Project finance

• Definition and rationale for project finance

• Cash-flows prediction and risk analysis
• Contracting and Risk transfer
• Project evaluation
• Project financing

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

Project finance
1/ Definition and rationale for project finance

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

1
 Project finance
―Project Finance‖ refers to complex contractual schemes and
financial structures , using a wide range of financial instruments.
Though projects may differ considerably from one to the other, so that
there is no well accepted general definition, there are common
characteristics

Characteristics of project finance:

 It mostly concerns long term capital intensive projects involving

proven technologies (typically public infrastructures)

 The project is segregated, funds are provided for a “ring fenced”

project through a project company (Special Purpose Vehicle, SPV).
Sponsors involved in the project build an alliance through a
“shareholders agreement”.
Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

Characteristics of project finance:

The equity contribution of sponsors is usually limited, lenders

providing most of the funds needed (up to 80%) with no or limited
recourse, counting on the project’s potential cash flows to cover the
debt service

To secure future cash-flows, risks are allocated to the project’s

participants best able to handle them. For this reason a large number
of stakeholders are normally involved through various types of
agreements and contracts

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

2
 Project structure
A combination of agreements and contracts for optimizing risk and income
allocation among stakeholders

Private Sponsors
(shareholders agreement)
Host government Escrow account

Property rights,regulation, Equity funding and Foreign account

permits, concession… operating agreements

Suppliers Sales
Agreements
Supply Special Purpose Vehicle
agreement (Project Company) Buyers

Lease contract

Constructors Lessors
Loan agreement
Engineering, Insurance (up to 80%) International
Procurement,& contract Organisations,
Construction contract ECAs
(EPC) Insurers
Loans & credit
Pool of banks enhancement
(arrangers & providers)

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

Project finance: by industry

Main domains concerned:
Capital intensive projects
Proven technologies
Long term perspective

Global Project Finance loans by sector

January 1st to March 31 2018, US$ Billions
Thomson Reuters
http://www.pfie.com/Journals/2018/04/25/e/v/u/
PFI-Financial-League-Tables-Q1-2018.pdf

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

3
 Project finance: by industry
Asia Pacific & Japan

Global Project Finance loans by sector

January 1st to March 31 2018, US$ Billions
Thomson Reuters
http://www.pfie.com/Journals/2018/04/25/e/v/u/
PFI-Financial-League-Tables-Q1-2018.pdf

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

Project finance: by region

Global Project Finance loans by region

Thomson Reuters
http://www.pfie.com/Journals/2018/04/25/e/v/u/PFI-Financial-
Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021 League-Tables-Q1-2018.pdf

4
 Project finance: Asia Pacific & Japan
Global Project Finance loans by region

Thomson Reuters
http://www.pfie.com/Journals/2018/04/25/e/v/u/PFI-Financial-
League-Tables-Q1-2018.pdf

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

An up to date topic in Vietnam

La Gan Wind Power Development Corporation, the joint

venture of the consortium comprising Copenhagen
Infrastructure Partners, Asiapetro and Novasia, has signed
two contracts with the Vietnamese government for studies
related to the planned 3.5GW La Gan offshore wind project.
21 May 11:38

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

5
 Rationale for project finance?
For sponsoring companies
 With reference to financial theory (Miller &Modigliani), no clear
advantage
 However, tax saving might be an incentive
 Off balance sheet accounting is not a strong argument
 Motivations are mainly organisational:
Dealing with agency issues:
Segregating the project in a SPV with a high level of debt help identifying
responsibilities and control performance

Dealing with information asymmetry and risk allocation

Joint interest among stakeholders and risk sharing reduce inefficiencies

Protecting sponsor’s assets:

The risk exposure for the sponsors is limited to their equity stake in the
SPV, and the cost of default is also reduced
Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

Rationale for project finance?

For governments
Private funds to limit public deficits (provided the risk is transferred
to the private sector)

 Cost of capital explicitly taken into account

 More efficiency is expected (investment expenditures & operating

costs)

 Project finance, with high leverage, may lead to lower price for
“off take” contracts (the optimal allocation of risks and state
guaranties reduce the cost of funds and therefore the required
profitability)

 Project finance is a source of technology transfer and contributes to

boost infrastructure development

 A tool for privatization (Public Private Partnerships, PPPs)

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

6
 Public-Private Partnership
Agreements
https://ppp.worldbank.org/public-private-partnership/agreements

PPPs take a wide range of forms varying in the extent of involvement of and risk
taken by the private party. The terms of a PPP are typically set out in a contract or
agreement to outline the responsibilities of each party and clearly allocate risk.

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

Need to improve government’s capacity

to handle PPPs
 Poor preparation
 Lack of clarity about project objectives

 Too much focus on the transaction, and not enough

on the fundamentals of the project
 Inappropriate risk model applied to the project

 Failure to realize value for money

 Lack of internal capacity

 Inadequate planning
(See: Closing the Infrastructure Gap: The Role of Public-Private Partnerships;
Deloitte Research Study; https://www.unece.org/fileadmin/DAM/ceci/ppt_presentations/2008/ppp/northoff.pdf)
Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

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 Deloitte, Public Private Partnership, February 2008
https://www.unece.org/fileadmin/DAM/ceci/ppt_presentations/2008/ppp/northoff.pdf

Vietnam?

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

Infrastructures: …enhancing competitiveness

3,8 (Vietnam 2018)

Source: Organisation for Economic Co-operation and Development, European Commission

From: Infrastructure financing: an investor’s perspective; KKR; Presentation to the French Chamber of Commerce in Great Britain, Sept. 2012

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

8
 A PROJECT FINANCE CASE IN VIETNAM
Nghi Son Refinery and Petrochemicals
NSRP is a joint venture company
established in April 2008, with
Vietnam Oil and Gas Group
(PVN), Kuwait Petroleum Europe
(KPE), Idemitsu Kosan Co.,Ltd.
(IKC) and Mitsui Chemicals Inc.
(MCI) as its sponsors, to develop,
construct and operate the Refinery
With a total investment capital of over US$ 9 billion and a
processing capacity of 200,000 barrels of Kuwait crude oil
per day (equivalent to 10 million tons per year), the Refinery
is one of Vietnam’s key national projects.
Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

A PROJECT FINANCE CASE IN VIETNAM

Nghi Son Refinery and Petrochemicals
18/07/2018
Nghi Son Refinery and Petrochemicals heading for
insolvency
―All the contribution capital parties are pushing PetroVietnam to
complete its state capital contribution this July, as following this
lenders will disburse the loans as commitments. Without the
disbursement of the loans, the project will default,‖
(vnexpress.net )
But a solution was found!
10/12/2018
Nghi Son refinery and petrochemical complex project
commences commercial operation (Europetrole)

2/13/2020
Vietnam's Nghi Son oil refinery offers first gasoil cargo for export
"We are exporting because domestic sales have been slow recently," the source said…
(Hydrocarbon Processing; e news)

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

9
 La Gan Offshore Windfarm
A Vietnamese ongoing project
(Binh Thuan province)

signing of the MOU with Binh Thuan People's Committee in July 2020 The proposed wind farm
will be installed off the coast of Binh Thuan Province at an estimated cost of up to USD 10 billion
(EUR 8.6bn). The partnership behind the project will seek to include the scheme into the Power
Development Plan of Vietnam and will then prepare to take a final investment decision. Once
completed, the plant will be one of the first large-scale offshore wind farms in the Asian country.
With a potential capacity of 3.5 GW, the La Gan offshore wind project will be one of the first large
scale offshore wind projects in Vietnam. Once fully installed, the project is expected to power more
than 7 million households per year and avoid 130 million tonnes of CO2 emissions over its
lifetime.

February 2021
The La Gan Wind Power Development Corporation, developer of the La Gan offshore wind farm
project owned by Copenhagen Infrastructure Partners, Asiapetro and Novasia, signed four
Memorandums of Understanding (MOUs) on foundation supply and harbour services.
The MOUs were signed with Vietnam-based contractors: CS Wind Corporation, PTSC Mechanical and
Construction (PTSC M&C), Southern Petroleum Construction J.S.0 (Alpha ECC) and Vietsovpetro.

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

La Gan Offshore Windfarm

A Vietnamese ongoing project
(Binh Thuan province)

signing of the MOU with Binh Thuan People's Committee in July 2020 The proposed wind farm
will be installed off the coast of Binh Thuan Province at an estimated cost of up to USD 10 billion
(EUR 8.6bn). The partnership behind the project will seek to include the scheme into the Power
Development Plan of Vietnam and will then prepare to take a final investment decision. Once
completed, the plant will be one of the first large-scale offshore wind farms in the Asian country.
With a potential capacity of 3.5 GW, the La Gan offshore wind project will be one of the first large
scale offshore wind projects in Vietnam. Once fully installed, the project is expected to power more
than 7 million households per year and avoid 130 million tonnes of CO2 emissions over its
lifetime.

February 2021
The La Gan Wind Power Development Corporation, developer of the La Gan offshore wind farm
project owned by Copenhagen Infrastructure Partners, Asiapetro and Novasia, signed four
Memorandums of Understanding (MOUs) on foundation supply and harbour services.
The MOUs were signed with Vietnam-based contractors: CS Wind Corporation, PTSC Mechanical and
Construction (PTSC M&C), Southern Petroleum Construction J.S.0 (Alpha ECC) and Vietsovpetro.

