Question Paper Project Management – II (242): January 2006 Section D : Case Study (50 Marks) This section consists of questions with serial number 1 - 3. Answer all questions. Marks are indicated against each question. Do not spend more than 80 - 90 minutes on Section D.
Case Study Read the case carefully and answer the following questions: 1.
2.
3.
You are the Manager of a Financial Consultancy firm in Kolkata. Your client wants to invest in paper industry, because he feels that it is currently the best sector to invest in. You have been assigned the job to suggest the client whether he should invest or not in Polaroid Paper Mills Ltd. Your seniors have given you the information about the proposed company and the existing industry scenario and its norms, which you will have to adhere to when you prepare the projections for the next five years. With this objectivea. You are required to estimate the cost of the project and show the means of financing. b. Prepare the projected profitability statement for the next 5 years. Show all the computations. (10 + 2 0 = 30 marks) < Answer > Prepare the projected cash flows of the project from the long-term funds point of view. (10 marks) < Answer >
Appraise the project in terms of the following criteria: a. Net Present Value. b. Modified Internal Rate of Return. c. Discounted Pay-back Period. Assume that the intermediate cash flows may be invested in government securities at the rate of 6% p.a. (4 + 3 + 3 = 10 marks) < Answer >
The details of proposed buildings and civil works are as follows:
Floor Area (Sq.ft) Factory Building Bonded Warehouse Chemical & Rag Godown Machine Hall Boiler House Transformer & L.T. Room Pulp Mill Battery Room Finishing House Waste Paper Finishing Paper Godown Hydropulper Godown Staff Quarter Guest House
Type of Construction
52814 Asbestor Roof, Steel trusses & Pulping Masonry wall, steel trusses, purlins 7744 7000
Asbestor Roof, RCC Flooring
10472 Asbestor Roof, Artificial Stone Flooring 2040 Column Beam, Asbestor Roof Masonry structure, RCC Roof stone 1757 flooring 10200 RCC, Steel Trusses, Artificial Stone 351.41 RCC Roof, Artificial Stone Asbestor Roof, Steel Trusses, Artificial 8976 Stone Flooring Masonry wall, Asbestor Roof, Artificial 9525.09 Stone Flooring Asbestor Roof/ Iron frame 4488
Cost of Construction (Rs. per Sq. Feet) 800 500 600 1000 1000 500 1000 500 600 600 600
Masonry wall Asbestor Roof, Artificial 600 Stone Flooring 4747 RCC Roof, Stone Flooring 500 RCC Roof, Artificial stone flooring, 2797 800 Mosaic flooring Other Sheds 9500 Asbestor Roof / Brick Wall 50 Cycle Shed 4500 Steel column / Asbestor Roof 50 The three machines Machine-I, Machine-II and Machine-III will be used to produce Writing and Printing Paper, Coated Duplex Board and Kraft Paper and Poster Paper respectively. Their estimated cost (i.e; FOR cost) is Rs.7.05 crore, Rs.9.10 crore and Rs.7.56 crore respectively. They will be purchased from indigenous sources only. The other plant and machinery required for the mill would be three nos. of Pulping Mill with a total cost of Rs.1.15 crore. The production process requires Drying Machines whose cost is estimated at Rs.0.85 crore and a captive power plant will be installed in the premises at a cost of Rs.0.25 Crore. Pump Motors will be installed at a cost of Rs.0.08 crore. A weighbridge is also to be installed at a cost of Rs.9.5 lac. Excise Duty payable for the new machineries would be 15%. Octroi, Freight, transportation, Loading, Unloading, Clearing and Forwarding charges is estimated @ 4% of the basic cost of the machineries. Erection charges are estimated @ 10% of the basic cost. Miscellaneous fixed assets: Office Equipments - Rs.65.00 Lac Boilers - Rs.15.00 Lac Diesel Generator Sets – Rs.85.00 Lac. Legal charges for drafting agreements for memorandum and articles of association cost them Rs.85,000. The cost of market survey was Rs.1,00,000. Your company will charge 3048.50
Rs.2.50 Lac for preparing the feasibility report. Other expenses expected to be incurred by the company till the date of commencement of commercial production are as follows: Traveling expenses to the tune of Rs.8,90,000 Printing and Stationery expenses to the tune of Rs.2,25,000 Advertisement expenses to the tune of Rs.5,50,000 Insurance premium during construction to the tune of Rs.85,00,000 Products and Uses The main products from this unit would be Kraft paper and Poster paper, Writing and Printing paper and Coated Duplex board. These products are used in the packaging applications of consumer durables, processed foods and many other products. The various range of products to be manufactured by PPML and the specification thereon are given in the following table: Machine Product Name of Product Annual Production No. Specification Writing and Printing 1 43 to 54 GSM 13200 MT paper 2 Coated duplex Board 180 to 400 GSM 19800 MT 3 Kraft Paper 25 to 120 GSM 