Download - Financing of Projects
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Presented by
Parikshit SahaPankaj LokeshRandeep GargSahil AggarwalNishant Adlakha
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Capital Structure Menu of Financing
Debentures Methods of Offering Term Loans Miscellaneous Sources Raising Venture Capital Raising Capital in International market
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DEBT EQUITY
Must be repaid or refinanced Can usually be kept permanently.
Requires regular interest payments.Company must generate cash flow to pay.
No payment requirements. May receivedividends, but only out of retainedearnings.
Debt providers are conservative. Theycannot share any upside or profits.Therefore, they want to eliminate allpossible loss or downside risks
Equity providers are aggressive. They canaccept downside risks because they fullyshare the upside as well
Interest payments are tax deductible. Dividend payments are not tax deductible
Debt has little or no impact on control ofthe company
Equity requires shared control of thecompany and may impose restrictions.
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Cost Nature of Assets
Business risk Norms of lenders Control considerations Market conditions
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InternalAccruals
Securities
WorkingCapital
Advances
TermLoans
MiscellaneousSources
Sources of Finance
Sources of Finance
Equity Debt
EquityPreferenceInternal Accruals
BondsTerm Loans Working Capital Advances
Miscellaneous Sources
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Internal accruals of a firm consist of depreciation charges andretained earnings. Depreciation represents the allocation ofcapital expenditure to various periods over which the capitalexpenditure is expected to benefit the firm.
Advantages:1. Internal accruals are readily available.2. It eliminates issue costs and losses on account of
underpricing.
Disadvantages:1. The amount that may be available by way of internal accrualsmay be limited.
2. The opportunity cost of depreciation-generated funds is equalto the weighted average cost of capital of the firm.
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Equity capital represents ownership capital as equity
shareholders collectively own the company. They enjoy the
rewards and bear the risks of ownership. However , their
liability, unlike the liability of the owner in a proprietary firm
and the partners in a partnership concern, is limited to theircapital contributions.
The book value of an equity share is equal to:
Paid-up equity capital + Reserves and surplus
Number of outstanding equity shares
The book value of an equity share tends to increase as the ratio
of reserves and surplus to paidup equity capital increases.
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Advantages:1. There is no compulsion to pay dividends.2. Equity capital has no maturity date and hence the firm has no
obligation to redeem.3. Equity capital provides cushion to lenders, it enhances the credit
worthiness of the company.4. Presently, equity dividends are tax-exempt in the hands of
investors.
Disadvantages:1. Sale of equity shares to outsiders dilutes the control of existing
owners.2. Cost is very high, usually the highest.3. Equity dividends are paid out of profit after tax, whereas interest
payments are tax-deductible expenses.4. Cost of issuing equity shares is generally higher than the cost of
issuing other types of securities.
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1. Right to income: The equity investors have a residual claimto the income of the firm.
2. Right to control: Equity shareholders elect the board ofdirectors and have the right to vote on every resolution placed
before the company. The board of directors, in turn, selects themanagement which controls the operations of the firm. Henceequity shareholders exercise an indirect control over the operationsof the firm.
3. Pre-emptive right: This right enables existing equityshareholders to maintain their proportional ownership bypurchasing the additional equity shares issued by the firm.
4. Right in Liquidation: Equity shareholders have a residualclaim over the assets of the firm in the event of liquidation. Claimsof all others-debenture holders, secured lenders, unsecured lenders,other creditors are settled prior to the claim of equity shareholders.
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Preference capital represents a hybrid form of financing- it
partakes some characteristics of equity and some attributes of
debentures. It resembles equity in the following ways
i. Preference dividend is payable only out of distributable
profits
ii. Preference dividend is not an obligatory payment
iii. Preference dividend is not a tax-deductible payment.
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Cumulative and Non-cumulative shares: Cumulativepreference shares entitle the shareholders to receive dividends for theprevious years in which dividend was not paid.
Participating and Non-participating shares: The holders ofparticipating preference shares get a share in the profits of the companyafter a certain date of dividends is paid to the equity shareholders of thecompany.
