Financing ofproject appraisal Project

7/29/2019 Financing ofproject appraisal Project

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Presentation By,

Jayan Suja

Neethu.P

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Project Finance

Project finance is the longterm financing of infrastructure and industrial projectsbased on the projected cash flows of the project rather than

the balance sheets of the project sponsors.

Issues considered in financing project are as follows:- What is an appropriate capital structure?

Which financing instrument make more sense? What are the pros and cons of public and private sources of

capital?

How much should a firm depend on domestic andinternational capital market?

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Financing Decision Vs Investment

DecisionFinancing Decision Investment Decision

Takes place in capital market

which are approximately perfect

While making financingdecision, you may observe the

value of similar assets.

There are very few opportunitiesin the realm of financing thathave NPV that is significantlydifferent from zero.

Takes place in Real Market

which tend to be imperfect

While making financingdecision, you have to estimatethe values of capital assets.

There are many opportunities inthe realm of capital budgetingthat have an NPV that issignificantly different from zero.

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Capital Structure

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Equity Vs DebtEquity Debt

Equity shareholders have aresidual claim on the income

and wealth of the firm Dividend paid to Equity

shareholders is not a taxdeductible payment

Equity ordinarily have indefinitelife

Equity shareholders enjoy theprerogative to control the affairsof the firm

Creditors have a fixed claim inthe form of interest and

principal repayment Interest paid to creditors is tax

deductible payment

Debt has a fixed maturity

Debt investors play a passiverole-of course, they imposecertain restrictions on the waythe firm is run to protect theirinterests

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Key factors Determining the D/E Ratio

Cost

Nature of Assets

Business Risk Norms of lenders

Control Considerations

Market Conditions

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A Check List

Use more Equity when Use more Debt when

The tax rate applicable isnegligible

Business Risk exposure isHigh

Dilution of control is not animportant issue

The assets of the project aremostly intangible

The project has manyvaluable growth options

The tax rate applicable isHigh

Business Risk exposure isLow

Dilution of control is animportant issue

The assets of the project aremostly tangible

The project has few growthoptions

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Menu of Financing Public and Private Sources of Capital

A firm can raise both equity and debt capital from both public

and private source Capital raised in the form of securities offered to public

through SEBI can be traded on public secondary markets likeNSE and BSE

Private placement come either in the form of loans by Banks

or financial institutions or in the form of issue of securitieslike equity shares, preference shares, debentures which areprivately placed venture capital firms, financial institutions,insurance companies etc.

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The typical Pattern of Financing

When a company is formed, it first issue shares to itspromoters and in most cases, raises loans from banks,financial institutions and other sources.

As the need for fund increases, the company may issue

shares and debentures privately to promoters relatives,friends, business partners etc.

As the company grow further, it may have to raise capitalfrom public.

The first issue of equity shares to public by an unlistedcompany is called Initial Public Offer (IPO).

Subsequent offerings are called Seasoned Offerings.

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Internal Accruals The Internal Accruals of a firm consists of Depreciation Charges

and Retained Earnings.

Depreciation represents the allocation of capital expenditure to

various periods over which capital expenditure is expected tobenefit the firm.

Retained Earnings is a portion of earnings (PAT less preferencedividends) which are ploughed back in the firm

Because Retained Earnings is the sacrifice made by theshareholders its called Internal Equity.

Companies normally retain 30% to 80% of PAT for financinggrowth.

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Advantages of Internal Accruals Internals Accruals are readily available

Use of Internals Accruals eliminates issue cost and losses onaccount of underpricing

There is no dilution of control when a firm relies on InternalsAccruals

Internals Accruals does not have any negative connotation

like stock market views equity shares with skepticism.

Disadvantages of Internal Accruals Internals Accruals is limited

Opportunity cost of retained earnings is quite high.

Opportunity cost of Depreciation-generated funds is equal toWACC of the firm

Many firms do not appreciate Opportunity cost generatedfrom retained earnings and Depreciation-generated funds.

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Equity Capital

Equity Capital represents ownership capital as equityshareholders collectively owns the company.

Their risk is Limited to the capital contribution.

The amount of capital that a company can potentially issue, asper the memorandum, represents theAuthorized Capital.

The amount offered to its investors represents IssuedCapital.

The part of issued capital subscribed by the investorsrepresents Subscribed Capital

The actual amount paid-up by the investors is called Paid-UpCapital.

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Par Value of an equity shares is the value stated in the

memorandum and written on the share scrip. The Issue Price is the price at which the equity share is

issued.

Book Value of an equity shares is equal to,

Paid Up Equity Capital+Reserves and Surplus

No. of O/s Equity shares

Market value of an equity share is the price at which it istraded is the market.

