Project Appraisal & Finance

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Need for private capital in Infrastructure
Key Drivers of change
• Pressure on the fiscal position of
governments coupled with need for
massive investments in infrastructure

• Globalization and breakdown of

trade barriers which is compelling • Role of public sector/state shifting from
local industry and services to become that of a financier, owner and
more competitive manager of facilities to that of a
facilitator and enabler of efficient
• Emergence of successful models for infrastructure creation and provision by
engaging the private sector and multiple players with an independent
increased access to capital across regulator
borders in providing infrastructure
services
• Changing economic models leading
to breakdown of erstwhile infrastructure
natural monopolies, that have made
possible the creation of competitive
market structures
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 WHAT IS PPP?

 PPP covers a wide variety of arrangements for the participation of

private organisations in public projects.

 Transportation facilities, water and waste-water services,

telecommunications systems, energy generation and distribution and
waste management facilities.
 Can be financed mainly by user charges.
 Private participation can cover design, construction, financing and
operation.

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While there are a wide range of forms of Public Private
Partnerships (PPPs) in infrastructure…

• Range of infrastructure delivery options: Each type differs in terms of government

participation levels, risk allocation, investment responsibilities, operational requirements and
incentives for operators

Ownership and Management / Concessions* Privatization** Divestiture By

Risk O & M contract (BOT) (BOO) License /Sale

Asset Ownership State State Private Private

Investment State Private Private Private

Responsibility

Primary State Private Private Private

Commercial Risk

It may would be better to start at the management contract end of the spectrum
and moving forward to deferred payment structures.
Project Finance Structures

 Special Project Vehicle

 Provides limited recourse

 BOT, BOOT, BOLT, BOO etc.

 Essentially a public project. Private finance
is resorted
 Should ownership with Private sector be
temporary or permanent?
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Concession Agreement

 An Agreement between Government (Grantor

of Concession or Permission) and Project
Company (Grantee or beneficiary) giving
permission to execute a Project.

Government Project Company

Lender
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Common Forms of PPP Models
in India
 BOT Models  Performance-based
Management / Maintenance
 User-fee based BOT model: contracts
Commonly used in medium- to
large-scale PPPs for the energy  PPP models that lead to
and transport sub-sectors improved efficiency are
(road, ports & airports) encouraged in an environment
that is constrained by the
 Annuity-based BOT model: availability of economic
Commonly used in resources.
sectors/projects not meant for  Sectors meant for such form of
cost recovery through user PPP models include water
charges such as rural, urban, supply, sanitation, solid waste
health and education sectors management, road
maintenance

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 Sectors have a varying degree of maturity in policy and
regulatory frameworks for PPPs in India
Increasing Commercial Attractiveness

Telecom Telecom and Electricity

Generation may not be strict
PPPs as defined in India but
Ports & Power account for a major share of
Airports Generation PPIs

Toll Roads
“Commercial Attractiveness”
defined as a function of
market structure, cost
Water and Urban
recovery and demand
Infrastructure
potential

Increasing Policy and Regulatory Clarity

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PPP Assessment Model
 Effectiveness
 Ability to meet program objectives
 Efficiency
 Financial efficiency in transfer of ownership & associated
risks
 Equity
 Ability to accrue benefits of program to the poor people
 Financial sustainability
 Financial viability of the model

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Project Finance

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Project Financing is like a chameleon;
It always finds a way to take advantages
of changes in the business.
Project Financing
 Economically separable capital investment
project which operates under a concession
from the host government

 Project cash flows as source of funds

 to service the loans
 to provide the return of &
 return on the equity invested in the project

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 Project Financing
 Non-recourse or Limited- recourse to
the promoter.
 Project is very big compared to firm’s
present size.
 The Project has unacceptable risk to be
brought to the balance sheet. (So,
quarantine the risk by forming a separate
company called Special Purpose Vehicle)
 risk does not attach, but return does!
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Project Financing
 Comprehensive contractual
arrangements with suppliers &
customers
 High ratio of debt to equity with limited-
recourse / non-recourse
 Cash waterfall / escrow mechanism

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 Project Financing
 An agreement by financially responsible
parties
 to complete the project
 to purchase the project output
 to supply the project inputs
 to make available necessary funds in the
event of disruption in operation occurs

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 Contractual Structure for Project
Finance
Insurers/
Off-taker Surety companies Government
Export Credit
Agencies Sales
contract Suppliers
Delays/
Guarantee Insurance

Arrangers/ Debt Special Purpose Vehicle/ EPC Contract EPC

Lead funders Project Company Contractor

Independent
Escrow agent/ experts/lawyers
Trustee
Sponsors Lessors O&M
Contractor
 Cash Waterfall
*

Customers Offshore Proceeds

Account
($ Denominated
Payments) (Banker’s Trust)

2. Debt Obligations
1. 90 Day Operating
Service ( 1 year 1.35x
Expense Account coverage ratio)

3. Debt Service Res. 4. Distribution to

Account (6 m. worth of Equity
principal & interest)
Holders
Project Finance

 When firm does not want to do balance

sheet financing because of higher
informational requirements.

