Case Notes/Answers
Financing the Mozal Project, by Benjamin Esty, Fuaad
Qureshi
Discussion Questions:
1. It illustrates the modern form of political risk management through project selection,
structuring, and insurance, and contrasts this approach with the older, financial style of political
risk management whereby sponsors simply increased hurdle rates to ensure sufficient project
returns. This case in particular illustrates the course theme that “structure matters.”
2. It presents an extreme example of political risk in a developing country setting and shows how
organizations like Institutional Investor, the Economist Intelligence Unit, and The PRS Group
attempt to analyze it for prospective investors.
3. It highlights the various roles multilateral development institutions, in general, and the IFC, in
particular, play in financing major projects.
4. It analyzes IFC’s involvement in appraising, structuring, monitoring, and financing projects,
and shows how these activities create value by resolving costly market imperfections including
information, distress, agency, and transactions costs. It also explores the IFC’s performance in
these various activities.
5. It provides a vehicle to raise various social and ethical issues associated with investing in
emerging markets. Questions such as “Does Mozal get enough out of the deal?” or “Are the
sponsors unfairly taking advantage of deeply impoverished people?” can be addressed towards
the end of the class.1
, 5-200-025
REV. MARCH 07, 2002
TEACHING NOTE
Financing the Mozal Project
The case opens with a project team from the International Finance Corporation (IFC)
recommending board approval for a $120 million investment in the Mozal project, a $1.4 billion
aluminum smelter in Mozambique. Four factors make this investment controversial. First, it would
be the IFC’s largest investment in the world and by far its largest investment in Sub-Saharan Africa.
Second, the project was enormous by Mozambican standards—it was not much smaller than the
country’s 1996 gross domestic project (GDP). Third, Mozambique was a very poor country (GDP per
capita of $90) that had only recently emerged from 20 years of civil war. Fourth, many aspects of the
deal remain undetermined such as who was going to provide half the equity needed to finance the
project.
Despite these factors, the sponsors, Alusaf (the aluminum subsidiary of the South African
minerals company, Gencor) and Industrial Development Corporation of South Africa (IDC is a
development bank), want to structure a limited-recourse deal to finance the smelter; it will be non-
recourse to the sponsors after completion. Commercial bankers have refused to participate unless the
International Finance Corporation gets involved in the deal and so the sponsors have approached the
IFC about participation. After reviewing the project’s commercial viability and development impact,
the IFC team is recommending the investment. The board must decide at its June 1997 meeting
whether it is the right time and the right project to make such a large investment.
Pedagogical Objectives
This case is part of a module on financing projects in the elective curriculum course entitled Large
Scale Investment (LSI) and is one of the great success stories in the course. In contrast to many of the
projects studied in the course (e.g. Iridium, EuroDisney, Petrozuata, etc), this one has a happy, and
financially successful, ending. The fact that the sponsors finished the project on time and under
budget in a country like Mozambique, a country totally lacking in infrastructure, is absolutely
incredible. Mozambique, however, also appears to have benefited greatly, though this point is open
for debate. The country got not only direct benefits in the form cash flows and an increase in human
capital (10,000 workers got some training), it also got indirect benefits in the form of a new
investment climate. The sponsors have recently announced they are proceeding with a $1 billion
expansion project. In addition, companies have announced plans to invest up to $4 billion in other
projects.
,200-025 Teaching Note—Financing the Mozal Project
The case was designed for MBA students and executives with either a financial or strategic
interest in emerging-market investments. For this reason, it is appropriate for business/government,
strategy, international business, and finance courses. As background reading, the instructor may
want to assign The Aluminum Industry in 1994 (HBS #799-129) or Aluminum Smelting in South
Africa: Alusaf’s Hillside Project (case HBS #799-130, teaching note HBS #700-014; Alusaf is also a
sponsor for the Mozal project).
The case has five pedagogical objectives:
1. It illustrates the modern form of political risk management through project selection,
structuring, and insurance, and contrasts this approach with the older, financial style of
political risk management whereby sponsors simply increased hurdle rates to ensure
sufficient project returns. This case in particular illustrates the course theme that “structure
matters.”
2. It presents an extreme example of political risk in a developing country setting and shows
how organizations like Institutional Investor, the Economist Intelligence Unit, and The PRS
Group attempt to analyze it for prospective investors.
3. It highlights the various roles multilateral development institutions, in general, and the IFC, in
particular, play in financing major projects.
4. It analyzes IFC’s involvement in appraising, structuring, monitoring, and financing projects,
and shows how these activities create value by resolving costly market imperfections
including information, distress, agency, and transactions costs. It also explores the IFC’s
performance in these various activities.
