Corporate and Project Finance Modeling

Chapter 45Refinancing and Valuing a Project Given Risk Changes over the Life of a Project

As a project goes through different stages of its life, its risk can change dramatically because of elimination of construction risks, building up an historical track record, resolution of permitting risks, and many other factors. When the risk of anything changes, its value also changes. Any project finance analysis should in theory account for risk changes across phases when assessing a variety of valuation metrics from both a debt and an equity perspective. This idea of risk changing during different phases may be most relevant for project financing but it can also apply to corporate finance. If a corporation somehow reaches the stable state where growth slows and return is close to the cost of capital, the risk is surely also different. Accounting for changes in risk during the life of a project is an essential part of the valuation analysis that is very often ignored. Risk changes over the life of a project should be incorporated in a project finance model in a number of different ways. The project should be valued at different discount rates that reflect the changing risk of the project. Measured rates of return on the project should be adjusted so as to reflect the changes in risk, meaning the internal rate of return (IRR) does not really work. Financing assumptions for a project should incorporate the ability to refinance a project after the risk profile has changed. The political ...