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A STUDY ON

ProjectFinance

(A Case Study with Reference to Installation of ExpansionProject 3MT to 6.3MT)

WITH REFERENCE TO RASHTRIYA ISPAT NIGAM LTD,VISAKHAPTNAM

A Project report submitted to international institute ofplanning and management, Hyderabad in partial fulfilments

for the award of the degree of

MASTER OF BUSINESS ADMINISTRATION

SUBMITTED BY

CH.SATISH KUMAR, IIPM

Under esteemedguidance of S. Ramprasad

Dy. Deputy finance Manager(Finance)

Visakhapatnam Steel Plant

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BANJARA HILS,

HYDERABAD

A C K N O W L E D G E M E N T

I express my profound sense of gratitude for the administration of

VISAKHAPATNAM STEEL PLANT, for giving me an opportunity to take up the

project wok in organization.

My sincere thanks to Mr.K.RAJA, Asst.Manager, HRD

VISAKHAPATNAM STEEL PLANT for accepting my request of doing the project

in this esteemed organization.

I also wish to thank all the staff of the HRD for their co-operation and help

extended to me during my project.

I take this opportunity to express my countless gratitude to my project

guide Sri.S.R.Prasad, Deputy Finance Manager, also I record my special

thanks to sri K.V RAO ,Manager, HRD, VISAKHAPATNAM STEEL PLANT who

have given kind assistance in my project work.

Last but not least but though I could not find words to express my gratitude

to my family members who have rendered great support and encouragement to

bring out this project a grand success.

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PROJECT SELECTION

CHAPTER V

PROJECT FINANCING

CHAPTER VI

PROJECT IMPLEMENTATION

PROJECT REVIEW & CONTROL

CHAPTER VII

EVALUATION OF THE PROJECT

CHAPTER - VIII

FINDINGS

SUGGESTIONS

CONCLUSION

ANNEXURE

BIBILOGRAPHY

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INTRODUCTION

A project is an activity sufficiently self-contained to permit financial and

commercial analysis .In most cases projects represent expenditure of capital

funds by pre-existing entities which want to expand or improve their operation.

In general a project is an activity in which, we will spend money in expectation

of returns and which logically seems to lead itself to planning. Financing and

implementation as a unit, is a specific activity with a specific starting point and a

specific ending point intended to accomplish a specific objective.

To take up a new project, involves a capital investment decision and it is the

Top managements duty to make a situation and feasibility analysis of that

particular project and means of financing and implementing it. Financing a project

involves a good deal of risk. Project finance is a rapidly expanding field, which

focuses not on the credit status of a company, but on cash flows that will be

generated by a specific project

Project finance has its origins in the natural resource and infrastructure

sectors. The current demand for infrastructure and capital investments is being

fuelled by deregulation in the power, telecommunications, and transportation

sectors; by the globalization of product markets and the need for manufacturing

scale; and by the privatization of government-owned entities in developed and

developing countries.

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The concept of private finance is a new method based on the use of private-

sector resources to build, maintain, manage and operate public infrastructure.

Interest in this approach has grown steadily as fiscal resources become more

constrained. One key advantage is the potential to use the management skills and

other resources of private enterprise to provide better public services at a lower

cost. Another benefit is economic revitalization through the creation of business

opportunities for private enterprise. In addition, it is possible to form new public-

private partnerships based on the appropriate sharing of roles between the

Government And Private Enterprise.

The advantage of the project finance method is that the various parties,

(including financial institutions) which are able to control these risks most

appropriately can share the various risk factors inherent to projects. In this way,

project risk can be both spread and reduced. In recent years there has been a

rapid increase in the number of companies opting for project finance. There are

three basic reasons for this trend. First, companies have become aware of their

own credit ratings. Second, improved risk control is needed for large-scale

projects. Third, access to finance can be facilitated by isolating good projects from

the reduced credit status of business corporations.

Project Finance can be defined in many ways and there does not exist any

single definition for it.

Finnerty s definition is that,Project financing is the raising of funds to finance an economically separable

capital investment project in which the providers of the funds look primarily to the

cash flow from the project as the source of funds to service their loans and

provide the return of and a return on their equity invested in the project.

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While Nevitt and Fabozzi define it as:

A financing of a particular economic unit in which a lender is satisfied to look

initially to the cash flow and earnings of that economic unit as the source of funds

from which a loan will be repaid and to the assets of the economic unit as

collateral for the loan.

The International Project Finance Association (IPFA) defines project finance

as:

The financing of long-term infrastructure, industrial projects and public services

based upon non-recourse or limited recourse financial structure where project

debt and equity used to finance the project are paid back from the cash flow

generated by the project.

Need for the study:

Now-a-days the Project Finance is necessary to study because to learn how

the allocation of financial resource in the implementation of new project or

expansion of existing project of any company.

To study the financial planning for ongoing expansion project at

Visakhapatnam Steel Plant, it tells about the allocation of financial resources for

the project.

A proposal for expansion of units at Visakhapatnam steel plant was made tocombat to the increasing demand for steel in order to cater the needs of domestic

market. The overall cost of the completion cost is Rs 8,692 Crores as expansion

project-up gradation to 6.3 MT.

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Objectives of the study:

The main objectives of the study i.e. The Project Financing of the expansion

plans are,( 3.0 MT to 6.3 MT),

To study the cost incurred in developing a project.

To know the sources of financing the project.

To study how the project serves the company as a long-term Asset.

To study the feasibility analysis of the project (expansion project) To study project appraisal of ongoing expansion plan.

Scope of the study:

The study of the project finance will helpful to know the allocation of the

financial resources and know how it is applicable to individual projects that

any Organization takes up. The scope of our study The project finance of

ongoing expansion plan in steel plant is confined to that particular

project(3.0 MT TO 6.3 MT). If the management wants to go further future

plans it needs to conduct project appraisal again. They can not rely upon

this report of the expansion plan and should make an exclusively new

study for it.

Methodology:

Methodology is a systematic procedure of collecting information in order

to analyze and verify a phenomenon. The collection of information is done

through two principal sources.

1. Primary Data.

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2. Secondary Data.

Primary Data

It is the information collected directly from financial department for

further studies, it was mainly through interviews with concerned officers

and staff, either individually or collectively, sum of the information has been

verified or supplemented with personal observation.

The data collection includes:

Conducting group seminars and with the concerned managers and

officers of finance department of V.S.P.

Secondary Data

This is taken from the annual reports, websites, company journals,

magazines and other sources of information of steel plant.

Limitations:

Though the project is completed successfully a few limitations may be

there.

1. Since the procedure and policies of the company will not allow to

disclose confidential financial information, the project has to be completed

with the available data given to us.

2. The period of study that is 6 weeks is not enough to conduct detailedstudy of the project.

3. The study is carried basing on the information and documents provided

by the Organization and based on the interaction with the various

employees of the respective departments.

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Frame work of the study

The study is organized into 8 Chapters.

Chapter I Gives the introduction, need, objective and methodology

of study.

Chapter II Focuses on the Indian Steel Industries.

Chapter III Profile of Visakhapatnam Steel Plant.

Chapter IV Project Evaluation

Chapter V Project Finance

Chapter VI Contain the summary Findings Suggestions.

Chapter VII Annexure

Chapter VIII Bibliography

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Steel Industry

Steel is a versatile, constantly developing material that underpins all

manufacturing activity. If a product is not made from steel, then it is certainly

made using steel at some point in the manufacturing process.

OVERVIEW OF IRON AND STEEL INDUSTRY

HISTORICAL PERSPECTIVE

The finished steel production in India has grown from a mere 1.1 million

tonnes in 1951 to 29.27 million tonnes in 2000-2001. During the first two decades

of planned economic development, i.e. 1950-60 and 1960-70, the average annual

growth rate of steel production exceeded 8%. However, this growth rate could not

be maintained in the following decades. During 1970-80, the growth rate in steel

production came down to 5.7% per annum and picked up marginally to 6.4% per

annum during 1980-90, which increased to 6.65% per annum during 1990-2000.

Though India started steel production in 1911, steel exports from India began only

in 1964. Exports in the first five years were mainly due to recession in the

domestic iron and steel market. Once domestic demand revived, exports declined.

