Project Financing
Main Features
Economically separable capital investment
Cash Flow of the project the main source of the capital recovery
Assets of the project is the only source used as collateral
No recourse to the assets of sponsoring companies. Unless
specifically required in the contract
Debt serving has priority over investors equity
During construction, interests on debt is accumulated as part of the
debt.
Context: Feasibility Phases
Project Concept
Land Purchase & Sale Review
Evaluation (scope, size, etc.)
Constraint survey
Site constraints
Cost models
Site infrastructural issues
Permit requirements
Summary Report
Decision to proceed
Regulatory process (obtain permits, etc)
Design Phase
Finance
Investment Firms
Company Company
Equity Equity
Project Project
Company Finance Vs. Project Finance
Company Finance Project Finance
Capital Formation Will impact debt capacity Will not impact debt
capacity, because it is off
balance sheet
Risk Exposure Could impact overall risk Limited
structure or the cost of
capital
Tax Shield Hard to take advantage of Easier to bundle
Cash Flow To corporate treasurer: Directly to the investor
subject to corporate policy
on dividend
Cost of Project Financing None High due to setting up cost
Capital Cost Companys track record High Due to no history
Oversight by the Sponsors None Very Demanding
Analysis of Financial
Performance
Strategic Objectives Financial Objectives
(Long Run) (Short Run)
Market Share Return on Investment (ROI)
Growth Rate Return on Equity (ROE)
Market Leadership Return on Asset (ROA)
Technology Leadership
Project Decision
Does the project make financial sense?
Is the project within the overall strategic
framework of the company?
If there is a clash between the objectives,
has financial evaluation correctly taken all
the costs and benefits into account?
Financial Ratios
Profitability Ratios
Liquidity Ratios
Debt Ratios
Activity Ratios
Leverage Ratios
Summary of Financial Ratios
Profitability Ratios Liquidity Ratio Activity Ratios
Gross Point Margin Current Ratio Inventory Turnover
An indication of margin available to cover Indicates the extent to which the claims of short When compared to industry averages,
operating expenses and yield profit term creditors are covered by assets that are it provides an indication of whether a
(Sales Cost of Goods Sold) /Sales expected to be converted to cash in a period company has excessive/inadequate
roughly corresponding to the maturity of liabilities finished good invent.
Current Assets/Current Liabilities Sales/Inventory of finished goods
Operating Profit Margin Quick Ratio (Acid Ratio) Fixed Asset Turnover
An indication of firms profitability from A Measure of firms ability to pay off short term A Measure of sales productivity and
current operations without regard to interest obligations without relying on the sale of its utilization of plant and equipment
changes accounting from capital structure inventory Sales/Fix Assets
Profit Before Tax and Interest/Sales (Current Asset-Inventory/Current Liability)
Net Profit Margin Inventory to Newt Working Capital Total Assets Turnover
Shows after tax profit per dollar of sales. A measure of the extend to which the firms A measure of utilization of all firms
Subpart profit margin indicates that the firm working capital ties up in inventory assets ratio below the industry average
sales prices are relatively low or that costs are Inventory/(Current Assets- Current liabilities) indicates the company is not
relatively high or both generating a sufficient volume of
Profit After Tax/Sales business, given its asset size
Sales/Total Asset
Return to Total Asset LEVERAGE RATIOS Account Receivable Turnover
A Measure of total investment in the A Measure of the average length of
enterprise. It is sometimes desirable to add Debt to Asset Ratio time it takes the firm to collect the sale
interest to alter tax profits to add form the Measures the extend to which borrowed funds it made on credit
numerator of the ratio since the total assets have been used to finance the firms operation Annual Credit Sale/Account
are financed by creditors as well as by Total Debt/Total Equity Receivable
stockholders; hence it is accurate to measure
the productivity of assets by the returns
OTHER RATIOS
provided to both classes of investors
Profit After Tax/Total Assets
Summary of Financial Ratios
Profitability Ratios Liquidity Ratios Activity Ratios
Return on Stockholders Equity Debt Equity Ratio Dividend Yield on Common Stock
A measure of the rate of return on Provides measure of the funds provided by Measure of returns to owners received in
stockholders investment in the enterprises creditors and equity in the firms long term dividends Annual Dividend per
Profit After Tax capital structure share/Current Market Price
Total Stockholders Equity Par Value Long Term Debt/Total Shareholders
Pref. Stock)
Return on Common Equity Long Term Debt to Equity Ratio Price Earnings Ratio
A measure of the rate of return on A widely used measure of balance between Faster growing or less-risky firms tend to
investment which the owners of the debt and equity in the firms long term have higher P/E than slower growing or
common stock have made in the enterprise capital structure risky firms
(Profit After tax-Preferred Stock Long Term Debt/Total Shareholders Current Market Price/After tax Earning
dividends) per share
[Tot. Stockholders Equity-par value Pref.
