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Lecture # 3

Lecture # 3. Engineering Economics (2+0) Tools of Economic Analysis Instructor: Prof. Dr. Attaullah Shah. Department of Civil Engineering City University of Science and IT Peshawar. What is a Project?. Project is a one time non-routine opportunity to develop a new product.

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Lecture # 3

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  1. Lecture # 3 Engineering Economics (2+0) Tools of Economic Analysis Instructor: Prof. Dr. Attaullah Shah Department of Civil Engineering City University of Science and IT Peshawar

  2. What is a Project? • Project is a one time non-routine opportunity to develop a new product. To satisfy the customer to achieve the organizational objectives. To be completed with in • Allocated budget. • Scheduled Time. • Approved Technical Performance. • Approved and agreed Scope of Work. • Without any change in the existing culture. • Examples • Construction of Roads • Construction of High-rise buildings • Opening of new Chain of KFC • Any other project

  3. What is management? The process of Planning, Organizing, Staffing, controlling and leading. Project management: The art of Directing and coordinating the human and non human Resources throughout the life of project by using modern Management techniques to achieve pre-determined objectives of scope, cost, time, quality and participants satisfaction. ( Project Management Institute America) • Project management includes: • Project Appraisal ( Before Commencement of Project PC-I, PC-II). • Project monitoring. ( During Execution of the Projects PC-III) • Project Evaluation ( After Completion of the projects. PC-IV,PC-V)

  4. Complete Establish Execute Three Stages of a Project • Define project objectives, scope and approach, mobilise project team • Execute the work plan to achieve desired outcome • Wrap up and transition

  5. Complete Establish Execute Project Stages & Project Management Model • Define project objectives, scope & approach, mobilise project team • Execute the work plan to achieve desired outcome • Wrap up and transition Project Selection Confirm Definition Complete Project Planthe Execution Report Status Control the Work Organise Resources

  6. Project Selection • Define Project Scope • Define Project Objectives • Define Approach • Define Business Case • Select Best Projects Project Stages & Project Management Model Establish Project Selection Confirm Definition

  7. Project Stages & Project Management Model Establish Confirm Definition • Understand Project Sponsor expectations • Understand Project Scope • Understand Project Objectives • Confirm any assumptions • Identify Project Risks Project Selection Confirm Definition

  8. Project Stages & Project Management Model Execute Plan the Execution • Define Project Deliverables • Develop Work Plans • Develop Scope, Change Control, Issue Management and Sign-off Processes • Develop Risk Mitigation Plan • Develop Quality Plan Plan the Execution Report Status Control the Work Organise Resources

  9. Project Stages & Project Management Model Execute Organise Resources • Identify Project Team Roles / Responsibilities • Assign Team Members to Work Plan tasks • Communicate responsibilities, target dates, deliverables • Train Team Members • Organise physical resources Plan the Execution Report Status Control theWork Organise Resources

  10. Project Stages & Project Management Model Execute Control the Work • Monitor work progress • Resolve issues • Measure performance Plan the Execution Report Status Control the Work Organise Resources

  11. Project Stages & Project Management Model Execute Report Status • Assess project progress • Prepare status reports • Communicate progress to relevant audience group • Follow up any issues resulting from status meeting Plan the Execution Report Status Control the Work Organise Resources

  12. Project Stages & Project Management Model Complete Complete Project • Complete any development / administrative activities • Obtain sign-off of final project deliverables • Transition to maintenance team where appropriate Complete Project

  13. What is Project Feasibility Study? • A feasibility study is defined as an evaluation or analysis of the potential impact of a proposed project or program. • A feasibility study is conducted to assist decision-makers. • In determining whether or not to implement a particular project or program. • The feasibility study is based on extensive research on both the current practices and the proposed project /program and its impact on the existing operation. • The feasibility study will contain extensive data related to financial and operational impact and will include advantages and disadvantages of both the current situation and the proposed plan.

  14. The selection of a sound project to achieve the given target of economic development in a particular sector is very important for attainment of Plan objectives. • Development projects, especially large and complex ones, often meet with difficulties during their execution process. A feasibility study is, therefore, a pre-requisite for preparation of a major development project on sound lines, and is not ruled out even for a minor one. • It is basically an in-depth "three-in-one" study consisting of the technical, financial and economic viability of a project. The study arrives at a definite conclusion about the feasibility of a project after considering the various options

  15. Assessing Project Feasibility • You need to calculate Nine categories of feasibility: • Economic • Financial • Operational & Technical • Schedule ( Time) • Legal and contractual • Political • Marketing • Ethical • Environmental

  16. Project Appraisal. • Technical Analysis • The analysis for determining the technical viability of the development project is based on the technical data and information given in the PC-I form as well as the earlier experience of carrying out similar projects. The technical analysis covers the following areas: • Impact Analysis: • Location, land, suitability of location ( Seismic Zones), • Utilities, roads, infrastructure, • Raw material, Present and Future needs. • Availability of machinery, plants and equipments, technology. • Transportation facilities, commercial centers, • Manpower, Local labor, technicians, unskilled workers. • Climate, natural hazards, • Demand and supply analysis. • Government incentives and commissions.

