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PROJECT FINANCE

Prof (Dr) AR Subramanian Director, AIMT

INTRODUCTION
 Harnessing

advancements in S&T to economic development, GoI laid emphasis on industrialisation through successive ……….. industrial development needed investment and therefore large capital base. arrangements for term finance. massive

 Rapid

 Prior to independence, there were no institutional  Moving away from the Development Banking concept

to Universal Banking
 DFIs restricted to SFCs

INTRODUCTION
 GoI,

therefore, established financial institutions:

the

following

 Indl. Finance Corporation of India (1948)  Indl. Credit & Inv. Corpn. of India (1955)  Indl. Development Bank of India (1964) &  Indl. Reconstruction Bank of India (1971)  Similarly, State Governments also established

SFCs in their respective states.

INTRODUCTION
 For long, commercial banks confined their

lendings to meet WC requirements only and they did not play any active role in extending term finance.
 However, with increasing proportion of Term

Deposits in their deposit portfolio and the paucity of resources in the country, it was felt that banks could enter the field of term finance, in a role complementary to that of Term Lending Institutions.

PROJECT BACKGROUND
 The purpose of term assistance is to meet a

part of the capital expenditure of a project.
 A project can be defined as ‘A scheme of things

to be done during a specified period in future for deriving expected benefits under certain assumed conditions’.
 A project may be in the nature of setting up a

new industrial unit, modernisation, expansion, diversification and promotion of R&D.

Capital – Investment Vs Financing  Investment is the  Financing is the choice fundamental aspect in an imperfect market with variety of options  Need to assess the value involved  Capital Budgeting and NPV in capital market for meeting long-term need  Better options to fund is chosen  Ownership and borrowing components decided .

consumer behaviour.Project Finance is basically governed by two major factors  Cost of funds/ capital  Financial risk  Other factors. include – demand-supply.... . techno-commercial viability and so on.

water supply. etc.. in addition to the Preliminary / Pre-Operative Expenses and margin on WC Limits.PROJECT BACKGROUND  To set up a project. certain capital expenditure needs to be incurred in acquiring assets such as L&B. P&M and other infrastructural facilities like roads. . Term Loans are sanctioned to supplement the promoters’ contribution.  Where promoters of a project are unable to meet the entire capital expenditure out of their own resources. railway sidings.

Co-operative Society & Joint Stock Company.  Our discussion of the subject would revolve . Partnership. JHF.PROJECT BACKGROUND  Promoters of an industrial project can constitute themselves into any of the following forms of business organisations to implement the project : Sole Proprietorship. around Joint Stock Company as promoter.

Promotion in relation to a project will comprise broadly the following functions:  I] Identification of a project  II] Feasibility investigation  III] Assembling the proposition  IV] Financing the proposition .PROJECT BACKGROUND  The Promotion Stage is a crucial stage in the entire life cycle of a project.

on the basis of his experience. I] Identification of a Project step in the project promotion is  The promoter. The first the identification of a project. .  There should be an unsatisfied demand. then considers the feasibility of manufacturing and marketing the product at a remunerative price. An industrial project originates as an idea in a promoter when he observes the existence of a potential market for a certain product. background and ability.

 A market study aims at assessing the aggregate demand for a product.II] Feasibility Investigation  A detailed feasibility study is a costly exercise. It is.  There are agencies. marketability of the product to be manufactured is firmly established. . desirable that. therefore. before it is undertaken. Promoters may take advantage of their services. which conduct such market studies. specialising in market research.

II] Feasibility Investigation  The promoter will now undertake the detailed feasibility investigation proper. comprising two feasibility studies:  i) The Technical Feasibility Study  ii) The Economic Feasibility Study .

II] Feasibility Investigation .Technical Feasibility  Technical Feasibility Study covers the following aspects:  Location of the project  Lay-out of the Plant  Size of the Plant  Factory construction  Manufacturing process / Technology  Process Design  Product Design  Scale of Operation  Infrastructural facilities .

therefore. concerns itself with matching of economic resources with the physical requirements of a project and determining the viability of investment therein.  Economic Feasibility Study. .II] Feasibility Investigation .Economic Feasibility  The prime objective of setting up a project is to derive a fair return on the investment.

CoP & MoF  When a promoter is satisfied about the technical feasibility and economic viability of a project. the next task is to work out the Cost of the Project and the Means of financing it. & Consultancy fees (e) Preliminary and Pre-operative expenses (f) Provision for contingencies (g) Margin on WC Limits  The Cost of the Project would broadly include: .III] Assembling the Proposition . Fixed Assets (d) Technical Know-how. (a) L&B (b) P&M (c) Misc. Engg.

