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Appraising PPP Projects

46 Developing the Financial Model

At the Appraisal Phase, the project must be accurately described in financial terms to allow for several feasibility exercises to produce meaningful results. For example, the following appraisal exercises in box 4.5 use some variation of the financial description of the project.

BOX 4.5: Different Financial Assessment Exercises


What is Assessed?

Economic feasibility

All costs and benefits of the project to society.

Commercial feasibility

Private sector cash flows for the project under PPP delivery.

Fiscal feasibility /affordability

Public sector cash flows for the project under PPP delivery.

Impact on government debt and deficit

Impacts of the project as a PPP under the applicable public sector accounting regulations.

Value for Money

Public sector (or user) cash flows for the project under PPP delivery in comparison to public sector (or user) cash flows for the project under traditional delivery.

The tool that allows the assessment of commercial feasibility is the financial model. It is a spreadsheet computer file (in Excel or other compatible format) that incorporates, for the duration of the contract, all the expected private sector investments, revenues, costs, taxes, as well as several analytical parameters such as the cost of loans, the cost of equity, insurance parameters, and the relative inflation rate[6].

As discussed later in the chapter, the financial model is a tool that, when sufficiently mature, presents a financial base case of the project[7] (see section6.9)[8] — that is, the financial characterization of the project over its lifetime, considering the assumptions and decisions made during the Appraisal Phase[9].

Despite being built by the project team during the Appraisal Phase, the financial model is meant to reflect the best available information about the private partner’s future financial situation.[10] Thus, it primarily represents the financial description of the project company and the events and risks that determine its financial life cycle.

In reality, the model will serve many purposes during the PPP process[11] and will be adapted accordingly. However, at this stage, the model reflecting the financial life of the special purpose vehicle (SPV) serves a very fundamental need by assessing the feasibility of the project from several perspectives, as will be discussed further in the chapter.

The building of the financial model should begin with an assessment of existing financial data. At this stage, some financial evaluations would already have been done, and information might be dispersed throughout the project paperwork. The likely sources of information already available are as follows.

  • The CBA which can include financial data that may be used as the starting point of some financial values (see chapter 3.8), such as estimated potential revenue, total costs, taxes, and others;
  • The costs estimated in the process of defining the technical requirements (see section 4.2 above), which should provide estimated values on investment, maintenance, and operations costs;
  • The description of benchmark projects identified in the Technical Feasibility stage and the respective historic data available;
  • If the infrastructure already exists, current data on demand, costs, and revenue; and
  • Studies already conducted to assess the need for the project. For example, in transport projects there may be existing traffic and revenue studies.

The model deals with a diverse set of data, coming from different sources and yielding different results. While it is not the purpose of this chapter to teach details about financial modelling, the most relevant elements that should be considered in the model are described below.

  • The financial model is designed, at this stage, to reflect the estimated financial situation of the project company during the life of the contract;
  • This information will be later adjusted for other modelling purposes such as;
  • the estimation of the fiscal consequences of the contracts, and
  • the Public Sector Comparator.

[6] A detailed description of the uses of a Financial Model in PPP contracts can be found in Yescombe’s book: PPP: Principles of Policy and Finance (2007), chapter 10.

[7] In some countries, the financial base case that is concluded by the Financial Model is called a “shadow bid”, or the estimation of the financial calculations a private sector bidder would do before participating in the tender. The Financial Model, in the sense used in this document, plays a similar role since it represents the perspective of the project company. This has been defined as such to allow for several feasibility exercises to be conducted, such as the commercial feasibility exercise and the affordability assessment. The financial base case is sometimes described in a document called the Financial Plan, which translates the findings of the Financial Model into a descriptive document.

[8] The section 6.9 presents the issues related to uncertainties in the financial model including the uses a sensibility analysis and the construction of the base-case.

[9] The Financial Model will also be used during the life of the contract as a tool to support contract management. Duly updated to reflect the winning bidder’s financial and cost structure, it is used mainly to evaluate the impact of risks and changes in the project contract and implement them, and it is usually annexed to the contract. However, more frequently, the authority´s Financial Model is substituted for this purpose by the one constructed by the successful bidder (duly audited). 

[10] At the very bottom line of the model should be the estimated Free Cash Flow of the project company and the Free Cash Flow of the equity investor, upon which analytical tools are applied to reach several relevant conclusions, presented latter in this chapter.

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