Project Financing 1

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INTRODUCTION

OVERVIEW:

Today India is on a threshold of massive development, thanks to the various initiatives

taken by the Govt. of India over the last 10 years or as we call it the Dawn of the era of

liberalization. The economics policies have been liberalized time and again to

accelerate the process of industrial growth. The government is making constant efforts

to encourage the entrepreneurs by providing the climate conducive for development

and growth. as a result of which various projects are coming up and due to which

various applications are being received by state and national financial institutions for

financial assistance. Project finance is thus becoming a field of specialization in itself.

There is an ever increasing thrust on the capital formation and this capital formation is

done in any economy through massive infrastructure projects like setting up a new

industry , launching of the green field projects to name a few. Apart form this the Govt.

of India has identified certain core factors through which it can make a quantum leap in

the area of foreign exports namely the IT sector and the Pharma sector. And due to the

competitive advantage that India has because of its labour force, which ids highlyskilled and at the same time available very cheap, the Pharma Industry in India is set

for growth.

But at the same time Pharma industry is a different type of industry altogether and it

has own set technical requirement and also its own capital and financial requirements.

Through this project I would like to bring forward the various details which are of up

most importance and importance to the Pharma industry right form the setting up to

actual growth prospects and have also enclosed in section 2 a detailed case study by

which the various complexity are discussed along with the DPCO guidelines 1995.

The project also attempts to provide an insight into the various critical aspects of

preparation and submission of a project report to the financial institutions and how the

financial institutions deals with the analysis of the same.

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And based on the technical details of the project report, financial institutions also uses

various key financial indicators to ensure the soundness of the project. Hence, the

project also aim at providing certain guidelines to the promoters to make a sound and

healthy project report by considering various risks and uncertainties into consideration.

Attempt is made to explain the same with help of a case study in section 2 of the

project report.

A sound Project report acts a strong back up for the promoter to avail finance from

various alternative sources of financing. Various types of finance schemes are available

to promote the growth of the industry not only of setting up of the company

But also helps it to sustain stability during the initial crucial period.

There are certain vital aspects related to a success of a project.

They are namely;

Technically feasible

Commercially desirable

Financially sound

Environment friendly

Managed by sound promoters

Adequately secured

Level of risk commensurate with the overall business risk and its corresponding

returns.

The entrepreneur has to look into details of al the above aspect to ensure that the

project will yield better results for the organization.

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A Project Report

A common occurrence

Many people plunge into business and expect success without adequate consideration

and planning, just as a student might register for a course simply because it sounds

interesting. If this student has to gain from the course and do well in the exams, she

would have to plan her studies carefully. Similarly, an aspiring new entrepreneur has to

plan her business activities carefully. Luck may be a contributing factor for success, but

good planning is crucial.

Planning is essential

Thousands of new businesses are established each year -- and many fail. The failure

may be because of poor locations or of inferior products or services. Many businesses

are started with inadequate capital and run out of money before they have a chance to

succeed. Whatever the cause for failure, poor planning is often at the root of it.

Good business planning envisages a match between aptitudes, interest, personality and

expectations. So remember, "A business without a plan is like a ship without a rudder.

Before long it will flounder and sink."

The first stage in proper planning is the preparation of the Project Report.

What is a Project Report?

The project report is a pre-investment comprehensive study of investment proposals,

which encompasses a thorough investigation relating to economic, technical, financial,

social and commercial aspects of your business. It is a working plan for the

implementation of your business proposals; a written record of your business project

from start to finish. This written document is also your spokesperson, when you are not

present, to explain your project. But, more importantly, it documents all your work and

evaluates the viability of your business before it is undertaken. So it's the key document

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if you seek loans from financial institutions and banks; they require the project report to

evaluate the desirability to finance your project.

How to prepare Project Report

When read by a person unfamiliar with your project, the report should be clear and

detailed enough for the reader to know exactly:

* What you intend to do and why;

* What will be the results of your venture.

* What experimental evidence is available to support your hypothesis; and

* Where did you get your research information.

If you can achieve this, then half your battle is won, as they say, "well begun is half

done."

Overall structure of the Project Report

It is important that a project report gives the readers a clear idea or feel of the project. If

you do not grasp the contents of the initial few pages then you tend to lose interest and

skim idly through the remaining pages. The project report, therefore, has two purposes.

First, it has to create an initial impression, and then it has to fill in the details after the

message has been conveyed to the readers. It should proceed from the general overview

stated in the initial pages to the more detailed considerations as the project is read.

You should neatly prepare your project report and make it more readable by including

graphs, diagrams and tables. If possible, use a computer to design the data displays. A

good report will include the following sections:

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Title page of the Project Report

The title of your project should grab the readers' attention and should capture the theme

of your project.

Abstract

An abstract is a brief overview of your business venture and includes the main purposes

and objectives of the business, a detailed work plan of the project, the time profile and

the main results and outcomes.

Introduction

The Introduction should include information about your business, its status, present

production, demand pattern, broad market trend, export potential, if any, project cost,

projected profitability, cash flows and targets.

Line of Action of your Project

The successful implementation of your project depends upon the line of action as

suggested in the project report. It should mainly analyze the following factors:

*Market Research to forecast demand for goods and services and establish objectives

relating to market leadership and mobilize customers.

* Financial analysis to project future cash flows, profitability, cost benefit analysis,

profit planning, budgeting and resource allocation.

* Economic Analysis suggesting to adopt optimal technology for project size and to

explore economic conditions to absorb the project.

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* Project Design i.e. detailed work plan of your project and its time profile.

Let me substantiate this with an example. Designing bags is a relatively unexplored

field gaining prominence as a promising and rewarding business.

