project finance modelling

project finance modelling

Advanced Techniques in Project Finance Modelling

1. Introduction to Project Finance

Also, in these cases, it is the entity that borrows cash and hence is seen as the entity primarily responsible for the repayment of the principal as well as interest. Even when other assets of the company are used as collateral for the loans, the company legally remains responsible for the repayment.

In asset finance, lenders value a single predetermined security and security only. If it is not able to repay the loan, even if it is otherwise an economically viable and attractive asset, it may be forced to be sold to pay off its loans, even if the sale of the asset is not in the best economic interest of the borrower.

In corporate finance, credit decisions are based on the creditworthiness of the borrowing company as a whole, positioning the company to service and repay its obligations. The company organizes and arranges sources of revenues and liquidity through a variety of ways from different assets on a corporate level.

“Project finance” is a specific method of financing in which the lenders provide capital for a specific investment under the condition that the investment’s cash flows take care of repayment of the principal as well as interest. This definition is perhaps clearer by contrast with other forms of finance like “corporate finance” or “asset finance.”

1.1 Project Finance: An Introduction

2. Key Concepts and Principles in Project Finance Modelling

The fundamental nature of project finance is rooted in the allocation of project risks, solving the conflict of interest between the project sponsors and the lending party which act as the creditors of the project financing for the purpose that they have a security interest in these assets and that they are entitled to receive their interests and to have their principal repaid over the life of these assets. Thus, project finance is highly complex and demands a specific financial modelling to properly reflect these complexities. This explains why, over the years, simple corporate finance and DCF based spreadsheet models became inadequate to perform a satisfactory evaluation of project finance initiatives. The role of the financial modeller is, therefore, essential to achieve a successful project finance closure. The role of the financial modeller has the following characteristics: A) Act interactively to implement properly the allocation of project risks proposed by concessionary agreement; B) Act in a reasonable way if new risks occur during operation. C) Act actively to propose a model to solve the conflict of interest among parties; D) Act proactively to present baskets of alternatives, quantitatively exploring the implications of contracting flexibility, which have potential to satisfy the parties involved.

Like most financial decision areas, project finance has matured into a discipline whereby specific mathematical models and techniques have been developed and taught at business schools in a fairly systematic way. In this section, we will give a brief overview of the key concepts and principles in project finance modelling, confronting the issues underpinning the complexity of the key elements in project finance structure. Furthermore, discussions are given about the conflict of interest and its consequences on the role of the financial modeller. It should be noticed that while the context of this section is to present a background in simple and comprehensive language, the goal is to provoke the financial model developers – either at the project sponsors’ side or the lenders’ side – so that they fully appreciate the significance of the many techniques in developing a project finance model.

3. Advanced Financial Modelling Techniques for Project Evaluation

Flexible TARIFF, INFLATION, and Foreign Exchange Variables For sensitivity testing, the model should feature TARIFF AND RENT REVIEWED, INFLATION, or AVERAGE WORKING CAPITAL CONTRIBUTION PRICING at OPIC. The INFLATION and FOREIGN EXCHANGE MODELING VARIABLES should be designed in a manner that would include: The PROJECT COST, PROJECT NO. (IF ANY), AND THE ACTUARIAL PREMIUM. The relevant coverage ratios for the project life.

Complex Financial Taxes and Relational Equations Modeling Normal and tax statements, activated (off-mode) and international project finance are normally analyzed and quantified in a standard and professional taxated financial model. They should also have options for calculation of off-balance sheet financing, partnership, and any equity swap financing or benefit levered lease elements in the most flexible way. Special guidelines for active stand-type and WFC (with fixed forwarding) project financing are contained in Element 5 Project Financing.

Advanced Pro-Forma Operating Model All the project input parameters should be explicitly determined from the pro-forma detailed operating model in a variety of standard IRR calculations and scenario analysis. Pro-forma and general operations should be professionally prepared and test-marketed with experienced investors. The operation should also be accurately reflected in the financing and equity IRR.

4. Risk Analysis and Sensitivity Testing in Project Finance Modelling

4.2 Financial Modelling and Risk Analysis Because of the multi-layered task risk analysis presents for private ventures, there is no universal in how risks should be taken into account in the context of financial modelling. However, the fundamental character of project finance indicates that this should never be evaluated solely in terms of classical measures such as IRR, NPV, and so forth, since its performance has frequently to be seen with due regard to the risk and uncertainty it brings under consideration. This could only be neglected if the project finance is secured against any kind of commercial competition. Model uncertainty does introduce an additional layer of complexity and requires specific logistic precautions.

4.1 Introduction According to the PMBOK, risk is “an uncertain event or condition that, if it occurs, has a positive or negative effect on a project’s objectives”. There are various sources of risk in any project. With regard to a revenue-generating project, the risk can be generally classified into two main types: revenue risk and cost risk. Revenue risk includes the uncertainty of the company’s sales, capacity utilization, etc. Cost risk is concerned with physical constraints or restrictions on the pipeline of inputs to be processed and is related to the timing of deliveries, and is thus characterized by pricing and quantity risks. The operating risk includes the possibility of force majeure or risk from the business cycle. Factors like management quality and the perception of credit providers are also part of project risks.

5. Case Studies and Real-World Applications

Given the projects which have been described in the first case study, it would be easier to understand the practicalities of what has been described in the methods and techniques sections if the authors had designed them in the first place and were responsible for the results. As it is, chosen projects must be used as examples; the empirical validation for the methods and techniques presented, and their unofficial real-world endorsement, is that they are based on the work of real financial advisors with whom the authors have worked in real project environments. The authors have worked on 40 or so smaller projects since 1991. Their model building, tax law skills, data research, and contract structuring background have allowed them to actually watch as projects unfold in real life. The history of these smaller projects has often thrown up interesting aspects and non-linearity (such as changes in who was involved, who financed and why, and how on-the-ground activities appeared to be different from the initial project deliberations) which were later helpful in instructing real PPP models.

Introduction: The purpose and construction of a model, and the context in which it might be used in project finance, have been explained in considerable detail. However, to make the model construction process an interactive exercise so that each logic and matrix may be understood and used independently, it is important to see them applied to real-world examples. There is no better way of showing the non-linear aspects of IA than by taking a bunch of business people into the real world where a project is about to be embarked upon, or where the near future of a particular business can be analyzed.