PF 1-4 2023 - Rescheduled

CV6214: Project Financing
NTU MSc / CV6214: Project Financing. All Rights Reserved. 1

02 Sep
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NTU MSc / CV6214: Project Financing. All Rights Reserved.

What is Project Financing?
• Funding when lender looks primarily to the revenues generated by a
single project for repayment and as security for the exposure
• Large, complex and expensive installations ie power plants, chemical

processing plants, mines, transportation infrastructure, environment
and telecommunication infrastructure
• Borrower is usually a special purpose vehicle that is not permitted to

perform any function other than developing, owning and operating
the installation

Public & Private Provision of Infrastructure
(Source: PPP, Principle of Policy & Finance, Yescombe, 2007)

Key Parties in the Project
Host
government Sponsors Financial
Export Advisory
Credit Agents
Agencies
Accountants
Project Company
Lenders
Market “Borrower” Multi-
experts Lateral
Insurers agencies
Technical Arrangers
experts
Lawyers

Project Financing
Parent Company
20%
(Sponsor support)
$80 Mil
Equity
Power Plant #1 Special Purpose Entity + i%
Dividend (Power Plant #3) Debt payment
Power Plant #2
$100 Mil Lender
Loan (Debt)
80%
Limited or No Recourse

Case Study on:
“Infrastructure Finance:
The Sydney Cross City Tunnel”
(HKU691)
13
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Debt & Equity

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* In this course, Loan = debt = debenture = bond = note = fixed income

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1. Regular bond pays semi-annual coupon.
2. On maturity, return the full principal sum

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Sustainable Financing
 What is Green bond?

 Most common institutional instrument
 Proceeds used for environmental benefits
 Benefits feasibly quantified, measured
and reported by borrowers
 Sustainability-linked (SL) loans?

 More flexible than Green bond/loan
 Borrowers’ performance on:
 Environmental
 Social
 Governance
 Interests vs ESG metrics
What is Equity?
• Equity is a share in the ownership of a company
• Equity represents a claim on the company’s

assets and earnings
• As you acquire more equity, your ownership

stake in the company becomes greater
Equity = Share = Stock

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An equity instrument A debt with a process to pay

Carrying ownership interest back the money with interest
Dividend Interest/Coupon
No Yes
Voting rights Preferential treatment

in the company when bond matures
Project Financing
Equity Financing over time:
$20 Mil can be worth $40 Mil Debt Financing over time
remain $80 Mil + i%
Parent Company
20%
(Sponsor support)
$80 Mil
Equity
Power Plant #1 Special Purpose Entity + i%
Dividend (Power Plant #3) Debt payment
Power Plant #2
$100 Mil Lender
Loan (Debt)
80%
Limited or No Recourse
Page 25
Bond Prices

Page 26
Key ratios are

computed
(Extract of Bank of Singapore Equity Research, 11 Sep 2018)


Page 28
Financial Accounting
for engineering managers
Page 29
Venture?
an undertaking that deploys resources for a potential
(therefore risk) cashflow
Owners’ equity vs loan?

Equity carries venture risk. Loan carries credit risk

Page 30
Accrual or Cash Basis accounting?

Financial statements use accrual accounting
Matching: Revenue & Expenses?

Because of accrual basis, we do matching of revenue
to respective expenses

Page 31
Why read financial statements?
• Lenders & creditors want to know if they’ll be paid

• Investors want to make comparison
• Business wants to know their quarter’s progress
• Regulatory agencies need to monitor industry
 Different users of financial statements

 Different questions
 Always involve comparison of accounting information for future
decision making

Page 32
Objectives in CV6214
• Understand the components in the three financial statements

(income statements, balance sheet and cash flow statement)
• Derive and interpret financial ratios
• Use financial ratios to analyse project profitability, operating

performance, long term solvency and viability

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1.1 Income Statement
1.2 Balance Sheet
1.3 Cash Flow Statement
1.4 Creative Accounting

Page 34
1.1
Components of the Financial Statement Report
INCOME STATEMENT
(Or PROFIT & LOSS STATEMENT)
• Reports information on the efficiency, control, and profitability of a

venture for some period of time. Sales represent efficiency, expenses
represent control, and earnings represent profitability.

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Income (or Profit & Loss) Statement
Measurement of,
Income = Revenue - Expenses

during a period (Eg. for month of Sep 2022)

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Income Statement
• Indicates the ability of a project to sell goods (e.g. electricity)
for more than the cost it incurs to produce and sell them
• it is the primary measure of performance of a project over a
period of time
• focus is specifically on net income OR net earnings. This is
derived from:
Net income = Revenue - Expenses

Page 37
Income Statement of Super Flavors

For Month of September 2022

Page 38
Income Statement
What are the usual revenue components?
• Sales or Turnover
• Non-operating income / revenue
• Interest income earned from cash holdings
• Interest or dividend income from marketable securities
• gain on disposal of assets
• foreign exchange gains

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Income Statement
What are the usual Cost and Expense Components?
• Raw material and direct labour
• Depreciation and amortisation
• Selling, General and Admin
• Interest expense
• Loss on disposal of assets
• Write-off from restructuring
• Bad debt expense

Analogy
Why did car drift sideway?

Steering? Understand
financial
Axle off-alignment?
statements A front or rear
shock-absorber?
Tire pressure/alignment? 40
Page 41
1.2
BALANCE SHEET
(Or STATEMENT OF FINANCIAL POSITION)
• Shows the resources (assets) a company has and how it funded them
(liabilities and equity) at a certain point in time.

