project mba sanjeev singh
TRANSCRIPT
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TYPES OF INFRASTRUCTURE PROJECTS
& THEIR FINANCING NEEDS (REFERENCEPUNJ LLOYD LIMITED).
BY
SANJEEV KUMAR SINGH
A DISSERTION/ THESIS SUBMITTED IN
PARTIAL FULFILLMENT OFTHE REQUIREMENTS FOR
MASTER OF BUSINESS ADMINISTRATION OF
S M U
MANIPAL
2 0 0 8
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THE DISSERTION / THESIS OF
SANJEEV KUMAR SINGH
TITLED
TYPES OF INFRASTRUCTURE PROJECTS& THEIR FINANCING NEEDS (REFERENCE
PUNJ LLOYD LIMITED).
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CERTIFICATE
THIS IS TO CERTIFY THAT THE PROJECT REPORT ENTITLED
TYPES OF INFRASTRUCTURE PROJECTS& THEIR FINANCING NEEDS (REFERENCE
PUNJ LLOYD LIMITED).
SUBMITTED IN PARTIAL FULFILLMENT OF THE REQUIREMENTSFOR THE DEGREE OF
MASTER OF BUSINESS ADMINISTRATION OFS M U
SANJEEV KUMAR SINGH
UNDER MY SUPERVISION AND GUIDANCE AND THAT NO PART OFTHIS REPORT HAS BEEN SUBMITTED FOR THE AWARD OF ANYOTHER DEGREE, DIPLOMA, FELLOWSHIP OR OTHER SIMILARTITLES OR PRIZES AND THAT THE WORK HAS NOT BEENPUBLISHED IN ANY JOURNAL OR MAGAZINE.
REGISTRATION NUMBER.:520623424
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STUDENT DECLARATION
I HEREBY DECLARE THAT THE PROJECT ENTITLED
TYPES OF INFRASTRUCTURE PROJECTS& THEIR FINANCING NEEDS (REFERENCE
PUNJ LLOYD LIMITED).
SUBMITTED IN PARTIAL FULFILLMENT OF THE
REQUIREMENTS FOR THE DEGREE OF
MASTER OF BUSINESS ADMINISTRATION
TO S M U IS MY ORIGINAL WORK AND NOT SUBMITTED FOR THE
AWARD OF ANY OTHER DEGREE, DIPLOMA, FELLOWSHIP OR
OTHER SIMILAR TITLE OR PRIZES.
PLACE: NEW DELHI SANJEEV KUMAR SINGH
DATE: REGN NO. : 520623424
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ACKNOWLEDGMENT
IAM MOST THANKFUL TO THE STUDY CENTER VAG
INFOTECH SOUTH EXTN. NEW DELHI FOR GIVING ME
SUCH A TOPIC. INFRASTRUCTURE FINANCE AS AN AREA
OF PROFESSION WAS NOT AS WIDELY PRACTICED A
DECADE AGO. SO, THIS AREA OF STUDY OFFERS AN
OPPORTUNITY ESPECIALLY IN THE POST LIBERALIZATION
ERA, TO EXPLORE THIS ENVIRONMENT. IAM GREATFULL
TO THE PERSONNEL AT PUNJ LLOYD LIMITED IN THE
FINANCE & ACCOUNTS, AND PROJECT PLANNING AND
INDUSTRIAL CIVIL STRATEGIC BUSINESS UNIT, FOR THE
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ALL ROUND SUPPORT AND MOTIVATION. I WOULD LIKE
TO SPECIALLY THANK,
FOR THEIR VALUABLE INSTRUCTIONS, GUIDANCE &
CONTINUOUS SUPPORT, MR PRAMOD MITTAL AGM (F&A),
Mr. AJAY GUATAM DGM (F&A), OF M/S PUNJ LLOYD LIMITED,
WITHOUT WHOM I WOULD HAVE DEVIATED FROM THE
MAIN SUBJECT.
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NATURE OF STUDY
THE TERM NATURE AS APPLIED TO PROJECT FINANCE REFERS
TO ITS RELATIONSHIP WITH THE CLOSELY RELATED FIELDS OF
ECONOMICS AND ACCOUNTING, ITS FUNCTIONS, SCOPE AND
OBJECTIVES. PROJECT FINANCE, AS AN ACADEMIC DISCIPLINE,
HAS UNDERGONE FUNDAMENTAL CHANGES AS REGARDS ITS
SCOPE AND COVERAGE. IN THE EARLY YEARS OF ITS EVOLUTION
IT WAS TREATED SYNONYMOUSLY WITH THE RAISING OF FUNDS.
IN THE CURRENT LITERATURE PERTAINING TO THIS GROWING
ACADEMIC DISCIPLINE, A BROADER SCOPE SO AS TO INCLUDE, IN
ADDITION TO PROCUREMENT OF FUNDS, EFFICIENT USE OF
RESOURCES IS UNIVERSALLY RECOGNISED. SIMILARLY, THE
ACADEMIC THINKING AS REGARDS THE OBJECTIVE OF PROJECT
FINANCE IS ALSO CHARACTERISED BY A CHANGE OVER THE
YEARS.
SCOPE OF PROJECT FINANCE
WHAT IS PROJECT FINANCE? WHAT ARE THE FIRMS OTHER
FINANCIAL ACTIVITIES? HOW ARE THEY RELATED TO THE FIRMS
OTHER ACTIVITIES / FUNCTIONS?
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THE APPROACH TO THE SCOPE AND FUNCTIONS OF PROJECT
FINANCE IS DIVIDED, FOR PURPOSES OF EXPOSITON, INTO TWO
BROAD CATEGORIES.
(1)TRADITIONAL APPROACH
(2)MODERN APPROACH
TRADITIONAL APPROACH
THE TRADITIONAL APPROACH TO THE ASPECTS OF PROJECT
FINANCE REFERS TO ITS SUBJECT MATTER IN THE ACADEMIC
LITERATURE IN THE INITIAL STAGES OF ITS EVOLUTION AS A
SEPARATE BRANCH OF ACADEMIC STUDY. THE TERM
CORPORATION FINANCE WAS USED TO DESCRIBE WHAT IS NOW
KNOWN IN THE ACADEMIC WORLD AS FINANCIAL
MANAGEMENT. AS THE NAME SUGGESTS, THE CONCERN OF
CORPORATION FINANCE WAS WITH THE FINANCING OF
CORPORATE ENTERPRISES. IN OTHER WORDS, THE SCOPE OF
FINANCE FUNCTION WAS TREATED BY THE TRADITIONAL
APPROACH IN THE NARROW SENSE OF PROCUREMENT OF
FUNDS BY CORPORATE ENTERPRISES TO MEET THEIR FINANCING
NEEDS. THE TERM PROCUREMENT WAS USED IN A BROAD
SENSE SO AS TO INCLUDE THE WHOLE GAMUT OF RAISING
FUNDS EXTERNALLY. THUS DEFINED, THE FIELD OF STUDY
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DEALING WITH FINANCE WAS TREATED AS ENCOMPASSING
THREE INTER-RELATED ASPECTS OF RAISING AND
ADMINISTERING RESOURCES FROM OUTSIDE: -
I. THE INSTITUTIONAL ARRANGEMENT IN THE FORM OF
FINANCIAL INSTITUTIONS WHICH COMPRISE THE
ORGANISATION OF THE CAPITAL MARKETS ALSO;
II. FINANCIAL INSTRUMENTS THROUGH WHICH FUNDS ARE
RAISED FROM THE CAPITAL MARKETS AND THE RELATED
ASPECTS OF PRACTICES AND THE PROCEDURAL ASPECTS
OF CAPITAL MARKETS; AND
III. THE LEGAL AND ACCOUNTING RELATIONSHIPS BETWEEN A
FIRM AND ITS SOURCES OF FUNDS. THE COVERAGE OF
CORPORATION FINANCE WAS, THEREFORE, CONCEIVED TO
DESCRIBE THE RAPIDLY EVOLVING COMPLEX OF CAPITAL
MARKET INSTITUTIONS, INSTRUMENTS AND PRACTICES. A
RELATED ASPECT WAS THAT FIRMS REQUIRE FUNDS AT
CERTAIN EPISODIC EVENTS SUCH AS MERGER,
LIQUIDATION, RE-ORGANISATION AND SO ON. A DETAILED
DESCRIPTION OF THESE MAJOR EVENTS CONSTITUTED THE
SECOND ELEMENT OF THE SCOPE OF THIS FIELD OF
ACADEMIC STUDY. THAT THESE WERE THE BROAD
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FEATURES OF THE SUBJECT MATTER OF CORPORATION
FINANCE IS ELOQUENTLY REFLECTED IN THE ACADEMIC
WRITINGS AROUND THE PERIOD DURING WHICH THE
TRADITIONAL APPROACH DOMINATED THE ACADEMIC
THINKING. THUS, THE ISSUES TO WHICH THE LITERATURE
ON FINANCE ADDRESSED ITSELF WAS HOW RESOURCES
COULD BEST BE RAISED FROM THE COMBINATION OF THE
AVAILABLE SOURCES.
THE TRADITIONAL APPROACH TO THE SCOPE OF THE FINANCE
FUNCTION EVOLVED DURING THE 1920S AND 1930S DOMINATED
THE ACADEMIC THINKING DURING THE FORTIES AND THROUGH
THE EARLY FIFTIES. IT HAS NOW BEEN DISCARDED AS IT
SUFFERS FROM SERIOUS LIMITATIONS. THE WEAKNESSES OF
THE TRADITIONAL APPROACH FALL INTO TWO BROAD
CATEGORIES:
1. THOSE RELATING TO THE TREATMENT OF VARIOUS TOPICS
AND THE EMPHASIS ATTACHED TO THEM;
2. THOSE RELATING TO THE BASIC CONCEPTUAL AND
ANALYTICAL FRAMEWORK OF THE DEFINITIONS AND SCOPE OF
THE FINANCE FUNCTION.
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AS REGARDS THE FIRST TYPE OF CRITICISM OF THE TRADITIONAL
APPROACH, THE EMPHASIS OF THE ACADEMIC LITERATURE ON
ISSUES RELATING TO THE PROCUREMENT OF FUNDS BY
CORPORATE ENTERPRISES WAS CHALLENGED DURING THE
PERIOD THE APPROACH DOMINATED THE SCENE ITSELF. THE
TRADITIONAL TREATMENT OF FINANCE WAS CRITICISED FOR THE
FOLLOWING REASONS.
SINCE THE FINANCE FUNCTION WAS EQUATED WITH THE ISSUES
INVOLVED IN RAISING AND ADMINISTERING FUNDS, THE THEME
WAS WOVEN AROUND THE VIEWPOINT OF THE SUPPLIERS OF
FUNDS SUCH AS INVESTORS, INVESTMENT BANKERS AND SO ON,
I.E. THE OUTSIDERS. IT IMPLIES THAT NO CONSIDERATION WAS
GIVEN TO THE VIEWPOINT OF THOSE WHO HAD TO TAKE
INTERNAL FINANCIAL DECISIONS. THE TRADITIONAL TREATMENT
WAS, IN OTHER WORDS, THE OUTSIDER-LOOKING-IN APPROACH.
THE LIMITATION WAS THAT INTERNAL DECISION-MAKING (I.E.
INSIDER-LOOKING-OUT) WAS COMPLETELY IGNORED.
THE SECOND GROUND OF CRITICISM OF THE TRADITIONAL
TREATMENT WAS THAT THE FOCUS WAS ON FINANCING
PROBLEMS OF CORPORATE ENTERPRISES. TO THAT EXTENT THE
SCOPE OF FINANCIAL MANAGEMENT WAS CONFINED ONLY TO A
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SEGMENT OF THE INDUSTRIAL ENTERPIESES, AS NON-
CORPORATE ORGANISATIONS LAY OUTSIDE ITS SCOPE.
YET ANOTHER BASIS ON WHICH THE TRADITIONAL APPROACH
WAS CHALLENGED WAS THAT THE TREATMENT WAS BUILT TOO
CLOSELY AROUND EPISODIC EVENTS, SUCH AS PROMOTION,
INCORPORATION, MERGER, CONSOLIDATION, REORGANISTATION
AND SO ON. FINANCIAL MANAGEMENT WAS CONFINED TO A
DESCRIPTION OF THESE INFREQUENT HAPPENINGS IN THE LIFE
OF AN ENTERPRISE. AS A LOGICAL COROLLARY, THE DAY-TO-DAY
FINANCIAL PROBLEMS OF A NORMAL COMPANY DID NOT RECEIVE
ANY ATTENTION.
FINALLY, THE TRADITIONAL TREATMENT WAS FOUND TO HAVE A
LACUNA TO THE EXTENT THE FOCUS WAS ON LONG-TERM
FINANCING. ITS NATURAL IMPLICATION WAS THAT THE ISSUES
INVOLVED IN WORKING CAPITAL MANAGEMENT WERE NOT IN THE
PURVIEW OF FINANCE FUNCTION.
THE LIMITATION OF THE TRADITIONAL APPROACH WAS,
HOWEVER, NOT ENTIRELY BASED ON TREATMENT OR EMPHASIS
OF DIFFERENT ASPECTS. IN OTHER WORDS, ITS WEAKNESSES
WERE MORE FUNDAMENTAL. THE CONCEPTUAL AND ANALYTICAL
SHORTCOMING OF THIS APPROACH AROSE FROM THE FACT THAT
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TO THE EXTENT IT CONFINED FINANCIAL MANAGEMENT TO
ISSUES INVOLVED IN PROCUREMENT OF EXTERNAL FUNDS, IT DID
NOT CONSIDER THE IMPORTANT DIMENSION OF ALLOCATION OF
CAPITAL. THE CONCEPTUAL FRAMEWORK OF THE TRADITIONAL
TREATMENT IGNORED WHAT SOLOMON APTLY DESCRIBES AS
THE CENTRAL ISSUES OF FINANCIAL MANAGEMENT.
THESE ARE:
SHOULD AN ENTERPRISE COMMIT CAPITAL FUNDS TO CERTAIN
PURPOSES?
DO THE EXPECTED RETURNS MEET FINANCIAL STANDARDS OF
PERFORMANCE?
HOW SHOULD THESE STANDARDS BE SET AND WHAT IS THE
COST OF CAPITAL FUNDS TO THE ENTERPRISE?
HOW DOES THE COST VARY WITH THE MIXTURE OF FINANCING
METHODS USED? IN THE ABSENCE OF THE COVERAGE OF THESE
CRUCIAL ASPECTS, THE TRADITIONAL APPROACH IMPLIED A
VERY NARROW SCOPE FOR FINANCIAL MANAGEMENT. THE
MODERN APPROACH PROVIDES A SOLUTION TO THESE
SHORTCOMINGS.
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MODERN APPROACH
THE MODERN APPROACH VIEWS THE TERM FINANCIAL
MANAGEMENT IN A BROAD SENSE AND PROVIDES A
CONCEPTUAL AND ANALYTICAL FRAMEWORK FOR FINANCIAL
DECISION-MAKING. ACCORDING TO IT, THE FINANCE FUNCTION
COVERS BOTH ACQUISITION OF FUNDS AS WELL AS THEIR
ALLOCATION. THUS, APART FROM THE ISSUES INVOLVED IN
ACQUIRING EXTERNAL FUNDS, THE MAIN CONCERN OF
FINANCIAL MANAGEMENT IS THE EFFICIENT AND WISE
ALLOCATION OF FUNDS TO VARIOUS USES. DEFINED IN A BROAD
SENSE, IT IS VIEWED AS AN INTEGRAL PART OF OVER-ALL
MANAGEMENT.
