Project Finance Modelling PDF

Objectives of Project Finance Models
Project Finance Modelling
Oct 18, 2008 1
Exercises
Understand the Cash Process in Models Evaluate Risk with Models
Delay in Completion of Construction Break-even Price and PPA Price Components Downside Case Production and Operation Expenses
Work with Structural Enhancements

Covenants Debt Service Reserves Liquidation Damages
Perform Financial Structuring with Model

Debt Sizing and Cash Flow Waterfall
Senior Subordinated
Loan Tenor Credit Spread

Project Finance Modelling Oct 18, 2008 2
Financial Models Standard and Poors

A good financial model should:
Be relatively simple Focus on key cash flow drivers Clearly convey assumptions and conclusions
Alternative Models
Back of the Envelope
Quickly run the impact of an acquisition on debt service coverage Sensitivity of earnings to commodity price swings
Deterministic
Set a number of assumptions and translate into financial ratios and cash flow
Stochastic
Develop a range of possible inputs using Monte Carlo simulation. Used where there is a good and predictable history for value drivers.
Oct 18, 2008 3
Model Objectives - Overview

Valuation
Decision to invest
Development Stage On-going
Basic Objective
Measure whether the expected returns are worth taking the risk Models must be able to somehow measure risk to be effective
Value of project Debt Structuring
Contract Structuring
Contract pricing Contract length
Risk Assessment
Equity risk Credit analysis
Financial Structuring
Covenants Gearing Debt service reserve Senior and subordinated debt
Oct 18, 2008 4
Objectives of Project Finance Modelling

Valuation
The basic objective of project finance is obviously to evaluate whether the project works whether the benefits of the project outweigh the costs of the project. The value of a project is measured by whether the returns on the project the IRR exceeds the risk adjusted cost of capital. The question of whether the project works is evaluated using base case assumptions.
Structuring of the Debt Facility and Other Contracts

The model is used to establish many terms in the various contracts that arise in project finance. The base case debt service cover establishes whether the gearing is appropriate; the base case can be used to set prices such as capacity charges in the project contract and the model is used to structure the appropriate repayment of the debt facility.
Credit Analysis
The model is used by lenders to the project to evaluate risks associated with default on the loan agreement. Typical analysis involves assessing the level at which various operating parameters cause the debt service coverage ratio to fall below 1.0 at some point over the life of the project.
Oct 18, 2008 5
Objectives of Project Finance Modelling (Continued)

Repository of Information
In working through the engineering, contracting, financing and other aspects of a project, the model serves as a database where important information is stored. If a new operating parameter is required or if a new contractual element is negotiated, the import of that new information is gauged in the model. If something matters to the economics of the project, it should influence the outcome of the project finance model.
Evaluating Whether Contract Provisions Appropriately Mitigate Risk

The model should be used to determine whether the language in various contracts mitigates risk to parties in the way the terms in the are intended to operate. The model can test whether covenant provisions, debt service provisions, liquidation damage provisions and other language in fact mitigates risk to lenders and developers. The use of project finance models in evaluating contract language is described in the next slides.
Oct 18, 2008 6
Project Finance Model Objective: Testing Structural Enhancements

A project finance model can be used to test whether agreements protect parties consistent with the intention of the contracts. In order to use the project finance model in this manner, the model must be run for a downside or a stress case scenario. In the base case:
There is no delay in construction that causes the trigger of liquidation damages; There is no reduced operation cash flow to test covenants that limit distribution of dividends; There is no increased price that causes a cash sweep covenant to be used; There are no financial problems that require withdrawal of funds from the debt service reserve; The PPA or project contract remains in place with no penalties.
The process of testing covenants involves first defining reasonable risks in a downside case or stress case and then running the model in two cases:
First, run the model without the structural enhancement; Second, run the model with structural enhancements and determine whether the contracts in fact mitigate risk.
Oct 18, 2008 7
Model Objectives Structuring of Funding and Debt Drawdown

In modeling the construction of the facility, various issues related to the potential for cost over-runs and delays must be addressed:
Who funds the construction of cost over-runs; Who funds interest costs if there is a delay in construction (debt, equity or another party). The model should accurately reflect what happens in a cost over-run or a delay scenario.
Example of the Kutubu Petroleum Development The project construction received high gearing; some equity holders received equity interests for agreeing to fund construction over-runs. Example of the Freeport Development The banks agreed to fund cost over-runs only up to 120% of the budgeted amounts.
Oct 18, 2008 8
Model Objectives Covenants in Loan Facility In writing covenants for loan facilities, the model should evaluate whether the covenants protect lenders.
The model should incorporate what happens to cash flow when covenants limit the distribution of cash flow; The model should show what happens to cash flows when covenants limit cash distributions from positive operating results; The model should be able to quantify the costs and benefits of alternative types of covenants and criteria for the covenants.
Example of Covenant: If the debt service coverage is below 1.2, then no distributions are allowed; the cash flow that would be distributed is instead used to increase funding of reserve
Oct 18, 2008 9
Elements of Project Economics that are not in the Project Finance Model For a modeler, it is tempting to assert that everything that matters to the economics of the project is included in the model. However it is important to understand what risks and contract elements of the project are not included in the model:
If you written a wonderful construction contract that protects developers and bankers with liquation damages, if the contractor does not have financial resources to meet the liquidation damages, the contract could be meaningless. The financial condition of the contractor and the necessity of bonding, letters of credit or insurance is not quantified in the project finance model. If you have written a solid PPA agreement that again protects developers and bankers, if the counterparty who buys power in the PPA agreement cannot make payments under the contract, the contract is again meaningless. The financial condition of the offtaker is not measured in the project finance model nor is the crucial issue of whether the off-taker has an incentive to get out of the contract.
Structure of Project Finance Models
Oct 18, 2008 11
Sheet Layout Project Model

