PROJECT FINANCE (SEMESTER – III) QUES NO. 1: ECONOMIC VIABILITY OF ANY PROJECT SHOULD BE IN CONFORMITY WITH THE GOVERNMEN’S GOAL TO ACHIEVE EQUIATABLE DISTRIBUTION OF INCOME – ELUCIDATE Ina any country’s economy, developmental activities are needed to sustain growth and to ensure overall prosperity of the nation and well being of all its citizens. The government formulates, directs and guides the destiny through various means. It frames policies to address growth and overcome poverty and to have equitable distribution of income among various strata of society. The documentation of the policy is through identification of areas where fresh investments are needed, devising investment methods and paving the way for different agencies capable of undertaking long-term & short-term financing depending on their structure and strength. The government also draws the core policy wherein prosperity can be perceived for overall development and equitable distribution of income. The economic analysis of projects includes an assessment of the sustainability of project effects to ensure that the project provides sufficient incentives for producers, sufficient funds are available to maintain project operations, the least cost means of providing the project benefits is used, the distribution of project benefits and costs is consistent with project objectives, and 1
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PROJECT FINANCE (SEMESTER – III)
QUES NO. 1: ECONOMIC VIABILITY OF ANY PROJECT SHOULD BE IN
CONFORMITY WITH THE GOVERNMEN’S GOAL TO ACHIEVE EQUIATABLE
DISTRIBUTION OF INCOME – ELUCIDATE
Ina any country’s economy, developmental activities are needed to sustain
growth and to ensure overall prosperity of the nation and well being of all its
citizens. The government formulates, directs and guides the destiny through
various means. It frames policies to address growth and overcome poverty and
to have equitable distribution of income among various strata of society. The
documentation of the policy is through identification of areas where fresh
investments are needed, devising investment methods and paving the way for
different agencies capable of undertaking long-term & short-term financing
depending on their structure and strength. The government also draws the core
policy wherein prosperity can be perceived for overall development and
equitable distribution of income.
The economic analysis of projects includes an assessment of the sustainability of
project effects to ensure that
the project provides sufficient incentives for producers,
sufficient funds are available to maintain project operations,
the least cost means of providing the project benefits is used,
the distribution of project benefits and costs is consistent with project
objectives, and
environmental effects are included in the analysis
The project has to generate an acceptable rate of return, which adequately
covers your cost of capital. The expected rate of return depends on the risk
profile of the project. In a rational economic world, nobody implements a project
to make losses. In other words net present value has to be positive if you
discount the cash flows by the desired rate of return.
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Many a time plants may be viable economically and financially but would be
socially undesirable. An example would be dyes units, which have mushroomed
around Ahmedabad. These are polluting and generate effluents not acceptable
to the society and environment. In the last 5 years, India is slowly becoming
environment conscious and friendly. So using hazardous chemicals or polluting
industries may not get the necessary clearances. For instance, the state
government has ordered closure of all dyes units in Gujarat unless suitable
effluent treatment is implemented.
Project proposals should be derived from, and placed in the context of, broader
development objectives. These objectives may be explicitly stated in a
government plan document, or implicitly given through a public investment
program. A statement should be given of the main development objectives of a
country to which a proposed project will contribute.
Many investments will work well only if there are complementary investments in
related sectors or activities. For example, for an irrigation project to raise
agricultural output, the appraisal report must elaborate the necessary extra
requirements for transport and processing. Projects to improve urban services
should consider the capacity of the existing systems to deliver additional power
and water. Potential constraints in supplies, whether they can be overcome, and
the necessary timing of complementary investments, must be considered.
Because a project takes place within a given macroeconomic and sector context,
an investment project can be seen as an incremental change to an existing
structure. In fact, the context may be more important than the project itself.
Moreover, a project that is financially sound within one sector and
macroeconomic context may be financially unsound in another. Thus policy
changes may be as important as the physical investment to the achievement of
development objectives.
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QUES. NO. 2: EXPLAIN IN DETAILS THE TECHNICAL PARAMETERS OF
APPRAISING THE PROJECT.
To implement any project, the entrepreneur needs to carry out different types of
feasibility studies. These feasibility studies evaluate all the risks and returns and
tries to balance them and help the entrepreneur to finalize his plans.
Technical Feasibility: Technical feasibility refers to the ability of the process
to take advantage of the current state of the technology in pursuing further
improvement. The technical capability of the personnel as well as the
capability of the available technology should be considered. Technology
transfer between geographical areas and cultures needs to be analyzed to
understand productivity loss (or gain) due to differences. An entrepreneur should
have the requisite number of technically capable people as well as technology
required to set up and run the plant. The technology should be such that is can
adapt to local conditions. Technology transfer from overseas often fails in this
regard. The conditions in USA and America are quite different from India. Most
parts of India are hot and dusty. Sophisticated process controls have known to
fail. Therefore, knowledge and suitability to local conditions is very important.
Technical appraisal is basically concerned with the project idea / concept,
encompassing various aspects like technology, design, lay-out of the plant as
well as inputs and infrastructure facilities envisaged in / for the project and the
problems likely to crop up, in various areas related with technical aspects.
