- Briefing Room
Michael Kay: Good afternoon. On behalf of the Federal Highway Administration's Innovative Program Delivery office, I would like to welcome you to today's webinar, a P3 Evaluation Overview. This is the first of our P3-VALUE 2.0 webinars. We're going to be talking about P3 options and overview. My name is Michael Kay. I'm with the U.S. DOT's Volpe Center in Cambridge, Massachusetts. I will be moderating today's webinar as well as facilitating our Q&A periods and helping to address any technical problems. Just quickly to orient everybody to the web room, on the top left-hand side of the screen you'll find the audio call-in information. You are welcome to listen through your computer speakers, however, if you do experience any bandwidth issues the audio may become a little bit choppy and I do recommend dialing in using that toll-free number. Below that you'll see an attendee list. Below that is a materials for download box where you can download a PDF version of today's presentation. Simply click on that file name, click download file, and follow the prompts on your screen. On the bottom left is a chat box that you can use to ask questions of our presenter at any point throughout the webinar. There's also a link there to access the P3-VALUE tool and other related materials. Our webinar is scheduled to run until about 3:30 P.M. Easter Time today. Currently all phones are muted, however, at the appropriate time when we stop for questions you are welcome to press *6 to unmute your line, but please hold off on that for now. In the meantime if you do have questions, again, feel free to use the chat box at any time, and I did want to mention that we are recording today's webinar so that any of your colleagues who are unable to join us today can listen at a later date, and with that I'd like to turn over to our instructor for today, Patrick DeCorla-Souza. Patrick.
Patrick DeCorla-Souza: Thanks, Michael, and welcome everybody to the first of five webinars in this series which is going to introduce you to the new and enhanced tool for P3 evaluation called P3-VALUE 2.0, and we are today going to simply introduce you to the tool. The remaining four webinars will get you a lot deeper into the tool including help you with hands-on use of the tool. So just to introduce myself, my name is Patrick DeCorla-Souza. I'm the P3 program manager in the Center for Innovative Finance Support. I've been there since about seven years. Prior to that I've been in the planning office in the policy office of the operations office, and of course P3 has a lot to do with finance, and I am in the process of learning about finance, just like many of you, and I think in that capacity I will better able to explain all of the intricacies of-- and the jargon related to finance. So, move on to the next slide. P3 stands for public-private partnerships and P3-VALUE 2.0 is a tool that will help you do hands-on analysis of P3 evaluation. This is the first of five webinars, as I said earlier, and we are simply going to introduce you to the tool in this webinar. This is a brief overview of what we're going to cover in this webinar, types of project delivery evaluation, timing of project delivery evaluation, and then the next four are going into the meat of evaluation, which is value for money analysis, project delivery benefit cost analysis, risk evaluation, and financial viability evaluation, and then I will close with a brief overview of FHWA's P3 toolkit. So hopefully at the end of this webinar you will be in a position to explain to others what the different types of P3 evaluation are and their key limitations and challenges, and hopefully also explain to others the types of tools that are available in FHWA's P3 toolkit. So let's start with the type of project delivery evaluation. When you're talking about project evaluation you are simply talking about whether the project is a worthwhile project from the viewpoint of society, that is, is it worth building that project. In project delivery evaluation, however, what you're trying to do is decide which delivery method is the best in order to the deliver the project that you have already determined is worthwhile. Now in order to do this type of evaluation you might first want to decide whether the project is financially viable, because if it's not then you cannot build it. The second question you might ask is what type of delivery would be best. Would a P3 procurement add value relative to conventional delivery or is conventional delivery a better option, and that is again a financial evaluation. Finally you are most likely wanting to know of several P3 options, which type of P3 would be the best. For example you might have a concession as an option and you might have another option being an availability payment concession. So delivery method evaluation will help you get the information you need to help decision makers make that decision. So P3-VALUE tool covers these various types of evaluation. It does financial viability assessment, which will tell you whether the project is affordable to the public agency, and it will also help you do valuation for money analysis, will tell you whether the P3 option is a better financial option than a conventional delivery option. Now, these are financial evaluations and involves simply cash flow analysis, which means that we are simply looking at costs and revenues and not overall benefits to society. If you want to look at benefits to society, which would include, for example, user benefits and externalities, you have to do an economic efficiency evaluation, and so on the right-hand side you see project delivery benefit cost analysis, which is another kind of evaluation that P3-VALUE will let you do. This slide shows you what the difference is between financial evaluation and an economic efficiency evaluation. As I said, in financial evaluation you only look at cash flows, and the important thing is you are looking at cash flows from the perspective of the procuring agency. So you are simply concerned about the balance sheet of the procuring agency. In economic efficiency evaluation, on the other hand, you are looking at the full range of costs and benefits to society, and so the perspective is that of society as a whole.
Patrick DeCorla-Souza: The financial evaluation questions can be of two types. One is the project affordable to the public agency. Will the subsidy required for the project be low enough that the agency can afford it from its budget, and once you determine that the next step is, of course, to find out whether P3 would be a better option than the conventional delivery option.
