DISTANCE LEARNING CENTRE

AHMADU BELLO UNIVERSITY

ZARIA-NIGERIA.

COURSE MATERIAL

FOR

Course Code & Title: BUAD 810: Investment And Project Analysis

Programme Title: Master in Business Administration (MBA)

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 COPYRIGHT PAGE

© 2018 Ahmadu Bello University (ABU) Zaria, Nigeria

All rights reserved. No part of this publication may be reproduced in any form or by any
means, electronic, mechanical, photocopying, recording or otherwise without the prior
permission of the Ahmadu Bello University, Zaria, Nigeria.

First published 2018 in Nigeria.

ISBN:

Ahmadu Bello University e‐Learning project,

Ahmadu Bello University
Zaria, Nigeria.

Tel: +234

E‐mail:

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COURSE WRITERS/DEVELOPMENT TEAM

Subject Matter Expert (s)

Dr. Mohammed Habibu Sabari
Chat Lot Kogi

Subject Matter Reviewers

Prof. Abiola Awosika

Halima Shuaibu

Language Reviewer
Enegoloinu Adakole

Instructional Designers/Graphics
Nasiru Tanko
Ibrahim Otukoya

Editor
Prof. Adamu Z. Hassan

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 QUOTE
“Open and Distance Learning has the exceptional ability of meeting the challenges of the three
vectors of dilemma in education delivery – Access, Quality and Cost”
‐ Sir John Daniels

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 TABLE OF CONTENT

Title Page
Acknowledgement Page
Copyright Page
Course Writers/Development Team
Table of Content

INTRODUCTION
Preamble
i. Course Information
ii. Course Introduction and Description
iii. Course Prerequisites
iv. Course Textbook(s)
v. Course Objectives and Outcomes
vi. Activities to Meet Course Objectives
vii. Time (To Complete Syllabus/Course)
viii. Grading Criteria and Scale
ix. Course Structure and Outline

STUDY MODULES
1.0 Module 1: A Conspectus to Investment Opportunities and Investment Decisions under
Risk and Uncertainty situations
Study Session 1: Investment and Projects
Study Session 2: Basic Investment Appraisal Techniques
Study Session 3: Probability Index
Study Session 4: Risk and Uncertainty
2.0 Module 2: Investment Decision’s programming approach and Investment Cost of
Capital Evaluation
Study Session 1: Linear Programming
Study Session 2: Simplex Approach to solving Linear Programming
Study Session 3: Cost of Capital
Study Session 4: Cost of Short-term Borrowing
3.0 Module 3: Evaluation of Non-monetary Aspects of Projects and Further Issues on
Investment and Project Appraisal
Study Session 1: Cost-benefit Analysis
Study Session 2: of Market Price in the Valuation of Costs and Benefits
Study Session 3: Choice of Interest Rates and Relevant Constraints
Cost-benefit Analysis

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Study Session 4: Technical Analysis
Study Session 5: Feasibility Studies

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 INTRODUCTION
i. COURSE INFORMATION
Course Code: BUAD 810
Course Title: Investment and Project Analysis
Credit Units: 3 credit units
Year of Study: Two
Semester: First

ii. COURSE INTRODUCTION AND DESCRIPTION

With the existence of various investment opportunities that cannot all be attained
due to resource limitations, the choices of the most relevant ones become
paramount. This has become more crucial as some of the opportunities are
competitive, some complementary, while others appear mutually exclusive, and
still others are independent. The choice of the most appropriate investment
opportunity among others can only be possible, by having an in-depth
understanding of the methodologies used in the selection and appraisal of
investment decisions.

The subject matter under study is made up of key concepts that have to do with
investments and project analysis. The concepts are presented to provide an insight
into the theory and practice of investments, focusing on investment portfolio
formation and management issues surrounding the formation. Emphases are given
to both theoretical and analytical aspects of investment decisions based on modern
approaches and instruments.

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The course is designed in such a way that you as a target audience is provided with
basic investment and project concepts, theories, appraisal techniques and their
areas of application in decision-making. This has become necessary due to
resource constraints facing each and every organisation, whether private or public.
It is presented in a concise and clear pattern, in order to aid the audience to have a
quick understanding of the subject matters under study. The outline is structured to
applying appraisal techniques to the real world situations.

iii. COURSE PREREQUISITES

You should note that although this course has no subject pre-requisite, you are
expected to have:
1. Satisfactory level of English proficiency
2. Basic Computer Operations proficiency

iv. COURSE LEARNING RESOURCES

You should note that there are no compulsory textbooks for the course.
Notwithstanding, you are encouraged to consult some of those listed for further
reading at the end of each study session.

v. COURSE OUTCOMES
After studying this course, you should be able to:
1. Describe and analyse the investment environment and different types of
investment vehicles;
2. Use the quantitative methods for investment decision making;
3. Analyse the meaning and significance of ‘investment’ and ‘investment
appraisal’;

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 4. Complete the cost-benefit analysis of various projects;
5. Describe how cost-benefit analysis has evolved over time;
6. Discuss the meaning and significance of ‘project’ and ‘project appraisal’;
7. Assess ‘project cycle’ and different aspects of project analysis.

vi. ACTIVITIES TO MEET COURSE OBJECTIVES

The key to success in investment and project analysis is for you to study each topic
slowly, in order to ensure full apprehension before moving onto the next one. In
the event any topic is not fully understood, there is every need to go through it over
and over again by re-working illustrations in the topic. This is based on the fact
that practice plays significant role in understanding subjects that deals with
computation issues.
On the basis of the above, there is going to be lecture guiding materials written in
clear and concise nature that will aid and guide you in understanding the subject
matter under study. Video lectures that address ambiguous areas are also going to
be provided. Relevant sites and standard reference books are also going to be used.
There are going to be series of group and individual assignments and you are
expected to do and submit them within the defined time limit. This is also to serve
as part of your assessment.

Provision of my email address and telephone line(s) are to enable you seek
clarification on things that are not clear to you. Also, tutorials will be arranged
within the two weeks on campus activities in which questions will be clarified to
enable you understand fully what you’ve learnt.

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Specifically, this course shall comprise of the following activities:
i. Studying courseware
ii. Listening to course audios
iii. Watching relevant course videos
iv. Field activities, industrial attachment or internship, laboratory or
studio work (whichever is applicable)
v. Course assignments (individual and group)
vi. Forum discussion participation
vii. Tutorials (optional)
viii. Semester examinations (CBT and essay based)

vii. TIME (TO COMPLETE SYLABUS/COURSE)

It is expedient that you patiently read through the study sessions, and consult the
suggested texts and other related materials. The study sessions contain self-
assessment questions to help you. As such, you are advised to devote at least 3
hours every day for this course.

viii. GRADING CRITERIA AND SCALE

Grading Criteria
A. Formative assessment
Grades will be based on the following:
Individual assignments/test (CA 1,2 etc) 20
Group assignments (GCA 1, 2 etc) 10
Discussions/Quizzes/Out of class engagements etc 10

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B. Summative assessment (Semester examination)
CBT based 30
Essay based 30
TOTAL 100%

C. Grading Scale (as appropriate for the course):

A = 70-100
B = 60 – 69
C = 50 - 59
D = 45-49
F = 0-44

D. Feedback
Courseware based:
1. In-text questions and answers (answers preceding references)
2. Self-assessment questions and answers (answers preceding references)

Tutor led:
1. Discussion Forum tutor input
2. Graded Continuous assessments

Student led:
1. Online programme assessment (administration, learning resource,
deployment, and assessment)

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 viii. COURSE STRUCTURE AND OUTLINE
Course Structure
WEEK/DAYS MODULE STUDY SESSION ACTIVITY

1 Study Session 1: 1. Read Courseware for the corresponding Study Session.

2. Listen to the Audio on this Study Session
Investment and 3. View any other Video/U-tube (https://goo.gl/8b8hNc )
Projects 4. View referred Animation (https://goo.gl/AvLA5x )

2 Study Session 2 1. Read Courseware for the corresponding Study Session.

2. Listen to the Audio on this Study Session
Basic Investment 3. View any other Video/U-tube (https://goo.gl/cSXDpd )
Appraisal Techniques 4. View referred Animation (https://goo.gl/mdw2nC )

3 Study Session 3 1. Read Courseware for the corresponding Study Session.

STUDY 2. Listen to the Audio on this Study Session
Probability Index 3. View any other Video/U-tube (https://goo.gl/yB1Rti )
MODULE 1
4. View referred Animation (https://goo.gl/rgYpno )

4 Study Session 4 1. Read Courseware for the corresponding Study Session.

2. Listen to the Audio on this Study Session
Risk and Uncertainty 3. View any other Video/U-tube (https://goo.gl/a2uZR4 )
4. View referred Animation (https://goo.gl/C1Rikp )

5 Study Session 1 1. Read Courseware for the corresponding Study Session.

2. Listen to the Audio on this Study Session
Linear Programming 3. View any other Video/U-tube (https://goo.gl/YuAKow )
4. View referred Animation (https://goo.gl/5Hh2PY )
STUDY
6 Study Session 2 1. Read Courseware for the corresponding Study Session.
2. Listen to the Audio on this Study Session

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 MODULE 2 Simplex Approach to 3. View any other Video/U-tube (https://goo.gl/LqP28e )
solving Linear 4. View referred Animation (https://goo.gl/6kj3FL )
Programming

7 Study Session 3 1. Read Courseware for the corresponding Study Session.

2. Listen to the Audio on this Study Session
Cost of Capital 3. View any other Video/U-tube (https://goo.gl/LV2f3W )
4. View referred Animation (https://goo.gl/9J2PXT )

8 Study Session 4 1. Read Courseware for the corresponding Study Session.

2. Listen to the Audio on this Study Session
Cost of Short‐term 3. View any other Video/U-tube (https://goo.gl/JiyHyE )
Borrowing 4. View referred Animation (https://goo.gl/Wr2uvH )

9 Study Session 1 1. Read Courseware for the corresponding Study Session.

2. Listen to the Audio on this Study Session
Cost‐benefit Analysis 3. View any other Video/U-tube (https://goo.gl/XduzS2 )
4. View referred Animation (https://goo.gl/3AhJgF )

10 Study Session 2 Title: 1. Read Courseware for the corresponding Study Session.
of Market Price in 2. Listen to the Audio on this Study Session
the Valuation of 3. View referred OER (https://goo.gl/xQykxW )
STUDY
Costs and Benefits 4. View referred Animation (https://goo.gl/ZcVTEZ )
MODULE 3
11 Study Session 3 1. Read Courseware for the corresponding Study Session.
2. Listen to the Audio on this Study Session
Choice of Interest 3. View any other Video/U-tube (https://goo.gl/Mp6GG9 )
Rates and Relevant 4. View referred Animation (https://goo.gl/rgtuKo )
Constraints
Cost‐benefit Analysis

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 12 Study Session 4 1. Read Courseware for the corresponding Study Session.
2. Listen to the Audio on this Study Session
Technical Analysis 3. View any other Video/U-tube (https://goo.gl/ZG8uny )
4. View referred Animation (https://goo.gl/VCtBjW )

13 Study Session 5 1. Read Courseware for the corresponding Study Session.

2. Listen to the Audio on this Study Session
Feasibility Studies 3. View any other Video/U-tube (https://goo.gl/1WyzzV )
4. View referred Animation (https://goo.gl/qjc6gx )

Week 14 & 15 REVISION/TUTORIALS (On Campus or Online)

Week 16 & 17 SEMESTER EXAMINATION

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Course Outline
MODULE 1: A Conspectus to Investment Opportunities and Investment
Decisions under Risk and Uncertainty situations
Study Session 1: Investment and Projects
Study Session 2: Basic Investment Appraisal Techniques
Study Session 3: Probability Index
Study Session 4: Risk and Uncertainty

MODULE 2: Investment Decision’s programming approach and

Investment Cost of Capital Evaluation
Study Session 1: Linear Programming
Study Session 2: Simplex Approach to solving Linear Programming
Study Session 3: Cost of Capital
Study Session 4: Cost of Short-term Borrowing

MODULE 3: Evaluation of Non-monetary Aspects of Projects and Further

Issues on Investment and Project Appraisal
Study Session 1: Cost-benefit Analysis
Study Session 2: of Market Price in the Valuation of Costs and Benefits
Study Session 3: Choice of Interest Rates and Relevant Constraints
Cost-benefit Analysi
Study Session 4: Technical Analysis
Study Session 5: Feasibility Studies

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 STUDY MODULES
1.0 MODULE 1: A Conspectus to Investment Opportunities and
Investment Decisions under Risk and Uncertainty situations
Contents:
Study Session 1: Investment and Projects
Study Session 2: Basic Investment Appraisal Techniques
Study Session 3: Probability Index
Study Session 4: Risk and Uncertainty

STUDY SESSION 1
Investment and Projects
Section and Subsection Headings:
Introduction
1.0 Learning Outcomes
2,0 Main Content
2.1 - Investment
2.2- Types of investments
2.3- Determination of economic cost of projects
2.4- Computation of the Economic Life of a Project
3.0 Study Session Summary and Conclusion
4.0 Self-Assessment Questions
5.0 Additional Activities (Videos, Animations & Out of Class activities)
7.0 References/Further Readings

Introduction:
In this study session you will be introduced to the definition of investment, types
of investments, steps involved in analysing capital projects which will form the
basis of our discussion.

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1.0 Study Session Learning Outcomes
After studying this study session, I expect you to be able to:
1. Define investment
2. Explain the types of investment
3. Describe how to determine economic cost and economic life of projects.

2.0 Main Content

2.1. Investment
Investment could be in real or financial form. Real investments generally
involve some kind of tangible assets, such as land, machinery and factories.
Investment is an activity that is engaged in by people, who have savings i.e.
investments are made from savings, or in other words people invest their
savings, but all savings are not investment.

