THE FUNDAMENTAL DIVISION, and everything else follows from it: EQUITY — ownership capital. The provider receives a share of the profits and bears the losses first. NO OBLIGATION TO REPAY, no fixed return, and NO SECURITY. Equity holders are paid LAST in a liquidation, which is why they demand the highest return. DEBT — borrowed capital. The provider receives interest at an agreed rate and repayment on an agreed schedule. MUST BE REPAID WHETHER OR NOT THE PROJECT SUCCEEDS, usually SECURED against assets, and paid FIRST. THE PRICE OF THE DIFFERENCE: DEBT IS CHEAPER THAN EQUITY — always, and for two reasons: the lender takes less risk (paid first, secured), and INTEREST IS TAX-DEDUCTIBLE while dividends are not. SO WHY NOT FINANCE ENTIRELY WITH DEBT? Because fixed repayments must be met in bad years as well as good, and a missed payment triggers default. LEVERAGE MAGNIFIES RETURNS IN BOTH DIRECTIONS. ── SOURCES OF EQUITY ─────────────────────────────────────── · promoters' and sponsors' own capital · retained earnings — the cheapest source, with no issue costs · public share issue (IPO). In Nepal, hydropower companies commonly issue shares to the public and, notably, to LOCAL RESIDENTS OF THE PROJECT DISTRICT — which converts potential opponents into shareholders and is as much a social risk strategy as a financing one. · private equity, venture capital · government equity participation ── SOURCES OF DEBT ───────────────────────────────────────── · commercial bank loans — term loans, working capital · SYNDICATED LOANS, where several banks share a large exposure that none would take alone. STANDARD FOR LARGE NEPALI HYDROPOWER PROJECTS. · debentures and bonds · DEVELOPMENT FINANCE INSTITUTIONS — the World Bank/IDA, the Asian Development Bank, IFC. They lend on CONCESSIONAL terms — lower interest, longer tenor, a grace period during construction — which matters enormously for infrastructure whose revenue begins only years after the spending does. · export credit agencies, tied to equipment purchases from their country · supplier credit and lease finance · in Nepal: the Hydroelectricity Investment and Development Company (HIDCL) and similar specialised institutions ── OTHER SOURCES ─────────────────────────────────────────── GRANTS — donor or government funds requiring no repayment, the cheapest money that exists but usually conditional and purpose-restricted. SUBSIDIES, viability gap funding — for projects with social benefits exceeding financial returns. INTERNAL ACCRUALS and deferred payment arrangements. ── THE COST OF CAPITAL ───────────────────────────────────── WEIGHTED AVERAGE COST OF CAPITAL: WACC = (E/V)·Re + (D/V)·Rd·(1 − t) E = equity, D = debt, V = E + D, Re = cost of equity, Rd = cost of debt, t = tax rate. THE (1 − t) FACTOR IS THE TAX SHIELD ON INTEREST, and forgetting it is the standard error. WORKED: a project funded 30% equity at 18% and 70% debt at 11%, with a 25% tax rate: WACC = 0.30(18%) + 0.70(11%)(0.75) = 5.40% + 5.775% = 11.175% AND THIS IS THE DISCOUNT RATE that should be used in the NPV analysis of the economics topics — the two subjects join here. THE DEBT-EQUITY RATIO (GEARING / LEVERAGE): Nepali hydropower projects are typically financed around 70:30 debt to equity, and lenders impose a maximum. HIGHER GEARING RAISES THE RETURN ON EQUITY WHEN THINGS GO WELL AND DESTROYS IT WHEN THEY DO NOT. THE DEBT SERVICE COVERAGE RATIO (DSCR): DSCR = cash available for debt service / (interest + principal due) Lenders require a minimum, commonly 1.2 to 1.5. A DSCR OF 1.0 MEANS THE PROJECT EXACTLY MEETS ITS REPAYMENTS WITH NOTHING TO SPARE — which is not comfort but a warning, since any shortfall becomes a default.

