SSRN Id1417289

THE RISK MATRIX OF PROJECT FINANCE IN THE HEALTHCARE SECTOR
THE RISK MATRIX OF PROJECT FINANCE

IN THE HEALTHCARE SECTOR
Roberto Moro Visconti
Department of Business Administration, Universit Cattolica del Sacro Cuore
Largo A. Gemelli, 1 20123 Milano, Italy roberto.morovisconti@morovisconti.it
revised version September 29th, 20101
New or restructured healthcare infrastructures are a typical risky investment, which can be
financed in many different and competing ways. Public Private Partnership and project financing
techniques are increasingly recognized as a useful and appropriate device.
Risk identification, transfer, sharing and management are a key point of the whole structure and
the risk matrix, used in order to classify and - wherever possible - measure risk is an unavoidable
part of the package. To the extent that it can be professionally managed by specialized agents,
risk sharing or transmission is not a zero sum game, even if fairly pricing risk is never a trivial
issue.
While the public part traditionally bears core market risk (demand for health services), other key
risks, such as those related to construction and management of commercial (hot) activities, are
typically transferred to the private part, often represented by a SPV.
An analysis of the SPV's governance peculiarities helps to understand why milder information
asymmetries and softer conflicts of interest can allow for higher even if unsecured leverage.
An original link between financial and operating risk is proposed in this paper, together with an
analytical description of the main kinds of risk.
JEL Classification: D61, D81, G32, H43, H54, L33

Key Words: project finance; risk; healthcare investments; financial and operating leverage
1. INTRODUCTION
Health project finance (PF) is the financing of long-term hospital social infrastructures based
upon a complex financial structure where project debt and equity are used to finance the project,
rather than to reward project sponsors.
Usually, a project financing structure involves a number of equity investors, known as sponsors,
as well as a syndicate of banks that provide loans to the operation. The loans are most
commonly non-recourse, paid entirely from project cash flow, rather than from the general
assets or creditworthiness of the project sponsors.
1
Previous editions: June 10th, 2009 and May 22nd, 2010.
roberto.morovisconti@morovisconti.it 1
Electronic copy available at: http://ssrn.com/abstract=1417289

Generally, a Special Purpose Vehicle (SPV) is a legally independent project company created
for each project by the concessionaire, thereby shielding other assets owned by its sponsors from
the detrimental effects of a project failure. As a SPV, the project company has no assets other
than the project and in public healthcare investments; typically the property of the hospital is
transferred to the public commissioner since the beginning. Capital contribution commitments
(limited recourse) by the owners of the project company are sometimes necessary to ensure that
the project is financially sound. No recourse, no personal risk for the SPV shareholders.
Project finance is typically more complicated than alternative financing methods.
Risk transfer and sharing from the public to the private part is a key element in project finance: a
principal / agent optimal risk allocation and co-parenting are the core philosophy of project
finance. Risk transfer is deeply involved with the allocation of risks associated with the
operation of a PFI contract according to the principle that it should lie with the party best able to
manage it.
Value for Money2 for the public part has to take into account not only an economic and financial
comparison with alternative financial packages and instruments, but also parameters such as3:
project efficiency (optimal use of assets facilities during the concession life ) and
(financial and economic) sustainability;
multi-benefit considerations (level of tangible and intangible social benefits to the end
users and the collectivity brought by the new hospital );
effective risk transfers to the private counterpart (considering, in particular, the real value
of the construction risk transfer, often underestimated).
Within the healthcare sector, considering investments in new hospitals, "cold" projects, where
revenues and demand for services mainly depend on the public part, are predominant, since
"hot" revenues for the private part are mainly represented by commercial activities related to the
core investment (parking; restaurants, shops around or within the hospital). The hotter the
projects, the higher the transmission of core demand risk to the private part. Hot revenues are
typically discounted at higher risk rates by the financing banks of the private counterpart, even if
these revenues are more flexible than cold ones and may allow for extra gains, this being the
benign scenario represented by upside risk (i.e., the statistical probability that revenues may be
higher than expected).
This paper covers with unprecedented analysis the main aspects of the risk matrix, identifying
the following main categories:
1. Risks concerning the construction site

2. Risks of planning - engineering - construction
3. Financial Risks
4. Governance sponsor Risk
5. Operating and Performance Risks
6. Market Risks
7. Network and interface risks
8. Procedural, contractual and legislative risks
9. Macroeconomic systemic risks
2
See http://www.hm-treasury.gov.uk/d/vfm_assessmentguidance061006opt.pdf.
As ROBINSON, SCOTT (2009) point out, "value for money" in a PFI project crucially depends on performance
monitoring to provide incentives for improvement and to ensure that service delivery is in accordance with the
output specification. However, the effectiveness of performance monitoring and output specification cannot be fully
assessed until PFI projects become operational. There is a need to examine the role of the performance monitoring
mechanism in ensuring that "value for money" is achieved throughout the delivery of services.
3
See LI, AKINTAYE, HARDCASTLE (2001).
Electronic copy available at: http://ssrn.com/abstract=1417289

Risk can take shape in many different forms, as seen above, but a synthetic consideration may
be focused on "ultimate" risk for the public or the private part (which is the worst event that can
happen?). Apart from force majeure considerations4, the ultimate risk may tentatively be
considered the following:
for the public part, risk that the hospital doesn't properly work, not being functional to
the changing needs of the patients, and that these inefficiencies bring extra costs and
delays; a correct assessment of the responsibilities of the project financing instrument is
however necessary, since malfunctioning would probably be present even choosing other
financing models and core (health) market risk is typically not included in the project
financing package;
for the private SPV and its shareholders, risk that the whole investment, across its (long)
life, is not profitable, eroding the forecast NPV or yielding insufficient financial returns;
for the lending institutions, risk that debt (principal and interests) is not timely and
properly paid back.
For each risk, the table in appendix 1, which constitutes a core part of the paper, gives an
explanation, following a well know structure:
part bearing risk: wherever it is indicated that the risk is private (public) or borne by the
lending institution, it should be noted that in reality the risk is in many cases at least
partially shared, because if one party is consistently disadvantaged, the whole project
might be affected and the counterpart could be exposed to abandonment, delay, extra-
costs or other problems;
description of the risk;
consequences for the risk bearing part (if the risk is mainly shared, as it happens in many
cases, then the impact might well be asymmetric);
mitigation measures, with useful hints for the risk bearing part, sometimes referring to
the bilateral relationship public-versus-private, while in other cases related parties,
mostly represented by the stakeholders which turn around the project and in particular
which have contractual links with the private part bear a substantial portion of risk (e.g.,
banks who finance the SPV; suppliers of goods and services ).
The above mentioned taxonomies are based on some simplifications and may flexibly be
extended to different contexts: for example, in this paper an omni comprehensive model of SPV
is considered, performing all the main business activities of the project financing investment
scheme (project, build, finance, operate and transfer), according to the PBOT scheme which can
be replaced by many other variants, following a well known "Alphabet soup" - a metaphor for
an abundance of abbreviations or acronyms:
BDOT Build-Design-Operate-Transfer
BLT Build-Lease-Transfer
BOO Build-Own-Operate
BOOS Build-Own-Operate-Sell
BOOT Build-Own-Operate-Transfer
BOT Build-Own-Transfer
BTO Build-Transfer-Operate
BRT Build-Rent-Transfer
4
See the annexed table, within the macroeconomic - systemic risk part.
The SPV activity may well be divided in different companies, each performing a single task
(building, management, supply of technical services ): considering just one SPV makes the
model simpler and reduces the counterpart risk of the public part, to the extent that it has just
one interlocutor; competition among different private bidders takes place during the tender, but
then the game is over and the wedding between the public and the private part is celebrated,
with few and painful divorce possibilities till the expiration of the concession. It shouldn't be
forgotten that each SPV is unique, with long term responsibilities and legal liabilities; as a
consequence, even if many basic rules and best practices of project financing are increasingly
standardized, each investment has its intrinsically risky peculiarities.
Hospital investments are capital intensive projects with a cash flow timing mismatch for the
SPV, for which the construction period is riskier. Not uniform risk distribution across the life
span of the project is so another hot issue. Although procedural risk is a major source of
problems and uncertainties, this paper will hardly deal with the topic, being focused on the SPV,
which starts functioning when the tender is over and the winner is chosen.
Contract design is crucial in setting reciprocal rewards and obligations.
2. THE INVESTMENT PERIMETER
The perimeter of the project finance investment is a core issue, typically designed by the public
proponent and sometimes agreed upon and contracted with the private counterparts, especially
for what concerns no-core issues, concerning hot commercial revenues.
The investment perimeter plays a fundamental part in shaping the investments overall risk,
defining its contractual boundaries, with deep financial implications.
In PBOT schemes, being the design of the overall investment a key competence of the private
bidder, albeit respecting the desires and musts of the public part, the perimeter is less clear cut
and so is the consequential project risk.
Experience teaches that restructuring is much more slippery and risky than mere building of
brand new hospitals from scratch, since in the former case facilities and plants have to be
adapted and synchronized, patients to be taken care with kindness and respect - have to be
moved from old to new locations possibly when the latter are completed and overall
coordination typically proves an uphill task.
Clear cut identification of all the input data is far from being an easy task for the public
proponent and vagueness or indeterminateness are a typical corollary of hard-to-make choices,
which sometimes may be beneficial for the private counterpart, leaving her more room for
flexible contracting and sometimes .. gambling, whereas the public part may sooner or later
discover unthinkable problems, difficult to be addressed whenever not carefully anticipated.
As an example of difficult input data, estimate of square meters (to restructure, build, clean up,
heat ) is a key but uneasy parameter to measure, often generating confusion and questioning.
If basic layout input data are necessary to make the investment boundary clear, excessive details
are likely to suffocate entrepreneurial freedom of the private participants, which stands within
the core philosophical issue of project financing.
Construction and management risk are different but consequential aspects to be assessed by
private bidders, both depending on the investments perimeter.
Another slippery albeit frequent issue concerns conversion costs from acute patients to long-
term care guests, in order to modernize and restructure existing facilities, concentrating acute
treatment in bigger excellence centres (where economies of scale and experience are likelier)
and strengthening the network system across the territory; computerization of medical data can
greatly help the coordination between hub hospitals and their satellites; flexible options of
conversion are greatly helpful and should conveniently be enclosed in PF programs, shaping
new investments in order to properly consider the healthcare trends.
3. THE RISK MATRIX
Risk is a concept that identifies and possibly measures the expected probability of specific
eventualities. Technically, the notion of risk is independent from the notion of value and, as
such, eventualities may have both beneficial (upside risk) and adverse (downside risk)
consequences. Lenders intrinsically have particular downside sensitivity.
However, in general usage the convention is to focus only on potential negative impact to some
characteristic of value that may arise from a future event.
Risk can conveniently be measured if compared to the desired outcome for the public part,
mainly identifiable in output (contractually) based specification and consequently to the
probability that the effective ex post outcome is different (lower) than the envisaged one. Pricing
risk is often more difficult than expected and unforeseen events are an additional and by
definition unpredictable source of risk
Figure 1 - Upside and downside risk, as a consequence of project revenues' volatility
risk (2 revenues)
upside
risk
project revenues
cold hot
(safer) (riskier)
revenues revenues
downside
risk
Even if many of the risks of a project financing scheme are similar to those of a standard long
term investment with multiple stakeholders pivoting around it, some characteristics are typical
of the peculiar PF structure, such as risk segregation of the SPVs shareholders, due to the ring
fence and no (little) recourse finance; the very fact that the property of the hospital belongs
from the beginning to the public entity increases the no-recourse paradigm, since creditors of the
SPV are unable to grasp neither the personal assets of the SPVs shareholders (ring fence
protection) nor the real estate property, built using the money that mainly privileged debt
holders have lent to the SPV.
The main risks can interact within the risk matrix, with many possible outcomes often difficult
to model and forecast; in many cases, the interaction follows a sort of shangai model, according
to which each stick can randomly hit the others, causing a chain effect with unforeseen results.
The impact of risk on the public or the private part (represented by the SPV and its stakeholders)
is highly asymmetric and while some risks are shared (e.g., bad project design; contractual risk;
force majeure; inflation ), most of them are borne either by the public part (first of all, the
demand for health services) or by the private SPV (construction risk; bankability and liquidity
).
The very fact that the healthcare business has little seasonality since patients unfortunately get
ill at any time contributes to decrease the intrinsic volatility of cash flows, which are anyway
mediated by the long time span of the investment.
To the extent that the SPV transfers its risk to its shareholders and, in a broader sense,
stakeholders, there can be a mitigation effect, not only as a consequence of the intrinsic
diversification and spreading, but also because professional stakeholders might undertake the
specific risk that they can conveniently handle; for example, a construction company can
undertake the building risk, while a financial shareholder can monitor the cash flow statements
and a professional manager the operations during the management phase; pass through (back to
back) agreements, according to which the SPV delegates and contracts out some functions (e.g.,
laundry; surveillance ), are highly frequent and can bring to substantial risk transfers, leaving
few if any residual risks within the SPV - good news for its lenders, not so for the lenders of the
sub-contractors, even if risk is both diversified and reduced, to the extent that is professionally
managed.
If the transfer of risks follows a sophisticated number of passages, then complexity can itself
become a risky problem, hiding information asymmetries and difficulties of coordination and
problem detection.
Project finance investments are frequently perceived by the private part as mildly less risky than
other long term investments5, especially if they are mainly driven by expected predominant cold
revenues and as a consequence EBIT volatility is lower than in other businesses; this is due to
the fact that the main market risk - demand for health services from the patients - is typically
borne by the public part.
This somewhat milder risk can be appreciated if the typical business model of a construction
company is considered: if such a company following its standard business model builds real
estate properties, then every 2-4 years its backlog of orders has to be renovated, at the current
market situation; if the portfolio is not sufficiently wide and diversified, then the company can
get stuck in difficult years. In a long term project financing, on the other side, the portfolio of
the management activity is less volatile across the concession period, with a forecast of more
stable cash flows.
Interactions between different risk factors can take place and be identified using either
sensitivity analyses6, changing one parameter at a time (e.g., impact of a decrease in the
availability payment7 on the overall economic and financial plan, from sustainability to
bankability and profitability ) or more complex what-if scenario analyses, where different
parameters change simultaneously, producing possible future events by considering alternative
outcomes8.
5
In project finance longer maturity loans are not necessarily perceived by lenders as being riskier than shorter-term
credits. This contrasts with other types of debt, where credit risk is found instead to increase with maturity ceteris
paribus. We emphasize a number of peculiar features of project finance structures that might underlie this finding,
such as high leverage, non-recourse debt, long-term political risk guarantees and the timing of project cash
flows. See SORGE, GADANECZ (2004)
6
Sensitivity analysis is a means of gauging the impact of individual risks on a financing. Key risks can occur in
three time periods: - Feasibility, engineering and construction phase; - Start up phase (usually through completion);
- Operating phase (post completion).
7
Payments to cover construction, building maintenance, lifecycle repair and renewal and project financing should
conveniently be made on an availability and performance basis, so as to stimulate the concessionaire to maintain a
high quality profile along all the useful life of the project.
8
Given the uncertainty inherent in project forecasting and valuation, analysts will wish to assess the sensitivity of
project NPV to the various inputs (i.e. assumptions) to the Discounted Cash Flow (DCF) model. In a typical
sensitivity analysis the analyst will vary one key factor while holding all other inputs constant, ceteris paribus. The
sensitivity of NPV to a change in that factor is then observed (calculated as NPV / factor). For example, the
analyst will set annual revenue growth rates at 5% for "Worst Case", 10% for "Likely Case" and 25% for "Best
Case" and produce three corresponding NPVs. Using a related technique, analysts may also run scenario based
forecasts so as to observe the value of the project under various outcomes. Under this technique, a scenario
comprises a particular outcome for economy-wide, "global" factors (exchange rates, commodity prices, etc...) as
Risk mitigation is a key issue that makes everybody happy, both from the public and the private
side; the problem is that it is much easier to say than to do; among the main devices, the
following are the most used and effective:
specialization of the agent (public or private) which professionally deals with a specific
risk;
risk sharing among different subjects (e.g., multiple shareholders of the SPV);
insurance, somewhat expensive and in many cases not possible (examples include
construction risk but not market risks, traditionally not insurable);
putting quality first; a good construction, maintenance and management can substantially
decrease risks and related costs.
4. A SYNTHETIC FINANCIAL MEASURE OF RISK: WACC
The weighted average cost of capital (WACC) is the rate that a company is expected to pay to
finance its assets. WACC is the minimum return that a company must earn on existing assets to
satisfy its creditors, owners, and other providers of sources of capital, consisting of a calculation
of a firm's cost of capital in which each category of capital is proportionately weighted.
All else being equal, the WACC of a firm increases as the beta ()9 and rate of return on equity
increases, as an increase in WACC notes a decrease in valuation10 and a higher risk.
In an ideal situation where the average equity = 1 and the riskless debt approaches 0, considering a
possible weighting where the ratio equity versus debt is 20 : 8011, the assets is the following:
well as for company-specific factors (revenue growth rates, unit costs, etc...). Here, extending the example above,
key inputs in addition to growth are also adjusted, and NPV is calculated for the various scenarios. Analysts then
plot these results to produce a "value-surface" (or even a "value-space"), where NPV is a function of several
variables. Another application of this methodology is to determine an "unbiased NPV", where management
determines a (subjective) probability for each scenario the NPV for the project is then the probability-weighted
average of the various scenarios. Note that for scenario based analysis, the various combinations of inputs must be
internally consistent, whereas for the sensitivity approach these need not be so. A further advancement is to
construct stochastic or probabilistic financial models as opposed to the traditional static and deterministic models
as above. For this purpose, the most common method is to use Monte Carlo simulation to analyze the projects
NPV. Using simulation, the cash flow components that are (heavily) impacted by uncertainty are simulated,
mathematically reflecting their "random characteristics". In contrast to the scenario approach above, the simulation
produces several thousand trials (i.e. random but possible outcomes) and the output is a histogram of project NPV.
The average NPV of the potential investment as well as its volatility and other sensitivities is then observed.
This histogram provides information not visible from the static DCF: for example, it allows for an estimate of the
probability that a project has a net present value greater than zero (or any other value).
See http://en.wikipedia.org/wiki/Corporate_finance#Valuing_flexibility.
9
represents sensitivity of the assets changes to a changing market value.
10
Operating cash flows discounted at higher WACC value are automatically reduced.
11
This ratio is decreasing after the credit crunch following the recession of 2008-2009 to lower debt levels.
Figure 2 - Standard Beta of assets, debt and equity
equity = 1
assets 1 * 20% +
0 * 80% 0,2
debt > 0
From the assets' risk structure (volatility) we derive hints about the convenience of issuing
convertible debt; while the risk is typically quite low within a PF healthcare initiative, hybrid
debt is rather uncommon, since subordinated debt is already considered as quasi equity and the
SPVs shareholders typically do not need or require any further equity kicker to increase their
stake.
In the real world, equity, including quasi equity subordinated debt, is slightly below average
unity, ranging at about 0,9, while debt, essentially represented by senior debt, is higher then zero
- being risky - but lower then the cost of equity. So the SPV representation may be the
following:
Figure 3 - Project finance Beta of assets, debt and equity
Cost of
shareholders's
equity 0,9* capital collection
Operating
Risk, linked to assets 0,9 * 20%
Cost of debt,
operating cash flows + 0,75 * 80% 0,78 linked to
debt 0,75 bankability
*Capital is slightly riskier then subordinated debt, since dividends can be paid out only after many years of
management, when retained earnings are consistent enough and have an adequate cash coverage (Free Cash Flow to
Equity), whereas interests on subordinated loans may be cashed out earlier by the same equity-subordinated debt
holders. And since senior debt commands a priority over subordinated debt in repayment of both interests and
principal, its market price is slightly lower (by some 50 basis point ). so a tentative can be estimated at around
0,7 - 0,8.
Market value of the firm's equity and debt is difficult to assess if the SPV is not listed - this
being the standard case. Should this be the case, value of equity may consider as a proxy market
capitalization, while value of debt could be represented by listed bonds; in standard SPVs,
capital markets benchmarks can be conveniently used only in countries or industries where there
is a significant number of listed and comparable companies. The very fact that each project is
unique represents an obstacle to comparisons.
In most developed financial markets, the presence of sophisticated institutional investors can
ease the start of a secondary market for debt and equity, and in such a case pricing becomes an
unavoidable - but precious - issue.
The WACC is a key parameter in project financing, strongly connected with other key financial
ratios, as we can see in table 1.
The WACC level can be a very rough measure of the risks effectively transferred from the
public to the private part. And the financial structure of the SPV (initial and subsequent, along
the whole life of the project) is another complementary indicator of the risk borne by the private
part, up to the limit (absolute and relative debt, measured by leverage) accepted by financial
sponsor.
A leverage simulation with a break even point (floor) / disaster case scenario may be helpful
in detecting which is the maximum bearable debt.
Table 1 - Interactions between WACC and other key financial ratios
RATIO FORMULA LINKS AND INTERACTIONS WITH WACC
E Df
WACC = k e + k d (1 t )
Df + E Df + E
Where:
WACC ------------
Df = Financial debts
E = Equity
Ke = Cost of equity
Kd = Cost of debt
t = Corporate tax rate
If WACC > IRRproject, NPVproject < 0; then it's possible
that CF0 (which strongly depends on the cost of
n
collected capital) > CFO n
t =1 (1 + IRR project ) t
CFO 1 CFO 2 CFO n
NPVproject = + + ... + CF0 = 0 If WACC = IRRproject, NPVproject = 0 and
IRR project 1 + IRR project (1 + IRR project ) 2 (1 + IRR project ) n n
CF0 = CFO n
where:
CFO = Operating Cash Flow
CF0= initial investment
If WACC < IRRproject, NPVproject > 0 and
n
CF0 < CFO n
If WACC > IRRequity, NPVequity < 0; then it's possible
that CF0 (which strongly depends on the cost of
n
collected capital) > CFN n
CFN 1 CFN 2 CFN n t =1 (1 + IRR equity ) t
NPVequity = + + ... + CF0 = 0
IRR equity 1 + IRR equity (1 + IRR equity ) 2 (1 + IRR equity ) n
If WACC = IRRequity, NPVequity = 0 and
where: n
CFN = Net Cash Flow CF0 = CFN n
CF0= Initial investment t =1 (1 + IRR equity ) t
If WACC < IRRequity, NPVequity > 0 and

