Valuation

Of

Submitted To:
Rajesh Sharma (Phd.)
Faculty of Finance and Economics
Kathmandu University School of Management

Submitted By:
Group 1
Bijay Shrestha
Manoj Sedai
Dikson Limbu
Rahul Lama
Contents
A. INTRODUCTION TO COMPANY...........................................................................................3

1. About Mountain Energy Nepal................................................................................................3

2. Business model........................................................................................................................3

3. Life cycle.................................................................................................................................4

4. Strategy/ SWOT Analysis........................................................................................................6

4. Chairman Statement/ CEO Statement/ Risk Report/ Corporate Governance/ CSR report.....7

5. Financial Structure...................................................................................................................7

6. Capital Structure of Mountain Energy Nepal..........................................................................8

7. Future goals and plan...............................................................................................................8

9. Economic Analysis..................................................................................................................9

10. Industry Analysis.................................................................................................................11

B. VALUATION...........................................................................................................................14

1. Discounted Cash Flow Basis.................................................................................................14

2. Relative Valuation.................................................................................................................22

Findings and Recommendations................................................................................................23

A. INTRODUCTION TO COMPANY
1. About Mountain Energy Nepal

 Company: Mountain Energy Nepal Limited

 Established in Jestha 31, 2065 as private company but was converted to public company in
Bhadra 9, 2071.
 Formed by merging Robust Energy limited (Mistri Hydro) and Aadishakti Power
Development Company (Tadi Khola)

2. Business model

Judgement Variable Feature Impact on

Revenue in Income
Revenue Stream Electricity sale in unit basis, Statement
Revenue in Income
Customer Segment NEA, Foreign importer Statement
Safe and Renewable energy
Value Proposition supply Tax policy
Cost of Supply in Income
Channel Grid supply Statement, CAPEX
Revenue in Income
Customer Relationship Based on PPA agreement Statement
Timely Production equipment
Supply, Regular Maintenance
Key resources manpower, Distribution Line, Depreciable Assets, CAPEX
Regular monitoring of production
facility, Maintenance of
infrastructure to avoid any
accident, maintain water level by
avoiding any disruption in water
bodies, Observe climatic Maintenance Cost, CAPEX,
Key Activities parameters Working Capital
Major supply contract, Power
Purchase Agreement,
Interconnection agreement,
Operation and Maintenance Revenue, Operating
Key partnership Agreement Expense, Cost of Material,
Include cost associated with Cost of Production, Supply
Cost Structure production and supply and Maintenance

2.1 Revenue Model

Hydro project Production Capacity Production Selling Price
 Started

Tadi Khola Chaitra 14, 5 Mega Dry Season-  Dry Season: Rs. 9.66 per
unit
Hydroelectric 2069 Watt 71,43,537 kWh
 Wet Season: Rs. 5.52 per
Project Wet Season- unit
(Cost: 2,54,96,101 kWh  Price increase by 3% each
year for 5 times
924,579,531) Total energy-  Excess energy sold at 50
3,26,39,639 kWh % less price

Mistri Khola Ashar 3, 42 Mega Dry Season-  Price increase by 3% each

year for 10 times
Hydroelectric 2078 Watt 3,07,03,362 kWh
 Price: Rs. 5.56 per unit
Project Wet Season-  Excess energy sold at 50
(Cost: 20,91,72,946 % less price

5,642,632,958) kWh
Total energy-
23,98,76,308
kWh

Mistri Khola – In Power 12 Mega Dry Season- No PPA till now

2 Purchase Watt 21.27 GWh
Hydroelectric Agreement Wet Season-
Project Phase (3 48.11 GWh
(Projected year Total energy-
cost: 1847 construction 69.4 GWh
million) period)

3. Life cycle

For analyzing in which lifecycle MEN lies, we analyzed its operating profit since it is the income
earned from the core operations of a business. The operating profit of the MEN was negative Rs.
1514614 in 2018(2075 Bs) which has been contracting from the previous years. Then afterward
MEN started earning revenues from sales of electricity which was Rs. 117410103 in 2019
generating an operating profit of Rs. 97385182 which on increasing on year on year basis by
7.65% and 28.96% in the year 2020 and 2021 respectively. Similarly, MEN has a high
investment in growth assets and capital stock financing has been initiated as well for this. All
these are the characteristic of high growth company; thus, it is assumed that MEN falls in the
high growth phase.
Industry MEN
  Judgement Variable Information Information Signal
Number of years for Since 1968 B.S, So
Industry Existence 111 years history
Number of hydropower
project operating 113
Available Maximum 20.48 years
life of firm in Industry 57.2 years (Tadi)
Internal Available Minimum 1.07 years
factor life of firm in Industry 0.3 years (Mistri)
Solar power (22
Substitute product Projects) 137.56
existence MW +20.18 MW)
Substitute product
growth rate based on
number of new venture High
 