Investment may be defined as a commitment of funds made in the

expectations of some positive rate of return. Expectation of returns is an
essential element of an investment.
In the financial sense, investment is the commitment of a person’s fund to
derive future income in the form of profit, dividend premium, pension benefit,
or appreciation, in the value of their capital. Example: purchasing of shares,
debentures, post office saving certificates, insurance policies are all investments
in the financial sense, such investment generates financial assets.
In the economic sense, investment means the net addition to the economy’s
capital stock, which consists of
goods, and services that are used in
the production of other goods and
services. Example: new
constructions of plants and

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machines, inventories etc.
Financial investments involve contracts in paper or electronic form such as
stocks and bonds. In a nut shell, investment simply means a conscious act of
an individual, or any entity that involves deployment of money (cash) in
securities or assets issued by any financial institution, with a view to obtain
the target returns over a specified period of time. The target returns on an
investment include:
1. Increase in the value of the securities or asset, and/or
2. Regular income must be available from the securities or asset.

In-text Questions 1
1. What is investment in both financial and economic sense?

2.2. Types of Investments

There are various types of investments as depict by the following chart:
1. Autonomous Investment is an investment that does not change with the
changes in income level. It remains constant irrespective of income level. This
means that even if the income is low, the autonomous investment remains the
same. It refers to the investment made on houses, roads, public buildings
and other parts of Infrastructure. The government normally makes such type
of investment and that is why it is sometimes called government investment.
2. Induced Investment is an investment which changes with the changes in the
level of income. It is positively related to the income level. That is, at high
levels of income, entrepreneurs are induced to invest more and vice-versa. At a
high level of income, consumption expenditure increases and this leads to an
increase in investment of capital goods, which are used to produce more
consumer goods.
3. Financial investment is an investment made in buying financial instruments
such as new shares, bonds, securities, etc. The money used for purchasing

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existing financial instruments such as old bonds, old shares, etc., is however not
considered as financial investment. It is a mere transfer of a financial asset from
one individual to another. In financial investment, money invested for buying
of new shares and bonds as well as debentures have a positive impact on
employment level, production and economic growth.
4. Real investment is an investment made in new machine tools, plant and
equipment, factory buildings, etc. It leads to increase in employment,
production and economic growth of the nation.
5. Planned investment also called intended investment is an investment made,
based on concrete plan to cater for several sectors of the economy. The opposite
of planned investment is unplanned, in which the investment is made arbitrarily
without considering specific objectives while making the investment decision.
6. Gross investment means the total amount of money spent or invested for
creation of new capital assets like plant and machinery, factory building etc in a
given period.
7. Net investment is an investment figure arrived at
after deducting capital consumption (depreciation)
figure, from the gross investment figure during a
period, usually a year.

In-text Questions 2
1. What are the types of investment?

As earlier stated, the term “investment” means something different to economists

from what it means to other people. When for example, from accounting
perspective investment is viewed from transactions on financial assets, economists
usually reserve the term investment for transactions that increase the magnitude of
real aggregate wealth in the economy. To an economist, financial assets such as
loans and bank accounts represent contracts to pay interest, and repay principal on

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borrowed money and they do not represent real net worth in the economy as a
whole. Economists argue that whenever someone invests in financial assets, there
is also someone else that disinvests at the same time, and on the overall, the effect
is nil.
There are so many theories and principles governing investment, both from
economic and non-economic perspectives. Some of these theories and principles
are briefly explained thus:
Efficient Market Hypothesis (EMH) states that, the market price for shares
incorporates all the known information about that stock. This means that the stock
is accurately valued until a future event changes that valuation. Since the future is
uncertain, an adherent to EMH is far better off owning a wide swath of stocks and
profiting from the general rise of the market.
Fifty percent principle predicts that before continuing, an observed trend will
undergo a price correction of one-half to two-thirds of the change in price. This
means that if a stock has been on an upward trend and gained 20%, it will fall
back 10% before continuing its rise.
Greater fool theory proposes that you can profit from investing as long as there
is a greater fool than yourself to buy the investment at a higher price. This means
that you could make money from an overpriced stock, as long as someone else is
willing to pay more to buy it from you. Eventually you run out of fools as the
market for any investment overheats. Investing according to the greater fool
theory means you ignoring valuation, earnings reports and all other data.
Prospect theory states that people's perceptions of gain and loss are skewed. That
is, people are more afraid of a loss than they are encouraged by a gain. If people
are given a choice of two different prospects, they will pick the one that they think
has less chance of ending in a loss, rather than the one that offers the most gains.

In-text Questions 3
1. What are the theories and principles governing investment?

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2.3. Determination of Economic Cost of Projects
I want you to know that investment decision is the most crucial decision taken by
a financial manager. In the case of real investment for instance, the financial
manager must determine whether or not to expand or replace the existing fixed
assets. The plans to expand production capacity and to purchase plant, machinery,
and equipment over a period of time are termed capital budget and the decision-
process necessary to make rational selection from various alternatives is known as
capital budgeting.
Capital budgeting plans differ from current assets expenditure from two
perspectives namely; the quantum of the money involved and the reversibility
of the decision once made. In the case of capital expenditure, the amount of
money involved is huge compared to current asset expenditure, and after making
decision on executing it and resources committed, it is very difficult to reverse
unlike in the case of current asset expenditure.
The underlying concept implied in capital budgeting is that money has a time
value, that is, a naira to be received tomorrow does not have the same value as a
naira received today. This therefore calls for very careful evaluation of possible
investments and the selection is to be based on the most profitable ones, keeping
in mind the availability of funds and the risks implications. Hence, you should
understand that financial evaluation of projects involves two broad procedures: (i)
the development of a financial standard or minimum profit goal for the company,
against which the individual proposed projects can be judged; and (ii) the use of
some mathematical technique to rate and rank individual projects in terms of
prospective profitability and relative acceptability and desirability.

2.4- Computation of the Economic Life of a Project

Basically speaking, the decision whether or not to undertake any proposed project
usually involves four steps:
1. Calculation of the economic cost of the project, which is measured in terms

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 of cash outflow to acquire a source of income.
2. Computation of the economic life of the project, which is measured in
terms of the duration of the stream of benefits, that is likely to flow back
from the project.
3. Measurement of the relationship between the cost and intake, i.e. rate of
return which is calculated by dividing the original cost of the project by the
net cash inflow.
4. Acceptance or rejection of a proposal after taking into account the risk
involved in investment. When taking this decision, it
will be rational to accept a project that affords a more
moderate yet more secure return, in relation to a
project that provides a higher but riskier return.

3.0 Conclusion/Summary
In this study session, we have discussed what an investment is, types of
investment, steps involved in analysing capital project as well as
determination of economic cost of project, and we also looked at some
theories of investment. We concluded with computation of economic life of
a project.

4.0 Self-Assessment Questions

1. Analyse the various definitions of investment
2. Discuss the types of investment
3. What is an efficient market hypothesis?
4. What are the determinants of economic cost of projects?
5. Discuss the computation of the economic life of a project.
6. What is the purpose of capital investment appraisal?
7. What do you understand by the assumption of certainty of cash flows?

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 8. What are the main steps when making a decision about a capital
investment?
9. What is the payback method of evaluating a project?
10. What are the advantages and limitations of the payback method?
11. What is the accounting rate of return?

6.0 Additional Activities (Videos, Animations & out of Class activities)

a. Visit U-tube add https://goo.gl/8b8hNcWatch the video & summarise in 1
paragraph

b. View the animation on add/site https://goo.gl/AvLA5xand critique it in the

discussion forum

Answer 1
1. In the financial sense, investment is the commitment of a person’s fund to derive future
income in the form of profit, dividend premium, pension benefit, or appreciation, in the value
of their capital.
In the economic sense, investment means the net addition to the economy’s capital stock,
which consists of goods, and services that are used in the production of other goods and
services.
Answer 2
1. Autonomous investment, induced investment, financial investment, real investment,
planned investment, gross investment.
Answer 3
1. Efficient market hypothesis, Fifth percent principle, Greater fool theory and prospect
theory.

7.0 References/Further Readings

Brounen, D., de Jong, A. and Koedijk, K. (2004) ‘Corporate finance in
Europe: confronting theory with practice’, Financial Management,
Tampa, USA. 33(4): 71–101.
Read: Lucey, T. (2000) Quantitative Techniques: An Instructional Manual
ELBS Ed. Pp. 377-421.

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 STUDY SESSION 2
Basic Investment Appraisal Techniques
Section and Subsection Headings:
Introduction
1.0 Learning Outcomes
2,0 Main Content
2.1 - Basic Investment Appraisal Techniques
4.0 Study Session Summary and Conclusion
5.0 Self-Assessment Questions
6.0 Additional Activities (Videos, Animations & out of Class activities)
7.0 References/Further Readings

Introduction:
You are welcome to another study session. In this study session, you will know
the basic investment appraisal techniques which
includes the accounting rate of return, the payback
period, the internal rate of return which will form the
basis of our discussion.

1.0 Study Session Learning Outcomes

After studying this study session, I expect you to be able to:
1. Explain traditional appraisal techniques;
2. Describe why Discounted Cash Flow (DCF) techniques are used;
3. compute and interpret Net Present Value (NPV);
4. explain Internal Rate of Return;
5. compute various methods of evaluating risks and uncertainty of projects;
6. compute and interpret Net Present Value (NPV);
7. explain Internal Rate of Return;
8. be able to compute various methods of evaluating risks and uncertainty of

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 projects;
9. Utilise Discounted Cash Flow (DCF) techniques.

2.0 Main Content

2.1. Basic investment appraisal techniques
Two particular methods of comparing the attractiveness of competing projects is
known as the ‘traditional techniques’. These are the Accounting Rate of Return
(ARR) and Payback Period (PP).

Accounting Rate of Return

ARR is basically the ratio of the average annual profits, after depreciation, to
the capital invested. Variations may exist when it comes to looking at the
definition of profit and capital. Some consider profit before tax, others may
consider after tax. Capital may or may not include working capital. ARR is
usually defined as the ratio of accounting profit earned in a particular period to
the book value, of the capital employed in the period.
Capital invested may mean the initial capital invested or the average of the
capital invested over the life of the project. Sometimes ARR is called Return on
Capital Employed (ROCE).

Payback Period
The PP is the length of time required for a stream of net cash inflows, from a
project to equal the original cash outlay. The usual decision rule is to accept the
project with the shortest payback period. Payback is considered to be the most
widely used technique.
The fact that investment appraisal is concerned with long run decisions, where
costs and income arise at intervals over a period; there is the need to take into
consideration the time value of money, by either discounting or compounding

25
methods. Some of the discounting methods frequently used are Net Present
Value (NPV) and Internal Rate of Return (IRR).

In-text Questions 1
1. What are the two particular methods of comparing the attractiveness of competing
projects?

The Net Present Value

The process of calculating present value is called discounting. The interest rate
used is called the discount rate. The net present value method of investment
appraisal and the internal rate of return method are both based on discounting.
The net present value of a project is equal to the present value of the cash
inflows minus the present value of the cash outflows, all discounted at the cost
of capital.
The decision rules for NPV are:
– Where the NPV of the project is positive, accept the project.
– Where the NPV is negative, reject the project.
– Where the NPV of the project is zero, the project is acceptable in meeting the
cost of capital but gives no surplus to its owners.

The Internal Rate of Return

The IRR is the discount rate at which the present value of the cash flows
generated by the project, is equal to the present value of the capital invested, so
that the net present value of the project is zero.

The decision rules for IRR are:

– Where the IRR of the project is greater than the cost of capital, accept the
project.
– Where the IRR of the project is less than the cost of capital, reject the project.
– Where the IRR of the project equals the cost of capital, the project is

26
 acceptable, in meeting the required rate of return of those investing in the
business but gives no surplus to its owners.

Other vital factors to consider when it comes to investment and project analysis
are the risks and uncertainty. In general, risky or uncertain projects are those
whose future cash flows, and hence the returns on the project, are likely to be
variable. The greater the variability of a project, the greater the risk involved.
Risk relates to insurable events, such as risk of fire or theft and the probability
of outcomes of these events can be estimated on the basis of past experience.
Some business decisions are unique in that, no past experience throws any light
whatever on their chances of success and such form of businesses is considered
as uncertain.
Uncertainties may be divided into two kinds, human uncertainties and physical
uncertainties. The human uncertainties include such events as, the reactions of
competitors, the police and the governments, and the attitudes of workers
towards innovations. The physical uncertainties relate to whether some new
bottlenecks will appear in the transition from innovation to invention, or
whether the product will have the properties expected of it.
Some of the methods that provide sufficient insight
into the importance of risk coverage are risk-adjusted
discount rate Method, certainty equivalents and
Probability Analysis.

In-text Questions 2
1. What are the basic investment techniques?

3.0 Conclusion/Summary
In this study session we discussed various investment appraisal techniques such
as accounting rate of return, payback period, internal rate of return and present

27
value method.

4.0 Self-Assessment Questions

1. What are the advantages and limitations of the payback method?
2. What is the accounting rate of return?
3. What are the advantages and limitations of the accounting rate of return,
as a technique for use in capital investment appraisal?
4. What are the advantages and limitations of the accounting rate of return,
as a technique for use in capital investment appraisal?
5. What do you understand by the time value of money?
6. What do you understand by the present value of a cash flow?
7. What do you understand by ‘discounting’?
8. Define net present value and explain how it is calculated.
9. State the net present value decision rule to be used in capital investment
appraisal.
10. How is the cost of capital decided upon?
11. Define internal rate of return and explain how it is calculated.
12. State the internal rate of return decision rule to be used in capital
investment appraisal.

6.0 Additional Activities (Videos, Animations & out of Class activities)

a. Visit U-tube add https://goo.gl/cSXDpd Watch the video & summarise in 1
paragraph

b. View the animation on add/site https://goo.gl/mdw2nC and critique it in the

discussion forum

Answer 1
1. It is known as the ‘traditional techniques’. These are the Accounting Rate of Return (ARR)
and Payback Period (PP).
Answer 2

28
1. The accounting rate of return, the payback period, the net present value and the internal
rate of return.

