the panama canal expansion projectcharvey/teaching/... · the panama canal expansion project the...

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The Fuqua School of Business at Duke University FUQ-01-2006 Rev. February 15, 2006 Prepared by Jorge Vallarino, Megan Riley, Michael Levin, Ahmed Karimou under the supervision of Campbell R. Harvey. Copyright © 2006. All Rights Reserved. THE PANAMA CANAL EXPANSION PROJECT As the Panama Canal Authority (PCA) Chief Financial Officer, Jose Barrios, sat in his office one sunny day in January 2005, the thunderous engines of an airplane from the airport near the Administration Building momentarily disrupted his thoughts. For a few minutes he had been pondering over an issue regarding the appropriate discount rate calculation to be used in the valuation of the Panama Canal expansion project. Barrios and his colleagues had been discussing the matter for months and were not able to come to a conclusion which satisfied all parties involved. As of March 2005, the project is estimated to cost around $4 to $5 billion and the PCA had been using a rate incorporating the CAPM model as a basis. However, due to the long timeline, size of the undertaking, and uncertainty around demand, Barrios felt as though these and other risk factors should be incorporated into the value of the project, either via cash flows or the discount rate. The PCA had already performed extensive technical and forecast studies, and had also commissioned various consultancies to better identify all of the factors affecting this project. Barrios felt comfortable with the level of analysis performed, and was ready to determine the rate to be used in the final document that would be published before the referendum that would decide the Canal’s fate. History of the Republic of Panama The Spanish arrived on the shores of Panama in the 16 th century and promptly overwhelmed the Cuevas and Cocle cultures. The Spaniards used Panama’s Pacific port to invade Peru whereby the wealth that was accumulated during these invasions was subsequently carried overland through Panama to the Caribbean for transport back to Spain. Pirates were eventually attracted to the vast quantities of wealth and by the 18 th century the Caribbean was so treacherous that the Spanish would avoid Panama and sail directly from Peru around Cape Horn to reach Europe. Panama deteriorated and eventually became a province of Colombia in 1821. However, in 1903, the Colombian government failed to reach a Canal treaty with the US. and Panama declared its independence from Colombia with the backing of the US. Panama subsequently signed a broad treaty that would eventually give the US rights to land on both sides of the Canal and extensive rights to intrude in Panamanian affairs. The treaty eventually led to tremendous friction between the two countries and in 1977

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Page 1: THE PANAMA CANAL EXPANSION PROJECTcharvey/Teaching/... · The Panama Canal Expansion Project The Panama Canal Authority The Panama Canal Authority (PCA) was legally established in

The Fuqua School of Business at Duke University FUQ-01-2006

Rev. February 15, 2006

Prepared by Jorge Vallarino, Megan Riley, Michael Levin, Ahmed Karimou under the supervision of Campbell R. Harvey. Copyright © 2006. All Rights Reserved.

THE PANAMA CANAL EXPANSION PROJECT

As the Panama Canal Authority (PCA) Chief Financial Officer, Jose Barrios, sat in

his office one sunny day in January 2005, the thunderous engines of an airplane from the airport near the Administration Building momentarily disrupted his thoughts. For a few minutes he had been pondering over an issue regarding the appropriate discount rate calculation to be used in the valuation of the Panama Canal expansion project. Barrios and his colleagues had been discussing the matter for months and were not able to come to a conclusion which satisfied all parties involved.

As of March 2005, the project is estimated to cost around $4 to $5 billion and the

PCA had been using a rate incorporating the CAPM model as a basis. However, due to the long timeline, size of the undertaking, and uncertainty around demand, Barrios felt as though these and other risk factors should be incorporated into the value of the project, either via cash flows or the discount rate. The PCA had already performed extensive technical and forecast studies, and had also commissioned various consultancies to better identify all of the factors affecting this project. Barrios felt comfortable with the level of analysis performed, and was ready to determine the rate to be used in the final document that would be published before the referendum that would decide the Canal’s fate.

History of the Republic of Panama The Spanish arrived on the shores of Panama in the 16th century and promptly

overwhelmed the Cuevas and Cocle cultures. The Spaniards used Panama’s Pacific port to invade Peru whereby the wealth that was accumulated during these invasions was subsequently carried overland through Panama to the Caribbean for transport back to Spain. Pirates were eventually attracted to the vast quantities of wealth and by the 18th century the Caribbean was so treacherous that the Spanish would avoid Panama and sail directly from Peru around Cape Horn to reach Europe.

Panama deteriorated and eventually became a province of Colombia in 1821.

