May 20, 2014

Valuation and Verification of Closing Stock

The valuation of closing stock is the important factor in determining the operating result.

Cost accounting system if it exists in the company will give the value of closing stock. But if cost accounting system is not in place, then physical stock verification needs to be done in the stores as well as on the shop floor and finished good stores.

Stock taking is the procedure or process of physical verification of stocks at periodic intervals.

Persons undertaking physical verification should be different from those responsible for store-keeping in respect of those stocks.

The auditor has to obtain sufficient appropriate audit evidence to corroborate the management's assertions regarding closing stock.

- that all inventories owned by the entity recorded and all recorded inventories are owned by the entity.
- that all recorded inventories exist at the year-end under the ownership of the entity.
- that the stated basis of valuation of inventories is appropriate and properly applied, and that the condition of inventories is recognized in their valuation.

The procedures used in auditing of inventories are:
1. Examination of records
2. Attendance at stock taking
3. Obtaining confirmations from third parties regarding invetories in their premises.
4. Examination of valuation policies and procedures
5. Analytical review procedures.

Knol Number 469

Valuation of Bonds and Equity Shares - Basic Principles and Models

Financial Management Revision Article

Basic Principle

The valuation of any asset, real financial is equal to the present value of cash flows expected from it.

Bond valuation

Valuation of a bond requires an estimate of expected cash flows and a required rate of return specified by the investor for whom the bond is being valued. If it is being valued for the market, the markets expected rate of return is to be determined or estimted.
A simplified bond valuation model or exercise is based on the following features of the bond.
Fixed coupon rate for the term of the bond.
Coupon payments are made annually and the next coupon payment is receivable in year from now.
The bond will be redeemed at par on maturity.
The bond is noncallable. It will not be redeemed before the maturity.
The formula for discounting the associated cash flows is
Sum of all  C/(1+r)t (t = 1 to n)+ P/(1+r)n
Where C = annual coupon payment
r = required rate of return
n = number of years to maturity
P = Par value 
The formula can be modified for various complex features of bond, like half yearly payments, redemption at premium on maturity etc.

Equity Share Valuation

P/E Multiple Based Method

Dividend discount model

Dividend valuation model is conceptually a very sound approach.
According to this approach the value of an equity share is equal to the present value of dividends expected from its ownership plus the present value of the sale price expected when the equity share is sold.

Simple Model: Constant dividend with no growth

The simple model of equity share valuation has assumption that the dividend per share remains constant year after year at a value D. Dividend will be received at the end one year now from now and required rate of return or that of market is r.
Then Present value of the equity share = V = D/r

Model with growth less than the required rate of return

If there is an expected growth in dividends whch is g constant in all the years in the future and also less than r, the required rate of return, the valuation formula is
V = D/(r-g)

High Current Growth Companies

The simple valuation model proposed for companies that have a high growth in dividends currently is two growth period model. In this model during the first period of n years, the growth g1 is higher than r. In the remaining period growth g is less than r.
The present value of dividends of n years is found out and the present value  terminal value of [D(n+1) /r-g] is added to it to find the value of the share.
More complexities can be added to the model.


Prasanna Chandra, Financial Management, 5th Ed.,  Tata McGraw Hill, 2001
Brealey and Myers, Corporate Finance, Fifth Edition, Prentice Hall India, 2001

Originally posted in Knol 2utb2lsm2k7a/ 370

Role of Mindfulness in Managing - Creative Stress Free Personality and Decision Making

Focus, clarity, creativity, compassion, and courage. There are the benefits of practicing mindfulness promoting techniques and practices. "These are the qualities of the mindful leaders I have worked with, taught, mentored, and interviewed." wrote Billy George, a professor management practice at Harvard Business School.

They are also the qualities that give today’s best leaders the resilience to cope with the many challenges coming their way and the resolve to sustain long-term success. The real point of leverage — which though it sounds simple, many executives never discover — is the ability to think clearly and to focus on the most important opportunities.

