[HW 3.4a] Evaluating a Projects with Junior Debt

In this model, we have a project without any debt.  In each proposal, there is a senior loan and a junior loan.  (For simplicity, we will assume that both the senior loan and the junior loan are from the same lender.  This does happen, but more often the senior and junior debt are held by different entities).

Your job is to model out and evaluate these two debt proposals, and advise the equity as to whether to move forward.

In the proposal from BNP Paribas (aka “BNP”,a large French bank):

  • The Senior Debt will be a 9 year mortgage at a 8% interest rate for 50% of the project’s cost.
  • The Subordinated Debt (aka Sub Debt or Junior Debt) will be a 11 year mortgage at a 12% for 15% of the project’s cost.

In the proposal from Bank of Tokyo-Mitsubishi (aka “BTM”, a large Japanese bank):

  • The Senior Debt will be an 10 year mortgage at a 9% interest rate for 55% of the project’s cost.
  • The Subordinated Debt (aka Sub Debt or Junior Debt) will be a 13 year mortgage at a 12% for 20% of the project’s cost.

If we move forward, there will be an intercreditor agreement which will state that cash flows from the project are to be used in the following priority:

  1. Interest on Senior Debt
  2. Principal Due on Senior Debt
  3. Interest on Sub Debt
  4. Principal on Sub Debt
  5. Available for distribution to Equity

Calculate the average and minimum coverage ratios for the Senior Debt and the Sub Debt.  (Give some thought as to how to calculate coverage for Sub Debt).

Also, calculate the effective cost of funds for each loan individually (it should be identical or nearly identical to the rates above) and for the combination of the Senior/Sub structures, using XIRR.

You’ll also want to calculate the Equity IRR for the investors.  Make a recommendation as to whether you would recommend moving forward with the BNP Paribas offer or the one from Bank of Tokyo-Mitsubishi.

I’ve put the above assumptions in this Comparing Debt Structures and begun the outlined process for you.

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