Use of Debt in Projects

1. 0 1 ………………………………………………………………..20 Coal Fuel Purchases 8.2 Million/Year Natural Gas Fuel Purchases 34.3 Million/Year Study the advantage of choosing coal over Natural Gas (oh yes subtract Preferred - the other thing) Coal Plant Construction 120 Million Dollars - Natural Gas Plant Construction 35 Million 0 1 …………………………………………………………………20 Cash flow for choosing coal over natural gas = 26.1 Million/Year in Fuel Savings 85 Million in Additional Construction Costs Use of Debt in Projects IRR of this Cash Flow is 30.56%

2. $6.57 Million Each Year in Debt Service $25 Million additional capital up front The remaining $60 million dollars we finance with bank loans over 20 years at 9% interest Change the Financial Structure $26.1 Million Each Year in Fuel Savings The IRR of this Cash Flow is 78.12%

3. What Happened???!! • We applied a principle called leverage • analogy is to the use of a lever that magnifies your strength • We use someone else's money at a lower rate of interest than the rate of return in the project and pocket the difference for ourselves

4. Use of Leverage • Most companies will try to sweeten investor returns by use of leverage • Some People buy stock on “Margin” • if the stock price is growing faster than the interest rate it increases your return • What makes more money than 400 shares doubling their price • 4000 shares of stock doubling their price • May have heard of leveraged buy outs where company operators buy the company using debt

5. How Can You Do That? • If the project is so good why doesn't the bank just buy it? • The expertise factor - banks know how to lend money - not necessarily run projects • Banks are more risk adverse - they don’t take as many chances and have a lower risk premium on investment • It’s the same project - how can the bank have less risk?

6. An $85 Million Dollar Investment An $85 Million Dollar Investment is paid for with $25 Million of Investor Money and $60 Million with borrowed money Declines in Value to $60 Million Dollars Declines in Value to $60 Million Dollars Risk deals with Likelihood and Magnitude of Loss The Bank Looses Nothing Our Investors Loose 29.5% of their Investment The Investor Looses With Leverage - You Pocket the Earnings and the Risk

7. The Gore Worms put a carbon tax on coal to save the world from Global Worming Life Skunk Power and Light Invested an extra $85 Million to build a coal fired power plant instead of natural gas When Things Were Rotten The Price of Natural Gas Drops to $2.20/MBTU from $4.50/MBTU Leaving $7.6 Million Per Year in Fuel Savings The IRR on the Project is now 6.31% But Then Larry Leverage Remembers that you can sweeten projects by using debt financing!

8. The Gore Worms put a carbon tax on coal to save the world from Global Worming Life Stuck spends an extra $25 Million for a coal plant Any More Bright Ideas Larry? The Price of Natural Gas Drops to $2.20/MBTU from $4.50/MBTU Leaving $7.6 Million Per Year in Fuel Savings The rest is financed at 9% for $6.57 Million per year The IRR of this Cash Flow is -1.77% (ie - it looses money and has no pay-back period)

9. The Dark Side of Leverage • Many people do not understand that if the return in a project drops below the interest rate that they will get levered down • They take the risk • The Bank takes the money • Leverage magnifies often improves project rate of return • But it can also increase down-side risk

10. Use Leverage with Caution And a Generous Helping of Understanding