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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