WK6.2 Project Financing Evaluation Pt1

Project financing & evaluation

Project Financing & Evaluation Part IBAA3032:Project Management in Construction

SEM II 1011

The end of this class, students are able to:Differentiate the type of project financingDetermine a project that economically feasible

outcomes2FKASA@SEMII1011ZZ

Project ConceptLand Purchase & Sale ReviewEvaluation (scope, size, etc.)Constraint survey Constraint surveySite constraintsCost modelsSite infrastructural issuesPermit requirementsSummaryDecision to proceedRegulatory process (obtain permits, etc) Design Phase1. Feasibility Phases3FKASA@SEMII1011ZZ

Type of Project FinancingOwnerContractor

2. Project Financing4FKASA@SEMII1011ZZ

Project Financing - OwnerCritical Role of FinancingMakes project possibleHas major impact on:Riskiness of constructionClaimsPrices offer by the contractorsFKASA@SEMII1011ZZ52. Project Financing

Project Financing OwnerThere are two way that owner could financing a projectPublicIn many areas, local governments will help local companies with major new venturesPrivatea loan is obtained from a bank or other financial institution to finance the cost of constructionthis financing plan would involve both short and long term borrowing

FKASA@SEMII1011ZZ62. Project Financing

Project Financing OwnerPrivatearranging financing may involve a lengthy period of negotiation and review

FKASA@SEMII1011ZZ72. Project FinancingActivitiesDurationAnalysis of financial alternatives4 weeksPreparation of legal documents 16 weeksPreparation of disclosure documents 17-18 weeksForecasts of costs and revenues 16-17weeksBond Ratings 3 weeksBond Marketing 3 weeksBond Closing and Receipt of Funds3-4 weeks

Project Financing ContractorBuild, Lease, Transfer (BLT) Build, Own, Operate, Transfer (BOOT)


Project Financing Contractorbuild, lease, transfer (BLT) Financing arrangement in which a developer (1) designs and builds a complete project or facility (such as an airport, power plant, seaport), (2) sells it to the government or a joint venture partner, (3) simultaneously leases it back (usually for 10 to 30 years) to operate it as a business and, after the expiry of the lease, (4) transfers it to the government or partner at a previously agreed upon or market price.

build, own, operate, transfer (BOOT) Financing arrangement in which a developer (1) designs and builds a complete project or facility (such as an airport, power plant, seaport) at little or no cost to the government or a joint venture partner, (2) owns and operates the facility as a business for a specified period (usually 10 to 30 years) after which (3) transfers it to the government or partner at a previously agreed-upon or market-price.FKASA@SEMII1011ZZ92. Project Financing

The financing problemWhy?2. Project Financing

10FKASA@SEMII1011ZZ

The financing problemthe project finance problem is to obtain funds to bridge the time between making expenditures and obtaining revenuescash flow will involve expenditures in early periodscontractor also may have a negative cash balance due to delays in payment and retain-age of profits or cost reimbursements on the part of the ownerFKASA@SEMII1011ZZ112. Project Financing

The financing problem


The financing problemRetention Fundthe amount of money retained by the owner from every invoice, before a payment is made to the contractorto ensure that the contractor will continue the work and that no problems will arise after completionranges from 5% to 10% from contract valueAdvance Paymentamount of money paid to the contractor for mobilization purposesimproves the contractor cash flow and prevents him/her from loading the prices at the beginning of the contracthowever, may be used only in projects that require expensive site preparation, temporary facilities on site, and storage of expensive materials at the beginning of the project


Project Financing OwnerRegardless of its size or type, a project must be economically feasibleIn general there are two ways to determine economic feasibility, depending on whether the owner is in the private sector or government sectorFor private project the economic feasibility can be determined by an economic analysis of the monetary return on the investmentFor government project usually determined by a benefit/cost ratioFKASA@SEMII1011ZZ143. Economic Feasibility Study

Project Financing Owner; Private ProjectCommonly method that always used are:Preliminaries Detail Abstract (PDA) & Project forecast unit costProject Cash FlowProfitMaximum CapitalPayback PeriodPresent Value (Present Worth)Net Present Value (NPV)Internal Rate of Return (IRR)

FKASA@SEMII1011ZZ153. Economic Feasibility Study

PDA & Project forecast unit costPDA (Preliminaries Detail Abstract) to estimate the project cost based on previous similar projects to estimate cost per square foot is very popularSome will used forecast unit cost:UC = (A + 4B + C) / 6Where: UC = forecast unit costA = minimum unit cost of previous projectsB = average unit cost of previous projectsC = maximum unit cost of previous projectFKASA@SEMII1011ZZ163. Economic Feasibility Study


Project forecast unit costCost information from 8 previously completed parking garage projects is given. Your company will construct a garage that will accommodate 135 cars. Estimate the cost of the project.