THE NEW APPROACH IS AN ANALYTICAL WAY OF VIEWING THE
FINANCIAL PROBLEMS OF A FIRM.
THE MAIN CONTENTS OF THIS APPROACH ARE:
WHAT IS THE TOTAL VOLUME OF FUNDS AN ENTERPRISE SHOULD
COMMIT?
WHAT SPECIFIC ASSETS SHOULD AN ENTERPRISE ACQUIRE?
HOW SHOULD THE FUNDS REQUIRED, BE FINANCED?
ALTERNATIVELY, THE PRINCIPAL CONTENTS OF THE MODERN
APPROACH TO FINANCIAL MANAGEMENT CAN BE SAID TO BE:
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1. HOW LARGE SHOULD AN ENTERPRISE BE AND HOW FAST
SHOULD IT GROW?
2. IN WHAT FORM SHOULD IT HOLD ASSETS?
3. WHAT SHOULD BE THE COMPOSITION OF ITS LIABILITIES?
THE THREE QUESTIONS POSED ABOVE COVER BETWEEN THEM
THE MAJOR FINANCIAL PROBLEMS OF A FIRM. IN OTHER WORDS,
FINANCIAL MANAGEMENT, ACCORDING TO THE NEW APPROACH,
IS CONCERNED WITH THE SOLUTION OF THREE MAJOR
PROBLEMS RELATING TO THE FINANCIAL OPERATIONS OF A FIRM,
CORRESPONDING TO THE THREE QUESTIONS, NAMELY,
INVESTMENT, FINANCING AND DIVIDEND DECISIONS. THUS,
FINANCIAL MANGEMENT, IN THE MODERN SENSE OF THE TERM,
CAN BE BROKEN DOWN INTO THREE MAJOR DECISIONS AS
FUNCTIONS OF FINANCE. THEY ARE: -
1. THE INVESTMENT DECISION,
2. THE FINANCING DECISION, AND
3. THE DIVIDEND POLICY DECISION.
WE BRIEFLY OUTLINE THE MAIN COMPONENTS OF THESE IN THE
FOLLOWING DISCUSSION.
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FUNCTIONS OF FINANCE
INVESTMENT DECISION
THE INVESTMENT DECISION RELATES TO THE SELECTION OF
ASSETS IN WHICH FUNDS WILL BE INVESTED BY A FIRM. THE
ASSETS WHICH CAN BE ACQUIRED FALL INTO TWO BROAD
GROUPS :-
1. LONG TERM ASSETS WHICH WILL YIELD A RETURN OVER A
PERIOD OF TIME IN FUTURE
2. SHORT TERM OR CURRENT ASSETS DEFINED AS THOSE
ASSETS WHICH IN THE NORMAL COURSE OF BUSINESS ARE
CONVERTIBLE INTO CASH USUALLY WITHIN A YEAR.
ACCORDINGLY, THE ASSET SELECTION DECISION OF A FIRM IS OF
TWO TYPES. THE FIRST OF THESE INVOLVING THE FIRST
CATEGORY OF ASSETS IS POPULARLY KNOWN IN THE FINANCIAL
LITERATURE AS CAPITAL BUDGETING. THE ASPECT OF FINANCIAL
DECISION-MAKING WITH REFERENCE TO CURRENT ASSETS OR
SHORT TERM ASSETS IS POPULARLY DESIGNATED AS WORKING
CAPITAL MANAGEMENT.
CAPITAL BUDGETING
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CAPITAL BUDGETING-THE LONG TERM INVESTMENT DECISION IS
PROBABLY THE MOST CRUCIAL FINANCIAL DECISION OF A FIRM.
IT RELATES TO THE SELECTION OF AN ASSET OR INVESTMENT
PROPOSAL OR COURSE OF ACTION WHOSE BENEFITS ARE LIKELY
TO BE AVAILABLE IN FUTURE OVER THE LIFE TIME OF THE
PROJECT. THE LONG TERM ASSETS CAN BE EITHER NEW OR
OLD / EXISTING ONES. THE FIRST ASPECT OF THE CAPITAL
BUDGETING DECISION RELATES TO THE CHOICE OF THE NEW
ASSET OUT OF THE ALTERNATIVES AVAILABLE OR THE RE-
ALLOCATION OF CAPITAL WHEN AN EXISTING ASSET FAILS TO
JUSTIFY THE FUNDS COMMITTED. WHETHER AN ASSET WILL BE
ACCEPTED OR NOT WILL DEPEND UPON THE RELATIVE BENEFITS
AND RETURNS ASSOCIATED WITH IT. THE MEASUREMENT OF THE
WORTH OF THE INVESTMENT PROPOSALS IS, THEREFORE, A
MAJOR ELEMENT IN THE CAPITAL BUDGETING EXERCISE. THIS
IMPLIES A DISCUSSION OF THE METHODS OF APPRAISING
INVESTMENT PROPOSALS.
THE SECOND ELEMENT OF THE CAPITAL BUDGETING DECISION IS
THE ANALYSIS OF RISK AND UNCERTAINTY. SINCE THE BENEFITS
FROM THE INVESTMENT PROPOSALS EXTEND INTO THE FUTURE,
THEIR ACCRUAL IS UNCERTAIN. THEY HAVE TO BE ESTIMATED
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UNDER VARIOUS ASSUMPTIONS OF THE PHYSICAL VOLUME OF
SALE AND THE LEVEL OF PRICES. AN ELEMENT OF RISK IN THE
SENSE OF UNCERTINITY OF FUTURE BENEFITS IS, THUS,
INVOLVED IN THE EXERCISE. THE RETURN FROM THE CAPITAL
BUDGETING DECISION SHOULD, THEREFORE, BE EVALUATED IN
RELATION TO THE RISK ASSOCIATED WITH IT.
FINALLY, THE EVALUATION OF THE WORTH OF A LONG-TERM
PROJECT IMPLIES A CERTAIN NORM OR STANDARD AGAINST
WHICH THE BENEFITS ARE TO BE JUDGED. THE REQUISITE NORM
IS KNOWN BY DIFFERENT NAMES SUCH AS CUT-OFF RATE,
HURDLE RATE, REQUIRED RATE, AND MINIMUM RATE OF RETURN
AND SO ON. THIS STANDARD IS BROADLY EXPRESSED IN TERMS
OF THE COST OF CAPITAL. THE CONCEPT AND MEASUREMENT OF
THE COST OF CAPITAL IS, THUS, ANOTHER MAJOR ASPECT OF
THE CAPITAL BUDGETING DECISION. IN BRIEF, THE MAIN
ELEMENTS OF THE CAPITAL BUDGETING DECISIONS ARE: -
1. THE TOTAL ASSETS AND THEIR COMPOSITION
2. THE BUSINESS RISK COMPLEXION OF THE FIRM, AND
3. CONCEPT AND MEASUREMENT OF THE COST OF CAPITAL
CAPITAL BUDGETING IS A COMPLEX PROCESS WHICH MAY BE
DIVIDED INTO FIVE BROAD PHASES:
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i. PLANNING: THE PLANNING PHASE IS CONCERNED WITH THE
ARTICULATION OF ITS BROAD INVESTMENT STRATEGY AND
THE GENERATION AND PRELIMINARY SCREENING OF PROJECT
PROPOSALS. THE INVESTMENT STRATEGY OF THE FIRM
DELINEATES THE BROAD AREAS OR TYPES OF INVESTMENTS
THE FIRM PLANS TO UNDERTAKE.
ii. ANALYSIS: THE FOCUS IS ON GATHERING, PREPARING, AND
SUMMARISING RELEVANT INFORMATION ABOUT VARIOUS
PROPOSALS WHICH ARE BEING CONSIDERED. BASED ON THE
INFORMATION DEVELOPED IN THIS ANALYSIS, THE STREAM OF
COST & BENEFITS ASSOCIATED WITH THE PROJECT CAN BE
DEFINED.
iii. SELECTION: THE PROJECTS ARE SELECTED ON SOME
SUITABLE BASIS FOR THEIR WORTHINES LIKE PAYBACK
PERIOD, ARR, NPV, IRR, BCR ETC. IN ORDER TO APPLY THE
APPRISAL CRITERIA CUT OFF VALUES ARE TO BE SPECIFIED,
LIKE (HURDLE RATE, TARGET RATE AND COST OF CAPITAL).
iv. IMPLEMENTATION: IT PASSES THROUGH SEVERAL STAGES,
NAMELY- PROJECT & ENGINEERING & DESIGNS, NEGOTIATION
& CONTRACTING, CONSTRUCTION, TRAINING, AND
COMMISSIONING.
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v. REWIEW: THIS PHASE SETS INTO MOTION AFTER THE
COMMISSIONING IS OVER. IT IS USEFUL IN THE FOLLOWING
WAYS,
IT THROWS LIGHT ON HOW REALISTIC WERE THE
ASSUMPTIONS UNDERLYING THE PROJECT,
IT PROVIDES A DOCUMENTED LOG OF EXPERIENCE
THAT IS HIGHLY VALUABLE IN FUTURE DECISION MAKING,
IT SUGGESTS CORRECTIVE ACTION TO BE TAKEN IN
THE LIGHT OF ACTUAL PERFORMANCE,
IT HELPS IN UNCOVERING JUDGEMENTAL BIASES,
IT INDUCES A DESIRED CAUTION AMONG PROJECT SPONSORS.
WORKING CAPTIAL MANAGEMENT
WORKING CAPITAL MANAGEMENT IS CONCERNED WITH THE
MANAGEMENT OF THE CURRENT ASSETS. IT IS AN IMPORTANT
AND INTEGRAL PART OF FINANCIAL MANAGEMENT AS SHORT
TERM SURVIVAL IS A PRE-REQUISITE TO LONG TERM SUCCESS.
ONE ASPECT OF THE WORKING CAPITAL MANAGEMENT IS THE
TRADE OFF BETWEEN PROFITABILITY AND RISK (LIQUIDITY) .
THERE IS A CONFLICT BETWEEN PROFITABILITY AND LIQUIDITY. IF
A FIRM DOES NOT HAVE ADEQUATE WORKING CAPITAL I.E. IT
DOES NOT INVEST SUFFICIENT FUNDS IN CURRENT ASSETS, IT
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MAY BECOME ILLIQUID AND CONSEQUENTLY MAY NOT HAVE THE
ABILITY TO MEET ITS CURRENT OBLIGATIONS AND THUS INVITE
THE RISK OF BANKRUPTCY. THE CURRENT ASSETS ARE TOO
LARGE, THE PROFITABILITY IS ADVERSELY AFFECTED. THE KEY
STRATEGIES AND CONSIDERATIONS IN ENSURING A TRADE-OFF
BETWEEN PROFITABILITY AND LIQUIDITY IS ONE MAJOR
DIMENSION OF WORKING CAPITAL MANAGEMENT. IN ADDITION,
THE INDIVIDUAL CURRENT ASSETS SHOULD BE EFFICIENTLY
MANAGED SO THAT NEITHER INADEQUATE NOR UNNECESSARY
FUNDS ARE LOCKED UP. TO SUMMARISE, THE MANAGEMENT OF
WORKING CAPITAL HAS TWO BASIC INGREDIENTS, NAMELY,
1. AN OVERVIEW OF WORKING CAPITAL MANAGEMENT AS A
WHOLE, AND
2. EFFICIENT MANAGEMENT OF THE INDIVIDUAL CURRENT
ASSETS SUCH AS CASH, RECEIVABLES AND INVENTORY.
FINANCING DECISION
THE SECOND MAJOR DECISION INVOLVED IN FINANCIAL
MANAGEMENT IS THE FINANCING DECISION. THE INVESTMENT
DECISION IS BROADLY CONCERNED WITH THE ASSET MIX OR THE
COMPOSITION OF THE ASSETS OF THE FIRM. THE CONCERN OF
THE FINANCING DECISION IS WITH THE FINANCING MIX OR
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CAPITAL STRUCTURE OR CAPITAL STRUCTURE OR LEVERAGE.
THE TERM CAPITAL STRUCTURE REFERS TO THE PROPORTION
OF DEBT AND EQUITY CAPITAL. THE FINANCING DECISION OF A
FIRM RELATES TO THE CHOICE OF THE PROPORTION OF THESE
SOURSES OF FINANCE THE INVESTMENT REQUIREMENTS. THESE
ARE TWO ASPECTS OF THE FINANCING DECISION.FIRST, THE
THEORY OF CAPITAL STRUCTURE WHICH SHOWS THE
THEORITICAL RELATIONSHIP BETWEEN THE EMPLOYMENT OF
DEBT AND THE RETURN TO THE SHAREHOLDERS AS ALSO THE
FINANCIAL RISK. A PROPER BALANCE BETWEEN DEBT AND
EQUITY TO ENSURE A TRADE-OFF BETWEEN RISK AND RETURN
TO THE SHAREHOLDERS IS NECESSARY. A CAPITAL STRUCTURE
WITH A REASONABLE PROPORTION OF DEBT AND
EQUITY CAPITAL IS CALLED THE OPTIMUM CAPITAL STRUCTURE.
THUS, ONE DEMENSION OF THE FINANCING DECISION IS: IS
THERE AN OPTIMUM CAPITAL STRUCUTE? IN WHAT PROPORTION
SHOULD FUNDS BE RAISED TO MAXIMISE THE RETURN TO THE
SHAREHOLDERS? THE SECOND ASPECT OF THE FINANCING
DECISION IS THE DETERMINATION OF AN APPROPRIATE CAPITAL
STRUCTURE, GIVEN THE FACTS OF A PARTICULAR CASE. THUS,
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THE FINANCING DECISION COVERS TWO INTER-RELATED
ASPECTS :
a) CAPITAL STRUCTURE THEORY, AND
b) CAPITAL STRUCTUE DECISION
DIVIDEND POLICY DECISION
THE THIRD MAJOR DECISION OF FINANCIAL MANAGEMENT IS THE
DECISION RELATING TO THE DIVIDEND POLICY. THE DIVIDEND
DECISION SHOULD BE ANALYSED IN THE RELATION TO THE
FINANCING DECISION OF A FIRM. TWO ALTERNATIVES ARE
AVAILABLE IN DEALING WITH THE PROFITS OF THE FIRM:THEY
CAN BE DISTRIBUTED TO THE SHAREHOLDERS IN THE FORM OF
DIVIDENDS OR THEY CAN BE RETAINED IN THE BUSINESS. ONE
SIGNIFICANT ELEMENT IN THE DIVIDEND DECISION IS,
THEREFORE, THE DIVIDEND PAY OUT RATIO, I.E WHAT
PROPORTION OF NET PROFITS SHOULD BE PAID OUT TO THE
SHAREHOLDERS. THE DECISION WILL DEPEND UPON THE
PREFERENCE OF THE SHAREHOLDERS AND INVESTMENT
OPPORTUNITIES AVAILABLE WITH IN THE FIRM. THE SECOND
MAJOR ASPECT OF THE DIVIDEND DECISION IS THE FACTORS
DETERMINING DIVIDEND POLICYOF A FIRM IN PRACTICE.
