PROJECT CLASSIFICATION

Project analysis  entails time and effort. The costs incurred in this exercise must be justified by the benefits from it. Certain projects, given their complexity and magnitude may warrant a detailed analysis other may call for a relatively simple analysis. Hence firms normally classify projects into different categories
 Each category is then analysed somewhat differently.
While the system of classification may vary from one firm to another, the following categories are found in most classifications.

Mandatory investment

These are expenditures required to comply with statutory requirement. Examples of such investment are pollution control equipment, medical dispensary, fire fighting equipment, creche in factory premises, and so on. These are often non revenue producing investments. In analysing such investments, the focus is mainly on finding the most cost effective way of fulfilling a given statutory need.

Replacement projects

Firms routinely invest in equipment meant to replace obsolete and inefficient is to reduce costs, increase yield and improve quality. Replacement projects can be evaluated in a fairly straightforward manner, though at times the analysis may be quite detailed.

Expansion projects

These investments are meant to increase capacity and/or widen the distribution network. Such investments call for an explicit forecast of growth. Since this can be risky and complex, expansion projects normally warrant more careful analysis than replacement projects. Decisions relating to such projects are taken by the top management.

Diversification projects

These investments are aimed at producing new products or services or entering into entirely new geographical areas. Often diversification projects entail substantial risks, involve large outlays, and require considerable managerial effort and attention. Given their strategic importance, such projects call for a very thorough evaluation, both quantitative and qualitative. Further they require a significant involvement of the board of directors.

Research and development projects

Traditionally, R&D projects absorbed a very small proportion of capital budget in most Indian companies. Things however are changing. Companies are now allocating more funds to R&D projects, more so in knowledge intensive industries.R&D projects are characterised by numerous uncertainties and typically involve sequential decision making. Hence the standard DCF analysis is not applicable to them. Such projects are decided on the basis of managerial judgement. Firms which rely more on quantitative methods use decision tree analysis and option analysis to evaluate R&D projects.

Miscellaneous projects

This is a catch all category that includes items like interior decoration, recreational facilities, executive, landscaped gardens, and so on. There is on personal preferences of top management.