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

10
 La Gan Wind Power Project
Surveys & Studies: (as of May 2021)

Public entity
• CPIM (VN/Geophysical, geological Binh Thuan People's Committee
& marine resources investigations)
• NIRAS (Danish/Environmental and Developers (Sponsors)
Social Impact Assessment (ESIA))
• Copenhagen Infrastructure Partners (CIP /CI New Markets Fund I )
Turbine supply: • Asiapetro (historically focused on the development of large-scale energy
projects including oil, gas, solar and wind)
• Novasia (development of renewable energy – particularly wind resources)
• GE Renewable Energy
• MHI Vestas Offshore Wind
Project Company (SPV)
Intallation & Commissioning: La Gan Wind Power
Development Vietnam-based contractors:
Corporation
• DEME (dredging, solutions for the
offshore energy market, infra marine and
environmental works)
• Jan De Nul (offers specific services for
the offshore energy market) • CS Wind Corporation, PTSC Mechanical and
• SEMCO maritime (Danish Construction (PTSC M&C)
company/ engineering design, fabrication, • Southern Petroleum Construction J.S.0 (Alpha ECC)
installation, service and maintenance of • Vietsovpetro.
offshore assets, providing comprehensive
project management across all phases of • LS Vina Cables & Systems (JV Korea/Hai Phong City)
energy projects) • PECC2 (Electrical intallation)

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

Illustration:
C-Power offshore windfarm on the Thorntonbank

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

11
Illustration: Belgium Offshore Wind Project
The concession area
Thornton sand bank about 30 km
offshore from the Belgian Coast

o Water depth 12 to 27,5 m

o Total capacity 325,20 MW

o Annual electricity generation 1.050.000.000 kWh or 1050 GWh

(= Enough energy for the annual consumption of 300.000 families)

o Avoided CO2 emission:

415,000 tonnes/year (compared with the environmentally most friendly gas power
stations)

o Wind turbines
• Phase 1: 6 x 5 MW each Total budget
• Phase 2: 30 x 6,15 MW each
1289 M€
• Phase 3: 18 x 6,15 MW each
Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

 First phase (Pilot phase)

The first phase was built by C-Power and consists of
six REpower offshore wind turbines of 5 MW capacity on the Thornton
sandbank, at a cost of €153 million (about 12% of total investment).
A 37 km 150 kV undersea cable connects the Thorntonbank Wind Farm to the
shore.
The first phase of what will ultimately be a 325 MW wind farm was
completed in September 2008. The six REpower 5 MW turbines, which were
installed on concrete gravity foundations, were linked to the Belgian power
grid, giving a total rated capacity of 30 MW for the first stage.

 Second and third phase

Phase 2, completed in October 2012, comprises the installation of 30 of the 48
additional wind turbines. These wind turbines have been installed on steel
jacket foundations designed by OWEC Tower AS and assembled at Smulders,
Hoboken.
In the third and last phase, completed in September 2013, the remaining 18
wind turbines were installed, bringing the total capacity to around 325 MW
https://en.wikipedia.org/wiki/Thorntonbank_Wind_Farm
Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

12
 Phase 1

Phase 2

Tranformer station
Phase 3

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

Part of financial group active in

Project Sponsors
the sector of energy transport
Worldwide operating networks, renewable energy, Specialists in financing and developing
maritime engineering environment and water environmental and utility projects
specialist

Z-Kracht is an investment
vehicle, enclosing 99
Belgian municipalities,
with Nuhma NV as
reference shareholder
PROJECT COMPANY
The company plans, builds
and operates renewable
power generation facilities,
and aims to vigorously
grow its renewable energy With operations in Europe
capacity in the UK and and North America, EDF
Continental Europe. Energies Nouvelles is a
market leader in green
electricity production.

Marguerite Wind is a vehicle of the 2020 European Fund for Energy, Climate Change and
Belgium Shareholders
Infrastructure (“the Marguerite Fund”) which is established with the backing of six of
Europe’s leading public financial institutions (Caisse des Dépôts et consignations, Cassa
Depositi e Prestiti, European Investment Bank, Instituto de Crédito Oficial, KfW, PKO
Three European
strategic partners Bank Polski) to make capital-intensive infrastructure investments, mainly in Renewables,
Energy and Infrastructure.

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

13
 Financing Sponsors

Total budget
1,289 M€

Financing parties

10 M€ EU grant
under the European
Energy Programme
for Recovery
(EEPR)

Non-recourse financing for EUR 913 M€

(70% of total budget, excluding contingent facilities)
Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

*Under the scheme, C-Power will Sponsors

receive certificates from the federal
energy regulator (CREG) which can
then be sold to the transmission Concession
system operator Elia at a premium CREG
on top of the price received for (20 years, Build & Operate)
(Federal Energy Regulator)
electricity sold on the market.
Belgium State Elia (Belgium TSO)
Provision of certificates*

Construction and engineering partners

o Tractebel Engineering (Design)

o THV sea wind (foundations)
o ABB (Electrical infrastructure) Insurance
o SENVION (supply, installation & o Ethias ("Construction
maintenance of turbines) All Risks" Insurance)
o Owec Tower A/S and Reinerstsen (jacket o Delta Lloyd
foundations for the turbines) (Operational insurance)
o HSM-Schiedam (Topside structure for the
offshore transformer station) Financing parties
o Smulders Foundations B.V. (EPC
Subcontractor Foundations)
o Mwaves (Marine Warranty Surveyor)
o Mott McDonald (Lenders Engineer)
o Det Norske Veritas (DNV) (Certification
of the offshore transformer station)
o DEWI-OCC (Certification of the project)
Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

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 A success story

June 2013
Phase 2 is completed

Nov 2010
Financial close for phase 2

May 2007 to May 2009

Phase 1 is completed

2003 to 2010
Building permits are obtained

2003
Environmental permits and domain concession are obtained

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

Project finance
•
2 Cash-flows and risk analysis

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

15
 Risk Management Process
Define the Objectives: “risk appetite” Related Activities
objectives…
Risk Identification Information
gathering
and analysis

A continuous process
Risk Evaluation
Monitoring
Risk Controling
Avoidance &
Anticipate… Reporting
Risk Treatment

Communication
Prevention Financing

Transfer

…to react Training

Crisis Management & Recovery
promptly
Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

The Corporate Risk System

a guide for risks identification
Legal Financial Socio-Economic Political
Greater Environment (cf. PESTEL*)

COMPETITORS
unfairness

Organisational risks

Access risk Local risks

Access risk
Local risks
Local risks Local risks
SUPPLIERS CUSTOMERS
Transfer Risks

Delivery failure Support activities Product liability risk,

Project level (organisation & processes) Solvency risk
…..
COMPETITORS
unfairness
Close Environment (corporate strategy)

Natural Technological Media

*PESTEL: Political, Economical, Social, Technological, Environmental & Legal risk factors

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

16
 Project risk resolution
Uncertainty
affecting
future cash- Completion phase
flows

Start up phase
Completion
Risk
(delays, cost
overruns,…)

Operating phase
Technological
Risk •Supply risk
(under performance,
premature obsolescence,.)
•Economic risk Months
•Political risk
•Environmental risk
•Financial risk
•Currency risk
•…….
Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

Project Risk Exposure over time

Capital Employed

Uncertainty
resolution

Completion start up development

Risk
exposure

mezzanine
financing
+ No recourse
Equity Contingent debt
financing

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

17
Illustration:
Short-Form Generic Risk Allocation Table for Toll Roads (1)
See: World Bank; https://ppp.worldbank.org/public-private
partnership/sites/ppp.worldbank.org/files/ppp_testdumb/documents/GenericRiskAllocationTablefortollroads.pdf

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

Illustration:
Short-Form Generic Risk Allocation Table for Toll Roads (2)
See: World Bank; https://ppp.worldbank.org/public-private
partnership/sites/ppp.worldbank.org/files/ppp_testdumb/documents/GenericRiskAllocationTablefortollroads.pdf

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

18
 Illustration:
Short-Form Generic Risk Allocation Table for Toll Roads (3)
See world Bank; https://ppp.worldbank.org/public-private-
partnership/sites/ppp.worldbank.org/files/ppp_testdumb/documents/GenericRiskAllocationTablefortollroads.pdf

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

Risk valuation
Project Cash Flow analysis
Cash-Flow Component
Quantities sold
x Price
= Sales
- Purchases
- Other operating costs
= EBITDA
- Depreciation T0 T n (?)
= EBIT
- Taxes
= NOPAT
+ Depreciation
- Change in WC
= Operating CF
- Investment expenditures
= CF Available For Debt Service
- Debt service
= Cash Flow to Equity

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

19
 Duration and termination of the project agreement
(in the case of off-take or concession)

COD (Commercial Term of the agreement

Operation Date) (residual value)
or, signature of the
agreement Term of the debt Useful life of the project

Preparation phase Completion Operating phase

Economic analysis phase
Risk analysis
Funding

Early termination (any time following COD)

•Default by the project company
•Default by the contracting party (offtaker, public authority)
•Force majeure
•Optional (for the offtaker)
(lenders are most concerned with the termination sum payment!)

