Term Loan and Project Appraisal

Prof : Naveen Rohatgi

TYBMS: Term loan

TERM LOANS AND PROJECT APPRAISAL Term loans (Oct 2004)are referred to as term finance; represent a source of debt finance which is generally repayable in more than one year but less than 10years. Such loans are raised for expansion, diversification and modernization of the enterprise. The primary source of such loans are financial institution. They are employed to finance acquisition of fixed assets and working capital margin. Term loans are repayable in fixed monthly, quarterly or half yearly installments and secured by term loan agreements between the borrower and the bank. Financial Financial institutions: institutions: the following financial institutions cater major part of financial needs of the industrial sector: INDUSTRIAL DEVELOPMENT BANK OF INDIA INDUSTRIAL CREDIT AND INVESTMENT CORPORATION OF INDIA INDUSTRIAL FINANCE CORPORATION OF INDIA STATE FINANCE CORPORATIONS STATE INDUSTRIAL DEVELOPMENT CORPORATIONS INDUSTRIAL CONSTRUTION BANK OF INDIA SMALL INDUSTRIES DEVELOPMENT BANK OF INDIA LIFE INSURANCE CORPORATION UNIT TRUST OF INDIA GENERAL INSURANCE CORPORATION and its Subsidiaries - New New Ind India ia Assu Assura ranc ncee Comp Compan any y Ltd Ltd - Orie Orient ntal al Ins Insur uran ance ce Com Compa pany ny Ltd Ltd - Unit United ed Indi Indiaa Ass Assur uran ance ce Comp Compan any y Ltd Ltd - Nati Nation onal al Ins Insur uran ance ce Com Compa pany ny Ltd Ltd SHIPPING CREDIT AND INVESTMENT COMPANY OF INDIA LTD. Security (April 2002) - Term loans are always secured. They are secured specifically by the assets acquired using term loan funds. This is called primary security. Primary security is taken for the assets for which term loans are given. Collateral Security (April 2002) - Upto term loan of a certain amount Collateral Security is needed. For term loan more than that amount minimum 30% to 35% security is needed. It depends on the credit ratings of the borrower and relations of borrower with the bank Charge (OCT 2005)- may be defined as the transfer on an interest or right in the assets of a person in the favour of a lender for the purpose of securing the repayment of a loan. First and Second ChargeCharge- loans are granted to the borrower against security. Sometimes the borrower may use the same asset for raising finance from two or more lenders. In this case the lender who has first first lent to the borrower borrower against the asset will have the right on the asset, before the second lender in case of default. This is known as the first charge. Only after the dues of the first lender are cleared, after selling off the asset the second lender can claim his dues. This is known as the second charge. Generally the lender who has the second charge will price his loan higher, considering the fact that he has to bear a greater risk.

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TYBMS: Term loan

Fixed and Floating Charge (Oct 2002, Oct 2005) - lenders lend money to the borrower again against st the the secu securi rity ty.. A lend lender er can can have have eith either er a fixe fixed d or a floa floati ting ng char charge ge on the the securities. In case of a fixed charge lender can recover his dues from a certain predecided asset only in case of default by the borrower. On the other hand, a lender who has a floating charge can recover his dues from a gamut of fixed asset. The lender who lends on a fixed asset has to bear a higher risk than the one lending on a floating charge Lien- is the right of retention. Right of retaining goods/securities until the debt due is Particular lien and paid off as per the statutory agreement. The lien can be of 2 types: Particular General lien. Particular lien is the right to retain goods until the claim pertaining to these goods is fully paid. On the other hand, general lien can be applied till all dues of the claimant are paid.

property. In hypothecati hypothecation on Hypothecation - means securing repayment against movable property. goods continue to remain in the possession of the owner. Generally, bank gives loan against hypothecation of stock of raw materials. Although the lender does not have physical possession of the goods. It has a right to sell the goods to realize the outstanding loan. Pledge - means securing repayment by transferring possession of goods in favor of lender. Bank gives loan by keeping in possession of shares and debentures. The borrower who off offers secu ecurity is called “pawnor” or” (ple plegor), whi while the lender is called “pawnee”(pledgee).The lodging of goods by plegor to the pledgee is a kind of bailment. Therefor e pledge creates some liabilities for the lender. It must take reasonable take reasonable reasonable care of goods with it. The term reasonable reasonable care means care of goods pledged with it. The term reasonable care means care which a prudent person would take to protect its own property. He would be responsible for any loss or damage if he uses the pleged goods for his own purposes. In case of non-repayment of the loans, the lender enjoys the right to sell the goods. Pari Passu (with equal pace) (April 2003): On equal footing or proportionately. Pari Passu is equal rights over the asset by two lending institution. It means equally without preference,e.g. a series of debentures may be issued subject to the condition that they are to rank Pari Passu as a first charge on the property charged by the debentures. Moratorium (Oct 2004) : Financial institution may allow for a delay in the payment of the principal installment to the borrowers. The period between the sanction of the loan and first principal installment repayment is known as moratorium. The bank studies profitability statement and cash flow projections prepared by borrowing unit and arrives at a conclusion regarding as to length of moratorium period. Re- Schedulement: In the event of a borrower not being able to pay their installments as as per the repayment schedule, the financial institutions may restructure the repayment schedule of the borrowers to prevent the term loan turning bad.

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TYBMS: Term loan

Flash report (April 2007): The Bank prepares flash report . The flash report is the guage whether it is feasible to provide the loan to the applicant. It determines the feasibility of the projec projectt by lookin looking g the financ financial ial,, economi economical cal,, techni technical cal,, market marketing ing,, manager managerial ial aspects. It determines the amount amount of money that bank will earn after providing loan. It

The financial ratios for appraisal of the project includes: (April 2005, OCT 2007) 1. 2. 3. 4.

