BIJU PATNAIK INSTITUTE OF IT & MANAGEMENT STUDIES, BHUBANESWAR

A
STUDY MATERIAL
ON
PROJECT APPRAISAL AND
FINANCING
Prepared by :

Prof. R. K. Mishra
Associate Prof. (Finance)

1 Prepared by : Prof. R. K. Mishra

Associate Prof. (Finance)
BIJU PATNAIK INSTITUTE OF IT & MANAGEMENT STUDIES, BHUBANESWAR

Prepared by : Prof. R. K. Mishra

MODULE-1 Associate Prof. (Finance)

PROJECT IDENTIFICATION AND FORMULATION

INTRODUCTION
Project may be defined as a plan for an undertaking involving huge cost and time. It can be
defined as a non – routine, non repetitive undertaking. Project is an organized unit dedicated
to the attainment of goal, on time, within budget, in conformance with pre-determined
programme specifications . The term project management refers to the proper execution of
projects and their control. The need for proper project management arises because of the
huge capital expenditure & long gestation period involved in it. Project management is a
difficult exercise in an ever changing environment where a number of factors influence the
success of execution of a project. But there are factors which could either be eliminated or
whose impact can be minimized. Project management is an organized venture for managing
projects. It involves scientific application of modern tools & techniques in planning,
financing, implementing, monitoring, controlling & coordinating unique activities or tasks to
produce desirable outputs in accordance with the pre – determined objectives within the
constraints of time and cost. Organizations perform work continuously. These works include
operations or projects though some works may overlap with each other. For the
organizations, projects are important elements of change. They are considered to be the
leading edge of change in organizations. A project consists of a combination of
organizational resources pulled together to create something that did not previously exist and
that will provide a performance capability in the design and execution of organizational
strategies. Projects are conceptualized, designed, engineered and produced (or constructed);
something is created that did not previously exist. An organizational strategy has been
executed to facilitate the support of ongoing organizational life. Projects therefore support
the ongoing activities of a going concern. For example,

• R&D project bridges the gap from an existing technology to a future technology.

• A new factory adds to the manufacturing capability.

• A new building contributes to the infrastructure of the city.

• A new highway improves transportation systems.

• A canal provides a waterway over land.

• A pipeline moves oil, gas, or water.

2 Prepared by : Prof. R. K. Mishra
Associate Prof. (Finance)
BIJU PATNAIK INSTITUTE OF IT & MANAGEMENT STUDIES, BHUBANESWAR

• A new house improves the living standards of a family.

Hence we can define a project as temporary endeavor to create a unique product or service. -
Project Management Body of Knowledge (PMOK)

Some more definitions are –

Newman et al. defined a project and described its value as simply a cluster of activities that is
relatively separate and clear-cut. Building a plant, designing a new package are examples. It
is "any undertaking that has definite, final objectives representing specified values to be used
in the satisfaction of some need or desire.” (Ralph Currier Davis)

PROJECT CHARACTERSTICS

1. Objective
2. Life cycle
(i ) Conception stage
(ii) Design stage
(iii) Implementation stage
(iv)Commissioning stage
3. Definite time limit
4. Uniqueness
5. Team work
6. Complexity
7. Sub – contracting
8. Risk and uncertainty
9. Customer specific nature
10. Change
11. Response to Environments
12. Forecasting
13. Rational choice
14. Optimality
15. Control mechanism

TAXONOMY OF PROJECTS

The term taxonomy refers to the science of classifying things by naming and identifying
them. Projects can be classified under different heads

BASED ON THE TYPE OF ACTIVITY

Under this category, projects can be classified as

3 Prepared by : Prof. R. K. Mishra

Associate Prof. (Finance)
BIJU PATNAIK INSTITUTE OF IT & MANAGEMENT STUDIES, BHUBANESWAR

A: Industrial Projects

B: Non – Industrial Projects

Industrial projects are set up for the production of some goods. Projects like health care
projects, educational projects, irrigation projects, pollution control projects, water supply
projects etc. come under the category of non- industrial projects.

BASED ON THE LOCATION OF THE PROJECT

Under this category, projects can be classified as national projects and international projects.
National projects are those set up within the national boundaries of a country, while inter-
national projects are set up in other countries

BAESD ON PROJECT COMPLETION TIME

Here projects can be classified as

A: Normal Projects

B: Crash Projects

Normal Projects are those for which there is no constraint on time. Crash Projects are those
which are to be completed within a stipulated time.

BASED ON OWNERSHIP

It can be classified into

A: Private Sector Projects

B: Public Sector Projects

C: Joint Sector Projects

A private sector project is one in which the ownership is completely in the hands of the
project promoters and investors. Public sector projects are those that are owned by the state.
Joint sector projects are those in which the ownership is shared by the government and by
private entrepreneurs.

BASED ON SIZE

Here projects can be classified as

A: Small Projects (up to Rs 1 cr in plant and mach.)

B: Medium sized projects

4 Prepared by : Prof. R. K. Mishra

Associate Prof. (Finance)
BIJU PATNAIK INSTITUTE OF IT & MANAGEMENT STUDIES, BHUBANESWAR

C: Large Projects (Above Rs 100 cr in plant and mach)

BASED ON NEED

Based on need, it can be

(i) New Project

(ii) Balancing Project

(iii) Expansion Project

(iv) Modernization Project

(v) Replacement Project

(vi) Diversification Project

(vii) Backward Integration Project

(viii) Forward Integration Project

PROJECT IDENTIFICATION

Identifying a new worthwhile project is a complex problem. It involves careful study from
many different angles. Following are some of the source from which new project ideas may
emerge.

PERFORMANCE OF EXISTING INDUSTRIES

Performance of existing Industries, provide a good indication about the health of a particular
industry.

An analysis of the profitability & break –even point of different industries will offer adequate
information about the financial health of different industrial sectors. One should also analyse
stage of the business cycle in which the different industries stand at a particular time.

AVAILABILITY OF RAW MATERIALS

Easy availability of good quality raw materials at cheaper prices is a definite indication that
some projects that can make use of those raw materials may be thought of.

AVAILABILITY OF SKILLED LABOUR

Based on the locally available skilled labour force, suitable industries that can make better
use of the skilled man power can be identified.

5 Prepared by : Prof. R. K. Mishra

Associate Prof. (Finance)
BIJU PATNAIK INSTITUTE OF IT & MANAGEMENT STUDIES, BHUBANESWAR

IMPORT/ EXPORT STATISTICS

Import/ Export statistics may reveal the potential of a particular industry.

PRICE TREND

The trend in the price of various products / services may give an indication about the
demand – supply relationship.

DATA FROM VARIOUS SOURSES

Various publications of government, banks, and financial institutions, research institutions

etc. contain data and statistic which may indicate prospective ventures.

RESERCH LABRATORIES

Research laboratories that are engaged in identifying new products/processes often offer new
avenues for commercial exploitation.

CONSUMPTION ABROAD

Those entrepreneurs who are willing to take higher risks can identify projects for the
manufacture of products or supply of services which are new to the country, but extensively
used abroad.

IDENTIFYING UNFULFILLED PSYCHOLOGICAL NEEDS

For some product groups, there may be unsatisfied psychological needs, though the physical
needs of the consumers might have been satisfied. New products of this group being
introduced and accepted by the consumers indicate the unfulfilled psychological needs of the
consumers.

PLAN OUTLAYS AND GOVERNMENT GUIDELINES

Government’s plan of outlays in different sectors provide useful pointers towards possible
investment opportunities.

PROJECT PREPARATION
Project preparation consists of four stages

A) Pre-feasibility study

B) Functional studies (or support studies)

6 Prepared by : Prof. R. K. Mishra

Associate Prof. (Finance)
BIJU PATNAIK INSTITUTE OF IT & MANAGEMENT STUDIES, BHUBANESWAR

C) Feasibility study

D) Detailed project analysis (leading to the preparation of Detailed Project Report).

Pre-Feasibility Study

A pre-feasibility study has the following main objectives.

(a) To determine whether the project offers a promising investment opportunity.

(b) To determine whether there are any aspects of the project that are critical requiring in-
depth investigation by way of market surveys, laboratory test etc.

© To determine the estimation of project cost, means of financing, cost of production, sales
revenue, financial profitability and social benefits etc.

(d) The market potential for the selected products/services , the competitions in the field and
their market share, the market forecast, the trading practices in the industry in terms of
pricing, credit, Government controls etc.

(e) The technologies available and the technology suitable for the project, the manufacturing
facilities required in terms of plant and machinery.

(f) The availability, cost and sources of raw materials.

(g) plant location.

(h) plant capacity.

(i) The man power requirement in terms of labour, staff and management personnel, their
availability and cost.

(j) Investment required, return on investment expected, means of financing the project, cost
of production and commercial profitability .

If the pre-feasibility study indicates that the project is a worthwhile proposition, a feasibility
study is taken up. If the pre-feasibility indicates certain areas of project that need a detailed
study, such studies are taken up before taking up feasibility study. Such studies are also
known as support studies of functional studies.

Support Studies (functional studies)

Support studies may be conducted in any of the following areas.

(i) Market study

(ii) Raw material/input study
(iii)Project location study

7 Prepared by : Prof. R. K. Mishra

Associate Prof. (Finance)
BIJU PATNAIK INSTITUTE OF IT & MANAGEMENT STUDIES, BHUBANESWAR

(iv) Plant size study

(v) Equipment selection study etc.

Pre-feasibility study might arrive at a conclusion that the success of the venture depends
upon successfully marketing the product in view of the stiff competition prevailing . In such
a case, the need for a detailed market study arises. If the detailed market study reveals that
marketing the proposed product successfully would be a difficult preposition, there is no
point in taking up feasibility study and the project can be better rejected .The need for a raw
material study might arise when there are many different raw materials available for
producing the same product and whose cost of procurement, cost of transportation,
continuous availability, quality etc., vary widely .

