Project finance models generally share the following features:
- Scrutiny on construction, modeled monthly
- A focus on optimizing debt
- Long term operations, modeled quarterly or semi-annually
- Not a going concern, therefore cash focused
- Hierarchy – the Cashflow Statement becomes the Cashflow Waterfall
- Reserve accounts
Scrutiny on construction, modeled monthly
A solar farm might be constructed in 6 months, but a hydro dam might take 5 years (the Three Gorges project in China took 13 years). Because project finance loans have a single purpose – to finance the construction & operation of the project, debt drawdowns occur in lock-step with construction of the project.Outflows of cash are large during this period to purchase components and construct the asset. Thus the construction period is and entire phase in the model, generally modeled monthly (changing to quarterly or semi-annually during operations).
A focus on optimizing debt
With ring-fenced cash-flows and risks heavily mitigated by contracts, project finance allows a high amount of debt, transforming a modest unlevered return into an attractive return to equity. The maximum amount of project finance debt funding possible is usually limited to gearing constraints (e.g. debt is a maximum of 70% of total project costs), and limited to a proportion of cash-flow (CFADS) to ensure debt can be repaid.
As the interest amount payable on debt feeds into both calculations, circularities arise. The model structure needs to deal with this (which also necessitates the need for a debt sizing macro).
Long term operations, modeled quarterly or semi-annually
Projects can have a long life. The operational life could be 5 years (e.g. a mine) to 120 years (e.g. Swansea Bay Tidal Project), with typical lives of 25-35 years, depending on asset class. These are not âmodel out 5 years and then whack a terminal value on the endâ type models. The full life of the project needs to be modeled because there are differences in the cash profile at each point.
- Has the project repaid debt? If so, more cash to equity holders for the duration of the project
- Does the project need a reserve for decommissioning? If so, it may need to start building up the cash years ahead of project end.
Cashflows from the project are based around payments to stakeholders. And equity holders distribution periods are guided by debt distributions. Thus modelers typically choose to match the model periodicity to that of the debt repayment, whether it is quarterly, or semi-annually.