International Center For Environmental Finance'

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International Center For Environmental Finance.
Series B - Course 2 Calculating Annual Debt
Service
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Annual Debt Service Payments

• There are three components of Annual Debt
  Service Payments
• Fees
• Interest
• Principal

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Annual Debt Service Payments FEES

• Types of fees
• One-time only fees
• Annual fees (expressed in flat dollar amounts)
• Fees that are expressed as a percentage of the
  outstanding principal balance of the loan

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Annual Debt Service Payments

• Treatment of Fees
• One-time, upfront fees are added to project cost.
• Annual fees in dollars are added to annual
  principal and interest payments.
• Annual percentage fees are added to the interest
  rate.

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Annual Debt Service Payments INTEREST

• Interest due and payable in any year is always
  calculated as follows
• outstanding principal balance
  of the loan
• X
• the rate of interest

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Annual Debt Service Payments PRINCIPAL

• The three ways in which principal is repaid are
• The level payment method
• The level principal method
• The irregular method, in which nothing is level

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• THE LEVEL PAYMENT METHOD

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The Level Payment Method

• The level payment method means that the total
  amount of principal and interest, combined, which
  system pays every year, is the same.

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Illustration Of The Level Payment Method

• Annual payment schedule for a 5-yr loan of
  100,000 at 10.

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Illustration Of The Level Payment Method

• As the amount of interest declines with every
  payment that is made, the amount of the principal
  paid increases by the same amount.

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Illustration Of The Level Payment Method
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Calculating Annual Debt Service Payments for
Loans Using The Level Payment Method
ADSP annual debt service payment P original
principal amount of the loan I interest rate
expressed as decimal N term of the loan
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Calculating Annual Debt Service Payments for
Loans Using The Level Payment Method

• P100,000
• I0.1 (10)
• N5 years

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Rules for Creating Annual Debt Service Payment
Schedules For The Level Payment Method

• Determine the annual payment.
• Calculate the first years interest payment.
• Obtain first years annual principal payment
  (AP-i).
• Obtain the outstanding principal balance for the
  next year (P-1st year principal payment).

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Rules for Creating Annual Debt Service Payment
Schedules For The Level Payment Method (contd)

• 5. Obtain the next years annual interest
  payment, by multiplying preceding years
  outstanding balance by I.
• 6. Obtain the next years annual principal
  payment (AP that years i).
• 7. Obtain the next years outstanding principal
  balance.
• 8. Repeat steps 5,6, and 7, for each year of the
  loan.

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Characteristics Of The Level Payment Method

• The annual payments are always the same.
• The amount of principal paid each year increases
  by the exact amount in which the interest payment
  decreases.
• The total of all of the annual principal payments
  equals the original principal amount of the loan.

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• THE LEVEL PRINCIPAL PAYMENT METHOD

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The Level Principal Payment Method

• The annual principal payments are the same each
  year.
• Both the annual interest payment and the annual
  payment decrease each year.
• The total of all of the annual principal
  payments, equals to the original principal amount
  of the loan

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Illustration Of The Level Principal Payment Method
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Illustration Of The Level Principal Payment Method
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Rules for Creating Annual Debt Service Payment
Schedules For The Level Principal Payment Method

• Calculate the level principal payment, which will
  be the annual Principal payment for each year of
  the loan, by dividing the original principal
  amount by the number of years in the term of the
  loan.
• Calculate the first years annual interest
  payment by multiplying the original principal
  amount of the loan by the rate of interest.

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Rules for Creating Annual Debt Service Payment
Schedules For The Level Principal Payment Method
(contd)

• 3. Obtain the first years annual payment by
  adding the level principal payment to the first
  years annual interest payment.
• 4. Obtain the outstanding principal balance at
  the end of the first year by subtracting the
  first years level principal payment from the
  original principal amount of the loan

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Rules for Creating Annual Debt Service Payment
Schedules For The Level Principal Payment Method
(contd)

• 5. Calculate the next years annual interest
  payment by multiplying the outstanding principal
  balance from the preceding year by the rate of
  interest.
• 6. Calculate the next years annual payment by
  adding that years annual interest payment to the
  level principal payment.

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Rules for Creating Annual Debt Service Payment
Schedules For The Level Principal Payment Method
(contd)

• 7. Calculate the next years outstanding
  principal balance by subtracting the current
  years level principal payment from preceding
  years outstanding principal balance.
• 8. Repeat steps 5,6, and 7, for each year of the
  loan term.

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• THE IRREGULAR METHOD

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The Irregular Method

• Unlike both the Level Payment Method and the
  Level Principal Payment Method, which have at
  least one constant, the irregular method of debt
  service payment has none.

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The Irregular Method

• There are very few scenarios where the irregular
  method might be preferable.

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The Irregular MethodScenario 1

• When a utility system issues a bond or obtains a
  loan prior to the construction of the project.
• In such case the project may require two or more
  years to complete, and the system may not want to
  begin charging users until the benefits of the
  project were available to all ratepayers.

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The Irregular MethodScenario 1

• Thus, if the goal is to minimize the cost to the
  ratepayers prior to the actual operation of the
  project, then, the system will elect not to pay
  principal or interest payments in the first three
  years.
• Financially strong systems will be offered an
  opportunity to defer such payments.

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The Irregular MethodScenario 1

• To do that a utility system will issue a bond and
  bondholders will still receive interest payments
  every six months. The system would make such
  payments from borrowed funds.
• In short, a system overborrows the precise amount
  it needs to make up for the missing user fees.

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The Irregular MethodScenario 2

• Another circumstance which might warrant the use
  of the irregular method is when the system might
  have a realistic expectation of future income.

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The Irregular MethodScenario 2

• For example, a system may be planning to sell
  some of its property. It will certainly be able
  to estimate the amount of gain from sale and set
  aside a portion of that gain to pay off loan
  principal.
• This would warrant using the irregular payment
  method with principal payments skewed to those
  years immediately after the planned sale date of
  property.

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The Irregular MethodScenario 3

• Another circumstance which might also warrant
  the use of an irregular payment method, arises
  not from within the system, but from without the
  system. It actually arises from within the bond
  market.

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The Irregular Method

• For example, if there is a large number of buyers
  willing to buy bonds of certain maturities (e.g.,
  five years or ten years) but not others (e.g.,
  six years or nine years), the interest rates on
  these maturities should be favorable to the
  system that is borrowing.
• A system can set its annual debt service schedule
  with principal payments skewed to those favorable
  maturities to take advantage of the favorable
  rates.

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Rules For Creating Annual Debt Service Payment
Schedules Using The Irregular Method

• Obtain the annual principal payments and the
  interest rates applicable thereto for each
  maturity.
• For a particular maturity, calculate each of the
  annual interest payments for each maturity by
  multiplying the amount of principal to be paid at
  that maturity by the rate of interest applicable
  to that maturity

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Rules For Creating Annual Debt Service Payment
Schedules Using The Irregular Method

• 3. For the same maturity, calculate each of the
  annual payments by adding the annual interest
  payment to the annual principal payment, if any,
  for each year.
• 4. Repeat steps 2 and 3, creating a schedule for
  each maturity.

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• Once you know the Cash Available for Debt
  Service and the Annual Debt Service Payments, you
  can then proceed to determine the financial
  feasibility of the project.