Case 049Debt capacity and loan structuringHard

Taranjot Solar's cash flow available for debt service rises from Rs 80 crore to Rs 110 crore over 15 years. Compare the debt it can raise with a level annuity repayment against a repayment sculpted to a constant 1.3x cover, at 9%.

The situation

Taranjot Solar owns an operating solar park selling power under a long-term contract whose tariff escalates each year faster than panel output degrades. Cash flow available for debt service is Rs 80 crore in year 1 and rises in a straight line to Rs 110 crore in year 15.

Lenders will lend for 15 years at 9% and require debt service cover of at least 1.30x in every year. The sponsor wants to know whether a level annuity repayment or a repayment sculpted to the cash flow raises more debt.

Your task

Size the debt under each structure, show why they differ, and say what extra risk the lender takes with sculpting.

Quick check

Which structure raises more debt, and why?

Worked solution

Try it on paper, then open one step at a time.

30-second answerThe answer to give first

Sculpting raises about Rs 568 crore against Rs 496 crore for a level annuity, about 15% more. A level payment must pass 1.30x in year 1, so it is capped at Rs 61.5 crore a year and cover rises to 1.79x by year 15, leaving later cash unused. Sculpting sets each year's payment at that year's cash divided by 1.30. The lender gets 1.30x every year but is repaid later, so it depends more on the tariff escalation arriving.

Step 1Why does a level annuity waste capacity here?

A young professional whose salary rises every year could take a home loan with a fixed EMI sized to today's salary, or one whose instalments step up with her pay; the second lets her borrow more today. A level payment must be affordable in the weakest year, so when cash flow rises, every later year carries spare cover that no one borrows against. Year 1 cash of Rs 80 crore at 1.30x allows Rs 61.5 crore a year; by year 15 cover under the annuity is 1.79x.

Sculpted repayments follow the cash; a level annuity is stuck at year 1406080100120yr 1yr 5yr 10yr 15cash 110sculpted 84.6annuity 61.5capacity the annuity leaves unusedRs crore a year
Cash flow rises from Rs 80 crore to Rs 110 crore; sculpted debt service follows it at 1.30x, from Rs 61.5 crore to Rs 84.6 crore, while the level annuity stays at Rs 61.5 crore and leaves the shaded capacity unused.
Step 2How is sculpted debt sized?

Set each year's debt service to that year's cash divided by 1.30, then discount those payments at 9%. The debt is the present value of the payments the lender allows, so larger later payments mean a larger loan: Rs 568.3 crore against Rs 496.0 crore for the annuity. The annuity is the special case where every payment is forced to equal the smallest one. Sculpting is standard in project financeLending repaid from a single asset’s own cash flows, with the asset and its contracts as the main security rather than a parent company balance sheet., because contracted cash flows can be forecast year by year.

The relationship
Dsculpted=∑t=115CFADSt/1.301.09tDannuity=801.30×1−1.09−150.09D_{\text{sculpted}} = \sum_{t=1}^{15} \frac{\text{CFADS}_t / 1.30}{1.09^{t}} \qquad D_{\text{annuity}} = \frac{80}{1.30} \times \frac{1 - 1.09^{-15}}{0.09}
CFADS_tcash flow available for debt service in year t, Rs 80 crore rising to Rs 110 crore
1.30the minimum debt service cover the lenders require
What it says in wordsBoth loans are present values of payments; sculpting lets every payment use its own year's cash.
Same cash, same minimum cover: sculpting raises more debtLevel annuity496: cover 1.30x in year 1, 1.79x by year 15496Sculpted to 1.30x568: cover 1.30x every year568Extra capacity: Rs 72 crore, 14.6% more debt
At 9% and 1.30x minimum cover the level annuity supports Rs 496 crore of debt and the sculpted profile Rs 568 crore, about Rs 72 crore more from the same cash flows.
Step 3What extra risk does the lender take?

Sculpting repays more slowly early on: after five years about Rs 488 crore is still owed against Rs 395 crore under the annuity, and after ten years Rs 315 crore against Rs 239 crore. The lender gets the same minimum cover but a thinner cushion in later years and more money outstanding when the forecast is least certain. Lenders manage this by sculpting only on contracted cash, applying a haircut to escalations or degradation assumptions, and keeping a tail: the power contract should run several years beyond the loan so there is cash left to restructure against if output disappoints.

Where candidates lose it

The usual slip is sizing the annuity on average cash flow, about Rs 95 crore, which fails the 1.30x test in the early years. A level payment is always sized on the weakest year.

The second is presenting sculpting as free money. The extra debt is borrowed against later, less certain cash, and a good answer names that risk and how lenders control it.

What the interviewer asks next

  • Cash flow falls instead, from Rs 110 crore to Rs 80 crore. Which structure raises more now?
  • What is a tail, and why do solar lenders insist on one?
  • How would a debt service reserve account change the sizing?
  • The lender applies 1.30x on a P90 case and 1.15x on P50. What does that do to the debt?

Company names and figures are illustrative.