FINC627 International Finance Case write-up: Tianjin Plastics Li Yu EXECUTIVE SUMMARY: Maple Engery (U.S), a U.S.

-based power plant provider, is evaluating the prospects for a project financing of the Tianjin Plastics power plant project in China in 1996. The proposed project financing agreement must ensure the financial viability of the project. In addition, the proposal must consider both the currency risk of potential RMB devaluation and the impact of substantial barriers to investing in China, including y Chinese government limited the target ROI between 15%-17%, while analyst estimated at least 18% was needed to adequate compensation for projects of this type. y Chinese government may refuse to guarantee fulfillment of a contract like this. This increased the project risk, hence the cost of borrowing. y Chinese government did not allow equity investment to be repatriated. Maple Engerymust find a solution to repatriate its invested capital. The case discussed in details of three options for repatriation of Maples equity investment, including back-to-back loans, dollar-indexed rate adjustment, and RMB swaps. We found backto-back loan was the most attractive option, with a NPV of $11.6 million and a discounted payback period of 5 years. Maple can also lock a fixed exchange rate at 8.32 RMB/$ for six years.

FINC627 International Finance Case write-up: Tianjin Plastics Li Yu Project overview 1. Background Maple Energy, a wholly-owned subsidiary of Northern States Utilities, was established in 1989. Maple was a developer of power plan projects and successfully completed power plan projects in four countries. In 1996, Maple had concluded the power purchasing agreement(PPA) with the Chinese Ministry of Power Industry (MOPI), with a free coal feedstock for the life of the power plant (20+ years). Maple formed a joint venture with Tianjin Plastics and MOPI to operate the power plant for 20 years and would hand out the control of the power plant to local government. The market potential for similar power plant projects in China was enormous. The projected power demand in China would be 21 gigawatts of new capacity each year, 150,000 times of the capacity of Maples power plant project. 2. Project Financing 2.1 Capital Structure

The project financing including two phases: construction phase(4 years) and post completion phase. 2.1.1 Construction phases In the construction phases, total capital of $93.5 was provided through a combination of loans from project sponsors( Maple Energy and Tianjin Plastics), equipment vendors and bank loans. The detailed schedule and cost is listed in EXHIBIT 1 and EXHIBIT 2. Timeline for Project Financing
Draw down $16.5 Draw down $27.5 bank loan from three sponsors
1996 1997

Draw down $27.5 bank loan

1998

Draw down $22 from equipment vendors

1999

2000

Interest and principal repayment

EXHIBIT 1 Timeline for construction phase

FINC627 International Finance Case write-up: Tianjin Plastics Li Yu

Construction Financing $Mil Equity Maple Engery Tianjin Plastic MOPI Debt Equipment Vendors Bank loan Total Invest % of USD % of RMB 49% 46% 5% 8.09 7.59 0.82 RMB equivalent Currency Cost of Debt 9% 14% 14%

USD 63.16 RMB 6.82 RMB

29% 71%

22 55 93.50 91% 9%

USD USD

9% 9%

EXHIBIT 2Detailed financing in construction phase

2.1.2 Post completion phase Upon the construction completion, the principle of the three sponsors would convert into equity, and accrued interest and the rest of the principle would be arranged by Bank of China loan and two tranches of syndication loan. The project WACC would be 9.3%.
Post ompletion Finaning $Mil Total Equity Debt Principle Accrued Interest Total Debt Total Capital Project WACC Debt Stutue 16.50 77.00 23.90 100.90 117.40 9.3% % 14% Cost of Capital 18.00%

86%

7.83%

Bank of hina loan Syndiation loan Limited recourse tranch non recourse tranch Total syndiation loan Total Debt % of USD % of RMB

$Mil

RMB equivalent Currency Cost of Debt Loan Term (y) 10.9 90.7 RMB 13% 12 33.0 57.0 90.0 USD USD 0.95%+LIBOR 1.75%+LIBOR 6 10

