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Underwriting Guidelines for the Community Development Block Grant Program. CDBG Underwriting Guidelines. Established by Statute: 42 USC 5305 (e) and Regulation: 24 CFR 570.209. CDBG Underwriting Guidelines. (a) Are project costs reasonable?

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Underwriting Guidelines for the

Community Development Block Grant Program


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CDBG Underwriting Guidelines

Established by Statute:

42 USC 5305 (e)

and

Regulation:

24 CFR 570.209


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CDBG Underwriting Guidelines

(a) Are project costs reasonable?

(b) Are all project financing sources committed?

(c) Are CDBG funds being substituted for non-federal sources?

(d) Is the project financially feasible?

(e) Is the return on the owner’s equity unreasonably high?

(f) Will CDBG funds be disbursed on a pro rata basis with other finances provided to the project?


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CDBG Underwriting Guidelines

(a) Are project costs reasonable?

Ensure thatproviding either too much or too little CDBG assistance for the proposed project is avoided

Accomplished by financial analysis of source and uses and revenue and expense projections.


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CDBG Underwriting Guidelines

(b) Are all project financing sources committed?

Ensure:

-sufficient sources of funds have been identified to finance the project

-participating parties funds have affirmed intention to make funds available

-participating parties have financial capacity to provide funds


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CDBG Underwriting Guidelines

(c) Are CDBG funds being substituted for non-federal sources?

Ensure the most efficient use of CDBG funds

Accomplished by financial analysis revenue and expense projections; debt service requirements and return on equity investments.


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CDBG Underwriting Guidelines

(d) Is the project financially feasible?

Ensure the public benefit of CDBG assistance will materialize by financing a viable project.

Accomplished by –

-examining assumptions about project’s market share, sales levels, growth potential.

- examiningfinancial projections to determine the breakeven point and debt service capacity.

-evaluating the experience of the company’s management to achieve the projections.


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CDBG Underwriting Guidelines

(e) Is the return on the owner’s equity unreasonably high?

Ensure-

- that the CDBG assisted activity should not provide more than a reasonable return on investment to the owner given the industry rates of return, local conditions and the risk of the project.

- that the ED program is able to maximize the use of CDBG funds for its economic development objectives.


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CDBG Underwriting Guidelines

(f) Will CDBG funds be disbursed on a pro rata basis with other finances provided to the project?

Ensure that CDBG funds are not placed at significantly greater risk than non-CDBG funds


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CDBG Underwriting Guidelines

Are project costs reasonable?

Are all project financing sources committed?

Are CDBG funds being substituted for non-federal sources?

Is the project financially feasible?

Is the return on the owner’s equity unreasonably high?

Will CDBG funds be disbursed on a pro rata basis with other finances provided to the project?


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CDBG Underwriting Guidelines

Application to financial underwriting


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Underwriting Guidelines applied to financial analysis

Working Capital Loans

Fixed Asset Loans



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Working Capital

Fixed Assets

Net Working Capital =

Current Assets $5,220

Minus

Current Liabilities $2,110

Equals $3,110


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Working Capital

Fixed Assets

Net Working Capital =

Current Assets $5,220

Minus

Current Liabilities $2,110

Equals $3,110


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Working Capital

For Loan Purposes

Accounts Receivable

Inventory

Minus

Accounts Payable


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Working Capital Loan Underwriting

Calculate the Working Capital Cycle

Calculate the Borrowing Base


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Working Capital Loan Underwriting

