Tianjin Case Solution Group 7

Dalia Abdelbaki 1979329

Chesron Essebom 1941143
Wouter Hendriksen 2123258

Construction risk

Construction risk is the risk that accompanies with setting up the power plant project from 1996
till 2000. In those four years Maple Energy is responsible for arranging a joint venture with a
local partner, arranging the financing needed, and acquire and contract for all power sales when
the project is operational. Considering all the factors Maple Energy is accountable for, there is a
possibility things could go wrong during this four- year period. Maple Energy and Tianjin
Plastics are major equity investors, with 49 percent and 46 percent at stake they are responsible
for repaying debt holders in case of failure or the lack of operating income to cover the debt
repayments or principal. The Chinese Ministry of Power Industry (MOPI) is according to their
share of five percent in this project also accountable, but the Chinese government refuses to give
any guarantees.
While Tianjin, a city in Northern China, is known as an industrial city that enjoys many foreign
investments, a big concern arises when we talk about coal. The intensive power plant (coal-fired
steam-electric) produces 140 megawatt could be seen as a huge amount of air pollution in the
Northern city that spreads to 82.300 kilometers with 9.2 million inhabitants.
From a financial point of view, the use of coal is actually beneficial for Maple Energy, because
of two reasons. The first reason is that the power purchasing agreement (PPA) with the Chinese
Ministry of Power Industry (MOPI) states that the coal used for the power plant during its
technical life of 20 years plus will be supplied free of charge. This means that costs are being
substantially reduced, which indicates higher free cash flows. Consequently, It also means that
Maple Energy does not have to bear the risk of fluctuations in coal prices. The second reason is
that MOPI has a stake in the project of five percent and a legally binding contract (PPA), which
would be in their benefit to honor. With this stated, we could assume that any resistance of
environmental activists in China that are against building the power plant would be turned down
by the government so it does not form a delay for finishing the project on time. Another aspect,
which will help the project, is local participation. The Tianjin Plastics, a state-owned enterprise,
owns 46 percent of the equity, therefore it is not mere a foreign investments but also a local one
that could benefit Tianjin with large employment opportunities.
However, this does not automatically mean that the environmental activists outside China cannot
do their share of image damaging of Maple Energy and any other investor involved in this
project. This could oppose a threat to the desirability of participating in a large project like The
Tianjin Plastics project and could eventually hurt the funding of the project if a party decides to
bail out. The government does not offer any guarantees on completing the project; hence in case
of a bank or private refusing to engage, the project could not count on additional investment
from the government and Maple Energy would have to bear the risk of any delays in the search
of a compatible investor.
Another common construction risk is costs overrun, which could interrupt the construction
process. This could cause costly delays or failure to complete the project. In that case taking out
more debt might be a costly solution considering the increasing risk of the project at that point in
time.




Construction Financing
% $(in millions) RMB eq Cost of Debt
Equityholders
Maple Energy 49% 8,09 $ 9% rE
Tianjin Plastic 46% 7,59 $ 63,16 14% 11,55%
Mopi 5% 0,82 $ 6,82 14%
Total Equity 16,50 $
Debt
Equipment Vendors 29% 22,00 $ 9% rD
Bank Loan 71% 55,00 $ 9% 9,00%
Total Debt 77,00 $
Total Investment 93,50 $
% in $ 91%
% in RMB 9%
WACC during construction 9,45%
Operating risk
The definition of operating risk is defined as the risk of a change in value resulting from the fact
that the actual losses differ from the budgeted losses caused by inadequate or failed internal
processes, people and systems or from external events. It is a form of risk that reflects the risk a
company has when it operates within a given field or industry. The operating is applicable as
soon as the financing risk and construction risk has occur.

Maple Energy, MOPI and Tianjin Plastics can all be negatively affected by the operational risk,
since the operating risk is a risk that has an effect on the client satisfaction, reputation and the
shareholder. The shareholders are not the only stakeholder who can suffer from a change in value
caused by a negative variance between the actual and budgeted losses. The U.S West Coast,
Canadian, Japanese Bank, and the Bank of China lenders could suffer from operating risk. If the
project turns into failure through the operating phase, then there is a possibility that the lenders
will not be able to get their full amount of funds back. The creditors of the supported limited
recourse loan with an amount of $33 million, have a large possibility to lose all of their funds in
case the project fails. The creditors of the supported non-recourse loan with an amount of $57
million will have a lower probability of losing all of their funds, due the fact that the loan is
secured by a pledge of collateral in the form of the assets of the project. For a more detailed debt
schedule, see appendix.

