Project Debt Capacity

One of the most common reasons for building a financial model is to assess the ability of the entity to handle debt, and more importantly how much debt the project/ company can handle. The project debt capacity will typically inform the financial structure.

Normally this is a complex calculation and depends on things like covenants and tax treatments. However, as a start it is useful to get a quick overview of what the potential debt capacity it. One way to do this is to use the NPV or XNPV function.

In its simplest form you need to create a row which shows how much money is available for debt repayments. This might be the entire free cash flow or perhaps a lesser amount with a buffer built in. Due to the nature of projects it is unlikely that it is smooth and rather goes up and down in the initial periods.

The discount rate to use will be the anticipated interest rate on the debt (for conservative purposes rather forget about the tax benefits of debt).

The number of cash flows to include is also important as the debt is unlikely to last the same length of time as the project. Ideally, using an OFFSET, you create various ranges in the model ranging from say 3 to 10 years so that you can see what can be handled over different time periods.

The result of this will be the debt that could be handled assuming all those cash flows are applied directly to the debt and that the roller coaster repayments are allowed. You may be able to handle a bit more due to tax savings, or a bit less due to restrictions from the financier but in general this will give you a starting point of what debt could be, especially in projects that don’t have a steady cash flow once operational.

For more on a projects ability to handle debt, consider our Financial Modelling course