ACA-TM-37 (v2.2-20-Nov-10)

Project Approach to Lending &Financial

AppraisalSatyajit DwivediMember of Faculty

CAB Pune

1

ACA-TM-37 (v2.2-20-Nov-10)

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.

2College of Agricultural Banking, RBI, PUNE

ACA-TM-37 (v2.2-20-Nov-10)

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.

3College of Agricultural Banking, RBI, PUNE

ACA-TM-37 (v2.2-20-Nov-10)

ETERNAL TRIANGLE OF PROJECT MANAGEMENT

4College of Agricultural Banking, RBI, PUNE

QUALITY

ACA-TM-37 (v2.2-20-Nov-10)

Project Cycle

Idea/identification

Formulation

AppraisalImplementation

Monitoring

Evaluation

5College of Agricultural Banking, RBI, PUNE

ACA-TM-37 (v2.2-20-Nov-10)

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

6College of Agricultural Banking, RBI, PUNE

ACA-TM-37 (v2.2-20-Nov-10)

PROJECT APPRAISAL

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

04/18/2304/18/23

7College of Agricultural Banking, RBI, PUNE

ACA-TM-37 (v2.2-20-Nov-10)

FINANCIAL APPRAISAL

• UNDISCOUNTED CASH FLOW METHOD

• DISCOUNTED CASH FLOW METHOD

8

ACA-TM-37 (v2.2-20-Nov-10)

COMPONENTS OF CASH FLOW

• INITIAL INVESTMENT

• OPERATING CASH FLOW

• TERMINAL CASH FLOW

9

ACA-TM-37 (v2.2-20-Nov-10)

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…..

ACA-TM-37 (v2.2-20-Nov-10)

Bankability / Repayment Schedule

• Repayment Schedule Types

1. Equal Principal Installment

Loan (Principal)

+ Accrued Interest

No of Installment

It changes (reduces) over time

Contd……

ACA-TM-37 (v2.2-20-Nov-10)

Economic Life of Project (Rs.)

Years 1 2 3 4 5 6

Aggregate Benefits

1000 1000 1100 1100 1100 1100

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

ACA-TM-37 (v2.2-20-Nov-10)

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

ACA-TM-37 (v2.2-20-Nov-10)

Time Value of Money

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

ACA-TM-37 (v2.2-20-Nov-10)

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.

ACA-TM-37 (v2.2-20-Nov-10)

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

ACA-TM-37 (v2.2-20-Nov-10)

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

ACA-TM-37 (v2.2-20-Nov-10)

(e) Discounting - Illustration ( 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

ACA-TM-37 (v2.2-20-Nov-10)

Techniques in Discounted Measures

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

ACA-TM-37 (v2.2-20-Nov-10)

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

ACA-TM-37 (v2.2-20-Nov-10) 21

Benefit Cost Ratio

• Year Investment

costBenefits DF

@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

ACA-TM-37 (v2.2-20-Nov-10)

Benefit Cost Ratio (contd)

Project (Rs) A B C Present worth of benefit

500 10000 1000

Present worth of cost

400 8000 900

Net present Benefit

100 2000 100

BC Ratio 1.25 1.25 1.11

ACA-TM-37 (v2.2-20-Nov-10)

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

ACA-TM-37 (v2.2-20-Nov-10)

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

ACA-TM-37 (v2.2-20-Nov-10) 25

Net Present Worth

• Year Investm

ent costBenefits

DF @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

ACA-TM-37 (v2.2-20-Nov-10)

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

ACA-TM-37 (v2.2-20-Nov-10)

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

ACA-TM-37 (v2.2-20-Nov-10)

Internal Rate of Return (IRR)

IRR = Lower Discount Rate +

Difference between the two discount rates

NPW at lower discount rate Absolute difference between NPWs at two discount rates

ACA-TM-37 (v2.2-20-Nov-10) 29

Net Present Worth

• Year Investment cost

Benefits DF @ 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

ACA-TM-37 (v2.2-20-Nov-10) 30

Internal Rate of Return• Internal Rate of Return ( IRR ) : Lower of the two discount rates (+ ) Difference between two discount rates x (NPW

@ 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%

ACA-TM-37 (v2.2-20-Nov-10)

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

CHANGE PROPOSAL

UPGRADE FACTORY

WITH NEW

MACHINERY

Developed by Kurt Lewin

ACA-TM-37 (v2.2-20-Nov-10)

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)

These changes would swing the balance from 11 : 10 (against the plan), to 9 : 12 (in favor of the plan).

FORCE FIELD ANALYSIS .. CONTD

ACA-TM-37 (v2.2-20-Nov-10)

Forces for CHANGE

Score FORCE FIELD ANALYSIS REVISED SCORES

Score Forces againstCHANGE

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 3+1+1

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

ACA-TM-37 (v2.2-20-Nov-10)

Case exercise on project -financial appraisal

Case:MI 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...

ACA-TM-37 (v2.2-20-Nov-10)

ACA-TM-37 (v2.2-20-Nov-10)

All the Best

Thank You