A SUMMER PROJECT REPORT

On

PROJECT FINANCE & PROJECT EVALUATION

Conducted​ a​ t
“INDIAN OIL CORPORATION LTD.”
Barauni Refinery

Submitted to

MOTILALAL NEHRU INSTITUTE OF RESEARCH

AND BUSINESS ADMINISTRATION

University of Allahabad

In partial fulfillment of the requirement

1
 For the degree of

MBA- FIN
(Session 2011-13)

Submitted by:
Subhash Kumar
MBA 1​st​ Year

INDEX

Chapter- I: INTRODUCTION

∙ ​Introduction
∙ ​Importance of investment decision
∙ ​Objective of the study
∙ ​Limitations
∙ ​Research Methodology

Chapter-II: COMPANY PROFILE

2
 ● Introduction
● Background
● Products
● Refineries
● IOCL Groups
● International Rankings
● Competitors
● Vision
● Mission
● Values
● Objectives
● Production performance
● Financial performance
● Board of Directors
● Pipelines Division
● SWOT Analysis
● Barauni Refinery

Chapter-III: PROJECT PLANNING

● Introduction
● Nature of investment decisions
● Purchase Process
● Process of Investment decisions

3
 ● Importance of Investment decisions
● Types of Investment decisions
● Investment Evaluation criteria
● Cost effective Analysis
● Project planning

Chapter- IV: PROJECT FINANCE

∙ ​Sources of finance

Chapter –V: EVALUTION OF CAPITAL BUDGETING

∙ ​Payback period
∙ ​Average rate of return
∙ ​Net present value
∙ ​Internal rate of return
∙ ​Profitability index method

Chapter-VIII: FINDINGS, SUGGESTIONS

∙ ​Findings
∙ ​Suggestions

4
 CHAPTER – I
Introduction 

 
 
 

5
 
 
 
 
 
 
 
 
Introduction:-

A project is an activity sufficiently self-contained to permit Financial and Commercial

analysis. In most cases projects represent expenditure of capital funds by pre-existing
entities which want to expand or improve their operation.

In general a project is an activity in which, we will spend money in expectation of

returns and which logically seems to lead it to planning. Financing and implementation
as a unit is specific activity with a specific starting point and a specific ending point
intended to accomplish a specific objective.

To take up new project involves a capital investment decision and it is the top
management’s duty to make a Situation and feasibility analysis of that particular project
and means of financing and implementing it financing is a rapidly expanding field
which focuses not on the credit status of a Company, but on cash flows that will be
generated by a specific Project.

Capital budgeting has its origins in the natural resource and infrastructure sectors. The
current demand for Infrastructure and capital investments is being fueled by
6
Deregulation in the power, telecommunications, and transportation sectors, by the
globalization of product markets and the need for manufacturing scale, and by the
privatization of government-owned entities in developed and developing countries.

The capital budgeting decision procedure basically involves the evaluation of the
desirability of an investment proposal. It is obvious that the firm most have a
systematic procedure for making capital budgeting decisions. The procedure must be
consistent with the objective of wealth maximization. In view of the significance of
capital budgeting decisions, the procedure must consist of step by step analysis.

Importance of investment decisions:-

Capital investments, representing the growing edge of a business, are deemed to be

very important for three interrelated reasons.
1. The influence firm growth in the long term consequences capital investment
decisions have considerable impact on what the firm can do in future.

2. They affect the risk of the firm; it is difficult to reverse capital investment decisions
because the market for used capital investments is ill organized and /or most of the
capital equipments bought by a firm to meet its specific requirements.

3. Capital investment decisions involve substantial out lays. Barauni Refinery is a

growing concern, capital budgeting is more or less a continuous process and it is
carried out by different functional areas of management such a production, marketing,
engineering, financial management etc. All the relevant functional departments play a
crucial role in the capital budgeting decision process.

Objectives of the study:-

1. To describe the organizational profile of Barauni Refinery.

2. To discuss the importance of the management of capital budgeting.
3. Determination of proposal and investments, inflows and out flows.
4. To evaluate the investment proposal by using capital budgeting techniques.
5. To summarize and to suggest for the better investment proposal.

Limitations:

Though the project is completed successfully a few limitations may be there.

a) Since the procedure and polices of the company will not allow to disclose
confidential financial information, the project has to be completed with the available
7
data given to us.
b) The period of study that is 4 weeks is not enough to conduct detailed study of the
project.
c) The study is carried basing on the information and documents provided by the
organization and based on the interaction with the various employees of the respective
departments.
d) Time limitation. The duration of the project is short to collect the required
information accurately.
e) The study is confined to IOCL, Barauni.

RESEARCH METHODOLOGY

Intensive research has been done during this project to find out the necessary
information regarding both financing and evaluation activities carried out in Barauni
Refinery and the various projects that are being implemented to optimize profit and
product yield. While working in the organization, I got much of the information during
the practical work. The methodology applied to gather the necessary information is
discussed as follows.

The project is related to capital budgeting procedures and various methods

involved in the process of tendering. There is very less or no scope of primary data in
this project. The project is basically based on secondary data made available by the
company and other sources for more information.

I collected information dealing with projects from finance department. These data
and information were studied and analysed properly to present the report in this form.
During the internship period, I went through Material Management Manual, Oil
Management Manual, Brochures, Financial Appraisal and Annual Operation Report
provided by IOCL, Barauni. Documents, books and last but not the least websites were
also referred to get enough information for the completion of the project.

The information for the study is obtained from two sources namely.

1. Primary Sources

2. Secondary Sources

Primary Sources:

It is the information collected directly without any references. It is mainly through

8
interactions with concerned officers & staff, either individually or collectively; some of
the information has been verified or supplemented with personal observation. These
sources include.
1. Thorough interactions with the various department Managers of Barauni Refinery.
2. Guidelines given by the Project Guide.

Secondary Sources:

This data is from the number of books and records of the company, the annual reports
published by the company and other magazines. The secondary data is obtained from
the following.
a) Collection of required data from annual records, monthly records, internal Published
book or profile of IOCL.
b) Other books and Journals and magazines
c) Annual Reports of the company

9
 CHAPTER-II COMPANY 
PROFILE 
 
 
 
 
 
 
 
 
10
 
INTRODUCTION

Indian Oil Corporation Limited, or Indian Oil, (BSE: 530965, NSE: IOC) is an Indian
state-owned oil and gas corporation with its headquarters in New Delhi, India. The
company is the world's 98th largest public corporation, according to the Fortune Global
500 list, and the largest public corporation in India when ranked by revenue. Indian Oil
and its subsidiaries account for a 47% share in the petroleum products market, 34%
share in refining capacity and 67% downstream sector pipelines capacity in India. The
Indian Oil Group of Companies owns and operates 10 of India's 21 refineries with a
combined refining capacity of 65.7 million metric tons per year. The President of
India owns 78.92% (1.9162 billion shares) in the company. In FY 2011 IOCL sold 64.1
million tons of petroleum products and reported a PBT of 90.96 billion, and
the Government of India earned an excise duty of 257.899 billion and tax of 16,500
million. It is one of the five Maharatna status companies of India, apart from Coal India
Limited,NTPC Limited, Oil and Natural Gas Corporation and Steel Authority of India
Limited. Indian Oil operates the largest and the widest network of fuel stations in the
country, numbering about 19,463 (15,946 regular ROs & 3,517 Kissan Sewa Kendra).
It has also started Auto LPG Dispensing Stations (ALDS). It supplies Indane cooking
gas to over 62.4 million households through a network of 5,456 Indian distributors. The
company has also been adjudged No.1 in petroleum trading among the national oil
companies in the Asia-Pacific region.

BACKGROUND

Indian Oil began operation in 1959 as Indian Oil Company Ltd. The Indian Oil
Corporation was formed in 1964, with the merger of Indian Refineries Ltd. In 1965 the
Corporation entered the field of LPG for domestic cooking and distribution started
under the name `Indane' in selected cities of the Eastern region.

PRODUCTS

Indian Oil's product range covers petrol, diesel, LPG, auto LPG, aviation turbine fuel,
lubricants, naphtha, bitumen, paraffin, kerosene etc. Xtra Premium petrol, Xtra Mile
diesel, Servo lubricants, Indane LPG cooking gas, Autogas LPG, IndianOil Aviation
are some of its prominent brands.
Recently Indian Oil has also introduced a new business line of supplying LNG
(liquefied natural gas) by cryogenic transportation. This is called "LNG at Doorstep".

