Term Loan/Project Appraisal A Presentation: by A K Mishra Iifb

Term Loan/Project Appraisal
A Presentation
By
A K Mishra
IIFB
INDIAN INSTITUTE OF BANKING & FINANCE

Term Loan
 Given for a Fixed period
 Repayment according to the agreed
Terms of Repayment/Period
 Required by Industrial units and
Traders/Industrialists/Entrepreneurs

Classification of Term Loan
 (i)ShortTerm Loan– Where Repayment
Period does not exceed 3 years
 (ii)
Medium Term 3 years and up to 5
Years
 (iii)
Long Term Loan – Where repayment
period exceeds 5 years Loan – Where
Repayment period is over

Term Loan
 What ever be the Purpose of Term
Loan, it is to be always ensured
that the Activity / Asset financed
must be capable of generating
adequate cash Profit so that it is
always sufficient to Repay the Term
loan installments with interest as
stipulated.
Purpose
 Financing Specific Asset
 Financing Modernization Programme
 Financing Expansion Programme
 Financing Diversification Programme
 Financing New Project
 Financing Rehabilitation Programme

Specific Asset
 The need of Purchase/ Installation
 Its contribution in regular operations
 Increase in Profit
 Whether additional Profit will cover
the Term Loan Installments
 Positive Decisions based on above
factors
Modernisation, Expansion, Diversification
 Proposals are received from Existing Units
 Project Report to be collected and studied
 Market condition of the product
 Any Threats to the product
 Requirement
 Additional Income Generation

Term Loan Appraisal- Basic Issues ??
 Who are the Promoters, their credentials-??
 Whether available information suggest Promoters are capable of managing
& Executing the Project successfully-??
 Whether Finished Goods Produced would have assured market-??
 Whether there is adequate demand supply Gap of this product in the
market & the same would continue all along the Loan Period-?
 Proposed Technology to be employed is adequate & appropriate-??
 Whether the installed Plant Capacity is adequate, commensurate with
existing & upcoming future Demand of the Product -??
 Do the Projections related to Operations & profitability of the Project over
the envisaged Repayment Period represents reality situation-??
 Whether the Term Loan asked for is adequate vis a vis actual funding
required of this Project-??
 Whether the Projected Cash Flow/Profitability is adequate enough to
service the Term loan amount asked for during the repayment Period -??

Term Loan Appraisal- Basic Issues contnd ??
 If the Term Loan is not repaid as scheduled in the Proposal,
whether proper risk mitigation measures would be in place in the
form of Collaterals if any-??
 Are various Approvals required for the Project in place -??
 Is the Implementation schedule/ Moratorium/Repayment Period
acceptable-??
 Entire Appraisal process is divided into following modules:-
 Human appraisal/Managerial competence
 Appraisal of Market & Economic Scenario
 Technical Feasibility aspects
 Examination of Financial & Commercial viability
 Risk Appraisal of the Proposal which consists of BEP, Sensitivity
Analysis

Technical Feasibility
 Locational advantage viz. Land (area, cost & approach road),
 Proximity to Raw Material,
 Proximity to Market,
 Licenses, Permits to start the Project
 Product & Process (Manufacturing Process adopted, modern
technology available, standing of Supplier of Technology)
 Availability of Labours (Skilled & non-skilled),
 Water, Power, Fuel,
 Transportation, Communication facilities
 Suitability of Effluent Disposal
 Community Infrastructure (Houses, Schools, Hospitals, Shopping
Centres, Cultural activities)
Feasibility Study
 While considering a proposal for Financing a
New Project the feasibility studies should be
done covering :-
 Technical Feasibility
 Commercial Viability
 Managerial Competence
 Economic Feasibility
 Financial Feasibility

Commercial Viability
 Favorable Market for goods produced as to whether
goods can be sold in quantity and price as projected by
Entrepreneur
 Buyer’s location like Rural, Town, Cities, Metros
 Main Suppliers to the Market
 Other Manufacturers entering into the field
 Sales : Seasonal or Uniform through out
 Export Possibilities/Import Substitution
 Economic Environment & Govt. Policies as to entry of
Multinationals and free Import which may be a threat to
the Project
Commercial Viability ..contd.
 Capability of the Unit to penetrate the Market
 Types of Customers who will use the products or who are
Targeted as Customers, their characteristics in terms of
Income, Occupation and Education
 Demand (present & future trend) which depend on several
factors e.g.
 Change in Price
 Change in Income
 Changing Taste & Fashion
 Prices of Substitute Goods

