Business valuation, leasing vs buying decision and project financing in bhel
A PROJECT REPORT ON :
BUSINESS VALUATION,BUSINESS VALUATION,
LEASING Vs BUYING DECISIONLEASING Vs BUYING DECISION
PROJECT FINANCINGPROJECT FINANCING
BHARAT HEAVY ELECTRICALSBHARAT HEAVY ELECTRICALS
S.No. PARTICULARS Page No.
Bharat Heavy Electricals Ltd. – Introduction
Research and Development
SWOT Analysis of BHEL
Corporate Functional Structure
Objectives of the Project
The Value Concept
Business Valuation Services
Accepted Valuation Approaches and Methods
The Approach Applied
Business Valuation of BHEL
Leasing Vs Buying Decision
Factors Effecting Cost of Financing Options
(Specifying BHEL’s Practices)
The Decision Platform – Net Cash Outflows
The Standardized Formats
5 – 23
25 – 40
41 – 73
74 – 100
The Financing Concept
Parties to Project Financing
Project Financing in BHEL – Selection of Bank /
The Decision Platform – NPV & IRR
The Standardized Formats
Bharat Heavy Electricals Limited
BHEL was set up by the Government of India in the late 50’s to manufacture power equipment
and to bridge the gap between demand and supply of power generations. Over the three decades,
BHEL developed capabilities in design manufacture, supply, erection and commissioning of power
plant equipment for thermal, hydro and nuclear power stations.
It is today a name to reckon with in the industrial world. It is the largest engineering and
manufacturing enterprise of its kind in India and one of the leading international companies in the
It offers over 180 products organized into thirty major product groups, BHEL met the needs of
various sectors of the Indian economy- power generation and transmission, transportation,
industry, telecommunication, defense, etc. The liberalization of the power sector during 1991 had a
significant impact on BHEL, which had been operating in a protected economy since its inception.
The company faced the challenge of competing with international power equipments majors like
Siemens, GE, ABB, etc. for obtaining orders.
BHEL has a wide-spread network comprising 14 manufacturing divisions, 8 service centers, four
power sectors regional centers, 15 regional offices, besides a large number of project sites spread
all over India and abroad, enables BHEL to be close to its customers and cater to their specialized
needs with total solution-efficiently and economically. An ISO9000 certification has given the
company international recognition for its commitment towards quality.
BHEL is one of India’s leading public sector companies. With an export presence in more than 50
countries, BHEL is truly India’s industrial ambassador to the world. In recognition of its record of
consistent profitability over the years, the Government of India had conferred on it the
“Navaratna” status in 1997.
THE RECENT HISTORY
In the 1970s and the 1980s, power sector projects were either funded by the Government through
budgetary resources or through central government undertakings like the NTPC, which largely
relied on multilateral organizations like the World Bank. Both sources of funding ensured a steady
stream of orders for BHEL, which won these contracts in spite of international competition. The
World Bank’s insistence on a 15 percent price preference for local equipment combined with the
low cost of BHEL equipment ensured that BHEL won 29 out of the 31 projects that were funded
by multilateral institutions during the 1980s.
By the late 1990s BHEL has emerged as a company whose products were competitive
internationally, in terms of price and quality.
In 1998, BHEL gave a renewed thrust to the Total Quality Management (TQM) drive that it had
initiated at its plants by following the European Foundation for Quality Management (EFQM)
Excellence Model. The company also finalized a Corporate Environment Management Policy,
which included a plan of action for various units to qualify for ISO 14001 Environment
management System certification in a phased manner.
BHEL’s business could be broadly classified into two categories – Power Equipment Business and
Industry Equipment Business. Power equipment business was BHEL’s core business and
generated about 52 percent of BHEL’s revenue during 1998. Its range of services included
systems design, engineering, manufacturing and project management.
Industry equipment business was set up to facilitate BHEL’s entry into growing areas like process
industries, telecommunications, non-conventional energy, transmission equipment industry, etc.
Lets deal with them segment wise:
This sector comprises of thermal, gas, hydro and nuclear power plant business. As of 31-3-2002,
BHEL-supplied sets account for nearly 67,232 MW or 64 per cent of the total installed capacity of
1,04,917 MW in the country, as against Nil till 1969-70.
BHEL has proven turnkey capabilities for executing power projects from concept to
commissioning. It possesses the technology and capability to produce thermal sets with super
critical parameters up to 1000 MW unit rating and gas turbine-generator sets of up to 250 MW unit
rating. Co-generation and combined-cycle plants have been introduced to achieve higher plant
efficiencies. To make efficient use of the high-ash-content coal available in India, BHEL supplies
circulating fluidized bed combustion boilers to both thermal and combined-cycle power plants.
The company has proven expertise in Plant Performance Improvement through renovation,
modernization and up rating of a variety of power plant equipment, besides specialized know-how
of residual life assessment, health diagnostics and life extension of plants.
TRANSMISSION AND DISTRIBUTION (T&D)
BHEL offers wide-ranging products and systems for T&D applications. Products manufactured
include: power transformers, instrument transformers, dry type transformers, series & shunt-
reactors, capacitors banks, vacuum & SF6 circuit breakers, gas-insulated switchgears and
A strong engineering base enables the company to undertake turnkey delivery of electric
substations up to 400 kV level, series compensation systems (for increasing power transfer
capability of transmission line and improving system stability and voltage regulation), shunt
compensation system (for power factor and voltage improvement) and HVDC systems (for
economic transfer of bulk power). BHEL has indigenously developed the state-of-the-art
controlled shunt reactor (for reactive power management on long transmission lines). Presently, a
400 kV FACTS (Flexible AC Transmission System) project is under execution.
BHEL is a major contributor of equipment and systems to industries: cement, sugar, fertilizer,
refineries, petrochemicals, paper, oil and gas, metallurgical and other process industries. The range
of systems and equipment supplied includes: captive power plant, co-generation plants, DG power
plants, industrial steam turbines, industrial boilers and auxiliaries, waste heat recovery boilers, gas
turbines, heat exchangers and pressure vessels, centrifugal compressors, electrical machines,
pumps, valves, seamless steel tubes, electrostatic precipitators, fabric filters, reactors, fluidized bed
combustion boilers, chemical recovery boilers and process controls.
The company is a major producer of large-size thyristor devices. It also supplies digital distributed
control systems for process industries and control & instrumentation systems for power plant and
industrial applications. BHEL is the only company in India with the capability to make simulators
for power plants, defense and other applications. The company has commenced manufacture of
large desalination plants to help augment the supply of drinking water to people.
BHEL is involved in the development, design, engineering, marketing, production, installation,
maintenance and after-sales service of rolling stock and traction propulsion systems. In the area of
rolling stock, BHEL manufactures electric locomotives up to 5000 HP, diesel electric locomotives
from 350 HP to 3100 HP, both for mainline and shunting duty applications. BHEL is also
producing rolling stock for special applications viz., overhead equipment cars, special well
wagons, Rail-cum-road vehicle etc. Besides traction propulsion systems for in-house use, BHEL
manufactures traction propulsion systems for other rolling stock producers of electric locomotives,
diesel – electric locomotive, electrical multiple units and metro cars. The electric and diesel
traction equipment of Indian Railways are largely powered by electrical propulsion systems
produced by BHEL. BHEL also undertakes retrofitting and overhauling of rolling stock. In the
area of urban transportation systems, BHEL is geared up to turnkey execution of electric trolley
bus systems, light rail systems, etc. BHEL is also diversifying in the area of port handling
equipment and pipelines transportation system.