11
REFINERIES

In​ ​Assam
● Digboi Refinery, in Assam, is India's oldest refinery and was commissioned in
1901. Originally a part of Assam Oil Company, it became part of Indian Oil in
1981. Its original refining capacity had been 0.5 MMTPA since 1901.
Modernization project of this refinery was completed by 1996 and the refinery
now has an enhanced capacity of 0.65 MMTPA. UOP licensed the technology
for the Coking process in this refinery.
● Guwahati Refinery, the first public sector refinery of the country, was built with
Romanian collaboration and was inaugurated by Late Pt. Jawaharlal Nehru, the
first Prime Minister of India, on 1 January 1962. Its capacity is 1 MMTPA.
● Bongaigaon Refinery became the eighth refinery of Indian Oil after merger of
Bongaigaon Refinery & Petrochemicals Limited w.e.f. 25 March 2009. It is
located at Dhaligaon in Chirang district of Assam, 200 km west of Guwahati​.

In Bihar
● Barauni Refinery, in Bihar, was built in collaboration with Russia and Romania.
It was commissioned in 1964 with a capacity of 1 MMTPA. Its capacity today
is 6 MMTPA.

In Gujarat
● Gujarat Refinery, at Koyali (near Vadodara) in Gujarat in Western India, is
Indian Oil’s second largest refinery. The refinery was commissioned in 1965. It
also houses the first hydro cracking unit of the country. Its present capacity is
13.70 MMTPA.

In West Bengal
● Haldia Refinery is the only coastal refinery of the Corporation, situated 136 km
downstream of Kolkata in the Purba Medinipur (East Midnapore) district. It was
commissioned in 1975 with a capacity of 2.5 MMTPA, which has since been

12
 increased to 7.5 MMTPA

In Uttar Pradesh
● Mathura Refinery was commissioned in 1982 as the sixth refinery in the fold of
Indian Oil and with an original capacity of 6.0 MMTPA. Located strategically
between the historic cities of Delhi and Agra, the capacity of Mathura refinery
was increased to 8.8 MMTPA.

In Haryana
● Panipat Refinery is the seventh and largest refinery of Indian Oil. The original
refinery with 6 MMTPA capacity was built and commissioned in 1998. Panipat
Refinery has since expanded its refining capacity to 15 MMTPA.
● It is believed that the future IOCL refinery will be Paradeep Refinery. It is
expected to be handed over in 2012.

Subsidiary refineries – Chennai Petroleum (10.5 MMTPA)

● Indian Oil (Mauritius) Ltd.

● Lanka IOC PLC – Group Company for retail and storage operations in Sri
Lanka.
● IOC Middle East FZE
● Chennai Petroleum Corporation Limited
● Green Gas Ltd. – a joint venture with Gas Authority of India Ltd. for city-wide
gas distribution networks.
● Indo Cat Pvt. Ltd., with Intercat, USA, for manufacturing 15,000 tonnes per
annum of FCC (fluidized catalytic cracking) catalysts & additives in India.
● Indian Oil – CREDA Biofuels Ltd., a joint venture with Chattisgarh government
for production and marketing of Bio-fuels.
● Numerous exploration and production ventures with Oil India Ltd., Oil and
Natural Gas Corporation

IOCL GROUP
IOCL Group consists of Indian Oil Corporation Ltd. and the following subsidiaries:

● Lanka IOC Ltd

● Indian Oil (Mauritius) Ltd.
● IOCL Middle East FZE
● Indian Oil Technologies Ltd.
● Chennai Petroleum Corporation Ltd. (CPCL)
● Bongaigaon Refinery & Petrochemicals Ltd (BRPL)

13
International rankings

Indian Oil is the highest ranked Indian company in the Fortune Global 500 listing, at
the 98th position in 2011. It is also the 18th largest petroleum company in the world
and the No. 1 petroleum trading company among the national oil companies in the
Asia-Pacific region. IOCL was featured on the 2011 Forbes Global 2000 at position
243. It is the fifth most valued brand in India according to an annual survey conducted
by Brand Finance and The Economic Times in 2010.

Competitors

Indian Oil Corporation has two major domestic competitors, Bharat

Petroleum and Hindustan Petroleum. Both are state-controlled, like Indian Oil
Corporation. There are two private competitors, Reliance Industries and Essar Oil.

VISION OF IOCL
A major diversified, transnational, integrated energy company, with national leadership
and a strong environment conscience, playing a national role in oil security & public
distribution.

● Ethics​- Setting high standard for ethics and values.

● People​- Leading with passion to excel.
● Innovation​- Pioneering the spirit of creativity and research.
● Environment​- Caring for the environment and community.
● Technology​- Harnessing frontier technology.
● Customers​- Fostering relationships for a lifetime.

MISSION OF IOCL
IOCL has the following mission:

● To achieve international standards of excellence in all aspects of energy and

diversified business with focus on customer delight through value of products
and services and cost reduction.
● To maximize creation of wealth, value and satisfaction for the stakeholders.
● To attain leadership in developing, adopting and assimilating state-of- the-art
technology for competitive advantage.
● To provide technology and services through sustained Research and
Development.
● To foster a culture of participation and innovation for employee growth and
contribution.
14
 ● To cultivate high standards of business ethics and Total Quality Management
for a strong corporate identity and brand equity.
● To help enrich the quality of life of the community and preserve ecological
balance and heritage through a strong environment conscience.

VALUES OF IOCL

Values exist in all organizations and are an integral part of any it. Indian Oil nurtures a
set of core values:

● CARE
● INNOVATION
● PASSION
● TRUST

OBJECTIVES OF INDIAN OIL

IOCL has defined its objectives for succeeding in its mission. These objectives are:

● To serve the national interests in oil and related sectors in accordance and
consistent with Government policies.
● To ensure maintenance of continuous and smooth supplies of petroleum
products by way of crude oil refining, transportation and marketing activities
and to provide appropriate assistance to consumers to conserve and use
petroleum products efficiently.
● To enhance the country's self-sufficiency in crude oil refining and build
expertise in laying of crude oil and petroleum product pipelines.
● To further enhance marketing infrastructure and reseller network for providing
assured service to customers throughout the country.
● To create a strong research & development base in refinery processes, product
formulations, pipeline transportation and alternative fuels with a view to
minimizing/eliminating imports and to have next generation products.
● To optimize utilization of refining capacity and maximize distillate yield and
gross refining margin.
● To maximize utilization of the existing facilities for improving efficiency and
increasing productivity.
● To minimize fuel consumption and hydrocarbon loss in refineries and stock loss
in marketing operations to effect energy conservation.
15
 ● To earn a reasonable rate of return on investment.
● To avail of all viable opportunities, both national and global, arising out of the
Government of India’s policy of liberalization and reforms.
● To achieve higher growth through mergers, acquisitions, integration and
diversification by harnessing new business opportunities in oil exploration &
production, petrochemicals, natural gas and downstream opportunities overseas.
● To inculcate strong ‘core values’ among the employees and continuously update
skill sets for full exploitation of the new business opportunities.
● To develop operational synergies with subsidiaries and joint ventures and
continuously engage across the hydrocarbon value chain for the benefit of
society at large.

Production Performance

Indian Oil refineries recorded the highest ever crude processing of 55.6 MMT during
the year 2011-12, recording an overall capacity utilization of 102.6%. Refineries have
achieved over 100% capacity utilization for the fifth year in a row despite planned M&I
shut downs.

Snapshot of Physical Performance (2011-12)

a) Marketing -

Domestic Sales - 70.1 MMT (growth by 5%)

No. of new ROs commissioned - 1205 including 708 KSKs, taking the tally to 20, 575
ROs and 4225 KSKs
Net addition to LPG connections - 50 lakh (total no. of Indane customers: 668 lakh)
Indane Distributorships under RGGLVY - 377

b) Refineries -

Group Capacity - 65.7 MMTPA

16
Crude Throughput - 55.6 MMT (5% jump)
Distillate yield - 77.8%
Specific Energy Consumption - 57 MBN

c) Pipelines -

Total Length - 10,909 km

Capacity - 75.76 MMTPA (+ 10 MMSCMD for R-LNG Pipeline)
Throughput - 75.5 million tonnes (Products = 27.95 MMT and Crude Oil = 47.58
MMT)

d) R&D -

New patents in the year - 6

Active Patents - 215
Total no. of formulations developed - 154

e) Petrochemicals -

Sales - 1.55 million tonnes (66% growth)

f) Gas -

Sales - 2.93 million tonnes (27% jump)

FINANCIAL PERFORMANCE

17
QUARTER-WISE PROFIT & LOSS, Rs. crore

18
BOARD OF DIRECTORS

● Shri R. S. Butola
Chairman w.e.f. 28.02.2011
● Shri P. K. Goyal
Director (Finance)
w.e.f. 02.05.2011
● Shri Michael Bastian
Independent Director
● Shri G. C. Daga
Director (Marketing)
● Shri P. K. Sinha
Government Director
● Shri Nirmal Kumar Poddar
Independent Director
● Shri B. N. Bankapur
Director (Refineries)
● Shri Sudhir Bhargava
Government Director
● Dr. Sudhakar Rao
Independent Director
w.e.f. 30.05.11
● Shri K. K. Jha
Director (Pipelines)
● Prof. (Dr.) Indira J. Parikh
Independent Director
● Shri B. M. Bansal
Chairman & Director (P&BD)
upto 31.01.2011
● Dr. R. K. Malhotra
Director
(Research & Development)
w.e.f. 05.08.2010
● Shri Anees Noorani
Independent Director

19
PIPELINES DIVISION IN IOCL

Indian Oil, the pioneer in cross-country petroleum product pipeline in the Indian
subcontinent.
Constructed and commissioned its first petroleum product pipeline, Guwahati- Siliguri
Pipeline in the year 1964. Since then Indian Oil has mastered the art and technology of
pipeline engineering. Over the last four decades the pipeline network of
Indian Oil has grown to 9273 km with a capacity of about 62 million metric tonnes per
year. IOCL owns approximately 67% of India’s total throughput capacity. Pipelines
offer a cost effective, energy efficient, safe and environment friendly method to
transport petroleum products from refineries to demand areas and crude oil from import
terminals as well as domestic sources to the inland refineries. India being a vast
country, a wide network of pipelines is required for transporting petroleum products to
interiors from refineries and crude oil to the refineries.
Indian Oil’s sustained pursuit and implementation of proven safety and environmental
management systems have brought rich results. All operating pipeline units have been
accredited with ISO 9000 and ISO 14001 certificates.

