Assignment of tasks to students

• CF1- Class code- 6zixri6

• IFA- Class code- q2bwsoy
• BFAS- Class code- tkegcao
1. Case study- Who is the project manager?
2. Simulating the real world –Student project
Simulating the real world-Activity

• Send the group members’ names and other details with

responsibilities and the project name to your class
representatives who will send the same to me
Case study- Who is the project manager?

• Submit your answers to the google class individually within

three days-before 23rd August
• Not more than 10 sentences
Contents of Module 2- Financing of Projects

Funding Sources –
• Long- and short-term sources, mezzanine finance, equity, quasi-equity, debt-Local
financing, Working Capital advances, Private equity funds, External commercial
borrowings- Export Credit Agencies and Development Banks - Multilateral development
finance institutions*, Viability Gap funding.

• Appraisal by Financial Institutions. Financing Infrastructure Projects-Project

Parties-Contracts, Power, Telecommunications, PPP model, Concession
Arrangements-Recommendations of the Committee.
Meaning and Importance of Project Finance

• International Project Finance Association (IPFA) defines Project

finance as
“the financing of long-term infrastructure, industrial projects and
public services based upon a non-recourse or limited recourse
financial structure where project debt and equity used to finance the
project are paid back from the cash flow generated by the project”.
Project finance is also defined as:

• A long-term method of financing large infrastructure and

industrial projects based on the projected cash flow of the
finished project.

• Project finance structures usually involve a number of equity

investors as well as a syndicate of banks who will provide loans
to the project.
Sources of Finance

• There are two sources of finances:

• Equity Financing-Money invested into your business in exchange for a
share in its ownership.
• Debt Financing–Debt financing is usually in the form of a loan where
the principal amount borrowed and interest accumulated on the loan
needs to be paid.
FL
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PRINCIPAL ADVANTAGES AND OBJECTIVES

1. Non-recourse-i.e., the sponsor has no obligation to make payments on the project loan if
revenues generated by the project are insufficient to cover the principal and interest payments on the loan

2. Maximize Leverage
• such costs are financed using 80 to 100 percent debt
• permits a sponsor to finance the project without diluting its equity investment in the project
• permit reductions in the cost of capital by substituting lower-cost, tax-deductible interest for higher-cost,
taxable returns on equity.
PRINCIPAL ADVANTAGES AND OBJECTIVES-Continued

3. Off Balance-Sheet Treatment

• the project sponsor may not be required to report any of the project debt on its
balance sheet because such debt is non-recourse or of limited recourse to the
sponsor.

4. Maximize Tax Benefits

• Due to usage of borrowed funds
DISADVANTAGES

• Project financings are extremely complex.

• Longer period of time to structure, negotiate and document a project financing
• The legal fees and related costs associated with a project financing can be very
high.
• The risks assumed by lenders are greater in a non-recourse project financing
than in a more traditional financing.
• Hence, the cost of capital may be greater than with a traditional financing.
PROJECT COMPANY AGREEMENTS

1. Ownership interest
2. Capital utilization
3. Allocation of profits and losses.
4. Dividend distributions.
5. Accounting. 7. Day-to-day management.
6. Governing body and voting. 8. Budgets.
9. Transfer of ownership interests.
10. Admission of new participants.
11. Defaults
12. Termination and dissolution
Signatories of common Project finance contracts

https://www.oreilly.com/library/view/project-finance-for/9781119486084/c09.xhtml
 MAIN PROJECT CONTRACTS

Concession Agreement
• The agreement entered into between the sponsors / Project Company and the host government by virtue of which
the project company is authorized to develop the project.
Construction Agreement
• A construction agreement is the agreement whereby one person (the contractor) agrees to construct a building or a
facility for another person (the employer) for an agreed remuneration by an agreed time.
Shareholders Agreement / Joint-Venture Agreement
• The shareholders of the project company are the sponsors of the project.. The main clauses of this agreement
involve :
• voting rights, - nomination of management / major decisions, - dividend distribution, -
• pre-emption rights, - each shareholder's contribution in equity to the project company
• non-dilution,
MAIN PROJECT CONTRACTS-Continued

Operating and Maintenance Agreement

• In most instances the project company will enter into an agreement with an operator which will be
responsible for the operation and maintenance of the project facility.

