June 16, 2014
A public agency that is considering delivering a project as a P3 may choose to conduct a VfM analysis to assess the comparative value that different delivery structures may provide. The key stages of a VfM analysis are listed below:
This User Manual demonstrates the comparison between a notional PSC and P3 Estimate, (or "shadow bid") that completes the quantitative VfM process. To determine which procurement structure provides better VfM to the public sponsor, the Financial Assessment Tool compares the Net Present Cost (NPC) of the P3 Estimate (from the Shadow Bid Tool) with the NPC of the PSC (from the PSC Tool). If the P3 Estimate is lower than the PSC's NPC when costs are compared on a like-for-like basis, the P3 delivery option may allow the public sector to realize value through more efficient management of risks and costs. Figure 3 below, demonstrates how a comparison of discounted, risk-adjusted project costs in the PSC and P3 estimate can be used to quantify value for money in the Financial Assessment Tool.
Figure 3: Quantitative VfM Analysis
Using the Financial Assessment Tool
Users can navigate to the "VfM Analysis" section of the Financial Assessment Tool through the "Tool Index" tab. The purpose of the VfM Analysis section is to allow users to complete the quantitative VfM analysis by comparing the outputs from the PSC Tool and the Shadow Bid Tool to assess which option may provide greater value for money to the public agency. The text below details what steps users may take in each worksheet of the "VfM Analysis" section to complete the quantitative VfM analysis.
The VfM Analysis section compares the outputs from the PSC Tool and the Shadow Bid Tool. These data need to be imported into the Financial Assessment Tool to complete the VfM analysis. The Source Data Sheet enables the user to import data from the PSC and Shadow Bid Tools. Both sets of data are required to populate the remaining sheets in the VfM Analysis section.
Tips for Importing Shadow Bid Cash Flows
The Shadow Bid Tool allows users to calculate Availability Payment, Real Toll and Shadow Toll estimates for P3 project delivery. Each estimate generates unique cash flows in the Shadow Bid Tool. To ensure that the proper cash flow is imported into the VfM Analysis, the user should take the following steps in the Shadow Bid Tool:
- In the Assumptions tab, select the desired delivery method.
- In the VfM Output tab and within the Payment Calculation Analysis, select desired payment analysis output from the drop-down menu. Run the payment calculation.
- Within Table 12 "Toll and Other Revenue," verify that the VfM Revenue payment cash flows are populated with the desired payment analysis.
- After following instructions to import the Shadow Bid cash flows into the Financial Assessment Tool, a user can check that the appropriate cash flow has been imported to perform the VfM analysis.
The "PSC Cash Flow" sheet contains a summary of the project nominal cash flows under the public delivery method. The sheet presents the project costs and then accounts for project revenues, funding and financing, and risks. All values are provided on a nominal basis for the "Example Scenario" and the sheet details the same cost and revenue categories as the "Cash Flow Summary" sheet in the PSC Tool. Together with the "Model VfM_PSC Outputs" table, this sheet is essential for generating several results charts in the Financial Assessment Tool. The project cash flows may also support users seeking further insight into the key cost components of the public delivery structure.
Similar to the "PSC Cash Flow Summary" sheet, this sheet contains values imported from the Shadow Bid Tool (note that the sheet name is a misnomer that cannot be changed without affecting the tool's functionality). Unlike the "PSC Cash Flow Summary," the "VfM Cash Flow" sheet contains two sections:
All values are provided on a nominal basis for the "Example Scenario" and the sheet details the same cost and revenue categories as provided in the Shadow Bid Tool for the public and private entities. Together with the "Model VfM_PSC Outputs" table, this sheet is essential for generating several results charts in the Financial Assessment Tool. The project cash flows may also support users seeking further insight into the key cost components of the private delivery structure.
This table provides a breakdown of the costs and revenues associated with the PSC and the P3 Estimate for comparative purposes. The costs and revenues in the table reflect the P70 results for the PSC and the P3 Estimate in nominal dollars (i.e., total cash flows in current or year of expenditure dollars). Many of the items presented in this table for the P3 Estimate are costs incurred by the private entity in delivering the project. These costs are displayed in detail on the "VfM Cash Flow Summary" sheet. The table also includes the total nominal value of payments to the private partner to illustrate how the costs incurred by the private entity support the payment calculation. Results Chart 5 presents a summary graph of the comparison table (see Figure 10 at the end of this chapter). Each numbered line item of the table is discussed below and the table for the Example Scenario is provided in Figure 4.
