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M4U

CDM/JI

M４ U

Advisory Service on Clean Development Mechanism and Financing for Sustainability

SustainableDevelopment

Investment

Finance

MASUDA, Masato President of M4U Limited

on Dec.5, 2004 at Workshop “CDM Methodologies and Project design” in Buenos Aires organized and supported by the Carbon Finance Business of the World Bank

Suggestions for improvement Suggestions for improvement of Benchmark Analysisof Benchmark Analysis

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Weighted Average Capital Cost Weighted Average Capital Cost (WACC)(WACC)

• M4U proposed WACC as Benchmark on M4U proposed WACC as Benchmark on Additionality Tool to the CDM EB.Additionality Tool to the CDM EB.

• Additionality Tool accepts WACC as Additionality Tool accepts WACC as “company internal benchmark” on condition “company internal benchmark” on condition that: that: ““there is only one potential project there is only one potential project developer”developer” and and ““The project developers shall demonstrate The project developers shall demonstrate that this benchmark has been consistently that this benchmark has been consistently used in the past”.used in the past”.

• The condition is too strict for many project The condition is too strict for many project participants to use WACC as Benchmark.participants to use WACC as Benchmark.

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WACC as General WACC as General BenchmarkBenchmark

• WACC is the most common concept of a hurdle WACC is the most common concept of a hurdle rate reflecting financial effects of investment.rate reflecting financial effects of investment.

WACC = Equity Cost X E/(D+E) WACC = Equity Cost X E/(D+E) + Debt Cost X D/(D+E) X (1 + Debt Cost X D/(D+E) X (1

- T)- T) wherewhere

Equity Cost: Equity Cost: government bond rate + government bond rate + β β (average return (average return in the equity market - government in the equity market - government

bond rate), bond rate),

herein herein ββ is to be determined as sensitivity of return on a is to be determined as sensitivity of return on acompany against average return in the equity marketcompany against average return in the equity market

Debt Cost: Debt Cost: cost of bank finance and/or bond issuingcost of bank finance and/or bond issuing

E: E: equity value at the marketequity value at the market

D: D: debt value debt value

T: T: tax ratetax rate

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• WACC should be used as general benchmark WACC should be used as general benchmark regardless of the past usage of the participant.regardless of the past usage of the participant.

IF Tax-adjusted Equity IRR > WACC, then Equity IF Tax-adjusted Equity IRR > WACC, then Equity Investment is financially acceptable,Investment is financially acceptable,IF Tax-adjusted Equity IRR =< WACC, then Equity IF Tax-adjusted Equity IRR =< WACC, then Equity Investment is NOT financially acceptableInvestment is NOT financially acceptable

wherewhereTax-adjusted Equity IRR: IRR of (equity cash inflow X (1 - T)),Tax-adjusted Equity IRR: IRR of (equity cash inflow X (1 - T)),because usually NOPAT/CE is compared with WACC because usually NOPAT/CE is compared with WACC

Project Activity Equity

Investment

Project Sponsor（ Tax-adjusted Equity IRR ＞

WACC ? ）Capital

Equity Providers

Debt Providers

Tax

Equity Cash Inflow Debt Cost

Equity Cost

Past Usage is Not ImportantPast Usage is Not Important

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WACC for Participant-WACC for Participant-specific or Sector/Market ?specific or Sector/Market ?

• WACC is derived from non-confidential data WACC is derived from non-confidential data which is usually available in the market.which is usually available in the market.

• WACC can be estimated not only for a WACC can be estimated not only for a company but also for a sector or the national company but also for a sector or the national market.market.

• Tool says “benchmark is to represent Tool says “benchmark is to represent standard return in the market”.standard return in the market”.

• Why should WACC be connected to a specific Why should WACC be connected to a specific developer or participant ?developer or participant ?

• Will any problem arise if WACC for Will any problem arise if WACC for Sector/Market is accepted ? Sector/Market is accepted ?

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Misleading WACCMisleading WACC

• WACC might be misleading if Data is WACC might be misleading if Data is unreliable or Market is distorted by unreliable or Market is distorted by regulation, interference, etc.regulation, interference, etc.

• Common Practice Analysis in Tool will Common Practice Analysis in Tool will prevent the misleading usage of WACC for prevent the misleading usage of WACC for participants, Sector and Market.participants, Sector and Market.

• If WACC presented by participants is If WACC presented by participants is apparently misleading, an independent apparently misleading, an independent financial expert should estimate the most financial expert should estimate the most likely WACC or propose other benchmark.likely WACC or propose other benchmark.

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Standard BenchmarkStandard Benchmark• Is WACC popular in Host Countries ?Is WACC popular in Host Countries ? • To promote CDM projects it is suggested:To promote CDM projects it is suggested:(1) Standard Benchmark for Sector/Market should (1) Standard Benchmark for Sector/Market should

be established by EB on request of Host Country,be established by EB on request of Host Country,(2) A panel/WG comprising of financial experts (2) A panel/WG comprising of financial experts

should be organized and should be organized and (3) Standard Benchmarks should be recommended (3) Standard Benchmarks should be recommended

initially and reviewed periodically by the initially and reviewed periodically by the Panel/WG before EB’s decisions.Panel/WG before EB’s decisions.

• Systematic introduction of Standard Benchmarks Systematic introduction of Standard Benchmarks could help reducing uncertainty and avoid could help reducing uncertainty and avoid increasing Transaction Cost.increasing Transaction Cost.

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ThankThank 　　 You !You !Muchas Gracias !Muchas Gracias !

Advisory Service on Clean Development Mechanism & Financing for

Sustainability　

9th Fl. AIG Bldg., 1-1-3, Marunouchi Chiyoda-ku, Tokyo 100-0005, JAPAN

E-mail: m4ujp@ybb.ne.jp

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