How Debt Sizing Works in Project Finance

Debt sizing is the process of determining the maximum amount of debt a project can support based on its expected cash flows. Unlike corporate finance where debt capacity is based on balance sheet metrics, project finance debt is sized purely on the project's ability to service that debt from operating cash flows.

The Core Principle

In project finance, debt is sized so that the project can always pay its debt service with a comfortable margin. This margin is expressed as the Debt Service Coverage Ratio (DSCR).

Once you know the maximum debt service the project can support each period, you work backwards to calculate the debt principal that corresponds to those payments.

Two Approaches to Debt Sizing

1. Mortgage-Style (Level Payments)

Like a home mortgage, the project pays the same total amount each period. Early payments are mostly interest; later payments are mostly principal.

Pros: Simple to model, predictable payments
Cons: Doesn't optimize for projects with uneven cash flows

2. Sculpted Debt

Debt service is "sculpted" to match the project's cash flow profile. If cash flows are higher in some years, debt service is higher in those years.

Pros: Maximizes debt capacity, maintains constant DSCR
Cons: More complex, requires detailed cash flow forecasting

The Debt Sizing Process

Here's the step-by-step process for sizing debt:

1. Project cash flows: Build a detailed operating model with revenue, opex, taxes, and maintenance capex
2. Calculate CFADS: For each period, determine Cash Flow Available for Debt Service
3. Apply target DSCR: Divide CFADS by target DSCR to get maximum debt service per period
4. Subtract interest: From max debt service, subtract interest to get principal repayment capacity
5. Size the debt: The debt amount that produces these principal payments (at the given interest rate and tenor) is your maximum debt

Constraints on Debt Sizing

Several factors can constrain debt below the DSCR-implied maximum:

The binding constraint — whichever limits debt the most — determines the final debt size.

Debt Sculpting in Practice

With sculpted debt, the model iteratively calculates:

1. Start with an assumed debt amount
2. Calculate interest expense based on opening balance
3. Maximum principal = (CFADS ÷ Target DSCR) − Interest
4. Closing balance = Opening − Principal repayment
5. Iterate until debt is fully repaid within the allowed tenor

The result is a repayment schedule where the DSCR is constant (at the target level) in every period, and debt service varies with cash flow.

Construction Period Considerations

During construction, there's no revenue and therefore no CFADS. Debt sizing must account for:

• Construction interest: Interest accruing during construction is typically capitalized (added to the loan)
• IDC (Interest During Construction): Must be included in total debt amount
• Fees and reserves: Upfront fees and DSRA funding often come from debt

Sensitivity Analysis

Lenders run sensitivities to stress-test debt sizing:

• P90 production: What if energy output is at the 90th percentile downside?
• Interest rate stress: What if rates rise 200 bps?
• Price sensitivity: What if merchant prices fall 20%?
• Opex overrun: What if operating costs are 10% higher?

Debt is often sized to the "downside case" — ensuring the project can meet coverage ratios even in adverse scenarios.