FILE COPY

DOCUMENT OF INTERNATIONAL BANK FOR RECONSTRUCTION AND DEVELOPMENTINTERNATIONAL DEVELOPMENT ASSOCIATION

Not For Public Use

Report No. 256a-YU

APPRAISAL OF

FOB IRON FOUNDRY EXPANSION PROJECT

YUGOSLAVIA

January 28, 1974

Industrial Projects Department

This report was prepared for official use only by the Bank Group. It may not be published, quotedor cited without Bank Group authorization. The Bank Group does not accept responsibility for theaccuracy or completeness of the report.

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CUR=CY NQUIVALENTS

Except where otherwise indicated,all ftures are qwted in Yugo-alav Dinars (Din).

US$ 1 -n 15.5lDin 1 D- US$o.0645Din 1,000 . U$64.516

EIGHTS ND MEASURES

All units are metric, except pipediameters which are in inches.

1 metric ton - 1,000 kilograms (kg)1 metric ton = 2,2064.6 poumds1 kilometer (km) - 0.62 mles1 cubic meter (m3 ) - 35.32 cubic feet (eu ft)

ABBREVIATIONS AND ACRONYMS

FOB, the Company - Fabrika Odlivaka BeogradIMR - Induatrija Motora RakovicaIMT - Indnstrija Masina i TraktoraKIKINDA - Livnica Zeljeza i TemperaSAS - Social Accounting ServiceTPY - (Metric) Tons Per YearUMI - Udruzena Metalska IndustrijaZCZ - Zastava Crvena Zastava

FOB FISCAL YEARJanuary 1 - Decexmer 31

Industrial Projects DepartmentJanuarr 28, 1971

YUGOSLAVIA

FOB IRON FOUNDRY EXPANSION PROJECT

TABLE OF CONTENTS

Page No.

SUMMARY AND CONCLUSIONS . .................. . i-iii

I. INTRODUCTION ........................... 1

A. General ... . ................. 1

II. THE COMPANY ...... ....... ....... 2

A. Background ...... ....... . . ............... 2B. Relationship with UMI ......................... . 2C. Organization and Management ................ 3D. Plant Facilities ................................ 4E. Past Growth and Financial Results ......... ...... 4F. Recent Financial Position ....................... 6

III. THE MARKET ........... ................................ 6

A. Supply and Demand of Castings ................... 6B. FOB's Market Position and Sales Forecasts ...... . 8C. Sales Build-up and Destination of Sales ......... 9D. Marketing Organization ......................... 10E. Prices and Competitive Position ................. 10F. Export Incentives ...... ..... ........ ..... ............. . 11G. Protection ...................................... 11

IV. THE PROJECT . .......................*.,...,.....so 11

A. Objectives and Scope ...... ...................... 11B. Observations .......... *.*... 11C. Ecology ..........so...... ................................ 12D. Labor Force ............................. .. 13E. Project Execution ...... ......................... 13F. Project Timing ........................... ....... 14

V. CAPITAL COST AND FINANCIAL PLAN ...................... 14

A. Project Cost ....... ......... .......... 14B. Working Capital ....... ...... .. .. ... .... s. 15

This report was prepared by Messrs. S. P. Nayar, Y. T. Shetty, J. Paschkeand I. Glenday of the Industrial Projects Department.

Table of Contents (Cont'd)Page No.

C. Financing Plan ...... .......... . .......... ...... . 15D. Procurement and Disbursement .............. O-*... 17

VI. REVENUES, RAW MATERIALS, AND PRODUCTION COST ......... 18

A. Sales Revenue ............. ...... .................... 18B. Raw Materals . . . . . . . . . . .. . .#. . . . . . .* .. . . . . . 18

C. Production Costs ................. ....... ....... 19

VII. FUTURE PROFITABILITY AND FINANCIAL POSITION .......... 21

A. Profitability ..... I............ ......................... 21B. Financial Position ............................ 21C. Financial Rate of Return ......................... 23D. Debt Service Coverage ...... .... *0..*. .. ....... 24E. Break-even Point ... .. ...... 24F. Major Risks ............................ 24G. Accounting and Audit Requirements ............... 25

VIII. ECONOMIC JUSTIFICATION ............................... 26

A. Available Alternatives ........... *.............. 26B. Economic Rate of Return ......................... 26C. Competitiveness ............... .. ............. ....... 27D. Linkages and Employment ....................... 27E. Estimated Foreign Exchange Effects .............. 28

IX. RECOMMENDATIONS ........................................ 28

ANNEXES

1-1 Description of Terms and Production Processes2-1 Workers' Self-Management and Organization Chart2-2 Description of Existing Facilities2-3 Production History and Forecasts3-1 Market for Iron Castings3-2 Sales of Iron Castings by Volume4-1 Proposed Facilities4-2 Plant Layout4-3 Ecology4-4 Labor Force Projections4-5 Project Implementation Schedule5-1 Capital Cost Estimates5-2 Working Capital Requirements5-3 Details of Financial Plan

TABLE OF CONTENTS (Cont'd)

5-4 Items to be Financed by Bank5-5 Procurement Procedures5-6 Disbursement Schedule6-1 Ex-plant Selling Price Assumptions and Revenue Forecasts6-2 Raw Materials and Utilities6-3 Production and Production Cost7-1 Historical and Projected Income Statements (with Expansion)7-2 Sources and Application of Funds (with Expansion)7-3 Historical and Projected Balance Sheets (with Expansion)7-4 Remarks on Historical and Projected Financial Statements7-5 Historical and Projected Income Statements (without Expansion)7-6 Historical and Projected Balance Sheets (without Expansion)7-7 Assumptions for Financial and Economic Rates of Return and Financial

Sensitivity Analysis7-8 Foreign Fund Sources and Uses7-9 Break-even Point8-1 Inputs for Economic Rate of Return and Economic Sensitivity Analysis8-2 Foreign Exchange Earnings and Savings8-3 Indirect Employment Generation

MAPS

(IBR) 10504R1) Main Foundry Locations(IBRD 10681) Location of Plant and Raw Material Sources

YUGOSLAVIA

FOB IRON FOUNDRY EXPANSION PROJECT

SUMMARY AND CONCLUSIONS

i. This report appraises the expansion of Fabrika Odlivaka Beograd(FOB), Belgrade, the second largest Yugoslav producer of iron castings.Until last year, FOB operated two plants--one in New Belgrade and theother in Rakovica, 5 km away--with a total annual capacity of 33,000 tonsof iron castings, including 28,000 tons of gray castings and 5,000 tons ofnodular castings. The Rakovica plant with a capacity of 8,000 tons per yearwas separated at the end of 1973. The proposed project would increase theannual capacity of the New Belgrade Foundry from 25,000 to about 90,000 tonsof which about 80,000 tons would be for gray iron castings and 10,000 tonsfor nodular iron castings and the capacity of the pattern shop will be doubled.The total financing required for the project, including interest during con-struction and incremental working capital, is Din 1,071 million (equivalentto US$69 million), of which the foreign exchange component would be aboutDin 300 million (US$19.2 million) or approximately 30% of the total. Theproposed Bank loan would be US$15.0 million equivalent. Implementation ofthe project has already started and is expected to be completed by the endof 1976 with full capacity production to be attained by the end of thefollowing year.

ii. During 1967-72, the Bank made three indirect loans to industry inYugoslavia through the Yugoslav Investment Bank, providing a total of US$45million equivalent for the modernization and expansion of 19 industrialprojects. However, the Bank has decided recently (for reasons explained inthe Kikinda Iron Foundry Appraisal Report 218a-YU, of November 5, 1973) tomodify its lending strategy to include direct loans to Yugoslav industrialprojects of key economic importance which cannot obtain long-term loans onreasonable terms from commercial and other sources. This approach is ex-pected to lead to maximization of the impact of Bank lending to industry inthat country.

iii. It is in this context that the Federal Government has asked theBank to help finance two iron foundries--Kikinda and FOB--which are givenhigh priority in the current Yugoslav Five-Year Plan (1971-75). A US$14.5million loan to Kikinda was approved by the Bank's Executive Directors inNovember, 1973. It represents the first direct industrial loan by the Bankto Yugoslavia, and the proposed loan to FOB would be the second. The loanof US$15 million to FOB would finance the c.i.f. foreign exchange cost ofcompetitively-bid equipment and spares as well as foreign consultant servicesand would be for 14 years, including 4 years of grace, with an effectiveinterest rate of 9% per annum, including a guarantee fee of 1-3/4% to theRepublic of Serbia where the project is located. The loan would help meetapproximately 28% of the project cost, while 11% (Din 88 million) would befinanced from the Company's internal cash generation and the remaining 61%.

