Indian Railway Codes and Manuals-Finance code-Vol-I-Chapter- 2 (II)
CHAPTER II
Financial Appraisal Of Railway Projects
201.
General Principle -Indian Railways is part of infrastructure Ministry and hence
substantial investments are to be made for augmentation of capacity and
expansion of network which require large investment. Investment decisions are
the most important decisions to be made. It is fundamental to railway system as
a commercial undertaking that expenditure other than that wholly chargeable to
Ordinary Revenue incurred on new assets or for improvement of existing assets
should be financially justified and no expenditure should be incurred without
sanction. Moreover these decisions are to be made by keeping long term
perspective in mind and treating IR as a national asset.
202.
As an exception to Para 201, while no financial justification as such need be
given in the following cases, it should be seen that the scale of expenditure
incurred is as economical as possible consistent with the extant orders, if
any, on the subject:-
a)
when the expenditure is incurred on a statutory obligation;
b)
when the expenditure is unavoidable on considerations of safety;
c)
when the expenditure is incurred on passenger amenity* works; and
d)
when the expenditure is incurred on labour welfare works except residential
buildings for which special rules are applicable. *(Authority Board’s letter
no. 2023/F(X) II/10/1 dated 01/02/2023 ACS No1)
Note
- 1) When expenditure on any of the above items forms part of a scheme and is
not essential independently of the scheme, the total cost of the scheme,
inclusive of the cost of the above works,should be financially justified.
2)
In the case of savings in engine days or wagon days or both by avoidance of or
reduction in detentions to stock, etc., the financial justification should be
worked out on the basis of increased locomotive or wagon, etc., utilization and
consequent postponement of the purchase of new engines or wagons, etc., if such
saving can be definitely secured, and not on the basis of the earning capacity
of the stock saved.
3)
Savings on a particular railway should not be taken into account if they mean a
loss on another railway. In such cases, the interest of railways as a whole
should be considered.
4)
No credit should be given to a proposed scheme for a saving which can be
achieved regardless of whether the proposed scheme is or is not embarked upon.
5)
If flag stations are included in the new scheme, the cost of operating them
should be taken into account as an item of expense in working out the financial
justification of the scheme.
6)
Where a number of works required in connection with and/or increasing the line
or transhipment capacity have to be carried out on different stations of a
section as part of a scheme, the financial justification should be worked out
for the section as a whole, as it might be difficult to allocate anticipated
savings to individual stations.
7)
Expenditure on works required for meeting statutory obligations or on
consideration of safety should be subjected to proper scrutiny to see if the
proposal is the result of a fresh development not already covered by the
existing rules, or for implementation of a new recommendation of the Standing
Safety Committee (accepted by the competent authority) or any Commission of
Enquiry set up by Government, as the case may be.
203.
Scrutiny by Finance & Accounts Officer -The Finance & Accounts Officer
in his position as the Financial Adviser to the Administration, should
carefully scrutinize the justification for proposed expenditure with reference
to the principles enunciated in this Chapter and other orders on the subject.
Even in cases where the return on the investment is not the determining factor,
it will be incumbent on him to examine and offer his advice on the general
merits of the proposal in the spirit of a prudent individual spending his own
money.
204.
Test of remunerativeness: The
net financial gain expected to accrue from a project be either by way of
savings in expenditure or increase in net earnings (i.e. gross earnings less
working expenses),or a combination of both. Except in case residential
buildings, assisted sidings and rolling stock to which special rules are
applicable, no proposal for fresh investment will be considered as financially
justified unless it can be shown that the net gain expected to be realized as a
result of the proposed outgo would after meeting the working expenses or
average annual cost of service(see para217) yield a return of not less than 10
percent under DCF method on the initial estimated cost.
(Authority:F(X)-II/2011/ROR/1 dated 05.10.2017)
Note:-1)
Interest during construction should be added to the cost (excluding that
chargeable to Revenue) of the projects, the construction of which is likely to
last for more than one year.
2)
Depreciation should be calculated on the total cost of the scheme and not only
on the portion chargeable to Capital, unless the contrary procedure can be
justified in any particular case. However, depreciation as an element of
working expense is to be ignored for assessing annual cash flows under the DCF
Method (see para 228).
3)
In the case of construction of bridges, maintenance charges should include,
besides the Maintenance charges on the bridges proper.
4)
The element of interest charges, vide item (d) of para-215, should be ignored
in determining the average annual cost of service in the case of a new project,
though it should otherwise be included for the purpose of working out the
comparative cost of two or more alternative schemes.
205.
Following is an illustrative list of the various types of investment proposals
which must pass the prescribed test of financial remunerativeness:
a)
New Lines: -
1)
Project oriented or ‘single purpose’.
2)
General purpose.
b)
Line Capacity Works
1)
Gauge conversions.
2)
Doublings.
3)
Major Signalling Schemes i.e. Tokenless Block Working, Automatic Block
Signalling, CTC, Route Relay Interlocking, KAVACH etc.
4)
Lengthening of loops and/or provision of additional loops.
5)
Crossing stations.
6)
Strengthening of electric traction distribution system and/or major modifications
to electric traction installations.
c)
Yard Remodelling and Terminal Facilities-
1)
Marshalling yards.
2)
Goods and passenger terminals.
3)
Transhipment points.
d)
Telecommunication Works.
e)
Electrification and provision of Loco Sheds herefore
f)
Introduction of new services- Passenger trains, container services, etc.
g)
Workshops
1)
Production Units.
2)
Repair Units.
206.
It may sometimes be necessary to reject a more economical alternative, because
of considerations on which it is difficult to put a precise money value. If on
the strength of any such factor a proposal is adopted that is less economical
than its alternatives, the reasons determining such a choice should be recorded
in the report of the estimate containing such proposals. In those cases in
which the reasons as recorded are not accepted by the Finance & Accounts
Officer, the latter should offer his remarks in his certificate of verification
of the estimate concerned, so that these remarks may be taken into
consideration by the authority sanctioning the proposal.
