In the case study, we’re told that we can raise 10-year debt for this business. However, we have an agreement in place to sell electricity for a much longer period than that. We, therefore, have a lot of unused debt capacity.
We can use this available debt capacity by refinancing the debt a few years into operation. With some track record behind us, we could possibly get a more extended debt repayment period, potentially on better terms. All of that would allow us to unlock more value.
In reality, we would likely get longer than 10-year debt for this business, and I go into much more detail about this in my Project Finance training courses. These are relatively simplistic assumptions to demonstrate concepts and modelling techniques rather than “realistic real-world” scenarios.
This is the kind of modelling we’d do before engaging with potential lenders. Previously we had firm “assumptions” to put into the model. Now we’re doing exploratory analysis to understand better which elements of the refinancing create the most value.
My hypothesis going into this assignment is that there are several components to a refinancing package, each of which could unlock value:
- Lower cost of debt. A lower debt margin would reduce the cost of debt and increase shareholder returns.
- Extending the debt repayment. If we refinanced at the end of the second year of operations, even if we could still only get a 10-year repayment period, we would be effectively pushing out the total debt repayment period to 12 years, again increasing shareholder returns.
- Lower debt sizing ratios. If we refinance the debt at, say, a 1.25 DSCR, we could increase the amount of debt at the time of the refinancing, creating a gain for shareholders.
In our modelling, we will look at each of those scenarios to better understand the impact of each.
To begin with, let’s hold the repayment term at ten years and the interest margin and debt sizing DSCR the same as the senior debt. That way, we can test each element to understand the impact on IRR. Let’s assume that we repay the debt using a sculpted repayment profile.
This assignment is worth trying on your own before you review the solution. You already have all the “reference” calculations in the model. Now it’s just a question of copying the right ones into the right place!
You’ll need to consider what changes you need to make to the senior debt calculations to facilitate early repayment. After that, you can replicate the senior debt interest & repayment calculations, calculate the ratios for the refinancing debt, and then consider which other areas of the model will be affected by this new debt tranche. (Hint: always think about the tax impact)
The solution for this bonus chapter is available in the file pack you'll receive when you purchase the handbook. See file 4.56 FMH refi BEG 01a.
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