Consistent valuation of project finance and LBOs using the flows‐to‐equity method

Abstract

The flows‐to‐equity method is used to value transactions where debt amortizes according to a fixed schedule, requiring a formula that links the changing leverage with a time‐varying equity discount rate. We show that extant formulas yield incorrect valuations because they are inconsistent with the basic assumptions of this method. The error from using the wrong formula can be large, especially at currently low interest rates. We derive a formula that captures the effects of a fixed debt plan, potentially expensive debt, and costs of financial distress. We resolve an important issue about what to use as the cost of debt.

LBO Valuation Using Flows-to-Equity

“…The flows to equity method can be reconciled with standard valuation methods. Doing so reveals several interesting issues that are not usually addressed explicitly when standard methods are used (Cooper and Nyborg, 2018). Consider, for example, the treatment of the debt spread.…”

Balanced Scorecard-Based Evaluation of Sustainable Energy Investment Projects with IT2 Fuzzy Hybrid Decision Making Approach

“…As a result, the success of the projects will be difficult. Similarly, Cooper and Nyborg [22] identified that the fact that companies are exposed to too much liquidity risk increases the probability that the project will fail. In addition to these studies, Montgomery et al [23], Sainati et al [24] and Rode et al [25] focused on this issue for different countries, such as UK, Turkey, Indonesia, Malaysia and Brazil.…”

Investment valuation model for sustainable infrastructure systems

“…However, the authors do not take into account either debt-equity conversion or sustainability issues. In this line, studies raised and developed new investment valuation models applied to infrastructure systems (Cooper and Nyborg, 2018;DiMuro et al, 2014;Hajji et al, 2017;Ho and Liu, 2002;Huang and Pi, 2014;Jackowicz et al, 2017;Jeong et al, 2016;Kashani et al, 2015;Kim et al, 2013;Lu et al, 2016;Pantelias and Zhang, 2010;Wibowo, 2006;Yan et al, 2017) and significant works on sustainable infrastructure financing. For example, Büyüközkan and Karabulut (2018) provided a structured overview of analytical assessment methods into conceptual sustainability frameworks; Lee and Zhong (2015) developed a financing instrument that securitises future income in the form of a hybrid bond for renewable energy projects; Shen et al (2016) examined the impacts of the contribution distribution between public and private sectors on project sustainability performance; Shen et al (2002) developed an alternative quantitative model for assessing the feasibility that a construction project gets involved in contributing to sustainable development; Quesnel et al (2017) developed a conceptual financing model for the water sector based on the electricity sector; Quesnel and Ajami (2018) examined advanced water financing through public benefit funds; and Shan et al (2017) analysed innovative models and mechanisms for sustainable construction finance.…”

“…From the sponsor's point of view, the selection of the discount rate is one of the crucial aspects of economic engineering analysis given that it represents the opportunity cost of money to the party considering some investment (Zhang, 2005). For this issue, the capital asset pricing model (CAPM), which is widely used both in corporate valuation (Damodaran, 2012;McKinsey & Company et al, 2015) and valuation techniques for infrastructure investment decisions (Cheah and Liu, 2006;Cooper and Nyborg, 2018;Dong et al, 2011;Garvin and Cheah, 2004;Menassa, 2011;Brandao and Saraiva, 2008;Wibowo, 2006;Ye and Tiong, 2000), is used for estimating the sponsor's discounted rate (k e ).…”

“…When the Water Criteria are met at the O&M stage, the debt-equity conversion could be executed giving rise to the FCV. From a theoretical and practical perspective, there is a special focus on the relation among the different cash flows, such as free cash flow, debt cash flow, equity cash flow and capital cash flow, which have been widely mentioned by Borgonovo and Gatti (2013), Borgonovoa et al (2010), Cooper and Nyborg (2018), Damodaran (2012), Espinoza and Morris (2013), Esty (1999), Gatti (2018) and Jackowicz et al (2017) because of its importance in the areas of infrastructure investment and firm valuation; however, none of them has either explicitly addressed sustainability issues with debt-equity conversion process nor has combined debt cash flow with equity cash flow.…”