Reviewing Other Models and Laying on a Bed of Nails

This webpage provides some ideas on how you could review a large model that you receive from somebody else. A systematic review is suggested through segregating cash flows into different components and computing a series of IRR’s. Other methods including creating selected graphs, adding simple sensitivity and evaluating the effect of different assumptions. The final method of verifying the model is to create a parallel model and evaluate items that can cause circular references.

Overview of Model Verification

Alternative Strategies to Model Review

  • Five Different Strategies
    • Accept Models and Prepare Sensitivities
    • Work through large models and understand sensitivities, cash flows and financial ratios from detailed model
    • Create Simple Models with Key Assumptions that produce similar results as large models
    • Split-up Cash Flows in Separate Page with Key Graphs and Summary
    • Implement Parallel Model Concept
  • Using models as case studies to understand project finance

Strategy 1: Accepting Models and Playing with Scenarios

  • Auditing of Models and Structural Accuracy of Models
  • Advantages and Disadvantages
  • Play with Scenarios in Actual Models
  • Creating your own sensitivity analysis
  • Creating your own scenarios with scenario reporter
  • Evaluating Models for Benchmarking
    • Compute the drivers
    • Where to find benchmarks
    • Understanding why costs are higher
    • Benchmarking O&M Costs
    • Benchmarking Capacity Factors

Strategy 2: Working Through Details of Actual Model

  • Advantages and Disadvantages
  • First Understand Structure of Model (Should be Similar to Our Structure)
  • Look for Key Equations for EBITDA, Taxes, Capital Expenditures and Debt
  • Understand how GCF Facility is Included and Work Through Equations in Detail
  • Case Exercise with Actual Model

Strategy 3: Create Simpler Model

  • Advantages and Disadvantages
  • Structure of Simple Model with Fixed Debt, Annual Flows and Tricks to Avoid Circular References
  • Comparing Key Figures with Large Cumbersome Model to Your Model Like EBITDA, CFADS and Dividends
  • Adding Different GCF Structures to Simpler Model
  • Example of Simplifying Case Exercise with Actual Model
  • Evaluating cost of debt
    • Database on credit spreads
    • Theory of credit spreads and probability of default
    • Implied probability of default in long-term debt

Strategy 4: Dissect Cash Flows in Separate Page

  • Advantages and Disadvantages
  • Putting Pre-tax Cash Flow, Taxes, After-tax Cash Flow, Debt Cash Flow including GFC, Equity Bridge Cash Flow, Tax Shield Cash Flow in a Separate Sheet
  • Reconciling Cash Flows in Model
  • Computing IRR’s on Separate Cash Flow
  • Presenting Cash Flows with CFADS and Debt Service Graph as well as Cash Flow Waterfall
  • Example of Cash Flow Dissection Method with Actual Model
  • Evaluating equity IRR and political risk
    • Realistic sources of political risk
    • Probability of nationalisation
    • Loss if nationalise
    • Mitigation of political risk

Strategy 5: Implement Parallel Model

  • Advantages and Disadvantages
  • Notion of Parallel Model with VBA Code and UDF
  • Using Parallel Model in Simple Case
  • Incorporation of CGF Facilities in Parallel Model
  • Fixing Circular References with Parallel Model Concept
  • Example of Parallel Method with Actual Model