The financial feasibility assessment is a critical part in the project preparation stage. It provides information about the costs, expenses and sources of revenues, and gives an indication whether the project is self-sustaining or requires additional financial support in the form of grant to make it viable. In other words, financial feasibility helps determine whether the project will make sufficient revenues to offset all the costs incurred as well as allow for a reasonable return on investment for the private partner. Financial feasibility forms the basis for determining an appropriate project structure and eventually informs the preparation of bidding documents.
The financial feasibility assessment helps to identify the potential costs and revenue streams associated with the project, and whether it is financially viable in the long term. It also helps to determine the appropriate funding sources for the project and identify any potential risks or obstacles that may affect its financial performance.
Moreover, public projects often involve public funds, and it is important to ensure that these funds are used efficiently and effectively. A financial feasibility assessment can help to identify potential cost savings and optimize the use of available resources.
The financial feasibility assessment however, is an iterative process which is done during different stages in the project – during risk analysis, determining value for proposition, assessing whether or not to proceed with a PPP structure, etc.
The financial feasibility of public projects is an important consideration for governments and public entities when making investment decisions. The following are some of the key factors that need to be considered when assessing the financial feasibility of public projects:
In conclusion, financial feasibility of public projects is crucial to ensure the best use of public funds and resources. A thorough analysis of project costs, funding sources, revenue streams, economic benefits, risks, and cost-benefit analysis is essential to make informed investment decisions.
Formulation of Reasonable and Realistic Assumptions
Assumptions are baseline data that apply throughout and are often the drivers in a business or financial model. It is always useful to organise the assumptions into logical groups. Indicative categories of assumptions are general assumptions, financing assumptions, tax assumptions, cost and revenue assumptions and market-related assumptions.
Formulating reasonable and realistic assumptions is a critical step in financial feasibility analysis. The following are some of the steps involved in formulating assumptions for financial feasibility analysis:
Documenting the assumptions is also essential to ensure that stakeholders are aware of the underlying assumptions and can make informed decisions based on them.
Life Cycle Cost Analysis
Life cycle costs are measured in terms of capital expenditure and operating expenditure (O&M costs). Capital expenditure usually is calculated as the sum of the base construction cost, preliminary & pre-operative expenses, and the financing costs. Each of such component are set out below:
1. Base Construction costs: These are basic direct
costs of the project
2. Pre-operative expenses: These include accounting/ management fees, legal fees, labor burden, expenses on rent, repairs, telephone bills, travel expenditures, utilities, etc. They reflect expenditure on administration, management, risks and profits.
3. Preliminary expenses: These are costs towards carrying out engineering studies such as land surveys, concept layouts, designing, drawing and preliminary studies.
4. Financing Costs: These are costs towards financing charges collected by lenders, interest during construction (IDC) etc.
Sources of Finance
Since infrastructure projects are highly capital intensive, the private partner clearly lists out the financing risks associated with them before making an investment decision. If the project is a greenfield investment, there would be no cash flow during the construction period. Therefore, the private sector is unlikely to fund the total capital expenditure through equity participation.
Sources of Finance
Innovative Means of finance
Mezzanine Means
These include subordinate debt and preference shares that fall in between senior debt and equity. Payment is made to these investors only after senior debt is serviced and upon complying with certain conditions such as adherence to coverage ratios and investment requisites related to project performance. The risks taken by mezzanine providers are lower than those of traditional equity investors. Since the use of mezzanine means of finance reduces the amount of equity required for the project, it works to the advantage of the project company.
Capital Markets – Bond Financing
Bonds are common means of financing in corporate finance whereas the same as a means of financing in project financing is not very common. The commercial debt financing in project finance are offered under a floating rate with a medium-term maturity whereas, bond financing offer long-term maturity by institutional investors thus making it a better option of debt financing.
Role of the Public Sector in Project Finance
The Government’s support to the private partner, in a PPP project, aimed at enabling the partner to arrange finance, works to a project’s advantage. Internationally, there are certain instruments that allow public participation in project finance and these instruments range from revenue enhancements to equity guarantees. However, these instruments need to be used with an element of caution.
a. Equity guarantees are a mechanism under which the public entity provides the concessionaire with an option to be bought out at a price that guarantees a minimum return on equity.
b. Under debt guarantees, the public entity pays for any shortfall related to principal and interest repayments by the private partner. The Government could also guarantee re-financing of the project.
Cost of Capital
Depending on the means used to finance a project, costs will differ since the cost of raising debt and equity are different. The effective cost of capital (or cost of raising funds) for a project is measured in terms of the Weighted Average Cost of Capital (WACC). WACC takes into consideration the amount and cost of debt and equity raised for the project.
The formula for WACC is
WACC = E x Re + D x Rd x (1-T)
Here,
E = Market value of the company‟s equity
D = Market value of the company‟s debt
Re = Cost of Equity
Rd = Cost of Debt or interest rate at which debt is raised
T= Tax Rate applicable for the project
Revenue Estimations
The revenues are based on the demand for the asset/service and the corresponding tariff rate. Estimation of revenues would be a fall out of the technical studies such as market study, traffic study, etc. that are carried out for the project.
Financial Feasibility Assessment
Financial analysis usually is conducted using a cash flow model. The model projecting cash flows may be simple or very complex depending on the type and size of the project and the variables involved. Capital expenditure, revenues, expenses, terminal cash flow (if any), discount rate and general assumptions are used to calculate cash flow projections, which is the key element in financial analysis.
Since the financial feasibility of a project is assessed on the basis of proposed investments in, and projected cash flows from, the project, it is only prudent to assess the present value of future investments and cash flows to understand the net financial costs and benefits to stakeholders. Annexure 6A of this module sets out an indicative structure of the Financial Feasibility report.
Optimise Financial Viability
The financial viability of a project could be optimised by analysing various options such as change of scope, type of PPP structure adopted, duration of the PPP arrangement, increased tariff, provision of Government support in terms of Viability Gap Funding or other grants, unbundling a project, Government guarantees for transferred risk, risk transfer to the Government, Government inputs in operations at subsidised rates etc.
Lenders’ Concerns on PPP Funding
Banks play a crucial role in PPP arrangements. In a PPP, the private partner is highly incentivised to deliver the project on time and within the budget. In case the private partner fails to complete the project on time, it will need to request the banks to allow delayed repayment of debt, as revenues would be delayed. In case of cost overruns, the private partner would need to ask the bank to increase the loan. In such cases, the banks may impose penalties on these companies leading to a lower return on investment for the shareholder.
The amount of debt which could be raised by a project company is primarily determined by its ability to service its debt services from future cash flows with reasonable comfort. The lenders generally estimate this ability based on a set of ratios that are calculated on a periodic basis over the life of a project.
Register as member and login to download attachment use this only for Educational Purpose
Information on this site is purely for education purpose. The materials used and displayed on the Sites, including text, photographs, graphics, illustrations and artwork, video, music and sound, and names, logos, IS Codes, are copyrighted items of respective owners. Front Desk is not responsible and liable for information shared above.
1 Comment
[…] Financial Feasibility […]