PROJECT APPAISAL FOR
TERM LOAN
A project report is essential before a decision for
setting & up of any project is taken. An entrepreneur must study all
aspects of the project including the product to be manufactured, technical
process involved in manufacturing, availability of infrastructure, plant and
machinery, technology, skilled labour, marketing arrangements and prospects of
the product etc. An assessment of total cost of the project and proposed means
of financing with emphasis on overall profitability of the project is also
necessary. Project report must, therefore, include all these information and
cover entire aspects of a project to stand scrutiny by financial institutions
who shall appraise the project from the following angles before taking any
decision to grant term loans.
·
Technical
feasibility.
·
Managerial
competency.
·
Financial and
commercial viability.
·
Environmental and
economic viability.
It is, therefore, necessary that a proper project report is prepared examine all these details. For industrial projects, help of experts/consultants may be commissioned for preparation of a suitable project report, which will enable the promoter to arrive at a correct decision. The project report shall cover all the aspects as stated above. We shall now make an attempt to examine all the above factors in details emphasising on important points that are required to be highlighted while presenting papers to the financial institution for its consideration and approval.
All factors relating to infrastructural needs,
technology, availability of machine, material etc. are required to be
scrutinised under this head. Broadly speaking the factors that are covered
under this aspect include:
·
Availability of
basic infrastructure.
·
Licensing/Registration
requirements.
·
Selection of
technology/technical process.
·
Availability of
suitable machinery/raw material/skilled labour etc.
The main points to be examined under this head are:
q
Land
and its location: Land
is the most basic requirement for setting up of any project. The size of the
available land should not only meet the present requirement but shall take care
of the future expansion plans as well. The location of land is also vital in as
much as to determine the transport facilities available in the area. Projects
located in well developed industrial areas enjoy the benefits of developed
basic infrastructure readily available to them.
q
Buildings: Necessary plans for factory buildings, plant room,
workshops, administrative blocks and residential blocks etc. as considered
necessary are to be finalised and provided in the project cost.
q
Availability
of water and power: Water and power are other two very vital requirements.
Some projects may consume large quantities of water, which shall be available
either through municipal supply or underground. Storage tanks of adequate
capacity may also be required and shall be provided for in the project. Many
projects have, of late, suffered due to erratic supply of' power in many
States. Arrangements for getting the required power load sanctioned from
Electricity Board and the necessity of providing alternative captive power
generation capacity need, to be very closely examined ill all the cases.
q
Availability
of labour: The availability of labour is mainly dependent on the
location of the project. The cheap and abundant supply of labour makes much
difference to the project implementation. For projects to be set up ill far
flung areas, special incentives might be necessary to induce the labour to
shift to that area which may add to the cost of' project and its implementation
Government of India has recently liberalised
provisions relating to licensing of industries to a great extent. As per the
Industrial Policy Statement, only 6 industries are subject to licensing by
Govt. of India, viz.
1. Distillation
and brewing of alcoholic drinks.
2. Cigars
and cigarettes of tobacco and manufactured tobacco substitutes.
3. Electronic Aerospace and defence equipment;
all types.
4. Industrial
explosives including detonating fuses, safety fuses, gunpowder, nitrocellulose
and matches.
5. Hazardous
chemicals.
6. Drugs
and Pharmaceuticals (according to modified Drug Policy September, 1994).
A few manufacturing industries where more than
adequate capacity has already cell created in the country are discouraged by
Govt. of India and are put in the negative list. This list is amended from time
to time and industries included in the list are generally not extended any
financial assistance by financial institutions. Special efforts would,
therefore, be necessary and some cogent reasons will have to he given justify
setting up of such projects
An important aspect of project evaluation is critical
examination of' the technology/technical process selected for the project. The,
main points to he considered in this regard are as under:
q
Availability:
The technical process/technology
selected for the project must be readily available either indigenously or
necessary arrangements for foreign collaboration must be finalised. Foreign
collaboration, if not covered under automatic route of RBI, requires prior
permission from Govt of India and is generally permitted in the following
cases:
(a) Where
indigenous technology is too closely held in India and is not available, or
(b) Where
foreign collaboration is necessary for updation of existing industry and
modernisation thereof, or
(c) Where the project is for import
substitution or for setting up of an export oriented unit.