n
CF0 < CFN n
(1 + IRR
t =1 )t
equity
n
CFO t If Kd or Ke grow, WACC increases; NPVproject
NPVproject = CF0 decreases.
t =1 (1 + WACC) t
NPV project
where:
CFO = Operating Cash Flow If Kd or Ke reduce, WACC decreases; NPVproject
t = time increases.
n
CFN t If Ke grows, WACC increases and NPVequity decreases.
NPVequity = CF0 If Ke reduces, WACC decreases and NPVequity
t =1 (1 + K e ) t
NPV equity increases.
where:
CFN = Net Cash Flow
t = time Kd changes might influence WACC, but not NPVequity.
Like NPVequity, considering also the fiscal benefit of
APV equity
debt. Higher leverage increases APV, provided that
(Adjusted NPVequity + Present Value of Tax Benefit
there is a positive taxable base and that increasing
Present Value)
probabilities of default do not prevent debt raising.
n
CFO t If Kd increases, financial charges (interests) increase
D too. In this case, ADSCR decreases, while WACC
Average Debt t =1 f t + It
Service Cover ADSCR = might increase (to the extent that riskier debt is not
n counterbalanced by safer equity).
Ratio where:
(ADSCR)12 CFO = Operating Cash Flow
Df = Financial Debts If Kd decreases, interests decrease too. ADSCR
I = Interests increases, while WACC might decrease.
t = time from 1 to n years
If Df grows, Kd increases and Ke decreases.
LEVERAGE Df If Df is reduced, Kd decreases and Ke increases.
E WACC might be unaffected.
12
Other cover ratio measures include Loan Life Cover Ratio, defined as: Net Present Value of Cash flow Available for Debt Service / Outstanding Debt in the period.
where:
Df = Financial Debts
E = Equity
This standardized indicator expresses in relative, rather
than in absolute terms, the multiplier of a project's
value times the EBITDA13, allowing for market
n
CFOt comparisons. If the average EBITDA grows, even
NPV project / NPV project / EBITDA = ( CF0 ) / EBITDAAVERAGE CFO increases, normally at a lower rate14, a higher
EBITDA t =1 (1 + WACC ) t EBITDA may lower the cost of capital, with a positive
impact on the WACC, since the overall risk for both
equity and debt holders is reduced by a higher cash
generation, provided that also the CFO grows.
n
CFO t
Discounted (1 + WACC) t
=0 If CFO decreases or WACC grows, payback period
t =0 increases.
Project Payback
If CFO grows or WACC decreases, payback period
Period
where: shortens.
CFO = Operating Cash Flow
t = time from 1 to n years
If CFN decreases or Ke grows, payback period
n
CFN t increases.
Discounted (1 + K =0 If CFN grows or Ke decreases, payback period
Equity Payback t =0 e )t
shortens. Ke is part of WACC, but it changes may have
Period where:
CFN = Net Cash Flow no effects on WACC, to the extent that cost of debt
t = time (Kd) symmetrically adjusts.
13
Alternatively, EBIT may be used instead of EBITDA.
14
being EBITDA operating net working capital capital expenditure = CFO, any increase in EBITDA is typically accompanied by an increase in Operating Net Working
Capital (a higher inventory and a bigger credit exposure are normally linked to a growing operating economic margin) and also in capital expenditure (more investments are
typically needed for an EBITDA increase). So if EBITDA grows, its positive marginality on CFO is normally lowered by an increase in Operating Net Working Capital and capital
expenditure, which burns out some of the extra cash created by the EBITDA's increase.
The relationship between the NPV of the project and its IRR can be represented in the following
graph, well known to any corporate finance practitioner. According to the graph - and the
formulas of NPV and IRR - when WACC grows, the discounted cash flows of the project get
smaller, approaching zero; actually, Internal Rate of Return represents the point at which NPV
is equal to zero.
Sensitivity analyses, aiming at finding the break even point under stress tests where each
variable at a time changes, are particularly useful.
Figure 4 - Net Present Value and Internal Rate of Return of a project

NPVproject
IRR interest rate (WACC)
weighted average
NPV risk premium
of debt and
equity
risk free nominal
long term interest rate
Ke risk premium Kd risk premium
Projects evaluations using NPV suffer from lack of flexibility. The use of real options allows
considering in the model the possibility to differ, expand, suspend, abandon, terminate a project. In
the public healthcare industry, flexibility is however very limited, possibly concerning "hot"
revenues deriving from commercial no-core businesses.
During the tender, NPV is driven down by competitive bidders, but not to the point of making the
project unbankable.
If the winner has a very low NPV even approaching zero one might wonder why the project is
still profitable and bankable. The only possible explanation is that either revenues are
underestimated and / or costs are overstated and there can be (significant) saving. In some
detrimental cases, "informal" commercial as well as building activities, may bring to improper
fiscal savings, and unofficial money can fuel corruption and fraud.
The risk matrix has a strong impact on the cost of capital (cost of equity and quasi equity, including
subordinated debt; cost of senior debt; WACC), especially if we consider the financial aspects of
risk, mainly depending on:
Time span / duration (of the project)

Financing unavailability (capital rationing)
Bankability
Liquidity
Degree of maturity (of the loans)
Availability of institutional investors and other qualified sources of funds
Currency and interest rate risk, sometimes bringing to an Assets & Liability mismatch (of
the SPV)
Amount and cash timing of the grant, the availability payment and other revenues
Financial risk is particularly important, since this is how risk is comprehensively priced by capital
providers. Periodical market evaluation of the SPV, wherever possible, should embody its overall
risk assessment and scoring. But two big problems make this theoretically sound reasoning hardly
working: the very fact that SPVs are not listed and, even if they would, capital markets
imperfections and malfunctioning in risk pricing - any reference to the dramatic financial crisis of
2008-2009 is, like in a movie, a pure coincidence
Financial risk, as we shall see in the next paragraph, is strongly linked especially with operating
risk.
4.1. The cost of subordinated debt
Paid in capital is expensive to be raised by the SPVs shareholders, even because it is risky capital,
with no fixed remuneration and to be cashed back as a last claim. Subordinated (junior) debt is
somewhat in the middle between capital and senior debt, being so allocated in the quasi equity
section. For the SPVs shareholders, advantages if underwriting subordinated debt, instead of
capital, derive from the very fact that debt is anyway interest bearing, whereas capital can be
remunerated with dividends only if net results and free cash flow are positive.
It is so convenient, for the SPV, to minimize its outstanding capital, maximizing senior debt and
using subordinated debt as a cushion to balance the two, keeping leverage under control. While the
issue mainly concerns the SPV and its banks, the public part has also an indirect but not trivial
interest in securing that the SPV is financially sound.
The higher the spread of the subordinated debt, the higher the cost of quasi equity; being
subordinated debt typically issued by the SPV's shareholders even if the underwritten amounts
may be asymmetric if compared to the subscribed capital interest rates paid by the SPV to the
subordinated debtholders compete with dividends paid to the SPV's shareholders, as an alternative
form of remuneration. The differences between the return (cost) of quasi equity versus the return
(cost) of equity concern not only the abovementioned possible asymmetric underwriting, but also
the timing since interests on debt start to be paid before dividends and subordinated debt is
reimbursed after senior debt but before capital so the present value of subordinated debt interests
and repayment is, ceteris paribus, higher than that of dividends and paid back capital.
The present value is higher also due to a lower discount factor, since subordinated debt is a fixed
claim whereas risky capital remuneration and reimbursement is conditional upon the SPV's
performance.
Furthermore, to the extent that interest rates on subordinated debt are fiscally neutral (being
deductible costs for the SPV and taxable incomes for its debtholders, with symmetric tax rates)
whereas dividends come up to the SPV's shareholders net of taxes and are (slightly) taxed even
when perceived by its shareholders (in Italy, 5% of the dividend represents its taxable base), there is
a further (small) element which favors subordinated debt and its service.
Asymmetric subordinated debt (and leverage) occurs whenever the shareholders composition
differs from that of the subordinated debtholders; in such a case, the latter, being typically
represented by financial stakeholders (normally underwriting subordinated debt in bigger
proportions if compared to equity) may be tempted to extract value from the SPV stressing the
repayment schedule and imposing to the SPV higher spreads, likely to reduce and delay the payable
dividends. Competition between the cost of core equity (underwritten share capital) and the cost
of quasi equity (represented by subordinated debt) may well be functional to the SPVs
incorporation, even if it should be kept within reasonable limits, beyond which the whole SPVs
financial structure may be overcharged by improper implicit costs of financial governance.
5. INVESTING AND RUNNING (OPERATING) RISKS
Being the project financing investment traditionally timed in different phases, concerning the
project, the construction and the management, an analysis of the risks typical in particular of the
latter two phases is important in order to detect the overall hazard of the project.
The optimal perimeter of a PF investment has to consider not only the construction investment
but also the amount and nature of (commercial) services transferred to the public part; the bigger the
amount transferred, the higher the expected economic margins for the private agent and so the lower
the required availability margin; there is a symmetric risk of (over)inclusion or (over)exclusion
Within the perimeters definition, technical equipment (electro-medical ) so crucial in hospitals
may be provided by the private agent:
either within the PF package, so exposing both parts, especially the public one, to the risk of
unpredictable technological advances, to be mitigated with complex technical and legal
agreements;
or with a shorter time agreement (consistent with the average useful life of the equipment),
with renewable contracts based on prevailing market tests.
Alternatively, technical equipment may be well excluded from the PF and its purchase could be
financed with a full lease or other debt instruments.
5.1. Investment risk (building or restructuring)
For the private agent, the investment risk is mainly concerned with the hospitals construction or
restructuring.
The Eurostat clarification of February, 11th, 2004, says that a Design, Build, Operate and Finance
projects asset is off balance sheet, and therefore does not affect the General Government Balance
upfront over the construction period, provided that the private sector partner carries the
Construction risk and either the Availability or the Demand risk. This classification of risk within
three main categories synthesizes the broader taxonomy described in the appendix.
Risk assessment typically follows a bottom up approach, detecting the possible basic risks and
eventually reconsidering them with a synthetic scoring.
This is an important device a sort of Troy horse to promote public investments in infrastructures
in highly indebted EU countries, which would otherwise be unfeasible. In the peculiar case of
public hospitals, the Demand risk later on described as mainly referring to the demand of public
healthcare treatment in that particular hospital, depending also on demographic and epidemiological
indicators obviously remains within the strategic priorities of the public part and so the other two
risks have to be transferred to the private part.
The transfer of the construction risk from the public to the private actor has a fundamental
importance, especially in countries where the construction of public infrastructures is typically
subject to long delays and cost increases, seriously risking to be borne old when the hospital is
eventually ready.
Variants and upgrading are typically expensive and unforeseen, so increasing the overall costs, even
if not considered in the initial project and in its financial structure. Just to give an idea of the
possible delays and extra costs, it often happens that hospitals directly constructed by the public part
normally take one or more extra years, with consistent construction delays well above the minimum
3 years (including the executive project) normally necessary to build them up from scratch (being
restructurings even longer and more subject to uncertainties).
Extra costs may well exceed 20 %, potentially with no upward limits. On the other side, should the
private part undertake the construction risk, as it always happens with PF investment schemes, the
public part is exempt from any construction risk and delays are typically charged to the private
concessionaire, and extra costs are harder to recognize. Since the private part has a better control
over construction risks, they can significantly be optimized with their transfer.
Financial costs tend to be cheaper for the public counterpart, if the State acts as a sort of lender of
last resource, protecting from any bankruptcy risk, even if delays in repayments are much more
frequent and may be exhausting, especially if the public part takes profit of its position, which
normally discourages or makes inconvenient any litigation. The private counterpart, being
potentially exposed to default, typically with no public parachute, is deemed to pay higher spreads
on lent funds, even if this higher cost of collected capital does not fully offset the benefits stemming
from the abovementioned construction risk transfer.
Alternative devices of financing do not comply with the Eurostat rules; for example, should leasing
be selected as an option, then the construction risk would be borne by the public counterpart and the
same happens with an undertaking contract backed by a mortgage.
Transfer of risk from the public to the private part also takes place when the price is partially paid in
kind, whenever the public part remunerates the private constructor with no-core real estate
properties. To the extent that the private part accepts to be paid with heterogeneous properties
(typically inherited by the public hospital), she bears the risk of dealing with them, whereas if the
public part puts them on sale, the risk remains public; in the latter case, in order to choose the
proper timing for selling, the public estate owner may well ask a bridge financing, backed by the
properties, to its shareholder (Municipality; State ).
While the issue is hardly questionable if concerning the construction risk, typically completely
transferred to the private part, the balance of power is held by the availability risk, whose
(predominant) transfer to the private part is decisive; a contractual clause according to which the
availability periodical payment is made to the private part not as an automatic repayment of the
construction costs incurred but, at least partially, conditionally upon the management quality and
performance may greatly help to consider the risk predominantly transferred to the private part, so
complying with the Eurostat requirements. The matter, in times of public debt expansion and audit
tightening is far from being trivial.
Considering the construction risk in particular, it shouldnt be forgotten that in practice there is a
(potentially) significant difference between building a new hospital from scratch and restructuring
an existing one: in the latter case, while the building phase can be more complex (avoiding possible
interferences with the patients hosted in the restructuring building), the financial planning can often
benefit to the extent that the management phase is (at least partially) coincident with the
restructuring and so invoicing can start sooner.
In such a case, due to the quicker payback, the whole time extension of the plan can be shorter, not
only because the construction period coincides with the management phase, but also because the
anticipated revenues allow to shorten the time extension of the overall project without necessarily
undermining its financial stability.
Restructuring of existing hospitals is a particularly difficult investment, due to the necessity of
intervening in a context where patients have to be moved and men at work have to cohabit with
them, possibly without disturbing already suffering people; restructuring needs a sound
organizational framework, with a coordination of the various phases and taking into account that
any delay, so common in complex investments, can have a chain effect on subsequent steps;
restructuring is often complemented by the building of new facilities, with a synergic interaction
between the two phases: for evident reasons, normally the building of the new areas commands a
priority, so as to let the transfer of patients when it is completed, so with a preliminary emptying of
the old part, making its restructuring possible.
Construction costs are typically kept fixed in the financial business plan of the SPV, even if they
tend to last some 2-3 years or even more, especially if restructuring is concerned. Lack of any
financial discount during this period is a risky factor entirely borne by the private agent, being
proportional to the time extension of the construction, to its deferral from the time when the
business plan has been conceived and approved and to the macroeconomic scenario within the
considered time span.
5.2. The interactive link between operating and financial leverage
The main risks to which the SPV in project financing is subject to the operating risk and the
financial risk. The operating leverage is a measure of how revenue growth translates into growth (
Sales) in operating income (EBIT). It is a measure of how risky (volatile) a company's operating
income is:
EBIT (EBITDA + Depreciation / provisions)