However, in 1903, the Colombian government failed to reach a Canal treaty with the US. and Panama declared its independence from Colombia with the backing of the US. Panama subsequently signed a broad treaty that would eventually give the US rights to land on both sides of the Canal and extensive rights to intrude in Panamanian affairs. The treaty eventually led to tremendous friction between the two countries and in 1977

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The Panama Canal Expansion Project

the two countries signed a new treaty in which Panama would regain full control of the canal in 1999.

In 1984, General Manuel Noriega took control of the country through the suppression

of democracy by committing political assassinations, money laundering, and drug trafficking. After the 1989 election in which Noriega lost, he forcefully pronounced himself President and swiftly declared war with the US. The US promptly invaded and Noriega was eventually captured and sentenced to 40 years in prison.

Guillermo Endara, who actually won the 1989 election, took control of the country as

the new president. Endara inherited a country that was essentially bankrupt. His presided over hard times for Panamanians, however, by the end of his term, significant progress had been achieved and the country was back on its feet. In 1994 Ernesto Perez Balladares took office and shortly thereafter, Balladares called for widespread privatization programs and greatly improved infrastructure, health care, and education throughout the country. In September 1999 Mireya Moscoso, Panama’s first female President, took office. Moscoso initiated a major investigation of crimes committed by the state over the previous three decades. However, allegations of corruption in both the government and the private sector continued during her term. In its latest Corruption Perception Index, International Transparency gave Panama a score of 3.7 out of 10, which ranks it #62 out of 145 surveyed countries in terms of perceived corruption levels.1

President Martin Torrijos took office in September 2004 and promptly enacted tax

reform. Lawmakers are currently discussing an overhaul of the social security system, which has been losing money. As a direct result of these changes as well as the new government’s commitment to reduce expenditures, on February 2005 S&P changed its credit outlook on Panamanian debt from Negative to Stable. As of March 2005 S&P rates Panamanian debt BB, two notches below investment grade. Panama’s current debt to GDP ratio is approximately 70%.

The government is structured as a constitutional democracy in which the sovereign

power of the people is explicitly stated in the constitution. The economy is primarily based on the service sector which accounts for three-fourths of the $13 billion GDP (E2003). Industries contributing to the service sector are: the Panama Canal, banking, the Colon Free Zone, insurance, container ports, flagship registry, and tourism. Economic growth from 2000-2003 was hampered by the global slowdown, a decline in the Colon Free Zone and agricultural exports, and the overall impact of the withdrawal of the US forces in 1999. However, real GDP growth was estimated to be approximately 4.1% in 2003. 37% of the population lives below the poverty line and the unemployment rate was hovering around 14% in 2003. Panama boasts a 92.6% literacy rate, and its official currency, the Balboa, has always been pegged to the US dollar. This has allowed the country to avoid the economic hardship that has plagued many Latin American countries as a result of currency collapses.

1 As published by International Transparency on its 2004 CPI report. Other countries with similar scores include Slovekia (4.0), Brazil (3.9), Mexico (3.6), and Thailand (3.6). The highest score was awarded to Finland (9.7) and the lowest to Haiti (1.5). The US scored 7.5 (#17).

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01-2006 The Expan

The Panama Canal In 1534, Spain’s King Charles V was the first to dream of cutting a path through the

mighty jungles on the Isthmus of Panama as a shortcut to transport his new Peruvian wealth back to Spain. Unfortunately, King Charles’ thinking was far too advanced for the technology available at that time and he never saw his dream become a reality. At the dawn of the 19th century, the US government started to contemplate the prospect of building a canal as they were in the midst of constructing a Trans-isthmian railroad. However, in 1878, the French got permission from the Colombian government to construct a canal in Panama the Compaigne du Canal Interoceanique finally got underway in 1881. The famed Ferdinand de Lesseps, who oversaw the construction of the Suez Canal, was in charge of the project. Unfortunately, a few years later de Lesseps was unable to replicate his success in Central America as malaria and yellow fever killed 22,000 workers and financial scandal caused the French to shut down the project and file for bankruptcy.

The 1903 political situation in Panama reignited the crusade to link the two oceans.

