2-3 Financial Model

Financial Modelling
Working with numbers: meanings beyond the excel

sheets
October 5, 2010 Strictly Private and Confidential

Yanggwi Michael Hwang
Senior Manager at Samil PricewaterhouseCoopers
Expat to PricewaterhouseCoopers Sydney office, Australia (2006 ~ 2008)

Assurance staff at Ernst & Young Palo Alto office, US (2001 ~ 2002)
Oman IPP Project, Turkey OOO Expressway, Cambodia OOOO Express
Highway, and Mongolia OOO Project.
Valuation of Commercial Port of Vladivostok in Russia
Buy-side financial due diligences on diverse Australia companies such as
Alinta (Australias leading power supplier), City Pacific Limited (Property
finance institute), Pacific National (Rail freight), Perfection Fresh Australia
Name: Yanggwi Michael Hwang Pty Limited, Choice Harvest Pty Ltd, Arnotts Snackfoods (Food), Powertel
(Telecommunication), Dymocks (Retail) and others
Title: Senior Manager
Financial model review services for the acquisition of Senoko Power Limited,
First Gas, Terra Renewal LLC and many other PPP projects
Line of Service: Deal Business
Financial due diligences and feasibility studies on diverse PPP companies in
Qualification: USCPA Korea such as Daewoo Logistics, Namkyung Power, Seoul-Chuncheon
Expressway, Daegu Dongbu 4th Beltway and others
Tel: +82 2 3781 9085 Advisory services on the preparation of PPP project plans such as Ulsan
Garbage Incinerating Facilities, Busan New Port 2-3 Phase and 2nd Yong-
E-mail: yghwang@samil.com Dong Expressway
Assist KDIs study on Financial arrangements and practices in Australian
and UK Public Private Investment
Financial Modelling Working with numbers: meanings beyond the excel sheets
Table of Contents
Page
1 Financial Model Development 1

2 Understanding Numbers 13
Appendix
1 Spreadsheet Design - Best Practice Top Tips 24
Section 1
Financial Model Development
Section 1 - Financial Model Development
FM Development Flowchart
Scope Specify Design Build Test

Understand Understand Identify Develop FM Change
the purpose key raw data sheets to be in Excel variables and
of FM (e.g. project developed format based check if the
cost, revenue, based on the on the Scope, changes
Understand
expense, and Project Specify, and reflect results
Project
loan terms Design as expected
Monthly/Quar
Understand and applied
terly/Yearly e.g. project
cash flow conditions)
FM cost, revenue,
pattern
Specify expense,
outputs (e.g. interest rate,
IRR, ROE, and others
ROI, DSCR)
Financial Modelling Working with numbers: meanings beyond the excel sheets 2
1. Scope: User of Financial Model (FM)
Sponsor Developer
Initial idea for the model. Ensures Translates the initial ambitions in to reality.
supporting resources are available. May
User
not have further involvement.
At least one person - usually more.
Owner
Heavily involved throughout whole process
Driving force behind model. Heavily of model development.
involved in objectives setting stage of the
Reviewer
project.
Involved in checking that the model
Project manager
matches initial specification, and contains
Communication between all separate no significant errors.
elements of project team and client
maintained by this person. The problem
solver.
1. Scope: Purpose of FM
Different users have different emphasis in FM

Developer: Total cash earning, IRR, ROE
Lender: Debt service coverage ratio
Construction Company: Return on construction cost
Government: Value for Money
FM shall explain Operating, Investing and Financing CF results.
CF from operating activity: Forecast Projects operating revenue and expense.
Shall be easily adjustable for operating assumption changes (e.g. traffic demand,
tariff, operating expense and others)
CF from investing activity: Forecast Projects investment cost. Shall be easily
adjustable for investing assumption changes (e.g. construction cost)
CF from financing activity: Forecast Projects required funding amount, debt and
equity amount, and drawdown and repayment schedules. Shall be easily
adjustable for financing assumption changes (e.g. interest rate, debt vs. equity)
1. Scope: Understand Cash Flow of Project
Understanding cash flow during construction and operation period
2. Specify: FM Logic
The logic of the specification should be built from the outputs through
calculations to the inputs
Model logic
Inputs Calculations Outputs
Model specification
2. Specify: Raw Data and Key Results
Raw data Key results

