which are not recorded in a register of the company. Such debentures
are transferable merely by delivery. Holder of bearer debentures is entitled to get the interest.
Secured or Mortgage Debentures
These are the debentures that are secured by a charge on the assets of the company. These are
also called mortgage debentures. The holders of secured debentures have the right to recover
their principal amount with the unpaid amount of interest on such debentures out of the assets
mortgaged by the company.
Unsecured Debentures

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Debentures which do not carry any security with regard to the principal amount or unpaid
interest are unsecured debentures. These are also called simple debentures.

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Redeemable Debentures
These are the debentures which are issued for a fixed period. The principal amount of such
debentures is paid off to the holders on the expiry of such period. These debentures can be
redeemed by annual drawings or by purchasing from the open market.

Non-redeemable Debentures
These are the debentures which are not redeemed in the life time of the company. Such
debentures are paid back only when the company goes to liquidation.

Convertible Debentures
These are the debentures that can be converted into shares of the company on the expiry of pre-
decided period. The terms and conditions of conversion are generally announced at the time of
issue of debentures.
Non-convertible Debentures
The holders of such debentures can not convert their debentures into the shares of the company.
First Debentures
These debentures are redeemed before other debentures.

Second Debentures
These debentures are redeemed after the redemption of first debentures

Difference between shares and debentures

Basis of distinction Shares Debentures

Meaning The shares are the owned funds of The debentures are the borrowed
the company. funds of the company.

The holder of shares is known as The holder of debentures is known

Holder
shareholder. as debenture holder.

Form of Return Shareholders get the dividend. Debenture holders get the interest.

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 The holders of shares have voting The holders of debentures do not
Voting Rights
rights. have any voting rights.

Shares can never be converted into Debentures can be converted into

Conversion
debentures. shares.

Repayment- in the Shares are repaid after the Debentures get priority over shares,
event of winding up payment of all the liabilities. and so they are repaid before shares.

Dividend on shares is an Interest on debentures is a charge

Quantum
appropriation of profit. against profit.

Working capital
requirement and its
financing
Working capital-Capital needed for
day to day operations is known as
working capital. It may be gross
working capital or net Working
capital. Gross Working capital is the
sum of all current assets while net
working capital is the difference
between CA and CL.

Factors influencing working

capital requirements

1) Nature of business- Trading

concerns have large investment in
working capital while public utility
concerns have limited need for
working capital. Service firm has
modest working capital.

2)Production policy-During
peak business season production
increases and more demand for
working capital and vice versa.

3)Credit policy-If liberal credit

terms have been given to customers,

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 more working capital will be
required but if liberal credit terms
have not been given to customers,
less working capital will be required.

4)Market conditions-In case of

high competition, more working
capital is required. But in case of
low completion less working capital
is required,

5)Manufacturing cycle-If the

manufacturing cycle involves a
longer period, the need for working
capital will be more.

6) Other Factors
a. Seasonal operations
b. Conditions of supply
c. Operating efficiency
d. Various sources of
financing at
international level

Lec 13- Miscellaneous Sources, Raising Venture Capital

Miscellaneous Sources
Loan from financial institutions-There are many specialised financial institutions
established by the Central and State governments which give long term loans at reasonable rate
of interest. Some of these institutions are:
Industrial Finance Corporation of India ( IFCI), Industrial Development Bank of India (IDBI),
Industrial Credit and Investment Corporation of India (ICICI), Unit Trust of India ( UTI ), State
Finance Corporations etc
Public Deposits-General public also like to deposit their savings with a popular and well
established company which can pay interest periodically and pay-back the deposit when due.
It is a very old source of finance in India. When modern banks were not there, people used to
deposit their savings with business concerns of good repute. Even today it is a very popular and
convenient method of raising medium and long term finance. The period for which business
undertakings accept public deposits ranges between six months to three years.

Venture Capital
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Venture capital is the money provided by investors to startup firms and small businesses with
perceived long-term growth potential. This is a very important source of funding for startups that
do not have access to capital markets. It typically entails high risk for the investor, but it has the
potential for above-average returns.
Venture capital can also include managerial and technical expertise. Most venture capital comes
from a group of wealthy investors, investment banks and other financial institutions that pool
such investments or partnerships. This form of raising capital is popular among new companies
or ventures with limited operating history, which cannot raise funds by issuing debt.

The venture capital recognises different stages of financing, namely:-

 Early stage financing - This is the first stage financing when the firm is undertaking
production and need additional funds for selling its products. It involves seed/ initial
finance for supporting a concept or idea of an entrepreneur. The capital is provided for
product development, R and D and initial marketing.

