Question Paper Project Management –I (241) : October 2004 Section A : Basic Concepts (30 Marks) • • • • 1.
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This section consists of questions with serial number 1 - 30.
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Answer all questions.
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Each question carries one mark.
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Maximum time for answering Section A is 30 Minutes.
Which of the following is not an advantage of the traditional form of organization for the management of projects?
< Answer >
(a) Budgeting and control are easy (b) It facilitates better technical control (c) It is easy to integrate the functions of all concerned departments towards the fulfillment of the project objectives (d) The lines of communication are well established (e) It is easy to estimate the staff requirement for each department. 2.
In which of the following conditions there is a high likelihood of entry of competitors into an industry? (a) (b) (c) (d) (e)
3.
4.
If a firm collects demand estimates from its salesmen, then the demand may be underestimated Estimation of demand based on users’ expectations requires the deployment of a large staff In the Delphi method of demand estimation, the estimates are collected from industry experts The end use method is a qualitative method of demand estimation The econometric method of demand estimation considers major economic factors influencing demand. < Answer >
Perfectly certain Highly variable Reinvested at the cost of capital of the firm Reinvested at a rate equal to the internal rate of return of the firm Reinvested at the cost of equity capital of the firm.
Gupta Plastics Ltd. invested Rs.36 crores in its recent project. The company expects a uniform cash inflow of Rs.12 crores for five years from this project. The cost of capital for the company is 12%. The modified NPV of this project is Rs. 8.123 crores. What is the reinvestment rate applicable to the cash inflows expected to be generated by this project? (a) 11%
6.
< Answer >
The internal rate of return can be said to be based on the assumption that the intermediate cash flows are (a) (b) (c) (d) (e)
5.
The economies of scale are high The capital required to set up a venture is high The profitability of an organization depends upon a wide access to distribution channels The existing players in the industry have a history of strong retaliation to any firm attempting to enter the industry There is a low degree of product differentiation in the industry.
Which of the following is false in the context of demand estimation? (a) (b) (c) (d) (e)
< Answer >
(b) 12%
(c) 13%
(d) 14%
Which of the following schemes is a type of direct assistance in project financing? (a) Bill rediscounting scheme (c) Equipment finance scheme (e) Underwriting.
(b) Supplier’s line of credit (d) Risk capital assistance
< Answer >
(e) 15%. < Answer >
7.
Value chain analysis is aimed at identifying the activities of the firm that are contributing value to the firm. Which of the following activities is considered to be a primary activity as per this analysis? (a) (b) (c) (d) (e)
8.
9.
Purchase of raw materials Creation of consumer awareness about the product Acquisition of process technology Recruitment of fresh people in the organization Rewarding creative people in the organization.
Which of the following is not a part of a milestone schedule prepared in project planning? (a) (b) (c) (d) (e)
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< Answer >
The date when the project starts The date when the project ends The inputs and standards of inputs required for each part of the project Major events like review meetings, testing, etc Both (c) and (d) above.
A project costs Rs.1 million and has a base case NPV of zero. If the firm invests, its debt capacity increases by Rs.5,00,000. The present value of interest tax shields on this debt is Rs.76, 000. Assuming a tax rate of 50%, the project’s adjusted net present value is (a) Zero (b) Rs.76,000 (e) Insufficient data.
(c) Rs.1,52,000
< Answer >
(d) Rs.2,88,000
10. Which of the following is not true with regard to the top-down approach to project budgeting?
< Answer >
(a)
The procedure starts with an estimate for the cost of the project which is broken down into the cost estimates for smaller and smaller activities in the project (b) The process assumes that employees at the lower level tend to overstate the time and cost factors (c) It fosters healthy relationship amongst the employees (d) Only essential activities are funded, as the overall budget is limited (e) It is easy to keep the expenditure within limit. 11.
The relationship between equipments, buildings and civil works is shown in (a) Organizational layout (c) Utilities layout (e) General functional layout.
< Answer >
(b) Communication layout (d) Transport layout
12. Which of the following statements is /are true regarding Boston Consultancy Group matrix?
< Answer >
I.
Question marks produce a lot of surplus, but have no potential for reinvestment as the growth of its market is low. II. Cash cows and dogs are very demanding – not just in terms of financial resources but also in terms of creative talent. III. Dog is the name used for units which neither have a good market share at present nor promise growth in future. (a) Only (I) above (c) Only (III) above (e) All (I),(II) and (III) above.
(b) Only (II) above (d) Both (I) and (III) above < Answer >
13. Consider the following projects:
Year 0 1 2 IRR
Cash Flow (Rs. lakhs) Project X –9 –4.105 +20 28%
Project Y –4 +25 –25 400%; 25%
Which of the following is\are
true regarding the projects? (a) (b) (c) (d) (e)
Project X is a simple and pure project but Project Y is a non-simple and pure project. Project Y is a non-simple and mixed project but Project X is a simple and pure project Both are non-simple and pure projects Both are simple projects but Project X is mixed project and Project Y is a pure project Both are non-simple and mixed projects.
14. A certain activity has a budgeted cost of Rs.80,000 and at the time of the periodic progress review it is estimated that 60 per cent of the work has been accomplished at the cost of Rs.52,800. Therefore cost over-run (under-run) is (a) 9.1%
(b) 34.0%
(c) (10%)
(d) (9.1%)
(e) 10%.
15. Which of the following is\are not true regarding the risk adjusted investment appraisal techniques? I. II. II. (a) (c) (e)
< Answer >
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In the certainty equivalent method, if there is high degree of correlation between the cash flows over the entire project life the certainty equivalent coefficient is taken as one for all the years. In sensitivity analysis, the impact of the changes in one or more variables on the criterion of merit is studied. Simulation does not produce an optimal solution but the user of the technique has to generate all possible combinations of conditions and constraints to choose the optimal solution. Only (II) above (b) Only (III) above Both (I) and (II) above (d) Both (I) and (III) above Both (II) and (III) above.