BHEL provided total turnkey solution with extensive customer support. BHEL was the first
company in India to have installed electronic Private Automatic Branch Exchange (PABX)
system, and Rural Automatic Exchange (RAX) system based on indigenous technology from C-
Renewable Energy: technologies that can be offered by BHEL for exploiting non-conventional and
renewable sources of energy include: wind electric generators, solar photovoltaic systems, solar
heating systems, solar lanterns and battery-powered road vehicles. The company has taken up
R&D efforts for development of multi-junction amorphous silicon solar cells and fuel cells based
OIL AND GAS
BHEL is a major contributor to the Oil and Gas sector industry in the country. BHEL’s product
range includes Deep Drilling Oil Rigs, Mobile Rigs, Work Over Rigs, Well Heads and X-Mas
Trees (of up to 10,000 psi ratings), Choke and Kill Manifolds, Full Bore Gate Valves, Mud
Valves, Mudline Suspension System, Casing Support System, Sub-Sea Well Heads, Block Valves,
Seamless pipes, Motors, Compressors, Heat Exchangers, etc. BHEL is the single largest supplier
of Well Heads, X-Mass Trees and Oil Rigs to ONGC and OIL.
BHEL is one of the largest exporters of engineering products and services from India, ranking
among the major power plant equipment suppliers in the world.
Over the years, BHEL has established its references in around 60 countries of the world, ranging
from the United States in the West to New Zealand in the Far East. These references encompass
almost the entire product range of BHEL, covering turnkey power projects of thermal, hydro and
gas-based types, substation projects, rehabilitation projects, besides a wide variety of products, like
transformers, insulators, switchgears, heat exchangers, castings and forgings, valves, well-head
equipment, centrifugal compressors, photovoltaic equipment, etc. Apart from over 1100 MW of
capacity contributed in Malaysia, and execution of four prestigious power projects in Oman, the
major successes achieved by the company have been in China, Saudi Arabia, Libya, Greece,
Cyprus, Egypt, Bangladesh, Azerbaijan, Sri Lanka, Iraq, Kazakhstan, Indonesia, etc.
The company has been successful in meeting demanding customers’ requirements in terms of
complexity of the works as well as technological, quality and other requirements viz., associated
O&M, financing packages, extended warranties etc. BHEL has proved its capability to undertake
projects on fast-track basis. The company has been successful in meeting varying needs of the
industry, be it captive power plants, utility power generation or for the oil sector requirements.
Execution of overseas projects has also provided BHEL the experience of working with world
renowned Consulting Organizations and Inspection Agencies.
In addition to demonstrated capability to undertake turnkey projects on its own, BHEL possesses
the requisite flexibility to interface and complement with international companies for large projects
by supplying complementary equipment and meeting their production needs for intermediate as
well as finished products.
THERMAL POWER PLANTS
GAS BASED POWER PLANTS
HYDRO POWER PLANTS
DG POWER PLANTS
HEAT EXCHANGERS AND PRESSURE VESSELS
POWER STATION CONTROL EQUIPMENT
OIL FIELD EQUIPMENT
INDUSTRIAL ELECTRICAL MACHINES
SYSTEMS AND SERVICES
NON-CONVENTIONAL ENERGY SYSTEMS
SEAMLESS STEEL TUBES
CASTINGS AND FORGINGS
RESEARCH AND DEVELOPMENT
Over the years, BHEL had successfully adapted many global technologies to suit Indian
conditions. BHEL had modified boiler designs suitably to accommodate Indian coal, which had
high ash contents. It had also indigenized many components for power plants. During the 1960s,
R&D activities at BHEL were conducted separately at its various units.
During 1997, BHEL’s research wing achieved two major breakthroughs. BHEL succeeded in the
development, manufacture and testing of India’s first 200 KVA (kilo volt-ampere)
superconducting generator. The company was also successful in developing ‘fuel cell technology.’
Company sources explained that ‘phosphoric acid fuel cells,’ would emerge as a major source of
pollution-free electric power in the 21st
To remain competitive and meet customers’ expectations, BHEL lays great emphasis on the
continuous up gradation of products and related technologies, and development of new products.
BHEL’s commitment to advancement of technology is reflected in its involvement in the
development of futuristic technologies like fuel cells and super conducting generators. BHEL’s
investment in R&D is amongst the largest in the corporate sector in India. Products developed in-
house during the last five years contributed about 7% to the revenues in 2002-03.
BHEL has envisioned to becoming “A world-class innovative, competitive and profitable
engineering enterprise, providing total business solutions.” For realizing this vision, continuous
development and growth of the 48,000 strong highly skilled and motivated people making the
Organization, is the only ‘mantra’.
BHEL was perceived as a company where the promotions were fast, jobs were challenging, and
people enjoyed a great degree of freedom to operate and function. Employees at all levels of
BHEL received extensive training in different facets of management, technology and operations.
The Human Resource Development Institute (HRDI) at Noida and the company’s other training
institutes along with professional management institutes conducted various programs to upgrade
the skills of BHEL employees.
BHEL sources felt that the strong emphasis on training had resulted in a positive work culture.
This had led to the development of a committed and motivated workforce and enhanced
productivity and quality. It launched various initiatives to encourage participative management.
During 1999, BHEL introduced a Voluntary Retirement Scheme (VRS) for its employees. The
VRS aimed to correct imbalances that had crept in due to the government’s decision to extend the
retirement age from 58 to 60 years. The response for the VRS was overwhelming. BHEL received
applications from 8,600 workers (about 13 percent of its workforce).
To formulate strategies for growth and harmonious labor relations in a changing business
environment, the company organized a specially designed workshop fro unit level trade union
representatives and central trade union leaders.
Over the years, BHEL had emerged as one of India’s leading exporters. BHEL’s exports turnover
during 1997-98 touched an all time high of Rs.1783.85crore, for which it was conferred the
‘National Export Award.’ Recently it has also crossed that mark in 2001-02 (Rs.2501.95). BHEL
received orders from multinational companies like Siemens, Schneider, Toa, GEC, Dresser and
Pasau for a variety of products like ceramics, condensers, valves, motors, transformers, castings
and forgings, ceralin and insulators. BHEL’s export orders during 1998-99 increased by over two
and a half times to Rs.250crore as against Rs.91crore in the previous year. This performance was
achieved despite a highly competitive international market affected by the currency crisis in South-
YEAR 1992 1993 1994 1995 1996 1997 1998 1999 2000 2001
-93 -94 -95 -96 -97 -98 -99 -00 -01 -02
DEEMED 621 612 659 727 1138 1570 1902 1395 1425 1523
PHYSICAL 165 238 138 115 156 213 69 355 247 987
TOTAL 786 850 797 842 1294 1783 1971 1750 1673 2510
Over the years, BHEL had successfully adapted many global technologies to remain competitive
and meet customers’ expectations, it lays great emphasis on the continuous up gradation of
products and related technologies, and development of new products. The company has up graded
its products to contemporary levels through continuous in-house efforts as well as through
acquisition of new technologies from leading engineering organizations of the world.