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Balance Sheet
Valuation of,
Asset = Liabilities + Owners’ Equity

On a specific date (as at 30 Sep 2022)

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Balance Sheet
• Report on the financial position of the business
(assets, liabilities and shareholders fund)
• Equivalent to “health screen” report at a point in time
• Assets = Liabilities + Shareholders’ fund (or OE)
• The above relationship shows the assets of the
project or business is funded by a combination of
“debt capital” and “equity capital”
• Everything that is not a liability is a component of
the Shareholders’ fund (ie retained earning)

Page 44
Balance Sheet of Super Flavors

As at 30 September 2022

Page 45


Page 48
Assets?
• These are tangible and intangible (ie patents) items that

have the ability to generate revenue and cashflow
• This is the “Black Box” containing a unique combination of

resources (ie human capital, funds, equipment) that will
continue to generate revenue
a. Fixed assets
b. Current assets
c. Intangible assets

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Fixed Assets?
• Immovable / Permanent
• Long term application and utilisation

Eg. Plant and Equipment / Property and Buildings
Furniture and Fixtures
• As fixed assets are used, part of their “cost” is recognised as

an annual expense - Depreciation - and charged against
revenue
Page 50
Current Assets?
• Movable / Temporary
• Part of the normal business operation cycle
• Inventory (Stock)
• Accounts Receivables (Debtors)
• Cash

Page 51
Intangible Assets?
• Long term / No Physical Attributes (Intangible)

• Contains intrinsic value and play a role in revenue creation
• License / Concession
• Goodwill

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Liabilities?
• These are tangible obligations that the business has
undertaken to third parties / external parties E.g.
“Accounts payable” because your suppliers give you
90 days credit term
Current liabilities
Long term liabilities
Contingent liabilities

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Current Liabilities?
• Short term obligations that has to be met within 1 year
• Accounts payable (creditors)
• Bills payable (due to banks)
• Current portion of long term debt

Page 54
Long Term Liabilities?
• Obligations that have to be met after 1 year
• Long term bank loans
• Leases

Page 55
Contingent Items?
• Do not appear on the balance sheet (“off-balance sheet”)
Examples:
• Guarantees given to third parties
• Legal litigation action with outcome pending decision
• Financial transactions entered with banks

Page 56
Increasing Focus on Contingent Items
• More off-balance sheet transactions such as securitisation of

assets
Eg. Selling property/receivables to a special purpose company
• Increase usage of derivative instruments for financial risk

management
Eg. Using interest rate and currency swaps to hedge and manage
interest rate and foreign currency exposures

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Where Do We Find Contingent Items
• Not on the balance sheet
• Details are in the “Notes to the Accounts”
• Important to read the “Notes” with the financial statements

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Shareholders Fund? (or Owners’ Equity)

• Represents the monies invested into the project or business by
the owners (“shareholders”)
• Initial capital injection
• Share premium
• Revenue reserve / retained earning
• Capital reserve / paid-up capital

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1.3
CASHFLOW STATEMENT
• Shows the impact of income flows and changes in balance sheet items
on the venture's cash flow. The statement shows the sources and uses
of cash flow for a venture

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Cashflow Statement
Shows the FLOW of cash and classify them into,
1. Cash flow from operating activities

2. Cash flow from Investing activities
3. Cash flow from financing activities

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Cash Flow Statement

• Reports on the sources and uses of funds by the project
for a specific period, thus explain how the Balance sheet
position changed
• Two methods of obtaining the Cashflow Statement:
Direct/Indirect
• Direct Method starts with Revenue or Sales and make
adjustments so that cashflow is reflected in (1) Operating
activities (2) Investment activities (3) Financing activities
• Indirect Method starts with Net Income
Page 62
Statement of Cashflow of Super Flavors

For month of September 2022
Note: (Using Indirect

Balance Sheet of Super Flavors Method, we
develop cashflow
breakdowns
starting from Net
Income)
Note: (number) in bracket

There is no “Cashflow from Financing activities” means negative

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Page 65
Cash Flow
• What is cash flow?
• It is the “life blood” of the project or business
• Cashflow Statement provide:

(1) information on liquidity & ability to change cash flows in future
(2) help evaluate changes in Asset, Liability & OE

Page 66
Cash Flow
• Cash flow is the process of how “cash” is converted into
the various components of the balance sheet and then
back to cash again at the end of the process
• Cash flow is not static
• A business has positive cash flow if it has more cash

balance at the end of a period of time when compared to
the beginning

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Cash Flow
• Cash flow is not the same as Revenue or Profit
• Profits do not pay for expenses, suppliers and new equipment
• A business can be profitable (Revenue > Cost) but may have

negative cash flow
• This means that it has ended operations with less cash than
what it had at the start of operations
Page 68
Simple cashflow conversion cycle
• Stage 1 cash is used to purchase raw material
• Stage 2 raw material is converted to finished goods
• Stage 3 finished goods are sold to customers on credit terms

(accounts receivable)
• Stage 4 cash is collected when accounts receivables are paid

Page 69
Factors that impact / affect cash flow

• Investment in inventory - obsolescence
• Investment in accounts receivable - bad debts
• Debt service - high interest expense
• Debt repayment - lumpy repayment of principal

Page 70
Analysis of Financial Statement across

different countries
(A) Accounting Statement Format Differences
1. The actual layout of the financial statements varies

from country to country.
2. The amount of data reported also is quite different

from country to country.

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Analysis of Financial Statement across different

countries
(B) Differences in Accounting Principles
Countries use somewhat different accounting

principles, though the study by Choi and Bavishi
demonstrates that the differences are not so large
as feared.

Page 72
Analysis of Financial Statement across different

countries
(C) International Ratio Analysis
While ratio analysis can be conducted in

essentially the same way on financial statements
of different countries, one should exercise care to
interpret the numbers within the overall
environment

Page 73
The Quality of Financial Statements
Balance Sheet: A quality balance sheet typically has:
1. Conservative use of debt.
2. Assets with market value greater than book value.
3. Little use of off-balance sheet liabilities.

Page 74
The Quality of Financial Statements
Income Statement: A quality income state typically reflects:
* Repeatable earnings.
* Use of conservative accounting principles.

Page 75
Value of Financial Statement Analysis
1. Financial statement analysis lets the analyst gain

knowledge of the firm's operating and financial
structure
2. This allows the analyst to determine the likely

effects of future events on the firm's cash flows

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Value of Financial Statement Analysis
3. The analyst can analyze future scenarios to

measure the risk and potential cash flows
4. Combining the above with possible micro and

macroeconomic scenarios, the analyst can better
ascertain venture returns and stock valuation

Many tools are deployed!
Page 89
Part 1.4 (Not for Exam)
Creative Accounting

Page 90
Creative Accounting (Not for Exam)

The intentional manipulation of financial information with the
objective of distorting financial statements and results
What are the motivations?