207.
In regard to works proposals which are intended to increase line capacity,
detailed traffic surveys should be conducted by a team consisting of officers
of requisite status and experience from the Commercial/Operating Department and
the Finance & Accounts Department. Where the traffic survey is conducted
along with an engineering survey (Reconnaisance, Preliminary Engineering or
Final location), the traffic survey report should be prepared under the general
guidance of the Leader of the Team who will be an officer of appropriate status
from the Civil Engineering Department.
208.
Provision of Rolling Stock
–Investment proposals for purchase/manufacture of additional rolling stock are
to be justified on the basis of a general increase in the level of traffic
which may or may not require line capacity works being taken up at the same
time for the anticipated level of traffic. Where a line capacity work is
justified due to anticipated increase in traffic, and also in the case of
proposals for new line construction, the initial cost estimate should, for the
purpose of Project appraisal, invariably include the cost of the rolling stock
and the financial return on the project should be measured with reference to
the overall initial cost of the project including the cost of rolling stock.
209.
A very substantial part of the capital employed on the Railways is represented
by the investment in rolling stock. The assessment of rolling stock required
for moving additional traffic is directly related to the targets for movement
of freight traffic, commodity-wise as projected by the Planning Directorate of
the Railway Board. For additional passenger coaches, the Planning Directorate
makes a forecast of the rate of growth of passenger traffic over a specified
plan period. This detailed exercise should take into account the existing and
projected operating parameters and efficiency indices such as wagon turn-round,
provision for ‘sickness’, requirements for busy season, etc. In all cases where
a distinctly new type of rolling stock is proposed to be acquired or
manufactured, a detailed financial appraisal should be made of the proposed
investment to see that it yields the requisite financial return.
210.
Scheme for change of traction
–Projects connected with the electrification are best formulated on a long term
basis after considering the relative claims of the various high density
sections of the Railways for better traction. A thorough technoeconomic
appraisal should be made in respect of each of the various sections proposed to
be taken up for change of traction. Wherever possible, priorities for taking up
the scheme for change of traction should be determined on the basis of
therelative financial return expected from the various alternative schemes.
211.
Revenue estimate –The revenues
expected from additional traffic whether on the existing line or on a new line
should be very carefully estimated in the traffic survey report. The estimate
of revenues should be worked out for each commodity and for the lead from its
origin up to the point of termination of the traffic. It should be ensured,
however, that in case line capacity works are required to be undertaken in the
contiguous section or Railway system over which the additional traffic is
expected to be moved, the initial cost estimate for the scheme takes into
account the cost of such additional line capacity works over the entire lead of
the traffic.
212.
In the case of a ‘project-oriented’ new line, i. e., when a new railway line is
proposed to be built to serve the needs of a specific project or industrial
complex, the estimated revenue from the traffic which will move on the line
should be assessed realistically in consultation with the authorities concerned
with that specific project. It is, however, essential that the Traffic Survey
Team also makes its own independent assessment of the likely traffic which the
project is expected to generate, instead of placing complete reliance on the
data furnished by the Project Authorities or, in the case of a public sector
undertaking, the concerned Department of the Government. The traffic survey
officers must deeply probe into the various stages of scheduling of the
project; e. g. what commitments have been entered into by the Project Authorities
and whether the progress in the execution of the project is adequate to justify
any specific claim in respect of the anticipated traffic. While working out the
additional revenue from the traffic expected to move on the new line over its
entire lead, the Railway Administration should make a careful assessment of the
line capacity works required or terminal or any other facilities to be
developed on the contiguous section/Railway system to carry this traffic. As
stated in Para- 211, if additional works are considered necessary, the scope
and cost thereof should be defined and included in the main project estimate.
In case it is considered that adequate line capacity exists in the contiguous
section or Railway system so that the additional traffic on the new line can be
carried throughout its lead on the Railway without any hindrance the Railway
Administration should confirm that no additional works would be required to be
undertaken anywhere on the system to carry this traffic.
213.
This approach inevitably involves grouping of a number of works with a common
(or complementary) objective, such as for movement of additional traffic by
improving line capacity, or for avoidance of detention to trains through yards.
‘Group Justification’ in such cases should be worked out for the project as a
whole in case the individual works cannot stand on their own and must
necessarily be taken up as part of a single project. However, where each of the
works is self-contained, selection of priorities after consideration of various
alternatives should necessarily be done with a view to ‘sub-optimization’, i.e.
to realise the optimum benefit for the project by substituting the less
remunerative sub-works by those anticipated to improve the return further.
214.
Before proposals are made out for new marshalling yards or major remodeling of
existing marshalling yards or mechanisation of marshalling yards, goods
terminals and transhipment yards, etc., a work study team should go into the
actual working and suggest such improvements in operation as can be achieved
even with the existing facilities. Additional facilities should be justified
only after all the possibilities of improvement in working by optimum
utilisation of the existing assets have been fully explored and evaluated. For
line capacity works generally Master Charts should be prepared of the existing
(optimum) capacity, the extent to which it is presently utilised, and the
capacity expected to be available after the provision of the proposed
facilities. The additional traffic beyond the optimum existing capacity of the
section should only be reckoned for financial appraisal.
215.
A. Assessment of Working expenses/Average Annual Cost of Service – The average
annual cost of service of an asset is the sum of:
a)
The average annual cost of operation;
b)
The average annual cost of maintenance and repairs of the assets;
c)
The annual depreciation charges (but see para 228);and
d)
Annual interest charges on the cost of the asset.
Note.–In
computing working expenses in financial evaluation of any capital expenditure
proposal under D.C. F. technique, only items (a) and (b) above should be
reckoned.