India once again started exporting steel only in 1975 touching a figure of 1 million

tonnes of pig iron export and 1.4 million tonnes of steel export in 1976-77.

Thereafter, exports again declined to pick up only in 1991-92, when the main

producers exported 3.87 lakhs tonnes, which rose to 2.79 million tonnes in 1995-

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96. The steel exports in 1999-2000 were 2.36 million tonnes and in 2000-01 it was

2.57 million tonnes. The growth in the steel sector in the earlier decades since

Independence was mainly in the public sector units set up during this period. The

situation has changed dramatically in the decade 1990-2000 with most of the

growth originating in the private sector. The share of public sector and private

sector in the production of steel during 1990-91 was 46% and 54% respectively,

while during 2000-01 the same was 32% and 68% respectively. This change was

brought about by deregulation and decontrol of the Indian iron and steel sector in

1991. A number of policy measures have been taken since 1991 for the growth

and development of the Indian iron & steel sector. Some of the important steps

are

Removal of iron & steel industry from the list of industries reserved for the

public sector and also exemption from the provisions of compulsory licensing

under the Industries (Development & Regulation) Act, 1951, deregulation of price

and distribution of iron & steel, inclusion of iron and steel industry in the list of high

priority industries for automatic approval for foreign equity investments up to 74%,

lowering of import duty on capital goods and raw materials etc.

THE INDIAN STEEL SECTOR AFTER LIBERALISATION

The Indian steel sector was the first core sector to be completely freed from

the licensing regime and the pricing and distribution controls. This was done

primarily because of the inherent strengths and capabilities demonstrated by the

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Indian iron and steel industry. During 1996-97, finished steel production shot up to

a record 22.72 million tonnes with a growth rate of 6.2%, while in 1997-98, the

finished steel production increased to 23.37 million tonnes, which was 2.8% more

than the previous year. The growth rate has drastically decreased in 1997-98 and

1998-99 being 2.8% and 1.9% respectively as compared to 20% in 1995-96 and

6.2% in 1996-97. The growth rate in 2000-2001 has improved to a healthy 9.60%

with the total production touching 29.27 million tonnes. The production of finished

steel during 2001-02 has been 30.61 million tonnes, which means a lower growth

rate of about 4.5% compared to the previous year. This fall in the growth rate of

steel production has been brought about by several factors that, inter-alia, include

general slow down in the industrial production and construction activities in the

country coupled with lack of growth in major steel consuming sectors. The total

production of finished steel and the share of main and secondary producers

during 90's and up to 2002-03 are given in the annexure.

APPARENT CONSUMPTION OF STEEL

Apparent consumption of steel is arrived at by subtracting export of steel

from the total of domestic production and import of steel in the country. Change in

stock is also adjusted in arriving at the consumption figures. It is also treated as

the actual domestic demand of steel in the country. The year-wise apparent

consumption of finished steel since 1990-91, is given in the table in the annexure.

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PROJECTIONS OF FINISHED STEEL

In order to have a long-term perspective and planning, a Sub-Group on

Steel and Ferro Alloys was constituted for steel sector under the aegis of Planning

Commission. The Sub-Group deliberated upon all aspects including supply-

demand projections for finished steel during the period 2001-02 to 2011-12.

Considering a GDP growth rate of 6.5% as realistic during the 10 th Plan, the Sub-

Group has projected the demand for finished carbon steel in the country. The

figures are given in enclosed chart.

The iron and steel sector has experienced slow down from the year 1997 to

2001. The growth of the steel sector is dependent upon the growth of the

economy in general and the growth of industrial production and infrastructure

sectors in particular. The major reasons for the slow growth in the steel sector

during the last few years include: -

(a) Sluggish demand in the steel consuming sectors Steel being the basic raw

material for the construction industry, the capital goods and engineering

goods industry, as also the auto sector and white goods sector, its growth

is dependent upon the demand for steel by these segments of the industry.

Since no major infrastructure or construction projects have beenimplemented in the last few years, demand for steel has remained low. No

major projects in the oil sector, power sector, fertilizer sector, where

intensity of steel consumption is high, have come up in the recent past.

(b) Overall economic slow down in the country. All major core sectors of the

economy have been facing an economic slow down. These include, power,

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coal, cement, industry, mining and steel. The slow down phenomenon is

not restricted to the steel sector alone. Only when the overall economy of

the country picks up, the steel sector would also show signs of revival.

(c ) Lack of investment by Government/private sector in major infrastructure

projects Due to budgetary constraints, no major construction activity in

mega projects including fertilizer, power, coal, railways etc. have been

planned by the Government. Despite liberalization of the economy and

relaxation in the investment norms, private sector investment is yet to

materialize in the core sectors of the economy. This has also contributed toslowing down demand for steel.

(d) Cost escalation in the input materials for iron and steel Power tariff, freight

rates, coal prices etc. have been under the administered price regime.

These rates have been frequently enhanced, thereby contributing to the

rise in input costs for steel making.

(e) Continuous reduction in import duty on iron and steel. After liberalization,

import duty rates on iron and steel items have been gradually reduced over

the years. This has opened up the domestic iron and steel sector to

international competition. Due to rationalization in the import duty structure

in 1999- 2000, the rates of basic custom duty have generally gone up to

about 35% average.

MARKET SCENARIO

After liberalization, with huge scale addition to steel making capacity, there

is no shortage of iron and steel materials in the country. Apparent consumption of

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steel increased from 14.84 million tonnes in 1991-92 to 27 million tonnes in 2001-

02. During 2001-2002, due to economic slow down, certain sector like power and

fertilizer projects, auto sector and white goods sector have shown a slump in

demand for steel. Steel Industry has been facing a slow down in the level of

demand due to slow down of the domestic economy and that of the major steel-

consuming sector. Efforts are being made to boost demand particularly in rural

areas and also to increase exports. Prices of iron and steel have declined in 2001-

02 in tune with global trends, while input cost have gone up. However, of late,

there has been resurgence in the price level mainly of flats and demand has also

witnessed an upward trend. In 2003-2004 steel sector market demand increased

mainly because of massive construction activity taken up in China.

PRODUCTION

Steel industry was de-licensed and decontrolled in 1991 and 1992

respectively. India is 8th largest producer of steel in the world. In 2001-02, finished

steel production was 30.61 million tonnes. Pig iron production in 2001-02 was

3.95 million tonnes. Sponge iron production was 5.66 million tonnes in 1999-2000.

In 2001-02, nearly 51% of crude steel production was by public sector the

remaining 49% was by private sector. In 2001-02, the integrated steel plants

produced 42% of finished steel and the remaining 58% was by the secondary

producers. Interface with consumers by way of Steel Consumer Council exists,

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which is conducted on regular basis. Interface helps in redressing availability

problems, complaints related to quality.

PRICING & DISTRIBUTION

Price regulation of iron & steel was abolished on 16.1.1992. Distribution

controls on iron & steel removed except 5 priority sectors, viz. Defence, Railways,

Small Scale Industries Corporations, Exporters of Engineering Goods and North

Eastern Region. Development Commissioner for Iron & Steel makes allocation to

priority sectors. Government has no control over prices of iron & steel. Open

Market Prices have been generally stable, though fluctuations have been noticed.

Price increases of late have taken place mostly in long products than flat

products. In the current financial year the long product prices have increased by

about 20% because of raise in demand internationally.

IMPORT AND EXPORT OF IRON AND STEEL

India was importing about 10 to 15 lakh tonnes of steel, annually. Due to a

rise in domestic demand, the import of saleable steel in 1996-97 reached a level

of 1.80 million tonnes. The incidence of import was mainly in hot rolled coils, cold

rolled coils and semis. Import of carbon steel during 2000-01 was about 1.41

million tonnes, which was about 12% less than the import in 1999-2000. The total

imports of carbon steel during six years up to 2001-02 are given in enclosed chart.

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The Industry has been able to maintain its net exporter status from the last

two years in the trading of finished steel. In fact exports of non-flat products

recorded a growth rate of 5.7% over 2000-01. The quantity of carbon steel

exported from the year 1996-97 is as given in enclosed chart.

Earlier, exports consisted mainly of plates, structurals, bars and rods,

whereas now additional items like semis, hot rolled coils, cold rolled coils, colour

coated sheets, GP/GC sheets and pig iron are also being exported. In future, it is

expected that the quantum of exports of more value added items would further

increase.