Stock]
Earning Per Share Time Interest-Earned Ratio Dividend Payout Ratio
Shows the earnings available to the owners Measured the extent to which earnings can Percentage of profits as dividends Annual
of each share of common stock decline without the firm becoming unable Dividends share/After tax Earning share
(Profit After tax-Preferred Stock to meet its annual costs .
dividends) Profit Before Interest and Taxes/ Total
Number of Common Stocks Outstanding Interest
Fixed Cost Coverage Cash Flow Per Share
A more inclusive indication of the firms A measure of the discretionary funds over
ability to meet all of its fixed charge and above expenses that are available for
obligations use by the firm
After tax Profits + Depreciation
Number of Common Shares Outstanding
In Construction
Liquidity Ratios:
Short term obligations:
Account Payable
Accrued Interest and Employee Benefits
Advanced billings on contracts
Short Term Assets
Cash Accounts Receivable
Inventory
Contract in Progress
Relation Between Contracting Firm,
Sponsor and Project
Contracting Firm
- +
Capital Investment &
Operating Cost
Working Capital
+
Project
Fund Transfer
Project Revenue
+
Sponsor
Traditional Financing Structure
Stockholders/ Banks and
Investors Financial
Institutions
+ Loan +
Dividend
Interest
Investment in
the Company +
+
Sponsor
+
Profit Capital Investment
+
Project
Investors Lenders
Equity Project
Finance Debt.
Contractor Finance Operator
EPC Operation
Contract Contract
Maintenance Proj.
Contract
Company
Concession Support
Toll Payments
Agreement Agreement
Road Users Contracting Government
Authority
Toll Road Project Finance Structure
Investors Lenders
Equity Project
Finance Debt.
Contractor Finance Operator
Construction Operation &
Contract Maintenance
Contract
Proj. Support
Company Agreement
Input Supply Off-take Concession
OR
Contract Contract Agreement or
License
Input Supplier Offtaker Government or other
public-sector authority
Simplified Project Finance Structure
Financing Gross Cashflows
Design/Preliminary Construction
Owner investment = contractor revenue
Early expenditure
Takes time to get revenue
Typical Project Structure for IPP
Multi-lateral, bi-lateral and Bank
Export Credit Agencies Sponsor Sponsor Sponsor
Syndicate
A B C
Non-Recourse EQUITY
DEBT Shareholder
Inter-creditor Agreement
Agreement
Board of Directors
70% 30%
Labor
Project Company Power Output
Gas Input
Under a supply (Power Plant) Under a purchase
contract
contract
Technol.
License
Equipment Construction Operating
Contract Contract & Maint.
(turbines) (EPC Contract) Contract Host Government:
legal system, permits,
Regulation, property rights, etc.
Adapted from: Esty & Sesia; HBS Oct. 2007
Private Owners w/Collateral Facility
Distinct Financing Periods
Short-term construction loan
Bridge Debt
Risky (and hence expensive!)
