Project Approach to Lending

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Project Approach to Lending Financial Appraisal

• Satyajit Dwivedi
• Member of Faculty
• CAB Pune

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Potential Activities

• Fruits and Vegetables
• Floriculture
• Medicinal and Aromatic Plants
• Minor Irrigation Schemes - development
  management
• Livestock based Schemes - Dairy, Poultry,
  Fisheries, etc.
• Land development activities - soil water
  conservation
• Mechanisation of Agriculture
• Organic Farming
• Bio-fuel and TBO seeds
• Agro-processing
• Seed and Planting material production
• Agri-clinic and Agri-Business Centres
• Post harvest and Marketing Infrastructure
  Development, etc.

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PROJECT

• AN ACTITY IN WHICH FINANCIAL RESOURCES ARE
  EXPENDED TO CREATE CAPITAL ASSETS THAT PRODUCE
  BENEFITS OVER AN EXTENDED PERIOD OF TIME AND
  WHICH LOGICALLY LENDS ITSELF TO
  PLANNING,FINANCING AND IMPLEMENTING AS A UNIT.

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ETERNAL TRIANGLE OF PROJECT MANAGEMENT
SCOPE
QUALITY
COST
TIME
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Project Cycle

Idea/identification
Evaluation
Formulation
Monitoring
Implementation
Appraisal
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WHY APPRAISE POJECT

• TO DETERMINE IF COMPONENTS OF PROJECT ARE
  CONSISTENT
• TO ASSESS SOURCES AND MAGNITUDE OF RISKS AND
  THEIR MANAGEMENT
• FINANCIAL/ECONOMIC VIABILITY OF
• PROJECT
• DECISION ON GOOD OR BAD PROJECTS

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PROJECT APPRAISAL

• TECHNICAL
• COMMERCIAL
• ENTERPRENEURIAL
• FINANCIAL
• ECONOMIC
• MANAGERIAL
• SOCIAL
• ENVIRONMENTAL

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FINANCIAL APPRAISAL

• UNDISCOUNTED CASH FLOW METHOD
• DISCOUNTED CASH FLOW METHOD

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COMPONENTS OF CASH FLOW

• INITIAL INVESTMENT
• OPERATING CASH FLOW
• TERMINAL CASH FLOW

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Bankability / Repayment Schedule

• Will the borrower be able to repay the loan
  interest within repayment period?
• Repayable surplus
• Generally 50 of gross surplus for small
  borrowers
• 75 of gross surplus for large borrowers
• Contd..

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Bankability / Repayment Schedule

• Repayment Schedule Types
• Equal Principal Installment
• Loan (Principal)
• 
  Accrued Interest
• No of Installment
• It changes (reduces) over time
• Contd

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Economic Life of Project
(Rs.)
Years 1 2 3 4 5 6
Aggregate Benefits 1000 1000 1100 1100 1100 1100
Costs Incurred Costs Incurred Costs Incurred Costs Incurred Costs Incurred Costs Incurred Costs Incurred
Fixed Cost 1000 - - - - -
Operation Mainten. cost 100 100 100 100 100 100
Production cost 200 200 200 200 200 200
Total 1300 300 300 300 300 300
Net Benefit/Surplus -300 700 800 800 800 800
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Discounted Measures of Project Worth

• Used in financial analysis
• Future stream of benefits and Future Stream of
  costs
• Reduced to present worth
• Present worth of costs and present worth of
  benefits during the project life is compared to
  know which project gives maximum benefits

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Time Value of Money

• Money has value
• Different values at different times
• Preference for smaller sums today
• Than larger sums at future date

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Concept of Interest

• For getting larger sum at future date
• Part with the present sum
• Forego the use of money for present
• We expect reward/benefit - interest
• Interest - payment for foregoing use of money by
  person to whom it is lent.

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Compounding (Future Worth)

• Interest determines price of money
• Compounding Future worth of present money at a
  specified interest rate
• Discounting Present worth of future money at a
  specified interest rate.
• Discount Factor also called Present Worth Factor

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Compounding-Illustration
Sl. No. Year Amount at the beginning of the year Rate of interest factor (9) Amount promised at the end of the year
1 2 3 4 (3X4)5
1 2010 650 1.09 708
2 2011 708 1.09 772
3 2012 772 1.09 841
4 2013 841 1.09 917
5 2014 917 1.09 1,000
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(e) Discounting - Illustration
( Rs.) ( Rs.) ( Rs.) ( Rs.) ( Rs.)
S. No. Year Amt. promised at the end of the year Rate of Interest Factor Amt. (in Rs.) worth at the beginning of the year
1 2 3 4 (3/4)5
1 2014 1,000 1.09 917
2 2013 917 1.09 841
3 2012 841 1.09 772
4 2011 772 1.09 708
5 2010 708 1.09 650
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Techniques in Discounted Measures

• Benefit Cost Ratio
• Net Present Worth / Value (NPW/NPV)
• Internal Rate of Return (IRR)

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Benefit Cost Ratio

• Total of Present Worth of Benefits BCR
• Total of Present Worth of Cost
• For selection of project BCR should be more than
  1 when discounted at opportunity cost of capital
• Broad idea of profitability of the project

