Astudy on

PROJECT APPRAISAL SYSTEMat

Andhra Pradesh State Financial Corporation- a case study

submitted

by

Shrath Chandra MalkaniProcess Engg. with M.B.A.(I.D.D.) 4th year

Indian Institute of Technology Roorkee

under the guidance of:Mr. V.P. Arun Mozhi

Senior ManagerProjects Department

APSFC

Contents

1 Introduction 51.1 Project Appraisal . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 51.2 Need for the study . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61.3 Objectives of the study . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61.4 Methodology . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 61.5 Limitations . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 6

2 Companys’ Profile 72.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 72.2 Objectives . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 72.3 Milestone Achivements of APSFC . . . . . . . . . . . . . . . . . . . . . . . 82.4 Ownership . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 82.5 Nominee Directors . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 92.6 Operational Results . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 9

3 Project Appraisal System at APSFC 113.1 Products & Services . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 11

3.1.1 Products- Fund based activities . . . . . . . . . . . . . . . . . . . . 113.1.2 Services- Non Fund based activities . . . . . . . . . . . . . . . . . . 12

3.2 New Schemes . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 133.3 Loan Sanction Criteria . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 133.4 CIBIL (Credit Information Bureau of India Limited) . . . . . . . . . . . . 133.5 Pre Sanction Inspection . . . . . . . . . . . . . . . . . . . . . . . . . . . . 133.6 Project Screening Committee . . . . . . . . . . . . . . . . . . . . . . . . . 143.7 Method of Project Appraisal . . . . . . . . . . . . . . . . . . . . . . . . . . 143.8 Viability, Profitability & Ratio analysis . . . . . . . . . . . . . . . . . . . . 163.9 Sensitivity Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 173.10 Internal Risk Rating Department . . . . . . . . . . . . . . . . . . . . . . . 17

4 Project Appraisal Mechanism -A theoretical Framework 184.1 Appraisal Procedure . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 184.2 Promoter Evaluation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 18

4.2.1 Educational Qualification . . . . . . . . . . . . . . . . . . . . . . . 19

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4.2.2 Family Background . . . . . . . . . . . . . . . . . . . . . . . . . . . 194.2.3 Experience . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 194.2.4 Credit Worthiness . . . . . . . . . . . . . . . . . . . . . . . . . . . . 194.2.5 Ability to offer collateral security . . . . . . . . . . . . . . . . . . . 19

4.3 Technical Evaluation : . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 204.3.1 Land . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 204.3.2 Structure and civil works: . . . . . . . . . . . . . . . . . . . . . . . 214.3.3 Plant & machinery . . . . . . . . . . . . . . . . . . . . . . . . . . . 224.3.4 Power . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 224.3.5 Water . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 224.3.6 Ambience . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 234.3.7 Availability of man power & Labour . . . . . . . . . . . . . . . . . . 234.3.8 Environmental factors . . . . . . . . . . . . . . . . . . . . . . . . . 23

4.4 Financial evaluation: . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 234.4.1 Cost of the project: . . . . . . . . . . . . . . . . . . . . . . . . . . 244.4.2 Means of Finance: . . . . . . . . . . . . . . . . . . . . . . . . . . . 264.4.3 Estimation of working capital: . . . . . . . . . . . . . . . . . . . . . 274.4.4 Estimates of sales and production: . . . . . . . . . . . . . . . . . . 284.4.5 Projected cash flows statements: . . . . . . . . . . . . . . . . . . . . 284.4.6 Viability Indicators . . . . . . . . . . . . . . . . . . . . . . . . . . . 294.4.7 Sensitivity analysis: . . . . . . . . . . . . . . . . . . . . . . . . . . . 31

4.5 Market evaluation: . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 314.5.1 Collection of Information . . . . . . . . . . . . . . . . . . . . . . . . 324.5.2 Market Survey . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 324.5.3 Concept of Michel porter on competition: . . . . . . . . . . . . . . . 334.5.4 Threat to new entrants: . . . . . . . . . . . . . . . . . . . . . . . . 334.5.5 Rivalry between existing firms: . . . . . . . . . . . . . . . . . . . . 334.5.6 Pressure from substitute products: . . . . . . . . . . . . . . . . . . 334.5.7 Bargaining power of buyers: . . . . . . . . . . . . . . . . . . . . . . 344.5.8 Bargaining power of suppliers: . . . . . . . . . . . . . . . . . . . . . 34

4.6 Risk evaluation: . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 344.6.1 Visibility of risks: . . . . . . . . . . . . . . . . . . . . . . . . . . . . 344.6.2 Types of risks: . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 344.6.3 Risk assessment . . . . . . . . . . . . . . . . . . . . . . . . . . . . 364.6.4 Qualifying the risks: . . . . . . . . . . . . . . . . . . . . . . . . . . 364.6.5 Strategies for managing risk: . . . . . . . . . . . . . . . . . . . . . 374.6.6 Limitations: . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 37

4.7 Credit Rating . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 374.7.1 Rating Nomenclature . . . . . . . . . . . . . . . . . . . . . . . . . . 374.7.2 Credit Rating Model . . . . . . . . . . . . . . . . . . . . . . . . . . 38

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5 Case Study 405.1 Introduction . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 40

5.1.1 Risk Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 415.2 Due Diligence Report . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 445.3 Technical Aspects . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 45

5.3.1 Scope of the project . . . . . . . . . . . . . . . . . . . . . . . . . . 455.3.2 Location . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 455.3.3 Raw Materials . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 455.3.4 Manufacturing Process . . . . . . . . . . . . . . . . . . . . . . . . . 465.3.5 Technical Know-how . . . . . . . . . . . . . . . . . . . . . . . . . . 465.3.6 Utilities . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 465.3.7 Manpower Requirement . . . . . . . . . . . . . . . . . . . . . . . . 47

5.4 Cost of Project . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 475.5 Notes on cost of the scheme . . . . . . . . . . . . . . . . . . . . . . . . . . 47

5.5.1 Land: . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 475.5.2 Buildings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 485.5.3 Plant & Machinery . . . . . . . . . . . . . . . . . . . . . . . . . . . 485.5.4 Erection . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 485.5.5 Estimation of Working Capital requirements . . . . . . . . . . . . . 495.5.6 Means of Finance . . . . . . . . . . . . . . . . . . . . . . . . . . . . 505.5.7 Promoters’ Contribution . . . . . . . . . . . . . . . . . . . . . . . . 505.5.8 Debt Equity Ratio . . . . . . . . . . . . . . . . . . . . . . . . . . . 505.5.9 Security . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 505.5.10 Market . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 50

5.6 Economics of Working . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 515.6.1 Raw material . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 515.6.2 Power . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 515.6.3 Fuel . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 525.6.4 Wages . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 525.6.5 Salaries . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 525.6.6 Provisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 535.6.7 Sales Revenue . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 535.6.8 Assumptions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 54

5.7 Break Even Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 545.8 Debt Service Coverage Ratio . . . . . . . . . . . . . . . . . . . . . . . . . . 555.9 Internal Rate of Return . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 555.10 Sensitivity Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 555.11 Conclusion . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55

6 Findings and Suggestions 566.1 Findings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 566.2 Suggestions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 56

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Chapter 1

Introduction

1.1 Project AppraisalProject appraisal is the structured process of assessing the viability of a project or proposal.It involves calculating the feasibility of the project before committing resources to it. Itis a tool that company’s use for choosing the best project that would help them to attaintheir goal. Project appraisal often involves making comparison between various optionsand this done by making use of any decision technique or economic appraisal technique.

Project appraisal is a tool which is also used by companies to review the projectscompleted by it. This is done to know the effect of each project on the company. Thismeans that the project appraisal is done to know, how much the company has invested onthe project and in return how much it is gaining from it.

The purpose of project appraisal is to establish whether a project is worthwhile in thelight of its costs in terms of resource commitments and the project’s expected benefits.Thatis, appraisal is an ex ante assessment of a project and is the key element in the decision as towhether or not to proceed with a project. This will involve the consideration of alternativeprojects (the with option[s]), or alternatively, by comparison with the status quo (thatis, the do-nothing option). In practice, this is an intricate and sophisticated process ofenquiry, with substantial data requirements. Examination of the viability of the projectmay require the specialised services of appraisal missions and appointed consultants.

Project appraisal is the process of critical evaluation of all the six faces of the projectappraisal namely:

1. Technical analysis2. Financial analysis3. Legal analysis4. Market analysis5. Management appraisal6. Ecological appraisal.The methodology basically look at trying to understand the capital budgeting mecha-

nism/techniques in evaluating the various aspects of project implementationand the method-

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ology followed by the reputed institution Andhra Pradesh State Financial Corporation(APSFC),which is a pioneer institution in extending term loands facility to small and medium scaleindustries, is examined critically

1.2 Need for the studyThe financial institutions and banks have a vital role to play in the different facets of projectwork.They are responsible for appraising the soundness of the project that is presented tothem for financial assistaance. The main purpose of this study is to understand the lendingcriteria and appraisal technique for financing the project

1.3 Objectives of the study• To understand the various aspects involved in appraising a project

• To know the methodology of project appraisal system adopted by Andhra PradeshState Financial Corporation

• To undertake the case study of a proposal which APSFC has appraised for sanctionof term loan and evaluate the methodology and its compliance to established norms

1.4 MethodologyThe data required for the study has been collected from both primary and secondarysources of information. As part of collection of information from primary sources, I metthe concerned officersof Project Appraisal system in APSFC whose inputs are the vitalpart of my study.The secondary sources of information are APSFC website and books likeFinancial Management and some online sources

1.5 Limitations• Due to Time constraints,couldnot meet the promoters of the project which would

have helped me in analyzing the case in detail

• Due to same reason, couldnot study the Risk Raing System of APSFC in detail whichwould have brought the report a complete form

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Chapter 2

Companys’ Profile

2.1 IntroductionAndhra Pradesh State Financial Corporation [APSFC] is a term lending Institution estab-lished in 1956 for promoting small and medium scale industries in Andhra Pradesh underthe provisions of the Sate Financial Corporations Act, 1951.The corporation came into exis-tence on 1-11-1956 by merger of Andhra State Financial Corporation and Hyderabad StateFinancial Corporation. The corporation has launched many entrepreneur-friendly schemesto provide term loans, working capital term loans, special and seed capital assistance tosuit the needs of various categories of entrepreneurs. The Corporation has completed fivedecades of dedicated service in industrial financing of tiny, small and medium scale sectorunits and contributing to the balanced regional development of the state.

