Presentation: PDF
Webinar recording: Audio
Homework assignment: Value for Money Analysis Part 1: Developing the Public Sector Comparator
P3-VALUE Webinar
February 21, 2014
Patrick DeCorla-Souza
P3 Program Manager
Center for Innovative Finance Support
Co-Instructor: Aaron Jette, Volpe Center
Victoria Farr: Thank you, Tim. And on behalf of the Federal Highway Administration's Innovative Program Delivery office, I would like to welcome everyone to today's webinar, the Value for Money Analysis Homework Assignment Review. My name is Victoria Farr. I'm with the U.S. Department of Transportation Volpe Center in Cambridge, Massachusetts, and I will be facilitating our question and answer period and providing technical support today. Our main presenter, Patrick DeCorla-Souza who is a P3 program manager in the Center for Innovative Finance Support was called away to Capitol Hill today, so my colleague Aaron Jette who is a Policy Analyst at the Volpe Center will be filling in. I will introduce him momentarily but before he begins I would like to point out a few key features of our webinar room. On the top left of your screen you'll find the audio call in information. If you are disconnected from our webinar at any time, please use that call information to reconnect to our audio. Below the audio information is a list of attendees and below the list of attendees is a box titled, "Materials for download" where you may access a copy of today's presentation as well as the homework assignment that we'll be reviewing. So to download a file you may click either one or both files in the pod there and click "Download files" then follow the prompts on your screen. Please note that a new tab or window may open in your browser to complete the download. Below the download box in the lower left corner is a chat box that you can use to submit questions to our presenters throughout the webinar. We will also take questions over the phone during our Q&A period and further instruction will be given at that time. If you have any technical difficulties please use the chat box to send a private message to myself, Victoria Farr. Our webinar is scheduled to run until 3:30 p.m. Eastern today and I wanted to remind you that we're recording the webinar so that anyone who is unable to join us may review the material at a later time. And with that, I will turn the webinar over to Aaron Jette. Aaron?
Aaron Jette: Thanks, Victoria. My name is Aaron Jette, I'm filling in for Patrick today. I helped developed the homework assignment so I'm very familiar with it and I'll walk you through it today using the tools. So our objective today is to show you how to use the tools to do a value for money analysis. If you've done the homework and have questions, that's great, if you haven't done the homework, that's fine, I'll walk through it today and you can see how we use the tools to do value for money analysis. So this webinar is a follow-up webinar. Patrick presented in January, the Value for Money Analysis Webinar in which you had an opportunity to download this homework. You may have also participated in the North Carolina workshop, that was a face to face workshop in North Carolina in which is also gave a presentation on value for money. So if you didn't have a chance to participate in that webinar, here's a link that you can use to listen to that recording. Patrick will go over sort of the conceptual principles behind value for money analysis in that. Today we're really going to go through the mechanics of how you do it using the tools.
So this webinar is in two parts, the first part is a value for money analysis for an availability payment project and the second part we'll do a toll concession project.
After participating in this office hours webinars, you should be able to explain value for money analysis results from the run to the PSC tool and the Shadow Bid tool, understand the types of sensitivity tests by changing different assumptions in the tools, undertake a value for money analysis using availability payment P3 concession project and explain its results. So using the tools you'll be able to run these values for money analyses using hypothetical projects and different types of project structures, availability payment structure and a toll concession structure.
So part one here, value for money analysis for an availability payment P3 project. In the presentation in January, Patrick walked you through this hypothetical project and at the time he used a very simple Excel spreadsheet based model to kind of walk you through the results. This time we'll use the slightly more complex P3-Value tools and walk through the same assumptions in the tool. So the value for money analysis that we'll be doing, we'll be looking at a project delivered by either the public sector or by the private sector. The PSC, the public sector comparator is that project delivered by the public sector in this case using a design bid build or design build structure. So we're going to assume that the base design and construction costs are $100 million, 30 million for the first year, 70 million in the second year, that there's an annual O&M cost of $10 million that we're going to be comparing the PSC to a concession that's 30 years in lengthy, two years for the construction and 28 years for the operation. So we'll be looking at O&M costs over that 28 year period. In the value for money analysis, we need to consider risk costs, we need to consider risks in both the design build phase and the operations phase. We have some very simple assumptions that we're using to demonstrate value for money analysis today. You can also use the Risk Assessment tool which is part of the P3 Value toolkit to assess individual risks and come up with a set of risk costs that can serve as inputs into the PSC tool and the Shadow Bid tool, if you wish you to do a more comprehensive value for money analysis where you include assessments at the costs of individual risks. So if you have an itemized list of risks and have assessed their probability and their potential impacts, you can use the risk tool to create a risk register and calculate risk cost at the P10, P70, P90 and use those as inputs into the PSC tool and Shadow Bid tool when conducting a value for money analysis. In this case, just for simplicity's sake, we're not going to use the risk assessment tool, we're not going to use an itemized set of risks in a risk register, we're just going to assume very simple set of risk cost. In a design build phase, $10 million at the P10 level, so there's a ten percent probability that the risk costs will be at or below $10 million, at the P70, 20 million and at the P90, 30 million. So these are risk costs that will be applied to cash flows in the design-build phase. The risk costs for the operations phase, so these are risk costs that will be applied to each year in the operations phase, will be one million at the P10 level, two million at the P70 level and three million at P90. And then all the other project costs will be zero, just for the sake of simplicity. So what the PSC tool and the Shadow Bid tool does with these risk inputs is it applies these two cash flows in either the construction period or the operations period. And you'll see that when I walk through the tools.