WHY PIPELINES ARE PREFFERED?

● Effective cost.
● Efficient energy.
● Safe.
● Environment friendly method of transportation.

Major Crude Oil Pipelines

● Salaya-Mathura Pipeline (SMPL)

● Haldia-Barauni Crude Oil Pipeline (HBCPL)
● Mundra - Panipat Pipeline (MPPL)

Major Product pipelines

● Guwahati-Siliguri Pipeline (GSPL)

● Koyali - Ahmadabad Pipeline (KAPL)
● Haldia - Barauni Pipeline (HBPL)
20
 ● Barauni - Kanpur Pipeline (BKPL)
● Haldia-Mourigram-Rajbandh Pipeline (HMRPL)
● Mathura-Jalandhar Pipeline (MJPL)
● Koyali - Dahej Product Pipeline

EXISTING & ONGOING CRUDE & PRODUCT PIPELINES

FUNCTIONING OF PIPELINE

● From Sea Shore (Exploration)

TO
Refinery Division

● From Refinery Division

TO
Marketing Division

● From Marketing Division

TO
Finished products to clients

SWOT ANALYSIS

21
STRENGTHS

HIGHEST MARKET SHARE

As India's flagship national oil company, Indian Oil accounts for 56% petroleum
products market share, 42% national refining capacity and 67% downstream pipeline
throughput capacity

EXPERTISE IN OIL & GAS INDUSTRY

Indian Oil is one of the leaders in providing engineering, construction and consultancy
services to the pipeline industry. Highly qualified professionals with vast experience
execute pipeline projects from concept to commissioning and provide services for
construction supervision and project management.

FOREIGN SUBSIDIARIES AND JOINT VENTURES

Indian Oil is strengthening its existing overseas marketing ventures and simultaneously
scouting new opportunities for marketing and export of petroleum products in foreign
markets. Two wholly owned subsidiaries are already operational in Sri Lanka and
Mauritius, and regional offices at Dubai and Kuala Lumpur are coordinating expansion
of business activities in Middle East and South East Asia regions. The Corporation has
launched eleven joint ventures (listed separately) in partnership with some of the most
respected corporate from India and abroad.

WEAKNESSES

HIGH FOREIGN EXCHANGE DEBT

IOCL has managed to significantly cut its borrowing cost due to high share of foreign
exchange debt. Its share of foreign exchange borrowings is increasing with foreign
exchange loans crossing 50% of its total debt compared to 42% at the end of the last
financial year.

STRINGENT CORPORATE POLICIES

The decisions relating to administration are taken at the corporate level. Even minor
proposals are to be referred to the top management. This leads to a delay in

22
decision-making.

LACK OF MARKETING EFFORTS

Among the public sector oil companies, Indian Oil Corporation is the only one to
follow a weak marketing strategy. It is only in the recent years that the company has
started to market its products. However, still the efforts seem to be weak when
compared with the competitors like BPCL and HPCL

PROMOTION POLICY

Most of the public sector companies seem to suffer from these lacunae. The employees
are promoted mainly on the basis of experience and not on the efforts and initiatives
displayed by the employee in his work. This results in de motivation and lack of
interest for their work on the part of the hardworking employees, who then tend to shift
jobs to satisfy their need for self-esteem.

TENDER PROCESS

The policy of selection of the lowest bidder tends to affect the quality of the
products/services on some occasions. A more simplistic procedure is also likely to
generate some savings for the company, since tendering process leads to expenses on
account of advertisement.

OPPORTUNITIES

Exploration and Production

Indian Oil is metamorphosing from a pure sectoral company with dominance in

downstream in India to a vertically integrated, transnational energy behemoth. The
Corporation is making investments in E&P and import/marketing ventures for oil and
gas in India and abroad, and is implementing a master plan to emerge as a major player
in petrochemicals by integrating its core refining business with petrochemical activities.

Exploration of Other energy Sources

Retail Business at outlets

THREATS

23
Entry of Big Private players

The opening up of the oil sector for private players poses a threat even for this well
established company. With Indian players like Reliance and Essar and foreign player
like Shell planning their entry into the Indian scenario, the road seems to be tough for
Indian Oil.

Devaluation of Indian Currency

Reducing Crude

IOCL, BARAUNI

The second public sector oil refinery was built in collaboration with Russia and
Romania. Situated 125 kilometres from Patna, it was built with an initial cost of Rs
49.40 crore. Barauni Refinery was commissioned in 1964 with a refining capacity of 1
Million Metric Tonnes per Annum (MMTPA) and it was dedicated to the Nation by the
then Union Minister for Petroleum, Prof. Humayun Kabir in January 1965. After
de-bottlenecking, revamping and expansion project, its capacity today is 6 MMTPA.
Matching secondary processing facilities such Resid Fluidised Catalytic Cracker
(RFCC), Diesel Hydrotreating (DHDT), Sulphur Recovery Unit (SRU) have been
added. Theses state of the art eco-friendly technologies have enabled the refinery to
produce environment- friendly green fuels complying with international standards.

Barauni Refinery was initially designed to process low sulphur crude oil (sweet crude)
of Assam. After establishment of other refineries in the Northeast, Assam crude is
unavailable for Barauni. Hence, sweet crude is being sourced from African, South East
Asian and Middle East countries like Nigeria, Iraq & Malaysia. The crude is brought up
to Haldia by Very Large Crude Carriers (VLCCs) from where it is pumped through
pipeline to Barauni. With various revamps and expansion project at Barauni Refinery,
capability for processing high -sulphur crude has been added high-sulphur crude oil
(sour crude) is cheaper than low sulphur crudes thereby increasing not only the capacity
but also the profitability of the refinery.

Barauni Refinery has an elaborate Safety Management System. Refinery is following

stringent Oil Industry Safety Directorate (OISD) standards and other Rules/ Acts as
applicable. Periodic Safety Audit of the facilities and system is carried out. Each
recommendation’s status is thoroughly discussed in the monthly Health & Safety
Committee Meeting chaired by the top most official of the company. No efforts are
spared to fulfil recommendations arising during Safety Audit, in shortest possible time.
24
 The crude oil for Barauni refinery was initially sourced exclusively from oil fields of
Assam through Oil India Pipeline. But due to utilization of available crude in
North-East itself after commissioning of Numaligarh Refineries, Barauni Refinery has
been fully sourced by imported crude from 2001-2002. To make this feasible, a new
Pipeline namely Haldia Barauni Crude Pipeline (HBCPL) was constructed and for
economic viability of fresh investment the old refinery management has roughly
invested Rs. 2000 cr. in expanding the refinery to 6 MMTPA in 2002-2003.

The crude movement take place in very large crude carriers (VLCC) up to the Bay of
Bengal but due to the poor sea condition can’t reach Haldia port directly. This
necessitates transhipment of crude in high sea to smaller vessels which in turn bring the
crude up to the port where it is unloaded in custom bonded tanks before being pumped
through HBCPL. This particular movement of transhipment involves additional costs in
the nature of

1. Freight of daughter vessels

2. Demurrage of VLCC

3. Additional wharfage

To this additional cost is putting Barauni Refinery into a sort of disadvantage in

comparison to other west coast Refineries. Considering the scene management is
implementing a new pipeline project to connect HBCPL with Paradip port to which
place VLCC’s will be directly wharfed and above additional expenditures can be
avoided. There is another additional expenditure which is specific to Barauni Refinery
and doesn’t apply to many Refineries of India is “Entry Tax”. This has been contested
by the management in the Court of Law on Constitutional grounds and stay off 50%
has been obtained from High Court, decision of which is pending in Supreme Court.

