BORROWING CAPACITY ESTIMATION

The next important step in financing planning after estimating the total fund requirements of the project is to assess the borrowing capacity of the project in order to know the extent to which the project funding can come in the form of debt financing. Borrowing capacity is the amount of debt the project can service during the loan repayment period. The loan repayment period is again determined by risk profile of the project, bank's lending policies, and the prevailing market conditions. Banks are seldom willing to lend to infrastructure projects for periods that exceed 10 years from the date the project is completed.

An important test to assess the ability of the project to meet its debt service payment obligations will be, first, to calculate the present value of the stream of cash flow expected to be available for debt servicing during the loan repayment period and, then estimate what fraction of this amount the lenders will be willing to lend. This can be represented as below in the form of an equation:

Where, PV is the present value of available cash flow, D⁰ is the maximum loan amount, and ∝is the target cash flow coverage ratio.

Rough estimates of the project cash flows over the loan repayment period can be projected from the revenues and expenses estimates during the first year of project operation and the rates at which the revenues and expenses are likely to grow during the period when the loan is outstanding. Figure 1 shows the cash flow model for the project. The description of the variables used in this model is given below:

R = Cash revenues during the first year of operation E = Cash expenses during the first year of operation C = Non-cash expenses deductible for tax purposes each year gR = Annual growth rate of cash revenues gE = Annual growth rate of cash expenses N = Life of the loan measure from the date of project completion