Valuing projects is project appraisal. There are various ways to do appraisal like Benefit cost ratio, scenario analysis, cost effectiveness analysis, multi criteria decision making among many.
In our class we discussed valuing projects based on Economic benefit cost analysis. The economic costs are the cash outflows and the economic benefits are the revenue from the project. Discounted cash flow is used for comparing benefits and costs considering the time value of money to make informed decisions. The discounting factor is also called the huddle rate or opportunity cost or the cost of capital. The cost of capital for large infrastructure projects is a measure of project risk, duration of investment and the sources of capital (whether equity source or debt source). In cases where there is a mix of equity and debt, the weight average cost of capital (WACC) is used. We also discussed that debt has to be adjusted for tax rate and equity rate is based on Capital Asset Pricing Model (CAPM).
We had a gaming section in this module which was Bid2Win which exposed us to some real market environment. We learnt through the exercise to Bid as many feasible projects are possible and not to keep money in hand. Also in the module we discussed Pennsylvania Turnpike case study.
In the business world project valuation is generally used for estimating monetary values of assets. There are several reasons for a company to conduct an asset valuation. A merger or acquisition is one of the major indications for the valuation of a project or a company. Each valuation is based on a financial model. Our course had a closer look at the Net Present Value (NPV). It is calculated on the basis of specific cash flows in each financial year and the Weighted Average cost of Capital (WACC). Therefore, the value of an asset depends on the revenue it can generate as well as the company’s / project’s financing structure and its corresponding costs. As the equity and debt costs are not solely determined by the project’s characteristics but also by the project owner’s creditworthiness and equity costs the NPV of one project can differ across companies.
Because financial gearing is a main driver of a project’s NPV we discussed the cost structures of equity and debt of the available project financing structures. The following financing structures were compared in the lecture: Project Finance, Corporate Finance and Revolving Construction Facility. We outlined the differences for the categories cost, time, flexibility, feasibility and refinancing risk between the three financing structures. It was clearly worked out that not only the factor cost counts for deciding on a financing structure. Flexibility, time, refinancing risk and feasibility are other important factors that have to be considered for the financing design. For the factor cost, however, we focused mainly on the difference between upfront cost and carrying capital cost for both equity and debt. We discussed a scenario where one has to choose between a financial structure with lower issuance cost and higher carrying cost and a second financing option offering higher issuance cost and lower carrying cost. Assuming the two financing vehicles gave the same NPV, it was recommended to strategically approach the decision. As the issuance cost has to be paid immediately, it would be a better decision for a CEO to postpone this payment by bearing higher carrying costs, as he should ensure to shift as much costs as possible in the future to be able to benefit from lower costs in his own tenure.
In the case study “Pennsylvania Turnpike” we could observe a similar strategy. The government decided to choose the option, which offered the largest upfront payment for the government. Also in politics it seems to be popular to be able to dispose of money better today than tomorrow.
Valuing Projects This module consisted of a case on High speed Rail development in Texas and a Bid2Win simulation game. Having already written a separate blog on Bid2Win, I will confine myself to Texas High speed Rail case. Although, this case was not discussed in class, the learnings from the case in my opinion are as follows:
This was a long gestation project with two years preliminary phase, 3 years of development phase and five years of construction phase before operations could start. Hence, if we followed a traditional project finance model with large debt taken for the construction period, the interest payable would yield tax shields which cannot be utilized because cashflows from operating income would start much later. Hence, they devised a concept of small amount of founder’s equity to fund preliminary expenses, private equity to fund development expenses and construction equity in the form of convertible bonds for the massive construction cost funding. This ensured that tax benefits were retained and resulted in higher value for the project.
The Pennsylvania case study dealt with leasing of public highway to private company which posed several issues like
1. Private companies would focus on profit-making rather than on public welfare. 2. Getting the future toll revenues upfront may cause the one time payment “to be spent quickly and unwisely”. 3. Leasing to a private company also may lead to an increase in toll rates which might be unacceptable to public.
The biggest challenge in valuing this project was to make financial projections for a period of 99 years. Only renegotiation will be able to help in future,if the leasing does not workout. Another challenge was whether the toll revenues could be capitalised to generate money for other investments.
Also we discussed two types of coverage ratios -Income coverage ratio and debt coverage ratio. Lesser the coverage more will be the up front capital. Since private financing brings equity, the coverage is kept low and hence more upfront capital is obtained.
