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PROJECT FINANCE

Dr. Sahil Narang

Course instructor, project finance

PhD,IIT Kharagpur

Assistant Professor II, JIMN

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CLASS 1 : INTRODUCTION TO PROJECT FINANCE

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COURSE OBJECTIVES

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LECTURE RESOURCES

  • Course website
  • PPTs
  • Book
  • Excel sheets

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COURSE OUTLINE

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GRADING COMPONENTS

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CLASSROOM RULES AND REQUIREMENTS

  • Maintain decorum.
  • Bring charged laptops for classroom practice.
  • Class: theory plus practice.
  • Put phones on silent model, phones not allowed in the classroom.
  • Excel based or a pen-paper exam?

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ASSIGNMENT SUBMISSION: PLAGIARISM AND AI GUIDELINES

  • Guidelines on use of internet,
  • Guidelines on use of AI and large language models such as Bard or GPT,
  • Guidelines of taking help from co-participants.

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INTRODUCTION TO THE COURSE

  • What is a project?

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VIDEO

  • Top mega projects

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OTHER PROJECTS EXAMPLES?

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Value of select infrastructure projects in the United States as of 2019 (in billion U.S. dollars)

Cost of select U.S. infrastructure projects 2019

Note(s): United States; 2019

Further information regarding this statistic can be found on Page 4.

Source(s): Global X; CG/LA Infrastructure; ID 1011230

Project (Sponsor, status)

Project value in billion U.S. dollars

Texas Central High Speed Rail (Texas Central Partners LLC, procurement)

15

The Gateway Program (Hudson Tunnel) (Port Authority of New York & New Jersey, construction)

12.70

Chicago O'Hare Airport expansion (Chicago Department of Aviation, design)

8.70

Las Vegas - California HSR (Brightline, planning)

7

Purple Line extension (LA Metro, construction)

2.80

Hell's Kitchen Lithium and Geothermal project (Controlled Thermal Resources, design)

1.75

AirTrain LaGuardia (MTA, planning)

1.50

New England Clean Energy Connect (Central Maine Power, planning)

1

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Value of the largest rail infrastructure projects worldwide as of February 2022 (in billion U.S. dollars)

Value of the largest rail infrastructure projects in the world in 2022

Note(s): Worldwide; 2022

Further information regarding this statistic can be found on page 8.

Source(s): GlobalData (Railway Technology); ID 916520

Project value in billion USD

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Value of infrastructure projects in the Emirate of Dubai in 2016, by category (in billion U.S. dollars)

Value of infrastructure projects in Dubai 2016, by category

Note(s): United Arab Emirates; 2016

Further information regarding this statistic can be found on page 8.

Source(s): BNC Network; ID 706735

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Leading energy storage projects in India as of 2023, by capacity (in megawatts)

Largest energy storage projects in India 2023, by capacity

Note(s): India; as of June 2023

Further information regarding this statistic can be found on page 8.

Source(s): power-technology.com; GlobalData; ID 1400361

Capacity in megawatts

Name of project or location

2

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WHAT IS PROJECT FINANCE?

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HOW IS PROJECT FINANCE DIFFERENT THAN THE CORPORATE FINANCE?

Scope and Purpose:

  • Corporate Finance: Focuses on the overall financial activities and management of a company. It deals with decisions related to capital structure, working capital management, dividend policy, and overall financial strategy for the entire organization.
  • Project Finance: Concentrates on financing a specific project or venture. It involves the creation of a standalone financial structure for a particular undertaking, such as a large infrastructure project or a new business venture.

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Project finance vs corporate finance

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RISK AND LIABILITY

  • Corporate Finance: The overall financial health of the company determines the risk and liability. Creditors and investors are concerned with the company's ability to generate profits and cover its obligations.
  • Project Finance: The risks and liabilities are often isolated to the specific project. If the project fails, the losses typically do not impact the sponsors' or investors' other assets.

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Project finance vs corporate finance

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COLLATERAL AND SECURITY

  • Corporate Finance: Collateral is often the entire set of assets of the company. Lenders may have claims on various assets of the corporation, and the overall financial health of the company serves as a guarantee.
  • Project Finance: The project itself is the primary collateral. Lenders have security over the project's assets and cash flows, and the project's success determines the ability to repay loans.

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Project finance vs corporate finance

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CASH FLOW STRUCTURE

  • Corporate Finance: Cash flows are generated from the overall operations of the company. The company's profitability and liquidity are key considerations.
  • Project Finance: Cash flows are generated specifically from the project. The financial structure is designed to allocate risks and returns among project stakeholders.

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Project finance vs corporate finance

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DURATION AND EXIT STRATEGY

  • Corporate Finance: Generally ongoing, with no specific endpoint. The company continues its operations indefinitely, and shareholders can exit through selling their shares on the stock market.
  • Project Finance: Has a defined lifespan tied to the project. Investors typically exit once the project is completed, and cash flows are sufficient to repay the debt and provide returns.

Project finance vs corporate finance

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OWNERSHIP AND GOVERNANCE

  • Corporate Finance: Ownership is in the form of shares, and governance is determined by the overall corporate structure. Shareholders have a say in the management through voting rights.
  • Project Finance: Ownership is project-specific, and governance is often tailored to the needs of the project. Decision-making may involve various stakeholders, including lenders, sponsors, and contractors.

