Aspects of Project Appraisal
Technical Appraisal
Commercial / Market Appraisal
Managerial Appraisal
Financial Appraisal
Analysis of past working results in case of existing concerns
Cost of Project and Means of Finance
Financial Projections – Cash flow and Profitability estimates
Ratio Analysis
Break even Points analysis
NPV, IRR analysis
Benefit Cost Ratio (BCR)
Technical Appraisal
Technical appraisal by the bank involves a study of :-
Location
Technology adopted Manufacturing process
Size of the plant
Product mix / Product range
Selection of Plant & Machinery
Plant lay out
Raw Materials
Labour
Utilities
Implementation Schedule
Licenses & Statutory requirement
Commercial / Market Appraisal
Information should collect of:-
Demand
Supply
Distribution
Pricing
External
Technique used for forecasting aggregate demand are:-
Import substitution
Past trend method
End use method
Correlation and Regression
Export market
Managerial Appraisal
Management appraisal is nothing but appraising of the persons behind the enterprise. The basic of this confidence is generally derived from the 5 C’s of the borrower
Character
Capacity
Capital
Collateral
Conditions
Management appraisal involves the assessment of:-
The Entrepreneur
The Board of Directors
The Chief Executive
The Departmental Heads
Financial Appraisal
Analysis of past working results in case of existing concerns
Assessment of latest financial position by audited B/s and P&L of last 3 year
Cost of Project and Means of Finance
Cost of projects includes:
Land & Site Development
Building
Plant & Machinery
Technical known-how and Engineering fees
Expenses on engaging foreign technicians and training of indian technicians
Miscellaneous assets
Preliminary & pre-operative expenses
Contingencies
Margin for working capital
Initial cash losses
Source of Finance
Source of finance includes:
Share Capital
Term Loan
Debenture Capital
Deferred Credit
Incentive Sources
Miscellaneous Sources
Financial Projections – Cash flow and Profitability estimates
The aim of estimation of profitability are:
The Earning Capacity of the Project
The Capacity of the Unit to Service the Loan
The Capability of the Unit to Service the Share Capital
Surplus Available with the Unit for Finance its Future Growth
Ratio Analysis
Debt Service Coverage Ratio (DSCR)
DSCR indiactes the ability of a concern to service its term liabilities
DSCR = (Net Profit + Depreciation + Other Non Cash Expenses + Interest on Term Loan) / (Interest on Term Loan + Instalment of Term Loan)
The Average DSCR of 1.50 is considered reasonable
Break even Points analysis
Break Even Analysis if often used in appraising the profitability
Break Even Point in terms of unit is = Fixed Cost / Contribution
Contribution = Sales price per unit – Variable cost per unit
Capital Budgeting
Pay Back Period
It is commonly used method of investment appraisal in view of the simple mode of its calculation. The payback period represents the number of years it takes for the operating earnings from a project to recoup the total investment on the project and is computed taking into account:
Net investment / Profit before depreciation and tax = Payback period (years).
The method is useful both for firms with plenty of investment opportunities but limited financial resources and for those projects which have obsolescence risk i.e. larger wear and tear.
Pay Back Period method has following limitations:
It can lead to incorrect ranking of industrial projects as the method ignores return of the project after the payback period.
The method does not give us any objective cut-off criterion. What should be the minimum or maximum payback ?
The projects which have low return initially but a longer economic life may be preferable to
those projects which have high earning capacity initially but have shorter life span.
This method like return on investment ignores the time value of money.
This method attaches undue importance to the quick yield and gives the impression that the projects have little or no development significant. It is a not enough to recoup the investment. The principal concern of the investor is to optimise the return/benefits. In view of the aforesaid limitations, the payback method is better accepted as a secondary method of investment appraisal rather than the final criterion for investment.
Average Rate of Return
Under this method, the entire life of a project is taken into account, unlike the payback period. An average of the annual net operating profits (After Depreciation) for the entire life of the project is taken and rate of return on original investment and average investment calculated.
Average Rate of Return method has following limitations:
This method like return on investment ignores the time value of money.
This method does not take into account the life differential of projects
Net Present Value (NPV)
NPV is the difference between cash outflows at base period and present value of future cash inflows. It helps the bank to ascertain, whether a oroject should be taken up for financing or not
Profitability Index = Present Value of Cash Inflows / Present Value of Cash Outflows
Internal Rate of Return (IRR)
The internal rate of return is the discount rate at which the total discounted value of future drawls from the unit is equal to the initial investment in to the unit. It is the discount rate that makes the net present value (NPV) of the project equal to zero. An investment to be accepted if it’s IRR is higher than its cost of capital and should be rejected if lower
Benefit Cost Ratio (BCR)
Benefit Cost Ratio (BCR) = PVB/I
Net Benefit Cost Ratio (NBCR) = (PVB – I) / I = BCR – I
BCR | NBCR | Rule |
> 1 | > 0 | Accept |
= 1 | = 0 | Indifferent |
< 1 | < 0 | Reject |