BHEL had modified boiler designs suitably to accommodate Indian coal, which had high ash
contents. It has also indigenized many components for power plants.
In its early years, BHEL did not have much choice while selecting its technology suppliers. By the
mid-1970s, BHEL had established its credibility and suppliers from the Western countries were
vying with each other to provide technology. These agreements enabled BHEL to gain access to
the latest technology and products of its collaborators.
In 1996, BHEL formed strategic alliances with Siemens and GE to set up two separate 50:50 joint
venture companies. The joint venture between Siemens and BHEL, set up with a capital of
Rs.6crore, was named Power Plant Improvement Private Ltd. (PPIPL). The joint venture between
BHEL and GE, set up with a capital of Rs.7crore, was named BHEL-GE Gas Turbine Services
Pvt. Ltd. which would carry out after sales repair and services.
BHEL completed a successful year in 1997-98, despite a highly competitive environment, a
decline in industrial growth from 7.9 percent to 4.15 percent, and a negative growth in the capital
goods sector. The company managed an order inflow of Rs.5853crore during 1997-98. the year
ended with outstanding orders in excess of Rs.10000crore.
In 1998, the Government on India, which held a 77 percent equity stake in BHEL, announced that
the company had been identified for further disinvestment in line with its policy of giving
Navaratnas more autonomy. The Government intended to reduce its stake to 51 percent.
BHEL’s share price had appreciated considerably from Rs.100 in April, 1995 to Rs.223 in May,
2003. In 1997-98, BHEL achieved the highest ever earnings per share (EPS) of 29.4. In
comparison, the EPS in 1996-97 was only 18.9. Since then it has kept fluctuating. BHEL’s
earnings had constantly grown till now, it is a growing company.
Defying the downward trend it has constantly grown and another successful year was completed
and has registered a net profit of Rs.4679 million. Net worth of the company has gone up from
Rs.36018 million in 2000-2001 to Rs.42203 million in 2001-2002 registering an increase of
17.17%. NAV per share has increased by 17.17% from Rs.147.16 in 2000-2001 to Rs.172.43 in
Order inflow during 2001-2002 stood at Rs.98553 million. The year ended with an outstanding
order book of around Rs.1,25,000 million available for execution 2002-2003 and beyond.
THE earnings performance of BHEL for the quarter ended March 2002 has been fairly good. Sales
revenues during the period rose around 11 per cent to Rs 3,374.2 crore, compared to the
corresponding previous period. Of this, close to 68 per cent of the sales were generated by the
power division and the rest from the industrial division.
BHEL’s power equipment segment is the undisputed market leader in this segment. Its huge
capacity, ability to offer contemporary technologies and competitive prices, make it among the
preferred suppliers of power equipment in the country. This is evidenced by the order book
position, way ahead of its closest competitors. This trend is likely to continue and be in favour of
BHEL’s near-to-medium-term prospects
Trading at around Rs 167, the BHEL stock may be a good investment option for a moderate-to-
high-risk portfolio. It trades at a price earnings multiple of around 12 times its latest quarter’s
earnings per share. Its earnings performance for the quarter ended March 2002 has been fairly
Despite tough industry conditions, the company has managed a sedate growth rate in both profits
and revenues. Gains have come mainly on account of the company’s dominant position in the
industry and also good management of resources. In this backdrop, the valuation of the stock over
the next three months should improve. Fresh positions can be considered at current levels.
However, investors should also look out for exit opportunities once the stock breaches the Rs 200-
210 levels. Risk-averse investors may consider taking an exposure if the stock declines to Rs 150-
155, and sell if it crosses Rs 200.
While the Indian Economy is continuing to grow at slow pace, there are positive impulses like on-
going Restructuring and Reforms in the Power Sector, enhanced focus on Distribution, increased
outlay for Accelerated Power Development and Reforms Program, creating regulatory system,
new Electricity Bill etc. Government’s commitment to enhance private and public investments in
the infrastructure is a positive aspect that will spur Industrial Growth and enhance market
prospects for industrial products in the coming years.
BHEL has put in place a number of initiatives, as follows, for furthering future growth prospects:
Strengthening company’s core businesses of Power Generation, Transmission and Distribution,
Transportation and Industrial Systems and Products, through accelerated project completion
and consequent benefits to customers, along with new initiatives in marketing, technology,
facility up gradation and modernization, enhancing operational effectiveness etc.
Business Development efforts in related and allied areas utilizing the organizational strengths
and former customer focused specialized business groups e.g. formation of Oil Sector R&M
Business Group to address business in Renovation and modernization of off-shore and on-
shore oil platforms, down streams petroleum refining areas and Power Plant Operational
Services Group to provide Operation and Maintenance (O&M) Services for Power Plants.
After Market Services being the areas for future growth, spares and R&M services business
have been integrated into one focused group. R&M for hydro sets is an area having major
growth opportunity, which BHEL is poised to tap.
Exploring Business Opportunities in areas like Energy Conservation, Water Management,
Pollution Control and Waste Management, Ports, LNG terminal etc.
Positioning for Information Technology Business leveraging the domain knowledge in Power
Sector and Engineering field to provide IT enabled services for Power Sector and software
services for Engineering Industry.
Sustain and Enhance Exports for products and services through multi-prolonged approaches.
BHEL is also taking steps to re-position itself to meet the demands of the new market economy
through suitable strategies keeping in view the ultimate objective of enhancing value for its
SWOT ANALYSIS OF BHEL
• The company has 180 products under 30 major product groups that cater to the needs of the
core sector like power, industry, transmission, transportation, defense, telecommunications and
• BHEL's ability to acquire modern technology and make it suitable to Indian conditions has
been an exceptional strength of the company.
• Strong relationship with NTPC is a strength as NTPC is planning a capacity expansion of Rs.
52 bn and based on the past, 85% of NTPC projects have been bagged by BHEL. The company
also enjoys purchase price preference.
• PSU status is a big weakness for BHEL as it is subject to their rules and regulations and is
forced to carry a huge amount of labor force, which it is not able to retrench.
• The company offers very stringent credit facilities to the customers and this is a weakness
when compared in the face of rising competition. On the other hand their customers in the
power segment, SEBs, have a huge amount of receivables standing against their name in the
company's balance sheet. This is a major weakness for the company.
• The company is vertically integrated, which could have been avoided by outsourcing its
components for power generation and transmission. This could have reduced the cost.
• The power sector reforms are expected to pick up in the near future in India, which would
directly benefit BHEL.
• Increase in defence budget will increase the topline for the company.
• NTPC is planning additional capacities to the tune of 2,800 MW, at a cost of Rs 52 bn. BHEL
could benefit a lot as it has happened in the past that significant portion of the project of NTPC
is handled by BHEL. Nearly 85% of the NTPC projects were assigned to BHEL only.
• The business of modernization and renovations of power plants is expected to grow in India.
• The disinvestment plans of the government would bring in new resources and experience into
• Joint Venture with Siemens in the name of Powerplant Performance Improvement Ltd. (PPIL),
is a major strength for the company. This tie-up will be beneficial as there is a lot of scope for
business. During FY00 the PPIL received orders worth Rs. 320 crore.