7.0 References/Further Readings

Brounen, D., de Jong, A. and Koedijk, K. (2004) ‘Corporate finance in
Europe: confronting theory with practice’, Financial Management. Tampa,
USA. 33(4): 71–101.
Read: Lucey, T. (2000) Quantitative Techniques: An Instructional Manual
ELBS Ed. Pp. 377-421.

29
 STUDY SESSION 3
Profitability Index
Section and Subsection Headings:
Introduction
1.0 Learning Outcomes
2,0 Main Content
2.1 - The profitability index
4.0 Study Session Summary and Conclusion
5.0 Self-Assessment Questions
6.0 Additional Activities (Videos, Animations & out of Class activities)
7.0 References/Further Readings

Introduction:
In this study session, you are introduced to profitability index using net present
value method, as well as comparing net present value and profitability index,
which will form the basis of our discussion.

1.0 Study Session Learning Outcomes

After studying this study session, I expect you to be able to:
1. define profitability index.
2. compare net present value with profitability index.
3. compare net present value with internal rate of return.

2.0 Main Content

2.1. The profitability index
The "Profitability Index" (PI) is simply the ratio between the
net present value (NPV, the sum of the discounted cash flows
of a project over its lifetime, including the initial investment

30
period) and its initial investment cost. It is used in industry and business as an
indicator of the profitability of a project, but a recent simple and innovative
analysis has shown that its advanced use gives access to a comprehensive,
reliable and simple way to analyse the profitability of all kinds of investment
projects. The profitability index method (PIM) is an adequate tool which can
give a competitive advantage, to assess at a very preliminary stage the
profitability of a simple project, to choose on a sound basis between various
options of investments.

In-text Questions 1
1. What is profitability index?

PI= Present Value of Inflows/Present Value of Outflows

PI Decision Rules
For Independent Projects
PI > 1 Accept Project
PI = 1 Indifferent
PI < 1 Reject Project
For Mutually Exclusive Projects
Take the project with the largest PI, Subject to PI > 1.

Net Present Value

Net Present Value is an evaluation method used by financial managers to
determine the overall value of a project (or a series of cash flows). NPV
represents the value in today’s dollars of all future cash flows. As you know, the
value of money received today is worth more (assuming you can earn interest)
than money received in the future. Thus, money received in the future must be
“discounted” to estimate its Present Value.

31
The Net Present Value (NPV) of a project is defined as the present value of
the cash inflows minus the present value of the cash outflows.

 Comparison of Net Present Value with Profitability Index

Net present value and profitability index techniques of capital investment are
closely related, both provide the same result as far as accept - reject
decisions are concerned. This is so because under NPV method, a proposal is
acceptable if it gives positive net present value and under PI method a proposal
is acceptable if the profitability index is greater than one.
The PI will be greater than one only when the NPV is positive and hence the
given identical accept-reject decisions. However, in case of mutually exclusive
proposals, having different scales of investment in the alternative proposal is not
the same.

 Comparison of Net Present Value and Internal Return

The results based on the calculations using the net present value and the internal
rate of return are often competing, in the technical literature of investment
profitability calculations. Decisions are usually made based on excess profits
above the rate of return requirements, calculated by the net present value
principle.

The net present value is determined by using the calculative rate of interest
(capital profit sacrifice cost) the minimum required
yield, the value of which can be derived from the
market, shows the amount of the increase in assets that
was created by the investment during its life span of
use, but does not give any information about the actual

32
profitability of the capital investment. On the other hand, the internal rate of
return supplies the decision maker with information about the way the real yield
of the long-term engrossed capital is created Illés (2008).

In-text Questions 2
1. What is net present value?

3.0 Conclusion/Summary
In this study session, we discussed profitability index as well as the decision
rule and we went further to look at comparison of net present value and
profitability index as well as comparison of net present value with internal rate
of return.

4.0 Self-Assessment Questions

1. What do you understand by time value of money?
2. What do you understand by the present value of a cash flow?
3. What is ‘discounting’?
4. Define net present value and explain how it is calculated.
5. State the net present value decision rule to be used in capital investment
appraisal.

6.0 Additional Activities (Videos, Animations & Out of Class activities)

a. Visit U-tube add https://goo.gl/yB1RtiWatch the video & summarise in 1
paragraph

b. View the animation on add/site https://goo.gl/rgYpno and critique it in the

discussion forum

Answer 1
1. The "Profitability Index" (PI) is simply the ratio between the net present value (NPV, the
sum of the discounted cash flows of a project over its lifetime, including the initial investment
period) and its initial investment cost

33
Answer 2
1. Net Present Value is an evaluation method used by financial managers to determine the
overall value of a project (or a series of cash flows).

7.0 References/Further Readings

Brealey-Myers (1992) Modern vállalati pénzügyek 1(Modern Corporate
Finance. Panem Kft., Budapest.
Chikán, A. (2008) Vállalatgazdaságtan (Company Economics) Aula Kiadó,
Budapest.
Illés I-né (2002) Társaságok pénzügyei (Finances of Companies), Saldo,
Budapest.
Illés, M. (2008) Vezetői gazdaságtan (Managerial Economics), Kossuth Kiadó,
Budapest.

34
 STUDY SESSION 4
Risk and Uncertainty
Section and Subsection Headings:
Introduction
1.0 Learning Outcomes
2,0 Main Content
2.1 - What is Risk and Uncertainty?
2.2- Methods of Evaluating Risk and Uncertainty
4.0 Study Session Summary and Conclusion
5.0 Self-Assessment Questions
6.0 Additional Activities (Videos, Animations & out of Class activities)
7.0 References/Further Readings

Introduction:
This study session will equip your knowledge on the concept of risk and
uncertainty and also the methods of evaluating risk and uncertainty.

1.0 Study Session Learning Outcomes

After studying this study session, I expect you to be able to:
1. Understand the concept of risk and uncertainty
2. Understand the methods of evaluating risk and uncertainty.

2.0 Main Content

2.1. What is Risk and Uncertainty?
When you ask managers how they define risk, most of them instead, distinguish
different types of risks, such as fire risk, financial risk, technical risk,
commercial risk, and investment risk. They say that a risky situation is a
situation where the outcome is unknown to the decision-maker, i.e. he/she is
not sure which outcome will occur and this uncertainty leads to erroneous

35
choices. When the managers were asked to describe a risky decision they had
recently made, or a risky situation they had been involved in, more than half of
them associated this with different kinds of investment activities and divided
them into such categories as:
(a) investing in new machines and techniques,
(b) acquisition of new companies,
(c) development of new products and entering new markets.

They were uncertain about whether they would reach the expected production
speed within the scheduled time, if they would be able to produce top quality
paper, and the reliability of the new machines. One manager said, “New
techniques are always riskier than old techniques. So, we must decide if we, for
example, want to be first in a new market or the first with a new product, or if
we should hold back for a while and enter the market as number two. Another
risky area pointed out by a manager was that they were very vulnerable,
concerning issues related to information technology.

Risk involves choices with multiple outcomes, where the probability of each
outcome is known or can be estimated. Uncertainty, on the other hand,
involves situations involving multiple outcomes, in
which the probability of each outcome is unknown or
cannot be estimated. There are two sources of
uncertainty. Uncertainty with complete ignorance
refers to those situations in which no assumptions can
be made about the probabilities of alternative outcomes under different
states of nature.
Uncertainty with partial ignorance refers to those situations in which the
decision maker is able to assign subjective probabilities

36
to possible outcomes. These subjective probabilities may be based on personal
knowledge, intuition, or experience. The process of decision making under
conditions of partial ignorance is effectively the same as decision making under
risk.

Uncertainty with complete ignorance requires alternative approaches to the

decision-making process.

In-text Questions 1
1. What is the difference between risk and uncertainty?

2.2. Methods of Evaluating Risk and Uncertainty

Risk may be measured as the dispersion of the all possible payoffs. The most
commonly used measure of the dispersion of possible outcomes is the variance.
The variance is the weighted average of the squared deviations of all possible
random outcomes from its mean, where the weights are the probabilities of each
outcome. An alternative way to express the riskiness of a set of random
outcome is the standard deviation. The standard deviation is the square root of
the variance.
Neither the variance nor the standard variation can be used to compare risk
involving two or more risky situations, involving different expected values. The
coefficient of variation is used to compare the relative riskiness of alternative
outcome. The project with the lowest coefficient of variation is the least risky.
Whether an individual undertakes a risky project will depend on the individual’s
attitude toward risk. An individual is said to be risk averse when that individual
prefers a certain payoff to a risky prospect with the same expected value. While
an individual is said to be a risk lover when that individual prefers the expected
value of a risky prospect to its certainty equivalent.

37
An individual is risk neutral when the individual is indifferent about a certain
payoff and its expected value. Generally speaking, most individuals are risk
averse because of the principle of the diminishing marginal utility of money.
Most individual, however, are not risk averse under all circumstances. It is not
unusual to find that even extremely risk-averse individuals become risk lovers
for “small” gambles, such as buying a lottery ticket where the cost of the ticket
is greater than the expected value of winning.
In-text Questions 2
1. The most commonly used measure of the dispersion of possible outcomes is called the …..

 Risk-Adjusted Discount Rate Method

The risk-adjusted discount rate method, where differential project risk is dealt
with by changing the discount rate: Average-risk projects are discounted at the
firm’s corporate cost of capital, above-average-risk projects are discounted at a
higher cost of capital, and below-average-risk projects are discounted at a rate
below the corporate cost of capital.

 Certainty Equivalents The certainty equivalent (CE) method follows

directly from the concept of utility
theory. Under the CE approach, the
decision maker must first evaluate a
cash flow risk and then specify how
much money, to be received with
certainty will make him or her indifferent from the riskless and the risky
cash flows. The certainty equivalent concept can be applied to capital
budgeting decisions, at least in theory, in the following way:
1. Estimate the certainty equivalent cash flow in each Year t, CE t, based on the
expected cash flow and its riskiness.
2. Given these certainty equivalents, discount by the risk-free rate to obtain the

38
project NPV.

In-text Questions 3
1. What is the difference between risk averse, risk lover and risk neutral?

3.0 Conclusion/Summary
In this study session, we have discussed risk and uncertainty, method of
evaluating risk and uncertainty of project, we went further to risk-adjusted
discount rate method and certainty equivalents.

4.0 Self-Assessment Questions

1. In recent times, Nigeria as a country had to battle with the management
of their interest rate regime. The most recent world economic woes that
had Europe and America scrambling for survival had a lot to do with
interest rate management or miss-management. Discuss the role of
interest rate management in economic development or revitalisation.
What lessons did we learn from these events?
2. How is the cost of capital decided upon?
3. Define internal rate of return and explain how it is calculated.
4. State the internal rate of return decision rule to be used in capital
investment appraisal.

6.0 Additional Activities (Videos, Animations & out of Class activities)

a. Visit U-tube add https://goo.gl/a2uZR4Watch the video & summarise in 1
paragraph

b. View the animation on add/site https://goo.gl/C1Rikp and critique it in the

discussion forum

39
Answer 1
1. Risk involves choices with multiple outcomes, where the probability of each outcome is
known or can be estimated. Uncertainty, on the other hand, involves situations involving
multiple outcomes, in which the probability of each outcome is unknown or cannot be
estimated
Answer 2
1. Variance.
Answer 3
1. An individual is said to be risk averse when that individual prefers a certain payoff to a
risky prospect with the same expected value.
While an individual is said to be a risk lover when that individual prefers the expected value
of a risky prospect to its certainty equivalent.
An individual is risk neutral when the individual is indifferent about a certain payoff and its
expected value. Generally speaking, most individuals are risk averse because of the principle
of the diminishing marginal utility of money.

7.0 References/Further Readings

Bowman, E. H. (1980) “A risk-return paradox for strategic management”
Sloan Management Review. 21, 17-31.
Fiegenbaum, A. (1990) Prospect Theory and the Risk-return Association: an
empirical examination of 85 industries. Journal of Economic Behaviour
and Organisations, 14, 187-204.
Knight, F.H. (1921) Risk, Uncertainty and Profit. New York: Hart, Schaffner
and Marx.
Rachev, S. T., S. Ortobelli, S. Stoyanov, F. J. Fabozzi and A. Biglova (2008)
‘Desirable properties of an ideal risk measure in portfolio theory’.
International Journal of Theoretical and Applied Finance 11 (1), 19–54.
Rockefeller, R. T., S. Uryasev and M. Zabarankin (2006) ‘Generalised
deviations in risk analysis’. Finance and Stochastics 10, 51–74.
Stoyanov, S., S. Rachev and F. Fabozzi (2008) ‘Probability metrics with
applications in finance’. Journal of Statistical Theory and Practice 2
(2), 253–277.

40
 2.0 MODULE 2
Investment Decision’s programming approach and Investment Cost of
Capital Evaluation
Contents:
Study Session 1: Linear Programming
Study Session 2: Simplex Approach to solving Linear Programming
Study Session 3: Cost of Capital
Study Session 4: Cost of Short-term Borrowing

STUDY SESSION 1
Linear Programming
Section and Subsection Headings:
Introduction
1.0 Learning Outcomes
2,0 Main Content
2.1 - Linear Programming
2.2- Characteristics of Linear Programming Problem
4.0 Study Session Summary and Conclusion
5.0 Self-Assessment Questions
6.0 Additional Activities (Videos, Animations & out of Class activities)
7.0 References/Further Readings

Introduction:
You are welcome to another study session. In this study session you are
introduced to linear programing which will form the basis of our discussion.
Under this study session, you will get to understand the characteristics of linear
programming models, as well as approaches to solving linear programming
model.