Patrick DeCorla-Souza: The economic efficiency questions can be posed first at the project level. In other words, to try to determine whether the project provides benefits to society that exceed their costs, and this will tell you whether the project is worthwhile. If the benefits exceed the cost it's worthwhile. On the other hand, you might also want to do economic efficiency evaluation to look at several design alternatives to determine which design would be preferable, and economic efficiency evaluation can also tell you whether the project would be better built today than perhaps postponed a few years. From an economic standpoint it might be better to build it later and that's what economic efficiency analysis can tell you. With regard to project delivery you are trying to decide whether the P3 option will increase benefits, met benefits, to society relative to conventional procurement.
Patrick DeCorla-Souza: So we now have a question for you. Michael, can you open the poll question.
Michael Kay: Absolutely, Patrick. So, we have all the poll questions for today's webinar on the screen. However, the only one that's active is the one at the top left, which is the one we are looking at the moment, and the question is true or false: financial evaluation considers the full range of costs and benefits to society, and let's give everyone about 30 seconds to give that some thought.
Michael Kay: It looks like most everybody has provided a response, so I will go ahead and close that out and post the results. Looks like about 22 percent said true and 78 percent said false. Patrick, do you want to elaborate a little bit?
Patrick DeCorla-Souza: Alright, I guess those who said financial evaluation considers the full range of costs and benefits is true are incorrect because financial evaluation only considers the cash flows of the public agency. It does not consider user benefits, for example, benefits of the facility, externalities such as air pollution, etcetera. Those would be costs and benefits to society as a whole. So economic efficiency evaluation is what you need when you're looking at or attempting to look at the full range of cost and benefits to society, but if you're looking at only at the balance sheet of the public agency and then you can do a financial evaluation
Michael Kay: Great, thanks, Patrick. With that we can come back to the presentation and here's the first point at which we will pause to take questions, and again, feel free to submit those through the chat box, which I can expand for the moment, or press *6 on your phone to unmute yourself. I don't see any questions at the moment. We will have several opportunities throughout the webinar to pause. So I think with that Patrick let's move on to lesson two.
Patrick DeCorla-Souza: Alright, so now we get to timing of project delivery evaluation and this slide shows you the various phases in implementing a project. You start with planning where you might want to do some preliminary screening to see whether P3 might be a better option than conventional delivery. You might then go to the project development phase where you might do more quantitative assessment of a P3 option relative to conventional delivery, and finally in step three, which is procurement, you might again want to do some type of value for money analysis or other types of evaluation to check whether the request for proposals as structured brings you more value than conventional delivery, or when you get the bids from the P3 developers you might then at that time want to check again and see whether the P3 bids offer more benefits than the conventional delivery. So at the first stage, which is at the planning stage when you're looking at screening of projects or simply you're trying to do a high level evaluation to check whether it is even worth doing detailed analysis. So at that point you might look at things such as the characteristics of the project. Does it provide a value proposition? In other words, does it allow for P3 concessionaire to perform the work more efficiently or bring innovation to the project to lower its costs or increase its benefits? You, of course, need to have the appropriate legal framework, that is your state legislation needs to allow you to do a P3. Institutional capacity refers to the capacity of the agency to do all the various procurement activities that are required in order to run a successful P3 procurement, and finally market interest evaluation refers to looking to see whether there are sufficient number of qualified bidders so that you have competition in the bidding process, because if you don't have sufficient market interest then of course you may not get sufficient bids to get a good price.
Patrick DeCorla-Souza: So I think WA has developed a screening tool that helps you go through these various factors and it is something that can be used with developing the initial financial plan for major projects. After you've completed screening and determined that it's worth going in for more detailed evaluation you will need to do several studies before you can actually do an evaluation of a P3 relative to conventional delivery. So whether you're doing benefit cost analysis, value for money analysis, or financial affordability analysis, you still need a lot of information to perform those analysis. So you will need a study on traffic and revenue. You need to have good cost estimating procedures. You need to perform a risk assessment, and only then can you get to the evaluation either using value for money analysis or benefit cost analysis, and of course affordability analysis which is the financial viability of the project, and market outreach, you can do more extensive market outreach at that point to-- for example, industry meetings to bring in the folks from various concessionaires and design build firms, etcetera, to see whether there's sufficient interest in the type of procurement you're seeking to implement. The P3-VALUE tool is structured to help you do these various types of evaluation. You need as input several of the studies I already mentioned, for example, assumptions about costs, traffic, and risks. You need to have identified risks. Now what the tool will help you do is take information that you've already developed and perform first a risk assessment which will give you values of the various risks and create an aggregate risk value. It will help you structure the P3 using a financial model. It will help you assess the financial viability of a P3, as well as conventional delivery, and finally after these are done you can then go to the value for money analysis to determine which option, P3 or conventional delivery, will provide more value to the public agency, at least keep it in a better financial position relative to its budget. Now if you want to look at the effect on society as a whole, whether the P3 delivery is better than conventional from the point of view of society as a whole, then you need to do what we term here as project delivery benefit cost analysis and that will also need to include the results of your risk assessment, however, benefit cost analysis ignores financing, and therefore the financial evaluation that you would be doing on the financial viability assessment would not be relevant. So we now have a test question. Value for money analysis may only be conducted in a project's procurement phase.
