FIN3CSF Case Studies In Finance

Dear Transurban Limited Board of Directors,

We thank you for employing the services of the Henry & Associates Corporate Advisory team to conduct the modelling and analysis of the West Gate Tunnel Project and to prepare the business case proposal for submission to the Victorian State Government.

Scope of the Project and Report

The West Gate Tunnel Project involves the following aspects:

• Construction of road tunnels and associated above-ground linkage roads and a new bridge crossing of the Maribyrnong River to take vehicle traffic from the existing West Gate Freeway to Footscray Road and the City Link road network feeding North-West exit routes from Melbourne
• Construction of a dedicated new tunnel / road from the West Gate Freeway to connect to the Port of Melbourne and widening of the existing West Gate Freeway by four lanes (two lanes in each direction).
• Operation and tolling of the above tunnel and road infrastructure for a 30-year period from 2022 to 2051 after which time the tunnel and road infrastructure will revert to Victorian State Government ownership and operation
• A proposed 10-year extension of the tolling of the City Link road network from the current expiry date of January 14^th 2035 through to January 13^th 2045

This Report will provide the following content:

• Summary of the project capital budgeting outcomes based on the project spreadsheet model development
• Provision of quantitative and qualitative risk assessment of project outcomes and feasibility
• An overall recommendation of project feasibility and important associated considerations
• A draft business case proposal prepared for submission to the Victorian State Government to seek approval and funding support for the project

This report should be reviewed in association with the project spreadsheet model we have developed incorporating the cash flows and investment evaluation outcomes associated with the West Gate Tunnel Project. Note that the spreadsheet file provided includes both real and nominal terms model outcomes and, while the nominal terms model specification is more representative of realised cash flows during the life of the project, the capital budgeting conclusions and feasibility decision are equivalent across the two model specifications.

Summary of Capital Budgeting Outcomes

Our project modelling and analysis has arrived at the following capital budgeting outcomes for the West Gate Tunnel Project:

Technique	Outcome	Quantitative Feasibility Signal
Net present value (NPV)	$406,356,299	Feasible (NPV > $0)
Internal rate of return (IRR) (in real terms)	8.27%	Feasible (IRR > 7.51% hurdle rate)
Profitability index (PI)	1.0972	Feasible (PI > 1.0000)
Undiscounted payback period (in nominal terms)	15.6301 years	Feasibility subject to your cash flow   recovery requirement
Discounted payback period	27.2637 years	Feasibility subject to your cash flow recovery requirement

Key spreadsheet model outcomes (in nominal terms):

• Total project revenue = $40,896,260,465 (Discounted value = $6,520,951,974)
• City Link toll extension revenue = $10,938,762,043 (Discounted value = $1,277,810,532)
• Total project Operating costs = $2,654,890,371 (Discounted value = $447,797,180)
• Total corporate tax expense: $9,822,411,028 (Discounted value = $1,485,492,586)

Our advice based on the above outcomes is that the project is clearly feasible on quantitative grounds and will create value and provide a return exceeding the project’s estimated cost of capital. Note that the contribution of the additional tolling on the City Link road network is a key element in driving the value creation of the overall project, so this will be an important negotiation requirement in discussions with the Victorian Government.

Project Risk Assessment

To provide some broader perspective on the underlying risk profile of the project, we have undertaken some detailed quantitative risk assessment of possible project outcomes relative to our base case modelling and identified a number of critical other considerations that we believe you should incorporate into your final project decision-making. The quantitative risk assessment will involve both detailed sensitivity analysis and well as the modelling of some plausible scenario outcomes associated with the project.

Sensitivity analysis

The table below summarises the sensitivity analysis results for important parameters associated with the project:

Parameter	Change	% Δ in Parameter	Revised NPV	% Δ in NPV
Discount rate	+0.50%	+6.66%	$131,764,330.9	-67.57%
	-0.50%	-6.66%	$715,516,673.2	+76.08%

Toll charge	+6.66%	+6.66%	$650,791,553.2	+60.15%
	-6.66%	-6.66%	$161,921,045.2	-60.15%
Traffic volume	+6.66%	+6.66%	$650,791,553.2	+60.15%
	-6.66%	-6.66%	$161,921,045.2	-60.15%
Operating costs	+6.66%	+6.66%	$385,479,994.7	-5.14%
	-6.66%	-6.66%	$427,232,603.7	+5.14%
Construction costs	+6.66%	+6.66%	$150,289,152.2	-63.02%
	-6.66%	-6.66%	$662,423,446.2	+63.02%
Taxation rate	+1.998%	+6.66%	$307,422,493.0	-24.35%
	-1.998%	-6.66%	$505,290,105.4	+24.35%