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TO SUMMARISE THE DISCUSSION OF THE SCOPE, FUNCTIONS
AND COVERAGE OF FINANCIAL MANAGEMENT, THE TRADITIONAL
APPROACH HAD A VERY NARROW PERCEPTION AND WAS DEVOID
OF AN INTEGRATED CONCEPTUAL AND ANALYTICAL
FRAMEWORK. IT HAS RIGHTLY BEEN DISCARDED IN THE
CURRENT ACADEMIC LITERATURE. THE MODERN APPROACH HAS
BROADENED THE SCOPE OF FINANCIAL MANAGEMENT WHICH
INVOLVES THE SOLUTION OF THREE MAJOR DECISIONS, NAMELY,
INVESTMENT, FINANCING AND DIVIDEND. THESE ARE INTER-
RELATED AND SHOULD BE JOINTLY TAKEN SO THAT FINANCIAL
DECISION MAKING IS OPTIMAL. THE CONCEPTUAL FRAMEWORK
FOR OPTIMUM FINANCIAL DECISIONS IS THE OBJECTIVE OF
FINANCIAL MANAGEMENT. IN OTHER WORDS, TO ENSURE
OPTIMUM DECISION IN RESPECT OF THESE THREE AREAS THEY
SHOULD BE RELATED TO THE OBJECTIVES OF FINANCIAL
MANAGEMENT WHICH ARE ELABORATED IN THE SUBSEQUENT
DISCUSSION.
OBJECTIVES OF FINANCIAL MANAGEMENT
THE PRECEDING DISCUSSIONS HAVE SHOWN THAT FINANCIAL
MANAGEMENT, AS AN ACADEMIC DISCIPLINE, IS CONCERNED
WITH DECISION-MAKING IN REGARD TO THE SIZE AND
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COMPOSITION OF ASSETS AND THE LEVEL AND STRUCTURE OF
FINANCI NG. TO MAKE WISE DECISIONS A CLEAR
UNDERSTANDING OF THE OBJECTIVES WHICH ARE SOUGHT TO
BE ACHIEVED IS NECESSARY. THE OBJECTIVE PROVIDES A
FRAMEWORK FOR OPTIMUM FINANCIAL DECISION-MAKING. IN
OTHER WORDS, THEY ARE CONCERNED WITH DESIGNING A
METHOD OF OPERATING THE INTERNAL INVESTMENT AND
FINANCING OF A FIRM. WE DISCUSS IN THIS SECTION THE
ALTERNATIVE APPROACHES IN THE FINANCIAL LITERATURE.
THERE ARE TWO WIDELY-DISCUSSED APPROACHES :-
1. PROFIT MAXIMISATION APPROACH, AND
2. WEALTH MAXIMISATION APPROACH.
IT SHOULD BE AT THE OUTSET NOTED THAT THE TERM
OBJECTIVE IS USED IN THE SENSE OF A GOAL OR DECISION
CRITERION FOR THE THREE DECISIONS INVOLVED IN FINANCIAL
MANAGEMENT. IT IMPLIES THAT WHAT IS RELEVANT IS NOT THE
OVER-ALL OBJECTIVE OR GOAL OF A BUSINESS BUT AN
OPERATIONALLY USEFUL CRITERION BY WHICH TO JUDGE A
SPECIFIC SET OF MUTUALLY INTER-RELATED BUSINESS
DECISIONS, NAMELY, INVESTMENT, FINANCING AND DIVIDEND
POLICY. THE SECOND POINT THAT SHOULD BE CLEARLY
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UNDERSTOOD IS THAT THE TERM OBJECTIVE PROVIDES A
NORMATIVE FRAMEWORK. THAT IS, THE FOCUS IN THE FINANCIAL
LITERATURE IS ON WHAT A FIRM SHOULD TRY TO ACHIEVE AND
ON POLICIES THAT SHOULD BE FOLLOWED IF CERTAIN GOALS
ARE TO BE ACHIEVED. THE IMPLICATION IS THAT THESE ARE NOT
NECESSARILY FOLLOWED BY FIRMS IN ACTUAL PRACTICE.
RATHER THEY ARE INTENDED TO SERVE AS A BASIS FOR
THEORETICAL ANALYSIS AND DO NOT REFLECT COMTEMPORARY
EMPIRICAL INDUSTRY PRACTICES. THUS, THE TERM IS USED IN A
RATHER NARROW SENSE OF WHAT A FIRM SHOULD ATTEMPT TO
ACHIEVE WITH ITS INVESTMENT, FINANCING AND DIVIDEND
POLICY DECISION.
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BACKGROUND & ASPECT OF THE PROBLEMS
FINANCING OF INFRASTRUCTURE
INFRASTRUCTURE IN A COUNTRY MEANS THE EDIFICE ON WHICH
THE FOUNDATION OF THE CIVILIZATION OF THE COUNTRY
MOSTLY DEPENDS, IT GENERALLY INCLUDES THE FOLLOWING:-
(a)PUBLIC WORKS LIKE ROADS, DAMS, IRRIGATION AND
DRAINAGE SYSTEMS;
(b)TRANSPORT SYSTEMS LIKE RAILWAYS, AIRPORTS, URBAN
TRANSPORTS, PORTS ETC.;
(c)OTHER PUBLIC UTILITIES WHICH INCLUDE POWER,
TELECOMMUNICATION, WATER SUPPLY, SANITATION AND
SEWERAGE, OIL & GAS FACILITIES.
FROM THE FIRST FIVE YEAR PLAN ITSELF GOVERNMENT TOOK
OVER THE RESPONSIBILITY OF FOUNDING THE ABOVE FACILITIES
VIA DIFFERENT ANNUAL BUDGETS. IT IS ONLY AFTER THE
PROCESS OF LIBERALISATION STARTED IN 1991 THAT THE
DISCUSSION ON FUNDING ABILITY/ADEQUACY / FEASIBILITY ON
THE PART OF THE GOVERNMENT HAVE STARTED.
THOUGH LATE, GOVERNMENT HAS UNDERSTOOD CLEARLY THAT
FIRSTLY, IT MAY NOT BE POSSIBLE ON ITS PART TO SHOULDER
THE WHOLE RESPONSIBILITY OF FINANCING THE
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INFRASTRUCTURE ANY MORE AND SECONDLY, THE PACE WITH
WHICH SUCH DIFFERENT PROJECTS AND INFRASTRUCTURAL
DEVELOPMENTS ARE GOING ON, THE RAPID INDUSTRIAL
DEVELOPMENT PROCESS IS BOUND TO SUFFER. ACCORDINGLY,
THE GOVERNMENT HAS OPENED THESE INFRASTRUCTURAL
AREAS FOR INVESTMENT BY PRIVATE SECTOR BY DRASTICALLY
CHANGING THE INDUSTRIAL POLICIES FROM TIME TO TIME WHICH
WERE SO LONG KEPT STRICTLY UNDER ITS OWN DOMAIN.
THE QUANTUM OF FUNDS REQUIRED IN DEVELOPMENT OF
INFRASTRUCTURE FOR RAPID INDUSTRIALISATION KNOWN, IT
WILL BE APPARENT AS TO WHY GOVERNMENT IS SO KEEN IN OFF
LOADING ITS RESPONSIBILITY TO THE PRIVATE INDUSTRIALISTS.
IN POWER GENERATION ALONE, THE COUNTRY NEEDS RS.30,000
CRORES EVERY YEARS AND IF WE ADD TRANSMISSION AND
DISTRIBUTION SYSTEMS TO IT THAT WILL NEED ANOTHER
RS.60,000 CRORES. ADDED TO IT, THE REQUIREMENTS OF
ROADS, TELECOM SECTOR, DAMS, IRRIGATION, PORTS,
RAILWAYS, AIRPORTS, URBAN TRANSPORT, WATER SUPPLY ETC.
THE QUANTUM OF INVESTMENT REQUIRED WILL BE
PHENOMENAL. THUS, BETTER LATE THAN NEVER APPROACH BY
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GOVERNMENT HAS BEEN WELCOMED BY ALL CONCERNED.
OBVIOUSLY, IT WILL NOT ONLY SHIFT FROM GOVERNMENT THE
CAUSE FOR CONCERN OF AVAILABILITY OF FUNDS BUT IT WILL
ALSO ENSURE COMPLETION OF NUMBER OF INFRASTRUCTURAL
PROJECTS EITHER WITHOUT ANY COST OF TIME OVERRUN OR
WITH MINIMUM OF BOTH IF AT ALL.
THE PRIVATE INVESTOR IN INFRASTRUCTURE GENERALLY TAKE
INTO ACCOUNT THE FOLLOWING RISKS AND IS AWARE THAT THE
ALLOCATION OF RISK IS VITAL FOR THE SUCCESS OF SUCH
PROJECTS. THE RISKS CAN BE GROUPED AS:-
(a) POLITICAL RISKS LEADING TO THE NEGATIVE DEVELOPMENT
IN GOVT. POLICIES AND CHANGE OF OUTLOOK OF THE NEW
GOVT. TOWARDS THE PROJECT. THE CASE OF RECENT
DEVELOPMENT OF THE CHANGE OF ATTITUDE OF THE GOVT.
IN MAHARASHTRA TOWARDS DABHOL PROJECT CAN BE CITED
AS AN EXAMPLE AND IS KNOWN TO ALL AND SUNDRY. THUS,
THE PRIVATE INVESTOR WILL TRY TO GUARD AGAINST SUCH
RISKS BY ALLOCATING THE RISKS TO INSURANCE COMPANY
WHO GENERALLY COVER SUCH INTERNATIONAL POLITICAL
RISKS.
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(b) THERE ARE ALSO RISKS RELATING TO OPERATIONS. THESE
RELATE TO RISKS OF OVERRUN OF COST OF PRODUCTION ON
COMPLETION OF THE PROJECT.
(c) SIMILARLY, THERE MAY BE RISKS WHILE COMPLETING THE
PROJECT. SUCH RISKS RELATE TO TIME AND COST OVERRUN
DURING PROJECT EXECUTION. SUCH RISKS ARE VERY
COMMON AND MAY BE DUE TO EXTERNAL AND INTERNAL
PARAMETERS ARISING DURING THE CONTINUATION OF THE
PROJECT.
(d) THERE MAY BE RISKS RELATING TO FLUCTUATIONS IN THE
INTEREST RATES. SUCH CASES MAY HAPPEN WHERE THERE
IS AN OPEN ECONOMY WHERE INTEREST RATES ARE
ALLOWED TO PLAY THEIR ROLE AND EXPECTED TO GET
STABILISED DURING THE COURTS OF TIME BY INTERACTION
OF MARKET FORCES.
(e) THERE MAY ALSO BE RISKS ARISING OUT OF CHANGE IN
DEMAND OF THE SERVICES/COMMODITY DURING THE YEARS
TO COME. THE BASIS OF DEMAND ON WHICH THE EDIFICE OF
THE PROJECT DEPENDS MAY COMPLETELY ALTER BECAUSE
OF THE UNCERTAINTY IN THE PROJECTED DEMAND FOR THE
CONCERNED SERVICE.
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IT IS FOR THE AFORESAID RISKS THAT DIFFERENT MECHANISMS
HAVE BEEN DEVISED BY PRIVATE SECTOR WHILE PARTICIPATING
IN INFRASTRUCTURE PROJECT. THEY ARE OUTLINED IN THE
FOLLOWING PARAGRAPHS:-
1. BOLT (BUILD, OPERATE, LEASE, TRANSFER)
IN THIS CASE, THE PRIVATE PARTICIPANTS BUILD AND RUN
THE FACILITY AND THE SAME IS SUBSEQUENTLY HANDED
OVER TO GOVERNMENT ON THE BASIS OF LEASE AGREEMENT.
THIS IS DONE AT THE END OF THE CONCESSIONAL PERIOD
WHICH IS MORE OR LESS PREFIXED DEPENDING ON THE
NATURE OF THE INFRASTRUCTURAL PROJECT. ON
COMPLETION OF SUCH PERIOD, THE CONCERNED ASSET
CREATED OUT OF COMPLETION OF THE PROJECT IS HANDED
OVER TO THE GOVERNMENT. HERE THE CONCERNED PRIVATE
COMPANY/INVESTOR SUBSEQUENTLY GETS THE LEASE
RENTAL FROM THE GOVERNMENT WHICH HELPS IT TO GET A
STEADY CASH FLOW. BUT THE PROBLEM IN SUCH CASES IS
THAT AS THINGS STAND TODAY THE LEASE RENTAL PAYMENT
ON THE PART OF THE GOVERNMENT ARE VERY UNSTEADY
AND THIS INTERRUPTS THE CASH FLOW OF THE CONCERNED
INVESTOR.
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2. BOT (BUILD, OPERATE, TRANSFER)
THE PRIVATE INVESTOR IN THIS CASE EXECUTES THE
PROJECT, RUNS IT AND THEN TRANSFER THE FACILITY AT THE
END OF THE CONCESSIONAL PERIOD TO THE GOVERNMENT.
IN SUCH CASE, THE RISKS ARE SHARED BY ALL THE
CONCERNED PARTICIPANTS INCLUDING THE GOVERNMENT.
WHILE THE RISK IS RESTRICTED TO ALL PARTIES
PROPORTIONATELY, THE GREY ASPECT OF THIS METHOD IS
THE ENERGY AND COST INVOLVED IN NEGOTIATING THE
ARRANGEMENT MUTUALLY BETWEEN THE PARTIES, THE
SEQUENCE OF THE CLAIMS ON THE CONCERNED ASSETS AND
COMPLEXITIES OF THE TOTAL DEAL ULTIMATELY MAY
FRUSTRATE THE PARTICIPANT IN CERTAIN CASES. HOWEVER,
THIS METHOD GUARDS AGAINST THE LIKELY RISK IN SUCH
MAJOR PROJECTS.
3. BOOT (BUILD, OWN, OPERATE, TRANSFER)
THE CONCERNED PARTICIPANT OF THE PRIVATE SECTOR ON
COMPLETION OF THE PROJECT OWNS AND OPERATES THE
ASSETS FOR A DEFINED PERIOD WHEN IT IS HANDED OVER TO
THE GOVERNMENT. BUT THE PERIODS UPTO WHICH IT
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OPERATES ARE GENERALLY VERY HIGH AND MAY EXTEND
SOMETIME AS HIGH AS 40 YEARS ONWARDS. OBVIOUSLY, THIS
DEPENDS ON THE RELATIVE PAY BACK TIME AND THE RATE OF
RETURN THAT MAY ARISE OUT OF THE INVESTMENT.
4. BOO (BUILD, OWN, OPERATE)
IN SUCH CASE, THE CONCERNED PRIVATE
COMPANIES/INVESTORS EXECUTE THE PROJECT, OWN IT AND
OPERATE THE INFRASTRUCTURAL ASSETS FOR THE WHOLE
LIFE. SINCE IN SUCH CASES THE INVESTORS ARE THE SOLE
HOLDERS AND OPERATORS OF THE ASSETS, NO HASSLES OF
NEGOTIATIONS AND AGREEMENTS COME IN THE WAY.
OBVIOUSLY, THE INVESTOR CAN ARRANGE LOAN BY
HYPOTHECATING THE ASSETS TO THE FINANCIAL
INSTITUTIONS/BANKERS. THE PROBLEM IN THIS METHOD IS
THAT ALL THE RISKS ARISING OUT OF THE PROJECTS ARE
BEING SHOULDERED BY THE INVESTOR HIMSELF AND
POLITICALLY IT IS MOST RISK ORIENTED.
AMONG THE INFRASTRUCTURE PROJECTS, PROBABLY POWER
SECTOR GOT THE GOVERNMENTAL NOD OF PRIVATE
INVESTMENT EARLIER THAN OTHER SECTORS. ACTUALLY, A
LOT OF HEADWAY HAS BEEN MADE BY DIFFERENT PRIVATE
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COMPANIES IN POWER SECTOR THAN OTHER SECTORS. IN A
UMBER OF SECTORS LIKE HIGH-WAYS, DAM, BRIDGE ETC.
STILL POLICY FORMULATION ON PRIVATE SECTOR
INVESTMENT IS ON THE WAY. ACCORDINGLY, THE REST OF
THE DISCUSSION MOSTLY ON POWER SECTOR EXPERIENCE IN
THE NEXT FEW PARAS.