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(Din 493 million, including Din 7 million in foreign exchange) from outsidelocal sources, mostly from the Ba!grade ink; n addition, Din 258 million(US$16.5 million) required for ilt6l-est Zrif9 construction, including US$3.5million in foreign exchange, would be met ftom ±iternally-generated funds.

iv. The project is crucial fctr rhe anti.cipated expansion of priorityindustries in Yugoslavia inciudita; agi~cultural machinery, commercial ve-hicles, rail wagons and shipb,u ldiug. These industries are targeted to ex-pand at an annual average rate of evrer 8.5% during the current Plan. Theirrapid growth would not be poseible without the increased supply of iron cast-ings, which would have tc be largely met from imports (at tight world marketsituation for such products) but for the expansion of FOB. To meet thestrong demand for its products, FOB is presently producing significantlyabove capacity with the risk of inadequate maintenance. The need for suchovercapacity production will only be overcome upon completion of the project,when FOB will have become the largest producer of Iron castings in Yugoslavia.

v. FOB is primarily domestico5iented. In 1972, about 85% of itsproduction volume was sold locally, oL i!Aich more than four-fifths was pur-chased within the seven-member UMI group of industries to which FOB belongs.After the expansion, however, a substantial portion of FOB castings (28%)would be exported and, at the same time, the share of exports to the con-vertible currency countries is expected to rise from 5% to 22% reflectingthe Company's plans to boost sales to those countries to earn foreign ex-change for repayment of its foreign obligations as required by Yugoslavlaw.

vi. Markets for FOB products appear well assured. The Company is try-ing to strengthen its export function by appointing representatives abroadto develop direct contacts with customers instead of relying on agents aswas the case in the past. Furthermore, the Company's export plans are ex-pected to be facilitated by the existing world shortage of iron castingswhich is likely to continue in the foreseeable future because, in developedcountries, it is becoming more difficult to attract labor to work in thefoundry industry and wage costs in this relatively labor-intensive industryare expected to pursue their upward climb. Finally, FOB is fully competi-tive internationally. Even if international prices were to fall by 10% fromthe levels assumed in the financial projections, FOB products would still beable to compete profitably.

vii. FOB has an efficient man-gement team headed by a capable GeneralManager, who was elected in 1971 for a feur-year term by the Central Workers'Council, the supreme management body of the enterprise. The General Manageris supported by an Executive Board coisisting of 10 members from the Council.In practice, the management makes all nacT decisions and has the full co-operation of the Council.

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viii. The Company has a sound financial position which provides a goodbase for expansion. The project, however, will require heavy borrowing whichwill strain FOB's financial position during the first three years of projectimplementation; the percentage of debt in the total of debt and equity wouldrise sharply from 16% in 1973 to 77% in 1975, but would decline to 56% by 1978.Since debt service coverage remains adequate throughout the forecast periodand, in the Yugoslav context, equity increases could only result from net in-come appropriations and the Yugoslav banking system is obligated to supportenterprises during temporary stringencies, the high debt/equity ratio in 1975and 19726 is acceptable.

ix. T'he project has high financial and economic rates of return of16% and 23% respectively, and even under foreseeable adverse conditions,the probability is low that they would drop below 10%. The annual incre-mental net foreign exchange earnings and savings to the economy once theproject's additional capacity is fully utilized in 1978 is expected to beabout US$27 million equivalent, thus offsetting in just one year morethan the entire foreign exchange cost of the project. The project wouldprovide direct permanent employment to over 900 persons. In addition, itis expected to open up jobs to at least 2,000 persons in the supplier in-dustries and the transport sector.

x. Appraisal of the project and preparation of this report were completedprior to the recent energy crisis. The likely impact on the project was re-viewed with FOB management in early January 1974 and is considered to be minimal.The capital cost of the project is not expected to increase by so much as tonecessitate a higher provision for price escalation and, in any event, anyadditional need for funds, whether caused by an increase in project cost and/or a shortfall in internally-generated funds during project implementation,would be covered by the Belgrade Bank. Furthermore, energy represents onlyabout 5% of FOB's direct operating costs and it can be assumed that any fuel-related increase in the Company's manufacturing costs could be passed on inthe form of higher selling prices, both at home and abroad. Finally, Yugoslaviaenjoys a favorable position with respect to energy and fuel supply and pricesand it may, therefore, be expected that the foundries in other parts of Europeagainst which FOB would compete will experience somewhat higher cost increasesthan the Company.

xi. Based on agreements reached during negotiations on necessaryassurances as summarized at the end of this report, the project is suitablefor a Bank loan equivalent to US$15.0 million.

I. INTRODUCTION

A. General

1.01 This report appraises the proposed expansion project of FabrikaOdlivaka Beograd (FOB), the second largest producer of iron castings inYugoslavia. The Company has been operating a 25,000-ton-per-year (TPY)foundry and a pattern shop in New Belgrade and a 8,000 TPY plant at Rakovica,5 km away (Maps, IBRD 10504R1, 10681), which was separated from FOB at theend of 1973. The proposed project would increase the capacity of the NewBelgrade foundry from 25,000 to about 90,000 TPY and more than double thecapacity o. the pattern shop. Total financing required for the project,including interest during construction and incremental working capital, isDin 1,071 million (equivalent to US$69 million) of which Din 300 million(US$19.2 million) would be in foreign exchange. The proposed Bank loan ofUS$15 million would cover almost the entire foreign exchange cost of equipmentand engineering.

1.02 This loan to FOB would be the second direct Bank loan to industryin Yugoslavia. The first loan was approved by the Bank's Executive Directorson November 20, 1973, for Livnica Zeljeza i Tempera-Kikinda, also an ironfoundry (Report No. 218a-YU, of October 19, 1973).

1.03 Following an industrial identification mission to Yugoslavia in1971, the Federal Government in May, 1972, submitted eight industrial projectsto the Bgnk for financing, of which the expansion of FOB was one of theprojects selected and one on the Government's priority list for industrialdevelopment. It is considered vital for the country's engineering industries,especially those manufacturing tractors, motor vehicles and ships. Some ofthe enterprises in these subsectors have already started expanding in anti-cipation of additional castings from FOB. One notable example is the expan-sion program of Industrija Masina i Traktora (IMT), located adjacent to FOB,which is to increase its annual production from 15,000 tractors in 1972 to35,000 tractors by 1976. IMT is another project for which a Bank loan isbeing considered. 1/

1.04 The FOB project was appraised by a mission which visited Yugoslaviain April/May and July/August 1973 and which consisted of Messrs. Nayar (Chief),Glenday, Paschke and Shetty of the Industrial Projects Department and

* Mr. Paschke (Consultant). Foundry terms and production processes are brieflydescribed in Annex 1-1.

1.05 FOB meets all criteria for Bank lending. First, the project is ofkey national importance as it accounts for about half of the total Yugoslavproduction of gray iron castings for engine-driven vehicles. Secondly, theproject does not require any foreign participation and, therefore, appearsunsuitable for IPC financing. Thirdly, the Company approached the Bank onlyafter failing to secure adequate long-term credits on reasonable terms fromother sources.

1/ See Appraisal Report 288a-YU dated January 28, 1974.

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II. THE COMPANY

A. Background

2.01 Until the end of 1973, FOB had been operating two production facilitiesone in New Belgrade comprising a large-scale foundry (capacity: 25,000 TPY)

and a pattern shop; and the other in Rakovica consisting of two small andrather obsolete gray iron foundries (capacities: 6,000 and 2,000 TPY respec-tively). The New Belgrade foundry was established during 1947/48 as a partof Zavodi Masinske Industrije to produce cast iron pipes. Three years later,when IMT bought it, the production of castings for farm implements was added.Later, in the early 1960's, the foundry discontinued the production of castiron pipes to concentrate on the manufacture of gray iron castings for farmimplements, wtor vehicles and ships. Today the foundry produces both grayand nodular iron castings, and its expansion has been particularly rapid duringthe last five years, rising from 11,000 tons in 1968 to 25,000 tons at present.

2.02 The pattern shop in New Belgrade was started in 1948 and becamepart of IMT five years later. It remained so until the end of 1970, whentogether with the New Belgrade and Rakovica foundries, it was merged to formFOB as a new member company of Udruzena Metalska Industrija (UMI), the 15thlargest industrial group in Yugoslavia formed at the end of 1969. The Rakovicafacility was separated from FOB at the end of 1973 to rejoin Industrija MotoraRokovica (IMR) of which it was a part until the end of 1970.

B. Relationship with UMI

2.03 The following table shows the location, main production lines and1972 sales value of all the seven UMI members:

UMI Companies - Selected Data

Names of Companies Locations Production Lines 1972 Sales(Din Million) %

1. FOB Belgrade & Gray and nodular iron 234 7.6Rakovica castings, and patterns

2. IMT Belgrade Tractors and other farm 1,031 33.6equipment

3. IMR Rakovica Diesel engines 399 13.0

4. Zmaj Zemun Farm implements 449 14.6

5. Ikarus Zemun & Buses, trucks and auto 402 13.1Aleksinac parts

6. 21 May Motor Belgrade & Gasoline engines and 450 14.7Facory (DMB) Rakovica motor parts

7. Industrija Belgrade Precision instruments 106 3.4PrecizneMehanike (IPM) 3,071 100.0

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2.04 The relation between UMI and its members is a complicated one becauseof attempts to combine common interests with those of the individual enterprises.Though UMI enterprises have a common development and marketing strategy whichsets out broad general objectives, each member company is a separate legalentity and is independent in its detailed production and marketing programs.All members have to contribute annually to a Joint Reserve Fund and a JointDevelopment Fund established by UMI. The former is used to make interest-free loans to member companies that incur losses and the latter to financeresearch and development programs benefiting the entire group, and to advanceinterest-free loans for investments of member enterprises. Moreover, UMI'sapproval is necessary for annual investments exceeding Din 1 million by amember company. During negotiations, FOB has agreed to provide evidence thatUMI has approved the project and that UNM will not request a higher increasein FOB's annual contribution than assumed in the financial projections andthus not adversely affect the availability of FOB's internally generated fundsto contribute to the project.

2.05 In 1972, UMI enterprises employed a total of about 20,000 persons,equivalent to some 15% of total industrial employment in Belgrade or about65% of the labor force in the metal-working industry of the capital city.The total revenue of UMI companies that year was nearly Din 3.1 billion(US$200 million), representing about 70% of total sales of the metal in-dustry in Belgrade. The same year, FOB accounted for 13% of the total employ-ment and 7.6% of the total sales of UMI. Over the past three years (1970-1972),total sales of the UMI group increased by more than 70% (from Din 1.8 billionto Din 3.1 billion), and net income during the same period rose more or lessin step, from Din 0.5 billion to Din 0.8 billion. UMI is, therefore, a ratherdynamic group of enterprises.