5. It provides a vehicle to raise various social and ethical issues associated with investing in
emerging markets. Questions such as “Does Mozal get enough out of the deal?” or “Are the
sponsors unfairly taking advantage of deeply impoverished people?” can be addressed
towards the end of the class.1
Substantive Analysis
Class discussion falls into three main topics: an initial discussion of the project’s risks and returns,
an analysis of sovereign risk and the sponsors’ attempts to mitigate it, and a final discussion on the
IFC’s ability to add value to emerging market investments. The class ends with students assuming
the role of IFC board members deciding whether to approve the recommended investment. If there is
time, the instructor can either explain what happened or raise the issue of whether the IFC possesses
a sustainable, competitive advantage.
Analysis of Project Risks and Returns
To introduce and motivate the class, the instructor should show Exhibits TN-1 and Exhibit TN-2.
Exhibit TN-1, a map of Southern African, will familiarize students with the setting. In addition to
showing the Zambezi River, it shows the proximity of Maputo, the proposed plant site, to South
Africa. Exhibit TN-2 motivates the class by presenting a list of 45 high-risk countries based on
1 See also The Chad-Cameroon Petroleum Development and Pipeline Project (A), HBS case #: 202-010.
2
, Teaching Note—Financing the Mozal Project 200-025
Institutional Investor ratings (lower ratings signify higher risk; countries with ratings under 25 are
considered “high” risk).2 These 45 high-risk countries represent 15% of the world’s population, but
account for only 2-3% of the world’s GNP (note several countries have missing GNP figures). Most
studies of economic development, though plagued by the econometric problem of endogeneity, find
that infrastructure investment is associated with one-for-one percentage increases in gross domestic
product (GDP).3 The question is, who is going to invest in these high-risk countries? Will the private
sector invest on its own? From this general question, the instructor can lead to the more specific
question, should Gencor/Alusaf should invest in the Mozal project, which will lead to a discussion of
the project’s risks and expected returns. Discussion will invariably migrate to the topic of sovereign
risk which provides a natural segue into the second section of the class or risk management.
Project Returns
Students should use Exhibit 6 to calculate the project’s internal rate of return (IRR). Because this
case is in a module on financing large projects, I have intentionally omitted information needed to
complete a full discounted cash flow analysis. Instead, the goal is to get a rough idea of the project’s
returns based on its IRR. Given the information in Exhibit 6, students will be able to calculate an IRR
for the combined equity and subordinated debt investment. Given the “quasi-equity” nature of the
subordinated debt, and the large overlap in the providers of equity and subordinated debt, I treat the
combination as an equity investment for the purposes of this analysis. According to Exhibit TN-3,
the IRR is 7.2% for cash flows through 2012 (the last year with numbers in Exhibit 6) and 12.0% over
the project’s 25-year life (assuming constant cash flows after 2012)—students may forget that the
project extends beyond 2012. While a 12% IRR may, at first, appear low, especially for a project with
a debt-to-total capital ratio of 50%, it is a real rate of return.
Students can evaluate the IRR using the supplementary information in the assignment questions.
Exhibit TN-3 shows an estimate for the real required rate of return using the Capital Asset Pricing
Model (CAPM) and the following assumptions: a real risk free rate of 3.57% (the yield on the 10-year
Inflation Indexed Treasury Bond), an asset beta of 0.78, an equity risk premium of 5.0% (the long-run
risk premium of 7.5% would obviously increase the required return), and a maximum leverage ratio
of 50%.
RMozal = RF + βE * (risk premium) = 3.57% + (1.56 * 5%) = 11.4%
βE = βA*(V/E) = (0.78)(1/0.50) = 1.56
The real required return ranges from 7.5% to 11.4% (it falls as leverage falls), which is below the
calculated IRR of 12.0%. Students may argue that a processing plant with supply and off-take
agreements is less risky than an integrated aluminum company like Alcoa. As a result, Mozal’s asset
beta and, therefore, the sponsors’ required returns, should be lower. Obviously, if one analyzed the
equity investment alone (i.e. treated the subordinated debt/quasi-equity as debt), the peak leverage
would increase from 50% to 61% and the required returns would increase commensurately.
Alternatively, students may follow practitioner recommendations for calculating discount rates in
emerging markets by adding the Brady Bond spread to the required return (see Godfrey and
2 Institutional Investor country risk ratings are based on a survey of 75-100 international bankers who are asked to grade each
country on a scale of 1 (greatest chance of default) to 100 (least chance of default). Results are published twice per year in
March and September. In March 1997, the magazine rated 135 countries with an average rating of 41.0. The survey excludes
many developing countries including most of Eastern Europe.