In exchange for support in their independence bid from Colombia, the Panamanian government granted the US permission to construct a canal through the isthmus, which led to the US buying the rights and properties of the French Company for $40 million. The US also paid the new Panamanian government $10 million for the rights to build the canal. On May 4, 1904 canal construction resumed. The U.S. Army Corps of Engineers learned from the misfortune of the French and therefore set forth a major effort to rid the area of malaria and yellow fever. They also recognized the French design of a sea level canal was flawed, and decided to implement a lock system in their designs. Another challenge was finding a labor force large enough to work on the mammoth project. With a sparse population in Panama, the US looked toward the Caribbean Islands for labor and eventually accumulated approximately 30,000 manual laborers to work on the project. John F. Stevens and Colonel George W. Goethals managed the construction and ended up completing the canal in ten years at a cost of $387 million, which was under budget and ahead of schedule. The canal was a colossal victory: the men and women who constructed the canal built the world’s largest artificial lake, constructed three sets of twin locks with enormous gates and effectively dug through the Continental Divide. (Exhibit 1)

Today, the Panama Canal provides a competitive advantage to its customers by

offering a reliable route that saves significant amounts of time and money. For example, a ship navigating between Yokohama, Japan and New York, USA saves 3,829 miles when compared to the shortest alternative. Between Chile and Europe, the savings is about 1500 miles and between Ecuador and New York ships save 8,477 miles. Currently, it takes a ship eight hours to transit through the canal, with total time in Canal waters averaging 24 hours. Approximately 900,000 ships have passed through the Canal since it opened in 1914. (Exhibit 2)

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The Panama Canal Authority The Panama Canal Authority (PCA) was legally established in 1997 in anticipation of

the transfer of the Panama Canal to the Panamanian government on December 31, 1999. It is a state-owned financially autonomous legal entity solely in charge the operation and administration of the Canal. As an independent entity, the PCA is under full control of its assets and has the right to administer its own budget. The Authority is headed by an administrator who is appointed every seven years2 by an 11 member board of directors. The board of directors is comprised of the following:

1. The president of the board who is appointed by the president of the Republic of

Panama.3 2. One director is appointed by the Legislative Branch. 3. Nine other directors are appointed by the president of the Republic and must be

approved by an absolute majority in the Legislative Assembly.

All directors are appointed for a nine year period, and may only be removed in accordance to circumstances stated in Article 13 of the Panama Canal’s organic law.4 In addition to naming the canal’s administrator, the board’s duties include setting the canal’s toll structure, adopting the canal’s annual budget submitted by the administrator.5

The Panama Canal Authority does not pay income taxes to the government. Instead, it

is required to pay a net tonnage fee for cargo that transits through the canal. This fee, as well as the toll structure, is set by the PCA’s board. After covering all the necessary costs for the efficient operation of the canal (including reserves for capital expenditures), the Authority is required to submit any remaining funds to the government in the form of dividends. Of the $380 million net income in FY2004, 183 million was distributed to the government as dividends. Net tonnage payments were $174 million, and total direct payments to the government totaled $504 million.

(Exhibit 3)

Impact on the Panamanian Economy Since its ownership transfer from the USA to Panama on December 31, 1999, the

Canal has generated tremendous benefits and increasing income to the country. The increasing importance of the Canal as a route of marine commerce prompted the formation in Panama of a vast conglomerate of businesses that includes suppliers of logistic and financial services related to the economic activity generated by the Canal.

2 The administrator can be reappointed for an additional seven year period. 3 The president of the board also holds the title of State Minister for Canal Affairs. 4 The initial members of the board were appointed for different tenures to ensure that the board will remain independent from any future government administration. The first group of three members was appointed for three years, the second for six years, and the third for nine years. 5 Changes in the toll structure are subject to the approval by the president’s cabinet. The annual budget is first submitted to the cabinet which then sends it to the Legislative Assembly for final approval. A full translation of the law can be found at http://www.pancanal.com/eng/legal/index.html

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01-2006 The Expan

This conglomerate, known today as the Canal Economic System (CES), is considered

a vital component of the economy of Panama. It has been estimated that in 1950, the accumulated total contribution of the CES to Panama was approximately B/260 million. Fifty years later, the annual contribution grew more than seven fold, reaching B/1.86 Billion in 1999. The contributions of the CES to the economy of Panama in 1999 represented 18.6% of the country’s GDP, 41.2% of the total exports, and 28.6% of the governmental income. The creation and development of this conglomerate of services for commerce, logistic and international finance would not have been possible without the existence of the Canal.

During its first five years of operation under Panamanian management, the Canal’s

direct and indirect contributions to the state exceeded $1.7 billion. As a comparison, during this same period the government invested approximately $1.6 billion in infrastructure projects that included schools, highways, irrigation systems, hospitals, and bridges. Altogether, in the last five years the Canal contributed nearly $3.4 billion for the country, including contributions to the central government, the social security system and the economy of Panama in general. As it enters its sixth year under Panamanian administration, the Canal’s contributions to the state will surpass the cumulative payments made to Panama by the Canal during the first 87 years under US administration.