In his new book Focus, psychologist Dr. Daniel Goleman, the father of emotional intelligence (or EQ), provides data that supports the importance of mindfulness in focusing the mind’s cognitive abilities, linking them to qualities of the heart like compassion and courage.

Gestalt Techniques in Supervision and Management


Gestalt is a German word meaning “see the whole.”  Gestalt practitioners use various methods to help individuals see different aspects of a work or other problem so as to provide an opportunity to understand the whole situation and to do something positive to solve the problem.

Role Playing

For example to provide a common understanding between management and workers, role playing is arranged. Members of both the groups take turns to be members of either group and try to solve problems like increasing production, reducing costs, absenteeism etc. This role playing increases understanding of the various points of view by both managers and workers.

Physical Discomfort Symptoms

Gestalt theory also assumes that problems at work place or various other interactions are constantly shown through physical discomfort symptoms. All situations that cause physical discomfort symptoms are analyzed for their relationship or behavioral problems groups of people or supervisor-subordinate.

Mental Awareness

Exercises teach workers to become accustomed to concentrating on the present. They can be practiced regularly. Supervisors may watch their workers for lack of awareness of the present. The worker’s mind may be dwelling on past injustices or hypothetical happy future situations. Supervisor can intervene appropriately to bring the operator into the present.


Lindley R. Higgins and Ruth W. Stidger (Editors), Cost Reduction: From A to Z, McGraw-Hill, 1976, pp. 187-188.


How Gestalt theory can facilitate teaching and learning processes

20 May 1926 - Birthday of Edwin C. Nevis, a gestalt practitioner in organizational development.


Originally posted in 2utb2lsm2k7a/ 65

May 19, 2014

Performance Appraisal and Career Strategy

The performance of staff has to be appraised periodically to assess them for current job as well as for future career planning.

Appraising Managers

Managerial appraisal is closely related to selection, placement, and promotion. Actually we can selection is appraisal only. But, appraisal term is used for the employees of an organization and one of the purposes it serves is  identifying persons within the enterprise who are ready for promotion. On the other hand, the candidates from outside the firm must first be recruited, selected, and placed before their performance can be appraised.

Appraisal is a necessity in organizational life. Superiors need to know about the quality of performance of their subordinates. Subordinates also want to know where they stand. There are many
traditional performance appraisals that focus on personality traits and do not give a clear answer to the question, How well am I doing? An approach that focuses on performance in accomplishing goals and plans is more effective.

In this chapter, Koontz and O'Donnell focus more on appraising managers.

Performance appraisal can have three components - a comprehensive review, progress or periodic reviews, and continuous monitoring.

It is generally agreed that comprehensive review must be done at least once a year. Formal review must be supplemented by progress or periodic reviews wherein the superiors learns about factors hindering an effective performance in case it is needed. Also there reviews maintain communication between a superior and subordinate. Also objectives can be changed during these periodic reviews if necessary. People need not pursue obsolete goals.

As an appraisal approach, the greatest deficiency of management by objectives is that it provides for appraisal of results of operating performance only.  There are other factors to appraise, the managerial abilities and development needs.

Koontz and O'Donnell suggest a checklist for appraising managerial abilities against management principles for fundamentals.

Senior managers can do career planning for the people under them and discuss the development plan for a subordinate to acquire the competencies for the immediate next career position and the next. Sometimes, managers may have to acquire additional academic qualifications and a discussion between the superior and subordinate can help to decide to focus on the career progression and acquire the required competencies.

Total Improvement Management

Total Improvement Management is a concept promoted by Dr. H. James Harrington, CEO of Harrington Institute Inc.

He identifies Total Quality Management (TQM), Total Resource Management (TRM), Total Cost Management (TCM), Total Productivity Management (Tpmgmt), and Total Technology Management (TTM) as five improvement movements competing for the scarce budget resources of an organization. To aid management decision making in this competitive situation, an improvement pyramid is advocated by Harrington.

