[APN Day2-4] Working with numbers Samil PwC · §Financial model review services for the acquisition of Senoko Power Limited, First Gas, Terra Renewal LLC and many other PPP projects

October 5, 2010

Financial ModellingWorking with numbers: meanings beyond the excel sheets

Strictly Private and Confidential

Yanggwi Michael HwangSenior Manager at Samil PricewaterhouseCoopers

§ Expat to PricewaterhouseCoopers Sydney office, Australia (2006 ~ 2008)

§ Assurance staff at Ernst & Young Palo Alto office, US (2001 ~ 2002)

§ Oman IPP Project, Turkey OOO Expressway, Cambodia OOOO Express Highway, and Mongolia OOO Project.

§ Valuation of Commercial Port of Vladivostok in Russia

§ Buy-side financial due diligences on diverse Australia companies such as Alinta (Australia’s leading power supplier), City Pacific Limited (Property finance institute), Pacific National (Rail freight), Perfection Fresh Australia Pty Limited, Choice Harvest Pty Ltd, Arnott’s Snackfoods (Food), Powertel (Telecommunication), Dymocks (Retail) and others

§ Financial model review services for the acquisition of Senoko Power Limited, First Gas, Terra Renewal LLC and many other PPP projects

§ Financial due diligences and feasibility studies on diverse PPP companies in Korea such as Daewoo Logistics, Namkyung Power, Seoul-Chuncheon Expressway, Daegu Dongbu 4th Beltway and others

§ Advisory services on the preparation of PPP project plans such as Ulsan Garbage Incinerating Facilities, Busan New Port 2-3 Phase and 2nd Yong-Dong Expressway

§ Assist KDI’s study on Financial arrangements and practices in Australian and UK Public Private Investment

Financial Modelling • Working with numbers: meanings beyond the excel sheets

Name: Yanggwi Michael Hwang

Title: Senior Manager

Line of Service: Deal Business

Qualification: USCPA

Tel: +82 2 3781 9085

E-mail: [email protected]

§ Expat to PricewaterhouseCoopers Sydney office, Australia (2006 ~ 2008)

§ Assurance staff at Ernst & Young Palo Alto office, US (2001 ~ 2002)

§ Oman IPP Project, Turkey OOO Expressway, Cambodia OOOO Express Highway, and Mongolia OOO Project.

§ Valuation of Commercial Port of Vladivostok in Russia

§ Buy-side financial due diligences on diverse Australia companies such as Alinta (Australia’s leading power supplier), City Pacific Limited (Property finance institute), Pacific National (Rail freight), Perfection Fresh Australia Pty Limited, Choice Harvest Pty Ltd, Arnott’s Snackfoods (Food), Powertel (Telecommunication), Dymocks (Retail) and others

§ Financial model review services for the acquisition of Senoko Power Limited, First Gas, Terra Renewal LLC and many other PPP projects

§ Financial due diligences and feasibility studies on diverse PPP companies in Korea such as Daewoo Logistics, Namkyung Power, Seoul-Chuncheon Expressway, Daegu Dongbu 4th Beltway and others

§ Advisory services on the preparation of PPP project plans such as Ulsan Garbage Incinerating Facilities, Busan New Port 2-3 Phase and 2nd Yong-Dong Expressway

§ Assist KDI’s study on Financial arrangements and practices in Australian and UK Public Private Investment

Table of ContentsPage

1 Financial Model Development 12 Understanding Numbers 13

Appendix1 Spreadsheet Design - Best Practice Top Tips 24

Section 1Financial Model Development

FM Development Flowchart

§Understand the purpose of FM

§Understand Project

§Understand cash flow pattern

§Understand key raw data (e.g. project cost, revenue, expense, and loan terms and conditions)

§Specify outputs (e.g. IRR, ROE, ROI, DSCR)

§ Identify sheets to be developed based on the Project

§Monthly/Quarterly/Yearly FM

§Develop FM in Excel format based on the Scope, Specify, and Design applied

§Change variables and check if the changes reflect results as expected

e.g. project cost, revenue, expense, interest rate, and others

Scope Specify Design Build Test

Section 1 - Financial Model Development

Financial Modelling • Working with numbers: meanings beyond the excel sheets 2

§Understand the purpose of FM

§Understand Project

§Understand cash flow pattern

§Understand key raw data (e.g. project cost, revenue, expense, and loan terms and conditions)