13200 MT (combined) 3 Poster Paper 28 to 60 GSM Apart from this, machine No. 1 i.e. writing and printing paper manufacturing machine can produce Cream woven paper of 44 to 80 GSM specifications and Maplitho Paper of 44 to 80 GSM. Process Paper and board production involves two steps. First, the fibres need to be produced. This is done in a pulp mill where pulp is produced using chemical or mechanical processes. And then the paper itself is produced on a paper machine from a mixture of fibres (which can be virgin or recovered fibres), chemicals and additives. All paper and board machines are based on similar basic process. There are six distinct sections: wire section, press section, drier section, size press, calendar and reel-up. Raw material fibres and chemicals (and 99% of water) are pumped to the head box, which feeds the stock evenly onto the wire section. As the paper stock flows from the head box onto the wire, the water drains away through the mesh leaving tiny fibres as a mat on top of the mesh. By the time it reaches the end of the wire section, it becomes a sheet of paper, although very moist and of little strength. It passes through press section where more moisture is squeezed out. The paper then passes through drier section with a temperature of slightly over 1000C. Here it becomes completely dry. Part way down the bank of drying cylinders is the size press, where a solution of water and starch are added in order to improve the surface. At the end of the drying process, the paper is smoothed by ‘ironing’ method, which consists of hot polished rollers mounted in pairs (Calendars). This also helps to consolidate, polish and glaze the surface of the paper. Still traveling at very high speeds, the paper comes off the machine ready for reeling up into large reels, which are normally cut or slit into smaller sizes, according to customer requirement. Raw Materials Wood pulp is considered the best as it lends strength and superiority to paper. Environment concerns have forced the industry to switch to non-conventional raw materials like waste paper, agro based products like rice and wheat straws, baggase, grass,
and non-wood crop fibres which include hemp, kenaf and cotton lintels. The technology supplied to this project recommends the use of all these types of raw materials in proportions, for the production of different grades and qualities of paper. Power PPML does not have power supply arrangements from power grid. Though the mill has plans for availing grid supply, with a power substation constructed within the mill premises it will not resort to grid supply due to the following reasons: PPML needs power supply arrangement of 33 KVA from West Bengal State Electricity Board (WBSEB) preferably. The mill needs to be connected to two feeder lines, which needs a vast amount of time and cost. The area faces inconsistent power supply due to frequent power cuts. Wide voltage fluctuations will cause disruption in continuous operation of mill and thereby hampering the operating efficiency both qualitatively and quantitatively. The mill, however, will resort exclusively to captive power generation through diesel generator sets. The mill at present will install four diesel generator sets, each having capacity of 1000 KVA. The product wise requirement will be as follows: (i) Writing and Printing Paper – 350 units per MT of production, (ii) Coated duplex Board –500 units per MT of production and (iii) Kraft Paper and Poster Paper – 411 units and 880 units per MT of production, respectively. Cost of power per unit will be Rs.7.07. Fuel Coal is a very important ingredient for the Boilers. The product wise requirement will be as follows: (i) Writing and Printing Paper – 500 units per MT of production, (ii) Coated duplex Board –714 units per MT of production and (iii) Kraft Paper and Poster Paper – 714 units and 1120 units per MT of production, respectively. Cost of fuel per unit will be Rs.1.50. Water PPML has its own tube well and will install turbine pumping set, overhead tank and water softening plant. Steam The mill has three numbers of Multitherm Boilers, operated with coal, two of which are having capacity of generating 4200 Kg per hour and the other having capacity of 5600 Kg per hour of steam. The steam generating system is fitted with pipelines and other accessories. Additional Information 1. Number of working days is 303 days in a year. The production will be carried out in 3 shifts in a day. The capacity utilization is expected to be as follows : Products Year 1 Year 2 Year 2 Year 4 onwards Writing and Printing Paper
65%
75%
85%
100%
Coated Duplex Board
65%
75%
85%
100%
Kraft Paper and Poster Paper 70% 80% 90% 100% The installed capacity product wise is as follows : (i) Writing and Printing Paper – 40 tonnes per day, (ii) Coated duplex Board – 60 tonnes per day and (iii) Kraft Paper and Poster Paper – 40 tonnes per day.