Debt Debt equi equity ty rati ratio. o. Inte Intere rest st cove covera rage ge rat ratio io.. Debt Debt ser servi vice ce cove covera rage ge rati ratio. o. Profitabi Profitability lity ratio. ratio.(such (such as as return return on capital capital employe employed, d, Net profit profit ratio, ratio, operating operating profit ratio) 5. Capi Capita tall stru struct ctur uree

Margin money (April 2004) : Margin means the own contribution of the owners for purc purchas hasee of mach machin iner ery y as no bank bank gener general ally ly finan finance cess 100% 100% of the the tota totall cost cost of machinery. The margin change according to the purpose of loans or nature of loan. For instance for machinery it is 25% and for land it is 40% which is negotiable.. Restrictive Covenants (Oct 2005) - a financially weak firm attracts stringent term of loans from lenders. The restrictive covenants may be categorized as follows a) Asset Asset-re -relat lated ed cove covenan nants ts i) borr borrow owin ing g com compa pany ny shou should ld main mainta tain in its its mini minimu mum m ass asset et base base ii) mini minim mum cur current rent rat ratio to be maint aintai aine ned d iii) iii) not to sell sell fixe fixed d ass asset etss wit witho hout ut the the lend lender er’s ’s appro approva vall iv) iv) refr refrai ain n fro from m cre creat atin ing g any any addi additi tion onal al char charge ge on its its ass asset etss b) liabilit liability-rel y-related ated covenant covenantss i) rest restrraine ained d from from incur ncurrring ing addi addittional onal debt debt ii) repay existing loan iii) iii) limi limits ts the the fre freed edom om of pro promo mote ters rs to to disp dispos osee of the their ir sha share reho hold ldin ing g c) cash flow- related covenants Restrain on the firm’s cash outflow by: (i) restricting ca cash di dividends (ii (ii) rest restrrict icting cap capiital exp expen endi ditture ure (iii) (iii) Restri Restricti cting ng sala salarie riess and and perks perks of manager managerial ial staff staff etc. etc. d) Control Control-re -relate lated d covenant covenantss i) broad-base bo board of of di directors ii) ii) appo appoin intm tmen entt of nomi nomine neee dire direct ctor orss by fina financ ncia iall inst instit itut utio ions ns to safeg safegua uard rd the the interests of financial institutions addition on to the forego foregoing ing negati negative ve covenan covenants, ts, certai certain n e) Positive Positive Covenant Covenants: s: in additi positive/ affirmative covenants stating what the borrowing firm should do during the term of a loan are also included in a loan agreement. They provide for: i) furn furnis ishi hing ng of perio periodi dica call rep repor orts ts/f /fin inan ancia ciall sta state teme ment ntss to to the the lende lenders rs ii) ii) main mainte tena nanc ncee of of a mini minimu mum m lev level el of work workin ing g cap capit ital al iii) iii) crea creati tion on of of sin sinki king ng fun fund d for for rede redemp mpti tion on of of deb debtt iv) Main Mainttenan enance ce of cert certai ain n net net wort worth. h.

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TYBMS: Term loan

Project Appraisal by Financial Institutions/ Content of project report (April 2008) Project Appraisal is the process by which the Financial Institutions makes an independent and objective assessment of the various aspects of the investment proposition for arriving at a financing decision Broad aspects of Appraisal Financial Appraisal Technical Appraisal Economic Appraisal Management competence Market Appraisal Technical Appraisal (Oct 2003) Focuses mainly on the following aspects i) product mix ii) capacity iii) process of manufacture iv) iv) engi engine neer erin ing g knowknow-ho how w and and tech techni nica call coll collab abor orat atio ion n v) raw materials and consumables vi) site and location vii) building vii viii) plan plantt and and equi equipm pmen ents ts ix) manpower re requirements x) break-even point Financial Appraisal It seeks to assess the following: 1) Cost Cost of Proj Projec ect. t. 2) Capi Capita tall str struct uctur ure. e. 3) Cash Cash flow flow esti estima mate te.. 4) Return Return of inves investme tment nt on the the project project.. 5) Tax Tax ben benef efiit.

Economic Appraisal Appraisal involves involves analysis analysis of critical critical Economi Economicc Appraisa Appraisall (Oc (Octt 2005): 2005): Economic fact factor orss such such soci socioo-eco econo nomi micc bene benefi fit, t, avai availa labi bili lity ty of labo labour ur,, impo import rt subs substi titu tuti tion, on, technology absorption, impact impact on ecology, value addition, forex forex earnings, economies of scale, development of backward region, effective utilization of resources. Managerial Appraisal: The success success of a business enterpris enterprisee depends largely largely upon on the the reso resour urcef ceful ulne ness ss,, comp compet etenc encee and and inte integr grit ity y of its its manag managem ement ent.. Howev However er the the assess assessmen mentt of manage manageria riall compet competenc encee has to be necessa necessaril rily y qualita qualitativ tivee callin calling g for understanding and judgment. The The managerial appraisal includes assessment of and skill of the promoters, Market / Marketing Appraisal: (April 2005)

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TYBMS: Term loan

1. Exam Examin inee the reas reasona onabl blen enes esss of the demand projections by utilizing the findings of the available market survey findings/ reports, industry association projections, planning commission and independent market surveys. 2. Assess Assess the adequacy adequacy of the marketing marketing infrastr infrastructure ucture in terns terns of promotio promotional nal effort, effort, distribution network, transport facilities, stock levels. 3. Judge the the knowledge, knowledge, experien experience ce and competence competence of of the key marketing marketing personne personnel. l.

