Finance Lecture # 5

Finance

Lecture # 5

Jan H. Jansen

E-mail: jan.jansen@han.nl

Wind energy

Minor Wind Energy Project Management

Project

Finance

Law

Supply Chain Management

Construction

Mechanical Engineering

Energy

Programme

Lecture Topic

1 Overview Energy Market

2 Annual Reports & Management Accounting

3 Management Accounting &Project Financials

4 Project Financials

5 Case study WEPM, DOSIT Methodology, Risk & Return

6 Case study WEPM (self study)

7 Case study WEPM & Annual Report, Business Model

8 Written Exam

Plan of Action

How to plan the financial

part?What should be in the financial

chapter?

Plan the financial chapter

• Planning of the financial chapter– Data & Assumptions– Cash Outflow– Cash Inflow– Calculations

• Financial criteria: IRR, NPV, ROI, BET & DSCR • Friday morning in period 2 consultancy

– Yellow Hurricane (09.00 – 09.20)– Blue Energy (09.30 – 09.50)– Green Air (10.10 – 10.30)– Red Viventorum (10.30 – 10.50)– Black Offshore(11.10 – 11.30)

Structure Excel model

Assumptions

Data

Cash Outflows

Cash Inflows

Results

Recap lecture # 4

Project Structure

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• Lenders

Operator (O&M)

Government Support Agreement

Government Concession / License

Off taker(Power Distributer)

Input Supplier

Contractor (Construction)

Source : Project Finance, Yescombe

Project Risks

Project Risks

Commercial Risks

Completion Risk Environmental risk

Operating Risk Revenue 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

RiskTransfer Risk

Expropriation Risk

War & Civil Disturbance Risk

Change of Law Risk

Quasi-political Risks

Lecture 5

Risk & Return

DOSIT Methodology

Investment Decisions

Investment trade off (I)

Investment• Equipment• Building• R&D• Environment

– Sustainability• Staff / HR• Maintenance• Operating costs

Funds• Equity• Loans

Investment trade off (II)

Cash Outflows• Equipment• Building• R&D• Environment

– Sustainability• Staff / HR• Maintenance• Operating costs

Cash Inflows• Sales• Lower costs

Components Capital Budget Model

• Investment (Year 0)• Economic Life of the Investment

– Years 1 - n• Interest Rate: i = r + π + σ

• r = real interest rate• π = inflation• σ = risk (project risk mark-up)

• Annual Cash Flows (During economic life)– Expenses– Revenues

Decision Criteria

• Pay Back Period (PBP)• Return On Investments (ROI)• Break Even Time (BET)• Net Present Value (NPV)• Profitability Index• Internal Rate of Return (IRR)• Debt Service Coverage Ratio(DSCR)

Weighted average cost of capital (kWACC)

Cost of equity (ke) with the Cost of debt (kd)

in proportion to the relative weight of each

in the firm’s optimal long-term financial

structure:

kWACC = ke * E + kd * (1-t) *D

V = E + D

V V

Capital asset pricing model (CAPM)

CAPM defines the cost of equity (ke) for a

firm as :

ke = krf + βj * (km – krf)

krf = interest rate on risk-free bonds

km = expected (required) rate of return on

equity

βj = firm’s systematic risk coefficient

risk free premium

WACC CALCULATOR ™ for GE

Source: http://thatswacc.com/index.php

CAPM Component Calculated Value:

Beta: 1.85

Historical Market Return rm: 11.00%

Risk Free rate rf: 3.00%

WACC CALCULATOR ™ for GE

Source: http://thatswacc.com/index.php

Element From Financial Statements

WACC: 7.34%

Cost of Debt rD: 3.64%

Corporate Tax Rate TC: 7.39%

Total Debt D: 438,661,500,000

Total Equity E: 166,430,000,000

Total Firm Value V: 605,091,500,000

Cost of Equity rE: 17.80%

Example (Excel)

Data:

Project β 2

Risk free interest rate: Rf 3%

Cost of debt: Rd 6%

Historical Market Return: Rm 11%

Corporate taxe rate: t 25%

Debt : Assets 70%

Equity : Assets 30%

Results:

Costs of Equity (CAPM): Ke 19%

WACC 8,9%

DOSIT Model

Model developed by:

– TNO (Applied Research in Science)– Research Chair of TQMinON

• Prof. Gerard Berendsen– Source:

• Duurzaam innoveren met de DOSIT-methodiek, G. Berendsen cs, Sigma Kluwermanagement, June 2006

• http://www.han.nl/onderzoek/kennismaken/ontwikkelen-van-excellente-organisaties/lectoraat/tqm-in-organisatienetwerken/publicaties/_attachments/kip_c2-11_20duurzaam_20innoveren_20met_20de_20dosit_20methodiek.pdf

DOSIT Model

Dutch

• Duurzaam• Ondernemen• Selectie• Innovatieve• Technologie

DOSIT

English

• Sustainable• Entrepreneurial• Selection• Innovative• Technology

SESIT

Why DOSIT?

Hot topics in business are:

• Innovation– Product innovation– Innovation of processes

• Sustainability / CSR– Stewardship / Managership / Bailiff (UK)

(Dutch: Rentmeesterschap)• Investments

SustainabilityInnovation:• Products• Process

Investing

Sustainability & Entrepreneurship in SME’s

• Company meets the requirements from the government and keeps in mind future requirements

• Company fulfils its social and cultural role in society

• Company plays in an effective way its role in the huge changes in society & economic development for the mid and long term

Sustainability & Entrepreneurship in SME’s

• The product, the way the product is used and will be used

• The production process (including resources) • The way the product is introduced on the market

Basic assumptions: DOSIT model

I. Focus as a company on a limited number of activities connected to sustainability

II. Intrinsic motivation of staff concerning change in general and sustainability in specific

III. Communication in the company concerning sustainability: Top Down & Bottom Up

IV. ‘Quick and dirty job’ in SME’s, staff wants to see immediately results

V. Aspects of sustainability have influence on the continuity of the company

VI. Sound financial base is important for the continuity of the company

Profit People

Planet

Stages in the DOSIT methodology

1. Preparation

2. Choice of priorities in the areas of Key Success Factors

3. Selection of possible Innovations

4. Final choices of Innovations

5. Implementation of Innovations

Elements of the DOSIT model

• Supply Chain & Value Chain • Raw materials• Components• Business development• Logistic Processes (I >T > O)• Production• Packaging• Warehousing & Distribution• Product & Market Development• Product Use / Reversed Logistics

DOSIT Matrix (Overview Priorities)

Supply Chain

↑

& Value Chain ↑

Raw materials

Components

Business development

Logistic Processes (ITO)

Production

Packaging

Warehousing & Distribution

Product & Market Development

Product Use / Reversed Logistics

 Aspects ↓                  

Planet                  

People                  

Profit                  

Constraints in the process of sustainable innovation

• ROI requirement (bottom line)• Requirements clients• How do process interfere in the chain?• Feasibility (in a technical way)• Connection with future developments &

ambitions of the company• What is target for the degree of sustainability• How much will be the impact of the innovation

(paradigm shift?)

DOSIT Method: Excel tool