Project location study might look into aspects like nearness of raw material source , nearness
of market for the finished product, cost of transportation of raw material/finished product,
nearness to air ports/sea ports, availability of labour etc . Plant size study is undertaken when
there are several technologies available each with a different economic plant size. The study
should also take into account the cost of production with each technology, the extent of
market that is available for the finished product etc . Equipment selection study is undertaken
when the sources of supply of equipments and the cost vary very much . The capital cost of
the equipments, the operational cost, the after-sales support , the operational efficiency of
the plant etc. are some of the factors that are studied under equipment selection study .

Feasibility Study

Before making a final decision to take up a project, the technical, economic, commercial and
financial justification of the chosen project shall be ascertained in concrete terms .

Feasibility study is also known by the term ‘techno-economic feasibility study’.

Technical Feasibility

The technical feasibility can be evaluated by answering the following questions.

(a) Is the technology proposed to be adapted, the latest one?

(b) What is the likelihood of the proposed technology becoming obsolete in the near future?

© Is the technology proposed to be adapted, a proven technology?

(d) Is the technology proposed to be adapted, available indigenously?

(e) In case of imported technology, is the technology available easily?

8 Prepared by : Prof. R. K. Mishra

Associate Prof. (Finance)
BIJU PATNAIK INSTITUTE OF IT & MANAGEMENT STUDIES, BHUBANESWAR

Economic viability

In simple terms, economic viability is an examination as to whether the investment made on

the project will give a satisfactory return to the economy. The major aspects to be looked into
are as to whether the project will make better use of available raw material, whether the
project will reduce/eliminate the use of some scarce/valuable resources, whether the
community as a whole will stand to gain as a result of the project etc.

Commercial Feasibility

Commercial Feasibility: Before producing any product/service, the scope for successfully
marketing the product/service shall be carefully and accurately assessed. If the
product/service proposed is new to the industry, conducting a systematic market survey is a
pre-requisite for assessing the probable estimates of likely sales.

Financial Feasibility

The financial feasibility examines the value of project proposal in respect of raising finance
to meet the investment required for the project, be it equity or debt. It consists of
calculations of cost of debt, cost of procuring capital, anticipated profits to checkup whether
the financial benefits expected are in excess of the financial costs involved , NPV calculation,
capital budgeting, budgeting etc

Detailed Project Report (DPR)

The DPR will contain almost the same information contained in the feasibility study , but in
a more detailed format. The main idea of preparation of the DPR is to formally communicate
the project promoter’s decision of venturing a new project to financial institutions for their
perusal and to Government departments for getting their approvals.

The main sub divisions of a DPR are the following :

1. General information about the project

2. Background and experience of the project promoters
3. Details and working results of industrial concerns already owned/promoted by the
project promoters
4. Details of the proposed project .
5. Details of the proposed project
6. Plant capacity
7. Manufacturing process
8. Technical known-how
9. Management team for the project

9 Prepared by : Prof. R. K. Mishra

Associate Prof. (Finance)
BIJU PATNAIK INSTITUTE OF IT & MANAGEMENT STUDIES, BHUBANESWAR

10. Details of land, building , plant and machinery

11. Details of infrastructural facilities (power, water,transport etc)
12. Raw material requirement/availability
13. Effluents produced by the project/effluent treatment arrangements
14. Labour requirements/availability
15. . Schedule of implementation of the project
16. Project cost
17. Means of financing the project
18. Working capital requirement/arrangements made
19. Marketing and selling arrangements
20. Profitability and cash-flow estimates
21. Mode of repayment of term loan
22. Government approvals, local body consents and other statutory permissions.
23. Details of collateral security that can be offered to the financial institution .

Zero based project formulation

In this type of project the project promoter should think to start from zero base. A logical
and rational project formulation is possible if the project promoter poses the question “is it
necessary?” to every component of the project cost. This may reveal an entirely different
aspect of the project. Each element of the fixed cost requires an unbiased, rational study
without any pre-conceptions in order to arrive at a decision as to their necessity for
inclusion in the project.

Summary
Project may be defined as a plan for an undertaking involving huge cost and time. It can be
defined as a non – routine, non repetitive undertaking. Project is an organized unit dedicated
to the attainment of goal, on time, within budget, in conformance with pre-determined
programme specifications . The term project management refers to the proper execution of
projects and their control. The need for proper project management arises because of the
huge capital expenditure & long gestation period involved in it. Project management is a
difficult exercise in an ever changing environment where a number of factors influence the
success of execution of a project.

A detailed study of different types of projects with reference to sequence of stages or

processes used in each case would provide us an idea to use project management in a most
effective manner. The success of a project-based organization lies in managing a portfolio of
projects.

The term taxonomy refers to the science of classifying things by naming and identifying
them. Projects can be classified under different heads. Industrial projects are set up for the
production of some goods. Projects like health care projects, educational projects, irrigation
10 Prepared by : Prof. R. K. Mishra
Associate Prof. (Finance)
BIJU PATNAIK INSTITUTE OF IT & MANAGEMENT STUDIES, BHUBANESWAR

projects, pollution control projects, water supply projects etc. come under the category of
non- industrial projects. , projects can be classified as national projects and international
projects. National projects are those set up within the national boundaries of a country, while
inter-national projects are set up in other countries. A private sector project is one in which
the ownership is completely in the hands of the project promoters and investors. Public sector
projects are those that are owned by the state. Joint sector projects are those in which the
ownership is shared by the government and by private entrepreneurs.

Performance of existing Industries, provide a good indication about the health of a particular
industry. An analysis of the profitability & break –even point of different industries will offer
adequate information about the financial health of different industrial sectors. One should
also analyse stage of the business cycle in which the different industries stand at a particular
time.

Project preparation consists of four stages

A) Pre-feasibility study, B) Functional studies (or support studies), C) Feasibility study, D)

Detailed project analysis (leading to the preparation of Detailed Project Report).

Before making a final decision to take up a project, the technical, economic, commercial and
financial justification of the chosen project shall be ascertained in concrete terms. Feasibility
study is also known by the term ‘techno-economic feasibility study’.

The DPR will contain almost the same information contained in the feasibility study, but in a
more detailed format. The main idea of preparation of the DPR is to formally communicate
the project promoter’s decision of venturing a new project to financial institutions for their
perusal and to Government departments for getting their approvals.

11 Prepared by : Prof. R. K. Mishra

Associate Prof. (Finance)
BIJU PATNAIK INSTITUTE OF IT & MANAGEMENT STUDIES, BHUBANESWAR

MODULE-2
PROJECT COST ESTIMATION AND PROJECT APPRAISAL
Project appraisal is a process of detailed examination of several aspects of a given project
before recommending the same. It is divided into

1.Technical appraisal

2.Commercial appraisal

3.Economic appraisal

4.Financial appraisal

5.Management appraisal

6.Social cost benefit analysis.

Technical appraisal

It includes

1. Selection of process /technology

2. Scale of operations

3. Raw material

4. Technical know-how

5. Collaboration agreement

6. Product mix

7. Selection and procurement of plant and machinery

8. Plant layout

9. Location of the project

10. Project scheduling and implementation

12 Prepared by : Prof. R. K. Mishra

Associate Prof. (Finance)
 BIJU PATNAIK INSTITUTE OF IT & MANAGEMENT STUDIES, BHUBANESWAR

Location of projects

Choosing the location for a new project is to be done taking many factors into account. The
study for plant location is done in two phases. First a particular region/territory is chosen that
is best suited for the project. Then, within the chosen region, the particular site is selected.
Thus, we may say that there are two major factor viz, Regional factors and site factors.

Regional factors

Raw materials : To procure raw material at minimum cost , the plant must be located nearer
to the place where raw material is available so that transportation cost will be reduced and the
number of middle men involved in the procurement process also will be reduced .

Proximity to market

If transportation of the finished product is more difficult (due to the special nature of the
finished product) than transporting the raw material and also if the cost of transporting the
finished product is more as compared to the transportation cost of raw material , it is
advantageous to locate the plant nearer to the market .

Availability of Labour

Though unemployed people are in plenty in our country , this does not mean that there will
be no problem in getting the labour force required for the project . Availability of skilled
labour is what is the criterion rather than availability of unemployed who are unemployable .
If the project needs skills of general nature, people can be recruited and trained to the
requirement . If the project needs skills of special nature, getting adequate skilled labour will
not pose any problem if the plant is located in areas where skilled labour force is available .

Availability of supporting industries

If a firm has proposed to get some of the production operations done from out side , there
must be suitable industries existing in the surrounding area to undertake such subcontracting
works .

Availability of infrastructural facilities

Availability of power , water, and transport facilities are the important aspects to be
considered under this head .

Power

Power intensive industries should be located at places where regular power supply is
available. If the manufacturing process is such that sudden power failure may disturb the
manufacturing activities and may cause considerable losses, it is always advisable to keep

13 Prepared by : Prof. R. K. Mishra

Associate Prof. (Finance)
BIJU PATNAIK INSTITUTE OF IT & MANAGEMENT STUDIES, BHUBANESWAR

power generators as a standby . In such cases, the cost of generator should be included in the
project cost

Water

Water requirement for the project should be correctly arrived at . After having arrived at the
water requirement , it must be checked if the required quantity of ground water can be
obtained from the site . The level of ground water table may be checked by observing the
open wells nearby .

Transport Facilities

Transportation costs are incurred in two stages. Firstly, for the transport of raw materials and
fuel into the factory site and secondly for the movement of the finished goods from the
factory site . Hence easy and cheap transport facilities are the most desired features. Locating
industries in backward areas, growth center areas. Government identifies regions which are
lacking in industrial development and notify them as back ward areas, most-backward areas,
etc. Government also notifies growth centres which have potential for high growth . The
Government offers many incentives in the form of capital subsidy, sale tax concessions,
concessional financial assistance etc.)

