Presentation on theme: "Financial Appraisal of Project"— Presentation

transcript:
Financial appraisal of a civil engineering project involves assessing its economic viability and
profitability. This process includes analyzing costs, benefits, and potential risks to determine if the
project is a sound investment. Key aspects include evaluating cash flows, return on investment, and
potential financing options.

Here's a more detailed breakdown:

1. Understanding the Purpose:

• The primary goal is to ensure that the project is economically justified, meaning it generates
sufficient returns to cover costs and provide a reasonable profit.

• This appraisal helps stakeholders make informed decisions about whether to proceed with the
project.

2. Key Aspects of Financial Appraisal:

• Cost Analysis:

Accurately estimating all project costs, including initial investment, ongoing operational expenses, and
potential maintenance costs.

• Revenue Forecasting:

Predicting potential revenue streams from the project, such as tolls, fees, or usage charges.

• Cash Flow Analysis:

Evaluating the net cash flow of the project, considering both inflows (revenue) and outflows (costs) over
time.

• Financial Modeling:

Using tools and techniques to model the project's financial performance and identify potential risks and
opportunities.

• Risk Analysis:

Identifying and assessing potential risks that could impact the project's financial viability.

• Funding Plan:
Developing a plan for financing the project, including debt financing, equity financing, or a combination
of both.

• Return on Investment (ROI):

Calculating the project's profitability and assessing whether it meets the required rate of return.

3. Methods Used in Financial Appraisal:

• Net Present Value (NPV):

A common method that discounts future cash flows to their present value, allowing for a comparison of
different investment options.

• Internal Rate of Return (IRR):

Determining the discount rate at which the project's NPV is zero, providing an indication of the project's
profitability.

• Cost-Benefit Analysis:

A comprehensive approach that compares the costs and benefits of a project, considering both financial
and non-financial factors.

4. Importance of Financial Appraisal:

• Decision Making:

Provides a framework for making informed decisions about project investments.

• Resource Allocation:

Helps prioritize projects based on their economic potential.

• Risk Management:

Identifies and manages potential financial risks associated with the project.

• Stakeholder Engagement:

Provides a transparent and objective assessment of the project's financial viability.

2 Financial appraisal involves critically examining the basic data, assumptions and methodology
used in project preparation to assure project’s viability, profitability, sustainability from the financial
point of view. The scope of financial appraisal varies considerably with the nature of project and
whether it is revenue producing (e.g. industry, agriculture) or not (e.g. roads, public schools). It
covers:- Review on investment cost and operating cost (is there over or under estimation) Sales and
Pricing Financing Income and expenditure Liquidity plan Selection of discount rate Profitability or self
sustainability etc.

4 Aspects to Review of Estimation on Investment Cost (Construction Cost)

Estimation of Operating Cost for the Operating Period Estimation of Operating Benefits for Operating
Periods Estimation of Scrap Value Differences Between Benefits and Costs

5 Investment Cost of the Project

The Investment cost of the project includes cost of all the items, consulting fees, Project
implementation costs. In Infrastructure Project, it is also called Construction Cost.

6 Cost Estimation Cost of land and site development Building cost

Plant and machinery cost Other fixed assets Project management cost Contingencies cost etc.

7 Cost of Land and Site Development (examples)

Cost Items Quantity Price Total cost Cost of land Cost of leveling and development5 ropani-5 lakhs
per ropani25 lakhs5 lakhsTotal30 lakhs

8 Cost of Building Total Cost Items Quantity Price Total cost

Building for main plantAdministrative BuildingCanteenGuest houseQuarter for staff110 lakhs5 lakhs2
lakhs6 lakhsTotal25 lakhs

9 Cost of Machinery Total Cost Items Quantity Price Total cost

Imported machineryIndigenous machineryInstallation charges1 2 -10 lakhs2 lakhs4 lakhs1
lakhsTotal15 lakhs

10 Other Fixed Assets Total Cost Items Quantity Price Total cost
FurnitureFire fighting equipment5 sets10 sets1 lakhs50 thousands lakhs5 lakhsTotal10 lakhs

11 Project Management and Administration Cost

Cost ItemsUnitsMonthsCost per monthTotalSalary to Project ManagerSalary to Project staffsSalary
to Technical Advisor1 3 12 520000100002400003600001000007 lakhs

12 Total budget
Cost Items1st Q2nd Q3rd Q4th QTotal BudgetCost of land and site developmentCost of
BuildingCost of MachineryOther Fixed AssetsProject Management
cost30 - 10 15 5 25 7Contingency cost3Quarterly cost90 lakhs

13 Review on sales Estimation

Estimation of Sales QuantityEstimation of Price per unitEstimation of Project’s benefit periods.