16. Which of the following is\are the difference(s) of the Capital Market Line and Security Market Line?
< Answer >
I.
In SML the measure of risk of individual security is its variance whereas in CML the measure of risk is its covariance of its return with the market return II. In SML the measure of risk is the beta of the asset and in CML it is the standard deviation of return. III. The slope of SML is E(Rm)–Rf whereas the slope of CML is R m -R f Standard Deviation of the market return
(a) Only (II) above (c) Both (I) and (II) above (e) Both (I) and (III) above.
(b) Only (III) above (d) Both (II) and (III) above
17. The method of project termination in which the property and functions of the project are absorbed into the parent and are distributed among the existing departments is (a) Extinction (b) Inclusion (e) Both (b) and (d) above.
(c) Absorption
< Answer >
(d) Integration
18. Which of the following is\are true regarding the Life Cycle Costing, a technique of budgeting?
< Answer >
I. It assumes that the life of the project is finite and is known. II. It is expensive to perform and is suited only for large projects. III. It considers the costs involved until project implementation and ignores the costs involved after implementation of the project. (a) Only (I) above (b) Only (II) above (c) Only (III) above (d) Both (I) and (II) above (e) Both (II) and (III) above. 19. Ramanna Constructions Ltd is evaluating projects P, Q, R, S and T for investment. If project R cannot be accepted unless at least two projects from the projects P, Q, S and T are accepted, then the
< Answer >
corresponding constraint can be represented as (a) XR ≤ XP + XQ + XS + XT (c) XR ≤ 2 (XP + XQ + XS + XT) (e) 2XR ≥ XP + XQ + XS + XT.
(b) 2 XR ≤ XP + XQ + XS + XT (d) 4 XR ≤ XP + XQ + XS + XT
20. If the objective is to minimize the value achieved in relation to a given level, then the corresponding term in the objective function while formulating that in a goal programming problem would be (a) Minimize (d–) (c) Minimize (d+ + d–) (e) Minimize (d+ – d–).
(b) Minimize (d+) (d) Minimize (d– – d+)
21. Which of the following aspects related to a project cannot be monitored by comparison of works with the schedules? (a) Cost of the project (c) Completion time of the project (e) Both (b) and (d) above.
(a) Simple organization structure (c) Line-staff organization structure (e) Matrix organization structure.
< Answer >
The objective function and the constraints are linear All the co-efficient in the objective function and the constraints are known with certainty The decision variables are discrete in nature The objective function is undimensional Resources are homogenous.
25. Which of the following does not indicate the presence of intense rivalry in an industry?
< Answer >
Competitors are numerous or are roughly equal in size and power Industry is growing very fast The product or service lacks differentiation Fixed costs are high or the product is perishable Exit barriers in the industry is very high.
26. Recently the rate per minute of long distance domestic telephone calls is reduced to Rs.4 from Rs.6. During the last year total long distance domestic telephone calls made were 3,350 billion hours, at Rs.6. If the price elasticity of demand for long distance domestic telephone calls is 1.41, the expected demand for the coming year is (a) 4295 billion hours (c) 5255 billion hours (e) 6250 billion hours.
< Answer >
(b) 4725 billion hours (d) 5980 billion hours
27. Which of the following is/are true? I.
< Answer >
(b) Traditional organization structure (d) Product organization structure
24. Which of the following is not an assumption in the linear programming model?
(a) (b) (c) (d) (e)
< Answer >
Has the longest duration Can be completed without committing any resources Does not contain any dummy activity Contains the largest number of dummy activities Has the shortest duration.
23. Which of the following organization structures is very costly to maintain due to duplication of equipment, skills etc. in each division?
(a) (b) (c) (d) (e)
< Answer >
(b) Morale of the employee (d) Attitude of the client
22. In a network diagram the critical path is the path, which (a) (b) (c) (d) (e)
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When exercise price is greater than the stock price, call option is said to be ‘in the money’.
< Answer >
II. When exercise price is less than the stock price, put option is exercised by the holder. III. The liability of the writer of call option may be nil if the exercise price is more than the stock price. (a) Only (III) above (b) Only (I) above (c) Both (I) and (II) above (d) Both (I) and (III) above (e) All (I), (II) and (III) above. 28. If you like to analyze the fate of a project under different market conditions, then the most appropriate analysis would be I. II. III. (a) (c) (e)
Sensitivity analysis. Scenario analysis. Monte Carlo simulation. Only (I) above Only (III) above Both (II) and (III) above.
(b) Only (II) above (d) Both (I) and (II) above
29. XA and XB are two decision variables pertaining to Project A and Project B respectively, in an integer linear programming problem formulation for decision making from multiple projects. If XA is less than or equal to XB, which of the following statements is/are true? (a) They are mutually exclusive projects (c) Project A is contingent on Project B (e) Both (b) and (c) above.
< Answer >
(b) They are complementary projects (d) Project B is contingent on Project A
30. In which of the following methods of project termination a successful project is institutionalized as a part of parent company, say as new division or department? I. Extinction II. Inclusion III. Integration (a) Only (I) above (c) Only (III) above (e) Both (II) and (III) above.
< Answer >
(b) Only (II) above (d) Both (I) and (II) above END OF SECTION A
< Answer >
Section B : Problems (50 Marks)
1.
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This section consists of questions with serial number 1 – 5. Answer all questions.
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Marks are indicated against each question. Detailed workings should form part of your answer.
•
Do not spend more than 110 - 120 minutes on Section B.
