Project Financing 547Exhibit 27.1 Project structure
BENEFITS OF PROJECT FINANCING
Project financing provides certain advantages vis-à-vis conventional financing. Some of these advantages are:
- Sharing of risk,
- Reduced agency cost of debt,
- Reduced agency cost of free cash flow,
- Expansion of sponsor’s debt capacity, and
- Reduction in costs of information asymmetry.
Sharing of Risk
The risks associated with a project may be so great that it may not be possible for one organization to bear
them alone. Project financing involves sharing of risk among project participants who are equipped to handle
them efficiently. Project risks can be broadly classified as operating and financial. Technology risk, perform-
ance risk, and completion risk are some of the operating risks whereas interest rate risk and currency risk are
financial risks. Exhibit 27.2 illustrates the different phases of a project and risks associated with each of the
phases of a project and their sharing.
The terms shown in Exhibit 27.2 are explained in Appendix 1. The risk of death or injury on the operating
facility is called liability risk. The risk that a sponsor may not meet quality standards or deadlines is called
sponsors performance risk. The risk that the project revenue may not meet projections because of changes in
market price is called offtake risk. The size of the project itself can be a source of risk if the outcome is
strongly correlated with returns from other businesses of the group so that losses coincide. Once the risks are
identified, suitable mechanism should be evolved to cover each of them. For instance, sponsors may be
asked to subscribe to equity to cover technology risk during the developmental phase. A major source of risk