Financial Management in Projects

•        Types and Sources of Finance

▫        Senior debt- Debt financing.  This types of financing have to be paid first ( money borrowed from number of sources including banks. They have the first claim to the project organization’s assets should the project fail and the company goes into liquidation. 

▫        Mezzanine debt- comes from the project organization’s equity holders.  Involves a schedule f loan repayments and interest payments at a predetermined rate.  Considered secondary to the senior debt.  Higher risk and higher interest rates.

▫        Secured vs. unsecured debt – secured against the companies assets and has lower interest rates in contrast to the unsecured debt. More risk to the lenders as it is only given to the project and its assets. Should the project fail the lenders have no way of securing their money.

•        Cost of Financing

▫        Cost of equity- is the dividends paid to shareholders plus any estimate of the equity’s capital growth. The cost of equity is usually calculated using the capital asset pricing model (CAPM). (More can be learned about this model in any finance textbook.)

▫        Cost of debt- is the cost of debt financing, or the interest paid on the money borrowed. While the cost of equity is payable out of untaxed income, the cost of debt is payable out of taxed income.

▫        Cost of capital = Ratio of equity * Cost of equity + Ratio of debt * Cost of debt

•        The cost of capital is the average cost of various forms of finance used by the project organization

▫        Expected Monetary Value - is also the most appropriate financial measure when measuring future uncertainty, or when multiple project outcomes are possible, each with a different cost and schedule. It is defined as the summation of the value of each outcome in dollars ($), weighted by the probability of that outcome. For example, consider a project that needs to be redesigned, and assume that the new approach involves some risk to accomplish this goal. One possible monetary outcome is $200,000 with a 40 percent probability of achieving this outcome, while anothermonetary outcome is $150,000 with a 60 percent probability of occurrence. The EMV of this project is

EMV = $200,00 ∗ 0.4 + $150,000 ∗ 0.6 = $170,000