Financing of Projects

Presentation By,
Jayan Suja
Neethu.P

01/06/2024 1
 Project Finance
 Project finance is the long
term financing of infrastructure and industrial projects
based 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 and international
capital market?
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 Financing Decision Vs Investment
Decision
Financing Decision Investment Decision
 Takes place in capital market  Takes place in Real Market
which are approximately perfect which tend to be imperfect
 While making financing  While making financing
decision, you may observe the decision, you have to estimate
value of similar assets. the values of capital assets.
 There are very few opportunities  There are many opportunities in
in the realm of financing that the realm of capital budgeting
have NPV that is significantly that have an NPV that is
different from zero. significantly different from zero.

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 Capital Structure

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 Equity Vs Debt
Equity Debt
 Equity shareholders have a  Creditors have a fixed claim in
residual claim on the income the form of interest and
and wealth of the firm principal repayment
 Dividend paid to Equity  Interest paid to creditors is tax
shareholders is not a tax deductible payment
deductible payment  Debt has a fixed maturity
 Equity ordinarily have indefinite  Debt investors play a passive
life role-of course, they impose
 Equity shareholders enjoy the certain restrictions on the way
prerogative to control the affairs the firm is run to protect their
of the firm interests

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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 is  The tax rate applicable is
negligible High
 Business Risk exposure is  Business Risk exposure is
High Low
 Dilution of control is not an  Dilution of control is an
important issue important issue
 The assets of the project are  The assets of the project are
mostly intangible mostly tangible
 The project has many  The project has few growth
valuable growth options options

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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 like
NSE and BSE
 Private placement come either in the form of loans by Banks
or financial institutions or in the form of issue of securities
like equity shares, preference shares, debentures which are
privately 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 its
promoters 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 capital
from public.
The first issue of equity shares to public by an unlisted
company 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 to
benefit the firm.
 Retained Earnings is a portion of earnings (PAT less preference
dividends) which are ploughed back in the firm
 Because Retained Earnings is the sacrifice made by the
shareholders its called Internal Equity.
 Companies normally retain 30% to 80% of PAT for financing
growth.

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 Advantages of Internal Accruals
 Internals Accruals are readily available
 Use of Internals Accruals eliminates issue cost and losses on
account of underpricing
 There is no dilution of control when a firm relies on Internals
Accruals
 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 to
WACC of the firm
 Many firms do not appreciate Opportunity cost generated from
retained earnings and Depreciation-generated funds.
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 Equity Capital
Equity Capital represents ownership capital as equity
shareholders collectively owns the company.
Their risk is Limited to the capital contribution.
The amount of capital that a company can potentially issue,
as per the memorandum, represents the Authorized Capital.
The amount offered to its investors represents Issued
Capital.
The part of issued capital subscribed by the investors
represents Subscribed Capital
The actual amount paid-up by the investors is called Paid-Up
Capital.

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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 is

traded 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 is
simply PAT-Preferred Dividend.
 Right to Control: They elect the BODs who in turn elects the
Management which controls the operation of the company. They
also have the right to vote for every resolution placed before the
company.
 Pre-Emptive Right: This right enables the existing shareholders
to maintain their proportional ownership by purchasing the
additional equity shares issued by the firm.
 Right in Liquidation: They have a residual claim over the assets
of 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 has
no obligation to redeem.
 It enhances creditworthiness of the company.

Disadvantages of Equity Capital

 Sales of Equity Shares to outsiders dilutes the control of
existing 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 in
following 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 in
which 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 equity
shareholders of the company.
 Redeemable and Non-Redeemable Preference Shares:
Redeemable Preference Shares are repayable at par or at premium after
a 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 of
the preference shareholders in accordance with certain predetermined
terms.

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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
 Innovations in Debentures
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 premium
Modern Finance Explanations
 Cash flow matching
 Financial synergy
 Agency cost
Floating Rate Bonds
Earn an interest rate that is linked to a benchmark rate
such 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
 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
Disadvantages
Entails fixed interest and principal payment
obligation
Increases financial leverage
Impose restrictions that limit the borrowing firms
financial and operating flexibility
If the rate of inflation turned out to be
unexpectedly low, the real cost of debt will be
greater than expected
 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
Private placement
Is an issue of securities to a selected group of persons not
exceeding 49
Can be of two types:
 Preferential allotment
 Qualified institutional placement (QIP)