Contents Input Sheets (Assumption Book)
Different colors Arranging of inputs
Working Sheets
Arrangements by revenues, expenses and capital expenditures Arrangements by capacity, demand, and cost structure
Monthly Construction Expenditures (Source and Use of Funds)

Conversion from Annual Computation of Interest During Construction
Debt Schedule (Sources of Funds) Depreciation Schedule Financial Statements

Source and Use of Funds Income Statement Balance Sheet Cash Flow -- Waterfall
Output Sheets
Valuation - IRR Debt Service Coverage Ratios
Oct 18, 2008 12
Modules in a Project Finance Model How to Move from Assumptions to Valuation

A project finance model begins with three primary inputs:
Capital Expenditures Revenues Expenses
The project finance model accepts these inputs along with tax and finance assumptions and computes project and equity cash flow Modules in project finance models should include:
Assumptions Working Analysis Sources and Uses Financial Statements Cash Flow and Valuation
Oct 18, 2008 13
Inputs, Outputs and Simple Computation of Cash Flow to Obtain Valuation

Inputs to Derive Free Cash Flow
Capital Expenditures Revenues Expenses Debtors and Creditors Tax Rates Plant Life
Calculations are simple: Revenues Expenses Working Capital Movement, net of tax Inputs to Derive Equity Cash Flow
Debt to Capital Interest Rates Debt Repayment Debt Service Reserves
The basic structure of project finance models are easy to understand without being a modelling expert The balance sheet must balance by far the most effective check on calculations and balances should be zero at the end of the project life (debt, asset balance, reserve balance etc.)
Oct 18, 2008 14
Model Sheets in Project Finance Model
Inputs
Prices, Costs, Capacity, Technical Parameters
Debt Schedule
Debt Balance From Drawdown Debt Balance, Interest Expense
Working Sheet to
Derive Revenues Expenses and Working Capital
Depreciation
Depreciation Expense Plant Balance
Outputs
Free Cash Flow, Equity Cash Flow Value (IRR), DSCR
Source and Use of Funds

Draw down, IDC, Equity Issues and Capital Expenditures
Annual Financials
Income Statement, Cash Flow (CASH WATERFALL) and Balance Sheet
Oct 18, 2008 15
Model Components
Cash Flow Waterfall: Senior debt service
Inputs
Operating - Capital Expenditures - Revenues - Operating Expenses - A/R and A/P Financial and Tax - Debt Leverage - Interest Rate - Debt Repayment - Tax Rate - Tax Depreciation
Senior debt service reserve Senior debt prepayments from covenants Junior Debt Service Junior debt re-payments of default Dividends
Mechanics
Construction Sources & Uses Income Statement Cash Flow Statement Balance Sheet Equity Cash Flow Project Free Cash Flow
Outputs
IRR Equity IRR Project Net Present Value Return on Investment Economic Profit Debt Service Coverage LLCR Payback Period Accounting Earnings
Oct 18, 2008 16
Results of Good Model Structure In a well programmed model:

The economics and the key risks of the project should be presented well and come off the page The model should be easy to follow where one can clearly trace the inputs, the mechanics and the outputs of the model The model should be stable which means that you can play with inputs equations in the model without fear of messing things up. The model should reflect the structure of the project including key contracts; the timing of project completion; key risks and alternative debt structure terms.
Oct 18, 2008 17
Valuation with Project Finance Models

Project Finance Issue
Limited Project Life Commercial Operation Date Cash Flow Waterfall and subordinated debt Modelling Issue 1. Measure cash flow over the entire life of the asset 2. Cash flows not really known until the project is in service no history of cash flows 3. Value of debt and equity driven by cash flow 4. Measure the value of different securities supported by project cash flow 5. No portfolio of assets to diversify risk 6. Value of debt and equity depends on covenants, debt service reserve 7. Risk analysis depends on contracts used to allocate risk to different parties
Non-Recourse Structural Enhancements Risk Allocation from contract