Managerial Competence
 The study covers considerations of the :-
 Qualification, Technical & Managerial skill
 Past Experience
 Entrepreneurial Skill (ambition, tenacity, risk taking aptitude)
 Family Background
 Character (Honesty, Integrity)
 Reputation in the Market (Capability to arrange Promoters
Contribution/ Margin in Contingency)
 Appearance of the Promoters
 RBI Defaulters list, ECGC Specific Approved List, CIBIL

Economic Feasibility
 The Project being considered for Financial support from
Bank should be Economically Viable.
 The Value to be fetched will provide Profit.
 The Profit should be adequate to take care of the Loan
Obligation.
 Other factors to be considered are :-
 Prospect of Employment Generation
 Import Substitution
 Contribution to the Govt. Exchequer

Cost of Project
 Land,
 Site Development,
 Buildings
 Plant & Machinery,
 Technical Know- how Fees,
 Misc. Fixed assets,
 Preliminary and Capital issue expenses
 Pre-Operative expenses
 Provision on Contingencies
 Margin for Working Capital

Land & Site Development
 Basic Cost of land & other Allied
charges
 Cost of leveling & development
 Cost of laying approach Road and
internal Roads
 Cost of Compound walls and Gates
 Cost of Tube Wells
INDIAN INSTITUTE OF BANKING & FINANCE 40

Buildings and Civil works
 Building for the main Plant & Equipment
 Building for auxiliary services like steam supply,
Workshops, Laboratory, Water supply etc.
 Go-down, Warehouses and open yard facilities
 Non-Factory building like Canteen, Guest house
 Quarters for essential staff
 Silos, tanks, wells, chest, basins, cisterns, bins
and other structures necessary for installation of
plant & equipment
 Sewers, Drainage
 Other Civil Engineering Works

Plant & Machinery
 Cost of Imported Machinery:- This is the sum of
(i) FOB Value (ii) Shipping, Freight & Insurance cost
(iii) Import duty (iv) clearing, loading, unloading &
transportation charges
 Cost of Indigenous Machinery:- This is the sum of
(i) FOR [Free on rail] Cost, (ii) Sales Tax, Octroi
and other Taxes if any (iii) Railway Freight and
Transport Charges to the site
 Cost of Stores & Spares
 Foundation & Installation charges
Technical know how & Engineering Fees
 Engaging Technical Consultants or Collaborators from
India/ abroad for advice or help in various technical
matters like:-
 Preparation of the Project report,
 Choice of Technology,
 Selection of the Plant & Machinery,
 Expenses on travel, Boarding & lodging, salaries &
allowances of foreign/ Indian technicians
 The royalty payable annually, which is typically a
Percentage of Sales, is an operating expense taken into
a/c in the preparation of projected profitability
statements

Misc Fixed Assets
 Fixed Assets & Machinery which are not part of the
direct Manufacturing Process e.g.:-
 Furniture, Office Machinery & Equipment
 Tools, vehicles, Railway siding, Diesel Generator Sets,
Transformers, Boilers, Piping system, Laboratory
equipment, Workshop equipment, Effluent treatment
plants, Fire fighting equipment
 Expenses incurred for the Procurement or use of
Patents, Licenses, Trademark, Copyrights etc and
Deposits made with Electricity Board may be placed
here

Preliminary & Capital issue expenses
 Expenses incurred for identifying the project
 Conducting the Market survey
 Preparing the Feasibility Report
 Drafting Memorandum & Articles of Association
 Incorporating the Company etc,
 Expenses incurred for raising the Capital from the
Public are called Capital issue expenses e.g.:-
 Underwriting Commission, Brokerage, Fees to
Managers & Registrars, Printing & Postage,
Advertising & Publicity, Listing fees, Stamp Duty etc

Pre-Operative Expenses
 Expenses incurred till Commencement of
Commercial Production are referred to here
 Establishment expenses
 Rent, Rates & Taxes
 Travelling Expenses
 Interest & Commitment Charge on Borrowing
 Insurance Charges
 Mortgage Expenses
 Interest on Deferred Payments
 Start up expenses & other Misc expenses