Line 1: Baseline Lifecycle Costs
This line provides the nominal costs of designing, constructing, operating and maintaining the facility independent of risk. The PSC Costs column shows these costs for a conventional procurement. The Shadow Bid Costs column shows these costs for a P3 procurement. The Shadow Bid baseline costs may differ from the PSC costs if the user has entered different cost and timing assumptions in the Shadow Bid and PSC tools or if the user has entered cost efficiency assumptions in the Shadow Bid Tool.
Lines 2 and 3: Values of Retained Risks and Transferrable
Lines 2 and 3 show the estimated impacts of risks on project costs under the P70 risk scenario for the PSC and the P3 Estimate. Risk assumptions for the PSC and P3 Estimate may be drawn from results of simulations conducted in the Risk Assessment Tool. Based on the results of the risk assessment the user may have entered different risk values in the PSC than in the Shadow Bid. For example, the user may have assumed that a private partner may be more capable of managing transferrable risks than a public agency and thus entered lower risk values in the Shadow Bid Tool than in the PSC Tool. In the PSC, the retained risk impacts and the transferrable risk impacts count as costs to the public partner. In the Shadow Bid, retained risk impacts count as public costs, but transferrable risks are counted as private partner costs.
Accounting for Toll Revenues and Toll Revenue Risk
In the prepopulated Example Scenario, toll revenue risk is not accounted for in line items 2 and 3. While a toll concession would bear the costs of revenue risk (which are retained by the procuring agency in the PSC and in the availability payment concession model), this risk is not included in the value of transferred risks, because its effect is incorporated in the higher costs for financing for a toll concession in line 8.
For the toll concession model, higher revenue risk will result in lenders and equity investors requiring a risk premium (i.e., a higher rate of return than for the availability payment model). This risk premium further increases finance costs and would be accounted for in lines 5, 6 and 7 in the toll concession option. This increase includes the value of revenue risk taken on by the concessionaire. The toll revenue risk is retained by the public agency in the PSC and availability payment models and should be accounted for under competitive neutrality in line 11.
When modeling an availability payment shadow bid, toll revenue will typically be assumed to be equivalent in the PSC and the Shadow Bid since the public agency would be entirely in control of setting toll rates in both cases. Higher toll revenue may be estimated for a toll concession Shadow Bid, since the private sector may be more aggressive in setting toll rates (within the limits imposed by the P3 agreement) and may seek revenue in innovative ways.
Line 4: Tax Costs
Tax costs calculated for the Shadow Bid reflect assumptions concerning the costs associated with Federal and State corporate income taxes paid by the private partner under a P3 arrangement. While a contractor responsible for delivering a project in a PSC and subcontractors of a concessionaire will also incur taxes it is assumed those costs are incorporated into the baseline costs.
Line 5: Total Debt Costs (Base)
Total debt costs represent the costs of borrowing to finance the design, construction, operation and maintenance of the project independent of risks. They include the costs of borrowing to fund both the construction costs and the interest reserve needed to meet the required debt service coverage ratio associated with the project financing. The total debt costs are equal to the total debt payments minus the total amount borrowed.
Line 6: Risk Impacts on Total Debt Costs
Additional borrowing is required to finance the impacts of risks on project costs. The Risk Impacts on Total Debt Costs represent the additional borrowing costs incurred under a P70 risk scenario. For the PSC, the totals reflect additional borrowing necessary to meet the costs associated with both retained and transferrable construction risks. For the Shadow Bid, the additional borrowing accounts for the impacts of transferrable risks alone.
Line 7: Total Costs of Equity
This line represents the costs of equity as the total amount of cash returned to equity investors in a P3 minus the total equity invested (i.e., cash in-flow from equity investors). Equity returns are calculated based on assumptions in the Shadow Bid Tool related to the portion of the project financed through equity investment and the expected rate of return tied to the equity invested. While technically not a cost to the private partner, they are factored into the calculation of the total payment to the private partner in the Shadow Bid.
Line 8: Total P70 Finance Costs (including equity returns)
This represents the sum of finance and equity costs as calculated in lines 5, 6 and 7.
