Careful analysis of alternative financial structures is required to establish the right financing structure for a project. As the expected return on equity is higher than return on debt, the relative shares of debt and equity in the total financing package have important implications for cash flow of the project. Their relative share is also important for taxation purpose (generally the higher the debt the lower is the tax on return). Higher proportion of debt, however, requires larger cash flow for debt servicing, which could be problematic, particularly in the early years of project operation when the revenue earnings are generally low. This is a typical situation faced by transport and water sector projects. In such a possibility, the risk of default would be considered high.

Why financial structures matter?