EDP RENEWABLES NORTH AMERICA:

TAX EQUITY FINANCING AND ASSET

ROTATION
Course Name: Capital Investment Decision
Case Study on EDP RENEWABLES NORTH AMERICA: TAX EQUITY FINANCING
AND ASSET ROTATION

Submitted to:
M. Sadiqul Islam
Professor
Department of Finance
University of Dhaka

Submitted by:

NAME ID

Md. Safiul Hasan 31031

Md. kamruzzaman 31041

Nur Mohammad Khandaker 31025

Date of Submission: 12/12/2016

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 Letter of Transmittal

12th Dec, 2016

Dr. M. Sadiqul Islam
Professor
Department of Finance
University of Dhaka.

Subject: Submission of group report on case analysis.

Dear Sir,

You assigned us to prepare a group report by analyzing a case named EDP Renewables North
America: Tax equity financing and Asset Rotation for the partial fulfilment of the course
Capital Investment Decision (F-601). We have made an effort to prepare such a report according
to your requirements and instructions. We have found the study to be quite interesting, beneficial
and insightful. We have tried our level best to prepare an effective and creditable report using all
of our related knowledge to come up with the product. We have completed it finally and are now
presenting it to you.

We hope you will find this report worth all the labour we have put in it. We shall be available to
answer any question for clarification. Thank you for your sincere support. We hope that you will
consider it and be obliged thereby.

Thanking you

1. Shafiul Hasan
2. Md. Kamruzzaman
3. Nur Mohammad

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 Table of Contents

Content Page No
Executive summary 5
1.1 Introduction 6
1.2 Objective of the Case 7
2. Analysis of the Economy 8-10
3. Analysis of the industry 11
3.1 PESTEL Analysis 11
3.2 Porters Five Forces Analysis 12
4.1 Ratio Analysis 13-14
4.2 DuPont System of Analysis 15-16
4.3 SWOT ANALYSIS 17-18
5.1 Problem Statement 19
5.2 Alternative courses of Action 19
5.3 Analysis of each alternative 20-22

6.1 Monte Carlo Simulation ICRG method 23-29

6.2 Country Risk Analysis using 30-37

7.1 Conclusion 37

7.2 Recommendation 38

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 EXECUTIVE SUMMARY:

Energias de Portugal, S.A. (EDP) is a vertically integrated power and gas utility that generates,
transmits, distributes and sells electricity; and explores for, produces, transports, distributes and
sells natural gas. They are going to invest in new project The Rising Star in USA. Capital
expenditure is estimated at 387090729. Among this investment 240 million will be covered
from Tax equity investor and from the remaining amount 49% will be finance from Asset
rotation investor and 51% will be financed from sponsored equity. Is the existing tax equity and
Asset rotation financing strategy perfect?. To find out the solution of this problem we find three
alternative like EDP will kept its current tax equity and asset rotation financing strategy, EDP
will issue new common stock through the IPO, EDP will issue some preferred stock along with
common stock. By analyzing the all alternatives we see that the existing alternative add more
value for the firm. As the total composite risk score for U.S is 80 which indicates country risk for
U.S during 2015 is Very low risk. So we did not add any risk premium with our WACC. So the
value of the real option of new rising star project is 56819487. So manager can make additional
cash flow of 56819487.

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1.1 Introduction:

Energias de Portugal, S.A. (EDP) is a vertically integrated power and gas utility that generates,
transmits, distributes and sells electricity; and explores for, produces, transports, distributes and
sells natural gas. It produces electricity through a diversified portfolio of generation assets
including wind, solar, biomass, nuclear, hydro and coal-based power plants. It also purchases and
supplies electricity in the Iberia electricity market. The company supplies electricity and gas to
residential, commercial, agricultural, industrial and other customers. EDP, along with its
subsidiaries, has operations in several countries including Portugal, Spain, the US, Canada,
Brazil, Poland, Romania, France, Belgium, the UK, Italy and China. EDP is headquartered in
Lisbon, Portugal. This comprehensive SWOT profile of Energias de Portugal S.A. provides you
an in-depth strategic analysis of the companys businesses and operations. The profile has been
compiled by Global Data to bring to you a clear and an unbiased view of the companys key
strengths and weaknesses and the potential opportunities and threats. The profile will help you
formulate strategies that augment your business by enabling you understand your partners,
customers and competitors better.

