Project

Appraisal
09/28/19 1
 Planning
Capital Investments
Importance
Long-Term Effects,
Irreversibility,
Substantial outlays
Difficulties
Measurement Problems,
Uncertainty,
Temporal Spread

09/28/19 2
 Types of Investment
Physical Assets – Tangible – Land,
Building etc.,
Monetary Assets – Financial Claims
Intangible Assets

Strategic Investment (new product) or

Tactical Investment (replacing machinery
to increase productivity)
09/28/19 3
 Other Classifications
Mandatory Investment (Pollution Control,
fire fighting
Replacement Investment,
Expansion Investment,
Diversification Investment,
R & D Investment and
Miscellaneous Investment (interior
decoration)
09/28/19 4
 Phases
Planning,
Analysis,
Selection,
Financing – FRICT influence capital structure,
Implementation
Adequate formulation of projects,
Use of the principle of Responsibility accounting and
Use of Net work Techniques and
Review

09/28/19 5
 Levels of Decision Making
Minor office equipment – Operating
Capital Budgeting Decisions
Balancing equipment –Administrative
Capital Budgeting Decisions and
Diversification Project – Strategic Capital
Budgeting Decisions

09/28/19 6
 Facets
Market Analysis,
Technical Analysis,
Financial Analysis,
Economic Analysis and
Ecological Analysis

09/28/19 7
 Market Analysis
Aggregate demand of the proposed product/
service?
Market Share of the project?

Consumption Trends – past and present,

Supply position – past and present,
Production possibilities and constraints,
Imports and exports
Cost Structure

09/28/19 8
 Elasticity of Demand,
Consumer behaviour, intentions, attitudes,
motivations, preferences and
requirements
Distribution channels and marketing
policies and
Administrative, technical and legal
constraints

09/28/19 9
 Technical Analysis
Preliminary tests and studies?
Availability of raw material, power, water etc.?
Scale of operation is optimal?
Suitability of production process?
Appropriateness of machines chosen?
Provision for auxiliary equipments and
supplementary engineering?
Provision for treatment for effluents?
Layout of site, building and plant is sound?

09/28/19 10
 Financial Analysis
Investment outlay and cost of the project,
Means of financing,
Cost of capital,
Projected profitability,
Break-even point,
Cash flows,
Merit criterion - Investment worthwhile-ness
Projected Financial position,
Level of risk

09/28/19 11
 Economic Analysis
Economic costs and benefits in terms of
shadow (efficiency) prices sans market
price,
Impact of distribution of income on society
Impact of level of savings and investment
Self sufficiency, employment and social
order?

09/28/19 12
 Ecological Analysis
Likely damage caused by the project to
the environment,
Cost of restoration measures for
containing the damage to the environment
within permissible limits

09/28/19 13
 Project Analysis

Financial analysis
Market Analysis
Economic Analysis
Technical Analysis Ecological Analysis
Technical viability
Benefits and cost of
Shadow Prices

Sensible Choice Other Impacts

Environmental Damage

Potential Market Risk

Restoration Measures

Market Share Return

09/28/19 14
 Process
Generation of Ideas
Initial Screening
Is the idea prima facie promising?
No – Terminate the Project
Yes – Conduct Market & Technical Analysis
Conduct Financial Analysis
Conduct Economic & Ecological Analysis
Is the project worth while?
No – Terminate
Yes – Proposal for Funding

09/28/19 15
 Common weaknesses in capital
Budgeting
Poor alignment between strategy and capital Budgeting,
Deficiencies in analytical techniques
– The base case is poorly identified
– Inadequate treatment of risk
– Options in the future are not properly evaluated
– Lack of uniformity in assumptions
– Side effects are ignored
No linkage between compensation and financial
measures
Reverse financial engineering
Weak integration between capital budgeting and
expense budgeting
Inadequate post audit

09/28/19 16
 Strategy
and
Capital Allocation
09/28/19 17
 The selection of investment projects and the
allocation of corporate capital to them are
among top management’s primary
responsibilities to the shareholders.
Capital budgeting is a task for general
management rather than financial specialists
Capital budgeting
– Identification of promising growth opportunities
through strategic planning techniques
– Analysis and evaluation of individual investment
proposals