This cycle is generally completed in a short period of less than one year.  C/A go through the operating cycle of RM. WIP . They are required to be retained over a period of time to exploit their productive potential. and FG.IV] Financing the Proposition  Setting up of a project involves acquisition of Fixed Assets which facilitate the process of production. Fixed Assets have a relatively longer life and are generally not meant for resale. which when sold bring in cash.

 As it takes a long time for the Fixed Assets to pay for themselves.IV] Financing the Proposition  Thus.  It is realised through surplus generated in the form of Net Profits. the promoter should raise suitable long term funds to finance a project. . investment in C/A is realised over a short term. while investment in Fixed Assets is long term in nature. Depreciation and other non-cash write-offs.

the promoter will explore the financial feasibility of the project by examining  a) The possible long term sources of finance  b) The feasible financial leverage  c) The expected return on the investment .IV] Financing the Proposition  Keeping the foregoing in view.

IV] Financing the Proposition L O O S h a r e W N E D C A P I T A N L G T E R M B O S O R R O U W R C E S E D C A P I T A L C a p R i et at al i n e d E a rD n e i bn e sn t u r T e e s r m g L o a n s P . u D b P l iG c s D e p o s i t E q u i t yP r e f e r e n c e .

IV] Financing the Proposition .  The other sources of long term funds are: (a) Capital Subsidy applicable to projects coming up in certain notified backward areas. . and (b) Interest free sales tax loans offered by State Governments.Long Term Sources  The aggregate amount of finance raised for financing a project is referred to as Capital. comprising two components – (a) Owned Capital and (b) Borrowed Capital.

.  Few projects can be financed entirely by equity . viz.  It will depend upon the financial leverage envisaged in the combination of sources of finance under the two categories. Owned Capital and Borrowed Capital. the promoter will decide about a suitable financial structure for the Company.IV] Financing the Proposition .Financial Leverage  After considering availability of long terms sources of finance.

Financial Leverage  The divergent interests of debt and equity are brought into alignment by the concept of Debt / Equity gearing which determines the level of debt that can be supported by a given quantum of equity. if available. Debt means Funded Debt including all term liabilities and equity will include Share Capital and retained earnings.IV] Financing the Proposition . .  For this purpose.

IV] Financing the Proposition .  In arriving at a financial plan for the project.  The process which assists the management in such a task is collectively known as ‘Capital . a promoter will examine the attractiveness of the project.Return on Investment  The amount invested in a project can be recouped through annual cash flows. over a period of time. vis-à-vis alternative sources of investment.

IV] Financing the Proposition .Return on Investment  The most important and widely used Capital Investment Evaluation techniques are:  Pay-back Method  Net Terminal Surplus Method  Excess Present Value Method  Internal Rate of Return Method .

Return on Investment  The object of Pay-back Method is to find out the period of time required for recovering the entire amount of investment made in a project.  The cash flows (Net Profit + Depreciation + Other non-cash write-offs) are compared with the outlay on the project to determine the payback period. Years to pay back would be: Total Investment Cash Flow per annum .IV] Financing the Proposition .

 Future Value = Principal x (1+i)η .IV] Financing the Proposition .Return on Investment  Net Terminal Surplus Method employs the concept of compounding which involves reinvesting the simple interest earned each year along with the principal so that the principal grows each year by the amount of interest earned during the previous year and interest being calculated on the increased principal also grows.

 In discounting. invested at a particular compound rate of interest has grown. (1+i)η  PV = Future sum .IV] Financing the Proposition . we arrive at the Present value of a future sum to which the original amount (which we want to find out).Return on Investment  Excess Present Value Method is based on the discounted cash flow technique and uses the concept of discounting which is just the opposite of compounding.

Between the two discount rates x NPV at lower discount rate Abs. between the two NPVs.Return on Investment  Internal Rate of Return Method – It is that rate at which the sum of the discounted cash flows is equal to the investment outlay.  IRR = Lower Discount Rate + Diff. . In other words. diff. The object of this method is to find the rate of return which a project is likely to earn over its useful life.IV] Financing the Proposition . IRR is the rate which makes the Present Value (PV) of benefits equal to the Present Value of costs or reduces the Net Present Value (NPV) to zero.

