B.tech admission in india

B.Tech Admission in IndiaB.Tech Admission in India
By:By:
admission.edhole.comadmission.edhole.com

1.040/1.4011.040/1.401
Project ManagementProject Management
Spring 2007Spring 2007
Project Financing & EvaluationProject Financing & Evaluation
Dr. SangHyun Lee
lsh@mit.edulsh@mit.edu
Department of Civil and Environmental EngineeringDepartment of Civil and Environmental Engineering
Massachusetts Institute of TechnologyMassachusetts Institute of Technology
admission.edhole.com

PreliminariesPreliminaries
 STELLAR access: to be announcedSTELLAR access: to be announced
 AS1 Survey due by tonight 12 pmAS1 Survey due by tonight 12 pm
 TP1 and AS2 are outTP1 and AS2 are out

AS 2: Student PresentationAS 2: Student Presentation
 10 minute presentation followed by 5 minute discussion10 minute presentation followed by 5 minute discussion
 1 or 2 presentations from Feb. 20 to Mar. 191 or 2 presentations from Feb. 20 to Mar. 19
 TopicsTopics
 Your past project experience (strongly recommended if you have any)Your past project experience (strongly recommended if you have any)
 Size of project is not important!Size of project is not important!
 Project main figuresProject main figures
 Main managerial aspectsMain managerial aspects
 Project management practicesProject management practices
 Problems, strengths, weaknesses, risksProblems, strengths, weaknesses, risks
 Your learningYour learning
 Emerging construction technologies (e.g., 4D CAD, Virtual Reality, Sensing, …)Emerging construction technologies (e.g., 4D CAD, Virtual Reality, Sensing, …)
 Volunteers for next week?Volunteers for next week?

 STELLAR access: to be announcedSTELLAR access: to be announced
 AS1 Survey due by tonight 12 pmAS1 Survey due by tonight 12 pm
 TP1 and AS2 are outTP1 and AS2 are out
 Pictures will be taken before you leavePictures will be taken before you leave
 Who we areWho we are
 Don’t memorize course content. Understand it.Don’t memorize course content. Understand it.

OutlineOutline
 Session Objective & ContextSession Objective & Context
 Project FinancingProject Financing
 OwnerOwner
 ProjectProject
 ContractorContractor
 Additional IssuesAdditional Issues
 Financial EvaluationFinancial Evaluation
 Time value of moneyTime value of money
 Present valuePresent value
 RatesRates
 Interest FormulasInterest Formulas
 NPVNPV
 IRR & payback periodIRR & payback period
 Missing factorsMissing factorsadmission.edhole.com

Session ObjectiveSession Objective
 The role of project financingThe role of project financing
 Mechanisms for project financingMechanisms for project financing
 Measures of project profitabilityMeasures of project profitability

Project Management PhaseProject Management Phase
FEASIBILITY
DESIGN
PLANNING
CLOSEOUTDEVELOPMENT OPERATIONS
Financing & Evaluation
Risk

Context: Feasibility PhasesContext: Feasibility Phases
 Project ConceptProject Concept
 Land Purchase & Sale ReviewLand Purchase & Sale Review
 Evaluation (scope, size, etc.)Evaluation (scope, size, etc.)
 Constraint surveyConstraint survey
 Site constraintsSite constraints
 Cost modelsCost models
 Site infrastructural issuesSite infrastructural issues
 Permit requirementsPermit requirements
 Summary ReportSummary Report
 Decision to proceedDecision to proceed
 Regulatory process (obtain permits, etc)Regulatory process (obtain permits, etc)
 Design PhaseDesign Phaseadmission.edhole.com

Lecture 2 - ReferencesLecture 2 - References
More details on:More details on:
 Hendrickson PM for Construction on-line textbookHendrickson PM for Construction on-line textbook
 Chapter 7Chapter 7

