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Project financing methods

This document provides an overview of various project financing methods, including equity methods like common stock and preferred stock, debt methods like bonds and loans, and discusses their advantages and disadvantages. It also categorizes the major worldwide segments of project financing as infrastructure like power, transportation, oil and gas. Motivations for project financing include reducing risks, making use of tax benefits, and ensuring projects are completed on time. The document discusses the definitions of projects and project financing and provides a history of project financing dating back to the 13th century.

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All-In-One Project Financing Methods
Full Name: Mahmood Oskooei Tehran University MBA Code: 38 Date: 28/01/2015 Email: moskooie@yahoo.com
Contents • Introduction • Project Financing Methods • How To Chose The Best
Introduction
Introduction- History History of project financing: Project financing techniques date back to at least 1299 A.D. when the English Crown financed the exploration and the development of the Devon silver mines by repaying the Florentine merchant bank, Frescobaldi, with output from the mines. The Italian bankers held a one-year lease and mining concession, i.e., they were entitled to as much silver as they could mine during the year. In this example, the chief characteristic of the project financing is the use of the project’s output or assets to secure financing. Another form of project finance was used to fund sailing ship voyages from Roman and Greek time until the 17th century. Investors would provide financing for trading expeditions on a voyage-by voyage basis. Upon return, the cargo and ships would be liquidated and the proceeds of the voyage split amongst investors. One of the Iranian examples could be IRAN MELI BANK Silver 1299 A.D Florentine merchant bank Sailing ships & cargo Roman & Greek until 17th centuries sailing ship voyages and their cargo Silver mining
Introduction- Definitions What is project and project financing: Project: A project is a temporary endeavor undertaken to create a unique product, service, or result. The temporary nature of projects indicates that a project has a definite beginning and end. The end is reached when the project’s objectives have been achieved or when the project is terminated because its objectives will not or cannot be met, or when the need for the project no longer exists. A project may also be terminated if the client (customer, sponsor, or champion) wishes to terminate the project. Project financing: is a form of debt or equity structure that relies primarily on the project's cash flow for repayment, with the project's assets, rights, and interests held as secondary security or collateral. Worldwide Project Shares America Aferica Middle East Europe Asia & Pacific 34.6% 25.2% 5.4% 9% 25.8% North America with 18.5% has the highest rate of project financing share in whole world.
Introduction- Worldwide What are the current worldwide project finance segmentation : The major share of recent days project finance segments are focused on infrastructures. The main reason is as the following facts: Worldwide Project Shares By SectorPower Transportation Oil & Gas Petrochemicals Leisure, real estate, property Industry Water and sewerage Mining Telecommunications Waste and recycling 5.3% 34.3% 19.9% 19.5% During 2011-2013 investment on agriculture has been reduced to 0% and energy and transportation have maintained the constant top three 3.8% 8.2% 3.2% 2.7% 2.1% 0.9% GDP is driven by Productivity is boosted by Infrastructure enables funding for Project Finance Improvement loop
Introduction- Motivations I Project financing motivations: Beside its direct impact on national GDP there are few other fact and figures which makes clear why project financing is a necessity. Resources & Balance Sheet • Financial, technical or even manpower resources limitations. • Lack of influential resources. • Limitation or lack of willingness to show big investments in balance sheets. Risk Reduction • Political risk reduction with local financing. • Resource reservations and opportunity costs. • Technical risk reduction. • Macro and Micro economic risk reduction. • Deflating bankruptcy risk. • Risk is too large for just one company. • Risk cross check the risks from investors angel. • Reducing vertical or horizontal risks.
Introduction- Motivations II Project financing motivations: Income & Tax • To include financing costs in balance sheets toward lesser tax and higher income. • Using benefits of tax exemption as kind of negotiation leverage for better financing. • Benefiting special projects tax exemptions toward more economical benefits. • Reduction of new conflict of interest with current partners. Timing • To influence the cost factor in order to finish the projects in shorter time. If time is more critical. • More precise timing milestone setting, monitoring and control.
Introduction- Motivations III Project financing motivations: Strategy • Project is spun-off as separate company (publicity, risk, competitors and regulations). • Increased accountability to investors. • Long term contracts and relations (purchase and supply) toward strategic partnerships. • Insurance costs reduction by presence of well-known parties. • Benefiting bigger partners leverages (bank negotiation, insurance and … ). Others • Obtaining capital and yet has control. • Influencing nation wide Monetary & Fiscal Policies. For instance reduce free cash flow through high debt service also reducing society unemployment rate. • Traditional monitoring mechanisms such as takeover markets, staged financing, product markets absent in large scales. • Concentrated ownership provides critical monitoring. • Generating higher financial cash flow and turnover.
Project Financing Methods
Methods- Categories Financing methods categories: Different vehicles could be used for project financing propos. In general there are just two types of financing methods: Each of the categories includes variety of approaches with their related advantages, disadvantages/ risks and their possible foreseen solutions which their details are in the next pages of this presentation starting with equity. Financing Methods Equity Debt
Methods- Stock Stocks: There are different types of stocks for the propose of project financing each with their own specific advantages and risks. Common stock: is a form of corporate equity ownership, a type of security. The terms "voting share" or "ordinary share" are also used frequently in other parts of the world; "common stock" being primarily used in the United States. It is called "common" to distinguish it from preferred stocks. Advantages Disadvantages/Risks Solutions It has the least advantage of dividends in compare to other types. Some how complicate and time consuming. Solid BP with the out most deviation standards also taking into consideration the needed time bounds. In case of bankruptcy this method has the least rights and risk. Limitation in amount upon already invested sum in the project. Could be complement solution of project financing. High publicity could gain credit for the future projects of the same group in case of successful project. High publicity could create huge risk for not precise/ unsuccessful project. High level of project management experience and public relation should be in place. Higher level of democracy in management, also it is long term credit with requirements equal to BEP (break even point) outcomes Stock holders could vote for choosing BD and gain more control on project and company None voting common stocks could be sold and in future they could be bought back by major owners.
Methods- Stock & Bond Preferred stock : is a type of stock which may have any combination of features not possessed by common stock including properties of both an equity and a debt instrument, and is generally considered a hybrid instrument. It should be mentioned it has different varieties. Advantages Disadvantages/Risks Solutions It is long term credit with requirements equal to BEP (break even point) outcomes. They have priority in comparison to common stock holders rights including minimum fixed dividends and also bankruptcy right. To motivate their change to common stocks and then to follow the same steam line as common stock foreseen. Gains more credit and rating for project owner entities. More complicated than common stock and requires specific rating. Solid BP, higher level of management experience and public relation are needed. Bond: Is an instrument of indebtedness of the bond issuer to the holders. It is a debt security, under which the issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay them interest (the coupon) and/or to repay the principal at a later date, termed the maturity date. Interest is usually payable at fixed intervals (semiannual, annual, sometimes monthly). Very often the bond is negotiable, i.e. the ownership of the instrument can be transferred in the secondary market. This means that once the transfer agents at the bank medallion stamp the bond, it is highly liquid on the second market. Thus a bond is a form of loan or IOU (sounded "I owe you"). Bonds provide the borrower with external funds to finance long-term investments, or, in the case of government bonds, to finance current expenditure.