The provisions regarding foreign technical
collaboration with or without financial collaboration have also been
liberalised recently. Many of foreign collaborations can be now approved by
Reserve Bank of India and approval from Government of India is not necessary.
Full provisions in this regard must be elaborated and form subject matter of
project report.
The technical process selected is to be briefly stated
in the project report and is to be critically compared with other technical
processes in operation for manufacture of similar products to establish its
superiority over other processes.
q
Application:
The selected technology
must find a successful application in Indian environment and the
management (promoter) shall be capable
of fully absorbing the technology. This is an important factor and many
projects have failed because of the wrong selection of technology which could
not be successfully implemented in Indian environments.
q
Continuous
updating: The selected
technology shall not only be modem but the underlying technical arrangement
must provide for its constant updation as a necessary safe‑guard against
the process becoming obsolete. The R & D (Research and Development)
facilities required to be created for complete absorption and continuous
updation of technology need to be very closely examined to ensure good long‑term
prospects for the project.
q
Availability
of skilled technical personnel/training facilities: The foreign technical collaboration shall provide
necessary training facilities to Indian, personnel who shall be involved in
project implementation and subsequent running of the project. The availability
of technically trained persons for the selected technical process, indigenous
or foreign, has to be ensured in any case.
q
Plant
size & production capacity: The selection of plant size and production capacity is mainly dependent on
the total capital outlay by the promoter and also on the available market for
the product. This aspect is, however, very important in selecting the right
technology which shall be suitable for the envisaged scale of production.
Creation of capacity for over production may increase the capital cost with
consequent interest load, which may ultimately effect the working of the
project. The project may fail solely on this ground despite the selection of
the best technology.
q
Availability
of machinery: The availability
of plant and machinery required for setting up of the project after selection
of technology is to be ensured. Some plants may require a long lead time which
may result in delay and consequent cost overrun upsetting the financial
planning in the beginning itself. It is also desirable that the suppliers of
plant must give a suitable guarantee for its performance up to the rated
capacity. Necessary arrangements for servicing of the machinery, supply of
spare parts and consumables are also to be examined so that there are no
production bottlenecks due to failure of plant and machinery in the long run.
q
Availability
of raw material and consumables: The
easy availability of raw material and consumables is a precondition for
successful operation of any project. This aspect, therefore, needs considerable
attention at the planning stage itself. Tie up arrangements with the suppliers
of raw material may be necessary if the suppliers are few.
Import of raw material may be necessary in a bunch
requiring storing of excess inventory for a long time forcing the unit to
arrange for additional working Capital thus increasing the project cost. Import
of a particular type of raw material may also be subject to licensing by Import
Trade Control Authorities; thus bringing into a sense of uncertainty on its
availability due to change in Govt’s policy. All these factors are very
important and detailed planning to ensure easy availability of required
raw material is necessary. Financial
institutions, lending for the project, have to be satisfied on this score as it
may prove vital for successful implementation of the project and its running.
The ultimate success of even a very well conceived and
viable project may depend on how' competently it is managed. Besides project
implementation, other important functions required to be controlled can broadly
be classified as under:
q
Production
q
Finance
q
Marketing
q
Personnel.
A complete integration of all these functions within
an organisation may be the first step towards an effective management.
The promoter of the project is to provide necessary
leadership and his qualification, experience and track record will be closely
examined by the lending institutions. The details of other projects
successfully implemented‑by the same promoter may provide the necessary
confidence to these institutions and help final approval of the project.
