PROJECT FINANCE (SEMESTER – III)

QUES NO. 1: ECONOMIC VIABILITY OF ANY PROJECT SHOULD BE IN

CONFORMITY WITH THE GOVERNMEN’S GOAL TO ACHIEVE EQUIATABLE
DISTRIBUTION OF INCOME – ELUCIDATE

Ina any country’s economy, developmental activities are needed to sustain

growth and to ensure overall prosperity of the nation and well being of all its
citizens. The government formulates, directs and guides the destiny through
various means. It frames policies to address growth and overcome poverty and
to have equitable distribution of income among various strata of society. The
documentation of the policy is through identification of areas where fresh
investments are needed, devising investment methods and paving the way for
different agencies capable of undertaking long-term & short-term financing
depending on their structure and strength. The government also draws the core
policy wherein prosperity can be perceived for overall development and
equitable distribution of income.

The economic analysis of projects includes an assessment of the sustainability of

project effects to ensure that

• the project provides sufficient incentives for producers,

• sufficient funds are available to maintain project operations,
• the least cost means of providing the project benefits is used,
• the distribution of project benefits and costs is consistent with project
objectives, and
• environmental effects are included in the analysis

The project has to generate an acceptable rate of return, which adequately

covers your cost of capital. The expected rate of return depends on the risk
profile of the project. In a rational economic world, nobody implements a project
to make losses. In other words net present value has to be positive if you
discount the cash flows by the desired rate of return.

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Many a time plants may be viable economically and financially but would be
socially undesirable. An example would be dyes units, which have mushroomed
around Ahmedabad. These are polluting and generate effluents not acceptable
to the society and environment. In the last 5 years, India is slowly becoming
environment conscious and friendly. So using hazardous chemicals or polluting
industries may not get the necessary clearances. For instance, the state
government has ordered closure of all dyes units in Gujarat unless suitable
effluent treatment is implemented.

Project proposals should be derived from, and placed in the context of, broader
development objectives. These objectives may be explicitly stated in a
government plan document, or implicitly given through a public investment
program. A statement should be given of the main development objectives of a
country to which a proposed project will contribute.

Many investments will work well only if there are complementary investments in
related sectors or activities. For example, for an irrigation project to raise
agricultural output, the appraisal report must elaborate the necessary extra
requirements for transport and processing. Projects to improve urban services
should consider the capacity of the existing systems to deliver additional power
and water. Potential constraints in supplies, whether they can be overcome, and
the necessary timing of complementary investments, must be considered.

Because a project takes place within a given macroeconomic and sector context,
an investment project can be seen as an incremental change to an existing
structure. In fact, the context may be more important than the project itself.
Moreover, a project that is financially sound within one sector and
macroeconomic context may be financially unsound in another. Thus policy
changes may be as important as the physical investment to the achievement of
development objectives.

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QUES. NO. 2: EXPLAIN IN DETAILS THE TECHNICAL PARAMETERS OF
APPRAISING THE PROJECT.

To implement any project, the entrepreneur needs to carry out different types of
feasibility studies. These feasibility studies evaluate all the risks and returns and
tries to balance them and help the entrepreneur to finalize his plans.

Technical Feasibility: Technical feasibility refers to the ability of the process to

take advantage of the current state of the technology in pursuing further
improvement. The technical capability of the personnel as well as the
capability of the available technology should be considered. Technology
transfer between geographical areas and cultures needs to be analyzed to
understand productivity loss (or gain) due to differences. An entrepreneur should
have the requisite number of technically capable people as well as technology
required to set up and run the plant. The technology should be such that is can
adapt to local conditions. Technology transfer from overseas often fails in this
regard. The conditions in USA and America are quite different from India. Most
parts of India are hot and dusty. Sophisticated process controls have known to
fail. Therefore, knowledge and suitability to local conditions is very important.

Technical appraisal is basically concerned with the project idea / concept,

encompassing various aspects like technology, design, lay-out of the plant as
well as inputs and infrastructure facilities envisaged in / for the project and the
problems likely to crop up, in various areas related with technical aspects.

Technical appraisal focuses upon appraising the likely technical gaps / grey areas
or technical problems which can be broadly grouped under the following three
phases:

1. PHASE I: Problems relating to the project conception & formulation. The

likely problems to be appraised in advance could be:
a. Location of the project taking into consideration the project site,
project office, land, raw material suppliers, work force availability,

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 market access, physical & social infrastructure & facilities, utilities
like telecommunication, water, power etc, transportation & general
state of development.
b. Selection of Process / Production Technology. It needs to be
analysed whether process / production technology is outdated or
obsolete or too advanced or dependable with proven track record &
upgradeable considering the size of the unit, plant capacity,
capacity utilisation, product mix & collaborators tie-ups. The
collaborators details & its track record is also appraised.
c. Detailed Project Engineering taking into account the logistics,
maintenance / service back up, spares & consumables, quality
standards / orientation, raw material suppliers / vendors etc
d. Project Implementation / Work Schedule
e. Project Competitiveness Indicators like manufacturing lead
time, work in process, trough-put, capacity, performability,
flexibility, quality etc

2. PHASE II: Problems faced during the construction and project

implementation. The likely problems to be appraised in advance could
be related to civil construction, civil layout & structures, projected charts
& layouts, machinery procurement, machinery installation /
commissioning, trial run etc.

