Topic 5 Flashcards
Project Finance AKA off-balance-sheet financing
In contrast to balance sheet finance, project finance is where the assets can be carved out into a separate entity and financed on their own merits. Advantages of project finance are not only to align the cost of capital with the project or asset type, but also to allow a larger investment pool that many investors can participate in. Some of the largest projects in the world are far beyond the ability of a single company to provide, and a collection of banks, investment firms, and corporations can get together in a project financing to complete the required investment.
Construction Finance
Obtaining the capital resources to finance the costs of construction
Sponsor?
In project finance, the equity in the project is usually held by the sponsor organization. The sponsor is often the organization that puts up the initial risk capital or is the developer of the asset, but may also be the vendor that sells the equipment or some other stakeholder who controls the completion of the project. Sometimes, the sponsor contributes a substantial portion of their equity in the form of upfront risk and “sweat equity”, but may also have to provide some additional cash equity to facilitate the completion of the deal.
Equity
There are many levels of equity with preferred equity or convertible equity (which may have payout characteristics similar to debt unless and until it is converted into equity at some Conversion price) available to fund certain kinds of transactions. Equity with a higher preference or more protection should be willing to receive a lower return on capital, with common equity having the highest expected return based on taking the biggest share of the risk.
Debt
Project finance companies typically provide the debt portion of any project financing. Debt financing is typically the most senior portion of the financing structure (“senior financing”), which means that it has the first claim on the cash flows and assets of a project in order to be repaid. Typically, junior financing (other forms of debt and equity), will only get paid out once the senior financing has been satisfied.
IRR?(internal rate of return)
IRR of an investment is the discount rate at which the net present value of costs (negative cash flows) of the investment equals the net present value of the benefits (positive cash flows) of the investment. (Wikipedia)
WACC?( Weighted Average Cost of Capital)
For costs incurred in one period but that need to be spread to many using an appropriate discount rate. This discount rate is usually measured as Weighted Average Cost of Capital (WACC), or the weighted average of debt and equity that an asset owner uses to fund their investment.
EPC?
Engineering, procurement and construction. Under an EPC contract, the contractor designs the installation, procures the necessary materials and builds the project, either directly or by of the work. In some cases, the contractor carries the project risk for schedule as well as budget in return for a fixed price, called lump sum LSTK depending on the agreed scope of work. An owner decides for an EPC contract for reasons that include:[citation needed]
PPA – Power Purchase Agreement
A PPA is the principal agreement that defines the revenue and credit quality of a generating project and is thus a key instrument of project finance. (Wikipedia)
REC – Renewable Energy Certificate
A REC represents the property rights to the environmental, social, and other nonpower qualities of renewable electricity generation. A REC, and its associated attributes and benefits, can be sold separately from the underlying physical electricity associated with a renewable-based generation source. (EPA)
Off-Taker
Customers of offtake contracts the form of which might include
Merchant Power
A merchant power plant is a generator that sells much or all of its output directly into the spot electricity market. (Financing Merchant Power Plants In The United States, Kriebel)
Warranties
Warranties are provided by component suppliers to mitigate risks in a project.
Security
Project finance requires the pledge of a comprehensive collateral security package to the lenders in exchange for the making of loans. The collateral security package, in the absence of recourse to the Sponsor, serves as the basis for the lenders’ securing repayment in the case of default. Specifically, all assets of the Project Company owned at the time of the loan closing, in addition to those acquired post-closing, will be pledged to the lenders until the loans are fully repaid.
Coverage Ratio
-Debt Service Coverage ratio: The debt service coverage ratio was determination of how much the cash was the project can cover of the periodic (monthly or annual) debt service payments necessary to the lenders. Lenders will want to see the debt service covered with a meaningful margin in order to feel safe that the project will remain solvent and viable– a ratio of substantially more than1.0x.
PTC – Production Tax Credit
A production tax credit (“PTC”) is available for the production and sale of electricity from certain renewable sources. Renewable sources of energy that qualify for the PTC include wind, biomass, geothermal, municipal solid waste (either landfill gas or trash), hydropower (in the case of newly installed turbines), and marine and hydrokinetic energy. To qualify for the PTC, electricity from these sources must be produced at a facility that is “placed in service” before (i) January 1, 2013 for a wind facility and (ii) January 1, 2014 for other qualifying facilities. The facility must be located in the United States.
ITC – Investment Tax Credit Accelerated Depreciation
Many renewable energy projects can qualify for the investment tax credit (“ITC”), which is based on the cost of the qualifying property (unlike the PTC, which is based on the amount of electricity generated and sold to an unrelated party). The ITC is equal to the product of the “energy percentage” and the taxpayer’s tax basis in its “energy property” that is “placed in service” during the taxable year. “Energy property” includes, among other things, equipment that uses solar energy to generate electricity, to heat or cool (or provide hot water for use in) a structure, or to provide solar process heat. Certain fuel cell power plants that are placed in service before January 1, 2017, also qualify for the ITC.
Project Finance Waterfall
Project revenues received->
Risk-adjusted Cost
Need to know the discount rate to reflect different levels of risk. Higher discount rate = more risky. Affects overnight cost, fixed O&M costs (anything that is amortized) LCOE calculations.
Nominal Interest Rate
The nominal interest rate (also known as an Annualised Percentage Rate or APR) is the periodic interest rate multiplied by the number of periods per year. For example, a nominal annual interest rate of 12% based on monthly compounding means a 1% interest rate per month (compounded). (Wikipedia)
Real Interest Rate
An interest rate that has been adjusted to remove the effects of inflation to reflect the real cost of funds to the borrower, and the real yield to the lender. The real interest rate of an investment is calculated as the amount by which the nominal interest rate is higher than the inflation rate. (Investopedia)
