Day 1
The mechanics and principles of project financing
- Introduction, project finance terms and project finance costs and benefits.
The course begins with introductory comments about the skills and general objectives in project finance analysis with an emphasis on the difficulty in measuring and valuing risk. project finance terminology, the structure of project finance debt, project contracts and other issues are discussed in the context of a case study and a completed project finance model. Subjects discussed in the first module include:
- Overview of project finance terms.
- Project finance definition.
- Phases in project financing.
- Structure and contracts in project financing.
- Characteristics of project finance debt.
- Advantages and disadvantages of project finance.
- Project finance process.
- Case study of a project finance transaction.
- Overview of transaction structure.
- Reasons for Use of project finance.
- Risk analysis in the transaction.
Issues addressed in the first session include: What is the big deal about project finance and what makes project finance different from other forms of financing? Where does debt and equity money come from these days in project financing? What are the benefits of project finance relative to the high fees received by lawyers and bankers? Where has project finance been used and what have been the largest project financings? What type of risks should be evaluated in project finance to test when projects go bad?
Day 2
Valuation and credit analysis in project finance
The second part of the course covers financial statement analysis of project finance transactions as well as valuation and credit analysis. The valuation section addresses appropriate use of equity and project internal rate of return and net present value. The credit analysis describes use of debt service cover and other ratios to measure the credit risk and debt capacity of a project. Issues addressed in this part of the course include:
- Financial statement analysis in project finance.
- Source and use of funds statement.
- Income statement and use of EBITDA.
- Cash flow statement; Equity cash flow and free cash flow.
- Sutton bridge case study.
- Project finance valuation.
- Cash flow as basis for valuation.
- Project IRR to screen projects.
- Equity IRR to structure projects.
- NPV, payback and other valuation metrics.
- Credit analysis in project finance.
- Project finance and probability of default and loss given default.
- Definition of DSCR.
- Use of DSCR.
- Application of LLCR and PLCR.
- Average Life and other ratios.
Some of the issues addressed in this session include: How are project IRR’s and the equity IRR’s used in making investment decisions? What is the difference between equity cash flow, free cash flow and cash flow for debt service? What debt service coverage ratio is appropriate for various types of projects? Why do bankers use the LLRC and PLCR in measuring the credit risk of a project?
Day 3
Understanding project finance models and financial statements
After the introductory discussion, participants construct a basic project finance model to become familiar with the structure of a project finance model, equity cash flow and free cash flow. The model is then used to demonstrate how interest during construction, multiple equity sources and target debt service cover can be added to a model. Once the fundamental model is built, it is used in the context of simple applications involving debt capacity, contract pricing, debt structuring, break-even analysis and probability of default. Construction of a simple model involves the following:
- Basic mechanics of project finance models.
- Separation of construction period from operating period.
- Sources and uses of funds statement during the construction period.
- Cash flow, net income, equity balance, construction financing and income taxes.
- Internal rate of return on the project and central concept of free cash flow.
- Construction of a balance sheet and use of a balance sheet in auditing the model.
- Interest during construction.
- Accounting concepts.
- Incorporation of IDC in models.
- Circularity problems.
- Multiple equity tranches in model.
- Reason for multiple tranches.
- Incorporation of equity tranches in models.
- Computation of IRR’s on tranches.
- Use of project finance model.
- Measurement of debt capacity.
- Measurement of contract prices.
- Optimisation of models with Excel solver.
Some of the issues addressed in this session include: What basic components should be included in a project finance model? How should the model be developed to assure flexibility in debt terms? How can a project finance model be used to compute the debt capacity of a project? What techniques should be used in computing the financial ratios for a project? How can a project finance model be used in determining contract prices? How can interest during construction be incorporated in a model?
Day 4
Risk analysis in project finance
This part of the course involves discussion of modelling mistakes, model layout and best practices spreadsheet conventions as a prelude to hands-on work on a comprehensive model. Lectures address the objectives of project finance models, mistakes that have been made in project finance models, how models should be laid out and best practices in programming a model. The objective is to explain the fundamental structure of a project finance excel model and excel techniques that create efficient, robust and stable project finance models.
- Risks and analytical failures in project finance.
- Risk classification in project finance.
- Analytical mistakes in measuring project finance.
- Risk measurement and analysis in project finance.
- Risk mitigation in project finance.
- Market risks in project finance.
- Capital expenditures.
- Forward price.
- Volume – capacity utilisation.
- Operation and maintenance expenses.
- Contract risks in project finance (BOOT, PPA and Other Long-term contracts).
- Economic rational for long-term contracts.
- Incentive to break contracts.
- Relation between cost and revenue contracts.
- Effects of variable supply contracts on cash flow.
- Best practices for Excel modelling.
- Best practice objectives.
- Inputs and organisation.
- Transparent calculations.
- Simple formulas.
- Auditing and model checks.
Some of the issues addressed in this session include: What have been analytical mistakes in project finance failures? What are examples of risks that have cause major projects to fail such as Eurotunnel, Euro Disney, U.S. merchant electric plants and Enron’s Dabhol LNG plant? How should risks be classified and mitigated in project finance? What are some of the excel rules that guide accurate and efficient development of models? How can project finance models be audited to check errors that we will make? What should we do to incorporate alternative debt structures and interest during construction into the model?
Day 5
Covenants and risk mitigation in project finance
This part of the course involves performing analysis with the case study. The course module addresses effectiveness of covenants, cash flow traps, and alternative levels of senior and subordinated debt issues. In addition, the model includes cash flow waterfalls, covenants, defaults and cash traps. The analysis deals with how risk and return can be gauged through equity IRR and debt service cover. Issues covered in analysis of the case study include:
- Measurement of risk and return.
- Risk analysis using break-even points on debt.
- IRR and risk with different senior and junior debt.
- IRR and risk with different cash flow trap structures.
- Debt service reserve accounting and modelling.
- Accounting for debt service and other reserves.
- Illustration of impacts in project model.
- Circularity problems.
- Interest income.
- Covenants in project finance.
- Positive and negative covenants.
- Project finance covenants versus corporate covenants.
- Covenants and risk analysis of projects.
- Examples of covenants.
Some of the issues addressed in this session include: What types of covenants are included in project finance transactions? Is it more important to trap cash during good times or develop covenants that prevent cash from leaving the project when times are bad? How much safer is senior debt than junior debt? Should cross defaults be included in the transaction? What is the appropriate level for various covenants and what financial ratios should be used in the covenants? How can we model inflows and outflows from a debt service reserve? What complications arise from modelling senior and subordinated debt tranches? Can we really quantify the cost and benefits of covenants and cash flow traps? What should we do to the model when a debt payment default occurs?
Course summary and close