The creation of EDPR was a natural consequence given the strategic growth path and future
investment plan of EDP Group, which have started with the installation of the first MWs during
the last decade of the 20th century. This unique relation framework with EDP will be explained
in shareholder structure, once it is a very important dimension when EDPR is being analyzed.

EDPR was listed in Euronext Lisbon since June 2008 through an IPO operation, immediately
after the companys creation. It was a successful operation, which could be understood as a
confident signal from the investors and the market for the ambitious future growth plan of the
company.

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1.2 Objective of the Case:
1.2.1 Main objective:
The objective of the case is to evaluate this investment opportunity and report to management
with opinion about whether Rising Star Wind Farm should take positive decision.

1.2.2 Secondary objective:

Identify the possibilities & problems of investment in the green electricity generation
project in the Jupiter, Florida through required factors like economic, political,
financial condition.
Determine Discount Rate, NPV, IRR, MIRR.
Determine economical, environmental, political risk and social situation.
To know how to take capital investment decisions.
To understand how business strategy can be taken and implemented considering
govt. influence and critical business factor.

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2. Analysis of the Economy:

The United States is the world's largest national economy in nominal terms and second largest
according to purchasing power parity (PPP), representing 22% of nominal global GDP and 17%
of gross world product (GWP). It has a mixed economy and has maintained a stable overall GDP
growth rate, a moderate unemployment rate, and high levels of research and capital investment.
Its seven largest trading partners are Canada, China, Mexico, Japan, Germany, South Korea, and
the United Kingdom. The US economy went through an economic downturn following the
financial crisis of 200708, with output as late as 2013 still below potential according to the
Congressional Budget Office. The economy, however, began to recover in the second half of
2009, and as of November 2015.

The United States economy experienced a crisis in 2008 led by a derivatives market and
subprime mortgage crisis, and a declining dollar value. On December 1, 2008, the NBER
declared that the United States entered a recession in December 2007, citing employment and
production figures as well as the third quarter decline in GDP. The recession did, however, lead
to a reduction in record trade deficits, which fell from $840 billion annually during the 200608
period, to $500 billion in 2009, as well as to higher personal savings rates, which jumped from a
historic low of 1% in early 2008, to nearly 5% in late 2009. The merchandise trade deficit rose to
$670 billion in 2010; savings rates, however, remained at around 5%. US real GDP grew by an
average of 1.7% from 2000 to the first half of 2014, a rate around half the historical average up
to 2000.

GDP

Year 2003 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015

% 2.8 3.8 3.3 3.0 2.6 0.3 -2.8 2.5 1.6 2.3 2.2 2.4 2.4
GDP

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GDP by industry

Industry GDP value added $ billions % of total GDP

2011

Real estate, renting, leasing 1,898 13%

State and Local Government t 1,336 9%

Finance and insurance 1,159 8%

Finance and insurance 1,159 8%
Health/social care 1,136 8%
Durable manufacturing 910 6%
Retail trade 905 6%
Wholesale trade 845 6%

Non-durable manufacturing 821 6%

Federal Government 658 5%

Arts, entertainment 591 4%
Utilities 297 2%
Mining 290 2%
Corporate management 284 2%
Education services 174 1%
Agriculture 173 1%

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Economic Forecast

The U.S. economy will enjoy a mild cyclical rebound in 2017, and then return to a lower growth
rate more in line with long-term potential. Gross domestic production, inflation-adjusted, grew at
fairly tepid rates over the past three quarters. But jobs are increasing at a moderately good pace,
with unemployment below five percent. Some of this years negative factors will turn around,
enabling the rebound next year.

The strongest part of the GDP reports has been consumer spending, up 3.8 percent over the past
12 months. That compares to a 3.6 percent gain in take-home pay, resulting in a minuscule drop
in the savings rate. Consumer attitudes are stable at a good level, a bit above the long-run
average. We expect consumers to continue increasing their spending in line with their incomes.