Technical appraisal focuses upon appraising the likely technical gaps / grey
areas or technical problems which can be broadly grouped under the following
three phases:
1. PHASE I: Problems relating to the project conception & formulation . The
likely problems to be appraised in advance could be:
a. Location of the project taking into consideration the project site,
project office, land, raw material suppliers, work force availability,
market access, physical & social infrastructure & facilities, utilities
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like telecommunication, water, power etc, transportation & general
state of development.
b. Selection of Process / Production Technology. It needs to be
analysed whether process / production technology is outdated or
obsolete or too advanced or dependable with proven track record &
upgradeable considering the size of the unit, plant capacity,
capacity utilisation, product mix & collaborators tie-ups. The
collaborators details & its track record is also appraised.
c. Detailed Project Engineering taking into account the logistics,
maintenance / service back up, spares & consumables, quality
standards / orientation, raw material suppliers / vendors etc
d. Project Implementation / Work Schedule
e. Project Competitiveness Indicators like manufacturing lead
time, work in process, trough-put, capacity, performability,
flexibility, quality etc
2. PHASE II: Problems faced during the construction and project
implementation. The likely problems to be appraised in advance could
be related to civil construction, civil layout & structures, projected charts
3. PHASE III: Problems pertaining to the period when the project is
in operation. The likely problems to be appraised in advance could be
related to raw material procurement, repairs & maintenance, power
supply availability, water supply, telecom facilities, other infrastructure
facilities, utilities status, quality control standards, organisation of
production function, data collection / information, feedback / reporting /
action etc.
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MORE SPECIFICALLY, THE LIKELY PROBLEMS TO BE APPRAISED IN
ADVANCE COULD BE STATED AS FOLLOWS:
MANUFACTURING PROCESS / TECHNOLOGY: Having decided on the
location and product, the promoter takes into account the manufacturing
process and technology that is to be adopted for producing the product. A
thorough study of the whole process starting from raw material stage to
the finished goods is made and the process flow chart is made.
Continuous efforts are made to integrate the process as far as possible in
order t maintain and meet stringent quality norms and meet with the
supply schedules.
TECHNICAL ARRANGEMENTS: For maintaining the quality & keep
forging the product in the international market the unit might require
transfer of technical know-how or hiring of technical & specialized
personnel for the manufacturing process. This necessitates pre-
determined contracts & finalization of terms even before the
commencement of the project at the conceptualization stage. The length
and the duration of the technical arrangement and training and
development acivities and its details are examined before entering into
actual contract. This again has the impact on the financial aspects of the
project.
SIZE OF THE PLANT: Size of the plant has a direct bearing on the
financial calculation in relation to annual production capacity. Hence in
the initial years about 60-70% production capacity is taken into account
for study of viability of the project. The determining factors of the size of
the plant is demand-supply of a particular product and the end use of the
product.
PRODUCT MIX: The process might require certain product mix to arrive
at the final product that is needed to be produced. The cost factors of the
product thus mixed is also taken into account to arrive at cost at various
levels of production & its cost impact on the manufacturing.
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SELECTION OF PLANT & MACHINERY: The selection of proper plant &
machinery with the latest technology is very important in the success of
the project. The decision to purchase the domestic machinery or importing
it has to be made very judiciously by taking into account the comparative
cost advantage.
PROCUREMENT OF PLANT & MACHINERY: The order for procurement
of machinery and the lead time it could take for final installation tests and
trials would be required and the time period for the same is taken into
consideration. In case of new projects the machinery is procured at such
time that the civil work is complete and necessary foundations can be
laid.
PLANT LAYOUT: The engineering layouts are scrutinized and finalized to
ensure maximum utilization of costly space on the shop floor & also the
safety of the personnel.
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QUES NO. 3: THE ECONOMIC VIABILITY AND TECHNICAL FEASIBILITY OF
ANY PROJECT GOES HAND IN HAND. EXPLAIN WITH EXAMPLES THE
IMPORTANCE OF BOTH STUDIES PROVING COMPLEMENTARY TO EACH
OTHER FOR SUCCESS OF ANY PROJECT.
A complete feasibility study for a business idea must be conducted at three
levels viz., technical; operational; and economic. The operational feasibility
begins with the question: “Will it work?” The technical feasibility asks: “Can it be
built?” These two levels are often addressed together and simply referred to as
technical feasibility. The economic feasibility brings the operational and
technical levels together to determine if the project can generate enough net
economic benefits to justify investments in it. Here, we ask: “Will it make
economic sense if it works and it is built?” External factors have significant
implications for the feasibility of any initiative. Therefore, the environment within
which the initiative is to be implemented must be defined as the domain for the
feasibility study. For example, an initiative that is feasible in a community with a
rail line may not be in one without, if rail transportation is a major technical
resource for the business.
Feasibility studies can result in one of three outcomes: (1) Feasible; (2) Feasible
with changes; and (3) Infeasible. All these decisions are defined within a
particular project’s context – location, markets, etc. Because feasibility studies
are based on expectations about the future, it is important that producer-
entrepreneurs who commission them understand the assumptions that go into
their development. Consultants and project owners often make flawed but
unarticulated assumptions that may go unchallenged, leading to wrong
conclusions and consequently wrong decisions. If a feasible project is deemed
infeasible because of a wrong assumption, an opportunity is missed and if an
infeasible project is deemed feasible, resources are lost.