It is also necessary to provide an organisation chart
clearly defining the responsibility and decision‑making levels and the
details of the arrangements already made/to be made to man these positions by
well qualified professionals. Proper planning and budgeting, participation of
workers in the management, decentralising decision‑making, developing
effective internal control system etc. are some of the factors which would help
in better management of any project.
Any project can be commercially viable only if it is
able to sell its production at a profit. For this purpose it would be necessary
to study demand and supply pattern of that particular product to determine its
marketability.
Various methods such as trend method, regression
method for estimation of demand are employed which is then to be matched with
the available supply of a particular product. The prospects of exporting the
product may also be examined while assessing the demand. If the selling of the
product has already' been tied up with foreign collaborators or with some other
users, the fact need to be highlighted. This factor shall definitely have a
positive influence on the commercial viability of a project. Necessary factors
which may influence the supply position such as licensing of new projects,
introduction of new products, change in import policy etc. shall also be taken
into cognisance while estimating the marketing potential of any product. This
exercise shall be, conducted for a sufficiently long period say 5 to 10 years
to determine the continued demand of
the product during the currency of the loan granted by financial
institutions.
This factor will also help the promoter to take a
right decision in selecting the size of the plant and determining the capacity
utilization.
Various steps are involved to determine the financial
viability of a project as under:
A realistic assessment of project cost is necessary to
determine the source for its availability and to properly evaluate the
financial viability of the project. For this purpose, the various items of cost
may be sub‑divided to as many sub-heads as possible so that all factors
are taken into account while arriving at the total cost. Sufficient cushions
may also be provided for any inflationary increase expected during the course
of project implementation. The major items of cost are as under.
q
Land
and Site development: The
various sub‑heads for estimation of cost of land and its development
which are to be taken into consideration include:
(i)
Cost of land or
premium payable on leasehold land.
(ii)
Registration and
other conveyancing charges.
(iii)
Cost of levelling
and development, if any.
(iv)
Cost of laying
approach road connecting the factory site to main road.
(v)
Cost of internal
roads in the factory.
(vi)
Cost of
fencing/compound wall.
(vii)
Cost of gates
etc.
Any other expenditure for development of land to make
it suitable for the project is also to be specifically provided to arrive at
the final cost under this item.
q
Buildings: Various sub‑heads for estimation of expenditure
under this item include:
(i) Factory building for the main plant and machinery.
(ii) Factory building for auxiliary services like steam supply, water, supply, laboratory, workshop etc.
(iii) Godowns, warehouses and open yard facilities.
(iv) Administrative buildings and other miscellaneous non‑factory buildings such as canteen, guest house, time office etc.
(v) Silos, tanks, basin, cisterns and such other structures which are necessary for installation of plant and equipment and other civil engineering work.
(vi) Garages.
(vii)
Cost of sever,
drainage etc
(viii)
Residential quarters
for essential staff.
(ix)
Architects' fee.
The cost of construction will mainly depend on the
type of construction envisaged and also, to some extent, on the type of soil
and its load bearing capacity. The construction of residential quarters for
workers and other key staff may be permitted only if the project is
situated in the less developed area. Detailed estimation of cost under various sub‑heads given
above may preferably be obtained from a reputed firm of civil
engineers/architects to avoid any cost overrun at a later stage.
q
Plant
& Machinery: The
cost of plant and machinery must include the transportation and other charges
up to the site and also the erection charges. Full details with broad
specification and number of equipments to be purchased in respect of imported
as well as indigenous machinery are to be given separately. The name of the
manufacturer and whether orders have already been placed or not is also to be
specified. The various sub‑heads under this major head include:
(i)
Cost of imported machinery
including freight, insurance, loading and unloading charges, customs duty and
transportation charges up to site.
(ii)
Cost of
indigenous machinery including transportation charges upto the site of the
project.
(iii)
Machinery stores
and spares.