Major Achievements

1. Barauni Refinery bagged the prestigious Five Star Grading in Jan’02 after audit
conducted in Nov’01 under the new scoring system of British Safety Council. Barauni
refinery is the first in India to receive a five star grading under the new scoring system.

2. ​Barauni Refinery won “Excellence in Consistent TPM Commitment" award by Japan

Institute of Plant Maintenance (JIPM).

25
3. As on 1​st April’ 02, Barauni Refinery established a new record of 1246 days
Fire-Free run (02.11.98 to 31.03.02) of the refinery.

4. As on 1​st April’ 02, Barauni Refinery completed 416 accident free days thereby
surpassing 5 million accident free man hours.

5. Highest ever BS-III MS annual production of 770 TMT achieved surpassing the
previous best of 517 TMT in 2010-11.

6. Highest ever BS-III HSD annual production of 2740 TMT achieved surpassing the
previous best of 2568 TMT in 2010-11.

FINACE DEPARTMENT AT IOCL BARAUNI

26
Functions of the Finance Department

● Management of financial resources for meeting the corporation’s programmes

of operations and capital expenditure including investment of surplus fund, if
any.

● Ensuring uniform financial and accounting policies and procedures, to the

extent possible, in the division.

● Establish and maintain a system of financial scrutiny and internal checks and
render advice on financial matter including examination of feasibility studies
and detailed projects reports.

● Establishment and maintain an appropriate system of budgetary control and

management information system for different levels of the management.

● Carry out periodical/special studies with a view to control costs, reduce

expenditure, economy in administrative expenditure, improve efficiency to
maximise profitability of the corporation.

● Maintain the financial accounts, cost accounts and other relevant books and
records in accordance with the various statutory and other requirements.

● Advise on corporate cash planning, credit policy and pricing policies of the
corporation.

● Ensuring that the corporation acts in all financial and accounting matters as per
approved policies of the corporation within the framework of government
policy for public enterprises.

FINANCE DEPARTMENT’S MISSIONS

27
 ● To provide high quality financial staff support for decision-making and control
to all levels of management – corporate, divisional, unit and location to enable
the achievement of overall corporate objectives and goals.

● To play a lead role in scanning the domestic and international financial

environment, the formulation and implementation of all financial policies and
plans for different time spans consistent with and conducive to the business
plans for expansion, diversification, productivity etc.

● To interact pro-actively with the relevant Government agencies on pricing and

investment and with financial institutions, depositors and creditors, with
sensitivity and promptness, for mobilization and provision of funds for
uninterrupted operations and project execution at optimal costs.

● To maintain, review and update all relevant accounting records, systems and
procedures for discharging the fiduciary responsibilities and enabling
compliance with statutory obligations.

● To inculcate financial awareness, cost benefit attitudes and system orientation in

the entire organization.

● To develop the human resources, systems and techniques of finance for

continuing innovation and contribution towards IOC corporate excellence

FINANCE DEPARTMENT’S OBJECTIVES

● To ensure adequate return on capital employed and maintain a reasonable

annual dividend on its equity capital.

● To ensure maximum economy in expenditure.

● To generate sufficient internal resources for financing partly / wholly

expenditure on new capital projects.

● To develop long term corporate plans to provide adequate growth of the

activities of the Corporation.

● To continue to make an effort in bringing reduction in the cost of production of

petroleum products by means of systematic cost control measures.

28
 ● The endeavor to complete all plans projects within stipulated time and within
stipulated cost estimates.

Financial Goals

● To inculcate cost consciousness in user departments.

● Development of standard refinery costs at each unit level.

● Proper implementation of budgetary control and submission of MIS in time.

● To keep the level of inventories below the level fixed by the board and
outstanding debts, loans & advances and claims at bare minimum.

● Ensure payment on due date to various agencies.

● Monitor capital expenditure to ensure completion within stipulated time and

cost.

● Optimise utilisation of working capital.

● Efficient management of funds.

​ INANCE
PROJECT​ F

29
INTRODUCTION:-

An efficient allocation of capital is the most important finance function in the modern
times. It involves decisions to commit the firm’s funds to the long-term assets. Capital
budgeting for investment decisions is of considerable importance to the firm since they
tend to determine its value by influencing its growth, evaluation of capital budgeting
decisions. Project financing involves identifying the project, determining the feasibility
of the project, identifying sources of finance for the project, mitigating the risk and
monitoring implementation of the project.

NATURE OF INVESTMENT DECISIONS:-

The investment decisions of a firm are generally known as the capital budgeting, or
capital expenditure decisions. A capital budgeting decision may be defined as the
firm’s decision to invest its current funds most effectively in the long- term assets in
anticipation of an expended flow of benefits over a series of years. The long-term assets
are those that affect the firm’s operational beyond the one year period. Investment
decisions generally include expansion, acquisition modernization and replacement of
the long-term assets. Sale of a division or business (Divestment) is also an investment
decision. Decision like the change in the methods of sales distribution, or an
advertisement campaign or a research and development program have long-term
implications for the firm’s expenditures and benefit, and therefore, they should also be
evaluated as investment decisions. The following are the features of investment
decisions.

● The exchange of current funds for future benefits.

● The funds are invested in long-term assets.
● The feature benefits will occur to the firm over a series of years.

OBJECTIVES OF INVESTMENT DECISIONS:-

● Understand the nature and importance of investment decisions.

● Explain the methods of calculating net present value (NPV) and internal rate of
return (IRR)
● Show the implicated of net present value (NPV) and internal rate of return
(IRR)
● Describe the Non- DCF evaluation Criteria. Payback period and accounting rate
of return (ARR).
● Compare and contract NPV and IRR and emphasize the superiority of NPV
rule.

30
PROCESS OF INVESTMENT DECISIONS:-

Capital Budgeting is a complex process which may be divided into the following
phases.
Capital Budgeting Process:-

1. Identification of investment proposal.

2. Screening the proposal.
3. Evaluation of various proposals.
4. Fixing priorities.
5. Final approval & preparation of capital expenditure budget.
6. Implementing proposal.
7. Performance review.

Identification of investment proposal:-

The capital budgeting process begins with the identification of investment proposal.
The proposal or idea about potential investment opportunities may originate from the
top of management or may come from the rank and file workers of any department or
from any officers of the organization. The departmental head analyses the various
proposals in the light of the corporate strategies and submits the suitable proposals to
the capital expenditures planning committee in case of large organization or to the
officers a concerned with the corporate strategies and submits the suitable proposals to
the capital expenditures. Capital expenditures planning committee in the case of large
organization or the officers concerned with the process of long-term investment
decision.

Screening the proposal:-

The expenditures planning committee screens the various proposals received from
different departments. The committee views these proposals from various angles to
ensure that these are in accordance with the corporate strategies or selection criterion of
the firm and also do not lead to the department imbalances.

Evaluation of various proposals:-

The next step in the capital budgeting process is to evaluate the profitability of various
proposals. There are many methods which may be used for this purpose such as
payback period method, rate of return method, net present value method, internal rate
of return, etc. All these method of evaluating profitability of capital investment
proposals have been discussed in detail separately in the page of this chapter. It should
be classified as below.
31
i. Independent proposals.
ii. Contingent or dependent proposals and
iii. Mutually exclusive proposals.

Fixing priorities:-
After evaluating various proposals, the unprofitable proposals may be rejected straight
away. But it may not be possible for the firm to invest immediately in the all the
acceptable proposals due to limitation of funds. Hence, it is very essentials to rank the
various proposals and to establish priorities after considering urgency, risk and
profitability involved there in.

Final approval & preparation of capital expenditure budget:-

Proposals meeting the evaluation and other criteria are finally approved to be included
in the capital expenditure budget. However, a proposal involving smaller investment
may be decides at the lower levels for expenditure action. The capital expenditures a
budget lays down the amount of the estimation expenditures to be incurred on fixed
assets during the budget period.

Implementing proposals:-

Translating an investment proposal into a concrete project is a complex, time

consuming, and risk- fraught task.

1. Adequate formulation of projects

The major reason for delay is insinuate formulation of projects put differently, if
necessary homework in terms of preliminary comprehensive and detailed formulation
of the project.

2. Use of the principle of responsibility accounting

Assigning specific responsibility to project managers for completing the project within
the defined time-frame and cost limits is helpful for expeditious execution and cost
control.

3. Use of Network Techniques

For project planning and control several network techniques like PERT (Programme
Evaluation Review Techniques) and CPM (Critical Path Method) are available.

Performance Review:-
Performance review, or post – completion audit, is a feedback device. It is a means for
comparing actual performance with projected performance. It may be conducted, most
appropriately, when the operations of the project have stabilized.
It is useful in several ways.
32
I. It throws light on how realistic were the assumptions underlying the project.

II. It provided a documented log of experience that is highly valuable for decision
making.

Importance of Investment Decisions:-

● Investment decisions require special attention because of the following reasons.
● They influence the firm’s growth in the long term.
● They affect the risk of the firm.
● They involve commitment of large amount of funds.
● They are irreversible, or reversible at substantial loss.
● They are among the most difficult decisions to make.