Provision on contingencies
 Provision on Contingencies:- Provision for unforeseen
expenses and Price increase e.g. Time & Cost over run
 Divide the Project Cost items into two categories:-
 (i) Firm Cost items- which have already been acquired or
for which definite arrangements have been made
 (ii)Non-Firm Cost items- Set the provisions for
contingencies at 5 to 10 % of the Estimated Cost of non-
firm cost items
 Alternatively make a provision of 10% on all items
(including the margin on W.C.) if the implementation
period is one year or less.
 For every additional year make an additional provision of
5%

Margin on Working Capital
 Principal support for Working Capital is provided by
Banks & Sundry creditors
 However a certain part of W.C. has to come from Long
Term Sources of Finance referred to as Margin Money
for Working Capital
 This Margin Money is sometimes used for meeting Cost
Over-runs in Capital cost leading to a problem (some
times a crisis) when the project is commissioned
 To mitigate this problem the financial institutions
stipulate that a portion of the loan amount, equal to
the Margin Money for W.C. be blocked initially so that it
can be released when the Project is completed.

Means of Finance- Long Term sources
 Part of the Finance should come from the Borrowers
except specific schemes where Term Loans are provided
free of margin
 Share Capital - Issue of Ordinary/ Preference shares
 Subsidies from Central/ State Govt.
 Borrowings- Debentures, External borrowings
 Term Loan from Institutions, Banks
 Misc Sources - Unsecured Loans & Deposits
 Deferred Credit from Equipment Suppliers
 Internal Reserves from existing undertakings

Financial Feasibility- Parameters
 Debt Equity Ratio(DER)
 Return on Total Assets & Net Worth
 Fixed Assets Coverage Ratio(FACR) & A.C.R.
 Debt Service Coverage Ratio (DSCR)
 Break Even Point Analysis (BEP)
 Pay Back Period on Discounted Cash Flow consideration
(GPV & NPV)
 Sensitivity Analysis
 Average Cost of Capital
 Internal Rate of Return (IRR)

Debt-Equity Ratio
 1. Term Liabilities/ Tangible Net Worth
(Term Liabilities= Term loans, Debentures, Preference
Shares, Public Deposits etc)
(Tangible Net Worth= Capital + Reserves + Surplus –
Intangible Assets)
 Standard Ratio as per Bank’s Loan Policy = 3:1
 2. Total Outside Liabilities / Tangible Net Worth
Total Outside Liabilities= Term Liabilities + Current
Liabilities
 Maximum 5:1, > 5:1 by Higher Authorities

Return on Total Assets & Net Worth
 ROTA = PBIT/ Total Tangible Assets

 Return on Capital Employed = PBIT
Total Capital Employed
 Total Capital Employed = (NW + TL + CL) or (NW + TL)
 Gives overall Profitability as Interest amount varies due
to level of Credit availed & Taxes are beyond control of
Units. Helps in comparing two Units.
 RONW= Net Profit/ Tangible Net Worth
 Ratios should be calculated for 3 to 4 years to see the
trend in rise/ fall of Profit

Asset Coverage Ratios
 Fixed Asset Coverage Ratio = Net Fixed Assets = 1.5 :1
Term Liabilities
 Net Fixed Assets = Gross Block of Fixed Assets minus
Depreciation (Method of charging should not change)
 2. Asset Coverage Ratio: Chargeable C.A. + Net F.A. +
Collateral / Cash Credit + Term Loan = 1.5 :1 (Standard
as per Bank’s Loan Policy)
 ACR For MSME: > 1.33/1
 Chargeable Current Assets = Inventory (Raw Materials+
SFG + Finished Goods) + Receivables (Sundry Debtors +
Bills receivable)

Interest Coverage Ratio
 PBDIT (Profit Before Depreciation, Interest & Tax)
Total Interest Obligation
= >1.60/1 For General
MSME:>1.50/1
 PBDIT i.e. Minimum Earning to Pay the
Interest, Installment & Dividend

Debt Service Coverage Ratio
 Repaying Capacity of the Unit
 Net Profit after Tax + Depreciation + Intt. on T/L + Prem Exp W/O
Interest. On T/L + Installment on T/L
 Standard for General as per Bank’s Board= 1.5 (Average)
 For MSME: DSCR:>1.25/1
 DSCR helps to determine length of Moratorium, Repayment
period, Amount of installment
 Low DSCR- Repayment Period can be Extended
 High DSCR- Repayment Period can be Reduced
 Very low DSCR- Proposal should not be considered
 Net DSCR:– Numerator (-) Interest on T/L
 Modified DSCR:– Numerator (–) Incremental NWC

