Financial Structures

Four distinct ownership perspectives were identified for this analysis. Each reflects a different financial structure , financing costs, taxes, and desired rates of return. Briefly, the four ownership scenarios are:

Generating Company (GenCo): The GenCo takes a market-based rate of return approach to building, owning, and operating a power plant. The company uses balance-sheet or corporate finance, where debt and equity investor s hold claim to a diversified pool of corporate assets. For this reason, GenCo debt and equity are less risky than for an IPP (see below) and therefore GenCos pay lower returns. A typical GenCo capital structure consists of 35 % debt at a 7.5% annual return (with no debt service reserve or letter of credit required) and 65% equity at 13% return. Although corporate finance might assume the debt to equity ratio remains constant over the project's lif e and principal is never repaid, it is often informative to explicitly show the effect of the project on a stand-alon e financial basis. Therefore, to be conservative, the debt term is estimated as 28 years for a 30-year project, and all the debt is repaid assuming level mortgage-style payments. Flow-through accounting is used so that the corporate GenCo receives maximum benefit from accelerated depreciation and tax credits.

Independent Power Producer (IPP): An IPP's debt and equity investment is secured by only the one project, not by a pool of projects or other corporate assets as is the case for a GenCo. In this project finance approach, a typical capital structure is 70% debt at 8.0% annual return (based on 30-year Treasury Bill return plus a 1.5% spread) and 30% equity at a minimum 17% return. A 6-month Debt Service Reserve is maintained to limit repayment risks . Debt term for an IPP project is generally 15 years, with a level mortgage-style debt repayment schedule. (For solar and geothermal projects that are entitled to take Investment Tax Credits, a capital structure of 60% debt and 40% equity should be considered.) Flow-through accounting is used to allow equity investors to realize maximu m benefit from accelerated depreciation and tax credits. IPP projects are required to meet two minimum deb t coverage ratios. The first requirement is to have an operating income of no less than 1.5 times the annual deb t service for the worst year. The second is to have an operating income of about 1.8 times or better for the average year. Because debt coverage is often the tightest constraint, actual IRR may be well over 17%, to perhaps 20% or more. Likewise, with good debt coverage, negative after-tax cash flows in later years of debt repaymen t (phantom income) are low.

Regulated Investor-Owned Utility (IOU): The regulated IOU perspective analyzes a project with a cost-base d revenue requirements approach. As described by the EPRI Technical Assessment Guide (TAG TM), returns on investment are not set by the market, but by the regulatory system. In this calculation, operating expenses, property taxes, insurance, depreciation, and returns are summed to determine the revenue stream necessary to provide th e approved return to debt and equity investors. Use of a Fixed Charge Rate is a way to approximate the levelize d COE from this perspective. IOU capital structure is estimated as 47% debt at a 7.5% annual return; 6% preferred stock at 7.2%; and 47% common stock at 12.0%. Debt term and project life are both 30 years. Accelerated depreciation is normalized using a deferred tax account to spread the result over the project's lifetime. IOUs ar e not eligible to take an Investment Tax Credit for either solar or geothermal projects.

Municipal Utility (or other tax-exempt utility): The municipal utility uses an analysis approach similar to that o f the IOU. Capital structure is, however, assumed to be 100% debt at 5.5% annual return, and the public utility pays neither income tax nor property tax.

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