W10_AI_Minimum Attractive Rate of Return (MARR) for Offshore Regasification Project in Indonesia using AHP

  1. Problem Definition

Related to the investment rule in company, they are using single hurdle rate for all project. In this blog, the appropriate MARR will be developed to find whether 10% is an appropriate rate. MARR calculation will be using Analytical Hierarchy Process (AHP) to determine range of project risk covers activity, technology type and demand (project location). Hence as the result, we can find the highest and lowest MARR for offshore regasification project.

  1. Identify the Possible Alternative
  • Estimating the Hurdle Rate

A company will invest to a project or execute a project which gives grater expected return than company cost of capital or WACC. WACC formula:

While the cost of equity is calculated by using CAPM formula:

  • Develop offshore regasification project risk

To cover all the MARR offshore regasification project scheme, there are 3 categories to be analyze which are:

  • Activity: Development and EPC
  • Technology Type: Floating Storage Regasification Unit (FSRU), Floating Storage Unit (FSU) – Floating Regas Unit (FRU), Floating Storage Unit (FSU) – Jetty
  • Demand: Sumatera Island, Java Island, Kalimantan Island, Sulawesi Island, Papua Island

 

  1. Development of The Outcome for Alternative
  • Estimating the Hurdle Rate
Item Value Source
Risk Free Rate 2.16 Damodaran 2017
Market Risk Premium 9.01 Damodaran 2017
Beta 1.07 Yahoo finance
% Debt 0.18 Public Financial Report
% Equity 0.82 Public Financial Report
After Tax Cost of Debt 4.4  

 

CAPM = 1.07 x 9.01 + 2.16
  = 11.8%

 

WACC = (0.18 x 4.4) + (0.82 x 11.8)
  = 10.47 %

 

 

  • Develop offshore regasification project risk

To purpose is to determine range of project risk based on activity, technology type and demand.

Picture 1. Hierarchical Tree

  1. Selection Criteria

Refer to Hierarchical Tree above, next step is to synthesize the relative ranking for each sub criterion using Analytical Hierarchy Process (AHP).

Table 1. The relative score

Based on the table above, hence the relative score result for each sub criterion as follow:

Table 2. Pairwise comparison matrix of offshore regasification project

Table 3. Project risk matrix algebra

  1. Analysis & Comparison of Alternative

Based on the table 3 above, the hierarchical tree with matrix rank result, as follow:

Picture 2. Matrix rank result

Refer to picture 2 above, the risk for each category will be scoring.

Table 4. Project Risk Scoring

The riskiest of offshore regasification project is EPC FSRU to supply Papua island with 8.35% and the least risky is Development FRU-Jetty to supply Kalimantan island with 0.91%.

  1. Selection of the Preferred Alternative

The MARR for offshore regasification project in Indonesia can be calculated by adding that risk scoring and country risk with formula:

WACC + Risk Scoring + Country Risk

MAX : 10.47% + 8.35% + 3.3% = 22.12%
MIN : 10.47% + 0.91% + 3.3% = 14.68%

The appropriate MARR for offshore regasification project in Indonesia should be around 14.68% to 22.12%.

  1. Performance Monitoring and The Post Evaluation of Result

To get more accurate WACC, the calculation and country risk data should be updating periodically. Project risk scoring will be updated due to change of Indonesia political and economic condition.

References:

  1. Liana, L. (2012). Using Analytical Hierarchy Process to Determine Appropriate Minimum Attractive Rate of Return for Oil and Gas Project in Indonesia
  2. Nunug, O.A. (2017). W12_OAN_Car Selection using AHP

Retrieved from

https://emeraldaace2017.com/2017/11/05/w12_oan_car-selection-using-ahp/

  1. Setyo, U.D. (2017). W9_UDS_Evaluation in Choosing Best Supply Pattern Part 2

Retrieved from

https://emeraldaace2017.com/2017/09/23/w9_uds_-evaluation-in-choosing-best-supply-pattern-part-2/

 

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