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Application of a decision tree model to a business case from Egypt.

INTRODUCTION

Egypt is one of the major markets in the Middle East and African region in terms of investment opportunities with positive NPV, high PI, high IRR and moderate Payback Period. In addition, there are several sectors in Egypt that are very promising to invest in and most, if not all, of those sectors are heavily supported by the government and have supporting infrastructures that make such sectors very interesting. Such sectors include oil and gas, petrochemicals, power, tourism, real estate, transport, engineering industries, heavy industries, chemicals and construction materials. Those sectors are supported by very reliable infrastructures that include: three cellular operators, 5,063 km of railways, several numbers of airports with thousands of flight destinations, several sea ports handling import and export, 64,000 km of highways, 5 investment zones and 47 industrial zones. Furthermore, a very strong banking sector already exists that includes local banks, foreign banks, joint-venture banks and private equity funds in addition to a very flexible monetary policy.

Therefore, making a decision on how to enter the Egyptian market and which sector to invest in is quite complex and requires several considerations that include Net Present Value (NPV), Internal Rate of Return (IRR), Profitability Index (PI) and a Payback Period. In this paper, we demonstrate the importance of using decision making techniques and applying the Decision Tree Model on a practical case in Egypt from which we select the most profitable investment.

THE CASE

In this case, the decision maker is a Private Equity Fund that owns 1.025 Km2 of land in A1 Ain Al-Sokhna, Egypt and is willing to develop a long term investment on it, while retaining land ownership, since the land is an asset that increases in value as time passes.

The Opportunities

The customer is offered two investment opportunities that will allow the customer to retain land ownership as required and yield a number of dollars by the end of the investment duration. Opportunities in brief are as mentioned in Table 1.

Opportunity 1: Land Lease

In this opportunity, the customer is being offered by a real estate investor an opportunity to have the land leased to the real estate investor, for the duration of 25 years. In return, the land owner (the customer) receives a fixed amount of payment annually for the contract duration. This summarized in Table 2.

Opportunity Feasibility

In this case, we are evaluating the outcome of the total payments at the end of the contract duration, 25 years in comparison with the current value of the land, $293,333,330, and at a discount rate of 2% (the current rate offered by local banks on USD deposits). The evaluation is performed based on the Net Present Value (NPV) and Profitability Index (PI). Results of the calculations are as mentioned in Table 3.

The calculations yields are NPV = Negative Value, PI = $0.13 (That means that every $1 yields only $0.13).

Opportunity 1: Final Outcome

The final outcome of Opportunity 1 is as displayed in Table 4

Opportunity 2: Investing in a 50 Mega-Watt Solar Energy Plant

In this opportunity, the customer is offered a proposal by a local project developer to invest in Photo-Voltaic Solar Energy Power Plant with installed capacity of 50 megawatt and to sell the produced electricity to the Egyptian Electricity Holding Company (EEHC) via the national grid according to Egypt's recently announced Feed-in-Tariff (FiT) Program, which allows investors to invest in solar energy plants and sell the electricity to the government based on a 25-year contract and for a fixed tariff per kilowatt hour (kWh) for the contract duration.

Opportunity's Non-Financial Details

In Egypt, the solar irradiation rate is considered among the highest in the world, ranging from 1900 kWh/m2 annually to 2574 kWh/m2 annually, according to the following solar map (Figure 1) announced over the solar Mediterranean atlas, developed by the Federal Ministry for the Environment, Nature Conservation and Nuclear Safety in Germany.

[FIGURE 1 OMITTED]

The customer's land is located in Al Ain Al-sokhna, according to the following map (Figure 2) and with solar irradiation rate of 2,020 kWh/m2 annually.

[FIGURE 2 OMITTED]

The exact solar irradiation rate per square meter of the customer's land location monthly and annually is as displayed in Figure 3 and Table 5.

[FIGURE 3 OMITTED]

Opportunity's Financial Details

The following table (Table 6) shows the official Feed-in-Tariff (FiT) rates officially announced by the Egyptian Ministry of Electricity and Egypt's New & Renewable Energies' Authority (NREA) as part of the Feed-in-Tariff (FiT) Program offered by the government for investors.

