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Infrastructure Project Finance

Investment Decisions
• The amount of cash flow available to meet annual
interest and principal payments on debt.

• This ratio should ideally be over 1. That would

mean the project is generating enough income to
pay its debt obligations.

• In general, it is calculated by:

Amount available to repay (Service) debt/ Debt to
be repaid
i.e (PADT+ Dep+ Interest on debt) / (Interest on
debt + Principal)
• A DSCR of less than 1 would mean a
negative cash flow. A DSCR of less than 1,
say .95, would mean that there is only
enough net operating income to cover 95%
of annual debt payments.
• Generally DSCR greater than 1.5 to 2
preferred. However this is not a set rule
Project Risks
• Capital budgeting / investment decision techniques were
discussed assuming that projects do not involve any risks
• However, in real situation risks exist -inability or limitation
of the decision maker to anticipate risks and include them in
project forecasts
• Large number of events influence forecasts which cannot be
generalized. However, Broadly can be grouped as follows.
– Risks related to General economic conditions
• Govt. Fiscal policies, political changes, social conditions etc
– Sector specific factors
• Change in sector policy, innovations in the technologies in the sector,
changes in the cost of raw material etc
– Project Specific factors
• Change in management, natural disaster, labour issues etc.
Project Risks
• Project Structuring
• Contracts and Agreements
• Conventional Techniques to handle risks
– Payback
– Risk Adjusted discount rate
– Certainty equivalent coefficient.
Project Risks
• Payback
– Oldest and commonly used method
– Used more often as risk handling method rather than investment
– Payback period fixed considering risk factors based on sector
– Usually prefers short payback to longer ones.
• Intuitive
• Assumption that project would go exactly as per plans for certain fixed
period (payback period)
• Ignores time value of money
Project Risks
• Risk Adjusted discount rate
– Riskier projects may have higher uncertainty of returns and hence
higher risk premium.
– Risk premium rate to be added to the risk free rate while
discounting the cash flows
NPV= -C0+C1/(1+kf+kr)+C2/(1+kf+kr)^2…..
– If IRR method used then IRR>= kf+kr.
• No easy way of estimating risk adjusted discount rate
• Does not make all types of risk adjustment in the cashflows that are
forecast over future years
Project Risks
• Certainty equivalent coefficient
– Riskier projects may have conservative cash flows.
NPV= -C0+C1*α1/(1+kf)+C2* α 2/(1+kf)^2…..
– If IRR method used then IRR>= kf. However conservative
cashflows will be used
• Intuitive α
• If forecasts pass through several layers in larger organization
forecasts may become ultra conservative
• Some good cashflows may also get reduced in the process