Methods- Bond I Advantages Disadvantages/Risks Solutions Kind of loan with fixed interest rate. If the coupon (interest rate) is already fixed then under any condition it should be paid on time. Solid BP with the least deviation beside precise BEP calculation should be in place. Long/ short kind of loan for project funding. Also paid interest could be considered as costs in accounting balance sheets to reduce tax. It has its own limitations and usually cannot be whole funding remedy (as usual case 20% of project investment). Also it is complicated enough. Could be complement solution of project financing. Also expert managing and finance team should be in place. Interesting for investors since it is highly equitable in the market . High responsibility in case of project bankruptcy toward bond holders. All requirements of solid project elements should be in place and this method of financing should be less preferred. Like stock it has market price also and could be sold higher than its purchased price. An interesting point for investors. It has much more publicity and its related concerns also direct effect on the project real and market value. Strong project management plan and execution should be conducted and all the progress and success cased should be broadly announced in public. Bond: It has different types with due advantages and risks. However, in general nature their major advantages and risks are the same as the following table;
Methods-Bond II Different Types Of Bonds: Fixed rate bond: have a coupon that remains constant throughout the life of the bond. A variation are stepped-coupon bonds, whose coupon increases during the life of the bond. Floating rate notes (FRNs, floaters): have a variable coupon that is linked to a reference rate of interest, such as LIBRO or Euribor. For example the coupon may be defined as three month USD LIBOR + 0.20%. The coupon rate is recalculated periodically, typically every one or three months. Zero-coupon bond (zeros): pay no regular interest. They are issued at a substantial discount to par value, so that the interest is effectively rolled up to maturity (and usually taxed as such). The bondholder receives the full principal amount on the redemption date. In other words, the separated coupons and the final principal payment of the bond may be traded separately. High-yield bond (junk bonds): are bonds that are rated below investment grade by the credit rating agencies. As these bonds are more risky than investment grade bonds, investors expect to earn a higher yield.
Methods-Bond III Convertible bond: let a bondholder exchange a bond to a number of shares of the issuer's common stock. These are known as hybrid securities, because they combine equity and debt Features. Exchangeable bond: allows for exchange to shares of a corporation other than the issuer. Inflation-indexed bond (linkers) (US) or Index-linked bond (UK): in which the principal amount and the interest payments are indexed to inflation. The interest rate is normally lower than for fixed rate bonds with a comparable maturity (this position briefly reversed itself for short-term UK bonds in December 2008). However, as the principal amount grows, the payments increase with inflation. The UK was the first sovereign issuer to issue inflation linked gilts in the 1980s. Treasury Inflation-Protected Securities (TIPS) and I-bonds are examples of inflation linked bonds issued by the U.S. government. Subordinated-bond: are those that have a lower priority than other bonds of the issuer in case of liquidation. In case of bankruptcy, there is a hierarchy of creditors. First the liquidator is paid, then government taxes, etc. The first bond holders in line to be paid are those holding what is called senior bonds. After they have been paid, the subordinated bond holders are paid. As a result, the risk is higher. Therefore, subordinated bonds usually have a lower credit rating than senior bonds. Perpetual bond perpetuities or 'Perps’: They have no maturity date.
Methods-Bond IIII .Bearer bond: is an official certificate issued without a named holder. In other words, the person who has the paper certificate can claim the value of the bond. Often they are registered by a number to prevent counterfeiting, but may be traded like cash. Bearer bonds are very risky because they can be lost or stolen. Especially after federal income tax began in the United States, bearer bonds were seen as an opportunity to conceal income or assets. A government bond: also called Treasury bond, is issued by a national government and is not exposed to default risk. It is characterized as the safest bond, with the lowest interest rate. A treasury bond is backed by the “full faith and credit” of the relevant government. Serial bond: is a bond that matures in installments over a period of time. In effect, a $100,000, 5-year serial bond would mature in a $20,000 annuity over a 5-year interval. Dual Currency Bond: a debt instrument in which the coupon and principal payments are made in two different currencies. The currency in which the bond is issued, which is called the base currency, will be the currency in which interest payments are made. The principal currency and amount are fixed when the bond is issued.
Methods- Loan I Loan In finance, a loan is a debt provided by one entity (organization or individual) to another entity at an interest rate, and evidenced by a note which specifies, among other things, the principal amount, interest rate, and date of repayment. A loan entails the reallocation of the subject asset(s) for a period of time, between the lender and the borrower. In a loan, the borrower initially receives or borrows an amount of money, called the principal, from the lender, and is obligated to pay back or repay an equal amount of money to the lender at a later time. The loan is generally provided at a cost, referred to as interest on the debt, which provides an incentive for the lender to engage in the loan. In a legal loan, each of these obligations and restrictions is enforced by contract, which can also place the borrower under additional restrictions known as loan covenants. In general all types of loans have almost same nature of advantages and risks with their possible remedies. As the following table; Advantages Disadvantages/Risks Solutions From taxation point of view the paid interest could be considered as cost and deducted from total profit, so lesser tax would be paid and more profit gained. All the payments including interest and principals should be paid on their due dates and maturities. Solid BP with the least deviation beside precise BEP calculation should be in place. The project could be financed with short- mid or long term maturity time upon our choice. Furthermore loan providers are usually large organizations with practical regulations. Good financial and business history is required beside all securities. Project wind up could happen since payment are not link to project BEP. Beside above mentioned necessities as B plan needed guarantees should be considered. Also from long enough time high level of turn over and financial outstanding should be foreseen.
Methods- Loan II . Different Types Of Loans Project financing loan: banks or financial institutes makes or guaranties a loan to a project. They carefully analyzes the economic, technical, marketing, and financial soundness of the Project (upon provide FS, BP and project owners backgrounds) to determine its creditworthiness. There must be adequate cash flow to pay all operational costs and to service all debt. It is expected that collateral, in the host country and/or locally will be provided to secure the loan. The project sponsors are expected to support the overseas operation until certain specific tests for physical completion, operational implementation, and financial soundness are met. To the extent that project financing is appropriate, sponsors may not need to pledge their own general credit beyond required completion undertakings. As usual practice project should not have loose ends. Which means even after project is operational all the purchases and sales (of final product) should be guaranteed upon long term contracts. Furthermore, minimum 15% of the project finance already should happened by means of land, machinery or any other project related requirements other than hard cash. Usual rate of interest of international bank are around 1.5 up to 2% and depending to the country the insurance related costs could be between 2-4% (in total in worse scenario max 6%).
