Financial Appraisal of Hydropower Projects

1. Costs
There are various costs incurred in hydropower project. The costs range from direct investment
on the construction works to the cost for enhancing the available construction, supervision and
operation facility. Broadly speaking, these costs can be categorized under two groups,

1.1 Associated Costs

Associated costs are generally site specific when it comes to hydropower projects immaterial of
their size. The associated include costs of all activities prior to physical construction of the
project, project preparation costs and any other costs that may incur in materializing a
hydropower project. They are,

i. Pre-construction
– Cost for Licenses, Water Rights and Other Regulatory Requirements
– Survey Expenses
– Project Preparation Costs
– Land Acquisition and Compensation Costs
– Community Mobilization and Institutional Development Costs
ii. Induced Costs
– Resettlement and rehabilitation
– Environmental impact mitigation
– Relocation of existing infrastructure
iii. External Costs
– Infrastructure costs including upgrading of existing structures
– Local development and rural electrification (Social Corporate
Responsibility Costs)
– Watershed management

1.2 Direct Costs

Directs costs are also site-specific in terms of construction quantity and complexity. The direct
costs can be further disaggregated into two main categories as costs incurred during
construction and during operation,
 1. Direct Costs (Construction)
These are capital Investment for
i. Civil Works,
ii. Electro Mechanical Equipments,
iii. Mechanical Structures
iv. Supervision and Administration Costs
v. Transportation, Installation and Commissioning Costs
2. Direct Costs (Operation)
i. Operation and Maintenance Costs
ii. Administrative Costs and Overheads
iii. Capital Replacement Costs
iv. Debt Servicing of borrowed Capital
v. Royalty
vi. Insurance Cost
vii. Bonus and Welfare Fund
3. Non cash expense
i. Depreciation
ii. Amortization

2. Factors affecting Direct Cost

There are numerous factors that plays important and critical role in designing, estimating and
deriving total project costs. Some of the highly important factors are,
1. Topography of Site: Among all parameters topography of the project site is as important
as the availability of water. Power generation is function of head through which water
could be made to fall and quantity of water. Therefore, a favourable topography can
make project cheap and vice versa as it derives length of Canal and Penstock Pipe,
availability of Head and length of transmission lines. Similarly, topography will also
derive length and degree of difficulty to construct necessary physical infrastructure for
hydro power generation.
2. Hydrology: Hydrology of the river derives amount of water and variation in its availability.
Since, electricity production is directly proportional to quantity of available, energy
generation and consequentially revenue is also affected by river hydrology.
 3. Combination of both: Combination of hydrology and physiography together governs the
hydropower project design including, alternator and turbine type (type and size in terms
of installed capacity), penstock pipe (length, diameter and thickness), canal length and
size to convey water, and so on. Therefore, it is very important to ensure correctness of
hydrological and physiographic information. Long term hydrological data if available
from secondary sources, they can be correlated and will reduce cost of acquiring
hydrological data greatly. Nonetheless, adequate hydrological data is essential for
designing a reliable hydropower project. Examples of Capital cost (Direct)

Range of Investment costs for grid connected Hydropower plants (example):

Table 1 Example of Capital Cost (Direct Cost)

1 Direct Costs (Operation and Maintenance)

1 Fixed O & M Costs

Cost Item Description
a. Personnel Operators, linesmen, Revenue Collector, etc

b. Administration Insurance, Costumer service cost, Land rent,

taxes, duties, etc
c. Maintenance of Materials (paints, cement, grease, etc) and
Civil Works local manpower
d. Maintenance of Spare parts, salaries of local fitters,
EM equipments electricians
e. Maintenance of Bush cutting, fuses, insulators, cross arms,
Transmission and distribution works poles, etc
f. Overheads of Communication, postage, staff housing, head-
electricity utility or local operators office charges, management costs, etc
Table 1 Operation and Maintenance Cost

2 Variable O & M Costs

i. No Energy Related Variable O & M Costs in hydropower projects
ii. In diesel generator, Variable O & M Costs would be fuel, lubricants,
transportation charges of fuel, etc