Total project costs (e.g. survey, design, NPV
construction, compensation, incidental,
IRR
operation equipment, taxes)
ROE
S-Curve
Total project cost
Equity: amount and input schedule
Equity and debt amount
Debt: amount, drawdown and payment
schedule, interest rate, financing cost, DSCR
and covenants
ST debt (how much, when, how long)
Government subsidy: amount and
Operating revenue and expense
input schedule
FM check
Operating revenue and expense
forecast Others
Others
3. Design
Design excel spread sheets to develop

Model unit period : Monthly, quarterly, yearly ?
Develop FM based on CF analysis purpose
Lender: If repayments are required on a quarterly basis, quarterly FM shall
be developed to calculate DSCR, DSRA, repayment schedule, interest rate
and others
Developer: Annual CF is enough to calculate IRR
Use different colours
Numbers in Blue: Input data
Numbers in Red: Key results
Numbers in Black: Calculated data
4. Build: FM Sheets Flowchart
4. Test
4. Test: Construction Period
Total investment cost input schedule Fudning input_cummulative
40,000 100,000
80,000
KRW M
KRW M
20,000 60,000
40,000
20,000
-
2011-03 2011-06 2011-09 2011-12 2012-03 2012-06 2012-09 2012-12 -
Construction expense Cost for operation of equipment 2011-03 2011-06 2011-09 2011-12 2012-03 2012-06 2012-09 2012-12
Incidental expense Operating reserve
Inflation Construction interest
Equity Senior debt
Total investment cost input_Cumulative Breakdown of funding
100,000
80,000 33%
KRW M
60,000
40,000
20,000 67%
-
2011-03 2011-06 2011-09 2011-12 2012-03 2012-06 2012-09 2012-12
Construction expense Cost for operation of equipment

Incidental expense Operating reserve Equity Senior debt
Inflation Construction interest
4. Test: Operation Period
Operating revenue analysis Operating expense and CAPEX analysis
% of operating revenue
20,000 150%
50,000
15,000
100%
KRW M
40,000
10,000
KRW M
30,000
50%
5,000
20,000
10,000 - 0%
13
14
15
16
17
18
19
20
21
22
23
24
25
26
27
-
20
20
20
20
20
20
20
20
20
20
20
20
20
20
20
Labor expense General expense
2013
2014
2015
2016
2017
2018
2019
2020
2021
2022
2023
2024
2025
2026
2027
CAPEX O & M Cost
Insurance expense Advertising expense
Rent expense Other expense
Toll revenue Other revenue Revenue to expense ratio
Cash balance at year-end by case
80,000
60,000
KRW M
40,000
20,000
-
2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026 2027
Case 1 Case 2 Case 3
Section 2
Understanding Numbers
Section 2 - Understanding Numbers
1. Net Present Value (NPV)?
NPV is the difference between the present value of cash inflows and the
present value of cash outflows.
To analyze the profitability of an investment or project.
Applied discount rate is an expected rate of return from project
n
CashIni n CashOuti
NPV = i
- i
i =1 (1 + r ) i =1 (1 + r )
n = the time of the cash flow r = Discount rate
CashIni = Cash inflow at time i CashOuti = Cash outflow at time i
NPV > 0: Positive net cash flow with r Project investment accepted
NPV < 0: Positive net cash flow with r Project investment declined
2. Internal Rate of Return (IRR)?
IRR is the discount rate that makes the net present value of all cash flows (both
positive and negative) from a particular investment equal to zero.
NPV vs. IRR
NPV: Expressed in monetary value
IRR: Expressed in percentile
IRR > Expected discount rate (r): Project return rate is greater than expected
one Project investment accepted
IRR < Expected discount rate (r): Project return rate is less than expected one
Project investment declined
3. NPV and IRR Example (1)
IRR : 6.0%
NPV (6.0%) = 0 : When r = IRR, NPV= 0.
NPV (4.0%) = 69,806 : When r < IRR, NPV > 0
NPV (7.0%) = (31,656) : When r > IRR, NPV < 0
Real cash flow
Nominal cash flow (Annual CPI growth of 5%)
Fisher effect
(1 + Real IRR) (1 + CPI growth rate) = (1 + Nominal IRR)
4. Feasibility Analysis Flowchart (Example)

