Smart Task 01

Intern’s Details

Name Md Rasool E Farman

Smart Task No. 1

Project Topic Project finance – Financial Modeling and Analysis (Infra)

Smart Task (Solutions’)

Task Q1: What is Finance? How Finance is different from Accounting? What are important
basic points that should be learned to pursue a career in finance?

Task Q1 Solution:

Finance is the basic of business. It is required to purchase assets, goods, raw material and for the other
flow of economic activities. Finance can be defined as “The provision of money at the time when it
is needed by a business”. Finance is the study of money and capital markets which deals with many
of the topics covered in macroeconomics.

It is the management and control of assets and investments, which focuses on the decisions of
individual, financial and other institutions as they choose securities for their investments portfolios.
Also, managerial finance involves the actual management of the firm, as well as profiling and
managing project risks.

The difference between finance and accounting is that –

1. Finance, is the efficient and productive management of assets and liabilities based on existing
information. On the other hand, Accounting is the practice of preparing accounting records,
including measuring, preparation, analyzing, and the interpretation of financial statements. These
records are used to develop and provide data measuring the performance of the firm, assessing its
financial position, and paying taxes.

2. Finance is a broader term for the management of assets and liabilities and the planning of future
growth, whereas accounting focuses on day-to-day flow of money in and out of a company and
institution,

3. The aim of finance includes decision making, strategy, managing & controlling. The aim of
accounting is to collect and present the financial information for both internal and external
purpose.

Within finance, one can find a variety of job roles that are not limited to just the accounting field.

You can explore financial career options in various industries such as financial service, financial
planning, fund management, regulatory compliance, trading, financial management, and so on.
 The important basic points to be learned to pursue a career in finance are as follows-

1. Understanding the importance of cash.

2. One should be quickly analytical and have the ability to understand the concept and practices
of finance.
3. One should learn to keep an update of market knowledge like knowledge of interest rates,
inflation, tax rates etc…
4. One should have ability to manage his own money and understands the value of money
according to current economical situation.
5. One should develop the ability of risk taking as higher the ability to take risk is considered as
higher the ability to earn high profit. Finance is all about risk taking.
6. One should learn the concept of return.

500 Words (Max)

Task Q2: What is project finance? How is project finance different from corporate finance? Why
can’t we put project finance under corporate finance? Define 20 terminologies related to project
finance.

Task Q2 Solution:

Project Financing is a long-term, zero or limited recourse financing solution that is available to a borrower
against the rights, assets, and interests related to the concerned project.

In other words, “Project finance involves a corporate sponsor investing in and owing a s ingle
purpose, industrial asset through a legally independent entity financed with n on-recourse debt”.

Project financing incorporates-

 Financing of long-term infrastructure, industrial projects, and public services.

 Non-recourse/limited recourse financial structure.
 Payment from cash flow generated by the project.

Methods of the Project Financing.

There are three methods in Project Financing-
1. Cost Share Financing or Low interest loan financing.
2. Debts Financing.
3. Equity Financing.
Project finance is different from corporate finance in the following ways-

BASIS PROJECT FINANCE CORPORATE FINANCE

 Financers look at c ash flow of  Financers look to the overall strength

Financing single assets (the project) for of a company’s balance sheet and
repayment. projections, which is usually derived
not from a single assets but a range of
assets and business.

 No/limited recourse to outside  All assets of the company can be used

support for project finance debt.
Security  Project contractors are
usually the main security for
lenders; project company’s assets
are likely to be worth much less
than debt during construction.
for security.
 Access to entire cash flow from various
spread of business as security, thus
even if project fails, corporate lenders
can be repaid.

 Project often has a f inite life as  Company assumed to remain a business

Duration such the debt must be repaid by or for indefinite period and losses can be
before the end of this life rolled over.

 Lenders e xercise close control  Leaves management of the company to

Control over activities of project company run business as they see fit.
to ensure value of project isnot
jeopardized

In corporate financing, capital is been procured by demonstrating lenders balance sheets as collateral to
be used in case of default, the lender can foreclose on sponsor company assets, sell them and use
proceeds in order to recover their investment.

Whereas, in P roject finance repayment is not based on sponsoring company’s assets or balance sheet,
but on the basis of revenues that the project will generate once it is completed. Corporate finance
cannot demonstrate that revenue stream from completed project will be sufficient to repay the
loan that’s why it can’t put Project finance under corporate finance.

500 Words (Max)

The 20 terminologies related to project finance are as follows-

1. Project sponsor- Whole idea of project comes from them; they are the investor of money into
the project who may be an existing company, a developer, or a government institution or agency.

2. SPV-special-purpose vehicle (SPV) is a single-asset legal entity that is created for the sole and
exclusive purpose of acting as the project owner in a project financing. Special-Purpose Entities
are created by the project sponsor to shield the parent companies from financial risk.

3. Non-recourse finance-Non-recourse finance is a type of commercial lending that entitles the

lender to repayment only from the profits of the project the loan is funding and not from any
other assets of the borrower. In case of default, the lender may not seize any assets of the
borrower beyond the collateral.

4. Capital intensive- Project finance is raising capital for huge amount of investment for
completion of project.

5. Common equity- It represents ownership of the project. The sponsors usually hold a
significant Portion of the equity in the project.

6. Repayment schedule- It sets out how the principal debt will be repaid – on either a
“Straight Line” or a “balloon” basis (when it is repaid at the end of the project).

7. Securitization -Is the financial practice of pooling various types of contractual debt such as
residential mortgages, commercial mortgages, auto loans or credit card debt obligations and
selling their related cash flows to third party investors as securities, which may be described as
bonds.

