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The Business and the Financing Plan for the Project. Financial Modeling and EvaluationPowerPoint Presentation

The Business and the Financing Plan for the Project. Financial Modeling and Evaluation

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### The Business and the Financing Plan for the Project. Financial Modeling and Evaluation

ACADEMY OF ECONOMIC STUDIES

FACULTY OF INTERNATIONAL BUSINESS AND ECONOMICS

Lecture 6:

Lect. Cristian PĂUN

The business and financing plan definition Financing plan is a distinctive part of the business plan and contain a detailed presentation of:

- Business plan is a picture or a model of what a business unit will be.
- Business plan contains information on:
- product(s)
- markets
- employees
- technology, facilities
- capital, revenues and profitability

- Borrowing capacity
- Sources of financial funds;
- Cost analysis for each source;
- WACC analysis;
- Discounted Cash Flow Analysis;
- Presentation of Financial Forecast
- Income Statements
- Balance Sheets
- Statements of Cash Flows

Why a business and financing plan ?

- To get help from others, especially financial funds providers (banks, equity investors);
- To convince the sponsors, banks and other creditworthiness parties that the project will be a successful one.
- Provides a guide for running operations once the project is started.
- Incidental benefit: Pulls the participants and management team together and forces owners/managers to fully understand the tasks ahead of them

Executive Summary

Mission Statement

Market

Background

The Customers

Product Description

Competitive Analysis

Pricing

Operations

Sources of Input/Costs

Processes / Equipment

Management/Staffing

Financial Projections

Current Statements

Projected Statements

Application for Funds

Contingency Planning

Appendices

Business Plan OutlineFinancing Plan Objectives

- Designing the optimal financing plan for a project generally involves the following objectives:
- Ensuring the availability of sufficient financial resources to complete the project;
- Obtaining the necessary funds at the lowest practicable cost;
- Minimizing the project sponsors exposure to the project;
- Establishing a dividend policy that maximize the rate of return for the sponsor’s equities;
- Maximizing the value of tax benefits for the project ownerships;
- Obtaining the most beneficial regulatory treatment.

Financing plan components

- Borrowing Capacity of the project;
- Project ability to service the debt;
- Financing Sources Table;
- WACC Analysis;
- Discounted Cash Flow Analysis;
- Income Statement;
- Balance sheet;
- Cash Flow Statement;

Financial Modeling Inputs

- Macroeconomic assumptions;
- Project costs and funding structure
- Operating revenues and costs;
- Loan drawings and debt service;
- Taxation and accounting.

Financial Modeling Outputs

- Construction phase costs;
- Drawdown of equity;
- Drawdown and repayment of debt;
- Interest calculation;
- Operating revenues and costs;
- Tax;
- Income statement;
- Balance Sheet;
- Cash Flow Statement;
- Lender’s coverage ratio.

Main steps for financial modeling

- Macroeconomic assumption;
- Project costs and funding structure;
- Operating revenues and costs;
- Borrowing capacity;
- Capacity to cover debt service;
- Taxation and accounting.
- WACC;
- IRR and NPV for the project;

Step 1: Macroeconomic assumption

Targets:

- Inflation
- Commodity prices
- Interest rates;
- Exchange rates;
- GDP Growth;
- Other macroeconomic aspects (ex: traffic)

Step1.1. Inflation Analysis

- Offer a “real” basis for the project;
- In the analysis could be used different indicators:
- Consumer price inflation in the Host Country;
- Indices of employment costs in the country of suppliers or providers of services;
- Industrial price inflation for the cost of spare parts;
- Specific price indices for commodities produced or purchased by the project.

Step 1.2. Commodity prices

- It referrers not to the inflation but to the vulnerability of the project to cyclical movements in commodity prices.
- The projects are developed when commodity prices are high, and assume that these prices will continue to remain at least at this level.
- Commodity prices may be very violent on a short term basis.

Step 1.3. Interest rates

- Interest rates factors;
- Interest rates components;
- Nominal interest rate vs real interest rate.

