Capital

Investment

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 Basics
• Capital investments are funds invested in a firm or
enterprise for the purposes of furthering its business
objectives.
• Capital investment may also refer to a firm's acquisition
of capital assets or fixed assets such as manufacturing
plants and machinery that are expected to be productive
over many years.
• While capital investment is usually earmarked for capital or
long-life assets, a portion may also be used for working
capital purposes.
• Sources of capital investment are manifold and can include
equity investors, banks, financial institutions, venture
capital and angel investors.
• Why is capital investment made?

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Objective of a Firm

• What is the primary objective of a firm?

• => Maximization of wealth of shareholders.

• How do we know that a project or a capital

investment will result in enhanced wealth?

• => Different options: NPV, IRR, but not profit

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 Accounting Profit Vs
Cash Flows
• Accounting has its own body of accepted
principles (eg. GAAP in the US) - the bases

for the financial statements such as Income

Statement & Balance Sheet.
• One of the accepted principles – Accrual based
accounting.

• Firm profit is, therefore, calculated on this base.

• Is the feasibility of a project evaluated based on

the accrual profits?

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Project Cash Flows
• When beginning capital-budgeting analysis, it is
important to determine a project's cash flows. These
cash flows can be segmented as follows:

1. Initial Investment Outlay

These are the costs that are needed to start the project,
such as new equipment, installation, etc.

2. Operating Cash Flow over a Project's Life

This is the additional cash flow a new project generates.

3. Terminal-Year Cash Flow

This is the final cash flow, both the inflows and
outflows, at the end of the project's life;
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Basic Principles for measuring
project cash flows
• For developing the stream of financial
costs and benefits, the following
principles must be kept in mind:

- Incremental principle

- Long-term funds principle

- Exclusion of financing costs principle

- Post-tax principle

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Incremental principle
• The cash flow of a project must be measured in incremental
terms.
• For this purpose, one has to look at what happens to the cash
flows of the firm with the project and without the project.

• In estimating the incremental CFs of a project, the following

guidelines must be borne in mind:
- Consider all incidental effects
- Ignore sunk costs
- Include opportunity costs
- Question the allocation of overhead costs

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Long-term funds
principle
• Though there are other alternatives, it is
reasonable to view a project from the long-term
funds point of view.

• So, while trying to determine the costs and

benefits on an investment project, questions such
as the following will be raised:

- What is the sacrifice made by the suppliers of long-

term funds?

- What benefits accrue to the suppliers of long-term

funds?

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Exclusion of financing costs principle

• When CFs relating to long-term funds are being

defined, financing costs of long-term funds
(interest on long-term debt and equity dividend)
should be excluded from the analysis. But why?

• Because the WACC used for evaluating the CFs

takes into account the cost of long-term funds.

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Post-tax principle
• Tax payments like other payments must be
properly deducted in deriving the CFs.

• CFs must be defined in post-tax terms.

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 Time Horizon of Analysis
• What should be the time horizon for CF analysis?
• The time horizon for CF analysis should be the
minimum of the following:

- Physical life of the plant – where the plant remains in a

physically usable condition.

- Technological life of the plant – the period of time for

which the present plant would not be rendered obsolete by a new
plant.

- Product market life of the plant – the period for which

the product of the plant enjoys a reasonably satisfactory market.

- Investment planning horizon of the firm – the time

period for which a firm wishes to look ahead for purposes of
investment analysis.

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Eg. Cash flow schedule for
a new project

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Appraisal: on Financial
ground
• From the financial perspective, there are different
selection criteria: Payback period, ROI, NPV, IRR,
MIRR, Accounting rate of return, etc.

• But the most commonly used one is NPV – as it

clearly indicates the benefits of a capital
investment from the wealth maximization point of
view (the primary goal of a firm).

• What does a +NPV tell us?

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FOUR PHASES OF A SUCCESSFUL
CAPITAL PROGRAM
• While nothing can guarantee the success of
corporate investments, a four-phase approach
increases the likelihood of success.

• The four phases include:

(1) planning,

(2) project or capital evaluation,

(3) status reporting, and

(4) post-completion reviews.

