EXCUTIVE SUMMARY

The main purpose of the project is to understand the whole concept of Project financing, and its methods and needs of project financing in the form of different committee recommendation and methods. To know the needs and methods of project financing for term loan and working capital loan in small- scale industry as well as large-scale industry and various guidelines issued by the RBI for banking sector for Project finance. The project has been divided into two parts. In initial chapters of the project was given to general concept and fundamental principles for project financing, method of project financing, requirement of project financing in various types of industries, the finance requirement to the borrowers and the various approaches adopted by the borrowers for selecting the mode of financing. The later chapter covers various methods of project financing and its sub methods the funding the requirement of the term loan and working capital by the following procedures of Credit Monitoring Assessment (CMA) for funding of short-term loan and long-term loan. And finally various committees recommendation and current scenario of the MPBF were elaborated in detail. This study is attempt to explore the realms of project financing, which is a core constituent of the financial world today. In a nutshell, it is a method of financing very large capital intensive projects, with long gestation period, where the lenders rely on the assets created for the project as security and the cash flow generated by the project as source of funds for repaying their dues. Then we have made an attempt to understand the rationale behind project financing, by analyzing its viabilities, the risk evaluation methodologies, the various security arrangements made, how the projects are structured, how the financial plans are laid, and finally about how lenders comprehend the various projects using the various cash flow methodologies. Project finance is worthy of study because of the size and complexity of the projects that can be financed using this technique. Project financing typically accounts for between 10% and 15% of total capital investment in new projects worldwide and for more than half the capital investments in very large projects all over the world. It has proven to be a very useful financing technique throughout the world and across a broad range of industry sectors. It is likely to be increasingly important in the years ahead as emerging economies increasingly rely on it to exploit their resource deposits and develop their infrastructure.

Studying project finance is interesting because it requires the application of all the tools in the corporate finance tool kit. It will also help improve your understanding of how firms choose their capital structures, how contracts affect managerial decision making and firm behavior, and how organizational choice can affect firm value. As project financing typically involves very high leverage, 70% or more debt initially on average, it is a potentially fruitful area for investigating the financial consequences of high leverage.

Chapter-1 Introduction

INTRODUCTION:

Project finance is the financing of long-term infrastructure and industrial projects based upon a complex financial structure where project debt and equity are used to finance the project. Usually, a project financing scheme involves a number of equity investors, known as sponsors, as well as a syndicate of banks which provide loans to the operation. The loans are most commonly non-recourse loans, which are secured by the project itself and paid entirely from its cash flow, rather than from the general assets or creditworthiness of the project sponsors. The financing is typically secured by all of the project assets, including the revenue-producing contracts. Project lenders are given a lien on all of these assets, and are able to assume control of a project if the project company has difficulties complying with the loan terms. Generally, a special purpose entity is created for each project, thereby shielding other assets owned by a project sponsor from the detrimental effects of a project failure. As a special purpose entity, the project company has no assets other than the project. Capital contribution commitments by the owners of the project company are sometimes necessary to ensure that the project is financially sound. Project finance is often more complicated than alternative financing methods. It is most commonly used in the mining, transportation, telecommunication and public utility industries.

OBJECTIVES OF THE STUDY To develop and understand the concept of Project finance To identify the different sources of financial aspect related to project financing To identify as well as study the the working of project finance in Lanco Infratech limited

NEED FOR THE STUDY

Project finance is an important way of promoting projects in infrastructure industries. As infrastructure industries are bubbling industries and project finance plays a critical role in it

NEED OF PROJECT FINANCE 1. Project finance is a finance structure which ensures that the projects are environmentally, socially, economically and politically viable. 2. Traditional methods are not suitable for projects which have a long life and require huge capital investment. 3. Risk sharing is another unique feature of project finance which traditional methods do not provide. 4. Project Finance improves the return on capital in a project by leveraging the investment 5. Project finance facilitates careful project evaluation & risk assessment RESEARCH METHODOLOGY Research Methodology deals with research design to be used, data collection methods to be used, sampling techniques to be used, fieldwork to be carried out, analysis and interpretation to be done, limitations inherent in the project and finally, coverage (scope) of the research is given in this selection.

RESEARCH DESIGN A research design is purely and simply the framework or plan for a study that guides the collection and analysis of data. It is a blue print that is followed in completing a study. A research design ensures that. The study will be relevant to the problem and the study will employ economical procedures The research for the study purpose uses the descriptive research design.

The descriptive study is typically concerned with determining frequency with which some thing occurs of how two variables vary together. As the research is descriptive in character based on an opinion survey primary data was collected through structured questionnaire for the customers.

DATA COLLECTION Data is collected both by primary sources and secondary sources. Primary source: Primary data is collected through personal interviews with executives of finance department of the company. Secondary source: Secondary data is collected from various books, journals, websites, reports and published sources of the company.

LIMITATIONS Data is collected from only executives of finance department. The study is limit to short period of time.. The study is conducted with the data available and analysis was made accordingly. Some of the financial information of the company is kept confidential.

CHAPTER-2 CORPORATE PROFILE

INRODUCTION OF LANCO INFRATECH LIMITED

Lanco odyssey began more than two decades ago in civil engineering and the core sector. The challenges and opportunities in a resurgent India following economic liberalization saw Lanco reengineer and consolidate itself under a single apex entity, Lanco Infratech Ltd and the various subsidies of the organization.Lancos operations have always been marked by creation of synergies, backward and forward integrations and strategic innovations for the competitive edge. Today, Lanco Infratech, through twenty-two subsidiaries has the operations across the synergistic span of the verticals.

In power generation, Lanco has a presence in thermal, hydro, wind and renewable. Projects in operation and those underway represent over 8000 MW. The operations in power generation draw deep strengths from its own EPC, entry into O&M and the capabilities of its Construction wing. Lancos presence in the power extends to being a leader in power trading. Multiple synergies are being leveraged for a strategic presence in transmission and the distribution of there BOOT (build-own-operate-transfer). Lancos admired expertise in civil engineering has been displayed across the years in the execution of dams, railways, roads, industrial structures, residential and commercial construction, canals and other areas across the length and breadth of India. These competencies and depth of resources are unfolding a new roadmap in the Indian infrastructure sector. Lanco is already executing projects in ports, highways, airports and other areas and all other areas even it has grabbed many international projects. In property development, Lanco has emerged as a trend setter with Lanco Hills, which has also drawn international attention. Lanco Hills, in the Indian metropolis of Hyderabad, is coming up as one of the worlds largest mixed property development with thirty million square feet of built-up area, including the worlds tallest residential tower.

Lanco Infratech is built on a tradition and culture of trust within and without. Lanco draws the best professionals who see growth in an environment underscored by good corporate governance and the melding of individual aspirations and organizational goals. A member of the UN Global Compact, Lancos Corporate Social Responsibility begins at home with facility audits and volunteerism of its people across all CSR initiatives. Lanco is spearheading CSR interventions and programmes have touched the lives of individuals and communities in the vicinity of Lanco facilities and across the country in areas where assistance is most needed. Demand driven, participatory CSR initiatives by Lanco exemplify the larger corporate vision that Lanco Infratech represents. of Inspiring Growth.

CHAPTER-3 REVIEW OF LITRATURE

10

3.1History of Project Financing:Limited recourse lending was used to finance maritime voyages in ancient Greece and Rome. Its use in infrastructure projects dates to the development of the Panama Canal, and was widespread in the US oil and gas industry during the early 20th century. However, project finance for high-risk infrastructure schemes originated with the development of the North Sea oil fields in the 1970s and 1980s. For such investments, newly created Special Purpose Corporations (SPCs) were created for each project, with multiple owners and complex schemes distributing insurance, loans, management, and project operations. Such projects were previously accomplished through utility or government bond issuances, or other traditional corporate finance structures. Project financing in the developing world peaked around the time of the Asian financial crisis, but the subsequent downturn in industrializing countries was offset by growth in the OECD countries, causing worldwide project financing to peak around 2000. The need for project financing remains high throughout the world as more countries require increasing supplies of public utilities and infrastructure. In recent years, project finance schemes have become increasingly common in the Middle East, some incorporating Islamic finance. The new project finance structures emerged primarily in response to the opportunity presented by long term power purchase contracts available from utilities and government entities. These long term revenue streams were required by rules implementing PURPA, the Public Utilities Regulatory Policies Act of 1978. Originally envisioned as an energy initiative designed to encourage domestic renewable resources and conservation, the Act and the industry it created lead to further deregulation of electric generation and, significantly, international privatization following amendments to the Public Utilities Holding Company Act in 1994. The structure has evolved and forms the basis for energy and other projects throughout the world.

