Financial Feasibility Assessments FINAL

1 Financial Feasibility Assessments Building and Using Assessment Models for Financial Feasibility Analysis of Investment Projects Anna Reg na Bj rnsd ttir Faculty of Industrial Engineering, Mechanical Engineering and Computer Science University of Iceland 2010. Financial Feasibility Assessments Building and Using Assessment Models for Financial Feasibility Analysis of Investment Projects Anna Reg na Bj rnsd ttir 60 ECTS thesis submitted in partial fulfillment of a Magister Scientiarum degree in Industrial Engineering Advisors Dr. P ll Jensson orbj rg S mundsd ttir Faculty Representative Dr. Helgi r Ingason Faculty of Industrial Engineering, Mechanical Engineering and Computer Science School of Engineering and Natural Sciences University of Iceland Reykjavik, January 2010.

2 Financial Feasibility Assessments - Building and Using Assessment Models for Financial Feasibility Analysis of Investment Projects 60 ECTS thesis submitted in partial fulfillment of a Magister Scientiarum degree in Industrial Engineering Copyright 2010 Anna Reg na Bj rnsd ttir All rights reserved Faculty of Industrial Engineering, Mechanical Engineering and Computer Science School of Engineering and Natural Sciences University of Iceland Hjardarhagi 2-6. 107, Reykjavik Iceland Telephone: 525 4000. Bibliographic information: Anna Reg na Bj rnsd ttir, 2010, Financial Feasibility Assessments - Building and Using Assessment Models for Financial Feasibility Analysis of Investment Projects, Master's thesis, Faculty of Industrial Engineering, Mechanical Engineering and Computer Science, University of Iceland, pp.

3 70. Printing: N n ehf. Reykjavik, Iceland, February 2010. Abstract This thesis examines how assessment models can be built and used for Financial Feasibility analysis of investment projects. An overview of Financial Feasibility assessment methods is presented, as well as a general assessment model, which can be used as a base when constructing new models. Risk analysis methods are introduced, as uncertainties can highly affect the outcome of the assessment. A. new optimization method used to estimate financing requirements of investment projects is presented, as well as a new method to predict the optimal year to sell the investment. A case study is used to illustrate the use of a model to assess the Financial Feasibility of a geothermal cogeneration plant.

4 The conclusion is that Net Present Value, Internal Rate of Return and Modified Internal Rate of Return should be used to assess Financial Feasibility of investment projects. In addition to calculating the Financial Feasibility criteria, assessment models should allow the user to perform sensitivity analysis, scenario analysis, and simulation to analyze risk associated with the investment project. Keywords: Financial Feasibility , Cash Flow Analysis, Assessment Models, Model Building, Risk Analysis, Geothermal Energy. tdr ttur essi ritger fjallar um sm i og notkun l kana vi greiningu ar semi fj rfestingarverkefna. Ar semisgreiningara fer ir eru dregnar saman ritger inni og almennt ar semisl kan, sem nota m sem grunn a n jum l k num, sett fram.

5 A fer ir vi h ttugreiningu er kynntar, ar sem vissa getur haft mikil hrif . ni urst ur ar semismatsins. N bestunara fer til a finna fj rm gnunar rf verkefna er kynnt, samt n rri a fer til a sp fyrir um hva a ri s hagst ast a selja fj rfestinguna. Bygging jar varmavirkjunar er notu sem ranns knard mi til a s na hvernig h gt s a nota l kan til a meta ar semi verkefnis. Ni ursta a verkefnisins er s a nota tti n vir i, innri vexti og lei r tta innri vexti til a . meta ar semi fj rfestingarverkefna. Auk treikninga ar semim likv r um ttu ar semisl k n a gefa kost a nota n mnigreiningu, svi smyndagreiningu og hermun til a greina h ttu tengda fj rfestingarverkefninu. Lykilor : Ar semi, Sj streymisgreining, L k n, Sm i L kana, h ttugreining, Jar varmi.

6 Table of Contents List of Figures .. ix List of Tables .. x Acknowledgements .. xi 1 Introduction .. 1. 2 Theory .. 3. Financial 3. Purpose of Financial Feasibility Analysis .. 3. Feasibility Study vs. Business 5. Conducting Financial Feasibility Analysis .. 6. Criteria for Financial Feasibility .. 7. Project Financing .. 18. 3 Financial Feasibility Assessment Model .. 21. Model Building .. 21. Model Architecture .. 23. Modular Components .. 25. Inputs and Assumptions .. 25. Financing .. 25. Income Statement .. 26. Balance Sheet .. 27. Cash Flow Statement .. 27. Profitability .. 29. Results .. 29. 4 Case Study A Geothermal Power Plant .. 31. Geothermal Energy Utilization .. 31. The Model .. 33. Model Inputs and Assumptions .. 34. Model Calculations.

7 39. Model Results .. 40. Case Study .. 41. Inputs and Assumptions .. 41. Calculations .. 45. Results .. 45. 5 Risk Analysis .. 53. Sensitivity Analysis .. 53. Scenario 55. vii simulation ..56. 6 Exit Policy .. 59. 7 Discussion .. 61. 8 Conclusion ..63. References .. 65. Appendix .. 67. viii List of Figures Figure 1 - Areas where Financial analysis can be necessary .. 4. Figure 2 - The relationship between NPV and IRR for two projects .. 13. Figure 3 - The basic elements of project financing .. 19. Figure 4 - Modular architecture and data flow through the model .. 24. Figure 5 - Cash flows in a production company .. 28. Figure 6 - User interface for general project information .. 42. Figure 7 - User interface for production information.

8 42. Figure 8 - User interface for wells and fluid information .. 42. Figure 9 - User interface for power plant information .. 43. Figure 10 - User interface for market information .. 43. Figure 11 - User interface for capital cost (in thousands of dollars).. 44. Figure 12 - User interface for Financial information .. 44. Figure 13 - Financing calculations (in thousands of dollars) .. 45. Figure 14 - Profitability calculations (in thousands of dollars) .. 46. Figure 15 - Result summary for the case study .. 47. Figure 16 - The cash flows of the project .. 48. Figure 17 - Accumulated NPV over the planning 49. Figure 18 - Internal Rate of Return .. 49. Figure 19 - Liquidity ratio .. 50. Figure 20 - Profitability ratios .. 50. Figure 21 - Market Value Ratio.

9 51. Figure 22 - Debt management ratios .. 51. Figure 23 - Sensitivity graph for case 54. Figure 24 - An example of a histogram of IRR of equity .. 58. Figure 25 - Exit policy calculations .. 60. ix List of Tables Table 1 - Scenario summary for case study project .. 56. x Acknowledgements First of all I would like to express my gratitude to my advisors, Dr. P ll Jensson for his academic guidance and support, and orbj rg S mundsd ttir for all the constructive criticism, and her endless patience and support. I would also like to thank Dr. P ll Valdimarsson, Krist n Vala Matth asd ttir and Lilja Tryggvad ttir for explaining technical details to me and for answering all my questions on geothermal energy. Finally, I would like to express my love and gratitude to my family for their support, patience and help during the course of this work.

10 Xi 1 Introduction Before an investment decision is made it is necessary to determine whether or not the planned investment idea is feasible. The Feasibility of an investment has to be considered with respect to several different aspects in order to determine whether the investment should be realized or not. Carrying out a Feasibility analysis is therefore one of the most critical steps in the decision-making process. A Feasibility analysis is an effective analytical tool that can be used to evaluate investments from various perspectives, technical, social, legal, Financial , market, and organizational. Financial Feasibility is often a predominant factor in Feasibility analysis, as most investments are not realized if they do not generate profit for the project owners.