ACA-TM-37 (v Nov-10 ) Project Approach to Lending &Financial Appraisal Satyajit Dwivedi Member of Faculty CAB Pune 1

ACA-TM-37 (v 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. 2 College of Agricultural Banking, RBI, PUNE

ACA-TM-37 (v 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. 3 College of Agricultural Banking, RBI, PUNE

ACA-TM-37 (v Nov-10 ) ETERNAL TRIANGLE OF PROJECT MANAGEMENT 4 College of Agricultural Banking, RBI, PUNE QUALITY

ACA-TM-37 (v Nov-10 ) Project Cycle Idea/identification Formulation Appraisal Implementation Monitoring Evaluation 5 College of Agricultural Banking, RBI, PUNE

ACA-TM-37 (v 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 6 College of Agricultural Banking, RBI, PUNE

ACA-TM-37 (v Nov-10 ) PROJECT APPRAISAL TECHNICAL COMMERCIAL ENTERPRENEURIAL FINANCIAL ECONOMIC MANAGERIAL SOCIAL ENVIRONMENTAL 12/2/ /2/201512/2/ /2/ College of Agricultural Banking, RBI, PUNE

ACA-TM-37 (v Nov-10 ) FINANCIAL APPRAISAL UNDISCOUNTED CASH FLOW METHOD DISCOUNTED CASH FLOW METHOD 8

ACA-TM-37 (v Nov-10 ) COMPONENTS OF CASH FLOW INITIAL INVESTMENT OPERATING CASH FLOW TERMINAL CASH FLOW 9

ACA-TM-37 (v 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 (v 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 (v Nov-10 ) Economic Life of Project (Rs.) Years Aggregate Benefits Costs Incurred Fixed Cost Operation & Mainten. cost 100 Production cost 200 Total Net Benefit/Surplu s

ACA-TM-37 (v 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 (v 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 (v 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 (v 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 (v Nov-10 ) Compounding-Illustration Sl. No. YearAmount at the beginning of the year Rate of interest factor (9%) Amount promised at the end of the year 1234(3X4)= ,000

ACA-TM-37 (v Nov-10 ) (e) Discounting - Illustration ( Rs.) S. No. YearAmt. promised at the end of the year Rate of Interest Factor Amt. (in Rs.) worth at the beginning of the year 1234(3/4)= ,

ACA-TM-37 (v Nov-10 ) Techniques in Discounted Measures Benefit Cost Ratio Net Present Worth / Value (NPW/NPV) Internal Rate of Return (IRR)

ACA-TM-37 (v 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 (v Nov-10 ) 21 Benefit Cost Ratio Year Investment cost PW of costs ( 2x4) PW of benefits (3x4) Total BC Ratio 1055 : : 1

ACA-TM-37 (v Nov-10 ) Benefit Cost Ratio (contd)

ACA-TM-37 (v 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 (v 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 (v Nov-10 ) 25 Net Present Worth YearInvest ment cost % PW of costs ( 2x4) PW of benefits (3x4) Total NPW

ACA-TM-37 (v 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 (v 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 (v Nov-10 ) Internal Rate of Return (IRR)

ACA-TM-37 (v Nov-10 ) 29 Net Present Worth YearInvestment cost 20 %PW of costs ( 2x4) PW of benefits (3x4) Total NPW (-) 31

ACA-TM-37 (v Nov-10 ) 30 Internal Rate of Return Internal Rate of Return ( IRR ) :  Lower of the two discount rates (+ ) Difference between two discount rates x lower discount rate :- Absolute difference between NPWs at two discount rates ) IRR= x ( multiplied by ) 55 :- 86 ( ) = 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 (v Nov-10 ) FORCE FIELD ANALYSIS-WORKSHEET Forces for change Score Forces against change Costumers want new product 43 Staff not happy with loosing OT Enhance speed of production 23 Fear of New technology Increase volume of output 31 New technology Environ. Impact Minimize maintenance cost 13 Increase in Expe nses on a/c of new technology 1 Disruption in work T O T A L 1011 T O T A L CHANGE PROPOSAL UPGRADE FACTORY WITH NEW MACHINERY Developed by Kurt Lewin

ACA-TM-37 (v 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 (v Nov-10 ) Forces for CHANGE ScoreFORCE FIELD ANALYSIS REVISED SCORES ScoreForces against CHANGE Costumers want new product 43-1 Staff not happy with loosing OT Enhance speed of production 23-2 Fear of New technology Increase volume of output 31-1 New technology Environ. Impact Minimize mainte nance cost Increase in Expenditure Impress staff-cha nge is inevitable 11 Disruption in work Impress staff- variety of work 1 T O T A L 129 T O T A L CHANGE PROPOSAL UPGRADE FACTORY WITH NEW MACHINERY

ACA-TM-37 (v 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 (v Nov-10 )

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