Question

Explain the project evaluation project in relation to capital budgeting and the purpose of investment projects. Purposes were categorized into 6 categories: replacement, renewal, expansion, cost-reduction, conforming, and all other projects.

Answer 1

CAPITAL BUDGETING PROCESS

capital budgeting process is a complex process which may be divided into the following five stages

1.IDENTIFICATION OF POTENTIAL INVESTMENT OPPORTUNITIES

the capital budgeting process begins with the identification of potential investment opportunities.For identifying investment ideas it is helpful to (1) monitor external environment regularly to find out investment opportunities (2) formulate a corporate strategy based on SWOT analysis(strengthe, weaknesses, opportunities and threats) ( 3) share corporate strategy and perspectives with persons who are involved in the process( 4) motivate employees to make suggestions

After the identification of proposals , they undergo preliminary screening and filtering for inconsistencies with starategic goals, risk levels, feasibility etc

2.EVALUATION AND SELECTION

in th\is stage survived proposals are thoroughly examined. This includes\ determining projected cashflows of project, identifying project risk determining cost of capital.

The commonly used methods of evaluation are NPV, IRR,Profitability index method under the DCF (discounted cashflow ) methods and Payback period and accounting rate of return in the Non DCF methods

On the basis of evaluation done the best projects are selected and forwarded to top management for approval and authorization

3. AUTHORIZATION

the capital requirement for the projects selected is compared with the company's capital expenditure budget.The capital expenditure budget which include internal and external sources of finance.After solving the question of financing the projects are ranked by strategic importance, return and risk. The projects perceived as best are authorized for implementation

4.IMPLEMENTATION

translating an investrment proposal into a concrete project is a complex , time consuming and risk fraught task.Delays in implementation can lead to substantial cost overruns. for expeditious implementation, ( 1) preliminary studies and detailed formulation of the project should be done ( 2 ) assign specific responsibilities to project managers for completing the project within the defined time frame and cost limits.This will help quick execution and cost control ( 3 ) use network techniques like PERT and CPM for monitoring of projects

5.performance review

Performance review or post completion audit, is a feed back device. It is a means of comparing actual performance with projected performance. It may be conducted when the operations of the project have stabilised.

This helps to determine how realistic were the assumptions underlying the project .It helps in finding out judge\mental biases.

PURPOSES OF INVESTMENT PROJECTS

1.REP[LACEMENT

firms routinely invest in equipments meant to replace obsolete and inefficient equipments even though they may be in serviceable condition.The objective of such investment is to reduce costs ( of labour, raw matereial and power) increase yield and improve quality

2. EXPANSION PROJECTS

THESE INVESTMENTS ARE MEANT TO INCREASE CAPACITY AND/OR WIDEN THE DISTRIBUTION NETWORK. the firm seeks to profitably increase sales of current products or introduce new product in the market

3. RENEWAL PROJECTS

renewal projects includes all projects in which the intention is to bring the base organisation to a highjer and better level of functioning. Examples include projects dealing with IT implementation , reorganisation, organisational development, human development and training,TQM and BPR.Thse are all projects focussed on deliverinbg results internally to the base organisation. This excludes projects where intention is to produce result for external customer

4.MANDATORY PROJECTS

These are expenditures required to comply with statutory requirements. examples are pollution control equipment, medical dispensary, fire fighting equipment etc.

5.COST REDUCTION PROJECTS

some processes and projects ( introducing new technology) will help the company in decreasing costs , increase performance of workers and eventually sales

6.MISCELLANEOUS PROJECTS

This category of projects include items like interior decoration, recreational facilities,landscaped gardens .Decisions regarding these projects are based on personal preferences of top management