215
B. Average cost per unit of service -The average cost per unit of service is
obtained by dividing the average annual cost of service by the total number of
units of service rendered by the asset in a year. In comparing two assets on
this basis, care must be taken to see that the number of units of service taken
into account in both cases represent the actual number utilised or consumed.
Units of service rendered by either of the assets in excess of the actual
requirements should be ignored in computing the cost per unit of the asset.
216.
For the purpose of assessment of the average annual cost of operation and
maintenance, full use should be made of the traffic costing data relevant to
the investment proposal under consideration. Correct application of the cost
data and, in particular, assessment of the direct/variable and the indirect/fixed
or semi-variable costs is very important in arriving at a realistic estimate of
the working expenses in respect of the proposed scheme.
217.
In applying the unit cost data for working out the cost of moving the
additional anticipated traffic, it has to be considered whether it would be
reasonable to adopt the ‘incremental cost’ approach or to take ‘fully
distributed costs’ into account. Logically, it would be realistic to work on
the basis of ‘incremental costs’ for any small increases in traffic and over
the short run. In the long run, however, even the so-called fixed costs will
vary, and the incremental or marginal costs may fail to cover such
semi-variable expenses. On the other hand, it would be equally unreasonable to
apply fully distributed costs in all cases while working out the financial
implications of a line capacity work. A realistic (though somewhat
conservative) approach would, therefore, be to adopt ‘long term variable costs’
(based on percentages given at the end of Annexure ‘A’ for each item of cost)
which will ensure not only that projects are not thrown out because of the
adoption of the ‘fully distributed costs’ but also that a project is considered
as remunerative so long as it yields the requisite return after meeting the
‘long term variable costs’.
218.
Provision for depreciation-
Depreciation provision in respect of an asset will be equal to the annual
payment to a Sinking Fund which, together with the interest thereon at such
rates as may be prescribed by the Railway Board, when compounded annually, will
provide the amount required for the replacement of the asset at the end of the
normal life. The duration of the Sinking Fund payment will be determined by the
‘normal life’ of the asset, and the amount of the annual Sinking Fund payment
will be ascertained by referring to the table reproduced as Annexure ‘B’ to
this Chapter, which shows the annual amount payable at different rates of
interest ranging from 2% to 8% (over periods extending up to 100 years).
219.
Normal lives of assets– For
the purpose of the annual Sinking Fund payment referred to in para 218, the
normal life of the various classes of railway assets should be taken as in the
table below (However, instructions issued from time to time from Board’s Office
regarding Codal Life may also be referred to):-
*Service
life as indicated in the table is general life/service life for track
components. However, renewal/replacement will be subject to various criteria
laid down in IRPWM about its condition.
220.
Technique of financial appraisal of projects- The following methods of
appraisal of capital expenditure proposals are commonly used in industrial and
commercial undertakings:
a)
Accounting rate of return,
b)
Pay back period, and
c)
Discounted Cash Flow. Of these, methods, (a) & (b) are employed without
considering the time value of money. These are also known as the 'Financial
statement' methods since the calculation involves data taken from and used
essentially in the same form as in financial statements. When time is
considered, the method employed for financial appraisal is the Discounted Cash
Flow method, also called the 'Present value method', since the time value of
money is an explicit consideration.
220
A. DPR for Technical and financial appraisal of projects- Detailed Project
Report (DPR) for projects are to be prepared as per Board’s guidelines.
Proforma for submission of Detailed Project Report is given in Annexure – ‘J’.
221.
Accounting rate of return method
- Under this method, the rate of return is worked out by arriving at a
percentage ratio of the net gain (i. e., revenue less working expenses) over
the initial anticipated investment of the project. Simply illustrated, it is
proposed to construct a masonry building at a cost of Rs.1 lakh to accommodate
an equipment, video camera 21 Large format display monitor/ Video wall &
LED/ LCD TV 8 22 Fax Earlier appearing as item 7 in RBA 25/2006. Shall not be
replaced after its normal life.
Note
1.: PCs and Secondary System may be deleted from list of Telecom assets and
their life will be as indicated under (ii) Computer and Other IT systems
Note
2. Para 219 ibid includes all correction slips circulated vide RBA circulars
issued upto 12.8.2022
Note
3: The average life of the assets is detailed above however the actual
replacement of all assets shall be based on the condition of the asset. office
which is now housed in a building at a rental of Rs.15,000 per annum. It will
be necessary to ascertain
(a)
the average annual cost of maintenance and repairs of the proposed building and
(b)
its scrap value at the end of its normal life. If these are taken to be (say)
Rs. 5,000 and Rs. 10,000 respectively, then the average annual cost of the
proposed new building will be
(a)
Rs.5,000 plus
(b)
Rs. 801 being the annual sinking fund payments (at 3 per cent for 50 years
which is equal to 0.0089 multiplied by Rs.1 lakh minus Rs.10,000), or Rs.5,801
in all. This will result in a saving of Rs. 9,199 (Rs.15,000 minus Rs. 5,801)
in the annual rental charges that are presently being paid, or a net return of
9.2 percent on the investment of Rs.1 lakh.
222.
A minor variant of the above illustration would be to take the average
investment over the life of the asset at half the initial cost, viz., Rs.50,000
on the assumption that depreciation is written off in equal instalments over
the life of the asset and the amount invested on the asset will decrease each
year as funds are released through the effect of the depreciation charge. In
that case the return on the average investment will work out to 18.4%.
223.
Pay back period method -Since
recoupment of the original capital invested in a project is an important
consideration in appraising a capital investment, the method of working out the
pay back period lays emphasis on the calculation of the time it takes to recoup
the expenditure incurred on the project. In the table given below, the pay back
period is 5 years, as the accumulation of the net cash flow, year by year
equals the initial investment at the end of 5 years: Original Investment-Rs.