Types of Term Assistance  The types of term assistance extended by the Bank can be broadly classified into:  I] Term Loans (Incl. Forex Loans)  II] Deferred Payment Guarantees  III] Bill Discounting Facilities  IV] Underwriting of Shares / Debentures .

intended normally for financing fixed assets acquired / to be acquired. they could be classified into (a) Short Term Loans (b) Medium Term Loans and (c) Long Term Loans.Types of Term Assistance -Term Loan  A Term Loan is a loan granted for a fixed term of not less than one year. . and scheduled for repayment in instalments. carrying interest at a specified rate.  Depending on the term for which the said terms loans are granted.

it serves the same purposes as a Term Loan. Term Loan and. in agreed instalments with stipulated interest on the respective due dates in case of default in payment thereof by the buyer. a substitute for a  .  A DPG is. in many respects.Types of Term Assistance -DPG  Deferred Payment Guarantee (DPG) is a contract to pay to the supplier the price of machinery. supplied by him on deferred terms. as far as the buyer of P&M is concerned.

the funds of the seller get blocked for unduly long periods and the seller requires finance against such deferred receivables to replenish his Working Capital.Bills Discounting  Under a contract for sale of machinery on deferred payment basis. .  Thus.Types of Term Assistance . the balance remaining to be paid after the initial down –payment represents the deferred receivables of the seller.

 The usance bills drawn by the seller will be accepted by the buyer before they are discounted by the seller’s banker. .Types of Term Assistance .Bills Discounting  To facilitate availment of finance against the deferred receivables. the seller usually draws a series of usance bills with graded maturities to coincide with the due dates of payment of the relative instalments (including applicable interest).

in consideration. a part of the Share Capital for part-financing a project. to take up a specified number of shares or debentures or amount of debenture stock to be offered to the public. in the event of the public not subscribing for them. agrees.Underwriting of Shares  The necessity for underwriting arrangement arises only in the case of a Public Limited Company resorting to raise through the capital issue market.Types of Term Assistance .  Underwriting is a contract whereby a person .

a high degree of selectivity should continue to be exercised in undertaking underwriting business. . therefore.  In view of this. the business stemmed not so much from the point of view of earnings on the investment as from the consideration that no viable project enjoying national priority should suffer for want of underwriting support.Underwriting of Shares  Underwriting as a business will come under the scope of ‘Investment Banking’ as distinct from ‘Commercial Banking’.  However.Types of Term Assistance .

financially and managerially – and ultimately viable as a commercial proposition.Project Appraisal  The purpose of Project Appraisal is to ascertain whether the project will be sound – technically. and . economically. examination of:  The appraisal of a project will involve the  a) Technical Feasibility : To determine the suitability of the technology selected and the adequacy of the technical investigation.

cost estimates. suitability of the envisaged pattern of financing and general soundness of the capital structure.  c) Financial Feasibility : To determine the accuracy of  d) Commercial Viability : To ascertain the extent of .Project Appraisal  b) Economic Feasibility : To determine the conduciveness of economic parameters to setting up the project and their impact on the scale of operations. profitability of the project and its sufficiency in relation to the repayment obligations pertaining to term finance.

from the point of view of its value to the national economy in terms of socioeconomic benefits like generation of employment opportunities. appropriate. the quantum of import substitution.Project Appraisal  e) Managerial Competency : To ascertain that competent men are behind the project to ensure its successful implementation and efficient management after commencement of commercial production. etc. forex earnings. wherever .  A project should also be examined.

if any. laid down by the Government. particularly in the proposed line of activity  The potential demand for the product  The availability of the required inputs. .Project Appraisal  The first step in Project Appraisal is to find out whether the project is prima facie acceptable by examining salient features such as:  The background and experience of the applicants. utilities and other infrastructural facilities  Whether the project is in keeping with the priorities.

Project Appraisal  The original application may not contain all the basic data / information. In such cases. the Branch should call for from the promoters. it may be necessary to interview the applicants and elicit all the necessary data / information with a view to forming an overall idea about the general feasibility of the project. containing the following essential data / information. an ‘Application’. such as:  After satisfying itself about the prima facie . acceptability of the project.

etc. inclusive of Preliminary / Pre-operative Expenses and WC margin requirements. . availability of construction / production facilities.  b) Estimates of cost of the project detailing the itemised assets acquired / to be acquired. manufacturing process.Project Appraisal  a) Particulars of the project along with a copy of the Project Report furnishing details of the technology.

