Term Loan and Project Appraisal

Prof : Naveen Rohatgi TYBMS: Term loan

TERM LOANS AND PROJECT APPRAISAL

Term loans (Oct 2004)are referred to as term finance; represent a source of debt finance which is generally repayable in more than one year but less than 10years. Such loans are raised for expansion, diversification and modernization of the enterprise. The primary source of such loans are financial institution. They are employed to finance acquisition of fixed assets and working capital margin. Term loans are repayable in fixed monthly, quarterly or half yearly installments and secured by term loan agreements between the borrower and the bank.

Financial institutions: the following financial institutions cater major part of financial needs of the industrial sector:INDUSTRIAL DEVELOPMENT BANK OF INDIAINDUSTRIAL CREDIT AND INVESTMENT CORPORATION OF INDIAINDUSTRIAL FINANCE CORPORATION OF INDIA STATE FINANCE CORPORATIONSSTATE INDUSTRIAL DEVELOPMENT CORPORATIONSINDUSTRIAL CONSTRUTION BANK OF INDIASMALL INDUSTRIES DEVELOPMENT BANK OF INDIALIFE INSURANCE CORPORATIONUNIT TRUST OF INDIAGENERAL INSURANCE CORPORATION and its Subsidiaries

- New India Assurance Company Ltd- Oriental Insurance Company Ltd- United India Assurance Company Ltd- National Insurance Company Ltd

SHIPPING CREDIT AND INVESTMENT COMPANY OF INDIA LTD.

Security (April 2002)- Term loans are always secured. They are secured specifically by the assets acquired using term loan funds. This is called primary security. Primary security is taken for the assets for which term loans are given.

Collateral Security (April 2002)- Upto term loan of a certain amount Collateral Security is needed. For term loan more than that amount minimum 30% to 35% security is needed. It depends on the credit ratings of the borrower and relations of borrower with the bank

Charge (OCT 2005)- may be defined as the transfer on an interest or right in the assets of a person in the favour of a lender for the purpose of securing the repayment of a loan.First and Second Charge- loans are granted to the borrower against security. Sometimes the borrower may use the same asset for raising finance from two or more lenders. In this case the lender who has first lent to the borrower against the asset will have the right on the asset, before the second lender in case of default. This is known as the first charge.Only after the dues of the first lender are cleared, after selling off the asset the second lender can claim his dues. This is known as the second charge. Generally the lender who has the second charge will price his loan higher, considering the fact that he has to bear a greater risk.

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Fixed and Floating Charge (Oct 2002, Oct 2005)- lenders lend money to the borrower against the security. A lender can have either a fixed or a floating charge on the securities. In case of a fixed charge lender can recover his dues from a certain predecided asset only in case of default by the borrower. On the other hand, a lender who has a floating charge can recover his dues from a gamut of fixed asset. The lender who lends on a fixed asset has to bear a higher risk than the one lending on a floating charge

Lien- is the right of retention. Right of retaining goods/securities until the debt due is paid off as per the statutory agreement. The lien can be of 2 types: Particular lien and General lien. Particular lien is the right to retain goods until the claim pertaining to these goods is fully paid. On the other hand, general lien can be applied till all dues of the claimant are paid.

Hypothecation- means securing repayment against movable property. In hypothecation goods continue to remain in the possession of the owner. Generally, bank gives loan against hypothecation of stock of raw materials. Although the lender does not have physical possession of the goods. It has a right to sell the goods to realize the outstanding loan.

Pledge- means securing repayment by transferring possession of goods in favor of lender. Bank gives loan by keeping in possession of shares and debentures. The borrower who offers security is called “pawnor” (plegor), while the lender is called “pawnee”(pledgee).The lodging of goods by plegor to the pledgee is a kind of bailment. Therefor e pledge creates some liabilities for the lender. It must take reasonable take reasonable care of goods with it. The term reasonable care means care of goods pledged with it. The term reasonable care means care which a prudent person would take to protect its own property. He would be responsible for any loss or damage if he uses the pleged goods for his own purposes. In case of non-repayment of the loans, the lender enjoys the right to sell the goods.

Pari Passu (with equal pace) (April 2003): On equal footing or proportionately. Pari Passu is equal rights over the asset by two lending institution. It means equally without preference,e.g. a series of debentures may be issued subject to the condition that they are to rank Pari Passu as a first charge on the property charged by the debentures.

