PROJECT FINANCE (SEMESTER – III)

QUES NO. 1: ECONOMIC VIABILITY OF ANY PROJECT SHOULD BE IN

CONFORMITY WITH THE GOVERNMEN’S GOAL TO ACHIEVE EQUIATABLE

DISTRIBUTION OF INCOME – ELUCIDATE

Ina any country’s economy, developmental activities are needed to sustain

growth and to ensure overall prosperity of the nation and well being of all its

citizens. The government formulates, directs and guides the destiny through

various means. It frames policies to address growth and overcome poverty and

to have equitable distribution of income among various strata of society. The

documentation of the policy is through identification of areas where fresh

investments are needed, devising investment methods and paving the way for

different agencies capable of undertaking long-term & short-term financing

depending on their structure and strength. The government also draws the core

policy wherein prosperity can be perceived for overall development and

equitable distribution of income.

The economic analysis of projects includes an assessment of the sustainability of

project effects to ensure that

the project provides sufficient incentives for producers,

sufficient funds are available to maintain project operations,

the least cost means of providing the project benefits is used,

the distribution of project benefits and costs is consistent with project

objectives, and

environmental effects are included in the analysis

The project has to generate an acceptable rate of return, which adequately

covers your cost of capital. The expected rate of return depends on the risk

profile of the project. In a rational economic world, nobody implements a project

to make losses. In other words net present value has to be positive if you

discount the cash flows by the desired rate of return.

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Many a time plants may be viable economically and financially but would be

socially undesirable. An example would be dyes units, which have mushroomed

around Ahmedabad. These are polluting and generate effluents not acceptable

to the society and environment. In the last 5 years, India is slowly becoming

environment conscious and friendly. So using hazardous chemicals or polluting

industries may not get the necessary clearances. For instance, the state

government has ordered closure of all dyes units in Gujarat unless suitable

effluent treatment is implemented.

Project proposals should be derived from, and placed in the context of, broader

development objectives. These objectives may be explicitly stated in a

government plan document, or implicitly given through a public investment

program. A statement should be given of the main development objectives of a

country to which a proposed project will contribute.

Many investments will work well only if there are complementary investments in

related sectors or activities. For example, for an irrigation project to raise

agricultural output, the appraisal report must elaborate the necessary extra

requirements for transport and processing. Projects to improve urban services

should consider the capacity of the existing systems to deliver additional power

and water. Potential constraints in supplies, whether they can be overcome, and

the necessary timing of complementary investments, must be considered.

Because a project takes place within a given macroeconomic and sector context,

an investment project can be seen as an incremental change to an existing

structure. In fact, the context may be more important than the project itself.

Moreover, a project that is financially sound within one sector and

macroeconomic context may be financially unsound in another. Thus policy

changes may be as important as the physical investment to the achievement of

development objectives.

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QUES. NO. 2: EXPLAIN IN DETAILS THE TECHNICAL PARAMETERS OF

APPRAISING THE PROJECT.

To implement any project, the entrepreneur needs to carry out different types of

feasibility studies. These feasibility studies evaluate all the risks and returns and

tries to balance them and help the entrepreneur to finalize his plans.

Technical Feasibility:  Technical feasibility refers to the ability of the process

to take advantage of the current state of the technology in pursuing further

improvement.  The technical capability of the personnel as well as the

capability of the available technology should be considered.  Technology

transfer between geographical areas and cultures needs to be analyzed to

understand productivity loss (or gain) due to differences. An entrepreneur should

have the requisite number of technically capable people as well as technology

required to set up and run the plant. The technology should be such that is can

adapt to local conditions. Technology transfer from overseas often fails in this

regard. The conditions in USA and America are quite different from India. Most

parts of India are hot and dusty. Sophisticated process controls have known to

fail. Therefore, knowledge and suitability to local conditions is very important.

Technical appraisal is basically concerned with the project idea / concept,

encompassing various aspects like technology, design, lay-out of the plant as

well as inputs and infrastructure facilities envisaged in / for the project and the

problems likely to crop up, in various areas related with technical aspects.

Technical appraisal focuses upon appraising the likely technical gaps / grey

areas or technical problems which can be broadly grouped under the following

three phases:

1. PHASE I: Problems relating to the project conception & formulation . The

likely problems to be appraised in advance could be:

a. Location of the project taking into consideration the project site,

project office, land, raw material suppliers, work force availability,

market access, physical & social infrastructure & facilities, utilities

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like telecommunication, water, power etc, transportation & general

state of development.

b. Selection of Process / Production Technology. It needs to be

analysed whether process / production technology is outdated or

obsolete or too advanced or dependable with proven track record &

upgradeable considering the size of the unit, plant capacity,

capacity utilisation, product mix & collaborators tie-ups. The

collaborators details & its track record is also appraised.

c. Detailed Project Engineering taking into account the logistics,

maintenance / service back up, spares & consumables, quality

standards / orientation, raw material suppliers / vendors etc

d. Project Implementation / Work Schedule

e. Project Competitiveness Indicators like manufacturing lead

time, work in process, trough-put, capacity, performability,

flexibility, quality etc

2. PHASE II: Problems faced during the construction and project

implementation. The likely problems to be appraised in advance could

be related to civil construction, civil layout & structures, projected charts

& layouts, machinery procurement, machinery installation /

commissioning, trial run etc.

