Probabilistic Risk Analysis and Project Capital Structures

Increases in the securitization and syndication of credit have led to a growing distance between borrowers and the ultimate lenders. As trends continue to encourage the efficient packaging and sale of loans, it has become important for lead lenders to convince fellow syndicate banks of the risk profile of the credit as quickly and effectively as possible. Likewise, having an understanding of how a firm’s value has changed as a result of financial distress is invaluable during a restructuring process. A key element in understanding the impact of risk on firm values is the differential response of the managers (equity) and lenders (debt) toward volatility. This paper develops a framework for using simulation analysis as a common platform from which to communicate about financing risks and capital structure. The methods outlined here can be used to optimize responses to restructuring scenarios by enabling a better match between expected cash flows and capital commitments.