09/28/19 18
 Techniques
Concept of Strategy,
Grand Strategy (The Thrust),
Diversification debate,
Portfolio strategy,
Business level strategy
Strategic planning and capital budgeting

09/28/19 19
 Concept of Strategy
The determination of the basic long term
goals and objective of an enterprise and
the adoption of courses of action and the
allocation of resources necessary for
carrying out those goals
Matching of firm’s strengths and
weaknesses with opportunities and threats

09/28/19 20
 Environmental Internal
Analysis Analysis

Opportunities Strength &

& Threats Weaknesses

Dovetailing between
Core capabilities &
External opportunities

Firm’s Strategy

09/28/19 21
 Cross sectional relationship –
complementarities and synergies between
existing assets and growth opportunities
Time-series relationship – between current
growth opportunities and future growth
opportunities
Risk profile – the impact of new
investment on overall riskiness of the firm

09/28/19 22
 Grand Strategy

Growth Stability Contraction

Concentration Vertical Divesture Liquidation

Integration
Forward
Backward
Diversification

Concentric Conglomerate

09/28/19 23
 Diversification debate
Pros and Cons
– Risk reduction
– Expands opportunities for growth

– Dampen average profitability

– Empirical studies shows that organisations
which stick to their business plan has out
performed others

09/28/19 24
 International Experience
In 1960 – 70s the wave of diversification swept
the Industrial world
– To add third and second leg to overcome cyclical
fluctuations
– Safety comes from a portfolio having at least three
different kinds of business
– A desire to get out from certain industries and get into
new ones
– Existence of role models e.g. Harold Geneen presiding
over gigantic corporate conglomerate
– Influence of Theodore Levitt’s doctrine to redefine
business in a broad sense

09/28/19 25
 Back to Basics
1980 – diversification succeeded in
related areas and failed in unrelated areas
United Biscuits sold its food business
Tata Steel sold its cement plant
Raymonds sold its cement plant
GNFC sold its auto plant
BP sold its world coal interest to
concentrate on oil
09/28/19 26
 Conglomerates – Value Addition in
Emerging Markets
Product Market – Buyers and sellers
suffers informational handicaps
– Poor infrastructure for communication
– No independent outfits to verify claims of sellers
– No satisfactory redress mechanism for consumers

Capital Market - underdeveloped

– Weak and inadequate venture capital mechanism
– Deficient regulatory measures
– Poor quality of financial reporting
– Less community of investment analysis
– Financial press is often not very objective and
professional

09/28/19 27
 Labour Market
– Shortage of trained labour
– Rigid laws relating to labour

Regulations
Contract Enforcement – lack of effective
contract enforcement mechanism, slow
judicial process

09/28/19 28
 Compulsions for Diversification
Indian Context
Restriction in growth in the existing line of
business
Vulnerability to changes to Government
policies
Opening up of newer areas of investment
Cyclicality of the main line of business
To avail tax incentives mainly in the form
of Investment allowance and initial
depreciation write-off
09/28/19 29
 Portfolio Strategy

09/28/19 30
 General Electric’s Stoplight Matrix
Business Strength
Industry Strong Average Weak
Attractiveness

High Invest Invest Hold

Invest Hold Divest

Average

Hold Divest
Low Divest

09/28/19 31
 Business Level Strategy
Cost Leadership
Differentiation

09/28/19 32
 Porter’s Generic Competitive
Strategies
Source of Competitive Advantage

Unique Value as
Lower Cost
Perceived by
Strategic Scope Customer

Broad Overall Overall Cost

(Industry-Wide) Differentiation leadership

Narrow Focused Focused Cost

(Segment only) differentiation Leadership

09/28/19 33
 SPACE
Four dimensional approach
– Company’s competitive advantage
– Company’s
– Conservative posture
– Defensive posture