Types of investment decisions:-

There are many ways to classify investments one classification is as follows;
● Expansion of existing business.
● Expansion of new business.
● Replacement and modernization.
● Expansion and diversifications

A company may add capacity to its existing product lines to expand existing operations.
For example, the Barauni Refinery may increase its plant capacity to produce more
bitumen. It is an example of related diversification. A firm may expand its activities in
a new business. Expansion of a new business requires investment in new products and
new kind of production activating within the firm. If packing manufacturing company
invests in a new plant and machinery to produce ball bearings, which the firm has not
manufactured before, this represents expansion of new business or unrelated
diversification. Sometimes a company acquires existing firms to expand its business.

Replacement and modernization.

The main objective of modernization and replacement is to improve operating

efficiency that reduce costs. Cost savings will reflect in the increased profits, but the
firm’s revenue may remain unchanged. Assets become outdated and absolute with
technological changes. The firm must decide to replace those assets with new assets
that operate more economically. Replacement decisions help to introduce more
efficient and economical assets and therefore, are also called cost- reduction
investments.
However replacement decisions that involve substantial modernization and
technological improvements expand revenues as well as reduce costs. Yet another
useful way to classify investments is as follows;
33
 ● Mutually exclusive investments
● Independent investments
● Contingent investments

Mutually exclusive investments

Mutually exclusive investments serve the same purpose and compete with each other. If
one investment understands others will have to be excluded. A company may, for
example, either use a more labour- intensive, semiautomatic machine, or employ a
more capital intensive, highly automatic machine for production.

Independent investments
Independent investments serve different purposes and do not compete with each other.
For example, a heavy engineering company may have been considering expansion of
its plant capacity to manufacture additional excavators and addition of new production
facilities to manufacture a new product.

Contingent Investments
Contingent investments are dependent projects; the choice of one investment
necessitates understanding one or more other investments for example, if a company
decides to build a factory in a remote, backward area, it may have to invest in houses,
roads, hospitals, schools, etc., and the total expenditure will be treated as one single
investment.

Investment Evaluation Criteria:-

Three steps are involved in the evaluation of investment.

· Estimation of cash flows
· Estimation of the required rate of return
(the opportunity cost of capital )
· Application of a decision rule for making the choice.

PROJECT APPRAISAL

Development projects impose a series of costs and benefits on recipient communities or

countries. Those costs and benefits can be social, environmental, or economic in nature,
34
but may often involve all three. Public investment typically occurs through the
selection, design and implementation of specific projects to achieve the goals of policy.
Why are some project proposals accepted and rejected, and how? What are the
considerations in appraisal other than the economic rate of return? How are questions
of environmental impact, welfare distribution and risk taken into account? In addition
to being financially viable, a development project cannot usually be considered
acceptable unless it is economically, technically and institutionally sound. It should be
the least-cost feasible solution to the problem being solved and should expect to
produce net economic and/or social benefits. For example, irrigation projects may
facilitate the growing of cash crops in one locality, but cause water shortages, and
hence economic, social and environmental pressures in another.
Appraisal is the analysis of a proposed project to determine its merit and acceptability
in accordance with established criteria. This is the final step before a project is agreed
for financing. It checks that the project is feasible against the situation on the ground,
that the objectives set remain appropriate and that costs are reasonable.
The purpose is to give a theoretical and applied background to project and programme
appraisal techniques, including technical analysis, financial and economic analysis,
impact assessment and risk analysis.

Technical Appraisal

• Whether pre-requisites for the success of project considered?

• Good choices with regard to location, size, process, machines etc.

Economic Appraisal

• Social cost -benefit analysis

• Direct economic benefits and costs in terms of shadow prices
• Impact of project on distribution of income in society
• Impact on level of savings and investments in society
• Impact on fulfillment of national goals :-
(1) Self sufficiency (2) Employment and (3) Social order

Ecological Appraisal
Impact of project on quality of :- Air, Water, Noise, Vegetation, Human life
Major projects ,such as these, cause environmental damage
Power plants

Technical: ​will the project work? Has due attention been paid to technical factors
affecting the project design? Given the human and material resources identified, can the
project activities be undertaken and outputs achieved within the time available and to
35
the required standards?

Financial: ​can the project be financed? Will there be sufficient funds to cover the
expenditure requirements during the life of the project?

Economic: ​will the nation and society at large be better off as a result of the project?
Will the project benefits be greater than the project costs over the life of the investment
when account is taken of time (namely, is the Net Present Value of the project positive
at the test discount rate)?

Social and gender: ​what will be the effect of the project on different groups, at
individual, household and community levels? How will the project impact on women
and men? How will they participate in various stages of the project cycle? Will the
social benefits of the project be greater than the social costs over the life of the
investment when account is taken of time?

Institutional: ​are the supporting institutions in place? Can they operate effectively
within the existing legislative and policy environment? Has the project identified
opportunities for institutional strengthening and capacity building?

Environmental: ​will the project have any adverse effects on the environment? Have
remedial measures been included in the project design?

Political: ​will the project be compatible with government policy, at both central and
regional levels?

Sustainability and risk: ​will the project be exposed to any undue risks? Will the
project benefits be sustainable beyond the life of the project?
Likely damage & the cost of restoration

Financial Appraisal
• Whether the project is financially viable?
o Servicing debt
o Meeting return expectations

Project Appraisal Criteria

36
TECHNICAL APPRAISAL

Clearly, every project must be technically feasible. Technical Appraisal provides a

comprehensive review of all technical aspects of the project such as rendering judgment
on merits of technical proposals and operating costs. Here is a checklist that can be
used:

● Is the technology proven or tested? If not, has it ever been successful elsewhere
and can that success be replicated in current context and conditions?

● Does the technology/ process/ equipment technically fit with the facility’s
existing technology/ process/ equipment & machinery? If not, what aspects of
the technology / process do not fit and what measures is the implementing
agency planning to take in this regard?

● List of equipments and machinery to be installed with cost and specifications of

the equipment.

● Equipment capacity & whether it is as per requirement?

● List of recommended equipment suppliers.

A checklist evaluating the proposed implementation plan to assess whether the project
can be implemented as per schedule and requirements should be reviewed and should
form part of the project report. Below is a sample of such a checklist:

a. Skills & Experience of the Project Implementation Team:

• Who is implementing the project?

• Does the project implementation team have adequate skills and experience? Provide a
list of relevant projects completed in the last two years as per table below:

Key Personnel in the Project

● Names of key people

● Position
● Total Length of Experience
● Number of years in current position
● Qualifications
● Training
● List of similar projects completed in last two years including his/her role in the
project
37
 ● Availability for the project

b. Selection of suppliers

● Have suppliers been selected? If yes, provide a list of selected suppliers

including equipments to be supplied by the supplier, price of the equipment and
delivery schedule.
● Reputation of the suppliers – whether the supplier is a large national or regional
distributor/ supplier or local supplier?
● Terms for supply and installation of the equipment by the suppliers.
● Is there any performance guarantees from the equipment suppliers?

c. Implementation time period

• Time period required to implement the project

• Consequences in case project implementation is delayed.

SOCIAL APPRAISAL
A social appraisal reviews the project design and the process of project identification
through to implementation and monitoring, from a social perspective. Particular
attention is paid to the likely impact of the project on different stakeholders, their
opportunities for participation, and the project’s contribution to poverty reduction.

Stakeholder analysis and participation

Based on the distinction of primary, secondary and key stakeholders1, stakeholder
analysis reviews the following:

● Who comprise the different stakeholders?

● What are their interests?
● How will they be affected by the proposed project?
● What are the project priorities between the different groups?
● What is their capacity to participate in the project?

Stakeholders have different abilities to influence the outcome of a project. Often target
beneficiaries are in a relatively weak position to influence the outcome of a project
whereas much of the control lies in the hands of secondary and key stakeholders (at B).
The former may be frustrated by a lack of access to information or be placed in a weak
social position due to traditional hierarchies.
In contrast the latter may have the time, money, and organizational capacity or political
power necessary to influence the project; however, if they are not interested in the
project, they could pose a risk to the project’s success by withholding support. Thus
recommendations from the social appraisal may be to
38
1 Stakeholders are individuals or organizations who, directly or indirectly, stand to gain
or lose from a given development activity or policy. Distinction is drawn between
primary stakeholders ​who are directly affected and would include the principal
project beneficiaries, ​secondary stakeholders ​who are indirectly affected, and ​key
stakeholders ​who are the agents of change.

