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All-In-One

Project Financing Methods


Full Name: Mahmood Oskooei
Tehran University MBA
Code: 38
Date: 28/01/2015
Email: moskooie@yahoo.com
Contents

Introduction
Project Financing Methods
How To Chose The Best
Introduction
Introduction- History
History of project financing:
Project financing techniques date back to at least 1299 A.D. when the English Crown
financed the exploration and the development of the Devon silver mines by repaying the
Florentine merchant bank, Frescobaldi, with output from the mines. The Italian bankers held a
one-year lease and mining concession, i.e., they were entitled to as much silver as they could
mine during the year. In this example, the chief characteristic of the project financing is the use
of the projects output or assets to secure financing. Another form of project finance was used to
fund sailing ship voyages from Roman and Greek time until the 17th century. Investors
would provide financing for trading expeditions on a voyage-by voyage basis. Upon return, the
cargo and ships would be liquidated and the proceeds of the voyage split amongst investors.
One of the Iranian examples could be IRAN MELI BANK

Roman &
Greek until 17th
1299 A.D
centuries
Florentine Silver sailing ship
merchant
voyages and
bank
their cargo
Silver mining Sailing ships & cargo
Introduction- Definitions
What is project and project financing:
Project: A project is a temporary endeavor undertaken to create a unique product, service, or
result. The temporary nature of projects indicates that a project has a definite beginning and end.
The end is reached when the projects objectives have been achieved or when the project is
terminated because its objectives will not or cannot be met, or when the need for the project no
longer exists. A project may also be terminated if the client (customer, sponsor, or champion) wishes
to terminate the project.
Project financing: is a form of debt or equity structure that relies primarily on the project's cash flow
for repayment, with the project's assets, rights, and interests held as secondary security or collateral.

Worldwide Project Shares


America
Aferica North America
Middle East with 18.5% has
Europe
34.6% 25.2% the highest rate
Asia & Pacific of project
5.4% financing share
9% in whole world.
25.8%
Introduction- Worldwide
What are the current worldwide project finance segmentation :
The major share of recent days project finance segments are focused on
infrastructures. The main reason is as the following facts:
Improvement loop
Infrastructure
GDP Productivity is enables funding
Project
is driven by boosted by for Finance

Power Worldwide Project Shares By Sector


Transportation 2.7% 2.1%
3.2%
Oil & Gas
0.9%
3.8% 8.2%
Petrochemicals During 2011-2013
investment on
Leisure, real estate, property
34.3% agriculture has
been reduced to
Industry 5.3%
0% and energy
Water and sewerage and transportation
19.5% have maintained
Mining 19.9% the constant top
three
Telecommunications

Waste and recycling


Introduction- Motivations I
Project financing motivations:
Beside its direct impact on national GDP there are few other fact and figures which
makes clear why project financing is a necessity.

Risk Reduction
Resources & Balance Sheet Political risk reduction with local
financing.
Resource reservations and
Financial, technical or even opportunity costs.
manpower resources Technical risk reduction.
limitations. Macro and Micro economic risk
Lack of influential resources. reduction.
Limitation or lack of willingness Deflating bankruptcy risk.
to show big investments in Risk is too large for just one
company.
balance sheets.
Risk cross check the risks from
investors angel.
Reducing vertical or horizontal risks.
Introduction- Motivations II
Project financing motivations:

Income & Tax

To include financing costs in Timing


balance sheets toward lesser
tax and higher income. To influence the cost factor in order
Using benefits of tax exemption to finish the projects in shorter time.
as kind of negotiation leverage If time is more critical.
for better financing. More precise timing milestone
Benefiting special projects tax setting, monitoring and control.
exemptions toward more
economical benefits.
Reduction of new conflict of
interest with current partners.
Introduction- Motivations III
Project financing motivations:

Strategy Others

Project is spun-off as separate Obtaining capital and yet has


company (publicity, risk, control.
Influencing nation wide Monetary &
competitors and regulations). Fiscal Policies. For instance reduce
Increased accountability to free cash flow through high debt
investors. service also reducing society
Long term contracts and unemployment rate.
relations (purchase and supply) Traditional monitoring mechanisms
toward strategic partnerships. such as takeover markets, staged
Insurance costs reduction by financing, product markets absent in
presence of well-known parties. large scales.
Concentrated ownership provides
Benefiting bigger partners critical monitoring.
leverages (bank negotiation, Generating higher financial cash
insurance and ). flow and turnover.
Project Financing
Methods
Methods- Categories
Financing methods categories:
Different vehicles could be used for project financing propos. In general there are just two
types of financing methods:

Financing
Methods

Equity Debt

Each of the categories includes variety of approaches with their related advantages,
disadvantages/ risks and their possible foreseen solutions which their details are in the next
pages of this presentation starting with equity.
Methods- Stock
Stocks:
There are different types of stocks for the propose of project financing each with their own
specific advantages and risks.

Common stock: is a form of corporate equity ownership, a type of security. The terms "voting
share" or "ordinary share" are also used frequently in other parts of the world; "common stock"
being primarily used in the United States. It is called "common" to distinguish it from preferred
stocks.

Advantages Disadvantages/Risks Solutions


It has the least advantage of Some how complicate and time Solid BP with the out most deviation
dividends in compare to other types. consuming. standards also taking into
consideration the needed time bounds.
In case of bankruptcy this method Limitation in amount upon already Could be complement solution of
has the least rights and risk. invested sum in the project. project financing.
High publicity could gain credit for High publicity could create huge risk High level of project management
the future projects of the same for not precise/ unsuccessful project. experience and public relation should
group in case of successful project. be in place.
Higher level of democracy in Stock holders could vote for choosing None voting common stocks could be
management, also it is long term BD and gain more control on project sold and in future they could be bought
credit with requirements equal to and company back by major owners.
BEP (break even point) outcomes
Methods- Stock & Bond
Preferred stock : is a type of stock which may have any combination of features not
possessed by common stock including properties of both an equity and a debt instrument,
and is generally considered a hybrid instrument. It should be mentioned it has different varieties.

Advantages Disadvantages/Risks Solutions


It is long term credit with They have priority in comparison to common To motivate their change to common
requirements equal to BEP stock holders rights including minimum fixed stocks and then to follow the same
(break even point) outcomes. dividends and also bankruptcy right. steam line as common stock foreseen.
Gains more credit and rating More complicated than common stock and Solid BP, higher level of management
for project owner entities. requires specific rating. experience and public relation are
needed.

Bond:
Is an instrument of indebtedness of the bond issuer to the holders. It is a debt security, under
which the issuer owes the holders a debt and, depending on the terms of the bond, is obliged to
pay them interest (the coupon) and/or to repay the principal at a later date, termed the maturity
date. Interest is usually payable at fixed intervals (semiannual, annual, sometimes monthly). Very
often the bond is negotiable, i.e. the ownership of the instrument can be transferred in the
secondary market. This means that once the transfer agents at the bank medallion stamp the
bond, it is highly liquid on the second market. Thus a bond is a form of loan or IOU (sounded "I
owe you"). Bonds provide the borrower with external funds to finance long-term investments, or,
in the case of government bonds, to finance current expenditure.
Methods- Bond I
Bond:

It has different types with due advantages and risks. However, in general nature their major
advantages and risks are the same as the following table;

Advantages Disadvantages/Risks Solutions


Kind of loan with fixed interest If the coupon (interest rate) is already fixed Solid BP with the least deviation
rate. then under any condition it should be paid beside precise BEP calculation should
on time. be in place.
Long/ short kind of loan for It has its own limitations and usually cannot Could be complement solution of
project funding. Also paid be whole funding remedy (as usual case project financing. Also expert
interest could be considered 20% of project investment). Also it is managing and finance team should be
as costs in accounting complicated enough. in place.
balance sheets to reduce tax.
Interesting for investors since High responsibility in case of project All requirements of solid project
it is highly equitable in the bankruptcy toward bond holders. elements should be in place and this
market . method of financing should be less
preferred.
Like stock it has market price It has much more publicity and its related Strong project management plan and
also and could be sold higher concerns also direct effect on the project execution should be conducted and all
than its purchased price. An real and market value. the progress and success cased
interesting point for investors. should be broadly announced in public.
Methods-Bond II
Different Types Of Bonds:

Fixed rate bond: have a coupon that remains constant throughout the life of the bond. A
variation are stepped-coupon bonds, whose coupon increases during the life of the bond.
Floating rate notes (FRNs, floaters): have a variable coupon that is linked to a reference
rate of interest, such as LIBRO or Euribor. For example the coupon may be defined as
three month USD LIBOR + 0.20%. The coupon rate is recalculated periodically, typically
every one or three months.
Zero-coupon bond (zeros): pay no regular interest. They are issued at a substantial discount
to par value, so that the interest is effectively rolled up to maturity (and usually taxed as such).
The bondholder receives the full principal amount on the redemption date. In other words, the
separated coupons and the final principal payment of the bond may be traded separately.
High-yield bond (junk bonds): are bonds that are rated below investment grade by the credit
rating agencies. As these bonds are more risky than investment grade bonds, investors expect to
earn a higher yield.
Methods-Bond III
Convertible bond: let a bondholder exchange a bond to a number of shares of the issuer's
common stock. These are known as hybrid securities, because they combine equity and debt
Features.
Exchangeable bond: allows for exchange to shares of a corporation other than the issuer.
Inflation-indexed bond (linkers) (US) or Index-linked bond (UK): in which the principal
amount and the interest payments are indexed to inflation. The interest rate is normally lower than
for fixed rate bonds with a comparable maturity (this position briefly reversed itself for short-term
UK bonds in December 2008). However, as the principal amount grows, the payments increase
with inflation. The UK was the first sovereign issuer to issue inflation linked gilts in the 1980s.
Treasury Inflation-Protected Securities (TIPS) and I-bonds are examples of inflation linked bonds
issued by the U.S. government.
Subordinated-bond: are those that have a lower priority than other bonds of the issuer in case
of liquidation. In case of bankruptcy, there is a hierarchy of creditors. First the liquidator is paid,
then government taxes, etc. The first bond holders in line to be paid are those holding what is
called senior bonds. After they have been paid, the subordinated bond holders are paid. As a
result, the risk is higher. Therefore, subordinated bonds usually have a lower credit rating than
senior bonds.
Perpetual bond perpetuities or 'Perps: They have no maturity date.
Methods-Bond IIII
. earer bond: is an official certificate issued without a named holder. In other words, the person
B
who has the paper certificate can claim the value of the bond. Often they are registered by a
number to prevent counterfeiting, but may be traded like cash. Bearer bonds are very risky
because they can be lost or stolen. Especially after federal income tax began in the United States,
bearer bonds were seen as an opportunity to conceal income or assets.

A government bond: also called Treasury bond, is issued by a national government and is not
exposed to default risk. It is characterized as the safest bond, with the lowest interest rate. A
treasury bond is backed by the full faith and credit of the relevant government.

Serial bond: is a bond that matures in installments over a period of time. In effect, a $100,000,
5-year serial bond would mature in a $20,000 annuity over a 5-year interval.

Dual Currency Bond: a debt instrument in which the coupon and principal payments are made
in two different currencies. The currency in which the bond is issued, which is called the base
currency, will be the currency in which interest payments are made. The principal currency and
amount are fixed when the bond is issued.
Methods- Loan I
Loan

In finance, a loan is a debt provided by one entity (organization or individual) to another entity at
an interest rate, and evidenced by a note which specifies, among other things, the principal
amount, interest rate, and date of repayment. A loan entails the reallocation of the subject
asset(s) for a period of time, between the lender and the borrower. In a loan, the borrower
initially receives or borrows an amount of money, called the principal, from the lender, and is
obligated to pay back or repay an equal amount of money to the lender at a later time. The loan
is generally provided at a cost, referred to as interest on the debt, which provides an incentive
for the lender to engage in the loan. In a legal loan, each of these obligations and restrictions is
enforced by contract, which can also place the borrower under additional restrictions known as
loan covenants. In general all types of loans have almost same nature of advantages and risks
with their possible remedies. As the following table;