09/28/19 34
 Strategic Postures
Aggressive posture
– Enjoys a competitive advantage and considerable financial strength
– Belongs to Attractive industry which operates in a relatively stable
environment
Competitive posture
– Enjoys a competitive advantage but has limited financial strength
– Belongs to Attractive industry which operates in a relatively unstable
environment
Conservative posture
– Enjoys financial strength but has limited competitive advantage
– Belongs to not such attractive industry which operates in a relatively
stable environment
Defensive posture
– Lacks competitive advantage as well as financial strength
– Belongs to not such attractive industry which operates in a relatively
unstable environment

09/28/19 35
 Generation
and
Screening
of
09/28/19
Project Ideas 36
 Generation of ideas,
Monitoring the environment,
Corporate appraisal,
Profit potential of Industries,
Scouting for project ideas,
Preliminary screening,
Project rating index,
Sources of positive net present value and
On being an entrepreneur

09/28/19 37
 Generation of Ideas
It is (barring truly new ideas based on
breakthroughs of technology) a
combination of existing technology or
offering a variant of existing services and
products, better features, lower price etc.
Ideas are endorsed by associates
Collaboration from associates
Recognition by venture capitalist
Finally support from Investors
09/28/19 38
 Operational objectives
Cost reduction,
Productivity improvement,
Increase in capacity utilisation,
Improvement in contribution margin,
Expansion into promising areas

Fostering a conducive environment

09/28/19 39
 Monitoring the environment,
Economic Sector
– State of the economy,
– Overall rate of growth,
– Growth rate of primary, secondary and tertiary sector
– Cyclical fluctuations,
– Linkage with world economy
– Trade surplus/ deficits,
– Balance of payment situation

09/28/19 40
 Government Sector
– Industry policy
– Government and projects
– Tax frame work,
– Subsidies, incentives and concessions,
– Import and Export policies
– Financing norms
– Lending conditions of Financial Institutions and Banks

Technological Sector
– Emergence of new technologies,
– Access to technical know-how, foreign and indigenous,
– Receptiveness on the part of Industry

09/28/19 41
 Socio-demographic sector
– Population trends,
– Age shifts in population,
– Income distribution, education profile,
– Employment of women,
– Attitude toward consumption and investment

Competition Sector
– No. of firms in the Industry and their Market share,
– Degree of homogeneity and differentiation among products,
– Comparison with substitutes in terms of quality, price, appeal and
functional performance
– Marketing policies and practices

Supplier Sector
– Availability and cost of RM and Sub-assemblies
– Availability and cost of energy
– Availability and cost of money

09/28/19 42
 Corporate Appraisal
Marketing and Distribution
– Market image,
– Product line,
– Market share,
– Distribution network,
– Customer loyalty
– Marketing and distribution costs
Production and operations
– Condition and capacity of plant and machinery,
– Availability RM, sub-assemblies and power
– Degree of vertical integration,
– Location advantage
– Cost structure

09/28/19 43
 Research and Development
– Research capabilities of the firm,
– Track record of new product developments,
– Laboratories and testing facilities
– Coordination between research and operations
Corporate Resources and Personnel
– Corporate image,
– Clout with governmental and regulatory agencies,
– Dynamism of top management,
– Competence and commitment of employees,
– State of industrial relations
Finance and Accounting
– Financial leverage and borrowing capacity,
– Cost of capital,
– Tax situation
– Relations with shareholders and creditors,
– Accounting and control system,
– Cash flows and liquidity

09/28/19 44
 Profit potential of Industries
Porter Model
– Threat of new entrants,
– Rivalry among existing firms,
– Pressure from substitute products,
– Bargaining power of buyers
– Bargaining power of sellers
Life cycle approach
– Pioneering Stage
– Rapid growth Stage,
– Maturity and Stabilisation Stage,
– Decline Stage
Experience Curve
– Learning effects,
– Technological Improvements, economies of Scale

09/28/19 45
 Scouting for project ideas
Analyse the performance of existing industries
Examine input and Output of various industries
Review Imports and Exports,
Study plan outlays and Government guidelines,
Suggestions of Financial & Developmental Agencies
Investigate Local Materials and Resources
Analyse Economic and Social Trends
Study new Technological Developments
Draw clues from consumption from abroad
Explore the possibility of reviving sick units
Identify unfulfilled psychological needs
Attend Trade Fairs
Stimulate creativity for generating new product ideas
Hope favour from chance factor