Oct 18, 2008 18
Inputs
The most important thing in modeling has always been Garbage in Garbage Out
Oct 18, 2008 19
Structure of Inputs One should be able to find all of the inputs in an easy manner and see how the inputs affect the outputs this is why the financial statement page should not have any inputs
All inputs should have a color convention so it is clear what numbers can be changed and what should not. Separate inputs that vary by year (or month) and inputs that are constant. Other sheets should have links to the input page where the inputs are repeated on the top of the page
Oct 18, 2008 20
Single Input Sheet If Inputs are all collected on a single sheet

Can find where to change all items (dont have to look around for switches and inputs) Easier to develop alternative scenarios with different assumptions Possible exceptions for interest rate and maturity payments on debt issues
In the real world, you develop a model with inputs in various places and then re-structure the spreadsheet to collect the inputs in a single sheet.
Oct 18, 2008 21
Input Sheet Example
Oct 18, 2008 22
Example of Difficult Inputs to Find
Inputs in a column far away from the sheet in a sheet that does not have other inputs
Oct 18, 2008 23
Use Hyperlinks to Document Assumptions

Given that the financial model is a database, I like to keep source documents in the spreadsheet, if possible. Hyperlinks can be used to trace each assumption to the original source. In the example below, the hyperlink in the assumption page refers to documents from an investment analyst presentation.
Assumption page with hyperlinks
Result of Hyperlink
Explanation of how to insert hyperlinks is shown in the excel background presentation.
Oct 18, 2008 24
Financial Statements And Working Sheets No Inputs in Financial Statements
Putting a Number in a Financial Statement is an Obvious No
Oct 18, 2008 25
Example of Input Number in a Spreadsheet Percentages and Factors Should be with Inputs
The 10% Factor should be shown explicitly in the spreadsheet
Oct 18, 2008 26
Corrected Sheet with Explicit Presentation of Inputs
II. Colocation Capex (90%) Core Infrastructure Civil Works/ MEP Network/ IT Services Subtotal Contingency Percent Contingency Sensitivity Factor Total Capex
Show the percentages in a separate line item
6,861,293 1,347,297 1,155,756 297,675 9,662,021 10% 1,073,558 100% 11,809,137
1,605,625 1,605,625 10% 178,403 100% 1,962,431
Oct 18, 2008 27
Use Excel Toolbars and Forms to Allow Sensitivity Cases from Multiple Locations
You allow excel to revise inputs in multiple locations using the view toolbars forms and then using the combo box, the spinner box or the scroll bar. This allows you to keep the inputs together and also to adjust the inputs in sheets to examine the effect of the input.
Oct 18, 2008 28
Operating Assumptions in Model The entire model is driven from only three basic operating inputs: Capital expenditures Revenues Operating expenses When you get a model from someone else find these three inputs and work backwards The working sheet should develop projections of these inputs from value drivers such as price, market share, market growth, capacity additions, capacity utilization, cost of new capital and the cost structure. History should be presented along with forecasts for the value drivers
Oct 18, 2008 29
Capital Expenditure Inputs

There are four inputs generally required related to capital expenditures. These include: 1. The monetary amount of the capital expenditure without IDC 2. The capacity derived from the capital expenditure 3. The timing of the capital expenditures 4. The "soft costs" related to the capital expenditures The modeling of capital expenditures is generally on a monthly basis were the draw-downs from equity and debt as well as interest during construction is derived. For simplicity, we begin by modeling capital expenditures on an annual basis. Computation of monthly draw-downs is precisely the same as the annual computation, except that months are used instead of years.
Oct 18, 2008 30
Capital Expenditures, Capacity and Cost Structure In an economic endeavor, capital expenditures give you the capacity to produce something. The capital expenditures can generally be stated in terms of the maximum productive capacity. Some examples are:
Capacity of an electric plant in MW ($/kW) Capacity of oil or gas reserves in barrels or BTU Capacity of a water desalination plant in M Gal Capacity of a pipeline in maximum throughput Capacity of a road in maximum traffic
Oct 18, 2008 31
Technical Parameters that Form the Basis of the Project Cost Structure
Power plant
Heat rate Heat content of fuel Availability Capacity factor Maintenance cycle Cooling water avail
Refinery
Product yield Throughput rate Maintenance time Utilization rate Product quality Catalyst life
Mine
Ore yield Production Rate Mining Prod Equipment avail
Oct 18, 2008 32
Revenue Inputs Revenue inputs come from price and quantity. Prices can commodity, contract-based or management determined.
Commodity - Oil, gas, electricity, metals, wood etc.
Contract - PPA, government tariff. Management - Tolls, entry fees.
Volumes are derived from the capital expenditure maximum capacity and the capacity utilization.
Oct 18, 2008 33
Inputs to Project Finance Model from Documents

Work in Project Contracts
Define completion date define specific provisions that determine when loan repayment begins and draws stop. Define drawdown provisions what happens if there are construction over-runs; which parties provide the added funding Define mechanics of the debt service reserve and its use with covenants Define the timing of debt repayments in the debt facility and definitions of default
Project Finance Modeling