3. PHASE III: Problems pertaining to the period when the project is

in operation. The likely problems to be appraised in advance could be
related to raw material procurement, repairs & maintenance, power
supply availability, water supply, telecom facilities, other infrastructure
facilities, utilities status, quality control standards, organisation of
production function, data collection / information, feedback / reporting /
action etc.

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MORE SPECIFICALLY, THE LIKELY PROBLEMS TO BE APPRAISED IN
ADVANCE COULD BE STATED AS FOLLOWS:

 MANUFACTURING PROCESS / TECHNOLOGY: Having decided on the

location and product, the promoter takes into account the manufacturing
process and technology that is to be adopted for producing the product. A
thorough study of the whole process starting from raw material stage to
the finished goods is made and the process flow chart is made.
Continuous efforts are made to integrate the process as far as possible in
order t maintain and meet stringent quality norms and meet with the
supply schedules.

 TECHNICAL ARRANGEMENTS: For maintaining the quality & keep

forging the product in the international market the unit might require
transfer of technical know-how or hiring of technical & specialized
personnel for the manufacturing process. This necessitates pre-
determined contracts & finalization of terms even before the
commencement of the project at the conceptualization stage. The length
and the duration of the technical arrangement and training and
development acivities and its details are examined before entering into
actual contract. This again has the impact on the financial aspects of the
project.

 SIZE OF THE PLANT: Size of the plant has a direct bearing on the
financial calculation in relation to annual production capacity. Hence in the
initial years about 60-70% production capacity is taken into account for
study of viability of the project. The determining factors of the size of the
plant is demand-supply of a particular product and the end use of the
product.

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 PRODUCT MIX: The process might require certain product mix to arrive
at the final product that is needed to be produced. The cost factors of the
product thus mixed is also taken into account to arrive at cost at various
levels of production & its cost impact on the manufacturing.

 SELECTION OF PLANT & MACHINERY: The selection of proper plant &

machinery with the latest technology is very important in the success of
the project. The decision to purchase the domestic machinery or importing
it has to be made very judiciously by taking into account the comparative
cost advantage.

 PROCUREMENT OF PLANT & MACHINERY: The order for procurement

of machinery and the lead time it could take for final installation tests and
trials would be required and the time period for the same is taken into
consideration. In case of new projects the machinery is procured at such
time that the civil work is complete and necessary foundations can be
laid.

 PLANT LAYOUT: The engineering layouts are scrutinized and finalized to

ensure maximum utilization of costly space on the shop floor & also the
safety of the personnel.

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QUES NO. 3: THE ECONOMIC VIABILITY AND TECHNICAL FEASIBILITY OF
ANY PROJECT GOES HAND IN HAND. EXPLAIN WITH EXAMPLES THE
IMPORTANCE OF BOTH STUDIES PROVING COMPLEMENTARY TO EACH
OTHER FOR SUCCESS OF ANY PROJECT.

A complete feasibility study for a business idea must be conducted at three

levels viz., technical; operational; and economic. The operational feasibility
begins with the question: “Will it work?” The technical feasibility asks: “Can it be
built?” These two levels are often addressed together and simply referred to as
technical feasibility. The economic feasibility brings the operational and technical
levels together to determine if the project can generate enough net economic
benefits to justify investments in it. Here, we ask: “Will it make economic sense if
it works and it is built?” External factors have significant implications for the
feasibility of any initiative. Therefore, the environment within which the initiative
is to be implemented must be defined as the domain for the feasibility study. For
example, an initiative that is feasible in a community with a rail line may not be
in one without, if rail transportation is a major technical resource for the
business.
Feasibility studies can result in one of three outcomes: (1) Feasible; (2) Feasible
with changes; and (3) Infeasible. All these decisions are defined within a
particular project’s context – location, markets, etc. Because feasibility studies
are based on expectations about the future, it is important that producer-
entrepreneurs who commission them understand the assumptions that go into
their development. Consultants and project owners often make flawed but
unarticulated assumptions that may go unchallenged, leading to wrong
conclusions and consequently wrong decisions. If a feasible project is deemed
infeasible because of a wrong assumption, an opportunity is missed and if an
infeasible project is deemed feasible, resources are lost.
The purpose of a business feasibility study is to make a decision about whether
to proceed with a particular opportunity based on its technical, operational and
financial feasibility. Since economic viability of a business is fundamental,
economic feasibility is the ultimate decision criterion in a feasibility study. Thus,
a technically and operationally feasible project that is uneconomical is not worth
pursuing. The critical component of the analysis is recognition of the leadership

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required to transform a technically and operationally feasible project into an
economically feasible one.

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 QUES NO. 4: COMPARE THE SUBTLE DIFFERENCES OF MARKET AND
COMMERCIAL APPRAISAL TECHNIQUES WITH EXAMPLES

A project has to be technically feasible and financially viable. The financial viability is possible
only if the project is able to realize the unit sales forecast / projection and thereby earn sales
revenue, ensuring smooth cash flow, funds flow and the resultant surplus generation. Market
appraisal therefore occupies a central position in project finance as it enables the promoters
and the financing institution to understand, estimate and assess the likely potential of the
market for the proposed product and arrive at a realistic projection as regards the market
share that can be captured.

