MIRAL MEHTA

PROJECT FINANCE – MODELLING AND ANALYSIS

MBA – 1ST YEAR
AMRUT MODY SCHOOL OF MANAGEMENT, AHMEDABAD UNIVERSITY

1. What is Finance? How Finance is different from Accounting? What are important
basic points that should be learned to pursue a career in finance?

Points Finance Accounting

Meaning It is basically defined as management It means systematically recording,
of money and investment for maintaining and reporting of
Individuals, corporations and company’s financial transactions in its
governments. It deals with many day to day life.
activities like investing, lending,
borrowing, budgeting, saving,
forecasting etc.

Aim The main aim of finance is to manage The main aim of accounting is to
company’s assets and liabilities and collect and present the financial
planning for future growth. information on day to day transaction
of company.
Types 1) Private finance 1)Financial accounting
2) Public finance 2)Managerial accounting
3) Corporate finance etc. 3)Cost accounting
4)Tax accounting etc.
Responsibility Finance professionals are responsible While accounting professionals are
of for analysing the financial statements. responsible for creating financial
professionals stamen.

Measuring Capital budgeting

1) 1) Balance sheet
Tools Ratio analysis
2) 2) Income statement
Risk analysis
3) 3) Cashflow statement etc.
Working capital management
4)
Leveraging etc.
5)
Fund Revenue is occurring when actual cash Revenue is pointing when sales
determination is the receipt. On the other way occurred not for waiting for money
expenses will occur when actual collection. On the other hand,
payment will be paid. expenses will acknowledgment when
payment occurs not for waiting for
payment.

 Important basic points that should be learned to pursue a career in finance: -

 Strong Analytical skills
 Ability make decision
 Interpersonal skills

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  Communication skills (written and verbal)
 Number crunching
 Problem solving skills
 Team spirit

2. What is project finance? How is project finance different from corporate finance?
Why can’t we put project finance under corporate finance?
Project finance defines as funding a long term infrastructural or capital-intensive projects by using the non
- recourse financial structure. For financing these projects, debt and equity both are used and proportion
of debt is kept higher than equity. During its lifetime, these projects are treated as distinct entities called
Special Purpose Vehicles (SPV) from its parent company. SPV is created to achieve narrow, specific or
temporary object of the company. Cash flows generated by SPVs must be sufficient enough to cover the
operating and financial costs of company. So, if new project fails to generate sufficient cashflows then,
creditors have no right to claim on parent company’s existing assets or any further assets that are not part
of said SPV and cashflows, even if liquidating assets of SPVs are not sufficient to cover dues of borrower. It
must be repaid exclusively out of its own cash flow and its own assets. It is off balance sheet financing
because balance sheet of project company (SPV) is not consolidated with the balance sheet of its parent
company. Project financing is usually for a long time typically – 15 – 25 years.
Project finance is different from corporate finance in following ways: -

Project finance Corporate finance

Lenders rely on cash flows of the project for Lenders have access to cash flow from
repayment borrowers’ various businesses
Collateral – assets of project itself Collateral – parent company’s assets

Non-recourse or limited recourse Recourse

Off balance sheet treatment On balance sheet treatment

High debt to equity ratio, typically around Moderate debt to equity ratio
70%-90% of capital expenditure
Risk is diversified and shared by all Highly risky form of financing and not
participants diversified
Cost of capital is low because high leverage Cost of capital is high
reduces the blended cost of debt and equity
Projects have a finite life considering length Projects have infinite time horizon
of contract

3. Define 20 terminologies related to project finance.

Following are the important terminologies related to project finance: -

1. Debt service coverage ratio: -

DSCR is defined as the amount of cash flow available to meet scheduled interest and principal repayment on
debt.
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 2. Loan life cover ratio: -

LLCR is defined as the number of times the cash flow over the scheduled life of the loan can repay the
outstanding debt balance.

3. Amortization: -

It means periodic repayment in instalments of principal of a loan prior to its final maturity.

4. Public private partnership: -

5. Concession agreement: -

It is an agreement between project company and public entity. It allows project company to use govt.
assets such as plot, land, road or bridge for specific period according to specified terms. It gives right to
private company to undertake public sector project and operate that project over period of time.

6. WACC: -

It is defined as the weighted after-tax cost of debt plus the weighted cost of equity.

7. Warrant: -

Warrant is financial instrument which allows the holder to purchase shares of firm at a given price for cash.
It is long term call option that is issued by firm.

8. Special purpose entity: -

It is separate legal entity which is created to achieve narrow, specific or temporary object of the company

9. Off balance sheet financing: -

It is Corporate obligations which do not need to appear as liabilities on a balance sheet.

