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project financing

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									Project Financing
• A project is a scheme for investing resources • It implies capital investment • It involves capital expenditure • Project financing is a method of financing economically viable project on the basis of the cash flow it is expected to generate

Features of the project financing
• The project is a separate legal entity • Such entity is called SPV • This entity receives loans from the lender and equity from the sponsors • Project financing is highly leveraged financing (Component of debt is high) • Its cash flows are separated from the parent company’s balance sheet

Features of the project financing
• The sponsor may or may not be the main user of the project’s output • The revenue generated from the project should be adequate to cover all operating expenses and debt servicing • Project assets are used as collateral for loan repayment • It should provide adequate return to equity investor

Features of the project financing
• Project finance is not only dependant on the credit support of the sponsor • It also depends upon the expected cash flow and / or collateral value of the project assets • Lenders should have high degree of confidence for performance of the project

Features of the project financing
• Risk is shared under project financing as follows
– Technology risk by sponsor – Credit risk by banks / lenders – Completion risk by contractors – Cost over-run risk by sponsors – Political risk by sponsors

Difference between corporate financing and Project financing
• Corporate Financing
– Lender gives loan to the parent / sponsor Co. – Parent Co. in turn invest this fund in a project – Lender look at the cash flow and the assets of the whole company

• Project Financing
– Lender gives loan to SPV – Lender look at the cash flow and the assets of the SPV

Financing for Infrastructure Project
• BOOT (Build – Own – Operate – Transfer)
– Private Co. builds the project – Operate it for sufficient period of time to earn adequate return on investment – Then transfer it to host Govt. or its agency

• BOOT project can be either solicited (by Govt.) or unsolicited • Pvt. group usually global Co. with local partners

Financing for Infrastructure Project
• BOO (Build – Own – Operate)
– Project is not transferred to host Govt. – Investor may divest his stake and seek investments from investor in capital market – This facilitate the availability of finance – Sponsor preserve the ownership

• BOO is emerged as in case of BOOT, transfer date is far away, and it is possible that the capital of the project is run down

Financing for Infrastructure Project
• BLT (Built – Lease – Transfer)
– Control of the project is transferred from SPV to lessee – Host Govt. agrees with lessee to buy output of the project (e.g. electricity in case of power project) – Lessor (SPV) receives lease rentals from lessee

• SPV need not spent time and resources for operation as it is leased

Risk Allocation in Project Financing
• Main risks in project financing
– Project completion risk – Market risk – Foreign currency risk – Supply of input risk

Project completion risk
• It is a major risk in most infrastructure project • It is usually covered by fixed price (Sponsor has fixed price to be paid to contractors or Govt. has fixed price to be paid to sponsor) • Provisions for claiming damages in case of delay • Performance guarantee

Market risk
• Lack of market for the output of the project is called market risk • Long term quantity and price agreement helps to reduce such risk

Market risk of power project
• For power project market risk can be mitigated by “take or pay power purchase agreement” • Usually power sold to Govt. • Under such agreement certain payment have to be made by Govt. to sponsor irrespective of actual power purchase • For power projects in India Govt. has evolved a system of two part tariff

Market risk of power project
• First part ensure recovery of fixed cost • Fixed cost includes dep., operating & maintenance exp., tax on income, int.on loans, and return on equity. • This part of the tariff is paid irrespective of actual power taken • Second part covers variable exp. Which includes cost of primary and secondary fuel. • It is based on the power actually purchased

Market risk of transport project
• Here tolls have to be collected from the public and not from a Govt. agency • Competition from alternative road or transport creates market risk • If traffic falls below expectation, project has recourse to adjustment in revenue sharing proportion • Automatic escalation clause in the agreement for increase in toll due to inflation

Foreign Exchange risk
• It is a major concern for foreign financiers investing in a developing countries • This risk is at two levels • Macro economic convertibility
– Whether project will have access to foreign exchange to cover debt and equity service

• Currency depreciation
– Whether local revenue is adequate to service foreign debt

Foreign Exchange risk
• Macro economic convertibility risk is eliminated by Govt. guarantee • Currency dep. risk can be eliminated by provision for tariff escalation

Supply of input risk
• It is important for power project • It requires reliable supply of quality fuel. • Risk is covered through a contract with fuel supply agency • Price risk is covered by provision for higher tariff to buyer of the power (usually Govt.) • Govt. will monitor the price of the input

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