Improving the financial appraisal of investment projects in BIDV giaiphong

BIDV: Bank for Investment and Development of VietnamIP: Investment project IRR: Internal rate of return NPV: Net present value DSCR: Debt service coverage ratio LIST OF TABLES Table 1:

NATIONAL ECONOMICS UNIVERSITY CENTRE FOR ADVANCED EDUCATIONAL PROGRAMS

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BACHELOR S THESIS ’

TOPIC: Improving the financial appraisal of investment projects in BIDV Giai Phong

Student : ĐINH THỊ KIỀU TRANG Major : Finance

Class : Advanced Finance 54B Student s ID : 11124079’

Supervisor : Prof TẠ VĂN LỢI, PhD.

Hanoi, 2016 ACKNOWLEDGEMENT

First of all, I would hereby like to write for the people who strongly support me

to complete my bachelor’s thesis

I wish to express my profound sense of gratitude to Mr Ta Van Loi, mysupervisor, for his enthusiastic guidance, useful advices and recommendations andgreat encouragement in carrying out this project work

I would also like to thank Mrs Vu Thi Thu Ha, my internship guide, for giving

me valuable experiences about banking and especially, investment appraisal, strongsupport me gather data as well as information that are necessary for my report

My grateful thank are also due to the staffs at BIDV Giai Phong, and at RiskManagement Department in particular, for their help and support during the time of myinternship

Table of Contents

STATUTORY DECLARATION

I herewith formally declare that I myself have written the submitted Barchelor’sThesis independently I did not use any outside support except for the quoted literatureand other sources mentioned at the end of this paper

Hanoi, 02/06/2016 Signature

ABBREVIATION

BIDV: Bank for Investment and Development of Vietnam

IP: Investment project

IRR: Internal rate of return

NPV: Net present value

DSCR: Debt service coverage ratio

LIST OF TABLES

Table 1: Deposit and borrowing of BIDV Giai Phong 2012-2014)

Table 2: The rate of return on assets (ROA) of BIDV Giai Phong 2012-Jun2015Table 3: The rate of return on equity (ROE) of BIDV Giai Phong 2012-Jun2015Table 4: Project loan in BIDV Giai Phong 2013-2015 (billion VND)

Table 5: Revenue (Dai Huu Company)

Table 6: Annual repayment schedule (Dai Huu Comepany)

Table 7: Business Performance (Dai Huu Company)

Table 8: Cash flow in the view of bank (Dai Huu Company)

Table 9: Cash flow in the view of investor (Dai Huu Company)

Table 10: The effectiveness of Nam Ha project

LIST OF FIGURES

Figure 1: BIDV organization structure

Figure 2: Growth rate of mobilized capital of BIDV Giai Phong from 2012 to 6/2015Figure 3: Mobilization interest rate on average of BIDV Giai Phong (2012-2014)Figure 4: Mobilization costs weighted average of BIDV Giai Phong (2012-2014)Figure 5: Mobilization from deposits of BIDV Giai Phong (2012-2015)

Figure 6: Operating expenses of BIDV Giai Phong 2012-Jun2015

Figure 7: Profit margin of BIDV Giai Phong 2012-Jun2015

Executive Summary

As we all know, banking system had played an integral role in promoting thestability and the development of the economy Especially, in order to contribute tocause of industrialization and modernization, the development bank is taken intoaccount as an efficient supporter of the government to strengthen the economy andincome of national citizens However, in recent years, the economic crisis in Vietnamhas crept into every industry, including banking industry, especially commercial bank.Meanwhile, the principal activities of commercial banks are take deposits and lend,while lending is the main activity that creates bank’s profits Therefore, in the process

of approving the investment credit capital, how to operate efficiently and keep theloans safely are always the top priorities of banks Commercial banks have used a

variety of different methods and measurements in order to estimate the projects arepossible or not, manage the investment to minimize the risk and enhance the quality offinancial appraisal Among those methods, BIDV considers the investment projectsappraisal through calculation of how much the total investment capital, how long theloan maturity are, etc to make investment decisions and to guarantee the investmentcredit’s effectiveness.

Nevertheless, the financial appraisal system of BIDV has displayed somelimitations which due to the wrong credit granting decisions and the inaccurate capitalamount In fact, there are some projects are not able to pay the debt back to the Bank

During the period of internship in BIDV Giai Phong, by my experimentalworking time and reference, I have understood this bank in both organizationalstructure and its business performance I also have a chance to look through the data ofthis bank to give the most retail and precise analysis For all the purposes above, Isummit this report of this internship to analyze the investment project of BIDV GiaiPhong, points out the drawbacks and recommendations the solution to enhance theproject It met its aims through a study of basic relevant literature frameworks and a

study of specific application at BIDV Giai Phong “Improving the financial appraisal

of investment projects in BIDV Giai Phong” The thesis’s structure consists of seven

main chapters including:

Chapter 1: Introduction

Chapter 2: Overview of BIDV Giai Phong

Chapter 3: Theoretical framework

Chapter 4: Current situation of financial appraisal of investment projects

in BIDV Giai Phong

Chapter 5: Solutions and recommendations

Conclusion.

Because the time is limited and I have not very much practical knowledge, Ilook forward to receiving the help of supervisor to achieve better results

I sincerely thank!

