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Lecture 2 Project Financing & Evaluation
Lecture 2 Project Financing & Evaluation
Lecture 2 Project Financing & Evaluation
401
Project Management
Spring 2007
Preliminaries
AS 2: Student
Presentation
Preliminaries
Outline
Project Financing
Financial Evaluation
Owner
Project
Contractor
Additional Issues
Missing factors
Session Objective
FEASIBILITY
DESIGN
PLANNING
DEVELOPMENT
Financing &
Evaluation
Risk
CLOSEOUT
OPERATIONS
Context: Feasibility
Phases
Project Concept
Land Purchase & Sale Review
Evaluation (scope, size, etc.)
Constraint survey
Site constraints
Cost models
Site infrastructural issues
Permit requirements
Summary Report
Decision to proceed
Regulatory process (obtain permits, etc)
Design Phase
Lecture 2 - References
More details on:
Chapter 7
Outline
Project Financing
Financial Evaluation
Owner
Project
Contractor
Additional Issues
Missing factors
Financing Gross
Cashflows
years
OWNER
investment
operation incomes
owner cashflow
owner cum cashflow
10
($10,000,000) ($20,000,000)
$2,000,000
$4,000,000
$6,000,000
$6,000,000
$0 ($10,000,000) ($20,000,000) $2,000,000
$4,000,000
$6,000,000
$6,000,000
$0 ($10,000,000) ($30,000,000) ($28,000,000) ($24,000,000) ($18,000,000) ($12,000,000)
CONTRACTOR
costs
($4,000,000) ($7,000,000) ($14,000,000)
revenues
$0 $10,000,000 $20,000,000
contractor cashflow
($4,000,000) $3,000,000
$6,000,000
contractor cum cashflow
($4,000,000) ($1,000,000) $5,000,000
$0
$0
$0
$5,000,000
$0
$0
$0
$5,000,000
$0
$0
$0
$5,000,000
$0
$0
$0
$5,000,000
$6,000,000
$6,000,000
($6,000,000)
$6,000,000
$6,000,000
$0
$6,000,000
$6,000,000
$6,000,000
$0
$0
$0
$5,000,000
$0
$0
$0
$5,000,000
$0
$0
$0
$5,000,000
Financing Gross
Cashflows
Design/Preliminary Construction
years
OWNER
investment
operation incomes
owner cashflow
owner cum cashflow
10
($10,000,000) ($20,000,000)
$2,000,000
$4,000,000
$6,000,000
$6,000,000
$0 ($10,000,000) ($20,000,000) $2,000,000
$4,000,000
$6,000,000
$6,000,000
$0 ($10,000,000) ($30,000,000) ($28,000,000) ($24,000,000) ($18,000,000) ($12,000,000)
CONTRACTOR
costs
($4,000,000) ($7,000,000) ($14,000,000)
revenues
$0 $10,000,000 $20,000,000
contractor cashflow
($4,000,000) $3,000,000
$6,000,000
contractor cum cashflow
($4,000,000) ($1,000,000) $5,000,000
$0
$0
$0
$5,000,000
$0
$0
$0
$5,000,000
$0
$0
$0
$5,000,000
$0
$0
$0
$5,000,000
$6,000,000
$6,000,000
($6,000,000)
$6,000,000
$6,000,000
$0
$6,000,000
$6,000,000
$6,000,000
$0
$0
$0
$5,000,000
$0
$0
$0
$5,000,000
$0
$0
$0
$5,000,000
Financing Gross
Cashflows
Design/Preliminary Construction
years
OWNER
investment
operation incomes
owner cashflow
owner cum cashflow
10
($10,000,000) ($20,000,000)
$2,000,000
$4,000,000
$6,000,000
$6,000,000
$0 ($10,000,000) ($20,000,000) $2,000,000
$4,000,000
$6,000,000
$6,000,000
$0 ($10,000,000) ($30,000,000) ($28,000,000) ($24,000,000) ($18,000,000) ($12,000,000)
CONTRACTOR
costs
($4,000,000) ($7,000,000) ($14,000,000)
revenues
$0 $10,000,000 $20,000,000
contractor cashflow
($4,000,000) $3,000,000
$6,000,000
contractor cum cashflow
($4,000,000) ($1,000,000) $5,000,000
$0
$0
$0
$5,000,000
$0
$0
$0
$5,000,000
$0
$0
$0
$5,000,000
$0
$0
$0
$5,000,000
$6,000,000
$6,000,000
($6,000,000)
$6,000,000
$6,000,000
$0
$6,000,000
$6,000,000
$6,000,000
$0
$0
$0
$5,000,000
$0
$0
$0
$5,000,000
$0
$0
$0
$5,000,000
Early expenditure
Takes time to get reve
Project Financing
Critical Role of
Financing
Riskiness of construction
Claims
Prices offered by contractors (e.g., high bid price for
late payment)
Public
Private
Project financing
Outline
Project Financing
Financial Evaluation
Owner
Project
Contractor
Additional Issues
Missing factors
Public Financing
Sources of funds
Private Financing
Major mechanisms
Equity
Debt
Borrow money
Bonds
Bridge Debt
Long-term mortgage
Senior Debt
construction
w/o tangible
operation
w/ tangible
time
Outline
Project Financing