Operating Leverage = =
SALES SALES
The factors that influence the operating revenue are:
revenue volumes and margins;

variable costs;
fixed costs.
The fixed/variable revenues and cost mix strongly depends on the company's business model and
allows to evaluate the degree of translation of an increase of revenues on the EBIT. In our case, the
SPV typically has a limited revenues growth potential, since commercial incomes normally can be
exploited up to a physical and contractual limit, but it also has a fairly stable cost structure.
Fixed revenues guarantee a valuable minimum revenue level, appreciated by lending institutions.
Contracts envisaging a guaranteed minimum produce fixed revenues for the private concessionaire
(with specular fixed costs for the public counterpart); this lack of flexibility produces a risk transfer
from the private to the public entity that should be carefully considered and agreed on.
A classification of the main operating revenues and costs, according to their level of flexibility and
resilience, is the following:
Table 2 - Fixed and variable revenues and costs
Fixed operating revenues (A) Public grant deferred revenues15; availability

payment16; fixed revenues from no-core
services; fixed commercial revenues
Variable operating revenues (B) variable revenues from no-core (no health)
services; variable commercial (tariff) revenues
Fixed operating monetary costs (C) Insurances, staff costs, financial fees, SPVs
managing costs, sundry fixed costs
Variable operating cost (D) variable costs from no-core (no health)
services17; variable commercial (tariff) costs18
15
The public grant partially covers the cost of the investment; the SPV cashes the grant in tranches, according to the
work in progress and then defers it in constant arrays till the end of the concession. For an analysis of the accounting
problems, see IAS 20 par. 12.
16
A (small) part of the availability payment is paid to the SPV subject to a quality control of the services rendered and
so can be variable.
17
Some of these costs may be fixed.
18
Only if there are no pass-through contracts with third partes.
EBITDA (E) (E) = (A) + (B) - (C) - (D)
Fixed operating costs (F) Depreciations, amortizations and provisions
EBIT (G) (G) = (E) - (F)
The level of EBIT is important in order to ascertain whether the SPV can reach an operating break
even point - minimum acceptable rate of return - this event being a matter of survival.
Residual Value At Risk for the SPV has to take into account the difference between construction
costs and variable incomes and costs, i.e. the part of the building costs which the SPV is not sure to
cover19:
Cumulated construction costs fixed revenues + fixed costs = operating amount to be covered
The SPV has to reach a minimum critical mass in order to guarantee its sustainability; in such an
effort, the growth risk factor - so important in start up scenarios - should not be so important and
limited to marginal hot revenues, since predominant cold revenues should come soon and demand
risk is external.
If the availability payment increases, fixed revenues go up, considering also that it is not subject to
pass through repayments to the SPVs suppliers and for this reason the whole marginality belongs
to the SPV. Marginal economic returns and cash flows of each service rendered are to be carefully
monitored, considering also their inter-temporal volatility, from which risk can be inferred.
For any given level of sales and profit, the higher the fixed costs, the more the operating leverage
grows: due to higher fixed costs has a higher contribution margin, and hence its operating income
increases more rapidly with sales than a company with lower fixed costs (and correspondingly
lower contribution margin20).
In project financing, the private part (SPV) often relies (with a "pass through" agreement) on third
parties (sub-contractors) for the management of non-core services and commercial areas, receiving
in return a percentage of revenues. In this case, the pass through contract increases the variable cost
of the SPV, with an impact on EBIT, smoothing operating leverage: in other words, any change in
revenues causes a smaller change in the EBIT - good news if revenues decrease and vice versa.
With pass through there is also a transmission of risk, aimed at having a positive impact on the
value chain.
Even with pass through agreements - typically, Design & Construction or Operation & Maintenance
- bonding the private partners together with back to back contracts within the contract which
subdivide and replicate the obligations of the main contract, some risks should conveniently be
retained within the SPV, in order to represent a permanent incentive to its efficiency21.
Scalability is, broadly speaking, the ability of a business model to generate incremental demand
(additional revenues) economically, i.e. without significantly increasing costs. In the presence of a
scalable business, the operating leverage works as a multiplier of the EBIT.
19
Considering:
- variable revenues
+ variable costs
+ negative interests
+ extraordinary costs
+ taxes
20
Contribution margin is a measure of the operating leverage: the higher the contribution margin (the lower variable
costs are as a percentage of price), the faster profits increase with sales.
21
MARTY, VOISIN (2007).
The business model of the SPV, in case of project financing in healthcare system, however, doesn't
seem particularly scalable.
Since any change in operating leverage affects a key parameter such as the EBITDA, it also has a
financial effect, due to the circumstance that EBITDA is both an economic and financial margin,
being represented by the difference between monetary operating revenues and costs, as it can be
seen in figure 3. This well known property has important side effects and is a key factor in order to
understand why and to what extent financial and operating risk can be linked.
The rationale behind this statement, applied to the SPV's context, is that any change in the
economic marginality, affecting EBITDA and EBIT, has an impact on operating cash flow, a key
parameter in order to assess the financial soundness of the SPV. Operating cash flow, as it is shown
in tables 1 and 3, is in turn linked with key financial parameters like cover ratio, NPV, IRR, WACC
A deep understanding of these neither immediate nor obvious links is a key factor for the SPV itself
and the stakeholders that pivot around it: shareholders can start to understand how much money
they can make out of the company, lenders can have a better idea of the company's soundness and
bankability and so on. Not a trivial particular.
Table 3 - Links between the operating leverage and key financial ratios
ITEMS FORMULA LINKS WITH OPERATING LEVERAGE

OPERATING Operating revenues Growing operating revenues generate an increase in
REVENUES - monetary and operating fixed costs EBIT, depending on the fixed / variable costs mix.
- monetary and operating variable costs EBITDA, given by the difference between operating
EBITDA = EBITDA revenues and (monetary) operating costs, influences
- amortizations, depreciations and provisions Operating Cash Flow. The same happens with EBIT,
which additionally considers non monetary operating
EBIT
= EBIT costs (depreciations, amortizations, provisions).
+/- Capital Expenditure (CAPEX)
+/- Commercial Net Working Capital
Increases in operating revenues increase EBITDA, EBIT
OPERATING
and Commercial Net Working Capital, normally pushing
CASH FLOW = OPERATING CASH FLOW = CFO
up Operating Cash Flow.
If operating revenues grow, EBIT and consequently net
profit should increase, with an induced Equity growth; if
E Df equity grows, ceteris paribus leverage decreases and
WACC WACC = k e + k d (1 t )
Df + E Df + E there is a transfer of risk from debtholders to
equityholders; to the extent that this risk transfer is
symmetric, WACC should be unaffected.
n
CFO t If EBITDA grows, Operating Cash Flow (CFO)
NPVproject NPVproject = CF0 increases, with a positive impact on NPV, especially if
t =1 (1 + WACC) t WACC decreases.
CFO 1 CFO 2 CFO n If Operating Cash Flow grows, NPV might increase,
IRRproject NPVproject = + + ... + CF0 = 0 then also IRR grows, increasing the financial break even
1 + IRR project (1 + IRR project ) 2
(1 + IRR project ) n
point; the project is more easily bankable.
The Operating Leverage is strictly connected with

ADS Cover
average debt service cover ratio - a typical debt metric -
Ratio
which strongly depends on Operating Cash Flow. If
n
CFO t cumulated CFOs grow, then financial debt may be
D reduced.
t =1 f t + It
ADSCR =
n
If the difference ( WACC - kd ) between the weighted

ke = [WACC + ( WACC - kd ) * Df/E ] NR / PT average cost (return) of capital and the cost of debt is
(FINANCIAL)
positive, then a leverage above unity (where Df > E)
LEVERAGE22 where:
enhances this positive difference, with a consequential
NR = Net Result
PT = Pre-tax result positive effect on the cost (return) of equity.
EBITDA should be consistent enough to cover financial

charges and other monetary costs; this parameter deeply
changes across time, being negative in the construction
phase and sometimes even at the beginning of the
EBITDA / management phase; higher financial charges, embodied
EBITDA / financial charges
financial charges in the cost of debt and in the WACC, decrease the
margin multiplier (EBITDA should be at least 5-6 times
the financial charges, depending on the amount of the
other monetary costs), with a direct impact on cover ratio
and leverage.
22
This is the standard Modigliani & Miller proposition II, adjusted for taxes. The M&M theorem states that, in a perfect market, how a firm is financed is irrelevant to its value.
Figure 5 shows the functional links existing at the level of the profit and loss, balance sheet and
cash flow statement.
Figure 5 - SPV's balance sheet, profit and loss account and cash flow statement
SPV - Balance Sheet
Fixed Assets Equity

(CAPEX)
Operating Net Financial Debts

Working Capital
Liquidity
Invested Capital Raised Capital

(Uses) (Sources)
SPV - Profit & Loss account

SCALABILITY
Operating Revenues
- Operating (monetary) Fixed Costs Operating
- Operating Variable Costs Leverage
= EBITDA
- Amortizations, depreciations and

Provisions
= EBIT
- Net Financial Charges

+/- Extraordinary Components
= Pre Tax Profit
- Taxes
= Net Profit
SPV - Cash Flow Statement

SCALABILITY
Operating Revenues
- Operating Fixed Costs
- Operating Variable Costs
= EBITDA
+/- Operating Net Working Capital

+/- CAPEX
= Operating Cash Flow (CFO)
+/- Financial Debts

- Taxes
- Extraordinary Costs
+/- Equity
= Net Cash Flow (CFN)
Operating revenues, the "engine" of any positive economic marginality and cash flow, depend on
three main sources, represented by the public grant, the availability payment and commercial (hot)
revenues.
Figure 6 - SPV's revenues and net results across time
SPV
total costs
time
construction management
public grant
availability payment
commercial revenues
net result
The amount of the public grant23 is an essential parameter for the financial soundness and
bankability24 of the SPV, since it represent a huge and timely source of cash, allowing to cover a
substantial part of the investment25 period, when revenue billing hasn't yet started and (building)
costs reach their peak.
An omni comprehensive risk analysis should also take into account that those who build and
operate, as in a traditional project finance investment, bear a self interest in pursuing a good quality
of constructing, so as to save money on the maintenance of the building in the following years. The
option "take the money and run" is not applicable, being the management following the
construction a long lasting period during which mistakes and inappropriate choices are likely to
come up.
Redevelopment risk of ordinary / extraordinary maintenance is another factor to consider: being the
former typically included in the PF and the latter separately paid, if occurring, the private agent may
have an incentive in neglecting ordinary maintenance to transform it into a payable extraordinary
maintenance; ordinary maintenance and programmed extraordinary maintenance are often part of
23
Public contributions from the State or regional institutions to the public hospital can be not repayable or in the form
of mortgages.
24
A preliminary feasibility study conducted by the public part, together with an informal soft test of the financial and
economic model conducted by an independent bank can be of great help in the simulation and solution of problems.
25
Roughly 55% in the Italian experience. See FINLOMBARDA (2007), chapter 2.
the package, while unforeseeable extraordinary maintenance should by definition be excluded from
the PF and negotiated upon occurrence
5.3. Coping with macroeconomic risk, from inflation to interest rates
Macroeconomic risk, mainly referring to inflation and interest rates (or even to exchange rates, if
considering foreign projects) is a typical external factor that cannot be influenced neither by the
public nor the private part and its effects may be significant, especially if protracted along time.
Indexation mechanisms (to the prevailing inflation rate ) are the first and most used mean of
mitigation and floating rates, albeit difficult to model ex ante, may be used instead of fixed rates,
with timely swaps floating-for-fixed.
While interest rates mainly concern the debt burden of the private agent (from the short termed
VAT or grant facility to the more consistent and protracted senior and subordinated debt), inflation
is a double edged sword for either the public or the public counterpart. Indexation with contractual
agreements and the level of coverage of inflation changes (up to 100 %) can have an impact on the
revenues and costs of the SPV in nominal and real terms, increasing or diminishing the net margin.
The same concept applies to the indexation of availability payment, revenues and costs (less
expected and effective volatility).
When the macroeconomic scenario is perturbed, as it is in the 2008-2010 recession, risk premiums
on debt and equity are increasing, due to the credit tightening following the economic slowdown,
and leverage is decreasing both in its absolute value and in its time extension - shorter projects are
increasingly fashionable.
6. THE PARADOX OF LEVERAGE: IS RISK MITIGATED BY MILDER GOVERNANCE

PROBLEMS?
If you were a bank, would you finance a project with 80-20 debt / equity ratio26, knowing that the
assets - mainly consisting of capitalized construction costs are not suitable collateral and that a
ring fence mechanism protects the SPV's shareholders?
Addressed this way, the question is tricky and would unavoidably bring to a negative answer. The
green light to bankability has to take into account the abovementioned paradox, considering also
other issues that have to make the difference: relatively stable and growing cash inflows are the key
parameter to modify an otherwise negative judgment. And since operating cash flows mainly
consist of positive economic margins, relying on a positive and sustainable operating leverage is the
true key of bankability.
As the operation is typically highly leveraged, repayment constraints represent a strong incentive
for the SPV to meet the performance level contractually required.
Even small but relatively stable marginal surpluses between the return and the cost of capital can
bring to positive capital returns, especially if amplified by leverage, intrinsically risky but well
know as a possible wealth multiplier27.
According to SUBRAMANIAN, TUNG, WANG (2009), project finance makes cash flows
verifiable, enhancing debt capacity, through:
contractual arrangements made possible by structuring the project company as a single,

discrete project, legally separated from the sponsor;
26
Leverage in some case has reached 85 15 or even higher ratios, but is now decreasing to softer rates, due to the
credit crunch effect and the impact on the whole financial system of predatory lending practices. Even safer
investments, such as healthcare PFIs, are affected and also the collection of equity has become more difficult and
expensive.
27
See table 3, (financial) leverage formula.
private enforcement of these contracts through a network of project accounts, that ensures
lender control of project cash flows.
In PF, extensive contracts combined with private enforcement mechanisms limit borrower
discretion on cash flows. To the extent that cash flows are verifiable, agency costs of debt are
reduced and debt capacity is enhanced. A network of non-financial contracts is set up in order to
limit the managerial discretion of project sponsors, to make cash flows better verifiable for lenders,
and to reduce the negative impact of unexpected events on project cash flows28.
An incentive to increase leverage derives from the tax deductibility of negative interest rates29, to
the extent that there is a sufficient taxable base; the volatility of the tax base, across the investment
time horizon, is a key issue, which changes significantly during the life cycle of the construction
and management period: in the construction years, the tax base is negative, since the SPV hasn't
started invoicing and carried forward losses from the initial period can significantly lower the tax
burden in the first years of management. If competition with other deductible costs excessively
erodes the tax base, the tax shield of debt may become a useless benefit, to the extent that it cannot
be brought forward. Normal business plans foresee a growing tax base towards the end of the
concession, especially when the senior debt is completely reimbursed; so competition with other
deductible costs is asymmetrically concentrated in the construction years and in the first part of the
management phase, progressively declining as time passes.
Risk distribution is, once again, asymmetrically distributed and this also affects the Free cash flow
to equity, with particular reference to dividends: when debt is reimbursed, there is obviously much
more room to remunerate capital but the very fact that this happens later and in a residual way
makes equity injections intrinsically riskier and cost of equity consequently more expensive.
A not ephemeral accumulation of Free cash flow to equity, consistent with the Jensen (1986)
model30, is the basis for the payment of dividends, in respect of restrictive debt covenants (Smith,
Warner 1979), according to which equity can not be depleted at the expense of debtholders, but
also avoiding trapped equity problems, should managers of the SPV prefer to retain liquidity, even
if profitable organic growth opportunities are limited - this being typically the case in our model,
where the project is mainly fixed and few innovations are admitted.
The very fact that cash flows are more verifiable in project than in corporate debt financing31 makes
Free Cash Flow possible abuses less harmful for debtholders, also considering that with public
health investments Free Cash Flow is intrinsically limited.
If the interest rate tax shield is a typical argument in favor of the leverage, conversely risk of default
of the SPV is a topic against excessive debt; this standard trade-off, well known in corporate
finance theory32, has to be adapted to the peculiar characteristics of the SPV. Its default,
28
GATTI, CORIELLI, STEFFANONI (2008).
29
This property influences the Adjusted Present Value, described in table 1.
30
According to Jensen's free cash flow theory, firms that generate substantial cash flow have two options. They can
reinvest the cash in the firm, or they can pay it out either through dividends or by repurchasing shares. Jensen argues
that if free cash flow is reinvested in negative net present value projects, share value will suffer. Alternatively, if free
cash flow is paid in dividends or used to repurchase stock, share value should rise.
31
See table 4.
32
The Trade-Off Theory of Capital Structure refers to the idea that a company chooses how much debt finance and how
much equity finance to use by balancing the costs and benefits. The classical version of the hypothesis goes back to
KRAUS, LITZENBERGER (1973) who considered a balance between the dead-weight costs of bankruptcy and the tax
saving benefits of debt. Often agency costs are also included in the balance. An important purpose of the theory is to
explain the fact that corporations usually are financed partly with debt and partly with equity. It states that there is an
advantage to financing with debt, the tax benefits of debt and there is a cost of financing with debt, the costs of financial
distress including bankruptcy costs of debt and non-bankruptcy costs (e.g. staff leaving, suppliers demanding
disadvantageous payment terms, bondholder/stockholder infighting, etc). The marginal benefit of further increases in
debt declines as debt increases, while the marginal cost increases, so that a firm that is optimizing its overall value will
focus on this trade-off when choosing how much debt and equity to use for financing.
See http://en.wikipedia.org/wiki/Trade-Off_Theory.
theoretically always possible, would have disastrous consequences for the public part, to the extent
that it would bring to an interruption of strategic services (e.g. clean up; maintenance ). Aware of
this, contractual provisions regulate the case in order to avoid any interruption of core services; this
intrinsically makes the risk of default less dramatic for the public counterpart but not automatically
for the creditors of the SPV. Some may wonder if, just in case, they can replace the equityholders in
managing the SPV and the answer, provided that the public part accepts and that the service is not
worsened, may well be positive; in such a case, the SPV would have a residual value (the
discounted value of future contracts), limiting its default risk, that seems however reasonably
unlikely - if compared with other businesses.
(High) leverage is sustainable also if debt service cover ratio is sufficiently robust, ranging well
above unity - but this unsurprisingly is the case once again especially approaching the final years of
management, where operating cash flows may not be too dissimilar to those of previous years but
residual debt, thanks to reimbursements, is consistently lower.
The standard agency problems of debt concern the conflict of interests between a potential lender
(the principal), who has the money but is not the entrepreneur, and a potential borrower (the agent),
a manager with business ideas who lacks the money to finance them. The principal can become a
shareholder, so sharing risk and rewards with the agent, or a lender, entitled to receive a fixed
claim. Agency theory explains the mismatch of resources and abilities that can affect both the
principal and the agent: since they need each other, incentives for reaching a compromise are
typically strong.
As leverage grows, risk is increasingly transferred from equity to debt holders.
Figure 7 - Agency costs of equity and debt when leverage changes
total agency costs (WACC)
From construction to end of management