Irevna Electronics is currently considering investment in a new plant using an indigenous technology with an intention of making a follow-on investment in an advanced technology three years from now. The advanced technology requires six times the outlay and is estimated to yield five times the cash inflows of the current project. The projected cash flows from the new project currently being estimated as follows: 0 Initial outlay
1
2
3
5
8
8
(20)
After tax operating cash flows Terminal cash flows
2
Assume the discount rate for the above to be 10 % and risk free rate is 5 %. You are required to compute: a. The net present value of the cash flows of the new project currently under study. b. The standard deviation per unit per year that the new technology project can have for the call value just enough to offset the NPV of old technology. (2 + 8 = 10 marks)< Answer > 2.
Eastern Industries Ltd. is planning to purchase a machine, which costs Rs.30 lakhs. The expected operating costs and salvage values of the machine are estimated for each year the machine will be in use, and are given in the table below: Year 1 2 3 4 5 6
Operating and maintenance costs (Rs. in lakhs) 6.0 7.0 8.0 10.0 13.0 17.0
Salvage value (Rs. in lakhs) 20.0 17.0 13.0 8.0 5.0 3.0
The rate of depreciation applicable to the machine is 30% on WDV basis. The tax rate applicable to the company is 36% and its cost of capital is 12%. You are required to find out the number of years of usage after which the machine should be replaced by the company. (10 marks) < Answer >
3.
Sabana industries is considering seven projects with the following characteristics:
Project
Initial outlay (Rs. in crores)
1 2 3 4 5 6 7
120 140 150 160 110 230 200
Contribution to net income (Rs. in crore) Year 1 Year 2 Year 3 4 4 5 6 7 7 5 6 7 8 7 6 4 3 4 11 8 8 9 9 8
Contribution to sales growth (%) Year 1 Year 2 Year 3 1.1 1.2 1.2 1.3 1.5 1.7 1.4 1.4 1.5 1.2 1.5 1.8 1.3 1.3 1.3 1.5 1.6 1.7 1.3 1.4 1.3
NPV 40 50 60 80 40 90 70
The
capital budget constraint is Rs.550 crore. The goals sought by management are as follows: a.
Maximization of NPV
b.
Contribution to net income of Rs.32 crores, Rs.35 crores and Rs.38 crores in years 1, 2 and 3 respectively.
c.
Contribution to sales growth of 5%, 7% and 9% in years 1, 2 and 3 respectively.
The priorities assigned to various goals are as follows: Priority 1 : Net income Priority 2 : Sales growth Priority 3 : NPV At priority level-1, the relative weights attached to the contribution to net income of year 1, 2 and 3 are 3, 2 and 1 respectively. At priority level-2, the relative weights attached to the contribution to sales growth of year 1, 2 and 3 are 4, 2 and 1 respectively. You are required to formulate the problem as a goal-programming problem. (10 marks)< Answer > 4.
The activities, durations and direct activity costs of a project are as follows: Activity 1–2 1–3 2–4 3–4 2–5 4–5
Time in weeks Normal Crash 12 6 10 6 4 2 20 12 6 4 8 4
Cost (Rs.) Normal 80,000 60,000 120,000 140,000 90,000 52,000
Crash 140,000 104,000 168,000 196,000 126,000 100,000
The indirect costs are
Rs.10,500 per week. You are required to determine (a)
The minimum time, after crashing, in which this project can be completed and the cost associated with it.
(b) The minimum cost, after crashing, at which the project can be completed and the duration of the same? (5 + 5 = 10 marks)< Answer > 5.
Ajay Industries Ltd. has the following two operating divisions:
Division Confectionaries Computers
Percentage of Firm value 0.7 0.3
AIL is proposing to start a cosmetics division, the
cash flows of which is estimated as follows: Year 0 1 2 3–5
Cash flows (Rs. Cr.) –1 0.1 0.2 0.5
It proposes to apply the risk adjusted discount rate method to appraise the above project and estimates a premium of 2% over the company’s weighted average cost of capital. To estimate the weighted average cost of capital of the firm, it has identified the following competitors:
Company Britania Satyam
Estimated equity beta 0.75 1.8
Estimated Debt Beta 0.2 0
D:E 1:4 2:3
Both the above firms
pay nil tax. AIL has a debt-equity ratio of 0.3, cost of debt of 10%, debt-beta of zero and the marginal tax rate of 30%. Assume the risk free rate of return and market return are 7.5% and 14% respectively. You are required to: a.
Calculate the present weighted average cost of capital of AIL without considering the investment in new division.
b.
Appraise the proposed project using risk adjusted discount rate method. (7 + 3 = 10 marks) < Answer >
END OF SECTION B
Section C : Applied Theory (20 Marks)
6.
•
This section consists of questions with serial number 6 - 7.
• •
Answer all questions. Marks are indicated against each question.
•
Do not spend more than 25 -30 minutes on section C.
A detailed project report (DPR) is a precious formal document of commitment prepared and presented by the sponsors of a project. This document should consist of ideas orchestrated around every piddling aspect of a project substantiated with supplementary notes. The preparation of DPR is undertaken only after the investment decision is made on the basis of the technical, economic and financial feasibility studies, so that expensive efforts involved in the preparation of DPR are not wasted. What is a DPR? Explain how is it different from the feasibility report (FR). ( marks) < Answer >
7.
In recent years, environmental concerns have assumed a great deal of significance and rightly so. Ecological analysis should be done particularly for major projects which have significant ecological implications like power plants and irrigation schemes etc. Discuss the major issues involved while preparing the Environmental Impact Statement. ( marks) < Answer >
END OF SECTION C END OF QUESTION PAPER
Suggested Answers Project Management-I (241) : October 2004 Section A : Basic Concepts 1.
Answer : (c) Reason : a.
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Budgeting and control are easy in the traditional form of organization.
b. b. c.
d. e. 2.
Answer : (e) Reason : a. b. c. d.
e.
