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New Tool to Understand Value-for-Money Analysis Concepts in Evaluating

Public-Private Partnership Options

Article in Transportation Research Record Journal of the Transportation Research Board · December 2014
DOI: 10.3141/2450-13

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New Tool to Understand Value-for-Money
Analysis Concepts in Evaluating
Public–Private Partnership Options
Patrick DeCorla-Souza
This paper presents a new public–private partnership (PPP) finan-
cial evaluation tool, PPP-VALUE (Public–Private Partnership Value-
for-Money Analysis to Learn and Understand Evaluation). The tool
is intended to help states learn how to assess quantitatively whether
a PPP is appropriate for specific projects and to understand the rela-
tive impacts of the key drivers of value for money. The tool is focused
on decisions about infrastructure delivery options to achieve the best
value for the public. PPP-VALUE helps states learn how to assess the
procuring agency’s costs for providing a project through the PPP pro-
curement model and to compare that result with conventional procure-
ment costs. The tool guides state officials in their efforts to understand
better the impacts of project risk, revenue, and financing on public
agency costs and helps them better understand the key financial vari-
ables in making a procurement decision. This paper demonstrates the
use of PPP-VALUE with a simplified hypothetical project to help read-
ers understand the basic concepts of value-for-money analysis and to
appreciate the complexity of more detailed financial modeling needed
to conduct a full-fledged analysis.
The objective of this paper is to introduce and demonstrate a new
tool, PPP-VALUE (Public–Private Partnership Value-for-Money
Analysis to Learn and Understand Evaluation), which can be used
by public-sector transportation practitioners with no financial model-
ing background to understand how value-for-money (VfM) analy-
sis is conducted to evaluate public–private partnerships (PPPs) for
the delivery of highway projects. The tool facilitates the analysis of
projects at a conceptual level. The paper is organized into sections
as follows:
• The section on VfM analysis and PPP-VALUE explains VfM
analysis and discusses two distinct approaches to conduct the analy-
sis, why the tool was developed, how it differs from tools that already
exist, and why one should use the tool.
• The section on hypothetical project assumptions introduces a
hypothetical project that is used in the rest of the paper to explain
what the tool does, using plausible assumptions, but at the same
time keeping the parameters simple so that the VfM process is more
easily understood.
Public–Private Partnerships Program, Federal Highway Administration, 1200
New Jersey Avenue, SE, Washington, DC 20590. patrick.decorla-souza@dot.gov.
Transportation Research Record: Journal of the Transportation Research Board,
No. 2450, Transportation Research Board of the National Academies, Washington,
D.C., 2014, pp. 99–108.
DOI: 10.3141/2450-13
99
• The section on the development of a public-sector comparator
(PSC) discusses different approaches to estimate the cost of con-
ventional procurement and how that option is evaluated by the tool;
results for the hypothetical project using one approach are displayed.
• The section on developing the shadow bid (SB) discusses the
types of PPP options that can be evaluated by the tool, displaying
results for the hypothetical project for two options.
• The section on VfM assessment discusses how a comparison
between conventional and PPP procurement is performed, display-
ing results for the hypothetical project, interpreting the results, and
discussing implications for the VfM analytical process.
• The final section discusses the limitations of VfM analysis and
the tool and summarizes the benefits to be gained by their use.
VfM Analysis and PPP-Value
What Is VfM Analysis?
VfM is defined by the UK Treasury as the optimum combination of
life-cycle costs and quality of a good or service to meet the user’s
requirements. VfM analysis is a quantitative analytical process used
to compare the financial impacts of procurement alternatives for a
project. The methodology for carrying out a preprocurement VfM
analysis involves the following:
• Creating a PSC that estimates the risk-adjusted life-cycle costs
and revenues from carrying out the project through a traditional
approach;
• Estimating the risk-adjusted life-cycle costs and revenues of
the PPP alternative—that is, a hypothetical SB; and
• Completing an item-to-item comparison of the present values
of costs and revenues under the two approaches.
When Is VfM Analysis Done?
VfM analysis may be done at many stages in the life of a project:
• At the project planning and development stage it may be used
to answer the questions “Can the life-cycle costs be reduced through
integration of design, construction, and operations?” and “Would a
P add value, and if so, what type of P is best?” This is the stage at
which PPP-VALUE may be useful in providing preliminary answers.
• At the procurement stage, VfM analysis could be used in devel-
oping the request for proposal (RFP) to answer the question “Would
the contract terms proposed in the RFP ensure value for money?”
100
• After bids are in, it could be used to answer the question “Does
the preferred bid provide value?”
• After the project is built, VfM analysis can be used to answer
the question “Has the anticipated value been realized at construction
completion?”
• During operations and at hand back, it can be used to answer
the question “Has the anticipated value been realized throughout
the project’s life?”
What Is PPP-VALUE?
PPP-VALUE is a suite of educational tools developed by FHWA
to introduce public-sector practitioners to the methods used in PPP
financial evaluation. PPP-VALUE can help users understand the pro-
cesses and considerations that go into a rigorous quantitative financial
analysis of procurement options for transportation projects. The focus
of the tool is on long-term PPP contracts that involve designing, con-
structing, financing, operating, and maintaining new highway facilities
(also known as greenfield projects).
PPP-VALUE is coded in Microsoft Excel and is supported by
three primers (1–3), four user manuals (4–7), and two guidebooks
(8, 9). Practitioners can use PPP-VALUE to better understand the
concepts, inputs, assumptions, and outputs of risk; financial feasi-
bility; and VfM analyses. PPP-VALUE has been designed for edu-
cational purposes only and is not intended to guide decisions on
actual projects. The complexity of the analyses that are required
for decision making for specific projects requires that they be per-
formed by experts using more detailed financial modeling; however,
PPP-VALUE provides hands-on instruction in how such detailed
modeling analyses are conducted and can help government offi-
cials understand the importance of the inputs and assumptions used
by modeling experts and the extent to which key assumptions can
affect the analysis results.
PPP-VALUE and its accompanying resources can help decision
makers and practitioners understand PPPs as a financing alternative
for major capital projects. Practitioners can use the PPP-VALUE
suite of tools to familiarize themselves with the process for evaluat-
ing procurement decisions, the data required to conduct quantitative
financial assessments of procurement options, and the impact that
various assumptions can have on the desirability and financial fea-
sibility of different procurement structures. This paper demonstrates
the use of two of the tools for VfM analysis by using a simplified
hypothetical project designed to help tool users understand the basic
concepts of VfM analysis.
PPP-VALUE is made up of four Excel-based analytical tools:
• Risk assessment tool, which shows users how to document proj-
ect risks and risk management strategies and to estimate the aggregate
costs of risks under different procurement structures;
• PSC tool, which shows users how to calculate the risk-adjusted
costs and revenues for a project that is designed, financed, constructed,
maintained, and operated under a conventional public-sector delivery