INVESTMENT IN POWER PROJECTS:-
THOUGH A NUMBER OF MOUS HAVE BEEN SIGNED, TILL DATE IN
INDIA FOLLOWING FAST TRACK POWER PROJECTS HAVE BEEN
CONTEMPLATED AND IN SOME CASES CERTAIN PROGRESS IN
THE PROJECTS HAVE ALSO BEEN MADE. HOWEVER, BECAUSE OF
ENRON CONTROVERSY MOST POWER PROJECTS ARE GOING
THROUGH FURTHER NEGOTIATIONS IN CAPITAL COST AND RATE
OF PURCHASE OF POWER PER UNIT.
THE GOVERNMENT OF INDIA HAS DEVISED AND IMPLEMENTED
POWER POLICIES WHICH ARE CONDUCIVE TO PRIVATE SECTOR
INVESTMENT IN THE POWER PROJECTS. THEY ARE OUTLINED
BELOW:-
1. COMPANIES WHICH WILL COME FOR POWER GENERATION AND
DISTRIBUTION FOR THE FIRST TIME WILL BE ENTITLED TO FIVE-
YEAR TAX HOLIDAY.
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2. CUSTOM DUTY ON EQUIPMENTS OF POWER WHICH ARE BEING
IMPORTED HAS BEEN REDUCED TO 20 PER CENT.
3. THE ORIGINAL COST OF THE POWER PROJECT WILL BE
ALLOWED TO INCLUDE CAPITALISATION OF INTEREST
CHARGES DURING THE GESTATION PERIOD (MOSTLY
BETWEEN THE PERIOD OF GRANTING OR LICENCE AND
COMMISSIONING OF THE PROJECT). THIS PRINCIPLE IS
APPLICABLE BOTH FOR NEW GENERATION PROJECT AND ALSO
FOR PROJECT OF EXPANSION.
4. THE RATES OF DEPRECIATION OF PLANT AND MACHINERY
HAVE BEEN LIBERALISED TO INCLUDE HIGHER RATES.
5. FOREIGN INVESTORS WILL BE ALLOWED TO REMIT TO
HOMELAND DIVIDENDS AND INTEREST ON THEIR EQUITY AND
LOAN COMPONENTS IN POWER PROJECTS.
6. A MINIMUM RATE OF RETURN OF 16 PER CENT ON EQUITY
(POST TAX) IS GUARANTEED BASED ON A OPERATING PLAN
LOAD FACTOR (PLF) OF 68.5 PER CENT. BEYOND THIS PLF,
INCREMENTAL RETURN ON EQUITY WILL BE ALLOWED TO
PRIVATE INVESTOR.
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7. WITH THE PERMISSION OF THE CONCERNED STATE
GOVERNMENT, THE PRIVATE DEVELOPER OF POWER CAN
DISPOSE OF POWER TO OTHERS.
8. FOREIGN PRIVATE DEVELOPERS WILL BE ALLOWED TO
PARTICIPATE IN EQUITY OF POWER GENERATING COMPANIES.
THE PRIVATE INVESTORS PREFER BOT(BUILD, OWN AND
TRANSFER) PROJECT. THE MAIN PARTIES INVOLVED IN SUCH
PROJECT ARE THE SPONSOR OF THE PROJECT, THE CONCERNED
BANK/FI/FII, THE CONSTRUCTION/OPERATION/MAINTENANCE
CONTRACTOR AND THE CONCERNED GOVERNMENT (STATE OR
CENTRE) AND THE TASK FORCE, IF ANY, SET UP FOR THE
PROJECT.
THE STRUCTURING OF DEBT AND EQUITY IS A CRUCIAL ASPECT
IN FUNDING OF ANY INFRASTRUCTURE PROJECT. GENERALLY,
SUCH STRUCTURING ROTATES ROUND AS LOW EQUITY AS
POSSIBLE SINCE THE SPONSOR TO THE PROJECT MAY NOT LIKE
OTHER LENDERS TO HAVE RECOURSE TO THE ASSETS OF THE
PROJECT. BESIDES, PUBLIC ISSUE OF SHARES IN AN
INFRASTRUCTURE PROJECT HAVING A GESTATION PERIOD OF 5
YEARS OR MORE MAY NOT EVOKE WARM RESPONSE LIKE THE
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ONE HAVING SHORT GESTATION PERIOD. UNLESS THE TOTAL
ATTITUDE OF THE GENERAL INVESTORS CHANGE OR THERE
EVOLVES SPECIAL TAX CONCESSION FOR INVESTMENT IN PUBLIC
ISSUE IN RESPECT OF PROJECTS WITH LONG GESTATION
PERIOD, THE SITUATION IS LIKELY TO CONTINUE. BESIDES,
GOING BY A DEBT RATIO OF 4:1, IF THE TOTAL REQUIREMENT OF
FUND IN INFRASTRUCTURE PROJECT AS PLANNED INCLUDING
REQUIREMENT OF TELECOMMUNICATION IS RS.5650 BILLION
(CMIF REPORT OF MAY 1995), THE REQUIREMENT OF EQUITY WILL
BE AROUND RS.1400 BILLION WHICH IS LIKELY TO BE ONE-THIRD
OF MARKET CAPITALISATION IN THE MAJOR STOCK MARKETS OF
THE COUNTRY. ACCORDINGLY, ARRANGING SO MUCH FUND
FORM EQUITY WILL BE DIFFICULT. ON THE DEBT FINANCING SIDE,
THE SOURCING OF LEFT OVER AMOUNT OF RS.4250 BILLION WILL
BE MORE DIFFICULT. ON CASE TO CASE BASIS, SOURCING OF
FUND FROM WITHIN THE COUNTRY MAY BE POSSIBLE IN CERTAIN
CASES. BUT LOOKING AT OVERALL SITUATION, IT MAY SOUND
IMPOSSIBLE. THUS, A MIX OF SOURCES BOTH IN AND OUTSIDE
THE COUNTRY IS INEVITABLE. TAPPING DEBIT FROM OVERSEAS
EXPORT CREDIT AGENCIES MAY RESULT IN LOWER RATE OF
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INTEREST IF PUT TO AGAINST A REASONABLY STABLE RATE OF
EXCHANGE OF FOREIGN CURRENCIES.
LOOKING FROM A DIFFERENT ANGLE, THERE ARE TWO POTS OF
HUGE FUND WAITING IN THE WINGS WHICH CANNOT BE RAPPED
FOR LEGISLATIVE RESTRICTIONS. THEY ARE FUNDS FROM LIC &
PFS. IF RESTRICTIONS ARE UNTIED, THEY WILL GO A LONG WAY
IN FILLING UP A MAJOR GAP BETWEEN DEMAND AND SUPPLY OF
FUNDS FROM INFRASTRUCTURE PROJECTS.
RECENTLY, FOR SOLVING THE FUNDING PROBLEM IN SUCH
PROJECT, FOUR TO FIVE INSTITUTIONS BOTH FROM PRIVATE AND
PUBLIC SECTORS HAVE JOINED HANDS. THESE HAVE BEEN SO IN
RECENT POWER PROJECTS, OIL REFINERY PROJECTS AND OIL
PIPELINE PROJECTS AND ROAD PROJECTS. THE REQUIREMENTS
FOR FUND IN INFRASTRUCTURE PROJECTS IS ON THE RISE AT A
STEEP RATE. WITH THE OPENING UP OF MORE AND MORE AREAS
FOR PRIVATE SECTOR INVESTMENT THE GOVERNMENT IS BOUND
TO MAKE A LOT OF LEGISLATIVE AMENDMENTS IN TERMS OF TAX
CONCESSIONS, RELAXATION OF NORMS OF BANK AND FINANCIAL
INSTITUTIONS REGARDING THE QUANTUM OF INVESTMENT IN
ANY SECTOR AND OTHER RELEVANT CHANGES. OTHERWISE IT
WILL BE LIKE PUTTING THE HORSE BEFORE THE CART
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SITUATION AND THE VERY PURPOSE OF LIBERALISATION WILL BE
DEFEATED IN ABSENCE OF FUND.
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PROJECT FINANCING
PROJECT FINANCING REFERS TO THE MEANS OF FINANCE
EMPLOYED FOR MEETING THE COST OF PROJECT. IN THIS
CHAPTER, WE WILL LOOK AT THE MEANS OF FINANCE AVAILABLE
IN INDIA AND THE KEY CONSIDERATIONS RELEVANT IN PLANNING
THE CAPITAL STRUCTURE FOR A NEW PROJECT . THIS APPENDIX
EXAMINES THIS ISSUE IN GREATER DETAIL. IT IS ORGANISED AS
FOLLOWS :
MEANS OF FINANCE
THE LONG-TERM SOURCES OF FINANCE USED FOR MEETING THE
COST OF PROJECT ARE REFERRED TO AS THE MEANS OF
FINANCE . TO MEET THE COST OF PROJECT, THE FOLLOWING
SOURCES OF FINANCE MAY BE AVAILABLE:
1. EQUITY CAPITAL
2. PREFERENCE CAPITAL
3. NON CONVERTIBLE DEBENTURES
4. CONVERTIBLE DEBENTURES
5. RUPEE TERM LOANS
6. FOREIGN CURRENCY TERM LOANS
7. EUROISSUES
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8. DEFERRED CREDIT
9. BILL REDISCOUNTING SCHEME
10. SUPPLIERS LINE OF CREDIT
11. SEED CAPITAL ASSISTANCE
12. GOVERNMENT SUBSIDIES
13. SALES TAX DEFERMENT AND EXEMPTION
14. UNSECURED LOANS AND DEPOSITS
15. LEASE AND HIRE PURCHASE FINANCE
EQUITY CAPITAL
THIS IS THE CONTRIBUTION MADE BY THE OWNERS OF
BUSINESS , THE EQUITY SHAREHOLDERS, WHO ENJOY THE
REWARDS AND BEAR THE RISKS OF OWNERSHIP. HOWEVER,
THEIR LIABILITY IS LIMITED TO THEIR CAPITAL CONTRIBUTION.
FROM THE POINT OF VIEW OF THE ISSUING FIRM, EQUITY
CAPITAL OFFERS TWO IMPORTANT ADVANTAGES (I) IT
REPRESENTS PERMANENT CAPITAL. HENCE THERE IS NO
LIABILITY FOR REPAYMENT (II) IT DOES NOT INVOLVE ANY FIXED
OBLIGATION FOR PAYMENT OF DIVIDENDS. THE DISADVANTAGES
OF RAISING FUNDS BY WAY OF EQUITY CAPITAL ARE (I) THE COST
OF EQUITY CAPITAL IS HIGH BECAUSE EQUITY DIVIDENDS ARE
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NOT TAX-DEDUCTIBLE EXPENSES. (II) THE COST OF ISSUING
EQUITY CAPITAL IS HIGH.
PREFERENCE CAPITAL
A HYBRID FORM OF FINANCING , PREFERENCE CAPITAL
PARTAKES SOME CHARACTERISTICS OF EQUITY CAPITAL AND
SOME ATTRIBUTES OF DEBT CAPITAL. IT IS SIMILAR TO EQUITY
CAPITAL BECAUSE PREFERENCE DIVIDEND, LIKE EQUITY
DIVIDEND, IS NOT A TAX-DEDUCTIBLE PAYMENT. IT RESEMBLES
BEBT CAPITAL BECAUSE THE RATE OF PREFERENCE FIVIDEND IS
FIXED. TYPICALLY , WHEN PREFERENCE DIVIDENED IS SKIPPED IT
IS PAYABLE IN FUTURE BECAUSE OF THE CUMULATIVE FEATURE
ASSOCIATED WITH IT THE NEAR FIXITY OF PREFERENCE
FIVIDEND PAYMENT RENDERS PREFERENCE CAPITAL SOMEWHAT
UNATTRACTIVE IN GENERAL AS A SOURCE OF FINANCE. IT IS ,
HOWEVER , ATTRACTIVE WHEN THE PROMOTERS DO NOT WANT
A REDUCTION IN THEIR SHARE OF EQUITY AND YET THERE IS
NEED FOR WIDENING THE NET WORTH BASE (NET WORTH
CONSISTS OF EQUITY AND PREFERENCE CAPITAL) TO SATISFY
THE REQUIREMENTS OF FINANCIAL INSTITUTIONS. IN ADDITION
TO THE CONVENTIONAL PREFERENCE SHARES, A COMPANY MAY
ISSUE CUMULATIVE CONVERTIBLE PREFERENCE SHARES
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(CCPS).THESE SHARES CARRY A DIVIDEND RATE OF 10 PER CENT
(WHICH , IF UNPAID, CUMULATES) AND ARE COMPULSORILY
CONVERTIBLE INTO EQUITY SHARES BETWEEN THREE AND FIVE
YEARS FROM THE DATE OF ISSUE.
DEBENTURE CAPITAL
IN THE LAST FEW YEARS, DEBENTURE CAPITAL HAS EMERGED AS
AN IMPORTANT SOURCE FOR PROJECT FINANCING . THERE ARE
THREE TYPES OF DEBENTURES THAT ARE COMMONLY USED IN
INDIA: NON CONVERTIBLE DEBENTURES (NCDS), PARTIALLY
CONVERTIBLE DEBENTURES(PCDS), AND FULLY CONVETIBLE
DEBENTURES (FCDS).AKIN TO PROMISSORY, NCDS ARE USED BY
COMPANIES FOR RAISING DEBT THAT IS GENERALLY RETIRED
OVER A PERIOD OF 5 TO 10 YEARS. THEY ARE SECURED BY A
CHARGE ON THE ASSETS OF THE ISSUING COMPANY. PCDS ARE
PARTLY CONVERTIBLE INTO EQUITY SHARES AS PER PRE
DETERMINED TERMS OF CONVERSION . THE UNCONVERTED
PORTION OF PCDS REMAINS LIKE NCD. FCDS, AS THE NAME
IMPLIES , ARE CONVERTED WHOLLY INTO EQUITY SHARES AS
PER PRE DETERMINED TERMS OF CONVERSION. HENCE FCDS
MAY BE REGARDED AS DELAYED EQUITY INSTRUMENTS.
RUPEE TERM LOAN
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PROVIDED BY FINANCIAL INSTITUTIONS ASN COMMERCIAL
BANKS, RUPEE TERM LOANS WHICH REPRESENT SECURED
BORROWINGS ARE A VERY IMPORTANT SOURCE FOR FINANCING
NEW PROJECTS AS WELL AS EXPANSION, MODERNISATION , AND
RENOVATION SCHEMES OF EXISTING UNITS. THESE LOANS ARE
GENERALLY REPAYABLE OVER A PERIOD OF 8-10 YEARS WHICH
INCLUDES A MORATORIUM PERIOD OF 1-3 YEARS.
FOREIGN CURRENCY TERMS LOANS
FINANCIAL INSTITUTIONS PROVIDE FOREIGN CURRENCY TERM
LOANS FOR MEETING THE FOREIGN CURRENCY EXPENDITURES
TOWARDS IMPORT OF PLANT , MACHINERY, AND EQUIPMENT AND
ALSO TOWARDS PAYMENT OF FOREIGN TECHNICAL KNOW HOW
FEES. UNDER THE GENERAL SCHEME, THE PERIODICAL LIABILITY
TOWARDS INTEREST AND PRINCIPAL REMAINS IN THE CURRENCY
/ CURRENCIES OF THE LOAN/S AND IS TRANSLATED INTO RUPEES
AT THE THEN PREVAILING RATE OF EXCHANGE FOR MAKING
PAYMENTS TO THE FINANCIAL INSTITUTION . APART FROM
APPROACHING FINANCIAL INSTITUTIONS (WHICH TYPICALLY
SERVE AS INTERMEDIARIES BETWEEN FOREIGN AGENCIES AND
INDIAN BORROWERS), COMPANIES CAN DIRECTLY OBTAIN
FOREIGN CURRENCY LOANS FROM INTERNATIONAL LENDERS.
