Question

1. The XYZ Pension Fund is resource-constrained and has only $8,000,000 available for co-investment in an infrastructure asset, and must show its Board of Trustees that it has selected the most potentially profitable investments. It is being offered 6 alternatives, each of which has reached construction completion, and with 25 years’ concession period remaining. These are:

Project type	Financed by	Gross Investment required	Net Present Value $	Projected IRR %
Single toll road	Bank debt	$1m	80,000	13.9
Large general Hospital	Bond	$4m	430,000	14.4
Metro-system expansion	Bank debt	$3m	250,000	16.0
Portfolio of PFI schools	Bank debt	$2m	230,000	14.1
Bridge River crossing	Bank debt	$2m	210,000	16.1
Skyscraper	Bond	$2m	190,000	15.7

You are the projects’ financial advisor retained by the Trustees. Advise them (explaining your reasons);

                                                [ 40 marks]

2. Now consider a significant new PPP project (financed wholly by the private sector) where for some reason construction completion is delayed. Critically analyse and describe the consequences for the “D&B”/”Tier 1” Contractor, of the following situations:
   1. a time overrun extending past the projected Completion Date
   2. what the “penalties” might be on the [Tier 1] Contractor, and importantly also explain why “penalties” is written here in quotes; and
   3. which parties might seek remedies and apply or enforce these “penalties” at each stage in a progressive delay;
   4. giving an indication of how large they might be and why; and demonstrate how this would be calculated and applied.

Answer 1

a. As a financial advisor investment advice would be based on two factors that are NPV & IRR in the present case based on available information. Here the board of trustees objective will be to obtain the maximum returns on there investment in infrastructure assets. As board is co-investing in the project, so we assume that partail investment in project is also possible i.e., if gross investment required is $ 4m & company has $ 1m funds, then company can invest upto $ 1m in that project.

Analysis based on NPV: Pension fund should invest $ 4m in large general hospital, $ 3m in metro system expansion & $ 1m in portfolio of PFI schools. Total NPV based on above investment would be $ 795000 ($430000+$250000+$115000). For portfolio of PFI schools npv is taken proportionately $ 115,000 ( $ 230000/2 ).   

Analysis based on IRR: Pension fund should invest $ 2m in bridge river crossing, $ 3m in metro system expansion, $ 2m in skyscrapper & $ 1m in large general hospital . Total NPV based on above investment would be $ 757500 ($210000+$250000+$190000+$107500). For large general hospital npv is taken proportionately $ 107,500 ( $ 430000/4 ).   

Both IRR and NPV can be used to determine how desirable a project will be and whether it will add value to the company. While one uses a percentage, the other is expressed as a dollar figure. While some prefer using IRR as a measure of capital budgeting, it does come with problems because it doesn't take into account changing factors such as different discount rates. In these cases, using the net present value would be more beneficial.

So, finally as an advisor based on above factors return on the basis of npv is prefferd. Also in monetary terms company will get more returns. So, Pension fund should invest $ 4m in large general hospital, $ 3m in metro system expansion & $ 1m in portfolio of PFI schools based on our advice to board of trustees.

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