Professional Documents
Culture Documents
Project - Financing - & - Evaluation 1
Project - Financing - & - Evaluation 1
401
Project Management
Spring 2007
CONTRACTOR
costs ($4,000,000) ($7,000,000) ($14,000,000) $0 $0 $0 $0 $0 $0 $0
revenues $0 $10,000,000 $20,000,000 $0 $0 $0 $0 $0 $0 $0
contractor cashflow ($4,000,000) $3,000,000 $6,000,000 $0 $0 $0 $0 $0 $0 $0
contractor cum cashflow
($4,000,000) ($1,000,000) $5,000,000 $5,000,000 $5,000,000 $5,000,000 $5,000,000 $5,000,000 $5,000,000 $5,000,000
$10,000,000
$5,000,000
$0
($5,000,000) 1 2 3 4 5 6 7 8 9 10 11
($20,000,000)
($25,000,000)
($30,000,000)
($35,000,000)
Financing – Gross Cashflows
Design/Preliminary Construction
years 1 2 3 4 5 6 7 8 9 10
OWNER
investment ($10,000,000) ($20,000,000)
operation incomes $2,000,000 $4,000,000 $6,000,000 $6,000,000 $6,000,000 $6,000,000 $6,000,000
owner cashflow $0 ($10,000,000) ($20,000,000) $2,000,000 $4,000,000 $6,000,000 $6,000,000 $6,000,000 $6,000,000 $6,000,000
owner cum cashflow $0 ($10,000,000) ($30,000,000) ($28,000,000) ($24,000,000) ($18,000,000) ($12,000,000) ($6,000,000) $0 $6,000,000
CONTRACTOR
costs ($4,000,000) ($7,000,000) ($14,000,000) $0 $0 $0 $0 $0 $0 $0
revenues $0 $10,000,000 $20,000,000 $0 $0 $0 $0 $0 $0 $0
contractor cashflow ($4,000,000) $3,000,000 $6,000,000 $0 $0 $0 $0 $0 $0 $0
contractor cum cashflow
($4,000,000) ($1,000,000) $5,000,000 $5,000,000 $5,000,000 $5,000,000 $5,000,000 $5,000,000 $5,000,000 $5,000,000
$10,000,000
$5,000,000
$0
($5,000,000) 1 2 3 4 5 6 7 8 9 10 11
($20,000,000)
($25,000,000)
($30,000,000)
($35,000,000)
Financing – Gross Cashflows
Design/Preliminary Construction
years 1 2 3 4 5 6 7 8 9 10
OWNER
investment ($10,000,000) ($20,000,000)
operation incomes $2,000,000 $4,000,000 $6,000,000 $6,000,000 $6,000,000 $6,000,000 $6,000,000
owner cashflow $0 ($10,000,000) ($20,000,000) $2,000,000 $4,000,000 $6,000,000 $6,000,000 $6,000,000 $6,000,000 $6,000,000
owner cum cashflow $0 ($10,000,000) ($30,000,000) ($28,000,000) ($24,000,000) ($18,000,000) ($12,000,000) ($6,000,000) $0 $6,000,000
CONTRACTOR
costs ($4,000,000) ($7,000,000) ($14,000,000) $0 $0 $0 $0 $0 $0 $0
revenues $0 $10,000,000 $20,000,000 $0 $0 $0 $0 $0 $0 $0
contractor cashflow ($4,000,000) $3,000,000 $6,000,000 $0 $0 $0 $0 $0 $0 $0
contractor cum cashflow
($4,000,000) ($1,000,000) $5,000,000 $5,000,000 $5,000,000 $5,000,000 $5,000,000 $5,000,000 $5,000,000 $5,000,000
$10,000,000
$5,000,000
$0
($5,000,000) 1 2 3 4 5 6 7 8 9 10 11
• Early expenditure
($10,000,000) owner cum cashflow • Takes time to get revenue
($15,000,000) contractor cum cashflow
($20,000,000)
($25,000,000)
($30,000,000)
($35,000,000)
Project Financing
Public
Private
“Project” financing
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
Public Financing
Sources of funds
General purpose or special-purpose bonds
Tax revenues
Capital grants subsidies
International subsidized loans
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)
Major motivation for public/private partnerships
MARR (Minimum Attractive Rate of Return) much lower (e.g.
8-10%), 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 Owners w/Collateral Facility
Distinct Financing Periods
Short-term construction loan
Bridge Debt
Risky (and hence expensive!)
Borrowed so owner can pay for construction (cost)
Long-term mortgage
Senior Debt
Typically facility is collateral
Pays for operations and Construction financing debts
Typically much lower interest
Loans often negotiated as a package
Man-hours
months
S-curve Cost
8 100
90
7
80
6
70
Cumulative costs $K
5
60
4 50 Daily cost
$K
Cum. costs
40
3
30
2
20
1
10
0 0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22
Working days
Expense & Payment
Contractor Financing II
Owner keeps an eye out for
Front-end loaded bids (discounting)
Unbalanced bids
120 140
100 120
100
80
80
Revenue
Revenue
60
60
40
40
20
20
0 0
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18
Month Month
Contractor Financing II
Owner keeps an eye out for
Front-end loaded bids (discounting)
Unbalanced bids
Contractors frequently borrow from
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
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 200,000.00
Time factor?
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
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
Basic Compounding
$x
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
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
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
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)
0 t
PV(x) t
t
PV(x) The net result is that I can convert a sure cost x at time t
into a (smaller) cost of PV(x) now!
