Risk and return analyses in project financing: Selected cases in Vietnam

RISK AND RETURN ANALYSES IN PROJECT FINANCING: SELECTED CASES IN VIETNAM By HOANG MINH TAM A research study submitted in partial fulfillment of the requirement for the degree of Master of Business Administration Examination Committee: Prof. Jyoti P. Gupta (Chairman) Prof. I. M. Pandey Dr. Urs Bumbacher Hoang Minh Tam Nationality : Vietnamese Previous Degree : B.Eng. ( Energy Technology) Czech University of Technology of Prague Czech Republic Scholarship donor : Government of Switzerland Asian Institute of Technology Bangkok, Thailand March, 1995. - i - ACKNOWLEDGMENTS The author would like to express his sincere gratitude to Prof. Jyoti P. Gupta, Research advisor and Chairman of the Research Committee for his valuable guidance, constructive comments and encouragement throughout the research study. Thanks are also due to Prof. I. M. Pandey and Dr. Urs Bumbacher for their valuable contribution in serving as Committee members, as well as for precious suggestions and comments on the research study. The author would like to take this opportunity to express his deep appreciation to the Government of Switzerland, Asian Institute of Technology and the Ministry of Education and Training of Vietnam for organizing the Management Development Program in Vietnam (SAV program) and for providing him with a scholarship to complete his MBA at AIT (Thailand). Thanks are also extended to the West Lake Development Co. Ltd. and Thuy Tien Office Building's Owners, Vietnamese banks and foreign bank branches, representative offices and other institutions in Hanoi that he visited for his data collection. The willingness of the Vietnamese and foreign managers, officers of those institutions to spare their valuable time for discussions is greatly appreciated. The author remains indebted to his family, who have provided continued moral support during his whole study period in Ho Chi Minh City (Vietnam) and in AIT, Bangkok (Thailand). Especially, the author would like to express his indebtedness to his wife for her great love, her taking care of our son and her invaluable assistance in completing this research. Last but no least, the author would like to thank all the faculties and friends at SOM and AIT for their help and boundless inspiration. - ii - ABSTRACT Seeking investment opportunities, foreign investors today face difficulties in assessing the political, social and economic situation to classify the country risks and any kind of risks possibly related to their business in Vietnam. This study aims to highlight main aspects influencing the risk-return analysis in project financing. The research is carried out on the basis of the fundamentals of risks identification and the application of methods dealing with risks. Together with focusing on property business, data collection was conducted from secondary sources, in-depth interviews concerning two projects, direct and indirect interviews in some financial institutions. All visits were realized in Hanoi capital. The research revealed that most foreign investors assume risks arising from the country's legal infrastructure, especially laws on foreign investment and land. Problems with credit risk assessment and less developed banking system have been placing constraints against capital mobilization, which has certain effects on the financing of both foreign and domestic investments. Based on specific characteristics of risks inherent in projects, this study proposes a risk-return analysis model which should be used as a guideline for decision makers in financing decisions, who want to minimize risks and expect maximum benefit from their investments in the country being in the transition phase to a market-oriented economy. - iii - TABLE OF CONTENT Title page Acknowledgement i Abstract ii Table of content iii List of tables and figures vi CHAPTER 1 Introduction and Methodology 1 1.1 Introduction 1 1.1.1 General background 1 1.1.2 Objectives of the study 1 1.2. Methodology 2 CHAPTER 2 Considerations Of Risk And Return In Project Financing 6 2.1. Project financing - Concept and definition 6 2.1.1. Definition of project financing 6 2.1.2. Interested parties 6 2.1.3. The process of project financing 7 2.1.4. Sources of funds 8 2.2. Different kinds of risk in project financing 9 2.3. Methods of dealing with risk 10 2.3.1. Sensitivity analysis 10 2.3.2 Scenario analysis (Probability analysis) 11 2.3.3. Monte Carlo Simulation 12 2.3.4. Utility theory 12 2.3.5. Decision trees 13 2.3.6. Game theory 14 2.4. Analytical framework for analyzing risk & return in project financing 17 CHAPTER 3 Main Traits Of Operating Environment Of Business In Vietnam 19 3.1. Introduction 19 3.2. Situational description of operating environment of business in Vietnam 19 3.2.1. Legal infrastructure and foreign investment status 19 3.2.2. Banking system and financial institutions 27 3.2.3. Prospects of domestic Stock Exchange market 28 3.2.4. Macroeconomic stability 30 3.2.5. The availability and reliability of the information 31 3.3. Project financing in the Vietnamese