Calculate the Working Capital Cycle

Determine Days Receivables

Determine Days Inventories

Determine Days Payables


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Determine DAYS RECEIVABLES

Divide Accounts Receivable $1,320 by

Annual Sales $16,000 = .0825 or 8.25%

Multiply .0825 X 365 days = 30 days


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Determine DAYS RECEIVABLES

equals

Divide Accounts Receivable $1,320 by

Annual Sales $16,000 = .0825 or 8.25%

Multiply .0825 X 365 days = 30 days


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Determine DAYS INVENTORY

Divide INVENTORY $1,430 by

COST of GOODS SOLD $8,760 = .165 or 16.50%

Multiply .165 X 365 days = 60 days

equals


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Determine DAYS INVENTORY

Divide INVENTORY $1,430 by

COST of GOODS SOLD $8,760 = .165 or 16.50%

Multiply .165 X 365 days = 60 days

equals


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Determine DAYS INVENTORY

equals

equals

Divide INVENTORY $1,430 by

COST of GOODS SOLD $8,760 = .165 or 16.50%

Multiply .165 X 365 days = 60 days


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Determine DAYS PAYABLES

Divide ACCOUNTS PAYABLES $600 by

COST of GOODS SOLD $8,760 = .069 or 6.90%

Multiply .069 X 365 days = 25 days


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Determine DAYS PAYABLES

equals

Divide ACCOUNTS PAYABLES $600 by

COST of GOODS SOLD $8,760 = .069 or 6.90%

Multiply .069 X 365 days = 25 days


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Determine WC Cycle

Add Days RECEIVABLES [30] plus Days INVENTORIES [60] subtract Days PAYABLES [25] = 65 days


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Determine WC Cycle

equals

Add Days RECEIVABLES [30] plus Days INVENTORIES [60] subtract Days PAYABLES [25] = 65 days



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Use WC Cycle to Determine Needs for Additional Growth

Add Days RECEIVABLES [30] plus Days INVENTORIES [60] subtract Days PAYABLES [25] = 65 days


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Use WC Cycle to Determine Needs for Additional Growth

At the same WC cycle the new WC requirement is$2,361; an increase of $211


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Use WC Cycle to Determine Needs for Additional Growth

At the same WC cycle the new WC requirement is$2,361; an increase of $211


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Working Capital Loan Underwriting

Calculate the Borrowing Base


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Calculate the WC Borrowing Base

Add ACCOUNTS RECEIVABLE [$1,320] plus INVENTORIES [$1,430] subtract ACCOUNTS PAYABLE [$600] =$2,150

Typically lenders do not make loans at 100% value


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Determine WC Borrowing Base

Loan to value ratios for AR and Inventory

Multiply ACCOUNTS RECEIVABLES [$1,320] X 80%; multiply INVENTORIES [$1,430] X 50% =$1,775


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Determine WC Borrowing Base

Assets Loan value =$1,775

Minus supplier credit [$600] = $1,175


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Determine WC Borrowing Base

Assets Loan value =$1,775

Minus supplier credit [$600] = $1,175


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Determine WC Borrowing Base

Assets Loan value = $1,775

Minus supplier credit [$600] = $1,175 which represents the Borrowing Base or collateral for a Working Capital loan


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Determine WC Borrowing Base

CDBG Underwriting Guidelines

(a) Are project costs reasonable?

Ensure that providing either too much or too little CDBG assistance for the proposed project is avoided

Accomplished by financial analysis of source and uses and revenue and expense projections.

Assets Loan value = $1,775

Minus supplier credit [$600] = $1,175 which represents the Borrowing Base or collateral for a Working Capital loan


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Determine WC Borrowing Base

CDBG Underwriting Guidelines

Are all project financing sources committed?

Ensure participating parties have financial capacity to provide funds

Total Net WC $2,150 minus external financing $1,175 = $975 equity financing needed


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Other Considerations for WC Loans

When sales remain even throughout the year, so do WC requirements


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Other Considerations for WC Loans

But when fluctuationsinSales occur so will changes in WC requirements


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Other Considerations for WC Loans

Sales fluctuations will change WC requirements


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Other Considerations for WC Loans

CDBG Underwriting Guidelines

Are all project financing sources committed?

Sufficient sources of funds been identified to finance the project

Sales fluctuations will change WC requirements



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Other Considerations for WC Loans

Changes in WC cycle can adversely effect the borrowing base


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Other Considerations for WC Loans

Net WC is $3,490 for base year


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Other Considerations for WC Loans

For the following year:

Net WC is $4,645; a 33% increase but Sales only increased 6%


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Other Considerations for WC Loans

The WC cycle has increased

The key financial ratio; Current Ratio has improved from 3:1 to 5:1; But the efficiency ratios; Sales/Working Capital has decreased from 7:1 to 5:1; Sales/Total Assets will also decrease



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Fixed Asset Loan Underwriting

Loan to Value Ratio

and

Cash flow to Debt Service requirements


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Fixed Asset Loan Underwriting

Loan to Value Ratio

General Rules

1. Do not finance 100% of the asset

2. Do not term the loan longer than the asset’s useful life


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Fixed Asset Loan Underwriting

Loan to Value Ratio [LVR]

1. Do not finance 100% of the asset

Establish a Maximum LVR [75%]


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Fixed Asset Loan Underwriting

Maximum 75% of Value

Asset Cost $8,000 X 75% [LVR] = $ 6,000 maximum loan


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Fixed Asset Loan Underwriting

Maximum 75% of Value

Asset Cost $8,000 - $ 6,000 = $2,000 the difference to be provided by the company


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Fixed Asset Loan Underwriting

CDBG Underwriting Guidelines

Are all project financing sources committed? Will CDBG funds be disbursed on a pro rata share with other finances provided to the project?