§Specify outputs (e.g. IRR, ROE, ROI, DSCR)

§ Identify sheets to be developed based on the Project

§Monthly/Quarterly/Yearly FM

§Develop FM in Excel format based on the Scope, Specify, and Design applied

§Change variables and check if the changes reflect results as expected

e.g. project cost, revenue, expense, interest rate, and others

1. Scope: User of Financial Model (“FM”)

Sponsor

Initial idea for the model. Ensures supporting resources are available. May not have further involvement.

Owner

Driving force behind model. Heavily involved in objectives setting stage of the project.

Project manager

Communication between all separate elements of project team and client maintained by this person. The problem solver.

Developer

Translates the initial ambitions in to reality.

User

At least one person - usually more. Heavily involved throughout whole process of model development.

Reviewer

Involved in checking that the model matches initial specification, and contains no significant errors.



Sponsor

Initial idea for the model. Ensures supporting resources are available. May not have further involvement.

Owner

Driving force behind model. Heavily involved in objectives setting stage of the project.

Project manager

Communication between all separate elements of project team and client maintained by this person. The problem solver.

Developer

Translates the initial ambitions in to reality.

User

At least one person - usually more. Heavily involved throughout whole process of model development.

Reviewer

Involved in checking that the model matches initial specification, and contains no significant errors.

1. Scope: Purpose of FM

• Different users have different emphasis in FM

– Developer: Total cash earning, IRR, ROE

– Lender: Debt service coverage ratio

– Construction Company: Return on construction cost

– Government: Value for Money

• FM shall explain Operating, Investing and Financing CF results.

– CF from operating activity: Forecast Project’s operating revenue and expense. Shall be easily adjustable for operating assumption changes (e.g. traffic demand, tariff, operating expense and others)

– CF from investing activity: Forecast Project’s investment cost. Shall be easily adjustable for investing assumption changes (e.g. construction cost)

– CF from financing activity: Forecast Project’s required funding amount, debt and equity amount, and drawdown and repayment schedules. Shall be easily adjustable for financing assumption changes (e.g. interest rate, debt vs. equity)



• Different users have different emphasis in FM

– Developer: Total cash earning, IRR, ROE

– Lender: Debt service coverage ratio

– Construction Company: Return on construction cost

– Government: Value for Money

• FM shall explain Operating, Investing and Financing CF results.

– CF from operating activity: Forecast Project’s operating revenue and expense. Shall be easily adjustable for operating assumption changes (e.g. traffic demand, tariff, operating expense and others)

– CF from investing activity: Forecast Project’s investment cost. Shall be easily adjustable for investing assumption changes (e.g. construction cost)

– CF from financing activity: Forecast Project’s required funding amount, debt and equity amount, and drawdown and repayment schedules. Shall be easily adjustable for financing assumption changes (e.g. interest rate, debt vs. equity)

1. Scope: Understand Cash Flow of Project

• Understanding cash flow during construction and operation period



2. Specify: FM Logic

Model logic

• The logic of the specification should be built from the outputs through calculations to the inputs



Inputs Calculations Outputs

Model specification

2. Specify: Raw Data and Key Results

Raw data

• Total project costs (e.g. survey, design, construction, compensation, incidental, operation equipment, taxes)

• S-Curve

• Equity: amount and input schedule

• Debt: amount, drawdown and payment schedule, interest rate, financing cost, and covenants

• Government subsidy: amount and input schedule

• Operating revenue and expense forecast

• Others

Key results

• NPV

• IRR

• ROE

• Total project cost

• Equity and debt amount

• DSCR

• ST debt (how much, when, how long)

• Operating revenue and expense

• FM check

• Others



Raw data

• Total project costs (e.g. survey, design, construction, compensation, incidental, operation equipment, taxes)

• S-Curve

• Equity: amount and input schedule

• Debt: amount, drawdown and payment schedule, interest rate, financing cost, and covenants

• Government subsidy: amount and input schedule

• Operating revenue and expense forecast

• Others

Key results

• NPV

• IRR

• ROE

• Total project cost

• Equity and debt amount

• DSCR

• ST debt (how much, when, how long)

• Operating revenue and expense

• FM check

• Others

3. Design

• Design excel spread sheets to develop

• Model unit period : Monthly, quarterly, yearly ?