TERM LOAN Procedure (April 2004, OCT 2008) 1. Submission of loan application - the borrower submits an application form that seeks comprehensive information about the project. The application form covers the following aspects Promoter’s Promoter’s Background Background - the the prom promot oter erss of the the comp compan any y must must give give thei their r • detailed biodata Particulars of the Industrial ConcernConcern- the products to be manufactured and • the market that need to be penetrated must be stated. Also the forecast for the growth in that industry as well as their opportunities (export potential) must be mentioned. Par Parti ticu cula lars rs of the the proj projec ectt-( ( capacit capacity, y, proces process, s, techni technical cal arrange arrangemen ments, ts, • mana managem gement ent,, loca locati tion, on, land land and and build buildin ings gs,, plant plant and and mach machin iner ery, y, raw raw materials, effluents, labor, housing and schedule of implementation) Cost of the project -the -the cost taking all factoring to account must be arrived at. • Means of financing - there should be details of the debt equity ratio, the level • of gearing, the capital structure, and the source of financing. Marketi Marketing ng and selli selling ng arrange arrangement ment - the the proj projec ectt repo report rt must must stat statee if the the • company has appointed any wholesalers or distributors for its goods, or if it has tied up with another company for marketing its product Economic considerationsconsiderations- the project must be economically feasible • Government Government consents consents- the promot promoters ers should should have obtain obtained ed the necess necessary ary • government approvals for the project 2 Initial processing of loan Application - when the application is received an officer of the financial institution reviews it to ascertain whether it is complete for processing. If it is incomplete the borrower is asked to provide the required additio additional nal inform informati ation. on. When When the applic applicati ation on is conside considered red comple complete te the fina financ ncia iall inst instit itut utio ion n prep prepar ares es a flas flash h repo report rt whic which h is esse essent ntia iall lly y a summarization of the loan application On the basis of the flash report it is decided whether the project justifies a detailed appraisal or not 3 Appraisal of the proposed project - the detailed appraisal of the project covers the marketing, technical, financial managerial and economic aspects. The appraisal memorandum is normally prepared within 2 months after site insp inspec ecti tion on.. Base Based d on that that deci decisi sion on is take taken n whet whether her the the proj project ect will will be accepted or not. 4 Issue of the letter of sanction - if the project is accepted, accepted, a financial letter letter of sanction is issued to the borrower. This communicates to the borrower the assistance sanctioned and the terms and conditions relating thereto

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TYBMS: Term loan

5

Accep Acceptan tance ce of the the ter terms ms and and condi conditio tions ns by the borr borrowi owing ng un unit it - on receiving the letter of sanction from the financial institution the borrowing unit convenes its board meeting at which the terms and conditions associated with the letter of sanction are accepted and an appropriate resolution is passed to that effect. The acceptance of the terms and conditions has ti be conveyed to the financial institution within stipulated period 6 Execution of loan agreement - the financial institution after receiving the letter of acceptance from the borrower, sends the draft of the agreement to the borrower to be executed by the authorized persons and properly stamped as per the Indian Stamp Act, 1899. the agreement properly executed and stamped along with other documents as required by the financial institution must be return returned ed to it. Once the financia financiall instit instituti ution on also also signs signs the agreem agreement ent,, it becomes effective. 7 Disburse periodica icall lly y the borrow borrower er is requir required ed to submit submit Disbursemen mentt of loansloans- period information on the physical progress of the projects, financial status of the project, arrangements made for financing the project, contributions made by the promot promoters ers,, projec projected ted funds funds flow flow statem statement ent,, compli compliance ance with with variou variouss statutory statutory requiremen requirements, ts, and fulfillm fulfillment ent of the pre-disburs pre-disbursement ement conditions. conditions. Based on the information provided by the borrower, the FI will determine the amount of term loan to be disbursed from time to time. Before the entire term loan loan is disb disbur urse sed, d, the the borro borrowe werr must must full fully y comp comply ly with with all all term termss and and conditions of the loan agreement. 8 Creation of security - the term loans and the deferred payment guarantee assistance assistance provided by the financial institutions institutions are secured secured through through the first first mortgage, by way of deposit of title deeds, of immovable properties and hypo hypoth thec ecat atio ion n of move moveabl ablee prop proper erti ties es.. As the the crea creati tion on of mort mortga gage, ge, particularly in the case of land, tends to be a time consuming process, the insti institut tution ionss permit permit interi interim m disbur disbursem sement ent agains againstt altern alternate ate securi security ty.. The mortgage however has to be created within specified period from the date of the first first disbur disbursem sement ent.. Otherw Otherwise ise,, the borro borrower wer has to pay an additio additional nal charge of 1%interest 9 Monitoring - Monitoring of the project is done at the implementation stage as well as at the operational stage. During the implementation stage, the project is monitored through: 1) Regular reports, furnished by the promoters, which provide information about the the plac placeme ement nt of orde orders rs,, cons constr truc ucti tion on of buil buildi ding ngs, s, proc procur urem ement ent of plant plant,, installation of plant and machinery, trial production etc. 2) Periodic site visits 3) Discussion with promoters, bankers, suppliers, creditors, and other connected with the project 4) Progress reports submitted by the nominee directors 5) Audited accounts of the company During During the operati operationa onall stage, stage, the project project is monito monitored red with the help of (i) quarterly progress report on the project (ii) site inspection (iii) reports of nominee directors (iv) comparison of performance Vs promise

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TYBMS: Term loan

The most important aspect of monitoring, of course, is the recovery of dues represented by interest and prince BOARD PAPER