Asset Cost $8,000 - $ 6,000 = $2,000 the difference to be provided by the company


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Fixed Asset Loan Underwriting

Asset Useful Life vs. Loan Amortization period

After two years the asset’s book value is $6,000 and the loan balance is $3,800

Asset useful life 8 years: $8,000 = $ 1,000 per year expensed

$6,000 loan amortized for 5 years


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Fixed Asset Loan Underwriting

Asset Useful Life vs. Loan Amortization period

After five years the asset’s book value is $3,000 and the loan balance is $0

Asset useful life 8 years: $8,000 = $ 1,000 per year expensed

$6,000 loan amortized for 5 years


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Fixed Asset Loan Underwriting

Asset Useful Life vs. Loan Amortization period

If the loan amortization is longer than the asset’s useful life, then the company’s net worth will decline

Asset useful life 8 years: $8,000 = $ 1,000 per year expensed

$6,000 loan amortized for 9 years


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Fixed Asset Loan Underwriting

Asset Useful Life vs. Loan Amortization period

CDBG Underwriting Guidelines

Are CDBG funds being substituted for non-federal sources? Is the return on the owner’s equity unreasonable high?


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Fixed Asset Loan Underwriting

Cash flow to Debt Service requirements

1. Establish a CF/DS ratio

2. Determine DS capacity


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Fixed Asset Loan Underwriting

Establish a CF/DS ratio: 1.5 : 1

Determine DS capacity

For every dollar of debt service, the project must have a dollar and half of cash flow


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Fixed Asset Loan Underwriting

Establish a CF/DS ratio: 1.5 : 1

Determine DS capacity

Subtract Operating Expenses from Gross Profit = Operating Cash Flow or Earnings Before Interest Taxes and Depreciation and Amortization

EBITDA


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Fixed Asset Loan Underwriting

Establish a CF/DS ratio: 1.5 : 1

Determine DS capacity

Operating Cash / EBITDA = $1,590


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Fixed Asset Loan Underwriting

Establish a CF/DS ratio: 1.5 : 1

Determine DS capacity

Operating Cash / EBITDA = $1,590

Divide by CF/DS ratio 1.5 =

$1,060 DS capacity


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Fixed Asset Loan Underwriting

$1,060 DS capacity

Divide by proposed loan $6,000 = .1766

Which is the Debt Service Constant [DSK]

Determine Debt Service Constant


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Fixed Asset Loan Underwriting

$1,060 DS capacity

Divide by proposed loan $6,000 = .1766

Price the Loan

Find best match for .1766 on the Debt Service Constant table


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Fixed Asset Loan Underwriting

$1,060 DS capacity

Divide by proposed loan of $6,000 = .1766 for an asset with 8 year service life

Price the Loan

DSK too high

Term too long


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Fixed Asset Loan Underwriting

$1,060 DS capacity

Divide by proposed loan $6,000 = .1766

Price the Loan

Find closest match to .1766 on the Debt Service Constant table


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Fixed Asset Loan Underwriting

Price the Loan

$1,060 DS capacity

Loan $6,000 @ 5.5% for 7 years = annual payment: $1,056

Loan Term less than asset useful life


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Fixed Asset Loan Underwriting

Price the Loan

$1,060 DS capacity

Loan $6,000 @ 5.5% for 7 years = annual payment: $1,056

CDBG Underwriting Guidelines

(d) Is the project financially feasible?

Ensure the public benefit of CDBG assistance will materialize by financing a viable project.

Accomplished by –

- examiningfinancial projections to determine the breakeven point and debt service capacity.

