Transcript Slide 1

Project Approach to
Lending &Financial
Appraisal
Satyajit Dwivedi
Member of Faculty
CAB Pune
ACA-TM-37 (v2.2-20-Nov-10)
Potential Activities
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Fruits and Vegetables
Floriculture
Medicinal and Aromatic Plants
Minor Irrigation Schemes - development & management
Livestock based Schemes - Dairy, Poultry, Fisheries, etc.
Land development activities - soil & water conservation
Mechanisation of Agriculture
Organic Farming
Bio-fuel and TBO seeds
Agro-processing
Seed and Planting material production
Agri-clinic and Agri-Business Centres
Post harvest and Marketing Infrastructure Development, etc.
ACA-TM-37 (v2.2-20-Nov-10)
PROJECT
• AN ACTITY IN WHICH FINANCIAL RESOURCES
ARE EXPENDED TO CREATE CAPITAL ASSETS
THAT PRODUCE BENEFITS OVER AN
EXTENDED PERIOD OF TIME AND WHICH
LOGICALLY
LENDS
ITSELF
TO
PLANNING,FINANCING AND IMPLEMENTING
AS A UNIT.
ACA-TM-37 (v2.2-20-Nov-10)
ETERNAL TRIANGLE OF PROJECT MANAGEMENT
QUALITY
ACA-TM-37 (v2.2-20-Nov-10)
Project Cycle
Idea/identification
Evaluation
Formulation
Monitoring
Implementation
Appraisal
ACA-TM-37 (v2.2-20-Nov-10)
WHY APPRAISE POJECT
• TO DETERMINE IF COMPONENTS OF PROJECT ARE
CONSISTENT
• TO ASSESS SOURCES AND MAGNITUDE OF RISKS AND
THEIR MANAGEMENT
• FINANCIAL/ECONOMIC VIABILITY OF
PROJECT
• DECISION ON GOOD OR BAD PROJECTS
ACA-TM-37 (v2.2-20-Nov-10)
PROJECT APPRAISAL
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TECHNICAL
COMMERCIAL
ENTERPRENEURIAL
FINANCIAL
ECONOMIC
MANAGERIAL
SOCIAL
ENVIRONMENTAL
ACA-TM-37 (v2.2-20-Nov-10)
FINANCIAL APPRAISAL
• UNDISCOUNTED CASH FLOW
METHOD
• DISCOUNTED CASH FLOW METHOD
ACA-TM-37 (v2.2-20-Nov-10)
COMPONENTS OF CASH FLOW
• INITIAL INVESTMENT
• OPERATING CASH FLOW
• TERMINAL CASH FLOW
ACA-TM-37 (v2.2-20-Nov-10)
Bankability / Repayment Schedule
• Will the borrower be able to repay the
loan + interest within repayment period?
• Repayable surplus
Generally 50% of gross surplus for small
borrowers
75% of gross
borrowers
surplus
for
large
Contd…..
ACA-TM-37 (v2.2-20-Nov-10)
Bankability / Repayment Schedule
• Repayment Schedule Types
1. Equal Principal Installment
Loan (Principal)
+ Accrued
Interest
No of Installment
It changes (reduces) over time
Contd……
ACA-TM-37 (v2.2-20-Nov-10)
Economic Life of Project
(Rs.)
Years
1
2
3
4
5
6
Aggregate
Benefits
1000
1000
1100
1100
1100
1100
Fixed Cost
1000
-
-
-
-
-
Operation &
Mainten. cost
100
100
100
100
100
100
Production
cost
200
200
200
200
200
200
Total
1300
300
300
300
300
300
Net
Benefit/Surplu
s
-300
700
800
800
800
800
Costs Incurred
ACA-TM-37 (v2.2-20-Nov-10)
Discounted Measures of Project
Worth
• Used in financial analysis
• Future stream of benefits and Future Stream
of costs
• Reduced to present worth
• Present worth of costs and present worth of
benefits during the project life is compared to
know which project gives maximum benefits
ACA-TM-37 (v2.2-20-Nov-10)
Time Value of Money
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Money has value
Different values at different times
Preference for smaller sums today
Than larger sums at future date
ACA-TM-37 (v2.2-20-Nov-10)
Concept of Interest
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For getting larger sum at future date
Part with the present sum
Forego the use of money for present
We expect reward/benefit - interest
Interest - payment for foregoing use of money
by person to whom it is lent.