We also need to make some assumptions about financing. In the homework assignment, we had you run through both a draw and a bond scenario for the financing costs. We're going to assume that all of the construction costs are financed, that they'll be financed at an interest rate of five percent over 30 years. We're going to assume that there are some issuance costs to the debt of two percent and that there will be some debt reserves and O&M reserves that will need to be financed as well. So the PSC tools and the Shadow Bid tools have a simplified set of financial assumptions in that there aren't multiple tranches. On the other hand, they do use reserves and they do set aside reserves for both risks and base borrowing, so that will add to the overall financing costs. And you'll see that when I show you the finance worksheet and the Excel tools. The inflation we'll assume to be three percent annual inflation and that will apply to all the costs in the O&M period. And the discount rate will be five percent. We'll consider this the risk free discount rate, that is, it's the rate that we're going to assume here that we're using the rate that is the public agency's borrowing rate. And we're going to assume that the risk cost that I showed you earlier account for all of the risks that would affect cash flows. So that's a risk that would be transferred to contractors and risks that would be retained by the public agency for each phase. There's a set of risks that are difficult to quantify in this typical risk register Monte Carlo analysis that we use in the Risk Assessment tool, these are systematic risks. Often the private sector will price those risks in their financing and discount those risks using a higher discount rate based on the financing costs. For simplicity's sake, in this first set of runs, we're going to assume that those systematic risks are also included. Later I'll show you how to use these tools to calculate these systematic risks, to calculate the virtual risk premium that is typically included in the private financing cost. So that difference between the public sector finance rate and the private sector finance rate, the private sector finance rate reflects risks that are not included in the public sector's finance rate but are real risks that will affect the public sector as well as the private sector. So if those are not accounted for in your risk costs, then you have to account for them in a different way and we'll show you how you might account for those using the PSC and the Shadow Bid tools.
So finally, we're going to assume that this is a project that has toll revenues associated with it, that those toll revenues are based on traffic obviously, average annual daily traffic of 21,600 vehicles, that traffic does not grow. So we're just going to for simplicity's sake assume that it has the same amount of daily traffic every year throughout the 28 years of the operations period, that the toll rate is just a flat simple $2 per vehicle, and that toll rate will increase at three percent in line with inflation every year. So that accounts for a base revenue in year three which is the first year of operations of 17.2 million. We're going to use the tools to account for some revenue leakage or a five percent reduction in tolls due to, let's just say toll cheaters or unenforceable toll use. So with that five percent discount, we'll get to 16.4 million. And then we'll also assume that there's a ramp up period so that traffic won't reach 21,600 vehicles until year five. So year three we'll see only a third of those 21,600 vehicles and in year four we'll see two-thirds of those vehicles. So those are the assumptions that we'll be using for the PSC.
Now, the Shadow Bid, we're looking at the same hypothetical project, the same base costs, but we're going to make some adjustments to those costs. So to begin with the structure that we'll first look at for the private sector delivery model will be a design, build, finance, operate, maintain with availability payments over a 30 year concession term. The toll revenue will not be allocated to the private sector but rather to the public agency. So the public agency will retain all the toll revenues and then make payments to the private sector based on an annual payment to the private sector based on the private sector meeting performance standards. We're going to assume that there's some efficiencies in this DBFOM structure that allows the project to be delivered at lower costs in terms of construction design build costs and lower O&M costs. So ten percent reduction in the overall design and construction costs and a five percent reduction in the O&M costs per year. And we're also going to assume that the risks that have been transferred to the private sector will be those that the private sector are better able to manage and/or have better incentives, stronger incentives to manage so that there'll be some inefficiencies there as well. So in this structure we're going to assume that 50 percent of those risk costs that I showed you earlier are transferred to the private sector and all of the operation phase risk costs are transferred to the private sector. And of those risks that are transferred to the private sector that those risks, costs associated with those risks are reduced by 25 percent either because the private sector is better able to avoid those risks or better able to mitigate those risks.
The financing costs will be different for a privately financed project, the equity and bank debt, so here we'll have 80 percent bank debt and 20 percent equity to fund the project. We'll assume that 80 percent bank debt will be at an interest rate at six percent, versus the five percent we use for the PSC and that the hurdle rate or the required after tax return on equity is 12 percent. So that 20 percent equity will effectively give it a 12 percent return for the sake of calculating the overall financing costs of the project. Like with the PSC we will have reserves and there'll be costs associated with those reserves. And then for simplicity's sake, we won't include any consideration of taxes, so we'll assume that taxes are zero on any equity returns. Inflation will be the same as it is in the PSC, three percent and the discount rate will be the same as it is in the PSC of five percent. Again, we're assuming that all the project risks are accounted for and the operational cash flows through contingencies and through risk premiums and the financing cost, this discount rate is not intended to account for any risks, this is a risk free discount rate.
