1. International Center For Environmental Finance. Series B - Course #2 Calculating Annual Debt Service

2. Annual Debt Service Payments There are three components of Annual Debt Service Payments:  Fees  Interest  Principal

3. Annual Debt Service Payments: FEES Types of fees:  One-time only fees  Annual fees (expressed in flat dollar amounts)  Fees that are expressed as a percentage of the outstanding principal balance of the loan

4. Annual Debt Service Payments Treatment of Fees  One-time, upfront fees are added to project cost.  Annual fees in dollars are added to annual principal and interest payments.  Annual percentage fees are added to the interest rate.

5. Annual Debt Service Payments: INTEREST Interest due and payable in any year is always calculated as follows: outstanding principal balance of the loan X the rate of interest

6. Annual Debt Service Payments: PRINCIPAL The three ways in which principal is repaid are: 1.The level payment method 2.The level principal method 3.The irregular method, in which nothing is level

7. THE LEVEL PAYMENT METHOD

8. The Level Payment Method  The level payment method means that the total amount of principal and interest, combined, which system pays every year, is the same.

9. Illustration Of The Level Payment Method Annual payment schedule for a 5-yr loan of $100,000 at 10%. YearPrincipal+Interest= Annual Payment 1$16,380+$10,000=$26,380 218,018+8,362=$26,380 319,820+6,560=$26,380 421,802+4,589=$26,391 523,980+2,400=$26,380

10. Illustration Of The Level Payment Method As the amount of interest declines with every payment that is made, the amount of the principal paid increases by the same amount.

11. Illustration Of The Level Payment Method

12. Calculating Annual Debt Service Payments for Loans Using The Level Payment Method ADSP=Px i 1- 1 (1+i)ⁿ ADSP – annual debt service payment P – original principal amount of the loan I – interest rate expressed as decimal N – term of the loan

13. Calculating Annual Debt Service Payments for Loans Using The Level Payment Method P=$100,000 I=0.1 (10%) N=5 years ADSP=$100,000x 0.1 =$26,380 1- 1 (1+0.1) 5

14. Rules for Creating Annual Debt Service Payment Schedules For The Level Payment Method 1.Determine the annual payment. 2.Calculate the first year’s interest payment. 3.Obtain first year’s annual principal payment (AP-i). 4.Obtain the outstanding principal balance for the next year (P-1 st year principal payment).

15. Rules for Creating Annual Debt Service Payment Schedules For The Level Payment Method (cont’d) 5. Obtain the next year’s annual interest payment, by multiplying preceding year’s outstanding balance by I. 6. Obtain the next year’s annual principal payment (AP – that year’s i). 7. Obtain the next year’s outstanding principal balance. 8. Repeat steps 5,6, and 7, for each year of the loan.

16. Characteristics Of The Level Payment Method 1.The annual payments are always the same. 2.The amount of principal paid each year increases by the exact amount in which the interest payment decreases. 3.The total of all of the annual principal payments equals the original principal amount of the loan.

17. THE LEVEL PRINCIPAL PAYMENT METHOD

18. The Level Principal Payment Method 1.The annual principal payments are the same each year. 2.Both the annual interest payment and the annual payment decrease each year. 3.The total of all of the annual principal payments, equals to the original principal amount of the loan

19. Illustration Of The Level Principal Payment Method Annual principal payment schedule for a 5-year loan of $100,000 at 10%. YearInterestPrincipal Annual Payment 1$10,000$20,000$30,000 28,00020,00028,000 36,00020,00026,000 44,00020,00024,000 52,00020,00022,000

20. Illustration Of The Level Principal Payment Method

21. Rules for Creating Annual Debt Service Payment Schedules For The Level Principal Payment Method 1.Calculate the level principal payment, which will be the annual Principal payment for each year of the loan, by dividing the original principal amount by the number of years in the term of the loan. 2.Calculate the first year’s annual interest payment by multiplying the original principal amount of the loan by the rate of interest.

22. Rules for Creating Annual Debt Service Payment Schedules For The Level Principal Payment Method (cont’d) 3. Obtain the first year’s annual payment by adding the level principal payment to the first year’s annual interest payment. 4. Obtain the outstanding principal balance at the end of the first year by subtracting the first year’s level principal payment from the original principal amount of the loan

23. Rules for Creating Annual Debt Service Payment Schedules For The Level Principal Payment Method (cont’d) 5. Calculate the next year’s annual interest payment by multiplying the outstanding principal balance from the preceding year by the rate of interest. 6. Calculate the next year’s annual payment by adding that year’s annual interest payment to the level principal payment.

24. Rules for Creating Annual Debt Service Payment Schedules For The Level Principal Payment Method (cont’d) 7. Calculate the next year’s outstanding principal balance by subtracting the current year’s level principal payment from preceding year’s outstanding principal balance. 8. Repeat steps 5,6, and 7, for each year of the loan term.

25. THE IRREGULAR METHOD

26. The Irregular Method  Unlike both the Level Payment Method and the Level Principal Payment Method, which have at least one constant, the irregular method of debt service payment has none.

27. The Irregular Method There are very few scenarios where the irregular method might be preferable.

28. The Irregular Method Scenario #1 When a utility system issues a bond or obtains a loan prior to the construction of the project.  In such case the project may require two or more years to complete, and the system may not want to begin charging users until the benefits of the project were available to all ratepayers.

29. The Irregular Method Scenario #1  Thus, if the goal is to minimize the cost to the ratepayers prior to the actual operation of the project, then, the system will elect not to pay principal or interest payments in the first three years.  Financially strong systems will be offered an opportunity to defer such payments.

30. The Irregular Method Scenario #1  To do that a utility system will issue a bond and bondholders will still receive interest payments every six months. The system would make such payments from borrowed funds.  In short, a system overborrows the precise amount it needs to make up for the missing user fees.

31. The Irregular Method Scenario #2 Another circumstance which might warrant the use of the irregular method is when the system might have a realistic expectation of future income.

32. The Irregular Method Scenario #2  For example, a system may be planning to sell some of its property. It will certainly be able to estimate the amount of gain from sale and set aside a portion of that gain to pay off loan principal.  This would warrant using the irregular payment method with principal payments skewed to those years immediately after the planned sale date of property.

33. The Irregular Method Scenario #3 Another circumstance which might also warrant the use of an irregular payment method, arises not from within the system, but from without the system. It actually arises from within the bond market.

34. The Irregular Method  For example, if there is a large number of buyers willing to buy bonds of certain maturities (e.g., five years or ten years) but not others (e.g., six years or nine years), the interest rates on these maturities should be favorable to the system that is borrowing.  A system can set its annual debt service schedule with principal payments skewed to those favorable maturities to take advantage of the favorable rates.

35. Rules For Creating Annual Debt Service Payment Schedules Using The Irregular Method 1.Obtain the annual principal payments and the interest rates applicable thereto for each maturity. 2.For a particular maturity, calculate each of the annual interest payments for each maturity by multiplying the amount of principal to be paid at that maturity by the rate of interest applicable to that maturity

36. Rules For Creating Annual Debt Service Payment Schedules Using The Irregular Method 3. For the same maturity, calculate each of the annual payments by adding the annual interest payment to the annual principal payment, if any, for each year. 4. Repeat steps 2 and 3, creating a schedule for each maturity.

37. Once you know the Cash Available for Debt Service and the Annual Debt Service Payments, you can then proceed to determine the financial feasibility of the project.