Financial Modeling in Excel

Project Finance

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 Agenda

Key Concepts in Project Finance Modeling

 Understanding Project Finance
 Quarterly to Yearly Revenue Conversion using Date functions
 Interest During Construction (IDC)
 Cash Flow Waterfall

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 Characteristics of Project Finance

Project Finance is the financing of

 often long-term, industrial projects
 Increasingly those which provide public services or infrastructure
 Based upon complex financial and contractual structures commonly involving many legal entities

Project Finance debt is often termed as "non-recourse"

 Typically secured by the project assets and the core project contracts

The cash flows from the project

 Come only after the project is fully complete (takes more than a single financial year for completion)
 are usually the sole means of repayment of the borrowed funds

Separate Entity and SPV Status

 Risk of the transaction is generally measured by the creditworthiness of the project itself rather than that of its
owners (Sponsors)

Two main types of Project Financing

 Greenfield – a fresh start
 Brownfield – expansion of an existing project
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 Characteristics of Project Finance

Multiple parties involved

 Sponsors
 Contractors
 Suppliers
 Governments
 Global financiers

From inception of an idea to Financial Close, a Project Finance deal can take years to negotiate

All about identifying risks, allocating them appropriately and ensuring that the responsible parties are
adequately incentivized to manage their risks efficiently
 Construction time, costs & specification
 Operational cost, reliability
 Supply reliability, quality, cost
 Off-take volume, price
 Political environment, war, local hostility, currency inconvertibility
 Socio-environmental responsibilities

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 Risks & Mitigants

Funding Risk
 Identification of sources for equity contribution.
 Stipulation for minimum upfront equity contribution.
 Disbursement only after financial tie-up for the project.

Regulatory Risk
 All major statutory approvals including MoEF and forest clearance stipulated as a pre - disbursement condition
 Concession agreement is reviewed commercially and risks identified
 Suitable undertakings/guarantees are obtained from sponsors to negate any adverse affect of concession provisions
 Financing of projects on time-tested concession formats approved by the Planning Commission

Land Acquisition Risk

 Minimum land acquisition stipulated as a pre-disbursement clause
 Projects in sensitive states avoided
 Land acquisition is the responsibility of Concession Authority
 Compensation is paid by the authority on account of any adverse delay

Market Risk
 Independent consultant appointed by Lenders to conduct market potential/ traffic study
 Project funding is structured based on cashflow projections to ensure smooth Debt servicing

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 Risks & Mitigants

Execution Risk
 Contracts for Civil works/Procurement of equipment on a fixed time fixed price basis.
 Contracts to be finalized before any disbursement
 Reputation of EPC contractor considered
 Suitable provisions for Liquidated damages/ penalty are incorporated in contract documents

Technology Risk
 Projects based on proven technology are financed
 Recourse stipulated in case of emerging technologies

Explicit Political Risks

 Most concession agreements / licenses have clear provisions classifying political risks into 2 categories:
• Direct Political and Indirect Political
• Mitigation mechanisms including compensation is specified in the agreement itself

Implicit Political Risk

 Policy Risk: Change in policies towards infrastructure like tax sops, concession agreements, grant policies
 Revenue/Toll Rate Risk: Change in toll rates
 Regime Change Risk
 Change in Applicable Laws / Tax Laws
 Cross Border Governing Law Enforcement Risk
 Concession Agreements / Licenses govern all aspects of projects under a contract based system and governments honor signed contracts

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 Key Stakeholders

SPONSORS INSURERS

HOST LENDERS
GOVERNMENT

EXPERTS SPV EPC CONTRACTOR

PROFESSIONALS

GUARANTORS OPERATOR

PURCHASER SUPPLIER

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 Contractual Arrangements to Mitigate Risk

Parties Agreements Mitigation mechanisms

Project Sponsors: Shareholders Agreement/Share
Subscription Agreement, Sponsor
Support Undertakings, Corporate
Guarantees.
Customers Off-take Agreements
They bear the risks of project design, construction, completion,
operation, and maintenance and repayment to the lenders. The cost
overrun risk is also borne by the sponsors.
When there are only a few potential customers for the project’s
output, revenue risk is likely to be transferred to those customers by
means of a long-term sales contract.
Contracts may include: take-or-pay clause, minimum throughput
agreement, tolling contract etc. The risk of payments is mitigated
through a proper payment security mechanism.

Government/ Concession/Implementation When a government grants a concession to a project company,

Statutory Agreements there will be a Concession Agreement that gives the company the
Authorities right to build and operate the project facility. Concession agreement
may require the government to construct supporting facilities such
as access roads, contains non-compete condition etc.
Construction EPC Agreement The risk of project construction is mitigated to the construction
Contractors contractors by entering into a fixed time fixed price contract with
them and the contract adequately providing for liquidated damages
(penalties) in case of delay in construction.

