B.tech Admission in India

B.
Tech Admission in India

By:
admission.edhole.com
1.040/1.401
Project Management
Spring 2007
Project Financing & Evaluation
Dr. SangHyun Lee

lsh@mit.edu
Department of Civil and Environmental Engineering

Massachusetts Institute of Technology
Preliminaries
STELLAR access: to be announced

AS1 Survey due by tonight 12 pm
TP1 and AS2 are out
AS 2: Student Presentation
10 minute presentation followed by 5 minute discussion

1 or 2 presentations from Feb. 20 to Mar. 19
Topics
Your past project experience (strongly recommended if you have any)
Size of project is not important!

Project main figures
Main managerial aspects
Project management practices
Problems, strengths, weaknesses, risks
Your learning
Emerging construction technologies (e.g., 4D CAD, Virtual Reality, Sensing, )
Volunteers for next week?
Preliminaries
STELLAR access: to be announced

AS1 Survey due by tonight 12 pm
TP1 and AS2 are out
Pictures will be taken before you leave
Who we are
Dont memorize course content. Understand it.
Outline
Session Objective & Context
Project Financing
Owner
Project
Contractor
Additional Issues
Financial Evaluation
Time value of money

Present value
Rates
Interest Formulas
NPV
IRR & payback period
Missing factors
Session Objective
The role of project financing
Mechanisms for project financing
Measures of project profitability
Project Management Phase
FEASIBILITY
DESIGN
PLANNING
DEVELOPMENT
Financing & Evaluation
Risk
CLOSEOUT
OPERATIONS
Context: Feasibility Phases
Project Concept
Land Purchase & Sale Review
Evaluation (scope, size, etc.)
Constraint survey
Site constraints
Cost models
Site infrastructural issues
Permit requirements
Summary Report
Decision to proceed
Regulatory process (obtain permits, etc)
Design Phase
Lecture 2 - References
More details on:
Hendrickson PM for Construction on-line textbook
Chapter 7
Outline
Project Financing
Owner
Project
Contractor
Additional Issues
Time value of money

Present value
Rates
Interest Formulas
NPV
Missing factors
Financing Gross Cashflows

years
OWNER
investment
operation incomes
owner cashflow
owner cum cashflow
10
($10,000,000) ($20,000,000)
$2,000,000
$4,000,000
$6,000,000
$6,000,000
$0 ($10,000,000) ($20,000,000) $2,000,000
$4,000,000
$6,000,000
$6,000,000
$0 ($10,000,000) ($30,000,000) ($28,000,000) ($24,000,000) ($18,000,000) ($12,000,000)
CONTRACTOR
costs
($4,000,000) ($7,000,000) ($14,000,000)
revenues
$0 $10,000,000 $20,000,000
contractor cashflow
($4,000,000) $3,000,000
$6,000,000
contractor cum cashflow
($4,000,000) ($1,000,000) $5,000,000
$0
$0
$0
$5,000,000
$0
$0
$0
$5,000,000
$0
$0
$0
$5,000,000
Owner investment = contractor revenue

$10,000,000
$5,000,000
$0
($5,000,000)
1 2 3 4 5 6 7 8 9 10 11
($10,000,000)
($15,000,000)
($20,000,000)
($25,000,000)
($30,000,000)
($35,000,000)
owner cum cashflow

$0
$0
$0
$5,000,000
$6,000,000
$6,000,000
($6,000,000)
$6,000,000
$6,000,000
$0
$6,000,000
$6,000,000
$6,000,000
$0
$0
$0
$5,000,000
$0
$0
$0
$5,000,000
$0
$0
$0
$5,000,000

Design/Preliminary
years
OWNER
investment
operation incomes
owner cashflow
owner cum cashflow
Construction
2
10
($10,000,000) ($20,000,000)
$2,000,000
$4,000,000
$6,000,000
$6,000,000
$0 ($10,000,000) ($20,000,000) $2,000,000
$4,000,000
$6,000,000
$6,000,000
$0 ($10,000,000) ($30,000,000) ($28,000,000) ($24,000,000) ($18,000,000) ($12,000,000)
CONTRACTOR
costs
($4,000,000) ($7,000,000) ($14,000,000)
revenues
$0 $10,000,000 $20,000,000
contractor cashflow
($4,000,000) $3,000,000
$6,000,000
($4,000,000) ($1,000,000) $5,000,000
$0
$0
$0
$5,000,000
$0
$0
$0
$5,000,000
$0
$0
$0
$5,000,000