100.90 89% 11%

EXHIBIT 3Detailed financing in post completion phase

FINC627 International Finance Case write-up: Tianjin Plastics Li Yu

De bt he dule Ban of hina Inte rest ayme nt riniple re pay e ndin balane

2000 10.9 1.42 1.84 0.4 10.5 2000 33.0 2.21 6.86 4.6 28.4 2000 57.0 4.3 8.3 4.0 53.0 7.90 9.1 17.01

2001 10.5 1.36 1.84 0.5 10.0 2001 28.4 1.90 6.86 5.0 23.4 2001 53.0 4.0 8.3 4.3 48.6 7.23 9.8 17.01

2002 10.0 1.30 1.84 0.5 9.5 2002 23.4 1.57 6.86 5.3 18.1 2002 48.6 3.6 8.3 4.7 44.0 6.51 10.5 17.01

2003 9.5 1.23 1.84 0.6 8.8 2003 18.1 1.21 6.86 5.6 12.5 2003 44.0 3.3 8.3 5.0 39.0 5.74 11.3 17.01

2004 8.8 1.15 1.84 0.7 8.1 2004 12.5 0.83 6.86 6.0 6.4 2004 39.0 2.9 8.3 5.4 33.6 4.91 12.1 17.01

2005 8.1 1.06 1.84 0.8 7.4 2005 6.4 0.43 6.86 6.4 0.0 2005 33.6 2.5 8.3 5.8 27.8 4.01 13.0 17.01

2006 2007 2008 2009 2010 2011 7.4 6.5 5.5 4.3 3.1 1.6 0.96 0.84 0.71 0.57 0.40 0.21 1.84 1.84 1.84 1.84 1.84 1.84 0.9 1.0 1.1 1.3 1.4 1.6 6.5 5.5 4.3 3.1 1.6 0.0 2006 2007 2008 2009 2010 2011

De bt Sche dule Limite d recourse tranch Inte rest ayme nt rinciple re pay e ndin balance De bt Sche dule Non recourse tranch Inte rest ayme nt rinciple re pay e ndin balance Total inte rest Total principle total payme nt

2006 2007 2008 2009 2010 2011 27.8 21.6 14.9 7.7 2.1 1.6 1.1 0.6 8.3 8.3 8.3 8.3 6.2 6.7 7.2 7.7 21.6 14.9 7.7 0.0 3.04 2.46 1.83 1.14 0.40 0.21 7.1 7.7 8.3 9.0 1.4 1.6 10.15 10.15 10.15 10.15 1.84 1.84

EXHIBIT 4 Detailed debt schedule

3. Project cash flow forecast Annual operating margin was forecasted to be RMB178 million with 3% annual growth rate; The project would have a six year tax holiday and the normal tax rate was 40%; Annual depreciation expense was RMB98 million for 10 years and required reinvestment was 25% of the depreciation expense; Maples required hurdle rate was 15%, but should be higher in this case due to higher risk associated in Chinese market. We set the hurdle rate at 18%, according to analyst estimation of ROI. Since Chinese government had limited ROI to between 15%-17%, we adjusted net income to reflect the restriction.For easy calculation, we used a mid-year factor, we assume the cash inflow/outflow was occurred in the middle of the year. Currency Risk The outlook for RMB was uncertain. As illustrated in EXHIBIT 6, Chinese government has imported inflate by stabilization its currency. Interest Rate Parity Chinas interest rate was about 5% higher than U.S interest rate. The cost of the construction loan in this project was at 14% for RMB loan and 9% for US loan. The case also cited a 10 year US loan of 8% and a 10 year RMB loan of 13%. Therefore, if IRP applies, RMB would depreciate about 5% during the course of Maple project. Lets assume RMB would depreciate 5% in 2000, the target date that bank of China set for full convertibility. Maple would face 4