3.2WHAT IS PROJECT FINANCING?

11

Definition. 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 finance" is a method for obtaining commercial debt financing for the construction of a facility. Lenders look at the credit-worthiness of the facility to ensure debt repayment rather than at the assets of the developer/sponsor. Farm biogas projects have historically experienced difficulty securing project financing because of their relatively small size and the perceived risks associated with the technology. However, project financing may be available to large projects in the future. In most project finance cases, lenders will provide project debt for up to about 80% of the facility's installed cost and accept a debt repayment schedule over 8 to 15 years. Project finance transactions are costly and often an onerous process of satisfying lenders' criteria. Project finance involves the creation of a legally independent project company financed with nonrecourse debt (and equity from one or more sponsoring firms) for the purpose of financing a single purpose capital asset, usually with a limited life.

This definition highlights the following features of Project Finance:

12

Project Finance involves creating a legally independent project company to invest in the project; the assets and liabilities of the project company do not appear on the sponsors balance sheet. As a result, the project company does not have access to internally generated cash flows of the sponsoring firm. Similarly, the sponsoring firm does not have access to the cash flows of the project company. In contrast, in Corporate Finance, the same investment is financed as part of the companys existing balance sheet. The purpose for Project Finance is to invest in a single purpose capital asset, usually a long-term illiquid asset. In contrast to a company, which may be investing in many projects simultaneously, a project-financed company invests only in the particular project for which it is created. The project company is dissolved once the project gets completed. In Project Finance, the investment is financed with non-recourse debt. Since the Project Company is a standalone, legally independent company, the debt is structured without recourse to the sponsors. As a result, all the interest and loan repayments come from the cash flows generated from the project. This is in contrast to Corporate Finance where the lenders can rely on the cash flows and assets of the sponsor company apart from those of the project itself. In a nutshell it is a method of financing very large capital intensive projects, with long gestation period, where the lenders rely on the assets created for the project as security and the cash flow generated by the project as source of funds for repaying their dues It includes the following basic features, an agreement by financially responsible parties to complete the project and, toward that end, to make available to the project all funds necessary to achieve completion. An agreement by financially responsible parties (typically taking the form of a contract for the purchase of project output) that, when project completion occurs and operations commence, the project will have available sufficient cash to enable it to meet all its operating expenses and debt service requirements, even if the project fails to perform on account of force majored or for any other reason. Assurances by financially responsible parties that, in the event a disruption in operation occurs and funds are required to restore the project to operating condition, the necessary funds will be made available through insurance recoveries, advances against future deliveries, or some other means.

3.3The Rationale behind Project Financing

13

Project financing differs from tradition financing in the following ways. The project has a finite life. Therefore, so does the legal entity that owns it. That entitys identity is defined by the project. In contrast, a traditional corporation does not have a limited life. The project entity distributes the cash flows from the project directly to project lenders and to project equity investors. In a traditional corporation, corporate managers can retain the free cash flow from profitable projects and reinvest it in other projects of managements own choosing. In a true project financing, equity investors get the free cash flow and make the reinvestment decision themselves. Project financing represents an alternative to conventional direct financing. Choosing project financing over direct financing involves choosing an alternative organizational form that is different from the traditional corporation in two fundamental respects the project financing entity has a finite life, and the cash flows from the project are paid directly to the project investors, rather than reinvested by the sponsor. Project financing can: Reduce the agency costs of free cash flow by giving investors the right to control reinvestment of the projects free cash flow; Mitigate the underinvestment problem that arises when firms have risky debt outstanding; Enhance a companys financial flexibility by giving it the ability to husband internally generated cash flow for investment in projects that involve proprietary information that it does not wish to disclose to investors at large; Facilitate the design of less costly debt contracts, which can be tailored to the cash flow characteristics of the project. Because of the higher transaction costs and the yield premium that is required is critical and very important, when both financing alternatives are available, project financing will usually be more cost-effective than conventional direct financing when project financing permits a higher degree of leverage than the sponsors could achieve on their own and the increase in leverage produces tax shield benefits sufficient to offset the higher cost of debt funds, resulting in a lower overall cost of capital

Economic Viability

14

The ability of a project to operate successfully and generate a cash flow is of paramount concern to prospective lenders. These providers of funds must be satisfied that the project will generate sufficient cash flow to service project debt and pay an acceptable rate of return to equity investors. There must be a clear, long-term need for the projects output, and the project must be able to deliver its products (or services) to the market place profitably. Therefore, the project must be able to produce at a cost-to-market price that will generate funds sufficient to cover all operating costs and debt service while still providing an acceptable return on the equity invested in the project. Project economics must be sufficiently robust to keep the project profitable in the face of adverse developments, such as increase in construction cost; delays in construction or in the start up of operations; increases in interest rates; or changes in production levels, prices, and operating costs.

Availability of Raw Materials and Capable Management Natural resources, raw materials, and the other factors of production that are required for successful operation must be available in the quantities needed for the project to operate at its design capacity over its entire life. To satisfy lenders, The quantities of raw materials dedicated to the project must enable it to produce and sell an amount of output that ensures servicing of the project debt in a timely manner, Unless the project entity directly owns its raw materials supply, adequate supplies of these inputs must be dedicated to the project under long-term contracts; and The term of the contracts with suppliers cannot be shorter than the term of the project debt. The useful economic life of a project is often constrained by the quantity of natural resources available to it. Many project sponsors enter into management contracts with engineering firms to ensure that skilled operating personnel are available

Technical Feasibility

15

Lenders must be satisfied that the technological processes to be used in the project are feasible for commercial application on the scale contemplated. In brief, providers of funds need assurance that the project will generate the output at its design the capacity. The technical feasibility of conventional facilities, such as pipelines and electric power generating plants, is generally accepted. But technical feasibility has been a significant concern in such projects as Arctic pipelines, large-scale natural gas liquefaction and transportation facilities, and coal gasification plants. Lenders generally require verifying opinions from independent engineering consultants, particularly if the project will involve unproven technology, unusual environmental conditions, or very large scale.

Analyzing Viabilities To arrange financing for a stand-alone project, prospective lenders (and prospective outside equity investors, if any) must be convinced that the project is technically feasible and economically viable and that the project will be sufficiently creditworthy if financed on the basis the project sponsors propose. Establishing technical feasibility requires demonstrating, to lenders satisfaction, that construction can be completed on schedule and within budget and that the project will be able to operate at its design capacity following completion. Establishing economic viability requires demonstrating that the project will be able to generate sufficient cash flow so as to cover its overall cost of capital. Establishing creditworthiness requires demonstrating that even under reasonably pessimistic circumstances; the project will be able to generate sufficient revenue both to cover all operating costs and to service project debt in a timely manner. The loan terms in particular, the debt amortization schedule lenders require will have a significant impact on how much debt the project can incur and still remain creditworthy. We understand these concepts in detail as follows

3.4 Importance of Project Financing

16

Project finance is worthy of study because of the size and complexity of the projects that can be financed using this technique. Project financing typically accounts for between 10% and 15% of total capital investment in new projects worldwide and for more than half the capital investments in very large projects all over the world. It has proven to be a very useful financing technique throughout the world and across a broad range of industry sectors. It is likely to be increasingly important in the years ahead as emerging economies increasingly rely on it to exploit their resource deposits and develop their infrastructure. Studying project finance is interesting because it requires the application of all the tools in the corporate finance tool kit. It will also help improve your understanding of how firms choose their capital structures, how contracts affect managerial decision making and firm behavior, and how organizational choice can affect firm value. As project financing typically involves very high leverage, 70% or more debt initially on average, it is a potentially fruitful area for investigating the financial consequences of high leverage. In a nutshell it is a method of financing very large capital intensive projects, with long gestation period, where the lenders rely on the assets created for the project as security and the cash flow generated by the project as source of funds for repaying their dues. It includes the following basic features, an agreement by financially responsible parties to complete the project and, toward that end, to make available to the project all funds necessary to achieve completion. An agreement by financially responsible parties (typically taking the form of a contract for the purchase of project output) that, when project completion occurs and operations commence, the project will have available sufficient cash to enable it to meet all its operating expenses and debt service requirements, even if the project fails to perform on account of force majored or for any other reason. Assurances by financially responsible parties that, in the event a disruption in operation occurs and funds are required to restore the project to operating condition, the necessary funds will be made available through insurance recoveries, advances against future deliveries, or some other means.