$10,000,000
$5,000,000
$0
($5,000,000)
1 2 3 4 5 6 7 8 9 10 11
($10,000,000)
($15,000,000)
($20,000,000)
($25,000,000)
($30,000,000)
($35,000,000)
owner cum cashflow

$0
$0
$0
$5,000,000
$6,000,000
$6,000,000
($6,000,000)
$6,000,000
$6,000,000
$0
$6,000,000
$6,000,000
$6,000,000
$0
$0
$0
$5,000,000
$0
$0
$0
$5,000,000
$0
$0
$0
$5,000,000

Design/Preliminary
years
OWNER
investment
operation incomes
owner cashflow
owner cum cashflow
Construction
2
10
($10,000,000) ($20,000,000)
$2,000,000
$4,000,000
$6,000,000
$6,000,000
$0 ($10,000,000) ($20,000,000) $2,000,000
$4,000,000
$6,000,000
$6,000,000
$0 ($10,000,000) ($30,000,000) ($28,000,000) ($24,000,000) ($18,000,000) ($12,000,000)
CONTRACTOR
costs
($4,000,000) ($7,000,000) ($14,000,000)
revenues
$0 $10,000,000 $20,000,000
contractor cashflow
($4,000,000) $3,000,000
$6,000,000
($4,000,000) ($1,000,000) $5,000,000
$0
$0
$0
$5,000,000
$0
$0
$0
$5,000,000
$0
$0
$0
$5,000,000
$0
$0
$0
$5,000,000
$6,000,000
$6,000,000
($6,000,000)
$6,000,000
$6,000,000
$0
$6,000,000
$6,000,000
$6,000,000
$0
$0
$0
$5,000,000
$0
$0
$0
$5,000,000
$0
$0
$0
$5,000,000

$10,000,000
$5,000,000
$0
($5,000,000)
1 2 3 4 5 6 7 8 9 10 11
($10,000,000)
($15,000,000)
($20,000,000)
($25,000,000)
($30,000,000)
($35,000,000)
owner cum cashflow

Early expenditure
Takes time to get revenue
Project Financing
Aims to bridge this gap in the most beneficial way!
Critical Role of Financing
Makes projects possible

Has major impact on
Riskiness of construction
Claims
Prices offered by contractors (e.g., high bid price for late
payment)
Difficulty of Financing is a major driver towards alternate

delivery methods (e.g., Build-Operate-Transfer)
How Does Owner Finance a Project?
Public
Private
Project financing
Outline
Project Financing
Owner
Project
Contractor
Additional Issues
Time value of money

Present value
Rates
Interest Formulas
NPV
Missing factors
Public Financing
Sources of funds
Social benefits important justification
Benefits to region, quality of life, unemployment relief, etc.
Important consideration: exemption from taxes

Public owners face restrictions (e.g. bonding caps)
General purpose or special-purpose bonds

Tax revenues
Capital grants subsidies
International subsidized loans
Major motivation for public/private partnerships
MARR (Minimum Attractive Rate of Return) much lower (e.g. 810%), often standardized
Private Financing
Major mechanisms
Equity
Invest corporate equity and retained earnings

Offering equity shares
Stock Issuance (e.g. in capital markets)
Must entice investors with sufficiently high rate of return

May be too limited to support the full investment
May be strategically wrong (e.g., source of money, ownership)
Debt
Borrow money
Bonds
Because higher costs and risks, require higher returns

MARR varies per firm, often high (e.g. 20%)
Private Financing
Major mechanisms
Equity
Invest corporate equity and retained earnings

Offering equity shares
Stock Issuance (e.g. in capital markets)
Must entice investors with sufficiently high rate of return

May be too limited to support the full investment
May be strategically wrong (e.g., source of money, ownership)
Debt
Borrow money
Bonds
Because higher costs and risks, require higher returns

MARR varies per firm, often high (e.g. 20%)
Private Owners w/Collateral Facility

Distinct Financing Periods
Short-term construction loan
Bridge Debt
Long-term mortgage
Senior Debt
Risky (and hence expensive!)