agency costs of debt Kd
agency costs of equity Ke
% financed by debt (leverage)

debt
0% 100%
equity
start end
of construction
end
start
management phase
Ke max Ke 0
Kd 0 Kd max
6.1. Information asymmetries, adverse selection and moral hazard
Typical corporate governance problems between lenders and borrowers, in our case respectively
represented by banks and the SPV, are somewhat milder than the standard ones present in other
private companies and standard corporate investment. It is well known that information
asymmetries traditionally arise since borrowers have better information about their creditworthiness
and risk taking that has the lending bank. They originate conflicts of interest which might seriously
prevent efficient allocation of finance: the liquidity allocation problem derives from the fact that
although money is abundant, it is nevertheless not easy to give it to the right and deserving
borrowers. In the case of project finance, the investment has to be carefully designed and
analytically described, so reducing the information gap between borrowers and lenders.
Relationship lending, which relies on personal interaction between borrowers and lenders and is
based on an understanding of the borrowers business, more than to standard guarantees or credit
scoring mechanisms, can take place when the sponsoring banks are part of the SPV's shareholders
or - to a lesser extent - if they already have strong ties with the main SPV's shareholders, whose
credit trustworthiness is positively acknowledged.
Adverse selection is another typical problem in money lending and it occurs when banks not
knowing who is who cannot easily discriminate between good and risky borrowers, who should
deserve higher interest rate charges.
Moral hazard is a classical take the money and run problem, since borrowers might try to abscond
with the banks money or try not to fully engage them in the project for which they have been
financed.
To the extent that there is symmetric information between debt and equity holders, project finance
simultaneously alleviates the classical inefficient managerial problems of under and over
investment.
Another positive characteristic of PF is the presence of relatively few information asymmetries in
the assets of the SPV. According to the LELAND and PYLE (1977) seminal paper, borrowers
typically know the value of their assets, to be used as a collateral, much better then lenders, so
rising moral hazard conflict which prevent optimal resource allocation; this produces an incentive to
minimize information asymmetries.
In our case, the SPV's assets used in the example (see paragraph 8) over the 3 years of construction
+ 25 years of management are mainly represented by construction costs (82 % of total assets) and
liquidity, including debt service reserve account (almost 18 % of assets).
Liquidity doesn't bear any information asymmetry33, but also capitalized construction costs are
easily observable by outside providers of finance, who can monitor work in progress during the
construction and get evidence of the effective costs of the SPV.
Incentives for borrowers to exaggerate positive qualities of their projects, with costly or impossible
verification of true characteristics by outside parties, considered in the Leland and Pyle model, are
hardly ever the case in project financing.
Strategic bankruptcy is false information that the borrower gives about the outcome of his financed
investment, stating that it has failed even if its not true only in order not to give back the borrowed
money.
These classical corporate governance problems are well known in traditional banking as it will be
seen in the comparison in table 4 and they naturally bring to sub-optimal allocation of financial
resources and to capital rationing problems that frequently affect even potentially sound borrowers,
if they are not able to differentiate themselves from those who bluff.
Within the project finance context, these problems can somewhat be mitigated, so reducing agency
costs of debt, not only taking profit of lower information asymmetries, but also using simple but
effective devices, such as cash flow channeling - since the SPV's cash flows mostly (apart from
smaller "hot" revenues) come from one big source, the public part, the bank can compensate cash
inflows with expiring debts, so avoiding any potential cash diversion.
PF enhances the crucial verifiability of cash flows through contractual constraints, including a
network of project accounts that are under the lender's control and into which project cash flows are
required to be deposited34.
In such a context, moral hazard temptations are relatively unlikely, since it is difficult either to
divert the bank's money from its strategic aim - financing the building - or to avoid getting fully
engaged in the project, due to the pressure for quality and achievements coming from the public
part - building and running a public hospital is not a joke.
Legal clauses, protecting the financing bank, may consider cash flow verifiability and segregation,
using waterfall provisions.
A comparison between standard corporate debt investments and corporate finance, useful also in
order to assess Value for Money, bankability issues and profitability, is synthesized in table 4.
33
In economics and contract theory, information asymmetry deals with the study of decisions in transactions where one
party has more or better information than the other. This creates an imbalance of power in transactions which can
sometimes cause the transactions to go awry. Examples of this problem are adverse selection and moral hazard. Most
commonly, information asymmetries are studied in the context of principal-agent problems. Potentially, this could be a
harmful situation because one party can take advantage of the other partys lack of knowledge.
34
SUBRAMANIAN, TUNG, WANG (2009).
Table 4 - To lend or not to lend? Comparison between corporate debt and project finance
Parameter / situation Corporate debt finance Project finance

Asset based projects bear physical The guarantee is given by the cash
guarantees and, to the extent that they flows of the project. Limited or no
Guarantees are not sufficient, personal covenants recourse models make SPV's
from the shareholders. shareholders mildly or not
responsible.
Typically higher than in standard
The (optimal) amount of leverage is a corporate investments, with a profile
consequence of the guarantees and more similar to LBOs. Lower risks,
Leverage many other parameters (bankability; described in many parameters in this
conflicts of interests and information table, make this possible, to an extent
asymmetries ...). that has to be decided and monitored
case by case.
The track record and reputation of
Adverse selection is a typical
borrowers is less easily identifiable in
problem in money lending, since
project finance, since the SPV
banks not knowing who is who
typically has several shareholders,
cannot easily discriminate between
Adverse selection but - to the extent that the borrower is
good and risky borrowers, who
the new SPV and that the investment
should deserve higher interest rate
project is highly detailed, adverse
charges.
selection problems are not so
important in project finance.
Moral hazard is a classical take the
money and run problem, since
Cash flow channeling through the
borrowers might try to abscond with
Moral hazard lending bank makes money hiding
the banks money or try not to fully
extremely difficult.
engage them in the project for which
they have been financed.
Moral hazard, adverse selection,
assets substitution are much less
harmful in project financing and cash
In economics and contract theory, an
flows pass through the lending
information asymmetry is present
institutions and are easier to forecast
Information asymmetries when one party to a transaction has
and monitor, leading to a consistent
more or better information than the
reduction in information
other party.
asymmetries, considering also that
there is just one well known (albeit
complex) investment to monitor.
Strategic bankruptcy is false
information that the borrower gives
about the outcome of his financed
investment, stating that it has failed
Less probable with verifiable cash
Strategic bankruptcy even if its not true only in order not
flows.
to give back the borrowed money.
The lender's right to liquidate is
central to forcing the borrower to
repay its debt.
Should the financed corporation go A project company SPV is separated
bankrupt, residual value becomes and bankruptcy remote from the
important and companies with a high investing firm sponsors that create it.
level of intangibles, mainly valuable The project company relies
in a going concern context, are extensively on debt capital provided
Probability of default
typically penalized while asking for by creditors to fund project
money. operations. Creditors provide more
Debt holders may threat to file for (less) debt as a percentage of overall
bankruptcy, in order to force project capital when there is less
repayments. This threat is effective to (more) risk of project failure and non-
the extent that there is an expected repayment.

value from asset liquidation35.
A company's exchange of lower-risk
investments for higher-risk
investments. Firms may use asset
substitution as a form of financing, or
as a move to please shareholders. It
can be detrimental to the company's
This risk is very unlikely in project
bondholders as it increases the
finance, where investments are
Asset substitution possibility of default without any
contractually fixed and observable by
corresponding benefit because bonds
financing institutions.
have a fixed interest rate. On the
other hand, asset substitution can
benefit shareholders as it carries the
possibility of higher returns.
This risk makes debt more difficult
and expensive.
Level of legal protection Cash flow based, with little if any
Asset based, often with guarantees.
of debtholders guarantee (limited or no recourse).
The volatility of the business model Even in project finance cash flows
and, in particular the fact that the are volatile, but normally consistently
demand risk is entirely borne by the less then in other businesses,
Cash flow volatility
company, typically makes cash flows especially if cold revenues and cash
highly volatile and hardly predictable flows are predominant, leaving core
- bad news for lenders. demand risk to the public part.
Difficult with multiple projects;
would be a (potentially harmful) Contractually envisaged in the
impediment to managerial discretion. agreements between the SPV and its
Cash flow segregation The lender's right to claim money lenders, it allows avoiding most
back central to force the borrower to conflicts between equity and debt
repay, limiting strategic default holders.
temptations.
Strictly dependent on the business When cash flows are more verifiable,
and market model, normally the entire distribution of cash flows
Cash flow verifiability
consistently harder than that of available to all fixed and residual
project financing. claimants shifts to the right.
Reward and excess return of the
investment, typically belonging only Upside potential is limited, due to the
to the shareholders. Should the risk / limited presence of hot revenues and
return profile be unbalanced, peculiar to contractual caps (market testing
Upside potential
sources of funds, more suitable to ) on other revenues. As a
follow the assets' profile, may be consequent, there is little if any need
issued (convertible bonds or other to issue hybrid securities.
hybrid securities )36.
The evaluation37 has to consider the
following peculiarities:

Cash flow evaluations are difficult, to no terminal value, since the SPV is
the extent that this parameter is typically dissolved once the
hardly predictable. Market concession has expired, its terminal
Evaluation comparisons are possible and make value is zero;
sense if there is a sufficiently wide less volatile (more predictable);
and similar database of other precise (contractual) duration of
transactions. useful life;
market comparisons are hindered by
the project's uniqueness.
Change in the business model Possible and even frequent, There is no risk of a change in the
(mission drift) especially from a substantial point of business model, due to little
35
See HART (1995).
36
See SMITH, WARNER (1979).
37
The valuation can be assets side NPVproject or equity side NPVequity.
view, trying to adapt the business to a competitive threats and binding

wildly changing market. Unperceived contractual agreements.
changes increase information
asymmetries and assets substitution
chances.
Normally consistently shorter than in
project finance, often uneasy to be
contractually bound, often
Long term investment, typically
overlapping with other investments
Time extension of the investment exceeding 20 years, is an intrinsic
having different amounts and
risk.
maturities. As a consequence, even
short term financing has a roll over
implicit option.
Little it any residual value if the
project is abandoned a rare case
Infrastructural investments typically
with public hospitals. In any case,
have a residual value, representing a
Residual value with a free transfer of the
worthy guarantee if debt is by then
infrastructure to the public part, the
still outstanding.
residual value of the SPV is typically
zero.
6.2. Triangulating risk among the public part, the private SPV and the lending institutions
Risk is not a private matter between the public and the private part, since most of the private risk is
transferred to the lending institutions, as it is witnessed by leverage, traditionally high both in
absolute and in relative terms.
In this triangular relationship, alliances and conflicts of interest are again a key point in order to
predict intentions and (mis)behaviors. Since for the SPV the public part is the client and the
borrower the supplier, the SPV has a natural interest to behave properly more with the client than
with the supplier, at least when he has got the money. From this simple reasoning, we draw the
general conclusion that lump sum financing is intrinsically riskier for the lender.
Each part has a natural attitude to behave selfishly, even if cooperative games become a necessity, if
the players want to make the deal. Balance of powers, a mix of shared dissatisfaction and
compromise in the name of a superior common goal are a necessary sign of intelligence, experience
and common sense.
Risk is a key problem to solve together, extracting value from its proper management; if sharing is
insufficient and unfair, the damaged part may claim her out of the game, in a context where all the
three players are needed and opportunistic free riding behaviors are short sighted and contractually
sanctioned. As MARTY, VOISIN (2007) point out, introducing financier as third party allows for
assessing the optimality of the risk allocation.
Even if in some cases the public part and the lending institutions are allies, since they share
incentives in complementarily monitoring the soundness of the SPV ex ante, i.e. during the tender,
in order to assess its reliability and bankability, their ex post objectives, when the bid is won by the
SPV, may substantially diverge: lets think, for example, about the possible extra gains of the SPV
(pushing high hot revenues or minimizing running costs), which make the public part unhappy, to
the extent that the quality of services is deteriorating and it cannot share the extra gains, while the
bank, even if also unable to share these extra gains, is happy about the SPVs cash flows
improvements, which contribute to making the debt safer.
Should the lending institutions be part of the shareholders of the SPV or should they have close
links with the shareholders (with crossed participations, interlocking directorships in their board of
directors ), well in such a case they naturally share common goals and it gets harder for the public
part to benefit from cooperation. The banks are often likely to have ties with sub-contractors, which
in many cases bear a substantial part of operating risk or, sometimes, even with the public part. Due
to their wide and flexible portfolio of clients, they are possibly the most probable source of conflicts
of interest.
While banks negotiate with the private counterpart the bankability and financial soundness of the
whole investment, they often require most of the expected cash flows to be represented by low risk
revenues such as the availability payment or the public contributions, whereas more volatile and
uncertain commercial returns from hot activities are discounted at a higher rate, albeit representing
the true nature of intrinsically risky project financing investments.
Competition is another strong element which forces the players to cooperate; the public part has to
internally compete with different investment solutions, before choosing project financing, according
to the Value for Money metrics; since ex ante competition between different bidders cannot
eliminate uncertainty and likely differences between ex ante contracting and ex post delivery of
service, value for money cannot be completely assessed before the tender and has to be checked
along the whole life of the investment, even when a definitive choice is made, trying to limit
damages with monitoring and contractual covenants.
Excessive competition among bidders only apparently represents a benefit for the public part, which
can extort better economic conditions. Unbankable or unprofitable bids, placed in order to
maximize the winning chances, are widely recognized as dangerous and able to distort free and fair
competition.
7. MONITORING A RISKY LONG TERM WEDDING
PF is a long term wedding, where divorce is a hardly practicable exit option. In the 1990s in the UK
a public functionary that was going to sign the contract with the private counterpart, entered the
meeting room dressed like a bride with a long white wedding suit, just to symbolize that the
agreement was like a wedding.
Since the PF is a long term contract, monitoring the quality performance of the conductor is
essential for the public proponent, considering that after some years a sort of relaxation, potentially
conducting to lower quality, is likely.
The actual trend is to reduce the PF time span, not only as a consequence of the recessionary credit
crunch, according to which debt facilities shorten, but also in order not to engage the public part for
an excessive time span, during which risks are increasingly difficult to forecast, monitor and
mitigate.
From a practical perspective, it should be worth considering that the reduction of the project length
has an impact on the repayment schedule of debt, which is compressed in a shorter time horizon,
with higher repayment instalments.
Time itself is a risk factor, not only for its financial implications, but also because a potentially
infinite set of events may occur, especially when the investment horizon grows.
Timely monitoring can reduce risk hopefully to an acceptable level; shorter deadlines for ancillary
investments, such as technical equipment (subject to substitution at prevailing market rates and
technological standards, using a market test contractual device) are gratefully acknowledged for
their contribution to the reduction of operating risk.
All the macroeconomic parameters such as interest or inflation rates are deeply time-sensitive, again
especially if a long term horizon is envisaged.
8. RISK ASSESSMENT AND MITIGATION
Risk - due to uncertain events - is extremely hard to detect and measure. The most straightforward
method is to estimate the statistical probability that a (negative) event occurs, associating to it a
measurable cost (or cash outflow). But this is hardly possible in many cases, due to the difficulty to
detect the risk source, to forecast the possible outcomes / states of the world and to associate to each
of them a weighted cost according to its probability of occurrence. Also, in a changing scenario,
many risky factors simultaneously interact among them, within a wide and interlinked risk matrix.
Risk assessment and scoring is a key step in a risk management process, consisting in the
determination of quantitative or qualitative value of risk related to a concrete situation and a
recognized threat (also called hazard). Quantitative risk assessment requires calculations of two
components of risk38:
the magnitude of the potential loss

the probability that the loss will occur.
Risk assessment consists in an objective evaluation of risk in which assumptions and uncertainties
are clearly considered and detected. Part of the difficulty of risk management is that measurement
of both of the quantities in which risk assessment is concerned - potential loss and probability of
occurrence - can be very difficult to identify or measure.
Risk can also derive from corporate governance problems and conflicts of interests between the
public and the private part or within the private stakeholders. The first step, hazard identification,
aims to determine the qualitative nature of the potential adverse consequences of the risky situation.
Quantitative risk assessments include a calculation of the single loss expectancy of an asset.
In Project Finance, risk is a holistic system, like the human body.
A risk matrix can be ideally represented by the following figure 8.
Figure 8 Interactive risk matrix
risk* risk* risk*

RISK
risk* risk* risk*
risk* risk* risk*
The graph shows that risks, purposely unspecified in this example, are linked among them, often in
an unpredictable risky way. The attempt to find out a synthetic measure of overall risk, albeit
theoretically captivating and practically meaningful, is uneasy to carry forward, but still
worthwhile.
A functional matrix of the different areas (heath-care; territorial; administrative; training;
technological and logistic ) may help to complement the risk profile of the project, considering it
from another synergic perspective.
A traditional risk scoring matrix - not so easy to adapt to the project financing context - is the one
described in Figure 9.
38
An example of risk measurement can be given by the Probability of Default used in Basel II credit scoring systems. It
is the likelihood that a loan will not be repaid and fall into default. This Probability Of Default will be calculated for
each company who have a loan. The credit history of the counterparty and nature of the investment will all be taken into
account to calculate the Probability Of Default figures. The probability of default of a borrower does not, however,
provide the complete picture of the potential credit loss. Banks also seek to measure how much they will lose should a
borrower default on an obligation. This is contingent upon two elements:
First, the magnitude of likely loss on the exposure: this is termed the Loss Given Default (and is expressed as a
percentage of the exposure).
Secondly, the loss is contingent upon the amount to which the bank was exposed to the borrower at the time of
default, commonly expressed as Exposure at Default.
Figure 9 - Risk scoring matrix
Probability of occurence Almost

