Finance Lecture # 4 Jan H. Jansen

Wind energy

Minor Wind Energy Project Management Project FinanceLaw Supply Chain Management Construction Mechanical Engineering Energy

Programme

DSCR Debt Service Cover Ratio: CFADS / DS DS (Debt Service) –Interest –Instalment or Repayment of the loan ( years) CFADS –Cash Flows Available for Debt Service –CFADS = Revenues – Costs – Taxes Costs –O&M costs (Operations & Maintenance) –Insurance costs –Management & Concession Costs

Recap lecture # 3

Project Financials (1) Investment amount (A) –Trade off’s: –Financial structure: –e = E : A –l = L : A Currency Risks –Transaction Risk –Economic Risk –Translation Risk Discount factor (d) –d = wacc + π + σ Cash Out Flows Cash In Flows

Structure Excel model Assumptions Data Cash Outflows Cash Inflows Result s

How to build an Excel model –Worksheet 1 (Project name) Project name Version & Date Authors –Worksheet 2 (Results) Investment amount Economic life Decision criteria –Worksheet 3 (Data) Data Assumptions –Worksheet 4 (COF) Cash Outflows –Worksheet 5 (CIF) Cash Inflows –Worksheet 6 (NCF) Net Cash Flows

Decision Criteria Capital Budgeting Pay Back Period (PBP) Return on Investment (ROI) Net Present Value (NPV) NPV Investment Ratio (NPV / INV) Internal Rate of Return (IRR) Break Even Time (BET)

Investment case Investment € 50,000,000 Expected economic life: 10 years Equity / Asset Ratio: 0,6 Required ROE: 5% Expected Interest rate: 3% Expected Inflation: 2.5% Risk mark up: 2.9% Annual Revenues: € 10,000,000 Increase electricity prices: 6% Annual Maintenance Costs: € 2,000,000 Increase maintenance costs: 4%

Results Investment € ,00 Economic life10years Pay Back Period (PBP)6years Return on Investments23,12%ROI Net Present Value€ ,75NPV NPV Investement Ratio0,29 Internal Rate of Return15,19%IRR Break Even Time8BET

Literature Management Accounting for Decision Makers, Atrill cs Management Accounting, Kaplan cs Advanced Management Accounting, Kaplan cs Cost Accounting, Horngren cs Fundamentals of Corporate Finance, Ross cs Fundamentals of Corporate Finance, Brealy cs Multinational Business Finance, Eitman Wind Energy (Fundamentals, Resource Analysis and Economics), Sathyajith Wind turbines (Fundamentals, Technologies, Application, Economics), Hau Principles of Project Finance, Yescombe

Project Finance A method of raising long-term debt financing for major projects through “financial engineering” based on lending against the cash flow generated by the project alone. It depends on a detailed evaluation of a project’s construction, operating and revenue risk, and their allocation between investors, lenders, and other parties through contractual and other arrangements Project Finance ≠ Financing Projects

Features of Project Finance Ring-fenced project (Separate Project Company) New project / New Business High Equity Debt Ratio No guarantees form the Project Company (non- recourse finance) Lenders rely on future cash flow for debt service payments (interest + repayment) Main security for lenders: –Contracts –Licenses / ownership natural resources Project has a finite life

Forms of Projects BOOT –Built-Own-Operate-Transfer BOT –Built-Operate-Transfer BTO –Built-Transfer-Operate BOO Built-Own-Operate

Financial structure (leverage) Low leverageHigh leverage Investment (=A)$ 1,000 Debt or Loans (=L)$ 300$ 800 Equity (=E)$ 700$ 200 Net Revenues$ 100 Interest rate5%7% Interest payable$ 15$ 56 Profit$ 85$ 44 Return on Equity (ROE)12%22%

Financial leverage effect on costs Low leverageHigh leverage Investment (=A)$ 1,000 Debt or Loans (=L)$ 300$ 800 Equity (=E)$ 700$ 200 Return on Equity (15%)$ 105$ 30 Interest rate5%7% Interest payable$ 15$ 56 Profit$ 85$ 44 Revenues Required $ 120 $ 86

Why project finance? High leverage Tax benefits Off-balance sheet financing Borrowing capacity Risk limitation Risk spreading Long-term finance Enhanced credit Unequal partnership

Project Structure (1) Project Company Finance Equity Investors Lenders Operator (O&M) Government Support Agreement Government Concession / License Off taker (Power Distributer) Input Supplier Contractor (Construction) Source : Project Finance, Yescombe

Ring-fenced project Project Company Finance Equity Investors LendersLenders Operator (O&M) Government Support Agreement Government Concession / License Off taker (Power Distributer) Input Supplier Contractor (Construction) Source : Project Finance, Yescombe

Project Structure (2) Source:

Project Structure (3) Source:

Wind Farm Finance Structure

Project Risks Commercial Risks Completion Risk Environmental risk Operating RiskRevenue Risk Input Supply Risk Force majeure risk Contract mismatch risk Sponsor support Risk Macroeconomic Risks Inflation Risk Interest Rate Risk Exchange Rate Risk Political Risks Currency Convertibility Risk Transfer Risk Expropriation Risk War & Civil Disturbance Risk Change of Law Risk Quasi-political Risks