C. Organizati n and Management

2.06 As a separate entity and as an autonomous part of the UIT group,FOB is hardly three years old. It is operated under the workers' self-management system of Yugoslavia explained in Annex 2-1 which also containsan organization chart of the enterprise. The supreme management body ofthe Company is the Workers' Council which currently consists of 30 memberselected by FOB workers for a period of two years. The Council formulatesthe enterprise's general policy and investment and production programs withinthe overall plans developed by UMI for the group as a whole. The Council'sapproval is necessary on plant expansions, annual budgets and appropriationsof net income, and it elects the General Manager as the Company's chiefexecutive officer.

2.07 The present General Manager, Mr. Milan Rodic, 41, was elected alongwith most key officials to the Company in June 1971, soon after the es-tablishment of FOB as a separate unit; his term is for four years but he iseligible for a second term. Mr. Rodic is capable and has had more than 20years of experience with FOB and related organizations in various key posts

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prior to his present position. He is assisted by an Executive Board whichconsists of 10 members elected by the Workers' Council plus the GeneralManager. The Board's main function is to propose measures to improve busi-ness policy, appoint committees for the selection of key personnel, and in-quire into specific issues. The General Manager is independent of the Boardin his functions and is responsible only to the Workers' Council.

2.08 The General Manager is supported by adequate administrative andtechnical staff. This team which was developed during the short span ofthree years of the Company's independent existence, is generally good but,in view of the further rapid expansion now envisaged, needs strengtheningin certain areas, especially finance and accounting. Specific measures toovercome these shortcomings are discussed in para. 7.14. On the whole, thepresent arrangements are considered satisfactory. According to Yugoslavlaw, no company can merge or consolidate without protecting the right ofthird parties such as its lenders.

D. Plant Facilities

2.09 The Company's existing facilities are described in detail in Annex2-2. They consist of the normal production units such as pattern-making,sand preparation, core-making, melting and molding as well as auxiliaryservices. There are production bottlenecks in both locations. Problems fac-ing the New Belgrade foundry are lack of in-plant space, limited cleaningroom capacity, and obsolete equipment, especially in the pattern shop. Theproduction at one of the Rakovica foundries, established about 27 years ago,is hampered because of obsolete manually-operated equipment. Though the otherRakovica foundry, 12 years old, is operating well, its general lay-out isunsatisfactory resulting in deficient material handling. As mentionedearlier, both these foundries were separated from FOB at the end of 1973.They are expected to be closed by 1976 as the Rakovica city developmentprogram envisages their removal from the present location. During negotiations,agreement has been reached with the Company that it will not sell, lease, trans-fer or dispose of its rights or assets without the prior consent of the Bank.

E. Past Growth and Financial Results

2.10 The following table shows the trend of sales and net income of FOBsince 1971, the enterprise's first year of operation as a composite, separateunit:

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FOB: Trend of Sales and Net Income

1971 1972 1973 % Increase(9 months) 1972/1971

Sales Volume ('000 tons)

Iron Castings 28.7 32.3 31.3 12.5of which: Gray 24.7 28.1 27.2 13.7

Nodular 4.0 4.2 4.1 5.0

Net Sales (Din Million) 171.0 233.8 261.2 36.7of which:- Exports to Convertible

Area 2.7 10.4 N.A. 285.0- Exports to Clearing Area 16.9 28.8 N.A. 70.0- Sales of Patents 1.6 4.3 N.A. 169.0

Net Income (Din Million) 16.4 25.0 24.8 53.0Net Income as % of Net Sales 9.6 10.6 9.5 12.0

N.A. - Not available

2.11 During 1971-72, the Company's sales revenue increased by about 37%,while physical sales rose by only 12.5%. This faster growth in sales pro-ceeds has been mainly due to a rapid inflationary increase in casting prices.During the same period, net income as a percentage of sales rose significant-ly from 9.6% to 10.7%. FOB's performance in the first 9 months of 1973 isgenerally in line with the 1973 projections. The Company's exports to theconvertible currency area increased more than threefold in 1972 though froma rather low base in 1971. But exports to this area are still small, accoun-ting for hardly 5.0% of total sales compared with 12% to clearing currencycountries. The Company plans to step up its exports to convertible currencycountries in the future through more intensive export promotion (para. 3.11and 3.13).

2.12 FOB has been concentrating on the production of gray castings whichin 1972 accounted for about 87% of its total casting output in volume. It isthe largest producer of gray iron castings for engines and engine-drivenvehicles in Yugoslavia, meeting at present about 50% of the country's needs.

2.13 In 1972, over 70% of FOB's castings in volume were sold internallyto the UMI group, of which the most important customer was IMT accounting forabout 28% of total sales of castings to UMNI. FOB prices to UMI menbers arecomparable to those charged to outside domestic customers.

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F. Recent Financial Position

2.14 Historical balance sheets (1971 and 1972) are given in Annex 7-1

and the balance sheet as of December 31, 1972 is summarized below:

FOB Balance Sheet, as of December 31, 1972(Din Million)

Cash and Bank 5.1 Accounts Payable 16.8

Receivables 53.6 Others 25.3

Inventories 32.4

Others 12.2

Total Current Assets 103.3 Total Current Liabilities 42.1

Net Fixed Assets 76.3 Long-Term Debt 29.6

Other Assets 33.3 Equity /1 141.2

Total Assets 212.9 Total Liabilities 212.9

/1 Equity includes the Business Fund, Collective Consumption Fund, Reserve

Fund, and Mutual Reserve Fund which are explained in Annex 7-4, pages

2-3.

2.15 The above table shows that at the end of 1972 the Company had a satis-

factory current ratio of approximately 2.5:1 add a low debt/equity ratio of

17:83. These ratios reflect FOB's sound financial position which provides

a viable base for the proposed expansion. However, the present book value

of net fixed assets is still low in spite of the 53% revaluation in 1971.

III. THE MARKET

A. Suply and Demand of Castings

3.01 A detailed analysis of the market for foundry products (castings)

is provided in Annex 3-1.

3.02 There are some 250 foundries in Yugoslavia, of which about 12

account for some 50% of total output, thus showing the concentration of pro-

duction in a few large enterprises. In 1972, total production of castings,

including steel and non-ferrous castings which make up some 18% of the total,

was about 453,000 tons; total iron casting output - i.e., FOB's line of

production - was about 373,000 tons, of which 92% consisted of gray castings,

5% of malleable castings and 3% of nodular castings. Taking into account the

present expansion plans of various Yugoslav foundries, including those of FOB

and Kikinda, it is expected that the output of iron castings in the country

will increase to about 627,000 tons in 1978, or by an average annual rate of

9%.

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3.03 The following table summarizes past and projected demand and supplyof iron castings in Yugoslavia through 1978, the year in which full productionis expected to be reached:

Yugoslavia-Demand/Supply Comparisons for Iron Castings('000 tons)

Average Annual1968 1972 1973 1978 Growth Rate (%)-- actual--- -forecast-- 1968-72 1972-78

Production 260.0 373.0 418.0 627.0 9.5 9Imports 4.0 14.0 15.0 28.0 37 12Total Supply 264.0 387.0 433.0 655.0 10 9

Domestic Consumption 212.7 321.0 375.0 691.0 11 13.5Exports 51.3 66.0 72.5 108.5 6.5 8.5Surplus (deficit) 0.0 0.0 (14.5)(144.5)

3.04 Domestic consumption of iron castings increased at an annual rateof 11% during 1968-72, reaching 321,000 tons in 1972. Considering the plansfor accelerated industrial development in Yugoslavia and based on an industryby industry assessment of their needs for castings, consumption in the futureis likely to grow at 13.5% per year, reaching 691,000 tons in 1978. The mainconsumers of castings are producers of agricultural machinery, motor vehicles,machine tools, electrical and non-electrical equipment, consumer durables,and rail wagons, as well as the construction and shipbuilding industries.

3.05 Yugoslavia is a net exporter of iron castings. Important exportmarkets have been the Federal Republic of Germany, France, Italy, Bulgaria,Czechoslovakia, Poland, Romania and the U.S.S.R. In 1972, exports reached66,000 tons (about 18% of production) of which about 65% and 35% respectivelywent to convertible and clearing currency countries. Imports, on the otherhand, amounted to only 14,000 tons and consisted mainly of items which are notproduced in Yugoslavia. In the future, exports to convertible as well asclearing currency countries are expected to grow at an annual rate of 8.5%,while imports are projected to increase by 12% a year from the present lowbase.

3.06 Based on these projections as shown in the above table, Yugoslaviain 1978 is expected to have a shortage of some 36,000 tons of iron castingsto meet internal demand alone, or a gap of about 144,500 tons when the exportdemand is taken into account. Some further expansion of capacity beyondthat already contemplated would, therefore, appear necessary if Yugoslaviawere to meet the expected domestic and export demand. Furthermore, the ex-port potential might well be greater than assumed here. As pointed out inthe Kikinda Iron Foundry Project Appraisal Report (No. 218-YU), the existingshortage of castings in the world is expected to continue at least in theforeseeable future.

