Presentation

On

Project Formulation & Appraisal

By

Col (Retd.) SP Tomar

(Unihorn India Pvt Ltd.)

08 Dec 2009
 Sequence of Coverage
 General Concept of Project Formulation
 Industrial
 Infrastructure or Construction
 Product Manufacturing
 Discussions on Important & Salient Features, NICMAR
Syllabus 1 - 10
 Analysis of Projects (General & Construction)
 Marketing & Demand
 Technical – Feasibility Studies
 Financial – BOT, Annuity, Gap Funding, Working Capital, Source.
 Sources of Finance & Working Capital Management
 Project Appraisal
 Risk Analysis
 Discussions of Question Paper of Previous Years
 Economy Through Ages &
Project Formulation
 1947 – 1985 : Social Concept, Traditional
Approach
 1985 – 1991 : Mix of Social &
Liberalisation
 1991 Onwards
 Integration with World Economy
 Vertical & Horizontal Integration Concept
 Infrastructure Sector & Construction Industry
 New Projects & Growth, GDP, GNP
 Recession
 Generation of New Project Ideas
 Why, new Projects ?
 Why, new Investments ?
 Idea Generation & Conceiving.
 Creativity, Organising & Planning
 Gap & Company Resource
 SWOT Analysis
 Technique of New Idea Generation
 Other Consideration to Project
Selection (Chapter – 10)
 Mission, Strategy & Capital Budgeting
(Kal per Control)
 Organisational Consideration
 Management
 Compatability with Resources
 Factors Affecting Judgement
 Track Record of Sponsor
 Internal Politics
 Opportunity Cost
 Information Spectrum
 Technical Analysis
 Analysis covers,
 Manufacturing process, Technology, Product
Mix, Plant Capacity, Capacity Strategy,
Profitability projections, Projected cash flows
statement & Projected balance sheet
 Break even Concept
 Plant location & Factors
 Site Rating Index
 Weighted Score of each location
= ∑Factor Weightx Factor Score
∑Factor Weight
 Finacial Analysis
 Shall involve,
 Cost of Project, Land Development, Buildings,
Plant & Machinery, Plant Utilities & Auxiliary
Equipment, Technical Know-how
 Managerial & Administrative Component
 Means of Finance
 Cost of Finace
 Margin Money & its Cost
 Weighted Cost of Finances
 Depreciation
 Working Capital, Cash
 Factors affecting Cash Flow
 Unscheduled Payments
 Sudden Price Rise, Material shortages
 Excessive build up of Inventory
 Payment of Half yearly Taxes
 Unwanted Renovations & Repairs
 Efficient Cash Management
 Effective Invetory Mgt
 Speedy Collection of Receivable
 Delaying payments of Payable accounts
 Project Accounting
 Stages
 Plant & Machinery
 Direct / Indirect Expenses
 Extra work done
 Sub Contract
 Work in Progress
 Uncertified work
 Profit on incomplete Contract
 Estimated Profit
 Recording & Measurement
 Completion
 Construction Project
 Highly Capital Intensive
 Long Gestation Period
 Huge Sunk Cost
 Vital Role in the Economy
 Important Social Dimension
 Sources of Capital
 Short & Long Term Finances
 Bank Loan
 Shares & Equities, Preferential Shares
 Debenture & Bonds (Discount & Fixed Rates)
 Bulk Deals between Companies
 Stock Exchanges
 Retained Earnings
 Gearing Ratio : Fixed Debt Finance
Equity Stake of Owners
 Sources of Capital (Contd)
 Venture Funds
 Cess Funds (Infosy & Infrastructure)
 International Funding
 FDIs
 Hedge Funds
 Call Money Concept (Short Term)
 Capital Structures of A Company
 Inflation & Taxations
Joint Venture & BOT Projects
 Project Execution
 Selection of Partners
 Level of Management
 Escrow Accts
 Lenders
 Financial Closures
 VARIOUS MODELS OF BOT AGREEMENTS &
CONTROLLING STRUCTURE
Sl Type of Funding Consultant Executing Remarks
No Agreement/ Agency
Models
1 Construction NHAI/ 100 % Control for Contractor Client- DPR-
Supervision NHDP, Technical & (No By Bids-
Supervision & Centre & Contractual Passing of Contractor-
Quality Control State, Obligations Consultant) Consultant-
(SQC) 100% Client
2 BOT (Build PPP RFIs– 30% Design Ownership
Operate 30%+ 70% Reviews Construction with Client,
Transfer) (Equity Recommendation Contract Feasibility
sharing + Consultants Management Studies &
Annuity Finance Traffic
Models) Funding-50%
Census etc
Known as IE
3 BOOT (Build As applicable Inbuilt/ PSUs
Own Operate Consultancy Private
Transfer Sector
Nuclear
Projects
 Market & Demand Analysis
 Situational Analysis & Specification of Objectives
 Requirement of a Particular Product, Competitors,
Customers, Distribution Net Work, Prospect of Sales
 Collection of Secondary Information
 Census, Sample Survey, Economic Survey, Industrial
Survey, Target Population
 Market Survey
 Demand & its Growth, Characteristics of Market,
Pricing & Present Comparison
 Delphi Method of Forecasting
 Interaction with Experts
 Extrapolative Forecasting Method
 Mathematical Methods of Forecasting
 Regression – Linear Regression i.e. Y =a+bx
Y = a+b1x1+b2x2+____ bnxn
x1 & x2 are variables, Age Profile etc.
 Time Series Method – Current & Previous Values
Y = f (Yt-1, Yt-2, ---------)
 Moving Average Method (Weighted Moving
Average)
t-L+1, t-L+2, t-L+3 + ----- t-1, t
moving average m, over the last & periods
ending in period t
m1 = {Yt-L+1+Yt-L+2 +Yt-L+3+------)/L
 Mathematical Methods of Forecasting
(Moving Average)
 Example
 Demand for 6 Months
 Forecast for 7th Month
Month 1 2 3 4 5 6
Table D
Demand (100) 42 41 43 38 35 37
 Three Months Moving Average (Minimum 3
m3 = (42+41+43)/3 = 42 (1)
m4 = (41+43+38)/3 = 40.7
m5 = (43+38+35)/3 = 38.7
m6 = (38+35+37)/3 = 36.7
 Forecast for 7th Month – 3670 Units
If we go Two Months moving Average
m2 = (42+41)/2, m2 (41+43)/2 + -----------
m6 = (35+37)/2 = 36
 Forecast for 7th Month – 3600
 Choosing Between Two Forecasts
 The 3 months average 42 (Ref (1))
 Becomes forecast for month 4
 Actual Demand – 38 (Ref Table D)
 Error 42- 38 = 4
 Forecast of Month 5 – 40.7, Actual 35
 Error – 5.7