In the traditional form of organization, technical control is better because the superiors are generally specialists in their respective fields. In the traditional form of organization, as the managers of each functional department are concerned with the work of their department only, integrating the functions of all concerned departments towards the fulfillment of the project objectives is difficult. The lines of communication are well established in the traditional form of organization. It is easy to estimate the staff requirement for each department in the traditional form of organization. The likelihood of entry of competitors into an industry is low when the economies of scale are high. The likelihood of entry of competitors into an industry is low when the capital required to set up a venture is high. The likelihood of entry of competitors into an industry is low when the profitability of an organization depends upon a wide access to distribution channels. The likelihood of entry of competitors into an industry is low when the existing players in the industry are known to have retaliated strongly any attempt by new competitors to enter the industry. The likelihood of entry of competitors into an industry is high when there is a low level of product differentiation in the industry.
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3.
Answer : (d) Reason : a. If a firm collects demand estimates from its salesmen, then the demand may be underestimated because salesmen tend to show low potential sales in order to show their future performance in a favorable light. b. Estimation of demand based on users’ expectations requires the deployment of a large staff because estimates are to be obtained from all the major user firms in the industry. c. In the Delphi method of demand estimation, the estimates are collected from industry experts. d. The end use method is a quantitative method of demand estimation. e. The econometric method of demand estimation considers major economic factors influencing demand.
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4.
Answer : (d) Reason : a. The internal rate of return is not based on the assumption that the intermediate cash flows perfectly certain. b. The internal rate of return is not based on the assumption that the intermediate cash flows highly variable. c. The internal rate of return is not based on the assumption that the intermediate cash flows reinvested at the cost of capital of the firm. d. The internal rate of return is based on the assumption that the intermediate cash flows reinvested at a rate equal to the internal rate of return of the firm. e. The internal rate of return is not based on the assumption that the intermediate cash flows
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are are are are are
reinvested at the cost of equity capital of the firm. 5.
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Answer : (c) Terminal Value
Reason : Modified NPV = 8.123 =
or
(1 + k) n
−I
12xFVIFA(r, 5) (1.12)5
FVIFA(r, 5) =
− 36
44.123x(1.12)5 = 6.480(approx) 12
or From the tables r = 13% 6.
Answer : (d) Reason : The schemes of assistance of the financial institutions can be broadly classified into direct assistance and indirect assistance. In the direct forms of assistance, the institutions provide the customers with funds. In indirect forms, the institutions support them by providing guarantees on their behalf.
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Different schemes of direct assistance in project financing are (i) Rupee term loans (ii) Foreign currency term loans (iii) subscription to equity shares (iv) seed capital assistance (v) Risk capital assistance. In risk capital assistance scheme funds are provided directly to the first generation entrepreneurs. So, alternative (d) is correct. Rest other alternatives are different forms of indirect assistance. Different schemes of indirect assistance in project financing are (i) Deferred payment guarantee, (ii) Guarantee for foreign currency loan, (iii) Underwriting the public issues, (iv) Bill rediscounting, (v) Supplier’s line of credit, (vi) Equipment finance scheme. 7.
Answer : (b) Reason : As per the value chain analysis the primary activities are i. Inbound Logistics: Activities like receiving, storing and distributing inputs, transportation of inputs etc. ii. Operations: Activities that convert the inputs into the final product. iii. Outbound Logistics: Activities related to collecting, storing and distributing final product. iv. Marketing and Sales: Activities relating to creation of customer awareness about the product. v. Service: Activities aimed at enhancing or maintaining the value of a product So clearly the option (b) is the answer.
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8.
Answer : (c) Reason : The milestone schedule does not include ‘inputs and standard of inputs required for each part of the project.’
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9.
Answer : (b) Reason : Base case NPV = 0 Present value of interest tax shield = Rs.76,000 ∴Adjusted NPV = 0 + 76,000 = Rs.76,000
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10.
Answer : (c) Reason : Top down approach to project budgeting does not facilitate healthy relationship amongst the employees.
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11.
Answer : (e) Reason : The relationship of the buildings, civil works and the equipments is shown in General Functional Layout. This layout is designed in such a way that the entire process of receiving raw materials, processing and the outward movement of the finished goods takes place smoothly and efficiently.
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Organizational layout shows number of people required, their requirement at each part of the project site, and their hierarchical relationship. Communication Layout shows the communication lines between the various divisions – the model and their numbers. Utilities Layout shows the points of availability and consumption of each utility at each point. Transport Layout shows the distances between various facilities outside the production line and the modes of transport between them. 12.
Answer : (c) Reason : Only statement III is the correct answer.
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13.
Answer : (b) Reason : Simple investments are those investments in which the cash outflows are followed by cash inflows whereas non-simple investments are those in which cash outflow (or stream of outflows) occur more than once. Hence, Project X is a simple investment and Project Y is a non-simple investment.
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A project is said to be pure investment if the unrecovered investment balance is either negative or zero through the life of the project and zero at the end of the project. The following are the unrecovered investment balances for both the projects: Project X
Project Y
F0
–9
–4
F1
– 9(1.28) – 4.105 = – 15.625
– 4(1.25) + 25 = 20; – 4(1 + 4) + 25 = 5
F2 – 15.625(1.28) + 20 = 0 20(1.25) – 25 =0; 5(5) – 25 = 0 As the unrecovered investment balance in case of X is negative through out and zero at the end of the project, X is termed as pure investment and in case of Y, the unrecovered investment balance is positive during the life of the project and hence it is mixed investment. And the answer is (b). 14.
ACTW
= 15.
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Answer : (e) Reason : Cost over-run (under-run) BCTW
1
52, 800 80, 000 0.60
1
= 10%
Answer : (c) Reason : Certainty equivalent method is based on the utility of the decision maker for the return obtained by taking each additional unit of risk. The change in the CEC depends on the degree of correlation among the cash flows of different years. If the cash flows are highly correlated, the CEC remains the same for all the years. CEC takes the value of one only when the CF is certain. Hence, I is not correct.