2.2 Objectives• To industrialise the State through balanced regional development and dispersal of

industries.

• To support promotion and development of tiny, small and medium scale industriesand service sector units by extending need based credit to them.

• Nurtures entrepreneurship and encourages first generation entrepreneurs.

• To act as a catalyst for generation of employment.

Andhra Pradesh State Financial Corporation was formed with the main objective ofextending financial assistance for setting up of industrial units and service enterprises intiny, small and medium scale sectors. APSFC has been playing a significant role in takingthe state to its rightful place on the industrial map of the country. Initially, APSFC hasbeen started with the main objective of a developmental financial institution for stting upindustries in all regions of the state mainly in order to create employment oppurtunities

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and contribute to ecnomic growth of the country.Subsequently, APSFC became a premierterm lending institution in the state of Andhra Pradesh providing financial assistance tonew and upcoming enterpreneurs as well as new identifiable and sustainable successfulindustrial activities.

2.3 Milestone Achivements of APSFC• So far sanctioned Rs.2,503 crores for 93,999 units in Andhra Pradesh as on 31/03/2012

• Disbursed Rs.8,571 crores to 73,480 units - 70% to Tiny/SSI sector as on 31/03/2012

• Recovered Rs.9,349 crores including interest since inception till 31/03/2012

• Established unblemished repayment track record since inception

• Has consistent record of earning operating profit throughout its history

• Created total Investment of around Rs. 27,487 crores

• Generated direct and indirect employment to about 11 lakh persons

• Channelled a significant share of assistance of around 70% to tiny and small scaleindustries

• Industrialised backward areas by extending 50% of its assistance to industries comingup in notified backward areas.

• Enjoying 60% of the market share in term lending in promoting First GenerationEntrepreneurs in Andhra Pradesh

2.4 OwnershipIn exercise of the powers conferred by Section 48 of the State Financial CorporationAct,1951, SFC Act specifies the share holding pattern as well as the powers of APSFCto issue shares. Currently the sntire shareholding is distributed between the Governmentof Andhra Pradesh(69%) and SIDBI(31%).

Recent amendments to SFCs Act,stipulates that the share holding of the State govern-ment and the parent development bank to be atleast 51%. The prospects of disvestmentsto other entities exist upto 49% of paid-up equity capital,equivalent to Rs. 50 crores(onRs. 100 crores authorized captal),disvestment of stake has also been by Khan Committee(for SLFIs) and Gupta Committee(for SFCs). However disvestment beyond the specifiedlevel of 49% will depend on Amendment in SFCs Act.

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2.5 Nominee DirectorsThe Corporation shall nominate officers of the corporation as nominee directors in respectof units where sanctioned amount is Rs. 5 crores and above.

2.6 Operational ResultsThe Corporation improved its operational results during the year„particularly in disburse-ments and recoveries. The total sancions of Rs. 1368.82 crore were made in FY 2012 asagainst Rs. 1386.38 crore recorded in FY 2011. The disbursements increased to Rs.936.89crore from Rs.904.64 crore,in the previous year, registering a growth of 3.556%. The per-formance of the corporation in disbursements during the year was highest ever recorded.

The total income of the Corporation grew by 14.14% to Rs.368.02 crore from Rs.322.43crore in FY 2011./the increase is on account of consistent growth in loan portfolio andincrease in rate of interest in FY 2012.The total expenditures increased by 12.96% toRs.222.12 crore from Rs.196.64 crore. The increase in total expenditure by Rs.25.48 ismainly due to increase in interest cost.

Figure 2.1: Performance Review for last 5 years

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Figure 2.2: Operating Income and Expenditure for last 5 years

Figure 2.3: Profit Before Tax

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Chapter 3

Project Appraisal System at APSFC

Corporation’s role on the project appraisal starts when a person/firm/company approachwith a request to consider financial assistance for setting up the industrial units with theirown ideas. The officers/Branch Managers at various districts,discuss the project to as-sess the product,application and demand for the product, present market trend, price,competition, qualifications & experience of the promoters and their investment capaci-ties,capabilities to implement and operate the project. After satisactory discussion,theBranch Office issues an application along with a list of information/documents to be fur-nished with regard to the project so as to complete the appraisal part with in the stipulatedtime limit.The branch officials also guide the enterpreneur in submission of necessary infor-mation and also explain the corporation’s experience in such activity to the enterpreneur.

3.1 Products & Services

3.1.1 Products- Fund based activities

Andhra Pradesh State Financial Corporation (APSFC) extends financial assistance forsetting up industrial units in Small Medium Scale, Service enterprises in the state ofAndhra Pradesh. The Corporation extends finance basically through two products theTerm Loans and the Working Capital Term Loans.

Term loans

The Corporation extends financial assistance up to Rs 2000 lakhs per project for acquiringfixed assets viz., Land, Building and machinery through Term Loan.The Corporation ishaving an understanding (MOU) with SIDBI and Five Leading Nationalised CommercialBanks and for bigger projects it extends need based finance through consortium financewith MOU Banks and Institutions. The loan period normally ranges from 5 to 8 years.

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MSME- MTL

The Corporation extends financial assistance for existing units with good working results.The loan period normally is upto 3 years. The Corporation in consortium with LeadingCommercial Banks, with which it is having a MOU, extends higher working capital loansto deserving units.

3.1.2 Services- Non Fund based activitiesMARKETING OF INSURANCE PRODUCTS (LIFE NON LIFE)

• Life Insurance Products In Collaboration With Life Insurance Corporation Of India

• General Insurance Products in Collaboration With United India Insurance CompanyLtd.

FIXED DEPOSITS

APSFC launched fixed deposit scheme during the year 2001, with the approval of theReserve Bank of India.

• CUMULATIVE DEPOSITS With a minimum deposit of Rs.20,000/- Interest is paidon maturity

• NON-CUMULATIVE DEPOSITS With a minimum deposit of Rs.40,000/- Interestis paid Quarterly

Valuation of Assets

The Corporation, leveraging its rich experience, will also provide property valuation serviceat an affordable fee.

Being in the business of financing, APSFC knows the value of assets of all kinds muchbetter than many. We can take up valuation of both tangible and intangible assets toreflect their true and fair value.

Internal Audit Services

APSFC is offering internal audit service to industries and service sector enterprises at anaffordable fee.

The Corporation, with its pool of highly experienced professionals, is eminently qual-ified to take up independent, objective and systematic internal audit of small, medium orlarge enterprises in all sectors. Our team of auditors have the experience, expertise and,above all, the right attitude towards the client’s requirements and the auditing process.

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3.2 New SchemesThe corporation reviews the existing schemes on regular basis, modifies them whereverrequired and introduces new schemes to suit the changing needs of customers. DuringFY 2012,it introduced ’Risk Capital Fund Scheme’ which envisages to supplment thepromoters’ margin for expansion/modernization/diversification of the existing unit andalso to meet working capital margins and other business needs.

3.3 Loan Sanction CriteriaCorporation sanctions loans to industrial units, service sector units like nursing homes,commercial complexes, hotels, motels, road laying equipment, transport operators, excava-tors, tourist transport vehicles etc. The Corporation considers loans at 75% on the assetssuch as land, buildings and machinery subject to DER norms i.e., 3:1 for the projects upto Rs. 10.00 lakhs and 2:1 for project cost above Rs. 10.00 lakhs and for loan amount uptoRs 2000 lakhs. The applicant shall offer collateral security ranging from 25% to 150% ofthe loan amount depending upon the type of the schemes and as guided by the lendingpolicy.

3.4 CIBIL (Credit Information Bureau of India Lim-ited)

Credit Information Bureau of India Limited (CIBIL) is a premier service organizationproviding information on the credit reports of various entities - commercial and individualthroughout the country

The entire Banking sector and Financial Institutions provide the credit information oftheir borrowers which in turn are provided to all the members on payment of prescribedfees.Corporation as a part of Risk Management and to know the details of credit history ofthe promoters and their enterprises also subscribed to the CIBIL and obtain the creditinformation reports viz., commercial and consumer during appraisal, both at Head Officeand Branches.

3.5 Pre Sanction InspectionOnce the enterpreneur submits the information, the officials visit the location to ascera-tinits sustainability and adequacy for the proposed activity and examine the informationwith regard to technical aspect of the project viz., machinery required & availability i.e.,by taking quotations from 3 similar machinery suppliers etc, raw material required andavailability,proximity of raw materials to unit and its price etc, operation process involvedand experience of promoters in such operations,marketing arrangements made i.e,details

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of customers contacted, enquiries obtained, details of dealers if appointed, market surveyreport indicating the demand of the product, details of competitors and their share in themarket, demand supply gap and projection of sales etc, licenses and approvals required asper statutory obligations for setting up the unit in that particular location and financialaspects like investment capacity of the promoters along wiht sources of finance, details ofsecurities proposed to be offered i.e, copies of property documents together with link doc-uments, encumbrance certificates or charges on the properties for establishing rights overthe properties,financial projections made by the promoters, details of the other associatedunits, if any in which the promoters are interested.Based on the information submitted by the enterpreneur, the project will be taken for de-tailed appraisal for extending necessary financial assistance. The appraisal of the projectsmay be done at branch level or at head office level depending on the quantum of finan-cial assistance sought by the promoters. In case financial assistance sought is above Rs.100 lakhs, the branch office prepares the project information sheet as per the informationsubmitted by the promoters and sends the same to the head office along with the loanapplication, for further action.

3.6 Project Screening CommitteeThe Projects Department at head office, on receipt of project information sheet studies theproposal thoroughly and lists out the merits and demerits of the proposal placed beforethe Projects Screening Committee for initial scrutiny. The promoters are also called forthe meeting to interact with higher officials and represent their case and request for anysort of concessions such as lesser rate of interest, reduction of collateral security,etc.

The PSC after detailed discussions with the promoters as well as among the membersof the committee, decide whether to take up the proposal for financial assistance or toreject the proposal. In case, the committee decides to take up the proposal with certainconditions, the proposal will be sent to the Projects Department and allocates the proposalto the concerned team depending on the time of activity.