Supply Agreements
• In most instances the project company will need to enter into a number of supply agreements in order to
purchase the main supplies for the operation of the project facility.

Off-Take Agreements
• A project need not necessarily have an off-take agreement in the sense of a long term product purchase
agreement.
Tasks of Project Manager in Pre- Operation and Operation Phases Personnel
1. Organization and Staffing
Major areas Technical Aspects 2. Leading and Motivating
• Technical Aspects 1. Planning, Scheduling 3. Communication
• Personnel 2. Setting of Priorities 4. Resolution of Conflicts
• Administration 3. Task Identification 5. Negotiation
• External Relations 4. Logistics 6. Performance Evaluation
5. Equipment Use and Schedules

Administration
1. Estimating and Controlling Cost
External Relations
2. Budgeting
1. Relation with Financial Institutions
3. Cash Flow Monitoring
2. Contracting and Use of Consultants
4. Management Information System
3. Dealing with Suppliers and Sub-
Contractors 5. Systems and Procedures
4. Coordination with Other Agencies 6. Terminal Project Evaluation
Sources of Finance

In the next few slides

One very interesting course on Coursera on Project Finance

• Financing and Investing in Infrastructure

Funding sources
Keys Aspects to Project finance

• Key to any project finance is to use a right mix of debt and

equity
• There should be a right mix of foreign currency and rupee loans
• There should be flexibility in respect of switching from foreign
currency to rupee loan and vice versa
• It is important that due care is taken in drafting the documents
concerning the financing of the project
 Basic Differences between Equity and Debt

Equity
■ Equity shareholders have a residual ■
claim on the income and the wealth of
the firm.
■ Dividend paid to equity shareholders is ■
not a tax deductible payment.
Debt
Creditors (suppliers of debt) have a fixed
claim in the form of interest and principal
payment.
Interest paid to creditors is a tax deductible
payment.

■ Equity ordinarily has indefinite life. ■ Debt has a fixed maturity.

■ Equity investors enjoy the prerogative ■ Debt investors play a passive role – of
to control the affairs of the firm. course, they impose certain restrictions on
the way the firm is run to protect their
interest.
Key Factors in Determining the Debt - Equity Ratio

The key factors in determining the debt-equity ratio for a project are:
• Cost of capital
• Nature of assets
• Business risk
• Norms of lenders
• Control considerations
• Market conditions
 A Checklist

Use more equity when Use more debt when

■ The corporate tax rate applicable is ■
negligible.
■ Business risk exposure is high. ■ Business risk exposure is low.
■ Dilution of control is not an ■
important issue.
■ The assets of the project are ■
important issue.
■ The assets of the project are mostly ■
intangible.
■ The project has many valuable ■
growth options.
The corporate tax rate applicable is
high.
Dilution of control is an issue.
Dilution of control is an issue.
The assets of the project are mostly
tangible.
The project has few growth options.
Equity Capital

• Contribution made by the owners of business, equity share holders

• Enjoys the rewards & bears the risk of ownership
• Liabilities limited to capital contribution
• Permanent capital
• Does not involve any fixed obligation for payment of dividend
• Cost of equity capital is high (dividend are not tax deductible )
• Cost of issuing equity capital is high
Equity capital (Continued)

• Authorized capital
• Issued capital
• Subscribed capital
• Paid-up capital
• Par value/ Face value
• Issue price-At par, premium or discount
• Book value
• Market value
Preference Capital

• Has characteristics of equity capital and some attributes of debt

• Dividend is not a tax deductible payment
• Rate of preference dividend is fixed
• TYPES
• Cumulative & non cumulative PS (Dividend)
• Participating & non participating PS (In profits)
• Redeemable & non redeemable PS
• Convertible & non convertible PS
Debentures