• The global trend of consolidation has already resulted in a fall in turnover of the company and
this will prove to be a major threat in the years to come as well.
• The company is dependent on NTPC to a great extent.
• Recently, the government has permitted the import of second hand capital goods that are 10
years old without the need for a license. This move will definitely increase competitive
pressures for BHEL.
CORPORATE FUNCTIONAL STRUCTURE
At the top most level are the Board of Directors under whom is Chairman and Managing Directors.
Under this level are corporate functions, business sectors and management committee. Under
Corporate functions there are four directors. They are:-
• Director Engineering Research and Development
• Director Human Resources
• Director Finance
• Chief Vigilance Officer
Under Director Finance comes Executive Director Finance under whom there are following
Provident Fund Trust
OBJECTIVES OF THE PROJECT:
• To Carry out Valuation of BHEL
• To develop standard formats for Leasing Vs. Buying decisions
• To standardize Purchase of Asset using Own Vs Borrowed funds decision formats
• To develop standard formats for Project Financing Decisions
THE VALUE CONCEPT
“The fundamental goal of all business is to maximize shareholder value” This statement is now
universally accepted as a guide to enhancing shareholder value. In United States, top management
is traditionally expected to seek shareholder value maximization. Failure to do so results in
pressure from board of directors and activist shareholders or even hostile takeover bids. Elsewhere
in the world, companies make different implicit tradeoffs among their various stakeholders.
Earlier, maximizing shareholder value was often seen as short sighted, inefficient, simplistic and
even antisocial. But the evidences against these arguments and in favor of Shareholder wealth
maximization—are mounting. Winning companies have higher productivity, greater increase in
shareholder wealth and greater employment gains than their competitors. There is no evidence of
any conflict between shareholders and other stakeholders.
A value-based system grows in importance as capital becomes mobile. In wake of economic
liberalization, companies are relying more on capital market, acquisitions and restructuring are
becoming commonplace, strategic alliances are gaining popularity, employee stock options are
proliferating, and regulatory bodies are struggling with tariff determination. In these exercises a
crucial issue is: How should the value of a company or division thereof be appraised ?
For the purpose of finding out a firm’s value, various methods are used and many a times, an
indepth appraisal of the company and it’s assets and liabilities has to be carried out. The goal of
such an appraisal is essentially to estimate a fair market value of a company. The most widely
accepted definition of fair market value was laid down by Internal Revenue Services of the US. It
defined fair market value as “the price as which the property would change hands between a
willing buyer and a willing seller when the former is not under any compulsion to buy and the
latter is not under any compulsion to sell , both parties have reasonable knowledge of relevant
facts.” When the asset being appraised is “a company”, the property the buyer and the seller are
trading consists of the claims of all the investors of the company. This includes outstanding equity
shares, preference shares, debentures, and loans.
BUSINESS VALUATION SERVICES
Business valuations provides the information necessary to make sound business decisions in
regards to assessing the value of assets owned by businesses or individuals. Business valuation
helps to meet individual and business needs in many situations of need or adversity, including:
Adequacy of Life Insurance
Allocation of Acquisition Price
Bankruptcy and Foreclosures
Employee Stock Ownership Plans (ESOPs)
Estate and Gift Taxes
Financial Statements for a Business Loan
Franchise Valuation or Evaluation
Incentive Stock Option Programs
Initial Public Offerings (IPOs)
Lease vs. Buy
Disruption of Business
Dissenting Shareholder Actions
Economic Loss Analysis
Liquidation or Reorganization
Mediation and Arbitration
Mergers and Acquisitions
Sale of a Business
ACCEPTED VALUATION APPROACHES AND METHODS
Valuing a company is hardly a precise science and can vary depending on the type of business
and the reason for coming up with a valuation. There are a wide range of factors that go into the
process -- from the book value to a host of tangible and intangible elements. In general, the value
of the business will rely on an analysis of the company's cash flow. In other words, it's ability to
generate consistent profits will ultimately determine its worth in the marketplace.
A company’s value can be examined using 16 different methods in order to arrive at a supportable
conclusion of value:
Asset Valuation Methods:
• Book Value
• Adjusted Asset Value
• Liquidation Value
Income Valuation Methods:
• Capitalization of Earnings
• Discounted Future Earnings
When determining discount and capitalization rates, you have the option to use either the Build-Up
method or the Capital Asset Pricing Model (CAPM) method. If you are valuing the company on a
debt-free basis, you can convert the discount and capitalization rates to their debt-free equivalents
based on the company’s weighted average cost of capital.
In valuing the company’s historic and/or future earnings, you can use any of the following:
Normalized Net Income, EBT, EBIT, EBITDA, Net Cash Flow and Free Cash Flow.
Market and Comparable Company Approaches:
• Price to Earnings
From Mergerstat database (uses Net Income)
From Done Deals/Completed Transactions database (uses Net Income)
Other selected data source (you select earning base)
• Price to Revenue
• Price to Cash Flow from Operations
• Price to Gross Cash Flow
• Price to Dividends
• Price to Total Assets
• Price to Equity / Book Value
From Done Deals/Completed Transactions database
Other selected data source
Other Valuation Methods:
• Capitalization of Excess Earnings
• Rule of Thumb
Preferred Stock Valuation:
• Market yield of the preferred stocks of comparable companies
The commonly used approaches are :
ADJUSTED BOOK VALUE APPROACH
The simplest approach to valuing a firm is to rely on the information found on its balance sheet.
There are two equivalent ways of using the balance sheet information to appraise the value of the
firm. First the book value of investor’s claims may be summed directly. Second, the assets of the
firm may be totaled and from this total non-investor claims (like accounts payable and provisions)
may be deducted.
The accuracy of the book value approach depends on how well the net book values of the assets
reflect their fair market values. There are three reasons why book values may diverge from market
• Inflation drives a wedge between the book value of an asset and it’s current value. The book
value of an asset is it’s historical cost less depreciation. Hence it does not consider inflation
which is definitely a factor influencing market value.
• Thanks to technological changes some assets become obsolete and worthless even before they
are fully depreciated in the books.
• Organizational capital, a very valuable asset is not shown on the balance sheet, is not shown on
the balance sheet. Organizational capital is created by bringing together employees, customers,
suppliers and managers in a mutually beneficial and productive relationship. An important
characteristic of organizational capital is that it cannot be easily separated from the firm as a
Hence, their values are adjusted to reflect either Replacement cost or Liquidation values. Using
any of these methods was out of the purview of this project.
CAPITALIZATION OF INCOME METHOD
This method places no value on fixed assets such as equipment, and takes into account a greater
number of intangibles. Capitalization refers to the return on investment that is expected by an
investor. There may be many variations in how this method is applied.
In one method, factors effecting income of the business are listed, rated and then averaged to get
capitalization rates which are multiplied with buyer’s discretionary cash to determine the market
value of business.
Another method compares risk free returns or income of business are compared with same level of
returns being generated by other risk free investments. The business is then valued equal to those
EXCESS EARNING METHOD
This method is similar to the capitalization method. The difference is that it splits off return on
assets from other earning (the excess earnings). The financially rational reason for owning
business assets is to produce a financial return. A reasonable return here should be based on
industry averages for return on assets adjusted to current economic conditions.