 Expansion financing - This is the second stage financing for working capital and
expansion of a business. It involves development financing so as to facilitate the public
issue.

 Acquisition/ buyout financing - This later stage involves acquisition financing in order to
acquire another firm for further growth

Lec 14-Raising Capital in International Markets, Generation of project

ideas
1) Term loan from FI—FIs provide foreign currency term loans for meeting foreign
currency expenditures towards import of plant, machinery etc.

2) Eurocurrency and Eurobond- The Eurocurrency market consists of banks (called

Eurobanks) that accept deposits and make loans in foreign currencies. A Eurocurrency is a
freely convertible currency deposited in a bank located in a country which is not the native
country of the currency. The deposit can be placed in a foreign bank or in the foreign branch of
a domestic US bank.
In the Eurocurrency market, investors hold short-term claims on commercial banks which
intermediate to transform these deposits into long-term claims on final borrowers.

3)Foreign domestic markets- Today, the marketing organisations are not restricted to their
national borders. The entire world is open for them. New markets are springing forth in emerging
economies like – China, Indonesia, India, Korea, Mexico, Chile, Brazil, Argentina, and many
other economies all over the world. In today’s global market opportunities are on a par with the
expansion of economies, with the increasing purchasing power, and with the changing consumer
taste and preferences.

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The economic, social, and political changes affect the practise of business worldwide, the
business organisations have to remain flexible enough to react rapidly to changing global trends
to be competitive.

4)Export credit schemes-An export credit agency (known in trade finance as an ECA) or
investment insurance agency is a private or quasi-governmental institution that acts as an
intermediary between national governments and exporters to issue export financing. The
financing can take the form of credits (financial support) or credit insurance and guarantees (pure
cover) or both, depending on the mandate the ECA has been given by its government. ECAs can
also offer credit or cover on their own account. This does not differ from normal banking
activities. Some agencies are government-sponsored, others private, and others a combination of
the two. Export credit agencies use three methods to provide funds to an importing entity:

5)Direct Lending-This is the simplest structure whereby the loan is conditioned upon the
purchase of goods or services from businesses in the organizing country.

6)Financial Intermediary Loans- Here, the export–import bank lends funds to a financial
intermediary, such as a commercial bank, that in turn loans the funds to the importing entity.

Interest Rate Equalization-Under an interest rate equalization, a commercial lender provides a

loan to the importing entity at below market interest rates, and in turn receives compensation
from the export–import bank for the difference between the below-market rate and the
commercial rate.

7) External commercial borrowing-An external commercial borrowing(ECB) is an

instrument used in India to facilitate the access to foreign money by Indian corporations and
PSUs (public sector undertakings). ECBs include commercial bank loans, buyers' credit,
suppliers' credit, securitised instruments such as floating rate notes and fixed rate bonds etc., The
DEA (Department of Economic Affairs), Ministry of Finance, Government of India along with
Reserve Bank of India, monitors and regulates ECB guidelines and policies. For infrastructure
and greenfield projects, funding up to 50% (through ECB) is allowed. In telecom sector too, up
to 50% funding through ECBs is allowed. Recently Government of India allowed borrowings in
Chinese currency yuan.

Generation of project ideas-A business idea may be discovered from many sources
1) Observing markets-careful observation of markets can reveal a working capital idea.
Market survey can also reveal the demand and supply position for various products.

2) Prospective customers-Customers knows best what they want and the habits which are
going to be popular in the near future. Contacts with prospective customers can reveal the
features that should be built into a product or service.

3) Developments in other nations-People in underdeveloped countries generally follow

the fashion trends of developed countries. An entrepreneur can develop good business ideas by
keeping in touch development in advanced nations.

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4) Study of project profiles-Profiles published by government and private agencies are
helpful in choosing the line of business. Experts may be employed to suggest the most promising
projects.

5) Government organizations-They also assist in discovering business idea as

Government can identify the priority sector for investment.

6) Trade fair and exhibitions-At these fairs, dealers put up their products or display. That
gives information about new products.

Approaches to generating ideas-

1) Brainstorming-All members of the group attempt to make suggestions. This process helps
in generating a large no of ideas

2) Improvement of an existing product-It is related with removing shortcoming in a

existing product.

3) New ways of doing things-E.g. ATM’s are a new way of making money available.
4) Converting hobby into business-E.g. photography and interior decoration can be
developed for business purpose.

5) Utilizing waste material-A useful product may be developed by recycling.