Realizing its importance to the economy, the Canal has a stated mission "To produce

a sustainable maximum benefit from our geographic position for all Panamanians". In order to maintain the level of present contributions to the state and, more importantly to increase the benefits that the Canal generates for the Panamanians, it is imperative that the PCA guarantees the continuous operation and competitive sustainability the Canal, as a key route of worldwide marine commerce. To achieve this goal, the PCA is constantly striving to improve its operational efficiency while analyzing the course that it must follow in the new Millennium. Part of this analysis indicates the Canal must take advantage of all the opportunities for growth that allow it to consistently renew its position as a major waterway for international commerce.

It is evident that if it is to maintain its competitive advantage, the Canal must respond

quickly to the growing demand for its services with expanded capacity and changes in technology that allow it to maximize the value of its position as a key marine transit hub.

Competitive Challenges The PCA is presently faced with the dilemma to continue with the current state of the

Canal or to invest in capacity and technology so that the Canal grows commensurably with demand, while maintaining the competitiveness of its services. The PCA has concluded an expansion will make the Canal more efficient and scalable, more reliable and more profitable.

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However, other alternatives exist to handle the load that today moves through the Panama Canal, including: the intermodal system of the United States complemented with the use of Post-Panamax6 ships on transpacific routes, and the use of Post-Panamax ships originating from Asia via the Suez Canal. These alternative routes offer means to compete aggressively and effectively with the Panamanian route. The intermodal system in the US, considered the Canal’s main competitor in the Asia to US East coast route, is believed to be operating at nearly full capacity. Even though users can theoretically save eight days by using the intermodal system, real savings average only 5 days due to reliability issues. In fact, a strike in 2002 in the ports of California caused large losses to customers of the intermodal system. This situation benefited the canal, which saw a spike in volume the year after the strike. (Exhibits 4 and 5)

It is important to understand the Canal is not an isolated component of the routes that

it serves. It is an indivisible link in the complex ecosystems surrounding the waterways, including shipping ports, railroads, distribution centers, and other components of the supply chain. This means any decision affecting the Canal’s operations will have repercussions on each of these interested parties. It is vital the Canal maintains the appropriate levels of investment so it does not to fall into obsolescence.

Due to the continued growth of world trade and the need to attain economies of scale,

ships have been growing in size over the years. For example, the average ship size has quadrupled in the last forty-five years. This trend has led to an increase in tonnage passing through the canal while the number of transits has decreased. In the container cargo segment, which accounted for 33% of Canal revenues in 2004, ships have grown in size from 1700 TEUs7 in the 1960s to 8000 TEUs today (Panamax ships have a capacity of approximately 4500 TEUs).8 As of August 2004, 27% of the ships under construction are Post-Panamax, which indicates a growing trend toward larger ships, as currently Post-Panamax ships represent 9.1% of the world fleet (Exhibit 9). Furthermore, Germanischer Lloyd expects that by 2006, the first 12,000 TEU Post-Panamax Ship will be commissioned. This expectation is based on the argument that larger ships would generate diseconomies of scale (Exhibits 6 and 7).

This trend towards larger ships represents a major challenge for at least two reasons:

first, as the fraction of Panamax transits increases (from 27% in 1997 to 42% in 2004), fewer ships will be able to use the waterway because larger ships require more resources and are subject to additional navigational restrictions. Second, in the future the current canal will not be able to service an increasing segment of the market. In 2004, it was estimated that the canal operated at over 93% of its capacity. Using the most probable

6 Panamax is the largest category of ship that can transit through the Canal. These ships measure between 100.6 and 106 feet wide and up to 965 feet in length. The Canal’s locks measure 110 feet wide, 1000 feet long, and can accommodate ships with a draft of up to 39 feet. 7 TEU (Twenty Foot Equivalent Unit): A TEU is a container that measures 20 feet long, 8 feet wide, and 8.5 feet high. Container ship capacity is frequently measured in TEUs. 8 The importance of this segment is expected to increase, as there is a tendency towards containerized cargo due to advantages in handling and flexibility. Within the segment, the most important route for the canal is Asia to the East Coast of the US. This route accounts for 50% of the container volume transported through the Canal.

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01-2006 The Expan

forecast scenario, the PCA has determined that with planned capital improvements of approximately $1.5 billion over the next seven years, the canal will reach 100% capacity by 2014.9 (Exhibit 8)

The Proposed Expansion The PCA estimates that even with planned capital expenditures to improve efficiency

and transit volume, the canal in its current form will reach its maximum capacity in FY 2014. In order to continue to meet growing demand and to allow transit of Post Panamax vessels through the waterway, the PCA has decided to expand the canal by building a third set of locks. The new locks will measure 1400 feet in length, 180 feet across and will have a depth of 55 feet. This lock size will be large enough to accommodate Post-Panamax ships with a container capacity of up to 12,000 TEUs. It has been estimated that such a ship would have a length of 1200 feet, a width of 180 feet, and would need 50 feet of water to navigate through the canal. The largest container ships currently under construction are those with a nominal capacity of 9,600 TEUs, commissioned by Seaspan Container Lines. They are expected to enter service at the end by 2006. In addition to accommodating post-panamax container ships, the new locks will allow the transit of Capesize ships used to transport dry grains and Suezmax tanquers with a displacement of 150,000 and 200,000 tons.10

Currently, major ports in East Asia can handle these ships and can be upgraded to

handle larger vessels. Ports in the eastern US are currently optimizing their facilities to receive these large ships under construction and are also building in the option to handle ships between 11,000 and 12,000 TEUs in the future.

