PROJECT FINANCING
The Projects are building blocks of a development plan. Creation of utilities is the sine qua non of business. Schemes in which investment is made in anticipation of deriving future benefits there from are known as projects. Project is thus a package of measures selected to reach an objective that has been precisely designated beforehand and is objectively verifiable. The basic characteristic of project is that it involves current outlay of funds in the expectation of future benefits.
The inputs of the project come in the form of equipment, supplies, personnel, etc. An efficient project makes productive use of land and other natural resources with the help of capital applying technical capability of human resources, giving an output adequate to enhance the nation’s economic growth. Project Financing involves raising funds for the acquisition of fixed assets such as land and buildings, plant and machinery, vehicle furniture and fittings etc. which are used in business to earn income.
It is necessary to define the financial requirements of a project at the investment and initial operational stage. During the period of construction or the project stage usually called the gestation period, the investment does not give anything in return. The investments in procurement of assets are illiquid and are known as Sunk Capital. Hence the project planners try to get such assets financed through external sources such as Buyer’s Credit.
Some relate to the specific financing structure, others to the nature and viability of the project itself, and still others to political, economic and related risks in the country in which the project will operate. Generally these risks as falling in the following broad categories: ?Political and regulatory risk – including regulatory risks related to pricing and permits approval, certainty within the regulatory system, along with the possibility of retroactive environmental legislation. There may also be risk of project expropriation and risk that unexpected political developments may prevent efficient use of domestic resources.
THE DECISION CRITERIA INTERNAL RATE OF RETURN AND NET PRESENT VALUE INTERNAL RATE OF RETURN
The internal rate of return may be defined as the rate that equates investment outlay with present value of inflow received after one period. In other words rate of return is the discount rate which makes NPV zero. Here it’s a case of receiving loan from a financer. So the internal rate is the rate that equates the loan amount received in the beginning as reduced by various upfront charges with the various cash outflows in form of repayment of principal ,interest charges and various other expenses. DECISION-After analyzing various options, the option in which this rate is the least will be the cheapest source of finance. For arriving at the best-suited and cheapest source of financing for the project, both the NPV and IRR of each option can be considered.
P1/(1+r)1 + P2/(1+r)2 + P3/(1+r)3
Pn/(1+r)n – U = C1/(1 + r)1 + C2/(1 + r)2 + C3/(1 + r)3
Cn/(1 + r)n P = Facility Amount drawn at different time periods
U = Up-Front charges
C = Various Outflows that include various Charges plus Interest Payments and Repayments at different Time Period
r = Rate of return/ Cost of Debt
NET PRESENT VALUE
Net present value being a discounted cash flow technique evaluates present value of future cash flows. In this case, we will calculate present value of future outflows for decision purposes.
DECISION
the option which gives the least present value of cash outflows made in the future at different time periods will be cheapest source.
NPV = [(P1/(1+r)1 + P2/(1+r)2 + P3/(1+r)3 …Pn/(1+r)n )-U] – C1/(1 + r)n – C2/(1 + r)n – C3/(1 + r)n… Cn/(1 + r)n P = Facility Amount drawn at time intervals
U = Up-Front charges
C = Various Outflows that include various Charges plus Interest Payments and Repayments at different Time Period
r = Discount Rate
The section scheme followed for the project is as follows:
- Section 1: Introduction Objective, Methodology, Hypothesis and explanation of the key concepts.
- Section 2: Literature Review Involves looking at researches done, their findings, and their correlation to the changing business scenarios.
- Section 3: Research Methodology Includes interpretation of the Mozambique project, the explanation of the key concepts involved in the project.
- Section 4: Findings and analysis Here we will analyze the various costs and the revenue generated by the project.
- Section 5: Conclusion Concluding the research and giving the limitation.
Currently, there are very few published papers on project finance. In fact, there has Been only one article directly on project finance published in the four leading finance Journals, and not more than 15 articles in all finance journals over the past 20 years. As a starting point, the growing use of project finance challenges the Modigliani And Miller’s (1958) ‘irrelevance’ proposition, the idea that corporate financing decisions do not affect firm value under certain conditions.