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Sensitivity analysis is based on the view that only those projects that can stand the possible changes in future in the critical elements which have a vital bearing on the costs/benefits of the project need to be undertaken. In such analysis the factors that are likely to change during the life of the project are first identified and then the extent of change in the NPV or other criterion chosen for evaluation with change in the factor is measured. However, the impact of change in only one variable at a time is considered. Hence, II is not true and the answer is (c). 16.
Answer : (d) Reason : CML shows the relation between return and risk for efficient portfolios and SML represents the return expected on individual assets or securities. CML can be written as
E(Rp) = Rf +
Rm − Rf σp σm
.
SML represents the return expected on individual assets or securities and is written as
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E(Rj) = Rf + βj[E(Rm)-Rf]. The measure of risk in case of CML is the standard deviation of return on the security whereas in case of SML it is the covariance of its return with the market return. Hence, I is not correct. The measure of risk is the beta of the assets in case of SML whereas in case of CML it is the standard deviation of return on the market. Hence, II is true. The slope of SML is E(Rm)-Rf whereas slope of CML is (Rm-Rf)/Standard Deviation of the market. Hence, III is also true and the answer is (d). 17.
Answer : (d) Reason : In Integration, the property and functions of the project are absorbed into the parent, and are distributed among the existing departments. Hence the answer is (d).
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Extinction may take place when the project has been completed and hence there is nothing more to do, or when the project is considered a failure beyond redemption. Inclusion or absorption is to include a project as a part of the organization. Inclusion is the method used when a project is a success and can be institutionalized as a part of the parent, say as a new division or department. 18.
Answer : (d) Reason : Life cycle costs are the total cost of acquiring and maintaining (ownership) of the system for the organization. Life cycle system is a method of evaluating alternative courses of action early in the life of a project, so that the resources can be committed to the best, however: i.
Life cycle costing is expensive to perform and is hence suitable only for large projects.
ii.
The entire exercise will have to be repeated whenever the requirements change.
iii.
It assumes that the life of the products is finite and is known.
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Hence, I and II are true and the answer is (d). 19.
Answer : (b) Reason : If project R cannot be accepted unless at least two projects from the projects. P, Q, S and T are accepted then the corresponding project interdependency constraint can be represented as
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2XR ≤ XP + XQ + XS + XT 20.
Answer : (e) Reason : The various situations and its corresponding term in the objective function while formulating that in a goal programming problem are: Nature of Achievement Desired Do not exceed a given goal At least reach the given goal Minimize the achievement relative to a given goal Maximise the achievement relative to a given goal Reach as close as possible to the given goal
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Term to be used Minimize (d+) Minimize (d–) Minimize (d+ – d–) Minimize (d– – d+) Minimize (d+ + d–)
21.
Answer : (e) Reason : Cost, time and performance of a project can be easily monitored by comparison of works with schedules. But qualitative factors such as the morale of the employees and the attitude of the client can not be monitored by comparison of works with the schedules.
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22.
Answer : (a) Reason : In network diagram critical path is the path with longest duration.
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23.
Answer : (d)
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Reason : In product form of organisation, a division is set up for each product. Within each division, different departments are set up for each of the different functions, engineering, manufacturing etc. The task of each division is to manage projects relating to that product. The biggest advantage of this form of organisation structure is that one person, designated as project manager exercises full control over the project. Cost of maintenance is the biggest disadvantage of this type of organisation. Cost of maintaining in this structure is very high due to duplication of equipment, skills etc. in each division. 24.
Answer : (c) Reason : In linear programming model decision variables are continuous in nature.
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25.
Answer : (b) Reason : The factors which contributes in enhancing the competitive pressure or intensifying the competitive rivalry are:
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• • • • •
•
The relative sizes of the players. If all are of equal size then competition will be high.
•
Stagnation, i.e., the industry is not growing very fast.
•
No product innovation i.e., lack of differentiation in product or service offerings.
•
High fixed costs, leading to a scramble to sell the break-even quantity.
• Due to high exit barriers, reluctant players can not leave the competition and continue to remain in the fray to make it more intense. So, alternative (b) is the answer. 26.
Answer : (d) Reason : Price elasticity is always negative. Here it is –1.41. We can write from the formula of price elasticity of demand that (6 + 4) / 2 x − 3350 × ( x + 3350) / 2 (6 − 4)
Or Or
x − 3350 x + 3350
x=
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= 1.41.
= 0.282.
3350 × (1 + 0.282) (1 − 0.282)
= 5981 ≅ 5980 billion hours.
So, the alternative (d) is the answer. 27.
Answer : (a) Reason : In case of a call option if the exercise price is more than the stock price, the holder of the option will not exercise the option and the writer of the option does not incur any liability. Hence, III is correct and the answer is (a).
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A call option is in the money if the market price at the time of exercise is greater than the exercise price. Hence, II is not correct. When an option is in the money the option, if exercised will provide the holder with a profit. A put option is said to be in the money if the exercise price is greater than the stock price at the time of the option. Hence, II is also not correct 28.
Answer : (b) Reason : The study of impact of variation in one factor at a time, holding other factors constant, is called sensitivity analysis. In this analysis typically one variable is varied at a time. If variables are interrelated as they most likely to be, then it is helpful to look at some plausible market scenarios or market conditions where each scenario represents a consistent combination of variables. This type of analysis is called scenario analysis. The objective of such scenario analysis may be to get a feel of what happens under the most favorable or the most adverse configuration of key variables, without bothering much about the internal consistency of such configurations. Monte Carlo simulation is used for developing the probability profile of a criterion of merit by randomly combining values of variables which have a
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bearing on the chosen criterion. So the scenario analysis is the most appropriate to analyze the fate of project in different scenarios or market conditions. So, alternative (b) is the answer. 29.