– Develop FM based on CF analysis purpose

• Lender: If repayments are required on a quarterly basis, quarterly FM shall be developed to calculate DSCR, DSRA, repayment schedule, interest rate and others

• Developer: Annual CF is enough to calculate IRR

• Use different colours

– Numbers in Blue: Input data

– Numbers in Red: Key results

– Numbers in Black: Calculated data



• Design excel spread sheets to develop

• Model unit period : Monthly, quarterly, yearly ?

– Develop FM based on CF analysis purpose

• Lender: If repayments are required on a quarterly basis, quarterly FM shall be developed to calculate DSCR, DSRA, repayment schedule, interest rate and others

• Developer: Annual CF is enough to calculate IRR

• Use different colours

– Numbers in Blue: Input data

– Numbers in Red: Key results

– Numbers in Black: Calculated data

4. Build: FM Sheets FlowchartSection 1 - Financial Model Development


4. TestSection 1 - Financial Model Development


4. Test: Construction Period

Total investment cost input schedule

-

20,000

40,000

2011-03 2011-06 2011-09 2011-12 2012-03 2012-06 2012-09 2012-12

KR

W M

Construction expense Cost for operation of equipmentIncidental expense Operating reserve Inflation Construction interest

Fudning input_cummulative

-

20,000

40,000

60,000

80,000

100,000

2011-03 2011-06 2011-09 2011-12 2012-03 2012-06 2012-09 2012-12

KR

W M

Equity Senior debt



Total investment cost input schedule

-

20,000

40,000

2011-03 2011-06 2011-09 2011-12 2012-03 2012-06 2012-09 2012-12

KR

W M


Total investment cost input_Cumulative

-

20,000

40,000

60,000

80,000

100,000

2011-03 2011-06 2011-09 2011-12 2012-03 2012-06 2012-09 2012-12

KR

W M


Fudning input_cummulative

-

20,000

40,000

60,000

80,000

100,000

2011-03 2011-06 2011-09 2011-12 2012-03 2012-06 2012-09 2012-12

KR

W M

Equity Senior debt

Breakdown of funding

67%

33%

Equity Senior debt

4. Test: Operation Period

Operating revenue analysis

-

10,000

20,000

30,000

40,000

50,000

2013

2014

2015

2016

2017

2018

2019

2020

2021

2022

2023

2024

2025

2026

2027

KR

W M

Toll revenue Other revenue

Operating expense and CAPEX analysis

-

5,000

10,000

15,000

20,000

2013

2014

2015

2016

2017

2018

2019

2020

2021

2022

2023

2024

2025

2026

2027

KR

W M

0%

50%

100%

150%

% o

f ope

ratin

g re

venu

e

Labor expense General expenseCAPEX O & M CostInsurance expense Advertising expenseRent expense Other expenseRevenue to expense ratio



Operating revenue analysis

-

10,000

20,000

30,000

40,000

50,000

2013

2014

2015

2016

2017

2018

2019

2020

2021

2022

2023

2024

2025

2026

2027

KR

W M

Toll revenue Other revenue

Operating expense and CAPEX analysis

-

5,000

10,000

15,000

20,000

2013

2014

2015

2016

2017

2018

2019

2020

2021

2022

2023

2024

2025

2026

2027

KR

W M

0%

50%

100%

150%

% o

f ope

ratin

g re

venu

e

Labor expense General expenseCAPEX O & M CostInsurance expense Advertising expenseRent expense Other expenseRevenue to expense ratio

Cash balance at year-end by case

-

20,000

40,000

60,000

80,000

2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027

KR

W M

Case 1 Case 2 Case 3

Section 2Understanding Numbers

1. Net Present Value (NPV)?

• NPV is “the difference between the present value of cash inflows and the present value of cash outflows.

– To analyze the profitability of an investment or project.