Methods- Loan III . Term loan: A term loan is simply a loan provided for business purposes that needs to be paid back within a specified time frame. It typically carries a fixed interest rate, monthly or quarterly repayment schedule - and includes a set maturity date. Term loans can be both secure (i.e. some collateral is provided) and unsecured. A secured term loan will usually have a lower interest rate than an unsecured one. Depending upon the repayment period this loan type is classified as under: a. Short term loan: repayment period less than 1 year. b. Medium term loan: repayment period between 1 to 3 years. c. Long term loan: repayment period above 3 years. Band overdraft facility: A Bank Overdraft Facility refers to the ability to draw funds greater than are available in the company's current account. The actual size of the facility and the interest to be paid on overdrafts is typically agreed to prior to sanction. An overdraft facility is considered as a source of short term funding as it can be covered with the next deposit. Letter of credit (LC): is a document issued by a financial institution assuring payment to a seller provided certain documents have been presented to the bank. This ensures the payment will be made as long as the services are performed (usually the dispatch of goods). Hence, a Letter of Credit serves as a guarantee to the seller that he or she will be paid as agreed. It is often used in trade financing when goods are sold to overseas customers or the trading parties are not well known to each other. LC has different types but we will just cover those which are most suitable for project finance with longer term of payment as the following page:
Methods- Loan IIII B) Acceptance LC: In the case of an acceptance credit, the payment to the seller is not made when the documents are submitted, but instead at a later time defined in the letter of credit. The seller can request a discount from the bank that accepted the bill of exchange, or from another bank, and thus draw the amount of the bill minus the discount at any time after the documents have been submitted. C) Standby LC: the payment to the seller is not made when the documents are submitted, but instead at a later time defined in the attached contract to the LC. However, seller could evoke payment of LC by bank whenever buyer has failed the payment. . A) Differed payment (usance LC): In the case of a letter of credit with deferred payment, the payment to the seller is not made when the documents are submitted, but instead at a later time defined in the letter of credit. In the Far East, this kind of documentary credit is also known as a "usance L/C.“
Methods- Loan V . Bank Guarantee (BG): is a 'letter of guarantee' issued by a bank on behalf of its customer, to a third party (the beneficiary) guaranteeing that certain sum of money shall be paid by the bank to the third party within its validity period on presentation of the letter of guarantee. A letter of guarantee usually sets out certain conditions under which the guarantee can be invoked. Unlike a line of credit, the sum is only paid if the opposing party does not fulfill the stipulated obligations under the contract. A bank guarantee is usually used to insure a buyer or seller from loss or damage due to non-performance by the other party in a contract. SME collateral free loan: This is usually a business loan offered to SMEs and are collateral- free or without third party guarantee. Here the borrower is not required to provide collateral to avail the loan. It is made available to SMEs in both the start-up as well as existent phases to serve working capital requirements, purchase of machines, support expansion plans. However, it is to be noted that small businesses involved in retail trade are not eligible for these type of loans. Construction equipment/ commercial vehicle loans: Construction Equipment loans are provided for purchase of both new and used equipment like excavators, backhoe loaders, cranes, higher end construction equipments etc. The tenure of such loans vary from 12 to 60 months depending upon the deal and nature of repayment capacity. This is usually a secured loan where the machine itself is hypothecated until the loan is repaid. The same definition is valid for commercial vehicles such as trucks, buses, tippers, light commercial vehicles.
Methods- Counter Trade I Counter trade: Means exchanging goods or services which are paid for, in whole or part, with other goods or services, rather than with money. Countertrade also occurs when countries lack sufficient hard currency, or when other types of market trade are impossible. A significant chunk of international commerce, possibly as much as 25%, involves the barter of products for other products rather than for hard currency. Types of counter trade: all advantages and disadvantages have been discussed from point of view of project owner and at the point the method has been accepted mutually. Barter: exchange of goods or services directly for other goods or services without the use of money as means of purchase or payment. Advantages Disadvantages/Risks Solutions Project production sales could be secured in advance also international market share would be awarded with no marketing costs. Also improving status of national off balance import/ export balance sheet. Price fluctuation should be considered in advance and Right pricing too. Increase of product/service market price in future if selling price in the beginning has been fixed. Selling price of the product/ service should be according to the international market price. Reduction of product price in future. Proper national/ international FS and BP should take place. Strengthening project owners position financially for banks and share holders. By project risk reduction. Reduction of future financial turn over. To have right balance of sells. Include the project in basket of variety of projects.
Methods- Counter Trade II Switch trading: practice in which one company sells to another its obligation to make a purchase in a given country. Advantages Disadvantages/Risks Solutions Almost same advantage and risks of Barter with same solutions. Some times the final product of our project is not in same line of first party company business but could be major business line of switched company and result better benefits and long term partnerships. Confusion in contract T&C in regard to Switched trading obligations. Contract T&C should be proper and matured enough toward Switched trading required T&C in advance. Counter purchase: Sale of goods and services to one company in other country by a company that promises to make a future purchase of a specific product from the same company in that country. All the below cases of Countertrade have the same status of Switch & Barter Trade T&C
Methods- Counter Trade III Buyback: occurs when a firm builds a plant in a country - or supplies technology, equipment, training, or other services to the country and agrees to take a certain percentage of the plant's output as partial payment for the contract. Offset: Agreement that a company will offset a hard - currency purchase of an unspecified product from that nation in the future. Agreement by one nation to buy a product from another, subject to the purchase of some or all of the components and raw materials from the buyer of the finished product, or the assembly of such product in the buyer nation. Compensation trade: Compensation trade is a form of barter in which one of the flows is partly in goods and partly in hard currency. Compensation trade: is a derivative in which two counterparties exchange cash flows of one party's financial instrument for those of the other party's financial instrument. The benefits in question depend on the type of financial instruments involved. Specifically, two counterparties agree to exchange one stream of cash flows against another stream. These streams are called the legs of the swap. The swap agreement defines the dates when the cash flows are to be paid and the way they are accrued and calculated. Usually at the time when the contract is initiated, at least one of these series of cash flows is determined by an uncertain variable such as a floating interest rate, foreign exchange rate, equity price, or commodity price.
Methods- Others I BOT (Build, Operate and Transfer): is a form of project financing, wherein a private entity receives a concession from the private or public sector to finance, design, construct, and operate a facility stated in the concession contract. This enables the project proponent to recover its investment, operating and maintenance expenses in the project. Advantages Disadvantages/Risks Solutions Right entities could be chosen for right projects. Corruption in official process of BOT to choose right BOT entity. Defining proper systems, detail BP and project definitions beside suitable controllers. The chosen entity could be good project builder but not reliable operation and maintenance administrator for future harvest and handover. Detail contract with proper T&C in all three milestones Building, operation/ maintenance and handovers. Encourage private investment, transfer of technology and know- how, injection of external capitals and providing additional financial source for other priority projects. Political and financial risks (currency fluctuation). Needed mutual guarantees should be in place.