OutlineOutline
 Session Objective & ContextSession Objective & Context
 Project FinancingProject Financing
 OwnerOwner
 ProjectProject
 RatesRates
 NPVNPV

Financing – Gross CashflowsFinancing – Gross Cashflows
($35,000,000)
($30,000,000)
($25,000,000)
($20,000,000)
($15,000,000)
($10,000,000)
($5,000,000)
$0
$5,000,000
$10,000,000
1 2 3 4 5 6 7 8 9 10 11
owner cum cashflow
contractor cum cashflow
years 1 2 3 4 5 6 7 8 9 10
OWNER
investment ($10,000,000) ($20,000,000)
operation incomes $2,000,000 $4,000,000 $6,000,000 $6,000,000 $6,000,000 $6,000,000 $6,000,000
owner cashflow $0 ($10,000,000) ($20,000,000) $2,000,000 $4,000,000 $6,000,000 $6,000,000 $6,000,000 $6,000,000 $6,000,000
owner cum cashflow $0 ($10,000,000) ($30,000,000) ($28,000,000) ($24,000,000) ($18,000,000) ($12,000,000) ($6,000,000) $0 $6,000,000
CONTRACTOR
costs ($4,000,000) ($7,000,000) ($14,000,000) $0 $0 $0 $0 $0 $0 $0
revenues $0 $10,000,000 $20,000,000 $0 $0 $0 $0 $0 $0 $0
contractor cashflow ($4,000,000) $3,000,000 $6,000,000 $0 $0 $0 $0 $0 $0 $0
contractor cum cashflow($4,000,000) ($1,000,000) $5,000,000 $5,000,000 $5,000,000 $5,000,000 $5,000,000 $5,000,000 $5,000,000 $5,000,000
Owner investment = contractor revenue

($35,000,000)
($30,000,000)
($25,000,000)
($20,000,000)
($15,000,000)
($10,000,000)
($5,000,000)
$0
$5,000,000
$10,000,000
1 2 3 4 5 6 7 8 9 10 11
owner cum cashflow
years 1 2 3 4 5 6 7 8 9 10
OWNER
investment ($10,000,000) ($20,000,000)
owner cashflow $0 ($10,000,000) ($20,000,000) $2,000,000 $4,000,000 $6,000,000 $6,000,000 $6,000,000 $6,000,000 $6,000,000
CONTRACTOR
costs ($4,000,000) ($7,000,000) ($14,000,000) $0 $0 $0 $0 $0 $0 $0
revenues $0 $10,000,000 $20,000,000 $0 $0 $0 $0 $0 $0 $0
Design/Preliminary Construction

($35,000,000)
($30,000,000)
($25,000,000)
($20,000,000)
($15,000,000)
($10,000,000)
($5,000,000)
$0
$5,000,000
$10,000,000
1 2 3 4 5 6 7 8 9 10 11
owner cum cashflow
years 1 2 3 4 5 6 7 8 9 10
OWNER
investment ($10,000,000) ($20,000,000)
owner cashflow $0 ($10,000,000) ($20,000,000) $2,000,000 $4,000,000 $6,000,000 $6,000,000 $6,000,000 $6,000,000 $6,000,000
CONTRACTOR
costs ($4,000,000) ($7,000,000) ($14,000,000) $0 $0 $0 $0 $0 $0 $0
revenues $0 $10,000,000 $20,000,000 $0 $0 $0 $0 $0 $0 $0
• Early expenditure
• Takes time to get revenue
Design/Preliminary Construction

Project FinancingProject Financing
Aims to bridge this gap in the most beneficial way!Aims to bridge this gap in the most beneficial way!