MEASURES ON IMPORTS

Iron & Steel are freely importable as per the Exim Policy. India has been

annually importing around 1.5 Million Tonnes of steel. Imports have largely

dropped, partly an indication of greater self-sufficiency and partly the ability to

control inflow of seconds and defectives. To check unbridled imports of

cheap/seconds & defective steel, several measures have been put in place, like;

The Government has fixed floor prices for seven items of finished steel viz. HR

coils, HR sheets, CR coils, Tinplates.

The other notable measure in this regard is that imports of certain types of

steel have been subject to mandatory compliance of quality standards as

specified by the Bureau of Indian Standards (BIS). Adherence to BIS norms imply

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supplying information like name and address of the importer, generic or common

name of the commodity, net quantity in terms of standard units of weights and

measures, month and year of packaging and maximum retail sale price. Moreover

all manufacturers/exporters of the listed products shall be required to register

themselves with the BIS.

Further protection in this regard has been the issuance of the Government

notification to 3 major ports Kolkata, Mumbai and Chennai to monitor the flow of

foreign steel into the country. The customs duty on second and defective HR Coils

has been raised to the bound rate of 40 per cent. Anti dumping duty has been

levied on import of HR coils from Russia and Ukraine.

MEASURES FOR EXPORT OF IRON & STEEL

Iron & Steel are freely exportable and India is a net exporter of steel.

Advance Licensing Scheme allows duty free import of raw materials for exports.

Duty Exemption Pass Book Scheme also facilitates exports. Indian steel exports

have been subject to anti-dumping/anti-subsidy duties actions by the stronger

economies over the last few years. These include:

Anti dumping duty on cuttosize plate exports from Bhilai Steel Plant of

SAIL with a total duty of 72.48 per cent, and an anti subsidy component of 14.82

per cent. India however, has been exempted from the safeguard duties under

Section 201 of the US Trade Laws on almost all steel products except carbon

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flanges. This is on account of the countrys status as a developing nation. EU has

also taken AD/CVD actions on import of HR coils. However, a Suspension

Agreement with exporters like SAIL allows the company to sell at a price not lower

than the agreed one. The EU has also imposed safeguard duties for India; such

measures apply on electrical steel sheets and stainless steel wire rods.

Canada has covered pipes, hot rolled, cold rolled and galvanized products

in the AD/CVD actions. China has recently imposed a safeguard duty on the

import of steel, which ranges from 7-26%. The country-wise details are yet to be

worked out. The rising trend in Indian steel exports that was being witnessed in

the last couple of years was halted due to these anti dumping actions initiated by

the advanced, developed nations of the world, which led to the loss of major

markets for the Indian steel exporters. Despite the initial setbacks Indian exports

have recovered - largely due to the ability to find out alternative export markets

where selling steel has been profitable. Steel Exporters Forum has been recently

set up to boost steel exports.

An Anti dumping Directorate has been set up under the Ministry of

Commerce & Industry with adequate power to fight trade actions while remaining

within the WTO framework.

DUTIES & LEVIES ON IRON & STEEL

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Custom Duties

Peak rate of Custom Duty has been reduced sharply during last 5 years. In

the Union Budget 2002-03 it has been further reduced to 30%. This has forced

domestic industry to become internationally competitive. Custom Duty on seconds

and defectives has been raised to the bound rate of 40%. Custom Duty has been

reduced on a wide range of inputs, which would bring down the cost of production

for the domestic steel industry. Custom Duty on Met Coke has been reduced to

5% for integrated steel plants using blast furnace, pig iron units and steel plants

using Corex technology.

Excise Duty

Excise Duty on iron & steel has not been reduced in successive budgets.

At present excise duty on all iron and steel products is 16% ad valorem called

CENVAT. High excise duty has made domestic industry unviable.

LEVIES ON IRON & STEEL

SDF- (Steel Development Fund)

This was a levy started for funding modernization, expansion and development

of steel sector. The Fund, inter-alia, supports:

Capital expenditure for modernization, rehabilitation, diversification,

renewal & replacement of Integrated Steel Plants.

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Research & Development

Rebates to SSI Corporations

Expenditure on ERU of JPC

Fund was abolished on 21.4.94. Cabinet decided that Corpus could be

recycled for loans to Main producers. Interest on loans to Main Producers be set

aside for promotion of R&D. An Empowered Committee has been recently set up

to guide the R&D effort in this sector.

EGEAF

This was a levy started for reimbursing the price differential cost of inputs

used for engineering exporters. Fund was discontinued on 19.2.96.

OPPORTUNITIES FOR GROWTH OF IRON AND STEEL

The New Industrial Policy Regime

The New Industrial policy has opened up the iron and steel sector for private

investment by

(a) Removing it from the list of industries reserved for public sector and

(b) Exempting it from compulsory licensing. Imports of foreign

technology as well as foreign direct investment are freely permitted

up to certain limits under an automatic route. Ministry of Steel playsthe role of facilitator, providing broad directions and assistance to

new and existing steel plants, in the liberalized scenario.

GLOBAL SCENARIO

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The global production of crude steel increased from 777 million tonnes in

1998 to 785 in 1999. The world steel consumption has also increased by 1%. The

international steel trade constituted around 279.6 million tonnes or 39.8% of the

production. World steel industry witnessed major ups and downs in the last two

decades and especially over the past five years. The pattern of trade has been

upset by two important developments. These are the collapse of the Soviet Union

and the severe financial crisis in most South East Asian countries as well as in

Korea and Japan. The Asian crisis and the collapse of USSR have transformed

importers of steel into exporters. Till the recent financial crisis, the Asian countries

were large importers of steel. In 1996, eight of the ten largest steel producing

nations were in Asia and import by the region in the mid 1990s was around 80-90

million tonnes of finished and semi finished steel per year, which is equivalent of a

third of total steel trade. After the Asian crisis, the region got transformed into a

net exporter of steel. The world steel industry is today characterized by excess

capacity and poor demand. This scenario has led to an undesirable impact in the

form of increasing protectionism within the developed countries and large scale

dumping in the international markets. During this year, Indian exports have been

subjected to Anti- dumping/Counter-veiling duties investigations in EU, USA and

Canada. There have also been instances of dumping of steel in our country. It is

in this global context that the Indian steel industry will have to cast its future role.

World production of crude steel in March 2003 rose by 8.2% to 79.6 million

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tonnes, the highest monthly total in over a decade. The total of the 3 months to

date was 226.8 million tonnes, 8.8% higher than the January to March period in

2002.

World production of crude steel in March 2003 rose by 8.2% to 79.6 million

tonnes, the highest monthly total in over a decade. The total of the 3 months to

date was 226.8 million tonnes, 8.8% higher than the January to March period in

2002.

In the former USSR, both Russia and the Ukraine showed an increase in

steel production, up by 4.5% in Russia and 7.5% in the Ukraine. The 3 months

total was up 6.3% in Russia to 14.7 million tonnes, while Ukrainian production

increased by 10.5% to 8.7 million tonnes. Production in Kazakhstan, on the other

hand, fell by 4.3% in March and by 0.3% in the three months to 1.2 million tonnes.

Crude steel production in the USA is still rising, up by 5.4% in March 2003,

bringing the first quarter total up by 6.5% to 23.1 million tonnes. Mexican

production is also improving with March production up 21.4% and the 3 months

total up 29.6% to 3.8 million tonnes, almost equal to the Spanish first quarter total.

Canadian steel production, on the other hand, fell by 3.6% in March and by 3.5%

in the year to date to 4.0 million tonnes.

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Steel imports by the USA have been falling with the total for the first two

months of 2003 30% below the same period in 2002. In fact the February total

was half the February 2002 total. Imports of blooms, billets and slabs were less

than half what they were in the first two months of 2002. Total exports, on the

other hand, have risen, with the year to date 17% higher than in 2002. One of the

largest rises was in hot rolled wide coil, which more than doubled in the first two

months of 2003. Exports of hot rolled wide coil to Canada almost doubled in the

first two months, and there was a very large tonnage exported to both China and

Singapore in February 2003. Net shipments of steel reported by the AISI were

7.5% up in the two months at almost 16.5 million tonnes, with most of the increase

going to the home market.

