Project Mba Sanjeev Singh

7/31/2019 Project Mba Sanjeev Singh

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TYPES OF INFRASTRUCTURE PROJECTS

& THEIR FINANCING NEEDS (REFERENCEPUNJ LLOYD LIMITED).

BY

SANJEEV KUMAR SINGH

A DISSERTION/ THESIS SUBMITTED IN

PARTIAL FULFILLMENT OFTHE REQUIREMENTS FOR

MASTER OF BUSINESS ADMINISTRATION OF

S M U

MANIPAL

2 0 0 8


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THE DISSERTION / THESIS OF

SANJEEV KUMAR SINGH

TITLED

TYPES OF INFRASTRUCTURE PROJECTS& THEIR FINANCING NEEDS (REFERENCE

PUNJ LLOYD LIMITED).


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CERTIFICATE

THIS IS TO CERTIFY THAT THE PROJECT REPORT ENTITLED



SUBMITTED IN PARTIAL FULFILLMENT OF THE REQUIREMENTSFOR THE DEGREE OF

MASTER OF BUSINESS ADMINISTRATION OFS M U

SANJEEV KUMAR SINGH

UNDER MY SUPERVISION AND GUIDANCE AND THAT NO PART OFTHIS REPORT HAS BEEN SUBMITTED FOR THE AWARD OF ANYOTHER DEGREE, DIPLOMA, FELLOWSHIP OR OTHER SIMILARTITLES OR PRIZES AND THAT THE WORK HAS NOT BEENPUBLISHED IN ANY JOURNAL OR MAGAZINE.

REGISTRATION NUMBER.:520623424


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STUDENT DECLARATION

I HEREBY DECLARE THAT THE PROJECT ENTITLED



SUBMITTED IN PARTIAL FULFILLMENT OF THE

REQUIREMENTS FOR THE DEGREE OF

MASTER OF BUSINESS ADMINISTRATION

TO S M U IS MY ORIGINAL WORK AND NOT SUBMITTED FOR THE

AWARD OF ANY OTHER DEGREE, DIPLOMA, FELLOWSHIP OR

OTHER SIMILAR TITLE OR PRIZES.

PLACE: NEW DELHI SANJEEV KUMAR SINGH

DATE: REGN NO. : 520623424


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ACKNOWLEDGMENT

IAM MOST THANKFUL TO THE STUDY CENTER VAG

INFOTECH SOUTH EXTN. NEW DELHI FOR GIVING ME

SUCH A TOPIC. INFRASTRUCTURE FINANCE AS AN AREA

OF PROFESSION WAS NOT AS WIDELY PRACTICED A

DECADE AGO. SO, THIS AREA OF STUDY OFFERS AN

OPPORTUNITY ESPECIALLY IN THE POST LIBERALIZATION

ERA, TO EXPLORE THIS ENVIRONMENT. IAM GREATFULL

TO THE PERSONNEL AT PUNJ LLOYD LIMITED IN THE

FINANCE & ACCOUNTS, AND PROJECT PLANNING AND

INDUSTRIAL CIVIL STRATEGIC BUSINESS UNIT, FOR THE


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ALL ROUND SUPPORT AND MOTIVATION. I WOULD LIKE

TO SPECIALLY THANK,

FOR THEIR VALUABLE INSTRUCTIONS, GUIDANCE &

CONTINUOUS SUPPORT, MR PRAMOD MITTAL AGM (F&A),

Mr. AJAY GUATAM DGM (F&A), OF M/S PUNJ LLOYD LIMITED,

WITHOUT WHOM I WOULD HAVE DEVIATED FROM THE

MAIN SUBJECT.


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NATURE OF STUDY

THE TERM NATURE AS APPLIED TO PROJECT FINANCE REFERS

TO ITS RELATIONSHIP WITH THE CLOSELY RELATED FIELDS OF

ECONOMICS AND ACCOUNTING, ITS FUNCTIONS, SCOPE AND

OBJECTIVES. PROJECT FINANCE, AS AN ACADEMIC DISCIPLINE,

HAS UNDERGONE FUNDAMENTAL CHANGES AS REGARDS ITS

SCOPE AND COVERAGE. IN THE EARLY YEARS OF ITS EVOLUTION

IT WAS TREATED SYNONYMOUSLY WITH THE RAISING OF FUNDS.

IN THE CURRENT LITERATURE PERTAINING TO THIS GROWING

ACADEMIC DISCIPLINE, A BROADER SCOPE SO AS TO INCLUDE, IN

ADDITION TO PROCUREMENT OF FUNDS, EFFICIENT USE OF

RESOURCES IS UNIVERSALLY RECOGNISED. SIMILARLY, THE

ACADEMIC THINKING AS REGARDS THE OBJECTIVE OF PROJECT

FINANCE IS ALSO CHARACTERISED BY A CHANGE OVER THE

YEARS.

SCOPE OF PROJECT FINANCE

WHAT IS PROJECT FINANCE? WHAT ARE THE FIRMS OTHER

FINANCIAL ACTIVITIES? HOW ARE THEY RELATED TO THE FIRMS

OTHER ACTIVITIES / FUNCTIONS?


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THE APPROACH TO THE SCOPE AND FUNCTIONS OF PROJECT

FINANCE IS DIVIDED, FOR PURPOSES OF EXPOSITON, INTO TWO

BROAD CATEGORIES.

(1)TRADITIONAL APPROACH

(2)MODERN APPROACH

TRADITIONAL APPROACH

THE TRADITIONAL APPROACH TO THE ASPECTS OF PROJECT

FINANCE REFERS TO ITS SUBJECT MATTER IN THE ACADEMIC

LITERATURE IN THE INITIAL STAGES OF ITS EVOLUTION AS A

SEPARATE BRANCH OF ACADEMIC STUDY. THE TERM

CORPORATION FINANCE WAS USED TO DESCRIBE WHAT IS NOW

KNOWN IN THE ACADEMIC WORLD AS FINANCIAL

MANAGEMENT. AS THE NAME SUGGESTS, THE CONCERN OF

CORPORATION FINANCE WAS WITH THE FINANCING OF

CORPORATE ENTERPRISES. IN OTHER WORDS, THE SCOPE OF

FINANCE FUNCTION WAS TREATED BY THE TRADITIONAL

APPROACH IN THE NARROW SENSE OF PROCUREMENT OF

FUNDS BY CORPORATE ENTERPRISES TO MEET THEIR FINANCING

NEEDS. THE TERM PROCUREMENT WAS USED IN A BROAD

SENSE SO AS TO INCLUDE THE WHOLE GAMUT OF RAISING

FUNDS EXTERNALLY. THUS DEFINED, THE FIELD OF STUDY


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DEALING WITH FINANCE WAS TREATED AS ENCOMPASSING

THREE INTER-RELATED ASPECTS OF RAISING AND

ADMINISTERING RESOURCES FROM OUTSIDE: -

I. THE INSTITUTIONAL ARRANGEMENT IN THE FORM OF

FINANCIAL INSTITUTIONS WHICH COMPRISE THE

ORGANISATION OF THE CAPITAL MARKETS ALSO;

II. FINANCIAL INSTRUMENTS THROUGH WHICH FUNDS ARE

RAISED FROM THE CAPITAL MARKETS AND THE RELATED

ASPECTS OF PRACTICES AND THE PROCEDURAL ASPECTS

OF CAPITAL MARKETS; AND

III. THE LEGAL AND ACCOUNTING RELATIONSHIPS BETWEEN A

FIRM AND ITS SOURCES OF FUNDS. THE COVERAGE OF

CORPORATION FINANCE WAS, THEREFORE, CONCEIVED TO

DESCRIBE THE RAPIDLY EVOLVING COMPLEX OF CAPITAL

MARKET INSTITUTIONS, INSTRUMENTS AND PRACTICES. A

RELATED ASPECT WAS THAT FIRMS REQUIRE FUNDS AT

CERTAIN EPISODIC EVENTS SUCH AS MERGER,

LIQUIDATION, RE-ORGANISATION AND SO ON. A DETAILED

DESCRIPTION OF THESE MAJOR EVENTS CONSTITUTED THE

SECOND ELEMENT OF THE SCOPE OF THIS FIELD OF

ACADEMIC STUDY. THAT THESE WERE THE BROAD


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FEATURES OF THE SUBJECT MATTER OF CORPORATION

FINANCE IS ELOQUENTLY REFLECTED IN THE ACADEMIC

WRITINGS AROUND THE PERIOD DURING WHICH THE

TRADITIONAL APPROACH DOMINATED THE ACADEMIC

THINKING. THUS, THE ISSUES TO WHICH THE LITERATURE

ON FINANCE ADDRESSED ITSELF WAS HOW RESOURCES

COULD BEST BE RAISED FROM THE COMBINATION OF THE

AVAILABLE SOURCES.

THE TRADITIONAL APPROACH TO THE SCOPE OF THE FINANCE

FUNCTION EVOLVED DURING THE 1920S AND 1930S DOMINATED

THE ACADEMIC THINKING DURING THE FORTIES AND THROUGH

THE EARLY FIFTIES. IT HAS NOW BEEN DISCARDED AS IT

SUFFERS FROM SERIOUS LIMITATIONS. THE WEAKNESSES OF

THE TRADITIONAL APPROACH FALL INTO TWO BROAD

CATEGORIES:

1. THOSE RELATING TO THE TREATMENT OF VARIOUS TOPICS

AND THE EMPHASIS ATTACHED TO THEM;

2. THOSE RELATING TO THE BASIC CONCEPTUAL AND

ANALYTICAL FRAMEWORK OF THE DEFINITIONS AND SCOPE OF

THE FINANCE FUNCTION.


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AS REGARDS THE FIRST TYPE OF CRITICISM OF THE TRADITIONAL

APPROACH, THE EMPHASIS OF THE ACADEMIC LITERATURE ON

ISSUES RELATING TO THE PROCUREMENT OF FUNDS BY

CORPORATE ENTERPRISES WAS CHALLENGED DURING THE

PERIOD THE APPROACH DOMINATED THE SCENE ITSELF. THE

TRADITIONAL TREATMENT OF FINANCE WAS CRITICISED FOR THE

FOLLOWING REASONS.

SINCE THE FINANCE FUNCTION WAS EQUATED WITH THE ISSUES

INVOLVED IN RAISING AND ADMINISTERING FUNDS, THE THEME

WAS WOVEN AROUND THE VIEWPOINT OF THE SUPPLIERS OF

FUNDS SUCH AS INVESTORS, INVESTMENT BANKERS AND SO ON,

I.E. THE OUTSIDERS. IT IMPLIES THAT NO CONSIDERATION WAS

GIVEN TO THE VIEWPOINT OF THOSE WHO HAD TO TAKE

INTERNAL FINANCIAL DECISIONS. THE TRADITIONAL TREATMENT

WAS, IN OTHER WORDS, THE OUTSIDER-LOOKING-IN APPROACH.

THE LIMITATION WAS THAT INTERNAL DECISION-MAKING (I.E.

INSIDER-LOOKING-OUT) WAS COMPLETELY IGNORED.

THE SECOND GROUND OF CRITICISM OF THE TRADITIONAL

TREATMENT WAS THAT THE FOCUS WAS ON FINANCING

PROBLEMS OF CORPORATE ENTERPRISES. TO THAT EXTENT THE

SCOPE OF FINANCIAL MANAGEMENT WAS CONFINED ONLY TO A


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SEGMENT OF THE INDUSTRIAL ENTERPIESES, AS NON-

CORPORATE ORGANISATIONS LAY OUTSIDE ITS SCOPE.

YET ANOTHER BASIS ON WHICH THE TRADITIONAL APPROACH

WAS CHALLENGED WAS THAT THE TREATMENT WAS BUILT TOO

CLOSELY AROUND EPISODIC EVENTS, SUCH AS PROMOTION,

INCORPORATION, MERGER, CONSOLIDATION, REORGANISTATION

AND SO ON. FINANCIAL MANAGEMENT WAS CONFINED TO A

DESCRIPTION OF THESE INFREQUENT HAPPENINGS IN THE LIFE

OF AN ENTERPRISE. AS A LOGICAL COROLLARY, THE DAY-TO-DAY

FINANCIAL PROBLEMS OF A NORMAL COMPANY DID NOT RECEIVE

ANY ATTENTION.

FINALLY, THE TRADITIONAL TREATMENT WAS FOUND TO HAVE A

LACUNA TO THE EXTENT THE FOCUS WAS ON LONG-TERM

FINANCING. ITS NATURAL IMPLICATION WAS THAT THE ISSUES

INVOLVED IN WORKING CAPITAL MANAGEMENT WERE NOT IN THE

PURVIEW OF FINANCE FUNCTION.

THE LIMITATION OF THE TRADITIONAL APPROACH WAS,

HOWEVER, NOT ENTIRELY BASED ON TREATMENT OR EMPHASIS

OF DIFFERENT ASPECTS. IN OTHER WORDS, ITS WEAKNESSES

WERE MORE FUNDAMENTAL. THE CONCEPTUAL AND ANALYTICAL

SHORTCOMING OF THIS APPROACH AROSE FROM THE FACT THAT


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TO THE EXTENT IT CONFINED FINANCIAL MANAGEMENT TO

ISSUES INVOLVED IN PROCUREMENT OF EXTERNAL FUNDS, IT DID

NOT CONSIDER THE IMPORTANT DIMENSION OF ALLOCATION OF

CAPITAL. THE CONCEPTUAL FRAMEWORK OF THE TRADITIONAL

TREATMENT IGNORED WHAT SOLOMON APTLY DESCRIBES AS

THE CENTRAL ISSUES OF FINANCIAL MANAGEMENT.

THESE ARE:

SHOULD AN ENTERPRISE COMMIT CAPITAL FUNDS TO CERTAIN

PURPOSES?

DO THE EXPECTED RETURNS MEET FINANCIAL STANDARDS OF

PERFORMANCE?

HOW SHOULD THESE STANDARDS BE SET AND WHAT IS THE

COST OF CAPITAL FUNDS TO THE ENTERPRISE?

HOW DOES THE COST VARY WITH THE MIXTURE OF FINANCING

METHODS USED? IN THE ABSENCE OF THE COVERAGE OF THESE

CRUCIAL ASPECTS, THE TRADITIONAL APPROACH IMPLIED A

VERY NARROW SCOPE FOR FINANCIAL MANAGEMENT. THE

MODERN APPROACH PROVIDES A SOLUTION TO THESE

SHORTCOMINGS.


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MODERN APPROACH

THE MODERN APPROACH VIEWS THE TERM FINANCIAL

MANAGEMENT IN A BROAD SENSE AND PROVIDES A

CONCEPTUAL AND ANALYTICAL FRAMEWORK FOR FINANCIAL

DECISION-MAKING. ACCORDING TO IT, THE FINANCE FUNCTION

COVERS BOTH ACQUISITION OF FUNDS AS WELL AS THEIR

ALLOCATION. THUS, APART FROM THE ISSUES INVOLVED IN

ACQUIRING EXTERNAL FUNDS, THE MAIN CONCERN OF

FINANCIAL MANAGEMENT IS THE EFFICIENT AND WISE

ALLOCATION OF FUNDS TO VARIOUS USES. DEFINED IN A BROAD

SENSE, IT IS VIEWED AS AN INTEGRAL PART OF OVER-ALL

MANAGEMENT.

THE NEW APPROACH IS AN ANALYTICAL WAY OF VIEWING THE

FINANCIAL PROBLEMS OF A FIRM.

THE MAIN CONTENTS OF THIS APPROACH ARE:

WHAT IS THE TOTAL VOLUME OF FUNDS AN ENTERPRISE SHOULD

COMMIT?

