FINANCIAL ANALYSIS I. INTRODUCTION AND METHODOLOGY

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1 Dhk Wter Supply Network Improvement Project (RRP BAN ) FINANCIAL ANALYSIS I. INTRODUCTION AND METHODOLOGY A. Introduction 1. The Asin Development Bnk (ADB) finncil nlysis of the proposed Dhk Wter Supply Network Improvement Project in Bngldesh covered two components: (i) the estblishment nd cpcity enhncement for new district metered res (component 1); nd (ii) dditionl finncing to complete the civil works for district metered res under the ongoing Dhk Wter Supply Sector Development Progrm (component 2), lso finnced by ADB from The nlysis ws crried out in ccordnce with ADB s guidelines. 2 B. Methodology 2. A discounted csh flow nlysis ws conducted in rel terms to clculte the finncil internl rte of return (FIRR) nd the finncil net present vlue. The finncil nlysis exmined whether the FIRRs of the two components met ADB s hurdle rte of return, which is clculted bsed on the cost of cpitl from different sources. The project would be considered finncilly vible if the FIRRs of both components exceeded the weighted verge cost of cpitl (WACC). A sensitivity nlysis ws then crried out to ssess the tolernce of the clculted FIRRs nd finncil net present vlues to dverse chnges in the prmeters ssumed for the bse cre scenrio. These chnges included increses in the estimted cpitl expenditures nd opertion nd mintennce (O&M) costs, reduction in revenues, nd dely in construction. 3. The finncil nlysis lso exmined the finncil sustinbility of the implementing gency the Dhk Wter Supply nd Sewerge Authority (DWASA). It looked t whether sufficient resources would be vilble from DWASA to support project implementtion nd opertion nd repy the ssocited lons. This nlysis included (i) review of DWASA s historicl finncil performnce, nd (ii) finncil forecst ment to determine whether it would hve the finncil strength to continue to mintin nd operte the ssets fter project completion. II. PERFORMANCE OF DHAKA WATER SUPPLY AND SEWERAGE AUTHORITY A. Generl 4. DWASA will be the implementing gency for the proposed project, s it hs been for ADB s 2007 progrm nd Dhk Environmentlly Sustinble Wter Supply Project. 3 DWASA owns nd opertes the project ssets nd hs mndte to develop, operte, nd control wter supply systems nd distribute wter for public, domestic, nd industril purposes in Dhk City. It currently provides piped wter supply to bout 13.5 million people in the cpitl. However, its pipes re ging, nd bout 30% of the wter supplied is now nonrevenue wter (NRW) i.e., it erns the utility no revenue. This is mostly due to physicl losses through the degrded supply 1 ADB Report nd Recommendtion of the President to the Bord of Directors: Proposed Lons nd Technicl Assistnce Grnt to the People s Republic of Bngldesh for the Dhk Wter Supply Sector Development Progrm. Mnil. 2 ADB Finncil Mngement nd Anlysis of Projects. Mnil. 3 ADB Report nd Recommendtion of the President to the Bord of Directors: Proposed Lon nd Administrtion of Lon to the People s Republic of Bngldesh for the Dhk Environmentlly Sustinble Wter Supply Project. Mnil.

2 2 system. The proposed nd ongoing projects im to improve the opertionl efficiency of the DWASA system nd build the cpcity of DWASA stff to better mnge the NRW issues, collect revenue, nd conduct proper system O&M. Together, these efforts seek to reduce the NRW rtio to 10% 15%. B. Pst Performnce 5. DWASA s finncil performnce ws nlyzed with dt for FY2010 FY2014 (Tble 1). Gross income incresed by compounded nnul growth rte (CAGR) of 14.0% during the period, compred with 14.3% for direct operting expenses. Profits fter tx incresed from $0.5 million to $1.4 million, registering CAGR of 29.1%. This shows tht DWASA is consistently generting profit. However, such mjor expenses s slries hve grown fster thn income t CAGR of bout 20.6%. If this continues, DWASA will fce losses in future yers. Accordingly, DWASA needs to tke steps to increse revenue growth nd review its expense structures. The nlysis lso showed tht DWASA hs not been recovering its wter supply operting expenditures from the revenue it genertes from wter triffs (Tble 2), lthough DWASA hs been generting overll profits through the revenues from sewerge tretment, street hydrnt, nd interest income. This is mtter of concern. Without pproprite triff revisions, this operting deficit is likely to worsen. Tble 1: Finncil Performnce of Dhk Wter Supply nd Sewerge Authority, FY2010 FY2014 DWASA Item FY2010 FY2011 FY2012 FY2013 FY2014 income ($ million) Gross mrgin (%) Net mrgin (%) Deprecition to sles revenue (%) Working rtio (%) Operting rtio (%) Current rtio Debt equity rtio Debt service coverge rtio Source: Asin Development Bnk estimtes bsed on DWASA nnul reports, FY2010 FY2014. Tble 2: Finncil Performnce of Dhk Wter Supply nd Sewerge Authority s Wter Supply, FY2010 FY2014 Wter Supply Sector Prmeters FY 2010 FY 2011 FY 2012 FY 2013 FY 2014 Annul wter produced (million liter) 697, , , , ,009 Annul wter distributed (million liter) 426, , , , ,603 Wter supply operting exp. ($/kilo liter) Weighted verge wter triff ($/kilo liter) Revenue from wter supply ($ million) Operting expenditure for wter supply ($ million) Surplus/deficit ($ million) (8.05) (9.98) (13.47) (15.00) (15.42) Surplus/deficit ($/kilo liter) (0.02) (0.02) (0.03) (0.03) (0.02) The triff is estimted t the weighted verge of domestic rte (82% out of totl revenue) nd nondomestic rte (18%). Source: DWASA s Audit Reports nd DWASA s Mster Pln (2013).