Of course, successful implementation is paramount to

any successful investment…/
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Some issues on Project
Management
Basics
• Project management is the process of managing,
allocating, and timing resources to achieve a given
goal in an efficient and expeditious manner.
• The objectives that constitute industrial project goals
may be in terms of time, costs, or technical results.
• The objectives that constitute industrial project goals
may be in terms of time (schedule expectations),
costs (budget limitations), or technical
results/performance (output targets/Quality).
• In order to achieve and sustain industrial
development, both the technical and managerial
aspects of industrial projects must come into play.
Lean thinking in Project Management

• LEAN PRINCIPLES AND APPLICATIONS

• Lean means the identification and elimination of

sources of waste in operations.

• Consequently, the organization can achieve higher

product quality, better employee morale, better
satisfaction of customer requirements, and more
effective utilization of limited resources.

• The basic principle of Lean is to take a close look at

the elemental compositions of a process so that
non-value-adding elements can be located and
eliminated.
• By applying the Japanese concept of “Kaizen,”
which means “take apart and make better,” an
organization can redesign its processes to be lean
and devoid of excesses.

• In a mechanical design sense, this can be likened

to finite element analysis, which identifies how the
component parts of a mechanical system fit
together.

• It is by identifying these basic elements that

improvement opportunities can be easily and
quickly recognized.
• It should be recalled that the process of work
breakdown structure in project management
facilitates the identification of task-level
components of an endeavor.

• Consequently, using a project management

approach facilitates the achievement of the
objectives of Lean.
• As a part of tools for Lean practices and procedures, the
Lean task value rating system can be applied to
compare and rank elements of a process for retention,
re-scoping, scaling, or elimination purposes.

• LEAN TASK VALUE RATING SYSTEM

• In order to identify value-adding elements of a Lean

project, the component tasks must be ranked and
comparatively assessed.

• The following method applies relative ratings to tasks.

It is based on the distribution of a total point system.

• The total points available to the composite process or

project are allocated across individual tasks.
• The steps are explained as follows:
1. Let T be the total points available to tasks.
2. T = 100(n), where n = number of raters on the rating team.
3. Rate the value of each task on the basis of specified output (or
quality) criteria on a scale of 0–100.
4. Let xij be the rating for task i by rater j.
5. Let m = number of tasks to be rated.
6. Organize the ratings by rater j (as shown next):
Rating for task 1: xij
Rating for task 2: x2j
. .
. .
. .
Rating for task m: xmj
Total rating points 100
7. Tabulate the ratings by the raters and calculate the overall weighted score for each Task i from the following
expression:
• The wi are used to rank order the tasks to determine the
relative value-added contributions of each.

• Subsequently, using a preferred cutoff margin, the low

or noncontributing activities can be slated for
elimination.

• The wi are used to rank order the tasks to determine the

relative value-added contributions of each.

• Subsequently, using a preferred cutoff margin, the low

or noncontributing activities can be slated for
elimination.
 COMBINING LEAN AND
PROJECT MANAGEMENT
• Lean uses analytical tools as the basis for pursuing
its goals.
• But the achievement of those goals is predicated on
having a structured approach to the activities of
production.
• If proper project management is practiced at the
outset on an industrial endeavor, it will pave the
way for realizing Lean outcomes.
• The key in any project endeavor is to have a
structured design of the project so that diagnostic
and corrective steps can easily be pursued.
Project Management (PM) in an
Agency Model
• The two PM models: Internal PMO & Agency model
• In an internal PMO (PM Office)  model, the work is
performed as part of an inter-company allocation with
the “client” usually having no choice as to who will
perform the work. 
• In an agency PMO model, the client chooses the firm
from among other service providers with the business
problem being solved in exchange for client payment. 
• In the internal model, the business relationship is by
necessity; in the agency model, by choice.  The
strategic opportunity for a project manager in an
agency model, therefore, is to influence this choice to
the mutual advantage of the client and the firm.
• What is agency? Who is an agent? What does acting
as a steward mean?

• What is agency problem?

• Principals want agents to work in their best interests.

However, sometimes they don’t.

• How is that possible to align the interests of the

project manager with that of the client (principal)?

• Why do you think are consulting engineers hired?

Project Review

• PR is the final phase of capital budgeting.

• Different facets of project review:

- Control of project in progress

- Postaudit (a one time unlike PE)

- Performance evaluation

- Abandonment analysis!!!!
THANK
YOU !!