Market Research in this project will involve finding the right contractor, the right

materials and the emerging trend on the fashion scene in order to be a sell out. When it

comes to materials you have a variety ranging from suede, leather, fake fur to jute and

brocade. Also you will have to find out the latest innovations in, for instance, colours

ranging from shocking brights to mellow pastels and animal prints. You may also want

to source the latest in fancy buckles, beads and stones.

Financial Analysis will involve projecting your working capital based on your market

research. In the bags, for instance, you will need funds for equipment like sewing

machines and the material required to make the bags and accessories like handles,

buckles etc.

Economic Analysis will involve deciding an optimum size for your project based on

the demands and latest trends in the market. For instance, of late, jute bags are popular.

So could start your project by designing more of jute bags than bags of other material.

Project Design will involve making a detailed analysis of your project and its gestation

period. For bags you will have to tap the right sources for raw material, accessories, etc.

The conclusion summarizes what you discovered based on your experimental results.

It should state your proposition and indicate that the data you have collected supports it.

It should also include a brief description of plans for exploring ideas for future

research.

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The sources:

Prepare a

Bibliography for the written material you have sourced.

A list of the people you have interviewed, in alphabetical order by their last name.

Also provide their titles and, with their permission, give their business addresses and

telephone numbers. Avoid listing home addresses and telephone numbers.

PROJECT FINANCE:

History of Project Finance

Project financing is not a new financing technique. Venture-by-venture financing of

finite-life projects has a long history; it was, in fact, the rule in commerce until the 17th

century. For example, in 1299 - nearly 700 years ago - the English Crown negotiated a

loan from the Frescobaldi ( a leading Italian merchant bank of that period) to develop

the Devon silver mines. The loan contract provided that the lender would be entitled to

control the operations of the mines for one year. The lender could take as much refined

ore as it could extract during that year, but it had to pay all costs of operating the mines.

There was no provision for interest. The English Crown did not provide any guarantees

(nor did anyone else) concerning the quantity or quality of silver that could be extracted

during that period. Such a loan arrangement was a forebear of what is known today as

theproduction payment loan.

CONCEPT OF PROJECT FINANCING:

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Project financing refers to the means of finance employed for meeting the cost of the

project. The means of finance refers to the long-term sources of finance used for

meeting the cost of the project.

Sources of finance :-

Equity capital and preference capital

Convertible and non-convertible debentures

Rupee term loans

Deferred credit

Sales tax deferment and exemption

Unsecured loans and deposits, etc.

What is Project Finance?

Project Finance (unique approach to "off-balance sheet, non-recourse" financing)

Project financing is an innovative and timely financing technique that has been used

on many high-profile corporate projects, including Euro Disneyland and the Euro

tunnel. Employing a carefully engineered financing mix, it has long been used to fund

large-scale natural resource projects, from pipelines and refineries to electric-generating

facilities and hydro-electric projects. Increasingly, project financing is emerging as the

preferred alternative to conventional methods of financing infrastructure and other

large-scale projects worldwide.

Project Financing discipline includes understanding the rationale for project financing,

how to prepare the financial plan, assess the risks, design the financing mix, and raise

the funds. In addition, one must understand the cogent analyses of why some project

financing plans have succeeded while others have failed. A knowledge-base is required

regarding the design of contractual arrangements to support project financing; issues

for the host government legislative provisions, public/private infrastructure

partnerships, public/private financing structures; credit requirements of lenders, and

how to determine the project's borrowing capacity; how to prepare cash flow

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projections and use them to measure expected rates of return; tax and accounting

considerations; and analytical techniques to validate the project's feasibility.

CHARACTERISTICS OF PROJECT FINANCING

A separate project entity is created that receives loans from lenders and equity from

sponsors

Component of debt is very high in project financing

Debt services and repayments entirely depend on the projects cash flows

Project assets used as collateral for loan repayments

Project financing - most appropriate for projects involving large amount of capital

expenditure and involving high risk.

Financial assistance is granted to the project based on the total project cost. A project in

a small scale sector would be financed by banks and/or State financial corporations and

state Industrial Development Corporation. The project could be financed any one of the

institutions or in consortium with each others. This is determined by the total

requirement of loan funds for the project.

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Feasibility Studies

To implement any project, the entrepreneur needs to carry out different types of

feasibility studies. These feasibility studies evaluate all the risks and returns and tries to

balance them and help the entrepreneur to finalize his plans. It enables the company to

anticipate problems that are likely to be encountered in the execution of the project and

places it in better position to respond to all the queries that may be raised by financial

institutions and others concerned with the project.

Different feasibility studies include:

Managerial Feasibility

Every business has different requirements from the management. Businesses, which are

complex, require significant experience on part of top management to run it.

Management expertise is not only technical know-how but also in understanding

market dynamics, ability to distribute product effectively, manage manpower and

environment.

In cases where a MNC, which has a long track record and significant experience, is

implementing a project, it would be an added comfort about management feasibility. In

businesses, which are technologically driven based on intellectual capital, technocrats

would be preferred.

The ultimate success of even a very well conceived project lies upon how competently

it is managed. Besides project implementation, other important function required to be

controlled can be broadly classified

Economic Feasibility

The project has to generate an acceptable rate of return, which adequately covers your

cost of capital. The expected rate of return depends on the risk profile of the project. In

a rational economic world, nobody implements a project to make losses. In other words

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net present value has to be positive if you discount the cash flows by the desired rate of

return.

Commercial Feasibility (Availability Of Key Factors)

We would like to distinguish between commercial feasibility and economic feasibility.