WHAT SPECIFIC ASSETS SHOULD AN ENTERPRISE ACQUIRE?

HOW SHOULD THE FUNDS REQUIRED, BE FINANCED?

ALTERNATIVELY, THE PRINCIPAL CONTENTS OF THE MODERN

APPROACH TO FINANCIAL MANAGEMENT CAN BE SAID TO BE:


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1. HOW LARGE SHOULD AN ENTERPRISE BE AND HOW FAST

SHOULD IT GROW?

2. IN WHAT FORM SHOULD IT HOLD ASSETS?

3. WHAT SHOULD BE THE COMPOSITION OF ITS LIABILITIES?

THE THREE QUESTIONS POSED ABOVE COVER BETWEEN THEM

THE MAJOR FINANCIAL PROBLEMS OF A FIRM. IN OTHER WORDS,

FINANCIAL MANAGEMENT, ACCORDING TO THE NEW APPROACH,

IS CONCERNED WITH THE SOLUTION OF THREE MAJOR

PROBLEMS RELATING TO THE FINANCIAL OPERATIONS OF A FIRM,

CORRESPONDING TO THE THREE QUESTIONS, NAMELY,

INVESTMENT, FINANCING AND DIVIDEND DECISIONS. THUS,

FINANCIAL MANGEMENT, IN THE MODERN SENSE OF THE TERM,

CAN BE BROKEN DOWN INTO THREE MAJOR DECISIONS AS

FUNCTIONS OF FINANCE. THEY ARE: -

1. THE INVESTMENT DECISION,

2. THE FINANCING DECISION, AND

3. THE DIVIDEND POLICY DECISION.

WE BRIEFLY OUTLINE THE MAIN COMPONENTS OF THESE IN THE

FOLLOWING DISCUSSION.


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FUNCTIONS OF FINANCE

INVESTMENT DECISION

THE INVESTMENT DECISION RELATES TO THE SELECTION OF

ASSETS IN WHICH FUNDS WILL BE INVESTED BY A FIRM. THE

ASSETS WHICH CAN BE ACQUIRED FALL INTO TWO BROAD

GROUPS :-

1. LONG TERM ASSETS WHICH WILL YIELD A RETURN OVER A

PERIOD OF TIME IN FUTURE

2. SHORT TERM OR CURRENT ASSETS DEFINED AS THOSE

ASSETS WHICH IN THE NORMAL COURSE OF BUSINESS ARE

CONVERTIBLE INTO CASH USUALLY WITHIN A YEAR.

ACCORDINGLY, THE ASSET SELECTION DECISION OF A FIRM IS OF

TWO TYPES. THE FIRST OF THESE INVOLVING THE FIRST

CATEGORY OF ASSETS IS POPULARLY KNOWN IN THE FINANCIAL

LITERATURE AS CAPITAL BUDGETING. THE ASPECT OF FINANCIAL

DECISION-MAKING WITH REFERENCE TO CURRENT ASSETS OR

SHORT TERM ASSETS IS POPULARLY DESIGNATED AS WORKING

CAPITAL MANAGEMENT.

CAPITAL BUDGETING


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CAPITAL BUDGETING-THE LONG TERM INVESTMENT DECISION IS

PROBABLY THE MOST CRUCIAL FINANCIAL DECISION OF A FIRM.

IT RELATES TO THE SELECTION OF AN ASSET OR INVESTMENT

PROPOSAL OR COURSE OF ACTION WHOSE BENEFITS ARE LIKELY

TO BE AVAILABLE IN FUTURE OVER THE LIFE TIME OF THE

PROJECT. THE LONG TERM ASSETS CAN BE EITHER NEW OR

OLD / EXISTING ONES. THE FIRST ASPECT OF THE CAPITAL

BUDGETING DECISION RELATES TO THE CHOICE OF THE NEW

ASSET OUT OF THE ALTERNATIVES AVAILABLE OR THE RE-

ALLOCATION OF CAPITAL WHEN AN EXISTING ASSET FAILS TO

JUSTIFY THE FUNDS COMMITTED. WHETHER AN ASSET WILL BE

ACCEPTED OR NOT WILL DEPEND UPON THE RELATIVE BENEFITS

AND RETURNS ASSOCIATED WITH IT. THE MEASUREMENT OF THE

WORTH OF THE INVESTMENT PROPOSALS IS, THEREFORE, A

MAJOR ELEMENT IN THE CAPITAL BUDGETING EXERCISE. THIS

IMPLIES A DISCUSSION OF THE METHODS OF APPRAISING

INVESTMENT PROPOSALS.

THE SECOND ELEMENT OF THE CAPITAL BUDGETING DECISION IS

THE ANALYSIS OF RISK AND UNCERTAINTY. SINCE THE BENEFITS

FROM THE INVESTMENT PROPOSALS EXTEND INTO THE FUTURE,

THEIR ACCRUAL IS UNCERTAIN. THEY HAVE TO BE ESTIMATED


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UNDER VARIOUS ASSUMPTIONS OF THE PHYSICAL VOLUME OF

SALE AND THE LEVEL OF PRICES. AN ELEMENT OF RISK IN THE

SENSE OF UNCERTINITY OF FUTURE BENEFITS IS, THUS,

INVOLVED IN THE EXERCISE. THE RETURN FROM THE CAPITAL

BUDGETING DECISION SHOULD, THEREFORE, BE EVALUATED IN

RELATION TO THE RISK ASSOCIATED WITH IT.

FINALLY, THE EVALUATION OF THE WORTH OF A LONG-TERM

PROJECT IMPLIES A CERTAIN NORM OR STANDARD AGAINST

WHICH THE BENEFITS ARE TO BE JUDGED. THE REQUISITE NORM

IS KNOWN BY DIFFERENT NAMES SUCH AS CUT-OFF RATE,

HURDLE RATE, REQUIRED RATE, AND MINIMUM RATE OF RETURN

AND SO ON. THIS STANDARD IS BROADLY EXPRESSED IN TERMS

OF THE COST OF CAPITAL. THE CONCEPT AND MEASUREMENT OF

THE COST OF CAPITAL IS, THUS, ANOTHER MAJOR ASPECT OF

THE CAPITAL BUDGETING DECISION. IN BRIEF, THE MAIN

ELEMENTS OF THE CAPITAL BUDGETING DECISIONS ARE: -

1. THE TOTAL ASSETS AND THEIR COMPOSITION

2. THE BUSINESS RISK COMPLEXION OF THE FIRM, AND

3. CONCEPT AND MEASUREMENT OF THE COST OF CAPITAL

CAPITAL BUDGETING IS A COMPLEX PROCESS WHICH MAY BE

DIVIDED INTO FIVE BROAD PHASES:


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i. PLANNING: THE PLANNING PHASE IS CONCERNED WITH THE

ARTICULATION OF ITS BROAD INVESTMENT STRATEGY AND

THE GENERATION AND PRELIMINARY SCREENING OF PROJECT

PROPOSALS. THE INVESTMENT STRATEGY OF THE FIRM

DELINEATES THE BROAD AREAS OR TYPES OF INVESTMENTS

THE FIRM PLANS TO UNDERTAKE.

ii. ANALYSIS: THE FOCUS IS ON GATHERING, PREPARING, AND

SUMMARISING RELEVANT INFORMATION ABOUT VARIOUS

PROPOSALS WHICH ARE BEING CONSIDERED. BASED ON THE

INFORMATION DEVELOPED IN THIS ANALYSIS, THE STREAM OF

COST & BENEFITS ASSOCIATED WITH THE PROJECT CAN BE

DEFINED.

iii. SELECTION: THE PROJECTS ARE SELECTED ON SOME

SUITABLE BASIS FOR THEIR WORTHINES LIKE PAYBACK

PERIOD, ARR, NPV, IRR, BCR ETC. IN ORDER TO APPLY THE

APPRISAL CRITERIA CUT OFF VALUES ARE TO BE SPECIFIED,

LIKE (HURDLE RATE, TARGET RATE AND COST OF CAPITAL).

iv. IMPLEMENTATION: IT PASSES THROUGH SEVERAL STAGES,

NAMELY- PROJECT & ENGINEERING & DESIGNS, NEGOTIATION

& CONTRACTING, CONSTRUCTION, TRAINING, AND

COMMISSIONING.


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v. REWIEW: THIS PHASE SETS INTO MOTION AFTER THE

COMMISSIONING IS OVER. IT IS USEFUL IN THE FOLLOWING

WAYS,

IT THROWS LIGHT ON HOW REALISTIC WERE THE

ASSUMPTIONS UNDERLYING THE PROJECT,

IT PROVIDES A DOCUMENTED LOG OF EXPERIENCE

THAT IS HIGHLY VALUABLE IN FUTURE DECISION MAKING,

IT SUGGESTS CORRECTIVE ACTION TO BE TAKEN IN

THE LIGHT OF ACTUAL PERFORMANCE,

IT HELPS IN UNCOVERING JUDGEMENTAL BIASES,

IT INDUCES A DESIRED CAUTION AMONG PROJECT SPONSORS.

WORKING CAPTIAL MANAGEMENT

WORKING CAPITAL MANAGEMENT IS CONCERNED WITH THE

MANAGEMENT OF THE CURRENT ASSETS. IT IS AN IMPORTANT

AND INTEGRAL PART OF FINANCIAL MANAGEMENT AS SHORT

TERM SURVIVAL IS A PRE-REQUISITE TO LONG TERM SUCCESS.

ONE ASPECT OF THE WORKING CAPITAL MANAGEMENT IS THE

TRADE OFF BETWEEN PROFITABILITY AND RISK (LIQUIDITY) .

THERE IS A CONFLICT BETWEEN PROFITABILITY AND LIQUIDITY. IF

A FIRM DOES NOT HAVE ADEQUATE WORKING CAPITAL I.E. IT

DOES NOT INVEST SUFFICIENT FUNDS IN CURRENT ASSETS, IT


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MAY BECOME ILLIQUID AND CONSEQUENTLY MAY NOT HAVE THE

ABILITY TO MEET ITS CURRENT OBLIGATIONS AND THUS INVITE

THE RISK OF BANKRUPTCY. THE CURRENT ASSETS ARE TOO

LARGE, THE PROFITABILITY IS ADVERSELY AFFECTED. THE KEY

STRATEGIES AND CONSIDERATIONS IN ENSURING A TRADE-OFF

BETWEEN PROFITABILITY AND LIQUIDITY IS ONE MAJOR

DIMENSION OF WORKING CAPITAL MANAGEMENT. IN ADDITION,

THE INDIVIDUAL CURRENT ASSETS SHOULD BE EFFICIENTLY

MANAGED SO THAT NEITHER INADEQUATE NOR UNNECESSARY

FUNDS ARE LOCKED UP. TO SUMMARISE, THE MANAGEMENT OF

WORKING CAPITAL HAS TWO BASIC INGREDIENTS, NAMELY,

1. AN OVERVIEW OF WORKING CAPITAL MANAGEMENT AS A

WHOLE, AND

2. EFFICIENT MANAGEMENT OF THE INDIVIDUAL CURRENT

ASSETS SUCH AS CASH, RECEIVABLES AND INVENTORY.

FINANCING DECISION

THE SECOND MAJOR DECISION INVOLVED IN FINANCIAL

MANAGEMENT IS THE FINANCING DECISION. THE INVESTMENT

DECISION IS BROADLY CONCERNED WITH THE ASSET MIX OR THE

COMPOSITION OF THE ASSETS OF THE FIRM. THE CONCERN OF

THE FINANCING DECISION IS WITH THE FINANCING MIX OR


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CAPITAL STRUCTURE OR CAPITAL STRUCTURE OR LEVERAGE.

THE TERM CAPITAL STRUCTURE REFERS TO THE PROPORTION

OF DEBT AND EQUITY CAPITAL. THE FINANCING DECISION OF A

FIRM RELATES TO THE CHOICE OF THE PROPORTION OF THESE

SOURSES OF FINANCE THE INVESTMENT REQUIREMENTS. THESE

ARE TWO ASPECTS OF THE FINANCING DECISION.FIRST, THE

THEORY OF CAPITAL STRUCTURE WHICH SHOWS THE

THEORITICAL RELATIONSHIP BETWEEN THE EMPLOYMENT OF

DEBT AND THE RETURN TO THE SHAREHOLDERS AS ALSO THE

FINANCIAL RISK. A PROPER BALANCE BETWEEN DEBT AND

EQUITY TO ENSURE A TRADE-OFF BETWEEN RISK AND RETURN

TO THE SHAREHOLDERS IS NECESSARY. A CAPITAL STRUCTURE

WITH A REASONABLE PROPORTION OF DEBT AND

EQUITY CAPITAL IS CALLED THE OPTIMUM CAPITAL STRUCTURE.

THUS, ONE DEMENSION OF THE FINANCING DECISION IS: IS

THERE AN OPTIMUM CAPITAL STRUCUTE? IN WHAT PROPORTION

SHOULD FUNDS BE RAISED TO MAXIMISE THE RETURN TO THE

SHAREHOLDERS? THE SECOND ASPECT OF THE FINANCING

DECISION IS THE DETERMINATION OF AN APPROPRIATE CAPITAL

STRUCTURE, GIVEN THE FACTS OF A PARTICULAR CASE. THUS,


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THE FINANCING DECISION COVERS TWO INTER-RELATED

ASPECTS :

a) CAPITAL STRUCTURE THEORY, AND

b) CAPITAL STRUCTUE DECISION

DIVIDEND POLICY DECISION

THE THIRD MAJOR DECISION OF FINANCIAL MANAGEMENT IS THE

DECISION RELATING TO THE DIVIDEND POLICY. THE DIVIDEND

DECISION SHOULD BE ANALYSED IN THE RELATION TO THE

FINANCING DECISION OF A FIRM. TWO ALTERNATIVES ARE

AVAILABLE IN DEALING WITH THE PROFITS OF THE FIRM:THEY

CAN BE DISTRIBUTED TO THE SHAREHOLDERS IN THE FORM OF

DIVIDENDS OR THEY CAN BE RETAINED IN THE BUSINESS. ONE

SIGNIFICANT ELEMENT IN THE DIVIDEND DECISION IS,

THEREFORE, THE DIVIDEND PAY OUT RATIO, I.E WHAT

PROPORTION OF NET PROFITS SHOULD BE PAID OUT TO THE

SHAREHOLDERS. THE DECISION WILL DEPEND UPON THE

PREFERENCE OF THE SHAREHOLDERS AND INVESTMENT

OPPORTUNITIES AVAILABLE WITH IN THE FIRM. THE SECOND

MAJOR ASPECT OF THE DIVIDEND DECISION IS THE FACTORS

DETERMINING DIVIDEND POLICYOF A FIRM IN PRACTICE.


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TO SUMMARISE THE DISCUSSION OF THE SCOPE, FUNCTIONS

AND COVERAGE OF FINANCIAL MANAGEMENT, THE TRADITIONAL

APPROACH HAD A VERY NARROW PERCEPTION AND WAS DEVOID

OF AN INTEGRATED CONCEPTUAL AND ANALYTICAL

FRAMEWORK. IT HAS RIGHTLY BEEN DISCARDED IN THE

CURRENT ACADEMIC LITERATURE. THE MODERN APPROACH HAS

BROADENED THE SCOPE OF FINANCIAL MANAGEMENT WHICH

INVOLVES THE SOLUTION OF THREE MAJOR DECISIONS, NAMELY,

INVESTMENT, FINANCING AND DIVIDEND. THESE ARE INTER-

RELATED AND SHOULD BE JOINTLY TAKEN SO THAT FINANCIAL

DECISION MAKING IS OPTIMAL. THE CONCEPTUAL FRAMEWORK

FOR OPTIMUM FINANCIAL DECISIONS IS THE OBJECTIVE OF

FINANCIAL MANAGEMENT. IN OTHER WORDS, TO ENSURE

OPTIMUM DECISION IN RESPECT OF THESE THREE AREAS THEY

SHOULD BE RELATED TO THE OBJECTIVES OF FINANCIAL

MANAGEMENT WHICH ARE ELABORATED IN THE SUBSEQUENT

DISCUSSION.

