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Project finance is finance for a particular project, such as a mine, toll road, railway,
pipeline, power station, ship, hospital or prison, which is repaid from the cash-flow of
that project.
Project finance is different from traditional forms of finance because the financier
principally looks to the assets and revenue of the project in order to secure and service
the loan.
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As a special purpose entity, the project company has no assets other than the project.
Capital contribution commitments by the owners of the project company are
sometimes necessary to ensure that the project is financially sound.
The project finance alternative to development has proved tremendously attractive and
efficient, creating much needed infrastructure as well as countless jobs.
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Project financing is an innovative and timely financing technique that has been used
on many high-profile corporate projects.
In a project financing the financier usually has little or no recourse to the non-project
assets of the borrower or the sponsors of the project.
The purpose of this project is to explain, in a brief and general way, the manner in
which risks are approached by financiers in a project finance transaction. Such risk
minimization lies at the heart of project finance.
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R.? Project finance is a finance structure which ensures that the projects are
environmentally, socially, economically and politically viable.
2.? Traditional methods are not suitable for projects which have a long life and
require huge capital investment.
3.? Risk sharing is another unique feature of project finance which traditional
methods do not provide.
4.? Project Finance improves the return on capital in a project by leveraging the
investment
5.? Project finance facilitates careful project evaluation & risk assessment
Project evaluation is a high level assessment of the project to see whether the project
is worthwhile to proceed and whether the project will fit in the strategic planning of
the whole organization.
Project evaluation helps to decide which of the several alternative projects has a better
success rate, a higher turnover.
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The key parameters to be evaluated in a project are:
R.? Risk Analysis
2.? Demand Analysis
3.? Project Cost |stimation
4.? Revenue Analysis
5.? Financial Analysis
6.? Project Selection Criteria
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Other risks constitute risks which may be an obstacle in the success/
Completion of the project. Risks which can be included in other risk are
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Demand analysis involves forecasting the demand on the basis of
market surveys and manufacturing capacity of the unit and this is decided through the
study of demand and supply.
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Revenue analysis is estimation of the revenues which would be
earned in the future. Revenue projections are formed on the basis of Output sales. It
helps in finding out the profits/ losses in the future.
Revenue analysis is all the more important in project finance
because the debts have to be repaid through the revenues generated by the project.
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Financial analysis refers to an assessment of the viability,
stability & profitability of a project.
It seeks to ascertain whether the proposed project will be
financially viable in the sense of being able to meet the burden of servicing debt and
whether the project will satisfy the return expectations of those who provide the
capital.
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Once information about expected return and costs has been gathered,
the next question arises: whether the project should be selected or not. There are many
methods of evaluating the profitability of the project.
The project selection can be done on basis of profitability of a project and profitability
measured by the following methods.
The Yet present value method is the modern method of evaluating investment
proposals.
YPV= Present value of cash inflows ± Present value of cash outflows.
IYT|RYAL RAT| OF R|TURY M|THOD: It is also known as trial & error yield
method.
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It measures the Present Value of returns per rupee invested
PI = Present value of Cash Inflows
Present value of cash Outflows
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Being that the United States is the leader when it comes to consumption of goods and
services; an economic recession here will send shockwaves across the world, creating
a global recession.
The only way to truly recession proof your portfolio during a severe global recession
is to move your money to cash or US treasury instruments.
In some other cases, when a country faces negative real economic growth, for two or
more successive quarters of a year, that¶s also termed as state of recession. Though,
the exact definition of recession has always been controversial and economists tend to
differ in defining recession.
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This is another staunchly debated topic; but the general consensus is that a recession is
primarily caused by the actions taken to control the money supply in the economy.
The Federal Reserve is responsible for maintaining an ideal balance between money
supply, interest rates, and inflation.
When the Fed loses the balance in this equation, the economy can spiral out of
control, forcing it to correct itself.
This is precisely what we have seen in 2007, where the Feds monetary policy of
injecting tremendous amounts of money supply into the money market has kept
interest rates low and inflation edging higher.
Combine this with the relaxed lending policies which made it easy to borrow money
and you have economic activity which becomes unsustainable, resulting in the
economy coming to a near halt.
