Professional Documents
Culture Documents
Project Appraisal
Constitution of Firm/Company
Priority/Government Policy
Institutional Policy Decisions
Acceptability of the Promoters by the Financial
Institutions.
2. Market Appraisal
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Study on Trends of Production, Supply, Imports,
Exports, Price Trends, Distribution and Sales Promotion,
Government Policies, Competition, Consumer Profile, etc.
3. Technical Appraisal
Location ad Site
Plant Capacity and Product-Mix
Technology and Technical Know-how
Selection and Procurement of Plant and Machinery
Civil and Structural Work
Charts and Lay-Outs
Raw Materials, Consumables and Utilities
Implementation Schedule
4. Financial Appraisal
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5. Economic Appraisal
Cost-Benefit Analysis
Domestic Resource Cost
Effective Rate of Protection
Employment Potential
Productivity and Investment per Worker
6. Entrepreneur/Promoter Appraisal
7. Management/Organization Appraisal
Management Set-Up
Organizational Set-Up
Recruitment and Selection of Executives
Training
Project Appraisal Criteria (Capital Budgeting - IRR & NPV etc.)
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company. He may take various parameters into considerations like;
what are the expectations of the investors in equity, what is the current
lending rate of the banks, and the financial institutions and what is the
average lending rate of the banks, and the financial institutions and
what is the average return on the capital employed in that kind of
industry? One can source the data from the various magazines and
journals on economic and finance published by Government of India.
Cash Accruals
Every company sells the product and earns some income from it.
However, this income is taxed after allowing the various permissible
deductions. Many deductions which are permitted are of non-cash flow
items like depreciation and the preliminary expense. Thus, one should
be conversant with the various provisions of the relevant sections of the
Income Tax Act 1961. There are certain deductions which are
permissible under the said Act, the main objective of these deductions to
reduce the effective rate of taxation of the company. However, it should
be clear that there is a difference between the net profit and the cash
flows. The terms used for estimating/evaluating the cash flows are gross
cash accruals and net cash accruals.
In case, the company does not declare dividend during a particular year
the gross cash flows and the net cash flows will be equal.
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• Accounting Rate of Return (ARR)
• Payback Period (PBP)
• Net Present Value (NPV)
• Internal Rate of Return(IRR)
• Benefit Cost Ratio (BCR) or Profitability Index (PI)
ARR is defined as the ratio of Average Profit after Tax to the Average
Book Value of the Investment. The higher the ARR, the better is the
project. Project having less than a pre-determined cut off rate of return,
say, 15% or 20%, are rejected.
The payback period is the method under which we find out the number
of years required to recover the initial outlay. Thus lower the payback
period, higher would be the attractiveness of the project.
The two widely used methods of discounted cash flow techniques are:
• Net Present Value (NPV)
• Internal Rate of Return (IRR)
• Benefit Cost Ratio (BCR) or Profitability Index (PI)
Under the NPV Method, the cash flows are discounted at the rate which
we call as the expected / required rate or cost of capital and the NPV is
evaluated with the help of the following equation:
n At
NPV = ∑ ────── - I, t= 1, 2, 3, ------------n
t=1 (1 +r) t
where, At refers to cash flow at the end of year ‘t’, r = Discount rate, n =
Life of the project in number of years, and, I = Initial Investment.
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The IRR Method:
The Internal Rate of Return (IRR) can be defined as the rate of return
at which the sum of future cash inflows, when discounted, is equivalent
to the initial outlay or the net present value is zero.
It is the ratio of the present value of the future cash flows and the initial
outlay. It is a relative method and not an absolute method. It is useful
for comparing two or more projects in terms of their acceptability or
profitability. Mathematically it is expressed as:
n At
∑ ──────
t=1 (1 +k) t
BCR = PI = ─────────── , where, k = Discount Rate
I
In case the required rate of return exceeds IRR, the proposal would be
rejected under IRR method. Likewise, if the expected return exceeds the
IRR, we would get negative NPV, hence the project will again be
rejected on the NPV basis. Hence under both the methods we would not
accept the project. Thus both the methods give us similar results so far
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as the appraisal criterion for the investment in a project is concerned,
except when the initial cash outlays are different and the timings of the
cash flows also differ.
CASE STUDY
Caselet:
Years 1 2 3 4 5
Cash
Inflows
2 3 3.5 4 4
before tax
(Rs.lakhs)
Find:
(a) Payback Period(PB)
(b) Average Rate of Return(ARR)
(c) NPV at 10% of cost of capital
(d)IRR
(e) Profitability Index at 10% cost of capital
(f) The acceptability or otherwise of the project based on NPV and
IRR
*****
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Solution to the Case Study on NPV, IRR, etc. :
= 3 + 0.991 = 3.991years
= 4 years (approx)
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10%
Total P.V
1.810 2.024 2.009 1.981 1.801
at 10%
P.V of Cash Outflows = Rs.10.00 lakhs
NPV = 9.634 – 10.00 = - Rs.0.366 lakhs
(D). IRR
Total PV Total PV
CFAT PV at 9% PV at 8%
at 9% at 8%
1 2.000 0.917 0.926 1.834 1.852
2 2.450 0.842 0.857 2.063 2.099
3 2.675 0.772 0.794 2.065 2.124
4 2.90 0.70 8 0.735 2.053 2.132
5 2.90 0.650 0.691 1.885 1.975
9.900 10.182
NPV (0.100) +0.182