1,00,000 Net Cash Flows (i. e., net earnings or reduction in expenditure) : -
Under
this method no attempt is made to assess the return on the capital invested. It
only shows the length of time required to recoup the amount invested on the
project, the assumption being that projects with short pay back period are
better investment propositions than those with long pay back periods. Bare
recoupment of the amount invested under the pay back period method would yield
no return unless a suitable rate of interest return on the capital outstanding
in each of the years involved is built into the calculation of the net cash
flow.
224.
The method of ranking projects, or project grading, on the basis of pay back
period is of limited application as it can be employed only in situations where
there is a strict time limit to the investment before the expiry of the useful
life of the project. An example would be of a proposed investment in a project
in a foreign country where the political stability can be foreseen only for a
limited number of years, or in plant and machinery involving processes or
products that are likely to be replaced by technological changes within a few
years or a 'single purpose' new line where the known reserves of coal, iron
ore, etc., are expected to be depleted/exhausted after a specific number of
years. Though presently not in vogue on the Indian Railways, there is no bar to
the application of the Pay Back Period method to evaluation of Railway Projects
in consultation with the Financial Adviser and Chief Accounts Officer in the
special circumstances illustrated in this Para.
225.
Discounted Cash Flow -The
accounting 'Rate of Return' (R.O.R.) Method commonly in use on the Railways
does not take into account the time value of money. Also, the return on
investment is worked out as at the time of completion of the project or at a
single point of time (6th year or 11th year) and not through the entire useful
life of the project. The R.O.R. method may, therefore, yield an incorrect
result depending on the point of time selected for the purpose of project
appraisal. A factor of fundamental importance to investment decisions and one
which the R.O.R. method does not take into account is the timing of profits and
cash flows that result from an investment and this factor is crucial to the
Discounted Cash Flow Method of project appraisal.
226.
Net Present Value (NPV) or Net Present Worth
(NPW) -The concept of the time value of money which is basic to
the Discounted Cash Flow Method is illustrated thus : Rs.100 receivable today
is more than Rs.100 receivable a year hence, as Rs. 100 received today will
earn interest or profits and shall accumulate to more than Rs. 100 in a year's
time. Alternatively, Rs. 100 received today can be used to reduce borrowing
thereby avoiding interest payments as well as reducing debts by Rs.100.
Assuming that the Railways' cost of finance is its current dividend rate (say
10% per annum), Rs. 110 received a year hence should be worth Rs.100 today and
Rs.100 which may be received in a year's time is worth about Rs. 91 today
(actually it is worth Rs.90.91). Likewise, the present value of Rs.100
receivable 2 years hence is about Rs.82.64, and so on. In this way the cash
flow for the project in any future year can be discounted to obtain the present
value.
227.
The NPV/NPW of a project is sum of the present values of the net cash flows for
all the years of the project's economic life. The net cash flow in each year
will be the expected net reduction in expenditure or increase in net earnings.
The net cash flows are discounted to arrive at the NPV of a project by applying
a pre-determined discount rate. For example, consider the following excerpts:
TABLE
-B is derived by adding the data in TABLE -A. At 20% the 0.833 in TABLE-B is
the same as the 0.833 in TABLE-A since the time involved is only one year. The
0.833 and the 0.694 for years 1 and 2 under 20% represent the 1.528 under
TABLE-B at 20% in year 2. The 0.833, 0.694 and 0.579 in TABLE-A are added to
form the 2.106 in TABLE-B. Thus, it can be seen that TABLE-B is essentially a
summation of TABLE-A. With TABLE-B, present value calculations can be made more
quickly if the cash inflows or out flows are constant. Instead of multiplying
the same cash flows by the individual items of TABLE-A, one can multiply the
annual cash flow only once by the sum of the data in TABLE-A which is
conveniently arranged in TABLE-B.
228.
Annual Cash Flows- It is
important that the annual cash flows should be estimated on a realistic basis.
By definition, the cash flow will take into account only the realisable revenue
and cash expenditure or, in the case of expenditure reducing projects, the net
reduction in cash expenditure. Purely accounting adjustments such as
depreciation and other provisions are to be completely ignored. The reason is
that cash flow is the foundation of the NPV and depreciation is an expense item
not involving a flow of cash. It is implicit in the basic arithmetic of the
D.C.F. Method of project appraisal that so long as the cash flows are adequate
from year to year and the NPV computed at the requisite discount rate equals or
exceeds the investment, the capital invested in the Project will remain intact.
This is shown by a solved example below:
The
small margin of difference (Rs.871) is accounted by the error in interpolation
of the rate of return. It will be seen that at the discount rate of 21.41%, the
project has recovered the original cost in full (Col. 5), apart from paying off
interest at the same rate.
229.
Rate of return under D. C. F.-Two
alternative methods can be used for assessing the viability of a project under
the D. C. F. technique. For example, assuming an even cash flow of Rs.4,000 per
annum over a period of 10 years in respect of a project where the original
investment is estimated to be Rs.18,000, it will be observed from the following
table that the discount factor of 4.5 (18,000 ÷ 4,000) occurs against the 10th
year under the discount rate of 18%:
In
this case the rate of return under the D.C.F method for an even cash flow of
Rs.4,000 per annum for an investment of Rs.18,000 will be about 18%. Since the
D.C.F. return of 18% is more than the minimum acceptable rate of return (say
10%) , the project would be considered desirable from the financial point of'
view. Under an alternative method, the minimum acceptable rate of return (say
10%) would be applied to calculate the NPV of the project. If the NPV is (zero
or) positive, it would be financially acceptable, and if the NPV is negative,
the project will not be financially acceptable. In judging the ranking of
competing projects, under the first method, the D. C. F. rate of return would
be used and whichever project gives the higher rate of return would be
preferred. Under the second method, the competing projects will be ranked
according to their NPV and whichever project gives a higher NPV at the minimum
acceptable rate of return would be the preferred project.