ACA-TM-37 (v2.2-20-Nov-10)
Compounding (Future Worth)
• Interest determines price of money
• Compounding:: Future worth of present
money at a specified interest rate
• Discounting: Present worth of future money
at a specified interest rate.
• Discount Factor also called Present Worth
Factor
ACA-TM-37 (v2.2-20-Nov-10)
Compounding-Illustration
Sl.
No
.
Year
Amount at
the
beginning of
the year
Rate of
interest
factor
(9%)
Amount
promised at
the end of
the year
1
2
3
4
(3X4)=5
1
2010
650
1.09
708
2
2011
708
1.09
772
3
2012
772
1.09
841
4
2013
841
1.09
917
5
2014
917
1.09
1,000
ACA-TM-37 (v2.2-20-Nov-10)
(e) Discounting - Illustration
( Rs.)
S.
No.
Year
Amt.
promised at
the end of the
year
Rate of
Interest
Factor
Amt. (in Rs.)
worth at the
beginning of
the year
1
2
3
4
(3/4)=5
1
2014
1,000
1.09
917
2
2013
917
1.09
841
3
2012
841
1.09
772
4
2011
772
1.09
708
5
2010
708
1.09
650
ACA-TM-37 (v2.2-20-Nov-10)
Techniques in Discounted Measures
• Benefit Cost Ratio
• Net Present Worth / Value (NPW/NPV)
• Internal Rate of Return (IRR)
ACA-TM-37 (v2.2-20-Nov-10)
Benefit Cost Ratio
Total of Present Worth of Benefits = BCR
Total of Present Worth of Cost
• For selection of project BCR should be more than 1
when discounted at opportunity cost of capital
• Broad idea of profitability of the project
ACA-TM-37 (v2.2-20-Nov-10)
Benefit Cost Ratio
•
Year
Investment
cost
Benefits
DF
@15%
PW of
costs
( 2x4)
PW of
benefits
(3x4)
1
2
3
4
5
6
0
1000
-
1.000
1000
-
1
-
400
0.870
-
348
2
-
500
0.756
-
378
3
-
500
0.658
-
329
Total
1000
1400
1000
1055
1055 :1000
1.055 : 1
BC
Ratio
ACA-TM-37 (v2.2-20-Nov-10)
Benefit Cost Ratio (contd)
Present worth
of benefit
Present worth
of cost
Net present
Benefit
BC Ratio
Project (Rs)
A
B
C
500
10000
1000
400
8000
900
100
2000
100
1.25
1.25
1.11
ACA-TM-37 (v2.2-20-Nov-10)
Benefit Cost Ratio (contd)
Cannot be used to compare 2 projects
projects may have same BC Ratio but net
benefits vary
 projects may have same net benefit but BC
Ratio varies
ACA-TM-37 (v2.2-20-Nov-10)
Net Present Worth (NPW)
• Present Worth of Benefits minus Present
Worth of Cost
• NPW should be positive at opportunity cost of
capital
• Indicates size of benefits at opportunity cost
of capital which BC Ratio cannot indicate
• Cannot rank project by size of NPW
ACA-TM-37 (v2.2-20-Nov-10)
Net Present Worth
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Year
Invest
ment
cost
Benefits DF @15 PW of
%
costs
( 2x4)
PW of
benefits
(3x4)
1
2
3
4
5
6
0
1000
-
1.000
1000
-
1
-
400
0.870
-
348
2
-
500
0.756
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378
3
-
500
0.658
-
329
Total
1000
1400
1000
1055
NPW
1055 1000
ACA-TM-37 (v2.2-20-Nov-10)
55
Internal Rate of Return
• Discount Rate at which PWB = PWC
OR
• Net Present Worth of Cash flow is zero
• Earning capacity of money invested in the
project over project life
• Helps in ranking the project
ACA-TM-37 (v2.2-20-Nov-10)
Internal Rate of Return (contd)
• Found out by Trial and Error method
• Discount rate increased in multiples of 5 (1520, 20-25, etc.)