Borrowed so owner can pay for construction (cost)
Long-term mortgage
Senior Debt
Typically facility is collateral
Pays for operations and Construction financing debts
Typically much lower interest
Loans often negotiated as a package
construction operation time
w/o tangible w/ tangible
Typical Terms
Project Company has to complete the project
under the terms of contract
Public Authority provides the land and the right-
of-way
Ownership remains by the Public Sector
Concession is given for limited period of time
Operation and Management is in the hand of
Project Company
Project Finance and Privatization
Project finance should be distinguished from privatization,
which:
either conveys the ownership of public-sector assets to the
private sector-this does not necessarily involve project finance;
a privatized former state-owned company may raise any
finance required through a corporate loan.
or provides for services to be supplied by a private company that had
previously been supplied by the public sector (e.g., street cleaning)
again, this does not necessarily involve project finance: the private
company may not have to incur major new capital expenditure and so
not require any finance at all, or may use a corporate loan to raise the
finance to make the investment required to provide the service.
Project finance may come into the picture if a company needs
finance for the construction of public infrastructure on the
basis of a contract or license, e.g.,
An Off-take Contract, based on which a project will be constructed to sell its
output to a public-sector body (e.g., construction of a power station to sell
electricity to a stat-owned power company)
A Concession Agreement under which a project will be constructed to
provide a service to a public-sector body (e.g., provision of a public-sector
hospital building and facilities)
A Concession Agreement under which a project will be constructed to
provide a service to the general public normally provided by the public sector
(e.g., a toll road)
A Concession Agreement or license under which a project will be constructed
to provide new services to the public (e.g., a mobile phone network).
Examples of other types of structured finance
Receivables financing
Securitization
Leveraged buyout (LBO) or management buyout (MBO)
financing
Acquisition finance
Asset finance
Leasing
Benefit of Leverage on Investors Return
Low Leverage High Leverage
Project Cost 1,000 1,000
(a) Debt 300 800
(b) Equity 700 200
(c) Revenue from project 100 100
(d) Interest rate on debt (p.a.) 5% 7%
(e) Interest payable [(a)x(d)] 15 56
(f) Profit [(c) (e)] 85 44
Return on equity [(f)÷(b)] 12% 22%
Contractor Financing
Payment schedule
Break out payments into components
Advance payment
Periodic/monthly progress payment (itemized breakdown structure)
Milestone payments
Often some compromise between contractor and owner
Architect certifies progress
Agreed-upon payments
retention on payments (usually, about 10%)
Often must cover deficit during construction
Can be many months before payment received
S-curve Work
S-curve Cost
Expense & Payment
Contractor's
expenses
Owner's payments
Time period
(month)
0 1 2 3 4 5 6 7 8 9
(A) Expenses and payments
0 1 2 3 4 5 6 7 8 9 Time period
(month)
(B) Cumulative net cash flow of contractor
Contractor Financing
Owner keeps an eye out for
Front-end loaded bids (discounting)
Unbalanced bids
Contractor Financing
Owner keeps an eye out for
Front-end loaded bids (discounting)
Unbalanced bids
Contractors frequently borrow from
Banks (Need to demonstrate low risk)
Interaction with owners
Some owners may assist in funding
Help secure lower-priced loan for contractor
Sometimes assist owners in funding!
Big construction company, small municipality
BOT
Contractor Financing
Agreed upon in contract
Often structure proposed by owner
Should be checked by owner (fair-cost estimate)
Often based on Masterformat Cost Breakdown Structure
(Owner standard CBS)
Certified by third party (Architect/engineer)
Latent Credit
Many people forced to serve as lenders to owner due
to delays in payments
Designers
Contractors
Consultants
CM
Suppliers
Implications
Good in the short-term
Major concern on long run effects
Role of Taxes
Tax deductions for
Depreciation -
the process of recognizing the using up of an asset through
wear and obsolescence and of subtracting capital expenses
from the revenues that the asset generates over time in
computing taxable income
Others
Develop or Not Develop
Is any individual project worthwhile?
Given a list of feasible projects, which one is the best?
How does each project rank compared to the others on
the list?
Project Evaluation Example:
Project A Project B
Construction=3 years Construction=6 years
Cost = $1M/year Cost=$1M/year
Sale Value=$4M Sale Value=$8.5M
Total Cost? Total Cost?
Profit? Profit?