3. PHASE III: Problems pertaining to the period when the project is

in operation. The likely problems to be appraised in advance could be

related to raw material procurement, repairs & maintenance, power

supply availability, water supply, telecom facilities, other infrastructure

facilities, utilities status, quality control standards, organisation of

production function, data collection / information, feedback / reporting /

action etc.

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MORE SPECIFICALLY, THE LIKELY PROBLEMS TO BE APPRAISED IN

ADVANCE COULD BE STATED AS FOLLOWS:

MANUFACTURING PROCESS / TECHNOLOGY: Having decided on the

location and product, the promoter takes into account the manufacturing

process and technology that is to be adopted for producing the product. A

thorough study of the whole process starting from raw material stage to

the finished goods is made and the process flow chart is made.

Continuous efforts are made to integrate the process as far as possible in

order t maintain and meet stringent quality norms and meet with the

supply schedules.

TECHNICAL ARRANGEMENTS: For maintaining the quality & keep

forging the product in the international market the unit might require

transfer of technical know-how or hiring of technical & specialized

personnel for the manufacturing process. This necessitates pre-

determined contracts & finalization of terms even before the

commencement of the project at the conceptualization stage. The length

and the duration of the technical arrangement and training and

development acivities and its details are examined before entering into

actual contract. This again has the impact on the financial aspects of the

project.

SIZE OF THE PLANT: Size of the plant has a direct bearing on the

financial calculation in relation to annual production capacity. Hence in

the initial years about 60-70% production capacity is taken into account

for study of viability of the project. The determining factors of the size of

the plant is demand-supply of a particular product and the end use of the

product.

PRODUCT MIX: The process might require certain product mix to arrive

at the final product that is needed to be produced. The cost factors of the

product thus mixed is also taken into account to arrive at cost at various

levels of production & its cost impact on the manufacturing.

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SELECTION OF PLANT & MACHINERY: The selection of proper plant &

machinery with the latest technology is very important in the success of

the project. The decision to purchase the domestic machinery or importing

it has to be made very judiciously by taking into account the comparative

cost advantage.

PROCUREMENT OF PLANT & MACHINERY: The order for procurement

of machinery and the lead time it could take for final installation tests and

trials would be required and the time period for the same is taken into

consideration. In case of new projects the machinery is procured at such

time that the civil work is complete and necessary foundations can be

laid.

PLANT LAYOUT: The engineering layouts are scrutinized and finalized to

ensure maximum utilization of costly space on the shop floor & also the

safety of the personnel.

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QUES NO. 3: THE ECONOMIC VIABILITY AND TECHNICAL FEASIBILITY OF

ANY PROJECT GOES HAND IN HAND. EXPLAIN WITH EXAMPLES THE

IMPORTANCE OF BOTH STUDIES PROVING COMPLEMENTARY TO EACH

OTHER FOR SUCCESS OF ANY PROJECT.

A complete feasibility study for a business idea must be conducted at three

levels viz., technical; operational; and economic. The operational feasibility

begins with the question: “Will it work?” The technical feasibility asks: “Can it be

built?” These two levels are often addressed together and simply referred to as

technical feasibility. The economic feasibility brings the operational and

technical levels together to determine if the project can generate enough net

economic benefits to justify investments in it. Here, we ask: “Will it make

economic sense if it works and it is built?” External factors have significant

implications for the feasibility of any initiative. Therefore, the environment within

which the initiative is to be implemented must be defined as the domain for the

feasibility study. For example, an initiative that is feasible in a community with a

rail line may not be in one without, if rail transportation is a major technical

resource for the business.

Feasibility studies can result in one of three outcomes: (1) Feasible; (2) Feasible

with changes; and (3) Infeasible. All these decisions are defined within a

particular project’s context – location, markets, etc. Because feasibility studies

are based on expectations about the future, it is important that producer-

entrepreneurs who commission them understand the assumptions that go into

their development. Consultants and project owners often make flawed but

unarticulated assumptions that may go unchallenged, leading to wrong

conclusions and consequently wrong decisions. If a feasible project is deemed

infeasible because of a wrong assumption, an opportunity is missed and if an

infeasible project is deemed feasible, resources are lost.

The purpose of a business feasibility study is to make a decision about whether

to proceed with a particular opportunity based on its technical, operational and

financial feasibility. Since economic viability of a business is fundamental,

economic feasibility is the ultimate decision criterion in a feasibility study. Thus,

a technically and operationally feasible project that is uneconomical is not worth

pursuing. The critical component of the analysis is recognition of the leadership

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required to transform a technically and operationally feasible project into an

economically feasible one.

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QUES NO. 4: COMPARE THE SUBTLE DIFFERENCES OF MARKET AND

COMMERCIAL APPRAISAL TECHNIQUES WITH EXAMPLES

A project has to be technically feasible and financially viable. The financial viability is possible only if the project is able to realize the unit sales forecast / projection and thereby earn sales revenue, ensuring smooth cash flow, funds flow and the resultant surplus generation. Market appraisal therefore occupies a central position in project finance as it enables the promoters and the financing institution to understand, estimate and assess the likely potential of the market for the proposed product and arrive at a realistic projection as regards the market share that can be captured.