Critical Role of FinancingCritical Role of Financing
 Makes projects possibleMakes projects possible
 Has major impact onHas major impact on
 Riskiness of constructionRiskiness of construction
 ClaimsClaims
 Prices offered by contractors (e.g., high bid price for latePrices offered by contractors (e.g., high bid price for late
payment)payment)
 Difficulty of Financing is a major driver towards alternateDifficulty of Financing is a major driver towards alternate
delivery methods (e.g., Build-Operate-Transfer)delivery methods (e.g., Build-Operate-Transfer)

How Does Owner Finance a Project?How Does Owner Finance a Project?
 PublicPublic
 PrivatePrivate
 ““Project” financingProject” financing

OutlineOutline
 OwnerOwner
 ProjectProject
 RatesRates
 NPVNPV

Public FinancingPublic Financing
 Sources of fundsSources of funds
 General purpose or special-purpose bondsGeneral purpose or special-purpose bonds
 Tax revenuesTax revenues
 Capital grants subsidiesCapital grants subsidies
 International subsidized loansInternational subsidized loans
 Social benefits important justificationSocial benefits important justification
 Benefits to region, quality of life, unemployment relief, etc.Benefits to region, quality of life, unemployment relief, etc.
 Important consideration: exemption from taxesImportant consideration: exemption from taxes
 Public owners face restrictions (e.g. bonding caps)Public owners face restrictions (e.g. bonding caps)
 Major motivation for public/private partnershipsMajor motivation for public/private partnerships
 MARR (Minimum Attractive Rate of Return) much lower (e.g. 8-MARR (Minimum Attractive Rate of Return) much lower (e.g. 8-
10%), often standardized10%), often standardized

Private FinancingPrivate Financing
 Major mechanismsMajor mechanisms
 EquityEquity
 Invest corporate equity and retained earningsInvest corporate equity and retained earnings
 Offering equity sharesOffering equity shares
 Stock Issuance (e.g. in capital markets)Stock Issuance (e.g. in capital markets)
 Must entice investors with sufficiently high rate of returnMust entice investors with sufficiently high rate of return
 May be too limited to support the full investmentMay be too limited to support the full investment
 May be strategically wrong (e.g., source of money, ownership)May be strategically wrong (e.g., source of money, ownership)
 DebtDebt
 Borrow moneyBorrow money
 BondsBonds
 Because higher costs and risks, require higher returnsBecause higher costs and risks, require higher returns
 MARR varies per firm, often high (e.g. 20%)MARR varies per firm, often high (e.g. 20%)

Private Owners w/Collateral FacilityPrivate Owners w/Collateral Facility
Distinct Financing PeriodsDistinct Financing Periods
 Short-term construction loanShort-term construction loan
 Bridge DebtBridge Debt
 Risky (and hence expensive!)Risky (and hence expensive!)
 Borrowed so owner can pay for construction (cost)Borrowed so owner can pay for construction (cost)
 Long-term mortgageLong-term mortgage
 Senior DebtSenior Debt
 Typically facility is collateralTypically facility is collateral
 Pays for operations and Construction financing debtsPays for operations and Construction financing debts
 Typically much lower interestTypically much lower interest
 Loans often negotiated as a packageLoans often negotiated as a package
timeconstruction
w/o tangible
operation
w/ tangibleadmission.edhole.com

OutlineOutline
 OwnerOwner
 ProjectProject
 RatesRates
 NPVNPV

““Project” FinancingProject” Financing
 Investment is paid back from the project profit rather than theInvestment is paid back from the project profit rather than the
general assets or creditworthiness of the project ownersgeneral assets or creditworthiness of the project owners
 For larger projects due to fixed cost to establishFor larger projects due to fixed cost to establish
 Small projects not much benefitSmall projects not much benefit
 Investment in project through special purpose corporationsInvestment in project through special purpose corporations
 Often joint venture between several partiesOften joint venture between several parties
 Need capacity for independent operationNeed capacity for independent operation
 BenefitsBenefits
 Off balance sheet (liabilities do not belong to parent)Off balance sheet (liabilities do not belong to parent)
 Limits riskLimits risk
 External investors: reduced agency cost (direct investment in project)External investors: reduced agency cost (direct investment in project)
 DrawbackDrawback
 Tensions among stakeholdersTensions among stakeholders