This excess earning is typically multiplied by a factor of 2 to 5 based on such factors as the level of
risk involved in the business, the attractiveness of the business and the industry, competitiveness,
and growth potential. The higher the factor used, the higher the estimate of the business will be. A
typical number is 3 for a solid, profitable company. That is, a good business that is judged to be
average in terms of the level of risk involved, the attractiveness of the business, the industry,
competitiveness, and growth potential would use three as a multiplier. The actual factor used is a
mix of opinion, comparison to others in the industry, and industry outlook.
These Capitalization methods is best used in non asset intensive businesses and ones that derive
their income primarily from tangible assets such as a utility (such as gas or electric companies) like
service companies, hence was not put to use in this project
MULTIPLIER OR MARKET VALUATION
This approach finds the value of a business by using an "industry average" sales figure as a
multiplier. This industry average number is based on what comparable businesses have sold for
recently. As a result, an industry-specific formula is devised, usually based on a multiple of gross
sales. This is the trouble point with these formulas, because they often don't focus on bottom line
profits or cash flow. Also, they don't take into account how different two businesses in the same
industry can be.
Here are a few industry multiplier examples, as mentioned in "The Complete Guide to Buying a
Business" by Richard Snowden (Amacom, 1994):
Travel agencies - .05 to .1 X annual gross sales
Ad agencies - .75 X annual gross sales
Retail businesses - .75 to 1.5 X annual net profit + inventory + equipment
To find the right multiplier for an industry, their trade associations may be contacted. Another
option is to utilize the services of a broker or appraiser who specializes in similar businesses.
RULE OF THUMB METHOD
One of the most common approaches to small business valuation is the use of industry rules of
thumb. While most financial analysts cringe at the use of these approaches, they do have their
place as adjuncts to other methods.
One industry rule of thumb says an Internet Service Provider company is worth $75 to $125 per
subscriber plus equipment at fair market value. Another says that small weekly newspapers are
worth 100% of one year's gross income.
The problem with these and all rule of thumb formulas is that they are statistically derived from
the sale of many businesses of each type. The rule of thumb averages may be accurate for those
businesses whose performances are right about at the average. The business with expenses and
profits that are right on target with industry averages may well sell for a price in line with the rule
of thumb formula. Others will vary. To apply the rule of thumb to a business that varies
significantly from the average is not appropriate.
THE APPROACH APPLIED
Making good decisions usually depends on having good information and value is the performance
metric that uses the best and most complete information. For understanding value creation, a long
term approach needs to be adopted, managing all cash flows across both income statement and
balance sheet and understanding how to compare cash flows from different periods on a risk
adjusted basis. It is this dependence on full picture that makes value the best metric.
No other measure of corporate performance is as comprehensive or as well correlated with a
company’s market value. Earnings per share or market value tend to be used myopically, looking
only a few years ahead at best. Furthermore the earnings measure generally focuses on managing
the income statement and plays down actual amount and timing of cash flows. Even the difference
between return on invested capital (ROIC) and cost of capital can be a bad metric. If it is used only
in the short term it tends to encourage under investment in or the harvesting of – a business to
The Discounted Free Cash Flow approach is ideally suited when fairly credible business plans are
available for the explicit forecast period and the firm is expected to reach a steady state at
the end of the explicit period. Also this approach considers the cash flows and growth of
invested capital in the forecasted period as well as beyond it. With the nature data
available at BHEL, this was the most suitable approach to carry our Business Valuation.
DISCOUNTED FREE CASH FLOW FORECAST APPROACH
Valuing a firm using discounted cash flow approach is conceptually identical to valuing a capital
project using present value method. However, there are two important differences:
• While a capital project is deemed to have a definite life, a firm is considered as an entity that
has an indefinite life. This means that when we value a capital project we define it’s economic
life and impute a salvage value to the assets of the project at the end of it’s economic life;
however, for a firm we do not define an economic life and impute a salvage value to it’s assets
at the end of such a period.
• A capital project is typically valued as a ‘one-off ‘ investment. We do not ordinarily look at the
follow on investments on the assumption that these will be evaluated separately as and when
they crystallize. A firm, however, is viewed as a growing entity and for valuing a firm we take
into account all the investments in fixed assets and net working capital that are expected to be
made over time to sustain the growth of the firm.
Thus, Valuing a firm using the discounted cash flow approach calls for forecasting cash flows over
an indefinite period of time for an entity that is expected to grow. To carry out this task,
in practice the value of firm is separated into two time periods:
Value of the firm = Present Value of cash flow + Present value of cash flow
During an explicit forecast after the explicit forecast
During the explicit forecast period – which is often a period of 5 to 15 years – the firm is expected
to evolve rather than rapidly and hence a great deal of effort is expended to forecast it’s
cash flow on an annual basis. At the end of the forecast period, the firm is expected to
reach a ‘steady state’ and hence a simplified procedure is used to estimate the continuing
value at the end of the explicit forecast period.
Thus, the discounted cash flow approach to valuing a firm involves the following steps:
A. Forecast the cash flow during the explicit forecast period.
B. Establish the Weighted Average cost of capital.
C. Determine the continuing value at the end of the explicit forecast period.
D. Calculate the firm value.
A Forecast the cash flow during the explicit forecast period.
i) Select the explicit forecast period – as in case of BHEL taken to be of four financial
years from 2003-04 to 2006-07.
ii) Define Free Cash Flow to firm.
FCFF = NOPLAT – Net Investment + Non-Operating Cash Flow
NOPLAT (Net Operating Profit Less Adjusted Tax)
= EBIT – Adjusted Tax on EBIT
• EBIT (Earnings Before Interest and Tax)
= Profit Before Tax (PBT)
+ Interest expense
- Interest Income
- Non-operating income
• Adjusted Tax on EBIT
= Tax provision from income statement
+ Tax shield on interest expense
- Tax on interest income
- Tax on non operating income
= Gross Investment - Depreciation
Adjusted Non-Operating Income
= Interest / Dividend Income - Tax on Non-Operating Income
B. Establish the Weighted Average Cost of Capital (WACC)
WACC = [Cost of Debt (Cd) * Avg. Debts / (Avg Debts + Avg Net Worth) ]
+ [Cost of Equity (Ce) * Avg. Net Worth / (Avg Debts + Avg Net Worth) ]
Cost of Debt
= Total Interest Cost / Avg Borrowings * 100
Cost of Equity
= Risk Free Rate of Return + Risk Premium * Beta
• Risk Premium
= Market Expected Rate of Return
- Risk Free Rate
C. Determine the Continuing Value at the end of the explicit forecast period.
Continuing Value (CV) = [ Free Cash Flow n+1 (1 + Growth Rate of last year of
Explicit Period) ] / ( WACC – Growth Rate )
Growth Rate (g) = (Net Investment / Invested capital ) * 100
D. Calculate the firm value
Firm Value = Present Value of Free Cash Flow in Explicit Forecast Period
+ Present Value of Continuing Value.
The lease-versus purchase (or lease-versus-buy) decision is one that commonly confronts firms
contemplating the acquisition of new long-term assets. Ultimately, a company or business must
pay for new equipment either from its own accumulated capital resources 'equity financing' or by
using borrowed funds 'debt financing' or have another party acquire the desired equipment and
lease it to the company or business. In most cases, equipment acquisition becomes a choice
between purchase (either by equity or debt financing) and lease.
