When thinking about the structure of a project finance deal, the first thing that is key is understanding how we approach debt capacity. At its simplest debt capacity is the present value of future cash flows during the amortization period of the loan. In reality, the lenders, when they're looking at the forecast, won't assume that absolutely every dollar, euro, or pound of cash will be generated. As the forecast suggest, they may apply a haircut to the forecast, and that could be anything up to 20 to 30% reduction on the forecast cash flows.

So it's a conservative forecast which may lead to a funding gap. The remaining funding that isn't provided by the debt based on the present value analysis needs to be contributed by the sponsors in the form of equity.

Also, the banks won't lend unless they're sure that there's going to be some equity financing because that will act as their headroom.

Here we've got the forecast. In road two, the unlevered free cash flows over an eight year period, and we're assuming year one and two as the construction phase. We've got an interest rate of 5% and a net present value calculation assuming no taxes for simplicity.

Using the NPV function gives us a value of 466.6.

That effectively is the amount of debt this structure could support, assuming every dollar, euro, or pound of cashflow is used to repay the debt.

You can prove this by looking at the base calculation in row six through nine. We've opened the balance at 466.6, and then the interest is based on a beginning balance, so that's the 466.6 multiplied by 5% to give us interest of 23.3. And the payment is just a total cashflow we used earlier. The payment is a combination of paying the interest and the principle. So for example, in year three, our interest is 25.7 and our payment is 50, and so of that 25.7 will go to paying the interest and the rest will be paying back the principle. That's why the ending balance is 490, and the beginning balance is 514.5. The total funding required is 600, but the maximum the banks would lend is 466.6, and that's assuming of course, that the cash forecast is accurate. So in that situation, the banks would Require shareholders to put in the rest 133.4, and in fact, they wouldn't generally lend unless there's at least some equity because that provides headroom for them in case things go wrong.