• Emerged as an important source of project financing

• TYPES
• Non convertible Debentures
• Partially convertible Debentures
• Fully convertible Debentures
Rupee Term Loans

• Provided by financial institutions & commercial banks

• Secured borrowing for new projects, expansion, modernization
& renovation scheme of existing units
• Repayable over a period of 8-10 years
• Rate of interest is fixed
Foreign currency Term Loans and Deferred credit

• Foreign currency Term Loans

• Financial institutions provide foreign currency term loans for meeting
the foreign expenditure import of plant, machinery and equipment and
also towards payment of foreign technical know-how fees.
• Deferred credit
• Suppliers of machinery provide deferred credit facility under which
the payment of machinery is made over a period of time.
• Normally issued with a bank guarantee furnished by buyer.
Bank credit , Public Deposits

• Bank credit
• Commercial banks in the country serve as the single largest source to
business firms
• Public Deposits
• Companies have been receiving public deposits for a long time to meet
the medium term & short term financial requirements
• Rate of interest offered is more than that offered by banks
• Cost of deposit to company is less that cost of borrowing from the bank
Government Subsidies, Unsecured loans

• Government Subsidies
• Subsidies provided by central and state govt. to industrial units located
in backward areas
• State subsidies varies between 5% to 25% of the fixed capital
investment of project
• Unsecured loans
• Provided by promoters to fill the gap between the promoters
contribution required by Financial Institutions and the equity capital
subscribed to by the promoters
• Subsidiary to Institutional loans
• Rate of interest is less than rate of interest on the Institutional loans
Leasing and Hire Purchase Finance

• With the emergence of scores of finance companies engaged in

the business of leasing and hire purchase finance, it may be
possible to get a portion, albeit a small portion, of the assets
financed under a lease or a hire purchase arrangement.
Mezzanine Financing

• Mezzanine financing is a hybrid of debt and equity financing that gives the
lender the right to convert to an equity interest in the company in case of
default, generally, after venture capital companies and other senior lenders are
paid.
• Mezzanine financing is a way for companies to raise funds for specific projects
or to aide with an acquisition through a hybrid of debt and equity financing.
• This type of financing costs more as compared to typical corporate debt, often
paying between 12% and 20% a year.
• Mezzanine loans are most commonly utilized in the expansion of established
companies rather than as start-up or early-phase financing.
 Characteristics of Mezzanine loans

• Mezzanine loans are subordinate to senior debt but have

priority over both preferred and common stock.
• They carry higher costs than ordinary debt.
• They are often unsecured debts.
• There is no amortization of loan principal.
(A non-amortizing loan has no amortization schedule because the principal is paid
off in a single lump sum. ... Non-amortizing loans require their principal to be paid
back in one lump sum rather than through regular installments)
Advantages of Mezzanine financing

• Investors–gaining equity in a business or warrants for

purchasing equity at a later date
• mezzanine financing providers receive contractually obligated
interest payments monthly, quarterly, or annually.
• Borrowers prefer mezzanine debt because the interest is
tax-deductible.
Disadvantages of Mezzanine financing

• Owners sacrifice control and upside potential due to the loss of

equity.
• Owners also pay more in interest the longer mezzanine
financing is in place.
• For mezzanine lenders, they're at risk of losing their investment
in the event of bankruptcy.
Working Capital Advances

• Cash credits / overdrafts-Under a cash credit or overdraft

arrangement, a pre-determined limit for borrowing is specified by
the bank. The borrower can draw as often as required provided the
outstanding does not exceed the cash credit/overdraft limit, subject
to the availability of adequate security.
• Loans -These are advances of fixed amounts to the borrower. The
borrower is charged with interest on the entire loan amount,
irrespective of how much he draws. In this respect, this system
differs markedly from the overdraft or cash credit arrangement
wherein interest is payable only on the amount actually utilised.
Working Capital Advances

• Purchase / discount of bills-A bill usually arises out of a trade transaction.