So now I'm going to go into the tools and show you how I entered these assumptions into each of the tools. So I'm going to share my screen and it'll just take one second while I pull this up. So, hold on one second, here we go. You should see now on your screen, the PSC tool. So when you open the PSC tool, if you haven't done this already, you might have a yellow bar that says, "Enable content." Sorry, I've got the wrong - I had the Shadow Bid tool open, I'm going to go into the PSC tool here. So here you have the PSC tool, there's a provision here that just advises you that, this tool is not meant to calculate actual value for money of an actual project that - really this is just to demonstrate to you how you might run a value for money analysis. If you were trying to conduct an actual value for money analysis, you'd want a more robust tool. This tool is designed as an instructional tool and so there are some aspects of this, particularly the financial structure of the projects that have been simplified for the purposes of this tool. Still, a very complex tool, those of you that have tried to use it, know that. But let me proceed. So you have to accept this caveat before you begin. So once you've accepted this it takes you to the tool index. You can navigate the tool using this index or you can just use the tabs that are at the bottom of the screen here. So I'm going to go the assumptions, I'm going to show you quickly how I've entered the assumptions that I just reviewed with you into the tool. Let me just make this a little larger for you. So to begin, we're just going to start with this example scenario. We're going to use the toll scenario template and I'll show you what that means in just a second. Like I said earlier, so this is a PSC but we need to enter in the project delivery structure we're comparing, the public sector delivery method to here. So I've got design, build, finance, operate, maintain and like I said earlier, there's toll revenues associated with this project as well. So I've checked off all of these boxes. If you uncheck any of these boxes, you'll see that some of these boxes black out. So if you're not considering toll, you don't need to consider when the tolling period starts. But as you see, I've checked off all these boxes and I've put in my assumptions here in terms of timing. I've got a base date here of two years, this is effectively the date to which all the cash flows are discounted to. I might want to update this to 2014 now but for now we're doing it as 2013, construction starting this year, 2014, construction period of two years. Just the way the tool is structured, all the blue fields are assumption fields that the users - the input fields and the white fields are calculated automatically based on the blue fields. So I've got like I said earlier, a two year construction period, a 28 year operation period, and operations as soon as the construction ends in 2016. I've zeroed out any of these - you can enter in other project costs. You can change these fields here, these cost type fields to whatever you want. We've sort of pre populated these fields and some typical project costs but you can change these as you wish and you can change the timing of these costs here, they can begin at the base date, 2013 or when construction starts or when construction ends, et cetera. But for now, just for simplicity's sake, we've zeroed that out. Our construction costs are here, these are really design and construction costs. You can enter construction costs for as many as eight different assets. We'll just for simplicity's sake have one, just label it Oak Road, overall cost of $100 million, 30 percent in the first year, and 70 percent in the second year. And you can go out to ten years and there's just a little check sum in case, so you don't go over 100 percent or stay under 100 percent in terms of allocating your cost for the year. Like I said in the assumptions, the O&M costs are going to be a total of $10 million per year. Sorry if I'm moving around too much but here you have five million for operating costs, five million for maintenance costs, these are applies on an annual basis. You can also enter in periodic maintenance costs for your rehabilitation, reconstruction, and repair type costs that might occur on a ten year or eight year cycle. You can enter in - for simplicity's sake, we're not doing anything with those costs here but the tool will accommodate that and you can enter in a period of years in which say you have a $10 million reconstruction cost. Total revenue leakage, five percent, I've entered in here and then I've entered in my ramp up. You can do a ramp up of up to a six year period and I've entered in my two years of ramp up here. We're not assuming any other non-tolling revenue but you do have the option of entering that. You can also enter a project subsidy. What's meant by a project subsidy here is any funding that comes from outside of the public agency, so this might be a federal grant or any sort of funding that's coming from outside of let's say if you're looking at this from the state DOT's perspective, any funding that might be coming from the federal government or any other sort of external to that state DOT you can include here as a project subsidy. We're going to assume zero percent again for simplicity. In terms of the percent of project funding through financing, you could assume that some of this funding is paid for as pay go. We're going to assume, and this is really to assist us in our comparison with the Shadow Bid that 100 percent of the project is financed. So all of the $100 Million construction costs are financed through this one debt tranche which we're going to start by assuming that this is a draw. So it's a 30 year draw, two percent issuance fee, five percent interest rate, we're going to look at a semiannual payment structure, debt service coverage ratio at 1.2 and no grace period. You may have noticed if you did the homework, that the bond costs, the financing costs for the bond are significantly higher than the financing costs for the draw, I'll explain that in a little bit. But I think the best approach is to use the draw for now, I think because we've simplified the financing structure so that we only have one debt trench, the draw is actually probably more representative of what a realistic financing cost might be for a project like this. So the draw is really just borrowing funding as needed to meet those construction costs, so it'll borrow 30 years - 30 million in year one and 70 million in year two, whereas the bond will borrow 100 million in that first year. Plus there's also additional borrowing for the reserves as well as risk costs. But I'll show you that in a second. So inflation costs you have here, you'll see there's several different inflation costs that you can enter, CPI, that's consumer price index. So this can be the overriding inflation rate that you use, you could just enter three percent and that's it and that affects all the O&M costs. You can also, if you want, enter in separate rates for construction versus operations. Let's say you think the construction costs are going to inflate at a higher rate than the operations phase costs, you could enter in five percent in this field or some other rate in this field. We've entered zero percent because we're just going to assume that $100 million is not going to be inflated in the next couple of years. But the operations costs we are going to assume are affected by inflation at a three percent rate. And we're also going to inflate our toll rates. So that two dollar rate that I went over is going to go up by three percent each year. Here you have our risk cost, so in the PSC scenario, 80 percent of those design build risks are going to be retained by the public sector and 20 percent will transferred to the private sector. And during the operations phase, the public will be solely responsible for that operations cost, if it's 100 percent of the risk cost will be allocated to the public sector. The schedule allocation, it doesn't really matter, we don't have any schedule cost