Overview Actual Q4/16 Q1/17 Q2/17 Q3/17 2020

GDP Growth 3.20 1.9 2 1.9 1.7 2
Rate
Unemployment 4.60 5.1 5.2 5.3 5.3 6
Rate
Inflation Rate 1.60 1.5 1.6 1.7 1.7 2.5
Interest Rate 0.50 .75 1 1 1.5 2.25
Balance of -42601.00 -39400 -38000 -38000 -40000 -48000
Trade
Government 104.17 105 106 106 106 108
Debt to GDP

While America's overall position as the world's largest economy will likely remain same so for a
number of years, it will most likely continue to shift towards an increasingly service based
economy. As the intellectual development of many high-tech devices remains domesticated in
the United States, the production of those devices usually occurs overseas, where production
costs keep these devices more affordable to the average consumer.

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3. Analysis of the industry:
EDPR is a subsidiary of EDP Group. It is the third largest electricity generator in the world.
When it started its business it aimed at becoming one of the top five global renewable
companies. By 2015 it is the third largest and it oparate their business successfully. Now they
are targeting to invest in a new project named Rising Star.

Industry analysis involves reviewing the economic, political and market factors that influence the
way the industry develops. Major factors like suppliers and buyers, the condition of competitors,
and the likelihood of new market entrants is the key to a successful investment.

3.1 PESTEL Analysis:

PESTEL analysis, which is also known as PEST analysis. It is a concept in marketing principles.
It gives us an overall view about the environment from many different angles.

The basic PEST analysis includes four factors. These are:

P = Political

E = Economic

S = Social

T = Technological

Expanding the analysis to PESTEL adds:

E = Environmental

L = Legal

Here, we have analyzed PESTEL of the renewable energy industry.

Political:

Political factors determine the extent to which a government may influence the economy or a
certain industry. U.S government is significantly influential regarding projects of wind energy
sector. The government gives tax incentives to encourage investment in energy sectors. If the
government change or political perception differs, it may influences or can create constraints the
total project.

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Economic:

Economic analysis is assessment of the factors that affect the internal and external economic
environment. The internal or micro-economic events relate to the project viability and internal
soundness of the project. Economic factors include economic growth, interest rates, exchange
rates and the inflation rate. The economic condition of U.S is very much stable. This project will
contribute significant economic benefits to the surroundings community in the form of payments
to land owners, local spending and annual community investment. The development,
construction and operation of the wind firm generated a significant number of jobs in the area.

Social:

U.S has about 319 million of population, and also has a complexes and well developed
domestic consumer market, One of the strongest in the world. The project will contribute to the
socio-economic development of the region through the improvement of wind energy sector. The
expected increase in employment and income for the regions will help to reduce poverty and lead
to sustainable development.

Technological:

Technological factors include ecological and environmental aspects, such as R&D activity,
automation, technology incentives and the rate of technological change. Technological factors
are represented by technologies, techniques and methods that influence the activities within an
organization. The technological factors could influence an organization from inside the industry,
by making the need to acquire the last technologies (by buying equipment), techniques and
methods (by hiring a trained human resource in new techniques or train the old human resource
with the new techniques and methods).

Environment:

For almost all the countries, environmental considerations are a major issue for businesses
running in the country. U.S put a lot of importance on environmental factors as they try to
prevent carbon emission. For this reason landowners are willing to lease their land to operate
wind renewable energy.

Legal:

Law of a country is a very important factor for businesses operating in the country. Restrictions
and strict monitoring of energy prices by government sometimes affect the business. U.S has a
strict regulatory environment. Consumer law, employment law, health and safety law is very
strict in U.S.

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3.2 Porters Five Forces Analysis:

The analysis peeks at the strength of 5 vital forces which affect business competition. The five
different forces are:

1. Supplier Power: Here, the first step is to assess how easy it is for the suppliers to increase
prices of inputs. This depends on the following factors:

The number of suppliers of the key input.

How unique their products or services are?

Their strengths and how much control they have over you?

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 The cost of switching from one to another.

Fewer number of supplier choices means you need suppliers help more. This also means that
fewer suppliers, makes them more powerful.