The main feature distinguishing leasing from other forms of financing like loans or mortgages is
the separation of usage from ownership. Throughout the term of the lease, the lessor retains legal
ownership while the lessee has possession and use. The lease will not normally confer on the
lessee either the right or the obligation to acquire the leased equipment from the lessor during the
lease term but may do so at its expiry.
If the business has excess cash to pay for an asset, purchasing it with that cash will be the least
expensive option since interest will be charged on any loan or lease option. Consideration though
would be that if cash that will be needed for day-to- day operations is used to purchase a long-term
asset, cash flow difficulties might arise.
Even if the company is doing well in terms of sales when purchase of asset is being considered
buying the asset, what is the likelihood of the situation changing over the next 3 years? This is
what is called Opportunity Cost. Opportunity Cost is defined simply as that cost incurred by
investing (utilizing cash) in one item over another.
If the interest rates in the market are dipping and the company hasn’t got a flush of resources to
invest in asset purchase, borrowing is the best option. It helps avoid large initial expenditure as
well as blocking of internal funds. Moreover since the repayment is spread over a long time period,
it helps to capture the Time Value advantage.
A Lease represents a contractual arrangement whereby the lessor grants the lessee the right to use
the asset in return of periodic leases rental payments. While Leasing of land, Buildings, and
animals has been known from times immemorial, the leasing of industrial equipment is a relatively
recent phenomenon especially on the Indian Scene.
Leasing and Hire-Purchase have emerged as a supplementary source of intermediate to long term
finance, provided mainly by Non-Banking financial companies, financial institutions, and other
An equipment lease transaction can vary along many dimensions such as – extent to which the
risks and rewards of ownership are transferred, number of parties to the transaction, domicilies of
the equipment manufacturer, the lessor and the lessee, etc.
Lease transaction are primarily classified as :
A finance lease, or Capital Lease, is essentially a form of borrowing. Its Salient features are:
It is an intermediate term to long term non-cancelable arrangement. During the initial lease
period, referred to as ‘primary lease period’, which is usually 3yrs, 5yrs or 8yrs, the lease
cannot be cancelled.
The Lease is more or less fully amortized during the primary lease period. This means that
during this period, the lessor recovers through the lease rentals his investment in the equipment
with an acceptable rate of return.
The Lessee is responsible for maintenance, Insurance and Taxes.
The Lessee usually enjoys the option for renewing the lease for further periods at substantially
An Operating Lease can be defined as any lease other than financial lease. The salient features of
an operating lease are:
The lease term is significantly less than the economic life of the equipment.
The Lessee enjoys the right to terminate the lease at short notice without any significant
The lessor usually provides the operating know-how and the related services and undertakes
the responsibility of insuring and maintaining the equipment.
Such an Operating lease is called a ‘Wet Lease’. An Operating Lease where the Lessee bears the
cost of insuring and maintaining the leased equipment is called a ‘Dry Lease’.
From the above features of an Operating Lease, it is evident that this form of a lease does not result
in substantial transfer of the risks and rewards of ownership from the lessor to the lessee. The
Lessor structuring an operating lease transaction has to depend upon multiple leases or on the
realization of a substantial resale value (on expiry of the first lease) to recover the investment cost
and a reasonable rate of return thereon. Therefore specializing in operating Lease calls for an in-
depth knowledge of the equipments per-se and the secondary (re-sale) market of such equipments.
FACTORS EFFECTING COSTS OF THE FINANCING OPTIONS
(Specifying BHEL’s practices) :
Nature of Asset
Nature of Lease
Insurance, Annual Maintenance and Other Expenses
Timing of Cash Outflows and the Repayment Schedule
Rate of Depreciation
Interest on Borrowed Funds
Expected end of the lease Contract
Organization’s asset management capabilities
NATURE OF ASSET
Leasing or buying—which is better? Isn’t it always better to be an owner? The answer: sometimes.
According to oil baron Paul Getty, “If it appreciates, buy it. If it depreciates, lease it.” There are
many benefits to both buying and leasing, depending on the type of property involved.
Businesses have two property types— real and personal. Real property encompasses buildings and
other permanent structures, and the land on which they stand. Personal property includes furniture,
fixtures, and equipment—everything from shelving to desks. Buying is often most beneficial when
financing real property, because it will appreciate and gain value over time. Owning real estate—
and the structures on it—is almost always a good investment for the long haul. Property owners
build equity and reap the benefits of the property’s increasing value. However, shops are heavily
comprised of machinery—which is in the category of personal property and, therefore, depreciates
in value over time. What’s more, technology is always changing, systems are always improving,
and the equipment needs to be updated and replaced every few years. For everything that needs to
be replaced every few years, therefore, leasing is very often the best option.
Nature of asset determines the rate of depreciation of the asset and thus it’s worth at the end of the
lease period. The amount of lease rental bears an effect of the residual value since that would be
the amount that the lessor would be recovering at the end of Lease period and thus wouldn’t
recover it through Lease rentals, thereby bringing down the overall cost of Leasing the asset i.e.
the lease rentals.
NATURE OF LEASE
The kind of lease contract i.e. Financial or Operating brings up differences in many aspects since
the treatment of several items is done in different manners according the rules and provisions of
various laws applicable in this context, such as:
Accounting Standards of India
Operating Lease are capitalized in the books of the lessor. Lease payments are treated as
income of the lessor and expense of the lessee. The depreciation of leased assets should be
on a basis consistent with the normal depreciation policy of the lessor for similar assets.
Financial Lease according to recent accounting standards of ICAI, must be capitalized in the
books of lessee. This means that:
a) At, the time of inception the leased equipment is shown as an asset on the balance sheet
of the lessee. It’s Value is equated to the present value of committed lease rentals. The
leased asset is matched by a corresponding liability called the ‘Lease Payable’
b) Lease payments are split into two parts : Finance Charge and Principal Amount. The
Finance Charge (Interest payment) is treated as an expense on the profit and loss
account and the principal amount is deducted from the liability ‘lease payable’.
c) The leased asset is depreciated in the books of lessee as per its depreciation policy.
Income Tax Provisions
a) The depreciation is claimed by the person in whose books, the asset has been
b) Tax benefit on maintenance and insurance to be claimed by the person who bears them.
c) The Lease rentals paid by lessee are tax deductible expenses for the lessee.
Sales Tax provisions
a) The lessor is not entitled for the concessional rate of Central Sales Tax because the
asset purchased for leasing is meant neither for resale nor for use in manufacture.
b) The 46th
Amendment Act has brought lease transactions under the purview of ‘sale’
and has empowered the central and state governments to levy sales tax on lease
transactions. While the central sales tax has yet to be amended, in this respect,
several state govt. have amended their sales tax laws in this respect.
As of yet, the Sales Tax provision is not applicable on the transactions entered into by BHEL.
Nature of lease
In Financial Lease, since the Lessor has to recover whole of the asset cost within one Lease period
(primary lease period) only, the rentals are expected to be higher than those in Operating
Lease, in which, Lessor may re-let the asset at for another lease period. But due to the
Insurance and Maintenance charges, the Operating Lease Rentals tends to rise.
