Since infrastructure projects are highly capital intensive, the private partner clearly lists out the financing risks associated with them before making an investment decision. If the project is a greenfield investment, there would be no cash flow during the construction period. Therefore, the private sector is unlikely to fund the total capital expenditure through equity participation.
| Why leverage? The project sponsor and its advisors typically seek to minimise the cost of finance for the project. Because equity is regarded as more expensive than debt, project sponsors often try to use a high proportion of debt to finance the project. Typically, leverage (the proportion of debt in the total financing package) is high for infrastructure projects. Debt providers have less risk than equity providers. Return on equity is based on dividends and capital gain. Equity providers receive dividends only after operating expenditures, debt service and taxes are paid. This is uncertain and equity providers will price this risk accordingly. Interest costs are tax deductible and hence bring down the cost of capital for the project. |
A project may use either conventional or innovative means to finance a PPP project. The kinds of financing that are considered conventional and innovative are shown in the figure below.