Benchmark Ratios as per Banks Board
Ratio Benchmark
Current Ratio 1.33 (1.10/1- MSME)
Current Ratio (Trading) 1.20
Current Ratio (Seasonal Industry) 1.00
Current Ratio (NBFC/MFI/EOU/Textile/Rice Mill) 1.11
TOL/TNW 5:1
TOL/TNW (MFI) 6:1
TOL/TNW (Infrastructure Projects) 7:1
TOL/TNW (NBFC/HFC) 8:1

TOL/ ATNW 4:1
TOL/ ATNW ( NBFC/HFC/MFI/Infra) 5:1
Debt-Equity TL (other than Infra/ NBFC/ HFC) 3:1 (4/1, 3/1-MSME)
Debt-Equity TL (NBFC/HFC, Infra, SEZ & SPVs created for Infra) 4:1

56
Benchmark Ratios
Bank Borrowing/TNW 4:1
Bank Borrowing/ TNW (NBFC/HFC) 5:1
Average DSCR (other than HAM) 1.5 (MSME-1.25/1)
Average DSCR (HAM) 1.25
Interest Coverage Ratio 1.60.1 (MSME-1.50/1)
Interest Coverage Ratio (Infra/ NBFC/ HFC/MFI/ 1.5:1
Textile/ Rice Mill)
Interest Coverage Ratio (Trading) 1.25.1
Asset Coverage Ratio (ACR) 1.5:1 (MSME-1.33/1)
Asset Coverage Ratio (ACR)-NBFC/HFC 1.11:1
Fixed Assets Coverage Ratio (FACR) 1.5:1
TOL/ TNW + Quasi Equity (Quasi Equity= Unsecured 4:1
Loans equal to 100% of TNW)

Sensitivity Analysis
 An Exercise by which the study is conducted to measure
impact of an assumed adverse change & its impact on
Project variables in general & profitability estimates in
particular
 If there is 10% rise in Raw Material Cost and because of
the change the effect on parameters viz. Profit, Cash-
Flow, NPV,DSCR, IRR, BEP etc.
 Similarly if hike in Wages Cost say 2%
 Reduction in Sales volume or Sales Price by 10%
 This analysis is done to test the viability of the Project
under different adverse conditions.
 After knowing the impact of the critical factor, steps are
taken to nullify their impact.
Operating Leverage
Sales 300000 Sales -10% 270000
V. Cost 240000 V. cost -10% 216000
Contribution 60000 Contribution 54000
Fixed cost 30000 Fixed cost 30000
Operating 30000 Op. Profit 24000
profit
OL = Contribution/ Operating Profit
OL= 60000/30000= 2
 Operating Leverage is 2, for a change in Sales by 10%, Change in
Operating Profit is 20%.
 So ideal OL should be 2, Otherwise if OL is high any change in Sale
will reduce the Operating Profit considerably.
 Proposals with high OL should Not be Accepted.
Break-Even Point Analysis
 Break-Even Point is the Amount of Sales at which a Unit
makes no Profit or no Loss.
 Level of Sales at which Sale’s Revenue = Total Cost
 Units Earn Profit if level of Sale is above BEP
 Units with Preferably Low BEP are Preferred
 T/ Loan installments are served out of Profits
 After calculation of BEP the Sale Projected in the
Financial Statements is compared with BEP
 If the difference between Projected Sales & BEP Sales is
very low, it is risky to Finance as a minor deviation in
elements of Projections may result in a Loss

Break-Even Point analysis
 Where Projected Sales is very high than BEP
Sales, the Probability of earning Profit still
remains even if there are some deviations.
 Difference between Projected Sales and BEP
sales is known as Margin of Safety.
 Units with high Margin of Safety are preferred
for Finance by Bank(if Sales drops by MOS-Loss)
 Where Projected Profitability statement for
many years are given, one should choose the
first year of Optimum Capacity utilization for
calculating BEP
All Costs to be classified into
Fixed Cost & Variable cost
 Fixed Costs- Incurred irrespective of level of Production
or even if there is no Production e.g. Depreciation,
Factory Rent, Manager’s Salary, Interest
 Total Fixed Cost of a unit remains constant, but Fixed
Cost per unit of Sale/ Production goes down with increase
in number of Units.
 Variable Cost (RM, Wages, fuel, Power) Varies/increases
with increase in Sales
 Total Variable Cost of a Unit goes up with increase in
production/ Sales, but Variable Cost per unit Remains
constant.