If the nature of your industry demands that you have the latest technology, a short-term operating
lease can help you get the equipment and keep your cash. Lease equipment that you expect to
depreciate quickly. Your risk of getting caught with obsolete equipment is lower because you can
upgrade or add equipment to meet your ever-changing needs.
INSURANCE, ANNUAL MAINTENANCE AND OTHER EXPENSES
In the options of Buying ( using own or borrowed funds) and Financial Leasing, since
the asset is capitalized in the hands of the person using it i.e. Lessee , he has to bear the Insurance
and maintenance charges and he only gets the Tax Benefits on them. But in Operating Lease, the
Lessor bears the Insurance and maintenance expenses, therefore he includes them in the Lease
These two elements shall be common to all the options. If purchased or taken on financial Lease,
the business shall have to bear these expenses itself and if taken on Operating Lease, the Lessor
will load these expenses in the Lease Rentals.
The nature of asset also has a hand in determining
TIMING OF CASH OUTFLOWS AND THE REPAYMENT SCHEDULE
In case of buying using own funds, substantial cash outlays have to be made in the initial phase for
acquisition of the asset, which renders this option costlier than buying using borrowed funds and
leasing. While in case of buying using borrowed funds, monthly EMI payments have to be made
according to the repayment schedule, periodic payment of lease rentals is spread over the lease
tenure. The repayment schedule has a bearing on the Present Value of outflows. The longer the
spread of Lease rentals, the lesser will be it’s present value. Thus the impact of timing of cash
outflows shows up in the NPV of outflows of these options.
RATE OF DEPRECIATION
The Rate of Depreciation that BHEL uses for it’s calculation is according to the IT provisions,
whereas the Lessors use the depreciation rate prevalent in market depending upon the nature of
asset. During the analysis, when the lease options are weighed using the IT rate, they generally
prove to be expensive since actually it’s difficult to realize that high salvage value of the
depreciated asset from the market.
Opportunity cost is the profit foregone in choosing the current option that could have been earned
in the second best option.
While using own funds to purchase the asset in addition to cash outlays, we are incurring
opportunity cost by blocking the funds in that asset instead of investing them in productive
business operations or any other investment option. Whereas when the asset is leased out or
purchased using borrowed funds, funds are not blocked and are available for alternative
investment. This variable is used to compute the present values of the cash flows associated with
both the leasing and purchase options
However while assessing proposals in BHEL this element was not considered since the assumption
of availability of funds free for reinvestment every year couldn’t hold true here.
Also a constant rate of return is assumed for the calculation of Opportunity cost, which might not
actually be possible to earn over a long period of time due to the volatility in market rate of
INTEREST ON BORROWED FUNDS
The Rate taken for the option of Purchase using borrowed funds is generally SBI MTLR
(State Bank of India – Medium Term Lending Rate.)
Tax Rates and the Tax Shield earned on the cash outlays and expenses incurred have a substantial
impact on the costs and thus the viability of various options. In all these options, tax shield is
availed by the person who is actually bearing the charges. Tax shields bring down the costs
Lease payments are deductible expenses for tax purposes. This is an important point because it
means every Rupee one pays as a lease payment reduces one’s taxable income. This is not the case
when a one elects to purchase an asset and finance the purchase with a loan. In this latter case only
depreciation expenses and interest paid on loans are tax deductible expenses. This difference in the
deductions that can be claimed depending on whether an asset is leased or purchased is something
one needs to consider when determining whether it is preferable to lease or own an asset.
EXPECTED END OF LEASE CONTRACT
Many lease arrangements (generally financial lease) give the lessee (user) the option of purchasing
the leased asset at the termination of the lease. This right to purchase a leased asset can be
beneficial to a person because it can put them in essentially in the same position they would have
been if they had initially purchased the asset in question. In cases where the lessee purchases an
asset that was previously leased, the price paid for the asset may be pre-decided or at or near the
current fair market value of the asset. While in others (like operating lease) the Lessor takes back
the asset at the end of lease period.
The expected end of lease would determine whether the lessor or the lessee would recover the
salvage value of the asset.
Depending upon the expected end of lease agreement, the salvage value is recorded in the books of
Lessee or Lessor. If the Lessee retains the asset and recovers the salvage value, the lessor would
include it for the purpose of lease rental calculation. Whereas if the Lessor takes back the asset at
the end of lease period, its effect shows on the reduced rentals. Thus Salvage value is an important
determinant of the amount of lease rentals.
ORANISATION’S ASSET MANAGEMENT CAPABILITIES
Leasing and asset management go hand in hand. The process of buying, maintaining and
disposing of equipment can distract valuable organizational resources from mission-
critical priorities. Leasing can be implemented as outsourced asset management. Hence
the choice of asset finance depends upon the organization’s efficiency levels in asset
THE DECISION PLATFORM- NET CASH OUTFLOW
The techniques for comparing lease and purchase alternatives may be applied in different ways. Like most
financial decisions, the lease-versus-purchase decision requires a certain degree of judgment or intuition.
There are basically 2 prime considerations in evaluating the financial options available. These are:
• The net (after tax benefit) cash flow; and
• The net present value of the cash flows.
THE NET CASH OUTFLOW CALCULATION
The amount of money spent on purchasing an asset or in lease or loan repayments does not reflect the net
cost of financing the acquisition of the asset. This is because tax deductions are available in relation to each
option. These deductions may take the form of:
• A straight deduction for repayments
• Depreciation of the plant or equipment acquired, or . The interest pertaining to the loan etc.
The net cash flow calculation involves taking the cash outlay on financing the purchase using own funds /
purchase using borrowed funds / leasing and subtracting the tax saving from that figure in order to arrive at
the net cash outflow.
The results generated by the standardized decision spreadsheet developed in this project reflect the
net present values of the cash costs and savings (tax savings) one would experience depending on
whether an asset is leased or purchased. A net present value is reported for the lease option and
another one is reported for the case where the asset is purchased. By comparing these net present
values it can be determined whether it is less or more costly to lease an asset. In cases where the
net present value for leasing is less than it is for purchasing, leasing would be the least costly
method for acquiring an asset. Alternatively, leasing would be more costly, and therefore not
preferable, any time the net present value reported for leasing is greater than it is for purchasing
These spreadsheets were successfully used for analysis of proposals such as Asset Lease,
Equipment Purchase etc. that came for consideration to the Financial Services Deptt. The working
of the worksheet is being presented using assumed values.
THE FINANCING CONCEPT
The Projects are building blocks of a development plan. Creation of utilities is the sine qua non of
business. Schemes in which investment is made in anticipation of deriving future benefits
therefrom are known as projects. Project is thus a package of measures selected to reach an
objective that has been precisely designated beforehand and is objectively verifiable.
The basic characteristic of project is that it involves current outlay of funds in the expectation of
future benefits. The inputs of the project come in the form of equipment, supplies, personnel, etc.
An efficient project makes productive use of land and other natural resources with the help of
capital applying technical capability of human resources, giving an output adequate to enhance the
nation’s economic growth.
Project Financing involves raising funds for the acquisition of fixed assets such as land and
buildings, plant and machinery, vehicle furniture and fittings etc. which are used in business to
earn income. It is necessary to define the financial requirements of a project at the investment and
initial operational stage. During the period of construction or the project stage usually called the
gestation period, the investment does not give anything in return. The investments in procurement
of assets are illiquid and are known as Sunk Capital. Hence the project planners try to get such
assets financed through external sources such as Buyer’s Credit.