Michael Kay: Thanks, Patrick. So let me open that. That's going to be at the top right of your screen. Again, true or false: value for money analysis may only be conducted in a project's procurement phase. We'll give everyone about 10 more seconds to provide answers on that question. Let's go ahead and close that one out, and we had about 18 percent say true, and 82 percent say false.
Patrick DeCorla-Souza: Alright, so those who said false are correct, and if you recall I said you can-- wait a second, on this side. Yeah, so value for money analysis can be conducted prior to procurement, during procurement, and even after procurement is completed in the implementation phase. So in the initial phases of project development you may not have a lot of information, but you can still do value for money analysis. In the procurement phase of course you have a lot more information. You have information from bidders, for example, and much more detailed information, and you can do a much more precise value for money evaluation, but the point is that it can be done not only in the procurement phase, but also earlier in the project development phase and perhaps with very limited information even in earlier planning phases.
Michael Kay: Alright, thanks, Patrick. We'll pull up the presentation. At this point we'll pause for questions. Again, feel free to submit those through the chat box or by pressing *6 on your telephone. Okay, seeing no questions, Patrick. I think we can move on to lesson three.
Patrick DeCorla-Souza: Okay, so value for money analysis if you recall the structure of the P3-VALUE tool it was one of those on the extreme right-hand side, and you know it's almost the end of the process of evaluation if you recall the flow diagram there, but the reason they're going to cover it first is it's important to understand what value for money analysis is before we actually go into the risk assessment and financial structuring because it's important to understand the importance of risk assessment and financial structuring to conduct a good value for money analysis. So let's first try to understand what value for money analysis is. This definition you see up on top is a definition provided by the UK Treasury Department and it says it's the optimum combination of lifecycle costs, and lifecycle cost include not just the implication cost, the construction cost, but also operations and maintenance throughout the life, and also considered in these costs are risks, so the risk adjusted lifecycle cost that you're looking at. Now it says that you also need to look at quality, the quality of the product. Just like when you go to a store you might have the same thing available but at different prices and you take your pick based on the quality relative to the price. Well, value for money analysis is similar. The product you are buying is a highway facility or a transportation facility, and its quality may differ depending on who is providing that product, and unfortunately this is not recognized very often and people do a value for money analysis with the quantitative side of things and produce a number which is the dollar difference between P3 and conventional delivery or percent difference, and they forget that there is something else that price or dollar cost needed-- needs to be traded off against, and that is quality, and so it's important to remember that value for money analysis is not just the number you get out of your financial analysis, because that is not going to tell you the full picture. So next we have the public sector comparator, and this is of course a very technical term for conventional delivery. Again, developed by the UK, and it's nothing but the baseline cost or conventional delivery, what you would spend if you were to, as a public agency, build and finance the project by yourself. The P3 shadow bid, or P3, is not just the bid price that the concessionaire or developer might provide, but it includes other costs borne by the agency, and these might be costs that might be retained as well as risks that might be retained by the agency in order to make a fair comparison with the full cost under the public sector comparator. This slide reinforces what we had indicated earlier about the timing of P3 evaluation. In the project development phase you see you can do an evaluation and that is simply to make a decision as to whether P3 is a better option. Now in the procurement phase you could again use value for money analysis to structure your draft agreement which would be part of the request for proposal. So you want to make sure that the agreement as designed still would give you the value for money that you were expecting up in the project development phase, and finally when you actually get bids from concessionaires you want to check again to see if the value for money that you were expecting does transpire or is realized, and if it is not the case, if value for money isn't obtained, of course, you know, usually that's too late in the game to stop the P3 procurement process, but one thing that can do is help you understand that some of the assumptions you made up in the project development phase when you made that decision were deficient, and you need to improve the value for money process you used up in the project development phase. Finally, even after a P3 concessionaire is selected and construction begins you can still do value for money because you made certain assumptions about what risks you were going to be retaining and what their impact would be on your budget and you want to see whether that in fact happened. So it's important to see whether the value you were expecting from a P3 continues to be realized as you were expecting up in the project development phase.
Patrick DeCorla-Souza: This graphic gives you a visual picture of how a comparison is made between conventional delivery and a P3. Now this particular graphic on the P3 is representing an availability payment P3 and what you see is that the base cost, the cost in purple, are much larger than the base costs under conventional delivery. The value of the bid, P3 bid, which includes the cost as well as the P3 financing fees, are also higher than the base costs and financing fees of conventional delivery. So how do we get a positive value for money, which you see if you look on top at the difference. Well, what you see is the reason for the value for money is basically the estimate of risks under the conventional delivery option, and you can see it's much, much larger than the risks retained by the public agency on the P3 side, and that basically accounts for, at least in this graphic, most of the difference between the two options. The other costs which are oversight costs, costs to oversee the contractors, costs for procurement, things of that type are relatively the same, although they definitely could be higher on the P3 side, and then there is something called competitive neutrality and that is simply an adjustment for the fact that a P3 concessionaire may be paying taxes to the state or federal government which in the case of conventional delivery no taxes are paid by the public agency, and so competitive neutrality simply adjusts for that by saying the government is going to be receiving those taxes, and if the government does not do a P3 then there is an opportunity cost to the public agency, because the public agency would not be receiving those taxes, and so those opportunity costs are simply added on the conventional side, and that's why you have that extra portion there in the bar for conventional delivery.