3.7 Method of Project AppraisalBroad items covered under project appraisals for which information is sought is detailspertaining to extent of land, adequacy of buildings, machinery & cost resonability creden-tials, prices of raw materials and finished products, technology and manufacturing process,market potential, availability of infrastructural facilities such as power, water, fuel, evalua-tion of plant capacity, machinery balancing, cashflows, BEP, IRR, Risk Evaluation etc.Thechecklist is isuued at the time of issuing the loan applicationProject Appraisal is a technique to study the viability of the project with regard to thefinancial,technical,marketing and economic aspects. The team members consisting of ex-perts in financial as well as in technical aspects will attend to the appraisal of the project

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The details are as under:

Technical Appraisal

It is done by the qualified and experienced engineers who will have detailed interactionwith the enterpreneur snd his technical consultant

Land & Buildings

The parameters, extent of building is assessed based on type of industry and cost ofbuilding is worked out based on the approved civil rates of the corporation. The com-ponents/provisions that are included while estimating the value of buildings & civil worksare civil rates for required plinth area and provison for sanitation, water supply, gate, ser-vice charges, artitect fee, etc and other specific civil works applicable as required for thespecific industries.

Machinery

The precaution taken for financing imported machinery is to obtain quotation directlyfrom foreign supplier or authorized agent. The cost of imported machinery is estimatedincluding customs duty, clearing & forwarding , freight, etc and basic cost„ excise duty, salestax,insurance & freight, packaging & forwarding,etc in case of indigeneous machinery. Ifthe data is available of the same supplier, no comparative quotation is required otherwisethree quotations shall be required.The machinery considered for financial assistance istreated as new if it is 1.5 years old from date of filling of application with loan eligibilty of75%. Otherwise, it is treated as second hand with loan eligibility of 50%. Suitable amountis provided for erection of machinery.

Preliminary & Pre-operative Expenses

THe overall provision of preliminary & pre-operative expenses is about 10% of project costand overall provision can be made up of maximum of 70% of loan considered. However,where the implementation period is very long in the projects like hotels, nursing homes,power plants, etc a higher provision may be made on case to case studies.

Financial Appraisal

Promoters contribution, Term loans, Unsecured loans, Working capital loan in case of loanconsidered under single window scheme. Promoter’s contribution: Promoters/partnerscapital in case of proprietary/partnership concern, paid up equity share capital in case oflimited companies including equity participation of other institutions, reserves & surplus,internal accruals, P&L A/c, interest free secured loans is given to bridge the gap in equity.The quantum of term loan assistance is decided based on PC,DER,perception of eligibility

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and also complying with the PSC decision on risk perception. Unsecured loans are consid-ered as equity or debt on the basis that Equity for interest free unsecured loans and Debtfor interest bearing unsecured loans.

3.8 Viability, Profitability & Ratio analysisMarket demand, while appraising the project -data on demand in state/country shall beverified. Also to chesk the authenticity of information given by enterpreneur the distribu-tion network may be ensured. The economic viability is verified on the bais of 1st yearof operating capacity, cash flow, profitability statements for 8 years and DSCR, IRR andBEP. Cashflow statement is prepared to show cash disbursement & cash availability withina specific period. It means:

1. No. of years in which the loan is to be repaid with the amount of installments

2. Dividends or Withdrawls

3. Value of output/capital employed

4. interest/ value of output

5. Operating profit/value of output

6. Net profit/ equityAcceptable Debt Service Coverage Ratio is 1.5 to 2 and if it is more, loan period shall

be reduced proportionately.

IRR

Rate at which total cash outflows of the unit becomes equal to the discounted futurecashinflows. IRR should usually be higher than the cost of borrowings. IRR above 20% issatisfactory

BEP

It is used estimation of no profit no loss zone and also to determine the level of margin ofsafety at an optimum capacity utilization. BEP should be less than the optimum capacityof the unit. More less the BEP, more viable is the project.

DER

The loan eligibility will be fixed based on the pre-determined DER as applicable to theline of activity.The Maximum DER is generally taken as 2:1.

Components of Debt are Term loan, Interest bearing unsecured loans,High Purchaseloans,etc.Components of Equity are Promoters’ capital, Share application money, Reservesand Surplus, Interest free unsecured loans, etc.

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Promoters’ contribution

Corporation’s term loan will be reckoned with a promoters’ contribution at 22.5% in caseof SSI sector and 25% in case of MSI sector.

3.9 Sensitivity AnalysisIt is done to ascertain the impact on the viability of the project. The viability of the proectwill also be verified by making changes in the sales revenue/cost of raw materials/ otherinputs to estimate how sensitive is the project with the changes made. The variationswill be upto 10% increase in the cost of raw material/inputs and upto 10% decrease inselling prices/job/work/revenue.If the project does not withstand increase in Raw materialor Sales price, it is said to be sensitive. decrease in The sensitivity is carried out on DSCR,BEP IRR.

3.10 Internal Risk Rating DepartmentThe corporation introduced risk assessment/risk rating of the proposals being put up torespective authorities for sanction of loan proposals involving loan amount more than Rs.100 lakhs. The Risk Management Department will analyze the case based on the creditwor-thiness of the promoter’s financial strengths, marketing arrangements, securities provided,management etc.The Corporation is enrolled as a member of CIBIL. The list of defaultersshall be furnished to CIBIL.The information received from CIBIL shall be analyzed bythe Branch Managers and HOD(Projects) and HOD(Operations), while appraising newproposals and indicated in the appraisal mechanism. After detailed appraisal,the draftmemoranda is circulated to the HOD for verification. The final memorandum is circulatedto the respective committee members viz, Head Office Sanction Committee or ExecutiveCommittee or Board of Directors. The sanction letter is then issued to the promoters afterdue approval of the respective authority.

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Chapter 4

Project Appraisal Mechanism -Atheoretical Framework

4.1 Appraisal ProcedureProject Appraisal procedure covers the following aspects

• Promoters Evaluation

• Technical Evaluation

• Financial Evaluation

• Means of Finance

• Market Evaluation

• Risk Evaluation

• Components of Project

4.2 Promoter EvaluationThe corporation attaches great importance to the background of the promoters of the unit.The role of corporation has been the development of enterpreneurship to promote the indus-tries in the state.Accordingly,the background of the promoters,his experience,educationalqualifications,etc assumes prime importance in the profile to the proposed industry.Thecorporation normally looks at the following aspects with regard to promoters’ backgroundas a part of appraisal of the project

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4.2.1 Educational QualificationThe relevance of education plays a great role in the ability of the enterpreneur to matchto the industrial requirements.The relevant educational qualifications always help in dis-charging the managerial activities related to the industrial activity proposed in a betterway.However there are several enterpreneurs who have minimal educational qualificationsand have become successful mainly on account of family background or experience acquriedover a period of time.

4.2.2 Family BackgroundIt plays a vital role in shaping the promoter to meet the requirements of the industry. Thepromoter who comes from business family generally adopts himself seamlessly to improvethe business oppurtunities.This skill is amply seen in enterpreneurs who come from businesscommunity in India.These enterpreneurs generally obtain training from their peers.Thesecategories of people right from young age are exposed to various facets of industry andbusiness and have proved to be successful in their industrial ventures.

4.2.3 ExperienceA greater weightage is appraised to the experience in the relevant industries of the pro-moters.His experience in the field shall be of great importance and is considered to be theright person to establish the industry.

4.2.4 Credit WorthinessAny project requires considerable amount of funds to be invested by the promoters.Mostof the institutions adopt a regulation of debt equity ratio of 2:1 which means that 35-40 percantage of the project cost has to be borne by the promoters.The ability of theenterpreneurs to bring in the required funds for meeting the working capital requirementsis assessed by examining their solvencies and abilities to mobilize the required funds.Apartfrom these, institutions look to aspects like if they have availed loans in the past,what istheir track record and if they have companie,what is their performance.

4.2.5 Ability to offer collateral securityNormally institutions look for additional security as collateral security to be offered by thepromoters for the term loan extended to secure the loan facility.In the event if promoterfails to reapy the loan ,the security of the financing institution is at stake.The institutioninsists on securities ranging from 25 to 150 percantage depending on the risk perceptions ofthe agency.In case promoters are not able to offer collateral security, alternatively the fixeddeposits are accepted as security and the details about collateral security is also examinedin detail during project appraisal.

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4.3 Technical Evaluation :The technical feasibility of the project will be examined with reference to the followingareas :

• Land/location of the site

• Construction of building and other civil works

• Plant lay out

• Plant and Machinery

• Determination of plant capacity

• Infrastructure facilities required such as power, water, effluent treatment facilities,fuel, etc.

• Inputs required(raw materials, consumables, stores spares)

• Environment aspects

4.3.1 LandLand is the primary requirement of a project. The location of the project has a prime im-portance. This is basically selected based on availability of raw materials, proximity to themarket, other aspects regarding availability of required skilled manpower, transportationfacilities and technical services. The topography of the land and other location relatedadvantages greatly influences the location of the project. The following factors play animportant role in finalizing the land:

Quantum of land required

The requirement of land is based on the type of project and if could be located in themidst of habitation or in areas specifically marked for industrial units like industrial de-velopment areas, industrial estates etc. government is creating necessary approvals fromthe connected authorities through single window mechanism. The government has createdcommon infrastructure facilities for providing uninterrupted power, telecommunicationsfacilities, other facilities i.e. treatment of effluents etc.

The cost of the land should be low as it ia a unproductive asset. If the cost of the landis high, the cost of the project enhances to that extent resulting low profitability / returnson the investment made. Thus the cost of land shall be minimal and appropriate.

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Proximity to raw materials and markets:

An important consideration for location is the proximity to sources of raw materials andnearness to the market for final products. In terms of a basic location model, the optimallocation is one where the total cost (raw material transportation cost plus production costdistribution cost for the final product) is minimized. This generally implies that (1) aresource basic material (for example, limestone in the case of a cement plant and iron-orein the case of a steel plant); (2) a project based on imported material may be located neara port; and (3) a project manufacturing a perishable product should be close to the centreof consumption. Generally , the nature of the product influences the location of the plant.If the consumption of the product is broadly distributed and spread over large areas , theplant can be located at any place close to one of the markets. However, if the product isdirectly linked to a major production centre viz. as an ancillary product to a specific largeunit, such ancillary unit invariably should be close to the consumption point.