Set-up the model with routines for construction period and operation period where formulas differ for the two periods. Program model to accurately reflect debt and equity contributions in sources and uses statement Program the model to make deposits and withdrawls from the debt service reserve Program aspects of the loans including debt repayment and debt defaults
Oct 18, 2008 34
Workings Analysis
Work through inputs and build components for the Financial Statements
Oct 18, 2008 35
Workings Should Clearly Describe the Value Drivers Capital Expenditures to Grow the Company
Investment Cost Per Unit Of Capacity On-going maintenance capital expenditures
Revenues
Product Prices (Price Setter or Price Taker) Volumes produced > Capacity x Capacity Utilization
Operating Expenses
Resource cost -> Resource Price x Resource Use Resource use -> Efficiency Factor x Volume Other Fixed, Variable and Overhead Expenses
Oct 18, 2008 36
Example of Relation Between Value Drivers and Financial Model Inputs
Oct 18, 2008 37
Conversions from Output Quantity to Input Quantity The most difficult part of model construction is often the conversion of units and making sure that the currency is correct. You can use the conversion program provided and I suggest that you put all of the currency in single units - not thousands, millions and so forth. Then you can convert to the appropriate units of the model when you are finished. Use the conversion program provided on the CD
Oct 18, 2008 38
Quantity from Capacity and Utilization
Production assumptions are derived from maximum capacity. The maximum capacity must be related to a time dimension and generally apply a capacity utilization factor. For example:
MWh = MW x hours x Capacity Factor BBLs = Reserves x Ratio of withdrawals Aluminum Tons = Capacity x Utilization
The most difficult part of model construction is often the conversion of units and making sure that the currency is correct. You can use the conversion program provided and I suggest that you put all of the currency in single units - not thousands, millions and so forth. Then you can convert to the appropriate units of the model when you are finished.
Cost Workings Analysis Cost risks apply to labor and materials inputs, productivity, and operating expenses (Opex) Cost risk includes the effect of inflation. Typical cashflows will show 7-10 key items of costs with the remaining cost categories usually amounting to only 5-10% of Opex Whether a contract exists or not, the position of the project in terms of cost of production relative to all the other producers of the given product is important. Generally, a project in the lower half or lower third of the cost curve (sorted costs of other producers) is adequate.
Oct 18, 2008 40
Financial Statement Modeling: Sources and Uses
Oct 18, 2008 41
Separation of Construction and Operation Time Period

Sources and Uses Statement During Construction No cash distributions to equity Sources and uses of cash to determine equity and debt issuance Debt drawdown and no debt maturities Interest expense capitalized to construction No revenues, expenses or depreciation Income Statement and Cash Flow Statement Distribute cash flow to equity Dividend distribution from the cash flow statement at the end of the cash flow waterfall Debt repayment included in the cash flow Interest expensed in the income statement Revenues, expenses and depreciation included
Oct 18, 2008 42
Modeling the Financial Structure

Model Structure
Sources and uses Debt financing Depreciation Schedule Financial statements
Time Periods
Construction Debt module Operating Financial statements Returns
Oct 18, 2008 43
Source and Use Statement Importance of statement in understanding the transaction where the money goes and where it comes from Time Periods do not be afraid of monthly statements Interest During Construction
Oct 18, 2008 44
Example of Sources and Uses In a model this is computed on an annual or monthly basis
SOURCES OF FUNDS(1) Principal amount of the old bonds........................... Equity Contribution(2)...................................... Revenues from operation of the Initial Units(3)............. $275,000,000 35,500,000 20,089,000 -----------TOTAL SOURCES OF FUNDS................................ $330,589,000 ============ USES OF PROCEEDS EPC Contract................................................ Electric Interconnection Facilities......................... Gas Supply Facilities....................................... Spare Parts................................................. Development Cost............................................ Initial Working Capital..................................... Project Management.......................................... Legal & Financing........................................... Net Interest During Construction(4)......................... Expenses of operation of the Initial Units.................. Contingencies............................................... Other....................................................... $229,065,000 1,000,000 3,123,000 3,649,000 7,000,000 258,000 4,643,000 5,114,000 52,757,000 4,831,000 11,962,000 7,187,000 -----------TOTAL PROJECT COSTS................................... $330,589,000 ============
Oct 18, 2008 45
Sources and Uses Statement During Construction

Interest During Construction
IDC is capitalized to construction cost -- this means that interest is not included on the income statements, but it is included as a part of construction cost. Depreciation includes IDC in the base. IDC can be computed from the debt balance. Interest Income on Debt Reserves has similar computations.
Monthly versus Annual Sources and Uses

The Only Reason for Monthly Analysis of Construction is for Accurate Representation of IDC, Otherwise Annual Would Be Fine: Monthly sources and uses of funds statement computed in exactly the same format, but compute monthly interest When computing interest expense, use the annual interest rate divided by twelve Tabulate the monthly interest balance and replace the lines in the annual model with the sum of the monthly interest. (You could do this with debt balances as well, but that is not necessary.)
Oct 18, 2008 46
Draw downs in Source and Use Statement

