Project Finance Case Study: Analysis of IRR, Equity IRR, CAPM, WACC, and Debt-Service Coverage Ratio

This report analyzes the IRR, Equity IRR, CAPM, WACC, and Debt-Service Coverage Ratio of Project B of APWater limited for ABC Pty Ltd. It suggests the best financing option for the project and provides recommendations for cost improvisation.

Project Finance Case
Study

EXECUTIVE SUMMARY
The below report summarises that the Project B of APWater limited should be selected
by the ABC Pty Ltd. The report is formed for the special purpose vehicle (SPV) which has been
unified in Australia. The project can be selected by using the capital expenditure, cash inflows
and cash outflows.

Contents
EXECUTIVE SUMMARY.............................................................................................................2
INTRODUCTION...........................................................................................................................4
METHODOLOGY..........................................................................................................................4
DISCUSSION..................................................................................................................................4
Calculate the project IRR.............................................................................................................4
Calculate the Equity IRR.............................................................................................................5
Calculate Debt – service coverage ratio......................................................................................5
Calculate Expected return using the CAPM model.....................................................................6
Calculate WACC.........................................................................................................................7
Should the project go ahead using a project finance scheme? Give reasons...............................7
CONCLUSION................................................................................................................................7
RECOMMENDATIONS.................................................................................................................8
REFERENCES................................................................................................................................9

INTRODUCTION
Project Finance is the term that is widely used for projecting the cash flow of the company.
In this, the capital expenditure, cash inflows, and outflow are determined on the basis of the
return the company is getting. It helps in building the financial structure of the company by
enforcing the agreements. It is a very capital intensive project which helps in generating the
project as a source of funds for repaying the dues (Harvey, 2020). In the accompanying report,
ABC Pty Ltd is an organisation whose purpose is to form a special purpose vehicle (SPV) that
has to be incorporated in Australia. For this, the company has signed three different agreements
for supplying the treated water. The following report is prepared for finding out the IRR of the
project, Equity IRR, CAPM, WACC, debt – service coverage ratio. Moreover, at the end of the
report, the project which the company should select for financing is to be determined on the basis
of the certain computation that will be performed.
METHODOLOGY
The methodology that has been used for completing the purpose of the project is quantitative
secondary research. The data is collected through the secondary data collection method. The
economic parameters that are used in the report is internal rate of return, capital asset pricing
model. The weighted average cost of capital, and debt – service coverage ratios is computed.
DISCUSSION
Calculate the project IRR.
A matrix used to estimate the probability of potential investments in financial analysis is
termed an Internal rate of return (IRR). IRR is a discounted rate and in a discounted cash analysis
it makes the NPV of the multitude of incomes equivalent to nothing. It is the yearly pace of
development that a financial investor hopes to produce. Positioning different speculations or
projects can be utilized. When an investment option is being compared with others the one with
the highest IRR would be considered as the best option probably. It understands and compares
potential rates of annual return and is ideal for analyzing capital budgeting projects. The
calculation of IRR cannot be done easily it can only be done by using the trial and error method.
It focuses on the identification of the rate of discount. Despite having several methods to
identify, IRR is the ideal method for analyzing the potential return of the project.

It is used in comparing the profitability of newly established projects with that of ongoing
projects. It is not adequate for long-term projects with discounted rates (Fernandez, 2019).
Project IRR provides return data for a specific business. As such, this IRR does not take into
account funding design, so the calculated IRR accepts 100% value support. Furthermore, this
IRR does not show any utilization impact because it does not take into account obligations.
Therefore, we can also refer to this IRR as "unlevered IRR" or "unlevered IRR". Although the
supporting design was not considered when calculating the project IRR, the project IRR will
continue as before, although independently of construction. Because it's designed for business,
not capital design or a mix of it.
IRR = Lower Discount Rate + (NPVL / (NPVL – NPVH) * (HDR – LDR)
So, according to this, the IRR of all the three agreements are as follows:
Call Water
19.6597967
5
AP Water
18.7968504
5
Nu Water
20.3411177
2
Calculate the Equity IRR.
Equity IRR considers only the cash flow which is related to equity shareholders. It
involves both the debt and equity value but gives a major focus on only equity cash flows and
returns. In this, basically, the return is computed which the shareholders tend to invest in the
particulars project. For computing, the value of equity internal rate of return, the free cash flow,
and the value of equity is utilized. The free cash flow is divided by the equity value (Carluccio,
Mazet-Sonilhac and Mésonnier, 2021).
The equity IRR considers the additional debt capital when financing the proposed projects
so that the leverage which affects the project occurs and increases the return.
Calculate Debt – service coverage ratio.
Debt service coverage ratio is a ratio used by any organization, government, or individual to
know its competency to pay back its creditors basically it tells about the financial condition /cash
flow to pay back current debt obligations.

