guide2008_en

4.5.3.2Technical features of the project

The project implies the purchase of the land, the construction of two main buildings, the acquisition of tools, machinery, software and hardware. Moreover, the company will be responsible for establishing road connections between the plant site and the city’s road network.

4.5.3.3Options analysis

The government considered two alternative options:

-‘Business as usual’: the region would carry on with its limited economic growth and in particular with a high unemployment rate.

-Supporting a productive investment in a highly-innovative sector: an alternative investment in nanotechnologies was proposed. Such an investment could be highly profitable and also a good growth-driver, but the uncertainties associated with the sector and the absence of an industrial environment sustaining the project make it too risky.

In the end the government preferred the project in a more traditional sector, one that promises an increase in social welfare and fits the present local industrial structure.

4.5.3.4Type of financing

The government can support the private investment promoter by co-financing the project in different ways:

-a subsidy to cover interest

-capital grant

-tax exemption.

Assuming a fixed amount of public disbursement, the main selective criterion is the time profile. For the private actor the preferred option would be a capital grant in order to cover the large cash outflows of the early years due to fixed investments. The least preferred type of contribution would be tax exemption because it implies no immediate cash inflows and a delayed saving of cash outflows. The subsidy for the interest account allows the company to borrow money from the credit system to start investments at a very low interest rate and it facilitates the spreading of financial outflows over many years, thus resulting in a lower burden on the yearly budget.

4.5.4Financial analysis

The financial analysis was conducted using the main elements and parameters referred to in Point E.1. of the Application Form.

The time horizon for evaluating the project is 10 years. The reference financial discount rate is 5%. The analysis is at constant prices, with changes in relative prices104.

The investment is expected to take three years for full realization. However, production activities will start in the second year, albeit at an initially slow rate. Indeed, in the first couple of years following full realization of the investment, the growth rate of production is very high, while from the sixth year onwards it is expected to stabilise at a lower level.

The following paragraphs illustrate the main categories of financial flows.

104 An analysis at current prices with a discount rate that includes inflation will be carried out as well (not reported here).

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The financial performance of the investment is modest (FRR(C) is 3.3%), while the returns on national capital and private equity are high (respectively 9.3% and 11.8%). In fact the investment itself would probably not have been implemented because of the fairly low expected financial return and the relatively high risk of investing in the area. Nevertheless, thanks to the contribution of EU funds, the company has a strong incentive to implement the investment, because it is guaranteed a satisfactory return on its equity.

The project performance in terms of return on private equity is computed by including in the outflows only the private equity (plus loan reimbursement and interest), thus disregarding both the contribution of the national public sector and the EU as financial outflows. The return in this case is higher, since it is intended to remunerate the risk of the private investor (see below, Risk assessment).

4.5.4.4Financial sustainability

One of the most relevant issues to be checked is the financial sustainability of the project, which implies that, for each year, the cumulated sum of the net inflows must be higher than the outflows of that year. The financial resources must be organised in order to satisfy this condition.

The financial resources planned are as follows:

-EU grant => €14,170,000

-Total national public contribution => €4,725,000

-Loans from credit system => €10,000,000

-Private equity => €33,608,0000

The EU grant is equal to the eligible costs (€63,000,000) * 30% (State Aid plafond) * 75% (co-financing rate). In the case of productive investment projects the funding-gap method is not applicable on the basis of Article 55(6) of Regulation 1083/2006. Therefore the national contribution is equal to 63,000,000 * 30% * 25%.

The real interest rate on loans was assumed to be 5%.

In order to guarantee the financial sustainability and capacity to minimise interest expenditure, the company will input its own capital in the first three years and will obtain the financial inflows from loans in the third year. The projected loan reimbursement is shown in the financial sustainability table.

4.5.5Economic analysis

The starting point for the economic analysis is the financial analysis. Specific conversion factors and standard conversion factors were used to convert market prices into prices adjusted for market imperfections.

The Value Added Tax on raw materials was eliminated. In a similar way, the energy costs were considered net of taxation. The labour cost was considered net of insurance contributions and income taxes because the reservation wage was to be taken as the shadow wage, due to high unemployment in the area. Sales were to be accounted net of Value Added Tax.

Land is provided by the local government at a concession price that is below the market price; for this reason a conversion factor of 1.235 was applied.

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4.5.6.1Sales

It is possible to consider a worse dynamic for the sales of product C (the one not designed for a specific customer). In this case, with a reduction of 5% in annual growth and of 5% in initial output, the performance of the project would decrease in a remarkable way. In this case, assumptions showed in the table were made.

Table 4.56 Sales of product C - Assumption

4.5.6.2Investment costs

The other possibility is to consider a worse situation for the dynamics of some investment cost items, as shown in the following tables.

An investigation into the impact of the single components of investment costs was conducted and has underlined the importance of building and new equipment costs.

Also in this case the results of financial and economic analyses for the two items are presented for a 5% variation in the yearly absolute value.

Table 4.57 Building costs – Assumption (thousands of Euros)

Table 4.58 New equipment costs – Assumption (thousands of Euros)

As requested by Point E.1. of the Application Form, the impact of parameter variation in terms of modification of the main performance indicators is summarised in the table below.

Table 4.59 Results of the sensitivity test

* Buildings and new equipment costs do not affect the FNPV(K) and FRR(K)

With regard to the investment costs, the analysis points out that the most critical item is new equipment costs. A similar variation in land cost only has a slight effect on both financial and economic profitability.

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This analysis shows the need to pay great attention to the forecasts of investment costs and sales. An over-optimistic provision for sales can turn an unprofitable investment project into a profitable one: so, it is important to analyse the market dynamics and the company’s capacity to compete successfully.

In order to properly assess the project risk, the risk analysis was based on an appropriate probability distribution for the critical variables. In the sensitivity analysis the most critical variables identified were ‘Sales of product C’ and ‘New equipment costs’.

Table 4.60 Assumed probability distributions of the project variables, Monte Carlo method

Figure 4.15 Probability distribution of sales of product C in units – Normal distribution

Figure 4.16 Probability distribution of new equipment costs in Euro – Triangular distribution

The results of the risk analysis (see Figure 4.17 below) show that the project is highly risky (more than 40% probability of a negative ENPV). Given the modest financial return on investment and the high risk for the economic return106, the project should be reconsidered and risk mitigation measures adopted.

105MV = Mean value; SD = Standard deviation.

106The risk is also relatively high for the private investor (the analysis is not reported here).

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Table 4.61 Probability parameters

Figure 4.17 Probability distribution of ENPV

Figure 4.18 Probability distribution of ERR

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Table 4.63 Financial return on national capital (thousands of Euros)

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