CHAPTER 1: INTRODUCTION

1.1 Rationale

After nearly 20 years of turning to the socialist-oriented market economy,Vietnam economy has made great achievements and encouraging, GDP growth took7% per year The unemployment rate fell, meaning that the economy created morejobs Commodities are provided in full, varied and good quality Vietnam commercialbanks systems played an important role in the developing of Vietnam economy Asfinancial intermediary, Vietnam commercial banks systems are not only the mostimportant factor of economic activities, but also mainstream funding for private andpublic projects In the implementation process of project financing, the most pivotalpoint that the banks in general and BIDV in particular concern about is the efficiencyand safety of their investment Regard for commercial banks, project lending activities,which are the main income of commercial banks, always take high percentages in totalloans However, these activities contain potential risks for banks, it leads to the needsfor improving the quality of financial appraisal in lending activities, especially,improving the quality of financial appraisal of investment projects in commercial banks

is necessary BIDV has used a variety of different methods to evaluate the feasibility ofthe projects, manage the investments to minimize the risk and improve the investmentquality

Nevertheless, the financial appraisal system of BIDV has displayed somelimitations which due to the wrong credit granting decisions and the inaccurate capitalamount In fact, there are some projects are not able to pay the debt back to the Bank Being aware of those limitations as well as the important of financial appraisal ofinvestment projects to the investment credit’s quality which in turn decides the

performance of BIDV, I decided to choose my final project topic is “Improving the financial appraisal of investment projects in BIDV Giai Phong”

1.2 Review of relative researches

Financial management is significant concerned with financing, dividend andinvestment decisions of the firm with some overall goal in mind Corporate financetheory has developed around a goal of maximizing the market value of the firm to itsshareholders This is also known as shareholder wealth maximization Althoughvarious objectives or goals are possible in the field of finance, the most widelyaccepted objective for the firm is to maximize the value of the firm to its owners.Financing decisions deal with the firm's optimal capital structure in terms of debt andequity Dividend decisions relate to the form in which returns generated by the firm arepassed on to equity-holders (DayanadaD, 2002)

Investment decisions deal with the way funds raised in financial markets areemployed in productive activities to achieve the firm's overall goal; in other words,how much should be invested and what assets should be invested in it is assumed thatthe objective of the investment or capital budgeting decision is to maximize the marketvalue of the firm to its shareholders This self-explanatory helps the reader to easilyvisualize and retain a picture of the capital budgeting function within the broaderperspective of corporate finance (Durand, 1981) Funds are invested in both short-termand long-term assets Capital budgeting is primarily concerned with sizableinvestments in long-term assets These assets may be tangible items such as property,plant or equipment or intangible ones such as new technology, patents or trademarks.Investments in processes such as research, design, development and testing — throughwhich new technology and new products are created — may also be viewed asinvestments in intangible assets Irrespective of whether the investments are in tangible

or intangible assets, a capital investment project can be distinguished from recurrentexpenditures by two features One is that such projects are significantly large Theother is that they are generally long-lived projects with their benefits or cash flowsspreading over many years

Sizable, long-term investments in tangible or intangible assets have long-termconsequences An investment today will determine the firm's strategic position many

years hence (Gil, 1994) These investments also have a considerable impact on theorganization's future cash flows and the risk associated with those cash flows Capitalbudgeting decisions thus have a long-range impact on the firm's performance and theyare critical to the firm's success or failure.

As such, capital budgeting decisions have a major effect on the value of the firmand its shareholder wealth This review deals with capital budgeting decisions It focus

on defining the shareholder wealth maximization goal, defines and distinguishes threetypes of investment project on the basis of how they influence the investment decisionprocess, discusses the capital budgeting process and identifies one of the most crucialand complex stages in the process, namely, the financial appraisal of proposedinvestment projects This is also known as economic or financial analysis of the project

or simply as `project analysis' This financial analysis is the focus of this review.Actual project analysis in the real world involves voluminous, tedious, complex andrepetitive calculations and relies heavily on computer spreadsheet packages to handlethese evaluations (STAPLETON, 1971)

1.3 Research objectives

1.3.1. Research objectives

The thesis is navigated to reach three main targets, including

Firstly, to understand the historical background, organizational structure as well

as business performance and financial condition of BIDV Giai Phong

Secondly, to understand the content and procedure of investment project

appraisal which is currently applied in BIDV Giai Phong, especially focusing on financial appraisal, by analyzing a typical investment project appraisal of the branch

Thirdly, to evaluate the efficiency of financial appraisal of investment projects

in the branch, which classifies its achievements and limitations as well in order to find out both implicit and explicit causes, then suggest proper solutions and

recommendations to enhance its financial appraisal of investment projects in credit activity

1.3.2. Research question

• How did the branch appraise its investment projects?

Project appraisal method

Payback period

Average rate of return

Internal rate of return (IRR) Net present value (NPV)

Profitability index

• How many criteria of appraisal investment project does the bank use?

• What is the root cause of failure in project appraisal at the branch?

• What are success and limitation in project appraisal at BIDV Giai Phong?

• What suggestion can be issued to improve project appraisal processes at thebranch?