The expansion project consists of building one lock in the Pacific entrance and one in

the Atlantic. The locks will each have three levels as opposed to a single level in order to minimize the amount of salt water released into the Gatun Lake, reduce technological risk in the design of lock gates, and use water more efficiently. It is also necessary to excavate new access waterways on for both sides. Once the ships go through the locks, they will use the current route through the Gatun Lake and Culebra Cut, which will have to be widened and deepened to accommodate the larger ships.11 Building the new locks and their access channels will require excavations of approximately 19 million cubic meters (MCM) on the Atlantic side (11.1 MMC of dry excavation and 7.9 MCM of dredging) and 56 MMC for the Pacific sector (51.7MCM dry and 4.3 MCM dredging).

9 The PCA commissioned a study by Global Insight to forecast demand. The study forecasted macroeconomic conditions in several countries and then determined demand for the Canal. This data was then fed into a model built by Mercer consulting to come up with projected revenues. The model also has a module that simulates water usage throughout the projection horizon. 10 These ships will initially navigate with partial cargo, due to the fact that the canal will not have the necessary depth to accommodate these ships at their full cargo capacity. The expanded canal is expected to initially accommodate dry grain ships with maximum cargo between 120,000 and 130,000 tons. 11 Currently, there are two sets of locks on the Pacific side of the canal. The new Pacific lock would be connected directly with the Gatun Lake through an access waterway of 5.5km, bypassing the Miraflores Lake and thus eliminating the need for an additional lock.

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Total estimated excavation costs are $950 million, with $700 million being expended to excavate a new access channel to the Pacific lock.

The project is scheduled to begin in 2006 and be completed by 2014. It is crucial that

the expanded canal is operational by then, as the current Canal is expected to reach capacity at that time. Due to traffic patterns in the Canal, completion of the Pacific lock would increase current capacity, so there is an advantage to focusing on the Pacific construction first. However, the PCA expects to build both locks simultaneously. Current estimates for the project’s total cost range from $4 to $4.5 billion dollars. (Exhibits 9 and 10)

Building the Locks Constructing the locks will be the most expensive and technologically challenging

part of the project. According to the PCA’s latest estimates, the lock on the Pacific side will cost 1.4 Billion dollars to build, and the lock on the Atlantic will cost 1.6 Billion. Lock gates are considered the most critical aspect in building the locks. The gates to the locks control water inflow to the lock from both the lake and the oceans. The moving mechanisms also affect transit time through each lock. Based on industry experience and a study performed by Permanent International Association of Navigation Congresses (PIANC), it has been determined that a sliding system will be used for all of the gates in the locks.12 Sliding doors with a length or over 180 feet are used in eight locks around the world, with those at the Zandvliet Lock in Belgium having operated for 40 years without major problems. There is also significant technological expertise in the designing and building of sliding gates for Post-Panamax locks. Materials needed for lock construction include 4 MCM of concrete, 1.6 MCM compacted concrete, and 219 tons of steel. It is anticipated that during its peak, the project will employ 6000 workers, mostly Panamanians. (Exhibit 11)

Navigation Waterways In addition to the construction of the locks, considerable amounts of dredging and

excavation are needed in order to expand the canal. In the Atlantic entrance, deepening to 45 feet and widening to 225 feet requires the dredging of approximately 6.95 MCM. This work is expected to take a year and a half. In the Pacific side, the same depth and width will require a total of 10.87 MMC. Due to the geological condition of the Pacific waterway, the PCA has estimated that completing the work will take a total of six years.

Widening of the Gatun Lake to 920 feet on the straights and 1200 ft. for the turns requires dredging of 7.4 MCM. PCA estimates that this work will take nine months to complete.

12 With this system, gates slide into a chamber on the side of the lock, as opposed to moving forward or backward as a conventional door. This system reduces the required size of the lock and does not require the removal of the gate (and lock shut-down) for maintenance operations.