8. Default-When a covenant has been broken or an adverse event has occurred. A money default
occurs when a repayment was not made on time. A technical default means a project parameter is
outside defined or agreed limits, or a legal matter is not yet resolved.

9. Financing agreements- The documents which provide the project financing and sponsor support
for the project as defined in the project contracts.

10. Sensitivity- An analysis of how changing an input variable in financial model affects the value,
performance or solvency of a given project.

11. Off take agreement- It is the agreement between the project company and off taker (the one
who is buying the product/services that the project produces/delivers).
 12. Leverage- The level of debt expressed as a percentage of equity or as a ratio to equity. Typically,
finance cost is 70% debt and 30% equity. Therefore, project finance is highly leveraged
transaction.

13. Financial model- A financial model is constructed by the sponsor as a tool to conduct
negotiations with the investor and prepare a project appraisal report.

14. Growth capex- It is a form of capital expenditure undertaken by a company to expand existing
Operations or further growth prospects. It focuses on activities such as the acquisition of fixed
Assets, purchase of hardware, vehicles for transporting goods, and building expansion.

15. Contingency- An additional amount or percentage to any cash flow item needed to provide a
cushion.

16. Merchant bank- It is a firm or financial institutions that invests equity capital directly in
businesses and often provides them advisory services.

17. Mezzanine Financing- it is mixture of financing instruments, with characteristics of both debt
and equity, providing further debt contributions through higher-risk, higher-return instruments,
subordinated debt, sometimes treated as equity.

18. Amortization- it is the reduction of the capital balance or up-front (capitalized) expenses over
time to reflect life-cycle depreciation and obsolescence, often an equal amount per annum.

19. Debt service coverage ratio-this is usually a historical test which compares the amount by
which the net cash flow for a given period, usually 12 months, has gone over the debt service
requirement (principal amount plus interest).

20. Operating risk- Cost, technology, and management components which impact opex and project
output/throughput. Costs include inflation.
500 Words (Max)

Task Q3: What are non-recourse debt / loan? What is mezzanine finance explained with an example.

non-recourse loan, more broadly, is any consumer or commercial debt that is secured only by collateral. In case of default, the lender may
Mortgages are common examples of non-recourse debts. In order to protect themselves, lenders
normally finance less than 80% of the commercial value of the property.

Mezzanine debt gets its name because it blurs the line between what constitutes debt and equity.

It is highest risk form of debt, but it offers some of the highest returns- a typical rate is in the range of
12% to 20% per year. A mezzanine lender is generally brought into a buy out to display some of the
capital that would as it usually be invested by an equity investor.

Mezzanine loans are a hybrid of both debt and equity. Depending on the terms of the agreement and
how events unfold, the arrangement can provide an equity interest to lenders.

Mezzanine lenders usually work with companies that have a successful track record. For example, you
might use a mezzanine loan to acquire an existing business or expand operations for a business that’s
already profitable.

In short,

 A mezzanine loan is a form of financing that blends debt and equity.

 Lenders provide subordinated loans (less-senior than traditional loans), and they potentially
receive equity interests as well.
 Mezzanine loans typically have relatively high-interest rates and flexible repayment terms.
 Mezzanine debt typically has a lower priority than senior debts when borrowers go bankrupt.
 Depending on the conditions of the loan, lenders may be able to set conditions of business
operations or receive a share in equity if the borrower goes into default.

Mezzanine funds can be used for buying a company or for expanding one’s own business without going
for an IPO.

Let’s say that Mr. Richard has an ice-cream parlor. He wants to expand his business. But he doesn’t
want to go for the conventional equity financing. Rather he decides to go for mezzanine financing. He
goes to mezzanine financiers and asks for mezzanine loans. The lenders mention that they need warrants
or options for the mezzanine loans. Since the loans are unsecured, Mr. Richard has to agree to the terms
set by the mezzanine lenders. So Mr. Richard takes $100,000 by showing that he has a cash flow of
$60,000 every year. He takes the loans and unfortunately defaults at the time of payment since his ice-
cream parlor couldn’t generate enough cash flow. The lenders take a portion of his ice-cream parlor and
sell off to get back their money. As we see from above, Federal Capital Partners (a Private Equity firm)
has provided
$6.5 million in the mezzanine fund to The Altman Companies for the development of Altis Grand Central.

500 Words (Max)

Task Q4: Explain in detail with reasons of what the sectors are or which types of projects are
suitable for project finance?

Task Q4 Solution:

Project financing is financing of long-term infrastructure, industrial projects, and public services.
Project finance is generally used in oil extraction, power production, and infrastructure sectors.
These are the most appropriate sectors for developing this structured financing technique, as they have
low technological risk, a reasonably predictable market, and the possibility of selling to a single buyer or
a few large buyers based on multi-year contracts (e.g. Take-or-pay contracts). Project finance structures
usually involve a number of equity investors as well as a syndicate of banks who will provide loans to the
project.

The most common structure for project finance are as-

1. A joint venture or other similar other unincorporated association.

2. A partnership.
3. A limited partnership.
4. An incorporated body, such as limited company (probably the most common).
Of these, joint venture and limited company structure are most universally
used.

The types of project for which project finance is suitable for are-

i. Infrastructure projects, such as government buildings and transport systems;

ii. Oil and gas exploration projects;
iii. Sports stadia; and
iv. Liquified natural gas development projects.
v. Mining
vi. Building
vii. Construction
viii. Real estate

500 Words (Max)