3 3 III. FINANCIAL ANALYSIS OF THE PROJECT A. Triff nd Cost Recovery 6. Before 1996, the wter triff ws set t low level, nd O&M cost recovery ws not chieved. After triff djustments mde effective in 1996 through wter supply nd sewerge legisltion, DWASA hs come to be ble to crry out n nnul 5% triff increse within its mndte, nd chieved the net profit t the entity level. However, the wter triff for domestic consumers in FY2015 ws Tk7.71 per kiloliter (kl), compred with the estimted required triff for O&M cost recovery of Tk8.31 per kl. When projected 4% nnul increse in wter consumption ws considered long with rising cpitl nd O&M expenditures, nd infltion, the nlysis found tht the unit cost for wter supply would increse more thn triff revenues under the present triff structure even with resonble reduction in nonrevenue wter. B. Affordbility Anlysis 7. An ffordbility nlysis ws conducted in the finncil nlysis for ADB s 2017 progrm (footnote 1). The ffordble wter triff is considered to be no more thn 5% of household income. Bsed on the triff in FY2015, the nlysis estimted the monthly wter nd sewer chrges together to be 1.02% of the monthly income of the lowincome consumers nd 0.52% of overll verge income of ll consumer ctegories. The nlysis estimted tht the triff ssumed under the present structure for FY2022 (when the project ssets re scheduled to begin operting) would be equivlent to bout 1.47% of household income for lowincome consumers (0.75% for ll ctegories). This is fr below the 5% ffordbility threshold (Tble 3). Tble 3: Wter Chrges, Usge, nd Averge Household Income Description Existing (FY2015) Projected (FY2022) b Averge HH monthly consumption (KL) Wter supply rte (Tk/kl) c Wter supply monthly bill (Tk/HH) Wter + sewer bill (Tk/HH) Wter + sewer bill with VAT 15% (Tk/HH) Averge HH monthly income low income group d, e (Tk) 26,000 44,873 Shre of Wter + sewer bill low income group 1.02% 1.47% Averge HH monthly income ll ctegories d, e (Tk) 50,753 87,593 Shre of wter + sewer bill ll ctegories 0.52% 0.75% HH = household, kl = kiloliter, Tk = Bngldeshi Tk HH Monthly Bill for Wter & Sewer Opertions of the proposed project re scheduled to strt in FY2022. c Under the Wter Supply nd Sewerge Act 1996, DWASA cn increse the 5% nnul increse. Such increses hve been projected to FY2022. d DWASA Citizen Report Crd Survey Report (Drft). Mnil. e Household income for FY2022 is projected bsed on the growth rte in the household income during FY2010 FY2015 reported by DWASA. Source: Asin Development Bnk estimtes. C. Finncil Anlysis 8. WACC. The WACCs were estimted s 0.24% for component 1 nd 1.43% for component 2 (Tble 4). Prmeters Weighting Nominl cost Tble 4: Estimted Weighted Averge Cost of Cpitl ADB Lon Government WACC ADB Lon Government WACC 67.41% 32.59% 75.50% 24.50% 2.00% 9.00% b 4.20% c 9.00%