Overall Electrification 94% (On grid and
in Nepal Off grid)
Electricity production HIGH
Capacity of Nepal 50000 MW GROWT
Electricity produced till H
now 2003.61 MW PHASE
Country Demand for
External Electricity growth 11.42%
factor Government Budget
Allocation for energy 75.10 billion
sector (Energy sector) 2021/22
GDP contribution 121.97 billion
growth rate for the (Energy, Water
energy sector 1.92% and Irrigation)
Energy sector growth
rate 14.73%
   
Ability to attract and Renowned person
Inject fund to electricity in board so can
Managemen
production attract finance
t Factor
Conflict in production No conflict seen in
area areas
   
 Revenue Growth rate 20.37%
CAPEX investment
Rate High
Retention rate 87.87% 100%
Profit margin
New hydro has
started earning so
Financial high earning
factor of Earning growth growth
MEN Huge capital
investment
required as Mistri
II construction is
Capital Investment about to start
Profit margin 34.26% 54.60%
ROE vs required return 20.35
Dividend payout 12.13% no payout

4. Strategy/ SWOT Analysis

Strength
 Revenue Risk shared with NEA through PPA
 Experienced high net worth and networked promoters and directors reducing financial
risk due to capital insufficiency.

Weakness
 Poor retention of skilled human resources
 No adequate corporate governance framework and disclosure affecting confidence of
public investor and creditors.
 Issues like resignation of Director Chandra Prasad Dhakal in 2077/11/03

Opportunity
 Growing energy demand in Nepal and South Asia, power purchase agreement with India
and Bangladesh

Threats
 Supplier risk as vendors of major project asset is of foreign origin so impact of exchange
rate on cost of project.
  Impact of climate change on amount of rainfall in Catchment area leading to production
capacity risk.

4. Chairman Statement/ CEO Statement/ Risk Report/ Corporate Governance/ CSR report

Mountain Energy Nepal Ltd. has a seven members Board of Directors which is an apex body for
the management of the company. Five members in the board represents promoter of the
company (80% promoters share), one member represents public shareholders (20% stake) and
one director in the board is Independent. The board is chaired by Suhrid Raj Ghimire, who has
an extensive industry experience ranging from trading, real estate, investment to hospitals and
resorts. All other directors also have relevant experience and meet the criteria provisioned in the
Company Act; hence the board has been assessed as competent.
However, the company does not have adequate structures under the Board to ensure prudent risk
management and high degree of corporate governance practices. The company has an Audit
Committee to provide oversight of the financial reporting process; however, information on
composition and meetings of the committee has not been published. The company apparently
lacks risk management committee, assets and liabilities committee, remuneration committee and
other committees which are the crucial components of the good corporate governance. In
conclusion, the company does not have an adequate and effective framework to ensure effective
oversight of the risk management, corporate compliance and the integrated framework of internal
controls.
Though, the company might try to justify the adequacy of their current structure on the ground of
simple business model, insufficient corporate governance practices can have adverse effect on
company valuation and share price.
The identified risks in the company emerges from the ever-growing phenomena of climate
change, foreign suppliers, currency risks, operational efficiency and retention of highly
competent human resources. We will try to quantify the identified risks and lack of corporate
governance practices in our final valuation by either adjusting the forecasted cash flow or cost of
capital.

5. Financial Structure

  31st 31st 31 31st 31st 31st

Ashadh Ashadh Ashadh Ashadh Ashadh Ashadh
 2078 2077 2076 2075 2074 2073
Debt to Equity Ratio 1.7608 2.0583 1.6631 0.0006 0.0006 0.0222

Equity Portion 36.221% 32.697% 37.550% 99.939% 99.942% 97.829%

Debt Portion 63.779% 67.303% 62.450% 0.061% 0.058% 2.171%
6. Capital Structure of Mountain Energy Nepal

In 2078 the company issued it’s shares to public where it issued 3,936,054 units of shares to
general public injecting equity from public as well thus debt to equity ratio fell to 1.7608 though
the debt portion contributes hugely to capital of Mountain Energy Nepal now with 63.78% of
assets being funded by debts.

