wall street prep project finance

wall street prep project finance

The Ultimate Guide to Project Finance: A Comprehensive Analysis from Wall Street Perspective

1. Introduction to Project Finance

The project finance technique has evolved over the last thirty years from the nascent stages of bank proliferation around the world, the emergence of large borrowing requirements of private corporations of the Eighties and the international development banks, the nationalization and privatization movements that have taken place since the Sixties, and the evolution and easing of restrictions on capital account transactions in both the private and public investing sector in many emerging countries. This technique exploded in use in many developed and emerging country bankers in the Eighties and is now used in a very large percentage of capital-intensive projects around the world. Finally, the due diligence procedures that the bankers undertake in assessing the risks of these projects are widely applied and are complex and investment standards must be among the strictest in the world.

Project finance has emerged as the major financing technique used by corporations in the United States to fund large infrastructure projects such as oil and gas, nuclear, solar and wind energy, and biofuel production facilities, as well as public projects such as hospitals, universities, schools, government buildings, and infrastructure facilities. This technique has also been used to fund major projects in developing industrial and emerging countries around the world. Project finance as a distinct way of financing long-term infrastructure projects has developed alongside corporate finance techniques and is based on the judgmental and sophisticated financial techniques that are, as yet, largely the proprietary knowledge of financial specialists that are arranged by the international investment bankers and other advisors and specialists. This financing technique is particularly important because large plant financings both in the USA and in the developing countries are markedly higher in volume than any other type of international project finance.

2. Key Concepts and Terminologies in Project Finance

Repayment of the loans is primarily dependent on cash flows generated by the project. However, project finance transactions are highly specialized and complex. Since their cash flows are dynamic and evolving with the life of the project, a well-constructed project finance model is an extremely important tool used in project finance transactions. Its forward-looking approach and its ability to evaluate an array of outcomes associated with a business project over its life make it a pivotal instrument for both arranging and allocating capital to a project.

This section provides a comprehensive list of key concepts and terminologies in project finance. A working understanding of these concepts contributes greatly to the acquisition of the skill set required for a successful career in project finance. Such a skill set is necessary for productive participation in the vast array of profitable activities in the capital and credit markets associated with the financing of major business ventures throughout the world. These and related financial and legal concepts are the building blocks for profitable activity in project finance. They are often used in the structuring of major corporate and investment banking transactions and are the essential tools for all professionals in the project finance field.

3. Structuring Project Finance Deals: Best Practices and Case Studies

The success of a project depends on the success of structuring or matching the different cash flows so that they are placed at the right level of the capital structure (the percentage of capital at different risk levels), the term structure (the amount, timing, and risk of cash flows), and the financial structure (the mix of different funding sources). The cash flows of a typical project are (1) the cash inflow streams as revenues paid by the users or other sponsors of the project and (2) the cash outflow streams, which include direct and operational expenses, the lender payments, the electricity and fuel supply, insurance costs, service payments, and payments to the capital suppliers (equity, preferred stock, and subordinated debt).

The objective of financing is always to meet the financial objectives of all of the stakeholders. Lenders and investors will evaluate a project’s cash flow to determine if it will provide an acceptable return commensurate with the level of risk that they are incurring. From a financial point of view, as long as the project is expected to generate more cash for either expansion or direct payment after the investors have received their targeted return, the project is said to be economically viable. Other stakeholders should also be satisfied with the project; for example, a regulated price might be acceptable to the customer if the project proportionality improves current pricing or quality of service levels or both.

A greenfield project is the one where the facility is constructed anew on a bare site. A brownfield facility is constructed on existing project sites or where there are existing assets around which the new assets are constructed. Some retail or commercial projects are part greenfield (such as the shopping center site location), part brownfield (existing land development or buildings to be refurbished), and part development (construction work to transform the land from what exists before to a shopping center including anchor fast-tracked projects).

A successful project finance structure can be best created through a careful balance of cash flows, risk allocation, and financing. Each project has its unique features and constraints. Hence, a good structure requires finding an optimal design that caters to the project requirements. Here we will discuss the common and successful structures applied in project finance, except for the greenfield and brownfield project split.

4. Risk Management Strategies in Project Finance

The nature of these structures, the incentives they provide, the key parameters that drive the value of the risks, and the way in which credit enhancements can be provided to them are explored below under the headings Inherent Project Risks, Risk Management, and Residual Credit Supports.

Introduction One of the key attractions of limited recourse financing is the embedded risk management structure of the project and the consequent allocation of risk to those parties best placed to control those risks. These risk management structures fall into one of three categories: those risks that are inherent to the project or the participants; those that are capable of being managed or mitigated through the project structure or implementation phase; and those that are residual in nature, with the credit supports provided to these risks usually structured in a way that they perform in a latent manner.

5. Valuation Techniques and Financial Modeling in Project Finance

Valuation is the main part of project finance, as in any other business. Investors would like to see what their financial benefits are and under what conditions these financial benefits accrue. Investors expect profit and low project risk. It is therefore very important for them to understand the risk-return relationships of individual projects and make good project valuation. We provide a comprehensive analysis to understand the project activities’ risk and profitability characteristics in the following sections, such as forecasting project activities and cash flows, carrying sensitivity analysis, and Internal Rate of Return (IRR) and Net Present Value (NPV), and Modified Internal Rate of Return (MIRR), Risk-adjusted rate of return (RRR), and Monte Carlo simulation.

Profitability, financing structure, sensitivity analysis, risk, and comparison of financing options represent the key aspects of project evaluation in project finance. In this chapter, we describe in detail the different valuation techniques that investors use to assess project risks and profitability. We also examine the best forecasting and sensitivity analysis techniques and how we can apply them for project evaluation and decision making.