Advantages Disadvantages/Risks Solutions


From taxation point of view the paid All the payments including Solid BP with the least deviation beside
interest could be considered as cost and interest and principals should be precise BEP calculation should be in
deducted from total profit, so lesser tax paid on their due dates and place.
would be paid and more profit gained. maturities.
The project could be financed with short- Good financial and business Beside above mentioned necessities as
mid or long term maturity time upon our history is required beside all B plan needed guarantees should be
choice. Furthermore loan providers are securities. Project wind up could considered. Also from long enough time
usually large organizations with practical happen since payment are not high level of turn over and financial
regulations. link to project BEP. outstanding should be foreseen.
Methods- Loan II
Different Types Of Loans

Project financing loan: banks or financial institutes makes or guaranties a loan to a project.
They carefully analyzes the economic, technical, marketing, and financial soundness of the
Project (upon provide FS, BP and project owners backgrounds) to determine its creditworthiness.
There must be adequate cash flow to pay all operational costs and to service all debt. It is
expected that collateral, in the host country and/or locally will be provided to secure the loan. The
project sponsors are expected to support the overseas operation until certain specific tests for
physical completion, operational implementation, and financial soundness are met. To the extent
that project financing is appropriate, sponsors may not need to pledge their own general credit
beyond required completion undertakings. As usual practice project should not have loose ends.
Which means even after project is operational all the purchases and sales (of final product)
should be guaranteed upon long term contracts. Furthermore, minimum 15% of the project
finance already should happened by means of land, machinery or any other project related
requirements other than hard cash. Usual rate of interest of international bank are around 1.5 up
.to 2% and depending to the country the insurance related costs could be between 2-4% (in total in
worse scenario max 6%).
Methods- Loan III
Term loan: A term loan is simply a loan provided for business purposes that needs to be paid
back within a specified time frame. It typically carries a fixed interest rate, monthly or quarterly
repayment schedule - and includes a set maturity date. Term loans can be both secure (i.e. some
collateral is provided) and unsecured. A secured term loan will usually have a lower interest rate
than an unsecured one.
Depending upon the repayment period this loan type is classified as under:
a. Short term loan: repayment period less than 1 year.
b. Medium term loan: repayment period between 1 to 3 years.
c. Long term loan: repayment period above 3 years.

Band overdraft facility: A Bank Overdraft Facility refers to the ability to draw funds greater than
are available in the company's current account. The actual size of the facility and the interest to be
paid on overdrafts is typically agreed to prior to sanction. An overdraft facility is considered as a
source of short term funding as it can be covered with the next deposit.

.Letter of credit (LC): is a document issued by a financial institution assuring payment to a


seller provided certain documents have been presented to the bank. This ensures the
payment will be made as long as the services are performed (usually the dispatch of
goods). Hence, a Letter of Credit serves as a guarantee to the seller that he or she will be
paid as agreed. It is often used in trade financing when goods are sold to overseas
customers or the trading parties are not well known to each other. LC has different types but we
will just cover those which are most suitable for project finance with longer term of payment as the
following page:
Methods- Loan IIII
A) Differed payment (usance LC): In the case of a letter of credit with deferred payment, the
payment to the seller is not made when the documents are submitted, but instead at a later time
defined in the letter of credit. In the Far East, this kind of documentary credit is also known as a
"usance L/C.

B) Acceptance LC: In the case of an acceptance credit, the payment to the seller is not made
when the documents are submitted, but instead at a later time defined in the letter of credit. The
seller can request a discount from the bank that accepted the bill of exchange, or from another
bank, and thus draw the amount of the bill minus the discount at any time after the documents
have been submitted.

C) Standby LC: the payment to the seller is not made when the documents are submitted, but
instead at a later time defined in the attached contract to the LC. However, seller could evoke
payment of LC by bank whenever buyer has failed the payment.