• To report better than expected results
• To distort the financial position of the business
• To satisfy financial covenants under loan agreements

Page 91

Some common “techniques” include,
• Debtors - failure to disclose debts which are long overdue and

unlikely to be collected
• Stock/Inventory - not recognising stock obsolescence,
overstatement of values
• Capitalising expenditure such as R&D cost, operating expenses
and depreciating them over a number of years
• Inflating turnover with related party transactions

Page 92
Some Are Acceptable (Not for Exam)
• Borrow short term money overnight to improve liquidity on

balance sheet date
• Liquidate stocks (Annual sale!) just before year end to improve
stock turnover
• Squeeze debtors to pay up quickly before year end
• Delay payment to creditors over the year end
• Pushing sales prior to year end increase turnover

Page 93
• Can we still trust what we read?

– All financial statements are dressed their sharpest before publication
– You can obtain clues of potential trouble from the notes to account
• Caveat Emptor!


Page 95
Financial Ratio Analysis

Page 96
FINANCIAL RATIO ANALYSIS
Financial ratios are indicators derived from the financial statements of a

project or business
Indicators of financial performance and changing condition over time
And, provides a comparison of the company relative to the industry or peer

group;
Therefore the strength & weakness of their business model

Page 97
Importance of financial ratios
1. Ratios have meaning only in relation to other pieces

of information. Ratios provide clues to relevant
relationships in the financial statements
2. The most important comparisons for ratios relate the

firm's performance to:
a. The aggregate economy, because almost all firms are

influenced by the business cycle

Page 98
Importance of financial ratios

2. (Con’t) relate the firm's performance to:
b. Its industry or industries, because of the similarities among

the firms in products and processes
c. Its major competitors, especially if there is a wide range of

size and type of ventures in the overall industry
d. Its own past performance, to look for signs of improvement

or deterioration. This time series analysis can be very useful in
estimating future performance
Page 99
Uses of Financial Ratios
1. Stock Valuation Modeling
2. Bond Ratings
3. Risk Assessment >>
4. Insolvency Assessment >>

Page 100
Risk Assessment
Variables that have been used to assess NON-systematic risk are:
1. Financial Ratios
Dividend payout, Total debt/total assets, interest coverage,
working capital/total assets, current ratio
2. Variability Measures
Variance of operating earnings, coefficient of variation of operating
earnings and profit margins
3. Non-ratio Variables
Asset size, Market Value of Stock

Page 101
Insolvency Assessment (Bankruptcy)

Ratios that are useful in evaluating the possibility of bankruptcy include:
1. Cash flow/total debt.

2. Cash flow/long-term debt.
3. Net income/total assets.
4. Total debt/total assets.
5. Working capital/total assets.
6. Current ratio
7. Cash/current liabilities.
8. Working capital/sales.

Page 102
What we will cover:

1. Commonly used groups of financial ratios
1.1 Profitability Ratios
1.2 Activity Ratios
1.3 Solvency and Leverage Ratios
(There are many ratios used. Each ratio may even have many variations. Limit the analysis
to those that are most useful in providing information on the situation under review)
2. Market-related & Dividend Ratios

3. Using Ratios to review Management Strategies
4. Common Size Financial Statements

What is a Ratio?
103
a
“name” =
b
a
name2000 = ½(b + b )
1999 2000
Say “b” is a balance sheet item, and value on 31 Dec 1999 is the same as 2 Jan 2000
104
a
name2000 = ½(b + b )
1999 2000
Net Sales Revenue

Asset Turnover = Average Total Assets
Net Sales Revenue

OR Ending Total Assets
105
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Page 107

Total Asset Turnover = 3500/[0.5x(2300+2065)]
= 3500/2182.5 = 1.6x
Eddie’s average = 1.5x
Industry average = 1.4x
108
Total Asset Turnover2000 = 3500/[0.5x(2300+2065)]
= 3500/2182.5 = 1.6x
Total Asset Turnover2000 = 3500/[2300]

= 1.52x
109
Page 110
1. Profitability Ratios
 Seek to associate income earned with resources used or amount of activity
that took place
(1) Return on Assets (ROA)
(2) Return on investment Capital (ROIC)
(3) Return on owners’ equity (ROE)
(4) EPS
(5) Profit Margin
(1) ROA = Net Income = $1,385 = 13.9% (Yr2003)

Assets $9,955
ROA relates net income to the investment in all of the financial resources at the
command of management. It is most useful as a measure of the effectiveness of
resource utilization without regard to how those resources have been obtained and
financed

Page 111
(2) ROIC = Net Income
Total Liab + Shareholders’ Equity – Current Liability
= $1,385
$9,955 - $3,658
= 22.0% (Yr2003)
Return on invested capital (ROIC) relates all net income to all resources committed to
the firm for long period of time
Two variations: (i) after tax interest expense is added to net income
(ii) average invested capital (2002 & 2003)

Page 112
(3) ROE = Net Income
Shareholders’ Equity
= $1,385
$2,224
= 62.3% (Yr2003)
Return on equity (ROE) relates net income to the amount invested by

stockholders. It is a measure of the efficiency with which the stockholders'
investment through their original capital contributions and earnings retained in the
business have been used

Page 113
(4) EPS = Net Income – Preferred Stock Dividends
No. of shares of Common Stock + Equivalents
= $1.35 (Yr2003)
Because corporations have many owners' not all of whom own an equal number of
shares it is quite common to express earnings of a company on a per-share basis for
those who wish to calculate their proportional share of earnings. The calculation of
earnings per share can be complicated if there is more than one class of ownership
each with differing claims against the income of the firm.
In published financial reports' this ratio is required to be presented' often in several

variations such as "basic" or "diluted" (a very conservative form) EPS

Page 114
(5) Profit Margin = Net Income
Net Sales
= $1,385
$9,252
= 15.0% (Yr2003)
This ratio shows sensitivity of income to price changes or changes in cost structure
Neither a high nor low profit margin necessarily means good performance. A
company with a high profit margin but high investment may not be returning a great
amount to investors. A firm with a very low profit margin may have required only a
very small investment so that it proves highly profitable to those who invest in it

Page 115
2. Activity Ratios
 Activity ratios shows how well assets are utilized by the
venture. Efficiency in using assets minimizes the need for
investment by lenders or owners. Activity ratios provide
measurements of how well assets or capital are being
utilized
(1) Asset Turnover
(2) Working Capital Turnover