In March 2002 the US President announced imposition of temporary

safeguard measures on import of key steel products into USA. In retaliation to the

US action EU has also imposed provisional safeguard measures against import

certain steel products. China, Canada and Thailand are some of the other

countries that have initiated safeguard investigations against import of steel

products into their countries. On the pricing front the steel prices have been

spiralling up especially since mid 2002 mainly due to the shortfall in supply. This

can be attributed to the facts.

Cessation of gas supply in Venezuela stopped about 6 million

tonnes of annualized production of steel.

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Ukraine has imposed export duty on scrap steel, which is a raw

material.

There has been series of blast furnace outages in USA.

Shut down of many coking coalmines in China due to safety

reasons.

Internal consumption of China has increased.

Global scrap prices increased

Capacity addition is not significant except in China.

US Dollar is weakening

The fascination for cheap steel has come down.

THE GROWTH PROFILE AFTER LIBERALISATION

The liberalization of industrial policy and other initiatives taken by the

Government have given a definite impetus for entry, participation and growth of

the private sector in the steel industry. While the existing units are being

modernized/expanded, a large number of new/Greenfield steel plants have also

come up in different parts of the country based on modern, cost effective, state of-

the-art technologies.

Increasing role of private sector in total production can be seen from the

fact that its share has increased from 51.4% in 1991-92 to approximately 67% in

1998-99. This trend is likely to continue. At present, total (crude) steel making

capacity is over 34 million tonnes and India, the 8 th largest producer of steel in the

world, has to its credit, the capability to produce a variety of grades and that too,

of international quality standards. As per the ratings of the prestigious " World

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Steel Dynamics", Indian HR Products are classified in the Tier II category quality

products a major reason behind their acceptance in the world market. EU,

Japan have qualified for the top slot, while countries like South Korea, USA share

the same class as India.

In pig iron also, the growth has been substantial. Prior to 1991, there was

only one unit in the secondary sector. Post liberalization, the AIFIs have

sanctioned 21 new projects with a total capacity of approx 3.9 million tonnes. Of

these, 16 units have already been commissioned. The production of pig iron has

also increased from 1.6 million tonnes in 1991-92 to 3.94 million tonnes in 2001-

02. The share of Private/secondary sector has increased over time and is

currently around 74% of total production.

Considering the facts of current low levels of per-capita consumption in

India, the huge potential for its increase and the estimated GDP growth, the steel

industry is likely to have substantial growth in the medium to long term

perspective.

Chapter-4

Profile of

Visakhapatnam Steel Plant

INTRODUCTION

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Steel occupies the foremost place among the materials in use today and

pervades all walks of life. All the key discoveries of the human genesis, for

instance, steam engine, railway, means of communication, automobile, aeroplane

and computers are in one way or other, fastened together with steel and with its

sagacious and multifarious application steel is a versatile material with multitude

of useful properties, making its indispensable for furthering and achieving

continual growth of the economy be it construction, manufacturing, infrastructure

or consumables. The level of steel consumption has long been regarded as an

index on industrialisation and economic maturity attained by a country. At the time

of independence India had only three integrated Steel Plants-Iron $ Steel

Company at Burnpur, Tata Iron And Steel Company at Jamshedpur, Iron $ Steel

Company in the erstwhile princely state of My sore. Keeping in view the

importance of steel, the following integrated steel plants with foreign

collaborations were set up in the public sector in the post-independence era.

1 Durgapur Steel Plant British

2 Bhilai Steel Plant Erstwhile USSR

3 Bokaro Steel Plant Erstwhile USSR

4 Rourkela Steel Plant German

BACKGROUND

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To meet the growing domestic needs of steel Government of India decided

to set up an integrated steel plant at Vishakhapatnam. An agreement was signed

with erstwhile USSR in 1979 for cooperation in setting up 3.4 MT integrated steel

plant at Vishakhapatnam. The foundation stone for the plant was laid by the then

prime Minister on 20th January 1971.

The project was estimated to cost Rs. 3897.22 Crores based on prices as

on 4th quarter of 1981. However on completion of construction and

commissioning of the whole plant in 1992, the cost escalated to around 8500

Cores. Visakhapatnam Steel Plant is one of the most modern steel plants in the

country. The plant was dedicated to the nation on 1st August 1992 by the then

Prime Minister Sri P.V. Narasimha Rao.

New technology, large scale computerisation and automation etc are

incorporated in the plant. To operate the plant at international levels and attain

such labour productivity, the organisational manpower has been rationalised. The

plant has a capacity of producing 3.0 MT of liquid steel and 2.656 MT of saleable

steel.

VSP TECHNOLOGY: STATE-OF-THE-ART

7 Metre tall Coke oven batteries with coke dry quenching

Biggest Blast furnaces in the country

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Bell less top charging system in Blast furnace

100% slag granulation at the BF cast house.

Suppressed combustion LD gas recovery system.

100% continuous casting of liquid steel.

Tempcore and Stelmor cooling process in LMMM & WRM.

Extensive waste heat recovery systems.

Comprehensive pollution control measures.

MAJOR SOURCE OF RAW MATERIALS

Iron ore lumps and fines Bailadilla, MP

BF lime stone Jagayyapeta, AP

SMS lime stone Jaisalmer, Rajasthan

BF Dolomite Dubai

SMS Dolomite Madharam, AP

Manganese Ore Chipurupalli, AP

Boiler coal Talcher, Orissa

Coking coal Australia

WATER SUPPLY

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Operational water requirement of 36 Mgd is being met from the Yeleru

Supply scheme.

POWER SUPPLY

Operational power requirement of 180 to 200 MW is being met through

Captive Power Plant. The capacity of the Power plant is 286.5 MW. VSP is

exporting 60 MW power to APTRANSCO.

MAJOR UNITS

Department Annual cap 000 T Units (3.0 MT stage)

Coke ovens 22613 Batteries each of 67 ovens and 7Meter height

Sinter Plant 52562 Sinter machines of 213 m2 grate area

eachBlast furnace 3400 2 Furnaces of 3200 m3 volume each

Steel melt shop 30003 LD converters each of 150 m3volume and strand bloom casters

LMMM 710 3 Stand finishing mill

WRM 850 2 x 10 stand finishing mill

MMSM 860 6 stand finishing mill

MAIN PRODUCTS OF VSP

Steel Products By products

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Angles Granulate slag

Billets Lime fines

Channels Coal tar

Beams Anthracene acid

Squares HP Naphthalene

Flats Benzene

Round Toluene

Rebars Zylene

Wire rods Wash oil

Ammonium sulphate

THE VISION OF VSP

CORPORATE PLAN OF VSP

VISION

To establish as an excellent corporate citizen and ensure optimal return on

investment.

MISSION

To become a 10 million tonne world class integrated steel plant by 2019-20.

OBJECTIVES

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Towards growthExpand the plant capacity to 6 MT by 2009-10, 8

MT by 2014-15 and 10 MT by 2018-19.

Towards Profitability Achieve net profits continuously from 2002-

03.

Towards Stakeholders Make VSP the company of choice.

Towards Technology Continuously upgrade technology to

operate at international efficiency levels.

Towards Safety, Environment and Society Continue efforts

towards safety of employees, conservation of environment and be

socially responsive.

CORE VALUES

Value foresight is crucial in todays competitive businesses climate VSP

values

Commitment

Customer satisfaction

Continuous improvement

Concern for environment

MARKETING NETWORK

The Company markets its products through headquarters marketing office

and a network of regional offices, branch offices and stockyards located all over

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the country. It also takes the help of consignment agents and consignment sales

agents for the marketing of its products. The exports are carried out by the export

wing of marketing division with the help of different agencies. The Company is

recognised as Star Trading House by the Director General of Foreign Trade,

Ministry of commerce, Government of India.

The end users of the steel products manufactured at the plant include

amongst other construction industry, automobile industry, engineering industry,

re-rolling industry, forging industry, cable industry, wire drawing industry, fastener

industry, electrode manufacturers and railways. The Company is ideally located

to serve the southern Indian market. Regional Mangers/Branch managers meet

at Head quarters regularly to assess the market situation and decide market

strategies.