Patrick DeCorla-Souza: So having seen the various components of P3 and conventional delivery we now see that there are several challenges in the value for money analysis, and the first is estimating those cost differences. We saw that there were differences in cost between P3 and conventional delivery and how do you make the estimates or how do you define the costs under these two methods is important, because that drives most of the differences. Risk, we saw that risk on the conventional delivery side was much higher, and so deciding on what the cost impact of risk is extremely important. Now risk to the public agency as we saw in that graphic reduces a great deal on the P3 side, but it doesn't really disappear on the P3 side because if the P3 is-- the concessionaire is going to take on these transferred risks they're going to charge for it, and that is why on the P3 side you see the much higher costs in the purple bar you saw in the earlier slide, because they incorporate the costs of those transferred risks, and finally an important consideration is discount rate. If you are doing conventional delivery you-- and your funding the project out of your own budget you are likely to have a very different present value depending on the discount rate relative to a P3. P3 costs, if you're in availability payment, for example, are spread out over the entire life, and if you use a high discount rate you are going to have a much lower present value than if you use a low discount rate, and so that is, again, choice of a discount rate is going to be very important in making that comparison and can really skew the result. So it is very important to choose wisely. Value for money analysis has limitations. As we said, it is simply procurement from the point of view, or valuation from the point of view of the public agency, and so it does not consider a nonfinancial cost and benefits, things such as user benefits, air pollution, other types of differences that do not affect the balance sheet of the public agency. One big assumption in value for money analysis is that the public sector comparator is possible in the same timeframe as a P3, and this is very important because in value for money analysis you are discounting costs that are incurred into the future. So if, for example, your public sector comparator is really only possible 10 years from now, and if you take the same cost 10 years from now, and you would be discounting those costs, and they would appear much smaller today, and whereas the P3 costs would be incurred today, and so you would get a difference in cost simply related to the fact that the conventional delivery occurs in the future, and that's why it's not possible to do value for money analysis if you don't make an assumption that conventional delivery is possible at the same time as the P3. Finally, if a concessionaire proposes scope changes to the project, for example, the Capital Beltway here, the Washington DC area, the concessionaire proposed additional ramps. Now these ramps, of course, would increase the cost, because if they're additional ramps, you know, that's going to affect the cost. Now in value for money analysis the scope has to be the same because the P3 would look more expensive simply because of the higher cost. If you don't consider the fact that the extra cost also brings in more benefits, and value for money, as we said, only looks at the cost side of the picture, and so it's not possible to do a value for money comparison between a P3 bid, which has a different scope than the conventional delivery option. So if you wanted to do that you would have to assume that the conventional delivery would build the same additional ramps as the P3 bidder, and of course, it won't tell you very much except what the cost difference is. Now I have our next question. True or false: value for money analysis assumes that under conventional project delivery, the project can be delivered and operated in the same timeframe as the P3 option.
Michael Kay: Great, thanks, Patrick. I'm going to open that one. It's going to be in the left column of questions, the middle one. I'll read it out once more and then give you some time to think about it. VFM analysis assumes that under conventional project delivery, the project can be delivered and operated in the same timeframe as the P3 option. Let's give everyone about 30 seconds there. Okay, I'll go ahead and close it out. We definitely have some confusion there and that may be based on just how the question is worded. We have about 54 percent saying true and 46 percent saying false.
Patrick DeCorla-Souza: Well, those who said it's true, of course, are correct. But I'm at least pleased to see that the true option got more votes. Yes, as I said, you have to assume in value for money analysis that the conventional delivery is possible in the same timeframe as the P3. As I indicated, if the conventional delivery costs are incurred ten years into the future, you would, using discount rate, simply make the cost appear to be much smaller, simply because you use the discount rate. So that is why value for money has to assume that the conventional delivery is possible in the same timeframe as the P3.
Michael Kay: Great, thanks, Patrick. Let's go back to the presentation and actually we'll take questions at this time, so I'll expand upon our chat box. We did have a question that I can copy and paste in here. Just bear with me a moment. In the meantime, if you have a question, feel free to press star 6 on your telephone. This was a question that was sent to us just hosts. I wanted to protect that questioner's anonymity, if that's what they preferred. But the question was, is VFM used to determine which P3 option is best for a project, or is that predetermined before doing a value for money analysis? By that, I mean what combination of DBFOM?
Patrick DeCorla-Souza: Well, the purpose of value for money analysis is to determine whether the P3 option is better than conventional delivery. The correct way to use value for money analysis is to make that decision. Now it's possible that a P3 is chosen for other reasons, whether it be political or just simply because the screening process, which is a qualitative process, determined that the project would be a good candidate for a P3. So it is possible that you would have done a P3 screening analysis, using the qualitative process, and then you would do a value for money analysis as a check to see whether the assumptions you made in the qualitative assessment are still correct. So yeah, it could be in some cases a follow on to a screening level evaluation, but the real purpose of VFM analysis is to make that final decision as to whether the P3 option is better than conventional delivery.
Michael Kay: Great, thanks, Patrick. That has opened the floodgates, which is terrific. We want to see your questions come in. So the next one is from Chelsea. Are there any MPOs that are succeeding in conducting project delivery evaluations at the planning level, perhaps their project in their regional transportation plans?