Page 116
2. Activity Ratios
(1) Asset Turnover = Net Sales
Total Assets
= $9,252
$9,955
= 0.929 (Yr2003)
This ratio measures the company's effectiveness in utilizing all of its assets.
Since different industries require very different asset structures' comparing asset
turnover ratios from one industry to those in another is potentially meaningless.
Likewise' when an organization participates in many industries' the exact
meaning of an asset turnover ratio can be obscured' and the most valid
comparisons of an asset turnover ratio at one date may be to that of the same
firm at another recent date

Page 117
2. Activity Ratios
(2) Working Capital Turnover =

= Net Sales
Average Current Assets – Average Current Liabilities
= $9,252
($3723.5 – $3,573.0)
= 61.5X
Working capital turnover is a measure of the speed with which funds are
provided by current assets to satisfy current liabilities

Page 118
3. Solvency & Leverage Ratios

 When an organization is unable to meet its financial obligations' it is said
to be insolvent. Because insolvency leads to organizational distress or
even to bankruptcy or organization extinction, ratios to test solvency are
often used by investors and creditors. By measuring a company's ability
to meet its obligations as they become current, solvency ratios give an
indication of the liquidity of the company
(1) Current Ratio

(2) Acid Test Ratio
(3) Debt Ratio
(4) Times Interest Earned

Page 119

(1) Current Ratio = Current Assets wc ratio
Current Liabilities -ve wc
= $3,650
$3,658
= 1.0 (Yr2003)
The size of the current ratio that a healthy company needs to maintain is
dependent upon the relationship between inflows of cash and the demands for
cash payments. A company that has a continuous inflow of cash or other liquid
assets such as a public utility or taxi company' may be able to meet currently
maturing obligations easily despite the fact that its current ratio may be small. On
the other hand' the manufacturing firm with a long product development and
manufacturing cycle may need to maintain a larger current ratio

Page 120

(2) Acid Test Ratio = Quick Assets
Current Liabilities
= $1,952
$3,658
= 0.53 (Yr2003)
To confirm the absolute liquidity of an organization, the current ratio is modified by

eliminating from current assets all that cannot be liquidated on very short notice.
Typically then, this ratio consists of the ratio of so-called "quick" assets (=cash
marketable security and some forms of accounts receivable) to current liabilities.
For 2003 add the cash short-term investments' and receivables to calculate the
acid test ratio

Page 121

(3) Debt Ratio
The degree to which the activities of a company are supported by liabilities and
long-term debt as opposed to owner contributions is referred to as leverage.
A firm that has a high proportion of debt to stockholder contributions would be

referred to as being highly leveraged. The advantage to the owners of the firm of
having high debt is that profits earned after payment of interest accrue to a
smaller group of owners.
On the other hand' when a firm is highly leveraged, risk rises when profits and
cash flows fall. A company can be forced to the point of insolvency by the cost of
interest on the debt

Page 122

(3) Debt Ratio = Total Debt
Total Assets
Alternatively,
Debt-to-Equity Ratio = Total Liabilities = $9,955 - $2,224
Owners’ Equity $2,224
= 3.5
Care must be taken in interpreting either of these ratios because there is no
absolute level that can be referred to as being better than another. In general as
the ratio increases in size, returns to owners are higher but so is risk. The trend in
this ratio may reveal important management decisions about the financing
activities of the two organizations. Differences in the size of the
ratio between two ventures may reveal management attitude toward risks and
alternative strategies toward financing

Page 123

(4) Times Interest Earned
Almost every firm has continuing commitments that must be met by future flows if the
company is to remain solvent. Interest payments are an example of such commitments. The
common ratio that measures the ability of a company to meet its interest payments is times
interest earned.
Time Interest Earned = Pretax Operating Income + Interest Expense

Interest
= $1,964 + $54 = 37.4X

$54
The number of times interest payments are covered by current earnings offers some
measure of the degree to which income could fall without causing insolvency in this
account. In many cases' this is not so much a test of solvency as a test of staying power
under adversity

Page 124
Long Term Solvency / Viability

• Over reliance on debt will result in the business not being able to
withstand business and financial stress
• There is inadequate equity (shareholders fund) to absorb impact

of potential losses
• Business and financial stress can lead to liquidity problems

(banks and creditors demanding early repayment)
• This would lead to long term solvency problems (no new banks
and creditors prepared to provide funding)
Page 125
2. Market-Related & Dividend Ratios
 These ratios are affected by the market price of its shares
(1) Price Earning (PE) Ratio

(2) Dividend Yield Ratio
(3) Dividend Payout Ratio

Page 126

(1) Price Earnings Ratio = Market Price per Share of Stock
Earnings per Share
= $34.00 (average price of share in 2003)
$1.35
= 25.2
The relationship of the market price of shares of stock to the earnings of the
company is of great interest to investors. Companies that are growing rapidly and
are thought to have good potential for future growth often find that their shares
are traded at a multiple of earnings per share much higher than companies
thought to have less promising. Since the market price of shares frequently
fluctuates' this ratio is sometimes calculated using an average market price for a
period of time

Page 127

(2) Dividend Yield Ratio = Dividends per Share
Market price per Share
= $0.65 (dividends per share)
$34.00 (average price of share in 2003)
= 1.9%
The dividend yield to common shareholders is dependent upon the market price
originally paid for the share and is calculated by dividing dividends received by
the market price originally paid for the shares. For a prospective investor dividend
yield is the dividend per share divided by the current market price of the stock

Page 128

(3) Dividend Payout = Dividends
Net Income (Available to common shareholders)
= $666 (dividends paid to common shareholders in 2003)
$1,385
= 48%
The dividend payout ratio shows the proportion of net income

that was paid in dividends. Both the dividend yield and dividend
payout ratio are useful for forecasting future dividend streams to
investors in the company's common stock

Page 129
3. Using Ratios for Management Strategies

Three factors DuPont ROE =
[Income/Sales] X [Sales/Assets] X [Assets/Equity]
[Profit margin] X [Asset turnover] X [Financial Leverage]