.
Methods- Loan V
Bank Guarantee (BG): is a 'letter of guarantee' issued by a bank on behalf of its customer, to a
third party (the beneficiary) guaranteeing that certain sum of money shall be paid by the bank to
the third party within its validity period on presentation of the letter of guarantee. A letter of
guarantee usually sets out certain conditions under which the guarantee can be invoked. Unlike a
line of credit, the sum is only paid if the opposing party does not fulfill the stipulated obligations
under the contract. A bank guarantee is usually used to insure a buyer or seller from loss or
damage due to non-performance by the other party in a contract.

SME collateral free loan: This is usually a business loan offered to SMEs and are collateral-
free or without third party guarantee. Here the borrower is not required to provide collateral to
avail the loan. It is made available to SMEs in both the start-up as well as existent phases to
serve working capital requirements, purchase of machines, support expansion plans. However, it
is to be noted that small businesses involved in retail trade are not eligible for these type of loans.

Construction equipment/ commercial vehicle loans: Construction Equipment loans are


.provided for purchase of both new and used equipment like excavators, backhoe loaders, cranes,
higher end construction equipments etc. The tenure of such loans vary from 12 to 60 months
depending upon the deal and nature of repayment capacity. This is usually a secured loan where
the machine itself is hypothecated until the loan is repaid. The same definition is valid for
commercial vehicles such as trucks, buses, tippers, light commercial vehicles.
Methods- Counter Trade I
Counter trade:
Means exchanging goods or services which are paid for, in whole or part, with other goods
or services, rather than with money. Countertrade also occurs when countries lack sufficient
hard currency, or when other types of market trade are impossible. A significant chunk of
international commerce, possibly as much as 25%, involves the barter of products for other
products rather than for hard currency.
Types of counter trade: all advantages and disadvantages have been discussed from
point of view of project owner and at the point the method has been accepted mutually.
Barter: exchange of goods or services directly for other goods or services without the use
of money as means of purchase or payment.

Advantages Disadvantages/Risks Solutions


Project production sales could be Price fluctuation should be considered in Selling price of the product/
secured in advance also international advance and Right pricing too. Increase of service should be according
market share would be awarded with product/service market price in future if selling to the international market
no marketing costs. Also improving price in the beginning has been fixed. price.
status of national off balance import/
Reduction of product price in future. Proper national/ international
export balance sheet.
FS and BP should take place.
Strengthening project owners position Reduction of future financial turn over. To have right balance of sells.
financially for banks and share Include the project in basket
holders. By project risk reduction. of variety of projects.
Methods- Counter Trade II
Switch trading: practice in which one company sells to another its obligation to make a
purchase in a given country.

Advantages Disadvantages/Risks Solutions


Almost same advantage and risks of Barter with same solutions.
Some times the final product of our project is Confusion in contract T&C in Contract T&C should be proper
not in same line of first party company regard to Switched trading and matured enough toward
business but could be major business line of obligations. Switched trading required T&C
switched company and result better benefits in advance.
and long term partnerships.

All the below cases of Countertrade have the


same status of Switch & Barter Trade T&C

Counter purchase: Sale of goods and services to one company in other country by a
company that promises to make a future purchase of a specific product from the same
company in that country.
Methods- Counter Trade III
Buyback: occurs when a firm builds a plant in a country - or supplies technology,
equipment, training, or other services to the country and agrees to take a certain
percentage of the plant's output as partial payment for the contract.

Offset: Agreement that a company will offset a hard - currency purchase of an unspecified
product from that nation in the future. Agreement by one nation to buy a product from
another, subject to the purchase of some or all of the components and raw materials from
the buyer of the finished product, or the assembly of such product in the buyer nation.

Compensation trade: Compensation trade is a form of barter in which one of the flows is
partly in goods and partly in hard currency.