Line 9: Sub-Total (Total P70 project costs w/o adjustments
This represents the total risk-adjusted, nominal costs associated with the project. For both the PSC and the Shadow Bid it includes the baseline life cycle costs, the retained and transferrable risk impacts, and the total financing costs. The Shadow Bid subtotal also includes any tax costs.
Line 10: Revenues
This line includes any project revenues from either tolls or other sources. In the PSC model, the revenues are retained by the public sector and are subtracted from project costs to calculate the total costs of the project to the public agency. For the Shadow Bid the treatment of revenue depends on the payment model assumed in the Shadow Bid Tool. In an availability payment or shadow toll model, the revenues are subtracted from the total payments to the private partner to calculate the total nominal costs of the project. In a real toll model, the revenues are retained by the private partner and are factored into the calculation of payments to the private partner. To ensure that revenues are treated appropriately in the calculation of private partner payments the user should select the appropriate payment model in the dropdown menu to the right of Line 15.
Line 11: Competitive Neutrality
This line includes adjustments to the PSC costs to account for differences in the way the public sector and the private sector treat certain costs and revenues. The adjustments for competitive neutrality are typically positive and are generally added to the PSC costs to account for: (1) the opportunity costs of real estate, sales and corporate taxes that would be paid by the concessionaire to the State or local government under a P3; and (2) toll revenue risk. Since the perspective taken in the VfM analysis is that of a State government sponsor, Federal taxes paid by the concessionaire may be ignored, as well as any Federal tax benefits to the concessionaire from depreciation allowances. An alternative way to represent the tax adjustments would be to subtract the concessionaire's tax payments in the Shadow Bid under the competitive neutrality line item.
Line 12: Other Projects Costs
Other project costs include costs to the public sector associated with project development, procurement and oversight that are otherwise not accounted for in the project's design, construction, operations, maintenance and finance costs. Generally, these costs would be similar for both the PSC and the Shadow Bid. Procurement costs may be included in the baseline PSC life cycle cost estimates and care should be taken to avoid double-counting these costs. These costs are added to the Shadow Bid estimates to account for public agency costs for procurement and oversight under the P3 options.
Line 13: External Subsidies
This line accounts for funding provided to the project from sources outside the public agency sponsoring the project (e.g., Federal funding). This funding is subtracted from the costs to the public agency in both the PSC and the Shadow Bid.
Line 14: Total Pre-Payment Net Costs to Private Partner
This line represents the total nominal costs incurred by the private partner in the Shadow Bid model. It includes total risk-adjusted, nominal costs associated with the project including financing costs and equity returns, minus any subsidies or revenues received by the private partner. To ensure that revenues are treated appropriately in calculating the pre-payment net costs to the private partner the user should select the payment model used to calculate results in the Shadow Bid Tool using the drop-down menu to the right of line 15.
Line 15: Total Payments to Private Partner
This line represents the sum of any payments made by the public sponsor agency to the private partner in the Shadow Bid. The Shadow Bid Tool treats payments to the private partner differently depending on the payment model selected. For an availability payment model, payments are made on an annual basis beginning at the end of construction and continuing through the concession term. In a real toll model the payment is made as a lump sum payment upon construction completion. In a shadow toll model, the public agency pays the private partner based on annual facility traffic and established shadow toll rates. The total payments to the private partner should be roughly equal to the total costs to the private partner. They may differ slightly due to the two percent tolerance level set in the Shadow Bid Tool for calculating these payments.
Line 16: Total Adjusted Cost to Public Agency
The total adjusted costs to the public agency include the total payments to the private partner and the cost impacts of retained risks as well as any competitive neutrality adjustments. These costs are offset by any revenues or external subsidies the public agency may receive.
This sheet displays the "NPC Results" data imported from the PSC Tool and Shadow Bid Tool to illustrate a comparison of the PSC and P3 Estimate in NPC terms to identify which delivery method may provide greater value to the public agency. If the user would like to update the scenario, such as changing the discount rate, then it is necessary to first update the underlying PSC Tool or Shadow Bid Tool, save the changes, and re-import the file in the "Source Data" sheet in the Financial Assessment Tool. The tool is not capable of applying different discount rates to cash flows depending on the risk level (i.e., P10, P70 or P90). Users would need to run the tools three times (once for each of three different discount rates) and would need to select results for the discount rate/risk level combination that is appropriate.
