Topic 1. Introduction to Project Financial Management Prof. dr. A Paškevičius

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Topic 1. Introduction to Project Financial Management 1.1 Understanding of the Project Finance 1.2 Methods of the Project financing 1.3 Project financing sources 1.4 Contract structure of a Project Finance Deal

1.1. Understanding of the Project Finance Project finance is the structured financing of a specific economic entity – the SPY, or special-purpose vehicle, also known as the project company – created by sponsors using equity or mezzanine debt and for which the lender considers cash flows as being the primary source of loan reimbursement, whereas assets represent only collateral. In finance, mezzanine capital is any subordinated debt or preferred equity instrument that represents a claim on a company's assets which is senior only to that of the common shares. Mezzanine financings can be structured either as debt (typically an unsecured and subordinated note) or preferred stock. Mezzanine capital is often a more expensive financing source for a company than secured debt or senior debt. The higher cost of capital associated with mezzanine financings is the result of its being an unsecured, subordinated (or junior) obligation in a company's capital structure (i.e., in the event of default, the mezzanine financing is only repaid after all senior obligations have been satisfied). Additionally, mezzanine financings, which are usually private placements, are often used by smaller companies and may involve greater overall levels of leverage than issues in the high-yield market; they thus involve additional risk. In compensation for the increased risk, mezzanine debt holders require a higher return for their investment than secured or more senior lenders.

1.2 Methods of the Project financing A sponsor can choose to finance a new project using two alternatives: 1. The new initiative is financed on balance sheet (corporate financing). 2. The new project is incorporated into a newly created economic entity, the SPY, and financed off balance sheet (project financing)

1.2 Methods of the Project financing Alternative 1 means that sponsors use all the assets and cash flows from the existing firm to guarantee the additional credit provided by lenders. If the project is not successful, all the remaining assets and cash flows can serve as a source of repayment for all the creditors (old and new) of the combined entity (existing firm plus new project).

1.2 Methods of the Project financing Alternative 2 means, instead, that the new project and the existing firm live two separate lives. If the project is not successful, project creditors have no (or very limited) claim on the sponsoring firms' assets and cash flows. The existing firm's shareholders can then benefit from the separate incorporation of the new project into an SPY.

1.3 Project financing sources Four types of sponsors are very often involved in a project financing venture: Industrial sponsors, who see the initiative as upstream or downstream integrated or in some way as linked to their core business; Public sponsors (central or local government, municipalities, or municipalized companies), whose aims center on social welfare

1.3 Project financing sources 3. Contractor/sponsors, who develop, build, or run plants and are interested in participating in the initiative by providing equity and/or subordinated debt. 4. Purely financial investors.

1.4 Contract structure of a Project Finance Deal Comfort letter Comfort letter Lending banks Host government Project sponsors Concessions Bank facilities and permits Equity subscription Security Fuel supplier Project company Product purchaser FSA (1) Sales agreement O&MA (3) TKCC (4) RMSA (2) Raw material Plant operator Plant constructor