The presentation talks about why is it necessary to carry out Financial appraisal and the different methods to analyse it. It also discusses the steps involved in a financial appraisal of a project.
2. TYPES OF APPRAISAL
Market Appraisal - Potential market, Location and
accessibility of consumer
Technical Appraisal - Technical Viability, Operating at
optimum level?
Financial Appraisal - Profitability, NPV, IRR, pay back Financial Appraisal - Profitability, NPV, IRR, pay back
period, Level of Risk etc
Socio-Economic Appraisal - Social Cost benefits, level of
savings in society
Ecological Appraisal - Impact of the project on quality of
Air, Water, Noise, Vegetation, Human life. Likely
Damage and the cost of restoration eg. Industries
3. FINANCIAL APPRAISAL
The Financial Appraisal test demonstrates-
methods for analyzing and evaluating a
range of fictional accounting ratios and other
commercial data to enable the candidate tocommercial data to enable the candidate to
assess the potential risks and returns of
applications and to make preliminary
recommendations on whether or not to
advance funds.
4. WHY NECESSARY?
• Main problem– unlimited wants/limited
resources.
• Judicious decision required – how much to
invest/where to invest/when to invest ininvest/where to invest/when to invest in
each sector of economy to achieve highest
growth of economy.
• All sectors are required to be developed at
minimum cost while achieving highest
overall economic growth
5. INVESTMENT CRITERIA
To investigate efficiency and profitability of
investment in a project. Two Categories of
Investment Criteria are used :
i. Non- Discounting Cash Flow Methodsi. Non- Discounting Cash Flow Methods
ii. Discounting Cash Flow Methods (DCF
method)
6. NON- DISCOUNTING CASH FLOW
METHODS
• Pay back period
• Rate of Return
• Annual Equivalent Method• Annual Equivalent Method
7. PAY BACK PERIOD
o Time in years, necessary to accumulate from
annual cash flow (cash receipts minus cash
payments – but not depreciation) – an
amount equal to initial investment.
o Simple – but ignores time value of money.
8. RATE OF RETURN
o Expresses profit as percentage of Capital
employed.
o Relates average annual expected incomeo Relates average annual expected income
to total initial investment.
o Both Pay back period and ROR are
popular in private industry.
9. ANNUAL EQUIVALENT METHOD
Total cost is converted into total annual
amounts by replacing the investment cost
with an annual equivalent cost, adding
annual operating cost, and getting the ratioannual operating cost, and getting the ratio
between the annual benefits and the total
annual cost.
10. DISCOUNTING CASH FLOW METHODS
Concept: Taking time value of money
Rs. 100 today at 10% annual interest would be Rs.
110/- after a year, Rs. 121/- after 2 years , Rs.
133/- after 3 years
Techniques:
• Net Present Values (NPV)
• Internal Rate of Return
• Benefit/Cost Ratio.
11. CASH FLOW
The total amount of money being transferred into and out of a business.
Year 2012 2013 2014 2015 2016
Outflows
Infrastructure Capital Costs 139.05 324.27 382.07 450.74 340.25
Infrastructure O&M Costs 28.5 33.5 43.1 52.0 57.5
Fleet Procurement Costs 0.0 0.0 22.0 43.2 30.2
Bus O&M Costs 11.4 23.0 68.5
Other System Costs 0.6 1.2 3.4
Total Outflows 167.53 357.72 459.16 570.17 499.83Total Outflows 167.53 357.72 459.16 570.17 499.83
Inflows
Fare Revenue pa (Rs crore) 11.0 21.8 62.7
Indirect Revenue 0.8 1.5 4.4
Bus Salvage Value 0.00 0.00 0.00 0.00
Grants for
Infrastructure Capital Costs- GOI + GoG 49.25 130.81 147.22 195.29 141.99
Fleet Procurement Costs (GOI+GoG) 0.00 0.00 17.64 34.56 24.15
Devolvements from UTF (D) 0.00 0.00 75.00 80.25 85.87
Total Inflows 49.25 130.81 251.58 333.38 319.09
Annual Cashflow -118.29 -226.92 -207.59 -236.79 -180.74
12. PRESENT VALUE (PV)
The value in the present of a sum of money, in
contrast to some future value it will have when it
has been invested at compound interest.
