Project appraisal

techniques
Undiscounted measures
1. Ranking by inspection
2. Payback period
3. Proceeds per rupee of outlay
4. Average annual proceeds of Rupee
Outlay
 Ranking by Inspection:
With the same investment, two projects
produce the same net income, but one
continues to earn longer than other will be
selected (or) in others instances, for the
same investment, the total net value of
production may be the same, but one
project has more of the flow earlier in the
time sequence will be selected. The project
which yields higher total net cash flow will
be selected.
Advantages: Simple to Workout
Disadvantage: Ignores time value of
money. Projects cannot be accepted fully
based on this method. More elaborate
analysis is necessary.
 Payback period
Pay back period is the time required for the
stream of cash inflow of an investment to equal
the initial project outlay i.e. the time required for
the project to pay itself out. The project which
bears quick payback will be selected.
Advantages: The main advantages of this
method is its simplicity. Since this method
emphasis on quick cash recovery it is suitable for
project with uncertain future returns.
Disadvantages: This method fails to consider
the earnings received after the payback period. It
does not account for the timing of cash flow and
time value of the money. Also there is no logical or
theoretical basis for fixing a meaningful payback
period.
Payback period
P = I/E
P = Payback period of the project in years
I = Investment of the project in rupees
E = Annual net cash revenue in Rupees
 Discounted measures

Net present worth (NPW)

Benefit-Cost Ratio (B-C Ratio)
Internal Rate of Return (IRR)
Net Present Worth (NPW) or Net Present value (NPV)
The cash flow is actually the difference between
cash inflows and cash outflows.
The investment made in the horticultural projects
is treated as cost of the project or simply it is cash
outflows of the project.
The various returns obtained from projects at
different time periods is termed as cash inflows or
gross benefits of the projects.
If the cash flows are discounted with appropriate
discount rate over the life span of the project,
then it is called Net Present Worth (NPW) of the
project.
The selection criterion of the project depends
upon positive value of NPV when discounted at
the opportunity cost of capital.
NPV is an absolute measure, not a relative
measure.
NPW = P1 + P2 + -----------+ Pn
C

(1+i) t1
(1+i)t2 (1+i)tn

where,
NPW = Net present Worth
P1 = Net cash flow in first year
i = Discount rate
t = Time period
C= Initial cost of the investment
NPV or NPW =

Bt = Cash inflows in rupees in tth year

Ct = Cash outflows in rupees in tth year
is the sigma and it stands for total summation
of cash flows over life span of the project
i.e., t = 1 to n years
Decision rules:
a. Accept the investment in the business if NPW is
positive or > 0
b. Reject the investment in the business if NPW is
negative or < 0
c. If NPW = 0, (cash inflows = cash outflows) that
means the cost of the investment has been fully
recovered at the rate of discounting
d. In case of selection from a number of alternative
investment proposals, the project would be
arranged in descending order of their NPVs and
give ranks i.e. first rank is given to the project
with highest positive NPV and so on.
e. Select such projects or investment proposals with
highest NPVs.
 Estimation of NPW for 2 projects
Project-I Project-II

Y Costs Gross Net Discou NPW Year Costs Gross Net Discoun NPW(Rs.)
e (Rs.) return income nt (Rs.) (Rs.) returns income t factor
ar s (Rs.) factor (Rs.) (Rs.) at 12%
(Rs.) at 12%

1 38,900 --- -38,900 0.8929 -34,734 At the 25,000 --- -25000 0.507 -12675
end of
6th year
2 9,239 28,475 19,236 0.7972 15,335 7th year 4,250 10,260 6010 0.452 2717

3 10,575 32,550 21,975 0.7118 15,642 8th year 4,792 12,550 7758 0.404 3134

4 11,952 35,610 23,658 0.6355 15,035 9th year 5,368 14,530 9162 0.361 3307

5 12,858 39,802 26,944 0.5674 15,288 10th year 5,975 16,275 10300 0.322 3317

NPW 26,566 11th year 6,456 19,396 12940 0.287 3714

12th year 7,187 21,470 14283 0.257 3671

NPW 7185
 Benefit-Cost Ratio (B-C Ratio)

It is one of the discounted measures that

are used to assess the credit-worthiness of
the project. Here we compare the present
worth of costs with present worth of
benefits.
This ratio is obtained by dividing the sum
of the present worth of benefit stream of
the project with sum of the present worth
of cost stream.
 n Bt
B-C Ratio = (1 + i) n
t=1

n
Ct

(1 + i) n
t=1
 Estimation of Benefit-cost ratio (BCR) for 2 projects
Project-I Project-II

