MBA-III SEM

Manav Rachna College of Engg.

Project management and
Infrastructure Finance
Risk Analysis
 Project finance analysis to a large degree involves identifying,
allocating and mitigating risk. One must therefore be able first
to identify risks and then to measure how effective the contracts
and other mitigating factors (covenant, debt service reserve,
liquidated damage) are in managing risk.

 Project Finance Adage:

At the beginning of the project
-Lender has the money
-Developer has the experience
At the end of the project
-Developer has the money
-Lender has the experience
Project Finance Risk Analysis Process
 The analytic task begins with identifying a
broad spectrum of risks to which lenders might
be exposed
 Determine which risks the project can avoid
through allocation of those risks elsewhere
 Those risks that remain unallocated,
unmitigated or minimal in consequence,
determine the risk of default.
Risk Management

 Risk
The chance of loss
A dangerous element
To expose to danger

 Management
Judicious use of means to accomplish an end
Risk Management Evolution
Currency, Interest Rates, Metals, Petroleum,
Alternative Risk Classification
 There are many ways to classify risk. (Arguing about which way
to classify risks is not very interesting.) Some of the
alternatives include:
Construction period versus operation risks according to the

Manav Rachna College of Engg.

phases of project finance
Construction risks include technological risks while operation risks
include market risks.
Risks associated with free cash flow and financing cash flow
Project risks, financial risks and political risks (Yescombe)
16 risks in project finance (Tinsley)
S&P six risks
Moody’s seven risks
Export Credit Agencie
Risk Analysis of Single Investments
 Project specific Risk: The earnings and cash flows of the
project may be lower than expected because of an estimation
error or due to some other factors specific to the project like
quality of management.
 Competitive Risk: The earnings and cash flows of the project
may be affected by the unanticipated actions of competitors
 Industry-specific Risk: Unexpected technological developments
and regulatory changes, that are specific to the industry to which
the project belongs, will have an impact on the earnings and cash
flows of the project as well
 Market Risk: Unanticipated changes in macroeconomic factors
like GDP growth rate, interest rate, and inflation have an impact
on all projects, albeit in varying
 International Risk: In the case of a foreign project, the earnings
and cash flows may be different than expected due to the
exchange rate risk or political risk.
Measures of risk
 Risk refers to variability. It is a complex and multi-faceted
phenomenon. A variety of measures have been used to
capture different facets of risk. The more important are:

Manav Rachna College of Engg.

 Range, Standard deviation, Coefficient of variation, and semi-
variance.
 Perspectives on Risk:
Regardless of the risk measure employed, there are
different perspectives on risk, which are:-

 Stand-alone risk: This represents the risk of a project when it is

viewed in isolation
 Firm risk : Also called corporate risk, this reflects the
contribution of a project to the risk of the firm.
 Systemic risk/ market risk: this represents the risk of a project
from the point of view of a diversified investor.
Contd….
 The varieties of techniques developed to handle risk in
capital budgeting fall into two broad categories:

 (i) Approaches that consider the stand-alone risk of a

project( sensitivity analysis, scenario analysis, breakeven
analysis, Hillier model, simulation analysis, and decision
tree analysis ).

 (ii) Approaches that consider the contextual risk of a project

(corporate risk analysis and market risk analysis).