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Dimitrios V.

Siskos

Financial Assessment of a Project

To: Dr. Igor Gvozdanovic

May 22, 2015

This paper is submitted in partial fulfillment of the requirements for the degree of Doctorate of Finance

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Contents

Contents.................

Abstract..............

Why are information memorandum and cash - flow analysis relevant in project evaluation?... 4

Describe in detail, the four types of financial ratios. What is the relevance of each in project
evaluation? ........

The key considerations in credit risk appraisal.....

Debt servicing can be impacted by factors such as market prices, inflation rates,
energy costs, tax rates..............................................

References....................... 8

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Dimitrios V. Siskos

SMC Working Papers

Financial Assessment of a Project


Siskos V. Dimitrios
Swiss Management Center (SMC) University
May 22, 2015

Abstract
Many professionals often talk about how successful a project has been. However, without conducting
an evaluation these types of statements are meaningless. An evaluation gives an organization feedback on
whether a project is achieving what it set out to achieve. Initially, this paper seeks to determine the relation
between the information memorandum and the cash-flow analysis with the project evaluation process.
Second, it describes the four types of financial ratios, stressing their role in project evaluation. Afterwards,
the article summarizes the key considerations in credit risk appraisal and last, it examines whether debt
servicing can be impacted by factors such as market prices, inflation rates, energy costs and tax rates.

Keywords: Project, Project Evaluation, Information Memorandum, Cash-Flow Analysis, Credit Risk
Appraisal, Debt Servicing.

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Why are information memorandum and cash- flow analysis relevant in project evaluation?
Every project finance transaction is considered to be risky in the beginning of the project due to the fact
that there are elements which fall outside the scope of traditional frameworks and checklists during the
project lifecycle. This fact results in many difficulties at the time which the company strives for financing the
project. Hence, the purpose of a memorandum is to sell the loan and to help the participating banks reach a
credit decision, especially small banks that do not have seasoned credit analyst (Fight, 2006).
A cash flow statement is one of the most important financial statements 1for a project or business as it
provides information about the cash receipts and payments of a firm for a given period (Barad, 2010). The
cash flow analysis statements display not only changes over time, but also the available net cash. Hence, the
cash flow analysis statements are generally separated into three parts: 1) operating activities, 2) investment
activities and 3) financing activities.
Generally, the information memorandum and cash-flow analysis are relevant concepts within a project
company since they act interactively and supplementary with each other. While the information
memorandum explains the project to potential lenders informing them about whether the proposed project is
achievable or not, the cash flow statement provides information not only about the amount of the cash flows
but also about the timing of the flows.
Describe in detail, the four types of financial ratios. What is the relevance of each in project evaluation?
The financial ratios can be divided into four types pertaining to:
1. Liquidity ratios. These ratios are used to judge a firms ability to meet short term obligations (Fight,
2006). The current ratio is calculated from balance sheet data as: Current Assets/Current Liabilities. So, if
a project firm has $500 in current assets and $100 in current liabilities, the calculation is $500/$100 =
1

Financial statements for businesses usually include: income statements, balance sheet, statements of retained earnings and cash

flows.