What is difference between Fixed Charge and Floating Charge? (Oct. 2002) What is Flash Report? (April 2007) Explain primary and collateral security with examples. (April 2002) Pan Passu Charge. (April 2003) Technical Appraisal. (Oct. 2003) What is margin money? (April 2004) What is Term Loan? (Oct 2004) What is Moratorium Period? (Oct 2004) What are the matters coy red in a Marketing Appraisal of a Term Loan Appraisal’? (April 2005) What do you mean by economic appraisal of a Term Loan Project? (Oct 2005) What is a charge? What is the difference between a Fixed and a Floating charge? (Oct. 2005) Discuss any five ratios which will have bearing on sanction of loan by Bank of Baroda. (Oct. 2007) Discuss the financial ratios used for appraisal of Term Loan Proposals. (April 2005) What are the important covenants of a Long Term Loan agreement? (Oct. 2005) What are the contents of a Project Report? (April 2008) What are the steps involved in the Project Financing? (Oct. 2008) Sums and Case study

1) Calculate the important ratios for granting Terms Loans and give recommendations from the given projections: (Rs in millions) Y ear 2006 2007 2008 2009 2010 EBIT 560 630 700 735 805 Additional Information a) Tax Tax Rat Rate@30 e@30% % b) Princi Principal pal amount amount of loan loan is repayabl repayablee equally equally along along with interes interestt payabl payablee on outstanding loans at the end of each year c) Loan amount amount in conside considerati ration on Rs.1750 Rs.1750 million million to be contracted contracted @9% @9% d) Repa Repaym ymen entt tenur tenuree 5 years years e) Total Capital Capital Invest Investment ment in Projec Project: t: Rs 2,500 milli million on depreciable depreciable equally equally over 5 years 2) Prepare an amortization schedule from the following information assuming that the Principal amount of loan is repayable equally along with interest payable on unpaid loans Amount Borrowed Rs 12 lakhs Annual Interest @12% Repayment Period 10 years

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TYBMS: Term loan

3) Prepare an amortization schedule from the following information assuming that the amount is an equated annual installment Amount Borrowed Rs 650000 Comp Compou ound nd Annu Annual al Inte Intere rest st @10% @10% Repayment Period 8 years 4) Prepare an amortization schedule from the following information assuming that the amount is an equated annual installment Amount Borrowed Rs 22000 Comp Compou ound nd Annu Annual al Inte Intere rest st @12% @12% Repayment Period 6years CASE STUDY ( OCT 2006)

5)Mr. Chawte, GM of FICOM, a Financial Financial Institution, was in relaxed mood. Just thought of having a walk around went out grabbed peanuts to munch. As he was about to throw the wrapping paper in dust bin, he noticed something! The paper was a part of old flash report of FICOM’s appraisal process. Only partial data was visible. GM could make out that the report was of Chemexperts Ltd of Nasik, a manufacturer of bulk drugs and whose directors were IIT Gold Medalist. Total loan sanctioned was Rs1200 lacs@13% rate of interest of reducing balance, against the total cost of the project at Rs.1850lacs. Principal amount to be repaid in 24 equal quarterly installments. Loan sanctioned against the secur securit ity y of Plant Plant and and Mach Machin iner ery, y, coll collat ater eral al secu securi rity ty of RBI RBI Bonds Bonds and and Pers Person onal al Guarantee of the directors. You are required to list any eight items of the flash report Solution: Name of the Term Lending Financial Institution: FICOM. Name of the Borrower: Chemexperts Ltd. Set up at: Nasik. Nature and Type of Business: Manufacturer of b ulk drugs. Loan Amount: Rs. 1,200 Lakhs. Tenure of Loan: 6 years. (i) Market Appraisal: (1) Manufacturi Manufacturing ng of bulk drugs which which has a huge demand. (ii) (ii) Techn echniical cal Appr Apprai aissal: al: (1) (1) Dire Direct ctor orss are are IIT IIT Gold Gold Meda Medali list st ther theref efor oree they they have have the the requ requir ired ed engineering know-how. (2) The site site and location location is at Nasik. Nasik. (iii (iii)) Fina Financ ncia iall Appra Apprais isal al:: (1) Total cost cost of the project project is Rs. 1,850 1,850 lakhs. (2) Amount of term loan loan is Rs. 1,200 1,200 lakhs. lakhs.

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(iv) (iv)

(v) (v)

TYBMS: Term loan

(3) Promoters Promoters are contributi contributing ng Rs. 650 lakhs [Capital [Capital cost Rs. 1,850 lakhs lakhs — Rs. 1,200 lakhs] as margin money towards the project. (4) Security Security for for term term loan: loan: (a) Primary Primary security security of Plant Plant and Machinery Machinery.. (b) Collateral Collateral securit security y of RBI Bonds and (c) Personal Personal guarantee guarantee of the the Directors Directors.. (5) Promoters are contributing 35.14% (approx.) of the total project cost. (6) The Debt-Equity Ratio Ratio after the proposed term loan will be 1.85: 1. Econ Econom omic ic Appr Apprai aisa sal: l: (1) Manufacturing of bulk drugs resulting into positive impact on health in the society. Manag anager eriial Appr pprais aisal: al: (1) Directors Directors are IIT IIT Gold Medalist. Medalist. (2) (2) Dire Direct ctor orss have have tech techni nica call expe expert rtiise due due to high higher er prof profes esssiona ionall qualifications.

