1. B.Tech Admission in IndiaB.Tech Admission in India
By:By:
admission.edhole.comadmission.edhole.com
2. 1.040/1.4011.040/1.401
Project ManagementProject Management
Spring 2007Spring 2007
Project Financing & EvaluationProject Financing & Evaluation
Dr. SangHyun Lee
lsh@mit.edulsh@mit.edu
Department of Civil and Environmental EngineeringDepartment of Civil and Environmental Engineering
Massachusetts Institute of TechnologyMassachusetts Institute of Technology
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3. PreliminariesPreliminaries
STELLAR access: to be announcedSTELLAR access: to be announced
AS1 Survey due by tonight 12 pmAS1 Survey due by tonight 12 pm
TP1 and AS2 are outTP1 and AS2 are out
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4. AS 2: Student PresentationAS 2: Student Presentation
10 minute presentation followed by 5 minute discussion10 minute presentation followed by 5 minute discussion
1 or 2 presentations from Feb. 20 to Mar. 191 or 2 presentations from Feb. 20 to Mar. 19
TopicsTopics
Your past project experience (strongly recommended if you have any)Your past project experience (strongly recommended if you have any)
Size of project is not important!Size of project is not important!
Project main figuresProject main figures
Main managerial aspectsMain managerial aspects
Project management practicesProject management practices
Problems, strengths, weaknesses, risksProblems, strengths, weaknesses, risks
Your learningYour learning
Emerging construction technologies (e.g., 4D CAD, Virtual Reality, Sensing, …)Emerging construction technologies (e.g., 4D CAD, Virtual Reality, Sensing, …)
Volunteers for next week?Volunteers for next week?
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5. PreliminariesPreliminaries
STELLAR access: to be announcedSTELLAR access: to be announced
AS1 Survey due by tonight 12 pmAS1 Survey due by tonight 12 pm
TP1 and AS2 are outTP1 and AS2 are out
Pictures will be taken before you leavePictures will be taken before you leave
Who we areWho we are
Don’t memorize course content. Understand it.Don’t memorize course content. Understand it.
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6. OutlineOutline
Session Objective & ContextSession Objective & Context
Project FinancingProject Financing
OwnerOwner
ProjectProject
ContractorContractor
Additional IssuesAdditional Issues
Financial EvaluationFinancial Evaluation
Time value of moneyTime value of money
Present valuePresent value
RatesRates
Interest FormulasInterest Formulas
NPVNPV
IRR & payback periodIRR & payback period
Missing factorsMissing factorsadmission.edhole.com
7. Session ObjectiveSession Objective
The role of project financingThe role of project financing
Mechanisms for project financingMechanisms for project financing
Measures of project profitabilityMeasures of project profitability
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9. Context: Feasibility PhasesContext: Feasibility Phases
Project ConceptProject Concept
Land Purchase & Sale ReviewLand Purchase & Sale Review
Evaluation (scope, size, etc.)Evaluation (scope, size, etc.)
Constraint surveyConstraint survey
Site constraintsSite constraints
Cost modelsCost models
Site infrastructural issuesSite infrastructural issues
Permit requirementsPermit requirements
Summary ReportSummary Report
Decision to proceedDecision to proceed
Regulatory process (obtain permits, etc)Regulatory process (obtain permits, etc)
Design PhaseDesign Phaseadmission.edhole.com
10. Lecture 2 - ReferencesLecture 2 - References
More details on:More details on:
Hendrickson PM for Construction on-line textbookHendrickson PM for Construction on-line textbook
Chapter 7Chapter 7
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11. OutlineOutline
Session Objective & ContextSession Objective & Context
Project FinancingProject Financing
OwnerOwner
ProjectProject
ContractorContractor
Additional IssuesAdditional Issues
Financial EvaluationFinancial Evaluation
Time value of moneyTime value of money
Present valuePresent value
RatesRates
Interest FormulasInterest Formulas
NPVNPV
IRR & payback periodIRR & payback period
Missing factorsMissing factorsadmission.edhole.com
15. Project FinancingProject Financing
Aims to bridge this gap in the most beneficial way!Aims to bridge this gap in the most beneficial way!