Borrowed so owner can pay for construction (cost)
Typically facility is collateral

Pays for operations and Construction financing debts
Typically much lower interest
Loans often negotiated as a package
construction
w/o tangible
operation
w/ tangible
time
Outline
Project Financing
Owner
Project
Contractor
Additional Issues
Time value of money

Present value
Rates
Interest Formulas
NPV
Missing factors
Project Financing
Investment is paid back from the project profit rather than the
general assets or creditworthiness of the project owners
For larger projects due to fixed cost to establish
Investment in project through special purpose corporations
Often joint venture between several parties
Need capacity for independent operation

Benefits
Small projects not much benefit
Off balance sheet (liabilities do not belong to parent)

Limits risk
External investors: reduced agency cost (direct investment in project)
Drawback
Tensions among stakeholders
Outline
Project Financing
Owner
Project
Contractor
Additional Issues
Time value of money

Present value
Rates
Interest Formulas
NPV
Missing factors
Contractor Financing I
Payment schedule
Break out payments into components
Often some compromise between contractor and owner

Architect certifies progress
Agreed-upon payments
Advance payment
Periodic/monthly progress payment (itemized breakdown structure)
Milestone payments
retention on payments (usually, about 10%)
Often must cover deficit during construction

Can be many months before payment received
S-curve Work
Man-hours
months
S-curve Cost
8
100
90
80
$K
60
50
40
30
2
20
10
0
1
9 10 11 12 13 14 15 16 17 18 19 20 21 22
admission.edhole.comWorking days
Cumulative costs $K
70
Daily cost
Cum. costs
Expense & Payment
Contractor Financing II
Owner keeps an eye out for
Front-end loaded bids (discounting)

Unbalanced bids
Contractor Revenue Projection
Contractor Revenue Projection

120
140
100
120
100
Revenue
Revenue
80
60
80
60
40
40
20
20
0
1
10
11
12
Month
13
14
15
16
17
18
10
Month
11
12
13
14
15
16
17
18
Contractor Financing II
Owner keeps an eye out for
Contractors frequently borrow from
Front-end loaded bids (discounting)

Unbalanced bids
Banks (Need to demonstrate low risk)
Interaction with owners
Some owners may assist in funding
Help secure lower-priced loan for contractor
Sometimes assist owners in funding!
Big construction company, small municipality

BOT
Contractor Financing III
Agreed upon in contract
Often structure proposed by owner
Should be checked by owner (fair-cost estimate)
Often based on Masterformat Cost Breakdown Structure

(Owner standard CBS)
Certified by third party (Architect/engineer)
Outline
Project Financing
Owner
Project
Contractor
Additional Issues
Time value of money

Present value
Rates
Interest Formulas
NPV
Missing factors
Latent Credit
Many people forced to serve as lenders to owner due

to delays in payments
Designers
Contractors
Consultants
CM
Suppliers
Implications
Good in the short-term

Major concern on long run effects
Role of Taxes
Tax deductions for
Depreciation - Link
the process of recognizing the using up of an asset through

wear and obsolescence and of subtracting capital expenses
from the revenues that the asset generates over time in
computing taxable income
Others
Outline
Project Financing
Owner
Project
Contractor
Additional Issues
Time value of money

Present value
Rates
Interest Formulas
NPV
Missing factors
Develop or Not Develop
Is any individual project worthwhile?
Given a list of feasible projects, which one is the best?
How does each project rank compared to the others on

the list?
Project Evaluation Example:
Project A
Project B
Construction=3 years
Construction=6 years
Cost = $1M/year
Cost=$1M/year
Sale Value=$4M
Sale Value=$8.5M
Total Cost?
Total Cost?
Profit?
Profit?
Quantitative Method
Profitability
Create value for the company
Profit
TOTAL
EQUIVAL. $
REVENUES
5,500,000.00
COSTS
4,600,000.00
Project management
400,000.00
Engineering
800,000.00
Material & transport
2,200,000.00
Construction/commissioning
1,300,000.00
Contingencies
GROSS MARGIN
Time factor?
200,000.00
900,000.00
Quantitative Method
Profitability
Create value for the company
Opportunity Cost
Time Value of Money
A dollar today is worth more than a dollar tomorrow
Investment relative to best-case scenario
E.g. Project A - 8% profit, Project B - 10% profit
Money Is Not Everything
Social Benefits
Hospital
School
Highway built into a remote village
Intangible Benefits (E.g, operating and competitive

necessity)
New warehouse
New cafeteria
Outline
Project Financing
Owner
Project
Contractor
Additional issues
Time value of money

Present value
Rates
Interest Formulas
NPV
Missing factors
Basic Compounding
Suppose we invest $x in a bank offering interest rate i