A Video by Harrington Group


A Presentation by Harrington (Good Presentation - Download and read it)

H. James Harrington, (1995) "The new model for improvement: total improvement management", Management Decision, Vol. 33 Iss: 3, pp.17 - 24

Total Improvement Management - Book By Harrington

Article by Harrington (Not available now)

2 page brochure

Determination of Optimum Productivity Improvement Programs: Total Productivity Based Model
Mohamed Zaki Ramadan,

Industrial Engineering Knowledge Revision Plan - One Year Plan

January - February - March - April - May - June

Total Industrial Engineering - H. Yamashina

Total industrial engineering is a concept identified by Yamashina as a part of his World Class Manufacturing Concept.

Total Industrial Engineering - Definition

by Yamashina

A system of methods where the performance of labor is maximized by reducing Muri (unnatural operation), Mura (irregular operation) and Muda (non-value added operation), and then separating labor from machinery through the use of sensor techniques.

( Source:

The above explanation of industrial engineering by Yamashina is the explanation for industrial engineering provided by Japanese scientific management pioneers. It is based on the precepts of Buddhism and also Japanese ideas regarding resource use.

Yamashina identified Total Industrial Engineering as an important components of the Toyota Production System which is the role model for World Class Manufacturing.  Total Industrial Engineering approach should be more properly credited to Alan Mogensen. From Alan Mogensen, it became part of supervisory training in USA during the second world war time. From this training, it was exported to Japan after the second world war. Toyota company conducted these training programs and substituted the improvement management module with a module from Japan Management Association and Shiegeo Shingo conducted these programs in Toyota Company. Total industrial engineering is involving supervisors and operations in industrial engineering projects in an active manner.

Total industrial engineering is a development in industrial engineering.When he proposed scientific management, which advocated improvement of efficiency by detailed study of work methods by the management, Taylor gave the opinion that both supervisors and operators are overburdened and therefore, a new cadre of staff specialists have to undertake it. That may be the right diagnosis at that time and a proper way to introduce a new management system. But thirty years later, Mogensen came to the conclusion, the time is appropriate to involve supervisors and operators actively in IE projects and successfully demonstrated its utility.

Elimination of three main enemies of Productivity

Muri - Difficult or unnatural operation - To be eliminated by motion study and motion analysis - Requires observation and study.

Mura - Irregular movement - To be eliminated by standard operation - To be observed for some time to recognize the problem.

Muda - Waste - To be eliminated by identifying and eliminating non value added activities - more easy to identify.


Existence of operational standards that assure quality, the operators follow them, there is a check on their following them and there is continuous improvement of those operational standards by operators.

Tools developed in TIE Philosophy

Muri, Mura, Muda
Multiskilled labor - Skill development
Video camera method
Standard operation
Pace monitor
Separation of labor from machinery
Separation of labor from operation and the one from transportation etc.

Safety Part of Total Industrial Engineering

Yamashina included Safety steps 1 -3 of his 7-step progression in the basic stage of IE.
Safety step 4 - 6 are included in intermediate stage.
Safety step 7 is included in the advanced stage.


Related Articles - Industrial Engineering
Principles of Industrial Engineering - Centenary Year
Contains the first chapter - Explanation of IE by Charles Going in 1911

World Class Manufacturing - Yamashina Way

Industrial Engineering Tool Kit

Industrial Engineering Definitions - 1911 to 2009

An article on TIE in Japanese. you can try translating with Google translate


Companies Utilizing Total Industrial Engineering Concepts

With the motto of "Quality People, Quality Products", PAC’s Total Industrial Engineering Dept. (TIE) annually holds the Quality Check Technical Skills Competition and In-House Quality Control Circle Competition.

