Here is a list of topics to focus on for subjective questions:

1. Risks in project finance

2. Stakeholders
3. PPP
4. Pure Play Method
5. Key Project Documents
6. Capital Budgeting Techniques
Q1 Risks in project finance

Construction risk

Ensuring the proper and timely construction of the project is therefore an absolutely fundamental
consideration for all of the parties.

● Can the project be completed and operated according to the agreed standards and
specifications?
● Can the project be completed on budget?
● Can the project be completed on schedule?
● Which party should assume the risk and liability for construction delays, costs overruns
and performance shortfalls?

Operational risk

Once the project is constructed it must be operated and maintained in such a manner that the project
company can comply

● Whether a competent project operator is engaged ?

● Whether proper insurance coverage is obtained ?
● Agreeing to extensive reporting obligations and inspection ?

Supply risk

● Many projects rely on raw materials or commodities for the project to work.
● For example, a coal or natural gas fired power plant requires access and rights to an
uninterrupted supply of coal or natural gas.
● The prices of these commodities can be volatile and their availability for the life of the
project is not assured.

Offtake risk

● An important consideration for the parties is whether the project will generate the
expected revenues or, at least, sufficient revenues to service the debt and pay the project
company’s expenses (and, preferably, to generate a return for the project sponsor).
● In addition, the parties must consider how any revenue shortfalls will be addressed.

Repayment risk

● This can occur if the project company generates insufficient revenues , and has
obligations to third parties

Political risk
 ●
Some of the main risks a project located in a less economically developed country faces
are political risks (also known as country risks), which includes war or civil disturbance,
expropriation, exchange controls or other types of currency transfer limitations
Q2 STAKEHOLDERS IN PROJECT FINANCE

Sponsors
● The equity investors and owners of the Project Company
● In PPP projects, the Government/Procurer may also retain an ownership stake in the
project and
therefore also be a sponsor.

Procurer

● Only relevant for PPP – the Procurer will be the municipality, council or department of
state responsible for tendering the project to the private sector, running the tender
competition, evaluating the proposals and selecting the preferred sponsor consortium to
implement the
project.

Government
● The government may contractually provide a number of undertakings to the Project
Company, Sponsors or Lenders which may include credit support in respect of the
Procurer’s payment
obligations (real or contingent) under a concession agreement.

Contractors
● The substantive performance obligations of the Project Company to construct and
operate the project will usually be done through engineering procurement and
construction (EPC) and
operations and maintenance (O&M) contracts respectively.

Feedstock providers and Offtakers

● Typically found in utility, industrial, oil and gas and petrochemical projects.
● One of the parties will be contractually obligated to provide feedstock (raw materials or
fuel) to the
project in return for payment.
 ● One of the parties will be contractually obligated to offtake / purchase some or all of the
product
or service produced by the project.
● Feedstock/Offtake contracts are typically a key area of lender due diligence given their
critical
role in the overall economics of the project.

Lenders
● Typically including one of more commercial banks and/or multilateral agencies, export
credit agencies or bond holders.

ADDITIONAL
Stakeholders:

3. Special Purpose Vehicles (SPV)

4. Financial Institution/Banks

5. Customers or Off Takers

6. Suppliers or Vendors

7. Contractors
Q3 PPP in project finance

● PPP are “innovative methods used by the public sector to contract with the private sector
who bring their capital and their ability to deliver projects on time and to budget, while the
public sector retains the responsibility to provide these services to the public in a way
that benefits the public and delivers economic development and improvement in the
quality of life”

● Creation of durable and high quality infrastructure is a prerequisite for rapid economic
development and requires sustained investment supported well by technological
innovation, skilled workforce and excellent project management.

● For governments alone to bring together all these elements is not always possible.

● This realization has brought together the public and the private sector in a mutually
beneficial relationship in the form of Public Private Partnerships (PPPs) to execute not
only infrastructure projects but also engender innovative strategies for social
development.

● Public Private Partnerships have emerged as one of the latest and successful
instruments of public finance, and are increasingly adopted by both developed and
developing countries for building and rebuilding their infrastructure framework

There are no. of types PPP model

● Build – Operate – Transfer (BOT)

● Build – Own – Operate (BOO)
● Build – Own – Operate – Transfer (BOOT)
● Design – Build
● Design – Build – Finance
● Design – Build – Finance – Operate (DBFO)
● Design – Build – Finance – Maintain (DBFM)
● Design – Build – Finance – Maintain – Operate (DBMFO)
● Design – Construct – Maintain – Finance (DCMF)
● O & M (Operation & Maintenance)
Q4 Pure Play Method
Pure play method is an approach used to estimate beta coefficient of a company whose
stock is not publicly traded. It involves finding beta coefficient of a pure play, a public
listed company having single business focus; unlevering it and then relevering it at the
first company's capital structure to find the beta coefficient.