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01-2006 The Expan

Financing Due to the nature of the Canal, whose assets may not be pledged as collateral and are

indirectly owned by the Panamanian government, financing the project could prove to be a major challenge. At this stage, it is unclear how much debt the Panama Canal will issue. PCA executives have stated they plan to fund as much of the project as possible with internal funds. However, due to the high cost of the project (over $4 billion) and planned capital expenditures of approximately $1.5 billion over the next seven years, it is evident cash flows from the current canal will likely not suffice.

The PCA is currently analyzing various scenarios to determine the optimal capital

structure for the expansion. Issues under consideration include what will become of the dividend in the future and how much debt to raise. The law states that before making dividend payments, the Canal has the right to allocate the necessary funds towards an investment reserve account. Another way to fund the expansion would be to increase current tolls. However, changes in the toll structure will undoubtedly affect traffic patters, so this course of action has to be carefully analyzed.

Finally, it is also important to note that the canal has recently adopted a new toll

structure for containerized cargo. The new scheme will be adopted in three steps, with the cost per TEU increasing to $42 (an increase of $8) by May 1, 2005, then increasing $7 in 2006 and finally $5 to $54 in the year 2007. This toll increase is considered independent from the expansion project, and extra cash flow will be used for capital expenditures to improve the efficiency of the current canal.

Water Supply and the Environment The PCA recognizes that a project of this magnitude could have a significant impact

on the environment. When expanding the Canal was first discussed several years ago, it was unclear if the current Canal had enough water capacity to expand.13 A major issue under consideration was the expansion of the Canal’s watershed, which would have meant that thousands of people would need to be displaced. The environmental impact of such an expansion was also believed to be significant, as several species of birds and other animals inhabit the shores and islands of the Gatun Lake. Additionally, since a large portion of Panama City gets its fresh water supply from the same lakes that supply the canal, expanding the lakes could impact the lives of approximately 1.5 million individuals.

To better understand the impact of the Canal expansion, the PCA has commissioned

several studies, covering almost every possible angle of the project. One of those studies, performed in conjunction with the US Army Corp of Engineers determined that increasing the depth (through excavation) of the Gatun Lake can provide the necessary amount of water needed for operating the expanded Canal in the future (Appendix 1 lists the studies commissioned by the PCA).

13 Currently, approximately 212 million gallons of fresh water are extracted form lakes Gatun and Alhajuela. A ship uses approximately 54 million gallons of fresh water to transit through the Canal.

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Exhibit 1 Diagram of the Panama Canal

Source: Panama Canal Authority

The three set of locks of the two-lane Canal work s water elevators that lift the ships

to the level of the Gatun Lake, 85 feet above sea level, and later lower them again to seal level on the other side of the Isthmus of Panama.

A detailed flash animation can be view at the following website:

www.pancanal.com/eng/general/howitworks/index.html

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01-2006 The Expan

Exhibit 2a Capacity frontier for the expanded canal as a function of the mix of ships and

demand.

Source: Panama Canal Authority

This chart shows the Canal’s capacity frontier under different combinations of “large”

and “small” ships. For example, the current Canal’s most efficient traffic mix is 60% large ships and 40% small ships. In this scenario, the current Canal would be able to handle 360 million CPSUAB in 2025. With the same traffic mix, the expanded Canal would be able to handle 460 million CPSUAB in 2005.14

14 CPSUAB is a volume measure used by the Canal to determine tolls.

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Exhibit 2b Routes that use the Panama Canal

Source: Panama Canal Authority

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01-2006 The Expan

Exhibit 3

(In Millions)2000 2001 2002 2003 2004

Transit Revenue $708.8 $715.9 $749.5 $863.6 $996.3Other Income 60.1 65.3 50.3 57.3 67.1

Total Operating Income $768.9 $781.2 $799.8 $920.9 $1,063.4Total Operating Expense 427.5 429.9 396.5 421.1 419.9Income Before Fees and Depreciation $341.4 $351.3 $403.3 $499.8 $643.5

Net Tonnage Fee 134.6 150.5 152.8 157.8 173.5Utilities Service Fee 29.0 29.0 29.0 29.0 29.0Depreciation 35.5 53.6 54.6 55.0 60.8

Net Income (Loss) $142.3 $118.2 $166.9 $258.0 $380.2Reserves and Contributions to Investment Program 104.9 82.5 78.1 151.2 196.6

Income Available for Distribution $37.4 $35.7 $88.8 $106.8 $183.6

Payments to the GovernmentDirect Payments to the Government $201.0 $215.2 $270.6 $293.6 $386.1Indirect Payments to the Government 132.1 113.0 108.5 111.4 117.8Total $333.1 $328.2 $379.1 $405.0 $503.9

Income Statement

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Exhibit 4

Source: Panama Canal Authority

Exhibit 5

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01-2006 The Expan

Exhibit 6 Volume vs. Number of Transits

Source: Panama Canal Authority

Exhibit 7 Global Fleet of Container Ships

Source: Panama Canal Authority

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Exhibit 8 Panamax Transits 1974-2004

Source: Panama Canal Authority

Exhibit 9 Project Timeline

Source: Panama Canal Authority

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01-2006 The Expan

Projected Costs

Source: Panama Canal Authority

Exhibit 11 Artist rendition of a ship entering the new Post-Panamax lock, showing the three

levels used to elevate the ships to Gatún Lake at 85 feet above sea level.

