Project financing

Presented by:-
Shasmita,
Sudhansu
 Introduction
• A project can be defined as ‘A scheme of
things to be done during a specified period in
future for deriving expected benefits under
certain assumed conditions’.
• A project may be in the nature of setting up
a new industrial unit, modernisation,
expansion, diversification and promotion of
R&D.
• Project financing means arrangement of
sufficient funds to finance the development
and construction of a specific project.
 Project background
• Steps for any project to be taken:-
 I] Identification of a project
 II] Feasibility investigation
 III] Assembling the proposition
 IV] Financing the proposition
 Approach of Project financing
• The gamut of ‘feasibility’ covers the following area:-
 To the idea technologically sound- Technical
feasibility.
 Would it be commercially viable- Commercial
viability.
 What would be its economic dimensions- Economic
viability.
 What financial demand would it make on the
promoters, the company and outside creditors. To
put it differently, what is the size of funds required-
Cost of the Project.
 Continued
 What would be the probable sources that can be
tapped? What sources should be selected-
Financial Plan
 Would the project be a paying proposition-
Financial viability
 How much would be the manpower requirement
and what type of managerial and organisational
structure will it require?- Organisational and
management structure.
 Capital
• Capital refers to total investment of money,
tangible assets like buildings, and intangible
assets like goodwill.
• Net capital refers to the excess of total assets
over total liabilities.
 Capitalization
• Capitalization is the sum-total of all long term
securities issued by a company and the surpluses
not meant for distribution; it includes only long
term loans and retained profits.
• If the company raises more capital than is
warranted by the figure of capitalization or its
earning power is known as overcapitalization
• If the company earning power is lower than its
earning power is known as undercapitalization
 Evils of Overcapitalization
• There is a considerable reduction in the rate of
dividend on equity shares;
• The market value of share declines and investors
loose their confidence in the company;
• The company resorts the window dressing; and
• There is a loss of goodwill.
From social angle:-
• Indication of reduced efficiency
• Results in misappropriation of society’s resources
• Leads to a cut in the wages of workers with a view
to raising profits.
 Overcapitalization v/s
undercapitalization
• A concern is said to be over-capitalized if its earnings are not • If the owned capital of the business is much less than
sufficient to justify a fair return on the amount of share capital and the total borrowed capital than it is a sign
debentures that have been issued. It is said to beover of under capitalization. This means that the owned
capitalized when total of owned and borrowed capital exceeds its capital of the company is disproportionate to the
fixed and current assets  i.e. when it shows accumulated losses on scale of its operation and the business is dependent
the assets side of the balance sheet. upon borrowed money and trade creditors. Under-
• An over capitalized company can be like a very fat person who capitalization may be the result of over-trading. It
cannot carry his weight properly. Such a person is prone to many must be distinguished from high gearing. Incase of
diseases and is certainly not likely to be sufficiently active. Unless capital gearing there is a comparison between equity
the condition of overcapitalization is corrected, the company may
capital and fixed interest bearing capital (which
find itself in great difficulties.
includes reference share capital also and excludes
• Causes of Over Capitalization: trade creditors) whereas in the case of
Some of the important reasons of over-capitalization are:
under capitalization, comparison is made between
• Idle funds: The company may have such an amount of funds that it total owned capital (both equity and preference
cannot use them properly. Money may be living idle in banks or share capital) and total borrowed capital (which
in the form of low yield investments.
includes trade creditors also). Under capitalization is
• Over-valuation: The fixed assets, especially good will, may have indicated by:
been acquired at a cost much higher than that warranted by the
services which that asset could render.
• Low proprietary Ratio
• Fall in value: Fixed assets may have been acquired at a time when • Current Ratio
prices were high. with the passage of time prices may have been • High Return on Equity Capital
fallen so that the real value of the asset may also have come down • The effects of under capitalization may be:
substantially even though in the balance sheet the assets are being
• Payment of excessive interest on borrowed capital.
being shown at book value less depreciation written off. Then the
book values will be much more than the economic value. • Use of old and out of date equipment because of
• Inadequate depreciation provision: Adequate provision may not inability to purchase new plant etc.
have been provided onthe fixed assets with the result the profits • High cost of production because of the use of old
shown by books may have been distributed as dividend, leaving no machinery
funds with which to replace the assets at the proper time.
 Capital Structure
• Capital structure of a company involves in a decision
regarding the ratio of ownership capital to credit capital,
between short-term and long- term capital, and the ratio
among different sources of finance for capital, which
includes loans, bonds, share issues and reserves.
• The maintenance of proper ratios between the different
types of securities is known as “capital gearing” & these
factors govern the capital gearing of a company.
• Trading in equity;
• Nature of enterprise;
• Legal requirements;
• Retaining control of a company;
• Requirement of investors;
• Elasticity of the financial plan
 Capital Structure
• Equity shares------------------------- one tier
• Equity shares+ preference shares ----- two tier
• Equity shares+ preference shares+ debentures
------------- three tier capital structure
 Finance for large scale industries
• These require funds to meet their fixed or
block capital expenses.
• Funds needed for block or fixed capital
generally raised:-
 By the issue of shares of different types and
debentures;
 By ploughing back a part of profit made by an
industry;
 By inviting long term deposit from the public
 Equity Shares ,Deferred Shares
• Features • Features
 Risk capital;  Last claim in profit
 Fluctuating dividend; sharing
 Changing market price;  Last claim in return of
 capital
Growth prospects;
  Widely changing
Protection against
dividends
inflation;
 Normal voting rights  Extraordinary voting
rights
 Only for private
companies
 Preference shares/ Debentures
• Features • Features
 Fixed return of income  Loan of borrowed capital
i.e., dividend  Fixed income or fixed
 First preference in profit interest
sharing  Right of priority in return
 First preference in of capital
repayment of capital  No voting rights
 No change to share the  May involve mortgage of
fruits of prosperity company’s property
 No normal voting rights  Usually redeemable after
certain period
 Difference between preference and
equity shares
• Ordinary shares are the most common kind of shares.
An ordinary share gives the holder voting rights in the
company and entitles the person to all dividend
distributions as a part-owner of the company.
• Preference shares allow holders to be paid dividends
before ordinary shareholders and they also have
priority over asset claims if the company goes bust.
The downside is that preference shareholders have a
fixed dividend and only limited voting rights with
respect to company affairs.
 Difference between Shareholders and
debentureholders
• There are many differences between shareholders and
debenture-holders of a company, all of which are illustrated
further. A shareholderis the proprietor of the company. On the
other hand, a debenture holder is the creditor of the company.
Moreover shareholders have the right to attend General
Meetings that the company holds, a privilege that the
debenture-holder does not have. This, in turn, gives the
shareholders the right to vote in the General Meeting as well.
Once again as the debenture-holders are not allowed to attend
the General Meetings, the case of voting does not apply to them
in the first place. Furthermore a shareholder gets a share in the
profit, which has a tendency to fluctuate. As for the debenture-
holder, they get interest whose rate is fixed. Also where shares
could be bought at discount, it is not the case with debentures,
which could not be purchased at adiscount rate. Lastly, shares
could be bought back by a shareholder but a debenture holder
could not buy the debentures back