Sensitivity Analysis of Railway Projects. Effect on Financial Viability. Project submitted by. Dr. Surya Lakshmi Chellapilla. Dy.

Transcription

1 Sensitivity Analysis of Railway Projects Effect on Financial Viability Project submitted by Dr. Surya Lakshmi Chellapilla Dy. FA & CAO/SR In connection with the Training on Project Appraisal with Latest Cost and Financial Analysis C- TARA, Secunderabad July 7 August 14, 2014

2 1.0 Introduction: Financial appraisal of Railway projects is one of the most difficult to make (201-F). The various techniques available for appraisal and the methodology for evaluation are available in Chapter 2 of the Indian Railway Finance Code and its annexures. The Railways follow the Internal Rate of Return technique to evaluate their projects, with some exceptions. In this study, an effort has been made to put three ongoing projects through the Sensitivity Analysis. 2.0 Background: The current benchmark of remunerativeness of a project is 14% (in 204- F, an illustrative rate of 10% is mentioned). The types of projects which need to pass the test of remunerativeness are New Lines, Line Capacity Works including Gauge Conversion, Doubling, etc. Others include Yard Remodelling and Terminal Facilities, Microwave and other Telecommunication Works, Change of Traction (Electrification and Dieselisation) and provision of Loco Sheds therefor, Introduction of new services and setting up of Workshops(205-F). However, in case of major projects like New Lines, the costs/ benefits accrued to the society are

3 assessed, but only by the Economic Adviser to the Railway Board (235- F, Annexure- F). As can be seen above, Railway Projects are evaluated only by the rate of remunerativeness and not by any measure of risk associated with it. Sensitivity Analysis is a measure of standalone risk, specific to the project (Chandra, 2014, p. 11.2), and can i. Show the robustness/ vulnerability of a project to changes in underlying variables ii. Highlight area of further analysis, like containment in the variability of the critical factor iii. Articulate the concern of evaluators, and is intuitively appealing (p. 11.6). This analysis is done by varying one variable at a time to understand the project s sensitivity to a change in that variable. 3.0 Selection Criteria/ Sampling/ Assumptions and Others: While applying Sensitivity Analysis to railway projects, the following criteria have been kept in mind: i. The sample size is too small to make any generalization, the idea being the application of an additional tool for financial appraisal. ii. The sampling is judgmental.

4 iii. The sample is confined to one each from new lines, gauge conversion and doubling. iv. The project should have figured in the Works- in- Progress section of the Pink Book (List of Capital Works) for the year v. The project should have incurred a substantial portion of its projected cost already. It was, however, realised that this criterion was not purposeful inasmuch as the projections were not updated at all. vi. Needless to state, the projects are being executed on Southern Railway. vii. This has been done purely for an academic purpose and simply to understand sensitivity analysis. Hence the ultimate sensitivity test (presuming that the costs would go up by 20%, and the revenues would be less by 20%) was not done. viii. The minimum rate of return is 14% as per extant guidelines, but this may not have been a pre requisite in project selection at the apex level. ix. A word on referencing: It is to point out that the APA guidelines have been invoked for citing books and reports, while official documents were referenced by the regular pattern in the Railways.

5 x. While referring to the cost of a project, it was mentioned in Rupees lakhs and crores in different locations. Calculations were done in lakhs of Rupees only. 4.0 Methodology: This student took the data pertaining to Initial Cost and Cost of Renewal and Replacement, Gross/ Total Earnings and Operational Savings, as the case may be, Credit for Released Railway Materials, as given in the survey report and as projected in the financial appraisal. Since none of the projects cleared the benchmark rate of 14%, their present values have been calculated by discounting at a rate nearer to the IRR. For example, in 5.1, the cash flows were discounted at 2%, in 5.2, at 8% and in 5.3, at 9%, which are close to their IRR. Likewise, in deference to 231-F, initial cost incurred before the zeroeth year (the year of starting operations) has been appreciated by the same factor. After working out the NPV (Total Inflows- Total Outflows), the same was analysed for sensitivity with reference to Initial Cost, Maintenance (Gross/ Total Working Expenses) and Renewal and Replacement and Gross/ Total Earnings including Operational Savings, wherever applicable. 5.0 The Analysis:

6 5.1 Tindivanam- Nagari New Line (179.2 km)- No.5 of SR Pink Book : Facts: The survey for this line was estimated at a gross cost of Rs crore, and an IRR of 1.291% in November, 2005 (CAO/C lr. No. C 221/TS/TMV- NG/2005(II) dt. 14/11/2005) It was included in the Supplementary Grants for (No. 22) The sanctioned cost of this project was Rs crores in Till , Rs crore had been spent Sensitivity: The analysis has thrown up the following results: Table Tindivanam- Nagari New Line (179.2 km)- No.5 of SR Pink Book Discount Factor: 2% Srl. No Description Value (in Rs. Lakhs) 1 Present Value of Initial Investment (231- F) Present Value of Replacement and Renewal