Source: Panama Canal Authority

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Exhibit 12

Exhibit 13 The trend has been changing over the years. The U.S. had much more relevance

through the canal than it does today.

“E.E.U.U.” = United States “Otras Rutas” = Other Routes Source: Panama Canal Authority

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01-2006 The Expan

Exhibit 14

Source: Panama Canal Authority

Note: notice the value of the cost of transit through the canal is only a small fraction

of the value of the merchandise. Exhibit 15 Canal Traffic by Segment

Source: Panama Canal Authority

Note: notice the growing importance of the container ship segment

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Exhibit 16 Organizational diagram of the Pacific lock construction site.

Source: Panama Canal Authority

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01-2006 The Expan

Exhibit 17

Cost of Equity = Ke = Rf + Be(Rp) + Country Risk Premium

Rf = US 10 Year Treasury 4.25%Be = Maritime Industry Beta 0.53 Rp = S&P 500 Earnings Yield 4.87%

Country Risk Premium 6.00%Cost of Equity 12.83%Inflation 2.00%Real Cost of Equity 10.83%

PCA Cost of Equity Analysis

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The Fuqua School of Business at Duke University FUQ-01-2006

Rev. February 15, 2006

Prepared by Jorge Vallarino, Megan Riley, Michael Levin, Ahmed Karimou under the supervision of Campbell R. Harvey. Copyright © 2006. All Rights Reserved.

Exhibit 18 (In Millions of Real Dollars) 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20

Income 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025Transit Revenue $0 $0 $0 $0 $0 $0 $4 $7 $11 $115 $324 $494 $667 $851 $1,048 $1,245 $1,444 $1,659 $1,886 $2,127

ExpensesMaintenance $0 $0 $0 $0 $0 $0 $0 $0 $0 $0 $6 $6 $6 $6 $6 $6 $6 $6 $6 $6Net Tonnage Payment 0 0 0 0 0 0 0 0 0 6 19 24 29 33 38 41 43 45 47 48Capex 12 130 397 571 714 739 593 480 314 0 0 0 0 0 0 0 0 0 0 0Total Costs $12 $130 $397 $571 $714 $739 $593 $480 $314 $6 $25 $30 $35 $39 $44 $47 $49 $51 $53 $54

Free Cash Flow ($12) ($130) ($397) ($571) ($714) ($739) ($589) ($473) ($303) $109 $299 $464 $632 $812 $1,004 $1,198 $1,395 $1,608 $1,833 $2,073

Incremental Value From Third Set of Locks

(In Millions)

Income 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025Transit Revenue $1,075 $1,127 $1,191 $1,251 $1,337 $1,422 $1,502 $1,588 $1,674 $1,847 $1,987 $2,130 $2,283 $2,445 $2,608 $2,773 $2,950 $3,139 $3,338 $3,551Other Income 41 42 42 42 43 43 44 44 45 45 45 46 46 47 47 48 48 49 49 50Total Income $1,116 $1,169 $1,233 $1,293 $1,380 $1,465 $1,546 $1,632 $1,719 $1,892 $2,032 $2,176 $2,329 $2,492 $2,655 $2,821 $2,998 $3,188 $3,387 $3,601

ExpensesOperating Costs $463 $473 $482 $488 $501 $513 $524 $536 $544 $568 $570 $579 $588 $598 $610 $620 $630 $641 $653 $664

Gain/loss before feesand depreciation $653 $696 $751 $805 $879 $952 $1,022 $1,096 $1,175 $1,324 $1,462 $1,597 $1,741 $1,894 $2,045 $2,201 $2,368 $2,547 $2,734 $2,937Net Tonnage Fee (179) (184) (189) (195) (204) (211) (217) (223) (229) (242) (248) (252) (257) (261) (264) (266) (268) (270) (272) (274)Utility Services Fee (29) (29) (29) (29) (29) (29) (29) (29) (29) (29) (29) (29) (29) (29) (29) (29) (29) (29) (29) (29)Interest Cost 0 (33) (73) (119) (165) (201) (229) (244) (244) (271) (303) (277) (236) (190) (144) (108) (80) (65) (65) (38)Depreciation (65) (74) (89) (100) (116) (129) (138) (140) (141) (143) (145) (147) (149) (151) (153) (154) (154) (155) (156) (154)