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

Risk valuation
Project Cash Flow analysis
Cash Flow Sources of risk
Component
Quantities sold Market demand
x Price market demand, price control, currency risk
= Sales
- Purchases supply failure, price volatility,import restriction..
- Other operating costs cost overruns: inflation, organisational inefficiency..
= EBITDA
- Depreciation Cf investment cost
= EBIT
- Taxes change in tax regulation,…
= NOPAT
+ Depreciation Cf investment cost
- Change in WC operating delays, increase in inventory & receivables
= Operating CF
- Investment expenditures cost overruns & delays
= CAFDS non availability for lenders
- Debt service interest rate & currency risk
= Cash Flow to Equity non availability for sponsors

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

20
 Risk valuation
Project Cash Flow analysis
Cash Flow Sources of risk Risk allocation or hedging
Component instruments
Quantities sold Market demand sales agreement ("off take")
x Price market demand, price control, currency risk sales agreement, hedging
= Sales
- Purchases supply failure, price volatility,import restriction.. supply agreement, hedging
- Other operating costs cost overruns: inflation, organisational inefficiency.. operating agreement
= EBITDA
- Depreciation Cf investment cost
= EBIT
- Taxes change in tax regulation,… political risk insurance
= NOPAT
+ Depreciation Cf investment cost
- Change in WC operating delays, increase in inventory & receivables operating agreement
= Operating CF
- Investment expenditures cost overruns & delays construction contract, insurance
= CAFDS non availability for lenders loan contract, escraw account
- Debt service interest rate & currency risk hedging
= Cash Flow to Equity non availability for sponsors Insurance, escrow accounts

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

Risk exposure: the « Risk Matrix »

Two axes….easy to represent! but other dimensions should also be considered: controlability, horizon

?
An accumulation of
« tolerable risks »
may end up in severe
total losses
A portfolio approach,
taking possible
correlations into
account, would be
necessary

? So unlikely! ….but
don’t forget
Mind group
assessments and
measurement bias A risk mapping tool design for
formal reporting rather than
Ambiguity is the rule….don’t trust numbers too much! managing risk?
Be ready to cope with unexpected events and detect early signals

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

21
 A focus on Risk Metrics

- Probabilistic approach
- Simulation tools
- Value & Earning at Risk

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

Representation of risk
Project description
Scenario S1 S2 ……………. Sn
Outcome C1 C2 ……………. Cn
Probability p1 p2 …………….. pn
Few remarks
probability Simulations can be carried out to obtain a
probability distribution (Montecarlo)
Volatility (standard deviation s) as a measure
of risk …. Be careful, probability of extreme
n=3
events might be underestimated!
The probability of a loss higher than a certain
C2
critical level is a current approach to assess risk
Most importantly, factors affecting
C1
? C3 significantly the outcome should be identified
A question one should always be able to
Critical loss 0 Outcome (NPV, IRR, ….) answer: what if the worst case scenario occurs?
Or, is the probability of a « critical loss » higher
than a given threshold?

• Below required profit (value destruction, ROCE<WACC, NPV <0)

Critical thresholds • Below zero profit (capital loss)
• Default (a critical loss resulting in a liquidity crisis)

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

22
 Representing uncertainty using simulations

Identification of the random parameters influencing the estimated

outcome (example: Sales = Price x Quantity)

For each random parameter (Price, Quantity) translate your subjective

knowledge into probabilities

Based on probabilistic representation produce a series of estimates to

obtain a distribution of outcomes Price quantity sales
P1 Q1 S1
P2 Q2 S2
…. …. ….
Pn Qn Sn

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

Illustration: translate your subjective knowledge into probabilities

Estimating an on-shore wind turbine expected life (years)?

“What is your lowest and highest estimate so that the probability of

the true value being in this range is 95%?”

Assuming a normal distribution

Let’s say 20 to
30 years

95% probability
20 (mean: 25) 30

Probability ≈ 95%
20 2s = 5 25 30 Mean: 25 years
2s=5 s = 2,5

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

23
 SIMULATION: Estimating EBITDA
Creation of a set of numbers normally distributed with excel, see:
http://www.mbaexcel.com/excel/how-to-create-a-normally-
distributed-set-of-random-numbers-in-excel/

mean s
Price $ 50 0
Quantity 2000 400
€ /$ Exch rate (1$ = ) 0,9 0,2
Variable costs (per unit) 3 0,3
Fixed costs 40000 0

Frequency curve
(EBITDA)
2.5%
-------------------------------------
2.0%
1.5%
1.0%
0.5%
0.0%
5000
-25000
-15000

105000
115000
125000
-5000

15000
25000
35000
45000
55000
65000
75000
85000
95000

Prob(EBITDA<0) = 3.3%

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

SIMULATION: Estimating EBITDA

-------------------------------------

Prob(EBITDA<0) = 3.3%

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

24
Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

RISK MEASUREMENT: few concepts

Prob{Loss > VaR} = a%

Expected (CVaR: conditional VaR, average loss if loss > VaR)
loss
probability
Value at Risk
VaR Risk limit
Provisions The probability of a loss higher than C should
not exceed a%

Critical
Loss: Prob{loss>C) > a%
C Or not acceptable
VaR > C

a%
a% Max possible loss
0 Stress test (worst case scenario)
Losses
Safety margin
(Capital at Risk, CaR, amount of equity
available to cover losses above expected loss)

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

25
 RISK MEASUREMENT: few concepts

Prob{loss>C) > a%
Or not acceptable
VaR > C
Need to take action

Prob{loss>C) < a%
probability Or acceptable
Value at Risk VaR < C
VaR

Critical
Loss:
C

a%
0
Losses

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

RISK MEASUREMENT: few concepts

Risk factors
EaR
Earning at Risk
simulations
EaR (a%):

Prob (E < EaR) = a%

Critical Loss
f (E)
acceptable not acceptable

a%
E
L 0 Expected
EaR(a) Earning
Max possible loss
Stress test (worst case scenario)

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

26
 a l
Considering the project
estimates and the limit
5% ..... 1.65 imposed, do you think it is
acceptable
2.5% ...1.96
2% …..2.05
1% ..... 2.33

Estimates:
IRR (7%-10%) with 90% probability
(assuming a normal distribution)

Critical limit:
Probability (IRR<5%)<1%

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

a l Estimates: IRR (7%-10%) with 90% probability

(assuming a normal distribution)
5% ..... 1.65
2.5% ...1.96 Critical limit: Probability (IRR<5%)<1%
2% …..2.05
1% ..... 2.33 Is the project acceptable?

L?
7%
1,65 s = 1.5% s = 0.91%

2,33 s

1,65 s
1%
5% 6,28% E(IRR)=8.5% IRR
Fine, the probability
of a return lower than
5% is less than 1%
2.33 s = 2.12% L = 8.5% - 2.12% = 6.28% (>5%)

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

27
 a l
Considering the project
estimates and the limit
5% ..... 1.65 imposed, do you think it is
acceptable
2.5% ...1.96
2% …..2.05
1% ..... 2.33

Estimates:
NPV (- 100; +400) with 90% probability
(assuming a normal distribution with E(NPV) = +150

Critical limit:
Probability (NPV<-300) < 1%

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

a l Then we have
Prob(NPV<-300) < 1%
5% ..... 1.65 The project is acceptable
2.5% ...1.96
2% …..2.05
1% ..... 2.33
Estimates:
NPV (- 100; +400) with 90% probability
(assuming a normal distribution with E(NPV = +150)

Critical limit:
Probability (NPV<-300) < 1%

1.65 s = 250 s = 151.5

L(1%) = E(NPV) – 2.33 s L(1%) = 150 – 2.33*151.5 = - 253

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

28
 Contracting and Risk transfer
• Revenue risk
• Business interruption
• Political risk
• Ancillary contracts
• Efficient contract management

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

Revenue risk…. Concession (BOT case)

In this form of PPP, the Government defines and grants specific
rights to an entity (usually a private company) to build and operate
a facility for a fixed period of time. The Government may retain the
ultimate ownership of the facility and/or right to supply the services.
…payments can take place both ways: concessionaire pays to
government for the concession rights and the government may also
pay the concessionaire, which it provides under the agreement to
meet certain specific conditions.
Usually such payments by the government may be necessary to
make projects commercially viable and/or reduce the level of
commercial risk taken by the private sector, particularly in the initial
years of a PPP programme in a country when the private sector may
not have enough confidence in undertaking such a commercial
venture.
Typical concession periods range between 5 to 50 years.
Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

29
Revenue risk…. Concession (Franchise)

Under a franchise arrangement the concessionaire provide

services that are fully specified by the franchising authority.

The private sector carries commercial risks and may be required

to make investments.

This form of private sector participation is historically popular in

providing urban bus or rail services. Franchise can be used for
routes or groups of routes over a contiguous area.

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

Revenue risk…. Off-Take contract

They lock-in a significant amount of future revenue and allow the project company to
account for recurring sales and profits for many years into the future.

Take or Pay Contracts: requires the off-taker to pay for the products on a regular basis whether or
not the offtaker actually takes delivery of the products.
Take-and-Pay Contracts: the offtaker only pays for the product taken on an agreed price basis.
Throughput Contracts: apply when the user of a pipeline agrees to use the pipeline to carry not less
than a specified volume of product at a contractually specified minimum price.
Power Purchase Agreements: are Offtake Agreements commonly used with electrical power
projects in developing countries. In this circumstance, the offtaker is usually a government entity that
is required to buy the power or utilities.
Contract for Differences: the project company sells its product into the market and not to the
offtaker or hedging counterpart. If however, market prices are below agreed-upon levels, the off-
taker pays the difference to the project company, and vice versa, if prices are above agreed upon
levels.
Hedging Contracts: are used in commodity markets such as in an oilfield project (options,
forwards, swaps,…)
Long-Term Sales Contracts: the offtaker agrees to take the contractually agreed-upon quantities of
the resource or product from the project. Under this structure, prices are not established in advance.
Instead, prices are based on the market prices of those resources or products at the time of actual
delivery or an agreed upon formula or market index, subject to certain contractual floor prices.

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

30
Dealing with revenue risk….

Service contracts
Hospital, air traffic control, prison,…
Payment made by the public authority based on the level of
activity and availability.

Toll contracts
Roads, bridges, tunnels,…
toll or fares collected from the general public. Maximum toll with
indexation (may be a “Shadow toll”)

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

Tariff (case of a PPA, Purchasing Power Agreement)

 The contract first stipulates

•Agreed technical characteristics
•Minimum required availability
 Tariff usually consists of two components:
•Fixed operating cost
Availability charge (rents, staff, scheduled maintenance,…)
(to cover fixed costs) •Debt service
(interest and principal repayments)
•Equity return
(Cost of equity: «fair» return for shareholders)
Energy charge
(based on quantities •Cost of purchases
to cover variable costs) (actual or indexed prices, based on pre-agreed
assumptions as to output/input ratio)
 Tariff indexation
Tariff are generally adjusted with reference to agreed economic indices
 Penalties (if the plant does not perform as required)
Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

31
 Case study: PPA, Combine Cycle Gas Turbine

Technology CCGT
Number of years of utilisation 20
size (MW) 830
Capacity factor 80%
Investment cost per MW 550000
Maintenance cost (fixed cost/year) 600000
Opex per MWh 3,8
Fuel cost per MWh 31
Cost of funds 8%
Assuming one shot capital expenditure year 0
no decommissioning and no carbon cost

1. Determine the annual payment including the availability charge

and the coverage of variable cost assuming a 60% utilisation
factor
2. What is the cost per KWh?
3. By how much would this cost be reduced if we assume the cost
of funds is only 6%?