7. Future goals and plan

1. The company has the future plan to be the hydro leader in Nepal.
2. To study the various possibilities of hydro energy project and construct it.
3. To invest capital in Hydroelectricity project.
4. To utilize abundance water resources of Nepal for electricity generation.
8. Basis for Competitor

Chilime Mountain Energy

COMPANY Hydropower Nepal Limited Basis
STOCK CHCL MEN
POWER PLANT CAPACITY 22.1 MW 5 MW + 42 MW
ANNUAL ENERGY 240 GWh+ 32.9
GENERATION 150 GWh GHw
LATEST CLOSE PRICE 395 800
PAID UP CAPITAL 6,751,794.68 1,968,027.00
RESERVES AND SURPLUS 3,398,712.86 828,967.43
Comparabl
TOTAL REVENUE 823,435.72 852,606.70 e
Comparabl
NET INCOME 516,804.13 426,997.54 e
GROSS MARGIN % 75.79% 47.39%
NET PROFIT MARGIN % 60.23% 0.41%
NET PROFIT MARGIN % 60.95% 49.91%
ROE % 6.83% 20.35%
ROA % 6.64% 8.51%
EPS 10.21 28.93
 Comparabl
BVP 150.34 142.12 e
PE 38.7 27.65

9. Economic Analysis

Factors Remarks Impact on

GDP growth and electricity consumption grow in
synchrony, with both increasing as the other does.
Umalla and Samal (2018) used the ARDL bounds
testing approach to cointegration to study the In the current fiscal
impact of hydropower energy consumption on year, Nepal's economy
economic growth and CO2 emissions in China is expected to grow by
from 1965 to 2016. They discovered bidirectional 5.84 percent. In the
causality between hydroelectric energy previous fiscal year,
consumption, economic growth, and CO2 such growth was 4.25
emissions in the long run, and they conclude that percent. The impact of
hydropower energy consumption is a driving force the Covid-19 outbreak
in China's economic growth. As a result, a decrease has been progressively
in economic growth has a negative impact on fading, according to the
demand for hydropower electricity. Economic Survey
GDP
Energy consumption from hydropower and 2078/79, and the
economic growth are complimentary, with an expansion of the energy
increase in energy consumption stimulating sector has been
economic growth and vice versa.  Bildirici (2016). promising due to the
During the 2000s, Nepal's economic development expansion of Nepal's
was less than 4% per year, which was due in part to economy. As a result,
energy supply issues for both traditional and we may anticipate that
modern sectors. Recent improvements in energy energy consumption will
supply to the industrial and service sectors are seen rise in the coming years,
to have contributed to improved economic growth. affecting growth rates
This upward trend in the electricity sector is likely and revenue.
to continue, owing to rising urbanization and an
increase in the number of energy-intensive
enterprises. Unconstrained power consumption is
anticipated to rise from 10,138 gigawatt-hours
(GWh) in 2019-2020 to 31,196 GWh in 2029-
2030(Nepal 2019) (Gunatilake,Wijayatunga, and
Roland-Holst,2020)
Budget Positive aspects:  Positive aspects,
(Recent)  A total of NPR 43.95 billion (USD 360 million) mainly increases the
has been allocated for transmission and demand of the
substation construction. electricity and will
 In the current fiscal year, the GoN plans to add increases sales
415 megawatts of hydropower capacity. Such thereby increasing
 developments will make it easier for private
companies to participate in the electricity trade.
 Furthermore, charging stations will be installed
in 50 locations across the country to promote the revenue. Some
the usage of electric vehicles. initiation will also
 Furthermore, industries utilizing more than 100 decrease the cost, for
million (USD 819,672) in electricity will instance budget
receive a 15% rebate on their electricity bill. allocated for
 The 'Prime Minister's Nepali Output and transmission and
Promotion Program' will be launched to substation.
promote export-oriented industries and increase  However, increasing
domestic production. A budget of NPR 3.45 in the excise duty
billion (USD 28.2 million) has been set aside from 40% to 60%,
for the program promoting "Own Production, will definitely
Own Consumption," as well as other private decreases the
sector initiatives such as Make in Nepal and demand for electric
Made in Nepal. vehicle thereby,
decreases the
Negative aspects: consumption and
sales of electricity.
 The excise charge on an electric car with a
capacity of more than 300 kilowatts has been
raised from 40% to 60%.
Inflation Expansion of hydropower can operate as a hedge According to the EIA,
against the negative growth impact of oil price the nominal price of
increases. While higher oil prices decrease the Brent crude oil will
positive growth effects, aggressive hydropower reach $66 per barrel by
expansion brings significant economic growth 2025. Global demand is
benefits. (Gunatilake, Wijayatunga, and Roland- expected to drive Brent
Holst,2020) prices to $89/b by 2030.
Prices are expected to
reach $132/b by 2040.
By then, the inexpensive
oil sources will have
been depleted, making
extraction more
expensive. Oil prices
might reach $185 per
barrel by 2050.
This will have an effect
on the price of imported
oil in Nepal. As a result,
it is reasonable to
anticipate that growth
and demand for
electricity will be
 significant in the future.
The demand for skilled
The budget allocated NPR 7.05 billion (USD 57.8 migrant workers should
million) under the ‘Prime Minister Employment rise as GCC nations
Program’. It aims to provide at least 0.2 million (Malaysia, Japan, and
employments in the agriculture and productive South Korea) try to
sector. In the fiscal year 2020-21, the GoN was lessen their reliance on
only able to employ 0.1 million applicants under oil and promote new
Employmen the scheme. industries including
t and Number of Nepali workers taking approval for tourism, manufacturing,
Remittance foreign employment increased significantly to and technology. As their
313,367 in 1st 11 months of 2022/13 which had labor forces quickly age,
decreased 68 percent in the same period of the Japan and South Korea
previous year. Remittance inflows increased 3.8 will be reliant on
percent to Rs.904.18 billion in the 1st 11 months migrant labor in
2022/23 compared to 12.6 percent in the same industries including
period of the previous year. According to agriculture,
projections, there will be up to a million Nepalis manufacturing, and
residing in Australia, Canada, the UK, and the US construction. However
by the year 2030 that will result in a larger diaspora nationalist policies to
living abroad and more money being sent back to prioritize locals frist
Nepal (Nepal Economic Forum, 2022).  may hinder in it. (S.
Bajracharya, 2022).
The monetary policy 2020/21 has made the
The programs support
provisions for sectoral credits in the sectors
the small enterprises and
Agriculture and Energy Sector, Micro, Cottage,
farmers who are then
Small and Medium Enterprises Credit, Deprived
Monetary likely to consume
Sector Lending and Concessional Loans. Also,
Policy electricity with running
there is provision of providing additional working
of the business as well
capital loan up to 20 percent of existing outstanding
as demand electrical
working capital loan to the existing borrowers and
goods. Also, the green
business continuity loans. Priority sector lending,
finance is being
interest rate, green bonds.
promoted with including
Also, the Government of Nepal will raise money by
ESRM for banks and
issuing Green Bonds in order to finance the
financial institutions by
construction of substantial and revolutionary
the NRB.
infrastructure.