model;
• SB tool, which shows users how to calculate public agency
payments to a private partner for delivering a project as a PPP con-
cession, as well as total PPP costs and revenues, including all costs
borne and revenues received (if any) by the procuring agency; and
• Financial assessment tool, which shows users how to conduct
a preliminary financial viability analysis.
Transportation Research Record 2450
This paper demonstrates the use of the PSC and SB tools. Practi-
tioners can use the tools to understand the VfM analytical processes
by doing a sketch analysis with assumptions for their project. How-
ever, because of the limitations of the simplified process, the results
should not be used for decision making. Finance professionals with
expertise in modeling should perform the detailed modeling and
analysis for a specific project. Nevertheless, nonmodelers can use
the tools to understand what exactly the detailed models produce,
what the key assumptions used in the models are, and how they can
affect the VfM results.
A review of the literature provides numerous examples as well
as guides for VfM analysis and risk assessment for PPPs (10–15).
Financial modelers have developed project-specific VfM models,
and others, such as the World Bank (16) and the University of Mary-
land (17), have developed general use tools for financial viability
assessment. However, only one quantitative analytical tool for gen-
eral use in VfM analysis has been developed, suitable for use in the
United Kingdom (18). Thus, FHWA’s effort is the first known attempt
to develop a general VfM analysis tool that can be used in the United
States to quantitatively evaluate a project, although at a preliminary
screening level only, to understand the chief drivers of VfM in a PPP
and their potential magnitude.
VfM Analysis Approaches
PPP-VALUE can accommodate two distinct approaches observed in
the literature to analyze VfM: (a) analysis based on operational cash
flows only, without financing costs, and (b) analysis that includes
financing costs. These approaches are discussed briefly below.
Analysis based on operational cash flows includes arrangement
fees and underwriting fees for financing, but not debt service and
equity returns. The approach can be used only if the financing itself
is not a discriminating factor in the VfM comparison—that is, there
is no reason to assume that the financing costs would be different for
the public agency if it were to finance a project on the basis of the
same project risk profile as the risk profile under a PPP approach. Of
course, financing costs in a conventional delivery method are often
lower than those in PPP financing, mainly because the financing
costs of a PPP reflect the market pricing of risks of the PPP proj-
ect that are not covered in the cash flows, whereas public financing
generally reflects only the creditworthiness of the public agency or
the risk of the revenue stream that is being pledged (e.g., a dedicated
sales tax). If public financing costs were to incorporate a project’s
systematic risks and risks such as coordination and long-term per-
formance risks [a.k.a. special purpose vehicle (SPV) risks], the costs
of public financing could possibly be equal to or greater than PPP
financing costs, especially if public-sector tax exemptions are not
taken into account.
Analysis based on financing cash flows provides additional
insight into budgetary consequences and ensures that most neces-
sary inputs for the financial viability assessment are collected; inputs
include financing structure, interest rates and required return on
capital employed, drawdown and repayment schedules, transaction
fees (e.g., arrangement and advisory fees), and other financing
conditions, including annual debt service coverage ratio, loan
life coverage ratio, and project life coverage ratio. The financ-
ing cash flows are simulated in a model reflecting the financing
structure. Instead of constructing a full-fledged financial model,
PPP-VALUE uses a simple model incorporating operational cash
flows, a debt-to-equity ratio, a specified equity rate of return, and
DeCorla-Souza101
a single tranche at an average interest rate that represents, in a
simplified manner, all debt tranches that would normally be used
to finance the project.
Qualitative Evaluation
Qualitative factors are often more important in making the final
VfM determination. A companion FHWA tool called PPP-SCREEN
assists with evaluating qualitative factors (19). Together, the quan-
titative and qualitative assessments typically inform the overall
VfM analysis and decision-making process. Qualitative factors that
should be considered in a preprocurement VfM assessment may
include, for example, earlier project delivery, which can result in
an increase in benefits to highway users; readiness of the project
(e.g., public and political support and environmental approvals);
organizational capacity of the procuring agency to develop and pro-
cure a PPP; and sufficient private-sector interest to ensure adequate
competition.
Hypothetical Project Assumptions
This paper focuses on demonstrating how to calculate VfM by using
PPP-VALUE with a hypothetical project. Simplifying assumptions
are made and round numbers are used to allow readers to do the
math in their heads so that they can easily understand the results
produced by PPP-VALUE. Assumptions made with regard to pro-
curement options are outlined in this section. The rest of the paper
shows how the options may be evaluated with PPP-VALUE.
Assumptions for Conventional
Procurement Option
The hypothetical project is assumed to have the following
characteristics under conventional procurement (i.e., the PSC):
• Design–bid–build procurement type.
• Base estimated design and construction costs of $100 million
incurred over 2 years, including $30 million in Year 1 and $70 million
in Year 2—in nominal dollars.
• Thirty-year project life requiring $10 million (real dollars) per
year in operations and maintenance (O&M) costs over 28 years
(i.e., excluding the 2-year construction period), divided equally
between operations and maintenance—for simplicity, periodic main-
tenance costs are assumed to be annualized and included in the total
for routine maintenance costs.
• The following nonsystematic project uncertainty costs (i.e., “pure”
risks and other project uncertainties, all of which would be retained
by the procuring agency under conventional procurement and would
be paid for either directly by the agency or through payments to
subcontractors) (8):
– Design–build (DB) phase:
1. 10% probability (P10) that they will be at or below
$10 million,
2. 70% probability (P70) that they will be at or below
$20 million, and
3. 90% probability (P90) that they will be at or below
$30 million and
– Operations phase:
1. 10% probability (P10) that they will be at or below
$1 million,
2. 70% probability (P70) that they will be at or below
$2 million, and
3. 90% probability (P90) that they will be at or below
$3 million.
Not included in the design–build and operations phase risk esti-
mates above are additional risks typically held by a concessionaire
in a PPP, such as systematic project risks, coordination and long-term
performance risks, and revenue risk in a toll concession (9).
• Other project costs (e.g., procurement and oversight costs) are
ignored for simplicity in the analysis, but in reality there will be lower
procurement costs for conventional delivery than for PPP options,
and public-sector oversight costs will be higher for an availability
payment concession than for a toll concession in the operations phase.
• Financing assumptions are as follows:
– Debt financing for 100% of design and construction costs
(at an average interest rate of 5% and 30-year maturity) by using
toll revenue bonds (backstopped by general revenues) up to the
project debt capacity, with the balance financed by pledging
general revenues of the procuring agency;
– Debt issuance costs amounting to 2% of the borrowed amount,
to be financed as part of the debt;
– No grace period for debt repayment, requiring additional
up-front borrowing to pay debt service before toll revenues begin
to flow in; and
– Annual debt service coverage ratio of 1:2 for project-financed