context 32 - iv - TABLE OF CONTENT (continue) CHAPTER 4 Case Study 1: West Lake Regency - Service Apartment Project 33 4.1. Introduction 33 4.2. Public hotels, property business and the Tourism Industry in Hanoi 33 4.3. The project 34 4.3.1. Structure of the project 34 4.3.2. Funding structure 34 4.3.3 Project description 37 4.4. Parties involved 39 4.5. Financing Analysis 40 4.5.1. Cost estimation 40 4.5.2. Financing plan 41 4.6. Project evaluation 43 4.6.1. Service apartments development analysis 43 4.6.2. Fees and Revenues 44 4.6.3. Financial Analysis 45 4.6.4. Sensitivity Analysis 46 4.6.5. Economic Analysis 47 4.6.6. Project risks and expected returns (in relation to risk) 48 CHAPTER 5 Case Study 2: Thuy Tien - Office Building Project 51 5.1 Introduction 51 5.2 Private hotels, service apartments and houses for rent in Hanoi 51 5.3. The project 52 5.3.1. Structure of the project 52 5.3.2. Funding structure 53 5.3.3 Project description 55 5.4. Parties involved 55 5.5. Financing Analysis 57 5.5.1. Cost estimation 57 5.5.2. Financing plan 58 5.6. Project evaluation 59 5.6.1. Office building development analysis 59 5.6.2. Fees and Revenues 60 5.6.3. Financial Analysis 61 5.6.4. Sensitivity Analysis 62 5.6.5. Economic Analysis 63 5.6.6. Project risks and expected returns (in relation to risk) 64 - v - TABLE OF CONTENT (continue) CHAPTER 6 Proposed Risk-Return Analysis Model In Project Financing In VN 67 6.1. Proposed risk-return analysis model 67 6.2. Suggested stage breakdown of project lifecycle 70 CHAPTER 7 Conclusions And Recommendations 72 7.1. Conclusions 72 7.2. Recommendations 73 7.3. Suggestions for further study 74 7.4. Limitations of the research 74 APPENDIX A 75 APPENDIX B 95 REFERENCES 102 - vi - LIST OF TABLES AND FIGURES LIST OF TABLES vi Table 2.1 Project financing risks during various phases of project lifecycle 9 Table 2.2 NPV under various situations (Ai,Si) 15 Table 2.3 NPV in the "best" worst case 15 Table 2.4 NPV in the "best" best case 15 Table 2.5 Differential NPV under each alternative (Ai) 16 Table 2.6 The largest NPV difference under each alternative (Ai) 16 Table 2.7 Possible outcomes in various cases (DCF yield) 17 Table 4.1 Equity structure (US$) 36 Table 4.2 Loan structure (US$) 36 Table 4.3A Project Cost Estimation (summary) 41 Table 4.3B Project cost (summary) 43 Table 4.4 Rental rates (monthly) 44 Table 4.5 Estimated Income Statement (summary) 45 Table 4.6 Sensitivity of Dividend in relation to change in rentals 46 Table 4.7 Sensitivity of Dividend in relation to change in rental rise 46 Table 4.8 Sensitivity of Dividend in relation to change in occupancy rates 47 Table 4.9 Net Cash Flow over first 6 years 47 Table 4.10 Net Present Value (US$) and Internal Rate of Return (%) 50 Table 5.1 Equity structure (VND) 54 Table 5.2 Loans structure (VND) 54 Table 5.3A Project costs estimation (summary) 58 Table 5.3B Realized cost of the office building development (summary) 60 Table 5.4 Summary of Estimated Income Statement (in US$) 62 Table 5.5 Sensitivity of net income in relation to change in rental price 62 Table 5.6 Sensitivity of NI in relation to change in annual rental rise 63 Table 5.7 Schedule for repayment of loans (US$) 63 Table 5.8 Schedule for repayment of loans and payback self-investment (US$) 64 Table 5.9 Schedule for repayment of total investment including land value (US$) 64 Table 5.10 Net Present Value (US$) and Internal Rate of Return 66 - vii - LIST OF FIGURES vii Figure 1 - The Organization Chart of Research Study Report 5 Figure 2 - Analytical framework for risk-return analysis in project financing 18 Figure 3.1 Legislative process 20 Figure 3.2 Investment by years, 1988-1994 (in million US$) 25 Figure 3.3 Investment by sector, from Jan 1988 to Dec. 1, 1994 25 Figure 3.4 Top five largest investors (1/1/88-1/12/94) 26 Figure 3.5 Investment by license type, January 1994 to December 1, 1994 26 Figure 4.1 West Lake Regency Organization Chart 35 Figure 4.2 West Lake Service Apartment Project Financing 38 Figure 5.1 Thuy Tien Project Financing Scheme 56 Figure 6.1 Risk-return Analyses Model 69 LIST OF TABLES AND FIGURES IN APPENDIX A vii For chapter 3: Table A3.1. Investment by country, Jan 1, 1994 to Dec 1, 1994 75 Table A3.2. Investment by country, Jan 1, 1988 to Dec 1, 1994 76 For chapter 4 Figure A4.1. Communication channels (WLR) 77 Table A4.1. Master Budget for West Lake Service Apartments Development Project 78 Table A4.2. Expenses in West Lake Service Apartments Development Project. 80 Table A4.3. Projected Income Statement (conducted in feasibility study) 82 Table A4.4. Estimated Income Statement (conducted just before starting operation) 87 For chapter 5 Table A5.1. Project cost estimation 92 Table A5.2. Expenses for project development and construction 93 Table A5.3. Estimated Income Statement 94 LIST OF TABLES AND FIGURES ETC. IN APPENDIX B vii Figure B1. Foreign bank branches in Vietnam (by Jan 1995) 95 Figure B2. Investment by sector, Jan 1, 1994 to Dec 1, 1994 95 Table B3. The Leaders (investment by country, 1/1/1988-1/12/1994) 96 Questionnaire B4 97 Questionnaire B5 99