OutlineOutline
 OwnerOwner
 ProjectProject
 ContractorContractor
 RatesRates
 NPVNPV

Contractor Financing IContractor Financing I
 Payment schedulePayment schedule
 Break out payments into componentsBreak out payments into components
 Advance paymentAdvance payment
 Periodic/monthly progress payment (itemized breakdown structure)Periodic/monthly progress payment (itemized breakdown structure)
 Milestone paymentsMilestone payments
 Often some compromise between contractor and ownerOften some compromise between contractor and owner
 Architect certifies progressArchitect certifies progress
 Agreed-upon payments
 retention on payments (usually, about 10%)retention on payments (usually, about 10%)
 Often must cover deficit during constructionOften must cover deficit during construction
 Can be many months before payment receivedCan be many months before payment received

S-curve WorkS-curve Work
Man-hours
months

S-curve CostS-curve Cost
0
1
2
3
4
5
6
7
8
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22
Working days
$K
0
10
20
30
40
50
60
70
80
90
100
Cumulativecosts$K
Daily cost
Cum. costs

Expense & PaymentExpense & Payment

Contractor Financing IIContractor Financing II
 Owner keeps an eye out forOwner keeps an eye out for
 Front-end loaded bids (discounting)Front-end loaded bids (discounting)
 Unbalanced bidsUnbalanced bids
Contractor Revenue Projection
0
20
40
60
80
100
120
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18
Month
Revenue
Contractor Revenue Projection
0
20
40
60
80
100
120
140
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18
Month
Revenue

Contractor Financing IIContractor Financing II
 Owner keeps an eye out forOwner keeps an eye out for
 Front-end loaded bids (discounting)Front-end loaded bids (discounting)
 Unbalanced bidsUnbalanced bids
 Contractors frequently borrow fromContractors frequently borrow from
 Banks (Need to demonstrate low risk)Banks (Need to demonstrate low risk)
 Interaction with ownersInteraction with owners
 Some owners may assist in fundingSome owners may assist in funding
 Help secure lower-priced loan for contractorHelp secure lower-priced loan for contractor
 Sometimes assist owners in funding!Sometimes assist owners in funding!
 Big construction company, small municipalityBig construction company, small municipality
 BOTBOT

 Agreed upon in contractAgreed upon in contract
 Often structure proposed by ownerOften structure proposed by owner
 Should be checked by owner (fair-cost estimate)Should be checked by owner (fair-cost estimate)
 Often based on “Masterformat” Cost Breakdown StructureOften based on “Masterformat” Cost Breakdown Structure
(Owner standard CBS)(Owner standard CBS)
 Certified by third party (Architect/engineer)Certified by third party (Architect/engineer)
Contractor Financing IIIContractor Financing III

OutlineOutline
 OwnerOwner
 ProjectProject
 Additional IssuesAdditional Issues
 RatesRates
 NPVNPV

Latent CreditLatent Credit
 Many people forced to serve as lenders to owner dueMany people forced to serve as lenders to owner due
to delays in paymentsto delays in payments
 DesignersDesigners
 ContractorsContractors
 ConsultantsConsultants
 CMCM
 SuppliersSuppliers
 ImplicationsImplications
 Good in the short-termGood in the short-term
 Major concern on long run effectsMajor concern on long run effects

Role of TaxesRole of Taxes
 Tax deductions forTax deductions for
 Depreciation -Depreciation - LinkLink
 the process of recognizing the using up of an asset throughthe process of recognizing the using up of an asset through
wear and obsolescence and of subtracting capital expenseswear and obsolescence and of subtracting capital expenses
from the revenues that the asset generates over time infrom the revenues that the asset generates over time in
computing taxable incomecomputing taxable income
 OthersOthers

OutlineOutline
 Project FinancingProject Financing
 Owner
 Project
 Contractor
 Additional Issues
 Financial EvaluationFinancial Evaluation
 RatesRates
 NPVNPV

Develop or Not DevelopDevelop or Not Develop
 Is any individual project worthwhile?Is any individual project worthwhile?
 Given a list of feasible projects, which one is the best?Given a list of feasible projects, which one is the best?
 How does each project rank compared to the others onHow does each project rank compared to the others on
the list?the list?