– Applied discount rate is an expected rate of return from project

n = the time of the cash flow r = Discount rate

CashIni = Cash inflow at time i CashOuti = Cash outflow at time i

• NPV > 0: Positive net cash flow with r à Project investment accepted

• NPV < 0: Positive net cash flow with r à Project investment declined

åå== +

-+

=n

iii

n

iii

rCashOut

rCashInNPV

11 )1()1(

Section 2 - Understanding Numbers


• NPV is “the difference between the present value of cash inflows and the present value of cash outflows.

– To analyze the profitability of an investment or project.

– Applied discount rate is an expected rate of return from project

n = the time of the cash flow r = Discount rate

CashIni = Cash inflow at time i CashOuti = Cash outflow at time i

• NPV > 0: Positive net cash flow with r à Project investment accepted

• NPV < 0: Positive net cash flow with r à Project investment declined

åå== +

-+

=n

iii

n

iii

rCashOut

rCashInNPV

11 )1()1(

2. Internal Rate of Return (IRR)?

• IRR is “the discount rate that makes the net present value of all cash flows (both positive and negative) from a particular investment equal to zero.

• NPV vs. IRR

– NPV: Expressed in monetary value

– IRR: Expressed in percentile

• IRR > Expected discount rate (r): Project return rate is greater than expected one à Project investment accepted

• IRR < Expected discount rate (r): Project return rate is less than expected oneà Project investment declined



• IRR is “the discount rate that makes the net present value of all cash flows (both positive and negative) from a particular investment equal to zero.

• NPV vs. IRR

– NPV: Expressed in monetary value

– IRR: Expressed in percentile

• IRR > Expected discount rate (r): Project return rate is greater than expected one à Project investment accepted

• IRR < Expected discount rate (r): Project return rate is less than expected oneà Project investment declined

3. NPV and IRR Example (1)

• IRR : 6.0%

• NPV (6.0%) = 0 : When r = IRR, NPV= 0.

• NPV (4.0%) = 69,806 : When r < IRR, NPV > 0

• NPV (7.0%) = (31,656) : When r > IRR, NPV < 0



• IRR : 6.0%

• NPV (6.0%) = 0 : When r = IRR, NPV= 0.

• NPV (4.0%) = 69,806 : When r < IRR, NPV > 0

• NPV (7.0%) = (31,656) : When r > IRR, NPV < 0

3. NPV and IRR Example (2)Section 2 - Understanding Numbers


3. NPV and IRR Example (3)

• Real cash flow

• Nominal cash flow (Annual CPI growth of 5%)

• Fisher effect

– (1 + Real IRR) × (1 + CPI growth rate) = (1 + Nominal IRR)



• Real cash flow

• Nominal cash flow (Annual CPI growth of 5%)

• Fisher effect

– (1 + Real IRR) × (1 + CPI growth rate) = (1 + Nominal IRR)

4. Feasibility Analysis Flowchart (Example)Raw data

-Project cost and input schedule, revenue, operating expense, tax and other data are prepared

Calculate total project cost during construction period

Debt vs. Equity amount Repayment schedule, interest rate, covenant and others

Period assumption applied



No problem with Debt repayment ?

Plan for debt repayment

Sensitivity and Scenario Analysis

Cash shortage during project period ?

YES

NO

NO

YES

5. Interpretation of Key Results

• Analysis on Project

– NPV > 0 ?

– IRR > Expected rate of return ?

– Any cash shortage ?

• Lender’s Analysis

– DSCR (Debt Service Coverage Ratio)

– Short term debt

– DSRA (Debt Service Reserve Account)

– MMRA (major Maintenance Reserve Account)

– Covenant for sub-debt and dividend payments



• Analysis on Project

– NPV > 0 ?

– IRR > Expected rate of return ?

– Any cash shortage ?