Availability of facilities

Facilities such as uninterrupted power, water, etc. also influence the location of the mar-ket industries. Generally such facilities are available at specific industries zones. Hence,location of the plants in such areas is desirable.

4.3.2 Structure and civil works:

Structures and civil works may be divided into three categories:Site preparation and development: This covers, granding and leveling of the site,demolition and removal of existing structures, relocation of existing pipelines, cables,roads, power lines, etc., reclamation of swamps and draining and removal of standingwater, connections for the following utilities from the site to the public network: electricpower(high tension and low tension), water for drinking and other purposes, communi-cations(telephone, internet etc.), roads, railway sidings, and other site preparation anddevelopment work.Building and structures: buildings and structures may be divided into, factory or pro-cess building, ancillary building required for stores, warehouses, laboratories, utility supplycenters, maintenance services, and others, administrative building, staff welfare building,cafeteria, and medical services buildings, and residential buildings.Outdoor works: It covers supply and distribution of utilities (water, electric power,communication, steam, and gas),handling and treatment of emission, wastages, and efflu-ents, transportation and traffic signals, outdoor lighting, landscaping and enclosure andsupervision (boundary wall, fencing, barriers, gates, doors, security posts, etc.) Further, aprovision is to be made for construction of facilities for treatment and discharge of effluents,plantation to protect environment, etc

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4.3.3 Plant & machineryThe cost of plant & machinery forms the critical aspects of the project. The machineryis important since they process the raw materials and convert them into finished goods ofthe desired standards. The requirement of machineries and equipments is dependent onproduction technology and plant capacity. It is also influenced by the type of project. Theselection of machinery is based on the following aspects:

• Specifications of the machinery for process required

• The credibility of the machinery suppliers

• Performance of the machinery in similar plant

• Ability to deliver the desired output

• Availability of after sales service

• Availability of spare parts

• Flexibility of the equipment to upgrade or modernize

4.3.4 PowerThe requirement of power is based upon the power requirement of individual machinery andits utilization time. Many a time, most of the machinery operates continuously. Some ofthe machinery operates intermittently. Thus the total quantum of power required is basedon the operations of machinery. Highly power intensive plants such as steel, ferroalloysetc, are to be established only after ascertaining the availability of uninterrupted powerto operate such plants. Frequent disruption of power to such plants may lead to loss ofthe production and in certain plants, loss on account of damage to materials which are inprocess. Some plants are providing generator sets which run on diesel, etc.

4.3.5 WaterWater also forms an essential part in an industry except for some specific activities. Waterbecomes a part of process in some of the industries such as paper, chemical, drugs etc. insuch industries water is used in process directly etc. availability of water either throughgovernment sources or through underground sources is to be ensured for such projects.Facilities shall also be provided for optimizing the utility of water by recirculation aftertreatment. Many a time, the water gets polluted by addition of various ingredients in themanufacturing process, thus necessitating treatment of such water before disposing it.

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4.3.6 AmbienceThe facilities created are in tune with the distinct technology and requirements of theproject. There are specific requirements for some projects in manufacturing viz.FDI (For-eign Direct Investment)regulations in case of pharma and drug industries, HACCP (HazardAnalysis Critical Control Point ) regulations in case of food processing industries, the stan-dard prescribed under BIS(Bureau of Indian Standards) regulations for air conditioning/humidification in textile units.

4.3.7 Availability of man power & LabourIt is important to understand the requirement of skilled manpower, etc. and the areachosen invariably should have such availability. Otherwise, the cost of manpower will behigh resulting in high cost of production. In labour-intensive projects, the labour situationin a particular location becomes important. The key factors to be considered in evaluatingthe labour situation are:

• Availability of labour, skilled, semi skilled and unskilled

• Prevailing labour rates

• Labour productivity

• State of industrial relations judged in terms of the frequency and severity of strikesand lockouts

• Degree of unionization

4.3.8 Environmental factorsA project may cause environmental pollution in various ways: it may throw gaseous emis-sions; it may produce physical liquid and solid discharges; it may cause noise, heat, andvibrations. World over, great importance is laid on protecting the environment. Govern-ment is also exercising stringent norms for protecting atmosphere. The projects, whichgenerate effluents or cause harm to environment invariably, should create facilities fortreatment of such effluents by installing suitable / adequate effluents treatment plants andensure that the discharged wastage is pollution free. Necessary approvals shall be obtainedfrom the concerned authorities before they come in to existence.

4.4 Financial evaluation:To judge a project from the financial angle, the following needs to be estimated after dueevaluation and projections made:

• Cost of the project

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• Means of financing

• Estimates of sales and production

• Cost of production

• Working capital requirements and its financing

• Estimates of working results(probability projections)

• Projected cashflow statements

• Debt-equity ratio & debt service coverage ratio

• Break even point

• Calculation of internal rate of return

4.4.1 Cost of the project:One of the important aspects of the project appraisal is arriving at the cost of the project:conceptually, the cost of the project represents the total of all items of outlay associatedwith a project, which are supported by long term funds. It is the sum of the outlays onthe following:

• Land and site development

• Buildings and civil works

• Plant and machinery

• Provision for contingencies

• Expenses on foreign technicians and training of Indian technicians aboard

• Preliminary and capital issues expenses

• Pre-operative expenses

• Margin money for working capital

Land & site development:

The cost of the land and site development includes basic cost of land/premium payable onleasehold and conveyance charges/cost of leveling and development/cost of laying approachroads and internal roads, cost of gates and cost of tube wells. The cost of land variesconsidering from one location from one location to another. The cost is very high inurban and even semi-urban locations and it is relatively low in rural locations. The sitedevelopment, too, varies widely depending on the location and topography of the land.

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Buildings & civil works:

Buildings and civil works cover main plant & equipment, auxiliary services like stream sup-ply , workshops, laboratory, water supply, godowns, warehouses and open yard facilities,non-factory building like canteen , guest house, time offices, excise houses, etc., staff quar-ters, tanks, wells, chests, basins, garages, etc. the cost of buildings and civil works dependson the kinds of structures required which in turn, are dictated largely by the requirementsof the manufacturing process. Once the kinds of structures required are specified, costestimates are based on the plinth area and rates for various types of structures. Theserates, of course vary with location to some extent.

Plant & machinery:

The cost of the plant and machinery typically the most significant component of the projectcost. It consists of cost of imported machinery including FOB(free on board) value, ship-ping, freight & insurance, import duty, clearing, loading & unloading and transportationcharges; cost of indigenous machinery including FOR(free on rail)cost, octroi, sales tax,excise duty, freest & insurance, packing, transportation charges to site etc., cost of storesand spares, foundation and installation charges. The cost of plant & machinery is basedon the latest available quotation duly adjusted for possible escalation.

Provision for contingencies:

A provision for contingencies is made to provide for certain unforeseen expenses and priceincreases over and above the normal inflation rate which is already incorporated in costestimates of buildings and plant and machinery.

Miscellaneous fixed assets:

Fixed assets and machinery which are not part of the direct manufacturing process may bereferred to as miscellaneous fixed assets viz. furniture, office equipments, tools, vehicles,railway siding, DG(diesel generating) sets, transformers, boilers, piping systems, laboratoryequipment, etc.

Preliminary & pre-operative expenses:

Expenses incurred for identifying the project, conducting the market survey, preparing thefeasibility report, drafting the memorandum & articles of association, incorporating thecompany, expenses, undertaking commission, brokerage, fees to managers and registrars,printing and postage, advertising and publicity, listing fee, stamp duty, etc. preoperativeexpenses include establishment expenses, rent rates & taxes, travelling expenses, interestand commitment charges on borrowings mortgage expenses, interest on deferred payments,trial run expenses, etc.

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Margin money for working capital:

The principal support for working capital is provided by commercial banks and tradecreditors. However, a certain part of working capital has to come from long- term sourcesof finance referred to as margin money for working capital. This is an important element ofthe project cost. Many a time, the margin money for working capital is utilized for meetingover runs in the capital (initial) costs; which leads to a working capital problem when theproject is commissioned. Thus, generally financial institutions stipulate that a portion ofthe loan amount equal to the margin money for working capital be blocked initially so thatit can be released when the project is completed.

4.4.2 Means of Finance:To meet the cost of the project, the following means of finance are available.

• Share capital/promoters capital

• Term loan

• Debentures

• Incentives

• Miscellaneous sources/unsecured loans (interest free or interest bearing).

Share capital/promoter’s capital:

There are two types of share capital i.e. equity share capital or preference share capital.Equity share capital represents the contribution made by the owners of the business, theequity shareholders, who enjoy the rewards and bear the risks of ownership. Equity carriesno fixed rate of dividend. Preference capital represents the contribution made by thepreference shareholders and the dividend paid on it is generally fixed. Capital brought inby the promoters of sole proprietary or partnership firm is referred to as promoter’s capital.

Term loans:

Provide by financial institutions and commercial banks, term loans represent secured bor-rowings which are a very important source (and often the major source) for financing newprojects as well as for expansion, modernization in india viz. rupee term loans for financingland, building, other civil works, and indigenous plant and machinery and foreign currencyterm loans which are provided for meeting the foreign currency expenditures towards theimport of equipment and technical know-how.

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Debentures:

Akin to promissory notes, debentures are instruments for raising debt capital. There aretwo broad types of debentures viz. non-convertible debentures and convertible debentures.Non convertible debentures are straight debt instruments. Typically they carry fixed rateof interest and have maturity period of 5 to 9 years. Convertible debentures are convertiblewholly or partly into equity shares. The conversion period and price are determined inadvance.

Deferred credit:

Many a times the suppliers of the plant & machinery offer a deferred credit facility underwhich payment for the purchase of the plant and machinery can be made over a period oftime.

Incentives:

The government and its agencies may provide financial support as an incentive to certaintypes of promoters or for setting up industrial units in certain locations or promote certainindustries viz. food processing, etc. these incentives may take the form of seed capitalassistance(provided at a nominal rate of interest to enable the promoter to meet his con-tribution to the project) or capital subsidy (to attract industries to certain locations) ortax deferment or exemption(particularly from sales tax)for a certain period.