Methods- Others II BOO (build–own–operate): in a BOO project ownership of the project remains usually with the project company. Therefore the private company gets the benefits of any residual value of the project. This framework is used when the physical life of the project coincides with the concession period. A BOO scheme involves large amounts of finance and long payback period. Some examples of BOO projects come from the water treatment plants. Advantages Disadvantages/Risks Solutions All the same advantages as BOT. All the same risks as BOT where ownership is not related. All the same solutions as BOT where ownership is not related. BLT (build–lease–transfer): Under BLT a private entity builds a complete project and leases it to the government. On this way the control over the project is transferred from the project owner to a lessee. In other words the ownership remains by the shareholders but operation purposes are leased. After the expiry of the leasing the ownership of the asset and the operational responsibility are transferred to the government at a previously agreed price. All the previous B starting methods related advantages and risks plus less country and operational risks beside more secure property rights.
Methods- Others III DB Design-Construct: An owner develops a conceptual plan for a project, then solicits bids from joint ventures of architects and/or engineer and builders for the design and construction of the project. DBOM Design-Build-Operate-Maintain: DBOM takes DB one step further by including the operations and maintenance of the completed project in the same original contract. All the previous B starting methods related advantages and risks plus less burden of designing responsibilities and more concern of its outsourcing. DBFO design–build–finance–operate: Design–build–finance–operate is a project delivery method very similar to BOOT except that there is no actual ownership transfer. Moreover, the contractor assumes the risk of financing till the end of the contract period. This model is extensively used in specific infrastructure projects such as toll roads. The private construction company is responsible for the design and construction of a piece of infrastructure for the government, which is the true owner. Moreover the private entity has the responsibility to raise finance during the construction and the exploitation period. All above matters but in addition one of disadvantages could be difficulty with long term relationships and the threat of possible future political changes which may not agree with prior commitments.
Methods- Others IIII DBOT design–build–operate–transfer DCMF design–construct–manage–finance ROT Rehabilitate-own-transfer ROOT Rehabilitate-own-operate-transfer ROO Rehabilitate-own-operate And Yet More The Other Types Of Project Financing Methods
How To Chose The Best
How To Chose The Best- Basics Recommendation of a suitable financing method: When recommending a financing method, consideration should be given to a number of factors. These factors are key to justifying your choice of method. The factors include: Cost Time Cash flow Risk Security and covenants Availability Maturity Control Costs and ease of issue The yield curve
How To Chose The Best- Key Factors I Cost: Majorly there are two categories for financing methods which are debt and equity. Accordingly, all two categories costs should be considered not only in short but also in long terms. Such as: - Interest Rate - Present Value - NPV Net Present Value - ROI - Taxation considerations - Accounting balance sheets and benefits simulation - Economical balances and benefits simulation & opportunity costs - BEP Break Even Point - And finally costs comparisons between methods In the same line usually debt finance is cheaper than equity finance and so if the Company has the capacity to take on more debt, it could have a cost advantage.
How To Chose The Best- Key Factors II Cash flows: While debt finance is cheaper than equity finance, it places on the project owners the obligation to pay out cash in the form of interest. Failure to pay this interest can result in action being taken to wind up the company. Hence, consideration should be given to the ability of the owners to generate cash. If the owners are currently cash-generating, then it should be able to pay its interest and debt finance could be a good choice. If the owners are currently using cash because they are investing heavily in research and development for example, then the cash may not be available to service interest payments and the owners would be better to use equity finance. The equity providers may be willing to accept little or no cash return in the short term, but will instead hope to benefit from capital growth or enhanced dividends once the investment currently taking place bears fruit. Also, equity Providers cannot take action to wind up a company if it fails to pay the dividend expected. Break Even Point Cash Generation Quantitative Measurements Choice Of Option Based On Cash Flow
How To Chose The Best- Key Factors III Time: As one of project major constrains time is very important. The considerations could be named as the following; • How time consuming is the capital obtaining process and procedures. • How fast financing could be obtained after that. • How long do we have time for addressing required financing. • How the financing method will effect project time constrain. • Direct and indirect effects of financing methods in short and long terms of time. • Before project start (planning stage), also during project and when project has been finished and is operational what are our time priorities. Time Is Money & Money Is Time
How To Chose The Best- Key Factors IIII Risk: The directors of the project must control the total risk of the project and keep it at a level where the shareholders and other key stakeholders are content. Total risk is made up of the financial risk and the business risk. Hence, if it is clear that the business risk is going to rise – for example, because the company is diversifying into riskier areas or because the operating gearing is increasing – then the company may seek to reduce its financial risk. The reverse is also true – if business risk is expected to fall, then the project owners may Be happy to accept more financial risk. Financing Method Direct & Indirect Risks
How To Chose The Best- Key Factors V Security and covenants: If debt is to be raised, security may be required. From the data given it should be possible to establish whether suitable security may be available. Covenants, such as those that impose an obligation on the company to maintain a certain liquidity level, may be required by debt providers and directors must consider if they will be willing to live with such covenants prior to taking on the debt. What Are The Guarantees & Convenants Availability: The likely availability of finance must also be considered when recommending a suitable finance source. For instance, a small or medium sized unlisted company will always find raising equity difficult and, if you consider that the company requires more equity, you must be able to suggest potential sources, such as venture capitalists or business angels, and be aware of the drawbacks of such sources. Furthermore, if the recent or forecast financial performance is poor, all providers are likely to be wary of investing. Being Qualified & Availability Of Resources
How To Chose The Best- Key Factors VI Maturity: The basic rule is that the term of the finance should match the term of the need (the Matching principle). Hence, a short-term project should be financed with short-term finance. However, this basic rule can be flexed. For instance, if the project is short term – but other short-term opportunities are expected to arise in the future – the use of longer term finance could be justified. Durations Of Financing Methods Controls: If debt is raised then there will be no change in control. However, if equity is raised control may change. Owners should also recognize that a rights issue will only cause a change in control if shareholders sell their rights to other investors. Predict Changes & Controls
How To Chose The Best- Key Factors VII Costs and ease of issue: Debt finance is generally both cheaper and easier to raise than equity and, hence, a company will often raise debt rather than equity. Raising equity is often difficult, time-consuming and costly. Usually Debt Is Better Than Equity Hence Should be Checked The yield curve : Consideration should be given to the term structure of interest rates. For instance, if the curve is becoming steeper this shows an expectation that interest rates will rise in the future. In these circumstances, a company may become more wary of borrowing additional debt or may prefer to raise fixed rate debt, or may look to hedge the interest rate risk in some way. Future Is As Important As Present If Not More
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Project financing methods

  • 1.
  • 2.
    Full Name: MahmoodOskooei Tehran University MBA Code: 38 Date: 28/01/2015 Email: moskooie@yahoo.com
  • 3.
