Project Finance 425 v1

PROJECT FINANCE
Sub Code 425
Developed by
Prof. Dipal Rokadia
On behalf of
Prin. L.N. Welingkar Institute of Management Development & Research
!
Advisory Board
Chairman
Prof. Dr. V.S. Prasad
Former Director (NAAC)
Former Vice-Chancellor
(Dr. B.R. Ambedkar Open University)
Board Members
1. Prof. Dr. Uday Salunkhe  2. Dr. B.P. Sabale  3. Prof. Dr. Vijay Khole  4. Prof. Anuradha Deshmukh 
Group Director  Chancellor, D.Y. Patil University, Former Vice-Chancellor  Former Director 
Welingkar Institute of Navi Mumbai  (Mumbai University) (YCMOU)
Management Ex Vice-Chancellor (YCMOU)
Program Design and Advisory Team
Prof. B.N. Chatterjee Mr. Manish Pitke

Dean – Marketing Faculty – Travel and Tourism
Welingkar Institute of Management, Mumbai Management Consultant
Prof. Kanu Doshi Prof. B.N. Chatterjee

Dean – Finance Dean – Marketing
Welingkar Institute of Management, Mumbai Welingkar Institute of Management, Mumbai
Prof. Dr. V.H. Iyer Mr. Smitesh Bhosale

Dean – Management Development Programs Faculty – Media and Advertising
Welingkar Institute of Management, Mumbai Founder of EVALUENZ
Prof. B.N. Chatterjee Prof. Vineel Bhurke

Dean – Marketing Faculty – Rural Management
Prof. Venkat lyer Dr. Pravin Kumar Agrawal

Director – Intraspect Development Faculty – Healthcare Management
Manager Medical – Air India Ltd.
Prof. Dr. Pradeep Pendse Mrs. Margaret Vas

Dean – IT/Business Design Faculty – Hospitality
Welingkar Institute of Management, Mumbai Former Manager-Catering Services – Air India Ltd.
Prof. Sandeep Kelkar Mr. Anuj Pandey

Faculty – IT Publisher
Welingkar Institute of Management, Mumbai Management Books Publishing, Mumbai
Prof. Dr. Swapna Pradhan Course Editor

Faculty – Retail Prof. Dr. P.S. Rao
Welingkar Institute of Management, Mumbai Dean – Quality Systems
Welingkar Institute of Management, Mumbai
Prof. Bijoy B. Bhattacharyya Prof. B.N. Chatterjee

Dean – Banking Dean – Marketing
Mr. P.M. Bendre Course Coordinators

Faculty – Operations Prof. Dr. Rajesh Aparnath
Former Quality Chief – Bosch Ltd. Head – PGDM (HB)
Welingkar Institute of Management, Mumbai
Mr. Ajay Prabhu Ms. Kirti Sampat

Faculty – International Business Assistant Manager – PGDM (HB)
Corporate Consultant Welingkar Institute of Management, Mumbai
Mr. A.S. Pillai Mr. Kishor Tamhankar

Faculty – Services Excellence Manager (Diploma Division)
Ex Senior V.P. (Sify) Welingkar Institute of Management, Mumbai
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1st Edition (May-2015)
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CONTENTS
Contents
Chapter
Chapter Name Page No.
No.
SECTION 1: THE PROJECT AND APPRAISALS 3
1 The Project 4-31
2 Project Appraisal 32-41
3 Technical Appraisal 42-68
4 Economic Appraisal 69-78
5 Market Appraisal 79-92
6 Financial Appraisal 93-128
7 Capital Structure 129-149
SECTION 2: FINANCING OF PROJECTS 150
8 Presentation of your Project for Financier 151-193
9 Term Loans 194-247
10 Working Capital Finance 248-276
11 Private Equity 277-313
12 Public Listing of Securities 314-333
13 International Capital 334-357
14 Crowd Funding 358-372
SECTION 3: PROJECT IMPLEMENTATION AND

373
REVIEW
15 Project Planning, Risks and Management 374-387
16 Project Quality Assurance and Audit 388-396
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SECTION - I - THE PROJECT AND APPRAISALS
SECTION - I
THE PROJECT AND APPRAISALS 
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THE PROJECT
Chapter 1
THE PROJECT
Objectives
After studying this chapter, you should be able to:
• Get a brief overview about Projects.

• Provide conceptual understanding on Capital Expenditure and Revenue
Expenditure.
• Understand the differences between Capital Expenditure v/s Revenue
Expenditure.
• Explain the steps to formulate a Project.
• Explain on steps to finance a Project.
• Learn on steps to implement a Project.
• Learn about Post Implementation Work.
Structure:
1.1 Introduction
1.2 Steps on Formulating a Project
1.3 Steps on Financing the Project
1.4 Steps on Implementation of the Project
1.5 Post Implementation Work
1.6 Total Project Life Cycle
1.7 Sample Form for Undertaking New Project
1.8 Summary
1.9 Self Assessment Questions
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1.1 Introduction
The Indian Government is considering interlinking the various rivers;

Mahindra Motors is taking over an international motor company; Reliance
Retail is planning to expand their stores throughout the country; A steel
plant wants to set-up new arc furnace; Meghna, a dentist is planning to
start her own clinic; Raj is planning to buy a motorbike; All these situations
involve are Projects and involve a Capital Expenditure Decision.
Often, Capital Expenditure Decisions represent the most important

decisions taken by a firm. The consequences are Long-term, Irreversible
and involve substantial outlays. Not only are they extremely important but
also pose difficulties due to measurement, uncertainty and have a temporal
spread.
Images of Certain Projects
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THE PROJECT
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As a financial manager, the investment decisions that you will make today
will be critical to the future of your firm. A wise investment decision will
create wealth and make the owners or shareholders of the company richer
by exploiting an opportunity to increase the value of the firm. Alternatively,
a poor investment decision will decrease the value of your company and
destroy shareholder wealth.
Throughout this subject, we shall assume that maximizing shareholder

wealth is the goal of the owners of the firm, the shareholders. We also
assume that managers, acting in the interest of the owners of the firm, use
shareholder wealth maximization as their ultimate decision criterion.
However, in reality, there are many conflicts of interest between the
shareholders and the managers.
Revenue expenditure if made on day-to-day operations of the organization

is for a relatively short period and has short-term impact. Comparison
between Capital Expenditure and Revenue Expenditure is enlisted in table
below: 
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Capital Expenditure Revenue Expenditure

Expenditure is made from one-time
Expenditure is incurred and benefits benefit/ utility. To avail benefit second
are available on recurring basis. time, the expenditure will have to be
incurred again.
Expenditure generally creates a Capital Expenditure is to use and maintain the
Asset. assets so created.
Expenditure is charged to the P&L A/c
Expenditure is charged to the P&L A/c
in form of depreciation charges spread
in the same year in which it is
over the useful life period of the
incurred.
assets.
Expenditure is subject to completion Expenditure is subject to budgetary
report of the scheme or asset. control only.
Expenditure precedes benefit/utility. Expenditure follows benefit/utility.
Expenditure requires administrative Expenditure requires only annual

approval from competent authority. budgetary approval.
A smart finance manager keeps controls on Revenue Expenditure to reduce

the overheads of the organization and make it more efficient. However, he
deploys Project Finance to take his organization to the next level. Let us
just have a look at the revenue expenditure of M/s Predict Projects Pvt.
Ltd. (your assumed company):
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THE PROJECT
Monthly Expense Sheet for M/s Predict Projects Pvt. Ltd.

Sr. Amount Ideas to Reduce
Expenditure Type %
No. (Rs.) Expenses
1 Factory
Raw Materials
a Variable
Consumed
Can we use up all old
Ferrous
Variable 12,42,142 18.56% stock first before
Materials
buying fresh material?
Fluxes – lime,
Variable 7,41,245 11.08%
alloying agent
Old material 6 months
is still not used. 30%
Refractories Variable 4,24,125 6.34% material spoilt.
Purchase less quantity
and improve storage.
Fuels – coke,
Variable 12,04,050 17.99%
coal, gas
We might have to
Salaries – increase as less staff
b Fixed 2,01,504 3.01%
Factory is causing reduced
output.
Electricity
c Expenses – Variable 3,12,421 4.67%
Factory
d Miscellaneous Variable 1,24,125 1.85%

Telephone
e Variable 10,125 0.15%
Expenses
f Rent Fixed 4,37,547 6.54% Can we re-negotiate?

Repairs and
g Variable 9,353 0.14%
Maintenance
Sub-total 47,06,637 70.33%
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THE PROJECT
2 Head Office
Can do a sales audit?

Which newspapers,
Business
a Variable 4,14,959 6.20% advertisements and
Promotion
hoardings are not
giving inquiries?
Electricity
b Expenses – Variable 14,540 0.22%
Office
Salaries – Head Can reduce non-
c Fixed 6,46,367 9.66%
Office performing staff?
Telephone
d Variable 21,754 0.33%
Expenses
Repairs and
e Variable 24,214 0.36%
Maintenance
f Bank Interest Variable 1,24,124 1.85%
g Bank Charges Variable 5,436 0.08%

Commission and
h Variable 4,00,000 5.98% Can we re-negotiate?
Brokerage
i Conveyance Variable 22,756 0.34%

Interest on
j Variable 95,050 1.42%
Payments
Printing and
k Variable 12,000 0.18%
Stationery
Professional
l Variable 5,000 0.07%
Charges
m Rent Fixed 75,000 1.12%
n Miscellaneous Variable 1,24,124 1.85%
Sub-total 19,85,324 29.67%
GRAND TOTAL 66,91,961 100.00%
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1.2 STEPS ON FORMULATING A PROJECT
Generally, Project involving Capital Expenditure is formulated in following

stages:
!
After it is concluded that a project is feasible and doable, the promoters
and finance managers work on getting the resources to complete the
project. He will look at the various sources available to his disposal and
cost of each source. He will arrive at an optimum level of debt and equity
to arrive at an optimum Weighted Average Cost of Funds and evaluate the
Return on the Investment in the project.
A project is a proposal for capital investment to develop facilities to provide

goods and services. It is implemented in order to generate cash flows. The
investment proposal may be for setting up a new unit, expansion or
improvement of existing facilities. The project, however, has to be
amenable for analysis and evaluation as an independent unit.
The projects have increased in size and complexity. Projects for tomorrow
are not geared to the mass production of simpler goods but customized
ones produced by flexible manufacturing systems.
Project identification is, however, a continual process. With the opening up

of the economy, demand for sophisticated inputs is continuously rising. The
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THE PROJECT
quest for new combinations of factors for optimizing output and improving
productivity to strengthen the competitive position of Indian industry in the
international marketplace is an ongoing process. Further, the growing
demand for complex, sophisticated, customized goods and services in
international markets has added a new dimension to project concept.
(a) Generation and Screening of Ideas

Project idea can be conceived either from input or output side. The former
are material based while the latter demand oriented. Input based projects
are identified on the basis of information about agricultural raw materials,
forest products, animal husbandry, fishing products, mineral resources,
human skills and new technical process evolved in the country or
elsewhere. Output based projects are identified on the basis of needs of
population as revealed by family budget studies or industrial units as found
by market studies and statistics relating to imports and exports. Desk
research surveying existing information in economical and wherever
necessary market surveys assessing demand for the output of project
could help not only in identification but in assessing viability of the project.
Good ideas are the key to success for any project. They can be generated
using various methods such as:
1. SWOT Analysis
2. Cost reduction
3. Productivity improvement
4. Increase in capacity utilization
5. Improvement in contribution margin
6. Expansion into promising fields
You can generate good ideas by following methodologies:
• Analyze the performance of existing industries

• Examine the inputs and outputs of various industries
• Review import and exports
• Study Plan Outlays and Governmental Guidelines
• Look at suggestions of Financial Institutions and Developmental
Agencies
• Investigate local materials and resources
• Analyze economic and social trends
• Study new technological developments
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• Draw clues from consumption need

• Explore the possibility of reviving sick units
• Identify unfulfilled psychological needs
• Attend trade fairs
• Simulate creativity for generating new product ideas
• Hope that the chance factor will favor you
Preliminary Screening can be taken up looking at following aspects:
• Compatibility with the promoter

• Consistency with governmental priorities
• Availability of inputs
• Adequacy of market
• Reasonableness of cost
• Acceptability of risk level
The identification of project ideas is followed by a preliminary selection

stage on the basis of their technical, economic and financial soundness.
The objective at this stage is to decide whether a project idea should be
studied in detail and to determine the scope of further studies. The findings
at this stage are embodied in a prefeasibility study or opportunity study.
For purpose of screening and priority fixation, project ideas are developed
into prefeasibility studies. Prefeasibility studies give output of plant of
economic size, raw material requirement, sales realization, total cost of
production, capital input/output ratio, labor requirement, power and other
infrastructure facilities. The project selection exercise should also ensure
that it conforms to overall economic policy of the government.
(b) Data Collection

Data collection is an important step towards formulation of the project. It
forms the backbone on making a good robust project. It has to be credible.
Data is both primary and secondary.
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THE PROJECT
Primary Information
Primary Information represents the information that is collected for the
first time to meet the specific purpose on hand. Following are some of the
various methods to obtain Secondary Information:
• Observation
• In-depth Techniques
• Experiments
• Market Survey
Data can be of various kinds – cost of raw materials, technical

specifications of raw materials, buyers’ market for finished products, price
points to effectively enter the market, geographical areas, excise duties on
raw materials and finished products, transportation costs, competition
analysis, etc.
Good amount of data is available through a number of sources – market

dealers, CMIE, the internet, Credit Agencies, Analysts, Trade Journals, etc.
For specialized or exclusive projects, Market Survey companies and
Technical Consultants can be contacted.
Nothing can be worse than a skewed Project Report based on inaccurate,

unreal data. It can cause great repercussion on the fate of the Project. 
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THE PROJECT
Secondary Information
Secondary Information is the information that has to be gathered in some
other context and is already available. Following are some of the various
methods to obtain Secondary Information:
• Census of India
• National Sample Survey Reports
• Plan Reports
• Statistical Abstract of India
• India Year Book
• Statistical Year Book
• Economic Survey
• Guidelines to Industries
• Annual Survey of Industries
• Stock Exchange Directory
• Trade Publications
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THE PROJECT
(c) Documentation
All the data collected and assimilated has to be documented and presented
in formats understandable to the Project Team, and Top Decision Makers.
It can be presented in various formats – Tables, Graphically – Pie Charts,

Bar Graphs, Line Graphs, etc.
(d) Project Appraisal

After ascertaining that a project idea is suitable for implementation, a
detailed Project Appraisal is carried out under the following heads:
1. Technical: To assess whether that project is technically sound with

respect to various parameters such as technology, plant capacity, raw
material availability, location, manpower availability, etc.
2. Economic: To look into the economic benefits to the society and to the
nation.
3. Market: To understand the potential market for the products and at the
marketing strategy. To review competence of the marketing team.
4. Financial: To assess the financial feasibility of project – cost of project,

cost of capital, revenues, cash flows and return on capital employed.
Project Appraisal is the final document in the formulation of a project

proposal. Project Appraisal is prepared either by the financial institution or
consultants or experts. The cost of project Appraisal can be debited to
project cost and can be counted as part of promoter’s contribution.
The Project Appraisal should contain all technical and economic data that
are essential for the evaluation of the project. Before dealing with any
specific aspect, Project Appraisal should examine public policy w.r.t. the
industry. After that, it should specify output and alternative techniques of
production in terms of process choice and ecology friendliness, choice of
raw material and choice of plant size. The Project Appraisal after listing and
describing alternative locations should specify a site after necessary
investigation. The study should include a layout plan along with a list of
buildings, structures and yard facilities by size, type and cost. An essential
part of the feasibility study is the schedule of implementation and
estimates of expenditure during construction. Major and auxiliary
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THE PROJECT
equipment by type, size and cost along with specification of sources of

supply for equipment and process know-how has to be listed. The study
has to identify supply sources and present estimates, costs for
transportation, services, water supply and power. The quality and
dependence of raw materials and their source of supply have to be
investigated and presented in the feasibility study. Before presentation of
the financial data, market analysis has to be covered to help in establishing
and determining economic levels of output and plant size.
Financial data should cover preliminary estimates of sale revenue, capital

costs and operating costs for different alternatives along with their
profitability. Project Appraisal should present estimates of working capital
requirement to operate the unit at a viable level. Additional information on
financing, breakdown of cost of capital and cash flow is prepared.
(e) Conclusion
Once all the data is put on the paper, the Project Team and the Top
management decision makers are to decide the priority of the project vis-
à-vis alternate proposals. They are prepared as to the profitability or
revenue decides whether the project has to be implemented or it is to be
shelved.
The decision makers will decide based on various criteria on how the
particular project will benefit the organization. A particular project may be
very sound financially may get shelved as it is less beneficial vis-à-vis
alternative project. Similarly, a project may not be financially viable but
may be considered as it has many indirect benefits such as improvement of
the quality or product or improved services to its customers.
1.3 STEPS ON FINANCING THE PROJECT
a. Investment in the Project

Once a project is desired to be taken up for implementation, the project
team along with the finance team will work on the finance required for the
above project.
Heads such as Plant, Machinery, Equipment, Manpower, Contingencies,

Power Costs, Raw Materials, Working Capital requirements, etc.
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THE PROJECT
b. Sources of Funds
There are two main sources of funds: Debt and Equity. A company can
raise equity and debt capital from both public and private sources. Capital
raised from public sources is in the form of securities offered to public.
These securities can be traded on public secondary markets like Bombay
Stock Exchange or National Stock Exchange, which are recognized stock
exchanges that facilitate trading of public securities.
Promoters usually go for Projects that creates value for the owners or
shareholders of the firm. Maximum value for shareholders is created if
project generates maximum ROI and Cost of Source of Funds is kept as
low as possible. If the Cost of Source of Funds is not higher than ROI by at
least 2% or the Net Present Value (NPV) of the project is negative, it is not
worthwhile doing the project.
Private capital comes either in the form of loan given by banks, financial
institutions, NBFCs, Private Lenders in form of Term Loans, Working
Capital, etc.
Public capital comes either in the form of issuing shares, preference,

warrants, debentures, bonds to public, institutions, investors, PE
companies, etc.
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c. Cost of Each Source

The different sources of funds have varying costs.
Debt and preference stock entail more or less fixed payments, estimating
cost of debt and preference is relatively easy. Preference capital carries a
fixed rate of dividend and is redeemable in nature.
Cost of Equity is difficult to estimate. The difficulty stems from the fact that
equity shareholders have a residual claim on the earnings of the company.
This means that they will receive a return when all other claimants
(lenders, preference shareholders) have been paid.
Generally, equity is costlier than debt as these investors expect higher rate
of return compared to debt.
d. Weighted Average Cost of Capital Invested in the Project

A company’s cost of capital is the weighted average cost of various sources
of finance used by it, viz., equity, preference and debt.
Suppose a company uses 30% equity @ 24%, 20% preference @ 12% and
40% debt @13%, and then the Weighted average cost of capital of the
company is
WACC = (Proportion of equity) × (Cost of equity) + (Proportion of

preference) × (Cost of preference) + (Proportion of debt)
× (Cost of debt)
Re × E Rp × P Rd × D
=! + +
D+E+P D+E+P D+E+P
= ! WeR e + WpR p + WdR d

= (0.30) × (24) + (0.20) × (12) + (0.40) × (13)
=14.8 %
Company cost of capital is the rate of return expected by existing capital

providers. It reflects the business risk of existing assets and the capital
structure currently employed.
Project cost of capital is the rate of return expected by existing capital

providers for a new project or investment the company proposed to
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undertake. It depends on the business risk and the debt capacity of the
new project.
e. Return from Investment from the Project

Suppose, the company invests Rs. 10 crores on a project which earns a
rate of return of 25% and uses equity, preference and debt in above
proportions, then
WACC = 14.8%
Total Return on Project = 10 × 25% = 2.50 crores
WACC = 10 × 14.8% = 1.48 crores
Return to Shareholders = 2.50 – 1.48 = 1.02 crores
1.02
ROI =! = 10.20%
10.00
1.4 STEPS ON IMPLEMENTATION OF THE PROJECT
a. Engagement of Consultants
For all projects, Consultants are very much required. Consultants may be
either in-house consultant or outside consultant or foreign consultant.
Sometimes, the projects are executed on turnkey contract basis or on EPC
contract basis. When the contractor is given full responsibility including the
design, engineering, consultancy as well as monitoring and supervision of
the project, in that case, there may not be requirement of a consultant.
But still, consultant may be required for the basic engineering and design
supervision and approval.
b. Financial Closure
Before the contracts are finalized or even before approval of the
Government is obtained for the projects involving foreign direct investment
(FDI), finalization of the financing of the projects has to be completed.
Financing of projects may be from external commercial borrowings, foreign
direct investment, financial institutions, and enquiry participation through
joint venture or issue of shares to the public. Completion of all these
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arrangements for financing modes of the project is called ‘Financial

Closure’.
c. Contracts Finalization
Contracts may be Turnkey, Non-turnkey, Engineering Procurement
Construction (EPC), Build Operate Transfer (BOT), Build Own Operate
Transfer (BOOT), Build Own Operate Lease (BOOL), Build Own Operate
Sale (BOOS), etc. Under this stage, mode of execution of project on the
basis of any one of the above mode of contract is decided.
d. Execution of Contracts/Project
After the contract/contracts have been finalized, the next stage for
execution of the contract and the project starts. This includes meetings
with contractors, follow-up of the progress by the contractors, site
activities, etc.
e. Monitoring and Control

Monitoring and control involves monitoring and control of physical
progress, financial progress, quality control, performance guarantee
parameters, etc. so as to ensure the successful execution and completion
of the project.
f. Completion of Construction
This includes physical completion of project in all respects, so that the
project may be finally commissioned for commercial production.
g. Commissioning
After the project has been physically completed, i.e., the work on all
activities such as civil engineering work, structural fabrication, supply and
installation of equipment have been completed, the next stage comes for
the commissioning of the project, so as to make the commercial utilization
of the project. Commercial utilization may be commercial production as
envisaged in the approved project.
h. Performance Guarantee Test

After the project has been commissioned and commercial production
started, the next stage would be to do the performance guarantee test as
per the parameters envisaged in the contract.
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i. Handing over to Operation

After the performance guarantee tests have been conducted and plant and
equipments have stabilized, the commissioned plant is handed over to
Operation Department.
In some organizations, the handing over of the plant and equipment is

done by executing the handing over and taking over act. Authorities from
both the departments, i.e., Project and Organization sign this Act. This is a
statement signed jointly by the authorities of project and operation
department.
j. Closure of Contract
After the project has been completed, commissioned, performance
guarantee test completed and handed over to Operations, all the contracts
are finalized and closed.
1.5 POST IMPLEMENTATION WORK
a. Completion Cost and Capitalization

The last but one activity in the project’s life cycle is to work out the
completion cost and capitalize the cost of completed project in the books of
accounts.
b. Post Project Evaluation and Report

The last stage in the project life cycle is the post project evaluation and
post completion audit report. In this stage, after the completion of the
project, the actual results, completion cost, profitability, etc. are compared
with the provisions made in the approved project. The variations are
scrutinized for the adverse results for correction in the future projects. 
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Every Project starts with an idea. Once the financiers are satisfied about
its feasibility, they finance it and they get their income from revenue
streams generated from the Project.
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1.6 Total Project Life Cycle
!  
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1.7 Sample Form for undertaking New Project
PROJECT
Project Type/Idea
Project Name/s
Generated by Key
Department Person
Brief Summary on the
project and its benefit
to the organization
Data Collected
SWOT Analysis
1.
2.
Strengths
3.
4.
1.
2.
Opportunities
3.
4.
1.
2.
Weaknesses
3.
4.
1.
2.
Threats
3.
4.
Appraisals/Findings
1.
2.
Technical
3.
4.
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1.
2.
Economic
3.
4.
1.
2.
Market
3.
4.
1.
2.
Financial
3.
4.
Additional Revenue
Generated/Costs Saved
1.
Conclusions 2.
3.
Potential Revenue
Potential Amounts
Saved
Amou
Amount Particula
Investments Particulars nt
(Rs.) rs
(Rs.)
(a) (e)
(b) (f)
(c) (g)
(d) (h)
Total Project
Cost (Rs.)
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Cost
Weighted
per
Sources of Particu Amount Cost p.a Average Capital
annu
Funds lars (Rs.) (%) Cost (WACC)
m
(%)
(Rs.)
Own
Contrib
ution
Preferre
d Stock
Internal
Accrual
s
Term
Loan/s
Debent
ures/
Warrant
s
Bonds
Other
Sources
Total
Return on
Project
Recommende
Name Designation Signature
d by
(A)
Approved/
Name Designation Signature
Rejected by
(A)
(B)
(C)
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! !
Government of India has launched the “MAKE IN INDIA” campaign to

promote the domestic industrial production.  
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1.8 Summary
• Essentially, a capital project represents a scheme for investing resources

that can be analyzed and appraised reasonably independently.
• Capital Expenditure is different from Revenue Expenditure.
• Capital Expenditure decisions often represent the most important

decisions taken by a firm. Their importance stems from three interrelated
reasons: long-term effects, irreversibility and substantial outlays.
• Shareholder Wealth Maximization is the goal of the financial manager.
• A smart financial manager will try to save running costs by reducing

expenses. He will increase expenses if more value is created by spending
more.
• Formulation of a Project involves various stages such as: Generation and

Screening of Ideas, Data Collection, Documentation, Project Appraisal
and Conclusion.
• Financing of a Project involves detailed study on various aspects such as:

Investment in the Project, Sources of Funds, Cost of Each Source,
Weighted Average Cost of Funds invested and Return on Investment from
the Project.
• Implementation of a Project involves Engagement of Consultants,

Financial Closure, Contracts Finalization, Execution of Contracts/Project,
Monitoring and Control, Completion of Construction, Commissioning,
Performance Guarantee Test, Handing over to Operations and Closure of
Contract.
• Post Implementation Work includes Analyzing Completion Cost and

Capitalization and Post Project Evaluation and Report.
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Activities
1. What capital project do you have in mind? Is it a new factory/new

machinery for new products/etc.? Is land acquired for said purpose? Do
a rough guesstimate of the capital project you have in mind? What
would be the approximate capital investment required? Remember that
banks will expect promoters to chip in some contribution (from 20% to
50%) for capital expenditure projects. You can expect assistance of
balance funds from the bank.
What security can you offer to avail the said loan? Usually, banks expect
additional security to the extent of loan amount.
a. If land is acquired or it is a running factory, copies of Conveyance

Deeds/ Agreements/title copies of the land.
b. Start collecting catalogues and price lists of various machineries

required for the unit. Catalogues and Prices from three different
vendors are desired.
c. Copies of Conveyance Deeds/Agreements/title copies of the collateral

security.
(In case, you are not able to provide documents as required for questions
(a) and (b), you may make a summary project report which you would like
to take up if you were provided the necessary resources).
2. Approach any nationalized bank or co-operative bank and take the

forms for Term Loans and Working Capital Loans. Study the data
requirements by the bankers to finance a Project Loan.
3. Make a excel sheet of monthly company’s Revenue Expenditure. Include

important heads such as Raw Materials, Business Promotion, Bank
Interest, Electricity, Salaries, Staff Welfare, Maintenance/Rent,
Electricity, Professional Charges, etc. Compare it vis-à-vis your
company’s monthly income.
Or
! !30
THE PROJECT
Make a excel sheet of monthly household expenses (Revenue Expenditure).

Include important heads such as Food, Education, Maintenance/Rent,
Electricity, Travel, Salaries, etc. Compare it vis-à-vis your household’s
monthly income.
4. Use net resources and find out and write in detail out the ‘Make in India’
campaign.
1. What is a Project?
2. Write down three major differences between Capital Expenditure v/s

Revenue Expenditure.
3. What can a company do to stimulate the flow of project ideas?
4. Draw the flowchart for different stages of a Project Formulation.
5. What are the different stages of Project implementation?
6. What is the Post Implementation Work carried out?
7. Draw the complete flowchart for entire life cycle of the Project.
! !31
THE PROJECT
REFERENCE MATERIAL
Click on the links below to view additional reference material for this
chapter
Summary
PPT
MCQ
Video Lecture
! !32
PROJECT APPRAISAL
Chapter 2
PROJECT APPRAISAL
Objectives
• Provide conceptual understanding about Project Appraisals.
• Outline the importance of Project Appraisals.
• Bring out the various aspects of Project Appraisals.
• Enlist the various documents required by financial institution.
Structure:
2.1 Introduction to Project Appraisals
2.2 Importance for Appraisals
2.3 Aspects of Project Appraisals
2.4 Supporting Documents Required by Financial Institution to Appraise a

Project
2.5 Summary
! !33
PROJECT APPRAISAL
2.1 Introduction to Project Appraisals
Project appraisal is the structured process of assessing the viability of a

project or proposal. It involves calculating the feasibility of a project before
resources are committed. It is an essential tool for effective action in
starting a project. Project Appraisal is also a tool used to review the
projects completed by the organization.
When a project is at the conceptualization stage, the owners and managers

have a rough idea of what they are going to produce, what price they
might sell it, and how many units will be sold. Many a times, project
conceptualization takes place on the basis of an idea or market gap
perceived by the Top Management or Project Manager.
Project Appraisal may be carried out by the various stakeholders or

interested parties such as:
• Owner of the project
• Banks, that do the financing
• Financial institutions, that do the financing
• Government appraising agencies.
! !34
PROJECT APPRAISAL
The Project Appraisal gives a clear and unbiased view from an outsider’s
point of view. It is a means which can give a better picture of partnerships
can choose the best projects to help them achieve what they want for the
organization. It is defined as taking a second look critically and carefully at
a project by a person who is in no way involved or connected with its
preparation. He is able to take independent, dispassionate and objective
view of the project in totality, along with its various components
Any project’s success or failure depends on the pre-planning work carried

out by the project’s team and the promoters. A project’s success or failure
depends 80% on thorough planning and appraisals and 20% on execution
and other parameters.
The earlier the project appraisal starts the better it is for the organization.
The company is in a better position to decide how much capital to deploy
for the project to decide to scrap an unviable project.
Various types of examinations forming part of the Project Appraisal are:
1. Technical Appraisal
2. Economic Appraisal
3. Market Appraisal
4. Financial Appraisal
Project appraisal is a requirement before funding of project is done. But

tackling problems is about more than getting the systems right on paper.
Experience in projects emphasizes the importance of developing an
‘appraisal culture’ which involves developing the right system for local
circumstances and ensuring that everyone involved recognizes the value of
project appraisal and has the knowledge and skills necessary to play their
part in it.
Project appraisal helps project managers to:
• Be consistent and objective in choosing projects
• Make sure their program benefits the organisation
• Provide documentation to meet financial and audit requirements and to

explain decisions to all the stakeholders and auditors.
! !35
PROJECT APPRAISAL
The terms evaluation, appraisal and assessment are used interchangeably.

They are used in analyzing the soundness of an investment project. The
analysis is based on projections in terms of cash flows. The analysis is
carried out by the entrepreneurs or promoters of the project, the merchant
banker who, is going to be involved in the management and underwriting
of public issue and public financial institutions who may lend money.
Project evaluation is indispensable because resources are limited and

alternative opportunities in terms of projects exist for commitment of
resources. A Project should only be selected if it is superior to others in
terms of profitability (net financial benefits accruing to owners of project)
or on national profitability (net overall importance of the project) to the
nation as a whole. The purpose of the project appraisal is to ensure that
the project is technically sound, provides reasonable financial return and
conforms to the overall economic policy of the country. In view of the
importance of the competitive status of unit, performance measures have
to be applied to assess the ability of a unit to meet competition in the
modern business environment.
2.2 Importance for Appraisals
Appraisals are very important before dedicating resources towards a

project. Some of the important reasons for appraising a project are:
1. Appraisal justifies spending money on a project

Appraisal asks fundamental questions about whether funding is required
and whether a project will create value for the organization. It can give
confidence that the money is being put to good use, and help identify other
funding to support a project. Getting it right may help an organization
garner further resources to meet the project objectives.
2. Appraisal is an important decision making tool

Appraisal involves the comprehensive analysis of a wide range of data,
judgments and assumptions, all of which need adequate evidence. This
helps ensure that projects selected for funding:
• Will help the organisation achieve its objectives

• Are deliverable
• Are sustainable
• Have sensible ways of managing risk.
! !36
PROJECT APPRAISAL
3. Appraisal lays the foundations for delivery

Appraisal helps ensure that projects will be properly managed, by ensuring
appropriate financial and monitoring systems are in place, that there are
contingency plans to deal with risks and setting milestones against which
progress can be judged.
4. Getting the system right

The process of project development, appraisal and delivery is complex and
should be suitable to the organization. Good appraisal systems should
ensure that:
• Project application, appraisal and approval functions are separate
• All the necessary information is gathered for appraisal, often as part of

project development in which projects will need support.
2.3 Aspects of Project Appraisals
Brief write-up on various types of appraisals namely:
1. Technical Appraisal
Technical Appraisal is the technical review to ascertain that the project is
technically sound in all respects with respect to various parameters such as
technology, plant capacity, raw material availability, location, manpower
availability, etc. The technical review is done by qualified and experienced
personnel available in institutions and/or outside experts (particularly
where large and technologically sophisticated projects are involved).
2. Economic Appraisal
Economic appraisal is the economic review carried out by financial
institutions that looks into the economic benefits to the society and to the
nation. They also look at various parameters such as resource cost and
effective rate of protection.
Admittedly, the economic appraisal done by financial institutions is not very
rigorous and sophisticated. Also, the emphasis placed on this appraisal is
rather limited.
3. Market Appraisal
Market Appraisal is carried out to understand the potential market for the
products and at the marketing strategy. A review of the market survey and
! !37
PROJECT APPRAISAL
competence of the marketing team. Also, whether the unit can sell its
products at the desired/estimated price points.
4. Financial Appraisal
Financial appraisal is concerned with assessing the financial feasibility of a
new capital investment proposal or expansion of existing productive
facilities. This involves an assessment of funds required to implement the
project and the sources of the same. The other aspect of financial appraisal
relates to estimation of operating costs and revenues, prospective liquidity
and financial returns in the operating phase.
! !
A 3D visual of the proposed project provide a vision to the project team.
2.4 Supporting Documents required by Financial Institution

to Appraise a Project
1. Completed Input Form in their format
2. Company Profile, Promoters Profile
3. Past audited accounts for three years of the company and associated
entities
4. Copies of J.V./Technical Collaboration, if any
5. Organization Chart
! !38
PROJECT APPRAISAL
6. Profile of Key Staff Members
7. List of machineries procured/to be procured
8. Contracts/Arrangement to procure various raw materials
9. Market Survey Report from reputed Consultants/Surveyors
10.Marketing material prepared, catalogues
11.Financial Projections, Cash flows, Fund flows, Break-even Point Analysis
12.Licenses, Clearances for the project
13.Title deeds of land, Approvals to start construction
14.In-principle arrangement for Working Capital Facility from Banks, etc.
! !39
PROJECT APPRAISAL
2.5 Summary
• Project Appraisal is a structured process of assessing the viability of a

project.
• Project Appraisal is important as it:
❖ justifies spending money on a project

❖ is an important decision making tool
❖ lays the foundations for delivery
❖ Ensure getting the system right.
• Project Appraisal is broadly divided into following four aspects:
❖ Technical
❖ Economic
❖ Market
❖ Financial.
• Financial Institutions require an exhaustive list of documents to carry out

Project Appraisal.
Activities
1. Your friend wants to start a company selling groceries online. He has

approached you for financial loan of Rs. 5 lakhs being part of the project
cost. What assessment (what questions would you ask) would you carry
out to decide whether you’ll assist your friend or not?
2. Find out suitable companies/consultants carrying out Project Appraisal

in and around your location.
! !40
PROJECT APPRAISAL
1. What is meant by Project Appraisal?
2. What is the importance of Project Appraisal?
3. What are the various aspects of Project Appraisal? Write a brief note on
each.
4. Enlist the major documents will help a financial institution to appraise

the Project. 
! !41
PROJECT APPRAISAL
REFERENCE MATERIAL
chapter
Summary
PPT
MCQ
Video Lecture 
! !42
TECHNICAL APPRAISAL
Chapter 3
TECHNICAL APPRAISAL
Objectives
• Provide conceptual understanding to Technical Appraisal.
• Inform the various aspects of Technical Appraisal.
• Get an introduction to Plant Flexibility and Flexible Manufacturing

Systems.
• Know about Project Charts and Layouts.
• Assess Competitive Status of a Project/Unit.
• Learn a few methods to improve quality and productivity.
Structure:
3.1 Introduction
3.2 Aspects of Technical Appraisal
3.3 Flexibility of Plant and Flexible Manufacturing Systems
3.4 Interdependence of the Parameters of Project
3.5 Project Charts and Layouts
3.6 Cost of Production
3.7 Assessing Competitive Status of a Project/Unit
3.8 Methods to Improve Quality and Productivity
3.9 Review of the Project
3.10 Summary
! !43
TECHNICAL APPRAISAL
3.1 Introduction
Technical Appraisal is the technical review carried out by financial

institutions to ascertain that the project is technically sound with respect to
various parameters such as technology, plant capacity, raw material
availability, location, manpower availability, etc.
Is the project in a position to deliver marketable products from the

resources deployed? Is the Return on Investment sufficient to service the
cost of loan/equity and leave a reasonable amount for the enterprise to
carry out sustainable operations?
Technical appraisal is important as:
1. It ensures that the project is technically feasible – all the inputs

required to set up the project are available.
2. It facilitates the optimal project formulations in terms of capacity,

technology, location, technology, size, etc.
Usually, technical appraisal is carried out by independent agencies carrying

out technical studies or by the institution by their in-house technical
experts. The financial analyst participating in the project appraisal exercise
should be able to raise basic issues relating to technical analysis using
common sense and economic logic.
Evaluation of industrial projects is undertaken to compare and evaluate

alternative variants of technology of raw materials to be used, of
production capacity, of location and of local production versus import.
! !44
TECHNICAL APPRAISAL
!
A Petrochemical Plant is a highly technical and complex project
!
A Marina bay though looks simple is very technically challenging project
! !45
TECHNICAL APPRAISAL
3.2 Aspects of Technical Appraisal
The technical review done by the financial institutions focuses mainly on

the following aspects:
• Manufacturing Process/Technology
• Technical Arrangements
• Material Inputs and Utilities
• Product Mix
• Plant Capacity
• Location and Site
• Machineries and Equipments
• Structures and Civil Works
• Environmental Aspects
3.2.1 Manufacturing Process/Technology

For a manufacturing product/service, often two or more alternative
technologies are available. For example,
• Cement can be made either by dry process or the wet process.
• Vinyl chloride can be manufactured by using one of the following

reactions: acetylene on hydrochloric acid or ethylene on chlorine.
• Steel can be made either from Bessemer process or open hearth process.
• Soda can be made by the electrolysis method or the chemical method.
• Paper, using bagasse as the raw material can be manufactured by the

Kraft process or the soda process or the Simon Cusi process.
• Soap can be manufactured by semi-bottled process or fully boiled

process.
! !46
TECHNICAL APPRAISAL
!
1. Production of Molten Steel
!
2. Production of iron and rough steel products
! !47
TECHNICAL APPRAISAL
!
3. Production of Cement by the Dry Process 
! !48
TECHNICAL APPRAISAL
!
4. Production of Vinyl Chloride
3.2.2 Choice of Technology
The choice of technology is influenced by a variety of considerations such

as:
• Availability of raw materials/inputs: Raw materials should be easily

available for unhampered production cycle. Sometimes, quality of some
raw materials affects the process/technology used. For example, the
quality of limestone determines dry or wet process should be used for a
cement plant.
• Availability of manpower and transport: The plant should not be

located where skilled labor for that industry is not available. For example,
a footwear company that required skilled stitching labor would not be
advisable to be set up where the laborers would be hesitant to travel/
stay.
• Plant Capacity: To meet a certain plant capacity requirement, only a

certain production technology may be viable.
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TECHNICAL APPRAISAL
• Investment outlay and production cost: The cost of technology/

process should not be so high that the unit itself is uncompetitive and
cannot sustain over a period of time.
• Use by other Units: The technology adopted should be proven

successful by other units, preferably in India.
• Product mix: Usually, a number of products/variants/models are

manufactured using the same process. Therefore, the technology/process
used must be able to produce all the products in the product mix.
• Latest developments: Technology adopted should be based on latest

developments so that technological obsolescence in near future is
avoided.
• Ease of absorption: An advanced technology may be available but may

have to be shelved due to inadequate trained manpower to handle that
technology.
3.2.3 Technical Arrangements
It is important for a unit to have a good technical collaborator or a good

consultant to guide it in relation to the manufacturing process. Major
technical inputs include:
a. Selection of the process or technology. Design, purchase, procurement

and installation of the plant and training of the manpower.
b. Process and performance guarantees in terms of plant capacity, product

quality and consumption of raw materials and utilities.
c. Periodic Royalty fees or one-time licensing fees.
d. Period of collaboration agreement.
3.2.4 Material Inputs and Utilities
An important aspect of technical analysis is concerned with defining the

materials and utilities required. Material Inputs and Utilities may be
classified into four broad categories:
! !50
TECHNICAL APPRAISAL
a. raw materials
b. processed industrial material and components
c. auxiliary materials and factory supplies
d. utilities.
3.2.5 Product Mix

A company offering a wider choice to its consumers can cater to a wider
segment of customers or offer better consumer satisfaction. While planning
production facilities for a firm, flexibility with respect to product mix
enables company to alter its product mix to survive in changing market
conditions. For example, a garment manufacturer can offer wide range in
terms of size and quality to different consumers. Biscuit and Fast food
snack manufacturers can have smaller pouches at low cost for one-time
users and larger economical sizes for monthly family consumption.
3.2.6 Plant Capacity

Plant Capacity refers to the number of units or volume that can be
produced during a given period. In traditional manufacturing system,
capacity is defined as the maximum output available.
However, operating conditions like power or raw material or labor

shortages can influence capacity. Sometimes, seasonal availability of raw
materials (such as sugarcane for sugar plants) can hamper plant capacity.
It is indeed difficult to assess capacity.
For instance, paper plant capacity varies with grammage. In a textile mill,
capacity varies with the composition of yarn of different counts. The daily
production in a sugar mill depends on sugar content of the cane; and
annual production on the length of the crushing season. The extent and
degree of integration and facilities for by-product recovery also affect size
of project investment and profitability. An integrated textile mill with cotton
as a starting material would require larger investment and is more
profitable than an unintegrated mill of the same capacity producing fabric
grey cloth.
Sometimes additional investment would improve the profitability

enormously. In a caustic soda plant, recovery of chlorine and hydrogen no
doubt require additional investment but improve profitability as compared
to a plant producing just caustic soda.
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TECHNICAL APPRAISAL
3.2.7 Location and Site

Location refers to a fairly broader area such as city or town or industrial
zone where the plant is likely to be set up. Site refers to the actual piece of
plot where the plant is going to be set up.
Usually, location is selected such that it is close to supply of raw materials

and/or to the markets where the final products shall be consumed. Further,
availability of infrastructure such as roads, power and water availability are
critical. By power, we broadly mean power supply that is cost-effective,
uninterrupted and stable. Transportation of raw materials to the plant and
finished goods to the markets is also possible in cost-effective and
available easily.
Polluting units should be set up away from residential areas, in approved

industrial zones and where permission from Pollution Control Board is
easily available. Usually, polluting units are set up where the Effluent
Treatment Plants (ETPs) are already available to neutralize the output
waste.
3.2.8 Machineries and Equipments

The machinery and equipments for a particular project are dependent on
the production technology and plant capacity. In selecting the machineries
and equipments, the various stages should be matched well. If technical
expertise is insufficient, external consultants must be employed to ensure
smooth flow of production over long periods of time.
3.2.9 Structures and Civil Works

Structures and civil works comprise of:
a. site preparation and development

b. buildings and structures
c. outdoor works.
Structures and civil works are the domain of the technical team, equipment
suppliers, architects, structural consultants and the administration team.
Various technical design parameters are taken into consideration such as
load requirements for machinery foundation, height of machinery/ceiling,
ventilation, heat generated in the production areas, cleanrooms,
administrative staff requirements, loading/unloading areas, secure zones,
handling of effluents and wastages, etc.
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TECHNICAL APPRAISAL
3.2.10 Environmental Aspects

A project may cause environmental pollution in the form of emissions,
effluent discharge, noise, heat and vibrations. Environmental aspects of the
project have to be properly examined.
Polluting units should be set up away from residential areas, in approved

industrial zones and where permission from Pollution Control Board is
easily available. Usually, polluting units are set up where the Effluent
Treatment Plants (ETPs) are already available to neutralize the output
waste.
In technical appraisal, inputs are scrutinized for availability and quality

dependability. If there are seasonal variations, especially, in the case of
agricultural inputs, variations in price have to be checked. Similarly, power
quality has to be checked in terms of variation in supply voltage and
in-line current frequency and duration of blackouts. Finally, the quality and
availability of water which shows seasonal trends especially in case of a
project requiring water as an input should be checked.
3.3 Flexibility of Plant and Flexible Manufacturing Systems
The consumer demands are at an all-time high – choice of colors, taste,

packaging, sizes and at the desired prices. At the same time, the
production being sustainable for the organization. Today is the age of mass
customization.
Flexibility is desired at the production level so that more customization is

possible to suit the wide variety of users. Flexible manufacturing system is
the emerging system to manufacture what the customer wants. These
systems help in production of a large variety of products in small batch
sizes. The days of assembly line manufacturing emphasizing economies of
scale are over. Even otherwise flexibility imparts strength to the project to
withstand market fluctuations and variations in the quality of inputs.
! !53
TECHNICAL APPRAISAL
3.4 Interdependence of the Parameters of Project
Undependable supply of basic inputs could result in closure of the project

or bankruptcy of the organization. If coal, the main ingredient for a power
plant is not available in sufficient quantity, it can throw all project
calculations in disarray. It will affect not just the organization but also
millions of consumers, production facilities and the national economy. If
iron ore is not available for a steel unit, it can disturb steel production
while will have a cascading effect on important infrastructure projects.
It is better to have as much interdependence of parameters so that

shortfall in one can have disorder in the entire project. For example, a
small integrated paper plant using bagasse, paddy husk or straw without
need to recover process chemicals is considered more viable than large
integrated paper mill requiring forest based raw material, water and
effluent disposal system.
3.5 Project Charts and Layouts
Project charts and layouts are the tools to define the scope of the project
and provide the basis for detailed project engineering. These are general
functional layout, material flow diagram, production line diagram, utility
layout and plan layout. The various different kinds of technical drawings
are:
1. General functional layout should facilitate smooth and economical

movements of raw materials, work-in-progress and finished goods.
2. Material flow diagram presents flow of materials, utilities,

intermediate products, final products scrap and emissions.
3. Production line diagram establishes the progress of production from

one machine to another with description, location, space required, need
for power and utilities and distance from the next section.
4. Utility layouts show the principal consumption points of power, water

and compressed air which helps in the installation of utility supply.
! !54
TECHNICAL APPRAISAL
5. Plant layout identifies the exact location of each piece of equipment

determined by proper utilization of space leaving scope for expansion,
smooth flow of goods to minimize production cost and safety of workers.
!
General Functional Layout/Plant Layout
! !55
TECHNICAL APPRAISAL
!
Material Flow Diagram
! !56
TECHNICAL APPRAISAL
!
Production Line Diagram
!
Utility Layout
! !57
TECHNICAL APPRAISAL
!
Plant Layout
3.6 Cost of Production
Estimates of production costs and projection of profitability is the

concluding part of the technical appraisal. Cost of production is worked out
taking into account the build-up of capacity utilization, consumption norms
for various inputs and yields and recovery of by-products. In estimating
production, a general build-up starting with 40% and reaching a normal
level of 80% in three to four years time is provided. In practice, capacity
utilization may fall short of estimated levels on account of defective plant
and machinery, inadequate operating skills, inadequacy of raw materials,
shortage of power and lack of demand. The cost of production and
profitability estimates take into account the level of production in different
years and product-mix (which are dependent on market potential, prices,
marketing strategy, technical constraints relating to process and plant
facilities, and operators’ efficiency), norms of raw material consumption
(including provision for wastage), power and fuel requirement, their costs,
salaries and wages, repairs and maintenance, administrative overheads,
! !58
TECHNICAL APPRAISAL
selling expenses (including product promotion) and interest on borrowings.