OBJECTIVES OF FINANCIAL MANAGEMENT

THE PRECEDING DISCUSSIONS HAVE SHOWN THAT FINANCIAL

MANAGEMENT, AS AN ACADEMIC DISCIPLINE, IS CONCERNED

WITH DECISION-MAKING IN REGARD TO THE SIZE AND


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COMPOSITION OF ASSETS AND THE LEVEL AND STRUCTURE OF

FINANCI NG. TO MAKE WISE DECISIONS A CLEAR

UNDERSTANDING OF THE OBJECTIVES WHICH ARE SOUGHT TO

BE ACHIEVED IS NECESSARY. THE OBJECTIVE PROVIDES A

FRAMEWORK FOR OPTIMUM FINANCIAL DECISION-MAKING. IN

OTHER WORDS, THEY ARE CONCERNED WITH DESIGNING A

METHOD OF OPERATING THE INTERNAL INVESTMENT AND

FINANCING OF A FIRM. WE DISCUSS IN THIS SECTION THE

ALTERNATIVE APPROACHES IN THE FINANCIAL LITERATURE.

THERE ARE TWO WIDELY-DISCUSSED APPROACHES :-

1. PROFIT MAXIMISATION APPROACH, AND

2. WEALTH MAXIMISATION APPROACH.

IT SHOULD BE AT THE OUTSET NOTED THAT THE TERM

OBJECTIVE IS USED IN THE SENSE OF A GOAL OR DECISION

CRITERION FOR THE THREE DECISIONS INVOLVED IN FINANCIAL

MANAGEMENT. IT IMPLIES THAT WHAT IS RELEVANT IS NOT THE

OVER-ALL OBJECTIVE OR GOAL OF A BUSINESS BUT AN

OPERATIONALLY USEFUL CRITERION BY WHICH TO JUDGE A

SPECIFIC SET OF MUTUALLY INTER-RELATED BUSINESS

DECISIONS, NAMELY, INVESTMENT, FINANCING AND DIVIDEND

POLICY. THE SECOND POINT THAT SHOULD BE CLEARLY


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UNDERSTOOD IS THAT THE TERM OBJECTIVE PROVIDES A

NORMATIVE FRAMEWORK. THAT IS, THE FOCUS IN THE FINANCIAL

LITERATURE IS ON WHAT A FIRM SHOULD TRY TO ACHIEVE AND

ON POLICIES THAT SHOULD BE FOLLOWED IF CERTAIN GOALS

ARE TO BE ACHIEVED. THE IMPLICATION IS THAT THESE ARE NOT

NECESSARILY FOLLOWED BY FIRMS IN ACTUAL PRACTICE.

RATHER THEY ARE INTENDED TO SERVE AS A BASIS FOR

THEORETICAL ANALYSIS AND DO NOT REFLECT COMTEMPORARY

EMPIRICAL INDUSTRY PRACTICES. THUS, THE TERM IS USED IN A

RATHER NARROW SENSE OF WHAT A FIRM SHOULD ATTEMPT TO

ACHIEVE WITH ITS INVESTMENT, FINANCING AND DIVIDEND

POLICY DECISION.


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BACKGROUND & ASPECT OF THE PROBLEMS

FINANCING OF INFRASTRUCTURE

INFRASTRUCTURE IN A COUNTRY MEANS THE EDIFICE ON WHICH

THE FOUNDATION OF THE CIVILIZATION OF THE COUNTRY

MOSTLY DEPENDS, IT GENERALLY INCLUDES THE FOLLOWING:-

(a)PUBLIC WORKS LIKE ROADS, DAMS, IRRIGATION AND

DRAINAGE SYSTEMS;

(b)TRANSPORT SYSTEMS LIKE RAILWAYS, AIRPORTS, URBAN

TRANSPORTS, PORTS ETC.;

(c)OTHER PUBLIC UTILITIES WHICH INCLUDE POWER,

TELECOMMUNICATION, WATER SUPPLY, SANITATION AND

SEWERAGE, OIL & GAS FACILITIES.

FROM THE FIRST FIVE YEAR PLAN ITSELF GOVERNMENT TOOK

OVER THE RESPONSIBILITY OF FOUNDING THE ABOVE FACILITIES

VIA DIFFERENT ANNUAL BUDGETS. IT IS ONLY AFTER THE

PROCESS OF LIBERALISATION STARTED IN 1991 THAT THE

DISCUSSION ON FUNDING ABILITY/ADEQUACY / FEASIBILITY ON

THE PART OF THE GOVERNMENT HAVE STARTED.

THOUGH LATE, GOVERNMENT HAS UNDERSTOOD CLEARLY THAT

FIRSTLY, IT MAY NOT BE POSSIBLE ON ITS PART TO SHOULDER

THE WHOLE RESPONSIBILITY OF FINANCING THE


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INFRASTRUCTURE ANY MORE AND SECONDLY, THE PACE WITH

WHICH SUCH DIFFERENT PROJECTS AND INFRASTRUCTURAL

DEVELOPMENTS ARE GOING ON, THE RAPID INDUSTRIAL

DEVELOPMENT PROCESS IS BOUND TO SUFFER. ACCORDINGLY,

THE GOVERNMENT HAS OPENED THESE INFRASTRUCTURAL

AREAS FOR INVESTMENT BY PRIVATE SECTOR BY DRASTICALLY

CHANGING THE INDUSTRIAL POLICIES FROM TIME TO TIME WHICH

WERE SO LONG KEPT STRICTLY UNDER ITS OWN DOMAIN.

THE QUANTUM OF FUNDS REQUIRED IN DEVELOPMENT OF

INFRASTRUCTURE FOR RAPID INDUSTRIALISATION KNOWN, IT

WILL BE APPARENT AS TO WHY GOVERNMENT IS SO KEEN IN OFF

LOADING ITS RESPONSIBILITY TO THE PRIVATE INDUSTRIALISTS.

IN POWER GENERATION ALONE, THE COUNTRY NEEDS RS.30,000

CRORES EVERY YEARS AND IF WE ADD TRANSMISSION AND

DISTRIBUTION SYSTEMS TO IT THAT WILL NEED ANOTHER

RS.60,000 CRORES. ADDED TO IT, THE REQUIREMENTS OF

ROADS, TELECOM SECTOR, DAMS, IRRIGATION, PORTS,

RAILWAYS, AIRPORTS, URBAN TRANSPORT, WATER SUPPLY ETC.

THE QUANTUM OF INVESTMENT REQUIRED WILL BE

PHENOMENAL. THUS, BETTER LATE THAN NEVER APPROACH BY


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GOVERNMENT HAS BEEN WELCOMED BY ALL CONCERNED.

OBVIOUSLY, IT WILL NOT ONLY SHIFT FROM GOVERNMENT THE

CAUSE FOR CONCERN OF AVAILABILITY OF FUNDS BUT IT WILL

ALSO ENSURE COMPLETION OF NUMBER OF INFRASTRUCTURAL

PROJECTS EITHER WITHOUT ANY COST OF TIME OVERRUN OR

WITH MINIMUM OF BOTH IF AT ALL.

THE PRIVATE INVESTOR IN INFRASTRUCTURE GENERALLY TAKE

INTO ACCOUNT THE FOLLOWING RISKS AND IS AWARE THAT THE

ALLOCATION OF RISK IS VITAL FOR THE SUCCESS OF SUCH

PROJECTS. THE RISKS CAN BE GROUPED AS:-

(a) POLITICAL RISKS LEADING TO THE NEGATIVE DEVELOPMENT

IN GOVT. POLICIES AND CHANGE OF OUTLOOK OF THE NEW

GOVT. TOWARDS THE PROJECT. THE CASE OF RECENT

DEVELOPMENT OF THE CHANGE OF ATTITUDE OF THE GOVT.

IN MAHARASHTRA TOWARDS DABHOL PROJECT CAN BE CITED

AS AN EXAMPLE AND IS KNOWN TO ALL AND SUNDRY. THUS,

THE PRIVATE INVESTOR WILL TRY TO GUARD AGAINST SUCH

RISKS BY ALLOCATING THE RISKS TO INSURANCE COMPANY

WHO GENERALLY COVER SUCH INTERNATIONAL POLITICAL

RISKS.


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(b) THERE ARE ALSO RISKS RELATING TO OPERATIONS. THESE

RELATE TO RISKS OF OVERRUN OF COST OF PRODUCTION ON

COMPLETION OF THE PROJECT.

(c) SIMILARLY, THERE MAY BE RISKS WHILE COMPLETING THE

PROJECT. SUCH RISKS RELATE TO TIME AND COST OVERRUN

DURING PROJECT EXECUTION. SUCH RISKS ARE VERY

COMMON AND MAY BE DUE TO EXTERNAL AND INTERNAL

PARAMETERS ARISING DURING THE CONTINUATION OF THE

PROJECT.

(d) THERE MAY BE RISKS RELATING TO FLUCTUATIONS IN THE

INTEREST RATES. SUCH CASES MAY HAPPEN WHERE THERE

IS AN OPEN ECONOMY WHERE INTEREST RATES ARE

ALLOWED TO PLAY THEIR ROLE AND EXPECTED TO GET

STABILISED DURING THE COURTS OF TIME BY INTERACTION

OF MARKET FORCES.

(e) THERE MAY ALSO BE RISKS ARISING OUT OF CHANGE IN

DEMAND OF THE SERVICES/COMMODITY DURING THE YEARS

TO COME. THE BASIS OF DEMAND ON WHICH THE EDIFICE OF

THE PROJECT DEPENDS MAY COMPLETELY ALTER BECAUSE

OF THE UNCERTAINTY IN THE PROJECTED DEMAND FOR THE

CONCERNED SERVICE.


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IT IS FOR THE AFORESAID RISKS THAT DIFFERENT MECHANISMS

HAVE BEEN DEVISED BY PRIVATE SECTOR WHILE PARTICIPATING

IN INFRASTRUCTURE PROJECT. THEY ARE OUTLINED IN THE

FOLLOWING PARAGRAPHS:-

1. BOLT (BUILD, OPERATE, LEASE, TRANSFER)

IN THIS CASE, THE PRIVATE PARTICIPANTS BUILD AND RUN

THE FACILITY AND THE SAME IS SUBSEQUENTLY HANDED

OVER TO GOVERNMENT ON THE BASIS OF LEASE AGREEMENT.

THIS IS DONE AT THE END OF THE CONCESSIONAL PERIOD

WHICH IS MORE OR LESS PREFIXED DEPENDING ON THE

NATURE OF THE INFRASTRUCTURAL PROJECT. ON

COMPLETION OF SUCH PERIOD, THE CONCERNED ASSET

CREATED OUT OF COMPLETION OF THE PROJECT IS HANDED

OVER TO THE GOVERNMENT. HERE THE CONCERNED PRIVATE

COMPANY/INVESTOR SUBSEQUENTLY GETS THE LEASE

RENTAL FROM THE GOVERNMENT WHICH HELPS IT TO GET A

STEADY CASH FLOW. BUT THE PROBLEM IN SUCH CASES IS

THAT AS THINGS STAND TODAY THE LEASE RENTAL PAYMENT

ON THE PART OF THE GOVERNMENT ARE VERY UNSTEADY

AND THIS INTERRUPTS THE CASH FLOW OF THE CONCERNED

INVESTOR.


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2. BOT (BUILD, OPERATE, TRANSFER)

THE PRIVATE INVESTOR IN THIS CASE EXECUTES THE

PROJECT, RUNS IT AND THEN TRANSFER THE FACILITY AT THE

END OF THE CONCESSIONAL PERIOD TO THE GOVERNMENT.

IN SUCH CASE, THE RISKS ARE SHARED BY ALL THE

CONCERNED PARTICIPANTS INCLUDING THE GOVERNMENT.

WHILE THE RISK IS RESTRICTED TO ALL PARTIES

PROPORTIONATELY, THE GREY ASPECT OF THIS METHOD IS

THE ENERGY AND COST INVOLVED IN NEGOTIATING THE

ARRANGEMENT MUTUALLY BETWEEN THE PARTIES, THE

SEQUENCE OF THE CLAIMS ON THE CONCERNED ASSETS AND

COMPLEXITIES OF THE TOTAL DEAL ULTIMATELY MAY

FRUSTRATE THE PARTICIPANT IN CERTAIN CASES. HOWEVER,

THIS METHOD GUARDS AGAINST THE LIKELY RISK IN SUCH

MAJOR PROJECTS.

3. BOOT (BUILD, OWN, OPERATE, TRANSFER)

THE CONCERNED PARTICIPANT OF THE PRIVATE SECTOR ON

COMPLETION OF THE PROJECT OWNS AND OPERATES THE

ASSETS FOR A DEFINED PERIOD WHEN IT IS HANDED OVER TO

THE GOVERNMENT. BUT THE PERIODS UPTO WHICH IT


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OPERATES ARE GENERALLY VERY HIGH AND MAY EXTEND

SOMETIME AS HIGH AS 40 YEARS ONWARDS. OBVIOUSLY, THIS

DEPENDS ON THE RELATIVE PAY BACK TIME AND THE RATE OF

RETURN THAT MAY ARISE OUT OF THE INVESTMENT.

4. BOO (BUILD, OWN, OPERATE)

IN SUCH CASE, THE CONCERNED PRIVATE

COMPANIES/INVESTORS EXECUTE THE PROJECT, OWN IT AND

OPERATE THE INFRASTRUCTURAL ASSETS FOR THE WHOLE

LIFE. SINCE IN SUCH CASES THE INVESTORS ARE THE SOLE

HOLDERS AND OPERATORS OF THE ASSETS, NO HASSLES OF

NEGOTIATIONS AND AGREEMENTS COME IN THE WAY.

OBVIOUSLY, THE INVESTOR CAN ARRANGE LOAN BY

HYPOTHECATING THE ASSETS TO THE FINANCIAL

INSTITUTIONS/BANKERS. THE PROBLEM IN THIS METHOD IS

THAT ALL THE RISKS ARISING OUT OF THE PROJECTS ARE

BEING SHOULDERED BY THE INVESTOR HIMSELF AND

POLITICALLY IT IS MOST RISK ORIENTED.

AMONG THE INFRASTRUCTURE PROJECTS, PROBABLY POWER

SECTOR GOT THE GOVERNMENTAL NOD OF PRIVATE

INVESTMENT EARLIER THAN OTHER SECTORS. ACTUALLY, A

LOT OF HEADWAY HAS BEEN MADE BY DIFFERENT PRIVATE


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COMPANIES IN POWER SECTOR THAN OTHER SECTORS. IN A

UMBER OF SECTORS LIKE HIGH-WAYS, DAM, BRIDGE ETC.

STILL POLICY FORMULATION ON PRIVATE SECTOR

INVESTMENT IS ON THE WAY. ACCORDINGLY, THE REST OF

THE DISCUSSION MOSTLY ON POWER SECTOR EXPERIENCE IN

THE NEXT FEW PARAS.

