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

INTRODUCTIONEgypt 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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Author: | Elkhouly, Sayed; Aldamati, Maher; Soliman, Michael; Alfakharany, Mohamed; Sobeeh, Diaa El-Dinne; Eba |
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Publication: | Competition Forum |

Geographic Code: | 7EGYP |

Date: | Jul 1, 2015 |

Words: | 3385 |

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