Miscellaneous sources:

A small portion of the project finance may come from miscellaneous sources like unsecuredloans, public deposits, leasing and hire purchase finance. Unsecured loans are typicallyprovided by the promoters to bridge a gap between the promoter’s contribution (as requiredby the financial institutions) and the equity share capital the promoters can subscribe to.Public deposits represent unsecured borrowing from public at large. Leasing and hirepurchase finance represent a form of borrowing which is different from the conventionalterm loans and debenture capital.

4.4.3 Estimation of working capital:In estimating the working capital requirement and planning its financing, the followingpoints have to be borne in mind:

• The working capital requirement consists cost of raw materials and components (in-digenous as well as imported), stocks of goods-in-process (also referred to as work inprocess), stocks of finished goods, debtors and operating expenses etc.

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• The principal sources of working capital finance are working capital advances pro-vided by commercial banks, trade credit, accruals and provisions and long termssources of financing.

• There are limits to obtaining working capital advances from commercial banks. Theyare two forms the aggregate permissible bank finance in specified as per the normsof lending followed by lending bank (prescribed by Tandon committee) and againsteach current asset a certain amount of margin money has to be provided by the firm.

• The Tandon committee has suggested three methods for determining the maximumpermissible amount of bank finance for working capital. The method that is generallyemployed now is the second method. According to this method maximum permissiblebank finance is calculated as follows: Current assets as per the norms laid down by theTandon committee (0.75)-Non bank current liabilities like trade credit and provisions.

• The implication of this norm is that at least 25 percent of current assets must besupported by long term sources of finance.

4.4.4 Estimates of sales and production:It is not advisable to assume a high capacity utilization level in the first year of operation.Even if the technology is simple and the company may not face technical problems inachieving high rate of capacity utilization in the first year itself, there are likely to be otherconstraints like raw material shortage, limited power, marketing problems etc. it is sensibleto assume that capacity utilization would be some-what low in the first year and rise thereafter gradually to reach the maximum level in the third or fourth year of operation.

The selling price considered should be the price realizable by the company net of exciseduty. It shall, however, include dealer’s commission which is shown as an item of expense(aspart of sales expenses).

The selling price used may be the present selling price.It is generally assumed thatchanges in selling prices will be matched by proportionate changes in cost of production. Ifa portion of production is saleable at controlled price, the controlled price for that portionhas to be taken.

4.4.5 Projected cash flows statements:The cash flow statement shows the movement of cash into and out of the firm and itsnet impact on the cash balance within the firm. A format for preparing the cash flowstatement, which is really a cash flow budget, is prescribed by All India financial insti-tutions. While this format calls for preparing the cash flow statement on a half yearlybasis for the construction period and on an annual basis for the operation period (for tenyears) for managerial purposes, it may be helpful to prepare it on a quarterly basis forthe construction period and on a half yearly basis for the first 2 to 3 operating years for

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managerial purposes. This would facilitate better financial planning, project evaluation,and fund control.

4.4.6 Viability IndicatorsDebt - Equity Ratio:

Meaning: This ratio establishes a relationship between long term debts and shareholdersfund.Objective: The objective of computing this ratio is to measure the relative proportion ofdebt and equity in financing the assets of a firm.Components: There are two components,

1. Long term Debts, which mean long-term loans (whether secured or unsecured) (e.g.,debentures, bonds, loans from financial institutions).

2. Shareholder’s funds, which mean equity share capital plus preference share capitalplus reserves and surplus minus fictitious assets (e.g., Preliminary expenses).

Computation: This ratio is computed by dividing the long terms debts by the shareholders-’ funds. This ratio is usually expressed as a pure ration e.g., 2:1. In the form of a formula,this ratio may be expressed as follows:

Debt-Equity Ratio = Long-term Debts/Shareholders’ Fund

Interpretation: It indicates the margin of safety to long-term creditors. A low debt-equityratio implies the use of more equity than debt which means a larger safety margin forcreditors since owner’s equity is treated as a margin of safety by creditors and vice versa.Traditionally, a debt equity of 2:1 is considered to be satisfactory which means debt couldbe twice the equity. The enterprise should have neither a very high nor a very low ratio,it should have a satisfactory ratio. To judge whether the ratio is satisfactory or not, itshould be compared with its own past ratios or with the ratio of similar enterprises in thesame industry or with the industry average.

Debt-Service Coverage Ratio:

Meaning: This ratio measures the relationship between Net Profits before Interest + Taxand Interest + Principal portion of installment. Objective: The objective of computing thisratio is to determine the firm’s capacity to pay off both the interest and principal portionof the installment. Components: There are two components of this ratio as follows:

• Net Profit before Interest and Tax

• Interest and Principal portion of Installment

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Computation: This ratio is calculated by dividing the Net Profit before Interest andTax by the aggregate of interest and Principal portion of installment. It is usually expressedin number of times. In the form of a formula, this ratio may be expressed as follows:

DSCR = (Annual Net Income + Interest Expense + Amortization&Depreciation + Otherdiscretionary and non-cash items like non contractual provided by the management)/(Principal Repayment + Interest Payments + Lease Payments)

Interpretation: DSCR shows the number of times the amount of interest on longtermdebts and the principal portion of instalment is covered by the profits out of which thatwill be paid. It indicates the limit beyond which the ability of the firm to service its debtwould be adversely affected. For instance, an debt service of five times would imply thateven if the firm’s net profits before interest and tax decreases by 80% of the present level,the firm will still be able to pay interest and instalment out of profits. Higher the ratio,greater the firm’s ability to pay current interest and instalment but very high ratio mayimply lesser use of debt and very efficient operations.

Break-Even Analysis

The break-even point (BEP) is the point at which cost or expenses and revenue are equal:there is no net loss or gain, and one has "broken even". A profit or a loss has not been made,although opportunity costs have been "paid", and capital has received the risk-adjusted,expected return. In short, all costs that needs to be paid are paid by the firm but theprofit is equal to 0.

the break-even point (in terms of Unit Sales (X)) can be directly computed in terms ofTotal Revenue (TR) and Total Costs (TC) as:

TR = TC (4.1)P × X = TFC + V × X (4.2)

P × X − V × X = TFC (4.3)(P − V) × X = TFC (4.4)

X = TFCP − V (4.5)

where:TFC is Total Fixed Costs,P is Unit Sale Price, andV is Unit Variable Cost.

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Accounting break-even analysis:

A project that breaks even in accounting terms is like a stock that gives you a return ofzero percent. Here you get back your original investment but you are not compensatedfor the time value of money or the risk that you bear. Put differently, you forego theopportunity cost of your capital. Hence a project that merely breaks even in accountingterms will have a negative NPV(net present value).

Financial break-even analysis:

The focus of financial break-even analysis is on NPV and not on accounting profit. i.e., atwhat level of sales will the project have a zero NPV.

4.4.7 Sensitivity analysis:Since the future is uncertain, you may like to know what will happen to the viability ofthe project when some variable like sales or investment deviates, or sensitivity analysis.The NPV based on the expected values of the underlying variables can vary widely andhence you would like to explore the effect of such variations on the NPV. So you define theoptimistic estimates for the underlying variables. To do this, vary one variable at a time.To study the effect of an adverse variation in one variable, you maintain the values of theother underlying variables at their expected levels.

4.5 Market evaluation:Market analysis forms an important part of the project appraisal methodology. Marketevaluation basically means the scope for the product produced/manufactured, the con-sumer acceptance, the other competitors who manufacture similar product, the segmentwhich uses the product, the rate at which the demand for the next years, etc. Each ofthese activities are critical for evaluation of the scope of the project.

Market analysis is also very critical, primarily at the time of conceptualizing the prod-ucts. There is no point in selecting a product to be manufactured/produced which has nodemand, low demand or falling demand. This necessarily means that the product afterbeing manufactured/roduced can be sold in the market with little efforts. However eval-uating or re-assessing all the above factors is very difficult since most of the analysis isbased upon certain presumptions in most of the cases as the details of the growth pattern,details of consumer pattern, details of strengths of the competitors, details of pricing ad-vantage are not available. This is more in unorganized sector where in several players areproducing the products and there is no agency, which organizes the date. If the productmanufactured/produced is used to cater a premium market and the players are few, thereis possibility of evaluating the scope for the product to enter into the market.

The appraisal pursuant to market evaluating and demand analysis is generally carriedout in a systematic manner, they could be said as:

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• Situation Analysis

• Collection of information: (1) Primary, (2) Secondary

• Conducting of market survey and adopting methodology of seed marketing

• Demand formulation

Finally evaluating the capacity at which the company has to operate. Under the situa-tion analysis, interacting with actual users and also ascertaining the scope for establishingthe unit whit specific reference to demand from end users. The specific advantage of theproduct proposed to be manufactured also has a bearing on the competitor with similarproduces in the market.

4.5.1 Collection of InformationThe primary information basically thus generated from the end users and potential forincrease in such usage. The secondary information is basically gathered from the publisheddata available through various agencies viz. Census regarding population availability inthe country or in the region, sample reports conducted by various agencies on differentproducts, economic survey conducted by the ministry of finance, annual survey of industriesconducted by them on various aspects of the industry, the bulletin published by departmentof exports and imports, specialized reports published by various specialized consultingagencies on specific lines of activities, the production details of various selected agencies /companies from Reserve bank of India etc.

4.5.2 Market SurveySome times a well â“ structured questionnaire is designed and circulated to various userssituated all over the industry, sector wise to the industrial needs. This questionnaire shouldbe so designed to indicate the various facets of the product proposed to be manufacturedby highlighting the features. The information should cater to the needs to be interpretedproperly to bring out a meaningful observation. The results of the market survey need tobe compensated for the sample size being non representative, not bringing a proper ques-tionnaire, failure of respondents to answer the questionnaire properly, deliberate incorrectobservations, improper scrutiny of the data and analysis. To sum up it would be concludedthat market evaluation basically needs an understanding on the following:

1. Effective demand for the product during the past and present

2. Components of demand of product (sector wise)

3. Pricing pattern

4. Segregation of customers

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5. Competition existing in the market and

6. Finally the government policies to support the market

4.5.3 Concept of Michel porter on competition:Michel porter has argued that the profit potential of an industry depends on the combinedstrength of the following five basic competitive forces that drive the industry competitionhas a bearing on designing the strategy the unit has to follow to counter such market forces.

4.5.4 Threat to new entrants:New entrants add capacity, inflate costs, push prices down and reduce profitability. Hence,if an industry faces the threat of new entrants, its profit potential would be limited. Thethreat from new entrants is low if the entry barriers confer an advantage on existing formsand deter new entrants. Entry barriers are high when:

• The new entrants have to invest substantial resources to enter the industry.

