Project Finance Coverage Ratios

Definitions:

CADS = Cash Available for Debt Service

CADS equals pre-tax operating income (revenues minus operating ex-
penses)
Plus interest income from reserve accounts minus mandatory capital
expenditures minus investments in net working capital minus required
contributions to reserve accounts (maintenance, capital expenditures,
etc.). Notes: (1) depreciation should not be subtracted from the operat-
ing expenses; and (2) certain taxes such as property taxes and sales
taxes should be subtracted out from operating income, but income
taxes should not be subtracted. Although proceeds from a debt service
 reserve account are available to pay debt service in the event of a cash
flow shortfall, they are not typically included in the cash available for
debt service.
DS = Debt Service
DS includes interest payments and principal repayments due on a given
date.
DSRA = Debt Service Reserve Account
EBIT = Earnings Before Interest and Taxes
EBITDA = Earnings Before Interest and Taxes plus Depreciation
and Amortization
FCF = Free Cash Flow
Free cash flow equals EBIT after taxes, plus depreciation and amortiza-
tion, minus capital expenditures and increases in net working capital
(NWC).
KD = The cost of debt (i.e., stated interest rate); if there are
multiple debt tranches or instruments, then it is the weighted
average cost of debt where the weights are based on principal
amounts.

Coverage Ratios:

1) Interest Coverage Ratios (e.g., Times Interest Earned, or TIE)

TIE = EBIT / Interest Due

The traditional interest coverage ratios commonly used in corporate finance are rarely
used in project finance. Because most projects have limited lives, their debt capacity falls
over time. As a result, project lenders require projects to use fully amortizing debt. In
contrast, corporations with theoretically infinite lives refinance or roll over existing debt.
For this reason, project lenders care more about the ability to cover total debt service than
interest payments alone.

2) Debt Service Coverage Ratio (DSCR) or Annual Debt Service Coverage Ratio (AD-
SCR)

DSCR = CADS / DS
The Minimum Debt Service Coverage Ratio (Minimum DSCR) provides a measure
of financial risk by highlighting the year with the lowest coverage ratio. Typical ranges for
the minimum DSCR are:
a) 2.0X for a merchant power plant (MPP) with full market risk
b) 1.8X for natural resources project with commodity pricing risks
c) 1.5X for an infrastructure project with some market risk
d) 1.3X for an independent power plant (IPP) with a power
purchase agreement
The Average Debt Service Coverage Ratio (Average DSCR) equals the average of the an-
nual debt service coverage ratios calculated over the life of the loan (Note: this measure
can be distorted in later years if cash flow is high and debt service is relatively low). It pro-
vides an indication of whether the project, over some defined period, generates sufficient
cash flow to repay its debt. It does not, however, guarantee that the project can pay its
debt service in all years. To the extent the Average DSCR is high, it is an indication that
principal amortization can be shifted through time to cover periods of tight coverage.

3) Loan Life Coverage Ratio (LLCR)

The LLCR equals the net present value of CADS from the calculation date through the
final maturity date (discounted at the weighted average interest rate on all debt facilities
and tranches) divided by the total principal outstanding at the calculation date. The ratio
measures a project’s ability to service all of its debt while outstanding but does not indi-
cate whether there are shortfalls in any given year.

4) Project Life Coverage Ratio (PLCR)

The PLCR is the same as the LLCR except that the net present value of CADS is calcu-
lated over the life of the project rather than the life of the loan. For infrastructure and other
kinds of projects, project life is defined as the concession or off take period (contractual
period). In contrast, for extractive industries (e.g., mining, oil, etc.), project life is deter-
mined as the time until a specified fraction of total reserves is left. In natural resources
projects, this ratio is sometimes referred to as the reserve coverage ratio (RCR). The ratio
measures a project’s ability to service all of its debt but does not indicate whether there
are shortfalls in any given year.

5) Drawdown Coverage Ratio (DCR)

The DCR is a forward-looking coverage ratio that is relevant in the early stages of a
project’s life, before it has drawn down the full loan amount. In contrast to the LLCR,
which analyzes current indebtedness, the DCR analyzes coverage relative to the maxi-
mum expected debt level.