Project Finance
Introduction
Project financing and corporate financing policies are crucial events or activities in relation to the operations of business entities. They provide accurate and reliable application of resources to enhance economic growth and development. This research paper seeks to highlight reasons behind the adoption of the two policies. This is through adequate definition of corporate and project financing policies. The project will also offer appropriate information on advantages and disadvantages of project financing. It will also evaluate limitations to project financing in relation to the two case studies.
What is project finance?
Project Finance refers to the corporate act of sponsoring, investing and owning single purpose asset (industrial asset) under the influence of legal and independent entity financing in relation to resource debt (Fight 2006, p. 14). In the context of the two case studies, project financing played key roles in the achievement of the goals and objectives by the relevant organizations. The team defined project finance as financial arrangement in which lenders rely on the assets and cash flows of the project in context and repayment of the loan rather than corporate finance.
What is cooperate finance?
Corporate finance is a financial or monetary policy that relates to the business organization and its financial resources. Corporate financing policy relates to all activities with an organization relating to IPOS to the acquisition stage.
Why project finance?
Companies opt for project financing with the aim of reducing or eliminating risks that might arise during the course of financing hence the prevention of harm to the resources. It is also crucial to offer accurate and reliable measure to the size and duration of the project. Project financing policy offers extensive measure for the project in comparison to the corporate financing policy. Project financing is also relevant in relation to the elimination of conflicting answers in the comparison of NPV of exclusive projects.
Why corporate finance?
Corporate financing policy is crucial in the execution of direct measure of the monetary contribution by the general shareholders to the exclusive stakeholders. This sense is not evident in the provisions of the project financing policy. Corporate finance policy also provides opportunity for the shareholders to determine the exact return in relation to the monetary resources in the task or project. This is crucial for the process of decision-making by the management of the organizations involved in the process of corporate financing.
Advantage and disadvantage of project finance
Advantages of Project Finance
Project finance plays critical roles in the development of downstream businesses following the merger of the organizations. This is because project finance is the ideal power plants. This is because power plants are discrete, lack history, exercise the use of contracts to set cash inflows and outflows, and prove to be non-core assets. It is also critical to note that the success of project finance in the downstream business was because of familiarity of the lenders to the finance policy. In the upstream business following the merger, project finance focused mostly on the production rather than exploration assets. This partially implementation was based on the reluctance by the bank to fund projects without verification of reserves (Esty 2004. p 8).
The merger between the two organizations represented a portfolio for exploration, refining, development and marketing assets. The BP/Amoco portfolio lacked perfect correlation with reference to several assets thus elements of risks in its operations. Project finance has a role in the elimination of the idiosyncratic risks by adopting diversification in production and operations. Project finance is crucial in the creation of the value via enhancing management of risks within the organizations following the merger. Despite the fact that management of risks occur in numerous forms, it is ideal to note that project finance was crucial for sharing of risk, direct eradication of risks, insuring risks through premiums, and hedging of the risks via foregoing the chances for profits or gains. This indicates that project finance is crucial towards limitation of exposure of the organization with reference to downside risks. Project financing enabled BP to exchange the downside exposure or risks at the expense of prices reflecting higher loans and interest rates. Project finance is crucial to the purchasing options in relation to projects. In the context of Amoco, the organization managed to protect its operations from downside exposure through implementation of project finance, unlike corporate finance (Esty 2004. p 8). The protection against downside exposure is elementary in some settings.
Project finance has the opportunity to increase the firm’s debt capability. This is with reference to lack of project assets and liabilities on the balance sheet of the sponsors. Project finance also contributed to the generation of extra interest tax shields in that the projects portrayed higher advantage ratios in comparison to the sponsoring firms. The firm (Amoco) had the opportunity to obtain more advantage via project finance structure. Project finance is also crucial to the reduction of the cost of the taxation system thus realization of tax holidays by BP and Amoco in their partial implementation of the policy, in their operations. The government has the opportunity and will to offer organizations concessions thus effectiveness in the adoption of project finance financial policy. Project finance also plays a crucial role to the efficient allocation of risks in relation to numerous parties with the aim of achieving a deal (Esty 2004. p 9).