The manner in which draw downs occur from debt and equity can have large effects on the equity IRR of a project. The model should be able to test different draw down schedules. Operating income and interest income can be incorporated in the source and use statement. Negative arbitrage can be important in the source and use statement from a higher borrowing rate than a funding rate.
Financing During Construction

120%
100%
0%
0%
80%
60%
100%
40%
100%
98%
91%
84%
20%
Debt Financing Equity Financing
0%
2%
1968 1969 1970
Year
9%
1971
16%
1972
Oct 18, 2008 47
Debt Schedule
Oct 18, 2008 48
Debt Sheet The debt module to model includes the total of all debt derived from the sources and uses statement. Each debt issue should show at minimum the beginning debt balance, debt draws, debt repayments, interest expense and ending debt balance.
Use a separate module and put interest expense and debt repayments etc. in the financials Reflect the actual repayment structure and the quarterly or semiannual repayments. Include interest expense in the income statement from the debt module - make sure that EBT subtracts interest expense.
Oct 18, 2008 49
Debt Service Reserves Debt service reserves should be modeled in a similar manner to debt issues:
Show beginning balance, inflows to debt service reserve (from sources and uses), with drawl from debt service reserve (when debt matures) and ending balance Model should be flexible enough to show withdrawls from debt service reserve when the cash flow is negative and inflows to debt service reserve when the debt service reserve is not topped off. Modeling of the debt service reserve can become complex.
Oct 18, 2008 50
Example of Debt Amortization Schedule

----------------July 2, 2001 July 2, 2002 July 2, 2003 July 2, 2004 July 2, 2005 July 2, 2006 July 2, 2007 July 2, 2008 July 2, 2009 July 2, 2010 July 2, 2011 July 2, 2012 July 2, 2013 July 2, 2014 July 2, 2015 July 2, 2016 July 2, 2017 July 2, 2018 July 2, 2019 July 2, 2020 PRINCIPAL PAYMENT DATES PERCENTAGE SCHEDULED PRINCIPAL PAYMENT ------------------$ 4,302,000 $ 19,496,000 $ 18,981,000 $ 17,227,000 $ 13,333,000 $ 14,359,000 $ 13,537,000 $ 16,880,000 $ 20,167,000 $ 23,778,000 $ 26,434,000 $ 24,504,000 $ 34,748,000 $ 37,364,000 $ 34,751,000 $ 6,139,000 $ 3,000,000 $ 3,000,000 $ 3,000,000 $ 3,000,000 -----------$338,000,000 AGGREGATE SCHEDULED
PRINCIPAL AMORTIZATION ---------------------1.272781% 5.768047% 5.615680% 5.096746% 3.944675% 4.248225% 4.005030% 4.994083% 5.966568% 7.034911% 7.820710% 7.249704% 10.280473% 11.054438% 10.281361% 1.816272% 0.887574% 0.887574% 0.887574% 0.887574% ----------100.000000%
Oct 18, 2008 51
Example of Amortization Schedule
TOTAL.............................. <S> December 15, 2000............................ June 15, 2001.............................. December 15, 2001............................ June 15, 2002.............................. December 15, 2002............................ June 15, 2003.............................. December 15, 2003............................ June 15, 2004.............................. December 15, 2004............................ June 15, 2005.............................. December 15, 2005............................ June 15, 2006.............................. December 15, 2006............................ June 15, 2007.............................. December 15, 2007............................ June 15, 2008.............................. December 15, 2008............................ June 15, 2009.............................. December 15, 2009............................ June 15, 2010.............................. December 15, 2010............................ June 15, 2011.............................. December 15, 2011............................ June 15, 2012.............................. December 15, 2012............................ June 15, 2013.............................. December 15, 2013............................ June 15, 2014.............................. December 15, 2014............................ June 15, 2015.............................. December 15, 2015............................ June 15, 2016.............................. December 15, 2016............................ June 15, 2017.............................. December 15, 2017............................ June 15, 2018.............................. December 15, 2018............................ June 15, 2019.............................. December 15, 2019............................ June 15, 2020.............................. December 15, 2020............................ June 15, 2021.............................. December 15, 2021............................ June 15, 2022.............................. December 15, 2022............................ June 15, 2023.............................. December 15, 2023............................ June 15, 2024.............................. December 15, 2024............................ -----------$320,000,000 -----------$130,000,000 PRINCIPAL PAYMENT DATES ----------------PRINCIPAL AMOUNT PRINCIPAL AMOUNT PRINCIPAL AMOUNT PAYABLE ON SERIES A-1 SENIOR SECURED BONDS ----------------<C> $ 50,000,000 45,000,000 45,000,000 53,500,000 53,500,000 17,500,000 17,500,000 19,000,000 19,000,000 PAYABLE ON SERIES B-1 SENIOR SECURED BONDS ----------------<C> $ 0 0 0 0 0 0 0 0 0 0 0 0 0 16,500,000 16,500,000 17,000,000 17,000,000 19,000,000 19,000,000 2,000,000 2,000,000 2,000,000 2,000,000 2,000,000 2,000,000 2,500,000 2,500,000 2,500,000 2,500,000 3,000,000 PAYABLE ON SERIES C-1 SENIOR SECURED BONDS ----------------<C> $ 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 0 3,000,000 3,000,000 3,000,000 3,500,000 3,500,000 15,500,000 15,500,000 17,000,000 17,000,000 18,500,000 18,500,000 20,000,000 20,000,000 22,000,000 22,000,000 23,000,000 23,000,000 26,000,000 26,000,000 -----------$300
Oct 18, 2008 52
Income Statement, Cash Flow Statement and Balance Sheet
Oct 18, 2008 53
Income Statement and Cash Flow Statement After Construction