Answer : (c) Reason : If they are mutually exclusive projects then that is represented as XA + XB ≤ 1
(p)
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Had they been complementary in nature then that would have been represented as (q)
XA + XB + XAB ≤ 1 When project A is contingent on project B then that is represented as XA ≤ XB (r) Otherwise if project B is contingent on project A, then that is represented as XB ≤ XA (s)
In the question we find that the constraint in the problem formulation is represented as XA less than or equal to XB which is same as inequation (r). So we can certainly conclude that project A is contingent on project B. 30.
Answer : (b) Reason : In integration, the property and functions of the project are absorbed into the parent, and are distributed among the existing departments. Inclusion is the method used when a project is a success and can be institutionalized as a part of the parent, say as a new division of department. Extinction may take place when the project has been completed and hence there is more to do or when the project is considered a failure beyond redemption. So, alternative (b) is the answer.
Section B : Problems 1.
2
NPV = –20 + 5/ 1.10 + 8/(1.10) + 10/ (1.10)3 = –20 + 4.545 + 6.6115 + 7.5131 = – 1.330 (b) The call value = – 1.330 (a)
Asset value = Exercise price =
5 / 1.10 8 / 1.10
2
10 / 1.10
3
x 5
PVIF (10,3) = 70.1337
Rs.20x6 =120 70.1337 120 /1.05
3
Asset value / Pv. of exercise price = = 0.68 Let call value / asset value = x X x 70.1337 = 1.330 Or, X = .01896 = 1.89% = 1.90% Let a = share price divided by PV ( exercise price ) b = standard deviation times square root of time and x = Value of call option as percentage of share price. From the table we get the following values of x.
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a
0.65
0.75
0.30
1.2
2.0
0.35
2.3
3.3
b
When a is 0.68 ,and b is 0.30 then x can be find out by following interpolation (x-1.2)/(0.68 – 0.65) = (2 – 1.2)/(0.7- 0.65) x = 0.48 + 1.2 = 1.68 ------- I When a is 0.68 and b is 0.35, then x can be find out by following interpolation (x- 2.3)/( 0.68-0.65) = (3.3 -2.3)/(0.70- 0.65) x = 0.6 + 2.3 = 2.9 -----------II When a = 0.68 and x = 1.9 ,then the value of b can be calculated by following interpolation (b – 0.30)/(1.9 – 1.68) = (0.35 – 0.30)/(2.9 – 1.68) b = 0.009016 + 0.30 = 0.309 = 0.31 T
Standard deviation x = x Or, standard deviation = 0.1789 σ
3
= 0.31 < TOP >
2. a. Calculation of UAEs for various years of usage in lakhs)
(Rs.
UAE of O & M costs A. Year (t) B. O & M costs C. Post tax O & M Costs = B (1-0.36) D. PVIF (12%, t) E. Present Value of C F. Cumulative of E G. PVIFA (12%, t) H.UAE (OM) UAE of initial out lay I. Initial Outlay J. PVIFA (12%, t) K. UAE (IO) UAE of DTS L. Depreciation M. Tax shield: L × 0.36 N. PVIF(12%, t) O. PV of M P. Cumulative of O Q. PVIFA(12%. t) R. UAE (DTS) UAE of Salvage value S. Salvage value T. PVIF(12%, t) U. PV of S V. PVIFA(12%, t) W. UAE (SV) 1. UAE (OM) 2. UAE (IO) 3. UAE (DTS) 4. UAE (SV) 5. UAE(TC) = 1 + 2 – 3 – 4
1 6 3.84 0.893 3.429 3.429 0.893 3.84
2 7 4.48 0.797 3.571 7.000 1.690 4.14
3 8 5.12 0.712 3.645 10.645 2.402 4.43
4 10 6.40 0.636 4.070 14.715 3.037 4.85
5 13 8.32 0.567 4.717 19.432 3.605 5.39
6 17 10.88 0.507 5.516 24.948 4.111 6.07
30.00 0.893 33.59
30.00 1.690 17.75
30.00 2.402 12.49
30.00 3.037 9.88
30.00 3.605 8.32
30.00 4.111 7.30
9.00 3.24 0.893 2.89 2.89 0.893 3.24
6.30 2.27 0.797 1.81 4.70 1.690 2.78
4.41 1.59 0.712 1.13 5.83 2.402 2.43
3.087 1.11 0.636 0.71 6.54 3.037 2.15
2.161 0.78 0.567 0.44 6.98 3.605 1.94
1.513 0.54 0.507 0.27 7.25 4.111 1.76
20 0.893 17.86 0.893 20 3.84 33.59 3.24 20 14.19
17 0.797 13.55 1.690 8.02 4.14 17.75 2.78 8.02 11.09
13 0.712 9.26 2.402 3.86 4.43 12.49 2.43 3.86 10.63
8 0.636 5.09 3.037 1.68 4.85 9.88 2.15 1.68 10.90
5 0.567 2.84 3.605 0.79 5.39 8.32 1.94 0.79 10.98
3 0.507 1.52 4.111 0.37 6.07 7.30 1.76 0.37 11.24
From above we can see that the UAE (TC) is minimum for a usage of 3 years. Hence the machine should be replaced after 3 years of usage. < TOP >
3. The goal programming formulation of the above problem is given below: Goal Function: P1
( 3d
− 1
+2d − +d 3−) +P2 2
( 4d
− 4
+2d 5− +d 6−)+P3
(d
− 7
− d 7+)
Min Z = Economic Constraints: 120x1 + 140x2 + 150x3 + 160x4 + 110x5 + 230x6 + 200x7 + S1 = 550 (Capital budget constraint) + s2 = 1 + s3 = 1 + s4 = 1 + s5 = 1
+ s6 + s7 + s8
= = =
1 1 1
0 (j = 1,2 …7) 0 (i = 1,2 …7) Goal constraints: d−1
+ 6x2 + 5x3 + 8x4 + 4x5 + 11x6 + 9x7 +
–
d1+
= 32 (Contribution to net income in year 1)
+ 7x2 + 6x3 + 7x4 + 3x5 + 8x6 + 9x7 +
d −2 − d +2
= 35 (Contribution to net income in year 2)
+ 7x2 + 7x3 + 6x4 + 4x5 + 8x6 + 8x7 +
d −d
= 38 (Contribution to net income in year 3)
− 3
+ 3
1.1x1 + 1.3x2 + 1.4x3 + 1.2x4 + 1.3x5 + 1.5x6 + 1.3x7 +
d −4 − d +4
1.2x1 + 1.5x2 + 1.4x3 + 1.5x4 + 1.3x5 + 1.6x6 + 1.4x7 +
d 5− − d 5+
1.2x1 + 1.7x2 + 1.5x3 + 1.8x4 + 1.3x5 + 1.7x6 + 1.3x7 +
= 5 (Contribution to sales growth in year 1) = 7 (Contribution to sales growth in year 2) d −6 − d +6
= 9 (Contribution to sales growth in year 3)
d −7 − d +7
1
+ 50x2 + 60x3 + 80x4 + 40x5 + 90x6 + 70x7 + = 400 (NPV of projects) It may be noted that in the goal constraint of NPV, it is arbitrarily set equal to 400. In the objective function, the NPV goal, set at (d
− 7
− d +7 )
priority level 3, is defined as minimize This has the effect of striving for maximum possible deviation from the target value – this means NPV is sought to be maximized. < TOP >
4.
