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Financial Feasibility Analysis
Vasundhara Sarraf Namrata Shah
Faculty Of Management Studies Banaras Hindu University
and for this it is important to understand the aims of the study. along with massive uncompleted project which you are unable to complete for the want of funds. money invested in the project must bring a fair return to you. profitability financing arrangements and national economic considerations. Financial and Economic Valuation Financial and economic evaluation aims at examining the project proposal from the angles of . Besides servicing social benefits. Achieving a clear understanding of the issues involved – the feasibility study must give a clear understanding of the issues. In the financial evaluation of the projects. it is necessary to develop the definition further and refine the estimates to be able to commit resources to maximum utilisation. profit is the most important objective. or a completed project which is not economical to operate. Capital cost estimate Asset Block Items Estimated cost(Lakhs) Bifurcated between . Exploring all options for the implementation of the project – as many ideas as possible should be explored. Capital cost estimate Needless to say that a wrong estimate of the capital cost will lead to many serious problems and can even threaten the survival of the business in the long term. the sum of the cost of the fixed assets and net working capital are added together to arrive at the total investment. capital cost. It hardly needs to be stated that in any business enterprise. Each option must be thoroughly reviewed to see whether it can be improved within the limitations of the market and technical conditions. so it is essential that they are well managed. working capital requirement. The original specification can act as a guide to the study but it should not be stifle imagination and creativity. to arrive at the return on investments (or earning before tax and interest). After the initial concept stage. The difference between investment and cost of the project is that in the latter the full net working capital is not taken. but only the margin money (at an agreed rate) is taken with the fixed capital.FINANCIAL FEASIBILITY OF THE PROJECT Introduction Feasibility study involves time and money.
Process auxiliaries like: piping and Supports. instrumentation and controls. Township D. registration fees. power generation and distribution. electricals. drains. pipe racks. treatment. welfare building.imported and local Foreign currency Land and land develop ment Building and civil Works Land cost. fencing road and rail road. communications. insulation. non process equipment other than furniture and office equipment. air conditioning.) and auxillary buildings. maintenance shops and store buildings B. platforms and machine foundations. lighting. survey fees. wells. Administration building. generation. sewers. Structures and civil works for tanks. paved storage yards and landscaping(land at market price. storage and handling Plant and machin ery Utilities and offsites . Process Indian (Rs. canteen. development cost per cubic meter) A. holding and distribution of air. and initial spare parts Cleaning. clearing and grading. hospital C. process structures. laboratory equipment and disposable facilities. and security and safety installations Process equipment. other general distribution networks for utilites and supply lines. fire fighting. inert gas. water and stream.
taxes and duties. construction spares. fees for engineering services. own engineering and drawing cost of all kinds. expenditure on capital issue. equipments and support services. recruitment and training of personnel and the like Interest and other bank charges on borrowings till the plant commences commercial production Insurance premiums. delegation of foreign experts and training of Indian personnel abroad. not included in equipment cost and errection cost Contingency as a percentage of every asset block depending on the level of Prelimin ary and preoperativ e expense s Interest Sundry expense s Conting ency or . technica l assistan ce and enginee ring fees and consulti ng charges Constru ction costs Payment for technology transfer – by whatever name called. cost of studies and investigations. supervision and consumable. supervision and other over heads cost upto the time of commercial production. temporary site installations and distribution arrangements. testing commissioning or start up expenses. promotional advertising and marketing arrangements. tools. Administration.facilities for raw materials/ feed stock and finished goods of all kinds and types Licence. and remuneration payable to consultants Labour.
and Making financing arrangement well in advance.2 from By-product Qty X Rate Annual Value of groups Rs. Operating Revenue 1. over the total operating cost expended. Lakh 1. Description Break-up Value Rs. later. so that when production starts. Assessing the impact of interest cost on the project viability. no constraints are experienced. Owners share of working capital at the rate agreed with the banks Operating cost estimate Income from the end product of a project is the most important deciding factor of the projects viability. Estimation of the operating cost must be done and compared with the estimated product revenue.manage ment reserve Margin for working capital accuracy of the estimate and the basic data and documents relied on.1 from main product Qty X rate 1. Income is the excess of the revenue earned from the end-product of the project in the year of stabilised production. Income statement for the year…. Lakh . Product volume should be studied be assumed very realistically lest you should experience widely different operating result. Working capital estimate Working capital estimation is necessary at this stage itself for: • • • Including your own margin of working capital in the capital cost estimates.