Step 1.4. Exchange rates

The approaches:

- Traditional theory;
- PPP Theory;
- Monetary approach;
- IPP Theory.

+ Step 1.5. GDP Growth

Step 2: Project Costs and funding

- Project costs:
- Development costs: stuff and other travel costs to develop the project;
- Development fees: taxes paid for the location, concessions;
- Project Company costs:
- Personnel costs;
- Office and equipment;
- Costs for permits and licenses;
- Construction supervision;
- Training and mobilization costs.

- Construction price;
- Construction insurance;
- Star-up costs:
- Fuel or raw materials;

- Initial spare parts;
- Working capital covering:
- Initial inventories;
- Office and personnel costs;
- The first operating insurance premium.

Project Costs and funding

- Project costs (cont.):
- Taxes: VAT or other sales taxes;
- Financing costs:
- Loan arrangements and underwriting fees;
- Loan and security registration costs;
- Costs of lender’s advisers;
- Interest during construction;
- Commitment fees;
- Loan agency costs.

- Funding of Reserves Accounts;
- Contingency (provisions for unexpected events).

Operating revenues and costs

- Operating revenues from sales of product
- Operating costs:
- Cost of fuel or raw materials;
- Personnel and office costs;
- Maintenance costs;
- Insurance costs.

Accounting and taxation issues

- Capitalization and depreciation of the project costs;
- The dividends;
- Tax payments and accountings

Project funding

- The required ratio between equity and debt;
- The borrowing capacity of the project;
- The capacity of the project to service the debt;
- For each financial source should be made an amortization table:
- Principals;
- Interest payments;
- Annuities.

- The priority of drawing between equity and debt;
- Any limitation of the use of debt;
- A drawdown schedule for both equity and debt;
- WACC Analysis.

Borrowing Capacity Model for a Project

Hypothesis A: Full drawdown of capital in the moment of full completion

- The amount the bank will lend to a project entity should equal a fraction of the present value – PV of the available cash flows:
α x D = PV

Where: α – is the target cash flow coverage ratio

D – the maximum loan amount

PV – present value of future cash flows

- PV is calculated from the cash flow projection for the project;
- The projection of cash flows is based on a preliminary estimation of:
- R – cash revenues during the first year;
- E – cash expenses during the first year;
- The rates (gE and gR) at which revenues and expenses are growing during the period of the project debt is contracting.

Borrowing Capacity Model for a Local Project

The cash flow available for debt service for year t is:

(1-T) x [R(1+gR)t-1 – E(1+gE)t-1-C] + C = (1-T) x [R(1+gR)t-1 – E(1+gE)t-1] + TC

Borrowing Capacity Model for a Local Project

Taking into consideration the initial assumption:

α x D = PV

We can obtain the value for the revenues that can cover a desired loan amount – D:

Where:

- “i” is the interest rate of the debt;

- “N” is life of the loan measured from the date of completion.

Example: Calculation of a Project’s Borrowing capacity

Initial Assumption

Task: - you should determine what is the total debt that the project is capable to support

Borrowing Capacity – Assumption 1

Formula for PV:

The answer is:

PV = 1.488.691 Euro

D* = 992.461 Euro

The debt capacity of the project is 992.461 Euro based on an estimated present value of the cash flows in value of 1.488.691 Euro.

Example: Calculation of a Project’s Borrowing capacity

Assumption 2: a lower debt level for the project

Task: - you should determine what is the minimum value for cash revenues in order to cover a debt of 700.000 Euro

Borrowing Capacity – Assumption 2

Formula for R:

The answer is:

Cash Revenues = 2.614.542 Euro

The minimum cash revenues that can support a debt of 700.000 Euro is R = 2.614.542 Euro. A lower debt level (700.000 Euro instead 992.461 Euro) involves a lower level of cash revenues for the project.

Example: Calculation of a Project’s Borrowing capacity

Assumption 3:a lower growth rate for cash revenues

Task: - you should determine what is the minimum value for cash revenues in order to cover a debt of 700.000 Euro.