Comparison of various methods

Public 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
 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
 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
 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
 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
should be 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
Lease finance( capital lease)
Is essentially a from of borrowing
It is an intermediate term to long term non cancellable
agreement
The lease is more or less fully amortized during the
primary lease period
Lessee is responsible for maintenance, insurance and
taxes
Lessee usually enjoys the option for renewing the lease
for further periods at substantially reduced lease rentals.
Operating lease
Lease term is less than the economical life of the
equipment
Lessee enjoys the right to terminate the lease at a short
notice without any penalty
Lessor usually provides the operating know-how and the
related services
Lessor undertakes the responsibility of insuring and
maintaining the equipment (wet lease)
Lessee bears the cost of insuring and maintaining the
leased equipment (dry lease)
Hire purchase
The hiree purchase the asset and gives it on hire to the
hirer
Hirer pays a regular hire purchase installments over a
specified period of time
When hirer pays the last installment the title of asset is
transferred from hiree to hirer
Hiree charges interest on a flat 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 the
payment of first installment itself
 Leasing Hire purchase
The lessee cannot claim The hirer is entitled to claim
depreciation depreciation

The entire lease rental is a tax Only the interest component of

deductible expense for lessee the hire purchase installments is a
tax deductible expense for the
hirer
The lessee not being the owner of The hirer not being the owner of
the asset does not enjoy salvage the asset enjoys salvage value of
value of the asset the asset
Unsecured loans and deposits
Provided by the promoters to fill the gap between the
promoters contribution required by the financial
institutions and the equity capital subscribed to by the
promoters
Rate of interest chargeable on these loans is less than the
rate interest on the institutional loans
Deposits represent unsecured borrowing of one to three
years duration
It may not be possible for a new company to raise public
deposits because it may be difficult to repay within three
years.
Special schemes of institution
Bill rediscounting scheme
 Operated by IDBI
 Is to promote the sale of indigenous machinery on deferred

payment basis
 The seller realizes sales proceeds by discounting the bills or

promissory notes accepted by the buyer with a commercial

bank which in turn rediscounts them with IDBI
Suppliers line of credit
 Administrated by ICICI
 Under this ICICI directly pays to the machinery manufacturer

against usance bill duly accepted or guaranteed by the bank of

the purchaser
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 capital
investment 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 certain
conditions relating to dividend track record, debt-equity
ratio, and interest coverage ratio
 They are unsecured and given on the strength of promissory
note
 The loan is given for 1 year and can be renewed for 2
consecutive years, given the original eligibility satisfied
Commercial papers
Short term unsecured promissory note issued by firms
having 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 services
relating to management and financing of debt arising
from credit sales
Features of factoring arrangement
The factor selects the account of the client and the credit
limit applicable to the selected accounts
Factor pays to the client at the end of the credit period or
when the account is collected whichever comes earlier
The factor advances money to the client against not yet
collected or not yet due debts
Factoring may be a recourse basis
Beside interest on advances ,the factor charges a
commission of 1 to 2 % of the face value of the debt
factored
Securitization
Packaging a designated pool of assets and issuing
securities which are collateralized by the underlying
assets and their associated cash flow streams
Originated by a firm that seeks to liquefy its pool of
assets
Securities backed by mortgages are known as mortgage
backed securities and securities backed by assets are
known as asset backed securities
Key steps of securitization
Seasoning
Credit enhancement
Transfer to a special purpose vehicle
Issuance of securities
 Venture Capital
A young company which is not yet ready or willing to
tap the public financial capital may seek venture
capital.
Venture Capital represents financial investment in a
risky preposition made in the hope to earn high
returns.

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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 global
market, which is beyond the purview of any regulatory
authority.
An Indian Firm can approach Euromarkets to raise a
Eurocurrency loan, or issue a euro bond, global
depository 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 of plant and machinery.
 Eurocurrency is simply the deposit of currency in bank
outside 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 high
appraisal 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 take
out loans or sell bonds.

Features of Eurocurrency Bonds:

It is issued outside the country in whose currency it is
denominated.
It is usually managed by a syndicate of investment banks
and 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 against these shares.
 These claims are called Depository Receipts (GDRs)-with each
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 to the
holders of GDRs.
 This way issuing firm can avoid listing fees and onerous disclosure
and reporting requirements
 A company planning for GDR issue must get approval from Ministry
of Finance as well as FIPB(Foreign Investment Promotion 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 bonds
issued in the US Capital Market by foreign borrowers.

Other Markets
 Other debt instruments includes Samurai Bonds(Publicly
issued bonds in Japanese Market), Shibosai Bonds(Privately
issued bonds in Japanese Market), Bulldog Bonds(UK
Market), Rembrant Bonds(Dutch Market)
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 Export Credit Schemes
Export credit schemes have been established by the
government of industrialized countries for financing
exports 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,
Buyer’s Credit
Supplier’s Credit

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 Buyer’s Credit: Credit is provided directly to the Indian
Buyers for purchase of Capital goods and Technical
Services from overseas exporter.

Suppliers Credit: This is a credit provided to overseas

suppliers 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 funds
required for the project have been tied up.

In general financial closure for is project is achieved

when,
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 appraisal
along with the project report/information
memorandum.

Project Appraisal: Financial institutions appraise a

project 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 to
its borrowers based on their ability and willingness to
repay the debt.

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