I did the homework with Melih TURLİN (2431963)

1)
Project financing offers a varios advantage over traditional corporate financing for large-scale
projects. In corporate loans, company's entire asset portfolio serves as collateral. Project financing
differs from traditional corporate loans in this way. In project financing, a separate legal entity, known
as the project company or special purpose vehicle (SPV), is established.
In corporate financing, project cash flow gets mixed with the company's overall cash flow,
creating a potential for conflicting interests. This "agency problem" can arise when management
prioritizes uses for the combined cash flow that might not align with the project's debt obligations.
Project financing solve this problem by segregating the project's cash flow.
Project financing also benefits from a risk-sharing structure. Project financing distributes risk
among multiple parties. This risk mitigation may help to decrease borrowing costs (WACC) compared
to corporate financing.

2)
a) Underinvestment problem occurs when a project with a positive NPV for shareholders becomes
unattractive for the company due to a high risk. So, the cost of debt increases, making the project
appear unprofitable from the company's perspective. Project financing mitigates this by establishing a
separate venture or entity. Each project is evaluated on its own conditions, it enables potentially high-
return and low-risk projects despite a company's high risk profile. Additionally, project financing can
leverage debt more effectively. Because lenders focus only on the project's cash flow, so a higher ratio
of debt to equity might be not problematic. This means that investors who put in equity could
potentially earn more returns.
b) Agency cost of free cash flow arises when managers have freedom to use the company's overall
cash flow, which might include funds generated by a specific project. This can lead to a conflict of
interest. Managers might prioritize other uses for the cash flow and don’t use the monet for best
interest of shareholders. Project financing eliminates this issue by creating a seperate project company
with its own cash flow.
c) Information asymmetry issues is stem from communication gap between a company and its
investors. In traditional settings, companies might hesitate to share positive project developments with
a large pool of investors because of competitional issues. Project financing, with its smaller, more
specialized investor group, provide a more open communication environment. So, it means that more
transparent environment. This transparency allows for better decision-making in the project lifecycle.

3)

Let's assume the following loan conditions:

Loan amount: £100,000,000

Agreement is LIBOR based.

Agreement Rate: LIBOR + 1%

Cap Rate: 7%
So, the project owner wants to hedge against the risk of LIBOR rates rising above 7%. The effective
rate after that point will be 8% (7% from cap + 1% from agreement)

LIBOR Rate Project Interest Rate (LIBOR+1%) Effective Rate (Interest Cost)
1% 2% 2%
3% 4% 4%
7% 8% 8%
8% 9% 8%
15% 16% 8%
120% 121% 8%

4)

Let's assume the following loan conditions

Loan amount: £100,000,000

Agreement is LIBOR based.

Agreement Rate: LIBOR + 1.5%

SPV will sign a swap agreement with a swap counterparty. Conditions:

Principal amount: £100,000,000 (same with the loan amount)

Interest Rate that SPV Will Pay: 6%

Interest Rate that SPV Will Receive: LIBOR Rate

LIBOR Rate Project Interest Rate Interest Rate of Interest Rate of Effective Rate
(LIBOR+1.5%) SWAP (Pay) SWAP (Receive) (Interest Cost)
1% 2.5% 6% 1% 7.5%
3% 4.5% 6% 3% 7.5%
6% 7.5% 6% 6% 7.5%
7% 8.5% 6% 7% 7.5%
15% 16.5% 6% 15% 7.5%
120% 121.5% 6% 120% 7.5%

Ahmet ER
2431518