  17. Institutional/Organizational/Managerial Analysis: • A whole range of issues in project preparation revolves around the overlapping institutional, organizational and managerial aspects of the project. Managerial Feasibility. Managerial feasibility involves the capability of the infrastructure of a process to achieve and sustain process improvement, Management support, employee involvement, and commitment are key elements required to ascertain managerial feasibility. It is the most neglected part in the feasibility studies of construction projects.

  18. Commercial/ Marketing Analysis The commercial aspects of a project include the arrangements for marketing the output produced by the project and the arrangement for the supply of inputs needed to build and operate the project. • Test marketing • Market Planning process. • Market Share determination. • Pricing and Competition strategies (Skimming or Penetration) • Distribution networks. • Advertisement plans. • Sales promotion strategies. • Product Life Cycle studies.

  19. Financial Analysis • Financial analysis involves assessment of financial impact, judgment of efficient resource use, assessment of incentives, provision of a sound financing plan, coordination of financial contribution and assessment of financial management competence. The following techniques are used. • The overall resource requirements of the projects are tabulated in three basic documents: • Income/Expenditure Statement ( Profit & Loss Statement) • Project Cash Flows ( Cash inflows and outflows) • Project Balance Sheets ( Assets & Liabilities) • Various tools of project Financial Analysis: • Simple Rate of Return • Break Even Analysis. • Pay Back period • Net present Value • Internal Rate of Return ( IRR) • Financial Ratio Analysis. • Benefits Cost Ratio.

  20. Financial Analysis of Project based on Social Cost Benefit Profitability • Contribution of the project to social welfare of a society. • Impact of the project on Foreign trade ( Exports and Imports) • Effect on trained Human Resource • Direct and Indirect impact on environment. • Techniques used for Social CBA. • Net Value Added • Distribution effect ( Poverty Alleviation) • Foreign Exchange Effect • Sensitivity analysis ( Impact of project in case of cost and time overruns). • Risk Analysis

  21. Economic Feasibility • Viability of a project over a period of time. • Capital Costs • Working Capital requirements. • Estimates of operating Costs • Depreciation/Taxes and Profits. • Determine Tangible Costs • Can easily be measured in PKR • Determine Tangible One-Time Costs • Associated with project startup, initiation and development Includes • System Development • New hardware and software purchases • User training • Site preparation • Data or system conversion

  22. Assessing Economic Feasibility • Determine Tangible Recurring Costs • Associated with on-going use of system • Includes: • Application software maintenance • Incremental data storage expense • New software and hardware releases • Consumable supplies • Determine Intangible Costs • Cannot be easily measured in dollars • Examples: • Loss of customer goodwill • Loss of employee morale

  23. Assessing Economic Feasibility • Determine Intangible Benefits • Cannot be measured easily • Examples • Increased employee morale • Competitive necessity • More timely information • Promotion of organizational learning and understanding

  24. Operational Feasibility • How likely is it that system can be used to meet desired objectives? (e.g., functional illiterate line workers make up 90% of production staff…can proposed system work at our facility?)

  25. Assessing Other Project Feasibility Concerns • Schedule Feasibility • Assessment of timeframe and project completion dates with respect to organization constraints for affecting change • Legal and Contractual Feasibility • Assessment of legal and contractual ramifications of new system (e.g., does it violate the union contract?)

  26. Assessing Other Project Feasibility Concerns • Political Feasibility • Assessment of view of key stakeholders in organization toward proposed system (e.g., How will this affect morale? Will we see a worker slowdown in other areas?) • Ethical Feasibility • Are there issues that are inconsistent with corporate ethics and goals even if legal (e.g., lots of e-waste?) • With above analyses, firm can rank order project and determine if it should be done via prioritization…

  27. EIA: Environmental Impact Assessment of Projects • EIA is a systematic process to identify, assess and manage the potential environmental effects of a proposed development or activity. • The findings of the EIA process are presented in an Environmental Statement (ES). The process and findings inform decision-makers e.g. Local Planning Authorities (LPAs) of the likely environmental consequences of the proposals. • The EIA process gathers data and evaluates effects on a range of technical topic areas that are specified in the legislation, these include, air, population, soil, fauna, flora, water, climatic factors, material assets including architectural and archaeological heritage, landscape and the inter-relationships between these factors. • The findings from evaluation of each of these topic areas link together to provide a picture of the effects of the proposal as a whole.