Payment of Feed-in-Tariff is quarterly, according to the government's Financial Year, which starts on July 1st, while contract duration is 25 years and the FiT has a flat rate during the entire 25-year contractual period. New FiT is negotiated upon the completion of the 25-year contract.

Solar plant production capacity installed is 50 megawatt, which is expressed in terms of kWh when calculating production. Taking into consideration that 1 megawatt = 1000 kilowatt, the installed capacity in terms of kW peak is 50,000 kWp. Concerning the Photo-Voltaic (Solar) Panels, the latest R&D researches and currently available PV panels in worldwide markets, warranty duration is a 25-year linear warranty, making guaranteed solar panel output over 25 years as mentioned in Table 7.

Therefore, expected annual production and gross cash from contractual FiT will be as mentioned in Table 8.

The amount of capital needed for the proposed 50 megawatt solar plant is $100,000,000 on an Engineering, Procurement, and Construction (EPC) basis. Project is depreciated over 15 years.

Like any proposed investment, there are three ways to raise the required capital: 100% equity, equity+debt and partnership with more investors. The proposed financing options in our case are as mentioned in Table 9.

Option 1: Detail

If option one is chosen (100% private equity) to raise the initial capital of $100,000,000, then two parts are to be considered. Part A, which includes the expected annual production and gross cash in from contractual FiT as mentioned in Table 8.

Part B, which considers fixed annual costs for years, a) years 1 through 15, b) year sl6 through 20 and c) years 21 through 25.

a) Fixed annual costs for years 1 through 15 includes depreciation = $4,666,666 and Operations & Maintenance (O&M) = $340,000.

Therefore, annual net income (years 1 through 15) at 100% production capacity is as mentioned in Table 10.

b) Fixed annual costs for years 16 through 20 includes Operations & Maintenance (O&M) = $340,000.

Therefore, annual net income (years 16 through 20) at 90% production capacity is as mentioned in Table 11.

c) Fixed annual costs for years 21 through 25 includes Operations & Maintenance (O&M) = $340,000.

Therefore, annual net income (years 21 through 25) at 85% production capacity is as mentioned in Table 12.

As a result, at discount rate of 2.03%, option l's NPV, IRR, PI and Payback Period are as mentioned in Table 13.

Option 2: Detail

If option one is chosen (80% private equity + 20% debt "5-year payment plan") to raise the initial capital of $100,000,000, then two parts are to be considered. Part A, which includes the expected annual production and gross cash in from contractual FiT as mentioned in Table 8.

Part B, which considers fixed annual costs for years, a) years 1 through 15, b) yearsl6 through 20, and c) years 21 through 25.

C) Fixed annual costs for years 1 through 15 includes depreciation = $4,666,666, Operations & Maintenance (O&M) = $340,000, and debt installment = $5,200,000.

Therefore, annual net income (years 1 through 15) at (80% private equity + 20% debt "5-year payment plan") will be as mentioned in Table 14.

b) Fixed annual costs for years 6 through 15 includes depreciation = $4,666,666 and Operations & Maintenance (O&M) = $340,000.

Therefore, annual net income (years 6 through 15) at 100% production capacity is as mentioned in Table 15.

b) Fixed annual costs for years 16 through 20 includes Operations & Maintenance (O&M) = $340,000.

Therefore, annual net income (years 16 through 20) at 90% production capacity is as mentioned in Table 11.

c) Fixed annual costs for years 21 through 25 includes Operations & Maintenance (O&M) = $340,000.

Therefore, annual net income (years 21 through 25) at 85% production capacity is as mentioned in Table 12.

As a result, at discount rate of 2.03%, Option l's NPV, IRR, PI and Payback Period are as mentioned in Table 16.

Option 3: Detail

If Option 1 is chosen (60% Private Equity + 40% Private Equity from a second partner) to raise the initial capital of $100,000,000, then two parts are to be considered. Part A, which includes the expected annual production and gross cash in from contractual FiT as mentioned in Table 8.

Part B, which considers fixed annual costs for years, a) years 1 through 15, b) year sl6 through 20, and c) years 21 through 25 will be the same as Option 1.

Also, at discount rate of 2.03%, Option 13's NPV, IRR, PI and Payback Period are the same as Option 1 and are as mentioned in Table 13.

