UNIT-4
Project Financing: Project cost estimation & working capital requirements, sources of
funds, capital budgeting, Risk & uncertainty in project evaluation, preparation of
projected financial statements viz. Projected balance sheet, projected income statement,
projected funds & cash flow statements, Preparation of detailed project report, Project
finance
Project Financing
Project Cost Estimation & Working Capital Requirements
🔹 A. Project Cost Estimation
Project cost estimation involves identifying all costs necessary to bring a project from conception
to operation. It is the foundation for project planning and financing.
Main Components:
1. Land & Site Development: Cost of acquiring land, site clearing, leveling, fencing, etc.
2. Buildings and Civil Works: Cost of constructing factory buildings, warehouses, offices.
3. Plant & Machinery: Purchase, transport, and installation of machines.
4. Technical Know-how: Fees for consultancy, training, and technical collaboration.
5. Pre-Operative Expenses: Costs incurred before operations start – salaries, rent, trial
runs, etc.
6. Contingencies: Reserve for unexpected cost overruns (usually 5–10%).
7. Margin Money for Working Capital: Promoter’s portion of working capital needs.
Working Capital Requirement (WCR)
Working capital refers to the capital needed for day-to-day operations.
Formula:
👉 Working Capital = Current Assets – Current Liabilities
Includes:
Inventory (Raw materials, WIP, Finished goods)
Debtors (Accounts receivable)
Cash and bank balances
Less: Payables and other current liabilities
.
Sources of Funds
🔹 A. Equity Capital
1. Promoter’s Contribution: Personal investment by the founder(s).
2. Angel Investors / Venture Capital: For startups and innovative ventures.
3. Public Issue of Shares: Listing on stock exchanges.
4. Private Placement: Selling shares to select investors.
🔹 B. Debt Capital
1. Term Loans from Banks/FIs: Long-term financing for assets.
2. Debentures: Secured or unsecured bonds issued to the public or institutions.
3. External Commercial Borrowings (ECBs): Foreign loans for large projects.
🔹 C. Hybrid Instruments
Preference shares
Convertible debentures
🔹 D. Government Support
Subsidies
Grants (e.g., for MSMEs, green projects)
Capital Budgeting
Capital budgeting is the process of evaluating and selecting long-term investments that are
consistent with the firm’s goal of wealth maximization.
Capital Budgeting Techniques
Technique Description Key Feature
Present value of inflows –
NPV (Net Present Value) Accept if NPV > 0
outflows
Discount rate that gives NPV = Accept if IRR > Cost of
IRR (Internal Rate of Return)
0 Capital
Time taken to recover
Payback Period Shorter payback is preferred
investment
PI (Profitability Index) Ratio of PV of inflows to Accept if PI > 1
Technique Description Key Feature
outflows
ARR (Accounting Rate of
Based on accounting profit Easy but ignores time value
Return)
Risk and Uncertainty in Project Evaluation
Projects face both quantifiable risks and unpredictable uncertainties. Evaluating them ensures
better decision-making.
Common Risks:
Cost overrun
Delays in completion
Demand shortfalls
Exchange rate risk (for imports)
Interest rate risk
Techniques to Evaluate Risk:
1. Sensitivity Analysis – Evaluates the effect of changing one variable at a time.
2. Scenario Analysis – Best case, worst case, most likely case.
3. Monte Carlo Simulation – Uses probability distributions and computer simulations.
4. Decision Trees – Graphical representation of decisions and possible outcomes.
5. Risk-adjusted Discount Rate – Higher rate for riskier projects.
Preparation of Projected Financial Statements
These are forecasted statements prepared to analyze the viability and fund requirements of a
project.
Projected Income Statement (P&L)
Forecast of expected revenues, costs, profits
Includes depreciation, taxes, and interest
Projected Balance Sheet
Reflects expected assets, liabilities, and equity over future years
Projected Cash Flow Statement
Inflows/outflows from operations, financing, and investing
Shows liquidity and debt servicing ability
Funds Flow Statement
Movement of funds – working capital changes, investments, and sources of funds
Purpose: Helps banks, investors, and management assess:
Break-even
Debt repayment
Return on Investment (ROI)
Internal Rate of Return (IRR)
Preparation of Detailed Project Report (DPR)
The DPR is a comprehensive blueprint of the project, used for evaluation by financiers,
investors, and regulatory authorities.
🔹 Structure of DPR:
1. Executive Summary
2. Promoter Background
3. Market Analysis & Demand Forecast
4. Technical Feasibility
5. Financial Feasibility
6. Project Cost & Means of Finance
7. Risk Analysis
8. Environmental & Social Impact
9. Implementation Schedule
10. Conclusion & Recommendations
Annexures: Financial projections, licenses, quotations, land documents, etc.
Project Finance
Project Finance is the method of funding in which the project’s cash flows and assets are used as
collateral, not the borrower’s overall balance sheet.
🔹 Features:
Special Purpose Vehicle (SPV): A separate legal entity for the project
Limited Recourse Financing: Lenders can claim only project assets
Long-term Contracts: Ensures revenue visibility (e.g., Power Purchase Agreements)
High Leverage: Debt-heavy structure
Risk Sharing: Between developers, lenders, and contractors
🔹 Commonly Used In:
Infrastructure (roads, airports, ports)
Energy (power plants, solar parks)
Large Industrial Projects