1 plant overheads 2.2. Interest and financing charges(as per schedule) 5.2 Fixed 2. power & fuel 8.2. Finished goods 5. WIP or Semi-finished goods 4. Raw materials/feedstock 2.1 variables 2. Utilities.1.2.5 Depreciation 3. Taxes & duties payable 9.3 power and fuel 2. Operating income (1-2) (Earning before interest and tax) 4.1 materials 2.2.1. Operating Revenue 2.1. Earnings Before Tax (-) Working Capital Estimate Item Descriptions 1. Overhead expenses Total Less: current liability Period or Level Amount Lakh) (Rs. Debtors(recievables) 6.2 marketing costs 2. Salaries & Wages 7.2. .2.3 distribution costs 2.2 labour 2. Ancilliary materials and consumables 3.4 general & Administration OH 2.
If NPV is positive. based on the product revenue and cost estimates discussed before. If the capital cost is spent beyond the first base year. the proposal is viable which means the investment is recoverable. discounted to the present value at the applicable interest rate. Pay back of investment The practice is to prepare projected statement of financial results for 10-15 years. cash flow and repayment capacity shall be computed and analyzed and reported from the angles of: • • • • • • Net present value(NPV) Internal rate of return(IRR) Pay-back period(PBP) Simple rate of return(SRR) Break even point (BEP) Sensitivity analysis (SA) NPV is the cumulative cash flow of the entire of the entire project life. Cash flow iii. . Profitability. the total financial viability of the project is to be examined closely from the angles of i.Net working Capital Margin @ -% taken in capital cost estimate Balance determined working capital limit as the Profitability and financial analysis Before deciding on investment. discount the cash flow using the required return rate or cutoff rate as the discounting factor. If you require a rate of return which is different from the interest rate . the proposal is not viable. The required rate of return must normally be above the rate of interest on the invested fund. to ascertain its present worth and compare it with the capital cost. If it is negative. Profitability or rate of return (ROI) ii. then that has also to be discounted to the present value for a meaningful comparison.
SA is an exercise aimed at assessing such sensitivity and determining the best possible combination of production factors in estimates for maximum commercial advantage. Especially in political unstable countries. The shorter the PBP. . Shorter PBP would also mean greater liquidity.IRR is what the accountants call “yield” as a criterion of project acceptability. arrive at the PV of the income streams and then compare the same with the investment – investment also discounted to its PV. the choice is there to include or exclude working capital form investment. Projects set up to meet wartime booms should have very short PBP. to accept the proposal with minimum risk to investment. Also. At the same time the whole projects viability may be exposed several risks. a shorter PBP is desirable. Sensitivity Analysis (SA) and Risk Analysis (RA). or when there are several project proposals. the more viable the project.project costs are mostly sensitive to economic changes. The idea to do SA is to adopt the best available alternative with the least risk. Instead of adopting complicated equations. in a situation where various alternatives are available and/or several uncertainties exist. for the purpose of payback calculation. Pay-back Period – is the number of years in which the capital cost is fully recovered. asking oneself “what if the rate is this? Or return is that?”or at acceptable or required yield rate. It is the discount rate at which the PV of both total outflow of funds and inflow of returns would equal and is the best way to measure the prospective results of alternative investments opportunities. The PBP may be calculated including or excluding construction period. PBP is determined by the after-tax profit and discount rate. the practical approach followed in calculating IRR is to work out several sets of PV projections.