The seller of goods draws the bill on the purchaser. The bill may be either
clean or documentary (a documentary bill is supported by a document of
title to goods like a railway receipt or a bill of lading) and may be payable
on demand or after a usance period.
• Letter of credit-A letter of credit is an arrangement whereby a bank helps
its customer to obtain credit from its (customer’s) suppliers. When a bank
opens a letter of credit in favour of its customer for some specific
purchases, the bank undertakes the responsibility to honour the obligation
of its customer, should the customer fail to do so.
Export Credit Agencies

• Project financing from export credit agencies is generally

available in two forms and often in a combination of both:
• either from the national export-import bank and / or as foreign
aid.
• When tied together they are called mixed credits
Multilateral agencies

• The World Bank, International Finance Corporation and

regional development banks often act as lenders or co-financers
to important infrastructure projects in developing countries.
• In addition, these institutions often play a facilitating role for
projects by implementing programs to improve the regulatory
frameworks for broader participation by foreign companies
and the local private sector.
Viability Gap Funding

• some projects, though economically worthwhile and necessary,

may not be financially viable. To promote such projects, the
government has designed Viability Gap Funding (VGF). It
represents a grant to support projects that are economically
justified but not financially viable.
• VGF is usually limited to 20 percent of the total capital cost of
the project.
Financing infrastructure projects

• Infrastructure projects, which typically provide essential

services, have one or more of the characteristics mentioned
below:
• They are highly capital-intensive.
• They involve huge sunk costs.
• They have a long operating life.
Public Private Partnership

Definitions
• The European Commission: PPP is cooperation between the public authorities
and economic operators.
• The Organization for Economic Cooperation and Development (OECD): PPP is an
agreement between the government and one or more private partners (which
may include the operators and the financiers) according to which the private
partners deliver the service in such a manner that the service delivery objectives
of the government are aligned with the profit objectives of the private partners
and where the effectiveness of the alignment depends on a sufficient transfer of
risk to the private partners.
The arguments in favor of PPP

• Limitations of government resources and capacity to meet the

infrastructure gap
• Need for new financing and institutional mechanisms
• Access to project finance
• Optimum risk allocation system
• International best practices, better technology, innovative
project and financial designs etc
The arguments against PPP

• Concerns regarding its viability and effectiveness especially in big

infra, which requires significantly large investment for a long period
• Who will be in charge of the cost recovery from the projects whose
gains due to their public nature are often indivisible?
• Loaded against projects which a) promote basic social, as against
purely economic, objectives b) result in economic gains which cannot
be appropriated through user charges and c) trigger with a time lag a
cumulative process of regional or national economic development
The arguments against PPP

• Though the net economic benefits from a road project are

positive, it may not be commercially viable.
• There is a tendency for the private investment to be less than
the optimal level.
• Government bears the cost of Project feasibility study, Land
acquisition for road, Land for the right of way and wayside
amenities, Environment clearance, cutting of trees etc.
Risks in PPP

• Pre-operative task risks: Delays in land acquisition, Financing risks,

Planning risks
• Construction phase risks: Design risk, Construction risk, Approvals
risk, Additional Site Risk
• Operation phase risks: Technology risk, Operations and maintenance
risk, Traffic risk, Payment risk, Financial risk
• Handover risks
• Other risks: Force Majeure, Concessionaire event of default,
Government event of default, Change in law
PPP MODELS
• Build, Operate and Transfer
(BOT)
Under this category, the private
partner is responsible for designing,
building, operating (during the
contracted period) and transferring
back the facility to the public sector.
Build, Own, Operate (BOO) or Build,
Own, Operate and Transfer (BOOT)
This is a variation of the BOT model,
except that the ownership of the newly
built facility will rest with the private
party during the period of contract
Lease, Operate and Transfer (LOT)
Already existing facility is entrusted to
the private sector partner for efficient
operation, subject to the terms and
conditions decided by mutual agreement.
Design, Build, Finance and Operate
(DBFO) or
Design, Build, Finance, Operate and
Maintain (DBFOM)
The private party assumes the entire
responsibility for the design, construct,
finance, and operate or operate and
maintain the project for the period of
concession. These are also referred to as
“Concessions”.