Welcome to this Session

on
Financial Appraisal of a Project
Md. Alamgir,
Associate Professor, BIBM
Former Central Banker
 Cost of the Project

 The cost of a project represents all capital

expenditure to be incurred for acquisition of its
fixed assets plus the net contribution of long-term
resources in the proposed current assets.
 In other words, the fixed cost of the project plus the
net ( or permanent) working capital requirement to
run the project will comprise its total cost.
 Proper assessment of the cost of the project is
important.
 Once the cost is estimated, the financing plan will
have to be worked out on realistic basis.
 Fixed Cost of the Project

 The requirement of physical assets for a project is

essentially an engineering estimate.

 The fixed cost of a project is the aggregate of cost

of land, building construction, plant, machinery
and equipments, preliminary and pre-operating
expenses and a margin of contingencies.
 Means of Finance
 A project may be financed in the following two
ways:
 1. The entire finance may be provided by the sponsors
 2. Part of the finance may be provided by the
sponsors and the rest by the creditors.
 Bank/DFI is required to appraise a project in the latter
case where it may like to invest by way of long-term
loans.
 After estimation of the cost of the project, it is to be
decided as to how it is going to be financed.
 How much the sponsors will arrange and how much
DFI/Bank will provide.
 There cannot be any watertight arrangement
concerning the means of financing.
The followings are the usual sources of fund:

 1. Equity Capital/ Owned Capital:

 (a) Paid-up share capital
 (b) Reserves & Surplus (For an existing concern)
 © Retained Earnings (For an existing concern)
 2. Loan capital/ Borrowed Capital:
 (a) Long-term borrowings ( both secure and
unsecured)
 (b) Interest during construction period (IDCP).
 (c) Other sources such as loans from directors.
 Financial Analysis Contd.

 The financial appraisal of a project thus covers the

following aspects:
 (i) Assessment of net-working capital, (ii)
Estimates of the total cost of the project. (iii)
Drawing means of finance (sources of finance),
(iv) Sales Estimates.
(v) Estimates of the cost of goods sold
and General Administrative and Selling
expenses, (vi) Estimates of Financial expenses.
(vii) Earning Forecast.
 All Capital Budgeting Techniques can be
categorized under the following two groups:
 (1) Non-Discounted Cash Flow (Capital
Budgeting) Techniques: These techniques do
not employ the time value of money concepts.
These techniques are also called traditional
techniques.

► Accounting Rate of Return (ARR)

► Regular Payback Period (PBP)
(2) Discounted Cash Flow (Capital
Budgeting) Techniques: These
techniques employ the time value of
money concepts.
► Discounted Payback Period
► Net Present Value (NPV)
► Internal Rate of Return (IRR)
► Benefit Cost Ratio (BCR) or
Profitability Index (PI)
 Regular Payback Period
 How to Calculate Regular Payback Period
 Let’s assume that the following cash flows are given
for Project X :
 How to calculate Payback
Period/NPV/BCR/Discounted Payback
Period
Year Expected Net cash Discounted cash flows( at
flows 12%)
0 (Tk. 1000) (Tk. 1000)
1 500 500X .893=446.5
2 400 400X .797=318.8
3 300 300X .712=213.6
4 100 100X .636=63.6
NPV 42.50
 Definition of IRR
 The IRR is the discount rate that equates the
present value of a project’s expected cash
inflows to the present value of the project’s
cost, i.e.,
 PV (inflows) = PV (outflows/investment costs)
 Equivalently, IRR is that discount rate at which
the NPV becomes zero.
CF1 CF2 CFn n CFt
NPV  CF0  1 2  n  t 0
1  IRR 1  IRR 1  IRR t0 1  IRR
Case Study

12
 SENSITIVITY ANALYSIS OF A PROJECT
 Sensitivity analysis shows how the value of the criterion (say,
NPV, IRR etc.) changes with the changes in the value of any
variable in the analysis. In other words, it is the investigation of
what happens to IRR or NPV when only one variable is
changed.

Sensitivity analysis is useful in pinpointing the areas where

forecasting risk is especially severe.

We can do this in two ways:

 For a given absolute change in variables
 For a possible percentage change in projected figures

     
 To illustrate how sensitivity analysis works,
the following project can be considered:

 1. Initial Cost Tk. 2,00,000

 2. Estimated Life 5 years & no salvage value
 3. Depreciation 40,000/ year
 4. Unit sales 6,000
 5. Price per unit Tk. 80
 6. Variable cost per unit Tk. 60
 7. Fixed costs per year Tk. 50,000
 8. Tax Rate 30%
 9. Required Return 12%
 NPV & IRR using unit sales
Particulars Base Case Worst Case Best Case
Unit sales 6,000 5,500 6,500
Price per unit 80 80 80
Variable cost 60 60 60
per unit
Fixed cost per 50,000 50,000 50,000
unit
Sales 4,80,000 4,40,000 5,20,000
Variable cost 3,60,000 3,30,000 3,90,000
Fixed cost 50,000 50,000 50,000
 NPV & IRR using unit sales
Particulars Base Case Worst Case Best Case
EBIT 30,000 20,000 40,000
Taxes(30%) (9,000) (6,000) (12,000)

Net profit 21,000 14,000 28,000

Yearly cash 61,000 54,000 68,000

flow
NPV 19,893 (5,341) 45,126
IRR 15.9% 10.9% 20.8%
 NPV & IRR using fixed cost
Particulars Base Case Worst Case Best Case
EBIT 30,000 25,000 35,000
Taxes(30%) (9,000) (7,500) (10,500)

Net profit 21,000 17,500 24,500

Yearly cash 61,000 57,500 64,500

flow
NPV 19,893 (7,276) 32,510
IRR 15.9% 13.5% 18.4%
Thank You for Your Attention