Valuation of the projects actually includes evaluating the monetary benefits as well as the non monetary benefits. First the sole conception of the idea of starting an infrastructure project includes the non-monetary benefits it could cause to the society. But for bidding purposes, we evaluate the project using the monetary values or cost benefit analysis. The results from evaluation can help us taking decisions whether or not to bid for the project. NPV and IRR are the most common economic indicators. The main concern in evaluation is the correctness of the future cash flow predictions. There can be fixed incomes like the power purchase agreement or there are variable inflows like the toll collection. The time period of consideration for project evaluation is the another major concern. If we consider the Pennsylvania Turnpike case study , cash flow projections are done for 99 years. That is too long for a project to be evaluated unless there are concerned clauses which allow for restructuring/renegotiation at a later stage.
Valuation of the projects actually includes evaluating the monetary benefits as well as the non monetary benefits. First the sole conception of the idea of starting an infrastructure project includes the non-monetary benefits it could cause to the society. But for bidding purposes, we evaluate the project using the monetary values or cost benefit analysis. The results from evaluation can help us taking decisions whether or not to bid for the project. NPV and IRR are the most common economic indicators. The main concern in evaluation is the correctness of the future cash flow predictions. There can be fixed incomes like the power purchase agreement or there are variable inflows like the toll collection. The time period of consideration for project evaluation is the another major concern. If we consider the Pennsylvania Turnpike case study , cash flow projections are done for 99 years. That is too long for a project to be evaluated unless there are concerned clauses which allow for restructuring/renegotiation at a later stage.
CE11B070 B. Pavan Kumar The third module was the valuing and bidding of the projects. The valuation is generally done by the financial projections of the project and demand prediction. The NPV and IRR of the projects will be calculated to evaluate the projects. Also most of these projections are based on demand prediction which are highly uncertain. Therefore, it is important to mitigate the demand risk. Then Bid2Win was played, where lot of techniques related to bidding were learnt. The leasing of pesylvania turnpike case study discussed on weather public assets can be leased to private companies. In this case as well, the major issue is the demand prediction for extremely large period of 99 years. The importance of renegotiations was also emphasized. Also, this case has shown that leasing will help to raise large upfront cost which can be used to improve other infrastructure.
CE11B071 Case study discussed in this module was Pennsylvania turnpike which discusses on leasing of infrastructure projects, here we see the inefficiency of the government to maintain rods due to lack of funds. The leasing of Pennsylvania turnpike was considered by going through two other leasing contracts namely Indiana Toll road and Chicago Skyway. We see that in leasing the government gets high upfront amount , coverage ratio for private players is lower as we think they are more careful and lenders are ready to risk. Here we see that the leasing of infrastructure projects has high upfront amount and the term for lease runs into decades. This could be a profitable sector when the roads have good amount of ridership. leasing roads is a good option but term of lease should be considerable as in case of Indiana and Chicago where the lease period was about 99 years may not be desirable for public assets. Other controversial issue was the toll price increase which when follow the Indiana or Chicago structure show an increase of more than two percent, this was also not desirable. Leasing strategy needs to be carefully studied and properly structured for optimal and fair implementation.
Pennsylvania Case Study describes the apprehensions of Government in leasing a public highway to a private company. Three options were available : (i) a long term lease to private toll road company, (ii) a bond issue by a public toll road company, (iii) Turnpike Commission’s proposal. The first two options could generate more funds. The drawback of the third option was that the Turnpike Commission had considered only the State’s highway needs and did not account for the needs of Urban transport. Private lease was chosen based on analysis by Morgan Stanley. This would help them to invest the upfront money obtained in some reserve to get returns. The main problem was the fear of misusing these returns and the errors in forecasting the toll revenues for a long period of 99 years.
Valuing a project is a highly uncertain and risky business for investing in any project. Other than estimating the cost of the project it is also important to decide upon a reasonable cost of investment to the investor. This is a function of the risks in the project and is usually compared with the opportunity cost. The mode of funding the investment is also important as a more analytical approach for this require creating a Capital Asset Pricing Model, where the required return rate or cost of capital for investor is obtained based on level of equity and loans, with corresponding return rates. This method was used to choose the best options for bidding as the CAPM model gave the cost of raising capital based on level of debt and loan. The credit rating of the company is another influential factor in determining the borrowing capacity of the company in case of corporate finance. Thus the financial model plays a key role in determining cost of capital for a project. The opportunity to save on taxes by increasing the debt ratio demonstrated the possibility of arbitrage in IPP and this will also influence the net project evaluation. Another factor complicating the valuation is the long period of investment usually associated with infrastructural projects. Though many of these uncertainties can be eliminated by contractual terms and risk sharing, with projects like Pennsylvania Turn Pike with a term of 99 years, it is impossible to predict not just the magnitude but also the kind of aspects that can influence the project, especially with rapidly changing technologies. So for such projects it is important to incorporate flexibility and options into the basic structure to ensure that modifications can be made to the projects that are compatible with new features in the sector.