Moratorium (Oct 2004): Financial institution may allow for a delay in the payment of the principal installment to the borrowers. The period between the sanction of the loan and first principal installment repayment is known as moratorium. The bank studies profitability statement and cash flow projections prepared by borrowing unit and arrives at a conclusion regarding as to length of moratorium period.

Re- Schedulement: In the event of a borrower not being able to pay their installments as as per the repayment schedule, the financial institutions may restructure the repayment schedule of the borrowers to prevent the term loan turning bad.

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Flash report (April 2007): The Bank prepares flash report . The flash report is the guage whether it is feasible to provide the loan to the applicant. It determines the feasibility of the project by looking the financial, economical, technical, marketing, managerial aspects. It determines the amount of money that bank will earn after providing loan. It

The financial ratios for appraisal of the project includes: (April 2005, OCT 2007)

1. Debt equity ratio.2. Interest coverage ratio.3. Debt service coverage ratio.4. Profitability ratio.(such as return on capital employed, Net profit ratio, operating

profit ratio)5. Capital structure

Margin money (April 2004): Margin means the own contribution of the owners for purchase of machinery as no bank generally finances 100% of the total cost of machinery. The margin change according to the purpose of loans or nature of loan. For instance for machinery it is 25% and for land it is 40% which is negotiable..

Restrictive Covenants (Oct 2005)- a financially weak firm attracts stringent term of loans from lenders. The restrictive covenants may be categorized as follows

a) Asset-related covenantsi) borrowing company should maintain its minimum asset baseii) minimum current ratio to be maintainediii) not to sell fixed assets without the lender’s approvaliv) refrain from creating any additional charge on its assetsb) liability-related covenantsi) restrained from incurring additional debtii) repay existing loaniii) limits the freedom of promoters to dispose of their shareholdingc) cash flow- related covenantsRestrain on the firm’s cash outflow by:(i) restricting cash dividends(ii) restricting capital expenditure(iii) Restricting salaries and perks of managerial staff etc.d) Control-related covenantsi) broad-base board of directorsii) appointment of nominee directors by financial institutions to safeguard the

interests of financial institutionse) Positive Covenants: in addition to the foregoing negative covenants, certain positive/ affirmative covenants stating what the borrowing firm should do during the term of a loan are also included in a loan agreement. They provide for:i) furnishing of periodical reports/financial statements to the lendersii) maintenance of a minimum level of working capitaliii) creation of sinking fund for redemption of debtiv) Maintenance of certain net worth.

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Project Appraisal by Financial Institutions/ Content of project report (April 2008)Project Appraisal is the process by which the Financial Institutions makes an independent and objective assessment of the various aspects of the investment proposition for arriving at a financing decision Broad aspects of AppraisalFinancial AppraisalTechnical AppraisalEconomic AppraisalManagement competenceMarket AppraisalTechnical Appraisal (Oct 2003)Focuses mainly on the following aspects

i) product mixii) capacityiii) process of manufactureiv) engineering know-how and technical collaborationv) raw materials and consumablesvi) site and locationvii) buildingviii) plant and equipmentsix) manpower requirementsx) break-even point

Financial AppraisalIt seeks to assess the following:

1) Cost of Project.2) Capital structure.3) Cash flow estimate.4) Return of investment on the project.5) Tax benefit.

Economic Appraisal (Oct 2005): Economic Appraisal involves analysis of critical factors such socio-economic benefit, availability of labour, import substitution, technology absorption, impact on ecology, value addition, forex earnings, economies of scale, development of backward region, effective utilization of resources.

Managerial Appraisal: The success of a business enterprise depends largely upon on the resourcefulness, competence and integrity of its management. However the assessment of managerial competence has to be necessarily qualitative calling for understanding and judgment. The managerial appraisal includes assessment of and skill of the promoters,

Market / Marketing Appraisal: (April 2005)

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1. Examine the reasonableness of the demand projections by utilizing the findings of the available market survey findings/ reports, industry association projections, planning commission and independent market surveys.

2. Assess the adequacy of the marketing infrastructure in terns of promotional effort, distribution network, transport facilities, stock levels.

3. Judge the knowledge, experience and competence of the key marketing personnel.

TERM LOAN Procedure (April 2004, OCT 2008)1. Submission of loan application- the borrower submits an application form that

seeks comprehensive information about the project. The application form covers the following aspects Promoter’s Background- the promoters of the company must give their

detailed biodata Particulars of the Industrial Concern- the products to be manufactured and

the market that need to be penetrated must be stated. Also the forecast for the growth in that industry as well as their opportunities (export potential) must be mentioned.

