Module: Introduction to Development Projects

Executive Summary

The Martinez dairy project is good in terms of costs and benefit. The project will generate money. The project will have an economic impact in helping to develop dairy farming, increase milk supply to Martinez division and Manzanilla town, help in fulfilling milk demand of the Manzanilla plant.

Discounted cash flow method has been used to assess the viability of the project. The project has a before financing, positive NPV of $ 10.33 indicating real positive movement of resources and IRR of 8% indicating efficiency of resources. Positive NPV and Positive IRR indicate that the project is a good investment over time. Net Benefit before financing is negative in the first year and the yearly Cash Balance of the project remains negative until the 11th year of the project hence project requires to be financed.


The project is dependent largely on the National Dairy Development Board’s Manzanilla Plant for sale of its milk produce. The milk sale price is tied to the Manzanilla plant and there is no scope to make the price for the milk sale. At the projected demand of 200,000 litres at $1.20, Manzanilla plant has an oversupply. The Manzanilla project is likely to make a loss, which will affect the Martinez project.

Martinez project though viable on its own is dependent upon success of Manzanilla plant. In case the Board decides to move ahead with the project the project will require a loan. Loan option no.2, which has higher grant element, may be used.














1. The report analyses the following questions
1. Is the project good in terms of its costs and benefits?

2. Is the project is going to make money

3. If it is going to make money then how much money, it will make.

4. Likely economic impact of the project





2. Methods to analyze the project
1. Cash Balance (Net benefit): Using the input and output prices the cash balance of the project will be calculated. This would indicate if sufficient cash is available to run the project through its project life.

2. Discounted Cash Flow(Discounted Net Benefit): DCF will calculate project worth, over a time scale. Public sector discount factor of 8% will be used for calculation. This will help to assess that if the value of investment in future will be more than it is today.

3. Net Present value: The DCF/DNB will help to measure NPV and the IRR of the project. A positive NPV will indicate that project is worth more in future and is right for investment.

4. Internal Rate of Return: The IRR will indicate return on the project at the discounted value.

5. Net Benefit before Financing (NBBF): This would indicate if the project is going to generate economic benefit. A positive NBBF would help in making an investment decision.

6. Net Benefit after Financing (NBAF): Calculation of NBAF will help sort out the any problem of financing the project.











3. Analysis of the project
This analysis is done in two parts

a. Analysis of the Martinez project
b. Analysis of milk sales of Martinez project to Manzanilla project

a. Analysis of the Martinez project
Net Benefit:
The project has a positive Net Benefit indicating that the project is worth much more in future than it is today. The Net Benefit is $ 490,000 indicating that the project will generate returns on completion of its 15 years of economic life. However, most of these returns come in the last 4 years of the project and $ 415,000 come only when the residual value of the land and the herd is realized in the 15th year of project life.

Discounted Net Benefit:
The Discounted Net Benefit is positive indicating that the project is worth more in the future than it is now. In other words, it will generate money even at discount rate of 8%.

Net Present Value and Internal Rate of Return:
The project has a positive NPV and it has an IRR of 8%, the NPV reduces the project value to a single digit and helps us to assess the project. Positive NPV for this project indicates that the project acceptable and will give adequate return on investment.

The yearly Cash Balance of the project remains negative until the 11th year of the project. This indicates that the project requires outside funding to take off and sustain until that period.

Net Benefit Before Financing and Net Benefit After Financing:
The NBBF gives a huge negative figure in the first year of the project, but since NPV is positive it indicates that, the project is economically viable and will generate economic benefit but it requires financing.

After financing NBAF is positive indicating that financing will help in getting the project of the ground.


c. Analysis of milk sales to Manzanilla plant
The break-even point of the Manzanilla project has been worked out at 336,000 liters at a selling price of $1.20 per liter. (Out of which 200,000 liters will be supplied by Martinez dairy and 80,000 liters by the existing suppliers.) However, the demand forecast chart of the Manzanilla plant indicates that there is a demand for only 200,000 liters at the sale price of $ 1.20. If the Manzanilla plant continues to buy from its existing suppliers there is an excess supply as indicated below.



Years Milk Availability for the Manzanilla plant (in liters)
Existing Suppliers Martinez Plant Production Demand forecast Manzanilla plant Excess Production
1 80,000 0 200,000 -120,000
2 80,000 137,200 200,000 17,200
3 80,000 161,200 200,000 41,200
4 80,000 182,600 200,000 62,600
5 80,000 197,200 200,000 77,200
6 80,000 202,200 200,000 82,200
7 to 15 80,000 193,200 200,000 73,200
Demand forecast for Manzanilla plant
@$1.20 per liter is 200,000


To resolve this situation two alternatives are possible:
The First alternative is that, since the Martinez project is being exclusively set up to sustain the Manzanilla project it should stop buying milk from other suppliers gradually and by the 6th year the production from Martinez project will be sufficient to meet the demand forecast.