10. Industry Analysis

Porter’s 5
Remarks Impact on
forces
Bargaining  High  Affects in the Sales
Power of since price
Buyers Reasons: controlled is on
  Sole buyer is NEA
 Other foreign buyers are also handled by NEA
NEA. Electricity can be exported to a  Selling price control
foreign country after entering into an will directly affects
export agreement with the Government the EBIT, FCFF and
of Nepal. Terminal value
 No differences among the hydropower
companies in the industry

Threats of  Medium to High Threats of new entrants

new Reasons: will increase in the
entrants  It is highly expensive to establish any competition, which will
hydropower company in Nepal. For create excess electricity
instance, it is estimated that the production, and NEA
government developed medium-sized will have more
hydropower cost an average of US$ bargaining power which
2,800/KW while private generators have will affects in the sales
been able to produce at US $ 1,000/KW, revenue. Moreover,
(Source: NRB Economic Review). further expansion cost
Therefore, threats of new entrants is will increase since,
medium in a sense since, new entrants investors get ample
need huge capital investment. choices of hydropower
 However, there is less barriers to entry to invest.
since, in every fiscal year, government,
main priority is to boost hydropower in
Nepal. For example, the latest budget
allocated NPR 43.95 billion (USD 360
million) for transmission and substation
construction. In the current fiscal year,
the GoN plans to add 415 megawatts of
hydropower capacity. Such
developments will make it easier for
private companies to participate in the
electricity industry, thereby increasing
the new entrants. The Nepalese
government, in its FY 79/80 budget, set
an ambitious goal of supplying
electricity to all of its residents within
two years. Mini hydropower plants have
been targeted for remote areas, and an
annual per capita electricity
consumption of 400 units is expected by
the end of this fiscal year. This is
 drawing new entrants as per our
assumptions, resulting in high entrant
threats.