    Contents • Introduction • ProjectFinancing Methods • How To Chose The Best
  • 4.
  • 5.
    Introduction- History History ofproject financing: Project financing techniques date back to at least 1299 A.D. when the English Crown financed the exploration and the development of the Devon silver mines by repaying the Florentine merchant bank, Frescobaldi, with output from the mines. The Italian bankers held a one-year lease and mining concession, i.e., they were entitled to as much silver as they could mine during the year. In this example, the chief characteristic of the project financing is the use of the project’s output or assets to secure financing. Another form of project finance was used to fund sailing ship voyages from Roman and Greek time until the 17th century. Investors would provide financing for trading expeditions on a voyage-by voyage basis. Upon return, the cargo and ships would be liquidated and the proceeds of the voyage split amongst investors. One of the Iranian examples could be IRAN MELI BANK Silver 1299 A.D Florentine merchant bank Sailing ships & cargo Roman & Greek until 17th centuries sailing ship voyages and their cargo Silver mining
  • 6.
    Introduction- Definitions What isproject and project financing: Project: A project is a temporary endeavor undertaken to create a unique product, service, or result. The temporary nature of projects indicates that a project has a definite beginning and end. The end is reached when the project’s objectives have been achieved or when the project is terminated because its objectives will not or cannot be met, or when the need for the project no longer exists. A project may also be terminated if the client (customer, sponsor, or champion) wishes to terminate the project. Project financing: is a form of debt or equity structure that relies primarily on the project's cash flow for repayment, with the project's assets, rights, and interests held as secondary security or collateral. Worldwide Project Shares America Aferica Middle East Europe Asia & Pacific 34.6% 25.2% 5.4% 9% 25.8% North America with 18.5% has the highest rate of project financing share in whole world.
  • 7.
    Introduction- Worldwide What arethe current worldwide project finance segmentation : The major share of recent days project finance segments are focused on infrastructures. The main reason is as the following facts: Worldwide Project Shares By SectorPower Transportation Oil & Gas Petrochemicals Leisure, real estate, property Industry Water and sewerage Mining Telecommunications Waste and recycling 5.3% 34.3% 19.9% 19.5% During 2011-2013 investment on agriculture has been reduced to 0% and energy and transportation have maintained the constant top three 3.8% 8.2% 3.2% 2.7% 2.1% 0.9% GDP is driven by Productivity is boosted by Infrastructure enables funding for Project Finance Improvement loop
  • 8.
    Introduction- Motivations I Projectfinancing motivations: Beside its direct impact on national GDP there are few other fact and figures which makes clear why project financing is a necessity. Resources & Balance Sheet • Financial, technical or even manpower resources limitations. • Lack of influential resources. • Limitation or lack of willingness to show big investments in balance sheets. Risk Reduction • Political risk reduction with local financing. • Resource reservations and opportunity costs. • Technical risk reduction. • Macro and Micro economic risk reduction. • Deflating bankruptcy risk. • Risk is too large for just one company. • Risk cross check the risks from investors angel. • Reducing vertical or horizontal risks.
  • 9.
    Introduction- Motivations II Projectfinancing motivations: Income & Tax • To include financing costs in balance sheets toward lesser tax and higher income. • Using benefits of tax exemption as kind of negotiation leverage for better financing. • Benefiting special projects tax exemptions toward more economical benefits. • Reduction of new conflict of interest with current partners. Timing • To influence the cost factor in order to finish the projects in shorter time. If time is more critical. • More precise timing milestone setting, monitoring and control.
  • 10.
    Introduction- Motivations III Projectfinancing motivations: Strategy • Project is spun-off as separate company (publicity, risk, competitors and regulations). • Increased accountability to investors. • Long term contracts and relations (purchase and supply) toward strategic partnerships. • Insurance costs reduction by presence of well-known parties. • Benefiting bigger partners leverages (bank negotiation, insurance and … ). Others • Obtaining capital and yet has control. • Influencing nation wide Monetary & Fiscal Policies. For instance reduce free cash flow through high debt service also reducing society unemployment rate. • Traditional monitoring mechanisms such as takeover markets, staged financing, product markets absent in large scales. • Concentrated ownership provides critical monitoring. • Generating higher financial cash flow and turnover.
  • 11.
  • 12.
    Methods- Categories Financing methodscategories: Different vehicles could be used for project financing propos. In general there are just two types of financing methods: Each of the categories includes variety of approaches with their related advantages, disadvantages/ risks and their possible foreseen solutions which their details are in the next pages of this presentation starting with equity. Financing Methods Equity Debt
  • 13.
    Methods- Stock Stocks: There aredifferent types of stocks for the propose of project financing each with their own specific advantages and risks. Common stock: is a form of corporate equity ownership, a type of security. The terms "voting share" or "ordinary share" are also used frequently in other parts of the world; "common stock" being primarily used in the United States. It is called "common" to distinguish it from preferred stocks. Advantages Disadvantages/Risks Solutions It has the least advantage of dividends in compare to other types. Some how complicate and time consuming. Solid BP with the out most deviation standards also taking into consideration the needed time bounds. In case of bankruptcy this method has the least rights and risk. Limitation in amount upon already invested sum in the project. Could be complement solution of project financing. High publicity could gain credit for the future projects of the same group in case of successful project. High publicity could create huge risk for not precise/ unsuccessful project. High level of project management experience and public relation should be in place. Higher level of democracy in management, also it is long term credit with requirements equal to BEP (break even point) outcomes Stock holders could vote for choosing BD and gain more control on project and company None voting common stocks could be sold and in future they could be bought back by major owners.
  • 14.
    Methods- Stock &Bond Preferred stock : is a type of stock which may have any combination of features not possessed by common stock including properties of both an equity and a debt instrument, and is generally considered a hybrid instrument. It should be mentioned it has different varieties. Advantages Disadvantages/Risks Solutions It is long term credit with requirements equal to BEP (break even point) outcomes. They have priority in comparison to common stock holders rights including minimum fixed dividends and also bankruptcy right. To motivate their change to common stocks and then to follow the same steam line as common stock foreseen. Gains more credit and rating for project owner entities. More complicated than common stock and requires specific rating. Solid BP, higher level of management experience and public relation are needed. Bond: Is an instrument of indebtedness of the bond issuer to the holders. It is a debt security, under which the issuer owes the holders a debt and, depending on the terms of the bond, is obliged to pay them interest (the coupon) and/or to repay the principal at a later date, termed the maturity date. Interest is usually payable at fixed intervals (semiannual, annual, sometimes monthly). Very often the bond is negotiable, i.e. the ownership of the instrument can be transferred in the secondary market. This means that once the transfer agents at the bank medallion stamp the bond, it is highly liquid on the second market. Thus a bond is a form of loan or IOU (sounded "I owe you"). Bonds provide the borrower with external funds to finance long-term investments, or, in the case of government bonds, to finance current expenditure.