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Rights of an Equity Shareholder Right to Income: The equity investors have claim over the

income left after satisfying the claims of all other investors. It issimply PAT-Preferred Dividend.

Right to Control: They elect the BODs who in turn elects theManagement which controls the operation of the company. Theyalso have the right to vote for every resolution placed before thecompany.

Pre-Emptive Right: This right enables the existing shareholdersto maintain their proportional ownership by purchasing theadditional equity shares issued by the firm.

Right in Liquidation: They have a residual claim over the assetsof the firm at the event of Liquidation.

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Advantages of Equity Capital

There is no compulsion to pay dividend

Equity Capital has no maturity date and hence the firm hasno obligation to redeem.

It enhances creditworthiness of the company.

Disadvantages of Equity Capital

Sales of Equity Shares to outsiders dilutes the control ofexisting owners.

Cost of Equity Capital is High Cost of Issuing Equity shares is generally high.

Equity dividends are paid out of PAT.

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Preference Capital

Preference Capital resembles Equity Capital infollowing ways:

It is paid out of distributable profit

It is not an Obligatory payment

It is not a tax-Deductible Payment

Preference Capital resembles Equity Capital in

following ways: The Dividend of preference capital is usually fixed

Their claim is prior to the claim of equity capital

They normally do not enjoy the voting rights.

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Types of Preference Shares Cumulative and Non-Cumulative Preference Shares: Cumulative

Preference Shareholder receives dividend for the previous year/s inwhich dividend was not paid.

Participating and Non-Participating Preference Shares:Participating Preference Shareholder get a share in the profit of the

company after a certain rate of dividend is paid to the equityshareholders of the company.

Redeemable and Non-Redeemable Preference Shares:Redeemable Preference Shares are repayable at par or at premium aftera specified period. Non-Redeemable Preference Shares are not

repayable, except when the company goes into Liquidation. Convertible and Non-Convertible Preference Shares: Convertible

Preference Shares can be converted into equity shares at the option ofthe preference shareholders in accordance with certain predeterminedterms.

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Advantages of Preference Capital There is no legal obligation to pay preference dividend There is no redemption liability in the case of perpetual

preference shares It is regarded as part of net worth They normally do not carry voting rights No security of assets is provided to preference shareholders

Disadvantages of Preference Capital Compared to debt-capital, its more expensive source of

financing Skipping preference dividend can adversely affect the image

of the firm in the capital market Compared to equity shareholders, preference shareholders

have a prior claim on the assets and earnings of the firm It the firm skips dividend fro three years, it has to provide

voting rights to preference shareholders.

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Debentures(or Bonds)

Are instrument for raising long term debt finance

Features

Trustee redeem Security

Interest rate

Maturity and Redemption

Call and Put Features

Convertibility


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Deep Discount Bonds does not Carry any coupon rate

Issued at a steep discount over its face value

Convertible Debentures Debenture that are convertible partially or wholly into equity

shares

Conventional Explanations

Cheaper debt

Equity at premiumModern Finance Explanations

Cash flow matching

Financial synergy

Agency cost


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Floating Rate Bonds

Earn an interest rate that is linked to a benchmark ratesuch a treasury bill interest rate.

Have been essentially a response to inflation risk

Indexed Bonds

Payoff of this bonds consists of two parts A fixed amount

A variable component whose value is dependent on some index

Strips

Separately tradable interest and principal debentures


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Debt financing

Advantages

Interest on debt are tax-deductable expense

Does not result in dilution of control

Do not partake in the value created by the company

Issue cost of debt are low

Burden of serving the debt is generally fixed in nominal

terms The maturity of the debt instrument can be tailored to

the needs of the borrowing firm


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Disadvantages

Entails fixed interest and principal paymentobligation

Increases financial leverage

Impose restrictions that limit the borrowing firmsfinancial and operating flexibility

If the rate of inflation turned out to be

unexpectedly low, the real cost of debt will begreater than expected


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Method of Offering

Public Offering

Sale of securities to the members of the public

Types of public offerings are:

Initial public offering

Seasoned Equity offering

Bond Offering

Rights issue Selling securities in the primary market by issuing rights

to the existing shareholders


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Private placement

Is an issue of securities to a selected group of persons notexceeding 49

Can be of two types:

Preferential allotment

Qualified institutional placement (QIP)

Comparison of various methodsPublic Issue Rights Issue Private

Placement

Amount that can be raised Large Moderate Moderate

Cost of issue High Negligible Negligible

Dilution of control Yes No Yes

Degree of underpricing Large Irrelevant Small

Market perception Negative Neutral Neutral


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Term loans

Primary source of long term debt

Features of term loans

Currency Security

Interest payment and principal repayment

Restrictive covenants

Term loan procedure Submission of loan application

Initial processing of loan application


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Appraisal of the proposed project

