Project Finance Exercise
Hi All,
I came across the below thread which includes this project finance example test:
Interviewing For Infrastructure Investment Roles | Wall Street Oasis
- Assume you are a developer who is constructing a solar asset with a 1 year construction timeline and an asset that will have a 30 year useful life
- The cost to construct this solar asset is $500mm spread evenly over a 12 month period
- The project has a nameplate capacity of 200MW and the asset will expect to produce power at a gross capacity factor of 30%. Assume degradation of 0.25% per year.
- The asset has arranged a 15-year power purchase agreement at $100/MWh without any escalation. Assume the post-contracted pricing for the power produced after the expiry of the PPA is $85 in real 2022 dollars escalated at inflation.
- Opex for the project is contracted under a full wrap EPC at $25mm per year escalated at inflation.
- Assume a tax rate of 25%
- Assume the asset is depreciated on a straight line basis over the useful life
- Assume that you procure a construction facility at 70% gearing, which will be refinanced by a long-term debt facility sculpted to contracted cash flows at 1.30x DSCR (interest rates for the facilities will typically be provided)
Wanted to get people's thoughts on how to approach this. I assume you would first size the construction loan based on the gearing ratio (taking into account the IDC) - assuming an interest rate of 7%, I get a debt quantum of 492.5. Let me know if you agree?
After the construction loan has been sized (let's say to 200m), would you;
i) Assume the construction loan is refinanced by an equal size 492.5m long term debt facility, with the repayments of that facility sculpted to cash flows at 1.30x DSCR.
OR
ii) re-size the long-term debt facility across a 30-year period at a DSCR of 1.30x?
Ah, the classic project finance conundrum! When you're looking at a solar project like this, you're right to start with the construction loan sizing. Based on the WSO content, here's how you might approach it:
Construction Loan Sizing:
Refinancing Post-Construction:
Which Option to Choose?
Remember, in project finance, the sizing of the debt is crucial and is typically based on the cash flows the project can generate, ensuring that the debt can be serviced appropriately. The DSCR is a key metric here, and the long-term debt will be sculpted to ensure that the project meets this coverage ratio throughout its life.
In the real world, you'd also consider factors like reserve accounts, maintenance costs, and potential changes in revenue (such as changes in electricity prices or production levels) over the life of the asset. But for your exercise, sticking to the given assumptions will keep things straightforward. Keep swinging through those financial models, and you'll be a project finance guru in no time!
Sources: https://www.wallstreetoasis.com/forum/real-estate/using-100-equity-for-a-project-does-it-ever-make-sense?customgpt=1, PE professional, what's your process while judging an investment?, Makena Capital, Is Project Finance interesting?, https://www.wallstreetoasis.com/forum/real-estate/walk-me-through-a-deal-you-worked-on-interview-question?customgpt=1
You basically have to model 2 facilities:
1) Construction debt facility = 70% (Max. Gearing) * CAPEX (Construction costs + IDC). This facility will have maturity of 12 months (Construction duration)
2) Term Loan Facility = Secured cashflows (PPA cashflows 15 years and P90 10yrs) sculpted by 1.30x DSCR (This facility will refinance construction debt on COD) and will have the maturity of the useful life (30 years), the trick here is that you'll have 2 constraints working at the same time (DSCR + Gearing) so in your formula make sure that the size of the facility is equal to your Construction debt facility even thought your cashflows are able to size more debt based on your DSCR this way you'll make sure to always raise debt equal to your initial CAPEX needs.
Banks only take risk of secured cashflows and will impose sizing on PPA duration rather than PPA+Merchant tail, specially in renewables. Otherwise, you will have multiple reserve accounts to mitigate it and min. 90% of the debt quantum will be sized on secured cashflows.
Hope this helps!
Your Construction debt facility will have a bullet reimbursement profile on COD*
Thanks a lot, this super helpful!
One things I’m still slightly unsure about.
Let's assume the refinancing facility (equal in size to construction facility) is indeed smaller than a debt facility sized over a period of 30 years at a DSCR of 1.30x – if this refinancing facility's repayments are sculpted to CFADS at a 1.3 DSCR, wouldn’t the facility be paid off earlier than 30 years?
Also, I did a quick sizing calculation for the sizing of the construction loans, assuming an interest rate of 7%. I arrive at a debt quantum of 492.5m. Not quite sure if I’ve calculate this correctly. Does it seem sensible to you?
Thanks again!
Your Term Loan should be sized only on secured cashflows which is 15 years not 30, and yes if the construction debt size is indeed smaller than the reimbursement profile of the sized debt then you'll have room for optimization because the debt will be repaid earlier than your max theoretical maturity date (useful life = 30 years).
For your second question, I can't really opine on this because I didn't model this exercise myself
Are there any resources you recommend for learning about this? or in general, how to combine debt sizing using gearing (construction) and then leverage for debt sizing (operations)? Thank you!
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