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

Case study: PPA, Combine Cycle Gas Turbine

Technology CCGT
Number of years of utilisation 20
size (MW) 830
Required capacity factor 80%
Investment cost per MW 550000
Maintenance cost (fixed cost/year) 600000
Opex per MWh 3,8
Fuel cost per MWh 31
Cost of funds 8%
Assuming one shot capital expenditure year 0
no decommissioning and no carbon cost

Fixed Cost:
• Capital expenditure*: (830*550 000) = 456 500 000 *A = r I0 / [1 – (1+r) -n ]
(annuity*/r= 8%, n= 20years) = 46 495 533
• Maintenance: 600 000 I0 = 456 500 000
Discount rate (per year): r 8%
Availability charge: 47095533 Economic life (years): n 20
Annuity: A 46495533
*Also called « Levelised Cost of Energy Generation* (LEC)
Variable cost: (31 + 3.8)/MWh = 34.8/MWh
Total for 60% utilisation factor:
34.8 * 830 * 24 * 365 * 60% = 151 814 304

Total payment for the year: 198 909 837

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

32
 Case study: PPA, Combine Cycle Gas Turbine
Technology CCGT
Number of years of utilisation 20
size (MW) 830
Required capacity factor 80%
Investment cost per MW 550000
Maintenance cost (fixed cost/year) 600000
Opex per MWh 3,8
Fuel cost per MWh 31
Cost of funds 8%
Assuming one shot capital expenditure year 0
no decommissioning and no carbon cost

Cost per MWh:

198 909 837/ (830 *24*365*60%) = 45.6

Cost per MWh (@6% cost of funds):

Capital cost would only be: 39 799 750
Total payment: 192 214 054
perMWh: 192 214 054 (830 *24*365*60%) = 44.06 (-3.37%)

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

Focus on: business interruption risk

Sales
Anticipated sales

C
Avoiding bottlenecks and
Decrease in sales preparing a recovery plan
A
is most important to limit
B potential losses resulting
from business interruption

Factors affecting losses

A : breakdown rate
For details on « Contingent Business
B : Interruption period Interruption Insurance » policy:
http://www.irmi.com/Expert/Articles/2003/Torpey05.aspx
C : Recovery
Importance of fixed costs (?)
Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

33
 Business interruption (BI)
From: Allianz Business Risk Barometer; 2018

Average value of BI
claim by cause of loss

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

Business interruption

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

34
 Focus on: Political Risk
Government Risks Instability Risks

•Discriminatory regulations •Sabotage

Firm-Specific Risks
•"Creeping" expropriation •Kidnappings
•Breach of contract •Firm-specific boycotts

•Mass nationalizations •Mass labor strikes

Country-Level Risks
•Regulatory changes •Urban rioting
•Currency inconvertibility •Civil wars
Source: Robert Egge

Provides political risk insurance

and credit enhancement to
investors and lenders to facilitate
foreign direct investment in
emerging economies.
https://www.miga.org/Documents/Annual-Report-2017.pdf

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

Risk transfer through ancillary contracts

 Construction contract (EPC: Engineering Procurement & Construction)

 Operation and maintenance (O&M)
 Input supply contract (see off take)
 Permits & governments support agreements
 Insurance
 Escrow account*

*A financial instrument held by a third party on behalf of the other two parties in a transaction. The funds are held
by the escrow service until it receives the appropriate written or oral instructions or until obligations have been
fulfilled. Securities, funds and other assets can be held in escrow.

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

35
 Contracting as a risk transfer tool

Traditional contracting: « planning for the future »

A complete contract eliminates opportunistic behaviour. It stipulates each party’s

responsibilities and rights for each and every contingency that could conceivably arise
during the transaction
D. Besanko, D. Dranove, M. Shanley, Economics of Strategy, Wiley 2000, Chap.4: « contracts an market exchange »

 It may be ambitious ( « incomplete contracts », vagueness )

 It may prove to be very costly (contract litigation, delays,…)
 It may reflect unfair practices (information asymmetry)
 A cultural issue (a substitute to trust building)

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

Poor contract management: a major source of risk

Contract Life cycle
Creation of the contract
Analysis Specification choice of contractor

Analysis of needs,
Identification of
designation of tasks
Design of a clear and eligible candidates,
and duties to be
detailed proposal so negotiation to adjust
transferred,
that contractors can the final contract
identification of
make a relevant offer design to enhance
potential contractors,
value
risk analysis

Management of the contractual relation

Start up phase Execution closure

Make sure there is a

common understanding Monitoring and control of the As planned, or by
of each party’s tasks adequacy of contractor’s anticipation, verification
and responsibilities, delivery, payments, necessary that all due services have
and how they will adjustment due to been fully delivered,
manage their relation circumpstances, handling identification of potential
and execute the litigation claims
contract
7
2
Key questions: who does what? Coordination along the life cycle? …..

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

36
 Relational contracts
a necessity when facing complex situations
Formal (classical) contract: a legally binding document between at least two parties that
defines and governs the rights and duties of the parties to an agreement
Because of incompleteness, losses may arise and opportunities lost from opportunistic
behaviour and the lack of flexibility due to poor cooperation and not enough trust between
contracting parties.
relational contract: a contract whose effect is based upon a relationship of trust between the
parties to which it pertains. The explicit terms of the contract are just an outline as there are
implicit terms and understandings which determine the behaviour of the parties.

Joint Risk Management

 Better risk analysis and assessment
 Optimal allocation of risks between parties
 Enhanced preparedness and capacity to adapt to unexpected events

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

Contracting: formal versus relational….

Formal Relational
Criteria contracts contracts

Identities and personal Identities and personal

Identity of parties
attributes of parties are attributes of parties are
irrelevant crucial

Specifies a discrete Normally

Duration of the
duration indeterminate duration
relationship

Contingencies, and Norms of behaviour, or

How to deal with penalties for non- Further readings:
shared codes of
contingencies performance, are conduct • Relational Contracting – Creating Value Beyond the Project, Barbara Colledge,
specified Lean Construction Journal,Vol 2 #1 April 2005,
https://www.researchgate.net/publication/267974716_Relational_Contracting_-
_Creating_Value_Beyond_the_Project
Written documentation Written documentation
Role of written • Formal and relational contracts between organizations: proposal of a model for
overrules any verbal treated as record of
documents agreement analysis of the transactional and governance structure characteristics of
what has been agreed
comparative cases, Luciana Cardoso Siqueira Ambrozini, Dante Pinheiro
Martinelli, Revista de Administração, Volume 52, Issue 4, 2017, Pages 374-391
https://www.sciencedirect.com/science/article/pii/S0080210717301930
Law courts adjudicate Norms of behaviour, or
Dispute procedures
in the event of shared codes of • Joint risk management through transactionally efficient relational contracting,
disagreement conduct, overrule M. MOTIAR RAHMAN* and MOHAN M. KUMARASWAMY, Construction
written documents in Management and Economics (2002) 20, 45–54
settling disputes

With reference to O. Williamson,

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

37
 Project finance
•
•
3/ Project evaluation

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

Project Evaluation
Most common criteria: NPV, IRR, payback

NPV:
•measure of value creation
•NPV/Capital invested

IRR:
• what is an acceptable IRR? (WACC? Opportunity cost?)
•The issue of cash-flow reinvestment
•Ambiguous to compare exclusive projects

Payback
•Not a measure of profitability
•A reference to liquidity
•Often used as a risk indicator
Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

38
 Project evaluation: two approaches

The project’s value depends on the future expected benefits

it generates
…. which have to be estimated and then discounted

Socio-economic

Two approaches

Market reference (CAPM)

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

Project evaluation: socio-economic approach

A broader approach*
Rather than assessing effective expected cash-flows only all type of externalities
(positive and negative) are also identified and evaluated to provide a more
complete picture. The idea is to consider the impact of the project on the society
at large (economic development, environmental impact, well being, …).

A policy discounting rate**

The discount rate is not determined with reference to market conditions (CAPM),
rather a policy rate is chosen (usually much lower and declining over time) with
reference to a social time value of money.

*See: Social impact project finance: An innovative and sustainable infrastructure financing framework
Zheng Lu, Feniosky Peña-Mora, Xiaodong Robert Wang, Charles Q. Shen, Zainab, Riaz; Procedia Ingineering 123 (2015) 300-307

**See: Jincheng Ni , Discount rate in project analysis, France Strategie, March 2017,
https://www.strategie.gouv.fr/sites/strategie.gouv.fr/files/atoms/files/10_fs_discount_rate_in_project_analysis.pdf

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

39
 ESG Project’s Profile Factors

In: ESG Evaluation Sustainable Practices. Sustainable Returns, S&P Global Ratings,
https://www.spglobal.com/_assets/images/ratings/brochures/esg_evaluation_brochure_digital_oct_2020.pdf

GRI Sustainability standards: a reference

The GRI Standards represent global best practice for reporting publicly
on a range of economic, environmental and social impacts.
Sustainability reporting based on the Standards provides information
about an organization’s positive or negative contributions to sustainable
development.
See: CONSOLIDATED SET OF GRI SUSTAINABILITY REPORTING STANDARDS 2020; https://www.globalreporting.org/how-to-use-the-gri-
standards/gri-standards-english-language/
Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

Discount rate?
Future cash flows have to be depreciated because:
• They are not immediately available (Time value of money)
• They are uncertain (Risk premium)
• When generated by a sale of asset, liquidity can be an issue (liquidity premium)

Financial markets provide “indications” for these elements (relevance)?

