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Investment Financing
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1
INVESTMENT FINANCING
CONCEPT
TO
CLOSURE
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Economic Environment
Impact of Foreign trade agreements and related EXIM policies
Regulation of foreign direct investment both Inward & Outward and limited capital account convertibility
Financial sector reforms
Tax regime – Direct & Indirect
Government finances
GAAP – Consolidation of Accounts
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Corporate investment structuring
Ball park figure of investment capability
- Strength of existing balance sheet
- Borrowing power
- Equity injection ability
- Non-balance sheet recourse financing
Sectoral analysis
Investment vehicle
Investment location
Firm up cost of project
Investment consortium
Structure means of financing
Establish viability
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Sectoral analysis for investments
• Existing organisational core competences
• Demand / supply equilibrium
• Level of protection
• key financial ratios
• Indirect Tax structure
• Scalability
• Backward / forward integration
• Risk balancing
• Flocking mentality
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Investment vehicle
• Strategic Positioning
• Control and promoter funding / exposure.
• Depreciation as a tax shield.
• Direct & Indirect Tax regime
• Tax Status and jurisdiction
• Joint venture partners – FDI restrictions
• Synergy with existing businesses.
• Size / risk of new investment on overall rating
• Leveraging of existing Balance sheet
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Cost of projectLand
Civil Construction
Plant & Machinery
Misc.. fixed assets
Erection and commissioning
Technical know-how fees
preliminary & preoperative expenses
Contingencies
Total capital cost
Margin money
Total project cost
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Project financing
Firming up cost of project
Analysis of factors influencing financial projections
Financial projections
Structure means of financing
Determine cost of capital
Project NPV / IRR with Sensitivity analysis
Equity / Dividend IRR & value generation
Sanction / Term Sheet / Pre disbursement conditions
Security creation / Documentation
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Investment document for bank ability
Part - I Introduction
.Background of promoters.
.Sister concerns / group activities
.Group financial strengths.
Part - II The Project
(A) TECHNICAL ASPECTS
(i) Proposed activity(ii) Product(iii) Statistics on other
existing/proposed units in the field
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(iv) Site details
(v) Technology and process
(vi) Raw materials
(vii) Infrastructural requirements
(viii) License, permits, clearances
(ix) Capital equipment suppliers.
(x) Implementation schedule
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(B) FINANCIAL ASPECTS
a) Cost of project b) Means of financing c) Working capital requirements d) Cash flow planning
during construction phase e) Projections
f) Inter firm / industry ratio analysis g) Sensitivity analysis
(C) BUSINESS PROPOSECTS
i) Demand supply equilibriumii) Competitor profileiii) Marketing strategy
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Lender’s participation
Direct financial support.
a. Rupee term loans.b. Multilateral lines of credit.c. Underwriting of instruments.d. Direct subscription to equity capital.e. Issuing guarantees.f. Bill rediscounting.g. Securitisation of receivablesh Loan syndication.
M&A financing
Over run financing.
Financial restructuring.
Promoter financing
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Facets of project appraisal
The important facets for project viability analysis are:
Market analysisTechnical analysisFinancial analysis Economic analysisEcological analysis
Market analysis
• What is the expected growth of the industry in the near future in which investments are sought to be made.
•What would be the market share the project will have to achieve for financial viability.
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A detailed analysis of the marketability of the products / Services proposed to be manufactured will have to be carried out which will encompass the following:
Consumption trends in the past and the present consumption levelPast and present supply positionProduction possibilities and constraintsImports and exportsStructure of competitionCost structureElasticity of demandConsumer behaviour, intentions, motivations, attitudes, . Distribution channels and marketing policies in useAdministrative, technical, and legal
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Technical analysis
Analysis of the technical and engineering aspects of a project needs to be done at the project formulation stage.Technical analysis seeks to determine whether the prerequisites for the successful commissioning of the project have been considered and reasonably good choices have been made with respect to location, size, process, etc. the important questions raised in technical analysis are:
Whether the preliminary tests and studies have been done
Whether the availability of raw materials, power, and other inputs has been established?
Whether the selected scale of operation is optimal?
Whether the production process chosen is suitable?
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Whether the equipment and machines chosen are appropriate?
Whether the auxiliary equipments and supplementary engineering works have been provided for?
Whether provision has been made for the treatment of effluents?
Whether the proposed layout of the site, buildings, and plant is sound?
Whether work schedules have been realistically drawn up?
Whether the technology proposed to be employed is appropriate from the social point of view?