INVESTMENT IN POWER PROJECTS:-

THOUGH A NUMBER OF MOUS HAVE BEEN SIGNED, TILL DATE IN

INDIA FOLLOWING FAST TRACK POWER PROJECTS HAVE BEEN

CONTEMPLATED AND IN SOME CASES CERTAIN PROGRESS IN

THE PROJECTS HAVE ALSO BEEN MADE. HOWEVER, BECAUSE OF

ENRON CONTROVERSY MOST POWER PROJECTS ARE GOING

THROUGH FURTHER NEGOTIATIONS IN CAPITAL COST AND RATE

OF PURCHASE OF POWER PER UNIT.

THE GOVERNMENT OF INDIA HAS DEVISED AND IMPLEMENTED

POWER POLICIES WHICH ARE CONDUCIVE TO PRIVATE SECTOR

INVESTMENT IN THE POWER PROJECTS. THEY ARE OUTLINED

BELOW:-

1. COMPANIES WHICH WILL COME FOR POWER GENERATION AND

DISTRIBUTION FOR THE FIRST TIME WILL BE ENTITLED TO FIVE-

YEAR TAX HOLIDAY.


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2. CUSTOM DUTY ON EQUIPMENTS OF POWER WHICH ARE BEING

IMPORTED HAS BEEN REDUCED TO 20 PER CENT.

3. THE ORIGINAL COST OF THE POWER PROJECT WILL BE

ALLOWED TO INCLUDE CAPITALISATION OF INTEREST

CHARGES DURING THE GESTATION PERIOD (MOSTLY

BETWEEN THE PERIOD OF GRANTING OR LICENCE AND

COMMISSIONING OF THE PROJECT). THIS PRINCIPLE IS

APPLICABLE BOTH FOR NEW GENERATION PROJECT AND ALSO

FOR PROJECT OF EXPANSION.

4. THE RATES OF DEPRECIATION OF PLANT AND MACHINERY

HAVE BEEN LIBERALISED TO INCLUDE HIGHER RATES.

5. FOREIGN INVESTORS WILL BE ALLOWED TO REMIT TO

HOMELAND DIVIDENDS AND INTEREST ON THEIR EQUITY AND

LOAN COMPONENTS IN POWER PROJECTS.

6. A MINIMUM RATE OF RETURN OF 16 PER CENT ON EQUITY

(POST TAX) IS GUARANTEED BASED ON A OPERATING PLAN

LOAD FACTOR (PLF) OF 68.5 PER CENT. BEYOND THIS PLF,

INCREMENTAL RETURN ON EQUITY WILL BE ALLOWED TO

PRIVATE INVESTOR.


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7. WITH THE PERMISSION OF THE CONCERNED STATE

GOVERNMENT, THE PRIVATE DEVELOPER OF POWER CAN

DISPOSE OF POWER TO OTHERS.

8. FOREIGN PRIVATE DEVELOPERS WILL BE ALLOWED TO

PARTICIPATE IN EQUITY OF POWER GENERATING COMPANIES.

THE PRIVATE INVESTORS PREFER BOT(BUILD, OWN AND

TRANSFER) PROJECT. THE MAIN PARTIES INVOLVED IN SUCH

PROJECT ARE THE SPONSOR OF THE PROJECT, THE CONCERNED

BANK/FI/FII, THE CONSTRUCTION/OPERATION/MAINTENANCE

CONTRACTOR AND THE CONCERNED GOVERNMENT (STATE OR

CENTRE) AND THE TASK FORCE, IF ANY, SET UP FOR THE

PROJECT.

THE STRUCTURING OF DEBT AND EQUITY IS A CRUCIAL ASPECT

IN FUNDING OF ANY INFRASTRUCTURE PROJECT. GENERALLY,

SUCH STRUCTURING ROTATES ROUND AS LOW EQUITY AS

POSSIBLE SINCE THE SPONSOR TO THE PROJECT MAY NOT LIKE

OTHER LENDERS TO HAVE RECOURSE TO THE ASSETS OF THE

PROJECT. BESIDES, PUBLIC ISSUE OF SHARES IN AN

INFRASTRUCTURE PROJECT HAVING A GESTATION PERIOD OF 5

YEARS OR MORE MAY NOT EVOKE WARM RESPONSE LIKE THE


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ONE HAVING SHORT GESTATION PERIOD. UNLESS THE TOTAL

ATTITUDE OF THE GENERAL INVESTORS CHANGE OR THERE

EVOLVES SPECIAL TAX CONCESSION FOR INVESTMENT IN PUBLIC

ISSUE IN RESPECT OF PROJECTS WITH LONG GESTATION

PERIOD, THE SITUATION IS LIKELY TO CONTINUE. BESIDES,

GOING BY A DEBT RATIO OF 4:1, IF THE TOTAL REQUIREMENT OF

FUND IN INFRASTRUCTURE PROJECT AS PLANNED INCLUDING

REQUIREMENT OF TELECOMMUNICATION IS RS.5650 BILLION

(CMIF REPORT OF MAY 1995), THE REQUIREMENT OF EQUITY WILL

BE AROUND RS.1400 BILLION WHICH IS LIKELY TO BE ONE-THIRD

OF MARKET CAPITALISATION IN THE MAJOR STOCK MARKETS OF

THE COUNTRY. ACCORDINGLY, ARRANGING SO MUCH FUND

FORM EQUITY WILL BE DIFFICULT. ON THE DEBT FINANCING SIDE,

THE SOURCING OF LEFT OVER AMOUNT OF RS.4250 BILLION WILL

BE MORE DIFFICULT. ON CASE TO CASE BASIS, SOURCING OF

FUND FROM WITHIN THE COUNTRY MAY BE POSSIBLE IN CERTAIN

CASES. BUT LOOKING AT OVERALL SITUATION, IT MAY SOUND

IMPOSSIBLE. THUS, A MIX OF SOURCES BOTH IN AND OUTSIDE

THE COUNTRY IS INEVITABLE. TAPPING DEBIT FROM OVERSEAS

EXPORT CREDIT AGENCIES MAY RESULT IN LOWER RATE OF


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INTEREST IF PUT TO AGAINST A REASONABLY STABLE RATE OF

EXCHANGE OF FOREIGN CURRENCIES.

LOOKING FROM A DIFFERENT ANGLE, THERE ARE TWO POTS OF

HUGE FUND WAITING IN THE WINGS WHICH CANNOT BE RAPPED

FOR LEGISLATIVE RESTRICTIONS. THEY ARE FUNDS FROM LIC &

PFS. IF RESTRICTIONS ARE UNTIED, THEY WILL GO A LONG WAY

IN FILLING UP A MAJOR GAP BETWEEN DEMAND AND SUPPLY OF

FUNDS FROM INFRASTRUCTURE PROJECTS.

RECENTLY, FOR SOLVING THE FUNDING PROBLEM IN SUCH

PROJECT, FOUR TO FIVE INSTITUTIONS BOTH FROM PRIVATE AND

PUBLIC SECTORS HAVE JOINED HANDS. THESE HAVE BEEN SO IN

RECENT POWER PROJECTS, OIL REFINERY PROJECTS AND OIL

PIPELINE PROJECTS AND ROAD PROJECTS. THE REQUIREMENTS

FOR FUND IN INFRASTRUCTURE PROJECTS IS ON THE RISE AT A

STEEP RATE. WITH THE OPENING UP OF MORE AND MORE AREAS

FOR PRIVATE SECTOR INVESTMENT THE GOVERNMENT IS BOUND

TO MAKE A LOT OF LEGISLATIVE AMENDMENTS IN TERMS OF TAX

CONCESSIONS, RELAXATION OF NORMS OF BANK AND FINANCIAL

INSTITUTIONS REGARDING THE QUANTUM OF INVESTMENT IN

ANY SECTOR AND OTHER RELEVANT CHANGES. OTHERWISE IT

WILL BE LIKE PUTTING THE HORSE BEFORE THE CART


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SITUATION AND THE VERY PURPOSE OF LIBERALISATION WILL BE

DEFEATED IN ABSENCE OF FUND.


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PROJECT FINANCING

PROJECT FINANCING REFERS TO THE MEANS OF FINANCE

EMPLOYED FOR MEETING THE COST OF PROJECT. IN THIS

CHAPTER, WE WILL LOOK AT THE MEANS OF FINANCE AVAILABLE

IN INDIA AND THE KEY CONSIDERATIONS RELEVANT IN PLANNING

THE CAPITAL STRUCTURE FOR A NEW PROJECT . THIS APPENDIX

EXAMINES THIS ISSUE IN GREATER DETAIL. IT IS ORGANISED AS

FOLLOWS :

MEANS OF FINANCE

THE LONG-TERM SOURCES OF FINANCE USED FOR MEETING THE

COST OF PROJECT ARE REFERRED TO AS THE MEANS OF

FINANCE . TO MEET THE COST OF PROJECT, THE FOLLOWING

SOURCES OF FINANCE MAY BE AVAILABLE:

1. EQUITY CAPITAL

2. PREFERENCE CAPITAL

3. NON CONVERTIBLE DEBENTURES

4. CONVERTIBLE DEBENTURES

5. RUPEE TERM LOANS

6. FOREIGN CURRENCY TERM LOANS

7. EUROISSUES


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8. DEFERRED CREDIT

9. BILL REDISCOUNTING SCHEME

10. SUPPLIERS LINE OF CREDIT

11. SEED CAPITAL ASSISTANCE

12. GOVERNMENT SUBSIDIES

13. SALES TAX DEFERMENT AND EXEMPTION

14. UNSECURED LOANS AND DEPOSITS

15. LEASE AND HIRE PURCHASE FINANCE

EQUITY CAPITAL

THIS IS THE CONTRIBUTION MADE BY THE OWNERS OF

BUSINESS , THE EQUITY SHAREHOLDERS, WHO ENJOY THE

REWARDS AND BEAR THE RISKS OF OWNERSHIP. HOWEVER,

THEIR LIABILITY IS LIMITED TO THEIR CAPITAL CONTRIBUTION.

FROM THE POINT OF VIEW OF THE ISSUING FIRM, EQUITY

CAPITAL OFFERS TWO IMPORTANT ADVANTAGES (I) IT

REPRESENTS PERMANENT CAPITAL. HENCE THERE IS NO

LIABILITY FOR REPAYMENT (II) IT DOES NOT INVOLVE ANY FIXED

OBLIGATION FOR PAYMENT OF DIVIDENDS. THE DISADVANTAGES

OF RAISING FUNDS BY WAY OF EQUITY CAPITAL ARE (I) THE COST

OF EQUITY CAPITAL IS HIGH BECAUSE EQUITY DIVIDENDS ARE


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NOT TAX-DEDUCTIBLE EXPENSES. (II) THE COST OF ISSUING

EQUITY CAPITAL IS HIGH.

PREFERENCE CAPITAL

A HYBRID FORM OF FINANCING , PREFERENCE CAPITAL

PARTAKES SOME CHARACTERISTICS OF EQUITY CAPITAL AND

SOME ATTRIBUTES OF DEBT CAPITAL. IT IS SIMILAR TO EQUITY

CAPITAL BECAUSE PREFERENCE DIVIDEND, LIKE EQUITY

DIVIDEND, IS NOT A TAX-DEDUCTIBLE PAYMENT. IT RESEMBLES

BEBT CAPITAL BECAUSE THE RATE OF PREFERENCE FIVIDEND IS

FIXED. TYPICALLY , WHEN PREFERENCE DIVIDENED IS SKIPPED IT

IS PAYABLE IN FUTURE BECAUSE OF THE CUMULATIVE FEATURE

ASSOCIATED WITH IT THE NEAR FIXITY OF PREFERENCE

FIVIDEND PAYMENT RENDERS PREFERENCE CAPITAL SOMEWHAT

UNATTRACTIVE IN GENERAL AS A SOURCE OF FINANCE. IT IS ,

HOWEVER , ATTRACTIVE WHEN THE PROMOTERS DO NOT WANT

A REDUCTION IN THEIR SHARE OF EQUITY AND YET THERE IS

NEED FOR WIDENING THE NET WORTH BASE (NET WORTH

CONSISTS OF EQUITY AND PREFERENCE CAPITAL) TO SATISFY

THE REQUIREMENTS OF FINANCIAL INSTITUTIONS. IN ADDITION

TO THE CONVENTIONAL PREFERENCE SHARES, A COMPANY MAY

ISSUE CUMULATIVE CONVERTIBLE PREFERENCE SHARES


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(CCPS).THESE SHARES CARRY A DIVIDEND RATE OF 10 PER CENT

(WHICH , IF UNPAID, CUMULATES) AND ARE COMPULSORILY

CONVERTIBLE INTO EQUITY SHARES BETWEEN THREE AND FIVE

YEARS FROM THE DATE OF ISSUE.

DEBENTURE CAPITAL

IN THE LAST FEW YEARS, DEBENTURE CAPITAL HAS EMERGED AS

AN IMPORTANT SOURCE FOR PROJECT FINANCING . THERE ARE

THREE TYPES OF DEBENTURES THAT ARE COMMONLY USED IN

INDIA: NON CONVERTIBLE DEBENTURES (NCDS), PARTIALLY

CONVERTIBLE DEBENTURES(PCDS), AND FULLY CONVETIBLE

DEBENTURES (FCDS).AKIN TO PROMISSORY, NCDS ARE USED BY

COMPANIES FOR RAISING DEBT THAT IS GENERALLY RETIRED

OVER A PERIOD OF 5 TO 10 YEARS. THEY ARE SECURED BY A

CHARGE ON THE ASSETS OF THE ISSUING COMPANY. PCDS ARE

PARTLY CONVERTIBLE INTO EQUITY SHARES AS PER PRE

DETERMINED TERMS OF CONVERSION . THE UNCONVERTED

PORTION OF PCDS REMAINS LIKE NCD. FCDS, AS THE NAME

IMPLIES , ARE CONVERTED WHOLLY INTO EQUITY SHARES AS

PER PRE DETERMINED TERMS OF CONVERSION. HENCE FCDS

MAY BE REGARDED AS DELAYED EQUITY INSTRUMENTS.

RUPEE TERM LOAN


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PROVIDED BY FINANCIAL INSTITUTIONS ASN COMMERCIAL

BANKS, RUPEE TERM LOANS WHICH REPRESENT SECURED

BORROWINGS ARE A VERY IMPORTANT SOURCE FOR FINANCING

NEW PROJECTS AS WELL AS EXPANSION, MODERNISATION , AND

RENOVATION SCHEMES OF EXISTING UNITS. THESE LOANS ARE

GENERALLY REPAYABLE OVER A PERIOD OF 8-10 YEARS WHICH

INCLUDES A MORATORIUM PERIOD OF 1-3 YEARS.

FOREIGN CURRENCY TERMS LOANS

FINANCIAL INSTITUTIONS PROVIDE FOREIGN CURRENCY TERM

LOANS FOR MEETING THE FOREIGN CURRENCY EXPENDITURES

TOWARDS IMPORT OF PLANT , MACHINERY, AND EQUIPMENT AND

ALSO TOWARDS PAYMENT OF FOREIGN TECHNICAL KNOW HOW

FEES. UNDER THE GENERAL SCHEME, THE PERIODICAL LIABILITY

TOWARDS INTEREST AND PRINCIPAL REMAINS IN THE CURRENCY

/ CURRENCIES OF THE LOAN/S AND IS TRANSLATED INTO RUPEES

AT THE THEN PREVAILING RATE OF EXCHANGE FOR MAKING

PAYMENTS TO THE FINANCIAL INSTITUTION . APART FROM

APPROACHING FINANCIAL INSTITUTIONS (WHICH TYPICALLY

SERVE AS INTERMEDIARIES BETWEEN FOREIGN AGENCIES AND

INDIAN BORROWERS), COMPANIES CAN DIRECTLY OBTAIN

FOREIGN CURRENCY LOANS FROM INTERNATIONAL LENDERS.