41
1.0 Study Session Learning Outcomes
After studying this study session, I expect you to be able to:
1. Explain the concept of linear programming

2.0 Main Content

2.1. Linear Programming
Linear programming, sometimes known as linear optimization, is the problem
of maximizing or minimizing a linear function over a convex polyhedron
specified by linear and non-negativity constraints. Simplistically, linear
programming is the optimization of an outcome based on some set of
constraints using a linear mathematical model.

Every linear programming problem, called the “primal problem,” which has a
corresponding or symmetrical problem called the “dual problem.” A profit
maximisation primal problem has a cost minimisation dual problem, while a
cost minimisation primal problem has a profit maximisation dual problem. The
solutions of a dual problem are the shadow prices. They give the change in the
value of the objective function per unit change in each constraint in the primal
problem. The dual problem is formulated directly from the corresponding
primal problem. According to duality theory, the optimal value of the primal
objective function equals the optimal value of the dual objective function.
In-text Questions 1
1. What is a linear programming problem called?

Whether linear programming is dualised or not, before solving the problem

according to the extreme-point theorem, the optimal solution can be found at a
corner of the feasible region, even when there are multiple solutions. The
simplex solution also indicates the binding constraints and the unused quantity
of each slack variable.

42
2.2. Characteristics of Linear Programming Problem
Linear programming is a branch of mathematics and statistics that allows
researchers to determine solutions to problems of optimization. Linear
programming problems are distinctive in that they are clearly defined in terms
of an objective function, constraints and linearity. The characteristics of linear
programming make it an extremely useful field that has found use in applied
fields, they are as follows:

i) Optimization
All linear programming problems are problems of optimization. This means that
the true purpose behind solving a linear programming problem is to either
maximize or minimize some value. Thus, linear programming problems are
often found in economics, business, advertising and many other fields that value
efficiency and resource conservation. Examples of items that can be optimized
are profit, resource acquisition, free time and utility.

ii) Linearity
As the name hints, linear programming problems all have the trait of being
linear. However, this trait of linearity can be misleading, as linearity only refers
to variables being to the first power (and therefore excluding power functions,
square roots and other non-linear functions). Linearity does not, however, mean
that the functions of a linear programming problem are only of one variable. In
short, linearity in linear programming problems allows the variables to relate to
each other as coordinates on a line, excluding other shapes and curves.

iii) Objective Function

All linear programming problems have a function called the "objective
function." The objective function is written in terms of the variables that can be
changed at will (e.g., time spent on a job, units produced and so on). The

43
objective function is the one that the solver of a linear programming problem
wishes to maximize or minimize. The result of a linear programming problem
will be given in terms of the objective function. The objective function is
written with the capital letter "Z" in most linear programming problems.

iv) Constraints
All linear programming problems have constraints on the variables inside the
objective function. These constraints take the form of inequalities (e.g., "b < 3"
where b may represent the units of books written by an
author per month). These inequalities define how the
objective function can be maximized or minimized, as
together they determine the "domain" in which an
organization can make decisions about resources.
In-text Questions 2
1. What are the characteristics of linear programming?

4.0 Conclusion/Summary
This study session was able to define linear programming as well as its
characteristics.

5.0 Self-Assessment Questions

1. What are the essential characteristics of problems that can be solved by:
linear programming methods?
2. What is the objective function?
3. How many objectives can be dealt with at one time in linear
programming problem?
4. What are limitations or constraints?
5. Distinguish minimising from maximising problems.
6. What type of linear programming can be solved by graphical methods?

44
 7. What is feasible region?
8. What are shadow or dual prices?
9. What method can be used to calculate shadow prices?
10. What is primal problem and what is dual problem?
11. What do shadow prices tell management?
12. What is sensitivity analysis and how is it carried out?
13What are limitations or constraints?
14 Distinguish minimising from maximising problems.
15 What type of linear programming can be solved by graphical methods?

6.0 Additional Activities (Videos, Animations & out of Class activities)

a. Visit U-tube add https://goo.gl/YuAKow Watch the video & summarise in 1
paragraph

b. View the animation on add/site https://goo.gl/5Hh2PY and critique it in the

discussion forum

Answer 1
1. Primal Problem.
Answer 2
1. Optimization, Linearity, Objective function and Constraints.

7.0 References/Further Readings

https://www.youtube.com/watch?v=M4K6HYLHREQ
https://www.youtube.com/watch?v=-32jcGMpD2Q
www.ehow.com/info_8596892_characteristics-linear-programming-problem.
html

45
 STUDY SESSION 2
Simplex Method to Solving Linear Programming
Section and Subsection Headings:
Introduction
1.0 Learning Outcomes
2,0 Main Content
2.1 - Using Simplex Method to Solve Linear Programming
4.0 Study Session Summary and Conclusion
5.0 Self-Assessment Questions
6.0 Additional Activities (Videos, Animations & out of Class activities)
7.0 References/Further Readings

Introduction:
Linear programming is the process of taking various linear inequalities relating
to some situation, and finding the "best" value obtainable under those
conditions. A typical example would be taking the limitations of materials and
labour, and then determining the "best" production levels for maximal profits
under those conditions.

1.0 Study Session Learning Outcomes

After studying this study session, I expect you to be able to:
1. understand how to use simplex method to solve linear programming
2. familiarise yourself with the steps used in solving linear programming

2.0 Main Content

2.1. Using Simplex Method to Solve Linear Programming
Solve using the Simplex method the following problem:
Maximize Z = f(x,y) = 3x + 2y

46
subject to: 2x + y ≤ 18
2x + 3y ≤ 42
3x + y ≤ 24
x≥0,y≥0
Consider the following steps:
1. Make a change of variables and normalize the sign of the independent
terms.
A change is made to the variable naming, establishing the following
correspondences:
o x becomes X1
o y becomes X2
As the independent terms of all restrictions are positive no further action
is required. Otherwise there would be multiplied by "-1" on both sides of
the inequality (noting that this operation also affects the type of
restriction).
2. Normalize restrictions.
The inequalities become equations by adding slack, surplus and artificial
variables as the following table:
Inequality type Variable that appears
≥ - surplus + artificial
= + artificial
≤ + slack
In this case, a slack variable (X3, X4 and X5) is introduced in each of the
restrictions of ≤ type, to convert them into equalities, resulting the system
of linear equations:
2ꞏX1 + X2 + X3 = 18
2ꞏX1 + 3ꞏX2 + X4 = 42

47
 3ꞏX1 + X2 + X5 = 24
3. Match the objective function to zero.
Z - 3ꞏX1 - X2 - 0ꞏX3 - 0ꞏX4 - 0ꞏX5 = 0
4. Write the initial tableau of Simplex method.
The initial tableau of Simplex method consists of all the coefficients of
the decision variables of the original problem and the slack, surplus and
artificial variables added in second step (in columns, with P0 as the
constant term and Pi as the coefficients of the rest of Xi variables), and
constraints (in rows). The Cb column contains the coefficients of the
variables that are in the base.

The first row consists of the objective function coefficients, while the last
row contains the objective function value and reduced costs Zj - Cj.

The last row is calculated as follows: Zj = Σ(CbiꞏPj) for i = 1..m, where if

j = 0, P0 = bi and C0 = 0, else Pj = aij. Although this is the first tableau of
the Simplex method and all Cb are null, so the calculation can simplified,
and by this time Zj = -Cj.

Tableau I. 1st iteration

3 2 0 0 0
Base Cb P0 P1 P2 P3 P4 P5
P3 0 18 2 1 1 0 0
P4 0 42 2 3 0 1 0
P5 0 24 3 1 0 0 1
Z 0 -3 -2 0 0 0

5. Stopping condition.
48
 If the objective is to maximize, when in the last row (indicator row) there
is no negative value between discounted costs (P1 columns below) the
stop condition is reached.
In that case, the algorithm reaches the end as there is no improvement
possibility. The Z value (P0 column) is the optimal solution of the
problem.

Another possible scenario is all values are negative or zero in the input
variable column of the base. This indicates that the problem is not limited
and the solution will always be improved.

Otherwise, the following steps are executed iteratively.

6. Choice of the input and output base variables.
First, input base variable is determined. For this, column whose value in
Z row is the lesser of all the negatives is chosen. In this example it would
be the variable X1 (P1) with -3 as coefficient.

If there are two or more equal coefficients satisfying the above condition
(case of tie), then choice the basic variable.

The column of the input base variable is called pivot column

Once obtained the input base variable, the output base variable is
determined. The decision is based on a simple calculation: divide each
independent term (P0 column) between the corresponding value in the
pivot column, if both values are strictly positive (greater than zero). The
row whose result is minimum score is chosen.

If there is any value less than or equal to zero, this quotient will not be
performed. If all values of the pivot column satisfy this condition, the

49
 stop condition will be reached and the problem has an unbounded
solution.
In this example: 18/2 [=9] , 42/2 [=21] and 24/3 [=8]

The term of the pivot column which led to the lesser positive quotient in
the previous division indicates the row of the slack variable leaving the
base. In this example, it is X5 (P5), with 3 as coefficient. This row is
called pivot row.

If two or more quotients meet the choosing condition (case of tie), other
than that basic variable is chosen (wherever possible).

The intersection of pivot column and pivot row marks the pivot value, in
this example, 3.
7. Update tableau.
The new coefficients of the tableau are calculated as follows:
o In the pivot row each new value is calculated as:
New value = Previous value / Pivot
o In the other rows each new value is calculated as:
New value = Previous value - (Previous value in pivot column *
New value in pivot row)

So the pivot is normalized (its value becomes 1), while the other values of
the pivot column are canceled (analogous to the Gauss-Jordan method).
Calculations for P4 row are shown below:

Previous P4 row 42 2 3 0 1 0
- - - - - -

50
 Previous value in pivot column 2 2 2 2 2 2
X x x x x x
New value in pivot row 8 1 1/3 0 0 1/3
= = = = = =
New P4 row 26 0 7/3 0 1 -2/3

The tableau corresponding to this second iteration is:

Tableau II. 2nd iteration
3 2 0 0 0
Base Cb P0 P1 P2 P3 P4 P5
P3 0 2 0 1/3 1 0 -2/3
P4 0 26 0 7/3 0 1 -2/3
P1 3 8 1 1/3 0 0 1/3
Z 24 0 -1 0 0 1
8. When checking the stop condition is observed which is not fulfilled since
there is one negative value in the last row, -1. So, continue iteration steps
6 and 7 again.
o 6.1. The input base variable is X2 (P2), since it is the variable that
corresponds to the column where the coefficient is -1.
o 6.2. To calculate the output base variable, the constant terms P0
column) are divided by the terms of the new pivot column: 2 / 1/3
[=6] , 26 / 7/3 [=78/7] and 8 / 1/3 [=24]. As the lesser positive
quotient is 6, the output base variable is X3 (P3).
o 6.3. The new pivot is 1/3.
o 7. Updating the values of tableau again is obtained:
Tableau III. 3rd iteration
3 2 0 0 0

51
 Tableau III. 3rd iteration
Base Cb P0 P1 P2 P3 P4 P5
P2 2 6 0 1 3 0 -2
P4 0 12 0 0 -7 1 4
P1 3 6 1 0 -1 0 1
Z 30 0 0 3 0 -1
9. Checking again the stop condition reveals that the pivot row has one
negative value, -1. It means that optimal solution is not reached yet and
we must continue iterating (steps 6 and 7):
o 6.1. The input base variable is X5 (P5), since it is the variable that
corresponds to the column where the coefficient is -1.
o 6.2. To calculate the output base variable, the constant terms (P0)
are divided by the terms of the new pivot column: 6/(-2) [=-3] ,
12/4 [=3] , and 6/1 [=6]. In this iteration, the output base variable is
X4 (P4).
o 6.3. The new pivot is 4.
o 7. Updating the values of tableau again is obtained:
o

Tableau IV. 4th iteration

3 2 0 0 0
Base Cb P0 P1 P2 P3 P4 P5
P2 2 12 0 1 -1/2 1/2 0
P5 0 3 0 0 -7/4 1/4 1
P1 3 3 1 0 ¾ -1/4 0
Z 33 0 0 5/4 1/4 0

10. End of algorithm.

52
 It is noted that in the last row, all the coefficients are positive, so the stop
condition is fulfilled.
The optimal solution is given by the value of Z in the constant terms
column (P0 column), in the example: 33. In the same column, the point
where it reaches is shown, watching the corresponding rows of input
decision variables: X1 = 3 and X2 = 12.
Undoing the name change gives x = 3 and y = 12.

3.0 Conclusion/Summary
This study session was able to explain how simplex method is used to solve
linear programming and also the steps.

4.0 Self-Assessment Questions

1. What do you understand by Simplex Method ?

6.0 Additional Activities (Videos, Animations & Out of Class activities)

a. Visit U-tube add https://goo.gl/LqP28eWatch the video & summarise in 1
paragraph

b. View the animation on add/site https://goo.gl/6kj3FL and critique it in the

discussion forum

7.0 References/Further Readings

www.phpsimplex.com/en/simplex_method_example.htm
https://www.youtube.com/watch?v=zDch07vVBxI
https://www.youtube.com/watch?v=rc9E1yLHFgo

53
 STUDY SESSION 3
Cost of Capital
Section and Subsection Headings:
Introduction
1.0 Learning Outcomes
2,0 Main Content
2.1 - Cost of capital
2.2- Measurement of cost of capital
4.0 Study Session Summary and Conclusion
5.0 Self-Assessment Questions
6.0 Additional Activities (Videos, Animations & out of Class activities)
7.0 References/Further Readings

Introduction:
You are welcome to yet another study session. In this study session you will be
introduced to the topic; cost of capital. You will also get to understand the
measurement of cost of capital, cost of retained earnings, cost of preference
shares and cost of debt capital.

1.0 Study Session Learning Outcomes

After studying this study session, I expect you to be able to:
1. Define Cost of capital.
2. Explain measurement of cost of capital.
3. Compute Cost of retained earnings.
4. Compute Cost of preference shares.
5. Describe Cost of debt capital.

