ACA-TM-37 (v2.2-20-Nov-10)

PROJECT FINANCINGPROJECT

FINANCINGPROJECT PROJECT APPRAISALAPPRAISALSatyajit DwivediSatyajit Dwivedi

CAB, PuneCAB, Pune

ACA-TM-37 (v2.2-20-Nov-10)

PROJECTS - DEFINITION

• CUTTING EDGE OF DEVELOPMENT – GITTINGER

• A SET OF ACTIVITIES LARGE ENOUGH TO REQUIRE PROPER PLANNING ETC.

ACA-TM-37 (v2.2-20-Nov-10)

PROJECTS - DEFINITION

• PROJECT IS AN ECONOMIC ACTIVITY IN WHICH

FINANCIAL RESOURCES ARE EXPENDED TO

CREATE CAPITAL ASSESTS THAT PRODUCE

BENEFITS OVER A PERIOD OF TIME AND WHICH

LOGICALLY LENDS ITSELF TO PLANNING,

FINANCING AND IMPLEMENTING AS A UNIT.

ACA-TM-37 (v2.2-20-Nov-10)

CHARACTERISTICS

•P – PRODUCT OF GOODS AND SERVICES

•R – RESOURCES : MAN, MATERIAL, MONEY

•O – ORGANISATION

• J – JUSTIFICATION : SOCIAL BENEFITS, WEALTH

•E – ECONOMIC & FINANCIAL VIABILITY

•C – CONTINUITY: PLANNING, RESEARCH & DEV.

•T – TIME BOUND IMPLEMENTATION

ACA-TM-37 (v2.2-20-Nov-10)

WHY PROJECT APPROACH ?

• Integrated approach for systematic exploitation of resources

• Gives an idea of costs year by year – Helps in resources planning

• Impact of investment on the stakeholders

• Better judgment of administrative & organisational problems

• Encourage examination of alternatives

ACA-TM-37 (v2.2-20-Nov-10)

ESSENCE OF PROJECT APPRAISAL

• A COMPREHENSIVE & SYSTEMATIC REVIEW

OF ALL ASPECTS OF PROJECT

• A SECOND LOOK TO THE PROJECT BY ONE

NOT INVOLVED IN PRJECT FORMULATION

• HIGHLIGHT THE WEAK AREAS OF THE

PROJECT FOR DUE RECTIFICATION

ACA-TM-37 (v2.2-20-Nov-10)

ESSENCE OF PROJECT APPRAISAL

• AN EXERCISE FOR FUTURE ASSESSMENT

• A JOINT ASSESSMENT BY THE

PROMOTER & FINANCIAL INSTITUTION

• ENFORCEMENT OF A TIME BOUND

PROGRAMME TO AVOID DISTORTION

ACA-TM-37 (v2.2-20-Nov-10)

TYPES OF PROJECTS

FARM SECTOR NON FARM SECTOR

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OTHERS

ACA-TM-37 (v2.2-20-Nov-10)

PROJECT CYCLE

• IDENTIFICATION•FORMULATION•APPRAISAL• IMPLEMENTATION•MONITORING•EVALUATION

ACA-TM-37 (v2.2-20-Nov-10)

IDENTIFICATION

FORMULATION

APPRAISAL

IMPLEMENTATAION

MONITORING

EVALUATION

PROJECT CYCLE

ACA-TM-37 (v2.2-20-Nov-10)

APPRAISAL

TECHNICAL COMMERCIAL MANAGERIAL / BORROWER ORGANISATIONAL SOCIAL ECONOMIC FINANCIAL

ACA-TM-37 (v2.2-20-Nov-10)

OBJECTIVES OF FINANCIAL APPRAISAL

• To assess the financial effect on the farmers and bank/financial institution

• To asses overall return on the investment as well as return to farmer after repayment of installments

• To know whether incremental benefits are attractive enough for farmer

• To work out a plan that projects financial situations and sources of funds and to determine timing of investments

ACA-TM-37 (v2.2-20-Nov-10)

CASH FLOW STATEMENT

• Cash flow prepared on an annual basis over the economic life of assets

• Identify the costs and benefits• Compare incremental benefits with incremental costs• Income and expenditure pertaining to the investment

alone to be reckoned• For deciding the price – price paid or received at the

farm-gate to be taken• Constant price principle is applied• Interest on borrowed capital is not included

ACA-TM-37 (v2.2-20-Nov-10)

CASH FLOW STATEMENT CONTD..

Identification of costs:Investment:• Expenditure made before the production starts and

replacement of machineries

Production:• All recurring expenditure during the project life

Pre-Development Income:• Pre-developmental income to be taken as cost

• Cost not to be reduced with subsidy/margin

ACA-TM-37 (v2.2-20-Nov-10)

Identification of Benefits

• Increase in production• Cost reduction• Improvement in quality• Grading• Prevention of loss• Consumed part of production• Scrap/residual value of investments

ACA-TM-37 (v2.2-20-Nov-10)

METHODS OF APPRAISAL

Two well known methods:

PAYBACK METHOD (Undiscounted)

TIME ADJUSTED RATE OF RETURN (Discounted)

ACA-TM-37 (v2.2-20-Nov-10)