The stakeholder analysis identified several groups of primary stakeholders who would
benefit directly from a proposal to rehabilitate 120 km of rural roads using labour​-​based
methods. Distinction could be drawn between those who would benefit during the
process of rehabilitation (road workers and local businesses) and those who would
benefit from using the roads once they were rehabilitated.
Most of the power to ensure the successful outcome of the project lay in the hands of
secondary and key stakeholders. This relationship had implications for the project
design and implementation. It was envisaged that several key stakeholders, together
with primary stakeholders, would work in partnership during project implementation
and monitoring, under the control of the contractor.

Classification of Stakeholders’ by Ability to Influence a Project

The manner in which stakeholders participate in a project varies, both between

stakeholders and over the life of a project. For example, some stakeholders may be
informed about a project at the identification stage and consulted during project design.
In contrast, other stakeholders may exercise control over certain stages of the project
cycle or act in partnership with others.

ECONOMIC & FINANCIAL APPRAISAL: COSTBENEFIT ANALYSIS & IRR

This includes an analysis of economic soundness of the project and the quantification
and valuation of costs and benefits to ensure financial viability.

Key Steps in Investment Appraisal

● Identify project ​benefits ​and ​costs ​(distinguishing between capital and recurrent
costs)
● Calculate the ​net cash flow ​by comparing benefits with costs over the life of the
investment
● Discount ​the net cash flow by expressing all future benefits and costs in present
values in order to take account of people’s preference for time
● Sum the discounted net cash flow to calculate the ​Net Present Value ​(NPV)
● Calculate the ​Internal Rate Of Return ​(IRR), the discount rate at which the
NPV equals zero (representing the maximum interest rate a project could pay
39
 and still break even)
● Conduct a ​sensitivity analysis ​to determine how sensitive the results are to
changes in key variables​.

Discount rates
Often governments and donors set test discount rates that vary according to the type of
project. At present, discount rates for public sector investments stand at 12%; for
projects with a strong poverty or environmental focus, rates may be as low as 3%. For
private sector investments, discount rates usually reflect commercial rates of interest.

Internal Rate of Return (IRR)

The IRR of a project is defined as that rate of discounting the future that equates the
initial cost and the sum of the future discounted net benefits. It is the discounted rate
that makes the NPV of a project equal to zero OR its BCR = one. The decision
criterion: A project with an IRR exceeding some predetermined level (Social discount
rate) is deemed acceptable.
It is calculated by using the following equation:
Or
IRR: Σ discounted benefits – Σ discounted costs = 0

The internal rate of return is a very popular method of project appraisal and it has much
to commend it. In particular it takes into account the time value of money. Basically,
what the IRR tells you is the rate of return you will receive by putting your money into
a project. It describes by how much the cash inflows exceed the cash outflows on an
annualized percentage basis, taking account of the timing of those cash flows.
IRR is also referred to as the ‘yield’ of a project.

Project Evaluation

40
Project evaluation is a high level assessment of the project to see whether the project is
worthwhile to proceed and whether the project will fit in the strategic planning of the
whole organization. Project evaluation helps to decide which of the several alternative
projects has a better success rate, a higher turnover.

STEPS IN PROJECT EVALUATION

Inception of Idea
Need & Justification
Project Design Selection
Cost Analysis
Revenue Analysis
Financial Analysis
Sensitivity Analysis
Strategic Analysis
Economic Analysis

KEY PARAMETERS TO BE EVALUATED IN A PROJECT

The key parameters to be evaluated in a project are:

● Risk Analysis
● Demand Analysis
● Project Cost Estimation
● Revenue Analysis
● Financial Analysis
● Project Selection Criteria

1. RISK ANALYSIS

Risk analysis is a technique to identify and assess factors that may jeopardize the
success of the project. Risks associated with capital investment proposals can be
broadly classified as:
 Financial Risk
 Other Risk

Financial Risk
Financial risk is defined as the possibility that the actual return on an investment will be
different from the expected return. Many techniques are available for determining
financial risk involved with the projects like Risk adjusted Discount Rate, Certainty
Equivalent, Sensitivity Analysis, DCF, Break Even Analysis, Probability Assignment,
Standard Deviation etc.

41
Other Risks
Other risks constitute risks which may be an obstacle in the success/ Completion of the
project. Risks which can be included in other risk are:
Availability Risk
Completion (technical and timing) Risk
Counterparty credit risk
Country (political) Risk
Inflation Risk
Input and throughput Risk
Market (demand) Risk
Technological Risks

2. DEMAND ANALYSIS

Success of a project depends on the projects usage potential and user willingness to
pay.
Demand analysis involves forecasting the demand on the basis of market surveys and
manufacturing capacity of the unit and this is decided through the study of demand and
supply. The potential users, their habits, and possibility of changing these habits, the
pricing of the products, the designing are studied under demand forecasting. In the
demand analysis we check if there is a scope for laying a pipeline, if the demand at
destination is less, then a pipeline is not required.
The major Steps in demand analysis are:

● Determining different uses of a project output

● Determining current consumption level and future demand
● Finding financial and economical benefits from the project

3. PROJECT COST ESTIMATION

Accurate estimation of costs is vital for the effective evaluation of the project since it is
important for knowing the financial feasibility of the project. The capital costs and
operating costs of the project is considered in this step.
The following factors needs to be kept in mind while estimating costs.

● Base Cost Estimate

● Contingency Costs
● Cost Factor for difference between domestic & foreign inflation rates
42
 ● Financing cost incurred during the construction period on loans specifically
borrowed for project is capitalized at the actual borrowing rates.

4. REVENUE ANALYSIS

Revenue analysis is estimation of the revenues which would be earned in the future.
Revenue projections are formed on the basis of Output sales. It helps in finding out the
profits/ losses in the future. Revenue analysis is all the more important in project
finance because the debts have to be repaid through the revenues generated by the
project. For a company, revenue is income that a company receives from its normal
business activities, usually from the sale of goods and services to customers. Some
companies also receive revenue from interest, dividends or royalties paid to them by
other companies. It also includes all net sales, exchange of assets etc. Savings made by
a company is also revenue for it. Revenue analysis as discussed earlier is estimating the
revenues that would be earned from the project, once it is implemented.
In IOCL, depending upon the project features, any one of the following method is used
for estimating revenue.

1) Based on Corporate Savings: ​When a new pipeline is to be layed between stations

where there is no existing way of transporting Crude/Product, revenues are calculated
by the Project Appraisal Group on the basis of corporate savings. Corporate savings is
the overall savings made by IOCL by implementing a project. Corporate savings is then
divided between the various divisions of IOCL (Refinery, Pipeline, Marketing and
R&D) as their revenue.

2) ​Based on NRF (Notional Railway Freight): ​If the Crude/Product was not
transported through pipeline, it should have been transported through roadways or
railways. Revenue in this method is the amount saved by transporting the product/crude
through pipeline, rather than transporting it through railways/roadways. Normally the
revenue is considered to be 75 % of NRF.

3) ​Based on IRR: ​In some cases, the IRR of the project is estimated first and based on
that the expected revenue for arriving at that IRR is calculated.
Thus, usually where we consider revenue either as notional earnings or corporate
savings.

43
 FINANCIAL ANALYSIS

1 INTRODUCTION

1.1 The financial analysis of a project is vital for assessing the viability of the
project and hence provides valuable information to the decision-maker. Financial
analysis produces an estimate of the financial gains, which accrue, to the
Corporation after implementation of the project.

1.2 The financial analysis entails determination of year-wise cash flow of the
project, computation of key decision criterion like internal rate of return (ROI &
ROE), net present value (NPV) of cash flows, debt service coverage ratio (DSCR)
and break even (BE) analysis etc.

2 Determination of Cash Flows

2.1 Determination of year-wise cash flows is the most crucial step of the financial
analysis. The cash flows are determined for three components namely:

a) Initial Investment
b) Operating Cash Flows
c) Terminal Cash Flows

2.2 Initial investment

This component of cash flow mainly represents net cash outlay in the period in
which the asset is purchased or constructed. In other words, initial investment
comprises of the total project cost as indicated in the capital investment proposal
and includes incremental value of working capital, wherever required.

2.3 Operating Cash Flows

The components of cash flow present year-wise cash flow generated from
operation after the project has been commissioned. The capacity utilization is not
taken more than 60% in the first year and at more than 90% from second year
onwards till project life cycle.

Operating Income

Operating income of a project represents total realization or savings from the

44
 operations, after implementation of the project.

Operating Expenses
The operating expenditure of a project includes the cost of chemicals and
consumables, utilities (like power, water, and fuel) repairs and maintenance, wages
and salaries, rent and insurance, depreciation, other administrative expenses etc.
The expenses under these various heads are estimated on a realistic set of
assumptions and past experience, wherever applicable. The basis for estimating the
expenditure is clearly indicated in the proposal.

2.4 Terminal Cash Flow

The cash flow in the terminal year of the project mainly represents the salvage
value of the project plus release of incremental working capital. Salvage value is
considered as under:

● Land to be valued at original cost

● Other items to be valued at 30% of the original cost without financing cost.
● Tax on Capital gain is considered.
● Capital gains are taken as terminal value minus written down value as per
income tax act.