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Financial AnalysisFinancial analysis seeks to ascertain whether the proposed
project will be financially viable in the sense of being able to meet the burden of servicing debt and whether the proposed project will satisfy the return expectations of those who provide the capital. The aspects, which have to be looked into are:
Investment outlay and cost of project
Means of financing
Cost of capital
Projected profitability
Cash flows of the project
Projected financial position
Level of risk
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Economic Analysis
Economic analysis, also referred to as social cost benefit analysis, is concerned with judging a project form the larger social point of view. benefits. The questions sought to be answered in social cost benefit analysis are:
What are the direct economic benefits and costs of the project measured in terms of shadow (efficiency) prices. What would be impact of the project on the distribution of income in the society?
What would be impact of the project on the level of savings and investment in the society?
What would be the contribution of the project towards the fulfillment of certain merit wants like self-sufficiency, employment, and social order.
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Ecological Analysis
In recent years, environmental concerns have assumed a great deal of significance and rightly so. Ecological analysis should be done particularly for major projects, which have significant ecological implications like power plants and irrigation schemes, and environmental – polluting industries (like bulk drugs, chemicals, and leather processing). The key questions raised in ecological analysis are:
What is the likely damage caused by the project to the environment?
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Financial indicators – Lender’s perspective
1) Operating & Cash break even point
2) Capex per unit of installed capacity
3) Debt service coverage ratio
4) Internal rate of return and cost of capital
5) Gross profit margin (EBIDTA / Net sales)
6) Enterprise value to Installed capacity
7) Return on capital employed (ROCE)
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8) Fixed asset coverage
9) Capital structure leveraging
11) Economic rate of protection (ERP)
12) Debt / EBIDTA : not to exceed 5 times
13) Return on net worth
14) Free cash flow generating capacity
15) NPV under different scenarios
16) Door to Door tenure of debt
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Lender’s norms
Debt / Equity 1.5 - 1.7 : 1
DSCR > 1. 8 times Debt / Ebidta
Promoters Contribution : 15 -20%
Current Ratio > 1.25 - 1.4 times
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Project financing –issues
Stock exchange listing & SEBI guidelines
Lender’s norms and Govt and RBI guidelines .
Promoter funding/ stake / perception
Applicable Direct and Indirect tax laws.
Collateral securities – Non recourse structures
Discounting till perpetuity or fixed tenure for project and Dividend / equity IRR
Impact of MAT ( 18.5 % of book profits ) & GAAR and Transfer pricing contracts
Credit Rating
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Project Financing Structures
• Full recourse structure– Asset backed lending– Either in SPV or otherwise
• Limited recourse structure– Cash flow based financing model– Public & Private participation in Infrastructure projects.– Project has to be implemented in SPV
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Considerations in Corporate Structuring
• Promoters shareholding & Entities acting in concert.
• Private , Public ,Limited ,Unlimited liability structure.
• Listed , Unlisted , Domestic , Offshore structure
• Tax residence status & GAAR
• Consolidated reporting and Disclosure requirement
• Cascading effect of DDT( 15%) to get set off & impact of
MAT( 18 .5%) and Vatability of Excise and Service tax
• Minority interests & consequential ownership thresholds
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Factors influencing capital structure
1) Cost of capital / Impact of Lower D:E in the later period should actually push up the Cost of Capital.
2) Free cash flow availability
3) Management control
4) Flexibility
5) Company’s existing financial strengths
6) Institutional / statutory guidelines
7) Investor preferences in instrument structuring
8) EV / EBIDTA multiple
9) Value at risk analysis(VAR)
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Financial Statements
• Projected balance sheet
• Projected Fund flow and cash flows
• Projected income statement
• All the above statements to be analysed for: New investment stand alone New investment + existing balance sheet Existing Operations without new investment
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Interest rate structuring
• Interest rate linked to inflation
• Risk based interest rate structuring
• Interest rates linked to G-sec or SBAR
• Periodical reset option
• Base rate inflation based with caps
• Company, project, instrument rating.
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Features of interest rates
• To reduce monetaisation of Public Debt
• Concessional interest rates
• Interest rates on govt. securities
• Relationship between Long term & Short term rates
• • Interest rates in unorganised structure.
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Irving Fischer Theory : Rate of interest is equal to the expected real rate plus the expected inflation rate.
To eliminate budgetary support to the banking sector and enable banks / institutions to raise and lend at market determined rates.
Govt borrowings also to shift to floating rate to reduce real term interest rates.
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Lending rate fixation
Basis : Base rate inflation indexed
Base rate : Net cost of funds to FI’s.
: Cap for maximum & minimum rate to be specified.
