Hello guys, today I would like to focus our attention on the estimation of the profitability of an infrastructure finance deal from the perspective of shareholders. This is particularly important because shareholders want to know exactly how much they can get out of a project finance transaction. And from this point of view, we have to exactly identify and measure, that it is sufficiently reliable from the point of view of shareholder, in order give him some hints in terms of how much exactly you can get out of this particular project. >> Well professor, we have seen how to set up the financial forecast for the transaction. Then from the point of view of the shareholders, what are the most relevant issues that have to be taken into account for evaluation? >> You know that in corporate finance and in capital budgeting theory, the most important profitability measures that you can apply to whatever kind of project are represented by either a net present value calculation or an internal rate of return calculation. And they are indifferent if you are taking into account one single project. In the world of project finance, IRR has been used very frequently, and has emerged as the most widespread used measure for calculating the profitability of these particular kind of transactions. So if IRR becomes the relevant measure that we want to calculate, we must put ourself in the shoes of a shareholder that must exactly identify the relevant cash flows that must be taken into account for the calculation of this measure. If we go back last week, we set up a capital budgeting exercise. And we ended up with two key elements, the budget of the construction phase and the budget of the operational phase. During the construction phase, the relevant flows for shareholders are the equity contributions that shareholders provide to the special purpose vehicle as long as the construction goes on. So, the key input for the calculation will be the work in progress schedule of payment and the debt to equity ratio that we have decided to use in order to finance the project. So during the construction phase, the financial analyst must take into consideration the contributions that the shareholders have provided throughout the construction phase. During the operational phase, you will certainly remind that last week, we ended up our cash flow statement with the calculation of the free cash flow to shareholders or free cash flow to project sponsors. These cash flows are potentially the relevant flows that the sponsors can get throughout the operational life. In reality, I suggest, because there are different kind of ways analysts calculate internal rate of return for project sponsor shareholders, I personally suggest to use dividends, rather than free cash flow to project sponsors. And there is a subtle difference between the two. In general, in the very early years of the operational phase, creditors do not allow project shareholders to withdraw all the free cash flow available to project sponsors. They prefer to keep a portion of the cash inside the vehicle in order to overcome future potential difficulties that the project could face. If this is the case, it is obvious that the value of dividends that you can get is always lower than the level of free cash flow available for shareholders. For this reason in corporate finance, you must take into account flows of cash, not potential flows of cash. Summing up, during the construction, take the contributions of equity. During your operational phase, take the stream of dividends from the beginning of the operational phase down to the end. Mix up the two and apply the standard IRR calculation. You will get a measure of IRR equity, which is the basic criteria that shareholder use in order to assess the profitability. And, of course, they will say go on if this IRR is higher then the cost of funding of a shareholder. And they would say no if this value is below a given threshold, typically represented by the cost of funding. >> Well professor, we have seen that the sponsor can play more than one role. I was thinking, does this measure of components will change if the sponsor is at the same time sponsor counter party? >> That's a good question. The answer is, yes, it changes, not from the point of view of the criteria. The criteria always remains the internal rate of return. So, from this point of view, the measurement remains exactly unaffected. However, the relevant flows that we must take into account change. Take for example the case of I don't know, you are a big contractor and at the same time you are also a shareholder of the special purpose vehicle. So arguably, what you will do is you will provide equity, because you want to get dividends. But you will also provide all of the facilities and construction during the construction phase. And for this kind of task, you will be paid, so you will get a margin also as a contractor of the construction phase. So, from this point of view, the correct calculation of IRR for this specific sponsor should include not only the equity contribution during construction, not only the dividend payments during the operational phase. But also the profit margin that this contractor is able to extract from this particular infrastructure during the construction phase, because he's paid for a service that he's providing to the SPV. And it could go on and on with other examples. If you are a supplier, you will also consider all the profit margins that you can get in providing raw materials to the SPV. I could consider the case of an operation of a maintenance agent. You could add to the flow of dividends all the stream of O and M fees that you will get from the project. And so, from this point of view, Jim, the calculation remains exactly the same. But the input for calculation is the base calculation for a pure financial sponsor. And on top of that, every other additional cash flow that you can get out of the project, because you are one of the counter parties of the SPV itself.