Project Finance Simple Test Question
- Assume you are a developer who is constructing a solar asset with a 1 year construction timeline
- The cost to construct this solar asset is $500mm spread evenly over a 12 month period
- Assume that you procure a construction facility at 70% gearing
- Assume the interest rate of the construction facility is 7%
- Determine the size of the construction facility
I know this is a simple exercise but I just wanted to confirm that I'm going about it the right way. Sizing the facility at 70% * (Capex + IDC), I get a debt quantum of 492.5m. Do others arrive at the same figure?
Based on the most helpful WSO content, let's break down the steps to calculate the size of the construction facility for your solar asset project:
Determine the Total Capital Expenditure (Capex):
Calculate the Gearing Percentage:
Calculate the Size of the Construction Facility:
So, the calculation would be: [ \text{Construction Facility Size} = \text{Total Capex} \times \text{Gearing} ] [ \text{Construction Facility Size} = \$500\text{mm} \times 70\% ] [ \text{Construction Facility Size} = \$350\text{mm} ]
Based on the WSO threads, the size of the construction facility would be $350 million, not $492.5 million. The figure you've arrived at seems to include the interest during construction (IDC) in the calculation, which is not typically how the initial size of a construction facility is determined. The facility size is based on the percentage of the project cost that will be debt-financed, before considering the additional costs like IDC.
Sources: January 2016 Data Update 6: Debt, the double edged sword, M&A Question Asked by PJT London, Sincerely, Jeff, More Records | The Daily Peel | 2/10/22, DOA – Debt on Arrival | The Daily Peel | 5/10/2023
How'd you get 492.5? I have 374.5
Thanks, I assumed made the below sources & uses table. Can i ask how you go to 374.5?
Why does your interest get more expensive over time?
You're using annual interest instead of monthly (7% / 12). Month 1 IDC should only be 30.67 * (7% / 12) and so on.
No way the answer is 492.
you have a hard capex of $500mm and 70% gearing
$350 (70%*$500)
would you include interest to get 374.5 or nah?
no
Have to assume they want you to include interest as part of the debt sizing calc, otherwise you wouldn't need to know the interest rate or months in construction. I get to ~$359mm when including interest.
Interest is capitalized during construction though
Capitalized interest is always included in Project Costs
You’re being asked for the size of the facility ($350m), not capital costs
The question is whether Max Gearing (70%) applies to Project Costs with or without interest costs ($500mm vs. $513mm). My hunch is that they want you to apply the 70% ratio to the $513mm value (which is consistent with how I typically see Min Equity Requirements determined).
It doesn’t apply to IDC because you will be paying that down with cash flows once the project is operational.
The prompt doesn't say anything about what happens in operations. Without further info, you have to assume it is fully repaid at the end of construction.
As an aside, in most PF deals we do, they are structured as a construction + TL mini-perm. The construction loan is equal to the size of the term loan, which is based on the amount of debt the operational cash flows can support.
However, in this case it seems like they are just looking for construction debt. I have done a couple construction only facilities and the facility size is typically a % of the Total Project Costs, with Total Project Costs including interest costs.
Assuming 70 cents debt and 30 cents equity is drawn for every dollar of spend (IDC + CapEx) your answer should be between the goal post of $350 (70% of $500) and $374.5 (add 70% * $500 * 7% = $24.5 which would assume the loan is outstanding fully for a whole year which obviously is too high). I also wish people could stop inventing new words like gearing which every infra person decided to use when we already had the term debt to cap. Just another example of overcomplicating finance
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