One of the key assumptions Underlying their irrelevance proposition is that financing and investment decisions are separable and independent. When this assumption holds, various financing decisions such as the firm’s organisational, capital, and ownership structures do not affect asset values or investment decisions.. Myers and Majluf (1984) explained that project finance can help reduce under investment due to asymmetric information, under investment occurs only when the value of both assets-in-place and investment opportunities is uncertain.
Myers and Majluf recommend two solutions: financing assets separately (i. . , project finance) and holding financial slack. While financing assets separately clearly improves information flow, this information-based motivation for using project finance has trouble explaining why non-recourse debt, the sine quo non of project finance, is needed. Stulz, (1984) examined that leverage affects expected cash flows available to capital providers; other structural attributes affect real investment decisions. The ability to create a standalone project company and finance it with non-recourse debt reduces the opportunity cost of under investment due to managerial risk aversion (or debt overhang ).
Stulz (1996) claims that Project finance allows the firm to isolate asset risk in a separate entity where it has limited ability to inflict collateral damage on the sponsoring firm; in essence, it allows firms to truncate large left-hand tail outcomes, which is the primary goal of risk management. Return to Equity in Project Finance for Infrastructure Duke University – Duke Center for International Development Sanford February 2000 Economics Teaching Program Working Paper In project finance, the viability of the project is based on the expected cash flows generated by the project rather than on the strength of the company’s balance sheet.
Thus, it is relevant to construct the annual cash flow from the equity point of view and estimate the annual returns to the equity holder but the usual simplifications for calculating the cost of capital do not permit the explicit estimation of the annual returns to the equity holder. Interpretation This paper relaxes many of the assumptions in the typical analysis, and provides a simple and practical way to estimate directly the annual returns to the equity holder. This approach requires the calculation of the annual present values of the future cash flows from the point of view of the equity holder.
Two equivalent ways for calculating the annual equity values are shown. Most importantly, the construction of the cash flow statement from the equity point of view permits the analysis of the likely impacts of contracts on the risk profile of the project for the equity holder.
The components of the business plan are General Approach Forecasting freight traffic has been an independent exercise in terms of the identification of the overall potential. There are two streams of traffic viz. National Traffic or traffic originating and terminating within Mozambique and International traffic or traffic that originates or terminates outside Mozambique. Forecast for national traffic has been made based on it current level, competitiveness vis-a-vis road mode and expected future economic scenario.
Forecast of international traffic, which is entirely imports or exports through Beira Port, has been made considering the composition of moving cargo through Beira Port vis-a-vis moving this cargo via other alternative ports. Marketing Strategy, Implementation Plan and Measures to attract additional Traffic. Appreciating this as the most important activity, the Marketing sub function has been made part of Corporate Services which will be directly look after by the Chief Executive Officer of the SPC. The Marketing Manager will co-ordinate with clients to prepare an annual plan for movement of traffic by rail.
He will negotiate the tariff for individual clients for approval. Marketing Manager will also explore possibilities for new traffic for movement by rail. Potential for new traffic will be explored by interaction with the key players in country’s economy and exporters in neighboring countries. Preliminary analysis shows that container traffic may have a vast potential in the future which will be exploited by providing value added services.
RAIL OPERATING PLAN
The rail-operating plan will be based on our experience of operation of railways in India as well as in other countries. The endeavor will be to make railway operations safe, efficient, competitive and customer friendly. This will be achieved through introduction of new systems, facility, and equipment with improved performance through upgraded maintenance techniques and extensive training of employees.
CALCULATION OF PROFITS AND LOSS
The profit and loss account gives the break up of various costs and the revenue projects, involved in the project over the period of 25 years which being the tenure of the project. In the years 2008 to 2012 there is a loss in terms of profits as the expenses increase on account of the Sena line becoming operative, after the period of 4 years the Revenues take a leap as the traffic in the Sena line is expected to increase. From the profits every year 5% of the Net Profits are transferred to the General Reserve. The profit & loss account, the balance sheet projects are given below
CONCLUSION
The objective was to analyse the project from the bidding stage to implementation, the criteria for the selection of the project from the point of view of both the bidder and the Mozambique government is the highest NPV the project was awarded to Rites, as its projected NPV was the highest amongst the bidders. The reason Rites chose to bid for the project as the organization had substantial experience in the implementation of railway projects and was confident of generating a high NPV.