4 4 Prmeters ADB Lon Government WACC ADB Lon Government WACC Tx rte d Txdjusted nominl cost Infltion Rel cost Weighted 0.00% 0.00% 6.75% 6.00% 0.75% 0.24% 0.24% 3.15% 1.65% 1.25% 6.75% 6.00% 0.75% 0.18% 1.43% ADB = Asin Development Bnk, WACC = weighted verge cost of cpitl. The government will relend the ADB lon to DWASA t 2% interest rte, per the subsidiry lon greement between the Ministry of Finnce nd DWASA for ADB lon (Lon 3051BAN). b The term deposit interest rte for more thn 3 yers by scheduled bnks in Bngldesh ws 8% 9% in c The figure is the weighted verge of the relending rte of 5% for the 2007 progrm nd relending rte of 2% for the dditionl finncing under the proposed project, s greed by the government. d Corporte txes (25%) re chrged to the government orgniztions including DWASA. Source: Asin Development Bnk estimtes. 9. Finncil fesibility. The estimted component 1 FIRR of 1.4% nd the projected 1.5% FIRR of component 2 re both higher thn their WACCs. The nlysis mde the following ssumptions in clculting the FIRRs: (i) The nlysis for component 1 covered FY2016 FY2040. Assets were ssumed to hve 20yer opertions period fter completion of construction. The costs lredy incurred during FY2008 FY2015 for component 2 were restted s FY2016 costs by using n infltionbsed index. The nlysis ssumed component 2 opertions period of 20 yers, beginning in (ii) The estimte of totl project costs for component 1 ws $355.5 million. The nlysis considered the finncil cost to be $322.2 million fter removing the price contingency nd ll finncil chrges. For component 2, $244.9 million ws considered to be the finncil cost, bsed on totl cost of $265.2 million. (iii) All costs were in 2016 prices nd converted t n exchnge rte of $1 = Tk78. (iv) O&M costs included personnel, periodic mintennce, dministrtive, chemicl, power, nd estblishment costs. (v) For the nlysis, the triff is ssumed to increse by 5% every yer, strting from FY2016, bsed on provisions dopted in 1996 government legisltion (pr. 6). (vi) The revenue to be derived from the sle of the dditionl volume of wter to be supplied due to the reduction of nonrevenue wter constitutes the only benefit considered in the nlysis. (vii) The nlysis ssumed 95% triff collection efficiency, in line with the current rte. 10. The fct tht the FIRRs of both components re higher thn their WACCs indictes tht the project will hve sufficient finncil return. A sensitivity nlysis produced stisfctory results for component 1, except when ll of the downside risks were combined. The risk scenrios tested were (i) n overrun of 10% in the bse cse estimte of cpitl costs, (ii) n O&M cost overrun of 10%, (iii) 10% decline in the projected revenue, nd (iv) 1yer construction dely. The results for component 2 were not stisfctory when the FIRR ws tested ginst these risks. This is due to the component s incresed cpitl cost nd high WACC. However, the likelihood tht these risks will ctully occur is not s high s in component 1 since component 2 is to be completed in Scenrio Bse cse Cpitl cost (+10%) O&M cost (+10%) Revenue ( 10%) Tble 5: Sensitivity Anlysis FIRR FNPV ($ million) WACC FIRR FNPV ($ million) WACC 1.4% % 1.5% % % (26.3) 1.0% % (5.7) 0.3% % (32.9)

5 5 Scenrio FIRR FNPV ($ million) WACC FIRR FNPV ($ million) WACC 1yer dely Combined (1.4%) 27.0 (78.1) (1.4%) (18.7) (82.6) FIRR = finncil internl rte of return, FNPV = finncil net present vlue, O&M = opertion nd mintennce, WACC = weighted verge cost of cpitl. Source: Asin Development Bnk estimtes. IV. FINANCIAL PROJECTIONS OF DHAKA WATER SUPPLY AND SEWERAGE AUTHORITY 11. The nlysis developed finncil projections for DWASA for the 20 yers of the opertion period, bsed on the ssumed nnul 5% increse in the triff (pr. 6 nd Tble 6). This showed tht DWASA would hve sufficient income to recover its O&M costs nd to service debts in the short term but not in the medium nd long terms. This finding underlines the need for strengthening of DWASA s revenue bse. The government needs to tke the ctions to ensure tht DWASA meets the pproprite level debt service coverge rtio of more thn 1.0 nd n operting rtio of less thn 100% for it to remin finncilly sustinble. This needs to be done by more thn nnul 5% triff increse or other mens. ADB will provide continued policy dvice nd cpcity development support to help DWASA chieve finncil sustinbility nd will closely monitor the progress towrd the necessry triff djustments during continuous dilogue with the government nd DWASA. 12. The key ssumptions for the DWASA finncil projections were the following: (i) Wter supply revenue ws projected bsed on wter production estimtes in Dhk s wter supply mster pln nd the nnul 5% increse in the triff. (ii) To other revenues such s sewerge tretment, street hydrnt, nd interest income, the nlysis used growth rtes from the DWASA s estimtes, with some djustments. (iii) For the existing nd future lons, the nlysis used 15 yers of repyment period except the grce period. Tble 6: Finncil Projections, FY2020 FY2040 ($ million) Item FY2020 FY2025 FY2030 FY2035 FY Income Revenue (WS & Sewer) Other income 2. Opertion nd Mintennce Cost Slry & wges Repir & mintennce Administrtive expenses , , , , ,766.7 Surplus/Deficit (1.5) (50.0) (86.1) 3. Cpitl Cost Interest Principl repyment Surplus/deficit 17.9 (164.5) (175.9) (205.1) (86.1) Working rtio (%) Operting rtio (%) Current rtio 3.61 (8.69) (18.18) (24.28) (23.01) Debt/Equity rtio (129.70) (6.80) (2.53) DSCR (0.3) NA These figures re projected bsed on the dt of DWASA (FY2010 to FY2014) nd Asin Development Bnk estimtes.

FINANCIAL ANALYSIS I. INTRODUCTION AND METHODOLOGY

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