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BANK MANAGEMENTSUBMITTED TO: SUBMITTED BY:RAMNEEK MAM SAKSHA SHARMA

5810, M.COM (II)

PROJECT APPRAISAL

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Meaning of Project Appraisal

Project Appraisal:Project Appraisal Meaning : Project appraisal means “the assessment of a project”. It is made for both proposed (Ex-ante analysis) and executed projects (Post-ante analysis). For an financial institution project appraisal “is a process whereby a leading financial institution makes an independent and objective assessment of the various aspects of an investment proposition for arriving at a financial decision and is aimed at determining the viability of the project” Methods of Project Appraisal: Appraisal of a proposed project includes, Economic Analysis, Financial Analysis, Market Analysis, Technical Feasibility and Managerial Competence.

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THE ROLE AND COMPONENTS OF PROJECT APPRAISAL

l. The Role of Project Appraisal To stop bad projects To prevent good projects from being

destroyed To determine if components of projects are

consistent To assess the sources and magnitudes of

risks To determine how to reduce risk and

efficiently share risk

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IMPACT OF ANALYSIS Quality of analysis has been shown by the

World Bank to be a key determinant of the success of a project’s performance.

A proper analysis will cause the project to be redesigned so that it is less likely to fail

World Bank experience shows that the probability of failure for poorly prepared projects within 3 years of a project’s life is 7 times that of well-prepared projects

Poorly prepared projects have 16 times as high a probability of failure within 5 years as compared to well-prepared projects

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ROLE AND COMPONENTS OF INVESTMENT EVALUATION

II. Stages in Project Appraisal and Approval

Why should a project evaluation be done in stages?

A. Idea and Project DefinitionB. Pre-Feasibility StudyC. Feasibility and FinancingD. Detailed DesignE. Project ImplementationF. Ex-Post Evaluation

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A. IDEA AND PROJECT DEFINITION Sources of Ideas for

Investments: Key questionsa. Where is the demand?b. Is this project

consistent with the organization’s expertise, current plans and strategy for the future?

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PROJECT DEFINITION

Project definition is defined broadly to include the scope and specification of the objectives of the project, its output, its different stakeholders, its economic and social benefits, and the data requirements.

Most of the project’s data requirements are identified in the pre-feasibility and feasibility stages of the project where the project’s variables and parameters are analyzed in detail.

The data are generally arranged in what we refer to as “building blocks” because they constitute the foundation for the different types of analyses.

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B. Pre-Feasibility Study

• Examines overall potential of project

• Should maintain same quality of information across all variables

• Wherever possible should use secondary information

• Biased information better than mean values

• Mainly done by the promoter of the project, also called as the first look at the project.

Key questions:a. Is this project financially and

economically feasible throughout the project’s life?

b. What are the key variables?c. What are the sources of risk?d. How can the risk be reduced

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C. FEASIBILITY STUDY

Focus is on improving accuracy of the key variables Alternatives for reducing risk are examined in

detail. Some primary data may be needed. Also called as the second look to the project and is

usually done by financial institution.Key questions: Is project financially attractive to all interested

parties in activity? What is level of uncertainty of key variables? Can final decision for approval be taken?

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WAY TO EVALUATE A PROJECT

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MODULES OF FEASIBILITY STUDIES

Building BlocksA. Demand (including

environmental factors) Module

B. Technical (including environmental factors) Module

C. Environmental Assessment Module

D. Human Resources and Administrative Support Module

E. Institutional Module

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BUILDING BLOCK A: TECHNICAL MODULE

Description of different processes available and Selection of the process for the project and the reason for the same. Selection of suitable know-how for the said project based on technical and economic evaluation from available data. Prospective collaborator and terms of collaborations.

Plant and Machinery List of imported/indigenous machinery Broad specifications of the machinery List of manufacturers of

machinery Critical items of the machinery. Location Actual site selection survey. Availability of raw material, electricity, water and other infrastructural facilities. Plot plan and building Overall plot plan along with building plan. Raw materials Raw material requirements and their specifications. Utilities: Requirements of power, water and others including fuel, steam, inert gas etc., and their specifications. Effluents Nature and type of effluent/specifications and quality of effluent. Effect of effluent if discharged as such,

Effluent treatment suggested

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BUILDING BLOCK A: TECHNICAL OR ENGINEERING MODULE

Output of Module Technology and life of project Quantities of inputs by type needed for

investment and operation Labor required by type and time Input prices and sources of supply Environmental impacts

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MODULE B: FINANCIAL APPRAISAL

Cost of the project and means of financing Profitability statement

Break even analysis

Fund flow statement

Balance sheet projections

Financial ratios

Sensitivity analysis

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A) COST OF PROJECT The major components of cost of project involve land and building,

plant and machinery, equipment for auxiliary services like transportation, insurance, duty, clearing, loading and unloading charges etc. It includes consultancy and know how charges , recurring royalty payment, preliminary expenses such as cost of incorporation, preparation of feasibility reports, market surveys, pre operative expenses like- salary, travelling, start up expenses, mortgage expense incurred before commencement of commercial production. Provision for contingencies to meet the unforeseen expenses, price escalation or other expenses which have been inadvertently omitted like margin for working capital requirements required to complete the production cycle, interest during construction period etc. also a part of capital cost of the project.