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MORE AND MORE COMPANIES APPEAR TO BE DOING SO
PRESENTLY.
EUROISSUES
BEGINNING WITH RELIANCE INDUSTRIESGLOBAL DEPOSITORY
RECEIPTS ISSUE OF APPROXIMATELY $150ML IN MAY 1992, A
NUMBER OF COMPANIES HAVE BEEN MAKING EUROISSUES. THEY
HAVE EMPLOYED TWO TYPES OF SECURITIES : GLOBAL
DEPOSITORY RECEIPTS (GDRS) AND EUROCONVERTIBLE BONDS
(ECBS).
DENOMINATED IN US DOLLORS, A GDR IS A NEGOTIBALE
CERTIFICATE THAT REPRESENTS THE PUBLICLY TRADED LOCAL
CURRENCY (INDIAN RUPEE) EQUITY SHARES OF A NON US
(INDIAN) COMPANY. (OFCOURSE, IN THEORY, A GDR MAY
REPRESENT A DEBT SECURITY ; IN PRACTICE IT RARELY DOES
SO.) GDRS ARE ISSUED BY THE DEPOSITORY BANK (SUCH AS THE
BANK OF NEW YORK) AGAINST THE LOCAL CURRENCY SHARES
( SUCH AS RUPEE SHARES) WHICH ARE DELIVERED TO THE
DEPOSITORY S LOCAL CUSTODIAN BANKS.GDRS TRADE FREELY
IN THE OVERSEAS MARKETS.
A EUROCONVERTIBLE BOND (ECB) IS AN EQUITY LINKED DEBT
SECURITY . THE HOLDER OF AN ECB HAS THE OPTION TO
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CONVERT IT INTO EQUITY SHARES AT A PRE DETERMINED
CONVERSION RATIO DURING A SPECIFIED PERIOD . ECBS ARE
REGARDED AS ADVANTAGEOUS BY THE ISSUING COMPANY
BECAUSE (I) THEY CARRY A LOWER RATE OF INTEREST
COMPARED TO A STRAIGHT DEBT SECURITY (II) THEY DO NOT
LEAD TO DILUTION OF EARNINGS PER SHARE IN THE NEAR
FUTURE AND (III) THEY CARRY VERY FEW RESTRICTIVE
COVENANTS.
DEFERRED CREDIT
MANY A TIME THE SUPPLIERS OF MACHINERY PROVIDE
DEFERRED CREDIT FACILITY UNDER WHICH PAYMENT FOR THE
PURCHASE OF MACHINERY IS MADE OVER A PERIOD OF TIME.
THE INTEREST RATE ON DEFERRED CREDIT AND THE PERIOD OF
PAYMENT VARY RATHER WIDELY. NORMALLY, THE SUPPLIER OF
MACHINERY WHEN HE OFFERS DEFERRED CREDIT FACILITY
INSISTS THAT THE BANK GUARANTEE SHOULD BE FURNISHED BY
THE BUYER.
BILLS RE DISCOUNTING SCHEME
OPERATED BY THE IDBI, THE BILLS REDISCOUNTING SCHEME IS
MEANT TO PROMOTE THE SALE OF INDIGENOUS MACHINERY ON
DEFERRED PAYMENT BASIS. UNDER THIS SCHEME, THE SELLER
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REALISES THE SALE PROCEEDS BY DISCOUNTING THE BILLS OF
PROMISSORY NOTES ACCEPTED BY THE BUYER WITH A
COMMERCIAL BANK WHICH IN TURN REDISCOUNTS THEM WITH
THE IDBI. THIS SCHEME IS MEANT PRIMARILY FOR BALANCING
EQUIPMENTS AND EQUIPMENTS AND MACHINERY REQUIRED FOR
EXPANSION,MODERNISATION , AND REPLACEMENT SCHEMES.
SUPPLIERS LINE OF CREDIT
ADMINISTERED BY THE ICICI , THE SUPPLIERS LINE OF CREDIT IS
SOMEWHAT SIMILAR TO THE IDBIS BILL REDISCOUNTING SCHEME
. UNDER THIS ARRANGEMENT , ICICI DIRECTLY PAYS TO THE
MACHINERY MANUFACTURER AGAINST USANCE BILLS DULY
ACCEPTED OF GUARANTEED BY THE BANK OF THE PURCHASER.
SEED CAPITAL ASSISTANCE
FINANCIAL INSTITUTIONS, THOUGH WHAT MAY BE LABELLED
BROADLY AS TH SEED CAPITAL ASSISTANCE SCHEME, SEEK TO
SUPPLEMENT THE RESOURCES OF THE PROMOTERS OF THE
SMALL AND MEDIUM SCALE INDUSTRIAL UNITS WHICH ARE
ELIGIBLE FOR ASSISTANCE FROM ALL INDIA FINANCIAL
INSTITUTIONS AND / OR STATE LEVEL FINANCIAL INSTITUTIONS.
BROADLY THREE SCHEMES HAVE BEEN FORMULATED:
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(i) SPECIAL SEED CAPITAL ASSISTANCE SCHEME-THE
QUANTUM OF ASSISTANCE UNDER THIS SCHEME IF
RS.0.2 MILLION OR 20 PER CENT OF THE PROJECT
COST,WHICHEVER IS LOWER. THIS SCHEME IS
ADMINISTERED BY THE STATE FINANCIAL
CORPORATIONS.
(ii) SEED CAPITAL ASSISTANCE SCHEME-THE ASSISTANCE
UNDER THIS SCHEME IS APPLICABLE TO PROJECTS
COSTING NOT MORE THAN RS20 MILLION. THE
ASSISTANCE PER PROJECT IS RESTRICTED TO RS 1.5
MILLION. THE ASSISTANCE IS PROVIDED BY IDBI
THROUGH STATE LEVEL FINANCIAL INSTITUTIONS. IN
SPECIAL CASES, THE IDBI MAY PROVIDE THE
ASSISTANCE DIRECTLY.
(iii) RISK CAPITAL FOUNDATION SCHEME-UNDER THIS
SCHEME, THE RISK CAPITAL FOUNDATION, AN
AUTONOMOUS FOUNDATION SET UP AND FOUNDED BY
THE IFCL, OFFERS ASSISTANCE TO PROMOTERS OF
PROJECTS COSTING BETWEEN RS 20 MILLION AND RS
150 MILLION. THE CEILING ON THE ASSISTANCE
PROVIDED BETWEEN RS 1.5 MILLION AND RS 4 MILLION
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DEPENDING ON THE NUMBER OF APPLICANT
PROMOTERS.
GOVERNMENT SUBSIDIES
PREVIOUSLY THE CENTRAL GOVERNMENT AS WELL AS THE
STATE GOVERNMENTS PROVIDED SUBSIDIES TO INDUSTRIAL
UNITS LOCATED IN BACKWARD AREAS. THE CENTRAL SUBSIDY
HAS BEEN DISCONTINUED BUT THE STATE SUBSIDIES CONTINUE.
THE STATE SUBSIDIES VARY BETWEEN 5 PER CENT TO 25 PER
CENT OF THE FIXED CAPITAL INVESTMENT IN THE PROJECT ,
SUBJECT TO A CEILING VARYING BETWEEN RS 0.5 MILLION AND
RS 2.5 MILLION DEPENDING ON THE LOCATION.
SALES TAX DEFERMENTS AND EXEMPTIONS
TO ATTRACT INDUSTRIES, THE STATES PROVIDE INCENTIVES,
INTER ALIA , IN THE FORM OF SALES TAX DEFERMENTS AND
SALES TAX EXEMPTIONS.
UNDER THE SALES TAX DEFERMENT SCHEME, THE PAYMENT OF
SALES TAX ON THE SALE OF FINISHED GOODS MAY BE DEFERRED
FOR A PERIOD RANGING BETWEEN FIVE TO TWELVE YEARS.
ESSENTIALLY IT IMPLIES THAT THE PROJECT GETS AN INTEREST
FREE LOAN, REPRESENTED BY THE QUANTUM OF SALES TAX
DEFERRED , DURING THE DEFERMENT PERIOD.
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UNDER THE SALES TAX EXEMPTION SCHEME, SOME STATES
EXEMPT THE PAYMENT OF SALES TAX APPLICABLE ON
PURCHASES OF RAW MATERIALS, CONSUMABLES, PACKING AND
PROCESSING MATERIALS FROM WITHIN THE STATE WHICH ARE
USED FOR MANUFACTURING PURPOSES . THE PERIOD OF
EXEMPTION RANGES FROM THREE TO NINE YEARS DEPENDING
UPON THE STATE AND THE SPECIFIC LOCATION OF THE PROJECT
WITHIN THE STATE.
UNSECURED LOANS AND DEPOSITS
UNSECURED LOANS ARE TYPICALLY PROVIDED BY THE
PROMOTERS TO FILL THE GAP BETWEEN THE
PROMOTERSCONTRIBUTION REQUIRED BY FINANCIAL
INSTITUTIONS AND THE EQUITY CAPITAL SUBSCRIBED TO BY THE
PROMOTERS. THESE LOANS ARE SUBSIDIARY TO THE
INSTITUTIONAL LOANS. THE RATE OF INTEREST CHARGEABLE ON
THESE LOANS IS LESS THAN THE RATE OF INTEREST ON THE
INSTITUTIONAL LOANS. FINALLY, THESE LOANS CANNOT BE
TAKEN BACK WITHOUT THE PRIOR APPROVAL OF FINANCIAL
INSTITUTIONS.
DEPOSITS FROM PUBLIC,REFERRED TO AS PUBLIC
DEPOSITS,REPRESENT UNSECURED BORROWING TWO TO THREE
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YEARS DURATION . MANY EXISTING COMPANIES PREFER TO
RAISE PUBLIC DEPOSITS INSTEAD OF TERM LOANS FROM
FINANCIAL INSTITUTIONS BECAUSE RESTRICTIVE COVENANTS DO
NOT ACCOMPANY PUBLIC DEPOSITS. HOWEVER, IT MAY NOT BE
POSSIBLE FOR A NEW COMPANY TO RAISE PUBLIC DEPOSITS .
FURTHER, IT MAY BE DIFFICULT FOR IT TO REPAY PUBLIC
DEPOSITS WITHIN THREE YEARS.
LEASING AND HIRE PURCHASE FINANCE
WITH THE EMERGENCE OF SCORES OF FINANCE COMPANIES
ENGAGED IN THE BUSINESS OF LEASING AND HIRE PURCHASE
FINANCE, IT MAY BE POSSIBLE TO GET A PORTION , ALBEIT A
SMALL PORTION, OF THE ASSETS FINANCED UNDER A LEASE OR
A HIRE PURCHASE ARRANGEMENT.
TYPICALLY, A PROJECT IS FINANCED PARTLY BY FINANCIAL
INSTITUTIONS AND PARTLY THROUGH THE RESOURCES RAISED
FROM THE CAPITAL MARKET . HENCE , IN FINALISING THE
FINANCING SCHEME FOR A PROJECT, YOU SHOULD BEAR IN MIND
THE NORMS AND POLICIES OF FINANCIAL INSTITUTIONS AND THE
GUIDELINES OF SECURITIES EXCHANGE BOARD OF INDIA AND
THE REQUIREMENTS OF THE SECURITIES CONTRACTS
REGULATION ACT (SCRA).
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PROJECT LAYOUT COST AN INDIAN SCENARIO
PROJECT FINANCING IN INDIA
PROJECT FINANCING REFERS TO THE MEANS OF FINANCE
EMPLOYED FOR MEETING THE COST OF PROJECT.
COST OF PROJECT REPRESENTS THE TOTAL OF ALL ITEMS OF
OUTLAY ASSOCIATED WITH A PROJECT WHICH ARE SUPPORTED
BY LONG TERM FUNDS. IT IS THE SUM OF THE OUTLAYS ON THE
FOLLOWING:
1. LAND AND SITE DEVELOPMENT: THE COST OF LAND AND SITE
DEVELOPMENT IS THE SUM OF THE FOLLOWING:
BASIC COST OF LAND INCLUDING CONVEYANCE AND
OTHER ALLIED CHARGES,
PREMIUM PAYABLE ON LEASEHOLD AND CONVEYANCE,
COST OF LEVELLING & DEVELOPMENT,
COST OF LAYING APPROACH ROADS AND INTERNAL
ROADS,
COST OF GATES,
COST OF TUBE WELLS.
THE COST OF LAND VARIES CONSIDERABLY FROM ONE
LOCATION TO ANOTHER. WHILE IT IS VERY HIGH IN URBAN AND
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EVEN SEMI-URBAN LOCATIONS, IT IS RELATIVELY LOW IN
RURAL LOCATIONS. THE EXPENDITURE ON SITE
DEVELOPMENT, TOO, VARIES WIDELY DEPENDING ON THE
LOCATION AND TOPOGRAPHY OF THE LAND.
2. BUILDING AND CIVIL WORKS: BUILDING AND CIVIL WORKS
COVER THE FOLLOWING :
BUILDING FOR THE MAIN PLANT & EQUIPMENTS
BUILDING FOR AUXILLARY SERVICES LIKE STEAM
SUPPLY, WORKSHOPS, LABORATORY, WATER SUPPLY, ETC.
GODOWNS, WAREHOUSES, AND OPEN YARD
FACILITIES,
NON-FACTORY BUILDINGS LIKE CANTEEN, GUEST
HOUSES, TIME OFFICE, EXCISE HOUSE, ETC.
QUARTERS FOR ESSENTIAL STAFF
SILOS, TANKS, WELLS, CHESTS, BASINS, CISTERNS,
HOOPERS, BINS, AND OTHER STRUCTURES NECESSARY
FOR INSTALLATION OF PLANT & EQUIPMENT
GARAGES
SEWERS, DRAINAGE, ETC.
OTHER CIVIL ENGINEERING WORKS
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THE COST OF BUILDINGS & CIVIL WORKS DEPENDS ON THE
KIND OF STRUCTURES REQUIRED WHICH, IN TURN, ARE
DICTATED LARGELY BY THE REQUIREMENTS OF THE PROJECT.
ONCE THE KINDS OF STRUCTURES REQUIRED ARE SPECIFIED,
COST ESTIMATES ARE BASED ON PLINTH AREAS AND RATES
FOR VARIOUS TYPES OF STRUCTURES. THESE RATES, OF
COURSE VARY WITH THE LOCATION TO SOME EXTENT.
3. PLANT AND MACHINARY: THE COST OF PLANT AND
MACHINARY, TYPICALLY THE MOST SIGNIFICANT COMPONENT
OF PROJECT COST, CONSISTING OF THE FOLLOWING:
COST OF IMPORTED MACHINARY: THIS IS THE SUM OF
(A) FOB VALUE, (B) SHIPPING, FREIGHT, AND INSURANCE
COST, (C) IMPORT DUTY, (D) CLEARING, LOADING,
UNLOADING, AND TRANSPORTATION CHARGES.
COST OF INDIGENOUS MACHINARY: THIS CONSISTS OF
(A) FOR COST, (B) SALES TAX, OCTROI, OTHER TAXES, (C)
RAILWAY FREIGHT AND TRANSPORT CHARGES TO SITE.