(iv)
Foundation and
erection charges.
q
Technical
know‑how fees which
shall also include ally expenses on drawings etc. payable to foreign
collaborator.
q
Expenses
on foreign: technicians and
training of Indian technicians abroad.
q
Miscellaneous
: fixed assets which include:
(i)
Furniture.
(ii)
Office machinery
and equipment.
(iii)
Vehicles such as
cars and trucks.
(iv)
Railway siding.
(v)
Laboratory,
workshop and fire‑fighting equipment.
(vi)
Equipment for
supply of power, supply and treatment of water etc.
This is not an exhaustive list of miscellaneous
assets; the requirement of which will differ from project to project. A
reasonable assessment of all the miscellaneous fixed assets essentially
required shall be made to determine the actual cost under this head.
It is important to note here that expenses may
sometimes be incurred to acquire patents, trade marks, copyrights etc.; the
cost of which is to be included n the project cost under this head.
q
Preliminary
and capital issue expenses: Some
expenditure is to be incurred by the promoter for floatation of the company,
preparation of the project report etc. Initial disbursement by way of
advertising and publicity, printing of stationery and also as underwriting
commission and brokerage etc. towards capital issue would be necessary and as
such will form a part of project cost. Reasonable estimation of such expenses
would, therefore, be necessary and shall be shown under this head.
q
Pre‑operative
Expenses: A few expenses
will have to be incurred in the pre‑operative stage during the course of
project implementation and shall form part of project cost. Such expenses
include outlay on:
(i)
Establishment
including salary to staff.
(ii)
Rent, rates and
taxes
(iii)
Travelling
expenses.
(iv)
Insurance during
construction.
(v)
Mortgage charges,
if any.
(vi)
Interest on deferred
payments and commitment charges on borrowings, if any.
(vii)
Other
miscellaneous start up expenses.
q
Provisions
for contingencies: No
estimation of cost even if done after a very detailed examination of all the
relevant aspects may be perfect and it is necessary that a reasonable cushion
in estimation of total cost of the project may be provided to meet any
contingencies in future and avoid over‑run. Estimates of cost under
various heads as already discussed might have been made either on the basis of
firm contracts already entered or on the basis of available market rates which
may change due to inflation or otherwise at the time of placement of firm
orders. Some items of expenditure might have been overlooked at the time of
estimation of preliminary and pre‑operative expenses.
Suitable provisions for such contingencies supported
by valid reasons must be made. The basis for calculation of provision need also
be clarified to justify the overall cost of project.
q
Margin
Money for Working Capital: Working
capital requirements of any project are met by commercial banks. The part of
working capital is, however, required to be financed from long‑term
resources. This part is generally referred to as margin for working capital and
is included in the cost of project. Banks now generally require that 25% of the
total current assets (working capital) shall be the margin to be provided from
the long‑term, resources and 75% shall be financed by them. Detailed
discussion on this aspect has been given in the subsequent chapters. It will be
sufficient here to add that necessary estimation for margin money required for
working capital shall, be made and included in the cost of project.
Sources
of Funds/Means of Financing
After estimation of the cost of a project, the next
step obviously will be to find out the sources of funds by means of which the
project will be financed. The project will be financed by contribution of the
funds by the promoter himself and also raising loans from others including
terms loans from financial institutions. The means of financing will include:
q
Issue of share
capital including ordinary/preference shares.
q
Issue of secured
debentures.
q
Secured long‑term
and medium‑term loan's (including the loans for which the application is
being put up to the term lending institutions),
q
Unsecured loans
and deposits from promoters, directors‑etc.
q
Deferred
payments.
q
Capital subsidy
from Central/State Government.
If any additional funds are to be raised from an alternative
source, the details there of may also be provided. The promoters contribution
by way of share capital and/or loans is required to be shown separately.
After determining the cost of project and means of
financing, the viability of the project will depend on its capacity to earn
profits to service the debt and capital. To undertake the profitability
analysis, it will be necessary to ra estimates of the cost of production and
working results. These estimation nor made for a period of 10 years and
projected profit and loss account for 10 year is prepared to draw inference for
the expected profit.