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MORE AND MORE COMPANIES APPEAR TO BE DOING SO

PRESENTLY.

EUROISSUES

BEGINNING WITH RELIANCE INDUSTRIESGLOBAL DEPOSITORY

RECEIPTS ISSUE OF APPROXIMATELY $150ML IN MAY 1992, A

NUMBER OF COMPANIES HAVE BEEN MAKING EUROISSUES. THEY

HAVE EMPLOYED TWO TYPES OF SECURITIES : GLOBAL

DEPOSITORY RECEIPTS (GDRS) AND EUROCONVERTIBLE BONDS

(ECBS).

DENOMINATED IN US DOLLORS, A GDR IS A NEGOTIBALE

CERTIFICATE THAT REPRESENTS THE PUBLICLY TRADED LOCAL

CURRENCY (INDIAN RUPEE) EQUITY SHARES OF A NON US

(INDIAN) COMPANY. (OFCOURSE, IN THEORY, A GDR MAY

REPRESENT A DEBT SECURITY ; IN PRACTICE IT RARELY DOES

SO.) GDRS ARE ISSUED BY THE DEPOSITORY BANK (SUCH AS THE

BANK OF NEW YORK) AGAINST THE LOCAL CURRENCY SHARES

( SUCH AS RUPEE SHARES) WHICH ARE DELIVERED TO THE

DEPOSITORY S LOCAL CUSTODIAN BANKS.GDRS TRADE FREELY

IN THE OVERSEAS MARKETS.

A EUROCONVERTIBLE BOND (ECB) IS AN EQUITY LINKED DEBT

SECURITY . THE HOLDER OF AN ECB HAS THE OPTION TO


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CONVERT IT INTO EQUITY SHARES AT A PRE DETERMINED

CONVERSION RATIO DURING A SPECIFIED PERIOD . ECBS ARE

REGARDED AS ADVANTAGEOUS BY THE ISSUING COMPANY

BECAUSE (I) THEY CARRY A LOWER RATE OF INTEREST

COMPARED TO A STRAIGHT DEBT SECURITY (II) THEY DO NOT

LEAD TO DILUTION OF EARNINGS PER SHARE IN THE NEAR

FUTURE AND (III) THEY CARRY VERY FEW RESTRICTIVE

COVENANTS.

DEFERRED CREDIT

MANY A TIME THE SUPPLIERS OF MACHINERY PROVIDE

DEFERRED CREDIT FACILITY UNDER WHICH PAYMENT FOR THE

PURCHASE OF MACHINERY IS MADE OVER A PERIOD OF TIME.

THE INTEREST RATE ON DEFERRED CREDIT AND THE PERIOD OF

PAYMENT VARY RATHER WIDELY. NORMALLY, THE SUPPLIER OF

MACHINERY WHEN HE OFFERS DEFERRED CREDIT FACILITY

INSISTS THAT THE BANK GUARANTEE SHOULD BE FURNISHED BY

THE BUYER.

BILLS RE DISCOUNTING SCHEME

OPERATED BY THE IDBI, THE BILLS REDISCOUNTING SCHEME IS

MEANT TO PROMOTE THE SALE OF INDIGENOUS MACHINERY ON

DEFERRED PAYMENT BASIS. UNDER THIS SCHEME, THE SELLER


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REALISES THE SALE PROCEEDS BY DISCOUNTING THE BILLS OF

PROMISSORY NOTES ACCEPTED BY THE BUYER WITH A

COMMERCIAL BANK WHICH IN TURN REDISCOUNTS THEM WITH

THE IDBI. THIS SCHEME IS MEANT PRIMARILY FOR BALANCING

EQUIPMENTS AND EQUIPMENTS AND MACHINERY REQUIRED FOR

EXPANSION,MODERNISATION , AND REPLACEMENT SCHEMES.

SUPPLIERS LINE OF CREDIT

ADMINISTERED BY THE ICICI , THE SUPPLIERS LINE OF CREDIT IS

SOMEWHAT SIMILAR TO THE IDBIS BILL REDISCOUNTING SCHEME

. UNDER THIS ARRANGEMENT , ICICI DIRECTLY PAYS TO THE

MACHINERY MANUFACTURER AGAINST USANCE BILLS DULY

ACCEPTED OF GUARANTEED BY THE BANK OF THE PURCHASER.

SEED CAPITAL ASSISTANCE

FINANCIAL INSTITUTIONS, THOUGH WHAT MAY BE LABELLED

BROADLY AS TH SEED CAPITAL ASSISTANCE SCHEME, SEEK TO

SUPPLEMENT THE RESOURCES OF THE PROMOTERS OF THE

SMALL AND MEDIUM SCALE INDUSTRIAL UNITS WHICH ARE

ELIGIBLE FOR ASSISTANCE FROM ALL INDIA FINANCIAL

INSTITUTIONS AND / OR STATE LEVEL FINANCIAL INSTITUTIONS.

BROADLY THREE SCHEMES HAVE BEEN FORMULATED:


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(i) SPECIAL SEED CAPITAL ASSISTANCE SCHEME-THE

QUANTUM OF ASSISTANCE UNDER THIS SCHEME IF

RS.0.2 MILLION OR 20 PER CENT OF THE PROJECT

COST,WHICHEVER IS LOWER. THIS SCHEME IS

ADMINISTERED BY THE STATE FINANCIAL

CORPORATIONS.

(ii) SEED CAPITAL ASSISTANCE SCHEME-THE ASSISTANCE

UNDER THIS SCHEME IS APPLICABLE TO PROJECTS

COSTING NOT MORE THAN RS20 MILLION. THE

ASSISTANCE PER PROJECT IS RESTRICTED TO RS 1.5

MILLION. THE ASSISTANCE IS PROVIDED BY IDBI

THROUGH STATE LEVEL FINANCIAL INSTITUTIONS. IN

SPECIAL CASES, THE IDBI MAY PROVIDE THE

ASSISTANCE DIRECTLY.

(iii) RISK CAPITAL FOUNDATION SCHEME-UNDER THIS

SCHEME, THE RISK CAPITAL FOUNDATION, AN

AUTONOMOUS FOUNDATION SET UP AND FOUNDED BY

THE IFCL, OFFERS ASSISTANCE TO PROMOTERS OF

PROJECTS COSTING BETWEEN RS 20 MILLION AND RS

150 MILLION. THE CEILING ON THE ASSISTANCE

PROVIDED BETWEEN RS 1.5 MILLION AND RS 4 MILLION


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DEPENDING ON THE NUMBER OF APPLICANT

PROMOTERS.

GOVERNMENT SUBSIDIES

PREVIOUSLY THE CENTRAL GOVERNMENT AS WELL AS THE

STATE GOVERNMENTS PROVIDED SUBSIDIES TO INDUSTRIAL

UNITS LOCATED IN BACKWARD AREAS. THE CENTRAL SUBSIDY

HAS BEEN DISCONTINUED BUT THE STATE SUBSIDIES CONTINUE.

THE STATE SUBSIDIES VARY BETWEEN 5 PER CENT TO 25 PER

CENT OF THE FIXED CAPITAL INVESTMENT IN THE PROJECT ,

SUBJECT TO A CEILING VARYING BETWEEN RS 0.5 MILLION AND

RS 2.5 MILLION DEPENDING ON THE LOCATION.

SALES TAX DEFERMENTS AND EXEMPTIONS

TO ATTRACT INDUSTRIES, THE STATES PROVIDE INCENTIVES,

INTER ALIA , IN THE FORM OF SALES TAX DEFERMENTS AND

SALES TAX EXEMPTIONS.

UNDER THE SALES TAX DEFERMENT SCHEME, THE PAYMENT OF

SALES TAX ON THE SALE OF FINISHED GOODS MAY BE DEFERRED

FOR A PERIOD RANGING BETWEEN FIVE TO TWELVE YEARS.

ESSENTIALLY IT IMPLIES THAT THE PROJECT GETS AN INTEREST

FREE LOAN, REPRESENTED BY THE QUANTUM OF SALES TAX

DEFERRED , DURING THE DEFERMENT PERIOD.


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UNDER THE SALES TAX EXEMPTION SCHEME, SOME STATES

EXEMPT THE PAYMENT OF SALES TAX APPLICABLE ON

PURCHASES OF RAW MATERIALS, CONSUMABLES, PACKING AND

PROCESSING MATERIALS FROM WITHIN THE STATE WHICH ARE

USED FOR MANUFACTURING PURPOSES . THE PERIOD OF

EXEMPTION RANGES FROM THREE TO NINE YEARS DEPENDING

UPON THE STATE AND THE SPECIFIC LOCATION OF THE PROJECT

WITHIN THE STATE.

UNSECURED LOANS AND DEPOSITS

UNSECURED LOANS ARE TYPICALLY PROVIDED BY THE

PROMOTERS TO FILL THE GAP BETWEEN THE

PROMOTERSCONTRIBUTION REQUIRED BY FINANCIAL

INSTITUTIONS AND THE EQUITY CAPITAL SUBSCRIBED TO BY THE

PROMOTERS. THESE LOANS ARE SUBSIDIARY TO THE

INSTITUTIONAL LOANS. THE RATE OF INTEREST CHARGEABLE ON

THESE LOANS IS LESS THAN THE RATE OF INTEREST ON THE

INSTITUTIONAL LOANS. FINALLY, THESE LOANS CANNOT BE

TAKEN BACK WITHOUT THE PRIOR APPROVAL OF FINANCIAL

INSTITUTIONS.

DEPOSITS FROM PUBLIC,REFERRED TO AS PUBLIC

DEPOSITS,REPRESENT UNSECURED BORROWING TWO TO THREE


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YEARS DURATION . MANY EXISTING COMPANIES PREFER TO

RAISE PUBLIC DEPOSITS INSTEAD OF TERM LOANS FROM

FINANCIAL INSTITUTIONS BECAUSE RESTRICTIVE COVENANTS DO

NOT ACCOMPANY PUBLIC DEPOSITS. HOWEVER, IT MAY NOT BE

POSSIBLE FOR A NEW COMPANY TO RAISE PUBLIC DEPOSITS .

FURTHER, IT MAY BE DIFFICULT FOR IT TO REPAY PUBLIC

DEPOSITS WITHIN THREE YEARS.

LEASING AND HIRE PURCHASE FINANCE

WITH THE EMERGENCE OF SCORES OF FINANCE COMPANIES

ENGAGED IN THE BUSINESS OF LEASING AND HIRE PURCHASE

FINANCE, IT MAY BE POSSIBLE TO GET A PORTION , ALBEIT A

SMALL PORTION, OF THE ASSETS FINANCED UNDER A LEASE OR

A HIRE PURCHASE ARRANGEMENT.

TYPICALLY, A PROJECT IS FINANCED PARTLY BY FINANCIAL

INSTITUTIONS AND PARTLY THROUGH THE RESOURCES RAISED

FROM THE CAPITAL MARKET . HENCE , IN FINALISING THE

FINANCING SCHEME FOR A PROJECT, YOU SHOULD BEAR IN MIND

THE NORMS AND POLICIES OF FINANCIAL INSTITUTIONS AND THE

GUIDELINES OF SECURITIES EXCHANGE BOARD OF INDIA AND

THE REQUIREMENTS OF THE SECURITIES CONTRACTS

REGULATION ACT (SCRA).


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PROJECT LAYOUT COST AN INDIAN SCENARIO

PROJECT FINANCING IN INDIA

PROJECT FINANCING REFERS TO THE MEANS OF FINANCE

EMPLOYED FOR MEETING THE COST OF PROJECT.

COST OF PROJECT REPRESENTS THE TOTAL OF ALL ITEMS OF

OUTLAY ASSOCIATED WITH A PROJECT WHICH ARE SUPPORTED

BY LONG TERM FUNDS. IT IS THE SUM OF THE OUTLAYS ON THE

FOLLOWING:

1. LAND AND SITE DEVELOPMENT: THE COST OF LAND AND SITE

DEVELOPMENT IS THE SUM OF THE FOLLOWING:

BASIC COST OF LAND INCLUDING CONVEYANCE AND

OTHER ALLIED CHARGES,

PREMIUM PAYABLE ON LEASEHOLD AND CONVEYANCE,

COST OF LEVELLING & DEVELOPMENT,

COST OF LAYING APPROACH ROADS AND INTERNAL

ROADS,

COST OF GATES,

COST OF TUBE WELLS.

THE COST OF LAND VARIES CONSIDERABLY FROM ONE

LOCATION TO ANOTHER. WHILE IT IS VERY HIGH IN URBAN AND


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EVEN SEMI-URBAN LOCATIONS, IT IS RELATIVELY LOW IN

RURAL LOCATIONS. THE EXPENDITURE ON SITE

DEVELOPMENT, TOO, VARIES WIDELY DEPENDING ON THE

LOCATION AND TOPOGRAPHY OF THE LAND.

2. BUILDING AND CIVIL WORKS: BUILDING AND CIVIL WORKS

COVER THE FOLLOWING :

BUILDING FOR THE MAIN PLANT & EQUIPMENTS

BUILDING FOR AUXILLARY SERVICES LIKE STEAM

SUPPLY, WORKSHOPS, LABORATORY, WATER SUPPLY, ETC.

GODOWNS, WAREHOUSES, AND OPEN YARD

FACILITIES,

NON-FACTORY BUILDINGS LIKE CANTEEN, GUEST

HOUSES, TIME OFFICE, EXCISE HOUSE, ETC.

QUARTERS FOR ESSENTIAL STAFF

SILOS, TANKS, WELLS, CHESTS, BASINS, CISTERNS,

HOOPERS, BINS, AND OTHER STRUCTURES NECESSARY

FOR INSTALLATION OF PLANT & EQUIPMENT

GARAGES

SEWERS, DRAINAGE, ETC.

OTHER CIVIL ENGINEERING WORKS


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THE COST OF BUILDINGS & CIVIL WORKS DEPENDS ON THE

KIND OF STRUCTURES REQUIRED WHICH, IN TURN, ARE

DICTATED LARGELY BY THE REQUIREMENTS OF THE PROJECT.

ONCE THE KINDS OF STRUCTURES REQUIRED ARE SPECIFIED,

COST ESTIMATES ARE BASED ON PLINTH AREAS AND RATES

FOR VARIOUS TYPES OF STRUCTURES. THESE RATES, OF

COURSE VARY WITH THE LOCATION TO SOME EXTENT.

3. PLANT AND MACHINARY: THE COST OF PLANT AND

MACHINARY, TYPICALLY THE MOST SIGNIFICANT COMPONENT

OF PROJECT COST, CONSISTING OF THE FOLLOWING:

COST OF IMPORTED MACHINARY: THIS IS THE SUM OF

(A) FOB VALUE, (B) SHIPPING, FREIGHT, AND INSURANCE

COST, (C) IMPORT DUTY, (D) CLEARING, LOADING,

UNLOADING, AND TRANSPORTATION CHARGES.

COST OF INDIGENOUS MACHINARY: THIS CONSISTS OF

(A) FOR COST, (B) SALES TAX, OCTROI, OTHER TAXES, (C)

RAILWAY FREIGHT AND TRANSPORT CHARGES TO SITE.

COST OF STORES & SPARES

FOUNDATION AND INSTALLATION CHARGES

THE COST OF PLANT & MACHINARY IS BASED ON THE

LATEST AVAILABLE QUOTATION ADJUSTED FOR POSSIBLE


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ESCALATION. GENERALLY, THE PROVISION FOR

ESCALATION IS EQUAL TO THE FOLLOWING PRODUCT:

(LATEST RATE OF ANNUAL INFLATION APPLICABLE TO THE

PLANT AND MACHINARY) X (LENGTH OF THE DELIVERY

PERIOD).