COST OF STORES & SPARES
FOUNDATION AND INSTALLATION CHARGES
THE COST OF PLANT & MACHINARY IS BASED ON THE
LATEST AVAILABLE QUOTATION ADJUSTED FOR POSSIBLE
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ESCALATION. GENERALLY, THE PROVISION FOR
ESCALATION IS EQUAL TO THE FOLLOWING PRODUCT:
(LATEST RATE OF ANNUAL INFLATION APPLICABLE TO THE
PLANT AND MACHINARY) X (LENGTH OF THE DELIVERY
PERIOD).
4. TECHNICAL KNOW-HOW AND ENGINEERING FEES: OFTEN IT IS
NECESSARY TO ENGAFE TECHNICAL CONSULTANTS OR
COLLABORATORS FROM INDIA AND / OR ABROAD FOR ADVICE
AND HELP IN VARIOUS TECHNICAL MATTERS LIKE
PREPARATION OF PROJECT REPORT, CHOICE OF
TECHNOLOGY, SELECTION OF PLANT AND MACHINARY,
DETAILED ENGINEERING, ETC. WHILE THE AMOUNT PAYABLE
FOR OBTAINING TECHNICAL KNOW-HOW AND ENGINEERING
SERVICES FOR SETTING UP THE PROJECT IS A COMPONENT
OF PROJECT COST, THE ROYALTY PAYABLE ANNUALLY, WHICH
IS TYPICALLY A PERCENTAGE OF SALES, IS AN OPERATING
EXPENSE TAKEN INTO ACCOUNT IN THE PREPARATION OF THE
PROJECTED PROFITABILITY STATEMENTS.
5. EXPENSES OF FOREIGN TECHNICIANS MAY BE REQUIRED IN
INDIA FOR SETTING UP THE PROJECT AND SUPERVISING THE
TRIAL RUNS. EXPENSES ON THEIR TRAVEL, BOARDING, AND
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LODGING ALONG WITH THEIR SALARIES AND ALLOWANCES
MUST BE TAKEN INTO ACCOUNT IN THE PREPARATION OF THE
PROJECTED PROFITABILITY STATEMENTS.
6. MISCELLANEOUS FIXED ASSETS: FIXED ASSETS AND
MACHINARY WHICH ARE NOT PART OF THE DIRECT
MANUFACTURING PROCESS MAY BE REFFERED TO AS
MISCELLANEOUS FIXED ASSETS. THEY INCLUDE ITEMS LIKE
FURNITURE, OFFICE MACHINARY AND EQUIPMENT, TOOLS,
VEHICLES, RAILWAY SIDINGS, DIESEL GENERATING SETS,
TRANSFORMERS, BOILERS, PIPING SYSTEMS, LABORATORY
EQUIPMENTS, WORKSHOP EQUIPMENTS, EFFLUENT
TREATMENT PLANTS, FIRE FIGHTING EQUIPMENTS, ETC.
EXPENSES INCURRED FOR PROCUREMENT OR USE OF
PATENTS, LICENSES, TRADE MARKS COPYRIGHTS, ETC. AND
DEPOSITS MADE WITH THE ELECTRICITY BOARD MAY ALSO BE
INCLUDED IN THE PROJECTED PROFITABILITY STATEMENTS.
7. PRILIMINARY AND CAPITAL ISSUE EXPENSES: EXPENSES
INCURRED FOR IDENTIFYING THE PROJECT, CONDUCTING THE
MARKET SURVEY, PREPARING THE FEASIBILITY REPORT,
DRAFTING THE MEMORANDUM AND ARTICLES OF
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ASSOCIATION, AND INCORPORATING THE COMPANY ARE
REFFERED TO AS PRELIMINARY EXPENSES.
EXPENSES BORNE IN CONNECTION WITH THE RISING OF
CAPITAL FROM THE PUBLIC ARE REFERRED AS CAPITAL ISSUE
EXPENSES. THE MAJOR COMPONENT OF THESE EXPENSES
ARE- UNDERWRITING COMMISSION, BROKERAGE, FEES TO
MANAGERS AND REGISTRARS, PRINTING AND POSTAGE
EXPENSES, ADVERTISING AND PUBLICITY EXPENSES, LISTING
FESES, AND STAMP DUTY.
8. PRE-OPERATIVE EXPENSES: THESE EXPENSES ARE DIRECTLY
RELATED TO THE PROJECT IMPLEMENTATION SCHEDULE. O,
DELAYS IN PROJECT IMPLEMENTATION, WHICH ARE FIRLY
COMMON, TEND TO PUSH UP THESE EXPENSES. APPRECIATIVE
OF THIS, FINANCIAL INSTITUTIONS ALLOW FOR SOME DELAY
(20 TO 25 PER CENT) IN THE PROJECT IMPLEMENTATION
SCHEDULE AND ACCORDINGLY PERMIT A CUSHION IN THE
ESTIMATE FOR PRE-OPERATIVE EXPENSES.
EXPENSES OF THE FOLLOWING TYPES INCURRED TILL THE
COMMENCEMENT OF COMMERCIAL PRODUCTION ARE
REFERRED TO AS PRE-OPERATIVE EXPENSES- (A)
ESTABLISHMENT EXPENSES, (B) RENT, RATES & TAXES, (C)
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TRAVELLING EXPENSES, (D) INTEREST ON BORROWINGS, (E)
INSURANCE CHARGES, (F) MORTGAGE EXPENSES, (G)
INTEREST ON DEFERRED PAYMENTS, (H) START-UP EXPENSES,
AND (I) MISCELLANEOUS EXPENSES.
THESE TYPES OF EXPENSES CAN BE CAPITALISED BY
APPORTIONING THEM TO FIXED ASSETS. UP TO A POINT OF
TIME. AFTER THAT THESE EXPENSES ARE TREATED AS
REVENUE EXPENSES.
9. PROVISION FOR CONTENGENCIES: A PROVISION FOR
CONTINGENCIES IS MADE TO PROVIDE FOR CERTAIN
UNFORSEEN EXPENSES AND PRICE INCREASES OVER AND
ABOVE THE NORMAL INFLATION RATE WHICH IS ALREADY
INCORPORATED IN COST ESTIMATES.
10. MARGIN MONEY FOR WORKING CAPITAL: THE PRINCIPAL
SUPPORT FOR WORKING CAPITAL IS PROVIDED BY
COMMERCIAL BANKS AND TRADE CREDITORS. HOWEVER, A
CERTAIN PART OF WORKING CAPITAL REQUIREMENTS HAS TO
COME FROM LONG TERM SOURCES OF FINANCE. THIS IS AN
IMPORTANT ELEMENT OF THE PROJECT COST. THE MARGIN
MONEY FOR WORKING CAPITAL IS SOMETIMES UTILISED FOR
MEETING OVER-RUNS IN CAPITAL COST. THIS LEADS TO A
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WORKING CAPITAL PROBLEM (AND SOMETIMES A CRISIS)
WHEN THE PROJECT IS COMMISSIONED. TO MITIGATE THIS
PROBLEM, FINANCIAL INSTITUTIONS STIPULATE THAT A
PORTION OF THE LOAN AMOUNT, EQUAL TO THE MARFIN
MONEY FOR WORKING CAPITAL, BE BLOCKED INITIALLY SO
THAT IT CAN BE RELEASED WHEN THE PROJECT IS
COMPLETED.
11. INITIAL CASH LOSSES: MOST OF THE PROJECTS INCUR
CASH LOSSES IN THE INITIAL YEARS. YET, PROMOTORS
TYPICALLY DO NOT DISCLOSE THE INITIAL CASH LOSSES
BECAUSE THEY WANT THE PROJECT TO APPEAR ATTRACTIVE
TO THE FINANCIAL INSTITUTIONS AND THE INVESTING PUBLIC.
FALIURE TO MAKE PROVISION FOR SUCH CASH LOSSES IN THE
PROJECT COST GENERALLY AFFECTS THE LIQUIDITY
POSITION AND IMPAIRS THE OPERATIONS. HENCE PRUDENCE
CALLS FOR MAKING A PROVISION, OVERT OR COVERT, FOR
THE ESTIMATED INITIAL CASH LOSSES.
EVERY PROJECT HAVE THE FOLLOWING ATTRIBUTES:
IT INVOLVES CAPITAL EXPENDITURE,
(a)CAPITAL BUDGETING,
(b)PROJECT ANALYSIS,
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(c)FEASIBILITY STUDY
CAPITAL EXPENDITURE DECISIONS OFTEN REPRESENT THE
MOST IMPORTANT DECISIONS TAKEN BY FIRM. THEIR
IMPORTANCE STEMS FROM THREE INTER-RELATED REASONS:
i. LONG TERM EFFECT,
ii. IRREVERSIBILITY,
iii. SUBSTANTIAL OUTLAY.
CAPITAL BUDGETING IS A COMPLEX PROCESS WHICH MAY BE
DIVIDED INTO FIVE BROAD PHASES:
1. PLANNING: THE PLANNING PHASE IS CONCERNED WITH THE
ARTICULATION OF ITS BROAD INVESTMENT STRATEGY AND
THE GENERATION AND PRELIMINARY SCREENING OF PROJECT
PROPOSALS. THE INVESTMENT STRATEGY OF THE FIRM
DELINEATES THE BROAD AREAS OR TYPES OF INVESTMENTS
THE FIRM PLANS TO UNDERTAKE.
2. ANALYSIS: THE FOCUS IS ON GATHERING, PREPARING, AND
SUMMARISING RELEVANT INFORMATION ABOUT VARIOUS
PROPOSALS, WHICH ARE BEING CONSIDERED. BASED ON THE
INFORMATION DEVELOPED IN THIS ANALYSIS, THE STREAM OF
COST & BENEFITS ASSOCIATED WITH THE PROJECT CAN BE
DEFINED.
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3. SELECTION: THE PROJECTS ARE SELECTED ON SOME
SUITABLE BASIS FOR THEIR WORTHINES LIKE PAYBACK
PERIOD, ARR, NPV, IRR, AND BCR ETC. IN ORDER TO APPLY
THE APPRISAL CRITERIA CUT OFF VALUES ARE TO BE
SPECIFIED, LIKE (HURDLE RATE, TARGET RATE AND COST OF
CAPITAL).
4. IMPLEMENTATION: IT PASSES THROUGH SEVERAL STAGES,
NAMELY- PROJECT & ENGINEERING & DESIGNS, NEGOTIATION
& CONTRACTING, CONSTRUCTION, TRAINING, AND
COMMISSIONING.
5. REWIEW: THIS PHASE SETS INTO MOTION AFTER THE
COMMISSIONING IS OVER. IT IS USEFUL IN THE FOLLOWING
WAYS,
IT THROWS LIGHT ON HOW REALISTIC WERE THE
ASSUMPTIONS UNDERLYING THE PROJECT,
IT PROVIDES A DOCUMENTED LOG OF EXPERIENCE
THAT IS HIGHLY VALUABLE IN FUTURE DECISION MAKING,
IT SUGGESTS CORRECTIVE ACTION TO BE TAKEN IN
THE LIGHT OF ACTUAL PERFORMANCE,
IT HELPS IN UNCOVERING JUDGEMENTAL BIASES,
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IT INDUCES A DESIRED CAUTION AMONG PROJECT
SPONSORS.
PROJECT ANALYSIS
FACETS OF PROJECT ANALYSIS
THE IMPORTANT FACETS OF PROJECT ANALYSIS ARE:
- MARKET ANALYSIS
- TECHNICAL ANALYSIS
- FINANCIAL ANALYSIS
- ECONOMIC ANALYSIS
- ECOLOGICAL ANALYSIS
MARKET ANALYSIS
MARKET ANALYSIS IS CONCERNED PRIMARILY WITH TWO
QUESTIONS:
- WHAT WOULD BE THE AGGREGATE DEMAND OF THE
PROPOSED PRODUCT / SERVICE IN FUTURE?
- WHAT WOULD BE THE MARKET SHARE OF THE PROJECT
UNDER APPRAISAL?
TO ANSWER THE ABOVE QUESTIONS, THE MARKET ANALYST
REQUIRES A WIDE VARIETY TO INFORMATION AND APPROPRIATE
FORECASTING METHODS. THE KINDS OF INFORMATION
REQUIRED ARE:
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- CONSUMPTION TRENDS IN THE PAST AND THE PRESENT
CONSUMPTION LEVEL
- PAST AND PRESENT SUPPLY POSITION
- PRODUCTION POSSIBILITIES AND CONSTRAINTS
- IMPORTS AND EXPORTS.
- STRUCTURE OF COMPETITION
- COST STRUCTURE
- ELASTICITY OF DEMAND
- CONSUMER BEHAVIOUR, INTENTIONS, MOTIVATIONS,
ATTITUDES, PREFERENCE, AND REQUIREMENTS
- DISTRIBUTION CHANNELS AND MARKETING POLICIES IN USE
- ADMINISTRATIVE, TECHNICAL, AND LEGAL CONSTRAINTS
TECHNICAL ANALYSIS
ANALYSIS OF THE TECHNICAL AND ENGINEERING ASPECTS OF A
PROJECT NEEDS TO BE DONE CONTINUALLY WHEN A PROJECT IS
FORMULATED. TECHNICAL ANALYSIS SEEKS TO DETERMINE
WHETHER THE PREREQUISITES FOR THE SUCCESSFUL
COMMISSIONING OF THE PROJECT HAVE BEEN CONSIDERED AND
REASONABLY GOOD CHOICES HAVE BEEN MADE WITH RESPECT
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TO LOCATION, SIZE, PROCESS, ETC. THE IMPORTANT
QUESTIONS RAISED IN TECHNICAL ANALYSIS ARE:
- WHETHER PRELIMINARY TESTS AND STUDIES HAVE BEEN
DONE OR PROVIDED FOR?
- WHETHER THE AVAILABILITY OF RAW MATERIALS, POWER, AND
OTHER INPUTS HAS BEEN ESTABLISHED?
- WHETHER THE SELECTED SCALE OF OPERATION IS OPTIMAL?
- WHETHER THE PRODUCTION PROCESS CHOSEN IS SUITABLE?
- WHETHER THE EQUIPMENT AND MACHINES CHOSEN ARE
APPROPRIATE?
- WHETHER THE AUXILIARY EQUIPMENTS AND SUPPLEMENTARY
ENGINEERING WORKS HAVE BEEN PROVIDED FOR?
- WHETHER PROVISION HAS BEEN MADE FOR THE TREATMENT
OF EFFLUENTS?
- WHETHER THE PROPOSED LAYOUT OF THE SITE, BUILDINGS,
AND PLANT IS SOUND?
- WHETHER WORK SCHEDULES HAVE BEEN REALISTICALLY
DRAWN UP?
- WHETHER THE TECHNOLOGY PROPOSED TO BE EMPLOYED IS
APPROPRIATE FROM THE SOCIAL POINT OF VIEW?
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FINANCIAL ANALYSIS
FINANCIAL ANALYSIS SEEKS TO ASCERTAIN WHETHER THE
PROPOSED PROJECT WILL BE FINANCIALLY VIABLE IN THE SENSE
OF BEING ABLE TO MEET THE BURDEN OF SERVICING DEBT AND
WHETHER THE PROPOSED PROJECT WILL SATISFY THE RETURN
EXPECTATIONS OF THOSE WHO PROVIDE THE CAPITAL. THE
ASPECTS WHICH HAVE TO BE LOOKED INTO WHILE CONDUCTING
FINANCIAL APPRAISAL ARE:
- INVESTMENT OUTLAY AND COST OF PROJECT
- MEANS OF FINANCING.
