Financial Management: Project Finance Analysis and Appraisal in Brunei

This report provides a comprehensive overview of project finance, specifically within the context of Brunei. It begins with an introduction to the concept of project finance, highlighting its significance and the various sources of funding available. The report details the role of government support and multilateral development banks in financing projects. It then explores the structure of project finance deals, including key agreements such as off-take agreements, construction agreements, and government support agreements. Furthermore, the report delves into project appraisal, encompassing technical, financial, market, and economic appraisals, as well as the use of financial ratios like payback period, NPV, IRR, and debt-equity ratio for project evaluation. Finally, the report addresses risk minimization strategies, including risk identification, analysis, and allocation, emphasizing the importance of managing risks throughout the project lifecycle. This report is a valuable resource for understanding the intricacies of project finance and its practical application in Brunei.

Financial Management
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Introduction
Project finance has come of age in Brunei. The industrialist or organizer of a
company has a wide choice of sources of funds out of which they can select.
The selection is mainly depending on cost of funds and financial risk
associated with project. The project of a company should be technologically
sound, financially feasible and unique concept. A unique or viable project
would have no issue in searching a market because it is easily acceptable in
the competitive market. With a limited resources and government support
the project company can finance their project. Brunei’s government
supports the industries in financing the projects because it help the country
in growth and enhance the GDP or National Income.
Project finance offers long-term, non-recourse or limited recourse loans
utilized to finance large industrial, commercial, sovereign and
infrastructure projects in emerging market nations worldwide. In other
words, project finance is the long-term infrastructure and industrial project
financing which are basically based on the projected project cash flow
rather than the balance sheets of the project promoters. It is examination of
the complete life-cycle of a project. Usually a cost- benefit analysis is
utilized to decide if the economic benefits of a project are better than the
economic expenses. Project finance loans are mostly prolonged on non-
recourse or limited recourse basis and are protected by the project assets
and operations. Loans repayment occurs wholly from project cash flow and
not from the assets or borrower credit (Rarasati, et. al., 2019).
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Figure 1: Parties to a project financing
These parties help to a company in financing their projects by providing
funds or loans in a reasonable rate. They are mostly involved in the
management of project and also in construction.
One of the foremost benefits of project financing is that it offers for off-
balance sheet financing of the project which will not influence the credit of
the government contracting authority, or shareholders. It also transfers
certain risk of the project to investors in exchange for which the investors
achieve a maximum margin than for corporate lending.
In Brunei, the Multilateral Development Banks offers grants, loans, and
investments for project that support country’s economic development. The
Multilateral Development Banks (MDBs) are global financial institutions
that encourage economic and social growth in their developing countries.
Every year MDBs extend a combined total of almost $50 billion in grants,
loans and investment to the private and public sectors for social and
economic development in developing markets (Estache, et. al., 2015).
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Parti
es
Suppliers
and
Contracto
rs
Lenders
Sponsors
&
Investors
Governme
nt
Customer
s

Project finance deal structure
As can be seen, there are a number of contracts and the
arrangements which are prepared by the company with the outsider
parties to generate funds for the project.
The off take Agreement
 An outline under which Project Company obtains returns
 Offers the “off taker” or “Buyer” with a secure project output supply
and the Company with the capability to sell the output on a pre-
agreed basis.
 Can take many methods, like as “PAY or TAKE” Contract: “POWER
PURCHASE Agreement” (PPA)
Construction Agreement
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Project
Comapny
Shareholders
(Shareholder Agreement)
Grantor (Concession
Agreement)
Input Supplier (Input
Supply Agreement)
Construction Contractor
(Construction
Agreement)
Operator (Operating
Agreement)
Lender (Loan
Agreement)
Offtake Purchaser
(Offtake Purchase
Agreement)

 An Agreement defining the “TURNKEY” accountability to provide a
whole project prepared for operation (Engineering, Procurement,
Construction [EPC] Agreement)
Input Supply Agreement
 It also offers a Project Company the safety in supplies input on a pre-
agreed basis of pricing.
 The conditions of Input Supply Agreement are generally created to
equal those of the “off take Contract” such as length of contract,
volume of input, etc.
Operation and Maintenance Agreement
 It basically ensures that the maintenance and operating expenses are
within the budgeted limit and project are operates as per prescribed
planned.
Government Support Agreement
 In this agreement the government supports the Project Company by
giving assurances on usage of public utilities, exemptions in tax,
expropriation compensation and disputes litigation in an agreed
jurisdiction.
Shareholders Agreement
 In this Agreement, a Project Company borrows funds from the capital
market or Shareholders and in return the company provides dividend
on monthly or yearly basis.
Lender Agreement
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 In this agreement, a Project Company takes a loan from the lender
and pay principle amount and interest on the basis of agreement.
Grantor Agreement
 A concession arrangement is a negotiated contract between a
government and a Project Company that provides the Project
Company the right to conduct a specific project within the
government jurisdiction, which is subject to specific conditions (Miglo,
2016).
Project Appraisal
Project Finance requires a project appraisal in which the “due diligence”
conducted on technical, sponsors, legal, environmental, financial and risk
aspects among others of the proposed project. The project appraisal is the
valuation of the feasibility of projected long-term investments in terms of
shareholder’s wealth. It is also focus on project efficiency which generates
sufficient cash flow to repay its loan or debt and also provide a satisfactory
rate of return to the company from its project (Shan, Hwang & Zhu, 2017).
Main Features of Project Finance
 Project Company is a SPV (Special Purpose Vehicle) with no previous
record or business.
 Capital intensive project on Greenfield site
 Highly leveraged project
 Lenders mainly depend on economic and technical estimates of the
project to make sure its capability to generate sufficient income.
 Higher margins and fees to reflect lenders risk.
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Project financing flowchart
Types of ratios used project
Payback period: The payback period is referred to as the period of time
within which the early investment on the project is compensated by the
company in the form of revenues. It shows in how much time the company
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Initiate process for raising equity capital
Sign loan agreement
Examine the letter of intent
Provide any clarification sought by project apprasial term of
financial instution
Arrange for site inspected by financing institution
Fill up loan application form
Make arrangements in principle for fiunding of Working
Capital
Acquire necessary govt. approval and permission
Preparation of feasibility Report