230.
Another illustration may be given of a case where the initial outgo of (say)
Rs. 4,00,000 is incurred in one year and the project starts giving a net cash
flow of Rs.1,00,000 per annum over 10 years thereafter. Discounted cash flow at
various rates of interest would be as shown below where the cash flows are
uniform throughout the project life:
231.
The simple illustrations given above presume that the investment is completed
in one year and the project starts yielding a return immediately thereafter.
Where the investment is spread over a number of years, it is necessary to work
out the value of the investment, by applying the relevant rate of interest,
from the inception up to the point when the project is expected to be ready for
operation, the rate of interest being the minimum acceptable rate of return of
(say) 10%. In the illustration given in the preceding para, if the investment
of Rs. 4,00,000 is assumed to have been spread over a period of three years
including the year in which the project was completed, the total investment,
inclusive of interest, up to the year of completion would be as shown below :-
In
this case, if the net return over the life of the project of ten years assumed
in the earlier illustration is constant amount of Rs.100,000, the return would
be about 18% instead of 21.41 % worked out in Para 230.
232.
A short write-up on the technique of working out the rate of return under the
Discounted Cash Flow Method is at Annexure 'D'. Detailed examples of railway
projects showing application of the D. C. F. technique are given in Annexure
'E'.
233.
Residual Value -Each project
will have an estimated life span at the end of which the various assets will be
disposed of or put to other uses. The flow of funds created by the sale or
disposal of the assets at the end of the life of the project should be
estimated so that appropriate credit can be given to the project in the year in
which the flow of funds is expected to occur by the sale or disposal of the
assets. Since all the assets may not be discarded or sold at the same time, the
cash flows resulting from residual values should be allocated to the years in
which they are likely to be received. If some of the assets are to be taken out
of service and disposed of before the termination of the project, the resultant
cash flows must be included in the appropriate years.
234.
Alternative Schemes -
Equivalent Annual Cost - The criterion of choice between alternative schemes,
each of which is capable of rendering the required service, is the principle of
least cost in the long run. This approach is particularly applicable when the
cash outflows under each competing project have sharply different time
patterns. To obtain the annual cost, the outlays of the project are summarised
into a single present worth amount and then spread over the years of the
project life as an equal amount per year, which includes interest at a standard
rate. By the same summarization and spreading for an alternate project, the two
projects can be compared by reference to the per year figure for each. The
comparison is usually of cost only, revenues being assumed as the same under
either project. An illustration appears below:
The
above analysis shows that Project ‘B’ has the lower uniform annual cost, by a
small margin, even though it shows a larger total outlay. The reason for this
is that the project outlays take place later under Project 'B', which reduces
its present worth and lowers its annual cost including interest, relative to
Project'A'.
235.
Economic Evaluation. -As a commercial undertaking, it is incumbent on the
Railways to ensure that a proper financial return is earned from every
investment subject to the exceptions given in Para 202. At the same time it has
to be borne in mind that the Railways are an important instrument of economic
and industrial development of backward areas not connected by a reliable transport
network. In the case of major projects such as new line constructions, or
change of traction from diesel to electric, the benefits likely to be realised
by the economy as a whole are assessed by the Economic Adviser to the Railway
Board. The principles on which economic evaluation of Railway investments
should be carried out as distinct from working out a financial return to the
Railways, are indicated in the note (together with an illustration) at Annexure
'F’.
235A.
A detailed economic appraisal framework is given in Annexure- ‘I’.
236.
Replacements and Renewals -The
proposal for replacement of an existing asset (whether involving improvement or
otherwise) should be examined critically with a view to seeing whether it would
not be possible to avoid, or, at least, postpone such replacement by suitable
repairing or reconditioning the asset at a cost that could be comparatively
justified financially. In all cases in which it is considered necessary to
replace an asset, instead of reconditioning it, it should be examined whether
the estimated average annual cost of service (i. e. cost of operation and
maintenance, sinking fund payment to the depreciation fund, and the interest on
the cost of the asset), or the estimated average cost per unit of service of the
new asset is likely to be less than that of the old asset after reconditioning.
Except when renewals or replacements are inevitable, the expenditure chargeable
to the Depreciation Reserve Fund, should be financially justified in the same
manner as any other expenditure of capital nature.
237.
Where a replacement is proposed on grounds of economy in operation and
maintenance costs,the estimate therefore should justify the ou tgo on the
proposed replacement by showing that the average annual cost of service or the
average cost per unit of service, that will be rendered by the new asset, is
less than that of the existing asset. Note -The above two paragraphs will not
apply to cases of casual or programme renewals, not involving any improvement.
238.
Reconditioning – When an as
asset is repaired at a comparatively high cost in preference to its being
replaced, it is referred to as being ‘reconditioned’. The cost of such
reconditioning is chargeable to Ordinary Repairs and Maintenance. It may be
noted that reconditioning is different from routine repair. For all
reconditioning works, detailed estimates should be prepared.
239.
Scrapping, condemning and abandoning assets - An asset may be scrapped,
condemned or abandoned without replacement, when the service rendered by it is
no longer required. If the service rendered by it is still necessary and if it
is proposed to make other arrangements for such service, it should be
definitely established that it is more economical to scrap, condemn or abandon
the existing asset and obtain the required service from the new arrangement
than to continue to obtain the required service from the existing asset. Here
also the relative economics of the two proposals should be assessed on the
basis of the average annual cost of service or the average cost per unit of
service, as the case may be. Note -The preparation of financial justification
as contemplated in this paragraph is not necessary for condemning rolling stock
in the following cases:-
i)
Overaged stock due to be replaced by virtue of their age but condemned before
replacement.
ii)
Under or overage stock involved in accidents and certified to be irrepairable
(not included under the category of “beyond economical repairs”).
iii)
Non I.R.S. type coaches and wagons of inherently weak design proposed to be
condemned on condition basis whether under or overage.
