W15_AAA_Projects Finance Using Loan Options (Constant Periodic Payment & Constant Principal Payment)


  1. Problem Definition

A Local oil and gas company wants to develop gas field in Indonesia, but the company need more money to develop the field. There are two Loan’s Provider (Bank) that offer the loans and the company wants to choose a Bank with low interest of loan. The economic analysis will be performed to find which bank that will give low interest of loan (MMUS$).

  1. Identify the Possible Alternative

The money  that will be borrowed is 200 MMUS$ with 11 years loan period to develop gas field in Sumatera, There are two banks that offer the loans with same interest rate but different payment models :

  • Bank A: Constant Periodic Payment
  • Bank B: Constant Principal Payment

The Interest rate that will be used is 11.49% (average interest rate per April 2015 based on http://www.bi.go.id/id/perbankan/suku-bunga-dasar/Default.aspx).

  1. Development of the Outcome for Alternative

There are some model of payment that will be given by loan provider (Bank).

  • Constant Periodic Payment:

A model of payment that gives a constant total annual payment (principal + interest) but different amount of Principal and interest payment in each year (see table 1.). There are some formula that will be used in Constant Periodic Payment and the formula is already given in excel as shown below.

Periodic Loan Payment:

“=PMT(rate,nper,pv,fv,type)”

Periodic Interest Payment:

“=IPMT(rate,per,nper,pv,fv,type)”

Periodic Principle Payment:

“=PPMT(rate,per,nper,pv,fv,type)”

where,

Picture2 (2)

  • Constant Principal Payment:

A model of payment that gives a constant principal annual payment but different amount of interest payment in each year (see table 1.).

Both constant periodic payment and constant principal payment above will give different cumulative net interest and principle cashflow and these model will be applied to find the lowest NPV of interest payment (MMUS$).

  1. Selection Criteria

The calculation of interest payment based on models above is as shown below.

Picture2

Picture1

  1. Analysis and Comparison of Alternative

From table 1, both models gives the same total NPV (200 MMUS$), but the NPV of interest payment are different. Bank B has lower NPV of interest Payment (89.59 MMUS$) compare to Bank A (101.77 MMUS$).

  1. Selection of the Preferred Alternative

Based on economic analysis, Bank B is chosen because they give lower NPV of interest payment compare to Bank A which means that the value (MMUS$) of interest payment of Bank B is cheaper than Bank A.

  1. Performance Monitoring and the Post Evaluation of Result

When Contractor propose a loan and expecting low interest payment (MMUS$), it is better to choose a loan with Constant Principal Payment model if the interest rate is same as shown in the case above, but if Bank propose different interest rate and different model of payment, then the company must calculate the interest payment as the methods shown above and these method can be applied in Project Finance Valuation (with Loan).

Reference:

  1. Mian.M.A. ((2011). Project Economics and Decision Analysis Vol. I: Deterministic Models, Oklahoma: Penn Well Corp.
  2. Sullivan, William G., Wicks, Elin M. &Koelling, C. Patrick. (2012). Engineering Economy 15th Edition, Singapore: Prentice Hall, Inc.
  3. bi.go.id. “Suku Bunga Dasar Kredit”. Retrieved from http://www.bi.go.id/id/perbankan/suku-bunga-dasar/Default.aspx
  4. graduatetutor.com. “Top 10 Microsoft Excel Tips for MBAs” . Retrieved from http://www.graduatetutor.com/microsoft-excel-tutoring/top-10-microsoft-excel-tips-for-mbas/
  5. chandoo.org. “PMT Excel Formula”. Retrieved from http://chandoo.org/excel-formulas/pmt.shtml
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About Ahmad Abdul Aziz

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2 Responses to W15_AAA_Projects Finance Using Loan Options (Constant Periodic Payment & Constant Principal Payment)

  1. drpdg says:

    Hi Pak Ahmad great case study but I had to dig really hard to figure out how/why you used the 11.49%. I finally figured it out but next time, you need to be REALLY CLEAR how you chose your WACC/MARR because if you get that number wrong, then everything else is garbage….

    Other than that, you did a great job on your analysis…….

    BR,
    Dr. PDG, Boston

    Like

  2. Pingback: W16_AAA_Project Finance Using Loan Options Part 2 (Constant Periodic Payment, Constant Principal Payment & Constant Interest Payment) | GARUDA AACE 2015

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