Particulars of the project-(capacity, process, technical arrangements, management, location, land and buildings, plant and machinery, raw materials, effluents, labor, housing and schedule of implementation)

Cost of the project-the cost taking all factoring to account must be arrived at. Means of financing- there should be details of the debt equity ratio, the level

of gearing, the capital structure, and the source of financing. Marketing and selling arrangement- the project report must state if the

company has appointed any wholesalers or distributors for its goods, or if it has tied up with another company for marketing its product

Economic considerations- the project must be economically feasible Government consents- the promoters should have obtained the necessary

government approvals for the project2 Initial processing of loan Application- when the application is received an

officer of the financial institution reviews it to ascertain whether it is complete for processing. If it is incomplete the borrower is asked to provide the required additional information. When the application is considered complete the financial institution prepares a flash report which is essentially a summarization of the loan application

On the basis of the flash report it is decided whether the project justifies a detailed appraisal or not3 Appraisal of the proposed project- the detailed appraisal of the project

covers the marketing, technical, financial managerial and economic aspects. The appraisal memorandum is normally prepared within 2 months after site inspection. Based on that decision is taken whether the project will be accepted or not.

4 Issue of the letter of sanction- if the project is accepted, a financial letter of sanction is issued to the borrower. This communicates to the borrower the assistance sanctioned and the terms and conditions relating thereto

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5 Acceptance of the terms and conditions by the borrowing unit- on receiving the letter of sanction from the financial institution the borrowing unit convenes its board meeting at which the terms and conditions associated with the letter of sanction are accepted and an appropriate resolution is passed to that effect. The acceptance of the terms and conditions has ti be conveyed to the financial institution within stipulated period

6 Execution of loan agreement- the financial institution after receiving the letter of acceptance from the borrower, sends the draft of the agreement to the borrower to be executed by the authorized persons and properly stamped as per the Indian Stamp Act, 1899. the agreement properly executed and stamped along with other documents as required by the financial institution must be returned to it. Once the financial institution also signs the agreement, it becomes effective.

7 Disbursement of loans- periodically the borrower is required to submit information on the physical progress of the projects, financial status of the project, arrangements made for financing the project, contributions made by the promoters, projected funds flow statement, compliance with various statutory requirements, and fulfillment of the pre-disbursement conditions. Based on the information provided by the borrower, the FI will determine the amount of term loan to be disbursed from time to time. Before the entire term loan is disbursed, the borrower must fully comply with all terms and conditions of the loan agreement.

8 Creation of security- the term loans and the deferred payment guarantee assistance provided by the financial institutions are secured through the first mortgage, by way of deposit of title deeds, of immovable properties and hypothecation of moveable properties. As the creation of mortgage, particularly in the case of land, tends to be a time consuming process, the institutions permit interim disbursement against alternate security. The mortgage however has to be created within specified period from the date of the first disbursement. Otherwise, the borrower has to pay an additional charge of 1%interest

9 Monitoring- Monitoring of the project is done at the implementation stage as well as at the operational stage. During the implementation stage, the project is monitored through:

1) Regular reports, furnished by the promoters, which provide information about the placement of orders, construction of buildings, procurement of plant, installation of plant and machinery, trial production etc.2) Periodic site visits3) Discussion with promoters, bankers, suppliers, creditors, and other connected with the project4) Progress reports submitted by the nominee directors 5) Audited accounts of the companyDuring the operational stage, the project is monitored with the help of (i) quarterly progress report on the project (ii) site inspection (iii) reports of nominee directors (iv) comparison of performance Vs promise

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The most important aspect of monitoring, of course, is the recovery of dues represented by interest and prince

BOARD PAPER

What is difference between Fixed Charge and Floating Charge? (Oct. 2002)What is Flash Report? (April 2007)Explain primary and collateral security with examples. (April 2002)Pan Passu Charge. (April 2003)Technical Appraisal. (Oct. 2003)What is margin money? (April 2004)What is Term Loan? (Oct 2004)What is Moratorium Period? (Oct 2004)What are the matters coy red in a Marketing Appraisal of a Term Loan Appraisal’? (April 2005)What do you mean by economic appraisal of a Term Loan Project? (Oct 2005)What is a charge? What is the difference between a Fixed and a Floating charge? (Oct. 2005)Discuss any five ratios which will have bearing on sanction of loan by Bank of Baroda. (Oct. 2007)Discuss the financial ratios used for appraisal of Term Loan Proposals. (April 2005)What are the important covenants of a Long Term Loan agreement? (Oct. 2005)What are the contents of a Project Report? (April 2008)What are the steps involved in the Project Financing? (Oct. 2008)

