Before we introduce how to model a project finance transaction, it is worth understanding the two phases in some detail, the construction phase where the project is built, and then the operational phase when cash flows are generated. So from a modeling perspective, we need to understand how much money is needed in the construction phase. Then we also need to understand how much cash flow we think the project can generate after the construction phase when the project is operational.

And lastly, we need to understand whether shareholders and the lenders are going to get the returns they require for taking risk to invest in the project in the first place.

So the construction phase budget is mainly focusing on how much money the special purpose vehicle is going to need to build the project. This phase takes typically two to three years, and in some cases five years.

One key thing to remember is that once you've raised the money, it's very difficult to go back for more. When we establish how much money we think the project is going to need, we need to be really sure that is the maximum amount they can raise.

Also, you can't expense interest or commitment fees during the construction phase, so they will need to be capitalized. In most cases, these fees and interest will still need to be paid in cash. You just won't expense on the income statement. You will add it to the construction costs and it'll become an asset on the balance sheet and it will be depreciated or amortized over time.

So what are the key costs that we're looking at? The largest cost is the turnkey construction contract. There will be a timetable of payments made to the contractor based on key deliverables. There are going to be other costs related to the construction of the project project. There could be startup costs like putting a road in where the project is located, putting electricity and other water services in. There may be some purchase of land. There's also other softer costs, which are things like fees to the banks, advisors, lawyers, engineers, and accountants. All these are costs related to the construction phase and all these costs will get capitalized onto the balance sheet.

There is some different terminology When when we think about costs in relation to project finance transactions, there is the direct investment costs or sometimes known as hard costs like capital expenditures, the building of fixed assets. Then there are other costs which are related to building the project but aren't for hard assets. And these are called soft costs. A good example of soft costs will be capitalized interest and fees, the lawyer's fees, the accountant's fees as well. We also have to think about other cash payments like VAT or value added tax on all these construction costs, both the hard and the soft costs. We'll typically pay VAT, and that's not in every jurisdiction, but only in jurisdictions which have value added tax that will be paying VAT during the construction phase. However, we won't be able to reclaim it until the operational phase. So we need financing that will cover the timing difference between paying the VAT and being able to reclaim it. We'll also need a contingency. We're not a hundred percent sure that this is going to be correct when we initially estimate the costs. So we always need a little bit of room in case that our costs are higher than expected.