A new trend: impact investing (or ESG*)

Impressive progression of ESG Funds
Another reason for depreciating future cash flows:
A negative social and environmental impact
*Environmental, Social & Governance

“Responsible Investors‖ may be

less demanding for ―sustainable‖
projects in line with ESG
requirements

From: https://www.businesstelegraph.co.uk/europe-leads-31tn-charge-on-sustainable-
investing/

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

40
 Discount rate?

Companies which distinguish themselves by effective efforts to improve their governance,

social & environmental impact display (apparently!) higher market performance

Frankly, I don’t know!

Concerning the
environmental impact,
the time horizon is so
long and uncertainty so But how can
high investors value
long term social
and environmental
impacts?

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

Project evaluation: socio-economic approach

La Gan Wind Farm Project
NIRAS has been awarded a multimillion USD contract to conduct an international standard Environmental and
Social Impact Assessment (ESIA) for the 3.5GW La Gan offshore wind farm in the Binh Thuan province of Vietnam.
November 16, 2020, https://www.niras.com/projects/la-gan-offshore-wind-farm-in-vietnam/

The major points of investigation are:

 Sampling of the seabed and water using traditional methods and state of the art
underwater cameras to record plants and animal life and their environment.

 Recording of seabirds, whales and dolphins numbers and their behaviours.

 Recording of intertidal and land-based plants and animals.

 Analysis of geophysical data (via images of the seabed) to investigate submerged

archaeology and cultural heritage.

 Analysis of marine traffic data and existing shipping patterns.

 Engagement with fishing communities to understand how and where they utilise the local
sea area.

 Engagement with the wider community with particular attention given to vulnerable
groups.

 3D design modelling to demonstrate what the windfarm will look like from the shore and
notable viewpoints.

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

41
 Project evaluation: socio-economic approach
La Gan Wind Farm Project
Economic impact study performed by:
https://www.vir.com.vn/la-gan-offshore-wind-farm-to-create-thousands-of-jobs-82558.html

• The economic benefits are mostly derived from utilising

the local supply chain for the development of the wind
farm (The total Vietnamese content is projected to be
approximately 45 per cent across the full supply chain of
the project )

• Creation of over 45,000 full time equivalent (FTE) jobs

in Vietnam (One FTE is defined as one full-time
equivalent job for a year)

• contribution of over $4.4 billion to the Vietnamese

economy over the project lifetime

• Increase the expertise of Vietnamese human resources

and companies which could kickstart other areas of the
supply chain in the wider offshore wind industry.
Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

Project Risk & required return: CAPM approach

Capital Employed Liabilities & Equity

b1 U1
b2 U2
b3 U3 Equity be (Can be estimated
using market data)
b eco b4 U4 (Levered b)
(average)
(Unlevered b)
b5 U5
Debt bd (assumed to be zero
b6 U6 for simplicity)

The total capital employed

can be seen as a portfolio
of projects
See Damodaran:
http://pages.stern.nyu.edu/~adamodar/
Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021 New_Home_Page/datafile/Betas.html

42
 Project Evaluation
Cost of equity (ke)?

CAPM ke = Rf + be (MRP)
Rf: Risk free rate
MRP: Market Risk Premium

be: equity b ; b eco = be for zero debt

b e = b eco [1+ (1-tx) D/E]

(assuming the debt is risk free!)

See Damodaran
http://pages.stern.nyu.edu/~adamodar/
New_Home_Page/datafile/Betas.html
Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

Estimating the discount rate for a new project

You are considering a wind farm project and you need an estimate of
the appropriate discount rate. However, this is a new project for the
company and you need to assess the risk associated with the project to
determine the appropriate discount rate. What methodology do you
suggest?

Financial information
•The target gearing for the project company is D/E = 2
•The project is rated BB with a spread of 200 bp over the Risk Free rate
•Risk free rate: Rf = 4%
•Market Risk Premium: 5%

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

43
 Estimating the discount rate for a new project
Wind Farm Project: Financial information
•The target gearing for the project company is D/E = 2
•The project is rated BB with a spread of 200 bp over the Risk Free rate
•Risk free rate: Rf = 4%
•Market Risk Premium: 5%

Methodology:
• Identify listed companies with a “comparable” activity and determine an adjusted
average “unlevered” b (noted beco)
• Based on this estimate determine the corresponding be, ke and finally the WACC

Market reference for « comparable » activities (see Damodaran)

Green & renewable energy: unlevered b : 0,67)
Project cost of equity:
be = beco (1+(1-t)D/E) = 0,67 [1+ (1- 30%) 2] = 1,608
ke = Rf + be (MRP) = 4% + 1,608 (5%) = 12,04%

WACC project = (1/3) 12,04% + (2/3) (1-30%) 6% = 6,81%

http://pages.stern.nyu.edu/~adamodar/
Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021 New_Home_Page/datafile/Betas.html

Project Evaluation:
NPV a critical view
Let’s consider the following simple case….
Investment 700
Perpetual Operating Cash-Flow 70
Equity (contribution from sponsors) 200
Perpetual debt 500
b zero debt 0,6
Rf 4%
MRP 5%
tax rate 30%
Interest rate kd 4%
NPV?

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

44
 Project Evaluation: NPV
Let’s consider the following simple case….
Investment 700
Perpetual Operating Cash-Flow 70
Equity (contribution from sponsors) 200
Perpetual debt 500
b zero debt 0,6
Rf 4%
MRP 5%
tax rate 30%
Interest rate kd 4% The true value of the
NPV?
NPV is actually
Gearing
kd
2,5
4%
lower because the
b leveraged 1,65 true proportion of
ke leveraged 12%
WACC
NPV
5,50%
573
equity is higher
Remark: this NPV calculation follows a current practice,
however it should be noted that this method is not correct
from a theoretical point of view because the proportion
of debt and equity is based on book values. !
Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

Project Evaluation: NPV

Let’s consider the following simple case….
Investment
Perpetual Operating Cash-Flow
700
70
What would be the NPV if the
Equity (contribution from sponsors) 200 estimated multiple ―Price to
Perpetual debt 500
b zero debt 0,6 Operating Cash Flow‖ is 5?
Rf 4%
MRP 5%
tax rate 30%
Interest rate kd 4%

The proportion of equity has increased

but the cost of equity has decreased, so
that in the end the WACC has only
slightly increased (5,76% instead of
5,50%).
However the NPV is 11.5% lower (514
instead of 573)

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

45
 Project Evaluation
Rationale for APV
(APV: Adjusted Present Value)
Practically WACC is not applicable because there is no easy reference for the D/E ratio.
When there is tax, debt is value enhancing because of the tax shield it generates
The idea with APV is to value the project with the cost of equity assuming zero debt and add the value
of the tax shields
(Remark: with the efficient market hypothesis, APV would be equivalent to the NPV calculated with
WACC)

APV (Adjusted Present Value)

= PV(Operating CF)@cost of equity (Zero debt)

+ PV(Debt tax shield)@cost of debt

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

Project Evaluation
Rationale for APV
APV (Adjusted Present Value)

= PV(Operating CF)@cost of equity (Zero debt)

+ PV(Debt tax shield)@cost of debt

ke zero debt 7%
Value CF @ ke (70/7%) 1000
Tax shield (4% x 500 x 0,3) 6
Value Debt tax shield @ kd (6/4%) 150
APV = -700 + 1000 + 150 450

Both methods lead to the same evaluation when NPV is calculated

rigorously, however practically APV is easier since the calculation
of WACC is tricky when the capital structure changes over time

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

46
 Exercise: APV calculation

Questions:
1. Determine the free cash flows
2. Determine the debt tax shields and their value
3. Determine the value of the loan subsidy
4. Calculate the APV

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

Exercise: APV calculation

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

47
 Exercise: APV calculation

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

Exercise: APV calculation

APV =
NPV cfc@ke zero debt:
+ Value of tax shield :
+ Value of loan subsidy :
----------------------------------------------------
= =

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

48
 Exercise: APV calculation

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

Exercise: APV calculation

APV =
NPV cfc@ke zero debt: 8364
+ Value of tax shield : 1881
+ Value of loan subsidy : 1497
------------------------------------------------
Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021 = 11742

49
 With reference to the data hereunder, determine the APV of the project
Sales 500
Sales growth 5%
Terminal value 0
EBITDA as a % of sales 35%
Workintg Capital Needs 20 days of sales
Capital expenditures 600 600
Depreciation (straight line) 10 years (project end)
Tax rate 30%
Risk free rate Rf 3%
Market Risk Premium 5%
b zero debt 0,60
Ke unlevered 6%
Kd 4%
Debt/Capital expenditures 70%

Debt will be repaid in full “in fine”

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

Years 0 1 2 3 4 5 6 7 8 9 10 11
Sales
EBITDA
Depreciation
EBIT
taxes
NOPAT
Depreciation
change in WC
Operating Cash Flow
Capital Expenditures
Free Cash Flow

PV FCF @ Ke unlevered

Tax shield

PV Tax shield @ Kd

APV

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

50
 Years 0 1 2 3 4 5 6 7 8 9 10 11
Sales 500 525 551 579 608 638 670 704 739 776
EBITDA 175 184 193 203 213 223 235 246 259 271
Depreciation 120 120 120 120 120 120 120 120 120 120
EBIT 55 64 73 83 93 103 115 126 139 151
taxes 17 19 22 25 28 31 34 38 42 45
NOPAT 39 45 51 58 65 72 80 88 97 106
Depreciation 120 120 120 120 120 120 120 120 120 120
change in WC 27,8 1,4 1,5 1,5 1,6 1,7 1,8 1,9 2,0 2,1
Operating Cash Flow 131 163 170 176 183 191 198 207 215 224
Capital Expenditures 600 600 0 0 0 0 0 0 0 0 0 0
Free Cash Flow -600 -600 131 163 170 176 183 191 198 207 215 224

PV FCF @ Ke unlevered -600 -566 116 137 134 132 129 127 124 122 120 118

Tax shield 10,08 10,08 10,08 10,08 10,08 10,08 10,08 10,08 10,08 10,08

PV Tax shield @ Kd 9,3 9,0 8,6 8,3 8,0 7,7 7,4 7,1 6,8 6,5

APV 173

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

Project Evaluation
Extension of APV
Identify all cash-flow components that may be valued independantly

APV (Adjusted Present Value)

= PV(Operating CF)@cost of equity (Zero debt)

+ PV(Debt tax shield)@cost of debt

+ PV (depreciation tax shield)@cost of debt

+/- PV(specific components* of CF)@appropriate rate

* example: valuation of emission rights for projects eligible for the Clean
Development Mechanism (CDM)

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

51
 Project Evaluation
valuing flexibility (real options)
The NPV approach does not take into account the possibility to adapt the
project when new information are revealed

Expanded Net Present Value =

Static NPV + Value of embedded options

Types of embedded options:

•Option to wait
•Option to grow
•Option to exit
•…..
with reference to the energy sector, an illustration of the use of real option can be found in:
Locatelli, G orcid.org/0000-0001-9986-2249, Mancini, M and Lotti, G (2020) A simple-to-implement
real options method for the energy sector. Energy, 197. 117226. ISSN 0360-5442
https://doi.org/10.1016/j.energy.2020.117226

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

PROJECT FINANCE

Valuing off-shore projects

Three issues to dicuss:

•The cost of funds with multiple currencies
•Cash flow denominated in a currency different from
investor’s home currency
•Integrating the country risk

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

52
 Project Evaluation
The case of offshore projects

First question: how to determine the cost of capital if funds are

raised in a foreign currency ?

