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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 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
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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
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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.
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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
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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
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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
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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
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Project Finance
Adapted from Project Finance Manual, January 2001
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Public Finance
Adapted from Project Finance Manual, January 2001
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Corporate Finance
Adapted from Project Finance Manual, January 2001
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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
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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)
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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
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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
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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
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Thank You