Market appraisal techniques

1. Demand analysis

 Qualitative methods: These methods rely essentially on the judgment of experts

to translate qualitative information into quantitative estimates. The important
qualitative methods are:

 Jury of executive method

 Delphi method
 Time series projection methods: These methods generate forecasts on the basis
of an analysis of the historical time series. The important time series projection
methods are:
 Trend projection method
 Exponential smoothing method
 Moving average method

 Casual Methods: More analytical that the preceding methods, casual methods
seek to develop forecasts on the basic of cause-effect relationship specified in an
explicit, quantitative manner. The important casual methods are:
 Chain ratio method
 Consumption method
 End use method
 Leading indicator method
 Econometric method

The commercial appraisal on the other hand normally resorts to undertaking forecasting.
Some of the techniques for forecasting are:

 Demand technique forecasting: The future demand of the product, its proper
survey and future availability and supply is studied in depth. This will naturally
involve employing surveyors to carry out detailed market survey and document
the findings to arrive at proper forecasting’s.
 Past Trend Method: Past trend method is adopted as a guide depending on the
consumption pattern of the society as a whole. Further, the changes that are
likely to take place are considered to arrive at the future demand.

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 End use method: Suitable for estimating the demand for intermediate products,
the end use method, also referred to as the consumption coefficient method,
involves the following steps:
 Identify the possible uses of the product.
 Define the consumption coefficient of the product for various uses.
 Project the output levels for the consuming industries.
 Derive the demand for the product.

 Export market: There exist a huge export potential in many products which need
to be tapped. Almost all sectors have good potential. The product that is planned
to be manufactured and its application is of vital importance to gauge the
potential.

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QUES NO.5: THE FINANCIAL APPRAISAL OF ANY PROJECT IS AN
ONGOING EXERCISE THROUGHT THE LIFE OF THE PROJECT. DISCUSS
THIS WITH VARIOUS TECHNIQUES & PRINCIPLES ADOPTED BY FINACIAL
INSTITUTIONS FOR VIBILITY STUDIES.

The setting up of projects not only involves substantial capital investment but
also the gestation period is long. The project completion cost is the basic
parameter based on which the cost of output is worked out. The implementation
of a project has to pass though a number of stages like planning and formulation
of project reports, obtaining statutory clearances, tying up finances and finally
the actual implementation of the project. Any slippage in project execution
stages will result in time and cost overrun, higher interest during construction
and consequently higher tariff. On the other hand, some more time and effort
taken in planning and formulation of project reports may be helpful in cutting the
time and cost overrun at the construction stage. It is, therefore, essential that all
the activities right from conceptualisation to execution of the power project are
properly planned and coordinated so that the project is implemented as per the
envisaged schedule of commissioning as well as within the estimated completion
cost of the project so that the cost of output is minimised to the ultimate
consumers. This is the first and foremost principle because the effect of any slip
up at this stage is permanent and can not be corrected subsequently.

The proposals for project finance would be considered by the financial

institutions on a selective basis in view of the larger outlay of funds an longer
duration of credit which may have an adverse impact on financial institution’s
Asset-Liability Management system and strain on its liquidity.
The project would be appraised by the financial institution and if required, the
assistance of the professionals would be obtained.

Before extending finance for Projects, the economic feasibility and financial
viability of the project in relation to the macro economic conditions prevailing at
the time of conceptualization of the project and also the likely scenario that may
prevail during the normal life span of the project should be established. The

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project should be able to withstand reasonable levels of variation in crucial
parameters which should be established by sensitivity analysis of the cash flows.

The means of finance for the project along-with provisions to meet contingencies
such as cost/ time overrun should be established. The entire source of funds for
the project from sources other than that by the promoters shall be fully tied-up
before sanction/ disbursement of the limits.

Wherever the project is one of unusually longer duration such as infrastructure

development, the ways of reducing the blockage of fund that are sourced mainly
out of short term lending institutions would be resorted to by take-out financing,
securatisation, Inter-Bank participation Certificates, etc..

The disbursements under project Finance would be made strictly in tune with the
sanction terms, only after ensuring the end use of funds already disbursed by
the consortium, meeting the required margin at each stage of project
implementation and certification by the competent consultants/ specialists as
per the procedure in vogue from time to time and as decided by the consortium.

The rate of interest on such credit facilities would be determined based on the
borrower gradation and the interest rate policy of the institution from time to
time. The credit facilities shall be secured by tangible assets and collaterals as
may be required based on the nature of project, quantum and duration of the
credit, anticipated return on investment and risk perception. In addition,
institution's usual normal lending norms and policy guidelines in force from time
to time would be equally applicable to project finance cases also.

Criteria for Financing

Banks/financial institutions (FIs) are free to sanction term loans for technically
feasible, financially viable and bankable projects undertaken by both public
sector and private sector undertakings subject to the following conditions :

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 i. The amount sanctioned should be within the overall ceiling of the
prudential exposure norms prescribed by the Reserve Bank of India from
time to time .
ii. Banks/FIs should satisfy themselves that the projects financed by them
have income generation capacity sufficient to repay the loan together with
interest. Banks/FIs should also satisfy themselves that the project financed
is run on commercial lines i.e. involving commercial considerations such
as identifiable activity, cash flow considerations and that they do not run
into liquidity mismatch on account of lending to such projects.
iii. FIs should evolve an appropriate debt-equity ratio for each project.
iv. Banks/FIs are free to decide the period of loans keeping in view, inter alia,
the maturity profile of their liabilities.
v. Banks/FIs should have the requisite expertise for appraising technical
feasibility, financial viability and bankability of projects, with particular
reference to risk analysis and sensitivity analysis.
vi. In respect of projects undertaken by public sector units, term loans may
be sanctioned only for corporate entities (i.e. public sector undertakings
registered under Companies Act or a Corporation established under the
relevant statute). Further, such term loans should not be in lieu of or to
substitute budgetary resources envisaged for the project. The term loan
could supplement the budgetary resources if such supplementing was
contemplated in the project design.

