Affordability relates to the capacity to pay for building, operating and maintaining the project, be it the capacity to pay of the users of the services or that of the Authority that has identified the need for the asset to be built.
An affordability assessment requires a careful analysis of the expected operating and maintenance costs of the project, together with the levels of cash flow required to repay the loans and provide a return to the investors in the PPP Company. The financial and technical advisers will develop a financial model to assess alternatives in terms of a range of capital, operating and maintenance cost estimates, appropriate cost escalation indexes, assumed financing structure and preliminary PPP contract terms. At the pre-feasibility stage, the financial model is developed at a fairly high level. It is later on, at the feasibility stage and when the PPP arrangement is designed in detail, that the financial model is further developed and refined.
The assessment of costs translates into an estimate of the required revenues to meet those costs:
• In PPPs where users pay directly for the service ("revenue-based PPPs"), the Authority and its advisers need to examine the capacity and willingness of users to pay, especially if tariffs need to be increased from current levels In many PPPs, the public sector will need to subsidise the service in order to make it affordable The use of public subsidies can impact the value for money of a PPP arrangement, requiring that the efficiency savings from the PPP option be large enough to compensate for the use of public funds.
• In PPPs where the Authority makes the payments ("availability-based PPPs"), the assessment of affordability is a key consideration in the design of the transaction The Authority will enter into payment obligations over the life of the PPP contract (the so-called "service fee"), which represent long-term commitments and can influence the design of the transaction and its value for money proposition.
Sometimes options that combine direct charges to users with service fees may need to be examined.
Thus affordability relates not only to the financial balance of the PPP arrangement, but also to public expenditure items in general. A PPP project is considered to be affordable if the public expenditure associated with it can be accommodated within the public sector's budget ceiling over time.