2.5 Project Life

For cash flow determination and financial analysis, the life of project is assumed as
15 years from the date of completion, unless the project life is shorter.

2.6 Issues requiring special care

a) Cash inflow can occur by increase in cash revenue and / or cash saving through
reduction in operating costs.
b) Cash outflow can occur by increase in operating expenses and / or decrease in
cash revenue, apart from outgo for initial capital investment.
c) The net cash flow is estimated on ‘after tax basis’, as payment of taxes is an
outflow of cash.
d) For calculation of IRR, all financial charges arising due financial leverage like
interest payment / dividend payment shall not be considered as cash outflows.
Similarly, tax shield / benefit allowable due to such financial charges shall also not
be considered as cash inflow / outflow.

Financial Evaluation

45
 After determination of cash flow the next logical step is to financially evaluate the
proposal. The evaluation is carried out through following two methods:

a) Internal Rate of Return

b) Net Present Value
Both the above methods fully recognize the timing of cash flows through the
process of discounted cash flows.

a) Internal Rate of Return

i. Internal rate of return (IRR) is the discounting rate at which present value
of cash inflow is equal to present value of cash outflow. In other words, the
discount rate that yields a ZERO net present value is called Internal Rate of
Return.
ii. IRR is computed and indicated for all capital investment proposals.
iii. Normally Projects having IRR of less than hurdle rate (i.e. cost of capital +
premium) is considered as commercially viable and therefore, it is fully
justified on non-commercial grounds, wherever applicable.

b) Net Present Value

i. The present value ​of a future sum of money can be found by discounting it
to the present point in time or year ‘O’ at the required rate of return/
discount rate. Required rate of return shall not less than cost of capital.
ii. The present value of each years’ net cash flow is calculated, starting from
the year ‘0’ till complete project life i.e. 15 years. The discounting rate
adopted is the hurdle rate.
iii. The project having positive net present value, is considered to be
commercially viable.

3.5 Other measures

i. For debt financed projects, Debt Service Coverage Ratio (DSCR) is also to
be calculated. So as to ascertain the debt serving capability of the project.
DSCR is calculated as under:

​Profit after tax+ Depreciation + Interest on Long Term loan

Interest on long term loan + Loan on Repayment installment
ii. Break-even analysis is a tool to ascertain the level of sales required to meet
the funds requirement (fixed + variable). This can be used as a sensitive
analysis tool and can be computed as under:

46
Break Even Units =

Total fixed cost

Unit Selling Price – Unit Variable Cost
BEUs are minimum sales units at which, project is just meeting its funds requirement
and there is no loss or gain.

The computed IRR is compared with benchmark IRR (hurdle rates). Hurdle Rates are
calculated based on Weighted Average Long Term Cost of Capital (WACC) along with
project specific risk premium. Hurdle Rates are revised annually after approval of
competent authority.

Approved post tax hurdle rate for different type of projects:

As approved for
Type of Project
2010-11
Combined Projects having
linkage 13%
with one or more department
Marketing Division Projects 13%
Petrochemical, Gas and Power 14%
Projects
Through JVs
On IOC's B/Sheet 16%
E&P Projects 19%
Global Projects 14%
Core areas/ Diversification
E&P 18%
Projects for
operational/statutory __
requirement and Quality
Projects.

Notes:
i. The above rates are based on Debt: Equity ratio of 1:1 and may be applied for
all non-plan projects and projects costing less than Rs 250 Crores.
ii. For other projects, project specific hurdle rate is evolved based on the funding
pattern and anticipated specific borrowing costs.
iii. Hurdle rate for global projects are only indicative and vary from country to
country depending upon country risk.

47
Summary of Financial Analysis

i. Cash flow estimates along with IRR, NPV, DSCR & Break Even Analysis is
attached to the proposal. Capacity utilization is not taken more than 90%
throughout the project life cycle for all projects.
ii. A statement of assumptions made for financial analysis is also enclosed.
iii. The more sophisticated and mathematical methods of investment appraisal,
particularly NPV and IRR are used practically.

Analysis of risk and uncertainty

1. Introduction

1.1 After presentation of financial analysis of the project, the capital investment
proposal indicates an analysis of risk and uncertainty involved in the proposal.

1.2 All capital investment proposal involves some risk or uncertainty with respect
to their completion, capacity utilization, fulfillment of specified need, safety and
profitability etc. as the underlying assumptions made at the project formulation
stage may not hold well during the project life.

2 Types of Risks

​Risks associated with capital investment proposals can be broadly classified as:

● Financial Risks
● Other Risks

TAX CALCULATION

In project finance basically three types of taxes are calculated while doing financial
analysis and these are:

 Minimum Alternate Tax

 Income Tax
 Capital Gains Tax

Minimum Alternate Tax (MAT)

Normally, a company is liable to pay tax on the income computed in accordance with
the provisions of the income tax Act, but the profit and loss account of the company is
prepared as per provisions of the Companies Act. There were large number of
companies who had profits as per their profit and loss account but were not paying any
48
tax because income computed as per provisions of the income tax act was either nil or
negative. To avoid this practice, MAT was introduced in section 115JB of the Income
Tax Act. Profit computed under the regular method is called regular profit and profit
computed under sec
115JB is called Book profit and the tax computed is called MAT.
If a company is having regular profits then income tax @ 33.99% (30% tax + 10%
surcharge + 3% education cess) is charged on it. However if the books show losses,
then MAT is calculated and if MAT shows profits, tax is calculated @ 11.33% (10%
tax + 10% surcharge + 3% education cess). And if MAT shows losses, then tax is not to
be charged.

MAT Credit
When a company pays tax under MAT, tax credit is allowed in respect thereof during
the years when the company pays normal corporate tax. The tax credit earned is the
difference between the amount payable under MAT and the regular tax. The amount of
MAT credit can be set-off only in the year in which the company is liable to pay tax as
per the regular tax. MAT credit will be allowed carry forward facility for a period of
five assessment years immediately succeeding the assessment year in which MAT is
paid.

MAT CALCULATION
First of all, the book profits are calculated using the formula

Book profit = Taxable profit + depreciation previously deducted - actual

depreciation as per Income tax Act

MAT loss is added to the book profit to obtain the adjusted book profit on which the
MAT is calculated @ 11.33% (MAT rate).

Capital Gains Tax

If any Capital Asset is sold or transferred, the profits arising out of such sale are taxable
as capital gains in the year in which the transfer takes place. Capital asset gains are of
two types

 Long term capital gains: Gains on assets held for more than 36 months before they
are sold or transferred. In case of shares, debentures and mutual fund units the period of
holding required is only 12 months. Rate of tax applied on long term capital gains is
22.66% (20% tax + 10% surcharge + 3% education cess).

 Short term capital gains: Gains on assets held for less than 36 months are included in
this category. Rate of tax applied on short term capital gains is 15%.

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CALCULATION OF CAPITAL GAIN
Net capital gain is calculated with help of formula:
Net Capital Gain = Gross Gain (Cost of Acquisition + Indexation Cost) – Expenses on
Sale
Indexation Cost = Original value X Present year Index
Capital gain is calculated at 22.66% of Net Capital Gain.

As per the IOCL guidelines, Capital gains tax is calculated on the terminal value of the
project at the end of 15 years, which is estimated to be 30% of Capex + Cost of land.

Interest & Repayment

In project finance, financing of projects is done through both debt and equity. The
interest
on the amount financed through debt and the repayment thereof is considered under this
heading. Interest & repayment increases the cash outflows as we are paying the
amount.
It helps in reducing the taxes and increasing the profits from the project.
The following points are considered while estimating interest and repayments in IOCL

 Interest & repayments are not applicable on projects where Capex less than 100
Crores.
 If the project’s Capex is more than 100 Crores, then debt and equity is considered
in 1:1 ratio.
 Interest rate is considered as per the latest bank lending rates, which is annually
revised by Project Appraisal Group.
 Repayments are made on reducing interest rate method.

INTERNAL RATE OF RETURN (IRR)

IRR is usually the rate of return that a project earns. Therefore, it is called internal rate
of return. IRR is also known as time adjusted rate of return, marginal efficiency of
capital, marginal productivity of capital and yield on investment.
IRR is the discount rate at which present value of cash inflow is equal to the present
value of cash outflows. In other words, it is the rate at which NPV of the project is zero.
IRR is preferred by IOCL over other selection methods because of the following
reasons:

 IRR consider time value of money (Cash flows are converted into present value).
 It takes into account all cash inflows and outflows occurring over the entire lifetime
of the project.
 IRR is consistent with the overall objective of maximizing the net worth.
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EVALUATING A PROJECT ON THE BASIS OF IRR METHOD:
To evaluate a project through IRR method, IRR of the project is compared with the
predetermined hurdle rate. Hurdle rate is the minimum rate of return that must be met
for a company to undertake a project. It is calculated with the help of Capital Asset
Pricing
Model (CAPM).
If IRR exceeds the required rate hurdle rate, the project would be accepted and if IRR is
lower than required hurdle rate, the project would be rejected.