Adequate provision is made for higher expenses in the initial years for,
technical troubles, higher wastages and lower yields, lower operating
efficiency and higher selling costs. Here, too, comparison with similar
projects is useful. The profitability estimates should be on a, realistic
selling price. In a competitive market, penetration price for a new producer
will have to be lower than the current price of an established manufacturer.
3.7 Assessing Competitive Status of a Project/Unit
Just delve over the technological developments over the past few years;
Do we use the VCR nowadays, Audio Players, CD Players, Fax machines,
Telex, Wire Connected Landline phones? Globalization of world economies
and availability of new technologies expose any product or project to the
severe global competition. It is necessary to ensure that the project/unit is
strong and can face competition. The competitive status of a
manufacturing unit is evaluated by eight performance measures some of
which form part of technical appraisal.
• Manufacturing Lead Time (MLT)

• Work-in-process (WIP)
• Throughput
• Capacity
• Flexibility
• Performability
• Quality
! !59
TECHNICAL APPRAISAL
1. MLT: The manufacturing lead time (MLT) is the total time required to
process the product through the manufacturing plant. MLT should ideally
be equal to actual machining and assembly time. The ratio of MLT to the
sum of processing time is a good indicator of the time a part is
unnecessarily lying on the factory floor. Real value is added to a product
during a product’s passage through the production system. Other times
such as move time, queue time and setup time should be reduced.
2. WIP: Work-in-process (WIP) is the quantity of semi-finished product

currently lying on the factory floor. WIP constitutes an investment and
many companies incur large WIP costs. Recent trend is to consider
inventory as avoidable since required items only are produced. WIP can
be measured by multiplying the rate at which parts flow through the
factory with the length of time parts spend in the factory which is MLT.
The number of parts currently being processed should be equal to the
number of busy machines which in turn equals the total number of
machines multiplied by the utilization factor. Ideally, there should be as
many parts waiting as are being processed. WIP should be low.
3. Machine utilization: Machine utilization should not be decided with a

view to amortize the cost of machinery faster by higher utilization. Such
a view turns a machine asset into an inventory asset. Idle inventory
may be perishable or may not be in demand resulting in tying up cash in
raw materials. If the choice is between idle machinery and building up
inventory, let the machine be idle. Machine should be run to
manufacture exactly the right quality of exactly right things at exactly
the right time.
4. Throughput: Throughput is the hourly or daily production rate which is

the reciprocal of production time per unit of the product.
5. Capacity: Capacity is defined in terms of possible output the plant is

able to produce over some specified duration. In the case of continuous
plant, the duration is 24 hours a day, 7 days a week whereas in others it
is defined over a shift period. Capacity is measured as tons in the case
of a steel mill, seat miles in the case of airlines, rooms in the case of
hotels and total available beds in the case of hospital. Available machine
hours are used to measure capacity when output is non-homogenous or
the plant produces a variety of products.
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TECHNICAL APPRAISAL
6. Flexibility: Flexibility is the ability of the system to respond effectively

to change. High degree of flexibility requires higher levels of automation
and large investment. Flexibility is fundamental to achieve
competitiveness. Further it provides a strategic advantage to handle risk
associated with uncertain markets. Transfer lines which produce
identical parts do not have flexibility and cannot tolerate design
modifications or part mix changes or machine failure. On the other
hand, job shops are highly flexible and are used for manufacture of one-
of-a-kind products. Their trait is large MLT and high WIP.
7. Performability: Performability is influenced by the unscheduled

downtime of the equipment. In a manufacturing system, the two
constituents are the workpiece and the manufacturing in equipment.
Workpiece can cause faults resulting in line stops; and equipment can
fail because of wearing down. Production is then a function of repair
time due to failures and fault. Reliability and availability measure the
percentage of down time and repair time. Reliability of a manufacturing
system is defined as the probability that it will perform well enough to
produce quality products. Availability is the instantaneous availability of
a system at an operational time.
8. Quality: Maintenance of high quality depends on the integrity of the

materials and integrity of manufacturing process. Together, they help
the supply of products that are made right the first time. Quality is an
important constituent in attaining competitiveness. Total Quality Control
(TQC) involves control of quality at source. Errors should be corrected at
the source where work is performed. This is defect prevention where
workers and supervisors have the primary responsibility for quality and
any problems with process are corrected immediately. Quality control at
source provides fast feedback on defects. This is unlike the sampling
method employed after the lot has already been produced. The benefits
of total quality control are fewer rework labor hours and less material
waste. Good quality increases productivity. The basic requirements of
total quality control are process control, easy to see quality, insistence
on compliance and 100% inspection.
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TECHNICAL APPRAISAL
3.8 Methods to Improve Quality and Productivity
India ranks at a dismal low vis-à-vis Global benchmarks in terms of launch

of innovative products, productivity and safety records. There is an urgent
need to improve the quality and productivity to strengthen the
competitiveness of Indian industry.
Among the methods used to Myron productivity and strengthen

competitiveness are expert systems and enterprise resource planning
(ERP) which spread the use of lean techniques and lean thinking. The
adoption of these methods has to be insisted upon while making appraisal
to help improve the competitiveness of the unit.
1. Expert Systems (ES): Expert Systems (ES) are being used in

manufacturing environments to improve productivity and flexibility.
They are used along with capacity planning to ensure that parts are
manufactured to meet due dates and optimize use of production
equipment. When used in conjunction with conventional methods, ES
can handle unforeseen circumstances allowing for easy extension and
modifications to revised schedules. They are also used for simulation of
the scheduling system and to assist with machine learning of scheduling
procedures.
An ES is a computer program that performs a task normally done by an

expert and which in doing so, uses captured, heuristic knowledge. It can
make the best expertise available to a decision maker at the very moment
the decision must be made. Its primary function has been in diagnostics,
decision making, system debugging and problem solving. Of late, its use in
the field of manufacturing has grown considerably, and now many systems
are being used in the areas of production scheduling, process planning,
quality control and inventory management.
Expert system has two components, knowledge base and an inference

engine. Inference engines are of two types, backward chaining which is
goal driven and forward chaining which is data driven. They can be used to
search knowledge and find a suitable solution to the problem one has.
For metal industry, researchers in the US have developed an ES to produce

rolling mill schedules (procedures) that yield specified values for
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TECHNICAL APPRAISAL
metallurgical properties such as grain size and internal stress. The results
were used to help consolidate and downsize the overall operations.
Expert systems are a way to convert corporate knowledge into corporate

assets. An ES enables the distribution of knowledge of experts present in
one place and to accumulate in one place; the knowledge of several widely
separated experts. Usually, ES is faster and more accurate as it uses the
same logic normally used by the expert.
Resort to ES is attributable to the need to cut the lead time required to

carry a product from conception to a finished state. To remain competitive
in the global context, manufacturing has to do better and more, using
fewer resources. Lean manufacturing uses less of each input: less labor,
less machinery, less space, and less time in designing products. In lean
production, each act in the factory, as it were done on demand.
!
Expert Systems
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TECHNICAL APPRAISAL
2. Enterprise Resource Planning (ERP): Lean techniques apply the idea

of lean production thinking to the whole company. The supply chain
connects the factory to its suppliers upstream and its customers
downstream. Various parts of the company need to share the flow of the
same information. The new software program let the companies
integrate their financial data with payrolls, manufacturing and inventory
records and purchasing. Enterprise Resource Planning (ERP) is the
toolkit that spreads lean thinking throughout the company. A company
using ERP can know, how efficiently its various resources, people,
money, machines are being used to satisfy its customers. The
integration of all aspects of company data into the same software helps
to keep manufacturing operations in balance and to keep work flowing
smoothly through the factory. Bottlenecks and imbalances show up
quickly and can be set right.
!
Enterprise Resource Planning
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TECHNICAL APPRAISAL
3.9 Review of the Project
Finally, the technical appraisal of the individual project may be

supplemented by a supplementary review of the project in terms of
interdependence of the basic parameters of the project which are plant
size, location and technology.
The implementation of the project has Cost and Time overrun implications.
The scheduling of construction, delivery and installation of machinery and
other potential causes of delay form an important part of the technical
aspects of the project appraisal.
The schedule of construction depends mainly on the speed of civil

construction works, delivery period of equipment, as well as the efficiency
of the management to tie up various ends in a coordinated and speedy
manner. Since an overrun in the pre-commissioning time invariably leads to
overrun in cost and consequential problems, it is important that the timing
of construction is realistically planned. For all main physical elements of the
projects, from project concept, obtaining Government approvals, tying up
financial arrangements, engineering design, land acquisition, building
construction, procurement of equipment, its erection and testing to final
commissioning, there must be realistic time schedules and a coherent
arrangement, which leads to the completion of the project on most
economical basis.
Use of scheduling techniques like Gantt Charts, PERT, CPM and GERT and
proper adherence to them is an essential aspect to be insisted upon in
technical appraisal.
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TECHNICAL APPRAISAL
3.10 Summary
• Technical Appraisal is the technical review to ascertain that the project is

sound with respect to various parameters such as technology, plant
capacity, raw material availability, location, manpower availability, etc.
• For manufacturing a product/service, often two or more alternative

technologies are available. The choice of technology is influenced by a
variety of considerations: plant capacity, principal units, investment
outlay, production cost, use by other up product mix, latest
developments, and ease of absorption.
• Satisfactory arrangements have to be made to obtain the technical know-

how needed for the proposed manufacturing process
• Material Inputs and Utilities forms is an important aspect of technical

analysis. Materials may be classified into four broad categories: (i) raw
materials, (ii) processed industrial materials and components, (iii)
auxiliary mated and factory supplies, and (iv) utilities.
• Appropriate technology refers to those methods of production which are

suitable local economic, social, and cultural conditions.
• Several factors have a bearing on the plant capacity decision: power, raw
material availability, technology requirements, etc.
• The choice of location is influenced by a variety of considerations:

proximity for materials and markets, availability of infrastructure
facilities, and other factors. Once a broad location is chosen, the
attention needs to be focused on the selection of site-specific piece of
land where the project would be set up.
• The requirement of machinery and equipment is dependent on product

technology and plant capacity. Further, it is influenced by the type of
product.
• A project may cause environmental pollution in various ways. Hence,

environmental aspects have to be properly examined.
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TECHNICAL APPRAISAL
• The important Project charts and layout drawings are: (1) general
functional layout, (ii) material flow diagrams, (iii) production line
diagram, (iv) transport layout, (v) utility consumption layout, (vi)
communication layout, (vii) organizational layout, and (viii) plant layout.
• Estimates of the Cost of Production takes into account the costs such as
raw materials, power and fuel, product R&D, administrative overheads,
interest on borrowings, etc.
• Competitive Status of a project is assessed to ensure that the project is

strong and can face competition.
• Quality and Productivity can be improved by implementing Expert

Systems (ES) and Enterprise Resource Planning (ERP).
Activities
1. Find out names and contact numbers of a Technical consultants. Use

internet resources to read their profile and work carried out by them.
2. The promoter you are working for is looking out for starting a new
engineering/assembly unit. Use local newspapers (advertisements in
classified sections) and net resources to locate suitable industrial zones
in your state and neighboring states. You may go to sites of various
State Industrial Development Corporations and/or search for private
industrial plots in various zones. Find out the minimum/maximum plot
sizes and approximate capital investment required for land purchase.
3. Which are the popular ERP packages available in the market? Do a

comparative study on them?
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TECHNICAL APPRAISAL
1. What is Technical Appraisal?
2. What are the different aspects of Technical Appraisal? Explain each in

brief.
3. Explain the different types of charts and layouts. What are the
differences between each?
4. What do you understand by Flexible Management System? Justify its

need.
5. State the criteria to evaluate the competitiveness of the unit.
6. Discuss the methods to improve productivity and competitiveness. 
! !68
TECHNICAL APPRAISAL
REFERENCE MATERIAL
chapter
Summary
PPT
MCQ
Video Lecture - Part 1
Video Lecture - Part 2 
! !69
ECONOMIC APPRAISAL
Chapter 4
ECONOMIC APPRAISAL
Objectives
• Provide conceptual understanding on Economic Appraisals.
• Know the different aspects of Economic Appraisals.
• Learn about Social Cost Benefit Analysis.
• Know how the SCBA is followed by Financial Institutions.
Structure:
4.1 Introduction
4.2 Aspects of Economic Appraisal
4.3 Social Cost Benefit Analysis
4.4 SCBA by Financial Institutions
4.5 Summary
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ECONOMIC APPRAISAL
4.1 Introduction
Let us study the names of some of the financial institutions that fund
projects:
a. IDBI – Industrial Development Bank of India

b. SICOM – Small Industries Corporation of Maharashtra
c. IFCI – Industrial Financial Corporation of India
d. TFCI – Tourism Finance Corporation of India
We see that these institutions are formed for some specialized purpose.
One’s objective is to promote Industrial Development, someone if for small
industries, someone else for promoting tourism. The goal is not simply to
earn profit.
This indicates that these institutions are formed for a greater purpose
rather than just earning profit. Earning money is important for creating
sustainable institutions, but while earning profit, they also do a good to the
society and the vast majority of population.
4.2 Aspects of Economic Appraisal
Economic Appraisal of a project deals with the impact of the project on

economic aggregates. The study of the potential impact of the project to
the nation and the society. We may classify these under two broad
categories:
They are:
1. Employment generation – effect of the project on net social benefits or

welfare
2. Foreign Exchange savings – effect of the project on foreign exchange
The economic appraisal looks at the project from the larger point of view.
Economic Appraisal analyzes if the benefits will justify the project cost/
investment done.
A successful project gives following benefits:
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ECONOMIC APPRAISAL
• Increased output
• Enhanced services
• Increased employment
• Larger government revenue
• Higher earnings
• Higher standard of living
• Increased national income
• Improved income distribution
The economic appraisal done by financial institutions is not very meticulous

and precise. Also, the emphasis placed on this appraisal is rather limited.
4.2.1 Employment Generation

While assessing the impact of a project on employment, the impact on
unskilled and skilled labor has to be taken into account. Not only direct
employment, but also indirect employment should be considered.
Direct employment refers to the new employment opportunities created

within the project and first round of indirect employment concerns job
opportunities created in projects related on both input and output sides of
the project under appraisal.
Since indirect employment is to be counted, additional investment needed

in projects with forward and backward linkage effects should be counted.
4.2.2 Foreign Exchange Savings

A project may produce goods that have to be imported from foreign
countries currently. By producing them in our country, the country might
save a lot of foreign exchange. Or a project could be Export Oriented that
might get a lot of foreign exchange within our country. In such cases, an
analysis of the effects of the project on balance of payments and import
substitution is necessary. Special formats are prepared by the institutions
to study this impact.
The analysis of net foreign exchange effect may be done for the entire life
of the project or on the basis of a normal year. If two or more projects are
compared on the basis of their net foreign exchange effect, the annual
figure should be discounted to their present value.
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ECONOMIC APPRAISAL
! !
SMEs provide a good source of employment for the Nation
4.3 Social Cost Benefit Analysis
Social Cost Benefit Analysis (SCBA) is a methodology for evaluating

investment projects from the social point of view. Social Cost Benefit
Analysis is concerned with the examination of a project from the view point
of maximization of net social benefit. SCBA has received a lot of emphasis
in the last few decades as it is believed that not just government but also
private projects carry some responsibility in imparting social benefits to the
nation.
In SCBA, the focus is on the social costs and benefits of the project. These
often tend to differ from monetary costs and benefits of the project. The
principal sources of discrepancy are:
a. Market imperfections
b. Externalities
c. Taxes and subsidies
d. Concern for savings
e. Concern for redistribution
f. Merit wants
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ECONOMIC APPRAISAL
a. Market Imperfections
Perfect market competition conditions are very rare. Market imperfections
create inaccurate prices of products and services. When imperfections
exist, market prices do not reflect social values.
The common imperfections found in developing countries are:
i) rationing,
ii) prescription of minimum wage rate, and
iii) foreign exchange regulation.
Consumers pay less for a commodity under rationing than they would in a
competitive market. When minimum wages are prescribed by law, laborers
are paid more than what they would be paid in perfect market conditions.
Similarly, foreign exchange rates in a regulated developing economy are
less than what would prevail in absence of exchange regulations.
b. Externalities
A project may have beneficial external effects. A road created for its new
project may benefit neighboring areas. These benefits are considered in
SCBA although they do not receive any monetary compensation from the
external beneficiaries.
Similarly, a project may have harmful external effect like environmental

pollution. In SCBA, the cost of environmental pollution is relevant although
the project sponsors do not incur monetary costs.
c. Taxes and Subsidies

Taxes are definitely monetary costs and subsidies are monetary gains. For
SCBA, they are irrelevant as they are just considered as transfer
payments.
d. Concern for Savings

For SCBA, the division of benefits between consumption and savings is
relevant especially in developing countries. However, for project sponsors
this may be irrelevant.
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ECONOMIC APPRAISAL
e. Concern for Redistribution:

A private company is not bothered as to how project benefits are
distributed amongst different groups in society. The society however, is
concerned about the distribution of benefits across different groups.
f. Merit Wants:
There are differences of goals amongst the marketplace and the
policymakers. For example, a blood donation camp or balanced nutrition
program for school going children is not sought by consumers in the
marketplace. However, from SCBA point of view, it is very relevant.
!
A Power Plant Generate a Lot of Social Benefits, Despite itself Creating
Substantial Pollution
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ECONOMIC APPRAISAL
4.4 SCBA by Financial Institutions
While financial institutions approach project proposals primarily from

finance point of view, they also evaluate projects from larger social point of
view. Though there a minor variations amongst various institutions, they
essentially follow a similar approach which is a simplified version of the
Little-Mirrlees approach.
Various financial institutions in India carry out Economic Appraisals

considering the following three aspects:
a. Economic Rate of Return

b. Effective Rate of Production
c. Domestic Resource Cost
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ECONOMIC APPRAISAL
4.5 Summary
• Financial Institutions are not just to fund promoters to fund their

projects. They would also like to evaluate how the projects benefit the
society.
• Economic Appraisal looks at Employment generation and Foreign

Exchange savings.
• Social Cost Benefit Analysis (SCBA) is a methodology for evaluating

investment projects from the social point of view.
Activities
1. Study the balance sheet of any five large Indian corporates. Find out
how the organizations have indirectly benefited the nation. What are the
CSR activities carried out by them?
2. Specifically, find out about five large projects. List out how their projects
stand as per SCBA.
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ECONOMIC APPRAISAL
1. What is Economic Appraisal? What are its aspects?
2. What do you understand by social cost benefit analysis?
3. What are the causes of discrepancies in SCBA?
4. Is distribution of project’s benefits irrelevant in Project Appraisal? Give

your views on the same.
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ECONOMIC APPRAISAL
REFERENCE MATERIAL
chapter
Summary
PPT
MCQ
Video Lecture 
! !79
MARKET APPRAISAL
Chapter 5
MARKET APPRAISAL
Objectives
• Provide a conceptual understanding on Market Appraisal.

• List the importance of Market Appraisal.
• Provide familiarization on Aspects of Market Appraisal.
• Understand Demand Analysis.
• Explain the various methods of Demand Forecasting.
• Understand Market Analysis.
• Shed light on Market Segmentation.
• Provide insight on Product Positioning and Pricing.
• Provide insight on Distribution and Promotional Strategies.
• Explain on Managerial Appraisal.
Structure:
5.1 Introduction
5.2 Importance of Market Appraisal
5.3 Sales and Marketing – Birth of a Project
5.4 Aspects of Market Appraisal
5.5 Demand Analysis
5.6 Methods of Demand Forecasting
5.7 Market Analysis
5.8 Market Segmentation
5.9 Product Positioning and Pricing
5.10 Distribution and Promotional Strategies
5.11 Competitive Analysis
5.12 Managerial Appraisal
5.13 Summary
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MARKET APPRAISAL
5.1 Introduction
Market Appraisal is the review carried out by financial institutions to

ascertain that the products manufactured by the project can be sold and its
value realized.
It ascertains whether the company has competent sales force and

distribution network to sell the products manufactured. It is also necessary
to establish how the project is going to capture its share of the feasible
market. Whether the unit can sell its products at the desired price points?
It ascertains the size of the potential market and whether the organization
has a suitable marketing strategy.
Is the project in a position to deliver marketable products from the

resources deployed? Is the Return on Investment sufficient to service the
cost of loan/equity and leave a reasonable amount for the enterprise to
carry out sustainable operations?
5.2 Importance of Market Appraisal
Market appraisal is important as:
1. It ensures that the project has the competent sales force and
distribution network to sell the products manufactured.
2. It can sell the products at the price points such that it can service the
interest on loans taken. Even after servicing the loan, there is sufficient
surplus for the unit to carry out sustainable operations.
3. It ensures that there is a potential market which can be met by the

production capacity of the unit.
4. There is a well thought-out sales and marketing strategy favorable for

long-term operations.
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MARKET APPRAISAL
5.3 Sales and Marketing – Birth of a Project
While launching a new product/model, a promoter or CEO or Project In-

charge will delve on the following questions:
How many units can be sold in first year, its expected selling price, its cost?
Also, sales in further few years down the line. Then he will estimate the
costs and profits generated. An example is depicted in the chart as shown:
Sr.
Particulars Year 1 Year 2 Year 3
No.
1 No of Units Sold 50,000 55,000 60,000
2 Sales Rate per piece (Rs.) 250 250 250
3 Sales (Rs.) 1,25,00,000 1,37,50,000 1,50,00,000
4 Cost Price per piece (Rs.) 175 175 175
5 Cost Price (Rs.) 87,50,000 96,25,000 1,05,00,000
6 Profit (Rs.) 37,50,000 41,25,000 45,00,000
Next he will ask what are the indirect costs such as the Cost of Capital,
interest costs, sales costs, salaries, etc. associated with the project. The
other costs will have to be lower than the profit generated per year. Else,
he will have to go to scratch and work out the numbers again.
Usually, corporations go about on a new project in a systematic and well-

defined manner. There is a detailed study on the market, demand for the
product, technical aspects of the project, financial estimates, ways to raise
the funds, etc.
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MARKET APPRAISAL
5.4 Aspects of Market Appraisal
The Market Appraisal done by the financial institutions focuses mainly on

the following aspects:
• Demand Analysis
• Market Analysis
The first step in project analysis is to estimate the potential size of the
market for the product proposed to be manufactured (or service planned to
be offered) and get an idea about the market share that is likely to be
captured. Two broad issues are covered by Market and Demand Analysis:
• What is likely aggregate demand for the product/service?

• What share of the market will the proposed project enjoy?
These are very important, yet difficult questions in project analysis.

Intelligent and meaningful answers to them call for an in-depth study and
assessment of various factors like patterns of consumption growth, income
and price elasticity of demand, composition of market, nature of
competition, availability of substitutes, reach of distribution channels, so on
and so forth.
It is not only essential to estimate the demand for the product but also
define the target customer to position the business in order to garner the
unit’s share of sales. Further, it is necessary to establish how the unit is
going to capture its share of the feasible market.
Suppose a company wants to launch a new brand of high quality

kitchenware in the domestic market. Important questions that should be
asked to get a correct Market and Demand Analysis will be:
• Who are the buyers of the kitchenware?
• What is the total current demand for this new kitchenware?
• How is the demand distributed temporarily (pattern of sales over the

year geographically)?
• What is the break-up of demand of kitchenware of different types?
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MARKET APPRAISAL
• What price will the customers be willing to pay for the improved range of
kitchenware?
• How can potential customers be convinced about the superiority of the

new kitchenware?
• What price and warranty will ensure its acceptance?
• What channels of distribution are most suited for the kitchenware? What
trade margins will induce distributors to carry it?
• What are the prospects of immediate sales?
5.5 Demand Analysis
Demand Analysis for the product proposed to be manufactured requires

collection of data and preparation of estimates. Market appraisal requires
description of the product, applications, market scope, market competition
from similar products/substitutes, areas of competitive advantage, pricing,
etc. In a highly competitive environment, customized products with short
lifespan are vital. Customer needs are foremost to be kept in the
manufacturer’s mind. Functionality, costs, delivery, service, physical
appearance, etc. are some of the key parameters to be attended to.
Physical distribution and manufacturing are a part of the supply chain.
Reasonable estimates have to be made regarding existing and future
demand of the product.
After gathering the information, the existing position has to be assessed to

ascertain whether unsatisfied demand exists. Since cash flow projections
are to be made, possible future changes in the volume and pattern of
supply and demand have to be estimated. This would help in assessing the
long-term prospects of the unit.
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MARKET APPRAISAL
5.6 Methods of Demand Forecasting
A wide range of forecasting methods are available to the market analyst. It

can be classified into three broad categories as under: Trend, Regression
and End-use Method.
5.6.1 Trend Method

The Trend Projection Method assumes that the demand in the number of
units/sales increases by the same proportion as earlier. The behavior
follows a linear equation or an exponential trend as in the past few years.
In a linear trend, it would increase by a constant amount whereas in an
exponential trend, it would increase by a constant percentage. Graphing
the data will help to decide which period to choose and what type of form
to be used for forecasting. Only after analysis of past data the trend line
should be fitted.
5.6.2 Regression Method

The Regression Method follows a concept of various dependent and
independent factors or variables. The dependent variable is the one subject
to forecasting. The independent variable is the ones that cause changes in
the dependent variable. If rate of inflation is to be forecast, the
independent variables may be money supply, per capita availability of
foodgrains and rate of monetization of the economy. Specification of
identification of factors is crucial in forecasting by regression approach. In
multiple regressions, we have more than one independent variable.
5.6.3 End-use Method

The method is appropriate for predicting demand of intermediate industrial
products such as steel and caustic soda. The industries using these
materials are identified. An intensive study of the past and thorough
assessment of the future prospects of the various end-user industries is
made. An expected production level of the various end-user industries is
made and based on that the product use forecasts are made. Provisions
have to be made for competition from substitute products and changes due
to technological changes. Hence, the end-use method should be used
judiciously.
The end-use approach enable preparation of industry-wise customer

demand forecasts and it is easy to evaluate any discrepancy in the
forecasts with the actual value.
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MARKET APPRAISAL
Comparison of Trend, Regression and End-use Methods

The Trend Method simply assumes that the demand follows the pattern as
it has done so in the past. It cannot predict the turning points. Regression
method is more accurate than the trend method because it takes into
account causal factors. In actual practice, forecasts by both methods may
be attempted.
The End-use Method has limitations as it may be difficult to estimate the

projected output levels of consuming industries. More important, the
consumption coefficients may vary from one period to another in the wake
of technological changes and improvements in the methods of
manufacturing.
5.7 Market Analysis
Market analysis deals with the study of the segmented market, product
positioning, product promotion and distribution strategies and analysis of
the competition. Market analysis defines the target customer, the resultant
market in terms of size, structure, growth prospects, trends and sales
potential.
Various private companies also carry out market surveys for a fee. Further,
good information relating to the market is available from various
manufacturer/trade associations, trade journals and related Government
Organizations.
5.8 Market Segmentation
Market Segmentation narrows the total market which is segmented by

factors such as geographic (where they live), demographic (who they are –
age, sex, income), psychographic (why they buy – lifestyle factors) and
synchrographic (when they buy).
After the target market is defined, the feasible market has to be defined by
identifying the various produce gaps. The unit’s share in the total feasible
market is tied to the structure of industry, the impact of competition,
strategies for market penetration and continued growth and advertisement
budget.
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MARKET APPRAISAL
Market share depends on industry growth which will increase the total
number of users of the product and conversion of users from the total
feasible market during a sales cycle. A sales cycle has four distinct stages –
early pioneer users, early majority users, late majority users and late
users.
!
Market Segmentation
!
Distribution Channels
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MARKET APPRAISAL
5.9 Product Positioning and Pricing
Product Positioning will help place the product as a differential identity in

the eyes of the potential buyer. The strategy used for product positioning is
usually the result of an analysis of customers and competition.
Product Pricing decision is very important because it has a direct effect on

marketing and financial success of the business. The basic rules of pricing
are that they must cover costs and should be reduced only through lower
costs. Prices may be determined on a cost plus basis as practiced by
manufacturers to recover all costs, both fixed and variable and realize a
desired profit percentage. Mark-up pricing is used by all retailers which are
calculated by adding desired profit to the cost of the product. Finally,
competitive pricing as in the case of markets where there is an established
price and the product is more or less homogeneous.
!
Product Positioning
! !88
MARKET APPRAISAL
!
Product Positioning for Chocolate Brands
5.10 Distribution and Promotional Strategies
Choice of distribution channel to move the product from the factory to the
end-user depends on channels being used by competitors and the strategic
advantage it would confer. The company may choose direct sales, OEM
(original equipment manufacturer) sales, manufacturer’s representative,
wholesale distributors, brokers, retail distributors or direct mail. Apart from
channels being used by competitors, choice of distribution strategy is
based on factors such as pricing method and internal resources.
A promotion plan consisting of controlled distribution to sell the product

has to be formulated after the distribution strategy is formulated. It
encompasses every marketing tool utilized in communication efforts. These
are advertising, packaging, public relations, sales promotion and personal
sales.
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MARKET APPRAISAL
Once the market has been researched and analyzed in terms of defining it,
positioning the product and pricing, distribution and promotional strategies
– financial projections can be made for three or five years.
5.11 Competitive Analysis
The purpose of competitive analysis is to determine the strengths and

weaknesses of competitors. Strategies that will confer a distinct advantage,
barriers that can be raised in order to prevent competition from entering
the market and any weaknesses that can be exploited within the product
development cycle.
The criteria employed to judge what constitutes a key asset or skill within
an industry or market segment may be identified from any analysis of
reasons behind successful as well as unsuccessful companies, prime
customer motivators, major component costs and barriers to mobility.
Through the competitor analysis, a marketing strategy that will generate a
unique asset or skill to provide a distinct and enduring competitive
advantage has to be framed. The results of market research which have
helped in defining the distinct competitive advantage have to be
communicated in a strategic form that will attract market share as well as
defend it.
Competitive strategies usually fall into product, distribution, pricing,

promotion and advertising. The competitive advantage has to be clearly
established. So, the appraiser of the project understands not only how the
goals will be achieved but why the company’s strategy will work.
5.12 Managerial Appraisal
In order to judge the managerial capability of the promoters, the following

questions are raised:
• How resourceful are the promoters?

• How sound is the understanding of the project by the promoters?
• How committed are the promoters?
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MARKET APPRAISAL
5.13 Summary
• Market Appraisal is the review carried out to ascertain that the products
manufactured by the project can be sold and its value realized.
• Market Appraisal is important to determine whether the unit has a

competent sales force and distribution network, the products can be sold
at the estimated price points, there is a potential market for the products
and there is a comprehensive sales and marketing strategy for long-term
operations.
• Market Appraisal comprises of Demand Analysis and Market Analysis.
• Demand Analysis analyzes the aggregate demand of the product/services

and what will be the potential market share of the unit.
• Market Analysis studies the market segmentation, product positioning,

product promotion and distribution strategies, competition, etc.
• Financial Institution carry out Managerial Appraisal of the promoters as

part of its appraisal.
Activities
1. Use internet resources to find out suitable Market Survey companies in

and around your location.
2. Do a comparative analysis of the products of your company vis-à-vis

competition. Please collect competitor’s catalogues and price lists. Make
under heads such as technical specifications, quality, price, etc.
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MARKET APPRAISAL
1. What is Market Appraisal? State its importance.
2. What are the various aspects of Market Appraisal? Describe each in

detail.
3. How do you estimate the demand for a product which you choose to
manufacture?
4. What is Market Analysis? Describe each aspect in detail.
5. What is Managerial Appraisal? 
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MARKET APPRAISAL
REFERENCE MATERIAL
chapter
Summary
PPT
MCQ
Video Lecture 
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FINANCIAL APPRAISAL
Chapter 6
FINANCIAL APPRAISAL
Objectives
• Provide a conceptual understanding on Financial Appraisal and its

importance.
• Shed light on working results of existing units.
• Provide familiarization on Cost of the Project.
• Provide familiarization on Sources of Finance.
• Provide understanding on Financial Projections.
• Explain Evaluation of Cash Flow and Profitability.
• Explain the popular methods of FA and Discounted Cash Flow Techniques.
• Explain estimation of Cost of Capital with CAPM.
• Shed light on Financial Analysis.
• Provide insight on Break-even Point.
• Appraisal of Advanced Manufacturing Systems.
Structure:
6.1 Introduction
6.2 Importance of Financial Appraisal
6.3 Working Results of Existing Units
6.4 Cost of the Project
6.5 Sources of Finance
6.6 Financial Projections
6.7 Evaluation of Cash Flows and Profitability
6.8 Discounted Cash Flow Techniques
6.9 Estimating Cost of Capital with Capital Asset Pricing Model (CAPM)
6.10 Financial Analysis
6.11 Break-even Point (BEP)
6.12 Appraisal of Advanced Manufacturing Systems
6.13 Summary
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FINANCIAL APPRAISAL
6.1 Introduction
Financial Appraisal is the review carried out by financial institutions to

ascertain whether the project to be financed is financial viable. The project
could be a new project or expansion of existing production facilities.
Any project appraisal exercise involves asking the three basic questions:
Can we produce the goods or services? Can we sell the goods or services?
Can we earn a satisfactory return on the investment made in the project?
While first two questions are answered can be answered reasonably well
through the technical and market appraisal. The most important question
of earning sufficient return is answered through the Financial Appraisal.
On aspect of Financial Appraisal is the assessment of funds required to

implement the project and sources of the same. The other aspect relates to
estimation of operating costs and revenues, prospective liquidity and
financial returns in the operating phase.
The project’s direct benefits are estimated at the prevailing market prices.
Financial appraisal is concerned with the measurement of profitability of
resources without reference to their source.
6.2 Importance of Financial Appraisal
Financial Appraisal is important as:
1. It ensures that the project is able to get a reasonable return on the

investment made to carry on sustainable operations.
2. It estimates the cash flows and reasonable level of profit that the unit
can make from the operations.
3. It estimates the Cost of the Project and the Sources of Finance, their
respective costs and the Cost of Capital of the unit to complete the
project.
4. It deals with various liquidity and Capital Structure ratios.
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FINANCIAL APPRAISAL
5. It determines the Break-even Point to find the exact level of sales and
production when the unit can break-even.
6.3 Working Results of Existing Units
For existing units, the banker and other stakeholders need to understand
of the past performance of the company. Although the financial projections
may project a very rosy picture about the future, they would like to assess
what has been your performance in the past. The company’s last three
audited balance sheets and profit and loss statements as well as the latest
unaudited provisional accounts certified by the management/CA have to be
analyzed.
The latest balance sheet and profit and loss account may be analyzed with
a view to ascertain, whether the concern is under/overcapitalized, whether
the borrowings raised are not out of proportion to its paid-up capital and
reserves, how the current liabilities stand in relation to current assets,
whether the gross block has been properly depreciated and has not been
shown at an inflated value, whether there is any interlocking of funds with
associate companies and whether the concern has been ploughing back
profits into the business and building up reserves.
They also assess the changes in balance sheets of the company over a
period of time with respect to sales, profitability, fixed assets, etc.
6.4 Cost of the Project
The capital cost of the project whether it refers to expansion or a new

project should be shown under:
i. Land and site development,

ii. Buildings,
iii.Plant and machinery,
iv. Technical know-how fees,
v. Expenses on foreign technicians and training of Indian technicians
abroad,
vi. Miscellaneous fixed assets,
vii.Preliminary and pre-operative expenses,
viii.Provision for contingencies, and
ix. Margin money for working capital.
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It has to be ascertained that all these items are covered in the cost and the
expenditure under each item is reasonable. It will help to compare the cost
of the project with the cost of a similar project or by the information about
cost that may be gathered in respect of other units in the same industry
with comparable installed capacity and other common technical features.
6.5 Sources of Finance
The usual sources of finance for a project are:
• Share capital
• Term loans
• Debenture capital
• Deferred payments
• Miscellaneous sources
• Unsecured loans from promoters
• Internal accruals in the case of an existing unit.
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FINANCIAL APPRAISAL
How should a promoter or project manager plan out the Project Capital
Structure? He will rationalize the capital structure with the current legal
and banking norms.
a. Share Capital: Share Capital is the long-term contribution to the

project by the promoters. Any financial institution/banker would expect
the promoter to contribute around 20-30% of the total project. This
promoter contribution increases with the increase in the size of the
project. For large projects, bankers expect promoters to contribute
almost 50% of the total project cost. The promoter contribution will be
in the form of unsecured loans which the financial institution will insist
to convert to Paid-up Equity Capital. Thus, the promoter contribution
becomes locked in the project.
Some portion of the Share Capital can also be in the form of Preference
Capital by the preference shareholders who get generally paid a fixed
dividend but who are not allowed to withdraw the sum invested.
Preliminary expenses incurred by the promoter are included in promoter’s

contribution.
Modern finance in the form of Private Equity is available for startups and
other companies that provide such companies with much needed equity
capital to develop but comes at a higher cost are available nowadays.
b. Term Loans: 70-80% of the Project Cost is usually funded by the

institution. It goes down to 50% for very large projects. Depending on
the project repaying capacity, the balance amount shall be funded by
the financial institution for the usual tenure as per their norms. This is in
form is a reducing balance Term Loan, where there is a principal
repayment and interest on the outstanding loan balance. As the
promoter repays and the outstanding loan balance is reduced, the
interest repayment also reduces.
There are some concessions by the government for technical entrepreneurs

and female entrepreneurs. Usually, technical entrepreneurs have flexibility
of lower promoter contribution and female entrepreneurs get some
discount in the rate of lending.
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FINANCIAL APPRAISAL
Terms loans are available in variety of forms such as Rupee Term Loans,
Foreign Currency Term Loans, Working Capital Term Loans, etc.
c. Debenture Capital: Debentures are debt instruments to raise capital

from the public. Maturity period is of 5 to 9 years. There are convertible
debentures and non-convertible debentures. Non-convertible debentures
are straight debt instruments. Convertible debentures are convertible
partially or wholly into equity shares – conversion period, price are
determined in advance.
d. Deferred Payments: Suppliers of capital goods offer a deferred credit

facility under which the payments can be made over a period of time.
e. Miscellaneous Sources: A small portion of the project finance can

come from miscellaneous sources like public deposits, unsecured loans,
hire purchase and lease facilities, etc.
f. Unsecured loans from promoters: Promoters also do provide

unsecured loans to bridge the gap between the promoter’s contribution
and the equity capital required.
g. Internal accruals in the case of an existing unit: Internal accruals

from existing operations can fund marginally gap between the capital
needs for the project.
It is important that no gap is left in financing patterns. Otherwise it will

result in cost overruns and time overruns in the implementation of the
project. Financial institutions stipulate a condition that any kind of cost
overrun or time overrun shall be funded by the promoters.
While the emphasis of financial institution is on the viability of the project,

they generally stipulate by way of security, a first legal charge on fixed
assets of the company ranking pari passu with the charge if any, in favor of
other financing institutions.
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FINANCIAL APPRAISAL
6.6 Financial Projections
Projected Profit and Loss Statements, Balance Sheets and Cash Flow
Statements over a long period – say 5 to 10 years will give us the realistic
picture of the finances of the project. What is the profit generated over a
period of time? What are the interest costs? What is the Return on Capital
Employed? etc.
These projected financial statements are interrelated and are prepared on

the basis of various assumptions regarding capacity utilization, availability
of inputs, their price trends and their selling prices, various indirect costs,
statutory taxes, etc. These assumptions should be scrutinized carefully
before making estimates. A proforma is annexed hereto.
New units should not go for any sharp build-up of capacity within a year or
two especially if the product is new. The quantum of raw materials and
utilities estimated to be consumed to obtain a particular quality/quantum
of end product is the core of cost of manufacture estimates and should
tally with the performance guarantees furnished by the collaborators/
machinery suppliers. In case of multiproduct companies, the product mix is
decided on the basis of contribution of each product, utilization of plant
capacity as well as market. There should also be reasonable annual
increases in indirect costs such as wages and salaries, electricity, etc.
Financial Appraisal’s main goal is to ascertain the profitability of the

project. The promoter might present a very rosy picture to the financial
institution due to his own conviction on the project but it is the task of
analyst to verify the estimates. It is to be ensured that the profits
projected are realistic and achievable.
Depreciation of fixed assets should be provided as per Income Tax Rules.

The selling price should be fixed keeping in view the present domestic price
of the product. Repairs and maintenance will have to be provided keeping
in view the type of industry and the number of shifts to be worked. The
profitability projections are closely linked to the schedule of
implementation. On the basis of profitability projections, cash flow and
projected balance sheets are prepared for a period of five to ten years.
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FINANCIAL APPRAISAL
Project Cost Financing and Cash Flow Proforma for Appraisal

(‘ lakhs)
Particulars Year
0 1 2 3 4 5 … 10
I. Cost of Project
1. Land and Building
2. Plant and Machinery
3. Working Capital
Total Outlay
II. Sources of Finance

1. Term Loans (1)
2. Equity Capital (2)
(DE Ratio 1 : 2) Total
III. Cash Flow Projections

A. Sales Revenues
B. Less: Operating Costs:
1. Raw Materials
2. Salaries & Wages
3. Manufacturing Expenses
4. Administration Expenses
5. Sales Tax @ x%
Earnings before Depreciation, Interest and Income
Tax (A – B)
Less: Interest
Profit before Depreciation and Income Tax
Less: Depreciation
Profit before Income Tax
Less: Income Tax
Net Profit
Add: Depreciation
Working Capital
Cash Inflows
Less: Cash Outflows
Net Cash Flow
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6.7 Evaluation of Cash Flows and Profitability
There are various methods and two discounted cash flow techniques for
financial appraisal to evaluate the cash flows and profitability of
investment. The methods should have three properties to lead to
consistently correct decisions.
1. It should consider all cash flows over the entire life of a project;
2. It should take into account the time value of money;
3. It should help to choose a project from among mutually exclusive
projects which maximize the value of the companies’ stock.
The two popular methods for Financial Appraisal are the:
1. Simple Rate of Return; and

2. Payback Period.
They employ annual data at their nominal value. They do not take into
account the life span of the project but rely on one year.
The two Discounted Cash Flow techniques for Financial Appraisal are the:
1. Net Present value Method (NPV)

2. Internal Rate of Return (IRR).
They take into consideration the project’s entire life and the time factor by
discounting the future inflows and outflows to their present value.
6.7.1 Simple Rate of Return Method
Simple Rate of Return is the ratio of net profit in a normal year to the initial
investment in terms of fixed and working capital. If one is interested in
equity alone, the profitability of equity can be calculated. The simple rate
of return could be presented as:
F+Y F
R= Re =
! !
I Q
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FINANCIAL APPRAISAL
where,
R = Simple rate of return on total investment;
Re = Simple rate of return on equity capital;
F = Net profit in a normal year after depreciation, interest and taxes;
Y = Annual interest charges;
I = Total investment comprising of equity and debt; and
Q = Equity capital invested.
Normal year is a representative year in which capacity utilization is at

technically maximum feasible level and debt repayment is still under way.
The simple rate of return helps in making a quick assessment of

profitability, particularly projects with short life. Its shortcoming is that it
leaves out the magnitude and timing of cash flows for the rest of the years
of a project’s life. For evaluation, accurate data is required. In its absence
simple rate of return may be incorrect. Simple rate of return method is
suitable for financial analysis of existing units. It is not suitable for
optimizing investment.
6.7.2 Payback Period Method

Payback period for a project measures the number of years required to
recover a project’s total investment from the cash flows it generates. It is
the expected number of years required to recover the original investment.
If we consider a project with an investment of Rs. 20 crores and an
expected cash flow of Rs. 2 crores per year for 10 years, the payback
period is given by,
Initial investment outlay 20,00,00,000
! Payback period = = = 10 years
Annual cash flow 2,00,00,000
The Payback period shows that the project’s initial investment is recovered
in ten years. Even if cash flows are not uniform, the payback period can be
calculated easily by adding together cash flows until the investment is
recovered. The payback method is calculated simple and lays importance
to recovering the original investment as fast as possible. The shorter the
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payback period, the quicker is the recovery of initial investment. But it

leaves out the time pattern of the cash flows within the payback period and
the cash flows after the payback period. Actually, it is biased against
projects which yield higher returns in later years. The payback period
method is not suitable for evaluation of alternatives and to make
systematic comparison.
6.8 Discounted Cash Flow Techniques
When appraising capital projects, basic techniques such

as ROCE and Payback could be used. Alternatively, companies could use
discounted cash flow techniques discussed on this page, such as Net
Present Value (NPV) and Internal Rate of Return (IRR).
Cash Flows and Relevant Costs

Money received today is worth more than the same sum received in the
future, i.e., it has a time value.
This occurs for three reasons:
1. potential for earning interest/cost of finance

2. impact of inflation
3. effect of risk.
Compounding
A sum invested today will earn interest. Compounding calculates the future
or terminal value of a given sum invested today for a number of years. To
compound a sum, the figure is increased by the amount of interest it would
earn over the period.
Example of compounding:
An investment of Rs. 1,00,000/- is to be made today. What is the value of
the investment after two years if the interest rate is 10%?
Solution:
Value after 1 year 1,00,000 × 1.1 = 1,10,000
Value after 2 years 1,10,000 × 1.1 = 1,21,000
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The Rs. 1,00,000 will be worth Rs. 1,21,000/- in two years at an interest
rate of 10%.
Formula for compounding:

To speed up the compounding calculation, we can use a formula to
calculate the future value of a sum invested now. The formula is:
F = P(1 + r)n
where, F = Future value after n periods
P = Present or Initial value
R = Rate of interest per period
N = Number of periods.
Discounting
In a potential investment project, cash flows will arise at many different
points in time. To make a useful comparison of the different flows, they
must all be converted to a common point in time, usually the present day,
i.e., the cash flows are discounted.
The present value (PV) is the cash equivalent now of money receivable/
payable at some future date.
Formula for Discounting:
The PV of a future sum can be calculated using the formula:

F
!P = n
= R × (1+ r)n
(1+ r)
This is just a rearrangement of the formula used for compounding.
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(1 + r)–n is called the discount factor (DF).
Example of Discounting:
What is the PV of Rs. 1,15,000 receivable in nine years time if r = 6%?
Solution:
F 1,15,000
P= n
= 9
= 68,068
!
(1+ r) (1+ 0.06)
The cost of capital
In discounted cash flow techniques, the rate of interest is required. There

are a number of alternative terms used to refer to the rate of interest:
• cost of capital
• discount rate
• required return.
Discounted cash flow (DCF) techniques take account of this time value of
money when appraising project investments. The Discounted Cash Flow
(DCF) methods are more objective than earlier methods. They take into
account both the magnitude and timing of expected cash flows in each
period of a project’s life. They take into account time value of money – a
rupee today is has more value than a rupee at a later date. The two
methods are the:
1. Net Present Value (NPV) method

2. Internal Rate of Return (IRR).
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6.8.1 Net Present Value (NPV) Method

To appraise the overall impact of a project using DCF techniques involves
discounting all the relevant cash flows associated with the project back to
their PV (present value).
If we treat outflows of the project as negative and inflows as positive, the

NPV of the project is the sum of the PVs of all flows that arise as a result of
doing the project.
Decision rule:
The NPV represents the surplus funds (after funding the investment)
earned on the project, therefore:
• if the NPV is positive – the project is financially viable

• if the NPV is zero – the project breaks even
• if the NPV is negative – the project is not financially viable
• if the company has two or more mutually exclusive projects under
consideration, it should choose the one with the highest NPV.
Assumptions in Calculating the Net Present Value

The following assumptions are made about cash flows when calculating the
net present value:
• all cash flows occur at the start or end of a year

• initial investments occur (T0)
• other cash flows start one year after that (T1).
Also interest payments are never included within an NPV calculation as

these are taken account of by the cost of capital.
Example using NPV

An organisation is considering a capital investment in new equipment. The
estimated cash flows are as follows:
Year Cash Flow (Rs.)
0 –240,000
1 80,000
2 1,20,000
3 70,000
4 40,000
5 20,000
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The company’s cost of capital is 9%.
Calculate the NPV of the project to assess whether it should be undertaken.
Solution:
Cash Flow
Year DF PV (Rs.)
(Rs.)
0 –240,000 1.000 –240,000
1 80,000 0.917 73,360
2 1,20,000 0.842 1,01,040
3 70,000 0.772 54,040
4 40,000 0.708 28,320
5 20,000 0.650 13,000
PV +29,760
The PV of cash inflows exceeds the PV of cash outflows by Rs. 29,760,
which means that the project will earn a DCF return in excess of 9%, i.e., it
will earn a surplus of Rs. 29,760 after paying the cost of financing. It
should, therefore, be undertaken.
Advantages and Disadvantages of Using NPV
Advantages
Theoretically, the NPV method of investment appraisal is superior to all
others. This is because:
• It considers the time value of money

• It is an absolute measure of return
• It is based on cash flows not profits
• It considers the whole life of the project
• It should lead to maximization of shareholder wealth.
Disadvantages
• It is difficult to explain to managers.
• It requires knowledge of the cost of capital.
• It is relatively complex.
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6.8.2 Internal Rate of Return (IRR)

The IRR is another project appraisal method using DCF techniques. The
IRR represents the discount rate at which the NPV of an investment is zero.
As such, it represents a break-even cost of capital.
Calculating the IRR using Linear Interpolation
The steps in linear interpolation are:
1. Calculate two NPVs for the project at two different costs of capital
2. Use the following formula to find the IRR:
⎛ NL ⎞
! IRR = L + ⎜ × (H − L) ⎟
⎝ NL − NH ⎠
where,
L = Lower rate of interest
H = Higher rate of interest
NL = NPV at lower rate of interest
NH = NPV at higher rate of interest.
The diagram below shows the IRR as estimated by the formula.
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FINANCIAL APPRAISAL
!
In all practical situation, NH < NL
Decision Rule:
• Projects should be accepted if their IRR is greater than the cost of

capital.
Example using IRR

A potential project’s predicted cash flows give a Novo Rs. 50,000 at a
discount rate of 10% and an NPV of Rs. 10,000 at a rate of 15%. Calculate
the IRR.
Solution:
50,000 × (15% − 10%)
! IRR = 10% + = 14.17%
50,000 − (−10,000)
The IRR = 14.17%
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Advantages and Disadvantages of IRR
Advantages
The IRR has a number of benefits, e.g.:
• It considers the time value of money.
• It is a percentage and therefore easily understood.
• It uses cash flows not profits.
• It considers the whole life of the project.
• It means a firm selecting projects where the IRR exceeds the cost of
capital should increase shareholders’ wealth.
Disadvantages
• It is not a measure of absolute profitability.
• Interpolation only provides an estimate and an accurate estimate
requires the use of a spreadsheet programme.
• It is fairly complicated to calculate.
• Non-conventional cash flows may give rise to multiple IRRs which means
the interpolation method can’t be used.
Difficulties with the IRR Approach

Interpolation only provides an estimate (and an accurate estimate requires
the use of a spreadsheet program). The cost of capital calculation itself is
also only an estimate and if the margin between required return and the
IRR is small, this lack of accuracy could actually mean the wrong decision
is taken.
Another drawback of IRR is that non-conventional cash flows may give rise
to no IRR or multiple IRRs. For example, a project with an outflow at T0
and T2 but income at T1 could, depending on the size of the cash flows,
have a number of different profiles on a graph (see below). Even where the
project does have one IRR, it can be seen from the graph that the decision
rule would lead to the wrong result as the project does not earn a positive
NPV at any cost of capital.
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NPV versus IRR

Both NPV and IRR are investment appraisal techniques which discount cash
flows and are superior to the basic techniques such as ROCE or payback.
However, only NPV can be used to distinguish between two mutually
exclusive projects, as the diagram below demonstrates:
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FINANCIAL APPRAISAL
The profile of Project A is such that it has a lower IRR and applying the IRR
rule would prefer Project B. However, in absolute terms, Project A has the
higher NPV at the company’s cost of capital and should, therefore, be
preferred.
NPV is, therefore, the better technique for choosing between projects.
The advantage of NPV is that it tells us the absolute increase in

shareholder wealth as a result of accepting the project, at the current cost
of capital. The IRR simply tells us how far the cost of capital could increase
before the project would not be worth accepting.
The modified internal rate of return (MIRR) solves many of these problems
with the conventional IRR.
6.9 Estimating Cost of Capital with Capital Asset Pricing

Model (CAPM)
In the analysis so far, the company’s cost of capital was used to discount
the forecasted cash flows of the new project. Many companies estimate the
rate of return required by investors in their securities. Towards this
purpose, the company’s cost of capital is used to discount cash flows in all
new projects. This is not an accurate method since the risk of existing
assets of a company may differ from the risk of new project assets. Since
investors require a higher rate of return from a very risky company, such a
company will have a higher cost of capital and will set a higher discount
rate for its new investment opportunities. The cost of capital or required
rate of return on the project would be the same as the one on company’s
existing assets if the risk is the sane. The company’s cost of capital is the
correct discount rate for projects that have the same risk as the company’s
existing business. If the project risk differs from the risk on existing assets,
the project has to be evaluated at its own opportunity cost of capital. The
true cost of capital depends on the use to which it is put.
The capital asset pricing model (CAPM) can be used for estimating the
company’s cost of capital. Each project should be evaluated at its own
opportunity cost of capital. Capital asset pricing theory tells us to invest in
any project offering a return that more than compensates for the project’s
beta which measures the amount that investors expect the stock price to
change for each one per cent additional change in the market risk. The
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discount rate increases as project beta increases. However, companies

require different rates of return from different categories of investment.
The higher the beta risk associated with an investment, the higher the
expected rate of return must be to compensate investors for assuming risk.
The CAPM provides a framework for analyzing the relationship between risk
and return. The CAPM holds that there is a minimum required rate of
return even if there are no risks, plus a premium for all non-diversifiable
risks associated with investment. Projects should be evaluated as portfolios
and there is a reduction of risk when they are so combined.
To calculate the company’s cost of capital, the beta of its assets has to be
ascertained. The beta cannot be plugged into the capital asset pricing
model to find the company’s cost of capital because the stock’s beta
reflects both business and financial risk. The beta has to be adjusted to
remove the Financial Appraisal effect of financial risk since borrowing
increases the beta (and expected return) of its stock. A more reliable
estimate is an average of estimated betas for a group of companies in the
same industry. While estimating project betas, fudge factors to discount
rates to offset bad outcomes of a project should be avoided. In cases
where project beta cannot be calculated directly, identification of the
characteristics of high and low beta assets (for instance, cyclical
investments are high beta investment) would help to figure out effect on
cash flows. Finally, operating leverage should be assessed since high fixed
production charges are like fixed financial charges resulting in an increase
in beta. The expected rate of return calculated from the capital asset
pricing model:
r = rf + B (rm – rf)
where r is discount rate, rf is interest rate on risk-free asset like treasury

bill and rm expected return can be plugged into standard discounted cash
flow formula:
T T
Ct Ct
! PV = ∑ t
= ∑ t
t=1 (1+ r) t=1 [1+ rf + B(rm − rf )]
The Capital Asset Pricing Model values only the cash flow for the first
period (C1). Projects, however, yield cash flows for several years. If the
risk adjusted rate r is used to discount the cash flow, we assume that
cumulative risk increases at a constant rate. The assumption will hold when
the project’s beta is constant or risk per period is constant.
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6.10 FINANCIAL ANALYSIS
An integral aspect of Financial Appraisal is Financial Analysis which takes

into account the financial features of a project, especially sources of
finance. Financial Analysis helps to determine smooth operation of the
project over its entire life cycle. The two major aspects of financial analysis
are liquidity analysis and capital structure analysis. For this purpose, ratios
are employed which reveal existing strengths and weaknesses of the
Project.
6.10.1 Liquidity Analysis

Liquidity ratios or solvency ratios measure a project’s ability to meet its
short-term obligations. Two ratios are calculated to measure liquidity, the
current ratio and quick ratio.
a. Current ratio: The current ratio is defined as current assets [cash,

bank balances, investment in securities, accounts receivable (sundry
debtors) and inventories] divided by current liabilities [accounts payable
(sundry creditors), short-term loans, short-term creditors and advances
from customers]. It is computed by,
Current Assets
Current Ratio =
Current Liabilities
The current ratio measures the assets closest to being cash over those
liabilities closest to being payable. It is an indicator of the extent to which
short-term creditors are covered by assets that are expected to be
converted to cash in a period corresponding to the maturity of claims.
A current ratio 1.5 to 1.0 is considered acceptable.
b. Acid test or Quick ratio: Since inventories among current assets are
not quite liquid, the quick ratio excludes it. The quick ratio includes only
assets which can be readily converted into cash and constitutes a better
test of liquidity.
Current Assets – Inventories
Quick Ratio =
Current Liabilities
A quick ratio of 1 : 1 is considered good from the viewpoint of liquidity.
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FINANCIAL APPRAISAL
6.10.2 Capital Structure Analysis

Long-term solvency ratios measure the project’s ability to meet long-term
commitments to creditors. Creditors’ claims on a company’s income arise
from contractual obligations which must be honored. The larger the
amount of these claims, the higher the chances of their not being met,
legal action may be initiated to enforce the fulfillment of the claims. The
two long-term solvency ratios are: debt utilization ratio and coverage ratio.
a. Debt utilization ratio: Debt utilization ratio measures a company’s

degree of indebtedness which measures the proportion of the company’s
assets financed by debt relative to the proportion financed by equity.
Debt includes current liabilities and long-term debt. Creditors prefer low
debt ratios because the lower the ratio, the greater the cushion against
creditor’s losses in the event of liquidation. The owners prefer higher
levels either to magnify earnings or to retain control total debt.
Total Debit
Debit Ratio=
Total Asset
b. Debt-Equity Ratio: Debt-Equity Ratio is the value of the total debt

divided by the book value of equity. In calculation of debt, short-term
obligations of less than one year duration are excluded.
Long-term Liabilities (Debit)
Debit-Equity Ratio =
Shareholders’ Equity
c. Fixed Assets Coverage Ratio: Two other ratios relating to long-term

stability used by development finance institutions (DFIs) in appraisal of
projects are fixed assets coverage ratio and debt coverage. The fixed
assets coverage ratio shows the number of times fixed assets cover
loan.
d. Debt Coverage Ratio: The debt coverage ratio measures the degree to
which fixed payments are covered by operating profits. The ratio
emphasizes the ability of the project to generate adequate cash flow to
service its financial charges (non-operating expenses). Debt coverage
ratio measures the number of times earnings cover the payment of
interest and repayment of principal. A debt coverage ratio of 2 is
considered good.
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FINANCIAL APPRAISAL
e. Interest Coverage Ratio: The interest coverage ratio measures the

number of times interest expenses are earned or covered by profits.
Net Profit before Taxes + Interest
Interest Coverage Ration =
Interest
f. Market Value Ratio: Market value ratios relate to the company’s share
price to its earnings and book value per share. These ratios are a
performance index of the company and indicate the investor’s
perception of the company’s performance and future prospects.
g. Price Earnings Ratio: P/E Ratio relates the per share earnings to price
of the share.
Market price per share
P/E Ratio =
Earning per share
P/E Ratios are computed for companies as well as for the market. P/E
ratios are higher for companies with high growth prospects and lower for
riskier companies.
h. Market/Book Value Ratio: The ratio of market price of the share of

the company to its book value per share gives an indication of how
investors regard the company. Generally, if the returns on assets are
high, these shares sell at higher multiples of book value than those with
low return. Book value per share is the sum of net worth (paid-up
capital plus reserves) divided by number of shares outstanding.
Total Net Worth
Book Value per share =
No. of Shares Outstanding
i. Market/Book Value Ratio (M/B ratio): If the market price per share
is divided by book value, we get the market book (M/B) ratio.
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FINANCIAL APPRAISAL
6.11 Break-Even Point (BEP)
An essential aspect of financial appraisal is the determination of BEP.

