Project Life Cover Ratio

The Project Life Cover Ratio is a widely used debt metric in project finance. In this tutorial we learn the steps to calculate the Project Life Cover Ratio, as well as some common modelling mistakes to avoid.

Introduction

The Project Life Cover Ratio (“PLCR”) is a widely used debt metric in project finance, along with the Debt Service Cover Ratio (“DSCR”) and the Loan Life Cover Ratio (“LLCR”). These debt metrics are generally included in the term sheets and loan documentation for project finance transactions. This tutorial explains the key characteristics of the PLCR, the steps to calculate this ratio and discusses some common mistakes when modelling the PLCR.

What is the PLCR?

The PLCR is the ratio of the net present value of the Cashflows Available for Debt Service (“CFADS”) available over the remaining full life of the project to the outstanding debt balance in the period. This ratio is similar to LLCR, however in LLCR the CFADS is calculated over the scheduled life of the loan, whereas the cashflow for PLCR is calculated over the “Project Life”. The PLCR is defined as:

It is common to have an end date for the PLCR calculation in the term sheet or loan documentation before the end of the project life. Lenders often build in a safety buffer and ignore the revenue or cashflows beyond a certain cut-off date to protect against relying on potentially more uncertain future cashflows. Therefore, when calculating the PLCR, the qualifying period for CFADS is from Commercial Operation Date (“COD”) up to the stated cut-off date. In this example, the end date for the PLCR calculation is twelve months before the end of the operations as illustrated in Screenshot #1.

Screen shot #1: Assumption for PLCR calculation

Differences in PLCR definition

It is not uncommon to find the Debt Service Reserve Account (“DSRA”) or the balance of the Project’s cash account added to the numerator or netted from the numerator. Note that extreme caution should be applied when evaluating a project where the PLCR is supported with cash account balances. When the DSRA is included, the PLCR is defined as:

Calculating the PLCR

Step 1: Calculating the discount rate

The discount rate (“r”) for discounting the CFADS for the PLCR calculation is typically the cost of debt, and is similar to the LLCR. The discount rate is calculated as:

As the qualifying CFADS extend beyond the loan life, what is the discount rate to be used post loan final maturity date? This depends upon a lenders’ perception on the certainty risk of the projected cashflows beyond the loan life. The discount rate to be applied post loan final maturity date is often stated in the loan documentation. The rate should be at least equal or even greater than the cost of debt of the senior debt at final maturity date to account for greater risk. In our example, we assume the discount rate for the PLCR calculation post final maturity debt (final maturity of senior debt is 30-Jun-15) to be 8.00% p.a. or 1.94% p.q. as illustrated in Screenshot #2.

Screen shot #2: Discount rate for PLCR calculation

Step 2: Calculating the qualifying CFADS

The PLCR calculation takes into account the NPV of CFADS over the life of a project or a specified cut-off end date. The qualifying CFADS occur from the start of operations or COD up until the end date. Therefore, we create binary flags [1,0] to bring CFADS into the calculation and for calculating the CFADS for the qualifying period. Therefore, qualifying CFADS are calculated as:

Step 3: Calculating the NPV of CFADS

This is similar to the LLCR calculation except that the CFADS is taken into account up to the end date as explained in Step 2. Screenshot #3 shows the calculation of the CFADS (NPV).

Screen shot #3: Calculating CFADS (NPV)

Screen shot #4: Calculating PLRC

Step 4: Calculating PLCR

In the final step, we bring in the discounted CFADS calculated in Step 3 and the debt balance b/f as illustrated in Screenshot #4. The PLCR is calculated as:

PLCR calculation: Common mistakes

Common mistakes in calculating the PLCR include:

Discount rate post loan final maturity date:

It is a common mistake to model the discount rate post loan final maturity date to be 0.00% because the modelled cost of debt post the final maturity date is nil or equal to the base rate. The projected cashflows beyond the loan life have an even higher level of uncertainty and therefore should be discounted with the rate at least equal to cost of debt of the senior debt at the final maturity date. One approach is to add the default margin to the cost of debt. An alternative is to leave it at the cost of debt on the basis it could be refinanced. The reality is that it makes little difference as it is so far out for long term financings.

Will the PLCR always be higher than LLCR?

The PLCR may be expected to be always higher than the LLCR owing to a longer evaluation period. However, the PLCR could be less than the LLCR. This is a result of some projects, particularly mining or resource-based projects, having a significant mine rehabilitation cost or closure costs towards the end of the Project Life which can materially reduce the CFADS (the numerator for PLCR).