2. Buyer Power: When assessing buyer power, a question comes naturally: how easy it is for the
customers to bring prices down. This depends on the following factors:

The number of buyers

The importance of each customer to a business

The cost to consumers switching from offered products and services by another company.

3. Competitive Rivalry: The critical thing to consider here is the number and capability of
business competitors. If there are many competitors and if they offer equally appealing products
and services, supplier & buyer will perhaps have very little power. This is because suppliers and
buyers will choose the competing companies if they do not like the deal you are offering.

The number of competitors

The quality difference between offered product and competitors product

Any other differences

Switching costs involved for suppliers and buyers

Customer loyalty

4. Threat of Substitution: The ability of buyers; to find an alternative is considered here. If you
provide unique software which automates a significant process, consumers can easily substitute
by conducting the process manually. They may choose to outsource it as well. If the substitution
is easy and viable, it may weaken the business. Factors we can assess are:

Performance of the substitute product

Cost of change

Threat of new entry

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5. Threat of new entry: Others ability to enter the market can affect power too. The below
factors affect this:

Time and cost of entering the market and competing

If there are few economies of scale in place

The amount of protection for the key technologies

The new businesses can swiftly enter the market and weaken your position. However, if the
market has strong and durable barriers to entry, you can maintain a favorable position.

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 Analysis of the Company
4.1 Ratio Analysis

Liquidity Ratios
The liquidity of a firm is measured by its ability to satisfy its short-term obligations as they come
due. Liquidity refers to the solvency of the firms overall financial positionthe ease with which
it can pay its bills. Because a common precursor to financial distress and bankruptcy is low or
declining liquidity, these ratios are viewed as good leading indicators of cash flow problems. The
two basic measures of liquidity are the current ratio and the quick (acid-test) ratio.

Current Ratio
The current ratio, one of the most commonly cited financial ratios, measures the firms ability to
meet its short-term obligations. It is expressed as follows:
Current ratio = Current assets/Current liabilities

= 0.68

Generally, the higher the current ratio, the more liquid the firm is considered to be. A current
ratio of 2.0 is occasionally cited as acceptable, but a values acceptability depends on the
industry in which the firm operates.

Quick (Acid-Test) Ratio

The quick (acid-test) ratio is similar to the current ratio except that it excludes inventory, which
is generally the least liquid current asset. The generally low liquidity of inventory results from
two primary factors: (1) many types of inventory cannot be easily sold because they are partially
completed items, special-purpose items, and the like; and (2) inventory is typically sold on
credit, which means that it becomes an account receivable before being converted into cash. The
quick ratio is calculated as follows:

2. Quick Ratio = Liquid Assets/Current Liabilities

= 0.67

A quick ratio of 1.0 or greater is occasionally recommended, but as with the current ratio, what
value is acceptable depends largely on the industry. The quick ratio provides a better measure of
overall liquidity only when a firms inventory cannot be easily converted into cash. If inventory
is liquid, the current ratio is a preferred measure of overall liquidity.

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Activity Ratios

Inventory Turnover
Inventory turnover commonly measures the activity, or liquidity, of a firms inventory. It is
calculated as follows:

Inventory turnover = Net Sales / Inventory

= 59.29

The resulting turnover is meaningful only when it is compared with that of other firms in the
same industry or to the firms past inventory turnover.

Profitability Ratios
There are many measures of profitability. As a group, these measures enable the analyst to
evaluate the firms profits with respect to a given level of sales, a certain level of assets, or the
owners investment.

Gross Profit Margin

The gross profit margin measures the percentage of each sales dollar remaining after the firm
has paid for its goods. The higher the gross profit margin, the better (that is, the lower the
relative cost of merchandise sold). The gross profit margin is calculated as follows:
1.Gross Profit Ratio = (Gross Profit/Net Sales )X 100

= 84.64%

Operating Profit Margin

The operating profit margin measures the percentage of each sales dollar remaining
after all costs and expenses other than interest, taxes, and preferred stock dividends
are deducted.