  • 15.
    Methods- Bond I AdvantagesDisadvantages/Risks Solutions Kind of loan with fixed interest rate. If the coupon (interest rate) is already fixed then under any condition it should be paid on time. Solid BP with the least deviation beside precise BEP calculation should be in place. Long/ short kind of loan for project funding. Also paid interest could be considered as costs in accounting balance sheets to reduce tax. It has its own limitations and usually cannot be whole funding remedy (as usual case 20% of project investment). Also it is complicated enough. Could be complement solution of project financing. Also expert managing and finance team should be in place. Interesting for investors since it is highly equitable in the market . High responsibility in case of project bankruptcy toward bond holders. All requirements of solid project elements should be in place and this method of financing should be less preferred. Like stock it has market price also and could be sold higher than its purchased price. An interesting point for investors. It has much more publicity and its related concerns also direct effect on the project real and market value. Strong project management plan and execution should be conducted and all the progress and success cased should be broadly announced in public. Bond: It has different types with due advantages and risks. However, in general nature their major advantages and risks are the same as the following table;
  • 16.
    Methods-Bond II Different TypesOf Bonds: Fixed rate bond: have a coupon that remains constant throughout the life of the bond. A variation are stepped-coupon bonds, whose coupon increases during the life of the bond. Floating rate notes (FRNs, floaters): have a variable coupon that is linked to a reference rate of interest, such as LIBRO or Euribor. For example the coupon may be defined as three month USD LIBOR + 0.20%. The coupon rate is recalculated periodically, typically every one or three months. Zero-coupon bond (zeros): pay no regular interest. They are issued at a substantial discount to par value, so that the interest is effectively rolled up to maturity (and usually taxed as such). The bondholder receives the full principal amount on the redemption date. In other words, the separated coupons and the final principal payment of the bond may be traded separately. High-yield bond (junk bonds): are bonds that are rated below investment grade by the credit rating agencies. As these bonds are more risky than investment grade bonds, investors expect to earn a higher yield.
  • 17.
    Methods-Bond III Convertible bond:let a bondholder exchange a bond to a number of shares of the issuer's common stock. These are known as hybrid securities, because they combine equity and debt Features. Exchangeable bond: allows for exchange to shares of a corporation other than the issuer. Inflation-indexed bond (linkers) (US) or Index-linked bond (UK): in which the principal amount and the interest payments are indexed to inflation. The interest rate is normally lower than for fixed rate bonds with a comparable maturity (this position briefly reversed itself for short-term UK bonds in December 2008). However, as the principal amount grows, the payments increase with inflation. The UK was the first sovereign issuer to issue inflation linked gilts in the 1980s. Treasury Inflation-Protected Securities (TIPS) and I-bonds are examples of inflation linked bonds issued by the U.S. government. Subordinated-bond: are those that have a lower priority than other bonds of the issuer in case of liquidation. In case of bankruptcy, there is a hierarchy of creditors. First the liquidator is paid, then government taxes, etc. The first bond holders in line to be paid are those holding what is called senior bonds. After they have been paid, the subordinated bond holders are paid. As a result, the risk is higher. Therefore, subordinated bonds usually have a lower credit rating than senior bonds. Perpetual bond perpetuities or 'Perps’: They have no maturity date.
  • 18.
    Methods-Bond IIII .Bearer bond:is an official certificate issued without a named holder. In other words, the person who has the paper certificate can claim the value of the bond. Often they are registered by a number to prevent counterfeiting, but may be traded like cash. Bearer bonds are very risky because they can be lost or stolen. Especially after federal income tax began in the United States, bearer bonds were seen as an opportunity to conceal income or assets. A government bond: also called Treasury bond, is issued by a national government and is not exposed to default risk. It is characterized as the safest bond, with the lowest interest rate. A treasury bond is backed by the “full faith and credit” of the relevant government. Serial bond: is a bond that matures in installments over a period of time. In effect, a $100,000, 5-year serial bond would mature in a $20,000 annuity over a 5-year interval. Dual Currency Bond: a debt instrument in which the coupon and principal payments are made in two different currencies. The currency in which the bond is issued, which is called the base currency, will be the currency in which interest payments are made. The principal currency and amount are fixed when the bond is issued.
  • 19.
    Methods- Loan I Loan Infinance, a loan is a debt provided by one entity (organization or individual) to another entity at an interest rate, and evidenced by a note which specifies, among other things, the principal amount, interest rate, and date of repayment. A loan entails the reallocation of the subject asset(s) for a period of time, between the lender and the borrower. In a loan, the borrower initially receives or borrows an amount of money, called the principal, from the lender, and is obligated to pay back or repay an equal amount of money to the lender at a later time. The loan is generally provided at a cost, referred to as interest on the debt, which provides an incentive for the lender to engage in the loan. In a legal loan, each of these obligations and restrictions is enforced by contract, which can also place the borrower under additional restrictions known as loan covenants. In general all types of loans have almost same nature of advantages and risks with their possible remedies. As the following table; Advantages Disadvantages/Risks Solutions From taxation point of view the paid interest could be considered as cost and deducted from total profit, so lesser tax would be paid and more profit gained. All the payments including interest and principals should be paid on their due dates and maturities. Solid BP with the least deviation beside precise BEP calculation should be in place. The project could be financed with short- mid or long term maturity time upon our choice. Furthermore loan providers are usually large organizations with practical regulations. Good financial and business history is required beside all securities. Project wind up could happen since payment are not link to project BEP. Beside above mentioned necessities as B plan needed guarantees should be considered. Also from long enough time high level of turn over and financial outstanding should be foreseen.
  • 20.
    Methods- Loan II . DifferentTypes Of Loans Project financing loan: banks or financial institutes makes or guaranties a loan to a project. They carefully analyzes the economic, technical, marketing, and financial soundness of the Project (upon provide FS, BP and project owners backgrounds) to determine its creditworthiness. There must be adequate cash flow to pay all operational costs and to service all debt. It is expected that collateral, in the host country and/or locally will be provided to secure the loan. The project sponsors are expected to support the overseas operation until certain specific tests for physical completion, operational implementation, and financial soundness are met. To the extent that project financing is appropriate, sponsors may not need to pledge their own general credit beyond required completion undertakings. As usual practice project should not have loose ends. Which means even after project is operational all the purchases and sales (of final product) should be guaranteed upon long term contracts. Furthermore, minimum 15% of the project finance already should happened by means of land, machinery or any other project related requirements other than hard cash. Usual rate of interest of international bank are around 1.5 up to 2% and depending to the country the insurance related costs could be between 2-4% (in total in worse scenario max 6%).
  • 21.