It is also said that economic recession can be caused by factors that stunt short term
growth in the economy, such as spiking oil prices or war.
While the growth in GDP will still be present, it will show signs of sputtering and you
will see higher levels of unemployment, decline in housing prices, decline in the stock
market, and business expansion plans being put on hold.
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The majority of project finance transactions are oriented around long term contracts,
usually with investment grade counterparties.
Fitch¶s rating analysis typically reflects the project¶s standalone credit metrics derived
under the pricing mechanics and delivery obligations of the contracts.
However, as the counterparty¶s credit quality begins to decline, there is greater risk
for contract termination or counterparty payment default.
Many project finance transactions have market exposure, usually via a merchant
business plan but occasionally through contracts indexed to market prices.
When evaluating these projects, Fitch¶s rating decisions are heavily based on the
financial performance during stressed market conditions ± typically involving fuel
prices and market overcapacity.
Subsequently, if the agency believes there is a permanent shift in the market away
from its initial stress assumptions, it could upgrade if the shift is favorable or
downgrade if unfavorable.
The primary risk for this category of projects involves technical performance and
operating costs. Although these are important contributors to credit quality, they are
largely project specific issues and not linked to industry wide events.
The rating outlook for projects selling their output to midsized or highly levered
competitive generators is negative, reflecting the possibility of deteriorating
counterparty credit quality.
The magnitude of rating action, if any, for an affected project will be highly specific
to the original contractual arrangements and the project¶s prospects in its local
marketplace.
The rating outlook for projects with market exposure is stable. Fitch acknowledges the
steep decline in gross margins and expects debt service coverage will be meaningfully
lower than in recent years.
This is particularly true for coal fired and hydroelectric projects, and to a lesser degree
for natural gas fired projects.
However, Fitch notes that previous market conditions were extremely favorable for
merchant generation. Yotably, current fuel prices remain above the levels assumed in
the agency¶s market stress scenarios and meaningful overcapacity is considered
unlikely.
Although cash flows will be lower than in previous years, Fitch expects financial
performance of merchant generators will exceed that assumed in its stress scenarios
on which the ratings are based.
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Fuel supply arrangements, especially for merchant coal fired generators. Considering
the steep decline in fuel prices, fixed price contracts executed in recent years may
result in a negative margin on market based energy sales.
Yotably, coal supply agreements often involve fixed prices for three to five year
terms. Counterparty credit quality, especially when the counterparty is an independent
generating company as this segment is more vulnerable to sudden credit issues.
Maturity of credit facilities that satisfy debt service and maintenance reserves,
performance obligations, and so on.
A failure to replace or renew will likely result in additional indebtedness as funds may
be drawn prior to maturity of the current facility.
|nvironmental compliance strategies may alter cost structure and operating practices
for |uropean generators. Coal fired generators appear particularly vulnerable.
In economic recession the project financing is very difficult because overall economy
is down the main problem is create for the finance that how finance will create
because company has a means of finance in following ways;
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A company has these kind of funds sources now in the situation of recession it is a
very difficult to use a equity capital because to get a fund from equity share and
preference share very hard because of bad situation of a market and economy.
Yow here I am going to explain that how project evaluate and what are the parameters
should check accordingly sector wise.
Yow If I want to prepare
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The majority of project finance transactions are oriented around longMterm
contracts, usually with investmentMgrade counterparties. Fitch¶s rating analys
typically reflects the project¶s standalone credit metrics derived under the pricing
mechanics and delivery obligations of the contracts.
Many project finance transactions have market exposure, usually via a merchant
business plan but occasionally through contracts indexed to market prices.
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? Fuel supply arrangements, especially for merchant coalMfired generators
Considering the steep decline in fuel prices, fixed price contracts executed in
recent years may result in a negative margin on marketMbased energy sales
Yotably, coal supply agreements often involve fixed prices for threeM to five
year terms.
? Maturity of credit facilities that satisfy debt service and maintenance reserves
performance obligations, and so on. A failure to replace or renew will likely
result in additional indebtedness as funds may be drawn prior to maturity of the
current facility.