7 Fro m th e ab 3 Present Value of Gross Working Expenses Present Value of Total Outflows (1+2+3) Present Value of Gross Earnings Present Value of Credit for Released Railway Materials (CRRM) Present Value of Total Inflows (5+6) Net Present Value (7-4) Sensitivity w.r.t Initial Investment (8/1) 5.74% 10 Sensitivity w.r.t Maintenance, Replacement and Renewal 5.71% (8/(2+3)) 11 Sensitivity w.r.t Gross Earnings (8/5) 2.78% ove table, it is clear that the project is more sensitive to gross earnings than either initial cost or the cost of maintenance and replacement and renewal. A mere 2.78% fall in gross earnings could make project unviable, whereas initial investment (5.74%) and maintenance, replacement and renewal costs (5.71%) had to rise at relatively higher levels to make the project unviable. However, despite the relative differences, it can be said that all the variables are highly sensitive. 5.2 Dindigul- Pollachi- Palghat/ Coimbatore Gauge Conversion ( km)- No.19 of SR Pink Book : Facts: This project was taken up despite it having an IRR of 8.097% mainly because the metre gauge in the project section would become isolated in view of

8 gauge conversion in connected sections and its growth potential Its survey cost was Rs lakh with an annual savings of Rs lakhs The sanctioned cost of the project was Rs crore in February, At present, it is expected to cost Rs crores, with an incurred cost of Rs crores till Sensitivity: In this project, there is a Savings component. The results of analysis are as follows: Table Dindigul- Pollachi- Palghat/ Coimbatore Gauge Conversion ( km)- No.19 of SR Pink Book Discount Factor: 8% Srl. No Description Value (in Rs. Lakhs) 1 Present Value of Initial Investment (231- F) Present Value of Replacement and Renewal Present Value of Total Working Expenses Present Value of Total Outflows (1+2+3) Present Value of Total Earnings Present Value of Operational Savings Present Value of Credit for Released Railway Materials (CRRM)

9 Thi s pr oje 8 Present Value of Total Inflows (5+6+7) Net Present Value (8-4) Sensitivity w.r.t Initial Investment (9/1) 7.85% 11 Sensitivity w.r.t Maintenance, Replacement and Renewal (9/(2+3)) 12 Sensitivity w.r.t Total Earnings and Operational Savings(8/(5+6)) 13.32% 5.17% ct also shows that the NPV is more sensitive to earnings and savings (5.17%), than to initial cost (7.85%) and even lesser to maintenance, replacement and renewal (13.32%). 5.3 Thanjavur- Ponmalai Doubling (46.93 km) with Bye- Pass line before GOC (1.13km)- No.19 of SR Pink Book : Facts: The project was surveyed to cost Rs lakhs in August, 2010, with an IRR of 9.189% (CAO/C lr. No W337/I/170/CN dt. 04/08/2010) It was sanctioned on 16/04/2014 for a total cost of Rs crore (RB letter no. 2009/W1/DL/SR/TP/1 DT. 16/04/2014) Till , an amount of Rs. 40 crore has been spent on this project Sensitivity:

10 The project was tested for its sensitivity despite its negative NPV. The conclusion would mean that costs should go down, or earnings, go up by a specified percentage to make the project viable. The results of the analysis are as follows: Table Thanjavur- Ponmalai Doubling (46.93 km) with Bye- Pass line before GOC (1.13km)- No.19 of SR Pink Book Discount Factor: 9% Srl. No Description Value (in Rs. Lakhs) 1 Present Value of Initial Investment (231- F) Present Value of Replacement and Renewal Present Value of Gross Working Expenses Present Value of Total Outflows (1+2+3) Present Value of Gross Earnings Present Value of Operational Savings Present Value of Credit for Released Railway Materials (CRRM) 8 Present Value of Total Inflows (5+6+7) Net Present Value (8-4) Sensitivity w.r.t Initial Investment (9/1) -0.02% 11 Sensitivity w.r.t Maintenance, Replacement and Renewal (9/(2+3)) 12 Sensitivity w.r.t Gross Earnings and Operational Savings (9/(5+6)) -0.01% -0.01% From the above table, it is clear that the very small value of negative NPV makes the project viable with very minor decreases in initial investment (0.02%) and maintenance replacement and renewal cost (0.01%), and with very marginal increase in gross earnings and operational savings (0.01%). Of the three projects analysed, this is the most sensitive one.

11 6.0 Conclusion: From the above discussion, the following have been observed: 6.1 It is noted that two of the projects selected, i.e., New Line and Gauge Conversion, are relatively more sensitive to earnings and savings, while the doubling project was, in general, highly sensitive to all the three variables. 6.2 If sensitivity analysis is to be done for Railway projects, additional formats need to be designed to facilitate a quick analysis. Updating of survey particulars (including cost and earnings projections and factoring in of inflation) at the time of inclusion in Pink Book and detailed estimation may help in verifying the viability of the project at that stage. Provision also needs to be made to additionally inflate/ discount costs / inflows respectively for every year of delay in completion (time over- run). 6.3 The benchmark IRR has not been met in all the three projects, so PV could not be calculated at a common benchmark rate, thereby depriving the student of additional insight. *** References: Assets-Acquisition, Construction and Replacement for (Pink Book for Southern Railway ). (n.d.). Ministry of Railways. Chandra, P. (2014). Projects: Planning, Analysis, Selection, Financing, Implementation, and Review. New Delhi: McGraw Hill Education (India) Private Limited.

12 Indian Railway Financial Code (Vol. I). (1998 (corrected upto )). New Delhi: Ministry of Railways. (January 2006). Preliminary Survey for Gauge Conversion between Dindigul- Pollachi- Palghat and Pollachi- Coimbatore. (November, 2005). Reconnaissance Engineering cum Traffic Survey for a New BG Line from Tindivanam to Nagari. (August, 2010). Updating of Preliminary Engineering cum Traffic Survey for for Doubling of Track between Thanjavur and Ponmalai with Bye- pass Line before GOC. ***********