Products Writing and Printing Paper Coated Duplex Board Kraft Paper and Poster Paper : Kraft Paper Poster Paper are as follows:
Product Mix 100% 100% 75% 25%
2.
Raw material requirements
Requirement in (Kg) per tonne of production For Kraft Paper : Waste paper 1180 For Poster Paper : White cutting 1125 Wood Pulp 105 For Coated Duplex Board : Top Layer 250 Protective Layer 144 Filler Layer 625 Bottom Layer 192.5 For Writing & Printing Paper : RM1 (White Cutting) 750 RM2 (Exercise Book) 500 3. Consumables required are as follows: Year 1 Year 2 Cost of Consumables Writing and Printing Paper 87.19 100.60 Coated Duplex Board 254.71 293.89 Kraft Paper 28.97 33.11 Poster Paper 24.49 27.98 Total 395.36 455.58 4. Cost of Stores & Spares: Rs./MT of Output Coated Duplex Board : 253.00
Rate/Kg (Rs) 6.00 12.00 16.00 12.00 7.50 4.50 5.00 13.50 10.00
Year 3 114.02 333.08 37.24 31.48 515.82
Year 4 134.14 391.85 41.38 34.98 602.35
Year 5 134.14 391.85 41.38 34.98 602.35
: 206.00 Kraft Paper : 367.00 Poster Paper 5. Contingencies have to be provided on Building, Plant and Machinery and Miscellaneous Fixed Assets at the rate of 10% to comply with cost escalation. 6. Cost of Packing materials: Rs./MT of Output Writing & Printing Paper : 150 : Coated Duplex Board 150 : Kraft Paper 106 : Poster Paper 150
7. The margin money for working capital requirement of first year is to be included in the cost of the project. The following periodicities have been estimated for the computation of working capital: Particulars Days Raw Materials : 30 Consumables : 45 Packing Materials : 45 Work in Progress : 20 Finished Goods : 15 Debtors : 30 However, the margin money required for working expenses in different years are as follows: Particulars Year 1 Year 2 Year 3 Year 4 Year 5 Working Expenses (Rs. in Lacs) 39.15 44.48 49.90 57.50 57.64 8. Gross Selling price of final Product in Rs. per MT: Writing & Printing Paper : 32,000 Coated Duplex Board
:
25,350
Kraft Paper
:
21,500
Poster Paper
:
37,000
9. The promoter’s contribution would be Rs.8.00 crore. The remaining amount of share capital would be raised from market through an IPO of its common stock. The cost of primary issue of equity shares would be 5%. 10. IDBI, Vijaya Bank and Dena Bank have agreed on principle that it will provide a secured long-term loan of Rs. 45 crore to the Company in a consortium with IDBI acting as the lead banker. The rate of interest is 9% p.a. The principal amount of the loan is to be repaid in equal annual installments from the end of the first year itself. 11. Indian Overseas Bank (IOB), Commercial Branch has agreed to finance the working capital requirement to the extent of 75% of working capital requirement at an interest rate of 13 % p.a. 12. Depreciation Rates applicable to different categories of fixed assets are as follows: Particulars Buildings Machinery Miscellaneous Fixed Assets As per Companies Act 3.34% 10.34% 10.34% As per Income Tax Act 5% 20% 20% 13. Income tax rate applicable to the company is 30%. Surcharge applicable is 10.02%. 14. Other Operating Costs: (Rs. in Lac) Year 1 Year 2 Year 3 Year 4 Year 5 Effluent Treatment Cost 5.58 6.41 7.24 8.26 8.26 Repairs & Maintenance 76.73 88.28 99.83 115.50 115.50 Wages 50.75 50.75 52.02 53.32 54.65
15. Carriage outwards in Rs. in Lac: Year 1 Year 2 Year 3 Year 4
Year 5
122.76 141.24 159.72 184.80 184.80 16. General and Administrative Overheads amount to Rs.15 Lac for the first year. Thereafter it will increase constantly @ 5% for the next four years. 17. Selling and other expenses are assumed to be 3% on gross Sales. Excise payable is 12.36% on Gross Sales. 18. Cost of equity is 14%.
END OF SECTION D
Section E : Caselets (50 Marks) This section consists of questions with serial number 4 - 9. Answer all questions. Marks are indicated against each question. Do not spend more than 80 - 90 minutes on Section E.