Profit margin = to focus management's attention on the relationship
between the price and cost of products or services sold
Asset turnover = to emphasize the efficient use of resources in producing
products and services
Assets over equity = to focus on the ability of management to leverage the
firm properly to provide maximum return to stockholders. Each of these
major classes of decisions that managers must make can be examined in
light of its ability to provide higher ROE for shareholders

Page 130

Five factors DuPont ROE =
(1)= [(Operating Margin x Asset Turnover) – Interest burden] x
[Financial Leverage] x [100% - Income tax rate]
(2)= [Operating Margin – (Interest Burden/Asset Turnover)] x

Financial Leverage x Asset Turnover x (100%-Income Tax rate)
(3)= [(Financial Leverage x Asset Turnover x Operating Margin) –

(Financial Leverage x Interest Burden)] x (100% - Income tax
rate)

Page 131

Five factors DuPont ROE involving
ROE = [(Operating Margin x Asset Turnover) – Interest burden] x

[Financial Leverage] x [100% - Income tax rate]
Operating Income - Depreciation

Operating Margin =
Sales
Sales Total Assets
Asset Turnover = Financial Leverage =
Total Assets Common Shareholder Equity
Interest Expense Income Tax

Interest Burden = Income Tax Rate =
Total Assets Pre-tax Income
Page 132
4. Common Size Financial Statements

In order to examine the changing financial structure of a firm through time and the
changing nature of operations' many analysts like to create common size financial
statements in which the balance sheet and the statement of income are prepared in
the percentage format. In a common size balance sheet' each asset' liability' and
owners' equity amount is expressed as a percentage of total assets. In a common
size statement of income' sales is set at 100%' and each item is expressed as a
percentage of sales.
Common size financial statements facilitate the comparison of firms of a different

size as well. Although firms may be in the same industry' they may be of
significantly different sizes' and common size statements allow an analyst to focus
on the efficiency with which managements of different firms have created a capital
structure and have achieved efficient operations.

Page 133
4. Common Sized Financial Statements
• Statements (in % term):

Balance Sheet expressed as %age of Asset (100%)
Income Statement expressed as %age of Sale (100%)
• Useful to examine how
(1) financial structure;
(2) nature of operation have changed over time
• Useful to compare similar projects of different sizes

Page 134

Page 135

Page 136

Page 137

Page 138

Page 139
In Conclusion,

There are
many more….
What is a Ratio?
a
“name” =
b
141
Page 142
Use & Interpretation Of Financial Ratios

• Intra-company analysis - Same company over a period of time
(say 5 years historical financial statement)
• Inter-company / industry peer group analysis
• Comparison to identify the strengths and weaknesses of

business model
• Analyse competitive advantages of different strategies

Page 143
Is There a “Right” Ratio Level?

• There is no absolute level which is “right” or “correct”
• Dependent on industry and business model adopted
• Market norm provide a guide to the appropriate range
• Ratios can be easily manipulated

– > analyst focus on trends in ratio measurements

Page 149
Limitations of Financial Ratios

1. One should consider relative financial ratios, not the absolute ratio by itself.
2. The accounting treatment for other firms should be comparable.
3. One should make sure that one is considering the correct industry segment. This is difficult
when analyzing firms with several distinct divisions.
4. Check to make sure the results are consistent with an overall picture.
5. Make sure the ratios are within a reasonable range for the industry. These last two might be
called the common sense rules.
6. Even the best ratio is not always indicative of the health status or performance of an
organisation
Historical information Seasonal Effects Operational Changes
Inflation Effects Change in Accounting Policies Manipulation


Page 151
Project Investment Decisions

Page 152
Economic Evaluation of Engineering Project

Topics covered:
1. Net Present Value (NPV)
2. Sensitivity Analysis
3. NPV decision for Mutually Exclusive Projects
4. Net Uniform Value or Equivalent Uniform Annual Value
5. Internal Rate of Return (IRR)

6. IRR for mutually exclusive project: incremental method
7. Cashflow with disbursement only

Page 153
• Computation of Basis for Comparison

– NPV, IRR(%)
• Financial Evaluation Technique regardless of
– Project Size
– Type of Project
– Location (Country)

Page 154
NET Present Value (NPV)

• Most commonly used, and most convenient measure of
profitability because it measures in dollars value ($).
• Represents the net earning from an investment.
• NPV = PV(+ve cash flows) + PV(-ve cash flows).
• An economically desirable project must have a +ve NPV, NPV>0.

Page 155
NPV Rules for Investment
• Accept projects with +ve NPV, i.e. NPV>$0
• Reject Projects with –ve NPV

Page 156
Sign Convention for Cash Flows
+ve
cash
inflow
0 1 n
-ve cash
outflow

Page 157
Project Economic Evaluation:

Example 1: Mining Operation
+150 k
0
1 2 3 4 5 6 7 8
-340 k X
Min. Acceptable Rate of Return MARR = 10 %
Initial Investment = $340,000

Annual net income = $150,000
n = 8
At end of year 8, $X required for landscape
protection
Page 158
Question:
Is Operation Economically Sound at MARR=10%
(a) if X = $980,000
(b) if X = $860,000
(c) Study the sensitivity of NPV to MARR by plotting NPV vs MARR for
0% to 30%

Page 159
Solution:
P P
NPV   340 k  150 k ( ,10 %, 8 )  X ( ,10 %, 8 )
A F
Case (a) : X = 980 k , NPV = + 3.08 k
NPV = -340k + 150k * 5.335 – 980k * 0.4665

= + 3.08k

Page 160
(P/A, 10%, 8yr) Example 1

Page 161
(P/F, 10%, 8yr) Example 1

Page 162
Solution:
P P
NPV   340 k  150 k ( ,10 %, 8 )  X ( ,10 %, 8 )
A F
Case (b) : X = 860 k NPV = + 59.06 k

NPV = -340k + 150k * 5.335 – 860k * 0.4665
= + 59.06k
Both A & B - Economically Acceptable

Page 163
Illustration

Page 164
Note: Converting to equivalent cashflows
500 500 500 1200

0 1
2 3 4 5
- 1,000 - 800
Let’s try converting some challenging cashflows together.