Lec 15-Cost of Project, Estimates of Sales and Production

Cost of Project The cost of project represents the total of all items of outlay associated with long-
term fields. It is the sum of the outlays on the following

 Land and Site Development

 Buildings and Civil Works
 Plant and Machinery
 Technical know-how and Engineering Fees
 Expenses on Foreign Technicians and Training of Technicians Abroad
 miscellaneous Fixed Assets
 Preliminary and Capital Issue Expenses
 Pre-operative Expenses
 Provision for Contingencies
 Margin Money for Working Capital
 Initial cash Losses

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Estimation of production and sales
It constitutes a crucial step in project planning. The aggregate cost indicates the quantum of
funds needed for bringing the project into existence. Therefore, cost of sales and production
should be fixed with great care and caution. It forms the basis on which the ‘Means of Finance' is
worked out.

The planning for a new project brings one inevitably to make an estimate of the production that
the new project would generate and the sale that it would entail. The cash inflows are highly
dependent upon the estimate of the production and sales levels. This dependence is heightened
because of the peculiar nature of the fixed cost. Thus cash inflows tend to increase considerably
after the sale reachesd above the break-even point. If in a year the sales are below the break-even
point, something which is quite possible in a large capital intensive project in the initial year of
its commercial production may be missing. The company may even have cash outflows in terms
of losses. On the basis of the additional production units that can be sold and the price at which
they can be sold, the gross revenues from a project can be worked out. However, in doing so the
possibility of a reduction in the sale price, introduction of cheaper or more efficient product by
competitors, recession in the market conditions and such other factors must be kept in
mind. Hence, it is always advisable to prepare the sales estimates at various levels of
probability. In other words, the more probable levels must be taken into account and the cash
inflows worked out at each level. A large integrated fertilizer complex in South India, which
came into commercial production in 1975, adopted this technique. In measuring its cash flow
estimates, the managers of this project worked out the sales at various level and under various
conditions of the market. Thus they knew exactly as to what would be the cash inflow if the
factors affecting the sales change. The main advantage of this exercise was available in the very
first year of production of this factor, when due to an unprecedented rise in the price of inputs
like naphtha etc., the fertilizer prices went up and consequently demand fell sharply. The
company immediately adjusted its sale prices and production levels to have the best possible
cash inflows.

Lec 16 Cost of Production

Cost of Production-It includes
1) Material cost- Material forms an integral part of the finished product. This refers to the
major parts or ingredients. Examples include wood in furniture, steel in automobile, water in
bottled drink, fabric in shirt, etc.

2) Labour cost-The cost of labour is the sum of all wages paid to employees, as well as the
cost of employee benefits and payroll taxes paid by an employer. The cost of labor is broken into
direct and indirect (overhead) costs. Direct costs include wages for the employees that produce a
product, including workers on an assembly line, while indirect costs are associated with support
labour, such as employees who maintain factory equipment.

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3) Cost of utility- Utilities expense is the cost consumed in a reporting period related to the
following types of expenditures:

 Electricity
 Heat (gas)
 Sewer
 Water

The category is sometimes also associated with expenditures for ongoing telephone and internet
service. This expense is considered a mixed cost

4) Other cost-Production cost refers to the cost incurred by a business when manufacturing a
good or providing a service. Production costs include a variety of expenses including, but not
limited to, labor, raw materials, consumable manufacturing supplies and general overhead.
Additionally, any taxes levied by the government or royalties owed by natural resource
extracting companies are also considered production costs.

Lec 17-Profitability Projections, Projected Cash Flow Statement

Profitability projection-Profitability of a project can be projected on the basis of

estimates of sales revenues and cost of production. Various items are considered like cost of
production, expected sales, gross profit before interest, provision for taxation, retained earnings,
net cash accruals etc.

Projected Cash Flow Statement-A cash flow statement is a statement showing inflows
and outflows of cash of the firm and its net impact on the cash balance within the firm, The main
sources of cash receipts and cash payments are found and recorded in the statement. A projected
cash flow statement helps the management to chalk out the detailed plan regarding its working
and operations in future.

Thus, a projected cash flow statement is used to evaluate cash inflows and outflows to deter.
mine when, how much, and for how long cash deficits or surpluses will exist for a farm business
during an upcoming time period

Note: Practical part to be discussed in the class

Lec 18-Profitability Projections, Projected Balance Sheet

Projected balance sheet-The balance sheet reflects the financial position of the firm at a
given period of time. The balances of various assets and liabilities accounts are shown in it. The
liability side of the balance sheet shows the sources of fund and the asset side shows how funds
have been used in the business.

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The Balance Sheet shows financial picture – assets, liabilities, and capital – at some specific
moment. It helps to understand that the Profit and Loss shows financial performance over a
length of time, like a month, quarter, or year.

Note: Practical part to be discussed in the class

Lec 19-Unit Test 1

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