Finance

Lecture # 4

Jan H. Jansen

E-mail: jan.jansen@han.nl

Wind energy

Minor Wind Energy Project Management

Project

Finance

Law

Supply Chain Management

Construction

Mechanical Engineering

Energy

Programme

Lecture Topic

1 Overview Energy Market

2 Annual Reports & Management Accounting

3 Management Accounting &Project Financials

4 Project Financials

5 Project risk & DOSIT Methodology

6 Business plan & Case study WEPM

7 Business Model & Case study WEPM

8 Written Exam

DSCR

• Debt Service Cover Ratio: CFADS / DS• DS (Debt Service)

– Interest– Instalment or Repayment of the loan (12 - 15 years)

• CFADS– Cash Flows Available for Debt Service– CFADS = Revenues – Costs – Taxes

• Costs– O&M costs (Operations & Maintenance)– Insurance costs– Management & Concession Costs

Recap lecture # 3

Project Financials (1)• Investment amount (A)

– Trade off’s: – Financial structure:

– e = E : A– l = L : A

• Currency Risks– Transaction Risk– Economic Risk– Translation Risk

• Discount factor (d)– d = wacc + π + σ

• Cash Out Flows• Cash In Flows

Structure Excel model

Assumptions

Data

Cash Outflows

Cash Inflows

Results

How to build an Excel model

– Worksheet 1 (Project name)• Project name• Version & Date• Authors

– Worksheet 2 (Results)• Investment amount• Economic life• Decision criteria

– Worksheet 3 (Data)• Data• Assumptions

– Worksheet 4 (COF)• Cash Outflows

– Worksheet 5 (CIF)• Cash Inflows

– Worksheet 6 (NCF)• Net Cash Flows

Decision Criteria Capital Budgeting

• Pay Back Period (PBP)• Return on Investment (ROI)• Net Present Value (NPV)• NPV Investment Ratio (NPV / INV)• Internal Rate of Return (IRR)• Break Even Time (BET)

Investment case

• Investment € 50,000,000• Expected economic life: 10 years• Equity / Asset Ratio: 0,6• Required ROE: 5%• Expected Interest rate: 3%• Expected Inflation: 2.5%• Risk mark up: 2.9%• Annual Revenues: € 10,000,000• Increase electricity prices: 6%• Annual Maintenance Costs: € 2,000,000• Increase maintenance costs: 4%

Results

Investment € 50.000.000,00  

     Economic life 10years          Pay Back Period (PBP) 6years     Return on Investments 23,12%ROI     Net Present Value € 14.294.531,75 NPV     NPV Investement Ratio 0,29       Internal Rate of Return 15,19%IRR     Break Even Time 8BET

Literature

• Management Accounting for Decision Makers, Atrill cs• Management Accounting, Kaplan cs• Advanced Management Accounting, Kaplan cs• Cost Accounting, Horngren cs• Fundamentals of Corporate Finance, Ross cs• Fundamentals of Corporate Finance, Brealy cs• Multinational Business Finance, Eitman• Wind Energy (Fundamentals, Resource Analysis and

Economics), Sathyajith• Wind turbines (Fundamentals, Technologies, Application,

Economics), Hau• Principles of Project Finance, Yescombe

Project Finance

• A method of raising long-term debt financing for major projects through “financial engineering” based on lending against the cash flow generated by the project alone.

• It depends on a detailed evaluation of a project’s construction, operating and revenue risk, and their allocation between investors, lenders, and other parties through contractual and other arrangements

• Project Finance ≠ Financing Projects

Features of Project Finance

• Ring-fenced project (Separate Project Company)• New project / New Business• High Equity Debt Ratio• No guarantees form the Project Company (non-

recourse finance)• Lenders rely on future cash flow for debt service

payments (interest + repayment)• Main security for lenders:

– Contracts– Licenses / ownership natural resources

• Project has a finite life

Forms of Projects

• BOOT– Built-Own-Operate-Transfer

• BOT– Built-Operate-Transfer

• BTO– Built-Transfer-Operate

• BOO• Built-Own-Operate

Financial structure (leverage)

Low leverage High leverage

Investment (=A) $ 1,000 $ 1,000

Debt or Loans (=L) $ 300 $ 800

Equity (=E) $ 700 $ 200

Net Revenues $ 100 $ 100

Interest rate 5% 7%

Interest payable $ 15 $ 56

Profit $ 85 $ 44

Return on Equity (ROE) 12% 22%

Financial leverage effect on costs

Low leverage High leverage

Investment (=A) $ 1,000 $ 1,000

Debt or Loans (=L) $ 300 $ 800

Equity (=E) $ 700 $ 200

Return on Equity (15%) $ 105 $ 30

Interest rate 5% 7%

Interest payable $ 15 $ 56

Profit $ 85 $ 44

Revenues Required $ 120 $ 86

Why project finance?

• High leverage• Tax benefits• Off-balance sheet financing• Borrowing capacity• Risk limitation• Risk spreading• Long-term finance• Enhanced credit• Unequal partnership

Project Structure (1)

Project Company

Finance• Equity

Investors• Lenders

Operator (O&M)

Government Support

Agreement

Government Concession /

License

Off taker(Power

Distributer)

Input Supplier

Contractor (Construction)

Source : Project Finance, Yescombe

Ring-fenced project

Project Company

Finance• Equity

Investors• Lenders

Operator (O&M)

Government Support

Agreement

Government Concession /

License

Off taker(Power

Distributer)

Input Supplier

Contractor (Construction)

Source : Project Finance, Yescombe

Project Structure (2)

Source: www.vestas.com

Project Structure (3)

Source: www..worldbank.org

Wind Farm Finance Structure

http://www.wind-energy-the-facts.org

Project Risks

Project Risks

Commercial Risks

Completion Risk Environmental risk

Operating Risk Revenue Risk

Input Supply Risk

Force majeure risk

Contract mismatch risk

Sponsor support Risk

Macroeconomic Risks

Inflation Risk

Interest Rate Risk

Exchange Rate Risk

Political Risks

Currency Convertibility

RiskTransfer Risk

Expropriation Risk

War & Civil Disturbance Risk

Change of Law Risk

Quasi-political Risks