Climatic factors

Climatic factors have some influence in certain type of industries. Textile spinning mills, for
example require high humidity for the spinning of cotton yarn . Hence places with high
ranges of humidity are suitable for locating cotton-spinning mills .

Site Factors

After having chosen a region that is comparatively more advantageous for the location of a
factory, for choosing a particular site in the chosen region, considerations like cost of land ,
suitability of land , availability and suitability of ground water, facilities for effluent disposal
etc. are to be taken into account . In general , industrial projects require considerable extent
of land . If the unit cost of land is high , the investment required to be made on land may
become prohibitively high , which should be looked into . Apart from cost of land , the soil
suitability also plays a major role . Since industrial projects mostly involve heavy machinery
which need strong foundations, the load bearing capacity of the soil should be sufficient to
withstand the pressure. Pollution control authorities some times stipulate conditions that
major polluting industries should not be located within a minimum stipulated distance from
natural watercourses . Hence, before choosing the sit location for polluting industries, the
possibility of getting consent from the concerned authorities should be ascertained
beforehand .

14 Prepared by : Prof. R. K. Mishra

Associate Prof. (Finance)
BIJU PATNAIK INSTITUTE OF IT & MANAGEMENT STUDIES, BHUBANESWAR

Choice of location

Decision on the choice of location for the given project is to be made after considering the
points enumerated above. In view of the number of factors involved, deciding upon the
project location is a complex problem. The problem is compounded further because of the
existence of both tangible and intangible factors.

Choice of location based on tangible factors

When tangible factors alone are considered, an ideal location is one for which the sum of cost
of procuring raw materials, cost of processing the raw material into finished product and cost
of distributing the finished product to the customers in minimum .

Observation

When only the tangible factors are considered location-A scored marginally higher over
location-D, as evidenced by marginally higher return on investment. However, when both
tangible and intangible factors are considered, location-D becomes preferable to location –A .

PROJECT SCHEDULING

Scheduling is nothing but the arrangement of activities of the project in the order of time in
which they are to be performed .The schedule which broadly indicates the logical sequence
of events would be as under .

(i) Land acquisition .

(ii) Site development

(Preparing building plans, estimates, designs, getting necessary approvals and entrusting the
construction work to contractors .

(iii) Construction of building, machinery foundation and other related civil works and
completion of the same.
(iv) Placing order for machinery.
(v) Receipt of machinery at site.
(vi) Erection of machinery.

Commissioning of plant and taking trial runs .Commencement of regular commercial

production.

Each of the above mentioned activities consume resources viz, time, money and effort. The
sequence of activities should be so planned as to minimize the resource consumption.
Without proper scheduling, resources are very likely to be wasted ) .

15 Prepared by : Prof. R. K. Mishra

Associate Prof. (Finance)
BIJU PATNAIK INSTITUTE OF IT & MANAGEMENT STUDIES, BHUBANESWAR

Economic Appraisal

Economic appraisal measures the effect of the project on the whole economy . Developing
countries and underdeveloped countries face scarcity of capital and foreign exchange .Hence
in the overall interest of the country, the limited stocks of capital and foreign exchange
should be put into the best possible use . Hence, policy makers are concerned as to where the
scarce resources can be directed to maximize economic growth of the country . So, among
the alternative projects, the policy makers make a choice based on the economic return . This
is true irrespective of whether resources are committed to a large project under taken by the
Government or to a smaller project under taken by an individual entrepreneur .

Financial Appraisal

Financial appraisal of project consists of two major areas viz . arriving at the cost of the
project and arriving at the appropriate means of financing the project . By means of financing
, we mean the combination of equity and debt . The proper equity-debt combination for a
project depends upon the revenue earning capacity of the project .

Commercial Appraisal

The Commercial appraisal is concerned with market for the product/service . The very idea
of promoting a project is to produce some product/service and to market the same to the
consumers and earning a profit thereby . Hence, market appraisal occupies a prime place in
project appraisal .

(i) Demand for the product

(ii) Supply position for the product
(iii) Distribution channels
(iv) Pricing of the product
(v) Government policies

Demand

Economists define demand for a commodity as the desire backed by the necessary
purchasing power. One of the most important determinants of a firm’s profitability is the
demand for its products. Inspite of an efficient and technologically advanced production
process and inspite of efficient financial management and cordial inter-personnel relationship
between the employees and the management, the firm will find it difficult to earn profit if its
products are not demanded by the consumers . The term ‘demand’ can be defined as the
number of units of a particular good or service that consumers are willing to purchase during
a specified period under a given set of conditions .

16 Prepared by : Prof. R. K. Mishra

Associate Prof. (Finance)
BIJU PATNAIK INSTITUTE OF IT & MANAGEMENT STUDIES, BHUBANESWAR

Demand Forecasting Techniques

A forecast is a prediction or estimation of a future situation . No forecast can be cent percent

correct, however scientifically designed the forecasting techniques are, in view of the reason
that future is uncertain.

Survey Methods

Jury of expert’s opinion method

In this method, experts in the particular field are requested to give their views on the likely
demand for the product in future . They are the persons who have been dealing in this
product and in related products for a long time and thus are able to predict the future trend .If
the views of more number of experts are obtained , and if their views differ significantly,
then a forecast can be safely arrived at by taking the average of the expert’s predictions .

Delphi technique

This is a group decision by experts in which the individual experts act separately . Their
views are pooled together and an attempt is made to arrive at a conclusion . If the views of
the experts differ significantly , the individual experts discuss with other experts in areas
where there is distinct difference and they are asked to further analyze the problem and to
revise/improve upon their in the light of the views of the other experts in the group . The
process can be repeated till a near conclusion of views is achieved .

Consumer’s survey method

This is the most direct approach to demand forecasting . In this method, consumers are
approached and asked to express their opinion of a particular product . The survey can cover
all the consumers if the consumers are smaller in number (eg. Medical practitioners) . If the
number of consumers is large, a selected group of consumers is chosen for the survey .

Sales forecast composite

This method of sales forecasting relies on the judgement of sales personnel . The field level
sales personnel are requested to offer their forecast in their respective geographic area, to
their sales managers .The forecasts of sales personnel are pooled together and the estimate
given by each person is adjusted by applying appropriate weights and the adjusted forecasts
are combined to arrive at the composite forecast .

Statistical Methods

Statistical methods make use of past data . The past data are arranged in a chronological
order and some statistical method is used to identity the trend indicated by the past data . The
trend is then extended to the future period . This process of extending the past trend to the

17 Prepared by : Prof. R. K. Mishra

Associate Prof. (Finance)
BIJU PATNAIK INSTITUTE OF IT & MANAGEMENT STUDIES, BHUBANESWAR

future is called extrapolation . The statistical methods are of two types, namely, (1) trend
analysis and (2) regression technique .

Trend analysis

The following are some of the methods used in trend analysis to estimate the future demand
based on the past data .

Curve fitting

Moving average method

Weighted moving average method

Exponential smoothing method

Management Appraisal

A good project at the hands of a poor management may fail while a not-so-good project at
the hands of an effective management may succeed.

Lending institutions look at two points before committing their funds to project financing

1.Capacity of the project to repay the loan

2.Willingness to repay

Integrity, foresightedness, ledership qualities, interpersonnel relationship, technical and

financial skills,commitment etc. are some of the parameters that need to be studied in
management appraisal.

SOCIAL COST BENEFIT ANALYSIS

There are some projects that may not offer attractive returns as for as commercial
profitability is concerned, but still such projects are undertaken since they have social
implications . Such projects are public projects like road, railway , bridge and other transport
projects, irrigation projects ,power projects etc., for which socio-economic considerations
pay a significant part rather than mere commercial profitability.

Such projects are analysed for their net socio- economic benefits and the profitability
analysis of such projects is known as national profitability analysis, which is nothing but the
socio-economic cost-benefit analysis done at the national level .

As against the direct cost and direct benefits that are alone considered for commercial
profitability analysis , socio-economic cost-benefit analysis takes into account the indirect
costs, and indirect benefits to the nation .

18 Prepared by : Prof. R. K. Mishra

Associate Prof. (Finance)
BIJU PATNAIK INSTITUTE OF IT & MANAGEMENT STUDIES, BHUBANESWAR

Objectives of Social Cost Benefit Analysis (SCBA)

Contribution of the project to the GDP (Gross Domestic Product) of the economy .

Contribution of the project to improve the benefits to the poorer sections of the society and to
reduce the regional imbalances in growth and development .

Justification of the use of scarce resources of the economy by the project.

Contribution of the project in protecting/improving the environmental conditions .

Approaches to Social Cost Benefit Analysis

There are two main approaches to Social Cost Benefit Analysis , Viz , the UNIDO Approach
and the Little –Mirrlees Approach .

UNIDO Approach to SCB Analysis

(Famous economists Stephen Marglin, Amertya Sen and Partha Dasgupta prepared a
manual based on UNIDO’s experience in cost-benefit analysis of projects .

The UNIDO approach places emphasis on “aggregate consumption” for the reason that it is
one of the important parameters for the measurement of the standard of living . As per
UNIDO approach, the raising of the standard of living of people, and hence the raising of
aggregate consumption is an important objective for social projects.

Shadow Prices : As explained already, for social cost-benefit analysis, the market prices of
both inputs and outputs of a project are required to be corrected suitably if they do not
represent the ‘real’ prices of inputs/outputs. Such corrected price of inputs/outputs is known
as shadow price . Hence, the shadow price takes care of the distortions in the market price by
suitably adjusting the market price .

The little-Mirrlees Approach

I.M.D. Little and James A. Mirrlees produced the “Manual of industrial Project Analysis in
Developing Countries” in 1968 for the Development Centre of the Organisation for
Economic Cooperation and Development (OECD).

19 Prepared by : Prof. R. K. Mishra

Associate Prof. (Finance)
BIJU PATNAIK INSTITUTE OF IT & MANAGEMENT STUDIES, BHUBANESWAR

CHAPTER – 3

PROJECT FINANCING AND RISK ANALYSIS

In project appraisal, risk analysis pay an important part. All projects afre prone to some kind
of risk or the other.

