To assess a project from the financial point of view, information about project cost, financing source, profitability, tax burden and projected financial condition is very important. The cost of a project represents all capital expenditure to be incurred for acquisition of its fixed assets plus the net contribution of long-term resources in the
proposed current assets.
In other words, the fixed cost of the project plus the net working capital requirement to run the project will comprise its total cost. Once the cost is estimated, the financing plan will have to be worked out on realistic basis.
Factors Determining the Cost of the Project
- Size of the project
- Duration of the project
- Ability to complete project within specified time period
- Nature of the project
Components of Project Cost
The requirement of physical assets for a project is essentially an engineering estimate. The analyst should, however, recheck the various cost items detailed in the fixed cost statement given in the technical report. Cost of the project represents the sum of all items of outlay of a project. Although it seems to be a simple term, it conveys different meaning to different part of the organization. The following could be the possible components of a project cost.
- Land and site development cost
- Cost of the building and civil works
- Cost of the plant and machinery
- Technical know-how fees
- Expense on foreign technicians and cost of training
- Miscellaneous fixed assets
- Preliminary and capital issue expense
- Pre-operative expense
- Interest during construction period
- Margin money for working capital
Means of Financing a Project
To meet the cost of the project the following sources of finance may be utilized:
- Fund provided by the sponsors.
- Issue of ordinary shares: This is the contribution made by the ordinary shareholders, who enjoy the rewards and bear the risks of ownership. However, the liability is limited to their capital contribution.
- Issue of preference shares: A hybrid form of financing. Preference capital partly takes some characteristics of equity capital and some attributes of debt capital. It is similar to equity because preference dividend like is not a tax-deductible payment. It resembles debt capital because the rate of preference dividend is fixed.
- Term Loans: Term loans, which represent secured borrowing, are presently the most important source of finance for new projects. They carry fixed rate of interest and are repayable over a period of 6 to 10 years in periodic instalments.
- Debt Instruments: Bonds and Debentures, a kind of promissory notes, are debt instruments for raising long-term debt capital. Secured instruments are protected by a charge on the properties of the issuing company.
- Deferred payment/Suppliers Credit: Generally, suppliers of the machinery provide deferred credit facility under which payment for the purchase of machinery can be made over a period of time under documentary credit or documentary collection process in international trade. The interest rate on deferred credit and the period of payment vary rather widely. Normally, the supplier of machinery when offers deferred credit facility insists that the buyer should furnish the bank guarantee.