1.2 Benefits

Associated Benefits

3 Improved Environment (Reduced deforestation)

4 Better Health situation specially of women and Children
5 Time savings on household chores
6 Improved productivity for home businesses
7 Contribution to economic growth
8 Employment opportunities
9 Support in Education

(Associated Benefits are difficult to quantify in monetary terms and are not considered in
Financial Analysis)

Direct Benefits (Revenue from Sales)

10 Revenue from electricity sales

11 Revenue from capacity sales
12 Subsidies from Government (in capital investment)
13 Liquidation yield of replaced equipment (scrap value)

Setting Tariff

14 Basis of setting Tariff

i. Avoided Costs
ii. Cost Plus
iii. Return on Investment
15 Policy Constraints
16 Tariff Structure
 i. Energy based – metered system
ii. Power based – flat system
iii. Combination of Power and Energy

Revenue (Tariff and Production)

17 Electricity sales x tariff

18 Capacity sales x tariff

Example
19 Capacity based
Annual Revenue from HH = n x W/HH x Tariff/Watt x 12
20 Metered, Energy based
Annual Revenue from HH = n x avg kWh/HH x Tariff/kWh x 12
21 Mixed
Annual Revenue from Industries/Commercial Entities (ICE)
= n x avg kWh/ICE x Tariff/kWh x 12 + ∑ kW x Cap Charge

1.3 Financing of MHP

22 Grants
i. Central Government Subsidy
ii. Other Local Grants
iii. Supports from National/International Charity
23 Bank Loan
i. Collateral
ii. Interest Rate and Repayment Period
24 Equity Investment
i. Ordinary Equity
ii. Preferential Equity
25 Debenture, Bond

Grant (Subsidy)
 26 Applicable to Projects up to 500 kW
27 Provided as below (based on AEPC Subsidy Policy 2009)

Table 2 AEPC Subsidy Policy

Equity (Share)

Money invested in a firm/industry in anticipation of regular payback (dividend); speculative value

of share or capital gain

28 Public Equity: Money invested in companies that are publicly traded on a stock
exchange
29 Private Equity: Money invested in companies that are not publicly traded on a
stock exchange

Bank Loan

30 Collateral
i. Physical Properties
ii. Group/Personal Guarantee
iii. Project Financing
31 Interest Rate and Repayment Period
i. Gestation Period
ii. Periodic Equated Payment (PMT)

r (1 + r ) n
PMT =
(1 + r ) n − 1

r = Interest Rate
 n = Number of Payment

Debentures (Bonds)

32 Debentures
i. A medium to long-term debt instrument
ii. Maturity period and Rate of Return

Other Parameters and Financial Appraisal Linkage

Financial & Market Developers, Bankers &

Experts Decision Makers
Technical/Functional
Experts
Project Cost
Technical/Functional
Experts Fixed Asset Cost

Different Project Estimated Project

Studies Design Annual Revenue Evaluation

Organization
Estimated
+
Annual Operating
Management
Cost
Structure

Organization
Management
Experts

Fig. 1 Financial Appraisal Linkage

1.4 Financial Analysis

Terminologies

33 Cash Flow: Cash receipts minus cash payment over a given period of time
34 Discount Rate: A multiplier to convert future cash flow into present value
reflecting time value of money. A concept similar but opposite to interest rate.
35 Inflation Rate: is a rise in the general level of prices of goods and services in an
economy over a period of time.
36 Break-even Point: The minimum tariff level required at which annual revenues
from electricity sales exceed the cost of production.
37 Annuity: Amount paid or received annually. With the annuity method, all costs
and revenues (benefits) are expressed in equal annual amounts. This allows quick
calculation of unit production costs, pay-back period and break-even point.
 38 Capital Outlay: Amount used during a particular period to acquire or improve
long-term assets such as property, plant, or equipment
39 Annual Depreciation: Term used to spread the cost of an asset over the span of
several years.
40 Amortization: Term used to spread pre-operating costs over the span of several
years.
41 Interest During Construction: May be amortized

Financial Indicators

42 Payback Period
Time in years from the beginning of the project until the time when the sum of the revenues from
electricity sales (and other income) equals the capital invested for the project.
43 Net Present Value (NPV):
Present value of net cash flow
44 Benefit-Cost (B-C) ratio:
The ratio of the present value of the project’s future cash flow divided by the initial capital outlay.
45 Internal Rate of Return (IRR):
The discount rate, which causes the net present value of an investment to become zero.

