The PPA price a sponsor can bid is an output of the debt sizing, not only of the cost of the plant: solve it with the loan moving, or the answer is wrong.
The break-even PPA price is the flat contract price at which the equity cash flows, after debt sized at the lender's cover ratio, return exactly the sponsor's target IRR. It has to be solved with the loan re-sized at every trial price, because a higher price raises CFADS and therefore the debt. On an illustrative 100 MW, 110.0 million solar project, a 10 per cent pre-tax equity IRR needs a PPA price of 61.84 a MWh, against 72.49 for an unlevered 10 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 →
A sponsor bidding into a PPA tender is asking one question: what is the lowest price I can offer and still earn my hurdle? LCOE does not answer it, because it ignores how the plant is financed. The answer runs through the whole model: price sets revenue, revenue less operating cost sets CFADS, CFADS divided by the sizing DSCR sets the debt service the lender will accept, and the present value of that debt service sets the loan. Equity funds the rest and receives what is left. Every one of those links moves when the price moves, so the break-even is found by iteration, in Excel with Goal Seek.
| Input | Value |
|---|---|
| Capacity | 100 MW |
| Capacity factor, year 1 | 24% |
| Output degradation a year | 0.5% |
| Capital cost, all-in | 110.0 |
| Operating cost, year 1, escalating 2% a year | 2.2 |
| PPA term and operating life, years | 25 |
| Debt tenor, years, sculpted | 18 |
| All-in cost of debt | 6.0% |
| Sizing DSCR / gearing cap | 1.30x / 80% |
| Target equity IRR | 10% |
Year-1 output is 100 × 8,760 hours × 24% = 210,240 MWh, falling to 186,410 MWh by year 25. Tax and tax credits are left out to keep the mechanics visible; on a US project they move the answer a long way, as ITC vs PTC for a solar project shows.
Step 1: put the price in one cell and build revenue from it. At a trial price of 61.84 a MWh, year-1 revenue is 210,240 × 61.84 = 13.00.
Step 2: CFADS is revenue less operating cost, 13.00 − 2.20 = 10.80 in year 1.
Step 3: size the debt from the price, not beside it. Sculpted debt service is CFADS divided by the DSCR in every year of the tenor, and the loan is its present value at the debt rate, capped at 80 per cent of cost.
Debt servicet = CFADSt / 1.30; year 1: 10.80 / 1.30 = 8.31
Debt = min( NPV6.0%(debt service, years 1 to 18), 80% × 110.0 ) = 83.5
Excel: =MIN(NPV(6%,DS1:DS18), 0.8*Capex)
Step 4: equity pays 110.0 − 83.5 = 26.5 at close and receives CFADS less debt service, 2.49 in year 1, then the whole CFADS from year 19.
Step 5: solve. Goal Seek sets the equity IRR cell to 10 per cent by changing the price cell. Because the debt formula reads the price, each trial re-sizes the loan.
Equity IRR(price) = 10% → price = 61.84 a MWh
At that price: debt 83.5, gearing 75.9%, project IRR 7.47%, lifetime revenue 306.3 on 4,952,403 MWh
The gap between the 7.47 per cent project IRR and the 10 per cent equity IRR is leverage: three-quarters of the cost borrowed at 6.0 per cent against an asset earning 7.47. Asked for an unlevered 10 per cent instead, the same plant needs 72.49 a MWh, 10.65 more. A sponsor that bids off its unlevered hurdle prices itself out of a tender it could have won.
| Target equity IRR | PPA price, a MWh | Debt | Equity | Gearing | Project IRR |
|---|---|---|---|---|---|
| 8% | 59.23 | 79.1 | 30.9 | 71.9% | 6.82% |
| 9% | 60.60 | 81.4 | 28.6 | 74.0% | 7.17% |
| 10% | 61.84 | 83.5 | 26.5 | 75.9% | 7.47% |
| 11% | 62.95 | 85.3 | 24.7 | 77.6% | 7.75% |
| 12% | 63.94 | 87.0 | 23.0 | 79.1% | 7.99% |
| 14% | 66.16 | 88.0 | 22.0 | 80.0% | 8.52% |
Each point of equity return costs only about 1.0 to 1.4 a MWh, because each dollar of extra price also buys more debt and so a smaller equity cheque. One more dollar a MWh above break-even lifts the equity IRR to 10.90 per cent. The cost of a point falls as gearing rises, from 1.37 between 8 and 9 per cent to 0.99 between 11 and 12. Then the 80 per cent gearing cap binds, the debt stops growing, and the next two points cost 2.21 together: the cheapening stops.
| Change | PPA price | vs base | Debt |
|---|---|---|---|
| Base case | 61.84 | 0.00 | 83.5 |
| Capacity factor 22% | 67.46 | +5.62 | 83.5 |
| Capacity factor 26% | 57.08 | −4.76 | 83.5 |
| Capital cost 120.0 | 66.30 | +4.46 | 91.0 |
| Capital cost 100.0 | 57.38 | −4.46 | 75.9 |
| Debt rate 7.0% | 64.53 | +2.69 | 82.0 |
| Debt rate 5.0% | 59.15 | −2.69 | 85.0 |
| Sizing DSCR 1.40x | 62.47 | +0.63 | 78.5 |
| Sizing DSCR 1.20x (cap binds) | 61.27 | −0.58 | 88.0 |
The resource and the capital cost dominate: two points of capacity factor are worth more than a full point on the debt rate. The DSCR matters less than sponsors assume, because a looser ratio is quickly stopped by the gearing cap. That is the order in which to spend diligence before a bid.
The common mistake is to run Goal Seek with the loan typed in as a number from an earlier sizing. Suppose the debt was sized when the working price was 55.00, which supported 71.9 of debt and an equity IRR of only 5.43 per cent. Hold that 71.9 fixed and solve again: the answer is 63.31 a MWh, 1.47 too high, with 38.1 of equity and minimum cover of 1.55 times that no lender asked for. The model has quietly assumed the sponsor refuses debt the price would support. In a competitive tender 1.47 a MWh is often the margin between first and second place. The fix is structural: the debt cell must be a formula of CFADS, so it moves with the price, and the solve must run on the equity IRR, not on the project IRR, unless the bid is genuinely unlevered.
The loan sizing behind this, sculpted debt service, the DSCR and the gearing cap, is laid out in sculpted vs annuity debt. The Project Finance Handbook works a solar and storage project whose equity return turns on its investment tax credit; that model is among the free workbooks for the book's two cases.
LCOE discounts lifetime costs and output at one rate, usually a blended cost of capital, and ignores how the deal is financed. The break-even PPA price solves the actual equity cash flows, after debt service sized at the lender's ratio, for the sponsor's hurdle. On the illustrative 100 MW plant the unlevered 10 per cent price is 72.49 a MWh, while the levered 10 per cent equity price is 61.84, because 75.9 per cent of the cost is borrowed at 6.0 per cent.
Build the annual revenue as output times a single price cell, run CFADS, size the debt from CFADS divided by the DSCR so that the loan moves with the price, then compute the equity IRR. Use Goal Seek, set the equity IRR cell to 10 per cent by changing the price cell. On the illustrative case it returns 61.84 a MWh. If the loan is a typed number, Goal Seek returns a wrong 63.31.
A lot, because every fixed cost is spread over fewer megawatt-hours. On the illustrative 110.0 million plant, cutting the capacity factor from 24 to 22 per cent lifts the price needed for a 10 per cent equity IRR from 61.84 to 67.46 a MWh, 5.62 more; raising it to 26 per cent lowers it to 57.08.
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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