when the .e.  d) WC requirements at the peak level (i. DPGs. etc.. Foreign Currency Loans. the quantum of Share Capital to be raised by public issue. the composition of the borrowed capital portion with particulars of Term Loans. level of Gross Current Assets is at the peak) during the first year of operations after the commencement of commercial production and the banking arrangements to be made for financing the WC requirements.Project Appraisal  c) Details of the proposed means of financing indicating the extent of promoters’ contribution.

 f) Organisational set up along with a list of Board of Directors and indicating the qualifications. production.Project Appraisal  e) Project Implementation Schedule. . experience and competence of (i) The key personnel to be in charge of implementation of the project during the construction period and (ii) The executives to be in charge of the functional areas of purchase. marketing and finance after commencement of commercial production.

 h) Estimates of sales. CoP and profitability.  j) ..Project Appraisal  g) Demand projection based on the overall market prospects together with a copy of the market survey report. i. schedule.e. Proposed amortisation repayment programme.  i) Projected P&L Account and B/S for the operating years during the currency of the Bank’s term assistance.

Project Appraisal  k) Projected Funds Flow Statement covering both the construction period and the subsequent operating years during the currency of the Term Loan. .  l) Details of the nature and value of the securities offered.  m) Consents from the Government / other authorities and any other relevant information.

present financial position.. . in addition to this information. its past performance.  The ‘Application’ completed in all respects and duly signed by the authorised signatories of the Company will form the basis for the detailed appraisal of the project.Project Appraisal  In respect of existing concerns. should also be called for. particulars regarding the history of the concern. etc.

 Each project has to be examined in proper perspective having due regard to its nature. appraising the viability of various projects are more or less the same. size and scope.Project Appraisal  An inspection of the project site (or factory in the case of existing units) is a must.  Although the basic techniques employed for . there could be no standard or uniform approach for appraising all projects.

proposed term assistance as the prospects of its repayment that should weigh with the Branch while appraising a project.  Therefore.Project Appraisal  The ultimate objective of the appraisal exercise is to ascertain the viability of a project with a view to ensuring the repayment of the borrower’s obligations under the Bank’s term assistance. it is not so much the quantum of the .

counter-checked through inter-firm and inter-industry comparisons.  All the data / information should be checked and. wherever possible. nothing should be assumed or taken for granted.  It should be borne in mind that “Healthy scepticism is a cardinal virtue in project appraisal.” .Project Appraisal  In project appraisal.

P e n d i n g s u i t s . F i n a n c i a l p o s i t i o n . M A & c t i v i t i e s . A P t u P P R A I S A L M E M O R A N R O P O S A L r e o f p r o p o s a l . e x p a n s i o n . C a p a c i t y u t i l i s a t i o n .Project Appraisal Memorandum P R O J E C T 1 N P u r p o s e : N e a w . S a l e d u r i n g t h e p a s t 3 y e a r s a n d h o w t h e . i t l y t i P e 3 . M e t h o d o f d e p r e c i a t i e s . B R I E F H I S T O R Y t o f c o r p o r a t e h i s t o r y . Q u a l i f i c . A e S u m t h e S T P E R F O R M A N C E m a r y o f C o m p a n y ' s p a s t p e r f o r m a n c e p a s t 3 y e a r s . P A 4 C o m p a n y 's a u d o f f i n a n c i a l a n a L i a b i l i R E S E N T F I N A N C I A L P O S I d B a l a n c e S h e e t s & P / L s i s . p r o j e c t . m B r i e L f c c o i n e o a u f n a 2 .

P P P R t h R O e A J I S A E L M E M O R A N D U s u ( a ) D e s c r i p t i o n o f o u t s i d e a g e n c y w h o i t a b i l i t y o f t e c h n o l o 6 . P R O D U C A s s e s s m s h a e r i n n g t o o t o t a l b u s i n . P r o c e t i l i t i e s & d d i s p o s a T I O N F A C T O R S s s .R e q u i r e m l o f e f f l u e n t s .B a s i s o f s e l e c t i o n & j u s t i f i E s s e n t i a l S e r v i c e s . W O R W e K I N G C A P I T A L R E Q U I R C r e q u i r e m e n t s a t t h s s a m o n g m e m b e r b a 7 . ( d ) O p e r a t i n g O 8 f f . e r e c t i o n I O N C P M C i n s t a ( a ) ( c ) M U a n f g . P R B O a C T p r o j e c t ( M o d e r n i s p r e p a r e d t h e P r o j e c t g y . s i z e & l o c a t i o n o f E C T T / / A T W i t h s c h r e f e r e n e d u l e f o c e r t o c o n J r s t r u I M P L E M E N C h a r t o r P E R T c t i o n .Project Appraisal Memorandum P R O J E C T 5 A .

