Post on 04-Jun-2018
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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
Financial Modeling and Project Evaluation Page 3Group 2
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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
Financial Modeling and Project Evaluation Page 5Group 2
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To be answered
Financial Modeling and Project Evaluation Page 6Group 2
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
Financial Modeling and Project Evaluation Page 7Group 2
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
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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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Financial Modeling and Project Evaluation Page 10Group 2
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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Financial Modeling and Project Evaluation Page 11Group 2
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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Financial Modeling and Project Evaluation Page 12Group 2
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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Financial Modeling and Project Evaluation Page 13Group 2
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
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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 Analysis
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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
Sensitivity Analysis
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
Financial Modeling and Project Evaluation Page 17Group 2