Write an essay on Fantastic University.
Fantastic University is a non-profit organization, which intends to start a building project, amounted to $6.5 million. The organization uses to own a handsome amount of endowment fund. It is appreciated with triple A rating in terms of credit rating. Inspite of having enough internal fund and scope of bond financing, the management wish to finance the project out of its net operational income.
The report is prepared to analyze the various sources of project financing and suggest the suitable source to the management. For this purpose, all the sources are critically overviewed along with the related advantages and disadvantages. Various consequences are also examined to co-relate with the project and with the organization to determine how any particular decision will affect the organization’s financial structure and operation.
According to International Project Finance Association, project finance can be explained as the financing procedure for long- term infrastructure and public services, where the project cost, in terms of debt and equity, used for financing the project, are used to be paid off out of the net revenue or the net cash flow, generated from the project.
The definition has given more focus on the financial activities of profit-seeking organization. For non-profit organization, the project finance may be defined as the process of sourcing the fund for financing any project, which will be covered by the net reserve fund, generated from financial activities.
Generally, the project costs for non-profit organizations, especially university, are acquired from donations made by trustees & government, endowment fund of the organization or by debt financing.
Project Finance Model:-
Before starting any project or planning for project finance, it is necessary to prepare an estimated financial cost structure on the basis of estimated inputs of the project. It will help to get an idea how much cost would be required periodically and also about the potential impacts of various funding options on the financial operation of the organization.
For this purpose, project finance model is used to be prepared for asses the capability of the project or the organization to cover the operating costs and the debt expenses, if any, over the total period of the period.
The main financial tool, used for the model, is the Estimated Cash Flow Statement. From the estimation, the organization can determine how much cash, it would require at any certain period of the project. Moreover, it can also provide the information whether the organization would be able to cover the additional debt expenses out of its operational cash inflow.
Assessment of the Sources for Project Financing:-
The most important part of project finance planning, is to determine the suitable finance structure. A suitable financial structure should include those financial sources, which can be more beneficial for the project or the organization. It is a common misconception that the sources, which would not cause any additional expenses, are more beneficial. It has been observed in many cases, that the additional expenses can be very useful for enjoying tax benefits and are proved to be cost effective than other sources.
The cost effectiveness of any financing source depends on its nature, taxation and government policies and the nature of the project.
Therefore, to determine the suitable project finance structure for Fantastic University, the possible financing options are discussed in detail below:-
1)Utilization of Endowment Fund:-
Endowment fund is the most common investment funds, maintained by the non-profit organizations in United States. Endowment fund is generally created from the donations and excess revenues, generated from the operations.
The endowment fund is mainly utilized for the operational activities and capital expenditures. Apart from that, it is also used for various specific purposes, such as, endowing professorship or student scholarships. The total fund is used to be invested in various investments and the expenses are met by the interest or dividend, earned from the investment, whereas, the principal fund is kept intact (Dimmock, 2012).
As discussed above, endowment fund is common source of project financing for the non-profit organizations. The management may use the endowment fund for the building project. The main advantage of using the endowment fund, is that the organization does not have to bear any additional interest expense for the project. There will be no extra burden on the operational activities to cover the project expenses.
Moreover, in the recent past, it has been observed that the total amount of donation to the universities and other educational institutions by non-government organizations or individuals has reduced as many universities were not utilizing the endowment funds properly. Therefore, if the organization would spend its endowment fund for development of the infrastructure, the donators might increase their donations. It would result in increase of the revenue of the organization.
The endowment fund is created not only for capital expenditures, but also for other special purposes. Therefore, if the fund is used for the building project, the organization may face problems to provide scholarship or professorship to deserved candidates. Moreover, this type of fund is also utilized to assist the operational activities. Hence, in future, the organization may suffer from shortage of funds in regard to continue its daily operations.
2) Bond Financing:-
Bond financing is a form of debt financing, which is provided by the local government authority to the non-profit organizations. The interest rate is very low in comparison to the conventional borrowings. These bonds are widely used for financing developments projects of the non-profit organizations.
Generally, the non-profit organizations use to borrow bonds from the government in exchange of credit enhancements, assets or other securities. Then the non-profit organizations use to appeal the investors to invest in the bond (Ke,2013).
The bond hold by the organization is credited with Triple A rating. Therefore, it will not have any problem to find potential investors for the bond investment. Moreover, the interest rate of the bonds are also very low and the organization can enjoy tax benefit from such financing policy also.
For the bond financing, though the interest is lower, the organization have to pay it on monthly or quarterly basis. Hence, it should have the financial strength to pay the interest on regular basis. Moreover, the principal amount of such debt has to be paid at one time. The organization may have problems to pay huge amount, which may affect its future operational activities.
3) Funding from General Business Operation:-
The profit and non-profit organizations also use to create funds from its normal operational activities and utilize the fund for project financing. This is another common way of raising funds from own resources. The organizations, who have steady source of income, use to follow this method.
Like, endowment fund, financing from general revenues, also uses to help the organization to avoid additional expenses, in terms of interest. Moreover, the organization can utilize its endowment funds for other purposes only by adopting this source of financing.
The organization should have the capacity to earn enough revenue to cover the periodical project costs. Such financing method may prevent the organization from spending its revenues for other purposes. Moreover, the project cost is based on estimation. If in the future the actual cost of the project increases, the organization will face great difficulty to complete the project as being an educational institution, its revenue generation is more or less fixed (McKinney,2015).
ent fund is the most commonly used financing sources for the capital projects of educational institutions. It does not have any interest expenses. On the other hand, the organizations use to utilize this fund for its operation and other specific purposes. Therefore, by utilizing the endowment fund, the management may face fund shortages for other operational activities.
higher rate of revenue generation till the ending of the project. For an educational institution, where the main source of income is donation and grants, it is not possible to maintain a steady income rate for a long period.
Therefore, it may be suggested that the most appropriate source of financing the project will be the bond financing. As the interest rate is lower, it will not be a cause of huge burden on the organization. The organization will also get tax exemption for the interest. For the repayment of the loan, the organization can create a reserve, where it will transfer some of its monthly earnings at end of each month (Wagner, 2013). As, there will be no fixed rate of savings, it will not hamper the daily operational activity. If at the end of the debt period, the organization cannot save enough fund for the repayment, the shortfall can be covered out of the endowment fund.