We have:
1 + r real = (1+ r nominal) / (1 + h)

h: anticipated inflation

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

Project Evaluation
The case of offshore projects
A European invests in Vietnam and decide to borrow local funds at rvnd = 13%
what is the equivalent rate express in € terms? (assuming anticipated inflation in
Vietnam is 10% and 2,5% only in the Eurozone)

Real interest rate in Vietnam Inflation in Europe

1+ r€ = [(1 + 13%)/ (1 + 10%)] (1 + 2,5%) = 1 + 5,3%

Borrowing at 13% in Vietnam is equivalent to 5.3% in Europe

Remark: if you borrow in VND it is apparently less attractive…but the value of your
debt may decrease if the dong is depreciated. That is expected as inflation is higher in
Vietnam (ppp theory)

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

53
 Determine the average cost of borrowing

Taking US $ as the home currency

US 3%

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

Project Evaluation
The case of offshore projects
Dealing with the foreign exchange risk and inflation
If you can hedge your foreign exchange risk exposure, then you can take the
investment decision without considering future exchange rate mouvements.
•Either you predict future cash-flows using the currency of the country where
the project is developed and then discount with reference to the cost of capital
in this country
•Either you take the forward exchange rates to predict future cash-flows in
your home currency and then discount with reference to the cost of capital in
your home country.

When investing in a foreign country, the decision to invest should (normally) be

separated from the decision to hedge the foreign exchange risk. A good investment
should not be affected by the fear of a currency depreciation, nor should you count
on a currency appreciation to justify a bad investment

For long term projects, however, hedging may be impossible!

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

54
 Project Evaluation
Dealing with the foreign exchange risk and inflation
when hedging is not possible
(the best guess with reference to ppp* theory)
As a European investor, for instance, you are exposed to a foreign exchange risk if
you invest outside of the Eurozone. In particular, the project cash-flow will have a
lower value if the foreign currency is depreciated (sensitivity analysis will help
assessing the importance of the risk exposure)
However, if ppp theory is assumed to be true (in the long run), you can analyse the
project on the basis of free cash flows expressed in your home currency (€) using
the current exchange rate:
a depreciation of the foreign currency would result from higher inflation in the
foreign country, meaning also higher cash-flows. If ppp theory applies, there is an
exact compensation.
Remark: if you consider ppp theory is not relevant, then you need to imagine
different scenarios reflecting how exchange rates and inflation may affect the
project cash-flows (it may well be the case for most energy projects)
*ppp: Purchasing Power Parity
Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

Project Evaluation
The case of offshore projects
Determining the equity risk premium?

Global perspective:
CAPM with reference to a global market index (such as MSCI)
Multi-country portfolio
( see Brealey & Myers, p234)
approach
(theoretical relevance)
International perspective
CAPM with reference to home market index
(combining project b and target country b )
(lessard 1996)
Single project
CAPM + consideration of country risk
approach
(Godfrey & Espinosa, 1996; Damodaran, 1999)
(managerial relevance)
Remark
The single project normally results in higher rates due to higher risk premium since
diversification effect is not fully integrated
Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

55
 Project Evaluation
The case of offshore projects
A proposal…among many others, to estimate the cost of equity:
CAPM with consideration of country risk*

k = Rf, home + country spread+ adjusted b (MRPhome)

•Project b
•Local market b / home market
Ajusted b ? •Correction factor (0,6) because country credit
spreads explain part of local market volatility
(about 40%)

Illustration: Rf €: 4% ; Country spread 2% (200bp), MRP = 5%

Project b : 1,2 , Local Market b : 0,4
ke = 4% + 2% + 1,2x0,4x0,6 (5%) = 8,88%

See Damodaranhttp: //pages.stern.nyu.edu/~adamodar/New_Home_Page/datafile/ctryprem.html

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

An Illustration
CFAO Case

Risky ventures…..

http://www.cfaogroup.com/static/2016/06/17/CFAO_2016_Profile-UK.pdf?wx_mCJ-
GMN0h5d5uCd-ibQ:wx_mCJ-GMN0h5d5uCd-ibQ:Jn6HNVHRVxMGpbUHgQTCtw

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

56
 COFACE Risk assessment for countries where CFAO operates

Rate: A1 A2 A3 A4 B C D E
Risk level: very low low quite acceptable significant high very high extreme
acceptable
1 2 3 4 5 6 7 8
Country risk assessment assesses the average risk of payment defaults by companies in a given country. This evaluation
combines economic and political prospects of the country, Coface payment experience and business climate
CFAO Group country risk Business
60.00%
African Operations rating climate
Algeria C B 6 7
50.00%
Angola D D 7 7
Benin B C 5 6
40.00%
Burkina Faso C C 6 6
Cameroon C C 6 6 country risk rating
30.00%
Congo C D 6 7
Ivory Cost B C 5 6 Business climate
20.00%
Gabon C C 6 6
Ghana C B 6 5
10.00%
Guinea D D 7 7
Mauritius A3 A3 3 3
0.00%
Malawi D D 7 7
A1 A2 A3 A4 B C D E
Mali D D 7 7
Morocco A4 A4 4 4
Mauritania C D 6 7
Niger
Nigeria
C
D
D
D
6
7
7
7 Each country,
Uganda C D 6 7
Central African Republic
Democratic Republic of Congo
E
D
D
D
8
7
7
7
individually, is risky
Sao Tome and Principe C D 6 7
Senegal B B 5 5
Sierra Leone D C 7 6
Tanzania
Chad
C
D
C
D
6
7
6
7
But one should adopt a
Simple average: 6,08 6,28
Rating not available for:
Gambia, Guinea-Bissau, Equatorial-Guinea
<C;D> <C;D> portfolio approach!
Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

Diversification at work
Average growth double that of African GDP over the last 15 years ….
Operating performance has decreased slightly but the volatility is low
Sales have decreased in
2009 as a consequence of the
financial global crisis…
a SYSTEMATIC risk

Revenue in € millions Operating Margin

In the end
http://www.cfaogroup.com/static/2016/06/17/CFAO_2016_Profile-UK.pdf?wx_mCJ-GMN0h5d5uCd-ibQ:wx_mCJ-
GMN0h5d5uCd-ibQ:Jn6HNVHRVxMGpbUHgQTCtw
it looks safe!
Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

57
 Country Analysis:
assessing opportunities and risk

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

Economic Performance: driving factors

• Confidence • Cost of funds
• Demography • Anticipations • Global economic
• Income : level & repartition • FDI situation
• Access to credit • International openness
• Budget policy

C + I + G + ( X - M )
Sustained Demand
+
Competitive Supply
Cost Innovation Access to Public action
finance
• Institutional stability
• Inflation, foreign • R&D • Relevancy & efficiency of public
exchange • Technology • Efficiency and depth policies
• Productivity/wages transfers of the financial • Infrastructures
• Taxation • Ease to do market • Education, health
• Efficiency of markets business • Local saving • Rule of law
• Flexibility • Country rating
Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

58
Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

Country Risk Analysis: list of relevant indicators

118
Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

59
 From risk analysis to risk rating
Risk assessment Risk profile
I
4
3
VI 2 II
1
0 Beware! Nice but:
V III
• Quality of sources?
• Subjectivity?
IV
• Additivity?
X
X • Weights?
X
X
I • Do you need numbers at all?
II
Risk Rating
III
Rate = Weighted average
IV

V (3+4+3,5+2,5+4+3)/6 = 3,33

VI
119
Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

Country Report: VIETNAM

Last reviewed: 2017-12-01

http://www.eulerhermes.com/economic-
research/blog/EconomicPublications/CR-Vietnam-Dec17.pdf

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

60
 Country Risk Analysis: VIETNAM (Oct. 2019)

Euler Hermes, country report:

https://www.eulerhermes.com/en_global/economic-
research/country-reports/Vietnam.html

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

Project finance
•
•
•
4/ Project financing

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

61
 Project Financing

Capital Employed

Uncertainty
resolution

Completion start up development

Risk
exposure
Mezzanine
Financing
+
Contingent facilities No recourse
debt
Equity

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

Project Financing
Role of banks ?
Provide funds and various services:
• financial engineering (issuing, structuring, hedging,…)
• tax optimisation
• Risk analysis and cash-flow prediction (models, simulations,…)
• Relationship with international organisations and local authorities

•Reputation
Level I
ARRANGERS & BOOK RUNNERS •Experience in project finance
(mandeted lead arrangers, Lead bond bookrunners •Experience in the field (sector/country)
Financial advisers, legal advisers..) • Provision of funds (mainly for the first phase)

Pool of providers Phase 1 & refinancing (no recourse debt)

Level II

Level III

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

62
 Project Financing

Thomson Reuters
http://www.pfie.com/Journals/2018/04/25/e/v/u/
Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021 PFI-Financial-League-Tables-Q1-2018.pdf

Project Financing

Thomson Reuters
http://www.pfie.com/Journals/2018/04/25/e/v/u/
Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021 PFI-Financial-League-Tables-Q1-2018.pdf

63
Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

PRESS RELEASE
C-Power Financing Close
EUR 1,289 M investment financing for the construction and operation of a 325 MW offshore wind farm
(Antwerp – 25 November 2010, https://green-giraffe.eu/article/c-power-reaches-financial-close-press-release)

C-Power is pleased to announce that it has closed the financing of the second and third phases
of the offshore wind farm on the Thornton Bank (located about 30 km in the North Sea off the
Belgian coast). A group of 7 commercial lenders: KBC, Rabobank, Société Générale, KfW
Ipex-Bank, Commerzbank, Dexia and ASN Bank together with export credit agencies Euler-
Hermes of Germany and EKF of Denmark, and the European Investment Bank will provide
between them long term facilities totaling EUR 869 M.

