As the demand for infrastructure grows, governments are increasingly looking to public private partnerships as an innovative way of financing infrastructure projects. However, regardless of who provides the financing, projects are financed using a mix of debt and equity instruments. The following chapter will review debt and equity as sources of financing, as well as the factors that contribute to their use.
The capital structure, as it is called, is the mix of debt and equity instruments that are used to finance a project. The capital structure can be made up of three components - equity, debt, and quasi equity/debt; the optimum of each, in theory, existing "when the capital structure balances the risk of bankruptcy with the tax savings of debt".8 However, the 'optimum' level of debt and equity for a project, as well as the sources of funding, are dependent on a number of factors including the project, stage of development, access to financial markets, and the project sponsors' own corporate finance strategy as demonstrated in Box 2-1.
Box 2-1 Hopewell Holdings Ltd and New World Development, both development companies, who during the 1990's generated approximately 80% of their revenues in Asia, each have a very different approach when putting together a financing structure for an infrastructure project. Hopewell, a pioneer in using project financing for infrastructure investments, believes in maximizing its use of external debt when funding projects and targets a capital structure that is approximately 75% debt and 25% equity. New World Development, unlike Hopewell, follows a completely different strategy. First, New World chooses a financing structure with a higher equity to debt ratio, with many of its project financed with 80% equity and only 20% debt. Second, its debt financing is full-recourse and on-balance sheet, rather than the more common non-recourse and off-balance sheet financing which is a key characteristic of project financing and a benefit of PPP structures.
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8 Simerly R. and Li M. Environmental dynamism, capital structure and performance: A theoretical integration and empirical test, Strategic Management Journal, Vol. 21, 31-49, 2000
9 All information pertaining to the capital structures of Hopewell and New World Development have been derived from research found in "Project Finance in Asia" by L.H.P. Lang.