Year Costs Gross Discoun Present Present Year Costs Gross Discoun Present Present
(Rs.) returns t factor worth of worth of (Rs.) returns t factor worth of worth of
(Rs.) at 12% costs gross (Rs.) at 12% costs gross
(Rs.) returns (Rs.) returns
(Rs.) (Rs.)
1 38,900 --- 0.8929 34,734 --- At the 25,000 --- 0.507 12,675 ---
end of
6th year
2 9,239 28,475 0.7972 7,365 22,700 7th year 4,250 10,260 0.452 1,921 4,638

3 10,575 32,550 0.7118 7,527 23,169 8th year 4,792 12,550 0.404 1,936 5,070

4 11,952 35,610 0.6355 7,596 22,630 9th year 5,368 14,530 0.361 1,938 5,245

5 12,858 39,802 0.5674 7,296 22,583 10th 5,975 16,275 0.322 1,924 5,241
year

64,516 91,083 11th 6,456 19,396 0.287 1,853 5,567

year

12th 7,187 21,470 0.257 1,847 5,518

year

24,094 31,278
 Present worth of gross returns
Benefit-cost ratio =
Present worth of costs
of Project-I
= 91083/64518 = 1.41
Benefit-cost ratio = 31278/24098 = 1.30
of Project-II
Decision rules:

a) If benefit-cost ratio (BCR) of the project is more than one, then

the investment in the project is credit worthy and hence the
proposed project can be accepted for implementation.
b) It is better to work out BCR for alternative projects or business
investment activities which are suitable to the given resources and
environment and then select the project with the highest BCR
among the alternatives for implementation.
c) Projects with BCR less then one should be dropped because they
are unworthy projects.
d) If BCR = 1, (cash inflows = cash outflows) that means the cost
of the investment has been fully recovered at the rate of
discounting
e) It is better to rank all the suitable alternative projects based on
their magnitudes of BCR. The first rank should be allotted to the
project with the highest BCR.
 Internal rate of return (IRR)
IRR is also referred to as discounted rate of return or yield of an investment. IRR is the
discount rate which makes the net present value equal to zero or IRR is the discount rate
which makes the Discounted benefits equal to Discounted costs i.e. BCR=1.

It is the rate of return per rupee invested in Projects obtained over the life span of the
projects for example, if IRR of an irrigation project is 33%, it means the project would
give an average annual return of Rs33 per Rs.100 invested in irrigation project. This
means at this IRR rate, the net present value of cash flow of the project (NPV) over its
life span becomes zero.

IRR is found out by trial and error method. Initially two discount rates one which results in
a positive NPV and the other one which results in a negative NPV is found out. Discount
rate with positive NPV is called lower discount rate and the discount rate with negative
NPV is called higher discount rate. From these lower and higher discount rates IRR is
worked out using the formula given below:
 IRR=
{Lower discount rate} +{Diff. between 2 discount
rates} x

Present worth of the cash flow at lower discount

rate
Absolute diff. between the PWs of the cash
flow at
2 discount rates
Decision Rules:
1. Accept the investment opportunity if IRR
is greater than the market rate of interest
2. Reject the investment opportunity if IRR
is less than the market rate of interest
3. When more than one investment
opportunities are involved in the selection
process:
a. Arrange the investment opportunities in
descending order of the value of IRR.
b. Choose that set of opportunities for
which IRR is greater than or equal to the
market rate of interest, depending on the
availability of funds.
Estimation of IRR for Project-I(one ha)

Year Costs Gross Net Discou Net Discount Net

(Rs.) income income nt facor present factor present
(Rs.) (Rs.) (40%) worth (43%) worth
(Rs.) (Rs.)
1 38,900 --- -38,900 0.7143 -27,786 0.6993 -27,203