Objective - To estimate "beta" for the project/private company so that CAPM can be used to
estimate the cost of equity or required return on equity.

Beta - systematic risk (non-diversifiable)

Statistically, beta can be calculated using covariance (stock price, market price) / variance
(market price)

---------- Sector risk/Business risk/Industry risk/Operational

risk
Beta is a function of
---------- Financial risk/Leverage risk
Pure Play Method:

1. Unlevering Beta - remove the leverage risk - Unlevered Beta/Pure Beta/Asset Beta = Equity
Beta or Levered Beta / (1+(1-Tax Rate) x (Debt/Equity)) - All data will belong to a comparable
company

2. Relevering Beta - reintroduce the leverage risk - Relevered Beta/Project Beta = Unlevered
Beta/Asset Beta x (1+(1-Tax Rate) x (Debt/Equity)) - All data will belong to your project
Q5 WHAT ARE KEY PROJECT DOCUMENTS

The project financing documents can be broadly categorized as

(a) Project documents (the documents for design, construction, operation and maintenance
of a project);
(b) Financing documents (the documents for financing and securing a project).

Project documents

○ the investment agreement (for equity investment by the sponsors, its timing and form)
○ project management agreement (agreement for management of the project company),
○ sponsor or JV agreement (agreement for rights, responsibilities and obligations of the
sponsors and their inter-se relationships)
 ○ The Operational Agreement is the main agreement under which certain rights/concession
is granted by the Government Authority in favour of the project company to develop,
construct and operate the facility.
○ An EPC contract is a construction contract that provides for complete engineering,
construction, procurement and commissioning of project facility by the project company
by a certain date for a fixed price, the performance of which is guaranteed by the project
company for a certain duration.
○ O&M Contract - for operation and maintenance of the project
○ Supply Contract - provides for supply of raw materials, fuel or other inputs necessary for
operating the facility
○ Off-take agreement - provides constant revenue stream to the project company for timely
repayment of debt to the lenders and return to the sponsors

Financing Documents

● Funding provides for funding of the project

●- agreement agreement between the sponsor and the project company for equity investment
by the Investment project sponsor
● agreement Intercreditor agreement - is an agreement that deals with the
competing interest of the creditors in the project company
● Security Agreement - provides for grant of all the security interests
in the project company in favour of lenders for repayment of debts
and interest thereon.
● Pledge Agreement - in this agreement the sponsors pledge all their
shares in the project company to lenders as security for
performance of their obligations under the financing agreement.
Q6 Capital Budgeting Techniques

Payback period method:

It purely emphasizes on the cash inflows, economic life of the project and the investment made in the
project, with no consideration to time value of money.

Payback period = Cash outlay (investment) / Annual cash inflow

Accounting rate of return method (ARR):

The rate of return is expressed as a percentage of the earnings of the investment in a particular project. It
works on the criteria that any project having ARR higher than the minimum rate established by the
management will be considered and those below the predetermined rate are rejected.

This method also ignores time value of money and doesn’t consider the length of life of the projects.

ARR= Average income/Average Investment

Discounted cash flow method:

The discounted cash flow technique calculates the cash inflow and outflow through the life of an asset.
These are then discounted through a discounting factor. The discounted cash inflows and outflows are
then compared. This technique takes into account the interest factor and the return after the payback
period.

Net present Value (NPV) Method:

This is one of the widely used methods for evaluating capital investment proposals. In this technique the
cash inflow that is expected at different periods of time is discounted at a particular rate. The present
values of the cash inflow are compared to the original investment. If the difference between them is
positive (+) then it is accepted or otherwise rejected. This method considers the time value of money and
is consistent with the objective of maximizing profits for the owners. However, understanding the concept
of cost of capital is not an easy task

NPV = PVB – PVC

PVB = Present value of benefits

PVC = Present value of Costs

Internal Rate of Return (IRR):

This is defined as the rate at which the net present value of the investment is zero. The discounted cash
inflow is equal to the discounted cash outflow. This method also considers time value of money. It tries to
arrive to a rate of interest at which funds invested in the project could be repaid out of the cash inflows.
However, computation of IRR is a tedious task.

It is called internal rate because it depends solely on the outlay and proceeds associated with the project
and not any rate determined outside the investment.

If IRR > WACC then the project is profitable.

If IRR > k = accept

If IR < k = reject