09/28/19 46
 Preliminary Screening
Compatibility with the promoter
– It fits the personality of the promoter
– It is accessible to him
– It offers to him the prospect of rapid growth & high returns
Consistency with Governmental Priorities
– Is the project consistent with national goals and priorities?
– Are there any environmental effects contrary to regulations?
– Can the foreign exchange requirements be easily accommodated?
– Will there be any difficulty in obtaining licence?
Availability of Inputs adequacy of markets
– Are the capital requirements of the project within manageable limits?
– Can the technical know-how required for the project be obtained?
– Are the RM required is available domestically at reasonable price?
There are no problems in case of import.
– Is the power supply is obtainable either from external or from captive
sources?

09/28/19 47
 Adequacy of the Market
– Total present domestic market
– Competitors and their market share
– Export markets
– Quality-price profile of the product vis-à-vis competitive
products
– Sales and distribution system
– Projected increase in consumption
– Barriers to the entry to the new units
– Economic, Social and demographic trends favourable to
increased consumption
– Patent protection

09/28/19 48
 Reasonableness of cost
– Cost of material inputs
– Labour costs
– Factory overheads
– General administration expenses
– Selling and distribution cost
– Service costs
– Economies of scale

Acceptability of risk level

– Vulnerability to business cycles
– Technological change
– Competition from substitutes
– Competition from imports
– Government control over price and distribution

09/28/19 49
 Project Rating Index
Identify factors relevant for project rating
Assign weight to these factors
Rate the project proposal on various
factors using a suitable rating scale
Multiply each factor with its weight
Add all to get overall project rating index

09/28/19 50
 Sources of Positive NPV
Economies of Scale
Product Differentiation
– Effective advertising and superior marketing,
– Exceptional service,
– Innovative product features
– High quality and dependability

Cost Advantage
– Accumulated experience and comparative edge on Competition
– Monopolistic access to low cost material
– Favourable location
– More effective cost control and cost reduction

09/28/19 51
 Marketing Reach
– Orient express
– Avon products having a network of 1,300,000
– Hindustan Lever’s network

Technological Edge
– Tata Steel
– Dr. reddy’s laboratory,
– Hero Honda

Government Policy
– Restrictive Licensing,
– Import Restrictions,
– High Tariff Walls,
– Environmental controls
– Special Tax Reliefs

09/28/19 52
 On Being An Entrepreneur
Are my goals well defined?
– Personal aspirations
– Business sustainability and size
– Tolerance for Risk
Do I have right Strategy?
– Clear definition
– Profitability and potential for growth
– Durability
– Rate of growth
Can I execute the strategy?
– Resources
– Organisational infrastructure
– The founder’s role

09/28/19 53
 Qualities and Traits
Willingness to make sacrifices,
Leadership,
Decisiveness
Confidence in the project
Marketing audience strong ego
Open mindedness

09/28/19 54
 Market
and
Demand
Analysis
09/28/19 55
 Situational analysis and specification of
objectives
Collection of secondary information
Conduct of market survey
Characteristic of the market
Demand forecasting,
Uncertainties in demand forecasting
Market planning

09/28/19 56
 Situational Analysis and
Specification of Objectives
Who are the buyers?
What is total current demand?
How is the demand distributed temporally and
geographically?
What is the break up of demand for different sizes?
What price will the customer be willing to pay?
How can potential customers be convinced about
superiority of the product?
What price and warranty will ensure its acceptance
What channels of distribution are most suited?
What trade margins will induce distributors to carry it?
What are the prospects of immediate sales?

