ACA-TM-37 (v Nov-10 ) PROJECT FINANCING PROJECTAPPRAISAL Satyajit Dwivedi CAB, Pune

ACA-TM-37 (v Nov-10 ) PROJECTS - DEFINITION CUTTING EDGE OF DEVELOPMENT – GITTINGER A SET OF ACTIVITIES LARGE ENOUGH TO REQUIRE PROPER PLANNING ETC.

ACA-TM-37 (v Nov-10 ) PROJECTS - DEFINITION PROJECT IS AN ECONOMIC ACTIVITY IN WHICH FINANCIAL RESOURCES ARE EXPENDED TO CREATE CAPITAL ASSESTS THAT PRODUCE BENEFITS OVER A PERIOD OF TIME AND WHICH LOGICALLY LENDS ITSELF TO PLANNING, FINANCING AND IMPLEMENTING AS A UNIT.

ACA-TM-37 (v Nov-10 ) CHARACTERISTICS P – PRODUCT OF GOODS AND SERVICES R – RESOURCES : MAN, MATERIAL, MONEY O – ORGANISATION J – JUSTIFICATION : SOCIAL BENEFITS, WEALTH E – ECONOMIC & FINANCIAL VIABILITY C – CONTINUITY: PLANNING, RESEARCH & DEV. T – TIME BOUND IMPLEMENTATION

ACA-TM-37 (v Nov-10 ) WHY PROJECT APPROACH ? Integrated approach for systematic exploitation of resources Gives an idea of costs year by year – Helps in resources planning Impact of investment on the stakeholders Better judgment of administrative & organisational problems Encourage examination of alternatives

ACA-TM-37 (v Nov-10 ) ESSENCE OF PROJECT APPRAISAL A COMPREHENSIVE & SYSTEMATIC REVIEW OF ALL ASPECTS OF PROJECT A SECOND LOOK TO THE PROJECT BY ONE NOT INVOLVED IN PRJECT FORMULATION HIGHLIGHT THE WEAK AREAS OF THE PROJECT FOR DUE RECTIFICATION

ACA-TM-37 (v Nov-10 ) ESSENCE OF PROJECT APPRAISAL AN EXERCISE FOR FUTURE ASSESSMENT A JOINT ASSESSMENT BY THE PROMOTER & FINANCIAL INSTITUTION ENFORCEMENT OF A TIME BOUND PROGRAMME TO AVOID DISTORTION

ACA-TM-37 (v Nov-10 ) TYPES OF PROJECTS FARM SECTOR NON FARM SECTOR * OTHERS

ACA-TM-37 (v Nov-10 ) PROJECT CYCLE IDENTIFICATION FORMULATION APPRAISAL IMPLEMENTATION MONITORING EVALUATION

ACA-TM-37 (v Nov-10 ) IDENTIFICATION F O R M U L A T I O N A P P R A I S A L IMPLEMENTATAION M O N I T O R I N G E V A L U A T I O N PROJECT CYCLE

APPRAISAL TECHNICAL COMMERCIAL MANAGERIAL / BORROWER ORGANISATIONAL SOCIAL ECONOMIC FINANCIAL

ACA-TM-37 (v Nov-10 ) OBJECTIVES OF FINANCIAL APPRAISAL To assess the financial effect on the farmers and bank/financial institution To asses overall return on the investment as well as return to farmer after repayment of installments To know whether incremental benefits are attractive enough for farmer To work out a plan that projects financial situations and sources of funds and to determine timing of investments

ACA-TM-37 (v Nov-10 ) CASH FLOW STATEMENT Cash flow prepared on an annual basis over the economic life of assets Identify the costs and benefits Compare incremental benefits with incremental costs Income and expenditure pertaining to the investment alone to be reckoned For deciding the price – price paid or received at the farm-gate to be taken Constant price principle is applied Interest on borrowed capital is not included

ACA-TM-37 (v Nov-10 ) CASH FLOW STATEMENT CONTD.. Identification of costs: Investment: Expenditure made before the production starts and replacement of machineries Production: All recurring expenditure during the project life Pre-Development Income: Pre-developmental income to be taken as cost Cost not to be reduced with subsidy/margin

ACA-TM-37 (v Nov-10 ) Identification of Benefits Increase in production Cost reduction Improvement in quality Grading Prevention of loss Consumed part of production Scrap/residual value of investments