10. Pay-in-kind: -

It means instead of paying cash interest monthly or quarterly or annually, borrower increases the principal
amount payable to lender by that amount and that amount will be payable by borrower at end of project.

11. Cash sweep: -

Cash Sweep is the use of surplus cash to prepay debt or provide extra security for lenders, instead of paying
it out to investors.
12. EPC Contract: -
Engineering, Procurement and Construction Contract is type of construction contract in which
contractor performs virtually all construction related work on facility and the project company only
having to wait to have key turned over at completion. These are fixed price contracts.

13. Contingency: -

Some percentage between 5% – 15% kept aside at the start of project for contingency requirement.

14. Internal rate of return: -

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It is the discount rate which equates investment outlay with present value of cashflow received after
one period. This is an indicator of earning capacity of the project and a higher IRR indicates better
prospects for the project.

15. Operation and maintenance agreement: -

It is contract between project company and professional operator which allows operator to operate and
maintain the project in accordance with its requirement.

16. Shareholder agreement: -

It is an agreement between the project sponsors to form a Special Purpose Entity for the project
development, ownership and operation. 

17.

4. What is non-recourse debt / loan? What is mezzanine finance explained with an

example.
Non – recourse debt: -
Non-recourse debt limits assets of borrower that lender can pursue to recover their dues in case of any
default. If borrower defaults on the loan, lender can only claim the assets that were designated as
collateral of the debt and have no right on borrower’s personal accounts in order to recover their dues. It is
harder to get and qualify for because of lender takes the majority of the risk of agreement.

Mezzanine finance: -
Mezzanine capital is used to finance a growth opportunity such as an acquisition, new product line, new
distribution channel or plant expansion, or in private businesses for the company owners to take money
out of the company for other uses or to enable management to buyout company owners for succession
purposes. Mezzanine financing consists features of both debt and equity financing and fills the gap
between two. It allows the borrower to take loan without providing any kinds of assets as collateral
because it is an unsecured loan. Mezzanine debt securities are non – traded.

When mezzanine debt is used in conjunction with senior debt it reduces the amount of equity required in
the business. As equity is the most expensive form of capital, it is most cost effective to create a capital
structure that secures the most funding, offers the lowest cost of capital, and maximizes return on equity.
Mezzanine debt is cheaper than equity and prevents the dilution of existing shareholders ownership.
Return on mezzanine financing is quite higher than senior debt but lower than equity.

it provides lenders rights to convert its loan into equity by exercising the warrants or options in case of any
kinds of defaults will arise. it has lower priority than senior debt in case of default. Interest on mezzanine
loan is deductible from tax.

It is useful for small business owners who are not able to pay a huge cost of capital on equity financing for
project. Borrower has to pay high interest as it is highly risky form of financing. If the small business owners
aren’t able to generate enough cashflow, it would be impossible for them to pay off the debt on time
because the interest rate of mezzanine financing is quite high. That’s why it is always recommended that
mezzanine debt should not be more than double the cash flow of the company.

Example of mezzanine finance: -

ABC ltd. Wants to buy a company worth $50 million and it approaches bank to fund the project. Bank is
willing to provide only $35 million to company. To fill the gap, ABC ltd. Pursue mezzanine financing.

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Through mezzanine financing, company is able to collect $10 million carrying 15% interest rate and rest $5
million has to provide by company itself to buy company. So,

 $5 million of owner’s equity

 $35 million bank loan
 $10 million mezzanine financing

So, with the use of mezzanine financing, ABC ltd. does not need to invest as much of their own money into
this project. it generates maximum return on equity at minimum cost of capital for company.

5. Explain in detail with reasons of what the sectors are or which type of projects are
suitable for project finance? 

Power & energy

Telecommunication: -
This sector continuously faces the rising risk
1. Transportation (Roads, Bridges, Rail, Airports, Ports, light Rail etc.): -
A feature of transport infrastructure projects is that they are expensive and take a long time to construct. This is
caused partly by the nature of the projects themselves and partly by the fact that they aim to meet a future demand.
This represents a long-term tying up of large resources, while the regularity and the level of the revenue remain
uncertain. The construction time horizon in this field usually exceeds 20 years, with the unavailability of ordinary
commercial credit banking. Also, govt. does not have sufficient means available to innovate, maintain and build
infrastructures. Therefore, it is desirable and natural to allow private investors to enter the market or to let users pay
for their” consumption”.
Project financing is usually used for large and expensive constructions with long-term duration, where a longer
period is required to amortize the investments and to generate the required revenue.

Water
Housing
Healthcare
Education
Prison
Real estate

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