The cash a refinancing releases is not the gain: the higher debt service and the lost tail years have to be netted off first.
A PPP refinancing gain is the net present value, at the refinancing date, of the equity cash flows after the refinancing less the equity cash flows the base case would have paid, discounted at the base case equity IRR. On an illustrative 480.0 availability project refinanced in year 5 at 4.5 per cent, the new loan releases 134.1 of cash but the refinancing gain is 87.7. Under a 50 per cent sharing clause the authority receives 43.8, and the sponsors' equity IRR still rises from 13.54 to 16.61 per cent.
Worked in full in The Project Finance Handbook by Julian R. Sterling, with every figure reproduced in a free workbook.See the book on Amazon →
The project is an illustrative availability-payment concession with 25 years of operations. The authority pays an indexed unitary charge, so cash flow available for debt service (CFADS) is 40.0 in the first operating year and grows at 2.0 per cent. Construction is collapsed into year 0 to keep the arithmetic visible. Figures are in millions.
| Input | Original loan | Refinancing |
|---|---|---|
| Capital cost | 480.0 | n/a |
| Interest rate, all-in | 6.0% | 4.5% |
| Sizing cover ratio (DSCR) | 1.30x | 1.20x |
| Final maturity, operating year | 22 | 24 |
| Annual debt service (annuity) | 30.77 | 36.80 |
| Loan amount | 370.5 | 463.5 |
| Refinancing costs | n/a | 1.5% |
| Equity at close / base case equity IRR | 109.5 | 13.54% |
At financial close the loan is sized as a level annuity at 1.30 times year-1 CFADS: 40.0 / 1.30 = 30.77 a year over 22 years at 6.0 per cent, which supports 370.5 of debt, 77.2 per cent gearing. Equity puts in the remaining 109.5 and, on the base case, earns 13.54 per cent.
Step 1, the new loan: debt service = year-6 CFADS / new DSCR = 44.16 / 1.20 = 36.80; loan = 36.80 × annuity factor (4.5%, 19 years) = 463.5. In Excel: =PV(4.5%,19,-44.16/1.2)
Step 2, cash released: new loan − balance outstanding on the old loan − costs = 463.5 − 322.4 − 6.95 = 134.1
Step 3, the change in equity flows: +134.1 at the refinancing date; −6.03 a year in years 6 to 22 (36.80 against 30.77); −36.80 in years 23 and 24, which were debt free
Step 4, the gain: NPV of step 3 at the base case equity IRR = 134.1 − PV of the extra debt service = 87.7. In Excel, with the post- and pre-refinancing equity rows side by side: =F20+NPV(BaseIRR,G22:Z22), where row 22 is the difference.
The refinancing has three levers, and each moves the gain: a lower rate, a lower sizing ratio (the old loan was sized at 1.30 times, and by year 6 the old debt service is covered 1.44 times), and a longer tenor that pushes final maturity from year 22 to year 24. The last lever is the one most often missed: it takes the two tail years, 73.6 of equity cash that used to be free of debt service, and turns them into repayment of the new loan.
| Item | Amount |
|---|---|
| Cash released at the refinancing date | 134.1 |
| Less PV of higher debt service and the lost tail, at 13.54% | (46.4) |
| Refinancing gain | 87.7 |
| Authority share at 50% | 43.8 |
| Retained by equity | 43.8 |
The gain is 65.4 per cent of the cash released. If equity kept all of it, its IRR would rise from 13.54 to 19.84 per cent; after paying the authority 43.8 as a lump sum at the refinancing date it is 16.61 per cent. The authority could instead take its share as a reduction in the unitary charge, which spreads the same present value over the remaining term.
Both equity rows use the same updated operating projections, with and without the new financing. If the project has outperformed, that outperformance sits in both rows and drops out; only the change caused by the new financing terms is shared. Here the project has tracked its base case, so the pre-refinancing equity IRR and the base case equity IRR are the same 13.54 per cent.
Holding the 24-year final maturity, the gain moves with the new rate and the sizing ratio. Lower cover releases more debt, and so does a lower rate, because the same debt service carries a larger loan.
| New rate | DSCR | New loan | Cash released | Gain | Authority 50% |
|---|---|---|---|---|---|
| 5.0% | 1.30x | 410.6 | 82.0 | 54.6 | 27.3 |
| 5.0% | 1.20x | 444.8 | 115.7 | 69.3 | 34.6 |
| 4.5% | 1.30x | 427.8 | 99.0 | 71.6 | 35.8 |
| 4.5% | 1.20x | 463.5 | 134.1 | 87.7 | 43.8 |
| 4.0% | 1.30x | 446.2 | 117.1 | 89.7 | 44.8 |
| 4.0% | 1.20x | 483.4 | 153.7 | 107.3 | 53.6 |
A pure rate refinancing, at 4.5 per cent but with the original 1.30 times cover and year-22 maturity, raises 397.7, releases 69.4 and creates a gain of 48.5. The extra tenor and the looser cover ratio account for the other 39.2. That split matters in negotiation, because a longer tenor transfers risk to the authority: if the project fails late in the concession, termination compensation is often linked to senior debt outstanding, and there is now more of it for longer.
Lay the pre- and post-refinancing equity rows side by side from the refinancing date, take the difference, and discount it at the base case equity IRR. Here 134.1 of cash released is an 87.7 gain, split 43.8 each way, and the sponsors still move from 13.54 to 16.61 per cent. The book's two deals, with their debt sizing and funding sheets, are in the free workbooks for this book; for how cover ratios set the loan in the first place, see what a good DSCR is for project finance, and for refinancing risk built into the structure, how a mini-perm works.
Contracts usually specify an equity IRR: the base case IRR the sponsors bid with or, in UK-style standard forms, the pre-refinancing equity IRR. Here both are 13.54 per cent. A lower rate gives later outflows more weight and shrinks the gain: discounting the illustrative flows at the new 4.5 per cent debt rate shows 30.9 instead of 87.7, which would cut the authority's 50 per cent share from 43.8 to 15.4.
No. The cash released is paid for by higher debt service for the rest of the loan and by debt service in years that used to be debt free. In the illustrative case 134.1 is released up front, but equity gives up 6.03 a year for seventeen years and 36.80 in each of two tail years, so the gain is 87.7, or 65.4 per cent of the cash.
Yes, but a smaller one. Refinancing the illustrative loan at 4.5 per cent with the original 1.30 times cover and the original final maturity raises debt to 397.7, releases 69.4 and creates a gain of 48.5. The longer tenor and lower cover ratio in the full refinancing add the remaining 39.2 of the 87.7 gain.
This article is one calculation from The Project Finance Handbook. The book takes the same case from first principles to the decision, chapter by chapter, and every figure it prints is a live formula in the free companion workbooks.
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