1.4 Scope of research

This thesis will study the financial aspects in 2 specific investment projectsappraisal of BIDV Giai Phong in the period of 2012-2015 The projects taken intoaccount in the research are the investment credit’s projects as approved by thegovernment for socio-economic development and the owners of projects are theenterprises and organizations, other than the individuals

1.5 Research methodology

In order to reach the research’s objectives, this project used a wide range ofresearch methods such as statistics, comparison, and analysis, ect To be detail, due tostrict regulation and appraisal process the branch used, the research follows the belowresearch model:

In addition, secondary data are used comprehensively, of which both qualitativeand quantitative data were collected by the author from BIDV Giai Phong’s annual

reports; operation report, financial statements of the branch from 2012 to Jun 2015;cases of project appraisals in BIDV Giai Phong and some internal documents Massmedia resources were also selectively used and so were the paper published byoverseas authors

Besides, personal observation during the internship period at BIDV Giai Phong

is also sources for assessment

CHAPTER 2: OVERVIEW OF Bank for Investment and

Development of Vietnam

2.1 General information

• Business Information:

Name of business: Bank for Investment and Development of Vietnam

Brand name: BIDV

Category: Finance - Banking

Slogan: Share opportunities, Share success

Address: BIDV Tower, 35 Hang Voi Street, Hoan Kiem District, Hanoi

The Joint Stock Commercial Bank for Investment and Development of Vietnam

was established on 26 April 1957 as the Bank for Construction of Vietnam, under

which name it operated until 24 June 1981, at which point it changed its name to

the Bank for Investment and Construction of Vietnam It adopted its present name

on 14 November 1990

Bank for Investment and Development of Vietnam is one of four state-ownedcommercial banks in Vietnam's largest formed the earliest and oldest, is now statespecial business, organized activities in the model form of state corporations

• Main business sectors:

Credit related activities (lending, discount, guarantee, credit card issuance, etc )Fund mobilization (savings deposit, bond, debenture)

Trade finance services

Payment services (domestic and international payment)

Account services

Bank card services

Other services as per Certificate of Business Registration

• Geographical distribution

Besides the Head Office, BIDV’s network now consisted of 136 branches(including 01 transaction center) with 595 transaction offices, 16 saving countersoperating widely throughout 63 provinces and cities nationwide The operatingnetworks are mainly allocated in North region (30%); South region (24%); Northmountainous region (11%); North Central Coast region (7%); Mekong Delta region(10%); South Central Coast region (7%); Central highland region (7%) and Red RiverDelta region (4%) BIDV has currently established correspondent relationships with

over 1,670 banks and branches in 122 countries and territories worldwide Besides,BIDV has systematically established commercial representative offices and joint-ventures in countries including Czech, Myanmar, Laos and Cambodia

With regard to business results of 2014, the North Region and the South Regionhave made a major contribution to the overall results of the Bank In particular : ( i )The North Region contributed 46 % of fund mobilization, 31 % of outstanding loans,

43 % of performance ; ( ii ) The South region contributed 24 % of fund mobilization,25% of outstanding loans, 23 % of performance

• Medium and long-term development strategy

Mission: BIDV commits to provide the best modern banking-finance services to

customers; bring the best value for shareholders, create a professional and prominentworking environment and worthy values for employees and pioneer in communitydevelopment activities

Vision: To become the most qualified, efficient and reputable Banking-Finance

Group in Vietnam

Core value: “Customer Orientation-Renovation and Development-Creation and

Professionalism-Social Responsibility-Quality and Reliability”

Service and product value orientation: To be the leader in making a

comprehensive product solution to differentiate BIDV’s with other conventionalbanking products provided by other banks to attract customers

Joint stock commercial bank for investment and development of Vietnam (BIDV JSC)

Subsidiaries

BIDV Financial Leasing Company Ltd

BIDV Asset Management

Company

BIDV International Holdings Company

Ltd, in HongKong

BIDV Insuarance Corporation

BIDV Securities Joint-Stock

VID-Public Joint-Venture Bank

Lao-Viet Joint-Venture Bank

Vietnam-Russia Joint-Venture Bank

BIDV-Vietnam Partners Investment Management

Joint-Venture Company

BIDV Tower Joint-Venture Company

BIDV Metlife Life Insurance Limited Liability

Figure 1: BIDV organization structure

(Source: BIDV annual report)

2.3 Branch performance from 2012 to 2015

2.3.1 Capital mobilization

2.3.1.1 Growth rate of mobilized capital

Figure 2: Growth rate of mobilized capital of BIDV Giai Phong from 2012 to

6/2015

(Source: annual reports of BIDV Giai Phong 2012-2015)

From 2012 to 6/2015, the growth rate of mobilized capital is not consistent,sometimes so high and sometimes so low, lower than 0% From 2012 to 2014, growthrate of mobilized capital increase from 0% to 13.399 %, but from 2014 to 6/2015, itdowns so fast, from 13.990% to (– 12.77%)

2.3.1.2 Capital mobilization cost

a.

Figure 3: Mobilization interest rate on average of BIDV Giai Phong (2012-2014)

(Source: Balance sheet BIDV Giai Phong branch 2012, 2013, 2014, 2015)

With the average deposit interest rate we must compare this index in three years:

2012, 2013, 2014 since 2015 is still moving, and not in complete, so interest payable isnot the same with the other three years

The average interest rate of BIDV Giai Phong branch decreased from 10.19% in

months, 6 to 11 months and 12 months For non-term interest rates and maturities ofless than one month is 1% / year.

- In USD:

Applicable interest rate ceiling is 1.0% / year for residential customers; interestrate cap of 0.25%/ year for the customer is the economic organization

And we have the following table:

Table 1: Deposit and borrowing of BIDV Giai Phong 2012-2014)

percentage is quite high

b.