4. TECHNICAL KNOW-HOW AND ENGINEERING FEES: OFTEN IT IS

NECESSARY TO ENGAFE TECHNICAL CONSULTANTS OR

COLLABORATORS FROM INDIA AND / OR ABROAD FOR ADVICE

AND HELP IN VARIOUS TECHNICAL MATTERS LIKE

PREPARATION OF PROJECT REPORT, CHOICE OF

TECHNOLOGY, SELECTION OF PLANT AND MACHINARY,

DETAILED ENGINEERING, ETC. WHILE THE AMOUNT PAYABLE

FOR OBTAINING TECHNICAL KNOW-HOW AND ENGINEERING

SERVICES FOR SETTING UP THE PROJECT IS A COMPONENT

OF PROJECT COST, THE ROYALTY PAYABLE ANNUALLY, WHICH

IS TYPICALLY A PERCENTAGE OF SALES, IS AN OPERATING

EXPENSE TAKEN INTO ACCOUNT IN THE PREPARATION OF THE

PROJECTED PROFITABILITY STATEMENTS.

5. EXPENSES OF FOREIGN TECHNICIANS MAY BE REQUIRED IN

INDIA FOR SETTING UP THE PROJECT AND SUPERVISING THE

TRIAL RUNS. EXPENSES ON THEIR TRAVEL, BOARDING, AND


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LODGING ALONG WITH THEIR SALARIES AND ALLOWANCES

MUST BE TAKEN INTO ACCOUNT IN THE PREPARATION OF THE

PROJECTED PROFITABILITY STATEMENTS.

6. MISCELLANEOUS FIXED ASSETS: FIXED ASSETS AND

MACHINARY WHICH ARE NOT PART OF THE DIRECT

MANUFACTURING PROCESS MAY BE REFFERED TO AS

MISCELLANEOUS FIXED ASSETS. THEY INCLUDE ITEMS LIKE

FURNITURE, OFFICE MACHINARY AND EQUIPMENT, TOOLS,

VEHICLES, RAILWAY SIDINGS, DIESEL GENERATING SETS,

TRANSFORMERS, BOILERS, PIPING SYSTEMS, LABORATORY

EQUIPMENTS, WORKSHOP EQUIPMENTS, EFFLUENT

TREATMENT PLANTS, FIRE FIGHTING EQUIPMENTS, ETC.

EXPENSES INCURRED FOR PROCUREMENT OR USE OF

PATENTS, LICENSES, TRADE MARKS COPYRIGHTS, ETC. AND

DEPOSITS MADE WITH THE ELECTRICITY BOARD MAY ALSO BE

INCLUDED IN THE PROJECTED PROFITABILITY STATEMENTS.

7. PRILIMINARY AND CAPITAL ISSUE EXPENSES: EXPENSES

INCURRED FOR IDENTIFYING THE PROJECT, CONDUCTING THE

MARKET SURVEY, PREPARING THE FEASIBILITY REPORT,

DRAFTING THE MEMORANDUM AND ARTICLES OF


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ASSOCIATION, AND INCORPORATING THE COMPANY ARE

REFFERED TO AS PRELIMINARY EXPENSES.

EXPENSES BORNE IN CONNECTION WITH THE RISING OF

CAPITAL FROM THE PUBLIC ARE REFERRED AS CAPITAL ISSUE

EXPENSES. THE MAJOR COMPONENT OF THESE EXPENSES

ARE- UNDERWRITING COMMISSION, BROKERAGE, FEES TO

MANAGERS AND REGISTRARS, PRINTING AND POSTAGE

EXPENSES, ADVERTISING AND PUBLICITY EXPENSES, LISTING

FESES, AND STAMP DUTY.

8. PRE-OPERATIVE EXPENSES: THESE EXPENSES ARE DIRECTLY

RELATED TO THE PROJECT IMPLEMENTATION SCHEDULE. O,

DELAYS IN PROJECT IMPLEMENTATION, WHICH ARE FIRLY

COMMON, TEND TO PUSH UP THESE EXPENSES. APPRECIATIVE

OF THIS, FINANCIAL INSTITUTIONS ALLOW FOR SOME DELAY

(20 TO 25 PER CENT) IN THE PROJECT IMPLEMENTATION

SCHEDULE AND ACCORDINGLY PERMIT A CUSHION IN THE

ESTIMATE FOR PRE-OPERATIVE EXPENSES.

EXPENSES OF THE FOLLOWING TYPES INCURRED TILL THE

COMMENCEMENT OF COMMERCIAL PRODUCTION ARE

REFERRED TO AS PRE-OPERATIVE EXPENSES- (A)

ESTABLISHMENT EXPENSES, (B) RENT, RATES & TAXES, (C)


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TRAVELLING EXPENSES, (D) INTEREST ON BORROWINGS, (E)

INSURANCE CHARGES, (F) MORTGAGE EXPENSES, (G)

INTEREST ON DEFERRED PAYMENTS, (H) START-UP EXPENSES,

AND (I) MISCELLANEOUS EXPENSES.

THESE TYPES OF EXPENSES CAN BE CAPITALISED BY

APPORTIONING THEM TO FIXED ASSETS. UP TO A POINT OF

TIME. AFTER THAT THESE EXPENSES ARE TREATED AS

REVENUE EXPENSES.

9. PROVISION FOR CONTENGENCIES: A PROVISION FOR

CONTINGENCIES IS MADE TO PROVIDE FOR CERTAIN

UNFORSEEN EXPENSES AND PRICE INCREASES OVER AND

ABOVE THE NORMAL INFLATION RATE WHICH IS ALREADY

INCORPORATED IN COST ESTIMATES.

10. MARGIN MONEY FOR WORKING CAPITAL: THE PRINCIPAL

SUPPORT FOR WORKING CAPITAL IS PROVIDED BY

COMMERCIAL BANKS AND TRADE CREDITORS. HOWEVER, A

CERTAIN PART OF WORKING CAPITAL REQUIREMENTS HAS TO

COME FROM LONG TERM SOURCES OF FINANCE. THIS IS AN

IMPORTANT ELEMENT OF THE PROJECT COST. THE MARGIN

MONEY FOR WORKING CAPITAL IS SOMETIMES UTILISED FOR

MEETING OVER-RUNS IN CAPITAL COST. THIS LEADS TO A


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WORKING CAPITAL PROBLEM (AND SOMETIMES A CRISIS)

WHEN THE PROJECT IS COMMISSIONED. TO MITIGATE THIS

PROBLEM, FINANCIAL INSTITUTIONS STIPULATE THAT A

PORTION OF THE LOAN AMOUNT, EQUAL TO THE MARFIN

MONEY FOR WORKING CAPITAL, BE BLOCKED INITIALLY SO

THAT IT CAN BE RELEASED WHEN THE PROJECT IS

COMPLETED.

11. INITIAL CASH LOSSES: MOST OF THE PROJECTS INCUR

CASH LOSSES IN THE INITIAL YEARS. YET, PROMOTORS

TYPICALLY DO NOT DISCLOSE THE INITIAL CASH LOSSES

BECAUSE THEY WANT THE PROJECT TO APPEAR ATTRACTIVE

TO THE FINANCIAL INSTITUTIONS AND THE INVESTING PUBLIC.

FALIURE TO MAKE PROVISION FOR SUCH CASH LOSSES IN THE

PROJECT COST GENERALLY AFFECTS THE LIQUIDITY

POSITION AND IMPAIRS THE OPERATIONS. HENCE PRUDENCE

CALLS FOR MAKING A PROVISION, OVERT OR COVERT, FOR

THE ESTIMATED INITIAL CASH LOSSES.

EVERY PROJECT HAVE THE FOLLOWING ATTRIBUTES:

IT INVOLVES CAPITAL EXPENDITURE,

(a)CAPITAL BUDGETING,

(b)PROJECT ANALYSIS,


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(c)FEASIBILITY STUDY

CAPITAL EXPENDITURE DECISIONS OFTEN REPRESENT THE

MOST IMPORTANT DECISIONS TAKEN BY FIRM. THEIR

IMPORTANCE STEMS FROM THREE INTER-RELATED REASONS:

i. LONG TERM EFFECT,

ii. IRREVERSIBILITY,

iii. SUBSTANTIAL OUTLAY.

CAPITAL BUDGETING IS A COMPLEX PROCESS WHICH MAY BE

DIVIDED INTO FIVE BROAD PHASES:

1. PLANNING: THE PLANNING PHASE IS CONCERNED WITH THE

ARTICULATION OF ITS BROAD INVESTMENT STRATEGY AND

THE GENERATION AND PRELIMINARY SCREENING OF PROJECT

PROPOSALS. THE INVESTMENT STRATEGY OF THE FIRM

DELINEATES THE BROAD AREAS OR TYPES OF INVESTMENTS

THE FIRM PLANS TO UNDERTAKE.

2. ANALYSIS: THE FOCUS IS ON GATHERING, PREPARING, AND

SUMMARISING RELEVANT INFORMATION ABOUT VARIOUS

PROPOSALS, WHICH ARE BEING CONSIDERED. BASED ON THE

INFORMATION DEVELOPED IN THIS ANALYSIS, THE STREAM OF

COST & BENEFITS ASSOCIATED WITH THE PROJECT CAN BE

DEFINED.


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3. SELECTION: THE PROJECTS ARE SELECTED ON SOME

SUITABLE BASIS FOR THEIR WORTHINES LIKE PAYBACK

PERIOD, ARR, NPV, IRR, AND BCR ETC. IN ORDER TO APPLY

THE APPRISAL CRITERIA CUT OFF VALUES ARE TO BE

SPECIFIED, LIKE (HURDLE RATE, TARGET RATE AND COST OF

CAPITAL).

4. IMPLEMENTATION: IT PASSES THROUGH SEVERAL STAGES,

NAMELY- PROJECT & ENGINEERING & DESIGNS, NEGOTIATION

& CONTRACTING, CONSTRUCTION, TRAINING, AND

COMMISSIONING.

5. REWIEW: THIS PHASE SETS INTO MOTION AFTER THE

COMMISSIONING IS OVER. IT IS USEFUL IN THE FOLLOWING

WAYS,

IT THROWS LIGHT ON HOW REALISTIC WERE THE

ASSUMPTIONS UNDERLYING THE PROJECT,

IT PROVIDES A DOCUMENTED LOG OF EXPERIENCE

THAT IS HIGHLY VALUABLE IN FUTURE DECISION MAKING,

IT SUGGESTS CORRECTIVE ACTION TO BE TAKEN IN

THE LIGHT OF ACTUAL PERFORMANCE,

IT HELPS IN UNCOVERING JUDGEMENTAL BIASES,


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IT INDUCES A DESIRED CAUTION AMONG PROJECT

SPONSORS.

PROJECT ANALYSIS

FACETS OF PROJECT ANALYSIS

THE IMPORTANT FACETS OF PROJECT ANALYSIS ARE:

- MARKET ANALYSIS

- TECHNICAL ANALYSIS

- FINANCIAL ANALYSIS

- ECONOMIC ANALYSIS

- ECOLOGICAL ANALYSIS

MARKET ANALYSIS

MARKET ANALYSIS IS CONCERNED PRIMARILY WITH TWO

QUESTIONS:

- WHAT WOULD BE THE AGGREGATE DEMAND OF THE

PROPOSED PRODUCT / SERVICE IN FUTURE?

- WHAT WOULD BE THE MARKET SHARE OF THE PROJECT

UNDER APPRAISAL?

TO ANSWER THE ABOVE QUESTIONS, THE MARKET ANALYST

REQUIRES A WIDE VARIETY TO INFORMATION AND APPROPRIATE

FORECASTING METHODS. THE KINDS OF INFORMATION

REQUIRED ARE:


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- CONSUMPTION TRENDS IN THE PAST AND THE PRESENT

CONSUMPTION LEVEL

- PAST AND PRESENT SUPPLY POSITION

- PRODUCTION POSSIBILITIES AND CONSTRAINTS

- IMPORTS AND EXPORTS.

- STRUCTURE OF COMPETITION

- COST STRUCTURE

- ELASTICITY OF DEMAND

- CONSUMER BEHAVIOUR, INTENTIONS, MOTIVATIONS,

ATTITUDES, PREFERENCE, AND REQUIREMENTS

- DISTRIBUTION CHANNELS AND MARKETING POLICIES IN USE

- ADMINISTRATIVE, TECHNICAL, AND LEGAL CONSTRAINTS

TECHNICAL ANALYSIS

ANALYSIS OF THE TECHNICAL AND ENGINEERING ASPECTS OF A

PROJECT NEEDS TO BE DONE CONTINUALLY WHEN A PROJECT IS

FORMULATED. TECHNICAL ANALYSIS SEEKS TO DETERMINE

WHETHER THE PREREQUISITES FOR THE SUCCESSFUL

COMMISSIONING OF THE PROJECT HAVE BEEN CONSIDERED AND

REASONABLY GOOD CHOICES HAVE BEEN MADE WITH RESPECT


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TO LOCATION, SIZE, PROCESS, ETC. THE IMPORTANT

QUESTIONS RAISED IN TECHNICAL ANALYSIS ARE:

- WHETHER PRELIMINARY TESTS AND STUDIES HAVE BEEN

DONE OR PROVIDED FOR?

- WHETHER THE AVAILABILITY OF RAW MATERIALS, POWER, AND

OTHER INPUTS HAS BEEN ESTABLISHED?

- WHETHER THE SELECTED SCALE OF OPERATION IS OPTIMAL?

- WHETHER THE PRODUCTION PROCESS CHOSEN IS SUITABLE?

- WHETHER THE EQUIPMENT AND MACHINES CHOSEN ARE

APPROPRIATE?

- WHETHER THE AUXILIARY EQUIPMENTS AND SUPPLEMENTARY

ENGINEERING WORKS HAVE BEEN PROVIDED FOR?

- WHETHER PROVISION HAS BEEN MADE FOR THE TREATMENT

OF EFFLUENTS?

- WHETHER THE PROPOSED LAYOUT OF THE SITE, BUILDINGS,

AND PLANT IS SOUND?

- WHETHER WORK SCHEDULES HAVE BEEN REALISTICALLY

DRAWN UP?

- WHETHER THE TECHNOLOGY PROPOSED TO BE EMPLOYED IS

APPROPRIATE FROM THE SOCIAL POINT OF VIEW?


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FINANCIAL ANALYSIS

FINANCIAL ANALYSIS SEEKS TO ASCERTAIN WHETHER THE

PROPOSED PROJECT WILL BE FINANCIALLY VIABLE IN THE SENSE

OF BEING ABLE TO MEET THE BURDEN OF SERVICING DEBT AND

WHETHER THE PROPOSED PROJECT WILL SATISFY THE RETURN

EXPECTATIONS OF THOSE WHO PROVIDE THE CAPITAL. THE

ASPECTS WHICH HAVE TO BE LOOKED INTO WHILE CONDUCTING

FINANCIAL APPRAISAL ARE:

- INVESTMENT OUTLAY AND COST OF PROJECT

- MEANS OF FINANCING.