Semi-Variable Costs (Neither Fixed nor
Variable) & Contribution
 SVC increase with increase in volume of Sales/ Production but the
increase is not directly proportional to increase in sales/ Production.
Examples- Telephone Charges, Selling Expenses, Power/ Electricity.
 SVC is considered as Fixed Cost for simplicity
 50% of SVCs to be taken as Fixed & 50% as Variable Cost
 Contribution = Sales – Variable cost
 Contribution per Unit = Sales per Unit- Variable Cost per Unit
 Contribution is Surplus left from Sales revenue after meeting the
Variable Cost contributing towards Fixed Cost & thereafter for
Generating Profit

Calculation of BEP
 BEP in Units= Fixed Costs
Contribution Per Unit
 or Fixed cost .
(Sales Price per Unit - Variable Cost per Unit)
 BEP in Rupees= BEP in Units X Sales Price per Unit or
BEP in Rupees=
 Fixed Cost X Total Sales in Rupees
Total Contribution
 Projects having BEP above 75% of Capacity utilization
should not be accepted for finance.

Calculation of BEP
 BEP in terms of Capacity Utilization or BEP in Capacity =
( Fixed Cost / Total Contribution ) X Projected Capacity Utilization at
optimum Sales level
 BEP in terms of P/V ratio = Fixed Cost
. (Profit Volume Ratio) P/V Ratio
 P/V Ratio = Total Contribution (Sales- V. Cost)
Total Sales
 Margin of Safety = Actual Sales - BEP Sales, or
 MOS = Actual Sales - BEP Sales x 100
Actual Sale

Examples/Calculation of Break Even Point
Items Company “ A” Company “B”
Fixed Cost 30000 50000
Sales Price/Unit 100 90
Variable Cost/Unit 40 30
Contribution/Unit = 100 – 40 = 60 90 – 30 =60

Sales- Variable Cost
BEP(Units) =Fixed 30000/60 = 500 Units 50000/60 = 833.33 Units
Cost/Contribution per Which means Profit will Which means Profit will
Unit come only after come only after
Sales>Rs50000/ Sales>Rs75000/

Break Even Point: Caselet -1
Caselet 1 : Fixed Cost of Firm A is Rs 80,000. Its selling Price is 40
and Variable Cost is Rs 24. What is Break Even and Break Even
Sales.
Ans :
 CONTRIBUTION PER UNIT = SP/Unit- VC/Unit = 40-24 =16
 BEP in Units = FIXED COST/CONTRIBUTION PER UNIT =

80000/16=5000 Units
 BEP in Rs = BEP in Units x SP/Unit = 5000X40 = Rs2,00,000

TERM LOAN
CALCULATION OF BEP
SUPPOSE IN A UNIT:
SELLING PRICE IS Rs.10 PER UNIT
VARIABLE COST IS Rs.7 PER UNIT
FIXED COST IS Rs.600
 CONTRIBUTION PER UNIT (SELLINGG PRICE – VARIABLE COST )= 10-7=3
 TO COVER FIXED COST OF Rs.600 IT REQUIRES SALE OF ……?? UNITS
 (FIXED COST/CONTRIBUTION PER UNIT) 600/3 = 200 UNITS= BEP IN UNITS
 BEP IN TERMS OF AMOUNT Rs.2000 (200 x 10)

Capital Budgeting
 It tells us how quickly investment in Fixed Assets will
be recovered from the future Cash Flows
 Methods of Capital Budgeting:-
 1. Pay Back Period
 2. Discounted Cash Flow Method
 3.Net Present Value (NPV)
 4.Internal Rate of Return (IRR)

Pay Back Period
 Pay Back Period is the time (in years) required to
Recover the entire Investment from Future Cash
Flows. ie Time required to recover Investment Cost
 It is calculated by comparing all Cash Out Flows
(Investment) with all Cash Inflows (Cash Profit) and
finding out at what point of time they both are Equal.
 Lower the Pay Back Period better is the acceptability
of the Investment.
 Higher is the Pay Back Period, unlikely investment to
happen & comeby!