Figure 4: Mobilization costs weighted average of BIDV Giai Phong (2012-2014)

(Source: Financial statements of the BIDV from 2012 to June - 2015)

Mobilization costs weighted average of BIDV Giai Phong branch decreased from 2012 to June-2015 (11.42% in 2011 and 3.21% in 2014) This show that, BIDV needs to earn the rate of return from loans and investments that may be larger than the average funding costs enough to offset the interest expense paid to mobilization This

index gradually decreased shows that the Bank have improve in the way of raising capital to achieve higher profits.

2.3.1.3 Mobilizing from deposit

Figure 5: Mobilization from deposits of BIDV Giai Phong (2012-2015)

(Source: Structure of deposits and loan classification)Looking at the statistical diagrams term non- deposits, term deposits, savingsdeposits and escrow of BIDV Giai Phong branch, we find non-term deposits and termdeposits have proportion higher than most savings deposits and escrow With termdeposits, up and down uneven over the years Specifically, in 2012, the amount ofdeposits in the high 69%, but fell sharply in 2013 (39%) and increases in both 2014and 2015 to the second quarter was 52% In contrast to the increased of non-termdeposits is a gradual reduction of term deposits (from 56% in 2013 to 41% in thesecond quarter / 2015) To explain this, because BIDV Giai Phong focus on businesscustomers in domestic and overseas simultaneously with term deposit help customersfacilitate the payment and enjoy high interest rates should be more organizational trustand use That is why the term deposits of BIDV Giai Phong branch development thanother types of deposits

2.3.2 Earnings

2.3.2.1 Cost to income

Cost/ income is the ratio to measure for the level cost efficiency activities like operating margin, but unlike the operating margin, the ratio is lower which is better

Figure 6: Operating expenses of BIDV Giai Phong 2012-Jun2015

(Source: Income statement of BIDV Giai Phong from 2012-Jun2015)

We can see that is a few changes over the year of BIDV Giai Phong, the index

in 2012 up to 43%, operating cost by nearly one half of the total income but this figure

had dropped to 37% in 2013, operating expenses increased only 1.5 times while total income increases almost two times than 2012 This number continues to increase until

2014 and the first half of 2015 It presents some activities for using of cost –

effectiveness fairly of the branch

2.3.2.2 Profit margin

This ratio shows the income account for how many percentage of revenue, theindex of BIDV Giai Phong over the year, which are positive that proves profitable ofbank Although the index in 2012 is relatively low (7%) because the economy is incrisis but BIDV branch was soon improved by rapid growth of the index, increased by6% since 2012 to 2013 and increased 4% from 2013 to 2014 and remain until June,2015

Figure 7: Profit margin of BIDV Giai Phong 2012-Jun2015

(Source: Income statement of BIDV Giai Phong from 2012 to Jun 2015)

2.3.2.3 The rate of return on assets (ROA)

Table 2: The rate of return on assets (ROA) of BIDV Giai Phong 2012-Jun2015

Net income Total assets

ROA

2012 27,519,340,887 4,367,335,512,834 0.63%

2013 54,811,740,917 4,217,491,742,102 1.30%

2014 62,680,199,384 4,552,565,146,988 1.38%Jun2015 22,789,594,539 4,024,640,872,167 0.57%(Source: Income statement and balance sheet of BIDV Giai Phong from 2012 to

Jun2015)This ratio represents the relationship between the profitability of total asset; itshows the efficient using of assets for profit Although in 2012 is an extremely difficulttime for all banks but ROA of BIDV Giai Phong still above the average is 0.63% ROA

in 2013 and 2014 have risen above 1%, reflecting activities of bank is very well and are

on the rise To June, 2015, ROA is only 0.57% but it is enough to show results by theend of 2015 will same with 2014

2.3.3.4 The rate of return on equity (ROE)

Table 3: The rate of return on equity (ROE) of BIDV Giai Phong 2012-Jun2015

Net income Equity

ROE

2012 27,519,340,887 593,200,385,362 5%

2013 54,811,740,917 593,200,385,362 9%

2014 62,680,199,384 647,304,850,157 10%Jun2015 22,789,594,539 619,087,637,195 4%(Source: Income statement and balance sheet of BIDV Giai Phong from 2012 to

Jun2015)

This target said ability to generate profits from one coin invested by the owners.This is an indicator that investors most interest as it in indicates the income of theshareholder and the fact that banks in working effectively or not

It likes the norms of BIDV Giai Phong in 2012, ROE is low (5%) that is levelindicator is low than indicator of international standards But the index recovered twotimes since 2013 – 2014, the bank has development activities and normal profit ROE

in 2015 will be approximately ROE in 2014 – it also represents a stable business ofBIDV

Although the index of bank through the year which are less than 15% but withthe date about ROE from 2012 – 2015, that also make investor recognize the effect ofbank is more profitability

CHAPTER 3: THEORETICAL FRAMEWORK

3.1 Overview of investment project and investment project appraisal

3.1.1 Overview of investment project

3.1.1.1 Definition of investment project

Investment is an important activity to any organization and individual in the

economy In the modern economist’s opinion, investment project (IP) is a set of

specific activities in order to create a new reality with methods based on certainresources In Vietnam, according to Clause 8, Article 3 of Investment Law

promulgated in 2005, IP is the set of proposals of investing the medium- and long-term

appraisal to implement the investment activities in the specific areas within a definedperiod of time” In regulations of medium- and long-term credit issued together with

the Decision No 367/QD-NH1 dated 21 December, 1995 of State Bank, IP is defined

as “a set of proposals based on scientific and practical basis about investing capital tobuild, expand, renovate technically and technologically the objects which are the fixedassets to reach the growth of quantity, renovate or improve the quality of products andservices within a defined period of time.”