B. FOB's Market Position and Sales Forecasts

3.07 FOB is one of Yugoslavia's largest producers of gray and nodulariron castings. As a result of the project, the Company will significantlyincrease its production of gray iron castings, advancing its market sharefrom 8% in 1972 to 14% in 1978, while maintaining its market share of aboutone-third in nodular castings, as shown in the following table:

Production, Demand and FOB's Share by Type of Castings('000 tons)

Country's Domestic FOB's % ShareProduction Demand Deficit Production of FOB1972 1978 1978 1978 1972 1978 1972 1973

(Actual)------Forecast------ (Actual) (Forecast)

Gray 341.6 566.5 622.0 (55.5) 28.1 80.0 8 14

Nodular 11.0 30.0 34.5 (4.5) 4.2 10.0 38 33

Malleable 20.3 30.5 34.5 (4.0) - - - -

Total Castings 372.9 627.0 691.0 (64.0) 32.3 90.0

3.08 The table indicates that for each of the different types of castingsproduced by FOB (as was the case for all the country's castings combined,para. 3.06), domestic production is not expected to fill domestic demand in1978; as a result, imports will have to continue, even if there were no exportsof castings from Yugoslavia. Nevertheless, largely to meet its foreign debtrepayment obligations, FOB plans to increase its foreign exchange earningsby exporting about 35% of its incremental output of castings, with totalexports expected to increase from about 5,000 tons (15% of total sales in 1972)to 25,000 tons (nearly 28% of total sales in 1978) of which some 20,000 tonswould be to convertible currency countries. Such a goal is consideredreasonable.

3.09 Also, while the Company's production in 1978 of gray and nodularcastings is anticipated to rise to about 14% of the country's total outputof these castings (compared to about 8% in 1972), due to its increased pro-nortion for export, FOB's share in the domestic market for these products isexpected to increase only from about 9% in 1972 to 10% in 1978. As will bedescribed further below, the Company has long-term sales contracts with itsmajor domestic customers, and it is also seeking similar contracts for itsexport sales as is usual in this type of industry.

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C. Sales Build-up and Destination of Sales

3.10 A year-by-year sales breakdown through 1983 is provided in Annexes3-2 and 6-1, by product, volume and value. Below the sales volume togetherwith destination of sales are summarized for 1972 (actual) and for 1978:

Sales Build-up by Product and Area of Destination('000 tons)

Total Distribution by Area /11972 1978

D CO CL T D Co CL T

CastingsGray Iron 24.0 0.2 0.6 24.8 57.4 19.4 3.2 80.0Nodular Iron 3.8 1.6 3.3 8.7 7.6 0.6 1.8 10.0

Total 27.8 1.8 3.9 33.5 65.0 20.0 5.0 90.0

/1 = Domestic; CO = Convertible currency countries; CL = Clearingcurrency countries; and T = Total.

3.11 As already noted, FOB sells most of its castings at home throughlong-term contracts, in particular to the UMI members, IMT and IMR, and toFAP-FAMOS, a Producer of trucks. These three customers alone will accountfor about 50% of the Company's total casting sales in 1978. FOB also hasexport agreements with Ford and Opel of Germany for 1974.1/ and 1975, and theyare expected to be renewed. Furthermore, it has a long-term cooperationagreement with Hungary for the supply of castings. Overall, on the basisof projections of sales contraets already agreed for 1975, about 75,000 tonsor about 83% of the expanded production is expected to be covered by contracts.The Company is negotiating with other foreign as well as local firms foradditional supply contracts and, on the basis of preliminary inquiries,indications are that demand for FOB's castings will be in excess of what itcould supply in 1978.

3.12 FOB and the other major foundry in Yugoslavia, Kikinda, signedan agreement in 1971, in which they reached a basic understanding on thedemarcation of their respective production. While Kikinda makes gray cast-ings only for its own machine tool production, FOB manufactures them as itsmajor product line and in great variety. Kikinda, in turn, concentrates onthe production of nodular and malleable castings which for FOB are of loweror no significance. Finally, FOB's nodular castings are sold primarilywithin the UMI group of industries.

1/ Major auto producers in Western countries have cut back-production becauseof the present energy shortage. As a result, the export of castings tothem by FOB may fall short of the projected level. However, even if autoproduction does not come back to normal, little difficulty is foreseen indiverting sales to other industries due to the continuing worldwide short-age of castings.

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D. Marketing Organization

3.13 FOB has a new marketing organization which is supported by themarketing research services of UMI's central staff. Sales contracts withinthe UMI group or outside are negotiated and entered into directly by FOB.In the domestic market, castings are sold directly to customers. As toexport sales, FOB relied in the past on agents, but is now giving increasedattention to direct sales to foreign customers as well. Its commercial depart-mtent has strengthened its direct contacts abroad to help promote export sales.

E. Prices and Competitive Position

3.14 An international comparison of prices of castings is difficultbecause of variations of castings in size, quality and intricacy. FOB'sprices for castings are internationally competitive on average; indeed, forsome particular items, there is a clear advantage. Approximate average 1973domestic, ex-plant, price indices for selected items of FOB are comparedwith those of German, Italian and French producers, also ex-plant, in thefollowing table (details are given in Annex 3-1):

Average 1973 Domestic Price Indices (Ex-Plant) /1(FOB Price - 100)

Selected Castings FOB German French Italian

Gray Casting (f]ywheel) 100 117 126 _

Gray Casting (engine block) 100 111 109 -

Nodular Casting (axle housing) 100 117 - 101

Nodular Casting (transmission case) 100 123 _ 108

/1 First quarter 1973.

3.15 FOB's sales prices vary among domestic, clearing and convertiblearea markets (Annex 6-1). Prices for the clearing currency countries arefixed according to agreements; they bear little relation to market conditionsin those countries, and are expected to remain higher than domestic prices.In the case of gray iron castings, an established product line, FOB's averagedomestic prices and export prices are approximately on the same level. Inthe case of nodular castings, a new product line for which the domestic demandis increasing sharply, the Company's export prices for the convertible areaare lower than its domestic prices for comparable products. This is partlybecause of keen competition with foreign suppliers in establishing new mar-kets. Domestic prices for castings are in general free of price controls,except for temporary controls for reasons of containing inflation.

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F. Export Incentives

3.16 The Federal Government provides export incentives, the most im-portant of which is the retention quota under which the exporting company isallowed to retain 20% of its foreign exchange earnings for unrestricted use.

G. Protection

3.17 As already noted, FOB's products are internationally competitive.However, nominal protection through customs duties and taxes exists to theextent of 25% for iron castings. This duty shelter is of interest to FOBonly as far as it helps prevent the sale of foreign products in Yugoslaviaat marginal cost.

IV. THE PROJECT

A. Objectives and Scope

4.01 The project is designed both to modernize and increase the produc-tion of the New Belgrade foundry and pattern shop. The capacity of the foundrywill be increased from 25,000 to 90,000 TPY with that of gray iron castingsrising from 20,000 to 80,000 TPY and of nodular iron castings from 5,000 to10,000 TPY; and the capacity of the pattern shop will be doubled.

4.02 The major facilities to be installed and alterations to the exist-ing facilities to be made under the project comprise extension of the exist-ing foundry building and pattern shop, two 20 tons/hr hot-blast cupolas, re-vamping of the existing melting plant, three new molding lines including aflaskless molding line, alterations to one of the existing molding lines, anew sand preparation plant, a new core room, a new cleaning room, two 44-48tons/day annealing furnaces, a new centralized storage and material handlingsystem, additional machines and some rearrangement of the existing machinesin the pattern shop, a new transformer station, a new gas vaporizing station,a new air-compressor station, pollution control devices, and modificationsto the present infrastructure. A detailed description of the project is givenin Annex 4-1 and the plant layout is shown in Annex 4-2.

B. Observations

4.03 The project is well-conceived. The main objective of the Companyis to increase and consolidate its production of castings as well as patterns.The proposed facilities and plant designs are primarily aimed at overcomingproblems encountered in the existing operations and also to improve qualityand productivity. The Company plans to limit its product lines by concentratingon large and intricate castings, which otherwise would not be produced inYugoslavia, leaving simple castings to less sophisticated foundries in thecountry. The Dlant design also provides flexibility to meet the changingneeds of customers and there is room for further expansion.

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4.04 The project can be implemented without significantly interferingwith present Production. FOB will be able to produce heavier castings withthe addition of more sophisticated and specialized machines. The proposedcleaning room facilities envisaged in the project will eliminate the currentoperational bottlenecks and will improve product quality. By modifying thepresent layout and material flow, replacing old and obsolete equipment, andinstalling more accurate and productive machines, the capacity of the patternshop will be increased and its operations improved.

4.05 In order to extend FOB's existing foundry building, IMT's adjacentimplement assembly plant will have to be relocated. Therefore, during nego-tiations, it was agreed that the Company will provide evidence that it hasobtained a commitment from IMT that this plant will be relocated by the endof 1974 in line with a specific time schedule. Plans for changes and additionsto infrastructure installations - power, hot water for central heating, sewageand road construction - have been prepared by the Company in conjunction withIMT and are considered satisfactory. During negotiations, FOB has providedevidence that it has obtained commitments from the respective authoritiesfor the timely development of these infrastructure facilities.

C. Ecology

4.06 Due to FOB's proximity to the residential area of New Belgrade,pollution abatement of this foundry is of utmost importance. Being awareof the importance of pollution control, the Company has considered alterna-tive locations before deciding to remain in its present location and expand.The Company's decision in this regard is justified considering economicimplications and practical difficulties of moving the plant (Annex 4-3).The present pollution control system is not satisfactory. The project, there-fore, includes modern dust and fume collection systems for the existing andexpanded facilities to be reviewed in detail by the consultants hired by FOB(para. 4.10). These systems are capable of meeting even more stringentstandards - comparable to West European requirements - than those set by arecently passed Federal law for environmental and pollution control. Thelaw stipulates that all enterprises conform to certain minimum requirementsby the end of 1973 and to all the set standards by 1977. Under the project,Din 30 million, equivalent to about 14% of the cost of the foundry equipment,is allocated for pollution control, and this is considered sufficient. Inview of the particular importance of environmental considerations, it wasagreed during negotiations that the Company will strictly adhere to theproposed plans and properly maintain such pollution control facilities tothe satisfaction of the Bank.