240.
Examples are given in Annexure ‘G’ illustrating the method of financial
justification to be adoptedin the case of replacement, reconditioning or
abandonment of existing assets. The data used in the illustrations are
hypothetical and the methods adopted are not to be regarded as exhaustive or as
precluding the use of other methods that may be found to be more appropriate.
The D.C.F. method can be conveniently used in some cases as has been shown in
Example
(1)
of Annexure ‘G’.
241.
Second-hand Value- The second-hand value of an asset is what it is presently
worth and has often to be distinguished from its scrap value. For purposes of
financial justification of transfer, purchase or sales, the second-hand value
of assets may, except in certain cases (e.g. rails, locomotives, boilers, etc.)
where separate rules have been prescribed for the determination of the
second-hand value, be determined as provided below :-
i)
The first cost of an asset (based on which its second-hand value has to be
computed) should be taken as the value of a similar asset at present day prices
and not the value actually paid for the asset when it was originally purchased.
ii)
The second-hand value of an asset that does not depreciate is the same as the
first cost. iii) The second-hand value of a depreciating asset should be so
appraised that the average annual cost of service or the average cost per unit
of service, as the case may be, of the second-hand asset is equal to that of
the same or similar asset while new.
242.
Examples illustrating the application of the principles enunciated in the
preceding paragraph are given in Annexure ‘H’.
243.
Post project appraisal - It is
important that an investment proposal is subjected to proper financial
appraisal not only before it is a sanctioned but also a certain period of time
after the project has been in operation. Whether the financial return
anticipated from a project at the estimate stage is actually realised in due
course or not should be determined by conducting a ‘Productivity test’ in
respect of all major works. For any such comparison to be meaningful and
realistic, it is important that the computation of the actual additional
earnings and working expenses is done on the same lines as at the project
estimate stage. As commercial profitability is liable to be affected by
escalation in prices or any other extraneous development, in order to have a
more reliable and accurate evaluation wherever relevant, a comparison in terms
of physical units of throughput may be carried out. Such a comparison should
preferably be done class-wise in the case of passenger traffic and
commodity-wise in the case of goods traffic. The post project appraisal should
be conducted by the user department in consultation with Engineering and
Finance. Further, all projects sanctioned on the basis of ROR, should be
subjected to mid term review at the time of every revision of estimated cost.
Such review shall consist of review of both existing projection in current
scenario, revised estimated cost and consequential change in ROR. Financial
feasibility of project need be assessed and commented by General Managers of
Zonal Railway.
244.
New Lines - In respect of each
new line opened for traffic, the railway administration should submit to the
Railway Board a statement, showing the financial results of its working in Form
No. 244 shown below. The statement should reach the Railway Board not later than
the 31st December following the financial year to which it refers and should be
accompanied by a covering memorandum in which brief explanations should be
given of important variations between the actual realisation and the estimated
revenue, together with a Note by the General Manager indicating how the actual
net cash flow compares with what was estimated at the project stage. The Note
should also bring out the probable traffic prospects of the line in the sixth
and the eleventh year of opening.
Note-
The traffic data required to be maintained vide Para 245 should be used for
costing purposes so as to arrive at the expenditure of the Branch proper and of
traffic moving from the existing line to the Branch line and vice versa.
245.
The following statistics should be maintained from year to year in respect of
all new lines opened for traffic and submitted to the Railway Board by l st
August of each year :-
i)
a) Passenger revenue from traffic local to the branch line. b) Other coaching
revenue from traffic local to the branch line.
ii)
a) Passenger revenue from traffic from the new line to the existing lines and
vice versa. b) Other coaching revenue from traffic from the new line to the
existing lines and vice versa.
iii)
a) Tonnage of goods traffic local to the branch line. b) Tonnage of goods
traffic inter-changed with the existing lines
iv)
a) Revenue from goods traffic local to the branch line. b) Revenue from goods
traffic interchanged with the existing lines.
246.
The following instructions should be followed in preparing the statement F-244
:-
i)
Column 3 should indicate the revenue of the branch from all traffic originating
therein, whether local or foreign (Proportion due to the branch) and all
traffic received from the main line.
ii)
Columns 4 & 5 should be worked out on the basis of the costing/financial
data under Group'C' (see Annexure 'A') in respect of the traffic referred to in
(i) above.
iii)
The additional or new traffic interchanged to be shown in column 6 should
include only that portion of the traffic received by the main line from the new
branch and of the traffic from the main line to the branch, which arises solely
from the construction of the new branch line. In the absence of actual figures
of additional traffic interchanged with the existing lines, a reasonably
approximate figure may be adopted. In the case of chord line short-circuiting a
previously existing route, figures relating to cross traffic which would have
been carried by the previously existing route, if the chord line had not been
constructed, may be omitted from this statement and a proportionate reduction
in the working expenses on the branch line made. Column 7 should be worked out
on the basis of costing financial data under group ‘C’ (See Annexure 'A' and
para 217).
247.
The statements vide Paras 244 & 245 should be submitted for every completed
financial year after the date of opening of the new line for a period of 11
years. The actuals for the years to end of which accounts have been closed and
the cash flows for the remaining years of the assumed project life should be
arrived at on the basis of the best possible estimation. The entire series of
net cash flows should then be discounted to arrive at the rate of return
compared to the originally expected return. In case the actual cash flows shown
in statement F.244 indicate a fair degree of proximity to the original
estimates, it may be assumedthat the cash flows for the remaining years of the
project life will also follow the same trend unless definite foreknowledge is
available to the contrary. If a review of the annual cash flows for a
sufficiently long period (say 5 to 7 years) indicates that the cash flows have
settled down, within limits, to a 'uniform' series, the Railway Board may
decide that submission of the Statements F. 244 & F. 245 for future years
in the case of a particular new line be discontinued.