There are also group learning circles, like the Quality Control Circle (also called Kaizen Circle) -- a group activity wherein members are challenged to solve problems according to the basic QC principles, using the QC tools. QCC activities improve the individual capabilities of each circle member resulting to performance improvement in the workplace and consequently, company development. (March 2008)

( )

You can read also

WCM - Japanese Way

Originally posted on Knol (3146)

Industrial Engineering Knowledge Revision Plan - One Year Plan

January - February - March - April - May - June

May 15, 2014

Supply Behavior/Decisions of Firm in Competitive Markets

Economics Revision Article


In perfectly competitive market, any one firm is so small relative to the market that it cannot affect the market price.

The firm will maximize profits. To maximize profits, the firm has to choose goods to produce, select production processes, determine output levels, buy inputs, manage its operations and make many other decisions so that they contribute to that objective. This means, the firm to maximize profits, must manage its internal operations and external activities. In internal operations it has to choose efficient production processes, encourage work morale and prevent waste. In external transactions it has to buy the correct quantities of inputs at least cost and manage transport etc., to get the materials to its production facility and transport materials to it customers at least cost. Profits increase the value of the firm to its owners.

Perfect Competition Demand Curve

For any single firm, the demand curve appears to be an horizontal line. At a single price, the firm can sell the maximum quantity that it can produce at that price. At a higher price, the demand will drop to zero.

The Production Quantity Decision by the Firm

Under perfect competition, a profit maximizing firm will set its production at that level where marginal cost equals price.

Economics of Competitive Markets or Perfect Competition

Six Sigma - Introduction

Six sigma is a fact-based, data-driven philosophy of improvement that values defect prevention by process improvement. It drives customer satisfaction and bottom-line results by reducing process variation and defects occurring due to variation.

Six sigma has a set of tools qualitative and quantitative that are used by six sigma practitioner to drive process improvement.

Methodology: As a definite sequence of steps, six sigma uses DMAIC sequence.

Metrics: Six sigma level processes produce only 3.4 defects per million pieces of output.

Six Sigma Organization

Black Belts (Program Managers)

Black belts work full time on six sigma projects.  According one Six Sigma authors, black belts should equal about 1% of the number of employees in the organization. It is expected that a black belt manages four projects per year for a total of $500,000 to $5,000,000 in contributions to the company's bottom line.

Master black belts have advanced knowledge in statistics and also have knowledge in the technical fields. They provide support to black belts.

Green Belts: A green belt works under the direction of a black belt and he undertakes six sigma projects as a part of his full-time job.

Champion: He is typically a top-level managers who appreciates the benefits of six sigma projects and provides support for the program.

Executive: The support of CEO or his deputies is required for successful implementation of Six sigma in an enterprise.

Process owners: They have to power of making changes in the process as suggested by six sigma teams. They should be provided green belt training at least.

Industrial Engineering Knowledge Revision Plan - One Year Plan

January - February - March - April - May - June

The Certified Six Sigma Black Belt - Donald Benbow and T.M. Kubiak - Book Information

Book copyright by American Society for Quality Inc., 2005

Published by Pearson Power

Chapters -

1. Enterprise-wide Deployment

2. Business Process Management

3. Project Management

4. Six Sigma Improvement Methodology and Tools - Define

5. Six Sigma Improvement Methodology and Tools - Measure

6.  Six Sigma Improvement Methodology and Tools - Analyze

7. Six Sigma Improvement Methodology and Tools - Improve

8.  Six Sigma Improvement Methodology and Tools - Control

9. Lean Enterprise

10. Design for Six Sigma

Preview the Book

Industrial Engineering Knowledge Revision Plan - One Year Plan

January - February - March - April - May - June

Acquired the book today. Going through it.

May 14, 2014

Supply Chain Management - Collaborative Planning, Forecasting and Replenishment (CPFR)

Supply Chain Management - Collaborative Planning, Forecasting and Replenishment (CPFR)

Supply Chain Management - Collaborative Planning, Forecasting and Replenishment (CPFR)

Collaborative Planning, Forecasting, and Replenishment (CPFR) takes a collaborative approach to supply chain management and information exchange among trading partners. The driving premise of CPFR is that all supply chain participants develop a synchronized forecast.