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D. Labor Force

4.07 At the end of 1973, there were 2,222 employees at the New Belgradefoundry, including 170 temporary employees. Labor productivity continues tobe low and the Company requires about 90 manhours per ton of castings comparedwith about 30 manhours in similar foundries in Western Europe. However, fol-lowing consolidation of operations, modernization and expansion of the exist-ing facilities, as provided for in the project, FOB productivity is expectedto rise sharply and the number of manhours per ton of castings produced isexpected to decline to about 45 by 1978, requiring at that time a total laborforce of nearly 3,000. This seems realistic. Details are given in Annex 4-4.

4.08 Although two-shift operation is common in the foundry business, asthis allows adequate time for maintenance, FOB is today operating on a three-shift basis using temporary labor to meet the surge in demand for its cast-ings. However, by the end of 1976, when the expansion work is scheduledto be completed, the Company will have overcome the need to operate threeshifts. In addition to 170 temporary labor currently with FOB who will behired on a permanent basis, 744 new employees will be recruited from outside.Thus, the total number of permanent jobs created directly by the project willbe 914.

E. Project Execution

4.09 The main task of project execution will be carried out by the FOBDevelopment Division headed by Mr. Dragoslav Perovich, 37, a skilled foundryplanning expert with specialized training in PERT and other advanced manage-ment tools. He has had more than 13 years of experience in important tech-nical positions with FOB and related organizations. Mr. Perovich is assistedby another foundry expert, Mr. Ranko Sotra, 46, who also serves as Adviser tothe General Manager. Although their caliber is high, the Development Divi-sion's work is likely to be adversely affected by inadequate budget andproject control due to lack of qualified staff. Therefore, during negotia-tions, it was agreed that the Company will strengthen its budget and projectcontrol functions with well-trained and experienced personnel, and with thehelp of outside consultants.

4.10 FOB will also require the assistance of a foreign consulting firmto prepare specifications for international competitive bidding and to evaluatetenders. The Company has appointed W.S. Atkins & Partners of the U.K. forthis purpose. During negotiations, the Company has agreed to retain thisfirm.

4.11 Civil construction and equipment erection for the project will beundertaken by Yugoslav contractors, while FOB's own construction departmentwill be responsible for similar work in connection with modifications of theexisting facilities. Equipment suppliers will assist in erection and start-upand also provide a performance guarantee for the equipment. These arrangementsare considered satisfactory, and follow FOB's previous practices.

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F. Project Timing

4.12 The project implementation schedule is shown in Annex 4-5. En-gineering and design work on the project is well advanced and prequalificationof suppliers as well as preparation of procurement documents have been com-pleted with the assistance of the technical consultant (para. 4.10). It isexpected that orders for foreign equipment to be financed by the Bank will beplaced during the first quarter of 1974 and that the project will be mechani-cally completed by the end of 1976 and reach full production capacity by theend of the following year. The delivery and erection schedules based oninformation provided by potential equipment suppliers are considered realistic.

V. CAPITAL COST AND FINANCING PLAN

A. Project Cost

5.01 Project cost estimates prepared by FOB are detailed in Annex 5-1and summarized below:

Summary of Capital Cost EstimatesDin Million US$ Million X

Local Foreign Total Local Foreign Total

Equipment and Spares 118.3 181.3 299.6 7.6 11.7 19.3 28.0Import Duty and Taxes 59.1 - 59.1 3.8 - 3.8 5.5Erection and Installation 62.1 - 62.1 4.0 - 4.0 5.8Civil Construction 101.3 - 101.3 6.5 - 6.5 9.4Sub-total 340.8 181.3 522.1 21.9 11.7 33.6 48.7

Contingencies: Physical 25.3 18.1 43.3 1.7 1.2 2.9 4.2Price 58.5 30.1 88.6 3.8 1.9 5.7 8.2

Sub-total 424.6 229.5 654.1 27.4 14.8 42.2 61.1

Flaskless Molding Line /1 8.8 7.7 16.5 0.6 0.5 1.1 1.6Pre-operating and Start-up

Expenses /2 12.4 3.4 15.8 0.8 0.2 1.0 1.5Engineering 6.0 3.0 9.0 0.4 0.2 0.6 0.8

Total Fixed Assets 451.8 243.6 695.4 29.2 15.7 44.9 65.0

Incremental Working Capital 118.0 - 118.0 7.6 - 7.6 11.0Total Project Cost 569.8 243.6 813.4 36.8 15.7 52.5 76.0

Interest During Construction 201.0 56.5 257.5 13.0 3.5 16.5 24.0Total Financing Required 770.8 300.1 1,070.9 49.8 19.2 69.0 100.0

_1 The flaskless molding line is treated separately because this facilitywill be installed under a sub-project and is not subject to disbursementunder the Bank loan.

/2 Start-up expenses of Din 4.0 million, included in the above estimates,will be charged to operations, in accordance with Yugoslav law.

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5.02 Equipment and civil construction cost estimates are based on quota-tions received by FOB in the first quarter of 1973. The prevailing importduty and taxes on the c.i.f. value of imported equipment at the Yugoslavborder have been added. Considering the advanced stage of project prepara-tion, physical contingencies of only 10% on the equipment and constructioncosts of the project (i.e. exclusive of import duty and taxes) are includedand they seem adequate. Pre-operating and start-up expenses as well as costsof engineering services are based on FOB's previous experience.

5.03 In addition to the physical contingency, an allowance for priceescalation of 6% per annum has been applied to the cost of foreign equipmentas well as duty and taxes on them. In the case of domestic costs, the fol-lowing rates on the cost of local equipment, construction and erection havebeen applied to cover anticipated inflation in Yugoslavia: 1973, 10%; 1974,8%; and 6% thereafter. The sliding rates are based on the assumption thatthe measures being taken in Yugoslavia to curb inflation will succeed. Totalphysical and price contingencies allowed for amount to about 16% of the totalproject cost, which appear adequate to cover even the possible increases incapital cost because of the recent spurt in fuel costs. The project costestimates, including these contingencies, are considered reasonable.

5.04 Of the total Din 1,071 million financing required for the project,foreign exchange expenditures, including Din 57 million for interest duringconstruction, are estimated at Din 300 million or about 28% of total cost.With the exception of the cost of the flaskless molding line, all other foreignexchange cost (c.i.£. Yugoslav border) of equipment and spares and foreignengineering services will be financed by the Bank. Since all equipment thatcan be procured locally has been allocated to local currency expenditures,Yugoslav manufactures are not expected to bid directly for Bank-financedequipment. However, Yugoslav components in foreign bids are expected to beabout 15% of total foreign equipment cost (para. 5.10).

B. Working Capital

5.05 The Company's 1972 working capital level, although low in cash,was satisfactory. Its measures since then to reduce receivables and inven-tories are proving successful. During 1973-1978, incremental working capitalrequirements due to the project are estimated at Din 118 million, of whichabout Din 60 million (about 50% of the total) would have to be borrowed andthe rest met from internal cash generation. Details of the Company's workingcapital needs are given in Annex 5-2.

C. Financing Plan

5.06 As noted previously, total financing required for the project isDin 1,071 million (US$69 million equivalent) including Din 300 million (US$19.2million) in foreign exchange. Internal cash generation will provide aboutDin 345 million (32% of the total) and credits from the Belgrade Bank, Din 463million (43%) and an IMT loan, Din 30 million (3%). The proposed Bank loanwould cover the remaining 22% of the financing requirements.

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5.07 About 97% of the costs of foreign machinery and equipment plus theentire cost of foreign engineering for the project would be financed from theBank loan of US$15.0 million (Din 232.5 million equivalent). The rest of theforeign exchange cost of Din 67 million (US$4.2 million) would be met from theCompany's own foreign exchange sources (from its 20% retention quota on exportsto the convertible area, and 10% of depreciation which could be converted tohard currency at the National Bank, supplemented by a foreign exchange loanof Din 7.7 million equivalent from the Belgrade Bank). A simmary of sourcesand applications of funds (Annex 7-2) during 1974-1978 follows:

Summarized Sources and Applications of FundsDuring 1974 - 1978

(Din Million)

Sources Applications

Cash from operations /1 381.3 Investments: Project /3 687.4Other 10.0

Loans: IBRD 232.5 Debt repayment 90.5Belgrade Bank 2 460.9 Power deposit 14.0IMT 30.0 Net increase in working

capital includingsurplus cash /4 302.8

1,104.7 1,104.7

/1 Net of start-up expenses, interest during construction andappropriations.

/2 Excludes Din 2.3 million already disbursed in 1973.i3 Fixed asset costs. Excludes Din 4.0 million spent in 1973.74 Surplus cash will be earmarked for future expansion.

5.08 The Bank loan would be for 14 years, including a grace period of4 years, at an assumed interest rate of 7-1/4% plus a guarantee fee of 1-3/4%payable to the Republic of Serbia, 1/ thus bringing the cost to the borrowerto 9%. The total credit required for the project from outside sources otherthan the Bank - including the Belgrade Bank and IMT - is, as already noted,about Din 493 million. Loans from the Belgrade Bank will be at 11% interestannually for 14 years including 4-year grace and the IMT loan will be for12 years, including 5-year grace, at an interest rate of 5-1/2% per annum.Further details are given in Annex 5-3. During negotiations, assurances tothis effect have been received.

