Hello everyone. Today we discuss one of the key aspects, of capital budgeting for project finance transactions. In particular, the definition of the budget of the construction phase. We want to exactly analyze how much money the SPV will absorb, during the phase where the construction is still pending. It is crucial because if we are not able to estimate correctly, the amount of money the project will absorb. We can end up with problems with shareholders and creditors because in project finance, once that the money is over, you don't have any possibility to increase the funding of the SPV. So, you must be as much careful as possible in order to, first of all, Identify the items, that we must include into the budget and second, to estimate how much money each item will require, in the project development. So, my question comes naturally to you. Should we have to put down a list, of all the possible items that we must, assess and quantify for the construction of the infrastructure. What would come to your mind? >> Well, for instance, construction costs? >> Yes, absolutely, this is probably the most important element. The construction cost is, the cost coming out from the turnkey construction contract. And the, the first element that you must take into account is exactly how much money will be given, to the contractor for the construction of the facility itself. Together with information regarding the time table of payments to the contractor itself. So, Valentina, good point, absolutely. >> For example, the cost of the land on which the project, it will be developed? >> Correct. If you don't have the land, you must also include, into the budget how much you will spend for the land. Take for example the case of a transportation project. You will have to expropriate the land, where the highway would pass through. And so, you have to take into account also the expropriation cost for land. So Carlo, good point. >> well, I also think the owners' cost. Because they have to bear ancillary cost on the construction. >> Correct. >> Also, I don't know, the insurance policies for the development of the construction. >> Correct, correct. Owners cost is a convenient level that we typically use in financial modeling to put together, all the ancillary additional costs. For example, I don't know, if you have to build an access road to the plant. You must take into consideration the construction, of the so-called outside the fence works, for example, a road. Another typical example is the insurance policies. That you typically must get in, during the construction to ensure the site of the construction. That are many other. For example, you must setup all the start up costs for telephone services, electricity services, et cetera, et cetera. And this costs must be quantified. >> For instance, given some development costs, in the starting phase. >> Exactly, development cost is another convenient label, we typically use for start up costs. And, it comes to my mind that, two of them are particularly important. The first one is, all the fees, that are paid to the bank syndicate. Or to the bank that helps the SPV to place the bonds in the market. Mind what we have seen in previous sessions. The second, element that comes to my mind, is all the fees that we pay to our advisors. During the analysis of the product. We must pay the lawyers. We must pay the engineers. The technical advisors, auditors, et cetera, et cetera. And this obviously is something that we must take into account. In setting up this kind of budget. Well you have done a good job. At the end of the day, cost of construction, cost of the land, owners' cost, and development cost, are typically grouped into the category of direct investment that. Is also the the category that absorbs most of the funds in the development of the construction phase. >> Well professor, if I understand correctly, the use of bank funds by the SPV would trigger interest payment, how can this be included in the budgets? >> Correct, nice question. The point is very tricky. Because, think about it. If during the construction, you use the funds of the shareholders, the sponsors, and the funds of banks, the funds of banks start producing interest, because you are using loans. But unfortunately, you can't pay interest, because all the money is committed for construction. So, from this point of view, what typically do, what we typically do in setting up the budget for the construction is to, let me use the term "imagine," that banks give up the payment of the interest throughout to the construction. And they agree with the special purpose vehicle to bring the interest until the end of the construction phase. We say, technically speaking, that we "capitalize" the interest, for all the period of construction. So that, at the very end, what we will have to give back. To the banks, it's not only the amount of principle but also the amount of accrued interest during construction. And the same, Carlo, holds true, if you have to pay any kind of fees. For example, commitment fees to banks. During the construction phase. You don't have money to pay them, as long as they are produced so they will be capitalized until the end and the total amount of funds that you will have, to give back to banks is the original principal plus all equity interest, plus all equity capitalize fees. This is an element that is not included into the budget of direct investment because it is a consequence of a direct investment. You have built facility, you have used the funds, and you have produced interest. That's why we typically include the capitalized interests and fees into the so-called budget indirect investment. Carlo, to complement your question I would also add one point. This is very country specific because not all countries apply VAT, Value Added Tax. But in countries where Value Added Tax is in action. You can understand that, if I pay the contractor, as long as the contractor builds the facility, the contractor will invoice me, demand some payment plus VAT. For example, if I am entitled as a contractor, to receive from the SPV an amount of 100 Million subject to VAT of 20%. In reality the special purpose, vehicle will receive an invoice, whose amount is 120 million and this additional 20 million, can be compensated with VAT on sales, only when sales will materialize. But this takes place, only when the construction is finished. So, you have also to finance the VAT that accrues during construction, and the VAT during construction is another important element that typically in countries where VAT's in action is typically included, into the budget over the indirect investment. So summing up. The budget of the construction. The budget of the construction is composed by the Direct investments, the indirect investments and for the sake of safety, this is the final element, very frequently we, financial modelers, typically include also a Contingency Amount. Contingency means that something can happen. We haven't expected it to materialize. And so, we go to shareholders and banks, and rather than asking them only the budget of direct and indirect investment, we ask to provide, additional amount of money in order to back up. Eventually the emergence of the so-called contingency. If the contingency will not materialize, the additional funds will not be used.