- COST OF CAPITAL
- PROJECTED PROFITABILITY
- BREAK-EVEN POINT
- CASH FLOWS OF THE PROJECT
- INVESTMENT WORTHWHILENESS JUDGED IN TERMS OF
VARIOUS CRITERIA OF MERIT
- PROJECTED FINANCIAL POSITION
- LEVEL OF RISK
ECONOMIC ANALYSIS
ECONOMIC ANALYSIS, ALSO REFERRED TO AS SOCIAL COST
BENEFIT ANALYSIS, IS CONCERNED WITH JUDGING A PROJECT
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FROM THE LARGER SOCIAL POINT OF VIEW. IN SUCH AN
EVALUATION THE FOCUS IS ON THE SOCIAL COSTS AND
BENEFITS OF A PROJECT WHICH MAY OFTEN BE DIFFERENT
FROM ITS MONETARY COSTS AND BENEFITS. THE QUESTIONS
SOUGHT TO BE ANSWERED IN SOCIAL COST BENEFIT ANALYSIS
ARE:-
- WHAT ARE THE DIRECT ECONOMIC BENEFITS AND COSTS OF
THE PROJECT MEASURED IN TERMS OF SHADOW (EFFICIENCY)
PRICES AND NOT IN TERMS OF MARKET PRICES?
- WHAT WOULD BE THE IMPACT OF THE PROJECT ON THE
DISTRIBUTION OF INCOME IN THE SOCIETY?
- WHAT WOULD BE THE IMPACT OF THE PROJECT ON THE LEVEL
OF SAVINGS AND INVESTMENT IN THE SOCIETY?
- WHAT WOULD BE THE CONTRIBUTION OF THE PROJECT
TOWARDS THE FULFILLMENT OF CERTAIN MERIT WANTS LIKE
SELF-SUFFICIENCY, EMPLOYMENT, AND SOCIAL ORDER?
ECOLOGICAL ANALYSIS
IN RECENT YEARS, ENVIRONMENTAL CONCERNS HAVE ASSUMED
A GREAT DEAL OF SIGNIFICANCE-AND RIGHTLY SO. ECOLOGICAL
ANALYSIS SHOULD BE DONE PARTICULARLY FOR MAJOR
PROJECTS WHICH HAVE SIGNIFICANT ECOLOGICAL IMPLICATIONS
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LIKE POWER PLANTS AND IRRIGATION SCHEMES, AND
ENVIRONMENTAL POLLUTING INDUSTRIES (LIKE BULK DRUGS,
CHEMICALS, AND LEATHER PROCESSING). THE KEY QUESTIONS
RAISED IN ECOLOGICAL ANALYSIS ARE:
- WHAT IS THE LIKELY DAMAGE CAUSED BY THE PROJECT TO
THE ENVIRONMENT?
- WHAT IS THE COST OF RESTORATION MEASURES REQUIRED
TO ENSURE THAT THE DAMAGE TO THE ENVIRONMENT IS
CONTAINED WITHIN ACCEPTABLE LIMITS?
WE HAVE LOOKED AT THE FIVE BROAD PHASES OF CAPITAL
BUDGETING AND EXAMINED THE KEY FACETS OF PROJECT
ANALYSIS. THE FEASIBILITY STUDY IS CONCERNED WITH THE
FIRST THREE PHASES OF CAPITAL BUDGETING, VIZ., PLANNING,
ANALYSIS, AND SELECTION (EVALUATION) AND INVOLVES
MARKET, TECHNICAL, FINANCIAL, ECONOMIC, AND ECOLOGICAL
ANALYSIS.
OBJECTIVES OF CAPITAL BUDGETING
FINANCIAL THEORY, IN GENERAL, RESTS ON THE PREMISE THAT
THE GOAL OF FINANCIAL MANAGEMENT (WHICH SUBSUMES
INVESTMENT DECISION MAKING) SHOULD BE TO THE MAXIMISE
THE PRESENT WEALTH OF THE FIRMS EQUITY SHAREHOLDERS.
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FOR A FIRM WHOSE EQUITY SHARES ARE ACTIVELY TRADED ON
THE STOCK MARKET, THE WEALTH OF THE EQUITY
SHAREHOLDERS IS REFLECTED IN THE MARKET VALUE OF THE
EQUITY SHARES. HENCE, THE GOAL OF FINANCIAL MANAGEMENT
FOR SUCH FIRMS SHOULD BE TO MAXIMISE THE MARKET VALUE
OF EQUITY SHARES.
THE PURSUIT OF THE WELFARE OF EQUITY SHAREHOLDERS IS
JUSTIFIED ON THE GROUNDS THAT IT CONTRIBUTES TO AN
EFFICIENT ALLOCATION OF CAPITAL IN THE ECONOMY. THE
BASES FOR ALLOCATION OF SAVINGS IN THE ECONOMY ARE
EXPECTED RETURN AND RISK. SINCE EQUITY SHARE PRICES
ARE BASED ON EXPECTED RETURN AND RISK, EFFORTS TO
MAXIMISE EQUITY SHARE PRICES WOULD RESULT IN AN
EFFICIENT ALLOCATION OF RESOURCES. ANOTHER
JUSTIFICATION MAY BE PROVIDED FOR THE GOAL OF
SHAREHOLDER WEALTH MAXIMISATION. EQUITY SHAREHOLDERS
PROVIDE THE VENTURE (RISK) CAPITAL REQUIRED TO START A
BUSINESS FIRM AND APPOINT THE MANAGEMENT OF THE FIRM
INDIRECTLY THROUGH THE BOARD OF DIRECTORS. HENCE, IT
BEHOOVES ON CORPORATE MANAGEMENTS TO PROMOTE THE
WELFARE OF EQUITY SHAREHOLDERS.
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WHAT ABOUT A PUBLIC SECTOR FIRM THE EQUITY STOCK OF
WHICH, BEING FULLY OWNED BY THE GOVERNMENT, IS NOT
TRADED ON THE STOCK MARKET? IN SUCH A CASE, THE GOAL OF
FINANCIAL MANAGEMENT SHOULD BE TO MAXIMISE THE
PRESENT VALUE OF THE STREAM OF EQUITY RETURNS. OF
COURSE, IN DETERMINING THE PRESENT VALUE OF THE STREAM
OF EQUITY RETURNS, AN APPROPRIATE DISCOUNT RATE HAS TO
BE APPLIED. A SIMILAR OBSERVATION MAY BE MADE WITH
RESPECT TO OTHER COMPANIES WHOSE EQUITY SHARES ARE
EITHER NOT TRADED OR VERY POORLY TRADED.
ALTERNATIVES
ARE THERE OTHER GOALS, BESIDES THE GOAL OF MAXIMUM
SHAREHOLDER WEALTH, EXPRESSING THE SHAREHOLDERS
VIEWPOINT? SEVERAL ALTERNATIVES HAVE BEEN SUGGESTED:
MAXIMISATION OF PROFIT, MAXIMISATION OF EARNINGS PER
SHARE, MAXIMISATION OF RETURN ON EQUITY (DEFINED AS
EQUITY EARNINGS / NET WORTH).
MAXIMISATION OF PROFIT IS NOT AS INCLUSIVE A GOAL AS
MAXIMISATION OF SHAREHOLDERS WEALTH. IT SUFFERS FROM
SEVERAL LIMITATIONS:
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- PROFIT IN ABSOLUTE TERMS IS NOT A PROPER GUIDE TO
DECISION MAKING. IT SHOULD BE EXPRESSED ON A PER
SHARE BASIS OR RELATED TO INVESTMENT.
- IT LEAVES CONSIDERATIONS OF TIMING AND DURATION
UNDEFINED. THERE IS NOT GUIDE FOR COMPARING PROFIT
NOW WITH PROFIT IN FUTURE OR FOR COMPARING PROFIT
STREAMS OF DIFFERENT DURATIONS.
- IT GLOSSES OVER THE FACTOR OF RISK. IT CANNOT, FOR
EXAMPLE, DISCRIMINATE BETWEEN AN INVESTMENT PROJECT
WHICH GENERATES A CERTAIN PROFIT OF RS.50,000/- AND AN
INVESTMENT PROJECT WHICH HAS A VARIABLE PROFIT
OUTCOME WITH AN EXPECTED VALUE OF RS.50,000/-.
THE GOALS OF MAXIMISATION OF EARNINGS PER SHARE AND
MAXIMISATION OF RETURN ON EQUITY DO NOT SUFFER FROM
THE FIRST LIMITATION MENTIONED ABOVE. THEY, HOWEVER,
SUFFER FROM THE OTHER LIMITATIONS AND HENCE ARE NOT
SUITABLE.
IN VIEW OF THE SHORTCOMINGS OF THE ALTERNATIVES
DISCUSSED ABOVE, MAXIMISATION OF THE WEALTH OF EQUITY
SHAREHOLDERS (AS REFLECTED IN THE MARKET PRICE OF
EQUITY) APPEARS TO BE THE MOST APPROPRIATE GOAL FOR
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FINANCIAL DECISION MAKING. THOUGH THE STRICT VALIDITY OF
THIS GOAL RESTS ON CERTAIN RIGID ASSUMPTIONS ABOUT
CAPITAL MARKETS, IT CAN BE REASONABLY DEFINED AS A GUIDE
FOR FINANCIAL DECISION MAKING UNDER FAIRLY PLAUSIBLE
ASSUMPTIONS.
OTHER CONCERNS OF THE BUSINESS
DO FIRMS REALLY ACT OR SHOULD SOLELY ACT TO FURTHER
SHAREHOLDERS WELFARE? THIS DOES NOT SEEM TO BE THE
ISSUE HERE. FIRMS MAY PURSUE OR OUGHT TO PURSUE
SEVERAL OTHER GOALS. BUSINESS FIRMS SEEK TO ACHIEVE A
HIGH RATE OF GROWTH, ENJOY A SUBSTANTIAL MARKET SHARE,
ATTAIN PRODUCT AND TECHNOLOGICAL LEADERSHIP, PROMOTE
EMPLOYEE WELFARE, FURTHER CUSTOMER SATISFACTION,
SUPPORT EDUCATION AND RESEARCH IMPROVE COMMUNITY
LIFE, AND SOLVE OTHER SOCIETAL PROBLEMS. SOME OF THESE
GOALS, MAY, OF COURSE, BE IN CONSONANCE WITH THE GOAL
OF SHAREHOLDER WEALTH MAXIMISATION. FOR A RAPID
GROWTH RATE, A DOMINANT MARKET POSITION, AND A HIGHER
CUSTOMER SATISFACTION MAY LEAD TO INCREASING RETURNS
FOR EQUITY SHAREHOLDERS. EVEN EFFORTS TOWARD SOLVING
SOCIETAL PROBLEMS MAY FURTHER THE INTEREST OF
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SHAREHOLDERS IN THE LONG RUN BY IMPROVING THE IMAGE OF
THE FIRM AND STRENGTHENING ITS RELATIONSHIP WITH THE
ENVIRONMENT. WHEN THESE OTHER GOALS SEEM TO CONFLICT
WITH THE GOAL OF MAXIMISING THE WEALTH OF EQUITY
SHAREHOLDERS, IT IS HELPFUL TO KNOW THE COST OF
PURSUING THESE GOALS. THE TRADE-OFF HAS TO BE
UNDERSTOOD. IT SHOULD BE APPRECIATED THAT THE
MAXIMISATION OF THE WEALTH OF EQUITY SHAREHOLDERS
CONSTITUTES THE PRINCIPAL GUARANTEE FOR EFFICIENT
ALLOCATION OF RESOURCES IN THE ECONOMY AND HENCE IS TO
BE REGARDED AS THE NORMATIVE GOAL FROM THE FINANCIAL
POINT OF VIEW.
BASIC CONSIDERATIONS: RISK AND RETURN
SUPPOSE A FIRM IS EVALUATING AN INVESTMENT PROPOSAL.
WHAT ASPECTS ARE RELEVANT FROM THE FINANCIAL ANGLE?
FROM THE FINANCIAL POINT OF VIEW THE RELEVANT
DIMENSIONS ARE RETURN AND RISK.
TAKE ANOTHER DECISION SITUATION IN WHICH THE FIRM IS
CONSIDERING A FINANCING PROPOSAL. THE ASPECTS ALONG
WHICH SUCH A PROPOSAL IS EXAMINED ARE COST AND RISK.
SINCE COST IS THE INVERSE OF RETURN, HERE TOO THE BASIC
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DIMENSIONS ARE RETURN AND RISK. IN GENERAL, WE FIND THAT
THESE ARE THE TWO BASIC DIMENSIONS OF FINANCIAL
ANALYSIS.
WHAT IS THE RELATIONSHIP BETWEEN RETURN, RISK, AND
MARKET VALUE OF EQUITY? HIGHER THE RETURN, CETERIS
PARIBUS, HIGHER THE MARKET VALUE; HIGHER THE RISK,
CETERIS PARIBUS, LOWER THE MARKET VALUE.
IT MAY BE EMPHASISED THAT TYPICALLY, RISK AND RETURN GO
HAND IN HAND. THIS MEANS THAT IN A DECISION SITUATION, AN
ALTERNATIVE WHICH HAS A HIGHER RETURN TENDS TO HAVE
HIGHER RISK TOO. LIKEWISE, AN ALTERNATIVE WHICH HAS A
LOWER RETURN TENDS TO HAVE A LOWER RISK. IN FINANCIAL
ANALYSIS, THE TRADE-OFF BETWEEN RISK AND RETURN NEEDS
TO BE CAREFULLY ANALYSED.
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LEGAL, REGULATORY & PROCEDURAL ENVIRONMENT IN INDIA
IMPORTS AS AN ACTIVITY IS GOVERNED BY DEFINITE LAWS AND
HAVE WELL & COMPREHENSIVELY DEFINED PROCEDURES ALONG
WITH THE POLICIES FRAMED BY THE GOVERNMENT TIME TO
TIME, KEEPING ABREAST WITH THE CHANGING TIMES &
SITUATIONS.
THE LAWS/ RULES/ REGULATIONS WHICH GOVERN THE IMPORTS
ARE AS FOLLOWS :
FOREIGN TRADE (DEVELOPMENT & REGULATION) ACT, 1992
SEBI GUIDELINES
COMPANIES ACT 1956
INCOME TAX ACT
GUIDELINES ISSUED BY FINANCIAL INSTITUTIONS
EXPORT IMPORT POLICY (BY GOVERNMENT OF INDIA)
CUSTOMS ACT (1962)
EXCHANGE CONTROL MANUAL OF RBI
CUSTOMS VALUATION (DETERMINATION OF PRICE OF
IMPORTED GOODS) RULES, 1988,
CUSTOMS TARIFF ACT, 1975,
PROJECT IMPORTS REGULATIONS, 1944,
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CUSTOMS (PROVISIONAL ASSESSMENT)
REGULATIONS,1963,
BILL OF ENTRY (FORMS) REGULATIONS 1976,
CENTRAL EXCISE ACT
FERA 1973 ,
IDRA,
MRTP,
ESSENTIAL COMMODITIES ACT
SOME OF THEM ARE BRIEFLY DISCUSSED BELOW :
FOREIGN TRADE (DEVELOPMENT & REGULATION) ACT, 1992.
THE BASIC LAW THAT GOVERNS THE IMPORTS INTO INDIA IS THE
FOREIGN TRADE (DEVELOPMENT & REGULATION) ACT, 1992.