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Benefit Cost Ratio
Year Investment cost Benefits DF _at_15 PW of costs ( 2x4) PW of benefits (3x4)
1 2 3 4 5 6
0 1000 - 1.000 1000 -
1 - 400 0.870 - 348
2 - 500 0.756 - 378
3 - 500 0.658 - 329
Total 1000 1400 1000 1055
BC Ratio 1055 - 1000 1.055 1

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Benefit Cost Ratio (contd)
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Benefit Cost Ratio (contd)

• Cannot be used to compare 2 projects
• projects may have same BC Ratio but net
• benefits vary
• projects may have same net benefit but BC
  Ratio varies

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Net Present Worth (NPW)

• Present Worth of Benefits minus Present Worth of
  Cost
• NPW should be positive at opportunity cost of
  capital
• Indicates size of benefits at opportunity cost of
  capital which BC Ratio cannot indicate
• Cannot rank project by size of NPW

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Net Present Worth
Year Investment cost Benefits DF _at_15 PW of costs ( 2x4) PW of benefits (3x4)
1 2 3 4 5 6
0 1000 - 1.000 1000 -
1 - 400 0.870 - 348
2 - 500 0.756 - 378
3 - 500 0.658 - 329
Total 1000 1400 1000 1055
NPW 1055 - 1000 55

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Internal Rate of Return

• Discount Rate at which PWB PWC
• OR
• Net Present Worth of Cash flow is zero
• Earning capacity of money invested in the
  project over project life
• Helps in ranking the project

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Internal Rate of Return (contd)

• Found out by Trial and Error method
• Discount rate increased in multiples of 5 (15-20,
  20-25, etc.)
• NPW decreases as discount rate increased
• Through trial and error a stage reached when NPW
  becomes negative
• IRR found out by interpolation

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Internal Rate of Return (IRR)
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Net Present Worth
Year Investment cost Benefits DF _at_ 20 PW of costs ( 2x4) PW of benefits (3x4)
1 2 3 4 5 6
0 1000 - 1.000 1000 -
1 - 400 0.833 - 333
2 - 500 0.694 - 347
3 - 500 0.579 - 289
Total 1000 1400 1000 969
NPW 969 - 1000 (-) 31

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Internal Rate of Return

• Internal Rate of Return ( IRR )
• Lower of the two discount rates ( ) Difference
  between two discount rates x (NPW _at_ lower
  discount rate - Absolute difference between
  NPWs at two discount rates )
• IRR
• 15 5 x ( multiplied by )
• 55 - 86 ( 55-31)
• 18 ( 18.2 )
• IRR determined by trial and error
• Represents return for resources over life of
  project
• Earning power of money used in project
• IRR not estimated beyond 50
• Present cut off IRR 15

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FORCE FIELD ANALYSIS-WORKSHEET
Forces for change Score Score Forces against change
Costumers want new product 4 3 Staff not happy with loosing OT
Enhance speed of production 2 3 Fear of New technology
Increase volume of output 3 1 New technology Environ. Impact
Minimize maintenance cost 1 3 Increase in Expe nses on a/c of new technology
1 Disruption in work
T O T A L 10 11 T O T A L
Developed by Kurt Lewin
CHANGE PROPOSAL UPGRADE FACTORY WITH NEW
MACHINERY
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• Training the staff - Increase in Expenditure
  ( 1)
• Fear of technology could be eliminated after
  training-Reduce fear(-2)
• Impress staff-change is inevitable for
  survival-New force in favor(1)
• Impress staff that new machines would introduce
  variety and interest
  
  
  to their jobs - New force in favor
  (1)
• Increase wages to reflect new productivity
• Increase in Expenditure (1) Reduce in
  loss of overtime (-1)
• Propose installation of slightly different
  machines with filters to
• eliminate pollution Reduce environmental
  impact (-1)

FORCE FIELD ANALYSIS .. CONTD
These changes would swing the balance from 11
10 (against the plan), to 9 12 (in favor of
the plan).
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Forces for CHANGE Score FORCE FIELD ANALYSIS REVISED SCORES Score Forces against CHANGE
Costumers want new product 4 3-1 Staff not happy with loosing OT
Enhance speed of production 2 3-2 Fear of New technology
Increase volume of output 3 1-1 New technology Environ. Impact
Minimize mainte nance cost 1 311 Increase in Expenditure
Impress staff-cha nge is inevitable 1 1 Disruption in work
Impress staff-variety of work 1
T O T A L 12 9 T O T A L
CHANGE PROPOSAL UPGRADE FACTORY WITH NEW
MACHINERY
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Case exercise on project -financial appraisal

• CaseMI Project
• A farmer having a water source like open well or
  canal nearby would like to invest on a pumpset to
  lift water. Presently, he is cultivating only a
  single crop and getting a net benefit of Rs.3,000
  (pre development income) per year
• On installation of pumpset, it would be possible
  to take two crops with some additional
  expenditure. First year he projects raising of
  one crop, as it is assumed that the installation
  of pumpset might take some time. Therefore,
  during first year, the production expenditure is
  estimated as Rs.4,500 for single crop, with a
  projected benefit of Rs.8,000 (benefit assumed to
  be increased from Rs.3,000 to Rs.8,000 due to
  irrigation)
• Contd...

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All the Best

• Thank You