Appraisal

Projects are often financed through Special Purpose Vehicles and are structured
on a limited/non-recourse basis. Financing of these projects would, therefore, call
for special appraisal skills on the part of lending agencies. Identification of
various project risks, evaluation of risk mitigation through appraisal of project
contracts and evaluation of creditworthiness of the contracting entities and their
abilities to fulfil contractual obligations will be an integral part of the appraisal
exercise. In this connection, banks/FIs may consider constituting appropriate
screening committees/special cells for appraisal of credit proposals and
monitoring the progress/performance of the projects. Often, the size of the

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funding requirement would necessitate joint financing by banks/FIs or financing
by more than one bank under consortium or syndication arrangements. In such
cases, participating banks/FIs may, for the purpose of their own assessment,
refer to the appraisal report prepared by the lead bank/FI or have the project
appraised jointly. Banks/FIs should, however, ensure that the appraisal in all
cases is completed within a time bound period and repetitive and sequential
appraisals by several institutions are avoided.

Infrastructure finance will continue to be governed by the instructions regarding

exposure limits currently in force viz., exposure of a bank/FI to an individual
borrower is restricted upto 25 per cent of its capital funds and that to a group of
borrowers to 50 per cent. Further, considering the large-scale financial
requirements of infrastructure projects, banks/FIs have been allowed to exceed
the group exposure limit by 10 per cent to 60 per cent, provided the additional
exposure is on account of infrastructure projects in the four specified sectors,
viz., roads, power, telecommunication and ports.

Asset-Liability Management

The long-term financing of infrastructure projects may lead to asset-liability

mismatches, particularly when such financing is not in conformity with the
maturity profile of a FI’s liabilities. FIs would, therefore, need to exercise due vigil
on their asset-liability position to ensure that they do not run into liquidity
mismatches on account of lending to such projects.

Administrative Arrangements

Timely and adequate availability of credit is the pre-requisite for successful

implementation of infrastructure projects. Banks/FIs should, therefore, clearly
delineate the procedure for approval of loan proposals and institute a suitable
monitoring mechanism for reviewing applications pending beyond the specified
period. Multiplicity of appraisals by every institution involved in financing,
leading to delays, has to be avoided. Also, setting up a mechanism for an
ongoing monitoring of the project implementation will ensure that the credit
disbursed is utilised for the purpose for which it was sanctioned.

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QUES NO. 6: DISCUSS THE LONG-TERM & SHORT-TERM FINANCING TOOLS
AND ENUMERATE THE STUDY IN RELATION TO VARIOUS FINANCIAL
RATIOS ADOPTED BY WAY OF TOOLS FOR ASSESSING THE VIABILITY OF
PROJECT.

The importance of financial appraisal of the project can be well understood from
the fact that an unsound investment decision may prove to be fatal to the very
existence of the firm. The need, significance or importance of assessing the
financial viability of the project arises mainly due to following:
1. Large Investments: Projects generally involve large investments of
funds. But the funds available are always limited and the demand for
funds far exceeds the resources. Hence it is very important to plan and
control the capital expenditure.
2. Long-term commitment of funds: Projects involves funds for long-term
or more or less on permanent basis. The long-term commitment of funds
increases the financial risk involved in the investment decision.
3. Irreversible Nature: Once the decision for acquiring a permanent asset
is taken, it becomes very difficult to dispose of these assets without
incurring heavy losses.
4. Long-term effect on profitability: Capital budgeting decisions not only
effect the present earnings but also the future growth and profitability of
the firm.. Capital budgeting is of utmost importance to avoid over
investment or under investment in fixed assets.
5. Difficulties of Investment Decisions: The long term decisions are
difficult to take because (i) decision extends to a series of years beyond
the current accounting period, (ii) uncertainties of future and (iii) higher
degree of risk.
6. National Importance: Investment decisions though taken by individual
concern is of national importance because it determines employment,
economic activities and economic growth.

FINANCIAL TOOLS FOR ASSESSING THE VIABILITY OF PROJECT:

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At each point of time a business firm has a number of proposals regarding
various projects in which it can invest funds. But the funds available are always
limited and hence it becomes essential to select amongst the various competing
proposals those, which give the highest benefit. There are many methods of
evaluating profitability of capital investment proposals. The various commonly
used methods are as follows:

1) PAY-BACK PERIOD METHOD: It represents the period in which the total

investment in permanent assets pays back itself.. Under this method various
investments are ranked according to the length of their pay-back period and
the investment with a shortest pay back period is preferred. The pay-back
period can be ascertained in the following manner:
a) Calculate annual net earnings (profits) before depreciation and after
taxes; these are called annual cash inflows.
b) Divide the initial outlay (cost) of the project by the annual cash
inflow, where the project generates constant annual cash inflows.
c) Where the annual cash inflows (profit before depreciation and after
taxes) are unequal, the pay-back period can be found by adding up
the cash inflows until the total is equal to the initial cash outlay of
project or original cost of the asset.