Raw data
-Project cost and input schedule, revenue, operating expense,
tax and other data are prepared
Period assumption applied
Calculate total project cost
during construction period
Debt vs. Equity amount
Repayment schedule, interest rate, covenant and others
Plan for debt repayment
No problem with Debt NO

repayment ?
YES
Cash shortage during YES
project period ?
NO
Sensitivity and Scenario Analysis
5. Interpretation of Key Results
Analysis on Project
NPV > 0 ?
IRR > Expected rate of return ?
Any cash shortage ?
Lenders Analysis
DSCR (Debt Service Coverage Ratio)
Short term debt
DSRA (Debt Service Reserve
Account)
MMRA (major Maintenance Reserve
Account)
Covenant for sub-debt and dividend
payments
6. SOC Project Sensitivity Analysis (1)
BTO/BOT Project IRR and usage fee calculation

n N N
CCi ORi - OCi ANRi

i =0 (1 + r ) i
=
i = n +1 (1 + r ) i
+
i = 0 (1 + r )
i
n : Construction completion year

CCi : Total Private Project Cost
N : Operation end period
ORi : Operating revenue
ANRi : Annual net income from ancillary project
OCi : Operating expense (tax excluded)
r : Project IRR
Key sensitivity factors affecting Project IRR/Usage fee/Government Subsidy
Total Project Cost
Operating Expense
Government subsidy
Project IRR or Usage fee
Operating Revenue
Net income from
ancillary project
6. SOC Project Sensitivity Analysis(2)
Increase in total project cost (survey, design, construction, compensation,

incidental, operation equipment, taxes) IRR Government subsidy/Usage fee

Decrease in operating cost (labour, general, maintenance) IRR
Government subsidy/Usage fee
Decrease in CPEX (# of units, unit per price) Total project cost
Replacement cost during operation period IRR Government
subsidy/Usage fee
Increase in revenue (traffic volume, tariff) IRR Government subsidy/Usage
fee
Increase in concession period IRR Government subsidy/Usage fee
But, IRR might decrease when major replacement costs need to be incurred.
6. SOC Project Sensitivity Analysis (3)
Increase in CPI rate Tax After-tax IRR Government subsidy/Usage

fee
If CPI growth rate is forecasted to increase from 4% to 5%, tax on cash flow is
affected.
The portion of amortization and interest expense from total tax base income is
reduced and as such tax expense increases.
After-tax project IRR is reduced and therefore government subsidy increases.
Decrease in interest rate Tax After-tax IRR Government
subsidy/Usage fee
If Annual debt interest rate decrease from 10% to 9%, tax on cash flow is affected.
After-tax project IRR is reduced and therefore government subsidy increases.
Government subsidy decrease while interest rate increase.
Before-tax IRR is not changed substantially from the changes in CPI growth rate and
interest rate
Appendix 1
Spreadsheet Design - Best Practice Top Tips
Appendix 1 - Spreadsheet Design - Best Practice Top Tips
Spreadsheet Design - Best Practice Top Tips (1)
1. Keep it simple!
l e.g. simple formula; refer input on same sheet, break formulae into multiple rows.
l less risk of confusing yourself and others
l easier to follow the audit trail
l no prizes for complicated formulae
2. Separate Inputs/Calculations/Outputs using different sheets & colours

l so you can easily identify the assumptions
l understand the flow of the model
3. Keep the flow natural, top to bottom, left to right

l e.g. display assumptions on calculation pages before referring to them in calculations
l makes the spreadsheet easier to read and understand
l however, key outputs should be on left of the model
4. Input data once - use it many times and link

l reduces risk of not updating all occurrences of an input
l reduces the number of inputs
5. One formula per row or column, and write them to be copyable

