INTRODUCTION

Financial modeling plays a very important role in evaluation of projects for making project financing decisions by both the lenders and equity investors. In project finance, the funding agencies look into the expected future cash flows in relation to the amount of the initial investment while making the investment decision. Equity investors used financial model to evaluate the returns from the project in order to ascertain their adequacy. On the other hand, financial model is used by lenders to know the level of cover for their loans and the timeliness of project debt service payments.

Financial models used the concept of discounted cash flow analysis for the evaluation. The typical steps in discounted cash flow analysis involves: (1) estimating the expected future cash flows; (2) determining the rate of return for discounting the cash flows; (3) computing the present value of the expected future cash flows; and (4) determine the cost of the project and compare whether the project is worth more than its cost. The following sections discuss the application of the discounted cash flow analysis in financial modeling of infrastructure projects.

PROJECT'S CASH FLOWS

Infrastructure projects are highly capital intensive projects. Project funding is utilised to build the project assets during the construction phase. On completion of the project facilities, the project enters into service and the project starts generating revenue from provision of service to either users or public authority. The cash flows associated with an infrastructure project during the two phases of construction and operation could be grouped into (1) net initial investment outlay; and (2) cash flows from project's operation.

While determining the expected future cash flows, the cash flows should be measured on an after-tax basis. Taxes represent one of the costs for doing business and they must be subtracted from the pre-tax cash flows. As a result, the project stakeholders are concerned with the after-tax cash flow as that is the amount available to them.

The net initial investment could be broken down into cash expenditures, changes in net working capital, net cash flow from operation of ancillary facility during construction phase, and investment tax credits.