Sums and Case study

1) Calculate the important ratios for granting Terms Loans and give recommendations from the given projections: (Rs in millions)Year 2006 2007 2008 2009 2010EBIT 560 630 700 735 805Additional Information

a) Tax Rate@30%b) Principal amount of loan is repayable equally along with interest payable on

outstanding loans at the end of each yearc) Loan amount in consideration Rs.1750 million to be contracted @9%d) Repayment tenure 5 yearse) Total Capital Investment in Project: Rs 2,500 million depreciable equally over 5

years

2) Prepare an amortization schedule from the following information assuming that the Principal amount of loan is repayable equally along with interest payable on unpaid loansAmount Borrowed Rs 12 lakhsAnnual Interest @12%Repayment Period 10 years

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3) Prepare an amortization schedule from the following information assuming that the amount is an equated annual installmentAmount Borrowed Rs 650000Compound Annual Interest @10%Repayment Period 8 years

4) Prepare an amortization schedule from the following information assuming that the amount is an equated annual installmentAmount Borrowed Rs 22000Compound Annual Interest @12%Repayment Period 6years

CASE STUDY

( OCT 2006)

5)Mr. Chawte, GM of FICOM, a Financial Institution, was in relaxed mood. Just thought of having a walk around went out grabbed peanuts to munch. As he was about to throw the wrapping paper in dust bin, he noticed something! The paper was a part of old flash report of FICOM’s appraisal process. Only partial data was visible. GM could make out that the report was of Chemexperts Ltd of Nasik, a manufacturer of bulk drugs and whose directors were IIT Gold Medalist. Total loan sanctioned was Rs1200 lacs@13% rate of interest of reducing balance, against the total cost of the project at Rs.1850lacs. Principal amount to be repaid in 24 equal quarterly installments. Loan sanctioned against the security of Plant and Machinery, collateral security of RBI Bonds and Personal Guarantee of the directors. You are required to list any eight items of the flash report

Solution:

Name of the Term Lending Financial Institution: FICOM.Name of the Borrower: Chemexperts Ltd.Set up at: Nasik.Nature and Type of Business: Manufacturer of bulk drugs.Loan Amount: Rs. 1,200 Lakhs.Tenure of Loan: 6 years.(i) Market Appraisal:

(1) Manufacturing of bulk drugs which has a huge demand.(ii) Technical Appraisal:

(1) Directors are IIT Gold Medalist therefore they have the required engineering know-how.

(2) The site and location is at Nasik.(iii) Financial Appraisal:

(1) Total cost of the project is Rs. 1,850 lakhs.(2) Amount of term loan is Rs. 1,200 lakhs.

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(3) Promoters are contributing Rs. 650 lakhs [Capital cost Rs. 1,850 lakhs — Rs. 1,200 lakhs] as margin money towards the project.

(4) Security for term loan:(a) Primary security of Plant and Machinery.(b) Collateral security of RBI Bonds and(c) Personal guarantee of the Directors.

(5) Promoters are contributing 35.14% (approx.) of the total project cost.(6) The Debt-Equity Ratio after the proposed term loan will be 1.85: 1.

(iv) Economic Appraisal:(1) Manufacturing of bulk drugs resulting into positive impact on health in the

society.(v) Managerial Appraisal:

(1) Directors are IIT Gold Medalist.(2) Directors have technical expertise due to higher professional qualifications.

Analysis and Observation:Amount of Term Loan Rs. 1,200 lakhs.Rate of interest @ 13% on RBM.

Principal amount repayment in 24 equal quarterly instalments

April 20026)The following data is available in respect of Jay Textiles Ltd.a) the company was incorporated in 1982 with the promoters have an experience of more than 35 years in the textile field and is a brand leader in micro yarnb) The company proposes to borrow the term loan under TUFSc) The present installed capacity is 10 machines or 6000 TPA of polyester texturised yarnd) The additional investment will increase the installed capacity by 3600 TPAe) The present and proposed set up is at silvassa a backward area and enjoys Income Tax holiday for 5 years. Tax Rate is 40%f) GIIC, GSFC and SBI financed the present unit. All the accounts are regular g) The project will lead to economies of scale, reduced cost of production, higher production due to yarn speed being faster due to latest generation machine best quality due to the modernized machineh) The expected ROI of the project is 18%i) Depreciation for the project is Rs 400 lacs every yearj) The cost of proposed project and the means of finance are as follows:

Proposed Project Rs. In lacsCost of projectLand and site development 27Factory building 155Plant and machinery 1604Electrical installation 24Misc. fixed assets 10Pre-operative exp 20Contingencies 67Margin money for working capital 93

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Total 2000Means of financePromoter’s fundAdditional equity share capital 300Internal cash accrual 500Term loan 1200Total 2000k) The term lending institution has interest rate of 13% for similar risk project and loan is repayable in 5 years with installment and interest repayable at the end of each yeaGeneral Manager of the Term Lending Institution has requested you to

a) Prepare flash report from the point of view of the Term Lending Institutionb) Evaluate the project for profitability in the next 5 yearsc) Calculate the Debt Service Coverage ratio for the Term Loans

Solution(I) Facts:Name of the Borrower: Jay Textiles Ltd.Incorporated: in 1982Present and Proposed Set up: at Silvassa(I) Market Appraisal:

(1) Brand Leader in micro yarn.(II) Technical Appraisal:

(1) Higher production due to yarn speed being faster due to latest generation machine.

(2) Best quality due to the modernized machine.Purpose of Term Loan: To increase the installed capacity by 3,600 IPA.

(3) Capacity: 6,000 TPA + 3,600 TPA = 9,600 TPA of Polyester Texturised Yam.(III) Financial Appraisal:

(1) 15% of the fund should be raised through issue of equity shares. 25% of the required funds can be arranged through internal accurals and only 60% is required as borrowings in the form of term loan. Since set-up in a backward area therefore it enjoys a tax holiday. Income-tax holiday for 5 years.

(3) Term Loan under TUFS (Technology Upgradation Fund Scheme) Rs. 1,200 Lacs. (4) Investment Rs. 2,000 Lacs Expected ROl @ 18% Rs. 360 Lacs Depreciation Rs. 400 Lacs Life 5 years (5) GIIC, GSFC and SBI financed the present unit.(IV) Economic Appraisal:

(1) Economies of scale resulting in reduced cost of production.(V)Managerial Appraisal:

(1) Promoters having an experience of more than 35 years in the textile field.

Term Loan Rs. 1,200 Lacs @ 13%

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Year Principal + Interest = Total Repayment12345

240240240240240

1,200

++++++

156.0124.893.662.431.2468

======

396.0364.8333.6302.4271.21,668

Debt-Service Coverage Ratio

Investment is Rs. 2,000 LacsROI is 18%

1 2 3 4 5 TotalCalculation of interestLoan outstanding at the beginningLess: Repayment yearly in 5 yearsLoan outstanding at the endInterest @ 13% on loan at beginningCalculation of ProfitabilityPBITLess: InterestProfit Before TaxLess: TaxProfit After TaxCalculation of DSCRProfit After TaxAdd: Depreciation

InterestFunds Available for Repayment(A)RepaymentsLoan RepaymentInterest RepaymentTotal Loan and InterestRepayments(B)Debt Service Coverage Ratio = (A/B)

1,200240960156

360156204

0204

204400156760

240156396

1.92

960240720

124.8

360124.8235.2

0235.2

235.2400

124.8760

240124.8364.8

2.08

72024048093.6

36093.6

266.40

266.4

266.440093.6760

24093.6

333.6

2.28

48024024062.4

36062.4

297.60

297.6

297.640062.4760

24062.4

302.4

2.51

240240

031.2

36031.2

328.80

328.8

328.840031.2760

24031.2

271.2

2.80

N. A.1,200N. A.

468

1800468

1,3320

1,332

1,3322,000

4683,800

1,200468

1,668

2.28

April 20037) You are approached by a Financial Institution to appraise the following project

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Name of the borrower: Blue Lines Chemicals Private LimitedProposed loan is taken to set up a chemical unit for processing industrial waste into a marketable product XYZ. The product has a demand for 50,000 Liters. The processing costs include variable cost Rs.5 per Liter and fixed cost (excluding depreciation) Rs.30,000 per year. Advertising expenses are also expected to be Rs.20,000 per yearXYZ can be sold at Rs10 per liter. Raw Material (industrial waste) is available at Re 1 per liter. The capital cost of chemical units is Rs.7,50,000.The company has applied for a loan of Rs.6,00,000 for term of 10 years that is over the life of the asset. The promoters are young and doing the venture for the first time. The promoters are unable to provide any collateral security for the loan except Personal Guarantee of their parentsThey have thought of this research after market research. The said research has stated the risk factors about invasion of South Korea in Chemical Market and drastic reduction in Selling Price of similar productsThe above unit is a SSI unit and its average tax rate is 20%Interest rate 12%Loan is repayable equally in 10 annual installments along with interest at the end of each yearYou are required to

a) Give the cash flow generated by the above project for the first three yearsb) Calculate the Debt Service Coverage Ratio for the above 3 years c) Prepare Flash Report presenting the above information to the Financial Institution