debt (i.e., cash available for debt service must be at least 1.2 times
the annual debt service payment).
• Inflation rate of 3% annually is applied in the operations phase
to costs as well as toll rates. (Construction phase costs are provided
in nominal dollars, so an inflation adjustment is not needed.)
• Nominal discount rate (i.e., discount rate that includes inflation)
is 5%. This rate was selected to be equal to the public-sector borrowing
rate—that is, a rate that does not include a project risk premium. It is
assumed that project risks not accounted for in the cash flows will be
accounted for through a virtual insurance premium (9). The reason
is that the PPP option accounts for all project risks in its cash flows,
including systematic and nonsystematic risks and uncertainties, and
risks not accounted for in the operational cash flows are accounted
for in the financing costs.
• Base revenue estimate is as follows:
– Average annual daily traffic in Year 3 of 21,600 vehicles, with
no growth over the project’s life (for simplicity) and
– Average toll rate of $2.00 in real (i.e., base year) dollars,
increasing at the rate of inflation (i.e., 3% annually).
• Revenue reduction for “leakage,” uncollected tolls amounting
to 5% of revenues, throughout the project’s life.
• Revenue reduction during a 2-year ramp-up period (Year 3 and
Year 4 of project life) as follows:
– Year 3 = 67% reduction and
– Year 4 = 33% reduction.
Assumptions for PPP Options
The conventional procurement is to be compared with two PPP
options—an availability payment concession and a toll concession.
With an availability payment concession, the public agency retains
all revenue and agrees to provide regular payments to the private sec-
tor in the operations phase on the basis of the facility’s availability
102
and level of service achieved. With a toll concession, the private-
sector partner has the right to retain all revenues generated by the
project during the concession period.
The availability payment PPP option would have a design–
build–finance–operate–maintain delivery structure with availability
payments made by the public agency during the 28-year operations
period of a 30-year concession term, contingent on meeting perfor-
mance standards. The toll concession PPP option would also have
a design–build–finance–operate–maintain delivery structure with a
28-year operations period. Both PPP options would have the following
characteristics:
• DB cost reduction relative to PSC is 10%.
• O&M cost reduction relative to PSC is 5%.
• Risk allocation is as follows:
– 50% of DB phase risk costs transferred to concessionaire,
– 100% of revenue risk transferred to concessionaire under
the toll concession only, and
– 100% of other operations phase risk costs transferred to the
concessionaire (assumed for simplicity in presentation of the
analysis—in reality, some operations phase risks will usually
be retained by the public sector).
• Private-sector risk management efficiency would result in 25%
lower risk costs relative to the PSC for all transferred risks except
for toll revenue risk (which would not be reduced under a PPP).
• Inflation, discount rate, and revenue assumptions are the same
as for conventional procurement.
Financing costs for the availability payment concession are assumed
to be as follows:
• Project funded 80% by debt and 20% by equity;
• Average debt interest rate amounting to 6.0% (versus 5% for
PSC) with a required average debt service coverage ratio of 1.15,
no grace period, and no fees; and
• Required return on equity amounting to 12%. (For simplic-
ity, a posttax rate is used, and the tax rate for taxes paid by the
concessionaire is set to zero.)
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. It would therefore have higher costs
for financing—higher revenue risk will result in lenders and equity
investors requiring a higher risk premium, resulting in a higher
weighted average cost of capital (WACC) than for the availability
payment model. Financing costs for the toll concession are assumed
to be as follows:
• Project funded 70% by debt and 30% by equity;
• Average debt interest rate amounting to 7.0% (versus 5% for
PSC) with a required average debt service coverage ratio of 1.3, no
grace period, and no fees; and
• Required return on equity amounting to 14% posttax, with the
tax rate for taxes paid by the concessionaire set to zero.
Developing A Public-Sector Comparator
This section discusses the results obtained by inputting the assumptions
discussed in the previous section in PPP-VALUE.
Transportation Research Record 2450
Net Present Cost Without SPV Risks
The net present cost (NPC) results displayed on the output sheet
of the PSC tool for the various risk scenarios (without SPV risks)
are shown in Figure 1. They are based on a discounted cash flow
analysis, which discounts the streams of revenues and costs (income
and payments) to estimate the value of the project in today’s dol-
lars. In the first two columns of the table shown in Figure 1, the
NPC is provided for the initial project costs or “raw PSC,” which
excludes risk adjustments, in nominal and present value dollar
terms; the rest of the columns provide the present values of risk-
adjusted costs at the 10th percentile, 70th percentile, and 90th
percentile values, so that the results may be presented as a range
of numbers rather than as a single, absolute figure. The 70th per-
centile is recommended by FHWA for cost estimation for major
projects. It is also a rough approximation of market-based pricing
of risk-adjusted costs.
The table of results groups the project costs in the first section
of the table to calculate the cash outflows. The first three line items
do not have values because all construction phase costs including
risk costs are assumed to be financed and therefore appear as cash
outflows in the line items on principal debt payments and interest
and fee payments at the bottom of the list in the first section. Oper­
ations phase base costs, including O&M costs during the 28-year
period, add up to more than $203 million in present value terms,
much less than the $280 million in real dollars that might be calcu-
lated on the basis of the $10 million per year operations phase base
costs multiplied by the 28 years in the operations phase. The differ-
ence between the $280 million estimate for total costs in real dollars
and their equivalent present value of $230 million reflects the effect
of applying the 3% inflation rate to obtain nominal dollar costs and
then discounting those nominal costs at a 5% rate.
Financing costs (debt payments, interest, and fees) include not
only borrowing costs for the base investment and for risks during
the DB phase, but also for financing costs for reserves required by
lenders for debt service and for O&M. Since the interest rate is equal
to the discount rate used to calculate present value, one would expect
financing costs to be roughly equal to the issuance costs of 2% of the
amount borrowed. However, the present value of the combined pay-
ments of principal and interest and fees may exceed the present value
of the DB phase risk-adjusted costs because of the extra financing
costs incurred to maintain reserves and for up-front borrowing to pay
for debt service before toll revenues begin to flow in.
Toll and other revenue amount to about $290 million in present
value and is subtracted from the present value of total public agency
payments to obtain the NPC of the PSC. This amount represents the
shortfall or the additional funding (in present value terms) that the
procuring agency will need to provide to make the project financially
feasible.
Sensitivity and Scenario Analysis
A sensitivity analysis is essential for assessing how different values
of a single assumption can affect the overall NPC. The PSC tool
includes a sensitivity analysis to illustrate the sensitivity of the NPC
results to changes of 10%, 20%, and 30% in key assumptions for
costs and revenues. The lower part of Figure 1 shows the sensitiv-
ity analysis results from the PSC tool, run for the P70 confidence
level for the hypothetical project. The columns provide the resulting
NPC of the PSC when the variables identified at the top of the col-
DeCorla-Souza103