This financing will enable the construction of the second and third phases of the 325 MW
offshore wind farm between 2011 and 2013, for a total investment cost (excluding
contingencies) of EUR 1,289 M, which includes the refinancing of the already operational
30 MW pilot phase which consists of 6 REpower 5M offshore wind turbines. …….

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

64
 PRESS RELEASE
C-Power Financing Close
EUR 1,289 M investment financing for the construction and operation of a 325 MW offshore wind farm
(Antwerp – 25 November 2010, https://green-giraffe.eu/article/c-power-reaches-financial-close-press-release)

The transaction is a non-recourse financing, with banks bearing risk with limited
sponsor support during the construction phase. Despite the use of the largest offshore
wind turbines available on the market, the financing deal was made possible by a strong
contractual package with the contractors, REpower (supply and operating of
the wind turbines), THV Seawind [DEME-Fabricom joint venture] (supply and installation
of the foundations, cable laying and installation of the offshore transformer station and
wind turbine installation logistics) and ABB (supply of the 33kV infields cables and the
second 150kV sea cable as well as the offshore transformer station), taking advantage of
their joint experience during the first phase construction. This firm contractual base
established with experienced contractors is supplemented by a solid contingency
package controlled by the lenders to cover potential cost overruns or delays, cash
sweep mechanisms which protect lenders from downside scenarios and specially
tailored availability guarantees under the operating contract with REpower which
allow revenues and debt service to be protected even during periods of lower turbine
operational availability. The project also benefits from a comprehensive insurance
program brokered by Willis. With the participation of 3 public institutions (the two export
credit agencies and the EIB) and 7 commercial banks, the transaction is one of the most
complex ever done in the wind sector.
Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

PRESS RELEASE
C-Power Financing Close
EUR 1,289 M investment financing for the construction and operation of a 325 MW offshore wind farm
(Antwerp – 25 November 2010, https://green-giraffe.eu/article/c-power-reaches-financial-close-press-release)

C-Power the company set up to develop the offshore wind farm in the concession area on
the Thornton Bank is owned by a group of 4 reputable Belgian shareholders: SRIW
Environnement, Socofe, Nuhma, DEME, and two European strategic partners EDF-EN
and RWE Innogy. C-Power completed its pilot phase project in June 2009,
with 6 REpower 5MW turbines having now produced over 155 GWh and achieving last
year an availability rate of about 97%. The project was the first ever to erect large scale
5MW wind turbines offshore on a commercial basis.
C-Power is advised by Energy Bankers in Paris (financing) and Allen & Overy (legal). The
lenders were advised by Mott MacDonald (technical), Watson Farley & Williams and
Loyens Loeff (legal), Jardine Lloyd Thomson (insurance), with Kromann Reumert advising
EKF and White & Case advising the EIB on legal matters, and Ernst & Young/AHB acting
as Independent Chartered Auditor for the Federal Republic of Germany.
This financial close is a demonstration of the trust that shareholders, contracting parties
and the finance community are giving on a well structured project setting a good
reference for the many more offshore wind farms to be financed in the near future‖,
comments Filip Martens, CEO of C-Power. ―This was the achievement of a strongly
motivated team which, in order to bring together 23 contractual parties including 10
financial institutions, designed a contractual framework of more than 20,500 pages.‖

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

65
 capital structure of the project company

•Transfer of ownership
Leasing •Mainly driven by tax optimisation
•Capital or operating lease (off balance sheet)

Senior debt
Secured

(first lien) •Secured by assets or cash-flows with a first priority

• Covenants (loan and management)

•Secured by an agreed portion of Cash-flow or property

Tranche B loans •Maturity ususally not shorter than senior debt
(second lien lending) •Typically with mandatory prepayment from excess cash
Unsecured

•Unsecured or deeply subordinated (third lien on property)

•Maturity: depends on the project
Mezzanine •Typically with principal repayment at maturity
(quasi Equity) •« Equity kicker » (convertible bond, warrant, option,…)
•May include preferred stocks (cumulative, convertible,
participating or redeemable)
Equity

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

A focus on “bullet loans”

Characteristics: a loan for which the payment of the

entire principal, and sometimes the principal and interest, is due at
maturity
Amount of the loan: 100 000
Maturity: 5 years
Coupon rate: 6%
Bullet payment (end of year 5): Capital + accrued interest*

100 000 (principal) + 33823 (accrued interest)

No payment, but included as a “ financial cost” in the income statement

*accrued interest refers to the amount of interest that has been incurred, as of a specific date, on a loan
or other financial obligation but has not yet been paid out

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

66
 A focus on “bullet loans”
Combination of an ―amortizing‖ loan with a ―bullet‖ loan is possible
Example:
Loan amount: 100 000
Maturity: 5 years
Interest rate: 6%
Grace period: 2 years (no capital repayments no interest)
From year 3 to 5
Partial amortization 20 000/year (60% of total amount)
Interest : 6% of due capital, payment of accrued interest at maturity
Bullet payment (end of yearv5): 40 000 + accrued interest
* Or ‖balloon payment‖

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

A focus on “bullet loans”

Combination of an ―amortizing‖ loan with a ―bullet‖ loan is possible
Loan amount: 100 000
Maturity: 5 years
Interest rate: 6%
Grace period: 2 years (no capital repayments no interest)
From year 3 to 5
Partial amortization 20 000/year (60% of total amount)
Interest : 6% of due capital, payment of accrued interest at maturity
Bullet payment (end of yearv5): 40 000 + accrued interest

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

67
 Mezzanine finance
Introduction
Mezzanine finance is unsecured debt (or preference shares) offering a high return with a high risk.
This type of debt generally offers interest rates two to five percentage points more than that on senior debt and frequently gives the lenders some right to a share in equity
values should the firm perform well.
Mezzanine finance tends to be used when bank borrowing limits are reached and the firm cannot or will not issue more equity. The finance it provides is cheaper (in terms
of required return) than would be available on the equity market and it allows the owners of a business to raise large sums of money without sacrificing control. It is a
form of finance which permits the firm to move beyond what is normally considered acceptable debt/equity ratios (gearing or leverage levels).
Preference Shares
Preference shares usually offer their owners a fixed rate of dividend each year. However if the firm has insufficient profits the amount paid would be reduced, sometimes
to zero.
The dividend on preference shares is paid before anything is paid out to ordinary shareholders.
Preference shares are attractive to some investors because they offer a regular income at a higher rate of return than that available on fixed interest stocks (bonds).
Preference shares are part of shareholders’ funds but are not equity share capital. The holders are not usually able to benefit from any extraordinary good performance of
the firm – any profits above expectations go to the ordinary shareholders. Also preference shares usually carry no voting rights, except if the dividend is in arrears or in
the case of liquidation.
Advantages to the Firm of Preference Share Capital
a) Dividend “optional”
There is no legal obligation to pay preference dividends every year which gives the company more flexibility and greater chance of surviving a downturn in trading.
b) Influences over management
Preference shares are an additional source of capital, which, because they do not (usually) confer voting rights, do not dilute the influence of the ordinary shareholders on
the firm’s direction.
c) Extraordinary profits
The limits placed on the return to preference shareholders means that the ordinary shareholders receive all the extraordinary profits when the firm is doing well.
d) Financial gearing consideration
There are limits to safe levels of borrowing. Preference shares are an attractive, if less effective, shock absorbers to ordinary shares because of the possibility of avoiding
the annual cash outflow due to dividends. In some circumstances a firm may be prevented from raising finance by borrowing as this increases the risk of financial distress
and the shareholders may be unwilling to provide more equity risk capital. If this firm is determined to grow by raising external finance, preference shares are one option.
Disadvantages to the firm of preference share capital
a) High cost of capital
The higher risk attached to the annual returns and capital cause preference shareholders to demand a higher level of return than debt holders.
b) Dividends are not tax deductible
Because preference shares are regarded as part of shareholders’ funds the dividend is regarded as an appropriation of profits. Tax is payable on the firm’s profit before the
deduction of the preference dividend. In contrast, lenders are not regarded as having any ownership rights and interest has to be paid whether or not a profit is made. This
cost is regarded as a legitimate expense reducing taxable profit.