T r e n d t o s e e w ( d ) M a r k e t i n g O r g a n i s a t i o n . F U N D S F L O W A N A s t o b e d i v i d e d i n t o L o n g T e d e c r e a s e i n W C G .S a t i o n ( C ) P r o f i t a b i l i T Y - t h ( a e d ) y S C R e a r o e t e r m D 1 . M A R K E T I N G ( a ) S a l e s p r o s p e c t s a n d u n d e r l y i n g ( b ) S e l l i n g P r i c e . ( k ) T a x 1 I A L V I A B I L I T Y e . L M t y ( p m / V a l u O v e r h e a d s . C O M M E R C I A L V I A B I L I ( G r o s s ) a n d ( N e t ) [ ' C o r e T e f m a x i m u m c a p a c i t y u t i l i s a t i n e ' S p a n o f R e s i l i e n c y ' o f t 1 S C s t ' R a t i o i o n . E x p . . ( b ) ( e ) D e p r e c i a t i o n .( a ) V o l u m e . D N t i r s i s t r C o o . C O M M E R C a h a s s u m e t h e c y .A d e q u 1 ( A ) S a l e s V ( d ) F a c t o r y o l u 0 e . ( c ) h e p r o j e L Y S I S r m F u n e x p e n h e e n t D F u n d i n c r e s a F s e l o o w r 2 .Project Appraisal Memorandum P R O J E C T A P P R A I S A L M E M O R A N D 9 . E s s e n t i a l a l l c o m m i t m e n t s d u r i n g t .

D E C O N O M I C S O F U N I n c a s e o f c o m o s i t e p r o p o s a l .U w o u l d a c c r u e t o t h e B a n k i f t h e E R W n d e r w n d e r w a m o . P R O J E C T E D B A L A r o j e c t e d B / S c o v e r i n g t h e e n t i r e P r o j e c t e d B / S t o b e s c r u t i n i s e d a h a v e b e e n w o v e n i n t o w 1 4 S E C U R I T Y & M A R G t a i l s o f s e c u r i t y t o b a v a i l a b l e a r e a d e q u o t h e r w i s e 1 5 . T E R M S & C O N D i o n o f b o r r o w e r 's b o o o n o f t h e B a n k ( i i ) R a t i n g i n t e r e s t i n t h e C o . C E S p e r i o n a l y t e l l c o i c - ( a ) C a n d o t h m e p l e t e d e m a r g i n I N A N D e o f f e r e a t e a n d S P ( a ) R i g h t o f e x a m i n a t w i t h o u t t h e p e r m i s s i t r a n s f e r o f c o n t r o l l 1 6 p . E C I A L .Project Appraisal Memorandum P R O J E C T A P P R A I S A L M E M N O R A N H d ( a ) ( c ) P 1 3 . ( a ) U ( e ) C o m p a r a t i v e E a r n i n g s A n a l y s i s .

Project Appraisal Memorandum P R O J 1 T ( d h ) e E 7 C . T C O A N P P R A T I S A L M E M O R A N D s e w i l l r e l a t e . A p p r o v a l f o r m ( f ) V a r i o u s 1 S E N i n t e r a l i a k i n g p a a p p r o v a 8 . t o ( a ) I n d u s t r i a l y m e n t s f o r i m p o r t l s / N o O b j e c t i o n C P C m O I E S p a n i e s i n d i c a t i p a i d s h a r e s i n M P A N ( a ) B r i e f r e s u m r e e o s p f e r o c t o C a o r t l y 1 ( a ) C a o n m d p a t h n e y ' s l e m v e a 9 n l . ( b ) C o m p n a g e r i a l e x p e r t i s e b u A G E R ( a ) V e r i f y R B I ' s c o m p a r i s o n w i t h v a l u e o f t h e C o m 2 L T H E R S A N i s t o f D e f a u l t e t h e I R R s f o r s i p a n y / G r o u p ' 0 .u p . O D R E C O M r s / W i l f u m i l a r p r o s c o n n e c t M E N D l D e f a j e c t s i o n s . a o M A g e f m N m a I A L C O M P E T E N e n t s e t . G G R u f O p p U S F R O M G O V E R N M a .

THANK YOU .

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