3.1.1.2 Content of investment project

- Objectives: the specific benefits or contributions of the project to development of theeconomy and the society in general

- Results: quantitative outcomes or outputs derived from different activities of theproject Results are extremely essential to achieve objectives

- Activities: all tasks or actions implemented in the projects to create certain outcomes orresults, along with a time schedule and responsibilities of the departments which makethe project’s implementation plan

- Resources: necessary inputs for the project, including human, financial andinfrastructure resource The total cost of these inputs constitutes investment capital ofthe project

- Time: the length of project’s time period needs to be fixed

3.1.1.3 Investment project life cycle

The precise formulation of a project and its phases vary from one agency toanother, but a typical investment project cycle is divided into three main stages:

project preparation, project implementation and monitoring, and valuation Among

three periods, project preparation is the most important one, which determines thesuccess or failure of two subsequent periods Each stage of investment project lifecycle is presented in detail below

 1 st stage: project preparation

+ Programing: the establishment of general guidelines and principles forcorporation, outlining of broad ideas for projects and programs.

+ Identification: within the program framework, problems, needs and interest ofpossible stakeholders are analyzed; ideas for project and other actions are identifiedand screened The result of this phase is the decision of whether or not the project isworth going ahead with the designing and detailed project document Recently,investors place much emphasis on project identification as an important element in theoverall success of the project

+ Preparation and analysis: this stage is formally a borrower responsibility Itparticipates creating a detailed plan Through careful and detailed analysis, projects arelikely to be shaped and redefined to take them a step closer to realistic conditions underwhich they may be implemented

+ Appraisal and investment decision:

 2 nd stage: project implementation and monitoring

The agreed resources are used to carry out the planned activities and achieveobjectives Implementation tends to be complicated in practice by many unforeseenproblems Flexibility is therefore required at this phase to enable the successfulexecution of this project The process of implementation can be long and drawn outdepending on the nature of the project and the time period over which is spans Whilethe project is being carried out, continuous monitoring is required to satisfy projectimplement that things are proceeding according to plan

 3 rd stage: valuation

Once the project is completed, it needs to be evaluated so as to enable analysis(borrowers and lenders) to assess its performances and outcome Has the project beensuccessful in attaining its objectives? If not, in what respect has it failed? How mightits design and implementation have been improved?

3.1.1.4 Classification of investment project

Investment projects can be classified into three categories on the basis of howthey influence the investment decision process: independent projects, mutuallyexclusive projects and contingent projects

An independent project is one the acceptance or rejection of which does not

directly eliminate other projects from consideration or affect the likelihood of theirselection For example, management may want to introduce a new product line and at

the same time may want to replace a machine which is currently producing a differentproduct These two projects can be considered independently of each other if there aresufficient resources to adopt both, provided they meet the firm’s investment criteria.These projects can be evaluated independently and a decision made to accept or rejectthem depending upon whether they add value to the firm.

Two or more projects that cannot be pursued simultaneously are called mutuallyexclusive projects – the acceptance of one prevents the acceptance of the alternativeproposal There- fore, mutually exclusive projects involve ‘either-or’ decisions –alternative proposals cannot be pursued simultaneously For example, a firm may own

a block of land which is large enough to establish a shoe manufacturing business or asteel fabrication plant If shoe manufacturing is chosen the alternative of steelfabrication is eliminated A car manufacturing company can locate its manufacturingcomplex in Sydney, Brisbane or Adelaide If it chooses Adelaide, the alternatives ofSydney and Brisbane are precluded

Mutually exclusive projects can be evaluated separately to select the one which

yields the highest net present value to the firm The early identification of mutuallyexclusive alternatives is crucial for a logical screening of investments Otherwise, a lot

of hard work and resources can be wasted if two divisions independently investigate,develop and initiate projects which are later recognized to be mutually exclusive

A contingent project is one the acceptance or rejection of which is dependent on

the decision to accept or reject one or more other projects Contingent projects may becomplementary or substitutes For example, the decision to start a pharmacy may becontingent upon a decision to establish a doctors’ surgery in an adjacent building Inthis case the projects are complementary to each other The cash flows of the pharmacywill be enhanced by the existence of a nearby surgery and conversely the cash flows ofthe surgery will be enhanced by the existence of a nearby pharmacy

3.1.2 Overview of investment project appraisal

3.1.2.1 Definition of investment project appraisal

Project appraisal is a consistent process of reviewing a given project andevaluating its content to approve or reject this project, through analyzing the problem

or need to be addressed by the project, generating solution options (alternatives) forsolving the problem, selecting the most feasible option, conducting a feasibilityanalysis of that option, creating the solution statement, and identifying all people and

organizations concerned with or affected by the project and its expected outcomes It is

an attempt to justify the project through analysis, which is a way to determine projectfeasibility and cost-effectiveness

Broadly, investment appraisal or capital budgeting is concerned with theselection and use of criteria and methodologies to guide the allocation of investmentexpenditure It thus focuses on alternative measures of project acceptability For bothprivate and public sector enterprises and firms, the decisions involved are important notonly because the expenditure involved can be very large, but also because the decisionsmade are often irreversible, and the uncertainties regarding their future benefits may beconsiderable

