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Infrastructure Planning and

ManagementInfrastructure Economics and Finance

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Agenda

Principles of Finance Infrastructure Economics

Developing Financial Models forInfrastructure

Introduction to Project Finance

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Present Value

Present value is the value today of moneytomorrow. It is denoted by the formula below,where C is the future cash flow, r is the discountrate and n is the number of years in the future

when this cash flow will present itself

PV = C / (1+r)n

Selecting the discount rate is often a difficult taskand is determined by the riskiness of theinvestment

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Net Present Value

NPV = PV Required Investment

NPV = C0 + Cn/(1+r)n

Cash Outflow is negative

Cash Inflow is positive

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IRR, Risk and Opportunity Cost IRR is the Internal Rate of Return

The rate of return where the NPV is zero

The rate of return on an investment What is the risk free rate?

Typically it is the bank interest rate

Why cant I use the risk free rate always todiscount cash flows? The risk facing your project might be larger. You may

be supporting an infeasible project

So how do I decide what r to use? r represents the risk in the venture not the risk of

the venture Use the same r you use for a venture of comparable

risk use the Opportunity Cost of Capital

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Discounted Cash Flows

NPV = Ct / (1+r)t The time period t for which the NPV is zero is

often called the break-even point

The rates of return can vary over different timeperiods. If this is so, the above formula shouldbe broken down into a sequential stream of cashflows.

Generally you should invest in a project whenthe NPV is positive or the IRR is greater than theopportunity cost of capital.

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Perpetuities

What are they?Cash-flows over an infinite time period

What equation governs static perpetuity?PV = C/r

What equation governs growingperpetuities?

PV = C / (r-g), where g is the rate of growth

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Annuities

What are they?Cash-flows for a certain period of time

Whats the present value of an annuity?

PV = C [ 1/r 1/r(1+r)t ]

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Funding

2 major componentsDebt

Equity

Weighted Average Cost of Capital

WACC = Kd (D/D+E) + Ke (E/D+E)

D and E are the relative proportion of Debtand Equity respectively

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Infrastructure Economics

The concepts in the previous slides areoften used to evaluate the viability of aninfrastructure project or to compare

infrastructure alternatives. This analysis is a key part of the project

preparation and analysis process

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Problem 1 Adapted fromInfrastructure Planning Handbook2007

An agency obtains Rs, 2,00,00,000 in order to constructa project by borrowing five equal beginning-of-yearamounts. The project is then operated for 20 years. Atthe end of the first year of operation, the project iscredited with Rs, 50,00,000 of revenues and therevenues increase by Rs. 1,00,000 per year for eachyear of operation. Estimate the present worth of therevenues and costs, and the average net revenues (withthe effect of interest) over the twenty-five years ofconstruction and operation. Take 7 percent interest intoaccount for all calculations

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Assumptions

Costs are incurred at the beginning of theyear while revenues are realized at theend of the year

Standard NPV formula is used to discountcash flows

NPV = Ct / (1+r)t

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580000014

570000013

560000012

550000011

540000010

53000009

52000008

51000007

50000006

040000005

040000004

040000003

040000002

040000001

RevenuesCostsYear

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Rs.25,744,372.53Net Revenues

Rs. 43,293,217.56Rs. 17,548,845.03NPV

690000025

680000024

670000023

660000022

650000021

640000020

630000019

620000018

610000017

600000016

590000015

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Problem 2 Adapted fromInfrastructure Planning Handbook2007

1. A new pipeline is to be installed. Alternativesizes considered are 8, 12 and 16 diameter.For 8, the construction cost is Rs. 20,000 and

the annual OMR including pumping cost is Rs.5,000. For 12 the costs are Rs. 25,000 and Rs.800 respectively and for 6 they are Rs. 40,000and Rs. 200. What is the most economic size ofpipeline if it is needed for 10 years and there isno salvage value at the end of that time? Theapplicable discount rate is 10%.