Financial Analysis Flowchart

Fig. 2 Flowchart of Financial Analysis

Financial Analysis Appraisal

46 Confirm Technical Parameters

 i. Hydrology, installed kW, Energy, etc.
47 X-check Derived Costs
48 X-check Derived Subsidy
i. Based on policy, population, Installed capacity
49 Ascertain Equity and Other Financing
50 Derive Loan Amount Requirement (Costs-(Subsidy+Equity))
51 Ensure derived Revenue based on proposed Tariff and Demand Projection is
correct
52 See whether Operation and Maintenance Costs are Realistic
53 Interest Rate, Moratorium Period and Repayment Period and Other terms
54 See adequacy of Discount Rate
Summary of Costs

('000 NPR)
SN Cost Item Cost
1 Pre-Operating Expenses 361
2 Civil Construction Works 8,805
3 Steel Works 2,575
4 Plant and Machinery 4,886
5 Transmission Line and Interconnection Facilities 2,889
6 Land Procurement and Development 180
7 Building and Camp Houses 311
8 Logistic and Office Equipments 180
9 Vehicles 181
10 Environmental and Social Costs 312
11 Project Supply and Management Cost 862
12 Price Escalation/Miscellaneous Expenses/Contingency 200
Total incl. pre-operating expenses 21,742

Table 3 Summary of Cost

Annual O&M Cost

Table 4 Annual Operation and Management Cost

Other Costs
55 EM Replacement Cost
Electromechanical Equipment is normally replaced depending on:
i. a) life of equipment specified by manufacturer
ii. b) Mode of operation of plant
iii. c) Periodic Maintenance
iv. d) Quantity and Quality of sediments

Royalty

Government seek royalty against the sale of electricity, but it is not applied for projects below 1
MW capacity

Income Tax

For the profit motive projects, government impose income tax on the net income, but it is
imposed on the projects below 1 MW capacity

Subsidy Calculation and OM Costs

Table 5 Subsidy and OM Calculation for MHPs

Financing and Revenue Calculation

Table 6 Financing and Revenue Calculation

Depreciation – Non-expenditure cost

Table 7 Depreciation Calculation

Financial Analysis Model

Cash Flow Analysis

MHP Projects
Particular Const. Operation
Year 2011 2012 20 13 20 14 20 15 2 01 6 2017 2018 2019 2020 2021 2022 2023 2024
Project yea r 1 2 3 4 5 6 7 8 9 10 11 12 13 14
Operation year 1 2 3 4 5 6 7 8 9 10 11 12
REVENUE (Cash IN) 0.00 0.00 3.30 3 .30 3.30 3.30 3 .30 3.30 3.3 0 3.30 3.30 3.30 3.30 3.30
Energy sa le income 0.00 0.00 3.30 3 .30 3.30 3.30 3 .30 3.30 3.3 0 3.30 3.30 3.30 3.30 3.30
COST 4.57 4.57 1.08 1 .08 1.08 1.08 1 .08 0.95 0.9 5 0.95 0.95 0.95 2.02 0.95
Project con struction cost 4.57 4.57
Ammortiza tion of P re-ooperating Co st 0.13 0 .13 0.13 0.13 0 .13
Annu al O&M cost 0.78 0 .78 0.78 0.78 0 .78 0.78 0.7 8 0.78 0.78 0.78 0.78 0.78
E&M replacement cost 1.07
Ins urance 0.17 0 .17 0.17 0.17 0 .17 0.17 0.1 7 0.17 0.17 0.17 0.17 0.17
Roya lty 0.00 0 .00 0.00 0.00 0 .00 0.00 0.0 0 0.00 0.00 0.00 0.00 0.00
0.00 0.00 0.00 0 .00 0.00 0.00 0 .00 0.00 0.0 0 0.00 0.00 0.00 1.00 1.00
Gross Cash-Flow (GCF) -4 .57 -4.57 2.22 2 .22 2.22 2.22 2 .22 2.35 2.3 5 2.35 2.35 2.35 1.28 2.35
Without Loan