Post-Completion Financing Cost of capital
Total Equity 16,50 $ 14,05% 18% rE
18,00%
Debt Principle 77,00 $
Accrued Interest 23,90 $
Total debt 100,90 $ 85,95% rD
Total capital 117,40 $ 7,83%
Debt structure RMB eq Loan term
Bank of China loan 10,80% 10,90 $ 0,00 13% 12y
Tranched loans
Limit resource loan 32,71% 33,00 $ 6,7% 6y
Non-limit resource loan 56,49% 57,00 $ 7,5% 10y
90,00 $
Total Debt 100,90 $
WACC post-completion phase 9,3%

Before looking at the operating risk, it must be clear to what extent there is an operational risk to
the parties mentioned. Operational risk can be caused by internal, external failures or
inadequacies and are difficult to predict, but often already diversified by the company. The
external are easier to predict when considering environmental risk. Natural disasters are well
known in China and affect more than 200 million people every year. They have become an
important restricting factor for economic and social development. The sea level in the Tianjin
area is rising at an alarming rate because of climate change and depleting groundwater threaten
coastal economies. There is a big chance that the project would suffer from losses caused by
external events, specifically floods that can damage a firms valuable tangible assets. The chance
for natural disasters can also easily cause an infrastructure shutdown. This would be dramatic for
especially the transfer of coal to the plant, which could cause a failure for the production of raw
industrial plastic and cause the project to fail. However, contracts with Chinese insurance
companies could diminish the loss of natural hazards but increases operating costs.
Political risk
The Peoples Republic of China, although not known for it implacable strict environmental
policy, has a very strict policy concerned foreign investments. The Chinese currency is the
Renminbi (Rmb), which is highly monitored and controlled by the Chinese government to an
extent approvals have to be given by the State Administration of Exchange Control (SEAC) in
order to convert their currency. This process has proven to be a long bureaucratic process in
which international banks were not convinced of their success (even with governmental
guarantees) over an extended period of time, which is needed for a project like Tianjin Plastics
power plant. This shows the difficulty in getting the cash out of the country in dollars instead of
Renminbi.
Unlike the dollar, the Renminbi itself does not prove to be a stable, reliable currency over the
years. The Chinese government highly controlled the currency and tried to stabilize it, even
succeeded at one point in time, by introducing a stabilization program. It remains unsure how the
currency will fluctuate in time and how this would affect the long- term investment in the power
plant. The course of the Renminbi cannot be derived from historical data, as it is sensitive to
multiple factors besides laying under governmental control. The three banks of the bridge loan
agreed to account for the currency convertible risk, as the Bank of China would not suffer from
this problem. Maple Energy as a foreign company, will face risk converting for a value of 10.22
million in the first year of operation (2000) and will continue to face this risk every year to take
out their profits in dollars.
Another main concern is the limit on return on investment (ROI) of 15 percent stated by the
government. This ROI could extend to 17 percent if the power plant proved to be outstanding
efficient. The power plant project should actually deliver a ROI of 18 percent according to the
analysts for this kind of investment. Registered capital is not allowed by the Chinese
government, which means that repatriation of equity is ruled out. This will lead to a loss of 8.085
million dollar invested by Maple Energy.
Credit Risk
Credit risk refers to the risk a lender has to bear regarding the loss of his fund in case of default
by the borrower. This risk includes losses of principal, interest, increased collection costs and
disruption to cash flows. There is a possibility the project fails and the equity holders would not
have sufficient fund created by the project to repay their debt to the lenders. In case of the
limited recourse loan of $33 million, the lenders will be exposed to the risk of losing all of their
money. In case of the non-recourse loan of $57 the lenders can seize the collateral, which are the
assets of the project, however it is uncertain if the assets could be sold. It is very important that
the assets of the project will be liquid so that in case the project fails, the lenders will have a
better change in selling the assets. The Bank of China will also be exposed to the risk of losing
their $23 million accrued interest in case the project fails. This would occur in case the
borrowers of the syndication loan are not able to repay the debt.

Maple, Tianjin Plastics and MOPI have a total equity value of 16.5 million dollar to finance the
project. In case the Tianjin project fails, these three equity holders will lose their capital. These
three companies are also exposed to the currency risk due the absence of financial products, such
as derivatives that could be used to hedge. Maple Energy will be very vulnerable for credit risk
in case the RMB exchange rate is volatile. Tianjin Plastics and MOPI both use the domestic
currency, and thus are not harmed by the volatility of the RMB.

Structure return and currency risk
As mentioned in the case the EBIT is forecasted at 178 mil RMB in 2000 with an annual growth
rate of 3%. In dollars this EBIT is $ 21.39 million. The first 6 years of operations will be tax-
free. Accumulated depreciation is 98 mil RMB, or $ 11.78 million each year, of which 25% has
to be reinvested in the project. This is a requirement of the Chinese government, besides this they
stated that the return on investment on the project should be between 15%-17%. The required
hurdle rate of maple is 15%, which is low due to the high risk that is involved with investments
in the Chinese economy. Analyst estimate the hurdle rate at 18%. After analyzing this given data
we computed the EBIT for coming years together with the Net Income and FCFE of both Maple
and the project.