Patrick DeCorla-Souza: Of course, I am not aware of what MPOs are doing. I'm sorry, I can't answer this question, but if anybody in the audience has the answer, feel free to respond.
Michael Kay: Okay. The next question from Catherine: the bar for competitive neutrality in your bar chart seems large. Are you counting the full value of taxes under the P3 paid to state and federal governments as foregone revenue to the project sponsor, or are there other elements to your competitive neutrality calculation?
Patrick DeCorla-Souza: First, of course, there is no calculation behind the bar chart. It is just a schematic to show the various components and the relative magnitudes. But you're right, that depending on whether or not the state taxes as well as federal taxes are included can increase the amount of that competitive neutrality adjustment. Of course, whether you choose to include federal taxes in that competitive neutrality adjustment is a choice of the procuring agency. If the procuring agency is doing the evaluation from the standpoint of the state budget, then they might not want to include federal taxes as an adjustment in the competitive neutrality adjustment. So of course, that is an option that is the choice of the state.
Michael Kay: Thanks, Patrick. Next question from Cathy Kendall: the assumption that the conventional cost would occur at the same time as P3 seems unlikely, since many P3s are done in order to get a project on the ground that the local government cannot themselves afford.
Patrick DeCorla-Souza: That is absolutely correct. Most, at least in the United States, the main reason P3s are undertaken is to accelerate a project. This points out the challenge in using value for money analysis, because it is not accounting for one of the biggest benefits as considered by the procuring agency in the States. One of the biggest benefits is that the project is accelerated and therefore more benefits to society are being provided. For this reason, we have now developed a process to undertake a benefit cost analysis which can provide a valuation of those extra benefits from accelerating the project.
Michael Kay: Thanks, Patrick. The next anecdote from Kay is, almost every VFM they've been involved with accelerates the project over time compared to convention delivery. The delay in cost is usually offset by advancing revenue from the project. So just kind of a comment from personal experience there.
Patrick DeCorla-Souza: Yeah, that's true.
Michael Kay: Do we have any questions over the phone? Again, star 6 to unmute your line. Okay, hearing none, I think we'll move onto lesson four.
Patrick DeCorla-Souza: Okay, so as we saw from the last question about accelerating project delivery, it's very important to try to capture the benefits from accelerating project delivery. So what we have done is developed a process to account for those benefits, that is, we are calling that project delivery benefit cost analysis. So it is almost another option that you can use in place of value for money analysis or to enhance your value for money analysis. So how it works is through a three step process. You first need to do a garden variety project benefit cost analysis. You need to, in other words, determine whether the project itself is worthwhile. Then in step two, you try to determine whether accelerating the project will provide benefits. So especially, if under conventional delivery, the project would be delayed, you need to see if advancing the project would provide more benefits than cost, and that's what you would do in step two, which is attempting to estimate the impacts of funding constraints. And finally in step three, is when you look at the actual benefits from P3 delivery per se. This is important to look at the list of four impacts of P3 delivery that you've listed there. The only one that is addressed in value for money analysis is the cost impacts. Timing impacts, for example, if a P3 concessionaire can complete the construction of the project in a shorter period of time, and therefore provide more benefits, is not considered. If there are quality improvements, for example, in a long term concession the pavement drive quality is better or if the emergency response procedures are better or the lane availability is better, those are not considered in value for money analysis, not in the quantitative aspect of value for money analysis. And finally, scope optimization, so if we have features that are introduced by the concessionaire that either increase the number of users and therefore increase benefits to society, or improve quality of service, those are not considered in the quantitative aspect of value for money analysis. This graphic shows you the mechanical process. The PSC and the P3 are exactly the same as under the value for money analysis. What we have introduced here is two other options. The first is the no build, and that is, of course, doing nothing, and not building the project, and something called the delayed PSC, and that addresses what one of the questioners had said earlier, is that in most cases, the reason you're doing a P3 is because the conventional delivery might be delayed. Well, here is a delayed PSC, which is structured exactly the same as the PSC, the only difference being that it is delayed, relative to the PSC. We conduct the evaluation by making comparisons. So we first compare the delayed PSC no build in order to figure out whether the project itself is beneficial. We then compare the PSC to the delayed PSC to find out if accelerating the project has more net benefits. Finally, we look at the P3 and compare it to the PSC to find out if P3 delivery has more economic benefits to society. So let's go one by one in the details of each step. What you see on the left here are all of the costs. These are exactly the same life cycle costs, risks, procurement and oversight costs. These are all the same as we had considered in value for money