FINANCIAL PERFORMANCE OF VSP

a) HISTORY

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In the industrial horizon of India, Rashtriya Ispat Nigam Ltd., (VSP),

Visakhapatnam Steel Plant (VSP) stands as a monument of advanced

technology. VSP is the first shore based integrated Steel Plant in the country.

The decision of Government of India to set up an integrated steel plant at

Visakhapatnam was announced by the Prime Minister Smt. Indira Gandhi in

Parliament on 17th April, 1970 followed by foundation stone laying by her. The

initial project cost was sanctioned at Rs. 2256 Crores with an Internal Rate of

Return (IRR) 4.20%. The Indian government and USSR signed an agreement on

12th June 1979 for cooperation in setting up the 3.4 million tonne integrated steel

plant at Visakhapatnam.

Thereafter the project has undergone three revisions as detailed below.

First revision Second revision Third revision

Date of sanction by GOI 30.07.1982 24.06.1988 12.07.1995

Capital asset. Rs. 3897.28 Cr. Rs. 6849.70 Cr. Rs. 8593.29 Cr.

Financial IRR 5.40% 6.56% 5.30%

Liquid steel capacity (inMT per annum)

3.40 3.00 3.00

The broad reasons for revisions were:

(1) Non-availability of funds on time

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(2) Price escalation

(3) Enhanced currency exchange rates

(4) Revision in taxes and duties

(5) Change in ocean freight.

REASONS FOR TIME OVER RUN

(1) Inadequate fund flow & its delay

(2) Midway revision of project concept

(3) Dislocation of Soviet equipment suppliers

(4) Delay in supplies made by major PSUs.

(5) Delay in providing water by AP Government

b) RATIONALISED CONCEPT

The construction of the plant started in 1981 and scheduled to be

completed in 4 to 6 years in two stages. However, due to inadequate funds

availability, there was a threat to project continuance. In order to contain project

cost, a Rationalised Project Concept was evolved where while retaining the Hot

Metal capacity, the liquid steel capacity was brought down to 3.0 MT from 3.4 MT

by dropping one SMS converter and up rating the capacity of other converter.

Further on the finishing line, Universal Beam Mill was dropped. The Rationalised

Concept helped in reducing the project cost by Rs. 1497 Crores. Details of major

production facilities under original concept and revised concept are given at

annexure.

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The plant was commissioned in two stages. The 1st

BF viz., Godavari was

commissioned in March 1990. The 2nd BF viz Krishna was commissioned in

March 1992 and finally the plant was dedicated to the Nation by the then

Honourable Prime Minister Sri PV Narasimha Rao in August 1992.

c) CAPITAL RESTRUCTURING

FIRST CAPITAL RESTRUCTURE

Long gestation period in commissioning the plant and escalation of the

project cost to Rs. 8593.29Crores (3.8 times over the original estimate)

necessitated capital restructuring, in order to ensure viability and to prevent from

becoming potentially sick under Sick Industrial Company (Special Provisions) Act

1985. Action was taken for restructuring the capital base even before the

Company became totally commercially operational. The first capital restructuring

took place in July 1993.

SALIENT FEATURES

Conversion of Rs. 1184 Crores Government of India loans into

Equity Capital.

Conversion of Rs. 1185 Crores Government of India loans into 7%

non-cumulative preference shares redeemable at the end of 10

years.

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Conversion of Rs. 791 Crores interest due on Government of India

loans into interest free loans for a period of 7 years.

Conversion of GOI loans receivable in 1992-93 into 7% non-

cumulative preference shares redeemable at the end of 10 years

from the date of allotment (Rs. 419 Crores released after 31 st July

1992).

Conversion of GOI loans receivable in 1993-94 into Preference

Shares to be decided after review.

Waiver of penal interest that becomes due up to July 1992 (Rs.

149.40 Crores).

Government of India ensures funds (RS. 1507 Crores) in the plan

period for the project.

BENEFITS FROM CAPITAL RESTRUCTURING

Reduction of loss by Rs. 432.47 Crores annually on account of

interest saving due to conversion of loans to equity capital,

Preference Capital and Interest free loan.

Reduction of loss by Rs. 149.40 Crores on account of interest

saving due to waiver of penal interest.

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d) SECOND CAPITAL RESTRUCTURE

Owing to historical capital burden, long gestation period in the

commissioning of the plant, the accumulated net losses before total

commissioning, the general recession set in Steel Industry from mid 1996, the

Company continued to incur net loses and getting close to erosion of 50% of net-

worth of the Company. At this stage, to avoid a situation of reporting a technically

viable integrated steel plant to BIFR, a second capital restructuring was

sanctioned by the Government.

The second capital restructuring was approved in May 1998, whereby Rs.

542.47 Crores of Government loan was converted into 7% non-cumulative

preference share capital redeemable after ten years from the date of release of

these loans. Further, conversion of Rs. 791 Crores interest free loan to 7% non-

cumulative preference capital was also agreed to. Benefits from this capital

restructuring was a reduction of loss by Rs. 235.85 Crores on account of interest

saving and an annual interest saving of Rs. 88.47 Crores. While approving

second capital restructure, government of India-Inter-alia desired to appoint a

financial consultant of repute to suggest a turnaround strategy for the

organisation.

e) FINANCIAL AND PHYSICAL PERFORMANCE

FINANCIAL PERFORMANCE

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The financial performance of the organisation against the set targets right

from 1990-91 to 2002-03 is placed at Annexure. From this table it can be seen

that the Company was gaining considerable gross margin which reflects the

satisfactory performance of the plant for all the years except during the year 1998-

99 and 1999-2000 when there was a major set back to Coke ovens. Further it

had also secured reasonable cash profits barring those two years and initial

period up to 1992-94.

The Company had again gained its momentum during 2000-01 when it

made cash profit of Rs. 153 Crores and turned around during the year 2002-03

making a Net Profit of around Rs. 520crores for the first time. During the last few

years, the Company had taken a number of steps like major capital repairs to

Coke ovens, BF capital repairs, austerity measures to cut down the cost,

restrictions on capital expenditure etc. It may need a special mention that a

special drive took place to cut down the interest cost on term loans and working

capital arrangements.

PHYSICAL PERFORMANCE

The details of physical performance as against the targets set right from

1990-91 to 2002-03 are placed at annexure. From the table it can be seen that

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the targets set were reasonably met by the organisation, up to 1999-2000 and far

exceeded the targets from the year 2000-01 onwards.

PRESENT PERFORMANCE

The Company turned around during the year 2002-03, making for first time

Net Profit of Rs. 520 Crores, achieving Gross sales/turnover of Rs. 5059 Crores.

The financial year 2002-03 is a happy note in VSPs diary because of its

remarkable performance in all fronts. On the production front, the Company far

exceeded the targets set. The performance of the Company for the year 2002-03

is placed at Annexure.

At the beginning of the financial year 2002-03, the Company was having

total term loans to the tune of Rs. 1373.98 Crores. UTI (Rs. 590.29 Crores, LIC

Rs. 580.80 Crores and Bonds Rs. 175 Crores) are the major outstanding. Apart

from this the utilisation of working capital limits from the banks were Rs. 600

Crores (CC Rs. 96 Crores, WODL Rs. 395 Crores in the form of FCNR (B) DL Rs.

267 cores, DCDL Rs. 128 Crores and EPC Rs. 109 Crores).

Taking advantage of falling interest rates, dynamism prevailing in the

financial market, strong economic factors with reference to countrys strengthened

foreign currency reserves; appreciation of rupee with reference to USD in the later

part of the year, the Company has taken several initiatives to reduce the debt

burden.

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STEPS TAKEN TO REDUCE DEBT BURDEN

The significant steps taken by the Company to reduce debt burden include

restructuring of dept through prepayment of high interest loans out of internal

resources, swapping of high cost loans with borrowings from banks at lower

interest rates, swapping off high cost working capital demand loans with FCNR

borrowings and commercial paper at cheaper rates of interest.

The Company due to the above initiatives could prepay the entire term

loan of Rs. 590 Crores from UTI during the year 2002-03 from out of internal

resources and by swapping with bank loans. 15% working capital demand loan of

Rs. 400 Crores was also substituted with commercial paper with an average

interest rate of 7% and FCNR demand loan at an average interest rate of 3.4% to

10.09T.

The above steps resulted in brining down outstanding term loans to Rs.