Project Evaluation Example:Project Evaluation Example:
 Project AProject A
 Construction=3 yearsConstruction=3 years
 Cost = $1M/yearCost = $1M/year
 Sale Value=$4MSale Value=$4M
 Total Cost?Total Cost?
 Profit?Profit?
 Project BProject B
 Construction=6 yearsConstruction=6 years
 Cost=$1M/yearCost=$1M/year
 Sale Value=$8.5MSale Value=$8.5M
 Total Cost?Total Cost?
 Profit?Profit?

Quantitative MethodQuantitative Method
 ProfitabilityProfitability
 Create value for the companyCreate value for the company

ProfitProfit
TOTALTOTAL
EQUIVAL. $EQUIVAL. $
REVENUESREVENUES 5,500,000.005,500,000.00
COSTSCOSTS 4,600,000.004,600,000.00
Project managementProject management 400,000.00400,000.00
EngineeringEngineering 800,000.00800,000.00
Material & transportMaterial & transport 2,200,000.002,200,000.00
Construction/commissioningConstruction/commissioning 1,300,000.001,300,000.00
ContingenciesContingencies 200,000.00200,000.00
GROSS MARGINGROSS MARGIN 900,000.00900,000.00
Time factor?Time factor?admission.edhole.com

Quantitative MethodQuantitative Method
 ProfitabilityProfitability
 Create value for the companyCreate value for the company
 Opportunity CostOpportunity Cost
 Time Value of MoneyTime Value of Money
 A dollar today is worth more than a dollar tomorrowA dollar today is worth more than a dollar tomorrow
 Investment relative to best-case scenarioInvestment relative to best-case scenario
 E.g. Project A - 8% profit, Project B - 10% profitE.g. Project A - 8% profit, Project B - 10% profit

Money Is Not EverythingMoney Is Not Everything
 Social BenefitsSocial Benefits
 HospitalHospital
 SchoolSchool
 Highway built into a remote villageHighway built into a remote village
 Intangible Benefits (E.g, operating and competitiveIntangible Benefits (E.g, operating and competitive
necessity)necessity)
 New warehouseNew warehouse
 New cafeteriaNew cafeteria

OutlineOutline
 Owner
 Project
 Contractor
 Additional issues
 Time value of moneyTime value of money
 RatesRates
 NPVNPV

Basic CompoundingBasic Compounding
 Suppose we invest $x in a bank offering interest rate iSuppose we invest $x in a bank offering interest rate i
 If interest is compounded annually, asset will be worthIf interest is compounded annually, asset will be worth
 $x(1+i) after 1 year$x(1+i) after 1 year
 $x(1+i)$x(1+i)22
after 2 yearsafter 2 years
 $x(1+i)$x(1+i)33
after 3 years ….after 3 years ….
 $x(1+i)$x(1+i)nn
after n yearsafter n years
$x
0 1 $x(1+i) 2 $x(1+i)22
n $x(1+i)nn
…

Time Value of MoneyTime Value of Money
 If we assumeIf we assume
 That money can always be invested in the bank (or someThat money can always be invested in the bank (or some
other reliable source) now to gain a return with interest laterother reliable source) now to gain a return with interest later
 That as rational actors, we never make an investment whichThat as rational actors, we never make an investment which
we know to offer less money than we could get in the bankwe know to offer less money than we could get in the bank
 ThenThen
 Money in theMoney in the presentpresent can be thought as of “equal worth” tocan be thought as of “equal worth” to
a larger amount of money in the futurea larger amount of money in the future
 Money in theMoney in the futurefuture can be thought of as having an equalcan be thought of as having an equal
worth to a lesser “present value” of moneyworth to a lesser “present value” of money