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 Assumptions

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 Monthly Statements

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 Conditional Formatting
Monthly & Yearly Statement Assumptions EPC Schedule

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 Yearly Statement

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 Concept of Interest During Construction (IDC)

When an asset is developed, and there is a considerable period between the start of a project and its completion, the interest
costs related to the construction are generally included in the cost of the asset, that is, the interest cost is capitalized

The capitalization period ends when the asset is ready for use

While modeling in excel, Interest During Construction (IDC) introduces a circular loop into the sheet due to the circular
references explained below (1-2-3-4)
 Equity and Grant commitments can be either a specific amount, or a certain percentage of the total project funds required (that
is, a fixed percentage in the capital structure)

Equity Project Specific

Cost Items
2
Grant
Interest Expense is Calculated 3
on Outstanding Debt Interest Expense
1 on Debt Raised Total Project Cost
Debt Amount is Debt (IDC) includes Interest During
made equal to the Construction (IDC)
Funding Gap
4
Total Funding Total Project Cost
Total Funding is made
equal to Total Project Cost

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 Incorporating IDC in a Project Financing Worksheet

 We begin by inputting the project cost assumptions and the equity and grant commitments during
the period of construction
 Next, we put the formula for total project cost (as sum of all project cost elements, including IDC)
 Total Funding is made equal to the total project cost, by referencing it to corresponding cell
 Debt to be raised is calculated as the funding gap in the project, after factoring equity and grant
commitments

Total Project Cost includes

Interest During Construction
(IDC)

Debt to be Raised is equal to the

Funding Gap in Project Financing

Total Project Fund is equal to the

Project Cost Requirement

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 Incorporating IDC in a Project Financing Worksheet

 We calculate the equity and grant commitments during the years of construction from the assumptions
 Then, we calculate the total project cost which is the sum of all project cost elements and the Interest
During Construction (IDC). Note that IDC cells are left blank at this point, as they are yet ot be calculated
 The Total Fund requirement is made equal to the Total Project Cost requirement
 Finally, the Debt to be Raised is made equal to the Funding Gap in that particular year

Initially Promoter Equity is deployed in the

debt equity ratio. Grant is infused only after
Promoter Equity is fully deployed.

Total Funding Requirement is

made equal to Total Project
Cost

Each of the Project Cost

Items are calculated from
the cost assumptions

Total Project Cost includes

Interest During Construction
(IDC)

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 Incorporating IDC in a Project Financing Worksheet

 The Interest During Construction (IDC) is calculated by multiplying interest rate on the outstanding debt
component and fed to corresponding cost element in project cost schedule
 The sum of all the IDCs in each of the years of construction is then linked to the total IDC under Project
Cost break-up.

IDC is calculated and fed into

corresponding row under
project cost schedule

Total IDC is made equal to

sum of all IDC in each of the
years of construction

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 Escrow Arrangement

Escrow Arrangement During  Escrow Mechanism is critical to

Construction / Operation – the monitoring & enforcement
Waterfall Mechanism functions of the lenders.
Claims  All Cash Inflows and Outflows
Insurers Sponsors are through the Escrow A/c.
Outflows are permitted under
Shortfall agreed appropriation of cash in
Revenue Proceeds the escrow account.
 All Reserves are maintained as
Escrow Bank
sub-accounts within the escrow
Statutory Taxes *NA for Road projects account
bodies Fuel
Expenses* Fuel Supplier
O&M O&M
Contractor Expenses
Contract EPC
Debt Payments Contractors
Lenders Servicing

Shortfall in
DSRA/MMR DSR
Govt. Bodies
Balance
SPV Co. Surplus

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 Charting with Excel – modeling revenue recognition

Percentage of completion method Revenue Recognition

(%age Completed)
 Used when project’s cost and revenue can be reliably estimated 1000
 Revenue, expense, and therefore profit, are recognized based 900

Revenue Recognized
800
on the percentage completed 700
 Case: An Infrastructure company has undertaken a project of 600
500
completing a bridge, construction work for which is going to 400
continue for the 5 years, and expected revenue earned at the 300
end of five years is Rs. 1,000,000,000 200
100
• The co. is expecting to build 10%, 25%, 25%, 25% and 15% in 0
each of the years 1 2
Year
3 4 5

Revenue Recognition
(Completed Contract)
Completed contract method 1000
900

Revenue Recognized
 Revenue is recognized at the completion as a bullet 800
700
600
500
400
300
200
100
0
1 2 3 4 5
Year

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 Cash Distribution and Tranches

ABC Investments and PQR Developers enter into a JV to develop and operate a project having the following characteristics
 Initial Investments: INR 50 Mn
• ABC Investment: INR 45 Mn
• PQR Investment: INR 5 Mn
 Project to be sold at the end of 5th Year (Net Profit from Sale: INR 75 Mn)
 Cash Flow from Operations as shown in table

Income Yielding Asset

(Unless otherwise specified, all financials are in INR Lakhs) Year 1 Year 2 Year 3 Year 4 Year 5
Cash Flow

From operation INR 1,000,000 2,000,000 5,000,000 6,000,000 6,500,000

From Sale of Asset INR 75,000,000

Terms and Conditions from Tranching of operating income

 ABC will receive 5% non-cumulative preferred return on invested equity (Shortfall not carried over)
 After that, PQR will receive 5% non-cumulative preferred return on invested equity
 Remaining cash flow from operations to be split 50-50

Terms and Conditions from Tranching of Sale of asset

 ABC to receive sufficient capital to earn a min IRR of 12%
 After that PQR receives its invested capital
 Remaining cash to be split 50-50

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 Total Cash generated in the project can be calculated

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 Cash Flow Tranches

ABC cash generation is given a

priority over PQR cash

To ensure that ABC gets min IRR or

12%, goal seek can be used

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 Cash Flow Tranches

Cash is distributed as per the

schedule decided

IRRs are as per the risk

undertaken

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