assumptions here, so we just have 100 percent here, 100 percent in the operations phase. But these could be zero percent, it doesn't really matter because we don't have any cost impacts, scheduled cost impacts assumed. So like I showed you earlier, the design build costs are 10 million, 20 million and 30 million for P10, P70, P90 respectively. And then for the risk values, so the one million, million, three million that I showed you were fuel, cost and now I've just - now I wanted to show you the total, we need to enter the total risk cost over the operations period. So there's 28 years in the operations period, so for P10, 28 times one, 28 million, P70, 28 times two million, so that's 56 million, et cetera. So that's what I've entered into the operations phase cost. We don't assume any schedule impacts. The discount rate is here, it's five percent, that's our risk free debt rate. You can enter in some PSC adjustments such as competitive neutrality adjustments, here affecting either the construction phase or the operations phase and they can be on an annual basis or on a total overall adjustment. But again, for simplicity's sake, we're not going to assume any adjustments. Finally, I want to show you the - as I mentioned earlier, this is a toll revenue project, we're using the toll scenario template here. We've provided some other tolling scenarios that you can use as well but here we're just - to show you a simple example, we're going to use the toll scenario template which we've populated below on another tab. So if you look below here, I'm going to navigate to the toll scenario template and you'll see here that I've just made a very simple set of assumptions. You can get much more complicated if you wish but here I've just entered two dollars per vehicle and then I've entered in 7,884,000 vehicles per year for all of the periods of all my operation periods. So this toll scenario template, that's our last input field, so once you've populated this you have all the basic inputs that you need to reflect that project scenario that I went over with you in the slides. The rest of these cash flow worksheets are just to show you the mechanics of the tool and the basic cash flows of the project that are calculated based on the assumptions you've entered. So here you see construction costs and how they've been allocated. You'll see these are semiannual cash flow periods so these first two periods, that's year one, these are year two, so 30 million in year one, 70 million in year two. You can look at your O&M costs, so these are now inflated costs over the operations period. So this is the five million per year inflated out to year three here that you're seeing and five million in maintenance inflated out to year three and those increase, are inflated out throughout the operations period. If you had entered any other project costs, they'd be reflected in this worksheet. These are my risk costs that I entered earlier. Here's the traffic scenario that we're using that's based on the traffic template assumptions that I showed you earlier and then the revenues are just the traffic multiplied by the rates. So here are the total revenues. And here you see the leakage, that five percent leakage as well as the ramp up that are being subtracted from that base toll revenue to calculate the overall revenue in each cash flow period. We don't have any PSC adjustments and we have no subsidies. The financing in this is interesting, worksheet, I suggest if you really want to understand this tool, that you spend some time looking at this financing worksheet. You'll see here we assumed a draw, so you see that the tool has a base borrowing of 100 million and that it's borrowing to pay for the construction costs in each period, so as needed. So there's 50 million for that first set of construction costs, 50 million for that next set of construction costs, 100 million over the two years and there's also issuance cost as well as interest cost that are paid for, so for a total set of payments over the 30 period of the loan or debt of 194 million. There are also some reserves that are set up and these are debt reserves to pay for interest costs, debt service costs. So there'll be some payments, financing costs associated with those debt reserves. And finally there'll be some financing and reserves associated with the risk costs, with the construction risk costs. So these are that 10, 20 and 30 million in risk cost that I assumed for the P10, P70 and P90, those are financed in addition to that base 100 million of construction cost. So here you see the financing costs associated with each of those. These are the risks that have - so of those risk costs, most of those risk costs are retained by the public sector but 20 percent of the design build risk costs are transferred, so these shows the transferable risks. So since this is the PSC, we're assuming this is delivered by the public sector but that some of the construction and construction risks will be transferred to a private entity. These are the risks that are retained by the public sector. And this is just a summary of all those cash flows that I just reviewed with you. Okay, here you see my overall toll revenues and the cash flows for those toll revenues, the debt financing and the risks. So to see results you do have to - you should see a disclaimer, read that, it's the same disclaimer that you see when you open the tool, accept that disclaimer and then we have our results here. So the results show both the nominal as well as the discounted results and then the risk adjusted results for different cash flows, for the different costs. So this is a five percent discount rate, overall operations costs, not discounted are 239 million and then once we apply the five percent discount rate, they're 101 million, same with the maintenance costs are the same. And then we have these risk costs, so these are the operations phase risks that are retained by the public sector. And finally, the reason why you don't see any construction costs, so you don't see any design and construction costs, is because all of those design and construction costs are fully financed, it's 100 percent financed, so they're reflected in these principal debt payments and interest and fee payments that you see at the bottom of this table here. So these are effectively the construction costs, the construction risk costs and the cost of financing the construction and construction risk costs. So you see here the total payments are - I'm looking at the P70, Federal Highways recommends that project managers, those responsible for estimating costs use a P70 risk adjustment in their estimates. So here you see 357 million in total payments and then I have those revenues that I assumed, so those revenues are 290 million, overall discounted project costs or the total payments that the public sector is responsible for, after the revenue are approximately $67 million. Below this table you'll see there's a sensitivity analysis. The way to read the sensitivity analysis table is first you have to quick run sensitivity and it'll run, it'll calculate these fields for you. The way to read this is if construction costs were ten percent lower, the overall - let me run this quickly for you, it does take a little while to run, it's actually taking a long while here for some reason. Here we go. So now that I've run that, you'll see that the base here is the same as my P70, so it's 67 million. If the construction costs were ten percent lower, then the overall total payment after toll and other revenues would be 57 million. If the operating costs were ten percent, you'll see that the overall project cost payments after toll and revenue would be ten million dollars less. And you can see from this that the variable that tends to have the strongest effect of those four on the total payments is the toll revenue. If that were to be reduced then the cost of the project would go up by $32 million or about 30 percent or so. So the other analysis that I can do here in the output field is I can adjust assumptions here, so I can raise the concession