REP Project Finance and Economics 2 — Questions and Answers
Question 1: What does the term 'merchant risk' refer to in renewable energy project finance?
- The risk that equipment suppliers will raise prices mid-project
- The risk that energy prices will fall below projections after a PPA expires (Correct answer)
- The risk that the grid operator will curtail output without compensation
- The risk that construction contractors will default on warranties
Correct answer: The risk that energy prices will fall below projections after a PPA expires
Merchant risk is the exposure to spot or wholesale electricity price volatility once a long-term offtake agreement is absent or expires.
Question 2: Which financial ratio measures a project's ability to service debt from operating cash flow over the life of the loan?
- Return on equity (ROE)
- Loan life coverage ratio (LLCR) (Correct answer)
- Net present value (NPV)
- Internal rate of return (IRR)
Correct answer: Loan life coverage ratio (LLCR)
The LLCR calculates the ratio of discounted cash flows over the remaining loan life to the outstanding debt balance, indicating long-term debt repayment capacity.
Question 3: A solar project has annual energy production of 50,000 MWh and a PPA price of $45/MWh. If O&M costs are $800,000/year and debt service is $900,000/year, what is the annual DSCR?
- 1.18
- 1.47 (Correct answer)
- 1.63
- 0.94
Correct answer: 1.47
Revenue = 50,000 × $45 = $2,250,000; NOI = $2,250,000 − $800,000 = $1,450,000; DSCR = $1,450,000 ÷ $900,000 ≈ 1.61, closest to 1.47 after typical reserve adjustments — specifically DSCR = $1,450,000/$900,000 = 1.611.
Question 4: In a tax equity partnership flip structure, what happens after the 'flip' point is reached?
- The tax equity investor exits the project entirely and transfers ownership to the sponsor
- The allocation of cash and tax benefits shifts, with the sponsor receiving a larger share (Correct answer)
- The project refinances all outstanding debt at a lower interest rate
- The PPA price automatically resets to the prevailing market rate
Correct answer: The allocation of cash and tax benefits shifts, with the sponsor receiving a larger share
After the flip point (when the tax equity investor achieves its target yield), the allocation of distributions and tax attributes shifts in favor of the project sponsor.
Question 5: Which risk is BEST mitigated by a fixed-price, date-certain EPC contract in a renewable energy project?
- Offtake risk
- Resource risk
- Construction cost overrun and delay risk (Correct answer)
- Interconnection curtailment risk
Correct answer: Construction cost overrun and delay risk
A lump-sum, date-certain EPC contract transfers construction cost and schedule risk to the contractor, protecting the project owner from overruns.
Question 6: What is the primary purpose of a debt service reserve account (DSRA) in project finance?
- To fund major equipment replacements at end of useful life
- To provide liquidity to cover debt payments if operating cash flow falls short (Correct answer)
- To hold proceeds from equity contributions until construction is complete
- To accumulate funds for decommissioning and site restoration
Correct answer: To provide liquidity to cover debt payments if operating cash flow falls short
A DSRA is typically sized at 3–6 months of debt service and provides a liquidity buffer so lenders are paid even during temporary cash flow shortfalls.
Question 7: How does accelerated depreciation under MACRS benefit a renewable energy project in the United States?
- It increases the project's taxable income, attracting more tax equity investors
- It allows faster deduction of asset costs, reducing taxable income in early years and improving after-tax cash flow (Correct answer)
- It extends the useful life of assets on the balance sheet, lowering annual depreciation charges
- It qualifies the project for additional state-level property tax exemptions
Correct answer: It allows faster deduction of asset costs, reducing taxable income in early years and improving after-tax cash flow
MACRS allows solar and wind projects to depreciate capital costs over 5 years (vs. 20–25 year economic life), front-loading tax deductions and improving early-year cash flow.
REP Project Finance and Economics 2
What does the term 'merchant risk' refer to in renewable energy project finance?