Unless it is determined, other measures make no sense. To calculate and
project cash flows, it is important to assess the BEP. Break-even is that
level of production and sales at which total revenues are exactly equal to
operating costs. BEP occurs at that production level at which net operating
income (sales – operating cost) is zero.
!
Break-even Point
It indicates the volume necessary for profitable operation of the project.

With the help of break-even analysis, the quantity required to be produced
at a given sales price per unit to cover total fixed cost and variable cost can
be found. If BEP is too high, the price assumed for the output may have to
be reviewed. In summary, the viability of a project can be assessed with
the help of break-even analysis. For the purpose of break-even analysis,
the conventional income statement has to be classified into fixed and
variable costs. An example of conventional income statement is presented
in Table 6.1 which is classified into fixed and variable expenses.
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FINANCIAL APPRAISAL
Table 6.1: Illustrative Conventional Income Statement

Total Cost
Particulars Cost (Rs.)
(Rs.)
Net Sales 6,00,000
Less: Cost of Goods Sold:
Materials 1,80,000
Labor 60,000
Manufacturing Expenses 1,95,000 4,35,000
1,65,000
Less: Operating Expenses 36,000
Selling Expenses 54,000 90,000
75,000
Less: Miscellaneous Expenses 3,000
Profit 72,000
Derivation of BEP from Income Statement

For deriving BEP, it is necessary to recast the income statement in Table
6.1 into fixed and variable costs.
Items of Cost Fixed Variable Total
Materials 1,80,000 1,80,000

Labour 60,000 60,000
Manufacturing Expenses 1,00,000 95,000 1,95,000
Less: Operating Expenses 20,000 16,000 36,000
Selling Expenses 46,000 8,000 54,000
Miscellaneous Expenses 2,000 1,000 3,000
Total 1,68,000 3,60,000 5,28,000

Net Profit 72,000
Total Sales 6,00,000
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FINANCIAL APPRAISAL
It may be seen from the above statement that for a sale of Rs. 6,00,000,
the variable cost is Rs. 3,60,000, i.e., 60% of sales. It means that on every
rupee of sales, 60 paisa (60%) is spent on variable costs and the balance
of 40 paisa (40%) is left to meet the Fixed Cost. To find the total sales
required to meet the fixed cost of Rs. 1,68,000, the total fixed cost is
divided by 40%.
1,68,000 × 100
! Sales required to meet fixed cost = = 4,20,000
40
The volume of Rs. 4,20,000 is known as the break-even sales volume
which must be achieved if loss is to be avoided. The profit status at this
level is,
Items of Cost Amount

Sales 4,20,000
Less: Variable Cost (60% of sales) 2,52,000
1,68,000
Margin Available for Fixed Expenses 1,68,000
Profit Nil
The computation of break-even sales volume can be summarized as,

Total Fixed Cost
Break - Even Sales Volume =
1- (Total Variable Cost/Total Sales Volume
F
! BEP =
1− (V / S)
where, F is fixed cost

V is variable cost
S is sales volume.
Substituting the figures mentioned above,
1,68,000 1,68,000 1,68,000

! Break - Even Sales Volume = = = = 4,20,000
1− (3,60,000 / 1,68,000) 1− 0.6 0.4
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FINANCIAL APPRAISAL
If Rs. 6,00,000 sales can be regarded as normal for a month (standard

sales volume), capacity utilization rate at which the project must operate in
order to ‘break-even’ can be calculated. This will be:
Break-even sales volume 4,20,000 ×100
! ×100 = = 70%
Standard sales volume 6,00,000
At capacities lower than 70%, the project is bound to incur losses. On the
other hand, it will make profits at levels above the 70% capacity utilization.
The ‘break-even’ capacity represents the capacity utilization rate to be
achieved to make the project viable. The normal rate for capacity
utilization is about 50%.
6.12 APPRAISAL OF ADVANCED MANUFACTURING

SYSTEMS
Intangible and Tangible Benefits

For evaluation of advanced manufacturing systems, conventional appraisal
techniques may be unsuitable since there are a large number of hidden
benefits in such systems. These benefits are of tangible and intangible
natures which have to be quantified. A few such benefits of advanced
manufacturing systems are listed here. Quantification of such benefits can
be carried out by analytic hierarchy process and other processes.
Intangible Benefits
• Centralized database
• Better quality control
• Faster product introduction
• Better competitive standing
• Greater customer satisfaction
• Improved employee participation
• Consistently high product quality
• Improved on-time product delivery
• Redistribution of personnel skills
• Better data quality for management
• Consistent and tireless operation
• Shortened design and manufacturing lead time
• Ability to simulate the total factory operations
• Wider variety of designs within a product family
• Ability to attract and retain high-quality engineers
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FINANCIAL APPRAISAL
• Ability to handle increasingly complex product designs

• Flexibility in design, product mix, volumes and schedules
• Greater control, accuracy and repeatability of production process
Tangible Benefits
• Lower inventory.
• Reduced labor costs.
• Less scrap and rework.
• Higher throughput and yield.
• Fewer engineering prototypes through the use of CAD.
• Reduced changeover costs and time.
• Improved and safer working conditions.
• Increased design and drafting productivity.
• Reduced and more predictable maintenance cost.
• Eliminated data re-entry and duplicated data processing systems.
Strategic Issues
The strategic issues to be considered before taking a decision on
acceptance or rejection of a proposal to set up an advanced manufacturing
system as compared to other traditional manufacturing systems are:
1. The goal of the company in 7 to 10 years.
2. The advantage, the investment is going to provide over competitors.
3. Ability to capture a greater proportion of the market for the company’s

products.
4. Ability to respond to market changes quickly.
5. Impact of improvements in quality and consistent output in obtaining

competitive advantage.
6. Incremental sales resulting from the publicity gained from the company
installing advanced manufacturing technology.
An advanced system should be viewed as a long-term, strategic move, not

a tactical adjustment in a strategy. The installation of such a system is
comparable to other strategic moves like installing a new computing
system or hiring a new dynamic, result-oriented, but a very highly paid
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FINANCIAL APPRAISAL
CEO. The benefits of such moves cannot be immediately quantified. Their

impact is felt in the long run.
Shortcomings of Traditional Financial Analysis for Advanced

Manufacturing Systems like FMS
Traditional evaluation assumes:
1. Impact of investment is limited to immediate environment of

equipment.
2. Capabilities and rates of new equipment are assumed to be well known

and do not change, i.e., not increase but will decrease as machine ages.
3. Savings and benefits can be estimated with accuracy and ease.
4. The pros and cons of the project can be envisaged by the manager or
specialist concerned with the project.
5. Evaluation should be done case by case.
These assumptions are not applicable to FMS as it integrates the complete

facilities of different stages of manufacturing. CNCs would just reduce labor
costs, but FMS in addition to reducing labor costs can also help in controls
and in-process inspection, work tracking, transportation, tool control,
scheduling and production control. FMS would require a smaller and
dedicated team, which is generally more motivated, loyal and sincere. It
has generally been observed in FMS that the capabilities of the system
tend to increase over passage of time because of increasing understanding
of operations of the system and the accumulated experience, upgradability
of the system, both software and hardware, to speed up operations and
intrinsic flexibility of the system. FMS has the flexibility to process several
part types simultaneously. In contrast, a transfer line requires full capital
expenditure before production can start. On the other hand, changes in
product type, or mix, or volume cannot be easily effected in transfer line
since such changes result in underutilization of lines. Actual costs and
benefits are difficult to evaluate in FMS. Many hidden costs like new skilled
labor, training costs, costs due to adjustments or refining cannot be
accurately estimated. Hidden/non-financial savings like simple and fast
engineering change over, reduction of lead time are difficult to quantify to
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FINANCIAL APPRAISAL
take into calculation in profit and loss account. Further, FMS operations and
benefits cut across various functions. A broader team is required to
evaluate FMS projects. Finally, capital costs cannot be appraised on a case
by case basis. They have to be evaluated by senior management of the
company on a long-term plan basis of say 5 to 10 years. Financial
evaluation of FMS is feasible in the following cases:
1. Total FMS picture is taken into consideration by evaluating

a. costs: direct and indirect of traditional systems and
b. savings: direct and indirect/non-financial savings of FMS.
2. All intangible benefits are evaluated and a hypothetical value attached

to every qualitative benefit.
3. Estimates of savings and costs cover 7 to 10 year period taking into

consideration long-term impact of FMS.
4. Probability and sensitivity are taken into account.
5. Justification/appraisal results are seen in a broader/strategic

perspective.
Before rejecting an FMS investment proposal, the following factors may be

considered:
1. What are the other options?
2. What happens if investment is not made in FMS?
3. What are the methods employed by competitor?
4. How can the benefits of FMS open up new markets and make the
company more competitive?
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FINANCIAL APPRAISAL
Conclusions
1. FMS should be an integral part of a well-defined strategy to meet the

corporate goals.
2. While evaluating FMS, judicious designing should be done. FMS project

may be unviable but technically feasible.
3. Traditional methods of analysis may lead us astray from real justification

of the FMS project.
4. Conventional appraisal techniques should be used to compare different

systems, as relevant facts of FMS will not be highlighted.
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FINANCIAL APPRAISAL
6.13 Summary
• Financial Appraisal is the review carried out to ascertain if the project is

financially viable. Whether a satisfactory return can be generated from
the investment made?
• Financial Appraisal is important as it determines whether a reasonable

return can be made, the cash flows, the cost of the project and the
sources of finance, various liquidity and capital structure ratios and the
break-even point of the project.
• For existing units, bankers need to understand the past performance of

the company. so they scrutinize the last three years audited financials.
• Cost of the Project is the total amount of all the various components of
the project.
• Sources of Finance refers to the total of from various sources such as

equity capital, term loans, debentures, deferred payments, miscellaneous
sources, etc.
• Financial Projections based on realistic assumptions will give a true

picture of finances of the company over a long period of time.
• Two popular methods of Financial Appraisal are Simple Rate of Return

and Payback period.
• Two popular DCF techniques are Internal Rate of Return (IRR) and Net
Present Value Method (NPV) methods of Financial Appraisal are Simple
Rate of Return and Payback period.
• CAPM is a tool to estimate the company’s cost of capital.
• Financial Analysis takes into account the financial features of the project,
especially sources of finance.
• Break-even Point is that level of sales at which revenues exactly equal

the operating costs.
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FINANCIAL APPRAISAL
• Advanced Manufacturing Systems have a number of tangible and

intangible benefits which have to be quantified.
Activity
1. You have a project in your mind that you want to set up. Find out the
cost of the project, sources of finance, appraisal through DCF methods
and break-even point.
1. What is Financial Appraisal? What is its importance?
2. What are the various parameters under Cost of Project and Sources of
Funds?
3. What the various methods and DCF Methods for Financial Appraisal?
Compare each.
4. Define Payback period. What is the Payback period of a project which

require Rs. 1,00,00,000 initial investment and has receipt of 37,00,000
for five years. What will be its payback if the receipts are 40,00,000 for
two years?
5. What are the weaknesses of the payback method?
6. Describe the IRR Method. What are its advantages and disadvantages?
7. Describe the NPV Method. What are its advantages and disadvantages?
8. Assume Rs. 5,00,000 investment and the following cash flows for two
alternatives:
Investment A Investment B
Year
(Rs.) (Rs.)
1 1,00,000 2,00,000
2 1,10,000 2,50,000
3 1,30,000 1,50,000
4 1,60,000 –
5 3,00,000 –
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FINANCIAL APPRAISAL
Which alternative would you select under the payback method?
9. The cost of a machine is Rs. 1,17,780 and you receive a cash inflow of
Rs. 20,000 per year for 10 years. What is the Internal Rate of Return?
10.If the cost of a new machine is Rs. 1,38,690, annual cash flow Rs.
30,000 for six years and cost of capital 12%, evaluate the project using
Internal Rate of Return method and indicate whether it should be
undertaken.
11.A project estimated to require an investment of Rs. 16,00,000 and a

cost of capital of ?% will produce the following cash flows. Using Net
Present Value method, state whether the project should be undertaken.
Cash Flow
Year
(Rs.)
1 5,40,000
2 6,60,000
3 - 600,000
4 5,70,000
5 12,00,000
12.Explain the estimation of cost of capital with CAPM.
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FINANCIAL APPRAISAL
REFERENCE MATERIAL
chapter
Summary
PPT
MCQ
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CAPITAL STRUCTURE
Chapter 7
CAPITAL STRUCTURE
Objectives
• Get an introduction and brief overview on Capital Structure.

• Provide conceptual understanding on Modigliani and Miller Proposition I
and II and its application in real-life situations.
• Understand the Pecking order theory and Agency Cost.
• Learn about Structural Corporate Finance and Gearing ratios.
• Learn about the Debt Tax Shield and Debt Capacity.
• Provide conceptual understanding on Weighted Average Cost of Capital.
Structure:
7.1 Introduction
7.2 Capital Structure Decision – Theory and Practice
7.3 Capital Structure – An Overview
7.4 Modigliani and Miller Proposition I and II
7.5 Trade-off Theory
7.6 Pecking Order Theory
7.7 Agency Cost
7.8 Structural Corporate Finance
7.9 The Debt Tax Shield
7.10 Debt Capacity
7.11 Weighted Average Cost of Capital (WACC)
7.12 Focus on WACC
7.13 WACC under Changing Debt Conditions
7.14 Financial Closure
7.15 Summary
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CAPITAL STRUCTURE
7.1 Introduction
Project financing structure refers to the way a company finances its assets
through some combination of equity, debt, or hybrid securities. A
company’s capital structure is then the composition or ‘structure’ of its
liabilities. For example, a company that sells Rs. 20 crores in equity and
Rs. 80 crores in debt is said to be 20% equity-financed and 80% debt-
financed. The company’s ratio of debt to total financing, 80% in this
example is referred to as the company’s leverage. In reality, capital
structure may be highly complex and include dozens of sources. Gearing
Ratio is the proportion of the capital employed of the company which come
from outside of the business finance, e.g., by taking a short-term loan etc.
This topic starts with a theory that shows capital structure is irrelevant in a
world with no taxes and no other market imperfections. It will also show
that when you increase the level of debt in a company, you increase the
required rate of return on equity because increasing leverage increases the
risk of equity.
7.2 Capital Structure Decision – Theory and Practice
The financing choices manager affect the liabilities and stockholder’s equity
side of the balance sheet. Capital budgeting decisions, on the other hand,
affect the asset side of the balance sheet.
Managers have choices of debt and equity. The key question is what mix of
these securities will maximize the value of the shareholders. Debt service
requires interest payments that are tax deductible, but equity service
requires dividends, which are paid from after tax income.
However, increases in the use of debt increase the risk of default on debt
service and can lead to bankruptcy. Managers must also make choices
about whether to use fixed-rate or floating-rate debt, and how to mix long-
term and short-term debt. These issues affect the cost of debt.
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CAPITAL STRUCTURE
7.3 Capital Structure – an Overview
Companies raise capital for their investment projects with a mix of debt
and equity instruments. The combination of all of these instruments is
known as the company’s capital structure. For the purposes of our
discussion, let us look at some key differences between debt and equity.
Key differences are:

Sr. Equity
Debt
No.
Equity is a residual claim to the cash
Debt is a contractual claim to the
flows of a company. Because the
cash flows of a company that has
claim to equity is residual, equity
1 a fixed life and does not depend
holders are entitled only to the
on the company’s operating
operating cash flows that remain
performance.
after debt holders have been paid.
Unlike debt holders, equity holders

Debt holders do not have the right
have the right to vote and thus can
2 to vote so cannot affect the overall
affect the overall management of
management of the company.
the company.
Dividends paid to stockholders are

Interest payments on bonds are not tax deductible. This benefits
3 tax deductible to the issuing lowers the company’s cost of issuing
corporation. debt, if the company is paying
taxes.
4 Debt is not a residual claim. Equity is a residual claim.
The company must make The company can announce

5
scheduled interest payments. dividends on its own will.
6 The company must repay the The company does not have to buy
principal. back the share.
7 The repayment is not optional. The payment of dividends is the

company’s prerogative.
It is important that a company consider its appropriate mix of debt and

equity. For a given level of sales, higher use of debt in proportion to equity
makes the company more risky, because the proportion of operating
income needed to cover debt service increases with increasing debt.
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CAPITAL STRUCTURE
Therefore, the probability rises that if sales decline due to changes in

market conditions, the company will not be able to service the debt.
Clearly, debt and equity present different opportunities to investors.
You might ask why companies use both debt and equity financing. By
issuing debt, a company’s owners can keep a greater amount of equity for
themselves. Assuming a company’s investments are profitable, the owners
can finance their projects and also reap the benefit of these investments.
Some companies, however, might not be able to make the annual interest
payments on debt – or they might desire the flexibility to use their cash
flow for other investments – and will tend to issue equity instead.
Furthermore, there is a key difference between the way debt and equity
holders are paid. Companies pay interest to debt holders and dividends to
equity holders. Interest expenses are tax deductible, but dividend
payments are not. As a result, companies receive a tax benefit from issuing
debt.
Most companies usually use a mix of debt and equity financing – despite
the tax advantages of debt – to suit their strategic and competitive
interests.
7.4 Modigliani and Miller Proposition I and II
A company’s capital structure is a mix of the various debt and equity

instruments used to finance the company. To assess the value of a
company, your first need to determine the appropriate discount rate use.
Should you use the rate that is appropriate for a company financed with
100% equity? Or should you use a company’s cost of debt as the rate at
which to discount its cash flows? Or a mix of both?
Modigliani-Miller
The Modigliani-Miller theorem, proposed by Franco Modigliani and Merton
Miller, forms the basis for modern thinking on capital structure, though it is
generally viewed as a purely theoretical result since it disregards many
important factors in the capital structure process factors like fluctuations
and uncertain situations that may occur in the course of financing a
company.
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CAPITAL STRUCTURE
The theorem states that, in a perfect market, how a company is financed is

irrelevant to its value. This result provides the base with which to examine
real-world reasons why capital structure is relevant, that is, a company’s
value is affected by the capital structure it employs. Some other reasons
include bankruptcy costs, agency costs, taxes, and information asymmetry.
This analysis can then be extended to look at whether there is in fact an
optimal capital structure: the one which maximizes the value of the
company.
In 1958, Franco Modigliani and Merton Miller (referred to as MM) published

an article that discussed whether companies could vary their capital
structures to obtain better returns – that is, whether companies could
manipulate the amounts of debt and equity financing in their capital
structures to yield a higher overall return.
MM showed the conditions under which the value of a project is invariant to

how it is financed. MM also demonstrated that when a company finances a
project using more debt than equity, the residual equity becomes riskier,
because it is supporting more debt claims. So even though the debt will
require a lower rate because financing with debt rather than equity is
cheaper, the equity will in turn require a higher discount rate as it takes on
more risk. However, the overall rate, or the weighted average cost of
capital (WACC), will not be affected as the ratio of debt to equity in a
company’s capital structure changes.
These claims are based on specific assumptions. It was MM’s intention to

define this ‘constant value’ condition as a benchmark, much like the
frictionless state or perfect vacuum in physics, or the concept of perfect
competition in economics. These conditions may not exist in the ‘real-
world’, but they provide useful anchors for thought, or benchmarks against
which real conditions can be measured. MM’s propositions offer a basis for
understanding why a company’s decisions about capital structure may, in
fact, matter.
Capital structure in a Perfect Market: Consider a perfect capital market

(no transaction or bankruptcy costs; perfect information); companies and
individuals can borrow at the same interest rate; no taxes; and investment
returns are not affected by financial uncertainty. Modigliani and Miller made
two findings under these conditions. Their first ‘proposition’ was that the
value of a company is independent of its capital structure. Their second
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CAPITAL STRUCTURE
‘proposition’ stated that the cost of equity for a leveraged company is equal
to the cost of equity for an unleveraged company, plus an added premium
for financial risk. That is, as leverage increases, while the burden of
individual risks is shifted between different investor classes, total risk is
conserved and hence no extra value created.
Their analysis was extended to include the effect of taxes and risky debt.
Under a classical tax system, the tax deductibility of interest makes debt
financing valuable; that is, the cost of capital decreases as the proportion
of debt in the capital structure increases. The optimal structure then would
be to have virtually no equity at all, i.e., a capital structure consisting of
99.99% debt.
Capital structure in the real world: If capital structure is irrelevant in a

perfect market, then imperfections which exist in the real world must be
the cause of its relevance. The theories below try to address some of these
imperfections, by relaxing assumptions made in the M&M model.
MM Proposition I
According to MM Proposition I, the total value of the securities issued by a
company does not depend on the company’s choice of capital structure. In
other words, the value of the company is determined by its real assets and
growth opportunities and not by the types of securities (debt or equity) it
issues. Under particular conditions, the company’s value turns out to be
constant regardless of its capital structure.
MM Proposition I applies in a world under the following assumptions:
1. Capital structure does not affect investment policy.

2. Cash flows paid out to different securities are taxed at the same rate.
3. No costs of bankruptcy exist.
4. Managers’ goal is to maximise shareholder wealth.
5. Everyone has immediate and equal access to all relevant information
about the company.
6. No transaction costs exist.
If these conditions hold, the company is said to operate in a perfect market

(comparable to perfect vacuum in physics).
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CAPITAL STRUCTURE
MM Proposition I is based on the idea that investors can, on their own,

replicate any capital structure designed by a company. Companies cannot
change value by altering the composition of their financing. If one capital
structure has a greater value than another, then investors could sell the
capital structure of greater value and buy the one of lesser value.
To understand Modigliani and Miller’s argument, consider two companies, U

and L, which are identical in all respects except for the capital structure.
Both companies are expected to generate earnings equal to Rs. 1,00,000
per annum in perpetuity, and the cash flows have the same risk.
MM Proposition II
The following formula states that the company’s weighted average cost of
capital is a weighted average of its cost of debt (rd) and its cost of equity
(re):
D × rd D × re
! ra = +
(D + E) (D + E)
In this formula, D and E are the market values of debt and equity,
respectively, and equity, and ra, rd, and re are the expected returns on
assets, debt and equity respectively. Note that there is no tax in the
equation above, as MM’s world has no tax assumption.
We have just seen that in a perfect market, a company’s value is

unaffected by its capital structure (MM Proposition I). We also know that a
company’s capital structure has no impact on the cash flows the company
is expected to generate. If the value and the future cash flows generated
by a company are not affected by its capital structure, then it must be true
that the company’s weighted average cost of capital is unaffected by a
company’s capital structure.
What about the cost of equity? How does the capital structure choice
impact the cost of equity?
Rearranging the equation above, you find that the return on equity is equal
to:
D
! re = ra +
E(ra − rd )
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CAPITAL STRUCTURE
If we assume that at low levels of debt rd is constant and equal to the risk-
free rate, the cost of equity increases linearly with leverage. At higher
levels of debt, debt becomes risky, which means that debt holders can no
longer be certain that the company is able to meet its commitments to pay
interest and repay the principal. When debt becomes risky, rd starts to
increase as leverage goes up. In this case, more of the company’s risk is
borne by the debt holders and re still increases as leverage increases, but
at a decreasing rate.
Since leveraged equity has greater risk, it should have greater return as
compensation. MM Proposition II states that the expected return on equity
is positively related to leverage.
As shown in the graph, MM Proposition II states that increasing a

company’s debt ratio does not affect the riskiness of its assets (ra is not
dependent on the leverage ratio), but it does increase the riskiness of its
equity. Also note that for any company, the return on debt will always be
less than the return on equity. This is because interest payments to debt
holders have higher priority than dividend payments to equity holders, and
thus debt carries less risk. However, the weighted average sum of the
return on debt and the return on equity is always constant and is equal to
the return on assets.
MM Proposition I and II point to the conclusion that companies cannot

change in value simply by repackaging their securities from equity to debt,
or vice versa. As equity is replaced by debt, a company’s overall value and
its cost of capital cannot be reduced, because the riskiness of the equity
increases as the amount of debt increases. This increase in risk of the
equity offsets the reduction in risk that results from issuing debt. In other
words, while the fraction of low-cost debt increases, equity demands a
return high enough to compensate for the extra risk it is bearing. Thus,
using the asset beta to calculate the cost of capital is appropriate in a
world based on MM’s assumptions where debt, but no tax, exists.
Application in the Real World

Every company has a limit to the amount of debt it can support. If a
company goes beyond this debt capacity level, it risks bankruptcy. Debt
does matter in the real world! Consider what happens when MM’s
assumption that there is no tax differential between debt and equity is
relaxed. In the real world, corporations are taxed on operating cash flow
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after interest payments have been made. Cash paid to shareholders as

dividends is taxed first to the corporation, but interest payments are not.
Therefore, two companies that have equivalent earnings before interest but
different capital structures – perhaps one with all stock and the other with
bond interest payments – will be worth different amounts. In a world with
taxes, companies with identical assets, cash flows, and risk will be worth
different amounts as capital structures differ. This concept will become
clearer as you learn more about the benefits of the debt tax shield.
7.5 Trade-Off Theory
Trade-off theory allows the bankruptcy cost to exist. It states that there is
an advantage to financing with debt (namely, the tax benefits of debt) and
that there is a cost of financing with debt (the bankruptcy costs and the
financial distress costs of debt). The marginal benefit of further increases in
debt declines as debt increases, while the marginal cost increases, so that
a company that is optimizing its overall value will focus on this trade-off
when choosing how much debt and equity to use for financing. Empirically,
this theory may explain differences in D/E ratios between industries, but it
doesn’t explain differences within the same industry.
!
After a certain level of Debt, the Firm’s Value reduces instead of
increasing
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7.6 Pecking Order Theory
Pecking Order Theory tries to capture the costs of asymmetric information.

It states that companies prioritize their sources of financing (from internal
financing to equity) according to the law of least effort, or of least
resistance, preferring to raise equity as a financing means “of last resort”.
Hence, internal financing is used first; when that is depleted, then debt is
issued; and when it is no longer sensible to issue any more debt, equity is
issued. This theory maintains that businesses adhere to a hierarchy of
financing sources and prefer internal financing when available, and debt is
preferred over equity if external financing is required (equity would mean
issuing shares which meant ‘bringing external ownership’ into the
company). Thus, the form of debt a company chooses can act as a signal
of its need for external finance. The pecking order theory is popularized by
Myers (1984) when he argues that equity is a less preferred means to raise
capital because when managers (who are assumed to know better about
true condition of the company than investors) issue new equity, investors
believe that managers think that the company is overvalued and managers
are taking advantage of this overvaluation. As a result, investors will place
a lower value to the new equity issuance.
7.7 Agency Cost
There are three types of agency costs which can help explain the relevance
of capital structure.
1. Asset substitution effect: As D/E increases, management has an

increased incentive to undertake risky (even negative NPV) projects.
This is because if the project is successful, shareholders get all the
upside, whereas if it is unsuccessful, debt holders get all the downside.
If the projects are undertaken, there is a chance of company value
decreasing and a wealth transfer from debt holders to shareholders.
2. Underinvestment problem (or Debt overhang problem): If debt is

risky (e.g., in a growth company), the gain from the project will accrue
to debt holders rather than shareholders. Thus, management has an
incentive to reject positive NPV projects, even though they have the
potential to increase company value.
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3. Free cash flow: Unless free cash flow is given back to investors,
management has an incentive to destroy company value through empire
building and perks etc. Increasing leverage imposes financial discipline
on management.
7.8 Structural Corporate Finance
An active area of research in finance is that which tries to translate the

models above as well as others into a structured theoretical setup that is
time-consistent and that has a dynamic setup similar to one that can be
observed in the real world. Managerial contracts, debt contracts, equity
contracts, investment returns, all have long lived, multi-period
implications. Therefore, it is hard to think through what the implications of
the basic models above are for the real world if they are not embedded in a
dynamic structure that approximates reality. A similar type of research is
performed under the guise of credit risk research in which the modelling of
the likelihood of default and its pricing is undertaken under different
assumptions about investors and about the incentives of management,
shareholders and debt holders. Examples of research in this area are
Goldstein, Ju, Leland (1998) and Hennessy and Whited (2004).
Other
The neutral mutation hypothesis—companies fall into various habits of

financing, which do not impact on value.
• Market timing hypothesis—capital structure is the outcome of the

historical cumulative timing of the market by managers.
• Accelerated investment effect—even in absence of agency costs,

leveraged companies invest faster because of the existence of default
risk.
• Capital structure substitution theory—managements of public companies

manipulate capital structure such that earnings per share are maximized.
• In transition economies, there have been evidences reported unveiling

significant impact of capital structure on company performance,
especially short-term debt such as the case of Vietnamese emerging
market economy.
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Capital Gearing Ratio

Capital Bearing Risk
! Capital gearing ratio =
Capital not Bearing Risk
• Capital bearing risk includes debentures (risk is to pay interest) and

preference capital (risk to pay dividend at fixed rate).
• Capital not bearing risk includes equity share capital.
Therefore, we can also say,
Debentures + Preference share capital

! Capital gearing ratio =
Shareholders' fund
Arbitrage
Similar questions are also the concern of a variety of speculator known as

a capital structure arbitrageur, see arbitrage.
A capital structure arbitrageur seeks opportunities created by differential

pricing of various instruments issued by one corporation. Consider, for
example, traditional bonds and convertible bonds. The latter are bonds that
are under contracted – for conditions, convertible into shares of equity. The
stock option component of a convertible bond has a calculable value in
itself. The value of the whole instrument should be the value of the
traditional bonds plus the extra value of the option feature. If the spread
(the difference between the convertible and the non-convertible bonds)
grows excessively, then the capital structure arbitrageur will bet that it will
converge.
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7.9 The Debt Tax Shield
One of the key assumptions made in the analysis above is that there are
no taxes. In fact, governments claim some of the cash flows in the form of
taxes. Although tax laws differ from country to country, in most countries,
interest costs can be deducted as an expense. This discussion assumes
that the tax code allows deduction of interest costs as a business expense
before computing taxes.
Equity holders and debt holders are not the only claimants to the cash
flows of a company – the government is an additional claimant. The
government exercises its claim by taxing the company’s earnings.
Payments to debt holders and equity holders are taxed differently; interest
payments to debt holders are tax-deductible, reducing a company’s taxable
income by the amount of the interest expense. Therefore, the amount of
debt (and the corresponding interest payments due) in a company’s capital
structure reduces the government’s share of the company’s cash flows and
increases what is left for equity and debt holders.
7.10 Debt Capacity
In a market that is perfect, except for the existence of corporate taxes, the
greatest value to a company would result from a capital structure with
100% debt. In practice, however, companies do not hold 100% debt, or
anywhere near that percentage for the following reasons:
Why Companies Do Not Hold 100% Debt?
Possible Bankruptcy
First, if a company goes bankrupt, it will no longer be able to utilize its tax
shield from debt. As leverage increases, the probability of financial distress
increases, moderating the company’s incentives to add more debt.
Additional Costs
There are additional costs of financial distress that also reduce a company’s
incentive to increase leverage. For example, when the company is in
financial distress, it will incur various legal, accounting and administrative
expenses.
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Negative Action
Various concerned parties will also react negatively.
• Creditors:More importantly, creditors will raise their required interest

rate to compensate for the higher risk of bankruptcy.
• Stakeholders: Other stakeholders in the company will also become

increasingly worried as leverage increases, and take actions that are
likely to worsen the company’s situation.
• Employees: For example, employees might start looking for other jobs
because they do not want to work for a company that might go bankrupt
in the near future. Note that it is likely that the best employees are the
ones to find new jobs first.
• Customers: Customers might also be worried about the survival of the

company and its commitment to supply spare parts in the future and the
value of product warranties. These customers might decide to switch to
another supplier.
• Suppliers: Finally, suppliers will be increasingly reluctant to trade on

favorable credit terms as the probability of financial distress increases.
Impact on Cash Flows

This discussion reflects another departure from the perfect market
assumption of MM. Here, we see that in reality, adding more debt to the
capital structure of a company that is close to financial distress will
negatively impact the company’s future cash flows. Thus, in reality’ capital
structure and future cash flows are not independent (in contrast to the
assumptions made by MM).
Flexibility
Another reason not to have a capital structure with 100% debt is the desire
for flexibility that comes from having cash on hand. Issuing new bonds or
new shares is expensive. If a company is financially constrained, it might
be hard to obtain additional financing when a good investment opportunity
arises, thereby limiting its growth potential. This ‘opportunity cost’ must be
considered as the company takes on additional amounts of debt.
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Covenants
Finally, a company might be limited in the amount of debt it can take on
based on covenants (promises) in existing debt contracts that prohibit
companies from issuing debt beyond a certain level.
The trade-off between the tax advantage of debt financing and the
disadvantage of financial distress costs results in a different optimal debt
level for each company. This Optimal debt level is often referred to as a
company’s debt capacity. A company’s debt capacity reflects the owner’s
subjective willingness to bear risk; other owners may have the desire or
ability to take on more debt. In fact, according to some, this issue is the
motivation behind some mergers and acquisitions. If a company’s owners
choose not to take on debt because they do not want to bear the default
risk, other potential owners or investors may see an arbitrage opportunity
to buy the company and increase its debt capacity.
7.11 Weighted Average Cost of Capital (WACC)
The WACC method allows analysts to value a company at any capital

structure – that is, at any amount of debt and equity – to determine a
blended discount rate that reflects the relative shares of debt and equity in
the company. This blended discount rate is the WACC, and it is used to
value the company’s expected future cash flows. The WACC method can be
used to value a company under either its current capital structure or under
a proposed or different structure. If you want to value a company at its
current capital structure, the basic WACC method is appropriate. However,
you will often want to know if a greater valuation can be achieved by
increasing the debt ratio. In these cases, you must extend your analysis to
consider WACC under changing debt conditions.
WACC declines as the per cent of debt in the capital structure increases
because of the debt tax shield. Also note that the return on assets is
defined as the required rate of return on the company’s assets if the
company is 100% equity financed.
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7.12 Focus on WACC
Let us consider the components of the equation in greater detail in the

section below.
Components of the WACC Formula
Return on Debt (Rd)

Return on debt (rd) is the expected return required by debt holders as
compensation for the risk associated with their debt claims. If you are
evaluating a new investment project, the return on debt to use in the
WACC calculation is the cost of debt to the company if the company was to
raise capital in the debt markets today. You should not use the interest rate
for debt that is already on the balance sheet. All other things equal, the
higher the percentage of debt on a company’s balance sheet, the greater
the interest rate the company will have to pay to debt holders. This is so
because greater amounts of debt increase the default risk of the company.
In the figure, this is illustrated by a flat rd line for low and medium levels
of debt, and an upward sloping line for higher levels of debt.
Return on Equity (Re)

Return on equity (re) is the expected return required by equity holders as
compensation for the risk associated with their equity claims. The expected
return on equity can be determined by using the Capital Asset Pricing
Model (CAPM) formula or any other asset pricing relationship such as the
Arbitrage Pricing Theory. Specifically, the CAPM measures risk of the equity
(through equity beta) and converts this risk measure into an expected
return on equity, as shown in the following formula.
! re = rr + β e(rm − rf )
Note that the equity beta will, other things held constant, be higher as the
debt ratio increases because of the increased risk of holding equity. This
higher equity beta will yield an increased return on equity because of the
increased proportion of debt, a concept illustrated in the graph shown
above. Also note that at high debt levels, the slope of re as a function of
the debt level is decreasing. The reason for this is that part of the
increased risk resulting from the increased debt level is borne by debt
holders.
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Equity (E)
Equity (E) is the market value of the equity. This amount can easily be
determined by multiplying the number of shares issued and outstanding by
the current stock price.
Debt (D)
Debt (D) is the market value of the debt. In practice, we often assume that
the market value of the debt is the same as the book value. Sometimes,
we can calculate the value of long-term debt by multiplying the number of
bonds outstanding by the market price. Short-term debt is determined by
using the amount shown on the balance sheet because it is due within one
year. Companies often list the value of debt in the notes to their financial
statements. Remember, a company will generally issue debt up to its
perceived debt capacity. Thus, it is assumed in this course that the
company is always operating at its current debt capacity.
Debt + Equity (D + E)
Debt + Equity (D + E) is equal to the market value of the company. Recall

that D and E are the market values of debt and equity, respectively. E is
also referred to as the ‘equity value’ of the company.
Marginal Corporate Tax Rate

The marginal corporate tax rate (Tc) is used in determining WACC. In doing
this, make sure that you count all taxes that a company bears. For
example, in the US, companies have a marginal federal tax rate of 35%;
they also have to bear state taxes. When considering state taxes, analysts
often use a total marginal tax rate of 40%. The marginal tax rate should be
used instead of the average tax rate, because the tax deduction of interest
payments will take effect at the marginal rate (i.e., the rate at which the
last dollar is taxed).
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7.13 WACC under Changing Debt Conditions
As you have learned, the WACC method can be used to value a company at
its debt capacity. WACC is a dynamic tool, however, and can also be used
to value a company at any capital structure different from its current one.
Use of WACC under changing debt conditions differs from basic WACC in
that it requires you to estimate the cost of capital for a company or asset
at an all-equity capital structure and then re-estimate your calculations
assuming a revised capital structure. In practice, using WACC under
changing debt conditions involves recalculating a company’s beta in a two-
step process. First, you must recalculate beta so that it reflects an all-
equity capital structure. This is known as unleveraging beta. Second, you
must recalculate beta at the new capital structure, which is known as
releveraging beta.
7.14 Financial Closure
Financial closure means that all the sources of funds required for the
project have been tied up / have been arranged. A key milestone in
project implementation, financial closure may take a long time particularly
for infrastructure projects, because several things have to be sorted out to
the project structure fundable. For example, it took about three years to
hammer out a in power purchase agreement to be signed by the
independent power producers with respective state electricity boards.
In general, financial closure is achieved soon when:
• Suitable credit enhancement is done to the satisfaction of lenders.
• Adequate underwriting arrangements are made for market-related

offerings.
• The resourcefulness of the promoters is well established.
• The process is started early and concurrent appraisal is initiated if several

lend agencies are involved.
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7.15 Summary
• Project financing refers to the way a company finances its assets through
some combination of equity, debt or hybrid securities.
• There a number of differences between Debt and Equity. Company

should consider an appropriate mix of debt and equity.
• Modigliani and Miller theorem states that in a perfect market, how a

company is financed is irrelevant to its value. It ignored costs such as
bankruptcy costs, agency costs, taxes and information asymmetry.
• Trade-off theory states that allows bankruptcy costs to exist.
• Pecking order theory states that companies prioritize their sources of

financing according to the law of the least effort.
• Three types of agency costs exist.
• Structural corporate finance aims to translate models discussed above

into real-world ones.
• The Government is also a claimant on share of the profits generated by

the company. Debt in a capital structure reduces the government’s share
and increases what is left for equity and debt holders.
• Weighted Average Cost of Capital method allows to value a company at

any capital structure.
• Financial Closure means that all sources of funds required for the project
have been set up.
Activities
1. Use internet resources to find out about the Capital Structure of large
Indian companies. Preferably use companies from different sectors.
2. Use internet resources to find out about the Capital Structure of large
multinational companies.
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3. Your sister wants to start her first venture - own fashion dress store.
She discusses with you about the capital required. Since, personal funds
at disposal are not sufficient, she will have to borrow money from
external sources (at cost). Work out a hypothetical model to ensure
optimum capital structure.
1. What is the meant by optimal Capital Structure? Comment.
2. Explain Modigliani-Miller Proposition I and II.
3. Can a company hold 100% debt and 0% equity? Why?
4. What is the Pecking Order Theory?
5. What is meant by Tax Debt Shield?
6. What is meant by Weighted Average Cost of Capital?
7. What is meant by Financial Closure?
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REFERENCE MATERIAL
chapter
Summary
PPT
MCQ
! !150
SECTION - II - FINANCING OF PROJECTS
SECTION - II
FINANCING OF PROJECTS 
! !151
PRESENTATION OF YOUR PROJECT FOR FINANCIER
Chapter 8
PRESENTATION OF YOUR PROJECT FOR
FINANCIER
Objectives
• Get a brief overview on Project Presentation.
• Understand the importance of Project Presentation.
• List of Support Documents required to complete the file.
• Learn on the importance of a Business Plan.
• Typical Format of a Business Plan.
Structure:
8.1 Introduction
8.2 Importance of Project Presentation
8.3 Support Documents in the Project Presentation
8.4 Preparing a Business Plan
8.5 Format of a Business Plan
8.6 Summary
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8.1 Introduction
Preparation and proper presentation of your project/files is very important

aspect of Project Finance. A proper, neat file submission will greatly
improve the chances of you getting the loan/equity. A well and thoughtfully
prepared file will help the bankers get their appraisals done faster, more
accurately and with minimum queries. This might improve the comfort of
the bankers. They will get the impression that they are working with
professional people.
Remember that every financial institution has exhaustive appraisal

procedures before lending to you. They have many professional and
technical people working with them. Many times, they take help of
professional consultants for appraisals. Further, once detailed reports are
prepared and recommendations put in, they are put before the Screening
Committees. If they are not fully satisfied with any of the appraisal reports,
they refer back to the appraisal team with their comments.
If a file is not presented completely, then there are high chances of delays/
rejection. Delayed funds or lack of funds can change the entire course of
the project. Even your loan application fees, if any can get forfeited,
Professional consultants are available who help you prepare your file and
who represent your company/group to the institution in a befitting manner
and get the work done.
8.2 Importance of Project Presentation
• It will improve the chances of you availing the loan/equity.
• Bankers will be more comfortable to sanction loan if almost all

requirements are submitted by the applicant.
• A well prepared file will make the project manager/promoter better

prepared with the project.
• Bankers will believe that they are dealing with professional people. 
! !153
8.3 Support Documents in the Project Presentation
1. Duly Filled Application Form
2. Audited Financial Statements for last three years
3. Audited Financial Statements for last three years of associate concerns
4. Memorandum and Articles of Association/Certificate of Incorporation/

Certificate of Commencement of Business/Partnership Deed/Trust Deed/
Bye-laws/Registration Certificate from Registrar of Companies/Societies,
as the case may be
5. IT/Wealth Tax assessment orders/returns/certificates for the last 3 years

in the respect of the applicant unit (if in existence) and the promoters
6. Sales Tax Returns and assessment orders for the last three years (if in
existence)
7. Ration card/Passport/Voter ID card of all the promoters/directors/

guarantors
8. Photograph of all the promoters/directors/guarantors with signatures

duly certified by their bankers
9. Biodata and Net worth statements of the promoters/directors/

guarantors duly signed by the concerned individual and certified by a CA
firm
! !154
10. SSI registration certificate/CA certificate for applicability of clubbing

provisions
11. Project feasibility report, if any
12. Collaboration agreement and related details including copy approval

from RBI/Government, if required
13. Agreement with Technical consultants (if any) and related details
including copy approval from RBI/Government, if required
14. Title Documents such as Sale/lease deed/agreement for the land and
buildings on which the project is to be operated/set up and of collateral
securities, if any
15. Government order/permission converting the land into industrial land,

if required
16. Location/site map of the land showing contour lines, the internal
roads, power receiving station, railway siding, tubewells, etc. and
blueprints of the building plan duly approved by the concerned
government/corporation/municipality/Panchayat authorities
17. Details of charges/encumbrances created/to be created on the existing

assets
18. Agreement with the electricity board for sanction of requisite power
load/Electricity Bill for last three months
19. No objection certificate/consent to operate/establish obtained from the

pollution control board (if applicable)
20. Orders/enquiries in hand for the output of the proposed project
21. Invoices/quotations from at least three suppliers for each item of plant
and machinery and miscellaneous fixed assets proposed to be
purchased under the project along with a write up on the technical
specifications, advantages, etc. of the machinery
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22. Justification for choosing a particular supplier of plant and machinery

with details of its credentials
23. Detailed estimates for civil construction with bio-data of the builder/
architect
24. Detailed assumptions underlying the projected profitability statements
25. Please attach worksheet for calculation of cost of various inputs and
break-even point
26. In-principle letter of sanction for working capital assistance to the

applicant unit given by a Bank
27. In case some portion of the expenditure has already been incurred,
please furnish necessary proofs (cash receipts) along with a CA
certificate with regard to sources of finance, items of expenditure, etc.
28. In case a Company has promoted the applicant unit, please furnish
Memorandum and Articles of Association and Audited Balance Sheet
and Trading and Profit and Loss A/cs for the past three years of the
promoter company
29. License/Permissions/Approvals by Regulatory Authority, where

applicable
30. Plan showing layout of machinery and organizational chart
! !156
8.4 Preparing a Business Plan
The promoter must prepare a Business Plan/Presentation stating the long-

term and short-term objectives of his business. It is a important tool for
availing means of funding such as Private Equity, Institutional investors,
etc.
What is a Business Plan?

If you’ve ever jotted down a business idea on a napkin with a few tasks
you need to accomplish, you’ve written a business plan, or at least the very
basic components of one. At its heart, a business plan is just a plan for
how your business is going to work, and how you’re going to make it
succeed.
Typically, a business plan is longer than a list on a napkin (although, as

you’ll see below, it is possible – and sometimes ideal – to write your entire
business plan on one page). For me in practice, and for most real
businesses, it can be as simple as a few bullet points to focus strategy,
milestones to track tasks and responsibilities, and the basic financial
projections you need to plan cash flow budget expenses.
Business plans should only become printed documents on select occasions,

when needed to share information with outsiders or team members.
Otherwise, they should be dynamic documents that you maintain on your
computer. The plan goes on forever, so the printed version is like a
snapshot of what the plan was on the day that it was printed.
If you do need a formal business plan document, then that includes an

executive summary, a company overview, some information about your
products and/or services, your marketing plan, a list of major company
milestones, some information about each member of the management
team and their role in the company, and details of your company’s financial
plan. These are often called the “sections” or “chapters” of the business
plan, and I’ll go into much greater depth about each of them below.
In all cases, the most important section of the business plan is the review
schedule. That’s as simple as “the third Thursday of every month” to cite
one obvious example. That’s the part of the plan that acknowledges that it
is part of a planning process, in which results and metrics will be reviewed
and revised regularly. A real business plan is always wrong — hence the
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regular review and revisions — and never done — because the process of
review and revise is vital.
Unfortunately, many people think of business plans only for starting a new
business or applying for business loans. But business plans are also vital
for running a business, whether or not it needs new loans or new
investments. Existing businesses should have business plans that they
maintain and update as market conditions change and as new
opportunities arise.
Every business has long-term and short-term goals, sales targets, and
expense budgets—a business plan encompasses all of those things, and is
as useful to a start-up trying to raise funds as it is to a 10-year-old
business that’s looking to grow.
Who Needs a Business Plan?

