Basics of Financial and Economic Analysis

8/12/2019 Basics of Financial and Economic Analysis

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BIDNUPP Building, Pakistan Atomic Energy Commission,Islamabad

Farzana Naqvi

Applied Systems Analysis DivisionPakistan Atomic Energy Commission

16 April 2013

Basics of Financial and Economic Analysis

First Training Course under 4Q HRD Programme of PAEC

15-19 April 2013


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Applied Systems Analysis Division

Need for Economic Analysis (EA)

To indentify Project Portfolio that ensuresBest Allocation of Resources

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The problem is that:

The resources are limited but our desires areunlimited

We need to find out the most efficient use of theseresources

Current developments have resulted inoverexploitation of these resources

We need to minimize the Burden of Development

Why do We Need Such Analyses?

Sustainable Development

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Example of Resources for an Energy System

Natural resources (coal, oil,

gas, hydro, wind, solar..)

Depletable

Renewable

Human resources(Engineering/Procurement/Construction, Management..)

Man-made

Capital stock (Machinery &Equipments..)

Environment (Air, Water,Land,.)

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Applied Systems Analysis Division6

Social and Economic Perspective

Identification of

Technology Choices

Assessment of

Natural Resources

Assessment ofElectricity andWater needs

Analysis ofElectricity andWater supply

Financial andother resourcerequirements

EnvironmentalBurdens andmitigation

Exogenous AssumptionsRegional trade of

electricity and fuels

Sustainable supply strategy

Social and Economic Perspective

Identification of

Technology Choices

Assessment of

Natural Resources

Assessment of

Needs

Analysis of

Supply

Options

Financial and

other resource

requirements

Environmental

Burdens and

mitigation

Exogenous AssumptionsRegional trade of

Components of Sustainable Development Plan


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Economic Analysis for Project Portfolio

Comparison of Levelized

Generation Cost

Optimization model for

Least-cost Expansion

Plan (MESSAGE, WASP)

OR

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Electricity Installed Capacity in 2011-12

8

MW Shares

Hydel 6,716 28.4%

Gas/Oil 15,985 67.5%

Coal 150 0.6%

Nuclear 787 3.3%

Wind 50 0.2%

Total 23,688 100.0%

Source: i) State of Industry Report 2012, National Electric Power Regulatory Authority.

ii) Power System Statistics 2011-12, 37thEdition, National Transmission and

Despatch Company.


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Electricity Generation Mix in Pakistan

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Nuclear4.9%

Hydro29.1%

Gas29.4%

Oil36.2%

Others

0.4%

2011-12


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Where

I = Investment cost

M = Operation and Maintenance cost

F= Fuel cost

E = Electricity generated

r = Discount rate

t = Time from year 1 to n

n = Economic life of supply project

Levelized Electricity Generation Cost

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MESSAGE

OUTPUT

MESSAGE

INPUT

Energy system

structure (including

vintage of plant and

equipment)

Base year energy

flows and prices

Energy demand

projections (MAED)

Technology and

resource options &their techno-economic

performance

Technical and

policy constraints

0

100

200

300

400

500

600

2000 2002 2004 2006 2008 2010 2012 2014 2016 2018 2020 2022 2024 2026

TWh

biomass

geoth

hydro

nuclear

gas

diesel

fuel oil

coal

Primary and final energy mix

Emissions and waste

Resource use

Build Schedule for infrastructure

Import dependence

Investment requirements

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Financial analysis

To assess Profitability of a business entity e.g., a

company, corporation

Comparison with its previous years

Comparison with other entities

To select an investment project in:

Public sector

Private sector

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Need for FA of an Investment Project

To establish profitabilityof an IdentifiedInvestment project under certain termsand conditions for financing it

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Financial Analysis for Appraisal of an Investment Project

Analysis to assess if

Income from the project over its operational life,will be sufficient to:

cover all costs and

bring back the initial investment with some

return

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Financial Analysis for Project Appraisal

The financial analysis is carried out

considering:

Conditions in the financial sector

Market conditions

Fiscal policy of the government

Risk factors


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Three major components of Financial Analysis (FA)

Funds required to buildFinancial plan

Cash-flow during

operation


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Some main questions to start FA for Project Appraisal

What will be the capital cost to build the project?

Who will provide investment funds during theconstruction period?

What will be the terms and conditions for taking

those funds and for repayment of those funds ?

What is the expected cash-inflow from the project

during its operational life?

Will the cash-inflow be sufficient to cover:

i) the operating cost andii) repayment to the project financers?

What will be the rate of return to the project

owner?

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Capital and other expenditure during construction

Overnight Cost

Escalation duringconstruction

Interest DuringConstruction (IDC)

Other financing costs

Contingencies

Initial working capital


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Major components of financial sector of a country

Financialsector

Stock

market Bonds

market

Banking

system

Commercial

banksInsurance

companies

Investment

funds

Other financial

institutions

Capital market

Central

banking

Export-import

Banks

World financial sector


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Two basic components of financing

Equity; funds provided by the project owner

Debt; all types of loans/bonds taken by the projectowner

Equity

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Major terms and conditions for financing

Interest rate/return onequity

Repayment period

Repayment method

Grace period

Capitalization ofinterest duringconstruction

Fees such asmanagement fee

Insurance coverage


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Market conditions

Market structure

Regulated Open competition

Monopoly

Cartel

Number of clients

Quantity to be sold to different clients

Price structure

Time of receivable ...