gets future revenue from their past investment. It can be calculated by
using below formulae:
P = I/C
P = Payback Period
I = Initial Investment
C = Yearly net cash inflow
Net Present value: Net present value is the variation between the present
value of cash inflows and the present value of cash outflows over a specified
period of time. It is an effective method than payback period method and it
is also used to evaluate the profitability of a project or projected investment.
It is calculated by using below formulae:
NPV = Net cash inflow – Net cash outflow
Internal Rate of Return: The internal rate of return is that rate of return
which creates the NPV (net present value) equal to zero. Thus, it is type of
discount rate which makes the initial investment in the project equal to the
discounted net returns from the investment during the entire life of the
project. It is calculated by using below formulae:
IRR= ra + NPVa/NPVa - NPVb (rb - ra)
ra = Lower discount rate
rb = Higher discount rate
NPVa = NPV at ra
NPVb = NPV at rb
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Note: If the IRR (internal rate of return) is higher or equal to the minimum
rate of return, then a company accepts the project proposal, otherwise the
project is rejected.
Debt- equity ratio: The debt-equity ratio is measured by dividing the long-
term debt or liabilities by the owner’s equity or equity plus long- term debt
or liabilities to get the proportion that long- term liabilities are to total debt
and equity. This ratio is used to analyze a company’s financial leverage. The
debt- equity ratio is an important metric used in project financing. Higher
leverage ratios indicate that a company or stock with higher risk to
shareholders.
By using below formulae the company can calculate the debt- equity ratio:
Debt/Equity = Total Liabilities/Total Shareholders’ Equity
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Appraisals in Project Finance
Technical Appraisal
Technical appraisal is mainly concerned with the project development
process which covers change in technology, its scope, design and
modification in the plant and equipment as well as infrastructure and inputs
facilities envisaged for the project. In technical appraisal, a project manager
investigates the future requirement of technology and how much cost
involved if the company purchased from the international market. Technical
appraisal has a bearing on the financial viability of the project as reflected
by its ability to earn acceptable rate of return on the investment made and
to service debt and equity (De Marco & Mangano, 2017).
Following points should consider by the company while preparing
the technical appraisal:
 Project concept
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Projec
t
Finan
ce
Technic
al
Apprais
al
Financi
al
Apprais
al
Market
Apprais
al
Econom
ic
Apprais
al

 Plant capacity
 Flexibility of plant and flexible manufacturing systems
 Technology evaluation
 Inputs
 Location
 Production cost
Financial Appraisal
Financial appraisal is basically concerned with measuring the viability of a
new investment proposal for setting up a unique project or extension of
existing productive facilities. Financial appraisal includes a valuation of
funds needed to apply the project and also on sources. Financial appraisal
relates to assessment of revenues, operation income or costs, prospective
liquidity and financial returns in the operating phase of the project. The
financial appraisal is utilized to evaluate the feasibility of a new project as
well as to rank projects on the basis of their profitability.
Following points should be considered by the project manager in
preparing the financial appraisal of the project:
 Evaluation of cash flow and profitability which are recovered by the
company.
 Cost of the project
 Cost involved in technology up gradation
 Financial projections
 Sources of finance
Market Appraisal
In Market Appraisal, the project manager requires a description of the
product, its major usage, and scope of the market, possible competition
from substitute product, unique product features, quality, quantity and
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price of the product. Valuation has to be made about current and upcoming
demand and supply of the proposed product to be produced. The project
manager do calculation of likely competition comes in future and unique
features of the project. After gathering a required data, the existing position
has to be evaluated to determine whether unsatisfied demand exists.
Demand estimation requires the determination of the total demand of the
product and appropriate survey of market.
Following are the methods of demand forecasting are:
 Trend method
 Regression method
 End- use method
The main components of market appraisal, both informal as well as
formal, are
 Competitive environment analysis
 Consumer analysis
 Preparation of marketing plans
 Assessment of market potential
 Demand forecasting
Economic Appraisal
Economic appraisal of a project basically deals with the effect of the project
on economic aggregates of the country. Economic appraisal may categorize
these under two broad categories. The first deals with the impact of the
project on net social welfare or benefits and second deals with the effect of
the project on employment and foreign exchange. Economic appraisal of a
project effects positively or negatively on the economy of a country.
Following points are considered by project manager in economic
appraisal:
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