- The optimal mix of available sources of debt and equity finance
- The investment vehicle: Whether to structure the investment within the owner (project sponsor) firm’s balance sheet, or rather to set up a special purpose vehicle(SPV) involving a non-recourse or limited recourse financial structure
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Determining the optimal mix of available sources of debt and equity finance

Figure 1
In order to determine the optimal financing mix, it is necessary to determine the default spread attributable to the project. For projects undertaken by firms with a debt rating the corresponding spread can be directly determined. If no debt rating is available, a synthetic rating and corresponding spread can be determined from the interest coverage ratio. Adding that number to a risk-free rate should yield the pre-tax cost of borrowing for the firm to finance a new investment. Figure 2 illustrates synthetic ratings and corresponding spreads for different values of the interest coverage ratio (developed market firms with market cap > $5 billion).
Figure 2
The operating income that should be used to identify the interest coverage ratio and thereby determine the default spread and optimal debt ratio is a “normalized” operating income (the operating income is the income that this firm would make in a normal year). Specifically:- For a cyclical firm, this may mean using the average operating income over an economic cycle rather than the latest year’s income
- For a firm which has had an exceptionally bad or good year (due to some firm-specific event), this may mean using industry average returns on capital
- One-time charges or profits should not be considered
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Off balance sheet project finance: non-recourse or limited recourse financial structures
Final thoughts
In conclusion, determining the optimal mix of available debt and equity sources of finance as well as the optimal vehicle through which to structure the investment are critical decision factors that can significantly improve the economic returns and feasibility of the project, and therefore facilitate capturing the required financing from 3rd parties to make the new undertaking a reality. At PEC Consulting Group we work with each of our customers to adapt a tailored approach to determine and help structure the best financing solution for new industrial projects, determined by the specific characteristics and objectives laid forth.