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Value for Money for Public-Private Partnerships: A Primer

September 11, 2012

For review by P3 Evaluation Toolkit Beta-Testers

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Chapter 4 - Life-Cycle Costs and Financing Costs

What Are Life-Cycle Costs?

The VfM process establishes, for each procurement approach, an overall cost estimate for the sum of all project elements (including costs of risks) anticipated throughout a project's life. This means accounting for not only a project's construction or capital expenditures (known as "CapEx"), but also the costs associated with operating and maintaining it (known as "OpEx") for the next 30 years or more, depending on the term of the concession. Costs for project development (including procurement costs) are also included. The sum of these costs is referred to as a project's life-cycle cost.

VfM processes establish a consistent methodology that seeks to identify as well as estimate all of the life-cycle costs for both public sector and P3 procurement options. Table 4-1 lists a few items that are included in the project's life cycle cost analysis.

Table 4-1. Life Cycle Costs
Cost Item Description
Capital Costs Referred to as the Capex, it includes costs for development of the project, including planning, environmental documents, design and procurement, right-of-way purchase and construction costs. These costs are incurred in the first few years of a P3 concession period (or term of the contract).
Operations Costs Day-to-day costs of operating the project such as snow and ice removal.
Maintenance Costs Items such as replacement of lighting.
Reconstruction and Rehabilitation Items such as bridge or pavement replacement, also known as heavy maintenance, which are included as Capex.
Overhead Costs Items such as administrative costs, office space, supplies, employee salaries, etc.

FHWA's Major Projects Cost Estimation Guidance provides guidance in developing capital cost estimates. Though the capital cost of a new road project certainly attracts focus, a project's life-cycle cost is a superior measure of true cost. New projects in the transportation sector are characterized not only by large-scale capital costs, but by a variety of other expenses. These other expenses can be difficult to fully understand or quantify with certainty.

Impact of Innovation on Life-Cycle Costs for a P3 Option

Assuming the same base costs under the PSC and the Shadow Bid may lead to a conservative assumption of the value for money under the P3 option, because it assumes that the private-sector party does not introduce any value-added innovations to reduce costs. Such innovations can occur when the responsibilities for design, construction, financing and maintenance are assumed by a single party, who will then optimize the trade-offs that are available between these different project cost elements. This is not possible in the case of a traditionally delivered project. However, sufficient empirical data regarding the probability and magnitude of such innovations will be needed to factor in the impact of these innovations. Unless such data is available, VfM analyses will generally assume that there are no cost reductions due to efficiencies or innovations.

Financing Costs

Financing costs are the costs associated with arranging financing for a project, with debt and equity for a P3 option, and generally with bonds for a traditional procurement. It can include items such as arrangement fees, commitment fees, and "swap" credit premiums. The processes of arranging financing and servicing the debt over the loan period represents significant costs which will be incurred as part of the investment in transportation infrastructure. These costs are incorporated into the PSC and the Shadow Bid as cash flows separately from the types of life-cycle costs discussed above.

Debt financing is obtained either through bank debt or bonds in a typical P3. When bank debt financing is used, a lender approves the maximum amount of debt for a project, and draw-downs occur through the construction period until this maximum is reached. Interest is accrued periodically on the outstanding balance as the debt is drawn down through the construction period, with a commitment fee applied to the unused portion. When construction is complete and the public agency begins payments to the private partner (or when tolling begins), the debt is repaid via fixed payments of principal and interest.

Alternatively, when bond financing is used, the full amount of the required funds is raised up front and interest starts accruing right away. To lower overall carrying costs of bonds, the public or private entity may borrow several "tranches" of debt (i.e., portions of the full amount of debt needed) over the construction period. The repayment of bonds is similar to bank debt financing, as fixed payments of principal and interest are paid after project construction is complete.

Equity providers structure their investments to be as efficient as possible. In addition to conventional equity investment, an efficient structure may also include a letter of credit or a "bridge" loan as a means of financing construction. (A bridge loan is interim financing until permanent financing can be obtained. Money from the new financing is generally used to "take out" (i.e. to pay back) the bridge loan). Payments to equity holders are not constant, with the Shadow Bid allowing for a minimum equity return to be specified. This required equity return becomes the cost of equity to the project and is the internal rate of return (IRR) to the equity investor.


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