SolutionFactsName of the Borrower : Blue Lines Chemicals Private Limited.Proposed Loan : Rs. 6,00,000.Tenure of Loan : 10 years.Purpose : To set up a chemical unit for processing industrial waste

into a marketable product “XYZ”.(I) Market Appraisal:

(1) Promoters have taken up this project after a proper market research.(2) The market research report in its risk factors has stated about invasion of South

Korea in chemical market(3) The market research report in its risk factors also mentioned drastic reduction in

selling price of similar products.(II) Technical Appraisal:

(1) The project involves setting up of a waste recycling plant.(III) Financial Appraisal:

(1) Promoters are contributing as margin money Rs. 1,50,000 (Cost 7,50,000 — 6,00,000 loan amount)

(2) Promoters are unable to provide any collateral security for the loan except personal guarantee of their parents.

(3) The unit is a Small Scale Industrial (SSI) unit and therefore it enjoys a lower tax rate of 20% along with other government incentives.

(IV) Economic Appraisal:

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(1) The project involves making proper resource utilization in the nation.(2) The project will result into reduction of waste and recycling it into usable product.

(V)Managerial Appraisal:(1) Promoters are young, dynamic and highly qualified people.(2) Promoters are doing the venture for the first time.

(I) Observation and Analysis:Rs. pa.

Projected Sales 50,000 litres Rs. 10 per litresLess: Variable Costs:

Processing Costs:Variable Cost Rs. 5 per litres 50,000 litresRaw Material (Industrial Waste) Re. 1 per litres 50,000 litres

Less: Fixed CostFixed Cost (Excluding Depreciation)Advertising Expenses

Profit Before Depreciation, Interest and Tax

Less: Depreciation

Profit Before Interest and Tax

5,00,000

2,50,00050,000

30,00020,000

150,000

75,000

75,000Years(Rs.)

1 2 3 TotalCalculation of Interest:Loan outstanding at the beginningLess: Repayment in 10 annual installmentsLoan outstanding at the endInterest 12% pa. on loan at beginningCalculation of Cash Flows:PBITLess: InterestProfit Before TaxLess: Tax @ 20%Profit After TaxCalculation of Debt Service Coverage Ratio:Profit After TaxAdd: Depreciation

InterestFunds Available for Repayment (A)RepaymentsLoan RepaymentInterest PaymentTotal Loan and Interest Repayments (B)Debt Service Coverage Ratio = (NB)

6,00,00060,000

5,40,00072000

75,00072.0003,000

6002,400

2,40075,00072,000

1,49,400

60,00072,000

1,32,0001.13

5,40,00060,000

4,80,00064800

7500064.80010,2002,0408,160

8,16075,00064,800

1,47,960

60,00064.800

1,24,8001.19

4,80,00060,000

4,20,00057,600

75,00057,60017,4003,480

13,920

13,92075,00057,600

1,46,520

60,00057,600

1,17,6001.25

N. A.1.80,000

N. A.1,94400

2,25,0001,94,400

30,6006,120

24,480

24,4802,25,0001,94,4004,43,880

1,80.0001,94,4003,74,400

1.19

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April 2006 8)Mr Anil Sane wishes to start a Manufacturing Unit from his ancestral factory premises. He has Rs1,05,200 in his bank account. His parents have promised to gift him Rs.3,50,000.He has estimated the project cost at Rs18,00,000 of which machinery will be Rs15,25,000 and the remaining amount will be for furniture and fittings. The bank finance is available to the extent of 80% of the project cost. He expects first year’s sales at Rs40,00,000 with the annual increase of 20% every year over previous year. The cost of sales will be 80%of sales. The rate of interest on loan will be 10% on reducing balance method. The loan is repayable @ Rs300000 at the end of every year. He charges depreciation @20% on his fixed assets under straight line and his other overheads for three years are Rs240000, Rs300000 and Rs360000 per year respectively. You are required to prepare the Projected Profit and Loss account and Projected Balance Sheet for the first 3 years of operations to be presented to the bankers, assuming that the first year is also a full year of 12 months activities and rate of income tax is flat @30%b) Also find out any five plus points of the above loan proposal from Banker’s Point of view.