Redeemable and Non- redeemable Preference shares:Redeemable preference shares are repayable at par or at premium after a
specific period. Non-redeemable preference shares are not repayableexcept when a company goes into liquidation.
Convertible and Non- convertible Preference shares:Convertible preference shares can be converted into equity shares at theoption of the preference shareholders in accordance with the certain
predetermined terms. Non-convertible shares do not carry such an option.
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Advantages:1. There is no legal obligation to pay preference dividend.
2. Preference capital is regarded as part of net worth.
3. Preference shares do not, under normal circumstances, carry
voting rights.
Disadvantages:1. Compared to debt capital, it is more expensive source of
financing.2. Skipping preference dividend can adversely affect the imageof the firm in the capital market.
3. Compared to equity shareholders, preference shareholders
have a prior claim on the assets and earnings of the firm.
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Public offering
Rights issue
Private placement
Methodsof Offering/Raising
Finance
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It involves sale of securities to the membersof the public.
There are three types of public offering asunder:Initial public offering(IPO)Seasoned equity offeringBond offering
Public offering
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It is the first public offering of equity shares ofa company, which is followed by a listing of
its shares on the stock market.The decision to go public is a very important
issue. It is a complex decision so carefullytaken Benefits over Cost.
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The company has a certain track record ofprofitability and a certain minimum net worth.
The securities are compulsorily listed on a
recognized stock exchange, which means that acertain minimum percent of each class ofsecurities is offered to the public.
The promoter group is required to make acertain minimum contribution to the post issuecapital.
The promoters contribution to the equity issubject to a certain lock-in period.
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Subscription and allotment
Marketing
Due diligence and prospectus preparation
Hiring the merchant bankers
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Also called Secondary offerings.As companies need more finances, they are
likely to make further trips to the capitalmarket with seasoned equity offering.The process of this is easy than that of IPO.
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It is similar to IPO process, though somedifferences are there:
The prospectus for a bond offeringemphasizes a companys stable cash flows,whereas prospectus for an equity offeringcompanys growth.
Book building method is not used. It is necessary for a company to appoint one
or more debenture trustees before adebenture issue.
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A rights issue involves selling securities in theprimary market by issuing rights to the
existing shareholders.When a company issues additional equity
capital, it has to be offered in the firstinstance to the existing shareholders on a prorata basis.
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It consists of four forms , i.e. forms A,B,C and D. Form A is meant for the acceptance of the rights
and application of additional shares. It has also a
column through which a request for additionalshares may be made. Form B is to be used if the shareholder wants to
renounce the rights in favour of someone else. Form C is meant for application by the
renouncee in whose favour the rights have beenrenounced, by the original allottee.
Form D is used to make a request for split forms.
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A private placement is an issue of securities to aselect group of persons not exceeding 49.
Private placement means direct sale of securities
to a small number of investors. These investors are financial institutions , Banks. This method is very popular because it saves
time and cost. Private placement of shares can be of two types: Preferential allotment Qualified institutional placement
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Public issue Right issue Privateplacement
Amount that canbe raised Large Moderate Moderate
Cost of issue High Negligible Negligible
Dilution of control Yes No Yes
Degree of underpricing Large Irrelevant Small
Market perception Negative Neutral Neutral
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Firms obtain long term debt mainly by raisingterm loans or issuing debentures.
Term loans given by financial institutions andbanks have been the primary source of longterm debt for private firms and most publicfirms.
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Currency
Security
Interest paymentand principalrepayment
Restrictivecovenants
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Submission of loan application.
Initial processing of loan application.
Appraisal of the proposed project.
Issue of the letter of sanction.
Acceptance of the terms and conditions by the borrowing unit.
Execution of loan agreement.
Creation of security.
Disbursement of loan.
Monitoring.
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Cash credits/overdrafts. Loans.
Purchase/discount of bills.
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Predetermined limit for borrowing isspecified by bank.