Rare - 1 Unlikely - 2 Possible - 3 Likely - 4
(likelyhood) Certain - 5
1 Negligible 1 2 3 4 5
Consequences
2 4 6 8 10
(Severity)
2 Minor
3 Moderate 3 6 9 12 15
4 Major 4 8 12 16 20
5 Catastrophic 5 10 15 20 25
Legend: impact of
Blue - Low risk risk mitigation
Grey - Moderate risk
Yellow - Significant risk
Red - High risk
A more sophisticated risk analysis can make use of Monte Carlo simulations39.
Risk Mitigation represents a benefit for all the parties and follows several complementary steps:
1. identification a trivial but fundamental and uneasy task: one can't avoid what he doesn't
know and a quick look to the risk matrix in appendix 1 can give a rough idea of the
problem;
2. selection - of the most suitable risk bearer and contractual insurance regulation;
3. measurement - with probability and severity quantitative estimates;
4. monitoring during the tender and afterwards in the building and management phase;
5. management risk mitigation has a strong impact on corporate governance conflicts among
different stakeholders40: the lower the risk, the higher the harmony and convergence of
interests.
9. A FINANCIAL AND ECONOMIC PLAN MODEL
A financial and economic plan of a public hospital project financing is synthetically represented in
appendix 2, with an indication of the basic assumptions, the statements and a synthesis of the
sensitivity analysis, which considers the impact on the model - with particular reference to its key
ratios - of the two most significant parameters:
a decrease in the availability payment, up to a break even point (where NPVproject = 0);
a shortening in the time span of the management phase (from 25 to 20 years).
39
Monte Carlo methods are useful for modeling phenomena with significant uncertainty in inputs, such as the
calculation of risk in business. Monte Carlo methods in finance are often used to calculate the value of companies, to
evaluate investments in projects at corporate level or to evaluate financial derivatives. The Monte Carlo method is
intended for financial analysts who want to construct stochastic or probabilistic financial models as opposed to the
traditional static and deterministic models. For its use in the insurance industry, see stochastic modeling. In finance and
mathematical finance, Monte Carlo methods are used to value and analyze (complex) instruments, portfolios and
investments by simulating the various sources of uncertainty affecting their value, and then determining their average
value over the range of resultant outcomes. The advantage of Monte Carlo methods over other techniques increases as
the dimensions (sources of uncertainty) of the problem increase.
See www.emeraldinsight.com/10.1108/01409170810920620.
40
See ZENNER (2001).
The pilot model is taken from a real case, conveniently simplified with rounded up figures and basic
assumptions. The main objective is to assess how the key financial parameters described in
paragraph 4 change if either the availability payment or the time span of the management period -
two key income factors for the SPV - decreases.
In each feasibility study, a similar task may be conveniently carried on, not only to ascertain if and
to what extent the pilot model is working and bankable, but also which are the break even points
(e.g., when the equity NPV reaches zero) which represent an ideal target for the public part: even if
private competitors will make bids above this threshold, if competition is effective they will get
closer to this point.
The main conclusion which can be drawn is that a decrease in the availability payment, ceteris
paribus, worsens all the ratios (NPV, IRR, leverage, cover ratio, payback period )
Figure 10 - Impact of changes of the availability payment on the project NPV
Availability
Payment ()

3 millions
2,5 millions
2 millions
1,5 million
1 million
NPVproject ()
10 mio 20 mio 30 mio
Table 5 - Sensitivity analysis induced by changes in the availability payment
SENSITIVITY ANALYSIS - AVAILABILITY PAYMENT
base case Break-even

Duration of the concession (years) 3 + 25 3 + 25 3 + 25 3 + 25 3 + 25
Annual Availability Payment (VAT not including, base 2009) 3.000.000 2.500.000 2.000.000 1.500.000 1.030.026
Annual Service Revenues (VAT not including, base 2009) 18.675.000 18.675.000 18.675.000 18.675.000 18.675.000
Annual Commercial Revenues (VAT not including, base 2009) 5.000.000 5.000.000 5.000.000 5.000.000 5.000.000
NPV equity 17.229.881 11.982.593 6.859.001 1.468.962 - 3.860.699

NPV project 30.034.485 22.081.887 14.605.403 7.094.621 - 0
Payback Period 2022 2024 2026 2029 2031
Average Debt Service Cover Ratio 2,02 1,83 1,64 1,45 1,27
IRR equity 11,66% 10,22% 8,64% 6,86% 4,99%
IRR project 10,91% 9,86% 8,75% 7,55% 6,34%
WACC 6,38% 6,41% 6,38% 6,36% 6,34%
Average leverage 1,19 1,23 1,28 1,34 1,42
Average EBITDA / financial charges 11,01 9,93 8,86 7,79 6,78
From the above example, we can confirm the basic principle (represented also in Figure 4)
according to which when NPVproject = 0, WACC = IRRproject.
The other big revenue driver for the SPV is represented by the time extension of the concession -
the longer, the better for the shareholders, knowing that free cash flow to equity is maximized
towards the end of the concession, when debt is repaid and the project can become - at least for
some time - a sort of "cash cows", what shareholders really love but patiently have to wait for,
hoping that nothing bad happens in the meantime.
Since this is a challenged parameter during the tender, competing bidders should wonder, in making
their offer, which is the financial and economic break even point:
shortening the time span of the management phase, always ceteris paribus, there is a strong -
negative impact - on all the key parameters of the SPV, up to the point of making the
investment unattractive for both shareholders and lenders;
interest rate changes don't have a big impact on the key ratios.
Table 6 - Sensitivity analysis induced by changes in the management phase
COMPARISON BETWEEN 25 AND 20 YEARS OF MANAGEMENT PHASE
Duration of the concession (years) 3 + 25 3 + 20
Annual Availability Payment (VAT not including, base 2009) 3.000.000 3.000.000
Annual Service Revenues (VAT not including, base 2009) 18.675.000 18.675.000
Annual Commercial Revenues (VAT not including, base 2009) 5.000.000 5.000.000
Fixed Investment Sum (VAT including) 100.000.000 100.000.000

Public Grants (VAT including) 50.000.000 50.000.000
Share Capital 5.000.000 5.000.000
Subordinated Debt 10.000.000 10.000.000
Senior Debt 46.978.861 47.612.421
VAT Facility 4.809.236 4.809.236
Average Inflation Rate 3% 3%

Senior Debt Rate 5,81% 5,81%
Subordinated Debt Rate 6,06% 6,06%
VAT Facility Rate 3,12% 3,12%
Risk Free Rate 4,70% 4,70%
Market Risk Premium 3,80% 3,80%
Total Financial Charges 40.334.867 32.128.333
NPV equity 17.229.881 10.404.963

NPV project 30.034.485 18.940.845
Payback Period 2022 2023
Average Debt Service Cover Ratio 2,02 2,04
IRR equity 11,66% 10,26%
IRR project 10,91% 9,86%
WACC 6,38% 6,34%
Average leverage 1,19 1,63
Average EBITDA / financial charges 11,01 10,52
Another factor that has an obvious impact on the leverage sustainability - so strongly linked with
the bankability of the project and the profitability of the shareholders - is represented by time41 and
by macroeconomic factors which are so strongly linked with the life span of the concession, interest
rates and inflation.
The term structure (yield curve) of interest rates, which represents the relation between the interest
rate (or cost of borrowing) and the time to maturity of the debt for a given borrower, allows to make
a forecast of the interests along the whole life of the project; to the extent that the curve is positively
sloped, longer term debt commands a liquidity premium over shorter term maturities, with a
consequent higher cost of capital; professional investors, especially if represented by banking or
financial institutions, are institutionally able to deal with long maturities, reducing risk (matching
the maturity of assets with that of liabilities, intermediating funds ).
While the models are normally quite resilient to interest rate changes, especially if the residual debt,
- whose capital is progressively reimbursed over time - decreases, inflation may have a bigger
impact.
41
See the simulation in this paragraph.
In general, if costs and revenues are fully indexed, growing inflation simply brings to higher
economic margins; as a matter of fact, it is however quite frequent that indexation mechanism are
asymmetric, this being a bargaining condition among different competitors in the tender. To the
extent that SPV's revenues are not fully indexed to inflation - with a discount of some 10% to the
chosen inflation rate - its economic margins may squeeze, should costs be on the contrary fully
indexed. Pass through agreements with sub-contractors are so important to detect if and to what
extent the SPV is protected from inflationary shocks and to what extent the risk is transferred.
10. CONCLUDING REMARKS: LOOKING FOR PROJECT FINANCE BANANA SKINS
Project finance is an infrastructural investment with extended duration and long and complex
gestation process, substantially illiquid due to its lumpiness and indivisibility, capital intensive,
highly leveraged and difficult to evaluate all characteristics that make the investment intrinsically
risky. When complexity grows, risk increases and supervision becomes more important.
In many countries, especially those with high public debt, limitations upon the public funds due to
constraints fixed by the EU Growth and Stability Pact have led governments, pushed by an
increasing demand in public investments to invite private sector entities to enter into long-term PPP
contractual agreements for the financing, construction and/or operation of capital intensive
projects42, such as hospitals.
For the public procurer, value-for-money is a key parameter in orienting the choice towards project
financing or elsewhere, while for the private project sponsors, such ventures are characterized by
low equity in the SPV and a reliance on direct revenues to cover operating and capital costs, and
service external debt finance.
No wonder that in such a context, risk is a complex and core issue, to be analyzed from the different
perspectives of the public and private sector entities, with the banking institutions representing the
major cash supplier not a secondary partner:
for the public entity, ex ante risks such as value for money comparisons, technical choices
such as selection of location and planning and ex post monitoring of quality and costs,
during the management phase; core market risk (demand of health services) is also entirely
borne by the public part;
for the SPV, profitability for equityholders (NPVequity; IRRequity), after having properly
served the debt;
for the lending institutions, debt service, i.e. getting lent money back.
Unpredictable risk - since goals are always different from outcomes - and wildly guessed
uncertainties need appropriate detection, sharing, transmission and mitigation, wherever possible.
Efficient risk allocation scenarios are one of the solutions that can minimize the risk of under-
performing projects43 and are crucial for bankability. Risk reduction is possible with sharing, but up
to a certain level. And zero-risk is only a dream.
Banana skin is a metaphor for slippery risks and an increasingly used term in the financial
community; empirical analyses are a useful consensus guideline, in order to consider both biggest
42
See GRIMSEY, LEWIS (2002).
43
See ZULHABRI, TORRANCE ABDULLAH (2006),
risk and fastest risers. No specific data are available for project financing, but samples in other areas
- for example, microfinance - can be a useful, albeit different, example44. According to the
Murphy's Law45, if anything can go wrong, it will. This basic rule may also apply to project finance.
The contents of this paper may conveniently be extended to non hospital investments, adapting the
main findings to a different context where the nature of the investment can be profoundly diverse,
with a different mix of cold and hot revenues, largely depending on the allocation of key (demand)
market risk.
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APPENDIX 1 RISK MATRIX

PART
MITIGATION
RISKS BEARING DESCRIPTION CONSEQUENCES
MEASURES
RISKS
1. Risks concerning the construction site
Risk that the existing health structures are inadequate to
support new improvements46; the hypothesis to settle
elsewhere the new hospital and a different case mix of
new health services offered can have a huge impact -
hopefully for the better - on the demand for services.
This decision concerning the location has a strong
impact on the public opinion and might be consistently Obsolete structures cause Careful programming with a
delayed - even for many years - by disputes (especially many problems, from feasibility and involvement of all
among doctors, in particular if they are also malfunctioning to the relevant social parties is an
"untouchable" academics) and conflicting interests of inadequateness. Additional unavoidable step to reach a
Existing structure local politicians. construction time and cost general and shared consensus.
(refurbishment/ extensions) The location and outlay of the new hospital is always a might follow, especially if Contracts with private parties
Location of the new Public big mess Whereas nobody wants a nuclear plant the original project is should be signed and
hospital close to home (following the NIMBY - Not In My Back continuously modified. consequently respected only
Yard - well known rule), everybody wants the hospital Disputes with private when the picture of the situation
to be as close as possible. counterparts, if projects are is sufficiently stable and clear.
The Project normally involves the development of new approved and then delayed Pre-feasibility studies are highly
facilities (and / or restructuring of existing ones), or even worse abandoned, recommended.
bringing together all the acute and health clinical are highly probable.
services which are spread in other hospitals, in order to
create an integrated and accessible hospital, increasing
the focus on community health services and enhancing
linkages between community and other health services
and giving medical research and clinical teaching a
strong, recognizable identity.
This risk may be contractually
shared.
Risk that unanticipated adverse ground conditions are
Site conditions Private SPV / Additional construction time Private part will pass the issue to
discovered, increasing
shared and cost. builder which relies on expert
construction costs and/or causing delays.
testing and due diligence.
Preliminary probing is strongly
46
In existing hospitals, this is a big challenge, due also to the fact that during the restructuring phase, patients have to be moved elsewhere. If additional buildings are being
constructed, normally patients are moved to the new structure when it is ready and only after the old and by then empty building is restructured.
advisable and should minimize

risk.
Prior to beginning, the tender
process public entity may seek a
planning scheme amendment or
environmental impact
assessment, taking risk of a route
Risk that necessary approvals from public competent diversion or special measures to
authorities may not be obtained or may be obtained protect environmental values; for
Delay in works beginning or
only subject to unanticipated conditions which have example in the case of linear
Approvals Private SPV completion and cost
adverse cost consequences or cause prolonged delays. infrastructure (road, rail,
political opposition increases.
Public support or opposition to the new hospital and its pipeline); during the tender
investment package have a strong impact against the process by means of a Project
decision or in favor of it. Development Agreement both
public entity and the private part
may achieve a measure of pre-
contractual certainty allowing an
early start to the approval
process and a sharing of costs.
Insurance, wherever possible;
Risk of contamination of the site during the
Clean-up costs and delay. best practices of construction and
Environment Private SPV construction period, with consequent increase of costs
careful monitoring should reduce
and time.
this risk.
Private part able to manage the
use of the asset and attend to its
Risk that the use of the project site over the contract maintenance and refurbishment;
Clean-up and rehabilitation term has resulted in a significant clean up or Financial liability on public entity may require sinking
Private SPV
rehabilitation obligation to make the site fit for future residual owner. funds if it is to resume the site
anticipated use. and its use is liable to result in
significant clean
up/rehabilitation cost.
Risk of costs and delays in negotiating indigenous land
use agreements where project site may be subject to
Search of registers and enquiry if
Native title native title or risk injunction and/or invalidity of
Public Delay and cost. appropriate and use of expert
approvals. In many underdeveloped countries with little
advice.
if any cadastral regulations, land titling can be a real
problem.
Search of registers and enquiry if
The risk of costs and delays associated with
appropriate; historical
Cultural heritage Public archaeological and cultural heritage discoveries, Delay and cost.
acquaintance of the area and use
especially in presence of local protective laws.
of expert advice (archeologists
).
Risk that tenure/access to a selected site which is not
Delay and cost. Bidders obligation to secure
Availability of site Private SPV presently owned by public entity or private part cannot
access prior to contract signing.
be negotiated or expropriated.
PART
MITIGATION
MEASURES
RISKS
2. Risks of planning - engineering - construction
Tangible and hidden extra
Risk that the selected structure of the project finance
costs, delays,
(PBOT, BOT, BOO, BRT ) is not the most suitable. Careful pre-feasibility study,
misunderstandings,
Project finance structure Public The decision about who makes the project - either the examining the pros and cons of
incoherence between the
public or the private part - is the first challenging the different structures.
ideal targets and the real
choice.
accomplishments.
Private part may pass risk to
builder/architects and other
Risk that the design of the facility is incapable of subcontractors while maintaining
delivering the services at anticipated cost and/or that primary liability; public entity
new needs and methodologies of taking care of patients Long term increase in has the right to abate service
(expansion of day hospital treatment, new technologies recurrent costs - possible charge payments where the risk
Design / project Private SPV ) find a physical obstacle in old and not flexible long term inadequacy of occurs and results in a lack of
structures. service. service - it may ultimately result
Late design changes, due to uncareful feasibility project in termination where the problem
or new unforeseen events or to changes due to cannot be suitably remedied. A
alteration of the project. good master planning is
essential: any mistake is going to
be long lasting.
The question is both difficult Careful feasibility studies,
and challenging, since considering the evolving needs
hospitals which are too small of the patients;
Which is the optimal size of a hospital? And according seriously risk being under acknowledgement of similar
Size
Public to which parameters (number of beds; number of specialized and unable to experiences. Comparison with
(of the hospital)
patients; cubic capacity )? reach sufficient economies competing structures,
of scale, while structures that considering key parameters such
are too big are increasingly as geographical closeness,
unmanageable. specialization
Below certain amounts, project
Small projects hardly ever allow to cover fixed costs, Economic viability may be
finance should be carefully
Public / while big projects may become unceasingly problematic, together with
Project's magnitude compared to other possible
Private SPV unmanageable and look more viable when risks are the assessment of Value for
cheaper and easier financial
spread broadly. Money.
packages.
Delay in Start Up (DSU)