Solution Rs.(1) Bank balance 1,05,200

Gift from parents 3,50,000Owned funds available 4,55,200

(2)

(3) Rs.Machinery 15,25,000Furniture and Fittings (Balance) 2,75,000Project Cost 18,00,000

(4) Depreciation (SLM) @ 20% =

(5) Bank Finance =

(6) Working Capital outflows to be show at:

Total Project CostRs.18 lacs

Owned Funds (Balance)Rs. 3.6 lacs

Bank LoanRs. 14.4 lacs

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Loan Amortisation Schedule (Equal Principal Repayment)Year Balance at the

BeginningPrincipal

RepaymentInterest@ 10%

Total LoanInstalment

Balance atthe End

123

14,40,00011,40,0008,40,000

3,00,0003,00,0003,00,000

1,44,0001,14,000

84,000

4,44,0004,14,0003,84,000

11,40,0008,40,0005,40,000

Income Statement / Profit and Loss A/cParticulars Years

1 2 3SalesLess: Cost of Sales/Cost of Goods Sold (80% of Sales)Gross ProfitLess: (i) Depreciation @ 20% (ii) Other OverheadsEBITLess: interest on LoanEBTLess: Tax @30%NPAT

40,00,00032,00,0008,00,0003,60,0002,40,0002,00,0001,44,000

56,00016,80039,200

48,00,00038,40,0009,60,0003,60,0003,00,0003,00,0001,14,0001,86,000

55,8001,30,200

57,60,00046,08,00011,52,0003,60,0003,60,0004,32,000

84,0003,48,0001,04,4002,43,600

Balance Sheet Year 1Liabilities Rs. Rs. Assets Rs. Rs. Rs.

Owned Funds(+) NPATBank Loan(—) Repaid

3,60,00039,200

14,40,0003,00,000

3,99,200

11,40,000

15,39,200

Fixed Assets:Machinery(-) 20% DepreciationFurniture and Fittings(-) 20% DepreciationNet Fixed AssetsWorking Capital(Balancing Figure)

15,250003,05,0002,75,000

55,000

12,20,000

2,20,00014,40,000

99,200

15,39,200Balance Sheet Year 2

Liabilities Rs. Rs. Assets Rs. Rs. Rs.Owned Funds(+) NPATBank Loan(—) Repaid

3,99,2001,30,200

11,40,0003,00,000

5,29,400

8,40,000

Fixed Assets:Machinery(-) 20% DepreciationFurniture and Fittings(-) 20% Depreciation

12,20,0003,05,0002,20,000

55,000

9,15,000

1,65,000

T - 0Additional investment in working capital will be required to the extent of Rs. Given Amount

T - 1The project will require working capital of Rs. Given Amount during the year 1.

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13,69,400

Not Fixed AssetsWorking Capital(Balancing Figure)

10,80,0002,89,400

13,69,400

Balance Sheet Year 3Liabilities Rs. Rs. Assets Rs. Rs. Rs.

Owned Funds(+) NPATBank Loan(—) Repaid

5,29,4002,43,6008,40,0003,00,000

7,73,000

5,40,000

13,13,000

Fixed Assets:Machinery(-) 20% DepreciationFurniture and Fittings(-) 20% DepreciationNot Fixed AssetsWorking Capital(Balancing Figure)

9,15,0003,05,0001,65,000

55,000

6,10,000

1,10,0007,20,0005,93,000

13,13,000(b) 5 positive points from Bankers point of view:

(1) Fresh MBA: Young qualified person.(2) Ancestral Factory Premises: No gestation time. Production can start immediately.

No charge on factory premises.(3) Gift from parents of As. 3,50,000: No burden of repayment and no charge on

company’s assets.(4) Own bank balance As. 1,05,200. No repayment burden.(5) 25.28% of the project cost can be contributed by him from his own bank balance

and gift from parents. This can be his margin money and only the balance amount is required in the form of bank borrowings.

