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Investment and Financing Perspectives For Solar Photovoltaic Projects

Investment and Financing Perspectives For Solar Photovoltaic Projects

Date: December 2nd 2020

Author: Andrea Marchioni, Carlo Alberto Magni, Davide Baschieri

Category: En.vision

Topic: Electricity , RES and EE , En.vision

Switching from traditional energy sources to renewable energy has a beneficial impact in terms of ecological sustainability. However, decisions by companies to switch from retail energy to renewable energy are strongly affected by considerations about the impact on a company’s economic profitability. Therefore, it is of paramount importance to provide companies and managers with an appropriate accounting and finance system for modelling the impact on shareholders’ wealth of replacing traditional energy with renewable energy.

This is the concern shared by Andrea Marchioni, Carlo Alberto Magni, and Davide Baschieri of the University of Modena and Reggio Emilia (Italy), who presented their work at this year’s Management International Conference (MIC 2020): “Focusing on value creation for equity holders, we calculated the expected effect of operating and financing activities on the increase in shareholder wealth. In particular, we highlighted the role of distribution policies in financial modelling by underlining the strict logical connections between estimated data and financial decisions.”

Carlo Alberto Magni (professor of Engineering Economics), Andrea Marchioni (doctoral student), and Davide Baschieri (doctoral student and business analyst at GRAF Spa) – hereinafter referred to as ‘the authors’ – are members of EngEcoLab, a research laboratory in Engineering Economics, pertaining to the School of Doctorate E4E of the University of Modena and Reggio Emilia (Italy). The laboratory develops financial modelling for engineering projects, with special attention placed on smart energy projects, employing an innovative accounting and finance engineering system for measuring the financial efficiency and value creation of sustainable investment projects.

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The team is particularly concerned with the application and refinement of the accounting and finance engineering system recently developed by Magni (2020. Investment Decisions and the Logic of Valuation. Linking Finance, Accounting, and Engineering. Springer NATURE, Cham Switzerland). Such a system rationalises the mapping that links the key performance drivers and the economic profitability of an investment, while bypassing the intricate network of the relations among technical aspects, accounting magnitudes, forecasting of financial data, and assumptions on financing decisions. This system may be used as a decision-making aid, which provides insights into the economic profitability of engineering projects and possible managerial actions that may affect the decision to replace the energy source.

In their paper titled Investment and financing perspectives for a solar photovoltaic project, presented at the Management International Conference (MIC 2020), in the Energy Session chaired by Alenka-Lena Klopčič, the authors illustrated a real-life example of a solar photovoltaic project funded through a lease contract, a loan contract and internal financing (i.e. withdrawal from liquid assets), which are the typical financing sources for solar energy projects. The authors modelled the technical and financial parameters and used the projected accounting data to compute the value created. They assessed the project from both an investment perspective (operating assets and liquid assets) and a financing perspective (debt and equity), as represented in Figure 1, showing that the value creation (i.e. the net present value, NPV) for equity holders not only depends on the operating activity (efficiency of solar panels, operating and maintenance costs, price of energy, disposal costs, etc.), but also on the management of liquid assets (reinvestment/distribution of cash generated by the project) and the ability of borrowing (i.e. borrowing at a lower or higher rate than the cost of debt prevailing in the capital markets).

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More precisely, the analysed case is a solar photovoltaic project proposed by an Italian installation company to a small firm located in Northern Italy, which aims to switch from retail energy to solar energy. The plant will be installed on a property owned by the company, which is currently rented out. With retail energy, the firm periodically pays a utility bill and receives a rental income from rental of the land. The solar photovoltaic plant implies a leasing contract, whereby lease payments and operating and maintenance costs are made periodically. After several years, on the expiration date, the lessee will pay a lump sum to acquire the plant, and the system will continue to generate electric power for some years. The lump sum is paid through the issuance of new debt capital and withdrawal from liquid assets. At the end of its useful life, the plant will be removed, and the firm will incur disposal costs. If the retail system is replaced by the solar plant, the income and cash flows will increase as a result of the ceased lease payment and the cost savings (utility bills), but will increase as a result of operating and maintenance costs, the terminal outlay for acquiring the plant, and the lost rental income.

The four-area classification entailed by the financial model enables one to appreciate the contribution of the various areas to the project’s economic profitability and the distribution of the value created between the capital providers (equity holders and debtholders). For the project under consideration, in terms of the investment perspective (left-hand side of Figure 1), it can be seen that operations create value of EUR 108,125, which is partly offset by a significant destruction in value of EUR 19,721 due to an inefficient liquidity management (the interest rate on reinvested cash is smaller than the required return on liquid assets). The net effect is that the investment creates a net value of EUR 88,404 (EUR 108,125-EUR 19,721). This amount of money represents the increase in shareholder wealth due to the energy switch, which is even slightly increased by the fact that equity holders gain EUR 231 in extra value generated by an efficient borrowing policy (the interest rate on debt is slightly smaller than the required return on debt). Figure 2 shows the weakening of the shareholder value created in the contributions of operations, liquid assets and debt. It is clear that, although the project is worth undertaking, the firm’s managers should consider more efficient management of liquid assets or, alternatively, reduce the cash retained (by increasing the cash distribution to the firm’s shareholders) which would further increase the firm’s shareholders wealth.

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In conclusion, contrary to traditional modelling, the analyses performed by the researchers of EngEcoLab do not merely take account of the technical variables and their impact on the project’s economic profitability but also of the financing variables (borrowing, distribution and cash reinvestment/retention) along with the subtle relations interconnecting operating variables and financing variables, which may greatly affect the financial efficiency and the change in the shareholders’ wealth. Indeed, the firm’s decisions on distribution/retention in the cash-flow statement must be necessarily forecasted because they are needed in order to draw up the balance sheets and the income statements in the various periods. The value creation for equity holders may be significantly different from the value generated from operations due to the remarkable role of financial policies relating to liquid assets and debt.



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