An Illustration of Pay Back Period Rs10 L
End of Year Investment in Company “A” Investment in Company “B”
Annual Returns/Cash In-flows Annual Returns/Cash In-flows
1 6 2.5
2 3 2.5
3 1 2.5
4 2 2.5
5 3 2.5
Total 15 12.50
Pay Back 3 Years 4 Years

Period
Let us assume that the initial investment of a Project was Rs.50 lacs.The
Cash Profit for next 8 years i.e., the life time of the Project as assessed is
as under:
Year Cash Profit (Rs in lacs) Cumulative Cash Profit (Rs in
lacs)

1 04 04
2 10 14
3 12 26
4 16 42
5 18 60
6 09 69
7 03 72
8 02 74
Pay Back Period in this

INDIAN INSTITUTE
case wouldOFbe
BANKING & FINANCE
4 Years 5 Months 10
Days (8/ 18 x 12)
Discounted Cash Flow
 The Pay Back Period has limitations, as it does
not take into consideration time value of money
 The money received after One year is worth less
than what it fetched today.
 The future Cash Flows is therefore to be
converted in the Present Value by Discounting
Techniques.
 In the same example if Discounting Rate is 10%,
the Pay Back Period would be worked out as :-

Year Cash Discounting Rate 10%
Profit Discounting Factor Present Cumulative
of Rs 1 Value PV (GPV)
A B (A) X (B)= C D
1 04 0.909 3.64 3.64
2 10 0.826 8.26 11.90
3 12 0.751 9.01 20.91
4 16 0.683 10.93 31.84
5 18 0.621 11.18 43.02
6 09 0.564 5.08 48.10
7 03 0.513 1.54 49.64
8 02 0.467 0.93 50.57
 By Discounting Method Pay Back Period comes to 7 Years
4 Months and 20 Days.
 Since the Time factor and Discounting factor can not be
ignored the Pay Back Period of 7 Years 4 Months and 19
Days to be considered.
 Future Value = Present Value x (1+r)^n
 Present Value= Future Value x 1 .
(1+r)^n
 Present Amount multiplied by Compounding Factor =
Future Value
 Future Amount multiplied by Discounted Factor =
Present Value
Net Present Value
 NPV= Present Value of Benefits – Present Value of Costs
 It is calculated by deducting Present Value of all Cash Outflows
from the Present Value of all Cash Inflows.
 Investment in Projects with Negative NPV should be rejected
 Investments with High NPV should be preferred.
 The NPV in the example @10% comes to 0.57 Lacs (Gross
Present Value = 50.57 Lacs(-) Investment Rs 50.00 lacs at the
Discounting rate of 10%)
 Rate = 10%, n=1,2,3 [PV=FV/(1+R)^N] [PV=1/(1+.10)^1]
 PV= [1/(1+.10)^2] & PV= [1/(1+.10)^3]

An illustration of NPV for Investment of Rs10 Lakhs -5 Years
Year Cash Inflow Discounted @10% Present Value Cumulative
Present Value
1 6,00,000 0.0091 545455 545455
2 3,00,000 0.8264 247934 793389
3 1,00,000 0.7513 75131 868520
4 2,00,000 0.6830 136603 1005123
5 3,00,000 0.6209 186276 1191399
Total 15,00,000 NPV=1191399-10 1191399

00000 =1,91,399
PBP = 3 Yrs Pay Back Period 1000000x4/1005 3.98 Years

under NPV = 123 =

Calculation of Internal Rate of Return(IRR)
Year Cash Inflow Discounted Present Discounted Present
@10% Value @20% Value
1 6,00,000 0.0091 545455 0.833 499800
2 3,00,000 0.8264 247934 0.694 208200
3 1,00,000 0.7513 75131 0.579 57900
4 2,00,000 0.6830 136603 0.482 96400
5 3,00,000 0.6209 186276 0.402 120600
TOTAL PRESENT VALUE 1191399 982900
TOTAL OUT FLOW 1000000 1000000
NET PRESENT VALUE 191399 -17100
IRR=19. LDR+ (Diff in DR) x (NPV at Diff of NPV At LDR- HDR