Issue of the letter of sanction Acceptance of terms and conditions by the borrowing

unit

Execution of loan agreement

Creation of security

Disbursement of loans

Monitoring

Syndicated loans Arrangement wherein several banks participate in a

single loan


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Working capital advances

Most important source for financing current assets Working capital advances is provided by commercial banks

in the following ways:

Cash credits/overdrafts Loans Purchase/Discount of bills Letter of credit

Security

Can in the form of: Hypothecation Pledge

Margin amount


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Miscellaneous source

Deferred credit Suppliers of machinery provide this facility under which

payment for the purchase of machinery is made over a period

of time. Interest rate and payment period vary widely

Supplier of the machinery insists that a bank guarantee shouldbe provided by the buyer

Lease finance and hire purchase Are supplementary form of debt finance There are two board type of lease:

Finance lease

Operating lease


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Lease finance( capital lease)

Is essentially a from of borrowing

It is an intermediate term to long term non cancellableagreement

The lease is more or less fully amortized during theprimary lease period

Lessee is responsible for maintenance, insurance andtaxes

Lessee usually enjoys the option for renewing the leasefor further periods at substantially reduced lease rentals.


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Operating lease

Lease term is less than the economical life of theequipment

Lessee enjoys the right to terminate the lease at a shortnotice without any penalty

Lessor usually provides the operating know-how and therelated services

Lessor undertakes the responsibility of insuring andmaintaining the equipment (wet lease)

Lessee bears the cost of insuring and maintaining theleased equipment (dry lease)


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Hire purchase

The hiree purchase the asset and gives it on hire to thehirer

Hirer pays a regular hire purchase installments over aspecified period of time

When hirer pays the last installment the title of asset istransferred from hiree to hirer

Hiree charges interest on a f lat basis

The total interest collected from the hiree is allocated

over various years Installment purchase

Here the title of asset is passed to the buyer on thepayment of first installment itself


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Leasing Hire purchase

The lessee cannot claim

depreciation

The hirer is entitled to claim

depreciation

The entire lease rental is a tax

deductible expense for lessee

Only the interest component of

the hire purchase installments is a

tax deductible expense for the

hirer

The lessee not being the owner of

the asset does not enjoy salvage

value of the asset

The hirer not being the owner of

the asset enjoys salvage value of

the asset


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Unsecured loans and deposits

Provided by the promoters to fill the gap between thepromoters contribution required by the financialinstitutions and the equity capital subscribed to by the

promoters

Rate of interest chargeable on these loans is less than therate interest on the institutional loans

Deposits represent unsecured borrowing of one to threeyears duration

It may not be possible for a new company to raise publicdeposits because it may be difficult to repay within three

years.


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Special schemes of institution

Bill rediscounting scheme Operated by IDBI

Is to promote the sale of indigenous machinery on deferredpayment basis

The seller realizes sales proceeds by discounting the bills orpromissory notes accepted by the buyer with a commercialbank which in turn rediscounts them with IDBI

Suppliers line of credit

Administrated by ICICI

Under this ICICI directly pays to the machinery manufactureragainst usance bill duly accepted or guaranteed by the bank ofthe purchaser


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Subsidies and sales tax deferments and exemptions The central subsidy has been discontinued but state subsidy

continue

The state subsidy vary between 5% to 25% of the fixed capitalinvestment of the project

The payment of sales tax on the finished goods mat be

deferred for a period ranging between 5 to 12 years Short term loans from financial institutions

To be eligible for the loan the company must satisfy certainconditions relating to dividend track record, debt-equity ratio,and interest coverage ratio

They are unsecured and given on the strength of promissorynote

The loan is given for 1 year and can be renewed for 2consecutive years, given the original eligibility satisfied


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Commercial papers

Short term unsecured promissory note issued by firmshaving high credit rating

The maturity period ranges from 90 to 180 days

Is sold at a discount rate of face value and redeemed as

its face value Is placed with the investors who mostly intend holding it

till maturity

Factoring

A factor is a financial institution which offers servicesrelating to management and financing of debt arising

from credit sales


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Features of factoring arrangement

The factor selects the account of the client and the creditlimit applicable to the selected accounts

Factor pays to the client at the end of the credit period orwhen the account is collected whichever comes earlier

The factor advances money to the client against not yetcollected or not yet due debts

Factoring may be a recourse basis

Beside interest on advances ,the factor charges acommission of 1 to 2 % of the face value of the debtfactored


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Securitization Packaging a designated pool of assets and issuing

securities which are collateralized by the underlyingassets and their associated cash f low streams

Originated by a firm that seeks to liquefy its pool ofassets

Securities backed by mortgages are known as mortgagebacked securities and securities backed by assets areknown as asset backed securities

Key steps of securitization

Seasoning Credit enhancement

Transfer to a special purpose vehicle

Issuance of securities


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Venture Capital

A young company which is not yet ready or willing totap the public financial capital may seek venturecapital.