Depreciation 0.00 0.00 2.06 1 .82 1.61 1.43 1 .27 1.13 1.0 0 0.90 0.80 0.72 0.64 0.58
Taxable amo unt 0.00 0.00 0.16 0 .40 0.61 0.80 0 .96 1.22 1.3 4 1.45 1.55 1.63 0.64 1.77
Tax 0.00 0.00 0.00 0 .00 0.00 0.00 0 .00 0.00 0.0 0 0.00 0.00 0.00 0.16 0.44
NET P ROJECT CASH FLOW -4 .57 -4.57 2.22 2 .22 2.22 2.22 2 .22 2.35 2.3 5 2.35 2.35 2.35 1.12 1.91
0.00 0.00 1.00 1 .00 1.00 1.00 1 .00 1.00 1.0 0 1.00 0.00 0.00 0.00 0.00
DEBT Analysis
Total De bt and Debt Service 1.37 4.57 -1.38 -1 .38 -1.38 -1.3 8 -1 .38 -1.38 -1.38 -1.38 0.00 0.00 0.00 0.00
Inte rest -0 .16 -0.73 -0.82 -0 .75 -0.68 -0.5 9 -0 .50 -0.40 -0.28 -0.15 0.00 0.00 0.00 0.00
Principal -0.56 -0 .62 -0.70 -0.7 8 -0 .87 -0.98 -1.10 -1.23 0.00 0.00 0.00 0.00
Total Loan Withsta nding 1.53 6.83 6.28 5 .65 4.96 4.18 3 .30 2.32 1.2 3 0.00 0.00 0.00 0.00 0.00

Gross Cash-Flow (GCF) -4 .57 -4.57 2.22 2 .22 2.22 2.22 2 .22 2.35 2.3 5 2.35 2.35 2.35 1.28 2.35
Debt and Debt Service (DDS) 1.37 4.57 -1.38 -1 .38 -1.38 -1.3 8 -1 .38 -1.38 -1.38 -1.38 0.00 0.00 0.00 0.00
Depreciation (DEP ) 0.00 0.00 2.06 1 .82 1.61 1.43 1 .27 1.13 1.0 0 0.90 0.80 0.72 0.64 0.58
Loan Repa yment (LR) 0.00 0.00 -0.56 -0 .62 -0.70 -0.7 8 -0 .87 -0.98 -1.10 -1.23 0.00 0.00 0.00 0.00
With Loan

Taxable Income (GCF+DDS-DEP-LR) -3 .20 0.00 -1.77 -1 .59 -1.46 -1.3 6 -1 .29 -1.13 -1.13 -1.15 1.55 1.63 0.64 1.77
Tax (TX) 0.00 0.00 0.00 0 .00 0.00 0.00 0 .00 0.00 0.0 0 0.00 0.00 0.00 0.16 0.44
NET DEVELOPER'S CASH FLOW -3 .20 0.00 0.85 0 .85 0.85 0.85 0 .85 0.97 0.9 7 0.97 2.35 2.35 1.12 1.91

Table 8 Financial Analysis Model

(Tariff as fixed by developer/community)

Financial Results
Table 9 Financial Indicators

Measures of Cost Control

56 Timely execution of project, proper management of material, manpower and

money is required.
57 The proposed construction schedule has to fit to working season.
58 Time/Cost over-run Risk Mitigation
59 Other Risk (Operational Period) Mitigation - Insurance
60 Different project management tools like CPM, Gantt chart will prove helpful in
managing the critical construction schedule and enhance cost control.

Common Deficiencies in Financial Analyses

61 Cost estimates incomplete – missing items such as land acquisition,

interconnection equipment, transportation and installation of equipment, and
environmental mitigation.
62 Interest during construction not taken into account
63 Escalation of project costs not considered
64 Absence of rationale used to select key parameters, such as interest rates or
term of loans