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Many economic changes have been introduced in Vietnam in the last ten years. The centrally planned economy dominated for more than 40 years, but had not helped improve the nation's welfare.
Chapter Introduction and Methodology 1.1 Introduction 1.1.1 General background Many economic changes have been introduced in Vietnam in the last ten years The centrally planned economy dominated for more than 40 years, but had not helped improve the nation's welfare Since 1986, certain economic reforms have been launched and have put the economy in an encouraging position The market oriented economic model is increasingly accepted by Vietnamese citizens from different social classes The changes in the economic structure have had a significant impact on the operating environment of business which influences decisions on investment projects due to the presence of risk and uncertainty Uncertainty and risk accompany many forms of investment They are inevitable and sometimes require complicated analysis before the decisions are made The return on projects has to be carefully analyzed taking into considerations the risk characteristics of the project 1.1.2 Objectives of the study The overall objective of this study is: To highlight the main traits in the operating environment of business in Vietnam, while focusing on financial aspects in analyzing risk and return in project financing To achieve this, the specific objectives are as follows Carry out a literature review with a view towards developing a conceptual model for risk and return as well as methods dealing with risk Based on secondary data collected from various sources, prepare a brief on the situation of project financing in Vietnam Based on findings, compare theoretical procedures with real practice and attempt to develop a model for risk-return analyses in project financing Draw conclusions and make recommendation 1.2 Methodology The researcher aims first to conduct a review of the literature in order to highlight the following issues: v Project financing - Concept and definition v Different kind of risks in project financing v Methods of dealing with risk An analytical framework for risk and return analyses will be presented to support methodology as guideline for next sections The researcher also examined secondary data through in order to describe the operating environment of business in Vietnam with respect to risks associated to and return on investment projects Some major points are named below v Legal infrastructure and investment situation v Banking systems and financial institutions (briefly) v Project financing in the Vietnamese context One of the main parts of this research is to study two cases typical for the housing business, with the focus on private sector The direct interview is supported by a set of questions developed in form of a questionnaire The case studies rely mainly on the materials collected on individual project The first case study is conducted on the Service Apartments Development project where the major capital contribution comes from foreign investors The second case will look at an Office Building Development project, where the funds come only from Vietnamese investors The author carried out the in-depth interviews concerning projects in order to find out problems associated with project financing, regarding: v Parties involved; v Funding structure; v Returns expected in relation to risk Interview of some financial institutions, concerning: v Lending conditions; v Interest rate priority and repayment terms; v Risk and return considerations Based on (1) literature review, (2) secondary data about operating environment of business, (3) case studies on selected projects, and (4) personal interviews made with some financial institutions, a model is proposed as a guideline for risk-return analyses in project financing in Vietnam µ The scope of the study Secondary data which are used to highlight main traits of operating environment of business in Vietnam were collected in Vietnam Data collection relating the financing of two hotel projects was carried out in Hanoi city µ Organization of the study This report begins with the introduction and objectives of the research study in Chapter 1, then it presents the methodology for research planning and implementation This chapter also presents the organization of the research report in form of organization chart Reviewing literature is carried out in Chapter 2, which provides an overview on: (a) Parties involved in project financing, (b) Different kinds of risks in project financing, and (c) Some methods dealing with risks Some main traits of operating environment of business in Vietnam are highlighted in Chapter The basis for conducting this part is secondary data derived from journals, magazines, reports and other sources Two case studies are presented in Chapter and Chapter One is concerned with service apartments project financed mainly by foreign investors The other is office building project funded by local investors Chapter makes a comparison between theoretical and practical aspects regarding project financing in Vietnamese context and attempts to develop a model for risk and return analyses in project financing within operating environment of business in Vietnam This chapter also suggests an breakdown structure of stages in project lifecycle to be used in combination with the model Conclusions and recommendations are made in Chapter 7, which also figures out the limitation of this research