 High This will affect the cost of

Reasons: maintenance, and capital
All the hydropower company outsource their expenditure.
Bargaining supplies from foreign company. The price of
power of import is highly impacted by the currency rate,
suppliers distance of import and timely supply. The
suppliers have high bargaining power due to
having expertise in respective equipment
supply.
 Low to Medium
Reasons:  This is positive aspects
 Biofuels and waste, such as firewood, for hydropower
agricultural waste, and animal dung, are industries in Nepal
Threats of
Nepal's primary energy supply (Asian since, country in moving
substitute
Development Bank [ADB] 2017). Other towards sustainable
products
important energy sources are oil products energy focusing on
and coal, both of which Nepal must import hydropower and
which are highly expensive. As a result, government is also
Nepal has a comparative advantage in pushing policy to
hydropower, and although there is medium electric economy. This
threats of substitute products, they will be will affect the growth
low in the future as the globe shifts toward rate, terminal value and
sustainable energy sources while focusing sales revenue.
on climate change.
 Medium  This will affect the cost,
Reasons: sales and growth rate in
 There are total 113 projects initiated as of the industry.
Jan 8, 2022 with the capacity of 2003.612
MW.
Competitive  There are high exit barriers since, it requires
Rivalry huge investment to enter.
 Rivalry among the competitors is medium
since, hydro industry of Nepal is in still
growth phase, since Nepal’s theoretical
potential capacity is 83,290, technical
potential capacity is 45610 and economic
potential is 42,133 as per ADB.
 Competition will increase among the
hydropower companies in Nepal to gain
finance for expansion, increasing
production.
B. VALUATION
Based on the above findings on lifecycle and business model, we will be using Discounted Cash
Flow Method and Relative Valuation method. The rationale for using DCF is that the company is
in high growth phase with huge capital expenditure on hydropower construction and it has not
given any dividends to its shareholder, which reflects that the company will be generating huge
cashflow in future. The proper estimate of cashflow will result in good estimate of its intrinsic
value.
The rationale for using relative valuation is that all the hydropower company of Nepal operate in
similar fashion. There is similarity in production process, revenue unit price, and customer. So,
using comparable company for valuation will be a good estimate of MEN value.

1. Discounted Cash Flow Basis

I. Weighted Average Cost of Capital

1.1 Cost of Equity
1.1.1 Risk Free Rate
 Any return should have two inherent characteristics to be considered Risk Free, namely no
default risk and no reinvestment risk. Though Nepal do not have a country credit rating, we
can still take financial instruments issued by the Government of Nepal as a risk free, given its
low Debt to GDP ratio and an absence of default history. However, if Nepal had a credit
rating, we should have adjusted the risk-free rate by a given default spread to reflect the
sovereign credit risk of Nepal. According to financial literature, it is prudent to take 10-years
Zero coupon rate as a proxy of risk-free rate as ten years bond issued at discount will have no
reinvestment risk and matches the projection horizon. However, as Nepal do not issue Zero
Coupon bond, we have decided to take Semi-Annual Coupon Bond as a proxy to risk free
rate.
 For this purpose, we have taken 8.5% Citizen Saving Bond 2079 ‘Ka’ as a risk-free
instrument which is maturing in some months. We did not take risk-free rate from current
bond issues to maintain the consistency as we have taken a historical market return of last
five years Nepse index.
 If we look at the history, the simple average rate on Bond issued by NRB in last 20 years
(2058-2077) is 7.92 percentage.
 Our risk-free rate is further justified by the fact that NRB has stated in the recent monetary
policy 2079/80 to contain the inflation rate to 7% and the risk-free rate must be higher
enough to accommodate the inflation of the country.
1.1.2 Market Return

We have estimated our market return to be 14.3% which is an annualized weekly return of Nepse
of the last two years. Finance literature suggests using either annualized monthly return for five
years or annualized weekly return for two years to prevent the noise. Financial literature suggests
that when the stock market is doing poorly, the risk premium of the investors increases as they
become more risk averse than when the market is doing well, which justifies the higher equity
risk premium of (14.3% - 8.5% = 5.8%).
Beta
The beta of the company is the manifestation of the risk associated with that company. Normally
it can be calculated using three ways -historical beta, fundamental beta and accounting beta. For
our purpose, historical beta is inappropriate because of trading length factor as the company has
been listed in NEPSE for two years only and two years of data will not reflect actual risk
associated with stock for the equity investors and cost of equity will be inappropriate. Similarly,
accounting beta is also inappropriate because the earning of hydropower company are stable
while the earning of companies except hydro in market are highly unstable and the regression of
such data will yield inappropriate beta. Also, the accounting earning of publicly traded firms are
smoothed out resulting in biasness in beta estimation. Thus, the only appropriate way to
calculated beta for our company is using the fundamental beta. For this, we will use the bottom-
up approach of beta calculation. The steps are as follows;
 We will be using 43 operating hydropower companies as comparable firms because the
volatility in earnings arises only from the production capacity of hydro and every hydro
company listed in NEPSE operates multiple hydropower projects of varying capacity.
Further, there is huge volatility the in performance of different hydropower stocks in NEPSE.
To remove biasness in beta resulting from varying capacity and varying market performance,
the average of all listed company will be used to estimate an unbiased beta for our company.
 We will gather beta, tax rate, debt to equity ratio, cash, and firm value of every comparable
firm and calculate unlevered beta corrected for cash. Then the weighted average of these
unlevered beta will be taken based on market capitalization.
 Based on those averaged beta, tax rate and D/E ratio, unlevered beta will be calculated.
 The debt-to-equity ratio to be used for calculating levered beta of MEN will be the targeted
optimum weight calculated by us rather than the existing.
 Based on these optimum D/E ratio, average tax rate and unlevered beta, levered beta for
MEN will be calculated.