The difference here is its 60%-40% partnership with 60% owned by the customer being the subject of discussion. Therefore, the final NPV, IRR, PI, and Payback Period for the project will be as mentioned in Table 17 and PI at 60% for subject of discussion will be $1,158.

Therefore, net income for Option 1, 2 and 3 by the end of the 25-year contract will be as mentioned in Table 18.

And results of finance Options 1, 2, and 3 can be summarized as in Table 19.

Application of Decision Tree Model

The results of Opportunity 1 and Opportunity 2 can be summarized as mentioned in Table 20.

Now, we apply the Decision Tree Model on the final summary in Table 20. The result will be as shown in Figure 4.

[FIGURE 4 OMITTED]

The application of the Decision Tree Model leads us to choose Opportunity 2 with Financing Option 1 (100% equity) that allows the customer to have a net income of 250,670,195 USD by the end of the 25-year contract (power purchase agreement).

CONCLUSION

From the calculations in the previous sections and the application of the Decision Tree Model, we can conclude that in evaluating investment opportunities of different and similar outcomes, even after applying the techniques that return solid and clear numbers, such as Net Present Value (NPV), Internal Rate of Return (IRR), Profitability Index (PI) and Pay-Back Period, there is still a probability of missing the most optimum and most profitable investment opportunity if a decision is only made based on the mentioned calculations. In such cases comes the importance of applying scientific decision making methods such as Decision Tree Model, which has been applied and demonstrated in this paper, to select the most profitable investment opportunity.

Sayed Elkhouly, Ain Shams University

Maher Aldamati, ESLSCA Business School

Michael Soliman, ESLSCA Business School

Mohamed Alfakharany, ESLSCA Business School

Diaa El-Dinne Sobeeh, ESLSCA Business School

Ahmed Ibrahim Ebaied, ESLSCA Business School
TABLE 1

                        Opportunity 1   Opportunity 2

Nature of opportunity   Land Lease      Investing in 50 MW Solar
                                          Energy Plant (BOO)

Investment duration     25 Years        25 Years

Offered by              Real Estate     Local Project Development
                          Investor        Company

TABLE 2

Option 1: Lease

Lease Contract Duration (years)    25
Annual Payment                     2,000,000 USD
Payment Collection Period          Semi-annual
Payment Start                      After 6 months of contract signage
Project Preparation Time           0

TABLE 3

Year                   Cash Flow      Present Value

0                      -293,333,330   -293333330
1                      2,000,000      1960207.782
2                      2,000,000      1921207.274
3                      2,000,000      1882982.725
4                      2,000,000      1845518.696
5                      2,000,000      1808800.054
6                      2,000,000      1772811.971
7                      2,000,000      1737539.911
8                      2,000,000      1702969.628
9                      2,000,000      1669087.158
10                     2,000,000      1635878.818
11                     2,000,000      1603331.195
12                     2,000,000      1571431.143
13                     2,000,000      1540165.778
14                     2,000,000      1509522.472
15                     2,000,000      1479488.848
16                     2,000,000      1450052.777
17                     2,000,000      1421202.368
18                     2,000,000      1392925.971
19                     2,000,000      1365212.164
20                     2,000,000      1338049.754
21                     2,000,000      1311427.771
22                     2,000,000      1285335.461
23                     2,000,000      1259762.286
24                     2,000,000      1234697.919
25                     2,000,000      1210132.234
       NPV                            -254423587.8
       Profitability                  $0.13
       Index

TABLE 4
Option 1: Lease

Lease Contract Duration (years)   25
Annual Payment                    2,000,000 USD
Payment Collection Period         Semi-Annual
Payment Start                     After 6 months of contract signage
Project Preparation Time          0
Project Cost                      0
NPV                               Negative
Profitability Index (PI)          %0.13

TABLE 5

Month   GHI    DNI    TEMPER

Jan     107    143    10.4
Feb     120    139    11.5
Mar     175    187    14.9
Apr     193    181    19.6
May     215    191    23.2
Jun     228    212    25.8
Jul     228    209    27.3
Aug     211    194    26.9
Sep     181    180    24.5
Oct     149    164    21.1
Nov     113    146    16.0
Dec     100    140    11.9
Year    2020   2087   19.4

