Project Financial Modeling.

ABC Pty Ltd intends to form a special purpose vehicle (SPV) in Australia. This
will involve building new water treatment facilities. ABC Pty Ltd intends to
undertake the development of the proposed water treatment facilities through a
project financing approach. The constructed facilities will be used as the
business solution in providing clean water to the local community. The
following are some of the in-principal agreements with the various parties after
much negotiation:

The project is to be developed using a BOT arrangement where WaterSolution

will finance and build, operate and transfer the facilities back to the state
government at the end of 20 years.
There are three off-take agreements:
to sell Call Water Pty Ltd 450,000 cubic litre of treated water per day at a price
of 0.025 per cubic litre. This agreement will expire at the end of 20 years. The
contract allows for the price to increase by 7% per annum.
to sell AP Water Limited 550,000 cubic litre of treated water per day at a fixed
price of 0.020 per cubic litre. This agreement will expire at the end of 20 years.
The contract allows for the price to increase by 10% per annum.
to sell Nuwater Pty Ltd 600,000 cubic litre of treated water per day at a fixed
price of 0.030 per cubic litre. This agreement will expire at the end of 20 years.
The contract allows for the price to increase by 5% per annum.
The capital expenditure (include construction cost plus all relevant professional
fees, and insurance) is estimated at 85,000,000 incurred at year 0
Water Solution has an agreement to buy untreated water from DirtyWater Ltd at
a price of 0.012 per cubic litre. The price of untreated water will increase by 3%
per annum.
The annual operation cost (starting from year 1) is estimated to be as follows:
a. Management fees 350,000 per annum with an increase of 10% per annum
b. Maintenance works 600,000 per annum with an increase of 10% per annum
c. Insurance costs 150,000 per annum with an increase of 5% per annum
d. Miscellaneous cost is fixed at 100,000 per annum
Also, assume the following:
The current interest-free rate (based on Government bonds) is 3.5%
ABC Pty Ltd's beta is estimated to be 0.9 (based on the ratio of the standard
deviation of the firm's return to the standard deviation of the stock market
return)
Expected market return of the water industry where ABC Pty Ltd's main
business lies, is 15%
Water Solution will borrow 75% of the capital expenditure from a consortium of
banks at a cost of 12%. The repayment will start immediately in Year 1 and
should be repaid fully in Year 20. The remaining 25% is raised through equity.
Assume construction is completed in year 0 and operation begins immediately
in year 1
Assume there is no tax involved
Prepare a report to the Board of ABC Pty Ltd. In your report, you should
include (but not limited to):
Calculation of the Project IRR
Calculation of the Equity IRR
Calculation of Expected Return on Equity using CAPM
Calculation of the WACC
Recommendation to the Board on whether the project go ahead using project
finance