length, I can change the interest rate on my bond, I can change the inflation rate and if I change these, then I could look over here and I'll see changes in my results. We didn't ask you to do that in the homework and I won't show you that now. And finally you can see this table here which shows the results in terms of present value and the various costs that the - with no risks, with the P10 risk adjustment, the P70 risk adjustment and the P90 risk adjustment. If you have any questions about the PSC tool, feel free to press star one to talk to the operator or enter questions into the chat box. I'm going to go onto the Shadow Bid but if you do have any questions I can go back. There's not very many of you on the line so I'm not going to pause for any long period of time, but like I said, just press star one to talk to the operator and I can go back to the PSC tool or enter your questions into the chat box. So you should have done that, you should have gotten these results, if you had done the homework, you would have gotten these results. Then the next component of the homework would be to fill out the Shadow Bid. So this is the Shadow Bid tool. And I won't spend as much time because it's very similar structure to the PSC tool. It has the same disclaimer at the beginning, we have to click, "I accept." I get to this very similar navigation page and then go to assumptions again. This is similar but not exactly the same as the PSC tool but you'll see I have the same timing assumptions, the same project delivery structure as I did in the PSC tool, same construction costs. Doesn't really matter what row you have this in. I have operating costs of five million per year, maintenance costs of five million per year, same toll revenue leakage, and same toll revenue ramp up. Now you start to see some differences here. So the first difference that you'll see is in the project financing you'll see that I can assume a percent of project finance from debt just like in the PSC but now the remainder is not funded as some pay go with no interest costs associated with it but rather is funded through equity. So I have below here in row 66, an equity return or this is the - so this is the hurdle rate that we're assuming, that the equity to invest in this project demands a certain amount of return. In this case we're going to assume a 12 percent return. So 80 percent of the project is financed at an interest rate of six percent, slightly higher than the five percent in the PSC and the remaining 20 percent, we're assuming an equity return of 12 percent on that. I'm also looking at a draw here and a debt service coverage ratio of 1.2. So here I have my same inflation, three percent, same discount rate, five percent. You may have noticed earlier that I had entered in the same construction costs and the same operations and maintenance costs as PSC even though I said in the presentation that there are some private sector efficiencies. This is where I'm entering my private sector efficiencies, in these fields here. So I have a construction cost efficiency of ten percent, I'm not assuming any schedule efficiency and I have efficiencies in terms of operations and maintenance costs as well of five percent. So this will just lower those cash flows by ten and five percent respectively. If you do assume taxes, then you also have to make some assumptions about depreciation. Just for simplicity we have zero percent tax cost here. So these depreciation assumptions don't really have any effect on our results. The risk cost is a little complicated because we only wanted to in terms of these allocations because we wanted to make sure that only the risks that are transferred are - that we only applied that if you remember, the 25 percent efficiency in terms of risk management, that we only want to apply those to the transferred risks. So it just gets a little complicated in terms of how we allocate those risks. So we've adjusted those allocations just to reflect that fact that only - because we've lowered these risk values by 25 percent but really only those risks that have been transferred to the private sector are reduced by 25 percent. So with the design build, not all of those risks are being transferred to the private sector, some are retained by the public sector. So we've had to just adjust our cost allocation to reflect the fact that 25 percent efficiency is only applied to the transferred risks. All these other costs are zero, we have other project costs as well as any additional funding for agency costs, so these are effectively any kind of subsidy that's applied to these other project costs, so we have zero percent here as well. It's the same structure in terms of the cash flow sheets for the most part. You'll see here some slight differences but effectively the same toll rate structure, I've got two dollars, I just have it for two axle vehicles, I had it under motorcycles in the other PSC tool but it's the same number of vehicles, the same toll rate, so it's the same toll revenues for both projects, for both the PSC and the Shadow Bid. These are the same cash flow worksheets that I showed you in the PSC tool. The one exception, well so here you see project financing, we do have some lines here for equity contributions, so this is the 20 percent equity contribution here. And then, here's a depreciation worksheet. So if you are assuming taxes, this depreciation comes into play in terms of calculating the taxes on the equity returns. The same cash flow summary except there's an equity contribution line. This is my other project cost sheet and it's the PSC and retain risks, obviously they're less than they were in the PSC but I still have some, so these are included here. The one big difference is this private cash flow summary is just the cash flow to the private sector rather than the cash flows to the public sector. It's just a different perspective. Again, I got the same disclaimer before I see results, I click, "I accept." And then here I need to calculate the availability payment. Those of you that did the homework saw that this takes a little bit of time to calculate the payment. I'm not going to do it right now just in the interest of time. But you'll see that it basically runs a go seek function to determine the availability payment that would be required to provide that 12 percent return on equity based on the project cost cash flows that we've assumed. So the annual payment that it - now this is an inflated payment so this is the initial payment in the first year at the end of construction, so in this case that would be year three. The first payment to the private sector based on this project structure would be $17 million and that'll be inflated at the - our assumption for CPI inflation. So this $17 million payment will go up by three percent each year for the 28 years remaining in the concession period. That's how the private sector is compensated. But I wanted to run a - if I were to assume that instead I'm going to transfer all these toll revenues to the private sector and have this be a real toll concession, so have all the payments to the private sector - have an initial public sector payment to the private sector and then allow the private sector to retain the toll revenues, I can calculate a real toll payment. Or I can assume that there's a shadow toll payment and then it'll calculate the required toll rates. So here are the final results that are discounted based on that five percent discount rate. So this is the overall total cost to the public sector of these availability payments, discounted by five percent, that's 350 million. This is what we'll compare to the PSC results. Most of the risks are transferred to the private sector and are reflected in the availability payments but some of the construction phase risks are retained by the public sector and we need to count those, so that's this $8.8 million here. So altogether, that's $360 million, $351 million in payments and another nine million in retained risks. So that's 360 million and then you have to remember that the public sector is retaining the toll revenues, so