In project finance deals, major maintenance is usually very costly and infrequent in nature. For example in a toll road the road surface may need to be overhauled every 10 years. This major maintenance or lifecycle capex is expensive and usually cannot be funded sufficiently with operational cash flows. To get around this problem a reserve called a major maintenance reserve account (MMRA) or lifecycle reserve account (LRA) is usually used. This MMRA reserves cash progressively up until a forecast major capex spend.
Modelling a MMRA
Ok, so how do we model a MMRA by reserving cash up to forecast capex spends? Let’s assume that we have a:
- CFADS of $20m pa (assume this is flat);
- Replacement capex of $25m every 10 years (assume two of these); and
- assume no interest is received on the MMRA.
Now we are going to use a simple corkscrew account to model cash inflows (reserving for capex) and cash outflows (major capex). We could add in interest, however we will keep it simple in this example. Link up the opening balance to the closing balance of the previous period as per below.
Now let’s put in our major capex amount of $25m every 10 years. This is a cash outflow from the reserve.
Let us now put in the final part of the equation. We need to reserve $25m every 10 years. Now, we can specify how many periods (years in this case) we want to reserve this over. Let’s say we do it over the 10 years. i.e. $2.5m per annum. Now we are going to use an offset formula as follows to get the right amount to reserve per period. This is shown below.
As you can see above there is a maximum of 15 years, which replacement capex can be reserved over. Hence we should put a note on the assumptions page that we cannot enter any number over 15 and the number should be an integer.
Finally we sum the total reserve amount up, and link it into the corkscrew account. If you have done everything correctly you should end up with something like the below.
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