The estimated NPV life cycle cost will be based on a number of inputs that come with an associated level of uncertainty. A sensitivity analysis should be undertaken to separate those inputs where the uncertainty is critical to the VFM estimate (and therefore critical to the decision making process) from those where the uncertainty is less important.
General steps to consider for the sensitivity analysis may include:
• Establishing the statistical and/or practical range of uncertainty for each input;
• Determining the significance each input has on value for money and ranking them accordingly; and
• Recognizing whether the inputs correlate negatively or positively with respect to value for money.
The selection of inputs to be analysed depends on the project, the financial and construction markets at the time the business case is prepared, and whether the risk of changes to the input has been evaluated in the risk assessment.
Value for money is impacted by the amount and cost of private financing and the risk of changes is generally not quantified in the risk assessment. Sensitivity analysis on financing inputs may therefore be required.
P3 projects benefit from an integrated design process to optimize lifecycle costs within a price-based competitive process. The efficiencies (construction and lifecycle) gained through this integrated process provide value for the P3 procurement. When significant value is assumed, sensitivity analysis around these inputs may be required.
P3 projects can also benefit from integrated construction methods that shorten the construction period. When significant value is generated from a shortened construction period (e.g. through reduced construction escalation or user benefits) it may be appropriate to test the impact of changing these inputs.
The following table provides examples of key inputs that may need to be evaluated through sensitivity testing:
Inputs | Typical Sources of Information and Supporting Evidence for Valuing the Cost of Inputs |
Project Size and Capital Costs | Planning studies, Owner's Engineering Consultant estimators and quantity surveyors, internal government records of historical unit prices. |
Operation and Maintenance and Cyclical Renewal /Rehabilitation Costs | Review of bids of similar past P3 projects, Owner's Engineering Consultant estimators and quantity surveyors, internal government records of historical unit prices, private-sector comparable information. |
Risks | Risk workshops, review of similar past P3 projects, historical government data based on past project experience. |
Construction Period and Operating Period Timelines | Review of past similar projects procured traditionally or as P3s. |
Construction Escalation | Annual research conducted by ministries of Transportation and Infrastructure, consultation with industry. |
Private Sector Efficiencies | Review of bids of similar past P3 projects, consultation with industry. |
Provincial Contribution | Market sounding, comparisons between similar past P3 projects, evaluation of project hand-back risk. |
Discount Rate and Inflation Rate | Consultation with Alberta Finance and Enterprise. |
Return on Equity, Return on Debt, Leverage Ratio | Capital Markets Consultant, Financial Consultant, Alberta Finance and Enterprise, research on recently closed P3 transactions, market sounding. |
The significance of the various inputs may not be the same from one project to the next. Furthermore, as the above list is not exhaustive, sensitivity analysis may be conducted on other inputs depending on the project, the financial and construction markets and risks quantified in the risk assessment.
Assessing the impact of all inputs is usually not necessary. The business case may include the results of changes in inputs that are significant and an explanation of the implications of any changes. The business case does not need to include all sensitivity analysis, but the results of all analysis should be retained in the project files.
Given that the business case is developed early in the project timeline, the accompanying sensitivity analysis should be revisited from time to time as the project evolves through the procurement process to determine if certain inputs and their related uncertainties have changed. Where changes are deemed material, the sensitivity analysis may require revisiting.
The relevance of the risk analysis relies on the robustness of the financial model through which the inputs are assessed. Expert advice in risk modelling may be required to determine the best analysis method to use for the specific project.
The Business Case Template may be found in Appendix D.2