248.
Open Line Works – For the purpose of
applying the productivity tests to open line works, i.e. works undertaken with
the definite object of increasing revenue or reducing expenditure and to which
such tests can be applied within five to seven years of their completion, selection
will be made out of these works sanctioned (and/or charged to Capital) on
grounds of remunerativeness. All such works costing over Rs. 1 crore will
invariably be subjected to this test. The result of the test should be reported
by the General Managers to the Railway Board. As stated earlier in the
preceding para in the case of New Lines, the actual net cash inflow for each
year, to end of the 5th/7th year from the date of commissioning should be
recorded for each open line work to be subjected to the productivity test, and
the cash flows for the rest of the project lifeassessed on the basis of the
latest estimate. The whole series of net cash flow should then be discounted to
arrive at the rate of return compared to the return originally expected.
249.
In addition to productivity test to be conducted as provided in paragraph 248
above, a productivity review should also be undertaken in respect of selected
works costing over Rs. 50 lakhs which are estimated to fetch some return, even
though not the return prescribed for a work being classified as remunerative.
The methodology to be followed will be the same as prescribed in the preceding
para in respect of works costing over Rs.1 crore each. Note-Justification for
works or part of a scheme should show the probable period ,that will elapse
between the completion of the works and the time when the productivity review
can be made. This note equally applies to paragraph 248.
250.
The fact that productivity tests are to be applied to a particular work should
be intimated to the authorities entrusted with its execution as also to the
Finance and Audit officers. In respect of all such selected works, the
Financial Adviser and Chief Accounts Officer should also keep such statistics
as would be necessary for the verification of the tests conducted by executive,
in addition to those usually available.
251.
In order to ensure that a work selected either by the Railway Board or by the
General Manager for the application of productivity tests or review is not lost
sight of, Executive Officers and Finance Officers should maintain a register
containing a list showing the following particulars :-
i)
Reference to sanction of the estimate.
ii)
Brief particulars of work selected for the application of productivity tests or
review.
iii)
Total estimated expenditure.
iv)
Nature and extent of "productivity" claimed in the estimate.
v)
When the test or review is to be applied.
vi)
Brief remarks about the results of the test or review. This list should be
reviewed half-yearly and timely action taken to apply the test or review to all
works due for examination during each half-year.
252.
When, in due course, the tests or reviews are actually applied or carried out,
the Financial Adviser and Chief Accounts Officer after verifying should submit
a report embodying the results of the test or review to the General Manager. In
case of works sanctioned by the Railway Board, the General Manager will submit
the Financial Adviser and Chief Accounts Officer's report to the Railway Board
with his own comments. The object of these reports is not only to furnish
information about results actually achieved to the authority who sanctioned the
expenditure but also to serve as a lesson for the future.
Multiple choice questions :
1. What is the fundamental
requirement for expenditure on new assets or improvement of existing assets in
Indian Railways?
- A) It should be justified financially.
- B) It should be approved by the Ministry of Finance.
- C) It should be completed within a year.
- D) It should involve private investments.
Answer: A) It should be justified
financially.
2. Which of the following
expenditures do NOT require financial justification according to Indian
Railways guidelines?
- A) Expenditure on new assets
- B) Expenditure on labour welfare works
- C) Expenditure on improvement of existing assets
- D) Expenditure on passenger amenity works
Answer: D) Expenditure on passenger
amenity works
3. How should financial
justification be worked out for savings in engine days or wagon days?
- A) On the basis of reduced purchase costs of new
engines or wagons.
- B) On the basis of the earning capacity of the stock
saved.
- C) On the basis of the current market value of the
engines or wagons.
- D) On the basis of increased locomotive or wagon
utilization.
Answer: D) On the basis of increased
locomotive or wagon utilization.
4. When evaluating a new railway
project, what should be ignored for assessing annual cash flows under the
Discounted Cash Flow (DCF) method?
- A) Depreciation as an element of working expense
- B) Initial estimated cost
- C) Annual maintenance costs
- D) Average annual cost of service
Answer: A) Depreciation as an
element of working expense
5. What is the minimum return on
investment required for a fresh investment proposal to be considered
financially justified under the DCF method?
- A) 5 percent
- B) 7 percent
- C) 10 percent
- D) 15 percent
Answer: C) 10 percent
6. Which of the following works
requires financial remunerativeness testing?
- A) Residential buildings
- B) Assisted sidings
- C) New Lines
- D) Rolling stock
Answer: C) New Lines
7. What should be done if an
expenditure proposal is less economical than its alternatives but chosen due to
non-monetary factors?
- A) Ignore the non-monetary factors.
- B) Record the reasons for choosing the less economical
proposal.
- C) Reevaluate all proposals again.
- D) Choose the most economical proposal regardless.
Answer: B) Record the reasons for
choosing the less economical proposal.
8. What must be included in the
initial cost estimate for a new line construction for project appraisal?
- A) Cost of land acquisition only
- B) Cost of rolling stock
- C) Only the construction costs
- D) Future maintenance costs
Answer: B) Cost of rolling stock
9. What is the primary consideration
for proposing additional facilities in marshalling yards or goods terminals?
- A) Anticipated increase in traffic
- B) Optimum utilization of existing assets
- C) Political factors
- D) Cost of new equipment
Answer: B) Optimum utilization of
existing assets
10. Under which circumstance is the
Pay Back Period method suggested for evaluation of railway projects?
- A) Projects with long-term returns
- B) Projects in foreign countries with limited political
stability
- C) Projects with high initial costs
- D) Projects expected to last over 100 years
Answer: B) Projects in foreign countries
with limited political stability
11. Which of the following methods
explicitly considers the time value of money for financial appraisal of
projects?