if I subtract the toll revenues from the total payments, that's a total of 70 million. And I can compare that to my PSC results. I'll just pull up the PSC tool here and you'll see at P70, the PSC tool, the total payments including all the risks after tolls and revenues was approximately 67 million. Now with the Shadow Bid, so we've assumed some efficiencies but then we also have higher financing costs, the total payment discounted at a five percent rate are 70 million. So it's marginally better if we're going to compare these two costs, the PSC appears to be marginally better by about $4 million in net present costs. So that's sort of a very basic value for money analysis. You'll see here that there's the same sensitivity analysis. This sensitivity analysis in the Shadow Bid tool actually takes a really long time. If you tried it, you'll notice it can take ten minutes on some computers because it's running this very complicated sensitivity analysis go seek function to do this sensitivity analysis. You'll see I ran it in advance so I have my results here. And then I can also adjust my assumptions here, I can either go back to my assumptions page or I can adjust them right here. But once I adjust those I have to run the payment calculation again. So you'll notice, so for the homework we had you run both an availability payment concession and a toll concession and we had you do - we also wanted you to look at the differences in the bond versus the draw financing costs. So just quickly, I'll go back to the PSC tool and just show you the differences in the bond costs versus the draw costs. So I had 67 million here for the cost of the PSC, assuming a draw type of financing. If I change those assumptions to a bond debt type you'll see that the overall costs go up quite significantly. And that's largely because of the timing of the costs and the amount that's borrowed. So you're doing the borrowing sooner and you're borrowing more because you have to have higher reserves to cover the interest costs. There are some glitches in the tool related to the bond costs that we're working on fixing now and once we get those fixed, that are actually increasing the financing costs on the risks more than they should be, we're working to fix those now, so we'll put up a new version of the tool once we get those fixed in the next couple of weeks. In the meantime, we recommend when you're using this version of the tool to use the draw based assumptions just because you can see here that there's a dramatic difference in the payments using a draw versus a bond assumption in the tool. So like I said, we're trying to fix that. The bond will generally be higher even without those glitches but partly due to those glitches, it's much higher. So I just wanted to show you that because that was part of the homework, we did want you to at least kind of look at that and see how that might affect your overall cost, how some financing assumptions can really strongly affect the results. The next thing we wanted you to do in the homework was to run a toll concession versus an availability concession. So the toll concession we use slightly different assumptions. We - so let me go back to the assumptions here and just show you those different assumptions. So we assumed that the financing cost would be slightly higher and that the - so I'm going to raise the interest rate from 6 percent to 7 percent. And we assumed that the - in a toll concession - so basically what we're saying is that the toll concession is - you're transferring demand risk in a toll concession so that the risk to the private sector is going to be higher. So the interest rate will be higher, reflecting that higher risk, and the structure of the financing might be different as well, based on that higher risk. So here we're going to assume that 70 percent of the project costs are debt-financed and 30 percent are financed through equity, and that the hurdle rate for the equity is higher too - 14 percent. So this is going to raise our financing costs, but those higher financing costs reflect that the demand risk that the private sector is taking on. Now I have to calculate those results, so I'm going to go back to my output page here, and rather than calculating availability payment, I'm going to look the real toll. And I have to click on Real Toll here to calculate this, and you'll see - again, here it's running this Goal Seek function, so it takes a little time to calculate. So you see it's calculating it now, and the difference here is that it's - we're not looking at a series of annual payments, but rather a one-time payment to the private sector, and that payment, it's assumed, is made at the end of the construction period. So it's just going through its calculations now. And then we're also of course assuming that those toll revenues are transferred to the private sector. So you see here that based on our assumptions, what the tool is telling us is that at the P70 level of risk, the private sector would demand a 63-million-dollar payment from the public sector at the end of construction, plus it would retain the toll revenue. So you'll see, if you remember in the availability payment, the total payments after toll revenue were approximately 70 million. So I believe it was about 350 million dollars in availability payments, or 360 million dollars - yeah, 350 million dollars in availability payments plus your retained risks, but then we were subtracting the 290 million in toll revenues to get about 70 million dollars in payments after toll revenue. So here we don't have the toll revenue, so the private sector is actually asking for less in payments; it's also getting paid sooner, rather than over 28 years. And so there's less - those total payments are being discounted - those nominal payments are being affected less by the discount rate. But overall with the discounting, it's slightly lower - 63 million versus - or 64 million, if we round up - versus 70 million in the availability payment. So you can use the tool, again, to sort of evaluate some different structures, how that might affect the net present cost of a project. So, we had you do that in the homework. So that was the first part of the homework. I'm going to pause now and just see if you have any questions before I go on to the next part of the homework. So you can press *1 or you can ask questions in the chat box. So this is really just the most basic form of value-for-money analysis. Using this - having the same discount rate in both the PSC and in the Shadow Bid, and we're just using the risk-free rate; we're not - so, you can - you'll notice if you look at some of the literature, best practices in value-for-money that some people recommend that you use this approach, using the risk-free discount rate, and others recommend other approaches. Some recommend that you use a different discount rate for the private sector than you use for the public sector. Some recommend that both the public sector and the private sector use the private sector's cost of capital, or the weighted average cost of capital, as the discount rate, as a way of accounting for risks that aren't included in - that haven't been applied to the cash flows. What we show you in the homework is a third approach. After showing you the sort of basic approach, there's another way to account for - let's say there are some systematic risks, like inflation risks, project coordination risk, toll demand risks - risks that are accounted in our risk register, that we haven't already applied to the cash flows. We need to account for those somehow, and what we show you in the homework is a way to do that. So, in the homework, what we have you do is adjust the discount rates. So, let me go back. I'm going to run the availability payment again and at the risk-free rate. And what we're going to do is we're just going to record a couple of these results, and then we'll run it another time, but we'll run it based on the weighted average cost of capital. So the only thing I'm looking for here are the toll revenues, because I want to be able to record what the toll