Analysis and Observation: Amount of Term Loan Rs. 1,200 lakhs. Rate of interest @ 13% on RBM. Principal amount repayment in 24 equal quarterly instalments April 20026)The following data is available in respect of Jay Textiles Ltd. a) the company was incorporated in 1982 with the promoters have an experience of more than 35 years in the textile field and is a brand leader in micro yarn b) The company proposes to borrow the term loan under TUFS c) The present installed capacity is 10 machines or 6000 TPA of polyester texturised yarn d) The additional investment will increase the installed c apacity by 3600 TPA e) The present and proposed set up is at silvassa a backward area and enjoys Income Tax holiday for 5 years. Tax Rate is 40% f) GIIC, GSFC and SBI financed the present unit. All the accounts are regular g) The project project will will lead lead to economi economies es of scale, scale, reduced reduced cost cost of product production ion,, higher higher production due to yarn speed being faster due to latest generation machine best quality due to the modernized machine h) The expected ROI of the project is 18% i) Depreciation for the project is Rs 400 lacs every year j) The cost of proposed project and the means of finance are as follows: Proposed Project Cost of project Land and site development Factory building Plant and machinery Electrical installation Misc. fixed assets Pre-operative exp Contingencies

Rs. In lacs 27 155 1604 24 10 20 67

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TYBMS: Term loan

Margin money for working capital 93 Total 2000 Means of finance Promoter’s fund Additional equity share capital 300 Internal cash accrual 500 Term loan 1200 Total 2000 k) The term lending institution has interest rate of 13% for similar risk project and loan is repayable in 5 years with installment and interest repayable at the end of each yea General Manager of the Term Lending Institution has requested you to a) Prepare Prepare flash flash report from from the point point of view view of the Term Term Lending Lending Instituti Institution on b) Evaluate Evaluate the project project for for profitab profitabilit ility y in the the next 5 years years c) Calculate Calculate the the Debt Service Service Coverage Coverage ratio ratio for the Term Term Loans Loans Solution (I) Facts: Name of the Borrower: Jay Textiles Ltd. Incorporated: in 1982 Present and Proposed Set up: at Silvassa (I) Market Appraisal: (1) Brand and Leader in micro yarn. (II) Technical Appraisal: (1) (1) Highe Higherr prod produc ucti tion on due due to yar yarn n spee speed d being being fast faster er due due to lat lates estt gener generat atio ion n machine. (2) (2) Best Best qual qualit ity y due due to the the mod moder erni nize zed d mac machi hine ne.. Purpose of Term Loan: To increase the installed capacity by 3,600 IPA. (3) (3) Capa Capaci city ty:: 6,00 6,000 0 TPA TPA + 3,60 3,600 0 TPA TPA = 9,60 9,600 0 TPA TPA of Pol Polye yest ster er Tex Textu turi rise sed d Yam. (III) Financial Appraisal: (1) (1) 15% 15% of the the fun fund d shou should ld be be rais raised ed thr throu ough gh iss issue ue of of equi equity ty shar shares es.. 25% 25% of the required funds can be arranged through internal accurals and only 60% is required as borrowings in the form of term loan. Since set-up in a backward area therefore it enjoys a tax holiday. Income-tax holiday for 5 years. (3) Term Loan under TUFS (Technology Upgradation Fund Scheme) Rs. 1,200 Lacs. (4) Investment R s. 2,000 Lacs Expected ROl @ 18% R s. 360 Lacs Depreciation R s. 400 Lacs Life 5 years (5) GIIC, GSFC and SBI financed the present unit. (IV) Economic Appraisal: (1) (1) Econ Econom omie iess of of scal scalee res resul ulti ting ng in in red reduc uced ed cos costt of of pro produc ducti tion. on. (V) Managerial Appraisal: (1) Promot Promoters ers having having an an exper experien ience ce of of more more than than 35 35 year yearss in in the the textil textilee fiel field. d.

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TYBMS: Term loan

Term Loan Rs. 1,200 Lacs @ 1 3% Y ear Principal + Interest = Total Repayment 1 240 + 156.0 = 396.0 2 240 + 124.8 = 364.8 3 240 + 93.6 = 333.6 4 240 + 62.4 = 302.4 5 240 + 31.2 = 271.2 1,200 + 468 = 1,668 Debt-Service Coverage Ratio ∑ PAT +Dep. +nt. on Long - Term Loan

=

∑ nt. on long term loan +Loan repayment Instalment

Investment is Rs. 2,000 Lacs ROI is 18% ROI

=

Profit Before Interest and and Tax Tax

PBIT

=

PBIT

= =

Investment Investment × ROI ROI 2,000

×

100

100 18/100

×

Rs. Rs. 360 Lacs

1 Calculation of interest Loan outstanding at the beginning Less: Repayment yearly in 5 years Loan outstanding at the end Interest @ 13% on loan at beginning Calculation of Profitability Profitability PBIT Less: Interest Profit Before Tax Less: Tax Profit After Tax Calculation of DSCR Profit After Tax Add: Depreciation Interest Funds Available for Repayment(A) Repayments Loan Repayment Interest Repayment Total Loan and InterestRepayments(B) Debt Service Coverage Ratio = (A/B)

