It is important to analyze a project's cash flow as available cash is used to service any debt obligations. The analysis is done through the development of a cash flow model. Once the financial model for a project is developed, the implications of alternative financial structures and effects of changes in other parameter values on cash flow can be analyzed. The following are the critical components of a cash flow model:
• Capital expenditure
• Financial structure and cost for finance from each source
• Terminal cash flow
• Discount rate
• Assumptions on parameter values
Capital expenditure is the cost of developing and building a project, regardless of funding sources. Typical components of capital expenditure are: land and site development costs; buildings and all civil works; plant and machinery; technical, engineering, legal and other professional service fees; project development and bidding costs; interest cost during construction and funding draw down; working capital, etc.
Alternative financial structures (that is relative shares of debt and equity finance from different sources) are considered to calculate the average cost of capital.
The terminal cash flow is the cash that is generated from the sale or transfer of assets upon termination or liquidation of the PPP contract tenure. In the case of a PPP project, the residual or transfer price is generally negotiated and included in the contract agreement.
The discount rate is the rate that is used to calculate the present value of future cash flows. It is often the weighted average cost of capital for the project from different sources.
In order to calculate the future cash flows, it is also necessary to make assumptions of important parameter values over the project's life. The main parameters for which values are assumed include: interest and inflation rates, pricing mechanism, demand for the goods and services produced by the project, construction time, debt repayment method, depreciation schedule, tax structure, and physical and technological life of assets.
Once the cost of capital, expenditures and terminal cash flow are known, the necessary assumptions are made and parameter values are set, a cash flow model can be constructed. The model is used to calculate cash flows in likely future situations to examine the availability of cash to meet the debt service obligations.