ARTS & COMMERCE
Corporate finance -II
Loans and project appraisal
Submitted to: Prof. Shweta Mishra
Academic year: 2011-12
Meaning of loan:
A loan is an amount of money that's given from one (the lender)
to another person (the borrower) with an expectation of
repayment. Loans are a type of debt. If you're not careful when
you take out a loan, you could end up with one that's hard to
repay, leaving you in debt.
Loan is a form of debt, often with interest. There are several
reasons why people apply for loans. Usually they borrow
money to purchase a house, buy a car, or start a business.
Often, applying for a loan is necessary because most do not
have available financial resources they need to make a
purchase. Other forms of loans, like the student loans have
helped a lot of students get through school. Those who
use student loan debt consolidation clearly have multiple
student loans. They do this to manage their obligations better.
An arrangement in which a lender gives money or property to
a borrower, and the borrower agrees to return the property
or repay the money, usually along with interest, at some
future point(s) in time. Usually, there is a predetermined time
for repaying a loan, and generally the lender has to bear the
risk that the borrower may not repay a loan (though modern
capital markets have developed many ways of managing this
Definition: A loan for equipment, real estate and working
capital that's paid off like a mortgage for between one year
and ten years.
Term loans are your basic vanilla commercial loan. They
typically carry fixed interest rates, and monthly or quarterly
repayment schedules and include a set maturity date. The
range of funds typically available is $25,000 and greater.
Short-term Loans (upto two years) for different short term
requirements including bridge loan, Corporate Loan etc.
Medium-term Loans (more than two years to eight years)
for business expansion, technology up-gradation, R&D
expenditure, implementing early retirement scheme,
Corporate Loan, supplementing working capital and repaying
high cost debt.
Long-term Loans (more than eight years to upto 15 years) Project Finance for new industrial/infrastructure projects
Takeout Finance, acquisition financing (as per extant RBI
guidelines / Board approved policy), Corporate Loan,
Securitisation of debt.
Feature of term loan:
1.Maturity – The maturity period of term loans is typically
longer in case of sanctions by financial institutions in the range
of 6-10 years in comparison to 3-5 years of bank advances.
2. Negotiated – The term loans are negotiated loans between
the borrowers and the lenders. They are akin to private
placement of debentures in contrast to their public offering to
3. Security – Term loans typically represent secured
borrowing. Usually assets, which are financed with the
proceeds of the term loan, provide the prime security. Other
assets of the firm may serve as collateral security.
All loans provided by financial institutions, alongwith interest,
liquidated damages, commitment charges, expenses, etc.
4. Interest payment and principal repayment – The interest
on term loans is a definite obligation that is payable irrespective
of the financial situation of the firm. To the general category of
borrowers, financial institutions charge an interest rate that is
related to the credit risk of the proposal, subject usually to a
certain minimum prime lending rate/ floor rate.
Financial institutions impose a penalty for defaults. In case of
default of payment of installments of principal and/or interest,
the borrower is liable to pay by way of liquidated damages
additional interest calculated at the rate of 2 per cent per
annum for the period of default on the amount of principal
and/or interest in default.
A financially weak firm attract stringent terms of loan from
lender. The restrictive covenants
1) Negative Covenants:
A)Asset Related Restrictive Covenants: These covenants
put certain restrictions on the assets of the borrower. The
borrower either cannot break these covenants or would need to
take due approval or permission before breaking. These
restrictions may be in the form of following:
Creation of any further charge on the assets.
Sale of fixed assets.
B)Liability Related Restrictive Covenants: These covenants
restricts any activity affecting the liability of the company which
Taking up additional loan.
Repayment of existing loan.
Issue additional equity shares.
Issue of deposit certificates or unsecured loans etc.
Any disposal or reduction in promoter’s shareholding.
C) Cash Flow Related Restrictive Covenants: These
covenants restrict the usage of the cash flow of the company.
Capital expenditure on new projects, expansion,
diversification, modernization etc.
Limitation on top management salaries etc.
D)Control Related Restrictive Covenants: Covenants on
control are very embarrassing for the management because it
directly impacts the way they have managed the company prior
to the debt.
organizational change in consultation with the bank or
Appointment of Nominee Directors.
2) Affirmative / positive covenants:
These covenants are called affirmative or positive covenants
because they do not put any restriction on anything but
normally impose certain additional task to the borrower.
Submission of financial statements from time to time as
agreed in the loan agreement.