3.5TRADITIONAL VERSUS PROJECT FINANCING

17

Traditional Financing 1. Conventional direct financing on balance sheet support. 2. Financing of Capital expenditure 3. Retained earning + long term finance. Debt / Loan. 4. Full recourse 5. Lenders look to firms entire asset portfolio, cash flow 6. Loan service.

Project Financing 1. With recourse to sponsors 2. Non recourse Recourse only to project cash flows & project assets. 3. Limited recourse Recourse to sponsors under certain defined circumstances. (Sponsor support obligation)Sponsor group commits to provide standby support has crystallized prior to financial closer in the event of any cost overruns in the project, it is met from such standby support 4. .Infra projects are characterized by large size, huge Capital Cost, long gestation and extended pay back period and high leverage ratios. 5. The approach is to properly identify and allocate various elements of the projects risk to the entities participating in the projects

Procedures: 1. Analysis of past and present financial statements

18

2. Analysis of Balance Sheet 3. Analysis of Cash Flow Statements 4. Examination of Profitability statements 5. Examination of projected financial statements 6. To assess the suitability of the company for disbursement of credit. This would involve. a. Use of credit rating charts b. Evaluation of management risk c. Evaluation of financial risk d. Evaluation of market-industry risk e. Evaluation of the facility f. Evaluation of compliance of sanction terms g. Calculation of credit rating

3.6Steps in term loan processing

19

Submission of Project Report along with the Request Letter.

Carrying out due diligence Preparing Credit Report

Determining Interest Rate

Preparing and submission of Term Sheet

If not approved

if approved

Preparation of proposal

Submission of Proposal to designated authority If No queries raised If queries raised

Project Rejected

Sanction of proposal on various Terms & Condition

Solve the queries

Communication of Sanction Terms & Condition

Acknowledgement of Sanction Terms & Condition

Application to comply with Sanction Terms & Condition & execution of Loan Documents Disbursement

Submission of Project Report along with the Request Letter. Carrying out due diligence

20

 Preparing Credit Report Determining Interest Rate Preparing and submission of Term Sheet If not approved if approved Preparation of proposal

3.7 CREDIT REPORT AND CREDIT RATING

The credit report is an important determinant of an individual's financial credibility. They are used by lenders to judge a person's creditworthiness. They also help the person concerned to narrow down on the financial problem areas. Credit report is a document, which comprises detailed information about the credit payment history of an applicant. It is mostly used by the lenders to determine the credit worthiness of an applicant. The business credit reports provide information on the background of a company. This assists one to take crucial business related decisions. People can also assess the amount of business risk associated with a company and then decide whether they would be comfortable in providing them with credit facilities. The degree of interest that would be shown by investors in their company can also be gauged from the business credit reports as they can get an idea of the conception of their customers regarding themselves. Since these records are updated at regular intervals of time they enable people to identify the risk levels associated with a business as well as its future. These reports also allow businesses to get detailed information about the financial status of business partners and suppliers.

What Is A Corporate Credit Rating?

21

Ratings can be assigned to short-term and long-term debt obligations as well as securities, loans, preferred stock and insurance companies. Long-term credit ratings tend to be more indicative of a country's investment surroundings and/or a company's ability to honor its debt responsibilities. . The ratings therefore assess an entity's ability to pay debts. There are various organization who perform credit rating for various business organization. Union Bank of India follows a finely defined Credit Rating Model for assessing the creditworthiness of the applicant. The credit rating model asses various aspects of the projects and assigns scores against them thereby determining the risk level involved with the project. It is divided in Four Sections: Rating of the Borrower Financial Risk Management Risk Market Condition/ Demand Situation Rating of the Facility Business Consideration Cash Flow related parameters 1) Rating of the Borrower: This part of credit rating model deals with assessing the financial and managerial ability of the borrower. The financial ability of the firm is derived by calculating ratios that determine the short term and long term financial position of the firm Short term ratios include Current Ratio, determines the liquidity position of the company over a period of one year. The current ratio is an indication of a firm's market liquidity and ability to meet creditor's demands. It is excess of current assets over current liability. If current liabilities exceed current assets (the current ratio is below 1), then the company may have problems meeting its short-term obligations. If the current ratio is too high, then the company may not be efficiently using its current assets. According to the guidelines given to UBI the ideal level is at 1.33:1 however the acceptable level is at 1.17:1.However at times current ratio may not be a true indicator, the current 22

ratio for road projects is very high but this does not indicate that the company is not using its assets well but the ratio is high because the activity involves more in dealing with current assets. Hence it is important for the evaluator to understand the nature of the industry. Long term ratio include Debt Equity Ratio is a financial ratio indicating the relative proportion of equity and debt used to finance a company's assets. This ratio is also known as Risk, Gearing or Leverage. A high debt equity ratio is not preferable by an investor as the company already has acquired high amount of funds from market thereby reducing the investor share over the securities available, increasing the risk. It is also important for the lender bank to assess the firms debt paying capacity over a period. Such capacity is derived by calculating ratio like Debt Service Coverage Ratio minimum acceptable level is 1.50.It also necessary for the lender to determine the ability of the firm to achieve the projected growth by evaluating the projected sales with actuals.However such parameter remains non applicable if the business is new. Financial risk evaluation is only one of the parameter and not the only parameter for determining the risk level. It is important to evaluate the Management Risk also while evaluating the risk relating to borrower. It is the management of the company that acts as guiding force for the firm. The key managerial personnel should bear the capacity to bail out the company form crisis situation. In order to remain competitive it is essential to take initiatives. Such skills are developed over years of experience, thus for better performance it is required to have a team of well qualified and experienced personnel.

2) Market potential / Demand Situation A Company does not operate in isolation there are various market forces that acts in either favorable or unfavraouble manner towards its performance. Thus the rating would not give

23

true picture if does take market or demand situation in consideration. The demand supply situation / market Potential plays an important role in determining the growth level of the company like Level of competition: monopoly, favorable, unfavorable Seasonality in demand: affected by short term seasonality, long term seasonality or may not be affected by seasonality in demand. Raw Material Availability: Vocational Issues like proximity to market, inputs, and infrastructure: Favorable, neutral, unfavorable. Technology ie, proven Technology- not to be changed in immediate future, technology undergo change, outdated technology. Capacity utilizations 3) Rating of the Facility The company can start functioning only after completing statutory obligations laid down by the governing authority. Such statutory obligation involves obtaining licenses, permits for ensuring smooth operations. Preparation and Submission of Financial Statements, Stock statements in the standard format within the given time schedule. 4) Business Consideration: The length of relationship with the bank enables the lender to assess the previous performance of the account holder. A good track record acts in the favour of the applicant, however a under performance make the lender more vigilante. The income value to the bank also given due consideration. Thus Credit Rating of the Business takes into consideration various aspects that directly or indirectly bear an effect the performance of the business. After evaluating the risk level involved the lender bank decided on lending Interest Rate.