The critical path is 1-3-4-5 The project duration is 38 weeks and the total direct cost is Rs5,42,000.
The time cost slopes of the different activities are as follows: Activity Time in weeks Cost to expedite per week (Rs) Normal Crash 1-2 12 6 10,000 1-3 10 6 11,000 2-4 4 2 24,000 3-4 20 12 7,000 2-5 6 4 18,000 4-5 8 4 12,000
Crashing
Path
Duration in weeks 38 24 18
Critical path 1-3-4-5
Direct cost (Rs) 5,42,000
Indirect cost (Rs) 3,99,000
Total Cost (Rs) 9,41,000
a. 1-3-4-5 b. 1-2-4-5 c. 1-2-5 Crash activity (3 – 4) by 8 weeks) a. 1-3-4-5 30 1-3-4-5 5,98 ,000 3,15,000 9,13,000 b. 1-2-4-5 24 c. 1-2-5 18 Crash activity (1 – 3) by 4 weeks a. 1-3-4-5 26 1-3-4-5 6,42,000 2,73,000 9,15,000 b. 1-2-4-5 24 c. 1-2-5 18 Crash activity (4 – 5) by 2 week a. 1-3-45 24 1-3-4-5 6,66,000 2,52,000 9,18,000 b. 1-2-4-5 24 1-2-4-5 c. 1-2-5 18 Crash activity (4 – 5) by 2 week a. 1-3-4-5 22 1-3-4-5 6,90,000 2,31,000 9,21,000 b. 1-2-4-5 22 1-2-4-5 c. 1-2-5 18 a. As there is no further possibility of crashing, the minimum project duration is 22 weeks and the associated cost is Rs 9, 21,000. b. If the objective is minimum project cost then the cost is Rs 9, 13,000and the duration is 30 weeks. < TOP >
5.
a.
To calculate the weighted average cost of equity we need to calculate the cost of equity of each division. Equity Beta of confectionaries division: Estimated equity Beta of Britania= 0.75 Debt to equity = 1:4 Estimate beta of debt = 0.2 Tax = Nil βE .
βA of Britania =
E D +βD E +D E +D
0.75 × 0.8 + 0.2 × 0.2
=
= 0.6 + 0.04 = 0.64 As Beta of debt in case of Ajay Industries is zero, equity beta of confectionaries division = =
D βA 1 + ( 1 − T ) E
0.64 [1 + 0.3 × 0.7]
= 0.774. Similarly, equity beta of computers divisions is calculated as follows: βE
βA of Satyam = =
E D +βD E +D E +D
1.8 × 0.6 = 1.08.
As Beta of debt in case of Ajay is zero, βE
=
βA[1 + D/E (1 – T)]
=
1.08 [1 + 0.3 × 0.7] = 1.307.
Equity beta of confectionaries division = 0.774 Weight in the firm value = 0.7 Equity beta of computers division = 1.307 Weight in the firm value = 0.3 Average equity Beta of firm Cost of equity =
=
Rf + (Rm – Rf)βE = =
0.075 + (0.14 – 0.075) 0.934 0.136
Average cost of capital of the firm b.
0.774 × 0.7 + 1.307 × 0.3 = 0.9339.
= 0.3 × 0.1 × 0.7 + 0.7 × 0.136
= Required rate of return on cosmetics division = 0.1162 + 0.02 = 0.1362 = 13.62% NPV of cosmetics division
= = =
0.021 + 0.0952 = 0.1162
0.1 0.2 + + 0.5 PVIFA13.62,3 PVIF13.62,2 1.1362 ( 1.1362 ) 2
–1 + –1 + 0.0880 + 0.1549 + 0.906 Rs.0.147897 crores
As NPV is (+) ve, the new division can be taken up. < TOP >
Section C: Applied Theory 6.
The preparation of detailed project report (DPR) is the preliminary phase of a project life cycle. The outline and content of DPR is similar to the techno-economic feasibility report. All the vital aspects of location and site, process technology, market demand, plant capacity, project revenue, manufacturing or construction costs, profitability, economic benefits etc, are covered in much greater detail. The basic difference between the feasibility report and DPR is the level of accuracy and degree of detail. Some of the differences between FR and DPR are as follows:
Features Objective
Feasibility Report Its aim is to serve the top management in arriving at feasible and viable project alternatives.