PAYBACK METHOD

• LENTH OF TIME FROM BEGINNING OF THE PROJECT TILL THE INCREMENTAL BENEFITS REACHES THE CAPITAL INVESTMENT

• FAILS TO CONSIDER EARNINGS AFTER THE PAYBACK PERIOD

• DOES NOT CONSIDER TIMIMGS OF OCCURRENCE OF CASH INFLOWS AND OUTFLOWS OF THE PROJECT

ACA-TM-37 (v2.2-20-Nov-10)

DISCOUNTED CASH FLOW METHOD

TAKES INTO ACCOUNT TIME VALUE OF MONEY

• COSTS AND BENFITS OCCUR AT DIFFRENT TIMINGS AND IN DIFFERENT AMOUNT

• DISCOUNT FACTOR IS USED TO BRING COSTS AND BENEFITS TO THEIR PRESENT VALUE

• BY DISCOUNTING AT A GIVEN RATE WE OVERCOME THE TIME DIMENSION

ACA-TM-37 (v2.2-20-Nov-10)

DISCOUNTED CASH FLOW METHOD

DISCOUNTED MEASURES OF PROJECT WORTH

• BENEFIT COST RATIO (BCR)

• NET PRESENT WORTH (NPW)

• ITERNAL RATE OF RETURN (IRR)

ACA-TM-37 (v2.2-20-Nov-10)

STEPS & METHODOLOGY FOR APPRAISAL

• COST AND BENEFIT STREAM IN THE CASH FLOW TO BE DISCOUNTED SEPARATELY

• TOTAL OF DISCOUNTED COST GIVES PRESENT WORTH OF COSTS (PWC)

• TOTAL OF DISCOUNTED BENEFIT IN CASH FLOW GIVES PRESENT WORTH OF BENEFITS (PWB)

ACA-TM-37 (v2.2-20-Nov-10)

STEPS & METHODOLOGY FOR APPRAISAL

• BENEFIT COST RATIO : RATIO OF PWB TO

PWC

• NET PRESENT WORTH : DIFFERENCE BETWEEN PWB AND PWC

• IF BCR IS > 1 AND NPW IS +VE AT THE DISCOUNTED RATE, THEN THE PROJECT IS VIABLE

ACA-TM-37 (v2.2-20-Nov-10)

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Benefit Cost Ratio

• Year Investment

costBenefits DF

@15%PW of costs( 2x4)

PW of benefits(3x4)

1 2 3 4 5 6

0 1000 - 1.000 1000 -

1 - 400 0.870 - 348

2 - 500 0.756 - 378

3 - 500 0.658 - 329

Total 1000 1400 1000 1055

BC Ratio

1055 :- 1000

1.055 : 1

ACA-TM-37 (v2.2-20-Nov-10)

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Net Present Worth

• Year Investm

ent costBenefits

DF @15 %

PW of costs( 2x4)

PW of benefits(3x4)

1 2 3 4 5 6

0 1000 - 1.000 1000 -

1 - 400 0.870 - 348

2 - 500 0.756 - 378

3 - 500 0.658 - 329

Total 1000 1400 1000 1055

NPW 1055 - 1000

55

ACA-TM-37 (v2.2-20-Nov-10)

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Net Present Worth

• Year Investment cost

Benefits DF @ 20 % PW of costs( 2x4)

PW of benefits(3x4)

1 2 3 4 5 6

0 1000 - 1.000 1000 -

1 - 400 0.833 - 333

2 - 500 0.694 - 347

3 - 500 0.579 - 289

Total 1000 1400 1000 969

NPW 969 - 1000

(-) 31

ACA-TM-37 (v2.2-20-Nov-10)

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Internal Rate of Return• Internal Rate of Return ( IRR ) : Lower of the two discount rates (+ ) Difference between two discount rates x (NPW

@ lower discount rate :- Absolute difference between NPWs at two discount rates )• IRR= • 15 + 5 x ( multiplied by ) • 55 :- 86 ( 55+-31)• = 18 % ( 18.2 )• IRR determined by trial and error• Represents return for resources over life of project• Earning power of money used in project IRR not estimated beyond 50% Present cut off IRR : 15%

ACA-TM-37 (v2.2-20-Nov-10)

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Appraisal of Projects- Techniques-contd.

Not feasibleNegative ( - )Lower than thelending rate

Less than one

Marginal OEqual to lendingrate

One

FeasiblePositive ( + )More than thelending rate

More than one

Feasibility orotherwise ofinvestment

N P WI R R B C Ratio

Tools for decision making- No single technique for estimating project worth Could be many socio- economic factors , which are not always quantifiable

ACA-TM-37 (v2.2-20-Nov-10)

TREATMENT OF DEPRECIATION AND INTEREST

Depreciation and interest on borrowed capital not treated as cost

In DCF approach;

‘return of capital’ is ensured and hence no depreciation of investment

‘return to capital’ i.e interest on investment is also ensured

ACA-TM-37 (v2.2-20-Nov-10)

SENSITIVITY ANALYSIS• Studies the changes in the scenario in case

either price structure or timeframe undergoes change

• Studies ability of the project to bear adversities

ACA-TM-37 (v2.2-20-Nov-10)

REPAYMENT SCHEDULEThree issues to be seen

Instalments to be fixed in relation to surplus so that sufficient is available with the farmer after repayment

Period of loan to be within economic life of the assets

Instalments are fixed when surplus is available

ACA-TM-37 (v2.2-20-Nov-10)

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THANK YOU