Capital Investment Decisions | Term Loans | PAPER III – ACCOUNTING & FINANCIAL MANAGEMENT FOR BANKERS | MODULE C: FINANCIAL MANAGEMENT

Capital Investment Decisions and Term Loans

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Descriptive Notes

Capital investment decisions involve long-term commitments of funds in projects or assets with the aim of generating future returns. These decisions are crucial as they determine the future growth and profitability of businesses.

Term Loans

Term loans are financial facilities provided by banks for a specific purpose, usually for acquiring fixed assets or capital expenditures. These loans have a fixed repayment schedule and can span short-term (up to 1 year), medium-term (1–5 years), or long-term (over 5 years).

Project Financing

Project financing is a method where lenders evaluate the viability of a project rather than the borrower’s creditworthiness. The cash flow generated by the project is the main source of repayment, and the project's assets act as collateral.

Deferred Payment Guarantees

Deferred Payment Guarantees (DPGs) are commitments by banks to pay suppliers on behalf of a borrower at a future date. This helps borrowers purchase capital equipment without immediate payment.

Investment Appraisal Methods

Non-Discounted Cash Flow Methods:

• Payback Period: Time taken to recover the initial investment from cash inflows.
• Accounting Rate of Return (ARR): Average profit divided by average investment.

Discounted Cash Flow Methods:

• Net Present Value (NPV): Present value of cash inflows minus the initial investment.
• Internal Rate of Return (IRR): Discount rate at which NPV is zero.
• Profitability Index (PI): Ratio of PV of inflows to initial investment.

Term Loan Appraisal vs Project Appraisal

Aspect	Term Loan Appraisal	Project Appraisal
Focus	Borrower's creditworthiness	Viability of the project
Security	Assets/collateral based	Project cash flow and assets
Repayment Source	Existing operations	Project revenues
Evaluation	Financial history, capacity, and character	Technical, financial, and market feasibility

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10 Mathematical Examples (Medium-Hard)

1. Initial investment = ₹1,00,000; Cash inflows = ₹25,000 annually for 5 years. Payback Period = 4 years.
2. NPV = -1,00,000 + (30,000 / 1.10) + (30,000 / 1.10²) + (30,000 / 1.10³) + (30,000 / 1.10⁴) + (30,000 / 1.10⁵) = ₹17,204 approx.
3. IRR: Cash inflows = ₹40,000 for 3 years; Initial outlay = ₹1,00,000; Trial and error IRR ≈ 15.2%.
4. ARR: Average profit = ₹15,000; Average investment = ₹75,000. ARR = (15,000/75,000) × 100 = 20%.
5. Profitability Index: PV of inflows = ₹1,10,000; Initial investment = ₹1,00,000. PI = 1.10.
6. Loan of ₹10 lakh at 10% p.a. for 5 years. EMI = ₹21,247. Loan appraisal checks if DSCR > 1.25.
7. Project cost ₹50 lakh; Promoter's equity = ₹15 lakh; Term loan required = ₹35 lakh. DER = 2.33:1
8. DPG: ₹25 lakh equipment import. Supplier credit for 3 years. Bank guarantees deferred payments quarterly.
9. NPV = -₹2,00,000 + ₹60,000×5 × PVAF @ 12% = ₹40,360 (use PVAF = 3.6048)
10. Break-even point: Fixed cost = ₹10 lakh; Variable cost/unit = ₹500; Price/unit = ₹1,000. Break-even units = 20,000

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10 MCQs with Answers

1. Which of the following is a discounted cash flow method?
   a) Payback Period
   b) Accounting Rate of Return
   c) Net Present Value
   d) Average Rate of Return
2. The Internal Rate of Return (IRR) is the rate at which:
   a) NPV is maximum
   b) Future value equals initial investment
   c) NPV is zero
   d) Discounted cash flow is zero
3. In project financing, what is primarily considered?
   a) Collateral value
   b) Promoter’s credit history
   c) Project's cash flows
   d) Company’s turnover
4. Deferred Payment Guarantee relates to:
   a) Issuing preference shares
   b) Guaranteeing supplier payments in future
   c) Project subsidy
   d) Promoter’s contribution
5. Which metric shows how much value is created per rupee invested?
   a) IRR
   b) Payback
   c) Profitability Index
   d) ARR
6. Which method ignores time value of money?
   a) Payback Period
   b) NPV
   c) IRR
   d) PI
7. Which statement is true for Term Loan Appraisal?
   a) It focuses on borrower's financials
   b) It considers only project cash flow
   c) It is applicable only to startups
   d) It needs no collateral
8. NPV is positive when:
   a) IRR < Cost of Capital
   b) IRR > Cost of Capital
   c) IRR = 0
   d) Discount rate is zero
9. Term loan repayment depends on:
   a) Marketing plan
   b) Past debt history only
   c) Cash flows from business operations
   d) Guarantor’s profile
10. What does a DPG not provide?
    a) Postponement of payment
    b) Support for capital goods purchase
    c) Import guarantee
    d) Cash disbursement upfront