2 9,239 28,475 19,236 0.5102 9,814 0.4890 9,406

3 10,575 32,550 21,975 0.3644 8,008 0.3419 7,513

4 11,952 35,610 23,658 0.2603 6,158 0.2319 5,657

5 12,858 39,802 26,944 0.1859 5,009 0.1672 4,505

52,913 1,203 -121

IRR=40+3 1203
1203+121

= 40+3(0.9083)
= 40+2.7249
= 42.7249
= 42.7%
Cost concepts
ii) Cost Concepts: Some of the cost concepts used in farm management
studies by the Commission on Agricultural Costs and Prices (CACP) of
Government of India are A1, A2, B1, B2, C1 and C2, which are defined as
follows:
Cost A1 includes:
1. Value of human labour (casual and permanent).
2. Value of bullock power (owned and hired).
3. Value of machine power (owned and hired).
4. Value of seeds.
5. Value of manures and fertilizers.
6. Value of plant protection chemicals.
7. Value of weedicides.
8. Irrigation charges. 181
9. Land revenue and other taxes.
10. Depreciation on farm implement and farm buildings.
11. Interest on working capital.
12. Other miscellaneous expenses.
 The following concepts can be used for easy calculation of the cost of cultivation.
1) Depreciation for buildings: 2 per cent for pucca building; 5 per cent for
tiled building and 10 per cent for katcha building.
2) Depreciation for implements: 10 per cent for major implements and 20 per
cent for minor implements.
3) Depreciation for cattle: Appreciation in the value of animals during the first
3 years would be at the ratio of 1:3:5.It remains constant during 4th and 5th year.
Then it is assumed that the value of animal depreciates @ 12.5 per cent per year
from 6th to 14th year in straight-line method.
4) Interest on working capital: 12 per cent per annum or opportunity cost of
capital.
Cost A2 = Cost A1 + Rent paid for leased in land.
Cost B1 = Cost A1 + Interest on the value of owned capital assets (excluding
land).
Interest rate of long - term government floated loans or securities: 10 per cent.
Cost B2 = Cost B1 + Rental value of owned land (less land revenue) and Rent
paid for leased in land.
Cost C1 = Cost B1 + Imputed value of family labour.
Cost C2 = Cost B2 + Imputed value of family labour.
iii) Income measures in relation to different cost concepts
1. Farm Business Income = Gross Return - Cost A1.
2. Owned Farm Business Income = Gross Return - Cost A2.
3. Family Labour Income = Gross Return - Cost B2.
4. Net Income = Gross Return - Cost C2.
5. Farm Investment Income = Net Income + Imputed rental value of owned land

+ Interest on fixed capital

 A model project proposal for floriculture industry

A. Title of the project:

Title should be brief and apt. It should be indicate clearly the main business
activity. Eg. Production of Rose cut flowers for domestic and export market.

B. Introduction:
Give a line of introduction of the proposed business. Justification for
starting the business, scope and competition should be clearly stated.

C. Production technology:
Give detailed account of the entire production process along with the
scientific basis for each step.

D. Project components: For cut flower production

1. Land
2. Greenhouse
3. Planting material
4. Irrigation
5. Fertilization system
6. Grading and packing room
7. Refrigerated van
8. Office equipment
9. Import of technology
10. Labour charge
11. Technical manpower
12. Pesticides, Fertilizers, preservatives
Give the costing for each of the major
components and classify them into
A. Fixed cost Permanent items
B. Recurring cost planting, cultivation,
maintenance, storage, packing andtransportation
costs.
E. Project yield
Estimate the total production expected in different
years and the realization expected through sales.
F. Repayment
Principal and interest are to be repayable in seven
years with a moratorium for the first year on
interest and for 2 years on principal.
Budget requirement
For a one hectare greenhouse to produce Rose cut
flowers.
Budget requirement
For a one hectare greenhouse to produce Rose cut
flowers.
 A. Fixed cost
Item Amount in lakhs
S. No.
1. Land and development 4.0
2. Green house 13.0
3. Cold storage 10.0
4. Grading and packing room 5.0
5. Office area 2.5
6. Refrigerated van 1.0
7. Generator set 2.0
8. Fax, telephone, Computer 1.0
9. Furniture 0.5
10. Power supply installations 1.5
11. Water supply system, drip irrigation and 6.0
misting liners
12. Planting material and planting 30.0
Total fixed cost 76.5 lakhs
 B. Recurring costs
Item Amount in
S. No. lakhs
1. Electricity charges / year 6.0
2. Manures and fertilizers 1.0
3. Plant protection 1.0
4. Preservatives 3.0
5. Packing material 2.0
6. Air freight 125.0
7. Labour charges 3.0
8. Commission / duty/ insurance 15.0
9. Salaries 5.0
10. Overhead costs 0.5
11. Maintenance cost 1.0
12. Miscellaneous 3.7
Total recurring cost 166.2
Total investment for the project = Fixed cost +
Recurring cost = 76.5 + 166.2 in first year=
242.7.
Project yield
No. of rose plants per hectare of greenhouse =
60,000
No. of flowers expected per plant = 100 to 150
No. of exportable quality flowers /plant = 60 to
100
Price per flower in international market = Rs. 6
to 11
Total exportable flowers /ha @ 100 flowers /plant
= 60 lakhs flowers
Gross income through exports @ 50
flowers/plant = 300 lakhs (minimum).
B-C ratio = Present worth of gross returns/
Present worth of costs
= 300/242.7 = 1.24
 Cost concepts of Capsicum Cultivation under 500 sq.m.
Polyhouse
S. No. Particulars Value (Rs.)
Cost A1 With subsidy
1 Hired human labour 44486
2 Inputs (Planting material, FYM, Fertilizers, chemicals) 24780
3 Electricity charges 2700
4 Depreciation 23648
5 Interest on working capital 9890
Total of A1
105504
Cost B

1 Cost A1 105504
2 Rental value of owned land 1125
3 Interest on fixed capital 42035
Total of B
148664
Cost C

1 Cost B 148664
2 Owned human labour 11030
3 Total of Cost C 159694
Different Income Measures for Capsicum
Cultivation under 500 sq.m. Polyhouse
S. No. Particulars Amount (Rs.)

