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Project Appraisal

Swagat Kishore MishraDepartment of Economics and Finance

WILP: Project Appraisal

Lecture 13

Email: swagat@goa.bits-pilani.ac.in

Tel. 0832-2580207 (O) 08879506995 (M)

1Course No. ETZC414 Project AppraisalOctober 13, 2014

mailto:swagat@goa.bits-pilani.ac.inmailto:swagat@goa.bits-pilani.ac.inmailto:swagat@goa.bits-pilani.ac.inmailto:swagat@goa.bits-pilani.ac.in

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Financing of Projects

i. Various sources of financing and

ii. Determination of the optimal financing mix

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Capital structure

Shareholders funds: equity capital, preference

capital

Loan funds: debenture capital, deferred credit,

working capital advance

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Equity vs Debt

Equity shareholders have a residual claim on the income and

wealth of the firm

Creditors have a fixed claim in form of interest and principal

payment

Dividend paid to equity shareholders is not a tax deductible

payment

Interest paid to creditors is a tax deductible payment

Equity has indefinite life Debt has fixed maturity

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Debt-equity ratio:

planning the capital structure

Earnings per share

Risk

Control Flexibility

Nature of assets

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Earnings per share

The term earnings per share (EPS) represents the portion of a

company's earnings, net of taxes and preferred stock

dividends, that is allocated to each share of common stock.

The figure can be calculated simply by dividing net

income earned in a given reporting period (usually quarterly

or annually) by the total number of shares outstanding during

the same term.

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EPS is a carefully scrutinized metric that is often used as a barometer

to gauge a company's profitability per unit of shareholder ownership.

As such, earnings per share is a key driver of share prices. It is alsoused as the denominator in the frequently cited P/E ratio.

Let's assume that during the fourth quarter,

Company XYZ reported net income of $4million. During the same time frame, the

company had a total of 10 million shares

outstanding. In this particular case, the

company's quarterly earnings per share (or EPS)

would be $0.40, calculated as follows:

$4 million / 10 million shares = $0.40

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Risk

Business risk: demand variability, price

variability, input prices variability and

proportion of fixed costs

Financial risk: financial leverage or financial

commitment

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Control

PROS CONSRights issue of

equity capital

No dilution of

control

Severe limits on

financing

Debt capital No financial risk,

limited dilution of

control, lower cost

Higher cost,

financial cost

Public issue of

equity capital

No financial risk Dilution of control,

higher cost, more

regulation

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Flexibility

Ability to raise capital

Firm does not fully exhaust its debt capacity

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Nature of assets

Tangible assets with liquidity in resale

Primarily intangible assets

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Fixed - used to purchase the permanent or fixed assets

of the business (e.g., buildings, land, equipment, etc.)

Working - used to support the small companysnormal

short-term operations (e.g., buy inventory, pay bills,

wages, salaries, etc.)

Growth - used to help the small business expand or

change its primary direction.

Capital is any form of wealth

employed to produce more

wealth for a firm.

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Equity CapitalRepresents the personal investment of the owner(s) in the

business.

Is called risk capital because investors assume the risk of

losing their money if the business fails.

Does not have to be repaid with interest like a loan does.

Means that an entrepreneur must give up some ownership inthe company to outside investors.

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Deciding between equity

financing and taking on a loan

for your business is a

challenge for all small

business owners when they

need capital to expand abusiness. Should you go to a

bank and apply for a business

loan? Or should you look for

an investor?

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Advantages to equity financing:It's less risky than a loan because you don't have to pay it back, and it's a good

option if you can't afford to take on debt.

You tap into the investor's network, which may add more credibility to your

business.Investors take a long-term view, and most don't expect a return on their investment

immediately.

You won't have to channel profits into loan repayment.

You'll have more cash on hand for expanding the business.

There's no requirement to pay back the investment if the business fails.

Disadvantages to equity financing:It may require returns that could be more than the rate you would pay for a bank

loan.

The investor will require some ownership of your company and a percentage of the

profits. You may not want to give up this kind of control.

You will have to consult with investors before making big (or even

routine) decisions -- and you may disagree with your investors.

In the case of irreconcilable disagreements with investors, you may need to cash in

your portion of the business and allow the investors to run the company without

you.

It takes time and effort to find the right investor for your company.

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Advantages to debt financing:

The bank or lending institution (such as the Small Business Administration) has no say in

the way you run your company and does not have any ownership in your business.

The business relationship ends once the money is paid back.The interest on the loan is tax deductible.

Loans can be short term or long term.

Principal and interest are known figures you can plan in a budget (provided that you

don't take a variable rate loan).

Disadvantages to debt financing:

Money must paid back within a fixed amount of time.

If you rely too much on debt and have cash flow problems, you will have trouble paying

the loan back.

If you carry too much debt you will be seen as "high risk" by potential investors

which will limit your ability to raise capital by equity financing in the future.

Debt financing can leave the business vulnerable during hard times when sales take a

dip.

Debt can make it difficult for a business to grow because of the high cost of repaying the

loan.

Assets of the business can be held as collateral to the lender. And the owner of the

company is often required to personally guarantee repayment of the loan.

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THANK

YOU

October 13, 2014 Course No. ETZC414 Project Appraisal25.07.13

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