Operating profit margin =(Operating Profit/Net Sales) X 100

= 21.55%

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4.2 DuPont System of Analysis
The DuPont system of analysis is used to dissect the firms financial statements and to assess its
financial condition. It merges the income statement and balance sheet into two summary
measures of profitability: return on total assets (ROA) and return on common equity (ROE). The
DuPont system first brings together the net profit margin, which measures the firms profitability
on sales, with its total asset turnover, which indicates how efficiently the firm has used its assets
to generate sales. In the DuPont formula, the product of these two ratios results in the return on
total assets (ROA):

Return on Total Assets (ROA)

The return on total assets (ROA), often called the return on investment (ROI), measures the
overall effectiveness of management in generating profits with its available assets. The higher
the firms return on total assets, the better. The return on total assets is calculated as follows:
ROA = Net profit margin*Total asset turnover

= 1.56%

The DuPont formula enables the firm to break down its return into profit-on sales and efficiency-
of-asset-use components. Typically, a firm with a low net profit margin has a high total asset
turnover, which results in a reasonably good return on total assets. Often, the opposite situation
exists. The second step in the DuPont system employs the modified DuPont formula. This
formula relates the firms return on total assets (ROA) to its return on common equity (ROE).
The latter is calculated by multiplying the return on total assets (ROA) by the financial leverage
multiplier (FLM), which is the ratio of total assets to common stock equity:

Return on Common Equity (ROE)

The return on common equity (ROE) measures the return earned on the common stockholders
investment in the firm. Generally, the higher this return, the better off are the owners. Return on
common equity is calculated as follows:

ROE=ROA*FLM

=4.11%

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4.3 SWOT ANALYSIS:
Analysis of a company includes the analysis of the companys internal and external factors. To
analyse these factors SWOT analysis is used. SWOT Analysis of the EDP (Energias de Portugal)
illustrates the strengths, weakness, opportunities and threats of the company.

Strengths: characteristics of the business or project that give it an advantage over

others
Weaknesses: characteristics of the business that place the business or project at a
disadvantage relative to others
Opportunities: elements in the environment that the business or project could
exploit to its advantage
Threats: elements in the environment that could cause trouble for the business or
project

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Strength:

Has plants in Portugal, Spain, Macau, Brazil, Africa and also in the U.S. with a total
installed capacity of over 16000 MW spread across thermal ,hydro and renewable
energy power generation employing over 13,000 people

Has a very balanced portfolio of thermal (coal and natural gas combined cycle) and hydro
power in the Iberian Peninsula (Portugal and Spain)

It is one of the largest producer of Wind Energy and also features in the top 250 of the
Forbes

Ranked highly in the Dow Jones sustainability index

Strong financial position and brand reputation

Weaknesses:

Focused mainly in Iberian Peninsula and having less presence in other parts of Europe or
in Africa
Most of its debt funding is through long and medium term bonds and commercial paper.
This can prove risky in case markets become volatile.

Opportunity:

Opportunities in other parts of Europe and in other countries

Opportunities in other forms of energy like Biomass, Solar etc
Ever growing need for power in Europe.

Threats:

Increase in prices of coal (internationally)

Consolidation of Power companies in Europe.

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5.1 Problem Statement

The rising star wind farm under construction in Florida is 200 MW wind farm. Its operation is
scheduled to occur at the end of 2015. Capital expenditure is estimated at 387090729. Among
this investment 240 million will be covered from Tax equity investor and from the remaining
amount 49% will be finance from Asset rotation investor and 51% will be financed from
sponsored equity. The problems are

Is the existing tax equity and Asset rotation financing strategy perfect?
Are there any alternative financing strategy?
The new rising star project is feasible or not.

5.2 Alternative courses of Action

We find the financing problem in this case. That means from which sources EDP should finance
for its new rising star project. What are the alternatives for financing decisions and which one is
the best for the firm that maximizes the value of the firm. We can find out that there are major
three alternatives for financing decision

EDP will kept its current tax equity and asset rotation financing strategy
EDP will issue new common stock through the IPO
EDP will issue some preferred stock along with common stock.

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5.3 Analysis of each alternative

Now we will try to analyze the each alternative which will help us to find out which alternative is
the best option for financing decision.