2) RATE OF RETURN METHOD: This method takes into account the earnings
expected from the investment over their whole life. According to this method
the project with the highest rate of return is selected. The return on
investment method can be used in several ways as follows:
S.No Method Formula
.
1 Average Rate of Total Profits (after Depreciation & Taxes) x 100
Net Investment in the project x No. of Yrs of
return
profits
2 Return per unit of Total Profits (after Depreciation & Taxes) x 100
Net Investment in the project
Investment Method
3 Return on Average Total Profits (after Depreciation & Taxes) x 100
Total Net Investment / 2
Investment Method

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 4 Average Return on Average Annual Profits (after Depreciation &
Average Investment Taxes) x 100
Total Net Investment / 2
Method
3) NET PRESENT VALUE METHODS: The Net present value method is the
modern method of evaluating investment proposals. This method takes into
consideration the time value of money and attempts to calculate the return
on investments by introducing the factor of time-element. The following are
the necessary steps to be followed for adopting the NPV method:
a) Determine an appropriate rate of interest that should be selected as the
minimum required arte of return called cut-off rate or discount rate.
b) Compute the present value of total investment outlay i.e. cash outflows at
the determined discount rate.
c) Compute the present value of total investment proceeds i.e. cash inflows
(profit before depreciation & after tax) at the determined discount rate.
d) Calculate the NPV of each project by subtracting the present value of cash
outflows from the present value of cash inflows for each project.
e) If NPV is positive or Zero, the proposal may be accepted otherwise it
should be rejected.
f) The project with maximum positive NPV may be selected.

1) INTERNAL RATE OF RETURN METHOD: It is also known as trial & error

yield method. The following steps are required to practice the internal rate of
return method:
a) Determine the future net cash flows during the entire economic life of the
project. The cash inflows are estimated for future profits before
depreciation but after taxes.
b) Determine the rate of discount at which the value of cash inflows is equal
to the present value of cash outflows. If annual cash flows are equal then
it can be easily found out otherwise it has to be found out by hit and trial
method.
c) Accept the proposal if the IRR is higher than or equal to the minimum
required rate of return i.e. cost of capital or otherwise reject the proposal.
d) In case of alternative proposals select the proposal with highest IRR.

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Break Even Point Analysis: A Business is said to break even when its total
sales are equal to its total costs. It is a point of no profit no loss. At this point
contribution is equal to fixed cost. A concern which attains break even point at
less number of units will definitely be better from another concern where break
even point is achieved at more units of production. The BEP can be calculated by
the following formula:
BEP (In Units) = Total Fixed Expenses / Contribution per Unit
BEP (Based on Total Sales) = Fixed Expenses / P/V ratio

Contribution: Contribution is the difference between the sales and the marginal
cost of sales and it contributes towards fixed expenses and profit.

Profit Volume Ratio: The ratio is calculated as: Contribution / Sales

Or (Fixed Expenses + Profit) / Sales
Or (sales – Variable Costs) / Sales
Or Change in Profits or Contributions / Change in Sales
The different types of ratios that can be used to analyze the viability of
the project can be broadly categorized into:

a) Liquidity Ratios

Liquidity Ratios tells about the ability of the firm to meet it’s short-term
financial obligations and commitments. These ratios are based on the
relationship between current assets which provide the sources of meeting
short term obligations and current liabilities which are obligations to be met
within one year. Two types of liquidity ratios are: Current Ratio & Acid –
Test Ratio.

b) Leverage Ratios
A firm uses a combination of equity and debt for financing it’s assets. Debt
is riskier source of finance as it entails a fixed outgo of periodic interest
payments and loan repayments. Leverage ratios help us to analyze the risk
arising from the use of Debt Capital.
The commonly used Leverage Ratios are:
i. Debt-Equity Ratio: = Debt/Equity

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 Debt includes all liabilities whether long-term or short-term. Equity
represents the net-worth of the firm i.e. Equity Capital, Reserves &
Surpluses and Preference Shares.
An alternative form of Debt-Equity ratio is the Long-term debt to equity.
The numerator would consist of only long-term debt.
A lower value of debt-equity ratio indicates a higher degree of protection
employed by the creditors.
ii. Interest-Coverage Ratio
Interest-Coverage Ratio = Profit before interest and Taxes
Fixed Interest Charge
Interest coverage ratio is used as an indicator of the paying capacity by
the lenders. A high interest coverage suggest more paying capacity but at
the same time may indicate the firms inability to use low interest debt as
a source of finance to increase the return to it’s shareholders.

iii. Debt-Service Coverage Ratio (DSCR)

This ratio is used by the financial institutions to assess the capacity of the
borrower to repay the term loan.
DSCR = (Profit after Tax + Depreciation + Other Non-Cash charges +
Interest on term loan) / (Interest on term Loan + Repayment of term loan)

PROJECTED CASH FLOW

The cash flow statement shows the movement of cash into and out of the firm. It
also shows the net impact on the cash balance available with the firm. For the
purpose of appraisal and project evaluation it is desirable to work out the
projected cash flow statement on a quarterly basis right through the construction
period to the operating period.

PROJECTED BALANCE SHEETS

The liabilities side of the Balance sheet indicates the sources from which finance
has been mobilized and the Assets side indicates how the funds have been
actually deployed in the business, thereby facilitating decisions about project
finance.

