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PROJECT FINANCE
AROLKAR ABHAY VASANT Partner, M/s A.V.Arolkar & Co., Chartered Accountants MUMBAI
INTRODUCTION
With a view to harnessing advancements in
economic development, GoI laid emphasis on industrialisation through successive Five Year Plans.
Rapid industrial development needed massive
investment.
Prior
INTRODUCTION
GoI,
the
following
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. April 28, 2012 4
A. V. Arolkar & Co., Chartered Accountants
PROJECT BACKGROUND
The purpose of term assistance is to meet a
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
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, water supply, railway sidings, etc., in addition to the Preliminary / Pre-Operative Expenses and margin on WC Limits. meet the entire capital expenditure out of their own resources, Term Loans are sanctioned to supplement the promoters April 28, 2012 6 contribution.
A. V. Arolkar & Co., Chartered Accountants
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, JHF, Partnership, Co-operative Society & Joint Stock Company. around Joint Stock Company as promoter.
April 28, 2012
A. V. Arolkar & Co., Chartered Accountants
PROJECT BACKGROUND
The Promotion Stage is a crucial stage in the
entire life cycle of a project. 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
April 28, 2012
A. V. Arolkar & Co., Chartered Accountants
I] Identification of a Project
The first step in the project promotion is the
identification of a project. An industrial project originates as an idea in a promoter when he observes the existence of a potential market for a certain product.
The promoter, on the basis of his experience,
background and ability, then considers the feasibility of manufacturing and marketing the product at a remunerative price.
April 28, 2012
A. V. Arolkar & Co., Chartered Accountants
It is, therefore, desirable that, before it is undertaken, marketability of the product to be manufactured is firmly established.
There are agencies, specialising in market
research, which conduct such market studies. Promoters may take advantage of their services.
A
market study aims at assessing aggregate demand for a product. April 28, 2012
A. V. Arolkar & Co., Chartered Accountants
the
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Feasibility Study covers 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 April 28, 2012 Infrastructural facilities
A. V. Arolkar & Co., Chartered Accountants
the
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Feasibility Study, therefore, concerns itself with matching of economic resources with the physical requirements of a project and determining the viability of investment therein.
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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. (a) L&B (b) P&M (c) Misc. Fixed Assets (d) Technical Know-how, Engg. & Consultancy fees (e) Preliminary and Pre-operative expenses (f) Provision for contingencies (g) Margin on WC Limits April 28, 2012 14
A. V. Arolkar & Co., Chartered Accountants
Fixed Assets which facilitate the process of production. Fixed Assets have a relatively longer life and are generally not meant for resale. They are required to be retained over a period of time to exploit their productive potential. and FG, which when sold bring in cash. This cycle is generally completed in a short period ofApril less than one year. 28, 2012 15
A. V. Arolkar & Co., Chartered Accountants
pay for themselves, the promoter should raise suitable long term funds to finance a project.
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A. V. Arolkar & Co., Chartered Accountants
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financing a project is referred to as Capital, comprising two components (a) Owned Capital and (b) Borrowed Capital.
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.
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A. V. Arolkar & Co., Chartered Accountants
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sources of finance, the promoter will decide about a suitable financial structure for the Company.
It will depend upon the financial leverage
envisaged in the combination of sources of finance under the two categories, viz., Owned Capital and Borrowed Capital.
Few projects can be financed entirely by
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A. V. Arolkar & Co., Chartered Accountants
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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.
For this purpose, Debt means Funded Debt
including all term liabilities and equity will include Share Capital and retained earnings, if available.
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A. V. Arolkar & Co., Chartered Accountants
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promoter will examine the attractiveness of the project, vis--vis alternative sources of investment.
The process which assists the management in
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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 pay-back period. Years to pay back would be: Total Investment
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concept of compounding which involves re-investing 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.
Future Value = Principal x (1+i)
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Present Value Method is based on the discounted cash flow technique and uses the concept of discounting which is just the opposite of compounding. future sum to which the original amount (which we want to find out), invested at a particular compound rate of interest has grown.
PV = Future sum
(1+i)
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which the sum of the discounted cash flows is equal to the investment outlay. In other words, 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. The object of this method is to find the rate of return which a project is likely to earn over its useful life.
IRR =
Lower Discount Rate + Diff. Between the two discount rates x NPV at lower discount rate Abs. diff. between the two NPVs.