Maintenance of certain working capital level and net worth
of the company.
Secure debt payment by maintaining sinking fund.
What not you have to do for obtaining and maintaining that loan
in the company? Taking money from a financial institution is not
so easy. Borrowers lose all their freedom. But, if we think from
the point of view of the bank or financial institution, who is
holding public money with it, has to do such due diligence
before handing over that money to anybody. They have to
make sure that the loan does not become bad debt.
Types of loan:
There are many different types of loans you can take out. When
you’re looking to borrow money, it’s important that you know
1)Open-Ended and Closed-Ended Loans:
Open-ended loans are loans that you can borrow over
and over. Credit cards and lines of credit are the most
common types of open-ended loans. With both of these
loans, you have a credit limit that you can purchase
against. Each time you make a purchase, your available
credit decreases. As you make payments, your available
increases allowing you to use the same credit over and
Closed-ended loans cannot be borrowed once they’ve
been repaid. As you make payments on closed-ended
loans, the balance of the loan goes down. However, you
don’t have any available credit you can use on closedended loans. Instead, if you need to borrow more money,
you’d have to apply for another loan. Common types of
closed-ended loans include mortgage loans, auto loans,
and student loans.
2. Secured and Unsecured Loans:
a)Secured loans: it is loans that rely on an asset as
collateral for the loan. In the event of loan default, the lender
can take possession of the asset and use it to cover the loan.
Interests rates for secured loans may be lower than those for
unsecured loans. The asset may need to be appraised before
you can borrow a secured loan.
Lien: A legal claim against an asset which is used to
secure a loan and which must be paid when the property is
sold. Liens can be structured in many different ways. In
some cases, the creditor will have legal claim against an
asset, but not actually hold it in possession, while in other
cases the creditor will actually hold on to the asset until
the debt is
common arrangement when the asset is productive, since
the creditor would prefer that the asset be used to produce a
stream of income to pay off debt.
Hypothecation: it is the practice where a borrower
pledges collateral to secure a debt. The borrower retains
ownership of the collateral, but it is "hypothetically"
controlled by the creditor in that he has the right to seize
possession if the borrower defaults. A common example
occurs when a consumer enters into a mortgage agreement,
in which the consumer's house becomes collateral until the
mortgage loan is paid off.
Pledge:The transfer of possession of personal property
from a debtor to a creditor as security for a debt or
engagement; also, the contract created between the debtor
and creditor by a thing being so delivered or deposited,
forming a species of bailment; also, that which is so
delivered or deposited; something put in pawn.
Mortgage: A loan to finance the purchase of real estate,
usually with specified payment periods and interest rates.
The borrower (mortgagor) gives the lender (mortgagee)
a lien on
the property as collateral for
The mortgagor's lien
property expires when
the mortgage is paid off in full.
b)Unsecured loans: These loans may be more difficult to
get and have higher interest rates. Unsecured loans rely solely
on your credit history and your income to qualify you for the
loan. If you default on an unsecured loan, the lender has to
exhaust collection options including debt collectors and lawsuit
to recover the loan.
credit card debt
credit facilities or lines of credit
Home Loans are given for the property like houses or
apartments bought in your name. This type of loans are very
common in the salaried employees to buy the house. The
eligible limit for the home loans will be based on the financial
strength of the app0licant. Nowadays all the banks are
tightening the loan restriction because of economy crisis.
One advantage with the home loans is tax savings. You can
read more about the tax benefits on home loans. Also you can
read the list of articles on home loans.
Personal car loans are loans which you obtain in your own
name for the purpose of purchasing a car. They cannot be used
for other expenses, or for other purchases. They must be spent
on a car, which the lender then uses as collateral to secure the
loan. They are repaid to the lender monthly, or at some other
period agreed upon by both parties. Personal car loans are the
responsibility of the individual who signed for the loan, and not
their company or business.
Personal loans are tricky – you never can quite make out
whether it is absolutely necessary or if it is just a luxury you will
be paying back for the next few years. That new computer, or
that credit card outstanding, or the house refurnishing…the
need for personal loans is never ending. This site helps to
get online cash advance through online application.
These loans may be long-term for funding asset procurement
or short-term for financing working capital requirements.
Startup entrepreneurs may be required to offer collateral.
Moreover, borrowers are asked to present a business plan to
become eligible for such loans.