Estimation of working results pre‑supposes a
definite level of production and sales and all calculations are based on that
level. It may, however, not be possible to realise those levels at all times.
The minimum level of production and sale at which the unit will run on 'no
profit no loss' is known as break even point and the first goal of any project
would be to reach that level. The break‑even point can be expressed in
terms of volume of production or as percentage of plant capacity utilisation.
The cost of production may be divided in two parts as
under:
Fixed costs: These costs are not related to the volume of
production and remain constant over a period of time. Examples of such costs
include rent of building, depreciation, interest on term loans etc. salaries of
permanent employees etc.
Variable costs: These costs have a direct relationship with the volume
of production. The costs will increase with any increase in the level of
production. Examples of such costs include raw material, fuel and power, wages,
packaging etc.
The concept of break even point can w understood by
the following illustration :
Installed capacity : 1,00,000 units
Total fixed costs : Rs.4,00,000 per
year
Sale price :
Rs.20 per unit
Variable cost :
Rs.12 per unit
The sales revenue is first adjustable towards
recovering the variable costs and the excess may then be utilised to cover the
fixed costs. The difference between the sale price and the variable costs is
termed as 'contribution'. The contribution per unit in the above illustration
will be:
Contribution per unit=
Sale price‑Variable costs
=Rs.20 ‑
Rs.12
= Rs.8 per unit
The 'contribution' will be utilised to cover the total
fixed costs and break-even point is reached when the 'contribution' becomes
equal to total fixed cost. The break even point in terms of volume of
production may thus be calculated as under:
Total Fixed cost
Break even in terms of volume =
of production Contribution per
unit
= 4,00,000 _ = 50,000 units
8
The break-even point in terms of plant capacity may
now be calculated as under:
Total capacity : 1,00,000 units
Volume of production for break even : 50,000
So Break - even point in
terms of plant capacity = 50,0000
1,00,000 * 100
= 50%
This is the most popular method of expressing the
break-even point. It conveys that the unit will reach the 'no profit no loss’
stage even at 50% capacity utilisation thereby providing a safety margin of 50%
within which the unit will earn profit.
It shall be appreciated from the above discussion that
lower the break‑even point, better it would be to carry out the project.
Lower break‑even point may be a desirable cushion for any unforeseen
circumstances which may force the unit not to realise the expected level of
production and sale.
After carrying out the profitability analysis and
determining the expected profits, a projected cash flow statement for a period of
10 years is drawn. Cash flow statement is, in fact, a narration of all the
sources of cash available during the course of operation within a period of
time (generally one operative year) and its possible use (development) during
that period. This helps to find out the total surplus funds created during the
operational year. This information helps to determine the capacity of the
project to service its debts and fix the repayment periods of loans granted for
a particular project and also to determine the moratorium period for repayment
of the loan. The repayment of the loan is from the surplus cash generated
during the operations in a year.
Debt service coverage ratio is calculated to find out
the capacity of the project servicing its debt i.e., in repayment of the term
borrowings and interest. The debt‑service coverage ratio (DSCR) is worked
out in the following manner:
D.S.C.R. = Net Profit
after tax + Depreciation + Interest on long‑term borrowing's
Repayment of term borrowings during the year + Interest on long‑term borrowings
The higher D.S.C.R. would impart intrinsic strength to the project to repay its term borrowings and interest as per the schedule even if some of the projections are not fully realised. Normally a minimum D.S.C.R. of 2:1 is insisted upon by the term lending institutions and repayment is fixed on that basis.
It may also be sometimes necessary to carry out
sensitivity analysis which helps in identifying elements affecting the
viability of a project taking into account the different sets of assumptions.
