Download - Infrastructure Economics and Finance

7/29/2019 Infrastructure Economics and Finance

1/36

Infrastructure Planning and

ManagementInfrastructure Economics and Finance


2/36

Agenda

Principles of Finance Infrastructure Economics

Developing Financial Models forInfrastructure

Introduction to Project Finance


3/36

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


4/36

Net Present Value

NPV = PV Required Investment

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

Cash Outflow is negative

Cash Inflow is positive


5/36

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


6/36

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.


7/36

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


8/36

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 ]


9/36

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


10/36

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


11/36

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


12/36

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


13/36

580000014

570000013

560000012

550000011

540000010

53000009

52000008

51000007

50000006

040000005

040000004

040000003

040000002

040000001

RevenuesCostsYear


14/36

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


15/36

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%.


16/36

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


17/36

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%


18/36

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


19/36

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


20/36

$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


21/36

Methodology

Rs 5,00,00,000 is paid back over 20 years at 5%leading to an annuity payment of Rs.40,12,129.36 per year

Cost per visitor per year is calculated such thatin every year the costs equal the revenues

The levelized tariff is calculated such that the

overall NPV of the project is 0 and comes to Rs.4.76 per person


22/36

Infrastructure Finance Models

When preparing a detailed report and study of aninfrastructure project, the earlier economic analysismight not suffice.

Detailed models have to be built that identify cash

inflows and outflows over every year of the project, therates of interest and discount for each item etc

A comprehensive NPV calculation can then beperformed to determine the feasibility of the project.

Sensitivity analysis can be performed by changinginterest rates, loan payment schedules etc to see if theproject can be structured differently


23/36

Problem Adapted from

Infrastructure Planning Handbook20071. A project for Water Supply was envisaged in city A. Constructioncosts totalled Rs. 33,250.94, to be paid back over 8 years starting

one year after the start of the project, with the majority of thepayments backloaded. Operations costs were set at Rs 1058 inthe first year and were set to increase by 10% per year.Distribution costs were estimated at 20% of the total water tariff.The analysis estimated that of the total capacity of 5.98 billiongallons per year, 0.84 billion would be needed to meet theincremental demand in the first year and six additional yearswould be needed before the full capability of the scheme isrealized. There was expected to be a loss in efficiency of supply

of 16%. Tariffs started at Rs. 1.88 and increased by Rs. 0.12every year, with an increase of 0.16 every third year. The netoperating income each year is used to meet the loan paymentdue, and if this is inadequate the water utilitys income from othersources could be utilized.


24/36

Cost Model

5341.281261020075220.8114642006

5100.32104222005

......

3493.9233211993

3333.2830191992

3212.827441991

3092.3224951990

2931.6822681989

2811.2206219882690.7218741987

2363.7617041986

1852.815491985

1395.3614081984

945.5212801983

60011641982

263.210581981

Distribution CostsOMR & TreatmentYear


25/36

Revenue Model

267065.325.025.982007

261045.25.025.982006

255025.085.025.982005

........

174703.485.025.981993

166663.325.025.981992

160643.25.025.981991

154623.085.025.981990

146582.925.025.981989

140562.85.025.981988

134542.685.025.981987

118192.524.695.581986

92642.43.864.591985

69772.283.063.65198447282.122.232.661983

300021.51.781982

13161.880.70.841981

IncrementalAnnual Revenue

Water Tariffper 1000 gal

Incremental WaterSold (billion gal/yr)

Incremental Prod.(billion gal/yr)Year


26/36

Overall Model

87558755875520079420942094202006

9980998099802005

......

1065510655106551993

1031410314103141992

1010710107101071991

9874987498741990

9459945994591989

5904260094-105210,235918319885617157518-134710,23588881987

5160054084-248410,23577511986

4713651509-437310,23558621985

4287148933-606210,23541731984

4290945499-2590509225021983

438274292490333312361982

4034440,349-50-51981

Cash Flow

Income fromother

sourcesProject

BalanceLoan

RepaymentNet Operating

IncomeYear


27/36

Project Finance

A project Company or a Special PurposeVehicle is created to execute a projectProject Company makes limited guarantees

Also known as non-recourse financingLenders have recourse only to the project

vehicle and not to the parent companies

Typically the asset being financed has alimited life


28/36

Project Finance

Adapted from Project Finance Manual, January 2001


29/36

Public Finance



30/36

Corporate Finance



31/36

The evolution of project finance Is it a recent phenomenon?

No it isn't! It has been around since medieval times. Became very popular in mining and oil

exploration projects in the 70s

Adopted by the power industry in the US in the80s

PPPs in other sectors now use it extensively

Volume of project financed projects is growingrapidly


32/36

Key Terms

Loan Amount Total value of the loan Drawdown conditions

Loan Pricing rate at which the loan is given

Term of Loan duration over which the loanmust be repaid

Debt Service Coverage Ratio (DSCR)

(Earnings before Income Tax)/(Loan amount to berepaid)


33/36

Is Low DSCR good?

For lenders?Yes. They get their money back quickly

For borrowers?No. They have lesser returns on Equity since

a lot of money is spent paying the loan

Borrowers prefer to pay lesser over longerperiods


34/36

Why Project Finance?

From the borrowers perspective

Less risk as their other assets are not at stake

Comparatively fewer covenants

Large transaction costs in putting the deal together


35/36

The lenders perspective Pros

More transparencyGreater project-based incentivesGuaranteed and high returns? But there are risks

What criteria do lenders consider? Technological risks Strength of sponsors, financial credibilities?Government backing/ Guarantees, expropriation

risks? Project economics Social and Environmental Risks? Equity invested by sponsorsAbsence of competition


36/36

Thank You