• NPW decreases as discount rate increased
• Through trial and error a stage reached when
NPW becomes negative
• IRR found out by interpolation
ACA-TM-37 (v2.2-20-Nov-10)
Internal Rate of Return (IRR)
IRR = Lower
Difference
Discount between
Rate
+ the two
discount
rates
ACA-TM-37 (v2.2-20-Nov-10)
NPW at lower
discount rate
Absolute
difference
between NPWs
at two
discount
rates
Net Present Worth
Year
Investment Benefits DF @ 20 % PW of
cost
costs
( 2x4)
PW of
benefits
(3x4)
1
2
3
4
5
6
0
1000
-
1.000
1000
-
1
-
400
0.833
-
333
2
-
500
0.694
-
347
3
-
500
0.579
-
289
Total
1000
1400
1000
969
969 1000
(-) 31
•
NPW
ACA-TM-37 (v2.2-20-Nov-10)
Internal Rate of Return
• Internal Rate of Return ( IRR ) :
 Lower of the two discount rates (+ ) Difference between two discount rates x (NPW
@ lower discount rate :- Absolute difference between NPWs at two discount rates )
IRR=
15 + 5 x ( multiplied by )
55 :- 86 ( 55+-31)
= 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 (v2.2-20-Nov-10)
FORCE FIELD ANALYSIS-WORKSHEET
Forces for
change
Costumers want
new product
Enhance speed
of production
Increase volume
of output
Minimize
maintenance
cost
TOTAL
Score
4
2
3
1
Developed by
Kurt Lewin
CHANGE
PROPOSAL
UPGRADE
FACTORY
WITH
NEW
MACHINERY
10
ACA-TM-37 (v2.2-20-Nov-10)
Score Forces against
change
3
3
1
3
Staff not happy
with loosing OT
1
11
Disruption in
work
Fear of New
technology
New technology
Environ. Impact
Increase in Expe
nses on a/c of
new technology
TOTAL
FORCE FIELD ANALYSIS .. CONTD
 Training the staff - Increase in Expenditure : (+ 1)
 Fear of technology could be eliminated after training-Reduce fear:(-2)
 Impress staff-change is inevitable for survival-New force in favor:(+1)
Impress staff that new machines would introduce variety and interest
to their jobs - New force in favor : (+1)
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 Increase wages to reflect new productivity –
Increase in Expenditure :(+1)
& Reduce in loss of overtime : (-1)
 Propose installation of slightly different machines with filters to
eliminate pollution – Reduce environmental impact : (-1)
These changes would swing the balance from 11 : 10
(against the plan), to 9 : 12 (in favor of the plan).
ACA-TM-37 (v2.2-20-Nov-10)
Forces for
CHANGE
Score FORCE FIELD ANALYSIS Score
REVISED SCORES
Forces against
CHANGE
Costumers want
new product
4
3-1
Staff not happy
with loosing OT
Enhance speed of
production
2
3-2
Fear of New
technology
Increase volume
of output
3
Minimize mainte
nance cost
1
Impress staff-cha
nge is inevitable
1
Impress staffvariety of work
1
TOTAL
CHANGE
PROPOSAL
UPGRADE
FACTORY
WITH
NEW
MACHINERY
12
ACA-TM-37 (v2.2-20-Nov-10)
1-1
New technology
Environ. Impact
3+1+1
Increase in
Expenditure
1
Disruption in
work
9
TOTAL
Case exercise on project -financial
appraisal
Case:MI Project
• A farmer having a water source like open well or canal nearby would like
to invest on a pumpset to lift water. Presently, he is cultivating only a
single crop and getting a net benefit of Rs.3,000 (pre development
income) per year
• On installation of pumpset, it would be possible to take two crops with
some additional expenditure. First year he projects raising of one crop, as
it is assumed that the installation of pumpset might take some time.
Therefore, during first year, the production expenditure is estimated as
Rs.4,500 for single crop, with a projected benefit of Rs.8,000 (benefit
assumed to be increased from Rs.3,000 to Rs.8,000 due to irrigation)
Contd...
ACA-TM-37 (v2.2-20-Nov-10)
ACA-TM-37 (v2.2-20-Nov-10)
All the Best
Thank You
ACA-TM-37 (v2.2-20-Nov-10)