(6) Projected increase in sales every year by 20%.(7) High Profitability Ratios [i.e. Gross Profit Ratio, Net Profit Ratio, etc.](8) Sound DSCR and Interest Coverage Ratios indicating loan instalment repayment

ability.Comments:

The company will utilise the entire bank loan and enjoy the benefit of “Trading on Equity” since cost of debt is lower than the profit percentage and the company’s sales and operating profits are on an increasing trend. If the company will utilise the entire owned funds available and take the balance by way of bank loan then it won’t be able to maximise the returns on its owned funds and enjoy the benefit of “Trading on Equity” and the Return on Net worth will be low in alt the three years.

OCT 2007 9) Mr. Hemendra Dane is carrying out retail business in electronic items. After observing trade practices, he has decided to start a small scale manufacturing unit to produce electrical fittings. His Balance Sheet as on 31 -3-2007, before starting manufacturing activities, is as under:Liabilities AssetsCapital 5,55,500 Furniture

ComputerInvestmentsFixed Deposits with bankCash and Bank balance

40,00060,000

1,50,0002,00,0001,05,500

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Rs. 5,55,500 Rs. 5,55,500In order to carry out new activity he will take factory premises on rental basis @ Rs. 10,000 p.m. from 1.9.2007 and from 1.4.2008 the rent will be Rs. 15,000 p.m. He is confident of setting up manufacturing unit by 30.8.2007 and start manufacturing and selling from 1st September 2007.

The cost of machineries will be Rs. 10,00,000 for which he will be approaching Bank of Baroda for term loan of Ps. 8,00,000, balance being his own contribution. The loan repayment will start from 1.4.2008, in the quarterly installment of Rs. 50,000 payable on 1st April, 1st July, 1st October and 1st January every year.

He will have no income in financial year 2007-08 till setting up of the unit i.e. upto 30-8-2007. Thereafter he expects his Sales to be Rs. 80,000 p.m. from 1-9-2007 to 31-3-2008 and afterwards every year Rs. 18,00,000 with yearly increment of 10% over previous year.

His cost structure will remain more or less unchanged upto 31-3-2010 and Cost break up on Sales will be: Direct Cost @ 40%, Office Overheads 20%; Selling and Distribution 5%, Depreciation will be charged on all fixed assets @ 10% under W.D.V.(full year’s depreciation even if the assets are used for a part of the year) and interest for first year ending 31 -3-2008 will be Rs. 59,000 and thereafter it will be at Rs. 70,000, Rs. 54,000 and Rs. 43,000 respectively for subsequent years.

You are required to prepare Projected Statement of Profit and Loss for the financial years 2007-08 08-09 and 2009-10.Solution:Projected Profit and Loss Statement (All figures in Rupees)

Particulars 2007-08

2008-09 2009-10

SalesLess: expenses:

Direct Cost (40% Sales)Office Overheads (20% Sales)Selling and Distribution Overheads (5% Sales)Factory Rent

PBDITLess: Depreciation on:

FurnitureComputerMachinery

PAITLess: Interest on Term LoanNPBT

5,60,000

2,24,000

1,12,000

2800070,000

1,26,000

4,0006,000

1,00,000

16,00059,000

(43,000)

18,00,000

7,20,0003,60,000

90,0001,80,0004,50,000

3,6005,400

90,0003,51,000

70,0002,81,000

19,80,000

7,92,0003,96,000

99,0001.80,0005,13,000

3,2404,860

81,0004,23,900

54,0003,69,900

Working Notes:(1) Factory Rent:01/09/200710 31/03/2008 (7 Months) @ Rs. 10,000 p.m. = Rs. 70,00001/04/2008 to 31/03/2009 and 01/04/2009 to 31/03/2010(12 Months) @ Rs. 15,000 p.m. = Rs. 1,80,000 p.a.(2) Sales:01/09/2007 to 31/03/2008 (7 Months) @ Rs. 80,000 p.m. = Rs. 5,60,00001/04/2008 to 31/03/2009 = Rs. 18,00,000

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01/04/09 to 31/03/2010 = Rs. 18,00,000 + 10% = Rs. 19,8C’.OOO(3) Cbst Break-up:

Direct CostOffice Overheads

S and D Overheads

40% Sales20% Sales5% Sales

(4) Depreciation on all Fixed assets:@ 10% WDV Method

Particulars Furniture Computer

Machinery

WDV/CostDepreciation 07-08WDVDepreciation 08-09WDVDepreciation 09-10

40,0004,000

36,0003,600

32,4003,240

60,0006,000

54,0005,400

48,6004,860

10,00,0001,00,0009,00,000

90,0008,10,000

81,000

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Documents

Term Loan and Project Appraisal