The purpose of a business feasibility study is to make a decision about whether
to proceed with a particular opportunity based on its technical, operational and
financial feasibility. Since economic viability of a business is fundamental,
economic feasibility is the ultimate decision criterion in a feasibility study. Thus,
a technically and operationally feasible project that is uneconomical is not worth
pursuing. The critical component of the analysis is recognition of the leadership
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required to transform a technically and operationally feasible project into an
economically feasible one.
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QUES NO. 4: COMPARE THE SUBTLE DIFFERENCES OF MARKET AND
COMMERCIAL APPRAISAL TECHNIQUES WITH EXAMPLES
A project has to be technically feasible and financially viable. The financial viability is possible only if the project is able to realize the unit sales forecast / projection and thereby earn sales revenue, ensuring smooth cash flow, funds flow and the resultant surplus generation. Market appraisal therefore occupies a central position in project finance as it enables the promoters and the financing institution to understand, estimate and assess the likely potential of the market for the proposed product and arrive at a realistic projection as regards the market share that can be captured.
Market appraisal techniques
1. Demand analysis
Qualitative methods: These methods rely essentially on the judgment of experts to translate qualitative information into quantitative estimates. The important qualitative methods are:
Jury of executive method Delphi method
Time series projection methods: These methods generate forecasts on the basis of an analysis of the historical time series. The important time series projection methods are:
Trend projection method Exponential smoothing method Moving average method
Casual Methods: More analytical that the preceding methods, casual methods seek to develop forecasts on the basic of cause-effect relationship specified in an explicit, quantitative manner. The important casual methods are:
Chain ratio method Consumption method End use method Leading indicator method Econometric method
The commercial appraisal on the other hand normally resorts to undertaking forecasting. Some of the techniques for forecasting are:
Demand technique forecasting: The future demand of the product, its proper survey and future availability and supply is studied in depth. This will naturally involve employing surveyors to carry out detailed market survey and document the findings to arrive at proper forecasting’s.
Past Trend Method: Past trend method is adopted as a guide depending on the consumption pattern of the society as a whole. Further, the changes that are likely to take place are considered to arrive at the future demand.
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End use method: Suitable for estimating the demand for intermediate products, the end use method, also referred to as the consumption coefficient method, involves the following steps:
Identify the possible uses of the product. Define the consumption coefficient of the product for various uses. Project the output levels for the consuming industries. Derive the demand for the product.
Export market: There exist a huge export potential in many products which need to be tapped. Almost all sectors have good potential. The product that is planned to be manufactured and its application is of vital importance to gauge the potential.
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QUES NO.5: THE FINANCIAL APPRAISAL OF ANY PROJECT IS AN
ONGOING EXERCISE THROUGHT THE LIFE OF THE PROJECT. DISCUSS
THIS WITH VARIOUS TECHNIQUES & PRINCIPLES ADOPTED BY FINACIAL
INSTITUTIONS FOR VIBILITY STUDIES.
The setting up of projects not only involves substantial capital investment but
also the gestation period is long. The project completion cost is the basic
parameter based on which the cost of output is worked out. The implementation
of a project has to pass though a number of stages like planning and formulation
of project reports, obtaining statutory clearances, tying up finances and finally
the actual implementation of the project. Any slippage in project execution
stages will result in time and cost overrun, higher interest during construction
and consequently higher tariff. On the other hand, some more time and effort
taken in planning and formulation of project reports may be helpful in cutting the
time and cost overrun at the construction stage. It is, therefore, essential that all
the activities right from conceptualisation to execution of the power project are
properly planned and coordinated so that the project is implemented as per the
envisaged schedule of commissioning as well as within the estimated completion
cost of the project so that the cost of output is minimised to the ultimate
consumers. This is the first and foremost principle because the effect of any slip
up at this stage is permanent and can not be corrected subsequently.
The proposals for project finance would be considered by the financial
institutions on a selective basis in view of the larger outlay of funds an longer
duration of credit which may have an adverse impact on financial institution’s
Asset-Liability Management system and strain on its liquidity.
The project would be appraised by the financial institution and if required, the
assistance of the professionals would be obtained.
Before extending finance for Projects, the economic feasibility and financial
viability of the project in relation to the macro economic conditions prevailing at
the time of conceptualization of the project and also the likely scenario that may
prevail during the normal life span of the project should be established. The
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project should be able to withstand reasonable levels of variation in crucial
parameters which should be established by sensitivity analysis of the cash flows.
The means of finance for the project along-with provisions to meet contingencies
such as cost/ time overrun should be established. The entire source of funds for
the project from sources other than that by the promoters shall be fully tied-up
before sanction/ disbursement of the limits.
Wherever the project is one of unusually longer duration such as infrastructure
development, the ways of reducing the blockage of fund that are sourced mainly
out of short term lending institutions would be resorted to by take-out financing,