1 Farm Business Income= 78496

Gross Returns - Cost A1
2 Family Labour Income= 35336
Gross returns-Cost B2
3 Net Income= Gross returns-Cost C2 24306

4 Farm Investment Income=Net Income + 67466

Imputed rental value of owned land

+ Interest on fixed capital

Calculation of NPW, B.C Ratio and IRR for Capsicum
cultivated under 500m2 Polyhouse
Total
Recurrin Net
Capital
Years g Costs Income Benefit discount
cost
Total . factor NPW PW of PW of
costs @25% (Rs.) costs benefits
184000
1 394745 -309170
98425 493170 0.8000 -247336 394536 147200
2 0 67610 67610 198000 130390 0.6400 83450 43270 126720
3 0 98425 98425 211000 112575 0.5120 57638 50394 108032
4 0 67610 67610 222500 154890 0.4096 63443 27693 91136
5 0 98425 98425 236000 137575 0.3277 45081 32252 77332
6 0 67610 67610 241000 173390 0.2621 45453 17724 63177

47729 565869 613597

 Calculation of Internal rate of
return(IRR)
Total
Capital Recurr
Year ing Net
co Income Discount Discount NPW(Rs.) at
s costs Benefits
st Total Factor NPW Factor 35%
costs @25% (Rs.) @35% disc.rate
184000
1 394745 -309170
98425 493170 0.8000 -247336 0.7407 -229015
198000
2 0 67610 67610 130390 0.6400 83450 0.5487 71545
211000
3 0 98425 98425 112575 0.5120 57638 0.4064 45755
222500
4 0 67610 67610 154890 0.4096 63443 0.3011 46632

5 0 236000 137575
98425 98425 0.3277 45081 0.2230 30681

6 0 241000 173390
67610 67610 0.2621 45453 0.1652 28643

47729 -5758
 Calculation of NPW, B.C Ratio and IRR for Carnation
cultivated under 500m2 Polyhouse
Total
Capital Recurri Net
Years ng Income Benefit discount
cost
Costs Total . factor NPW
costs @25% (Rs.)

1 416795
150825

2 0
70271

3 0
150825

4 0
70271

5 0
150825

6 0
70271
Depreciation
Defined as the annual loss in value of durable
assets due to use, wear, tear, age, etc.
A business expense that reduces annual profit
A reduction in the value of an asset
 Assets that May Be
Depreciated
a useful life of more than one year
a determinable useful life but not an unlimited
life
a use in business

xamples: vehicles, machinery, equipment,

uilding, fences, purchased breeding livestock,
ells. Land is not depreciable, but some
mprovements to land (e.g. drains) are deprecia
Depreciation Terms
Cost: the price paid for the asset
Useful life: number of years the asset is
expected to be used in business
Salvage value: expected market value of the
asset at the end of its useful life
Book value: the assets original cost less
accumulated depreciation
Depreciation Methods
Straight Line

Sum-of-the-Years Digits (SOYD)

Declining Balance
 Straight LineCost Salvage Value
Annual Depreciation =
Useful Life

Or

Annual Depreciation = (Cost Salvage Value) x

where R is found by dividing 100% by useful lif
 Sum-of-the-Years DigitsRL
Annual Depreciation = (Cost Salvage
Value) x SOYD

RL = remaining years of useful life

SOYD = sum of all the numbers from 1 through

the estimated useful life

For 5 year life, SOYD = 1+2+3+4+5 = 15

Declining Balance
Annual Depreciation =
Beginning Year Book Value x R

R is a constant percentage rate. Its value

depends on useful life and the type of
declining balance chosen. It is a multiple
of the straight line rate.
 Examples
Calculate depreciation for a machine with
a cost of $10,000, a salvage value of $2,000
and a useful life of 10 years.
 Using Straight Line
($10,000 $2,000)
Annual Depreciation =
10

= $800

nnual depreciation will be the same every yea

nder this method.
 Using SOYD
+2+3+4+5+6+7+8+9+10 = 55
10
Year 1: ($10,000 $2,000) x =
$1,454.55 55
9
Year 2: ($10,000 $2,000) x =
$1,309.09 55
 Using Double Declining Balance
Year 1: $10,000 x 20% = $2,000
Year 2: $ 8,000 x 20% = $1,600
Year 3: $ 6,400 x 20% = $1,280

100%
20% = 2 x
10

useful life
 Using 15% Declining Balance
Year 1: $10,000 x 15% = $1,500
Year 2: $ 8,000 x 15% = $1,275
Year 3: $ 6,400 x 15% = $1,084

100%
15% = 1.5 x
10

useful life