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QUES NO. 7: MANAGERIAL APPRAISAL POINTS MORE TO THE INTEGRITY
OF THE ENTERPRENUER THAN THE CAPABILITY TO RUN THE UNIT
SMOOTHLY – DISUSS WITH EXAMPLES.

Every business has different requirements from the management. Businesses,

which are complex require significant experience on part of top management to
run it. Management expertise is not only technical know-how but also in
understanding market dynamics, ability to distribute product effectively, manage
man power and environment.

In cases where a MNC, which has a long track record and significant experience,
is implementing a project, it would be an added comfort about management
feasibility. In businesses, which are technologically driven based on intellectual
capital, technocrats would be preferred.

Managerial appraisal also points towards the integrity of the

entrepreneur apart from the capability to run the unit smoothly. This is
particularly more important in the light of high amount of gross and net
NPAs of the Banks / FIs. Still a large number of public sector banks have
net non-performing assets ranging between 10 to 20 per cent of net
advances.

The dues to the banking sector are generally related to the performance of the
unit/industrial segment. In a few cases the cause of NPA has been due to internal
factors (to the banks) such as weak appraisal or follow-up of loans but more
often than not, it is due to factors such as management inefficiency of borrower
units, obsolescence, lack of demand, non- availability of inputs, environmental
factors etc. Wherever the unit/segment is doing well the credit relationship is
generally maintained except in cases of willful default / misappropriation /
diversion of funds. The problems to the unit/ segment arising out of various
internal/ external factors were felt to be originating point for NPAs in banks.

The high level of NPAs is a historical legacy mainly due to lacunae in credit
recovery system, largely arising from inadequate legal provisions on foreclosure
and bankruptcy, long drawn legal procedures and difficulties in execution of the

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decrees awarded by the Court. The Indian legal system is sympathetic towards
the borrowers and works against the banks' interest. Despite most of their loans
being backed by security, banks are unable to enforce their claims on the
collateral, when the loans turn non-performing, and therefore, loan recoveries
have been insignificant. Due to this the integrity of the entrepreneur
becomes all the more important.

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QUES NO. 8: THE LONG TERM FINANCIAL INSTITUION LAY MORE STRESS
ON FUTURE PRODUCTION AND PROFITABILITY BASED ON PROJECTED
TURNOVER, WHEREAS THE BANKS AND SHORT-TERM FINANCING
AGENCIES GO IN FOR SHORT TERM VIABILITY AND SUCCESS OF ANY
PROJECT. EXPRESS YOUR OPINION IN THE LIGHT OF LARGE SCALE
FAILURE OF LONG TERM PROJECTS IN RECENT TIMES.

The fact that the financial sector of a country plays a very important role in
economic growth and development is well documented. In using the financial
sector as an engine of economic growth. Prudential regulations like capital
adequacy requirements, collateral requirements, lending restrictions, direct
supervision and others are required to keep the financial institutions sound. The
most common causes of failure of financial institutions in different parts of the
world are political pressure to finance bad projects and poor incentives for
financial institutions to screen and monitor projects. In East Asia, among the key
success factors was an insistence on commercial standards within priority
sectors. Successful development banks transformed themselves from
government agencies financing development projects into more market-oriented
financial enterprises, enhancing growth through financial restraint and credit
allocation.

Many projects fail to live up to their potential. Some projects fail to achieve their
schedule or budget goals or fail to deliver everything initially promised. Still
other projects simply fail altogether. Many of the problems faced by projects can
be avoided, or at least contained, by effective project management practices.
Most frequent reasons for project failure, and some alternatives and
remedies for each are as follows:

1. Lack of clear link between the project and the organisation’s key strategic
priorities, including agreed measures of success.
2. Lack of clear senior management and Ministerial ownership and
leadership.
3. Lack of effective engagement with stakeholders.

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 4. Lack of skills and proven approach to project management and risk
management.
5. Too little attention to breaking development and implementation into
manageable steps.
7. Evaluation of proposals driven by initial price rather than long- term value
for money (especially securing delivery of business benefits).
8. Lack of understanding of and contact with the supply industry at senior
levels in the organisation.
9. Lack of effective project team integration between clients, the supplier
team and the supply chain.
If any of the answers to the above questions are unsatisfactory, project
should not be allowed to proceed until the appropriate assurances are
obtained.

Defining, planning and managing business projects takes project management

skills that require time to learn, and practice to master. It isn’t hard to fail...
failure is easy. Remember that most projects involve creation of a product or
service, and creation is always a difficult task because it involves trying to
predict the future and manage to that prediction. The key to success is to realize
that your predictions will not always be right, and to deal with reality as it
unfolds. Effective project management avoids or minimizes most of the
situations described above by encouraging effective and timely communication,
acknowledging that plans are educated guesses about the future that will not
always be correct, and trying to work with the project team to deal with reality
as it is revealed rather than trying to deny it as long as possible.

ESSENTIALS OF SUCCESSFUL PROJECT

1) Clearly defined goals (including the general project philosophy or

general mission of the project, as well as commitment to those goals on the
part of the team members).
2) Competent project manager. The importance of initial selection of
skilled (interpersonally, technically, and administratively) project leader.