54
2.0 Main Content
2.1. Cost of Capital
The cost of capital refers to the rate of return the company has to pay, to various
suppliers of funds in the company. It can be described as the minimum rate of
return that a firm must earn on its investments so that market value per share
remains unchanged. In other words, it is the minimum required rate of return, on
the investment project that keeps the present wealth of shareholders unchanged.
There are variations in the costs of capital, due to the fact that different kinds of
investment assume different levels of risk, which is compensated for by
different levels of return. The fact that different sources are opened to a business
firm when raising funds, basically equity and debt, the determination of cost of
funds becomes a phenomenon.

Cost of capital is also referred to as cut-off rate, target rate, hurdle rate,
minimum required rate of return and standard return. It consists of risk-free
return plus premium for risk, associated with the particular business. Risk
premium represents the additional return paid to the providers of capital and
debt, in regards to the associated business and financial risks.
Cost of capital can be defined both from organisations and investors point of
view.
In-text Questions 1
1. What is the cost of capital?

From an organisation point of view, cost of capital is a rate which an

organisation raises to invest in various projects. The basic motive of an
organisation to raise any kind of capital is to invest in various project for
earning profit, further out of that profit, the organisation pays interest and
dividend to the sources of capital. The amount paid as interest and dividend is
considered cost of capital.

55
From an investor point of view, cost of capital is the rate of return, which
investors expect from capital invested by them into the organisation.
The significance of cost of capital is very important for the management of an
organisation. The significances are as follows:
1. Capital budget decision.
2. Capital requirement.
3. Optimum capital structure.
4. Resource mobilisation.
5. Determination of the duration of project.

2.2. Measurement of Cost of Capital

Measurement of cost of capital means to calculate the exact rate of cost of
capital. Cost of capital can be measured using the following;
1. Cost of equity capital.
2. Cost of retained earnings.
3. Cost of preference shares.
4. Cost of debt capital.

1. Cost of equity capital

This is the ordinary shareholders required rate of return, which equates the
present value of the expected dividends with the market value of the share. It
can also be defined as the minimum rate of return that a company must earn, on
the equity share capital, financial portion of an investment project to maintain
the market price of the shares.
Different methods are used in calculating cost of equity. These include:
a) Dividend Yield Method.
b) Dividend Growth Model.
c) Price Earning Method.
d) Capital Asset Pricing Model (CAPM).

56
In-text Questions 2
1. What is the meaning of the measurement of cost of capital?

a. Dividend yield method

Under this method, cost of equity is seen as the discounting rate that equates the
present value of all expected future dividends per share, with the current market
price or the net proceeds of the sale of a share.
b. Dividend growth model
In practice, growth in dividend yearly is expected. Dividend is not expected to
remain unchanged in perpetuity. This method therefore makes provision for
dividend growth.
c. Price earning method
This method incorporates the earnings per share (EPS) and the market price of the
share. This is based on the assuring firm that the future earnings whether
disbursed to the shareholders or ploughed back into the business, will cause future
growth in the earnings of the company, as well as the increase in market prices of
the share.
d. Capital asset pricing model (CAPM)
CAPM divides the required rate of return into two parts:
i) Risk free return.
ii) Risk Premium.
The risk premium is calculated by applying the project’s beta factor (B) to the
difference in the market return and the risk free rates of the return.

2. Cost of retained earnings

Retained earnings represent the accumulated funds of the company over years, by
keeping part of the funds generated without distribution. It is the proportion of the
total earnings of a company distributable to the equity shareholders, which is
ploughed back into the business for further profitable investment opportunities. If
57
the retained earnings are distributed among equity shareholders; the amount would
have been reinvested to earn return on it. The
cost of retained earnings therefore is the return
forgone by the equity shareholders and it is the
opportunity cost of funds not available for
reinvestment by the individual shareholders.
The cost of retained earnings is therefore equivalent to opportunity rate of
earnings forgone by the equity shareholders. Hence, cost of equity includes
retained earnings.
3. Cost of preference shares
Preference share capital represents the fixed dividend capital. It is easier to
estimate because the interest received by the holder of the security is fixed by
contract and will not fluctuate in amount. It may be redeemable or irredeemable.
Redeemable preference shares, are shares the holders refunded due sum at
redemption in accordance with the terms under which
the shares were issued and retained of the shares by
the company.

4. Cost of debt capital

The cost of debt forms a significant part of the cost of capital allowance for
regulated companies. The cost of debt represents the cost incurred by a company
in compensating its creditors. Unlike the cost of
equity, which is not directly observable, the historical
cost of debt can be easily derived from financial
statements: it can be estimated by computing the ratio
of the interest expenses to the current and long-term
debt balances. Alternatively, debt capital markets provide a useful measure of the
return required by investors on a company’s bonds.

58
To compensate companies for the financing costs incurred on their borrowings,
regulators may use one of two main approaches:
 the cost of debt allowance can be set to cover the actual cost paid by a
company on its borrowings. This is often referred to as the ‘embedded debt’
approach;
 the allowance can be set according to market rates i.e., the expected cost of
debt as evidenced by market yields on bonds issued by other corporations,
that are similar in terms of their sector or credit rating.

In-text Questions 3
1. What are the methods used in measuring cost of capital?

3.0 Conclusion/Summary
In this study session we have discussed cost of capital, measurement cost of
capital, cost of equity, cost of retained earnings, cost of preference shares and
cost of debt capital.

4.0 Self-Assessment Questions

1. What do you understand by cost of capital?
2. Explain the measurement of cost of capital
3. Differentiate between cost of retained earnings and cost of debt capital.
4. What is cost of preference shares?

6.0 Additional Activities (Videos, Animations & out of Class activities)

a. Visit U-tube add https://goo.gl/LV2f3W Watch the video & summarise in 1
paragraph

b. View the animation on add/site https://goo.gl/9J2PXT and critique it in the

discussion forum

59
Answer 1
1. The cost of capital refers to the rate of return the company has to pay, to various suppliers
of funds in the company
Answer 2
1. measurement of cost of capital means to calculate the exact rate of cost of capital.
Answer 3
1. Cost of equity capital, Cost of retained earnings, Cost of preference shares and
Cost of debt capital

7.0 References/Further Readings

Ken, garret (2009) Cost of capital: Part 2. Relevant to ACCA qualification
papers F9 and P4.
Ravi, M.K. (2007) Financial Management. 6th Ed: Taxmann Allied Services
(P.) Ltd.
Van, Horne J.C. and Wachowicz J.M. (1996) Fundamentals of Financial
Management.

60
 STUDY SESSION 4
Cost of Short-Term Borrowing
Section and Subsection Headings:
Introduction
1.0 Learning Outcomes
2,0 Main Content
2.1 - Distinction between Debt and Equity
2.2- Cost of capital as an investment criterion
2.3- Cost of Depreciation Funds
4.0 Study Session Summary and Conclusion
5.0 Self-Assessment Questions
6.0 Additional Activities (Videos, Animations & out of Class activities)
7.0 References/Further Readings

Introduction:
You are welcome once more to another study session. In this study session, you
are introduced to the topic; cost of short term borrowing which will form the
basis of our discussion and we are going to explore further on the concept of
debt and equity, cost of capital as an investment criterion and cost of
depreciation funds and cost of capital in the market context.

1.0 Study Session Learning Outcomes

After studying this study session, I expect you to be able to:
1. Describe cost of debt and equity
2. Understand the cost of capital as an investment criterion

2.0 Main Content

2.1. Distinction between Debt and Equity
Debt and equity are different on the following grounds:

61
1. Debt capital is repayable to the providers while equity capital is not
repayable.
2. The interest on debt is mandatory but dividends on equity are not
compulsory.
3. Interest on debt is tax deductible while dividend on equity is not.
4. Introduction of debt in a firm’s capital structure increases the financial risk.
However, equity cannot increase a firm’s financial risk.
5. Debt has a relatively cheaper issuing cost.
6. With the issue of debt, there is no control dilution
whereas; new issue of equity may lead to control
dilution.
7. Debt has a less future financing flexibility compared to
equity.
8. It is often easier to issue debt to financial institutions than equity.

In-text Questions 1
1. What is the main distinction between debt and equity?

2.2. Cost of Capital as an Investment Criterion

When the risk in various investment projects undertaken by a firm do not differ
materially from each other, it is unnecessary to derive separate project or
divisional required rate of return. With homogeneous risk across investments, it
is appropriate to use the firms overall requires rate of return as the acceptance
criterion.
The cost of equity capital is the minimum rate of return that a company
must earn on the equity-financed portion of its investment; in order to

62
leave the unchanged market price of its stock. This stock can be estimated
using a market model capital asset pricing model CAPM, or APT multifactor.

2.3. Cost of Depreciation Funds

The value of the asset net of all accumulated depreciation that has been recorded
against it is refers to as cost of depreciation funds. It follows the formula of:
Depreciation cost= purchase price (or cost of basis) -
cumulative depreciation.
Depreciation cost is also known as the “net book value”
or adjusted cost basis.
In a broader economic sense, the cost of industry is the
aggregate amount of capital that is used up in a given
period, such as a fiscal year.
In-text Questions 2
1. What is the cost of equity capital?

3.0 Conclusion/Summary
In this study session, we discussed differences between debt and equity
financing, the cost of capital as an investment criterion and cost of depreciation
funds.

4.0 Self-Assessment Questions

1. Discuss the distinction between debt and equity
2. What is the cost of capital as an investment criterion?
3. Discuss the cost of depreciation funds.

6.0 Additional Activities (Videos, Animations & out of Class activities)

a. Visit U-tube add https://goo.gl/JiyHyE Watch the video & summarise in 1

63
paragraph

b. View the animation on add/site https://goo.gl/Wr2uvH and critique it in the

discussion forum

Answer 1
1. Debt capital is repayable to the providers and also, interest on debt is mandatory. While
equity capital is not repayable and dividends on equity are not compulsory.
Answer 2
1. The cost of equity capital is the minimum rate of return that a company must earn on the
equity-financed portion of its investment; in order to leave the unchanged market price of its
stock

7.0 References/Further Readings

Aborode R. Financial Management (2005)
Drury C. Management and Cost Accounting (1987)
Ravi M.K. (2007) Financial Management. 6th Ed: Taxmann Allied Services (P.)
Ltd.
Van Horne J.C. and Wachowicz J.M. (2004) Fundamentals of Financial
Management

64
 3.0 MODULE 3
Evaluation of Non-monetary Aspects of Projects and Further Issues on
Investment and Project Appraisal
Contents:
Study Session 1: Cost-benefit Analysis
Study Session 2: of Market Price in the Valuation of Costs and Benefits
Study Session 3: Choice of Interest Rates and Relevant Constraints
Cost-benefit Analysis
Study Session 4: Technical Analysis
Study Session 5: Feasibility Studies

STUDY SESSION 1
Cost Benefit Analysis
Section and Subsection Headings:
Introduction
1.0 Learning Outcomes
2,0 Main Content
2.1 - Cost Benefit Analysis
2.2- Enumeration of Costs and Benefits
2.3- Identifying Benefits
2.4- Evaluate Costs and Benefits
2.5- Spill over Effect and Secondary Benefits of Cost Benefit- Analysis
2.6- Valuation of Cost and Benefits
2.7- Ratio analysis
4.0 Study Session Summary and Conclusion
5.0 Self-Assessment Questions
6.0 Additional Activities (Videos, Animations & out of Class activities)
7.0 References/Further Readings

65
Introduction
In study session nine, you will be introduced to the concept
of cost-benefit analysis which will form the basis of our
discussion.

1.0 Study Session Learning Outcomes

After studying this study session, I expect you to be able to:
1. Discuss cost benefit analysis.
2. List the parts of cost benefit analysis.
3. Discuss the benefits of cost benefit analysis.

2.0 Main Content

2.1. A. Cost Benefit Analysis
A cost benefit analysis is specifically concerned with identifying and
measuring, and then discounting future costs and benefits, to present values
which enables the calculation of the net economic worth of project options. It is
used in evaluating total anticipated cost of a project compared to the total
expected benefits, in order to determine whether the proposed implementation is
worthwhile for a company or project team. If the results of this comparative
evaluation method suggest that the overall benefits associated with a
proposed action outweigh the incurred costs, then a business or project
manager will most likely choose to follow through with the implementation.

Generally speaking, a cost-benefit analysis has three parts this are;

1. all potential costs that will be incurred by implementing a
proposed action must be identified.
2. one must record all anticipated benefits
associated with the potential action.

66
 3. subtract all identified costs from the expected benefits to
determine whether the positive benefits outweigh the negative
costs.

In-text Questions 1
1. What is cost benefit analysis?

2.2. Enumeration of Costs and Benefits

The first step is to identify and quantify all costs associated with a proposed
action. In order to successfully identify all potential costs of a project, you must
follow the subsequent steps.
1. Make a list of all monetary costs that will be incurred, upon implementation
and throughout the life of the project. These include start-up fees, licenses,
production materials, payroll expenses, user acceptance processes, training, and
travel expenses, among others.
2. Make a list of all non-monetary costs that are likely to be absorbed. These
include time, lost production on other tasks, imperfect processes, potential risks,
market saturation or penetration uncertainties, and influences on one’s
reputation.
3. Assign monetary values to the costs identified in steps one and two. To
ensure equality across time, monetary values are stated in present value terms. If
realistic cost values cannot be readily evaluated, consult with market trends and
industry surveys for comparable implementation costs in similar businesses.
4. Add all anticipated costs together to get a total costs value.

2.3. Identifying Benefits

The next step is to identify and quantify all benefits anticipated as a result of
successful implementation of the proposed action. To do so, complete the
following steps.

67
1. Make a list of all monetary benefits that will be experienced, upon
implementation and thereafter. These benefits include direct profits from
products and/or services, increased contributions from investors, decreased
production costs due to improved and standardised processes, and increased
production capabilities, among others.
2. Make a list of all non-monetary benefits that one is likely to experience.
These include decreased production times, increased reliability and durability,
greater customer base, greater market saturation, greater customer satisfaction,
and improved company or project reputation, among others.
3. Assign monetary values to the benefits identified in steps one and two. Be
sure to state these monetary values in present value terms as well.