Financial Evaluation
Owner
Project
Contractor
Additional Issues
Missing factors
Project Financing
Drawback
Outline
Project Financing
Financial Evaluation
Owner
Project
Contractor
Additional Issues
Missing factors
Contractor Financing I
Payment schedule
Advance payment
Periodic/monthly progress payment (itemized breakdown
structure)
Milestone payments
S-curve Work
Man-hours
months
S-curve Cost
8
100
90
80
6
5
$K
60
50
40
30
2
20
1
10
0
1
6 7
9 10 11 12 13 14 15 16 17 18 19 20 21 22
Working days
Cumulative costs $K
70
Daily cost
Cum. costs
Contractor Financing II
Contractor Financing II
Outline
Project Financing
Financial Evaluation
Owner
Project
Contractor
Additional Issues
Time value of money
Present value
Rates
Interest Formulas
NPV
IRR & payback period
Missing factors
Latent Credit
Designers
Contractors
Consultants
CM
Suppliers
Implications
Role of Taxes
Depreciation - Link
Others
Outline
Project Financing
Financial Evaluation
Owner
Project
Contractor
Additional Issues
Missing factors
Project Evaluation
Example:
Project A
Project B
Construction=3
years
Construction=6
years
Cost = $1M/year
Cost=$1M/year
Sale Value=$4M
Sale Value=$8.5M
Total Cost?
Total Cost?
Profit?
Profit?
Quantitative Method
Profitability
Profit
TOTAL
EQUIVAL. $
REVENUES
5,500,000.
00
COSTS
4,600,000.
00
Project management
400,000.00
Engineering
800,000.00
2,200,000.00
Construction/commissioni
ng
1,300,000.00
Contingencies
GROSS
MARGIN
Time
factor?
200,000.00
900,000.0
Quantitative Method
Profitability
Opportunity Cost
Money Is Not
Everything
Social Benefits
Hospital
School
New warehouse
New cafeteria
Outline
Project Financing
Financial Evaluation
Owner
Project
Contractor
Additional issues
Missing factors
Basic Compounding
0
$x
$x(1+i)
$x(1+i)2
$x(1+i)3
$x(1+i)n
after 1 year
after 2 years
after 3 years .
after n years
1 $x(1+i)
2 $x(1+i)2
n $x(1+i)n
If we assume
Then
Equivalence of Present
Values
Preliminaries
STELLAR access:
http://stellar.mit.edu/S/course/1/sp07/1.040/
Next Tuesday Recitation: Skyscraper Part I
Please set up an appointment to discuss
your AS2 if you choose emerging
technologies (MF preferred)
Office: 1-174
TA (50%) for our class
Outline
Project Financing
Financial Evaluation
Owner
Project
Contractor
Additional issues
Missing factors
If we assume
Then
l = PV(r)
Future to Present
Revenue
If I know this is coming
x
t
t
0
PV(x)
-x
If I know this cost is coming
x
t
t
PV(x)
Summary
PV
FV
t
Summary
PV
v= v(1+i)t
FV
t
Outline
Project Financing
Financial Evaluation
Owner
Project
Contractor
Additional issues
Missing factors
Rates
Rates
Interest Rate
Outline
Project Financing
Financial Evaluation
Owner
Project
Contractor
Additional issues
Missing factors
Interest Formulas
PV = Present Value
FV = Future Value
Interest Formulas:
Payment
Factor that will make your present value future value in single
payment
(F/P, i, n) = (1 + i )n
n
F
Interest Formulas:
Payment
(P/F, i, n) = 1/ (1 + i )n = 1/ (F/P, i, n)
0
n-1
P
F
Interest Formulas:
Payment
- Example
Interest Formulas:
Payment
- Example
P=?
F=$100,000
Interest Formulas:
Payment
- Example
P = F(P/F, 0.12, 5)
P = 100,000 0.5674 =
$56,740
Factor that will make your annuity value future value in series
payment
Annuity
period occurs at the end of the interest
Factor that will make your annuity value future value in series
payment
Factor that will make your annuity value future value in series
payment
Factor that will make your annuity value future value in series
payment
F = A + A(1+i) + + A(1
+ i )n-1
Factor that will make your future value annuity value in series
payment
(A/F, i, n) = i / [ (1 + i )n 1] = 1 / (F/A, i, n)
A
F
(P/A, i, n) = [ (1 + i )n -1 ] / [ i (1 + i )n ]
P
0
(P/A, i, n) = [ (1 + i )n -1 ] / [ i (1 + i )n ]
P = A/ (1 + i )
0
(P/A, i, n) = [ (1 + i )n -1 ] / [ i (1 + i )n ]
P = A/(1 + i ) + A/(1 + i )2
0
(P/A, i, n) = [ (1 + i )n -1 ] / [ i (1 + i )n ]
Verify it!