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3) Top Management Support. Top or divisional management support for the
project that has been conveyed to all concerned parties.
4) Competent project team members. The importance of selecting and, if
necessary, triaging project team members.
5) Sufficient resource allocation. These are Resources in the form of
money, personnel, logistics, etc.
6) Adequate communication channels. Sufficient information is available
on the project objectives, status, changes, organizational coordination,
clients’ needs, etc.
7) Control Mechanisms. (Including planning, schedules, etc.). Programs are
in place to deal with initial plans and schedules.
8) Feedback capabilities. All parties concerned with the project area able
to review project status, make suggestions, and corrections through formal
feedback channels or review meetings.
9) Responsiveness to client. All potential users of the project are consulted
with and kept up to date on project status. Further, clients receive
assistance after the project has been successfully implemented.
10)Client consultation. The project team members share solicited input
from all potential clients of the project. The project team members
understand the needs of those who will use the systems.
11)Technical tasks. The technology that is being implemented works well.
Experts, consultants, or other experienced project managers outside the
project team have reviewed and critiqued the basic approach.
12)Client Acceptance. Potential clients have been contacted about the
usefulness of the project. Adequate advanced preparation has been done
to best determine how to sell the project to the clients.
13)Trouble-shooting. Project team members spend a part of each day
looking for problems that have surfaced or are about to surface. Project
team members are encouraged to take quick action on problems on their
own initiative.

THE THREE KEY AREAS THAT, IF DONE WELL, POINT TO A SUCCESSFUL

PROJECT COMPLETION.

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Good Planning The first indicator, Good Planning, requires excellent forward
planning, which includes detailed planning of the process implementation
stages, task timeliness, fall-back positions, and re-planning. Notice that initial
planning is not enough. Projects often take wrong turns, or initial solutions
prove unfounded. The project manager who does not prepare to re-plan, or
has not considered and planned fall-back positions when initial plans fail, will
often find that the project first stalls, and then fails. We must remember that
project management is not a straight-line process, but an iterative process
that requires agile rethinking as the known environment changes before your
eyes.

Clear Responsibility and Accountability of Team Members: This requires

that all team members have a clear understanding of their roles and duties in
the project. They must understand how expectations vs. achievements will be
measured and graded. It is left to the project manager to properly implement
the communication of these responsibilities, to provide feedback, and to
assure all understand that for which they will be held accountable.

Schedule Control: This requires the continual monitoring and measurement

of time, milestones, people, and equipment schedules. Properly done
schedule control will also give the first hint that initial planning may not be
going according to schedule. If you pickup on these hints, you have an
opportunity to implement a fallback position and/or re-plan to get back on
track.

CONCLUSION
So at this point we have several lists of things that might indicate project
success and others that might indicate project failure. But there is one thing
primarily that one must recognize in all of these lists. There are no stock
answers, and there is no one list that will guarantee success. Projects are
complex by nature, and each is unique. It is very difficult to plan with complete
certainty something that has never before been done. Every single factor in
all of these lists is important and must be considered for each project. The
most difficult part may be prioritizing the factors. Which are most important?

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Which must be done first? In each case one must ultimately make the
decisions based upon the unique circumstances of one’s immediate project.
Good project management is a process of continuous improvement. It is a
process of making mistakes and learning from those mistakes. It is a process
of continuous study and learning. For those who cannot devote themselves to
this never-ending process, there will be few successes.

QUES NO. 9: IN FINANCING WORKING CAPITAL THE BANKS AND SHORT-

TERM FINANCING AGENCIES ARE THE TRUE BENEFICIARIES IN THE
SUCCESS OF THE PROJECT THAN THE EQUITY HOLDER AND THE LONG-
TERM FINANCIAL INSTITUIONS – DO YOU AGREE WITH THE STATEMENT?
DISCUSS FULLY THE IMPACT OF FAILURE ON BOTH FINANCIAL
ISNTITUTION AND ENTREPRENUER.

Working capital comprises short term net assets: stock, debtors, and cash, less
creditors. Working capital management then is to do with management of all
aspects of both current assets and current liabilities, so as to minimise the risk of
insolvency while maximising return on assets.

Thus strictly speaking, working capital is not a part of the project finance which
deals with providing finance for fixed assets.

However, working capital has to be dealt with project finance as:

1. the margin money for working capital has to be financed by long term
sources and
2. inadequate working capital leads to liquidity crunch, diversion of funds
and financial problems.

The working capital limits would be considered only after the project nearing
completion and after ensuring full tie-up of the term loan requirements of the
borrower. These limits would be either in the form of fixed loans or running
accounts and / or bill financing facility. The finance extended under this category
would be for meeting the funds requirements for day to day operations of the
units i.e, to meet recurring expenses such as acquisition of raw material, the

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various expenses connected with products, conversion of raw materials into
finished products, marketing and administrative expenses, etc.

Eligible Working Capital Limits would be assessed by adopting various methods

such as Projected Turnover Method, Permissible Bank Finance Method, Cash
Budget Method and Net Owned Funds Method, depending upon the type of
borrower, the aggregate working capital facility enjoyed from the banking
system, the scale of operation, nature of activity/enterprise and the duration/
length of the production cycle, etc.

The working capital limits may require such security and personal/ third party
guarantees as applicable to general lending norms of the bank and risk
perception in respect of individual borrowal account in the form of:

i. First charge by way of hypothecation of current assets.

ii. Charge on fixed assets of the unit.
iii. Personal Guarantee of Promoter Director/Corporate Guarantee
iv. First pari-passu charge on the fixed assets of the unit, if the assets
are mortgaged to other institutions/ Bank
v. Adequate collateral security.