Nominal Discount Rate Results - Initial Project Payment ($) Results - Risk Adjusted Payments ($)
Nominal Value of PV of Payments PV of Payments
Present Value (PV) of PV of Payments with
5.00% Initial Project with P10 Risk with P90 Risk
Initial Project Payments P70 Risk Adjustment
Payments Adjustment Adjustment

Payment Item
Design and Construction After Subsidy - - - - -

Construction Phase Transferable Risks - - - - -

Construction Phase Retained Risks - - - - -

Operations 239,823,466 101,692,152 101,692,152 101,692,152 101,692,152

Routine Maintenance 239,823,466 101,692,152 101,692,152 101,692,152 101,692,152

Periodic Maintenance - - - - -

Operations Phase Transferable Risks - - - - -

Operations Phase Retained Risks - - 20,338,430 40,676,861 61,015,291

Other Project Costs (ROW, etc.) - - - - -

PSC Adjustments - - - - -

Principal Debt Payments 119,235,597 48,231,007 53,054,108 57,877,209 62,700,309

Interest and Fee Payments 116,683,413 68,670,961 75,887,514 83,104,066 90,320,618

Total Payments $ 715,565,942 $ 320,286,272 $ 352,664,355 $ 385,042,439 $ 417,420,522

Toll and Other Revenue (700,700,670) (290,082,714) (290,082,714) (290,082,714) (290,082,714)

Total Payments After Toll and Other Revenue $ 14,865,272 $ 30,203,558 $ 62,581,641 $ 94,959,724 $ 127,337,808

Sensitivity Analysis of Results

Select the Risk Percentile and the Result

P70 $
Type from the Drop Down Menus
Routine and Periodic
Multiplier Construction Costs Operating Costs Toll Revenue
Maintenance Costs
–30% $ 59,866,647 $ 63,658,820 $ 63,658,820 $ 191,432,141

