Infrastructure Economics and Finance

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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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    Problem 3 Adapted from

    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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    Problem 4 Adapted from

    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