546 Corporate Finance
Chapter 27
27. Special Topic: Project Financing
OBJECTIVES
Provide an overview of the project finance market.
Introduction to project financing as a means to achieve financial objectives.
Provide a rationale for project finance.
Provide an overview of sources of project finance and the role of multilateral agencies.
Sensitize students to valuation issues in project finance settings.Project finance is a method of financing an economically viable project on the basis of the cash flows it is
expected to generate. The project is a separate legal entity and its cash flows are segregated from the sponsoring
organization. The sponsor may be the main user of the project’s output, contractor or supplier, a consortium
or a government. The revenue generated from the project should be adequate to cover all operating expenses,
debt-servicing burden and provide an adequate return to the equity investors. This enables the sponsors to
shift the operating risk and debt-servicing burden to the project entity while retaining some benefits from the
project. Project finance is usually restricted to large-scale, capital-intensive projects and often involves a
high proportion of debt finance provided by a group of lenders. Toll roads, tunnels, bridges, ports and power
projects are general candidates for project financing.
Project finance is not dependent on the credit support of the sponsors of the project but on the expected
cash flows and/or the collateral value of project assets. Typically, lenders have no recourse to the sponsor in
case of project failure. As a result, lenders should have a high degree of confidence in the performance of the
project. Accordingly, extensive feasibility studies are necessary so that cash flow projections are accurate.
As one project is not like the other, project finance package should be custom built and careful financial
engineering is required to allocate risks and rewards among the participants. Project financing is ideal when
the project’s output has a strong demand and parties are willing to enter into long-term contracts. A typical
project structure is shown in Exhibit 27.1.
The construction, operation and maintenance contractors are responsible for timely completion and effective
maintenance respectively. The project sponsor undertakes bidding, financing, and implementing. The com-
plexity of the documentation necessitates the retention of a law firm, at least in the case of large-scale
international projects. The Hub project in Pakistan, Petrozuata in Venezuela, and the Mozal project in
Mozambique are some of the prominent project finance transactions.