Market appraisal techniques

1. Demand analysis

Qualitative methods: These methods rely essentially on the judgment of experts to translate qualitative information into quantitative estimates. The important qualitative methods are:

Jury of executive method Delphi method

Time series projection methods: These methods generate forecasts on the basis of an analysis of the historical time series. The important time series projection methods are:

Trend projection method Exponential smoothing method Moving average method

Casual Methods: More analytical that the preceding methods, casual methods seek to develop forecasts on the basic of cause-effect relationship specified in an explicit, quantitative manner. The important casual methods are:

Chain ratio method Consumption method End use method Leading indicator method Econometric method

The commercial appraisal on the other hand normally resorts to undertaking forecasting. Some of the techniques for forecasting are:

Demand technique forecasting: The future demand of the product, its proper survey and future availability and supply is studied in depth. This will naturally involve employing surveyors to carry out detailed market survey and document the findings to arrive at proper forecasting’s.

Past Trend Method: Past trend method is adopted as a guide depending on the consumption pattern of the society as a whole. Further, the changes that are likely to take place are considered to arrive at the future demand.

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End use method: Suitable for estimating the demand for intermediate products, the end use method, also referred to as the consumption coefficient method, involves the following steps:

Identify the possible uses of the product. Define the consumption coefficient of the product for various uses. Project the output levels for the consuming industries. Derive the demand for the product.

Export market: There exist a huge export potential in many products which need to be tapped. Almost all sectors have good potential. The product that is planned to be manufactured and its application is of vital importance to gauge the potential.

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QUES NO.5: THE FINANCIAL APPRAISAL OF ANY PROJECT IS AN

ONGOING EXERCISE THROUGHT THE LIFE OF THE PROJECT. DISCUSS

THIS WITH VARIOUS TECHNIQUES & PRINCIPLES ADOPTED BY FINACIAL

INSTITUTIONS FOR VIBILITY STUDIES.

The setting up of projects not only involves substantial capital investment but

also the gestation period is long. The project completion cost is the basic

parameter based on which the cost of output is worked out. The implementation

of a project has to pass though a number of stages like planning and formulation

of project reports, obtaining statutory clearances, tying up finances and finally

the actual implementation of the project. Any slippage in project execution

stages will result in time and cost overrun, higher interest during construction

and consequently higher tariff. On the other hand, some more time and effort

taken in planning and formulation of project reports may be helpful in cutting the

time and cost overrun at the construction stage. It is, therefore, essential that all

the activities right from conceptualisation to execution of the power project are

properly planned and coordinated so that the project is implemented as per the

envisaged schedule of commissioning as well as within the estimated completion

cost of the project so that the cost of output is minimised to the ultimate

consumers. This is the first and foremost principle because the effect of any slip

up at this stage is permanent and can not be corrected subsequently.

The proposals for project finance would be considered by the financial

institutions on a selective basis in view of the larger outlay of funds an longer

duration of credit which may have an adverse impact on financial institution’s

Asset-Liability Management system and strain on its liquidity.

The project would be appraised by the financial institution and if required, the

assistance of the professionals would be obtained.

Before extending finance for Projects, the economic feasibility and financial

viability of the project in relation to the macro economic conditions prevailing at

the time of conceptualization of the project and also the likely scenario that may

prevail during the normal life span of the project should be established. The

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project should be able to withstand reasonable levels of variation in crucial

parameters which should be established by sensitivity analysis of the cash flows.

The means of finance for the project along-with provisions to meet contingencies

such as cost/ time overrun should be established. The entire source of funds for

the project from sources other than that by the promoters shall be fully tied-up

before sanction/ disbursement of the limits.

Wherever the project is one of unusually longer duration such as infrastructure

development, the ways of reducing the blockage of fund that are sourced mainly

out of short term lending institutions would be resorted to by take-out financing,

securatisation, Inter-Bank participation Certificates, etc..

The disbursements under project Finance would be made strictly in tune with the

sanction terms, only after ensuring the end use of funds already disbursed by

the consortium, meeting the required margin at each stage of project

implementation and certification by the competent consultants/ specialists as

per the procedure in vogue from time to time and as decided by the consortium.

The rate of interest on such credit facilities would be determined based on the

borrower gradation and the interest rate policy of the institution from time to

time. The credit facilities shall be secured by tangible assets and collaterals as

may be required based on the nature of project, quantum and duration of the

credit, anticipated return on investment and risk perception. In addition,

institution's usual normal lending norms and policy guidelines in force from time

to time would be equally applicable to project finance cases also.

Criteria for Financing

Banks/financial institutions (FIs) are free to sanction term loans for technically

feasible, financially viable and bankable projects undertaken by both public

sector and private sector undertakings subject to the following conditions :

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i. The amount sanctioned should be within the overall ceiling of the

prudential exposure norms prescribed by the Reserve Bank of India from

time to time .

ii. Banks/FIs should satisfy themselves that the projects financed by them

have income generation capacity sufficient to repay the loan together with

interest. Banks/FIs should also satisfy themselves that the project

financed is run on commercial lines i.e. involving commercial

considerations such as identifiable activity, cash flow considerations and

that they do not run into liquidity mismatch on account of lending to such

projects.

iii. FIs should evolve an appropriate debt-equity ratio for each project.

iv. Banks/FIs are free to decide the period of loans keeping in view, inter alia,

the maturity profile of their liabilities.

v. Banks/FIs should have the requisite expertise for appraising technical

feasibility, financial viability and bankability of projects, with particular

reference to risk analysis and sensitivity analysis.

vi. In respect of projects undertaken by public sector units, term loans may

be sanctioned only for corporate entities (i.e. public sector undertakings

registered under Companies Act or a Corporation established under the

relevant statute). Further, such term loans should not be in lieu of or to

substitute budgetary resources envisaged for the project. The term loan

could supplement the budgetary resources if such supplementing was

contemplated in the project design.