Caselet 1 Read the caselet carefully and answer the following questions: 4.
The caselet states, “the quality of the results cannot be better than the quality of the input”. According to you what are the different events influencing the risk in a project. Discuss. (9 marks) < Answer >
5.
‘Uncertainty analysis is to a greater extent used as a support for decision-making in projects’. Discuss how you would propose to manage the risk of projects. (9 marks) < Answer >
Uncertainty analysis is to a greater extent used as a support for decision-making in projects. If used and implemented correctly the analysis may give the decision maker a view of uncertainties that may influence project accomplishment. There are different methods and techniques for evaluating uncertainties in a project; references are in this respect made to Chapman and Ward (2003, 2002 and 1997), Kendrick (2003), Kerzner (2003), Klakegg (1993), Lichtenberg (2000), Samset (2001) and Williams (1995). Common for all these methods and procedures are, presumably, that the quality of the results cannot be better than the quality of the input. On the other hand, the quality of the results can be worse than the input, if there are weaknesses in the procedure or the model (Stoelsnes, 2005). The largest source of “error” in uncertainty analysis is presumably the limitation inherent in the analysis team (the group of people carrying out the uncertainty analysis) and its ability to identify and evaluate uncertainties involved in the project. Their ability to set the “correct” confidence limit is also assumed to be a source of error (Stoelsnes, 2005). Regardless these sources of error, the optimal quality will, presumably, be only achieved when we obtain the highest possible quality of the input and the highest possible quality of the procedures and the calculation model.
It is further necessary to consider that carrying out an uncertainty analysis only has limited effect on project accomplishment if the results from it are not used, for instance by implementing an action plan and follow-up. The benefits of conducting an uncertainty analysis lie in identifying threats and opportunities in early stages of a project. By making uncertainty analysis, an ongoing activity that includes implementing an action plan, monitoring and updating with regards to uncertainties (herein abbreviated as uncertainty management), we may be able to eliminate, bypass and reduce possible threats. We will also be able to intensify and see that desirable events really happen during the execution of the project. Caselet 2 Read the caselet carefully and answer the following questions: 6.
Why should the profitability of an investment from the government or society’s perspective differ from the private investor’s perspective?’ Discuss. (7 marks) < Answer >
7.
‘In the traditional approaches to social cost benefit analysis, the private returns are calculated using actual market prices, and the social returns using shadow prices’. What are the traditional approaches to social cost benefit analysis? Also discuss the similarities and dissimilarities between the two approaches. (8 marks) < Answer >
Governments would be interested in supporting an infrastructure project only if the ‘social benefits’ exceed the ‘social costs’. Social returns are different from private returns, and there are difficulties in assessing the economic impact of very large projects. Economic Rate of Return (ERR) used by Multilateral Institutions such as the International Finance Corporation (IFC) is used to evaluate the developmental impact of large projects. The decision to go ahead with a social infrastructure project is critical for any host government. This is because the private sponsors and the government view the value of a large project differently. While the private sponsors would be willing to implement the project if its return is commensurate with the risks, governments would be interested in supporting a project, financially or otherwise, only if the ‘social benefits’ outweigh the ‘social costs’. In financial terms, the private sponsor of a large project would be looking for an attractive Internal Rate of Return (IRR) or Financial Rate of Return (FRR) from the project. However, the government supporting the project would look at a rate of return that would factor in, apart from the risks, the social costs and benefits as well—such a rate of return is called the Economic Rate of Return (ERR). Why should the profitability of an investment from the government or society’s perspective differ from the private investor’s perspective? Some of the difficulties in assessing social returns are: • Assessing the social impact of educating and training the workforce, not only on the workforce itself but also on the local and domestic economy; • Assessing the developmental impact of construction of schools, hospitals, housing, and other facilities that the project could bring with it; • Assessing the spin-off effects of investment in a particular industry, or locality on the larger goal of economic development; and • Assessing the multiplier effect of one large project on the community and the country. A look at the traditional approaches to social cost benefit analysis is appropriate before understanding the ERR approach being practiced by multilateral institutions like the IFC. Multilateral institutions such as the World Bank and its arms support private and public projects in developing countries with the objectives of reducing poverty and stimulating
economic growth. To participate in large projects of these countries, they need to understand and assess the private and social returns of the projects. In the traditional approaches to social cost benefit analysis, the private returns are calculated using actual market prices, and the social returns using ‘shadow prices’. The Multilateral institutions calculate the social return in two stages, also using shadow prices. ERR gives results similar to traditional social cost benefit analysis, but is more scientific in its approach. Being adopted and in the process of being improved by IFC, the ERR would be a powerful valuation tool for governments and public bodies to make decisions on the economic viability of infrastructure projects. Caselet 3 Read the caselet carefully and answer the following questions: 8.