- COST OF CAPITAL

- PROJECTED PROFITABILITY

- BREAK-EVEN POINT

- CASH FLOWS OF THE PROJECT

- INVESTMENT WORTHWHILENESS JUDGED IN TERMS OF

VARIOUS CRITERIA OF MERIT

- PROJECTED FINANCIAL POSITION

- LEVEL OF RISK

ECONOMIC ANALYSIS

ECONOMIC ANALYSIS, ALSO REFERRED TO AS SOCIAL COST

BENEFIT ANALYSIS, IS CONCERNED WITH JUDGING A PROJECT


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FROM THE LARGER SOCIAL POINT OF VIEW. IN SUCH AN

EVALUATION THE FOCUS IS ON THE SOCIAL COSTS AND

BENEFITS OF A PROJECT WHICH MAY OFTEN BE DIFFERENT

FROM ITS MONETARY COSTS AND BENEFITS. THE QUESTIONS

SOUGHT TO BE ANSWERED IN SOCIAL COST BENEFIT ANALYSIS

ARE:-

- WHAT ARE THE DIRECT ECONOMIC BENEFITS AND COSTS OF

THE PROJECT MEASURED IN TERMS OF SHADOW (EFFICIENCY)

PRICES AND NOT IN TERMS OF MARKET PRICES?

- WHAT WOULD BE THE IMPACT OF THE PROJECT ON THE

DISTRIBUTION OF INCOME IN THE SOCIETY?

- WHAT WOULD BE THE IMPACT OF THE PROJECT ON THE LEVEL

OF SAVINGS AND INVESTMENT IN THE SOCIETY?

- WHAT WOULD BE THE CONTRIBUTION OF THE PROJECT

TOWARDS THE FULFILLMENT OF CERTAIN MERIT WANTS LIKE

SELF-SUFFICIENCY, EMPLOYMENT, AND SOCIAL ORDER?

ECOLOGICAL ANALYSIS

IN RECENT YEARS, ENVIRONMENTAL CONCERNS HAVE ASSUMED

A GREAT DEAL OF SIGNIFICANCE-AND RIGHTLY SO. ECOLOGICAL

ANALYSIS SHOULD BE DONE PARTICULARLY FOR MAJOR

PROJECTS WHICH HAVE SIGNIFICANT ECOLOGICAL IMPLICATIONS


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LIKE POWER PLANTS AND IRRIGATION SCHEMES, AND

ENVIRONMENTAL POLLUTING INDUSTRIES (LIKE BULK DRUGS,

CHEMICALS, AND LEATHER PROCESSING). THE KEY QUESTIONS

RAISED IN ECOLOGICAL ANALYSIS ARE:

- WHAT IS THE LIKELY DAMAGE CAUSED BY THE PROJECT TO

THE ENVIRONMENT?

- WHAT IS THE COST OF RESTORATION MEASURES REQUIRED

TO ENSURE THAT THE DAMAGE TO THE ENVIRONMENT IS

CONTAINED WITHIN ACCEPTABLE LIMITS?

WE HAVE LOOKED AT THE FIVE BROAD PHASES OF CAPITAL

BUDGETING AND EXAMINED THE KEY FACETS OF PROJECT

ANALYSIS. THE FEASIBILITY STUDY IS CONCERNED WITH THE

FIRST THREE PHASES OF CAPITAL BUDGETING, VIZ., PLANNING,

ANALYSIS, AND SELECTION (EVALUATION) AND INVOLVES

MARKET, TECHNICAL, FINANCIAL, ECONOMIC, AND ECOLOGICAL

ANALYSIS.

OBJECTIVES OF CAPITAL BUDGETING

FINANCIAL THEORY, IN GENERAL, RESTS ON THE PREMISE THAT

THE GOAL OF FINANCIAL MANAGEMENT (WHICH SUBSUMES

INVESTMENT DECISION MAKING) SHOULD BE TO THE MAXIMISE

THE PRESENT WEALTH OF THE FIRMS EQUITY SHAREHOLDERS.


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FOR A FIRM WHOSE EQUITY SHARES ARE ACTIVELY TRADED ON

THE STOCK MARKET, THE WEALTH OF THE EQUITY

SHAREHOLDERS IS REFLECTED IN THE MARKET VALUE OF THE

EQUITY SHARES. HENCE, THE GOAL OF FINANCIAL MANAGEMENT

FOR SUCH FIRMS SHOULD BE TO MAXIMISE THE MARKET VALUE

OF EQUITY SHARES.

THE PURSUIT OF THE WELFARE OF EQUITY SHAREHOLDERS IS

JUSTIFIED ON THE GROUNDS THAT IT CONTRIBUTES TO AN

EFFICIENT ALLOCATION OF CAPITAL IN THE ECONOMY. THE

BASES FOR ALLOCATION OF SAVINGS IN THE ECONOMY ARE

EXPECTED RETURN AND RISK. SINCE EQUITY SHARE PRICES

ARE BASED ON EXPECTED RETURN AND RISK, EFFORTS TO

MAXIMISE EQUITY SHARE PRICES WOULD RESULT IN AN

EFFICIENT ALLOCATION OF RESOURCES. ANOTHER

JUSTIFICATION MAY BE PROVIDED FOR THE GOAL OF

SHAREHOLDER WEALTH MAXIMISATION. EQUITY SHAREHOLDERS

PROVIDE THE VENTURE (RISK) CAPITAL REQUIRED TO START A

BUSINESS FIRM AND APPOINT THE MANAGEMENT OF THE FIRM

INDIRECTLY THROUGH THE BOARD OF DIRECTORS. HENCE, IT

BEHOOVES ON CORPORATE MANAGEMENTS TO PROMOTE THE

WELFARE OF EQUITY SHAREHOLDERS.


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WHAT ABOUT A PUBLIC SECTOR FIRM THE EQUITY STOCK OF

WHICH, BEING FULLY OWNED BY THE GOVERNMENT, IS NOT

TRADED ON THE STOCK MARKET? IN SUCH A CASE, THE GOAL OF

FINANCIAL MANAGEMENT SHOULD BE TO MAXIMISE THE

PRESENT VALUE OF THE STREAM OF EQUITY RETURNS. OF

COURSE, IN DETERMINING THE PRESENT VALUE OF THE STREAM

OF EQUITY RETURNS, AN APPROPRIATE DISCOUNT RATE HAS TO

BE APPLIED. A SIMILAR OBSERVATION MAY BE MADE WITH

RESPECT TO OTHER COMPANIES WHOSE EQUITY SHARES ARE

EITHER NOT TRADED OR VERY POORLY TRADED.

ALTERNATIVES

ARE THERE OTHER GOALS, BESIDES THE GOAL OF MAXIMUM

SHAREHOLDER WEALTH, EXPRESSING THE SHAREHOLDERS

VIEWPOINT? SEVERAL ALTERNATIVES HAVE BEEN SUGGESTED:

MAXIMISATION OF PROFIT, MAXIMISATION OF EARNINGS PER

SHARE, MAXIMISATION OF RETURN ON EQUITY (DEFINED AS

EQUITY EARNINGS / NET WORTH).

MAXIMISATION OF PROFIT IS NOT AS INCLUSIVE A GOAL AS

MAXIMISATION OF SHAREHOLDERS WEALTH. IT SUFFERS FROM

SEVERAL LIMITATIONS:


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- PROFIT IN ABSOLUTE TERMS IS NOT A PROPER GUIDE TO

DECISION MAKING. IT SHOULD BE EXPRESSED ON A PER

SHARE BASIS OR RELATED TO INVESTMENT.

- IT LEAVES CONSIDERATIONS OF TIMING AND DURATION

UNDEFINED. THERE IS NOT GUIDE FOR COMPARING PROFIT

NOW WITH PROFIT IN FUTURE OR FOR COMPARING PROFIT

STREAMS OF DIFFERENT DURATIONS.

- IT GLOSSES OVER THE FACTOR OF RISK. IT CANNOT, FOR

EXAMPLE, DISCRIMINATE BETWEEN AN INVESTMENT PROJECT

WHICH GENERATES A CERTAIN PROFIT OF RS.50,000/- AND AN

INVESTMENT PROJECT WHICH HAS A VARIABLE PROFIT

OUTCOME WITH AN EXPECTED VALUE OF RS.50,000/-.

THE GOALS OF MAXIMISATION OF EARNINGS PER SHARE AND

MAXIMISATION OF RETURN ON EQUITY DO NOT SUFFER FROM

THE FIRST LIMITATION MENTIONED ABOVE. THEY, HOWEVER,

SUFFER FROM THE OTHER LIMITATIONS AND HENCE ARE NOT

SUITABLE.

IN VIEW OF THE SHORTCOMINGS OF THE ALTERNATIVES

DISCUSSED ABOVE, MAXIMISATION OF THE WEALTH OF EQUITY

SHAREHOLDERS (AS REFLECTED IN THE MARKET PRICE OF

EQUITY) APPEARS TO BE THE MOST APPROPRIATE GOAL FOR


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FINANCIAL DECISION MAKING. THOUGH THE STRICT VALIDITY OF

THIS GOAL RESTS ON CERTAIN RIGID ASSUMPTIONS ABOUT

CAPITAL MARKETS, IT CAN BE REASONABLY DEFINED AS A GUIDE

FOR FINANCIAL DECISION MAKING UNDER FAIRLY PLAUSIBLE

ASSUMPTIONS.

OTHER CONCERNS OF THE BUSINESS

DO FIRMS REALLY ACT OR SHOULD SOLELY ACT TO FURTHER

SHAREHOLDERS WELFARE? THIS DOES NOT SEEM TO BE THE

ISSUE HERE. FIRMS MAY PURSUE OR OUGHT TO PURSUE

SEVERAL OTHER GOALS. BUSINESS FIRMS SEEK TO ACHIEVE A

HIGH RATE OF GROWTH, ENJOY A SUBSTANTIAL MARKET SHARE,

ATTAIN PRODUCT AND TECHNOLOGICAL LEADERSHIP, PROMOTE

EMPLOYEE WELFARE, FURTHER CUSTOMER SATISFACTION,

SUPPORT EDUCATION AND RESEARCH IMPROVE COMMUNITY

LIFE, AND SOLVE OTHER SOCIETAL PROBLEMS. SOME OF THESE

GOALS, MAY, OF COURSE, BE IN CONSONANCE WITH THE GOAL

OF SHAREHOLDER WEALTH MAXIMISATION. FOR A RAPID

GROWTH RATE, A DOMINANT MARKET POSITION, AND A HIGHER

CUSTOMER SATISFACTION MAY LEAD TO INCREASING RETURNS

FOR EQUITY SHAREHOLDERS. EVEN EFFORTS TOWARD SOLVING

SOCIETAL PROBLEMS MAY FURTHER THE INTEREST OF


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SHAREHOLDERS IN THE LONG RUN BY IMPROVING THE IMAGE OF

THE FIRM AND STRENGTHENING ITS RELATIONSHIP WITH THE

ENVIRONMENT. WHEN THESE OTHER GOALS SEEM TO CONFLICT

WITH THE GOAL OF MAXIMISING THE WEALTH OF EQUITY

SHAREHOLDERS, IT IS HELPFUL TO KNOW THE COST OF

PURSUING THESE GOALS. THE TRADE-OFF HAS TO BE

UNDERSTOOD. IT SHOULD BE APPRECIATED THAT THE

MAXIMISATION OF THE WEALTH OF EQUITY SHAREHOLDERS

CONSTITUTES THE PRINCIPAL GUARANTEE FOR EFFICIENT

ALLOCATION OF RESOURCES IN THE ECONOMY AND HENCE IS TO

BE REGARDED AS THE NORMATIVE GOAL FROM THE FINANCIAL

POINT OF VIEW.

BASIC CONSIDERATIONS: RISK AND RETURN

SUPPOSE A FIRM IS EVALUATING AN INVESTMENT PROPOSAL.

WHAT ASPECTS ARE RELEVANT FROM THE FINANCIAL ANGLE?

FROM THE FINANCIAL POINT OF VIEW THE RELEVANT

DIMENSIONS ARE RETURN AND RISK.

TAKE ANOTHER DECISION SITUATION IN WHICH THE FIRM IS

CONSIDERING A FINANCING PROPOSAL. THE ASPECTS ALONG

WHICH SUCH A PROPOSAL IS EXAMINED ARE COST AND RISK.

SINCE COST IS THE INVERSE OF RETURN, HERE TOO THE BASIC


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DIMENSIONS ARE RETURN AND RISK. IN GENERAL, WE FIND THAT

THESE ARE THE TWO BASIC DIMENSIONS OF FINANCIAL

ANALYSIS.

WHAT IS THE RELATIONSHIP BETWEEN RETURN, RISK, AND

MARKET VALUE OF EQUITY? HIGHER THE RETURN, CETERIS

PARIBUS, HIGHER THE MARKET VALUE; HIGHER THE RISK,

CETERIS PARIBUS, LOWER THE MARKET VALUE.

IT MAY BE EMPHASISED THAT TYPICALLY, RISK AND RETURN GO

HAND IN HAND. THIS MEANS THAT IN A DECISION SITUATION, AN

ALTERNATIVE WHICH HAS A HIGHER RETURN TENDS TO HAVE

HIGHER RISK TOO. LIKEWISE, AN ALTERNATIVE WHICH HAS A

LOWER RETURN TENDS TO HAVE A LOWER RISK. IN FINANCIAL

ANALYSIS, THE TRADE-OFF BETWEEN RISK AND RETURN NEEDS

TO BE CAREFULLY ANALYSED.


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LEGAL, REGULATORY & PROCEDURAL ENVIRONMENT IN INDIA

IMPORTS AS AN ACTIVITY IS GOVERNED BY DEFINITE LAWS AND

HAVE WELL & COMPREHENSIVELY DEFINED PROCEDURES ALONG

WITH THE POLICIES FRAMED BY THE GOVERNMENT TIME TO

TIME, KEEPING ABREAST WITH THE CHANGING TIMES &

SITUATIONS.

THE LAWS/ RULES/ REGULATIONS WHICH GOVERN THE IMPORTS

ARE AS FOLLOWS :

FOREIGN TRADE (DEVELOPMENT & REGULATION) ACT, 1992

SEBI GUIDELINES

COMPANIES ACT 1956

INCOME TAX ACT

GUIDELINES ISSUED BY FINANCIAL INSTITUTIONS

EXPORT IMPORT POLICY (BY GOVERNMENT OF INDIA)

CUSTOMS ACT (1962)

EXCHANGE CONTROL MANUAL OF RBI

CUSTOMS VALUATION (DETERMINATION OF PRICE OF

IMPORTED GOODS) RULES, 1988,

CUSTOMS TARIFF ACT, 1975,

PROJECT IMPORTS REGULATIONS, 1944,


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CUSTOMS (PROVISIONAL ASSESSMENT)

REGULATIONS,1963,

BILL OF ENTRY (FORMS) REGULATIONS 1976,

CENTRAL EXCISE ACT

FERA 1973 ,

IDRA,

MRTP,

ESSENTIAL COMMODITIES ACT

SOME OF THEM ARE BRIEFLY DISCUSSED BELOW :

FOREIGN TRADE (DEVELOPMENT & REGULATION) ACT, 1992.

THE BASIC LAW THAT GOVERNS THE IMPORTS INTO INDIA IS THE

FOREIGN TRADE (DEVELOPMENT & REGULATION) ACT, 1992.