UNDER THIS ACT, IMPORTS OF ALL GOODS IS FREE EXCEPT FOR
THE ITEMS REGULATED BY THE POLICY OR ANY LAW FOR THE
TIME BEING IN FORCE. USING THE POWERS CONFERRED BY THE
SAID ACT, THE GOVERNMENT HAS ISSUED THE FOLLOWING
RULES & ORDERS :-
FOREIGN TRADE (REGULATION) RULES, 1993, WHICH INTER
ALIA, PROVIDE FOR GRANT OF SPECIAL LICENCE,
APPLICATION FOR GRANT OF
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LICENCES, FEES, CONDITIONS FOR LICENCES, REFUSAL OF
LICENCE, AMENDMENT TO LICENCE, SUSPENSION OF LICENCE,
CANCELLATION OF LICENCE, DECLARATION AS TO THE VALUE
AND QUANTITY OF IMPORTED GOODS, DECLARATION AS TO THE
IEC NUMBER, UTILIZATION OF IMPORTED GOODS, PROVISIONS
REGARDING MAKING, SIGNING OF ANY DECLARATION /
STATEMENT OR DOCUMENTS, POWER TO ENTER THE PREMISES
AND INSPECT, SEARCH AND SEIZURE OF GOODS, DOCUMENTS,
THINGS AND CONVEYANCE, SETTLEMENT, CONFISCATION AND
REDEMPTION AND CONFISCATION OF CONVEYANCE.
FOREIGN TRADE (EXEMPTION FROM APPLICATION OF
RULES IN CERTAIN CASES) ORDER 1993 ;
NOTIFICATIONS UNDER FOREIGN TRADE (DEVELOPMENT &
REGULATION) ACT 1992 ;
SEBI GUIDELINES
THE GUIDELINES APPLY TO THE SPECIAL PURPOSE VEHICLE FOR
THE PURPOSE OF ISSUANCE OF THE NEW INSTRUMENTS THIS
INCLUDES LAWS LIKE SEBI ACT, 1992. THE LAW LAYS STRESS ON
ADEQUATE DISCLOSURE, SEEK TO SAFEGUARD THE INTEREST
OF THE INVESTORS, AND EMPHASIS PRUDENTIAL CONTROLS, BY
REGULATING :
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1. PRICING OF PUBLIC ISSUES OF EQUITY CAPITAL
2. ISSUE OF FCD / PCD / NCD (TYPES OF DEBENTURES)
3. PROMOTERS CONTRIBUTION
COMPANIES ACT, 1956
THE CREATION OF THE SPECIAL PURPOSE VEHICLE IS
GOVERNED BY THE SAID LAW. THIS PROVIDES THE FRAMEWORK
FOR VARIOUS ASPECTS OF BRINGING THE SPV INTO EXISTANCE,
NAMELY:
1. NAME OF THE COMPANY
2. ARTICLE AND MAMORANDUM OF ASSOCIATION
3. CERTIFICATE OF INCORPORATION
4. SHAREHOLDING PATTERN
5. ACCOUNTING METHODS AND STANDARDS
6. DISCLOSURE POLICY
7. OTHER PENAL AND REGULATORY PROVISIONS AS APPLICABLE
INCOME TAX ACT
FOR PREPARING THE ESTIMATES OF WORKING RESULTS, THE
EXPECTED TAX BURDEN FOR THE FORECAST PERIOD, WHICH IS
USUALLY EIGHT TO TEN YEARS, HAS TO BE FIGURED OUT. THIS
CALLS FOR FAMILIARITY WITH THE PROVISION OF INCOME TAX
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ACT THAT ARE RELEVANT FOR DETERMINING THE MAGNITUDE
AND TIMING OF THE TAX BURDEN FOR A NEW PROJECT.
CUSTOMS ACT, 1962
BUT, ONE OF THE MOST IMPORTANT LAW PERTAINING TO
THE IMPORTS IS THE CUSTOMS ACT 1962. THE PATTERN AND
SCHEME OF THE CUSTOMS ACT, 1962 ARE TO CONSOLIDATE
AND AMEND THE LAW RELATING TO CUSTOMS. IT REPEALED :-
> THE SEA CUSTOMS ACT, 1878,
> THE INLAND BONDED WAREHOUSES ACT, 1896,
> THE LAND CUSTOMS ACT, 1924, AND
> THE AIRCRAFT ACT 1934.
THE CUSTOMS ACT, 1962, AS AN ADJECTIVE LAW, LAYS
DOWN THE PROCEDURE AND FORMALITIES CONNECTED WITH
COLLECTION OF CUSTOMS REVENUE, BOTH ON IMPORT AND
EXPORT OF GOODS. AT THE SAME TIME, IT IS CONCERNED WITH
PROHIBITIONS AND RESTRICTIONS ON IMPORTATION ON ITS
OWN. THE CUSTOMS ACT TELLS US :-
> WHEN IMPORT OR EXPORT TAKES PLACE AND WHEREFROM
SUCH OPERATION COMMENCE,
> WHAT ARE ILLEGALLY IMPORTED OR CONTRABAND GOODS,
> HOW ILLEGAL EXPORT IS PREVENTED OR DETECTED,
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> HOW ARE CUSTOMS DUTIES LEVIED OR EXEMPTED
PARTIALLY OR FULLY,
> HOW GOODS ARE ALLOWED TO BE IN TRANSIT AND THE
RESPONSIBILITY OF CARRIERS,
> WHEN AND HOW WAREHOUSING OF IMPORTED GOODS IS
ALLOWED, >HOW IS REFUND OR DRAWBACK OF DUTY
ALLOWED, WHAT CONTROL IS EXERCISED OVER COASTAL
GOODS,
> HOW THE POSTAL ARTICLES AND BAGGAGE DEALT WITH
AND ALLOWANCES THEREFOR ARE GIVEN,
> WHEN SEARCHES, SEIZURES AND ARRESTS ARE LEGAL,
> HOW ADJUDICATION IS MADE AND WHEN GOODS ARE
RELEASED OR CONFISCATED AND FINE
IN LIEU OF CONFISCATION AND PENALTIES ARE IMPOSED,
> WHEN CONVEYANCES ARE ALSO CONFISCATED,
> PROSECUTION FOR INFRINGEMENT OF CUSTOMS LAW IS
LAUNCHED, >HOW CLEARING AGENTS ARE APPOINTED TO
FACILITATE CLEARANCE OF GOODS AND HOW CONTROL IS
EXERCISED OVER THEM etc.
THE EXPORT IMPORT POLICY ALSO KNOWN AS THE TRADE
POLICY, IS A NECESSARY INSTRUMENT OF A GOVERNMENT TO
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REGULATE THE EXPORTS AND IMPORTS OF THE COUNTRY TO
ENSURE THE BALANCE OF TRADE. THE FOREIGN EXCHANGE
IS AVAILABLE TO THE GOVERNMENT ONLY THROUGH TWO
MEANS :-
> THE EXPORT PROCEEDS AND THE FOREIGN EXCHANGE
LOANS ; AND
> GRANTS FROM OTHER GOVERNMENTS AND INTERNATIONAL
AGENCIES ;
THE EXIM POLICY 1992-97
AS A RESULT OF THESE CHANGES, THE 1990-91 TO 1992-93
POLICY ALSO BECAME OUTDATED. HENCE, A NEW EXPORT
IMPORT POLICY WAS ANNOUNCED ON 31st MARCH 1992. IN
CONTRAST TO THE EARLIER THREE-YEAR POLICIES, THIS WAS A
FIVE YEAR POLICY EFFECTIVE FROM 1992-93 TO 1996-97. THIS
TIME FRAME COINCIDED WITH THE TIME FRAME FOR THE EIGHTH
FIVE YEAR PLAN.
THIS NEW POLICY SUBSTANTIALLY ELIMINATED LICENSING AND
QUANTITATIVE CONTROLS, BARRING TWO LISTS OF
PROHIBITED AND RESTRICTED ITEMS FOR BOTH EXPORTS AND
IMPORTS.
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OBJECTIVES OF THE EXIM POLICY 1992-97: - THE PRINCIPAL
OBJECTIVES OF THE EXIM POLICY 1992-97 ARE AS FOLLOWS :-
# TO ACCELERATE THE COUNTRYs TRANSITION TO AN
INTERNATIONALLY ORIENTED ECONOMY WITH A VIEW TO DERIVE
MAXIMUM BENEFIT FROM EXPANDING GLOBAL MARKET
OPPORTUNITIES;
# TO AUGMENT THE PRODUCTIVITY, MODERNIZATION AND
COMPETITIVENESS OF INDIAN AGRICULTURE, INDUSTRY &
SERVICES AND THEREBY TO ENHANCE THEIR EXPORT
POTENTIAL AND CAPABILITIES;
# TO ENCOURAGE THE ATTAINMENT OF INTERNATIONALLY
ACCEPTED STANDARDS OF QUALITY AND THEREBY IMPROVE THE
IMAGE OF INDIAs PRODUCTS ABROAD;
# TO STIMULATE INDIAs EXPORTS BY FACILITATING ACCESS
TO REQUIRED RAW MATERIALS, INTER-MEDIATES, COMPONENTS,
CONSUMABLE AND CAPITAL GOODS FROM THE INTERNATIONAL
MARKET;
# TO ENCOURAGE EFFICIENT AND INTERNATIONALLY
COMPETITIVE IMPORT SUBSTITUTION WITHIN THE LIBERALIZED
FRAMEWORK OF FOREIGN TRADE;
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# TO IMPART GREATER TRANSPARENCY IN THE
EXPORT- IMPORT POLICIES AND MINIMIZE QUANTITATIVE
RESTRICTIONS, LICENSING AND OTHER DISCRETIONARY
CONTROLS;
# TO STRENGTHEN AND STIMULATE THE COUNTRYs
RESEARCH AND DEVELOPMENT (R&D) CAPABILITIES;
# TO CONSERVE THE FORESTS A-ND WILDLIFE OF INDIA AND
ASSIST EFFORTS AT PRESERVATION, PROTECTION AND
PROMOTION OF A HEALTHY ECO SYSTEM FOR ENSURING
BALANCED AND SUSTAINABLE DEVELOPMENT; AND
# TO SIMPLIFY AND STREAMLINE THE PROCEDURES
GOVERNING EXPORTS AND IMPORTS.
EXIM POLICY 1997-2002
THE EXPORT IMPORT POLICY 1997-2002 CLEARLY
REFLECTS THE WILL OF THE GOVERNMENT TO LIBERALIZE THE
ECONOMY AT A GIVEN PACE. THE POLICY DEFINES AND
EXHAUSTIVELY EXPLAINS THE CATEGORIES OF IMPORTERS,
SPECIFIC PROVISIONS FOR IMPORT OF GOODS, SPECIAL
SCHEMES FOR IMPORTS HOW AND WHEN TO OBTAIN IMPORT
LICENSE FOR IMPORT OF THE ITEMS INCLUDED IN THE NEGATIVE
LIST, TERRITORIAL JURISDICTION OF LICENSING AUTHORITIES,
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CONDITIONS FOR ISSUE OF THE LICENSE VALIDITY OF IMPORT
LICENSES / CCPs, REVALIDATION OF LICENSE, THE BACKGROUND
OF THE POLICY CLEARLY SUGGESTS THAT INDIA WOULD ACHIEVE
THE LEVELS OF TARIFFS PREVAILING IN THE ASEAN COUNTRIES.
THE EFFORTS MADE IN THIS DIRECTION IS THROUGH THE
REDUCTION IN THE CUSTOMS DUTY ON CAPITAL GOODS FROM 25
% TO 20 %. THE SAID RATES ARE APPLICABLE TO THE PROJECT
IMPORTS. THIS OPTIMIZES THE INITIAL STEPS FOR FURTHER
REDUCTION OF THE DUTIES IN THE FORTHCOMING YEARS. THE
DUTY ON SEVERAL STEEL INDUSTRY INPUTS, LIKE COKING COAL,
FROM 5 % TO 3 %, THE DUTY ON COLD ROLLED COILS REDUCED
FROM 30 % TO 25 %, REDUCTION ON THE NON-COKING COAL
FROM 20 % TO 10 % TO HELP THE POWER SECTOR, BESIDES, THE
IMPORT PROCEDURES ARE FURTHER SIMPLIFIED , AGAINST
SEVEN APPLICATION FORMS REQUIRED FOR IMPORT OF VARIOUS
ITEMS IN THE NEGATIVE LIST ONLY ONE FORM WILL BE
REQUIRED. NOW MOST OF THE ITEMS ARE FREE FROM LICENSE.
ALSO, THE VALIDITY OF THE IMPORT
LICENSES AND CUSTOM CLEARANCE PERMITS IS UPTO 12
MONTHS, IN CASE OF NON-CAPITAL ITEMS, AND FOR CAPITAL
ITEMS THE VALIDITY OF THE LICENSES IS UPTO 24 MONTHS,
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FURTHER, REVALIDATION MAY BE GRANTED ON THE MERIT OF
THE INDIVIDUAL CASE. DECENTRALIZATION OF THE LICENSING
AUTHORITIES ON REGIONAL BASIS, FREE TRANSFERABILITY OF
GOODS SO IMPORTED EXCEPT UNDER CERTAIN CASES,
ANOTHER SIGNIFICANT FEATURE OF THE POLICY IS THE
ALLOWANCE OF THE IMPORTS OF THE SECOND HAND ITEMS
EXCEPT IMPORT OF THE USED RUBBER TYRES, THE POLICY HAS
FURTHER MODIFIED THE PROCEDURE FOR OBTAINING
IMPORTERS-EXPORTERS CODE NUMBER, THE SPECIAL IMPORT
LICENSE (SIL) ENTITLEMENT OF EXPORTERS HOLDING ISO 9000
OR IS/ISO 9000 CERTIFICATION HAS BEEN INCREASED FROM 2 %
TO 5 %, (SIL) ON EXPORT OF PRODUCTS OF SMALL SCALE
INDUSTRIES (SSIs) HAS BEEN INCREASED FROM 1 % TO 2 %, 542
RESTRICTED ITEMS HAVE BEEN LIBERALIZED FOR IMPORTS,
SPECIAL DEPRECIATION NORMS HAVE BEEN PROVIDED FOR
ELECTRONIC GOODS UPTO 70 % IN THREE YEARS AND ALSO
PERMISSION GRANTED FOR DISPOSAL, ON PAYMENT OF
APPLICABLE DUTY.
THE IMPORT OF ANY TYPE OF GOODS INTO INDIA IS
REGULATED BY GOVERNMENT OF INDIA AND ITS POLICIES IN THIS
REGARD IS ANNOUNCED BY DIRECTOR GENERAL OF FOREIGN
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WHICH HE COMES TO KNOW THAT SUCH FOREIGN EXCHANGE
CANNOT BE SO USED OR THE CONDITIONS CANNOT BE
COMPLIED WITH, SELL THE FOREIGN EXCHANGE
T0 AN AUTHORIZED DEALER OR TO A MONEY-CHANGER.
SECTION 8(4) - FOR THE AVOIDANCE OF DOUBT, IT IS HEREBY
DECLARED THAT WHERE A PERSON ACQUIRES FOREIGN
EXCHANGE FOR SENDING OR BRINGING INTO INDIA ANY GOODS
BUT SENDS OR BRINGS NO SUCH GOODS OR DOES NOT SEND OR
BRING GOODS OF A VALUE REPRESENTING THE FOREIGN
EXCHANGE ACQUIRED, WITHIN A REASONABLE TIME OR SENDS
OR BRINGS ANY GOODS OF A KIND, QUALITY OR QUANTITY
DIFFERENT FROM THAT SPECIFIED BY HIM AT THE TIME OF
ACQUISITION OF THE FOREIGN EXCHANGE, SUCH PERSON
SHALL, UNLESS THE CONTRARY IS PROVED, BE PRESUMED NOT
TO HAVE BEEN ABLE
TO USE THE FOREIGN EXCHANGE FOR THE PURPOSE FOR WHICH
HE ACQUIRED IT OR, AS THE CASE MAY BE, TO HAVE USED THE
FOREIGN EXCHANGE SO ACQUIRED OTHERWISE THAN FOR THE
PURPOSE FOR WHICH IT WAS