FINC627 International Finance Case write-up: Tianjin Plastics Li Yu substantial currency risk before the full convertibility of RMB, because of the lack of financial derivatives to hedge RMB. Since RMB was only about 10% of the total capital in both construction phase and post completion phase (EXHIBIT 2 and 3), we assume all the revenue and expense was converted to USD. The project NPV would be $14.1 million; the project payback would be 8 years without construction extension risk; the equity NPV for Maple would be $3.74 million; the equity payback would be 6.4 years (EXHIBIT 5).
Pro Forma Projection for Maple Tianjin Project (Base Case) Assumptions EBIT margin growth Tax rate (first 6 years) Annual Depreciation (for 10 years in RMB mils) Capex = 25%*Dep Hurdle Rate (cost of equity) WACC Midyear Factor Exchange (RMB/$) Exchange (RMB/$) New Project NPV and payback 1996 EBIT (in RMB) EBIT (in $,RMB/$ = 8.736 EBIT (1-t) Depreciation ($) CAPEX (25% of Dep) FCFF Adjust for ROI @ 17% Initial Cash Outlay PV of Cash Flow (@WACC) IRR Project NPV ($mils) Project payback (y) Equity NPV and payback for Maple 1996 EBIT (in RMB) EBIT (in $,RMB/$ = 8.736 Interest expense EBT Tax NI NI caped at ROI = 17% NI adjustment Depreciation ($) CAPEX (25% of Dep) Net Debt FCFE FCFE for maple (49%) Initial Cash Outlay PV of FCFE @Hurdle Rate IRR Equity NPV (Maple) Discounted Equity Payback 1997 1998 1999 2000 178.0 20.4 7.9 12.5 0.0 12.5 12.5 0.0 11.2 2.8 -9.1 11.8 5.8 -8.085 -8.085 44.7% $3.74 6.4 2.7 2001 183.3 21.0 7.2 13.8 0.0 13.8 13.8 0.0 11.2 2.8 -9.8 12.4 6.1 2.4 2002 188.8 21.6 6.5 15.1 0.0 15.1 15.1 0.0 11.2 2.8 -10.5 13.0 6.4 2.2 2003 194.5 22.3 5.7 16.5 0.0 16.5 15.9 -0.6 11.2 2.8 -11.3 13.0 6.4 1.8 2004 200.3 22.9 4.9 18.0 0.0 18.0 15.9 -2.1 11.2 2.8 -12.1 12.2 6.0 1.5 2005 206.4 23.6 4.0 19.6 0.0 19.6 15.9 -3.7 11.2 2.8 -13.0 11.3 5.5 1.2 1997 1998 1999 2000 178.0 20.4 20.4 11.2 2.8 28.8 28.8 -16.5 -16.5 14.1% $14.14 7.9 -27.5 -25.2 -27.5 -23 -22 -16.9 19.3 2001 183.3 21.0 21.0 11.2 2.8 29.4 29.4 18.1 2002 188.8 21.6 21.6 11.2 2.8 30.0 30.0 16.9 2003 194.5 22.3 22.3 11.2 2.8 30.7 30.0 15.5 2004 200.3 22.9 22.9 11.2 2.8 31.3 29.2 13.8 2005 206.4 23.6 23.6 11.2 2.8 32.0 28.3 12.2 3% 0% 98 25 18% 9.3% 50.0% 8.32 8.736

EXHIBIT 5 Pro forma projection for Tianjin Plastic power plant project

FINC627 International Finance Case write-up: Tianjin Plastics Li Yu

Inf
 t  n (%) 30 25 20 15 24 1 10 5 0 9 3 18 8 6 5 7 3 18 6 4 14 7 3 1 3 4 17 1 8 3

Inflation and Exchange Rate in China

RMB/$ 10 8 6187 8 351 8 3142 9 8 7 6 5 4 3 2 1 0

1985 1986 1987 1988 1989 1990 1991 1992 1993 1994 1995 1996   I f    Exch e  e( /$)

