FMID Group 2_Financial Modelling and Project Evalutaion

8/13/2019 FMID Group 2_Financial Modelling and Project Evalutaion

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The crucial role of Cash FlowProjections for Project

Evaluation

By

Akash Mittal

Prateek Vijay Gupta

Sandeep Shrivastava

Sankalp Raghuvanshi

Tobias Kahn


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Key terms

Economic viability

Depends on cash inflows and outflows

Timing of cash flows is importantDCF model, NPV

Cash inflows are difficult to predict than cash outflows

Discount rateshould take riskiness into account

Projects total cost Direct costs => engineering, labour, materials

+

Indirect costs

- Finance charges => interest, commitment fees

- Cost of financial guarantees

Preconstruction costs - permits

Financial Modeling and Project Evaluation Page 2Group 2


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Constant dollars vs current dollars:

Constant dollar refers to the value of currency adjusted for inflation (using the consumerprice index)

Current dollars refers to the actual amount of currency earned or spent over a period oftime, representing the market value

Key terms



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Financing and allocation of income

Private equity

investors

Engineering

firm

Local

utility

Limited partners

Engineering

firm

Local

utility

General partner

Cogeneration company Long-term lenders

Each contributes$5.675 million for22.22% limitedpartnership interest

Each contributes $1.419million for 50% equityownership interest ingeneral partner

Receive 90% ofincome, losses, and

distributions untilreversion

Contributes$25.539 millionfor 90% equityinterest

Contribute $85.131million of non-recourse loan

Debt service payments



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To be answered


What is the critical part of the case? Given the construction cost $100 million,why is the interest cost an important factor, according to the sponsors?

In the case, explain the criterions used or determining the proportions of debtand equity. What are the assumptions of cash flow projection for cogenerationproject?

Discuss the process of sensitivity analysis in the case with reference to returnson equity, interest coverage and debt service ratio (Refer to tables 8.8 and8.9)

What are the learning from the case?


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The Nature of Cash Flow Projection


The projected Cash Flows of a Project are the difference between the outflowsof the project (revenues) and the on going costs according to the financialarrangements of the project

Main components are the calculated debt service and the returns for the investors

Therefore Cash flow analysis is critical in determining the viability of anyProject

Moreover, the applied discount rate plays also a decisive role in affecting the

projects value The higher the rate, the lower the projects value


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Assumptions


The proportions of equity and debt were set by evaluating the profitability ofthe project

With a high guaranteed operating income (Cash Flow), the greater amount of debtcan be serviced

The Cogeneration Projects revenues were contractually assured by 15-yearpurchase agreement with Local Utility (electricity) and from sale of steamunder the 15-year steam purchase agreement with a Chemical Company

Prediction was made under a high degree of certainty, because the price per unit(MW-hour) was contractually secured and the operating reliability of similar plants

was well-documented

The gas supply agreement covered an contained an increasing gas price,founded on specific economic forecasting

Management fees and other operating fees increase also with the PPI


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Project Financing

Long term debt From commercial

bank Non recourse

financing

General Partners Engineering firm

and local utility

Limited partners: Not involved in

operations

Total capitalization = $113.5 mm

Debt75%

Equity25%

=

Total expected cost = $113.5 mm Construction

Commitment fee and interest Presonstruction cost Cost of arranging financing

Loan - $120 mmIncludes safety net for contingencies and

interest rate fluctuation


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Two owners: Engineering Firm and Local Utility

Agreed to pay preconstruction costs which were necessary to get further loans ($3

million)

Debt-Equity-Ratio 0.75/0.25

Funds during the construction period will be given by a commercial bank(100% of the cost during the construction period)

Total Construction Loan is about $120 million

$1.2 million (1%) are paid in advance as a facility fee

$2 million of fees related to the permanent financing were estimated

Constructing-period loans were made on a floating-rate basis

Financial Analysis I


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Cost of capital

Expected construction cost to $100 million

Commitment fees add $7.308 million

Difference of $12.692 million available to cover cost overruns or higher interestcharges (including $3 million preconstruction costs + $3.2 million cost of arrangingfinance)

Total project cost ($113.508 million) is sensitive to the interest rate during the

construction period

If interest rate increases, project cost increases

Financial Analysis II


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Overview (in $ million)

Amount Percent

Long-term debt 85.131 75.0

Equity 28.377 25.0

General Partner 2.838 2.5

Limited Partners 25.539 22.5

Total Capitalization 113.508 100.0

Financial Analysis III


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The total amount of debt is considered to be very high (75%)

The return on capital is split in active & passive investors

The general partners receive 10% and the limited partners 90% of the partnerships

income, until the limited partners have received cumulative cash distributions equalto their original investment ($25.539 million), the split will change to 50/50

Limited Investors will only invest in Cogeneration Project if the return rate ishigher than the profit of other investments with a similar risk

Indeed, the timing of equity investment affects the investors expected rate of return

Critical Points


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Sensitivity Analysis


Results rarely turn out exactly as expected

UNCERTAINITY

ResidualValue

Interest Rateon 10 yeardebt issued

ConstructionCost

Electric Powerpurchase

agreementGas Price Risk

Remainsuncertain

Interest rateprotection

arrangement isrequired to

make 10 yeardebt issue

certain

ConstructionContract

eliminates

uncertainty

No significantdesign changewill follow

previous design

15 year electricpower purchaseagreement & 15

year steampurchase

agreementmitigate output

pricing risk

15 year GasPrice agreement

mitigate gasprice risk


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Sensitivity of the projected returns on equity to variation inthe residual value

Return on

Equity (%)

Return on

Equity (%)

45 45

44 44

43.75

43 43

42 42

41 41

40 4039.41

39 39

Residual

Value

0.00 81.00 162.00 243.00 324.00 Before Tax

0.00 48.60 101.54 155.81 210.08 After Tax

Sponsors

Passive Equity Investors

The projectedrate of return

show verylittle sensitivityto the residual

value


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Learnings

Construction Loan

provide funds for contingencies & fluctuations in interest rates

Capital Structure

depends on assurity of cash flows, interest rate, maturity date, loanamortization requirements, and lenders coverage requirements

Cash Flow Projections

provide all details and assumptions

escalating revenues and costs at same rate

on the basis of constant dollars (esp. in a high inflation economy)

Group 2 Financial Modeling and Project Evaluation Page 16


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Learnings

Interest Rate

term loan

structured futures contract

interest rate swaps


performed for each variable factor

Discounted Cash Flow Analysis

financial model demonstrating projects profitability

ability to service debt obligations

accceptable rate of return for equity investors


Documents

FMID Group 2_Financial Modelling and Project Evalutaion