Balancing Project Financing and Mezzanine Project Financing with Option Value to Mitigate Sponsor’s Risks for Overseas Investment Projects

Abstract

Major steel-making companies in Korea have recently been trying to advance into international markets for better profitability and new market shares. Even with strategic partnerships with local organizations, the Korean steel companies are facing and incurring significant risks which impact their ability to achieve a sustainable profit. The objective of this research is to determine an optimum combination of financial models, specifically Project (PF) and Mezzanine Financing (MF) with an option (convertible bond and bond with warrant). The results of the proposed model can lower interest rates of financing, thereby increasing the profitability of the project investors. To analyze the MF method’s effectiveness and proper use, the following three steps are applied: (1) Monte-Carlo Simulations (MCS) using Excel and @Risk software are performed for the Net Present Value (NPV) of the project and its volatility; (2) the Black-Scholes model (BSM) is applied to evaluate MF based on project value; and (3) interest rate of MF is calculated from its option value and is reapplied back to the NPV calculation of the project to determine the effects of MF. Assuming a 50% debt/equity ratio, these simulations were performed on five cases (50% senior debt, 0% MF for a base case then increasing MF and decreasing senior debt by 10% four times). Through this process, using the 10%, MF lowered the borrowing size by 20% and using MF continued to lower the borrowing size up to 40% borrowing when using 40% MF. Based on this result, the researchers support the use of MF to optimize Korean steel international financial models. The resultant data will serve as an effective method to increase net cash flow in overseas steel-plant project investments. This research was performed for a steel plant located in Iran as a case-study, but this optimized financing method using MF with an option product can be applied sustainably not only for overseas investment of steel plants but also any other business, such as oil & gas, power generation, and transportation industries.