1. Add all anticipated benefits together to get a total benefits value.

2.4. Evaluate Costs and Benefits

The final step when creating a cost benefit analysis is to weigh the costs and
benefits to determine if the proposed action is worthwhile. To properly do so,
follow the subsequent steps.
1. Compare the total costs and total benefits values. If the total costs are much
greater than the total benefits, one can conclude that the project is not a
worthwhile investment of company time and resources.
2. If total costs and total benefits are roughly equal to one another, it is best to
reevaluate the costs and benefits identified and revise the cost benefit analysis.
Often times, items are missed or incorrectly quantified, which are common
errors in a cost benefit analysis.
3. If the total benefits are greater than the total costs, one can conclude that the
proposed action is potentially a worthwhile investment and should be further
evaluated as a realistic opportunity.

68
2.5. Spill over Effect and Secondary Benefits of Cost Benefit- Analysis
Inducement to create other activities is considered to be secondary effect. These
should be taken into account. For example, irrigation system will lead to more
grain production, which in turn lead to series of other related activates
downstream. There is debate as to whether we should use the secondary
benefits. General consensus is that, if the market price reflects benefit of
secondary effect we should use that otherwise, we must impute the value of
secondary benefits (if water is sold for irrigation to farmers then use the
revenue).

2.6. Valuation of Cost and Benefits

• Issues which are relevant as regards the price for the estimation of revenue.
Expected price of input and output should be used, but not change in the price
due to overall price changes. Current price and cost may under estimate overall
value (since it effects consumer and producer surplus).

• Market prices should be used as much as possible. But what if investment

is large to the extent that it changes price structure. A new power project may
alter price structure of electricity and may lead to its decline. Assumption of
prevailing price may over estimate revenue.

• Market Imperfection may also result in distortion of price structure. In

such a case price is not reflective of social benefit of the output of the project.
For example; government authorities which control water supplies, would have
control over price of water (since there is little or no alternative for consumer).
In this case price does not reflect marginal cost of water. In such a
circumstance, correction should be made both to the cost and benefit of the
project to reflect the actual value.

69
• Also, divergence of social cost and private cost would emerge when there
is unemployment in the economy. In such a circumstance, any project would
actually positively impact the employment situation. Clearly, the social benefits
of reduction in unemployment should be
added to overall benefits (relevant to
Stimulus package being implemented at this
time).

• There are also intangible costs and

benefits of project. The intangibles are those that are either unquantifiable (such
as scenic effect of a highway) or they can be quantified but is difficult to value
in a market sense (life-saving impact).

2.6. Ratio Analysis

Another vital technique that is used in evaluating investment or project is ratio
analysis. The technique is quit sophisticated and is being used by all businesses
and industrial concerns in modern times. By means of ratio analysis,
comparison can be made between different statistics concerning varied facets of
a business unit.

A ratio is simply one number expressed in terms of another and as such it

expresses the quantitative relationship between any
two numbers. Since Ratio Analysis is based upon
accounting information, its effectiveness is limited
by the distortions which arise in financial
statements, due to such things as Historical Cost
Accounting and inflation. Therefore, Ratio Analysis

70
should only be used as a first step in financial analysis, to obtain a quick
indication of a firm's performance and to identify areas which need to be
investigated further.

In-text Questions 2
1. What is a ratio?

Ratios are classified into various categories and each category serves and provides
information useful for decision making by organisations. Some of the vital
classifications are presented thus:
1. Short-term Solvency or Liquidity Ratios: These ratios attempt to measure the
ability of a firm to meet its short-term financial obligations. In other words, these
ratios seek to determine the ability of a firm to avoid financial distress in the short-
run. The two most important Short-term Solvency Ratios are the Current Ratio
and the Quick Ratio. (Note: the Quick Ratio is also known as the Acid-Test
Ratio.)
Current Ratio
The Current Ratio is calculated by dividing Current Assets by Current Liabilities.
Current Assets are the assets that the firm expects to convert into cash in the
coming year and Current Liabilities represent the liabilities which have to be paid
in cash in the coming year. The appropriate value for this ratio depends on the
characteristics of the firm's industry and the composition of its Current Assets.
However, at a minimum, the Current Ratio should be greater than one.

Quick Ratio
The Quick Ratio recognises that for many firms, inventories can be rather illiquid.
If these inventories had to be sold off in a hurry to meet an obligation, the firm
might have difficulty in finding a buyer and the inventory items would likely have

71
to be sold at a substantial discount from their fair market value.
This ratio attempts to measure the ability of the firm to meet its obligations relying
solely on its more liquid Current Asset accounts such as Cash and Accounts
Receivable. This ratio is calculated by dividing Current Assets less Inventories by
Current Liabilities.

2. Debt Management Ratios: These ratios attempt to measure the firm's use of
Financial Leverage and ability to avoid financial distress in the long run. These
ratios are also known as Long-Term Solvency Ratios.
Debt is called Financial Leverage because the use of debt can improve returns to
stockholders in good years and increase their losses in bad years. Debt generally
represents a fixed cost of financing a firm. Thus, if the firm can earn more on
assets which are financed with debt than the cost of servicing the debt, then these
additional earnings will flow through to the stockholders. Moreover, our tax law
favours debt as a source of financing, since interest expense is tax deductible.

With the use of debt also comes the possibility of financial distress and
bankruptcy. The amount of debt that a firm can utilise is dictated to a great extent
by the characteristics of the firm's industry. Firms which are in industries with
volatile sales and cash flows cannot utilise debt to the same extent as firms in
industries with stable sales and cash flows. Thus, the optimal mix of debt for a
firm involves a tradeoff between the benefits of leverage and possibility of
financial distress.

Debt Ratio, Debt-Equity Ratio, and Equity Multiplier

The Debt Ratio, Debt-Equity Ratio, and Equity Multiplier are essentially three
ways of looking at the same thing: the firm's use of debt to finance its assets. The

72
Debt Ratio is calculated by dividing Total Debt by Total Assets. The Debt-Equity
Ratio is calculated by dividing Total Debt by Total Owners' Equity. The Equity
Multiplier is calculated by dividing Total Assets by Total Owners' Equity.

3. Asset Management Ratios: These ratios attempt to measure the firm's success
in managing its assets to generate
sales. For example, these ratios can
provide insight into the success of
the firm's credit policy and
inventory management. These
ratios are also known as Activity or Turnover Ratios.

Receivables Turnover and Days' Receivables

The Receivables Turnover and Days' Receivables Ratios assess the firm's
management of its Accounts Receivables and, thus, its credit policy. In general,
the higher the Receivables Turnover Ratio the better, since this implies that the
firm is collecting on its accounts receivables sooner. However, if the ratio is too
high then the firm may be offering too large a discount, for early payment or may
have too restrictive credit terms. The Receivables Turnover Ratio is calculated by
dividing Sales by Accounts Receivables. (Note: since Accounts Receivables arise
from Credit Sales, it is more meaningful to use Credit Sales in the numerator if the
data is available.)

73
The Days' Receivables Ratio is calculated by dividing the number of days in a
year, 365, by the Receivables Turnover Ratio. Therefore, the Days' Receivables
indicates how long, on average, it takes for the firm to collect on its sales to
customers on credit. This ratio is also known as the Days' Sales Outstanding
(DSO) or Average Collection Period (ACP).

Fixed Assets Turnover

The Fixed Assets Turnover Ratio measures how productively the firm is
managing its Fixed Assets to generate Sales. This ratio is calculated by dividing
Sales by Net Fixed Assets. When comparing Fixed Assets Turnover Ratios of
different firms, it is important to keep in mind that the values for Net Fixed Assets
reported on the firms' Balance Sheets are book values, which can be very different
from market values.

Total Assets Turnover

The Total Assets Turnover Ratio measures how productively the firm is managing
all of its assets to generate Sales. This ratio is calculated by dividing Sales by
Total Assets.

4. Profitability Ratios: These ratios attempt to measure the

firm's success in generating income. These ratios reflect the
combined effects of the firm's asset and debt management.

Profit Margin

74
The Profit Margin indicates the dollars in income that the firm earns on each
dollar of sales. This ratio is calculated by dividing Net Income by Sales.

Return on Assets (ROA) and Return on Equity (ROE)

The Return on Assets Ratio indicates the dollars in income earned by the firm on
its assets and the Return on Equity Ratio indicates the dollars of income earned by
the firm on its shareholders' equity. It is important to remember that these ratios
are based on accounting book values and not on market values. Thus, it is not
appropriate to compare these ratios with market rates of return, such as the interest
rate on Treasury bonds or the return earned on an investment in a stock.

5. Market Value Ratios: These ratios relate an observable market value, the
stock price, to book values obtained from the firm's financial statements.

Price-Earnings Ratio (P/E Ratio)

The Price-Earnings Ratio is calculated by dividing the current market price per
share of the stock by earnings per share (EPS). (Earnings per share are calculated
by dividing net income by the number of shares outstanding.)
The P/E Ratio indicates how much investors are willing to pay per dollar of
current earnings. As such, high P/E Ratios are associated with growth stocks.
(Investors who are willing to pay a high price for a dollar of current earnings

75
obviously expect high earnings in the future). In this manner, the P/E Ratio also
indicates how expensive a particular stock is. This ratio is not meaningful,
however, if the firm has very little or negative earnings.

where

Market-to-Book Ratio
The Market-to-Book Ratio relates the firm's market value per share to its book
value per share. Since a firm's book value reflects historical cost accounting, this
ratio indicates management's success in creating value for its stockholders. This
ratio is used by "value-based investors" to help to identify undervalued stocks.

where

It is to be noted that ratio analysis can also be conducted

using multivariate approach, in which instead of looking
at the ratios on one to one basis, they are to be considered
collectively.

In-text Questions 3
1. What are the vital classification of ratios?

4.0 Conclusion/Summary
In this study session, we touched the concept of cost benefit analysis, secondary
benefits of cost-benefit analysis as well as the valuation of costs and benefits.

76
 5.0 Self-Assessment Questions
1. Why is it important to conduct cost and benefit analysis before embarking
on project?
2. Explain the difference between risk and uncertainty in project analysis.

6.0 Additional Activities (Videos, Animations & out of Class activities)

a. Visit U-tube add https://goo.gl/XduzS2 Watch the video & summarise in 1
paragraph

b. View the animation on add/site https://goo.gl/3AhJgF and critique it in the

discussion forum

Answer 1
1. A cost benefit analysis is specifically concerned with identifying and measuring, and then
discounting future costs and benefits, to present values which enables the calculation of the
net economic worth of project options.
Answer 2
1. A ratio is simply one number expressed in terms of another and as such it expresses the
quantitative relationship between any two numbers.
Answer 3
1. Short-term solvency/ liquidity ratios, Debt management ratios, Asset management Ratios,
Profitability ratios and Market value ratios.

7.0 References/Further Readings

Aaheim, A., and K. Nyborg (1995) On the Interpretation and Applicability of a
'Green National Product'. The Review of Income and Wealth 41, 57-71.
Arrow, K., R. Solow, E. Leamer, P. Portney, R. Radner, and H. Schuman
(1993) Report of the NOAA Panel on Contingent Valuation: National
Oceanic and Atmospheric Administration. Federal Register/Vol. 58,
no.10, 4602-4614.
Boardman Anthony E. (2004) Cost Benefit Analysis: concepts and practice – nd
Edition: ARC, Bucharest, F. John Reh, Ed. Cost Benefit Analysis,
http://management.about.com/cs/money/a/cost benefit.htm MIT
OpenCourseWarehttp://ocw.mit.edu
77
Karine, Nyborg (1996) Environmental Valuation, Cost-benefit Analysis and
Policy making. A survey.
Zerbe, Richard, Richard O., and Dwing D. Dively (1995) Benefit-Cost
Analysis-in Theory and Practice. New York: HarperCollins.

78
 STUDY SESSION 2
Role of Market Price in the Valuation of Cost and Benefit
Section and Subsection Headings:
Introduction
1.0 Learning Outcomes
2,0 Main Content
2.1 - Valuation of Costs and Benefits and how it affects market price.
2.2- Incorporation of Political and Social Judgment into the Valuation
Process
4.0Study Session Summary and Conclusion
5.0Self-Assessment Questions
6.0Additional Activities (Videos, Animations & out of Class activities)
7.0 References/Further Readings

Introduction:
We are in study session ten and you are welcome. In this study session, you will
be introduces to the role of market price in the valuation of cost and benefit,
where we are going to discuss valuation of costs and benefits on market price
and we will further discuss the incorporation of political and social judgment
into the valuation process.

1.0 Study Session Learning Outcomes

After studying this study session, I expect you to be able to:
1. Explain valuation of costs and benefits on market prices.
2. Describe Incorporation of political and social judgement into the valuation
process.

79
2.0 Main Content
2.1. Valuation of Costs and Benefits and How it Affects Market Price
• Issue that is relevant in regards to price for the estimation of revenue.
Expected price of input and output should be used, but not change in the price
due to overall price changes. Current price and cost may under estimate overall
value (since it affects consumer and producer surplus).

• Market prices should be used as much as possible. But what if

investment is large to the extent that it changes price structure. A new power
project may alter price structure of electricity and may lead to its decline.
Assumption of prevailing price may over estimate revenue.

• Market Imperfection may also result in distortion of price structure.

In such a case, price is not reflective of social benefit of the output of the
project. For example; government authorities which control water supply,
would have control over price of water (since there is little or no alternative for
consumer). In this case price does not reflect marginal cost of water. When such
happens, correction should be made both to the cost and benefit of the project to
reflect the actual value.