2 1,20 0 240 960 156 360 156 204 0 204 204 400 156 760 240 156 396

3

4

5

Total

960 240 720 124.8

720 240 480 93.6

480 240 240 62.4

240 240 0 31.2

N. A. 1,200 N. A. 468

360 124.8 235.2 0 235.2

360 93.6 266.4 0 266.4

360 62.4 297.6 0 297.6

360 31.2 328.8 0 328.8

1800 468 1,332 0 1,332

235.2 400 124.8 760

266.4 400 93.6 760

297.6 400 62.4 760

328.8 400 31.2 760

1,332 2,000 468 3,800

240 124.8 364.8

240 93.6 333.6

240 62.4 302.4

240 31.2 271.2

1,200 468 1,668

2.08

2.28

2.51

2.80

2.28

1.92

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TYBMS: Term loan

April 20037) You are approached by a Financial Institution to appraise the following project Name of the borrower: Blue Lines Chemicals Private Limited Proposed loan is taken to set up a chemical unit for processing industrial waste into a marketable product XYZ. The product has a demand for 50,000 Liters. The processing costs include variable cost Rs.5 per Liter and an d fixed cost (excluding depreciation) Rs.30,000 per year. Advertising expenses are also expected to be Rs.20,000 per year XYZ can be sold at Rs10 per liter. Raw Material (industrial waste) is available at Re 1 per liter. The capital cost of chemical units is Rs.7,50,000. The company has applied for a loan of Rs.6,00,000 for term of 10 years that is over the life of the asset. The promoters are young and doing the venture for the first time. The promoters are unable to provide any collateral security for the loan except Personal Guarantee of their parents They have thought of this research after market research. The said research has stated the risk factors about invasion of South Korea in Chemical Market and drastic reduction in Selling Price of similar products The above unit is a SSI unit and its average tax rate is 20% Interest rate 12% Loan is repayable equally in 10 annual installments along with interest at the end of each year You are required to a) Give the cash cash flow flow generated generated by the above above project project for the first first three three years years b) Calculate Calculate the the Debt Service Service Coverage Coverage Ratio Ratio for the the above 3 years years c) Prepare Prepare Flash Report Report presenti presenting ng the above informat information ion to the Financial Financial Instit Institution ution

Solution Facts Nam Namee of of the the Bor Borrowe rowerr Proposed Loan Tenure of Loan Purpose Purpose

: Bl Blue Line Liness Che Chem mical icalss Pr Privat ivatee Li Limite mited. d. : Rs. 6,00,000. : 10 years. : To set up a chemical chemical unit for processing processing industrial industrial waste into a marketable product “XYZ”. (I) Market Appraisal: (1) Promot Promoters ers have have taken taken up up this this proje project ct after after a proper proper mark market et resea research rch.. (2) The mark market et resea research rch repo report rt in in its risk risk fact factors ors has has state stated d about about invasi invasion on of South Korea in chemical market (3) (3) The The mark market et rese resear arch ch repo report rt in its its risk risk facto factors rs also also ment mentio ione ned d dras drasti ticc reduction in selling price of similar products. (II) Technical Ap Appraisal: (1) (1) The The proj projec ectt inv invol olve vess set setti ting ng up up of of a wast wastee recy recycl clin ing g plan plant. t. (III) Financial Ap Appraisal: (1) (1) Prom Promot oter erss are are contr contrib ibut utin ing g as marg margin in mone money y Rs. Rs. 1,50,0 1,50,000 00 (Co (Cost st 7,50 7,50,00 ,000 0 — 6,00,000 loan amount) (2) (2) Prom Promot oter erss are una unabl blee to provi provide de any any colla collate tera rall secur securit ity y for for the the loan loan excep exceptt personal guarantee of their parents.

12


TYBMS: Term loan

(3) (3) The The unit unit is a Smal Smalll Scale Scale Indu Indust stri rial al (SSI (SSI)) unit unit and ther theref efor oree it enjoy enjoyss a lower tax rate of 20% along with other government incentives. (IV) Economic Ap Appraisal: (1) (1) The The proje project ct invo involv lves es maki making ng prop proper er res resou ourc rcee utili utiliza zati tion on in the the nati nation. on. (2) (2) The The proje project ct will will res resul ultt into into reduct reductio ion n of waste waste and and recyc recycli ling ng it int into o usabl usablee product. (V) Managerial Appraisal: (1) (1) Prom Promot oter erss are are young young,, dyn dynam amic ic and and hig highl hly y qua quali lifi fied ed peo peopl ple. e. (2) (2) Prom Promot oter erss are are doin doing g the the vent ventur uree for for the the fir first st time time.. (I) Observation and Analysis: Rs. pa. Projected Sales 50,000 litres × Rs. 10 per litres 5,00,000 Less: Variable Costs: Processing Costs: Variable Cost Rs. 5 per litres × 50,000 litres 2,50,000 Raw Material (Industrial Waste) Re. 1 per litres × 50,000 litres 50,000 Less: Fixed Cost Fixed Cost (Excluding Depreciation) 30,000 Advertising Expenses 20,000 Profit Before Depreciation, Interest and Tax 150,000 Less: Depreciation

7,50,000

75,000

10 Years

Profit Before Interest and Tax 75,000 Years (Rs.) Calculation of Interest: Loan outstanding at the beginning Less: Repayment in 10 annual installments Loan outstanding at the end Interest 12% pa. on loan at beginning Calculation of Cash Flows: PBIT Less: Interest Profit Before Tax Less: Tax @ 20% Profit After Tax Calculation of Debt Service Coverage Ratio: Profit After Tax Add: Depreciation Interest Funds Available for Repayment (A) Repayments Loan Repayment Interest Payment

1

2

3

Total

6,00,000 60,000 5,40,000 72000

5,40,000 60,000 4,80,000 64800

4,80,000 60,000 4,20,000 57,600

N. A. 1.80,000 N. A. 1,94400

75,000 72.000 3,000 600 2,400

75000 64.800 10,200 2,040 8,160

75,000 57,600 17,400 3,480 13,920

2,25,000 1,94,400 30,600 6,120 24,480

2,400 75,000 72,000 1,49,400

8,160 75,000 64,800 1,47,960

13,920 75,000 57,600 1,46,520

24,480 2,25,000 1,94,400 4,43,880

60,000 72,000

60,000 64.800

60,000 57,600

1,80.000 1,94,400

13


TYBMS: Term loan

Total Loan and Interest Repayments (B) Debt Service Coverage Ratio = (NB)