    Methods- Loan III . Termloan: A term loan is simply a loan provided for business purposes that needs to be paid back within a specified time frame. It typically carries a fixed interest rate, monthly or quarterly repayment schedule - and includes a set maturity date. Term loans can be both secure (i.e. some collateral is provided) and unsecured. A secured term loan will usually have a lower interest rate than an unsecured one. Depending upon the repayment period this loan type is classified as under: a. Short term loan: repayment period less than 1 year. b. Medium term loan: repayment period between 1 to 3 years. c. Long term loan: repayment period above 3 years. Band overdraft facility: A Bank Overdraft Facility refers to the ability to draw funds greater than are available in the company's current account. The actual size of the facility and the interest to be paid on overdrafts is typically agreed to prior to sanction. An overdraft facility is considered as a source of short term funding as it can be covered with the next deposit. Letter of credit (LC): is a document issued by a financial institution assuring payment to a seller provided certain documents have been presented to the bank. This ensures the payment will be made as long as the services are performed (usually the dispatch of goods). Hence, a Letter of Credit serves as a guarantee to the seller that he or she will be paid as agreed. It is often used in trade financing when goods are sold to overseas customers or the trading parties are not well known to each other. LC has different types but we will just cover those which are most suitable for project finance with longer term of payment as the following page:
  • 22.
    Methods- Loan IIII B)Acceptance LC: In the case of an acceptance credit, the payment to the seller is not made when the documents are submitted, but instead at a later time defined in the letter of credit. The seller can request a discount from the bank that accepted the bill of exchange, or from another bank, and thus draw the amount of the bill minus the discount at any time after the documents have been submitted. C) Standby LC: the payment to the seller is not made when the documents are submitted, but instead at a later time defined in the attached contract to the LC. However, seller could evoke payment of LC by bank whenever buyer has failed the payment. . A) Differed payment (usance LC): In the case of a letter of credit with deferred payment, the payment to the seller is not made when the documents are submitted, but instead at a later time defined in the letter of credit. In the Far East, this kind of documentary credit is also known as a "usance L/C.“
  • 23.
    Methods- Loan V . BankGuarantee (BG): is a 'letter of guarantee' issued by a bank on behalf of its customer, to a third party (the beneficiary) guaranteeing that certain sum of money shall be paid by the bank to the third party within its validity period on presentation of the letter of guarantee. A letter of guarantee usually sets out certain conditions under which the guarantee can be invoked. Unlike a line of credit, the sum is only paid if the opposing party does not fulfill the stipulated obligations under the contract. A bank guarantee is usually used to insure a buyer or seller from loss or damage due to non-performance by the other party in a contract. SME collateral free loan: This is usually a business loan offered to SMEs and are collateral- free or without third party guarantee. Here the borrower is not required to provide collateral to avail the loan. It is made available to SMEs in both the start-up as well as existent phases to serve working capital requirements, purchase of machines, support expansion plans. However, it is to be noted that small businesses involved in retail trade are not eligible for these type of loans. Construction equipment/ commercial vehicle loans: Construction Equipment loans are provided for purchase of both new and used equipment like excavators, backhoe loaders, cranes, higher end construction equipments etc. The tenure of such loans vary from 12 to 60 months depending upon the deal and nature of repayment capacity. This is usually a secured loan where the machine itself is hypothecated until the loan is repaid. The same definition is valid for commercial vehicles such as trucks, buses, tippers, light commercial vehicles.
  • 24.
    Methods- Counter TradeI Counter trade: Means exchanging goods or services which are paid for, in whole or part, with other goods or services, rather than with money. Countertrade also occurs when countries lack sufficient hard currency, or when other types of market trade are impossible. A significant chunk of international commerce, possibly as much as 25%, involves the barter of products for other products rather than for hard currency. Types of counter trade: all advantages and disadvantages have been discussed from point of view of project owner and at the point the method has been accepted mutually. Barter: exchange of goods or services directly for other goods or services without the use of money as means of purchase or payment. Advantages Disadvantages/Risks Solutions Project production sales could be secured in advance also international market share would be awarded with no marketing costs. Also improving status of national off balance import/ export balance sheet. Price fluctuation should be considered in advance and Right pricing too. Increase of product/service market price in future if selling price in the beginning has been fixed. Selling price of the product/ service should be according to the international market price. Reduction of product price in future. Proper national/ international FS and BP should take place. Strengthening project owners position financially for banks and share holders. By project risk reduction. Reduction of future financial turn over. To have right balance of sells. Include the project in basket of variety of projects.
  • 25.
    Methods- Counter TradeII Switch trading: practice in which one company sells to another its obligation to make a purchase in a given country. Advantages Disadvantages/Risks Solutions Almost same advantage and risks of Barter with same solutions. Some times the final product of our project is not in same line of first party company business but could be major business line of switched company and result better benefits and long term partnerships. Confusion in contract T&C in regard to Switched trading obligations. Contract T&C should be proper and matured enough toward Switched trading required T&C in advance. Counter purchase: Sale of goods and services to one company in other country by a company that promises to make a future purchase of a specific product from the same company in that country. All the below cases of Countertrade have the same status of Switch & Barter Trade T&C
  • 26.
    Methods- Counter TradeIII Buyback: occurs when a firm builds a plant in a country - or supplies technology, equipment, training, or other services to the country and agrees to take a certain percentage of the plant's output as partial payment for the contract. Offset: Agreement that a company will offset a hard - currency purchase of an unspecified product from that nation in the future. Agreement by one nation to buy a product from another, subject to the purchase of some or all of the components and raw materials from the buyer of the finished product, or the assembly of such product in the buyer nation. Compensation trade: Compensation trade is a form of barter in which one of the flows is partly in goods and partly in hard currency. Compensation trade: is a derivative in which two counterparties exchange cash flows of one party's financial instrument for those of the other party's financial instrument. The benefits in question depend on the type of financial instruments involved. Specifically, two counterparties agree to exchange one stream of cash flows against another stream. These streams are called the legs of the swap. The swap agreement defines the dates when the cash flows are to be paid and the way they are accrued and calculated. Usually at the time when the contract is initiated, at least one of these series of cash flows is determined by an uncertain variable such as a floating interest rate, foreign exchange rate, equity price, or commodity price.
  • 27.
    Methods- Others I BOT(Build, Operate and Transfer): is a form of project financing, wherein a private entity receives a concession from the private or public sector to finance, design, construct, and operate a facility stated in the concession contract. This enables the project proponent to recover its investment, operating and maintenance expenses in the project. Advantages Disadvantages/Risks Solutions Right entities could be chosen for right projects. Corruption in official process of BOT to choose right BOT entity. Defining proper systems, detail BP and project definitions beside suitable controllers. The chosen entity could be good project builder but not reliable operation and maintenance administrator for future harvest and handover. Detail contract with proper T&C in all three milestones Building, operation/ maintenance and handovers. Encourage private investment, transfer of technology and know- how, injection of external capitals and providing additional financial source for other priority projects. Political and financial risks (currency fluctuation). Needed mutual guarantees should be in place.