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5.00X. The "X" (times) part at the end is important as it means that the firm can pay its current liabilities
from its current assets five times over. Similarly, the quick ratio is a more accurate guide to liquidity, and
is as follows (Fight, 2006): Current assets less inventories/Current liabilities. The main difference
between those ratios regarding evaluation is the absence of the inventory in the calculation of the quick
ratio due to the difficulty of turning into cash quickly.
2. Debt ratios. These ratios are used to judge a firms ability to meet short term obligations (Fight, 2006).
The debt ratios are strongly related to project evaluation as they point on a company's leverage position
comparing total liabilities to shareholders' equity, as opposed to total assets in the debt ratio. As such, a
high ratio indicates that a company may not be able to generate enough cash to satisfy its debt
obligations, while a low one may also indicate that a company is not taking advantage of the increased
profits that financial leverage may bring.
3. Profitability ratios. They measure income relative to sales and resources, determining the ability of a
company to generate earnings and effective employment of resources (Monea, 2009). It is considered that
a company is doing well when a profitability ratio has a higher value relative to the same ratio from a
previous period.
4. Covering ratios. Coverage ratios measure the ability of a company to generate cash flow in excess of its
financing commitments (Fight, 2006). In relation to the project evaluation, the interest coverage ratios
reveal how well companys earnings can cover the interest payments on its debt, and express a measure
of safety, being expressed as a multiplier (Monea, 2009).
The key considerations in credit risk appraisal
Credit appraisal in project finance means an investigation done by the financial institution prior to
providing any funding, in which it examines the economic, financial and technical viability of the proposed
project (NIBAF, 2013). Although there are many differences among the criteria used for credit analysis,
some common fundamentals, which almost every bank applies to the credit decision, exist.
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During the pre-construction phase, the investor chooses in which real project to invest, or which shares
to buy or get rid of (Taipale, 2007). Moreover, lenders should assure themselves that any technology being
used in the project is of a reliable and proven design, as evidenced by a solid track record of similar
installations (Fight, 2006). Last, to ensure the projects acceptance within the established schedule and
budget as well as to provide performance guarantees, it is suggested to sign construction contracts.
The post-construction phase includes the owner plans to operate and maintain a facility during start-up
and the early years of a project as well as to use sustainability criteria in the procurement of services. It also
includes the decision of a financing institution to accept a security for a loan, the evaluation of the tax
authority, e.g. whether the project is eligible for a reduced real estate tax rate (in case of industrial project).
Last, an analysis of counterparty risk2 is very critical to a projects rating since its potential failure can put the
projects viability at risk (Fight, 2006).
Debt servicing can be impacted by factors such as market prices, inflation rates, energy costs, tax rates
Projects are vulnerable to financial threats in their effort to generate stable and sufficient levels of cash
flows. As such, negative impacts can arise from elements such as foreign exchange risks, inflation risks,
energy costs and tax rates (Fight, 2006).
Foreign exchange risk is one of the most important sources of uncertainty in transition countries and
emerging markets in general, as many of them are small open economies, very vulnerable to exchange rate
fluctuations (Orlowski, 2004). As such, debt servicing is being impacted by the variation of foreign exchange
risk. The higher the risk, the lower is the debt servicing.
The inflation rate plays an important role in determining the health of a project and whether the
company can service its debts. For example, projects whose contractual revenues are linked to inflation risk
being weakened if inflation falls below inflation assumptions (Fight, 2006). Hence, overlooking inflation risk
factors can produce a productive process that could secure debt servicing.
2

In most financial contracts, counterparty risk is also known as "default risk".

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However, on a most macroeconomic scale, the inflation rate is a result of energy costs. A well-known
example of such an energy phenomenon was the OPEC oil embargoes during the early and late 1970s. The
economic effect of the oil embargoes was a surge in the price of oil and other petroleum products. Higher oil
prices caused energy prices to soar, which translated into electricity price spikes (Kaplan, 2002). As such, the
domino effects of energy costs hamper debt servicing within the project company.
One of the crucial discussions on project finance is how one perceives tax rates in relation to debt
servicing. Economic critics claim that with the reduction of tax rates, it generates higher cash flow within
project thus contributing to higher debt servicing (Sherly, 2013). Similarly, when tax rates are increased the
business ability to repay debts is reducing.

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SMC Working Papers

References
Barad, M., (2010). A Study of Liquidity Management of Indian Steel Industry, thesis PhD, Saurashtra
University.
Fight, A. (2006). Introduction to Project Finance. Essential Capital Markets. Elsvier 1st Edition.
Kaplan, J. (2002). Inflation & Economic Growth. Retrieved on 13/5/2012, from University of Colorado
Boulder: http://www.colorado.edu/Economics/courses/econ2020/section6/section6
Monea M., (2010). Financial Ratios Reveal How a Business is Doing? Annals of the University of
PetroSani, Economics, 9(2), Universitas Publishing House, PetroSani, pp.137144
Orlowski, W., (2004). Accelerate Change Published. Europes Conundrum- Viewpoints on Enlargement.
Pakistans National Institute of Banking and Finance (NIBAF), (2013). Credit appraisal/Evaluation.
Sherly, G., (2013). The effects of tax rates on tax revenue and growth: A case study of Malaysia, 3rd
International conference on Business and Economic Research, ISBN: 978-967-5705-05-2
Taipale K., ed. (2007) Buildings for a Better Future, Best Policy Practices. Ministry of the Environment of
Finland. http://www.ymparisto.fi/download.asp?contentid=67404&lan=en

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Dimitrios V. Siskos