Reference no: EM133253305
Gironde Water Systems (GWS) is planning to build a water treatment plant in Cornucopia, a developing country with foreign currency sovereign debt ratings of Ba2/BB-/BB. GWS has signed a 15-year water treatment agreement with the municipal water department of Cornucopia's capital city. (The 15-year term of the agreement begins when the plant is ready to operate.) The agreement provides for level pricing - in local currency - throughout its term; thus, GWS will receive the same revenues every year. Inflation in Cornucopia is relatively moderate, and GWS believes that, by efficiency improvements, it can keep its operating expenses level, also.
Jean-Paul Aulard, the project manager for GWS, has investigated the bank market in Cornucopia and determined that lenders would be willing to finance the project with fixed-rate loans denominated in moola, the currency of Cornucopia (the symbol for which is e) for a term equal to the project's construction period, plus 10 years. In view of the fact that the project's pre-tax cash flow available for debt service is likely to be the same in every year, Jean-Paul has decided that a mortgage style loan with level payments of interest and principal would be the most appropriate financing choice.
GWS will fund its equity contributions prorata during the construction period. At the completion of construction, the outstanding balance of the loan will be e100 million. The interest rate required by lenders is 5.5%. Unfortunately, when Jean-Paul recalculated the project's financial projections using the proposed 10-year debt, the resulting debt service coverage ratio was only 1.30, far below the 1.50 pre-tax DSCR that lenders informed him that they would require.Seeking a way to extend the tenor of the loan, Jean-Paul went to Cornucopia's Ministry of Water to discuss the possibility of a sovereign guarantee of the water supply agreement. In view of the importance of the project to the country, the Ministry was prepared to offer a guarantee at the cost of an annual payment equal to 0.5% of the outstanding balance of the loan. When Jean-Paul discussed this proposal with lenders, they said that, with a sovereign guarantee of the contract, they would be willing to extend the tenor of the loan to construction, plus 15 years, but at an interest rate of 6.0%.
Does the sovereign guarantee and longer tenor solve Jean-Pauls' problem? Why or why not? What is the annual debt service coverage ratio for the 15-year loan?