Commercial feasibility refers to availability of raw material, skilled labor,

infrastructure, and other factors of production. A number of projects have run into

rough weather due to poor commercial viability. One of the classic examples of this is a

cycle factory which was set up in Baroda, Gujarat. The management was good, market

survey showed existence of a good market and the government was giving fiscal

incentives. What was overlooked was availability of skilled labor. Bicycle assembly is

a hard work and labor in Gujarat is used to process industries. Therefore the project

failed. The center of the bicycle industry is Ludhiana where native Punjabis/ Sikhs are

sturdy people and used to hard work and have requisite skills in assembly of bicycles.

Financial Feasibility

The ability to raise money to implement the project is of paramount importance. The

promoter should be capable of raising funds either from his own sources or from banks

and institutions. One area that often gets overlooked is contingency planning. In most

cases, the first generation entrepreneur has problems in raising funds to implement his

project, and even if he does so, he lacks staying power and is not able to withstand

unforeseen problems like delays and overruns.

Technical Feasibility

An entrepreneur should have the requisite number of technically capable people as well

as technology required to set up and run the plant. The technology should be such that

is could adapt to local conditions. Technology transfer from overseas often fails in this

regard. The conditions in USA and America are quite different from India. Most parts

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of India are hot and dusty. Sophisticated process controls have known to fail.

Therefore, knowledge and suitability to local conditions is very important.

Social Feasibility

Many a time plants may be viable economically and financially but would be socially

undesirable. An example would be dyes units, which have mushroomed around

Ahmedabad. These are polluting and generate effluents not acceptable to the society

and environment. In the last 5 years, India is slowly becoming environment conscious

and friendly. So using hazardous chemicals or polluting industries may not get the

necessary clearances. For instance, the state government has ordered closure of all dyes

units in Gujarat unless suitable effluent treatment is implemented.

Market Feasibility

This is a critical analysis because the output of any factory has to sell in the market

place for the promoter to earn revenues. Very often demand analysis and projections

are optimistic leading to problems in the future. Another observation has been that

products that sell abroad may not have a market in India. India, in general is a cost

conscious market and the promoter has to keep this in the back of his mind. T series

with its low priced cassettes met phenomenal success.

ENVIRONMENTAL ASPECTS:

The project should be sensitive to the demand of the environment

Environmental concerns highly significant today

Key questions raised in ecological analysis:

o What is the likely damage caused to the environment?

o What is the cost of the restoration measures?

Environmental planning evaluates the likely impact of a project on the environment

and suggests remedial action to minimize damage.

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MANAGEMENT BY SOUND PROMOTORS

The promoters form the backbone of every project. While a bad promoter can make a

mess of a good project, a good promoter can make a success of a weak project.

Following are the qualities of sound promoters:

Willingness to make sacrifices

Leadership skills

Decisiveness

Confidence in the project

Marketing orientation

Strong ego.

While new promoters and technocrats are being encouraged, care is taken to ensure that

all the aspects of managing an industrial enterprise have been carefully considered. The

promoters are appraised by the institutions to ensure that they have the requisite

resourcefulness, undertaking, commitment and ability to manage the unit.

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The resourcefulness of the promoters is gauged from their business experience,

organization of offices, know-how, approvals and sanctions required for the project and

the ability to organize and present the project to the institution with the understanding

and credibility.

The understanding of the promoters is gauged by the details submitted to the

institutions and the manner in which the additional information sought by the

institutions is furnished.

The commitment of the promoter is determined from the desire to plan the long term

objectives or be satisfied with short term gains. In addition to these provisions for

recruitment and training requisite personnel in the field of production, administration

and management are assessed. This is shown by he time schedule indicated for

implementation of the project and package for the retention of the personnel.

Criteria for Promoters Appraisal:

A. Managerial attributes.

1. Ability to plan

2. Clarity of goals and objectives

3. Ability to organize

4. Ability to select right kind of people.

5. Ability to lead and motivate

6. Ability to procure right kind of equipment and spares.

7. Ability to direct.

8. Ability to control

9. Knowledge of finance or technology.

10. Production ability

11. Marketing and sales ability

12. Problem solving capability

13. Readiness to delegate

14. Communication skills

15. Human relations skills

16. Forecasting abilities

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17. Leadership style

18. Ability to co-ordinate

19. Consistency

B. Entrepreneurial attributes.

1. Ability to take calculated risk.

2. Commitment to project.

3. Perception of market opportunity.

4. Willingness to take new challenges.

5. Readiness to co-operate.

6. Positive self-confidence

7. Ability to create a following

8. Creativity and innovation.

9. Initiative and drive.

10. Resourcefulness.

11. Achievement motivation

12. Perseverance and persistence

13. Quality consciousness.

14. Inquisitiveness.

15. Desire to change.

16. Absence of dissatisfaction.

17. Independence in thinking.

18. Flexibility and adaptability.

19. Attitude to ambiguity.

20. Learning from failure.

21. Cohesiveness.

C. Personal Attributes.

1. Appearance.

2. Level of education.

3. Business experience.

4. Experience relevant to project being financed.

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5. Technical capacity.

6. Maturity.

7. Ability to get along with others.

8. Financial support and stability.

9. Supportive family background.

10. Ability to raise finance from outside sources.

11. Social, economic and industrial awareness.

12. Resourcefulness.

13. Intelligence.

14. Patience.

15. Honesty and noble mindness.

PROJECT RISKS:

Two main sources of risk:

o Business risk

o Financial risk

A project should ideally have the ability to raise further capital from any sources it

wishes to tap to meet the future financing needs

Sensitivity analysis is a popular method used for assessing risk.