analysis. What's new is, we also considering benefits. So on the right hand side, you see user benefits and externalities. So in step one, we are introducing benefits into the picture and then taking those benefits, subtracting the costs to find out what the net present value of the project. So if the net present value is positive, it--the project is a good idea and is worthwhile. In step two, we are comparing the delayed dimensional delivery to conventional delivery. So again, the delayed conventional delivery is exactly what we had in the prior step. Conventional delivery is the same as the delayed conventional delivery, except it's advanced. In other words, since it's advanced in time, now we get more user benefits for those additional years. However, because costs are also advanced, the present value of those costs are going to be higher. So the net impact of those two should be positive and give us some net benefits which would be the net benefits of accelerating the project. It doesn't seem to be advancing. Am I stuck? Okay, here we are. Now we went too far. Let me go backwards. So now we go to step three. What this shows is the effects of P3 delivery. Again, in value for money, all we calculated were the cost impacts, what you see in the left hand side, the differences in public transaction costs, differences in private transaction costs and life cycle costs. We have not, at least not in value for money, considered the fact that a short construction period might bring in more user benefits. So these are additional benefits that we are considering in step three here. And then quality impacts that I'd mentioned earlier, due to better pavement drive quality, lane unavailability, incident response and outreach. In the case of a toll facility, a concessionaire might advertise the facility during the ramp up period and therefore bring in more users, and of course, bringing in more users means that more people are benefiting, which increases the benefits to society. Finally, scope optimizations. When a concessionaire introduces new features into the P3 option--that might increase user benefits. Again, something that can be calculated after a bid is received. So taking these three steps, you would get three different comparisons. Each of these options, delayed dimensional delivery, conventional delivery and the P3 option, are compared to the no build option. You can see in this graphic, on the delayed-- here, the delayed conventional delivery cost, relative to the conventional delivery cost. The reason the cost is lower, in the case of delayed conventional delivery, is simply the present value of the cost is lower. The actual nominal cost would be-- or the real cost, would be the same. Now the benefits minus the cost is the net present value. In the case of conventional delivery, you see benefits are higher, costs are higher, but hopefully this net present value here is more than what we had in the case of the prior comparison. That would tell us whether it's beneficial to accelerate the project. Finally, in the P3 case, again we have benefits and we subtract the cost and then we look at this net present value here. If it is larger than this net present value, then we know that we have a better value in the P3 option. So when we're doing these comparisons, these economic analyses, it's important to understand that on the cost side we are considering only agency costs or state costs, whereas on the benefits side, we are considering costs to society. This is probably not a big issue, except for the fact that usually, within these costs to the agency or to the state might be some subsidies from the federal government relating to the financial. For example, tax exempt debt is one way that the federal government subsidizes the costs of the state or the agency. Another is TIFIA loans, low cost TIFIA loans. So these subsidies are not included in those costs, so really, if you want to do a true benefit cost analysis, you have to do that at the national level. The cost would include societal costs, which would then of course also include cost to the federal government. And then on the benefit side, of course, we continue to use the same societal benefits as we've considered in the other two perspectives. Then we go to our test question. Michael?
Michael Kay: Thanks, Patrick. Just bear with me a moment while we switch over the screen. We're going to go to the fourth question, which is on the right most column in the middle. True or false: benefits from product acceleration should always be attributed to P3 delivery? Again, benefits from product acceleration should always be attributed to P3 delivery? We'll give everyone about 15 seconds. Okay, let's go ahead and close that out. We have 26 percent say true and 74 percent say false.
Patrick DeCorla-Souza: All right, thanks, Michael. Now this is a very difficult issue. Those that said false are actually correct. What we like to point out is that a state could advance a project under conventional delivery in two ways. One is, it could increase taxes, for example, so that its budget is capable of building the project, or it could borrow money. And the fact that it is not raising taxes and not borrowing money is a political choice that it has used to constrain itself. So the fact that we are now using a P3 project to accelerate project delivery is not necessarily the only way that a project can be accelerated. So really, the fact that you are accelerating the project using P3 delivery is definitely a good thing, but it is not the only way. In every case, it's not true that the project acceleration should be attributed only to P3 delivery. Michael?
Michael Kay: Yep, thanks, Patrick. With that, we can take some questions. For that, I will go to our question slide. If you do have any questions, please submit those through the chat box or by pressing star 6 on your phone. I don't see any questions, Patrick, at this time, so we can move on to lesson five.
