aca-tm-37 (v2.2-20-nov-10 ) project approach to lending &financial appraisal satyajit dwivedi...
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ACA-TM-37 (v2.2-20-Nov-10)
Project Approach to Lending &Financial
AppraisalSatyajit DwivediMember of Faculty
CAB Pune
1
ACA-TM-37 (v2.2-20-Nov-10)
Potential Activities• Fruits and Vegetables• Floriculture• Medicinal and Aromatic Plants• Minor Irrigation Schemes - development & management• Livestock based Schemes - Dairy, Poultry, Fisheries, etc.• Land development activities - soil & water conservation• Mechanisation of Agriculture• Organic Farming• Bio-fuel and TBO seeds• Agro-processing • Seed and Planting material production• Agri-clinic and Agri-Business Centres• Post harvest and Marketing Infrastructure Development, etc.
2College of Agricultural Banking, RBI, PUNE
ACA-TM-37 (v2.2-20-Nov-10)
PROJECT• AN ACTITY IN WHICH FINANCIAL RESOURCES
ARE EXPENDED TO CREATE CAPITAL ASSETS THAT PRODUCE BENEFITS OVER AN EXTENDED PERIOD OF TIME AND WHICH LOGICALLY LENDS ITSELF TO PLANNING,FINANCING AND IMPLEMENTING AS A UNIT.
3College of Agricultural Banking, RBI, PUNE
ACA-TM-37 (v2.2-20-Nov-10)
ETERNAL TRIANGLE OF PROJECT MANAGEMENT
4College of Agricultural Banking, RBI, PUNE
QUALITY
ACA-TM-37 (v2.2-20-Nov-10)
Project Cycle
Idea/identification
Formulation
AppraisalImplementation
Monitoring
Evaluation
5College of Agricultural Banking, RBI, PUNE
ACA-TM-37 (v2.2-20-Nov-10)
WHY APPRAISE POJECT• TO DETERMINE IF COMPONENTS OF PROJECT ARE
CONSISTENT
• TO ASSESS SOURCES AND MAGNITUDE OF RISKS AND THEIR MANAGEMENT
• FINANCIAL/ECONOMIC VIABILITY OF PROJECT
• DECISION ON GOOD OR BAD PROJECTS
6College of Agricultural Banking, RBI, PUNE
ACA-TM-37 (v2.2-20-Nov-10)
PROJECT APPRAISAL
• TECHNICAL• COMMERCIAL• ENTERPRENEURIAL• FINANCIAL• ECONOMIC• MANAGERIAL• SOCIAL• ENVIRONMENTAL
04/18/2304/18/23
7College of Agricultural Banking, RBI, PUNE
ACA-TM-37 (v2.2-20-Nov-10)
FINANCIAL APPRAISAL
• UNDISCOUNTED CASH FLOW METHOD
• DISCOUNTED CASH FLOW METHOD
8
ACA-TM-37 (v2.2-20-Nov-10)
COMPONENTS OF CASH FLOW
• INITIAL INVESTMENT
• OPERATING CASH FLOW
• TERMINAL CASH FLOW
9
ACA-TM-37 (v2.2-20-Nov-10)
Bankability / Repayment Schedule
• Will the borrower be able to repay the loan + interest within repayment period?
• Repayable surplus
Generally 50% of gross surplus for small borrowers
75% of gross surplus for large borrowers
Contd…..
ACA-TM-37 (v2.2-20-Nov-10)
Bankability / Repayment Schedule
• Repayment Schedule Types
1. Equal Principal Installment
Loan (Principal)
+ Accrued Interest
No of Installment
It changes (reduces) over time
Contd……
ACA-TM-37 (v2.2-20-Nov-10)
Economic Life of Project (Rs.)
Years 1 2 3 4 5 6
Aggregate Benefits
1000 1000 1100 1100 1100 1100
Costs Incurred
Fixed Cost 1000 - - - - -
Operation & Mainten. cost
100 100 100 100 100 100
Production cost
200 200 200 200 200 200
Total 1300 300 300 300 300 300
Net Benefit/Surplus
-300 700 800 800 800 800
ACA-TM-37 (v2.2-20-Nov-10)
Discounted Measures of Project Worth
• Used in financial analysis • Future stream of benefits and Future Stream
of costs• Reduced to present worth• Present worth of costs and present worth of
benefits during the project life is compared to know which project gives maximum benefits
ACA-TM-37 (v2.2-20-Nov-10)
Time Value of Money
• Money has value• Different values at different times • Preference for smaller sums today • Than larger sums at future date
ACA-TM-37 (v2.2-20-Nov-10)
Concept of Interest
• For getting larger sum at future date • Part with the present sum• Forego the use of money for present • We expect reward/benefit - interest • Interest - payment for foregoing use of money
by person to whom it is lent.
ACA-TM-37 (v2.2-20-Nov-10)
Compounding (Future Worth)
• Interest determines price of money• Compounding:: Future worth of present
money at a specified interest rate• Discounting: Present worth of future money
at a specified interest rate.• Discount Factor also called Present Worth
Factor
ACA-TM-37 (v2.2-20-Nov-10)
Compounding-Illustration
Sl.
No.
Year Amount at the
beginning of the year
Rate of interest factor
(9%)
Amount promised at the end of the year
1 2 3 4 (3X4)=5
1 2010 650 1.09 708
2 2011 708 1.09 772
3 2012 772 1.09 841
4 2013 841 1.09 917
5 2014 917 1.09 1,000
ACA-TM-37 (v2.2-20-Nov-10)
(e) Discounting - Illustration ( Rs.)