773.37 Crores as at the end of the year 2002-03 (debt free on date) and utilisation

of working capital to the extent of only Rs. 368 Crores. The above steps resulted

in containing the interest expenditure to Rs. 135 Crores for the year 2002-03 as

against the previous year level of Rs. 290 Crores as shown in Annexure.

PERFORMANCE OF VSP

a) PRODUCTION, COMMERCIAL AND FINANCIAL PERFORMANCE

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PRODUCTION PERFORMANCE (000 Tonnes)

Year Hot metal Liquid steel Saleable steel

1999-2000 2943 2656 2382

2000-01 3165 2909 2507

2001-02 3485 3083 2757

2002-03 3941 3356 3056

2003-04 4055 3508 3169

2004-05 3920 3560 3173

2005-06 4153 3603 3237

2006-07 4046 3606 3290

production performance

0500

1000

1500

2000

2500

3000

3500

4000

4500

1999-

2000

2000-

01

2001-

02

2002-

03

2003-

04

2004-

05

2005-

06

2006-

07

years

values Hot metal

Liquid steel

Saleable st

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COMMERCIAL PERFORMANCE (Rs. Crores)

Year Sales turnover Domestic sales Exports

1999-00 3037 2677 295

2000-01 3436 3122 322

2001-02 4081 3710 371

2002-03 5059 4433 626

2003-04 6169 5400 769

2004-05 8181 7933 248

2005-06 8469 8026 443

2006-07 9126 8702 425

2007-08 8881 7412 1469

commercial performance

0

1000

2000

3000

4000

5000

6000

7000

8000

9000

10000

19

99-

00

20

00-

01

20

01-

02

20

02-

03

20

03-

04

20

04-

05

20

05-

06

20

06-

07

20

07-

08

ears

values Sales turnov

Domestic sa

Exports

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FINANCIAL PERFORMANCE (rs. In crs)

Year Gross margin Cash profit Net profit1999-00 252 -130 -5622000-01 504 153 - 2912001-02 690 400 -752002-03 1049 915 5212003-04 2073 2024 15472004-05 3271 3260 20082005-06 2383 2355 1251

2006-07 2632 2584 22222007-08 3001 2977 2686

Financial performance

-1000

-500

0

500

1000

1500

2000

2500

3000

3500

1999-

00

2000-

01

2001-

02

2002-

03

2003-

04

2004-

05

2005-

06

2006-

07

2007-

08

years

values Gross ma

Cash p

Net profit

b) POLLUTION CONTROL AND ENVIRONMENTAL PROTECTION

Generally, integrated steel plant is seen as a major contributor to

environmental pollution as it discharges a large volume of waste products.

Elaborate measures have been adopted to combat air and water pollution in VSP.

In order to be eco friendly, VSP has planted more than 3 million trees over an

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area of 35 square Kms. and incorporated various technologies at a cost of Rs.

460 Crores towards pollution control measures.

c) HUMAN RESOURCE MANAGEMENT

Human resource initiatives at VSP are clearly linked to the corporate

strategy of the organisation. VSP has exemplary industrial relations where the

entire workforce works as a well knit team for the progress of the Company. The

productive environment prevailing in the Company fosters an atmosphere of

growth, both for the employees and for the Company. VSP has introduced multi

skilling concept since inception and the employees are trained as per this

concept. VSP has adopted a system of overlapping shifts, the first of its kind, in

the industry. This system ensures smooth change over of the shifts and

uninterrupted peace of operation of the plant during the shift change over.

Another unique feature followed at VSP is the uniform working hours for the

ministerial employees.

i) TRAINING AND HUMAN RESOURCE DEVELOPMENT

Training and HRD are given due emphasis at VSP. Each year, a minimum

of 1/3rd of the employees undergo various training sessions either at Training and

Development Centre or at Centre for HRD for sharpening their skills on the

technical and management related issues. Training is also given in the area of

safety, fire prevention, occupational health besides on the job at the shop floor.

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ii) WELFARE AMENITIES

The welfare measures provided for the employees of the Company are the

best in the industry. A modern township with all amenities has been developed

with 8032 quarters to house the plant employees and other government agencies

in 11 sectors. The township is having best facilities in terms of drinking water

supply, drainage system, roads, community centres, crche, parks, schools,

shopping complexes, medical facilities, recreational facilities, etc to cater to the

needs of the employees and their dependent families. The Company also

provides welfare facilities much beyond the statutory requirements by way of

introduction of a unique superannuation benefit fund and a unique family benefit

scheme.

d) ACHIEVEMENT AND AWARDS

The efforts of VSP have been recognised in various forums. Some of the

major awards received by VSP are in the area of the energy conservation,

environment protection, safety, quality, quality circles, Rajbhasha, MoU, sports

related awards and a number of awards at the individual level.

Some of the important awards received by VSP are indicated below.

ISO 9001 for SMS and all the downstream units a unique

distinction in the Indian Steel Industry.

CII (Southern Region) Energy conservation award in 1995-96.

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Gold star award for excellent performance in productivity.

Best Labour Management award from the government of AP.

SCOPE award for best turn around from 2001.

Best Enterprise award from SCOPE, WIPS for 2001-02.

Prime Ministers trophy for 2002-03.

MoU excellence award for 2003-04.

Total quality, latest technology, sophisticated equipment, up to date

knowledge, high skills, cost consciousness, production with less cost and

customer satisfaction have become the hallmark of VSP.

Today, VSP is moving forward with an air of confidence and with pride

amongst its employees who are determined to give their best for the Company

to enable it to reach new heights in organisational excellence.

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PROJECT EVALUATION

Capital budgeting is a complex process, which may be divided into six broad

phases: Planning, Analysis, Selection, Financing, Implementation, and Review.

The following chart shows the relationship among these phases

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Planning

Analysis

Selection

Financing

Implementation

Review


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Project Planning

The planning of a project is a technically pre-determined set of interrelated

activities involving the effective use of given material, human, technological and

financial resources over a given period of time. Which in association with other

development projects result in the achievement of certain predetermined

objectives such as the production of specified goods & services.

Project planning is spread over a period of time and is not a one shot

activity. The important stages in the life of a project are:

Its identification

Its initial formulation

Its evaluation (whether to select or to reject).

its final formulation

Its implementation.

Its completion and operation (Management and control to ensure targeted

benefits).

The time taken for the entire process is the gestation period of the project.

Contents of Project report:

1. Market and marketing.

2. Size of the project.

3. Project engineering dealing with technical aspects of the project.

4. Location and layout of the project building.

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5. Building.

6. Production capacity.

7. Work schedule.

Details of the cost of the Project:

1. Cost of Land.

2. Cost of Building.

3. Cost of Research and Developing.

4. Cost of Plant & Machinery.

5. Cost of Furniture and Fittings.

6. Profitability of Projects.

7. Organisational Structure.

8. Proposed Financing of the Project.

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At present Vizag Steel Plant is producing 3.5 million Tonnes of liquid steel.

VSP wants to expand its plant capacity to 10 million Tonnes per year by 2020.

Now it is in ongoing expansion plan by increasing its capacity from 3.0 MT Stage

to 6.3 MT stage in order to cater the needs of the domestic market and inturn

contributing for the growth of gross domestic product rate.VSP aiming to produce

at international standards of cost and quality ; and to meet the aspirations of the

stakeholders. In VSP there are three coke oven batteries they produce the

required coke for steel production in VSP. Due to the expansion of the plant the

three coke oven batteries, existing rolling mills, steel melt shop are not sufficient.

The planning for the expansion project is very essential in order to completethe project in given time. Without proper planning of the material, human and

technological resources the project cannot be completed efficiently. The detailed

project report helps in estimating requirements of the project and completing the

project systematically.

Project analyzing

After the primary stages of screening, the analysis of the market, technical,

financial, economic and ecological aspects are to be taken up. The focus of this

phase of capital budgeting is on gathering, preparing and summarizing relevant

information about various project proposals. Based on the information developed

in this analysis, the stream of costs and benefits associated with the project can

be defined.