Appraisal

Projects are often financed through Special Purpose Vehicles and are structured

on a limited/non-recourse basis. Financing of these projects would, therefore, call

for special appraisal skills on the part of lending agencies. Identification of

various project risks, evaluation of risk mitigation through appraisal of project

contracts and evaluation of creditworthiness of the contracting entities and their

abilities to fulfil contractual obligations will be an integral part of the appraisal

exercise. In this connection, banks/FIs may consider constituting appropriate

screening committees/special cells for appraisal of credit proposals and

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monitoring the progress/performance of the projects. Often, the size of the

funding requirement would necessitate joint financing by banks/FIs or financing

by more than one bank under consortium or syndication arrangements. In such

cases, participating banks/FIs may, for the purpose of their own assessment,

refer to the appraisal report prepared by the lead bank/FI or have the project

appraised jointly. Banks/FIs should, however, ensure that the appraisal in all

cases is completed within a time bound period and repetitive and sequential

appraisals by several institutions are avoided.

Infrastructure finance will continue to be governed by the instructions regarding

exposure limits currently in force viz., exposure of a bank/FI to an individual

borrower is restricted upto 25 per cent of its capital funds and that to a group of

borrowers to 50 per cent. Further, considering the large-scale financial

requirements of infrastructure projects, banks/FIs have been allowed to exceed

the group exposure limit by 10 per cent to 60 per cent, provided the additional

exposure is on account of infrastructure projects in the four specified sectors,

viz., roads, power, telecommunication and ports.

Asset-Liability Management

The long-term financing of infrastructure projects may lead to asset-liability

mismatches, particularly when such financing is not in conformity with the

maturity profile of a FI’s liabilities. FIs would, therefore, need to exercise due

vigil on their asset-liability position to ensure that they do not run into liquidity

mismatches on account of lending to such projects.

Administrative Arrangements

Timely and adequate availability of credit is the pre-requisite for successful

implementation of infrastructure projects. Banks/FIs should, therefore, clearly

delineate the procedure for approval of loan proposals and institute a suitable

monitoring mechanism for reviewing applications pending beyond the specified

period. Multiplicity of appraisals by every institution involved in financing,

leading to delays, has to be avoided. Also, setting up a mechanism for an

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ongoing monitoring of the project implementation will ensure that the credit

disbursed is utilised for the purpose for which it was sanctioned.

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QUES NO. 6: DISCUSS THE LONG-TERM & SHORT-TERM FINANCING

TOOLS AND ENUMERATE THE STUDY IN RELATION TO VARIOUS

FINANCIAL RATIOS ADOPTED BY WAY OF TOOLS FOR ASSESSING THE

VIABILITY OF PROJECT.

The importance of financial appraisal of the project can be well understood from

the fact that an unsound investment decision may prove to be fatal to the very

existence of the firm. The need, significance or importance of assessing the

financial viability of the project arises mainly due to following:

1. Large Investments: Projects generally involve large investments of

funds. But the funds available are always limited and the demand for

funds far exceeds the resources. Hence it is very important to plan and

control the capital expenditure.

2. Long-term commitment of funds: Projects involves funds for long-term

or more or less on permanent basis. The long-term commitment of funds

increases the financial risk involved in the investment decision.

3. Irreversible Nature: Once the decision for acquiring a permanent asset

is taken, it becomes very difficult to dispose of these assets without

incurring heavy losses.

4. Long-term effect on profitability: Capital budgeting decisions not only

effect the present earnings but also the future growth and profitability of

the firm.. Capital budgeting is of utmost importance to avoid over

investment or under investment in fixed assets.

5. Difficulties of Investment Decisions: The long term decisions are

difficult to take because (i) decision extends to a series of years beyond

the current accounting period, (ii) uncertainties of future and (iii) higher

degree of risk.

6. National Importance: Investment decisions though taken by individual

concern is of national importance because it determines employment,

economic activities and economic growth.

FINANCIAL TOOLS FOR ASSESSING THE VIABILITY OF PROJECT:

At each point of time a business firm has a number of proposals regarding

various projects in which it can invest funds. But the funds available are always

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limited and hence it becomes essential to select amongst the various competing

proposals those, which give the highest benefit. There are many methods of

evaluating profitability of capital investment proposals. The various commonly

used methods are as follows:

1) PAY-BACK PERIOD METHOD: It represents the period in which the total

investment in permanent assets pays back itself.. Under this method various

investments are ranked according to the length of their pay-back period and

the investment with a shortest pay back period is preferred. The pay-back

period can be ascertained in the following manner:

a) Calculate annual net earnings (profits) before depreciation and

after taxes; these are called annual cash inflows.

b) Divide the initial outlay (cost) of the project by the annual cash

inflow, where the project generates constant annual cash inflows.

c) Where the annual cash inflows (profit before depreciation and after

taxes) are unequal, the pay-back period can be found by adding up

the cash inflows until the total is equal to the initial cash outlay of

project or original cost of the asset.

