23TH SEPTEMBER 2018

FINANCIAL APPRAISAL OF WATER TREATMENT

ASSIGNMENT 1

SUBMITTED BY:

YU JIANG – S3555588

ANKUR VERMA – S3692087

This report provides an appraisal and analysis of the current and prospective situation of ABC Pty Ltd

about building the new water treatment facilities. This facility provides clean water to the local

community; these facilities will be used as the business solution. The special purpose vehicle (SPV) is

going to be formed by ABC Pty Ltd to be incorporated in Australia will involve building this facility.

The approach of this analysis will include trend and debt, current interest. Other calculations included in

this project IRR, calculation of the equity IRR, calculation of the DSCR, and calculation of expected

return on equity using CAPM, calculation of the WACC. All calculations can be found in the appendix.

The purpose of this report is to evaluate and analyse the calculations that are related to this project to

determine the financial feasibility of the project and find out if this new water treatment project is viable

for the board of ABC Pty Ltd. This report finds logical ways to describe why the calculations in the

spreadsheet specifically IRR and NPV could be chosen to identify whether the project is successful or

not for ABC Pty Ltd.

The report finds this project is viable due to the cash flow, NPV and IRR. The best case is when the

discounted rate is 11%, IRR is 16% and Net present value is $40,321,016, the project is viable in this

case. The worst case is when the discounted rate is 11% and IRR is 9% and the project is not viable is

this case. The conclusion for this report was this project is viable. Although the cash flow shows the

whole project will cost a lot at the initially, it will be beneficial for ABC Pty Ltd the coming years. The

recommendations for ABC Pty Ltd include are as follows: Lower the cost of miscellaneous, lower the

management fee by reduce the number of staff, find another finance company to lower the rate of interest

to reduce cost as much as possible, so ABC Pty Ltd could start earning money from this project earlier.

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 TABLE OF CONTENTS

EXECUTIVE SUMMARY .....................................................................................................1

INTRODUCTION....................................................................................................................3

APPROACH ........................................................................................................................ 4

FINDINGS/RESULTS AND

DISSCUSSION.................................................................................................................7

CONCLUSION…………………………………………………………………………… 10

RECOMMENDATIONS…………………………………………………………… 11

• Lower the cost Of miscellaneous

• Lower the management fee by reduce the number of staff

• Negotiate a better interest rate and finance deal

APPENDIX…………………………………………………………………………12

REFERENCE LIST…………………………………………………………………17

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 INTRODUCTION

ABC Pty Ltd is about to create a special purpose vehicle (SPV) for being incorporated in Australia.

The project that is being considered is a new water treatment facility, as a solution to provide clean

water to the local community. The project will commence with a project financing strategy. The

project will be developed using a BOT arrangement and the state government will acquire the water

treatment facility at the end of 20 years from Water Solution, which is going to build and transfer the

facilities.

The purpose of this report is to evaluate and analyze the calculations that are related to this project to

determine the financial feasibility of the project and find out if this new water treatment project is

viable for the board of ABC Pty Ltd. =

Due respectively to the importance of short-term profitability of the project, IRR and DIRR were

selected as the most important economic criteria from the economic perspective (Shabnam Sanaei,

Virginie Chambost & Paul R Stuart, 2014). NPV, IRR is the key point to help to identify whether this

project is viable or not for ABC Pty Ltd and they have to be calculated correctly for proving the

project’s accuracy.

This report will draw on the calculation results and the theory of the financial viability for a company

to show to the board of ABC Pty Ltd whether this project is viable or not. This is identified by IRR,

NPV and cash flows. Although the project is good for the community and should return profit within

20 years, the company still needs to realize they will spend a lot of money before the project can

benefit them.

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 APPROACH
1. NET CASH FLOW

• Management and operational cost of the project is calculated by the adding management fees,

maintenance work, insurance cost, and miscellaneous cost for each year. The given data

indicates an increase of 10% per annum in management fees, maintenance works. Insurance

cost increases by 5% per annum as shown in the given information and the miscellaneous cost

is fixed.

• By adding the revenue generates by selling water to Call water, AP water and Nu water,

overall revenue is obtained. Multiplying the volume of the water with per day price per cubic

liters and multiplying whole by 365 to get per annum cost.

• The input cost per day is calculated by multiplying the volume of water with the price per

cubic liter and annual cost can be calculated by multiplying by 365.

