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

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
3

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
4

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
5

Cost of project
Land
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

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
(A)

The Project

TECHNICAL ASPECTS
(i)
(ii)
(iii)

Proposed activity
Product
Statistics on other
existing/proposed units
in the field

(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)
b)
c)
d)
e)
f)
g)

(C)

Cost of project
Means of financing
Working capital requirements
Cash flow planning
during construction phase
Projections
Inter firm / industry ratio analysis
Sensitivity analysis

BUSINESS PROPOSECTS
i)
ii)
iii)

Demand supply equilibrium

Competitor profile
Marketing strategy
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Lenders participation
Direct financial support.
a.
b.
c.
d.
e.
f.
g.
h

Rupee term loans.

Multilateral lines of credit.
Underwriting of instruments.
Direct subscription to equity capital.
Issuing guarantees.
Bill rediscounting.
Securitisation of receivables
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 analysis
Technical analysis
Financial analysis
Economic analysis
Ecological 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 achieve12
for financial viability.

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 level
Past and present supply position
Production possibilities and constraints
Imports and exports
Structure of competition
Cost structure
Elasticity of demand
Consumer behaviour, intentions, motivations, attitudes, .
Distribution channels and marketing policies in use
Administrative, technical, and legal
13

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
engineering works have been provided for?

supplementary

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 Analysis
Financial 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 Lenders 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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Lenders norms

Debt / Equity

DSCR

1.5 - 1.7 : 1

> 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
Lenders 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

22

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) Companys 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 FIs.

Cap for maximum & minimum rate to be

specified.

Lending rate :
Risk spread

Base rate + risk spread.

AAA
AA
A

0.5 1%
2.5%
3.5%

Rating score
> 80
> 75 - 80
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 of
Quantitative analysis
General ratio analysis
50
Equity - related ratio
06
Qualitative analysis
Quality of management
Operations
Fund-raising abilities
Total

12
20
12
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
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100 is to be arrived at.

Project risk analysis

1. 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 )
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6. Sectoral risk Power, Mining, Oil & Gas, Telecom etc

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 IRRs 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
Owners 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 material
consumption / 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
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Taxation of Securities
Equity Oriented Funds

Debt Oriented Funds

Nil on Div recd

Nil on LTCG
15% on STCG
No DDT

Nil on Div recd

10% with indexation or
20 % without whichever is
lower on LTCG
30% on STCG
LTCG on shares : Nil ( STT ) DDT of 12.5% for
STCG on shares : 15 % ( STT ) individuals and 30% for
companies.
Without STT on LTCG : 20%
Interest income fully taxed
and STCG : Slab rate
at Slab rate.
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