l prevents errors from copying over mid-row formulae changes
l logic is always in one place, and the same place, in each row
l makes reviewing/testing and future maintenance easier
6. Make column headings consistent, and use the same starting column for each time
series (rule of F14)
l allows for simpler formulas and avoids referencing errors
l multiple narrative columns (A-E) allows for clear labelling
7. Use protection
l reduces the chance of accidental change
l not for prevention of malicious damage, so dont use worksheet passwords
8. Range names
l makes formulae more readable, particularly when referring to another worksheet
l encourages good design and structure
l can enable a building block approach
l very useful if linking to another workbook
9. Make extensive use of error traps and cross checks, and summarise results on a
single sheet
l makes Excel work to help find mistakes
l quick view to see if errors have been introduced
10. Use colour coding and formatting in a clear and consistent manner
l e.g. indicates cell types, worksheet categories and conditional formatting highlights exceptions
l provides visual clues to make meaning and intention clear
l reduces risk of inappropriate data being entered
l flags items of interest for investigation
11. Use repeating worksheets with identical structures or repeat calculation blocks
l reduces the work involved in repetitive calculations
l enables punch-through consolidations
l facilitates testing
12. Use navigation tools such as hyperlinks

l so you can move around easier and understand structure
l include a single Navigation worksheet that all sheets link back to
13. Include documentation and instructions at the front of the model

l enables other to understand and use the model
14. Identify and label real and nominal costs

l avoids apples and pears errors
l avoids double inflation errors
15. Treat external links as inputs and do not include external links in formulae
l avoids confusing references and overlong and unreadable formula

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Financial Modelling

Working with numbers: meanings beyond the excel

October 5, 2010 Strictly Private and Confidential

Expat to PricewaterhouseCoopers Sydney office, Australia (2006 ~ 2008)

1 Financial Model Development 1

Scope Specify Design Build Test

1. Scope: User of Financial Model (FM)

Different users have different emphasis in FM

1. Scope: Understand Cash Flow of Project

Understanding cash flow during construction and operation period

Inputs Calculations Outputs

2. Specify: Raw Data and Key Results

Raw data Key results

Design excel spread sheets to develop

4. Build: FM Sheets Flowchart

4. Test: Construction Period

Total investment cost input schedule Fudning input_cummulative

Total investment cost input_Cumulative Breakdown of funding

Construction expense Cost for operation of equipment

4. Test: Operation Period

Operating revenue analysis Operating expense and CAPEX analysis

Cash balance at year-end by case

Case 1 Case 2 Case 3

1. Net Present Value (NPV)?

2. Internal Rate of Return (IRR)?

3. NPV and IRR Example (1)

3. NPV and IRR Example (2)

3. NPV and IRR Example (3)

Real cash flow

Nominal cash flow (Annual CPI growth of 5%)

4. Feasibility Analysis Flowchart (Example)

Plan for debt repayment

No problem with Debt NO

Sensitivity and Scenario Analysis

5. Interpretation of Key Results

6. SOC Project Sensitivity Analysis (1)

BTO/BOT Project IRR and usage fee calculation

n : Construction completion year

Total Project Cost

6. SOC Project Sensitivity Analysis(2)

Increase in total project cost (survey, design, construction, compensation,

6. SOC Project Sensitivity Analysis (3)

Increase in CPI rate Tax After-tax IRR Government subsidy/Usage

Spreadsheet Design - Best Practice Top Tips (1)

2. Separate Inputs/Calculations/Outputs using different sheets & colours

3. Keep the flow natural, top to bottom, left to right

Spreadsheet Design - Best Practice Top Tips (2)

4. Input data once - use it many times and link

5. One formula per row or column, and write them to be copyable

Spreadsheet Design - Best Practice Top Tips (3)

Spreadsheet Design - Best Practice Top Tips (4)

Spreadsheet Design - Best Practice Top Tips (5)

12. Use navigation tools such as hyperlinks

13. Include documentation and instructions at the front of the model

14. Identify and label real and nominal costs

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