Income Statement and Cash Flow Statement
Compute cash flow for dividends
Complicated Part is Between Operating Cash Flow and Dividends

Cash Flow to Senior Debt Use of cash flow
Pre-payments from covenants Payment of debt service reserve Defaults
Cash Flow to Junior Tranches Funding of Debt Service Reserves
Debt Repayment in Cash Flow

Time Periods -- for accuracy of interest expense Incorporation of Re-payment Structure Flexibility to model defaults, pre-payments, reserves
Oct 18, 2008 54
Income Statement
Compute profit or loss from revenues and expenses:
EBITDA is Revenues less Expenses EBIT is EBITDA less Depreciation and Amortization EBT is EBIT less net Interest Net income is EBT less taxes.
Notes
May compute net operating loss carry forward Net interest should include interest income earned on reserves
Oct 18, 2008 55
Cash Flow Mechanics

Separate Statement into normal components
Operating
Net income plus depreciation less working capital movements less gain on asset sale
Investing
Capital expenditures (including IDC), on-going capital expenditures and proceeds from asset sale
Financing
Bottom line is dividend distributions. Include financing inflows, debt repayments and flows from reserves.
Cash flow before financing (similar to free cash flow) is the number that must be financed. Compute cash flow statement for construction period and the operating period.
Oct 18, 2008 56
Model Components and Project Contracts

Sources and Uses Statement
EPC Contract Construction Loan
Income Statement
PPA Contract Concession Agreement Supply Agreement
Cash Flow Statement

Cash Flow Waterfall Permanent Debt Agreement Debt Service Reserves Covenants
Oct 18, 2008 57
Model Outputs
Oct 18, 2008 58
Structure of Outputs Outputs should generally come from the financial statements and should not affect any of the calculations (you should be able to delete the outputs page without any impact on the model) Outputs for comparative graphs can be saved in a separate sheet -- you can develop a macro using a paste as value method to compare scenarios Put macro buttons, spinner boxes, combo boxes and scroll bars on the summary page.
Output Rule: You should be able to delete cells in the output sheet and summary sheet without affecting any of the previous sheets.
Output Example Project Finance
Try to summarize key inputs and key outputs on a single page and make the numbers jump out at you
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Example of Summary Page with Graph

Payback (Yrs) 3.6 Discounted Payback (Yrs) 7.0
NPV (AED M) Year Summary Financial Data Free Cash Flow Equity Cash Flow Net Income Colocation utilization Base Case Low Case High Case Case Applied Managed Service Utilization Base Case Low Case High Case Case Applied Prices Colocation Managed Service 0 (12,609,137) (800,000) 1 136,584 (1,576,593) (256,994) 2 2,912,624 1,199,446 399,928 3 5,438,598 3,725,420 2,986,744 4 6,766,992 5,053,814 4,379,630 5 8,354,138 6,640,960 6,035,138 5.5
IRR (%) 23.1%
35% 30% 35% 35% 5% 5% 5% 5% Base 20,000 200,000
50% 30% 70% 50% 10% 5% 15% 10% Sensitivity 100% 100%
70% 30% 90% 70% 15% 5% 20% 15% Applied 20,000 200,000
80% 40% 90% 80% 20% 10% 30% 20%
90% 40% 90% 90% 30% 10% 40% 30%
Financing and Valuation Assumptions Cash Flow Growth in Perpetuity Discount factor Book Value Multiple Debt Financing Assumptions Debt Percent Repayment Period (Maturity) Per Effective Interest Rate Cost Parameters Hardware Percent Network Costs Rental Rate Additional Staff
0% 12% 1.00 100% 10 1 6.00% 60% 1,000,000 50 300,000
Payback Period 3.6 Discounted Payback 7.0 Project IRR 23.1% NPV 5.5
When the inputs are change, the graph changes and the title of the graph changes. This is an effective way to present results.
15,000,000 10,000,000
5,438,598 6,766,992
13,272,065
5,000,000 -5,000,000 -10,000,000 -15,000,000

-12,609,137 136,584
2,912,624
Payback Period 3.6 Discounted Payback 7.0 Project IRR 23.1% NPV 5.5

