In the early stages of project planning, the cost of capital is typically calculated using the rate of return determined based on a financial model of the capital structure of a project. This calculation requires developing a financial model that includes a potential PPP partner's financing structure, based on a combination of debt and equity financing.
Following the selection of a preferred proponent for a PPP, the cost of capital can be validated using the proponent's financial model, where a financial model has been requested as part of the procurement process.
Working with PPP proponent models is considered reliable for this purpose since the models are subjected to considerable scrutiny during the bidding process. The proponent financial models are provided to lenders, where debt financing commitments are required, and to equity sponsors, who provide an additional level of diligence in validating the model outputs.
When calculating the cost of capital using a financial model it is recommended that all capital inflows and outflows be identified and modelled for the term of the partnership. The cost of capital should then be expressed as the IRR of cash flows from and to debt and equity capital.
Further detail on financial modelling and modelling the discount rate is provided in the worked example in Appendix 6.
For PPP procurement, the NPC of the cash flow estimates, based on the costs listed in Section 2.1, are evaluated based on the payment the owner would be required to make to the private partner that would cover these costs, and would also include the private partner's required rate of return on their investment in the project. This payment from the public sector to the private partner is called the annual service payment (ASP).