10% LDR)/
Discounted Rate - @11%
 Now calculate the NPV @11% i.e. by Increasing the
Discounting Rate?
 1/1.11- 1st year, 1/(1.11)^2- 2nd year, 1/(1.11)^3- 3rd
year then the G.P.V. will be Rs48.84 Lacs and the NPV
will become [48.84-50.00= (-)1.16lacs]
 By increasing the Discounting Factor from 10 to 11%
the change in NPV is 1.16 + 0.57= 1.73 Lacs
 So IRR in this case will lie between 10% to 11%
 IRR is the rate of Discount at which Present Value of
Cash Inflows is equal to the Present Value of Cash
Outflows
 IRR is that Discount Rate at which NPV is Zero

Discounted cash flow
year Cash Discounting Rate 11%
Profit Discounting Present Cumulative
Factor of Rs 1 value P.V. (G.P.V.)
A B (A) X D
(B)=C
1 04 0.9009 3.60 3.60
2 10 0.8116 8.12 11.72
3 12 0.7312 8.77 20.49
4 16 0.6587 10.54 31.03
5 18 0.5934 10.68 41.71
6 09 0.5346 4.82 46.53
7 03 0.4816 1.44 47.97
8 02 0.434 0.87 48.84
Internal Rate of Return (IRR)
 A Project is acceptable when the IRR(Rate of Discount if
applied to all Cash inflows/Outflows, the NPV is Zero) is
More than the Cost of Capital
 Higher the IRR, Better is the Project
 IRR = Lower Discounting Rate + (NPV at Low Discounting
Rate/ NPV at Lower Discounting Rate – NPV at High
Discounting Rate) x (Higher Discounting Rate- Lower
Discounting Rate)
 10% + 0.57/ [0.57- (-1.16)]x (11% -10%)= 10.33%
 For Difference of 1.73(0.57-(-1.16)) Difference of
Discounting Rate is 1, so for 1 it is (1/1.73) and for 0.57 it is
(0.57/ 1.73) =0.33
Internal Rate of Return
 IRR should be 2% higher than Effective Cost of Capital.
Since Effective Cost of Capital is 7.54%, IRR should be
minimum 9.54% but here the IRR is 10.33%. So it is a
Bankable & Viable Project.
 For Infrastructure Projects IRR should be 1% Higher
than Effective Cost of Capital
 For calculation of cost of fund, the cost of Equity
should be assumed as Coupon rate for 7 years Bonds
issued by GOI and actual ROI for unsecured loan and
Term loan.
 It is generally calculated for Projects of Rs 10 Crore &
above with Repayment Period of 5 Years or more.

Internal Rate of Return
 For other than Infrastructure projects the IRR

(Post Tax) should be 2% and above from Effective
Cost of Funds.
 For infrastructure projects IRR (Post Tax) should
be 1% and above from Effective Cost of Funds.
 For IRR(The rate of Discount @ where NPV is
Zero) the unit must remain in profit for the
entire repayment period, only then there is
actual representation of IRR.

Average Cost of Capital
 Every money has a Cost – ACC is calculated on this concept
 The cost of project is financed by different Sources as Means of
Finance
 Each Source has a Cost in the form of interest (Loans & Debenture)
or Dividend (Preference Share)
 For Equity Capital though at the time of issue of shares no pre-
determined Rate of dividend is committed but it is assumed that
the fund has a Cost, which is Opportunity Cost i.e. the Earning it
would have provided had it been invested otherwise.
 The ACC so calculated is used as the basis for comparing with it the
IRR

Assuming that the Initial Investment for a Project was Rs 50
lacs. The composition of the Sources of Fund was as under
Rate Source Amount Dividend

(Rs in lacs) interest
10% Equity Capital 7.50 0.75
12% Preference share Capital 6.00 0.72
7% Unsecured loan 4.00 0.28
6% Suppliers Credit 5.00 0.30
8% Debentures 7.50 0.60
11% T/L from Financial Institution 10.00 1.10
10% T/L from Bank 10.00 1.00

