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Table 43-2 Monthly Cash Flow Analysis for Various Financing Terms at 15% Interest Rate.

Table 43-2 Monthly Cash Flow Analysis for Various Financing Terms at 15% Interest Rate.

It is important to note that extending the financing term usually increases the interest rate applied to the financing. If, in this example, the simple annual interest rate was 13% for a 36 month term, 14% for a 48 month term, and 15% for a 60 month term, the net cash flows would be as shown in Table 43-3.

Even though the simple annual interest rate increases with increasing term, net cash flow increases in the positive direction more rapidly. Thus, the 60 month term, which has a simple annual interest rate of 15%, shows positive cash flow, while the 36 month term, which has a lower simple annual interest rate of 13%, shows negative cash flow.

Projects that do not produce positive cash flow during the financing term may still be desirable and financeable, depending on the circumstances:

• Projects that are required by a facility, such as the replacement of a retired system, may produce a level of cost savings that only partially offsets the financing costs. The new system alternative with the lowest negative cash flow will generally be selected. If the facility is credit worthy, these types of projects are financeable, even though they are not self-funding. While savings may not be seen in existing operating budgets, an objective view recognizes the required replacement cost as part of the financial baseline.

• Positive cash flow financing enables the facility to cover finance costs with project savings, but may result in excess interest costs. Depending on the financing strategy of the facility, projects that produce negative cash flow during the financing term, but positive cash flow after the term is complete, may be desirable. These projects may still be considered as self-funding, as long as they produce a positive NPV over the life-cycle of the investment. Here again, the credit strength of the host/user must support the financing.

If, in the example shown in Table 43-3, one were to extend the cash flow analysis for the scenario in which the project is financed at 13% over 36 months to 60 months, it would produce a cumulative positive cash flow of

$203,508. This is more than double the $96,300 of cumulative cash flow produced with the 60 month financing term arrangement. While these differences might support the notion that the shorter financing term is superior, not considered is that fact that with the shorter term, the project must endure several years of negative cash flows.

The above examples are simplistic and are meant to show only short-term on balance sheet projects. Numerous other factors come into play when energy outsourcing contracts (i.e., projects that provide services to a host customer, but are owned by other parties and are not treated by the host as a long-term capital obligation) are used.

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