PV = FV / (1+r)n
PV is Present Value
FV is Future Value
r is the interest rate (as a decimal, so 0.10, not 10%)
n is the number of years
13. instead of "adding 10%" to each year it is easier to
multiply by 1.10
Future Back to Now: what money in the future is worth now, go
backwards (dividing by 1.10 each year instead of multiplying):
14. Examples:
1) Sam promises you $500 next year, what is the Present
Value? (r=10%)
To take a future payment backwards one year divide by
1.10
So $500 next year is $500 ÷ 1.10 = $454.55 now
The Present Value is $454.55
PV = FV / (1+r)n
2) Alex promises you $900 in 3 years, what is the Present
Value? (r=10%)
To take a future payment backwards three years divide by
1.10 three times
So $900 in 3 years is:
$900 ÷ 1.10 ÷ 1.10 ÷ 1.10
$900 ÷ (1.10 × 1.10 × 1.10)
$900 ÷ (1.10)^3
$900 ÷ 1.331
$676.18 now
15. NET PRESENT VALUE
Net Present Value (NPV) is the difference
between the present value of cash inflows and
the present value of cash outflows. NPV is used
in capital budgeting to analyze the profitability
of a projected investment or project.of a projected investment or project.
NPV = ∑ {Future Value/(1+r)^n} - Initial
Investment
where r is the rate of return and n is the number
of time periods.
16. Example:
Assume a company wants to analyze the predicted
profitability of a project that requires an initial outlay of
$10,000. Over the course of three years, the project is
expected to generate revenues of $2,000, $7,000 and
$11,000, respectively. The anticipated discount rate is
4.5%. At first glance, it seems the returns are nearly
double the investment. However, a dollar earned in three
years is not as valuable as a dollar earned today, so the
company's accountant calculates the NPV as follows tocompany's accountant calculates the NPV as follows to
determine profitability while accounting for the
discounted time value of the projected revenues:
NPV = ∑ {Future Value/(1+r)^n} - Initial Investment
= {$2,000/(1+.045)^1} + {$7,000/(1+.045)^2} +
{$11,000/(1+.045)^3} - $10,000
= $1,913.88 + $6,410.11 + $9,639.26 - $10,000
= $7,963.25
17. INTERNAL RATE OF RETURN
The IRR is the interest rate, also called the
discount rate, that is required to bring the net
present value (NPV) to zero. That is, the
interest rate that would result in the present value of
the capital investment, or cash outflow, being equal
to the value of the total returns over time, or cashto the value of the total returns over time, or cash
inflow.
NPV= ∑ {FV/ (1+r)^n} - Initial Investment
where r is the interest rate and n is the number of
time periods. IRR is calculated using the NPV
formula by solving for r if the NPV equals zero.
19. COST BENEFIT ANALYSIS
Cost-Benefit Analysis (CBA) estimates and totals up
the equivalent money value of the benefits and costs
to the community of projects to establish whether
they are worthwhile.
Main measure of cost and benefit – is difference in
costs and benefits ‘with’ and ‘without’ projectcosts and benefits ‘with’ and ‘without’ project
What level of output would be with the project and
what they would have been without it
Economic Cost: The cost in economic terms means
the cost of the resource actually forgone, free from
the effect of taxes, subsidy
(factor-0.85)
20. STEPS INVOLVED IN A FINANCIAL
APPRAISAL OF A PROJECT
(i) A forecast of demand,
(ii) Estimation of financial costs; capital and
annual maintenance/recurring cost
(iii) Estimation of benefits on the basis of(iii) Estimation of benefits on the basis of
forecasted future traffic and
(iv) Comparison of costs and benefits for
assessing viability.
21. COST BENEFIT ANALYSIS of MRTS
PROJECT
• Basics involve traffic projection, estimation of costs, benefits and
conducting appraisal using ‘with’ and ‘without’ approach.
• Cost streams
Capital cost- civil works, rolling stock, signaling, interest
(current lending rate), construction of bus way, buses
Operating costs-metro, bus way, existing buses/private Operating costs-metro, bus way, existing buses/private
vehicle that will continue even after MRTS.
• Benefit items
Capital and operating cost of traffic if MRTS is not taken up
This become benefit (as this is not incurred after MRTS)
Saving due to decongestion
Saving in travel time
Saving in petrol/ diesel consumption
• IRR/EIRR
22. DECISION RULES
• NPV - Accept all projects with a positive NPV when
discounted at a rate reflecting the opportunity cost
of capital.
(Shouldn’t use NPV alone, club it with IRR)
• IRR - Accept all projects with an IRR reflecting the• IRR - Accept all projects with an IRR reflecting the
opportunity cost of capital.
• B/C - Accept all projects with a ratio (gross
benefit/Above 1.00 when discounted at a gross
costs) rate reflecting the opportunity cost of
capital.