Risk analysis of a project is one of the most complex areas in finance.

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PROJECT APPRAISAL BY FIS

A project report is essential before a decision for setting up of any project is taken. We

have seen that an entrepreneur must study all the aspect of the project including the

product to be manufactured. An assessment of the total cost of the project and proposed

means of financing with emphasis on overall profitability of the project is necessary.

Project report must therefore include all these information and cover entire aspects of a

project to stand scrutiny by financial institutions who shall appraise the project from the

following angles before taking any decision to grant term loans.

The feasibility of a project can be ascertained in terms of technical factors, economic

factors, or both. A feasibility study is documented with a report showing all the

ramifications of the project. In project finance, the pre-financing work (sometimes

referred to as due diligence) is to make sure there is no "dry rot" in the project and to

identify project risks to ensure they can be mitigated and managed in addition to

ascertaining "debt service" capability.

Technical Feasibility. Technical feasibility refers to the ability of the process to take

advantage of the current state of the technology in pursuing further improvement. The

technical capability of the personnel as well as the capability of the available

technology should be considered. Technology transfer between geographical areas

and cultures needs to be analyzed to understand productivity loss (or gain) due to

differences (see Cultural Feasibility).

The

Product mix

Location

Land and building

Capacity

Process of manufacture technology employed

Plant and equipments

Collaboration

Manpower requirements and break - even point

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Power and water supply

Effluent disposal

Implementation schedule

Managerial Feasibility. Managerial feasibility involves the capability of the

infrastructure of a process to achieve and sustain process improvement. Management

support, employee involvement, and commitment are key elements required to

ascertain managerial feasibility.

Focus on larger social point of view

Methodology adopted is referred to as the social cost benefit analysis

Assessing integrity, caliber and resourcefulness of the promoters

Assessing understanding of the promoters

Quality of the management

Assessment of

o Entrepreneur

o Board of directors

o Chief Executive

o Departmental heads

Economic Feasibility. This involves the feasibility of the proposed project to generate

economic benefits. A benefit-cost analysis and a breakeven analysis are important

aspects of evaluating the economic feasibility of new industrial projects. The tangible

and intangible aspects of a project should be translated into economic terms to facilitate

a consistent basis for evaluation.

Financial Feasibility. Financial feasibility should be distinguished from economic

feasibility. Financial feasibility involves the capability of the project organization to

raise the appropriate funds needed to implement the proposed project. Project

financing can be a major obstacle in large multi-party projects because of the level of

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capital required. Loan availability, credit worthiness, equity, and loan schedule are

important aspects of financial feasibility analysis.

Assessing reasonableness of the estimate of capital cost

Assessing reasonableness of the estimate of working results

Assessing adequacy of rate of return: (general norms: - IRR - 15%, ROI - 20-25%

after tax and DSCR - 1.5 to 2)

Assessing appropriateness of the financing pattern: (general debt - equity ratio

norm of 1.5 : 1, promoters contribution - 12.5% to 22.5% of project cost, etc)

Cultural Feasibility. Cultural feasibility deals with the compatibility of the proposed

project with the cultural setup of the project environment. In labor-intensive projects,

planned functions must be integrated with the local cultural practices and beliefs. For

example, religious beliefs may influence what an individual is willing to do or not do.

Social Feasibility. Social feasibility addresses the influences that a proposed project

may have on the social system in the project environment. The ambient social structure

may be such that certain categories of workers may be in short supply or nonexistent.

The effect of the project on the social status of the project participants must be

assessed to ensure compatibility. It should be recognized that workers in certain

industries may have certain status symbols within the society.

Safety Feasibility. Safety feasibility is another important aspect that should be

considered in project planning. Safety feasibility refers to an analysis of whether the

project is capable of being implemented and operated safely with minimal adverse

effects on the environment. Unfortunately, environmental impact assessment is often

not adequately addressed in complex projects. As an example, the North Americal Free

Trade Agreement (NAFTA) between the U.S., Canada, and Mexico was temporarily

suspended in 1993 because of the legal consideration of the potential environmental

impacts of the projects to be undertaken under the agreement.

Political Feasibility. A politically feasible project may be referred to as a "politically

correct project." Political considerations often dictate direction for a proposed project.

This is particularly true for large projects with national visibility that may have

significant government inputs and political implications. For example, political

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necessity may be a source of support for a project regardless of the project's merits. On

the other hand, worthy projects may face insurmountable opposition simply because of

political factors. Political feasibility analysis requires an evaluation of the

compatibility of project goals with the prevailing goals of the political system.

Environmental Feasibility. Often a killer of projects through long, drawn out

approval processes and outright active opposition by those claiming environmental

concerns. This is an aspect worthy of real attention in the very early stages of a project.

Concern must be shown and action must be taken to address any and all environmental

concerns raised or anticipated. A perfect example was the recent attempt by Disney to

build a theme park in Virginia. After a lot of funds and efforts, Disney could not

overcome the local opposition to the environmental impact that the Disney project

would have on the historic Manassas battleground area.

Market Feasibility. Another concern is market variability and impact on the project.

This area should not be confused with the Economic Feasibility. The market needs

analysis to view the potential impacts of market demand, competitive activities, etc.

and "divertible" market share available. Price war activities by competitors, whether

local, regional, national or international, must also be analyzed for early contingency

funding and debt service negotiations during the start-up, ramp-up, and commercial

start-up phases of the project.