In UBI they are categorized in 9 segments Lowest Risk CR-1 Low Risk CR-2

24

 Medium Risk CR- 3 Moderate/ Satisfactory Risk CR- 4 Fair Risk CR- 5 High Risk CR- 6 Higher Risk CR- 7 highest risk CR- 8 NPA CR- 9

In UBI, a business receiving Credit Rating above level 6 are not considered good from point of investment and thus are avoided. Project Owner Applicant/Borrower Entity Full legal/business name with address, phone/fax numbers, e-mail, etc.Brief background/main activities Authorized/paid up capital Shareholdings (names of shareholders with percentage of shares Board of Directors (names and position) Financing Promoters equity The promoters contribution towards equity capital of the company should come from their own resources. Banks should not normally grant advance to take up shares of other companies an exception may be made to this policy for financing the acquisition of promoters share is an existing Company engaged in Infra project subject to following condition Bank facilities are only for acquisition of shares of existing company providing Infra facilities. Existing promoters (foreign & domestic) voluntarily disinvest their majority shares in compliances with SEBI guide. Companies to which loan are extended should have a satisfactory net worth. Company financed and promoters should not be defaulter to banks/FS.In order to ensure the borrower has substantial stoke in the Infra Company, bank fianc should be restricted to 50% of the finance required. Finance extended should be against the security of the assets of the borrowing company or the assets of the acquired company and not against the shares of that company the company being acquired. Shares of the borrower Co/ Co being acquired may be accepted as additional security and not as primary security. Banks to ensure stipulated margin at all time. The tenor the bank loans may not be long than 7 years but Banks Board can make exception the financing would be subject to compliance with statutory requirements under section-19(2) of the 25

Banking Regulation Act 1949.Banks financing acquisition of equity shares by promoters should be within the regulatory ceiling of 5% capital market exposures in relation to its total outstanding advances as on March 31st of the previous year

Inter institutional Guarantees Banks are precluded from issuing guarantees favor of other Banks/ lending institution for the loans extended by the latter for infra.Primary lender in expected to assume the credit risk and funding is not allowed not applicable to FISNo General relaxationKeeping in view of the Special features of lending. High degree of appraisal skills on the part of the lenders is required is very important. Availability of resources of a maturity matching with the project period. Banks are permitted to issue guarantee favoring other lending institutions provided bank issuing guarantees .Takes a funded shares in the project at least to the extent of 5 percent of the project cost and undertake normal credit appraisal, monitoring and follow up all the project. Project Complete name Location (exact address, land area/zoning, etc.) Description (concept, profit centers, etc.) Type (project finance, refinancing or acquisition finance)

3.8 Modes of Infra Financing

BOT Build, operate & transfer BOLT Build, operate, lease and transfer BOOT Build, own, operate & transfer

26

BOO Build, own & operate BOOS Build, own, operate & sell

Build Operate Transfer (BOT) BOT is a type of project financing. BOT is relatively new approach to infra development, which enables direct private sector investment in large scale infra project.The theory of BOT is as follows Build a private company (or consortium) agrees with a govt. to invest in a public Infra project. The Co then secure their own finance to construct the project Operate the private developer then owns, maintains & manages the facility for a agreed concession period and recoups their investment through charges or tolls. Transfer after the concessionary period the Co transfers ownership & operation of the facility to the Govt. or relevant state authority. The major parties to BOT projects will usually include Govt. agency Govt. dept or statutory authority is a pivotal party Grant the sponsor the concession that is the right to build, own and operate the facility. Grant a long term lease or sell the site to the sponsor. Govt. Co-operation is critical in large projects approvals, authorizations, consents for the construction & operation of the projectGovt. agency is normally the primary party. It will initiate the project, conduct the tendering process, and evaluations of tenders and will grant the sponsor the concession & where necessary the off take agreement.

Sponsor-Usually a consortium of interested groups - typically a consortium group, an operator, a financing institution which in response to the invitation by the Govt. prepare the proposal to construct, operate, & finance the particular project Construction contractor Operation & maintenance contractor Finance. Others insurers, equipment suppliers and design consultant lawyers & tax advisers 27

Advantages of BOT Govt. gets benefit of private sector to mobilize finances and use the best management skills in the construction operation and maintenance. Private participation also ensures efficiency and quality by using the best equipment. Projects are conducted in a fully competitive bidding situation & are thus completed at the lowest possible cost.

Trust and Retention arrangement (TRA) Independent agent acting on behalf of security trustee will appropriate all cash flows. This is then allocated in a pre-determined manner to various requirements including debt servicing. Residual Cash flow is available to the project company.

Total Project Cost Means as estimated by the govt. / statutory entity that owns the project As sanctioned by the lead bank As actually expended But does not include the cost of land increased by the govt. / statutory entity. Cost of land Development cost (construction/infrastructure, furniture, fixtures and equipment, fees and expenses, etc.)Working capital (if applicable),

28

unforeseen, etc. -NOTE:

In a case of a request for refinancing, please indicate the

breakdown of existing debt/loans outstanding, and respective names of Banks/ Financial Institutions. Loan Requested Amount and Breakdown of the use of the loan proceeds Loan Period requested (number of years including the construction/ development period) Equity/Financial Responsibility Hard Equity presently available (assets: land/properties, cash, etc.)Offered Guarantees (corporate, personal, others) Studies/Investigations already made (only author/names and dates) Feasibilities Studies (market survey, marketing/operation plans, financial analysis/projections/debt service, etc.)Appraisal Report (land/property valuation, figures, etc.) Upon submission of the above requested information, EVALUATION FUNDING S.L. would be in the position to initially check the parameters of your project, contact potential loan arrangers/lenders interested specifically in this type of project and get back to you in about 2 to 3 working days with the results. At that time you will be informed if applicable, and if you decide to proceed with us of the respective fees to be paid for our services (Project Appraisal/Evaluation Report and Loan Arranger/Lender Contact), and the necessary step-by-step procedure to follow towards a successful Project Evaluation and Funding. Submission of Proposal to designated authority If No queries raised If queries raised Sanction of proposal on various Terms & Condition Application to comply with Sanction Terms & Condition & Execution of Loan Documents Disbursement Public Private Partnership (PPP) Project Means a project based on a contract or concession agreement between the govt. or statutory entity on the one side and a Private company on the other side, for delivering an infrastructure service on payment of user charges. A project awarded to a private sector

29

company for development, financing, construction, maintenance and operation through public private partnership. In case of PPP project, the private sector co shall be selected through a transparent and open competition bidding process.PPP projects based on standardized model documents duly approved by the respective govt. would prefer. Stand alone document may be subjected to detailed scrutiny.

30

Generation of Ideas

Initial Screening

Is the idea Prima Facie Promising

Plan Feasibility Analysis

Terminate

Conduct Market Analysis

Conduct Technical Analysis

Conduct Financial Analysis

Conduct Economic Ecological Analysis &

Is the Project Worthwhile ?

Prepare Funding Proposal

Terminate

31

3.9 PROJECT EVALUATION

Project evaluation is a high level assessment of the project to see whether the project is worthwhile to proceed and whether the project will fit in the strategic planning of the whole organization. Project evaluation helps to decide which of the several alternative projects has a better success rate, a higher turnover. STEPS IN PROJECT EVALUATION

Inception of Idea Econom Analysis ic Need & Justification Strategic Analysis Project Design Selection

Cost Analysis

Revenue Analysis

Financial Analysis

Sensitivity Analysis

32

KEY PARAMETERS TO BE EVALUATED IN A PROJECT The key parameters to be evaluated in a project are: Risk Analysis Demand Analysis Project Cost Estimation Revenue Analysis Financial Analysis Project Selection Criteria

RISK ANALYSIS Risk analysis is a technique to identify and assess factors that may jeopardize the success of the project. Risks associated with capital investment proposals can be broadly classified as:

Financial Risk: Financial risk is defined as the possibility that the actual return on an investment will be different from the expected return. Many techniques are available for determining financial risk involved with the projects like Risk adjusted Discount Rate, Certainty Equivalent, Sensitivity Analysis, DCF, Break Even Analysis, Probability Assignment, Standard Deviation etc.

33

Financial Parameters Debt Equity Ratio 2.5:1 to 4:1 in exception cases.Promoters contribution not less than 15% of the project cost. Fixed asset coverage ratio 1.25 and above, Overall Debt service coverage Ratio not less than 1.50-2.0, Interest ie Earning before Interest & Tax coverage average expenses. Internal Rate of Return (Post Tax) 4% over the estimated cost of funds.