EXHIBIT 6 Inflation and exchange rate in China1

4. Analysis the repatriation options 4.1 Dollar indexed rate adjustment clauses The simplest solution to repatriate Maples equity was to have the power price paid by Tianjin Plastics indexed to the dollar. The major cost of this project was the financing cost because the cost of coal, the variable cost, was free. The NPV and payback in this case was shown in EXHIBIT 5. However, MOPI had ruled out the solution as the revenue structure of Tianjin itself was purely RMB. 4.2 Back to back loan The back to back loan was essentially a currency swap. Maple would be the fixed rate payer that borrows RMB from Wintel for six years at 10.5%; Wintel would be the float rate payer that borrows USD from Maple for six years at LIBOR+1.45%. Both parties would be better off in this back to back loan structure. Maples discount rate would be only 10.5%, rather than 18% (the hurdle rate). In addition, Maple also locked in an exchange rate of 8.32RMB/$. The NPV dollar equivalent for Maple would be $11.6 million, substantially higher than $3.74 million in
http://www.rmbguide.com/China_RMB_yuan_Dollar.htm and http://www.indexmundi.com/china/inflation_rate_%28consumer_prices%29.html
1

FINC627 International Finance Case write-up: Tianjin Plastics Li Yu previous scenario. The payback period would also be reduced to 5year from previous 6.4 years.The improved result was the result of improved hurdle rate and the offset of the currency risk.
 Ba  a an Anay

1996 EBIT ( n RMB) " " In e #e $ e% pen $e EBT Tax NI NI caped at ROI = 17% NI adju $tment Dep #ec ation ( &) CAPEX ( 25% of Dep) N e t Debt FCFE FCFE for map 'e ( 49%) PV of FCFE @( 10!5%) IRR Map 'e NPV i n RMB Map 'e NPV i n $ Discounted Paybac(
EXHIBIT 7 Back to back loan analysis

1997

1998

1999

-67!3 16!1% 96!6 11!6 5!0

2000 178!0 65!8 112!2 0!0 112!2 112!2 0!0 98!0 24!5 -75!7 110!0 53!9 34!4

2001 183!3 60!2 123!2 0!0 123!2 123!2 0!0 98!0 24!5 -81!3 115!4 56!5 32!6

2002 188!8 54!2 134!6 0!0 134!6 132!2 -2!4 98!0 24!5 -87!3 118!5 58!0 30!3

2003 194!5 47!8 146!7 0!0 146!7 132!2 -14!5 98!0 24!5 -93!7 112!0 54!9 26!0

2004 200!3 40!8 159!5 0!0 159!5 132!2 -27!3 98!0 24!5 -100!7 105!1 51!5 22!0

2005 206!4 33!4 173!0 0!0 173!0 132!2 -40!7 98!0 24!5 -108!1 97!6 47!8 18!5

4.3 RMB swap The last solution was to finance the majority of the project in RMB at 13%, cost of equity in this case would be 18%-4% = 14%, since Maple can earn 4% interest rate for its US$ deposit. The resulted Maple NPV in USD term would be $5.4 million, at exchange rate of 8.74 (assume 5% depreciation of RMB)
Total Equity Total Debt De * ,-.e /01e Be2 3nning ba1an -e Inte 4e 5t Pay6e nt Prin -iple re pay e nding balan -e RMB i n mils Cost 14% 142)894 844)480 13% WACC 13)1% 2000 2001 844)5 109)8 155)6 45)8 798)6 798)6 59)9 155)6 95)7 702)9

2002 702)9 52)7 155)6 102)9 600)0

2003 600)0 45)0 155)6 110)6 489)4

2004 489)4 36)7 155)6 118)9 370)4

2005 370)4 27)8 155)6 127)8 242)6

2006 2007 2008 2009 242)6 18)2 155)6 137)4 105)2 105)2 -42)6 -201)4 7)9 -3)2 -15)1 155)6 155)6 155)6 147)7 158)8 170)7 -42)6 -201)4 -372)1

EXHIBIT 8 Debt schedule and cost of equity of RMB swap

FINC627 International Finance Case write-up: Tianjin Plastics Li Yu

Pro Forma Projection for Maple Tianjin Project (RMB swap Case) Assumptions EBIT margin growth Tax rate (first 6 years) Annual Depreciation (for 10 years in RMB mils) Capex = 25%*Dep Hurdle Rate (cost of equity) WACC Midyear Factor Exchange (RMB/$) Exchange (RMB/$) New Project NPV and payback 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005

