Corporate Finance Concepts-Applicable To Infrastructure Sector Ernst & Young LLP
Corporate Finance Concepts-Applicable To Infrastructure Sector Ernst & Young LLP
Corporate Finance Concepts-Applicable To Infrastructure Sector Ernst & Young LLP
Applicable to Infrastructure
sector
► Basic foundation of all finance-business finance, consumer finance and govt. finance
► Isbased on the premise that money today is preferable to the same amount of money in
future, all other things being equal
►The interest rate used in determining the present value of future cash
flows
►For example:
►Let's say you expect INR 1,000 in one year's time. To determine the present value
of this INR 1,000 (what it is worth to you today) you would need to discount it by a
particular rate of interest. Assuming a discount rate of 10%, the INR 1,000 in a
year's time would be the equivalent of INR 909.09 to you today (1000/[1.00 +
0.10]).
►Discounted cash flow (DCF) is a valuation method used to estimate the value of an
investment based on its future cash flows. DCF analysis finds the present of
expected future cash flows using a discount rate. A present value estimate is then
used to evaluate a potential investment. If the value calculated through DCF is
higher than the current cost of the investment, the opportunity should be
considered.
►The time value of money (investors would rather have cash immediately than
having to wait and must therefore be compensated by paying for the delay)
►A risk premium that reflects the extra return investors demand because they
want to be compensated for the risk that the cash flow might not materialize
after all
►Amortization is the distribution of a single lump-sum cash flow into many smaller
cash flow installments, as determined by an amortization schedule. Amortization is
chiefly used in loan repayments. A greater amount of the payment is applied to
interest at the beginning of the amortization schedule, while more money is applied
to principal at the end.
►The opportunity cost of an investment; that is, the rate of return that a
company would otherwise be able to earn at the same risk level as the
investment that has been selected.
►Cost of Debt (Kd): The effective rate that a company pays on its
current debt.
►The cost of debt is computed by taking the rate on a risk free bond
whose duration matches the term structure of the corporate debt,
then adding a risk premium.
► A company will use various debt instruments like bonds, loans and
other forms of debt; cost of debt reflects the overall rate paid by the
company for debt financing.
►After Tax Cost of Debt = Before Tax Cost of Debt X (1 – Tax Rate)
► Re = Rf + b (Rm-Rf),
Where,
► Re = Cost of Equity
► Rf = Risk-free rate of return
WHERE:
► Re = cost of equity, Rd = cost of debt ,
► V = E + D,
►The Internal Rate of Return (IRR) is the discount rate that results in a
net present value of zero for a series of future cash flows. It is a
Discounted Cash Flow (DCF) approach to valuation and investing just
as Net Present Value (NPV).
►Both IRR and NPV are widely used to decide which investments to
undertake and which investments not to undertake.
► ProjectIRR- Project IRR is determined at the project level, without considering cash flows related to
financing. In this computation of project IRR, interest and debt-service payments are kept out
► Most of the time equity IRR is greater than Project IRR because cost of debt is less than equity.
► The big question Can equity IRR be lower than project IRR?
► The equity IRR will be lower than the project IRR whenever the cost of debt exceeds the project IRR.
Note it is the cost of debt and not the weighted average cost of capital. when the cost of debt is
equal to the project IRR, the equity IRR is equal to the project IRR.
► Note that the cost of equity doesn’t impact either the project IRR or the equity IRR. Cost of equity
affects the weighted average cost of capital (WACC) and hence the NPV calculation. It affects both
project NPV and NPV for the equity holders.
►Rental Yield is the net amount of money a landlord receives in rent over one
year (after deducting operating expenses), shown as a percentage of the
money invested in the property.
►Rental yield= (Net Annual Rent/ Cost or Current Market Value) X 100
►Rental Yield is the net amount of money a landlord receives in rent over one
year (after deducting operating expenses), shown as a percentage of the
money invested in the property.
►Rental yield= (Net Annual Rent/ Cost or Current Market Value) X 100
► DSCR-It is a measurement of the cash flow available to pay current debt obligations. The ratio
states net operating income as a multiple of debt obligations due within one year, including interest,
principal, lease payments etc.
► Typically, a DSCR greater than 1 means the entity – whether a person, company or government – has
sufficient income to pay its current debt obligations.
► The minimum DSCR a lender will demand can depend on macroeconomic conditions. If the economy
is growing, credit is more readily available, and lenders may be more forgiving of lower ratios
► Straight-line depreciation is a very common and simple method of calculating the expense. In
straight-line depreciation, the expense amount is the same every year over the useful life of the asset.
► Depreciation Formula for the Straight Line Method:
► Itis used in cash flow (in calculating Net Inflow PAT + Dep) and P&L Statement of Financial
analysis.
► Consider a piece of equipment that costs $25,000 with an estimated useful life of 8 years and a Rs.0
salvage value. The depreciation expense per year for this equipment/ created asset would be as
follows:
► Written down value depreciation is also known as Reducing Balance or Reducing Instalment
Method or Diminishing Balance Method. Under this method, the depreciation is calculated at a certain
fixed percentage each year on the decreasing book value commonly known as WDV of the asset
(book value less depreciation).
► The use of book value (the balance brought forward from the previous year) and fixed rate of
depreciation result in decreasing depreciation charges over the life span of the asset.
► While applying the depreciation rate both salvage or scrap value and removal costs are ignored. It is
not possible to reduce the book value to zero; but it can be reduced close to its salvage value at the
end of its useful life.
► In Infrastructure projects Financial analysis it used in Tax depreciation which can be listed as an
expense on a tax return for a given reporting period under the applicable tax laws. It is used to reduce
the amount of taxable income reported by a business. It is used in Taxation sheet of Financial analysis
to get net Tax liability.
► Depreciation as per Income Tax Act (Section 32) Depreciation is allowable as expense in Income Tax
Act, 1961 on basis of block of assets on Written Down Value (WDV) method, the percentage of
depreciation is taken as 10%.
Reference: https://www.incometaxindia.gov.in/charts%20%20tables/depreciation%20rates.html