Project Completion Risks

Completing the project in time and within the estimated cost itself is a major achievement . A
project that is delayed will result in time over-run which will consequently result in cost
over-run . There can be also technology failures, which may result in non-completion of
projects. For projects with long gestation period in the fields of fast developing technology ,
there is risk of project not being completed due to technology, there is risk of project not
being completed due to technological obsolescence during the course of project
implementation ) .

Resource Risk

Raw material, power, fuel, manpower etc. are the resources used by a project. Shortage of
raw material may lead to reduction in capacity utilization and higher cost of production ,
which will make all profitability estimates wrong . Similarly, shortage of power ,fuel, and
shortage of skilled manpower will also jeopardize the project profitability calculations and
the project may run the risk of not earning the estimate returns .

Price risk

Price fluctuations of both inputs and outputs (i.e. , raw material and finished products) affect
the project.

Technology risk

Technology risk may appear in two forms . A project that is based on unproven technology
(i.e., a technology that is proved at laboratory level but not proved at commercial level) may
have hidden defects which may make the project a non-starter . Rapid growth in technology
may make a project obsolete in technology due to the evolution of latest technology.

Political risk

The Government intervenes in many forms such as levying and regulating taxes, regulating
monopolistic trade practices, imposing import duties, promoting exports, prohibiting export
of certain commodities, issuing import licences, controlling foreign exchange transactions ,
price controls , expropriation, nationalization etc. Political risk is a major risk since it can not
be predicted easily.

20 Prepared by : Prof. R. K. Mishra

Associate Prof. (Finance)
BIJU PATNAIK INSTITUTE OF IT & MANAGEMENT STUDIES, BHUBANESWAR

Interest rate risk

Fluctuations in interest rate may bring in an adverse effect .For example, if a project is
funded by way of long-term borrowings at a particular rate of interest, and if the interest rate
falls down subsequently, the project that availed long-term borrowing at a higher interest rate
has to service the loan only at the higher rate of interest

Exchange rate risk

Exchange rate risk (also called currency risk) is the risk arising from currency fluctuations .
Volatile exchange rates can reduce cost and productivity advantages gained over year of
hard work . Firms exposed to international economy face this risk

Techniques of Risk Analysis

Break Even analysis

Sensitivity analysis

Decision tree analysis

Monte-carlo technique

Game theory

Break Even Analysis

Break even point (BEP) refers to the level of operation at which the project neither earns
profit nor incurs loss . Calculation of BEP for the given cost and price levels indicate the
minimum capacity utilization that the project should aim at in order to be in a no-profit, no-
loss situation. BEP also helps in identifying the level of profit/loss for a specified level of
operation and the level of operation required to attain a specified profit/to avoid a specified
loss etc.

Sensitivity Analysis

It is a technique that measures the change in the profitability of a project caused by changes
in the factors that affect the cash inflows of the project . If a small change in one factor leads
to a major change in the profitability of the proposed investment, the project is considered
more sensitive to that factor, in other words, the project is more risky . Other things being
equal, a project that is less sensitive is preferable to projects that are more sensitive .

What happens to the NPV if the demand for the product drops down?

What happens to the NPV if the economic life of the project reduces?

21 Prepared by : Prof. R. K. Mishra

Associate Prof. (Finance)
BIJU PATNAIK INSTITUTE OF IT & MANAGEMENT STUDIES, BHUBANESWAR

What happens to the DRCR if the selling price for the product falls down Etc.?

Decision tree analysis

Decision tree approach is a graphical technique that can be used for analyzing the pros and
cons of alternative decisions and choosing the best possible course of action. In real life
situation, decisions are taken under conditions of uncertainty. In project management this is
more so in view of the multiplicity of factors involved

A company, for example, might have to decide whether to go for investment in a large plant
or a small plant; whether to invest in a new venture or to acquire an existing company ;
whether to produce goods indigenously or to import from abroad etc, All such decisions are
taken keeping various factors in mind

Monte Carlo Simulation

‘Monte Carlo’ is a code name given by Von Newmann and Ulam to the technique of solving
problems using random numbers. Monte Carlo technique can be used to solve a variety of
problems involving stochastic situations. ( a stochastic situation is one where some or all
parameters of the problem are described by random variables.) It is a very popular technique
and it uses random numbers to solve problems requiring decision making under uncertainty
where a mathematical solution is highly complex/impossibl.

Game theory

In real life situation, business firms compete with one another . Game theory deals with
situations in which two intelligent opponents have conflicting interests. For example, two
business firms may compete for attracting the consumers towards their products. To achieve
their goals, the two firms will form strategies. The strategy that one firm forms will depend
upon the strategy that the other firm has already formed/in the process of forming . The
approach to such competitive problems was developed by Von Neumann who named it
“Game Theory” .

Project Cost Estimation

Cost of the project Correct estimation of the capital cost of a project is the foundation over
which the edifice of financial appraisal stands . Resources for the project are tied up after the
project cost is estimated. If the project cost is under-estimated, the project will run short of
funds during implementation .

Components of Capital Cost of a Project

The following are the components that constitute the capital cost of any project.

22 Prepared by : Prof. R. K. Mishra

Associate Prof. (Finance)
 BIJU PATNAIK INSTITUTE OF IT & MANAGEMENT STUDIES, BHUBANESWAR

a. Land
b. Land development
c. Buildings
d. Plant and machinery
e. Electricals
f. Transport and erection charges
g. Know-how/consultancy fees
h. Miscellaneous assets
i. Preliminary and preoperative expenses
j. Provision for contingencies
k. Margin money for working capital

PROJECT FINANCING
Introduction

Project financing involves non-recourse financing of the development and construction of a

particular project in which the lender looks principally to the revenues expected to be generated
by the project for the repayment of its loan and to the assets of the Project as collateral for its
loan rather than to the general credit of the project sponsor. Project financing may be defined as
the raising of funds required to finance an economically separable capital investment proposal in
which the lenders mainly rely on the estimated cash flow from the project to service their loans.

Rational

Project financing is commonly used as a financing method in capital-intensive industries for

projects requiring large investments of funds, such as the construction of power plants, pipelines,
transportation systems, mining facilities, industrial facilities, and heavy manufacturing plants.
The sponsors of such projects frequently are not sufficiently creditworthy to obtain traditional
financing or are unwilling to take the risks and assume the debt obligations associated with
traditional financings. Project financing permits the risks associated with such projects to be
allocated among a number of parties at levels acceptable to each party.

Project Financing Participants and Agreements

1. Sponsor/Developer

The sponsor(s) or developer(s) of a project financing is the party that organizes all of the other
parties and typically controls, and makes an equity investment in, the company or other entity
that owns the project. If there is more than one sponsor, the sponsors typically will form a
corporation or enter into a partnership or other arrangement pursuant to which the sponsors will

23 Prepared by : Prof. R. K. Mishra

Associate Prof. (Finance)
 BIJU PATNAIK INSTITUTE OF IT & MANAGEMENT STUDIES, BHUBANESWAR

form a "project company" to own the project and establish their respective rights and
responsibilities regarding the project.

2. Additional Equity Investors

In addition to the sponsor(s), there frequently are additional equity investors in the project
company. These additional investors may include one or more of the other project participants.

3. Construction Contractor

The construction contractor enters into a contract with the project company for the design,
engineering, and construction of the project.

4. Operator

The project operator enters into a long-term agreement with the project company for the day-to-
day operation and maintenance of the project.

5. Feedstock Supplier

The feedstock supplier(s) enters into a long-term agreement with the project company for the
supply of feedstock (i.e., energy, raw materials or other resources) to the project (e.g., for a
power plant, the feedstock supplier will supply fuel; for a paper mill, the feedstock supplier will
supply wood pulp).

6. Product Off taker

The product off taker(s) enters into a long-term agreement with the project company for the
purchase of all of the energy, goods or other product produced at the project.

7. Lender

The lender in a project financing is a financial institution or group of financial institutions that
provide a loan to the project company to develop and construct the project and that take a
security interest in all of the project assets.

First Step in a Project Financing: The Feasibility Study

As one of the first steps in a project financing the sponsor or a technical consultant hired by the
sponsor will prepare a feasibility study showing the financial viability of the project. Frequently,
a prospective lender will hire its own independent consultants to prepare an independent
feasibility study before the lender will commit to lend funds for the project.

24 Prepared by : Prof. R. K. Mishra

Associate Prof. (Finance)
 BIJU PATNAIK INSTITUTE OF IT & MANAGEMENT STUDIES, BHUBANESWAR

Contents

The feasibility study should analyze every technical, financial and other aspect of the project,
including the time-frame for completion of the various phases of the project development, and
should clearly set forth all of the financial and other assumptions upon which the conclusions of
the study are based, Among the more important items contained in a feasibility study are:

 Description of project.
 Description of sponsor(s).
 Sponsors' Agreements.
 Project site.
 Governmental arrangements.
 Source of funds.
 Feedstock Agreements.
 Off take Agreements.
 Construction Contract.
 Management of project.
 Capital costs.
 Working capital.
 Equity sourcing.
 Debt sourcing.
 Financial projections.
 Market study.
 Assumptions.

Principal Advantages and Disadvantages

1. Non-recourse

The typical project financing involves a loan to enable the sponsor to construct a project where
the loan is completely "non-recourse" to the sponsor, i.e., the sponsor has no obligation to make
payments on the project loan if revenues generated by the project are insufficient to cover the
principal and interest payments on the loan. In order to minimize the risks associated with a non-
recourse loan, a lender typically will require indirect credit supports in the form of guarantees,
warranties and other covenants from the sponsor, its affiliates and other third parties involved
with the project.