3 The World Bank (1994), pp. 2-4 and 13-16.
3
Financing the Mozal Project, by Benjamin Esty, Fuaad
Qureshi
Discussion Questions:
1. It illustrates the modern form of political risk management through project selection,
structuring, and insurance, and contrasts this approach with the older, financial style of political
risk management whereby sponsors simply increased hurdle rates to ensure sufficient project
returns. This case in particular illustrates the course theme that “structure matters.”
2. It presents an extreme example of political risk in a developing country setting and shows how
organizations like Institutional Investor, the Economist Intelligence Unit, and The PRS Group
attempt to analyze it for prospective investors.
3. It highlights the various roles multilateral development institutions, in general, and the IFC, in
particular, play in financing major projects.
4. It analyzes IFC’s involvement in appraising, structuring, monitoring, and financing projects,
and shows how these activities create value by resolving costly market imperfections including
information, distress, agency, and transactions costs. It also explores the IFC’s performance in
these various activities.
5. It provides a vehicle to raise various social and ethical issues associated with investing in
emerging markets. Questions such as “Does Mozal get enough out of the deal?” or “Are the
sponsors unfairly taking advantage of deeply impoverished people?” can be addressed towards
the end of the class.1
, 5-200-025
REV. MARCH 07, 2002
TEACHING NOTE
Financing the Mozal Project
The case opens with a project team from the International Finance Corporation (IFC)
recommending board approval for a $120 million investment in the Mozal project, a $1.4 billion
aluminum smelter in Mozambique. Four factors make this investment controversial. First, it would
be the IFC’s largest investment in the world and by far its largest investment in Sub-Saharan Africa.
Second, the project was enormous by Mozambican standards—it was not much smaller than the
country’s 1996 gross domestic project (GDP). Third, Mozambique was a very poor country (GDP per
capita of $90) that had only recently emerged from 20 years of civil war. Fourth, many aspects of the
deal remain undetermined such as who was going to provide half the equity needed to finance the
project.
Despite these factors, the sponsors, Alusaf (the aluminum subsidiary of the South African
minerals company, Gencor) and Industrial Development Corporation of South Africa (IDC is a
development bank), want to structure a limited-recourse deal to finance the smelter; it will be non-
recourse to the sponsors after completion. Commercial bankers have refused to participate unless the
International Finance Corporation gets involved in the deal and so the sponsors have approached the
IFC about participation. After reviewing the project’s commercial viability and development impact,
the IFC team is recommending the investment. The board must decide at its June 1997 meeting
whether it is the right time and the right project to make such a large investment.
Pedagogical Objectives
This case is part of a module on financing projects in the elective curriculum course entitled Large
Scale Investment (LSI) and is one of the great success stories in the course. In contrast to many of the
projects studied in the course (e.g. Iridium, EuroDisney, Petrozuata, etc), this one has a happy, and
financially successful, ending. The fact that the sponsors finished the project on time and under
budget in a country like Mozambique, a country totally lacking in infrastructure, is absolutely
incredible. Mozambique, however, also appears to have benefited greatly, though this point is open
for debate. The country got not only direct benefits in the form cash flows and an increase in human
capital (10,000 workers got some training), it also got indirect benefits in the form of a new
investment climate. The sponsors have recently announced they are proceeding with a $1 billion
expansion project. In addition, companies have announced plans to invest up to $4 billion in other
projects.
,200-025 Teaching Note—Financing the Mozal Project
The case was designed for MBA students and executives with either a financial or strategic
interest in emerging-market investments. For this reason, it is appropriate for business/government,
strategy, international business, and finance courses. As background reading, the instructor may
want to assign The Aluminum Industry in 1994 (HBS #799-129) or Aluminum Smelting in South
Africa: Alusaf’s Hillside Project (case HBS #799-130, teaching note HBS #700-014; Alusaf is also a
sponsor for the Mozal project).
The case has five pedagogical objectives:
1. It illustrates the modern form of political risk management through project selection,
structuring, and insurance, and contrasts this approach with the older, financial style of
political risk management whereby sponsors simply increased hurdle rates to ensure
sufficient project returns. This case in particular illustrates the course theme that “structure
matters.”
2. It presents an extreme example of political risk in a developing country setting and shows
how organizations like Institutional Investor, the Economist Intelligence Unit, and The PRS
Group attempt to analyze it for prospective investors.
3. It highlights the various roles multilateral development institutions, in general, and the IFC, in
particular, play in financing major projects.
4. It analyzes IFC’s involvement in appraising, structuring, monitoring, and financing projects,
and shows how these activities create value by resolving costly market imperfections
including information, distress, agency, and transactions costs. It also explores the IFC’s
performance in these various activities.