In my point of view, financial modelling is essential for evaluating a project. As discussed in the Cogeneration model, financial modelling includes estimating the total cost of the project, projecting the cash flows for pre-decided number of years (which is a crucial term), coverage ratios and finding out the tentative NPV/IRR and returns to debt and equity investors. Then, whether the project is viable or not has to be decided. ‘Leasing the Pennsylvania Turnpike’ was discussed in this module. As my friends mentioned, considering 99 years of life span while evaluating the project is not advisable. There are two options in front of the Pennsylvania government to choose between leasing the road for maintenance to private companies or government per se managing the roads raising funds through public resources. Leasing the turnpike would mean loss of public control, mortgaging the future, toll increases, daily user toll payment, potential gas taxes etc. But the positive side of leasing is high upfront payment to the government which helps it to focus on other beneficiary projects for the public as quoted by the bureaucrats. There can be necessary clauses in the contract to accommodate the public issues for smoother run of the deal
In this module, we learnt how to value projects. We started with Bid2win in which we ourselves valued projects and bid for them. Thus we were putting a monetary value to each project and saying that we will pay a maximum amount of X rupees to get this project. NPV and IRR are used to find the monetary value of projects. We also discussed opportunity costs, weighted average cost of capital (WACC), debt shields, capital assets pricing (CAPM) model which help in valuation. We also discussed ratios such as Interest Coverage Ratio (ICR) and Debt Service Coverage Ratio (DSCR) which are used by debt issuers during project evaluation, which is also a way to ascertain the value of their debt issued to the specific company.
We also see how in the Pennslyvania turnpike case, different bidders value the same asset (the highway) differently and the difference can be huge. Thus there can be no final word on valuation of projects. Investors will have to value a project keeping in mind their resources and constraints in mind (such as oppurtunity costs) and a project that could be a positive NPV project for somebody else can turn out to be a loss for the company.
Thus project valuation is as much science as art and managers have to find ways to add value to projects.
CE14D040
ReplyDeleteValuing projects is project appraisal. There are various ways to do appraisal like Benefit cost ratio, scenario analysis, cost effectiveness analysis, multi criteria decision making among many.
In our class we discussed valuing projects based on Economic benefit cost analysis. The economic costs are the cash outflows and the economic benefits are the revenue from the project. Discounted cash flow is used for comparing benefits and costs considering the time value of money to make informed decisions. The discounting factor is also called the huddle rate or opportunity cost or the cost of capital. The cost of capital for large infrastructure projects is a measure of project risk, duration of investment and the sources of capital (whether equity source or debt source). In cases where there is a mix of equity and debt, the weight average cost of capital (WACC) is used. We also discussed that debt has to be adjusted for tax rate and equity rate is based on Capital Asset Pricing Model (CAPM).
We had a gaming section in this module which was Bid2Win which exposed us to some real market environment. We learnt through the exercise to Bid as many feasible projects are possible and not to keep money in hand. Also in the module we discussed Pennsylvania Turnpike case study.
MS15F007
ReplyDeleteIn the business world project valuation is generally used for estimating monetary values of assets. There are several reasons for a company to conduct an asset valuation. A merger or acquisition is one of the major indications for the valuation of a project or a company. Each valuation is based on a financial model. Our course had a closer look at the Net Present Value (NPV). It is calculated on the basis of specific cash flows in each financial year and the Weighted Average cost of Capital (WACC). Therefore, the value of an asset depends on the revenue it can generate as well as the company’s / project’s financing structure and its corresponding costs. As the equity and debt costs are not solely determined by the project’s characteristics but also by the project owner’s creditworthiness and equity costs the NPV of one project can differ across companies.
Because financial gearing is a main driver of a project’s NPV we discussed the cost structures of equity and debt of the available project financing structures. The following financing structures were compared in the lecture: Project Finance, Corporate Finance and Revolving Construction Facility. We outlined the differences for the categories cost, time, flexibility, feasibility and refinancing risk between the three financing structures. It was clearly worked out that not only the factor cost counts for deciding on a financing structure. Flexibility, time, refinancing risk and feasibility are other important factors that have to be considered for the financing design. For the factor cost, however, we focused mainly on the difference between upfront cost and carrying capital cost for both equity and debt. We discussed a scenario where one has to choose between a financial structure with lower issuance cost and higher carrying cost and a second financing option offering higher issuance cost and lower carrying cost. Assuming the two financing vehicles gave the same NPV, it was recommended to strategically approach the decision. As the issuance cost has to be paid immediately, it would be a better decision for a CEO to postpone this payment by bearing higher carrying costs, as he should ensure to shift as much costs as possible in the future to be able to benefit from lower costs in his own tenure.
