2015 Eup 222 Notes Project Finance Lecture 2

EUP 222 ENGINEER IN SOCIETY PROJECT FINANCE

Understand the financial concepts to appraise a project efficiently and make decisions effectively.

Dr. Sharifah Akmam Syed Zakaria, PPKA . email: [email protected]

Outline Lecture Objective & Context

Project Financing Owner Project Contractor

Financial Evaluation Time value of money Present value Rates Interest Formulas NPV IRR & payback period

Lecture Objectives:

The role of project financing

Mechanisms for project financing

Measures of project profitability

What is Project Finance?

Project financing refers to a financing in which lenders to a project look primarily to the cash flow and assets of that project as the source of payment of their loans.

5Why Project Financing?Project Owners PerspectiveSize and cost of projectsRisk minimizationPreservation of borrowing capacity and credit ratingMay be only way that enough funds can be raised

The Basic Elements of a Project Financing:

Loan funds

Debt repayment

Equity funds

Returns to investors

Cash deficiency agreement and other forms of credit support

Equity investors

Lenders

Suppliers Purchasers

Raw materials

Supply contract(s)

Purchase contract(s)

Output

Assets comprising the project

7Prerequisites for Project Financing:

Financial Analysis

Economic Analysis

Risk Analysis

We must welcome the future, remembering that soon it will be the past, and we must respect the past, knowing that once it was all that was humanly possibleForbes

8Its All About Risk!

The key to project financing is the

reallocation of any risk away from the

lenders to the project.

Project Management Phase:

FEASIBILITYDESIGN

PLANNING CLOSEOUTDEVELOPMENT OPERATIONS

Financing & Evaluation

Risk

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

OutlineLecture Objective & Context



Financing Gross Cash flows

($35,000,000)

($30,000,000)

($25,000,000)

($20,000,000)

($15,000,000)

($10,000,000)

($5,000,000)

$0

$5,000,000

$10,000,000

1 2 3 4 5 6 7 8 9 10 11

owner cum cashflow

contractor cum cashflow

years 1 2 3 4 5 6 7 8 9 10

OWNER

investment ($10,000,000) ($20,000,000)

operation incomes $2,000,000 $4,000,000 $6,000,000 $6,000,000 $6,000,000 $6,000,000 $6,000,000

owner cashflow $0 ($10,000,000) ($20,000,000) $2,000,000 $4,000,000 $6,000,000 $6,000,000 $6,000,000 $6,000,000 $6,000,000

owner cum cashflow $0 ($10,000,000) ($30,000,000) ($28,000,000) ($24,000,000) ($18,000,000) ($12,000,000) ($6,000,000) $0 $6,000,000

CONTRACTOR

costs ($4,000,000) ($7,000,000) ($14,000,000) $0 $0 $0 $0 $0 $0 $0

revenues $0 $10,000,000 $20,000,000 $0 $0 $0 $0 $0 $0 $0

contractor cashflow ($4,000,000) $3,000,000 $6,000,000 $0 $0 $0 $0 $0 $0 $0

contractor cum cashflow($4,000,000) ($1,000,000) $5,000,000 $5,000,000 $5,000,000 $5,000,000 $5,000,000 $5,000,000 $5,000,000 $5,000,000

Owner investment = contractor revenue

Early expenditure Takes time to get revenue

Design/Preliminary Construction

Project Financing

Aims to bridge

this gap in

the most

beneficial

way!

Critical Role of Financing

Makes projects possible

Has major impact on Riskiness of construction

Claims

Prices offered by contractors

Difficulty of Financing .


Project FinancingOwner Project Contractor


Public FinancingSources of funds

General purpose or special-purpose bonds

Tax revenues

Capital grants subsidies

International subsidized loans

Social benefits : important justification Benefits to region, quality of life, unemployment relief, etc.

Important consideration: exemption from taxes

Public owners face restrictions

oMajor motivation for public/private partnerships

MARR (Minimum Attractive Rate of Return) much lower (e.g. 8-10%), often standardized.

Private FinancingMajor mechanisms Equity

Invest corporate equity and retained earnings Offering equity shares

Stock Issuance (e.g. in capital markets) Must entice investors with sufficiently high rate of return May be too limited to support the full investment May be strategically wrong (e.g., source of money, ownership)

Debt Borrow money Bonds

Because higher costs and risks, require higher returns

MARR varies per firm, often high (e.g. 20%)


Project Financing OwnerProject Contractor


Project FinancingInvestment is paid back from the project profit rather than the general assets or creditworthiness of the project owners

For larger projects due to fixed cost to establish Small projects not much benefit

Investment in project through special purpose corporations Often joint venture between several parties

Need capacity for independent operation

Benefits Off balance sheet (liabilities do not belong to parent)

Limits risk

External investors: reduced agency cost (direct investment in project)

Drawback Tensions among stakeholders


Project Financing Owner ProjectContractor


Contractor FinancingOwner 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

Role of Taxes

2015 Eup 222 Notes Project Finance Lecture 2

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