Maple has 3 options to overcome the currency risk involved with the project. They can index to
the dollar, agree with the back-to-back loans or finance the project in RMB. The first option is
not available because MOPI wants the revenues to be in RMB since the Tianjin project is also in
RMB. For the other 2 options the goal is to have the lowest possible WACC, in order to give a
good advice to Mr. Johnson we will compute the WACCs of both options. The Cost of equity
tax first 6 years 0%
operating margin growth 3%
depreciation 98 million rmb
$ depreciation 11,78
reinvest 25 % 24,5
reinvest 25% in $ 2,94
cost of equity 18%
exchange rate (RMB/$) 8,32%
Scenario 1 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005
EBIT (RMB) 178 183,3 188,8 194,5 200,3 206,4
EBIT ($) 21,39 22,04 22,70 23,38 24,08 24,80
Interest exp 7,90 6,99 6,07 5,16 4,25 3,33
Net income 13,49 15,05 16,62 18,22 19,83 21,47
Depreciation 11,78 11,78 11,78 11,78 11,78 11,78
Reinvest 2,94 2,94 2,94 2,94 2,94 2,94
Debt -12,11 -12,11 -12,11 -12,11 -12,11 -12,11
FCFE 10,22 11,77 13,35 14,94 16,56 18,19
FCFE Maple -8,085 0 0 0 5,01 5,77 6,54 7,32 8,11 8,92
FCFE discounted with 18% rE 1,84 2,12 2,40 2,69 2,98 3,28
NPV 7,32
IR 29%
for the back-to-back loan and the swap deal are respectively 10,5 and 14% (18%-4%). The Cost
of debt for both options are 7.83% on average, as computed in the post-completion financing
phase.
Back-to-back loan WACC : (16.5/117.4)*0.105 + (100.9/117.4)*0.0783 = 8.2%
Swap deal WACC : (16.5/117.4)*0.14 + (100.9/117.4)*0.0783= 8.6%
We can see that the WACC of the Back-to-back loan is lower than the swap deal. When
computing NPVs for both options the Back-to-back loan will be more favorable than the swap
deal. The swap deal still has a high factor of currency risk, which is not the case in the back-to-
back loan. Also the IR for the back-to-back loan will be higher, so more favorable.
DBFMO

DBFMO is the abbreviation for Design-Build-Finance-Manage-Operate and is a contract form
that consist of a collaboration between a public and private party. The private party is
accountable for providing a service and make it publicly available. On the other hand, the public
party pays in installments starting from when the service is publicly available according the
deadline of the contract. There are multiple benefits for the public party to engage in this form of
contract instead of a traditional form. While the private party is responsible for making the
project operational, it manages the administration and maintenance for an agreed period of time.
This leads to costs reductions due to specialization, while the public party has the opportunity to
focus on its core operations. The risks in this type of contract is assigned to the party that is the
most capable of managing the risk, which indicates that the risks are not bore by only one party.
The Ministry of Finance engaged in a DBFMO contract with Safire B.V. for the renovation of its
building. This contract consists of designing, renovation, financing, and restructuring of the
ministry. The company is also responsible for managing the administration and maintenance of
the building for an agreed period of 25 years. The project was completed in 2008 and has a value
of 173 million Euro, which is a large project and led the way to more DBFMO projects
contracted by the government.
Similarity
For both cases, Tianjin Plastics power plant and building of Ministry of Finance, the completion
of the projects in time is crucial. Any delays in completing the projects are costly. In case of the
power plant, any delay means that the construction phase will take up more than four years. In
that scenario, the cash flows will not start in 2000 while the repayments of the debt will start on
time according to the contract (2000). For the renovation project of the Ministry of Finance
building a penalty will be enforced when not delivered on time. This penalty appears to be not
taken lightly by Safire B.V. The project was finished two months before the estimation date.
Differences
According to the DBFMO contract of the renovation project of the Ministry of Finance building,
Safire B.V. is responsible for designing, building, financing, managing, and operating of the
building for 25 years. The Tianjin Plastics power plant will not be operated by Maple Energy,
but will be turned over to Tianjin Plastics and MOPI once the power plant is fully operational.
This project is considered to be a turnkey EPC, which means that Maple Energy will turn the key
to the actual owners after completing the construction phase of four years. The Tianjin Plastics
power plant could be considered to be a DBFM contract, hence no operating element.
The DBFMO in the case of the renovation of the Ministry of Finance building assigned the risk
to the party that is capable of managing the risk better. In case neither of the parties is able to
fulfill the role, the risk will be divided between the two parties according to some proportions
agreed upon. In the case of the Tianjin Plastics power plant, there appears to be a power
imbalance relationship. The government owns the Tianjin Plastics company, which has a 46
percent stake in the project, but refuses to provide any guarantees in case of failure of the project
besides the refusal of MOPI which is a governmental entity.
Maple Energy expects an annual operating margin of 178,000,000 Renminbi (Rmb) generated by
the power plant, with an annual growth of 3 percent till 2020. The financing of the renovation
project of the Ministry of Finance building will be paid in installments rather than in cash flows.
The contracted company, Safire B.V. has no stake in the building of the Ministry of Finance but
merely arranged the financing of it (along the other contracted responsibilities).