Conclusions from the sensitivity analysis:

• Project cash flow and financing risk (discount rate) is the most sensitive parameter to project outcomes
• The project is also highly sensitive to construction cost management, so meeting project delivery on time and budget will be important to project
• Changes in toll charges and traffic usage of the road and tunnel network have equivalent large impacts on project outcome, although the likely ability to influence traffic volume is greater than toll charges which we expect will be legislatively controlled.
• The project is relatively insensitive to variation in operating costs consistent with these being forecast to be small relative to toll revenue. Movements on corporate tax rates do, however, have a quite substantial impact on project NPV projections, although the current Federal Government taxation policy reform agenda appears to be focused on lowering the corporate tax rate over the longer-term so we only expect a positive sensitivity in relation to the corporate tax

Scenario Analysis (This just uses the scenario examples shown in Lecture 3)

We also model a number of scenarios that we think are useful to aid in your wider decision- making relating to the undertaking or otherwise of the project. These are as follows:

• Optimal operating conditions outcome
• Represented by: 5% increase in traffic volume, 0.20% decrease in discount rate, 5% decrease in operating costs
• Revised NPV = $907,893,941.2 (% change in NPV = 123.42%)
• Worst case operating conditions outcome
• Represented by: 5% increase in construction costs, 5% decrease in traffic volume, 10% increase in operating costs
• Revised NPV = -$742,056.7 (% change in NPV = -100.18%)
• Business and public sentiment scenario
• Represented by: reduced car (45%) and motorcycle (4%) usage share and increased transportation vehicle (LCV (23%) and HCV (18%)) usage share
• Revised NPV = $584,756,408.5 (% change in NPV = 43.90%)

The overall conclusions from the quantitative risk assessment are:

• There is a significant level of risk perceived with the project evidenced by both the large variations in project NPV from potential changes in a range of project parameters and the worst-case scenario for the operating outcomes of the project resulting in a negative project
• The business and public sentiment scenario suggests that it would be beneficial for the operator to cultivate relationships with the logistics sector and major transportation operators, possibly including the provision of incentives, whose increased patronage will provide substantial valuation

Qualitative Risk Assessment

We have analysed the broader transportation network and policy environment in Melbourne and we believe that there are a number of important qualitative considerations that you should also factor into your final decision-making regarding the West Gate Tunnel Project, as follows:

• Recently updated transportation project priorities released by Infrastructure Victoria lists the previously proposed East West Link road and tunnel project linking current Western and Eastern Melbourne road networks still as a high priority project. If there is a change in State Government or a revision in transportation policy then the subsequent completion of a project similar to the East West Link proposal would potentially have major traffic volume implications for the West Gate Tunnel
• We expect there to be significant public opposition to the West Gate Tunnel project on environmental grounds, and particularly from residents and businesses in the Western Suburbs local councils of Melbourne. This is expected to be related to the proposed tunnelling activities and potential impact this will have on ground stability and animal habitat, aesthetic concerns with the construction of new roads and bridges and the potential for increase air pollution in the Western Suburbs due to increased vehicle usage on the West Gate Tunnel road
• Broader climate change considerations are also potentially relevant and State or Federal Government policy initiatives associated with road usage pricing to aid in meeting emissions targets could also impact on the forecast traffic volumes associated with the West Gate Tunnel

Our sensitivity modelling indicates that the project will still be financially feasible with a moderate reduction in traffic volume, so this tempers some of these qualitative concerns. We would also recommend that the operator considers potential additional community investment in green spaces, aesthetic and screening additions to road and bridge components

of the network and conducting of a public awareness and consultation campaign to engage with stakeholders impacted by the proposed project.

Overall Project Recommendation

Based on the analysis conducted and the content of this report our overall conclusions are as follows:

• The project appears to be quantitatively feasible and should create value for Transurban Limited assuming our project projections are accurate. This is based on the large positive NPV of over $406 million, a 76% excess return above the project hurdle rate and a per

$1.00 invested discounted return nearing $1.10.

