Construction end and Debt Refinancing
An important issue at the finalization of the construction period is the treatment of any gains arising from debt refinancing. The completion of the construction stage involves a major change in project risk and cash-flow. On the one hand construction risks disappear as the asset is completed. On the other hand the cash-flow usually turns positive as the project starts to generate revenue (see Graph RR).
Graph RR - Construction end and Cost of Debt
| As the construction phase of the project comes to an end the inherent risk in the project drops, meaning that better terms of finance can be secured. In the graph to the left 'x' represents the difference between the risk in the construction and operational phases of the project. It also represents the difference in the level of interest rates which can be secured in the two phases. |
Source: Comptroller and Auditor General UK - 2006
For this reason many projects start with short term debt which is refinanced once the construction is complete. This will usually generate a positive impact on the project116. The treatment of economic and financial profits arising from refinancing will depend on the rules established in the contract. Since 2002, in the UK, PFI contracts provide for public authorities to receive 50 per cent of any gains arising from debt refinancing; for older contracts, a voluntary code ("the Code") applies whereby authorities expect to receive 30 per cent of the gains from debt refinancing.
A report by the comptroller and auditor general in the UK warns raises certain important issues that have to be analyzed during the refinancing. These relate on the one hand, to the risk of the government taking back certain risks as the result of the change in the debt profile (see BOX).
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116 A report by the House of Commons Committee of Public Accounts (2007) shows that in some projects the internal rate of return (IRR) increases my a multiple of between 4,6 to 2,4 as a result of refinancing