A delay in the start up Insurance policy that covers all
involves the public entity, non-site force majeure, changes
the future operator of the in law or regulations, and the
Prolonged project start up time may result in significant
Delay in start up Private SPV hospital (the SPV but not its contingent liability of a
underestimation of initial start up costs.
sub-contractors, contractor. Only those partes
manufacturers or suppliers which would incur a loss-for-
of the facilities). profits risk in the event of a
delay in start-up can be insured.
Risk that the price of commodities and materials used
Operating margins of the Fixing the forward price of
in the construction and transport (cement, steel, oil )
Commodity / materials SPV shrink and liquidity commonly traded commodities
Private SPV unexpectedly grows (even due to shortages) or becomes
price might suffer; forecasts might smooth wild and
very volatile, representing an obstacle to efficient
become more difficult. unexpected fluctuations.
budgeting.
For the private part and its
financiers - delayed/lost
Risk that either the physical or the operational
revenue: no payment by
commissioning tests which are required to be Technical monitoring from the
public entity until all
Testing of the construction completed for the provision of services to start, cannot public entity (contractual
Shared physical and operational
/ commissioning be successfully completed. The building, plants, covenants and penalties) and
commissioning tests have
fixtures and fittings do not pass the inaugurating testing insurances.
been successfully completed
before the management phase.
For public entity - delayed
service beginning.
Careful and flexible design of
the new hospital can mitigate
Risk that the useful life of the hospital (normally
risks and problems, who are
estimated around 60 years), once finished, shortens as a Decreasing marginal utility
however hardly predictable,
result of unanticipated events such as force majeure, of the hospital structure,
Useful life (of the hospital) Public especially in the long run.
big demographic or health treatment changes, due to even when the concession
Economic depreciation
which the structure becomes obsolete or increasingly has expired.
according to the real residual
useless.
useful life gives a better
accounting view of the risk.
Rigid or technologically
Hospitals are increasingly complex technological poor projects soon become Flexibility and constant
Technological risk Public
structures dysfunctional and uneasy to marking to market upgrading
change or upgrade
PART
MITIGATION
MEASURES
RISKS
3. Financial risks
Excessive spending and low
Price for quality indicator, depending on contractual quality either in the Detailed contracting, monitoring
Value for money Public remuneration for the performance. The risk is to construction or in the with periodic market test
overpay for poor quality. management can have long inspections.
lasting consequences.
Interest rates
Risk that prior to completion, interest rates may move Bankability of the project Hedging (with derivatives )
pre-completion Shared
adversely (increasing) thereby undermining bid pricing. may be threatened. against interest rates fluctuations
Time span of the whole

concession is fixed in the
tender and stands out as one
of most important clauses, as
a "ceiling" parameter which
If the planning and the construction period are almost cannot be exceeded.
standard, typically not exceeding three years, the Competitors may
Contractual provision in the
management period can greatly vary in different conveniently propose shorter
tender of the "ceiling" duration
projects, normally not going beyond 25-30 years and time spans, this being a
has to be carefully assessed,
occasionally being shorter than 15-20 years. Longer sensitive issue for the
balancing the cost burden of the
projects are intrinsically riskier, even if in this case a economic and financial
public part with the minimum
typical trade off between the public and the private burden of the project,
appeal necessary to attract
Time span / duration (of entity arises: the longer the concession (management strongly affecting key ratios
Shared private competitors.
the project) phase), the higher the costs for the public entity and such as NPV, IRR, WACC,
Different scenario simulations
conversely the revenues for the public counterpart. leverage or cover ratio.
can help to prepare the tender;
Impact on bankability is twofold: longer lasting debt is Since the economic overall
any further improvement,
intrinsically riskier (even if there is more time for its returns of the SPV mainly
shortening the duration, can only
depreciation), but if the management phase is too short, depend on few parameters -
come out of competition among
the private part may find it difficult to service its debt. amount of the public grant,
private bidders.
This risk is financial but also operational and expected income on services
contractual. and commercial revenues,
availability payment and
duration of the concession
this last parameter is a key
one and any change in it
brings to chain effect: ceteris
paribus, shorter duration

decrease profitability for the
private part.
A typical trade-off dilemma
for the public part is whether
to diminish the duration of
the project or the availability
payment, this even being an
option of the competing
private bidders.
Broadly speaking, in a stable
macroeconomic outlook,
where inflation and interests
rates are reasonably low,
lower availability payments
may better decrease the
overall expenses of the
public part, whereas in a
double digit inflation
scenario a longer time span
exacerbates self fulfilling
indexation mechanism.
Careful contractual provision
between the SPV and its
Since project finance is intrinsically cash flow based,
suppliers and especially lenders,
with little if any guarantee on the assets of the SPV and Preferential payments of
disciplining the SPV's duties.
with a ring fence / limited or non recourse47 that subordinated lenders
These cash flow waterfall
protects the SPV's shareholders, segregation of SPV's (mainly, the SPV's
Private SPV / contracts finely detail the order
cash flows is crucial to suppliers and lenders. A strict shareholders), bypassing the
Cash flow (segregation) Lending of distribution of project cash
cash flow trapping and waterfall mechanism is crucial preferential claims of senior
Institution flows across a number of
in order to prevent improper leakage. Being project debt holders, might be
contingencies48.
finance a single project and the SPV a dedicated strongly detrimental for the
Careful and constant monitoring
company, cash flow segregation is naturally easier, if latter.
of the SPV's payments, to be
compared to standard investments.
channeled through the financing
banks.
47
In general terms, a nonrecourse loan is a secured loan that is secured by a pledge of collateral, typically real property, but for which the borrower is not personally liable. If the
borrower defaults, the lender/issuer can seize the collateral, but the lender's recovery is limited to the collateral. If the property is insufficient to cover the outstanding loan balance,
the lender is simply paid out the difference. The purpose of non-recourse debt is to require lenders to underwrite their loans on a sustainable and prudent basis since the lender is in
the first-loss position with these loans, not the borrower. In project financing concerning public hospital investments, they cannot be disposed of by the banks who finance the SPV.
48
See SUBRAMANIAN, TUNG, WANG (2009).
Careful contracting with

waterfall clauses (ensuring that
Limited verification of cash each cash flow item occurs at the
Private SPV / Verification of cash flows, eased by their segregation, flows is a risk for the lending correct seniority to other items)
Cash Flow
Lending reduces information asymmetries institution and may bring to and private enforcement
(verification)
Institution abuses and mismanagement mechanisms to limit borrower
of the SPV. discretion on cash flows,
centralized treasury handled by
the lending institutions.
Risk that when debt and/or equity are required by the
private part for the project, they are not available on Public entity requires all bids to
Financing
that very moment and in the amounts and on the No funding to progress or have fully documented financial
unavailability (capital Private SPV
conditions anticipated. Since the need for money complete construction. commitments with minimal and
rationing)
reaches its peak during the construction, this is the easily achievable conditionality.
typically riskiest moment.
Private part must assume best
endeavors obligation to fund at
agreed rate of return with option
on public entity to pay by way of
uplift in the services charge over
the balance of the term or by a
Risk that by reason of economic and financial crisis, a No sufficient further funding
separate capital expenditure
change in law, policy or other event (increase of available to complete further
payment; public entity to satisfy
Additional finance Public construction costs to materials more expensive than works required by public
itself as to likelihood of this need
expected .), additional funding uneasy to obtain is entity.
arising, its likely criticality if it
needed to rebuild, alter, or reequip the facility.
does arise, and as to financial
capacity of private part to
provide required funds and (if
appropriate) budget allocation if
public entity itself is required to
fund it.
Risk that the SPV is unable to meet its financial Decrease of leverage, presence
obligations, avoiding to pay its debts towards third of an adequate debt service
The SPV might find it
Private SPV / financing parties (especially underwriters of senior reserve account and good cover
increasingly difficult to run
Liquidity Lending debt) and suppliers. Limited or zero recourse together ratios indicators (above unity),
its business keeping going
Institution with ring fence prevents the right to attach claims together with continuous
concern equilibrium.
against the assets of the project sponsor, since assets monitoring of the financial
and cash flows of the project are segregated. The assets equilibrium and request of equity
of the project (hospital with plants, fixtures and injections if needed are all
fittings49) belong from the beginning to the public measure aimed at preventing
entity and are dedicated to a public usefulness, so liquidity risk.
preventing expropriation from the SPVs debt holders.
Interest rates Interest rate hedging (fixing a
Risk that prior to completion, interest rates may move
pre-completion Shared Increased project cost. ceiling) may occur under Project
adversely (increasing) thereby undermining bid pricing.
Development Agreement.
49
The building always belongs to the public entity from the beginning, while the property of plans, fixtures and fittings follows possible different legal frameworks and might for
instance be in leasing (belonging to the lessor before redemption).
Private part generally will enter a

fixed term, fixed price building
contract to pass the risk to a
builder with the experience and
resources to construct so as to
satisfy the private part's
obligations under the contract.
The builder is normally a (key)
shareholder of the SPV, bearing
Delay and extra costs; fines an incentive in aligning his
Risk that unforeseen events occur during construction
and penalties are interests with those of the other
which prevent the facility being delivered on time and
increasingly present in private partners. Business
without extra costs. Architectural innovation and
Construction contracts, often interruption insurance protects a
sophisticated technology are a must in new projects and
(and shape of the new Private SPV counterbalanced by business owner against losses
the construction has to follow the planning, with a
hospital) premiums if the construction resulting from a temporary
rational use of the spaces which reduces running costs.
is ready earlier. Innovative shutdown. Generally, it provides
Ergonomic and energy saving solutions are particularly
structures always bear reimbursement for lost net
welcome.
unforeseen problems. profits and necessary continuing
expenses.
The Contractors All Risks
(CAR) insurance offers
comprehensive coverage for all
types of civil construction risks.
This policy covers physical loss
or damage to property, as well as
third part liability related to work
conducted on the contract site50.
SPV shareholders might inject
more equity or subordinated debt
Risk that the project is not bankable and that the SPV is / mezzanine (quasi equity) to
Bankability Private SPV unable to raise enough financing. It is a synthesis of No bankability, no project. decrease leverage and external
most other risks. funding needs. Soft (preliminary)
test can reduce bankability risk,
allowing for a correction of the
50
The coverage for physical loss or damage to property is on an "All Risks" basis, i.e. the policy insures against damage to property in the course of construction by all sudden,
accidental and unforeseen causes other than specified excluded perils and forms of damage. This cover includes works brought on to the site for the purposes of the contract as well
as temporary works erected or constructed on-site. Additionally, the policy includes coverage for physical loss or damage to construction plant & machinery, equipment and tools
used per the insured contract. This policy also includes third party liability coverage. This insures against accidental bodily injury or illness to third parties as well as accidental
loss of, or damage to property belonging to third parties, caused by an accident at the construction site. The policy also indemnifies for legal costs and expenses recovered by a
claimant from the insured.
model's weak points.

Shortening the time span
between the decision to award
the concession to an SPV and the
Risk that the effective financial closing with the banks Higher financial charges,
effective start of the project can
who support the SPV who has definitively won the with corresponding lower
contribute to reduce uncertainty,
tender is subject to a market change whereas credit margins for the SPV, are the
Financial closing Private making unexpected events less
availability and terms are substantially modified, if smallest problem, since the
likely; careful and flexible
compared to the soft test conducted during the tender, real risk is represented by
contracting from the SPV's side
especially if the time span grows. turned up no-bankability.
with the public part and -
especially - the financing
institutions seems also important.
Credit risk is typically higher at project inception and
gradually decreases over the life of the project. The
The financial structure of the
Private SPV / debt maturity structure has an impact on risk and Longer maturity loans are
Degree of maturity SPV has to be carefully designed
Lending bankability. Long lasting projects are not easy to not necessarily riskier than
(of the loans) since inception, considering also
Institution finance and specific intermediaries able to match long shorter-term credits51.
its timing debt facilities.
term investments with liabilities of similar maturity,
such as pension funds, might be useful.
Public entity will assure itself
Upside probability52 that at completion or at any other that likely benefit has been
A beneficial change in the
Refinancing Private SPV stage in project development the project sources of factored into competitive bids to
financing cost structure of
benefit /shared funds can be restructured so as to materially reduce the avoid the risk that the private
the project.
project's financing costs. part will be allowed to earn super
profits from the project.
Financial innovation and
Institutional investors, particularly if long term focused
sophistication can help, but they
(pension funds, life insurance companies, private equity
need an attractive environment.
funds ), are highly wanted and they can ease Alternative use of more
Compliance with international
bankability, especially if they are equity underwriters. traditional and less
best practices can attract foreign
In many countries or industries these sophisticated and specialized investors makes
Availability of specialized investors. Syndicated
Private peculiar investors are missing. Closed end funds the project more expensive
institutional investors loans of a consortium of lenders
typically have a maturity which is much shorter than and the risk transfer less
can allow raising large amounts
that of the project and normally underwrite the capital efficient. Suitable investors
of finance.
at the beginning (unless they don't enter the secondary are naturally less risk averse.
Possible exit strategies for
market), trying to sort out after some 4-7 years of
unsatisfied investors range from
management.
"fire sales" to more efficient
51
See SORGE (2004).
52
Risk can be generally defined as the probability that the actual volatile outcome differs from the estimated one; should the outcome be better than foreseen, the (upside) risk
would have a positive impact.
secondary market options.
Risk that the VAT added to the availability payment

invoiced to the public entity is not fully offset, due to Should the public hospital be
Favorable legislation should
the presence of a high exempt rate (typical of prevented to offset its VAT
reassess this issue, make VAT
hospitals); another risk might be present in the SPV, if charges, its costs would
Private SPV / deductible or exempt for public
VAT financial charge the VAT credit it generates during the construction is increase up to the amount of
public hospitals. The state never
not easily absorbed during the management phase. the deductible VAT rate, i.e.
benefits from changing higher
Exempt VAT rates are much appreciated by the public net of its corporate tax
costs to public hospital53.
part but represent a huge cost for the private burden.
counterpart.
Currency losses happen
Risk deriving from a currency mismatch of assets and Currency hedging with forward /
when due to adverse foreign
liabilities, in a project which involves international futures; balancing of assets and
Currency Private SPV exchange fluctuations, assets
players (SPVs shareholders, suppliers, bank debt liabilities in homogeneous
are depreciated and/or
holders ). currencies54.
liabilities increase.
Leverage should decrease in
Risk that the composition of assets and liabilities of the
Depreciation in the value of presence of risky assets;
SPV is not properly balanced, due to currency or
Assets & Liability assets can erode the equity, information asymmetries
Private SPV interest rate risk (see above) or to the asset's
mismatch (of the SPV) and if it becomes negative, concerning the assets
composition, if considered too risky in comparison with
debt holders are at risk. composition are normally
the liabilities.
limited.
Public grant is riskless The amount of the public grant
The higher of the amount of the public grant, as a
money for the private part, and the percentage of the overall
percentage of the cost of the investment, the lower the
subject to the only condition investment it allows to cover are
risk of financial coverage for the private part. The
that the construction is the first parameter to be
balance funds that the private part has to receive to
properly carried on and considered in the strategic design
reach its financial break even have to come from both
completed. of a PF scheme.
the availability payment and the marginality on trade
Public grant Since other sources of funds About the amount there is little
Private SPV and other revenues.
(amount of) especially commercial negotiation possible between the
Public grant can sometimes cover up to 60% or more of
(hot) revenues are riskier, public and the private part, who
the investment: the higher, the better for both parties,
the public grant (available in this case naturally agree and
even thought should the public grant grow tending
from the beginning) both want to get the most they
towards a full coverage of the investment, then there
decreases the SPV's need for can; the real debate is between
would be no need to build up a project financing
money, reducing its leverage the public part and its
scheme, having nothing to finance!
and increasing its "shareholders", represented by
53
This phenomenon causes a well known redistribution effect according to which if the hospital spends more, it increases its deficit, which sooner or later has to be covered by
public funds. But this process is neither quick nor straightforward, often generating expensive complications and sometimes bringing to inefficient and suboptimal allocation,
opening the funds mismanagement and "improper use" of funds, which hollow crooked ways, uneasy to detect and monitor.
54
Considering also the (often asynchronous) matching of expiration times.
bankability. local and / or central authorities,

who give dead-end contributions
according to their budget
possibilities and to contractual
(political) bargaining, following
the Orwell's Animal Farm's rule,
according to which all public
hospitals are equal but some
are more equal than others.
Risk that the public grant installments or lump sum are
paid before the reaching of contractual milestones or
completion of the building; should the public grant be
anticipated by a facility, this line of credit would The public part might find it Contractual clauses; efficient
Public grant
Public undergo similar risks. Public grants can be partially difficult to claim back monitoring of the building
early payment
sponsored or covered by private-not-for-profit unduly paid money. progresses.
institutions (foundations, NGOs, endowment funds ),
whose aims are consistent with the development of
locally eradicated health facilities.
Decrease leverage and / or other
deductible costs which
"compete" with otherwise fully
Risk that the SPV does not produce a taxable income The SPV pays more taxes, deductible interest rates; carried
Tax shield Private SPV
high enough to absorb deductible interest rate charges. increasing its cash outflows. forward losses from the years of
construction can significantly
lower the tax burden in the first
years of management.
Deferred tax assets generally arise where tax relief is
provided after an expense is deducted for accounting Deferred tax credits, if not
Careful forecast of future
purposes. A SPV typically incurs tax losses in the properly used, have to be
revenues and prudent accounting
Deferred tax credits Private SPV construction years and normally carries them forward to written off, generating losses
of tax credits, considering the
reduce taxable income in future years; risk originates which erode the equity, so
likeliness of their effective use.
when future incomes are not sufficient to absorb the increasing the leverage.
credit in due time.
The public entity sometimes pays part of the While cash, represented by
Protective covenants might be
availability giving assets in kind to the SPV, mainly the availability payment, is
asked by non professional
represented by real estate properties (often, the facilities objectively measurable by
stakeholders of the SPV.
of the old hospital). This swap (building of a new anybody, real estate
Assets in kind swap Private SPV Since bankability might be
hospital against the property of the old one) bears a properties are harder to
harder, senior debt holders of the
well known pricing risk (which is the real value of the appreciate and professional
SPV might ask for a guarantee
real estate properties, often located in central areas?) stakeholders of the SPV
on these estate properties.
and brings no cash to the SPV, often making (constructors, property
bankability harder. A mispricing (underpricing) of the managers ) might have an

property may however affect the public entity. For the advantage on others.
private part, the swap may bring to a long term return,
intrinsically riskier, if the property is represented by
assets which need to be fully restructured, often
changing their zoned purpose. A frequent example is
represented by the old hospital which can become
"something else", in accordance with local authorities.
A risky challenge but also an opportunity.
Is the public entity fully backed by the State in case of