S.
No.
Year Amt. promised at
the end of the year
Rate of Interest Factor
Amt. (in Rs.) worth at the beginning of
the year
1 2 3 4 (3/4)=5
1 2014 1,000 1.09 917
2 2013 917 1.09 841
3 2012 841 1.09 772
4 2011 772 1.09 708
5 2010 708 1.09 650
ACA-TM-37 (v2.2-20-Nov-10)
Techniques in Discounted Measures
• Benefit Cost Ratio • Net Present Worth / Value (NPW/NPV)• Internal Rate of Return (IRR)
ACA-TM-37 (v2.2-20-Nov-10)
Benefit Cost Ratio
Total of Present Worth of Benefits = BCR Total of Present Worth of Cost • For selection of project BCR should be more than 1
when discounted at opportunity cost of capital• Broad idea of profitability of the project
ACA-TM-37 (v2.2-20-Nov-10) 21
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)
Benefit Cost Ratio (contd)
Project (Rs) A B C Present worth of benefit
500 10000 1000
Present worth of cost
400 8000 900
Net present Benefit
100 2000 100
BC Ratio 1.25 1.25 1.11
ACA-TM-37 (v2.2-20-Nov-10)
Benefit Cost Ratio (contd)
Cannot be used to compare 2 projects
projects may have same BC Ratio but net benefits vary
projects may have same net benefit but BC Ratio varies
ACA-TM-37 (v2.2-20-Nov-10)
Net Present Worth (NPW)
• Present Worth of Benefits minus Present Worth of Cost
• NPW should be positive at opportunity cost of capital
• Indicates size of benefits at opportunity cost of capital which BC Ratio cannot indicate
• Cannot rank project by size of NPW
ACA-TM-37 (v2.2-20-Nov-10) 25
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)
Internal Rate of Return
• Discount Rate at which PWB = PWC OR
• Net Present Worth of Cash flow is zero• Earning capacity of money invested in the
project over project life • Helps in ranking the project
ACA-TM-37 (v2.2-20-Nov-10)
Internal Rate of Return (contd)
• Found out by Trial and Error method • Discount rate increased in multiples of 5 (15-
20, 20-25, etc.)• NPW decreases as discount rate increased • Through trial and error a stage reached when
NPW becomes negative • IRR found out by interpolation
ACA-TM-37 (v2.2-20-Nov-10)
Internal Rate of Return (IRR)
IRR = Lower Discount Rate +
Difference between the two discount rates
NPW at lower discount rate Absolute difference between NPWs at two discount rates
ACA-TM-37 (v2.2-20-Nov-10) 29
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) 30
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)
FORCE FIELD ANALYSIS-WORKSHEET
Forces for change
Score Score Forces against change
Costumers want new product
4 3 Staff not happy with loosing OT
Enhance speed of production
2 3 Fear of New technology
Increase volume of output
3 1 New technology Environ. Impact
Minimize maintenance cost
1 3 Increase in Expe nses on a/c of new technology
1 Disruption in work
T O T A L 10
11
T O T A L
CHANGE PROPOSAL
UPGRADE FACTORY
WITH NEW
MACHINERY
Developed by Kurt Lewin
ACA-TM-37 (v2.2-20-Nov-10)
Training the staff - Increase in Expenditure : (+ 1)
Fear of technology could be eliminated after training-Reduce fear:(-2)
Impress staff-change is inevitable for survival-New force in favor:(+1)
Impress staff that new machines would introduce variety and interest to their jobs - New force in favor : (+1)
Increase wages to reflect new productivity – Increase in Expenditure :(+1) & Reduce in loss of overtime : (-1)
Propose installation of slightly different machines with filters to eliminate pollution – Reduce environmental impact : (-1)
These changes would swing the balance from 11 : 10 (against the plan), to 9 : 12 (in favor of the plan).
FORCE FIELD ANALYSIS .. CONTD
ACA-TM-37 (v2.2-20-Nov-10)
Forces for CHANGE
Score FORCE FIELD ANALYSIS REVISED SCORES
Score Forces againstCHANGE
Costumers want new product
4 3-1
Staff not happy with loosing OT
Enhance speed of production
2 3-2
Fear of New technology
Increase volume of output
3 1-1
New technology Environ. Impact
Minimize mainte nance cost
1 3+1+1
Increase in Expenditure
Impress staff-cha nge is inevitable
1 1 Disruption in work
Impress staff-variety of work
1
T O T A L 12
9 T O T A L
CHANGE PROPOSAL
UPGRADE FACTORY
WITH NEW
MACHINERY
ACA-TM-37 (v2.2-20-Nov-10)
Case exercise on project -financial appraisal
Case:MI Project• A farmer having a water source like open well or canal nearby would like
to invest on a pumpset to lift water. Presently, he is cultivating only a single crop and getting a net benefit of Rs.3,000 (pre development income) per year
• On installation of pumpset, it would be possible to take two crops with some additional expenditure. First year he projects raising of one crop, as it is assumed that the installation of pumpset might take some time. Therefore, during first year, the production expenditure is estimated as Rs.4,500 for single crop, with a projected benefit of Rs.8,000 (benefit assumed to be increased from Rs.3,000 to Rs.8,000 due to irrigation)
Contd...
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