2) RATE OF RETURN METHOD: This method takes into account the earnings

expected from the investment over their whole life. According to this method

the project with the highest rate of return is selected. The return on

investment method can be used in several ways as follows:

S.No

.

Method Formula

1 Average Rate of

return

Total Profits (after Depreciation & Taxes) x

100

Net Investment in the project x No. of Yrs of

profits

2 Return per unit of

Investment Method

Total Profits (after Depreciation & Taxes) x

100

Net Investment in the project

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3 Return on Average

Investment Method

Total Profits (after Depreciation & Taxes) x

100

Total Net Investment / 2

4 Average Return on

Average Investment

Method

Average Annual Profits (after Depreciation &

Taxes) x 100

Total Net Investment / 2

3) NET PRESENT VALUE METHODS: The Net present value method is the

modern method of evaluating investment proposals. This method takes into

consideration the time value of money and attempts to calculate the return

on investments by introducing the factor of time-element. The following are

the necessary steps to be followed for adopting the NPV method:

a) Determine an appropriate rate of interest that should be selected as the

minimum required arte of return called cut-off rate or discount rate.

b) Compute the present value of total investment outlay i.e. cash outflows at

the determined discount rate.

c) Compute the present value of total investment proceeds i.e. cash inflows

(profit before depreciation & after tax) at the determined discount rate.

d) Calculate the NPV of each project by subtracting the present value of cash

outflows from the present value of cash inflows for each project.

e) If NPV is positive or Zero, the proposal may be accepted otherwise it

should be rejected.

f) The project with maximum positive NPV may be selected.

1) INTERNAL RATE OF RETURN METHOD: It is also known as trial & error

yield method. The following steps are required to practice the internal rate of

return method:

a) Determine the future net cash flows during the entire economic life of the

project. The cash inflows are estimated for future profits before

depreciation but after taxes.

b) Determine the rate of discount at which the value of cash inflows is equal

to the present value of cash outflows. If annual cash flows are equal then

it can be easily found out otherwise it has to be found out by hit and trial

method.

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c) Accept the proposal if the IRR is higher than or equal to the minimum

required rate of return i.e. cost of capital or otherwise reject the proposal.

d) In case of alternative proposals select the proposal with highest IRR.

Break Even Point Analysis: A Business is said to break even when its total

sales are equal to its total costs. It is a point of no profit no loss. At this point

contribution is equal to fixed cost. A concern which attains break even point at

less number of units will definitely be better from another concern where break

even point is achieved at more units of production. The BEP can be calculated by

the following formula:

BEP (In Units) = Total Fixed Expenses / Contribution per

Unit

BEP (Based on Total Sales) = Fixed Expenses / P/V ratio

Contribution: Contribution is the difference between the sales and the marginal

cost of sales and it contributes towards fixed expenses and profit.

Profit Volume Ratio: The ratio is calculated as: Contribution / Sales

Or (Fixed Expenses + Profit) / Sales

Or (sales – Variable Costs) / Sales

Or Change in Profits or Contributions / Change in Sales

The different types of ratios that can be used to analyze the viability of

the project can be broadly categorized into:

a) Liquidity Ratios

Liquidity Ratios tells about the ability of the firm to meet it’s short-term

financial obligations and commitments. These ratios are based on the

relationship between current assets which provide the sources of meeting

short term obligations and current liabilities which are obligations to be met

within one year. Two types of liquidity ratios are: Current Ratio & Acid –

Test Ratio.

b) Leverage Ratios

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A firm uses a combination of equity and debt for financing it’s assets. Debt

is riskier source of finance as it entails a fixed outgo of periodic interest

payments and loan repayments. Leverage ratios help us to analyze the risk

arising from the use of Debt Capital.

The commonly used Leverage Ratios are:

i. Debt-Equity Ratio: = Debt/Equity

Debt includes all liabilities whether long-term or short-term. Equity

represents the net-worth of the firm i.e. Equity Capital, Reserves &

Surpluses and Preference Shares.

An alternative form of Debt-Equity ratio is the Long-term debt to equity.

The numerator would consist of only long-term debt.

A lower value of debt-equity ratio indicates a higher degree of protection

employed by the creditors.

ii. Interest-Coverage Ratio

Interest-Coverage Ratio = Profit before interest and Taxes

Fixed Interest Charge

Interest coverage ratio is used as an indicator of the paying capacity by

the lenders. A high interest coverage suggest more paying capacity but at

the same time may indicate the firms inability to use low interest debt as

a source of finance to increase the return to it’s shareholders.

iii. Debt-Service Coverage Ratio (DSCR)

This ratio is used by the financial institutions to assess the capacity of the

borrower to repay the term loan.

DSCR = (Profit after Tax + Depreciation + Other Non-Cash charges +

Interest on term loan) / (Interest on term Loan + Repayment of term loan)

PROJECTED CASH FLOW

The cash flow statement shows the movement of cash into and out of the firm. It

also shows the net impact on the cash balance available with the firm. For the

purpose of appraisal and project evaluation it is desirable to work out the

projected cash flow statement on a quarterly basis right through the

construction period to the operating period.

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PROJECTED BALANCE SHEETS

The liabilities side of the Balance sheet indicates the sources from which finance

has been mobilized and the Assets side indicates how the funds have been

actually deployed in the business, thereby facilitating decisions about project

finance.

