Lesson No. 19 – Term Loan / Project Appraisal

W are today discussing Term Loan / Project Loan appraisal. The difference between these two are in Term Loans we generally consider appraisal for loans for Fixed assets singly say one or few machines OR Vehicle or for Buildings.
In Project Loans the whole Project is considered which includes right from Preoperative expenses,L&B,technical Know how,Royalties, Patents etc.; Plant & Machinery & cost of erection, Transformers,Furniture fixture,Office building, office equipment, godowns, roads, even infracture for staff/workers, waste disposal, mechanism for pollution control and what not.The margin money and even funding for capital is also a part of the project. In short it may be very exhaustive.

While appraising a TL proposal we always start with The Types of Assets to be acquired called as Cost of the Project and
Means to acquire them.
Therefore a banker broods into the matter whether the Assets are sufficient and essential to carry out the proposed activity. The assets will help production/manufacture and then sale/marketing activity.
The usual items on Asset side are
COST of the PROJECT
- Land and Buildings(godown etc)
- Plant and Machinery
- Furniture and Fixture/Transformer
-Electrical Fittings/Computer Systems etc.
- Transport vehicles
- Know how or Technical fees/Royalties/
- Margin for Working Capital
- 5% of FA as Contingency

(A)TOTAL COST of the PROJECT =( )**
(* * To the list other items can be added based on requirement.)

MEANS of FINANCE
- Capital and Reserves
- Term Loans from banks
- Term Loans from other Institution
- Deferred Liabilities/Debentures
- Capital Subsidy/Assistance etc
- Loans /Deposits from Friends and Relatives
- Equity funding

(B)TOTAL MEANS Of FINANCE ( )

It should be ensured that the borrower has standing and goodwill and will be able to raise the requisite funds from the sources he has projected and that too at reasonable costs and at proper time.(Just imagine amount raised from friends @3% per month). Banker is not satisfied the proposal may fall down or has to reduce the planned assets.
Banker should also verify independently that cost of assets are at their market value and suppliers are the manufacturer or authorised suppliers. By overvaluing ,the borrower tends to build the Margin.
Once banker is satisfied ; he goes further to work out the viability by studying ratios. Let us resume on this subject.
We have discussed about DSCR, but it has one draw back.The firm has invested the amount today in FA but the Cash Flows will be received in the next few years. As such it is prudent to find out the present value of future cash flows.This is done by discounting the cash flows at a particular rate. (Exactly opposite to compounding).
Say today we have Invested Rs.600
and we will be receiving the following Cash flows for 5 years from the project. Discount rate is say 15%pa.(last column shows discounted value from tables available on Line)
Period|Cash Flow| Present ValuePV
O. (-600). (-600)
1. +150. +130.43
2. +250. +189.04
3. +300. +197.24
4. +300. +171.54
5. +200. + 99.44
Total | +1200. + 787.69
1 to 5 |
Net value. +600. +187.69
Thus by simple method the benefit accrues to Rs.600 but if PV is considered at 15% discounted rate then value is only Rs +187.69
This is Net Present Value (NPV) method.
Suppose in this case the Rate of Interest charged is say 14.5% then this surely a good project as it will yield +cash flow.
A project is sanctioned if NPV is +ve.
This is Discounted Cash flow method.

(II) Internal Rate of Return - IRR
It is the Discount Rate which makes the NPV zero.
In this case at a Discount Rate of 14.75%(approx) the Outflow ie Cost of Project (- 600) will be equal to Cash inflow (+600) ie IRR is 14.75%.
The projects are accepted when IRR is more than Cost of Capital(COC)
IRR 14.75% and COC is 14.50%*
(* The rate at which loan is sanctioned).
"""' It is a difficult concept to grasp and hence I am closing the discussion so that the subject sinks in the mind. """

Good bye.

RATE the Discussion
-----------------------------------
A- Not Understood
B- Some What Clear
C- Very Clear

T H A N K S
Waman Gokhale
7350901500
waman.gokhale@gmail.com