• The economies of scale are enjoyed by the industry.

• Existing firms control the distribution channels, benefit from product differentiationin the form of brand image and customer loyalty, and enjoy some kind of proprietaryexperience curve.

• Switching costs - these are essentially one-time costs of switching from the productsof one supplier to another - are high.

• The government policy limits or even prevents new entrants.

4.5.5 Rivalry between existing firms:Firms in an industry compete on the basis of price, quality, promotion, sevice, warrantiesand so on. Generally, a firms attempts to improve its competitive position provoke re-taliatory action from others. If the rivalry between the firms in an industry is strong,competitive moves and counter moves dampen the average profitability of the industry.

4.5.6 Pressure from substitute products:All firms in an industry face competition from industries producing substitute products.Performing the same function as the original product, substitute products may limit theprofit potential of the industry by imposing a ceiling on the prices that can be charged bythe firms in the industry. Thus the threat from substitute products is high.

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4.5.7 Bargaining power of buyers:Buyers are competitive force. They can bargain for price cut, ask ;for superior quality andbetter service and induce rivalry rivalry among competitors. If they are powerful, they candepress the profitability of the supplier industry.

4.5.8 Bargaining power of suppliers:Suppliers, like buyers, can exert a competitive force in an industry as they can raise prices,lower quality and curtail the range of free services they provide. Powerful suppliers canhurt the profitability of the buyer industry.

4.6 Risk evaluation:Innovations and industry developments are inherently risky. It is important to identify andunderstand different types of risks as well as describing strategies to manage and minimizethe impact of risk in an industry. Such an analysis critical to every industrial project. Riskvaries from industry, but the dimensions of risk are similar across all businesses. The levelof risk associated with a particular industry or project will depend upon the following:

• The value of resources devoted to the project

• The length of time for which the resources will be devoted to the project

• The inherent risk of the project

• The cost of exiting the project

• The recoverable costs when the project to fail

4.6.1 Visibility of risks:Many potential risks can be identified during the industry planning process and strategiescan be developed to mitigate them. There will also be unforeseen risks that an industrymust be able to deal with as and when they arise. A businessâTMs ability to manageunforeseen risks will largely depend on the caliber and experience of management and thenature of the event. An important aspects of industry planning is that, as a result ofhaving development a comprehensive plan, when unforeseen events occur, manages havethe time and the resources available to tackle them.

4.6.2 Types of risks:Industry risks can be categorized as:

• Operational

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• Industry

• Financial

• Political

Operational:

Operational risks are internal to the business and relate to its ability to achieve its chosenstrategy. They include the following:

• Unforeseen problems in the production process

• Machinery break down or its incompatible with the raw materials

• Stock damages

• Fire, theft and floods

• Technology problems

• The product is so successful that the business cannot meet demand

Industry:

Industry risks caused by external developments in the industry and may develop as a resultof actions by the business itself. They include the following:

• A new firm enters the market

• A key supplier closes down or prevents the supply of crucial raw materials

• Demand for the product falls or fails to materialize

• A competitor aggressively cuts prices

• A new technology is developed making existing products obsolete

• Two competitors merge providing them with a major cost advantage

Financial:

Potential financial risks include the following:

• Interest rates increase dramatically, raising the cost of servicing the industrys debts.

• There is a significant devaluation, which increases the cost of raw materials purchasedfrom abroad.

• High demand for the product leads to overtrading and lack of available workingcapital to fund the industrial activities.

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Political:

• Political risks include not only government risks but also those resulting from theactions of trade unions, lobbyists and activists. They include the following:

• Sanctions imposed on a country preventing access to customers or raw materials

• Taxation rates change or taxation policy alteration

• Grants, loans and subsides alteration

• Trade unions organize industrial action, preventing production from continuing

• Pressure from lobbyists requiring a change in the business practice of industry

• The industry suffers organized vandalism by radical protesters

4.6.3 Risk assessmentIndentifying risks

The task of risk assessment is to try and identify as many potential risks for an industryas possible. Many of the existing outputs from the business planning process can be usedin the exercise. PEST(political, economic, social, technology) analysis may well highlightpolitical and financial risks. Lastly, a brainstorming exercise, examining each of the fourrisk categories, should be performed.

4.6.4 Qualifying the risks:The business-planning model can be used to examine the financial impacts of the risks.A useful technique is to run a sensitivity analysis across the key inputs in the model thatbest relate to the identical risks:

• The quality demanded of the product

• The selling price of the product

• Distribution costs

• Sales and marketing costs

• The costs of raw materials

• Interest rates

• Taxation rates

• Exchange rates

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4.6.5 Strategies for managing risk:The tactics and strategies for managing and mitigating the identified industry risks will bespecified to the business, its industry and its position within that industry. The strategiesfor mitigating potential risks, however, must be based on influencing one of the dimensionsof risks.

4.6.6 Limitations:If risks are improperly assessed and prioritized, time can be wasted in dealing with riskof losses that are not likely to occur. Spending too much assessing and managing unlikelyrisks can divert resources that could be used more profitably. Unlikely events do occur,but if the risk is unlikely enough to occur, it may be better to simply retain the risk,and deal with the results it the loss does in fact occur. Prioritizing too highly the riskmanagement processes, it could potentially keep an organization from ever completing aproject or even getting started. This is especially true if other work is suspended until therisk management process is completed.

4.7 Credit RatingThe Corporation has introduced credit risk rating models for rating of loan proposalsinvolving loans of above Rs.100 lakhs in the following categories, during September,2005and successfully implemented the rating mechanism.

• Risk rating model for Term loans

• Credit Risk rating Model for Additional Term loans

• Credit Risk raing Model for Working Capital Term loans

4.7.1 Rating Nomenclature

S.No. Total score Grade Implication ofGrade accorded

1 91-100 CR 1 Excellent safety2 81-90 CR 2 Very Good safety3 71-80 CR 3 Good safety4 61-70 CR 4 Ordinary safety5 51-60 CR 5 Less ordinary safety6 41-50 CR 6 Low safety7 31-40 CR 7 Unsafe8 21 -30 CR 8 Loss category

Table 4.1: Rating Nomenclature

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The proposals falling in the rating of CR 1, CR 2, CR 3 & CR 4 only shall be considered.Theproposals with rating CR 5 are considered selectively with higher Collateral security.

Grop Exposure

The Corporation considering the risk with regard to exposure to a closely held group fixesthe maximum expossure that can be taken at any given point of time. The present exposurelimits are as under:

• Group borrowers of GE category in industrial sector - Rs. 60 crores

• Others - Rs. 40 crores

4.7.2 Credit Rating ModelSummary score sheet for Credit Risk Rating

S.No. Risk Parameter Full Marks1 Financial Risk 222 Business Risk 183 Industry Risk 104 Management Risk 265 Risk Mitigation 24

Total 100

Table 4.2: Summary Score sheet

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Detailed Score sheet

S.No. Parameter Full MarksFinancial Risk Parameters1 Projected DER 52 IRR 23 Gross Avg. DSCR 54 Terms of Repayment 55 Stress tested DSCR 5

Aggegrate Financial risk score 22Business Risk Parameters1 Technology 42 Capacity Utlsn vs BE point 23 Compliance of Environmental 4

regulation4 User/Product profile 25 Market net-work 46 Location of unit 2

Aggregate Business risk score 18Industry Risk Parameters1 Competition 22 Industry Outlook (in industry 4

cycle)3 Regulatory risk 24 Contemporary viz., WTO issues 2

Aggregate Industry Risk Score 10Management Risk factors1 Integrity 42 Track Record 33 Management competence/ 5

Expertise4 Experience in industry 55 Payment record 46 Length of ralationship 5

Aggregate Management Risk Score 26Risk Mitigation

1 Value of CS 52 Nature of CS 53 PC Margins 54 Default ratio in portfolio 65 Solvency of promoters 3

Aggregate Risk Mitigation Score 24Total Score 100

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Chapter 5

Case Study

5.1 Introduction

APPLICATION FOR A TERM LOAN OF Rs. 550 LAKHS FROM TRIDENTPAPER MILLS LTD. FOR SETTING UP OF A 50 TPD CAPACITY KRAFTMANUFACTURING UNIT IN MEDAK DISTRICT

—————————————————————————————————————-

Name of unit : Trident Paper Mills Ltd.

Location : Sy No 98/AA, Mogaligidda (v), Farookhnagar (m), Medak Dt.

Constitution : Partnership concern

Name of Partners : Mr. Mukesh, Mr. Naresh, Mr. Mahesh, Mr. Dinesh

Line of activity : Manufacturing of Kraft paper

Capacity : 50 TPD on 3 shifts and 300 working days per annum

Operating Capacity :

Year capacity(%)1st year 502nd year 55

3rd year onwards 60

Table 5.1: Operational capacity

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Application : Manufacture of corrugated boxes/sheets

Size of the unit: Small scale industry

Cost of project : Rs. 830 lakhs

Implementation Schedule:

Activity Start FinishLand Acquired during

Jun-13Civil Works Jul-13 Mar-14Plant & Machinery Jan-14 Sep-14Erection Aug-14 Sep-14Trial runs Oct-14 Nov-14Stabilization of Operations Nov-14 Apr-15Date of commencement of May-15operations onwards

Table 5.2: Schedule of Implementation

Financial Indicators :

Indicators Normal As worked outLoan Eligibility max 75% 73.85

DER max 2:1 1.96Promoters Contribution min 22.5% 33.74Avg. DSCR (for 8 years) min 1.55 1.94

Break Even Point max 60% of capacity 35IRR min 20% 32.18

Repayment period max 8 years 8 yearsMoratorium period max 2 years 2 years

Table 5.3: Financial Indicators

Collateral security : The unit shall furnish Collateral security of 40% of loanamount

5.1.1 Risk AnalysisBusiness Risk

Price:

Prices of the different grades of paper being manufactured is lower than the prevailingmarket price.

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Demand :

There are plenty of units situated close to the applicant firm. The unit obtained markettie up letters from 5 customers.

In view of above , the risk involved is low.

Technological obsolescence

The process adopted is pulping of waste Kraft paper and producing kraft paper on kraftmachining section.

