MINI CASE: DELAYED COMPLETION

An edible oil unit was completed with a delay of three years. Total cost at the time of completion was Rs.25 million as shown below:

As budgeted cost was only Rs.18 million, the Project Manager was asked to explain. He said with an air of confidence. "This was beyond my control. There were political disturbances hindering smooth progress. Inflation was running at 10% p.a. Actual cost of foreign machinery was $440,000 as against $400,000 estimated in the appraisal. Further, $ rate in 1991 was Rs.25 which appreciated by 20% by the time foreign expenditure were incurred. There was absolutely nothing I could do."

This was not considered as reasonable explanation by the Chief Executive. He fired the Project Manager.

Was he justified in doing so?

The Chief Executive was right in firing the Project Manager. The impact of inflation was not as much as stated. The Project Manager was either in-efficient for not knowing valid reasons or he was dishonest fleecing money through over-billings. In either case, he should be fired.

How we can explain to others about inflationary impact. For this purpose, we shall try to strip off the annual figures of inflation and than introduce inflation at the given rate. If our figures of base cost + inflation are far below than what has been reported by the project manager, we would take it as mis-reporting with an intent to rob the project.

First, we shall construct a simple statement, based on the above information, which shows local and foreign costs separately.

We shall now concentrate on what the Project Manager has reported. We shall classify his comments into two categories: Internal Factors and External Factors. Based on what he said, we can summarize as under:

1. Political Trouble disrupting the progress
2. Inflation at 10% per annum
3. Increase in base (C&F) cost of the machinery
4. Increase in dollar rate

The Chief Executive was aware of the political problems, inflation rate, machinery cost and forex rate. By a simple calculation, he can find out that there was no mis-reporting as to foreign cost:

ACTUAL: 440,000 X 30 =13,200,000 minus estimated Rs.10,000,000=3,200,000. (same as reported)

This leaves inflation. In order to see its impact, we shall first try to find out as to what would be year by year investment on project were there no inflation. Remember, the actual figures are with inflation. We take out inflation element by simply taking Rs.8 million as cost and dividing it on the pattern of actual progress. This is shown below:

Had there been zero inflation but only political disruption (resulting in strikes, road blocks etc), the original amount of Rs.8.00 would have got divided into four years.  Now that we know what was spent in which year, we can introduce inflationary factor as shown below:

It is clear that for a substantial sum (Rs.2.82 million), the Project Manager had no explanation.  As already stated that he was either in-efficient or dishonest and was fired rightly.