ACA-TM-37 (v Nov-10 ) METHODS OF APPRAISAL Two well known methods:  PAYBACK METHOD (Undiscounted)  TIME ADJUSTED RATE OF RETURN (Discounted)

ACA-TM-37 (v Nov-10 ) PAYBACK METHOD LENTH OF TIME FROM BEGINNING OF THE PROJECT TILL THE INCREMENTAL BENEFITS REACHES THE CAPITAL INVESTMENT FAILS TO CONSIDER EARNINGS AFTER THE PAYBACK PERIOD DOES NOT CONSIDER TIMIMGS OF OCCURRENCE OF CASH INFLOWS AND OUTFLOWS OF THE PROJECT

ACA-TM-37 (v Nov-10 ) DISCOUNTED CASH FLOW METHOD  TAKES INTO ACCOUNT TIME VALUE OF MONEY COSTS AND BENFITS OCCUR AT DIFFRENT TIMINGS AND IN DIFFERENT AMOUNT DISCOUNT FACTOR IS USED TO BRING COSTS AND BENEFITS TO THEIR PRESENT VALUE BY DISCOUNTING AT A GIVEN RATE WE OVERCOME THE TIME DIMENSION

ACA-TM-37 (v Nov-10 ) DISCOUNTED CASH FLOW METHOD DISCOUNTED MEASURES OF PROJECT WORTH BENEFIT COST RATIO (BCR) NET PRESENT WORTH (NPW) ITERNAL RATE OF RETURN (IRR)

ACA-TM-37 (v Nov-10 ) STEPS & METHODOLOGY FOR APPRAISAL COST AND BENEFIT STREAM IN THE CASH FLOW TO BE DISCOUNTED SEPARATELY TOTAL OF DISCOUNTED COST GIVES PRESENT WORTH OF COSTS (PWC) TOTAL OF DISCOUNTED BENEFIT IN CASH FLOW GIVES PRESENT WORTH OF BENEFITS (PWB)

ACA-TM-37 (v Nov-10 ) STEPS & METHODOLOGY FOR APPRAISAL BENEFIT COST RATIO : RATIO OF PWB TO PWC NET PRESENT WORTH : DIFFERENCE BETWEEN PWB AND PWC IF BCR IS > 1 AND NPW IS +VE AT THE DISCOUNTED RATE, THEN THE PROJECT IS VIABLE

ACA-TM-37 (v Nov-10 ) 22 Benefit Cost Ratio Year Investment cost PW of costs ( 2x4) PW of benefits (3x4) Total BC Ratio 1055 : : 1

ACA-TM-37 (v Nov-10 ) 23 Net Present Worth YearInvest ment cost % PW of costs ( 2x4) PW of benefits (3x4) Total NPW

ACA-TM-37 (v Nov-10 ) 24 Net Present Worth YearInvestment cost 20 %PW of costs ( 2x4) PW of benefits (3x4) Total NPW (-) 31

ACA-TM-37 (v Nov-10 ) 25 Internal Rate of Return Internal Rate of Return ( IRR ) :  Lower of the two discount rates (+ ) Difference between two discount rates x lower discount rate :- Absolute difference between NPWs at two discount rates ) IRR= x ( multiplied by ) 55 :- 86 ( ) = 18 % ( 18.2 ) IRR determined by trial and error Represents return for resources over life of project Earning power of money used in project  IRR not estimated beyond 50%  Present cut off IRR : 15%

ACA-TM-37 (v Nov-10 ) 26 Appraisal of Projects- Techniques- contd.

ACA-TM-37 (v Nov-10 ) TREATMENT OF DEPRECIATION AND INTEREST Depreciation and interest on borrowed capital not treated as cost In DCF approach; ‘return of capital’ is ensured and hence no depreciation of investment ‘return to capital’ i.e interest on investment is also ensured

ACA-TM-37 (v Nov-10 ) SENSITIVITY ANALYSIS Studies the changes in the scenario in case either price structure or timeframe undergoes change Studies ability of the project to bear adversities

ACA-TM-37 (v Nov-10 ) REPAYMENT SCHEDULE Three issues to be seen  Instalments to be fixed in relation to surplus so that sufficient is available with the farmer after repayment  Period of loan to be within economic life of the assets  Instalments are fixed when surplus is available

ACA-TM-37 (v Nov-10 ) * THANKYOU