Patrick DeCorla-Souza: Okay, thank you. So this one will be brief. Now that we understand how important risk valuation is, because of the big effect it has on value for money analysis, let's look at the various risks. And risks are of three types: first, risks related to cost. The fact that you might have cost overruns is one type of risk. Revenues is another type of risk. In other words, all the revenues that you were expecting from tolls may not happen, and that's another risk. Finally, benefits, all of your traffic forecasts may not happen, so that's another type of risk, but that would apply only in benefit cost analysis where you're using the traffic volumes in the facility to calculate your benefits. It's important to consider all of these risks. We will go into much more detail in the risk assessment webinar, which is the fourth webinar that we will have in this series. We will discuss in more detail how the cost risk and the revenue risk and the benefit risk are addressed. I just wanted to point out here that there are different types of risk that need to be considered in our P3 evaluation. There are three categories of risk cause. Normally, when we think of risk, we think about just cost risks. Base variability or base cost to variability is the first type of risk that we consider in P3 value. It's simply related to the fact that you don't know, for example, how much of volume of asphalt or the exact dimensions of a bridge or things of that type, so you can't estimate accurately what the total cost might be in reality. This base variability tends to reduce, the closer you get to project implementation, as you add more information. Pure risks, on the other hand, are something that may also be called event risks. They may or may not happen. So there's a probability that they might happen. An example is an accident at a construction site causing delays. So you need to take the probability of the risk into consideration in calculating its cost impact. Now these two types of risk, base variability and pure risks, are usually pushed down to subcontractors by the concessionaire. What is normally not pushed down or cannot be pushed down by the concessionaire is something called life cycle performance risks. These are sometimes also called systematic risks. They're risks related to the economy, inflation, recessions, things of that type, that can affect costs or revenues. Of course, in the process of managing the project, there could be conflicts between a design build contractor and an O&M contractor. There can be supervening events, force majeure, things of that type. All of these risks are borne by the concessionaire. So in P3 value, we calculate these various types of risks and we will discuss them in more detail when we get to webinar four. I just wanted to show you how these various cost risks are considered in value for money analysis. Base variability and pure risks, cost adjustments, are made to the total cost and then those total costs are used to calculate the life cycle performance risk premium, as it is called in the P3 value tool. That life cycle performance risk is something that is added to conventional delivery, both to delayed conventional delivery as well as the PSC or the accelerated conventional delivery. However, it is not added to the risk adjusted P3 cost. So the P3 costs already include costs that are pushed down to subcontractors, that is, the base variability and the pure risk cost adjustments. The reason we don't add in life cycle performance risk is because the P3 bid already includes the value of the life cycle performance risk and it does it through something called the weighted average cost of capital. So the weighted average cost of capital, which is the equity return and the premium on interest rates, reflect these additional life cycle performance risks. For example, if lenders perceive that a project is risky, they're going to charge higher interest rates. Equity that is taking on most of these risks has a higher rate of return. The more the risk, the more the rate of return. A toll concession might have more risks and so equity requires a higher rate of return. So all of these are incorporated into the financing costs of the P3, so there's no need to additionally add in a life cycle performance risk premium. Let's go to the question, Michael.
Michael Kay: Great, thanks, Patrick. The next one can be found in the left column of question on the bottom there. True or false: for value for money analysis, an estimate for a life cycle performance risk should be included in the conventional delivery and delayed conventional delivery cost estimates? So let's give everyone about 30 seconds to read and respond to that. Okay, we'll go ahead and close that one out. We have about 86 percent say true and 14 percent say false.
Patrick DeCorla-Souza: Yes, and those who said true are correct. As I indicated, the life cycle performance risk is already included in the bid of the concessionaire in the form of interest rates to debtors and equity rate of return to the shareholders. So there's no need to additionally add in a value for life cycle performance risk.
Michael Kay: All right. We'll switch back and I believe we'll take additional questions at this time. Again, through the chat box or by pressing star 6 on your phone to unmute your line. I see at least one person is typing, so let's wait about 15 seconds to see if any questions come in, or again, star 6 to unmute your phone line. There we go, a question from Catherine. Life cycle performance costs would need to be-- excuse me. Life cycle performance costs would need to be accounted for if the P3 were in about availability payment transaction, correct? Then she corrects herself. Life cycle performance cost risk would need to be accounted for if the P3 were an AP transaction, correct?
Patrick DeCorla-Souza: Well, the availability payment also has a weighted average cost of capital. That is, equity gets a rate of return and the debt holders get a premium on the interest rate. So those risks are already included in these premiums on interest rate and equity rate of return. So yes, they are incorporated already in the bid of the P3, so we do not need to add a new additional life cycle performance risk.
Michael Kay: Patrick, a follow up from Catherine: but the financing would reflect the risk of the public sector payments, not the risk of the project.
Patrick DeCorla-Souza: In an availability payment, that is obviously one of the risks, the risk of public sector payment, yes. That's the revenue risk, as it is called. On a toll concession, the volatility of the tolls would be the risk on the revenue side, but then there are also risks of the cost side. For example, operations and maintenance costs, and things such as inflation and things of that type. So yes, the risks of the public sector payments would need to be reflected, but they're lower in the case of toll revenue, and that's why the WACC or the weighted average cost of capital or the risk premium, if you will, in the weighted average cost of capital, is lower in the case of an availability payment than under a toll concession.
Michael Kay: Great, thank you, Patrick. Another question just came in. Should there be two different discount rates, WACC for P3 and public sector borrowing costs for the public sector comparator?
Patrick DeCorla-Souza: As you will see in the next webinar two weeks from now, we recommend the same discount rate applied to both the P3 and the PSC. But remember, when we say P3, we are talking about the public agency's costs under a P3. They're not talking about the concessionaire's cost. The concessionaire will of course discount its cost at the WACC rate. The issue is, when you are making comparisons, for example, in an availability payment that is made to a concessionaire, those are agency costs of a P3. Those are always discounted at the same rate as the PSC, if you want to make a fair comparison. But we'll get into that in webinar two. Good question and stay tuned, and do join us at the next webinar.
Michael Kay: Great. With that, Patrick, we've got about eight minutes to conclude with our last couple sections, starting with financial viability assessment.
Patrick DeCorla-Souza: All right, okay. This is also a preview of webinar five, so I will go through it just to give you a flavor of what to expect in webinar five. The key is the financial models and we will open the black box for you, because that is so important to understand how P3s are structured and how financial viability assessment is done. Just briefly in the slide, you see what a financial model looks like. You have sources of funds. So you, for example, have equity and debt and subsidies that go to fund the uses, which are capital expenses and then you have toll revenues which are used to pay for operating expenses and debt service and tax and dividends. All of these are thrown into a financial model. What the financial model tell you is how much you can borrow, for example, based on certain things called debt service coverage ratios, which I will talk about in a little bit.