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16. Critical Role of FinancingCritical Role of Financing
Makes projects possibleMakes projects possible
Has major impact onHas major impact on
Riskiness of constructionRiskiness of construction
ClaimsClaims
Prices offered by contractors (e.g., high bid price for latePrices offered by contractors (e.g., high bid price for late
payment)payment)
Difficulty of Financing is a major driver towards alternateDifficulty of Financing is a major driver towards alternate
delivery methods (e.g., Build-Operate-Transfer)delivery methods (e.g., Build-Operate-Transfer)
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17. How Does Owner Finance a Project?How Does Owner Finance a Project?
PublicPublic
PrivatePrivate
““Project” financingProject” financing
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18. OutlineOutline
Session Objective & ContextSession Objective & Context
Project FinancingProject Financing
OwnerOwner
ProjectProject
ContractorContractor
Additional IssuesAdditional Issues
Financial EvaluationFinancial Evaluation
Time value of moneyTime value of money
Present valuePresent value
RatesRates
Interest FormulasInterest Formulas
NPVNPV
IRR & payback periodIRR & payback period
Missing factorsMissing factorsadmission.edhole.com
19. Public FinancingPublic Financing
Sources of fundsSources of funds
General purpose or special-purpose bondsGeneral purpose or special-purpose bonds
Tax revenuesTax revenues
Capital grants subsidiesCapital grants subsidies
International subsidized loansInternational subsidized loans
Social benefits important justificationSocial benefits important justification
Benefits to region, quality of life, unemployment relief, etc.Benefits to region, quality of life, unemployment relief, etc.
Important consideration: exemption from taxesImportant consideration: exemption from taxes
Public owners face restrictions (e.g. bonding caps)Public owners face restrictions (e.g. bonding caps)
Major motivation for public/private partnershipsMajor motivation for public/private partnerships
MARR (Minimum Attractive Rate of Return) much lower (e.g. 8-MARR (Minimum Attractive Rate of Return) much lower (e.g. 8-
10%), often standardized10%), often standardized
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20. Private FinancingPrivate Financing
Major mechanismsMajor mechanisms
EquityEquity
Invest corporate equity and retained earningsInvest corporate equity and retained earnings
Offering equity sharesOffering equity shares
Stock Issuance (e.g. in capital markets)Stock Issuance (e.g. in capital markets)
Must entice investors with sufficiently high rate of returnMust entice investors with sufficiently high rate of return
May be too limited to support the full investmentMay be too limited to support the full investment
May be strategically wrong (e.g., source of money, ownership)May be strategically wrong (e.g., source of money, ownership)
DebtDebt
Borrow moneyBorrow money
BondsBonds
Because higher costs and risks, require higher returnsBecause higher costs and risks, require higher returns
MARR varies per firm, often high (e.g. 20%)MARR varies per firm, often high (e.g. 20%)
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21. Private FinancingPrivate Financing
Major mechanismsMajor mechanisms
EquityEquity
Invest corporate equity and retained earningsInvest corporate equity and retained earnings
Offering equity sharesOffering equity shares
Stock Issuance (e.g. in capital markets)Stock Issuance (e.g. in capital markets)
Must entice investors with sufficiently high rate of returnMust entice investors with sufficiently high rate of return
May be too limited to support the full investmentMay be too limited to support the full investment
May be strategically wrong (e.g., source of money, ownership)May be strategically wrong (e.g., source of money, ownership)
DebtDebt
Borrow moneyBorrow money
BondsBonds
Because higher costs and risks, require higher returnsBecause higher costs and risks, require higher returns
MARR varies per firm, often high (e.g. 20%)MARR varies per firm, often high (e.g. 20%)
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22. Private Owners w/Collateral FacilityPrivate Owners w/Collateral Facility
Distinct Financing PeriodsDistinct Financing Periods
Short-term construction loanShort-term construction loan
Bridge DebtBridge Debt
Risky (and hence expensive!)Risky (and hence expensive!)