Borrower can draw as often as required within that limit. Borrower enjoy the facility for repaying the
amount , partially or fully and when he desire. Interest is charged only for the running
balance.
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Advances of fixed money to the borrower. Interest charged on the entire loan amount.
Payable either on demand or in periodicinstallments.
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Arrangement whereby a bank help itscustomer to obtain credit from its supplier.
Letter of credit Here bank take responsibility to honour the
obligation of its customer if the customerfailed to do so.
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The information furnished in the applicationcovers the following..
Name and the address of the borrower andhis establishments. Detail of the borrowers business. Nature and amount of security offered. Financial statements and financial projections
of the firm.
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Involve examination of the following factors. Ability, integrity and experience of the borrower
in the particular business.
General prospects of the borrowers business. Purpose of advance. Requirement of the borrower and its
reasonableness. Adequacy of margin. Provision of security. Period of repayment. Repayment capacity.
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The amount of the loan or the maximum limitof the advance.
The nature of the advance. Period for which the advance will be valid.
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Rate of interest applicable to advance. Insurance of the security.
Details of the collateral security. Margin to be maintained. Other Restriction and obligations on the part
of borrower.
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Hypothecation-owner of goods borrowsmoney against the security of movable
property.
Pledge-owner of goods deposits the goodswith the lender as security for borrowing.
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Deferred credit- Under this the supplier gives time to the
buyer to pay for the machinery. But bank guarantee should be furnished by
the buyer.
Lease finance- Contractual agreement whereby the lesser
grants the lessee the right to use an asset inreturn for periodic lease rental payments.
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Intermediate term to long term noncancelable arrangement which vary from
three, five or eight years. The lesser recovers through the lease rentals
and acceptable rate of return. The lessee is responsible for maintenance,
insurance and taxes.
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The lease term is less then the economic lifeof the equipment.
Lessee enjoy the right to terminate the
contract at short notice without any penalty. The lesser provides the know how and the
related services and responsibility of insuring
and maintaining the equipment.
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Most leases are finance leases not operatingleases.
Lease finance is available for identifiable
performing assets. Lease finance is available in small volume. There is great deal of flexibility in structuring
lease finance. Lease of immovable assets is not possible bybanks.
Lease tenors up to eight years is available.
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The hiree purchases the asset and gives it onhire to the hirer.
Hirer pays regular installments over specified
period of time. With the payment of last installment the
asset is transferred from hiree to the hirer.
Hiree charges interest on flat basis not ondiminishing rate.
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Similar to the hire purchase but here the titleof the assets is transferred from hiree to thehirer when he pays his first installment.
In case of default the hiree can force thebuyer to sell the asset and recover hisremaining amount.
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Provided by the promoters to fill the gapbetween the promoters contribution
required by the financial institution and theequity capital subscribed to by the promoter. These are the deposits from the public with
tenor one to three years
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Bill rediscounting scheme- Operated by the IDBI. Meant to promote the sale of indigenous
machinery on deferred payment basis.Suppliers line of credit- Administered by ICICI. Under this scheme the bank directly pays to the
machinery manufacturer against usance billsduly accepted or guaranteed by the bank of thepurchaser.
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Subsidies and sales tax deferments andexemptions-
Provide subsidies to industrial units located inbackward areas.
Under sales tax deferment scheme the paymentof sales tax on the sales of finished goods maybe deferred for a period.
Commercial paper- Issued by firms which enjoys a high credit rating. Maturity period ranges from 90 to 180 days. Sold at discount and redeemed at par.
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Factoring- A factor is a financial institution work as a
mediator between the creditor and thedebtor.
Factoring may be recourse basis or non-recourse basis.
Factor charges a commission which may be 1to 2 percent of the face value of the debtsfactored.
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Euromarkets ForeignDomesticMarkets
ExportCreditScheme
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1. Composed of Eurobanks who accept ormaintain deposits of foreign currency
2. Dominant currency: US$
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caused by restrictive US government policies,especially
1. Reserve requirements on deposits2. Special charges and taxes3. Required concessionary loan rates4. Interest rate ceilings
5. Rules which restrict bankcompetition.
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1. A chain of deposits
2. Changing control/usage of deposit
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3. Eurocurrency loans
a. Use London Interbank Offer Rate: LIBOR as
basic rate
b. Six month rollovers
c. Risk indicator: size of margin between costand rate charged.