BP had the opportunity to sign fixed price contracts thus the transfer of risks with reference to completion of the project to the experienced contractors. This transfer of risks paid no attention to the method through which the qualified contractor decides to finance the project. Project finance is also essential for implementation in cases of high risks projects for instance the investment termed as first-timer with reference to fresh industry, technology, and market. In this context, project finance plays a crucial role in the creation of value via the introduction of other levels of discipline within the procedures hence provision of access to relevant partners. Project finance also played a vital role in the financing of mega projects, political projects, and projects entailing joint venture with dissimilar partners. This is because project finance in mega projects limits the extent of harm that might result in connection with material risks to the company’s debts, earnings, and existence. Project finance also reduces the elements of political risks in association with political projects. These risks include war, sabotage, strikes, and property rights (Esty 2004. p 9).
Disadvantages
One of the evident disadvantages of project financing is its ability to capture much time in order to structure effectively and efficiently like in the context of corporate finance (Kamara 2012, p.240). There are several steps involved in the structuring or obtaining the project finance. This makes it an expensive financing method or policy in relation to time involved. The other disadvantage in the development of project financing policy relates to the cost of transaction. Project financing policy projects higher or greater costs of transactions in comparison to the corporate financing policy. This indicates that project-financing policy must incorporate the cost vital for the creation of identity cost. The cost of independent identity in the project financing could sum up to 60 bp thus draining an organization of the limited resources in relation to achievement of goals and objectives. Project financing policy also depicts greater costs of the debt value. The debt value of the project is high or more expensive because of the non-recourse nature of project financing policy. This is a burden to the organization receiving benefits and the business entity offering the crucial service of financing process. The other disadvantage of project financing policy is the need for greater disclosure value relating to the proprietary information and relevant strategic deals and agreements. This is a burden to the limited finances of the organizations involved in the ordeal of project financing policy. Project financing policy also restricts the need and execution of effective and efficient managerial decisions. This is evident in the context of extensive nature of the project financing method (Kamara 2012, p. 242).
What is the limitation of project finance?
Project finance should be limited to the financing of mega projects, political projects, and projects entailing joint venture with dissimilar partners. This is because project finance in mega projects limits the extent of harm that might result in connection with material risks to the company’s debts, earnings, and existence. Project finance also reduces the elements of political risks in association with political projects. These risks include war, sabotage, strikes, and property rights (Esty 2004. p 9). Project financing in relation to projects of joint venture of unique or dissimilar partners would be essential because of the reduction of the risks that might emanate from the transactions. These three scenarios offer accurate and reliable benefits of project financing method in the context of organizations and business entities as either shareholders or stakeholders.
Use an example from the case study how project finance is used.
An execution of the project financing method can be drawn from the case of Disney and Chase bank. Project financing was crucial to the execution of the proposal by Disneyland by Chase Bank despite the essence of numerous risks such as long-term return on capital. The role of the project finance in this context was to eliminate some of the risks that might be associated with the mega project as proposed by Disneyland. The bank did not include the agreements that demanded minimum debt-service coverage ratios in the bid thus the ability to reduce or relocate risks that might be harmful to the organization (Esty 2004. p 80).
Project Finance enabled the bank to underwrite the full amount of the project proposal despite the elements of risks exposure. This was possible through the approval by the senior management of the bank in reference to the proposal. The proposal would illustrate bank’s support for the client thus the confidence in the deal. The proposal would also improve the profit levels for the firm hence the positive role by project financing policy (Dowsett 2012, p. 25). Application of project finance by the Bank provided adequate opportunity for the bank to increase its chances of winning the bid to finance the proposal. This is through enabling the bank to standout among other bidder. The other role of project finance was the determination of the credit exposure by the bank in relation to the duration of the proposal. Since the proposal was a mega project, the Bank decided to adopt slightly lower credit exposure (HK $ 300) depending on the 15-year maturity (Esty 2004. p 82).
Project finance was adequate in the determination of the price. The bank decided to follow the procedures of benchmarking the proposal price in relation to the current transactions in consideration of adjustments to the competitive aspects and market conditions (Chiou et al 2012, p. 587). Comparing transactions were critical because of existence of unique loans within the industry and market.
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