study and provides some suggestions for further considerations in this topic Appendices and references are listed at the end of the report µ Organization chart of the report The organization of this report, summarized in the section above, is presented in form of organization chart (figure 1) INTRODUCTION METHODOLOGY LITERATURE REVIEW (Conceptual) SECONDARY DATA (Situational) CASE STUDIES CONCEPTUAL FRAMEWORK CONCLUSIONS AND RECOMMENDATION Figure - The Organization Chart of Research Study Report Chapter Literature Review Consideration of the risk and return In project financing 2.1 Project financing - Concept and definition 2.1.1 Definition of project financing "Project financing is a financing of a particular economic unit in which a lender is satisfied to look initially to the cash flows and earnings of that economic unit as the source of funds from which a loan will be repaid and to the assets of the economic unit as collateral for the loan" [Nevitt,1983] 2.1.2 Interested parties Project sponsors They take equity risk in the project and normally have the highest portion of profit or loss They are a group of companies and organizations which identify the market opportunities, then organize and negotiate with other parties to appraise, invest, subcontract, operate and monitor the project [Nevitt,1983] v First group: Corporations, Investment Banks v Second group: Government agencies, The World Bank (WB), regional Development Bank (DB), Government Banks Creditors They take debt risk in the project and have priority in claim against the project in the case of default Creditors can be categorized as senior debtors and subordinated debtors They include: v Commercial banks, v Institutional Investors, v Public Investors Supplier The profitability of the project is strongly influenced by the price of feedstock for project Relevant uncertainties will be relieved if project gets a long-term supply contract within certain price limits with supplier The project-supplier relationship secures mutual benefit since project is normally a big potential customer for the supplier Buyer For the project this is potential customer, whose promise to buy output of the project can greatly enhance the credit of the project The project-buyer relationship also secure their mutual benefit because the buyer can be sure about the future supply to itself Contractors They could be construction contractors or operating contractors Their ability to complete construction on time and the ability to operate the project effectively are two of the major concerns of creditors Multilateral agencies are government agencies and international organizations which provide their support to some large projects specially important for the socialeconomic development of a country The form of this support could be providing of equity capital, guarantees, concessions, low interest loans, subsidies, and local service, roads, water, sewers, and police protection 2.1.3 The process of project financing µ Preliminary feasibility study The purpose of this stage is to determine whether the project has sufficient merit to warrant further expenditure of time and effort to bring it about Normally, independent engineering, legal and financial consulting firms are invited to conduct a preliminary feasibility study, since their judgments are considered subjective and could be easily accepted by both sponsors and lenders A preliminary feasibility study will determine the objectives of the sponsors; review the plan of the sponsors to see whether the project is both technically and financially feasible; raise questions and issues which must be answered; and suggest alternatives ways to accomplish the sponsors' objectives µ Planning In this stage, different scenarios for the financing will: v be derived based on the preliminary feasibility study and assumptions about term structure of interest rate, currency exchange risk, inflation risk, debt/equity ratio, anticipated cash flow, completion risk, political risk, etc v be tested and compared to get one optimum funding plan µ Arranging the financing An information memorandum is prepared and presented to prospective lenders with the following: v The sponsors and promoters of the project are identified v Third party guarantors to the project (suppliers, buyers, contractors, etc.) are v v v v identified Location of the project The estimate of construction cost The financial plan The proposed terms for financing (amounts, maturities, and timing) µ Monitoring and administering the financing Cost over-runs and completion delays are the major concerns while monitoring the project during the construction period Debt must be taken down to match the financial plan and construction schedule, and estimates to completion must be prepared from time to time Administration of the loan agreements when implementing financing plans involves monitoring the actual operating cost and economics against the financial plan and production goals (market, sales revenues) 2.1.4 Sources of funds The main sources of funds are lenders and sponsors: µ Commercial lenders include v v v v v v v Banks; Institutional investors; Commercial finance companies; Leasing companies; Individuals; Investment management companies; Money market funds µ Commercial sponsors are v Companies requiring products or services; v Companies supplying a product or material to the project; v International agencies (WB, DB) 2.2 Different kinds of risk in project financing Risks related to project financing can be identified separately during various