Management Engineering - Financing complex projects

Mock Exam Exercises

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Politecnico di Milano Master of Science in Management Engineering Financing Complex Projects Dr. Roberto Bianchini - Alberto Ghezzi Mock Exam Notes and Instructions • The Final Written Exam will be taken by students on campus, in a supervised classroom, digitally, on their PCs or laptops. It will be presented through a link ( tentatively , in Microsoft Forms, which you will have to access via your Polimi account). • Students will be graded on what you submit through the provided link by the end of the test, only. • In open exercises that require calculations, you are invited to write with normal keyboard symbols (i.e. no math editor will be available), as calculations will not required more complex editing. The two mock problems below include a proposed solution, written in a format that should provide an example to follow during the exams. • During the test, students will be allowed to use scrap paper, which, however, will not be graded . • Students are allowed to use a calculator (excludin g calculators that allow storing formulas or present value automated calculations). No notes or books are allowed during the test. • Please round numbers to the second decimal (for percentages, to the fourth ), where necessary. • “Ordinary students ” (refer to the Syllabus for their definition and requirements) are required to answer the “Open Questions ” and the “Multiple Choice Questions ” sections . The ir exam lasts 60 minutes. • “Eligible students ” (refer to the Syllabus for their definition and requ irements) are required to answer the “Open Questions ”, the “Multiple Choice Questions ” and the “Additional Questions” sections . Their exam lasts 70 minutes. Open Questions 1 What are the typical features of a project finance deal ? (3 points). Proposed solution The following features characterize a project finance deal: • The borrower is set up as an ad -hoc project company , legally independent from the sponsors. • Lenders have only limited recourse over sponsors (or in some cases none at all) after the project is complete. • Project risks are allocated as appropriate among all project participants. • The cash flow generated by the initiative has to be sufficient to cover operating costs, service the debt and pay relative interest. • Sponsors provide collateral to lenders of the SPV as security for the project’s receipts and assets. 2 Please identify and describe the additional project investment that a sponsor might have to finance in addition to the core investments (i.e. in addition to construction costs, land costs, owner’s costs and development costs) . (3 points). Proposed solution Additional, i ndirect investments are generated as consequences of the direct (i.e. the main) investments . The most notable indirect investments are: • Capitalized commitments fees and capitalized interests: if funds borrowed from banks are used, the interests to pay on the loans received must be considered. During this phase there is not enough money to pay the interests and so in the budget it is unders tood that the banks give up the payments of interests during the construction phase. They agree with the SPV to calculate the interests at the end of the construction phase. • VAT (Value Added Tax) on direct investments: if the contractor is entitled to rec eive an amount of 100 million dollars that is subjected to a certain value added tax, suppose, equal to 20% , the SPV will invoice an amount of 120 million dollars. The additional 20 million dollars can be compensated with the VAT reimbursements that can be later collected from the authorities or, alternativ ely, with the V at on sales only when these sales will come to fruition . Therefore , there is also the necessity to finance the VAT that accrues during the construction phase. 3 Consider a project, entering its operating period. The outstanding debt, equal to 90 €m, is supposed to be repaid in constant principal payments in the following three years. The interest rate is equal to 5% (assume interests are calculated on beginning -of-period outstanding debt). The expected cash flows available for debt service in the following three years are, respectively: 25, 35 and 45 €m. Determine the average debt service coverage ratio during the periods in which debt will be repaid (3 points). Proposed solution Principal payment = 90/3=30 Year 0 1 2 3 Debt, end of year 90 90 -30=60 60 -30 =30 30 -30= 0 Interests 90*0,05=4,5 60*0,05= 3 30*0,05= 1,5 Debt service 4,5+30=34,5 3+30= 33 1,5+30= 31,5 DSCR 25/34,1,0=0,72x 35/33= 1,06x 45/31,5= 1,43x ADSCR = (0,72+1,06+1,43)/3 = 1,07x 4 Consider a project with €m 50 total construction costs, before value added taxes (VAT rate = 20%). Construction is supposed to last 2 years; CAPEXs are made equally in each period. Financing is available with a Main Line, target ing a debt to total investments ratio equal to 0,5. The base loan interest rate is 6%, while the VAT can be entirely financ ed by a Facility, whose rate is equal to 4 %. Lending will be repaid starting operations, while interests accrue during constructions, on end -of-per iod values. Determine the total outstanding debt ( Main Line + VAT Facility ) at the end of constructions (3 points). Proposed solution Year 1 2 Main Line - Raised 50*0,5/2=12,5 12,5 VAT Facility - Raised 50*0,2/2=5 5 Main Line, ending balance 0*1,06+12,5=12,5 12,5*1,06+12,5=25,8 VAT Facility, ending balance 0*1,04+5=5 5*1,04+5=10,2 Total financial debt at the end of constructions = 25,8+10,2=36 Multiple Choice Questions (1 point each) 1 Which one of the following characteristics of a project makes them suitable for project finance? A A project is characterized by volatile and less predictable cash flows B A project involves long term assets with a long economic life C A project involves a high technological risk D A project typically operates in markets with low entry barriers 2 Which of the following is a motivation for using project financing (i.e. off -balance sheet lending) instead of "traditional" corporate finance (i.e. on-balance sheet lending)? A Maximizing returns by using a higher financial leverage B Co -insuring debt C Managing a portfolio of projects better D Diversifying the expected cash flows 3 What category of sponsors most typically also provides know -how to a project ? A Public sponsors B Industrial sponsors C Financial sponsors D Industrial and public sponsors 4 What lifecycle phase of a project does technology risk belong to? A Post -completion phase B Pre -completion