1/ The Federal Government is the guarantor of the Bank loan. It, in turn,is required by Yugoslav law to obtain a guarantee from the Republic orAutonomous Province where the project is located--in this case, theRepublic of Serbia. Since Yugoslav law prevents the Federal Governmentfrom accepting the guarantee fee, the Government would request the Repub-lic of Serbia to receive the fee.

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5.09 During project implementation (1974-77), FOB's internal cash genera-tion, together with the proposed borrowings from the Bank, the Belgrade Bankand IMT would be adequate to meet the financial needs of the project. What-ever additional resources, foreign as well as local, that might be needed tocomplete the project and to bring it into full operation after start-up,irrespective of whether the need for such additional funds is caused by acost overrun or a shortfall in cash generation, would be provided by theBelgrade Bank on terms satisfactory to the Bank. Assurances to this effecthave been provided during negotiations.

D. Procurement and Disbursement

5.10 Procurement of items to be financed from the Bank loan will bein accordance with the Bank's guidelines. A detailed list of these itemsis given in Annex 5-4. They will be purchased under 17 contracts, 15 forfoundry and 2 for the pattern shop. Equipment packages costing over US$100,000equivalent each would be procured by international competitive bidding, whilepackages costing less than US$100,000 equivalent each (totalling less than 3%of the total foreign equipment costs) would be obtained through a procedureunder which the borrower may award contracts after having received at leastfour comparable bids from qualified suppliers in at least three eligiblecountries. Because of the need for the supplier to be responsible for theoverall performance of certain groups of equipment, only foreign bids can beexpected and, for the purpose of bid comparisons, it is proposed that apreference margin of 15% 1/ would be accorded to clearly identified Yugoslavcomponents incorporated in the foreign bids for 4 equipment packages (thecupola plant, sand preparation plant and the two molding lines) which areexpected to cost about US$10 million (Annex 5-5). For the remaining 13 Bank-financed equipment packages no margin of preference will be accorded forYugoslav components in foreign bids.

5.11 In the selection of the foreign engineering consultant (para. 4.10),the Company has followed the Bank guidelines. As early appointment of thisconsultant is crucial for meeting the project implementation schedule (para.4.12), FOB has already appointed a consulting firm (para. 4.10). The paymentsto this firm, before the loan is considered by the Executive Directors, arelikely to total about US$150,000. It is recommended that the Bank reimbursethe Company this amount.

5.12 For the flaskless molding line, imported but not Bank financed, FOBplaced the order in October 1973, following normal Yugoslav regulations. Asto domestic equipment, quotations have already been received from variousYugoslav suppliers in the majority of cases. However, FOB will place ordersfor these items only after the consultant already appointed has had an oppor-tunity to review the foreign equipment packages, which might necessitate somechanges. However, since these items are standard equipment for which deliverytimes are relatively short, this procedure will not delay project implementation.The Company plans to award civil construction contracts in the very near future

1/ Duties on equivalent components are more than 15%.

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to two of the four Yugoslav contractors who have already submitted their bidsin accordance with Yugoslav law which requires competitive bidding for suchcontracts. Finally, FOB also plans to contract out erection work to Yugoslavcontractors as mentioned previously. Both civil construction and erectionwork will be carried out under the direction of FOB.

5.13 The Bank loan would finance the foreign exchange cost (c.i.f.Yugoslav border or port of entry) of equipment and spares as well as theex-factory cost of locally-manufactured items in foreign bids, and 100% of theforeign exchange cost of consultant services. The estimated disbursementschedule for the Bank loan is shown in Annex 5-6, which is based on detailedestimates of order placements, payment schedules and expected delivery timesfor equipment in line with the project implementation schedule (para. 4.12).

VI. REVENUES, RAW MATERIALS, AND PRODUCTION COST

A. Sales Revenue

6.01 Sales revenue has been calculated in current value terms and itexcludes freight and handling charges. Details of selling price assumptionsfor gray and nodular castings - the Company's main product lines - and expectedsales revenue assuming 75% capacity utilization on a three-shift operationduring 1973-1976 and on a two-shift operation for subsequent years, are givenin Annex 6-1 and Annex 3-2. This seemingly low utilization of capacity isrealistic as it is not only in line with FOB's past performance, but also onlysomewhat below that of comparable foundries in other countries. As a resultof the expansion, FOB's sales revenue is forecast to increase by nearly 300%(see table below), from Din 234 million (US$15.1 million) in 1972 to Din 934million (US$60.3 million) in 1978, when the project would reach full produc-tion i.e. 75% of nominal capacity.

-Growth of Sales Revenue and Volume /1

1972 1978 1972 1978(Din Million) -(000 tons)-

Gray Iron Castings 193.5 780.0 28.1 80.0Nodular Iron Castings 36.0 124.3 4.2 10.0Patterns for Castings 4.3 30.0 - -

Total 233.8 934.3 32.3 90.0

/1 Based on full production (75% of nominal capacity) on atwo-shift operation.

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6.02 Of the incremental total revenue of about Din 700 million (US$37.8million) resulting from the project, nearly Din 165 million (US$10.6 million)representing 24% of the total, will accrue from exports to the convertiblearea, and Din 44 million (about 6%) from exports to the clearing area.

B. Raw Materials

6.03 FOB seems to be well assured of the supply of its major raw materialssuch as pig iron, steel scrap, ferroalloys, graphite, coke, anthracite, bento-nite, sand, synthetic resins and refractories for which the Company's importrequirements are expected to be low, except for minor items such as graphite,resins and ferromanganese (Annex 6-2). No problem is foreseen in meeting itsimport needs because of import liberalization and the availability inforeign ex-change of 20% of FOB's annual export earnings from the convertible area asretention quota which can be used freely under Yugoslav law. Furthermore,the supply of gas, water and power also appears assured. The annual electricpower needs of the Company are expected to rise sharply from about 16 millionKWH to 64.5 million KWH during 1973-78. There is a general agreement betweenFOB and' Electro-Distribucija, Belgrade, for adequate power supply to theproject. However, during negotiations, evidence has been provided by theCompany that it has in fact obtained commitments for timely and adequatesupply of electric power.

C. Production Costs

6.04 Production cost estimates (Annex 6-3), like those of sales, are basedon the assumption of 75% capacity utilization on a three-shift basis during1973-76 and on a two-shift basis for subsequent years. Present (1972) andprojected (1978) production costs at constant (1972) as well as current pricesare given below:

Direct Production Costs /1(Din/Ton)

1972 1978 % Increase or (Decrease)(Actual) (at 1972 (at Current (at 1972 (at Current

Prices) Prices) /3 Prices) Prices)

Gray Castings (FOB,New Belgrade) 4,479 4,110 5,748 (9) 28

Gray Castings (FOB,Rakovica) 5,577 - -

Nodular Castings(FOB, New Belgrade) 6.940 5,862 8,470 (16) 22

Weighted Average for FOB 5,036 4,272 6,050 (15) 20Weighted Average forKikinda /2 6,630 5,840 7,745 (12) 17

/1 Including costs of raw materials, supplies, utilities and labor./2 For gray and nodular castings only./3 Because of recent sharp increases in fuel costs direct production costs are

likely to go up by about 5%. However, this increase is expected to bepassed on to the customer by way of selling price increases.

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6.05 As a result of the project, the direct production cost (at 1972constant prices) at the New Belgrade foundry for gray castings is expectedto decline by 9% and for nodular castings by 16% during 1972-1978. However,at current prices, as used in the financial projections, the cost would showan increase of 28% for gray castings and 22% for nodular castings (Annex 6-3).The slower percentage rise with respect to the latter is mainly due to thefact that the direct production cost per unit of nodular castings, a newproduct line, is currently 55% higher than that of gray castings and thatwith better experience of FOB in such production, it is expected to come downin real terms more substantially than for gray castings.

6.06 For current price projections of direct production costs, it hasbeen assumed that during the forecast period (1973-1983), FOB's labor costswould increase annually by about 12% (compared to the expected rate of 5% ayear in Kikinda) while raw material costs would rise at the annual rate ofabout 6% (slightly more than the rate assumed for Kikinda mainly because ofthe higher rates of increase of utility costs in New Belgrade). However, be-cause of factors already mentioned (para. 6.05), the aggregate production costat current prices would rise at a slower pace of 3.5% compared to the annualaverage general Yugoslav inflation Trate of over 6% expected during the sameperiod.

6.07 Data presented in the above table shows that the average directcost per ton of nodular and gray castings is significantly lower in FOBthan in Kikinda because gray castings, which are less expensive to produce,represent about 90% of FOB's total production while Kikinda produces suchcastings only in minor quantities (10% of total production). Furthermore,FOB concentrates on the manufacture of large castings, while Kikindaspecializes in small but complex castings of higher value per unit of weight.As the average yield in a foundry increases more with the size than itdecreases with the complexity of castings, the yield is higher in FOB thanin Kikinda. This factor is largely responsible for the lower direct produc-tion cost per unit of casting weight in FOB.

6.08 However, one of the major problems facing FOB is the high outsiderejection rate of about 7% on its exports to the convertible area comparedwith about 2% for Kikinda. The main reason for this is lack of proper qualitycontrol resulting from over-capacity production and inadequate direct contactwith foreign customers. Therefore, during negotiations, the Company hasagreed to take necessary steps to improve its quality control functions.