revenues are at the risk-free discount rate. So those are - so just take a note here - those are 290 million. So now I'm going to go back, I'm going to readjust my assumptions here. I'm going to go back. We're going to look at the availability payment first. So what we're accounting for here is what's called the virtual risk premium, and to do that first I want to - I'm going to look at the availability payment structure first. So I've adjusted my assumptions back to my availability payment. So 80 percent debt, 20 percent equity, 12 percent hurdle rate, and 6 percent interest rate. What I'm going to do differently here is I'm going to adjust my discount rate, and I'm going to make that the weighted average cost of capital. And I'm doing that because I want to see the difference in the financing - difference in the overall cost if I use this - if I discount it at the cost of my weighted average cost of capital. Because I'm going to use that as a proxy for the systematic risk cost, or the virtual risk premium. So I go back now to my BSM output, and now I rerun my toll. So you see here I - so if you remember, we had initially, with the availability payments, we had a - what was our - we had about 70 million dollars under the 5 percent discount rate. Under the WAC discount rate, the weighted - under the 7.2 percent discount rate, we should expect to see a lower net present cost of availability payments. And we're going to look at the difference in those costs and that will account for the virtual - yeah - that will account for the virtual insurance premium. So actually, since the toll - let me just backtrack a little bit. We actually want to look at the payments - the total cost of the availability payment - that difference. So the availability payments were 351 million, because now my tolls and revenues are discounted too. And I want to disregard that because that won't affect my - that's not included as part of my risk premium. What I want to look at is the difference in the availability - the net present cost of the availability payments at the 5 percent discount rate, the risk-free discount rate, compared the net present cost of the availability payments at the discount rate that's equal to the weighted average cost of capital for the private sector. So that is - so we're going to basically - it's 351 million minus 255 million, or approximately a risk premium of 96 million. And that accounts for all these risks that may not have been in our risk register - so inflation rate risk, demand risk; there may not have been - there's some risks associated with just project coordination and long-term performance that are often not accounted for in the risk registers that we typically see, but may be accounted for in the project-specific weighted average cost of capital for the private sector. So what we're going to do is take that 96 million that we've calculated here by running our Shadow Bid availability payment at the discount rate equal to the weighted average cost of capital. We're going to apply that 96 million to our PSC cost. So for the PSC - let me run this again at - I need to make this a draw again. So our PSC we originally estimated was approximately the - before the toll revenues - was 357 million. Now I have to add - I'm going to add 96 - that difference that I just calculated, that 96 million, to the 357 million to get approximately 452 million.
It might be easier if I show you here in the presentation. So I'm going to just flip back here. We had you do sort of gymnastics in the homework assignment. So let me just go to that slide here. So here are the instructions.
So here's that 350 million minus the - 351.6 million minus 255.8 million, so 95.8 million dollar risk premium - present value of the risk premium.
And we're applying that to the PSC with the draw option, the total payments - this is before we subtract the toll revenues. That's 452.9 million. And if we compare that - so what we've basically done is we've said, "Okay, well, when we did the PSC at the risk-free rate, we weren't really accounting for - even though we added risks to the cash flows, we didn't capture all those risks." There's actually a large amount of risk that's associated with those toll revenues, with inflation, that we failed to account for. So now we're going to add those in. So if we add those in, you'll see, whereas before the PSC compared - it was a very close comparison to the Shadow Bid. Once we add in those other risks, that virtual risk premium, you'll see that the value for money tilts strongly in favor of the Shadow Bid. And these are typically risks that aren't considered by the public sector necessarily when estimated lifecycle costs. And so this is one method that you can consider those costs. You could also try to account for those costs in your risk register as well; it's just it's not - it's just a challenge to do that. So we've tried to do that here, using this method.
You can do the same thing for the toll concession. It's just a little more complicated.
So, if you remember, I had you look at - so we had this 290 million in tolls and other revenues, but what we have to do now is - we're going to run the Shadow Bid concession, and we have to just remember that 290 million is the toll revenues at the risk-free rate, because when we run it at the weighted average cost of capital for the - now I'm going to run that same availability payment at the weighted average cost of capital for the toll concession, which is slightly different than it was for the availability payment because the financing costs - structure and costs are different. So again, I'm just going to go back to my screen share. I'm going to pull up the Shadow Bid Tool, and what I want to show you here - I'm going to go - again, I'm going to adjust these, make this 70 percent, make this 14 percent, and make my rate 7 percent. So my weighted average cost of capital now is a little different. It's about 9.1 percent. You might have seen this in the homework. And now I'm going to run - I'm not going to run a real toll; I'm actually going to run - I'm first going to run an availability payment at that 9.1 percent, because this is the only way - I need to find what the toll revenues would be at the discount rate for the weighted average cost of capital, and if I run the real toll, the tool won't tell me that. So this is kind of a workaround. I think in a future version of the tool we'll actually - we'll try to make it so that the outputs show you the total toll revenues, even though that isn't really factored into the public sector perspective of the payments under the real toll. So I'm running the availability payment calculation first, and what I'm going to do is I'm just going to record the toll revenues at the 9.1 percent discount rate. So I have - here you'll see a toll revenue of 160 million dollars. So I'm going to remember that; I record that. You remember that at the risk-free rate, these were 290 million, so now they're 130 million dollars less, because I'm discounting it at a higher rate - 9.1 percent versus 5 percent. I record that, and now I can run my real toll. So I've got all my real toll assumptions in there and I've got the weighted average cost of capital, that 9.1 percent is my discount rate. Now I'm running the real toll payment again. So I've clicked on Real Toll. It's calculating the payments. It takes a little while. Just give it a second. And once you've seen this, then I'll just go back to the presentation; I'll show you how - the little worksheet that we've created to, again, account for the virtual risk premium, this time in a toll concession. We're almost done here. Okay. So now the - I want to look at these payments again, so now I see it's 48.9 million, so I'm going to record that. So now let's go back to - so we had about 130 million dollars in difference in the toll revenues and there was some difference in the availability payments, or just payments from the public - they're not technically availability payments, but that one-time payment from the public sector to the private sector at the completion of construction.