2. off-Balance-Sheet Treatment

Depending upon the structure of a project financing, the project sponsor may not be required to
report any of the project debt on its balance sheet because such debt is non- recourse or of
limited recourse to the sponsor. Off-balance-sheet treatment can have the added practical benefit

25 Prepared by : Prof. R. K. Mishra

Associate Prof. (Finance)
 BIJU PATNAIK INSTITUTE OF IT & MANAGEMENT STUDIES, BHUBANESWAR

of helping the sponsor comply with covenants and restrictions relating to borrowing funds
contained in other indentures and credit agreements to which the sponsor is a party.

3. Maximize Leverage

In a project financing, the sponsor typically seeks to finance the costs of development and
construction of the project on a highly leveraged basis. Frequently, such costs are financed using
80 to 100 percent debt. High leverage in a non-recourse project financing permits a sponsor to
put less in funds at risk, permits a sponsor to finance the project without diluting its equity
investment in the project and, in certain circumstances, also may permit reductions in the cost of
capital by substituting lower-cost, tax-deductible interest for higher-cost, taxable returns on
equity.

4. Maximize Tax Benefits

Project financings should be structured to maximize tax benefits and to assure that all available
tax benefits are used by the sponsor or transferred, to the extent permissible, to another party
through a partnership, lease or other vehicle.

Disadvantages

Project financings are extremely complex. It may take a much longer period of time to structure,
negotiate, and document a project financing than a traditional financing, and the legal fees and
related costs associated with a project financing can be very high. Because the risks assumed by
lenders may be greater in a non-recourse project financing than in a more traditional financing,
the cost of capital may be greater than with a traditional financing.

Financial Plan and Control in Projects

We have seen that cost and time are the important elements in a project. We have seen how
project scheduling keeps control on time and to some extent on cost also. Schedule plan is
fundamental to cost. But a financial plan is equally important in a project planning. Financial
management controls are also important part of monitoring and control of a project.

Financial Plan

It tells you:

• What each phase and work package in the project costs?

• Who is accountable to these costs?

• Whether the financial benefits derived from the project.

• Whether financial commitments made.

26 Prepared by : Prof. R. K. Mishra

Associate Prof. (Finance)
 BIJU PATNAIK INSTITUTE OF IT & MANAGEMENT STUDIES, BHUBANESWAR

• Whether cash flows forecasted.

• Whether financial authorization given.

• What is the net effect of the project on company's Balance Sheet and Profit and Loss

Account?

The elements of financial plan or analysis are

1. Cost of the Project

It is dependent upon

• The scope of the project

• The approach to the project

• The time-scale to complete the project

• The risks associated with the project

Conceptually the cost of the project represents the total of all items of outlay associated

with a project, which are represented by long-term funds. E.g.

• Fixed Assets like Land & building, machinery

• Technical Know-how costs, engineering fees

• Preliminary and capital issue expenses

• Margin money for working capital

• Contingency provisions

• Pre-operative expenses

2. Means of Finance

They are to meet the cost of the project and include

• Share capital

• Term loans

• Debentures

• Deferred credits

27 Prepared by : Prof. R. K. Mishra

Associate Prof. (Finance)
 BIJU PATNAIK INSTITUTE OF IT & MANAGEMENT STUDIES, BHUBANESWAR

• Incentives like subsidy

• Miscellaneous sources

Factors influencing the planning of Means of Finance

. Norms of Regulatory Bodies and Financial Institutions

Key Business Considerations like cost of funds, risk, control, and flexibility

3. Estimates of Sales and Production

Some considerations in this regard are-

1. It is not advisable to assume a high capacity utilization level in the first year of operation.
2. It is not necessary to make adjustments for stocks of finished goods. For practical
purposes, it may be assumed that production would be equal to sales.
3. The selling price considered should be the price realizable by the company net of excise
duty. It shall, however, include dealers' commission, which is shown as an item of
expense [as part of sales expenses].
4. The selling price used may be the present selling price - it is generally assumed that
changes in selling price will be matched by proportionate changes in cost of production.

4. Cost of Production

Given the estimated production, the cost of production may be worked out

The major components of cost of production are:

A. Material cost
B. Utilities cost
C. Labor cost
D. Factory overhead cost

5. Working Capital Requirement and its Financing

In estimating the working capital requirement and planning for its financing the following points
have to be borne in mind:

a. The working capital requirement consists of the following:

i] Raw materials and components [indigenous as well as imported]

ii] Stocks of goods-in-process [also referred to as work-in-progress]

iii] Stocks of finished goods

28 Prepared by : Prof. R. K. Mishra

Associate Prof. (Finance)
 BIJU PATNAIK INSTITUTE OF IT & MANAGEMENT STUDIES, BHUBANESWAR

iv] Debtors

v] Operating expenses.

b. The principal sources of working capital finance are:

i] Working capital advances provided by commercial banks ii] trade credit

iii] Accruals and provisions, and iv] long-term sources of financing.

c. There are limits to obtaining working capital advances from commercial banks.

They are in two forms:

i] The aggregate permissible bank finance is specified as per the norms of lending,

(prescribed by the Tandon Committee in India),

ii] Against each current asset a certain amount of margin money has to be provided by

the firm.

d. The Tandon Committee has suggested three methods for determining the maximum

permissible amount of bank finance for working capital. The method that is generally employed
now is the second method. According to this method, the maximum permissible bank finance is
calculated as follows:

Current assets as per the

- Non-bank current liabilities norms laid down by the like trade credit and provisions.

Tandon Committee.

The implication of this norm is that at least 25% of current assets must be supported by

long-term sources of finance.

e. The margin requirement varies with the type of current assets. While there is no fixed
formula for determining the margin amount, the ranges within which margin
requirements for various current assets lie are as follows.

Current Assets Margin Raw materials 10 - 25 per cent

Work-in-process 20 - 40 per cent

Finished goods 30 - 50 per cent

Debtors 30-50 per cent

29 Prepared by : Prof. R. K. Mishra
Associate Prof. (Finance)
 BIJU PATNAIK INSTITUTE OF IT & MANAGEMENT STUDIES, BHUBANESWAR

6. Profitability Projection [or Estimates of Working Results]

Given the estimates of sales revenues and cost of production, the next step is to prepare the
profitability projections or estimates of working results [as they’re referred to by term-lending
financial institutions in India].

7. Break-even Point

The profitability projections or estimates of working results discussed above are based on the
assumption that the project would operate at given levels of capacity utilization in future. In
addition to knowing what the projected profits would be at certain levels of capacity utilization,
it is also helpful to know what the level of operation should be to avoid losses. For this purpose,
the breakeven point, which refers to the level of operation at which the project neither makes
profit nor incurs loss, is calculated?

8. Projected Cash Flow Statements

The cash flow statement shows the movement of cash into and out of the firm and its net impact
on the cash balance with the firm. The format for preparing the cash flow statement, which is
really a cash flow budget, as prescribed by the all-India financial institutions is shown here.
While this format calls for preparing the cash flow statement on a half-yearly basis for the
construction period and an annual basis for the operating period [for ten years] for managerial
purposes, it may be helpful to prepare it on a quarterly basis for the construction period and half-
yearly basis for the first 2 to 3 operating years for managerial purposes. This would facilitate
better financial planning, project evaluation, and fund control.

Cash Flow Statement Sources of funds

1. Share issue

2. Profit before taxation with interest added back

3. Depreciation provision for the year

4. Development rebate reserve

5. Increase in secured medium and long-term borrowings for the project

6. Other medium/long-term loans

7. Increase in unsecured loans and deposits

8. Increase in bank borrowing for working capital

9. Increase in liabilities for deferred payment [including interest] to machinery suppliers

30 Prepared by : Prof. R. K. Mishra

Associate Prof. (Finance)
 BIJU PATNAIK INSTITUTE OF IT & MANAGEMENT STUDIES, BHUBANESWAR

10. Sale of fixed assets

11. Sale of investments

12. Other income

Disposition of Funds

1. Capital expenditure for the project

2. Other normal capital expenditure

3. Increase in working capital

4. Decrease in secured medium and long-term borrowings

- All India Institutions

-SFCs

- Banks

5. Decrease in unsecured loans and deposits

6. Decrease in bank borrowings for working capital

7. Decrease in liabilities for deferred payments [including interest] to machinery

suppliers

8. Increase in investments in other companies

9. Interest on Term Loans

10. Interest on bank borrowings for working capital

11. Taxation

12. Dividends

- Equity

- Preference

13. Other expenditure

- Opening balance of cash in hand and at bank

- Net surplus/deficit

31 Prepared by : Prof. R. K. Mishra

Associate Prof. (Finance)
 BIJU PATNAIK INSTITUTE OF IT & MANAGEMENT STUDIES, BHUBANESWAR

- Closing balance of cash in hand and at bank

9. Projected Balance Sheets

The Balance sheet, showing the balances in various asset and liability accounts, reflects the
financial condition of the firm at a given point of time. The format of Balance sheet prescribed
by the Companies Act is given below Format of Balance Sheet Prescribed by the Companies Act

Liabilities Assets

Share capital Fixed assets

Reserves and surplus Investments

Secured loans Current assets loan and advances

Unsecured loans Miscellaneous expenditures and - losses

Current liabilities

And provisions
Project Cash Flows
The three basic steps in determining whether a project is worthwhile or not is:
a] Estimate project cash flows.
b] Establish the cost of capital [or hurdle rate], and
c] Apply a suitable decision or appraisal criterion.
Measuring Project Cash Flows: Basic Principles
For developing the stream of financial costs and benefits, the following principles must
be kept in mind:
1. Principle of Incremental Cash Flows
2. Principle of Long Term Funds
3. Principle of Financial Costs Exclusion
4. Principle of Post-tax
Principle of Incremental Cash Flows
The cash flows of a project must be measured in incremental terms. To ascertain a project's
incremental cash flows, one has to look at what happens to the cash flows of the firm with the
project and without the project. The difference between the two reflects the incremental cash
flows attributable to the project.