Years Milk Availability for the Manzanilla plant (in liters)
Existing Suppliers Martinez Plant Production Demand forecast Manzanilla plant Excess Production
1 200,000 0 200,000 0
2 62,800 137,200 200,000 0
3 38,800 161,200 200,000 0
4 17,400 182,600 200,000 0
5 2,800 197,200 200,000 0
6 0 202,200 200,000 0
7 to 15 7,000 193,200 200,000 0
Demand forecast for Manzanilla plant
@$1.20 per liter is 200,000




The second alternative is that if the sale price of the milk by the Manzanilla plant is reduced to $1.00 as per the demand forecast, the sale volume of milk goes up to 290,000 liters. This will then absorb the entire production of the Martinez plant as can be seen in table below:


Years Milk Availability for the Manzanilla plant (in liters)
Existing Suppliers Martinez Plant Production Manzanilla milk production Excess production
1 80,000 0 290,000 -210,000
2 80,000 137,200 290,000 -72,800
3 80,000 161,200 290,000 -48,800
4 80,000 182,600 290,000 -27,400
5 80,000 197,200 290,000 -12,800
6 80,000 202,200 290,000 -7,800
7 to 15 80,000 193,200 290,000 -16,800
Demand forecast for Manzanilla plant @$1.00 per liter is 290,000


It is thus obvious that the Manzanilla plant will not be able to make a profit. If we interpolate the figures in demand forecast, it is seen that Manzanilla plant can sell milk at about $1.10 per liter to be able to sell 280,000 liters, which is the optimum demand forecast. However, this would result in a loss of $0.10 per liter, which will have to be either borne by the Manzanilla plant or subsidised by the government. Alternatively, the purchase price of milk from other suppliers would have to be reduced to compensate for this. If this loss is going to be passed on to Martinez project by the Manzanilla project then the diary project becomes unviable as it would then be loss making.










5 a. Answers to project questions

1. The project is good in terms of costs and benefit

2. The project will generate money

3. The project will generate $ 490,000 at the end of 15 years of its economic life.

4. The economic impact of the project will be:

a. Help in dairy development in the region.

b. Increase milk supply to Martinez division and Manzanilla town.

c. Help in fulfilling milk demand of the Manzanilla plant.

5 b. Recommendations to the Board
1. The project has positive Net Benefit and the gives a positive Discounted Net Benefit at a discount rate of 8%

2. The Martinez project has a before financing, positive NPV of $ 10.33 indicating real positive movement of resources.

3. It is giving an IRR of 8% thereby indicating positive efficiency of resources.

4. Positive NPV and Positive IRR indicate that the project is a good investment over time.

5. The project has a positive NPV but NBBF is negative is the first year hence it is good investment but requires financing.

Thus, the project is viable and but it has some inherent problems, which need to be looked into before we proceed.

These are:

1. The project is viable only if it runs for 15 years as most of the returns come in the last few years of the project life.

2. The project is dependent largely on the National Dairy Development Board’s Manzanilla Plant for sale of its milk produce.

3. The milk sale price is tied up to the Manzanilla project and there is no scope to make the price for the milk sale.

4. The milk production of the Martinez project will compete with existing local dairy farmers who may increase production or reduce prices to be competitive.

5. The sale of the culled animals has not been tied up with any reliable source and in the absence of the same; it may be difficult to have regular sales and this may affect the inflow of income.

6. The price offered by the National Dairy Development Board’s plant for raw milk is $0.50 per liter is only for initial 5 years. There is no tie up for milk sale after 5 years.

7. At the projected demand of 200,000 at $1.20, Manzanilla plant has oversupply. Either it has to stop buying from the other suppliers to accommodate supply from Martinez project or it has to reduce its selling price to $1.10 to meet optimal demand forecast of 280,000 litres. In either scenario Manzanilla project makes a loss.

8. As Manzanilla plant will continue to make losses it is, possible that it may be shut down, thereby leading to closure of the Martinez Dairy project also.

9. The Martinez project though viable on its own is dependent upon Manzanilla plant for milk sales. Unless there is assured sale of milk at $ 0.50 for 15 years Martinez project will find it difficult to sustain











6. Loan Option:
In case the Board decides to move ahead with the project the project will require a loan.

The initial capital investment and the operating costs for the first year are $ 412,700, this needs financing through a loan.

There is further requirement of loan in subsequent years to pay the loan installments and refinance the machinery.

There are two options which are available.
The two options which are available have been analyzed as under;

1st year Year 1-2 year 2-15
Amount
Loan 1 471300
CF 1.08 509004
CRF 2% 0.082602 42044.75
DF/AF 8% 7.633
PV 320927.6
GE 150372.4

1st year year 2-4 year 5-15
Loan 2 471300
CF 1 471300
CRF 6% 0.126793 0 59757.54
DF/AF 8% 5.247
PV 313547.8
GE 157752.2

GE of Loan 2 is higher than GE of loan 1 by 7379.747

1. It is seen that the Loan option 2 has a higher grant element.

2. Further, in Loan option 2, no repayment has to be made in the first 4 years, thus Loan option 2 is advisable.

3. It is also advised that entire loan of $ 471,000 may not be drawn in the first year, only $ 417,300 may be drawn (see table below) a further draw down of $ 15,000 can be done in the year 8, and another $7000 in the year 12, for the refinancing of machinery. The balance can be funded from the internal resources. This would entail efficient use of internal resources and would also reduce the loan component and ease the repayment load on the Dairy.