PROJECT FINANCE

PROJECT BACKGROUND
The purpose of project finance is to meet a part of
the capital expenditure of a project.
A project can be defined as ‘A scheme of things to
be done during a specified period in future for
deriving expected benefits under certain assumed
conditions’.
A project may be in the nature of setting up a new
industrial unit, modernization, expansion,
diversification and promotion of R&D.
PROJECT BACKGROUND
To set up a project, certain capital expenditure
needs to be incurred in acquiring assets such as
L&B, P&M and other infrastructural facilities like
roads, water supply, railway sidings, etc., in
addition to the Preliminary / Pre-Operative
Expenses and margin on WC Limits.

Where promoters of a project are unable to meet

the entire capital expenditure out of their own
resources, Term Loans are sanctioned to
supplement the promoters’ contribution.
PROJECT BACKGROUND
Promoters of an industrial project can
constitute themselves into any of the following
forms of business organisations to implement
the project : Sole Proprietorship, JHF,
Partnership, Co-operative Society & Joint Stock
Company.

Our discussion of the subject would revolve

around Joint Stock Company as promoter.
 PROJECT BACKGROUND
The Promotion Stage is a crucial stage in the entire life
cycle of a project. Promotion in relation to a project will
comprise broadly the following functions:
I] Identification of a project
II] Feasibility investigation
III] Assembling the proposition
IV] Financing the proposition
 Financing the Proposition
Setting up of a project involves acquisition of Fixed Assets
which facilitate the process of production. Fixed Assets
have a relatively longer life and are generally not meant
for resale. They are required to be retained over a period
of time to exploit their productive potential.

C/A go through the operating cycle of RM, WIP and FG,

which when sold bring in cash. This cycle is generally
completed in a short period of less than one year.
 Financing the Proposition
Thus, investment in C/A is realised over a short
term, while investment in Fixed Assets is long
term in nature.
It is realised through surplus generated in the
form of Net Profits, Depreciation and other
non-cash write-offs.
As it takes a long time for the Fixed Assets to pay
for themselves, the promoter should raise
suitable long term funds to finance a project.
 Financing the Proposition
Keeping the foregoing in view, the promoter will explore
the financial feasibility of the project by examining
a) The possible long term sources of finance
b) The feasible financial leverage
c) The expected return on the investment
Financing the Proposition
 Long Term
⚫ Shares (Shareholders are part owners of a company)

⚫ Ordinary Shares (Equities):

⚫ Ordinary shareholders have voting rights
⚫ Dividend can vary
⚫ Last to be paid back in event of collapse
⚫ Share price varies with trade on stock
exchange
Preference Shares:
⚫ Paid before ordinary shareholders
⚫ Fixed rate of return