09/28/19 57
Collection of Secondary Information
General sources
– Census of India
– National Sample Survey Reports,
– Plan Reports,
– Statistical Abstract of Indian union,
– India Year Book,
– Statistical Year Book,
– Economic Survey,
– Guidelines to Industries,
– Annual Survey of Industries,
– Annual Reports of The Development Wing, Ministry of
Commerce and Industry,

09/28/19 58
 – Annual Bulletin of Statistics of Exports and Imports,
– Techno-Economic
– Industrial Potential Surveys,
– The Stock Exchange Directory,
– Monthly studies of Production of Selected Industries,
– Publications of Advertising Agencies
– Other Publications
Annual report on Currency and Finance
Weekly bulletin of Industrial Licences

09/28/19 59
 Evaluation of Secondary
Information
Who gathered the information?
What was the objective?
When was the information gathered?
When was it published?
Have the terms in study been clearly and
unambiguously defined?
How representative was the period?
What was the target population?
09/28/19 60
 How was the sample chosen?
How representative was the sample?
How satisfactory was the process of
information gathering?
What was the degree of sampling bias and
non-response bias in the information
gathering?
What was the degree of misrepresentation
by respondents?
How accurately was the information edited,
tabulated and analysed?
Was statistical analysis properly applied?
09/28/19 61
 Conduct of Market Survey
Total demand and rate of growth of demand
Demand in different segments of the market
Income and price elasticity of demand
Motives for buying
Purchasing plans and intentions
Satisfaction with existing products
Unsatisfied needs
Attitudes toward various products
Distributive trade practices and preferences
Socio-economic characteristic of buyers

09/28/19 62
 Characterisation of the Market
Effective demand in the past and present
Breakdown of Demand
Price
Methods of distribution and sales
promotion
Consumers
Supply and competition
Government policy

09/28/19 63
 Demand Forecasting
Qualitative Methods
– Jury of executive opinion method
– Delphi method
Time Series Projection Method
– Trend projection method Y = a + bX
– Exponential method Ft+1 = Ft + αet
– Moving average method
Casual Method
– Chain ratio method
– Consumption level method income & price elasticity of demand
– End use method
– Leading indicator method
– Econometric method

09/28/19 64
 Dt = a0 + a1Pt + a2Nt
GNPt = Gt + It + Ct
Where It = a0 + A1GNPt
Ct = b0 + B1GNPt

09/28/19 65
 Uncertainties in Demand
Forecasting
Data about past and present markets
– Lack of standardisation
– Few observations
– Environmental change
Methods of forecasting
– Inability to handle unquantifiable factors
– Unrealistic assumptions
– Excessive data requirement
Environmental changes
– Technological change
– Shift in Government policy
– Developments on international scene
– Discovery of new sources of raw material
– Vagaries of monsoon

09/28/19 66
 Market planning
Current market situation
Opportunity and issue analysis
Objectives
Marketing strategy
Action Programme

09/28/19 67
 Technical
Analysis

09/28/19 68
 Objective
It is technically feasible i.e. all inputs
required for the project are available
To facilitate the most optimal formulation
of the project in terms of technology, size,
location etc.

09/28/19 69
Manufacturing Process/ Technology
Choice of technology
– Plant capacity
– Principal inputs
– Investment out lay and production cost
– Use by other units (proven technology
– Product mix
– Latest development
– Ease of absorption

09/28/19 70
 Appropriateness of technology
– Whether the technology utilises local raw material
– Whether the technology utilises local man power
– Whether the goods and services produced cater to basic
needs
– Whether the technology protects ecological balance
– Whether the technology is harmonious with social and
cultural conditions

09/28/19 71
 Technical arrangements
The nature of support to be provided by
collaborators in the designing, selection and
procurement of equipment, installation and
erection
Processes and performance guarantee in terms of
plant capacity, product quality and consumption of
raw material and utilities
The price of technology in terms of one time
licensing fee and periodic royalty fee
The period of collaboration agreement
Covenants imposed by the collaborator with
respect to exports
09/28/19 72
 The level of equity participation and
manner of sharing management control
Assignment of the agreement by either
side in case of change of ownership
Termination of agreement or other
remedies
Approach to be adopted in force majeure
situations

09/28/19 73
 Material Inputs and Utilities
Raw materials
– Agricultural products
– Mineral products
– Livestock and forest product
– Marine products

Processed industrial
Auxiliary materials and factory supplies
Utilities

09/28/19 74
 Product Mix
Plant capacity
– Technological requirement
– Input constraints
– Investment cost C1 = C2(Q1/Q2)α
– Market conditions
– Resources of the firm
– Governmental policy