5. It provides a vehicle to raise various social and ethical issues associated with investing in
emerging markets. Questions such as “Does Mozal get enough out of the deal?” or “Are the
sponsors unfairly taking advantage of deeply impoverished people?” can be addressed
towards the end of the class.1
Substantive Analysis
Class discussion falls into three main topics: an initial discussion of the project’s risks and returns,
an analysis of sovereign risk and the sponsors’ attempts to mitigate it, and a final discussion on the
IFC’s ability to add value to emerging market investments. The class ends with students assuming
the role of IFC board members deciding whether to approve the recommended investment. If there is
time, the instructor can either explain what happened or raise the issue of whether the IFC possesses
a sustainable, competitive advantage.
Analysis of Project Risks and Returns
To introduce and motivate the class, the instructor should show Exhibits TN-1 and Exhibit TN-2.
Exhibit TN-1, a map of Southern African, will familiarize students with the setting. In addition to
showing the Zambezi River, it shows the proximity of Maputo, the proposed plant site, to South
Africa. Exhibit TN-2 motivates the class by presenting a list of 45 high-risk countries based on
1 See also The Chad-Cameroon Petroleum Development and Pipeline Project (A), HBS case #: 202-010.
2
, Teaching Note—Financing the Mozal Project 200-025
Institutional Investor ratings (lower ratings signify higher risk; countries with ratings under 25 are
considered “high” risk).2 These 45 high-risk countries represent 15% of the world’s population, but
account for only 2-3% of the world’s GNP (note several countries have missing GNP figures). Most
studies of economic development, though plagued by the econometric problem of endogeneity, find
that infrastructure investment is associated with one-for-one percentage increases in gross domestic
product (GDP).3 The question is, who is going to invest in these high-risk countries? Will the private
sector invest on its own? From this general question, the instructor can lead to the more specific
question, should Gencor/Alusaf should invest in the Mozal project, which will lead to a discussion of
the project’s risks and expected returns. Discussion will invariably migrate to the topic of sovereign
risk which provides a natural segue into the second section of the class or risk management.
Project Returns
Students should use Exhibit 6 to calculate the project’s internal rate of return (IRR). Because this
case is in a module on financing large projects, I have intentionally omitted information needed to
complete a full discounted cash flow analysis. Instead, the goal is to get a rough idea of the project’s
returns based on its IRR. Given the information in Exhibit 6, students will be able to calculate an IRR
for the combined equity and subordinated debt investment. Given the “quasi-equity” nature of the
subordinated debt, and the large overlap in the providers of equity and subordinated debt, I treat the
combination as an equity investment for the purposes of this analysis. According to Exhibit TN-3,
the IRR is 7.2% for cash flows through 2012 (the last year with numbers in Exhibit 6) and 12.0% over
the project’s 25-year life (assuming constant cash flows after 2012)—students may forget that the
project extends beyond 2012. While a 12% IRR may, at first, appear low, especially for a project with
a debt-to-total capital ratio of 50%, it is a real rate of return.
Students can evaluate the IRR using the supplementary information in the assignment questions.
Exhibit TN-3 shows an estimate for the real required rate of return using the Capital Asset Pricing
Model (CAPM) and the following assumptions: a real risk free rate of 3.57% (the yield on the 10-year
Inflation Indexed Treasury Bond), an asset beta of 0.78, an equity risk premium of 5.0% (the long-run
risk premium of 7.5% would obviously increase the required return), and a maximum leverage ratio
of 50%.
RMozal = RF + βE * (risk premium) = 3.57% + (1.56 * 5%) = 11.4%
βE = βA*(V/E) = (0.78)(1/0.50) = 1.56
The real required return ranges from 7.5% to 11.4% (it falls as leverage falls), which is below the
calculated IRR of 12.0%. Students may argue that a processing plant with supply and off-take
agreements is less risky than an integrated aluminum company like Alcoa. As a result, Mozal’s asset
beta and, therefore, the sponsors’ required returns, should be lower. Obviously, if one analyzed the
equity investment alone (i.e. treated the subordinated debt/quasi-equity as debt), the peak leverage
would increase from 50% to 61% and the required returns would increase commensurately.
Alternatively, students may follow practitioner recommendations for calculating discount rates in
emerging markets by adding the Brady Bond spread to the required return (see Godfrey and
2 Institutional Investor country risk ratings are based on a survey of 75-100 international bankers who are asked to grade each
country on a scale of 1 (greatest chance of default) to 100 (least chance of default). Results are published twice per year in
March and September. In March 1997, the magazine rated 135 countries with an average rating of 41.0. The survey excludes
many developing countries including most of Eastern Europe.
3 The World Bank (1994), pp. 2-4 and 13-16.
3