Other Risks: Other risks constitute risks which may be an obstacle in the success/ Completion of the project. Risks which can be included in other risk are Availability Risk Completion (technical and timing) Risk Counterparty credit risk Country (political) Risk Inflation Risk Input and throughput Risk Market (demand) Risk Technological Risk

34

DEMAND ANALYSIS: Success of a project depends on the projects usage potential and user willingness to pay. Demand analysis involves forecasting the demand on the basis of market surveys and manufacturing capacity of the unit and this is decided through the study of demand and supply. The potential users, their habits, and possibility of changing these habits, the pricing of the products, the designing are studied under demand forecasting. In the demand analysis we check if there is a scope for laying a pipeline, if the demand at destination is less, then a pipeline is not required. The major Steps in demand analysis are Determining different uses of a project output Determining current consumption level and future demand Finding financial and economical benefits from the project PROJECT COST ESTIMATION Accurate estimation of costs is vital for the effective evaluation of the project since it is important for knowing the financial feasibility of the project. The capital costs and operating costs of the project is considered in this step. The following factors needs to be kept in mind while estimating costs. Base Cost Estimate Contingency Costs Cost Factor for difference between domestic & foreign inflation rates Financing cost incurred during the construction period on loans Specifically borrowed for project is capitalized at the actual borrowing rates

35

REVENUE ANALYSIS Revenue analysis is estimation of the revenues which would be earned in the future. Revenue projections are formed on the basis of Output sales. It helps in finding out the profits/ losses in the future. Revenue analysis is all the more important in project finance because the debts have to be repaid through the revenues generated by the project. FINANCIAL ANALYSIS Financial analysis refers to an assessment of the viability, stability & profitability of a project. It seeks to ascertain whether the proposed project will be financially viable in the sense of being able to meet the burden of servicing debt and whether the project will satisfy the return expectations of those who provide the capital.

36

3.10 PROJECT SELECTION CRITERIA

Once information about expected return and costs has been gathered, the next question arises: whether the project should be selected or not. There are many methods of evaluating the profitability of the project. The various commonly used methods are as follows:

PAY-BACK PERIOD METHOD: It represents the period in which the total investment in permanent assets pays back itself. Under this method various investments are ranked according to the length of their pay-back period and the investment with a shortest pay back period is preferred. The pay-back period can be ascertained in the following manner: Payback period = Investment Cash Flows/year

Acceptance Rule The project would be accepted if its payback period is less than the maximum or standard payback period set by management. As a ranking method, it gives highest ranking to the project, which has the shortest payback period and lowest ranking to the project with highest payback period

37

AVERAGE RATE OF RETURN METHOD: This method takes into account the earnings expected from the investment over their whole life. According to this method the project with the highest rate of return is selected. The return on investment is calculated with the help of following formula.

ARR = Average Annual Profits after depreciation & Taxes x 100 Average Investment

Where, Average Investment = Original Investment + Salvage Value 2

Acceptance Rule This method will accept all those projects whose ARR is higher than the minimum rate established by the management and reject those projects which have ARR less than the minimum rate. This method would rank a project as number one if it has highest ARR and lowest rank would be assigned to the project with lowest ARR.

38

NET PRESENT VALUE METHODS: The Net present value method is the modern method of evaluating investment proposals. This method takes into consideration the time value of money and attempts to calculate the return on investments by introducing the factor of time-element. NPV= Present value of cash inflows Present value of cash outflows. OR NPV =CF1 + CF2 + + CFn (1+k) - ICO (1+k) 1 (1+k) 2

Acceptance Rule Accept the project when NPV is positive Reject the project when NPV is negative May accept the project when NPV is zero the higher NPV should be selected. NPV > 0 NPV < 0 NPV = 0

The NPV method can be used to select between mutually exclusive projects; the one with

39

INTERNAL RATE OF RETURN METHOD: It is also known as trial & error yield method. The following steps are required to practice the internal rate of return method. Determine the future net cash flows during the entire economic life of the project. The cash inflows are estimated for future profits before depreciation but after taxes. Determine the rate of discount at which the value of cash inflows is equal to the present value of cash outflows. If annual cash flows are equal then it can be easily found out otherwise it has to be found out by hit and trial method. Accept the proposal if the IRR is higher than or equal to the minimum required rate of return i.e. cost of capital or otherwise reject the proposal. In case of alternative proposals select the proposal with highest IRR.

ICO = CF1

+ CF2

+..

CFn (1+IRR)n

(1+IRR)1 (1+IRR)2

Acceptance Rule Accept the project when r > k. Reject the project when r < k. May accept the project when r = k. In case of independent projects, IRR and NPV rules will give the same results if the firm has no shortage of funds.

40

PROFITABILITY INDEX This method is also known as benefit cost ratio and is similar to NPV approach. It measures the Present Value of returns per rupee invested based on the following formula: PI = Present value of Cash Inflows Present value of cash Outflow or PI =CF1 + CF2 +. + CFn (1+k)n (1+k)1 (1+k)2 PI = 1 + [NPV / ICO]

Acceptance Rule The following are the PI acceptance rules: Accept the project when PI is greater than one. PI > 1 Reject the project when PI is less than one. PI < 1 May accept the project when PI is equal to one. PI = 1 The project with positive NPV will have PI greater than one. PI less than means that the projects NPV is negative.

Conventional and Non-conventional Cash Flows A conventional investment has cash flows the pattern of an initial cash outlay followed by cash inflows. Conventional projects have only one change in the sign of cash flows; for example, the initial outflow followed by inflows, i.e. + + +. A non-conventional investment, on the other hand, has cash outflows mingled with cash inflows throughout the life of the project. Non-conventional investments have more than one change in the signs of cash flows; for example, + + + ++ +.

41

Case of Ranking Mutually Exclusive Projects Investment projects are said to be mutually exclusive when only one investment could be accepted and others would have to be excluded. Two independent projects may also be mutually exclusive if a financial constraint is imposed. The NPV and IRR rules give conflicting ranking to the projects under the following conditions: The cash flow pattern of the projects may differ. That is, the cash flows of one project may increase over time, while those of others may decrease or vice-versa. The cash outlays of the projects may differ. The projects may have different expected lives TAX CALCULATION In project finance basically three types of taxes are calculated while doing financial analysis and these are: Minimum Alternate Tax Income Tax Capital Gains Tax Minimum Alternate Tax (MAT) Normally, a company is liable to pay tax on the income computed in accordance with the provisions of the income tax Act, but the profit and loss account of the company is prepared as per provisions of the Companies Act. There were large number of companies who had profits as per their profit and loss account but were not paying any tax because income computed as per provisions of the income tax act was either nil or negative. To avoid this practice, MAT was introduced in section 115JB of the Income Tax Act. Profit computed under the regular method is called regular profit and profit computed under sec 115JB is called Book profit and the tax computed is called MAT. If a company is having regular profits then income tax @ 33.99% (30% tax + 10% surcharge + 3% education cess) is charged on it. However if the books show losses, then MAT is calculated and if MAT shows profits, tax is calculated @ 11.33% (10% tax + 10% surcharge + 3% education cess). And if MAT shows losses, then tax is not to be charged.

42

MAT Credit When a company pays tax under MAT, tax credit is allowed in respect thereof during the years when the company pays normal corporate tax. The tax credit earned is the difference between the amount payable under MAT and the regular tax. The amount of MAT credit can be set-off only in the year in which the company is liable to pay tax as per the regular tax. MAT credit will be allowed carry forward facility for a period of five assessment years immediately succeeding the assessment year in which MAT is paid. MAT CALCULATION First of all, the book profits are calculated using the formula Book profit= Taxable profit + depreciation previously deducted - actual depreciation as per Income tax Act MAT loss is added to the book profit to obtain the adjusted book profit on which the MAT is calculated @ 11.33% (MAT rate).

Capital Gains Tax If any Capital Asset is sold or transferred, the profits arising out of such sale are taxable as capital gains in the year in which the transfer takes place. Capital asset gains are of two types Long term capital gains: Gains on assets held for more than 36 months before they are sold or transferred. In case of shares, debentures and mutual fund units the period of holding required is only 12 months. Rate of tax applied on long term capital gains is 22.66% (20% tax + 10% surcharge + 3% education cess).Short term capital gains: Gains on assets held for less than 36 months are included in this category. Rate of tax applied on short term capital gains is 15%.

43

CALCULATION OF CAPITAL GAIN Net capital gain is calculated with help of formula: Net Capital Gain = Gross Gain (Cost of Acquisition + Indexation Cost) Expenses on Sale Indexation Cost = Original value X Present year Index Base year/year of Acquisition Index

Capital gain is calculated at 22.66% of Net Capital Gain.