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

Types of Preference Shares

a) Cumulative
If dividends are missed in any year the right to eventually receive a dividend is carried forward. The prior-
year dividends have to be paid before any payout to ordinary shareholders.
b) Participating
As well as the fixed payment, the dividend may be increased if the company has high profits.
c) Redeemable
These have a finite life, at the end of which the initial capital investment will be repaid. Irredeemable
preference shares have no fixed redemption dates.
d) Convertibles
These can be converted into ordinary shares at specific dates and on pre-set terms (for example, one
ordinary share for every two preference shares). These shares often carry a lower yield since there is the
attraction of a potentially large capital gain.
Some Unusual Types of Shares
In addition to ordinary and preference shares there are other, more unusual, types of shares:
Non-voting shares
These are sometimes issued by firms (especially family-controlled) which need additional equity finance
but wish to avoid the diluting effects of an ordinary share issue. They are often called ―A‖ shares and
usually get the same dividends, and the same share of assets in a liquidation as the ordinary shares.
Preferred ordinary shares rank higher than deferred ordinary shares for an agreed rate of
dividend.
So, in a poor year the preferred ordinary holders might get their payment while deferred ordinary holders
receive nothing. However in an exceptionally good year the preferred ordinary holders may only receive
the minimum required while the deferred ordinary holders are entitled to all profits after a certain
percentage has been paid to all other classes of shares.
Golden shares
These are shares with extraordinary special powers, for example the right to block a take-over. Golden
shares are also useful if a company wishes to preserve certain characteristics it
Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

68
 Project funding prospects:
Economic uncertainty and geopolitical tension, complexity
and heterogeneity of project finance instruments are
obstacles …. But new solutions emerge
High level of debt ratios in the world and growing uncertainty
will make it more difficult to fund infrastructure risky projects

The reliance on bank lending subject projects to refinancing risks,

hence a need to develop market instruments

infrastructure assets as a new asset class through standardisation

The result is the simplification of refinancing or securitisation,

See:
- ASIAN INFRASTRUCTURE FINANCE 2019; AIIB, https://www.eiu.com/graphics/marketing/pdf/Asian-Infrastructure-Finance-
2019.pdf
- Infrastructure Asia, Standardising of Project Finance Loan Documentation
, https://www.infrastructureasia.org/en/insights/standardising-of-project-finance-loan-documentation

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

Green Bonds
The various types of bonds or loan have their green equivalent. The difference
concerns essentially the ―use of proceeds‖:
« The Proceeds from these bonds are earmarked for green projects but are backed
by the issuer's entire balance sheet »*

An impressive progression

*in: Climate Bond Initiative; https://www.climatebonds.net/market/explaining-green-bonds

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

69
 Mapping of project categories to environmental objectives

Green Project Mapping

(June 2019)
ICMA
(International Capital Market Association)

https://www.icmagroup.org/assets/documen
ts/Regulatory/Green-Bonds/June-
2019/Green-Projects-Mapping-Document-
100619.pdf

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

Green Bonds:
standard bonds with a bonus "green" feature*
*See: Climate Bond Initiative; https://www.climatebonds.net/market/explaining-green-bonds

In: Borrowers tap hot ESG demand to sell green bonds at a premium, FT April 9 2021
https://www.ft.com/content/4ee8a964-7f85-4f80-90bf-38780d5ba8e7

A sustained demand for these bonds while

funding needs progress at a lower rate….
Isn’t it a recipe for a bubble?

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

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 Determining the cost of funds

Equity:
Required rate of return

Hybride and debt instruments:

•Arrangement fees
•Cash interest
•Payment in kind (accrued interests)
•Embedded options
•Implicit cost of covenants

Typical covenants
•Loan covenants ( limits for new loans, reference to selected debt ratios)
•Management covenants (investment policy, Dividend policy,board
representation, adherence to the business plan, remedies in case of
distress,…)

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

Project Finance: capital vs operating lease

Should be treated as a capital lease* (similar to a debt)

1. If the lease life exceeds 75% of the life of the asset

2. If there is a transfer of ownership to the lessee at the end of the lease
term
3. If there is an option to purchase the asset at a « bargain price » at the
end of the lease term
4. If the present value of the lease payments, discounted at an appropriate
discount rate, exceeds 90% of the fair market value of the asset
*Conditions stipulated by the Financial Accounting Standard Board

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

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 Growing importance of “impact investing”
New Financing Tools
Guarantees
Guarantees are used to enhance credit. Only creditworthy projects can secure
financings. Sometimes one or more narrow risks are scaring away private
investors. Guarantors are usually third parties who contribute to impact
investments by partnering with public institutions to offer a loan guarantee (often
in the form of a grant) to reduce particular risks and potential losses
Catalytic first-loss capital
Catalytic first-loss capital — called CFLC for short — refers to an investor, or
grant-maker, agreeing to bear the first losses for an impact investment in order to
catalyze participation by other investors.

SIBs
The United Nations Development Programme defines social impact bonds as a
form of public-private partnership where one or more investors provide upfront
capital for the realization of public projects that generate verifiable social or
environmental outcomes.
See: New tools to overcome barriers to financing impact projects, Norton Rose Fulbright, project finance ;
https://www.projectfinance.law/publications/new-tools-to-overcome-barriers-to-financing-impact-projects

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

Growing importance of “impact investing”

New Financing Tools

Two leading CSR indexes:

• FTSE4Good (London)
• Dow Jones Sustainability World Index (New York).

See: New tools to overcome barriers to financing impact projects, Norton Rose Fulbright, project finance ;
https://www.projectfinance.law/publications/new-tools-to-overcome-barriers-to-financing-impact-projects

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

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 Project Financing: Debt Cover Ratios
ADCR: Annual Debt Cover Ratio
LLCR: Loan Life Cover Ratio
CFADS 400 450 500 500 500 500
Outstanding debt 1000 800 600 400 200 0
Debt repayment 200 200 200 200 200 0
Interest payment 60 48 36 24 12 0
Debt service 260 248 236 224 212 0
ADCR 1,54 1,81 2,12 2,23 2,36
LLCR 1,97 2,11 2,23 2,29 2,36
ADCR: CFADS/ Debt service
LLCR: Present Value @ cost of debt of anticipated CFADS until the end of the
loan period / Outstanding debt
Years 1 2 3 4 5
CFADS 400 450 500 500 500
Disc. CFADS (6% ) 377 400 420 396 374
Total PV (a) 1967
Outstanding debt (b) 1000
LLCR (a/b) 1,97

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

Project Financing: Debt Cover Ratios

ADCR: Annual Debt Cover Ratio
LLCR: Loan Life Cover Ratio

ADCR: CFADS/ Debt service

LLCR: Present Value @ cost of debt of anticipated CFADS until the end of the
loan period / Outstanding debt

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

73
 Project Financing: Debt Cover Ratios

Prob(FCF<DS)<1%

What is the maximum loan annuity payment that the bank can accept?

(1000/534)

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

Based on information provided, and your own assumptions, you are requested to:
1. Build a forecast of‖ Cash Flows Available for Debt Service‖ generated by this
project
2. Based on your estimates, provide the series of income statements and balance
sheet for the period analysed
3. Evaluate the project using the ―Adjusted Present Value‖ method
4. Determine the‖ Annual Debt Cover Ratio‖ and the‖ Loan Life Cover Ratio‖
(considering the No Recourse loan debt only)

Remark
Since it is necessary to make some assumptions to treat the above question you have
to provide a justification for the choices you have made
Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

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Technical details

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

Sales & operations

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

75
 Financing

No dividend paid as long as the cash available in the balance sheet has not
reached a level equivalent to 1.5 year of debt service. - Once the necessary
cash buffer is accumulated, it should be maintained at this minimum, under
this condition 100% of profits can be distributed as dividends

Loans
Tranche 1
• Amount as a % of total investment expenditures: 75%
• Bullet loan available from year 0, to be repaid in full, including accrued interest, end of completion phase (see:
scheduling graph)
• Rated BBB3 with a spread of 200 basis points above the risk free rate
3thanks to a credit enhancement due to a guarantee provided for free by an international organisation aiming at reducing

CO2 emissions. Without this guarantee the market risk premium would apply (450bps)

Tranche 2
• Substitute for tranche 1, amount covering the capital repayment and accrued interest of tranche 1
• No recourse debt with a coupon rate of 3% and a 20 years maturity
• Loan repayment: constant annuity including capital repayment and interest
Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

Assumptions:
• 20 year of operations, starting year 2
1/ Project Cash Flows and Valuation • Selling priced maintained at 49 all along the operating period
• Inflation: 2%/year impacting operating expenses only

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

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 2/ Financing

Equity & tranche 1

tranche 2, no recourse debt, maturity 20 years, coupon rate 3%

*A = r I0 / [1 – (1+r) -n ]

Annuity*: 26 614 898

LLCR (as of end of year 2): 2.17

ADCR (CAFDS/outstanding debt): around 1,6
slightly declining
Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

3/ Income statement

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

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 4/ Balance sheet

Prof Patrick GOUGEON/ ESCP Europe/ Project Finance June 2021

Reading list
European PPP Expertise Centre (EPEC), PPP guide, EBI, 2015, http://www.eib.org/epec/g2g/index.htm

ASIAN INFRASTRUCTURE FINANCE 2020, Asian Infrastructure Investment Bank,

https://www.aiib.org/en/news-events/asian-infrastructure-finance/2020/introduction/index.html

Project finance in Vietnam: overview, David Harrison, Partner Vietnam,

https://content.next.westlaw.com/4-635-
6445?__lrTS=20201030130727634&transitionType=Default&contextData=(sc.Default)&firstPage=tr
ue

VIETNAM CAPITAL MARKET AND PROJECT FINANCE: Its Structure and Future Dr. Le
Net, LNT & Partners, https://vietnamlawinsight.files.wordpress.com/2016/08/vietnam-capital-market-
and-project-finance.pdf

New tools to overcome barriers to financing impact projects, June 05, 2018 | By Clare Karabarinde,
Princess Fuller, https://www.projectfinance.law/publications/new-tools-to-overcome-barriers-to-
financing-impact-projects

Standardising 50% of Project Finance Loan Documentation, Infrastructure Asia, 2020,

https://www.infrastructureasia.org/en/Insights/Standardising-of-Project-Finance-Loan-Documentation

Investment Guarantee Guide, MULTILATERAL INVESTMENT GUARANTEE AGENCY WORLD

BANK GROUP (MIGA),
https://www.miga.org/sites/default/files/archive/Documents/IGG_English_final.pdf

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