Collaborative Planning, Forecasting, and Replenishment (CPFR) takes a collaborative approach to supply chain management and information exchange among trading partners.
The driving premise of CPFR is that all supply chain participants develop a synchronized forecast. Every participant in the supply chain involved in a CPFR process — supplier, manufacturer, distributor, retailer — can view and amend forecast data. Therefore, CPFR puts an end to independent guesswork in the forecasting process by various participants. It results into a situation wherein  manufacturers and retailers share their plans, with detailed knowledge of each others’ assumptions and constraints.
The steps involed in installing a CPFR systems are:
1. Develop Front End Agreement
2. Create Joint Business Plan
3. Create Sales Forecast
4. Identify Exceptions for Sales Forecast
5. Resolve/Collaborate on Exception Items
6. Create Order Forecast
7. Identify Exceptions for Order Forecast
8. Resolve collaborate on Exception Items
9. Order Generation
10. Delivery Execution

CPFR Case Studies from VICS


Collaborative Planning, Forecasting and Replenishment (CPFR): A Tutorial

Cecil Bozarth , PhD
North Carolina State University
Author of "Introduction to Operations and Supply Chain Management," 2nd edition, Pearson, Prentice-Hall
Links to web pages

White Papers


The article needs update and reposting. Needs to be done.

May 12, 2014


You have probably heard about shareholder value. Perhaps your company has declared a commitment to shareholder value. Fortune magazine called shareholder value “the real key to creating wealth.” You might have read in some of the chairman’s speeches, references to share holder value creation. You may have seen some of the seminar brochures on this topic or on various acronyms associated with this area: EVA, SVA, CFROI and VBM. This paper aims to explain what shareholder value means, and how the present emphasis on shareholder value management as a strategic initiative developed in management practice and the present day tools and techniques of shareholder value management.

What is shareholder value?

The total economic value of an entity such as a company or business unit is the sum of the values of its and its equity. This value of the business is called “corporate value” and the value of the equity portion is called “shareholder value.” In summary;

Corporate value = Debt + Shareholder value

The debt portion of corporate value includes the market value of debt, unfunded portion of employment benefits if any, and the market value of other claims such as preferred stock.

Shareholder value is reflected in the market price of equity shares of a company. Shareholder value can also be understood as the market capitalization of the equity capital of the company at any point of time.

Is the concern for shareholder a new idea in management?

“Finance theory rests on the premise that the goal of the firm should be to maximize the wealth of its current shareholders.”(Prasanna Chandra, 2001)

Corporate finance theory since from its origin was developed on the above premise. The financial managers are supposed to take decisions, which help to create additional value or wealth for current shareholders of the company. This goal probably remained as the goal of the finance management function only and rest of the organization may not be assessing its decisions on the touchstone of shareholder value or wealth building. Also, even today shareholders are given accounts of past transactions only. They do not know what the management is going to do in the future and how it is going to protect their wealth and increase it. The financial reporting profession mandated that only audited record of the past transactions are made available to capital market participants to make their decisions regarding fair prices to buy and sell equity shares in the market.

The new movement of Shareholder value management

The publication of Creating Shareholder Value by Professor Alfred Rappaport of Northwestern University, Illinois in 1986 can be said to be the beginning of the current movement of shareholder value management. He subsequently founded the Alcar group, a company dedicated to the production of software to help companies achieve some of the goals laid out in his book. Rappaport introduced the free cash flow (FCF) model of business and equity valuation and showed how the normal discounted cash flow techniques used in project evaluation can be put into use in valuing ongoing business firms and companies.