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B) PROFITABILITY STATEMENT Also known as Income and

Expenditure is prepared after considering the net sales and details of direct cost/ expenses.. ECONOMIC APPRAISAL includes scrutinizing all items of cost to ensure that these are realistic and achievable. The past trend of performance in an industry and other environmental factors influencing the cost and revenue items should also be considered.

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C) BREAK EVEN ANALYSIS It helps in knowing the level of output and sales at

which the business enterprise just breaks even i.e. there is no profit- no loss. Breakeven point in an algebraic equation can be put as under:-

BREAK EVEN POINT = TOTAL FIXED COST (Sales price per unit) - (Variable cost per unit)

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D) FUND FLOW STATEMENT Often described as the statement of movement of funds, it is used to

know where got, where gone of funds. It is derived by comparing the successive balance sheets on two specified dates and finding out the net changes in the various items appearing in the balance sheets. Critical analysis shows various changes in the sources and application of funds to ultimately give the position of net funds available with the business for repayment of the loans.

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E) RATIO ANALYSIS

Analysis of the ratios over a period of time tells about liquidity position, management stake in the business, capacity to service the debts etc. E.g.

DEBT EQUITY RATIO

DEBT SERVICE COVERAGE RATIO

CURRENT RATIO

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Analysis Module C: Environmental Assessment Module

• Environmental Assessment augments information for the Economic Analysis

• Identification of Environmental Impacts and Risks• Where possible, Quantify the Environmental Impacts

• Key questions:a. What are the likely environmental impacts from undertaking

project ?b. What is the cost of reducing the negative impact?c. Evaluation of the environmental impacts and risks with and

without technical measures are taken to reduce these impacts?d. Are there alternative ways of supplying the good or service of

project without incurring these environmental costs? What are the costs of these alternatives?

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BUILDING BLOCK D: HUMAN RESOURCES AND ADMINISTRATIVE SUPPORT MODULE

What are managerial and labour needs of the project?

Does organization have the ability to get the managerial skills needed?

Is timing of project consistent with quantity and quality of management?

What are wage rates for labor skills required?

Manpower requirements by category are reconciled with availabilities and project timing

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BUILDING BLOCK E: INSTITUTIONAL MODULE

This module deals with the adequacy of the institution responsible for managing the different stages or phases of the project.

Insufficient attention to the institutional aspects creates serious problems during the implementation and operations phases of the project.

Key questions:a. Is the entity that is supposed to manage the project

properly organized and its management adequately equipped to handle the project?

b. Are the capabilities and facilities being properly utilized?c. Is there a need for changes in the policy and institutional

set up outside this entity? What changes may be needed in policies of the local, regional and central governments?

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ANALYSIS MODULE G: ECONOMIC MODULE

What is done: Examines the project using the whole country as the accounting

entity Evaluation of externalities including environmental

Key questions:a. What are differences between financial and economic values for a

variable?b. What causes these differences?c. With what degrees of certainty do we know values of these

differences?d. What is the expected value of economic net benefits?e. What is the probability of positive economic feasibility?

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ANALYSIS MODULE H: STAKEHOLDERS AND BASIC NEEDS ANALYSIS

What is done: Identification and quantification of extra-economic impacts of project Distributive Appraisal Income, Cost, and Fiscal Impacts on various stakeholders Poverty Alleviation and Political Necessities Basic Needs: Evaluate the impact of project on achieving basic needs objectives

Basic needs will vary from country to countryKey Questions:a. In what ways does project generate beneficial and cost impacts on stakeholders?b. What stakeholders could the project impact?c. Who benefits and who pay the costs?d. What are the basic needs of the society that are relevant in the country?e. What impact will the project have on basic needs?f. What alternative ways are there to generate desirable social impacts?g. Is project relatively cost effective in generation of desirable social impacts?

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METHODS OF PROJECT APPRAISAL

NET PRESENT VALUE (NPV)

Meaning: NPV is equal to the present value of all future free cash flows less the investment’s initial outlay. It measures the net value of a project in today’s dollars.

. PROFITABILITY INDEX (BENEFIT-COST RATIO)

Meaning: PI is the ratio of the present value of the future free cash flows (FCF) to the initial outlay. It yields the same accept/reject decision as NPV.

PI = PV of FCF/Initial outlay

. INTERNAL RATE OF RETURN (IRR)

Meaning: IRR is the discount rate that equates the present value of a project’s future net cash flows with the project’s initial cash outlay.

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THE PAYBACK PERIOD Meaning: Number of years needed to recover

the initial cash outlay of a capital budgeting project.

Decision Rule: Project feasible or desirable if the payback period is less than or equal to the firm’s maximum desired payback period. In general, shorter payback period is preferred while comparing two projects.

DISCOUNTED PAYBACK PERIOD

The discounted payback period is similar to the traditional payback period except that it uses discounted free cash flows rather than actual undiscounted cash flows.

The discounted payback period is defined as the number of years needed to recover the initial cash outlay from the discounted free cash flows.

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