Presentation By, Jayan Suja Neethu.

3/13/2013

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?
3/13/2013 2

Financing Decision Vs Investment Decision

Financing Decision
Takes place in capital market

Investment Decision
Takes place in Real Market

which are approximately perfect While making financing decision, you may observe the value of similar assets. There are very few opportunities in the realm of financing that have NPV that is significantly different from zero.

which tend to be imperfect While making financing decision, you have to estimate the values of capital assets. There are many opportunities in the realm of capital budgeting that have an NPV that is significantly different from zero.

3/13/2013

Capital Structure

3/13/2013

Equity Vs Debt
Equity
Equity

Debt
Creditors have a fixed claim in

shareholders have a residual claim on the income and wealth of the firm Dividend paid to Equity shareholders is not a tax deductible payment Equity ordinarily have indefinite life Equity shareholders enjoy the prerogative to control the affairs of the firm
3/13/2013

the form of interest and principal repayment Interest paid to creditors is tax deductible payment Debt has a fixed maturity Debt investors play a passive role-of course, they impose certain restrictions on the way the firm is run to protect their interests
5

Key factors Determining the D/E Ratio

Cost
Nature of Assets Business Risk

Norms of lenders
Control Considerations Market Conditions

3/13/2013

A Check List
Use more Equity when
The tax rate applicable is

Use more Debt when

The tax rate applicable is

negligible Business Risk exposure is High Dilution of control is not an important issue The assets of the project are mostly intangible The project has many valuable growth options

High Business Risk exposure is Low Dilution of control is an important issue The assets of the project are mostly tangible The project has few growth options
7

3/13/2013

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.
3/13/2013 8

 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.

3/13/2013

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.
10

3/13/2013

 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.
3/13/2013 11

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.
12

3/13/2013

 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.

3/13/2013

13

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.
3/13/2013 14

 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.

3/13/2013

15

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.
3/13/2013 16

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.
3/13/2013 17

 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.
3/13/2013 18

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)

Public Issue Rights Issue Moderate Negligible No Irrelevant Neutral Private Placement Moderate Negligible Yes Small Neutral

Comparison of various methods

Amount that can be raised Cost of issue Dilution of control Degree of underpricing Market perception Large High Yes Large Negative

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 The lessee cannot claim depreciation The entire lease rental is a tax deductible expense for lessee

Hire purchase The hirer is entitled to claim depreciation

Only the interest component of 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 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

Suppliers line of credit

 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.

3/13/2013

40

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.

3/13/2013

41

 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.
3/13/2013 42

 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.

3/13/2013

43

 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.

3/13/2013

44

 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
45

3/13/2013

 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)
3/13/2013 46

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,
Buyers Credit

Suppliers Credit

3/13/2013

47

 Buyers 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.
3/13/2013 48

Project Financing Structure

Full Recourse Structure:

3/13/2013

49

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
3/13/2013 50

What Information does Financial Institution want? And How they Appraise?
Information to be furnished for term loan appraisal

along with memorandum.

the

project

report/information

Project Appraisal: Financial institutions appraise a

project from, Marketing Appraisal Technical Appraisal Financial Appraisal Economic Appraisal Managerial Appraisal
51

3/13/2013

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.

3/13/2013

52