MODULE I: Introduction and Model Structure

The course begins with introductory comments about the skills and general objectives in project finance with an emphasis on the difficulty in measuring and valuing risk. After the introductory discussion, participants work on a case involving assessment risks of a project. Issues addressed in the first module include:

• What is the big deal about project finance and what makes project finance different from other forms of financing?
• Where does debt and equity money come from these days in project financing?
• What are the benefits of project finance relative to the high fees received by lawyers and bankers?
• Where has project finance been used and what have been the largest project financings?
• What type of risks should be evaluated in project finance to test when projects go bad?
• What are the financial criteria used to quantify project financings?
  
  

Lectures

• Sources of debt and equity finance
• Review of funding and risks in selected project finance transactions
• Key financial metrics in project finance (IRR, DSCR, LLCR and Cash Flow)
• Analysis of a completed project finance model
• Background on risk measurement and financial modelling
  
  

Case Exercises

• Exercise 1a: Petrozuata Case: PF cost/benefit and risk identification
• Exercise 1b: Construction of a simple financial model
  
  

MODULE II: Debt Capacity and Debt Structure

As described above, the afternoon sessions of the course deal with technical aspects of project finance modelling. The first modelling session covers development of a basic model, given capital expenditures, revenues and expenses. Issues addressed include: How can we make the models flexible enough to incorporate inevitable delays in construction and alternative retirement dates? What are some of the excel rules that guide accurate and efficient development of models? How can project finance models be audited to check errors that we will make? What should we do to incorporate alternative debt structures and interest during construction into the model?


Lectures

• Comments on spreadsheet style and conventions
• Building block approach to modelling
• Basic mechanics of project finance models
  - Separation of construction period from operating period
  - Sources and uses of funds statement during the construction period
  - Cash flow, net income, equity balance, construction financing and income taxes
  - Internal rate of return on the project and central concept of free cash flow
  - Construction of a balance sheet and use of a balance sheet in auditing the model
• Interest during construction
• Accounting
• Illustration of impacts in completed model
• Circularity problems
  
  

Class Exercises

Exercise 2a: Base model layout and financial Statements without Debt (1 hour)
Exercise 2b: Addition of debt leverage to the basic model (1 hour)

MODULE III: Risk Analysis and Economic Assumptions

Valuation of project finance debt, project finance equity and project finance assets involves projecting cash flows and assessing the risks associated with the cash flows. The risks can often be mitigated through revenue and expense contracts. The most time spent developing project finance models should be to develop economic assumptions in a base case and assessing risks. Module three addresses economic analysis behind key value drivers in a project finance model.

A case study is used to develop economic assumptions and to demonstrate use ofsensitivity analysis, break-even analysis and tornado diagrams. Issues addressed in this module include: If we sign a contract that changes the risk profile of a project, how should we value the contract? What are the three fundamental drivers of the value of projects? Where should we start in looking for the most important risks? What are examples of risks that have caused major projects to fail such as Eurotunnel, Euro Disney, U.S. merchant electric plants and Enron’s Dabhol LNG plant?


Lectures

• Market risks in project finance
  - Capital expenditures
  - Forward price
  - Volume – capacity utilisation
  - Input forward price
  - Efficiency
  - Operation and maintenance expenses
• Contract Risks in project finance (BOOT, PPA and other long-term contracts)
  - Economic rational for long-term contracts
  - Incentive to break contracts
  - Relation between cost and revenue contracts
  - Example of flexible supply contracts
  - Effects of variable supply contracts on cash flow
• Financial risks in project finance
  - Interest rate risk
  - Hedging of risks
  - Exchange rate risk
  - Political risk
  
  

Class Exercises

Exercise 3a: Computation of price Levels in contracts (30 minutes)
Exercise 3b: Break-even analysis in toll road project finance case with completed model (45 minutes)

MODULE IV: Modelling of Construction Draw-downs and Sensitivity Analysis

The second modelling session extends the base model to incorporate specific aspects of project financing including construction draw-downs, free cash flow, debt service coverage and LLCR. Issues covered in this module include: What difference does it make that project finance models show construction schedules on a monthly basis? How can we convert annual flows to monthly flows? Are look-up tables really useful in project finance models? How easy is it to incorporate those macros in project finance models? How can I add those tornado diagrams to my project finance model? How can I add features such as conditional formatting and list boxes to the model?


Lectures

• Monthly draw downs and semi annual debt service
  - Reports for monthly construction
  - Reports for semi-annual debt service
  - Analysis of subordinated debt
• Debt Sizing Macros
  - Basic goal seek macro
  - Working with range names
  - Alternative ways to enter data
  - Use of range names
  
  

Class exercises


Exercise 4a: Construction profiles and monthly construction (45 minutes)
Exercise 4b: macro exercise (30 minutes)
Exercise 4c: Tornado diagrams (1.5 hours)

MODULE V: Debt Structuring in Project Finance

The fifth module addresses debt structuring aspects of project finance including covenants, cash flow traps, senior and subordinated debt issues, collateral and debt capacity. Issues covered include: What type of covenants are included in project finance transactions? Is it more important to trap cash during good times or develop covenants that prevent cash from leaving the project when times are bad? How much safer is senior debt than junior debt? Should cross defaults be included in the transaction? What is the appropriate level for various covenants and what financial ratios should be used in the covenants?


