Question:

Calculation of the Project IRR,Calculation of the Equity IRR,Calculation of the DSCR Calculation of Expected Return on Equity using CAPM,Calculation of the WACC,Recommendation to the Board on whether the project go ahead using project finance scheme? Give your reasons and justifications.

Answer:

Executive Summary

ABC Pty Limited has recently launched a Special Purpose Vehicle (SPV) that is to be incorporated in Australia. The Special Purpose Vehicle is a BOT arrangement where Water Solution will develop and build, operate and transfer the facilities back to the government at the end of 20 years. The evaluation of the project help the management to decide whether it is feasible to form the Special Purpose Vehicle with the capital structure and cost of debt given.

The report gives the detail analysis of the cost and benefits from the arrangement of providing treated water. In order to evaluate the project, we use two methods the Project IRR and the Equity IRR and the relationship between the two. We even used the NPV Method at the end to compare the result.

Therefore, with all the assumptions available we can decide whether to proceed with the water project or not. The investment rules suggest that higher the project’s internal rate or return the more profitable the investment will be. Further more, Project IRR is compared with equity IRR, to know the effect of debt on the profitabilitiy of the project. Based on all the above analysis, we further provide a series of conclusion and the recommendation on the basis of the conclusion so provided.

Assumptions

All the calculations made are based on the assumptions below:

1. The amount expressed in Australian Dollars
2.  The interest free rate (based on Government bond) is 3.5%
3.  ABC Pty Ltd’s beta is estimated to be 1.1 (based on the ratio of the standard deviation of the firm’s return to the standard deviation of the stock market return)
4.  Expected market return of the water industry where ABC Pty Ltd main business lies, is 18%
5.  WaterSolution will borrow 80% of the capital expenditure from a consortium of banks at a cost of 11%. The repayment will start immediately in Year 1 and should be repaid fully in year 20. The remaining 20% is raised through equity.
6. Construction completed in year 0 and operation begin immediately in year 1
7.  There is no tax involved.

Introduction:

ABC Pty Limited, is considering a project of purchasing untreated water and changing it to treated water and sell the same to its clients. The initial investment is $ 75,000,000. On the basis of the assumptions and the sales, purchase and maintenance amount given. ABC Pty limited wants to know whether the Special Purpose Vehicle so formed is economically feasible or not Various methodologies are used time to time, to determine the feasibility of the project but the most import ant is the IRR and the Net Present Value Concept. Most of the times, both provide the same result. In our report, we have used the IRR concept. The report focuses more on the IRR without the influence of the capital structure of the firm and one Equity IRR which shows the effect of leveraging on the project’s financing decision. The relationship between the Project IRR and Equity IRR . Furthermore, we have calculated the debt service coverage ratio to see whether the cash flows are enough to service the debt raised.