3% 0% 98 25 14% 13.1% 50.0% 8.32 8.736

EBIT (in RMB) EBIT (1-t) Depreciation ($) CAPEX (25% of Dep) FCFF Adjust for ROI @ 17% Initial Cash Outlay PV of Cash Flow (@WACC) IRR Project NPV in RMB mils Project NPV in $ miles Project payback (y) Maple NPV and Payback Analysis

178.0 178.0 98.0 24.5 251.5 251.5 -844.5 -340.8 88.1% $163.12 18.67 6.9

183.3 183.3 98.0 24.5 256.8 256.8

188.8 188.8 98.0 24.5 262.3 258.5

194.5 194.5 98.0 24.5 268.0 250.7 99.6

200.3 200.3 98.0 24.5 273.8 242.4 85.2

206.4 206.4 98.0 24.5 279.9 233.5 72.5

130.5 116.1

1996 EBIT (in RMB) Interest expense EBT Tax NI NI caped at ROI = 17% NI adjustment Depreciation ($) CAPEX (25% of Dep) Net Debt FCFE FCFE for maple (49%) PV of FCFE @(14%) IRR Maple NPV in RMB Maple NPV in $ Discounted Payback

1997

1998

1999

-67.3 9.4% 46.8 5.4 5.7

2000 178.0 109.8 68.2 0.0 68.2 68.2 0.0 98.0 24.5 -45.8 95.9 47.0 26.1

2001 183.3 59.9 123.4 0.0 123.4 123.4 0.0 98.0 24.5 -95.7 101.2 49.6 24.1

2002 188.8 52.7 136.1 0.0 136.1 132.2 -3.9 98.0 24.5 -102.9 102.8 50.4 21.5

2003 194.5 45.0 149.5 0.0 149.5 132.2 -17.3 98.0 24.5 -110.6 95.1 46.6 17.4

2004 200.3 36.7 163.6 0.0 163.6 132.2 -31.4 98.0 24.5 -118.9 86.8 42.5 14.0

2005 206.4 27.8 178.6 0.0 178.6 132.2 -46.3 98.0 24.5 -127.8 77.9 38.2 11.0

FINC627 International Finance Case write-up: Tianjin Plastics Li Yu

EXHIBIT 9 RMB swap analysis

Do 778r 9:dexed r8te Ter =s >evenue ?nde@ ed to do AAar Cap Ae's ?nvest =ent Equ ?tF ?n US G fro = >evenue strea = ($) >epatr ?at ?on

B8ck to ;8ck 7o8 :

RMB < w8p

dvantaJ e

ost of debt Cost of equ ?ty HI CC Cap Ae LPV G?scount Payback

G?sadvantaJe M

S ?=p Ae Legat ?ve ?=pact on COPI's >OIC >evenue structure of T ?anj ?n was on Ay >CB St ?AA face currency r ?sk D 7.8 D 18.0 D 9.3 $3.74 6.39

D Borrow >CB at 10.5 for Ca EAe's equ ?tF ; D >ece ?ve US G ?nvest =ent at 1.45 + LI BO > F Equ ?t ?n >CB H fro = ?nte A's US G paF =ent D >CB/$ f ?@ ed at 8.32 for 6 years Borrow at Aower rate for bot K part ?es

D Borrow >CB at 13 for ent ?re project D >ece ?ve US G ?nvest =ent at 4 F Equ ?t ?n >CB >evenue ?n >CB Catch Project's >CB cash ?nf Aow/outf Aow Cap Ae st ?AA face currency r ?sk for ?ts share of prof ?t D 13.0 D 14.0 D
13.1 $5.36 5.71

7.8 D 10.5 D 8.2 $11.61 5.01

EXHIBIT 10 Comparison of three alternatives

5. Conclusion Maple should choose back to back loan with Wintel to financing its equity, as the dollar indexed rate proposal had been rejected by MOPI and the cost of funding the entire project in RMB (RMB swap) would be too high. In addition, Maple would lock in a fixed exchange rate of 8.32 RMB/$. However, Maple would still face currency risk if Maples shared profit cant satisfy the interest payment of RMB7.4 million per year.