ECONOMICS MOTIVATIONS

FOR PROJECT FINANCE.

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Project Finance:

• Project finance involves the creation of a legally independent

project company financed with nonrecourse debt for the purpose
of investing in a capital asset, usually with a single purpose and a
limited life.
Project financing:

• Project financing is the long-term financing of

infrastructure and industrial projects based upon the
projected cash flows of the project rather than the balance
sheets of its sponsors. Usually, a project financing structure
involves a number of equity investors, known as ‘sponsors’
or other lending institutions that provide loans to the
operation.
The nature of project finance:

• Project finance is generally defined as the provision of funds for a

single-purpose facility (or facilities) that generates cash flow to
repay the debt. Debt is secured by the project's assets and cash
flows, not by the assets or general credit of the project's
sponsor(s).Therefore the debt generally is issued with no recourse,
or, in some cases, with limited recourse, to the project sponsors.
Project finance is often used for capital-intensive facilities such as
power plants, refineries, tollroads, pipelines, telecommunications
facilities and industrial plants.
NEED FOR PROJECT FINANCE:

• The rise of project finance is the creation of an independent

project company financed with secured loan provides strong
evidence that financing structures is essentially needed.
• Project finance involves both an investment decision involving
a capital asset and a financing decision.
• Convincing bankers, who have limited upside potential yet bear
significant downside exposure, to provide the majority of the
capital is an important constraint on the investment process.
Market Retention tree diagram:

Market retentions
are the activities a
organization/comp
any uses to
increase the
likelihood of the
customer.
PROJECT FINANCE REDUCES :

• The cost of agency conflicts inside project companies.

[4:40 PM]

• The opportunity cost of underinvestment due to leverage

and incremental distress costs in sponsoring firms
The reduction in cost of agency conflicts
inside project companies:

• The first motivation to use project finance, the agency cost motivation,
recognizes that certain assets, namely large, tangible assets with high free
cash flows, are susceptible to costly agency conflicts. The creation of a
project company provides an opportunity to create a new, asset-specific
governance system to address the conflicts between ownership and control.
The opportunity cost of underinvestment due to leverage and incremental distress costs in
sponsoring firms

• Project structures can also reduce agency conflicts between owners and
related parties. The transaction-specific nature of project assets creates a
need to deter strategic behavior by suppliers of critical inputs or
expropriation by host governments. The threat of opportunistic behavior or
“hold-up” is especially severe in project companies where the deals
typically involve negotiations.
Risk identification/management:

• Risk identification and allocation is a key component of project

finance. A project may be subject to a number of technical,
environmental, economic and political risks, particularly in
developing countries and emerging markets. A riskier or more
expensive project may require limited recourse financing secured
by a surety from sponsors.
SPE(Special purpose entity):

• Generally, a special purpose entity is created for each project,

thereby shielding other assets owned by a project sponsor from
the detrimental effects of a project failure. As a special purpose
entity, the project company has no assets other than the project.
Capital contribution commitments by the owners of the project
company are sometimes necessary to ensure that the project is
financially sound or to assure the lenders of the sponsors'
commitment.
Decision helping in management
Stages, Advantages and limitations of project
financing:

• pre-financing stage
 Project identification
Risk minimization
Financial feasibility
• Financing stage
Equity arrangement
Negotiation
Documentation
Disbursement
• Post financing stage
Monitoring
Project closure stage
Repayment