Alt-1: analysis of current Strategy:

Calculation of cost of capital

In the current strategy, tax equity investor contributes 240 million. Lets cost of tax equity is 7%.
It is given that institutional asset rotation investor looking to earn 6% yield. Lets Cost of
sponsored equity is 8%. The composite cost of capital under current strategy is calculated below
-

Component Amount Component cost Weighted

(million) average cost of
capital
Tax Equity 240 .620 7% 4.34
Asset Rotation 72 .186 6% 1.116
Sponsored equity 75 .194 8% 1.552
Total 387 1 7.008

So weighted average cost of capital is 7.008%

NPV $16,454,094.05
IRR 8%
MIRR 7%

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Alt-2: EDP will issue new common stock through the IPO:

In the second alternative can be that EDP will issue new common stock through IPO. We easily
evaluate this decision through break point analysis. Break point is the amount that can be
financed without having new common stock. That means if the new projects investment amount
is above the break point then firm have to issue new common stock.

Calculation of break point:

It projects its net income to be $65 million for the next year after charging depreciation expense
of $141 million. Dividend payout ratio is 35%. So retention ratio is 65%. Equity fraction is
0.194.

Contribution to Retained Earning

Break Point Depreciation
Equity Fraction

42
141 357 million
0.194

We can see that the rising stars capital investment is 30 million (387-357) higher than break point so EDP
should issue 30000 common stock par value of $100. Lets floatation cost adjustment factor is 2%

Calculation of cost of capital after issuing the newly common stock

Component Amount (million) Component cost Weighted average

cost of capital
Tax Equity 240 .620 7% 4.34
Asset Rotation 72 .186 6% 1.116
Sponsored equity 45 .1163 8% 0.9304
New stock 30 .078 10% 0.78
Total 387 1 7.17%

NPV $12,586,920.45
IRR 8%
MIRR 7%

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Alt-3: EDP will issue some preferred stock along with common stock:

Another alternative can be that EDP will issue some preferred stock along with common stock.
Assume EDP will issue 10000 preferred stock at 12% $100 preferred stock with floatation cost
of 5%.

So cost of preferred stock

DP
Kp Pp Price of Preferred Stock
PP (1 F )
F Floatation Cost
12
0.1263 or 12.63%
100 (1 - 0.05)

Calculation of cost of capital after issuing preferred stock:

Component Amount (million) Component cost Weighted average

cost of capital
Tax Equity 240 .620 7% 4.34
Asset Rotation 72 .186 6% 1.116
Sponsored equity 45 .1163 8% 0.93
New stock 20 .052 10% .0.52
Preferred stock 10 .026 12.63% .0.33
Total 387 1 7.23%

NPV $11,173,448.16
IRR 8%
MIRR 7%

Recommendation:

By analyzing the available alternatives we see that IRR and MIRR are same for each alternative
but the NPV is gradually decreasing when EDP issue the new common stock as well as preferred
stock. So EDP should not go for IPO. That means EDP should retain their current tax equity and
asset rotation strategy because the current strategy increase the value of the firm with greater
amount.

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6.1 Monte Carlo Simulation
In this case the NPV of the rising star project is 16 million, IRR is 8%, MIRR is 7%. What is the
probability that npv will be more than 16 million or what is the likelyhood that npv will negative
or make loss? Because all the outcome is not certain as they make some assumption on inputs
like price per energy, variable cost. We can answer all the questions by applyimg the monte
carlo simulation.

1) Frequency view (NPV) :

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Interpretation: the above figure shows forecast chart. We can see that 49.7% certainty that
projects NPV will at least 16 million. That means there is a half chance that NPV will be 16
million. In the 3rd graph we see that there is 0% certainty that NPV will negative or make loss. 4th
graph shows that if we r 80% confident then NPV will be between 15.9 million to 16.9 million.

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 2) Sensitivity chart (NPV):

Interpretation: sensitivity chart shows that which input has the great impact on variability of
output or risk. We see that Turbine O & M has the great impact (96.4) on variance of outcome. If
we control the variability of Turbine O & M expense we can control the variability of output.
Price hasnt any impact on variability of NPV.

3) Statistics view

Interpretation: we know that if the coefficient of variance is .05 or more then project is more
risky, here the coefficient of variance is 0.0231. So the project is low risky.