32 Prepared by : Prof. R. K. Mishra

Associate Prof. (Finance)
 BIJU PATNAIK INSTITUTE OF IT & MANAGEMENT STUDIES, BHUBANESWAR

In estimating the incremental cash flows of a project, the following guidelines must be borne in
mind:
1. Consider all incidental effects
2. Ignore sunk costs
3. Include Opportunity costs

4. Question the allocation of overhead costs

Principle of Long Term Funds

A project may be evaluated from various points of view: total funds point of view, long- term
funds point of view, and equity point of view. The measurement of cash flows as well as the
determination of the discount rate for evaluating the cash flows depends on the point of view
adopted. It is generally recommended that a project may be evaluated from the point of view of
long-term funds [which are provided by equity stockholders, preference stock-holders, debenture
holders, and term-lending institutions] because the principal focus of such evaluation is normally
on the profitability of long-term funds. This argument, though plausible, cannot be regarded as
unassailable. Nonetheless, we subscribed to the position that it is quite reasonable to view a
project from the long-term funds point of view. Hence for determining the costs and benefits of
an investment project we will raise the questions. What is the sacrifice made by the suppliers of
long- term funds? What benefits accrue to the suppliers of long-term funds? The sacrifice made
by the suppliers of long-term funds is equal to the outlays on fixed assets and net working capital
[it may be recalled that net working capital, which represents the difference between current
assets and current liabilities, is supported by long-term funds]. The benefits accruing to the
suppliers of long-term funds consist of operational cash inflows after taxes and salvage value of
fixed assets and net working capital.

Cash Flow Stream Components

The cash flow stream associated with a project may be divided into three basic

Components:

[i] An initial investment

[ii] Operating cash inflows and

[iii] Terminal cash flow.

The initial investment represents the relevant cash outflow when the project is set up. The
operating cash inflows are the cash inflows that arise from the operation of the project during its
economic life. The terminal cash flow is the relevant cash flow occurring at the end of the project
life on account of liquidation of the project.

33 Prepared by : Prof. R. K. Mishra

Associate Prof. (Finance)
 BIJU PATNAIK INSTITUTE OF IT & MANAGEMENT STUDIES, BHUBANESWAR

Errors in Cash Flow Estimation

As cash flows have to be forecast far into the future, errors in estimation are bound to occur.

Yet, given the critical importance of cash flow forecasts in project evaluation, adequate care
should be taken to guard against certain biases, which may lead to over- statement or under-
statement of true project profitability.

Overstatement of Profitability

Knowledgeable observers of capital budgeting believe that profitability is often overstated

because the initial investment is under-estimated and the operating cash flow exaggerated.

The principal reasons for such optimistic bias appear to be as follows:

1. Intentional overstatement

2. Lack of experience

3. Myopic euphoria

4. Capital rationing

Under Statement of Profitability

The problem of optimistic bias may lead to an over-statement of project cash flows and
profitability. There can be an opposite kind of bias relating to the terminal benefit, which may
depress a project's true profitability.

1. Salvage values are under-estimated

2. Intangible benefits are ignored

3. The value of future options is overlooked.

Time Value of Money

Cash flows occur in a project at different point of time. Due to inflation the money value erodes
over a period of time. But this is not factored in the normal cash flow analysis. Hence different
discounting techniques may have to be used to represent correct value of cash flow.

Cost of Capital

A Firm's cost of capital is the rate of return it must earn on its investments for the market value
of the firm to remain unaffected. It can also be regarded as the rate of return required by
investors on capital provided by them. A central concept in financial management, linking the
investment and financing decisions, the cost of capital is important for three reasons:

34 Prepared by : Prof. R. K. Mishra

Associate Prof. (Finance)
 BIJU PATNAIK INSTITUTE OF IT & MANAGEMENT STUDIES, BHUBANESWAR

1. For a proper analysis of capital expenditure decisions, an estimate of the cost of capital is
required. The cost of capital is the discount rate used in the net present value calculation (time
value as discussed above) and also the financial yardstick against which the internal rate of
return is evaluated.

2. Several other decisions - like leasing, long-term financing, and working capital policy -
require estimates of cost of capital.

3. In order to maximize the value of the firm, the costs of all inputs [including thecapital input]
must be minimized and in this context the firm should be able to measure the cost of capital.

Some Misconceptions about cost of capital are

1. The concept of cost of capital is too academic or impractical.

2. The cost of equity is equal to the dividend rate or return on equity.

3. Retained earning are either cost free or cost significantly less than external equity.

4. Depreciation has no cost

5. The cost of capital can be defined in terms of an accounting-based measure.

6. If a project is heavily financed by debt, its weighted average cost of capital [WACC]

is low.

Financial Management Controls

They comprise

• Estimating the costs and benefits

• Obtaining authorization to spend funds

• Recording actual costs committed costs

• Forecasting future costs and cash flow

• Reporting

Of these we have already studied about estimating the costs and forecasting the costs and cash
flows, as a part of Financial Plan.

35 Prepared by : Prof. R. K. Mishra

Associate Prof. (Finance)
 BIJU PATNAIK INSTITUTE OF IT & MANAGEMENT STUDIES, BHUBANESWAR

Authorizing Spending of Funds

In case of process of authorization to spend funds the following criteria are to be looked into

• It should be consistent with the project framework • It should concentrate only on substantive
issues

• It should not be too lengthy

• There should not be redundancy

Recording of Actual Costs and Committed Costs

As far as the recording of actual costs and committed costs are concerned it should be noted that
it has nothing to do with normal bookkeeping, which is of no relevance to project management.
A system of capturing costs and commitments wherever they originate in your company and
allocating them to project is to be established. It is also necessary that this done in for each stage
to have control.

Financial Reporting

Financial reporting is converting accounting and operational data into meaningful information to
promote action.

Reports should be

• Timely

• Accurate

• Forward looking

Usually a financial report tells you what has been spent to date

• The expected outcome of the project

• The impact on the current financial year

• The cost of work yet to be done

• List of transactions, purchases made on the project

• Details of time booked to the project.

36 Prepared by : Prof. R. K. Mishra

Associate Prof. (Finance)
 BIJU PATNAIK INSTITUTE OF IT & MANAGEMENT STUDIES, BHUBANESWAR

CHARACTERISTICS OF PROJECT FINANCING

1. There is a presence of a special project entity.

2. The component of debt is very high and therefore gives raise to a highly leveraged firm.

3. Project financing is separated from the parent company’s balance sheet.

4. Debt servicing and repayments are done only from the cash flows arising from the projects.

5. Project financier’s risks are not entirely covered by the sponsor’s guarantee.

6. Third parties like suppliers, customers, government and sponsors commit to share the risk of
the project.

SOURCES THROUGH SHARES

ORDINARY SHARES:

Features

Advantages

Disadvantages

PREFERENCE SHARES

Features

Types

Advantages/Disadvantages

SOURCES THROUGH DEBT

DEBENTURES/BONDS

Features

Types

Advantages/Disadvantages

TERM LOANS

ICICI

37 Prepared by : Prof. R. K. Mishra

Associate Prof. (Finance)
 BIJU PATNAIK INSTITUTE OF IT & MANAGEMENT STUDIES, BHUBANESWAR

IDBI

IFCI

SIDBI

Equity/Ordinary Shares:

Equity share represent ownership capital and its owners- ordinary share holders/ equity holders-
share the reward and risk associated with the ownership of corporate enterprises. They are also
called ordinary shares in contrast with preference shares.

Preference Shares:

Preference share is a unique type of long term financing in that it combines some of the features
of equity as well as debentures. As a hybrid security or from of financing:

lly does not have voting rights.

A preference share ordinarily does not carry voting rights. It is, however, entitled to vote

every resolution if:

cumulative preference shares.

preceding
years or for an aggregate period of three/more years in the preceding six years ending with the
expiry of the immediately preceding financial year.

Debenture/ Bonds/ Notes:

Promissory note, debenture / bonds, represent Creditors hip securities and debenture holders are
long term creditors of the company. As a secured instrument, it is a promise to pay interest and
repay principal at stipulated times. In the contrast to equity capital which is a variable income
(dividend/ security, the debenture / notes are fixed income (interest) security).

Term loans:

Term loans are also known as term/ project finance. The primary source of such loans is
financial institutions. Commercial banks also provide term finance in a limited way. The
financial institutions provide project finance for new projects as also for

38 Prepared by : Prof. R. K. Mishra

Associate Prof. (Finance)
 BIJU PATNAIK INSTITUTE OF IT & MANAGEMENT STUDIES, BHUBANESWAR

expansion/diversification and modernization, whereas the bulk of term loans extended by banks
is in the form of working capital term loan to finance the working capital gap. Though they are
permitted to finance infrastructure projects on a long term basis, the quantum of such financing is
marginal. The term may be 6 to 10 years.

Shipping Credit Investment Company of India Ltd (SCICI)

SCICI is promoted by ICICI for the development of fishing and related industries. Financing of
projects are based on commercial viability after careful evaluation of each project. This is so
because the amount involved will be very high and the gestation period is also very long.

Advantages/Disadvantages

A balance has to be struck between debt and equity. A debt equity ratio of 1:1 is

considered ideal but it is relaxed up to 2:1 in suitable cases. Further relaxation in debt-

equity is made in the case of capital intensive projects. All long term loans/deferred

credit are treated as debt while equity includes free reserves.