Any project can be commercially viable only if it is able to sell its production at a

profit. For this purpose it would be necessary to study demand and supply pattern of

that particular product to determine its marketability. Various methods such as

regression method for estimation of the demand are employed which is then to be

matched with the available supply of that particular product. The prospect of exporting

that product may also be examined while assessing the demand. If the selling of the

product is already been tie up with the foreign collaborators or some of the other users,

the fact needs to be highlighted. This factor shall definitely have a positive influence on

the commercial viability of the project. Necessary factors that may influence the supply

position such as licensing of new products, introduction of the new products, changes

in the import policy etc., shall be taken into cognizance while estimating the market

potential of any project. this exercise shall be conducted for sufficiently longer period

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say5 to 10 years to determine the continued demand for the product during the currency

of the loan granted by financial institutions. This factors are not only important fro m

the financial institutions point of view but also help the promoter to take aright

decision in selecting the size of the plant and determining the capacity utilization.

The financial institutions look into following considerations in considering the

marketing appraisal of the project;

Product, scope of the market, competition

Special features, quality and price

Examining reasonableness of demand projections (existing and future)

Export possibilities

Assessing adequacy of marketing infrastructure and principal customers

Judging competence of key marketing personnel

Selling arrangements

Trends in price

Scope of Feasibility Analysis

In general terms, the elements of a feasibility analysis for a project should cover the

following:

Need Analysis. This indicates recognition of a need for the project. The need may

affect the organization itself, another organization, the public, or the government. A

preliminary study is then conducted to confirm and evaluate the need. A proposal of

how the need may be satisfied is then made. Pertinent questions that should be asked

include:

Is the need significant enough to justify the proposed project?

Will the need still exist by the time the project is completed?

What are the alternate means of satisfying the need?

What are the economic, social, environmental, and political impacts of the need?

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Process Work. This is the preliminary analysis done to determine what will be

required to satisfy the need. The work may be performed by a consultant who is an

expert in the project field. The preliminary study often involves system models or

prototypes. For technology-oriented projects, artist's conception and scaled-down

models may be used for illustrating the general characteristics of a process. A

simulation of the proposed system can be carried out to predict the outcome before the

actual project starts.

Engineering & Design. This involves a detailed technical study of the proposed

project. Written quotations are obtained from suppliers and subcontractors as needed.

Technology capabilities are evaluated as needed. Product design, if needed, should be

done at this time.

Cost Estimate. This involves estimating project cost to an acceptable level of

accuracy. Levels of around -5% to +15% are common at this level of a project plan.

Both the initial and operating costs are included in the cost estimation. Estimates of

capital investment and of recurring and nonrecurring costs should also be contained in

the cost estimate document. Sensitivity analysis can be carried out on the estimated

cost values to see how sensitive the project plan is to the estimated cost values.

Financial Analysis. This involves an analysis of the cash flow profile of the project.

The analysis should consider rates of return, inflation, sources of capital, payback

periods, breakeven point, residual values, and sensitivity. This is a critical analysis

since it determines whether or not and when funds will be available to the project. The

project cash flow profile helps to support the economic and financial feasibility of the

project.

Project Impacts. This portion of the feasibility study provides an assessment of the

impact of the proposed project. Environmental, social, cultural, political, and economic

impacts may be some of the factors that will determine how a project is perceived by

the public. The value added potential of the project should also be assessed. A value

added tax may be assessed based on the price of a product and the cost of the raw

material used in making the product. The tax so collected may be viewed as a

contribution to government coffers.

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Conclusions and Recommendations. The feasibility study should end with the overall

outcome of the project analysis. This may indicate an endorsement or disapproval of

the project. Recommendations on what should be done should be included in this

section of the feasibility report.

COST OF THE PROJECT

It is very important to estimate each constituent of the project cost with utmost care. As far

as possible, the estimate should be based on the supporting data. Care should be taken to

ensure sufficient cushion for the unforeseen factors as well as for the as well the

inflationary trends. The cost of the project is estimated after assessing the critical process

parameters and the suitability of the technology for manufacturing the proposed product

under Indian scenario.

Critical factors affecting the cost of the project:

Production Technology:

Suitability of the technology needs to be evaluated in terms of the soundness, raw

material capital investment involved, cost of production and absorption capacity of the

promoters. during the appraisal the institution may insist on visiting the site using same or

similar technology to evaluate its feasibility and longevity.

Raw Material and Inputs:

Raw material used for manufacturing should be easily available preferably under

OGL (Open General License)

Capital and Product Mix:

The capacity of the unit should be so planned that the cost of the production of the

product is optimal. The plant capacity should be so installed to ensure maximum

profitability.

The installed capacity should also have the flexibility for future expansion and

diversification at the minimal additional capital expenditure.

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Broad heads of the Cost of the Project :

Land, location and site development.

Building and civil work.

Plant and machinery

Technical know-how and engineering fees/royalty.

Miscellaneous fixed assets.

Utilities

Preliminary and pre-operative expenses

Provision for contingencies. Margin money for working capital.

NORMS AND POLICIES OF FINANCIAL INSTITUTIONS:

ELIGIBILITY

Till recently, long - term loans were provided to concerns in certain industries

only and denied to concerns in industries placed on the negative list

Gradual shift in policy

Currently, inclination of FIs to finance almost every kind of industry

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DEBT - EQUITY RATIO

One of the important factor which determines the components for the financing of aproject is the debt equity ratio. There are certain guide lines prescribed by IDBI for

debt equity ration for different category of industries. They are;

General debt - equity norm for medium and large scale projects is 2 : 1

General debt - equity norm for small scale projects is 3 : 1

However it has been learnt that financial institutions these days require debt equity

ration of 1.5 : 1 for medium to large scale industries.