–20% $ 71,453,462 $ 74,026,129 $ 74,026,129 $ 159,139,978

Run
–10% $ 83,160,152 $ 84,458,994 $ 84,458,994 $ 126,850,264 Sensitivity
0% $ 94,959,724 $ 94,959,724 $ 94,959,724 $ 94,959,724

10% $ 106,829,514 $ 105,530,614 $ 105,530,614 $ 63,700,962

20% $ 118,753,660 $ 116,174,430 $ 116,174,430 $ 32,853,967

30% $ 130,721,107 $ 126,894,176 $ 126,894,176 $ 2,022,091

FIGURE 1   PSC tool output sheet. (The payment value shown for the items in the first three rows represents any unfinanced payments for
the agency. Repayment of the debt utilized for these items is reflected in principal debt payments. ROW 5 right of way.)

umn (i.e., construction costs, operating costs, routine and periodic
maintenance costs, and toll revenue) are changed by the percentages
identified in the rows (i.e., −30% to +30%).
A scenario analysis feature enables users to change individual
assumptions to assess the effect that changes in a set of assump-
tions have on the NPC results. It can also provide a means to assess
financial viability under alternative assumptions such as different
toll rates or project life assumptions. However, changes in traffic
demand that may occur as a result of toll rate changes are not taken
into consideration. The scenario analysis input table is located in
the output sheet and displays key project assumptions, their cur-
rent values based on inputs on the assumptions sheet, and arrows
to adjust the value of the current assumption. As users change the
key assumptions, they can observe resulting changes in the NPC
results table.
Calculating the Costs of Systematic Risks,
Long-Term-Performance Risks,
and Project Coordination Risks
In conventional procurement, in addition to risks quantified in a
normal project risk assessment, the public agency bears systematic
risks, long-term-performance risks, and project coordination risks
that would be borne by a concessionaire under a long-term PPP
contract. These risks are called SPV risks. The literature suggests
four ways to deal with them:
• Value the risks in cash flows. The advantage of this method is
that, in theory, it is straightforward and easy to follow. However in
practice the valuation often proves to be very complicated, particu-
larly concerning the valuation of typical concessionaire coordination
104
and interface risks—categories associated with the long-term and
integrated characteristics of the contract.
• Value the risks in a market-based discount rate. The advantage
of this approach is that there is market-based information available
for risk pricing, and the risks are priced in the same way in the
PSC and the SB, making them directly comparable. However, using
this approach with solely negative cash flows (as in an availability
payment PPP option) may lead to counterintuitive results: a higher
discount rate (which means risk costs are higher) leads to a lower
NPC. Consequently, this approach may be appropriate if NPC is
not used to determine the project value but only to compare the two
delivery methods.
• Value the risks in a virtual insurance premium. The virtual risk
premium may be estimated as the difference between the present
value estimate of life-cycle costs based on an appropriate discount
rate reflecting concessionaire risks (based on market information
on similar projects) and an estimate of the same costs based on a
project-risk-free discount rate. The approach is demonstrated later
in this paper.
• Value the risks by using a negative risk premium in the discount
rate. In this method, the discount rate is calculated by subtracting from
the project-risk-free discount rate a risk premium calculated as the
difference between the concessionaire’s WACC and the project-
risk-free discount rate. This approach will increase the NPC of the
PSC as the risk increases, and addresses the problem of counter­
intuitive results in the second approach. An issue with this approach is
that the PSC will use a different discount rate than the PPP option, and
that difference may be difficult to explain to nontechnical reviewers.
For the hypothetical project, the third approach has been chosen—
that is, the calculation of a virtual insurance premium. This premium
calculation is based on the difference between the present values
of revenues received by a concessionaire calculated on the basis of
the project-risk-free discount rate and the same revenues with the
WACC of the concessionaire as the discount rate. This calculation
is made after the development of the SB by using the SB tool as
discussed in the next section.
Developing the Shadow Bid
The SB tool is structured to provide an illustration of three differ-
ent PPP delivery structures: availability payment concessions, toll
concessions, and shadow toll concessions. Shadow tolls are similar
to availability payments except that payments to the private opera-
tor are calculated on the basis of the volume of traffic using the
facility. This paper demonstrates results from the SB tool for the
hypothetical project, for an availability payment concession, and
for a toll concession.
Availability Payment Estimation
The annual nominal availability payment is calculated in the SB
tool by a goal seek function. A goal seek is a what-if analysis tool
that calculates the input values needed to achieve a goal. The goal
of the “payment calculation” is to identify the funds needed to meet
the required equity rate of return given the project cash flows. The
payment calculation goal seek solves for this amount by selecting
different payment amounts and checking whether they are sufficient
to meet the targeted equity return. When an amount is detected that
provides an after-tax cash flow equal to the required rate of return,
Transportation Research Record 2450
the availability payment is solved and the amount of the first annual
payment is shown in the output sheet for the base (no risk) and the
P10, P70, and P90 risk-adjusted project cash flows. The availability
payment is assumed to increase at the rate of inflation (input as the
consumer price index) through the life of the concession.
The nominal availability payment for the first year, calculated for
the hypothetical project as provided in the SB tool’s output sheet, is
shown in the upper part of Figure 2. Payments throughout the con-
cession period are provided in the toll and other revenue sheet of
the SB tool. The NPC of all payment amounts and additional costs
incurred by the agency in delivering the PPP project is shown in the
value-for-money analysis results section of the output sheet as shown
in the lower part of Figure 2.
Estimation of Payments for
a Real Toll Concession
With an availability payment concession, the SB tool allocates all
toll revenue to the public agency, and the revenue is subtracted to
obtain the net public agency cost in the value-for-money analysis
results. With a real toll concession, however, the private entity
retains all revenue and uses this revenue to deliver the project and
meet its financing commitments. The tool calculates the subsidy
that would be required by the concessionaire if the revenues are
inadequate. If there is a revenue surplus, the tool calculates the pay-
ment the concessionaire would need to make to the public agency.
For the hypothetical project, the upper part of Figure 3 shows the
funds that the private entity would require from the public agency
to deliver the project and pay its debt and equity obligations, tak-
ing into account the toll revenues it collects. The real toll goal
seek function calculates a single payment to be made by the public
agency at the end of the construction phase. The value-for-money
analysis results section of the output sheet shown in the lower part
of Figure 3 shows the present values of the completion payment
amounts, called “availability payments” in the table, and the other
costs incurred by the agency in delivering the PPP project.
NPC Results
The lower parts of Figures 2 and 3 present the NPC results tables for
the two PPP options for the hypothetical project. A 5% discount rate
was used to obtain the present values of all costs and revenues—that
is, the same rate as that used for the PSC. NPC results are provided
for the initial project estimate, which excludes the risk adjustments,
and for the risk-adjusted NPC at the 10th percentile, 70th percentile,
and 90th percentile values. The tables include present values of
• Payments to the concessionaire (called “availability payments”
in the tables),
• Retained DB phase risk costs borne by the public agency (since
it is assumed for simplicity that all operations phase risks are trans-
ferred, no retained risks are shown in the operations phase), and
• Toll revenue for the availability payment scenario. (For the toll
concession, toll revenues are not shown because they are not a public
agency cash flow. They flow directly to the concessionaire, thereby
reducing the required public payments shown in the first row.)
The tables of results sum the project costs to indicate total payments
before revenue. Any revenues generated by the project and retained by
the agency, such as toll revenues in an availability payment concession,
 Availability Payment Analysis