Equivalence of Present ValuesEquivalence of Present Values
 Given a source of reliable investments, we areGiven a source of reliable investments, we are
indifferent between any cash flows with theindifferent between any cash flows with the
same present value – they have “equal worth”same present value – they have “equal worth”
 This indifferences arises because we can convertThis indifferences arises because we can convert
one to the other with no extra expenseone to the other with no extra expense

 STELLAR access:STELLAR access:
http://stellar.mit.edu/S/course/1/sp07/1.040/http://stellar.mit.edu/S/course/1/sp07/1.040/
 Next Tuesday Recitation: Skyscraper Part INext Tuesday Recitation: Skyscraper Part I
 Please set up an appointment to discuss your AS2 ifPlease set up an appointment to discuss your AS2 if
you choose emerging technologies (MF preferred)you choose emerging technologies (MF preferred)
 Office: 1-174Office: 1-174
 TA (50%) for our classTA (50%) for our class
 Send your resume (or brief your experience) by this SundaySend your resume (or brief your experience) by this Sunday

OutlineOutline
 Owner
 Project
 Contractor
 Additional issues
 Time value of money
 Present valuePresent value
 RatesRates
 NPVNPV

Time Value of Money: RevisitTime Value of Money: Revisit
 If we assumeIf we assume
 That money can always be invested in the bank (or someThat money can always be invested in the bank (or some
other reliable source) now to gain a return with interest laterother reliable source) now to gain a return with interest later
 That as rational actors, we never make an investment whichThat as rational actors, we never make an investment which
we know to offer less money than we could get in the bankwe know to offer less money than we could get in the bank
 ThenThen
 Money in theMoney in the presentpresent can be thought as of “equal worth” tocan be thought as of “equal worth” to
a larger amount of money in the futurea larger amount of money in the future
 Money in theMoney in the futurefuture can be thought of as having an equalcan be thought of as having an equal
worth to a lesser “present value” of moneyworth to a lesser “present value” of money

Present Value (Revenue)Present Value (Revenue)
 How is it that some future revenueHow is it that some future revenue rr at timeat time tt has a “presenthas a “present
value”?value”?
 Answer: Given that we are sure that we will be gaining revenueAnswer: Given that we are sure that we will be gaining revenue rr
at timeat time tt, we can take and spend an immediate loan from the, we can take and spend an immediate loan from the
bankbank
 We choose size of this loanWe choose size of this loan ll so that at timeso that at time tt, the total size of the loan, the total size of the loan
(including accrued interest) is(including accrued interest) is rr
 The loanThe loan ll is the present value ofis the present value of rr
 ll = PV(= PV(rr))

Future to Present RevenueFuture to Present Revenue
x
t
-x
tPV(x)
0 I’ll pay this back to the bank later
I can borrow this from the bank now
tPV(x)
If I know this is coming…
The net result is that I can convert a sure x at time t
into a (smaller) PV(x) now!

Present Value (Cost)Present Value (Cost)
 How is it that some future costHow is it that some future cost cc at timeat time tt has a “present value”?has a “present value”?
 Answer: Given that we areAnswer: Given that we are suresure that we will bear costthat we will bear cost cc at timeat time tt,,
we immediately deposit a sum of moneywe immediately deposit a sum of money xx into the bank yieldinginto the bank yielding
a known returna known return
 We choose size of depositWe choose size of deposit xx so that at timeso that at time tt, the total size of the, the total size of the
investment (including accrued interest) isinvestment (including accrued interest) is cc
 We can then pay offWe can then pay off cc at timeat time tt by retrieving this money from the bankby retrieving this money from the bank
 The size of the deposit (immediate cost)The size of the deposit (immediate cost) xx is theis the present valuepresent value ofof cc..

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