By Ajay Jain

Prashant Fegade

 Traditional method- Government provides

infrastructure facilities
Modern Method- Private sector investment
Why such a shift?
Limitation of Governments in developing countries
New models for private participation
Efficiency gain from private participation
Economic benefits from the infrastructure

 Why should invest?

Appropriate rate of return on equity
Tolls and tariffs to recover operating costs and provide

return on capital employed

ROE overall viability and acceptability
Most elements of cost can be decided by market prices,

ROE cannot be.

 Depend on
Risk of cash flows
Financial structure(i.e debt to equity ratio)

Risk Mitigation contracts( BOOT, BOT, BOOST etc.)

BOOT scheme- an extension of project financing

Assets, contracts, inherent economics and cash flows
are separated form promoters
Assets- Collateral for loan
Loan payment made from the cash flows
2. Corporate Financing/ Balance sheet financing
Lenders looks the cash flows and assets of the whole
company to service the debt and provide security
1.

 Made possible by combining undertakings and various

kinds of guarantees by parties interested- no one party

alone has to assume full credit responsibility
BOOT projects can be solicited or unsolicited.

 Allocate risks to those party who are best in position to

control particular risk factor.

Reduces Moral Hazard problem and minimizes cost
of bearing risk
1. Project completion risk
2. Market Risk
3. Foreign Exchange risk
4. Supply of inputs
5. Government Guarantees

 Developing countries have pattern of 20-30 percent

equity and 70-80 percent debt.

Power projects 68:32
Telecom 1:1

 Both are functions on risk of cash flows

Guarantees and risk mitigation arrangements affect the

risk of cash flow

Difference between ROE and IRR
ROE should be commensurate with risk of cash flow to
equity
Risk of cash flow depends on uncertainty of revenues and
operating and financial leverage
ROE determined by another existing project with same
business risk
Risk is measured by
Ks =kRF + (kM - kRF).

 Equity risks measurement is complicated by impact of

numerous guarantees.
Guarantees enable firms to raise loans at cheaper rates.

 Determines overall distribution of risk and return between two

classes of investors
Increasing debt- increase risk and return to equity
Risk and return to debt also increases to account for the increase
in bankruptcy risk.
Change in financial structure leaves risk and return, and
therefore the value for the firm as a whole unchanged
Alternative interpretation-structure doesnt affect cost of capital
If debt is cheaper than equity, increased proportion increases the
risk and cost of equity-overall cost remains same
Interest on debt is tax deductible
If income from infrastructure enjoys tax benefits advantages
reducing debt

 Implications for financial distress

Interest and principal repayments on debt have to made

as per schedule no fixed commitment for dividend

payments
Project with lower level of debt has greater flexibility in
managing cash flows
Cost of financial distress may not be an important
consideration for projects in presence of guarantees
reduce risk of project cash flows
Government restrictions In India 4:1
Consideration of government ECBs and minimum
equity participation

 ROE will be determined by the risk of specific projects,

sectors and countries taking into account guarantees

Development period has the highest risk with the
promoter running the risk of project being aborted
before financial close or the development period
taking longer and requiring more resources
Implications for government to reduce delays and
uncertainties .
Competitive bidding