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VII. FUTURE PROFITABILITY AND FINANCIAL POSITION

A. Profitability

7.01 Details of income statements and sources and application of fundsforecasts through 1983 are shown in Annex 7-1 and 7-2 respectively and sum-marized below:

Selected Income Statement Items(Din Million)

1972 1973 1974 1975 1976 1977 1978 1983(actual) ---- ----------(projected)-----------------

Net Sales 233.8 335.1 332.4 /2 416.9 577.9 800.3 934.3 1,136.7Operating Income 16.2 39.0 41.4 67.1 132.2 142.9 180.6 116.9Net Income After Taxes 25.0 32.0 12.5 7.6 55.7 66.6 114.9 89.5

-% of Net Sales 10.6 9.5 3.8 1.8 9.6 8.3 12.3 7.9-% of Average Equity 19.9 21.5 7.4 4.1 22.1 20.7 27.3 9.1

Cash Generation /1 23.9 28.2 13.2 20.8 58.1 125.2 164.0 134.2

/1 Annual depreciation and net appropriation to the Business Fund.

/2 The drop is due to the separation of Rakovica plant.

7.02 In 1973, net income was projected to jump by about 34% over the pre-ceding year level primarily because of a 39% increase in physical sales ofcastings from 32,300 to 44,500 tons made possible by the introduction of anadditional (third) working shift that year. In 1974, in spite of the separa-tion of Rakovica facility from FOB, net sales would virtually remain on the1973 level because of the coming on stream of the Disamatic molding line in-cluded in the project. Though during the project implementation period bothsales and operating income are expected to increase steadily with the com-missioning of various equipment under the project, net income is staggeredduring this period because of the charging to operations of interest duringconstruction on new borrowings as required by Yugoslav law. The net incomeposition begins to improve markedly in 1976 with the commissioning of mostequipment under the project and is expected to reach a peak of Din 115 mill-onin 1978 - the first year of capacity production - reflecting nearly a five-fold increase compared to the 1972 level. However, net income begins to de-cline from 1978 onwards because of the higher inflation rate assumed foroperating costs than for selling prices. But the general level of profitabilitywould continue to be at a high level, reflecting the sound operation of theCompany.

B. Financial Position

7.03 Balance sheet projections for 1973-1983 contained in Annex 7-3 aresummarized below:

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Selected Balance Sheet Items(Din Million)

Year ending December 31 1972 1973 /3 1974 1975 1976 1977 1978 1983(actual)

Net Working Capital 68.8 88.4 66.0 72.2 100.4 116.5 136.8 156.7Equity /1 141.2 156.4 179.0 194.8 260.0 335.6 461.3 1022.1Long-Term Debt 29.5 30.5 388.1 650.6 736.6 669.6 593.5 246.7Current Ratio /2 2.5:1 4.6:1 2.8:1 3.3:1 4.3:1 1.4:1 1.5:1 1.6:1Long-Term Debt/EquityRatio 17:83 16:84 68:32 77:23 74:26 67:33 56:44 18:82

/1 Including a long-term loan of Din 11.6 million borrowed for the CollectiveConsumption Fund.

/2 Excluding surplus cash.

/3 Data from 1973 onward is only for the New Belgrade facility.

7.04 FOB's cash position was tight in the past, although the currentratio in 1972 was at a satisfactory level of 2.5:1 because of low payables.The Company's current ratio is projected to decline gradually from the cur-rent high level of 2.5:1 to 1.4:1 in 1977, one year prior to full production,because of the peaking of the short-term portion of long-term debt in thatyear. However, the current ratio is expected to improve steadily thereafter.In order to maintain a satisfactory liquidity position, agreements have beenreached during negotiations that the company will maintain at all times acurrent ratio of at least 1.3:1 and that this obligation will appropriatelybe backed up by the Belgrade Bank.

7.05 Because of heavy borrowing (to meet about 70X of total financingrequired for the project), the long-term debt equity ratio is expected torise continuously up to 1975 from the 1973 low level of 16:84, reaching apeak of 77:23 in 1975 and subsequently improving to 56:44 in 1978, restoringthe Company to a sound financial position. The strained financial positionduring the first three-years of project implementation is acceptable in thiscontext because - as shown further below - the debt service coverage remainsadequate throughout the forecast period. Also, according to Yugoslav law,equity increases could result only from appropriations from net income andthese are already foreseen as part of the financing plan. The alternativewould have been to reduce the scope of the project and thus reduce the needfor borrowings, but this does not appear to be a justifiable course, in viewof the short period during which the strained financial position is likelyto exist and the available financial backing of the Belgrade Bank to whichthat bank is committed by law (Annex 7-4).

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7.06 The allocation to the equity-like Business fund - the only internalsource available for the build-up of equity except depreciation - would, how-ever, be affected if the Workers' Council were to decide to appropriateexcessive amounts to the Collective Consumption Fund or to distribute higherwages and salaries than projected. Therefore, during negotiations, agree-ments have been reached that the Company will not, during project implementa-tion, without prior consent of the Bank: (a) distribute income to its employ-ees, make allocation to Collective Consumption Fund and/or make other cashoutlays except to the extent that the Funds available to the Company exceedthe required expenditures for the project implementation and (b) undertakecapital investments or incur new debts in excess of Din 20 million equivalentin any one year for other than the project. Prior to embarking on any newinvestment or borrowing exceeding Din 75 million in any one year, the Companyhas agreed to seek the approval of the Bank during first three years afterproject completion and to consult the Bank thereafter. For comparison purposes,the income statement and balance sheet projections, without the proposed ex-pansion, are given in Annex 7-5 and 7-6 respectively.

C. Financial Rate of Return

7.07 The project provides an incremental financial rate of return of16.2% in real value terms. 1/ The assumptions used in this calculationare contained in Annex 7-7.

7.08 To determine the effect of various events on the financial rate ofreturn, sensitivity tests have been made (Annex 7-7) and they show the fol-lowing results:

Sensitivity Tests on Financial Rate of Return

Case Description Rate of Return (%)

1 Base Case 16.22 Sales revenue decrease 5% 11.23 Operating cost increase 10% 12.3

4 One year project delay plus 10%7 cost overrun 9.75 Sales revenue decrease 5% and operating cost increase 10% 8.96 Operating cost increase 10% and project cost increase 110% 6.4

7.09 The project has a low financial risk since it provides an adequaterate of return even under the foreseeable adverse conditions as assumed inthe above table. If the revenue drops by 15% - which is equivalent to about50% drop in the assumed exports to the clearing currency area or a 25% de-cline in exports to the convertible currency area without any change in domes-tic sales - without a corresponding reduction in operating costs, the returnwould decrease to 11.2%. The investment is not capital intensive because thereturn tends to be more sensitive to changes in operating costs than capital

1/ At current value terms, the financial rate of return is about 20%.

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costs (Annex 7-7). If raw material costs were to increase by 15% or laborcost by 30% - equivalent to about 10% increase in operating costs - the returnwould drop to 12.3%. It is unlikely that, in real terms, the cost of produc-tion would increase without corresponding increase in selling prices. Oneyear project delay plus 10% cost overrun would drop the return to about 10%.However, in view of the advanced preparation of the project, the chances ofthis occurring are low. Hence, even with such combinations of adverse condi-tions, the likelihood of the return falling below 10% is rather low.

D. Debt Service Coverage

7.10 Based on the projections and the proposed financing plan, FOB'slong-term debt service coverage would show the following trend:

Debt Service Coverage

1974 1975 1976 1977 1978/1 1979 1980

Times covered 2.5 1.7 2.5 2.5 1.7 1.6 1.6

/1 Repayment of the Bank loan begins that year.

7.11 The debt service coverage is considered sufficient to meet theCompany's financial obligations. However, in the Yugoslav context, the Companyhas to generate enough foreign exchange funds (through retention and depre-ciation quotas) to meet its foreign obligations including debt repayments.As shown in Annex 7-8, the foreign exchange balance is very tight especiallyin 1975, 1976 and 1978, and will only improve in the following years. Duringnegotiations, it has been agreed that the Belgrade Bank will make foreignexchange funds available to the Company in case and to the extent such fundsgenerated by the Company are not adequate to meet its obligations to the Bank.

E. Break-even Point

7.12 After completion of the pro1ect, the profit break-even point isabout 72% of effective capacity, equal to 66,000 TPY of castings. Differentlyexpressed, once the project is operating at full capacity, the price couldfall 12% before the Company would show a loss. The cash break-even point,at the peak debt service requirement in 1978, would be at about 69% of capa-city. Further details of break-even levels are found in Annex 7-9.

F. Major Risks

7.13 The project has essentially three major areas of potential risk ofwhich one - a strained financial position during project execution - was dis-cussed in para. 7.05. The second risk could lie in future technological de-velopments that might lead to a general shift from the use of gray iron to

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aluminum alloys especially in the production of engine blocks, one of FOB's

products which is expected to account for nearly 25% of the Company's total

sales revenue in 1978. This risk has been lessened by the recent spurt in oil

prices making aluminum smelting relatively more expensive. However, FOB is

closely watching developments in this field to make necessary adjustments in

its future development program, and the project is designed to have flexibilityfor such adjustments. The third risk may be due to the fact that the Company,

which is not yet well established in the convertible currency area because of

the strong domestic demand, could find expansion of exports in that area moredifficult than presently envisaged because of the temporary cutback in autoproduction there due to fuel shortages. However, even if auto production were

not to come back to normal, little difficulty is foreseen in diverting sales

to other industries due to the continuing worldwide shortage of castings.Further, even if exports to the convertible area were to fall short of pre-

dictions, the Company should have no problem in selling that portion of its

production to domestic consumers without adverse effect on its earnings.