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QUES NO. 7: MANAGERIAL APPRAISAL POINTS MORE TO THE INTEGRITY

OF THE ENTERPRENUER THAN THE CAPABILITY TO RUN THE UNIT

SMOOTHLY – DISUSS WITH EXAMPLES.

Every business has different requirements from the management. Businesses,

which are complex require significant experience on part of top management to

run it. Management expertise is not only technical know-how but also in

understanding market dynamics, ability to distribute product effectively, manage

man power and environment.

In cases where a MNC, which has a long track record and significant experience,

is implementing a project, it would be an added comfort about management

feasibility. In businesses, which are technologically driven based on intellectual

capital, technocrats would be preferred.

Managerial appraisal also points towards the integrity of the

entrepreneur apart from the capability to run the unit smoothly. This is

particularly more important in the light of high amount of gross and net

NPAs of the Banks / FIs. Still a large number of public sector banks

have net non-performing assets ranging between 10 to 20 per cent of

net advances.

The dues to the banking sector are generally related to the performance of the

unit/industrial segment. In a few cases the cause of NPA has been due to internal

factors (to the banks) such as weak appraisal or follow-up of loans but more

often than not, it is due to factors such as management inefficiency of borrower

units, obsolescence, lack of demand, non- availability of inputs, environmental

factors etc. Wherever the unit/segment is doing well the credit relationship is

generally maintained except in cases of willful default / misappropriation /

diversion of funds. The problems to the unit/ segment arising out of various

internal/ external factors were felt to be originating point for NPAs in banks.

The high level of NPAs is a historical legacy mainly due to lacunae in credit

recovery system, largely arising from inadequate legal provisions on foreclosure

and bankruptcy, long drawn legal procedures and difficulties in execution of the

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decrees awarded by the Court. The Indian legal system is sympathetic towards

the borrowers and works against the banks' interest. Despite most of their loans

being backed by security, banks are unable to enforce their claims on the

collateral, when the loans turn non-performing, and therefore, loan recoveries

have been insignificant. Due to this the integrity of the entrepreneur

becomes all the more important.

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QUES NO. 8: THE LONG TERM FINANCIAL INSTITUION LAY MORE STRESS

ON FUTURE PRODUCTION AND PROFITABILITY BASED ON PROJECTED

TURNOVER, WHEREAS THE BANKS AND SHORT-TERM FINANCING

AGENCIES GO IN FOR SHORT TERM VIABILITY AND SUCCESS OF ANY

PROJECT. EXPRESS YOUR OPINION IN THE LIGHT OF LARGE SCALE

FAILURE OF LONG TERM PROJECTS IN RECENT TIMES.

The fact that the financial sector of a country plays a very important role in

economic growth and development is well documented. In using the financial

sector as an engine of economic growth. Prudential regulations like capital

adequacy requirements, collateral requirements, lending restrictions, direct

supervision and others are required to keep the financial institutions sound. The

most common causes of failure of financial institutions in different parts of the

world are political pressure to finance bad projects and poor incentives for

financial institutions to screen and monitor projects. In East Asia, among the key

success factors was an insistence on commercial standards within priority

sectors. Successful development banks transformed themselves from

government agencies financing development projects into more market-oriented

financial enterprises, enhancing growth through financial restraint and credit

allocation.

Many projects fail to live up to their potential. Some projects fail to achieve their

schedule or budget goals or fail to deliver everything initially promised. Still

other projects simply fail altogether. Many of the problems faced by projects can

be avoided, or at least contained, by effective project management practices.

Most frequent reasons for project failure, and some alternatives and

remedies for each are as follows:

1. Lack of clear link between the project and the organisation’s key strategic

priorities, including agreed measures of success.

2. Lack of clear senior management and Ministerial ownership and

leadership.

3. Lack of effective engagement with stakeholders.

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4. Lack of skills and proven approach to project management and risk

management.

5. Too little attention to breaking development and implementation into

manageable steps.

7. Evaluation of proposals driven by initial price rather than long- term value

for money (especially securing delivery of business benefits).

8. Lack of understanding of and contact with the supply industry at senior

levels in the organisation.

9. Lack of effective project team integration between clients, the supplier

team and the supply chain.

If any of the answers to the above questions are unsatisfactory, project

should not be allowed to proceed until the appropriate assurances are

obtained.

Defining, planning and managing business projects takes project management

skills that require time to learn, and practice to master. It isn’t hard to fail...

failure is easy. Remember that most projects involve creation of a product or

service, and creation is always a difficult task because it involves trying to

predict the future and manage to that prediction. The key to success is to realize

that your predictions will not always be right, and to deal with reality as it

unfolds. Effective project management avoids or minimizes most of the

situations described above by encouraging effective and timely communication,

acknowledging that plans are educated guesses about the future that will not

always be correct, and trying to work with the project team to deal with reality

as it is revealed rather than trying to deny it as long as possible.

ESSENTIALS OF SUCCESSFUL PROJECT

1) Clearly defined goals (including the general project philosophy or

general mission of the project, as well as commitment to those goals on the

part of the team members).

2) Competent project manager. The importance of initial selection of

skilled (interpersonally, technically, and administratively) project leader.

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3) Top Management Support. Top or divisional management support for

the project that has been conveyed to all concerned parties.