Default (of the public Without this "last resort" A public guarantee might be
default? If not, a guarantee is needed.
entity) Private SPV guarantee, the bankability of needed, if the local laws do not
the project becomes difficult. already solve the problem.
During the construction, the private builder develops a
VAT facility is an important
VAT credit, difficult to offset due to the lack of
resource in the financially Bank monitoring and technical
revenues. The sponsor banks might open a new credit
difficult phase of check of the timing of the
line, guaranteed by the VAT credit. Risk involves also
VAT facility Private SPV construction, with a mixed invoicing, together with a
reimbursement, with a chain effect, since the SPV
impact on bankability (debt constant audit of the VAT
repays its debt to the bank when it gets back the VAT
increases but without it the compensation rules.
credit from the Government. Arrangement fees increase
model is more fragile).
costs and risk of reimbursement.
Since the public contribution is not paid to the SPV
Bank monitoring, as for the VAT
when the construction starts but with installments No progress on the job, no
facility (see above) and technical
which follow the progress on the job, the sponsor banks grant payment. In such a
audit of the building in progress,
Grant Facility Private SPV might open a new credit line, guaranteed by the grant case, any undue anticipation
which entitles the SPV to receive
credit. Risk is similar to the VAT facility case (see received represents a risk for
the grant, which is underlying its
above), even if somewhat milder, since the grant is the bank.
facility.
already available.
Insufficient equity injections and too much debt
underwriting can bring to excessive leverage, especially
Private SPV / If leverage grows too much, Equity injections, better if
during the construction period when cash flows are
(excessive) leverage Lending debt repayment and contractually binding; bank
typically negative. In case of an equity burn out, due to
Institution bankability are at risk. monitoring.
cumulated losses, an immediate recapitalization is
necessary; in the meantime, leverage explodes.
Equilibrium between debt Dividend payments, leverage
and equity is necessary in rebalancing or new debt issue. If
Equity is more expensive than debt, since as a residual order to balance the risk - capital is underwritten but not
(excessive) equity Private SPV
claim is intrinsically riskier. return profile of the SPV, fully paid up (unless it becomes
with particular reference to necessary), then the equity
its shareholders. Too many structure is more flexible.
equity infusions reduce their

expected returns.
Negative economic margins
(EBITDA, EBIT, pre tax
If the investment, covered by financial sources whose result ), negative liquidity Risk and consequently the
weighted average cost of capital (WACC) exceeds its progressively bringing a WACC has to be reduced with
assets' return, then the investment progressively cash and equity out, equity injections, if leverage is
destroys value, putting the SPV at risk. Internal Rate of undermining the SPV's too high, financial renegotiations
Financial-economic
Return (IRR) should always exceed WACC, possibly chances of survival. If looking for cheaper funds but
unbalance Private SPV
with a "security cushion" able to absorb interest rate WACC > IRR, then there is especially struggle enhance
(if WACC > IRR)
increases. no Financial Viability, i.e. assets returns, increasing the
The ability of a project to productivity and efficiency, with
provide acceptable returns to an optimal use of source and
equity holders and to service expensive resources.
its debt on time and in full is
endangered.
Cash outflows including
Social contributions have to be paid by the SPV, but its fines can asymmetrically hit
Social contribution Monitoring of regular payments;
Private SPV shareholders may be jointly responsible, under some the SPV's shareholders and
solidarity cross-checking; guarantees.
restrictive local laws. the good ones might pay for
everybody.
PART
MITIGATION
MEASURES
RISKS
4. Governance sponsor risk
Ensure project is financially
remote from external financial
Risk that the private part is unable to provide the
liabilities, ensure adequacy of
required services or becomes insolvent or is later found
Termination of service to finances under loan facilities or
to be an improper subject for
public entity and possible sponsor commitments supported
Sponsor Public involvement in the provision of these services.
loss of investment for equity by performance guarantees; also
Risk that financial needs on the private part or its
providers. through the use of non financial
sponsors exceed its or their financial capacity, up to the
evaluation criteria and due
point of causing corporate failure.
diligence on private parties (and
their sponsors).
Risk that the private part who doesn't fully have the
knowledge or competence to perform a task, Legal covenants to prevent
Availing one selfs of other legitimately asks somebody else to join him, causing Decrease in quality and loss improper availing on other
Private SPV
parties however problems. Free riding, lack of coordination, of time and coordination. parties, with constant monitoring
inefficiencies or extra costs might originate, damaging of performance quality.
also the public part.
Periodical tests through the

Contracts among the
lifetime of the project, together
Risk that partnership agreements, from financial different private partners,
with value testing schemes as
Partnership Contract Private SPV syndication to pass through contracts, bring delays, aimed at sharing the job to
benchmarking or market testing,
inefficiencies and extra costs. be done, bring transaction
can maintain competitive
costs.
pressure.
Public entity assurance of
the financial robustness of
the private part may be
diminished and, depending
Risk that a change in ownership or control of the on the type of project, Public entity requirement for its
Change in ownership Shared private part results in a weakening in its financial probity and other non consent prior to any change in
standing or support or other detriment to the project. financial risks may arise control.
from a change in ownership
or control which may be
unacceptable to the public
entity.
Debt holders of the SPV can suffer an expropriation of
their wealth should shareholders adopt, through the If debt holders get a whiff of
directors and managers that they appoint , strategies danger of expropriation, debt Debt covenants and debt holders
Debt holders expropriation that maximize their own interests, at the expense of placement becomes harder, monitoring, cash flow
Private SPV
(from shareholders) other stakeholders (adoption of risky projects in a over- wherever still possible, and verifiability and especially
levered company; payout of excessive dividends; issue more expensive. Bankability segregation.
of new senior debt ), including private benefits of may be at risk.
control.
Senior debt holders can have a conflict with junior
(subordinated) debt holders, these two categories being
Private SPV / almost always present in SPVs. Junior debt holders are
Conflict between different Senior debt is harder and Protective covenants for senior
Lending typically represented by equityholders and they might
debt holders more expensive to place. debt holders.
Institution extract wealth from the SPV, damaging the privileged
senior debt holders, should they receive excessive
interest rates of should they be paid in advance.
The partnership contract leads to the creation of a Single stakeholders may take
consortium, as a single operator cannot provide the advantage of their strategic
whole package of services needed. The project situation, taking free of Clear and meritocratic rules,
Free riding Private SPV governance requires re-allocating the risks transferred charge profit from the effort establishing duties and
to the private sector between the SPV stakeholders of other stakeholders, who consequent awards.
(investors, builders, facility managers ). This process may face a disincentive to go
gives way to a series of back-to-back contracts, on working.
designed to prevent any free riding between the

parties55.
Free riding, asymmetric
gains unrelated to real effort
and true investments and - in
the worst cases - intentional
misbehavior and fraud are
possible consequences of
this slippery conflict of
interest.
If the debt to finance the
construction of the hospital
is concentrated on the SPV
and its shareholders can
Multiple role stakeholders are very frequent in SPVs.
benefit of the ring fence and
As an example, both the constructor and the suppliers
no (or limited) recourse
of services (internal or external, in such a case linked to
mechanism, then they
the SPV with a pass-through contract) are typically Contractual covenants and
transfer their own risk on the
Private SPV / shareholders. Should multiple role stakeholders have a efficient monitoring can soften
SPV and mainly on its
Multiple role stakeholders Lending personal interest prevailing on other more general the problem, together with
external debt holders
Institution objectives, then a conflict of interest would arise (e.g. sharing of duties, responsibilities
(normally, the banks who
the operator who supplies services is often much more and capital underwritings.
have provided senior debt).
interested in being well paid, following the more You
In such a context, is priority
give, the better I live" model, than in getting a dividend,
in repayments a sufficient
to be shared with other shareholders).
guarantee for senior debt
holders? Much depends on
the overall risk structure of
the SPV and in particular
on its foreseen capacity to
service the debt, with little if
any parachute for the debt
holders in case of
delinquency. Bankability
scrutiny has to carefully
consider these potential
problems.
New unfit shareholders Liking clause present in the by
Liking clauses Risk that existing shareholders with certain professional
Private SPV might be not professional or laws of the SPV might prevent
pre-emption rights characteristics are replaced by unfit new ones.
unable to meet the financial improper replacement of existing
55
See MARTY, VOISIN (2007).
needs of the SPV. shareholders; if new

shareholders add up to existing
ones, the problem is smaller or
even not existent. Key
shareholders might be asked to
underwrite minimum quotes of
capital; shareholders providing
services has to stay till they have
finished their job.
Pre-emption rights in favor of
remaining shareholders and non-
competition clauses for those
who exit can prevent conflicts of
interests.
Good and reasonable rules,
aimed at reducing information
The project becomes more
Risk that smuggling or mismanagement of funds can asymmetries, increasing
expensive and less efficient.
Private SPV / harm the SPV or the public hospital or both parties. transparency, objectivity and
Fraud / corruption Hidden costs are by
public Corruption, collusion, graft, briberies are symptoms of fairness are the best antidote
definition difficult to
severe misallocation of funds. against corruption. Continuous
measure and identify.
and effective monitoring / audit
is necessary.
Flexible governance rules,
contractually enforced and
periodically audited, can mitigate
Information asymmetries can conflicts of interests which
be more substantial and naturally arise wherever
harder to detect - monitoring complexity dwells. Incentives
Complexity is a hidden - and so difficult to measure -
is more difficult and aimed at aligning the interests of
cost, borne by the presence of many stakeholders which
Private SPV / expensive. Contracts and different stakeholders are highly
Complexity pivot around the SPV, pursuing ones own interests.
Public covenants regulating one-to- welcome even for those who are
Problems due to complexity can well involve the public
one relationships might lack not fans of Pareto optimality56,
part, causing delays, extra costs and lower quality.
a general and systematic (peace is more convenient than
framework and unifying war!). Concentration of problems
vision. and issues within the SPV can
soften relationship problems
with the external public
contractor.
Moral hazard Private SPV / Moral hazard is a classical take the money and run Cash diversions, Cash flow channeling through
56
Pareto efficient situations are those in which any change to make any person better off would make someone else worse off.
Lending problem, since borrowers might try to abscond with inefficiencies and losses. the lending bank makes money
Institution the banks money or try not to fully engage them in the hiding extremely difficult
project for which they have been financed.
The track record and reputation
of borrowers is less easily
identifiable in project finance,
Adverse selection is a typical problem in money since the SPV typically has
lending, since banks not knowing who is who several shareholders, but - to the
Private SPV / Bad projects can be
cannot easily discriminate between good and risky extent that the borrower is the
Adverse selection Lending incorrectly chosen and
borrowers, who should deserve higher interest rate new SPV and that the investment
Institution preferred to deserving ones
charges. project is highly detailed,
adverse selection problems are
not so important. Soft testing of
bankability can reduce the
problem.
If the final client is
unsatisfied about the Transparent and understandable
services, the whole structure rules and contractual duties
Patients are the ultimate and most important
is damaged and a consequent linking the private with the
stakeholder which pivots around the hospital; although
decrease in demand for public counterpart, together with
not directly linked to the SPV or to the project finance
health services is likely, efficient and continuous quality
Damaging patients Public agreement, the quality of cares and health intervention
since patients are monitoring.
strongly depends on the Public Private Partnership
increasingly able to choose Patients are not directly handled
how it effectively works is not a private matter between
among different competing by the private part and so its role
the public hospital and the SPV private contractor.
structures and quality is a is for the good or for the bad
vital and highly wanted intrinsically limited.
parameter.
Opportunities can be
deceiving or go beyond Innovation, fancy and incentives,
The new hospital represents a network of opportunities
expectations. The more the together with entrepreneurial
for a large set op people around it, such as its
hospital contributes to the attitudes the best
Networking contribution contribution to education and professional training, job
socio-economical characteristics of capitalism
to the general development Public opportunities in the hospital and in related activities
development of the area, the play a hidden but significant role
of the area (even commercial initiatives run by the private part),
better for the public and in igniting general development,
technological innovation. But opportunities are
private part, who can able to trickle down well beyond
uncertain and intrinsically risky.
directly benefit from related the core business of the hospital.
business.
Changes in the key elements of the contracts, The more flexible the Flexible contractual provisions
Renegotiation increasingly likely if the time span is long, enhance the contract, the easier the which allow renegotiations,
Shared
(of the agreements) risk (and opportunities) of renegotiation of the negotiation of the services to especially under agreed
agreements. be rendered, always circumstances (after a certain
considering their economic amount of years of management;

and financial impact. when some conditions occur;
upon attainment of specific
milestones ).
PART
MITIGATION
MEASURES
RISKS
5. Operating - Performance Risks
Risk of poor management
strongly affects the risk / Professional management is
The success key point is represented by a good project return profile of the whole highly wanted, especially for
Project management Private SPV
management during the concession. investment. Extra costs, increasingly sophisticated
complaints and inefficiencies projects.
naturally follow.
Private part may manage risk
through long term supply
contracts where
quality/quantity can be assured;
risk can partially be shifted to the
Risk that required inputs (services, materials, SPV's suppliers with pass
Inputs equipments all organized and delivered as a Cost increases and in some through contract if suppliers are
(price quality Private SPV functioning device) cost more than anticipated, are of cases adverse effect on shareholders of the SPV, the risk
availability) inadequate quality or are unavailable in required quality of service output. diversification may be more
quantities. theoretical than real. Pass
through agreements should
consider arm's length conditions,
where the parties are
independent and on an equal
footing.
A change in output
Public entity can mitigate this
requirements prior to
risk by minimizing the chance of
commissioning may
its specifications changes and,
necessitate a design change
should there be a change,
with capital cost
Risk that public entity's output requirements are ensuring the design is likely to
Changes in output consequences depending on
Public changed outside the agreed range after contract signing accommodate it at least expense;
specification the significance of the
whether pre or post commissioning. this will involve considerable
change and its proximity to
time and effort in specifying the
completion; a change after
outputs up front and
completion may have a
planning likely output
capital cost consequence or a
requirements over the term.
change in recurrent costs
only; for example where an

increase in output
requirements can be
accommodated within
existing facility capacity.
Contractual specifications reduce
Core - binding - issues and flexibility and freedom.
duties should not be too Real options (of expansion,
Flexibility and resilience are options with different
flexible; a bit of flexibility suspension, abandonment,
Public SPV / possible outcomes, often welcome but intrinsically
Flexibility and creative risk borne by downsizing ), if correctly
Private risky. It might bring to unwanted behaviors which
the private entity complies estimated, can have a positive
damage the public part, or to good creative surprises.
with the "philosophy" of impact on the project's NPV.
project finance. Monitoring of Value At Risk can
reduce uncertainty.
Cost increases where private
part has assured whole of
Risk that the planning or the construction quality is not life obligation and adverse Joint monitoring (public &
adequate and so unable to prevent an increase in effect on delivery of private) during the construction
Maintenance -
Private SPV restructuring costs. Ordinary and extraordinary contracted services and, in and the management. Mitigation
restructuring
maintenance has to be considered even during the core services model, a with forecasting of future needs
management case, especially if long lasting. corresponding adverse effect and quality controls.
on public entity ability to
deliver core services.
Activity can be slowed down
Risk that a catastrophic event (earthquake, flood; fire or interrupted, depending on Insurances, prevention and
) might damage or destroy the building. the gravity of the events. monitoring can reduce, but not
Private SPV / To a less pessimistic extent, general risk of improper Privacy can be violated. For eliminate - the problem.
Security
Public access to the off limits areas, intrusion in the ICT sensitive issues, the public Technology (with firewalls;
systems, not respecting the privacy of the patients, part is more responsible, check in controls ) can also
thefts or other illegal and harmful actions. even if the private part may help.
share some of the risks.
The failure may result in
service unavailability, an
Risk of default of the SPV-general contractor or inability for public entity to
Default (of the general Private SPV / subcontractor with interruption of the services or deliver core services and, in Monitoring of the financial
contractor or Lending worsening of their quality below the contractual each case, a need to make soundness of the SPV-contractor
subcontractor) Institution agreements. The risk of default of a sub-contractor alternate arrangements for or subcontractor.
might be handled, if he can be easily replaced. service delivery with
corresponding cost
consequences.
Technical obsolescence or Private SPV Risk that design life of the facility proves to be shorter Cost of upgrade. Private part may have recourse
innovation /shared than anticipated, accelerating refurbishment expense. Private part's revenues may to
Risk of a quicker technical obsolescence of plants, fall below projections either designer, builder or their
fixtures and fittings. It might bring to a shortening of via loss of demand (user insurers.
the useful life of (part of) the hospital. pays model) payment Private part may arrange
abatement (availability contingency/reserve fund to meet
model) and/or operating upgrade costs subject to public
costs increasing; for public entity agreement as to funding
entity - consequence will be the reserve and control of reserve
failure to receive contracted funds upon default;
service at appropriate monitoring from the public
quantity/quality including entity; contractual covenants.
adverse effect on core
service delivery in core
service model.
Revenues of the private part
shrink up to the point of Contractual guarantees with
Risk that some services might terminate before their
endangering the going penalties might soften the
Early termination Private SPV contractual expiration time, for reasons of public
concern of the SPV which problem, albeit not completely
interest which might concern the whole concession.
might be forced to prevent it.
liquidation before time.
Risk that the quality of the services becomes
Benchmarking and periodically
technologically obsolete or that they become too
market testing the ongoing
expensive; new products, to be tested, may make
services component of projects,
obsolete the previous ones.
with a technical monitoring,
Projects have provisions in their contracts that require
Economic margins of the allow periodical quality checking
the value of certain services, such as catering and
private part risk to shrink, and prevent rent maximizing
cleaning, to be tested at intervals, typically every five to
due to growing costs of attempts from the SPV, should
seven years. The services that are subject to this value
running out-of-date services economic margins become
testing are often a significant part of the total cost of a
Market test or to missing new revenues, excessive.
Private SPV PFI contract and so the process of value testing is an
(benchmarking) should the services be Testing the value of services
important aspect in seeking to achieve value for money
assigned to a competitor. during the management phase is
from a PFI contract which may run for 25 or 30 years
Even benchmarking may a mean to reintroduce
or more. Value testing may involve comparing
result in a cost reduction. competition after the initial bid.
information about the current service providers
Benchmarking is cheaper than
provision with comparable sources [benchmarking] or
market testing, as no re-
alternatively, inviting other suppliers to compete with
tendering of the service against
the incumbent in an open competition [market testing].
the incumbent supplier is
While market testing results in a re-tendering of the
needed.
service against the incumbent supplier, with consequent
high transaction costs, benchmarking is potentially a