 Similarly for 6, 38.7 – 37 = 1.7

 In two monthly average Errors go to Negative.
 Thus to close the error we can square their called Average
Square Error – Pg 37 of your Book 17.13 & 12.9
 Mean Square Deviation or Mean Square Error – Lower of
two
 Thus Two Monthly Moving Average better go for 3600 Units
 Single Exponential Smoothing
 Disadvantage of Previous Method, equial weightage to all months
Recent or Past
 This Method gives more weightage to Recent month & less to past
 Current Forecast – Previous Forecast – u (error in previous forecast)
Mt = Mt-1-u (Mt-1-Y)
 Refer Previous Table
M1 = Y1 = 42, M2 = 0.2 Y2 + 0.8 M1 = 0.2x41+0.3x42 = 41.80
M3 --------------------------- - 42.04, M4 - 41.23
M5 ---------------------------- 39.38, M6 = 39.38
So for 7th Month – 39.38
With u = 0.9 we get M6 = 3684
 A more reasonable figure for Forecast.
 Refer Example for Forecast at Pg 39 & 40
 Other Methods
 Casual Method - Based on Present Data only
 Chain Ratio Method - General Ratios calculated by monthly extra
Polations
 Process of Capital
Investment Decision,
Evaluation, Ranking &
Project Appraisal
 Evaluation Criteria
 Non discounting Criteria.
 Pay Back Period.
 Average Rate of Return.
 Discounting Criteria.
 Discounted Cash Flow.
 NPV (Net Present Value)
 Internal Rate of Return.
 Risk adjusted discount Rate Approved.
 Mean Standard Deviation Method
 Pay Back Period.
 Investment Rs. 40,000/-
Pay Back – 5
Years
 Return @ year Rs. 8,000/-
 Year 0 1 2 3 4 5
Net Cash 100 20 30 50 80 100
Flow
Cumulative 20 50 100 180 280

Not preferred since, Risk Factor not taken into account.

