Case Study - Calpine

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OMB 2 – Calpine, How should Calpine finance its high-growth strategy?

In the case in question we are dealing with a power company that is planning a growth strategy. The main focus of this paper is to choose the optimal financing. The managers Kelly and Crabtree are discussing which one of the following funding strategies that would be optimal to reach Calpine’s growth strategy. The 3 options are project financing, corporate financing and a hybrid of the two. Each funding strategy has its pros and cons, which we will use to determine the best strategy. Project Finance

In general project financing seems as a bad choice. Firstly, there is a size-limitation in the bank-loan market along with difficulties in finding sufficient lenders. This creates inflexibility with regard to treating the 4 plants as a power system. An additional drawback of project financing in this particular case is that it is very time-consuming to lock down all the deals connected to growth plan, which is quite costly. Another drawback is that whether the lenders insist on rapid repayment or a big balloon payment Calpine will suffer. Calpine would either face a reduction in the internal rate of return or exposure towards refinancing risk at the end of the loan term. These cons outweigh the usual benefits of project financing (e.g non-recourse debt) and thus project financing is not a good funding strategy for Calpine. Corporate Finance

Corporate financing also has its pitfalls in terms of funding. The main concern is not being able gathering sufficient funds because the high-yield market is thinner and more volatile than the investment grade market. However, if Calpine manages to get enough funding the debt rating might be jeopardized because of the large debt issue. In order to avoid this Calpine should issue additional equity. Another problem with corporate financing is the cost of negative arbitrage. This is created through the difference between the paid long-term interest rate and the...
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