PROJECT FINANCE- MODELING AND ANALYSIS SMART TASK-1

1.What is Finance? How Finance is different from Accounting? What are important basic points
that should be learned to pursue a career in finance?

Finance is a broad term which involves the carry of transactions in monetary terms and assists in
attainment of the funds , focuses on the company’s cash flows and project requirements. Many of
the finance theories originate from the concepts of micro-economics and macro-economics, One
such theory is the time value of money which suggests that a value of a dollar today will have a
worth more than the dollar in the future.

The basic difference between accounting and finance is that accounting focuses mainly on the day-to
day activities and transactions that take place in the organization at present whereas finance focuses
on the future aspects of the company and involves company valuation, future planning and
fundamental and technical analysis. Accounting is more about accurate reporting of what has
already happened and compliance with the laws and standards. Finance is all about in looking
forward and growing a pot of money or mitigating losses. Hence for a longer time horizon finance
enjoys an upper hand than accounting.

IMPORTANT BASIC POINTS TO CONSIDER TO PURSUE A CAREER IN FINANCE:

1. COMMUNICATION SKILLS: Finance people cannot just be good at calculations and

numbering but they also need to buckle up with their communication skills of verbal and
written communication and presentation skills.
2. MARKETING AND SALES SKILLS: Marketing and sales knowledge is very essential in
understanding the finance approach to management. A view of the sales and marketing
pattern will help in building up of financial strategies.
3. RESEARCH ORIENTED: Financial proffessionals need to perform various researches for most
appropriate financial model and strategies. Understanding the market and its aspects is
very important.
4. ANALYTICAL SKILLS: Finance nowdays require basic analytical skills to perform operations
and conduct the planned projects and investment areas for the company. The research is
conducted through analytical skills.
2. What is project finance? How is project finance different from corporate finance? Why
can’t we put project finance under corporate finance?

Project finance is reffered as the financing of the long and broad term industrial and
infrastructure projects which promise to yield good amount of cash flows. The companies
finance their projects through non-recourse loans. The debts and equity are cleared out from
the cash flows generated by the project. The project assets are considered as collateral security
for the debts and are to be sold off if the cash flows fail to repay the debt loan.

Difference between Project Finance and Corporate Finance

In company’s early stages it is beneficial to carry out corporate financing. Project financing is
suitable for the company and projects with 3-4 years of experience and research oriented. Also
in the project financing several project financers are involved to carry out the financing in the
projects. While request for the loan the company’s assets are considered as security collateral in
corporate finance and in project finance the assets of the project are undertaken as collateral for
the settlements of the loan. Corporate finance involves high risks and high amounts of returns
while investing, on the other hand in project financing the investment has low risks hence less
returns for the investments. Equity ownership in corporate financing is carried out through
voting rights by the management, in project financing equity comprises of various direct
investments involving mezzazine debts ,grants, cash and cash equivalents.

Hence under project finance the funds are raised for a particular project such as infrastructure
based, constructive projects etc by forming contracts with lenders and financial institutions. In
corporate finance funds are raised for the company management in order to make better
utilization of the funds and generate cash flows for repayments for the loans. The financial
management in the company focuses on the preparation of strategic plans for the future and
preparing successful financial models for better growth. Therefore Project finance cannot be a
part of Corporate finance.
3. Define 20 terminologies related to project finance.

