Written Report Case Study Analysis
Bidding for a large infrastructure project - Understanding project evaluation techniques, building a project evaluation model and determining the capital structure.
You are the senior portfolio manager of a major infrastructure fund, Baulder-Hornibrook Group that is invited to participate in a Public Private Partnership transaction that involves building a major toll road to replace the ageing Westgate Freeway linking the west and east of Melbourne city. Currently, traffic from the Westgate Freeway flows into a busy arterial road causing significant congestion. The new toll road will provide an important link in the overall traffic network, taking the pressure of the ageing infrastructure.
Your infrastructure fund has formed a bid consortium that includes a global road building and tunnelling company, road Maintenance and Services Company, a major Australian bank and a consulting firm. The State Government will provide a concession agreement that allows the winning bidder (i.e. concessionaire) to collect tolls at a regulated rate over the concession period of 30 years from the date of completion of the project. In recognition of the current tight credit conditions, the State Government has agreed to provide the concessionaire with a "credit wrap" (or financial guarantee) of up a total of 30% of the project value for debt facilities to include project finance, working capital facilities, and infrastructure bonds as outlined below:
1. For an amount not exceeding 10% of the project value - 10 years
2. For an amount not exceeding 10% of the project value - 5 years
3. For an amount not exceeding 10% of the project value - 3 years. The concession agreement required the bid group to contribute equity of a minimum of 30%.
For the purposes of this exercise you may assume the following:
1. Once the government guarantee period is over, the loan pricing reverts to the standard interest rate for BBB rated debt
2. All loans are repaid by way of a single bullet repayment in Year 27
It is estimated that the construction will take around two years and for the purposes of our analysis, we assume that all cash - flows during a period occur at the end of the period. The State Government is rated AAA by global rating agency Standard & Poors and your banking partner estimates that the residual project debt is rated BBB (flat) based on S&P rating methodology.
For the purposes of this analysis you will assume a "flat term structure" of interest rates or interest rate swap curve of 10%. Your banking partner has estimated the following credit spreads over the inter-bank swap rate:
1. AAA rated debt = 0.5 %
2. BBB rated debt = 2.5%
They have offered to provide an interest rate hedge to lock in the interest rates at this level if deemed appropriate by the bid team. They would also be willing to offer credit facilities to help the project lock in any foreign exchange or commodity price risks. Key parameters of the project as determined by your consultants are outlined below:
Project Costs: Year 0 - Bid Costs capitalised - A$ 55 million Year 1 - A$ 1, 000 million
Year 2 - A$ 1,500 million
Hence the total project value is estimated at A$2.55 billion Interest costs on the bank loan during the construction process are capitalised and included in the total amount of A$2.55 billion calculated above.
Interest costs for the period of the concession agreement will be based on your capital structure and type of debt employed. You are also provided with the following cost structures:
1. Annual Expenses other than Bank Interest costs - Estimated at A$ 10,000,000 per annum
2. Bank Interest Costs - As calculated by you based on debt structure employed
3. Annual Toll Receipts as outlined below:
• Year 1 of the concession period - A$ 100 million
• Year 2 of the concession period - A$ 115 million
• Year 3 of the concession period - A$ 130 million
• Year 4 of the concession period - A$ 135 million
• Year 5 onwards to year 25 - A$ 150 million
The bid group has agreed on an internal hurdle rate of 15% for the purposes of evaluation of this project. In bidding for the project, you are required to provide the State Government with an estimate of either how much you expect the State Government to pay you (upfront) as a subsidy or
how much you are willing to pay the State Government in consideration for taking up the concession agreement.
Note to students:
This is a group assignment and the key focus is on ensuring you understand the financial concepts - You are required to discuss key issues among yourselves and develop a detailed excel model for calculating the project NPV. Please incorporate your excel calculation tables into the word document as a "pdf" or "picture" and submit a SINGLE pdf document on Moodle. The assignment cover sheet may be incorporated into the single "pdf" file.
Secondly, aspects of the assignment will be discussed during tutorial sessions to assist you in the learning process.
Thirdly, you can also avail the time allocated for student consultations to get a better understanding of project related issues.
Q1. Based on the information provided in the case study, determine the optimal capital structure, the various financing options available and the debt maturity profile of the project. Discuss the merits and limitations of each form of financing proposed.
Q2. Discuss briefly some of the financial market risks associated with the project. Consider: Interest Rates, Currency and Commodity Risks if any. How can these be hedged using financial derivatives and what derivative instruments do you propose to use.
Q3. Calculate all cash-flows of the project and draw a detailed cash-flow diagram for the project over 25 years. Develop a detailed NPV model in excel showing Cash Inflows, Cash Outflows and NPV of the project. What is the amount that you either expect to receive or are willing to pay the State Government to win this concession? Provide your arguments.