Patrick DeCorla-Souza: And then it tells you how much equity you can attract and that of course depends on the rate of return that equity investors are asking for. So once you know the capacity of the project to attract debt and the capacity to attract equity, if the actual cost of the project is more than the two capacities combined, the net, the balance has to be paid for by somebody. And guess who that is? It is the public subsidy that has to fill in the gap. And that's why it's very important to understand the structuring and the impacts of structuring of P3s.
Patrick DeCorla-Souza: Very briefly, what the public agency is looking for from the financial model is, can it expect a concession fee that is a payment from the P3 partner because revenues are higher than the cost, or will it need to provide a subsidy. And this would be if revenues are insufficient to pay for the debt and the equity returns. Now, there are some ways that the concession fee can be increased or subsidy decreased and that is by increasing toll rates or increasing the concession term. And that we will also talk about in webinar 5.
Patrick DeCorla-Souza So here are the key metrics for financiers. I mentioned debt service coverage ratio and there's something called gearing, there are a couple of slides, I'll go into that in a bit. And equity rate of return, weighted average cost of capital, and project internal rate of return, which is a form of weighted average cost of capital that takes into account the fact that the percentage of debt actually decreases over time as debt is paid off. And we'll talk about all of these in much more detail in webinar 5. I just wanted to show you very quickly what debt service coverage ratio is. So you have the cash flow, let's say you have toll revenues, you pay off the O&M costs and the balance is called cash flow available for debt service. And you take that value and divide it by annual debt service. So that is how much you would be paying in terms of principal and interest to pay back the debt. And that ratio is what lenders use to decide how much they can lend you. So if you have a higher minimum debt service coverage ratio that is going to reduce your debt capacity because it means that you have a much smaller amount that you can devote to debt service, to pay back. So if you have a smaller amount that you can pay back, you have a smaller amount that you can borrow.
Now leverage or gearing, and these terms are used interchangeably, is the debt to equity ratio. The percentage of debt relative to the total financing and the percentage of equity relative to total financing is what is called the gearing ratio. So if you have a higher gearing ratio, you can increase debt because debt as a percentage would be higher. For example a 90:10 ratio would allow you to borrow more money than a 70:10 ratio. Okay so let's go to the question Michael.
Michael Kay: Alright let's do it. I'll pull it up and this will be the last one on the bottom right. True or False: A higher DSCR will allow a project to obtain a higher amount of debt. Okay we'll go ahead and close that out. 73% say true, actually that adjusted to 69% said true and 31% said false.
Patrick DeCorla-Souza: I guess I confused everybody when I went into leverage. So with a higher leverage you can borrow more, okay, so you can have a higher amount of debt. But a higher DSCR will reduce the amount that you can pay back, and therefore if you can pay back less you can borrow less. So like if it's your house, if your income is too low, you have to purchase a smaller house, basically, or a less expensive house.
Patrick DeCorla-Souza: Alright let's go to the final stretch here, the closing. I just want to introduce you to the P3 toolkit which is available on our website. It has fact sheets, primers, guidebooks, and the tools, including this P3-VALUE tool that we are talking about today as well as P3-Screen. P3-VALUE is an analytical tool that we've developed to educate users so they can understand all of these concepts of P3 evaluation. And this we will get into in much more detail in the next webinar on value for money analysis. You can see on the left hand side you've got value for money analysis and on the right hand side you've got project delivery benefit cost analysis. And that's what we are going to cover the next two webinars. We have in this P3-VALUE tool four training modules. We will be covering value for money analysis first, project delivery second, and then we will go to risk assessment and financial viability assessment. This is just a graphic of what the tool looks like, the four modules for training. And we'll get into it at the next webinar. Here's what you will find on our website. The tool is going to be up on our website by the end of the week, the new P3-VALUE 2.0 tool, along with the user guide. Of course primers and guidebooks are already up there. So to summarize, we've talked about types and timing of project delivery evaluation, we've introduced you to the four modules that we're going to cover in the next four webinars, and we've introduced you to the P3 toolkit. So here are the dates for the upcoming webinars that will cover each of the four modules. Please feel free to go ahead and register if you haven't already. And this is the URL for our website. In particular, go to the P3 website and click on P3 toolkit. There you will find everything that I showed you previously. Here is the information to contact me, and I guess, this must be the last slide. I'll turn it over to you Michael.
Michael Kay: Thanks, Patrick. I just wanted to see if anyone had last minute questions, again to the chat box, or by pressing *6 on your phone. A question did come in about the PowerPoint. The PDF version will be made available, and again as a reminder that is available for download now and will be available later as well. If you want to look at the center of your screen in the materials for download box, click on the file, click download file and follow the prompts on your screen. Any final questions? Alright, with that, Patrick, I think we're ready to conclude.
Patrick DeCorla-Souza: Thank you very much and thank you all for attending and we hope you'll join us at the next webinar in two weeks.
Michael Kay: Thank you, bye now.