Debt sizing with a target debt service coverage ratio (DSCR) is a method used in project finance to determine the appropriate amount of debt financing that a project can support while maintaining a certain level of debt repayment capacity.

What is the Debt Service Coverage Ratio (DSCR)?

The debt service coverage ratio (DSCR) is a financial metric that measures the ability of a project to generate enough cash flow to cover its debt service obligations, including principal and interest payments. A DSCR of 1.0x indicates that the project generates enough cash flow to cover its debt service obligations, while a DSCR above 1.0x indicates that the project generates more cash flow than required to cover its debt service obligations.

To size the debt with a target DSCR, a financial model is used to estimate the project's expected cash flows over the life of the project. This cash flow forecast is then used to determine the maximum amount of debt that the project can support while maintaining a target DSCR.

Debt Sizing Case Study: 50 MWp Solar PV Project

Let’s look at a case study for a 50 MWp solar PV project. The following Information Memorandum provides all information necessary to determine the maximum debt capacity as well as a sculpted debt repayment profile for this specific project.

Since we would like to understand how much debt the solar park can take on while meeting a minimum target DSCR, Debt Option 2 (sculpted repayment) is relevant for building our business case.

The key information needed for debt sizing purposes is the following:

1.     Maximum gearing ratio: 80.0%

2.     Minimum (Target) DSCR: 1.30x

3.     All-in interest rate: 2.00% p.a.

4.     Maximum loan tenor: 20 years

5.     Grace period: 1 year

This information allows us to build a financial model to determine the maximum debt capacity, debt repayment profile considering seasonality effects, and many other return metrics such as IRR, NPV, Cash-on-Cash return, and payback period.

1. Step: Set up relevant debt inputs

First, we need to set up all relevant debt inputs for the sculpted debt repayment profile. It is best practice to set up such inputs in a separate sheet that solely considers input figures. Below is an example of how such inputs may be organized in a best-practice project finance model.

2. Step: Determine Cash Flow Available to Debt Service

Next, you need to determine how much cash flow available for debt service (CFADS) each respective period offers. These quarterly CFADS will be used to size the appropriate loan repayment profile.

Cash flow available for debt service (CFADS) is a financial metric that measures the amount of cash generated by a project that is available to service its debt obligations after all operating expenses, taxes, and capital expenditures have been paid. CFADS is an important metric concerning debt sizing and project finance because it represents the cash flow available to pay back debt service to project finance lenders.

When sculpting a debt profile to match a target DSCR, CFADS is used to determine the amount and timing of debt payments required to meet a debt sizing-specific target DSCR. The process of sculpting a debt profile involves structuring the debt payments to match the expected cash flow available for debt service over the project's life or the loan's maximum tenor.

3. Step: Determine the appropriate sculpted repayment profile considering a target DSCR of 1.30x

To determine a sculpted debt repayment profile considering a target Debt Service Coverage Ratio (DSCR) of 1.30x, the following steps have to be taken:

1.     Use the Cash Flow Available for Debt Service (CFADS) for each quarter of the project based on the projections of the financial model. CFADS represents the cash generated by the project that is available to service debt obligations, after taking into account all operating expenses, taxes, and other required payments.

2.     Determine the quarterly debt service for the project based on the financing terms (e.g., interest rate, tenor, payment frequency, etc.). This represents the total amount of principal and interest that needs to be paid each quarter to service the debt.

3.     The total debt service is determined by dividing the quarterly CFADS by the target DSCR for each quarter. The DSCR represents the project's ability to generate enough cash flow to meet its debt service obligations.

4.     Final step in the debt sizing process: Implement a macro using VBA to automate this highly iterative debt sculpting process.

Overall, a sculpted debt repayment profile helps to ensure that debt service obligations are manageable throughout the life of the project and that the project is able to meet its financial commitments. By adjusting the repayment profile based on the CFADS and the target DSCR, lenders can mitigate the risk of default and ensure that the project is successful over the long term.

Enhance the decision-making process of your organization with a comprehensive financial model dashboard.

If you're looking to invest in renewable energy, you need a comprehensive financial model dashboard that summarizes all the key investment metrics relevant to your decision-making process.

This financial model dashboard for renewable energy investments is designed to help you make informed investment decisions with ease. It includes a detailed breakdown of the project's capital structure, allowing you to understand the financing mix of the project and the risks associated with each layer of the capital stack.

The dashboard also considers critical investment metrics such as IRR and NPV on both a levered and unlevered basis, giving you a complete picture of the project's profitability.

In addition to these essential investment ratios and multiples, the dashboard details the payback periods, CFADS/EV, Revenue/EV, EV/MWp, and EV/MWh. These metrics are crucial in evaluating the financial viability of the project and determining its potential for generating returns over the long term.

The dashboard also features eye-catching charts that provide a visual representation of the project's cash flow generation and cash on cash returns over its entire asset lifetime. This feature will give you valuable insights into the project's cash flow patterns and help you make informed investment decisions.

With all these critical investment metrics and data points in one place, this financial model dashboard is the ultimate tool for renewable energy investment decision-makers.

How to build a project finance model from scratch?

Do you want to learn how to build a project finance model from scratch? Then check out the Advanced Renewable Energy Financial Modeling course.