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1) Frequency view (IRR) :

2) Sensitivity chart (IRR):

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 3) Statistics view

Interpretation: above are the forecast charts of IRR. In sensitivity chart we can see that Turbine
O & M expense has the great impact on variability of IRR. To control the variability of IRR
EDPR has to careful about this expense. Coefficient of variance is lower than 0.05. So risk is
lower.

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1) Frequency view (MIRR) :

2) Sensitivity chart (MIRR):

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 3) Statistics view (MIRR):

Interpretation: In case of MIRR we also see that Turbine O & M has great impact on the variability of
MIRR. EDPR has to careful about this variable.

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6.2 Country Risk Analysis using ICRG method:

The International Country Risk Guide (ICRG) rating comprises 22 variables in three
subcategories of risk: political, financial and economic. A separate index is created for each of
the subcategories. The Political Risk index is based on 100 points, Financial Risk on 50 points,
and Economic Risk on 50 points. The total points from the three indices are divided by two to
produce the weights for inclusion in the composite country risk score. The composite scores,
ranging from zero to 100, are then broken into categories from Very Low Risk (80 to 100 points)
to Very High Risk (zero to 49.9 points).

For our case, we proceed to estimate the country risk by considering all the three risk categories
along with their major components. Below are the details of our estimation:

The Political Risk Rating:

The aim of the political risk rating is to provide a means of assessing the political stability of the
countries covered by ICRG on a comparable basis. This is done by assigning risk points to a pre-
set group of factors, termed political risk components. The minimum number of points that can
be assigned to each component is zero, while the maximum number of points depends on the
fixed weight that component is given in the overall political risk assessment. In every case the
lower the risk point total, the higher the risk, and the higher the risk point total the lower the risk.
It is important to mention that a poor political risk rating can be compensated for by a better
financial and/or economic risk rating.

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Our assessment of the total political risk for U.S in 2015:

Political risk:

Points Obtained Max. Point

Components
Government Stability 9 12
Government Unity 3 4
Legislative Strength 3 4
Popular Support 3 4
Socioeconomic Conditions 9 12
Unemployment 3 4
Consumer Confidence 3 4
Poverty 3 4
Investment Profile 8 12
Contract Viability 3 4
Profits Repatriation 2 4
Payment Delays 3 4
Internal Conflict 9 12
Civil War/Coup Threat 3 4
Terrorism/Political Violence 3 4
Civil Disorder 3 4
External Conflict 9 12
War 3 4
Cross-Border Conflict 3 4
Foreign Pressures 3 4
Corruption 5 6
Military in Politics 5 6
Religious Tension 4 6
Law and Order 6 6
Law 3 3
Order 3 3
Ethnic Tension 5 6
Democratic Accountability 5 6
Bureaucracy Quality 3 4
Total 77 100

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The Economic Risk Rating:

The overall aim of the Economic Risk Rating is to provide a means of assessing a countrys
current economic strengths and weaknesses. In general terms where its strengths outweigh its
weaknesses it will present a low economic risk and where its weaknesses outweigh its strengths
it will present a high economic risk. Once again, a poor economic risk rating can be compensated
for by a better political and/or financial risk rating. Our assessment of the total economic risk for
U.S 2015

Components Points obtained Max. point

GDP per head 4.5 5
Real GDP growth 8 10
Annual inflation rate 8 10
Balance of payment as a % of GDP 8 10
Current Account as a % of GDP 12.5 15
Total 43 50
=

Financial Risk Analysis:

The overall aim of the Financial Risk Rating is to provide a means of assessing a countrys
ability to pay its way. In essence, this requires a system of measuring a countrys ability to
finance its official, commercial, and trade debt obligations. Once again, however, a poor
financial risk rating can be compensated for by a better political and/or economic risk rating. Our
assessment of the total financial risk for U.S in 2015:

Components Point obtained Max. point

Foreign debt as a % of GDP 7 10
Debt service as % paid 8 10
Current account as % of export 12 15
Net International Liquidity 4 5
Exchange Rate Stability 8 10
Total = 39 50

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The Composite Risk Rating

The method of calculating the Composite Political, Financial, and Economic Risk Rating
remains unchanged. The political risk rating contributes 50% of the composite rating, while the
financial and economic risk ratings each contribute 25%. The following formula is used to
calculate the aggregate political, financial and economic risk:

CPFER (country X) = 0.5 (PR + FR + ER)

Where,
CPFER = Composite political, financial and economic risk ratings
PR = Total political risk rating
FR = Total financial risk rating
ER = Total economic risk rating

The highest overall rating (theoretically 100) indicates the lowest risk, and the lowest rating
(theoretically zero) indicates the highest risk.