1. mainly attributable to commencement of implementation before making adequate funding and disbursement arrangements.Sources of Project Finance Main sources of Project Finance are as follows We all must have heard of many project failures resulting from unplanned. Promoter Group’s Contribution: The minimum contribution the promoters. Below are discussed all the main sources of project financing. either alone or together with their friends. untimely and insufficient financing. In the public sector this is provided by the Central and State Governments or Government institutions or mutual funds which are shareholders of the undertaking. To avoid these problems various financing sources could be tapped. The promoter’s contribution should be locked-in without transfer or withdrawal for a period of five years from the date of commencement . associates and relatives as described in the prospectus. Long term Rupee Funds • Equity and Preference Share Capital-Equity is principally the promoter’s and other shareholder’s funds.
depending on the attractiveness of the project viewed from various angles. subject to a certain maximum amount in each unit. equally. Public Subscription: Public subscription deals with the issue of equity shares to the public. It is engaged in development and commercialization of technology. for medium scale units set up and run. It provides both risk capital and technology finance under one roof to innovative entrepreneurs and technocrats for their technologyoriented ventures. TDICI assistance: It is the ICICI’s counterpart of RCTFC. innovative technologies. It gives venture capital to entrepreneurs up to a certain amount for projects aimed at commercial development of high technology. of production or date of allotment whichever is later. through state financial corporation’s (SFCs). both of state level and all India. Share subscription by financial institutions and mutual funds: Most of the Financial Institutions. The objective of this lock-in is that the promoters must share the risks with the shareholders. to qualified entrepreneurs of a unit whose project cost does not exceed the specified limit. State Government Contribution: State governments. The RCF was converted into RCTFC on 12 January 1988. holders of options generally experience a direct financial Employee Stock Options: An employee stock option is a call option on the . As the scheme’s terms and conditions and interest rates will keep changing. (RCTFC) The IFCI sponsored the Risk Capital Foundation (RCF) in 1985 to give positive encouragement to new entrepreneurs. you are well advised to contact the SFC or SIDC concerned when you start your unit. Share subscription by NRIs: Participation by NRIs in equity shares and convertible debentures are subject to certain limits. RCTFC assistance: Risk Capital and Technology Finance Corporation Ltd. If the company's stock rises. Seed Capital Existence: It is a financial assistance scheme operated by IDBI. subscribe to capital issues. common stock of a company. and Mutual Funds participate in the equity of projects. or new usages of existing technology. on a whole time basis. issued as a form of non-cash compensation. Restrictions on the option (such as vesting and limited transferability) attempt to align the holder's interest with those of the business' shareholders. by technically and/or professionally qualified and experienced entrepreneurs. This assistance is given through SFCs and SIDCs. It is governed by SEBI guidelines and certain sections of The Companies Act. new projects using such technology and commercial application of either indigenously developed or imported. Most of the projects it assisted were based on new technology. 1956.
employee-type stock options can be offered to non-employees: suppliers. Employee stock options are similar to warrants. although the company does not have to pay this dividend if it lacks the financial ability to do so. non-cumulative. and convertible also called preferred stock. although preferred stock shareholders do not enjoy any of the voting rights of common stockholders. In most cases. In general. and which takes precedence over common stock in the event of a liquidation. retained earnings can become negative. Employee stock options are mostly offered to management as part of their executive compensation package. The formula calculates retained earnings by adding net income to (or subtracting any net losses from) beginning retained earnings and subtracting any dividends paid to shareholders. companies retain their earnings in order to invest them into areas where the company can create growth opportunities. It is recorded under shareholders' equity on the balance sheet. Preference Shares or Preferred stock: Capital stock which provides a specific dividend that is paid before any dividends are paid to common stockholders. Like common stock. This gives employees an incentive to behave in ways that will boost the company's stock price. The main benefit to owning preference shares are that the investor has a greater claim on the company's assets than common stockholders. They may also be offered to non-executive level staff. preference shares represent partial ownership in a company. Also unlike common stock. insofar as they may have few other means of compensation. The retained earnings general ledger . preference shares pay a fixed dividend that does not fluctuate. consultants. which are call options issued by a company with respect to its own stock. participating. • Internal Generation of Funds Retained Profits: The percentage of net earnings not paid out as dividends. Preferred shareholders always receive their dividends first and. there are four different types of preferred stock: cumulative preferred. Applications for subsidies are usually routed through the Financial Institution which has funded the project. such as buying new machinery or spending the money on more research and development. Should a net loss be greater than beginning retained earnings. lawyers and promoters for services rendered. preferred shareholders are paid off before common stockholders. but retained by the company to be reinvested in its core business or to pay debt. in the event the company goes bankrupt. sales tax loan and development assistance: Various capital investment subsidies and incentives are given by the Central and State Government. creating a deficit. Alternatively. especially by businesses that are not yet profitable.benefit. Central and State capital subsidies.