? |nvironmental compliance strategies may alter cost structure and operating
practices for |uropean generators. CoalMfired generators appear particularly
vulnerable. |quipment supply; technical failures; and reliability of forecasts.
Projects in this group generally have financial structures that reflect their exposure to
volatile market prices. Gearing is low (30M50% debt to project costs) relative to other
infrastructure sectors.
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? Increasing capital costs;
? Breakeven hydrocarbon price; and
? Construction delays.
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? A continuation of the decline in vehicle miles travelled (VMT) could cause larger
? reductions in toll road traffic and make free alternatives less congested and
more competitive on a travel time basis.
? Publicly run facilities will face increased political opposition to toll increases at
? a time when these increases will be critical for many facilities to maintain
financial flexibility and to meet covenants.
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The outlook for the sector remains negative for 2009. |ven with fuel prices falling
substantially from record highs in 2008, the primary drivers for air travel business and
leisure still remain under significant pressure with employment down 2.8 million
in December 2008 over December 2007.
Further losses are expected into 2009. As a result, the previously announced
capacity reductions for the fourth quarter of 2008 were increased after the summer
and Fitch views the likelihood for either capacity or traffic growth in 2009 as
limited to a handful of facilities.
In addition that business and consumer sentiment over the ensuing year will likely
limit the effect of airline attempts to fill seats with lower fares and thus
enplanement growth will likely be muted over the next few years.
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In 2008, Fitch noted that delaying capital spending and increasing operating
Margins through expense reductions and the mothballing of facilities were two
Important tools that management could exercise to deal with declining enplanements.
During 2008, most airports slowed capital spending and reduced expenses but
only passed on limited increases in rates and charges.
And it¶s because of recession the overall transportation projects and tertiary sector
was down due to law demand and over production.
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? The airline industry¶s increased focus on the bottom line could make it harder for
airports to pass along needed increases in rates and charges.
? The pace of airline service contraction throughout the region and the effect that it
might have on deferred capital expenditures; the financial counterparty risk faced
by some major publicly owned airports in Asia to offshore airport project joint
ventures; and the implications to airport capital expenditures of the growing
market presence by low cost carriers.
In economic recession the project finance is very important the project manager
should focused on the following aspects.
? MAYG|RIAL
? FIYAYCIAL
? T|CHYICAL
? COMM|RCIAL
? L|GAL
? |COYOMICAL
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Compare profitability with that of existing firms in similar line, particularly the
PBIDT margin.
YPV/ (net present value) IRR (internal rate of return) method: Considered to be best
method for evaluating the capital investment proposals. It takes into account time
value of money
The sum of money received in future is less valuable than it is today. Present value
of rupee to be received is less than one. |.g. Re R00 today may not have the same
value after one year.
As the problem persists, investors are now reluctant to take currency mismatch,
interest rate and refinancing risks.
|mirates Business 24/7 reported that the global economic distress has smothered
project finance in the Middle |ast and other areas of Yorth Africa and Western Asia
after it spearheaded such activity worldwide.
The UY Conference on Trade and Development said in its 2009 report that before the
eruption of the financial crisis in mid September 2008, West Asia was the world's
biggest market in project finance, largely surpassing such key markets as West |urope
and Yorth America.
The report said that the local and foreign private sector had played a key role in
project financing in Western Asia before the crisis.
Its figures showed that in the January to September of 2008, nearly USD 40 billion in
project debt was raised for developments in West Asia and Yorth Africa compared to
USD 32 billion in Western |urope and USD 29 billion in Yorth America.
In addition, the project finance debt rose in West Asia and Yorth Africa in the whole
of 2006 amounted to over 5% of the region's GDP compared to less than 0.25% in
Western |urope.
The report said that "However, the deepening global financial and economic crisis has
dried up project finance and has also led developers to reappraise projects in light of
the new economic outlook.
Indeed, falling demand and the worsening outlook for credit markets are affecting
project prospects and their financing, especially those that require substantial
investments."
It said that "The collapse of the project finance market and the drying up of financing
from international banks has put pressure on governments to mobilize local liquidity
through increased direct public funding additional local equity or loans from local
banks.