Cashflow illustration
Page 166
Discussion 1 NPV = -30 + 5 (P/F, 10%, 1)

+ 6 (P/F, 10%, 2)
+ 7 (P/F, 10%, 3)
+10k
+9k + 8 (P/F, 10%, 4)
+8k
+7k + 9 (P/F, 10%, 5)
+6k
+5k + 10 (P/F, 10%, 6)
0 7
Year - 5 (P/F, 10%, 7)
1 2 3 4 5 6
-30k -5k
MARR = 10 %

Page 167

Page 168
Discussion 2
MARR = 10 %
+8k
+4k
Year 0
1 5 6 12
-24k
Method 1
NPV = -24 +8 (P/A, 10%, 5)
+4 (P/A, 10%, 7) (P/F, 10%, 5)

Page 169

Page 170
Discussion 2
+8k
+4k
Year 0
1 5 6 12
-24k MARR = 10 %
How to Solve?

Page 171
Discussion 2
NPV = 8 (P/A, 10%, 5)
+8k
+6k
Year 0 1 5 6 12 Year
MARR = 10 %
-24k

Page 172
Discussion 2
X (P/F, 10%, 5) +4 X (P/A, 10%, 7)
+4k
Year 0 1 5 6 12
MARR = 10 %
-24k

Page 173
Discussion 2
+8k
+4k
Year 0
1 5 6 12
-24k MARR = 10 %
NPV = -24 + 8 (P/A, 10, 5)

+ 4 (P/A, 10, 7) (P/F, 10, 5)

Page 174
Discussion 2
+8k
+4k
Year 0
1 5 6 12
-24k MARR = 14 %
Is there another way to solve this?

Page 175
Discussion 2
+8k MARR = 14 %
+4k
Year 0
1 5 6 12
-24k +4k
+4k
Method 2
Year 0
1 5 6 12
-24k
NPV = -24 +4 (P/A, 14%, 5)
+4 (P/A, 14%, 12)
Page 176
Discussion 2
+8k
+4k
Year 0
1 5 6 12
-24k MARR = 14 %
Method 1
NPV = -24 +8 (P/A, 14%, 5)
+4 (P/A, 14%, 7) (P/F, 14%, 5)
Method 1 or Method 2 easier?
Page 177
Discussion 2a
+8k
+4k
Year 0
1 5 6 12
-24k MARR = 14 %
NPV = -24 +8 (P/A, 14%, 5)

+4 (P/A, 14%, 7) (P/F, 14%, 5)

Page 178
Discussion 2a No Cashflow in Year 6

and 7
+8k
+4k
Year 0
1 5 68 12
1
4
-24k MARR = 14 %
NPV = -24 +8 (P/A, 14%, 5)

+4 (P/A, 14%, 7) (P/F, 14%, 7)

Page 179
Discussion 3
+12k MARR = 14 %
+8k
Year 0
1 5 6 10
-24k
NPV = -24 +8 (P/A, 14%, 5)

+12 (P/A, 14%, 5)(P/F, 14%, 5)
Page 180
Discussion 3 +12k
+8k MARR = 14 %
Year 0
1 5 6 10
-24k
-4k
+12k
Year 0
1 5 6 10
-24k
Page 181
Discussion 3
MARR = 14 %
NPV = -24 +12 (P/A, 14%, 10)

-4 (P/A, 14%, 5)
-4k
+12k
Year 0
1 5 6 10
-24k
Discussion 4
MARR = 10 %
(USD Millions) +8
+5
+3k
Year 0
1 3 4 9 10 15
-20
+5
+3k
Year 0 1 3
9 15
-3
-20
Discussion 4
(USD Millions) MARR = 10 %

+5
+3k
Year 0 1 3
9 15
-3
-20
NPV = -20 + 3 (P/A, 10%, 15)

+ 5 (P/A, 10%, 9)
- 3 (P/A, 10%, 3)
Discussion 5
MARR = 15 %
+8
(USD Millions)
+3k
Year 0 1 3
4 9 10 15
-3
-15
(USD Millions)
+5
+3k
Year 0 1 3
9 15
-11
-15

Page 192
Sensitivity Analysis using NPV

Page 193
Sensitivity Analysis
P P
NPV   340 k  150 k ( , i % , 8 )  X ( , i % , 8 )
A F
NPV ($ k)
i (%) Case (a) Case (b)
0 -120 0
5 - 34 + 47
10 + 3 + 59
15 + 13 + 52
20 + 8 +36
25 - 5 +15
30 - 22 - 7

Page 194
Fig 3.1 : Case (a) : NPV vs i % , X  $980K

P P
NPV   340 k  150 k ( , i % , 8 )  X ( , i % , 8 )
A F
30
0 30
- 30 9.6 22.9
- 60
- 90
-120
5 10 15 20 25 30 i%
NPV = 0 at i = 9.6 %
Small change from specified MARR = 10%
+ve NPV is small, be sensitive to small reduction in i
Seek more information before decision

Page 195
Fig 3.2 : Case (b) : NPV vs i %, X  $860K
P P
NPV   340 k  150 k ( , i % , 8 )  X ( , i % , 8 )
A F
60
30
28.4
0
0 5 10 15 20 25 30
i%
NPV > 0 for a wide range around MARR =10%

Economically Feasible

Page 196
NPV decision for mutually exclusive projects

Page 197
Comparison of Mutually Exclusive Proposals
• Rank the projects in the order of the NPV s

 Select project with the maximum positive NPV
 All projects evaluated at a specified MARR
 Evaluated over the same planning horizon

Page 198
Example 2
• Mutually exclusive alternatives X, Y, Z
Cash Flows ( $k )
Year
X Y Z
0 - 250 - 200 - 300
1-5 + 50 + 35 + 60
6 - 10 + 40 + 40 + 40
MARR = 12 %
Determine which alternative should be selected.