4) Competent project team members. The importance of selecting and, if

necessary, triaging project team members.

5) Sufficient resource allocation. These are Resources in the form of

money, personnel, logistics, etc.

6) Adequate communication channels. Sufficient information is available

on the project objectives, status, changes, organizational coordination,

clients’ needs, etc.

7) Control Mechanisms. (Including planning, schedules, etc.). Programs are

in place to deal with initial plans and schedules.

8) Feedback capabilities. All parties concerned with the project area able

to review project status, make suggestions, and corrections through formal

feedback channels or review meetings.

9) Responsiveness to client. All potential users of the project are

consulted with and kept up to date on project status. Further, clients

receive assistance after the project has been successfully implemented.

10) Client consultation. The project team members share solicited input

from all potential clients of the project. The project team members

understand the needs of those who will use the systems.

11) Technical tasks. The technology that is being implemented works

well. Experts, consultants, or other experienced project managers outside

the project team have reviewed and critiqued the basic approach.

12) Client Acceptance. Potential clients have been contacted about the

usefulness of the project. Adequate advanced preparation has been done

to best determine how to sell the project to the clients.

13) Trouble-shooting. Project team members spend a part of each day

looking for problems that have surfaced or are about to surface. Project

team members are encouraged to take quick action on problems on their

own initiative.

THE THREE KEY AREAS THAT, IF DONE WELL, POINT TO A SUCCESSFUL

PROJECT COMPLETION.

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Good Planning The first indicator, Good Planning, requires excellent forward

planning, which includes detailed planning of the process implementation

stages, task timeliness, fall-back positions, and re-planning. Notice that initial

planning is not enough. Projects often take wrong turns, or initial solutions

prove unfounded. The project manager who does not prepare to re-plan, or

has not considered and planned fall-back positions when initial plans fail, will

often find that the project first stalls, and then fails. We must remember that

project management is not a straight-line process, but an iterative process

that requires agile rethinking as the known environment changes before your

eyes.

Clear Responsibility and Accountability of Team Members: This

requires that all team members have a clear understanding of their roles and

duties in the project. They must understand how expectations vs.

achievements will be measured and graded. It is left to the project manager

to properly implement the communication of these responsibilities, to provide

feedback, and to assure all understand that for which they will be held

accountable.

Schedule Control: This requires the continual monitoring and measurement

of time, milestones, people, and equipment schedules. Properly done

schedule control will also give the first hint that initial planning may not be

going according to schedule. If you pickup on these hints, you have an

opportunity to implement a fallback position and/or re-plan to get back on

track.

CONCLUSION

So at this point we have several lists of things that might indicate project

success and others that might indicate project failure. But there is one thing

primarily that one must recognize in all of these lists. There are no stock

answers, and there is no one list that will guarantee success. Projects are

complex by nature, and each is unique. It is very difficult to plan with complete

certainty something that has never before been done. Every single factor in

all of these lists is important and must be considered for each project. The

most difficult part may be prioritizing the factors. Which are most important?

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Which must be done first? In each case one must ultimately make the

decisions based upon the unique circumstances of one’s immediate project.

Good project management is a process of continuous improvement. It is a

process of making mistakes and learning from those mistakes. It is a process

of continuous study and learning. For those who cannot devote themselves to

this never-ending process, there will be few successes.

QUES NO. 9: IN FINANCING WORKING CAPITAL THE BANKS AND SHORT-

TERM FINANCING AGENCIES ARE THE TRUE BENEFICIARIES IN THE

SUCCESS OF THE PROJECT THAN THE EQUITY HOLDER AND THE LONG-

TERM FINANCIAL INSTITUIONS – DO YOU AGREE WITH THE STATEMENT?

DISCUSS FULLY THE IMPACT OF FAILURE ON BOTH FINANCIAL

ISNTITUTION AND ENTREPRENUER.

Working capital comprises short term net assets: stock, debtors, and cash, less

creditors. Working capital management then is to do with management of all

aspects of both current assets and current liabilities, so as to minimise the risk of

insolvency while maximising return on assets.

Thus strictly speaking, working capital is not a part of the project finance which

deals with providing finance for fixed assets.

However, working capital has to be dealt with project finance as:

1. the margin money for working capital has to be financed by long term

sources and

2. inadequate working capital leads to liquidity crunch, diversion of funds

and financial problems.

The working capital limits would be considered only after the project nearing

completion and after ensuring full tie-up of the term loan requirements of the

borrower. These limits would be either in the form of fixed loans or running

accounts and / or bill financing facility. The finance extended under this category

would be for meeting the funds requirements for day to day operations of the

units i.e, to meet recurring expenses such as acquisition of raw material, the

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various expenses connected with products, conversion of raw materials into

finished products, marketing and administrative expenses, etc.

Eligible Working Capital Limits would be assessed by adopting various methods

such as Projected Turnover Method, Permissible Bank Finance Method, Cash

Budget Method and Net Owned Funds Method, depending upon the type of

borrower, the aggregate working capital facility enjoyed from the banking

system, the scale of operation, nature of activity/enterprise and the duration/

length of the production cycle, etc.

