In principle, capital budgeting is about cash flows, figuring out the cash outflows or how much you've got to invest versus the cash inflows from the project. And then looking at those two things to calculate returns. In the context of project finance, we have a long period of cash flows that we have to forecast and a very detailed cash outflow during the construction period. And we have to remember to include all the costs of construction, not just the CapEx, but all the soft costs, including things like VAT payments. We would normally do all this in a multi-year sources and uses of funds. The uses of funds is all the spending and the sources is all the financing. The financing of debt and equity remains proportionally constant. In other words, if you assume that debt is going to be 70% of the total capital, it will be 70% of the capital in year one in year two, and in year three of the construction phase.

You will probably have a VAT facility, which is separate and just finances the VAT spend. You'll also have an interest facility, which is financing the payment of interest during the construction phase.

If you take a look at this as an example, you can see in the uses of funds we are spending money on the development or the CapEx. Then we have soft costs, which could be accounting fees, legal fees and interest. We have working capital, which is built up in the last year of the construction phase in preparation for operations. And in this case we have two syndicated loan tranches, tranche A and tranche B, or term A and B. Term A will be paid off first and of course as a result, term A will be cheaper than term B. Finally, in this example, the sponsors are putting their money in both an equity and also a subordinated loan trench where the loan trench just helps them avoid the dividend trap.

Here we have a more detailed example. As you can see, we have CapEx as our hard costs, other expenses, legal fees, accounting fees, and other soft costs. And then we have VAT on all these costs, we are assuming a 15% VAT rate, and we're going to have to pay that VAT during these three years of construction and then we'll be able to claim it back once the project Is operational. We have a working capital buildup just in the last year, and we have a tranche for capitalized interest, and that is the interest we're paying on the debt that we have raised. And to make this simple, we've just assumed that interest is calculated on the beginning balance of the debt, so we avoid a circular reference down below. You can see the VAT facility exactly matches the VAT that is being paid. The equity is just 20% of the total uses of funds and the debt is our balancing figure. This gives us a more detailed example of a sources and uses of funds.