Solar IPP Versus Captive Generation with Scarce Equity
Indus Solar is offered a 50 MW PV project in Bahawalpur under a 25-year take-or-pay PPA with CPPA-G at 5.6 US cents/kWh, payable in rupees against a USD/PKR reference rate. Expected generation is 105 GWh in year one, degrading 0.5% a year. Capex is USD 28 million, funded 70% by a rupee loan at 13.5% and 30% equity; O&M is PKR 150 million a year, indexed. CPPA-G currently pays 9-12 months late, and the sponsor must finance receivables at 14%. The sponsor's equity is limited, and the alternative is a 12 MW captive plant for its own textile mill, costing PKR 1.2 billion and saving PKR 520 million a year of grid electricity for 15 years. The sponsor uses a 14% rupee WACC for both, and the board asks which investment creates more value per rupee of scarce equity. Current PKR/USD is 278.
1. Build the project cash flow in the correct currency and recommend a discount rate. Quantify the drag from payment delays.
Read the worked answer
Build the solar cash flow in rupees because the PPA is paid in rupees, but keep the USD reference rate visible. At PKR 278, capex is PKR 7.784bn. Revenue is 105m kWh x USD 0.056 = USD 5.88m, or PKR 1.635bn at the reference rate. O&M is PKR 150m, leaving EBITDA of PKR 1.485bn. Depreciation over 25 years is about PKR 311m, EBIT is PKR 1.174bn, tax at 29% is PKR 340m, and unlevered cash flow is about PKR 1.144bn a year. At a 14% rupee WACC and a 25-year annuity factor of 6.873, PV is about PKR 7.86bn, an NPV of roughly PKR 80m before payment delays.
The 14% WACC is defensible only if it already reflects the PPA counterparty and payment-delay risk. If not, add a country/counterparty spread or model the delay explicitly. A 9-12 month average delay of 10.5 months creates receivables of about PKR 1.43bn, financed at 14% for roughly PKR 200m a year pre-tax, or PKR 142m after tax. The PV of that drag over 25 years is about PKR 976m, which more than eliminates the PKR 80m NPV. The project is value-destroying unless the delay is cured or the tariff is raised.
2. Compare the solar IPP and the captive plant using NPV, profitability index and EAA; explain why the IRR ranking may mislead.
Read the worked answer
Solar: NPV is about PKR 80m before delay and negative after delay; PI is about 1.01 before delay; EAA is about PKR 12m over 25 years. Equity is 30% of PKR 7.784bn, or PKR 2.335bn.
Captive: annual pre-tax saving is PKR 520m. After 29% tax, the saving is PKR 369m; depreciation of PKR 80m adds a tax shield of PKR 23m, so annual cash flow is about PKR 392m. At 14% for 15 years, the annuity factor is 6.142, giving PV of PKR 2.41bn and NPV of PKR 1.21bn. PI is about 2.01 and EAA is about PKR 197m. Equity is PKR 1.2bn.
Captive wins on NPV, PI and EAA, and it wins per rupee of scarce equity by a wide margin. IRR can mislead because solar's IRR is close to the 14% WACC while captive's IRR is far above it; the solar project is much larger, so a higher IRR on a smaller project or a lower IRR on a larger one does not tell the board which creates more value. IRR also ignores the timing of the payment delay and the different lives. Use NPV for total value and PI or EAA when capital is rationed and lives differ.
3. CPPA-G offers an escrow account and a partial guarantee that would cut delays to three months for a 30 basis point tariff reduction. Evaluate.
Read the worked answer
Cutting the delay from 10.5 months to 3 months reduces receivables from about PKR 1.43bn to PKR 409m and receivable financing from about PKR 200m to PKR 57m pre-tax, a saving of about PKR 143m a year, or PKR 101m after tax. The PV at 14% over 25 years is about PKR 695m.
The tariff cut from 5.6 to 5.3 cents reduces revenue by USD 0.315m, or PKR 87.6m a year. After tax and depreciation effects, annual cash flow falls by roughly PKR 62m, with a PV of about PKR 426m. On those numbers the guarantee is net positive by about PKR 269m. The guarantee may also justify a lower discount rate because counterparty risk falls; at 12.5% instead of 14%, the PV benefit is larger and the project becomes comfortably positive. The 30 bp price is therefore reasonable if the escrow is legally robust and the guarantee is from a credible entity. Check whether the tariff reduction applies for all 25 years and whether the guarantee covers both energy and capacity payments. If the guarantee is only partial, model the uncovered tail separately.