⚫ Cumulative preference shareholders – have

right to dividend carried over to next year
in event of non-payment
⚫ New Share Issues – arranged by merchant or
investment banks
⚫ Rights Issue – existing shareholders given
right to buy new shares at discounted rate
⚫ Bonus or Scrip Issue – change to the share
structure – increases number of shares and
reduces value but market capitalisation stays
the same
Borrowed Capital
⚫ Loans (Represent creditors to the company – not owners)
⚫ Debentures – fixed rate of return, first to be paid
⚫ Bank loans and mortgages – suitable for small to medium
sized firms where property or some other asset acts as
security for the loan
⚫ Merchant or Investment Banks – act on behalf of clients
to organise and underwrite raising finance
⚫ Government/EU – may offer loans in certain circumstances
⚫ Grants
 -Term Loan
A Term Loan is a loan granted for a fixed term of not less
than one year, intended normally for financing fixed
assets acquired / to be acquired, carrying interest at a
specified rate, and scheduled for repayment in
instalments.
Depending on the term for which the said terms loans are
granted, they could be classified into (a) Short Term
Loans (b) Medium Term Loans and (c) Long Term Loans.
 DPG
Deferred Payment Guarantee (DPG) is a contract to pay to
the supplier the price of machinery, supplied by him on
deferred terms, in agreed installments with stipulated
interest on the respective due dates in case of default in
payment thereof by the buyer.
A DPG is, in many respects, a substitute for a Term Loan
and, as far as the buyer of P&M is concerned, it serves the
same purposes as a Term Loan.
Standards of appraisal are the same as TL.
 Bills Discounting
Under a contract for sale of machinery on deferred
payment basis, the balance remaining to be paid after the
initial down –payment represents the deferred receivables
of the seller.
Thus, the funds of the seller get blocked for unduly long
periods and the seller requires finance against such
deferred receivables to replenish his Working Capital.
 Types of Term Assistance
- Bills Discounting
To facilitate availment of finance against the deferred
receivables, the seller usually draws a series of usance
bills with graded maturities to coincide with the due
dates of payment of the relative instalments (including
applicable interest).
The usance bills drawn by the seller will be accepted by
the buyer before they are discounted by the seller’s
banker.
 Underwriting of Shares
The necessity for underwriting arrangement arises only in
the case of a Public Limited Company resorting to raise
through the capital issue market, a part of the Share
Capital for part-financing a project.
Underwriting is a contract whereby a person agrees, in
consideration, to take up a specified number of shares or
debentures or amount of debenture stock to be offered to
the public, in the event of the public not subscribing for
them.
 Underwriting of Shares
Underwriting as a business will come under the scope
of ‘Investment Banking’ as distinct from ‘Commercial
Banking’.
In view of this, therefore, a high degree of selectivity
should continue to be exercised in undertaking
underwriting business.
However, the business stemmed not so much from the
point of view of earnings on the investment as from
the consideration that no viable project enjoying
national priority should suffer for want of
underwriting support.
 Project Appraisal
The purpose of Project Appraisal is to ascertain whether
the project will be sound – technically, economically,
financially and managerially – and ultimately viable as a
commercial proposition.
The appraisal of a project will involve the examination of:
a) Technical Feasibility : To determine the suitability of
the technology selected and the adequacy of the
technical investigation, and design.
 Project Appraisal
b) Economic Feasibility : To determine the
conduciveness of economic parameters to setting up
the project and their impact on the scale of
operations.
c) Financial Feasibility : To determine the accuracy of
cost estimates, suitability of the envisaged pattern of
financing and general soundness of the capital
structure.
d) Commercial Viability : To ascertain the extent of
profitability of the project and its sufficiency in
relation to the repayment obligations pertaining to
term finance.
 Project Appraisal
e) Managerial Competency : To ascertain that competent
men are behind the project to ensure its successful
implementation and efficient management after
commencement of commercial production.
A project should also be examined, wherever appropriate,
from the point of view of its value to the national
economy in terms of socio-economic benefits like
generation of employment opportunities, forex earnings,
the quantum of import substitution, etc.
 Project Appraisal
The first step in Project Appraisal is to find out
whether the project is prima facie acceptable by
examining salient features such as:
The background and experience of the applicants,
particularly in the proposed line of activity
The potential demand for the product
The availability of the required inputs, utilities and
other infrastructural facilities
Whether the project is in keeping with the priorities,
if any, laid down by the Government.
 Project Appraisal
The original application may not contain all the basic data
/ information. In such cases, it may be necessary to
interview the applicants and elicit all the necessary data
/ information with a view to forming an overall idea
about the general feasibility of the project.
After satisfying itself about the prima facie acceptability
of the project, the Branch should call for from the
promoters, an ‘Application’, containing the following
essential data / information, such as:
 Project Appraisal
a) Particulars of the project along with a copy of the
Project Report furnishing details of the technology,
manufacturing process, availability of construction /
production facilities, etc.
b) Estimates of cost of the project detailing the itemised
assets acquired / to be acquired, inclusive of Preliminary
/ Pre-operative Expenses and WC margin requirements.
 Project Appraisal
c) Details of the proposed means of financing
indicating the extent of promoters’ contribution, the
quantum of Share Capital to be raised by public issue,
the composition of the borrowed capital portion with
particulars of Term Loans, DPGs, Foreign Currency
Loans, etc.
d) WC requirements at the peak level (i.e., when the
level of Gross Current Assets is at the peak) during
the first year of operations after the commencement
of commercial production and the banking
arrangements to be made for financing the WC
requirements.
 Project Appraisal
e) Project Implementation Schedule.
f) Organisational set up along with a list of Board of
Directors and indicating the qualifications, experience
and competence of (i) The key personnel to be in charge
of implementation of the project during the construction
period and (ii) The executives to be in charge of the
functional areas of purchase, production, marketing and
finance after commencement of commercial production.
 Project Appraisal
g) Demand projection based on the overall market
prospects together with a copy of the market survey
report.
h) Estimates of sales, CoP and profitability.
i) Projected P&L Account and B/S for the operating years
during the currency of the Bank’s term assistance.
j) Proposed amortisation schedule, i.e., repayment
programme.
 Project Appraisal
k) Projected Funds Flow Statement covering both the
construction period and the subsequent operating years
during the currency of the Term Loan.
l) Details of the nature and value of the securities
offered.
m) Consents from the Government / other authorities and
any other relevant information.
 Project Appraisal
In respect of existing concerns, in addition to this
information, particulars regarding the history of the
concern, its past performance, present financial position,
etc., should also be called for.
The ‘Application’ completed in all respects and duly
signed by the authorised signatories of the Company will
form the basis for the detailed appraisal of the project.
 Project Appraisal
An inspection of the project site (or factory in the case of
existing units) is a must.
Each project has to be examined in proper perspective
having due regard to its nature, size and scope.
Although the basic techniques employed for appraising
the viability of various projects are more or less the
same, there could be no standard or uniform approach for
appraising all projects.
 Project Appraisal
The ultimate objective of the appraisal exercise is to
ascertain the viability of a project with a view to ensuring
the repayment of the borrower’s obligations under the
Bank’s term assistance.
Therefore, it is not so much the quantum of the proposed
term assistance as the prospects of its repayment that
should weigh with the Branch while appraising a project.
 Project Appraisal
In project appraisal, nothing should be assumed or taken
for granted.
All the data / information should be checked and,
wherever possible, counter-checked through inter-firm
and inter-industry comparisons.
It should be borne in mind that “Healthy skepticism is a
cardinal virtue in project appraisal.”