Borrowed so owner can pay for construction (cost)Borrowed so owner can pay for construction (cost)
Long-term mortgageLong-term mortgage
Senior DebtSenior Debt
Typically facility is collateralTypically facility is collateral
Pays for operations and Construction financing debtsPays for operations and Construction financing debts
Typically much lower interestTypically much lower interest
Loans often negotiated as a packageLoans often negotiated as a package
timeconstruction
w/o tangible
operation
w/ tangibleadmission.edhole.com
23. OutlineOutline
Session Objective & ContextSession Objective & Context
Project FinancingProject Financing
OwnerOwner
ProjectProject
ContractorContractor
Additional IssuesAdditional Issues
Financial EvaluationFinancial Evaluation
Time value of moneyTime value of money
Present valuePresent value
RatesRates
Interest FormulasInterest Formulas
NPVNPV
IRR & payback periodIRR & payback period
Missing factorsMissing factorsadmission.edhole.com
24. ““Project” FinancingProject” Financing
Investment is paid back from the project profit rather than theInvestment is paid back from the project profit rather than the
general assets or creditworthiness of the project ownersgeneral assets or creditworthiness of the project owners
For larger projects due to fixed cost to establishFor larger projects due to fixed cost to establish
Small projects not much benefitSmall projects not much benefit
Investment in project through special purpose corporationsInvestment in project through special purpose corporations
Often joint venture between several partiesOften joint venture between several parties
Need capacity for independent operationNeed capacity for independent operation
BenefitsBenefits
Off balance sheet (liabilities do not belong to parent)Off balance sheet (liabilities do not belong to parent)
Limits riskLimits risk
External investors: reduced agency cost (direct investment in project)External investors: reduced agency cost (direct investment in project)
DrawbackDrawback
Tensions among stakeholdersTensions among stakeholders
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25. OutlineOutline
Session Objective & ContextSession Objective & Context
Project FinancingProject Financing
OwnerOwner
ProjectProject
ContractorContractor
Additional IssuesAdditional Issues
Financial EvaluationFinancial Evaluation
Time value of moneyTime value of money
Present valuePresent value
RatesRates
Interest FormulasInterest Formulas
NPVNPV
IRR & payback periodIRR & payback period
Missing factorsMissing factorsadmission.edhole.com
26. Contractor Financing IContractor Financing I
Payment schedulePayment schedule
Break out payments into componentsBreak out payments into components
Advance paymentAdvance payment
Periodic/monthly progress payment (itemized breakdown structure)Periodic/monthly progress payment (itemized breakdown structure)
Milestone paymentsMilestone payments
Often some compromise between contractor and ownerOften some compromise between contractor and owner
Architect certifies progressArchitect certifies progress
Agreed-upon payments
retention on payments (usually, about 10%)retention on payments (usually, about 10%)
Often must cover deficit during constructionOften must cover deficit during construction
Can be many months before payment receivedCan be many months before payment received
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31. Contractor Financing IIContractor Financing II
Owner keeps an eye out forOwner keeps an eye out for
Front-end loaded bids (discounting)Front-end loaded bids (discounting)
Unbalanced bidsUnbalanced bids
Contractors frequently borrow fromContractors frequently borrow from
Banks (Need to demonstrate low risk)Banks (Need to demonstrate low risk)
Interaction with ownersInteraction with owners
Some owners may assist in fundingSome owners may assist in funding
Help secure lower-priced loan for contractorHelp secure lower-priced loan for contractor
Sometimes assist owners in funding!Sometimes assist owners in funding!