Net Income $380 $376 $371 $362 $365 $382 $409 $460 $532 $639 $737 $892 $1,070 $1,263 $1,455 $1,644 $1,837 $2,028 $2,212 $2,442

Projected Income StatementIncludes Third Set of Locks

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01-2006 The Expansion of the Panama Canal

Exhibit 18 (continued) (In Millions)

Assets 2003A 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025PP&E $1,939 $2,620 $3,117 $3,702 $4,375 $5,049 $5,563 $5,955 $6,179 $6,088 $5,995 $5,900 $5,803 $5,704 $5,603 $5,500 $5,396 $5,292 $5,187 $5,081 $4,977Current Assets 619 425 693 997 1,304 1,610 1,913 2,214 2,509 2,922 3,914 4,549 4,767 4,950 5,021 5,068 5,094 5,239 5,578 5,403 5,192Total $2,558 $3,045 $3,810 $4,699 $5,678 $6,660 $7,476 $8,168 $8,688 $9,009 $9,909 $10,449 $10,570 $10,654 $10,625 $10,568 $10,490 $10,531 $10,765 $10,485 $10,169

Liabilities & EquityEquity $2,408 $2,859 $3,050 $3,234 $3,405 $3,576 $3,759 $3,964 $4,217 $4,538 $4,961 $5,519 $6,232 $7,122 $7,900 $8,476 $8,883 $9,188 $9,421 $9,615 $9,852Liabilities 150 187 760 1,465 2,273 3,084 3,718 4,204 4,470 4,472 4,948 4,930 4,339 3,533 2,724 2,092 1,608 1,343 1,344 870 318Total $2,558 $3,045 $3,810 $4,699 $5,678 $6,660 $7,476 $8,168 $8,688 $9,009 $9,909 $10,449 $10,570 $10,654 $10,625 $10,568 $10,490 $10,531 $10,765 $10,485 $10,169

Projected Balance Sheet

(In Millions)

Cash Flows From Operations 2006 2007 2008 2009 2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025Net Income $380 $376 $371 $363 $366 $382 $409 $461 $532 $639 $738 $893 $1,070 $1,263 $1,455 $1,644 $1,836 $2,027 $2,213 $2,441Change in working Capital 1 1 1 1 1 1 1 1 1 1 0 0 0 0 0 1 1 1 1 1Depreciation 65 74 89 100 116 129 138 140 141 143 145 147 149 151 153 154 154 155 156 154Cash Flow From Operations $445 $451 $460 $464 $482 $512 $548 $601 $673 $782 $883 $1,040 $1,219 $1,414 $1,609 $1,798 $1,991 $2,183 $2,369 $2,596

Cash Flows From InvestingCapital Expenditures ($399) ($571) ($673) ($773) ($790) ($643) ($530) ($364) ($50) ($50) ($50) ($50) ($50) ($50) ($50) ($50) ($50) ($50) ($50) ($50)Cash from Investments ($399) ($571) ($673) ($773) ($790) ($643) ($530) ($364) ($50) ($50) ($50) ($50) ($50) ($50) ($50) ($50) ($50) ($50) ($50) ($50)

Cash Flows From InvestingDebt Issuance $0 $572 $705 $807 $810 $633 $485 $265 $0 $476 $553 $112 $0 $0 $0 $0 $0 $0 $0 $0Debt Amortization 0 (286) (286) (286) (286) (286) (286) (286) (286) (1,140) (1,195) (920) (686) (484) (322) (217) (147) (114) (114) (67)Dividend to the State (180) (184) (188) (192) (195) (199) (203) (207) (211) (216) (180) (180) (180) (484) (880) (1,237) (1,531) (1,794) (2,019) (2,205)Cash from Financing ($180) $102 $231 $329 $328 $147 ($4) ($228) ($498) ($880) ($822) ($988) ($866) ($968) ($1,202) ($1,453) ($1,679) ($1,908) ($2,133) ($2,271)

Change in cash ($135) ($18) $18 $20 $20 $17 $14 $9 $126 ($148) $11 $2 $304 $396 $357 $295 $263 $224 $186 $275Beginning Cash 493 358 340 358 378 398 414 428 438 563 416 427 429 733 1,129 1,486 1,780 2,043 2,267 2,454Ending Cash $358 $340 $358 $378 $398 $414 $428 $438 $563 $416 $427 $429 $733 $1,129 $1,486 $1,780 $2,043 $2,267 $2,454 $2,729

Projected Statement of Cash Flows