In the case of government DSCR is used to define the amount of debt obligation on external
borrowing while in the case of households it is used for the amount required to pay on loans
from banks and financial institutions.
Formula for calculating DSCR is:
NET OPERATING INCOME
TOTAL DEBT SERVICE
Where,
Net operating income = Total income-operating expenses
Total debt service = Current debt
A DSCR is used for checking the creditability of an organization when applying for a loan
debt service coverage ratio is checked. A DSCR of 1.25 is regarded as a strong situation while
anything below 1 is regarded as the weak situation and the organization is facing financial
credibility issues (Fernandez, 2020).
The debt service coverage ratio is according to the situation of the organization based on its
expenses, operating income, loans, and paying back the creditors.
DSCR is also used in real estate to determine if the return from the property will be able to
make the debt taken on the asset.
CallWAter = -13.887
APwater = 3.364
NuWater = -0.202
From the above, it can be said that the s
Calculate Expected return using the CAPM model.
The Capital Asset Pricing Model (CAPM) is a model that describes the link between
normal returns and the opportunity to put resources into securities. It shows that, in addition to
the gambling premium, the security's normal profit equals the no-investment return, which
depends on the security's beta (Jylha and Ungeheuer, 2021). The following is an outline of
CAPM formula and computation:
CAPM = Rf + β * (Rm – Rf)
= 3.5 + 0.9 * (15 – 3.5)
= 3.5 + 0.9 * 11.5

= 3.5 + 10.35
= 13.85 %
CAPM strategies are utilized to work out typical returns for assets. This relies upon the
chance of exact betting (otherwise called non-diversifiable betting), which monetary sponsors
ought to make up for as a betting premium. The betting premium is a more conspicuous pace of
return than the no-bet rate. Alongside viable monetary preparation, monetary allies need higher
betting charges while facing more dangerous challenges.
Calculate WACC.
WACC is equally important in breaking down the expected advantages of taking on a
business or acquiring another business. For example, if the organization believes that the merger
will generate a higher return than capital expenditure, then this may be a decent decision for the
organization. If their government expects returns to be lower than their own financial backers
expect, they will need to put their cash flow to more likely uses (French, 2019).
In general, a lower WACC indicates a robust business that can attract financial backers at a
lower cost. Conversely, in most cases, higher WACCs correspond to organizations that are seen
as more at risk and must reward financial backers with higher yields.
WACC = (We * Re) + [Wd * Rd]
= (0.25 * 13.85) + [0.75 *12]
= 3.4625 + 9
= 12.4625 %
Should the project go ahead using a project finance scheme? Give reasons.
From all the computations ascertained in the above report, it can be said that the agreement
of APWater is better for the company. Ass it is ascertaining more present value after 20 years in
the project. Also, the IRR of the project is 18.79%.
CONCLUSION
From, the above report, it can be summarised that financing any project is very crucial and it
takes logical thinking for processing all the funds and return and to determine the exact
calculations. The above report says that IRR is generated through the present value of cash

inflows and outflows considering the discounted rate of return. Further, The WACC and CAPM
model is calculated with the help of the cost of capital and the value of market return given.
RECOMMENDATIONS
The suggestions that can be given to ABC Water Pty Limited is that the costs of expenditure
should be improvised. It will be beneficial for the company and for the project as well.

REFERENCES
Books and Journals
Carluccio, J., Mazet-Sonilhac, C. and Mésonnier, J.S., 2021. Private firms, corporate investment
and the WACC: evidence from France. The European Journal of Finance, pp.1-25.
Chung, J.H., 2020, November. Debt/Equity Tradeoff Model for Revenue Based DBFOM PPP
Transportation Infrastructure: Case Study of I-95 (VA) Express Lanes. In Construction
Research Congress 2020: Project Management and Controls, Materials, and
Contracts (pp. 1177-1185). Reston, VA: American Society of Civil Engineers.
Fernandez, P., 2019. wacc and capm according to utilities regulators: Confusions, errors and
inconsistencies. Errors and Inconsistencies (February 19, 2019).
Fernandez, P., 2020. The Most Common Error in Valuations using WACC. Available at SSRN
3512739.
French, N., 2019. Property investment: gearing and the equity rate of return. Journal of Property
Investment & Finance.
Harvey, L.D., 2020. Clarifications of and improvements to the equations used to calculate the
levelized cost of electricity (LCOE), and comments on the weighted average cost of
capital (WACC). Energy, 207, p.118340.
Jylha, P. and Ungeheuer, M., 2021. Growth Expectations out of WACC. Available at SSRN
3618612.
Magni, C.A. and Cuthbert, J., 2018. Some problems of the IRR in measuring PEI performance
and how to solve it with the pure-investment AIRR. Journal of Performance
Measurement, 22(2), pp.39-50.