Question

Conduct a financial analysis of water system operation for the City of Smallville over the next ten years. Use the data below.   If you lack data, make assumptions or ask for it. Analyze O&M, capital costs and cash flows. The water system currently serves 100,000 people and is to be expanded to handle a population influx of 5% per year for the next ten years. Land use is mixed residential and commercial, but no industry. Base your estimates on residential demands and assume that commercial water use adds 15% to the residential use. You expand the system to accommodate growth and simultaneously maintain and renew the existing system during the period. The system is currently 15 years old and has depreciated on a 30-year depreciation cycle at 3.33% per year on a straight-line basis.

Your system expansion will be staged so that half is built now and half in five years. When you also invest in system renewal to overcome depreciation, the investments would be added to the costs of system expansion. System renewal is governed by the rule that current system value must not fall below 50% of replacement value.

You will take a loan for the first part of the construction and issue bonds for the next increment (in five years). You may vary from this if you choose different capital financing vehicles.   Loans are “revolving loans” and come from an infrastructure bank. Annual loan payments begin in one year and continue for ten years. Recommend how to finance the expansion and renewal with funding from plant investment fees, water use fees, sales tax revenues, and property tax revenues. Commercial property has 25% of the assessed valuation of the residential property. Set up a spreadsheet and forecast cash flows for the next fifteen years. Submit:

• Cover memo with comprehensive one-page explanation of your analysis
• Schedule for capital improvements (the capital improvement program)
• Spreadsheet showing your financial analysis and cash flows
• Pro forma income statement (projected financial statement) for year ten
• Pro forma balance sheet for December 31 of year ten
• A graph showing how your system value varies over the ten year period

Current population	100,000 (33,333 households)
Rate of population growth	5% per year for ten years; 0% after that.
Per capita water usage (average)	150 gpcd
Land Use	Mixed residential and commercial.
Planning horizon for capital improvements	10 years to meet demands; 30 yrs for system life
Plant investment fee	$5,000 per house connection
Current water fees	$2.50/1000 gal
Property tax dedicated to water system improvements	0.8 mills
Assessed valuation residential (market value * 0.2)	$980 million
Sales tax dedicated to water system	0.8%
Current anticipated taxable sales	$800 million per year
Interest rate on loan (due in ten years)	8%
Interest rate on bonds (use 20 year life)	6%
Projected inflation rate	0%
Capital cost of new or replacement system	$3,000 for each new person
Current value of existing system (average age15 years)	Replacement value less 15 years depreciation
Capital improvement goal	System value not below 50% of replacement
Depreciation of assets	3.33% per year
O&M cost	$50 per capita per year

Answer 1

Financial and Operating Performance of the National Water Supply and Drainage Board 1. The National Water Supply and Drainage Board (NWSDB) was established in 1975 as a statutory entity and has been functioning under the supervision of the Ministry of Water Supply and Drainage (MWSD). NWSDB’s mandate is to develop, operate, and control an efficient, coordinated water supply system and to distribute water for public, domestic, and industrial purposes. By the end of 2011, an estimated 44%1 of the total national population had access to piped water supply, of which more than 75% was served by NWSDB. NWSDB was providing piped water supply to 33% of the total national population, or 6,900,000 people. 2 In 2011, Colombo City’s population was about 700,000 and service coverage was about 95%, much higher than the national coverage. NWSDB also operates piped sewerage systems for 2.3% of the total national population. 2. NWSDB’s 5-year corporate plan for 2012–2016 includes plans to increase service coverage to provide piped water to an additional 1,800,000 people by 2016. This will translate into NWSDB providing service coverage for 40% of the total national population. To improve the service coverage from the current 33% to 40%, NWSDB anticipates adding more than 350,000 new connections nationwide by the end of 2016, at an estimated annual growth rate of 5%. Substantial capital investments are needed to achieve these service expansion objectives, and at the same time maintain and improve existing service quality. 3. Colombo City, with an estimated total population of more than 772,000 by 2020 and a floating population of more than 500,000 a year, requires immediate improvements in its dilapidated infrastructure to satisfy demand from the growing population. The existing water supply network has been in place for more than 100 years and the physical leakage is estimated to reach 33%. When combined with other commercial and apparent losses, nonrevenue water (NRW) in Colombo City comprises 49% of the water supplied to the city. Reducing NRW therefore provides an immediate solution to the problem of finding an additional source of supply that can be used for expanding current services. 4. In 2007–2011, NWSDB improved its financial performance through revenue growth and cost control in conjunction with water tariff increases effective from 2009. According to audited financial statements from 2007 to 2010, as well as the unaudited financial statements for 2011, sales revenues increased by a compound annual growth rate (CAGR) of 16% per year, while direct operating expenses increased at a CAGR of only 11%. Net income improved from a loss of SLRs1,224 million to a profit of SLRs479 million, and cash flow from operations3 increased by a CAGR of 44%. According to audited and unaudited financial statements, NWSDB prepared common-sized financial statements4 1 Central Bank of Sri Lanka. 2011. Annual Report 2011. Colombo. to forecast its financial performance from 2012 to 2021. The financial projection is included at the end of Appendix 7. The pro forma financial statements indicate that, with a 20% proposed tariff increase for 2013 and improved operating efficiency, NWSDB’s financial position will continue to improve throughout the analysis period and full cost recovery can be achieved by 2020, the year when the investment program is completed.