  28. Why EIA of the Projects?

  29. Tools of Financial Analysis of Projects Present Value/Present Worth/Net Present worth Rate of Return (RoR) Future Value of Investment ( Future Worth) Annual Equivalent Method Financial Ratio Analysis

  30. Present worth Method • REVENUE-DOMINATED CASH FLOW DIAGRAM • With initial investment of P and Revenues in various years as R1, R2…. Rn for year 1, year 2 and …. Year n and salvage value as S. The present value of the cash flow will be • Revenue is positive and expenditure as negative • COST DOMINATED CASH FLOW DIAGRAM • Here the initial investment of P and annual Cost of C1, C2, C3 ….Cn with salvage value of S as shown in Fig. • The present value of all expenditure is given as

  31. Example ABC Company wants to expand its facility. Three options have been given as follows: With annual markup rate of 20%, determine the Present Worth of each option and select the best one. Solution: Option 1: Initial outlay, P = Rs. 12,00,000, Annual revenue, A = Rs. 4,00,000 Interest rate, i = 20%, compounded annually , Life of this technology, n = 10 years Cash flow diagram: Present worth: Option 2: Rs. 5,15,500 Option 3: Rs. 2,96,250 ( Please Calculate) The Present Worth/Value of Technology 2 is selected as it has the largest value of Rs.515,500 After comparison of the options on the basis of Present Worth/ Vlaue, the option with highest NPV is selected

  32. Class Attempt Investment proposals A and B have the net cash flows as follows: Determine the net Present Worth/Net Present value of both the investment opportunities and select the best one?

  33. Cost Based Methods There are two options to buy a car: Option 1: Lump sum payment of Rs: 16,00,000 Option 2: Down payment Rs: 200,000 and 10 yearly installments of Rs. 200,000 each. Which option would you prefer if the i=18% Solution: Present worth of cost Option 1: The Lump sum payment is Rs: 16,00,000 Option 2: Present Value of total Cost = Rs. 12’98,820 The option 2 is selected. Hence for Cost, the minimum present value/worth is selected

  34. Class Assignment Two Business investment proposals for a Small Business: 1. Novel Investment Ltd. accepts Rs. 10,000 at the end of every year for 20 years and pays the investor Rs. 8,00,000 at the end of the 20th year. 2. Innovative Investment Ltd. accepts Rs. 10,000 at the end of every year for 20 years and pays the investor Rs. 15,00,000 at the end of the 25th year. Which is the best investment alternative? Use present worth base with i = 12%. NPW(1) = Rs. 8,266 NPW (2) = Rs. 13,506 Which one is better option and why?

  35. Problems for discussion For all assignments, the given interest rate of i may be modified as: i/Class No. + (Class/5) For Example for Class No.5 and given i =15% 15/5 +5/5 = 3+1 = 4% For Class No. 40 15/40 + 40/5 = 0.375+8 = 8.375% Every student will have his unique interest rate for all asssignemnts: Due date: Next Class ( After one week)

  36. Rate of Return Method • Internal Rate of Return: • The rate of return of a cash flow pattern is the interest rate at which the present worth of that cash flow pattern reduces to zero. • So, one has to start with an intuitive value of i and check whether the • present worth function is positive. If so, increase the value of i until PW(i),becomes negative. Then, the rate of return is determined by interpolation method in the range of values of i for which the sign of the present worth function changes from positive to negative.

  37. Example: Rate of Return • EXAMPLE: A person is planning a new business. The initial outlay and cash flow pattern for the new business are as listed below. The expected life of the business is five years. Find the rate of return for the new business. • Solution • Initial investment = Rs. 1,00,000 • Annual equal revenue = Rs. 30,000, Life = 5 years • The cash flow diagram for this situation is illustrated • The present worth function for the business is PW(i) = –1,00,000 + 30,000(P/A, i, 5) • When i = 10%, PW(10%) = –1,00,000 + 30,000(P/A, 10%, 5) = • –1,00,000 + 30,000(3.7908) = Rs. 13,724. • When i = 15%, PW(15%) = –1,00,000 + 30,000(P/A, 15%, 5) = • –1,00,000 + 30,000(3.3522) = Rs. 566. • When i = 18%, PW(18%) = –1,00,000 + 30,000(P/A, 18%, 5) = • –1,00,000 + 30,000(3.1272) = Rs. – 6,184

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