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