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UBC Theses and Dissertations

Management of large capital projects Fromson, Douglas Arthur

Abstract

The value of an investment project is a function of the magnitude and the distribution over time of the current capital outlay and future cash benefits pertaining to the project. Three basic problems must be resolved in capital budgeting and decision-making during project implementation: 1) It is difficult to estimate capital costs and cash benefits. 2) The realization of future benefits is uncertain. 3) Future benefits must be compared with current capital costs. Generally, risk and uncertainty associated with an investment project are given implicit consideration by basing decisions on the most likely single-valued estimates of capital cost and cash flow. However, recent developments in investment management techniques enable risk and uncertainty to be given explicit consideration by assignment of a priori probability distributions to capital cost and cash flow estimates. These methods are enabled by the introduction of Monte Carlo computer simulation. The problem of comparing current capital costs with future benefits can be resolved by discounted cash flow (dcf) or net present value (npv) analysis. Both methods enable the distribution over time of the cash flow to be explicitly taken into account. The minimum acceptable yield for a project is dependent upon the firm's cost of capital. The decision to undertake a project included in the set of viable projects available to the firm is constrained by the availability of resources, particularly financial and managerial resources. A normative model of a large industrial capital project can be divided into seven reasonably distinct phases: 1) Idea Generation, 2) Preliminary Analysis, 3) Comprehensive Feasibility Study, 4) Project Development, 5) Project Implementation, 6) Start-Up, and 7), Post-Completion Audit. A decision to proceed with a project is generally made at the completion of the feasibility study phase; however, the decision can reasonably be reviewed and revoked at the completion of the project development phase. Beyond this point the implementation process is essentially irreversible, as cash outlays accelerate for fixed and intangible assets which have little or no salvage value. To ensure optimization of the project's value to the firm, a competent and sufficient management team must be provided to direct the implementation. For a large single undertaking, definable in terms of a specific end result which is unique, complex and involves a high degree of interdependence of task accomplishment, a project or task force organization is invariably utilized. The uniqueness, frequency, and critical importance of project decision-points demand a high degree of senior executive attention and control. Modern network methods (PERT/CPM) enable the separation of the planning and scheduling functions and aid in the establishment of an efficient, coordinated work flow. Network diagrams provide an explicit means of considering dependencies between events, even for large projects which include several thousand or more significant activities. Network analysis enables critical activities to be distinguished from non-critical activities, and thus project durations can be controlled or minimized by application of resources to specific key areas. Established computer routines are available to systematically 'crash' projects and to aid in schedule formulation which facilitates stabilization of resource input levels. A case study of a hypothetical industrial project is used to illustrate the comprehensive feasibility study, project development, and project implementation phases. Although confidential requirements prevented the use of a specific project, the case is realistic in that the data base was synthesized from several actual projects of corresponding scope. Examination of the methodology of capital project management on an overall basis indicates that the integrated systems concept approach is required for maximum efficiency of resource utilization. The future will undoubtedly see rationalization of the fragmented approach to problems in economics, finance, engineering and administration; as well as more widespread application of modern techniques in data processing, management science and information system design.

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