10,000,000
6,766,992
15,000,000
13,272,065
Oct 18, 2008 61
Complexities
Oct 18, 2008 62
Complexities Debt Defaults Cash Flow Waterfall Net Operating Loss Terminal Value Vintage Depreciation and On-going Capital Expenditures
Oct 18, 2008 63
Periodic Cash Flow Modeling Monthly versus Annual Periodic Modeling

Need to model with years on a vertical rather than a horizontal basis because you run out of room. Use look-up tables to find inputs from annual workings analysis and monthly construction etc. Adds accuracy where
Debt service is quarterly etc. Scrapping occurs at specific points
Oct 18, 2008 64
Cash Flow Waterfall Waterfall Issues

Defaults and subsequent repayments of defaults before dividend distributions Model different priorities of debt Model cash flow trap mechanisms Evaluate Pre-payments from covenant violations Compute Debt service reserve injections and withdrawls Accumulation of debt service reserve after construction period
Oct 18, 2008 65
Modelling Defaults on Debt Modelling defaults on debt is important in credit analysis. Through modelling defaults, the probability of default and the loss given default can be evaluated through break-even analysis and through Monte Carlo simulation. The following process shows how to model defaults:
Set up the debt balance to incorporate defaults and re-payment of defaults The default comes from an if statement in the cash flow statement The re-payment of default is the previous year default amount. This means the model attempts to fully repay the default in the year immediately following the default. If there is no cash flow to repay the default, the default increases by the amount of the default.
Oct 18, 2008 66
Modelling Defaults on Debt - Procedure The following illustrates the modelling process for defaults.
Note how the default comes from the cash flow statement The if statement in the cash flow statement The repayment of default from the prior default
Oct 18, 2008 67
Maximum Default When modelling the defaults on debt, it is possible that the cash flow is less than the total debt service. In this case, the default is only the debt service that was not covered, not the negative of the cash flow. Therefore, the default formula should be:
If(cash<0,min(-cash,debt service),0) Notes:
Cash is cash flow to tranche Debt service includes the repayment of defaults
Oct 18, 2008 68
Analysis with Defaults Once defaults are modeled, one can evaluate the IRR earned on debt instruments and the amount of debt outstanding.
The amount of debt outstanding is the loss given default. The IRR allows you to compute a probability distribution for the loan facility
Oct 18, 2008 69
Computing Cash Flow for the Waterfall

To model priorities in a cash flow waterfall the first step is setting up a the cash flow statement in a model that reflects the actual ordering of cash flow:
Begin with the cash flow after capital expenditures and after all new financing and acquisitions Add back interest expense that was deducted because the interest will be accounted for on an issue by issue basis Add the beginning balance of cash. Even though it seems odd to add the cash balances, these cash balances are available to pay off debt. The sum of these items gives the cash flow for the waterfall as illustrated below.
Cash Flow After Capital Expenditures
Add: New Debt Issues Add: New Equity Issues
Cash Flow before waterfall adjustments

Add: Total Interest Expense Add: Beginning Cash Balance
Cash Flow for Waterfall
Oct 18, 2008 70
Cash Flow Priorities

Once the cash flow for the waterfall is computed, you can compute the defaults on senior and junior debt. Subtract scheduled interest payments and maturities from the cash flow for waterfall Also subtract attempts to re-pay earlier defaults The difference is cash flow after senior debt that determines default defaults are the driven by an if statement driven by whether there is negative cash flow. Any defaults are added to cash flow to determine the cash flow to junior debt
This step of the waterfall is illustrated below:
Cash Flow for Waterfall
Less: Scheduled Repayment Less: Interest on Senior Less: Repayment of earlier defaults
Cash Flow after Senior Debt

Add: Default on Senior Debt
Cash Flow to Junior Debt

Less: Scheduled Repayment Less: Interest on Junior Less: Repayment of earlier default
Oct 18, 2008 71
Cash Flow Traps and Dividends

After junior debt is evaluated, traps on cash and distributions can be evaluated. You must subtract the cash balance that was added at the beginning of the waterfall Cash Traps can be evaluated at this point that prevent excess cash going dividends before debt is paid
This step of the waterfall is illustrated below:
Cash Flow after Junior Debt
Add: Default on Junior Debt Less: Cash Balance Added Above
Net Cash Flow

Switch for Trapping Cash Less: Cash Trapped Add: Cash Withdrawn from Account
Dividend Distributions
Oct 18, 2008 72
Free Cash Flow Adjustments in Project Finance Models Free cash flow should be the same whether or not IDC was computed:
Use direct capital expenditures rather than capital expenditures with IDC Make adjustments for the tax effect of IDC depreciation. The tax shield from IDC depreciation should not be part of free cash flow and it should be removed.
Oct 18, 2008 73
Depreciation Expense
Compute straight line depreciation expense Multiply the accumulated plant balance from the balance sheet by the depreciation rate More complex depreciation modeling vintage, accelerated, deferred taxes, multiple categories will be covered later Models may have separate pages for capital expenditure and depreciation analysis
Oct 18, 2008 74
Net Operating Loss