If interest is compounded annually, asset will be worth
$x(1+i)
$x(1+i)2
$x(1+i)3
$x(1+i)n
after 1 year
after 2 years
after 3 years .
after n years
1 $x(1+i)
$x
2 $x(1+i)2
n $x(1+i)n
Time Value of Money
If we assume
That money can always be invested in the bank (or some

other reliable source) now to gain a return with interest later
That as rational actors, we never make an investment which
we know to offer less money than we could get in the bank
Then
Money in the present can be thought as of equal worth to

a larger amount of money in the future
Money in the future can be thought of as having an equal
worth to a lesser present value of money
Equivalence of Present Values
Given a source of reliable investments, we are

indifferent between any cash flows with the
same present value they have equal worth
This indifferences arises because we can

convert one to the other with no extra expense
Preliminaries
STELLAR access:
http://stellar.mit.edu/S/course/1/sp07/1.040/
Next Tuesday Recitation: Skyscraper Part I
Please set up an appointment to discuss your AS2 if
you choose emerging technologies (MF preferred)
Office: 1-174
TA (50%) for our class
Send your resume (or brief your experience) by this Sunday
Outline
Project Financing
Owner
Project
Contractor
Additional issues
Time value of money

Present value
Rates
Interest Formulas
NPV
Missing factors
Time Value of Money: Revisit
If we assume
That money can always be invested in the bank (or some

other reliable source) now to gain a return with interest later
That as rational actors, we never make an investment which
we know to offer less money than we could get in the bank
Then
Money in the present can be thought as of equal worth to

a larger amount of money in the future
Money in the future can be thought of as having an equal
worth to a lesser present value of money
Present Value (Revenue)
How is it that some future revenue r at time t has a present

value?
Answer: Given that we are sure that we will be gaining revenue r
at time t, we can take and spend an immediate loan from the
bank
We choose size of this loan l so that at time t, the total size of the loan
(including accrued interest) is r
The loan l is the present value of r
l = PV(r)
Future to Present Revenue

If I know this is coming
x
t
I can borrow this from the bank now

PV(x)
PV(x)
Ill pay this back to the bank later
-x
The net result is that I can convert a sure x at time t

into a (smaller) PV(x) now!
t
Present Value (Cost)
How is it that some future cost c at time t has a present value?

Answer: Given that we are sure that we will bear cost c at time t,
we immediately deposit a sum of money x into the bank yielding
a known return
We choose size of deposit x so that at time t, the total size of the

investment (including accrued interest) is c
We can then pay off c at time t by retrieving this money from the bank
The size of the deposit (immediate cost) x is the present value of c.

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B.

Tech Admission in India

Dr. SangHyun Lee

Department of Civil and Environmental Engineering

STELLAR access: to be announced

10 minute presentation followed by 5 minute discussion

Your past project experience (strongly recommended if you have any)

Size of project is not important!

Emerging construction technologies (e.g., 4D CAD, Virtual Reality, Sensing, )

Volunteers for next week?

STELLAR access: to be announced

Session Objective & Context

Time value of money

The role of project financing

Mechanisms for project financing

Measures of project profitability

Project Management Phase

Financing & Evaluation

Context: Feasibility Phases

More details on:

Hendrickson PM for Construction on-line textbook

Session Objective & Context

Time value of money

Financing Gross Cashflows

Owner investment = contractor revenue

owner cum cashflow

Financing Gross Cashflows

Owner investment = contractor revenue

owner cum cashflow

Financing Gross Cashflows

Owner investment = contractor revenue

owner cum cashflow

Aims to bridge this gap in the most beneficial way!

Critical Role of Financing

Makes projects possible

Difficulty of Financing is a major driver towards alternate

How Does Owner Finance a Project?

Session Objective & Context

Time value of money

Social benefits important justification

Benefits to region, quality of life, unemployment relief, etc.

Important consideration: exemption from taxes

General purpose or special-purpose bonds

Major motivation for public/private partnerships

Invest corporate equity and retained earnings

Stock Issuance (e.g. in capital markets)

Must entice investors with sufficiently high rate of return

Because higher costs and risks, require higher returns

Invest corporate equity and retained earnings

Stock Issuance (e.g. in capital markets)

Must entice investors with sufficiently high rate of return

Because higher costs and risks, require higher returns

Private Owners w/Collateral Facility

Short-term construction loan

Risky (and hence expensive!)

Typically facility is collateral

Loans often negotiated as a package

Session Objective & Context

Time value of money

Investment in project through special purpose corporations

Often joint venture between several parties

Need capacity for independent operation

Small projects not much benefit

Off balance sheet (liabilities do not belong to parent)