Page 199
NPV (X), MARR@12%

NPV = - 250k
+ 50k (P/A, 12%, 5)
+ 40k (P/A, 12%, 5) (P/F, 12%, 5)
= -250k + 50k * 3.605 + 40k * 3.605 *0.5674
= + 12.1 k

Page 200
NPV (Y), MARR@12%
NPV = - 200k
+ 35k (P/A. i %, 5)
+ 40k (P/A, i %, 5) (P/F, i %, 5)
i = 12%, NPV = + 8.0 k

Page 201
NPV (Z), MARR@12%
NPV = - 300k
+ 60k (P/A. i %, 5)
+ 40k (P/A, i %, 5) (P/F, i %, 5)
i = 12%, NPV = - 1.9 k

Page 202
Decision
1. X and Y are economically acceptable, but Z is not
2. Order of ranking:
(1) X;
(2) Y

Page 203
NPV – MARR Graph for Mutually Exclusive

Alternatives
• To show the sensitivity of the ranking of the alternatives it is advisable to
plot NPV versus MARR
X
NPV
Y
12%
0 Z
Z
Y
X
5 10 15 20 25 30
i % (MARR)
• Ranking of all three alternatives change as i varies
Page 204

Topics covered:


Page 205
Equivalent Uniform Annual Value

(NUV or EUAV)
• Uniform series over useful life where NPV is the same as

the NPV of the cash flow profile
• Conceptually similar to NPV criterion

– Leads to same ranking of alternatives

Page 206
NUV: Repeat Example 2 (Example 3)

Mutually exclusive alternatives X, Y, Z
Cash Flows ( $k )
Year
X Y Z
0 - 250 - 200 - 300
1-5 + 50 + 35 + 60
6 - 10 + 40 + 40 + 40
MARR = 12%

Page 207
NUV: Repeat Example 2 (Example 3)

NUVX = -250k (A/P, 12, 10) + 40k
+ 10k (P/A, 12, 5) (A/P, 12, 10)
= -250k * 0.1770 + 40 k
+ 10k * 3.605 * 0.1770
= + 2.131 k
NUVY = + 1.410 k
NUVZ = - 0.338 k
Same conclusions as NPV criterion

 X, Y economically acceptable but Z isn't
 Order of rank : (1) X (2) Y
Page 208

Topics covered:


Page 209
Internal Rate of Return (IRR) Method

• Earlier result from NPV vs i curve
NPV = 0 for one or more i values
• IRR is Discount rate i* that makes NPV = 0
• Only one change in sign of cash flow profile

Unique value of IRR
• Computation of IRR
trial and error procedure
use of tables

Page 210
IRR: Example 4
500 500 500 1200
0 1
2 3 4 5
- 1,000 - 800
NPV = - 1,000 - 800 (P/F, i, 1)

+ 500 ( P/A, i, 4) (P/F, i , 1)
+ 700 (P/F, i , 5)
= 0 if i = i*

+38.7 Page 211
IRR: Example 4 13%

12% -11.8
12.8%
NPV = - 1,000 - 800 (P/F, i, 1)
+ 500 ( P/A, i, 4) (P/F, i , 1)
+ 700 (P/F, i , 5)
= 0 if i = i *
i = 12 % : NPV = + 38.7
i = 13 % : NPV = - 11.8
Using linear interpolation, IRR = 12.8 %

Page 212
IRR (continued)
• To determine IRR : MARR need not be used. But MARR
still needed for comparison with IRR in choosing the
alternatives
• Merit of project understood by layman shareholders

Page 213
Cash Flows with Single Rate of Return

• NPV vs. i curve cuts i-axis at only one point
• Cash flow profile must satisfy following three

conditions:
1. A0 < 0 : First non-zero Cash flow is a disbursement

2. Only one change in sign of cash flow sequence
 series of disbursements followed by receipts
3. NPV ( i = 0 ) > 0
  Receipts >  Disbursements

Page 214
Cash Flows with Multiple IRR Values

• NPV vs i curve cuts i -axis at more than one point
• No satisfactory answers to
– Which IRR value is correct ?
– Are decision rules applicable ?
If multiple rates of return are found, there is no

rational means for judging which of them is most
appropriate for determining economic desirability

Page 215
IRR Method for Direct Analysis

(Independent Project)
• IRR > MARR : ACCEPT
• Otherwise REJECT

Page 216
IRR for mutually exclusive project:
incremental method

IRR Method Mutually Exclusive Proposals
 Alternative with highest IRR
- NOT the best proposal
 Consider Example 2 & Fig. 3.3
- X has the highest IRR
- At MARR = 10 % Y & Z have greater NPV than X
Fig. 3.3 : NPV - MARR graph

NPV
Z
Y
X
0 5 10 15 20 25 30
i%
Page 218
IRR Method Mutually Exclusive Proposals

• Decision criterion based on
– IRR of incremental investment ( A2 - A1 )
– Only the differences between 2 alternatives matter
IRR of ( A2 - A1 ) > MARR : A2 preferred

IRR of ( A2 - A1 ) < MARR : A1 preferred
• Make pairwise comparison of alternatives listed

in the order of increasing cost
– Defender : " Current Best " alternative
– Challenger : Next unconsidered alternative in list
Note: The current “best” proposal must satisfy the
basic requirement of IRR>MARR

Page 219
Example 5
Three mutually exclusive proposals A1, A2, A3

MARR = 20 %
Cash Flow Profiles
n years A1 A2 A3
0 - 100 - 200 - 300
1 + 150 + 280 + 395

Page 220
Cash Flow Profiles

n years A1 A2 A3 A4
0 - 100 - 200 - 300 -400
1 + 150 + 280 + 395 +610
150
For A1 : NPV   100   0
(1  i * )
Alternative IRR (i * ) %  A1 has highest IRR

A1 50.0
A2 40.0 • NOT necessarily the " best "
A3 31.6  Perform Incremental Analysis
A4, IRR = 52.5%

Page 221
IRR Method – Incremental Analysis
1. Decide on order of considering proposals

– Ascending order of first cost: A1 ; A2; A3
2. Calculate IRR of first proposal A1: 50%

– IRR ( 50 % ) > MARR ( 20 % )
– Economically acceptable : Current best proposal

Page 222
3. Perform incremental analysis of ( A2 - A1 )

n CF
0 - 100
1 +130
130
NPV   100  0
(1  i * )
i * = 0.3 or 30 %
• ( A2 - A1 ) has IRR = 30 % > MARR (20%)
• A2 is preferred. A2 becomes current best

Page 223

4. Perform incremental analysis of (A3 - A2)
n  CF
115
0 - 100 NPV   100  0
1 +115 (1  i * )
i * = 15%
• ( A3 - A2 ) has IRR = 15 % < MARR (20%)