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4. Multicurrency Clauses
a. Clause gives borrower option to switch
currency of loan at rollover.
b. Reduces exchange rate risk
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5. Domestic vs. Eurocurrency Markets
a. Closely linked rates by arbitrage
b. Euro rates: tend to lower lending, higherdeposit
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1. Recent Substantial Market Growth-due touse of swaps.
Financial instrument which gives 2 parties theright to exchange streams of income overtime.
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2. Links to Domestic Bond Market arbitragehas eliminated interest rate differential.
3. Placement underwritten by syndicates ofbanks
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4. Currency Denominationa. Most often US$b. Cocktails allow a basket of currencies
5. Eurobond Secondary Market result of risinginvestor demand
6. Retirementa. sinking fund usuallyb. some carry call provisions.
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7. Ratingsa. According to relative riskb. Rating AgenciesMoodys, Standard & Poor
8. Rationale For Market Existencea. Eurobonds avoid government
regulationb. May fade as market deregulate
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E. Eurobond vs. Eurocurrency Loans International bond denominated in a currency not native to the country
where it is issued. Also called external bond.
A Eurodollar bond that is denominated in U.S. dollars and issued inJapan by an Australian company would be an example of a Eurobond.
1. Five Differencesa. Eurocurrency loans use variable rates
b. Loans have shorter maturitiesc. Bonds have greater volumed. Loans have greater flexibilitye. Loans obtained faster
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F. Note Issuance Facility (NIF)A syndicate of commercial banks that have agreed topurchase any short to medium-term notes that a borrower
is unable to sell in the Eurocurrency market.
1. Low-cost substitute for loan2. Allows borrowers to issue own notes
3. Placed/distributed by banks
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G. NIFs vs. Eurobonds
1. Differences:
a. Notes draw down credit as neededb. Notes let owners determine timing
c. Notes must be held to maturity
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Foreign Domestic Markets
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Most firms raise their initial capital in theirown domestic market
While many can be tempted to skip the
intermediate steps to complete anEuroequity issue in global markets, goodfinancial advisors will offer a reality check onthis strategy
Most firms that have only raised capital intheir domestic market are not well enoughknown to attract foreign investors
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Depositary Receipts Depositary receipts are negotiable certificates issued by a
bank to represent the underlying shares of stock, whichare held in trust at a foreign custodian bank Global Depositary Receipts (GDRs) refers to certificates traded
outside the US
American Depositary Receipts (ADRs) are certificates traded inthe US and denominated in US dollars
ADRs are sold, registered, and transferred in the US in the same
manner as any share of stock with each ADR representing somemultiple of the underlying foreign share
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Depositary Receipts
This multiple allows the ADRs to possess a priceper share conventional for the US market
ADRs are either sponsoredor unsponsored
SponsoredADRs are created at the request of aforeign firm wanting its shares traded in the US;
the firm applies to the SEC and a US bank forregistration and issuance
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Export Credit Schemes
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Prominent Export Agencies US EXIM,JEXIM, HERMES, and COFACE
Follow certain consensus guidelines forsupporting exports under Berne Union
Interest Rate is regulated Two Kinds of Export Credit
Buyers Credit
Suppliers Credit
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The overseas exporter and the Indian Buyernegotiate a contract
An application for the buyers credit facility ismade to the export agency of the exporterscountry along with relevant details
The buyers credit facility is approved by the
export credit agency f the exporters country A negotiated loan agreement delineating the
terms and conditions
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The overseas exporter notifies his bank andthe export credit agency of a potential exportorder of an Indian buyer who requiresmedium term finance
The export credit agency communicates tothe bank its willingness to provide the facility
The terms of the facility are incorporated inthe contract between the overseas exporterand the Indian Buyer.
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