• Also, divergence of social cost and private cost would emerge when
there is unemployment in the economy. In such a circumstance, any project
would actually positively impact the employment situation. Clearly, the social
benefits of reduction in unemployment should be added to overall benefits
(relevant to Stimulus package being implemented at this time).

• There are also intangible costs and benefits of

project. The intangibles are those that are either

80
unquantifiable (such as scenic effect of a highway) or they can be quantified but
is difficult to value in a market sense (life-saving impact).

In-text Questions 1
1. How does valuation of cost and benefit affect the market price?

2.2. Incorporation of Political and Social Judgment into the Valuation

Process
Although most environmental goods are not bought and sold in markets, the use
of environmental goods is often connected to consumption of private, traded
goods and/or services. The private good may be complementary to the
environmental good, as in the case of a cross-country skiing area and a pair of
skis, or they may be substitutes, for example, clean water from the tap and
bottled drinking water. Information about the demand for such private goods (or
services), can be used to estimate the latent demand for the associated
environmental good. Such estimation depends, of course, on the plausibility of
the assumptions made about the relationship between demand for the market
good and the environmental good.

The travel cost method has frequently been used to value recreational sites. A
crucial assumption is that consumers regard the journey to and from the site as a
cost, not as part of the recreation. The travel costs incurred may then be
regarded as a price to visit the recreational site. Using information about
visitors' travel cost, and studying the relationship between the number of visits
to the site and individual travel costs, one can estimate a demand function for
the recreational services of the site. For a discussion of the method, see
Bockstael et al (1991).

81
Hedonic methods are based on the fact that some goods or services, although
serving approximately the same purpose, are not perfectly homogeneous. For
example, two living houses may differ with respect to the number of rooms, the
view from the house, and local environmental features, such as air pollution. By
comparing the prices of houses with varying characteristics, and using
econometric techniques such as multiple regression analysis, it is possible to
estimate a market valuation of those characteristics. Similarly, hedonic methods
have been used to estimate how much larger wages workers demand, to accept
risky work and this has been used to deduce valuations for a statistical life.
However, this application requires an assumption that individuals behave, in
accordance with expected utility theory when faced with risk; an assumption
which has been questioned by several scholars (Kahneman and Tversky (1979),
Rubinstein, (1988).
A large number of studies have been conducted using hedonic methods,
particularly in the U.S.A. However, such methods are less reliable if the
relevant markets are heavily regulated, since in such cases, prices may not
reflect marginal willingness to pay for the commodity or service in question. In
several European countries, this is the case, or has been so until recently, for the
housing and/or labour market. This is perhaps one reason why such methods
have not been used much in Europe. A closer description of hedonic methods
can be found in Freeman (1993). In some cases, environmental goods can be
valued by using information about the demand for private good substitutes. For
example, a filtering device to purify tap water may diminish or even abolish the
problems connected to contaminated drinking water.

82
In such cases, demand for the private substitute can give an indication of the
underlying demand for the
environmental good. Usually, it is
not possible to find a perfect
substitute for an environmental
good. Purifying equipment does
perhaps not clean the tap water good enough, or consumers may prefer to know
that their drinking water originates from a pure water source

In-text Questions 2
1. What is Hedonic method all about?

4.0 Conclusion/Summary
In this study session we have discussed valuation of costs and benefits on
market prices and we went further to discuss the incorporation of political and
social judgment in the valuation process

5.0 Self-Assessment Questions

1. Explain the roles played by political and social judgment, in the valuation
of cost and benefit.

6.0 Additional Activities (Videos, Animations & out of Class activities)

a. Visit U-tube add https://goo.gl/xQykxW Watch the video & summarise in 1
paragraph

b. View the animation on add/site https://goo.gl/ZcVTEZ and critique it in the

discussion forum

Answer 1
1. Issue that is relevant in regards to price for the estimation of revenue. Market prices
should be used as much as possible, Market Imperfection may also result in distortion of
price structure. Divergence of social cost and private cost would emerge when there is
unemployment in the economy, there are also intangible costs and benefits of project

83
Answer 2
1. Hedonic methods are based on the fact that some goods or services, although serving
approximately the same purpose, are not perfectly homogeneous,

7.0 References/Further Readings

Aaheim, A., and K. Nyborg (1995) On the Interpretation and Applicability of a
'Green National Product'. The Review of Income and Wealth 41, 57-71.
Arrow, K., R. Solow, E. Leamer, P. Portney, R. Radner, and H. Schuman
(1993) Report of the NOAA Panel on Contingent Valuation: National
Oceanic and Atmospheric Administration. Federal Register/Vol. 58,
no.10, 4602-4614.
Karine Nyborg (1996) Environmental Valuation, Cost-benefit Analysis and
Policy making. A Survey.

84
 STUDY SESSION 3
Choices of Interest Rate and Relevant Constraints of Cost-Benefit Analysis
Section and Subsection Headings:
Introduction
1.0 Learning Outcomes
2,0 Main Content
2.1 - Limitation of cost-benefit analysis
4.0 Study Session Summary
5.0 Self-Assessment Questions and Answers
6.0 Additional Activities (Videos, Animations & out of Class activities)
7.0 References/Further Readings

Introduction:
You are welcome to study session eleven. In this study session we will talk
about the limitation of cost-benefit analysis.

1.0 Study Session Learning Outcomes

After studying this study session, I expect you to be able to:
1. Mention some limitations of cost-benefit analysis.
2. Describe the solution to these limitations.

2.0 Main Content

2.1. Limitation of Cost-benefit Analysis
Some of the limitations of cost-benefit analysis are as follows.
1. Potential inaccuracies in identifying and quantifying cost and
benefits: a cost benefit analysis requires that all cost and benefit be
identified and appropriately quantified. Unfortunately, human errors often
result in common cost-benefit analysis errors such as, accidentally
omitting certain cost and benefits due to the inability to forecast indirect

85
 causal relationship. Additionally, the ambiguity and uncertainty involve
in quantifying and assigning a monetary value to intangible items leads to
inaccurate analyses, which can lead to increased risk and inefficient
decision making.
2. Increased Subjectivity for Intangible Costs and Benefits. Another
disadvantage of the cost benefit analysis is the amount of subjectivity
involved when identifying, quantifying, and estimating different costs and
benefits. Since some costs and benefits are non-monetary in nature, such
as increases in customer and employee satisfaction, they often require one
to subjectively assign a monetary value for purposes of weighing the total
costs compared to overall financial benefits of a particular endeavour.
This estimation and forecasting is often based on past experiences and
expectations, which can often be bias. These subjective measures further
3. result in an inaccurate and misleading cost benefit analysis.
In-text Questions 1
1. What are the human error that often result in common cost benefit analysis errors?

3. Inaccurate Calculations of Present Value Resulting in Misleading

Analyses. Since this evaluation method estimates the costs and benefits for a
project over a period of time, it is necessary to calculate the present value. This
equalises all present and future costs and benefits by evaluating all items in
terms of present-day values, which eliminates the need to account for inflation
or speculative financial gains. Unfortunately, this poses a significant
disadvantage because, even if one can accurately calculate the present value,
there is no guarantee that the discount rate used in the calculation is realistic. A
cost benefit analysis template has been developed to help reduce the likelihood,
of incorrectly calculating the present value of costs and benefits, and it is
available for download in the Project Management Media Gallery.

86
4. A Cost Benefit Analysis might turn in to a Project Budget.
Another disadvantage seen when utilising a cost benefit analysis is the
possibility that the evaluative mechanism turns in to a proposed budget. When
a project manager puts together a cost benefit analysis and presents it to a
leadership team, the leadership team might view the expected costs as
actual rather than estimation, which may lead to misappropriating costs
and setting unrealistic goals, when approving and implementing a project
budget.

This can put a project manager in an unfavourable

situation, when he or she attempts to control costs in
order to maintain the expected profit margin.

In-text Questions 2
1. What are the limitations of cost benefit analysis?

4.0 Conclusion/Summary
In this study session, we have discussed limitations of cost-benefit analysis.

5.0 Self-Assessment Questions

1. What do you understand by cost-benefit-analysis ?

6.0 Additional Activities (Videos, Animations & out of Class activities)

a. Visit U-tube add https://goo.gl/Mp6GG9 Watch the video & summarise in 1
paragraph

b. View the animation on add/site https://goo.gl/rgtuKo and critique it in the

discussion forum

87
Answer 1
1. The human error are accidentally omitting certain cost and benefits due to the inability to
forecast indirect causal relationship
Answer 2
1. Increased Subjectivity for Intangible Costs and Benefits Potential, Inaccuracies in
identifying and quantifying cost and benefits, Inaccurate Calculations of Present Value
resulting in misleading analyses and Cost Benefit Analysis might turn in to a Project Budget.

7.0 References/Further Readings

Aaheim, A., and K. Nyborg (1995) On the Interpretation and Applicability of
Potential inaccuracies in identifying and quantifying cost and benefits a
'Green National Product'. The Review of Income and Wealth. 41, 57-71.
Arrow, K., R. Solow, E. Leamer, P. Portney, R. Radner, and H. Schuman
(1993) Report of the NOAA Panel on Contingent Valuation: National
Oceanic and Atmospheric Administration, Federal Register/Vol. 58,
no.10, 4602-4614.
Karine Nyborg (1996) Environmental Valuation, Cost-Benefit Analysis and
Policy making. A survey.

88
 STUDY SESSION 4
Technical Analysis
Section and Subsection Headings:
Introduction
1.0 Learning Outcomes
2,0 Main Content
2.1 - Technical Analysis
4.0 Study Session Summary and Conclusion
5.0 Self-Assessment Questions
6.0 Additional Activities (Videos, Animations & out of Class activities)
7.0 References/Further Readings

Introduction:
In this study session you will be introduced to the concept of technical analysis
which will form the basis of our discussion and we will also discuss the concept
of ratio analysis.

1.0 Study Session Learning Outcomes

After studying this study session, I expect you to be able to:
1. Describe technical analysis.
2. Explain ratio analysis.

2.0 Main Content

2.1. Technical Analysis
Technical analysis is a method of evaluating securities by analysing the
statistics generated by market activity, such as past prices and volume.
Technical analysts do not attempt to measure a security's intrinsic value,
instead, use charts and other tools to identify patterns that can suggest
future activity. Just as there are many investment styles on the fundamental

89
side, there are also many different types of technical traders. Some rely on chart
patterns; others use technical indicators and oscillators, and most use some
combination of the two. In any case, technical analysts' exclusive use of
historical price and volume data which is what separates them from their
fundamental counterparts.

Unlike fundamental analysts, technical analysts do not care whether a stock is

undervalued - the only thing that matters is a security's past trading data and
what information this data can provide, about where the security might move in
the future. The field of technical analysis is based on three assumptions:
1. The market discounts everything.
2. Price moves in trends.
3. History tends to repeat itself.
In-text Questions 1
1. What is technical analysis?

1. The Market Discounts Everything. A major criticism of technical analysis

is that it only considers price movement, ignoring the fundamental factors of the
company. However, technical analysis assumes that, at any given time, a stock's
price reflects everything that has or could affect the company - including
fundamental factors. Technical analysts believe that the company's
fundamentals, along with broader economic factors and market psychology, are
all priced into the stock, removing the need to actually consider these factors
separately. This only leaves the analysis of price movement, which technical
theory views as a product of the supply and demand for a particular stock in the
market.
2. Price Moves in Trends: In technical analysis, price movements are believed
to follow trends. This means that after a trend has been established, the future

90
price movement is more likely to be in the same direction as the trend than to be
against it. Most technical trading strategies are based on this assumption.

3. History Tends to Repeat Itself Another important idea in technical analysis

is that history tends to repeat itself, mainly in terms of price movement. The
repetitive nature of price movements is attributed to market psychology; in
other words, market participants tend to provide a consistent reaction to similar
market stimuli over time. Technical analysis
uses chart patterns to analyse market
movements and understand trends.
Although many of these charts have been
used for more than 100 years, they are still
believed to be relevant because they
illustrate patterns in price movements that
often repeat themselves.
In-text Questions 2
1. The field of technical analysis is based on three assumptions namely:

4.0 Conclusion/Summary
In this study session we were able to have a basic understanding on what
technical analysis is.

6.0 Self-Assessment Questions

1. What do you understand by technical analysis?

6.0 Additional Activities (Videos, Animations & out of Class activities)

a. Visit U-tube add https://goo.gl/ZG8uny Watch the video & summarise in 1
paragraph

b. View the animation on add/site https://goo.gl/VCtBjW and critique it in the

91
discussion forum

Answer 1
1. Technical analysis is a method of evaluating securities by analysing the statistics
generated by market activity, such as past prices and volume.
Answer 2
1. The market discounts everything, Price moves in trends and History tends to repeat itself.

7.0 References/Further Readings

Technical analysis tutorial;
http://www.investopedia.com/university/technicalanalysis/default.asp

92
 STUDY SESSION 5
Feasibility Studies
Section and Subsection Headings:
Introduction
1.0 Learning Outcomes
2,0 Main Content
2.1 - Feasibility Studies
2.2- Project conceptualisation
2.3- Project Design
2.4- Project Marketing
4.0 Study Session Summary and Conclusion
5.0 Self-Assessment Questions
6.0 Additional Activities (Videos, Animations & out of Class activities)
7.0 References/Further Readings

Introduction:
This is the last study session for this course and you are most welcome. In this
study session you will be introduced to the concept of feasibility. Before you
set up a business, it is important that you weigh the cost and benefits. Careful
survey and planning and calculation of both financial, material and human
resources are what it takes to do a feasibility study. All these will be discussed
in this session.

1.0 Study Session Learning Outcomes

After studying this study session, I expect you to be able to:
1. Define feasibility studies.
2. Explain project conceptualisation, design and marketing.