3.1.2.2 Process of investment project appraisal

Capital budgeting is a multi-faceted activity There are several sequential stages

in the process For typical investment proposals of a large corporation, the distinctivestages in the capital budgeting process are depicted, in the form of a highly simplifiedflow chart

• Financial appraisal of projects

Projects which pass through the preliminary screening phase become candidatesfor rigorous financial appraisal to ascertain if they would add value to the firm Thisstage is also called quantitative analysis, economic and financial appraisal, projectevaluation, or simply project analysis

This project analysis may predict the expected future cash flows of the project,analyze the risk associated with those cash flows, develop alternative cash flowforecasts, examine the sensitivity of the results to possible changes in the predictedcash flows, subjected the cash flows to simulation and prepare alternative estimates ofthe project’s net present value

Thus, the project analysis can involve the application of forecasting techniques,project evaluation techniques, risk analysis and mathematical programming techniquessuch as linear programming While the basic concepts, principles and techniques ofproject evaluation are the same for different projects, their application to particulartypes of projects requires special knowledge and expertise For example, assetexpansion projects, asset replacement projects, forestry investments, propertyinvestments and international investments have their own special features andpeculiarities

Financial appraisal will provide the estimated addition to the firm’s value interms of the projects’ net present values If the projects identified within the currentstrategic framework of the firm repeatedly produce negative NPVs in the analysisstage, these results send a message to the management to review its strategic plan.Thus, the feedback from project analysis to strategic planning plays an important role

in the overall capital budgeting process The results of the quantitative project analysesheavily influence the project selection or investment decisions These decisions clearlyaffect the success or failure of the firm and its future direction Therefore, projectanalysis is critically important for the firm This book focuses on this complexanalytical stage of the capital budgeting process, that is, financial appraisal of projects(or simply, project analysis)

• Qualitative factors in project evaluation

When a project passes through the quantitative analysis test, it has to be furtherevaluated taking into consideration qualitative factors Qualitative factors are thosewhich will have an impact on the project, but which are virtually impossible to evaluateaccurately in monetary terms They are factors such as:

- The societal impact of an increase or decrease in employee numbers

- The environmental impact of the project

- Possible positive or negative governmental political attitudes towards the project

- The strategic consequences of consumption of scarce raw materials

- Positive or negative relationships with labor unions about the project

- Possible legal difficulties with respect to the use of patents, copyrights and trade

or brand names

- Impact on the firm’s image if the project is socially questionable

Some of the items in the above list affect the value of the firm, and some not.The firm can address these issues during project analysis, by means of discussion andconsultation with the various parties, but these processes will be lengthy, and theiroutcomes often unpredictable It will require considerable management experience andjudgemental skill to incorporate the outcomes of these processes into the projectanalysis

Management may be able to obtain a feel for the impact of some of these issues,

by estimating notional monetary costs or benefits to the project, and incorporatingthose values into the appropriate cash flows Only some of the items will affect theproject benefits; most are externalities In some cases, however, those qualitative

factors which affect the project benefits may have such a negative bearing on theproject that an otherwise viable project will have to be abandoned.

• The accept/reject decision

NPV results from the quantitative analysis combined with qualitative factorsform the basis of the decision support information The analyst relays this information

to management with appropriate recommendations Management considers thisinformation and other relevant prior knowledge using their routine informationsources, experience, expertise, ‘gut feeling’ and, of course, judge to make a majordecision – to accept or reject the proposed investment project

• Project implementation and monitoring

Once investment projects have passed through the decision stage they then must

be implemented by management During this implementation phase various divisions

of the firm are likely to be involved An integral part of project implementation is theconstant monitoring of project progress with a view to identifying potential bottlenecksthus allowing early intervention Deviations from the estimated cash flows need to bemonitored on a regular basis with a view to taking corrective actions when needed

• Post-implementation audit

Post-implementation audit does not relate to the current decision supportprocess of the project; it deals with a post-mortem of the performance of alreadyimplemented projects An evaluation of the performance of past decisions, however,can contribute greatly to the improvement of current investment decision making byanalyzing the past ‘rights’ and ‘wrongs’

The post-implementation audit can provide useful feedback to project appraisal

or strategy formulation For example, ex post assessment of the strengths (oraccuracies) and weaknesses (or inaccuracies) of cash flow forecasting of past projectscan indicate the level of confidence (or otherwise) that can be attached to cash flowforecasting of current investment projects If projects undertaken in the past within theframework of the firm’s current strategic plan do not prove to be as lucrative aspredicted, such information can prompt management to consider a thorough review ofthe firm’s current strategic plan

3.2 Financial appraisal of investment project

The essence of financial appraisal is the identification of all expenditures andrevenues over the lifetime of the project, with a view to assessing the ability of aproject to achieve financial sustainability and a satisfactory rate of return The appraisal

is usually done at constant market prices and in a cash flow statement format It is thedifference of all revenues and expenditures at the time at which they are incurred

• Revenues

The cash flow statement sets out the revenues to be derived from a project.These revenues can take several forms The easiest to identify are the products andservices from the project sold through normal commercial channels as well as anycommercially exploitable by-products and residues Revenue valuation is then simply amatter of estimating the sales values of these products and services