• The quantitative risk assessment does indicate relatively high variability in potential project outcomes and the potential for a negative outcome in a worst-case setting, however, on balance we predict based on our modelling that there is a very low probability that the project will not be profitable.
• There are some qualitative concerns particularly related to future Government policy decisions, however, these are difficult to predict with any degree of certainty and given the nature of political election cycles and long-term planning associated with infrastructure investment and funding decisions we don’t see any policy impediments for the West Gate Tunnel Project for at least the next decade after
• Other important aspects include the key contractual negotiation requirement associated with extending tolling on your City Link toll road network, clear and transparent engagement with the local community and businesses, and we also see potential positive externalities for the City Link project if the West Gate Tunnel Project is delivered
• Overall, our firm’s recommendation for the project is: ACCEPT.

West Gate Tunnel Project – Business Case Proposal

December 31^st 2016

For Attention of: Mr Daniel Andrews (Victorian State Government Premier) and Mr Luke Donnellan (Victorian State Government Minister for Roads)

Dear Honourable Premier Andrews and Minister Donnellan,

We present this Business Case with the supporting Project Assessment Report to seek your approval for Transurban Limited to construct and operate the West Gate Tunnel Project. We support your views and those of Infrastructure Victoria that this project is the centrepiece in resolving the transportation movement and congestion problems increasingly prevalent on the West Gate Freeway and West Gate Bridge and also through the Western Suburbs as the major commuter route to the Port of Melbourne. As you know, we have significant experience in major road and tunnel construction and toll road operation with the City Link road network in Melbourne and similar road projects in other states around Australia, so we are confident that we can deliver this project on time and budget to contribute significantly to Victorian Government policy objectives associated with traffic improvement in Melbourne. The projected benefits of the West Gate Tunnel Project and our role in managing the delivery of the project are as follows:

• The West Gate Tunnel Project will remove up to 20,000 vehicles, including 6,000 trucks and heavy-haulage vehicles, from using the West Gate Bridge and feeder roads close to the Melbourne CBD. This will significantly improve logistic vehicle access to the Port of Melbourne and enhance transportation routes to Northern Melbourne which is the largest growth corridor in Melbourne and also the gateway to major interstate transportation
• This will reduce commuting times from the Western side of Melbourne to the Melbourne CBD and the Port of Melbourne by approximately 20 minutes a day which will equate to billions of dollars in productivity gains for Victorian businesses and productivity and lifestyle benefits for Victorian citizens.
• Transurban Limited is prepared to contribute the large majority of the cost of the project (up to $4 billion of the proposed $5.5 billion construction cost) and to take on the operational risks associated with the project. This will remove a significant political risk that could otherwise impact on public support for the Victorian Labour
• In return, we propose an in-kind offering by the Victorian Government to extend our operational control and tolling privileges on the existing City Link Road network for an additional 10-year period from 2035 to 2045. Both the City Link and West Gate Tunnel networks will then revert to State Government ownership and control in 2045 and 2051, respectively, at no cost.
• During the construction phase of the project there will be the creation of many hundreds of additional construction and contracting jobs and ongoing employment by Transurban

Limited of 100-200 staff for the operation of the West Gate Tunnel network once it opens for use in 2022. This will deliver significant payroll tax income to the Victorian Government as well as increased expenditure within the Melbourne and Victorian communities that will contribute to ongoing GST revenue being directed to the Victorian Government.

• The completion of the project will also significantly enhance the liveability of the Western Suburbs by removing the current road congestion experienced in Yarraville, Newport and Footscray and contribute to an increase in land values which will further contribute additional stamp duty and land tax revenue for the Victorian
• As part of the construction process we commit to employing current best-practice technology in minimising noise and air pollution during the construction phase and also as part of the structural infrastructure supporting the road and bridge parts of the
• We further commit to using a portion of the project value to create new animal habitat and green spaces throughout the Western Suburbs and to contribute sponsorship funding for local community and sporting clubs.

Based on the benefits for the Victorian Government and Victorian businesses and the community outlined in this project business case and our demonstrated success in the delivery and operation of major road and infrastructure projects, we believe we are the most suitable organisation to construct and manage the West Gate Tunnel Project and work with you in delivering this critical project.

We look forward to hearing a positive outcome on our tender proposal.