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MBA – PM0012 : List the advantages and disadvantage of project finance.

Posted on: March 2, 2012

 MBA – PM0012 :  List the advantages and disadvantage of project finance.

Answer:- The major advantages of project finance are:

· Allows the promoters to undertake projects without exhausting their ability to borrow amount for traditional projects.

· Limits financial risks to a project to the amount of equity invested.

· Enables raising more debts as lenders are sure that cash flows from the project will not be siphoned off for other corporate uses.

· Provides stronger incentives for careful project evaluation and risk assessment.

· Facilitates the projects to undergo careful technical and economic review.

· Eliminates the dependency on alternative nature of funding a project.

· Facilitates the arrangement of liability financing and credit improvement, accessible to the project but unavailable to the project sponsor.

· Enables the diversification of the project sponsor’s investments to reduce political risk.

· Gives more incentive for the lender to cooperate in an atmosphere of a troubled loan.

· Enables to have prolonged credit opportunities.

· Matches specific assets with specific liabilities.

Project finance[2] primarily benefits sectors or industries where, projects are structured as a separate entity, apart from their sponsors. Let us take the example of a stand-alone production plant. This is assessed in accounting and financial terms separately from the sponsors’ other activities. Generally, such projects tend to be relatively huge because of the time and other transaction costs involved in structuring, and because of the considerable capital equipment that needs long-term financing. In the financial sector, by contrast, the large volume of finance that flows directly to developing countries’ financial institutions has continued to be a part of the usual corporate lending kind.

All these do not mean that Project Finance is devoid of any disadvantages.

The major disadvantages of project finance are:

· Complexity of the process due to the increase in the number of parties and the transaction cost.

· Expensive as the project development and diligence process is a costly affair.

· Litigious with regard to negotiations.

· Complexity due to lengthy documentation.

· Requires broad risk analysis and evaluation to be performed.

· Requires qualified people for performing the complicated procedures of project finance.

· Obligations regarding the trust fund account need to clearly specify.

· Higher level of control which might be exercised by the banks, which might bring conflict with the businesses or contracts.

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