G. Accounting and Audit Requirements

7.14 The Company's present accounting methods follow the Yugoslav systemwhich is cumbersome and,leads to inconsistencies. Moreover, it is difficultand time-consuming to transform financial statements into a format whichi wouldmake them a more meaninAful management tool. The Company's financial control

is less than satisfactory. Lack of capable financial management is a weakness

of the Company. FOB is aware of these deficiencies and is taking steps toimprove the present situation. More specifically, as preconditions for loan

effectiveness, the Company has agreed during negotiations that it will:

(i) appoint well-qualified and experienced people to strengthen the financial

department; (ii) appoint a consultant to improve its accounting proceduresand financial control and also to provide training for its financial staff;

and (iii) establish separate accounts for the project in a form satisfactory

to the Bank.

7.15 Accounts of Yugoslav enterprises are not audited in the strictsense of the term. The Social Accounting Service (SAS) annually conducts alimited review of the statutory financial statements, for arithmetic ac-curacy; its inspectors visit the enterprises only occasionally if errorsor incorrect reporting are suspected. The principal duty of SAS is to ensure

that financial transactions of the enterprises comply with Yugoslav laws; it

does not provide a report on the accounts. SAS has already started a programunder which its staff will be trained by an international accounting firm in

auditing methods consistent with Bank requirements. 1/ In the case of the

1/ Coopers & Lybrand of the U.K. was appointed in January 1974 to carry outthe training program.

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Kikinda project, the Bank has received assurance that Kikinda will invite SASto undertake annual audits of its 1974 and 1975 accounts in collaboration withthe international firm of accountants as part of SAS's on-the-job training ofits inspectors. Moreover, in the event that SAS is not able to achieve aconsistent and satisfactory standard of auditing thereafter, Kikinda will re-tain, at the request of the Bank, an experienced independent auditing firmafter consultation with the Bank. A similar agreement has been reached withFOB.

VIII. ECONOMIC JUSTIFICATION

A. Available Alternatives

8.01 Though Yugoslavia produces at present over 340,000 tons of grayiron castings, only a small portion (53,000 tons) is of a specialized varietyfor use in the fast-growing sector of engines and engine-driven vehicles.The demand for such specialized gray castings is expected to more than doubleto 125,000 tons by 1978. FOB is Yugoslavia's largest producer of such graycastings, currently accounting for over half of Yugoslav production. Apartfrom FOB, there are eight foundries producing mainly gray castings for en-gine-driven vehicles. All of them are small-scale units in none of whichthe present annual capacity exceeds 8,000 tons. Taking their expansion plansinto account, the total production would rise to 82,000 tons by 1978, stillfalling short of the estimated demand by a margin of 43,000 tons. The actualgap would be higher as those firms are likely to export a portion of their pro-duction to earn hard currency to meet their foreign exchange debt serviceobligations.

8.02 In this context, the available alternatives are either to expandFOB or to import gray castings to meet the widening gap between supply anddemand. The latter is an uneconomic alternative considering the fact thatYugoslavia is a very competitive producer of castings in Europe and thatthere is an acute shortage of castings in the world. Therefore, the viableoption to help alleviate the shortage of gray and also nodular castings inYugoslavia is to expand FOB, the experienced large-scale producer of suchproducts, and this is what the Company plans to do (para. 4.01). Nodularcastings are also primarily for use in engine-driven vehicles. The produc-tion and use of nodular castings (as a substitute for malleable castings)is of recent origin in Yugoslavia. FOB and the other Bank-assisted foundry,Kikinda, are the two leading producers of such castings in the country.

B. Economic Rate of Return

8.03 The incremental economic rate of return of the project is about23% at constant 1973 prices. Prices used for this calculation are shown inAnnex 7-7 and the economic sensitivity analysis is given in Annex 8-1. Ex-port prices (c.i.f., Yugoslav border) of FOB to the convertible currency

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area have been, used as accounting prices to calculate sales revenues. Allmaterial inputs, most of which are of domestic origin, have been valued atinternational prices (c.i.f., Yugoslav border). Labor costs have been basedon market wage rates. The economic rate of return is generally sensitiveto changes in revenues and costs to the same extent as the financial return.A decrease of 10% in revenue lowers the economic return to 14.2%, while a10% increase in operating and capital costs would reduce the return to 17.5%and 20.1% respectively. A combination of 10% higher capital costs and 10%higher operating costs would lbwer the return to 15.1%. Thus the projecthas a good return under foreseeable adverse circumstances.

C. Competitiveness

8.04 FOB domestic prices in general are comparable to Western Europeanprices with respect to gray castings while they are slightly lower for nodularcastings, and significantly lower for patterns. FOB sales are predominantlydomestic-oriented. For example, in 1972 domestic sales of castings by volumeaccounted for about 85% of total sales. But the share of exports by volumeto the converteible area is expected to rise sharply from the current low levelof 5% to 22% of total sales by 1978. However, even after expansion, FOB wouldbe primarily domestic-oriented. About 60% of its total sales are contractedto the UMI group; about 12% would go to domestic customers outside UMI; andthe remaining 28% would be exported to the convertible and clearing areas.Export prices to the clearing area would continue to be higher than those forthe covertible area. In the case of the convertible area, even if prices ofcastings were to fall by 10% by 1978, the total sales revenue would fall hardly2%. FOB does not require the existing duty shelter of 257% from customs dutiesand other taxes except to be protected against the sale of foreign foundryproducts at or below marginal cost in Yugoslavia.

D. Linkages and Employment

8.05 The project is crucial for the projected expansion of a number ofindustries including those manufacturing tractors and other farm equipment,commercial vehicles, railways and ships which are expected to expand at anannual rate of over 8.5% in the foreseeable future. This rapid growth wouldnot be possible without the availability of adequate iron castings at reason-able prices. Without the FOB expansion, Yugoslavia would have to depend onlarge-scale casting imports at prices higher than those of locally-madecastings, straining the foreign exchange resources of the country.

8.06 The FOB foundry is located in the capital city of Belgrade, wherethe heavy concentration of industry makes it imperative to develop adequatefoundry capacity there to meet industrial needs. The proposed project wouldcreate directly 914 additional permanent jobs. In addition, it would openup jobs to at least 2,000 persons in the supplier industries and the transportsector (Annex 8-3). Furthermore, at least three of the major industries with

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large-scale expansion plans (IMT, IMR, and 21 May) would have to trim theirexpansion programs resulting in reduced employment creation but for the assuredsupply of castings from the project. It is also probably fair to assume thattheir expansions would have to be scaled down if these companies were to dependlargely on imported castings.

E. Estimated Foreign Exchange Effects

8.07 The more important benefits from the project are foreign exchangesavings and earnings which are considered oi crucial importance to the Yugoslaveconomy burdened by chronic balance of trade problems. As noted earlier, wereit not for the project, Yugoslavia would have no option but to import castingson a large scale, thus aggravating its foreign exchange difficulties. In thiscontext, the net incremental revenue from the project, after deducting the netincrease in annual foreign exchange outflow due to it, could be considered asthe net foreign exchange savings and earnings from the project. These amountto, at 1973 constant prices, Din 418 million (US$27 million) in 1978, thefirst year of full production (Annex 8-2). Therefore, the foreign exchangecost of the project, US$17 million equivalent (at 1973 prices), would be morethan offset by the net foreign exchange savings and earnings of one year aloneafter project completion. During the 10-year (1974-83) forecast period,total net foreign savings and earnings from the project would be about Din3,350 million (US$216 million), or an annual average equivalent to approxi-mately US$21.6 million.

IX. RECOMMENDATIONS

9.01 During negotiations the following principal assurances and agreementswere reached with the Belgrade Bank and the Company:

A. Agreements that the Belgrade Bank will:

(1) Provide funds required for the project (para. 5.08);

(2) Make project completion and cost overrun guarantees (para. 5.09);and

(3) Make.foreign exchange funds available to the Company, if thelatter's foreign exchange funds are not sufficient to coverits obligations (para. 7.11).

B. Agreements that the Company will:

(1) Provide evidence that UMI has approved the project and thatUMI will not request an increase in FOB 's annual contribution(para. 2.04);

(2) Not sell, lease, transfer or dispose of its rights or assets(para. 2.09);

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(3) Strengthen certain departments (paras. 4.09, 6.08 and 7.14);

(4) Provide evidence that IMT will relocate its assembly plant(para. 4.05);

(5) Implement and maintain strict pollution controls (para. 4.06);

(6) Retain the technical consultant appointed to assist in pro-curement (para. 4.10);

(7) Provide evidence of IMT financing (para. 5.08);

(8) Observe certain financial covenants to maintain a soundliquidity and financial position (paras. 7.04 and 7.06);

(9) Maintain separate accounts for the project (para. 7.14);and

(10) Arrange for proper external auditing (para. 7.15).

9.02 Based on the foregoing agreements, the project provides a soundbasis for a Bank loan to FOB equivalent to US$15.0 million for 14 years, in-cluding a 4-year grace period.

Industrial Projects DepartmentJanuary 28, 1974

ANNEX 1-1Page 1

YUGOSLAVIA: FOB FOUNDRY PROJECT

DESCRIPTION OF TERMS AND PRODUCTION PROCESSES

1. In a broad sense, the art of founding may be described as making acavity in the sand and filling it with fluid metal. In the cold state, themetal retains the shape and contour of the cavity and becames a metal casting.

2. The term "iron castings" covers a wide range of iron - carbon -silicon alloys containing from 2% to 4% carbon and 0.25% or more of siliconin combination with varying percentages of manganese, sulphur and phosphorous,and sometimes one or more of special alloying elements, such as nickel, chro-mium, molybdenum and vanadium.

3. There are various kinds of iron castings; they are roughly groupedas chilled-iron castin