PROMOTERS CONTRIBUTION

FIs require promoters to contribute 25 to 30% of the project cost

This is lowered selectively in certain cases like capital-intensive projects, high

priority projects, etc

THE GOVT OF India has classified the location in three categories;

A category: No industry districts,

B category: Where Industrial activities have already started.

C category: Where Industrial activity has gained sufficient ground

The promoters contribution may reduce as we move from C to A in order to

promote industrial growth in backward areas.

The promoters contribution is also reduced for the non-MRTP companies.

FOREIGN CURRENCY LOANS :

In case of large projects involving heavy capital equipments, foreign currency loans are

emerging as an important source of project finance. The department of Economic

Affairs, Govt. of India, specifically permits borrowing in foreign currency loans in

respects of specific projects.

Apart from rupee term loans, FIs also provide foreign currency loans

This assistance is now provided only for the import of capital equipment

There are two types of foreign currency borrowings;

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Fixed rate borrowings: funds that can be borrowed on fixed interest rates.

Floating rate borrowings: funds that can be raised on floating rates of interest..

Fixed rate of borrowing insulate the borrower against the movements in the interest

rates.

KEY FINANCIAL INDICATORS USED BY FIS

Internal rate of return (IRR)

Internal rate of return is defined as the discount rate which equate the present value of

the investment in the project to the present value of the future returns over the life of

the project. this is an indicator of the earning capacity of the project and a higher IRR

indicates better prospects for the project. the present investment in cash outflow which

is assumed to be negative cash flow and returns are assumed to be positive cash flow.

The sum total of the discounted cash flows shall be zero or as near to zero as possible.

The rate of discount applied to bring the sum total to zero as above is the IRR.

Cash outflows and cash inflows of the project taken into consideration

Ideally, IRR should be 15% or more

Debt Service Coverage Ratio (DSCR):

Debt service coverage ration is calculated to find out the capacity of the project

servicing its debt i.e. in repayment of the term borrowing and interest. The Debt servicecoverage ratio is worked out in following manner.

DSCR = Net PAT + Depn. + Interest on long term borrowing

(Repayment of term borrowing during the year

+Interest on long term borrowing.)

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The higher DSCR would impart intrinsic strength to the project to repay its term

borrowing and interest as per the schedule even if some of the projections are not fully

realized. Normally a min. DSCR of 2:1 is insisted upon by the term lending institutions

and repayment is fixed on that basis.

Break-even Point:

Estimation of working results pre-supposes a definite level of production and sales and

all calculations are based on that level. It may, however, not be possible to realise those

levels at all times. The minimum level of production and sale at which the unit will run

on no profit no loss is known as beak even point can be expressed in terms of

volume of production or as percentage of plant capacity utilisation.

The cost of production may be divided in two parts as under :

Fixed costs : These costs are not related to the volume of production and

remain constant over a period of time. Examples of such costs include rent of building,

depreciation, interest on term loans etc, salaries of permanent employees etc.

Variable costs : These costs have direct relationship with the column of

production. The costs will increase with any increase in the level of production.

Examples of such costs include raw material, fuel and power, wages, packaging etc.

Sensitivity Analysis :

It may also be sometimes necessary to carry out sensitivity analysis which helps in

identifying elements affecting the viability of project taking into account the different

sets of assumptions. While evaluating profitability projections, the sensitivity analysis

may be carried in relation to changes in the sale price and raw material costs, i.e. sale

price may be reduced by 5% to 10% and raw material costs may be increased by 5% to

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10 % and the impact of these changes on DSCR. If the new DSCR, so calculated after

changes, still proves that the project is viable, the financial institution may go ahead in

funding the project.

Net Present Value :

The Discounted Cash Flow (DCF) Technique which is more commonly known as Net

Present Value method(NPV) takes into account the time value of money for evaluating

the costs and benefits of a project. It recognises that streams of cash inflows at different

points of time differ in value. A sound comparison among such inflows and outflows

can be made only when they are expressed in terms of a common denominator i.e.

present values. For determining present values, an appropriate rate of discount is

selected and the cash flow streams then are converted into present values with the help

of rate of discount so selected. If NPV is positive (i.e. difference between present

values of inflows and outflows) the project is taken to be viable and as such proceeded

with otherwise not.

Other indicators: ( Debt equity ratio, Current ratio, Profit margin on sales, Return on

owners equity, ROI after taxes, ROI before taxes)

OTHER INDICATORS

Profit margin on sales = Net profit after tax / Sales

Return on owners equity = NPAT/ promoters cont.+ S/L

Debt - equity ratio = Long term debt / equity

Current ratio = Current assets / current liabilities

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ROI before taxes = PBT + Depn. + Interest / project cost

ROI after taxes = PAT + Depn. + Interest / project cost

MEANS OF FINANCING:

Capital & Reserves ( Net worth )

Net worth is a measure of financial stake of the promoters/owners in, the business and

is also referred to as owned funds. This is an important indicator of intrinsic financial

strength of the concern and is generally compared to the total outside liabilities of the

concern which is discussed in details in subsequent paragraphs. The following items on

the liability side of the balance sheet are added up to find out the net worth :

Ordinary share capital.

Preference share capital (redeemable after 12 years ).

General reserve.

Share premium

Development rebate reserve.

Investment allowance reserve.

Other reserves (excluding provisions ).

Surplus in profit and loss account.

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However, if there is any deficit (carry forward loss) in profit and loss a/c on the assets

side of the balance sheet, the same should be deducted to find out the net worth of the

concern. The value of any intangible assets is also deducted to arrive at the tangible net

worth.

The revaluation reserve, if any, is generally not counted for the purpose of determining

the net worth.

Capital investment in subsidiary/other group companies may also be sometimes

deducted from the net worth/net owned founds to arrive at the correct status of the stake

of owners in the business.