ARR : Average income after Taxes + Initial Investement
but before Interest.
It lacks, since does not consider Time value of Money
Ranking of Project.
Projcet ‘C’ ‘R’ Pay Back Ranking
A 36000 6000 6 4
B 24000 8000 3 1
C 20000 5000 4 2
D 15000 3000 5 3
 NPV Method
 Concept of Present Value of Money, on Investment & ROI
 Example

C = 100 (Investment) ROI 10%.

 After One Year - 100 +100x10/100 = Rs 110/-

- 100 +100 (0.1)

 Inference – Rs. 110/- received after One Year is only worth Rs. 100/-
Today.

 PV of Rs. 110/- 110/(1+0.1) = 100

 Thus Value discounted @10%

 General Formula
X1 = (X0 + rX0) = X0 (1+r)
PV of X = X1*1/(1+r) after One Year
PV of Rs 200/- = 200(1/1+0.08) =
185.19 (@8%)
Discount Formula
Dn = 1/(1+r)n
PV = Xn [1/(1+r)n]
Thus Total Present Value after N
years.
 General Formula
TPV = R1(1/1+r) + R21/(1+r)2 +R31/(1+R)3
n
TPV = ∑ Rn x 1/(1+r)n
r=1
Net Present Value
NPV = PV-C
If NPV > 0, Project Profitable.
< 0, Reject.
 Internal Rate of Return (IRR)
or
Marginal Efficiency of Investment (MEI)
Definition
 Rate of Interest or Return which rendess PV of expected future
marginal yields equal to Cost of Projcet.
 Thus IRR is Rate of Return - r, when discounted PV of
Recievables & Expenditure (Investment are equal).

Project Cost 1st Year 2nd Year

A 100 0 140
B 100 130 0
n n
 ∑ Rn - ∑ Cn =0
=1 (1+ r )n 1 (1+r)n
r @ 10% (IRR)
NPV of Project A
PV = 0 140 = 115.70
(1+0.10)1 (1+0.10)2
NPV – 115.70 – 100 = 15.70
Project Acceptable
Incase IRR increase to 20%
NPV = 0 + 140 - 100
1+0.20) (1+.20)2
= 97.22 - 100
= - 2.78
Project B
@ 10 % NPV = 130 + 0 - 100 = 118.8
(1+.10) (1+.10)2
@ 20 % NPV = 130 + 0 - 100 = 8.338
(1+.20) (1+.20)2
Project B is Acceptable
 Let us now Calculate
MEI or IRR for of Both the Projects A & B for Decision Making when
NPV shall be Zero.

Project A
NPV = 0 + 140 =100
(1+r)2
(1+r)2 = √ 140/100 = √ 1.40 = 0.183, r = 18.3%

Project B NPV = 130 +0 = 100

(1+r)

1+r = 130/100 = 1.30

r = 030 = 30%

MEI or IRR for A - 18.3%

MEI or IRR or B - 30%
Risk Adjusted Discount Rate Approach

D = 1/1+r+u
U = Digree of Risk, Discount to be more.
 Mean Standard Deviation Method
 Discounted PV Calculated on Mean
values of Returns.
 Not on actual Cash Flows.
 Risk an important Factor to be
incorporated into Cash Flow, so some
percentages are kept
 Risk Analysis & Mgt
 Risk Identification, Analysis & Assessment
 Risk Response Strategy - Avoid, Reduce, Transfer, Accept
 Financial Analysis of Risk
 Sensitivity of Project to Changes, Costs etc
 Scenario, Various Options
 Simulation
 Major Risks (16 Nos), Operating, Technical, Costs, Sales,
Participants (JV etc), Financial Completion, Supply &
Demand, Market Fluctuations, Infrastructure or
Transportation, Environment, Political & War
 Force Majeure Use - Act of Man, Nature, Government,
Impersonal, Syndicate, Foreign Exchange, Engineering,
Legal (RIL & RNRL), Foreign Exchange Risk, Syndicate,
Interest Funding & Legal
Risk in International Project
 Commercial – International
Market – WTO etc
 Political
 Exchange Risk
 Operating Risk
 Working Capital Requirement
THANK YOU