The utilities consumption like steam,power, labour,etc are the least as in the indus-try.Hence, the technology adopted is the latest and therefore the risk is low in this regard.

Political Economic Conditions (Government Policies)

The policy on packing paper is favourable which is imposing restrictions on use of plasticpaper as packing material.

The unit is adopting all pollution control methods such as Effluent Treatment of Pro-cessed Water(used for recirculation in machining section operations).Pollution control mea-sures for gaseous outlets like cyclones and chimney in case of boiler.

The unit is obtaining permission from AP Control Board,so risk in this regard is low.

Management Risk

The Managing Partner Mr. Mukesh is having six years experience in Kraft Paper man-ufacturing unit and has a good track record in the organization.Mr. Naresh and Dineshhave 4 year experience in trading of kraft paper.

Partners can manage unit both technically and manageriallySo, Treat in this regard is low.

Financial Risks

Solvency:

The solvency of all the partners combined is Rs. 470 crore which is adequate to meet thepromoters margin

Security for Institutional loans:

The proposal is secured by way of primary security of land,building,plant & machinery ofproject and collateral security of 40% of loan amounting to Rs.220 crores.

DER:

The Debt Equity Ratio of 1.96 which is less than 2.Hence, the risk even in this regard is low.

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Risk Rating:

The rating to the project is CR-4 Ordinary Safety which indicate that the proposal is abovethe investible grade for the corporation

Credit Rating CR-4 (Ordinary Safety)PLR rate 14%

Application Rate PLR + 1%Net Rate 15% p.a.

Table 5.4: CR

CIBIL Data verification

Verified the credit information on all the borrowers on CIBIL site and found them to bein order(no adverse credit information found).

PSC meeting:

The proposal was put up to Project Screening Committee who have decided to process theapplication as per norms. The collateral security to be offered is 40% of term loan.The proposal is processed as per Project Screening Committee decision.

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Background of Promoters

S.No. Name Qualification Experience1 Mr. Mukesh B. Tech. Managing Partner of Company,

Has six years of experiencein Kraft paper manufacturing

unit in A paper mills Ltd.2 Mr. Naresh M.B.A (Sales) Has two years of experience in

trading of kraft paper

Worked as Marketing Engineer inM/s APHMEL during 2002-04

3 Mr. Dinesh M.B.A (Marketing) Has two years of experience intrading of kraft paper

4 Mr. Mahesh Diploma L.M.E Proprietor of Mahesh Paper Mills

Income Tax assesse

Table 5.5: Promoters Background

Solvency details of Promoters

5.2 Due Diligence ReportThe Branch submitted the Due Diligence Pre-sanction Cum site inspection report andobservations are as under:

Integrity :

Promoters/Management’s is having good reputation about integrity in the market

Track record with the corporation :

The promoter approached the Corporation for the first time

Management competence :

Management Profile indicates adequate level of competency and commitment

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Experience in industry :

Managing Partner, Mr. Mukesh is having six years of experience in Kraft paper manufac-turing unit and two other managing partners have experience in trading of kraft paper.

Hence, Management can be categorized with long experience in the industry of morethan 5 years

Credit Worthiness :

The promoters are having ability to invest their margins and to raise unsecured loans andto raise working capital loans from banks or from friends and relatives.

Solvency and financial standing :

The aggregate solvency of Promoters is Rs. 470 crore.

5.3 Technical Aspects

5.3.1 Scope of the projectThe project envisages to setup of a unit for manufacturing of kraft paper of 50 TPDcapacity or 15000 TPA The firm proposes to produce kraft paper with thickness rangefrom 100 GSM to 200 GSM and Burst Factors of 14,16 and 18.

5.3.2 LocationThe unit is proposed to be located in land admeasuring 6 acres. situated at Sy No 98/AA,Mogaligidda (v), Farookhnagar (m), Medak Dt

The proposed site is located in industrial park at kavalimandal, Medak Dist. which ison the NH-9 road leading to Mumbai from hyderabad, where all the required infrastructurefacilities are available.

5.3.3 Raw MaterialsThe main raw material is local kraft paper which is easily available locally with stockistsand dealers . Promoters identified suppliers for continuos supply of waste kraft paper within13km vicinity. Small amount of waste kraft paper which is imported from Indonesia.

In addtion to the above, the company requires materials like Rosin , Alum, packingmaterial which is available from local suppliers.The cost of raw materials at 50% operating capacity during first year of operation isestimated at Rs.902.6 lakhsProduct Mix is assumed as 50% 14 BF, 30% 16 BF and 20% 18 BF.BF indicates BurstFactor

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5.3.4 Manufacturing ProcessThe process is as follows:

Pulping section

• Waste kraft paper is fed and crushed in hydropulper

• Removal of wastes like plastics, steel ,etc by various screens and refiners

• Softening of pulp

• Final cleaning of pulp

• Spreading of fine pulpon the wire part in machining section

Machine section

• Pressing of paper

• Drying of paper in series of heaters until paper reaches moisture content of 5-6%

• Cutting and packaging of paper

5.3.5 Technical Know-howProcess adopted is pulping and forming of paper in machine section which is well establishedManaging Partner has six years experience who can operate the unit successfully with thehelp of skilled workers.

5.3.6 UtilitiesPower

The connected load of the unit is 1475 HP and contracted load is 1032 HP. The unitproposes to approach APDISCOM for power connection.

Fuel

The fuel used is agrowaste which is available locally and required fuel in first year ofoperation 4752 tonnes.

Water

Water required for operating purpose is 135KL per day and domestic purposes can be metby borewell in unit premises

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Effluent

The wastewater generated is treated in Effluent Treatment Plant and recirculated for usein pulp section. Boiler is equipped with Multi Cyclone Dust Collector for disposing ofwaste gases and approval is taken from APPCB

5.3.7 Manpower Requirement

The company proposes to appoint 15 skilled workers, 12 semi skilled and 20 unskilled work-ers. In addition to above, thecompany proposes to recruit 1 Plant Manager, 6 Supervisors,3 Chemist Storekeeper, 1 Admn.Officer / Accounts, 3 Asst/Typist and 4 Watchmen /Attenders.

5.4 Cost of Project

COST OF THE SCHEME Rs IN LAKHS- -

LAND 8.10BUILDINGS 146.00PLANT & MACHINERY 535.00ERECTION 22.00ELECTRICALS 0.00DEPOSITS 16.00PREL. & PRE-OP EXP 46.90MARGIN MONEY FOR W/C 56.00T O T A L : 830.00

-

Table 5.6: Cost of the Scheme

5.5 Notes on cost of the scheme

5.5.1 Land:

The company entered into sale agreement for purchase of land admeasuring 6 acres situatedat Sy No 98/AA, Mogaligidda (v), Farookhnagar (m), Medak Dt.

The total cost of land is Rs.8.1 lakhs including registration and stamp duty and loanis proposed on land.

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5.5.2 Buildings

S. no. Buildings Area Req.1 Main Factory Shed 1400 sq. mt.

10 mts height2 Pulp & waste paper shed 470 sq.mt.3 Boiler Shed 180 sq.mt.4 Admin Office 70 sq.mt.5 Chest Tank 512 KL

8 no.s6 Chimney 13 m ht

Table 5.7: Buildings

Civil works are approved by DTCP. The cost of buildings is estimated as Rs. 146 lakhs.

5.5.3 Plant & Machinery

Machinery is required mainly for pulping section and machine section which is essentiallyobtained from DS Engineers, Ahmedabad. Other connected machinery are 5TPH boiler,vacuum pumps, Electric motors, cranes, Pollution Control Equipment, etc are proposedfrom standard suppliers.

The machinery is acquired from standard suppliers and the cost including taxes isestimated as Rs. 535 lakhs.

5.5.4 Erection

An amount of Rs. 22 lakhs is provided for erection.

Deposits

DEPOSITS (RS. IN LAKHS)

Consumption Deposit to AP DISCOM 15.40Telephone 0.10

Miscellaneous 0.50Total 16.00

Table 5.8: Deposits

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Preliminary & Pre-operative expenses

CONSIDERED FOR LOAN ELIGIBILITY:

Interest during constructuion 32.00Legal expenses 1.00

Wages during construction period 0.30Insurance during construction period 0.15

Trial run exps. 0.25 33.70

NOT CONSIDERED FOR LOAN ELIGIBILITY:Service charges & Upfront fee to APSFC 6.18

Service line charges to AP DISCOM 4.30Initial advertisement 0.50Travelling expenses 0.90

Office establishment & misc. 1.3213.20

Total 46.90

Table 5.9: PRELIMINARY & PRE-OPERATIVE. EXPENSES:

5.5.5 Estimation of Working Capital requirements

Description Cost No of Days Quantum of % of Borrowingsworking capital eligibility Rs.(lakhs)

Raw material 902.60 10.00 30.09 75% 22.56Wages & OE 73.14 25.00 6.09 0% 0.00

WIP & Finished goods 1244.07 3.00 12.44 75% 9.33Sundry debtors 1571.25 30.00 157.13 75% 117.84

Loans and advances 0.00 0.00 0.00Other current assets 0.00 0.00 0.00

Total 205.75 149.74206.00 150.00

Table 5.10: Working Capital Estimates

The Working Capital margin is Rs. 56 lakhs.

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5.5.6 Means of Finance

Means Rs.(lakhs)Promoters Capital 280.00

Term Loan- APSFC 550.00

Total 830.00

Table 5.11: Means of Finance

5.5.7 Promoters’ ContributionPromoters contribution works out to Rs. 280 lakhs which is 33.73 % of project cost and issatisfactory.

5.5.8 Debt Equity RatioAPSFC Term Loan is Rs. 550 lakhs and Promoters capital is about Rs. 280 lakhs TheDER ratio works out to 1.965 :1 which is less than 2:1

5.5.9 SecurityThe loan is secured through primary and secondary security.

Primary security is mortagage of land & building and hypothecation of Plant & Ma-chinery.

Collateral security is estimated as Rs.220 lakhs as per criteria set by PSC @ 40% of loanamount and unit proposes to offer residential plots in hyderabad and land and building ofpromoter.

5.5.10 MarketKraft paper is used as Raw Material for manufacture of corrugated boxes.

The demand is huge and has several applications such as beverages,FMCG products,pharma products, footwear, crackers, etc. The growth for industry is continuous.Packingof export products requires superior packing material and the exports are growing contin-uously. The promoters are having good market network by way of trading units of twopromoters.