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Project Appraisal

In the project cycle, preliminary establishment precedes the project appraisal

proposed to be achieved through implementation of a project. The appraisal of an

investment proposal needs to examine the following aspects:

Demand and supply analysis to determine the gap and whether product

specifications, market plan and delivery system are soundly conceived, for

preferably through market surveys and/or other reliable forecasts of demand

and supply of products/services proposed to be produced by project underconsideration. In the case of an export oriented pr4oject export potential of

products/services would need to be assessed.

Technical analysis to determine whether the specifications of technical

parameters chosen realistic and optimal.

Organisational and managerial aspects to determine whether the Organisation

has the managerial capability to implement and operate the project, the

preparedness to execute the project including implementation plans,

PERT/CPM chart/activity taking in to account the projects that are already

being implemented by the concerned agency and resources required for

implementing the project.

Environmental aspects to ensure that the environment related issues such as

protective measures, rehabilitation, resettlement etc as may be required as per

environmental guidelines have been fully covered in the project cost estimates.

Financial analysis to determine whether financial costs are properly estimated,

funding is assure and the project is financially viable.

Economic analysis to determine whether the project is worthwhile from the

point of view of the economy as a whole.

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Sensitivity / Risk analysis to assess the impact of different variables of input

and output on the viability of the project is carried out which can suggest

potential management activity to reduce overall project risk.

Capital investment decisions are a firms decisions to acquire long term assets. They

involve large capital expenditure, and have considerable effect on the firms

growth and profitability. The firms investment decisions would generallyinclude expansion, acquisition, modernization and replacement of the long-term

assets.

The three steps involved in the evaluation of an investment or project.

1. Estimation of cash flows.

2. Estimation of required rate of return.

3. Application of a decision rule for making the choice.

An analysis of cash flows is useful for short run planning firm needs sufficient

cash to pay debts maturing in the near future, to pay interest and other expenses

and to pay dividends to shareholders. The firm can make projections of cash

inflows and outflows for the near future to determine the availability of cash. This

balance can be matched with the firms need for cash during the period and

accordingly arrangements can be made to meet the deficit or invest the surplus

cash.

The investment decision rules may be referred to as capital budgeting

techniques or investment criteria. A sound appraisal technique should be usedto measure the economic worth of an investment project. The essential property

of a sound technique is that it should maximise the shareholders wealth. The

following other characteristics should also be possessed by a sound investment

evaluation criterion.

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It should consider all cash flows to determine the time profitability of the

project.

It should provide for an objective and unambiguous way of separating good

projects from bad projects.

It should help ranking of projects according to their time profitability.

It should recognize the fact that bigger cash flows are preferable to smaller

and early cash flow.

It should help to choose among mutually exclusive projects, those projects

that maximise the shareholders wealth.

It should be a criterion, which is applicable to any conceivable investment

project independent of others.

Familiarity with the capital budgeting techniques will facilitate an easier

understanding of costs and benefits risk analysis and cost of capital.

Economists, Accountants, and others have suggested more than thirty criteria

to judge the worthwhileness of the capital project. Some techniques are general

and applicable to wide range of projects and some are specialized and suitable forcertain types of investments and industries.

The investment criteria or techniques are classified into two broad categories-

1.Discounting criteria

a. Net present value

b. Internal rate of return

c. Profitability index

d. Net operating benefits per unit of investment method

2.Non discounting criteria

a. pay back period

b. Accounting rate of return

c. Debt-service coverage ratio

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d. Cost effectiveness analysis

1. NET PRESENT VALUE:

N.P.V is a modern method of evaluating investment proposals. This method

takes into account the time value of money and calculates the return on

investment by introducing the factor of time element, i.e. NPV recognizes the

fact that a rupee earned today is worth more than a rupee tomorrow. The net

present value criterion has a sound rationale underlying in it, it represents the

net benefit over and above compensation for time and risk.The NPV of a project is the sum of the present values of all the cash flows,

which is either positive or negative that are expected to occur over the life of the

project.

n Ct

NPV of a project = ---------t=1 (1+r)

Here,

Ct = cash flow at the end of yeart n = life of the project

t = discount rate

2. INTERNAL RATE OF RETURN:

Internal rate of return is also a method that uses the concept of time value of

money.

The internal rate of return of a project is the discounted rate, which

makes Its NPV equal to zero. IRR equates the present value of future cashflows with the initial investment. IRR is also known as time adjusted return, trail& error yield method.

In the NPV calculation we assume that the discount rate is known and

determine the NPV, but in the case of IRR we set the NPV equal to zero and

determine the discount rate that satisfies this condition.

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C0

4. NET OPERATING BENEFITS PER UNIT OF INVESTMENT METHOD

NPV/IRR methods are quite useful when project resource are unlimited.

When resource constraint that time Net Operating Benefit Method will use.

N Bt N OCt

---------- - --------------t=1 (1+k)t t=1 (1+k)t

PV/K = ------------------------------------------------------

N It

----------t=1 (1+k)t

Bt = Benefits in year t

OCt = Operating costs in year t

It =Investment in year t

5. BENEFIT COST RATIO:

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It is of paramount importance for the finance manager to access the

benefits that the firm will accrue by taking up a certain project and the costs

that are involved. If the benefits are much more than the costs then the

projects are desirable and if the costs are very large with the benefits meager,

the projects become undesirable.

PVB

Benefit cost ratio = -------

I

Where, PVB is the present value of the benefits.

It is the initial investment.

6. PAYBACK PERIOD:

The payback period is the length of the time required to recover the initial

cash outlay on the project. According to the payback criterion, the shorter the

period of payback, more is the desirability of the project.

Firms using this criterion specify the maximum acceptable payback period.

If n is the number of years that is fixed by the firm, the payback period less

than n is desirable and the projects with payback period exceeding n is

undesirable.

The payback period does not take in to consideration the time value of

money, so this conventional technique is modified as Discounted Payback

Period, which converts the cash flows in to the present values. The Payback

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period is a popular method in practice as it is simple helps to tackle risk and

focuses on liquidity.

The payback period however suffers serious drawbacks,

It does not recognize the time value of money. It gives equal weight to the

cash flows occurring over different periods of time.

It is not a measure of profitability. It does not consider all cash flows of the

project.

It can be misleading since it ignores cash flows after the payback period.

Between two projects, it will accept the project with a shorter period, even if

the excluded project generates larger cash flows after the payback period.

7. ACCOUNTING RATE OF RETURN

The accounting rate of return or average rate of return on investment, is a

measure of profitability, which relates income to investment both measured in

accounting terms.

ARR is calculated on the basis of average income over the life of the

project. If the ARR is calculated for each year using the expected net income

the following generalizations can be made:

1. The accounting rate of return tends to understate the internal rate of return for

earlier years and over state for the later years.

2. The ARR and the IRR can be the same if the depreciation schedule is equal

to the economic depreciation schedule.

3. Inflation and creative accounting tend to create a discrepancy between the

accounting rate of return and internal rate of return.

Average income after tax

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ARR = ---------------------------------

Initial investment

In this method a project is accepted if the ARR is higher than the minimum

rate established by the management and reject those projects which have

ARR less than the minimum rate. This method would rank a project as number

one if it has highest ARR and lowest rank would be assigned to the project

with lowest ARR.

The ARR can be readily calculated from the accounting data and this rule

incorporates the entire stream of income in calculating the projects

profitability.

8. DEBT SERVICE COVERAGE RATIO (DSCR)

Projects are generally financed in a certain debt and equity ratio. The equity

is contributed by the promoters of the project and /or by the public if theOrganisation is government owned. While the debt is financed by various

financial institutes and banks. The various evaluation techniques like NPV,

IRR, Payback etc do not give adequate ranking of the project in case it is debt

financed.

DSCR is the annual net project cash flow after tax divide by the annual

principal plus interest charges.

The banks/financial institutions would finance the debt portion of the project

cost, if this ratio exceeds 1.5 on the average for the duration of debt

repayment. If the ratio exceeds 3 to 4, the project would be attractive and it

would be financed by venture capitalist

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Cost Effective Analysis

In the cost effectiveness analysis the project selection or technological

choice, only the costs of two or more alternative choices are considered

treating the benefits as identical. This approach is used when the question of

how to minimize the costs forundertaking an activity at a given discount rates.

In case the benefits and operating costs are given, one can minimize the

capital cost to obtain a given discount.

