Project Finance in Construction: A Structured Guide to Assessment by Tony Merna, Yang Chu, Faisal F. Al-Thani

Project Finance in Construction: A Structured Guide to Assessment by Tony Merna, Yang Chu, Faisal F. Al-Thani
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Project Finance in Construction: A Structured Guide to Assessment

by Tony Merna, Yang Chu, Faisal F. Al-Thani


192 pages August 2010, Wiley-Blackwell


Project finance has spread worldwide and includes numerous industrial projects from power stations and waste-disposal plants to telecommunication facilities, bridges, tunnels, railway networks, and now also the building of hospitals, education facilities, government accommodation and tourist facilities. Despite financial assessment of PF projects being fundamental to the lenderĄ¯s decision, there is little understanding of how the use of finance is perceived by individual stakeholders; why and how a financial assessment is performed; who should be involved; where and when it should be performed; what data should be used; and how financial assessments should be presented.

Current uncertainty in financial markets makes many sponsors of construction project financings carefully consider bank liquidity, the higher cost of finance, and general uncertainty for demand. This has resulted in the postponement of a number of projects in certain industry sectors. Governments have seen tax receipts drastically reduced which has affected their ability to finance infrastructure projects, often irrespective of the perceived demand. Equity providers still seek to invest, however there are less opportunities due to market dislocation. Due to the demand for global infrastructure it is believed that project financings will return to their pre-crunch levels, or more so, however lendersĄ¯ liquidity costs will be passed on to the borrowers. Lenders will also be under stricter regulation both internally and externally.

The steps outlined in the guide are designed to provide a basic understanding for all those involved or interested in both structuring and assessing project financings. Secondary contracts involving constructors, operators, finance providers, suppliers and offtakers can be developed and assessed to determine their commercial viability over a projects life cycle.

Special Features

a structured guide to assessing the commercial viability of construction projects

explains economic metrics to use in the decision making process

detailed case study shows how stakeholders apply the concept of project finance


List of illustrations. List of tables.

About the Authors.


1 Introduction.

1.1 The development of project finance.

1.2 Financial assessment.

What is financial assessment?

Why perform a financial assessment?

Who is involved in the risk assessment process?

Where should a financial assessment be performed?

When should a financial assessment be performed?

What data are to be used?

How should assessment outputs be presented?

1.3 Purpose of this guide.

1.4 Scope of the guide.

2 Project finance.

2.1 Introduction.

2.2 Definition of project finance.

2.3 The key characteristics of project finance.

Special project/purpose vehicle.

Contractual arrangement.

Non-/limited recourse.

Off-balance sheet transaction.

Robust income stream of the project as the basis for financing.

2.4 Legal and financial considerations in project finance.



3 Financial instruments and cash flow modelling.

3.1 Introduction.

3.2 Debt finance.

Senior debt.

3.3 Mezzanine finance.

Subordinate debt.

Bond finance.

3.4 Equity finance.

3.5 Sources of debt and equity.

3.6 Cash flow modelling and project financing.

4 Risk management.

4.1 Introduction.

4.2 Risk.

4.3 Risk management process.

Risk identification.

Risk analysis.

Risk response.

4.4 Typical risks in project financing.

5 The financial assessment process.

5.1 Introduction.

5.2 The financial assessment structure.

SPV assessment.

Lenders' assessment.

SPV and lender final assessment.

6 Case study.

6.1 Introduction.

6.2 Independent power project.

6.3 Supply and offtake contracts.

Supply contracts.

Offtake contracts.

Applications of supply and offtake contracts.

6.4 Assumptions for initial assessment.

7 Developing the base case model.

7.1 Introduction.

7.2 SPVĄ¯s initial assessment.

7.3 Identify the estimated activities, time, costs and revenues of the project.

7.4 Development of the base case model.

7.5 Identify major project risks.

7.6 Assessment of base case model incorporating risks.

8 Initial economic assessment by lenders.

8.1 Introduction.

8.2 Financial package assessment.

Finance package (1).

Finance package (2).

Finance package (3).

8.3 Conclusions.

9 Financial engineering.

9.1 Introduction.

9.2 Financial instruments used in financial engineering.

Forward rates.

Financial futures.



Caps, floors, collars, swaptions and compound options.

Asset-backed securities.

9.3 Refinancing.

9.4 Reappraising public¨Cprivate partnerships.

9.5 Techniques applied in the reappraisal of PPP concession agreement.

9.6 Other financial engineering techniques.

10 Final assessment to determine project commercial viability.

10.1 Introduction.

10.2 Detailed risk assessment.

10.3 Financial engineering.

Tax holiday.

Financial collar.

Extending the concession.

Increasing debt.

Grace period.

Phasing construction and operation.

Upfront payments.

Existing concession revenues.

10.4 Summary.

11 Financial close.

11.1 Introduction.

11.2 Due diligence.


Legal due diligence.

Trigger step in rights.

Model audit and sensitivity analysis.

Risk valuation.

Term sheet.

Inter-creditor agreement.

Hedge strategy.

Letters of credit.

Reserve account.

Escrow and ring-fenced facilities.

Economic indicators.



11.3 Financial close.

Credit committee approval process.

Due diligence report.

Technical closure.

Financial close.

Technical commencement.

Execute interest rate swaps.

12 Islamic finance and project finance.

12.1 Introduction.

12.2 Islamic finance.

12.3 Shariah.

Qiyas and Litihad.

12.4 Core principles of Islamic finance.

Sharing (profit/loss and risk).

No unfair gain.

No speculation.

No uncertainty.

No investments that are not in the public interest.

No hoarding of money.


Islamic financial institutions.

Shariah supervisory boards.

12.5 Project finance.

The Ijara principle.

Ijara Mawsufah Fi Al Dhimmah (forward lease).



Sukuk al Istisna'a.

A typical SAI deal.



12.6 Other Islamic finance techniques for projects.

Musharaka (equity financing).

Bai salam (forward financing).

12.7 Risks and liabilities.

12.8 Summary.

13 Conclusions and recommendations.

13.1 Review.

13.2 Conclusions.

13.3 Recommendations.






Anthony Merna is senior partner of Oriel Group Practice, a multidisciplinary research and consultancy practice based in Manchester and a visiting lecturer to Manchester Business School at the University of Manchester. He has been teaching Project Finance for the last 14 years to a number of UK and overseas universities, businesses and government agencies. Yang Chu is a graduate of the School of Mechanical, Aerospace and Civil Engineering at the University of Manchester and a research consultant with Oriel Group Practice specialising in the areas of project finance and risk modelling. He is currently carrying out risk management research at Manchester Business School.

Faisal Al-Thani is Senior Development Manager, Middle East for Maersk Oil based in Doha and a board member of the Marsh International Risk Council.