If you’re just planning on picking up some freelance work to supplement
your income, you can skip the business plan. But, if you’re embarking on a
more significant endeavour that’s likely to consume a significant amount of
time, money, and resources, then you need a business plan.
If you’re serious about business, taking planning seriously is critical to your

success.
Start-up Businesses
The most classic business planning scenario is for a start-up, for which the
plan helps the founders break uncertainty down into meaningful pieces,
like the sales projection, expense budget, milestones and tasks. The need
becomes obvious as soon as you recognize that you don’t know how much
money you need, and when you need it, without laying out projected sales,
costs, expenses, and timing of payments. And that’s for all start-ups,
whether or not they need to convince investors, banks, or friends and
family to part with their money and fund the new venture. In this case, the
business plan is focused on explaining what the new company is going to
do, how it is going to accomplish its goals, and—most importantly—why
the founders are the right people to do the job. A start-up business plan
also details the amount of money needed to get the business off the
ground, and through the initial growth phases that will lead (hopefully!) to
profitability.
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Existing Businesses
Not all business plans are for start-ups that are launching the next big
thing. Existing businesses use business plans to manage and steer the
business, not just to address changes in their markets and to take
advantage of new opportunities. They use a plan to reinforce strategy,
establish metrics, manage responsibilities and goals, track results, and
manage and plan resources including critical cash flow. And of course, they
use a plan to sets the schedule for regular review and revision.
Business plans can be a critical driver of growth for existing businesses.

Did you know that businesses that write plans and use them to manage
their business grow 30% faster than businesses that take a “seat of the
pants” approach? A recent study by Professor Andrew Burke, the founding
Director of the Bettany Centre for Entrepreneurial Performance and
Economics at Cranfield School of Management, discovered exactly this.
For existing businesses, a robust business planning process can be a

competitive advantage that drives faster growth and greater innovation.
Instead of a static document, business plans in existing businesses become
dynamic tools that are used to track growth and spot potential problems
before they derail the business.
Choosing the right kind of business plan for your business

Considering that business plans serve many different purposes, it’s no
surprise that they come in many different forms.
Before you even start writing your business plan, you need to think about
whom the audience is and what the goals of your plan are. While there are
common components that are found in almost every business plan, such as
sales forecasts and marketing strategy, business plan formats can be very
different depending on the audience and the type of business.
For example, if you’re building a plan for a biotech firm, your plan will go
into details about government approval processes. If you are writing a plan
for a restaurant, details about location and renovations might be critical
factors. And, the language you’d use in the biotech firm’s business plan
would be much more technical than the language you’d use in the plan for
the restaurant.
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Plans can also differ greatly in length, detail, and presentation. Plans that
never leave the office and are used exclusively for internal strategic
planning and management might use more casual language and might not
have much visual polish. On the other end of the spectrum, a plan that is
destined for the desk of a top venture capitalist will have a high degree of
polish and will focus on the high-growth aspects of the business and the
experienced team that is going to deliver stunning results.
Here is a quick overview of three common types of plans:
One-page Business plan

A one-page business plan is exactly what it sounds like: a quick summary
of your business delivered on a single page. No, this doesn’t mean a very
small font size and cramming tons of information onto a single page—it
means that the business is described in very concise language that is direct
and to-the-point.
A one-page business plan can serve two purposes. First, it can be a great
tool to introduce the business to outsiders, such as potential investors.
Since investors have very little time to read detailed business plans, a
simple one-page plan is often a better approach to get that first meeting.
Later, in the process, a more detailed plan will be needed, but the one-
page plan is great for getting in the door.
This simple plan format is also great for early-stage companies that just
want to sketch out their idea in broad strokes. Think of the one-page
business plan as an expanded version of jotting your idea down on a
napkin. Keeping the business idea on one page makes it easy to see the
entire concept at a glance and quickly refine concepts as new ideas come
up.
The Internal Business Plan

The internal business plan dispenses with the formalities that are needed
when presenting a plan externally and focuses almost exclusively on
business strategy, milestones, metrics, budgets, and forecasts. And of
course, it also includes the review schedule for monthly review and
revision. These internal business plans skip details about company history
and management team since everyone in the company almost certainly
knows this information.
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Internal business plans are management tools used to guide the growth of
both start-ups and existing businesses. They help business owners think
through strategic decisions and measure progress towards goals.
External Business Plan (a.k.a. The Standard Business Plan

Document)
External business plans, the formal business plan documents, are designed
to be read by outsiders to provide information about a business. The most
common use is to convince investors to fund a business, and the second
most common is to support a loan application. Occasionally, this type of
business plan is also used to recruit or train or absorb key employees, but
that is much less common.
A formal business plan document is an extension of the internal business

plan. It’s mostly a snapshot of the internal plan as it existed at a certain
time. But while the internal plan is short on polish and formality, a formal
business plan document should be very well-presented, with more
attention to detail in the language and format.
In addition, an external plan details how potential funds are going to be

used. Investors don’t just hand over cash with no strings attached—they
want to understand how their funds will be used and what the expected
return on their investment is.
Finally, external plans put a strong emphasis on the team that is building
the company. Investors invest in people rather than ideas, so it’s critical to
include biographies of key team members and how their background and
experience is going to help grow the company.
What to Include in Your Business Plan?

While we just discussed several different types of business plans, there are
key elements that appear in virtually all business plans. These include the
review schedule, strategy summary, milestones, responsibilities, metrics
(numerical goals that can be tracked), and basic projections. The
projections include sales, costs, expenses, and cash flow.
These core elements grow organically as needed by the business for actual
business purpose.
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And for the formal business plan document, to be read by outsiders for
business purposes such as backing a loan application or seeking
investment, the following summarizes those special case business plans.
Here’s what they normally include:
…………………………………………………………………………………………………………………………
…………………………………………………………………………………………………………………………
Executive Summary
Just like the old adage that you never get a second chance to make a first
impression, the executive summary is your business’s calling card. It needs
to be succinct and hit the key highlights of the plan. Many potential
investors will never make it beyond the executive summary, so it needs to
be compelling and intriguing.
The executive summary should provide a quick overview of the problem

your business solves, your solution to the problem, the business’s target
market, key financial highlights, and a summary of who does what on the
management team.
While it’s difficult to convey everything you might want to convey in the
executive summary, keeping it short is critical. If you hook your reader,
they’ll find more detail in the body of the plan as they continue reading.
You could even consider using your one-page business plan as your
executive summary.
…………………………………………………………………………………………………………………………
…………………………………………………………………………………………………………………………
Company Overview
For external plans, the company overview is a brief summary of the
company’s legal structure, ownership, history, and location. It’s common to
include a mission statement in the company overview, but that’s certainly
not a critical component of all business plans.
The company overview is often omitted from internal plans.
…………………………………………………………………………………………………………………………
…………………………………………………………………………………………………………………………
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Products and Services

The products and services chapter of your business plan delves into the
core of what you are trying to achieve. In this section, you will detail the
problem you are solving, how you are solving it, the competitive landscape,
and your business’s competitive edge.
Depending on the type of company you are starting, this section may also
detail the technologies you are using, intellectual property that you own,
and other key factors about the products that you are building now and
plan on building in the future.
…………………………………………………………………………………………………………………………
…………………………………………………………………………………………………………………………
Target Market
As critical as it is that your company is solving a real-world problem that
people or other businesses have, it’s equally important to detail who you
are selling to. Understanding your target market is key to building
marketing campaigns and sales processes that work. And, beyond
marketing, your target market will define how your company grows.
…………………………………………………………………………………………………………………………
…………………………………………………………………………………………………………………………
Marketing and Sales Plan

The marketing and sales plan details the strategies that you will use to
reach your target market. This portion of your business plan provides an
overview of how you will position your company in the market, how you
will price your products and services, how you will promote your offerings,
and any sales processes you need to have in place.
…………………………………………………………………………………………………………………………
…………………………………………………………………………………………………………………………
Milestones and Metrics

Plans are nothing without solid implementation. The milestones and
metrics chapter of your business plan lays out concrete tasks that you plan
to accomplish complete with due dates and the names of the people to be
held responsible.
This chapter should also detail the key metrics that you plan to use to track
the growth of your business. This could include the number of sales leads
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generated, the number of page views to your website, or any other critical
metric that helps determine the health of your business.
…………………………………………………………………………………………………………………………
…………………………………………………………………………………………………………………………
Management Team
The management team chapter of a business plan is critical for
entrepreneurs seeking investment, but can be omitted for virtually any
other type of plan.
The management team section should include relevant team bios that
explain why your management personnel are the right people for their
jobs. After all, good ideas are a dime a dozen—it’s a talented entrepreneur
who can take those ideas and turn them into thriving businesses.
Business plans should help identify not only strengths of a business, but
areas that need improvement and gaps that need to be filled. Identifying
gaps in the management team shows knowledge and foresight, not a lack
of ability to build the business.
…………………………………………………………………………………………………………………………
…………………………………………………………………………………………………………………………
Financial Plan
The financial plan is a critical component of nearly all business plans.
Running a successful business means paying close attention to how much
money you are bringing in, and how much money you are spending. A
good financial plan goes a long way to help determine when to hire new
employees or buy a new piece of equipment.
If you are a start-up and/or are seeking funding, a solid financial plan helps
you figure out how much capital your business needs to get started or to
grow, so you know how much money to ask for from the bank or from
investors.
A typical financial plan includes:
• Sales Forecast
• Personnel Plan
• Profit and Loss Statement
• Cash Flow Statement
• Balance Sheet
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For more details on what to include in your business plan, check out
our detailed business plan outline, download a business plan template in
Word format, or read through our library of sample business plans so you
can see how other businesses have structured their plans and how they
describe their business strategy.
Using Your Business Plan to Get Ahead

I mentioned earlier in this article that businesses that write business plans
grow 30% faster than businesses that don’t plan. Taking the simple step
forward to do any planning at all will certainly put your business at a
significant advantage over businesses that just drive forward with no
specific plans.
But just writing a business plan does not guarantee your success.
The best way to extract value from your business plan is to use it as an
ongoing management tool. To do this, your business plan must be
constantly revisited and revised to reflect current conditions and the new
information that you’ve collected as you run your business.
When you’re running a business, you are learning new things every day:
what your customers like, what they don’t like, which marketing tactics
work, which ones don’t. Your business plan should be a reflection of those
learnings to guide your future strategy.
This all sounds like a lot of work, but it doesn’t have to be. Here are some
tips to extract the most value from your plan in the least amount of time:
1. Use your one-page business plan to quickly outline your strategy. Use
this document to periodically review your high-level strategy. Are you
still solving the same problem for your customers? Has your target
market changed?
2. Use an internal plan to document processes that work. Share this

document with new employees to give them a clear picture of your
overall strategy.
3. Set milestones for what you plan to accomplish in the next 30 days.
Assign these tasks to team members, set dates, and allocate part of
your budget, if necessary.
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4. Keep your sales forecast and expense budget current. As you learn
more about customer buying patterns, revise your forecast.
5. Compare your planned budgets and forecasts with your actual results at
least monthly. Make adjustments to your plan based on the results.
The final, most important aspect of leveraging your business plan as a

growth engine is to schedule a monthly review. The review doesn’t have to
take longer than an hour, but it needs to be a regular recurring meeting on
your calendar. In your monthly review, go over your key numbers
compared to your plan, review the milestones you planned to accomplish,
set new milestones, and do a quick review of your overall strategy.
It’s easier than it sounds, and can put you in that “30% growth” club faster
than you think.
A format of a business plan covering almost all points required by various

stakeholders is annexed hereto.
Importance of a Business Plan

Why do you want a business plan? You already know the obvious reasons,
but there are so many other good reasons to create a business plan that
many business owners don’t know about. So, just for a change, let’s take a
look at the less obvious reasons first and finish with the ones you probably
already know about. Think of this as a late-show top 10, with us building
up to the most important reasons you need a business plan.
1. Set specific objectives for managers. Good management requires

setting specific objectives and then tracking and following up. I’m
surprised how many existing businesses manage without a plan. How do
they establish what’s supposed to happen? In truth, you’re really just
taking a short-cut and planning in your head—and good for you if you
can do it, but as your business grows you want to organize and plan
better, and communicate the priorities better. Be strategic. Develop a
plan; don’t just wing it.
2. Share your strategy, priorities and specific action points with

your spouse, partner or significant other. Your business life goes by
so quickly: a rush of answering phone calls, putting out fires, etc. Don’t
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the other people in your business life need to know what’s supposed to
be happening? Don’t you want them to know?
3. Deal with displacement. Displacement is probably by far the most

important practical business concept you’ve never heard of. It goes like
this: “Whatever you do is something else you don’t do.” Displacement
lives at the heart of all small business strategy. At least most people
have never heard of it.
4. Decide whether or not to rent new space. Rent is a new obligation,

usually a fixed cost. Do your growth prospects and plans justify taking
on this increased fixed cost? Shouldn’t that be in your business plan?
5. Hire new people. This is another new obligation (a fixed cost) that
increases your risk. How will new people help your business grow and
prosper? What exactly are they supposed to be doing? The rationale for
hiring should be in your business plan.
6. Decide whether you need new assets, how many, and whether to
buy or lease them. Use your business plan to help decide what’s going
to happen in the long term, which should be an important input to the
classic make vs. buy. How long will this important purchase last in your
plan?
7. Share and explain business objectives with your management

team, employees and new hires. Make selected portions of your
business plan part of your new employee training.
8. Develop new business alliances. Use your plan to set targets for new
alliances, and selected portions of your plan to communicate with those
alliances.
9. Deal with professionals. Share selected highlights or your plans with

your attorneys and accountants, and, if this is relevant to you,
consultants.
10.Sell your business. Usually, the business plan is a very important part
of selling the business. Help buyers understand what you have, what it’s
worth and why they want it.
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11.Valuation of the business for formal transactions related to

divorce, inheritance, estate planning and tax issues. Valuation is
the term for establishing how much your business is worth. Usually that
takes a business plan, as well as a professional with experience. The
plan tells the valuation expert what your business is doing, when, why
and how much that will cost and how much it will produce.
12.Create a new business. Use a plan to establish the right steps to

starting a new business, including what you need to do, what resources
will be required, and what you expect to happen.
13.Seek investment for a business, whether it’s a start-up or not.

Investors need to see a business plan before they decide whether or not
to invest. They’ll expect the plan to cover all the main points.
14.Back up a business loan application. Like investors, lenders want to

see the plan and will expect the plan to cover the main points.
15.Grow your existing business. Establish strategy and allocate

resources according to strategic priority.
Business Plan for a Start-up Business

The business plan consists of a narrative and several financial worksheets.
The narrative template is the body of the business plan. It contains more
than 150 questions divided into several sections. Work through the sections
in any order that you want, except for the Executive Summary, which
should be done last. Skip any questions that do not apply to your type of
business. When you are finished writing your first draft, you’ll have a
collection of small essays on the various topics of the business plan. Then
you’ll want to edit them into a smooth-flowing narrative.
The real value of creating a business plan is not in having the finished
product in hand; rather, the value lies in the process of researching and
thinking about your business in a systematic way. The act of planning helps
you to think things through thoroughly, study and research if you are not
sure of the facts, and look at your ideas critically. It takes time now, but
avoids costly, perhaps disastrous, mistakes later.
This business plan is a generic model suitable for all types of businesses.
However, you should modify it to suit your particular circumstances. Before
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you begin, review the section titled Refining the Plan, found at the end. It
suggests emphasizing certain areas depending upon your type of business
(manufacturing, retail, service, etc.). It also has tips for fine-tuning your
plan to make an effective presentation to investors or bankers. If this is
why you’re creating your plan, pay particular attention to your writing
style. You will be judged by the quality and appearance of your work as
well as by your ideas.
It typically takes several weeks to complete a good plan. Most of that time
is spent in research and rethinking your ideas and assumptions. But then,
that’s the value of the process. So, make time to do the job properly.
Those who do never regret the effort. And finally, be sure to keep detailed
notes on your sources of information and on the assumptions underlying
your financial data.
8.5 Format of a Business Plan
A sample format for preparing a Business Plan is as under:
Business Plan
OWNERS
Your Business Name
Street Address
Address 2
City, ST ZIP Code
Telephone
Fax
E-mail
…………………………………………………………………………………………………………………………
I. Table of Contents
I. Table of Contents
II. Executive Summary
III. General Company Description
IV. Products and Services
V. Marketing Plan
VI. Operational Plan
VII. Management and Organization
VIII. Personal Financial Statements
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IX. Start-up Expenses and Capitalization

X. Financial Plan
XI. Appendices
XII. Refining the Plan
…………………………………………………………………………………………………………………………
II. Executive Summary
Write this section last.
We suggest that you make it two pages or fewer.

Include everything that you would cover in a five-minute interview.
Explain the fundamentals of the proposed business: What will your product
be? Who will your customers be? Who are the owners? What do you think
the future holds for your business and your industry?
Make it enthusiastic, professional, complete, and concise.
If applying for a loan, state clearly how much you want, precisely how you
are going to use it, and how the money will make your business more
profitable, thereby ensuring repayment.
…………………………………………………………………………………………………………………………
III. General Company Description
What business will you be in? What will you do?
Mission Statement: Many companies have a brief mission statement,

usually in 30 words or fewer, explaining their reason for being and their
guiding principles. If you want to draft a mission statement, this is a good
place to put it in the plan, followed by:
Company Goals and Objectives: Goals are destinations—where you

want your business to be. Objectives are progress markers along the way
to goal achievement. For example, a goal might be to have a healthy,
successful company that is a leader in customer service and that has a
loyal customer following. Objectives might be annual sales targets and
some specific measures of customer satisfaction.
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Business Philosophy: What is important to you in business?
To whom will you market your products? (State it briefly here—you will do
a more thorough explanation in the Marketing Plan section).
Describe your industry. Is it a growth industry? What changes do you

foresee in the industry, short term and long term? How will your company
be poised to take advantage of them?
Describe your most important company strengths and core competencies.

What factors will make the company succeed? What do you think your
major competitive strengths will be? What background experience, skills,
and strengths do you personally bring to this new venture?
Legal Form of Ownership: Sole proprietor, Partnership, Corporation,

Limited Liability Corporation (LLC)? Why have you selected this form?
…………………………………………………………………………………………………………………………
IV. Products and Services

Describe in depth your products or services (technical specifications,
drawings, photos, sales brochures, and other bulky items belong in
Appendices).
What factors will give you competitive advantages or disadvantages?

Examples include level of quality or unique or proprietary features.
What are the pricing, fee, or leasing structures of your products or
services?
…………………………………………………………………………………………………………………………
V. Marketing Plan
Market Research – Why?

No matter how good your product and your service, the venture cannot
succeed without effective marketing. And this begins with careful,
systematic research. It is very dangerous to assume that you already know
about your intended market. You need to do market research to make sure
you’re on track. Use the business planning process as your opportunity to
uncover data and to question your marketing efforts. Your time will be well
spent.
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Market Research – How?
There are two kinds of market research: primary and secondary.
Secondary research means using published information such as industry

profiles, trade journals, newspapers, magazines, census data, and
demographic profiles. This type of information is available in public
libraries, industry associations, chambers of commerce, from vendors who
sell to your industry, and from government agencies.
Start with your local library. Most librarians are pleased to guide you
through their business data collection. You will be amazed at what is there.
There are more online sources than you could possibly use. Your chamber
of commerce has good information on the local area. Trade associations
and trade publications often have excellent industry-specific data.
Primary research means gathering your own data. For example, you could
do your own traffic count at a proposed location, use the yellow pages to
identify competitors, and do surveys or focus group interviews to learn
about consumer preferences. Professional market research can be very
costly, but there are many books that show small business owners how to
do effective research themselves.
In your marketing plan, be as specific as possible; give statistics, numbers,

and sources. The marketing plan will be the basis, later on, of the all-
important sales projection.
Economics
Facts about your industry:
• What is the total size of your market?

• What per cent share of the market will you have? (This is important only
if you think you will be a major factor in the market.)
• Current demand in target market.
• Trends in target market—growth trends, trends in consumer preferences,
and trends in product development.
• Growth potential and opportunity for a business of your size.
• What barriers to entry do you face in entering this market with your new
company? Some typical barriers are:
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○ High capital costs

○ High production costs
○ High marketing costs
○ Consumer acceptance and brand recognition
○ Training and skills
○ Unique technology and patents
○ Unions
○ Shipping costs
○ Tariff barriers and quotas
• And of course, how will you overcome the barriers?
• How could the following affect your company?
○ Change in technology
○ Change in government regulations
○ Change in the economy
○ Change in your industry
Product
In the Products and Services section, you described your products and
services as you see them. Now describe them from your customers’ point
of view.
Features and Benefits
List all of your major products or services.
For each product or service:
• Describe the most important features. What is special about it?
• Describe the benefits. That is, what will the product do for the customer?
Note the difference between features and benefits, and think about them.
For example, a house that gives shelter and lasts a long time is made with
certain materials and to a certain design; those are its features. Its
benefits include pride of ownership, financial security, providing for the
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family, and inclusion in a neighborhood. You build features into your

product so that you can sell the benefits.
What after-sale services will you give? Some examples are delivery,
warranty, service contracts, support, follow-up, and refund policy.
Customers
Identify your targeted customers, their characteristics, and their

geographic locations, otherwise known as their demographics.
The description will be completely different depending on whether you plan

to sell to other businesses or directly to consumers. If you sell a consumer
product, but sell it through a channel of distributors, wholesalers, and
retailers, you must carefully analyze both the end consumer and the
middleman businesses to which you sell.
You may have more than one customer group. Identify the most important
groups. Then, for each customer group, construct what is called a
demographic profile:
• Age
• Gender
• Location
• Income level
• Social class and occupation
• Education
• Other (specific to your industry)
For business customers, the demographic factors might be:
• Industry (or portion of an industry)

• Location
• Size of company
• Quality, technology, and price preferences
• Other (specific to your industry)
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Competition
What products and companies will compete with you?
List your major competitors:
(Names and addresses)
Will they compete with you across the board, or just for certain products,
certain customers, or in certain locations?
Will you have important indirect competitors? (For example, video rental
stores compete with theaters, although they are different types of
businesses.)
How will your products or services compare with the competition?
Use the Competitive Analysis table below to compare your company with
your two most important competitors. In the first column are key
competitive factors. Since these vary from one industry to another, you
may want to customize the list of factors.
In the column labeled Me, state how you honestly think you will stack up
in customers’ minds. Then check whether you think this factor will be a
strength or a weakness for you. Sometimes, it is hard to analyze our own
weaknesses. Try to be very honest here. Better yet, get some disinterested
strangers to assess you. This can be a real eye-opener. And remember that
you cannot be all things to all people. In fact, trying to be causes many
business failures because efforts become scattered and diluted. You want
an honest assessment of your company’s strong and weak points.
Now, analyze each major competitor. In a few words, state how you think
they compare.
In the final column, estimate the importance of each competitive factor to

the customer. 1 = critical; 5 = not very important.
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Table 1: Competitive Analysis

Importance
Competitor Competitor
Factor Me Strength Weakness to
A B
Customer
Products
Price
Quality
Selection
Service
Reliability
Stability
Expertise
Company
Reputation
Location
Appearance
Sales
Method
Credit
Policies
Advertising
Image
Now, write a short paragraph stating your competitive advantages and

disadvantages.
Niche
Now that you have systematically analyzed your industry, your product,
your customers, and the competition, you should have a clear picture of
where your company fits into the world.
In one short paragraph, define your niche, your unique corner of the
market.
Strategy
Now outline a marketing strategy that is consistent with your niche.
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Promotion
How will you get the word out to customers?
Advertising
What media, why, and how often? Why this mix and not some other?
Have you identified low-cost methods to get the most out of your
promotional budget?
Will you use methods other than paid advertising, such as trade shows,
catalogs, dealer incentives, word-of-mouth (how will you stimulate it?),
and network of friends or professionals?
What image do you want to project? How do you want customers to see
you?
In addition to advertising, what plans do you have for graphic image

support? This includes things like logo design, cards and letterhead,
brochures, signage, and interior design (if customers come to your place of
business).
Should you have a system to identify repeat customers and then

systematically contact them?
Promotional Budget
How much will you spend on the items listed above?
Before start-up? (These numbers will go into your startup budget.)
Ongoing? (These numbers will go into your operating plan budget.)
Pricing
Explain your method or methods of setting prices. For most small
businesses, having the lowest price is not a good policy. It robs you of
needed profit margin; customers may not care as much about price as you
think; and large competitors can underprice you anyway. Usually, you will
do better to have average prices and compete on quality and service.
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Does your pricing strategy fit with what was revealed in your competitive
analysis?
Compare your prices with those of the competition. Are they higher, lower,
the same? Why?
How important is price as a competitive factor? Do your intended

customers really make their purchase decisions mostly on price?
What will be your customer service and credit policies?
Proposed Location
Probably, you do not have a precise location picked out yet. This is the time
to think about what you want and need in a location. Many start-ups run
successfully from home for a while.
You will describe your physical needs later, in the Operational Plan section.
Here, analyze your location criteria as they will affect your customers.
Is your location important to your customers? If yes, how?
If customers come to your place of business:
Is it convenient? Parking? Interior spaces? Not out of the way?
Is it consistent with your image?
Is it what customers want and expect?
Where is the competition located? Is it better for you to be near them (like
car dealers or fast-food restaurants) or distant (like convenience food
stores)?
Distribution Channels
How do you sell your products or services?
Retail
Direct (mail order, Web, catalog)
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Wholesale
Your own sales force
Agents
Independent representatives
Bid on contracts
Sales Forecast
Now that you have described your products, services, customers, markets,
and marketing plans in detail, it’s time to attach some numbers to your
plan. Use a sales forecast spreadsheet to prepare a month-by-month
projection. The forecast should be based on your historical sales, the
marketing strategies that you have just described, your market research,
and industry data, if available.
You may want to do two forecasts: (1) a “best guess”, which is what you
really expect, and (2) a “worst case” low estimate that you are confident
you can reach no matter what happens.
Remember to keep notes on your research and your assumptions as you

build this sales forecast and all subsequent spreadsheets in the plan. This
is critical if you are going to present it to funding sources.
…………………………………………………………………………………………………………………………
VI. Operational Plan

Explain the daily operation of the business, its location, equipment, people,
processes, and surrounding environment.
Production
How and where are your products or services produced?
Explain your methods of:

• Production techniques and costs
• Quality control
• Customer service
• Inventory control
• Product development
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Location
What qualities do you need in a location? Describe the type of location
you’ll have.
Physical requirements:
• Amount of space
• Type of building
• Zoning
• Power and other utilities
Access:
Is it important that your location be convenient to transportation or to

suppliers?
Do you need easy walk-in access?
What are your requirements for parking and proximity to freeway, airports,
railroads, and shipping centers?
Include a drawing or layout of your proposed facility if it is important, as it

might be for a manufacturer.
Construction: Most new companies should not sink capital into

construction, but if you are planning to build, costs and specifications will
be a big part of your plan.
Cost: Estimate your occupation expenses, including rent, but also including
maintenance, utilities, insurance, and initial remodeling costs to make the
space suit your needs. These numbers will become part of your financial
plan.
What will be your business hours?
! !180
Legal Environment
Describe the following:

• Licensing and bonding requirements
• Permits
• Health, workplace, or environmental regulations
• Special regulations covering your industry or profession
• Zoning or building code requirements
• Insurance coverage
• Trademarks, copyrights, or patents (pending, existing, or purchased)
Personnel
• Number of employees
• Type of labor (skilled, unskilled, and professional)
• Where and how will you find the right employees?
• Quality of existing staff
• Pay structure
• Training methods and requirements
• Who does which tasks?
• Do you have schedules and written procedures prepared?
• Have you drafted job descriptions for employees? If not, take time to
write some. They really help internal communications with employees.
• For certain functions, will you use contract workers in addition to
employees?
Inventory
• What kind of inventory will you keep: raw materials, supplies, finished
goods?
• Average value in stock (i.e., what is your inventory investment)?
• Rate of turnover and how this compares to the industry averages?
• Seasonal buildups?
• Lead time for ordering?
! !181
Suppliers
Identify key suppliers:

• Names and addresses
• Type and amount of inventory furnished
• Credit and delivery policies
• History and reliability
Should you have more than one supplier for critical items (as a backup)?
Do you expect shortages or short-term delivery problems?
Are supply costs steady or fluctuating? If fluctuating, how would you deal
with changing costs?
Credit Policies
• Do you plan to sell on credit?

• Do you really need to sell on credit? Is it customary in your industry and
expected by your clientele?
• If yes, what policies will you have about who gets credit and how much?
• How will you check the creditworthiness of new applicants?
• What terms will you offer your customers; that is, how much credit and
when is payment due?
• Will you offer prompt payment discounts? (Hint: Do this only if it is usual
and customary in your industry.)
• Do you know what it will cost you to extend credit? Have you built the
costs into your prices?
Managing Your Accounts Receivable

If you do extend credit, you should do an aging at least monthly to track
how much of your money is tied up in credit given to customers and to
alert you to slow payment problems. A receivables aging looks like the
following table:
Over
30 60 90
Total Current 90
days days days
days
Accounts Receivable Aging
! !182
You will need a policy for dealing with slow paying customers:
• When do you make a phone call?

• When do you send a letter?
• When do you get your attorney to threaten?
Managing Your Accounts Payable

You should also age your accounts payable, what you owe to your
suppliers. This helps you plan whom to pay and when. Paying too early
depletes your cash, but paying late can cost you valuable discounts and
can damage your credit. (Hint: If you know you will be late making a
payment, call the creditor before the due date.)
Do your proposed vendors offer prompt payment discounts?
A payables aging looks like the following table.
Over
30 60 90
Total Current 90
days days days
days
Accounts Receivable Aging
…………………………………………………………………………………………………………………………
VII. Management and Organization

Who will manage the business on a day-to-day basis? What experience
does that person bring to the business? What special or distinctive
competencies? Is there a plan for continuation of the business if this
person is lost or incapacitated?
If you’ll have more than 10 employees, create an organizational chart

showing the management hierarchy and who is responsible for key
functions.
Include position descriptions for key employees. If you are seeking loans or
investors, include resumes of owners and key employees.
! !183
Professional and Advisory Support
List the following:

• Board of directors
• Management advisory board
• Attorney
• Accountant
• Insurance agent
• Banker
• Consultant/s
• Mentor and Key Advisors
…………………………………………………………………………………………………………………………
VIII. Personal Financial Statement

Include personal financial statements for each owner and major
stockholder, showing assets and liabilities held outside the business and
personal net worth. Owners will often have to draw on personal assets to
finance the business, and these statements will show what is available.
Bankers and investors usually want this information as well.
…………………………………………………………………………………………………………………………
IX. Start-up Expenses and Capitalization

You will have many expenses before you even begin operating your
business. It’s important to estimate these expenses accurately and then to
plan where you will get sufficient capital. This is a research project, and the
more thorough your research efforts, the less chance that you will leave
out important expenses or underestimate them.
Even with the best of research, however, opening a new business has a
way of costing more than you anticipate. There are two ways to make
allowances for surprise expenses. The first is to add a little “padding” to
each item in the budget. The problem with that approach, however, is that
it destroys the accuracy of your carefully wrought plan. The second
approach is to add a separate line item, called contingencies, to account for
the unforeseeable. This is the approach we recommend.
Talk to others who have started similar businesses to get a good idea of
how much to allow for contingencies. If you cannot get good information,
we recommend a rule of thumb that contingencies should equal at least
20% of the total of all other start-up expenses.
! !184
Explain your research and how you arrived at your forecasts of expenses.
Give sources, amounts, and terms of proposed loans. Also explain in detail
how much will be contributed by each investor and what per cent
ownership each will have.
…………………………………………………………………………………………………………………………
X. Financial Plan
The financial plan consists of a 12-month profit and loss projection, a four-
year profit and loss projection (optional), a cash flow projection, a
projected balance sheet, and a break-even calculation. Together they
constitute a reasonable estimate of your company’s financial future. More
important, the process of thinking through the financial plan will improve
your insight into the inner financial workings of your company.
12-Month Profit and Loss Projection

Many business owners think of the 12-month profit and loss projection as
the centerpiece of their plan. This is where you put it all together in
numbers and get an idea of what it will take to make a profit and be
successful.
Your sales projections will come from a sales forecast in which you forecast
sales, cost of goods sold, expenses, and profit month-by-month for one
year.
Profit projections should be accompanied by a narrative explaining the

major assumptions used to estimate company income and expenses.
Research Notes: Keep careful notes on your research and assumptions, so

that you can explain them later if necessary, and also so that you can go
back to your sources when it’s time to revise your plan.
Four-year Profit Projection (Optional)

The 12-month projection is the heart of your financial plan. This section is
for those who want to carry their forecasts beyond the first year.
Of course, keep notes of your key assumptions, especially about things

that you expect will change dramatically after the first year.
! !185
Projected Cash Flow

If the profit projection is the heart of your business plan, cash flow is the
blood.
Businesses fail because they cannot pay their bills. Every part of your
business plan is important, but none of it means a thing if you run out of
cash.
The point of this worksheet is to plan how much you need before start-up,
for preliminary expenses, operating expenses, and reserves. You should
keep updating it and using it afterward. It will enable you to foresee
shortages in time to do something about them—perhaps cut expenses, or
perhaps negotiate a loan. But foremost, you shouldn’t be taken by
surprise.
There is no great trick to preparing it: The cash flow projection is just a
forward look at your checking account.
For each item, determine when you actually expect to receive cash (for
sales) or when you will actually have to write a check (for expense items).
You should track essential operating data, which is not necessarily part of
cash flow but allows you to track items that have a heavy impact on cash
flow, such as sales and inventory purchases.
You should also track cash outlays prior to opening in a pre-start-up

column. You should have already researched those for your start-up
expenses plan.
Your cash flow will show you whether your working capital is adequate.
Clearly, if your projected cash balance ever goes negative, you will need
more start-up capital.
This plan will also predict just when and how much you will need to borrow.
Explain your major assumptions, especially those that make the cash flow
differ from the Profit and Loss Projection. For example, if you make a sale
in month one, when do you actually collect the cash? When you buy
inventory or materials, do you pay in advance, upon delivery, or much
later? How will this affect cash flow?
! !186
Are some expenses payable in advance? When?
Are there irregular expenses, such as quarterly tax payments, maintenance

and repairs, or seasonal inventory buildup, that should be budgeted?
Loan payments, equipment purchases, and owner's draws usually do not

show on profit and loss statements but definitely do take cash out. Be sure
to include them.
And of course, depreciation does not appear in the cash flow at all because
you never write a check for it.
Opening Day Balance Sheet

A balance sheet is one of the fundamental financial reports that any
business needs for reporting and financial management. A balance sheet
shows what items of value are held by the company (assets), and what its
debts are (liabilities). When liabilities are subtracted from assets, the
remainder is owners’ equity.
Use a start-up expenses and capitalization spreadsheet as a guide to

preparing a balance sheet as of opening day. Then detail how you
calculated the account balances on your opening day balance sheet.
Optional: Some people want to add a projected balance sheet showing the
estimated financial position of the company at the end of the first year.
This is especially useful when selling your proposal to investors.
Break-Even Analysis
A break-even analysis predicts the sales volume, at a given price, required
to recover total costs. In other words, it’s the sales level that is the dividing
line between operating at a loss and operating at a profit.
Expressed as a formula, break-even is:
Fixed Costs
Break-even Sales =
1- Variable Costs
(where, fixed costs are expressed in dollars, but variable costs are
expressed as a per cent of total sales.)
! !187
Include all assumptions upon which your break-even calculation is based.

…………………………………………………………………………………………………………………………
XI. Appendices
Include details and studies used in your business plan; for example:
• Brochures and advertising materials

• Industry studies
• Blueprints and plans
• Maps and photos of location
• Magazine or other articles
• Detailed lists of equipment owned or to be purchased
• Copies of leases and contracts
• Letters of support from future customers
• Any other materials needed to support the assumptions in this plan
• Market research studies
• List of assets available as collateral for a loan
…………………………………………………………………………………………………………………………
XII. Refining the Plan
The generic business plan presented above should be modified to suit your
specific type of business and the audience for which the plan is written.
For Raising Capital
For Bankers
• Bankers want assurance of orderly repayment. If you intend using this

plan to present to lenders, include:
๏ Amount of loan
๏ How the funds will be used
๏ What this will accomplish—how will it make the business stronger?
๏ Requested repayment terms (number of years to repay). You will
probably not have much negotiating room on interest rate but may be
able to negotiate a longer repayment term, which will help cash flow.
๏ Collateral offered, and a list of all existing liens against collateral.
! !188
For Investors
• Investors have a different perspective. They are looking for dramatic

growth, and they expect to share in the rewards:
๏ Funds needed short-term

๏ Funds needed in two to five years
๏ How the company will use the funds, and what this will accomplish for
growth
๏ Estimated return on investment
๏ Exit strategy for investors (buyback, sale, or IPO)
๏ Percent of ownership that you will give up to investors
๏ Milestones or conditions that you will accept
๏ Financial reporting to be provided
๏ Involvement of investors on the board or in management
For Type of Business
Manufacturing
• Planned production levels

• Anticipated levels of direct production costs and indirect (overhead) costs
—how do these compare to industry averages (if available)?
• Prices per product line
• Gross profit margin, overall and for each product line
• Production/capacity limits of planned physical plant
• Production/capacity limits of equipment
• Purchasing and inventory management procedures
• New products under development or anticipated to come online after
start-up
Service Businesses
• Service businesses sell intangible products. They are usually more

flexible than other types of businesses, but they also have higher labor
costs and generally very little in fixed assets
• What are the key competitive factors in this industry?
• Your prices
• Methods used to set prices
• System of production management
! !189
• Quality control procedures. Standard or accepted industry quality

standards
• How will you measure labor productivity?
• Per cent of work subcontracted to other companies. Will you make a
profit on subcontracting?
• Credit, payment, and collections policies and procedures
• Strategy for keeping client base
High Technology Companies
• Economic outlook for the industry

• Will the company have information systems in place to manage rapidly
changing prices, costs, and markets?
• Will you be on the cutting edge with your products and services?
• What is the status of research and development? And what is required
to:
○ Bring product/service to market?
○ Keep the company competitive?
• How does the company:
○ Protect intellectual property?

○ Avoid technological obsolescence?
○ Supply necessary capital?
○ Retain key personnel?
High-tech companies sometimes have to operate for a long time without

profits and sometimes even without sales. If this fits your situation, a
banker probably will not want to lend to you. Venture capitalists may
invest, but your story must be very good. You must do longer-term
financial forecasts to show when profit take-off is expected to occur. And
your assumptions must be well documented and well argued.
Retail Business
• Company image
• Pricing:
○ Explain mark-up policies.
○ Prices should be profitable, competitive, and in accordance with
company image.
! !190
• Inventory:
○ Selection and price should be consistent with company image.
• Inventory level: Find industry average numbers for annual inventory
turnover rate (available in RMA book). Multiply your initial inventory
investment by the average turnover rate. The result should be at least
equal to your projected first year’s cost of goods sold. If it is not, you
may not have enough budgeted for start-up inventory.
• Customer service policies: These should be competitive and in accord
with company image.
• Location: Does it give the exposure that you need? Is it convenient for
customers? Is it consistent with company image?
• Promotion: Methods used, cost. Does it project a consistent company
image?
• Credit: Do you extend credit to customers? If yes, do you really need to,
and do you factor the cost into prices?
! !191
8.6 Summary
• Presentation of your project/file is a very important aspect of Project

Finance. It improves the chances of you availing the loan, creates a
greater comfort towards your bankers, creates a good impression.
• There is an exhaustive list of documents required to scrutinize your loan

application.
• Business Plan presents the long-term and short-term plan of the

organization. It is an important tool for availing funding.
Activities
1. During the progress of this book, students should enable themselves to

prepare themselves to submit a Capital Project proposal. Students may
start gathering all support documents to submit a project proposal for
institution/bank. Please keep a separate project file and start preparing
and putting following documents in the file. Use very good spring/box
file and good clear xerox copies. Use separators/cardboard leafs to
segregate different papers. Remember that success depends on
presentation. A company with long-term vision with need for funding
over longer tenure will always keeps its presentation and financials in
immaculate order.
a. Prepare Company Profile (following heads must – Name, Addresses,

Contact Details, Name of Directors, Project/Business Activity,
Management Structure, Competitor Details
b. Catalogues/Brochures of products
c. Profile of Promoters/Directors/Partners – Name, Address, Contact

Details, Education Qualifications, Skills, Experience, Responsibilities
in the unit
d. Prepare an Organization Chart
e. Prepare a Employee Chart with details of Key Employees – Name,

Designation, Qualification, Experience, Any special achievements,
Functional duties at the unit
! !192
f. Shareholding Pattern of the Company
g. Copy of Memorandum and Articles of Association/Partnership Deed
h. Copies of audited Balance Sheets and Profit and Loss Statements for
past three years
i. Copies of IT returns – company and directors for past three years
j. Copies of VAT Returns for past three years IT returns (if applicable)
k. Copies of personal balance sheets of directors for past 2 years
l. Copies of Bank Statements for past 12 months – company and

directors
m. Copies of registration with various departments such as SSI,

Pollution Control Board, Electricity Board, etc. (if applicable)
n. Copies of identity and address proofs of the company and directors
2. Prepare a business plan for a business/project in which you are working

in/you desire to create.
1. What is the importance of a properly presented file to your bankers?
2. What is a Business Plan? What is its importance?  
! !193
REFERENCE MATERIAL
chapter
Summary
PPT
MCQ
Video Lecture
! !194
TERM LOANS
Chapter 9
TERM LOANS
Objectives
• Provide a brief overview about Term Loans.

• Learn about the advantages/disadvantages of Term Loans.
• Provide conceptual understanding on features of Term Loans.
• Learn about procedure to avail Term Loan.
• Learn about Syndicated Loans and Foreign Currency Loans.
• Learn the relevance of DSCR Ratio.
• Have a look at the Application Form for Term Loan from Financial
institution.
Structure:
9.1 Introduction
9.2 Advantages/Disadvantages of Term Loans
9.3 Aspects of Term Loans
9.4 Term Loan Procedure
9.5 Syndicated Loans
9.6 Foreign Currency Loans from Financial Institutions
9.7 Debt Service Coverage Ratio (DSCR)
9.8 Summary
! !195
TERM LOANS
9.1 Introduction
Development financial institutions (DFIs) or development banks provide

long-term credit for projects. The rapid industrialization of continental
Europe in the 19th century has been facilitated with the emergence of
DFIs. Many of these institutions were sponsored by national governments
and international organizations. Netherlands set up an institution in 1822;
and in France institutions such as Credit Froncier and Credit Mobilizer were
created dining 1848-1852. In Asia, the Industrial Bank of Japan founded in
1902 assisted not only in the development of the domestic capital markets,
but also obtained equity for the industrial companies in Japan.
To resolve the dearth of long-term funds and the perceived socially

unjustified risk aversion of creditors specialized financial institutions were
set up in India: Industrial Finance Corporation in 1948 followed by the
setting up of State Finance Corporations (SFCs) at the state level under the
State Finance Corporation Act, 1951; Industrial Credit and Investment
Corporation (ICICI) in 1955; and Industrial Development Bank of India
(ICICI) as the apex bank in 1964.
There are investment institutions which mobilize resources and provide

medium- to long-term investment. These are Unit Trust of India (1964)
and LIC and GIC and its subsidiaries; and specialized institutions like the
Technology Development and Information Company of India Ltd. (TDICI),
Tourism Finance Corporation of India (TFCI) and Small Industries
Development Bank of India (SIDBI) to serve in their specified areas. Of the
total disbursements of Rs. 51,885 crores in 1997-98 by the all-India
financial institutions, the three major all-India financial institutions IDBI
(29.2%), IFCI (10.9%) and ICICI (30.5%) account for 70.6%. These
institutions played an important role in acquiring and disseminating skills
necessary to assess investment projects and borrowers creditworthiness.
Companies in India obtain long-term debt mainly by raising term loans or

issuing debentures. Term loans given by banks and financial institutions
have been the primary source of long-term debt for private companies and
most public companies. Term loans, also referred to as term finance,
represent a source of debt finance which is generally repayable in less than
10 years. They are self-liquidating in nature. For western and European
market, issuing bonds is also a part of raising loan term debt. However, the
Indian Bond market is nascent and not very developed.
! !196
TERM LOANS
In India, term loans are typically provided by Commercial Banks, Financial

Institutions like Industrial Development Bank of India (IDBI), Industrial
Finance Corporation of India (IFCI), IL&FS, IDFC, IMF/World Bank, State
Financial Corporations (SFCs), Industrial Credit and Investment
Corporation of India (ICICI), Power Finance Corporation, HUDCO,
Insurance Companies (LIC and GIC), Small Industries Development Bank
of India (SIDBI) and investment companies.
Term Loans typically are those having maturity between 7 to 10 years.

Term loans make take the form of an ordinary loan or a revolving credit. In
an ordinary term loan, the funds are arranged for a period of one year upto
10 years as per the loan agreement. Line of Credit, is a commitment by the
lender to lend a certain amount of money to a company for a certain
specified period of time.
Usually, Term Loans are self-liquidating in nature. Lenders do ask for

audited annual reports every year till the loan is liquidated. They undertake
inspections during the development stage and at least once in a year.
Valuation reports are taken prior to each disbursement. However, there is
no monthly Stock and Book Debts statements to be submitted as in case of
Working Capital facilities.
9.2 Advantages/Disadvantages of Term Loans
A term loan is the most traditional (and generic) type of loan for
businesses and consumers. Term loans have a specific duration, payment
frequency and carry fixed interest rates.
Some advantages of term loans include the following:
1. Payment w i l l be the s ame every month – budgeti ng i s

straightforward.
2. Rate does not change – not at mercy of the interest rate markets.
3. Accounting entries for term loan transactions are clear and easy.
4. Helpful for improving a credit report – steady but sure wins the race.
! !197
TERM LOANS
Debt is least costly source of long-term financing. It is the least costly

because:
1. Interest on debt is tax-deductible,

2. Bondholders or creditors consider debt as a relatively less
risky investment and require lower return.
3. Debt financing provides sufficient flexibility in the financial/capital
structure of the company. Flexibility in capital structure of the
company can be increased by inserting call provision in the bond
indenture. In case of overcapitalization, the company can redeem the
debt to balance its capitalization.
4. Bondholders are creditors and have no interference in business
operations because they are not entitled to vote.
5. The company can enjoy tax saving on interest on debt.
Some Disadvantages of term loans include the following:
1. Interest on debt is permanent burden to the company. Company has to

pay the interest to bondholders or creditors at fixed rate whether it
earns profit or not. It is legally liable to pay interest on debt.
2. Debt usually has a fixed maturity date. Therefore, the financial officer
must make provision for repayment of debt.
3. Debt is the most risky source of long-term financing. Company must

pay interest and principal at specified time. Non-payment of interest
and principal on time take the company into bankruptcy.
4. Debenture indentures may contain restrictive covenants which may limit

the company’s operating flexibility in future.
5. Only large scale, creditworthy firm, whose assets are good for collateral
can raise capitalfrom long-term debt.
6. Any change in need requires a new/additional loan.
7. If interest rates go down, interest expense payments are higher relative

to the market rate.
! !198
TERM LOANS
8. Many term loans have prepayment penalties.
9.3 Aspects of Term Loans
The following features of term loans are discussed below:
• Currency
• Purpose
• Interest and Principal Payment
• Period of Repayment, Moratorium Period
• Security
• Cost
• Flexibility
• Guarantee/s
• Pre-disbursement and Special Conditions
• Protective Covenants
9.4 Term Loan Procedure
The procedure associated with a term loan involves the following steps:
9.4.1 Submission of Loan Application
The borrower submits an application form which seeks comprehensive

information about the project. The application form covers the following
aspects:
• Promoters’ background
• Particulars of the industrial concern
• 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
• Means of financing
• Marketing and selling arrangements
• Profitability and cash flow
• Economic considerations
• Government consents
! !199
TERM LOANS
9.4.2 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 not.
9.4.3 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 two months after site inspection. Based on
that, a decision is taken whether the project will be accepted or not.
9.4.4 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.
9.4.5 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 to be conveyed to the financial institution within a
stipulated period.
9.4.6 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 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.
! !200
TERM LOANS
9.4.7 Creation of Security

The term loans (both rupee and foreign currency) 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 movable properties. As the
creation of mortgage, particularly in the case of land, tends to be a time-
consuming process, the institutions permit interim disbursements. The
mortgage, however, has to be created within a year from the date of the
first disbursement. Otherwise, the borrower has to pay an additional
charge of 1% interest.
9.4.8 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, contribution 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 financial institution 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.
9.4.9 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:
i. Regular reports, furnished by the company, which provide information

about placement of orders, construction of buildings, procurement of
plant, installation of plant and machinery trial production, etc.,
ii. Periodic site visits,
iii. Discussion with promoters, bankers, suppliers, creditors, and others
connected with the project,
iv. Progress reports submitted by the nominee directors, and
v. Audited accounts of the company.
During the operational stage, the project is monitored with the help of:
i. quarterly performance reports on the project,

ii. site inspection,
! !201
TERM LOANS
iii. reports of nominee directors, and

iv. comparison of performance with promise.
The most important aspect of monitoring, of course, is the timely recovery

of due represented by interest and principal repayment.
9.5 Syndicated Loans
Syndication is an arrangement wherein several banks participate in single

loan. The corporate seeking a syndicated loan chooses a lead bank to
manage the same. The lead bank prepares an information memorandum
which is sent to other banks potentially interested in participating in the
syndicated loan. Based on the interest evinced by the participating banks,
the lead bank works out the sharing arrangement.
While bilateral loans are preferred for small ticket loans, syndicated loans
are becoming popular for large ticket loan. For example, IDBI Bank lead
managed a Rs. 6,000 crore syndicated loan for HINDALCO in 2005. The
loan has a tenor of 10 years with a reset after five years. Thirty banks
participated in this loan which was priced at five-year G-Sec yield plus 65
basis points.
How is loan syndication different from consortium financing which was

popular earlier? Consortium financing involved a presentation to be given
by the company to a group of bankers and was more rule-based. Further,
under a consortium arrangement, participating banks offered other
services like letter of credit, working capital credit, guarantees and so and
interacted regularly with the company.
! !202
TERM LOANS
9.6 Foreign Currency Loans from Financial Institutions
Wherever imported machinery and equipment is necessary, the financial

institutions provide the necessary foreign exchange loan after assessing
the viability of the project. The foreign currency loans are part of various
lines of credit for financing projects based on imported plant and
equipment. Some of the lines of credit are Eurodollar loans, export credit
from UK, Japanese yen loans, Deutsche Mark Revolving Funds and KFW,
Germany. The loan covers CIF value of the capital goods and the know-how
fees. Interest rate depends on the rate applicable to the foreign currency
funds utilized by the financial institution. IFCI, IDBI and ICICI grant foreign
currency loans.
All India financial institutions (IDBI, IFCI and ICICI) operate Exchange Rate
Administration Scheme (ERAS) to cover the risk of foreign exchange rate
fluctuations. The institutions carry the risk themselves and charge a
composite rate to the borrower. The composite rate is announced from time
to time for ERAS loans to be sanctioned during the period as a band of
interest rates.
9.7 Debt Service Coverage Ratio (DSCR)
Debt Service Coverage Ratio (DSCR) essentially calculates the repayment

capacity of a borrower. DSCR less than 1 suggests inability of firm’s profits
to serve its debts whereas a DSCR greater than 1 means not only serving
the debt obligations but also the ability to pay the dividends.
Debt Service Coverage Ratio (DSCR), one of the leverage/coverage ratios,

is calculated in order to know the cash profit availability to repay the debt
including interest. Essentially, DSCR is calculated when a company/firm
takes loan from bank/financial institution/any other loan provider. This ratio
suggests the capability of cash profits to meet the repayment of the
financial loan. DSCR is very important from the viewpoint of the financing
authority as it indicates repaying capability of the entity taking loan.
Just a year’s analysis of DSCR does not lead to any concrete conclusion
about the debt servicing capability. DSCR is relevant only when it is seen
for the entire remaining period of loan.
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TERM LOANS
How to Calculate Debt Service Coverage Ratio?
Calculation of DSCR is very simple. To calculate this ratio, following items

from the financial statement are required:
• Profit after tax (PAT)

• Non-cash expenses (e.g., Depreciation, Miscellaneous expenses written
off etc.)
• Interest for the current year
• Instalment for the current year
• Lease Rental for the current year.
Sometimes, these figures are readily available but at times, they are to be
determined using the financial statements of the company/firm. Formula
for DSCR is stated as follows:
PAT + Interest + Lease rental + Non-cash expenses

DSCR =
Instalment (Interest + Principal repayment) + Lease Rental
• Profit After Tax (PAT): PAT is generally available readily on the face of
the Profit and Loss account. It is the balance of the profit and loss
account which is transferred to the reserve and surplus fund of the
business. Sometimes, in absence of the profit and loss statement, we can
also find it from the balance sheet by subtracting the current year
P&L account from the previous year’s balance, which is readily available
under the head of reserve and surplus.
• Interest: The amount which is paid or payable for the financial year
under concern on the loan taken.
• Non-Cash Expenses: Non-cash expenses are those expenses which are

charged to the profit and loss account for which payment has already
been done in the past years. Following are the non cash expenses:
- Writing off of preliminary expenses, pre-operative expenses, etc.