SENSITIVITY ANALYSIS (RISK ANALYSIS)

Sensitivity analysis is a procedure to determine the sensitivity of the outcomes of an
alternative, to changes in its parameters. If a small change in a parameter results in
relatively large changes in the outcomes, the outcomes are said to be sensitive to that
parameter. This may mean that the parameter has to be determined very accurately or
that the alternative has to be redesigned for low sensitivity.
The major parameters on which changes are made to study the revenue/IRR sensitivity
are as follows:
 Capex (Capital costs)
 Opex (Operating Costs)
 Throughput
 Freight charges

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Unit : Indian Oil Corporation Limited, Barauni

Project : ​Capital Investment Proposal For Capacity Enhancement

Estimates: ​Cost Estimates (Rs/Lacs)

​Item​ ​Total Cost

Plant & Machinery 2854.43

Civil 1548.68
Contingencies 132.09
Total 4535.00

Projected expenditure: Rs. 533.98 Lacs in 2012-13 and Rs. 4001.02 Lacs in 2013-14

Financial Returns (on incremental basis):

IRR – 15.43%
ROI – 19.81%
Payback period – 7.96 Years.

Scheduled Completion: 21 months after approval.

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FINANCIAL ANALYSIS SUMMARY OF INVESTMENT FOR CAPACITY
ENHANCEMENT OF HEAT EXCHANGE BLOWERS

PROJECT COST: Rs 45.35 Cr

INCREM
ENTAL TOTAL
BASIS BASIS
Parameters IRR% ROI% Payback IRR% ROI% Payback
100% Equity 0.1543 19.81 7.96 16.95 37.55 7.22
10% reduction in physical sale 13.81 16.67 8.4 11.36 26.43 8.93
10% increase in material cost 3.32 4.19 11.59 -2.22 -4.97 12.29
10% increase in investment 14.28 17.55 8.25 16.39 34.4 7.35
10% reduction in physical sale, 1.88 2.15 13 _ -15.58 13.14
10% increase in material cost
& investment

(-) indicates not determinable

Analysis

As above, there is a risk involved in investing as well as in not investing. However,

keeping in view the strategic requirement of Barauni unit as centre for meeting the
requirement of bitumen, it is essential to go ahead with the above investment proposal.

FINANCIAL ANALYSIS

A. CAPITAL INVESTMENT: ​A total investment of Rs. 4535 Lakhs has been

envisaged as per this proposal which includes import of certain plant& machinery of
Rs. 1716.08 Lakhs in terms of foreign exchange. Item wise estimates are based on the
latest budgetary offers obtained from prospective suppliers. Custom duties have been as
per prevailing current rate ​(with EPCG benefits) and exchange rates. Investment of Rs.
4535 Lakhs as proposed has been arrived considered CENVAT benefits. Matching
statutory export obligation for the expected EPCG benefits will be fulfilled from the
export business of the unit.

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B. PHASING OF INVESTMENT: ​Investment is planned of Rs. 534 Lakhs in
2011-12 and Rs. 4001 Lakhs in 2012-13. Investment will be completed in around 21
months from approval. Category-wise breakup i.e. P&M and civil facilities has been
furnished. The benefit of commercial production will be available from year 2013-14.

C. MANPOWER COST: An addition of 70 workers has been projected for the

scheme. Cost of manpower has been taken as per budget 2011-12 after taking account
of wage revision impact. An increase of 5% in personal payment year to year has been
considered.

D. MATERIAL CONTENT: ​based on latest estimate, material consumption on

turnover has been considered as 72.54%

E. OVERHEADS: ​The overhead expenses have been considered as 12.0% of turnover

for the financial analysis in this report.

F. INVENTORY: ​Holding period of raw material and components has been taken as
45 days of material consumption and work in progress as 75 days of turnover.

G. DEPRECIATION: ​Depreciation has been taken on straight line basis. Rates of

depreciation for plant & machinery and civil works has been taken as 20% and 3.34%
respectively considering 3 shift utilization. For income tax calculations, written down
value method has been adopted with depreciation rates of plant & machinery and civil
works as 15% with additional 20% in first year and 10% respectively.

H. CAPITAL STRUCTURE: ​Funding pattern for the scheme has been assumed on
100% equity basis.

I. INTEREST CHARGES: ​Since analysis is based on financing out of own resources,

WC of 12.00% as interest on working capital has been considered.

J. INCOME TAX: ​Corporate tax has been taken as per prevailing rate of 30%, with
additional surcharge of 10% and 3% educational cess. Thus effective tax works out to
be 33.99%.

K. OTHER FINANCIAL PARAMETERS: ​Have been taken as under:

● Debt collection Period : 30days sales
● Credit payment period : 60 days of material receipt
● Advances from customers : NIL

L. FINANCIAL ANALYSIS: ​IRR has been calculated based on turnover from

bitumen blowing unit with additional investment and manpower. 40% provisional
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impact of wage revision due with effect from 1​st jan-10 has been taken in personnel
payment for financial analysis purpose. ROI has been worked out based on average of
PAT projection of Bitumen blowing unit for 15 years period.
IRR :- 15.43%
ROI :- 19.81%
Payback Period :- 7.96 Yrs.

Incremental Basis

The calculation is based on incremental basis which means some part of the input
is taken from old input which is already there in the organization. And the
invested amount is Rs. 4535.00 Lakhs

As per the data calculated by the project department it shows separately IRR & payback
period which comes to

IRR = 15.43%
Payback period = 7.96 years

Acceptance rules: ​Any proposal is accepted in IOCL if it satisfies the following

conditions.

1. IRR should be greater than or equal to current rate of interest for loan (13%, as
approved for 2010-11)
2. Payback period should be less than or equal to 10 year. As decided by the
management.

Interpretation:

1. As the value of IRR, 15.43 which is more than the current hurdle rate i.e.
13%
2. Payback period as calculated comes to 7.96 which are again less than 10
years. It means that the amount of investment can be recovered
maximum in 8 years.
3. Average value of the profit after tax for 12 years is Rs. 898.30 Lakhs
which is quite high.
4. The return on investment is 19.81%.

Hence the proposal is accepted.

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SENSITIVITY ANALYSIS:

1. With 10% reduction in physical sale

a. As per taking this contingency the calculated value of IRR is coming to 13.81%
which is less than 15.43% but still more than bank rate of interest i.e. 13%.
b. If such condition occurs then also the organization will have a profit after tax of
Rs. 765.09 Lakhs and the return on investment will be 16.67%.
c. The payback period is coming to 8.4 years which means the organization will
recover the invested amount in 8.4 years.
d. The total output is Rs. 14000 Lakhs.

2. With 10% increase in Material cost

a. As per taking this contingency the calculated value of IRR is coming to 3.32%.
b. If such condition occurs then also the organization will have the profit after tax
of Rs. 189.91 Lakhs and the return on investment will be 4.19%.
c. The payback period is coming to 11.59 years which means that the organization
will recover the invested amount in 11.59 years.
d. The total output is Rs. 14000 Lakhs.

3. With 10% increase in Investment:

Under this the value of investment has increased to Rs. 4988.72 which causes the
following changes:
a. As per taking this contingency the calculated value of IRR is coming to 14.28%
which is less than 15.43% but still more than bank rate of interest i.e. 13%.
b. If such condition occurs then also the organization will have the profit after tax
of Rs. 875.50 Lakhs and the return on investment will be 8.25%.
c. The payback period is coming to 8.25 years which means that the organization
will recover the invested amount in 8.25 years.
d. The total output is Rs. 14000 Lakhs.

4. With 10% reduction in Material, Investment & 10% reduction in physical sale:
In this case all the contingencies above are taken together
a. As per taking this contingency the calculated value of IRR is coming to 1.88%
b. If such condition occurs then also the organization will have the profit after tax
of Rs. 107.22 Lakhs and the return on investment will be 2.15%.
c. The payback period is coming to 13 years which means that the organization

56
 will recover the invested amount in 13 years.
d. The total output is Rs. 14000 Lakhs.

After checking the sensitivity on all grounds of contingencies it is found that hardly
there is any chance of making loss, otherwise we are making a profit in all cases. That’s
why the proposal is being accepted.

CONCLUSION

IOCL is a leading organization in India, and is one among the Maharatna. IOCL

maintains the standard, quality of services and the brand image through its

uncompromising customer service. It has separate finance department which is

entrusted with the task of carrying out its various roles efficiently. The business

of IOCL is carried on in a very scientific manner. The procedure followed in the

capital budgeting of the proposal is in the scientific manner. The organization

also does the sensitivity analysis so that in case of any contingency the

organization will not have loss. Overall, the financial performance of the

organization is very well as it is having a continuous growth.

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