Select payment analysis output from the drop-down menu

Availability Payment

Payment Calculation
Select Accuracy

P10 P70 P90

Initial Project Estimate 50000

Annual Nominal Payment Amount: 15,089,286 16,187,500 17,299,107 18,410,714

Value for Money Analysis Results

Manual Input Initial Project Payments ($) Risk Adjusted Payments ($)

5.00% Nominal Value of Initial Present Value (PV) of PV of Payments with P10 PV of Payments with P70 PV of Payments with
Project Initial Project Risk Adjustment Risk Adjustment P90 Risk Adjustment
Payment Item
Availability Payments $ 723,752,961 $ 306,892,387 $ 329,228,341 $ 351,836,686 374,445,030

Construction Phase Retained Risks $ - $ - $ 4,434,779 $ 8,869,557 13,304,336

Operations Phase Retained Risks $ - $ - $ - $ - -

Other Project Costs (For Agency) $ - $ - $ - $ - -

Total Payments Before Toll Revenue $ 723,752,961 $ 306,892,387 $ 333,663,120 $ 360,706,243 387,749,366
Toll and Other Revenue $ (700,700,670) $ (290,082,714) $ (290,082,714) $ (290,082,714) (290,082,714)
Total Payments After Toll Revenue $ 23,052,290 $ 16,809,672 $ 43,580,406 $ 70,623,529 97,666,652

FIGURE 2   SB tool output sheet for availability payment PPP option.

Payment Scenario Analysis

Real Toll calculation assumes one payment is made at the end of
the construction period The project assumptions should be reviewed before running any scenarios. Please consider how a scenario impacts the Project's Timing
Assumptions; Design, Construction, Operations, Maintenance and Other Project Cost assumptions; Risk Values and Allocation; Revenue and
Tolling assumptions; Project Financing assumptions; Tax and Depreciation assumptions; Discount Rate; and Efficiency assumptions.

Real Toll
P10 P70 P90
Initial Project Estimate

Real Toll Payment: 36,488,281 49,137,106 63,654,986 87,235,065

Shadow Toll #DIV/0! #DIV/0! #DIV/0! #DIV/0!

#DIV/0! #DIV/0! #DIV/0! #DIV/0!

#DIV/0! #DIV/0! #DIV/0! #DIV/0!

Project IRR Analysis

Calculate IRR Project IRR 8.25%

Value for Money Analysis Results

Manual Input Initial Project Payments ($) Risk Adjusted Payments ($)

5.00% Nominal Value of Initial Present Value (PV) of PV of Payments with P10 PV of Payments with P70 PV of Payments with
Project Initial Project Risk Adjustment Risk Adjustment P90 Risk Adjustment
Payment Item
Availability Payments $ 36,488,281 $ 31,519,949 $ 42,446,480 $ 54,987,571 75,356,929

Construction Phase Retained Risks $ - $ - $ 4,434,779 $ 8,869,557 13,304,336

Operations Phase Retained Risks $ - $ - $ - $ - -

Other Project Costs (For Agency) $ - $ - $ - $ - -

Total Payments Before Toll Revenue $ 36,488,281 $ 31,519,949 $ 46,881,258 $ 63,857,128 88,661,264

Toll and Other Revenue $ - $ - $ - $ - -

Total Payments After Toll Revenue $ 36,488,281 $ 31,519,949 $ 46,881,258 $ 63,857,128 88,661,264

FIGURE 3   PSC tool output sheet for toll concession PPP option (IRR 5 internal rate of return).
106 Transportation Research Record 2450

are reflected in the toll and other revenue line and subtracted from the viously by using a 5% discount rate. This process results in estimated
total payments to obtain total payments after toll revenue. present values of SPV risks under the three risk scenarios as follows:

• P10 estimate: $329.2 million at 5% discount − $239.5 million

Sensitivity and Scenario Analysis
As with the PSC tool, the SB tool provides a sensitivity analysis
to illustrate the sensitivity of the NPC results to changes in each
key cost and revenue assumption. As with the PSC tool, the SB
tool provides a scenario analysis capability that enables changes
to be made to key project assumptions. After making changes to
any of the key assumptions, users need to solve again for the avail-
ability payment amount for an availability payment concession, for
the completion payment amount for a toll concession, and for the
shadow toll amounts for a shadow toll PPP option. Scenario analysis
may be conducted to estimate the effects of modifying assumptions
such as toll rates and term of the concession.
Estimating the Virtual Insurance Premium
As indicated previously, while SPV risks are reflected in the NPC
results of the SB tool through the higher financing costs relative to
the PSC, the NPC results from the PSC tool do not include SPV
risks. A virtual risk premium must be calculated and added to the
NPC of the PSC to account for these risks. This procedure may
be done with the SB tool to calculate the difference between the
present values of public payments to the concessionaire under two
different discount rates—the risk-free rate and a risk-adjusted rate,
which accounts for the market-priced risk premium as reflected in the
WACC of the concessionaire. The present value of the risk premium
must then be added to the PSC as an adjustment. This calculation is
presented below for the hypothetical project.
To estimate the value of SPV risks for the availability payment
option for the hypothetical project, the following steps were taken
with the use of the SB tool. First, the present value of the availability
payments under the availability payment concession was calculated
by using a 7.2% discount rate (i.e., the approximate concessionaire
WACC calculated from the financial inputs). Next, this value was
subtracted from the present value of the same payments obtained pre-
at 7.2% discount = $89.7 million,
• P70 estimate: $351.8 million at 5% discount − $255.0 million
at 7.2% discount = $96.8 million, and
• P90 estimate: $374.4 million at 5% discount − $272.4 million
at 7.2% discount = $102.0 million.
To estimate the SPV risk costs for the toll concession, the process
is somewhat more complicated because payments to the conces-
sionaire come from two sources—payments from the public agency
(in the form of a completion payment) and payments from users (in
the form of tolls). The present values of both payments must be cal-
culated by using the risk-adjusted discount rate, which is estimated
at 9.1% (i.e., the approximate concessionaire WACC calculated
from the financial inputs for the toll concession). First, the present
value of the completion payment is calculated by rerunning the SB
tool with a 9.1% discount rate. Next, the present value of the toll
revenue is calculated by rerunning the SB tool with the 9.1% dis-
count rate, but since toll revenue does not appear as a line item in the
NPC results table under a toll concession (because it is not a public
agency cost), it is necessary to obtain the present value of toll rev-
enue by clicking on the availability payment option when rerunning
the SB tool. The two values are then added, and are subtracted from
the present value of the same payments obtained previously with
a 5% discount rate. This process results in present value estimates
of SPV risks as follows (the first number in the parentheses is the
completion payment and the second value is the toll revenue):
• P10 estimate: $(42.4 + 290.0) million at 5% discount −
$(37.8 +160.3) million at 7.2% discount = $134.3 million,
• P70 estimate: $(55.0 + 290.0) million at 5% discount −
$(49.0 +160.3) million at 7.2% discount = $135.7 million, and
• P90 estimate: $(75.4 + 290.0) million at 5% discount −
$(67.1 +160.3) million at 7.2% discount = $138.0 million.
The virtual insurance premium estimates are added to the NPC
estimates of the PSC obtained from the PSC tool, resulting in
adjusted PSC estimates. The results are shown in Table 1.

TABLE 1   Value for Money Estimates

Risk-Adjusted NPV,
by Probability

VfM Estimation Process P10 P70 P90

Availability Payment Option

a  PV of PSC without SPV risks, from PSC tool
N 62.5 95.0 127.3
b NPV of virtual insurance premium 89.7 96.8 102.0
c Adjusted NPV of PSC (a + b) 152.2 191.8 229.3
d NPV of AP concession 43.6 70.6 97.6
e VfM of availability payment concession (c − d) 108.6 121.2 131.7
Toll Concession Option
f  PV of PSC without SPV risks, from PSC tool
N 62.5 95.0 127.3
g NPV of virtual insurance premium 134.3 137.5 138.0
h Adjusted NPV of PSC (f + g) 196.8 230.7 265.3
i NPV of toll concession 46.9 63.9 88.6
j VfM of toll concession (h − i) 149.9 166.8 176.7

Note: NPV = net present value; AP = availability payment.