- A) Accounting rate of return
- B) Pay back period
- C) Fully distributed costs
- D) Discounted Cash Flow
Answer: D) Discounted Cash Flow
12. What concept does the Net
Present Value (NPV) method illustrate?
- A) Equal value of money over time
- B) Time value of money
- C) Immediate expenditure requirements
- D) Static investment returns
Answer: B) Time value of money
13.What
does NPV/NPW of a project represent?
- A. The total future value of net cash flows.
- B. The sum of the present values of the net cash
flows.
- C. The total gross revenue of the project.
- D. The cumulative cash inflow of the project.
Answer:
B. The sum of the present values of the net cash flows.
14.How
are the net cash flows discounted to arrive at the NPV of a project?
- A. By using the project’s internal rate of return.
- B. By applying a pre-determined discount rate.
- C. By calculating the average annual cash flows.
- D. By summing the future values of the cash flows.
Answer:
B. By applying a pre-determined discount rate.
15.Which
of the following should be ignored when estimating annual cash flows for NPV
calculations?
- A. Realisable revenue
- B. Cash expenditure
- C. Depreciation and other provisions
- D. Net reduction in expenditure
Answer:
C. Depreciation and other provisions
16.What
is the minimum acceptable rate of return used for in D.C.F. project appraisal?
- A. To estimate the future value of cash flows.
- B. To calculate the NPV of the project.
- C. To determine the initial investment required.
- D. To calculate the internal rate of return.
Answer:
B. To calculate the NPV of the project.
17.If
a project has an even cash flow of Rs. 4,000 per annum over 10 years and an
initial investment of Rs. 18,000, what is the approximate rate of return under
the D.C.F. method?
- A. 10%
- B. 15%
- C. 18%
- D. 21%
Answer:
C. 18%
18.What
does the Equivalent Annual Cost method help in determining?
- A. The total future cash inflows of a project.
- B. The annual cost of a project including interest.
- C. The annual revenue generated by a project.
- D. The net present value of multiple projects.
Answer:
B. The annual cost of a project including interest.
19.In
a financial justification for replacing an asset, which of the following costs
should be considered?
- A. The original purchase price of the asset.
- B. The reconditioning cost of the old asset.
- C. The average annual cost of service of the new
asset.
- D. The scrap value of the old asset.
Answer:
C. The average annual cost of service of the new asset.
20.What
is the main purpose of post-project appraisal?
- A. To estimate the future cash flows of the project.
- B. To determine if the anticipated financial return is
realized.
- C. To calculate the initial investment cost.
- D. To evaluate the environmental impact of the
project.
Answer:
B. To determine if the anticipated financial return is realized.
21.What
is the criterion of choice between alternative schemes using the principle of
least cost in the long run?
- A. The project with the highest initial investment.
- B. The project with the shortest payback period.
- C. The project with the lower equivalent annual cost.
- D. The project with the highest gross revenue.
Answer:
C. The project with the lower equivalent annual cost.
22.What
should be done if an asset is scrapped, condemned, or abandoned without
replacement?
- A. Ensure that the required service is obtained from a
new arrangement.
- B. Calculate the residual value of the asset.
- C. Determine the scrap value of the asset.
- D. Recondition the asset for continued use.
Answer:
A. Ensure that the required service is obtained from a new arrangement.
Multiple
Choice Questions: DCF vs. IRR
23.What
does DCF stand for in financial project evaluation?
- A. Discounted Cost Flow
- B. Direct Cash Flow
- C. Discounted Cash Flow
- D. Delayed Cash Flow
Answer:
C. Discounted Cash Flow
24.Which
method involves calculating the present value of future cash flows using a
discount rate?
- A. Internal Rate of Return (IRR)
- B. Net Present Value (NPV)
- C. Payback Period
- D. Profitability Index
Answer:
B. Net Present Value (NPV)
25.What
is the primary goal of the IRR method in project evaluation?
- A. To calculate the net present value of a project.
- B. To determine the rate of return that sets the NPV
to zero.
- C. To estimate the total future cash flows.
- D. To identify the payback period of the project.
Answer:
B. To determine the rate of return that sets the NPV to zero.
26.When
comparing multiple projects, which method ranks projects based on the return
rate?
- A. DCF
- B. NPV
- C. IRR
- D. Payback Period
Answer:
C. IRR
27.Which
of the following is true about the DCF method?
- A. It calculates the future value of cash flows.
- B. It ignores the time value of money.
- C. It discounts future cash flows to their present
value.
- D. It is the same as the Payback Period method.
Answer:
C. It discounts future cash flows to their present value.
28.What
does the IRR represent in project evaluation?
- A. The minimum acceptable rate of return for a
project.
- B. The discount rate that makes the NPV of cash flows
equal to zero.
- C. The total investment required for the project.
- D. The average annual cash inflow of the project.
Answer:
B. The discount rate that makes the NPV of cash flows equal to zero.
29.If
a project has an IRR greater than the cost of capital, what does this indicate?
- A. The project is not viable.
- B. The project will break even.
- C. The project is expected to generate value.
- D. The project has a negative NPV.
Answer:
C. The project is expected to generate value.
30.Which
method can handle projects with non-conventional cash flows more effectively?
- A. DCF
- B. IRR
- C. Payback Period
- D. NPV
Answer:
D. NPV
31.In
the context of the DCF method, what is the significance of the discount rate?
- A. It is the expected inflation rate.
- B. It represents the project's internal rate of
return.
- C. It is the rate used to discount future cash flows
to their present value.
- D. It is the project's gross revenue rate.
Answer:
C. It is the rate used to discount future cash flows to their present value.
32.Which
method should be used when comparing projects with different scales and
timelines to ensure consistent evaluation?
- A. DCF
- B. IRR
- C. NPV
- D. Payback Period
Answer:
C. NPV
******
Comments
Post a Comment