• Expenditures

The cash flow statement embraces both capital and operational expenditures.Capital expenditures are simply the expenditures of those items needed to set up orestablish the project so that it can be operated Operating expenditures are thoseincurred in operating and maintaining the project Capital expenditures usually coveritems related to construction of facilities, including site preparation and other civilcosts; plant and equipment, comprising not only the acquisition cost but also the cost oftransport, installation and testing; vehicles; and working capital

Operating expenditures typically comprise raw materials, labour and other inputservices, repairs and maintenance Pre-operating expenses, sunk costs, and workingcapital may be included under certain conditions In a financial appraisal used as thebasis of an economic appraisal, other costs such as depreciation, interest and loanrepayments are not included Depreciation is excluded, because it would double countthe capital cost Interest payment and loan repayment are not included, because one ofthe major purposes of deriving the cash flow is to determine the rate of interest theproject can bear

Some projects do not lead to any direct increase in revenues, but achieve theirobjective by reducing operating expenditures When these can be quantified, they areincluded in the cash flow as negative operating expenditures

This can be quite straightforward with “greenfield” projects However, wherethe project is instead an addition to an existing activity, then a difference between the

“with” and “without” project is established The entire output of the enterprise cannot

be treated as the outcome of the project, either in terms of increased revenues ordecreased operating expenditures Only the impact of the project ought to be counted.Care must be exercised in constructing a counterfactual, for some increases inexpenditures or revenues that occur after the establishment of a project would haveoccurred even without the project "Before and after" is not the same as "with andwithout", and in project analysis it is the "with and without" comparison that matters

In cases of this kind it has proven more effective to prepare two separate cash flows,one with the new project and one without it, and then to treat the differences as theproject impact

• Financial profitability

The financial profitability evaluates the returns to the financial stakeholders inthe project, by calculating the rates of return to the holders of equity and thereforeproviding indications about improvements in the financing structure of the project Thecash flow statement describes the ability of a project to raise its own financing and toassess whether it is financially sustainable The latter is summarized by indicators such

as the financial internal rate of return (FRR), i.e the discount rate that yields a zero netpresent value of the cash flow over the lifetime of the project The FRR is thencompared with the overall cost of funding rate If the FRR falls below it, the project asdefined is financially not worth undertaking, and therefore requires a redesign and/oradditional sources of funding such as for instance grants and subsidies A frequentlyused alternative indicator is the Net Present Value (NPV) of the project, which iscalculated by using the cost of funding rate5 as discount rate The project is financiallyviable if the NPV is positive The FRR and NPV capture different aspects of theproject return, but in any case lead to the same conclusions with respect to viability

3.3 The factors affecting the quality of financial appraisal of investment project 3.3.1 Subjective factors

Awareness of the leaders of the credit institution on the financial appraisal of the project: this is extremely important Because if the leaders of the credit institutions

that finance the appraisal project is unnecessary for the credit institutions would nothave the financial appraisal of the project before making investment decisions.Business financial appraisal of investment projects are just really interested andadvanced when the leaders of the credit institutions recognize the significance of thiswork for investment activities.

The level of project evaluation staff: the ability of people to participate in

appraising projects very important role for the evaluation of financial results are based

on the research results, technical analysis, market , organization of production, Thecapacity of project appraisal officers directly influence to the outcome that theyundertake Therefore, in any case, in order to want to complete the evaluation workproject finance, first quality itself of personnel evaluation must constantly be improved.They must meet the demands of professional skills, master the laws, regulations andpolicies of the State Also, as a moral quality of personnel evaluation is also anindispensable condition

Process the content and methods of financial appraisal of the project: The

process has great influence to the financial appraisal of the project A process, contentand appropriate methods, scientific objectivity and complete the base ensures goodperformance appraisal project finance However, the processes, content and evaluationmethodology unreasonable, sketchy sure to result in financial evaluation projects arenot high and the credit institution is difficult to rely on for decision accurate investmentdecisions

Information is the basis for the analysis and evaluation: the "raw material" for

the operational work of the staff appraisal The most important source of information isprimarily from the project file If the information in the project file is missing orunclear, the verifier may request the project to provide additional information orexplain it Besides the information about the project, so the evaluation is conducted in

an active way, with the objective evaluation, more accurately, the ability to access,collect other information sources and the ability to process information evaluation ofits staff play a decisive role

Operating Organization: Financial Evaluation of investment projects is a

collection of activities that are closely related to each other and with other activities.The evaluation results will depend on the organization of management and

administration, the coordination of staff in the appraisal process Unlike other factors,the operating entity indirectly impact to the evaluation work The organizationoperating is done rigorously, science and will maximize all resources for the operation

of project evaluation

3.3.2 Objective factors

The legal framework and mechanisms of state policy: This factor acts as aframework of action oriented actors in the economy, including credit institutionsserving the common goal of society The defect in rationality, uniformity or negative ofthe legislation and policies of the State management can cause difficulties, increasingrisks to the operating results of the project as well as the evaluation activities of creditinstitutions Some of the main shortcomings of the legal system and by themanagement mechanisms of the common state are:

- With these projects and foreign investment related policies that these policies are notfully completed, stable, often in flux leads to psychological peace of mind, confidence

CHAPTER 4: CURRENT SITUATION OF FINANCIAL APPRAISAL OF

INVESTMENT PROJECT IN BIDV GIAI PHONG

4.1 General information of investment project appraisal in BIDV Giai Phong 4.1.1 The process of financial appraisal of investment project in BIDV Giai

Phong

The appraisal of investment projects in BIDV Giai Phong includes the followingsteps:

Step 1: After receiving the loan file project, appraisal staffs check its facilities

appraisal In the case of insufficient basis of appraisal, bank staffs have to switch back

to their customer in order to complete the missing information, additional profile Onthe contrary, if customers have enough facilities appraisal, they will sign track profile

in the book and forward it directly to appraisal staffs

Step 2: Based on provision, relevant information and reference which are

specified in the instruction of the process, appraisal staffs consider the projects andpotential customers for a loan In the case of investigation, customers have to explainclearly

Step 3: Financial factor of the projects will be sent to the Head in order to be

taken into revision process by the appraisal officers

Step 4: After receiving the appraisal of projects, the Head examine and control

commerce, approve or demand the appraisal officers modify and clarify the projects

Step 5: Bank staffs finish contents of appraisal report, fill the necessary

information and submit profile including appraisal report to the Head of Credit Inparticular, appraisal staffs often concentrate on estimating the financial effectiveness,analyzing each characteristics of project and the ability to pay off debt in order to findthe potential project

4.1.2 The content of financial appraisal of investment project in BIDV Giai

Phong

Regarding the instruction of project appraisal and the lending procedure ofBIDV Giai Phong, the content of financial appraisal of investment project carries outthrough the following factors:

Collect and process information about customers and their projects: BIDV

verifies the accuracy of the information sent by customers Appraisal staffs investigatethe business background of enterprises, study the state of factory and equipment of thecommerce Besides, they have to gather other information such as price, theconsumption of similar products, suppliers, mass media, etc in order to consider all theaspects of projects (for example: legality, inputs and outputs, financial and managerialaspects, review the technical aspects, ability to supply raw material, …) which willsupport the examination to plan and execute debt repayment responsibility of thebusiness for the Bank Business performance of the firm doesn’t significantly depend

on appraiser’s assessment

Total investment of capital: Evaluating total investment of capital is an

extremely significant stage Appraisal staffs must examine abundance of totalinvestment of capital which includes of fixed capital, working capital, pooling To bemore specific, fixed capital includes capital equipment and capital to buildinfrastructure… Working capital was determined by the speed of relation of annualcapital projects Appraisal officers analysis, compare, conduct and then find out acapital structure that is reasonable to ensure the achievement of target for determiningthe maximum level of funding that BIDV should be involved in the project Inaddition, some factors (for example: fluctuating prices, inflation, additional volume ofsome items, or fluctuating exchange rate when the project use foreign exchange) whichmake contribution to the rise of costs are needed to consider In the case of sufficient

evaluation, a lot of shortage and surplus of capital can be avoided Therefore, investorsare able to equalize expected sources of capital to control the budgeting of the project.Furthermore, it is also the standard to calculate the financial effectiveness and theability of debt repayment of the considering project

Appraisal revenue – cost of project:

- Input and cost of project: Provided information and technique features, raw materialinputs are taken into account when investigating production process and estimatingprice fluctuation of imported materials and final products sold in the near future, inwhich appraisers evaluate expected unit price and production cost

- Output market, product scalability of project: Consumer market products and serviceoutputs play an integral role in determining the ability to succeed of the project Bankstaffs often focus on considering and evaluating the strengths and the weaknesses ofthe product on the market and the competitive challenges of the outputs After that,they bring out some consumption plans which can be mobilization capacity or annualrevenue Besides, the current tax regime and the text of individual references also areconsidered in order to determine the duty of the investment project for the Bank, thusverifying the Profit after tax in the source of project payment

Source of capital and payment plan: Based on the volume of investment

approved, appraisal staffs reinvestigate each source of capital and then evaluate theability of certainty of each investment project Moreover, they also need to consider thecost and lending conditions of each capital source From these, BIDV officers willexamine the possibility of capital sources

- Credit line, term of lending and term of payment

- Financial indicators: On the basis of all the above calculation, appraisal staffs guide tocalculate NPV, IRR, ROA, ROE, annual repayment sources, time to repay loan, etc inorder to forecast if the assumption change These activities can contribute to help bankescape from some direct consequences when the risk happens

- Profitability indicators: including NPV, IRR, Payback period

- Ability to pay off debts: including annual sources of payment, time of principlepayment, repayment durations, debt service coverage ratio (DSCR), time of interestpayment, collateral of debts

+

+

+ Collateral of debts: Debts are collateralized by all the assets of the project which purchased or built by equity and debts (including land)

Check the safety conditions of loans: The safety conditions of loans to project

are taken into account against risk of the capital loan BIDV can also ask for the

guarantee of third party in some necessary cases

4.1.2.1 An example of a successful project appraisal case

a Overview of the project

• Project

- Project name: Investing in PP package manufactory

- Investor: Dai Huu Company (Joint Stock Company)

- Project’s location: Ha Dong industrial zone

- Total investment: 50.200,613 billion VND

Owner’s equity: 15.200,613 billion VND (account for 30% total investment)Debt (from Bank): 35 billion VND (account for 70% total investment)

- Borrowing term

Medium-term loan: 6 years

Short-term loan: up to 12 months

- Collaterals: asset originated from borrow capital and equity (has an approximate value

of 50,200 million VND)

• Investor

- Trading name: Dai Huu Company (Joint Stock Company)

- Address: Thanh Tri, Ha Dong, Hanoi

- Business Registration Certification: No 0103000740 by the Department of Planningand Investment of Hanoi

- Capital: 52 billion VND