• Lender’s Analysis

– DSCR (Debt Service Coverage Ratio)

– Short term debt

– DSRA (Debt Service Reserve Account)

– MMRA (major Maintenance Reserve Account)

– Covenant for sub-debt and dividend payments

6. SOC Project Sensitivity Analysis (1)

ååå=+== +

++-

=+

N

iii

N

niiii

n

ii

i

rANR

rOCOR

rCC

010 )1()1()1(CCi : Total Private Project Cost

ORi : Operating revenue

OCi : Operating expense (tax excluded)

n : Construction completion year

N : Operation end period

ANRi : Annual net income from ancillary project

r : Project IRR

• BTO/BOT Project IRR and usage fee calculation



CCi : Total Private Project Cost

ORi : Operating revenue

OCi : Operating expense (tax excluded)

n : Construction completion year

N : Operation end period

ANRi : Annual net income from ancillary project

r : Project IRR

Total Project Cost

Operating Expense

Operating Revenue

Net income from ancillary project

Project IRR Government subsidy or Usage fee

• Key sensitivity factors affecting Project IRR/Usage fee/Government Subsidy

6. SOC Project Sensitivity Analysis(2)

• Increase in total project cost (survey, design, construction, compensation,incidental, operation equipment, taxes) à IRR ↑ à Government subsidy/Usage fee↓

• Decrease in operating cost (labour, general, maintenance) à IRR ↑ àGovernment subsidy/Usage fee ↓

• Decrease in CPEX (# of units, unit per price) à Total project cost ↓ àReplacement cost during operation period ↓ à IRR ↑ à Governmentsubsidy/Usage fee ↓

• Increase in revenue (traffic volume, tariff) à IRR ↑ à Government subsidy/Usagefee ↓

• Increase in concession period à IRR ↑ à Government subsidy/Usage fee ↓

è But, IRR might decrease when major replacement costs need to be incurred.



• Increase in total project cost (survey, design, construction, compensation,incidental, operation equipment, taxes) à IRR ↑ à Government subsidy/Usage fee↓

• Decrease in operating cost (labour, general, maintenance) à IRR ↑ àGovernment subsidy/Usage fee ↓

• Decrease in CPEX (# of units, unit per price) à Total project cost ↓ àReplacement cost during operation period ↓ à IRR ↑ à Governmentsubsidy/Usage fee ↓

• Increase in revenue (traffic volume, tariff) à IRR ↑ à Government subsidy/Usagefee ↓

• Increase in concession period à IRR ↑ à Government subsidy/Usage fee ↓

è But, IRR might decrease when major replacement costs need to be incurred.

6. SOC Project Sensitivity Analysis (3)

• Increase in CPI rate à Tax ↑ à After-tax IRR ↓ à Government subsidy/Usagefee ↑

à If CPI growth rate is forecasted to increase from 4% to 5%, tax on cash flow isaffected.

à The portion of amortization and interest expense from total tax base income isreduced and as such tax expense increases.

à After-tax project IRR is reduced and therefore government subsidy increases.

• Decrease in interest rate à Tax ↑ à After-tax IRR ↓ à Governmentsubsidy/Usage fee ↑

à If Annual debt interest rate decrease from 10% to 9%, tax on cash flow is affected.


à Government subsidy decrease while interest rate increase.

☞ Before-tax IRR is not changed substantially from the changes in CPI growth rate andinterest rate



• Increase in CPI rate à Tax ↑ à After-tax IRR ↓ à Government subsidy/Usagefee ↑

à If CPI growth rate is forecasted to increase from 4% to 5%, tax on cash flow isaffected.

à The portion of amortization and interest expense from total tax base income isreduced and as such tax expense increases.


• Decrease in interest rate à Tax ↑ à After-tax IRR ↓ à Governmentsubsidy/Usage fee ↑

à If Annual debt interest rate decrease from 10% to 9%, tax on cash flow is affected.


à Government subsidy decrease while interest rate increase.

☞ Before-tax IRR is not changed substantially from the changes in CPI growth rate andinterest rate

Appendix 1Spreadsheet Design - Best Practice Top Tips

Spreadsheet Design - Best Practice Top Tips (1)

1. Keep it simple! l e.g. simple formula; refer input on same sheet, break formulae into multiple rows.l less risk of confusing yourself and othersl easier to follow the audit traill no prizes for complicated formulae

2. Separate Inputs/Calculations/Outputs using different sheets & coloursl so you can easily identify the assumptionsl understand the flow of the model

3. Keep the flow natural, top to bottom, left to rightl e.g. display assumptions on calculation pages before referring to them in calculationsl makes the spreadsheet easier to read and understandl however, key outputs should be on left of the model

