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Difference between Quantitative

and Qualitative VfM Criteria

Owain Ellis
12 June 2008
Contents

• Pros and Cons

• Qualitative VfM Criteria

• Quantitative VfM Criteria

• Challenges
Why Assess VfM ?

• Starting Point:
– Major capital investment

• Desired End point:


– Optimum and enforceable risk allocation to the private
sector partner
When is the VfM assessment made?

• Programme level

– Suitability of using private finance

• Project level – pre market launch

– Important decision point

• Procurement level

– Check that procurement will deliver the forecast VfM benefits


Qualitative assessment - Viability

• Measurable and definable outputs, clear scope


• Operational flexibility
• Inclusion of soft services
• Equity/efficiency reasons for private sector service
provision
• Strategic/ regulatory issues
Qualitative assessment - Desirability

• Risk Management
• Innovation
• Duration, requirement and asset life
• Lifecycle costs
• Do the benefits outweigh the costs?
Qualitative assessment - Achievability

• Market capacity and interest


• Timing
• Procurement time scales
• Value
• Procuring authority skills and resources
Balanced Approach

• Balanced qualitative and quantitative assessment

• Evidence-based approach

• Generic VfM model


VfM Quantitative analysis

Identify cost inputs

Adjust costs for Optimism Bias

Factor in finance cost assumptions

Adjust for:
•Flexibility
•Tax
•Life cycle investment
Measuring VfM - Public Sector Comparator (PSC)

• Same outputs specified under PFI

• PSC helps to determine:


– indicative costs (as benchmark)
– risk transfer
– VfM of private sector bidders’ solutions
Public Sector Comparator

Typical Profile of Net Present Cost of PSC vs. PFI

Risks retained, that are


transferred under PFI

Total net present value


of PFI Co’s unitary
charges, over life of
NPV of PSC contract
risk transfer

NPV of PFI
NPV of PSC cash flows
Total value of public sector cash flows
delivering same outputs over
life of contract
– Design and build costs Risk retained Risk retained
– Operating costs
by Authority by Authority
PSC PFI
Measuring VfM - Public Sector Comparator (PSC)

• Key considerations:-
– sensible costing
– proper use of advice
– benchmarking with similar schemes
– recognition of risk and uncertainty
– optimism bias
– established public sector discount rate
Technical Adjustments

• Unbundled discount rate - time preference rate of 3.5%

• Optimism Bias factored in to investment appraisal

• Monetisation of non financial benefits and costs

• Material tax differentials recognised and monetised


VfM Analysis – Input Sheet
General PFI Funding
Timings (Yrs) Rates - Escalators & Discount Rates (%) Base Year Gearing (%) 90%
Contract period 29 CapEx escalator 4.5% 0 Sterling swap rate (%) 5.15%
Initial CapEx period 5 OpEx (non employment) escalator 2.5% 0 Credit spread (bps) 12
Year when OpEx is first incurred 5 OpEx (employment) escalator 3.5% 0 Bank margin (bps) 100
Unitary charge escalator 50% 0 Tail for bank debt (yrs) 2
Real discount rate 3.5% NA Commitment fee (bps) 50
Upfront fee (bps) 90
Costs Grace period (yrs) 1
Whole Life PSC OB Pre (%) OB Post (%) PFI OB Pre (%)
Initial CapEx (£'000) 65,250 10% 30% 71,775 10% Unitary Charge
Lifecycle costs at each LC date (£'000) 6,535 10% 30% 1,076 10% Initial CapEx period payment (%) 50%
Lifecycle intervals (yrs) 10 NA NA 1 NA
OpEx (non employment)(p.a.) (£'000) 1,075 10% 20% 1,183 10% Pre Tax IRR Targets
OpEx (employment per person) (p.a.) (£'000) 20 NA NA 20 NA High 18%
OpEx (employee number) 25 NA NA 25 NA Medium 15%
Transaction Low 13%
Public sector (£'000) 1,958 10% 10% 1,435 10%
Private sector (£'000) 0 0% 0% 1,077 0%

Third Party Income PSC OB Pre (%) OB Post (%) PFI OB Pre (%)
Income ( p.a.) (£'000) 475 10% 10% 575 10%

Flexibility PSC PFI


Scope change year 10 10
Probability factor (%) 50% 50%
Level of scope change (%) 50% 50%
Premium flexibility factor (%) 0 10% bps Basis Points
CapEx Capital Expenditure
Indirect VfM Factors PSC PFI LC Lifecycle Costs
Amount (Npv)(£'000) 0 2,000 NA Not Applicable - no input required
OB Pre Pre-FBC Optimism Bias
Tax PSC PFI OB Post Post-FBC Optimism Bias (for PSC only)
PSC adjustment factor (%) 6% NA OpEx Operational Expenditure
PSC Public Sector Comparator (i.e. conventional procurement)
Lifecycle Related Adjustments Input required
PSC lifecycle VfM adjustment 40% Hard-wired Assumption - no input required
Residual cost benchmark 50%
PSC residual cost factor if lower than benchmark 70%
PSC residual cost factor if higher than benchmark 35%
#END
VfM Model - Challenges

• Timing: Decision making tool or demonstrator?

• Optimism Bias: availability of a reliable evidence base (PFI & PSC)

• Data management - double counting

• Limitations of a standardised approach

• Care over presenting numbers


Conclusions

• Qualitative VfM Assessment assists with decision at


Programme and Project levels

• Quantitative VfM Assessment assists with demonstration


of VfM at Procurement level

• Limitations - Part of Business Case approach