In most cases, we require a high return from emerging market investments in order to justify the high risks associated with such investments. However, requiring high returns can itself make emerging market projects more politically risky and more subject to eventual expropriation by the foreign government. An alternative to demanding high returns is to rely on creative project structuring (both financial structuring and operational structuring), to reduce the investment risks to manageable levels. The Mozal Project offers such a good example to illustrate the theme that "structure matters".

1. What is project finance? Why do the sponsors use it in the Mozal case?

2. How risky is investing in Mozambique?  Sovereign risk? Construction risk? Operating risk? Why would anyone invest in such a high-risk country?

3. Based on the information in Exhibit 6, what is the Internal Rate of Return (IRR) for the combined capital of equity and subordinated debt (treat the combination of equity and subordinated debt as an equity investment)? Use the CAPM to determine an approximate required rate of return on this investment (use a market risk premium of 7.5% and make other assumptions if necessary). Then, is the IRR too high or too low? Should Alusaf/Gencor invest in the project?

4. One common valuation technique for emerging market projects is to use a discount rate that is equal to the CAPM-determined  rate plus a Brady Bond yield spread for the subject country's sovereign debt. Assume that as of 1997, the Nigerian Brady Bond spread is 6.8% and that Nigerian country risk is similar to Mozambique's. Then, apply this method to value the combined investment of equity and subordinated debt in the Mozal Project. What is the NPV then? Suppose you want to change the dividend+interest payment flows to the equity and sub debt investors from the project, so that under this required rate of return the new resulting NPV for the combined equity and sub debt will be zero. What would be the new payment flow to this combined investment? Will this new payment stream create more political risk and hence make expropriation more likely? It should be realized that the GDP for Mozambique was just $1.7 billion in 1996.

5.  How are the risks mitigated through the proposed project finance structure? Is the high leverage better for mitigating sovereign and expropriation risks? Is there currency risk remaining? What is in the structure to mitigate currency risk? Discuss how the operating and production input-output structure mitigates the sovereign, expropriation and operating risks (e.g., the use of South African power supply, alumina from Australia, technology from France, management from South Africa, aluminum output sold abroad, and sale proceeds kept in a foreign bank trustee account).

6. The sponsors expect to get political risk insurance (PRI) for the bank loans from CGIC.  What is the purpose of PRI? Why would CGIC sell such insurance as PRI? How would CGIC "hedge" their risks that come with PRI?

7. How does IFC's involvement affect the deal? Will the IFC and the sponsors share similar objectives? Should the IFC play an advisory role only or should it also invest in the Mozal project? If you were an IFC board member, would you approve the deal?

8. Why is IFC's presence in the deal important? What do they provide that is unique, valuable, and sustainable? How is the track record of the IFC's past investments? Evaluate the IFC's past performance.