Project and Enterprise Financing

• The lecture provides an overview of project and enterprise financing.
• Corporate financing deals with the entire company, which usually consists of a portfolio of projects.
• Project financing deals specifically with one project.
• A special economic entity, like an SPV, is typically established for a single project.

Corporate vs Project Financing

• Corporate financing involves many projects evaluated via capital budgeting, utilizing private and public equity, and bond and credit financing.
• Project Financing deals with only one project.

Cash Flows

• Firms raise money through loans and securities.
• Firms then invest in both current and fixed assets.
• Operations generate cash flow; some is reinvested and some is used for dividends and debt payments.
• Cash is also allocated for taxes.
• Investors receive interest, dividends, and debt repayments.

New Projects: Corporate Financing

• WACC is applied to existing assets and debt.
• New projects and equity have associated costs of equity.
• New debt also incurs debt costs.

New Projects: Project Financing

• The existing firm has assets, equity and debt, which contributes to the company's WACC.
• The SPV is for new projects and equities, and both have a cost.

Financing Instruments

• Instruments used to finance an enterprise and an SPV are generally very similar.

Financing Gap

• This gap arises due to the time difference between the outflow of money for production and the inflow from sales.
• Financing is necessary to bridge this gap.

Balance Sheet Review

• Assets = Liabilities + Stockholder's Equity
• The Cash Conversion Cycle (CCC) and Operating Cycle (OC) are important metrics.
• Operating Cycle = Inventory Days + Accounts Receivable Days
• Cash Conversion Cycle = Operating Cycle – Accounts Payable Days

Global Conglomerate Corporation Example

• The accounts receivable days are 36.3 days.
• The inventory days are 36.5 days.
• The accounts payable days are 69.7 days.

Nike Example

• Inventory period is 83 days.
• The receivables period is 47 days.
• The duration of accounts payable is 36 days.
• Cash conversion cycle is 94 days.

Securities as Claims

• Debt has a higher priority than equity.
• Debt is promised by the firm to repay a fixed Euro amount by a certain date.
• Equity has residual claim and represents a call option on the firm's value.
• Equity payoff is equivalent to a call option with a strike price equal to the pending debt.
• If the firm's assets value exceeds the pending debt, equity holders receive the remaining value after debt repayment.
• If the pending debt is more than the firm asset value, the firm goes bankrupt, and its equity is essentially worthless.
• Debt can be viewed as firm's assets less the equity call option or as a risk-free bond, less a put option.
• Debt as an option portfolio means If the firm's asset value is enough to cover the debt, debt holders are repaid fully.
• If the firm is bankrupt, debt holders receive all remaining firm assets

Goals of a Firm

• The primary goal is to add value for stockholders, also know as shareholder value maximization.
• This is achieved if shareholder value maximization is a long-term goal.

Shareholder Value Maximization

• As an optimal output in the long-run, it is not achievable via: bad working conditions or products of low quality or too much debt
• An overall economic optimum requires a good legal environment and public goods provided by the state.
• It also requies that non-public goods should be provided by the private sector.

Agency Problem

• This involves investors/owners (principal) and management (agent).
• Investors often delegate responsibilities to managers, who can have incentives to diminish the value of investor's investments.
• 'Inappropriate' spending of funds include harmful operational decisions, excessive compensation etc...

Solutions to Agency Problem

• Monitoring by the board of directors
• Market for corporate control could act as a hostile takeover
• Information intermediaries like financial analysts and rating agencies
• Optimal contracts aligning manager interests with external equity and debt holders.
• Stock options used as compensation could conflict with long-term goals.

Stock Option Disadvantages

• An existing stock price is considered, and million of stock options granted.
• Increased share value can lead to riskier projects, cost-cutting, and higher risk.

Project Finance

• Involves structured financing of a special economic entity like the SPV.
• SPVs are created by sponsors, are financed by equity and debt, and generate cash flows as the primary source for loan repayments.
• Typical features always include that the project company is financially and legally indepentent from the sponsors.
• Lenders only have limited recourse to sponsors.
• Cash flows must be sufficient to cover payments for operating costs and to service the debt.
• Collateral is sometimes provided by sponsors to lenders.
• Sponsors use corporate finance and project finance to fund new projects.
• Alternative 2 (Project Finance): A new project is incorporated into a newly created economic entity (SPV) and financed off-balance sheet, which keeps the firm independent.
• The main disadvantage of Project Finance is that it is more costly.
• The the total transaction costs amount to 5-10% of the total investment.
• This is due to legal, technical, and insurance advisors.
• Also due to high costs of monitoring and high risks for lenders.
• Project Finance can mitigate costly agency conflicts.
• SPVs have highly leveraged structures, with a disciplinary role to prevent managers from wasting cash flow.
• Lower agency costs lower financing costs.

Debt Overhang Motivation

• Companies with little debt capacity may not be able to invest in some positive NPV projects.
• Risk Management: The SPV protects the sponsor from risk contaminations.
• Better risk management may lower financing costs.

Project Finance Market

• In 2014, Loans accounted for 84% and Bonds accounted for 16% of the market.
• The biggest sectors for project-financed bonds globally are infrastructure and oil & gas.
• Project Finance loans have $2,103.2 Billion, whereas Non-Project Finance loans have 40,337.2.