phase C Both pre -completion and post -completion phases D None of the other answers is correct 5 What phase of the project is the fluctuation of macroeconomic variables a source of risk in? A Both phases B Pre -completion phase C Post -completion phase D None of the other answers is correct 6 Who is natural disaster risk best allocated to? A The contractor B The operator C The supplier D The insurer 7 Which of the following financial items are typical direct investments during the construction phase? A Operational and maintenance fees B Development costs C VAT on direct investments D Capitalized Commitment Fees 8 Which of the following financial items are generally not related to the operations phase? A Operational & maintenance fees B Insurance costs C Income taxes D Capital expenditures 9 Which of the following statements about VAT loans is correct? A They are funds used to finance the exposure of the VAT accrued during the operating phase of the project. B They are generally repaid from the VAT reimbursed by authorities during the operational phase. C The VAT facility is used to finance the VAT deficit accrued during the operational phase. D Interest and financial costs on the VAT facility are capitalized during the operational phase. 10 What is the rate creditors generally use to discount cash flows available for debt service to their present value, in order to compute the loan life cover ratio? A The interest rate on loans/bonds B The risk free rate C The financial sponsor's cost of equity D The interbank loan rate 11 A project is expected to generate cash flows before debt service equal to 45, 55 and 60 €m in years 1, 2 and 3, respectively. Compute the loan life cover ratio at year 0 for an outstanding loan of 150 €m that pays an annual interest rate of 10% and a target debt service cover ratio equal to 1,3x. Assume all valu es manifest at year end. Round the final result at the second decimal. The LLCR is closest to: A 0,88x B 1,07x C 1,14x D 1,30x 12 A __________________ is a contract between some or all of the shareholders of a company intended to regulate their relationship and certain related matters (governance, circulation of quotos/shares, etc) A Article of association B Company's by -law C Sales and purcha se agreement (SPA) D Shareholders' agreement 13 Consider ASTM's guest speech. According to their view of the highway concession management market: A The higher expected number of projects is in Latin America and in the USA B The sector is highly capital intensive and its expected cash flows are very uncertain C The region where traffic regulatory and country risk is lowest is the USA D All of the other answers are correct Additional Questions (2 point each) 1 Consider the paper "The Regulatory Asset Base Model and the Project Finance Model" by Makovšek and Veryard (2016). Which of the following statements is correct? A In infrastructures that might be operated by a large number of actors, the difference between a RAB and a PPP contractual framework is that the latter derives its efficiency through the competition with the regulator, while the former does so through the competition for the contract. B In infrastructures that might be operated by a large number of actors, the difference between a RAB and a PPP contractual framework is that the former derives its efficiency through the competition with the regulator, while the latter does so through the competition for the contract. C In infrastructures that present natural monopoly characteristics, the difference between a RAB and a PPP contractual framework is that the latter derives its efficiency through the competition with the regulator, while the former does so thro ugh the competi tion for the contract. D In infrastructures that present natural monopoly characteristics, the difference between a RAB and a PPP contractual framework is that the former derives its efficiency through the competition with the regulator, while the latter does so through the competition for the contract. 2 Young , Weiyant and Manav, in their paper "Pricing Climate -Related Risks of Energy Investments" (2021), suggest that incorporating climate risk in portfolio management: A should be made looking at each asset in the portfolio individually, in order to identify energy projects and to price risks based on their specific climate resilience. B should be made looking at the overall portfolio composition, analyzing the correlation of energy assets with other asset classes. C both statements are correct D no statement is correct 3 Consider the paper "The Regulatory Asset Base Model and the Project Finance Model" by Makovšek and Veryard (2016). Which of the following statements is correct? A In RAB models, regulators are unable to estimate with certainty the appropriate overall rate of return on capital that the network manager is allowed to make. Given the uncertainty, regulators tend to set higher values, as the social welfare cost of overestimation is lower. B In RAB models, regulators are unable to estimate with cert ainty the appropriate overall rate of return on capital that the network manager is allowed to make. Given the uncertainty, regulators tend to set lower values, as the social welfare cost of underestimation is lower. C In RAB models, regulators set precise and discretionary rates of return on capital values that the network manager is allowed to make. D In RAB models, regulators are unable to estimate with certainty the appropriate overall rate of return on capital that the network manager is allowed to make, therefore, models requiring this parameter are generally not applied 4 Consider the paper "Carbon risk and corporate capital structure" by Nguyen & Phan (2020). A conclusion of the authors' research is that: A Light emitters, contrary to heavy emitters, decrease financial leverage following the introduction of the Kyoto Protocol ratification and the decrease is more pronounced for financially constrained companies B Heavy emitters, contrary to light emitters, decrease financial leverage following the introduction of the Kyoto Protocol ratification and the decrease is less pronounced for financially constrained companies C Light emitters, contrary to heavy emitters, decrease financial leverage following the introduction of the Kyoto Protocol ratification and the decrease is less pronounced for financially constrained companies D Heavy emitters, contrary to light emitters, decrease financial leverage following the introduction of the Kyoto Protocol ratification and the d ecrease is more pronounced for financially constrained companies