Summary of Project Finance and Risk Management till 26/03/2014

Submitted By: Abhi Krishna Shrestha, Akhilesh Sthapit, Shishir Bajracharya

Foundation of Project Finance

In project finance measures are based on Cash flow.
All investments are based on future cash flow.
Improving financial value: Improve IRR and minimize WACC
Cash-flow should be measured after tax
How the project is taxed affects the IRR of the project.
Cash-flow should be adjusted for changes in working capital





Concept of circular debt
3 sources of cash flow (investment, operations, financing)
Interest is tax deductible, expense
Dividend is distribution of profit
Cash-flow is distributed in 3 parts, tax, debt service and dividend

NATCF = EBIT(1-T) + Depreciation Working Capital
Factors affecting NPV and IRR, scenario analysis
Borrowing capacity is the amount of debt a project can fully service during a
loan repayment period for a given set of project and loan parameters. Hence,
looking just the IRR and NPV cannot determine the amount of money that
need to be paid to meet the debt service requirement. Hence Debt Service
Coverage Ratio (DSCR) should be high in order to meet the payment of debt
to meet the debt service requirement within the given loan period.











Key Financial Decisions
Investment (Where to put the
money)
-Net Present Value > 0
-Internal Rate of return > WACC
Dependent on Cash-flow
Dividends (How to
distribute surplus)
-Managing Cash
-Enough for reinvestment
-Minimize risk by dividend
payout
-Avoid cash pile up

Financing (Where to get the
money)
-Weighted Average Cost of
Capital
Working Capital = Current Assets Current Liabilities
Account receivables
Inventory
Account receivables

Investment Decision:
IRR and NPV can be calculated on the basis of different stakeholders. So there will
not be single IRR or NPV. This is because there are multiple stakeholders all the
stakeholders try to pull in their favor Hence, these IRR and NPV is used for the
source of negotiation. The perspective is very important

Financing Decision:
Calculating WACC
RF: Driven by economy
RM: Driven by investors perception of the market
: Driven by the project, project sensitivity to economy
Ke= RF+(RM-RF): Cost of equity
Kd= Cost of debt from lender (1 tax rate)
Ratio= Equity : Debt = E:D
WACC: E*Ke+D*Kd

Debt is cheaper source of financing (Riskier)
Equity is expensive source of financing (Safer)

Dividend Decision:
The main criteria to have a dividend policies is to avoid the cash pile up.
Mange the risk There are many risk for the investors the risk of converting
the money. Liquidity risk, currency risk etc.
Also we have to bring in the element of risk. Risk is investor specific as well
as project specific.

Borrowing Capacity:
Borrowing capacity is the amount of debt a project can fully service during a
loan repayment period for a given set of project and loan parameters. Hence, looking
just the IRR and NPV cannot determine the amount of money that need to be paid to
meet the debt service requirement. Hence Debt Service Coverage Ratio (DSCR)
should be high in order to meet the payment of debt to meet the debt service
requirement within the given loan period.
Parameters that affect the Project are Revenues, Expenses, Growth Rate, Tax Rate.
All of these are captured in a Project Companys Credit Rating. These rating
determine the borrow rate.
The project has to decide when to drawn down there is some charge of commitment
fee which can be huge. That fee has to be paid even if we dont draw cash. There are
two ways that the project finance can be drawn down
i) Under full drawdown,
Maximum loan amount (D) = present value of project cash flow/target
cash flow coverage ratio(n)


ii) Under periodic drawdown,
D = PV/(n*(1+i)^m),
Maximum Loan Amount(D)=Present Value of Project Cash Flows/(target cash
flow coverage ratio*(1+i)^time between initial drawdown and cash flows into
the project)




Key characteristics of Project Finance:

Independent project company with specific purpose oriented
Raising of funds on a limited recourse or a non-recourse basis
Providers of funds look primarily to the cash flow from the project as the
source of fund to service their loans and the return on equity invested in the
project
Off balance sheet financing since the assets and liabilities will be off the
balance sheet of sponsors
Contractual arrangements redistribute project related risk
High information, contracting and transaction costs
By contract, free cash flow must be distributed to equity investors
Debt contracts are tailored to the specific characteristics of the project.
Highly leveraging potential.



Criteria for financial modeling
Debt service coverage ratio must reflect the margin of safety (eg. Above 2)
Payment to limited partners must be reasonable (IRR>WACC, NPV>0),
considering shareholder optimization, after tax income
Payment to general partners must include incentives to operate, considers
before and after tax income.
Consistent in currency invested and currency in return.
Repayment of debt should be done before the project ends with some time
margin.
Use of short term and guaranteed financing during construction period.
Use of long term, non-recourse financing after construction.



















Keep in mind, NPV is probabilistic, so try different scenarios and analyze on
the worst and best case scenario.
Project finance cash flows are agreement based and negotiable
Debt to equity ratio is decided by sponsors, but is approved only if DSCR is
reasonable for lenders.


Stages in Project Financing











Extracts from Cases

2 Key Inputs
Capital Budgeting
NATCF (Net After Tax Cash Flow)
-Working Capital subtracted from EBIT(1-t)
- Depreciation added to EBIT(1-t)
WACC
Stage 1
-Pre-construction
-Research Phase
-Permit
-License
-Official matters
-Feasibility Study

Project Finance
Stage 2
-Construction
-Short-term loan
-Recourse
-May get stuck

Stage 3
-Post Construction
-Long-term loan
-In Operation

Shareholders
Limited Partners
-Passive Investors
-Only Invest
-Limited Liability
-No management
authority
General Partners
-Active investors
-Invest and operate
-Unlimited liability
-Management
authority
Chad-Cameroon Case
Assessing the structure of the project
Assessing vested interests of different stake holders
Difference in asset types
Corporate structure of the project
Leverage used in the project
Recourse and limited recourse in Corporate finance and Project finance
respectively.
Different share holders and their vested interest
Exposure of risk to different stakeholders
Cashflow distribution discretion to different parties (Reasons behind it)

Airbus Case
Introduction of new project and its valuation
Understanding the market
Necessity of margin of safety while estimating cash inflow
Concept of perpetuity revised
Predicting future demand estimating from competitors product
Involvement of superior power (governments) in a project

Tate & Lyle Case
Need of ERR in decision making for government and development
supporting organizations
Difficulties in changing trade culture in a market
Role of infrastructure in trade
Comparative analysis with alternatives
Cost and benefit analysis due to a change in market
Value addition or loss to all stakeholders involved.