Net operating loss should be part of a reasonable model. If earnings before tax is less than zero and a simple if statement is used, future years do not get credit for the earlier negative taxable income. Therefore, not including NOL will tend to understate value. To model the Net Operating Loss:
First compute taxes without the NOL which allows negative taxes Create a cork-screw that keeps track of the beginning balance and the additions and subtractions to the NOL The additions occur when there are negative taxes The subtractions occur when there is positive tax and a balance in the beginning NOL The taxes paid are the taxes without NOL plus the inputs to the NOL minus the withdrawls from the NOL.
Oct 18, 2008 75
NOL Example The following example illustrates modelling of an NOL

To model the NOL use the following:
An if statement the adds to the NOL when the taxes before NOL are positive An if statement together with a minimum statement to withdraw from the NOL balance.
Oct 18, 2008 76
Expiration of NOL Generally, the NOL expires after a period of years (in the US this is a 6 year period). To model expiration of the NOL, all you have to do is add another line in the NOL corkscrew:
Add a line for reductions due to loss of NOL Use the offset command to model expirations the offset command with a negative parameter for the column can look back The formula only applies after the period of the NOL
For example in the case of the US, this would be only after year 6 in the model unless you have data on existing NOLs and how they arose.
Oct 18, 2008 77
Expiration of NOL The following example illustrates programming of the NOL with expiration after a certain length of time. The two examples shows how expiration of the NOL can reduce its benefit if there is volatility in earnings:
Oct 18, 2008 78
Model Layout
Oct 18, 2008 79
Open Model
Check the logic of returns and debt costs. Project IRR should be above aftertax debt cost.
Oct 18, 2008 80
Reviewing an Actual Model - Inputs

Inputs have different colour. The inputs should be arranged logically.
Oct 18, 2008 81
Reviewing Model - Workings

Workings separate revenues, expenses and capital expenditures. Questions: Capital expenditure detail, explanation of financing and debt service reserve accounts.
Oct 18, 2008 82
Debt Schedule Note How Semi-Annual Debt Repayments are Incorporated

The debt repayments are modelled as period A and period B payments. Note the cork screw for debt analysis. Check the closing balance.
Oct 18, 2008 83
Sources and Uses - Monthly

Begin with uses EPC and Financing costs that include IDC and other financing costs. Sources are debt and equity. Difference between sources and uses go into cash account.
Oct 18, 2008 84
Financial Statements during Operation

The next sheets include the income statement, cash flow statement and the balance sheet during the operation of the plant.
Oct 18, 2008 85
Compute DSCR and LLCR

The DSCR is computed with and without the amounts in the debt service account. Note the minimum debt service account can be below 1.0
Oct 18, 2008 86

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Objectives of Project Finance Models

Project Finance Modelling

Oct 18, 2008 1

Work with Structural Enhancements

Perform Financial Structuring with Model

Loan Tenor Credit Spread

Financial Models Standard and Poors

Project Finance Modelling

Oct 18, 2008 3

Model Objectives - Overview

Value of project Debt Structuring

Project Finance Modelling

Oct 18, 2008 4

Objectives of Project Finance Modelling

Structuring of the Debt Facility and Other Contracts

Project Finance Modelling

Oct 18, 2008 5

Objectives of Project Finance Modelling (Continued)

Evaluating Whether Contract Provisions Appropriately Mitigate Risk

Project Finance Modelling

Oct 18, 2008 6

Project Finance Model Objective: Testing Structural Enhancements

Project Finance Modelling

Oct 18, 2008 7

Model Objectives Structuring of Funding and Debt Drawdown

Project Finance Modelling

Oct 18, 2008 8

Project Finance Modelling

Oct 18, 2008 9

Structure of Project Finance Models

Project Finance Modelling

Oct 18, 2008 11

Sheet Layout Project Model

Monthly Construction Expenditures (Source and Use of Funds)

Debt Schedule (Sources of Funds) Depreciation Schedule Financial Statements

Project Finance Modelling

Oct 18, 2008 12

Modules in a Project Finance Model How to Move from Assumptions to Valuation

Project Finance Modelling

Oct 18, 2008 13

Inputs, Outputs and Simple Computation of Cash Flow to Obtain Valuation

Project Finance Modelling

Oct 18, 2008 14

Model Sheets in Project Finance Model

Source and Use of Funds

Project Finance Modelling

Oct 18, 2008 15

Project Finance Modelling

Oct 18, 2008 16

Results of Good Model Structure In a well programmed model:

Project Finance Modelling

Oct 18, 2008 17

Valuation with Project Finance Models

Non-Recourse Structural Enhancements Risk Allocation from contract

Oct 18, 2008 18

Project Finance Modelling

Oct 18, 2008 19

Project Finance Modelling

Oct 18, 2008 20

Single Input Sheet If Inputs are all collected on a single sheet

Project Finance Modelling

Oct 18, 2008 21

Input Sheet Example