Analyzing and Structuring Financially Sustainable Investments The World Bank

Basic Requirements for Financially Sustainable WSS Investments At minimum, operating revenues need to recover operating costs and administrative expenses Cost Recovery The system must be able to sustain an adequate level of working capital Working Capital The projected cash flow must remain positive for all years of projection period Positive Cash Flow Basic Requirements for Financially Sustainable WSS Investments

Foundation for a Sustainable Utility Expand Coverage/ Service Poor Communities Financial Viability Cost Recovery Break Through Financing Limits Improved Management

WSS Providers Must Have Sufficient Working Capital to Pay Their Ongoing Bills Working Capital is measured by the Current Ratio which essentially calculates current assets over current liabilities. At minimum, the Current Ratio should be 1.2. However, a much higher ratio may indicate that short term assets are not used efficiently. A ratio of less than 1.0 may indicate cash flow problems or the inability to convert revenues into cash.

Determining the Cash Flow Solution

Strategy for Financial Sustainability Improve sector performance and close revenue gap Use subsidies sparingly and for transition Bring in government as real owners in the financing challenge Make use of all sources of financing Use concessional finance correctly Improve Sector Performance and Close the Revenue Gap Bring in Government as Key Stakeholders in the Financing Challenge – as contributors of equity, guarantors, or direct borrowers). Over-Reliance on Subsidies Will Only Delay Progress. The Use of Subsidies Should be Transitional and Primarily Aimed at Serving Poor Communities. Make Use of All Sources of Financing – Public or Private and Create Framework Where Risks Are Properly Allocated and Bound By Enforceable Contracts.

FIRR vs. NPV? The NPV is the value of the sum of projected cash flows discounted at the cost of capital. Any value over zero indicates adequate return, but the higher positive value show a higher return. The NPV calculation Does not give you’re the exact rate of return. Just tells you that you are either above or below your threshold level. The Financial Internal Rate of Return is the rate of return expressed as a percentage that the Project yields. Through extrapolation you can equate the two by either increasing or decreasing the discount rate so that the NPV equals zero. In other words if your NPV is 0 at 15% discount rate then the FIRR should be 15%. However, the FIRR can produce different values of the same cash flow and can produce the wrong number. Moreover, the FIRR formula assumes that the cash surpluses are reinvested at the FIRR rate – which is not necessarily correct. In order to correct this problem the Modified IRR formula was developed which deals separately with the reinvest rate. The formula for NPV and FIRR are exactly the same for the economic analysis. In that case they are usually referred to as the ENPV or the EIRR. The difference is how you calculate the costs and benefits. The financial analysis only includes cost and benefits that accrued to the project, not externalities that accrue outside the project to the wider economy.

Which Project is More Financially Sustainable? FIRR No 1 7.7% No 2 9.1% No 3 2.6% Year 1 Year 2 Year 3 Year 4 Year 5 -150 40 60 30 -50 250 -100 20 25 32 WACC 10% 7% 2% Go/No Go

Ways to Close the Financial Sustainability Gap Revising Capex Program by Allowing PIP to Take Effect Reducing CAPEX Program Altogether Ways to Close the Financial Sustainability Gap

Ways to Close the Financial Sustainability Gap Shape Financing Structure Improve Cost Recovery Modify CAPEX Program Ways to Close the Financial Sustainability Gap

Shaping the Financing Structure Full or Partial Grant funding for CAPEX Blending with Concessional Loans or Commercial Finance Reverse Engineering to Determine Loan Amount that Can be Sustained Restructuring Unsustainable Debt Shaping the Financing Structure

Tax and Other Financial Incentives Direct Grants Concessional Loans Tax and Other Financial Incentives Guarantees Government Support

How Financing Can be Structured to Address Sustainability Cash Flow Problems Bank Loan/Credit Agreement to Government Subsidiary Loan Agreement Financially Sustainable Terms to the Utility Terms to government Local currency financing Extended grace and maturity periods Lower cost of funds Grant allocation

Government Support Options

Approach of Blended Finance Attempts to lower the overall cost of capital to an investment Stretch out repayment obligations through long term sources. Hence meet both cash flow and efficiency considerations. Can work with higher leverage structures with enhancements such as performance bonds

Common Transaction PPP Structures Characteristics Straight Private Deal Typical Private Finance with 35-65 capital structure, 15 year, 3 year grace. Least Govt. Subsidy Private financed deal with up-front government subsidy component. Viability Gap Financing Viability Gap fund made available through ODA replaces upfront grant from Government. ODA Hybrid I ODA can increase debt component . WB has gone up to 85% debt with tenures of as high 30 years and 10 years grace. ODA Hybrid II Can add government grant component to the hybrid I structure.

Effects of Blended Finance Structures for PPPs

Effects of Blended Finance on Net Present Value and Cash Flows

Improving Cost Recovery Incorporate Performance Improvement Program in Project OPEX Support for a Transitional Period Extended Commissioning Period Adjust Tariff to Justified Levels Improving Cost Recovery

Biggest Mistakes Our Clients Make Our Loans Trickling Disbursements and Losing the Benefit of Grace periods Taking on More Debt than the Utility Can Sustain Loans in FX Currencies

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