Modelling distributions to investor in a 100% equity structure?
The dividends to equity are going to be the lesser of
a) cash available and
b) profits earned for that year + reserves,
due to legal restrictions on not distributing dividends that exceed that year’s profit + reserves. This is a greenfield project so you start with zero reserves. Due to depreciation (talking about a greenfield project here with substantial capital investment) your profits are below your cash available for distribution, at least until you depreciate your capital.
So, as the project progresses each year you are distributing all the profits you earn and not building any reserves and also having to retain cash (the extra cash over profits due to depreciation impacting the profit line), which impacts the IRR. How would you get around this problem in a real life situation and subsequently in the model, ie. is there a way to distribute all the cash available every year?
How is the project financed? You can return the depreciation portion of your earnings by returning capital via paying down debt or buying back shares. Look at it from a balance sheet prospective. As your asset declines via depreciation, you can return the same amount of capital by reducing equity/debt. So if you are financed 80/20 debt equity, when you depreciate your asset by $100, you pay down $80 of debt and $20 of equity. This is outside the payment of any earnings via dividends. So earnings are paid as dividends, depreciation as a return of capital. The problem is when you want to ramp up leverage, which is difficult to do in jurisdictions that don’t permit dividends in excess of retained earnings. Eventually you’ll run out of equity paid in capital to return. Some partnership structures can be used to deal with this as well, but this beyond my expertise or desire to explain it here.
^ I now see you said its 100% equity, which makes this easy. Your depreciation won’t exceed your paid in capital, so distribute your earnings as dividends and your depreciation by buying back shares/return of capital.
If the financing structure is fixed in stone, then equity redemptions as has been suggested. Otherwise, perhaps use shareholder loans with maturities matching the expected dividend stream. You might run into thin capitalisation constraints, however.
Have to say haven’t come across a 100% equity financed project in quite a while. Ordinarily debt service covenants would be the really limiting factor.