1,32,000 1.13

1,24,800 1.19

1,17,600 1.25

3,74,400 1.19

April 2006 8)Mr Anil Sane wishes to start a Manufacturing Unit from his ancestral factory premises. He has has Rs1, Rs1,05, 05,20 200 0 in his his bank bank accou account nt.. His His parent parentss have have prom promis ised ed to gift gift him him Rs.3,50,000.He has estimated the project cost at Rs18,00,000 of which machinery will be Rs15,25,000 and the remaining amount will be for furniture and fittings. The bank finance is available to the extent of 80% of the project cost. He expects first year’s sales at Rs40,00,000 with the annual increase of 20% every year over previous year. The cost of sales will be 80%of sales. The rate of interest on loan will be 10% on reducing balance meth method od.. The The loan loan is repay repayab able le @ Rs30 Rs30000 0000 0 at the the end of ever every y year year.. He charg charges es depreciation @20% on his fixed assets under straight line and his other overheads for three three years years are Rs24000 Rs240000, 0, Rs30000 Rs300000 0 and Rs36000 Rs360000 0 per year year respect respective ively. ly. You are required to prepare the Projected Profit and Loss account and Projected Balance Sheet for the first 3 years of operations to be presented to the bankers, assuming that the first year is also a full year of 12 months activities and rate of income tax is flat @30% b) Also find out any five plus points of the above loan proposal from Banker’s Point of view.

Solution (1) Bank balance Gift from parents Owned funds available (2)

R s. 1,05,200 3,50,000 4,55,200

Total Project Cost Rs.18 lacs

Owned Funds (Balance) Rs. 3.6 lacs

Bank Loan Rs. 14.4 lacs

(3) Machinery Furniture and Fittings (Balance) Project Cost

Rs. 15,25,000 2,75,000 18,00,000 20

(4)

Depreciation (SLM) @ 20% =

(5)

Bank Finance =

(6)

Working Capital outflows to be show at:

80 100

100

18 lacs =Rs. 3,60,00O p.a.

×

18 lacs =Rs. 14,40,00O

×

p.a.

14


T - 0 Additional investment in working capital will be required to the extent of Rs. Given Amount

TYBMS: Term loan

T - 1 The project will require working capital of Rs. Given Amount during the year 1.

Loan Amortisation Schedule (Equal Principal Repayment) Y ear Balance at the Principal Interest Total Loan Beginning Repayment @ 10% Instalment 1 14,40,000 3,00,000 1,44,000 4,44,000 2 11,40,000 3,00,000 1,14,000 4,14,000 3 8,40,000 3,00,000 84,000 3,84,000 Income Statement / Profit and Loss A/c Particulars

Sales Less: Cost of Sales/Cost of Goods Sold (80% of Sales) Gross Profit Less: (i) (i) Depreciation @ 20% (ii) Other Overheads EBIT Less: interest on Loan EBT Less: Tax @30% NPAT Balance Sheet Year 1 Liabilities Rs. Rs. Assets Owned Funds 3,60,000 Fixed Assets: (+) NPAT 39,200 3,99,200 Machinery Bank Loan 14,40,000 (-) 20% Depreciation (—) Repaid 3,00,000 11,40,000 Furniture and Fittings (-) 20% Depreciation Net Fixed Assets Working Capital (Balancing Figure) 15,39,200 Balance Sheet Year 2 Liabilities Rs. Rs. Assets Owned Funds 3,99,200 Fixed Assets: (+) NPAT 1,30,200 5,29,400 Machinery Bank Loan 11,40,000 (-) 20% Depreciation (—) Repaid 3,00,000 8,40,000 Furniture and Fittings (-) 20% Depreciation

Balance at the End 11,40,000 8,40,000 5,40,000

1 40,00,000 32,00,000 8,00,000 3,60,000 2,40,000 2,00,000 1,44,000 56,000 16,800 39,200

Years 2 48,00,000 38,40,000 9,60,000 3,60,000 3,00,000 3,00,000 1,14,000 1,86,000 55,800 1,30,200

Rs.

15,25000 3,05,000 2,75,000 55,000

Rs.

3 57,60,000 46,08,000 11,52,000 3,60,000 3,60,000 4,32,000 84,000 3,48,000 1,04,400 2,43,600 Rs.

12,20,000 2,20,000 14,40,000 99,200 15,39,200

Rs.

12,20,000 3,05,000 2,20,000 55,000

Rs.

9,15,000 1,65,000

15

Rs.


TYBMS: Term loan Not Fixed Assets Working Capital (Balancing Figure)

10,80,000 2,89,400 13,69,400

13,69,400 Balance Sheet Year 3 Liabilities Rs. Owned Funds 5,29,400 (+) NPAT 2,43,600 Bank Loan 8,40,000 (—) Repaid 3,00,000

Rs.

