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## Introduction

Greenfield (think of new build) project finance deals consist of both construction and operations period. In this blog tutorial we will focus on the construction phase of a greenfield project and find out how to calculate interest during construction, construction funding requirements and ultimately our required debt and equity drawdowns.

## Required funding during construction

You may be wondering what project costs may be incurred during a typical project finance construction phase. Here are a few of the most common costs:

- Construction costs – amounts which are usually paid from the Concessionaire (SPV) to the EPC contractor
- SPC costs during construction – administration costs, including management staff’s salary, advisory costs, ongoing insurances etc.
- Upfront bid costs – cost incurred prior to financial close and to be recovered at financial close – advisory costs, consultants, insurances
- Financing costs – arrangement fees, commitment fees, interest costs, equity yield (often in the form of sub-debt payments), Debt Service Reserve Funding

## But how do we fund these costs?

As the majority of project finance deals have no revenue during construction, construction funding is required.

In the most basic form funding for the above costs comes in the form of both debt and equity. The above costs are aggregated together usually on a monthly basis, with drawdowns on financing facilities assumed to occur at the end of each month period.

Assuming that the drawdowns occur at the end of the month eliminates any circular reference related to interest during construction. There are however other gremlins (otherwise known as circularities) that we need to look out for such as commitment fees and arrangement fees. We can break these circularities quite easily, but we will save that topic for another day.

## Putting it all together- an example

Download the youtube video and spreadsheet to follow along.

Ok, so we now know where our funding requirement is coming from and how it is funded.

Now let’s take a look at an example. Say we had the following assumptions:

Note: Let’s also assumes there are no commitment fees or arrangement fees (i.e. we’ll leave out the gremlins).

Firstly let’s work out our funding requirements. To do this we need to add the construction costs, SPV costs, upfront bid costs and the financing costs together.

You’ll note that we’ve missed out the financing costs for the moment.

Now let’s setup a corkscrew account for the debt as shown below. Remember in a corkscrew account the opening balance in the current period is equal to the closing balance for the previous period. Because we have a gearing of 80%, the debt drawdown will simply be 80% x the funding requirement.

Given the debt balances, we can now calculate the debt interest payments for each month. This will simply be 6% x opening balance x 1/12 (remember we are dealing in months).

We can feed this interest cost back in the funding requirement.

The equity capital injected is then simply equal to (1-gearing) x funding requirement or equivalently the funding requirement minus debt.

If all has went smoothly you should end up with a debt amount of 121 and an equity amount of 30.

## A quick side note

In most instances, during construction there will be no free cashflow left over after utilising debt and equity. i.e. funding requirements should exactly offset debt and equity drawdowns.

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KattyOctober 29, 2011 at 9:15 amAlways a good job right here. Keep rolling on thuogrh.

hayFebruary 11, 2012 at 6:40 pmGreat work! In calculating Project IRR, interest and principal repayments are not considered. How to treat IDC for calculating Project IRR and Equity IRR? Am I confusing my ideas?

adminJuly 7, 2013 at 5:08 amHay, in calculating Project IRR, interest and principal would not be considered. Project IRR looks at the IRR, prior to any financing. Interest during construction, would therefore not be included in any project IRR calculation.

In calculating equity IRR, you would just look at all equity contributions as negative equity cash flows and all distributions to equity as positive equity cash flows. Aggregate these cash flows, to get net equity cash flow, then do an IRR calculation on the net equity cash flows. This will give you the equity IRR.

Let us know if you require any further explanation.

Regards

Brett

Michael RudolfFebruary 25, 2016 at 1:48 amHi Brett, I know that this is a dicussion from 2.5 years ago. But I just had the same problem / question that Hay was asking. You pointed out that the IDC would not be considered for calculating the project IRR. But when you calculate the equity IRR, the IDC are part of that calculation because a portion (in this example 20%) of the IDC would be financed by equity. Would it therefore not make sense to take out the IDC portion in the equity payment stream to calculate the equity IRR ? Thanks and best regards Michael

adminFebruary 25, 2016 at 9:41 amHi Michael

Good question. Strictly speaking the project IRR excludes any financing costs (including IDC). In terms of equity IRR it should simply be calculated by net equity cash flows over the project term (eg. equity injections and distributions). This includes any amounts of equity used to fund IDC payments. i.e. equity financiers are only looking at money in and out to get their equity IRR, and it doesn’t matter what that money in is used for

I hope this clears your question. Let us know if you have any follow on questions.

Thanks and regards

Brett

SalmaAugust 1, 2017 at 11:37 amHello Brett, thanks for the helpful explanations. On IDC, I have a follow up please.

If we think of project cash inflows and outflows, the above conversation suggests we should not include IDC in the cash outflows/leakage from the project. I agree with that. but what about IDC as part of CAPEX, thinking of CAPEX as an inflow from capital holders into project? i.e when I map out the CAPEX spending profile to calculate project IRR, should IDC be included in CAPEX line or not?

If we think of PIRR as Cash income to project and CAPEX. I will not adjust the cash income down by the the interest paid during construction, bbut on the CAPEX side, should I reflect the IDC in the CAPEX (i.e. if physical assets are 100 dollars and IDC is 10 dollars, should CAPEX be 100 or 110?

thanks so much in advance!