While evaluating profitability projections, the sensitivity analysis may be
carried in relation to changes in the sale price and raw material costs, i.e.
sale price may be reduced by 5% to 10% and raw material costs may be increased
by 5% to 10% and the impact of these changes on DSCR. If the new DSCR, so
calculated after changes, still proves that the project is viable, the
financial institution may go ahead in funding the project. An illustration as
to how sensitivity analysis works is given below:
Estimated
Profitability Statement
1.Cost of Operations and Income
Statement
|
S.No. Particulars |
I |
II |
III |
IV |
V |
VI |
VII |
VIII |
IX |
X |
|
I. INCOME: Income from fees Income from Hostel fees Misc. Income TOTAL INCOME II.EXPENDITURE General Administration Staff Salary Maintenace & Misc. Expd. Interest on Loan Interest on
other Loan Depreciation Preliminary Expenses W/O TOTAL EXPENDITURE III. EXCESS OF INCOME OVER EXPD. IV. TAXATION V. NET INCOME VI.DIVIDEND VII.NET INOCME C/F TO B/S VIII.CASH ACCRUALS XI. NET CASH ACCRUALS X. CASH RETURN ON PROMOTERS INVESTMENT % _______________ Debt service/year Fund for Debt Service DSCR Average DSCR |
92.52 8.64 4.84 106.00 12.72 25.44 4.24 43.20 0.00 12.93 1.50 100.03 5.97 0.00 5.97 0.00 5.97 20.40 20.40 40.80 _____ 43.20 63.60 1.47 2.82 |
185.14 17.28 9.68 212.00 25.44 50.88 8.48 72.00 0.00 18.72 1.50 177.02 34.98 0.00 34.98 0.00 34.98 55.20 55.20 55.20 _____ 72.00 127.20 1.77 |
277.56 25.92 9.52 313.00 37.56 75.12 12.52 67.50 0.00 22.65 1.50 216.85 96.15 0.00 96.15 0.00 96.15 120.30 120.30 92.54 _____ 117.50 187.80 1.60 |
370.08 34.56 9.36 414.00 49.68 99.36 16.56 56.25 0.00 27.82 1.50 251.17 162.83 0.00 162.83 0.00 162.83 192.15 192.15 106.75 _____ 131.25 248.40 1.89 |
370.08 34.56 9.36 414.00 49.68 99.36 16.56 42.75 0.00 27.82 1.50 237.67 176.33 0.00 176.33 0.00 176.33 205.65 205.65 114.25 _____ 117.75 248.40 2.11 |
370.08 34.56 9.36 414.00 49.68 99.36 16.56 29.25 0.00 27.82 1.50 224.17 189.83 0.00 189.83 0.00 189.83 219.15 219.15 121.75 _____ 104.25 248.40 2.38 |
370.08 34.56 9.36 414.00 49.68 99.36 16.56 13.50 0.00 27.82 1.50 208.42 205.58 0.00 205.58 0.00 205.58 234.90 234.90 130.50 _____ 113.50 248.40 2.19 |
370.08 34.56 9.36 414.00 49.68 99.36 16.56 2.25 0.00 27.82 1.50 197.17 216.83 0.00 216.83 0.00 216.83 246.15 246.15 136.75 _____ 27.25 248.40 9.12 |
370.08 34.56 9.36 414.00 49.68 99.36 16.56 0.00 0.00 27.82 1.50 194.92 219.08 0.00 219.08 0.00 219.08 248.40 248.40 138.00 _____ 0.00 248.40 |
370.08 34.56 9.36 414.00 49.68 99.36 16.56 0.00 0.00 27.82 1.50 194.92 219.08 0.00 219.08 0.00 219.08 248.40 248.40 138.00 _____ 0.00 248.40 |
The average DSCR works
out to 2.82.
II.