- Depreciation on the fixed assets
- Amortization of the intangible assets like goodwill, trademark, patent,
copyright, etc.
- Provisions for doubtful debts
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TERM LOANS
- Deferment of expenses like advertisement, promotion, etc.
• Instalment Amount: The amount which is paid or payable for the

financial year under review for the loan taken. It includes the payment
towards principal and interest for the financial year.
• Lease Rental: The amount of lease rent paid or payable for the financial
year.
Interpretation of Debt Service Coverage Ratio

Just calculating a ratio does not serve the purpose till it is not interpreted
in the correct sense. The result of a debt service coverage ratio is an
absolute figure. Higher this figure better is the debt serving capacity. If the
ratio is less than 1, it is considered bad because it simply indicates that the
profits of the firm are not sufficient to service its debt obligations.
Acceptable industry norm for a debt service coverage ratio is between 1.5
to 2. The ratio is of utmost use to lenders of money such as banks,
financial institutions etc. There are two objectives of any financial
institution behind giving loan to a business, viz., earning interest and not
letting the account go bad.
Let’s take an example where the DSCR is coming to be less than 1, which
directly indicate negative views about the repayment capacity of the firm.
Does this mean that the bank should not extend loan? No, absolutely not.
It is because the bank will analyze the profit generating capacity and
business idea as a whole and if the business is strong in both of them; the
DSCR can be improved by increasing the term of loan. Increasing the term
of loan will reduce the denominator of the ratio and thereby enlarge the
ratio to greater than 1.
! !205
TERM LOANS
!
Term Loans remain a favorite avenue of raising funds for setting up new
projects
! !206
TERM LOANS
9.8 Summary
• Term Loans is a long-term debt having maturity period from 7 to 10

years.
• There are various advantages of Term Loans such as simple repayment,

rate is fixed, less cost, interest cost is tax-deductible, relatively less risk.
• There are various disadvantages of Term Loans such as being permanent

burden on company, having fixed maturity date, most risky of long-term
financing, less operating flexibility, only large creditworthy companies can
avail, prepayment penalties, etc.
• Term Loan has many aspects such as Currency, Interest and Principal
Repayment, Period of Repayment, Security, Guarantee, Pre-disbursement
and Special Conditions, Protective Covenants, etc.
• Term Loan procedure comprises of submission of loan application file,

initial processing, appraisal, issue of letter of sanction, acceptance of
terms of sanction, execution of loan agreement, creation of security,
disbursement of loans and monitoring.
• Syndicated Loans are used when the requirement is larger with

participation from multiple banks.
• Foreign Currency Loans are used when imported machinery and

equipment is necessary for the project.
• Debt Service Coverage Ratio (DSCR) essentially calculates the repayment

capacity of a borrower.
Activity
1. Have a look at Application Form for Credit Facilities from a financial

institution. Make a soft copy in MS Excel and try filling in all the details
as per your project/industry.
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TERM LOANS
1. Define a term loan. Discuss some of the characteristics of a typical term

loan.
2. State the sources of term loans.
3. What are the advantages/disadvantages of Term Loans?
4. What are the aspects of Term Loans?
5. What is procedure to avail Term Loan?
6. How do you negotiate effective Term Loan Arrangements?
7. What is relevance of DSCR Ratio? Explain in detail.
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TERM LOANS
TYPICAL FORM FOR APPLICATION FORM FOR CREDIT FACILITIES
Kindly study the data and documentation requirements of the institution.

Students already working on projects can copy the requirements in Word
format and start filling in the details.
SMALL-SCALE INDUSTRIES (SSI)
APPLICATION FORM FOR CREDIT FACILITIES
(Term Loan plus Working Capital)*
(To be submitted in duplicate)
(*For Working Capital application to be submitted to a Commercial Bank

separately)
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TERM LOANS
LOAN APPLICATION – CHECKLIST
Please enclose Certified Xerox Copy of:

Sr. List of Documents to be Furnished/  Enclosure Furnished
No. Enclosures to be Completed No. (Yes/No)
Audited Financial statements for the last three

1
years of the applicant unit (if in existence).
Audited Financial statements for the last three

2 years of all the associate concerns of the
applicant unit.
Memorandum and Articles of Association/

Certificate of Incorporation/Certificate of
Commencement of business/ Partnership Deed/
3
Trust Deed/Bye-laws/Registration Certificate
from Registrar of companies/Societies, as the
case may be.
IT/Wealth Tax assessment orders/returns/

certificates for the last 3 years in the respect of
4
the applicant unit (if in existence) and the
promoters.
Sales Tax Returns and assessment orders for the

5
last three years (if in existence).
Ration card/Passport/Voter ID card of all the

6
promoters/ directors/guarantors.
Photograph of all the promoters/directors/

7 guarantors with signatures duly certified by their
bankers.
Bio-data and Net worth statements of the

promoters/directors/ guarantors duly signed by
8
the concerned individual and certified by a CA
firm.
SSI registration certificate/CA certificate for

9
applicability of clubbing provisions.
10 Project feasibility report, if any.
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TERM LOANS
Collaboration agreement and related details

11 including copy approval from RBI/Government, if
required.
Agreement with Technical consultants (if any)

12 and related details including copy approval from
RBI/Government, if required.
Title Documents such as Sale/lease deed/

agreement for the land and buildings on which
13
the project is to be operated/set up and of
collateral securities, if any.
Government order/permission converting the

14
land into industrial land, if required.
Location/site map of the land showing contour

lines, the internal roads, power receiving station,
railway siding, tubewells, etc. and blueprints of
15
the building plan duly approved by the
concerned government/corporation/
municipality/Panchayat authorities.
Details of charges/encumbrances created/to be

16
created on the existing assets.
Agreement with the electricity board for sanction

17 of requisite power load/Electricity Bill for last
three months.
No objection certificate/consent to operate/

18 establish obtained from the pollution control
board (if applicable).
Orders/enquiries in hand for the output of the

19
proposed project.
Invoices/quotations from at least three suppliers

for each item of plant and machinery and
miscellaneous fixed assets proposed to be
20
purchased under the project along with a write-
up on the technical specifications, advantages,
etc. of the machinery.
Justification for choosing a particular supplier of

21 plant and machinery with details of its
credentials.
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TERM LOANS
Detailed estimates for civil construction with bio-

22
data of the builder/architect.
Detailed assumptions underlying the projected

23
profitability statements as per Annexure XI.
Please attach worksheet for calculation of cost of

24
various inputs and break-even point.
In-principle letter of sanction for working capital

25
assistance to the applicant unit given by a Bank.
In case some portion of the expenditure has

already been incurred, please furnish necessary
26 proofs (cash receipts) along with a CA certificate
with regard to sources of finance, items of
expenditure, etc.
In case a Company has promoted the applicant

unit, please furnish Memorandum and Articles of
27 Association and Audited Balance Sheet and
Trading and Profit and Loss A/cs for the past
three years of the promoter company.
License/Permissions/Approvals by Regulatory
28
Authority, where applicable.
Plan showing layout of machinery and

29
organizational chart.
Note: All the required information should be duly typed in the application
form. The comments like “As per the project report”, “As per the Annexure”
will not be accepted. A soft copy should also be submitted in a floppy along
with the signed hard copy of the Application form.
! !212
TERM LOANS
APPLICATION FORM
 
FOR CREDIT FACILITIES
(Term Loan plus Working Capital*)
(To be submitted in duplicate)
1 DETAILS OF APPLICANT UNIT
1.1 Name of the Unit

1.2 Addresses with Telephone/Telex/Fax No.
(a) Registered Office

(b) Administrative office
(c) Factory
– Existing
– Proposed
1.3 Constitution (please strike out which are
not applicable)
1.4 Date of Incorporation

1.5 (As given by the District Industries
Center/Directorate of Industries)
1.6 Exporters’ Code Number

1.7 Name of the business house/group to
which the unit belongs
2 PROJECT
(In case of existing units, please furnish
detailed information as per Annexure I)
3 MANAGEMENT
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TERM LOANS
Brief particulars of the Promoters/Directors
(Furnish Bio-data and net worth statement for each person in

Annexure II and III respectively)
S. Name, Area of Age Qualifi- Relation Experie Other Whether Net

No Desig- responsi- (in cations ship nce in Experi- income worth
. nation bility in yrs.) with propose ence tax (Rs.
the Unit the d line of (in Payee lakh)
chief activity years) as on
promot (in ____
er/s years)
In case the promoters are a limited company, please furnish a write-up on

the activities and past performance.
3.2 Shareholding
3.2.1 - Please provide a list of existing and proposed equity and preference
shareholders owning or controlling 5% or more of equity shares, indicating
the amount owned and business relationship, if any, with the Company.
Name Existing Shareholding Proposed Shareholding
No. of equity Face Amount % No. of Face Amount %

shares value (Rs. equity value (Rs.
(in lakhs) lakhs) shares lakhs)
Total
Others
Total
! !214
TERM LOANS
3.3 - Details of the associate concern(s), if any
(Please furnish detailed information for each associate concern in

Annexure IV)
S. No. Name of the concern In operation, since Activity
3.4 - Particulars of key technical and executive staff
(Please furnish data for existing as well as proposed staff)
Name Designation Qualification Experience Any special Functio-nal

achievement duties at the
(Inventions/  Unit
Research
etc.)
(Please enclose Organizational Chart)
4 - TECHNICALLY FEASIBILITY
(Please enclose the feasibility/project report, if available/considered

necessary)
4.1 - Name of the Products (including by-products) and its (their) uses
4.2 - Capacity (No. of Units/Quantify in Kg./Volume in Liters)
! !215
TERM LOANS
Proposed
Existing
Capacity for Each Licensed/Installed
Product Licensed/
Operating
Installed
No. of working days in a month: No. of shifts in a day: No. of hours per shift:
4.3 - Manufacturing process (Indicate technical details including type of

process, material flow, etc.)
4.4 - Arrangement proposed for technology transfer/know-how
4.4.1 - Through technical collaboration (If yes, please furnish relevant

information in Annexure V).
4.4.2 - Through technical consultants (If yes, please furnish relevant

information in Annexure V).
4.4.3 - In-house – Yes/No. If yes, briefly explain how this will be done.
4.5 - Location advantages of existing and proposed premises with

reference to absence of civic restrictions; proximity to the source of raw
materials; market for the product; availability of power, water, labor,
transport; and whether backward area and benefits available.
4.6 - Type of soil and load bearing capacity (enclose test report)
4.7 - Raw Materials and components (enclose copies of Proforma Invoices

in respect of each item)
! !216
TERM LOANS
Raw Material/Component
Imported/Indigenous
Quantity Required per unit of Product
Sources of Supply
Minimum Purchase Quantity/unit cost
Availability (Easy/Restricted/Seasonal,
etc.)
Arrangement for transportation in case of

bulky Raw Materials/Components
4.8 - Employment
Present Proposed
– Executives/Supervisors/Engineers
– Administrative/Office Staff
– Skilled Labor
– Unskilled Labor
– Others (specify)
4.9 - Utilities (Give comments on requirements, availability/adequacy, etc.)
! !217
TERM LOANS
4.9.1 - Power
(a) Sources of Power and Supply Voltage
(b) Maximum Demand
(c) Contracted Load
(d) Connected Load
(e) Energy consumption per year
(f) Power tariff (Rs./Unit)
(g) Cost of Power per annum at maximum capacity utilization
h) DG Set Capacity
(i) Power cost per unit using DG set
(j) Alternate arrangement for Power
4.9.2 - Water
4.9.2.1 - Indicate the requirements and suitability of water
4.9.2.2 - Describe water treatment arrangements
4.9.2.3 - Sources for supply of water, arrangement proposed and water

charges payable
4.9.3 - Steam/Compressed Air:
a. Requirement
b. Arrangements proposed
4.9.4 - Fuel:
a. Requirement of fuel (Type, Amount and Rate)

b. Arrangements proposed for supply
No requirements for fuels
4.10 - Effluent Treatment: Please furnish full details of the nature of

atmosphere, soil, and water pollution likely to be created by the project
! !218
TERM LOANS
and the measures proposed for control of pollution. Indicate whether

necessary permission for the disposal of effluent has been obtained from
the concerned authority; if yes, a copy of the certificate should be
furnished.
4.11 - Quality control
a. Details of arrangement made for quality control

b. Particulars of R&D activity proposed, if any
4.12 - Schedule of implementation
Please indicate the progress made so far in the implementation of project

and furnish the schedule of implementation as follows:
Date of Expected Date

Commencement of Completion
Acquisition of Land
Development of Land
Civil Works for

– Factory building
– Machinery foundation
– Administrative Building
Placement of Order for Plant and

Machinery and MFA
– Imported
– Indigenous
Arrangement for power
Arrangement for water
Erection of equipment
Commissioning
Initial Procurement of Raw Material
Trial Runs
Commercial Production
! !219
TERM LOANS
4.13 - Government Consents

Please indicate whether the various licenses/consents/approvals required
for the project have been obtained from the respective authorities.
(Indicative list Consent from Pollution Control Board, Non-agricultural (NA)

Land Order, Approval for commencement of building construction approved
building plan, Food and Drug, Storage of explosive material, MMPO etc.)
4.13.1 - Specify any special condition attached to the licenses/consents/

approvals and the undertaking given by The Company in connection
herewith.
5 - ECONOMIC FEASIBILITY
5.1 - Market (Please enclose a Market Survey Report)

The Products and Marketing Strategy:
5.1.1 - Industry/Sector Profile and its performance, Demand Supply Gap
5.1.2 - Names/Type of the Major Customers
5.1.3 - Region/Area where the product is being/will be sold
5.1.4 - Extent of competition, number and names of units engaged in

similar line in the area, their capacity utilization/performance
5.1.5 - How do the unit/meet propose to meet the competition (comment

on the competitive advantages enjoyed by the unit?)
5.1.6 - In price and quality, how does the unit's product compare with
those of its competitors?
5.2 - Selling Arrangements
5.2.1 - Is the unit selling directly to its customers? If so please furnish

details like sales force, showrooms, depots, etc.
5.2.2 - If a selling/distribution agency has been appointed, its name,

period of contract, commission payable, period by which the bills will be
paid by it etc. (enclose copies of agreement, wherever applicable)
! !220
TERM LOANS
5.2.3 - Nature and volume of orders/enquiries on hand, if any (Xerox

copies to be furnished)
6 - COST OF PROJECT
(Please furnish estimates of cost of project under the following heads.

Indicate the basis for arriving at the cost of project)
Project at a glance (1st stage)
Cost of Project Means of Finance
Land Capital
Land Development and Other Unsecured Loans

Infrastructures without Interest
Preliminary Expenses Internal Accruals
Margin on Working Capital Term Loan from Bank
… …
… …
TOTAL TOTAL
6.1 - Land
1. Location
2. Area (in sq. mt./sq. ft.)
3. Whether Freehold land or Leasehold
4. Purchase Price of Land, if owned
5. Name of the person(s) from whom land has been/is being purchased
(Please indicate relationship, if any with the applicant unit or the

promoters/director
6. Terms of lease (such as rent, period, mortgage clause etc.)
! !221
TERM LOANS
6.2 - Details of Site Development expenses
6.3 - Building
1. Location
2. Whether Owned or Leased
3. Purchase price of Building, if owned
4. Rents in Case of Leased/Rented Premises
5. Terms of lease
6. Estimated Cost of construction
7. Particulars of building (Furnish details in Annexure VI).
6.4 - Particulars of Plant and Machinery and Misc. Fixed Assets

(Furnish details in Annexure VI)
6.5 - Arrangements made for erection and commissioning of the plant
6.6 - Break-up/Details of Preliminary and pre-operative expenses; Refer

project report
Establishment Expenses
Company Formation
Deposit with SEB
Traveling Expenses
Pre-operative Expenses
Interest During Construction
Upfront Fee
Other (Specify)
Total
! !222
TERM LOANS
6.7 - Margin Money Requirements for Working Capital (As per Annexure X).
7 - MEANS OF FINANCING
(Please furnish details of sources of finance for meeting the cost under the
following heads)
(Rs. lakhs)
Amount
Amount Already
Proposed
S. No. Particulars Raised as Total
to be
on______
Raised
(A) Share Capital
(B) Internal Accruals
Term Loans (give full

(C)
particulars)
Unsecured Loans and

Deposits (indicate
(D) sources, rate of
interest, repayment
period, etc.)
Other sources
(E)
(specify)
(F) Total
* Please note that the Subsidy from State/Central Government if any may
be utilized for reducing the term liability of the unit
7.1 - Indicate sources from which expenditure already incurred has been
financed (Please indicate CA certificate for the same along with copies of
Bills/Invoices)
7.2 - Indicate the sources from which the share capital is proposed to be
raised
7.3 - In case internal accruals are taken as source of finance explain the
basis for estimation of internal accruals by means of a statement
7.4 - Promoter's contribution to the project as % of the total cost @ 25%
! !223
TERM LOANS
7.5 - Financial Assistance required:
7.5.1 - Rupee Loan
7.5.2 - Foreign currency Loan
7.5.3 - Working Capital Term Loan
7.5.4 - Other forms of assistance (e.g., LCs guarantees, etc.)
7.6 - Repayment period required years and Moratorium Period (if required)
8 - FUTURE PROJECTIONS
Please furnish:
8.1 - Projected profitability as per Annexure VII
8.2 - Project cash flow statement as per Annexure VIII
8.3 - Projected Balance Sheet as per Annexure IX
8.4 - Working Capital Requirements as per Annexure X
9 - DETAILS OF SECURITIES OFFERED FOR THE PROPOSED

ASSISTANCE
9.1 - Primary:
9.2 - Collateral [Give full details like nature (residential/industrial/

commercial) and address of the property, area, name of the owner, cost/
market value, freehold/leasehold, whether charged to any other bank,
tenancy, etc.]
9.3 - Details of guarantor(s). Please furnish Net worth Statements in the

format enclosed at Annexure III separately for each guarantor.
9.3.1 - Name(s)
9.3.2 - Residential Address(es)
! !224
TERM LOANS
9.3.3 - Occupation(s) (If in service, name and address of his/her employer)
9.3.4 - Details of any similar guarantee, if any, given to other institutions
10 - OTHER DETAILS
10.1 - Whether any Government enquiry, proceedings or prosecution has

been instituted against the unit or its proprietor/partners/ promoters/
directors for any offences? If so, please give details
10.2 - Details of pending litigation, if any, against and by the concern
10.3.1 - Please indicate whether any of the promoters or directors has at

any time declared themselves as insolvent
I/We certify that all information furnished by me/us is true; that I/We have
no borrowing arrangement for the unit with any Bank except as indicated
in the application; that there is no overdues/statutory dues against me/us/
promoters except as indicated in the application; that no legal action has
been/is being taken against me/us/promoters that I/We shall furnish all
other information that may be required by you in connection with my/our
application; that this may also be exchanged by you with any agency you
may deem fit; and you, your representatives, representatives of the
Reserve Bank of India or any other agency as authorized by you, may, at
any time, inspect/verify my/our assets, books of accounts, etc. in our
factory/business premises as given above.
Signature of the Borrower
Name and Designation
Date:
Place:  
! !225
TERM LOANS
Annexure – I
Details of Existing Unit
(To be filled up in case of existing units only)
1. Nature of activity, Product and their uses
2. Capacity (No. of Units/Quantity in Kg./Volume in Liters)
NOT APPLICABLE
Capacity for each product Licensed Installed Operating
No. of working days in a month: No. of shifts in a day: No. of hours per shift:
3.1 Details of Existing Fixed Assets
(a) 1. Location
2. Area (in sq. ft./sq. mt.)
3. Whether Freehold land or Leasehold
4. Purchase Price of Land, if owned
5. Rent in case of leased Land
6. Terms of Lease
(b) Building
1. Whether Owned or Leased Own Building
2. Purchase price of Building, if owned
3. Rent in Case of Leased/Rented Premises
4. Terms of lease
5. Building details
! !226
TERM LOANS
Structure Type of Area Actual Cost Date of Erection

construction (in sq.m) (in Rs. lakh)
(c) Particulars of Machinery (including those taken on lease/hire-purchase)
S.No. Name of Second Name of Date of Purchase

Machinery Hand/ manufacturer/ acquisition cost
and New fabricator (place of including
Specification Country and Origin, taxes,
if imported excise duty,
etc.
Indigenous
Imported
(d) In case the assets have been revalued or written up at any time during
the existence of the unit, furnish full details of such revaluation together
with the reason therefore
3.2 Whether existing assets fully insured?
4 Past Performance
Last but One Last but Two
Particulars Last Year
Year Year
Capacity utilization (%)
Turnover – Domestic
– Exports
Net Profit
Net Worth
(Please enclose audited balance sheet for last three years)
! !227
TERM LOANS
4.1 Monthly turnover for last twelve months
5 Financial Arrangement: Sole Banking/Consortium/Multiple Banking
Sole Banking
5.1 Details of Existing Credit Facilities (Please enclose copies of sanction letters)
(Rs. in lakhs)
Name Nature Amt Rate of Amount Amount Security
and of sanctioned Interest O/S as Overdue (including
address facility (date of on , if any collateral,
of Bank/ sanction) ____ if any)
FI
5.2 Arrears in Statutory Payments (if any) NO Arrears in Statutory Payments
a. Income Tax
b. Sales Tax
c. Provident Fund
d. Employees State Insurance Corporation
e. Others (Specify)
5.3 - Contingent liabilities (if any) (including Bank Guarantee/Corporate

Guarantees, if any, etc.)
6 - If the unit is an ancillary unit, the undertaking to which it is catering and its
address
7- Necessity and purpose for the proposed investment/addition to factory

premises/machinery (in case where such investment is intended) and details of
benefits that would accrue to the unit by way of reduction in unit cost of
production, quality improvement etc. after implementation of the scheme
8 - In case of switch over from another bank/FI, give reasons thereof
! !228
TERM LOANS
Bio-Data Form Annexure - II
Details of Proprietor/Partners/Managing Partner/Promoters/Directors/Managing

Director 
(Please indicate interrelationship, if any, among the partners/directors/promoter) 
(Please use separate sheet for each person)
1. Full Name
2. Name of the Father/Husband
3. Age
4. Sex
5. Whether belongs to Scheduled Castes/Scheduled Tribes/Minority Community

Yes/No
6. Are you an Ex-Servicemen Yes/No
7. Ration Card No. and name of the Issuing Office
8. Passport No.
9. Address
Office Tel. No.
Permanent Residence
10.Academic Qualification
11.Experience
Year Employer Designation Last Salary Drawn
12. Functional responsibilities in the unit
13. Capital/Loan contribution at the Beginning at Present in the unit
14. Reasons for joining/ establishing the unit (Please mention about the
motivating factors)
! !229
TERM LOANS
15. If associated as proprietor/partner/director/shareholder with concerns other

than the applicant unit, please furnish following details separately for each
concerns by way of enclosure
16. Name and address of the branch/associates/identical concern

Activity of the concern
Functional responsibility in that concern
Capital/ Loan contribution
Name of the associate concern’s banker and their address
Aggregate credit facilities enjoyed by the concern
Security offered by the concern for its borrowing
Working results of the units for the past three years
17.Personal Assets and Liabilities:
18.Immovable property details like land/buildings, location, area, date of

acquisition, cost, present value, basis of valuation etc.
19.Other Assets
20. Personal Liabilities, if any (indicating guarantees/acceptances given)
21. Any other relevant information
Place:
Date: Signature
! !230
TERM LOANS
Net Worth Statement Form Annexure-III

Net Worth of Details of Proprietor/Partners/Managing Partner/Promoters/
Directors/ 
Managing Director/Guarantors
(Please use separate sheet for each person)
Net Worth Statement of _______________
A. Investment in immovable property
(including construction/investment activity yet to be completed):
S. Details of location Type If in joint Date Built-up Cost Market

No. of property (As of ownership of area (in (Rs. Value
per revenue and Proper with acquis sq.ft./ Lakh) @ (Rs. Lakh)
municipal records, ty (*) others ition sq.mt.) @ @
postal address) (indicate
names)
TOTAL 7.60
*Indicate type as Residential/Industrial/Agricultural/Gala/ others (Please specify)
@ if jointly owned with others, only relevant share to be taken for value
B. Investment in shares/debentures/capital/securities/bonds/mutual funds etc.
! !231
TERM LOANS
S. Name of the Invest No. of Cost Market Value

No Company/ ment Units (Rs. (Rs. Lakh)
Concern Type Lakh)
Associate/Sister/Group Concern
Sub-total
Other
s
Sub-total
C. Loans and Advances/Investment in

S Name of the Company/ Investmen Long Amount
No. Concern t type term/ (Rs. Lakh)
Short
term
Sub-total
Other
s
Sub-total
! !232
TERM LOANS
TOTA
L
D. Other Assets
S. Details Amount Long term/Short term
No. (Rs. Lakh)
TOTAL
E. Secured/Unsecured Borrowings from

S. Name of the Nature Purpose Amou Amount Natu
No. Lender of nt overdue, if any   re of
Borro outst (Rs. Lakh) Secu
wing andin rity
(long g  offer
term/ (Rs. ed
short Lakh)
term)
Banks/Financial Institutions/Finance Companies
-
Sub-total
-
Sub-total
Others
-
Sub-total
! !233
TERM LOANS
TOTA
L
F. Any Other Liability
S. No Details Amoun Long term/Short term

t (Rs.
Lakh)
TOTA
L
G. Networth [A + B + C + D – E – F]:
I, _______________, Son of _______________, certify that the contents of this

statement are true and correct to the best of my knowledge and belief.
Place:
Date: Signature 
! !234
TERM LOANS
Annexure – IV
Details of Associate/Sister/Group Concerns
(Please use separate sheet for each Concern)
1. Name of the Concern:
2. Address:
3. Name(s) of Proprietor/Partners/ Promoters/Directors:
4. Past Performance (please enclose copies of audited balance sheet for

last three years)
(Rs. Lakh)
Particulars Last Year Last But One Year Last But Two Year
Turnover – Domestic
– Exports
Net Profit
Net Worth
5. Existing credit facilities (Please enclose copies of sanction letters)

[Rs. Lakh]
Name and Nature Amt Rate of Amount O/S Amount
address of of sanctioned   Interest as|  Overdue,  
Bank/FI facility (date of on _______ if any
sanction)
! !235
TERM LOANS
Annexure – V
Arrangement Proposed for Technical Know-How for the Project
1. Technical Collaboration:
Please furnish a brief write-up on the period of collaboration agreement,
the name of the collaborator company, indicating the activities, size,
turnover, particulars of the existing plants, and other projects in India and
abroad set up with same collaboration, fees/royalties payable and the
manner in which payable, etc.
2. Technical Consultants:
Please furnish full details of arrangement proposed to be made for
obtaining technical advice and services needed for the implementation of
the project, Particulars of the Consultants like name and address of the
consultants, fees payable and the manner in which payable, scope of work
assigned to them, organizational set-up, bio data of senior personnel,
names of directors/partners, particulars of work done in the past and work
on hand.
3. Whether any of partners/promoters/directors has any interest in

consultant/collaboration firm. If so, details to be furnished.
! !236
TERM LOANS
Annexure – VI
Details of Building, Plant and Machinery and Miscellaneous Fixed

Assets Proposed in the Project
1 Particulars of building proposed to be constructed
Sr. Description Type of Built-up Total Rate of Estimated Lump sum

No of each construc area (in floor construction cost of amount (in
building -tion meters) area per sq. m.   each bldg case not
in sq. (in Rs.) (Rs. calcula-
m. Lakh) ted)
(Rs. lakh)
Length Breadth Height
Architect’s
fees
Others
(specify)
2. Please furnish the following particulars of Architect(s)

(a) Name and address of the architect(s) firm
(b) Scope of work
(c) Fee payable and manner in which payable
(d) Past experience of the architect(s) in similar work
3. Particulars of Plant and Machinery and Miscellaneous Fixed Assets 
! !237
TERM LOANS
S. Name of Second Name of Date of Expected Invoice Price Estimated Total

No Machinery Hand/ manufactur acquisition date of including expenses cost
and New er/supplier /Date of Delivery taxes for o/a of
Specificati fabricator placement Indigenous insurance,
on (place of of order machinery/ freight,
Country (actual/ CIF for installation
and Origin, expected Imported , import
if imported Machinery duty
PLANT and MACHINERY
– Indigenous
– Imported
Total Cost of Plant and Machinery
MISCELLANEOUS FIXED ASSETS
– Indigenous
– Imported
Total cost of Miscellaneous Fixed Assets
! !238
TERM LOANS
3. Particulars of Plant and Machinery and Miscellaneous Fixed Assets
3.1. Competitive Quotations/Catalogues/Invoices from at least three

suppliers and other details like technical specifications, advantages and
justification for choosing a particular supplier along with the credentials of
the suppliers in respect of each machine is to be furnished.
3.2. In case of second hand machinery, valuation report regarding age,

performance and value from competent valuer to be submitted. Also please
indicate reasons for going in for second hand machinery and its
depreciated value Prior approval necessary
3.3 In case of imported machinery, please indicate mode of payment and

price of the machinery in foreign currency also.
! !239
TERM LOANS
Projections of Performance, Profitability and Repayment

Annexure – VII
Break-even point Break-even quantity

% of installed capacity (Rs. In lakhs) Break-even Value
1st 2nd 3rd 4th 5th 6th 7th
year year year year year year year
A Production during the year

(Quantity)
B Sales
1 (a) Domestic Sales
(b) Export Sales
2 Less: Excise
3 Net Sales
4 Other income (give

details), if any
Total Income
C Cost of Production
1 Cost of construction
2 Administrative Expenses
3 Office Expenditure
4 Selling and Marketing

Expenses
5 Preliminary and Pre-

operative Expenses
6 Contingencies
Total operating Expenses
D Gross Profit (B – D) (EBIDTA)
E Interest on
1 Term Loans
2 Working Capital
! !240
TERM LOANS
3 Other Loans, if any
Depreciation
F Profit before Taxation ( E – F +

G)
G Other Non-operating Expenses
H Provision for Taxes
I Net Profit (H – I)
J Depreciation added back
K Net Cash Accruals (J + K) 357.29
L Repayment obligations
1 Towards term loan
2 Towards other loans, if

any
Total Repayment
M Debt Service Ratio
(K + E1 + E3) : (L + E1 + E3)
Average DSCR 
! !241
TERM LOANS
Projected Cash Flow Statement (Rs. in lakhs) Annexure - VIII

Year Year Year Year Year Year Year
Particulars
1 2 3 4 5 6 6
A. Sources of funds
Cash accruals (viz. profit

1 before Taxation +
interest)
Increase in share
2 capital: Equity/
Preference
3 Depreciation
Increase in long-term
4
loans/ debentures
Increase in deferred
5
payment facilities
Decrease in current
6
assets
Increase in unsecured
6
loans and deposits
Increase in bank
7 borrowing for working
capital
Sales of fixed assets/

8
investments
Decrease in intangible
9
assets
Others (specify) –
10 increase in current
liabilities
TOTAL SOURCE (A)
B Disposition of Funds
Preliminary and pre-

1
operative expenses
Increase in capital
2
expenditure
Decrease in current
3
liability
! !242
TERM LOANS
Increase in current
4
assets
Decrease in long-term
5
loans/ debentures
Decrease in deferred
6
payment facilities
Decrease in unsecured
7
loans/ deposits
8 Increase in investment
9 Interest
10 Taxation
Dividend (amount and

11
rate)
12 Other expenses (specify)
Total Disposition (B)
C Opening Balance
D Net Surplus (A – B)
E Closing Balance
Tally Cash Balance with Balance Sheet
! !243
TERM LOANS
Annexure – IX
PROJECTED BALANCE SHEET
[Rs. lakh]
A. LIABILITIES
1 Equity Share Capital
2 Reserve and Surplus
Net Worth
3 Unsecured Loans
4 Term Loans
5 Current Liabilities
Total Liabilities
B. ASSETS
1 Net Block
2 Investment (ONCA)
3 Intangible Assets
4 Current Assets
a Inventories
b Sundry Debtors
c Cash and Bank

Balance
d Other Current Assets
Total Assets
! !244
TERM LOANS
Assessment of Working Capital Requirements Annexure – X

I. Current Assets
1 Raw materials
including stores
1.1 Imported
(Month’s consumption)
1.2 Indigenous
(Month’s consumption)
2 Other consumables
spares
3 Stock-in-process
(Month’s cost of
production)
4 Finished goods
(Month’s cost of sales)
5 Receivables other than

export and deferred
receivables (including
bills purchased/
discounted by banks )
(Month’s domestic
sales excluding
deferred payment
sales)
6 Export receivables
(including bills)
purchased/discounted
by banks)
(Month’s export sales)
! !245
TERM LOANS
7 Advances to suppliers
of raw materials and
stores/spares/
consumables
8 Other current assets

including cash and
bank balances and
deferred receivables
due within one year
(furnish individual
details of major items)
Total Current Assets (I)
II Current Liabilities
1 Creditors for
purchases of raw
materials and stores/
spares/ consumables
(Month’s purchases)
2 Advances from
customers
3 Accrued expenses
4 Statutory liabilities
5 Other current liabilities
(furnish individual
details of major items)
Total Current Liabilities (II)
III. Working Capital Gap (I – II)
IV. Margin Money for Working Capital
V. Bank Borrowings
! !246
TERM LOANS
Annexure - XI
Major Assumptions underlying Projected Profitability Statements
Indicative Format: NOT APPLICABLE

Particulars Previous Current Projections
Year Year
I  II III IV V
(Actual) (Estimate)
Year Year Year Year Year
Installed capacity*
% Capacity Utilization
Product-wise Sale Price

per unit (Rs.)
Other Income*
Excise Duty (%)
Raw material cost/Sales

(%)
Consumables/Sales (%)
Labour cost
Other manufacturing
expenses
Selling and marketing

expenses
Administrative expenses
Other major expenses,

if any
Depreciation rate
* Detailed calculation may be indicated.
! !247
TERM LOANS
REFERENCE MATERIAL
chapter
Summary
PPT
MCQ
Video Lecture 
! !248
WORKING CAPITAL FINANCE
Chapter 10
Objectives
• Provide a brief overview about Working Capital Finance.
• Learn about the Definition of Working Capital.
• Learn about Working Capital Techniques to find the optional level of

Working Capital.
• Learn about the Methods of Analysis of Working Capital.
• Provide conceptual understanding about find Flow Charge Analysis.
Structure:
10.1 Introduction
10.2 Definition of Working Capital
10.3 Different Types of Working Capital Facilities
10.4 Working Capital Management Techniques for Finding Optimal Level of

Working Capital
10.5 Methods of Analysis of Working Capital
10.6 Funds Flow Analysis
10.7 Summary
! !249
10.1 Introduction
Working capital financing is done by various modes such as trade credit,

cash credit/bank overdraft, working capital loan, purchase of bills/discount
of bills, bank guarantee, letter of credit, factoring, commercial paper, inter-
corporate deposits, etc.
Arrangement of working capital financing forms a major part of the day-to-

day activities of a finance manager. It is a very crucial activity and requires
continuous attention because working capital is the money which keeps the
day-to-day business operations smooth. Without appropriate and sufficient
working capital financing, a firm may get into troubles. Insufficient working
capital may result into non-payment of certain dues on time. Inappropriate
mode of financing would result in loss of interest which directly hits the
profits of the firm.
10.2 Definition of Working Capital
Working capital refers to Current Assets and Current liabilities. Strictly, it is

not a part of project finance which deals with financing fixed assets. But
working capital has to be dealt with under project finance for two reasons:
1. The margin money for working capital has to be financed by long-term

sources.
2. The record of industrial sickness establishes that many a unit flounders

on the quagmire of inadequate working capital. Industrial sickness ties
up national resources and renders waste the project loan as well as the
equity of the promoter.
Promoters have to make sure that adequate working capital to reach

break-even point and step up capacity utilization is available. It is essential
that such estimates are available and resources are tied up to meet the
working capital requirements of the project.
Net working capital is the difference between current assets and current
liabilities and is a measure of the company’s liquidity. A survey of large
companies shows that almost 50% of total net assets of all companies are
devoted to current assets; and current liabilities constitute 59.1% of total
liabilities.
! !250
• In the case of smaller companies, almost 63% of total net assets were
devoted to current assets.
• In the case of medium companies, 55% of total assets were devoted to

current assets.
• In the case of large companies, 40% of total assets were devoted to

current assets, and current liabilities constituted almost 40% of total
liabilities.
10.3 Different Types of Working Capital Facilities
10.3.1 Trade Credit

Trade Credit is simply the credit period extended by the creditor of the
business. Trade credit is extended based on the creditworthiness of the
firm which is reflected by its earning records, liquidity position and records
of payment. Just like other sources of working capital financing, trade
credit also comes with a cost after the free credit period. Normally, it is a
costly source as a means of financing business working capital.
10.3.2 Cash Credit/Bank Overdraft

Cash Credit or Bank Overdraft is the most useful and appropriate type of
working capital financing extensively used by all small and big businesses.
It is a facility offered by commercial banks whereby the borrower is
sanctioned a particular amount which can be utilized for making his
business payments. The borrower has to make sure that he does not cross
the sanctioned limit. Best part is that the interest is charged to the extent
the money is used and not on the sanctioned amount which motivates him
to keep depositing the amount as soon as possible to save on interest cost.
Without a doubt, this is a cost-effective working capital financing.
10.3.3 Working Capital Loans

Working capital loans are as good as term loan for a short period. These
loans may be repaid in instalments or a lump sum at the end. The
borrower should take such loans for financing permanent working capital
needs. The cost of interest would not allow using such loans for temporary
working capital.
! !251
10.3.4 Purchase/Discount of Bills

For a business, it is another good service provided by commercial banks for
working capital financing. Every firm generates bills in the normal course of
business while selling goods to debtors. Ultimately, that bill acts as a
document to receive payment from the debtor. The seller who requires
money will approach bank with that bill and bank will apply discount on the
total amount of the bill based on the prevailing interest rates and pay the
remaining amount to the seller. On the date of maturity of that bill, the
bank will approach the debtor and collect the money from him.
10.3.5 Bank Guarantee

It is primarily known as non-fund based working capital financing. Bank
guarantee is acquired by a buyer or seller to reduce the risk of loss to the
opposite party due to non-performance of agreed task which may be
repaying of money or providing of some services etc. A buyer ‘B1’ is buying
some products from seller ‘S1’. In this case, ‘B1’ may acquire bank
guarantee from bank and give it to ‘S1’ to save him from the risk of non-
payment. Similarly, if ‘S1’ may acquire bank guarantee and hand it over to
‘B1’ to save him from the risk of getting lower quality goods or late delivery
of goods etc. In essence, a bank guarantee is revoked by the holder only in
case of non-performance by the other party. Bank charges some
commission for same and may also ask for security.
10.3.6 Letter of Credit

It is also known as non-fund based working capital financing. Letter of
credit and bank guarantee has a very thin line of difference. Bank
guarantee is revoked and bank makes payment to the holder in case of
non-performance of the opposite party whereas in case of letter of credit,
the bank will pay the opposite party as soon as the party performs as per
agreed terms. So, a buyer would buy a letter of credit and send it to the
seller. Once the seller sends the goods as per agreement, the bank would
pay the seller and collect that money from buyer.
10.3.7 Factoring
Factoring is an arrangement whereby a business sells all or selected
accounts payables to a third party at a price lower than the realizable value
of those accounts. The third party here is known as the ‘factor’ who
provides factoring services to business. The factor would not only provide
financing by purchasing the accounts but also collects the amount from the
debtors. Factoring is of two types – with recourse and without recourse.
! !252
The credit risk of non-payment by the debtor is borne by the business in

case of with recourse and it is borne by the factor in case of without
recourse.
Some other sources of working capital financing used are inter-corporate

deposits, commercial paper, public deposits etc.
10.4 Working Capital Management Techniques for Finding

Optimal Level of Working Capital
Working capital management techniques such as intersection of carrying

cost and shortage cost, working capital financing policy, cash budgeting,
EOQ and JIT are applied to manage different components of working
capital like cash, inventories, debtors, financing of working capital etc.
These effective techniques mainly manage different components of current
assets.
Working capital management techniques are very effective tools in

managing the working capital efficiently and effectively. Working capital is
the difference between current assets and current liabilities of a business.
Major focus is on current assets because current liabilities arise due to
current assets only. Therefore, controlling the current assets can
automatically control the current liabilities. Now, current assets include
Inventories, Sundry Debtors or Receivables, Loans and Advances, Cash and
Bank Balance.
All working capital management techniques attempt to find optimum level

of working capital because both excess and shortage of working capital
involves cost to the business. Excess working capital carries the ‘carrying
cost’ or ‘interest cost’ on the capital lying unutilized. Shortage of working
capital carries ‘shortage cost’ which include disturbance in production plan,
loss in revenue etc. Finding the optimum level of working capital is the
main goal or winning situation for any business manager.
There are certain techniques used for finding the optimum level of working
capital or management of different items of working capital.
! !253
10.4.1 Intersection of Carrying Cost and Shortage Cost

One of the important methods of finding the optimum level of working
capital is the point of intersection of carrying cost and shortage cost in a
graphical representation. The total of carrying and shortage cost is
minimum at this point.
!
Intersection of Carrying Cost and Shortage Cost
Here, the levels of current assets are optimum at the point where the
shortage and carrying costs are meeting or intersecting. At this point, the
total cost, as we can see, is minimum and this is why that level of current
assets is considered to be optimal.
10.4.2 Working Capital Financing Policy

Working capital can be divided into two, viz., Permanent and Temporary.
Permanent working capital is the level of working capital which is always
required and maintained. Temporary working capital is the part of working
capital which keeps on fluctuating. It is high in good seasons and low in
bad seasons. There are two types of financing available. They are long-
term financing and short-term financing. Three strategies are possible with
respect to financing of working capital. Efficient financing of working capital
reduces carrying cost of capital:
! !254
1. Long-term financing is used for both permanent and temporary WC.
2. Long-term financing is used for permanent and some part of temporary

WC. Remaining part of temporary WC is financed through short-term
financing as and when required.
3. Long-term financing is used for permanent and short-term financing for

temporary WC.
These strategies should be chosen so as to match the maturity of source of

finance with the maturity of the asset.
10.4.3 Cash Budgeting

Cash budgeting is another important technique for working capital
management which helps keeping optimum level of cash in the business.
Cash budgeting involves estimating the requirements of cash by estimating
all the forthcoming receipts and payments. For effective management, a
balance is needed between both excess and shortage of cash. It is because
both ends are costly. Speeding up of collection and getting relaxed credit
terms from the creditors can reduce the cash requirements.
10.4.4 Inventory Management

Inventory is an important component of working capital or current assets.
Optimum level of inventory can save on costs heavily.
1. EOQ: Economic Order Quantity (EOQ) model is a famous model for

managing the inventories. It helps the inventory manager know how to
find the right quantity that should be ordered considering other factors
like cost of ordering, carrying costs, purchase price and annual sales.
The formula used for finding EOQ is as follows:
EOQ = √[(2 × A × O)/(P × C)]
where, A – Annual Sales

O – Cost per Order
P – Purchase price per unit
C – Carrying Cost 
! !255
2. Just-in-time: Just-in-time is another very important technique which

brought about paradigm shift in the management of inventories. It did
not reduce cost of inventory but it abolished it completely. Just-in-time
means acquiring raw material or manufacturing product at the time
when it is required by the customer. This strategy is very difficult to
implement but if implemented can bring down inventory cost to
minimum levels.
These are some important techniques discussed here. They are very
effective in managing working capital. Managing working capital means
managing current assets. Current assets like cash can be managed using
cash budgeting; inventory can be managed using inventory techniques like
EOQ and JIT. Debtors and financing of working capital can be managed
using appropriate sources of finance.
10.5 Methods of Analysis of Working Capital

Analysis of working capital is significant for both management and short-
term creditors. Management can assess the efficiency of the working
capital employed in the business. Such an analysis helps management to
detect trends and initiate corrective measures. It helps the shareholders
and creditors to determine prospects of payment of dividend and interest.
The analysis of working capital helps in determining the ability of the
company to repay its current debts promptly, assess the effectiveness of
management of working capital, adequacy of working capital and to
undertake credit rating. Analysis of working capital relates to an
examination of circulation, liquidity, level and structural aspects of working
capital. In the analysis of working capital, the tools used are ratio analysis
and funds flow analysis of the company.
10.5.1 Ratio Analysis

To analyze the current financial position of a company, ratios computed on
the basis of figures appearing in the balance sheet are covered with the
norms set for the ratios. Depending upon the purpose, various ratios are
used. The ratios discussed here relate to liquidity, circulation level and
structure of working capital.
! !256
10.5.2 Liquidity Ratios
a. Net working capital to total assets: It was noted earlier that current
assets are those assets which the company expects to turn into cash in
the near future and current liabilities are those which it expects to meet
in the near future. Net working capital is the difference between current
assets and current liabilities. Net working capital toughly measures the
company’s potential reserve of cash. Net working capital is expressed as
a proportion of total assets.
Net working capital
! Total assets
b. Current Ratio: Current ratio serves a similar purpose and is frequently

used. It is also called working capital ratio. It is considered as an index
of solvency of a company. It indicates the ability of the company to
meet its current obligations. Changes in current ratio can, however, be
misleading. If a company raises money through commercial paper and
invests the amount in marketable securities, net working capital is
unaffected but the current ratio changes.
Current ratio is computed by dividing the total current assets by current

liabilities. The result shows the number of times the current assets pay off
the current liabilities.
Current assets
Current ratio =
Current liabilities
A current ratio of 2 : 1 is generally considered satisfactory for a
manufacturing company. It constitutes a rule of thumb for measuring
liquidity. A demand for 100% margin of current assets over current
liabilities is a precaution based on the practical knowledge of the possible
shrinkage that may occur in the value of current assets. The current ratio
cannot, however, be applied as a norm for all companies because the
quality and character of current assets varies according to the type of
activity.
c. Quick (or Acid test) ratio: Another ratio which measures immediate
solvency is the current ratio. It includes assets which can be quickly or
immediately converted to cash. Such assets include only cash,
marketable securities and bills customers have not yet paid
! !257
(receivables). Inventories are excluded because they cannot be sold at

any thing above fire-sale prices. The liquidity arises because finished
goods cannot be sold for more than production cost. Quick ratio is
computed as:
Cash + Marketable securities

QR = + Receivables = Current assets – Current liabilities
Current liabilities Current liabilities
= Liquid assets
Current liabilities
d. Interval Measure: Sometimes, it may be useful to compare current
assets to regular cash outgoings of a company. The interval measure is
calculated by:
Cash + Marketable securities + Receivables

!
Average daily expenditure from operations
The interval expressed in number of days measures the ability of the

company to finance its daily expenditure with the current assets in its
position even if it receives no further cash.
10.5.3 Inventory Turnover Ratios

The inventory turnover ratios show the extent of use of work in different
types of inventory. These ratios include:
1. Turnover of raw materials: This ratio shows the number of times the
raw materials were replaced during a year. It is obtained by dividing raw
materials issued to the factory by raw materials in ending inventory.
The raw materials inventory of a manufacturing enterprise may be reduced

to a number of months in a year by the turnover of raw materials
inventory. A low turnover ratio of raw materials inventory indicates that
excessive raw materials have been procured and the opposite is the
condition with a high turnover of raw materials inventory.
! !258
2. Turnover of stores and spares: This ratio shows utilization of funds in

stores and spares inventory. This ratio is obtained by dividing stores and
spares consumed in a fiscal year by the value of stock and spares at the
end of the fiscal year.
The stores and spares inventory may be reduced to number of months

stores and spares inventory by dividing number of months in a year by the
turnover of stores and spares inventory. A higher turnover of stores and
spares inventory is an indication of management’s efforts to reduce
investment in this component. On the other hand, a falling turnover of
stores and spares inventory may be taken to mean that excessive working
funds have been deployed in this component.
3. Turnover of goods-in-process: This ratio is obtained by dividing the

value of goods produced in a year by the value of goods-in-process at
the end of a fiscal year. This ratio establishes relationship between the
value of goods produced and the value of goods-in-process of
production. A high turnover indicates less accumulation of inventory and
less working finance tied up in this component.
4. Turnover of finished goods: This ratio is computed by dividing the

net sales by finished goods inventory. The finished goods inventory may
be reduced to number of months’ finished goods inventory by dividing
number of months in a year by turnover of finished goods inventory. A
higher turnover of finished goods inventory indicates that a higher level
of sales has been attained with less investment in the finished goods
inventory. A falling turnover indicates that the investment in finished
goods is increasing in relation to sales.
5. Turnover of aggregate inventory: This ratio is obtained by dividing

the net sales in a year by the value of aggregate inventory at the end of
the year. The aggregate inventory of a business enterprise may be
reduced to a number of months’ inventory by dividing the number of
months in the year by ratio of turnover of aggregate inventory.
10.5.4 Work-in-process
Work-in-process represents investment by firm. It is the amount of semi-
finished products currently lying on the factory floor. In the traditional
view, inventories including WIP are considered as assets and inventory
build-up is seen as value added. They are also considered as a buffer
! !259
against uncertainties arising out of delayed supplies, machine breakdowns,

absenteeism and uncertain customer orders. The desire to improve
utilization of expensive equipment also contributed to building up WIP.
In recent times, inventory is considered evil and evidence of poor design,

poor forecasting, poor coordination and poor operation of the
manufacturing system. The current trend is to produce times as required.
WIP should be equal to the sum obtained by multiplying the rate at which
parts flow through the factory with the length of time parts spent in the
factory.
The higher turnover of inventory quickens the flow of funds from inventory.
A low turnover ratio indicates an over-investment in inventory in relation to
sales.
10.5.5 Receivables Turnover Ratio

The receivables turnover ratio is computed by dividing annual credit sales
by total customer receivables. When the number of days in a year is
divided by the turnover of receivables, the ratio gives average collection
period. The turnover of receivables indicates the rate at which sales are
converted into cash and the average collection period shows the number of
days of sales that are represented by the account receivables. A declining
turnover of account receivables indicates an over-investment of funds in
receivables which may raise the requirement of working capital of a firm.
a. Cash turnover ratio: This ratio shows the relationship between cash
balance plus other liquid assets and operating costs and expenses. It
shows the adequacy of liquid assets to meet current operating needs. A
high turnover of cash indicates an insufficiency of cash to provide for
emergencies. A low turnover of cash shows that an excess cash balance
is lying with the enterprise.
b. Current assets turnover ratio: This ratio measures the turnover of

total current assets used in business operations. The ratio is obtained by
dividing the cost of goods sold by total current assets. This ratio may be
linked with the profitability of an enterprise. For this purpose, two other
computations are done. First, net income is divided into current assets
which gives the rate of profit on average current assets. Second, the
rate of profit of current assets is divided by the turnover of current
assets which gives the rate of profit per turnover of current assets.
! !260
The lower turnover and profitability of current assets indicate utilization of

working capital and reverse is the case with a higher turnover and
profitability.
c. Working capital turnover ratio: This ratio is obtained by dividing net

sales by working capital. This ratio indicates the efficiency with which
the working capital has been used in the company. The higher turnover
of working capital represents lower investment in it and greater
profitability. But a very high turnover of working capital may also
indicate the efficient utilization of working capital in the enterprise.
10.5.6 Efficiency or Profitability Ratios

These ratios are employed to judge how efficiently a company is using its
assets. It should, however, be noted that there is quite a bit of ambiguity
about these ratios.
a. Sales to Total Assets: The ratio shows how hard the company’s assets
are being to put to use. The ratio is represented by:
Sales
!
Average total assets
This reveals how close a company is operating to capacity. A high ratio

would imply that sales cannot be stepped up without an increase in capital
invested in the company.
b. Sales to Net Working Capital: The ratio would help focus on how
efficient working capital is being used. The ratio is represented by:
Sales
!
Average net working capital
c. Net Profit Margin (NPM): The ratio helps in establishing the

proportion of sales that finds its way into profits. It is computed by:
Earnings before interest and taxes (pa) – Tax
NPM =
!
Sales
d. Inventory turnover: The ratio which tells about the rate at which
companies turnover their inventories is obtained by:
! !261
Cost of goods
! Inventory Turnover =
Average inventory
A high inventory ratio could mean efficiency or hand-to-mouth existence.
e. Return on Total Assets: The ratio of income (earnings before interest

and after taxes) to total assets (original cost – depreciation) is used to
measure the performance of a company.
EBIT – Tax
Return on Total Assets =
! Average total assets (average of assets at the
beginning and end of the year)
f. Payout ratio: The ratio measures the earnings paid out as dividends.
Dividend per share
Payout ratio =
!
Earning per share
Companies follow a low average payout ratio if earnings are not stable.
Earnings not paid out are retained in business.
Retained earnings = 1 – Payout ratio

Earnings – Dividend
!=
Earnings
The impact of retained earnings in the growth of shareholders’ investment
can be measured by multiplying retained earnings by the return on equity
(earnings/equity).
Earnings – Dividends Earnings

! Growth in Equity = ×
Earnings Equity
! !262
10.5.7 Market Value Ratios
There are four ratios that combine accounting and stock market data which
are useful in assessing the company’s position.
a. Price earning ratio (P/E ratio): It is a common measure of the

investors’ estimate of the company. It is obtained by:
Stock price
! P/E ratio =
Earnings per share
The stock price is arrived at by assuming that dividends are at steady rate.
DIV1
! Po =
r–g
Where, DIV1 measures the expected dividend next year, r is the required
rate of return and g is the expected rate of dividend growth.
To find the P/E ratio, divide current stock price formula with expected
earnings per share:
Po DIV1 1
! = ×
EPS1 EPS1 r – g
Normally, P/E ratios are in mid-teens. In the Indian stock market, PE ratios
are quite high. High P/E ratios normally indicate that:
• Investors expect high dividend growth (g);
• The share has low risk and therefore investors accept a low prospective
return (r);
• The company is expected to achieve average growth while paying out a

high proportion of earnings (DIV1/EPS). But in the Indian context, high
PE ratios are a demand phenomenon. Excess demand for shares has
driven up prices and high P/E ratios have been registered.
b. Dividend yield: Dividend yield measures dividends as a proportion of

the share price.
Dividend yield per share
! Dividend yield =
Share price
In the case of a company with a steady expected growth in dividends,
! !263
DIV1
! Dividend yield = =r–g
Po
High yield is indicative of investors’ expectation of low dividend growth or
requirement of a high return.
c. Market to book ratio: The ratio of market price per share to book
value per share reveals the market worth of the company as compared
to what past and present shareholders have put into it. Book value per
share is net worth (paid-up capital ÷ free reserves) divided by the
number of shares outstanding.
Stock price
! Market to Book Ratio =
Book value per share
Market value (assets, debt and equity) to replacement cost or Tobin’s q.