Compensation trade: is a derivative in which two counterparties exchange cash flows of


one party's financial instrument for those of the other party's financial instrument. The
benefits in question depend on the type of financial instruments involved. Specifically, two
counterparties agree to exchange one stream of cash flows against another stream.
These streams are called the legs of the swap. The swap agreement defines the dates
when the cash flows are to be paid and the way they are accrued and calculated. Usually
at the time when the contract is initiated, at least one of these series of cash flows is
determined by an uncertain variable such as a floating interest rate, foreign exchange
rate, equity price, or commodity price.
Methods- Others I
BOT (Build, Operate and Transfer): is a form of project financing, wherein a private
entity receives a concession from the private or public sector to finance, design, construct,
and operate a facility stated in the concession contract. This enables the project
proponent to recover its investment, operating and maintenance expenses in the project.

Advantages Disadvantages/Risks Solutions


Right entities could be chosen for Corruption in official process of BOT to Defining proper systems, detail BP
right projects. choose right BOT entity. and project definitions beside
suitable controllers.
The chosen entity could be good project Detail contract with proper T&C in
builder but not reliable operation and all three milestones Building,
maintenance administrator for future operation/ maintenance and
harvest and handover. handovers.
Encourage private investment, Political and financial risks (currency Needed mutual guarantees should
transfer of technology and know- fluctuation). be in place.
how, injection of external capitals
and providing additional financial
source for other priority projects.
Methods- Others II
BOO (buildownoperate): in a BOO project ownership of the project remains usually
with the project company. Therefore the private company gets the benefits of any
residual value of the project. This framework is used when the physical life of the project
coincides with the concession period. A BOO scheme involves large amounts of finance
and long payback period. Some examples of BOO projects come from the water
treatment plants.

Advantages Disadvantages/Risks Solutions


All the same advantages as BOT. All the same risks as BOT where All the same solutions as BOT
ownership is not related. where ownership is not related.

BLT (buildleasetransfer): Under BLT a private entity builds a complete project and
leases it to the government. On this way the control over the project is transferred from
the project owner to a lessee. In other words the ownership remains by the shareholders
but operation purposes are leased. After the expiry of the leasing the ownership of the
asset and the operational responsibility are transferred to the government at a previously
agreed price.

All the previous B starting methods related advantages and risks plus
less country and operational risks beside more secure property rights.
Methods- Others III
DB Design-Construct: An owner develops a conceptual plan for a project, then solicits
bids from joint ventures of architects and/or engineer and builders for the design and
construction of the project.

DBOM Design-Build-Operate-Maintain: DBOM takes DB one step further by including


the operations and maintenance of the completed project in the same original contract.

All the previous B starting methods related advantages and risks plus less
burden of designing responsibilities and more concern of its outsourcing.

DBFO designbuildfinanceoperate: Designbuildfinanceoperate is a project


delivery method very similar to BOOT except that there is no actual ownership transfer.
Moreover, the contractor assumes the risk of financing till the end of the contract period.
This model is extensively used in specific infrastructure projects such as toll roads. The
private construction company is responsible for the design and construction of a piece of
infrastructure for the government, which is the true owner. Moreover the private entity has
the responsibility to raise finance during the construction and the exploitation period.
All above matters but in addition one of disadvantages could be difficulty
with long term relationships and the threat of possible future political
changes which may not agree with prior commitments.
Methods- Others IIII
The Other Types Of Project Financing Methods

DBOT designbuildoperatetransfer
DCMF designconstructmanagefinance
ROT Rehabilitate-own-transfer
ROOT Rehabilitate-own-operate-transfer
ROO Rehabilitate-own-operate

And Yet More


How To Chose The Best
How To Chose The Best- Basics
Recommendation of a suitable financing method:
When recommending a financing method, consideration should be given to a
number of factors. These factors are key to justifying your choice of method.
The factors include:

Security
Cash
Cost Time Risk and
flow covenants

Costs
The
and
Availability yield Maturity Control
ease of
curve
issue
How To Chose The Best- Key Factors I
Cost:

Majorly there are two categories for financing methods which are debt and equity.
Accordingly, all two categories costs should be considered not only in short but also in
long terms. Such as:
- Interest Rate
- Present Value
- NPV Net Present Value
- ROI
- Taxation considerations
- Accounting balance sheets and benefits simulation
- Economical balances and benefits simulation & opportunity costs
- BEP Break Even Point
- And finally costs comparisons between methods