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of not less than one year, intended normally for financing fixed assets acquired / to be acquired, carrying interest at a specified rate, and scheduled for repayment in instalments.
Depending on the term for which the said
terms loans are granted, they could be classified into (a) Short Term Loans (b) Medium Term Loans and (c) Long Term Loans.
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A. V. Arolkar & Co., Chartered Accountants
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pay to the supplier the price of machinery, supplied by him on deferred terms, in agreed instalments with stipulated interest on the respective due dates in case of default in payment thereof by the buyer.
Loan and, as far as the buyer of P&M is concerned, it serves the same purposes as a Term Loan.
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deferred payment basis, the balance remaining to be paid after the initial down payment represents the deferred receivables of the seller.
Thus, 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.
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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).
The usance bills drawn by the seller will be
accepted by the buyer before they are discounted by the sellers banker.
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arises only in the case of a Public Limited Company resorting to raise through the capital issue market, a part of the Share Capital for part-financing a project. agrees, in consideration, 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. April 28, 2012 33
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be
exercised
in
undertaking
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.
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Project Appraisal
The purpose of Project Appraisal is to ascertain
whether the project will be sound technically, economically, financially and managerially and ultimately viable as a commercial proposition.
appraisal of examination of: a project will involve the
The
of the technology selected and the adequacy of the technical investigation, and design.
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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. of cost estimates, suitability of the envisaged pattern of financing and general soundness of the capital structure.
profitability of the project and its sufficiency in relation to the repayment obligations pertaining to term finance. A. V. Arolkar & Co., Chartered Accountants April 28, 2012 36
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. appropriate, from the point of view of its value to the national economy in terms of socio-economic benefits like generation of employment opportunities, forex earnings, the quantum of import substitution, etc. April 28, 2012 37
A. V. Arolkar & Co., Chartered Accountants
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,
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Project Appraisal
The original application may not contain all the basic
data / information. In such cases, it may be necessary to provide all the necessary data / information with a view to give an overall idea about the general feasibility of the project at the time of interview by the bankers. satisfying itself about the prima facie acceptability of the project, the Bankers will call for an prescribed Application, containing the following essential data / information, such as:
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After
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Project Appraisal
a) Particulars of the project along with a copy
of the Project Report furnishing details of the technology, manufacturing process, availability of construction / production facilities, etc.
b) Estimates of cost of the project detailing
the itemised assets acquired / to be acquired, inclusive of Preliminary / Pre-operative Expenses and WC margin requirements.
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A. V. Arolkar & Co., Chartered Accountants
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Project Appraisal
c) Details of the proposed means of financing
indicating the extent of promoters contribution, the quantum of Share Capital to be raised by public issue, the composition of the borrowed capital portion with particulars of Term Loans, DPGs, Foreign Currency Loans, etc. 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.
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Project Appraisal
e) Project Implementation Schedule.
f) Organisational set up along with a list of
Board of Directors and indicating the qualifications, 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, production, marketing and finance after commencement of commercial April 28, 2012 42 production.
A. V. Arolkar & Co., Chartered Accountants
Project Appraisal
g) Demand projection based on the overall
Projected P&L Account and B/S for the operating years during the currency of the Banks term assistance. Proposed amortisation April 28, 2012 repayment programme. schedule, i.e.,
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A. V. Arolkar & Co., Chartered Accountants
j)
Project Appraisal
k) Projected Funds Flow Statement covering
both the construction period and subsequent operating years during currency of the Term Loan. securities offered.
the the
any
other
relevant
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Project Appraisal
In respect of existing concerns, in addition to
this information, particulars regarding the history of the concern, its past performance, present financial position, etc., should also be called for.
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.
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A. V. Arolkar & Co., Chartered Accountants
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Project Appraisal
An inspection of the project site (or factory in the
Each
project has to be examined in proper perspective having due regard to its nature, size and scope. the basic techniques employed for appraising the viability of various projects are more or less the same, there could be no standard or uniform approach for appraising all projects.
Although
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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 borrowers obligations under the Banks term assistance. the proposed term assistance as the prospects of its repayment that weighs with the bankers while appraising a project.
