Lauren Leigh Essaram
27 September 2010
Submitted in partial fulfilment of the duly performed requirement of International Business Finance, School of Economics and Finance, University of KwaZulu-Natal Abstract
Non-recourse financing has grown in popularity, especially in developing countries. It has done so more specifically in the basic infrastructure, natural resources and also in the energy sectors. Large-scale investments are mostly financed by project finance, due to the costs and complexities that face the standard sources of finance. The main feature of Project Finance is in the accurate estimation of cashflows and a precise risk analysis in order to provide high leverage and ensuring the separation of the project from that of its sponsors. Project finance may not be easy to implement in developing countries due to the risks faced by investors in those economies. Therefore contractual and structured financing elements are introduced. The following seminar aims to provide an explanation and discussion of Project finance and draws on the conclusion that when compared to traditional corporate finance, project finance is a much better technique and financing mechanism to use, as it mostly reduces agency costs.
Table of contents Page Number
2. Project Finance-What does it entail2
3. The organisational structure4
1. Project constituents5
2. Non-Recourse debt and limited recourse debt6
3. How a project company raises debt and Equity7
4. Sources of funds8
1. How to value a project9
5. Project Finance vs Corporate Finance10
1. Project Finance and Public Private Partnerships14 6. The rationale for using project finance15
Project finance encompasses the creation of an entity that is legally independent and the company is financed by at least one sponsor and non-recourse debt. Public private partnerships which can be linked to project finance can be defined as a government service or private business venture, that has been started, funded and runs via a partnership of government and/ or one or more private sector companies. Just like a project company, a PPP also has a special vehicle company that is responsible for acquiring assets and liabilities for the company. The project financing structure of a project is made up of debt and equity and the sources of funds of the project are the same as those of public and private companies though project companies have to form special vehicle companies to issue debt. Most of the project is financed by debt therefore a project can be likened to a leveraged buyout. The high leverage does not affect the balance sheet of the sponsors therefore the cost of equity of the sponsors will not increase due to the increase in financial risk. The risk adjusted discount rate of a project is used in valuing the firm. Corporate finance and project finance are different and the main factors that differentiate them are financial structure, duration of the projects, agency costs and liquidity of the instruments that are used to finance the project. The most important factor that a project manager can consider when choosing public finance over traditional sources is how public finance can reduce various agency costs.
2. PROJECT FINANCE- WHAT DOES IT ENTAIL?
As mentioned by Esty (2004: 215), academic theory and research based on the topic of project finance is relatively unexplored territory and the literary works based on the topic of project finance lag in comparison to its current practice. Unlike sub-fields like entrepreneurial finance and behavioural finance that are relatively new, project finance has not been explained as extensively. This lack of attention is...