The ratio q is obtained by:
Market value of assets
! q=
Estimated replacement cost
Assets in the ratio include all assets, debt and equity; and replacement
cost is current cost estimated after adjusting historic cost for inflation.
When capital equipment is worth more than it costs to replace, q is greater
than one and companies have an incentive to invest; and when equipment
is worth less than its replacement cost, q is less than one, companies will
stop investing. The merger route is preferred for acquisition of assets than
purchase new assets when q is less than 1. High market values may exist
even when existing assets are worth much more than their cost because
investors believe that the company has good opportunities.
10.5.8 Level of Working Capital

The analysis of level of working capital throws light on the size of working
capital. It shows whether the size of working capital of an enterprise is
excessive or adequate or inadequate to its needs.
The most important ratio tests in this regard are the amount of working
capital in terms of months’ cost of production or months’ average sales
turnover. The results of these ratio tests when compared with the norms
! !264
for the industry indicates whether the size of working capital maintained by
the enterprise is excessive or adequate or inadequate to its requirements.
A comparison of working capital with other variables such as output and

sales over a period of time may also indicate the trend in the growth of
working capital.
10.6 Funds Flow Analysis

Funds flow analysis shows the sources and uses of funds of a company.
This technique helps to analyze changes in working capital components
between two dates. A comparative analysis of current assets and liabilities,
as shown in the balance sheet at the beginning and the end of a year,
indicates changes in each type of current assets as well as the sources
from which working capital has been obtained. However, the technique of
funds flow analysis fails to clarify the significance of movements in the
working capital structure.
Predict Projects Pvt. Ltd. has just started trading operations of an

engineering product in last year. It has applied to a Commercial Bank for
Working Capital facility. A typical application for a Working Capital Facility
of Rs. 70 lakhs by M/s Predict Projects Pvt. Ltd. is enclosed herewith.
Kindly study it.  
! !265
Predict Projects Pvt. Ltd. 

Assessment of Working Capital Requirements 
FORM II 
Operating Statement
Audited Provisional Projected
Latest 1st Year 2nd Year
1 Gross Sales
(i) Domestic Sales 124.65 215.30 360.00
(ii) Other Revenue Income – – –
Total 124.65 215.30 360.00
2 Less: Excise duty – Deduct other items – – –
3 Net Sales (item 1– item 2) 124.65 215.30 360.00
% age rise (+) or fall (–) in net sales as

4 compared to in net sales as compared to – 72.72 67.21
previous year (annualized)
5 Cost of Sales
(iii) Raw materials 131.90 204.59 345.00
(iv) Salary and Wages – – –
(v) Other manufacturing expenses – – –
(vi) Depreciation 0.80 1.26 0.80
(vii) Sub-total (i to vi) 132.70 205.85 345.80
Add: Opening Stocks-in-process and Raw

(viii) – – –
MATERIALS
Sub-total 132.70 205.85 345.80
Deduct: Closing Stocks-in-process and

(ix) – – –
Raw materials
(x) Cost of Production 132.70 205.85 345.80
(xi) Add: Opening stock of finished goods – 17.02 23.75
Sub-total 132.70 222.87 369.55
(xii) Deduct: Closing stock of finished goods 17.02 23.75 50.00
(xiii) Sub-total (Total cost of sales) 115.68 199.12 319.55
! !266
Selling, general and administrative

6 4.42 6.78 10.00
expenses
7 Sub-total (5 + 6) 120.10 205.90 329.55
8 Operating profit before interest (3 – 7) 4.55 9.40 30.45
9 Interest – 9.80
10 Operating profit after interest (8 – 9) 4.55 9.40 20.65
11 Add: Other non-operating income
(a) Interest received – – –
(b) Dividend Received – – –
(c) Facility Fee – – –
(d) Miscellaneous
Sub-total (income) – – –
(ii) Deduct: Other non-operating expenses
(a) Preliminary Expenses
(b) Deferred Revenue Expenses – – –
Sub-total (expenses) – – –
Net of other non-operating income/

(iii) – – –
expenses
12 Profit before tax/loss [10 + 11(iii)] 4.55 9.40 20.65
13 Provision for taxes 1.00 2.00 4.00
14 Net Profit/Loss (12 – 13) 3.55 7.40 16.65
15 Drawing 0.48 0.48 1.00
16 Retained Profit (14– 15) 3.07 6.92 15.65
17 Retained Profit/NET profit (% age) 86.48 93.51 93.99
! !267
FORM III Analysis of Balance Sheet

Current Liabilities
1 Short-term borrowings from banks (incl.

bills purchased, discounted and excess
borrowings placed on repayment basis)
(i) From applicant bank – – 70.00
Sub-total (A) - – 70.00
2 Short-term borrowings from others - – -
3 Sundry creditors (Trade) 16.65 27.73 2.00
4 Advance payments from customer/deposits

from dealers
5 Provision for Taxation 1.00 2.00 4.00
6 Dividend payable – – -
7 Other statutory liabilities – – -
8 Deposits/Instalments of term loans/DPGs/ – – -

Debentures, etc. (due within one year)
9 Other current liabilities and provisions (due 0.32 0.36 0.50

within one year)
Sub total (B) 17.97 30.09 6.50
10 Total Current Liabilities (total of 1 to 9 excl. 17.97 30.09 76.50

1(iii))
11 Term Loans from Promoters (not maturing – – -

within one year)
12 Preference shares (redeemable after one - – -

year)
13 Term loans (excl. instalments payable - – -

within one year)
14 Deferred Payment Credits (excluding - – -

instalments due within one year)
15 Security Deposits (repayable after one - – -

year)
16 Other Term Liabilities - – -
! !268
17 Total Term Liabilities - – -
18 Total Outside Liabilities (Item 10 plus item 17.97 30.09 76.50

17)
19 Capital - 18.07 24.99
20 Add: Additions 15.00 – -
21 Add: Net Profit 3.55 7.40 16.65
22 18.55 25.47 41.64
23 Less: Drawing 0.48 0.48 1.00
24 Net Worth 18.07 24.99 40.64
25 Total Liabilities 36.04 55.08 117.14
Current Assets
26 Cash and bank balances 1.36 1.66 2.53
27 Investments (other than long-term - - -

investments)
(i) Government and other Trustee Securities
(ii) Fixed deposits with banks – margin money - - -
28 Receivables other than deferred and 16.77 28.51 60.00

(i) exports (incl. bills purchased and
discounted by banks)
(ii) Exports receivables (incl. bills purchased – – –

and discounted by bank
29 Instalments of deferred receivables (due

within one year)
30 Inventory:
(i) Raw materials – – –
(a) Imported
(b) Indigenous
(ii) Stocks-in-process – – –
(iii) Finished goods 17.02 23.75 50.00
(iv) Other consumable spares – –
(a) Imported
! !269
(b) Indigenous
31 Advances to suppliers of raw materials and – – 4.25

stores/ spares
32 Advance payment of taxes – –
33 Other current assets – –
34 Total Current Assets 35.15 53.92 116.78
(Total of 26 to 33)
35 Gross Block (land and building machinery, 1.69 2.42 1.16

work-in-progress)
36 Depreciation to date 0.80 1.26 0.80
37 Net Block (35 – 36) 0.89 1.16 0.36
Other Non-current Assets
38 Investments/book debts/advances/deposits
which are non-current assets
(i) Investments in subsidiary companies – – –

(a)
(b) Others – – –
(ii) Advances to suppliers of capital goods and – – –

contractors
(iii) Deferred receivables (maturity exceeding – – –

one year)
(iv) Others – CWIP – – –
39 Non-consumables stores and spares – – –
40 Other non-current assets incldg dues from – – –

directors
41 Total Other Non-current Assets – – –
42 Intangible assets (patents, goodwill, – – –

preliminary expenses not provided for, etc.)
(Doubtful debts)
43 Total Assets (34 + 37 + 41 + 42) 36.04 55.08 117.14
44 Tangible Net Worth (24 – 42) 18.07 24.99 40.64
45 Net Working Capital [(17 + 24) – (37 + 41 17.18 23.83 40.28

+ 42)]
! !270
46 Current Ratio 1.96 1.79 1.53
47 Total Outside Liabilities/Tangible Net Worth 0.99 1.20 1.88
48 Total Term Liabilities/Tangible Net Worth – – –
17.18 23.83 40.28
! !271

FORM IV 
Comparative Statement of Current Assets and Current Liabilities
(A) Current Assets
1 Raw materials (incl. stores and other items

used in the process of manufacturing):
Indigenous – – –
Days’ consumption – – –
2 Other consumable spares, excluding those

included in (1) above:
Indigenous – – –
Days’ consumption – – –
3 Stocks-in-process – – –
4 Finished goods:
Amount 17.02 23.75 50.00
Days’ cost of sales 46.81 42.11 52.78
5 Receivable other than export and deferred

receivables (incl. bills purchased and
discounted by banks):
Purchased and discounted 16.77 28.51 60.00
Days’ domestic sales 49.11 48.33 60.83
6 Export receivable (incl. bills purchased and – – –

discounted)
7 Advances to suppliers of materials and – – –

stores/spares, consumables
8 Other current assets including cash and 1.36 1.66 2.53

bank balances and defer receivables due
within one year (specify major items)
9 Total Current Assets 35.15 53.92 112.53
35.15 53.92 116.78
! !272
(B) Current Liabilities
(Other than bank borrowings for working

capital)
10 Creditors for purchase of raw materials,

stores and consumable spares:
Amount 16.65 27.73 2.00
Days’ purchase 46.07 49.47 2.12
11 Advances from customers – – –
12 Statutory liabilities 1.00 2.00 4.00
13 Other current liabilities – specify major

items
(a) Short-term Borrowings – others – – –
(b) Dividend payable – – –
(c) Instalments of TL, DPG and public deposits – – –
(d) Other current liabilities and provisions 0.32 0.36 0.50
14 Total Current Liabilities 17.97 30.09 6.50
! !273

FORM V 
Working of Maximum Permissible Bank Finance
First Method of Lending
1 Total current assets 35.15 53.92 116.78
2 Total current liabilities (other than Bank 17.97 30.09 6.50

Borrowings)
3 Working capital gap 17.18 23.83 110.28
4 Min stipulated Net working capital (25% 8.79 13.48 29.20

of Total Current Assets)
5 Actual/Projected net working capital 17.18 23.83 40.28
6 Item 3 minus Item 4 8.39 10.35 81.09
7 Item 3 minus Item 5 – – 70.00
8 Maximum permissible bank finance 70.00

(lower of 6 or 7)
9 Excess borrowings representing shortfall – – –

in NWC
! !274
10.7 Summary
• Working Capital is the money which keeps the day-to-day business

operations smooth. It refers to Current Assets and Current Liabilities.
• Working capital financing is done by various modes such as trade credit,

cash credit/ bank overdraft, working capital loan, purchase of bills/
discount of bills, bank guarantee, letter of credit, factoring, commercial
paper, inter-corporate deposits etc.
• Working capital management techniques such as intersection of carrying

cost and shortage cost, working capital financing policy, cash budgeting,
EOQ and JIT are applied to manage different components of working
capital like cash, inventories, debtors, financing of working capital etc.
These effective techniques mainly manage different components of
current assets.
• Analysis of working capital is carried out by various ratio analysis such

as:
i. Liquidity
ii. Inventory turnover
iii. Receivable turnover
iv. Efficiency/profitability ratios
v. Market value ratios.
• Funds flow analysis shows the sources and uses of funds of a company.
Activities
1. Study the application form for Predict Projects Pvt Ltd. Now, apply this
in your company or a project in which you have interest. Amounts,
assumptions may vary. They should be reasonable and achievable. Take
all this charts in MS Excel and prepare one for your company.
2. Find out the general cost of Working Capital charged by various

nationalized banks and cooperative banks in India.
! !275
1. What is Working Capital? What is its importance?
2. What are the different kinds of Working Capital which a finance manager
may tap into?
3. Discuss the various Working Capital Management Techniques for finding

Optimal Level of Working Capital.
4. Explain the various liquidity ratios of Working Capital. What is each

one’s relevance?
5. Explain the various inventory turnover ratios. What is each one’s

relevance?
6. Explain the various receivable turnover ratios. What is each one’s

relevance?
7. Explain the various efficiency or profitability ratios. What is each one’s

relevance?
8. Explain the various market value ratios. What is each one’s relevance? 
! !276
REFERENCE MATERIAL
chapter
Summary
PPT
MCQ
! !277
PRIVATE EQUITY
Chapter 11
PRIVATE EQUITY
Objectives
• Get a brief overview on the Private Equity Market, its history,

performance and trends.
• Get a list of top 10 private equity companies in India.
• Understanding Venture Capital.
• Shed light on the stages of Venture Capital Financing.
• Learn about Venture Capital Process.
• Learn about steps in Venture Capital Process.
• Refer some sample Term Sheets.
Structure:
11.1 Introduction
11.2 Private Equity Market
11.3 Venture Capital
11.4 Stages of Venture Capital Financing
11.5 Venture Capital Process
11.6 Summary
! !278
PRIVATE EQUITY
11.1 Introduction
Many young companies are unable to raise capital in public equity markets
because they are not large enough to attract investor’s interests. A
company having a very promising product or service but not sufficient
track record. This also holds true for companies that are in financial
distress. Such companies can get funding from Private Equity investments.
Venture represents financial investment in a risky proposition made in the
hope of earning a high rate of return.
11.2 Private Equity Market
The Private Equity Market is dominated by private equity companies that

represent large institutional investors. The private equity market is crucial
for both start-up companies and established publicly traded companies. For
example, a public company in financial difficulty will generally not be able
to raise public equity or public debt.
Private equity companies invest private money in businesses they consider

attractive. Private equity companies are usually structured as partnerships,
with general partners (GP) presiding over limited partners. The partners
tend to be high net-worth individuals, public and private pension funds,
endowments, foundations and sovereign wealth funds. According to PEI
Media’s 2008 ranking of the top 50 private equity companies worldwide,
the top four were United States-based. These were The Carlyle Group,
Goldman Sachs Principal Investment Area, TPG Capital, and Kohlberg
Kravis Roberts.
11.2.1 History
From obscure beginnings as boutique investment houses, through the junk
bond leveraged buyout debacle of the 1980s, to the thousands in existence
today, private equity companies have become an important source of
capital. According to the trade industry association, Private Equity Growth
Capital Council (PEGCC), in 2009, private equity companies raised close to
$250 billion and made more than 900 transactions with a total value over
$76 billion.
11.2.2 Facts
Private equity companies typically manage funds on behalf of their
investors. They look for businesses with higher-than-average growth
! !279
PRIVATE EQUITY
potential over the long term. They often provide senior management
direction to the companies in which they invest. This is especially true in
cases of majority control, because bigger returns mean bigger carried
interest payouts for the GPs. Carried interest is the portion of the funds
that remains with the company after paying the limited partners and other
investors their paid-in capital plus a minimum rate of return, known as the
hurdle rate, and transaction expenses.
11.2.3 Strategies
In 2009, private equity companies invested mainly in five sectors: business
services, consumer products, healthcare, industrial products and services,
and information technology.
The most common types of investment structures are leveraged buyouts,

or LBOs; venture capital; growth capital and turnaround capital. LBOs use
both equity and borrowed capital to invest in companies, hence the term
“leveraged”. Venture capital funds focus on new companies, mainly in the
technology, biotechnology and green energy sectors. Growth capital invests
in mature companies deemed to be undervalued. Turnaround capital, also
known as distressed capital or vulture funds, looks for financially-troubled
companies to buy inexpensively; potentially restructured, often through
layoffs and asset sales; and then sold for a healthy profit.
11.2.4 Performance
It is difficult, from the outside, to judge the performance of a private equity
firm. Unlike public companies that trade on the stock exchanges, subject to
regulatory disclosure requirements, private equity companies do not
typically disclose their financial statements. Private equity companies that
trade publicly, like Kohlberg Kravis Roberts, do provide information on
realized and unrealized profits from their investments. The realized profits
are significant. According to PEGCC, through 2009, private equity
companies have returned close to $400 billion in cumulative net profits to
their investors.
11.2.5 Trends
With consolidation, private equity companies are getting bigger, investing
larger amounts all over the world, and employing multiple investment
strategies. After the financial crisis of 2008, the lavish payouts and
secretive nature of these companies were under the media and regulatory
! !280
PRIVATE EQUITY
spotlight. Disclosure requirements and other regulations are under

consideration in the US and Europe, with some already in place.
11.2.6 Top 10 Private Equity Companies in India

Private equity funds—investment funding made without stock being issued
—have raised over $17 billion since the year 2000, according to the
research agency Preqin. The private equity sector in India declined about
60% in 2009 due to recession in overseas markets, but as of 2010, the
Indian markets have stabilized despite volatility and uncertainty in global
finances. When determining the top 10 private equity companies in India,
one measure of success is the amount of funds raised.
1. ICICI Venture
ICICI Venture Fund management, headquartered in Mumbai, has raised
funds to the tune of $3 billion over the last decade. As one of the largest
funds, it is a subsidiary of ICICI bank, the largest private sector bank in
India.
2. Chrys Capital
This New Delhi-based fund, launched in 1999, has raised $1.9 billion in
private equity funds. It has made more than 45 investments since its
inception, according its website.
3. Sequoia Capital
Sequoia Capital India, formerly known as WestBridge Capital Partners,
mainly invests in consumer, energy and financial services in India.
Headquartered in Bangalore, it focuses on investment in the seed, early
and growth stages of industry.
4. India Value Fund

India Value Fund, a Mumbai-based fund, was established in 1999 and
boasts more than $1.4 billion distributed across four funds. It was formerly
known as GW Capital.
5. Kotak Private Equity Group

This company stands as one of the early investors in Indian private equity,
launched in 1997. Kotak pumped $1.4 billion into the Indian market mainly
in the infrastructure and health care sectors.
6. Baring Private Equity Partners
! !281
PRIVATE EQUITY
Established in 1998, Gurgaon-based BPEP has over $3 billion invested

mainly in the American, Latin and Indian markets. It generally invests in
manufacturing, pharmaceutical and information technology.
7. Ascent Capital
Ascent Capital, as one of India largest private equity funds, has invested
$600 million across three funds, helping more than 40 entrepreneurs
access its funds.
8. CX Partners
CX Partners promoted by former Citigroup Venture Capital Investment
made “a final close of its debut fund in excess of $500 million,” according
to a July 7, 2010, report from Reuters.
9. Everstone Capital
Everstone Capital, the equity subsidiary of Future Holdings, raised its first
fund in 2006, for $425 million, and set its sights on a $550-million fund in
2010, reports AltAssets.com. Everstone invested in engineering companies,
a renowned children clothing producer and other industries.
10.Blackstone Group
Blackstone, a US-based firm, remains an emerging player, announcing
plans to invest as much as $1.5 billion in Indian infrastructure. In April
2010, it invested $50 million in a regional Indian newspaper, “Jagran
Prakashan.”
11.3 Venture Capital
Venture Capital is part of the private equity market. In return for the
venture capital, companies have to offer a share in their ownership.
Venture capital investments can be in different stages of business.
However, it is usually made in the early stages because those investments
are more likely to yield high returns. To compensate for some likely
venture failures, high returns on some of these investments are required
for venture capitalists to be willing to take on the risks associated with
these high growth businesses. 
! !282
PRIVATE EQUITY
11.4 Stages of Venture Capital Financing
Venture capitalists invest in different stages of the company’s life cycle.

The various stages are:
1. Seed-money stage
2. Start-up
3. First-round funding
4. Second-round funding
5. Third-round funding
6. Fourth-round funding
Let us discuss each stage in detail:
1. Seed-money Stage
Seed money is the initial equity capital needed to start a new business. The
initial capital money is used to develop a product or prove a concept. It is
usually a small amount of financing and does not include marketing.
2. Start-up
Financing for companies that were started within the past year. The funds
usually include marketing and product development expenditures.
3. First-round Funding
After the company has spent the start-up funds, additional capital is
provided to begin sales and manufacturing.
4. Second-round Funding
Funds provided for the working capital needs of a company whose product
is selling but still losing money.
5. Third-round Funding
Financing for a company that is at least breaking even and is considering
expansion. This is also known as mezzanine funding.
6. Fourth-round Funding
Funds provided to companies that are likely to go public within half a year.
This is also called bridge financing.
! !283
PRIVATE EQUITY
An IPO is the next stage after venture capital financing. As mentioned

before, venture capital funds are significant players in the IPOs. It is the
norm that venture capitalists do not sell their shares when one of their
portfolio companies goes through an IPO. Instead, they usually sell out in
subsequent public offerings.
The maximum number of companies need seed capital. Then as they

progressively move up the pyramid, number of companies requiring
funding reduces. And they move up the pyramid, the investment size
increases.
An informal survey shows that most of the companies die off in the seed
financing stage itself. Current trends indicate that only 27% of companies
that are seed funded actually raise the required angel round. 16% of the
companies shut down at the Seed stage.
11.5 Venture Capital Process
Venture Capitalists invest in private businesses to make profit. They attract

most of their financial resources from sophisticated institutional investors.
Venture capitalists try to create value by monitoring the companies and
making sound business decisions about follow-on (staged) investments.
Venture capital financing can be thought of as a joint product of both
investment capital and consulting services. The venture capital process can
be analyzed in following five steps.
Steps in Venture Capital Process
Step 1: Getting the attention of private equity investors

Many young businesses are interested in raising capital from the limited
supply of private equity investors. These investors are interested in specific
types of businesses that include biotechnology, internet and technology. In
order for any of the companies to be able to attract these investors, their
management must have a vision for converting their private company into
a public company in the future.
Step 2: Performing the valuation and rate of return

Once the private equity investors are interested in a particular company,
they will attempt to estimate its value. In addition to the conventional
valuation methods, venture capitalists use another method to value private
! !284
PRIVATE EQUITY
companies. In this method, the future earnings of the company, i.e., when
it is expected to go public, are forecasted. With the use of price-earnings
multiples for similar public traded companies, the value of this particular
company is assessed at the time of the contemplated IPO. This value is
called the exit, or terminal value because the IPO is an exit strategy for
venture capitalists.
Step 3: Structuring the deal

In structuring the deal, private equity investors and the owners of the
company negotiate through the ownership proportion. Private equity
investors need to determine what proportion of the company they want in
return for their investment. On the other hand, the company needs to
determine the ownership proportion that they are willing to give up in
return for the capital.
Step 4: Post-deal management

After the investment, it is usual for the private equity investors to have an
active role in the investment of the company. Sometimes, they also seek
out new business opportunities and try to raise more capital for the
company.
Step 5: Exit
Private equity investors and venture capitalists invest in private businesses
because they are interested in high return on their investment. There are
different ways of realizing targeted returns such as an IPO which can be an
exit strategy for venture capitalists.
However, as mentioned before, these companies usually do not sell their

shares at the IPO, but after the securities have traded for some time.
Alternatively, investors may exit by selling the business to another
company. Quite often, private equity investors prefer to liquidate a
company, if it is not generating sufficiently high returns.
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Preparing a Business Plan for Venture Capitalist

If you are approaching a venture capitalist to finance your project, how
should you prepare your business plan? Here are some guidelines:
1. Use simple and clear language. Avoid bombastic presentation and

technical language
2. Focus on four basic elements, viz., people, product, market, and

competition.
3. Give projections for about two to five years with emphasis on cash
flows.
4. Identify risks and develop a strategy to cope with the same.
5. Convince them that the management team is talented, experienced,

committed and determined.
THE TIMES OF INDIA
Reeba Zachariah and Boby Kurian, TNN | May 30, 2014, 07.03AM IST
JustDial’s private equity backers set to sell $600 million shares
MUMBAI: Three private equity backers of India’s first voice-based search
company JustDial — Sequoia Capital, Tiger Global and SAIF Partners — will at
least part sell their shares worth $600 million as the capital markets regulator-
mandated lock-in period gets over this week.
Investment bankers have held talks with the PE funds for a block trade on
bourses, which would see them making one of the heftiest returns in Indian
start-up investing.
The JustDial share price ended at Rs. 1,428 on Thursday, boosting the
company’s market value to $1.7 billion, or Rs. 10,000 crore. Thursday’s stock
price was more than double the listing price of Rs. 530 a year ago.
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2014: Private Equity Players Seal Over $11 Billion Deals

NEW DELHI: Led by the booming e-commerce sector, private equity
investments in India surged over 17% with deals worth $11.49 billion and the
outlook for next year also remains positive, says a PwC report.
According to the report by the consultancy firm, PE investments in India this
year till December 22 stood at $11,492 million (excluding real estate deals)
across 459 deals.
In 2013, PE investments stood at $9,781 million by way of 469 deals.
The higher level of PE investments was largely driven by increased interest in e-
commerce, which has so far seen investments of over $2,474 million in 48 deals
as against $553 million last year (in 36 deals).
Inclusive of e-commerce, the information technology and IT-enabled Services
(IT/ITeS) sector attracted $4,827 million in PE investments, more than double
the value it had attracted in 2013.
A sector-wise analysis shows that financial service was another sector which
saw a spate of deals, attracting $1,775 million of PE investments. It was
followed by energy (mostly renewables). Engineering and construction together
witnessed $1531 million of PE investments.
Manufacturing and healthcare put in disappointing performances and saw
decline of 62% and 33% respectively at $459 million and $868 million
respectively, the report said.
Going forward, “the outlook for PE in 2015 is positive. In part, this could be
attributed to the anticipated higher levels of growth owing to the economic
reforms on the anvil, it is in part also attributed to the exit activity from the
funds of 2006-08 vintage”, PwC said.
Anticipated higher growth rates and a lower interest rate regime are likely to
create investment opportunities in the consumer sector, it added.
Healthcare and Life Sciences are expected to continue to receive significant PE
attention. Financial Services is also expected to continue to see significant
interest on both book-based and fee-based businesses.
E-commerce is expected to continue to generate interest, as would the IT
sector; high growth levels in large developed markets like the US will help this
trend, it said.
“Private equity investors are also going to be watching the impact of key
reforms such as the introduction of the Goods and Services Tax regime that
said, there are some concerns about the ability of the Government to speed up
reforms, and this would be key to the activity levels in 2015,” the PwC report
said.
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Example:
Let us explore a scenario where you need to raise capital for your business.
You run a biotechnology start-up Predict Projects Pvt. Ltd. You are looking
for venture capital funding. Let us perform the steps in the venture capital
process to raise capital for your business. At every step, you need to make
critical decisions that will determine whether you move to the next step.
The companies, individuals and events referred to herein are fictional. Any
similarity to actual companies, individuals and events is purely
coincidental.
The first step is getting the attention of the private equity investors. Your
management team has narrowed down private equity investors, Vertical
Ventures to present your company’s strategy. Vertical Ventures is a top
venture capitalist in the biotechnology space.
What must your team focus on in the presentation?
1. Convey your vision of converting Predict Projects Pvt. Ltd. into a public
limited company in 3 years.
2. Focus on Vertical Venture’s key interest area, which is biotechnology.
3. Emphasize Predict Projects Pvt. Ltd.’s improved performance since it

was formed two years ago.
4. Explain in detail how Predict Projects Pvt. Ltd. plans to spend the
expected venture capital.
Predict Projects Pvt. Ltd. into a public company in 3 years? You are right.
To attract investors, the management team must have a vision of
converting their private company into a public company in the future. This
focus will get Ventura interested in your company.
The second step is performing the valuation and rate of return.
Vertical Ventures is convinced about Predict Projects Pvt. Ltd.’s plans to go

public in 3 years. Now, Vertical venture needs to estimate the value of the
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company. Predict Projects Pvt. Ltd.’s net income in three years is expected
to be US$ 6 million. The price to earnings ratio of similarly publicly traded
companies is 20. The exit value is equal to price to earnings ratio
multiplied by Net Income. This is equal to 120 and is calculated as 20
multiplied by 6. The exit value is estimated as US$ 120 million three years
from now. This value is discounted back to the present at a rate called
target rate of return.
Given the risk that the venture capitalists are exposed to and assuming a
return of 25%, what is the discounted exit value estimated by Vertical
Ventures?
Hint: The discounted exit value is computed as the estimated exit value
divided by the summation of 1 and the target rate of return to the power of
number of periods.
1. US$ 80000
2. US$ 32 million
3. US$ 6.144 million
4. US$ 120 million
Having reviewed the options, did you think the correct answer is option 3,
US$ 61.44 million. That is correct. Vertical Ventures needs to calculate the
target rate of return, which is set at a much higher level than the cost of
equity for the company. Assuming a 25% return, the discounted exit value
is US$ 61.44 million.
The third step is structuring the deal. Vertical Ventures has agreed to
invest US$ 15 million. The ownership proportion of Vertical Ventures is
estimated as 24.4% of the firm.
Which one component needs to be considered while determining the

ownership proportion?
1. The ownership proportion depends on the capital invested and the

estimated value of the company.
2. To determine ownership proportion, estimate the company’s net income

expected in three years.
3. Ownership proportion depends only upon the capital invested by the

company.
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4. Ownership proportion depends upon the discretion of the company

looking for funds.
Did you identify the correct answer as option 1. The ownership proportion
depends on the capital invested and the estimated value of the company?
You are right again. Ownership proportion depends on the capital invested
and the estimated value of the company. The ownership proportion is equal
to capital invested by estimated value. The ownership proportion is equal
to capital invested by estimate value. The ownership proportion of Vertical
Ventures is equal to 15 divided by 61.44, which is equal to 24.4% of
Predict Projects Pvt. Ltd.
The fourth step is the post-deal management. Vertical Ventures places two
people on the board to monitor the operations of Predict Projects Pvt. Ltd.
!
Private equity is popular among e-retail sites
Sample Term Sheets are enclosed herewith for your reference. Kindly study
them. Find out the terms which are good and flexible and ones that can
create difficulties in future.
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PRIVATE EQUITY
SAMPLE TERM SHEET 1

Date:
THE TERMS SET FORTH BELOW ARE SOLELY FOR THE PURPOSE OF
OUTLINING THOSE TERMS PURSUANT TO WHICH A DEFINITIVE
AGREEMENT MAY BE ENTERED INTO AND DO NOT AT THIS TIME
CONSTITUTE A BINDING CONTRACT, EXCEPT THAT BY ACCEPTING THESE
TERMS THE COMPANY AGREES THAT FOR A PERIOD OF 30 DAYS
FOLLOWING THE DATE OF SIGNATURE, PROVIDED THAT THE PARTIES
CONTINUE TO NEGOTIATE TO CONCLUDE AN INVESTMENT, THEY WILL
NOT NEGOTIATE OR ENTER INTO DISCUSSION WITH ANY OTHER
INVESTORS OR GROUP OF INVESTORS REGARDING THIS “SERIES X”
ROUND OF INVESTMENT. AN INVESTMENT IN THE COMPANY IS
CONTINGENT UPON, AMONG OTHER THINGS, COMPLETION OF DUE
DILIGENCE AND THE NEGOTIATION AND EXECUTION OF A SATISFACTORY
STOCK PURCHASE AGREEMENT.
Summary of Terms for Proposed Private Placement of Series X

Preferred Stock
I. Issuer: Predict Projects Pvt. Ltd.

(Hereinafter referred to as the “Company”).
II. Investor: Venture Capital Partners, LLC or its affiliates (“VC”) and
other investors acceptable to the Company and VC (collectively the
“Investors”)
III. Security: Series X Preferred Stock (“Preferred”)
IV. Amount of Investment: $[ ]
V. Valuation: Pre-money valuation is $[ ]
VI. Post Investment Ownership: The company would be capitalized

such that post investment ownership at closing would be as follows:
VC [ ]%
Founders, Management and Other [ ]%
Option Pool [ ]%
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VII. Closing Date: Closing for the investment would be on or before

__________, provided that all requirements for the closing have been met
or expressly waived in writing by the investors.
VIII. Board Representation: The Board of Directors will include a total

of five (5) people. Holders of Series X Convertible Preferred Stock are
entitled to two (2) representatives on the Company’s Board of Directors.
Common Shareholders will have three (3) designees to the board, one of
which must be the CEO of the Company. Board of Directors meetings would
be scheduled on a monthly basis until such time as the Board of Directors
votes to schedule them less frequently.
VC’s representative would be appointed to all Board Committees (including

the compensation committee), each of which would consist of three (3)
members. The Company would reimburse each Director’s reasonable
expenses incurred in attending the board meetings or any other activities
(e.g., meetings, trade shows) which are required and/or requested and
that involve expenses.
IX. Proprietary Information and Inventions Agreement: Each officer,

director, and employee of the Company shall have entered into a
proprietary information and inventions agreement in a form reasonably
acceptable to the Company and the Investors. Each Founder and other key
technical employee shall have executed an assignment of inventions
acceptable to the Company and Investors.
Description of Series B Preferred
X. Dividends: An [ ]% annual dividend would accrue as of the closing date

to holders of the Series X Convertible Preferred. Accrued dividends would
be payable:
a. if, as and when determined by the Company’s Board of Directors,

b. upon the liquidation or winding up of the company, or
c. upon redemption of the Series X Preferred. Upon an automatic
conversion, accrued but unpaid dividends would be forfeited.
No dividends may be declared and/or paid on the Common Stock until all
dividends have been paid in full on the Convertible Preferred Stock. The
Convertible Preferred Stock would also participate pari passu in any
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PRIVATE EQUITY
dividends declared on Common Stock. Dividends will cease to accrue in the

event that the investor converts its holdings to Common Stock.
XI. Liquidation Preference: In the event of any liquidation or winding up

of the Company, the Series X Preferred will be entitled to receive in
preference to the holders of Common Stock an amount per share equal to
their Original Purchase Price plus all accrued but unpaid dividends (if
any).
The Series X Preferred will be participating so that after payments of the

Original Purchase Price and all accrued dividends to the Preferred, the
remaining assets shall be distributed pro-rata to all shareholders on a
common equivalent basis.
A merger, acquisition or sale of substantially all of the assets of the

Company in which the shareholders of the Company do not own a majority
of the outstanding shares of the surviving corporation shall be deemed a
liquidation of the Company.
XII. Conversion: The Preferred will have the right to convert Preferred
shares at the option of the holder, at any time, into shares of Common
Stock at an initial conversion rate of 1-to-1. The conversion rate shall be
subject from time to time to anti-dilution adjustments as described below.
XIII. Automatic Conversion: The Series X Preferred would be automatically
converted into Common Stock, at the then applicable conversion price,
upon the sale of the Company’s Common Stock in an initial public offering
(“Public Offering”) at a price equal to or exceeding [ ] times the Series X
Preferred original purchase price in an offering which, after deduction for
underwriter commissions and expenses related to the gross proceeds, is
not less than [ ].
XIV. Antidilution Provisions: Proportional anti-dilution protection for

stock splits, stock dividends, combinations, recapitalization, etc. The
conversion price of the Preferred shall be subject to adjustment to prevent
dilution, on a “weighted average” basis, in the event that the Company
issues additional shares of Common or Common equivalents (other than
reserved employee shares) at a purchase price less than the applicable
conversion price.
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XV. Voting Rights: The Preferred will have a right to that number of votes
equal to the number of shares of Common Stock issuable upon conversion
of the Preferred.
XVI. Restrictions and Limitations: Consent of the Series X Preferred,

voting as a separate class would be required for any actions which:
i) alter or change the rights, preferences or privileges of the Series X

Preferred;
ii) increase the authorized number of shares of Series X Preferred;
iii) increase the authorized number of shares of any other class of Preferred
Stock;
iv) create any new class or series of stock, which has preference over or is
on parity with the Series X Preferred;
v) involve a merger, consolidation, reorganization, encumbrance, or sale of

all or substantially all of the assets or sale or of more than 50% of the
Company’s stock;
vi) involve a repurchase or other acquisition of shares of the Company’s

stock other than pursuant to redemption provisions described below
under “Redemption”; or
vii)amend the Company’s charter or bye-laws.
XVII. Redemption: After five (5) years and at the request of the holders
of the Series X Preferred, all or part of the Series X Preferred shares may
be redeemed at 110% of the Series X purchase price plus all accrued but
unpaid dividends.
XVIII. Conditions precedent to Investor’s obligation to invest:
i. Legal documentation satisfactory to the Investor and Investor’s counsel.

ii. Satisfactory completion of due diligence.
iii. If not already in place, the Company would obtain employment
agreements with key employees, which would include satisfactory (to
Investor) non-compete and non-disclosure language.
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XIX. Registration Rights:
1. If, at any time after the Issuer’s initial public offering (but not within 6
months of the effective date of a registration), Investors holding at least
51% of the Common issued or issuable upon conversion of the Preferred
request that the Issuer file a Registration Statement covering at least
20% of the Common issued or issuable upon conversion of the Preferred
(or any lesser percentage if the anticipated aggregate offering price
would exceed $[ ]), the Issuer will be obligated to cause such share to
be registered. The Issuer will not be obligated to effect more than two
registrations (other than on Form S-3 under these demand right
provisions.
2. Company Registration: The Preferred shall be entitled to “piggy-back”

registration rights on registrations of the Company or on demand
registrations of any later round investor subject to the right, however, of
the Company and its underwriters to reduce the number of shares
proposed to be registered pro rata in view of market conditions. No
shareholder of the Company shall be granted piggyback registration
rights superior to those of the Series X Preferred without the consent of
the holders of at least 50% of the Series X (or Common Stock issued
upon conversion of the Series X Preferred or a combination of such
Common Stock and Preferred).
3. S-3 Rights: Preferred shall be entitled to an unlimited number of

demand registrations on Form S-3 (if available to the Company) so long
as such registration offerings are in excess of $500,000, provided,
however, that the Company shall only be required to file two Form S-3
Registration Statements on demand of the Preferred every 12 months.
4. Expenses: The Company shall bear registration expenses (exclusive of

underwriting discounts and commissions and special counsel of the
selling shareholders) of all demands, piggybacks, and S-3 registrations.
The expenses in excess of $15,000 of any special audit required in
connection with a demand registration shall be borne pro rata by the
selling shareholders.
5. Transfer of Rights: The registration rights may be transferred

provided that the Company is given written notice thereof and provided
that the transfer (a) is in connection with a transfer of at least 20% of
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the securities of the transferor, (b) involves a transfer of at least

100,000 shares, or (c) is to constituent partners of shareholders who
agree to act through a single representative.
6. Other Provisions: Other provisions shall be contained in the Investor

Rights Agreement with respect to registration rights as are reasonable,
including cross-indemnification, the period of time in which the
Registration Statement shall be kept effective, standard standoff
provisions, underwriting arrangements and the ability of the Company
to delay demand registrations for up to 90 days (S-3 Registrations for
up to 60 days).
XX. Right of First Offer: The Preferred shall have the right in the event
the Company proposes an equity offering of any amount to any person or
entity (other than for a strategic corporate partner, employee stock grant,
equipment financing, acquisition of another company, shares offered to the
public pursuant to an underwritten public offering, or other conventional
exclusion) to purchase up to [ ]% of such shares.
The Company has an obligation to notify the Preferred of any proposed

equity offering of any amount.
If the Preferred does not respond within 15 days of being notified of such
an offering, or decline to purchase all of such securities, then that portion
which is not purchased may be offered to other parties on terms no less
favourable to the Company for a period of 120 days. Such right of first
offer will terminate upon an underwritten public offering of shares of the
Company.
In addition, the Company will grant the Preferred any rights of first refusal
or registration rights granted to subsequent purchasers of the Company’s
equity securities to the extent that such subsequent rights are superior, in
good faith judgment of the Board, to those granted in connection with this
transaction.
XXI. Right of Co-Sale: The Company, the Preferred and the Founders will
enter into a co-sale agreement pursuant to which any Founder who
proposes to sell all or a portion of his shares to a third party, will offer the
Preferred the right to participate in such sale on a pro rata basis or to
exercise a right of first refusal on the same basis (subject to customary
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PRIVATE EQUITY
exclusions for up to 15% of the stock, gifts, pledges, etc.). The agreement
will terminate on the earlier of an IPO or fifteen (15) years from the close
of this financing.
XXII. Use of Proceeds: The proceeds from the sale of the Preferred will
be used solely for general corporate purposes.
XXIII. Reporting Covenants: The Company would furnish to the

Investor the following:
i. Monthly Reports: Within 20 days following the end of each month, an

income statement, cash flow and balance sheet for the prior monthly
period. Statements would include year-to-date figures compared to
budgets, with variances delineated.
ii. Annual Financial Statements: Within 90 days following the end of the
fiscal year, an unqualified audit, together with a copy of the auditor’s
letter to management, from a Big Five accounting company or
equivalent, which company would be approved by the Investor.
iii. Audit: In the event, the Company fails to provide monthly reports and/
or financial statements in accordance with the foregoing, Investor would
have the authority, at the Company’s expense, to request an audit by an
accounting company of its choice, such that statements are produced to
the satisfaction of the Investor.
iv. Annual Budget: At least 30 days before the end of each fiscal year, a
budget, including projected income statement, cash flow and balance
sheet, on a monthly basis for the ensuing fiscal year, together with
underlying assumptions and a brief qualitative description of the
company’s plan by the Chief Executive Officer in support of that budget.
v. Non-compliance: Within 10 days after the discovery of any default in

the terms of the stock purchase agreement, or of any other material
adverse event, a statement outlining such default or event, and
management’s proposed response.
XXIV. Purchase Agreement: The purchase of the Company’s Series X

Preferred Stock would be made pursuant to a Series X Convertible
Preferred Stock Purchase Agreement drafted by counsel to the Investor,
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PRIVATE EQUITY
which would be mutually agreeable to the Company, and the Investor. This
agreement would contain, among other things, appropriate representations
and warranties of the Company, covenants of the Company reflecting the
provisions set forth herein and other typical covenants, and appropriate
conditions of closing, including among other things, qualification of the
shares under applicable Blue Sky laws, the filing of a certificate of
amendment to the Company’s charter to authorize the Series X Preferred,
and an opinion of counsel. Until the Purchase Agreement is signed, there
would not exist any binding obligation on the part of either party to
consummate the transaction. This Summary of Terms does not constitute a
contractual commitment of the Company or the Investor or an obligation of
either party to negotiate with the other.
XXV. Other: The Company would pay legal expenses incurred by the
Investor at closing from the proceeds of the investment. The investor
would make all reasonable efforts to see that this expense does not exceed
$30,000. Once this term sheet is signed, the Company would accept
responsibility for legal fees incurred by the Investor if the transaction does
not close up to the amount set forth above.
XXVI. Exclusivity:
(i) Upon the acceptance hereof, the Company, its officers and shareholders
agree not to discuss the sale of assets or any equity or equity type
securities, provide any information to or close any such transaction with
any other investor or prospective investor, except to named entities
mutually acceptable to Management and Investor.
(ii)The undersigned agree to proceed in good faith to execute and deliver

definitive agreements incorporating the terms outlined above and such
additional terms as are customary for transactions of the type described
herein. This letter expresses the intent of the parties and is not legally
binding on any of them unless and until such mutually satisfactory
definitive agreements are executed and delivered by the undersigned.
This letter of intent may be signed by the parties in counterparts.
If this Summary of Terms is not signed and returned to VC by midnight

(EST) [ ], it shall expire without any further action on the part of VC and
shall be of no further force or effect.
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VENTURE CAPITAL PARTNERS, LLC

Date ___________
By: _______________________
Terms agreed to and accepted by:
PREDICT PROJECTS PVT. LTD.
Date _______________
By:_________________________
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SAMPLE TERM SHEET 2

XYZ Company  
SERIES A OPTIONALLY CONVERTIBLE FINANCING  
TERM SHEET
The intent of this document is to describe, for negotiation purposes only,
some key terms of the proposed agreement between Venture Fund
Investment Advisors Limited or one of its affiliates (“Venture Fund”)
(referred as “Series A Preferred Investors” or “Investors”) and XYZ
Company, (the “Company”). By signing this agreement, the Company
agrees, undertakes and shall procure that henceforth (a) no directors,
officers, employees, agents and representatives of it or of any of its direct
or indirect subsidiaries or affiliates will initiate or participate in any
discussion or negotiations with any person other than investors mutually
agreed upon relating to the sale, issuance or grant of any equity interests
in the Company (including any form of options, derivatives or arrangement
relating thereto) (“Company Equity Interests”) and (b) no issuance, sale,
or offer to sell will be made to any person other than investors mutually
agreed upon in respect of any Company Equity.
Notwithstanding anything to the contrary, any obligations of Venture Fund

to complete or provide funding for any transaction, whether contemplated
herein or otherwise, are subject to Venture Fund’s internal approvals,
completion of due diligence to the satisfaction of Venture Fund in their sole
and absolute discretion, all necessary corporate approvals having been
obtained, and the parties having negotiated, approved, executed and
delivered the appropriate definitive agreements. Notwithstanding anything
to the contrary, any obligations of the Company to complete any
transaction, whether contemplated herein or otherwise, are subject to the
parties having negotiated, approved, executed and delivered the
appropriate definitive agreements and such definitive agreements
remaining in full force and effect. Until execution and delivery of such
definitive agreements, Venture Fund and the Company shall have the
absolute right to terminate all negotiations for any reason without liability
therefore, but without prejudice to Clauses (a) and (b) in the foregoing
paragraph.
This term sheet shall remain valid until __________. If this term sheet
remains unsigned after that time, Venture Fund at its option may
immediately terminate discussions with the Company or change any or all
pricing, terms and conditions contained herein.
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Confidentiality
The terms and conditions described in this Term Sheet including its
existence shall be confidential information and shall not be disclosed to any
third party. If either party determines that it is required by law to disclose
information regarding this Term Sheet or to file this Term Sheet with the
Securities and Exchange Board of India (SEBI) or any equivalent regulatory
body, it shall, a reasonable time before making any such disclosure or
filing, consult with the other party regarding such disclosure or filing and
seek confidential treatment for such portions of the disclosure or filing as
may be requested by the other party.
Legal Structure Venture Fund will in XYZ Company
Amount of Up to Rs. Fifteen Crores

Financing
(Investment
Amount)
Type of Series A Optionally Convertible Preferred Stock (“Series A
Security Preferred”), convertible into (“Common Shares”), in part or
full, at any time, at the option of Venture Fund, at the pre-
money valuation of the Company as described below.
Valuation 8 times Profit after tax or One time revenue (Inter-company

revenue, revenue attributable to minority interests, and
other income excluded) which ever is lower for the FY _____
of the consolidated holding company. The pre-money
valuation is subject to a floor of _____ and cap of _____.
Definitions “Qualified IPO” means closing of an underwritten public
offering of shares of Common Stock of the Company with
gross proceeds to the Company in excess of Rs. Fifty Crores
Mn, at a minimum pre-IPO market capitalization of Rs. Two
Hundred Crores.
“Strategic sale” means sale of majority shareholding (>50%)
of the Company for cash or listed securities as approved by
Series A.
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Purchase Price An amount per share (the “Purchase Price”) such that the
Purchase Price multiplied by the number of shares
outstanding on a fully diluted basis (taking into account,
without limitations, all options, warrants, stock option plans
or any other arrangements relating to the Company’s equity)
prior to this Series A Preferred financing is equal to the pre-
money valuation as explained above.
Fully diluted means the total of all classes and series of

shares outstanding combined with all options (including both
issued and unissued), warrants (including both issued and
unissued) and convertible securities of all kinds and the
effect of any anti-dilution protection regarding previous
financings, all on an “as if converted” basis and in addition,
taking into account a ___ per cent (___%) pool for issuance
of employee options/equity.
Closing Approximately __________
Conditions Reasonable Closing conditions include:

Precedent to
Closing 1. Completion of Accounting, Business, Technical and Legal
due diligence of the Company and all of its subsidiaries,
to the satisfaction of Series A Preferred Investors.
2. Obtaining all regulatory permissions, approvals and

consents required.
3. Creating an Employee Stock Option Pool of ___% shares

to be granted over the next 4 years.
4. Execution of Definitive agreements.
5. Passing requisite resolutions by shareholders of Company

for the issue of shares to Series A Preferred Investors.
6. Opinion from Company’s attorneys, in standard form, of