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5.6 Economics of WorkingInstalled capacity : 50 TPD or 15000 TPA

OPERATING CAPCITY:1st Year 50% 7500 Tons2nd Year 55% 8250 Tons3rd Year & onwards 60% 9000 Tons

Table 5.12: EOW

5.6.1 Raw material

Raw Material Req./p.a. (tons) Rate/ton Total Cost in Rs lakhs

Local Waste Kraft paper 7050.00 9500.00 669.75Imported waste 450.00 14000.00 63.00Rosin (fortified) 28.13

Alum 78.75Provision for Waste (Plastics, metal, moisture, etc.) 62.97

Total 902.60

Table 5.13: Raw Material Requirement

5.6.2 Power

Load HPConnected Load - Machinery 1464 HPConnected Load - Lighting & Pumps 11 HP

Total Connected Load 1475 HPContracted Load 70% 1032 HPDemand Factor 80%Load factor 60%Demand Tariff ( per KVA p.m ) Rs.250Energy Tariff ( per kwh ) Rs.4.80

Demand Charges ( 1032 * 0.8776 *0.8 df *250*12/100000 ) Rs 21.74 LakhsEnergy Charges ( 1032x0.746x 21x300 x 0.5 oc x 0.6 x4.8 ) Rs 69.84 LakhsCustomer Charges @ Rs 1125 p.m Rs 0.14 Lakhs

Total Power charges p.a (rounded) Rs 91.70 Lakhs

Table 5.14: Power Estimation

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5.6.3 Fuel

Capacity of the Boiler 6 TPHBoiler Efficiency 82%

Net Calorific Value of fuel - Husk 3000 kcal/kgHusk Required per Hr (6x 540 kcal/kg / 0.82 / 3000) 1.32 Tons

Husk required per yr (1.32 x 24 hrs x 300days x 0.5 o.c) 4,752.00 TonsCost of Husk Rs 2000 per Ton

Fuel required p.a (4752 x 2000 ) Rs.95.04 lakhsTOTAL COST OF POWER & FUEL Rs 186.74 Lakhs

Table 5.15: Estimation Fuel consumption

5.6.4 Wages

Particulars No. Wages P.M. Total Wages Wages P.A.Skilled Workers 15 Rs 9,000 Rs 135,000 Rs 1,620,000

Semiskilled Workers 12 Rs 8,000 Rs 96,000 Rs 1,152,000Unskilled Workers 20 Rs 6,000 Rs 120,000 Rs 1,440,000

Total 47 Rs 4,212,000Add: Fringe benefits @ 15% Rs 631,800

Total Wages P.A. Rs 4,843,800Or Say Rs 48.44 lakhs

Table 5.16: Wages calculation

5.6.5 Salaries

Particulars No. Salries P.M. Total Salary Salary P.A.Plant Manager 1 Rs 22,000 Rs 22,000 Rs 264,000

Supervisors 6 Rs 10,000 Rs 60,000 Rs 720,000Chemist & Storekeeper 3 Rs 8,000 Rs 24,000 Rs 288,000

Admn.Officer / Accounts 1 Rs 15,000 Rs 15,000 Rs 180,000Asst/Typist 3 Rs 10,000 Rs 30,000 Rs 360,000

Watchmen / Attenders 4 Rs 7,000 Rs 28,000 Rs 336,000Total 18 Rs 2,148,000

Add: Fringe benefits @ 15% Rs 322,200Total Salaries P.A. Rs 2,470,200

Or Say Rs 24.70 lakhs

Table 5.17: Salaries Estimation

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5.6.6 Provisions

Provisions Amount (Rs lakhs p.a)REPAIRS & MAINTENANCE 18.00TAXES AND INSURANCE 3.00MANAGEMENT REMUNERATION 12.00OTHER ADMINISTRATIVE EXPENSES 6.00MISCELLANEOUS EXPENSESFreightcharges for transportation of Kraft Paper(Rs. 300 per ton) 22.5Other Miscelleneous Expenses 6.00Total Miscellaneous Charges 6.00SELLING EXPENSES @2% on sales revenue 31.43

Table 5.18: Provisions

5.6.7 Sales Revenue

Product Quantity (TPA) Sale Price/ton Revenue (Rs lakhs)Kraft Paper 14 BF 3750 Rs 20,000 Rs 750.00Kraft Paper 16 BF 2250 Rs 21,500 Rs 483.75Kraft Paper 18 BF 1500 Rs 22,500 Rs 337.50

Total 7500 Rs 1,571.25

Table 5.19: Sales Revenue from finished products

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5.6.8 Assumptions

FINACIAL ASSUMPTIONS

RATE OF INT ON TERM LOANS 15.00% INT ON BANK BORROWINGS 14.00RATE OF INCOME TAX 30.90REPAYMENT PERIOD FOR T/L(PROP) 8.00MORATORIUM FOR TERM LOANS(PROP) 2.00

RATE OF DEPRECIATION : W.D.VBUILDINGS 10.00PLANT & MACHINERY 15.00FURNITURE 10.00VEHICLES 15.00OTHER ASSETS 25.00

OTHER ASSUMPTIONS

CAPACITY UTILISATIONFIRST YEAR 50%SECOND YEAR 55%THIRD YEAR 60%FOURTH YEAR ONWARDS 60%% INC IN REP & MAINT 10%INC IN SALARIES & WAGES 5% INC IN MANAGEMENT REMUNERATION 5% INC IN OTHER ADMN EXP 5% INC IN RENT,TAXES & INS 5OPTIMUM YEAR 3

Table 5.20: Assumptions

5.7 Break Even Analysis

The unit is expected to breakeven at 35% and cash breakeven at 23.03% of its installedcapacity. The breakeven calculations are based on company’s working results in the 3rdyear of operation which is optimum level of operation.

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5.8 Debt Service Coverage RatioThe average Debt Service Coverage Ratio comes out to 1.94 which is well above 1.55 andDSCR of no single individual year is less than 1 which is satisfactory.The maximum andminimum values of DSCR are 3.35 and 1.88.

5.9 Internal Rate of ReturnThe project’s IRR for a period of 15 years works out to 32.18% and is satisfactory. Theassumptions made are as under:

• Life of the project is assumed at 15 years

• The residual value of fixed assets at the end of 15th year is fixed at 5% of originalvalue and 100% for land

• The realization value of current assets is taken at 100%

5.10 Sensitivity AnalysisThe sensitivity analysis is done by increasing raw material cost by 5% and reducing thesales revenue by 5%. The details of DSCR, IRR and BEP on such changes are given below:

Parameter Normal 5% Increase in 5% Decrease inRaw Material Cost Sales Revenue

DSCR 1.94 1.6 1.42IRR 32.18% 25.49% 21.96%BEP 35% 41.54% 46.17%

Table 5.21: Sensitivity Analysis

From the above, it is observed that the unit is more sensitive when there is decrease insales revenue than increase in raw material costs.Normally, prices of finish goods dependson the cost of raw materials. Any increase/decrease in raw materials generally results in acorresponding change in prices of finished goods.

5.11 ConclusionRecommended to sanction a term loan of Rs.550 lakhs

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Chapter 6

Findings and Suggestions

6.1 Findings• APSFC is jointly promoted by SIDBI and Government of ANdhra Pradesh. APSFC,

an ISO 9001:2008 organization, offers a range of schemes for encouraging first gener-ation entrepreneurs in different sectors.

• As part of Promoter’ evaluation, the background of the promoter, his creditworthi-ness, experience, his past track record, etc are scrutinized. In fact a Due DiligenceReport is generated on the promoters before a final decision on funding the projectis done.

• Information required for promoters’ evaluation is collected from the place of opera-tions of projectby the branch officials who oversee the project

• The economic viability is verified on the basis of optimum year of operating capacityand cashflow, profitability statements and DSCR, IRR, BEP are calculated for 8years for evaluation

• The viability of project is verified by making sensitivity analysis by reducing the salesrevenue by 5% and increasing the raw material cost by 5%. The DSCR, BEP, IRRparticulars for both normal and above said changes are calculated and analyzed.

6.2 Suggestions• The corporation is providing many schemes for first generation entrepreneurs and

enjoying major share of term lending in promoting them. But there is still largeuntapped market for which the corporation needs to market those schemes in a widerange, so that this will motivate the uneducated first generation entrepreneurs.

• The corporation should reduce the collateral security requirements as it is difficultfor first generation entrepreneurs to provide high collateral security.

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• The appraisal teams need to update themselves to meet the changing technical andindustrial trends. They could be deputed to large industrial and trade fairs andseminars, etc to understand the dynamics of industry.

• In case of sick units, the corporation should try to know the reasons for sickness andimprove the mechanism to avoid sickness by focussing on these specific areas.

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List of Tables

4.1 Rating Nomenclature . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 374.2 Summary Score sheet . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 38

5.1 Operational capacity . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 405.2 Schedule of Implementation . . . . . . . . . . . . . . . . . . . . . . . . . . 415.3 Financial Indicators . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 415.4 CR . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 435.5 Promoters Background . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 445.6 Cost of the Scheme . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 475.7 Buildings . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 485.8 Deposits . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 485.9 PRELIMINARY & PRE-OPERATIVE. EXPENSES: . . . . . . . . . . . . 495.10 Working Capital Estimates . . . . . . . . . . . . . . . . . . . . . . . . . . . 495.11 Means of Finance . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 505.12 EOW . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 515.13 Raw Material Requirement . . . . . . . . . . . . . . . . . . . . . . . . . . . 515.14 Power Estimation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 515.15 Estimation Fuel consumption . . . . . . . . . . . . . . . . . . . . . . . . . 525.16 Wages calculation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 525.17 Salaries Estimation . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 525.18 Provisions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 535.19 Sales Revenue from finished products . . . . . . . . . . . . . . . . . . . . . 535.20 Assumptions . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 545.21 Sensitivity Analysis . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 55

59

Bibliography• Prasanna Chandra, "Projects:Planning, Analysis, Selection, Financing, Implementa-

tion and Review"

• I.M. Pandey, "Financial Management"

• Shahi Gupta & R.K. Sharma, "Financial Management Theory & Practice"

• The journal of Venture Capital

• www.wiley.co.uk