Loan Term less than asset useful life


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Grant and Loan Combinations

Borrower has an CF/EBITDA of $1,110;

at the established CF/DS of 1.5:1

DS capability is $740


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Grant and Loan Combinations

Borrower has an CF/EBITDA of $1,110;

at the established CF/DS of 1.5:1

DS capability is $740

DSK = $740 divided by loan $6,0000 = .123

for an asset with a eight year useful life


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Grant and Loan Combinations

DSK = $740/$6,0000 = .123 for an asset with an eight year useful life

DSKs are two high within the asset’s useful life; terms are too long for borrower’s repayment ability


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Grant and Loan Combinations

DSK = $740/$6,0000 = .123 for an asset with an eight year useful life

Lender’s terms are 4% ; at one year less than useful life; DSK is .167


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Grant and Loan Combinations

Divide CF $740 by .167 [4% @7 yrs] = $4,442


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Grant and Loan Combinations

Asset Cost $6,000

Equals Borrowing Capacity of $4,442

Difference is Grant $1,558


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Grant and Loan Combinations

Asset Cost $6,000

Equals Borrowing Capacity of $4,442

Difference is Grant $1,558

CDBG Underwriting Guidelines

Are project costs reasonable? Is the project financially feasible? Is the return on the owner’s equity unreasonably high?



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Other Considerations for Long Term financing

Owner’s Rate of Return

Profit

divided by

Owner’s Equity

=


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Other Considerations for Long Term financing

Owner’s Rate of Return

Profit

divided by

Owner’s Equity

= Return on Equity (Investment)


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Other Considerations for Long Term financing

Owner’s Rate of Return

No Debt

Return on Equity (Investment)


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Other Considerations for Long Term financing

Owner’s Rate of Return

Addition of Debt

and

Reduction of Equity

Increases the

ROE


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Other Considerations for Long Term financing

Owner’s Rate of Return

This financing structure [5% 7 Yrs] meets Cash flow to debt service ratio

And Loan to Value

ratio


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Other Considerations for Long Term financing

Owner’s Rate of Return

Increasing the debt increases the owner’s ROE

But also increases the risk indicators

Lower CF:DS

Higher LVR

Lower D/Eq


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Other Considerations for Long Term financing

Owner’s Rate of Return

CDBG Underwriting Guidelines

Are CDBG funds being substituted for non-federal sources? Is the return on the owner’s equity unreasonably high?



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Determining Project Feasibility Situation B?

Calculating Sales Breakeven Point

Calculating Project Sources and Uses


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Determining the Breakeven Sales point Situation B?

Calculate the variable cost as a percentage of Sales


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Determining the Breakeven Sales point Situation B?

Calculate the variable cost as a percentage of Sales


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Determining the Breakeven Sales point Situation B?

Subtract the total variable cost from 1

= the Contribution Margin


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Determining the Breakeven Sales point Situation B?

Divide the Fixed Costs by the CM

equals

The Breakeven Sales Point


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Determining the Breakeven Sales point Situation B?

Recalculate variable costs as a percentage of sales


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Determining the Breakeven Sales point Situation B?

Subtract fixed costs; the Profit /(Loss) should equal $0


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Determining the Breakeven Sales point Situation B?

Situation B – Operating at a Loss;

Same Sales, Same fixed Costs, higher variable costs and lower CM

4,000 / 16% =


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Determining the Breakeven Sales point Situation B?

(d) Is the project financially feasible?

Ensure the public benefit of CDBG assistance will materialize by financing a viable project.

Accomplished by –

- examiningfinancial projections to determine the breakeven point.

Higher Breakeven Sales Point



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Use the Breakeven Sales point to calculate project Sources and Uses

Additional Sales and COGS means additional WC requirements


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Determining Project Sources and Uses and Uses

WC requirements


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Determining Project Sources and Uses and Uses

An increase in productive capacity may require additional fixed assets


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Determining Project Sources and Uses and Uses

Calculate Additional Financing required


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Determining Project Sources and Uses and Uses

Calculate Additional Financing required


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Determining Project Sources and Uses and Uses

After total Project USES have been determined…


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Determining Project Sources and Uses and Uses

Identify SOURCES to finance project costs


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Determining Project Sources and Uses and Uses

CDBG Underwriting Guidelines

Are project costs reasonable? Are all project financing sources committed? Is the project financially feasible? Is the return on the owner’s equity unreasonably high? Will CDBG funds be disbursed on a pro rata share with other finances provided to the project?


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Underwriting Guidelines for the and Uses

Community Development Block Grant Program

THE END


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