Project Finance Assignment Example | Topics and Well Written Essays - 7500 words

Project Finance - Assignment Example Unlike project finance which is considered a non-recourse option, the conventional source of funding for long term investments greatly depended on cash flows. Primarily, the classic lending principally depended on the credit rating of the borrower, since the company assets were used as security for the lending. However, due to the size of the project finance operation, the balance sheets of the participating company may be overshadowed, considering the possible lack of credit history by the special purpose vehicle that acts as the borrowing entity. Additionally, project financing has increasingly been used to fund investments as a non-recourse alternative because for an individual project, the debtor’s liabilities will not be remedied using the project sponsor’s assets. Instead of relying on the creditworthiness of the project sponsor, credit assessment is based on the expected cash flows of the project. The project sponsor is therefore relieved from any interest paymen ts or liability associated with servicing of the project. Similarly, a limited recourse in project financing implies that certain responsibilities and obligations of the project sponsor are incapacitated. ... Although the US corporations recorded a lower use of project finance compared to the foreign counterparts, the $34 billion investment in 2004 surpassed the $25 billion that was invested in new businesses by venture capitalists, and was half the $73 billion raised by stock listed companies via IPOs. From the study, project financed corporation investments were only 19% of the US corporations while 53% of international firms were project financed. Therefore, project finance has a 50% chance, and growing, over traditional corporate finance. The major short-comings of project finance First, the numerous participants involved in project financing have each a specific interest in mind. The complexity of the transactions results in conflicts of interest during risk diversification; lengthy negotiations and escalating costs for compensating parties that have accepted risks. Secondly, higher prices result because of the limited channels of enhancing credit risk to acceptable levels by banks. Consequently, increases in costs for due diligence services by consultants, engineers and lawyers are impacted by the increases in cost of credit. Thirdly, the complexity of the transaction structure and the lengthy documentation causes an increase in the interest on project financings channeled to a project sponsor compared to direct loans of equal magnitude. These costs accrue from the time spent during the evaluation of the project and documentation by the technical experts, lenders and lawyers employed by the project sponsor; cost of insurance cover against country risk; costs of employing technical professionals to oversee the project and adherence to the financing agreement; and costs of compensating lenders and third parties for accepting risk. The fourth disadvantage of project