TABLE 6

Feed-in-Tariff for Renewable
  Energy Projects
A) Solar (PV) Projects'
  Feed-in-Tariffs
PV Power Plant Installed Capacity   Corresponding Feed-in-Tariff
Residential                         84.4 P.T./kWh
Installed Capacity [less than       90.1 P.T./kWh
  or equal to] 200 Kw
200 Kw [less than or equal to]      97.3 P.T./kWh
  Installed Capacity < 500 Kw
500 Kw [less than or equal to]      13.3 $ Cent/kWh
  Installed Capacity < 20 MW
20 MW [less than or equal to]       14.34 $ Cent/kWh
  Installed Capacity <50 MW
PV Projects FiT has a flat rate during the entire 25-year contractual
period

TABLE 7

Year       Output Capacity

1 to 15    100%
16 to 20   90%
21 to 25   85%

TABLE 8

Year   Annual Production (kWh)   Annual Gross Cash-in from FiT
                                 ($0.1434/kWh)

1      127,750,000               $18,319,350
2      127,750,000               $18,319,350
3      127,750,000               $18,319,350
4      127,750,000               $18,319,350
5      127,750,000               $18,319,350
6      127,750,000               $18,319,350
7      127,750,000               $18,319,350
8      127,750,000               $18,319,350
9      127,750,000               $18,319,350
10     127,750,000               $18,319,350
11     127,750,000               $18,319,350
12     127,750,000               $18,319,350
13     127,750,000               $18,319,350
14     127,750,000               $18,319,350
15     127,750,000               $18,319,350
16     114,975,000               $16,487,415
17     114,975,000               $16,487,415
18     114,975,000               $16,487,415
19     114,975,000               $16,487,415
20     114,975,000               $16,487,415
21     108,587,500               $15,571,447
22     108,587,500               $15,571,447
23     108,587,500               $15,571,447
24     108,587,500               $15,571,447
25     108,587,500               $15,571,447

TABLE 9
#          Details

Option 1   100% Privet Equity
Option 2   80% Private Equity
           20% Debt
           (Interest Rate 6%, Duration 5-years)
Option 3   60% Private Equity
           40% Private Equity from second
           partner

TABLE 10

Sales                       18,319,350
Depreciation                -4,666,666
Gross Income                13,652,684
O&M                         -340,000
Operating Income            13,312,684
25% Income Tax              -3,328,171
After 25% Income Tax        9,984,513
5% Income Tax (Above 1 M)   -615,634
Net Income After Tax        9,368,879

TABLE 11

Sales                       16,487,415
Gross Income                16,487,415
O&M                         -340,000
Operating Income            16,147,415
25% Income Tax              -4,036,853
After 25% Income Tax        12,110,562
5% Income Tax (Above 1 M)   -757,370
Net Income After Tax        11,353,192

TABLE 12

Sales                       15,517,447
Gross Income                15,517,447
O&M                         -340,000
Operating Income            15,177,447
25% Income Tax              -3,892,861
After 25% Income Tax        11,284,586
5% Income Tax (Above 1 M)   -725,872
Net Income After Tax        10,558,714

TABLE 13

Year   Cash Flow                               Present Value

0                               -100,000,000   -100000000
1                               9,368,879      9182474.762
2                               9,368,879      8999779.244
3                               9,368,879      8820718.655
4                               9,368,879      8645220.675
5                               9,368,879      8473214.422
6                               9,368,879      8304630.425
7                               9,368,879      8139400.593
8                               9,368,879      7977458.192
9                               9,368,879      7818737.814
10                              9,368,879      7663175.354
11                              9,368,879      7510707.982
12                              9,368,879      7361274.118
13                              9,368,879      7214813.405
14                              9,368,879      7071266.692
15                              9,368,879      6930575.999
16                              11,353,192     8231363.791
17                              11,353,192     8067591.68
18                              11,353,192     7907077.997
19                              11,353,192     7749757.911
20                              11,353,192     7595567.883
21                              10,558,714     6923495.38
22                              10,558,714     6785744.762
23                              10,558,714     6650734.844
24                              10,558,714     6518411.099
25                              10,558,714     6388720.081
       NPV                                     92931913.76
       IRR                                     8%
       Profitability Index                     $1.93
       Payback Period (years)                  10.7