Firm Beta D/E Unlevered Cash and Market Total Firm Unlevered
ratio beta Marketable Value Debt value beta
Securities of (B) (A+B) corrected
Equity for cash
(A)

Cash correction is required because hydropower company have huge cash and marketable
securities at any point of time due to timely cash inflow from NEA.
Further, companies across the world are giving importance to the implementation of ESG
because of huge demand from their investors. Similar situation will be in Nepal in upcoming
future and many listed companies have already implemented it. The implementation of ESG will
directly impact the beta of the company. So, we will be adjusting the beta obtained from above
based on the ESG impact. For this a binary logistic regression will be done to find relationship
between beta, and ESG implementation. Dependent variable will be increased beta (Yes/No) and
the independent variable will be ESG implementation (Yes/ No).

1.2 Cost of Debt

 There are many ways to calculate cost of debt such as estimating Bond YTM, using
company’s credit rating to find the YTM of bond issued by equally rated companies,
estimating a Synthetic rating and default spread and others. However, since hydropower
companies has not issued bond in Nepal, first two methods are inapplicable in this case.
 Therefore, we have decided to use the synthetic bond rating method to arrive at the cost of
debt for the Mountain Energy Nepal as below.
 Before tax cost of debt (Kd) = (Risk Free rate + Default Spread)
 We have used Interest Coverage Ratio as a proxy to rate the company and S&P/Moody’s
rating and spread corresponding to the level of Interest Coverage Ratio.
 From our calculation, the five years average Interest Coverage Ratio was 3.50 that
correspond to a rating of BBB- which suggests us the default spread of 2.64%.
 Before tax cost of debt (Kd) = 8.5% + 2.64% = 11.14%
 The risk of using only Interest Coverage Ratio is that we may be missing the information that
is available in the other financial ratios and the qualitative information used by ratings
agencies.
1.2.1 Tax Rate
 While calculating the after-tax cost of debt (I.e., effective cost of debt), we should use the
marginal tax rate and the after-tax cost of debt is calculated as follow:
 After tax cost of debt = Before tax cost of debt (1 – Marginal Tax)
 Marginal tax rate is the tax rate company pay on additional unit of income. Income tax rate in
Nepal for Hydropower project is 20% despite that normal tax rate for entity in Nepal is 25%.
 However, Hydropower sector in Nepal is exempt from income tax for first 10 years and 50
percent for additional 5 years to those which generate electricity within Mid-April 2024.
 Since, Mountain Energy Nepal do not pay income tax on sale of electricity to NEA, we have
difficulty estimating the marginal tax rate though the company pays tax on office operations
such as a home rent tax and vehicle tax.
 Since, the tax for entity in Nepal is not progressive, we assume that the marginal tax rate is
flat 20% in case of hydro, 25% in case of normal entity and 30% in case of BFIs.
1.3 Weight of Equity (Market Value)

Market value of equity is calculated by multiplying the recent market price of stock and number
of diluted outstanding shares in the balance sheet. It is not wise to take a book value of equity
because as an investor we expect return on the market price of the stock as it is our opportunity
cost. i.e., we could simply sell the stock at the recent market price and invest it somewhere else,
therefore even if company had raised a capital @ 100 per share, company must earn return on the
current market price of the stock to satisfy the investor.

1.4 Weight of Debt (Market Value and Book Value)

Book value of debt is calculated by adding all the interest bearing current and non-current
liabilities. For our estimation, there are two items worth taking into consideration, current and
non-current debt to calculate the book value of debt. However, since interest rate fluctuates over
the loan period and since market value of equity is taken to calculate the weight, we have
decided to calculate the market value of debt by dividing the projected annual interest expense
by the cost of debt.
1.5 Optimal capital Structure

For determining optimal capital structure, a regression will be done among listed variables for
listed hydropower companies of Nepal. Based on the obtained equation, the optimal long-term
debt for company will be calculated for given market value of equity. Those value will give the
optimal weight.
Dependent variables Independent variables
market-to-book ratio (as a proxy for growth opportunities) (

Total liabilities
Total long-term debt
Total current liability

Natural logarithm of revenue – LN (revenue)