Scope of information management
The interests of the management can be met by collecting relevant information in vital areas of technical, economic, commercial and environmental areas at the onset. However, about 70–80% information may be collected and analyzed in feasibility studies based on which certain reliable forecasts are made and decisions are taken by the management. These studies are subjected to an exploratory type of research and hence consume a span of 6 to 15 months.
Time span
Costs involved
Reliability
Depth of analysis
7.
The cost of feasibility studies varies on the type of project. As an average for any project the costs may range approximately between 1.5-3% of the project costs. These studies are reliable for a short period of time (till the decisions are made about a project). In the long run they serve only as a data bank as the information stinks. The depth and magnitude of the feasibility studies are obviously reflected through costs and time consumed in conducting studies. The level of information furnished in these reports is clear, yet some secondary issues are perfunctorily managed.
Detailed Project Report Its focus is to communicate formally about the project sponsor’s decision on a specific project to the government departments and financial institutions for seeking their approvals and funding. It is compulsory for any project sponsors to provide full and final information including a provision for contingencies of any sort on a project proposal. These reports are supposed to equip with total (100%) available information on the proposed project. However, there may be probable variation of 5% down the line due to unwarranted conditions while making future projections. A lot of care and diligence is inevitable on the part of the estimator while preparing the official document and hence may consume time within the range of 1 year to 2 years after the decision is taken by the top management. The cost of preparing a detailed project report is little higher than that of feasibility studies. The total costs may range between 5-7.5% of the expected investment. The detailed reports help in guiding the entire project and even if any variation is there in the project data it can be compared and observed. However, this acts as a major signpost for all practical purposes in the project development and for future reference. The depth and magnitude is perfectly maintained by furnishing intricate details of the project. The report is prepared with diligence taking all precautions to avoid ambiguity and mystery concerning issues of the project. < TOP >
Some major issues in the Preparation of EIS/EIA: The following are the major issues reported to be encountered commonly while conducting and preparing the EIS/EIA. Some of the issues cannot be resolved. In the absence of better alternatives, the analyst has to accept the issues as they are. (i) Determining the Environmental Impacts: This is the central theme in any EIS / EIA. It is a very complex process. At the environmental attributes. Our interest is on the “impacts” and not on the ‘changes’ which normally take place even without the project. The determination of environmental impacts involves: (a) identification of impacts in environmental attributes of environmental attributes or the ER / Vs, (b) measurement of impacts on attributes, and (c) aggregation of impacts on attributes to reflect the total impact on environment.
(ii) With and Without the Project: The environmental impacts are measurement of attributes with and without the project or activity at a given point in time. But the changes in the attributes take place over time without the activity. Therefore the impact must be measured in terms of “net” change in the attribute at a given point in time. (iii) Identifying the impacts: The number of attributes to be evaluated is practically infinite because any characteristic of the environment is considered to be an attribute. Therefore, they have to be reduced to manageable numbers. Thus, duplicative, redundant, difficult to measure, and obscure attributes may be eliminated in favour of those that are more tractable. This implies that some attributes which are difficult to measure or conceptualize, may still remain to be examined. In this case, bias and subjectivity are likely to be crept in. (iv) Characteristics of the Base: Conditions Prior to the Activity: The nature of the impact is determined by the conditions of the environment existing before the project. The assessment of the characteristics of the base is a critical factor. (v) Role of Attributes: Though the impacts are considered to be the effects on the definite discrete attributes of the environment, the actual impacts are not correspondingly well categorized. Nature does not necessarily respect man’s discrete categories. Rather, the actual impacts may be the effects of varying severity on a interrelated attributes. The issue is one of identifying and assessing the cause-condition-effect in order to work out the remedial measures. (vi) Measurement of Impact: Ideally, all impacts must be translatable into common units. However, this is not possible because of the difficulty in defining impacts in common units (eg. On income and on water quality). In addition, the quantification of some impacts may be beyond the state of the art. (vii) Aggregation Problem: After measuring the project impacts on various individual attributes or ER/Vs, one encounters the problem of how to aggregate all impacts (quantitative and qualitative) thus assessed to arrive at a single composite measure to represent the ‘total activity impact’. This would involve expressing the various impact measures in common units which is very difficult. Some use a weighting procedure to accomplish this which is again subjective. There is another associated problem of summing up and comparing with the impact of an alternative activity. (viii) Secondary Impact: Secondary or indirect impacts on environment should also be considered particularly in relation to the infrastructure investments that stimulate or induce secondary effects in the form of associated investments and changed patterns of social and economic activity. Such induced growth brings significant changes in the natural conditions. Similarly, there can also be significant secondary impacts in the biophysical environment. (ix) Cumulative Impacts: Here, cumulative refers to the similar activities spread over in an environmental setting like hotels, beach resorts, surface or underground mines, industrial estates, etc. A single individual activity may produce significant cumulative effect on certain aspects of environment. This raises the question of how to deal with these significant cumulative effects. Therefore, it is suggested to prepare an environmental impact assessment (EIA) on broad programmes rather than on a series of component actions (e.g industrial estates, mining sector, tourism industry, etc). or, alternatively, one can prepare on EIA for a particular geographical area where a series of similar activities are located (eg. Mining areas, coastal line for beach resorts, etc) (x) Report Findings: The results should be displayed in such a way that it makes easy and clear to comprehend the total impacts of an activity from a brief review. It is suggested to display the impacts on a summary sheet in a matrix form. The knowledge about the issues as explained above, however complex they are, will be useful in understanding the processes and complexities involved in preparing an EIS / EIA. Such an awareness will help improve the understanding of EIS, leading to more objective, informed and unbiased decision-making on activities/ projects. < TOP >
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