TABLE 14

Sales                       18,319,350
Depreciation                -4,666,666
Income After Depreciation   13,652,684
Debt Installment            -5,200,000
Gross Income                8,452,684
O&M                         -340,000
Operating Income            8,112,684
25% Income Tax              -2,028,171
After 25% Income Tax        6,084,513
5% Income Tax (Above 1 M)   -355,634
Net Income After Tax        5,728,879

TABLE 15

Sales                       18,319,350
Depreciation                -4,666,666
Gross Income                13,652,684
O&M                         -340,000
Operating Income            13,312,684
25% Income Tax              -3,328,171
After 25% Income Tax        9,984,513
5% Income Tax (Above 1 M)   -615,634
Net Income After Tax        9,368,879

TABLE 16

Year   Cash Flow                            Present Value

0                            -100,000,000   -100000000
1                            5,728,879      5614896.599

2                            5,728,879      5503182.004
3                            5,728,879      5393690.095
4                            5,728,879      5286376.649
5                            5,728,879      5181198.323
6                            9,368,879      8304630.425
7                            9,368,879      8139400.593
8                            9,368,879      7977458.192
9                            9,368,879      7818737.814
10                           9,368,879      7663175.354
11                           9,368,879      7510707.982
12                           9,368,879      7361274.118
13                           9,368,879      7214813.405
14                           9,368,879      7071266.692
15                           9,368,879      6930575.999
16                           11,353,192     8231363.791
17                           11,353,192     8067591.68
18                           11,353,192     7907077.997
19                           11,353,192     7749757.911
20                           11,353,192     7595567.883
21                           10,558,714     6923495.38
22                           10,558,714     6785744.762
23                           10,558,714     6650734.844
24                           10,558,714     6518411.099
25                           10,558,714     6388720.081
       NPV                                  75789849.67
       IRR                                  7%
       Profitability Index                  $1.76
       Payback Period                       12.6

TABLE 17

NPV                      92931913.76
IRR                      8%
Profitability Index      $1.93
Payback Period (years)   10.7

TABLE 18

Option   Net Income at end of 25-year

1        $250,670,195
2        $231,892,715
3        $150,402,117

TABLE 19

Opportunity 2: Invest in 50 Mega-Watt Solar Energy Plant

Power Purchase       25 Years
  agreement
(PPA)/Duration
Initial Cost         $100,000,000
Project              1 Year
Installation
Duration
Payment Collection   Quarterly
  Period
Payment Start        After Project Installation and
                       Commissioning; after 1 Year
Finanace Options     Option 1: 100%       NPV = Positive Number
                       Equity             IRR = 8%
                                          Profitability Index = $1.93
                                          Payback Period =10.7 Years
                     Option 2: 20% Debt   Interest Rate = 6%
                       + 80% Equity       Grace Period = 6 Months
                                          Duration = 5 Years
                                          NPV = Positive Number
                                          IRR = 7%
                                          Profitability Index = $1.76
                                          Payback Period =12.6 Years
                     Option 3: 60%-40%    NPV = Positive Number
                       Partnership        1 IRR = 8%
                                          Profitability Index = $1.93
                                          1 Payback Period =10.7 Years

TABLE 20

                       Opportunity 1:   Opportunity 2: Invest in
                         Lease            50 MW PV Plant

Contract Duration      25               25
Payment Collection     Semi-Annual      Quarterly
Period
Net Income by end of   31,525,812 USD   100% Equity = 250,670,195 USD
Contract                                20%Debt+80%Equity =
                                          231,892,715 USD
                                        60-40 Partnership =
                                          250,670,195 USD
                                        @60% = 150,402,117 USD
NPV                    Negative Value   100% Equity Finance =
                                          Positive Value
                                        20%Debt+80%Equity =
                                          Positive Value
                                        60-40 Partnership =
                                          Positive Value
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Article Details
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Author:Elkhouly, Sayed; Aldamati, Maher; Soliman, Michael; Alfakharany, Mohamed; Sobeeh, Diaa El-Dinne; Eba
Publication:Competition Forum
Geographic Code:7EGYP
Date:Jul 1, 2015
Words:3385
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