Sensitivity Analysis when there is decrease in income
In
the same project, now it is assumed that total income is decrease by 10%. By this
assumption, the average DSCR works
out to 2.35 as below: (Rs.
in Lacs)
|
S.No. Particular |
I |
II |
III |
IV |
V |
VI |
VII |
VIII |
IX |
X |
|
|
10% DECREASE IN TOTAL INCOME |
|||||||||||
|
1. Institution
Running Expenses 2. Other Costs 3. Depreciation 4. Prelim. Expenses 5. Total Cost 6. Total Income 7. Income
before tax 8. Taxation 9. Income after tax 10.Gross Cash accruals ___________________ Debt service/Year Fund for Debt Service DSCR Average DSCR |
42.40 43.20 12.93 1.50 100.03 95.40 -4.63 0.00 -4.63 9.80 ______ 43.20 53.00 1.23 2.35 |
84.80 72.00 18.72 1.50 177.02 190.80 13.78 0.00 13.78 34.00 ____ 72.00 106.00 1.47 |
125.20 67.50 22.65 1.50 216.85 281.70 64.85 0.00 64.85 89.00 ____ 117.50 156.50 1.33 |
165.60 56.25 27.82 1.50 251.17 372.60 121.43 0.00 121.43 150.75 ____ 131.25 207.00 1.58 |
165.60 42.75 27.82 1.50 237.67 372.60 134.93 0.00 134.93 164.25 ____ 117.75 207.00 1.76 |
165.60 29.25 27.82 1.50 224.17 372.60 148.43 0.00 148.43 177.75 ____ 104.25 207.00 1.99 |
165.60 13.50 27.82 1.50 208.42 372.60 164.18 0.00 164.18 193.50 _____ 113.50 207.00 1.82 |
165.60 2.25 27.82 1.50 197.17 372.60 175.43 0.00 175.43 204.75 ____ 27.25 207.00 7.60 |
165.60 0.00 27.82 1.50 194.92 372.60 177.68 0.00 177.68 207.00 ____ |
165.60 0.00 27.82 1.50 194.92 372.60 177.68 0.00 177.68 207.00 ____ |
|
III
Sensitivity Analysis where is increase in Running Cost
In the second instance, institutional running costs are increased by 10% whereas total income is decreased by 10%. The average DSCR, is thus works out to 2.16 as below:
(Rs.
In Lacs)
|
S.No. Particular |
I |
II |
III |
IV |
V |
VI |
VII |
VIII |
IX |
X |
|
|
A. 10% INCREASE IN INSTITUTION RUNNING COST & 10%
DECREASE IN INCOME: |
|||||||||||
|
1.Institution Running Expenses 2. Other Costs 3. Depreciation 4. Prelim. Expenses 5. Total Cost 6. Total Income 7. Income
before tax 8. Taxation 9. Income after tax 10.Gross Cash accruals ________________ Debt service/Year Fund for Debt Service DSCR Average DSCR |
46.64 43.20 12.93 1.50 104.27 95.40 -8.87 0.00 -8.87 5.56 _____ 43.20 48.76 1.13 2.16 |
93.28 72.00 18.72 1.50 185.50 190.80 5.30 0.00 5.30 25.52 ____ 72.00 97.52 1.35 |
167.72 67.50 22.65 1.50 229.37 281.70 52.33 0.00 52.33 76.48 ____ 117.50 143.98 1.23 |
182.16 56.25 27.82 1.50 267.73 372.60 104.87 0.00 104.87 134.19 _____ 131.25 190.44 1.45 |
182.16 42.75 27.82 1.50 254.23 372.60 118.37 0.00 118.37 147.69 ____ 117.75 190.44 1.62 |
182.16 29.25 27.82 1.50 240.73 372.60 131.60 0.00 131.87 161.19 _____ 104.25 190.44 1.83 |
182.16 13.50 27.82 1.50 224.98 372.60 147.62 0.00 147.62 176.94 _____ 113.50 190.44 1.68 |
182.16 2.25 27.82 1.50 213.73 372.60 158.87 0.00 158.87 188.19 ____ 27.25 190.44 6.99 |
182.16 0.00 27.82 1.50 211.48 372.60 161.12 0.00 161.12 190.44 ____ |
182.16 0.00 27.82 1.50 211.48 372.60 161.12 0.00 161.12 190.44 ____ |
|
In
both the situations i.e. after applying sensitivity analysis, the lowest DSCR
is 2.16 which is well above 1.5 and as such project
can be taken as viable. And therefore is acceptable for funding.