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Project finance vs corporate finance

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Capital Investments : Importance and Difficulties

Importance

∙ Long – term effects

∙ Irreversibility

∙ Substantial outlays

Difficulties

∙ Measurement problems

∙ Uncertainty

∙ Temporal spread

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Types of Investments

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∙ Mandatory Investments

∙ Replacement investments

∙ Expansion investments

∙ Diversification investments

∙ R & D investments

∙ Miscellaneous investments

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Capital Budgeting Process

Financing

Implementation

Selection

Analysis

Review

Planning

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1. PLANNING

  • Problem statement
  • Objectives and scope (key deliverables)
  • Project team
  • Work breakdown structure (organizing the project components)
  • Resource requirement, manpower, time, cost, etc. estimation
  • Project schedule (Gantt charts, critical paths)
  • Risk identification and management
  • Budgeting and cost outlining and estimation
  • Communication

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2. PROJECT ANALYSIS

  1. Feasibility analysis
  2. Market analysis
  3. Risk analysis
  4. Financial analysis
  5. Social impact analysis
  6. Regulatory and legal compliance analysis
  7. Technical analysis
  8. Resource analysis
  9. Stakeholder analysis
  10. Strategic alignment test

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Key Issues in Project Analysis

Market Analysis

Technical Analysis

Potential Market

Market Share

Technical Viability

Sensible Choices

Financial Analysis

Risk

Return

Economic Analysis

Benefits and Costs in Shadow Prices

Other Impacts

Ecological Analysis

Environmental Damage

Restoration Measures

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Feasibility Study : A Schematic Diagram

Generation of Ideas

Initial Screening

Is the Idea Prima Facie Promising

Plan Feasibility Analysis

Conduct Market Analysis

Conduct Technical Analysis

Conduct Financial Analysis

Conduct Economic and Ecological Analysis

Is the Project Worthwhile ?

Prepare Funding Proposal

Terminate

Terminate

Yes

No

No

Yes

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3. PROJECT SELECTION

  1. Define strategic objectives
  2. Establish selection criteria: priorities, viabilities, market demand, etc.
  3. Project specific scope and ideas
  4. Evaluate, compare, and prioritize projects
  5. Balance project portfolio
  6. Review, approval, and documentation
  7. Adjustment and reviews

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4. PROJECT FINANCING

  • Various options in financing?

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5. PROJECT IMPLEMENTATION AND REVIEW

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Levels of Decision Making

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Operating decisions

Administrative decisions

Strategic decisions

  • Where is the decision taken

Lower level management

Middle level management

Top level management

  • How structured is the decision

Routine

Semi-structured

Unstructured

  • What is the level of resource

commitment

Minor resource commitment

Moderate resource commitment

Major resource commitment

  • What is the time horizon

Short-term

Medium-term

Long-term

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Key Issues in Major Investment Decisions

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    • Investment story
    • Risks
    • DCF Value
    • Financing
    • Impact on Short-term EPS
    • Options

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Objective of Capital Budgeting

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Finance theory rests on the premise that managers should manage their firm’s resources with the objective of enhancing the firm’s market value. This goal has been eloquently defended by distinguished finance scholars, economists, and practitioners. With the following :

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“ The quest for value drives scarce resources to their most productive uses and their most efficient users. The more effectively resources are deployed, the more robust will be the economic growth and the rate of improvement in our standard of living.”

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Basic Considerations : Risk and Return

Investment decisions

Financing decisions

Return

Risk

Market value of the firm

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Common Weaknesses in Capital Budgeting

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∙ Poor alignment between strategy and capital budgeting

∙ Deficiencies in analytical techniques

∙ Poor identification of base case

∙ Inadequate treatment of risk

∙ Improper evaluation of options

∙ Lack of uniformity in assumptions

∙ Neglect of side effects

∙ No linkage between compensation and financial measures

∙ Reverse financial engineering

∙ Weak integration between capital budgeting and expense budgeting

∙ Inadequate post - audits

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SUMMING UP

Essentially a capital project represents a scheme for investing resources that can be analysed and appraised reasonably independently.

The basic characteristic of a capital project is that it typically involves a current outlay (or current and future outlays) of funds in the expectation of a stream of benefits extending far into the future.

Capital expenditure decisions often represent the most important decisions taken by a firm. Their importance stems from three inter-related reasons: long-term effects, irreversibility, and substantial outlays.

While capital expenditure decisions are extremely important, they pose difficulties which stem from three principal sources: measurement problems, uncertainty, and temporal spread.

Capital budgeting is a complex process which may be divided into six broad phases: planning, analysis, selection, financing, implementation and review.

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One can look at capital budgeting decisions at three levels: operating, administrative, and strategic.

The important facets of project analysis are: market analysis, technical analysis, financial analysis, economic analysis, and ecological analysis.

Financial theory, in general, rests on the premise that the goal of financial management should be to maximize the present wealth of the firm’s equity shareholders. Business firms may pursue other goals. When these other goals conflict with the goal of maximizing the wealth of equity shareholders, the trade-off has to be understood.

The common weaknesses found in capital budgeting systems in practice are: poor alignment between strategy and capital budgeting; deficiencies in analytical techniques; no linkage between compensation and financial measures; reverse financial engineering; weak integration between capital budgeting and expense budgeting; inadequate post-audits.