Assets Rs. Rs. Fixed Assets: 7,73,000 Machinery 9,15,000 (-) 20% Depreciation 3,05,000 6,10,000 5,40,000 Furniture and Fittings 1,65,000 (-) 20% Depreciation 55,000 1,10,000 Not Fixed Assets Working Capital (Balancing Figure) 13,13,000 (b) 5 positive points from Bankers point of view: (1) Fresh resh MBA: MBA: Youn Young g qua quallifie ified d per perso son. n. (2) Ance Ancesstral tral Facto actorry Premi emises: ses: No gest gestat atio ion n time. me. Prod Produc ucttion ion can can star tart immediately. No charge on factory premises. (3) (3) Gift Gift fro from m pare parent ntss of As. As. 3,5 3,50,0 0,000 00:: No bur burde den n of rep repay ayme ment nt and and no charg chargee on company’s assets. (4) (4) Own Own bank bank bal balan ance ce As. As. 1,0 1,05, 5,20 200. 0. No No repa repaym ymen entt burd burden en.. (5) (5) 25.28 25.28% % of the the proj projec ectt cost cost can can be be cont contri ribu bute ted d by him him fro from m his his own own ban bank k balance and gift from parents. This can be his margin money and only the balance amount is required in the form of bank borrowings. (6) (6) Proj Projec ecte ted d inc incre reas asee in in sal sales es ever every y yea yearr by by 20% 20%.. (7) High High Prof Profita itabil bility ity Ratios Ratios [i.e. [i.e. Gros Grosss Prof Profit it Ratio, Ratio, Net Profit Profit Ratio, Ratio, etc.] etc.] (8) (8) Soun Sound d DSCR DSCR and and Inte Intere rest st Cover Coverag agee Rati Ratios os indi indica cati ting ng loan loan inst instal alme ment nt repayment ability. Comments: The company will utilise the entire bank loan and enjoy the benefit of “Trading on Equity” since cost of debt is lower than the profit percentage and the company’s sales and operating profits are on an increasing trend. If the company will utilise the entire owned funds available and take the balance by way of bank loan then it won’t be able to maximise the returns on its owned funds and enjoy the benefit of “Trading on Equity” and the Return on Net worth will be low in alt the three years.

OCT 2007 9) Mr. Hemendra Dane is carrying out retail business in electronic items. After observing trade practices, he has decided to start a small scale manufacturing unit to produce electrical fittings. His Balance Sheet as on 31 -3-2007, before starting manufacturing activities, is as under: Liabilities Assets Capital 5,55,500 Furniture 40,000 Computer 60,000 Investments 1,50,000 Fixed Deposits with bank 2,00,000 Cash and Bank balance 1,05,500 Rs. 5,55,500 Rs. 5,55,500

16

Rs.

7,20,000 5,93,000 13,13,000


TYBMS: Term loan

In order to carry out new activity he will take factory premises on rental basis @ Rs. 10,000 p.m. from 1.9.2007 and from 1.4.2008 the rent will be Rs. 15,000 p.m. He is confident of setting up manufacturing unit by 30.8.2007 and start manufacturing and selling from 1st September 2007. The cost of machineries will be Rs. 10,00,000 for which he will be approaching Bank of Baroda for term loan of Ps. 8,00,000, balance being his own contribution. The loan repayment will start from 1.4.2008, in the quarterly installment installment of Rs. 50,000 payable on 1st April, 1st July, 1st October and 1st January every year. He will have no income in financial year 2007-08 till setting up of the unit i.e. upto 30-8-2007. Thereafter he expects his Sales to be Rs. 80,000 p.m. from 1-9-2007 to 31-3-2008 and afterwards every year Rs. 18,00,000 with yearly increment of 10% over previous year. His cost structure will remain more or less unchanged upto 31-3-2010 and Cost break up on Sale Sales s will will be: be: Dire Direct ct Cost Cost @ 40%, 40%, Offi Office ce Over Overhe head ads s 20%; 20%; Sell Sellin ing g and and Distribution 5%, Depreciation will be charged on all fixed assets @ 10% under W.D.V. (full year’s depreciation even if the assets are used for a part of the year) and interest for first year ending 31 -3-2008 will be Rs. 59,000 and thereafter it will be at Rs. 70,000, Rs. 54,000 and Rs. 43,000 respectively for subsequent years. You are required to prepare Projected Statement of Profit and Loss for the financial years 2007-08 08-09 and 2009-10. Solution: Proj Projec ectted Prof rofit and Los Loss s Sta State teme men nt (All (All figu figurres in Rupees ees) Particulars 20072008-09 2009-10 08 Sales 5,60,00 18,00,000 19,80,000 Less: expenses: 0 Direct Cost (40% Sales) 7,20,000 7,92,000 Office Overheads (20% Sales) 2,24,00 3,60,000 3,96,000 Selling and Distribution Overheads (5% Sales) 0 90,000 99,000 Factory Rent 1,12,00 1,80,000 1.80,000 PBDIT 0 4,50,000 5,13,000 Less: Depreciation on: 28000 Furniture 70,000 3,600 3,240 Computer 1,26,00 5,400 4,860 Machinery 0 90,000 81,000 PAIT 3,51,000 4,23,900 Less: Interest on Term Loan 4,000 70,000 54,000 NPBT 6,000 2,81,000 3,69,900 1,00,00 0 16,000 59,000 (43,000) Working Notes: (1) Factory Rent: 01/09/200710 31/03/2008 (7 Months) @ Rs. 10,000 p.m. = Rs. 70,000 01/04/2008 01/04/2008 to 31/03/2009 31/03/2009 and 01/04/2009 01/04/2009 to 31/03/2010( 31/03/2010(12 12 Months) Months) @ Rs. 15,000 p.m. = Rs. 1,80,000 p.a. (2) Sales: 01/09/2007 to 31/03/2008 (7 Months) @ Rs. 80,000 p.m. = Rs. 5,60,000 01/04/2008 to 31/03/2009 = Rs. 18,00,000 01/04/09 to 31/03/2010 = Rs. 18,00,000 + 10% = Rs. 19,8C’.OOO

17


TYBMS: Term loan

(3) Cbst Break-up: Direct Cost Office Overheads S and D Overheads

40% × Sales 20% × Sales 5% × Sales (4) Depreciation on all Fixed assets: @ 10% WDV Method Particulars Furniture

WDV/Cost Depreciation Depreciation 07-08 WDV Depreciation Depreciation 08-09 WDV Depreciation Depreciation 09-10

40,000 4,000 36,000 3,600 32,400 3,240

Compute r 60,000 6,000 54,000 5,400 48,600 4,860

Machiner y 10,00,000 1,00,000 9,00,000 90,000 8,10,000 81,000

18

Term Loan and Project Appraisal

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