Discounted Cash Flow Analysis and Financing Costs
Depending on the level of interest rates and the term of the borrowing, the debt cost shown in lines 5 and 6 (i.e., annual interest payments) can significantly increase a project's overall costs in nominal terms. Since the rates of return required for private debt and equity will generally exceed the public sector's borrowing rate, differences in finance costs may result in large differences in the nominal costs between the PSC and the shadow bid.
In VfM Analysis the costs of financing, which are incurred in throughout the term of the debt, are discounted to calculate the net present costs of the PSC and Shadow Bid. Depending on the discount rate used and the borrowing rates assumed, those costs may even result in negative net present costs. For example, the present value of the debt service on a bond issue discounted at the effective borrowing rate by definition equals the par amount borrowed. Thus, for the PSC, the effective cost of debt financing in present value terms would be near zero and (except for bond issuance costs) is equivalent to paying for the project with cash on hand. If the selected discount rate exceeds the procuring agency's borrowing rate, debt financing costs would have a negative value. For the Shadow Bid, which will typically rely on debt borrowed at higher rates, discounting future cash flows using the public agency's borrowing rate will not negate the costs of financing the project.
The "NPC Results" calculated in the PSC Tool and the Shadow Bid Tool are based on a DCF analysis of the net costs of delivering the project under each delivery method. A DCF involves forecasting all revenues and costs for a project into the future. The streams of cash flows to and from the public agency are discounted to estimate the value of the project in today's dollars. The discount rate is applied to the project cash flows in each period. The Financial Assessment Tool imports the results of the DCF analysis completed in the PSC Tool and the Shadow Bid Tool and presents the results on the "NPC Results" sheet as a side-by-side comparison.
The results are presented as a table as shown in Figure 5. Project costs are summarized in the first section of the table. Any revenues generated by the project, such as toll revenues that are passed to the agency, are reflected in the "Toll and Other Revenue" line and subtracted from the costs to calculate the "Total Payments". Revenues that are retained by the concessionaire would be subtracted from its negative cash flows (i.e., its expenditures) to calculate the payment required by the concessionaire (in addition to toll revenues) to deliver the project.
The NPC is provided for the PSC and P3 Estimate, indicating the cost to the agency of delivering the project under each delivery structure, including:
Value for money is calculated by subtracting the NPC of the P3 Estimate from the NPC of the PSC. The result of this calculation is shown as a dollar value and also as a percentage of the PSC. If this value is positive, then the NPC of delivering the project as a P3 is lower than the NPC of delivering the project by public delivery, indicating that the P3 provides greater value to the public agency. In the prepopulated scenario, the "NPC Results" sheet in the Financial Assessment Tool indicates that the "Example Scenario" is less expensive under the public delivery structure, as the "Notional Value for Money" is negative under the initial project and risk adjusted cash flows.
Often, when the NPV of the PSC is compared with the NPC of the Shadow Bid, a saving may be estimated. The reduced value of risks and life cycle costs and higher toll revenue yield under a toll concession may more than make up for its higher financing and procurement costs, so the net financial savings for the public agency may be positive. In an availability payment model, life cycle cost efficiencies and reductions in risk costs may still exceed the higher financing costs, producing value for money.
The savings to the public agency estimated in a Shadow Bid may be relatively small compared to the total costs of the two procurement options. This is not unusual in quantitative VfM analyses. Qualitative factors are often more important in making the final VfM determination. Together, the quantitative and qualitative assessments typically inform the overall VfM analysis and decisionmaking process. Qualitative factors that should be considered in a pre-procurement VfM assessment may include, for example, earlier project delivery.
Figure 5: VfM Analysis - NPC Results
Reviewing the Results
The Financial Assessment Tool includes five charts to assist the user in understanding and interpreting the results of the VfM analysis. The data provided on the "Model VfM_PSC Output Sheet," "NPC Results," the "PSC Cash Flow Summary," and "VfM Cash flow Summary" sheets form the basis of the charts provided, which include:
Figure 6: Results Chart 1 - VfM Quantitative Analysis
Figure 7: Results Chart 2 - PSC Cash Flow Summary
Figure 8: Results Chart 3 - P3 Cash Flow Summary
Figure 9: Results Chart 4 - Net Cash Flow Comparison
Figure 10: Results Chart 5 - SB PSC Cost Breakdown Comparison