In the same line usually debt finance is cheaper than equity finance and so if the
Company has the capacity to take on more debt, it could have a cost advantage.
How To Chose The Best- Key Factors II
Cash flows:

While debt finance is cheaper than equity finance, it places on the project owners the
obligation to pay out cash in the form of interest. Failure to pay this interest can result in
action being taken to wind up the company. Hence, consideration should be given to the
ability of the owners to generate cash. If the owners are currently cash-generating, then it
should be able to pay its interest and debt finance could be a good choice. If the owners
are currently using cash because they are investing heavily in research and development
for example, then the cash may not be available to service interest payments and the
owners would be better to use equity finance. The equity providers may be willing to accept
little or no cash return in the short term, but will instead hope to benefit from capital growth
or enhanced dividends once the investment currently taking place bears fruit. Also, equity
Providers cannot take action to wind up a company if it fails to pay the dividend expected.

Choice Of
Break Even Cash Quantitative
Option Based
Point Generation Measurements
On Cash Flow
How To Chose The Best- Key Factors III
Time:

As one of project major constrains time is very important. The considerations could be
named as the following;

How time consuming is the capital obtaining process and procedures.


How fast financing could be obtained after that.
How long do we have time for addressing required financing.
How the financing method will effect project time constrain.
Direct and indirect effects of financing methods in short and long terms of time.
Before project start (planning stage), also during project and when project has been
finished and is operational what are our time priorities.

Time Is Money & Money Is Time


How To Chose The Best- Key Factors IIII
Risk:

The directors of the project must control the total risk of the project and keep it at a
level where the shareholders and other key stakeholders are content. Total risk is made up
of the financial risk and the business risk. Hence, if it is clear that the business risk is going
to rise for example, because the company is diversifying into riskier areas or because the
operating gearing is increasing then the company may seek to reduce its financial risk.
The reverse is also true if business risk is expected to fall, then the project owners may
Be happy to accept more financial risk.

Financing Method Direct & Indirect Risks


How To Chose The Best- Key Factors V
Security and covenants:

If debt is to be raised, security may be required. From the data given it should be possible
to establish whether suitable security may be available. Covenants, such as those that
impose an obligation on the company to maintain a certain liquidity level, may be required
by debt providers and directors must consider if they will be willing to live with such
covenants prior to taking on the debt.

What Are The Guarantees & Convenants

Availability:

The likely availability of finance must also be considered when recommending a suitable
finance source. For instance, a small or medium sized unlisted company will always find
raising equity difficult and, if you consider that the company requires more equity, you must
be able to suggest potential sources, such as venture capitalists or business angels, and
be aware of the drawbacks of such sources. Furthermore, if the recent or forecast financial
performance is poor, all providers are likely to be wary of investing.
Being Qualified & Availability Of Resources
How To Chose The Best- Key Factors VI
Maturity:

The basic rule is that the term of the finance should match the term of the need (the
Matching principle). Hence, a short-term project should be financed with short-term
finance. However, this basic rule can be flexed. For instance, if the project is short term
but other short-term opportunities are expected to arise in the future the use of longer
term finance could be justified.

Durations Of Financing Methods

Controls:

If debt is raised then there will be no change in control. However, if equity is raised control
may change. Owners should also recognize that a rights issue will only cause a change in
control if shareholders sell their rights to other investors.

Predict Changes & Controls


How To Chose The Best- Key Factors VII
Costs and ease of issue:

Debt finance is generally both cheaper and easier to raise than equity and, hence, a
company will often raise debt rather than equity. Raising equity is often difficult,
time-consuming and costly.

Usually Debt Is Better Than Equity Hence Should be Checked

The yield curve :

Consideration should be given to the term structure of interest rates. For instance, if the
curve is becoming steeper this shows an expectation that interest rates will rise in the
future. In these circumstances, a company may become more wary of borrowing additional
debt or may prefer to raise fixed rate debt, or may look to hedge the interest rate risk in
some way.

Future Is As Important As Present If Not More


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