In case of partnership & proprietary concerns any debit balance in the current account

of the partners/proprietor shall also be deducted from partners capital while computing

the net worth.

TERM LOANS:

Term loans represent secured borrowings and at present are the most important source

of finance for new projects. They generally carry a rate of interest varying from 17.5%

to 22%, inclusive of interest tax, depending on the credit rating of the borrower, the

perceived risk of lending and the cost of funds. The interest rates applicable for

different types of financial assistance are indicated in Annexure VII. These loans are

repayable over a period of 6 to 10 years in annual, semi-annual or quarterly installment.

Term loans are provided by banks, state financial / development institutions and all

India term lending financial institutions, Banks and state financial corporations

normally provide term loans to projects in the small scale sector while for the medium

and large industries term loans are provided by state developmental institutions alone

or in participation with banks and state financial corporations. For large scale projects

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or in consortium with other all-India financial institutions, state level institutions and /

or banks.

DEFFERRED PAYMENT GUARANTEE:

Many a time the suppliers of machinery provide deferred credit facility under which

payment for the purchase of machinery can be made over a period of time. Generally,

the entire cost of the machinery is financed and the company is not required to

contribute any amount initially towards acquisition of the machinery. However, in

some cases the financing is done to the extent of 90 percent of the cost of the

machinery. Such a facility does not have a moratorium period for repayment. Hence, it

may be advisable only for an existing profit making company. Normally, the supplier

of machinery insists that bank guarantee should be furnished by the buyer.

UNSECURED LOANS FROM PROMOTERS:

Unsecured loans are typically provided by the promoters to fill the gap between the

promoters contribution required by financial institutions and the equity capital

subscribed to by the promoters or to meet the promoters contribution norm. These

loans are subordinate to the institutional loans and do not carry interest till the company

declares dividend. The rate of interest chargeable on these loans should be less than or

equal to the rate of interest on the institutional loads or the rate of dividend whichever

is lower and interest can be paid only of there is no default in payment of the

institutional dues. These loans cannot be repaid without the prior approval of the

financial institutions. Unsecured loans from promoters are considered part of the equity

for the purpose of the calculation of the debt-equity ratio.

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INTERNAL CASH ACCRUALS:

Existing profit making companies which undertake an expansion / diversification

program may be permitted to invest a part of their accumulated reserves or cash profits

for creation of capital assets. In such cases, the past performance of the company

permits the capital expenditure from within the company by way of disinvestments of

working / invested funds. In other words, the surplus generated from the operations

after meeting all the contractual, statutory and working requirements of funds is

available for further capital expenditure.

GOVERNMENT SUBSIDIES

Subsidies extended by the Central as well as State government from a very important

type of funds available to a company for implementing its project. Subsidies may be

available in the nature of outright cash grant or long-term interest-free loan. Infact,

while finalising the means of finance, Government subsidy forms an important source

having a vital bearing on the implementation of many a project.

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FINANCIAL ASSISTENCE:

1. Direct Financial Assistance:

Foreign currency loan

Subscription to equity shares

Seed Capital Finance

2. Indirect financial Assistance:

Deferred Payment Guarantee

Guarantee for foreign currency loan

Underwriting

3. Special Schemes:

Bill discounting scheme

Suppliers line of credit

Equipment Finance schemes

FOREIGN CURRENCY LAONS

Foreign currency loans are also arranged by all India financial institutions out of

various lines of credit, some of which are:

a) Euro Dollar Loans.

b) Export Credit from the U.K.

c) Japanese Yen loans.

d) Deutsche Mark Revolving Funds

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e) KFW (Kreditanstalt-Fur-Wiederaufbau), Federal Republic of Germany

f) International Bank for Reconstruction and Development

g) Asian Development Bank

h) Commonwealth Development Corporation.

The loan amount normally available is the C.I.F. value of the capital goods/equipment

to be imported and the know-how fees payable. The interest rates depend upon the

interest rate applicable to the foreign currency funds utilised by the funding institution.

Foreign currency loans carry a commitment charge of 1% per annum on the undrawn

amount from the date of the letter of intent issues by the financial institution. The

repayment period is normally synchronised with the relative repayment commitments

of the funding institution.

Foreign currency loans can also be availed from foreign banks under Suppliers Credit

Scheme or any other foreign bank or institution approved by the Government of the

India.

EQUITY SHARE CAPITAL:

This is the contribution made by the owners of the company, i.e., the equityshareholders, who enjoy the rewards and bear the risks of ownership. However, their

liability is limited to their capital contribution. This is most important source of ling

term funds. It has the following advantages:

1. It represents permanent capital. Hence, there is no liability for repayment.

2. It does not involve any fixed obligation for payment of dividends.

3. It enhances the credit worthiness of the company. Larger the equity base, higher

the ability of the company to obtain credit.

The disadvantages of equity share capital are:

1. The cost of equity share capital is high, usually the highest.

2. Equity dividends are not deductible for tax purposes.

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3. The cost of issuing equity share capital is generally higher than the cost of

issuing other types of securities.

4. Sale of equity shares to outsiders may result in the dilution of the control of

existing shareholders.

If the size of the public issue for share capital is small, it may be advisable for the

company to approach mutual funds, venture capital organisations or opt for private

placement of such shares.

The minimum issued capital should be at least Rs. 300 lacs for a company, of which at

least 60% should be, offered to the public as prescribed in the listing requirements of

the stock exchanges.

With the abolition of the Controller of Capital Issues (CCI) and the introduction of the

concept of free pricing by SEBI, more and more companies may raise equity share

capital at a comparatively higher premium.