These loans are intended for funding higher education in the
absence of scholarships and grants. Initially, student loans only
covered tuition. Currently, education loans cover other
expenses pertinent to a college education, including
accommodation, books and supplies. Student loans in the US
are offered by private financial institutions, as well as the US
federal government. The latter accompanies lower interest
rates and flexible repayment terms.
Advantages of loans :
Below are the advantages of getting a loan. These are also the
reasons why many apply for it:
1. There is a loan for just about anything. If you are in need
of money to purchase a house, you can apply for a housing
loan. If you need a car, you can apply for a car loan. With all
the loans available, you will be able to purchase everything you
2. It helps a person afford an expensive purchase. All of us
wish to acquire a property. However, we do not have the
amount of money to make the purchase. Loans allow us to do
this. They lend us the money so that we can finally afford our
3. Payment is staggered, which makes it affordable. This
enables the person to pay off the loan gradually. If a person
has chosen a good deal, he should be able to finish paying off
the loan in the time specified.
4. One gets the funding he needs. If a person wants to start a
business, he can do so by applying for a business loan. He
does not have to wait for his savings to build up before he can
start his own business. They can also use the amount they loan
for investment purposes.
Getting a loan is very helpful to start building your dream.
However, you have to be very careful with your decisions. This
is because of the problems you will possibly encounter if you
mismanage your loans and other debts. If you have multiple
loans, make sure to manage it well. Use a debt consolidation
loan calculator and check if it is better to consolidate all your
Disadvantages of loans :
long-term debt: This means that you have to deal with
it for a specified period, which means that you have to
commit yourself to making monthly payments specified in
your agreement for the period indicated to repay the
Miss payments: you will face serious consequences.
You can face foreclosure or repossession of the property.
In addition, you could also face penalties and legal issues.
It will also reflect in your credit rating, which can lead
to a low credit scores.
Borrowers over-borrow: People sometimes over
borrow money and get caught in their own debt. Often,
this can lead to a shortfall in cash flow and payments can
take precedence over income. To prevent this, loan
repayments are restricted to a set percentage of a
Prepayment penalty: Often, loans come with a
prepayment penalty which prevents the borrower from
paying the loan earlier than the stipulated date without
incurring any extra costs.
Restrictions: Banks levy a number of restrictions on the
transaction. This includes having a good credit history
before applying for a loan, and there are often restrictions
about how the money should be used.
Project appraisal: it is a generic term that refers to the
process of assessing, in a structured way, the case for
proceeding with a project or proposal. In short, project appraisal
is the effort of calculating a project's viability. It often involves
comparing various options, using economic appraisal or some
other decision analysis technique.
It involves detail study of the arrangements made for
production, marketing and financing. Any venture, which is put
on stream, should sustain itself without external support and
only then it can be treated as viable. Viability study can be
made on the following aspect:
A) Technical Feasibility
B) Commercial and Economic Viability
C) Financial Feasibility
D) Managerial Competence
Areas of Project Appraisal:
1) Marketing Appraisal:
a)Examine the reasonableness of the demand projections
by utilizing the findings of available market survey reports
b) Assess the adequacy of the marketing
infrastructure in terms of:
c)Judge the knowledge, experience and competence of
the key marketing personal
2) Technical Appraisal: Focuses mainly on the following
a. Product mix
c. Process of manufacture
d. Raw material
e. Site and Location
g. Break-even point
3) Financial Appraisal:
The process of evaluating businesses, projects, budgets and
other finance-related entities to determine their suitability for
investment. Typically, financial analysis is used to analyze
whether an entity is stable, solvent, liquid, or profitable enough
to be invested in. When looking at a specific company, the
financial analyst will often focus on the income statement,
balance sheet, and cash flow statement.
In addition, one key area of financial analysis involves
extrapolating the company's past performance into an estimate
of the company's future performance.
4) Economic appraisal:
it is a type of decision method applied to a project, programme
or policy that takes into account a wide range of costs and
benefits, denominated in monetary terms or for which a
monetary equivalent can be estimated. Economic Appraisal is a
key tool for achieving value for money and satisfying
requirements for decision accountability.
It is a systematic process for examining alternative uses of
resources, focusing on assessment of needs, objectives,
options, costs, benefits, risks, funding, affordability and other
factors relevant to decisions.
5) Managerial Appraisal:
Managerial appraisal involves efficiently allocating the scare
resources such as Manpower material and facilities. One of the
main preoccupations of management in any organisation and in
project organisation is the allocation of scare resources. There
should be all the required resources for a given project should
be available and the best use of these resources.
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