UNDER THIS ACT, IMPORTS OF ALL GOODS IS FREE EXCEPT FOR

THE ITEMS REGULATED BY THE POLICY OR ANY LAW FOR THE

TIME BEING IN FORCE. USING THE POWERS CONFERRED BY THE

SAID ACT, THE GOVERNMENT HAS ISSUED THE FOLLOWING

RULES & ORDERS :-

FOREIGN TRADE (REGULATION) RULES, 1993, WHICH INTER

ALIA, PROVIDE FOR GRANT OF SPECIAL LICENCE,

APPLICATION FOR GRANT OF


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LICENCES, FEES, CONDITIONS FOR LICENCES, REFUSAL OF

LICENCE, AMENDMENT TO LICENCE, SUSPENSION OF LICENCE,

CANCELLATION OF LICENCE, DECLARATION AS TO THE VALUE

AND QUANTITY OF IMPORTED GOODS, DECLARATION AS TO THE

IEC NUMBER, UTILIZATION OF IMPORTED GOODS, PROVISIONS

REGARDING MAKING, SIGNING OF ANY DECLARATION /

STATEMENT OR DOCUMENTS, POWER TO ENTER THE PREMISES

AND INSPECT, SEARCH AND SEIZURE OF GOODS, DOCUMENTS,

THINGS AND CONVEYANCE, SETTLEMENT, CONFISCATION AND

REDEMPTION AND CONFISCATION OF CONVEYANCE.

FOREIGN TRADE (EXEMPTION FROM APPLICATION OF

RULES IN CERTAIN CASES) ORDER 1993 ;

NOTIFICATIONS UNDER FOREIGN TRADE (DEVELOPMENT &

REGULATION) ACT 1992 ;

SEBI GUIDELINES

THE GUIDELINES APPLY TO THE SPECIAL PURPOSE VEHICLE FOR

THE PURPOSE OF ISSUANCE OF THE NEW INSTRUMENTS THIS

INCLUDES LAWS LIKE SEBI ACT, 1992. THE LAW LAYS STRESS ON

ADEQUATE DISCLOSURE, SEEK TO SAFEGUARD THE INTEREST

OF THE INVESTORS, AND EMPHASIS PRUDENTIAL CONTROLS, BY

REGULATING :


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1. PRICING OF PUBLIC ISSUES OF EQUITY CAPITAL

2. ISSUE OF FCD / PCD / NCD (TYPES OF DEBENTURES)

3. PROMOTERS CONTRIBUTION

COMPANIES ACT, 1956

THE CREATION OF THE SPECIAL PURPOSE VEHICLE IS

GOVERNED BY THE SAID LAW. THIS PROVIDES THE FRAMEWORK

FOR VARIOUS ASPECTS OF BRINGING THE SPV INTO EXISTANCE,

NAMELY:

1. NAME OF THE COMPANY

2. ARTICLE AND MAMORANDUM OF ASSOCIATION

3. CERTIFICATE OF INCORPORATION

4. SHAREHOLDING PATTERN

5. ACCOUNTING METHODS AND STANDARDS

6. DISCLOSURE POLICY

7. OTHER PENAL AND REGULATORY PROVISIONS AS APPLICABLE

INCOME TAX ACT

FOR PREPARING THE ESTIMATES OF WORKING RESULTS, THE

EXPECTED TAX BURDEN FOR THE FORECAST PERIOD, WHICH IS

USUALLY EIGHT TO TEN YEARS, HAS TO BE FIGURED OUT. THIS

CALLS FOR FAMILIARITY WITH THE PROVISION OF INCOME TAX


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ACT THAT ARE RELEVANT FOR DETERMINING THE MAGNITUDE

AND TIMING OF THE TAX BURDEN FOR A NEW PROJECT.

CUSTOMS ACT, 1962

BUT, ONE OF THE MOST IMPORTANT LAW PERTAINING TO

THE IMPORTS IS THE CUSTOMS ACT 1962. THE PATTERN AND

SCHEME OF THE CUSTOMS ACT, 1962 ARE TO CONSOLIDATE

AND AMEND THE LAW RELATING TO CUSTOMS. IT REPEALED :-

> THE SEA CUSTOMS ACT, 1878,

> THE INLAND BONDED WAREHOUSES ACT, 1896,

> THE LAND CUSTOMS ACT, 1924, AND

> THE AIRCRAFT ACT 1934.

THE CUSTOMS ACT, 1962, AS AN ADJECTIVE LAW, LAYS

DOWN THE PROCEDURE AND FORMALITIES CONNECTED WITH

COLLECTION OF CUSTOMS REVENUE, BOTH ON IMPORT AND

EXPORT OF GOODS. AT THE SAME TIME, IT IS CONCERNED WITH

PROHIBITIONS AND RESTRICTIONS ON IMPORTATION ON ITS

OWN. THE CUSTOMS ACT TELLS US :-

> WHEN IMPORT OR EXPORT TAKES PLACE AND WHEREFROM

SUCH OPERATION COMMENCE,

> WHAT ARE ILLEGALLY IMPORTED OR CONTRABAND GOODS,

> HOW ILLEGAL EXPORT IS PREVENTED OR DETECTED,


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> HOW ARE CUSTOMS DUTIES LEVIED OR EXEMPTED

PARTIALLY OR FULLY,

> HOW GOODS ARE ALLOWED TO BE IN TRANSIT AND THE

RESPONSIBILITY OF CARRIERS,

> WHEN AND HOW WAREHOUSING OF IMPORTED GOODS IS

ALLOWED, >HOW IS REFUND OR DRAWBACK OF DUTY

ALLOWED, WHAT CONTROL IS EXERCISED OVER COASTAL

GOODS,

> HOW THE POSTAL ARTICLES AND BAGGAGE DEALT WITH

AND ALLOWANCES THEREFOR ARE GIVEN,

> WHEN SEARCHES, SEIZURES AND ARRESTS ARE LEGAL,

> HOW ADJUDICATION IS MADE AND WHEN GOODS ARE

RELEASED OR CONFISCATED AND FINE

IN LIEU OF CONFISCATION AND PENALTIES ARE IMPOSED,

> WHEN CONVEYANCES ARE ALSO CONFISCATED,

> PROSECUTION FOR INFRINGEMENT OF CUSTOMS LAW IS

LAUNCHED, >HOW CLEARING AGENTS ARE APPOINTED TO

FACILITATE CLEARANCE OF GOODS AND HOW CONTROL IS

EXERCISED OVER THEM etc.

THE EXPORT IMPORT POLICY ALSO KNOWN AS THE TRADE

POLICY, IS A NECESSARY INSTRUMENT OF A GOVERNMENT TO


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REGULATE THE EXPORTS AND IMPORTS OF THE COUNTRY TO

ENSURE THE BALANCE OF TRADE. THE FOREIGN EXCHANGE

IS AVAILABLE TO THE GOVERNMENT ONLY THROUGH TWO

MEANS :-

> THE EXPORT PROCEEDS AND THE FOREIGN EXCHANGE

LOANS ; AND

> GRANTS FROM OTHER GOVERNMENTS AND INTERNATIONAL

AGENCIES ;

THE EXIM POLICY 1992-97

AS A RESULT OF THESE CHANGES, THE 1990-91 TO 1992-93

POLICY ALSO BECAME OUTDATED. HENCE, A NEW EXPORT

IMPORT POLICY WAS ANNOUNCED ON 31st MARCH 1992. IN

CONTRAST TO THE EARLIER THREE-YEAR POLICIES, THIS WAS A

FIVE YEAR POLICY EFFECTIVE FROM 1992-93 TO 1996-97. THIS

TIME FRAME COINCIDED WITH THE TIME FRAME FOR THE EIGHTH

FIVE YEAR PLAN.

THIS NEW POLICY SUBSTANTIALLY ELIMINATED LICENSING AND

QUANTITATIVE CONTROLS, BARRING TWO LISTS OF

PROHIBITED AND RESTRICTED ITEMS FOR BOTH EXPORTS AND

IMPORTS.


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OBJECTIVES OF THE EXIM POLICY 1992-97: - THE PRINCIPAL

OBJECTIVES OF THE EXIM POLICY 1992-97 ARE AS FOLLOWS :-

# TO ACCELERATE THE COUNTRYs TRANSITION TO AN

INTERNATIONALLY ORIENTED ECONOMY WITH A VIEW TO DERIVE

MAXIMUM BENEFIT FROM EXPANDING GLOBAL MARKET

OPPORTUNITIES;

# TO AUGMENT THE PRODUCTIVITY, MODERNIZATION AND

COMPETITIVENESS OF INDIAN AGRICULTURE, INDUSTRY &

SERVICES AND THEREBY TO ENHANCE THEIR EXPORT

POTENTIAL AND CAPABILITIES;

# TO ENCOURAGE THE ATTAINMENT OF INTERNATIONALLY

ACCEPTED STANDARDS OF QUALITY AND THEREBY IMPROVE THE

IMAGE OF INDIAs PRODUCTS ABROAD;

# TO STIMULATE INDIAs EXPORTS BY FACILITATING ACCESS

TO REQUIRED RAW MATERIALS, INTER-MEDIATES, COMPONENTS,

CONSUMABLE AND CAPITAL GOODS FROM THE INTERNATIONAL

MARKET;

# TO ENCOURAGE EFFICIENT AND INTERNATIONALLY

COMPETITIVE IMPORT SUBSTITUTION WITHIN THE LIBERALIZED

FRAMEWORK OF FOREIGN TRADE;


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# TO IMPART GREATER TRANSPARENCY IN THE

EXPORT- IMPORT POLICIES AND MINIMIZE QUANTITATIVE

RESTRICTIONS, LICENSING AND OTHER DISCRETIONARY

CONTROLS;

# TO STRENGTHEN AND STIMULATE THE COUNTRYs

RESEARCH AND DEVELOPMENT (R&D) CAPABILITIES;

# TO CONSERVE THE FORESTS A-ND WILDLIFE OF INDIA AND

ASSIST EFFORTS AT PRESERVATION, PROTECTION AND

PROMOTION OF A HEALTHY ECO SYSTEM FOR ENSURING

BALANCED AND SUSTAINABLE DEVELOPMENT; AND

# TO SIMPLIFY AND STREAMLINE THE PROCEDURES

GOVERNING EXPORTS AND IMPORTS.

EXIM POLICY 1997-2002

THE EXPORT IMPORT POLICY 1997-2002 CLEARLY

REFLECTS THE WILL OF THE GOVERNMENT TO LIBERALIZE THE

ECONOMY AT A GIVEN PACE. THE POLICY DEFINES AND

EXHAUSTIVELY EXPLAINS THE CATEGORIES OF IMPORTERS,

SPECIFIC PROVISIONS FOR IMPORT OF GOODS, SPECIAL

SCHEMES FOR IMPORTS HOW AND WHEN TO OBTAIN IMPORT

LICENSE FOR IMPORT OF THE ITEMS INCLUDED IN THE NEGATIVE

LIST, TERRITORIAL JURISDICTION OF LICENSING AUTHORITIES,


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CONDITIONS FOR ISSUE OF THE LICENSE VALIDITY OF IMPORT

LICENSES / CCPs, REVALIDATION OF LICENSE, THE BACKGROUND

OF THE POLICY CLEARLY SUGGESTS THAT INDIA WOULD ACHIEVE

THE LEVELS OF TARIFFS PREVAILING IN THE ASEAN COUNTRIES.

THE EFFORTS MADE IN THIS DIRECTION IS THROUGH THE

REDUCTION IN THE CUSTOMS DUTY ON CAPITAL GOODS FROM 25

% TO 20 %. THE SAID RATES ARE APPLICABLE TO THE PROJECT

IMPORTS. THIS OPTIMIZES THE INITIAL STEPS FOR FURTHER

REDUCTION OF THE DUTIES IN THE FORTHCOMING YEARS. THE

DUTY ON SEVERAL STEEL INDUSTRY INPUTS, LIKE COKING COAL,

FROM 5 % TO 3 %, THE DUTY ON COLD ROLLED COILS REDUCED

FROM 30 % TO 25 %, REDUCTION ON THE NON-COKING COAL

FROM 20 % TO 10 % TO HELP THE POWER SECTOR, BESIDES, THE

IMPORT PROCEDURES ARE FURTHER SIMPLIFIED , AGAINST

SEVEN APPLICATION FORMS REQUIRED FOR IMPORT OF VARIOUS

ITEMS IN THE NEGATIVE LIST ONLY ONE FORM WILL BE

REQUIRED. NOW MOST OF THE ITEMS ARE FREE FROM LICENSE.

ALSO, THE VALIDITY OF THE IMPORT

LICENSES AND CUSTOM CLEARANCE PERMITS IS UPTO 12

MONTHS, IN CASE OF NON-CAPITAL ITEMS, AND FOR CAPITAL

ITEMS THE VALIDITY OF THE LICENSES IS UPTO 24 MONTHS,


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FURTHER, REVALIDATION MAY BE GRANTED ON THE MERIT OF

THE INDIVIDUAL CASE. DECENTRALIZATION OF THE LICENSING

AUTHORITIES ON REGIONAL BASIS, FREE TRANSFERABILITY OF

GOODS SO IMPORTED EXCEPT UNDER CERTAIN CASES,

ANOTHER SIGNIFICANT FEATURE OF THE POLICY IS THE

ALLOWANCE OF THE IMPORTS OF THE SECOND HAND ITEMS

EXCEPT IMPORT OF THE USED RUBBER TYRES, THE POLICY HAS

FURTHER MODIFIED THE PROCEDURE FOR OBTAINING

IMPORTERS-EXPORTERS CODE NUMBER, THE SPECIAL IMPORT

LICENSE (SIL) ENTITLEMENT OF EXPORTERS HOLDING ISO 9000

OR IS/ISO 9000 CERTIFICATION HAS BEEN INCREASED FROM 2 %

TO 5 %, (SIL) ON EXPORT OF PRODUCTS OF SMALL SCALE

INDUSTRIES (SSIs) HAS BEEN INCREASED FROM 1 % TO 2 %, 542

RESTRICTED ITEMS HAVE BEEN LIBERALIZED FOR IMPORTS,

SPECIAL DEPRECIATION NORMS HAVE BEEN PROVIDED FOR

ELECTRONIC GOODS UPTO 70 % IN THREE YEARS AND ALSO

PERMISSION GRANTED FOR DISPOSAL, ON PAYMENT OF

APPLICABLE DUTY.

THE IMPORT OF ANY TYPE OF GOODS INTO INDIA IS

REGULATED BY GOVERNMENT OF INDIA AND ITS POLICIES IN THIS

REGARD IS ANNOUNCED BY DIRECTOR GENERAL OF FOREIGN


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WHICH HE COMES TO KNOW THAT SUCH FOREIGN EXCHANGE

CANNOT BE SO USED OR THE CONDITIONS CANNOT BE

COMPLIED WITH, SELL THE FOREIGN EXCHANGE

T0 AN AUTHORIZED DEALER OR TO A MONEY-CHANGER.

SECTION 8(4) - FOR THE AVOIDANCE OF DOUBT, IT IS HEREBY

DECLARED THAT WHERE A PERSON ACQUIRES FOREIGN

EXCHANGE FOR SENDING OR BRINGING INTO INDIA ANY GOODS

BUT SENDS OR BRINGS NO SUCH GOODS OR DOES NOT SEND OR

BRING GOODS OF A VALUE REPRESENTING THE FOREIGN

EXCHANGE ACQUIRED, WITHIN A REASONABLE TIME OR SENDS

OR BRINGS ANY GOODS OF A KIND, QUALITY OR QUANTITY

DIFFERENT FROM THAT SPECIFIED BY HIM AT THE TIME OF

ACQUISITION OF THE FOREIGN EXCHANGE, SUCH PERSON

SHALL, UNLESS THE CONTRARY IS PROVED, BE PRESUMED NOT

TO HAVE BEEN ABLE

TO USE THE FOREIGN EXCHANGE FOR THE PURPOSE FOR WHICH

HE ACQUIRED IT OR, AS THE CASE MAY BE, TO HAVE USED THE

FOREIGN EXCHANGE SO ACQUIRED OTHERWISE THAN FOR THE

PURPOSE FOR WHICH IT WAS

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