Location and site

– Proximity to raw materials and markets
– Availability of infra structure
– Labour situation
– Governmental policy
– Other factors – climatic conditions, general living
conditions, proximity to ancillary units

09/28/19 75
 Machines and Equipment
Types
– Plant (process equipment),
– Mechanical equipment,
– Electrical equipment,
– Instruments, controls,
– Internal transportation system and
– Others
Spare parts and tools purchased with the original
equipment
Spare parts and tools purchased for operational
wear and tear

09/28/19 76
 Constraints in selecting Machineries and
Equipment
– Limited availability of power
– Difficulty in transporting heavy equipment to remote
location
– Workers may not be able to operate, initially, the
sophisticated plant
– Import policy may ban import of certain type of equipment

Procurement of Plant and Machinery

– May be on turnkey basis
– Supplier’s ability to supply quality machinery
– Level of technological sophistication
– Delivery schedule,
– Preferred payment terms
– Required performance guarantee

09/28/19 77
 Structure of Civil Works
Site preparation and development
– Grading and leveling of site
– Demolition and removal of existing structure
– Relocation of existing pipelines, cables, roads, power line
– Reclamation of swamps and draining and removal of standing
water
– Connections for the following utilities from the site to public
network
Electric power (LT & HT)
Water
Communications
Roads
Railway sidings
– Other site preparation and development work

09/28/19 78
 Buildings and Structures
– Factory and Process building
– Ancillary building required for stores, warehouses,
laboratories, utility supply centers, maintenance services
– Administrative building,
– Staff welfare building,
– Cafeteria and medical services building,
– Residential building

Outdoor works
– Supply and distribution of utilities
– Handling and treatments of emissions and effluents
– Transportation and traffic signals
– Outdoor lighting
– Landscaping
– Boundary wall, fencing, barriers, gates doors, security
posts etc.

09/28/19 79
 Environmental Aspects
Types of effluents and emissions
generated
Proper disposal
Statutory clearances

09/28/19 80
 Project Chart and Lay Out
General functional layout
Material flow diagram
Production line diagrams
Transport layout
Utility consumption layout
Communication layout
Organisational layout
Plant layout
09/28/19 81
 Important considerations
Consistency with production technology
Smooth flow of goods
Proper utilisation of space
Scope of expansion
Minimisation of product cost
Safety of personnel

09/28/19 82
 Social Cost
Benefit Analysis

09/28/19 83
 Rationale
Market imperfections
– Rationing
– Minimum wage rate
– Foreign exchange regulations
Externalities
– Positive and negative impact on environment
Taxes and subsidies
Concern for savings
Concern for redistribution
Merit wants
– Adult education
– Balanced nutrition

09/28/19 84
 UNIDO Approach
Financial profitability at Market prices
Benefit in terms of Economic/ Efficiency
prices
Impact on savings and investment
Impact on income distribution
Impact on merit goods and demerit where
social values differ from their economic
values
09/28/19 85
 Benefit in terms of Economic/
Efficiency prices
Shadow pricing
Choice of numeriare
– Domestic or foreign currency
– Measurement of costs and benefits in current value or constant
values
– Evaluation for present value or future value
– Income – consumption or investment
– “net present consumption in the hands of people at
the base level of consumption in the private sector at
constant prices in domestic currency
Concept of tradability
– International/ border price represent the real value of good

09/28/19 86
 Sources of shadow prices
– Increase or decrease in total consumption in the
economy
– Decrease or increase production in the economy
– Decrease imports and increase imports
Or
– Increase exports or decrease exports

Taxes
– Diversion/ addition of non traded inputs which are in fixed
supply from other producers taxes should be included
– Augmentation of domestic production by other producers
taxes should be excluded
– Fully traded goods, taxes should be ignored

Consumer willingness to pay

09/28/19 87
 Shadow pricing of specific
resources
Tradable inputs and outputs (Border price)
– In case import quota it is nor restrictive
– Import supply is perfectly elastic over the relevant range of
import volume
– No surplus capacity in domestic industry
– In case of surplus domestic capacity c.i.f. is less than MC of
local production
A good is fully tradable on satisfaction of above conditions
Non-tradable inputs and outputs
– c.i.f. is more than MC of local production
– F.o.b. price is less than MC of local production
Value is measured as consumers’ willingness to pay when local
supply is increased else MC of production when it causes
reduction in supplies by other units

