Project Appraisal

Class 1
What is a project?

A set of well defined activities , clear cut
beginning and end
Having a desired objective/ outcome.
Consumption of large amounts of money
Limitations on resources
Not undertaken frequently
The Process
What is a project?

Definition:
Channelising predetermined amounts of
money to generate something that will
assist the organization in designing and
executing its strategies.
What is project appraisal?

- A process of analyzing the technical
feasibility and economic viability of project
proposal with a view to financing their
costs.

Importance of project appraisal

It is a capital investment decision
It has long term effects
Decision once taken is irreversible
Expenditures are high
Difficulties in respect of project
appraisal

Measurement of costs and potential
benefits are difficult
High degree of uncertainty
Long term spread time value of money
Types of projects

Mandatory investment (to comply with statutory
requirement)
Replacement investment
New projects
Expansion projects
Diversification projects
Research and Development projects
Public good /social welfare projects
Infrastructure projects
Project Financing
In India barring infrastructure projects , project
financing is identical to corporate financing

Balance sheet based financing
Project financing is based on the credit
worthiness of the sponsor (company or the body
proposing the business idea to launch the
project )
Such loans are secured by not only the pool of
assets created out of the project but also the
existing assets of the sponsor.

Project Financing
However in Western Economies the term
Project Financing connotes financing that as a
priority does not depend on the soundness or
creditworthiness of the sponsors.

Instead, it is a function of the projects ability to
repay the debt contracted and remunerate
capital invested at a rate commensurate with
degree of risk associated with the project.
Modern Definition
of Project Finance

Structured financing of a specific
economic entity, the SPV created by
sponsors using equity or mezzanine debt
and for which lenders consider cash flows
as the primary source of loan repayment
whereas assets represent only collateral .
Distinctive features
The debtor is a project company
Lenders have only limited recourse or no recourse to the
sponsors
Sponsors involvement in the deal is limited in terms of
time, amount and quality.
Project risks are equitably allocated between all parties
with the objective of assigning risks to those parties who
are best able to control and manage them.
Cash flows generated by the SPV must be sufficient to
cover payments for operating costs and to service debt.
Only residual funds after servicing debt are payable to
the sponsors.
Collateral is given by the sponsors to lenders for receipts
and assets tied up in managing the project.
Project finance Vs
Corporate Finance


Why - Project Financing
1. Avoidance of contamination risk

Where the size of the proposed project is very large compared to
size of the existing operations

Where the project means of financing involves higher leverage (D/E
ratio)

In such a scenario with traditional Corporate Financing the failure
of the project (inability to yield ROI higher than WACC of the
project) can pull down even the existing operations of the sponsor
and jeopardize returns to existing shareholders.

Failure of the new project leads to failure of existing operations and
failure of the business

In such cases project financing option is preferable
Why - Project Financing
Conflict of interest between sponsors and lenders and
wealth expropriation

However project financing will not provide the co-
insurance benefit to the creditors.

This would happen in a case where the project fails but
the existing operations continue to perform.

The absence of contamination effect saves the existing
creditors and shareholders but the new creditors lose as
they do not partake the benefits of existing operations.
Categories of project sponsors

Industrial sponsors
Public sponsors with social welfare goals
Contractor/sponsors who develop , build
and run the plant
Pure financial investor.
Risk Management aspects

.

.
Project Life Cycle
Project life cycle and its impact on
feasibility

Conception and selection phase
Planning and scheduling phase
Implementation, monitoring and control
phase
Evaluation and termination phase
Project Life Cycle
Uncertainty regarding cost and time estimates in
respect of later stages
Estimates need to be adjusted and revised
periodically depending on the lessons leant in
the earlier cycles.
Typically the focus of project managers is initially
on performance, and then shifts to costs and
finally meeting the deadline. But focus should be
on performance from the beginning.
THINK LIKE A PROJECT
MANAGER

A clergyman, a doctor and a project manager were playing golf together one
day and were waiting for a particularly slow group ahead. The project
manager exclaimed, "What's with these people? We've been waiting over
half and hour! It's a complete disgrace." The doctor agreed, "They're
hopeless, I've never seen such a rabble on a golf course." The clergyman
spotted the approaching greenkeeper and asked him what was going on,
"What's happening with that group ahead of us? They're surely too slow and
useless to be playing, aren't they?" The greenkeeper replied, "Oh, yes,
that's a group of blind fire-fighters. They lost their sight saving our
clubhouse from a fire last year, so we always let them play for free anytime."
The three golfers fell silent for a moment. The clergyman said, "Oh dear,
that's so sad. I shall say some special prayers for them tonight." The doctor
added, rather meekly, "That's a good thought. I'll get in touch with an
ophthalmic surgeon friend of mine to see if there's anything that can be
done for them." After pondering the situation for a few seconds, the project
manager turned to the greenkeeper and asked, "Why can't they play at
night?"