The gain on a sale at commercial operation is two things: time at the construction-stage rate, and a lower rate once completion risk has gone.
A solar project's equity is worth more at commercial operation (COD) than at financial close for two separate reasons: eighteen months of the discount rate unwinding, and a lower discount rate once construction risk is gone. On an illustrative 200 MW project with 66.0 million of equity, the equity is worth 66.4 at close at a 10.0 per cent construction-stage rate and 91.5 at COD at 8.5 per cent: a gain of 25.5 on the equity invested, of which 0.4 is the project's NPV at close, 10.2 is only the passage of time and 14.9 is the re-rating. A developer who sells at COD earns 24.3 per cent a year on the equity it put in, and most of that rests on one assumption, the 150 basis point fall in the discount rate.
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 question comes up whenever a developer or a construction-stage fund plans to sell a project once it is built, and whenever a buyer of operating assets is asked why it is paying so much more than the equity cost. The answer is usually called "value creation at COD". It is real, but it mixes a time effect that every investor earns with a risk premium that only appears if the market agrees the risk has gone.
| Input | Value |
|---|---|
| Capacity | 200 MW |
| Capital cost, including interest during construction | 220.0 million |
| Senior debt, 70% gearing | 154.0 million |
| Equity, contributed at financial close | 66.0 million |
| Debt: rate and tenor, annuity repayment | 6.0%, 18 years |
| Cash flow available for debt service (CFADS), a year | 20.5 million |
| Operating life | 30 years |
| Construction period, close to COD | 1.5 years |
| Equity discount rate in construction / once operating | 10.0% / 8.5% |
The discount rates are illustrative, not market data. The 150 basis point gap stands for the premium investors ask for completion risk: cost overruns, delay, grid connection, performance tests.
Step 1, equity cash flows. Debt service = 154.0 × 6.0% ÷ (1 − 1.06−18) = 14.22 a year, a DSCR of 1.44x. Equity receives 20.5 − 14.22 = 6.28 a year for 18 years, then the full 20.50 for the last 12. Total: 359.0.
Step 2, value at financial close. Discount the cash flows to COD at 10.0%, then back 1.5 years: 76.6 ÷ 1.1537 = 66.4. The equity IRR from close is 10.05 per cent, so a buyer at close pays about what the equity cost.
Step 3, the unwind. At COD, at the same 10.0%: 76.6. The increase of 10.2 is the 10.0 per cent return on 66.4 for 1.5 years. Nothing has been created; time has passed.
Step 4, the re-rating. At COD, at 8.5%: 91.5. The extra 14.9 is the value of construction risk disappearing.
In Excel, with equity cash flows in C5:AF5 from year 1 of operation: value at COD =NPV(8.5%,C5:AF5); value at close =NPV(10%,C5:AF5)/1.1^1.5.
| Step | Change | Equity value |
|---|---|---|
| Equity contributed at close | 66.0 | |
| NPV at the 10.0% construction-stage rate | 0.4 | 66.4 |
| Unwind over 1.5 years at 10.0% | 10.2 | 76.6 |
| Re-rating from 10.0% to 8.5% | 14.9 | 91.5 |
| Gain on a sale at COD | 25.5 | 91.5 |
The sale returns 1.39 times the equity in 1.5 years, 24.3 per cent a year. The re-rating is 58 per cent of the gain. It is also back-loaded: the 12 years after the debt is repaid make up 38 per cent of the value at COD and 64 per cent of the re-rating, because a lower discount rate lifts distant cash flows most. The buyer's lower rate is mostly a bet on the post-debt tail, the same years whose price risk is discussed in how much the merchant tail is worth in a solar project.
| Discount rate at COD | Value at COD | Gain on equity | Multiple | Annualised |
|---|---|---|---|---|
| 7.5% | 104.1 | 38.1 | 1.58x | 35.5% |
| 8.0% | 97.5 | 31.5 | 1.48x | 29.7% |
| 8.5% | 91.5 | 25.5 | 1.39x | 24.3% |
| 9.0% | 86.1 | 20.1 | 1.30x | 19.4% |
| 9.5% | 81.1 | 15.1 | 1.23x | 14.7% |
Each 50 basis points on the buyer's rate moves the sale price by 5 to 7 million, about a quarter of the developer's gain. A construction delay works the other way, through time. Holding the value at COD at 91.5 and ignoring any extra cost, six months' delay cuts the annualised return on a sale to 17.8 per cent, and a year's delay to 14.0 per cent; at the 10.0 per cent construction rate the equity is then worth 63.3 and 60.4 at close, below the 66.0 invested. In practice a delay also adds interest and lost revenue that liquidated damages may only partly cover.
Calling the whole 25.5 "development value" and counting it as the reward for building the project. The 10.2 of unwind is what any investor earns by holding a 10 per cent asset for eighteen months; a fund that reports it as a gain at COD has only stopped discounting. Only the 14.9 re-rating comes from removing risk, and it exists only if a buyer actually accepts 8.5 per cent. The opposite mistake, common in buyers' models, is to discount at the operating rate from close: 8.5 per cent from day one would value the equity at 81.0 before a single panel is installed, a price that pays the developer for completion risk the buyer is still carrying.
Both of the book's deals, debt sizing and equity returns included, are modelled in the free workbooks for this case; the IRR definitions are in project IRR vs equity IRR.
Because completion risk, cost overruns, delay, grid connection and performance tests, has gone, and investors ask a premium for it. In the illustrative case a 150 basis point fall, from 10.0 to 8.5 per cent, lifts the equity value at COD from 76.6 to 91.5. The figures are illustrative; actual premia depend on the market and the contract.
Even before any extra cost, it stretches the time the equity is tied up. Holding the sale value at 91.5 on 66.0 of equity, the annualised return falls from 24.3 per cent with 1.5 years of construction to 17.8 per cent with two years and 14.0 per cent with 2.5 years, and the value at close drops to 60.4 against 66.0 invested.
Only partly. In the illustrative case 0.4 of the 25.5 gain is the NPV at close and 10.2 is the unwind of the 10.0 per cent construction-stage rate over 1.5 years, which any holder earns. The 14.9 re-rating is the value of removing completion risk, and it exists only if a buyer accepts the lower 8.5 per cent rate; at 9.5 per cent the gain falls to 15.1.
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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