Cash Flow Analysis II

3.2 Cash Flow Analysis II

Individual Cash Flows Analysis of Individual Cash Flows Free Cash Flow FCF Year Sales revenue Year Input cost Operating cost Taxes Net investment in maintenance Construciton costs FCF used for NPV IRR analysis Anatomy of FCF for project finance Construction I  Construction contracts  Fixed price contract high premiumlow risk, payment based on progress  Turn-key contract  The contractor accepts full responsibility for delivering a fully operational facility on a date-certain, fixed price basis.  EPC contract engineering, procurement, and construction contract  Cost plus fee contract low premiumhigh risk, frequent payments  Cost plus fee contract with maximum price and incentive fee Based on: The Law and Business of International Project Finance, Scott L. Hoffman, 2001 Construction II  Major risks I  Increase in construction cost cost over-run  Unavailability of sufficient funds to complete construction  Inability to the project company to pay increased debt service during operation, even if funded by debt  Risk mitigation  Turn-key contract  Contractual undertakings—infusion of additional equity, standby equity participants, contingency tranche in construction loan, standby cost over-run funding agreements  Escrow funds, contingency account  Delay in completion  Increase in construction costs and in debt service costs  Delay in the scheduled flow of revenue to cover debt service and expenses  Breach of project contracts, such as fuel supply or off-take  Risk mitigation  Turn-key contract  Stated milestones tied to construction loan contract Based on: The Law and Business of International Project Finance, Scott L. Hoffman, 2001 Construction III  Major risks II  Project performance at less guaranteed levels  Breach of off-take contractdecrease in project revenue  Increase in maintenance costs and inpututility costs  Inability to the project company to repay debt  Risk mitigation  Performance liquidated damage to cover the loss  Third party guarantees such as letter of credit or performance bond payment bond, when financially weak contractors  Bid bondwarranty bondretention bond  Other risks  Site acquisition and construction related facilities  Equipment, building material, and utility supply  Laborenvironmental issues  Force majeure risks  Risk mitigation  All risk contractor’s riks insurance Based on: The Law and Business of International Project Finance, Scott L. Hoffman, 2001 Off-take Purchase I  Off-take agreements  Take-or-pay contract a form of unconditional guarantee  the purchaser is required to pay for a certain amount fixed cost, even the product is not delivered. The rest of the amount variable cost will be paid if the purchaser wants to buy.  Take-and-pay a form of conditional guarantee  the purchaser required to pay for a certain amount fixed cost for the product delivered, when the product meets the contract quality requirements.  Long-term sales agreements obligation to purchase  typically one- to five-year agreement for the purchase and sale of specified quantities of the project’s output. The purchaser has the obligation to purchase the contract quantity only if it is produced and delivered, and meet the contract quality requirements.  Off-take purchaser’s financial strength  Market for product or service in the long run Based on: The Law and Business of International Project Finance, Scott L. Hoffman, 2001 Off-take Purchase II  Merchant project Merchant facility  Merchant facility is a project finance without off-take contracts  Cash flow fully relies on the market for project output and forecasts of future market conditions revealed to market risks.  The analysis of market risk is similar to that used in any business model price, supply and demand.  Risk mitigation  Linking inputs and outputs  Reserve funds  Cash calls  Subordination of project costs to debt services  Hedging strategies  The commodity supplier as project partner Based on: The Law and Business of International Project Finance, Scott L. Hoffman, 2001 Input  Major risks  Increase in input costs  Risk mitigation  Supply-or-pay contract  Fixed amount contract  Requirements contract capfloor  Output contract  Subordination of project costs to debt services  Other issues  Delay in completion of transportation facilities  Availability of supply  Disruption of transportation  Title and risk of loss  Force majeure  Financial strength of supplier Based on: The Law and Business of International Project Finance, Scott L. Hoffman, 2001 Operation  Major risks  Increase in operating costs  Excessive equipment replacement and unscheduled maintenance  Poor productivity of labors, incorrect assumptions of required labor  Increase in utility costs  Risk mitigation  Performance guarantees liquidated damage  Fixed price operation and maintenance contract very rare  Cost plus fee operation and maintenance contract  Cost plus fee contract with maximum price and incentive fee  Other risks  Force majeure risks  Risk mitigation  All risk operator’s risk insurance  Financial strength of the operator Based on: The Law and Business of International Project Finance, Scott L. Hoffman, 2001 ExchangeInterestInflation Rate  Currency and exchange risks  Loan agreement  Loan disbursements construction loan and term loan  Principal repayment and interest repayment  Availability of swap markets  All other agreement  Export and import of equipment, input, out-put, operating costs  Cash flow will be affected depends who takes the risks and covers  Interest rate  Incorrect interest rate projections can severely affect the ability of the project revenue to service debt by  Inflation rate  Risk allocation  Cash flow projection Based on: The Law and Business of International Project Finance, Scott L. Hoffman, 2001 Collateral I  The “blanket” lien  The blanket lien covers all the assets of the project company, including real unmovable and personal movable, tangible and intangible.  Project cash flow  A security interest in the cash flows generated by the project under long-term off- take agreements.  Accomplished through a cash collateral account in which off-take purchaser pays all payments into the account established by the lenders.  Offshore accountsescrow accounts  Ownership interests  Pledge of ownership interests  Voting trust  Negative pledges  An agreement under which the project company will not create, directly or indirectly, any security interest, lien or encumbrance in its assets for the benefit of any other entity. Based on: The Law and Business of International Project Finance, Scott L. Hoffman, 2001 Collateral II  Personal movable property  Intangible assets  Permits, licenses and concessions  Contracts  Insurance proceeds  Surety bonds  Guarantees  Liquidated damages  Political risk insurance  Accounts  Disbursement agreement Based on: The Law and Business of International Project Finance, Scott L. Hoffman, 2001 Collateral III  Review the contracts to verify that they are each assignable under the country’s law.  In the event of a foreclosure, the contracts will only have value to the lender if they can be assumed by the lender and later assigned to a purchaser of the project.  Other issues  Types of liens allowed  Local formalities  Denomination of lien in local currency  Priority of lien perfection  Enforcement  Foreclosure Based on: The Law and Business of International Project Finance, Scott L. Hoffman, 2001 Equity and Dividneds  Timing and certainty of equity contribution  A part of equity contributions to the project company may be planned after the financial closing. Some funds may be injected with construction draw-downs, or await investment until project completion.  Risk mitigation  Condition precedents in loan agreement  Covenants in loan agreement  Some conditions for dividend payments  Requirement to replenish before dividend payments  Reserve contingent account  Off-shore account  Financial covenants: a financial covenant limiting the dividend payments to a certain level Based on: The Law and Business of International Project Finance, Scott L. Hoffman, 2001 PermitLicenseConcession  Status  Permits already obtained and in full force and effect  Permits routinely and mandatorially granted on application and fulfillment of applicable criteria and that would not normally be obtained before construction before loan agreement  Other than above  Risks  Unable to operatetermination of project  Damage payments  Different policies between central and local governments  Permit vocation, additional permit requirements  Risk mitigation  Integrated management of all necessary permits: apply, obtain, maintenance, renew processes Based on: The Law and Business of International Project Finance, Scott L. Hoffman, 2001

3.3. Stress TestingSimulation