• By the addition of maintenance and operational cost, revenue cost and the input cost we get

net cash flow of the given data.

2. NET PRESENT VALUE (NPV)

• Firstly, we can assume the discount rate.

• For the calculation of NPV, the discount factor is needed, which is calculated by

1/(1+r) t,

FOR NPV,

NPV= (Ct/(1+r)t)- lo

Where,

R= Discount rate

Io = initial cost

Ct= cash flow with period t.

3. PROJECT INTERNAL RATE OF RETURN (IRR)

• The value of IRR is estimated by using trial and error method.

IRR= ∑ (CT/(1+IRR)t)-I0=0

4. CASE SCENARIO

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 • To evaluate and check the practicality of the project, two case scenario is computed.

I. Worst case scenario

In this case, the NPV and IRR can be calculated by the same method but

initial cost, maintenance, and operational cost and input cost have an

escalation of 10%, and revenue is declined by 10%.

II. Best case scenario

Initial cost, maintenance cost, and revenue cost are declined by 5%, and

revenue has an escalation of 5% and the same procedure followed to calculate

NPV and IRR.

5. LOAN AMORTIZATION-

• As per the given data, 75% of debt and the remaining 25% is equity at an interest rate

of 12%. The debt amount is calculated by 75% of CAPEX.

• Annual repayment is calculated by

Z=(LXR)/(1-(1+r)-t)

Where,

L= Debt amount

R= loan interest

T= period

• Loan amortization schedule is prepared by dissection of the annual payment into

interest and remaining principal amount.

• Interest = loan interest * principle at the start.

• Remaining principle = annual repayment – interest

6. EQUITY IRR

• In the given data, 75% is debt so the remaining 25% in equity. The equity amount

calculated by 25% of CAPEX.

• In equity IRR, the gross cash flow is calculated by addition of initial equity, revenue

cost, maintenance, and operational cost and input cost. Similarly, net cash flow can

be calculated by adding gross cash flow and loan repayment.

• Afterward, discounted net cash flow is obtained by multiplying net cash flow with a

discount factor of each year.

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 • Net present value and IRR can be calculated with the same procedure as calculated in

section 2 and three respectively.

EQUITY IRR

=∑(Ct/(1+q)t)-E0 = 0

7. DEBT SERVICE COVER RATIO (DSCR)

• DSCR shows the resources generated in the year which allows covering the debt

from the lenders.

DSCR can be calculated by

= OCFt/(Kt + It)

8. INTEREST RATE COVER RATIO (IRCR)

• IRCR shows the safety margin of the project in interest payment terms.

IRCR can be calculated by

= OCFt/It

9. COST OF EQUITY USING CAPM

It is the return that holders require for their investments in a project.

• Cost of equity, E(re)

= Rf + β(Rm - Rf)

10. Weighted Average cost of capital (WACC)

It is the weighted average cost of all debt and equity of the package.

• WACC can be calculated by

= ∑wiri

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 RESULTS/FINDINGS
To develop a successful BOT project, the project should be politically, socially, legally, environmentally,

economically, and financially viable (Shen, Lee, and Zhang 1996). Project viability may only be

determined following a detailed and accurate feasibility study. Since the feasibility study of a large-scale

infrastructure project includes a large number of qualitative (subjective in nature) and quantitative

decision factors, the study is usually expensive, needs extensive efforts, and a relatively long time to be

properly completed.

Kodukula and Paoudesu (2006) claimed that discounted cash flow (DCF) analysis is a well-established

method that has been successfully used in evaluating projects for several years. Therefore, the financial

viability of BOT projects has been evaluated based on the net present value (NPV), internal rate of return

(IRR), and also according to Zhang (2005) ,debt service coverage ratio.

• NET PRESENT VALUE (NPV)

The success in achieving the company’s goal is to judge the efficiency of financial management. The

goal of the maximization of shareholder wealth states that the head of the company and management of

the company should try their best to maximize the net present or current value of the expected future

cash flows to the shareholders of the company. In corporate project analysis, Ross, Westerfield, Jaffe, &

Jordan (2009) announced that management typically use for evaluating the level of confidence, it can

enjoy in its estimate of Net Present Value (NPV) for a project under consideration. Of course, the greater

the uncertainty related to any NPV estimate, the lower is the level of confidence in that estimate. Two

methods commonly used in assessing this uncertainly are sensitivity and scenario analyses.