── PROJECT FINANCE (NON-RECOURSE FINANCING) ──────────────── THE STRUCTURE THAT MAKES LARGE INFRASTRUCTURE POSSIBLE: LENDING IS SECURED ON THE PROJECT'S OWN FUTURE CASH FLOWS AND ASSETS, NOT ON THE SPONSOR'S BALANCE SHEET. THE MECHANICS: · A SPECIAL PURPOSE VEHICLE (SPV) is incorporated to own and operate the single project, legally separate from its sponsors. · Lenders' recourse is limited to the SPV. IF THE PROJECT FAILS, THE LENDERS LOSE; THE SPONSORS LOSE ONLY THEIR EQUITY. · Security is taken over the project's contracts, licences and revenue accounts. WHY SPONSORS WANT IT: it RING-FENCES the risk, keeps the debt off their own balance sheet, and lets a modest company undertake a project far larger than itself. WHY LENDERS ACCEPT IT: because the revenue is contractually locked in. WHICH IS WHY THE CONTRACT STRUCTURE IS EVERYTHING. A bankable project finance package requires: · a POWER PURCHASE AGREEMENT (or equivalent offtake contract) fixing who buys the output, for how long, at what price · an EPC CONTRACT at a fixed price with a completion guarantee · an O&M contract · a concession or licence from the government · insurance and, often, political risk cover NO PPA, NO FINANCING. This is the single most important practical fact about hydropower development in Nepal, and it explains why PPA negotiation with the NEA dominates a developer's early years. ── PUBLIC-PRIVATE PARTNERSHIP (PPP) ──────────────────────── A long-term contract in which a private party finances, builds and operates public infrastructure, recovering its investment from user charges or government payments. BOT Build-Operate-Transfer BOOT Build-Own-Operate-Transfer BOO Build-Own-Operate (no transfer) DBFO Design-Build-Finance-Operate In Nepal, governed by the PPP and Investment Act. THE CASE FOR PPP: private capital for public assets; risk transferred to the party better able to manage it; whole-life incentives, since the party that builds it also has to run it and therefore has reason to build it well. THE CASE AGAINST: private borrowing costs more than government borrowing; long contracts are inflexible; renegotiation is common and always favours the party that cannot be replaced; and CONTINGENT LIABILITIES — government guarantees that do not appear as debt until they are called. THE HONEST SUMMARY: PPP MOVES A COST FROM THE CAPITAL BUDGET TO FUTURE OPERATING BUDGETS. It is not free money, and treating it as such is how governments accumulate obligations they have not counted. ── THE FINANCING PLAN AND CASH FLOW ──────────────────────── A financing plan must match the TIMING of funds to the TIMING of need, because a project can be fully funded on paper and still fail on liquidity: CONSTRUCTION PERIOD — heavy outflow, no revenue. Financed by drawdowns of equity first (lenders normally require the sponsors' equity to be spent before debt is released), then debt. INTEREST DURING CONSTRUCTION (IDC) — interest accrues before any revenue exists, and IS CAPITALISED INTO THE PROJECT COST. On a five-year construction period this is a large number and is frequently omitted from student answers. GRACE PERIOD / MORATORIUM — principal repayment deferred until commercial operation begins. Essential, and a standard feature of DFI lending. OPERATION PERIOD — revenue begins, debt is serviced, and equity holders are paid last from what remains. THE STANDARD FINANCING RISKS: cost overrun (who funds it?), completion delay (revenue postponed while interest accrues), interest rate movement, EXCHANGE RATE MISMATCH when debt is in foreign currency and revenue in rupees, and the offtaker's own creditworthiness. THE CURRENCY MISMATCH DESERVES ATTENTION: a project earning Nepali rupees and repaying US dollar debt takes a real risk that no amount of good engineering can manage, and a depreciation can turn a viable project into an insolvent one without anything physical changing.