Projection

Projection is one of the most dominant activities of the management. This particular activity has been regarded as Project Management. Under the umbrella of project management, the management evaluates different projects and decide which to undertake and which to not. Whenever an organization wants to undertake any project they often borrow on short term basis and this is the right process to undertake rather put your own money on risk.

One of the basic formations of project management is that, undertakes those projects for the organization whose Net Present Value (NPV) depicting positive figure and at the end of the life of the project it should surpasses the initial outlay. A dollar has more worth when you receive it today, rather one or two years later because of the continuously mounting inflationary or interest rates. There are a number of methods for the project evaluation like IRR, Accounting rate of return, Payback Period and many more, but the most reliable one is the NPV approach because of its propensity to calculate the future amount in terms of present, which makes this approach more credible than that of others. The method is consistent with the company’s objective of maximizing shareholder’s wealth. Not even a single approach except the NPV is able to provide such a comprehensive result to the managers like the NPV approach do, that is why a number of financial officials have the perception that the NPV approach is far more superior to others, and yes! They are rightly so. One thing must be keep in mind, while implementing the method on the investment appraisal is that “you must accept the project which have the high net present value, than the money you put in as an investment.”

We have admitted that if the NPV comes in positive than undertake that project is a universal law but what will happen if all the projects gives equal NPV? In this scenario we will evaluate the cost of short term borrowings which is called Effective short term borrowing cost. Let say the company is planning to borrow US$5000, 000 (5 million). The company has three options to borrow the money which predominantly are 1) Line of Cost (LOC), 2) Banker’s acceptance (B.A) and 3) Commercial Paper. All these three alternatives have different conditions and rules pertaining to their borrowings.  The conditions of the three alternatives are,

1)      Drawing down on a LOC at 6.5% with a ½ percent commitment fee on the full amount for one month

2)      A BA at 6.5%, an all inclusive rate

3)      Commercial Paper at 6.15% with a dealer’s commission of 1/8 percent and a backup line cost of ¼ percent, both of which would be assessed on the US$5 million of commercial paper issue.

The cost of the all the alternatives are mentioned below.

You have seen that from the above table that the lowest borrowing possibility is with the commercial paper to finance the project for the organization. Now we will look over the cumulative cost of these projects to evaluate the overall cost of each alternative. The cumulative cost in the light of above mentioned alternatives are,

The overall project cost, if choosing 1^st alternative would be US$5,350,000, if 2^nd then US$5,339,500 and US$5,328,000, if take 3^rd alternative. From the analysis we have found that the third alternative implicit the lower cost for the project.