Verify it!
A = P * (which factor?)
Equipment Example
A - Annual Equivalent
P - Present Equivalent
Equipment Example
Equipment Example
Outline
Project Financing
Financial Evaluation
Owner
Project
Contractor
Additional issues
Missing factors
Calculation of Net
Present Value
Total Revenue (R)
(+)
Tax (-)
Calculate Gross
Return
Calculate Net
Return
PV of Net Return
>
=
<
Project Evaluation
Example Revisit: Which
one is better?
Project A
Project B
Construction=3
years
Construction=6
years
Cost = $1M/year
Cost = $1M/year
Total Cost?
Total Cost?
Profit?
Profit?
Project A
0
$4M
1
$1M
$1M
$1M
Project B
0
$8.5M
6
$1M
$1M
$1M
$1M
$1M $1M
Or Using Interest
Formulas
Project A
Project B
Four Independent
Projects
Solution
[NPV1]20%
= -77 + (235)(P/F, 0.2, 5) = -77 + 94.4
= 17.4
Year 0
$235 M
-$77 M
[NPV2]20%
= -75.3 + (28)(P/A, 0.2, 5) = -75.3 + 83.7
= 8.4
NPV2 Cash
Flow
Year 0
-$75.3 M
Solution
[NPV3]20%
= -39.9 + (28)(P/A, 20%, 4) - (80)(P/F, 20%, 5)
= -39.9 + 72.5 - 32.2
$28 M each year
= 0.4
NPV3 Cash Flow
Year 0
-$39.9 M
-$80 M
[NPV4]20%
= 18 + (10)(P/F, 20%, 1) - (40)(P/F, 20%, 2)
- (60)(P/F, 20%, 3) + (30)(P/F, 20%, 4)
+ (50)(P/F, 20%, 5)
= 18 + 8.3 - 27.8 - 34.7 + 14.5 + 20.1 = -1.6
NPV4 Cash Flow
$50 M
$30 M
$18 M $10 M
Year 0
2
-$40 M
-$60 M
Solution
[NPV1]
[NPV2]
[NPV3]
[NPV4]
=
=
=
=
17.4
8.4
0.4
-1.6
Example
Link
Outline
Project Financing
Financial Evaluation
Owner
Project
Contractor
Additional issues
Missing factors
Link
IRR
>
=
r*
<
Accept
Indifferent
Reject
- r = IRR,
* r = MARR
Discount Rate
Link
Payback Period
Payback Period
Comparing Projects
Comparing Projects
Use NPV
Verify IRR
Other Methods
Cost-effectiveness
$/Life saved
$/Life quality
i ' i j ij
If i, A(y=0) will be A*(1+i) after
one year. Then, if j, A will be
A*(1+i)*(1+j).
i' i j
i i' j
NPV A0 At / (1 i ) t
t 1
Inflation Example
Solution
Depreciation costs are not inflated to current dollars in conformity with the
practice recommended by the U.S. Internal Revenue Service.
Price
Index
1982 $
100
104
111
118
122
123
130
134
140
144
146
154
165
165
165
175
172
176
181
183
189
195
202
Price
Index
2002 $
53
55
59
62
65
65
69
71
74
76
77
82
88
88
87
93
91
94
96
97
100
103
107
Project
Expenses
($ K)
33,000
82,000
131,000
164,000
214,000
197,000
246,000
574,000
854,000
852,000
764,000
1,206,000
1,470,000
1,523,000
1,329,000
1,246,000
1,272,000
1,115,000
779,000
Project
Expenses
(1982 $ k)
27,000
67,000
101,000
122,000
153,000
137,000
169,000
372,000
517,000
515,000
464,000
687,000
853,000
863,000
735,000
682,000
674,000
572,000
386,000
Project
Expenses
(2002 $ K)
51,000
126,000
190,000
230,000
289,000
258,000
318,000
703,000
975,000
973,000
877,000
1,297,000
1,609,000
1,629,000
1,387,000
1,288,000
1,272,000
1,079,000
729,000
Outline
Project Financing
Financial Evaluation
Owner
Project
Contractor
Additional issues
Missing factors
Main uncertainties:
Financial concerns
Project risks
FEASIBILITY
DESIGN
PLANNING
DEVELOPMENT
Financing &
Evaluation
Risk
CLOSEOUT
OPERATIONS
Risk Management
Case Study