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Project Appraisal
In project appraisal, nothing is assumed or taken for
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2. BRIEF HISTORY Brief account of corporate history; MA & AA; Regd. address; Present organisational set up with BoD; Qualifications, experience and background; Line of activities, Financial position, etc., of Associate Concerns; Overall structure of inter-corporate investments
3. PAST PERFORMANCE Summary of Company's past performance in terms of licensed / installed / operating capacities, sales, operating profit and Net Profit for the past 3 years; Capacity utilisation; Sales & profitability; Dividend policy; Capital expenditure programmes implemented by the Company during the past 3 years and how they were financed; Company's management-labour relations 4. PRESENT FINANCIAL POSITION Company's audited Balance Sheets & P/L Accounts for the past 3 years with analysis; Company's Capital structure; Summarise conclusions of financial analysis; Method of depreciation; Revaluation of F/A; Record of major defaults; Position of Company's tax assessment; Contingent 49 Liabilities; Pending suits; Qualifications / Adverse remarks by auditors
7. PRODUCTION FACTORS (a) Mfg. Process - Basis of selection & justification; (b) Raw Materials - Imported / Indigenous, Names of main suppliers, Pattern of unit prices & fluctuation; (c) Utilities & Essential Services - Requirements of power, fuel, water, transport, railway siding with comments on adequacy of arrangements, treatment and disposal of effluents; (d) Operating Organisation - Experience and expertise of Managerial / Technical personnel, other staff required
8. WORKING CAPITAL REQUIREMENTS Assessment of total WC requirements at the peak level (GCA) during the first year of operations after commencement of commercial production; sharing of business among member banks; financing of additional WC requirments in case of existing companies 50
11. COMMERCIAL VIABILITY - DSCR & REPAYMENT PROGRAMME (a) DSCR (Gross) and (Net) ['Core Test' Ratio], Margin of safety and extent of risk coverage; (b) Break-Even Analysis - For first full year of production and the year of maximum capacity utilisation; (c) Cost-Volume-Price (CVP) or Senstivity Analysis - For the year with operating profit nearest to the average operating profit to determine 'Span of Resiliency' of the project; (d) Repayment Programme based on the above factors and initial moratorium (start-up) period
12. FUNDS FLOW ANALYSIS Funds Flows to be divided into Long Term Funds Flows and Short Term Funds Flows - Dif. would indicate Long Term Surplus or Deficit / Movements in C/A & OCL leading to increase or decrease in WCG; Essential expenditure on F/A, repayment obligations, taxes and dividends are fully provided for; Cash generation would be adequate to meet 51 all commitments during the entire repayment period.
15. SPECIAL TERMS & CONDITIONS (a) Right of examination of borrower's books; (b) Restriction with regard to change in Capital Structure; (c) Restriction with regard to (i) Repayment of deposits from F&R without the permission of the Bank (ii) Rate of interest payable on such deposits to be lower than the rate of interest charged by the Bank; (d) Restriction with regard to transfer of controlling interest in the Co. or drastic change in the Company's management set-up without Bank's prior permission; (e) Other standard T&C. 16. ECONOMICS OF UNDERWRITING In case of composite proposal, (a) Underwriting tie-up; (b) Capital Market trends; (c) Market response to the proposed public issue; (d) Lock-up of funds; (e) Comparative Earnings Analysis - Underwriting Commission, Dividends, Capital Gains after Tax; (f) Comparison of total earnings thus arrived at with total earnings that 52 would accrue to the Bank if the amount (Value of shares devolving) is lent by way of Term Loans for the same period
19. MANAGERIAL COMPETENCY (a) Company's management set-up; (b) Composition of the BoD; (c) CEO in charge of day-to-day affairs of the Company; (d) Quality of the Company's management and the level of managerial expertise built-up within the Group; (e) Whether all departments are well served by professionals
20. OTHERS AND RECOMMENDATIONS (a) Verify RBI's List of Defaulters / Wilful Defaulters / Suit Filed Accounts; (b) Verify ECGC's Specific Approval List; (c) Indicate the IRR for the project and comments on comparison with the IRRs for similar projects in the same industry; (d) Indicate the importance of the project in terms of national priority and impact thereon; (e) Detail the value of the Company / Group's connections to the Bank; (f) Whether, all considered, the proposal is a fair banking risk; (g) Recommendations for sanction of Term Loan.
THANK YOU
April 28, 2012
A. V. Arolkar & Co., Chartered Accountants
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