A case on project financial and risk analysis

An investor is planning to establish a modern medium-size flourmill in Assela at the beginning of year 2004E.C to supply high quality wheat flour to the area. The life of the project is 10 years. The project analyst considers the following assumptions for his financial analysis (1) Capacity determination The plant will have an installed capacity of 10 quintals of raw wheat/hr/24hours The plant will be operational for 16hours/day(two shifts only) The annual working days will be 285

(2) Capacity is planned to be utilized at the rate of 75% in year 1, 90% in year 2, and 100% thereafter. (3) Output extraction rate A quintal of wheat will yield in 75% main product, 20% by-product, and 5% waste. (4) Price The average purchase price of wheat (a raw material) is Br 500 a quintal. One sack of 100kgs costs Br 10 per piece and is to be used 5 times in a year. Processed wheat flour is packed in sacks of 50kg and cost Br 5 per piece. The average wholesale price of the main product is Br 950 a quintal, net of VAT The by-product is sold for Br 250 per quintal and the buyer brings his own sack

(5) Utilities The electricity requirement is 5kw per quintal of wheat flour produced. The cost of electricity is Br 0.95 per kwh, plus annual service charge (rent) of Br 850. 1 cubic meter of water is needed per 10 quintal wheat and each cubic meter costs Br 5

(6) Labor costs

Case study on project financial and risk analysis

The annual direct labor cost (operators and daily laborers) in the first year of the project is estimated to be Br 250,000, and pay raises of 2% per year are anticipated throughout life of the project. (7) Factory overhead cost The annual fuel, oil, lubricants and staff benefits cost is estimated to be Br 450,000, with a 1% annual increase in year 5 onwards

(8) Repair and maintenance costs and spare part requirements

The annual repair and maintenance cost, which includes spare parts cost, is assumed to be Br 90,000.

(9) Administrative overhead costs The annual administrative overhead costs which includes staff salary, is Br 450,500, with a 2% increase per year from year 4 onwards. (10) Depreciation costs

The annual depreciation expense of factory buildings, machineries and equipments is Br 189,600 and that of administrative buildings , vehicles and equipments is Br 124,500.

(11)

The initial total investment cost

The total financial requirement of the project is estimated to be Br 4,585,650 out of which Br 4,125,600 is fixed assets while the remaining Br 460,050 is net working capital requirement. Additional working capital requirement is Br 25,500 in the second year and Br 45,000 in the third year, to be covered by a bank loan. The bank loan will be paid back the following year including annual interest of 8%. (12) Replacement costs

The replacement cost of vehicles at the end of the seventh year will be Br 450,000. (13) Salvage value 2
Case study on project financial and risk analysis

Upon termination of the project, salvage value will be Br 86,500 for buildings, Br 68,500 for machineries and equipments, and Br 55,450 for vehicles. The total working capital will also be recovered at the end of the tenth year. (14) Source of finance

The promoter will contribute 40% of the initial total investment cost, and 60% of the initial total investment cost is to be covered by a bank loan at the beginning of the first year for 6 years with a grace period of 2 years at the rate of 10% interest per annum. The loan will be repaid at an equal quarterly installments during the last 4 years of the loan period. (15) The tax holiday

The income tax will be 35% and the promoter is required to begin payment only after 3 years of operation for establishing the project in the government priority area. Required: A. Prepare (1) The raw material requirement (in quintals) and the packing materials requirements (in pieces) for the whole project life (2) The sales forecast of the project during its lifetime (in quintals) (3) The cost of raw materials and packing materials (in Birr) (4) The annual revenue of the project (in Birr) (5) The loan repayment schedule for the project (6) The total production cost(in Birr) (7) The projected profit/loss statement of the project (8) The projected cash flow statement (9) The cash flow statement for discounting

B. Calculate (1) Payback period (2) The NPV at 10% discount rate (3) The IRR and tell whether the project is financially worthwhile or not 3
Case study on project financial and risk analysis

C. Sensitivity analysis Determine the change in NPV using the following assumptions (1) Total production cost increases by 3% (2) Raw material cost increases by 2% (3) Selling price of main product decreases by 3% (4) (1) and (3) take place simultaneously.

Case study on project financial and risk analysis