• INTERNAL RATE OF RETURN (IRR) AND PROJECT CASH FLOW

Different from Brealey and Myers, Dennis and Smith (2011) develop, and demonstrate the application

of, an innovative measure of sensitivity of Internal Rate of Return (IRR) as an indicator of project

uncertainty from scenario analysis.

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Using the given data and approaches results has been calculated –

COST (FOR 20 YEARS) TOTAL

1. MAINTAINENCE AND OPERATRIONAL COST $61,371,143

2. INPUT COST $188,307,584

3. REVENUE $615,540,181

4. NET CASH FLOW $280,861,455

• Cumulative cash flow with a pay period of 9 years can be shown in the graph below-

CUMALATIVE CASH FLOW

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• The net present value of the project $22142991, which is helpful in perceiving the

worth of the project.

• The IRR comes out to be 14% from the value we have calculated. Higher value of IRR

means the project is quite enviable to undertake.

• Case scenario-

A. Worst case scenario

NPV Value comes out to be negative -$14306888, value of IRR is 9%.

B. Best case scenario

NPV value comes out to be $40321016, value of IRR is 16%.

• The value of Annual repayment (z) $8534772 with a debt of 75% and equity of 25%.

The value Z helps us to make amortization schedule.

• Equity NPV is calculated to be $1615225 and has an equity IRR of 16% which shows

the project has an highly desirable to be taken under.

• The DSCR value helps us in better understanding of the project. We can see that in

the first three year the values 0.75,0.83,0.93 , which is less than one and after that

DCSR value obtained more than one for all years. This results in the debt will be

covered in the same year expect initial 3 years in the operation.

• The IRCR value in initial two years are 0.84 and 0.95. After that , the value is greater

than 1 for all years. This shows the interest amount will be paid in the same year.

• The value of cost of equity using CAPM is 13.85% and WACC calculated comes out

to be 12.46. The company is earning 2 cents in every dollar investment.

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 CONCLUSION

This new water treatment facility project is viable for ABC Pty Ltd in many different aspects. It is

beneficial for both the government and the public. The key features for the success of this project are

IRR and NPV of the calculation. There are many different features that are necessary for the financial

viability of ABC Pty Ltd. Although this project might have high costs at the beginning, ABC Pty Ltd

would still be benefit by taking on this project in the next few years as the cash flow shows in the

appendix. This project will improve the quality of water and bring back a cleaner community also

assisting with the company’s public image. This project is viable for ABC Pty Ltd and the board of

ABC Pty Ltd should try to negotiate a better interest rate so the project doesn’t have as large initial

start up costs and try not cost ABC Pty Ltd much in the long run and they can lower the risk and

financial exposure.

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 RECOMMENDATIONS

·Lower the cost of miscellaneous

Miscellaneous cost is fixed at $100,000 per annum currently, for example, identify and

categorize miscellaneous and cut cost from sub category and avoid wasting funds. Such as

power consumption, the lighting can always be turned on and off at scheduled time; the

facilities have to be managed not to open and close too many times rather operate on longer

hours rather than opening and losing. The miscellaneous category could include so many

parts and ABC Pty Ltd should be able to save money from this part by making a list to show

how many parts and costing this will allow them to try and cut the unnecessary parts.

· Lower the management fee by lowering the numbers of staff

The management fee is $350,000 per annum with the increase of 10% per annum. ABC Pty

Ltd can try to use less management team and less management members to save the money

from this part. For example, for transferring water from one place to another place, they can

only use one manager to tell the staff what to do and ask the labor workers to follow the

instruction instead of hiring a lot of management to monitor them all the time. They need to find

experienced reliable workers so the money and time can be saved.

· Negotiate a better interest rate and finance deal

Water Solution will borrow 75% of the capital expenditure from a consortium of banks at a

cost of 12%. 12% is really high 
according to the amount of the money. If it’s possible, ABC

Pty Ltd could borrow money from different bank with lower interest or borrow small amount

from many different banks. This will lower the cost for the interest rate.

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 APPENDIX

• START

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• NPV&IRR

13
• WORST CASE

• BEST CASE

14
• LOAN AMORTIZATION

15
• EQUITY IRR

• DSCR & IRCR

16
• CAPM-WACC

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