such transfers are done with the approval of the government. In case of PSEs. Bond buyers generally purchase debentures based on the belief that the bond issuer is unlikely to default on the repayment. Like other types of bonds. They lend for the purpose of Revival of sick units. An example of a government debenture would be any government-issued Treasury bond (T-bond) or Treasury bill (T-bill). Sundry sources of long term loans: There are many sources of institutional and Central and State financial assistance operated for different schemes of industrial development. Inter-corporate loans: Public Sector Enterprises functioning under one and the same administrative ministry as well as associate private sector companies resort to temporary transfer of funds from one unit to another.account is adjusted every time a journal entry is made to an income or expense account. • Debentures: A type of debt instrument that is not secured by physical asset or collateral. can print off more money or raise taxes to pay these type of debts. This shall be against reasonable interest. T-bonds and T-bills are generally considered risk free because governments. Debentures have no collateral. • Central Government Budgetary Support: The central government budgetary support is the initial capital investment in the central sector projects. From all-India development banks and investment institutions: Financial assistance can be taken from the major all India public sector development banks and investment institutions. Depreciation: As depreciation is not cash expenditure is just an expenditure shown in the books of accounts it can be treated as an inflow of cash. at worst. • Public Sector Bonds: They are similar to debentures. • Lease Financing: This method is being used by many banks and financing companies. • Long-term rupee loans: Long-term institutional assistance is usually the largest single source of project financing. They pay full price of the required equipment and then lease them out to the project owner under an agreement providing for repayment of principal and interest as monthly and quarterly installments. Usually this is given partly in the form of equity and partly as loan on a 1:1 ratio. Debentures are backed only by the general creditworthiness and reputation of the issuer. . Both corporations and governments frequently issue this type of bond in order to secure capital. with a view to helping the unit which is in need of financial resources. debentures are documented in an indenture. They are issued by public sector undertakings (PSUs) for raising funds. Modernization of existing undertakings and for supplier’s deferred credit.
credit from official export credit agencies. ii) The bulk of the balance to be lent by your commercial bank or otherwise to be borrowed or brought in by you as short term finance. Even certain banks form consortium to finance huge working capital needs of big projects . the Reserve Bank of India (RBI). • External Commercial Borrowings: An Indian enterprise borrowing in foreign exchange has to comply with the external commercial borrowings (ECB) policy announced by the regulator. multilateral aid is given through the intermediacy of an international organization. buyers’ credit. which pools donations from several countries' governments and then distributes them to the recipients. by means of equity participation and loan. given at least partly with the objective of benefiting the recipient country. to operate the project after it commences production. Bilateral aid is given by one country directly to another. The ECB policy is monitored and updated by RBI on a regular basis. Short-term Rupee Funds for Working Capital: Short term working capital .1. Source of working capital are as follows: • From commercial banks: Commercial banks follow certain norms for lending money for working capital. would consist of i) The margin to be provided by you. foreign currency convertible bonds and commercial borrowings from the private sector lending arms of multilateral financial institutions—for instance. Foreign Currency Funds • Free foreign exchange from FE dealers and loans from development banks. ECBs encompass commercial bank loans. suppliers’ credit. 1. usually in collaboration with other investors. • External Aid: It is a voluntary transfer of resources from one country to another. the NRI equity alone may be sufficient to meet the whole of the foreign currency requirements. such as the World Bank. the International Finance Corporation and the Asian Development Bank. that is. • Collaborator’s equity participation in foreign exchange • Share subscription by overseas investors: • NRI and OCB share subscription in foreign exchange: Share subscription made by NRIs can be a long-term source of foreign currency for project’s needs. • Assistance from International Finance Corporation: The IFC gives financial assistance to the private sector in the developing countries among its members. according to the macroeconomic conditions and foreign exchange liquidity situation. Depending on the blend of financing and quantum of requirements. securitised instruments such as floating rate notes and fixed rate bonds.
. There are restrictions on the quantum of deposits intake and rate of interests.• • • Public deposits: These are regulated by the government through the companies act and Public Deposit rules. Debentures/Bonds: Debentures can be used to fund both short term as well as long term working capital needs. Supplier’s Credits: Its available for 1-3 months for supply of raw materials and other inputs and is used as source of short term financing.
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