In the case study “Pennsylvania Turnpike” we could observe a similar strategy. The government decided to choose the option, which offered the largest upfront payment for the government. Also in politics it seems to be popular to be able to dispose of money better today than tomorrow.
MS15D002 M R Aravindan
ReplyDeleteValuing Projects
This module consisted of a case on High speed Rail development in Texas and a Bid2Win simulation game. Having already written a separate blog on Bid2Win, I will confine myself to Texas High speed Rail case. Although, this case was not discussed in class, the learnings from the case in my opinion are as follows:
This was a long gestation project with two years preliminary phase, 3 years of development phase and five years of construction phase before operations could start. Hence, if we followed a traditional project finance model with large debt taken for the construction period, the interest payable would yield tax shields which cannot be utilized because cashflows from operating income would start much later. Hence, they devised a concept of small amount of founder’s equity to fund preliminary expenses, private equity to fund development expenses and construction equity in the form of convertible bonds for the massive construction cost funding. This ensured that tax benefits were retained and resulted in higher value for the project.
CE11B074, Harishchandra Meena
ReplyDeleteThe Pennsylvania case study dealt with leasing of public highway to private company which posed several issues like
1. Private companies would focus on profit-making rather than on public welfare.
2. Getting the future toll revenues upfront may cause the one time payment “to be spent quickly and unwisely”.
3. Leasing to a private company also may lead to an increase in toll rates which might be unacceptable to public.
The biggest challenge in valuing this project was to make financial projections for a period of 99 years. Only renegotiation will be able to help in future,if the leasing does not workout. Another challenge was whether the toll revenues could be capitalised to generate money for other investments.
Also we discussed two types of coverage ratios -Income coverage ratio and debt coverage ratio. Lesser the coverage more will be the up front capital. Since private financing brings equity, the coverage is kept low and hence more upfront capital is obtained.
Valuation of the projects actually includes evaluating the monetary benefits as well as the non monetary benefits. First the sole conception of the idea of starting an infrastructure project includes the non-monetary benefits it could cause to the society. But for bidding purposes, we evaluate the project using the monetary values or cost benefit analysis. The results from evaluation can help us taking decisions whether or not to bid for the project. NPV and IRR are the most common economic indicators. The main concern in evaluation is the correctness of the future cash flow predictions. There can be fixed incomes like the power purchase agreement or there are variable inflows like the toll collection. The time period of consideration for project evaluation is the another major concern. If we consider the Pennsylvania Turnpike case study , cash flow projections are done for 99 years. That is too long for a project to be evaluated unless there are concerned clauses which allow for restructuring/renegotiation at a later stage.
ReplyDeleteValuation of the projects actually includes evaluating the monetary benefits as well as the non monetary benefits. First the sole conception of the idea of starting an infrastructure project includes the non-monetary benefits it could cause to the society. But for bidding purposes, we evaluate the project using the monetary values or cost benefit analysis. The results from evaluation can help us taking decisions whether or not to bid for the project. NPV and IRR are the most common economic indicators. The main concern in evaluation is the correctness of the future cash flow predictions. There can be fixed incomes like the power purchase agreement or there are variable inflows like the toll collection. The time period of consideration for project evaluation is the another major concern. If we consider the Pennsylvania Turnpike case study , cash flow projections are done for 99 years. That is too long for a project to be evaluated unless there are concerned clauses which allow for restructuring/renegotiation at a later stage.
ReplyDeleteCE11B070 B. Pavan Kumar
ReplyDeleteThe third module was the valuing and bidding of the projects. The valuation is generally done by the financial projections of the project and demand prediction. The NPV and IRR of the projects will be calculated to evaluate the projects. Also most of these projections are based on demand prediction which are highly uncertain. Therefore, it is important to mitigate the demand risk. Then Bid2Win was played, where lot of techniques related to bidding were learnt. The leasing of pesylvania turnpike case study discussed on weather public assets can be leased to private companies. In this case as well, the major issue is the demand prediction for extremely large period of 99 years. The importance of renegotiations was also emphasized. Also, this case has shown that leasing will help to raise large upfront cost which can be used to improve other infrastructure.