So let me go back to my presentation and show you what we've done with those numbers that I just ran the tools to calculate. So, one second here while we pull up the presentation. Here we go. So you saw these worksheets in the tool. So what I've done now - what we're showing you here is here's the present value of the payments to the concessionaire using the risk-free rate. So that was the first time we calculated the toll concession, at that 5 percent discount rate. The total payments were 54.8 million. Now with that run we just did, we saw that the payments to the concessionaire were slightly lower; at that 9.1 percent discount rate, they were about 49 million. So that's a total risk premium for the payments of about 6 million. So then there's also - there's a significant difference in the toll revenues, which we also have to consider as part of the risk premium. So the toll revenues at the risk-free rate were 290 million; the toll revenues at the weighted average cost of capital discount rate were 160 million. So that's another 130 million dollars in - that's effectively your demand risk. So this is risk that the private sector is taking on, risk that toll revenues are not going to be as high as expected, as anticipated. So that's a significant amount of risk. So it's total virtual insurance premium of 135.7 million.
And now I have to apply that - now again, for comparison sake, I'm going to apply that to the PSC that I ran earlier with the draw option, and add that virtual risk premium to compare it with the toll concession. With the toll concession, I'm going to add in the toll revenue at that risk-free rate, so to get a comparison of 492 million for the PSC. So that's the PSC payments plus the risk premium at the P70 rate, and then the toll concession payments plus the toll revenues, that's 345 million, for value-for-money for the toll concession of 147.9 million.
So, to summarize - so just pulling from those earlier tables, once we've calculated that virtual risk premium and adjusted the PSCs, we get a substantial difference in the value-for-money, and we see that the value-for-money with the availability payment, just based on the calculations of the tools, is significantly better for the availability payment option compared to the toll revenue option. I'm sorry, the value-for-money is significantly greater for the toll revenue option compared to the availability payment option. So, in this sense, what the tool is telling us is that transferring that toll revenue risk to the private sector is maybe worth a significant amount of, and that may not be reflected in the risk cost that we previously calculated. So that's just something for consideration. We wanted to show you several different ways - I understand that this is pretty complicated, but we wanted to show you a few different ways to run a value-for-money and calculate the costs of risks and compare those costs of risks under different delivery mechanisms. So that's what I've tried to show you today.
Any questions about this? Thanks for bearing with me. I know this can feel a little tedious at times. These are complicated tools. They're still somewhat simplified compared to what a tool with, say, a full financial cost and a comprehensive financial structure might include, but it's complicated nonetheless. So thank you for bearing with us. If you have any questions, you can also - if you want to work with the homework assignment we've given you, now that you've had some introduction to the tools, and you have any questions, you can send to us in email at - Victoria, what's our P3 Value email?
Victoria Farr: P3-VALUE@dot.gov
Aaron Jette: Okay, great. So bear with us. We're going to type in - give you a helpline, if you will, that you can reach - this goes directly to my email as well as Patrick DeCorla-Souza also will see - the P3 Program Manager for Federal Highways will also see these. Just like I said earlier, we're still working out a few glitches in the tool, particularly when it comes to the bond financing assumptions, so we really strongly recommend that you use the draw financing assumptions for now, if you want to run through some scenarios with the tools. We tried to design these tools so you can kind of look under the hood and see how these cash flows change based on different assumptions. So they're really designed to just help train people on how to look at project finance models, how to look at value-for-money in different ways. There are a set of user manuals that you can get online at the Federal Highway's IPD website, and some primers as well that are associated with these P3 Value tools that I strongly recommend you look at if you plan on using this tool further. I hope this was helpful for you. Again, if you have any questions, I'll just pause, and you can type those into the chat box, or press *1. In the meantime, here is some upcoming webinars that you may be interested in.
There's a fourth tool that - right now we're kind of doing some extensive revisions to it, the Financial Assessment Tool, that allows the users to do some basic financial analysis of the - "Well, what if I had some TIFIA financing? How would that change the debt capacity of these cash flows?" for example. We're going to be using that tool and going over how to do some simple financial assessment of P3s on March 13. Patrick will be back then. Hopefully he won't be called up to the Hill again at the last minute. In April - we'll have a homework assignment associated with that like we did for this, and in April we'll go over that homework assignment and, again, just walk you through the tools. So again, thanks for joining us today. I really appreciate your time. Thanks for bearing with us. I see a couple people are typing, so I'm just going to hold on a second before we close. Several thank yous. Thank you, again, for joining us and sticking with us. Again, I know it's a lot to take in. And hopefully you'll get a chance to just play around with the tools. This webinar is just giving you some basic familiarity and a certain comfort level. And like I said, feel free to email us with any questions whatsoever and we can help you with any - if you get stuck with anything. Or if you see some strange results, if you think there might be a glitch - we're not claiming these tools are perfect. We're still trying to refine these tools. So, again, we really appreciate any feedback at all that you might provide. So if you do have that, just email us at p3value@dot.gov. Thanks for joining us today and have a good rest of your afternoon.