Company’s good standing and that the issue of shares to
Series A Preferred Investors has been duly authorized and
does not conflict with contractual commitments of the
company.
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7. Preparation of a pre-closing financial statements in

accordance with Indian GAAP and evidence acceptable to
investors that the Company is not subject to any present
or potential liabilities, defaults, claims or proceedings
which, if adversely decided or concluded, would materially
affect the Company or its properties or assets or impair
its ability to comply with its obligations under the
Definitive Agreements.
8. Take all actions required under law to amend the Articles

of Association of the Company, to reflect the terms and
conditions of the Definitive Agreements.
9. Appointment of a reputable Accounting and a reputable

Legal company to the satisfaction of the Series A
Preferred Investors.
10.Incorporation of a legal corporate structure which is

acceptable to Venture Fund.
Rights and
Preferences of
Series
Preferred
Dividend Rights No dividend, whether in cash, in property or in shares of the

Company or any of its subsidiaries, would be allowed to be
paid on any other class or series of shares of the Company
without a specific written approval of Series A Preferred
Investors. On approval as mentioned above, the dividend will
be paid only after dividend in like amount and other
contractual payments were first paid in full on Series A
Preferred.
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PRIVATE EQUITY
Liquidation In the event of any liquidation, dissolution or winding up of

Preference the Company, the holders of the Series A Preferred would be
entitled to receive, prior to any distribution to the holders of
the Common Stock, an amount so as to return the
Investment Amount and give them a 2 times return on the
Investment Amount (plus all declared but unpaid dividends)
from the date of investment thereon (the “Preference
Amount”).
A merger or consolidation of the Company in which its
shareholders did not retain a majority of the voting power in
the surviving corporation, or a sale of all or substantially all
the Company’s assets, would each be deemed to be a
liquidation, dissolution or winding up of the Company.
Conversion The holders of the Series A Preferred would have the right to
Rights convert the Series A Preferred into shares of Common Stock,
in part or full, at any time. The Conversion rate for the Series
A Preferred would be based on the valuation described
above.
Drag Along The company will provide an exit through a Qualified IPO/
Rights: Strategic sale before _____. In the event of the company not
providing an exit route, Series A Preferred investors have the
right to sell, merge or liquidate the Company at its own
option and the founders shall be obliged to offer their shares
in part or in full to facilitate an exit for Series A Preferred.
Automatic The Series A Preferred would automatically be converted into
Conversion Common Stock, at the then applicable conversion rate, upon
a Qualified IPO/Strategic Sale.
Antidilution The conversion price of the Series A Preferred would be

Provisions subject to adjustment on a full ratchet basis, for issuances at
a purchase price less than the then-effective conversion price
with a carve-out for: (i) issuances of up to ___% option pool
and any other equity issued to employees, officers or
directors of the Company pursuant to stock purchase or
stock option plans or agreements or other incentive stock
arrangements approved by the Board. (ii) Issuances up to
___% of the company to strategic vendors and other
strategic investors approved by the board and proportional
anti-dilution protection for rights issue, stock splits, stock
dividends, etc. This would be applicable till the execution of a
Qualified IPO/Strategic sale.
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PRIVATE EQUITY
Approval of Detailed business plan shall be presented to the board of

Business Plan directors 30 days prior to the commencement of the new
financial year. The business plan including financial
statements will be made out on a monthly basis for the
remainder of the first fiscal year following investment and on
a quarterly basis thereafter. Such plan to be approved by the
board of directors. Any business plan that has less than 10%
growth on any of the “Key financial parameters” has to be
specifically approved by the Series A Preferred.
Key financial parameters are defined as: (a) Consolidated
revenue from operations, (b) Consolidated net income from
operations and (c) Net cash flow from operations.
Appointment of The senior management of the company will include (a) CEO,
Senior (b) CTO, (c) Head of India operations, (d) Head of SBU, and
Management (e) Head of sales and marketing. Any recruitment or change
to the senior management will be done in consultation with
the Series A Preferred.
The investor has the option to change any individual in the
senior management if there is significant non-performance
by the team. Significant non-performance is defined as
follows:
Under achievement of key financial parameter on any
financial year by more than 30% compared to the business
plan as approved by the board of directors.
Founders Earn Founders have the option to earn back up to 15% of the
Back company based on achievement of the following for CY Dec
__:
1. Consolidated net income of _____ and above and
operating cash flow of _____ and above for CY Dec ____,
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PRIVATE EQUITY
Protective Consent of the holders of Series A Preferred would be

Provisions required for (with regard to items (v) through (xvi) below,
the term “Company” is expanded to include the Company
and all of its subsidiaries):
(i) Any amendment or change of the rights, preferences,

privileges or powers of, or the restrictions provided for the
benefit of, the Series A Preferred;
(ii)Any action that authorized, created or issued shares

including rights issue of any class or series of stock having
preferences superior to or on a parity with the Series A
Preferred;
(iii)Any action that reclassified any outstanding shares into

shares having preferences or priority as to dividends or
assets senior to or on a parity with the preference of the
Series A Preferred;
(iv)Any transactions with related parties or companies;
(v)Any amendment of the Company’s Memorandum and

Articles of Association (the “M/A”);
(vi)Any merger or consolidation of the Company;
(vii) The sale of all or substantially all the Company’s assets;
(viii) The liquidation or dissolution of the Company;
(ix) Any dividend payout;
(x)Incurrence of indebtedness either through loan or

guaranteed future lease payment or capital commitment
in excess of _____;
(xi)An increase of more than 15% in the total compensation

of any of the five (5) most highly compensated employees
of the Company in a twelve (12) month period;
(xii)The purchase or lease of any automobile with a purchase

value greater than _____ and an aggregate value of
_____. in a twelve (12) month period;
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PRIVATE EQUITY
(xiii)The purchase or lease of any real estate used in the

ordinary course of business in excess of ______ per year
(purchase or lease of any real estate to includes only
office and R&D space);
(xiv)The strategic purchase of equity securities with a

purchase value greater than ______ (no purchase of
securities, either private or publicly traded, for speculative
or non-strategic investment purposes to be allowed, other
than high grade money market securities. No purchases
of the Company’s own securities from any party allowed);
(xv)The extension of any loan to any party except loans to

full time employees, up to _____ per employee, under the
normal course of business (Advances to employees
towards Lease deposits excluded and will be decided by
the Compensation Committee); (and)
(xvi)Any material changes in the Company’s business plan

Terms of the The purchase of shares of Series A Preferred would be made
Stock Purchase pursuant to a Stock Purchase Agreement and a Rights
Agreement and Agreement reasonably acceptable to the Company and
Rights Series A Preferred Investors, which agreement would
Agreement contain, among other things, customary representations and
warranties of the Company, covenants of the Company
reflecting the provisions set forth herein, and appropriate
conditions of closing, including an opinion of counsel for the
Company.
Board of The Company’s Memorandum and Articles of Association

Directors would provide for a Board of five (5) Directors. The number
of directors could not be changed except by amendment.
With respect to the election of the Board, so long as Venture
Fund continues to hold at least 30% of its original
investment, Venture Fund would be entitled to elect one (1)
member of the Board of the Company and one (1) member
of the Board of each of its subsidiaries.
Committees The Company would constitute Audit and Compensation
Committees and Venture Fund would be entitled to appoint a
member to each of these committees.
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PRIVATE EQUITY
Use of Proceeds The Company would use the proceeds from the Series A
Preferred Financing for acquisitions, capital expenditure and
general working capital in its business.
Right of First Each holder of Series A Preferred would have a right of first
Offer offer to purchase up to its pro rata share (based on its
percentage of the Company’s outstanding common shares,
calculated on a fully diluted as-converted basis at the
Purchase price) of any equity securities offered by the
Company on the same price and terms and conditions as the
Company offers such securities to other potential investors
(with a right of oversubscription if any holder of Series A
Preferred elected not to purchase its pro rata share). This
right would not apply to: (i) the issuance to employees
and officers of the Company, pursuant to stock purchase or
stock option plans approved by the Board, (ii) issuances up
to ___% of the equity to strategic vendors and other
strategic investors approved by the board and (iii) issuances
in consideration for the acquisition of other businesses.
Right of First The Company, each holder of Series A Preferred and the
Refusal and Co- Founders would enter into a Co-sale Agreement which would
sale and give the holders of the Series A Preferred first refusal rights
Restriction for and co-sale rights providing that any Founder or major
Founders shareholder who proposed to sell all or a portion of his
shares to a third party must permit the holders of the Series
A Preferred hereunder at their option: (i) to purchase such
stock on the same terms as the proposed transferee, or (ii)
sell a proportionate part of their shares on the same terms
offered by the proposed transferee. This right would
terminate upon the closing of a Qualified IPO.
Founders Lock- The Promoters agree that they will not pledge, hypothecate,
up Period and sell, transfer, or otherwise dispose their shareholding
Employee following the closing of this financing, without the written
Vesting consent of Series A Preferred holders.
Stock issued to employees, directors and consultants under
bona fide incentive stock option plans would be subject to
vesting over four (4) years.
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PRIVATE EQUITY
Information So long as shares of Series A Preferred were outstanding,

Rights the Company would deliver to each holder of Series A
Preferred: (i) audited consolidated annual financial
statements within 90 days after the end of each fiscal year;
(ii) unaudited consolidated monthly financial statements
within 15 days of the end of each month; and (iii) an annual
budget within 30 days prior to the end of each fiscal year. All
financial statements to include a balance sheet, income
statement and statement of cash flows prepared in
accordance with Indian GAAP. All annual audited financial
statements to be prepared by an international accounting
company or an associate of an international accounting
company of the Company’s choosing. For so long as shares
of Series A Preferred were outstanding, such holders would
have standard inspection rights. These information and
inspection rights would terminate upon the Company’s initial
public offering.
Confidentiality The terms and conditions of the equity financing, including
(prior to closing) its existence, would-be confidential
information and would not be disclosed to any third party by
the Company except as provided below. Both Venture Fund
and the Company would be able to disclose the existence of
the equity financing, but not its pricing or other terms and
conditions. The pricing or other terms and conditions of
Venture Fund’s investment in the Company could be
disclosed solely to the Company’s lenders, investors,
partners and advisors and to bona fide prospective lenders,
investors, partners and advisors, in each case only where
such persons or entities are under appropriate non-
disclosure obligations. In the event of a disclosure required
by law, and other regulatory bodies, the disclosing party
would use all reasonable efforts (and cooperate with the
other party’s efforts) to obtain confidential treatment of
materials so disclosed.
Confidential Each key officer and employee of the Company would have
Information entered into an acceptable confidential information and
and Invention invention assignment agreement. The Company would use
Assignment its best efforts to have the remainder of the employees and
Agreement officers sign such an agreement.
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PRIVATE EQUITY
Capitalization The capitalization of the Company on a fully diluted as if

converted basis will be listed out in the definitive
Agreements.
Other Major Covenants
Exclusivity The Company will work exclusively with Venture Fund for 60
to 75 days from the date of signing of this term sheet. The
Company shall not solicit, have discussions or provide any
information to any other investors, without written approval
from Venture Fund during this period.
Due Diligence Venture Fund will perform detailed due diligence (DD) on the
Expenses Company and all of its subsidiaries. Conditional upon closing,
the cost of financial and legal due diligence including travel
and stay for the team, and the other legal expenses of
Venture Fund in connection with the financing will be borne
entirely and directly by the Company up to a maximum of
_____. The payment will be made directly by the company to
the financial and legal firm. Any additional expenditure will
be borne by the Series A Preferred Investors. The
appointment, scope of the audit for financial and legal
companies will be done by the Series A Preferred and the
companies will be of international repute.
Other Expenses The Company shall bear all reasonable expenses incurred
towards providing an exit through IPO/listing to Series A
Preferred Investors. Investors will bear their own exit-related
expenses for sale to private Investors.
IN WITNESS whereof the parties hereto executed this Term Sheet the day and
year first above written.
Venture Fund
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XYZ Company
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PRIVATE EQUITY
!
Real estate developers use Private Equity for selected projects where the
area above a certain threshold as per Indian Government Norms.
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PRIVATE EQUITY
11.6 SUMMARY
• Private equity investments are not traded on exchanges and are

generally available to companies that do not have access to public
funding.
• Venture capital is part of the Private Equity market and can be defined as
the capital provided to young and relatively risky businesses seeking
rapid growth, in return for a share in the company’s ownership.
• Venture Capitalists invest in the different stages of the life cycle of

private companies; the seed money stage, the start-up stage and
additional rounds of funding until the IPO.
• The venture capital process starts when a private company approaches a

venture capitalist who will estimate the value of the company. The
owners of the company and the venture capitalists state their interests
and negotiate the terms of the deal. After the deal is structured, the
venture capitalists continue to support the company, often becoming
actively involved in the management and business development of the
company.
• The final step in a venture capital process is to implement the exit
strategy. It can be an IPO, the selling off of the business or the
liquidation of the company.
Activities
1. Use internet resources to find out how the e-retail web portals such as
Snapdeal, Flipkart, various others are funded through Private Equity/
Venture Capital.
2. Use internet resources to find out how Facebook, Pinterest are funded.
3. Suppose you had a great idea or invention. But you did not have a
strong balance sheet or past performance to tap the bank debt. Prepare
a business plan to access venture capital for your great idea.
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PRIVATE EQUITY
1. What is Private Equity? Discuss its history and performance in past two
decades.
2. Name the top 10 Private Equity companies in India.
3. What are the various stages of Venture Capital Financing? Describe each
in brief.
4. What are the steps in venture Capital Process?
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PRIVATE EQUITY
REFERENCE MATERIAL
chapter
Summary
PPT
MCQ
Video Lecture 
! !314
PUBLIC LISTING OF SECURITIES
Chapter 12
Objectives
• Get a brief overview about listing a company.
• Provide conceptual understanding on various types of equity offerings.
• Explain listing a company, its pros and cons.
• Explain the methods of offerings.
Structure:
12.1 Introduction
12.2 Various Types of Equity
12.3 Listing a Company
12.4 Stock Exchanges
12.5 Methods of Offering
12.6 Summary
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12.1 Introduction
At some point, a successful company may expand to that point that it is no

longer feasible for a single investor or even a small group of investors, to
provide all the capital that the company needs to keep growing. When that
occurs, the company may choose to convert from private to public
ownership. When a company makes the transition from private to public
ownership, it may decide to list its stock on a recognized stock exchange.
Popular Stock Exchanges in India are NSE and BSE.
To list on an exchange, a company must comply with all listing

requirements established by the exchange and a host of laws and
regulations enforced by SEBI and ROC.
An international company can list itself on following exchanges:
US New York Stock Exchange (NYSE) or NASDAQ
UK London Stock Exchange
Japan TSE or Tokyo Stock Exchange
Australia ASX or Australian Stock Exchange
Malaysia Bourse or ‘Bursa Malaysia’
Singapore SGX or Singapore Stock Exchange
To list its stock on an international exchange, a company must comply with

any listing requirements established by the exchange (such as minimum
profit requirements) and a host of laws and regulations enforced by the
government body that administers the company law and regulates equity
markets. For example, in the US, this body is the Securities and Exchange
Commission (SEC); in Australia, the Australian Securities and Investments
Commission (ASIC); and in Malaysia, the Malaysian Securities Commission.  
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Benefits Costs
Access to a larger pool of capital Dilution
Respectability Loss of flexibility
Lower cost of capital compared to Disclosures and accountability

private placement
Liquidity Periodic costs
12.2 Various types of Equity

There are a variety of types of stocks a company can offer in the form of
equity. These are:
1. Common Stock
2. Preferred Stock
3. Rights
4. Debentures
5. Warrants
6. Convertibles
7. Sweat Equity
8. ESOPs
12.2.1 Common Stock

The most familiar form of equity is the common or ordinary stock. Holders
of common stock are entitled to a proportionate share in any cash that is
distributed to the company’s investors. They also enjoy the right to vote
(typically one vote per share) at the company’s annual meeting.
Collectively, a company’s shareholders elect the board of directors that
oversees the actions of senior management, and they also vote on
important matters such as mergers and acquisitions or changes to the
corporate charter, the legal document that outlines how the company will
be governed. In some countries, companies are allowed to issue more than
one class of common stock. Often these dual-class companies issue a
second class of stock with special voting rights (such as 10 votes per share
rather than 1 or the exclusive right to elect a majority of the board of
directors). Usually, senior managers or members of the founding family
hold the second class of stock; this offers insiders a mechanism to exercise
control of a majority of the company’s votes without having to invest a
majority of the capital needed to finance the firm.
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12.2.2 Preferred Stock

Some companies issue a hybrid security known as preferred stock,
sometimes called as preference shares. Like debt, preferred stock promises
to pay a fixed cash payment, usually one payment per quarter. Like debt,
preferred stock has a higher priority claim than common stock, meaning
that preferred shareholders must receive their dividends before dividends
may be paid to common stockholders. Some preferred shares pay
cumulative dividends, meaning if a financially troubled company misses a
preferred payment, the payment must be made before any dividends can
be paid on common stock.
However, preferred stock has several features that more closely resemble
traditional equity securities than debt. For example, when a company pays
dividends to preferred shareholders, it cannot deduct them from taxes as it
can on interest payment to bondholders. Likewise, when a company fails to
make the promised payments on its preferred stock, the preferred
shareholders have no legal right to force the company to make these
payments.
Bondholders can force the company into bankruptcy or liquidation if it does

not make principal and interest payments on time. Therefore, preferred
stock is a hybrid security offering neither a pure fixed claim like debt nor a
residual claim like equity. Because it is somewhat riskier than debt, but not
as risky as common equity, preferred stock generally offers investors a
return that is a little higher than bonds, but somewhat lower than common
stock.
12.2.3 Rights
A rights issue involves selling securities in the primary market by issuing
rights to the existing shareholders. When a company issues additional
equity capital, it has to be offered; in the first instance to the existing
shareholders on a pro rata basis. This is required under Section 81 of the
Companies Act, 1956. The shareholders, however, may by a special
resolution forfeit this right, partially or fully, to enable a company to issue
additional capital to the public.
Procedure for Rights Issue:

A company making a rights issue sends a letter of offer along with a
composite application form consisting of four forms (A, B, C and D) to the
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shareholders. Form A is meant for the acceptance of the rights and

application of additional shares. This form also shows the number of rights
shares the shareholder is entitled to. It also has a column through which a
request for additional shares may be made. Form B is to be used if the
shareholder wants to renounce the rights in favour of someone else. Form
C is meant for application by the renounced in whose favour the rights
have been renounced, by the original allottee, through Form B. Form D is
to be used to make a request for split forms. The composite application
form must be mailed to the company within a specific period, which is
usually 30 days.
Rights Issue versus Public Issue:

A rights issue offers several advantages over a public issue. The flotation
costs of a rights issue are significantly lower than those of a public issue.
Theoretically, the subscription price of a rights issue is irrelevant because

the wealth of a shareholder who subscribes to the rights issue or sells the
rights remains unchanged, irrespective of what the subscription price is.
Hence, the problem of transfer of wealth from existing shareholders to new
shareholders does not arise in a rights issue.
Public Issue Rights Issue Private Placement
Amount that can be raised Large Moderate Moderate
Cost of Issue High Negligible Negligible
Dilution of Control Yes No Yes
Degree of underpricing Large Irrelevant Small
Market perception Negative Neutral Neutral
12.2.4 Debentures
Debenture is a debt instrument. A debenture is a written instrument signed
by a company acknowledging its debt due to its holders. The instrument
promises to pay its holders a specific amount of money at a fixed date in
future together with periodic payment of interest. It is an unsecured
instrument. If the company gets liquidated, its debenture holders will
become general creditors. Debentures secured by specific asset of the
company are termed as “Secured Debentures”.
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Important aspects of Debentures are that:
a. They have a specific maturity date.

b. Debenture holders have claim to income of the company. They have
priority over stockholders.
c. Debenture holders have priority in respect of claim on the assets of the
company. They have priority over stockholders.
d. Debenture holders do not have voting or controlling right on the
company.
Various kinds of Debentures are raised in Indian market:
a. Non-cumulative Debentures
b. Cumulative Debentures
c. Floating Rate Bonds
d. Secured Premium Notes
e. Zero Coupon Bonds
f. Deep Discount Bonds (DDB)
g. Convertible Bonds/Debentures
12.2.5 Warrants
A warrant is an option to buy a stated number of shares of stock at a
specified price. It gives the holder the right to buy common stock for cash.
When the holder exercises the option, he surrenders the right.
Warrants are a means for long-term financing. They have maturity dates of
5 years or more in the future.
12.2.6 Convertibles
Convertible represent a bond or a share of preferred stock with embedded
options issued by organizations. The holder has a right to exchange
convertible bond for equity in the issuing company at certain times in the
future. Convertible preference shares are preference shares with the right
to convert to ordinary shares.
12.2.7 Sweat Equity, ESOPs

Sweat equity shares are equity shares issued by a company to its
employees or directors at a discount, or as a consideration for providing
know-how or a similar value to the company. A company may issue sweat
equity shares of a class of shares already issued if these conditions are
met.
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The issue of sweat equity shares should be authorized by a special

resolution passed by the company in a general meeting The resolution
should specify the number of shares, current market price, consideration, if
any, and the section of directors/employees to whom they are to be issued
As on the date of issue, a year should have elapsed since the company was
entitled to commence business.
The sweat equity shares of a company whose equity shares are listed on a
recognized stock exchange should be issued in accordance with the
regulations made by the Securities and Exchange Board of India (SEBI).
In the case of a company whose equity shares are not listed on any
recognized stock exchange, sweat equity shares can be issued in
accordance with such guidelines as may be prescribed.
In the case of unlisted companies, sweat equity shares cannot be issued

before one year of commencement of operations. Moreover, there is a cap
of 15% on the number of sweat equity shares that can be issued without a
specific central government approval.
Sweat equity shares are no different from employee stock options with a
one year vesting period. It is essential when a company is formed, to
assure the financial investors that the know-how providers will stay on, or
for a start-up with limited resources to attract highly qualified professionals
to join the team as long-term stakeholders.
These shares are given to a company’s employees on favourable terms, in

recognition of their work. Sweat equity usually takes the form of giving
options to employees to buy shares of the company, so they become part
owners and participate in the profits, apart from earning salary.
Section 79A of the Companies Act lays down conditions for the issue of
sweat equity shares. For listed companies, there are regulations made by
the SEBI. The SEBI also prescribes the accounting treatment of sweat
equity shares. Thus, sweat equity is expensed, unless issued in
consideration of a depreciable asset, in which case it is carried to the
balance sheet.
Sweat equity is a device that companies use to retain their best talent.
Usually, it is given as part of a remuneration package. However, start-ups
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sometimes use sweat equity to retain talent. If the company fails, its
employees may end up with worthless paper in the form of sweat equity
shares.
Unlisted companies cannot issue more than 15% of the paid-up capital in a
year or shares with a value of more than Rs. 5 crores – whichever is higher
– except with the prior approval of the central government. If the sweat
equity is being issued for consideration other than cash, an independent
valuer has to carry out an assessment and submit a valuation report.
The company should also give ‘justification for the issue of sweat equity
shares for consideration other than cash, which should form a part of the
notice sent for the general meeting’.
The board of directors’ decision to issue sweat equity has to be approved

by passing a special resolution at a shareholders’ meeting later in the year.
The special resolution must be passed by 75% of the members attending
voting for it.
An ESOP is a type of employee benefit plan which is intended to encourage

employees to acquire stocks or ownership in the company.
Definition: An employee stock ownership plan (ESOP) is a type of

employee benefit plan which is intended to encourage employees to
acquire stocks or ownership in the company.
Description: Under these plans, the employer gives certain stocks of the
company to the employee for negligible or less costs which remain in the
ESOP trust fund, until the options vests and the employee exercises them
or the employee leaves/retires from the company or institution.
These plans are aimed at improving the performance of the company and
increasing the value of the shares by involving stock holders, who are also
the employees, in the working of the company. The ESOPs help in
minimizing problems related to incentives.
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12.3 Listing a Company
Converting from a private company to a public company is a complex and

highly regulated process. Companies usually enlist the help of investment
bankers or merchant bankers. Working in concert with the company’s
management, investment bankers prepare a prospectus. The prospectus
contains:
• A description of how the company operates

• An outline of the risks that investors in the company will face
• The lists of names and backgrounds of senior managers
• Detailed financial information about the company
Following steps are followed while listing a company:
1. An investment banker distributes a company’s prospectus to potential

investors to generate interest in the company and to solicit orders for
shares in the soon to be public company.
In return for these and other services that it provides, the investment bank
charges the company a fee, usually about 7% of the total amount of
money that the company raises in the offering.
2. When the investment bank is confident that the demand for shares will
be more than sufficient to supply the company with the capital it needs,
the bank will write the company a cheque in exchange for shares of
stock.
The bank than resells these shares to investors who want to buy them, a
process known as underwriting.
3. When a company issues shares directly to investors (with help of an

investment banker), it is selling shares on the primary market.
4. Once securities are listed on the Stock Exchange, investors may trade
these securities in the secondary market.
There are many costs of listing as a public company
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1. One of the biggest is that listed companies must comply with an array of
securities regulations and disclosure requirements.
2. Listed companies must file quarterly and annual shareholding patterns,

results and secretarial audits.
3. Executives who work for these companies face insider trading

regulations limiting the circumstances in which they may buy or sell
shares in the company.
4. If the company or its executives fail to comply with any of these

regulations, they may face action from the Stock Exchange or the
regulator.
12.3.1 Relationship between SEBI and the Stock Exchanges in

India
SEBI and the Stock Exchanges play very different roles in the securities
market even though both impose certain requirements on companies that
want to list.
SEBI was created by the Government to enforce legislation passed in the

Securities Act. SEBI is primarily charged with prevention of fraud in
securities market. Consequently, SEBI devotes a substantial fraction of its
resources to establish and enforce various disclosure requirements.
Stock Exchanges, on the other hand, exist mainly to provide liquidity to

investors. Exchanges act as intermediaries between buyers and sellers of
securities of securities, lowering the costs of trading.
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12.3.2 Pros and Cons of Public Listing
Advantages
• A listed company can raise capital from a much wider pool of investors
than can a company that does not list its shares.
• Once the company’s shares are publicly traded, the share price can serve
as a useful barometer of how the business is performing. The market’s
perception of the value of a listed company’s equity is reflected every day
– indeed at every moment.
• The company may use shares or stock options as part of the

compensation package that it offers to recruit and retain talented
employees. Companies also use stock and stock options as incentive
devices. By including stock options in employee compensation packages,
companies tie employee’s financial rewards directly to the overall
financial success of the company. The financial linkage between
employee success and overall company success reduces the need for
constant monitoring.
• Listing the company’s stock on the public market allows the original
entrepreneurs and other investors with large stakes to sell a portion of
their investment and diversify their portfolios if they choose.
• Listing shares on any exchange may also provide companies with

marketing benefits. The publicly and news coverage associated with
listing securities may attract new customers as well as new investors.
Disadvantages
• There are substantial costs of going public. Firstly, there are direct costs
of an Initial Public Offering (IPO) such as underwriting fees.
• Public companies are also required to provide quarterly and annual

reports, and are subject to greater public scrutiny.
• Publicly listed companies have to provide more information to their

shareholders than private companies. This information will also be
available to their competitors and might put the company at a
competitive disadvantage.
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12.4 Stock Exchanges
12.4.1 NSE – The National Stock Exchange (NSE)

(www.nseindia.com)
NSE is India’s leading stock exchange covering various cities and towns
across the country. NSE was set up by leading institutions to provide a
modern, fully automated screen-based trading system with national reach.
The Exchange has brought about unparalleled transparency, speed and
efficiency, safety and market integrity. It has set up facilities that serve as
a model for the securities industry in terms of systems, practices and
procedures.
12.4.2 BSE – The Bombay Stock Exchange (www.bseindia.com)

BSE is the oldest stock exchange in India. It is very popular covering
various cities and towns across the country. NSE was set up by leading
institutions to provide a modern, fully automated screen-based trading
system with national reach. The Exchange has brought about number of
revolutionary steps for the safety and security of various members and
retail investors.
12.4.3 BSESME – SME Stock Exchange (www.bsesme.com)

This is a platform for SME companies to raise money from the public. SME
companies form the backbone of any developing economy. This platform is
a great avenue to raise equity capital for the growth and expansion of the
SMEs.
! !
BSE is a popular exchange for domestic companies
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12.5 METHODS OF OFFERING

There are different ways in which a company may raise finances in the
primary market public offering, rights issue, and private placement.
12.5.1 Public Offering

A public offering or public issue involves sale of securities to the members
of the public. The three types of public offering are: the initial public
offering (IPO), the seasoned equity offering, and the bond offering.
12.5.2 Initial Public Offering

The first public offering of equity shares of a company, which is followed by
a listing of its shares on the stock market, is called the initial public
offering (IPO)..
Decision to Go Public
The decision to go public (or more precisely the decision to make an IPO so
that the securities of the company are listed on the stock market and are
publicly traded) is a very important issue. It is a complex decision, which
calls for carefully weighing the benefits against costs.
Eligibility for IPOs

An Indian company, excluding certain banks and infrastructure companies,
can make an IPO if it satisfies the following conditions:
• The company has a certain track record of profitability and a certain

minimum net worth.
• The securities are compulsorily listed on a recognized stock exchange,

which means that a certain minimum per cent of each class of securities
is offered to the public.
• The promoter group (promoters, friends, relatives, associates, etc.) is

required to make a certain minimum contribution to the post-issue
capital.
• The promoters’ contribution to the equity is subject to a certain lock-in

period.
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The IPO Process: From the perspective of merchant banking, the IPO
process consists of four major phases:
(a) hiring the merchant bankers,

(b) due diligence and prospectus preparation,
(c) marketing, and
(d) subscription and allotment.
The company wishing to go public has to hire the merchant bankers to

manage its offering. The selection of a merchant banker is usually referred
to as a ‘beauty contest’. Typically, it involves meeting different merchant
bankers, discussing the plans for going public, and getting a valuation
estimate. Understandably, the choice of the merchant banker is guided
mainly by the valuation estimate offered. Often, a company going for an
IPO selects two or more merchant bankers to manage the issue. The
primary manager is called the “lead manager” and the other managers are
called “co-managers”.
Once the managers are selected, due diligence and prospectus preparation
begin. The merchant bankers understand the company’s business and
plans, examine various documents and records, prepare the draft
prospectus, file the same with the regulatory authorities, and arrange for
its printing. Merchant bankers, lawyers, accountants, and company
managers have to toil for countless hours to complete the legal formalities
that finally culminate in the printing of the prospectus. Since book building
is commonly used, the issue price is not fixed in advance, but a price band
is given.
The next phase of an IPO is the marketing phase. After all the regulatory
approvals are in place, the company embarks on a road show to promote
the issue. A road show involves presentation by the management of the
company to potential investors (mostly institutional) in different locations.
Concurrently, the issue is advertised in various media primarily targeted at
retail investors.
The final phase of the IPO involves receiving subscription and allotment of
shares. The subscription is normally kept open for five to ten days. During
this period, investors can submit their bid-cum-application forms. After the
subscription is closed, the merchant bankers fix the final issue price,
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determine the pattern of allotment, complete the allotment of shares, and

secure the listing on one or more recognized stock exchanges.
Seasoned Equity Offering: For most companies, their IPO is seldom their
last public issue. As companies need more finances, they are likely to make
further trips to the capital with seasoned equity offerings, also called
secondary offerings.
While the process of a seasoned equity offering is similar to that of an IPO,

it is much complicated. The company may employ the merchant bankers
who handled the IPO. Further, with the availability of secondary market
prices, there is no need for elaborate valuation. Finally, prospectus
preparation and road shows can be completed with lesser effort and time
than that required for the IPO.
Bond Offering: The bond offering process is similar to the IPO process.
There are, however, some differences:
• The prospectus for a bond offering typically emphasizes a company’s

stable flows, whereas the prospectus for an equity offering highlights the
company’s growth prospects.
• Pure debt securities are typically offered at a predetermined yield

because the book building route is not considered appropriate for them.
• Debt securities are generally secured against the assets of the issuing
company and that security should be created within six months of the
close of the issue of debentures.
• A debt issue cannot be made unless credit rating from a credit rating
agency is obtained and disclosed in the offer document.
• It is mandatory to create a debenture redemption reserve for every issue

of debentures.
• It is necessary for a company to appoint one or more debenture trustees

before a debenture issue.
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Private Placement
A private placement is an issue of securities to a select group of persons
not exceeding 49 (number increased in the new Companies Act, 2013).
Private placement of shares and convertible debentures by a listed
company can be of two types:
Preferential Allotment: When a listed company issues shares or

debentures to a select group of persons in terms of the provisions of
Chapter XIII of SERI (DIP) Guidelines, it is referred to as a private
placement. The issuer has to comply with various provisions, starting from
pricing, disclosures, lock-in period and so on, apart from the requirements
of the Companies Act.
Qualified Institutional Placement (QIP): A QIP is an issue of equity

shares or convertible securities to Qualified Institutional Buyers in terms of
the provisions of Chapter XIIIA of SEBI (DIP) Guidelines.
Private Placement of Bonds: From 1995 onwards, private placement of

debentures thrived, minimal regulation. Corporates, financial institutions,
infrastructure companies, depended considerably on privately placed
debentures which were subscribed to mutual funds, banks, insurance
organizations, and provident funds.
Information and disclosures to be included in the Private Placement

Memorandum were not defined, credit rating was not mandatory, listing
was not compulsory, and banks and institutions could subscribe to these
issues without too many constraints.
The regulatory framework changed significantly in late 2003 when SEBI

and RBI tightened their regulations over the issuance of privately placed
debentures and the subscription of the same by banks and financial
institutions. The key features of the new regulatory dispensation are:  
! !330
• The disclosure requirements for privately placed debentures are similar

to those of publicly offered debentures.
• Debt securities shall carry a credit rating of not less than investment
grade from a rating agency registered with SEBI.
• Debt securities shall be issued and traded in demat form.
• Debt securities shall be compulsorily listed.
• The trading in privately placed debt shall take place between QIBs and
HNIs (High Net Worth individuals) in standard denomination of Rs. 10
lakh.
• Banks should not invest in non-SLR securities of original maturity of less

than one other than commercial paper and certificates of deposits which
are covered under guidelines.
• Banks should not invest in unrated non-SLR securities.
! !331
12.6 Summary
• At some point in time, a company may expand to a point when it is no

longer feasible for a group of investors to provide all the capital it needs.
When that occurs, it may decide to convert from private to public
ownership.
• To list on an exchange, a company must comply with all the listing

requirements by the exchange and the securities regulator.
• Various types of equity are issued such as common stock, preferred

stock, rights, debentures, warrants, convertibles, Sweat Equity and
ESOPs.
• Converting a private company to a listed company is a complex and

highly regulated process.
• There are various advantages of listing a company – can raise more

capital from a wider pool of investors, share prices reflect its
performance, company can use ESOPs to retain talented employees,
Original entrepreneurs can sell a portion of their investment and diversify
their portfolios and marketing benefits.
• There are disadvantages of listing a company – direct costs of an IPO,

companies have to provide results quarterly and annually, disclosed
information can be misused by the competitors.
• There are local popular stock exchanges – NSE, BSE for companies. New
BSESME exchange for SMEs.
• There are various methods of offerings in the primary market.
Activities
1. You want to list your enterprise on a local exchange. What is the

eligibility criteria for various exchange? What documents will your
merchant banker require to complete this?
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2. Logon to www.nseindia.com, www.bseindia.com and www.bsesme.com.

Find out the number of companies registered, annual turnover of the
exchange and number of issues in current financial year.
1. When should a company decide to go public?
2. Which are the major international exchanges?
3. Which are the major Indian Exchanges?
4. What are the various kinds of equity stocks that can be listed? Describe
each in brief.
5. What are the pros and cons of going public?
6. What is difference between Sweat Equity and ESOPs? 
! !333
REFERENCE MATERIAL
chapter
Summary
PPT
MCQ
Video Lecture 
! !334
INTERNATIONAL CAPITAL
Chapter 13
Objectives
• Understand the scenario in terms of Indian companies raising

International Capital.
• Know the popular destinations where companies go for International

Capital.
• Government and regulator laws relating to International Capital.
Structure:
13.1 Introduction
13.2 An Interesting Article on International Capital Raising Trends by

Indian Companies
13.3 Summary
! !335
13.1 Introduction
Thanks to the globalization of capital markets, Indian companies can raise

capital from Euromarkets or from the domestic markets of various
countries or from Export Credit Agencies.
13.2 An Interesting Article on International Capital Raising

by Indian Companies
I am presenting a few notes from the City of London Corporation prepared

by TRUSTED SOURCES and published in 2010. This will give students a
perspective of how international financiers view India and how Indian
companies are tapping international markets for capital.
“Although Indian companies can now largely rely on their domestic capital
market to fulfil even “jumbo” equity offerings, this was not always the
case. The equity issuance market for Indian companies saw rapid growth
from 2004 just as India’s economic growth rate started to accelerate.
Previously, only a handful of Indian firms had tapped overseas capital
markets in any size and usually by ADR/GDR issuances in New York and
London, typically at around the US$100-200 million level. These offerings
included ADRs listed on the NYSE by Wipro and Satyam in 2000 and HDFC
and Dr. Reddy’s Laboratories in 2001; Infosys listed on NASDAQ in 2003.
They tended to be carried out in conjunction with an offering on the BSE
and/or the NSE, India’s two leading stock exchanges, for the purpose of
augmenting the limited amount of funds capable of being raised
domestically. The chart below shows the dramatic increase in overall equity
issuance since 2004. This upward trend was temporarily dented during the
global crisis in 2008 but resumed again in H2/09.
! !336
!
Public equity raised by Indian companies on domestic and foreign
markets, 2000-10 year to date (US$ million).
NOTE: Does not include companies incorporated offshore.
Source: Bloomberg, TS estimates.
Most of the new issues in 2004 were in the domestic market as the
government came forward with privatization offers for energy companies
Oil and Natural Gas Corporation (ONGC) (US$ 2.3 billion) and, after the
election that year, National Thermal Power Corporation (NTPC) (US$ 1.1
billion), while Tata Consultancy Services managed a US$ 1.2 billion
offering. Such large offerings were made possible primarily by the recovery
in global investor appetite as memories of the 2000-01 collapse of the
technology bubble faded. In addition, investors were reassured when a
Communist-supported coalition led by the Congress Party came to power in
May 2004 and signalled broad policy continuity with its right-wing
! !337
predecessor government; political risk was no longer seen as a major

impediment to investment.
This picture started to change in 2005 as the supply of listing candidates

increased and was met by growing overseas demand. The most popular
mode for Indian firms to raise capital during the first big equity rush of
2005/06 was GDR listings in Luxembourg, owing to the low compliance
costs and relatively fast approval process. These were typically small deals
in the range of US$ 30-100 million issued by mid-cap firms wishing to
source quick, cheap capital for domestic operations. But these smaller
issues were overshadowed by “jumbo” offerings in 2005 for Infosys (US$
1.1 billion, listed both in Mumbai and on NASDAQ) and ICICI Bank (US
$1.6 billion, listed both in Mumbai and on the NYSE). These companies
were joined in 2007 by Sterlite with a US$ 2 billion NYSE-listed IPO as well
as follow-on offerings from both ICICI and Infosys.
Meanwhile, the capacity of the local markets was expanding, and Cairn
India raised US$1.9 billion from a purely domestic IPO in 2006. This was
followed by more “jumbo”-sized domestic offerings including large retail
tranches for Reliance Power (US$ 2.6 billion) and the State Bank of India
(US$ 4.2 billion) in 2007-08. Subsequently, several state-owned minerals
and energy firms made “jumbo” offerings in 2009-10: National Mineral
Development Corporation (NMDC) Ltd. (US$ 2.1 billion), NTPC Ltd. (US$
1.8 billion) and National Hydroelectric Power Corporation (NHPC) Ltd. (US$
1.2 billion); this trend towards privatization continues with imminent
issuances from ONGC, Indian Oil and Coal India among others. Of the
remainder, the bulk of those in the US$ 200 million to US$ 1 billion range
came from banks/financials, infrastructure, energy/power generation and
realty. These huge offerings demonstrated that the domestic market,
helped by a vibrant retail segment, had come of age.
Capital raising efforts in large part relocated to Indian exchanges following

the introduction by the Securities and Exchange Board of India (SEBI) of a
local qualified institutional placement (QIP) programme in May 2006. This
coincided with the gradual easing of the foreign institutional investor (FII)
scheme in India and subsequent growth in foreign institutional investors
buying and trading shares in the domestic market, thereby enabling Indian
firms to tap into a larger pool of institutional capital domestically.
! !338
Foreign institutional investors were first allowed access to India’s equity

markets in 1991 as part of the broader economic liberalisation process.
Regulatory sector caps (on percentage of equity owned in a company)
restricted FII investment until 2002 when they were lifted in most sectors.
FIIs were also allowed into all derivative segments at this point, facilitating
a much greater volume of FII trading. This was followed in 2007 by the
streamlining of the process for granting FII licences.
By March 2010, there were 1,713 FIIs registered (with 5,378 registered
sub-accounts). This expansion helped portfolio flows into India soar from
US$ 979 million in FY2003 to US$ 11.3 billion in FY2004. Except for a dip
in FY2009 caused by the global credit crisis, inflows have stayed strong
ever since, hitting a high of US$ 32.3 billion in FY2010. Flows remained
strong in Q1/FY2011, at US$ 4.6 billion.
!
Source: RBI, India; Portfolio flows, FY2003 – FY2010 (US$ billion)
! !339
Accordingly, the volume of Indian issuances from Luxembourg dropped off

sharply in 2007. There were only four listings that year compared to 26 in
2006. A Hong Kong based hedge fund told us, “Indian GDRs died as more
investors got access to the domestic market via FII licences”. Luxembourg
has still attracted a handful of Indian firms to list each year since 2006, but
these tend to be small issues by mid-cap companies. The exceptions have
been larger GDR issues (in the US$ 100-400 million range) by Suzlon, Tata
Motors and Tata Power. Tata Steel chose to make a US$500 million GDR
issue in London in July 2009 because of the need to raise its profile there
following its 2007 acquisition of UK steel company Corus. (One attraction
of GDRs for firms concerned about management control is that they can be
issued in non-voting form; QIPs always involve the issuance of local voting
stock).
The majority of companies now use the QIP route in India. A total of 36
issuers raised Rs. 255 billion (US$ 5.5 billion) in QIPs domestically in
FY2008, a figure that plummeted during the credit crisis to just two
companies raising a total of Rs. 2 billion (US$ 43 million) in FY2009. This
route to raising capital has, however, seen strong growth in FY2010: 62
QIP issues have raised Rs. 427 billion (US$ 9.2 billion). 
! !340
! !
! !
! !341
Where Have Companies Been Going?
• New York has attracted technology, banks and pharmaceuticals.

The August 2010 NASDAQ listing of MakeMyTrip.com (online travel
services) is the latest example of a technology firm sourcing capital in
New York. Other examples include Satyam Computer Services (2005,
NASDAQ), Rediff.com (2005, NASDAQ) and Infosys Technology
(2005-06, NASDAQ), all of which focus on software and business process
outsourcing. They have been able to tap into the large pools of capital
available in the US for investment in the tech sector, and thereby raise
their profile among current and potential US clients. As highlighted
earlier, two Indian banks (ICICI and HDFC) and a pharmaceutical
company (Dr. Reddy’s Laboratories) have also listed on the NYSE. Indian
banks in particular are attracted to New York by the perception that
tighter disclosure norms and greater ADR liquidity will strengthen
investor confidence in those firms.
• London has attracted metals, mining and energy companies. Back

in 2003 the UK-registered holding company of Vedanta Resources raised
US$ 1 billion in its London offering. A “jumbo” US$ 1.9 billion offering for
the UK-registered holding company of Essar Energy as well as a modest
US$ 500 million GDR placement by Tata Steel took place in 2009. Great
Eastern Energy, specializing in coalbed methane, has recently been
transferred from AIM to the LSE Main Market. The pattern on AIM is a
little different. More than one-third of India related listings on AIM have
come from real estate firms and funds. Other sectors have been clean
energy, private equity, media and infrastructure; the most recent listings
are in these sectors. Only one Indian-domiciled firm – the Noida Toll
Bridge – is presently listed on AIM; most are either funds of companies
domiciled in UK tax havens such as the Isle of Man and Guernsey.
• Singapore is targeting the Indian market. Singapore has so far not

succeeded in attracting a large number of Indian listings. However, an
officer of the Singapore Stock Exchange (SGX) announced that it was
keen to win Indian business and could offer regional “clusters” in
“marine, offshore and energy, real estate investment trusts (REITs) and
property trusts, resources and commodities trading”. Recent press
comment suggests that the much delayed launch of Indian REITs by DLF
and Unitech on the SGX may be back in prospect, potentially the first
such issuances since the Ascendas and Indiabulls REITs in 2007 and
! !342
2008. If the REITs were launched, this would be a major achievement for
Singapore. But, as a Hong Kong fund management source told us:
“The Singapore listing of REITs and property companies has been a high
profile disaster. SEBI has not pushed forward a 2008 proposal to facilitate
domestic REITs, leaving Singapore as the only outlet for such a vehicle.”
Singapore does hold some attraction in the form of geographical proximity

to India, cheaper costs and lower taxes than London and New York. Indian
firms in real estate, telecoms and financial services could be attracted to a
good peer group listed in Singapore. However, most Indian firms remain
focused on the advantages of a London or New York listing.
Outlook for Capital Raising
We expect several sectors to generate a large proportion of capital raising

in the future:
• Infrastructure. There is huge demand among energy, construction,

power generation and ports sectors for capital. These companies will
continue to raise capital to finance their growth plans inside and outside
India, both for parent firms and for project-specific entities also known as
“special purpose vehicles”. Some of the big issues in the past have come
from Adani Enterprises (US$ 850 million in July 2010), GMR
Infrastructure (US$ 1 billion in 2007), Jaypee Infratech, JSW Energy and
Videocon.
• Mining and energy companies. The successful flotations of Vedanta,

Sterlite and Essar Energy may encourage other capital-hungry and
acquisitive companies to come to London and NYSE.
• Banks and other financial services firms. Banks will need capital to
finance their rapid expansion in India’s underpenetrated market. ICICI
Bank, HDFC Bank and Axis Bank have already raised substantial
quantities of capital internationally.
• Technology, internet and renewable energy companies. Typically,

firms in these sectors can obtain better valuations overseas because
dedicated investor pools exist in London and New York.
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• Acquisitive multinationals. Indian multinationals are attracted to

foreign listings to raise their profiles among host consumers, suppliers,
financiers and investors. However, most have not sought to finance their
acquisitions through foreign equity issuances and have relied instead on
debt, internal resources and domestic rights issues.
• REITs. SEBI has not permitted REITs in India, which leaves a Singapore
listing as the only feasible option. Ascendas and Indiabulls listed India-
focussed REITs in Singapore in 2007 and 2008. Other property firms are
expected to follow suit. These include Fortis Healthcare (with a reported
planned deal size of US$ 600-700 million), DLF (US$ 1.5 billion), Unitech
(US$ 500 million) and Embassy Property Developments (US$ 300-500
million).
[From 2014, SEBI has permitted REITs to enter India]
The Indian Exchanges Will Dominate New Listings

The BSE and NSE in Mumbai will continue to be the primary venues for
Indian firms to raise capital and we believe they will take further market
share away from international exchanges such as London and New York.
According to our sources, the domestic markets can already handle
issuances of US$ 3-4 billion without the support of dual or follow-on GDR
listings in New York or London, as the US$ 2.6 billion IPO of Reliance Power
in January 2008 illustrated. Market participants are watching the upcoming
US$ 3-4 billion Coal India IPO to test demand for the largest domestic
listing to date. If successful, it will pave the way for more “jumbo” listings
that no longer need to be accompanied by a GDR issuance in London or
New York.
Will Recent Government Programmes Affect This Position?
Privatization
In its current second term, the Congress-led coalition has managed to
accelerate minority stake sales in state-owned firms, targeting revenues of
around US$ 8-10 billion per year from issues in the domestic market.
The volume of these issues has the potential to saturate the domestic
markets and force some companies to go abroad in search of better
valuations. In FY2010, for example, a high-volume stream of overpriced
issues by state-owned firms dampened primary market sentiment. Six such
! !344
issuances accounted for 54% of the total Rs. 576 billion (US$ 12.4 billion)
raised on the domestic markets. Aggressive pricing deterred retail
investors from subscribing, and state-owned financial institutions such as
the Life Insurance Corporation of India and the State Bank of India were
forced to step in and support the issuances. The government also missed
its revenue targets because it was necessary to hold back further
issuances.
The outlook for successful issuances is better in FY2011 because the

government appears to have decided to adopt more realistic pricing for its
next privatization round to attract retail investors. The target for the year
is Rs. 400 billion (US$ 8.6 billion), and stakes in good quality firms in
energy and minerals are once again up for sale: Coal India, ONGC, Indian
Oil, Manganese Ore India and MMTC Ltd. If these issuances prove
successful, investment bankers expect private firms to get involved and
take advantage of primary market momentum.
The New 25% Rule

The government introduced a new rule in June 2010 that required at least
25% of the equity of all listed firms to be made available to the public.
Close to 5,000 firms are listed on the BSE, although only about one-third
are actively traded. As of March 2010, 41% of the equity of all firms on the
NSE was available to the public, but in practice, there are many firms in
which family ownership groups known as “promoters” hold more than 75%
of the equity. Promoters own approximately 49% of the share capital in the
market today. The original implementation of this rule would have
unleashed a flood of equity into the local market and possibly encouraged
some firms to issue shares abroad that would not have done so in the
absence of the rule.
The government subsequently relaxed the programme following fears that

the domestic market could not handle the supply. State-owned enterprises
will now have to dilute only up to 10% of their equity until 2014. This
means that whereas under the original requirement a projected
Rs. 1,250 billion (US$ 27 billion) was to be issued by 35 state-owned firms,
only 15 will now be required to issue Rs. 200 billion (US$ 4.3 billion) of
equity. Private companies will still be required to dilute their equity to 25%
over the next three years but they will be at liberty to decide both timing
and strategy (the original order mandated an annual 5% dilution until the
threshold was reached).
! !345
The chart below highlights the dominance of international investors

compared to domestic institutions.
Shareholding of Major Institutions in BSE-listed Companies (Per

Cent)
FIIs have emerged as the biggest market movers in India and currently
account for 32% of the free float market capitalization of the BSE. As the
chart above illustrates, they also make up the largest institutional investor
base, holding 55% of the total institutional shareholding on the BSE.
FII interest in primary markets remains strong. SEBI data show that in the
year to 27 August 2010 FIIs invested a net Rs. 201 billion (US$ 4.3 billion)
in primary markets compared with Rs. 390 billion (US$ 8.4 billion) in
secondary markets. According to the India Brand Equity Foundation, FIIs
invested more in primary markets than in secondary markets in the April-
September 2009 period. This is a very substantial commitment of funds to
primary markets, demonstrating how foreign investors are increasingly
willing to buy equity in local primary markets rather than wait for GDR or
ADR issuances.
! !346
Where Will Firms Go to Carry Out International Listings?