  • 28.
    Methods- Others II BOO(build–own–operate): in a BOO project ownership of the project remains usually with the project company. Therefore the private company gets the benefits of any residual value of the project. This framework is used when the physical life of the project coincides with the concession period. A BOO scheme involves large amounts of finance and long payback period. Some examples of BOO projects come from the water treatment plants. Advantages Disadvantages/Risks Solutions All the same advantages as BOT. All the same risks as BOT where ownership is not related. All the same solutions as BOT where ownership is not related. BLT (build–lease–transfer): Under BLT a private entity builds a complete project and leases it to the government. On this way the control over the project is transferred from the project owner to a lessee. In other words the ownership remains by the shareholders but operation purposes are leased. After the expiry of the leasing the ownership of the asset and the operational responsibility are transferred to the government at a previously agreed price. All the previous B starting methods related advantages and risks plus less country and operational risks beside more secure property rights.
  • 29.
    Methods- Others III DBDesign-Construct: An owner develops a conceptual plan for a project, then solicits bids from joint ventures of architects and/or engineer and builders for the design and construction of the project. DBOM Design-Build-Operate-Maintain: DBOM takes DB one step further by including the operations and maintenance of the completed project in the same original contract. All the previous B starting methods related advantages and risks plus less burden of designing responsibilities and more concern of its outsourcing. DBFO design–build–finance–operate: Design–build–finance–operate is a project delivery method very similar to BOOT except that there is no actual ownership transfer. Moreover, the contractor assumes the risk of financing till the end of the contract period. This model is extensively used in specific infrastructure projects such as toll roads. The private construction company is responsible for the design and construction of a piece of infrastructure for the government, which is the true owner. Moreover the private entity has the responsibility to raise finance during the construction and the exploitation period. All above matters but in addition one of disadvantages could be difficulty with long term relationships and the threat of possible future political changes which may not agree with prior commitments.
  • 30.
    Methods- Others IIII DBOTdesign–build–operate–transfer DCMF design–construct–manage–finance ROT Rehabilitate-own-transfer ROOT Rehabilitate-own-operate-transfer ROO Rehabilitate-own-operate And Yet More The Other Types Of Project Financing Methods
  • 31.
    How To ChoseThe Best
  • 32.
    How To ChoseThe Best- Basics Recommendation of a suitable financing method: When recommending a financing method, consideration should be given to a number of factors. These factors are key to justifying your choice of method. The factors include: Cost Time Cash flow Risk Security and covenants Availability Maturity Control Costs and ease of issue The yield curve
  • 33.
    How To ChoseThe Best- Key Factors I Cost: Majorly there are two categories for financing methods which are debt and equity. Accordingly, all two categories costs should be considered not only in short but also in long terms. Such as: - Interest Rate - Present Value - NPV Net Present Value - ROI - Taxation considerations - Accounting balance sheets and benefits simulation - Economical balances and benefits simulation & opportunity costs - BEP Break Even Point - And finally costs comparisons between methods In the same line usually debt finance is cheaper than equity finance and so if the Company has the capacity to take on more debt, it could have a cost advantage.
  • 34.
    How To ChoseThe Best- Key Factors II Cash flows: While debt finance is cheaper than equity finance, it places on the project owners the obligation to pay out cash in the form of interest. Failure to pay this interest can result in action being taken to wind up the company. Hence, consideration should be given to the ability of the owners to generate cash. If the owners are currently cash-generating, then it should be able to pay its interest and debt finance could be a good choice. If the owners are currently using cash because they are investing heavily in research and development for example, then the cash may not be available to service interest payments and the owners would be better to use equity finance. The equity providers may be willing to accept little or no cash return in the short term, but will instead hope to benefit from capital growth or enhanced dividends once the investment currently taking place bears fruit. Also, equity Providers cannot take action to wind up a company if it fails to pay the dividend expected. Break Even Point Cash Generation Quantitative Measurements Choice Of Option Based On Cash Flow
  • 35.
    How To ChoseThe Best- Key Factors III Time: As one of project major constrains time is very important. The considerations could be named as the following; • How time consuming is the capital obtaining process and procedures. • How fast financing could be obtained after that. • How long do we have time for addressing required financing. • How the financing method will effect project time constrain. • Direct and indirect effects of financing methods in short and long terms of time. • Before project start (planning stage), also during project and when project has been finished and is operational what are our time priorities. Time Is Money & Money Is Time
  • 36.
    How To ChoseThe Best- Key Factors IIII Risk: The directors of the project must control the total risk of the project and keep it at a level where the shareholders and other key stakeholders are content. Total risk is made up of the financial risk and the business risk. Hence, if it is clear that the business risk is going to rise – for example, because the company is diversifying into riskier areas or because the operating gearing is increasing – then the company may seek to reduce its financial risk. The reverse is also true – if business risk is expected to fall, then the project owners may Be happy to accept more financial risk. Financing Method Direct & Indirect Risks
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    How To ChoseThe Best- Key Factors V Security and covenants: If debt is to be raised, security may be required. From the data given it should be possible to establish whether suitable security may be available. Covenants, such as those that impose an obligation on the company to maintain a certain liquidity level, may be required by debt providers and directors must consider if they will be willing to live with such covenants prior to taking on the debt. What Are The Guarantees & Convenants Availability: The likely availability of finance must also be considered when recommending a suitable finance source. For instance, a small or medium sized unlisted company will always find raising equity difficult and, if you consider that the company requires more equity, you must be able to suggest potential sources, such as venture capitalists or business angels, and be aware of the drawbacks of such sources. Furthermore, if the recent or forecast financial performance is poor, all providers are likely to be wary of investing. Being Qualified & Availability Of Resources
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    How To ChoseThe Best- Key Factors VI Maturity: The basic rule is that the term of the finance should match the term of the need (the Matching principle). Hence, a short-term project should be financed with short-term finance. However, this basic rule can be flexed. For instance, if the project is short term – but other short-term opportunities are expected to arise in the future – the use of longer term finance could be justified. Durations Of Financing Methods Controls: If debt is raised then there will be no change in control. However, if equity is raised control may change. Owners should also recognize that a rights issue will only cause a change in control if shareholders sell their rights to other investors. Predict Changes & Controls
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    How To ChoseThe Best- Key Factors VII Costs and ease of issue: Debt finance is generally both cheaper and easier to raise than equity and, hence, a company will often raise debt rather than equity. Raising equity is often difficult, time-consuming and costly. Usually Debt Is Better Than Equity Hence Should be Checked The yield curve : Consideration should be given to the term structure of interest rates. For instance, if the curve is becoming steeper this shows an expectation that interest rates will rise in the future. In these circumstances, a company may become more wary of borrowing additional debt or may prefer to raise fixed rate debt, or may look to hedge the interest rate risk in some way. Future Is As Important As Present If Not More
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