44

CHAPTER-4 ANALYSIS AND INTERPRETATION

45

PROJECT EXPANSION OF LANCO THERMAL (BOT):

Lanco is operating at 6.3 K.W of thermal plant at present. It is framed to Enhance its capacity to produce 6.3 K.W of thermal plant by expansion. The estimated cost of expansion is: Approved cost: 8692 Crs (Base Jun, 05) Debt component: 4346Crs. Assumed in calculation as per rate as 5.5%. Should it accept the expansion project or not any how expansion will affect the capacity in positive way: Project Schedule: Divided in two stage Stage I Stage-II Structural mills Time 36Months 48 Months

46

Pay Back Period:

Income (Profit Depreciati Sl.No 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 (a) (b) Years 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 2018-19 2019-20 After Tax) 1493 1316 1457 2645 3022 3100 3331 3519 3553 3619 3686 3755 3839 3931 4030 on 474 474 527 874 919 924 685 507 513 518 524 529 535 540 546

Cash Inflows 1967 1790 1984 3519 3941 4024 4016 4026 4066 4137 4210 4284 4374 4471 4576

Cumulative In Flows 1967 3757 5741 9260 13201 17225 21241 25267 29333 33470 37680 41964 46338 50809 55385

Cash

Cash Outlay : 8692 Payback Period : Initial investment Annual cash flow 3+ 3.10 years 2951 3519

Pay Back Period: It is assumed that the profit earning of the project will start from 2008-09.Taken consideration of (incremental adjusted cash flow) i.e. expansion Base year, for calculation 47

PAY BACK PERIOD. Estimated profits are taken from the data provided. For CIF we have deducted depreciation from profit &then cumulative profit. So the projected payback period is calculated as 3.10 years. We should increase this period with same exception as there May be any additional factor and other cause so rounding of3.10 to 4 years will be right, so that it will give more assistance to the calculation.

pay back period

4000 3500 3000 2500 2000 1500 1000 500 0 Initial investment Annual cash flow 3.10 years 3+

Series1

Cash Outlay : (a)

Payback Period : (b)

Average Rate of Return: Cash SL.No Years Income Depreciation Inflows (Before

depreciation) 48

1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 2018-19 2019-20

1967 1790 1984 3519 3941 4024 4016 4026 4066 4137 4210 4284 4374 4471 4576

474 474 527 874 919 924 685 507 513 518 524 529 535 540 546

1493 1316 1457 2645 3022 3100 3331 3519 3553 3619 3686 3755 3839 3931 4030

ARR =

Average profit Average investment Total cash inflows No. of years 46296 15

x 100

Average Profit=

= 3086.4

Average investment: here the additional working capital is also taken the consideration while calculating the ARR. Average investment = investment 2 8692 + WC + 702 Ad.

49

2 = ARR = = 5048 3086.4 5048 61.14% Average profit Total ROI = ROI = investment 3086.4 8692 ROI = 35.51% Annual initial x 100 x 100 x 100

It is more calculation taking total profit and taking average of it. It Show the return on an average as what an average income of the firm on Long run basis with certain assumption 61.14% for any firm at long run is good but there must be some decrease as future is not certain.

50

ARR
100% 80% 60% 40% 20% 0% 1 6 11 16 21 26 31 36 41 46 51 Series7 Series6 Series5 Series4 Series3 Series2 Series1

51

NPV: Cash Sl.No Years Inflows 1 2005-06 1967 2 2006-07 1790 3 2007-08 1984 4 2008-09 3519 5 2009-10 3941 6 2010-11 4024 7 2011-12 4016 8 2012-13 4026 9 2013-14 4066 10 2014-15 4137 11 2015-16 4210 12 2016-17 4284 13 2017-18 4374 14 2018-19 4471 15 2019-20 4576 Total Present Values of Inflows DCF (19%) 0.840 0.706 0.593 0.499 0.419 0.352 0.296 0.249 0.209 0.176 0.148 0.124 0.104 0.088 0.074 Present Inflows 1652.28 1263.74 1176.51 1755.98 1651.28 1416.45 1188.74 1002.47 849.79 728.11 623.08 531.22 454.90 393.45 338.62 15026.62 Values of

N P V = Total Present Value of Cash inflows Total Outlay = 15026.62 8692 = 6334.62

It is the factor of Re.1 calculation at the end of the year. It will be Value of Re.1 at the end of the year which is based interest rate, cost of Capital and market state which is called as

52

discounted rate to get an Discounted rate to get an approximate decision. It should be taken in every calculation of project so that an approximate. Decision can be taken. As it is more reliable the simple cash inflows (profits).

NPV
16000 14000 12000 10000 8000 6000 4000 2000 0
1 4 7 10 13

Y ears C as h Inflow s D C F (19% ) P res ent V alues of Inflow s

Internal Rate of Return: Discount rate taken as 18% (in crores)

To tal

Pr es en tV

alu es of Inf lo

ws

53

Present Values of Sl.No 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 Years 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 2018-19 2019-20 Cash Inflows 1967 1790 1984 3519 3941 4024 4016 4026 4066 4137 4210 4284 4374 4471 4576 DCF (18%) 0.847 0.718 0.609 0.516 0.437 0.370 0.314 0.266 0.225 0.191 0.162 0.137 0.116 0.099 0.084 Inflows 1666.049 1285.220 1208.256 1815.804 1722.217 1488.880 1261.024 1070.916 914.850 790.167 682.020 586.908 507.384 442.629 384.384 15826.708

Total Present Values of Inflows

Discount rate taken as 35% SL.No 1 Years 2005-06 Cash Inflows DCF(35%) 1967 0.741

(in crores) Present Inflows 1457.5 Values of

54

2 3 4 5 6 7 8 9 10 11 12 13 14

2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 2012-13 2013-14 2014-15 2015-16 2016-17 2017-18 2018-19

1790 1984 3519 3941 4024 4016 4026 4066 4137 4210 4284 4374 4471

0.549 0.406 0.301 0.223 0.165 0.122 0.091 0.067 0.050 0.037 0.027 0.020 0.015 0.011

982.71 805.5 1059.2 878.84 663.96 489.95 366.37 272.42 206.85 155.77 115.67 87.48 67.065 50.336 7659.621

15 2019-20 4576 Total Present Values of Inflows

A - Cash out lay IRR = L+ A-B 15826.708 - 8692 = = 18 + 15826.708 7659.6921 18 + 7134.708 8167.016 X 17 X (35-18) X (H L)

55

= =

18 + 32.85

0.874

X 17

In this calculation, is done on the basis of trail and errors. By taking various percentage of (DCF).So that an appropriate percentage of Internal Rate of Return can be judge out. Calculated figure is 32.85%, so we can take it as 35% cause at market Uncertainty.

IRR
9000 8000 7000 6000 5000 4000 3000 2000 1000 0 SL.No 12 15 3 6 9

Present Values of Inflows 1666.049 1285.22 1208.256 1815.804 1722.217 1488.88 1261.024 1070.916 914.85 Present Values of Inflows 1666.049 1285.22 1208.256 1815.804 1722.217 1488.88 1261.024 1070.916 914.85 DCF (18%) 0.847 0.718 0.609 0.516 0.437 0.37 0.314 0.266 0.225 0.191 0.162 0.137 0.116 0.099 0.084 Cash Inflows 1967 1790 1984 3519 3941 4024 4016 4026 4066 4137 4210 4284 4374 4471 4576

Profitability Index Method:

56

Cash Sl.No 1 2 3 4 5 6 7 8 9 Years 2005-06 2006-07 2007-08 2008-09 2009-10 2010-11 2011-12 2012-13 2013-14 Inflows 1967 1790 1984 3519 3941 4024 4016 4026 4066 4137 4210 4284 4374 4471 4576 DCF(19%) 0.840 0.706 0.593 0.499 0.419 0.352 0.296 0.249 0.209 0.176 0.148 0.124 0.104 0.088 0.074 Present Values of Inflows 1652.28 1263.74 1176.51 1755.98 1651.28 1416.45 1188.74 1002.47 849.79 728.11 623.08 531.22 454.90 393.45 338.62 15026.62

10 2014-15 11 2015-16 12 2016-17 13 2017-18 14 2018-19 15 2019-20 Total Present Values of Inflows

Cash P. I = Inflows Cash Outflows 15026.62 8692 1.73

= =

In calculation of P.I. simple income is taken in to consideration thats why p.i=1.73.But it is not correct as per practical study. So discounted rate will help to get good path to get an approximate P.I and it will be more reliable than old Traditional approach.