This was followed in 1987 by, Managing for Value, by Bernard Reimann, which discussed linking shareholder value creation (SHV) to the art of running a company. Management consultants took the initiative from there and developed a new practice area of shareholder value creation and management.

Tom Copeland and others from McKinsey Group published the book, Valuation in 1990. This book contained a detailed exposition of the issues of valuing companies, so that companies can act in the direction of increasing the value.

In the year 1991, G.Bennett Stewart authored The Quest for Value, which introduced the idea of economic value added (EVA). The book focused more attention on the detailed measurement of a firm’s balance sheet, and how certain items need to be treated differently from the way accountants usually handle them.

Andrew Black and others from PricewaterhouseCoopers brought out in search of shareholder value in 1998 and argued that shareholder value management is a necessary activity in the era of shareholder activism.

The book EVA and Value-Based Management: A Practical Guide to Implementation by S. David Young and Stephen F. O’Byrne was published in 2001. Stephen O’Byrne was a former senior vice president at Stern Stewart & Co. and is the president of Shareholder Value Advisors Inc., a firm specializing in shareholder value management.

Today, there are a series of booklets and brochures published by all top management consulting firms in the area shareholder value management. This is an area where actual practice is being attempted in a large number of companies in many countries in the world where capital markets provide bulk of the resources for corporate sector.

What is the imperative?

Three forces in particular have contributed to a growing awareness of the importance of shareholder value and value-based management. They are the increasing role of private capital in capital formation in various countries; the globalization of markets; and the information revolution including the internet.

In the first half of the 20th century, there was a loss of faith in capital markets and people accepted the expansion of the state into areas of commercial and financial life on a massive scale in many countries of the world. In particular, many states entered into long-term obligations in the areas of pensions, health and social security. Combined with demographic developments – increased life expectancy, for example-this has meant that in the last 20 years these states have hit the limits of their taxing and borrowing powers and have begun to withdraw from at least some of their commitments and to shift provision back to the individual. The individuals are placing their long-term and retirement-funds with institutional investors. These institutional investors are demanding actions that lead to adequate shareholder returns from corporate concerns.

Since 1970s, true global markets have developed in an increasing range of goods and services, accompanied by various agreements under GATT and WTO. By the 1980s, along with widespread domestic financial de-regulation, most restrictions on capital flows had been removed by the OECD countries. Following the establishment of global markets for financial assets, it has become possible to invest internationally in a much more proactive way than before. Companies across the world are now competing not only for customers, products and employees, but also for capital. The major criterion for attracting capital is creation of shareholder value. Even in capital rich countries, local companies can no longer expect to gain access to funds as cheaply as before. Many of the larger companies in countries such as Germany and Japan are not able to get capital from banks etc. and they also have to approach capital market for funds.

The increased sophistication of telecommunications and computers means that money can now travel across the world in a matter of seconds. The advent of PC-based modeling software enabled investors to make more complex calculations related to valuation of shares. The quantity and quality of information available to investors are far superior now. Edgar database provides immediate access to US financial filings. Many companies are now spending considerable amount on investor relations and communications through internet and media. You can’t hide from the markets by not communicating. Any company that wants to attract investment and any management that wants to stay in the saddle have to submit themselves to the scrutiny of the people whose money it is using.

Agreed. We want to manage our shareholder value. What should we do?

Do you understand how equity shares are valued in the stock market? Every finance text has a chapter on valuation of securities to provide inputs in this area to finance students. But how many of us really understand this chapter and value shares using the methodology given. How many finance executives in a company can come out with their estimated value for their companies’ shares with an underlying methodology. If we want to talk of operating executives, the number will be negligible. Why so? Because so far shareholder value is not a management issue most of the time except when the company is planning a right issue or a public issue.

