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The project life coverage ratio (PLCR) is a commonly used debt metric in project finance. Together with the debt service coverage ratio (DSCR) and loan life coverage ratio (LLCR), these debt metrics, in one form or another, usually appear in project finance term sheets and loan documentation, so need to be modelled clearly and accurately.
This tutorial covers the definition of the PLCR, show how to calculate this ratio, and highlight key points to keep in mind when modelling PLCR.
- Definition of the PLCR
- PLCR calculation
- Variations in the PLCR calculation
- Common mistakes in the PLCR calculation
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The Project Life Coverage Ratio (“PLCR”) is a commonly used debt metric in Project Finance. It is the ratio of the Net Present Value (NPV) of the cashflow over the remaining full life of the project to the outstanding debt balance in the period.
Definition of PLCR
Generally the PLCR is calculated as:
PLCR = NPV [CFADS over Project Life] / Debt Balance c/f
The Discount Rate used in the NPV calculation is usually the Cost of Debt, also known as the Weighted Average Cost of Debt.
The CFADS qualifying for PLCR calculation extend beyond loan life, so there is always a question as to what discount rate to use post loan final maturity date. This depends upon a lender’s perception of the certainty risk of the projected cash flows beyond the loan life.
Loan documentation often states the discount rate to be used post the loan life, 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, as projected cash flows beyond the loan life are even more uncertain to be relied upon.
For example, in models pertaining to mining or resource industries, a substantial mine rehab cost or closure costs towards the end of the project life is often seen which can dramatically reduce the CFADS (the numerator for PLCR).
In practice, lenders often build in a safety cushion and ignore the revenue or cash flow beyond a certain cut-off date. This allows lenders to protect against relying on potentially more uncertain future cash flows. It is common to encounter an end date for the PLCR calculation in the term sheet or loan documentation before the end of the project life. This means the qualifying period for CFADS in the PLCR calculation is only from commercial operation date (COD), and up to such end date.
Variations in PLCR definition
Extreme caution needs to be applied when assessing the economics of a project where the PLCR is supported with cash account balances. When, for example, DSRA is included, the PLCR shall then be calculated as:
LLCR = (NPV [CFADS over Project Life] + DSRA/c Balance c/f) / Debt Balance c/f
Screenshot#1 depicts the calculation of PLCR, where:
- CFADS till the end of project life qualify for the calculation of present value.
- A constant discount rate of 9% p.a., which is higher than the cost of debt at final maturity date is used to discount cashflows post project life.
- End of period PLCR is calculated till the penultimate debt service period
- The Discount Rate, which is usually the ‘Average Cost of Debt’ is overcomplicated rather than calculated simply as:<Cost of Debt> = Total Interest (for all tranches) / Total Debt Balance b/f (for all tranches)
- 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 just the base rate
- Incorrect use of the (X)NPV function in Excel.
- The definition of the LLCR in the model is not clear and has not been validated against the debt term sheet.
- LLCR covenants are used to trigger cash sweeps, while at the same time including interest on reserve accounts / cash balances in the model resulting in a circular model.
- The inclusion of CFADS has not been correctly capped beyond the end of the loan life, with the cut-off date for PLCR
- CFADS has not been clearly presented in the cash waterfall and the PLCR is incorrectly referring to some other line in the waterfall.
- The discounting of CFADS is calculated incorrectly by confusing compound/simple interest rates.
- Adjustment has not been made and an annual discount rate is being applied to quarterly cashflows, or vice versa.
- PLCR is generally perceived to be higher than LLCR, owing to a longer evaluation period.
However a lower PLCR can also be seen if the model has substantial closure or decommissioning costs towards the end of the project life, bringing down the CFADS considerably.