Borrowing Capacity – Assumption 3

Formula for R in case of different growth rates for cash revenues and expenses and C=0:

The answer is:

Cash Revenues = 2.869.381 Euro

The minimum cash revenues that can support a debt of 700.000 Euro is R = 2.869.381 Euro. A lower growth rate for the cash revenues (than cash expenses) involves a higher level of cash revenues for the project in order to maintain the same debt level.

Borrowing Capacity Model for a Project

Hypothesis B: The revenues and operating expenses do not begin for M years

- The amount the bank will lend to a project entity should equal a fraction of the present value – PV of the available cash flows beginning with the year M:
- The project company will draw a loan in the initial moment but the cash revenues and expenses are generated in a future moment M.
- The present value of the project future cash flows should equal present value of the debt D drawn in the initial moment:

M

Construction phase

Operating phase

Drawing moment for the debt D

α x D x (1+i)M = PV

Borrowing capacity for a project – Hypothesis B

α x D x (1+i)M = PV

Example: Estimation of M

Average life = 1.929 years = M

This is the estimated period before the project produces any operating cash flows.

Example: Calculation of a Project’s Borrowing capacity

Assumption 4: the project generates cash flows after 2 years

Task: - you should determine what is the total debt that the project is capable to support

Example: Calculation of a Project’s Borrowing capacity

Assumption 5: the project generates cash flows after 3 years

Task: - you should determine what is the total debt that the project is capable to support

Project Ability to service the debt

- To evaluate the project ability to service its debt usually it is used three main financial ratios:
- Interest coverage ratio:
ICR=EBIT / Interest

- Fixed Charge Coverage ratio:
FCCR=(EBIT + 1/3 rentals) / (Interest + 1/3 rentals)

- Debt Service Coverage ratio:

- Interest coverage ratio:

Cost of International Financing

Step 1: Determine the proportions of each source to be raised as capital.

Step 2: Determine the marginal cost of each source.

Step 3: Calculate the weighted average cost of capital.

Current Yield =

Current Yield = 9.04%

Present Value, Net Present Value, Internal Rate of Return

IRR = k NPV = 0

- Inflation rate
- Interest rate
- Estimated profit for an investment project

Expectations in terms of

Discounted rate

Present Value, Net Present Value, Internal Rate of Return

Conclusion 1:

Internal Rate of Return is the best measure for the marginal cost of international financing (real cost is 17.80 instead 10% or 8.89%)

Comparing credits in different currencies using NPV

- Method I:
- Estimating k(euro)
- Estimating k(USD)
- NPVeuro x spot0 = NPVeuroUSD

Comparing credits in different currencies using NPV

- Method II:
- Estimating k(euro)
- Estimating exchange rate
- Transforming An from USD in €
- Comparing NPV

Comparing credits in different currencies using NPV

- Method III (best accuracy):
- Estimating k(euro)
- Estimating k(USD)
- Estimating an average FX rate
- Transforming NPV from USD in €
- Comparing NPV

Comparing credits in different currencies using IRR

Method I: Comparing IRR obtained on initial An expressed in different currencies

We have the same IRR (= 17.8%)

Method II: Transforming An from USD to Euro and calculating IRR

We have different IRR:

NPV Criteria in International Financing

- Easier to be calculated than IRR
- It is difficult to estimate different discount rates for different financial markets;
- We should take into consideration the exchange rate when we compare different NPVs;
- NPV encourage big investment projects and discourage big financing projects.

IRR Criteria in International Financing

- Independent from FX rate;
- It is quite complicated to be estimated;
- In some cases we can’t calculate it (symmetric annuities, positive annuities).

CONCLUSION 2: When compare different financing alternatives we should use both two criteria: NPV and IRR

Cost of Equity

- Scenario A:
- Buy – back of stocks after 5 years:

NPV = 0 Kstocks

Scenario B: no buy - back

Kstocks = (D0/IP)+g (Gordon – Shapiro Model)

International Financing Plan - summary

WACC = 13.27%

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