14 Basis of Project’s Benefit Analysis Period

Physical life of the plantTechnical life of the plant (Until plant will not be obsolete by new
technology)Product market life of the plantInvestment planning horizon of the firm
15 Estimated Sales and Production Budget for 10 yrs (Examples)
Cost Items1st yr2nd yr3rd yr4th yr5th to 10th yrInstalled Capacity100 million lt100million ltEstimated
Annual production and Sales40 ml40ml50ml80 mlSelling price per ltRs. 10Rs. 12Total sales
VolumeRs. 400 millionRs. 400 MillionRs 600 MillionRs. 960 Million

16 Cost Items 1st yr 2nd yr 3rd yr 4th yr 5th to 10th yr

Estimation of Total Cost operation and Maintenance for operational life of projectCost Items1st yr2nd
yr3rd yr4th yr5th to 10th yrMaintenanceDepreciationTaxAdministrative Cost (Office rentStationary,
telephone etc.)Selling and Distribution Expenses- Sales person’s commission - Advertisement-
Traveling expenses etc.Total Cost of Operation

17 Operational working result of Project (yearly Profit)

Cost Items1st yr2nd yr3rd yr4th yr5th to 10th yrA. Sales
RevenueLess:MaintenanceDepreciationTaxAdministrative Cost (Office rentStationary, telephone
etc.)Selling and Distribution Expenses- Sales person’s commission- Advertisement- Traveling
expenses etc.B. Total Cost of OperationC. Net Profit Before tax (A- B)D. Tax (30%)E. Net Profit after
tax (C – D)

18 Calculation of Operational Cash inflow

Cost Items1st yr2nd yr3rd yr4th yr5th to 10th yrA. Sales
RevenueLess:MaintenanceDepreciationTaxAdministrative Cost (Office rentStationary, telephone
etc.)Selling and Distribution Expenses- Sales person’s commission- Advertisement- Traveling
expenses etc.B. Total Cost of OperationC. Net Profit Before tax (A- B)D. Tax (30%)E. Net Profit after
tax (C – D)F. Cash inflow (E + Depreciation)

19 Review on Estimation of Terminal Cash inflow

Scrap value of assets at the end of operational yearRecovery of working capital at the end of
operational year

20 Review on Estimation of Working Capital

Working capital is the fund required to finance stock level of raw material, finished goods,
receivables and minimum cash or bank balance.Funds required for Working Capital Should be
planned carefullyLiquidity plan

21 Liquidity Cycle related to working Capital

22 Sources of Finances and Suitability

Equity CapitalPreference ShareDebenturePublic DepositsIncentive SourcesBank LoanLease
Finance etc.

23 Estimation of Net Cash flow of Project

Net cash flow of the project will be estimated for whole life of the project.Net cash flow will help to
analyze financial profitability of the project

24 Criteria of Financial Viability

Payback PeriodCalculation of Net Present Value (NPV)Calculation of Internal rate of return
(IRR)Calculation of Benefit/Cost Ratio
25 Payback PeriodThe payback period method calculates the period of time a project takes for the
future net cash flows to equal the original cost of projects. The payback method therefore indicates
how quickly the investment cost will be recovered.A quick pay back period indicates a reduction in
risk.Projects with early payback period are therefore usually more attractive.However, payback
method ignores the later cash inflow and time value of money.

26 Time Value of MoneyBefore discussing NPV,IRR and Benefit/Cost ratio, discussion on time
value of money and cost of capital (opportunity cost of capital) is necessary)A rupee in hand today is
worth more than a rupee received in the future.

27 Methods for Dealing with Time Value of Money

Calculation of Future valueFV = PV (1+k)nWhere FV = Future value, PV = Present Value, K =
Interest rate per year, n = number of years)2. Calculation of Present ValuePV = FV(1+k)n

28 Estimation of Cost of Capital

Cost of capital is the weighted average cost of capital the project has to pay for its sources of
finance. It is also called discount rate.

29 Calculation of NPVNPV is defined as present value of benefits (cash inflows) less present value
of costs (cash outflows)Formula for calculating present valuePV = FV(1+k)nIf the NPV > 0, the
project will be accepted.If the NPV < 0, the project should be rejected.

30 Calculation of Internal Rate of Return (IRR)

The internal rate of return is calculated at the rate at which the NPV of aproject is zero.In the IRR
calculation, we set the NPV equal to Zero, and determine a rate that satisfies the condition.This is
found by trial and error.

31 Decision Under IRR criteria

If the IRR is greater than cost of capital (discount rate), the project will be accepted.If the IRR less
than the cost of capital, then the project should be rejected.

32 Process for calculation of IRR

1. Determine the NPV at two closest discount rate to produce one positive NPV and another
negative NPV. (example) NPV at 15% = 802, NPV at 16% = Find the sum of absolute values of NPV
in step 1 e. g = Calculate the ratio of NPV of the smaller discount rate identified in step 1 to the sum
of obtained in step 2 e.g. 802 ÷ 2161 = 0.37

33 Process for calculation of IRR cont…

4. Add the number obtained in Step 3 to the smaller discount rate e.g. 15% = 15.37%5. The IRR is
the 15.37%.

34 Calculation of Benefit/Cost ratio

Benefit/cost ratio is the present value of benefit (cash inflow) divided by present value of cost (cash
outflow).B/C ratio > 1, Project will be acceptedB/C ration < 1, Project should be rejected

35 Sensitivity AnalysisSensitivity analysis is a technique to understand to what extent change in a

variable of a project will affect its profitability. For Example what will happen to the Net Present Value
if labor cost increases by 50%? This will give an indication of risk and among the variables which
variable is risky.
36 Further Study Identification of errors if any
Review data sources, assumption, methodologyCollect and analysis further data if
neededRecommendations required to approve and finance the project

37 Thank You