For example, the Saudi Arabian Government has significantly relaxed its tight
monetary policy by cutting both the repurchase rate and reserve requirements for
banks to encourage lending."
UYCTAD said that several projects had been either cancelled or put on hold in the
M|YA region including a USD R0 billion aluminum smelter and 2 refineries with a
combined cost of USD 20 billion in Saudi Arabia. 2 other projects including a
destination plant and a theme park in the UA| have been delayed.
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.
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: assessment of risk and management of risk can be done following
ways.
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The project sponsors will usually prepare a feasibility study, e.g. as to the construction
and operation of a mine or pipeline. The financiers will carefully review the study and
may engage independent expert consultants to supplement it. The matters of particular
focus will be whether the costs of the project have been properly assessed and whether
the cash-flow streams from the project are properly calculated.
m ???Yow fund raiser can be done by internal and external ways which I
saw above.
Firstly I selected the location that I want to construct the road b/w Rajkot to
Ahmadabad and particularly it is |xpress Way so there should be a straight and
forward road location where minimum turning point and Bridge would be there.
The cost of material like send, bricks, cement, still, labor, and other expenses will be
cheaper but main cost is cement, still and labor now in last when the recession was
there the labor was very high even a recession in all over the company and economy.
|ven to get the labor in law prices will become very difficult so that company has to
pay labor cost what they want.
Yow main problem is that how fund can generate in recession because all the bank
was affected by the recession and majorly banking sector was their which is highest
affected by the recession.
In this scenario to get a loan from a bank very difficult and if bank will section a loan
then the rate will become very high. And the repayment of loan will increase and
profitability of the project will decrease and at the time of project finance the project
should create and designed in which the profitability is high.
Yow for the fund generation of Fund Company has designed two different projects.
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Yow this project is decided to generate a fund by joint venture i.e. with company X
and Y which is still company.
Company has R00 cr. Already fund available so by contract and terms and Condition
Company Y will also invest R00 cr. From their profitability.
So,
By commercial and other paper instrument ± 50 cr.
Yow in the situation of recession the project 2 is much better and profitable because
company has done well financial planning by joint venture doing.
Company has generate a fund by debenture and IPO (equity capital) which is very
risky for investor and also for the company because both are the primary market
instruments and investor more interested in primary market because generally they are
safe and in debenture the investor will get good and fixed returns so investor will
ready to invest even a in recession situation due to fixed returns.
Because company has done joint venture with still company which will benefit for the
company X to reducing their cost of material.
In recession it is very difficult to get a loan so non banking finance company and
debenture instrument is best for the company for generate a fund fro a project.
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So every company has these instruments by which they can generate fund even in
downfall economy.
a) |quity capital: It is the initial fund provided by the promoters of the firm for the
project. This is the permanent long-term capital invested by the owners/promoters.
The general public as well as investment institute also provide equity capital. Cost of
capital under equity capital is the rate of dividend declared and paid out of profit of
the company upon the completion and start of operation of the project.
(b) Preference shares: Initial funds for the project can also be raised through issue of
preference shares. The difference between the preference shares and equity shares is
that preference shareholders get a preference over the equity shareholders in the event
of liquidation. Preference shareholders also get a fixed dividend.
(c) Debentures: The issue of debentures also raises Funds. Debentures carry fixed rate
of interest redeemable after a stipulated period. At the end of stipulated period, the
issuing company buys the debentures back or converts then in equity share and pays
bask.
(d) Bonds: Funds for project are also raised particularly by the public sector
enterprises through bonds. Issues of bonds are to get approval of the concerned
authorities. These bonds can be bought back by the issuing company after completion
of the stipulated period.
(e) Joint ventures: This is another new opening in the project financing through
participation. This includes besides equity participation and in technology transfer
also.
(g) Loans from other companies: This is also termed as an inter-corporate loan. This is
mainly to meet short-term needs i.e. mainly working capital requirement or the
repayment of loans, which have become due for repayment, this is short-term loan.
Banks, public deposit, financial deposit, foreign direct investments, World Bank loan,
commercial papers, lease financing, Infrastructure development finance company,
Contract financing, finance through special development funds, retention of profit and
ploughing back of money,