Seed capital

In consonance with the government policy which encourages a new class of

entrepreneurs and also intends wider dispersal of ownership and control of

manufacturing units, a special scheme to supplement the resources of an entrepreneur

has been introduced by the Government. Assistance under this scheme is a available in

the nature of seed capital which is normally given by way of long-term interest free

loan. Seed capital assistance is provided to small as well as medium scale units

promoted by eligible entrepreneurs.

Special Seed Capital Assistance Scheme.

This scheme is exclusively administered by state level financial institutions out of

funds provided by IDBI. Sometimes concerned State Governments also provide

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contribution to the seed capital. The maximum assistance under this scheme is

restricted to 20% of the project cost of Rs. 2 lacs whichever is lower and thus basically

meets the requirement of comparatively smaller projects.

Issue of Deferred Payment Guarantees (DPGs) by Banks Exclusively for

Financing of Project.

Where all-India financial institutions are not involved in providing financial assistance,

the banks may meet the entire financial requirement by way of deferred payment

guarantees to projects for modermisation/diversification/expansion of existing units. In

such cases, however, the concerned bank or the lead bank should make a detailed

appraisal of the project and assess the risks involved before sanctioning the deferred

payment guarantees.

Salient Features of the Bill Rediscounting Scheme.

The Bills Rediscounting Scheme was introduced in April, 1965, in terms of the powers

vested in the Industrial Development Bank of India under section 9(I)(b) of its statute,

which authorizes it to accept, discount or rediscount bills of exchange and promissory

notes of industrial concerns subject to such conditions as may be prescribed. The

objective of the Scheme is two-fold. The manufacturers of indigenous

machinery/capital equipment can push up the sales of their products by offering

deterred payment facilities to the prospective purchaser-user. The purchaser-user of the

machinery, on the other hand, is enabled to utilize the machinery acquired and repay its

cost over a number of years. The manufacturer, of the machinery by discounting with

his banker, the bills of exchange/promissory notes arising out of sale of the machinery.

The scheme thus helps the indigenous machinery manufacturing industry to increase

their turnover, which, in turn, helps expansion/modernization of existing industrial

units, thereby contributing to the industrial progress of the country.

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Suppliers credit scheme.

The Suppliers Credit Scheme envisages providing a Non-Revolving Line of Credit to

machinery, equipment and computer manufacturing concerns for sale of their

equipment to actual-user-purchaser concern on deferred payment basis.

The basic objective of the Scheme is to provide facility to the manufacturing concerns

to sell their equipment, and the needy industrial concerns to acquire the same for their

actual use on deferred payment basis.

The Scheme, thus, has the unique advantage of being beneficial to both equipment

manufacturers and equipment users.

Equipment Credit Scheme.

Based on eligibility, creditworthiness and repaying capacity of the actual user-industrial

concern, the Scheme envisages that IFCI finances the entire cost of equipment

purchased/fabricated by such actual-user against the security of the equipment to be

purchased/fabricated.

The facility under the Equipment Credit Scheme is a available only to those existing

industrial concerns:

( i ) Which are in the corporate or co-operative sector, i.e. those which are

incorporated as limited companies ( including private sector, joint sector and

public sector companies) and/or are registered as a co-operative society, under

the relative enactments.

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(ii) Which fall within the purview of Section 2(c) of the IFC Act, 1948 as eligible

industrial concerns and

(iii)Which have a satisfactory record in terms of operating results, financial position

and creditworthiness.

AN EXAMPLE OF

PROJECT FINANCING

Name of the company - Reliance Petroleum Limited

Type of project - fuel refinery project

Estimated capacity - 9 million metric tonnes per annum

Project cost :

o (land and site development, building and township, P/M, Technical know-

how, miscellaneous fixed assets, preliminary and pre-operative expenses, contingency

provision and margin money for working capital)

Means of finance :

o (Privately placed PCDs, ECB, Leasing, Unsecured loans, FIIs, public issue

of TOCDs)

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PROJECT COST DETAILS

Type of cost Rs. in million

Land and site development 920

Building and township 880

Plant and machinery 28870

Technical know-how 1090

Miscellaneous fixed assets 2620

Preliminary and pre-operative exp. 5030

Contingency provision 9850

Margin money for working capital 2160

Total 51420

MEANS OF FINANCE DETAILS

Type of finance Rs. in million

Privately placed PCDs 10000

Overseas suppliers credit/ECB 6000

Reliance Industries Ltd. and Associates

-TOCDs 5770

- Leasing / Unsecured loans 1430

Leasing by other cos./Unsecured loans 3500

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Euro issue/FIIs/ NRIs/OCBs 3000

Public issue of TOCDs 21720

Total 51420

Eg2: (PROJECT : MANUFACTURE OF MOTORS)

Sale projections :Rs.900 lacs for 1st year and Rs.1200 lacs

from 2nd year onwards

Capacity utilisation :75% in 1st year and 100% from 2nd yr

Economic life of the project :10 years

Total project cost :Rs. 1619 lacs

Promoters contribution (proposed) :20.94% of proj. cost

ROI (before tax) :27.94 %

ROI (after tax) :23.27 %

IRR :19.77 %

Average DSCR :2.164

Debt equity ratio :About 1 : 1

SOLUTION TO Eg 2:

The project should be financed, on account of the following reasons :

1. IRR is more than 15 % and therefore the project is worthwhile

2. Average DSCR is satisfactory

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3. Promoters contribution is fairly good

4. ROI (before tax) and ROI (after tax) are good

5. Profitability ratios show that the project would earn sufficient returns on the capital

employed over its estimated life

Documents

Project Financing 1