The working capital limits may require such security and personal/ third party

guarantees as applicable to general lending norms of the bank and risk

perception in respect of individual borrowal account in the form of:

i. First charge by way of hypothecation of current assets.

ii. Charge on fixed assets of the unit.

iii. Personal Guarantee of Promoter Director/Corporate Guarantee

iv. First pari-passu charge on the fixed assets of the unit, if the assets

are mortgaged to other institutions/ Bank

v. Adequate collateral security.

It is important to ensure proper management of working capital

because of the following reasons:

Investment in current assets represent a substantial portion of total

investments.

Investment in current assets and the level of current liabilities have to be

quickly adjusted to change in sales.

Fixed assets cannot generate income unless they are used with the help of

working capital. Therefore, working capital is considered as life blood of an

enterprise.

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Even profitable companies fail if they have inadequate cash flow. Liabilities are

settled with cash not profits. The primary objective of working capital

management is to ensure that sufficient cash is available to:

meet day-to-day cash flow needs;

pay wages and salaries when they fall due;

pay creditors to ensure continued supplies of goods and services;

pay government taxation and providers of capital – dividends; and

ensure the long term survival of the business entity.

Poor working capital management can lead to:

over-capitalisation (and therefore waste through under utilisation of

resources and hence poor returns); and

overtrading (trying to maintain a level of sales which is higher than

working capital can sustain – for businesses which extend credit terms,

more sales means more debtors and higher working capital demands).

Characteristics of over-capitalisation are excessive stocks, debtors, and cash,

low return on investment with long term funds tied up in non-earning short term

assets. Overtrading leads to escalating debtors and creditors, and if unchecked,

ultimately to cash starvation.

Many companies lose billions annually through inefficient management of their

working capital. When the length of time between making a sale and receiving

revenue stretches out, companies miss out on having that cash available for

paying off debts, developing new products and making other investments.

Decreasing working capital -- the difference between a company's assets and

liabilities -- frees up cash and makes it easier for a company to quickly respond

to market changes.

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QUES NO. 10: A PROJECT SHOULD LAY EQUAL STRESS ON TECHNICAL,

FINANCIAL, COMMERCIAL AND MANAGERIAL APPRAISAL. DO YOU AGREE

WITH THIS STATEMENT? IF SO, SUBSTANTIATE YOUR ANSWER WITH

WEIGHTAGE SYSTEM FOR EACH APPRAISAL.

To implement any project, the entrepreneur needs to carry out different types of

appraisal / feasibility studies. These feasibility studies evaluate all the risks and

returns and tries to balance them and help the entrepreneur to finalize his plans.

Technical Appraisal

An entrepreneur should have the requisite number of technically capable people

as well as technology required to set up and run the plant. The technology

should be such that is can adapt to local conditions. Technology transfer from

overseas often fails in this regard. The conditions in USA and America are quite

different from India. Most parts of India are hot and dusty. Sophisticated process

controls have known to fail. Therefore, knowledge and suitability to local

conditions is very important.

Financial Appraisal

The ability to raise money to implement the project is of paramount importance.

The promoter should be capable of raising funds either from his own sources or

from banks and institutions. One area that often gets overlooked, is contingency

planning. In most cases, the first generation entrepreneur has problems in

raising funds to implement his project, and even if he does so, he lacks staying

power and is not able to withstand unforeseen problems like delays and

overruns.

Commercial Appraisal (Availability of Key Factors)

Commercial feasibility refers to availability of raw material, skilled labor,

infrastructure, and other factors of production. A number of projects have run

into rough weather due to poor commercial viability. One of the classic examples

of this is a cycle factory which was set up in Baroda, Gujarat. The management

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was good, market survey showed existence of a good market and the

government was giving fiscal incentives. What was overlooked was availability of

skilled labour. Bicycle assembly is a hard work and labor in Gujarat is used to

process industries. Therefore the project failed. The center of the bicycle

industry is Ludhiana where native Punjabis/ Sikhs are sturdy people and used to

hard work and have requisite skills in assembly of bicycles.

Managerial Appraisal

Every business has different requirements from the management. Businesses,

which are complex require significant experience on part of top management to

run it. Management expertise is not only technical know-how but also in

understanding market dynamics, ability to distribute product effectively, manage

man power and environment.

In cases where a MNC, which has a long track record and significant experience,

is implementing a project, it would be an added comfort about management

feasibility. In businesses, which are technologically driven based on intellectual

capital, technocrats would be preferred.

Economic Appraisal

The project has to generate an acceptable rate of return, which adequately

covers your cost of capital. The expected rate of return depends on the risk

profile of the project. In a rational economic world, nobody implements a project

to make losses. In other words net present value has to be positive if you

discount the cash flows by the desired rate of return.

Social Appraisal

Many a time plants may be viable economically and financially but would be

socially undesirable. An example would be dyes units, which have mushroomed

around Ahmedabad. These are polluting and generate effluents not acceptable

to the society and environment. In the last 5 years, India is slowly becoming

environment conscious and friendly. So using hazardous chemicals or polluting

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industries may not get the necessary clearances. For instance, the state

government has ordered closure of all dyes units in Gujarat unless suitable

effluent treatment is implemented.

Market Appraisal

This is a critical analysis because the output of any factory has to sell in the

market place for the promoter to earn revenues. Very often demand analysis

and projections are optimistic leading to problems in the future. Another

observation has been that products that sell abroad may not have a market in

India. India, in general is a cost conscious market and the promoter has to keep

this in the back of his mind. T series with its low priced cassettes met

phenomenal success.

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