CPFER (U.S) = 0.5 (77 + 39+ 43) = 80

As a general guide to grouping countries on the basis of comparable risk, the individual risk of
individual countries can be estimated using the following fairly broad categories of Composite
Risk.

Risk Ratings Points Risk Premium

Very High Risk 00.0 to 49.9 points 3
High Risk 50.0 to 59.9 points 2
Moderate Risk 60.0 to 69.9 points 1.5
Low Risk 70.0 to 79.9 points 1
Very Low Risk 80.0 to 100 points 0

As the total composite risk score for U.S is 80 which indicates country risk for U.S during 2015
is Very low risk. So we did not add any risk premium with our WACC.

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6.3 Value of real options
Real option resembles the call options. In call options, it is right to buy. Like that in real option it
is right to exercise the project like deferring, abandoning, expanding, staging, or contracting a
capital investment project. A real option itself is the right but not the obligation.

The value of real options can be calculated. If the value is positive the investor has the right to
exercise the project but if negative investor has the right to abandon the project.

In our case, $-385000889 capital expenditure needed for rising star project. We also have 25
years expected future cash flow and our discounting rate is 7.008%. Let assume risk free rate is
3% and standard deviation of projects return is 15%. IF EDP can exercise the real options within
3 years then what is the value of the real option.

Here -

X (cost) 385000889.2
S (pv of future cashflow) $401,454,983.20
r (risk free rate) 3%
SD( sd of projrct return) 15%
T (time) 3

d1 = {ln(S/X)+(rf+(V/2)*t}/(SD*T)
= [ ln(401,454,983/385000889)+{(.03+0.0225/2)*3}]/(.15*3)
= 1.81

d2=d1-(SD*T)
= .23-(.15*3)
=1.55

N(d1) = .9649
N(d2) = .9394

CE= (401454983*.9649)-(385000889*2.718^-(.03*3)*.9394)
= 56819487

Option has a value because manager can make additional cash flow or deduct the risk. So the
value of the real option of new rising star project is 56819487. So manager can make additional
cash flow of 56819487.

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7.1 Conclusion

Energias de Portugal, S.A. (EDP) is a vertically integrated power and gas utility that generates,
transmits, distributes and sells electricity; and explores for, produces, transports, distributes and
sells natural gas. The company supplies electricity and gas to residential, commercial,
agricultural, industrial and other customers. EDP, along with its subsidiaries, has operations in
several countries including Portugal, Spain, the US, Canada, Brazil, Poland, Romania, France,
Belgium, the UK, Italy and China. EDP is headquartered in Lisbon, Portugal. They are going to
invest in new project The Rising Star in USA. Capital expenditure is estimated at 387090729.
Among this investment 240 million will be covered from Tax equity investor and from the
remaining amount 49% will be finance from Asset rotation investor and 51% will be financed
from sponsored equity. Is the existing tax equity and Asset rotation financing strategy perfect?.
To find out the solution of this problem we find three alternative like EDP will kept its current
tax equity and asset rotation financing strategy, EDP will issue new common stock through the
IPO, EDP will issue some preferred stock along with common stock. Country risk is very low.
So EDP can invest in USA without considering any extra risk premium with its WACC.

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7.2 Recommendation:

By analyzing this study we have some recommendation for EDP

EDP should retain their current financing strategy

Issue of new common stock and preferred stock doesn't add extra value to the firm.

They need not tensed with the country risk

Turbine O & M contribute major part to the variance of the result. So they have to
handle effectively Turbine O & m expenditure.

Coefficient of varience is lower that .05, so the risk is lower

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