PARTIES TO PROJECT FINANCING
The principal parties to a project financing includes the following:
SPONSORS – The parties behind the project, which may be single entity or a consortium of,
for example, the principal contractors and the prospective buyers of the output of the project when
it is completed.
SUPPLIERS – The party which is supplying the equipments or assets to the sponsors and
arranging credit through banks and financial institutions for them. They have to analyze the
sponsors for their creditworthiness and the project for it’s feasibility to ensure timely payment of
BORROWERS – The choice of legal entity to act as a borrower will be dependent upon, for
example, the applicable laws, taxes and exchange controls. If the sponsor is a consortium then two
or more than one borrower for that project.
FINANCIERS / LENDERS – Because the amounts involved are usually large and the risks
high it is normal for any facility to be syndicated between two or more providers of finance. One
bank is usually “mandated” by the other to act as the “arranger”, putting together the funding
package. That bank, or another as appropriate then acts as “agent” to coordinate the syndicate of
financiers once the funds have been made available. Those banks providing the most are often
named as “managers” or “lead managers”.
Some banks may, instead of lending themselves, provide guarantees to other banks or
organizations able to provide subsidized or lower cost-finance since they either cannot or do not
want to carry the credit risk. Finance may be provided in the form of a loan or, for example, bonds,
guarantees, export credits, commercial paper or leases.
Interest on the facility is often “rolled up” and added to capital during the construction phase of a
project . Charges on the project asset and revenue streams( Escrow Account ) are sometimes taken
by lenders solely to stop third parties obtaining prior charges.
PROJECT FINANCING IN BHEL
As per the needs and demands of the customers interested in purchasing equipments from BHEL,
proposals for financing the asset purchase are called from a selected group of banks and financial
institutions. The marketing division refers the proposal of customers to Financial Services Deptt.
(FSD) .The details of the project and other financials supplied by the customer thoroughly
analyzed to establish his creditworthiness. Thereafter proposals are sent to the selected banks and
SELECTION OF THE BANK / FINANCIAL INSTITUTION
All the banks and financial institutions verify the receipt of these proposals and upon carrying out
the feasibility analysis from financing point of view, they respond with their terms and conditions,
clearly defined. On receipt of proposals from banks and financial institutions BHEL carries out
their analysis to arrive upon the best suited and cheapest source of finance for it’s customer.
The major aspects of the analysis are:
Interest During Construction Capitalized (IDC)
Interest Rate on Borrowings
Repayment Schedule and timing of outflows.
It is the amount of financing agreed upon by the bank / FI. This amount may be equal or less than
the value of the equipment or asset. It may be in Indian or foreign currency in case any foreign
bank has come up with a financing proposal. In case the principal amount is less than value of the
asset, the supplier of asset may himself finance the remaining part.
It is the Initial period (Construction or Gestation) of the project in which no repayment of the
borrowed funds has to be made. Moratorium may be allowed either on Principal amount or Interest
or both. The length of moratorium period depends upon the ability of project to start generating
returns and the terms acceptable to the Lender.
INTEREST DURING CONSTRUCTION CAPITALISED (IDC)
Generally, the amount of interest not paid during Moratorium period is capitalized and added to
the principal. At the end of Moratorium period, a revised principal is calculated by adding up the
accumulated interest into original principal. This revised principal is repaid as per the repayment
schedule after the Moratorium period. Higher the capitalized amount, costlier the financing option
RATE AND COMPUNDING OF INTEREST ON BORROWINGS
The Banks / FIs use the Term lending rates for the purpose of Project Financing since these are
generally long term projects spreading from 5-10 years. These rates may be fixed , floating or a
combination of both. Generally, the benchmark used in floating rates is LIBOR( London Inter-
Bank Offered Rate). This is a major contributory factor rendering any financing option viable or
unviable. The rate of compounding of interest during moratorium period effects the cost of
financing. Higher the frequency of compounding, the costlier the option becomes.
Banks / FIs do not release whole of the borrowed amount at the time of sanctioning of the loan
itself. Instead a schedule is finalized by the bank / FI according to the funding requirements of
various stages of project completion. This schedule is called the drawdown schedule. The longer
stretched the drawdown schedule, higher would be the commitment charges but lower shall be the
REPAYMENT SCHEDULE AND TIMING OF OUTFLOWS
This factor majorly affects the present value of different financing options. A quarterly repayment
schedule will be dearer than a six monthly repayment schedule since the earlier repaid amount is
discounted by a lower discounting rate. The rate used for discounting is generally the minimum
rate of return, the project is expected to generate or the interest rate being charged by the bank.
These are charged on the undrawn or otherwise unutilized portion of a facility, to compensate the
lender for any capital adequacy costs for tying up its funds or limits in case they are needed by the
borrower. These add up to the cost of financing option and are payable over the moratorium
These charges may include Management fees, Success fee, processing fee etc.
THE DECISION PLATFORM – NET PRESENT VALUE AND
INTERNAL RATE OF RETURN
For arriving at the best suited and cheapest source of financing for the project, both the NPV and
IRR of each option are considered.
Considering all these factors, standard formats in MS Excel were developed for various
possibilities of variation in these factors such that only the initial details had to be put in to find out
the most viable financing option.
The variants were :
Without Moratorium on Interest (18 months moratorium on principal)
• Monthly Compounding Monthly Payment of Interest
• Monthly Compounding Quarterly Payment of Interest
• Quarterly Compounding Six monthly Payment of Interest
• Six monthly Compounding Six monthly Payment of Interest
Without Moratorium on Interest (36 months moratorium on principal)
• Monthly Compounding Monthly Payment of Interest
• Monthly Compounding Quarterly Payment of Interest
• Quarterly Compounding Six monthly Payment of Interest
• Six monthly Compounding Six monthly Payment of Interest
With Moratorium on Interest (18 months moratorium on principal)
• Monthly Compounding Monthly Payment of Interest
• Monthly Compounding Quarterly Payment of Interest
• Quarterly Compounding Six monthly Payment of Interest
• Six monthly Compounding Six monthly Payment of Interest
With Moratorium on Interest (36 months moratorium on principal)
• Monthly Compounding Quarterly Payment of Interest
• Quarterly Compounding Quarterly Payment of Interest
• Quarterly Compounding Six monthly Payment of Interest
• Six monthly Compounding Six monthly Payment of Interest
These Standardized formats were successfully utilized for analyzing the projects that came up
consideration in the duration of the project. Changes in these formats whenever required
depending upon the individual cases were made from time to time. Enclosed are two of such
worksheets i.e. With Moratorium on Interest (36 months moratorium on principal) with Quarterly
Compounding Quarterly Payment of Interest and Without Moratorium on Interest (36 months
moratorium on principal) with Quarterly Compounding Quarterly Payment of Interest using
The Valuation of BHEL carried out through this projects was accepted as fairly correct by the
internal officials since the expected valuation of BHEL stands between 10000 to 15000 crore.
In General, while going for an asset lease, company’s own funds should not be used untill the
funds are lying absolutely idle or their opportunity cost is quite low.
Project Financing proposals can be analysed quite accurately and objectively using the tools of
NPV and IRR.