09/28/19 88
 Externalities
Incidental outcome of a legitimate activity
Beyond the control of the persons affected
Not traded in the market place

09/28/19 89
 Labour inputs

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 Report - Extract
1. Name of the Company:
2. Registered Office:
3. Plant Location:
4. Capacity:
5. Promoters:

09/28/19 102
 6. Cost of the Project

Item Cost Revised Incurred Budget Balance

Cost for 6 Mths
A. Land and Site Development
B. Building
C. Plant & machinery
Imported
Indigenous
D. Technical know how and Engineering fees
E. Expenses of Foreign Technicians and Training
of Indians Abroad

09/28/19 103
F. Miscellaneous Fixed Assets
G. Preliminary Expenses
H. Pre-Operative Expenses
I. Margin Money for Working Capital
J. Contingencies

09/28/19 104
 7. Means of Financing
Item Original Revised Raised Budget Balance
6 months
Promoters
Share Capital
Preference Capital
Loans
Public
Share Capital
Preference Capital

09/28/19 105
Bonds
Debentures
Loans
Foreign Currency Loan
Rupee Currency Loan
Foreign Loan Guarantee
Differed Loan Guarantee
Internal Accruals
09/28/19 106
Strategic Financial Decision
Making

09/28/19 107
 Cost of Capital
Cost of Capital Cut off rate or hurdle rate)
is minimum required rate of return on
funds committed to the project.
It is required for discounting the cash flows
of the project for
Evaluating investment decisions
Designing firm’s debt capacity
Appraising the financial performance of the top
Management

09/28/19 108
 Opportunity Cost of Capital
Opportunity Cost is the rate of return
foregone on the next best alternative
investment opportunity of comparable risk

Required rate of return on an investment

project is an Opportunity Cost

09/28/19 109
 Risk Difference
OCC
Equity Shares

Preference shares

Corporate bonds

Government bonds

Risk free Security

Risk

09/28/19 110
 Cost of Debt
The before – tax cost
of debt is the rate of
return required by the
lenders
INT
Debt issued at Par kd  i 
Bo

09/28/19 111
 Cost of Debt
Debt Issued at
Discount or Premium
n
INTt Bn
Bo   
t 1 (1  k d )
k
t
(1 
d t ) (1  k d ) n

or

1
INT  ( F  Bo )
kd  n
1
( F  Bo )
2

After tax cost of debt = k d (1  t )

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 Preference Shares
PDIV
Irredeemable kp 
Po

n
PDIVt Pn
Po   
Redeemable t 1 (1  k p ) t
(1  k p ) n

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 Cost of Equity Capital
Is Equity capital free of cost?
Cost of internal equity?
Cost of external equity?

09/28/19 114
 Cost of Internal Equity
DIV1
Normal Growth ke  g
Po

n
DIVo (1  g s ) t P
Po  
DIVo Pn
 n n n

Po  
t 1 (1  k e ) t
(1  k e )

Supernormal Growth 
t 1 (1  k p ) t
(1  k p ) n

DIV1
ke 
Zero Growth Po

09/28/19 115
n
DIVo (1  g s ) t Pn
 Cost of External Equity
DIV1
Normal Growth ke  g
Po

n
DIVo Pn
Supernormal Growth Po   
t 1 (1  k p ) (1  k p ) n
t

DIV1
Zero Growth ke 
Po

09/28/19 116
 Weights
Book Value
Market Value

09/28/19 117
 Weighted Average Cost of Capital

WACC  k d wd  k p w p  we k e

09/28/19 118
 Financing Alternatives
Equity
Preference
Redeemable
Irredeemable
Debt
Bonds
Loan
Internal Accrual
09/28/19 119
 Capital Structure
Optimum Capital Structure
Financial Leverage
– The change in shareholders return caused by
change in profits
Operating leverage
– Affects firms operating profit
Risk
Return
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