 When raising finance in domestic (developed)

market means giving out more information; so
finance these internal projects through internal
resources and mobilize additional resources
through project finance.

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Risks in PPP Projects
Regulatory Political
Commercial

Operational &
Maintenance
Financial Risk

RISKS
Force Majeure
Risk

Market Risk

Cost Overrun
Risk
Land Acquisition
Risk
Technology Risk
Construction
Risk
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Project Choice
 Efficiency in Resource Allocation

 Bankable Projects / Profitable Projects

Cost-Benefit Analysis
 Project Cost (t0 to t3)
 Land & Site Development
 Building & Civil Works
 Plant & Machinery
 Furniture & Fixtures
 Technical Know-how Fees
 IT Infrastructure
 Preliminary & Pre-Operative expenses
 Margin Money for Working Capital
Cost-Benefit Analysis
 Benefits (t4 to t15), FCFF (Free Cash Flows to
Firm)
 Toll Revenues
 (-) Operating & Maintenance expenses
 = Operating Profit
 (-) Income Tax
 = Net Operating Profits After Tax (NOPAT)

 Salvage Value / Terminal Value (t15)

 Analysis of Individual Cash Flows
Free
Cash Year
FCF used for NPV (IRR)
Flow
analysis
(FCF)

Sales
revenue

Anatomy of FCF Year

for project finance
Input cost

Operating cost
Construciton
costs Taxes
Net investment
(in maintenance)
 Analysis of Individual Cash Flows
Free
Cash Year
FCF used for NPV (IRR)
Flow
analysis
(FCF)

Sales
revenue

Anatomy of FCF Year

for project finance
Input cost

Operating cost
Construciton
costs Taxes
Net investment
(in maintenance)
Net Present Value (NPV)
Financial Agreement (Closing)
Free t=5 t = 10 t = 20 t = 30 t = 40
cash flow
Year

Salvage
Sunk value
costs

Sunk cost does not affect

Cash cash flow analysis because
out flow it is an existing fact regardless
of the investment decision
(it is not incremental costs).

t=0 Example
t=1 - CF2
t=2 Present value of PV =
cash out flow at t=2 (1 + r ) 2

CF10
Present value of PV =
Present Value cash in flow at t=10 (1 + r ) 10
NPV versus IRR
 NPV
 1000

 800 Project N Project M



 600

 400


 200

 0
 0% 5% 10% 15% 20% 25% 30%
 -200

 -400
 Financial Evaluation- IRR/NPV
 Focus is on adequacy of cash flow for servicing debt.
 “Interest and principal cannot be serviced out of earnings, which is an
accounting concept- payment has to be made in cash. Many transactions and
accounting entries can affect earnings, but not cash and vice versa” Standard
and Poor’s

 Present value numbers are not the best indicators of project viability,
given that they reduces the importance of sizeable amounts of “residual”
cash flow that may be available towards the latter periods of the project’s
life.

 IRR is not an useful measure of project viability as it assumes

reinvestment of cash flows at the IRR- often an incorrect assumption.
Calculating NPV necessitates making assumptions on the cost of capital-
often difficult to estimate.

27Project IRR and Equity IRR ( Sponsors Perspective)


Lenders Perspective – Coverage Ratios
and DSCR

 Thus, from a lender’s perspective the key ratio is the DSCR.

 The most widely accepted method for computing DSCR is as
follows;
 Available Cash Flow (ACF)/ Principal + Interest, where ACF is
defined as
 Operating Cash Flow (Revenues minus operating expenses)
 less Taxes
 less Working Capital Increase
 less Maintenance Capital Expenditure
 less Monies for replenishment of reserves such as maintenance
and debt service reserves
 plus Callable Capital
 less Clean up/ abandonment costs
 plus Residual/ Salvage value
At the end of the project

Net Net Cash Flow = ACF- Principal - Interest

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Lenders Perspective – Other measures
ACF/ Interest
 Interest Cover Ratio
ACF-Interest/ Principal
 Principal Cover Ratio  Measure of surplus that would be available for
prepayment/ servicing subordinate debt
holders/ dividend.
 Loan Life Ratios
 PV of ACF over relevant period/ Max debt outstanding
 Measures cash flow cover available for servicing debt
 This ratio is a function of discount rate used.
 Does not measure year to year variations in cash flows.

 No “correct” level for a project.

 Debt Equity Ratios  Would depend upon what cash flows the
project can support
 Leveraged/Equity
Measure of returns available to equity
29IRR

investors.
 Challenges in PPP in India
 Regulatory Environment
 No Independent PPP Regulator
 Lack of Information
 Database regarding projects to be awarded
 Project Development
 Detailed feasibility study, land acquisition, environmental/forest
clearances etc are not given adequate importance by
Concessioning Authorities
 Lack of Institutional Capacity
 Financing Availability
 Dependent on Commercial Banks to raise debt for PPP Projects
 Sectoral Exposure Limits