57

PI
16000 14000 12000 10000 8000 6000 4000 2000 0 1 3 5 7 9 11 13 15 P rofitability Index M ethod: P res ent V alues of Inflows P rofitability Index M ethod: DCF(19% ) P rofitability Index M ethod: Cash Inflows P rofitability Index M ethod: Y ears

58

CAPITAL STRUCTURING
Framework for Capital Structure: The FRICT analysis a financial structure may be evaluated from various perspectives. From the owners point of view, return risk and value are important consideration. From the strategic point of view, flexibility assumes great significance. A sound capital structure will be achieved by balancing all these considerations. Flexibility: The capital structure should be determined within the debt capacity debt capacity of the company, and this capacity should not be exceeded. The debt capacity of a company depends on its ability to generate future cash flows, it should have enough cash to pay creditors fixed charges and principal sum and leave some excess cash to meet future contingency. The capital structure should be flexible. It structure should be flexible. It should be possible for a company to adapt if warranted by a changed situation. It should also be possible for a company to adapt its capital structure with a minimum cost and delay if warranted by changed situation. It should also be possible for the company to provide funds whenever needed to finance its profitable activities. Risk: The risk depends on the variability in the firms operations. It may be caused by the macroeconomic factors and industry and firm specific factors. The excessive use of debt magnifies the variability of shareholders earnings, and threatens the solvency of the company. Income: The capital structure of the company should be most advantageous to the owners (Shareholders) of the firm. It should create value; subject to other considerations, it should generate maximum returns to the shareholders with minimum additional cost.

59

Control: The Capital structure should involve minimum risk of loss of control of the company. The owners of closely held companies are particularly concerned about dilution of control. Timing: The capital structure should be feasible to implement given the current and future conditions of the capital market. The sequencing of sources of financing is important. The current decision influences the future options of raising capital. The FRICT (Flexibility, Risk, Income, Control and Timing) analysis provides the general framework for evaluating a firms capital structure. The particular characteristics of a company may reflect some additional specific features. Further, the emphasis given to each of these features will differ from company may reflect some additional specific features. Further the emphasis given to each of these features will differ from company to company. For example, a company may give more importance to flexibility than control, while another company may be more concerned about solvency than any other requirement. Furthermore, the relative importance of these requirements may change with shifting conditions. The companys capital structure should, therefore, be easily adaptable.

60

APPROACHES TO ESTABLISHMENT TARGET CAPITAL STRUCTURE

The capital structure will be planned initially when a company is incorporated. The initial capital structure should be designed very carefully. The management of Company should set a Target Capital Structure and the subsequent financing decisions should be made with a view to achieve the target capital Structure. The company needs funds to finance its activities continuously. Every time when funds have to be procured, the financial manager weighs the pros and cons of various sources of finance and selects the most advantageous sources keeping in view the target capital Consequently, it is being increasingly realized that a company should plan its capital structure to maximize the use of the funds and to be able to adapt more easily to the changing conditions. Theoretically, the financial manager should plan an Optimum Capital Structure for his company. The optimum capital structure is one that maximizes the market value of the firm. So far out discussion of the optimum capital structure has been theoretical. In practice, the optimum capital structure has been theoretical. In practice, the determination of an optimum capital structure is a formidable task, and one has to go beyond the theory. There are significant variations among industries and among companies within an industry in terms of capital structure. Since a number of factors influence the capital structure decision of a company, the judgment of the person making the capital structure decision plays a crucial part. Two similar companies may have different capital structures if the decision- makers differ in their judgment of the significance of various factors.A totally theoretical model perhaps cannot adequately handle all those factors, which affect the capital structure decision in practice these factors are highly psychological, complex and qualitative and do not always follow accepted theory, since capital markets are not perfect and the decision has to be taken under imperfect knowledge and risk.

Elements of Capital Structure: 61

A company formulating its long-term financial policy should first of all, analyze its current financial structure. The following are the important elements of the companys financial structure that need proper security and analysis. Capital Mix: Firms have to decide about the mix of debt and equity capital. Debt capital can be mobilized from a variety of sources. How heavily does the company depend on debt? What is the mix of debt instruments? Given the companys risks, is the reliance on the level and instruments of debt reasonable? Does the firms debt policy allow it flexibility to undertake strategic investments in adverse financial conditions? The firms and analysis use debt ratios, debt-service coverage ratios, and the funds flow statement to analyze the capital mix. 1. Net Income Approach (NI Approach): Accounting to NI Approach, the debt in the capital structure influences the total value of the enterprise. In other words the overall cost of capital as well as the total value of the enterprise, in other words, the overall cost of capital as well as the value of the firm would change with change in debt in the capital structure.NI Approach states that if the proportion of debt in the capital structure in increased, the weighted average cost of capital would decrease and the market value of the firm would increase. On the other hand a decrease in the financial leverage will lead to an increase in the overall cost of capital thus reducing the value of the firm. 2. Net Operating Income Approach (NOI Approach) NOI Approach is contrary to the NI Approach. It argues that the capital structure changes do not influence the value of the firm. In other words, the value of the firm and the overall cost of capital are independent of the degree of leverage (Debt).The Net Operating Income Approach has made the following assumptions.

62

1. The market evaluates the value of the firm as a whole. So the split between debt and equity is insignificant. 2. Net Operating Income is capitalized at the overall cost of capital (K 0) which is dependent on the business risk. If business risk is assumed to be constant K0) remains unchanged. 3. Cost of Debt (K0) is constant. 4. Cost of Equity (K0) increases with the degree leverage. 5. Corporate taxes do not exist...

3. Traditional Approach: First Stage: In the first stage Overall cost of capital is reduced or the value of the firm is increased with increasing leverage. Cost of equity (Ke) remains constant or there may be a slight rise because the increased use of debt increases the financial risk to shareholders, only to some extent. But this rise is not sufficient to offset the advantage derived than using cheaper source of debt. Cost of debt (K0) remains constant since the proportion of debt is considered to be within reasonable limit. As a result, with the use of more debt. A cheaper source, the value of the firm increase or the overall cost of capital decreases with increasing leverage (proportion of debt.) Second Stage: After reaching a certain level of debt, the degree of leverage has little or no effect on the value or the overall cost of the firm. This is because the advantage of low cost debit is offset by increased cost of equity. The cost of equity is increased due to a higher financial risk. In this stage. Overall cost of capital is minimum or the value of the firm is maximum.

Third Stage:

63

Beyond the acceptable limit, if the amount of debt is increased, the cost of equity would show a great rise thus offsetting advantage of low cost debt. Further, the cost of debt (K d) also rises because the firms capacity to borrow decreases. Thus, during this stage, the cost of capital increases or the value of the firm decreases with leverage.

CAPITAL RESTRUCTURING IN LANCO INFRATECH

64

A. FIRST CAPITAL RESTRUCTURING: The ensure viability and to prevent from becoming potentially sick under sick industrial companies (Special Provisions) Act 1985 as the analysis made in 1989 indicated non- viability even at 100% capability utilization due to high capital related charges. Salient Features: Conversion of Rs. 1184 Crs Banks Loans into the Equity Capital. Conversion of Rs. 1185 Crs Banks loans into 7% non- cumulative preference shares redeemable at the end of 10 years. Conversion of Rs.791, Crs interest due on Banks loans into interest free loan for a period of seven years. Conversion of Banks loans receivable in 1992-1993 into 7% non- cumulative preference shares redeemable at the end of 10 years from the date of allotment (Rs. 419 Crs released after 31st July, 1992). Conversion of Banks Loans receivable in 1993-94 into preference shares to be decided after review. Waiver of penal interest that become due up to July, 1992 (Rs.149.40. Crores) Banks ensures funds (Rs. 1507 Crs) in the plan period for the project.

Challenges Set: 100% Capacity utilization by 1996-97. Net profit with no interest on Banks funds by 1997-98. Cumulative losses to be wiped out by 2004-05.