Venture Capital represents financial investment in arisky preposition made in the hope to earn highreturns.

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Raising Capital in International

Market Euromarkets

Euromarkets or Offshore markets refers to a collection

of Banks that helps firms in raising capital in globalmarket, which is beyond the purview of any regulatoryauthority.

An Indian Firm can approach Euromarkets to raise aEurocurrency loan, or issue a euro bond, globaldepository receipts, Eurocurrency convertible bonds.

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Eurocurrency Loans

Subject to certain terms and conditions, Government of India

permits External Commercial Borrowings for the import ofplant and machinery.

Eurocurrency is simply the deposit of currency in bankoutside the country of the currency.

Main Features of Eurocurrency Loans

They are often syndicated loans

The rate of interest of Eurocurrency Loans is Floating rate.Usually linked to LIBOR or SIBOR.

Interest period may be 3,6,9 or 12months in duration.

The borrower usually enjoys multi currency option

They are repayable in a bullet payment or in installments.

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Advantages of Overseas Debt

Participating Institutions have very deep pockets and

professional approach There is a great deal of flexibility in structuring these

loans

Tenors up to 10years are easily available

Disadvantages of Overseas Debt

It is not economical for small pockets due to highappraisal and syndication cost

Pricing of loan depends on risk perception

It may be difficult to negotiate changes with investors.

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Eurocurrency Bonds

The firms using Euromarkets for debt financing can takeout loans or sell bonds.

Features of Eurocurrency Bonds:

It is issued outside the country in whose currency it isdenominated.

It is usually managed by a syndicate of investment banksand offered to investors of many countries

It is a Bearer Bonds The interest of it is usually paid annually or half-yearly.

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Global Depository Receipts (GDR) In the Depository Receipts mechanism, the shares issued by a

firm is held by depository, usually large international banks,who receives dividend, reports etc. and issues claims againstthese shares.

These claims are called Depository Receipts (GDRs)-witheach receipt being a claim on a specified number of shares

The underlying shares are called Depository Shares GDRs may be listed and traded in major stock exchanges or

OTC market The issuer firm may pay dividend in home currency which is

converted into dollars by the depository and distributed tothe holders of GDRs.

This way issuing firm can avoid listing fees and onerousdisclosure and reporting requirements A company planning for GDR issue must get approval from

Ministry of Finance as well as FIPB(Foreign InvestmentPromotion Board), since GDR issues are deemed to FDI

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Foreign Domestic Markets Another way to raise money internationally is to sell securities

directly in the domestic capital market of foreign countries.This is referred to as Direct Issuance.

US Capital Markets The most prestigious funding option in the US market is a

public issue of Yankee Bonds (Dollar denominated bondsissued in the US Capital Market by foreign borrowers.

Other Markets

Other debt instruments includes Samurai Bonds(Publiclyissued bonds in Japanese Market), Shibosai Bonds(Privatelyissued bonds in Japanese Market), Bulldog Bonds(UKMarket), Rembrant Bonds(Dutch Market)

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Export Credit Schemes

Export credit schemes have been established by thegovernment of industrialized countries for financingexports of capital goods and related technical services.

The prominent export credit agencies are US EXIM,JEXIM, HERMES, COFACE.

Two types of export credits are provided,

Buyers Credit Suppliers Credit

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Buyers Credit: Credit is provided directly to the IndianBuyers for purchase of Capital goods and Technical

Services from overseas exporter.

Suppliers Credit: This is a credit provided to overseassuppliers so that they can provide medium term finance to

the Indian Importers.

Salient Features of Finance Provided:

The finance is tied to import of goods and services

Up to 85% of the value of imports are available as finance

The finance is available for long tenors at reasonable cost

Export Credit Agencies insist on a bank guarantee.

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Project Financing Structure Full Recourse Structure:

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Financial Closure

Financial closure means that all the sources of fundsrequired for the project have been tied up.

In general financial closure for is project is achievedwhen,

Suitable credit enhancement is done to the satisfaction

of the lender Adequate underwriting arrangements are made for

market related offerings

The resourcefulness of the promoters is well established

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What Information does Financial

Institution want? And How they Appraise?

Information to be furnished for term loan appraisalalong with the project report/informationmemorandum.

Project Appraisal: Financial institutions appraise aproject from,

Marketing Appraisal

Technical Appraisal

Financial Appraisal

Economic Appraisal

Managerial Appraisal

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Credit Risk Rating

Credit Risk Rating is a rating assigned by the bank toits borrowers based on their ability and willingness torepay the debt.

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