1. Arbitrage pricing theory: The arbitrage pricing theory implies and signifies multiple risk
factors determine an asset’s required rate for the return.
2. Contingency: An additional amount or percentage to any cash flow item (capital
expenditures) that is needed to provide a cushion.
3. Debt service coverage ratio: For any given debt service period, the debt service ratio
would justify the relation between the cash/ funds available for the debt service and the
total amount of the debts.
4. Balloon payment: The payment which has a major portion than the preceeding
payments(emi) for the debt repayment.
5. Forward contract: A legal contract which is prepared for 2 parties for exchange of a
commodity at a set price on the future date. However such contracts carry risks of
operations in the future.
6. Internal rate of return: The internal rate of return is a measure used in capital budgeting
to estimate the profitability of the potential/ previous investments.
7. Off Balance sheet liability: A corporate obligation that does not appear as a liability on
the company’s balance sheet or is not required to appear by the applicable accounting
standards.
8. Off Balance sheet assets: A corporate obligation that does not appear as an asset in the
balance sheet of the company nor is required to appear by the applicable accounting
standards.
9. Special purpose vehicle: A project in which the company has no past records. It is
referred as a single legal asset entity which is created for a specified purpose which acts
as a project owner in project financing.
10. Securitization: Packaging up a stream of receivables or assets to fund via capital markets,
tradable funding.
11. Hedging: A risk management strategy used in limiting probability of loss from
fluctuations in the prices of commodities, currencies, securities.
12. Operating risks: These are general risks that may affect the cash fllow of the project by
increasing the operating costs to continue to generate quantity and quality of the
planned output over the life of the project.
13. Working capital finance: Working capital finance is concerned with short term
investment decisions taken by a firm extended by commercial banks. Working capital
finance plays a vitol role in keeping the business cycle running.
14. Pledge: The goods which are presented as security are transferred to the physical
possession of the lender. An essential pre-requisite of pledge is that the goods/assets
are in custody of the banks.
15. Mortgage: It is a transfer of a legal interest in specific immovable property for security
the payment of debt.
16. Operation phase risk: This is the risk that for a mining project , rail project,power station
or toll road there are inadequate inputs that can be processed to produce adequate
returns.
17. Annual debt service coverage ratio: The ratio symbolizes the relation of operating cash
flows and debt service during any 1 period. This project is used to determine a project’s
debt capacity.
 18. Merchant Bank: Merchant Banks are a combination of banking and consultancy services
providers. They perform the banking functions of giving loans and deposits and provide
advices and consultancy for a particular projects, investment decisions, risk threats.
19. Sponser of project finance: The sponser of project financing is the party that organizes
all of the other parties and typically controls and makes an equity investment in the
company or other entity that owns the project.
20. Capital intensive: Project financing involves a huge amount of investments including the
purchase of good equipments and machine power for the completion of the project.

4. What is non-recourse debt / loan? What is mezzanine finance explained with an

example.

A non recourse loan is the loan which favours the borrower than the lender. If the
borrower borrows a loan from the lender by issue of the assets as collateral for the
payment and a balance amount is left after selling off the collateral security offered by
the borrower then there would be a loss which the lender has to bear without any
option.

Mezzanine finance is referred to that layer of financing between a company’s senior

debt and equity , filling the gap between the two.

Characterstics of mezzazine capital involve:-

 Tax-status- Interest payments on some types of mezzazine finance are tax
deductable .
 Returns-Mezzazine finance pays higher interest rates than other debts (20-
30)%.
 Image of the company- The confidance of the mezzanine capital provider
increases the image of the company.

For example:- A bank provides mezzanine finance to a surgical company with 15 lakhs. The funding
replaced a higher interest 10 lakhs credit line with more favourable terms. Company gained more
working capital to help bring additional products to the market and paid off a higher interest debt.
The bank will collect 10% a year in interest payments and will be able to convert to an equity stake if
the company defaults.
5.Explain in detail with reasons of what the sectors are or which type of projects are
suitable for project finance?

The areas where Project finance is essentially required are:-

1. Legal firms: Sponsers of projects adapt many different legal firms for the ownership of
the project. The specific form adopted for any particular project will depend upon
amount of equity required, the concern with the management of the project, the
availability of tax benefits with the project.
2. Corporations : This is the simplest form of ownership of the project. A special purpose
corporation may be formed under the laws of jurisdiction in which the project is located,
or it may be formed in some other jurisdiction and be qualified to do business in the
jurisdiction of the project.
3. Limited Partnerships: A limited partnership is similar to general partnership except that
the limited partners have limited control over the business and are liable to the debts
and liabilities of the business upto their capital shares.
4. General Partnerships: The sponsers may form a general partnership. A partnership will
be used when the tax benefit associated with the project are significant. Because general
partners are liable for all the debts and liabilities of the business the sponsers frequently
will form a wholly owned, single purpose subsidiary to act as its general partner in
partnership.