Profitability –(EBITDA/TA)
Ratio of fixed to total assets (tangibility) – (FA/TA)
The following statement are copied from the research paper and highlights the physical
interpretation of regression output,
 The results of analysis reveal that companies with high levels of growth opportunities have
tended to utilise more long- and short-term debt. However, it appears that such companies
have shifted from debt towards equity finance over our sample horizon, with a particularly
strong move out of short debt components, most notably short-term bank debt and trade
credit. Although our analysis does not allow us to emphatically conclude the reasons for
 these patterns, we have suggested that this may be due to the growth in demand for equity of
companies with large growth opportunities such as those in the areas of high technology and
the internet.
 Larger companies have traditionally been more reliant on long term debt and smaller
companies on short term debt, they also suggest that larger companies have moved from long
term bank debt and have become increasingly reliant upon long term securitised debt.
 More profitable firms appear to be using more debt. Monotonic increase in the correlation
between short term bank debt and profitability throughout the horizon of our study. Banks
have tended to become more cautious when providing short term debt finance, by examining
the earnings capacity of firms rather than simply relying upon secured collateral.
 Results reveal that long term debt has become increasingly positively correlated with
tangibility
 Results suggest that banks may also have changed their behaviour over our sample period, by
increasingly engaging in maturity matching of their loans. It appears that short term bank
debt has become increasingly associated with the earnings profile of firms. Hence, while
banks have become increasingly cautious and have required more security when extending
loan finance, security has been required to be more liquid the more short- term the debt.

II. Cash Flow Estimation

1.6 EBIT
1.6.1 Revenue projection

Growth for Mountain Energy Limited comes from three sources, namely, improvement in
capacity utilization of existing projects, increase in per unit price of electricity and construction
of new hydroelectricity projects. However, using historical growth rate would be inappropriate to
use as last year’s financial statement consist of only one month’s operations of Mistri Khola
Hydropower project which commercially started its production on Ashar 03, 2078. Revenue for
the first nine months which stood at NPR 16.82 crore at the end of 2078 Ashad 31 has reached
85.26 crore at the end of Chaitra 30, 2079. To incorporate this development, we had decided to
forecast the financial statement of 2078/79 by using the quarterly reports and use the forecasted
statement of 2078/79 as a base year. However, since the fourth quarter report has been published,
we have incorporated the published data for a base year.
Further, since the construction of new hydropower is unlikely within the projected duration of
coming five years, the revenue growth stems either from the increase in production or rise in
electricity price. Currently, Mountain Energy has two projects in operations: namely, Tadi Khola
Hydroelectric Project and Mistri Khola Hydroelectric Project. The design capacity of Tadi Khola
Hydroelectric Project is 32639639 kWh. However, electricity generation from this project in the
last fiscal year was 21,428854 kWh which was 65.65 % capacity utilization. The realized
utilization for 2078/79 for Tadi Khola was 80.23%. Similarly, the design capacity of Mistri
Khola Hydroelectric Project is 23,98,76,308 kWh). The realized utilization of Mistri for 2078/79
for Tadi Khola was 80.23%.
Taking all these variables into consideration, we have forecasted that the revenue growth rate for
the coming five years would be
1. Price appreciation – 3%*0.9 = 2.7% (Only per unit price of Mistri Khola will increase as
per PPA)
2. Capacity Utilization Improvement – (2%*0.1+3%*0.9) = 2.9 %)

Where revenue contribution of Tadi Khola (5 MWh) is 10% and revenue contribution of
Mistri Khola (42 MWh) is 90%
Projected growth rate for next five years – 5.6 %
Since capacity utilization of Tadi Khola was 80.23% of the designed capacity for the fiscal year
2079/80, the revenue growth of 2% is projected for this hydro for the coming five years which
comes from the improved capacity utilization only as the price is constant as per PPA. However,
since the capacity utilization of Mistri was 80.81% in FY 2079/80, revenue growth of 5.4%
where 2.7 % is contributed by price factor while 2.7% is contributed by the efficiency
improvement. The maximum attainable production is assumed to be 90% of Design Capacity for
Tadi and 95% for Mistri as per industry average reference.

1.7 Changes in Capital Expenditure

Since the projects are operated / constructed under BOOT (Build, own, Operate and Transfer)
mechanism as per the Generation License, from Government of Nepal – Ministry of Energy, the
project shall be handed to the Government of Nepal after expiry of Generation License. Both the
projects will be hand over to the Government in 2103 BS, i.e., after 24 years.

 Tadi Khola (5MW) – License will be expired on 2103 BS Mangsir 05.

  Mistri Khola (42 MW) – License will be expired on 2103 Kartik 19.

