Valuation of a tollway project is easy in concept. A project's value is equal to the net present value of the cash flows of that project. For a toll road, these cash flows consist primarily of a large up-front capital expenditure for the road's initial construction, followed by incremental cash inflows over time as traffic builds and toll revenues increase (less expenses for ongoing operations and maintenance). The rate at which expected future cash flows are discounted is determined by the risk-adjusted cost of funds.
Interest cost is easily understood. The concept of cost of equity is also widely understood - equity, if used, requires a higher rate of return because it carries the residual risk. So, discounting at a properly estimated cost of mixed debt and equity funds makes sense. Basically, a determination is made as to whether or not a net positive present value is created when future net cash flows are discounted at the estimated cost of funds.
As to the choice between a situation where a tollway is financed solely with public debt and one where the tollway is financed through a public-private partnership, no definitive and clear choice of better value can be made "a priori" between all public debt or PPP methods of financing. We often hear that private projects cannot compete with their public equivalent because the public sector's cost of capital will always be lower than the private sector's. This is not necessarily the case. The value of a tollway carrying 100% public financing does not always exceed the value of a tollway governed by a public - private partnership.
Consider the risk to bonds for a tollway financed 100% by a public agency. The risk of agency default is likely to not be the only consideration. Rather, explicit or implicit bond guarantees and paths for coverage become significant. In a corporate situation, equity serves as a cushion for debt. Equity holders lose before bond holders do. In the government agency and all-debt situation, the risk is reduced for the issuer itself but borne somewhere. Operational risk of a project is the same regardless of how it is financed. How is this reconciled?
A. First, through the taxing power of the state because entities and agencies have no inherent taxing power. State rates for borrowing should logically rise as increased numbers of toll projects are taken on by state agencies and state-created regional organizations. It is unlikely the nominal project rate for borrowing reflects this spread of risk.
B. Second, through guarantees and securitizations. The same considerations hold as those discussed for project borrowing rates and spread of risk.
C. Third, it is possible to conceive of asset mortgages. However, this is unlikely to be the case in that roadways themselves are not used as collateral. The state or its agency retains ultimate ownership. In fact, this points up the central issue: risk with a PPP is handled differently than risk with 100% public agency borrowing.
D. Fourth, by means of a system carrying the risk. Are NTTA, HCTRA and the like on the line? If so, then the marginal debt rate chosen for analysis should reflect the increased risk and increased debt cost now shared across many projects. All debt costs for a system may rise if there is cross-collateralization. The debt cost for one project is no longer sufficient for analysis.
For the above reasons and stated another way, a PPP appears to be able to carry more risk on the debt it issues than a public agency can for the same debt interest rate. This is because in the all-debt financed situation, the availability of debt is limited. There is no way the enlarged budget of an agency seeking to fund all projects at hand by debt, down to the marginal cost of debt exceeds the expected return rate of the tollway, would be funded.
Beyond some point, the debt markets would deny availability. In a PPP, however, there are two offsetting effects reducing debt risk. As more projects are added, the equity carries most of the increased risk and second, more equity is often demanded by lenders and subsequently added. The private sector's ability to utilize leverage may allow it to construct marginal projects that the public sector cannot; or to construct them faster. In a well structured transaction, the private sector will have a sufficient equity stake in the project to motivate performance; an element that does not factor in a public sector procurement.