phases of project lifecycle (Table 2.1) Table 2.1 Project financing risks during various phases of project lifecycle Development phase v v v v Bid risk Credit risk Technological risk Market risk Construction phase v v v v v Political risk Exchange risk Performance risk Cost over-run risk Completion risk Operating phase v v v v v v Political risk Exchange risk Performance risk Cost over-run risk Liability risk Off-take risk µ Development phase Bid risk Because the lenders are not willing to participate in development phase, sponsors have to provide equity If the project proposal does not get the approval for its implementation, the sponsors would loose the money spent in preparing the bid, this is referred as bid risk Similarly, financial advisers would have to write off their costs if project proposal is not accepted [Nevitt,1983] Credit risk This risk refers to sponsors' creditworthiness, which would be supported by letters of credit from banks The questions of whether a credit risk or an equity risk is involved usually arises in connection with the adequacy of the underlying equity investment in the project, and the risks assumed by the sponsors and third parties [Nevitt,1983] Technological risk This risk is considered when a new technology is used in a project Lenders always try to avoid financing a project using new and untested technologies on a nonrecourse basis, unless the technological risks can be fully absorbed by some other parties The reason is that new technology would increase the completion risk, cost over-run risk and even the risk of failure of the project Market risk This risk refers to the marketability of a product or service produced from project operation, and must be considered at the beginning in form of market survey and research Competing products, estimated price and volume of the product, future cash flows, and completion from suppliers closer to the markets, or with less expensive sources of raw materials, feedstocks or energy are involved in a careful market study [Nevitt,1983] µ Construction phase Political risk refers to the occurrence of likelihood that a firm will suffer losses because of political or macroeconomic developments (political risk has the same meaning as country risk) This risk is difficult to ensure against, although there are various strategies to avoid it (such as joint agreement with a public partner) 10 Exchange risk The major concern for international investors is currency and foreign exchange risk when cash inflows and cash outflows are realized in more than one currency Potential losses may occur due to currency fluctuation Performance risk Final responsibility for a project's performance lies with the sponsors, who may provide performance guarantees [Nevitt,1983] Cost over-run risk Cost over-run plagues many projects, and usually have a stand by facility which is based on the guarantees from sponsors and the additional capital from sponsors in the form of subordinated loans or through fixed price contractors Completion risk involves both contractors and suppliers at construction phase To achieve the completion of the project by a certain date, sponsors often provide performance incentives and guarantees µ Operating phase Most of the risks at the operational phase can be covered through agreements with the relevant parties Operating risks can be taken by the operating and maintenance contractors through a performance guarantees; cost over-run by the sponsors through fixed price contractors; off-take risk through take-or-pay agreements or advance payments; and liability risk can be covered through insurance Political risks can be classified into two group: extra-legal versus legal-government risk and macro versus micro risk Since political risks refer to the probability of occurrence of the events (which will cause losses to the firm) in the non-market (political, economic, and social) environment of business, they are difficult to avoid 2.3 Methods of dealing with risk 2.3.1 Sensitivity analysis " Sensitivity analysis is a risk analysis technique in which key variables are changed and the resulting changes in the net present value (NPV) and the rate of return are observed." [Brigham,1992] It is clear that many of the variables which determine a project's cash flows are based on a probability distribution rather than being known with certainty If a key input variable, such as units sold, changes, the project's NPV will also change Sensitivity analysis can indicate exactly how much the NPV will change in response to a given change in a input variable, other things held constant The analysis technique begins with the so-called base case situation, which is developed using the expected values for each input Then the table describing the deviation from base level of considered variables will be developed The values used to develop the table, including units sales, sales price, fixed cost, and variable cost, are ... with an advantage even under these conditions, such as the minimization of the risk of loss, the maximization of the chance of gain, or the minimization of the regret the decision maker may suffer... financing of two hotel projects was carried out in Hanoi city µ Organization of the study This report begins with the introduction and objectives of the research study in Chapter 1, then it presents the. .. requiring a sequence of interrelated decisions to be made over a certain period of time The more complex the chain, the more essential becomes the use of such technique The concept of the network diagram