Benefits from Capital Restructuring:

65

 Reduction of loss by Rs. 432.47 crores annually on account of interest saving due to conversion of loans to the equity capital, preference capital and interest free loan. Reduction of loss by Rs. 149.40 crores on account of interest saving due to waive of penal interest. B. SECOND CAPITAL RESTRUCTURING: To prevent becoming potentially sick unit under the sick industrial companies (Special Provision) Act 1985. Salient Features: Conversion of Rs. 542.47 Crs loan into 7% non cumulative preferences capital redeemable after 10 years. Conversion of Rs.791, Crs interest free loan to 7% non- cumulative preference capital with effect from 31.03.1998 redeemable after 2000-01 with repayment schedule to be communicated in due course. Benefits from capital Restructuring: Reduction of loss by Rs. 235.85 Crs on account of interest saving due to conversion of loans to preference capital retrospectively. Interest saving of Rs. 88.47 Crs. Per annum. Company could avoid attracting provisions of sick industrial companies (Special Provisions) Act 1985.

1st Condition:

66

When 70% of the project expenses is taken through loans (long term at 5.5%) & rest. 30% as equity. Particular EBIT Less : Interest (8692 X 70%) = 6084. 4 Cr X 5.5% as int EBT Less : Tax at 35% as on 1294.358 x 35% EAT Less: Pref. Share at 7% Calculation of EPS: Project cost 8692 Cr Its 30% as equity 8692 x 30 % = 2607.6 Cr into Rs. 26076000000 And divide it by face value of equity - 1000 Rs/- share Total Equity share value No of Equity = Value of the Share Amount 1629.000 334.642 1294.358 453.025 841.333 322.646

26076000000 No of Equity = 1000 = For EPS = 26076000 Earnings to Equity (E to E) ______________________

67

No of Equity Share 8413330000 = 26076000 = 322.646

68

1st condition
1 0.9 0.8 0.7 0.6 0.5 0.4 0.3 0.2 0.1 0 = 322.646 =
2nd Condition: When the mix ratio between debt & Equity is change as 70% equity & 30% as debts. Then the level of impact, With same assumptions Particular EBIT Less : Interest Amount 1629.000

Calculation of EPS: Project cost 8692 Cr Its 30% as equity 8692 x 30 % = 2607.6 Cr into Rs. Calculation of EPS: Project cost 8692 Cr Its 30% as equity 8692 x 30 % = 2607.6 Cr into Rs.

69

(8692 X 30%) = 2607.6 Cr X 5.5% as int EBT Less : Tax at 35% as on 1485.582 x 35% EAT Less: Pref. Share at 7% (No issue of pref. Share) E To E For EPS Earning per share

143.418 1485.582 519.954 965.628 ____ 965.628 158.706

EPS calculation: 8692 cr X 70% = No of Equity = Value of the Share In Rs. = 60844000000 1000 So EPS = E to E No of Equity = 9656280000 = 158.706 60844000 = 60844000 6084.4 Cr Total Equity share value

70

2nd condition 6084.4 Cr No of

70000000 60000000 50000000 40000000 30000000 20000000 10000000 0 No of Equity

EPS calculation: Equity = Rs. = 60844000000 EPS calculation: 6084.4 Cr No of Equity = 60844000

= E to E

So EPS = 158.706

EPS calculation: 6084.4 Cr Total Equity share value No of Equity = Value of the Share

3rd Condition: In this part debt Equity mix are divided in ratio 60:40 as debt as 60% and equity as 40%. Particular EBIT Less : Interest (8692 X 60%) = 5215.2 Cr X 5.5% as int Amount 1629.000 286.836

71

EBT Less : Tax at 35% as on 1342.164 x 35% EAT Less: Pref. Share at 7% (No issue of pref. Share) E To E For EPS Earning per share

1342.164 469.757 872.407 ____ 872.407 250.922

EPS Calculations: Project cost = 8692 Cr 3476.80 Cr Total Equity share value No of Equity = Value of the Share In Rs. = 34768000000 1000 For EPS = E to E = No of Equity 34768000 8724070000 = 250.922 = 34768000 40%as equity =

72

3rd condition
40000000 35000000 30000000 25000000 20000000 15000000 10000000 5000000 0 = = 250.922 No of Equity = = 250.922

34768000 Value Total 3476.80 Cr 8692 Cr

73

CHAPTER-5 FINDING AND SUGGESTION

74

FINDINGS:
The project completion cost is estimated to be Rs. 8692. Cr. The payback period of the project in LANCO is 3 years and 10 months. The payback period is less than the target period so the project may be accepted. The NPV of the project is positive than the value of the capital. The Internal rate of return is Internal rate of 31.85% it is greater than the cost of capital i.e., 19% so the project accepted. The profitability index is also more than 3 times returns on investment so the project is accepted. The estimated cash flows of the project include interest and tax. Before expansion the EPS value is Rs. 13,603.6 For only expansion the EPS (at 7 : 3) of LANCO is Rs. 322.646 For expansion project the mix of Capital structure (6: 4) is also best for the company, but equity to be raised and debt to be lowered.

75

SUGGESSIONS
The project completion cost is estimated to be Rs. 8692. Cr. The payback period of the project in LANCO is 3 years and 10 months. The payback period is less than the target period so the project may be accepted. The NPV of the project is positive than the value of the capital. The Internal rate of return is Internal rate of 31.85 % it is greater than the cost of capital i.e., 19% so the project accepted. The best Capital restructuring mix is 70: 30, because it having EPS (Equity per Share) value is higher than the other mixes. The company has to maintain at 7: 3 (debt: equity), that is better for company. It also maintains 60: 40, but equity to be raised.

76

CHALLENGES IN PROJECT FINANCING

Infrastructure development has huge potential in developing countries of the Asia-Pacific region. Emerging economies in this area need billions of dollars in private funding to spark infrastructure investment. However, the classic problem of supply and demand puts forth an obstacle while the demand for infrastructure investment is enormous, these economies have failed to attract a supply of private investment in infrastructure projects. This lack of ventures in building adequate infrastructure can be attributed to weak tariff regulation, reluctance in honoring concession commitments, inconsistent enforcement of laws, corruption, poor governance practices, lack of availability of long-term local currency financing at fixed interest rates, weak accounting and dis-closure norms, and weak securities legislation. As the problem persists, investors are now reluctant to take currency mismatch, interest rate and refinancing risks. Traditionally, commercial banks have been the suppliers of longterm financing in Asia and in doing so they have heavily relied on short-term deposits to meet their funding requirements. Such a practice, especially in a weak banking environment, exposes the banking sector to systemic risks. A testament to these issues is the large number of infrastructure projects in Asia that were financed in hard currency and later struggled with the adverse impact of Asian financial turbulence and required restructuring. We are all aware that the real cost of the Asian financial crisis was in the form of reduced lending volumes, and

77

..

KEY LEARNINGS FROM THE PROJECT

Each and every activity in life helps us to learn new things. This project too was a perfect learning experience and has helped me to learn a lot. Corporate aspect: This project has provided me with good exposure to actual working environment of an organization. . Financing of Projects: Project finance is a new & emerging concept for financing the projects. This project has helped me to understand the nitty- gritties & application of project finance which cannot be understood by reading books. Procedure of evaluating projects: Through this project, I have learned the various aspects of evaluating the project, financial tools for assessing the viability of project, cost estimation and how depreciation, taxes etc impact the evaluation of the projects.

78

LIMITATIONS Each and every project or research carried out has some limitations, be it time constraints or any other such issues that invariably, plague the result. There was a constraint with regard to time allocation for the research study i.e. for a period of two months. Data collection was strictly confined to secondary source thus is subject to slight variation than what the study includes in reality There were various technical terms used in the project, which were difficult to understand.

CONCLUSIONS At the end it may be concluded that project financing is a good method for financing and evaluating the projects. It covers all the aspects of the project and help in mitigating the risks. This project includes step wise analysis starting from need & justification to sensitivity analysis.

79

BIBLOGROPHY:
Books and company magazine Financial Management by I M Pandey Financial Management by D K Goel Projects: Appraisal, Evaluation and Financing by Prasanna Chandra WEBSITES www.google.com www.incometax.india.in

80