DeCorla-Souza107
VfM Assessment
A comparison between the PSC and the PPP estimate (i.e., the SB)
completes the quantitative VfM process. To determine which pro-
curement structure provides better VfM to the public sponsor, the
analyst must compare the NPC of the PPP estimate from the SB tool
with the NPC of the adjusted PSC after accounting for the virtual
insurance premium.
The adjusted PSC estimates and comparisons with the two PPP
options are shown in Table 1. VfM is calculated by subtracting the
NPC of the PPP from the adjusted NPC of the PSC. For the hypo-
thetical project, a saving is estimated for the PPP options, regardless
of risk level, suggesting that the reduced risk and life-cycle cost
efficiencies under the PPP options bring significant value.
Table 1 suggests that the availability payment concession has a
higher NPC than the toll concession at the higher risk levels. Since
the debt interest rate and equity rate of return for the availability
payment concession are lower than for the toll concession (because
toll revenue risk is not reflected in its financing costs), one would
have expected the toll concession to be more costly. The lower cost of
the toll concession results simply from the fact that a high proportion
of payments from the public agency are made through a completion
payment that is made early in the concession period, while availability
payments made with the availability payment concession are spread
over a much longer period. As a result the toll concession conces-
sionaire does not have to finance as much of its investment over a
long period, reducing its financing costs. The significant impact of the
relatively early payment by the public agency under the toll conces-
sion suggests that for a fair financial comparison between procurement
options, it is important to ensure that the timing of any public subsidies
is consistent between all options (conventional as well as PPP), or that
appropriate adjustments are made to the analysis to account for the
differences in the timing of payments.
There will always be some uncertainty concerning the appropriate
discount rate as well as the risk cost estimates. These factors can sig-
nificantly affect the outcomes of the VfM assessment. It is therefore
suggested that outcomes of VfM analysis be presented as a bandwidth
to avoid creating false precision in the results. Also, in making the final
VfM determination, qualitative assessments should be considered.
Cautions and Conclusions
VfM assessment can facilitate the decision-making process for the
choice between delivery methods and can do so transparently. VfM
should not be a black box that only financial experts can understand,
because the VfM assessment is also an important communication
tool for explaining the concept of VfM to the general public. In that
regard, the suite of PPP-VALUE tools is helpful to public-sector
officials. It assists them with developing a thorough understanding
of VfM concepts so that they can explain them to the public. How-
ever, PPP-VALUE and VfM analysis itself have limitations, which
must be clearly understood. These are discussed below.
Valuing Public Benefits
A key issue with the use of VfM analysis is that the quantitative
analysis takes the perspective of the public agency sponsor and
focuses only on financial impacts to the sponsor. To assess whether
a PPP is beneficial from a societal perspective, an analyst must take
a broader view of the public as a whole, including users and non­
users of the project, and must consider all economic resource costs
and not just financial cash flows.
Taking a broader public view will lead to more direct consid-
eration of public benefits such as user and nonuser benefits from
earlier delivery of a project. In the United States, the choice is often
not simply between alternative types of procurement approaches, but
may also be between implementation of a project on schedule as
planned through a PPP or a delayed implementation of the project
through conventional procurement. The reason is that conventional
procurement is often delayed if there are borrowing limits or other
funding constraints on public agency sponsors. In some cases, proj-
ect implementation could be delayed indefinitely without a PPP.
With VfM analysis procedures, stretching out the construction of
a project and delaying the start of operations could significantly
reduce the present value of its life-cycle costs relative to an on-time
PPP project delivery because of the impact of discounting as costs
are pushed further into the future. In other words, delaying con-
struction may be “beneficial” to the financial balance sheet of the
procuring agency but could deny significant benefits to the public
at large. It is for this reason that sound VfM analysis requires that
the PSC reflect roughly the same schedule as the PPP alternative.
FHWA is currently conducting research to develop a benefit–cost
analysis approach for PPP evaluation to help compare procurement
options that reflect significant differences in schedule.
Treatment of Toll Revenues
Toll revenues are, in effect, a direct payment from the public to the
toll operator. If the PPP concessionaire is responsible for setting toll
rates under a toll concession, it may be able to increase toll reve-
nues by charging higher rates (but within limits imposed by the PPP
agreement). If this is incorporated into an SB for the toll concession
model, a lower NPC that compares more favorably with the PSC
may result, even if there is no difference in total costs excluding toll
revenue. But the public nevertheless bears the costs of higher tolls,
and from a societal perspective it is questionable whether a PPP can
be considered a better VfM if the only source of that higher value is
the higher revenues from tolls.
Treatment of Financing Costs
In the United States the federal government has provided a num-
ber of direct and indirect opportunities for subsidized financing of
transportation infrastructure, including tax-exempt debt (such as
municipal bonds or private activity bonds), tax credit bonds (such
as Build America Bonds), and subsidized direct loans (such as loans
under the Transportation Infrastructure Finance and Innovation Act).
Accounting for such subsidies within the VfM financial analysis
could potentially produce different results from analyses that treat
these subsidies as being external from the perspective of the state or
local public agency or of the PPP concessionaire. Of particular con-
cern in this hypothetical project analysis is how these subsidies may
affect the calculation of the virtual insurance premium that is added
to the risk-adjusted PSC.
PPP-VALUE Limitations
A number of assumptions and formulas are included in the PPP-
VALUE tools that may not be suitable for all potential scenarios.
 108
A financial tool used to model a PSC or SB for a real-world project
is highly customized to reflect its unique project structure and to
optimize the financing needed to deliver the project for the lowest
cost. The PPP-VALUE suite has been constructed so that users are
able to understand each step in the VfM analysis process. While
this aspect provides greater clarity to users in how each tool pro-
duces outputs, it limits the flexibility of PPP-VALUE to produce
the most efficient results from a financing perspective. For example,
the financing structure allows only one debt facility, which cannot
be optimized to make the most efficient use of financing throughout
the construction phase. More flexible debt financing options would
typically be seen in financial models used when a detailed VfM
analysis is conducted for a real-world project.
Also, the PPP-VALUE PSC tool has been designed for projects
with a dedicated revenue stream such as tolls. If a project revenue
stream is not available or is inadequate, the balance of funds needed
to operate a project is borrowed at the beginning of each year to
ensure sufficient reserves for debt service and O&M costs. This step
results in the tool calculating extra financing costs. These costs may
tip the balance against the PSC in a comparison with a PPP option
since similar “borrowing” by the public agency to make periodic
availability payments or completion payments is not included in
the SB tool.
Acknowledgments
The author acknowledges the valuable comments on an earlier ver-
sion of this paper from several reviewers of the TRB Revenue and
Finance Committee.
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The views expressed are those of the author and not necessarily those of the
U.S. Department of Transportation or FHWA.
The Revenue and Finance Committee peer-reviewed this paper.