Since companies are supposed to be a going concern, it is apparent that the company will invest
in hydropower production in future which requires huge capital expenditure. For a company to
continue generating the constant cash flow which the company is projected to generate at the end
of 2083/84 i.e., after five years (Five years is our projection period at the end of which terminal
value is calculated), Mountain Energy Nepal must build and operate 47 MW hydro power project
within 24 years (Assuming 90% average capacity utilization which company is projected to
achieve by 83/84).
The current construction cost per MW is 13,42,00000 (NPR 13.42m) which is lower comparing
to industry average. Assuming it to be 15 crore per MW in days to come, the company requires
minimum 7 arba 5 crore. Assuming the project finance structure of Mistri Khola 42 MW project
which is 75% debt and 25% equity, MEN will have to mobilize 25% of 7 arba 5 crore i.e., 1 arba
76.25 crore from its own resources (assuming no external equity) which is 7.34 crores per year
which is a 6% of projected sales revenue.
However, as we believe that company will construct more than 47 MW new hydropower plants
in coming 24 years and assuming 4% terminal growth, Capex will be 10% of total sales revenue
every year. (7.34 Crores is 6% of current sales).

1.8 Terminal growth and value

After five years, the growth of the company will be solely depended on the company’s future
investment in the new projects as the price per unit of the current projects will become constant
and there will be no room for capacity utilization improvement as the projects will be optimally
operated by the end of next five years. Since the company has to handover the existing projects
to the Government of Nepal in 2103 B.S. i.e., after 24 years, the company has to build at least 47
MWh new projects in coming 24 years to have the same cash flow to perpetuity. Moreover,
looking at the GDP growth rate, demand for electricity, company’s future plan, per MWh
production cost (CAPEX), it can be expected that the company’s cash flow will be increased by
4% forever.
The terminal growth rate will be tested against industry’s growth, demand for electricity and
governments polices.

2. Relative Valuation

For relative valuation, we used following parameters.

Multiple Numerator Denominator Affecting variable
Market price per share Earning pr share Payout ratio, Expected
PE ratio (Current, Average of (Historic, current, Growth rate, Expected
year) Forecasted) Return
EV/ Market value of debt Tax rate, WACC, growth
EBITDA
EBITDA and equity - Cash rate, Reinvestment Rate
Price to Market price per share Payout ratio, Expected
Book (Current, Average of Book Value per Share Growth rate, Expected
Ratio year) Return
Payout ratio, ROE, Expected
Sales Revenue (units’
EV/Sales Enterprise Value Growth rate, Expected
sale)
Return
EV/
BV of equity + BV of ROC, WACC, Expected
Invested Enterprise Value
Debt - Cash growth rate
Capital
Comparable Firms
Comparable firms Arun Kabeli Power Ltd.
Butwal Power Company Limited
Chilime Hydropower Company
Limited
Kalika power Company Ltd
Mountain Energy Nepal
Based on Similar Revenue, Mountain Hydro Nepal Limited
Ltd.
PE and Beta Ngadi Group Power Ltd.
Nepal Hydro Developers Ltd.
Panchthar Power Company
Limited
Sahas Urja Ltd.

These comparable are selected after controlling the differences. The differences are controlled by
dividing Price to Book value by ROE. The firms having similar ratio are taken as comparable.
Findings and Recommendations

Free cash flow per share has been estimated at Rs. 558 per share while free cash flow to equity
per share is estimated at Rs. 459 after deducting debt and adding cash. The market price of
Mountain Energy Nepal on Friday, 2nd September 2022 is Rs. 780. The difference is Rs. 321
which is about 41% can be attributed to different factors both market and assumption on
valuation. One reason could be the growth expectation of market for the Mountain Energy Nepal.
The company started production of 42 MWh of electricity just last year and revenue has been
boosted ten folds in the last fiscal year. Further, the company is in a process of concluding PPA
for a 12 MWh electricity with the NEA. These events along with the expectation that the
company will grow in the future through acquisition might have fueled the market price of MEN.

Using the relative valuation with growth parameters, the price of the stock is estimated at Rs. 780
which is close to the last traded price of the stock which signals that the expectations among
investors regarding the growth of the company are well reflected in the price. However, based on
the book value of the company, the price is estimated at Rs. 469 which stems from the Assets in
Place and not future assets. The remaining difference in the price comes from the growth
expectation.

Recommendations
 As the company has started production of the 42 MWh project and the revenue has grown
significantly, we advise MEN to declare a dividend in the coming AGM. Further, we
recommend MEN to provide a dividend in the form of bonus share to consolidate the
capital base to finance the new project that is in the process of PPA as the project
structure consists of 25% equity. This will give confidence to the investors to hold the
share and stop the price from going down.
 Further, we recommend MEN improve corporate governance practice by setting adequate
risk management committees and developing a risk management framework.