93
2.0 Main Content
2.1. Feasibility Studies
A feasibility study is an analysis of the viability of an idea. The feasibility
study focuses on helping to answer the essential question of “should we
proceed with the proposed project idea?” All activities of the study are
directed toward helping to answer this question. Feasibility studies can be used
in many ways but primarily focus on proposed business ventures.
A feasible business venture is one where the business will generate adequate
cash flow and profits, withstand the risks it will encounter, remain viable in the
long-term and meet the goals of the founders.
The feasibility study outlines and analyses several alternatives or methods of
achieving business success. Feasibility study helps to
narrow the scope of the project to identify the best
business scenario(s).
Feasibility study helps to narrow the scope of the
project to identify and define two or three scenarios or alternatives.

In-text Questions 1
1. What is a feasibility study?

2.2. Project Conceptualisation

Project conceptualisation is the initial process of designing a project that leads
to a project concept document. The project concept is
the basis on which the interest of potential donors is
secured. The process of conceptualising a project
encourages project sponsors/managers to consider all of
the main aspects of the proposed project, including a
situation analysis, a stakeholder analysis, a theory of
change (covering both the problem analysis and the logic of the proposed
intervention) and an indicative budget.

94
In-text Questions 2
1. What is project conceptualisation?

2.3. Project Design

This is like building a house or nurturing a child. What are the things or steps and
other resources or conditions required to be put in place to address the identified
problem and reach the expected outcome?
This should also indicate:
- What work will be performed?
- Who will do it?
- When will it be done?
-Who is responsible for what and
- How the project will be managed, monitored and controlled.

2.5. Project Marketing

From a marketer’s perspective, project marketing relates to the various marketing
activities that take place prior to winning a contract. It deals with marketing of
large and complex projects such as the construction of buildings and power
stations. Project Marketing works closely with clients to identify and develop
opportunities of projects; it focuses on the long-term
consequences of these projects on a specific
customer’s business. This field of study is customer
and stakeholder based and the actors involved could be
internal or external to the organisation. Project marketing, however, is a concept in
development and
seem not to be practiced in the industry today.

4.0 Conclusion/Summary
In this study session, we have discussed what feasibility study is and we
95
 went further to discuss the concept of project conceptualisation and project
design and we concluded with project marketing.

5.0 Self-Assessment Questions

1. Explain what is meant by feasibility studies.

2. What are the stages involved in conducting feasibility studies?

3. What do you understand by the term project conceptualisation?.

6.0 Additional Activities (Videos, Animations & out of Class activities)

a. Visit U-tube add https://goo.gl/1WyzzV Watch the video & summarise in 1
paragraph

b. View the animation on add/site https://goo.gl/qjc6gx and critique it in the

discussion forum

Answers 1
1. A feasibility study is an analysis of the viability of an idea. . Feasibility studies can be
used in many ways but primarily focus on proposed business ventures

Answer 2
1. Project conceptualisation is the initial process of designing a project that leads to a
project concept document

7.0 References/Further Readings

Lecoeuvre, Koninika; “Project Marketing Implementation and its link with

Project Management and Project Portfolio Management”. Business School of

Management (Lille) Lille School of Management Research Group.

File C5-65 October 2009. www.extension.iastate.edu/agdm.

96
 FURTHER READING

Boardman, A., Greenberg, D., Vining, A., & Weimer, D. (2006) Cost Benefit
Analysis: Concepts and Practice. (3rd. Ed.): Upper Saddle River, NJ: Prentice
Hall.

Boardman, A.E., D.H. Greenberg, A.R. Vining and D.L. Weimer (1996) Cost
Benefit Analysis: Concepts and Practice. Englewood Cliffs, NJ: Prentice Hall.

Cohn, E. (1972) Public Expenditure Analysis, with Special Reference to Human

Resources. Toronto: Lexington Books.

Gittinger, J. P. (1982) Economic Analysis of Agricultural Projects. Baltimore:

Johns Hopkins University Press.

Mishan, E. J. (1988).Cost-Benefit Analysis (4th Ed.): London: Unwin Hyman.

Society for Benefit-Cost Analysis (2010) The Society for benefit-cost analysis.
Retrieved from http://benefitcostanalysis.org/

Thompson, M. S. (1980) Benefit-Cost Analysis for Programme Evaluation

Beverly Hills: Sage.

White, K. R. (1988) Cost Analyses in Family Support Programmes (Pp. 429-

443). In, H. B. Weiss & F. H. Jacobs (Eds.) Evaluating Family Programmes.
New York: Aldyne de Gruyter.

97
 GLOSSARY

Acquired services: Services obtained through formal arrangements, such as

contracts, memoranda of understanding and letters of agreement, to support
internal or external clients or stakeholders in achieving specific outcome.

Budget request: Could include any formal securing of funds at a proposal

stage. It should reflect the maturity of the proposal. A budget request is
inclusive of all project costs and any other funds being sought for the initiative.

Business case: Typically, a presentation or proposal to an authority by an

organisation seeking fund, approval or both for an activity, initiative or project
that identifies and explores options and develops recommendations for the
proposed investment.

Capital assets:

Tangible assets that are purchased, constructed, developed or otherwise

acquired and that:

a. Are held for use in the production or supply of goods, the delivery of
services or to produce programme outputs;

b. Have a useful life extending beyond one fiscal year and are intended to be
used on a continuing basis; and

c. Are not intended for resale in the ordinary course of operations.

Change control: The process of identifying, documenting, approving or

rejecting, and controlling changes to the project.

Indicative cost estimate: An estimate of sufficient quality and reliability to

support a request for project approval.

98
Infrastructure: The basic physical and organisational structures and facilities
(e.g., buildings, roads, power supply), needed for the operation of a society or
enterprise. Examples are highways and roads, bridges and overpasses, water
supply systems, wastewater treatment facilities, and sanitary and storm sewers.

Interdepartmental agreement: An arrangement concluded between the

sponsoring department and a participating department (including the
contracting authority) that documents specific roles and responsibilities in
support of a particular project.

Investment: The use of resources with the expectation of a future return, such
as an increase in output, income or assets, or the acquisition of knowledge or
capacity.

Investment planning: The process of allocating and reallocating limited

resources, within departmental reference levels for both existing and new assets
and acquired services, in a diligent and rational manner to support programme
outcome and government priorities.

Investment portfolio: A collection of projects and/or programmes, grouped

together to facilitate effective management to meet strategic business objectives.
The projects or programmes of the investment portfolio may not necessarily be
interdependent or directly related.

Investment programme: A group of related projects managed in a coordinated

way to obtain benefits and control not available from managing them
individually. Investment programmes may include elements of related work
outside the scope of the discrete projects in the programme.

Life cycle of an investment: The life cycle of an investment, be it assets or

acquired services, consists of all activities required in support of its
development, acquisition, sustainment and operations, and its eventual disposal
or close-out.

99
Management of projects: Encompasses the structure (framework) within
which projects are initiated, planned, executed, controlled and closed.

Methodology: A system of practices, techniques, procedures and rules used by

those who work in a discipline.

Performance parameters: The actual approved quantity and technical and

operational characteristics of the end item (e.g., equipment, facility), as well as
any quality aspects it should reflect. Performance parameters are key project
objective.

Performance reports: Documents and presentations that provide organised and

summarised work performance information and analyses of project work
progress and status.

Phase: Phases are the top-level breakdown of the project. Treasury Board of
Canada Secretariat uses the following four phases of the project management
life cycle: initial planning and identification, project definition, project
implementation, and project close-out. Note that departments are free to
establish their own phase structure and nomenclature.

Public-private partnership: Public-private partnerships (P3s) are a long-term

performance-based approach to procuring public infrastructure, where the
private sector assumes a major share of the risks in terms of financing and
construction and ensuring effective performance of the infrastructure, from
design and planning to long-term maintenance.

Programme: Any group of resources and activities, and their related direct
outputs, undertaken pursuant to a given objective or set of related objectives and
administered by a department or agency of the government. Distinguished from
a project, which has a specific objective, activity, beginning and end, a
programme may include various projects at various times.

100
Project: An activity or series of activities that has a beginning and an end. A
project is required to produce defined outputs and realise specific outcome in
support of a public policy objective, within a clear schedule and resource plan.
A project is undertaken within specific time, cost and performance parameters.

Project approval: A decision by the appropriate governance level (e.g., project

review committee, deputy head, minister or the Treasury Board) normally
requested when the initial project planning and identification phase is
completed, but before the project definition phase starts. In providing project
approval, there is agreement that a programme requirement has been identified
and that there is adequate justification for meeting that requirement through a
particular project. It is distinct from expenditure authority.

Project approval authority limits: The threshold above which ministers are to
seek project approval and expenditure authority from the Treasury Board.

Project baseline (or project phase baseline): The project baseline comprises
each of the project objectives established at the time of securing expenditure
authority from the appropriate authority (e.g., project review committee, deputy
head, minister or the Treasury Board). Typically, project objectives include
cost, schedule and performance, as well as any other critical objectives. Any
significant deviations from this baseline must be authorised by the appropriate
approval authority.

Project brief: A project brief provides Treasury Board ministers or the

department's approval authority with a clear understanding of the proposed
initiative and is supported by a business case, project charter and project
management plan. A project brief also identifies key decision points or
opportunities for review during the life cycle of the project.

Project charter: Prepared during the project planning and identification phase,
the project charter forms the basis of understanding between the project

101
sponsor and the project manager. The project charter documents the project's
goals and objectives, key deliverables, conditions for success, constraints, and
roles and responsibilities.

Project close-out: The final phase in the project life cycle that involves final
acceptance of the deliverables, archiving of the project documents and
disbanding of the project team. A project close-out would also take place at the
termination of a project prior to the end of implementation.

Project costs: Project costs include the full costs of all activities and
deliverables from the project definition phase through to and including project
close-out (regardless of the source of funds) that are necessary to achieve the
project objectives or outcomes. Project costs are expected to include such
provisions as the costs of employee benefit plans (20 per cent of salaries) for all
salaries charged to the project and normal contingencies such as for inflation
and foreign exchange.

Project definition: This is a distinct phase of the project life cycle. Its purpose
is to establish sound objectives, refine the implementation phase estimate
(which may include design and property acquisition costs), reduce project risk,
and support development of an element that will be part of the end-product of
the project.

Project gate: A project gate is a key decision and control point that occurs
before the next major milestone or deliverable (e.g., business case) or a new
project phase (e.g., implementation) begins. The gate represents a logical point
at which executive "gatekeepers" can determine whether and how to proceed.
Project gates effectively "open" or "close" the path leading to a subsequent
project phase.

Project implementation: This is a distinct phase of the project life cycle.

Project implementation or execution is directing, managing, performing and

102
accomplishing the project work; providing the deliverables; and providing work
performance information.

Project life cycle: A collection of generally sequential project phases whose

name and number are determined by the control needs of the organisation or
organisations involved in the project. A life cycle can be documented with a
methodology.

Project management: The systematic planning, organising and control of

allocated resources to accomplish identified project objectives and outcomes.
Project management is normally reserved for focused, non-repetitive and time-
limited activities that have some degree of risk, and for activities that are
beyond the usual scope of programme (operational) activities.

Project management plan: A document that identifies the planned objectives

and deliverables of the project, the scope, work breakdown structure, budget,
schedule, risks, roles, resources, functional strategies, project monitoring and
control strategies, governance, process deviations, and management style. It
becomes the plan for the project against which changes are measured.

Project manager: The person assigned by the performing organisation to

achieve the project objectives.

Project planning and identification: This is the initial phase of the project life
cycle during which the sponsoring department establishes the operational
need(s), produces the statement of operational requirements, conducts initial
options analyses and feasibility studies, sets up the appropriate management
framework and agreements, assigns resources, and makes an initial assessment
of project risk.

Project objectives: These are the measurable individual performance objectives

of a project that are approved by the appropriate authority through approval of
the expenditure authority. Typically, the project objectives include cost,

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schedule and performance, as well as any other critical objectives. Once
approved, collectively the project objectives form the project baseline.

Project office (also referred to as project management office): This office is

responsible for establishing, maintaining and enforcing project management
processes, procedures and standards within the organisation. A project office is
a function that supports the project manager with project planning and control
activities such as management of schedule, cost, risks, information and
communication. On smaller projects, these functions may be performed by a
single person; on larger projects, a team may be required.

Project scope: The work that must be performed to deliver a product, service or
result with the specified features and functions.

Project sponsor: A senior executive in the organisation who is responsible for

the success of the project and represents the benefactor(s) of the project
deliverables or objectives. The project sponsor rarely becomes involved in the
day-to-day running of the project.

Quality standards: Quality standards address both the management of the

project and the output(s) of the project. They are those standards established to
ensure that the project will satisfy the needs for which it was undertaken.

Risk: Risk refers to the uncertainty that surrounds future events and outcomes.
It is the expression of the likelihood and impact of an event with the potential to
influence the achievement of an organisation’s objectives.

Risk assessment: Refers to an analysis of the risks of a project at a particular

point in time in which specific risks to the success of the project are identified
and quantified (impact and probability), and mitigation plans are defined and
actioned, according to the degree of the quantified threat.

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Scope statement: A narrative description of the project scope (what needs to be
accomplished) that may include deliverables, project objectives, project
assumptions and constraints.

Stakeholders: People who are actively involved in a project, or whose interests

may be positively or negatively affected by the execution or completion of the
project.

Statement of requirements (SOR): This is the sponsoring department's

documentation of the operational requirements (i.e., the performance objectives
of the project) stated in qualitative and quantitative terms. SORs are normally
expressed in operational or mission terms and are related to the department's
mandate or programme accountability.

Substantive cost estimate: An estimate of sufficiently high quality and

reliability to warrant approval as a cost objective for the project-phase(s) under
consideration.

Work breakdown structure: A work breakdown structure is a hierarchical

itemisation, oriented by deliverables, of the work to be executed by the project
team to accomplish the project objectives and create the required deliverables. It
organises and defines the total scope of the project.

Work package: The lowest level of the work breakdown structure. Together,
all work packages identify all the work required to deliver the project's
objectives. A work package ideally has a single accountable lead.

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