PROMOTER’S CONTRIBUTION TO PROJECTS

The norm of promoter’s contribution in the project is 22.5% of project cost with a lower
contribution for projects promoted by technical entrepreneurs. Normally the promoter’s
contribution should be in the form of equity capital. If unsecured loans from promoters/directors
form an integral part of the means of finance, it should be assumed that they would not be
withdrawn during the currency of the loan and do not carry higher interest than that is payable on
the institutional loans. Preliminary expenses incurred by promoters are included in the
promoter’s contribution. It is important that no gap is left in the financing pattern of the project.
Otherwise, it will result in delays in the implementation of the project. The financial institutions
stipulate a condition that promoters shall arrange for funds to meet any overrun in the cost of the
project

OTHERS

(1) DEFERRED CREDITS

Projects are financed through deferred credits obtained from the suppliers of machinery and
equipment and/or bankers to the suppliers. If the credit is routed through the supplier and backed
by his financial obligation, it is called supplier’s credit and if it is a direct credit given to the
project, it is called buyer’s credit.

39 Prepared by : Prof. R. K. Mishra

Associate Prof. (Finance)
 BIJU PATNAIK INSTITUTE OF IT & MANAGEMENT STUDIES, BHUBANESWAR

Supplier’s credit

Suppliers do provide credit extended over a period, usually a substantial portion neatly 80-90%
of the equipment cost as a part of the sale contract. These facilities are available generally in
export of machinery and the credit is covered by the insurance and guarantee cover of the export
insurance agency of the supplier’s country. The supplier sells the machinery against a down
payment and asks the buyer to pay the balance over a fixed number of years in half yearly or
annual installment, with interest at a specified rate. These credits are mostly backed by bills of
exchange drawn on the buyer by the supplier or his banker.

Buyer’s credit

When the banker of the buyer gives a guarantee to the deferred payments by either issuing a
unconditional guarantee or by accepting or co-accepting the bills drawn on the buyer it is called
as buyer’s credit. When a bank gives financial guarantees beyond 12 months it is called a
deferred payment guarantees.

Deferred payment guarantees can be classified into the following:

1. Expressed in Foreign currencies

a) Favouring foreign lenders for financing plant and machinery.

b) Favouring Foreign lenders for financing raw material and stores

c) Favouring Indian financial institutions.

2. Expressed in Indian currency

Such deferred payment guarantees were very common in the past under a special scheme
formulated by the IDBI in order to enable the indigenous machinery suppliers to sell the machine
on credit terms.

2. LEASE FINANCING

Lease as a source of project financing is mainly suitable for expansion projects. This is because
of the reason that repayment of lease rentals start immediately after acquisition of the leased
asset by the lessee. New projects will take time for generating cash for repayment whereas
existing projects that go for expansion can start repaying immediately out of their cash
generation from their existing facilities.

3. UNSECURED LOANS

If there is some shortfall in the mean-of-finance, the promoters/directors can mobiliz funds from
their friends, relatives and well-wishers. Such loans are always unsecured i.e., the lenders cannot

40 Prepared by : Prof. R. K. Mishra

Associate Prof. (Finance)
 BIJU PATNAIK INSTITUTE OF IT & MANAGEMENT STUDIES, BHUBANESWAR

have any charge over the assets of the company. Banks and financial institutions stipulate the
following conditions if unsecured loan is to form part of the means-of-finance.

- The promoters shall not repay the unsecured loan till the term loan persists.

- Interest if any payable on unsecured loan shall be paid only after meeting the

term loan repayment committees.

-The rate of interest payable on unsecured loan shall not be higher than the rate of

interest applicable for term loans.

Normally unsecured loan component is expected not to exceed 50% of the equity capital.

4. INTERNAL ACCRUALS

Internal accruals form a part of the source of finance in respect of expansion projects.
Depreciation which is not cash expenditure and profits retained after payment of dividends are
the main sources of internally generated funds. As existing company that foes for an
expansion/diversification/modernization project may opt to finance a portion of the capital
investment out of internal cash accruals.

5. BRIDGE LOANS

This is a temporary loan meant for tying up the capital cost of the project. The necessity for
bridge finance arises in situations where finance from particular source is being delayed.
However, the availability of finance from that source is certain.

CAPITAL INVESTMENT SUBSIDY

Government provides subsidy for setting up of industries. The subsidy offered is of two

types:

(i) Area Subsidy (ii) Product Subsidy

(i) Area Subsidy: This is available for projects set-up in notified backward areas. Government
notifies backward areas from time to time based on the industrial activity prevailing in different
parts of the country. It will be between 15%-20% on the investment on fixed assets. Government
also extends subsidy to projects coming up in Industrial estates.

(ii) Product Subsidy: This is available for projects that manufacture specified products. These
products that are eligible for subsidy are identified by the government by keeping in view the
potential for the economic development of the country in such sectors of industries and notified
by the government. It ranges from 10%- 20% for different types of notified products.

41 Prepared by : Prof. R. K. Mishra

Associate Prof. (Finance)
 BIJU PATNAIK INSTITUTE OF IT & MANAGEMENT STUDIES, BHUBANESWAR

A project can avail only one subsidy. For example if food processing is eligible for 20% product
subsidy and if the project is going to be located in a notified backward area that is eligible for
15% area subsidy, the project promoters can choose only one, who will obviously choose 20%
product subsidy.

DISBURSEMENTS OF LOANS/LOAN ARRANGEMENT

TERMS AND CONDITIONS FOR GRANTING TERM LOANS FOR PROJECTS

Terms loans are granted subject to the following terms and conditions.

1. Clear title to land as security.

2. Insurance of assets, building and machinery separately.

3. Scrutiny of Articles of Association to ensure that it does not contain any restrictive clause
against covenants of the financial institutions.

4. Lien on all fixed assets.

5. Personal and corporate guarantees of major shareholders and associates concerns.

6. Approval of appointment of managerial personnel by DFI.

7. Payment of dividend and issue of bonus shares subject to the approval of financial
institution.

8. Undertaking for non-disposal of promoters shareholding for a period of 3 years.

Before the loan is disbursed, documents have to be executed and submitted. Stamp duty and
registration fees have to be paid.

PROCEDURE FOR DISBURSEMENT OF LOAN

After the loan has been sanctioned, the security documents should be obtained and charge on the
assets – present and future –created in favour of the bank. Thereafter, suitable disbursements
may be made, keeping in view the following aspects:

1) The bank should verify the status of implementation of the project. If no progress at all has
been made the reasons should be ascertained and satisfactory answers obtained.

2) As far as possible, disbursement should be made direct to the supplier of machinery or other
services in order to ensure that the proceeds of the term loan are not diverted for unauthorized
purposes.

42 Prepared by : Prof. R. K. Mishra

Associate Prof. (Finance)
 BIJU PATNAIK INSTITUTE OF IT & MANAGEMENT STUDIES, BHUBANESWAR

3) It is preferable to disburse the loan in installments instead of in one lump sum. Lump sum
disbursement of the entire loan will be permitted if the project or scheme involves one-time
acquisition of machinery.

4) It should be ensured that the projected debt-equity ratio of the project is maintained at all
stages of disbursement.

5) If the loan is sanctioned by a number of lenders to the project, the concerned bank’s
disbursement should be in proportion to its share in the loan.

6) After the disbursement of one installment, the next installment should be disbursed only after
verifying whether the earlier installment had been properly utilized.

7) Sometimes the borrower would request for interim loans or bridge loans, before the security
and other formalities are completed. Such requests may be acceded to by granting interim
advances for short periods of, say, 3 months, provided the bank is satisfied that the requisite
formalities would be completed within a short period.

After these requirements are complied, disbursements are made on the basis of assets created at
site. There has to be security matching, every disbursement starting with land and buildings. As
machines arrive, term loan is disbursed at 75% of their value, the cheque being made in the
name of the supplier. In case of large projects, disbursements are need based. In such cases,
promoters have to bring in their entire contribution.

Monitoring and Follow-up

The most important and yet quite difficult part of any loan is to monitor proper utilization of the
loan and follow-up the borrower’s performance and working results, so that the borrower does
not default on his financial commitments to the lender. The follow-up can be split into: (a)
follow-up during the implementation stage of the project; (b) follow-up after commencement of
commercial production.

The objectives of the follow-up during the implementation stage are:

(a) To ensure that the borrower mobilizes the various sources for the project in time.

(b) To ensure that the physical progress of the project is in accordance with the project
implementation schedule; and

(c) To ensure that, in the event of an escalation in the cist of the project, due to reasons beyond
the control of the borrower, the promoters bring in their proportionate share.

The above follow-up could be done by obtaining periodical reports from the borrower on the
progress – both physical and financial of the project.

43 Prepared by : Prof. R. K. Mishra

Associate Prof. (Finance)
 BIJU PATNAIK INSTITUTE OF IT & MANAGEMENT STUDIES, BHUBANESWAR

Objectives of follow-up after commercial production commence:

Once the project is set up and commercial production commences, the bank should put in place a
suitable mechanism to follow-up the performance of the project.

1) To ensure that the assets created or acquired for the project are put to effective use and well
maintained.

2) To monitor periodically the borrower’s financial position and working results by comparing
the actual performance with the earlier projections; if there is substantial variance, especially
negative, the reason thereof should be critically analyzed.

3) To ensure such corrective action, as may be warranted, on the basis of warning signals thrown
up during the course of monitoring.

4) To ensure that the borrower conforms to the terms of the loan more particularly periodical
payment of interest and repayment of loan.

Role of Financial Institutions in Project Financing

In India, All India Financial Institutions (like IDBI, ICICI, SIDBI, IRBI), State Financial
Corporations and Banks undertake project financing .

All India Financial Institutions and State Financial Corporations come under the category of
Development Finance Institutions (sometimes called Development Bankers) as against banks
which come under the category of commercial Financiers. Banks are the custodian of public
funds and thus they occupy the position of trustee . Hence, it is their bounden duty that they lend
money only after very careful analysis and after getting it ensured that their money land in safe
hands . Development finance institutions were set up with the objective of promoting industrial
development . They played a significant role in helping new and first generation entrepreneurs
in setting up industrial ventures. Of late, the role of developing finance institutions is undergoing
a change and they are expected to function on commercial lines.