The first step in the process has to be understanding of how investors in the stock markets practically determine the value of equity shares and trade them. No doubt, in the stock market there are many participants with divergent motives. There are participants who act as market makers and buy a share and sell the same share in the next deal for little bit extra. There are promoters of companies who plan to keep the shares within their family for generations. We have to understand the valuation process in this complex market where different people speak different languages. To gain the perspective we can have a look at the criteria for valuation of equity shares proposed by Benjamin Graham, hailed as the father of the subject of Security Analysis.

Benjamin Graham’s Quality and Valuation Criteria for Value Stocks

1. Adequate Size

For India let us specify that it has to be Rs.100 crore in sales (Graham- Rao Method for India)

2. Strong Financial Condition

Current assets should be at least twice current liabilities.

Long-term debt should not exceed the net current assets


Total Debt-equity ratio is to be less than 1:1

3. Earnings Stability

Some earnings for the common stock in each of the past ten years.

4. Dividend Record

Uninterrupted dividend payments for at least the past 20 years.

5. Earnings Growth
A minimum growth rate equal growth in national income over the last 7 years.

6. Moderate Price/Earnings Ratio

Current price should not be more than 20 times average earnings of the past seven years for the best companies. To give a more specific instruction, set the multiplier equal to the growth rate in EPS in percentage in the last 7 years subject to a maximum value of 20.


Current price should not be more than 15 times average earnings of the past three years for the best companies.

7.Moderate Ratio of Price to Assets

Current Price should not be more than 1.5 times the book value last reported.

As a rule the product of the multiplier times the ratio of price to book value should not exceed 22.5.

Rules of Graham highlight the importance of earnings per share (EPS) as a determinant of share prices and values. Benjamin Graham taught Security Analysis at Columbia University during 1928 to 1956. Prior to Graham the book value of the company was the important benchmark for the valuation of equity shares. Despite the popularity of Graham’s classes and books the valuation principles of Graham were not embraced wholeheartedly by the stock market participants. Most of the active investors preferred P/E ratios based on single year EPS figures. Also the emphasis was much more on fluctuations. Hence there were no clear cut guidelines on the ratio to be applied. One thing became a rule, increases in EPS are generally welcome and are likely to be followed by share price increases. Decreases in EPS are followed by share price declines. In this paradigm, companies concentrated on reporting increasing EPS figures.

J.B. Williams brought discounting of dividends into the share valuation methods. The infinite growth model and two-stage growth model became the popular valuation formulas. But the implementation of the formulas required future dividend estimates till infinity and cost of capital estimates. Companies were not providing such estimates. Investors and analysts on their own could not come with such estimates with the required level of confidence. Warren Buffett is credited with using dividend discounting models extensively for his investment decision making. He is said to use yield rate on 30-year government bonds in USA as the discount rate. He will buy only those shares which are available at 50% discount to the fair value estimated by him using dividend discount formula.

Modern portfolio theory gave birth to the capital asset pricing model which came out with the formula for expected return on securities. According to this formula the expected return on a security is equal to the risk free return plus the sensitivity coefficient (called beta) multiplied by the excess return on a market portfolio having all the risky securities. The market portfolio is generally taken as a representative share price index in the country. Thus a formula to calculate cost of capital of a listed company emerged.

Rappaport came out with his free cash flow model to value companies and equity shares. According to the free cash flow model, excess cash flows generated by the company after taking care of requirements for increased capital spending and working capital investments are a cash return to the security holders and these cash flows can be discounted at the cost of capital to determine the value of shares. It is also hypothesized that in any industry, free cash flows above the cost of capital are earned by the companies for few years. Competitors enter an industry till free cash flows are positive for existing companies. Hence stability will come in an industry only when the free cash flow earned is equal to the cost of capital. Thus to estimate and value free cash flows company managers and analysts have to estimate the competitive advantage period during the company concerned will earn excess free cash flows.

Rappaport’s model is accepted by the management thinkers and consultants as best suited for shareholder value management. Some of the consultants have come out with their variations like EVA, CVA etc. But the underlying foundation is Rappaport’s argument. Understanding and managing the free cash flows, competitive advantage period and cost of capital for the firm form part of the value management process. Management has to keep the market informed of the results of present value creating activities and as well as plans for future value creating activities. This reporting process is being christened as Value Reporting.