Project Selection

The selection of a project involves a large number of techniques that judge

whether the project is worthwhile or not. The discounting techniques like NPV,

Internal rate of return and cost benefit ratio are considered. The non-discounting

techniques like payback period and accounting rate of return are also considered.

The management fixes the cut-off values.

The Visakhapatnam Steel Plant has two alternatives in selecting the project.

1. To establish the expansion plant i.e up gradation to 6.3 MT

2. To continue with existing production capacity.

Proper project appraisal to be done for expansion projects otherwise it leads

to problems. In order to accomplish its vision and mission statements and to

meet aspirations of the stake holders, VSP has to go for expansion plans

subsequently.

VSP will enhance the volume of production in long products segment in view ofbrand image. In order to diversify the product mix and help reduce the

dependence on import of pipes in oil and gas sector, a seamless pipe mill is

envisaged.

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PROJECT FINANCE

Project financing is considered right from the time of the conception of the

project. The proposal of the project progresses working capital. So, in general a

project is considered as a mini firm which is a part and parcel of the

Organisation.

Sources of project financing

Equity capital debt capital

Equity share capital Term loansPreference share capital Debentures

Internal accruals W.C advances

Misc.sources

EQUITY SHARE CAPITAL:-

Equity shareholders are the real owners of the company whose

ownership is limited only to their capital contributions unlike partnership firms and

sole-trading concerns. They bear the risks of ownership and enjoy rewards

accordingly.

Equity share capital may be Authorized, Issued, Subscribed,Called up &

paid up capital. The amount of capital that a company can issue as per its

Memorandum of Association is called Authorized capital. The amount of share

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Disadvantages of Equity capital :

1. Public issue and private placement leads to the dilution of control of

existing Equity shareholders.

2. Cost of Equity share capital is higher than that of other investors

since Equity shareholders bear the highest risk. The higher the risk,

the larger the return they expect.

3. Cost of issuing Equity shares which includes brokerage,

underwriting commission etc.., is higher than that involve in issuing

the securities.PREFERENCES SHARE CAPITAL:

Preference shareholders get preference in the form of priority given

to them while making dividend is fixed and the preference shareholders do not

enjoy the voting rights on any resolution places before the company. In any year if

the company is unable to pay preference dividends, The arrears will be carried

forward to the next year. In the next year, cumulative preference dividend is paid.

It is clear that unless the company pays the cumulative preference dividends

along with the arrears the company cannot declare equity dividends. Normally

preference shares are redeemed after 10 to 15 years.

Advantages:

1. Company can skip preference dividend and pay in the next year.

2. Preference capital enhance the credit worthiness of the company.

3. No dilutions of control as preference shareholders do not carry any voting

rights.

4. No collateral pledge in favour of preference shareholders.

Disadvantages:

1. It is costlier sources of financing when compared to debt capital because

unlike interest payments, preference dividends are not deductible.

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2. As there is skipping of dividends in one year, it can be adversely affect the

reputation of the company. If the company skips the dividends for three

year. it has to give voting right to the preference shareholders.

INTERNAL ACCURALS:

A part from equity share capital and preference share capital, internal

accruals are also one form of long term sources of project financing. Internal

accruals consist of depreciation charges and retained earnings. Since

depreciation is a periodic write off of a capital expenditure of an asset inbeginning, it is also a long term internal sources of financing a product. On the

other hand, retained earnings are that portion of the profit after tax minus

preference dividend which is ploughed back in the company. Retained earnings

are also known as internal Equity. Generally in India, companies retain 30%

to80% profit after tax less preference dividend.

Advantages:

1. This source is readily available for which company need not consult either

shareholders or lenders.

2. No need of any issue cost to be bleared

3. No dilution of control as there will not be any increase

in the number of shareholders.

Disadvantages:

1. Limitation on the funds available by the way of internal accruals.

2. If there is ploughing back of profits through retained earings,there is

opportunity cost of capital by the way of dividends for the by equity share

holders.

TERM LOANS:

Sources of long term project financing, are the long term loans given by

financial institutions and banks to the companies to be repayable in less than 10

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years. It is a form of debt financing. Term loans are generally used for financing

fixed assets and long term working capital needs. They differ from short term bank

loans which are employed for financing short term assets and short term working

capital needs. Financial institutions grant Rupee term loans as well as foreign

currency term loans. Term loans are secured by first Equitable mortgage of all

immovable properties or assets of the company. Normally in case of default of the

interest and principal payments by the borrower, the borrower has to pay penalty

in the form of additional interest of 2% p.a.for the period of default on the amount

of principal in default. Term loans are subject to the levy of upfront fee of 1% onthe loan amount sanctioned.

DEBENTURES:

Debentures are the debt financing instruments issued by large

companies. These are the long term debt instruments having the similar features

to those of ordinary debt. The company as to pay interest and principal instalment

at the specified regular times without fail. Debentures offer greater flexibility with

respect to date of maturity, rate of interest, repayment etc., when compared to

term loans. In India, generally, debentures are secured by mortgage on the

immovable asset and a floating charge on the other assets of the company.

Debentures may be medium term having the maturity of 1 to 5 years or long term

having the maturity period of 5 to 12 years. Debentures, sometimes, may have the

Call or put options. As per the companies Act if the debentures are issued, a

trustee, which may be a bank or financial institution or insurance company, is

appointed to ensure that the company fulfils all the contractual obligations.

Contemporary types of debentures:

Deep discount bonds

Convertible debentures

Floating rate bonds

Secured premium notes

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Indexed bonds

Privately placed debentures

Advantages:

1. Interest on debt is tax-deductible.

2. No dilution of control.

3. Cost of issuing debt is lower than that of equity capital.

4. Provides protection against high unanticipated inflation as the interest

charges are once per all fixed in nominal terms.

Disadvantages:

1. Increase financial leverage which in turn raises the cost of Equity as per

CAPM model.

2. Debt imposes restrictions on limit of the companys borrowings.

3. The real cost of debt will be greater than the expected value in case of low

inflation.

WORKING CAPITAL ADVANCES:

These are the short term advances granted by commercial banks in

three ways namely cash credit, loans, purchase/ discount of bills and letter of

credit.

Cash credit:

Cash credit is the overdraft agreement made by a bank for the purpose of

borrowing by the customer. The borrower can draw the amount as often as

required provided the amount does not exceed cash credit limit. Interest is

charged only on the running balance but not on the limit sanctioned. The

borrower is very much interest in this type of loan as he can withdraw amount

as and when he requires and pays interest only on the amount he has

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withdrawn. However for availing this facility, the borrower has to pay some

minimum charges irrespective of the level of borrowing.

Loans:

Loans are the short term loans granted by the commercial banks and the

interest is repayable on the whole loan amount sanctioned unlike cash credit

agreement. They are disbursed either on demand or in periodical instalments.

Purchase/discount of Bills: Discount of bills is the bill of exchange having the maturity period of 90

days. It may be clean bill or documentary bill. The seller of goods draws the

bill and sends it to the purchaser for acceptance. Once it is accepted by the

purchaser, it is to be received back by the seller. The seller, if he needs

money before the maturity date encashes or discounts the bill with any

commercial bank. Later on the purchaser pays the amount of bill to the bank

on the due date. So here the commercial banks finance the bill to the seller on

behalf of the purchaser.

Letter of credit:

Letter of credit is the form of advances granted by a bank in favour of his

customer. Generally it is useful in case of foreign trade. On behalf of importer,

the bank of the importer pays the due amount to the exporter and later on

collects the amount from the customer.

OTHER SOURCES:

I) DEFERRED CREDIT:

It is the credit provided by the supplier of materials to the buyer so

that the latter can make the payment over a period of time.Generally,the

supplier provides these facility if there is banks guarantee furnished by the

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buyer. The rate of interest charged by the supplier will be high. This type of

finance is short term in nature normally.

II) LEASE FINANCE:

It is a type of debt finance wherein two persons have the contractual

agreement stating that one person gives the right to use his asset/machinery

to another person for periodic rental payments. The person who grants the

right is called Lessor and the person who uses the asset is called Lessee.The two types of lease are available namely finance lease and operating

lease.

III) HIRE PURCHASE:

It is also a contractual agreement between to persons wherein one

person purchase the asset and gives it on hire to the another person per

some periodic payments of instalments. The instalments cover interest as well

as principal. At the end of the payment of the last ins

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