Covenants Attached to Lending

The bank/financial institution that extends term loan for the setting up of a project imposes
certain conditions to be fulfilled by the borrower and these conditions (covenants) are contained
in the term loan sanction orders/mortgage deeds executed by the borrower in favour of the
bank/financial institution . The covenants depend on the nature of the project and the financial
soundness of the borrower . Some of the typical conditions normally stipulated are as under :

(i) The project sponsor (or project promoter) shall offer collateral security as required
by the financial institution.

44 Prepared by : Prof. R. K. Mishra

Associate Prof. (Finance)
BIJU PATNAIK INSTITUTE OF IT & MANAGEMENT STUDIES, BHUBANESWAR

(ii) The project promoter should furnish periodic information about the project.
(iii) The project sponsor should use the borrowed funds only for the project
implementation and for the specific purposes intended.
(iv) The project sponsor should maintain all the assets in good condition, should insure
the assets against fire, burglary and natural calamities till such time all the dues to the
bank/financial institution are paid back.
(v) The project sponsor should not dispose of any of the assets of the project without the
prior approval of the bank/financial institution
(vi) The project sponsor should get the consent of the bank/financial institution before
declaring dividends on equity shares.
(vii) Unsecured loans raised if any, for funding the project should not be repaid as long as
the dues to the bank/financial remain unpaid.
(viii) If interest is paid on unsecured loans, the rate of interest should not be in excess of the
rate payable to the bank/financial institution.

BENEFIT COST RATIO METHOD :

BCR = Present value of Cash inflows

Present value of cash outflows

NET BENEFIT COST RATIO

NBCR = BCR – 1

If BCR is more than one (or if NBCR is more than Zero), it indicates that the benefits from
the project are in excess of the cost incurred towards the project .

DATA REQUIRED FOR THE CALCULATION OF NPV/PI/IRR/BCR/NBCR

Life of the Project

Cash Outflow

Cash Inflow

Cost of Capital

Apportionment of Contingency Provision towards fixed Assets

While arriving at the project Cost, a contingency provision is included to take care of
unexpected Cost. The contingency provision provided in the project cost is to be added to the
different fixed assets in proportion to their value for the purpose of arriving at the
depreciation on fixed assets .

45 Prepared by : Prof. R. K. Mishra

Associate Prof. (Finance)
 BIJU PATNAIK INSTITUTE OF IT & MANAGEMENT STUDIES, BHUBANESWAR

Apportionment of Preliminary and pre-operative expenses :

As per Sec. 35-D of the Income Tax Act, Preliminary expenses, upto a limit of 5.00% of the
project cost can be written off from profits over a period of 5 years .

Eligible heads of preliminary expenses are

Expenditures in connection with preparation of feasibility report, preparation of project

report, conducting market survey or any other survey necessary for the business of the
assessee .

Legal charges for drafting of any agreement between the assessee and any other person .

Legal charges for drafting of Memorandum of Association and Articles of Association of the
company.

If the preliminary expenses are more than 5% of the Capital Cost, the excess portion of
preliminary expenses over and above 5% of the Capital Cost and also the pre-operative
expenses shall be added to the fixed assets in proportion to the cost of the fixed assets . This
increased cost of fixed assets after adding the share of amortized preliminary and pre-operative
expenses is taken into account for calculating depreciation on fixed assets .

POST PROJECT EVALUATION

Introduction

Post project evaluation is also known as Project Audit . It is an evaluation of the project after
its completion . After the project is completed , project audit is carried out to assess the actual
project cost and the actual time taken for project completion . Thus, while project appraisal
is an estimate for the ‘future’ , post project evaluation is an assessment of the ‘past’ .

Objectives of Project Audit

(i) Building up an information base to help proper estimation of project cost and time .
(ii) Educating all those concerned with the project about the realities of project
management .
(iii) Establishing correct time-cost relationship .
(iv) Creation of appropriate standards for work based on suitable work techniques .
(v) Sharing of project audit information among all concerned , in order to build up better
understanding and better comprehension of the project and its problem areas so that
lapses could be avoided in future .

46 Prepared by : Prof. R. K. Mishra

Associate Prof. (Finance)
BIJU PATNAIK INSTITUTE OF IT & MANAGEMENT STUDIES, BHUBANESWAR

PHASES OF PROJECT AUDIT

Project audit is carried out in two phases, viz., immediately after the completion of the
project and after the lapse of some time (say 2 or 3 years) since the completion of the project.

Project audit that is carried out immediately after project completion is done for studying the
differences between the actual project cost and the estimated project cost .

(i) for studying the difference between the actual time taken for project
implementation and the estimated time .
(ii) for locating the areas that have contributed to the various in project cost and time
.
(iii) for identifying the reasons for such variances, classifying them into avoidable and
unavoidable variances .
(iv) for analyzing the steps that could have been taken to avoid the avoidable
variances .
(v) for analyzing in depth the factors that have caused the unavoidable variances and
examining the possibilities of their removal in future by adopting suitable
methodology .

Project audit that is carried out after the lapse of 2 to 3 years is done with a wider perspective
. This study is done :

(i) for studying whether the product goals and objectives are achieved .
(ii) for knowing whether the project product produces products of acceptable quality.
(iii) for knowing whether the estimated output is achieved.
(iv) for knowing whether the product is accepted by the market and whether the
production volume is commensurate with the market share planned to achieve

The post project evaluation, whether done immediately after the project completion or after
the lapse of some time has the main aim of studying the pitfalls and gray areas and
identifying the required corrective measures .

Types of Project Audit

Technical evaluation

Technical evaluation refers to the evaluation of quality and quantity of production, the
operating costs in production etc. A comparison of these factors is done between what is
presented in the feasibility report/ detailed project report and what has been the actual
achievement .

47 Prepared by : Prof. R. K. Mishra

Associate Prof. (Finance)
 BIJU PATNAIK INSTITUTE OF IT & MANAGEMENT STUDIES, BHUBANESWAR

Apart from evaluating the actual output vis-à-vis the rated output, the other areas of interest
are the evaluation of utilities consumed by the plant, like power, fuel, water, steam,
consumables, spares etc. An evaluation of these aspects is made and compared with what was
estimated/ projected at the time of project appraisal. Technical evaluation also includes
evaluation of the quality of the output and checking-up if the quality standards as envisaged
are reached .

Financial evaluation

Financial evaluation is done to verify whether the actual project cost, operating costs,
profitability , cash/fund flows etc., are as per the estimates and projections made at the time
of appraisal .

Economic evaluation:

Economic evaluation is the most difficult to make since it involves many subjective aspects
which are difficult to be quantified .The evaluator should have an ‘eye’ for identifying the
social costs and benefits of the project . Economic evaluation is more relevant for public
sector and community development projects since such projects are undertaken with social
objective in mind, apart from financial and other objectives .

The social costs and social benefits, though subjective the nature , are quantified using some
techniques while doing Social Cost Benefit Analysis (SCBA) at the appraisal stage of the
project .

Agencies for project audit ( Indian Scenario )

For private sector projects, the project audit is normally done by the project promoter and /or
the financial institution that has funded the project . For community development projects,
programme Evaluation Organisation (PEO) of the planning commission carries out the audit .
The PEO is entrusted with the task of evaluating the impact of community development
projects on the lives of the people and on the economy of the community and to offer
suggestions/recommendations for rural development . Apart from the PEO which is under the
control of the Central Government, every State Evaluation Organisation (SEO) under its control
to evaluate the projects sponsored by the State Government . For public sector projects the post
project evaluation is done by the respective ministries along with the Department of public
Enterprises (DPE) and Bureau of Public Enterprises (BPE) . Besides, public sector projects are
also audited by the Comptroller and Auditor general of India .

48 Prepared by : Prof. R. K. Mishra

Associate Prof. (Finance)
BIJU PATNAIK INSTITUTE OF IT & MANAGEMENT STUDIES, BHUBANESWAR

SUMMARY

Post project evaluation is also known as Project Audit. It is an evaluation of the project after
its completion . After the project is completed, project audit is carried out to assess the actual
project cost and the actual time taken for project completion . Thus, while project appraisal
is an estimate for the ‘future’ , post project evaluation is an assessment of the ‘past’. Project
audit is carried out in two phases, viz., immediately after the completion of the project and
after the lapse of sometime (say 2 or 3 years) since the completion of the project. Project
audit that is carried out immediately after project completion is done for studying the
differences between the actual project cost and the estimated project cost .

Technical evaluation refers to the evaluation of quality and quantity of production, the
operating costs in production etc. A comparison of these factors is done between what is
presented in the feasibility report/ detailed project report and what has been the actual
achievement. Financial evaluation is done to verify whether the actual project cost, operating
costs, profitability , cash/fund flows etc., are as per the estimates and projections made at the
time of appraisal . Economic evaluation is the most difficult to make since it involves many
subjective aspects which are difficult to be quantified .The evaluator should have an ‘eye’ for
identifying the social costs and benefits of the project.

KEY WORDS:

Post project evaluation

Post project evaluation is also known as Project Audit. It is an evaluation of the project after
its completion .

Phases of project audit

Project audit is carried out in two phases, viz., immediately after the completion of the
project and after the lapse of some time (say 2 or 3 years) since the completion of the project.

Technical evaluation

Technical evaluation refers to the evaluation of quality and quantity of production, the
operating costs in production etc.

49 Prepared by : Prof. R. K. Mishra

Associate Prof. (Finance)
BIJU PATNAIK INSTITUTE OF IT & MANAGEMENT STUDIES, BHUBANESWAR

Financial evaluation

Financial evaluation is done to verify whether the actual project cost, operating costs,
profitability , cash/fund flows etc., are as per the estimates and projections made at the time
of appraisal .

Economic evaluation

Economic evaluation is the most difficult to make since it involves many subjective aspects
which are difficult to be quantified. The evaluator should have an ‘eye’ for identifying the
social costs and benefits of the project.

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50 Prepared by : Prof. R. K. Mishra

Associate Prof. (Finance)