Project Finance

Topics: Finance, Risk, Investment Pages: 28 (8432 words) Published: July 13, 2010

The use of non-recourse project financing has grown steadily in emerging markets, especially in basic infrastructure, natural resources and the energy sector. Because of its cost and complexity, project finance is aimed at large-scale investments. The key is in the precise estimation of cash flows and risk analysis and allocation, which enables high leverage, and in ensuring that the project can be easily separated from the sponsors involved. Project finance is more difficult in emerging countries, which tend to pose unpredictable risks with unfavorably biased results. This study investigates the role of project finance as a driver of economic growth. It is hypothesized that project finance is beneficial for the developing economies as it compensates for any lack of domestic financial development. The contractual structure unique to project finance should lead to better investment management and governance.


| Definition. Project financing involves non-recourse financing of the development and construction of a particular project in which the lender looks principally to the revenues expected to be generated by the project for the repayment of its loan and to the assets of the project as collateral for its loan rather than to the general credit of the project sponsor.Project financing is an innovative and timely financing technique that has been used on many high-profile corporate projects, including Euro Disneyland and the Eurotunnel. Employing a carefully engineered financing mix, it has long been used to fund large-scale natural resource projects, from pipelines and refineries to electric-generating facilities and hydro-electric projects. Increasingly, project financing is emerging as the preferred alternative to conventional methods of financing infrastructure and other large-scale projects worldwide.Project Financing discipline includes understanding the rationale for project financing, how to prepare the financial plan, assess the risks, design the financing mix, and raise the funds. In addition, one must understand the cogent analyses of why some project financing plans have succeeded while others have failed. A knowledge-base is required regarding the design of contractual arrangements to support project financing; issues for the host government legislative provisions, public/private infrastructure partnerships, public/private financing structures; credit requirements of lenders, and how to determine the project's borrowing capacity; how to prepare cash flow projections and use them to measure expected rates of return; tax and accounting considerations; and analytical techniques to validate the project's feasibility.| |  |

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|  Characteristics of Project FinanceInvestments that are liable to be financed through this method have the following main characteristics: 1. Projects evolve through two clearly differentiated stages: construction and operation. 2. As the financing is “made to measure”, its structuring tends to be costly, and therefore is only justifiable for large-scale projects. 3. The bulk of the investment is aimed at tangible assets 4. The totality of the project’s assets are pledged to financial creditors. 5. High leverage is usually employed. 6. Investments are usually long-term (e.g., 20 years). 7. The only purpose of the financing is to complete the project, and as such it has a limited lifetime.| | Principal Advantages and Objectives|

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 | 1.| Non-recourse. The typical project financing involves a loan to enable the sponsor to construct a project where the loan is completely "non-recourse" to the sponsor, i.e., the sponsor has no obligation to make payments on the project loan if revenues generated by the project are insufficient to cover the principal and interest payments on the loan. In order to minimize the risks associated with a non-recourse loan, a lender typically will require indirect credit...
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