Total 50.00 4.75
Average Cost of Capital = 4.75 x 100 = 9.50%
50
 The calculation of Average Cost of
Capital of 9.50% has been made ignoring
the Tax benefit available for Interest
Provisions.
 Had the Tax benefit been considered
the effective interest rate would have
been less.
 As a result the ACC also would have
been less.
 Assuming Tax @ 30%
Effective Post Tax Average Cost of Capital
Stipulated Effective Source Amount Actual Effective Div./
Rate % Rate % Div/Intt. Intt.
10 10 Equity Capital 7.50 0.75 0.75
12 12 Pref. Share Capital 6.00 0.72 0.72
7 4.90 Unsecured Loan 4.00 0.28 0.20
6 4.20 Suppliers Credit 5.00 0.30 0.21
8 5.60 Debentures 7.50 0.60 0.42
11 7.70 T/L from F.I. 10.00 1.10 0.77
10 7.00 T.L. from Bank 10.00 1.00 0.70
Total 50.00 4.75 3.77
Hence the effective ACC would be 3.77 x 100= 7.54%
50
 Where stipulated Interest Rate for Term Loan
is 10%, for charging 10% interest, the Profit
would be lower by equal amount and as
profit would be lower the tax provision also
would be lower.
 The lower Tax Provision is the benefit in
interest rate thus making effective interest
rate lower. But the benefit would not be for
dividend as Provision Dividend is made after
Profit has been computed

Benefit cost Ratio
 The Benefit Cost Ratio is employed as a tool to
Evaluate a Project, in terms of Discounted Value.
 It is essentially the comparisons of Benefits in
relation to Costs at Present Value.
 It can be represented as :-
 Benefit Cost Ratio = Present Value of Benefits
Present Value of Cost
 If Benefit cost Ratio is above 1 :– Accept
 If B.C.R. is below 1 :– Reject the Proposal

NPV V/s IRR (Internal Rate of Return)
 NPV is the difference between the Present Value of
Cash Inflows and the Present Value of Cash Outflows.
 NPV is used in Capital Budgeting to analyze the
Profitability of an Investment or Project.
 IRR is essentially the return that a company would earn
if it expended or invested in itself, rather than
investing that money/Fund elsewhere.
 The NPV is Net Present Value: In place when the Cost of
Capital is known.
 The IRR is Internal Rate of Return. In place when the
Cost of Capital is unknown.
 NPV is expressed in Monetary Units
 IRR is the true yield expected from an Investment as a
Percentage. INDIAN INSTITUTE OF BANKING & FINANCE
Any “Q” Please!
Thank You!

Contact Details (Optional):
Phone / Email
A K Mishra Faculty IIFB Mumbai
Mob- 7428045854
Mail ID: akmishra@iifb.org.in

Term Loan/Project Appraisal A Presentation: by A K Mishra Iifb

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Term Loan/Project Appraisal

INDIAN INSTITUTE OF BANKING & FINANCE

INDIAN INSTITUTE OF BANKING & FINANCE

INDIAN INSTITUTE OF BANKING & FINANCE

INDIAN INSTITUTE OF BANKING & FINANCE

INDIAN INSTITUTE OF BANKING & FINANCE

INDIAN INSTITUTE OF BANKING & FINANCE

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INDIAN INSTITUTE OF BANKING & FINANCE

INDIAN INSTITUTE OF BANKING & FINANCE

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 ROTA = PBIT/ Total Tangible Assets

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INDIAN INSTITUTE OF BANKING & FINANCE

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TOL/TNW (NBFC/HFC) 8:1

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Items Company “ A” Company “B”

Fixed Cost 30000 50000

Sales Price/Unit 100 90

Contribution/Unit = 100 – 40 = 60 90 – 30 =60

INDIAN INSTITUTE OF BANKING & FINANCE

 CONTRIBUTION PER UNIT = SP/Unit- VC/Unit = 40-24 =16

 BEP in Units = FIXED COST/CONTRIBUTION PER UNIT =

 BEP in Rs = BEP in Units x SP/Unit = 5000X40 = Rs2,00,000

INDIAN INSTITUTE OF BANKING & FINANCE

SELLING PRICE IS Rs.10 PER UNIT

VARIABLE COST IS Rs.7 PER UNIT

FIXED COST IS Rs.600

 CONTRIBUTION PER UNIT (SELLINGG PRICE – VARIABLE COST )= 10-7=3

 TO COVER FIXED COST OF Rs.600 IT REQUIRES SALE OF ……?? UNITS

 (FIXED COST/CONTRIBUTION PER UNIT) 600/3 = 200 UNITS= BEP IN UNITS

 BEP IN TERMS OF AMOUNT Rs.2000 (200 x 10)

INDIAN INSTITUTE OF BANKING & FINANCE

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INDIAN INSTITUTE OF BANKING & FINANCE

Pay Back 3 Years 4 Years

Pay Back Period in this

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2 3,00,000 0.8264 247934 793389

3 1,00,000 0.7513 75131 868520

4 2,00,000 0.6830 136603 1005123