CE11B071
ReplyDeleteCase study discussed in this module was Pennsylvania turnpike which discusses on leasing of infrastructure projects, here we see the inefficiency of the government to maintain rods due to lack of funds. The leasing of Pennsylvania turnpike was considered by going through two other leasing contracts namely Indiana Toll road and Chicago Skyway. We see that in leasing the government gets high upfront amount , coverage ratio for private players is lower as we think they are more careful and lenders are ready to risk. Here we see that the leasing of infrastructure projects has high upfront amount and the term for lease runs into decades. This could be a profitable sector when the roads have good amount of ridership. leasing roads is a good option but term of lease should be considerable as in case of Indiana and Chicago where the lease period was about 99 years may not be desirable for public assets. Other controversial issue was the toll price increase which when follow the Indiana or Chicago structure show an increase of more than two percent, this was also not desirable. Leasing strategy needs to be carefully studied and properly structured for optimal and fair implementation.
CE11B045, Pooja Battagani
ReplyDeletePennsylvania Case Study describes the apprehensions of Government in leasing a public highway to a private company. Three options were available : (i) a long term lease to private toll road company, (ii) a bond issue by a public toll road company, (iii) Turnpike Commission’s proposal. The first two options could generate more funds. The drawback of the third option was that the Turnpike Commission had considered only the State’s highway needs and did not account for the needs of Urban transport. Private lease was chosen based on analysis by Morgan Stanley. This would help them to invest the upfront money obtained in some reserve to get returns. The main problem was the fear of misusing these returns and the errors in forecasting the toll revenues for a long period of 99 years.
Valuing a project is a highly uncertain and risky business for investing in any project. Other than estimating the cost of the project it is also important to decide upon a reasonable cost of investment to the investor. This is a function of the risks in the project and is usually compared with the opportunity cost. The mode of funding the investment is also important as a more analytical approach for this require creating a Capital Asset Pricing Model, where the required return rate or cost of capital for investor is obtained based on level of equity and loans, with corresponding return rates. This method was used to choose the best options for bidding as the CAPM model gave the cost of raising capital based on level of debt and loan. The credit rating of the company is another influential factor in determining the borrowing capacity of the company in case of corporate finance. Thus the financial model plays a key role in determining cost of capital for a project. The opportunity to save on taxes by increasing the debt ratio demonstrated the possibility of arbitrage in IPP and this will also influence the net project evaluation.
ReplyDeleteAnother factor complicating the valuation is the long period of investment usually associated with infrastructural projects. Though many of these uncertainties can be eliminated by contractual terms and risk sharing, with projects like Pennsylvania Turn Pike with a term of 99 years, it is impossible to predict not just the magnitude but also the kind of aspects that can influence the project, especially with rapidly changing technologies. So for such projects it is important to incorporate flexibility and options into the basic structure to ensure that modifications can be made to the projects that are compatible with new features in the sector.
CE11B096 Y V Sandeep
ReplyDeleteIn my point of view, financial modelling is essential for evaluating a project. As discussed in the Cogeneration model, financial modelling includes estimating the total cost of the project, projecting the cash flows for pre-decided number of years (which is a crucial term), coverage ratios and finding out the tentative NPV/IRR and returns to debt and equity investors. Then, whether the project is viable or not has to be decided. ‘Leasing the Pennsylvania Turnpike’ was discussed in this module. As my friends mentioned, considering 99 years of life span while evaluating the project is not advisable. There are two options in front of the Pennsylvania government to choose between leasing the road for maintenance to private companies or government per se managing the roads raising funds through public resources. Leasing the turnpike would mean loss of public control, mortgaging the future, toll increases, daily user toll payment, potential gas taxes etc. But the positive side of leasing is high upfront payment to the government which helps it to focus on other beneficiary projects for the public as quoted by the bureaucrats. There can be necessary clauses in the contract to accommodate the public issues for smoother run of the deal
Zubin Nayak MS14S018
ReplyDeleteIn this module, we learnt how to value projects. We started with Bid2win in which we ourselves valued projects and bid for them. Thus we were putting a monetary value to each project and saying that we will pay a maximum amount of X rupees to get this project. NPV and IRR are used to find the monetary value of projects. We also discussed opportunity costs, weighted average cost of capital (WACC), debt shields, capital assets pricing (CAPM) model which help in valuation. We also discussed ratios such as Interest Coverage Ratio (ICR) and Debt Service Coverage Ratio (DSCR) which are used by debt issuers during project evaluation, which is also a way to ascertain the value of their debt issued to the specific company.
We also see how in the Pennslyvania turnpike case, different bidders value the same asset (the highway) differently and the difference can be huge. Thus there can be no final word on valuation of projects. Investors will have to value a project keeping in mind their resources and constraints in mind (such as oppurtunity costs) and a project that could be a positive NPV project for somebody else can turn out to be a loss for the company.
Thus project valuation is as much science as art and managers have to find ways to add value to projects.