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Cash-flow during operation

Operation cost

Debt service

Taxes, fees...

...

Sales to different

clients

Other sources of

income

Cash outflow

Cash inflow


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Operation costs and Debt Service

Operation Cost

Fuel costs O&M Costs

Fixed

Variable

Others

Debt Service

Repayment of Loan

Interest payment


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Methodology

A set of accounting statements on

Cash inflow/outflow statement Income and expenditure (Profit and

loss statement)

Balance Sheet

A set of indicators derived from thesestatements

Project risk and sensitivity analysis


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NPV= (BnCn) / (1 + r)n

n26

Year (n)Cost ( C )

Million Rs.

Benefit (B)

Million Rs

NetBenefitsMillion Rs

Discount

Factor (r)

NetBenefits

Discountedat 10%

-1 40 - -40 1.100 -44.00

0 110 40 -70 1.000 -70.00

1 10 40 30 0.909 27.27

2 10 40 30 0.826 24.79

3 10 40 30 0.751 22.54

4 - 70 70 0.683 47.81

Net Present Value (Million Rs): 8.41

Cost and Benefit Statement


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Time Value of Money

Future Value (FV) of a Present Value (PV)

0 1 2 3 4 5

100 ?

FV1 100 1 0 10 110 .

? 100

0 1 2 3 4 5

Present Value (PV) of a Future Value (FV)

PV0= 100 / (1+0.01) = 90.91

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Time Value of Money

Future Value (FV) of a Present Value (PV)

1

1

N

N

N

N

FV PV i

FVPV

i

Present Value (PV) of a Future Value (FV)

What is i ?

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Economic conditions

Inflation:A rise in prices caused

by decline in the purchasing power

of a currency

Discount rate/factor:

Opportunity Cost of Capital

Nominal Discount rate:

i) Compensation of Inflation

ii) Real return

iii) Compensation for risk

Nominal discount rate = [(1+ r)(1+f) ] -1

Where iis real discount rate

fis inflation rate


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Set of indicators

NPV: Net Present Value ofBenefits

IRR: Discount rate atwhich NPV of project iszero

Payback Period: Time(Years) required torecover the investmentmade on the project


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Criteria for Selection of Project

Private Sector: Project withmaximum NPV

Public Sector:

IRR > prevailing discount

rate On given terms and

conditions of financing, NPVis positive.


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ThankYou

Do You Need FA or EA or none?


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Major criteria of financial viability

Private sector projects

Rate of return on equity

Net present value of theequity

... ...

Expected /

negotiated /

market/regulated

prices

Public sector projects

Net present value of theinvestment

Payback

Break even

Regulated

prices(Cost plus)


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B / C = B / ( 1+ r )n/ C / ( 1+ r )n]n n

Value of discounted benefits = 40 + 36.36 + 33.06 + 30.05 + 47.81

= 187.28

Value of discounted costs = 44 + 110 + 9.09 + 8.26 + 7.51= 178.86

B / C ratio = 187.28 / 178.86


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1998 1999

Income/Expenditure Statement

Income of electricity sales 125.0 128.8

Other income 2.0 2.7

Cost of generating (other than fuel) 18.0 18.5

Fuel costs 50.0 52.0

Other expenses 8.0 7.0

Depreciation 25.0 25.0

Earning before interest and tax (EBIT) 26.0 29.0

Net interest 10.0 9.0

Tax paid 6.4 8.0

Net income 9.6 11.7

Preferred stock dividend (if any) - -

Earning of the common stock 9.6 12.0

Summary Pro forma financial statement for apower generating company


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Assets 1998 1999

Cash and short-term securities

5.5 5.0

Receivables 20.0 21.0

Inventories 15.0 16.0

Other currentassets 2.5 2.5

Total currentassets

43.0 44.5

Land, plant andequipment

554.0 544.0

Other long-term assets

20.0 40.0

Total assets 617.0 628.5

Equity/Liabilities 1998 1999

Debt due 10.0 10.0

Payable 100.0 95.0

Other currentliabilities

5.0 5.0

Total currentliabilities

115.0 110.0

Long-term debt 100.0 90.0

Other long-termliabilities

102.0 118.9

Preferred stock(if any)

- -

Shareholdersequity

300.0 309.6

Total liabilities 617.0 628.5

Balance Sheet


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Contents

Need for Financial Analysis (FA) and Economic

Analysis (EA) of Investment Projects Difference between FA and EA

Terminologies:

Inflation Escalation

Discount rate

Net Present Value (NPV)

Rate of Return (RoR) Cost-Benefit Ratio

Pay-back period

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C i f NPP C t ith th C t f


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Comparison of NPP Cost with the Cost ofAlternative Electricity Generation Options

8.85

19.15

11.68

9.96

12.04

14.70

0

5

10

15

20

Nuclear Oil (Furnace) Coal (Thar) Coal(Imported)

Gas(Imported)

Wind

Ce

nts/kWh

$10

0/barrel

UpfrontTarifffor

1000MWp

lant

UpfrontTarifffor

1000MWp

lant

$13/MBTU

UpfrontTariffbyNE

PRA

Notes: 1. Interest/discount rate of 10% used for NPP and Oil-based plants.

2. Upfront tariff offered by NEPRA for wind and coal based plants.

Hydro: 4.81 to 9.62 Cents/kWh

Basics of Financial and Economic Analysis

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