Appendix 1 - Spreadsheet Design - Best Practice Top Tips


1. Keep it simple! l e.g. simple formula; refer input on same sheet, break formulae into multiple rows.l less risk of confusing yourself and othersl easier to follow the audit traill no prizes for complicated formulae

2. Separate Inputs/Calculations/Outputs using different sheets & coloursl so you can easily identify the assumptionsl understand the flow of the model

3. Keep the flow natural, top to bottom, left to rightl e.g. display assumptions on calculation pages before referring to them in calculationsl makes the spreadsheet easier to read and understandl however, key outputs should be on left of the model


4. Input data once - use it many times and linkl reduces risk of not updating all occurrences of an input

l reduces the number of inputs

5. One formula per row or column, and write them to be “copyable”l prevents errors from copying over mid-row formulae changes

l logic is always in one place, and the same place, in each row

l makes reviewing/testing and future maintenance easier

6. Make column headings consistent, and use the same starting column for each time series (rule of F14)l allows for simpler formulas and avoids referencing errors

l multiple narrative columns (A-E) allows for clear labelling



4. Input data once - use it many times and linkl reduces risk of not updating all occurrences of an input

l reduces the number of inputs

5. One formula per row or column, and write them to be “copyable”l prevents errors from copying over mid-row formulae changes

l logic is always in one place, and the same place, in each row

l makes reviewing/testing and future maintenance easier

6. Make column headings consistent, and use the same starting column for each time series (rule of F14)l allows for simpler formulas and avoids referencing errors

l multiple narrative columns (A-E) allows for clear labelling


7. Use protection

l reduces the chance of accidental change

l not for prevention of malicious damage, so don’t use worksheet passwords

8. Range names

l makes formulae more readable, particularly when referring to another worksheet

l encourages good design and structure

l can enable a building block approach

l very useful if linking to another workbook

9. Make extensive use of error traps and cross checks, and summarise results on a single sheetl makes Excel work to help find mistakes

l quick view to see if errors have been introduced



7. Use protection

l reduces the chance of accidental change

l not for prevention of malicious damage, so don’t use worksheet passwords

8. Range names

l makes formulae more readable, particularly when referring to another worksheet

l encourages good design and structure

l can enable a building block approach

l very useful if linking to another workbook

9. Make extensive use of error traps and cross checks, and summarise results on a single sheetl makes Excel work to help find mistakes

l quick view to see if errors have been introduced


10. Use colour coding and formatting in a clear and consistent mannerl e.g. indicates cell types, worksheet categories and conditional formatting highlights exceptions

l provides visual clues to make meaning and intention clear

l reduces risk of inappropriate data being entered

l flags items of interest for investigation

11. Use repeating worksheets with identical structures or repeat calculation blocksl reduces the work involved in repetitive calculations

l enables “punch-through” consolidations

l facilitates testing



10. Use colour coding and formatting in a clear and consistent mannerl e.g. indicates cell types, worksheet categories and conditional formatting highlights exceptions

l provides visual clues to make meaning and intention clear

l reduces risk of inappropriate data being entered

l flags items of interest for investigation

11. Use repeating worksheets with identical structures or repeat calculation blocksl reduces the work involved in repetitive calculations

l enables “punch-through” consolidations

l facilitates testing


12. Use navigation tools such as hyperlinksl so you can move around easier and understand structurel include a single “Navigation” worksheet that all sheets link back to

13. Include documentation and instructions at the front of the model l enables other to understand and use the model

14. Identify and label real and nominal costsl avoids apples and pears errors

l avoids double inflation errors

15. Treat external links as inputs and do not include external links in formulael avoids confusing references and overlong and unreadable formula



12. Use navigation tools such as hyperlinksl so you can move around easier and understand structurel include a single “Navigation” worksheet that all sheets link back to

13. Include documentation and instructions at the front of the model l enables other to understand and use the model

14. Identify and label real and nominal costsl avoids apples and pears errors

l avoids double inflation errors

15. Treat external links as inputs and do not include external links in formulael avoids confusing references and overlong and unreadable formula

Documents

[APN Day2-4] Working with numbers Samil PwC · §Financial model review services for the acquisition of Senoko Power Limited, First Gas, Terra Renewal LLC and many other PPP projects