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O tion 2 is the best o tion

Rs.41,228.91

Rs.29,915.65

Rs.50,722.84Total NPV

Rs.1,228.9140000\$4,915.6525000

Rs.30,722.8420000NPV

11

200800500010

20080050009

20080050008

20080050007

20080050006

20080050005

20080050004

20080050003

20080050002

20040000800250005000200001

VariableFixedVariableFixedVariableFixed

Option 3 - 16"Option 2 - 12"Option 1 - 8"Year

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Infrastructure Planning Handbook2007 Projects A and B are to be compared in terms of the

present worth of their net benefits. Project A requiresone year for construction and costs Rs. 1,00,000. Itinvolves an annual O&M cost of Rs. 10,000 per year of

operation and provides benefits for five years afterconstruction. These benefits start from Rs. 20,000 andincrease by Rs. 20,000 annually. Project B requires twoyears for construction and costs Rs. 2,00,000. It involvesan annual O&M cost of Rs. 20,000 per year of operation

and provides benefits for ten years after construction.These benefits start from Rs. 40,000 and increase byRs. 20,000 annually, capping out at Rs. 2,00,000. Allamounts are end-of-year values. Which project is better?

Assume a discount rate of 10%

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Rs. 300,006.05 Better ProjectRs. 68,312.64Overall NPV

Rs.

575,122.86

Rs.

101,563.09

Rs.

173,553.72

Rs.

193,683.42

Rs.

34,461.70

Rs.

90,909.09NPV

2000002000012

20000020000111800002000010

160000200009

140000200008

120000200007

10000020000100000100006

800002000080000100005

600002000060000100004

400002000040000100003

0010000020000100002

00100000001000001

RevenuesOMR CostConst CostRevenuesOMR CostConstCost

Project BProject AYear

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Infrastructure Planning Handbook2007 A municipal agency is considering building an exhibition

hall. Its feasibility will depend on whether the averagecost per visitor is reasonable. Investment cost includinginterest during construction is Rs 5,00,00,000;

repayment is done by 5 percent bonds over a 20 yearoperating period. Annual OMR is Rs. 2,50,000. Annualvisitors are projected to be 500,000 the first year andincreasing by 50,000 per year. Perform an analysis todetermine the annual cost of the facility for each year

over a twenty-year period of operation, the unadjustedcost per visitor for each year, and the levelized cost pervisitor over the operating period based on a discount rateof 5 percent

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\$53,115,552.68(\$3,115,552.59)(\$50,000,000.00)NPV6903982.152.941,450,000-250000(\$4,012,129.36)20

6665913.83.041,400,000-250000(\$4,012,129.36)19

6427845.453.161,350,000-250000(\$4,012,129.36)18

6189777.13.281,300,000-250000(\$4,012,129.36)17

5951708.753.411,250,000-250000(\$4,012,129.36)165713640.43.551,200,000-250000(\$4,012,129.36)15

5475572.053.711,150,000-250000(\$4,012,129.36)14

5237503.73.871,100,000-250000(\$4,012,129.36)13

4999435.354.061,050,000-250000(\$4,012,129.36)12

47613674.261,000,000-250000(\$4,012,129.36)114523298.654.49950,000-250000(\$4,012,129.36)10

4285230.34.74900,000-250000(\$4,012,129.36)9

4047161.955.01850,000-250000(\$4,012,129.36)8

3809093.65.33800,000-250000(\$4,012,129.36)7

3571025.255.68750,000-250000(\$4,012,129.36)63332956.96.09700,000-250000(\$4,012,129.36)5

3094888.556.56650,000-250000(\$4,012,129.36)4

2856820.27.10600,000-250000(\$4,012,129.36)3

2618751.857.75550,000-250000(\$4,012,129.36)2

2380683.58.52500,000-250000(\$4,012,129.36)1

Levelized Cost Per

YearCost Per Visitor per yearAnnual VisitorsOMRConst CostYear

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Methodology

Rs 5,00,00,000 is paid back over 20 years a