A2
• A2 is preferred. A3 is rejected. A3
(A3-A2)
• Select A2 as the best of the 3 alternatives

Page 224

5. Perform incremental analysis of (A4 - A2)
n  CF 115
330
0 - 200 NPV   100
200  0
1 +330 (1  i * )
i * = 65%
• ( A4 - A2 ) has IRR = 65 % > MARR (20%)

A2
• A4 is preferred. A2 is rejected. A4
(A4-A2)
• Select A4 as the best of the 4 alternatives

Page 225
Example 5.1: What if A2 has a delayed expense?
Three mutually exclusive proposals A1, A2, A3

MARR = 20 %
Cashflow Profiles
n year A1 A2 A3
0 -100 -125 -300
1 150 -75 395
2 - 280 -

Page 226
Cash Flow Profile with Disbursements Only

Page 227
Cash Flow Profile with Disbursements Only

• In certain situations, the cash flow profiles of all the alternatives may be
represented by disbursements only.
Example: Alternative proposals for installing

air-conditioning system to a building.
• In such situations, it is not possible to determine the IRR for any of the
individual proposals.
• It is assumed that one of the proposals must be selected. The proposal with
the lowest first cost will be the “current best” initially.
• Incremental analysis will then be carried out

Page 228
Example 6
• The OSSE Oil Refinery Co. must install anti-pollution

equipment in a new refinery that is to commence operation
soon
• Two proposals are being studied.

Page 229
Example 6
Information about the proposals
Proposal A Proposal B
Investment ($) 1,240,000 1,600,000
Annual O & M Cost $ 630,000 574,000
Salvage Value($) 0 0
Life (years) 10 10

Page 230
Example 6
• The information regarding both proposals deals only
with disbursements. Since anti-pollution equipment
must be installed, one of the proposals must be
accepted.
• The proposal A is the initial “current best” alternative

because it has a smaller first cost or investment.
• Proposal B is regarded as the “challenger”
• Calculate the incremental rate of return, Analysis is

based on the incremental cash flows for the incremental
investment (B – A)

Page 231
Eg 6: Decision for proposals with disbursements only

• If IRR of ( B - A ) > Specified MARR, Proposal B is selected
• If IRR of ( B - A ) < Specified MARR, Proposal A is selected
Cash Flow Diagrams
0 1 n=10 years
-630 A
-1240
0 1 n=10 years B
-574
-1600
0 +56 B-A
1 n=10 years
-360

IRR for mutually exclusive project:
incremental method (Example)
NTU MSc / CV6214: Project Financing. All

Rights Reserved.
Page 232
NTU MSc / CV6214: Project Financing. All Rights
234
Reserved.
235
Reserved.
MOBA is selected as best because IRR(2-1) < MARR of 20%
(8 marks)

236
Reserved.
Individual IRR of:
MOBA is 27.3% (2) Shooter is 25.5%; (3) MMORPG is 25.8%; (4) Sandbox is 25.0%

237
Reserved.
238
Reserved.
239
Reserved.
Page 240

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CV6214: Project Financing

NTU MSc / CV6214: Project Financing. All Rights Reserved. 1

NTU MSc / CV6214: Project Financing. All Rights Reserved.

• Large, complex and expensive installations ie power plants, chemical

• Borrower is usually a special purpose vehicle that is not permitted to

NTU MSc / CV6214: Project Financing. All Rights Reserved. 9

NTU MSc / CV6214: Project Financing. All Rights Reserved. 10

NTU MSc / CV6214: Project Financing. All Rights Reserved. 11

NTU MSc / CV6214: Project Financing. All Rights Reserved. 12

NTU MSc / CV6214: Project Financing. All Rights Reserved.

NTU MSc / CV6214: Project Financing. All Rights Reserved.

Debt & Equity

* In this course, Loan = debt = debenture = bond = note = fixed income

1. Regular bond pays semi-annual coupon.

2. On maturity, return the full principal sum

NTU MSc / CV6214: Project Financing. All Rights Reserved.

 What is Green bond?

 Sustainability-linked (SL) loans?

• Equity represents a claim on the company’s

• As you acquire more equity, your ownership

Equity = Share = Stock

NTU MSc / CV6214: Project Financing. All Rights Reserved. 22

An equity instrument A debt with a process to pay

Voting rights Preferential treatment

NTU MSc / CV6214: Project Financing. All Rights Reserved.

Key ratios are

(Extract of Bank of Singapore Equity Research, 11 Sep 2018)

NTU MSc / CV6214: Project Financing. All Rights Reserved. 27

Owners’ equity vs loan?

NTU MSc / CV6214: Project Financing. All Rights Reserved.

Accrual or Cash Basis accounting?

Matching: Revenue & Expenses?

NTU MSc / CV6214: Project Financing. All Rights Reserved.

Why read financial statements?

• Lenders & creditors want to know if they’ll be paid

 Different users of financial statements

NTU MSc / CV6214: Project Financing. All Rights Reserved.

• Understand the components in the three financial statements

• Derive and interpret financial ratios

• Use financial ratios to analyse project profitability, operating

NTU MSc / CV6214: Project Financing. All Rights Reserved.

1.1 Income Statement

1.2 Balance Sheet

1.3 Cash Flow Statement

1.4 Creative Accounting

NTU MSc / CV6214: Project Financing. All Rights Reserved.

• Reports information on the efficiency, control, and profitability of a

NTU MSc / CV6214: Project Financing. All Rights Reserved.

Income (or Profit & Loss) Statement

Income = Revenue - Expenses

NTU MSc / CV6214: Project Financing. All Rights Reserved.

Net income = Revenue - Expenses

NTU MSc / CV6214: Project Financing. All Rights Reserved.

Income Statement of Super Flavors

NTU MSc / CV6214: Project Financing. All Rights Reserved.

NTU MSc / CV6214: Project Financing. All Rights Reserved.

NTU MSc / CV6214: Project Financing. All Rights Reserved.

Why did car drift sideway?

NTU MSc / CV6214: Project Financing. All Rights Reserved.

Asset = Liabilities + Owners’ Equity

NTU MSc / CV6214: Project Financing. All Rights Reserved.

NTU MSc / CV6214: Project Financing. All Rights Reserved.