It is important to ensure proper management of working capital

because of the following reasons:

→ Investment in current assets represent a substantial portion of total

investments.
→ Investment in current assets and the level of current liabilities have to be
quickly adjusted to change in sales.
→ Fixed assets cannot generate income unless they are used with the help of
working capital. Therefore, working capital is considered as life blood of an
enterprise.

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Even profitable companies fail if they have inadequate cash flow. Liabilities are
settled with cash not profits. The primary objective of working capital
management is to ensure that sufficient cash is available to:

• meet day-to-day cash flow needs;

• pay wages and salaries when they fall due;
• pay creditors to ensure continued supplies of goods and services;
• pay government taxation and providers of capital – dividends; and
• ensure the long term survival of the business entity.

Poor working capital management can lead to:

• over-capitalisation (and therefore waste through under utilisation of

resources and hence poor returns); and
• overtrading (trying to maintain a level of sales which is higher than
working capital can sustain – for businesses which extend credit terms,
more sales means more debtors and higher working capital demands).

Characteristics of over-capitalisation are excessive stocks, debtors, and cash, low

return on investment with long term funds tied up in non-earning short term
assets. Overtrading leads to escalating debtors and creditors, and if unchecked,
ultimately to cash starvation.

Many companies lose billions annually through inefficient management of their

working capital. When the length of time between making a sale and receiving
revenue stretches out, companies miss out on having that cash available for
paying off debts, developing new products and making other investments.
Decreasing working capital -- the difference between a company's assets and
liabilities -- frees up cash and makes it easier for a company to quickly respond
to market changes.

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QUES NO. 10: A PROJECT SHOULD LAY EQUAL STRESS ON TECHNICAL,
FINANCIAL, COMMERCIAL AND MANAGERIAL APPRAISAL. DO YOU AGREE
WITH THIS STATEMENT? IF SO, SUBSTANTIATE YOUR ANSWER WITH
WEIGHTAGE SYSTEM FOR EACH APPRAISAL.

To implement any project, the entrepreneur needs to carry out different types of
appraisal / feasibility studies. These feasibility studies evaluate all the risks and
returns and tries to balance them and help the entrepreneur to finalize his plans.

Technical Appraisal

An entrepreneur should have the requisite number of technically capable people

as well as technology required to set up and run the plant. The technology
should be such that is can adapt to local conditions. Technology transfer from
overseas often fails in this regard. The conditions in USA and America are quite
different from India. Most parts of India are hot and dusty. Sophisticated process
controls have known to fail. Therefore, knowledge and suitability to local
conditions is very important.

Financial Appraisal

The ability to raise money to implement the project is of paramount importance.

The promoter should be capable of raising funds either from his own sources or
from banks and institutions. One area that often gets overlooked, is contingency
planning. In most cases, the first generation entrepreneur has problems in
raising funds to implement his project, and even if he does so, he lacks staying
power and is not able to withstand unforeseen problems like delays and
overruns.

Commercial Appraisal (Availability of Key Factors)

Commercial feasibility refers to availability of raw material, skilled labor,

infrastructure, and other factors of production. A number of projects have run
into rough weather due to poor commercial viability. One of the classic examples
of this is a cycle factory which was set up in Baroda, Gujarat. The management

29
was good, market survey showed existence of a good market and the
government was giving fiscal incentives. What was overlooked was availability of
skilled labour. Bicycle assembly is a hard work and labor in Gujarat is used to
process industries. Therefore the project failed. The center of the bicycle industry
is Ludhiana where native Punjabis/ Sikhs are sturdy people and used to hard
work and have requisite skills in assembly of bicycles.

Managerial Appraisal

Every business has different requirements from the management. Businesses,

which are complex require significant experience on part of top management to
run it. Management expertise is not only technical know-how but also in
understanding market dynamics, ability to distribute product effectively, manage
man power and environment.

In cases where a MNC, which has a long track record and significant experience,
is implementing a project, it would be an added comfort about management
feasibility. In businesses, which are technologically driven based on intellectual
capital, technocrats would be preferred.

Economic Appraisal

The project has to generate an acceptable rate of return, which adequately

covers your cost of capital. The expected rate of return depends on the risk
profile of the project. In a rational economic world, nobody implements a project
to make losses. In other words net present value has to be positive if you
discount the cash flows by the desired rate of return.

Social Appraisal

Many a time plants may be viable economically and financially but would be
socially undesirable. An example would be dyes units, which have mushroomed
around Ahmedabad. These are polluting and generate effluents not acceptable
to the society and environment. In the last 5 years, India is slowly becoming
environment conscious and friendly. So using hazardous chemicals or polluting

30
industries may not get the necessary clearances. For instance, the state
government has ordered closure of all dyes units in Gujarat unless suitable
effluent treatment is implemented.

Market Appraisal

This is a critical analysis because the output of any factory has to sell in the
market place for the promoter to earn revenues. Very often demand analysis and
projections are optimistic leading to problems in the future. Another observation
has been that products that sell abroad may not have a market in India. India, in
general is a cost conscious market and the promoter has to keep this in the back
of his mind. T series with its low priced cassettes met phenomenal success.

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