Case 092Capital budgetingHard
A developer is bidding for a 25-year, 100 MW solar concession with 70% debt over 15 years and a 12% equity return target. Work backwards from the return to the tariff it should bid.
1The situation
Suryaprabha Renewables, an invented solar developer, is bidding for a 100 MW plant under a 25-year power purchase agreement at a fixed tariff per kWh. Building it costs Rs 450 crore. The site's capacity utilisation factor is 24%, which gives about 210 million kWh a year. Operations and maintenance cost Rs 6 crore a year.
Lenders will fund 70% of the cost at 9%, repaid in equal yearly instalments over 15 years. The equity investors want a 12% IRR over the 25-year life. Ignore tax for this exercise; the concession may carry tax benefits whose current terms you would confirm before a real bid. The bid team asks for the lowest tariff that delivers the equity return.
2Your task
What tariff per kWh should Suryaprabha bid, how is the revenue split between lenders and equity, and what moves the number most?
Quick check
Does borrowing 70% at 9% raise or lower the tariff needed to earn 12% on the equity?
Worked solution
Try it on paper, then open one step at a time.
30-second answerThe answer to give first
Bid about Rs 2.72 per kWh. At that tariff revenue is Rs 57.1 crore a year; after Rs 6 crore of O&M and Rs 39.1 crore of debt service the equity receives Rs 12.1 crore a year for 15 years and Rs 51.1 crore for the last ten, a 12% IRR on Rs 135 crore. Year-one DSCR is 1.31x, which most lenders would accept but not by much. The capacity factor and the cost of debt move the tariff most: 22% utilisation needs Rs 2.97, and debt at 10% needs Rs 2.81.
Step 1Why is a tariff bid solved backwards?
A tailor asked to quote for a uniform contract starts from the margin he needs, adds cloth, labour and rent, and arrives at a price; he does not pick a price and hope. An infrastructure bid is the same sum run in reverse: fix the return the equity needs, fix what the lenders take, and the tariff is whatever is left over. Three fixed quantities do most of the work. The plant produces 210.2 million kWh a year, so every rupee of tariff is Rs 21.02 crore of revenue. The lenders take Rs 39.1 crore a year for 15 years, the instalment that repays Rs 315 crore at 9%. And the equity's Rs 135 crore must earn 12% over 25 years. The capacity utilisation factorActual generation as a share of what the plant would produce running at full rated power all year; for solar it is set by sunlight hours and weather. is the number everything else rests on.
| DS | yearly debt service, Rs crore, an equal instalment over 15 years |
| a(15, 9%) | the 15-year annuity factor at 9% |
| 21.02 p | revenue in Rs crore: 210.2 million kWh times the tariff p in rupees |
| 135 | the equity invested, 30% of Rs 450 crore |
Step 2How does the revenue divide between lenders and equity?
At Rs 2.72, revenue is Rs 57.1 crore. For the first 15 years the lenders take Rs 39.1 crore of the Rs 51.1 crore left after O&M, and the equity gets Rs 12.1 crore; once the debt is gone the equity gets all Rs 51.1 crore for ten years. That shape is why the equity return is sensitive to the plant's later life: more than half of the equity's cash arrives after year 15, when panels have degraded and the PPA counterparty's willingness to pay has been tested for a decade and a half. Year-one DSCRDebt service coverage ratio: cash available after operating costs divided by that year's interest plus principal. is 51.1 over 39.1, 1.31x. Lenders commonly ask for a minimum around 1.2x on solar, so the bid clears their test too, though the exact covenant is a term to confirm with them; at a 1.20x floor the lenders alone would require at least Rs 2.52.
Step 3What moves the tariff most?
Rerun the solve with one input changed at a time. Two points of capacity factor, from 24% to 22%, lift the required tariff to Rs 2.97, and one point on the cost of debt lifts it to Rs 2.81; stretching the loan to 18 years lowers it to Rs 2.69. A 14% equity target instead of 12% needs Rs 2.88. The bidder who wins is usually the one with the cheapest debt and the most confident view of sunlight, which is why a bid team spends more time on the lenders' term sheet and the site's irradiation data than on the spreadsheet itself. The limits of this exercise are worth naming: no panel degradation, no tax, no inflation in O&M, and no delay in payments from the buyer, each of which pushes the real tariff up.
| Change from the base case | Tariff for 12% equity IRR, Rs per kWh | Why |
|---|---|---|
| Base case | 2.72 | 24% utilisation, 9% debt over 15 years |
| Utilisation 22% | 2.97 | Less electricity to sell from the same cost |
| Debt at 10% | 2.81 | Higher instalments for 15 years |
| Debt over 18 years | 2.69 | Smaller instalments, more left for equity early |
| Equity target 14% | 2.88 | The equity wants more of each rupee |
| No debt, project IRR 12% | 3.01 | All Rs 450 crore must earn 12% |
Where candidates lose it
The common loss is solving for a project IRR of 12% on the full Rs 450 crore and bidding about Rs 3.01. The equity wants 12% on its Rs 135 crore; the other Rs 315 crore costs 9%, and a bidder who ignores that loses the auction to one who did not.
The second loss is forgetting the debt stops after 15 years. Treating debt service as a 25-year cost understates the equity's later cash flows and overstates the tariff; treating it as perpetual interest only, with no repayment, does the opposite.
What the interviewer asks next
- Panel output degrades 0.5% a year. Roughly how much does the tariff need to rise?
- The lenders insist on a minimum DSCR of 1.30x. What tariff does that force, and who bears the difference?
- The PPA buyer pays 90 days late on average. How would you reflect that in the bid?
- Why might a competitor with a 10% equity target and 8% debt bid much lower than Rs 2.72?
Asked at Bain Capital, Private Equity, San Francisco, 2025 (Wall Street Oasis): Asked unique case questions regarding infrastructure assets but also software/healthcare
Company names and figures are illustrative.