Big construction company, small municipalityBig construction company, small municipality
BOTBOT
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32. Agreed upon in contractAgreed upon in contract
Often structure proposed by ownerOften structure proposed by owner
Should be checked by owner (fair-cost estimate)Should be checked by owner (fair-cost estimate)
Often based on “Masterformat” Cost Breakdown StructureOften based on “Masterformat” Cost Breakdown Structure
(Owner standard CBS)(Owner standard CBS)
Certified by third party (Architect/engineer)Certified by third party (Architect/engineer)
Contractor Financing IIIContractor Financing III
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33. OutlineOutline
Session Objective & ContextSession Objective & Context
Project FinancingProject Financing
OwnerOwner
ProjectProject
ContractorContractor
Additional IssuesAdditional Issues
Financial EvaluationFinancial Evaluation
Time value of moneyTime value of money
Present valuePresent value
RatesRates
Interest FormulasInterest Formulas
NPVNPV
IRR & payback periodIRR & payback period
Missing factorsMissing factorsadmission.edhole.com
34. Latent CreditLatent Credit
Many people forced to serve as lenders to owner dueMany people forced to serve as lenders to owner due
to delays in paymentsto delays in payments
DesignersDesigners
ContractorsContractors
ConsultantsConsultants
CMCM
SuppliersSuppliers
ImplicationsImplications
Good in the short-termGood in the short-term
Major concern on long run effectsMajor concern on long run effects
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35. Role of TaxesRole of Taxes
Tax deductions forTax deductions for
Depreciation -Depreciation - LinkLink
the process of recognizing the using up of an asset throughthe process of recognizing the using up of an asset through
wear and obsolescence and of subtracting capital expenseswear and obsolescence and of subtracting capital expenses
from the revenues that the asset generates over time infrom the revenues that the asset generates over time in
computing taxable incomecomputing taxable income
OthersOthers
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36. OutlineOutline
Session Objective & ContextSession Objective & Context
Project FinancingProject Financing
Owner
Project
Contractor
Additional Issues
Financial EvaluationFinancial Evaluation
Time value of moneyTime value of money
Present valuePresent value
RatesRates
Interest FormulasInterest Formulas
NPVNPV
IRR & payback periodIRR & payback period
Missing factorsMissing factorsadmission.edhole.com
37. Develop or Not DevelopDevelop or Not Develop
Is any individual project worthwhile?Is any individual project worthwhile?
Given a list of feasible projects, which one is the best?Given a list of feasible projects, which one is the best?
How does each project rank compared to the others onHow does each project rank compared to the others on
the list?the list?
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38. Project Evaluation Example:Project Evaluation Example:
Project AProject A
Construction=3 yearsConstruction=3 years
Cost = $1M/yearCost = $1M/year
Sale Value=$4MSale Value=$4M
Total Cost?Total Cost?
Profit?Profit?
Project BProject B
Construction=6 yearsConstruction=6 years
Cost=$1M/yearCost=$1M/year
Sale Value=$8.5MSale Value=$8.5M
Total Cost?Total Cost?
Profit?Profit?
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41. Quantitative MethodQuantitative Method
ProfitabilityProfitability
Create value for the companyCreate value for the company
Opportunity CostOpportunity Cost
Time Value of MoneyTime Value of Money
A dollar today is worth more than a dollar tomorrowA dollar today is worth more than a dollar tomorrow
Investment relative to best-case scenarioInvestment relative to best-case scenario
E.g. Project A - 8% profit, Project B - 10% profitE.g. Project A - 8% profit, Project B - 10% profit
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42. Money Is Not EverythingMoney Is Not Everything
Social BenefitsSocial Benefits
HospitalHospital
SchoolSchool
Highway built into a remote villageHighway built into a remote village
Intangible Benefits (E.g, operating and competitiveIntangible Benefits (E.g, operating and competitive
necessity)necessity)
New warehouseNew warehouse
New cafeteriaNew cafeteria
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43. OutlineOutline
Session Objective & ContextSession Objective & Context
Project FinancingProject Financing
Owner
Project
Contractor
Additional issues
Financial EvaluationFinancial Evaluation
Time value of moneyTime value of money
Present valuePresent value
RatesRates
Interest FormulasInterest Formulas
NPVNPV
IRR & payback periodIRR & payback period
Missing factorsMissing factorsadmission.edhole.com
44. Basic CompoundingBasic Compounding
Suppose we invest $x in a bank offering interest rate iSuppose we invest $x in a bank offering interest rate i
If interest is compounded annually, asset will be worthIf interest is compounded annually, asset will be worth
$x(1+i) after 1 year$x(1+i) after 1 year
$x(1+i)$x(1+i)22
after 2 yearsafter 2 years
$x(1+i)$x(1+i)33
after 3 years ….after 3 years ….