Despite the likely dominance of the BSE and NSE in attracting future Indian
IPOs and SPOs, many Indian firms believe that the benefits from listing
abroad outweigh the greater compliance costs and currency risks than are
incurred in domestic listings.
These benefits fall into the following categories:
Higher valuations (and greater analyst coverage) in specialty

stocks. The main international investor bases for several key sectors do
not invest directly into India either because of restrictions on EM exposure
or because they do not have the research bandwidth to cover local Indian
companies. As a result, many Indian firms will continue to gravitate
towards their natural investor base in order to achieve higher valuations.
The main trends are:
• Technology stocks on the NYSE and NASDAQ. There is a history of

Indian outsourcing and technology firms accessing capital on NASDAQ
and the NYSE. This trend will continue. The recent IPO of
MakeMyTrip.com on NASDAQ is the latest illustration of this trend.
• Valuation arbitrage. Indian stock markets generally offer higher

earnings multiples for stocks than international markets. However, in
some sectors, Indian valuations are lower than global valuations, and
there are opportunities to arbitrage this presumed mispricing. For
instance, India’s largest paper company, Ballarpur Industries, is planning
to list its Malaysian subsidiary Sabah Paper Industries in London or
Singapore, partly because it hopes that better valuations there will help
to improve its Indian stock price.
• Mining, metals and renewable energy in London. Indian mining and

energy private companies have traditionally listed in London. There is a
good possibility that more energy firms will list there, and Indian firms
that acquire foreign energy or commodity assets will likely list them
separately in London. For instance, it is conceivable that the state-owned
Bharat Petroleum will list its Australian shale gas assets in London or
Singapore. An additional incentive for larger firms is to get
representation in the FTSE 100 Index, which brings additional prestige
and may bring better valuations from buying by index funds. However,
there is no evidence that state-owned firms in these sectors will list in
! !347
London; the recent spate of “jumbo” issuances has been exclusively

domestic.
Another sector in which foreign valuations tend to be higher than in India is

renewable energy, and a foreign listing in London or elsewhere could make
sense for a domestic renewables firm.
Foreign capital for global expansion. Mergers and acquisitions will be

the biggest driver favouring foreign listings by Indian companies. Indian
firms invested Rs. 818 billion (US$ 17.5 billion) outside India in FY2009
and Rs. 570 billion (US$ 12 billion) in FY2010. This is a long-term process
and is likely to gather force over time. The motivation for Indian companies
expanding abroad to list in their target markets is to raise their profile and
reputation among host consumers, suppliers, financiers and of course
investors. A higher local profile can help to increase company sales if
consumers gain confidence in the firm. This will also have a positive effect
on suppliers. Debt costs will be more manageable if domestic financial
institutions reward a higher local profile with better terms. The ability to
tap the pool of investors that have traditionally had confidence in the
acquired firm, such as British Steel and the Tata-acquired Corus, is useful
because it also allows the Indian firm to access foreign currency financing
without exposing itself to FX risk if the debt is in the same local currency
as the acquired firm.
Our interviews revealed that the sectors considered to have the greatest
potential for foreign listings are banks and financial services, automobiles
and components, metals, pharmaceuticals and energy. London has a
natural advantage when it comes to metals and energy firms, but firms
seeking a foothold in Europe will also gravitate towards a London listing.
This dynamic works both ways: Standard Chartered and Cairns have made
domestic offerings in India in order to raise their local profile and to tap
into the local investor base. Stanchart’s IDR was a small percentage of its
overall equity, but the Cairns issue was significant (US$ 1.9 billion) and
involved a productive Indian asset.
London’s prestigious premium listing. A full London listing offers

access to most global investment groups. A senior banker at a London-
based global investment bank told us:
! !348
“A London listing allows access to an enormous pool of capital. If you are in

the FTSE Index, tracker funds have got to own you and others will follow.”
Both Vedanta Resources and Essar Energy are members of the FTSE 100.
London’s reputation as a market with high standards of transparency and
corporate governance is another draw for Indian companies. Both Vedanta
and Essar have faced criticism on corporate governance grounds in India,
and a foreign listing is seen as one way to signal to investors that the
company does maintain high standards. For example, the marketing of
Essar’s London listing prominently emphasized how doing so would
highlight the company’s good corporate governance. At the same time,
firms in sectors like infrastructure, mining, energy and property that
sometimes face corporate governance issues may perceive that London’s
governance regime is less onerous than that of the US under Sarbox.
A further advantage of London may be better research coverage. The

senior banker quoted above advised,
“There is a global problem in equity research. The secondary equity market

alone cannot produce sufficient research coverage. This is a big problem
for US listed firms from the emerging markets where at US$ 3 billion you
are only a mid-cap. You will be lucky to have a couple of analysts following
you.”
He pointed out that, at least for the present, companies of this size attract
better coverage in London. This research coverage should of course be
particularly strong in the mining and energy clusters described above.
Finally, London’s track record as a successful and liquid home for
companies from Russia, South Africa, Eastern Europe and India offers
encouragement to Indian firms considering foreign listings.
Opportunities for the City of London
Capital raising business

Although the volume of business in the immediate term has been hit by the
success of QIPs in domestic Indian markets and the liberalization of FII
access to them, investment bankers we spoke to said that there is strong
interest among Indian firms for a London listing and that several offerings
on LSE and AIM are in the pipeline.
! !349
Although New York remains attractive for banks and technology and
outsourcing firms, London will be a draw for Indian multinationals seeking
to access European markets, as well as energy, mining and metals
companies and, not least, firms that believe that a London listing will help
them in strategic or valuation terms.
Advisory work
There is a level playing field in India for financial intermediaries like
brokerages, underwriters and merchant banks. Foreign firms are permitted
to establish wholly owned subsidiaries that can practise with a SEBI
licence. Even state-owned issuances have involved both domestic and
foreign-owned firms: book runners and lead managers for Coal India’s
forthcoming domestic listing are Citi, Deutsche Bank, Morgan Stanley,
Enam Financial, Kotak Mahindra and BofA Merrill Lynch. Foreign audit firms
such as PwC, Ernst & Young and KPMG are also permitted to offer financial
advisory services under the same regulatory umbrella (though their audit
functions are more strictly regulated).
Only Indian citizens licensed in India are permitted to practise Indian law.
This means that any legal work related to domestic listings must be carried
out by local lawyers and partnerships. Indian firms such as Amarchand &
Mangaldas & Suresh A. Shroff & Co., AZB & Partners, Dua Associates,
Luthra & Luthra, FoxMandal Little and Trilegal will continue to be the main
players in the domestic market. However, foreign law firms are permitted
to handle external work related to Indian issuances abroad. This has
created an opportunity for firms like Linklaters, Freshfields Bruckhaus
Deringer, Allen & Overy, Clifford Chance and Jones Day. In practice, foreign
firms work closely with their Indian counterparts and in many cases have
developed longstanding relationships. Larger firms like Linklaters have
dozens of Indian lawyers on their staff in locations such as Hong Kong and
London.
There are less onerous restrictions on audit-related functions by accounting

firms. Global audit firms are not permitted to use their own names while
practising in India, and there is a cap of 20 on the number of partners a
firm can have and on the number of audits per partner. However, there are
no similar restrictions on the Big Four audit firms’ advisory functions such
as underwriting and consultancy once they have secured SEBI registration.
! !350
Conclusion
Continued rapid growth in demand for capital

The impressive growth over the past 10 years in the number of EM firms
raising equity capital and the amount of capital raised will continue.
Although the 2008 crisis sharply interrupted this trend, we have already
witnessed a strong resumption in domestic and international capital raising
activities by companies from the larger markets of India and Brazil,
including several “jumbo” offerings (NHPC Ltd. [India] – 2009, Essar
Energy [India] ─ 2010, VisaNet [Brazil] – 2009, Banco Santander Brasil –
2009). Capital market activity in Russia (which was the most severely
affected by the crisis) and South Africa remains subdued. With the
exception of two IPOs this year, Mexico’s new issue market remains
sluggish as it comes out of a deep recession – although, it must be noted,
the demand for equity capital by Mexican firms has historically lagged that
of other EMs.
Robust economic growth in Brazil, India and Russia over the next few years
will propel demand for investment capital from local companies attempting
to ramp up domestic operations and expand into new markets. This
demand will be intensified by other drivers, including the high levels of
investment capital needed for infrastructure development (Brazil and
India), the privatization of state-owned enterprises (Russia and India), the
rapid expansion of consumer sectors (Brazil and Russia) and foreign M&A
(India).
Capital raising in South Africa and Mexico, in contrast, faces constraints on

growth. In particular, Mexico’s corporate environment, dominated by
family-run companies, has a culture of preferring debt financing over
equity.
India, Brazil and South Africa: Demand will be met in large part by
domestic markets, unless there are compelling reasons to go
abroad. Brazil and India’s equity markets are now large and liquid
following financial market reforms and rapid growth since 2003. They can
and do handle the majority of new offerings by local firms without the
support of dual or ADR/GDR listings in New York or London, as had been
necessary in the late 1990s and early 2000s. At the top end of the scale,
the Reliance Power IPO (US$2.6 billion in 2008) highlighted the capacity of
the Indian market. The upcoming US$ 3-4 billion Coal India IPO will be a
! !351
good test of post-crisis capacity. Brazil’s Novo Mercado has shown it can
handle even larger amounts, with the Banco do Brasil IPO (US$ 5.4 billion
in 2010) and the VisaNet IPO (US$ 4.2 billion in 2009) being completed
without accompanying US listings.
The super-”jumbo” Petrobras global offering, in spite of its ADR listing on

the NYSE, challenged the local market due to its sheer size. It has drained
liquidity from the system and will likely prevent many smaller offerings by
mid-cap firms from taking place for several months.
The depth and liquidity of the BOVESPA and BSE/NSE in India mean that
Indian and Brazilian firms will carry out offerings domestically unless there
are compelling reasons to go abroad. The most important of these is the
goal of accessing a wider pool of investors, who increase demand and thus
the pricing tension for large offerings while also providing greater
institutional support in the after-market. “Jumbo” offerings of more than
US$3-5 billion in these markets are not the only operations to benefit from
twin-track issuance. Some specialty stocks benefit from deep knowledge of
their sector in certain international centres. Access for large firms to major
global indices, such as the FTSE 100 Index, has been another important
driver of going abroad, as have raising foreign capital for global expansion
and building profile and reputation among host consumers, particularly for
Indian firms. Vedanta Resources, Essar Energy and Tata Steel have all
followed this path.
Nearly, all new offerings in South Africa will be carried out on the JSE, but
for different reasons than in India and Brazil. Government controls prevent
all but a handful of companies from going abroad and are unlikely to be
relaxed in the near term.
! !352
13.3 Summary
This is an article prepared by International financiers and will give students

an independent perspective on how Indian companies are tapping
international markets for capital.
1. Although Indian companies largely rely on domestic capital market to

fulfill jumbo equity offerings, they do approach International Capital
Markets.
2. There is rapid growth from 2004 just as India’s economic growth rate
started to accelerate. Again in 2008, growth was temporarily dented
during the global crisis.
3. Previously, only a handful of Indian firms had tapped overseas capital

markets in any size and usually by ADR/GDR issuances in New York and
London, typically at around the US$ 100-200 million level.
4. There was increase in domestic Issues also after 2004.
5. Some examples are: 
! !353
Wipro NYSE 2000
Satyam NYSE 2000
HDFC NYSE
Dr. Reddy’s Labs NYSE
ONGC Domestic 2004 US$2.3 billion
NTPC Domestic 2004 US$1.1 billion
TCS Domestic 2004 US$1.2 billion
Infosys Mumbai + 2005 US$1.1 billion

NASDAQ
Rediff.com NYSE 2005
ICICI Bank Mumbai + NYSE 2005 US$1.6 billion
Cairn India Domestic 2006 US$1.9 billion
Sterlite NYSE 2007 US$2.0 billion
Reliance Power Domestic 2007 US$2.6 billion
SBI Domestic 2007-08 US$4.2 billion
NMDC Domestic 2009-10 US$2.1 billion
NTPC Domestic 2009-10 US$2.1 billion
NHPC Domestic 2009-10 US$1.2 billion
ONGC
Indian Oil
Coal India
MakeMyTrip NYSE 2010
6. By March 2010, there were 1,713 FIIs registered (with 5,378 registered
sub-accounts). This expansion greatly helped portfolio flows into India
soar from US$ 979 million in FY2003 to US$ 11.3 billion in FY2004
(except for a dip in FY2009).
7. Indian GDRs listed with Luxembourg died sharply after 2007 as more
investors got access to the domestic market via FII licences.
! !354
Suzlon Luxembourg
Tata Motors Luxembourg
Tata Power Luxembourg
Tata Steel London 2007 US$500 million
8. The majority of companies now use the QIP route in India.
9. New York has attracted technology, banks and pharmaceuticals.
10.London has attracted metals, mining and energy companies.
11.Singapore is targeting the Indian market. Singapore has so far not

succeeded in attracting a large number of Indian listings. It was keen to
win Indian business and could offer regional “clusters” in “marine,
offshore and energy, real estate investment trusts (REITs) and property
trusts, resources and commodities trading.
12.Outlook for capital raising:
Several sectors are expected to generate a large proportion of capital

raising in the future:
• Infrastructure. Adani Enterprises (US$ 850 million in July 2010), GMR

Infrastructure (US$ 1 billion in 2007), Jaypee Infratech, JSW Energy
and Videocon.
• Mining and energy companies. Vedanta, Sterlite and Essar Energy

may encourage other capital hungry and acquisitive companies to come
to London and NYSE.
• Banks and other financial services firms. ICICI Bank, HDFC Bank
and Axis Bank have already raised substantial quantities of capital
internationally.
• Technology, internet and renewable energy companies. Typically,

firms in these sectors can obtain better valuations overseas because
dedicated investor pools exist in London and New York.
! !355
• Acquisitive multinationals.
• REITs. Ascendas and Indiabulls listed India-focussed REITs in

Singapore in 2007 and 2008. Other property firms are expected to
follow suit. Fortis Healthcare (with a reported planned deal size of US$
600-700 million), DLF (US$ 1.5 billion), Unitech (US$ 500 million) and
Embassy Property Developments (US$ 300-500 million).
13.The Indian exchanges will dominate new listings.
14.The new 25% Rule – required at least 25% of the equity of all listed
firms to be made available to the public.
15.Despite the likely dominance of the BSE and NSE in attracting future
Indian IPOs and SPOs, many Indian firms believe that the benefits from
listing abroad outweigh the greater compliance costs and currency risks
than are incurred in domestic listings.
• Higher valuations (and greater analyst coverage) in specialty stocks.
• Technology stocks on the NYSE and NASDAQ.
• Valuation arbitrage.
• Mining, metals and renewable energy in London.
• Foreign capital for global expansion.
! !356
1. How would your describe the current situation for capital raising in
international markets for Indian companies?
2. Which are the most desirable markets for Indian companies –

sectorwise?
3. Your view – Indian companies can get sufficient capital from India itself.
They do not need to tap foreign shores.  
! !357
REFERENCE MATERIAL
chapter
Summary
PPT
MCQ
Video Lecture 
! !358
CROWD FUNDING
Chapter 14
CROWD FUNDING
Objectives
• Get a brief overview on Crowd Funding.
• Learn about different types of Crowd Funding.
• Learn about various sites to generate Crowd Funding.
• Get a list of top 50 projects funded by Crowd Funding.
Structure:
14.1 Introduction to Crowd Funding
14.2 Types of Crowd Funding
14.3 Various Sites to Generate Crowd Funding
14.4 List of Top 50 Projects Funded by Crowd Funding
14.5 Summary
! !359
CROWD FUNDING
14.1 Introduction to Crowd Funding
Crowd funding is solicitation of funds (small amount) from multiple

investors through a web-based platform or social networking site for a
specific project, business venture or social cause.
Crowd sourced funding is a means of raising money for a creative project

(for instance, music, film, book publication), a benevolent or public interest
cause (for instance, a community based social or co-operative initiative) or
a business venture, through small financial contributions from persons who
may number in the hundreds or thousands. Those contributions are sought
through an online crowd funding platform, while the offer may also be
promoted through social media.
! !360
CROWD FUNDING
14.2 Types of Crowd Funding
As per IOSCO Staff Working Paper – Crowd-funding: An Infant Industry

Growing Fast, 2014 (‘IOSCO Paper’), Crowd funding can be divided into
four categories: donation crowd funding, reward crowd funding, peer-to-
peer lending and equity crowd funding.
1. Donation Crowd Funding

Donation crowd funding denotes solicitation of funds for social, artistic,
philanthropic or other purpose, and not in exchange for anything of
tangible value. For example, in the US, Kickstarter, Indiegogo etc. are
some of the platforms that support donation-based crowd funding.
2. Reward Crowd Funding

Reward crowd funding refers to solicitation of funds, wherein investors
receive some existing or future tangible reward (such as an existing or
future consumer product or a membership rewards scheme) as
consideration. Most of the websites which support donation crowd funding,
also enable reward crowd funding, e.g., Kicktstarter, Rockethub etc.
3. Peer-to-peer lending
In Peer-to-peer lending, an online platform matches lenders/investors with
borrowers/ issuers in order to provide unsecured loans and the interest
rate is set by the platform. Some Peer-to-peer platforms arrange loans
between individuals, while other platforms pool funds which are then lent
to small- and medium-sized businesses. Some of the leading examples
from the US are Lending Club, Prosper etc. and from UK are Zopa, Funding
Circle etc.
! !361
CROWD FUNDING
A report by the Open Data Institute in July 2013 found that between
October 2010 and May 2013, some 49,000 investors in the UK funded
peer-to-peer loans worth more than £378 million.
14.3 Various Crowd Funding sites to generate Capital
a. Kickstarter
Kickstarter is a site where creative projects raise donation-based funding.
These projects can range from new creative products, like an art
installation, to a cool watch, to pre-selling a music album. It’s not for
businesses, causes, charities, or personal financing needs. Kickstarter is
one of the earlier platforms, and has experienced strong growth and many
break out large campaigns in the last few years.
b. Indiegogo
While Kickstarter maintains a tighter focus and curates the creative
projects approved on its site, Indiegogo approves donation-based
fundraising campaigns for most anything — music, hobbyists, personal
finance needs, charities and whatever else you could think of (except
investment). They have had international growth because of their
flexibility, broad approach and their early start in the industry.
c. Crowd Funder
Crowdfunder.com is the platform for raising investment (not rewards), and
has a one of the largest and fastest growing network of investors. It was
recently featured on Fox News as the new breed of crowd funding due to
the story about a $ 2 billion exit of a crowd funded company. After getting
rewards-based funding on Kickstarter or Indiegogo, companies are often
giving the crowd the opportunity to invest at Crowd Funder to raise more
formal Seed and Series A rounds.
Crowd funder offers equity crowd funding currently only from individuals +
angels + VCs, and was a leading participant in the JOBS Act legislation.
d. RocketHub
Rockethub powers donation-based funding for a wide variety of creative
projects. What’s unique about RocketHub is their FuelPad and LaunchPad
programs that help campaign owners and potential promotion and
marketing partners connect and collaborate for the success of a campaign.
! !362
CROWD FUNDING
e. Crowdrise
Crowdrise is a place for donation-based funding for Causes and Charity.
They’ve attracted a community of do-gooders and fund all kinds
of inspiring causes and needs.
A unique Points System on Crowdrise helps track and reveal how much
charitable impact members and organizations are making.
f. Somolend
Somolend is a site for lending for small businesses in the US, providing
debt-based investment funding to qualified businesses with existing
operations and revenue. Somolend has partnered with banks to provide
loans, as well as helping small business owners bring their friends and
family into the effort.
With their Midwest roots, a strong founder who was a leading participant in
the JOBS Act legislation, and their focus and lead in the local small
business market, Somolend has begun expanding into multiple cities and
markets in the US.
g. Appbackr
If you want to build the next new mobile app and are seeking donation-
based funding to get things off the ground or growing, then check
out appbackr and their niche community for mobile app development.
h. AngelList
If you’re a tech start-up with a shiny lead investor already signed on, or
looking for Silicon Valley momentum, then there are angels and
institutions funding investments through AngelList. For a long while
AngelList didn’t say that they did crowd funding, which makes sense as
they have catered to the investment establishment of VCs in tech start-
ups, but now they’re getting into the game. The accredited investors and
institutions on AngelList have been funding a growing number of top tech
start-up deals.
i. Invested.in
You might want to create your own crowd funding community to support
donation-based fundraising for a specific group or niche in the market.
Invested.in is a Venice, CA based company that is a top name “white label”
software provider, giving you the tools to get started and grow your own.
! !363
CROWD FUNDING
j. Quirky
If you’re an inventor, maker, or tinkerer of some kind, then Quirky is a
place to collaborate and crowd fund for donation-based funding with a
community of other like-minded folks. Their site digs deeper into helping
the process of bringing an invention or product to life, allowing community
participation in the process.
These 10 crowd funding sites cover most campaign types or funding goals
you might have. Whether you’re looking to fundraise or not, go check out
the sites here that grab your attention and get involved in this collaborative
community.
• How Crowd funding is shaping a new economy.
• Crowd funding has revitalized the Arts at a time when public programs
that support it are steadily dying off.
• Crowd funding is growing a market for impact investing in social

enterprises, marrying the worlds of entrepreneurship and philanthropy,
and helping a broader base of investors to back companies for
both profits and purpose.
• Crowd funding is accelerating angel investing and creating an entirely

new market for investment crowd funding for businesses.
• So get involved and join a crowd funding community today. You’ll make a
difference for a project or business owner, and also help build a new and
more collaborative economy.
! !364
CROWD FUNDING
! !
! !
! !365
CROWD FUNDING
The Coolest Cooler 

– successfully funded by Kickstarter
! !366
CROWD FUNDING
14.4 List of highest Crowd Funded Projects (Ref:

Wikipedia)
This is an incomplete list of the most well-funded crowd funding projects,

either successful or not (23-Sep-2014).
Campaig
Campaign  Amount 
Rank Project Category Platform n 
target raised
end date
Star Kickstarter,
1 Video game Ongoing $2,000,000 $53,845,242
Citizen Independent
Protocol & Bitcoin, Sept 2, $18,441,318.4

2 Ethereum --
Platform Independent 2014 6
Coolest Product Aug 29,

3 Kickstarter $50,000 $13,285,226
Cooler Design 2014
Ubuntu Aug 21,

4 Smartphone Indiegogo $32,000,000 $12,814,196
Edge 2013
Pebble May 18,

5 Smartwatch Kickstarter $100,000 $10,266,845
(watch) 2012
Video game
Aug 9,
6 OUYA   Kickstarter $950,000 $8,596,474
2012
console
Elite: Kickstarter,
7 Video game Ongoing £ 12,50,000 £ 36,86,327
Dangerous Independent
Digital
Pono Apr 15,
8 music Kickstarter $800,000 $6,225,354
Music 2014
player
Mayday Jul 4,
9 Super PAC Independent $6,000,000 $6,132,554
PAC 2014
WEISSEN
10 Real Estate Companisto Ongoing € 20,00,000 € 43,00,000
HAUS
Veronica Apr 13,

11 Movie Kickstarter $2,000,000 $5,702,153
Mars 2013
! !367
CROWD FUNDING
Project
Bring Back
Reading
Rainbow Jul 2,
12 Television Kickstarter $1,000,000 $5,408,916
for Every 2014
Child,
Everywher
e
Torment:
Kickstarter, Apr 5,
13 Tides of Video game $900,000 $4,188,927
Independent 2013
Numenera
Mighty No. Oct 1,

14 Video game Kickstarter $900,000 $4,046,579
9 2013
Project Kickstarter, Oct 16,

15 Video game $1,100,000 $3,986,929
Eternity Independent 2012
Reaper
Gaming Aug 25,
16 Miniatures Kickstarter $30,000 $3,429,235
miniatures 2012
Bones
May 7,
17 The Micro 3D Printer Kickstarter $50,000 $3,401,361
2014
Mar 31,
18 The Dash Headphones Kickstarter $260,000 $3,390,551
2014
Double
Mar 13,
19 Fine Video game Kickstarter $400,000 $3,336,371
2012
Adventure
Reaper
Gaming Oct 26,
20 Miniatures   Kickstarter $30,000 $3,169,610
miniatures 2013
Bones II
World Of
Project Nov 11,
21 Video game Mass $3,108,600 $3,142,808
CARS 2012
Development
Wish I May 24,

Was Here 2013
Oct 26,
23 FORM 1 3D Printer Kickstarter $100,000 $2,945,885
2012
Wasteland Apr 17,

2 2012
! !368
CROWD FUNDING
SCiO: Your
Spectromet Jun 15,
25 Sixth Kickstarter $200,000 $2,762,571
er 2014
Sense
Stone
Groundbre
Aug 29,
26 aking Beer Indiegogo $1,000,000 $2,532,211
2014
Collaborati
ons
Homestuc
k Adventure Oct 4,
27 Kickstarter $700,000 $2,485,506
Adventure game 2012
Game
Lazer Jul 6,
28 Movie Indiegogo $650,000 $2,480,209
Team 2014
VR head-
Sep 1,
29 Oculus Rift mounted Kickstarter $250,000 $2,437,429
2012
display
3D Mar 25,
30 3Doodler Kickstarter $30,000 $2,344,134
printing pen 2013
Hex:
Jun 7,
31 Shards of Video game Kickstarter $300,000 $2,278,255
2013
Fate
Gosnell May 12,

32 Movie Indiegogo $2,100,000 $2,241,043
Movie 2014
Camelot May 2,
33 Video game Kickstarter $2,000,000 $2,232,933
Unchained 2013
Planetary
Sep 14,
34 Annihilatio Video game Kickstarter $900,000 $2,229,344
2012
n
Solar Jun 20,

35 Technology Indiegogo $1,000,000 $2,200,961
Roadways 2014
Shroud of
the
Kickstarter, Apr 7,
36 Avatar: Video game $1,000,000 $2,067,246
Independent 2013
Forsaken
Virtues
Canary
Home Aug 26,
37 Home Indiegogo $1,000,000 $1,961,464
security 2013
Security
! !369
CROWD FUNDING
Blue
Mountain May 15,
State: The 2014
Movie
Shadowru Apr 29,

n Returns 2012
Scanadu Health scan Jul 20,

40 Indiegogo $100,000 $1,664,375
Scout ner 2013
Warmachi Aug 10,

ne: Tactics 2013
Dreamfall
Chapters:
Mar 10,
42 The Video game Kickstarter $850,000 $1,538,425
2013
Longest
Journey
ARKYD: A
Space
Space Jun 30,
43 Telescope Kickstarter $1,000,000 $1,505,366
Telescope 2013
for
Everyone
Aug 12,
44 Kreyos Smartwatch Indiegogo $100,000 $1,504,616
2013
Elevation Feb 11,

45 Design Kickstarter $75,000 $1,464,706
Dock 2012
Fund Aug 2,
46 Road Hard Movie $1,000,000 $1,445,889
Anything 2013
The Jun 29,

47 3D Printer Kickstarter $100,000 $1,438,765
Buccaneer 2013
The
Newest
Aug 21,
48 Hottest Movie Kickstarter $1,250,000 $1,418,910
2013
Spike Lee
Joint
Petzval
Photograph Aug 24,
49 Portrait Kickstarter $100,000 $1,396,149
y 2013
Lens
Tesla Sep 29,

50 Museum Indiegogo $850,000 $1,370,461
Museum 2012
! !370
CROWD FUNDING
14.5 Summary
• Crowd funding is solicitation of funds (small amounts) from multiple

investors through a web-based platform or social networking site for
specific project, business venture or social cause.
• There are four basic types of Crowd-funding – Donation, Reward, Peer-

to-peer and Equity.
• Various sites to generate Crowd Funding are provided.
• There is huge amounts of capital collected through crowd funding. Top 50

projects funded by crowd funding is enlisted.
Activities
1. Study the various crowd funding websites? If you were to set up a

crowd funding site, what would you need?
2. Do you think that crowd funding is ethical or unethical? Your views?
3. Go to the website www.kickstarter.com and describe features of 3

project success of these projects.
4. Go to the website www.indiegogo.com and describe features of 3 project

success of these projects.
! !371
CROWD FUNDING
1. What is crowd funding?
2. What are various types of crowd funding?
3. Which are the popular crowd funding sites?
4. Study the list of the top 50 projects funded by crowd-funding. Which are
the different types of projects funded by crowd funding? 
! !372
CROWD FUNDING
REFERENCE MATERIAL
chapter
Summary
PPT
MCQ
Video Lecture 
! !373
SECTION - III - PROJECT IMPLEMENTATION AND REVIEW
SECTION - III
PROJECT IMPLEMENTATION
AND REVIEW 
! !374
PROJECT PLANNING, RISKS AND MANAGEMENT
Chapter 15
PROJECT PLANNING, RISKS AND
MANAGEMENT
Objectives
• Provide a conceptual understanding on Project Planning.
• Provide a conceptual understanding on Project Risk Management.
• Learn about Project Management through Work Breakdown Structure.
• Learn about why some projects fail.
Structure:
15.1 Project Planning
15.2 Project Risk Management
15.3 Project Management through Work Breakdown Structure (WBS)
15.4 Why Projects Fail?
15.5 Summary
! !375
15.1 Project Planning
The key to a successful project is in the planning. The first thing to do

while undertaking any kind of project is to create a Project Plan. Many
times, project planning is ignored in favour of getting on with the work.
However, many people fail to realize the value of a project plan in saving
time, money and many problems.
Step 1: Project Goals

A project is successful when the needs of the stakeholders have been met.
A stakeholder is anybody directly, or indirectly impacted by the project.
As a first step, it is important to identify the stakeholders in your project. It

is not always easy to identify the stakeholders of a project, particularly
those impacted indirectly. Examples of stakeholders are:
• The project sponsor, financier
• The customer, end-user, dealers, intermediaries
• The project manager and project team.
Once you understand who the stakeholders are, the next step is to find out
their needs. The best way to do this is by conducting stakeholder
interviews. Take time during the interviews to draw out the true needs that
create real benefits. Needs that aren’t relevant and don’t deliver benefits
can be recorded and set as a low priority.
The next step, once you have conducted all the interviews, and have a
comprehensive list of needs is to prioritize them. From the prioritized list,
create a set of goals that can be easily measured. This way it will be easy
to know when a goal has been achieved.
Once you have established a clear set of goals, they should be recorded in
the project plan. It can be useful to also include the needs and
expectations of your stakeholders. This is the most difficult part of the
planning process completed. It’s time to move on and look at the project
deliverables.
! !376
Step 2: Project Deliverables

Using the goals you have defined, create a list of things the project needs
to deliver in order to meet those goals. Specify when and how each item
must be delivered.
Add the deliverables to the project plan with an estimated delivery date.
More accurate delivery dates will be established during the scheduling
phase, which is next.
Step 3: Project Schedule

Create a list of tasks that need to be carried out for each deliverable
identified in Step 2. For each task, identify the following:
• The amount of effort (hours or days) required to complete the task.
• The resource who will carryout the task.
Once you have established the amount of effort for each task, you can
workout the effort required for each deliverable, and an accurate delivery
date. Update your deliverables section with the more accurate delivery
dates.
At this point in the planning, you could choose to use a software package
such as Primavera or Microsoft Project (Gantt Charts) to create your
project schedule. Alternatively, use one of the many free templates
available. Input all of the deliverables, tasks, durations and the resources
who will complete each task.
A common problem discovered at this point, is when a project has an

imposed delivery deadline from the sponsor that is not realistic based on
your estimates. If you discover this is the case, you must contact the
sponsor immediately. The options you have in this situation are:
• Renegotiate the deadline (project delay).

• Employ additional resources (increased cost).
• Reduce the scope of the project (less delivered).
! !377
Use the project schedule to justify pursuing one of these options.
!
Microsoft Projects and Primavera are two effective software programs designed
to implement complex projects.
Step 4: Supporting Plans

This section deals with plans you should create as part of the planning
process. These can be included directly in the plan.
15.1.1 Human Resource Plan

Identify by name, the individuals and organizations with a leading role in
the project. For each, describe their roles and responsibilities on the
project.
Next, describe the number and type of people needed to carryout the
project. For each resource detail start dates, estimated duration and the
method you will use for obtaining them.
! !378
Create a single sheet containing this information.
15.1.2 Communications Plan

Create a document showing who needs to be kept informed about the
project and how they will receive the information. The most common
mechanism is a weekly or monthly progress report, describing how the
project is performing, milestones achieved and work planned for the next
period.
15.1.3 Risk Management Plan

Risk management is an important part of project management. Although
often overlooked, it is important to identify as many risks to your project
as possible, and be prepared if something bad happens.
Here are some examples of common project risks:
• Time and cost estimates too optimistic.
• Customer review and feedback cycle too slow.
• Lack of resource commitment.
• Unexpected budget cuts.
• Unclear roles and responsibilities.
• Stakeholders input is not sought, or their needs are not properly

understood.
• Stakeholders changing requirements after the project has started.
• Stakeholders adding new requirements after the project has started.
• Poor communication resulting in misunderstandings, quality problems

and rework.
Risks can be tracked using a simple risk log. Add each risk you have
identified to your risk log; write down what you will do in the event it
occurs, and what you will do to prevent it from occurring. Review your risk
! !379
log on a regular basis, adding new risks as they occur during the life of the
project. Remember, when risks are ignored they don’t go away.
15.2 Project Risk Management
Project Risk Management is an important aspect of project management.

Project Risk Management is one areas in which a project manager must be
competent. Project risk is ‘an uncertain event or condition that, if it occurs,
has a positive or negative effect on a project’s objectives’.
Good Project Risk Management depends on supporting organizational

factors, clear roles and responsibilities, and technical analysis skills.
Project risk management in its entirety, includes the following six process
groups:
1. Planning risk management

2. Risk identification
3. Performing qualitative risk analysis
4. Performing quantitative risk analysis
5. Planning risk responses
6. Monitoring and controlling risks.
Project Risk Management is the identification, assessment, and

prioritization of risks followed by coordinated and economical application of
resources to minimize, monitor, and control the probability and/or impact
of unfortunate events or to maximize the realization of opportunities.
It will reap great rewards for an organization. If uncertainties in a project

are taken care of or removed, it will result in timely completion of projects
in the estimated budgets. Also, all threats and firefighting will be removed.
! !380
15.3 Project Management using Work Breakdown Structure

(WBS)
The Work Breakdown Structure, usually shortened to WBS, is a tool project

managers use to break projects down into manageable pieces. It is the
start of the planning process and is often called the ‘foundation’ of project
planning. Most project professionals recognize the importance and benefits
of a WBS in outperforming projects without one.
What is a WBS?
A WBS is a hierarchical decomposition of the deliverables needed to
complete a project. It breaks the deliverables down into manageable work
packages that can be scheduled, costed and have resources assigned to
them. As a rule, the lowest level should be two-week work packages.
Another rule commonly used when creating a WBS is the 8/80 rule. This
says no single activity should be less than 8 hours, or greater than 80
hours.
A WBS is deliverables based; meaning the product or service the customer

will get when the project is finished. There is another tool called a Product
Breakdown Structure (PBS), which comes before the WBS and breaks a
project down into outputs (products) needed to complete the project.
Why Create a WBS?
These are some of the benefits of a WBS:
• Provides a solid foundation for planning and scheduling.

• Breaks down projects into manageable work packages.
• Provides a way to estimate project costs accurately.
• Makes sure no important deliverables are forgotten.
• Helps project managers with resource allocation.
• Provides a proven and repeatable approach to planning projects.
• Provides an ideal tool for team brainstorming and for promoting team
cohesion.
! !381
WBS Inputs
There are three inputs to the WBS process:
1. Project Scope Statement: Detailed description of the project’s

deliverables and work needed to create them.
2. Statement of Requirements: Document detailing the business need

for the project and what will be delivered in detail.
3. Organizational Process Assets: The organization’s policies,

procedures, guidelines, templates, plans, lessons learned, etc.
These items give you and your team all the information needed to create
the WBS. You’ll also need a WBS template.
WBS Outputs
There are four outputs from the WBS process:
1. W o r k B r e a k d o w n S t r u c t u r e ( W B S ) : D e l i v e ra b l e s b a s e d
decomposition of the total project scope.
2. WBS Dictionary: Accompanying document describing each WBS

element.
3. Scope Baseline: The Project Scope Statement, WBS and WBS

Dictionary.
4. Project Documentation Updates: Changes and additions to project

documentation.
! !382
How to Create a WBS?

A WBS is easy to create. Once the aims and objectives of the project are
understood, a meeting can be arranged where the project team breaks
down the deliverables needed to complete the project. Creation is best
done as a team exercise. This helps engage your team and gives them an
emotional stake in the project. It’s a good idea to involve your stakeholders
at this point.
There are two formats in which the WBS can be expressed, tabular form
and graphical form. The tabular form can be created in a spreadsheet;
numbering each level and sub-level. The graphical form can be created
using drawing software, creating a tree style diagram. Either form starts
with the project name as its first level. Then all the top-level deliverables
are added. Remember, at the second level, you are looking to
identify everything needed to complete the project.
Break down each second level deliverable until you reach work packages of
no less than two weeks. As a general rule, two-week work packages are
manageable. You might also consider the 8/80 rule at this point. It is up to
the team how each item is broken down; there are no rules that define
this, and it will reflect the style of the team creating the WBS. It’s
important to note that activities and tasks are not included in a WBS, these
are planned out from the work packages later.
Check no major areas or deliverables have been missed, and you’ve only
included the work needed to complete your project successfully. Your WBS
should contain the complete project scope, including the project
management work packages. Conducting the WBS creation as a team
exercise helps make sure nothing is forgotten.
This level of decomposition makes it easy to cost each work package and
arrive at an accurate cost for the project. Similarly, people can be assigned
to the work packages; however, you may prefer to add the skills needed
for the work packages and leave the people allocation until you create your
schedule, when you can see the timeline.
The next step is to transfer your WBS output into a project schedule,
typically a Gantt chart. Expand the work packages with the activities and
tasks needed to complete them. The Gantt chart is used to track progress
across time of the work packages identified in your WBS.
! !383
15.4 Why Projects Fail?
In a perfect world, every project would be “on time and within budget.” But
reality (especially the proven statistics) tells a very different story. It is not
uncommon for projects to fail. Even if the budget and schedule are met,
one must ask “did the project deliver the results and quality we expected?”
True project success must be evaluated on all three components.
Otherwise, a project could be considered a “failure.”
Have you ever seen a situation where projects begin to show signs of
disorganization, appear out of control, and have a sense of doom and
failure? Have you witnessed settings where everyone works in a silo and no
one seems to know what the other team member is doing? What about
team members who live by the creed “I’ll do my part (as I see fit) and after
that, it’s their problem.” Even worse is when team members resort to
finger-pointing. Situations similar to these scenarios point to a sign that
reads “danger.” And if you read the fine print under the word “danger” it
reads, “your project needs to be brought under control or else it could fail.”
When projects begin to show signs of stress and failure, everyone looks to
the project manager for answers. It may seem unfair that the burden of
doom falls upon a single individual. But this is the reason why you chose to
manage projects for a living! You’ve been trained to recognize and deal
with these types of situations.
There are many reasons why projects (both simple and complex) fail; the
number of reasons can be infinite. However, if we apply the 80/20 rule, the
most common reasons for failure can be found in the following list: 
! !384
1. Undefined objectives and goals

2. Poorly managed
3. Lack of management commitment
4. Lack of a solid project plan
5. Lack of user input
6. Lack of organizational support
7. Centralized proactive management initiatives to combat project risk
8. Enterprise management of budget resources
9. Provides universal templates and documentation
10.Poorly defined roles and responsibilities
11.Inadequate or vague requirements
12.Stakeholder conflict
13.Team weaknesses
14.Unrealistic timeframes and tasks
15.Competing priorities
16.Poor communication
17.Insufficient resources (funding and personnel)
18.Business politics
19.Overruns of schedule and cost
20.Estimates for cost and schedule are erroneous
21.Lack of prioritization and project portfolio management
22.Scope creep
23.No change control process
24.Meeting end-user expectations
25.Ignoring project warning signs
26.Inadequate testing processes
27.Bad decisions
Even with the best of intentions or solid plans, project can go awry if they
are not managed properly. All too often, mishaps can occur. This is when
the project manager must recognize a warning sign and take action. If you
understand the difference between symptoms and problems and can spot
warning signs of project failure, it will help you take steps to right the ship
before it keels over. Yes, it’s the project manager’s responsibility to correct
the listing no one else. In addition to applying the processes and principles
taught in project management class, you can also use your personal work
skills of communication, management, leadership, conflict resolution, and
diplomacy to take corrective action.
! !385
During the course of managing a project, the project manager must

monitor activities (and distractions) from many sources and directions.
Complacency can easily set in. When this happens, the process of
“monitoring” breaks down. This is why the project manager must remain in
control of a project and be aware of any activity which presents a risk of
project failure.
! !386
15.5 Summary
• Project Planning in the most important step in Project and if done

properly done, can save time, money and many problems. The Plan
should include Project Goals, Deliverables, Schedules and Supporting
Plans.
• Project Risk Management involves steps such as Risk identification,

Performing qualitative risk analysis, Performing quantitative risk analysis,
Planning risk responses and Monitoring and controlling risks.
• The need for an emphasis on planning is what separates project

management from general management. The WBS is the first step in
producing a quality project plan and setting you and your team on the
road to success. Neglecting this process in favour of getting on with the
work has been the downfall of many projects. Improve your chances of
success by always producing a WBS for your projects.
• Projects fail for a variety of reasons mainly being Undefined objectives

and goals, Poor management, Lack of management commitment and
Lack of a solid project plan.
1. What is Project Planning? What are the aspects of Project Planning?

What is their importance?
2. What is Project Risk Management? What is their importance?
3. What is Work Breakdown Structure? What is its importance?
4. Why do Projects fail?
! !387
REFERENCE MATERIAL
chapter
Summary
PPT
MCQ
Video Lecture 
! !388
PROJECT QUALITY ASSURANCE AND AUDIT
Chapter 16
Objectives.
• Get a brief overview on Project Quality Assurance.
• Learn about steps to Project Audit.
Structure:
16.1 Project Quality Assurance
16.2 Project Audit
16.3 Summary
! !389
16.1 Project Quality Management
The Quality Management Plan defines the acceptable level of quality, which
is typically defined by the customer, and describes how the project will
ensure this level of quality in its deliverables and work processes. Quality
management activities ensure that:
• Products are built to meet agreed-upon standards and requirements.
• Work processes are performed efficiently and as documented.
• Non-conformances found are identified and appropriate corrective action

is taken.
Quality Management plans apply to project deliverables and project work

processes. Quality control activities monitor and verify that project
deliverables meet defined quality standards. Quality assurance activities
monitor and verify that the processes used to manage and create the
deliverables are followed and are effective.
16.1.1 Quality Plan Components

The Quality Management Plan describes the following quality management
components:
1. Quality objectives
2. Key project deliverables and processes to be reviewed for satisfactory
quality level
3. Quality standards
4. Quality control and assurance activities
5. Quality roles and responsibilities
6. Quality tools
7. Plan for reporting quality control and assurance problems
16.1.2 Rationale/Purpose
The purpose of developing a quality plan is to elicit the customer’s
expectations in terms of quality and prepare a proactive quality
management plan to meet those expectations.
The Quality Management Plan helps the project manager determine if

deliverables are being produced to an acceptable quality level and if the
! !390
project processes used to manage and create the deliverables are effective
and properly applied.
16.1.3 Who is Involved?

1. Project Manager
2. Project Team
3. Customer
4. Project Sponsor
16.2 Project Audit
A Project Audit involves comparing actual results with predicted results and
explaining the differences, if any.
The post-audit serves three purposes:
1. Improvement of forecasts
2. Improvement in operations
3. Identification of termination opportunities.
It provides an opportunity to uncover issues, concerns and challenges

encountered during the project life cycle. Conducted midway through the
project, an audit affords the project manager, project sponsor and project
team an interim view of what has gone well, as well as what needs to be
improved to successfully complete the project.
If done at the close of a project, the audit can be used to develop success
criteria for future projects by providing a forensic review. This review
identifies which elements of the project were successfully managed and
which ones presented challenges. As a result, the review will help the
organization identify what it needs to do to avoid repeating the same
mistakes on future projects.
Regardless of whether the project audit is conducted mid-term on a project

or at its conclusion, the process is similar. It is generally recommended
that an outside facilitator conduct the project audit. This ensures
confidentiality, but also allows the team members and other stakeholders
to be candid. They know that their input will be valued and the final report
will not identify individual names, only facts. Often, individuals involved in
a poorly managed project will find that speaking with an outside facilitator
! !391
during a project audit allows them to openly express their emotions and
feelings about their involvement in the project and/or the impact the
project has had on them. This “venting” is an important part of the overall
audit.
A successful project audit consists of three phases:
1. Success Criteria, Questionnaire, and Audit Interview Development.

2. In-depth Research.
3. Report Development.
Phase 1: Success Criteria, Questionnaire and Audit Interview

Development
1. Success Criteria Development

Interview the core project sponsor and project manager to determine their
“success criteria” for the project audit and find out what they expect to
gain from the audit. This ensures that their individual and collective needs
are met.
2. Questionnaire Development
Develop a questionnaire to be sent to each member of the core project
team and to selected stakeholders. Often, individuals will complete the
questionnaire in advance of an interview because it helps them to gather
and focus their thoughts. The actual interview will give the facilitator the
opportunity to gain deeper insights into the team member’s comments.
The questionnaire simply serves as a catalyst for helping team members
and stakeholders reflect on the project’s successes, failures, challenges and
missed opportunities.
3. Audit Interview Questions

There are many questions that can be asked in an audit interview. It is
most effective, however, to develop open-ended questions, i.e., questions
that cannot be answered with a simple “yes” or “no.” Develop interview
questions that will help identify the major project successes; the major
project issues, concerns and challenges; how the team worked together;
how vendors were managed; how reporting and meetings were handled;
how risk and change were managed, etc. Questionnaires can be used for
team members and/or other stakeholders who are unable to attend an
interview.
! !392
Phase 2: In-depth Research

1. Conduct individual research interviews with the project sponsor, project
manager and project team members to identify past, current and future
issues, concerns, challenges and opportunities.
2. Conduct individual research interviews with stakeholders, including

vendors, suppliers, contractors, other internal and external project
resources and selected customers.
3. Assess the issues, challenges and concerns in more depth to discover

the root causes of any problems.
4. Review all historical and current documentation related to the project,

including team structure, scope statement, business requirements,
project plan, milestone reports, meeting minutes, action items, risk
logs, issue logs and change logs.
5. Review the project plan to determine how the vendor plan has been
incorporated into the overall project plan.
6. Interview selected stakeholders to identify and determine their initial

expectations for the project and determine to what extent their
expectations have been met.
7. Review the project quality management and the product quality

management to identify issues, concerns and challenges in the overall
management of the project. Identify any opportunities that can be
realized through improvements to the attention of project and product
quality.
8. Identify any lessons learned that could improve the performance of

future projects within the organization.
! !393
Phase 3: Report Development

1. Compile the information collected from all of the interviews.
2. Compile the information collected from individuals who only completed

the questionnaire.
3. Consolidate the findings from the project documentation review.
4. Identify the issues, concerns and challenges presented through the

review of the project quality management and product quality
management plans and isolate the opportunities you believe may be
realized.
5. Identify all of the project’s issues, concerns and challenges.
6. Identify all of the project’s opportunities that can be realized through

the report’s recommendations.
7. Identify the lessons learned that can improve the performance of future
projects within the organization.
8. Finalize the creation of the report and recommendations based on the

findings and present the detailed report and recommendations,
including a road map to get future projects to the “next level” of
performance.
! !394
16.2.1 Conclusion
The purpose of a project audit is to identify lessons learned that can help
improve the performance of a project or improve the performance of future
projects by undertaking a forensic review to uncover problems to be
avoided. In this way, project audits are highly beneficial to the organization
and provide the following outcomes:
• Development of lessons learned on the project that can be applied to

both the organization and its vendors.
• Development of strategies which, if implemented within the organization,

will increase the likelihood of future projects being managed successfully.
• Development of strategies which, if implemented within the organization,

will increase the likelihood of change initiatives being managed
successfully.
• Development of project success criteria which might include on-time, on-

budget, meeting customer and other stakeholder requirements,
transition to next phase successfully executed, etc.
• Recognition of risk management so that risk assessment and the

development of associated contingency plans becomes commonplace
within the organization.
• Development of change management success criteria which might

include how staff are involved, how customers are impacted, how the
organization is impacted, transition to next level of change to be
initiated, etc.
• Development of criteria that will continue the improvement of

relationships between the organization and its vendors, suppliers and
contractors regarding the management of projects.
• Application of the lessons learned on the project to future projects within

the organization.
! !395
16.3 Summary
• Project Quality Management defines the acceptable level of quality, which

is typically defined by the customer, and describes how the project will
ensure this level of quality in its deliverables and work processes.
• A Project Audit involves comparing actual results with predicted results

and explaining the differences, if any. It serves three purposes –
Improvement of forecasts, Improvement in operations and Identification
of termination opportunities.
1. What is Project Quality Management? Explain in detail.
2. What is meant by Project Audit? What is its relevance? 
! !396
REFERENCE MATERIAL
chapter
Summary
PPT
MCQ
Video Lecture
! !397

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PROJECT FINANCE

Sub Code 425

Program Design and Advisory Team

Prof. B.N. Chatterjee Mr. Manish Pitke

Prof. Kanu Doshi Prof. B.N. Chatterjee

Prof. Dr. V.H. Iyer Mr. Smitesh Bhosale

Prof. B.N. Chatterjee Prof. Vineel Bhurke

Prof. Venkat lyer Dr. Pravin Kumar Agrawal

Prof. Dr. Pradeep Pendse Mrs. Margaret Vas

Prof. Sandeep Kelkar Mr. Anuj Pandey

Prof. Dr. Swapna Pradhan Course Editor

Prof. Bijoy B. Bhattacharyya Prof. B.N. Chatterjee

Mr. P.M. Bendre Course Coordinators

Mr. Ajay Prabhu Ms. Kirti Sampat

Mr. A.S. Pillai Mr. Kishor Tamhankar

COPYRIGHT © by Prin. L.N. Welingkar Institute of Management Development & Research.

NOT FOR SALE. FOR PRIVATE CIRCULATION ONLY.

1st Edition (May-2015)

SECTION 1: THE PROJECT AND APPRAISALS 3

1 The Project 4-31

2 Project Appraisal 32-41

3 Technical Appraisal 42-68

4 Economic Appraisal 69-78

5 Market Appraisal 79-92

6 Financial Appraisal 93-128

7 Capital Structure 129-149

SECTION 2: FINANCING OF PROJECTS 150

8 Presentation of your Project for Financier 151-193

9 Term Loans 194-247

10 Working Capital Finance 248-276

11 Private Equity 277-313

12 Public Listing of Securities 314-333

13 International Capital 334-357

14 Crowd Funding 358-372

SECTION 3: PROJECT IMPLEMENTATION AND

15 Project Planning, Risks and Management 374-387

16 Project Quality Assurance and Audit 388-396

After studying this chapter, you should be able to:

• Get a brief overview about Projects.

1.2 Steps on Formulating a Project

1.3 Steps on Financing the Project

1.4 Steps on Implementation of the Project

1.5 Post Implementation Work

1.6 Total Project Life Cycle

1.7 Sample Form for Undertaking New Project

1.9 Self Assessment Questions

The Indian Government is considering interlinking the various rivers;

Often, Capital Expenditure Decisions represent the most important

Throughout this subject, we shall assume that maximizing shareholder

Revenue expenditure if made on day-to-day operations of the organization

Capital Expenditure Revenue Expenditure

Expenditure precedes benefit/utility. Expenditure follows benefit/utility.

Expenditure requires administrative Expenditure requires only annual

A smart finance manager keeps controls on Revenue Expenditure to reduce

Monthly Expense Sheet for M/s Predict Projects Pvt. Ltd.

d Miscellaneous Variable 1,24,125 1.85%

f Rent Fixed 4,37,547 6.54% Can we re-negotiate?

Can do a sales audit?

g Bank Charges Variable 5,436 0.08%

i Conveyance Variable 22,756 0.34%

m Rent Fixed 75,000 1.12%

n Miscellaneous Variable 1,24,124 1.85%

Sub-total 19,85,324 29.67%

GRAND TOTAL 66,91,961 100.00%