Approaches to Shareholder Value Estimation

1. Marakon approach
2. Alcar approach
3. McKinsey approach
4. Economic value added approach
5. BCG approach

Original post

Software Cost Management

Software Cost Management

Software Cost Management





 Project cost management includes the processes required to ensure that the project is completed within an approved budget.
    Project Cost Management Processes
   Cost estimating: Developing an approximation or estimate of the costs of the resources needed to complete a project.
Cost budgeting: Allocating the overall cost estimate to individual work items to establish a baseline for measuring performance.
 Cost control: Controlling changes to the project budget.

 Interesting web page

 Software Cost  Estimation

Software estimation is a complex activity and to take care of it many commercial software estimation tools are developed and marketed. As of 2005, some of these estimating tools include COCOMO II, CoStar, CostModeler, CostXpert, KnowledgePlan, PRICE S, SEER, SLIM, and SoftCost.
  The major features of commercial software-estimation tools include the attributes:
  • Sizing logic for specifications, source code, and test cases.
  • Phase-level, activity-level, and tasklevel estimation.
  • Adjustments for specific work periods, holidays, vacations, and overtime.
  • Adjustments for local salaries and burden rates.
  • Adjustments for various software projects such as military, systems, commercial, etc.
  • Support for function point metrics, lines of code (LOC) metrics, or both.
  • Support for backfiring or conversion between LOC and function points.
  • Support for both new projects and maintenance and enhancement projects.
    Some estimating tools also include more advanced functions such as the following:
  • Quality and reliability estimation.
  • Risk and value analysis.
  • Return on investment.
  • Sharing of data with project management tools.
  • Measurement models for collecting historical data.
  • Cost and time-to-complete estimates mixing historical data with projected data.
  • Support for software process assessments.
  • Statistical analysis of multiple projects and portfolio analysis.
  • Currency conversion for dealing with overseas projects.
  (Source: Capers Jones,
      Cost Drivers for Large Software Systems: Paperwork and Defect Removal (Capers Jones)
  Large software projects devote more effort to producing paper documents and to removing bugs or defects than to producing source code.
  Therefore, accurate estimation for large software projects must include the effort for producing paper documents, and the effort for finding and fixing bugs or defects, among other things.
  A key aspect of software cost estimating is predicting the time and effort that will be needed for design reviews, code inspections, and all forms of testing. To estimate defect removal costs and schedules, it is necessary to know about how many defects are likely to be encountered.
  The typical sequence is to estimate defect volumes for a project and then to estimate the series of reviews, inspections, and tests that the project utilizes. The defect removal efficiency of each step will be estimated also. The effort and costs for preparation, execution, and defect repairs associated with each removal activity also will be estimated.
  One important aspect of estimating is dealing with the rate at which requirements creep and, hence, make projects grow larger during development.
  Adjustment Factors for Software Estimates (Capers Jones)
For estimating costs for  real software projects, the basic default assumptions of estimating tools must be adjusted to match the reality of the project being estimated. These adjustment factors are a critical portion of using software estimating tools. Some of the available adjustment factors include the following:
Staff experience with similar projects.
Client experience with similar projects.
Type of software to be produced.
Size of software project.
Size of deliverable items (documents, test cases, etc.).
Requirements methods used.
Review and inspection methods used.
Design methods used.
Programming languages used.
Reusable materials available.
Testing methods used.
Paid overtime.
Unpaid overtime.

 Related Knols



Continued in a new article - 12 May 2014
Software Cost Management - Article 2

Software Cost Management - Article 2

Article 1 on the topic

A good seminar on Cocomo Model which is based on Thousand Delivered Source Instructions (KDSI)

A text book chapter having content on soft productivity estimation and cost estimation