$x(1+i)$x(1+i)nn
after n yearsafter n years
$x
0 1 $x(1+i) 2 $x(1+i)22
n $x(1+i)nn
…
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45. Time Value of MoneyTime Value of Money
If we assumeIf we assume
That money can always be invested in the bank (or someThat money can always be invested in the bank (or some
other reliable source) now to gain a return with interest laterother reliable source) now to gain a return with interest later
That as rational actors, we never make an investment whichThat as rational actors, we never make an investment which
we know to offer less money than we could get in the bankwe know to offer less money than we could get in the bank
ThenThen
Money in theMoney in the presentpresent can be thought as of “equal worth” tocan be thought as of “equal worth” to
a larger amount of money in the futurea larger amount of money in the future
Money in theMoney in the futurefuture can be thought of as having an equalcan be thought of as having an equal
worth to a lesser “present value” of moneyworth to a lesser “present value” of money
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46. Equivalence of Present ValuesEquivalence of Present Values
Given a source of reliable investments, we areGiven a source of reliable investments, we are
indifferent between any cash flows with theindifferent between any cash flows with the
same present value – they have “equal worth”same present value – they have “equal worth”
This indifferences arises because we can convertThis indifferences arises because we can convert
one to the other with no extra expenseone to the other with no extra expense
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47. PreliminariesPreliminaries
STELLAR access:STELLAR access:
http://stellar.mit.edu/S/course/1/sp07/1.040/http://stellar.mit.edu/S/course/1/sp07/1.040/
Next Tuesday Recitation: Skyscraper Part INext Tuesday Recitation: Skyscraper Part I
Please set up an appointment to discuss your AS2 ifPlease set up an appointment to discuss your AS2 if
you choose emerging technologies (MF preferred)you choose emerging technologies (MF preferred)
Office: 1-174Office: 1-174
TA (50%) for our classTA (50%) for our class
Send your resume (or brief your experience) by this SundaySend your resume (or brief your experience) by this Sunday
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49. Time Value of Money: RevisitTime Value of Money: Revisit
If we assumeIf we assume
That money can always be invested in the bank (or someThat money can always be invested in the bank (or some
other reliable source) now to gain a return with interest laterother reliable source) now to gain a return with interest later
That as rational actors, we never make an investment whichThat as rational actors, we never make an investment which
we know to offer less money than we could get in the bankwe know to offer less money than we could get in the bank
ThenThen
Money in theMoney in the presentpresent can be thought as of “equal worth” tocan be thought as of “equal worth” to
a larger amount of money in the futurea larger amount of money in the future
Money in theMoney in the futurefuture can be thought of as having an equalcan be thought of as having an equal
worth to a lesser “present value” of moneyworth to a lesser “present value” of money
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50. Present Value (Revenue)Present Value (Revenue)
How is it that some future revenueHow is it that some future revenue rr at timeat time tt has a “presenthas a “present
value”?value”?
Answer: Given that we are sure that we will be gaining revenueAnswer: Given that we are sure that we will be gaining revenue rr
at timeat time tt, we can take and spend an immediate loan from the, we can take and spend an immediate loan from the
bankbank
We choose size of this loanWe choose size of this loan ll so that at timeso that at time tt, the total size of the loan, the total size of the loan
(including accrued interest) is(including accrued interest) is rr
The loanThe loan ll is the present value ofis the present value of rr
ll = PV(= PV(rr))
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51. Future to Present RevenueFuture to Present Revenue
x
t
-x
tPV(x)
0 I’ll pay this back to the bank later
I can borrow this from the bank now
tPV(x)
If I know this is coming…
The net result is that I can convert a sure x at time t
into a (smaller) PV(x) now!
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52. Present Value (Cost)Present Value (Cost)
How is it that some future costHow is it that some future cost cc at timeat time tt has a “present value”?has a “present value”?
Answer: Given that we areAnswer: Given that we are suresure that we will bear costthat we will bear cost cc at timeat time tt,,
we immediately deposit a sum of moneywe immediately deposit a sum of money xx into the bank yieldinginto the bank yielding
a known returna known return
We choose size of depositWe choose size of deposit xx so that at timeso that at time tt, the total size of the, the total size of the
investment (including accrued interest) isinvestment (including accrued interest) is cc
We can then pay offWe can then pay off cc at timeat time tt by retrieving this money from the bankby retrieving this money from the bank
The size of the deposit (immediate cost)The size of the deposit (immediate cost) xx is theis the present valuepresent value ofof cc..
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