2015 eup 222 notes project finance lecture 2
TRANSCRIPT
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EUP 222 ENGINEER IN SOCIETY PROJECT FINANCE
Understand the financial concepts to appraise a project efficiently and make decisions effectively.
Dr. Sharifah Akmam Syed Zakaria, PPKA . email: [email protected]
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Outline Lecture Objective & Context
Project Financing Owner Project Contractor
Financial Evaluation Time value of money Present value Rates Interest Formulas NPV IRR & payback period
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Lecture Objectives:
The role of project financing
Mechanisms for project financing
Measures of project profitability
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What is Project Finance?
Project financing refers to a financing in which lenders to a project look primarily to the cash flow and assets of that project as the source of payment of their loans.
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5Why Project Financing?Project Owners PerspectiveSize and cost of projectsRisk minimizationPreservation of borrowing capacity and credit ratingMay be only way that enough funds can be raised
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The Basic Elements of a Project Financing:
Loan funds
Debt repayment
Equity funds
Returns to investors
Cash deficiency agreement and other forms of credit support
Equity investors
Lenders
Suppliers Purchasers
Raw materials
Supply contract(s)
Purchase contract(s)
Output
Assets comprising the project
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7Prerequisites for Project Financing:
Financial Analysis
Economic Analysis
Risk Analysis
We must welcome the future, remembering that soon it will be the past, and we must respect the past, knowing that once it was all that was humanly possibleForbes
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8Its All About Risk!
The key to project financing is the
reallocation of any risk away from the
lenders to the project.
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Project Management Phase:
FEASIBILITYDESIGN
PLANNING CLOSEOUTDEVELOPMENT OPERATIONS
Financing & Evaluation
Risk
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Context: Feasibility Phases Project Concept
Land Purchase & Sale Review
Evaluation (scope, size, etc.)
Constraint survey Site constraints
Cost models
Site infrastructural issues
Permit requirements
Summary Report
Decision to proceed
Regulatory process (obtain permits, etc)
Design Phase
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OutlineLecture Objective & Context
Project Financing Owner Project Contractor
Financial Evaluation Time value of money Present value Rates Interest Formulas NPV IRR & payback period
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Financing Gross Cash flows
($35,000,000)
($30,000,000)
($25,000,000)
($20,000,000)
($15,000,000)
($10,000,000)
($5,000,000)
$0
$5,000,000
$10,000,000
1 2 3 4 5 6 7 8 9 10 11
owner cum cashflow
contractor cum cashflow
years 1 2 3 4 5 6 7 8 9 10
OWNER
investment ($10,000,000) ($20,000,000)
operation incomes $2,000,000 $4,000,000 $6,000,000 $6,000,000 $6,000,000 $6,000,000 $6,000,000
owner cashflow $0 ($10,000,000) ($20,000,000) $2,000,000 $4,000,000 $6,000,000 $6,000,000 $6,000,000 $6,000,000 $6,000,000
owner cum cashflow $0 ($10,000,000) ($30,000,000) ($28,000,000) ($24,000,000) ($18,000,000) ($12,000,000) ($6,000,000) $0 $6,000,000
CONTRACTOR
costs ($4,000,000) ($7,000,000) ($14,000,000) $0 $0 $0 $0 $0 $0 $0
revenues $0 $10,000,000 $20,000,000 $0 $0 $0 $0 $0 $0 $0
contractor cashflow ($4,000,000) $3,000,000 $6,000,000 $0 $0 $0 $0 $0 $0 $0
contractor cum cashflow($4,000,000) ($1,000,000) $5,000,000 $5,000,000 $5,000,000 $5,000,000 $5,000,000 $5,000,000 $5,000,000 $5,000,000
Owner investment = contractor revenue
Early expenditure Takes time to get revenue
Design/Preliminary Construction
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Project Financing
Aims to bridge
this gap in
the most
beneficial
way!
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Critical Role of Financing
Makes projects possible
Has major impact on Riskiness of construction
Claims
Prices offered by contractors
Difficulty of Financing .
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OutlineLecture Objective & Context
Project FinancingOwner Project Contractor
Financial Evaluation Time value of money Present value Rates Interest Formulas NPV IRR & payback period
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Public FinancingSources of funds
General purpose or special-purpose bonds
Tax revenues
Capital grants subsidies
International subsidized loans
Social benefits : important justification Benefits to region, quality of life, unemployment relief, etc.
Important consideration: exemption from taxes
Public owners face restrictions
oMajor motivation for public/private partnerships
MARR (Minimum Attractive Rate of Return) much lower (e.g. 8-10%), often standardized.
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Private FinancingMajor mechanisms Equity
Invest corporate equity and retained earnings Offering equity shares
Stock Issuance (e.g. in capital markets) Must entice investors with sufficiently high rate of return May be too limited to support the full investment May be strategically wrong (e.g., source of money, ownership)
Debt Borrow money Bonds
Because higher costs and risks, require higher returns
MARR varies per firm, often high (e.g. 20%)
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OutlineLecture Objective & Context
Project Financing OwnerProject Contractor
Financial Evaluation Time value of money Present value Rates Interest Formulas NPV IRR & payback period
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Project FinancingInvestment is paid back from the project profit rather than the general assets or creditworthiness of the project owners
For larger projects due to fixed cost to establish Small projects not much benefit
Investment in project through special purpose corporations Often joint venture between several parties
Need capacity for independent operation
Benefits Off balance sheet (liabilities do not belong to parent)
Limits risk
External investors: reduced agency cost (direct investment in project)
Drawback Tensions among stakeholders
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OutlineLecture Objective & Context
Project Financing Owner ProjectContractor
Financial Evaluation Time value of money Present value Rates Interest Formulas NPV IRR & payback period
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Contractor FinancingOwner keeps an eye out for Front-end loaded bids (discounting) Unbalanced bids
Contractors frequently borrow from Banks (Need to demonstrate low risk)
Interaction with owners Some owners may assist in funding
Help secure lower-priced loan for contractor
Sometimes assist owners in funding! Big construction company, small municipality
BOT
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OutlineLecture Objective & Context
Project Financing Owner Project Contractor
Financial Evaluation Time value of money Present value Rates Interest Formulas NPV IRR & payback period
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Role of Taxes