Lectures

• Debt Structure Theory and Analysis
  - Alternative debt repayment structures
  - Introduction to debt as a put option
  - Cash flow sweeps and traps
  - Duration and other debt measures
• Covenants in project finance
  - Positive and negative covenants
  - Project finance covenants versus corporate covenants
  - Covenants and risk analysis of projects
  - Examples of covenants
• Debt capacity analysis in project finance
  - Sources of debt financing in project finance
  - Amounts of debt leverage for alternative projects
  - Senior versus junior debt tranches
  - Debt term
  - Use of debt service reserves
  - Appropriate benchmarks and information
• Capital structure theory and project finance objectives
  - Miller and Modigliani
  - Income taxes
  - Bankruptcy monitoring cost
  - Information signalling
  - Pecking order theory

Class exercises


Exercise 5a: Eurotunnel Financial Structure (.5hours)
Exercise 5b: Evaluation of covenants and senior versus subordinated debt using completed model (45 minutes)

MODULE VI: Modelling Complex Debt Features in Project Finance

The third technical modelling session involves modelling cash flow waterfalls, covenants, defaults and cash traps. Once this part of the model is complete, the IRR on debt can be measured as well as the IRR on equity. Modelling issues include: How can we model inflows and outflows from a debt service reserve? What complications arise from modelling senior and subordinated debt tranches? Can we really quantify the cost and benefits of covenants and cash flow traps? What should we do to the model when a debt payment default occurs?


Lectures

• Debt service reserve accounting and modelling
  - Accounting for debt service and other reserves
  - Illustration of impacts in project model
  - Circularity problems
  - Interest income
• Modelling defaults on debt service
  - Revenue scenarios
  - Cash flow waterfall
  - Interest after default
  - Repayment after default
• Modelling covenants and cash flow traps
  - Defining bad time covenants
  - Cash flow sweeps
  - Cash traps
  - Sensitivity
  - Circularity
  
  

Class exercises


Exercise 6a: Debt service reserve (90 minutes)
Exercise 6b: Defaults on debt service (100 minutes)
Exercise 6c: Covenants (85 minutes)

MODULE VII: Multilateral Agencies and Project Finance Credit Analysis

One of the features that differentiates project financings from other transactions is that various political risks can be mitigated through procurement of insurance from multilateral agencies. Project financing also involves different methods of risk rating than other corporate credits. The seventh module addresses risk rating and risk mitigation through multilateral agencies. Issues addressed in this section include: What are the benefits and costs of using multilateral agencies? What are the various multilateral agencies that can be used? How do rating agencies assess project finance debt? How can you use project finance models to assign a risk rating?


Lectures

• Multilateral agencies
  - Export agencies
  - Use of agencies in various types of projects
  - Political risk insurance
• Credit analysis and economic assumptions in models
  - Bond ratings of project finance
  - Credit scoring of project finance
  - Revenue and cost risk
  - Probability of default
  - Loss given default
  - Sources of repayment
  - Sensitivity analysis
• General discussion of southport case
  - History of the project
  - Issues facing the mining projects
  - Model and valuation objectives
  
  

Class exercises

Exercise 7a: Economic assumptions and financial structure in southport case (1.5 hours)
Exercise 7a: Computation of risk spread in Southport case with alternative debt Structures (1.5 hours)

MODULE VIII: Technical Project Finance Modelling Issues

The afternoon module deals with miscellaneous technical issues that arise in project finance modelling. Subjects include working capital, formatting, use of data tables, depreciation, leases, and resolving circularity. The module will cover further use of macros in modelling as well as financial issues associated with the topics. Issues include: Does it matter that circularity arises in our models? Are data tables worth the hassle in model building? What should be done to include movements of working capital in the model? Can we demonstrate the basic cost and benefits of leases with a relatively simple model?


Lectures

• Circularity macros
  - Alternative methods to resolve circularity
  - Working with range names
  - Use of range names
  - Alternative ways to enter data- Use of range names
• Theory and analysis of leases
  - Tax depreciation versus debt repayment
  - Tax reasons for using leases
  - Formulas for computing lease payments
• Accelerated depreciation
  - Tax depreciation conventions
  - Formulas for computing tax depreciation
  - Vintage computations of tax depreciation
• Working capital
  - Balance sheet approach
  - Use of revenue and expense ratios
  - Cash flow effects
  
  

Class exercises


Exercise 8a: Computation of lease rates (1 hour)
Exercise 8b: Working capital, data tables and resolving circularity (2.5 hours)

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