Summary
Because we can flexibly switch from one such value to
another without cost, we can view these values as equivalent
FV v’
0
PV v t
Summary
Because we can flexibly switch from one such value to
another without cost, we can view these values as equivalent
FV v’ = v(1+i)t
0
PV v t
Where:
0 1 2 … n
F
P
Interest Formulas: Payment
0 1 … n-1 n
P
F
Interest Formulas: Payment
- Example
0 n
P=? F=$100,000
P = F×(P/F, 0.12, 5)
P = 100,000 × (P/F, 0.12, 5)
P = 100,000 × 0.5674 = $56,740
Interest Formulas: Series
F
0 1 2 … n
A A A A
F=A
F
0 1 2 … n
A A A A
Interest Formulas: Series
F = A+A(1+i)
F
0 1 2 … n
A A A A
Interest Formulas: Series
0 1 2 … n
A A A A
Interest Formulas: Series
0 1 2 … n
A A A A
F
Interest Formulas: Series
P
0 1 2 … n
A A A A
Interest Formulas: Series
P = A/ (1 + i )
0 1 2 … n
A A A A
Interest Formulas: Series
P = A/(1 + i ) + A/(1 + i )2
0 1 2 … n
A A A A
Interest Formulas: Series
0 1 2 … n
A A A A
Verify it!
Interest Formulas: Series
0 1 2 … n
A A A A
P
Verify it!
Interest Formulas: Series
- Example
A ranch is offered for sale in Mexico with a 15 year
mortgage rate at 40% compounded annually, and 20%
down payment. Annual payments are to be made. The first
cost of the ranch is 5 million pesos. What yearly payment
is required?
Interest Formulas: Series
- Example
A ranch is offered for sale in Mexico with a 15 year
mortgage rate at 40% compounded annually, and 20%
down payment. Annual payments are to be made. The first
cost of the ranch is 5 million pesos. What yearly payment
is required?
= -5,373
= -18,011
Outline
Session Objective & Context
Project Financing
Owner
Project
Contractor
Additional issues
Financial Evaluation
Time value of money
Present value
Rate
Interest Formulas
NPV
IRR & payback period
Missing factors
Net Present Value
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?
Drawing out the examples
Project A $4M
0 1 2 3
Project B $8.5M
0 1 6
Project A
-$1M * (P/A, 0.1, 3) + $4M * (P/F, 0.1, 3)
Project B
-$1M * (P/A, 0.1, 6) + $8.5M * (P/F, 0.1, 6)
-$77 M
[NPV2]20%
= -75.3 + (28)(P/A, 0.2, 5) = -75.3 + 83.7
= 8.4
$28 M each year
-$75.3 M
Solution
[NPV3]20%
= -39.9 + (28)(P/A, 20%, 4) - (80)(P/F, 20%, 5)
= -39.9 + 72.5 - 32.2
= 0.4 $28 M each year
-$39.9 M
-$80 M
[NPV4]20%
= 18 + (10)(P/F, 20%, 1) - (40)(P/F, 20%, 2)
- (60)(P/F, 20%, 3) + (30)(P/F, 20%, 4)
+ (50)(P/F, 20%, 5)
= 18 + 8.3 - 27.8 - 34.7 + 14.5 + 20.1 = -1.6 $50 M
$30 M
$18 M $10 M
-$40 M
-$60 M
Source: Hendrickson and Au, 1989/2003
Solution
[NPV1] = 17.4
[NPV2] = 8.4
[NPV3] = 0.4
[NPV4] = -1.6
2 pieces of equipment: one needs a human operator (initial cost $10,000, annual $4,200
for labor); the second is fully automated (initial cost $18,000, annual #3,000 for power).
n=10years.
Is the additional $8,000 in the initial investment of the second equipment worthy the
$1,200 annual savings? (discount rate: 5 or 10%)
Link
Selection of Discount Rate: Example
2 pieces of equipment: one needs a human operator (initial cost $10,000, annual $4,200
for labor); the second is fully automated (initial cost $18,000, annual #3,000 for power).
n=10years.
Is the additional $8,000 in the initial investment of the second equipment worthy the
$1,200 annual savings? (discount rate: 5 or 10%)
There is a critical value of i that changes the equipment choice (approximately 8.15%)
Example: The US Federal Highway Administration promulgated a regulation in the
early 1970s that the discount rate for all federally funded highways would be zero. This
was widely interpreted as a victory for the cement industry over asphalt industry. Roads
made of concrete cost significantly more than those of made of asphalt while requiring
less maintenance and less replacement [Shtub et al., 1994] - Link
Outline
Session Objective & Context
Project Financing
Owner
Project
Contractor
Additional issues
Financial Evaluation
Time value of money
Present value
Rate
Interest Formulas
NPV
IRR & payback period
Missing factors
Internal Rate of Return (IRR)
Defined as the rate of return that makes the NPV of the project
equal to zero
To see whether the project’s rate of return is equal to or higher
than the rate of the firm to expect to get from the project
IRR Calculation Example
IRR
IRR Investment Rule
> Accept
r- =
r* Indifferent
< Reject
- r = IRR,
* r = MARR
Discount Rate
Link
IRR vs. NPV
Oftentimes, IRR and NPV give the same decision/ranking
among projects.
IRR only looks at rate of gain – not size of gain
IRR does not require you to assume (or compute) a discount
rate.
IRR ignores capacity to reinvest
IRR may not be unique
When the inflation rate j is small, these relations can be approximated by:
i' i j or i i' j
n
NPV A0 At / (1 i ) t
t 1
n
NPV A0 At' / (1 i ' ) t
t 1
Link
Solution
Depreciation costs are not inflated to current dollars in conformity with the practice recommended
by the U.S. Internal Revenue Service.
Case Study