On the basis of profitability and cash flow statements
already drawn, the projected balance sheet for a period of 10 years is also prepared
to know the financial position of the project at any given point of time.
ENVIRONMENTAL
& ECONOMIC VIABILITY
The performance of a project may not only be influenced
by the financial factors as stated above. Other external environmental factors,
which may be economic, social or cultural may have a positive impact as well.
The larger projects may be critically evaluated by the lending institutions by
taking into consideration the following factors:
q
Employment
potential.
q
Utilisation of
domestically available raw materials and other facilities.
q
Development of
industrially backward area as per Government policy.
q
Effect of the
project on the environment with particular emphasis on the pollution of water
and air to be caused by it.
q
The arrangements
for effective disposal of effluent as per the Government policy.
q
Energy
conservation devices etc. employed for the project.
Other economic factors which influence the final
approval of a particular project are, Net Present Value based on DCF, Internal
Rate of Return (IRR) and Domestic Resources Cost (DRC).
The Discounted Cash Flow (DCF) Technique which is more
commonly known as Net Present Value method (NPV) takes into account the time
value of money for evaluating the costs and benefits of a project.. It
recognises that streams of cash inflows at different points of time differ in
value. A sound comparison among such inflows and outflows can be made only when
they are expressed in terms of a common denominator i.e. present values. For
determining present values, an appropriate rate of discount is selected and the
cash flow streams then are converted into present values with the help of rate
of discount so selected. If NPV is positive (i.e. difference between present
values of inflows and outflows) the project is taken to be viable and as such
proceeded with otherwise not. The concept of NPV shall be clear with the help
of following example:
Let us assume that on an initial outlay of Rs.50,000,
a project's cash inflows for next seven years are as below, present value being
calculated at a Discount rate of 14%.
Year Cash
inflows P. V. factor at 14% Present values
1 12000 o.877 10524
2 10000 0.769 7690
3 15000 0.675 10125
4 13000 0.592 7696
5 14000 0.519 7266
6 12000 0.456 5472
7 11000 0.400 4400
Total present value of cash inflows
Less: Cash
outflow
NPV
Since NPV is positive the project may be considered.
Internal Rate of Return ORR) is defined as the
discount rate which equate the present value of investment in the project to
the present value of future returns over the life of the project. This is an
indicator of earning capacity of the project and a higher internal rate of
return indicates better prospects for the project. The present investment is
cash outflow which is assumed to be negative cash flow and the returns (cash
inflow) are assumed to be positive cash flows The sum total of the discounted
cash flows shall be zero or as near to zero a, possible. The rate of discount
applied to bring the sum total to zero as above is the internal rate of return.
Domestic Resources Cost (DRC) helps to establish a
relationship between the total domestic resources in rupees spent for
manufacturing a product a., against the foreign exchange outlay that would be
necessary to import that particular product. It may be taken as a measure of
total rupees spent to save 1 unit of foreign currency (for import substitution)
or to earn a unit of foreign currency (for products to be exported). This may
in turn be compared with the exchange rate (parity rate) of the unit of foreign
currency in rupees to determine if it is worthwhile to manufacture the product
in the country. If DRC is equal to or less than the parity rate of the unit of
foreign currency, it means manufacturing the product in India is possible at a
cost which is equal to or lower than the cost of foreign exchange and it is
worthwhile to implement the project. However, as foreign exchange is scarce,
projects with slightly higher DRC (than parity rate) may also be approved
keeping in view of other important factors such as employment potential or
Government policy to create manufacturing capacity at home due to strategic
importance of the product or to gain a position in the international market
etc.