UC = (A + 4B + C) / 6Where: UC = forecast unit costA = minimum unit cost of previous projectsB = average unit cost of previous projectsC = maximum unit cost of previous project


FKASA@SEMII1011ZZ193. Economic Feasibility StudyProjectTotal CostNo. CarsUnit Cost11,387,5001509,2502 896,000 8011,20031,797,00012014,97541,107,0009014,9755 590,4006012,30061,903,0002208,6507 889,0007012,70081,615,5001808,975Total79,034Average cost per car9,879

C = Highest Value

A = Lowest Value

B = Average ValueTotal cost project : 135 cars x 10,524 = 1,420,673

FKASA@SEMII1011ZZ203. Economic Feasibility StudyProject cash flowCash flow = Cash in Cash out (Income Expense)The project cash flow deal with the whole life of project not only the construction periodThe project will experience negative cash flow

Project cash flowThe cumulative cash flow provides indicators for:Payback periodProfitMaximum capitalThese indicators called the project profitability indicators


Project Profitability IndicatorsProfit It is the difference between total payments and total revenue without the effect of time on the value of moneyWhen comparing alternatives, the project with the maximum profit is ranked the bestMaximum CapitalIt is the maximum demand of money, i.e., the summation of all negative cash (expenditures).The project with minimum capital required is ranked the bestFKASA@SEMII1011ZZ223. Economic Feasibility Study

Project Profitability IndicatorsPayback periodIt is the length of time that it takes for a capital budgeting project to recover its initial costWhen comparing alternatives, the project with the shortest payback period is ranked the best.FKASA@SEMII1011ZZ233. Economic Feasibility Study

Project Profitability IndicatorsPresent Value (Present Worth)Present value describes the process of determining what a cash flow to be received in the future is worth in today's dollar. Therefore, the Present Value of a future cash flow represents the amount of money today which, if invested at a particular interest rate, will grow to the amount of the future cash flow at that time in the future


Project Profitability IndicatorsNet Present ValueNet present value (NPV) is the summation of all PV of cash flows of the project, where expenses are considered negative and incomes are considered positive. A project will be considered profitable and acceptable if it gives a positive NPV. When comparing projects, the project with the largest (positive) NPV should be selected.FKASA@SEMII1011ZZ253. Economic Feasibility Study

Project Profitability IndicatorsInternal rate of return (irr)The internal rate of return (irr) of a capital budgeting project is the discount rate (i) at which the NPV of a project equals zero. The IRR decision rule specifies that a project with an IRR greater than the minimum return on capital should be accepted. When choosing among alternative projects, the project with the highest IRR should be selected (as long as the IRR is greater than the minimum acceptable return of capital). The IRR is assumed to be constant over the project life. FKASA@SEMII1011ZZ263. Economic Feasibility Study

Project Profitability IndicatorsEngineering economic analysis is the process of evaluating alternatives. The basic variable time value analysis for economic feasibility are:P = present worth amount (the value of money today)F = compound amount (the future value of money after n period of time at i interest)A = equal payment seriesi @ irr = interest rate per interest period (usually one year)n = number of period of time (usually in years)


Project Profitability IndicatorsThe basic variable time value analysis for economic feasibility can be used in two situationSingle Payment SeriesF = P [(1+i)n] ------ eq 1P = F / [(1+i)n] ----- eq 2

Equal Payment SeriesF = A [((1+i)n 1)/i] ----- eq 3P = A [((1+i)n 1)/i(1+i)n] ----- eq 4A = P [i(1+i)n/((1+i)n 1)] ----- eq 5FKASA@SEMII1011ZZ283. Economic Feasibility Study

Single Payment Series vs Equal Payment Series

A project investment worth RM18.0M (P), a net annual profit will of RM3.5M (A) will be gain with 15% interest.A project investment worth RM1.05M is being considered 5-years with net profit as shown below.FKASA@SEMII1011ZZ293. Economic Feasibility StudyP0123n(n-1)(n-2)AAAAAAFEnd of YearNet Profit001-350k2-120k3420k4735k5680k

Fi-n : Fi-1

Project Profitability IndicatorsExercise 1:Your company invested for a project worth RM18.0M. A net annual profit is RM3.5M. 15% is the rate of return on the investment, what is the payback period for the project?Answer = 10.5 yearsFKASA@SEMII1011ZZ303. Economic Feasibility Study

Project Profitability IndicatorsExercise 2:Your company project is worth RM7.0M with an expected operation life of 12 years. Annual maintenance and operating expenses are forecast as RM560K per year. Using 10% interest rate, what net annual income must be received to recover the capital investment of the project?Answer : RM1.588M per year


Project Profitability IndicatorsExercise 3:You as a project manager to decide which project is feasible to carried out based on data given by the quantity surveyor. The data as below: Establish the ranking of the projects in order of attractiveness to the company using:Maximum capital needed, profit and payback periodFKASA@SEMII1011ZZ323. Economic Feasibility StudyYear12345678Project A-10K-40K-30K2060201530Project B-30K-80K305010204040

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WK6.2 Project Financing Evaluation Pt1