Lending rate : Base rate + risk spread.Rating score
Risk spread : AAA 0.5 1% > 80 AA 2.5% > 75 - 80
A 3.5% 70 -75
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The overall rating of the company shall be arrived at after considering the rating of qualitative aspects together with that of quantitative aspects. The total score out of 100 shall consist of the following.
Score out ofQuantitative analysisGeneral ratio analysis 50Equity - related ratio 06
Qualitative analysisQuality of management 12Operations 20Fund-raising abilities 12Total 100
A minimum score of 30 out of 56 in the quantitative analysis is necessary for any company to be assigned a rating. If this requirement is met, the score obtained on the qualitative analysis is to be added to the score obtained in the quantitative analysis and the total score out of 100 is to be arrived at.
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Project risk analysis1. Currency risk
- Capital account- Revenue account
2. Commercial risk- Contract failure- Construction - Performance levels & input-output norms
3. Status of Market in terms of depth , width and growth rate.
4. Direct / indirect taxation
5. Value at risk analysis ( Multiplex / housing project )
6. Sectoral risk – Power, Mining, Oil & Gas, Telecom etc
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Evaluating Risk
• “Base case’ forecast for future cash flows and sensitivity analysis
• Determine Debt appetite of the project under different debt door to door tenures and operating scenarios.
• Calculate Project / Equity/ Dividend IRR’s and compare with returns available on alternate investments of similar risk profile.
• Key to successful Project financing is the right allocation of risks among the project participants
• Risks must be allocated to the party that is best possible to manage it.
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Political Risk
• Change in Government• Change in Legal and Tax system• Dividend repatriation• Currency Fluctuation
Mitigation measures :
• Off shore Escrow accounts• Government investment in the project• Political risk insurance
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Force Majure Risk
• War• Flood / Fire / Explosion• Earthquake• Strike
Mitigation measures :
• Commercial Insurance• Construction Insurance
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Price Risk
• Commodity Price Volatility• Foreign exchange fluctuations• Prices of Utilities
Mitigations measures :
• Floor prices with sponsors or third party• Contracted price with sponsors or third party
buyers• Commodity price and forex hedging techniques
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Price Risks
Type of Purchase & Sale contracts :
• Take - or - Pay contracts• Take - if - Offered contract• Through put agreement• Tolling agreement• Concession Agreement• Input - out put norms
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Credit Risks
• Default of contractor• Default of fuel supplier• Default of Off-taker
Mitigation measures:
• Careful selection of credit worthy business relationship• L/C , Bank gurantees, Escrows etc.• Government gurantees for obligations of state controlled
entities
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Capital costs risks• Capital cost over run• Changes in development plans / design• Completion delays• Increase in Financing costs• Unforseen liabilities
Mitigations measures :
• Fixed price,date certain EPC contract• Liquidated damages back to back• Owner’s engineer review• Financial Hedging
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Sensitivity analysis of Capex decisions
• Monte Carlo simulation
• Break even analysis
• Decision tree analysis
• Expected value criterion
• Impact under different scenerios
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Sensitivity analysis
- Basis of financial projections is based on the assumptions
- Key parameters a. Gestation period
b. Capacity utilisation
c. Selling price
d. Raw materialconsumption / price
e. Capital cost
overrun
- Impact of changes in the parameters on DSCR,NPV and IRR.
- Project resilience to changes
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Debt security
• Exclusive charge / Parri-passu charge
• Covenant Financing
• First charge / Second charge
• Hypothecation of movables
• Mortgage of immovable
• Personal guarantees
• Escrow cover
• Co-lateral securities : Corporate gurantees
• Permanent security / Interim security• Trust & Retention account• Debt service retention account
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Equity Financing• Treasury issuance through IPO • Private Placement• SPV structure with holding company• Local market / Offshore• Valuation• Controlling stake• Rights / Offer for sale• No long term capital gains tax if STT is paid• Short term capital gains tax at 10% if STT Paid.• For Listed Entities 25% must be public float• Share premium collected in excess of FMP to be taxed as income in
Private & closely held companies
Taxation of Securities
• Nil on Div recd• Nil on LTCG• 15% on STCG• No DDT
• LTCG on shares : Nil ( STT )• STCG on shares : 15 % ( STT )• Without STT on LTCG : 20% and STCG : Slab rate
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• Equity Oriented Funds • Debt Oriented Funds• Nil on Div recd• 10% with indexation or 20
% without whichever is lower on LTCG
• 30% on STCG• DDT of 12.5% for
individuals and 30% for companies.
• Interest income fully taxed at Slab rate.
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