“The difference between traditional and Critical Chain scheduling is in how uncertainty is managed”. Discuss the problems associated with traditional project scheduling. (7 marks) < Answer >
9.
“Using the Critical Chain Method, projects can be completed more quickly and with greater scheduling reliability”. In light of the caselet, discuss the important steps you would propose, to identify and manage a Critical Chain schedule. (10 marks) < Answer >
Product development projects, like many other types of projects, often can exceed their planned schedule by 50% to 100%. Often this is attributing to uncertainty or the unforeseen. To compensate for this age-old dilemma, managers and project personnel have learned to compensate by adding additional time to their schedule estimates. Yet even when they do, projects still overrun their schedules. The Critical Chain Method (CCM) is an outgrowth of the Theory of Constraints (TOC) developed by Eliyahu Goldratt to scheduling and managing manufacturing. TOC focuses on identifying and fixing bottlenecks in order to improve the throughput of the overall system. Likewise, Critical Chain focuses on bottlenecks. For example, one pharmaceutical company was experiencing significant delays with drug approvals. After investigation, it found that the bottleneck was statisticians to analyze clinical trial data. The cost of hiring statisticians was more than offset by the revenue from getting products to market sooner. Using the Critical Chain Method, projects can be completed more quickly and with greater scheduling reliability. The difference between traditional and Critical Chain scheduling is in how uncertainty is managed. In traditional project scheduling, uncertainty is managed by padding task durations, starting work as early as possible, multi-tasking, and focusing on meeting commitment dates. Critical Chain approach is perhaps the most important new development in project scheduling in the last 30 years. Used properly, the Critical Chain approach is an extremely powerful means of gaining more predictability, productivity and speed from project plans. It has been found to be an effective tool to protect projects from uncertainty and the effects of Murphy’s Law. This new approach to project management provides mechanisms to allow a “whole system” view of projects. It identifies and protects what’s critical from inevitable uncertainty, and as a result, avoids major impact of Parkinson’s Law at the task level while accounting for Murphy’s Law at the
project level. Project managers and teams need to shift their attention from assuring the achievement of task estimates and intermediate milestones to assuring the only date that matters – the final promised due date. Safety that is typically built into tasks to cover Murphy’s Law is inefficient, leading to longer than necessary (or acceptable) schedules, and apparently ineffective, given the impact of Parkinson’s Law from which many projects suffer. END OF SECTION E END OF QUESTION PAPER
Suggested Answers Project Management – II (242): January 2006 Section D : Case Study 1.
a.
Cost of project:
Rs. in Lacs
Land: Basic cost of land (52 acres @ Rs.8 Lacs per i. Acre) ii. Stamp duty @ 16% iii. Cost of leveling the site iv. Cost of laying internal roads v. Cost of approach roads vi. Cost of boundary walls and main gate vii. Cost of tube-well digging viii. Cost of construction of Main Gate
Rs. in Lacs
A
416.00 66.56 23.40 18.63 9.56 7.32 3.72 1.81
547.00
TOTAL B
Building and Civil Works:
i.
Factory Building Bonded ii. Warehouse Chemical & iii. Rags Godown iv. Machine Hall v. Boiler house Transformer vi. Room vii. Pulp Mill viii. Battery Room ix. Finishing House Waste paper x. Godown Finishing paper xi. Godown Hydropulper xii. Godown xiii Staff Quarters xiv Guest house xv. Other Sheds xvi. Cycle Sheds
Area (Square. Ft) 52814
Rate (@ Rs. per Square. Ft) 800
422.51
7744
500
38.72
7000
600
42.00
10472 2040
1000 1000
104.72 20.40
1757
500
8.79
10200 351.41 8976
1000 500 600
102.00 1.76 53.86
9525.09
600
57.15
4488
600
26.93
3048.5
600
18.29
4747 2797 9500 4500
500 800 50 50
23.74 22.38 4.75 2.25 950.23
TOTAL C i. ii. iii. iv. v.
Plant and Machinery:
(Machine-I) Writing and Printing Paper (Machine-II) Coated Duplex Board (Machine-III) Kraft Paper and Poster Paper Pulping Mills (3 Nos.) Drying Machines
705.00 910.00 756.00 115.00 85.00