cheaper option, as no re-tendering is involved57 .
Risk that the cost of employees increases beyond Make the labour force flexible,
Operating margins of the
expectation, due to new social charges, increase in whenever possible; at least
Employee Cost Private SPV SPV shrink as well as cash
wages difficult to forecast and almost impossible to partially transfer the cost to sub-
flows.
prevent, if decided at the Government's level contractors.
Availability fees can be compared, at least theoretically,
to some (most) of the expenses that public hospitals
The risk is for both parties,
would alternatively pay for interests on mortgages on
since evidently if the
new facilities and on expenses of fixed assets. This
availability payment is Smart contractual provisions,
comparison has to be fully considered in the Value for
excessive the private part with a careful picture and
Money assessment. The availability payment has a
gains while the public one regulation of each part's duties
variable part depending on the performance of the
Availability payment (fee) Shared loses money and vice versa. and rewards.
services rendered by the SPV/concessionaire. The fixed
Since the payment is Monitoring reduces the public
part may be discounted within the banking system,
independent of the level of part's risk.
improving the bankability.
patient demand for hospital Poor service, reduced payment.
If the payment deduction the SPV incurs fails to
services, this risk belongs
remedy its poor performance, there are provisions in the
only to the public part.
PFI contract for its early termination, with the
replacement of the supplier of (poor) services.
Scalability is mainly represented and measured by
operating leverage, i.e. the impact of a change of
operating revenues on the EBIT. Operating leverage
and the mix of fixed and variable costs in the SPV
hugely influence the scalability of the model; a limit to
Since the SPV has a ceiling
a (positive) scalability effect is due to the fact that there
imposed on its potential
can be a market cap on revenues which cannot grow too
revenues, it should also demand
much anyway (market expansion possibilities are Exceptional returns are
a floor on its possible losses.
limited by the numbers of the hospital project and the typically not feasible and are
The business model is much
Scalability Private SPV very fact that the model cannot be replicated contractually regulated in
more stable than elsewhere and
elsewhere). There is however a floor in operating order to prevent excessive
further contractual provisions of
margins decrease, since demand of services is public spending.
minimum revenues might allow
predominantly rigid and demand risk of the core
for a further protection of the
business (patients healthcare) is borne by the public
SPV.
entity, considering its high social impact.
Risk can arise whenever the business model of the SPV
is not sufficiently scalable. The presence of huge fixed
costs within the SPV which can be highly labour
intensive, unless it passes through its services to
57
MARTY, VOISIN (2007).
external companies and a natural and contractual

ceiling on revenues for cold services normally
reduces but also stabilizes the scalability of the business
model of the SPV.
Should the commercial revenues of the SPV trespass a
stated amount, what exceeds might be shared with the
A ceiling is placed on In the absence of a specific
public entity, if the contract envisages such an option.
potential SPVs extra-gains, contractual provision, there is no
The contract might foresee compensation with a
Sharing of commercial making the whole project risk for the private part - but then
Private SPV reduction of the availability payment.
revenues less attractive for the private the public part is not enabled to
A positive consequence can be the alignment of the
part and (mildly) less participate to the extra gains. It's
interests of the SPV and the public entity all motivated
bankable. a negotiable issue.
to fully exploit the opportunity to develop the
commercial revenues.
For any new service, if there are
no extension options in the
contract, an auction has to be
done; concessionaire can
At the end of the concession, the structure is freely
Cost (and time consumption) compete and normally has a
given back to the public part; from that time on, the
of new competitive tenders, strategic information and
Delivery Public public part bears any risk, since risk sharing is formally
potentially more expensive operating advantage (he knows
over; in particular, there might be a risk of a renewal of
for the public part. the job better than his potential
the services under different conditions.
competitors). Should a
newcomer win the bid, he might
be forced to hire the employees
of the former concessionaire.
Monitoring and careful control
Quality can be decrease and
Know-How and Risk that the SPV does not use adequately qualified and since inception of quality
Private SPV the public counterpart
competence level skilled personnel. requirements might significantly
affected by poor service.
reduce this risk.
The behavior of the private
part may be sub-optimal,
The public entity, no more involved in direct
decreasing the quality of the Realistic contractual provisions
management, has to develop new skills concerning the
project, especially if it is and a comprehensive list of the
monitoring and assessment of the quality of the services
difficult to observe and engagements of the private part,
of the SPV. It also has properly to monitor the
check. concerning in particular the
Monitoring Public substantial transfer of risk and the effectiveness of
Since the reality is often effective risk transfer, can
mitigation measures. Monitoring is a costly and risky
quite different from the mitigate the problem, together
activity which arises from agency problems and
contractual provisions, with effective and professional
asymmetric information. Realized projects may diverge
accurate and regular audit.
from contractual expectations.
monitoring is absolutely
necessary in the relationship
with the private counterpart.

Auditing and monitoring is
both expensive and difficult.
Quality might be affected
and delays, malfunctioning
Sub-contracting the construction and / or the operation are always possible, Complex contractual provisions
of the investment reduces the residual risk that remains especially for complex tasks. with sub-contractors and
with the SPV. The SPV however faces other, passing In presence of many constant quality monitoring from
Sub-contracting Private SPV
through part of its obligations and duties to third sub- different sub-contractors, the SPV and - indirectly - also
contracting companies: extra-costs, coordination, quality controls and from the public entity, to which
quality monitoring, lower marginalities identification of the SPV is finally responsible.
responsibilities become
harder.
Careful modeling, based on
58 experience and analytical
Errors and bias in judgement bring to distortions ,
Extra sunk costs can arise, comparisons with similar cases;
according to which People can underestimate costs, due
Cost bias Private SPV hardening both profitability involvement of skilled
to ignorance about possible or likely complex
and bankability consultants; prudent assessment
situations, over confidence and excess of optimism
of likely and unlikely potential
outcomes and situations.
Operating cash flow tends to
be negative, absorbing
Due to costs overrun and / or to insufficient revenues, liquidity. Extra funds, either Strategic restructuring, cutting
Private SPV / during the construction or the management phase. Sums from external lenders or costs and increasing, wherever
Operational revenue
Lending up all the operating risk for the private part; strongly shareholders, are needed and possible, revenues. Tariff
below par
Institution linked with financial risk (of not producing adequate the SPV becomes adjustments, whenever
cash flows )59. increasingly risky, especially contractually possible.
if the unbalance is
protracted.
Risk that the Information and Communication Delays, interruption of Autonomous continuity
Private /
ICT breakdown technologies break down or have a temporary failure, services, loss of data can generators prevent core activities
Public
with potentially severe effects on the workings of the severely jeopardize the (in operation's theatres; intensive
58
these include cases and situations such as:
Comfort Zone Biases (People tend do what's comfortable rather than what's important);
Perception Biases (People's beliefs are distorted by faulty perceptions).
Motivation Biases (People's motivations and incentives tend to bias their judgments).
Errors in Reasoning (People use flawed reasoning to reach incorrect conclusions).
Group Think (Group dynamics add additional distortions).
See http://www.prioritysystem.com/reasons1.html.
59
See par. 4.
hospital. hospital, especially if it is therapy ) from halting; back

strongly dependent on up of data and recovery teams
technologies, as it normally soften the problems, speeding up
happens for the most their solution. Transfer of the
sophisticated projects. service with a pass through
contract to an external expert,
within a segregated server farm,
may be strongly advisable.
PART
MITIGATION
MEASURES
RISKS
6. Market Risks
Arises from the risk that the project may lose its
Lower than expected
competitive position in the output market and is
revenues, up to the point of Careful strategic and market
Public / affected by the timing of the output. In the health sector
(General) market making not bankable or analysis of the real needs and
Shared this risk is relatively low, if compared to other
convenient the project, when trends of the health sector.
businesses, but delays can make the new hospital
it is too late to abandon it.
obsolete and "borne old".
This is the main demand driver, influencing for the
good or the bad the whole project. The risk that the If demand of health services
demand for health services decreases - if patients declines, all revenues, even
address themselves elsewhere - is entirely borne by the the commercial ones driven Careful and far-seeing forecast
public part and is formally out of the project financing's by the presence of patients, of the evolution of the demand
perimeter, since core health services are typically not visitors and employees, and flexible adjustments to new
Health services demand Public
delegated to the private part. But the consequences are shrink. This key market risk trends may limit damages.
remarkable and substantial even for the project is partially transferred to the Changes are a risk but also an
financing, influencing key parameters such as the private part, to the extent opportunity to grasp.
ancillary services to be rendered. Also commercial that no minimum fees are
revenues are strongly connected: no patients and foreseen.
visitors, no customers.
Risk of decrease of the demand on commercial
Contractual covenants limiting
revenues, whereas no revenue integrations from the
risk and responsibility of the
public entity are foreseen. Volumes of core services
public entity; contracts should
asked to the SPV (maintenance, ICT, security, laundry,
prevent unwanted or unsuitable
catering, thermal management, parking, ) have to be Revenues below projections,
Demand (on tariff / Private SPV businesses, considering the
carefully estimated. An excess of demand is less also due to marketing
commercial incomes) /shared hospital's mission (only hygienic
problematic than an excess of supply from the private problems.
and decent shops are to be
(SPV) side, whereas unsatisfied demand concerning
admitted, to a limit and extent
public health services is one of the most serious
that does not transform the
problems for the public part, who is typically reluctant
hospital in a mall ).
to assign very core" (health) services to private parties
such as the SPV.

Contractually enforced right of
exclusivity protecting the private
part, otherwise there is an .
Revenues below projections opportunity for the public entity;
arising from a need to reduce if the contractor defaults, the risk
Offer of alternative Risk that a new competitor offers cheaper commercial the price and/or from a is also somewhat shared by the
Private SPV
services services. reduction in overall demand, public entity. Periodical market
because of increased test with external benchmarking
competition. and comparisons might be
contractually envisaged,
especially for services which
concern technological updating.
PART
MITIGATION
MEASURES
RISKS
7. Network and interface risks
Private part will seek financial
redress against change which
unfairly discriminates against the
project particularly on a user
Risk that, where the facility relies on a complementary Negative patronage and
Withdrawal of support pays project where revenues are
Public public entity network, that support is withdrawn or revenue
network directly affected; under an
varied adversely affecting the project. consequences.
availability model private
part will seek to avoid abatement
if public entity 'prevention' is
cause of unavailability.
private part will seek financial
redress against change which
Changes in Negative patronage and
Private SPV / Risk that an existing network is extended/changed/re- unfairly discriminates against the
competitive revenue
shared priced so as to increase competition for the facility. project by public entity
network consequences.
subsidizing competition (existing
or new).
Adverse effect on delivery of Private part manages contracted
Risk that the delivery of core services in a way which is contracted service, potential service activities.
not specified/anticipated in the contract adversely for default by private part Public entity manages core
Private SPV / affects the delivery of contracted services and possible need for public service activities allowing it to
Interface
shared Risk that the delivery of contracted services adversely entity to make other influence the materializations of
affects the delivery of core services in a manner not arrangements for service interface risk and its
specified/anticipated in the contract. provision consequences; other mitigates
Adverse effect on delivery of include an upfront assessment
core services, default by (by both public entity and the

private part and possible private part) of the likely
need for public entity to interface issues, continual review
make other arrangements for and monitoring and development
core service provision. of a communications strategy in
respect of delivery of the two
related services; public entity
will also specify in the contract
the extent of core services and
the way in which they will be
delivered so that only manifest
and adverse changes and
deficiencies can trigger this risk.
PART
MITIGATION
MEASURES
RISKS
8. Procedural, contractual and legislative risks
Delays, extra costs, lack of Strict and binding rules,
All of some of the competitors don't have an adequate
Private SPV / quality, non-fulfillments, according to which the unskilled
Lack of experience track record and little if any experience. A more likely
public often discovered when it is participants are excluded from
case with new markets or products/investments.
too late to intervene. the tender.
Risk that the selection criteria are too few or not fair or
inappropriate, being unable to carry on a meritocratic
discrimination among competitors. The public part might spend
Quantitative criteria tend to be objective, but are more and / or get a lower
Use of best practices, wherever
Private SPV / intrinsically unable to assess not fully measurable quality project; serious and
Bid selection criteria existent, and internationally
public characteristics, while qualitative assessment are competitive bidders might be
accepted standards.
discretionary and risk lack of motivation or meritocratic preferred by sub-optimal
evidence. competitors.
The best known evaluation criteria guidelines include
Ahp, Topsis, Evamix60
Delays in the tender, Bidders to submit certified
Bidders pre-qualifications Risk that bidders are inadequate and don't have reliable
Public possible litigation among financial statements and
standards standard
participants. auditors opinions.
Risk that the price offered by a dumping competitor is Legal and contractual provisions,
Delays in the tender, unfair
too low, with subsequent problems of quality, preventing unfair pricing, even
Anomalous offer Public competition, likely litigation
feasibility, bankability , if the anomalous offer is with careful technical appraisal
among participants.
accepted. and monitoring.
60
AHP (Analytic Hierarchy Process); TOPSIS (Technique for Order Preference by Similarity to Ideal Solution); EVAMIX (Evaluation of Mixed Criteria).
If the anomalous offer is properly detected, the tender is

suspended and the offer rejected. There is also an high
risk of litigation from unfairly excluded competitors.
Qualities of legal advice, careful
The bid might not be
check of respect of legal
Risk that (unfairly?) excluded competitors appeal to assigned and the auction
procedures in any phase of the
Appeal Court, slowing down the project, especially if the Court might restart in the worst
Shared bid are the best mitigation
(litigation) suspends the tender and a new bid has to readmit the cases; in other cases, delays
measure. Legal costs should
excluded competitor. and legal costs should be
deter the opponent to propose
considered.
unfounded cases.
Private part or its sub-contractors
Industrial relations and Risk of strikes, staff crises, industrial action
Private SPV Cost and time delay. manage project delivery and
civil commotion or civil commotion causing delay and cost to the project.
operations
Risk that the tender is not qualified as a project finance,
due to its wrong architecture, not-sufficient risk transfer Back to the starting point? Careful design of the tender and
Requalification Public and sharing, lack of compulsory legal provisions, Cost and time delay, with discriminating comparison with
excessive similarity / confusion with other instruments missed opportunities. its alternatives.
(leasing; bid contract ).
Private part to anticipate
Further project development
Private SPV Risk that additional approvals required during the course requirements private part unless
Approvals or change in business
/ shared of the project cannot b obtained. public entity has initiated the
operation may be prevented
change requiring approval
Risk of delays, extra costs, misunderstandings,
Both private and public
differences in the interpretation and enforcement of laws
Private SPV partners might suffer, Good legal consultancy; clear
Procedural and contracts, court litigation. Significant changes might
/ public bearing delays and extra and well tested legal framework.
occur over time. Risk of discretionary interpretation of
costs.
rules.
Risk that the legislation changes during the life of the A material increase in the Contractual rules according to
Changes in the legislative project. Government policies can also change, with private part's operating costs which the conditions might not
framework and in Public potential big impacts on public hospitals (amount of and/or a requirement to carry worsen the position of the public
government policies resources dedicated to the health system; strategic out capital works to comply entity; possibility to amend the
choices in the public-private mix ). with the change. contract.
Where there is a statutory regulator involved, there are Private part to assess regulatory
Regulation Private SPV pricing or other changes imposed on the private part Cost or revenue effects. system and may make
which do not reflect its investment expectations. appropriate representations.
A negative effect on the The financial returns of the
private part's financial private part should be sufficient
Changes in the fiscal Risk that taxes might increase, worsening the economic returns and in extreme cases, to withstand such change; with
Private SPV
legislation returns of the contractor. it may undermine the respect to specific infrastructure
financial structure of the taxation particularly that relating
project so that it cannot to transactions with public entity,
proceed in that form. the private part should obtain a

private tax ruling.
Complete omni comprehensive contracts dont exist
and not all the risks can be foreseen and interpretation Experience, careful and
of happenings often brings to disagreements. Possible Delays, disputes, extra costs analytical contract provisions
occurrences are too complex and risky to be fully often difficult to measures and common sense (awareness of
Contractual Shared predictable and there's little room for getting safe or but anyway troublesome. human imperfection) are the first
bored . Contractual costs slightly (much less than Contract variations are antidote against contractual
proportionally) increase with bigger projects and small always a risk. problems, limiting discretional
operations might not conveniently absorb legal and choices and interpretations.
consultancy costs.
The security package is the sum of all the real and / or
contractual guarantees negotiated before the issue of the
financing and of all the recourse guarantees, if present.
This typical risk mitigation measure, aimed at easing
contractual optimal risk sharing and management,
Security package Shared according to the specific know how of the different Delays, disputes, extra costs. Careful contract design.
stakeholders, is itself risky to the extent that it does not
efficiently and properly work. The security package is
structured on a tailor made basis, with a view to
adequately enhance the creditworthiness of the
borrower.
Corruption is operationally defined as the misuse of Corruption brings to Transparency61 is an
entrusted power for private gain. Public health officials, suboptimal allocation, antidote since it allows those
in charge of the decisions about the project finance potentially highly detrimental. affected by administrative
Public / tender, may be corrupted, seeking illegitimate personal The cost of corruption is four- decisions or business
Corruption fold: political, economic,
Private SPV gain through actions such as bribery, extortion, and transactions to know not
embezzlement and sharing the proceeds with a private social, and environmental. only the basic facts and
counterpart, chosen as the bid winner even without figures but also the
deserving it. mechanisms and processes.
61
See www.transparency.org.
PART
MITIGATION
MEASURES
RISKS
9. Macroeconomic systemic risks
Force Majeure is a common clause62 in contracts which Insurances, wherever possible;
essentially frees both parties from liability or obligation contractual covenants; reserve
when an extraordinary event or circumstance beyond the funding; contingency provisions;
control of the parties, such as a war, strike, riot, crime, building best practices (against
Loss or damage to the asset,
or an event described by the legal term "act of God" earthquakes ). Mechanisms for
service discontinuity for
(e.g., flooding, earthquake, eruption), prevents one or minimizing such risks include:
public entity (which may
both parties from fulfilling their obligations under the (a) conducting due diligence as
include inability to deliver
Force majeure Shared contract. However, force majeure is not intended to to the possibility of the relevant
core service) and loss of
excuse negligence or other malfeasance of a party, as risks; (b) allocating such risks to
revenues, or delay in
where non-performance is caused by the usual and other parties as far as possible
revenues beginning, for
natural consequences of external forces (e.g., predicted (e.g. to the builder under the
private part.
rain stops an outdoor event), or where the intervening construction contract); and (c)
circumstances. These circumstances are unlikely but requiring adequate insurances
catastrophic. which note the financiers'
interests to be put in place.
The likelihood that changes in the business
Repatriation of international
environment will adversely affect operating profits or
funds becomes harder and Contractual provision of
the value of assets in a specific country. Country risk
more expensive, if possible protective clauses is possible but
includes the threat of currency inconvertibility,
at all. hardly effective if the host
expropriation of assets, currency controls, devaluation
Financial costs borne by country falls apart, its guarantees
or regulatory changes, institutional corruption or
foreign equity and debt tend to be worthless
instability factors such as mass riots, civil war and other
holders of the SPV grow Country and political risk can be
Country Private SPV potential events. Failing states with bad policies and
(little if any dividends, reduced with Country Default
governance, especially if landlocked63 by bad
interests and debt Swaps.
neighbors, unsurprisingly have a higher and persistent
repayments). Depending on Currency hedging, wherever
country risk. In times of distress, sovereign risk
the timing of country risk possible and effective, might also
becomes effective; credit default swaps spreads
events, the project can be mitigate but not entirely solve
"explode" and recovery value shrinks. Country debt
abandoned, delayed, country risk problems.
restructuring might prove painful and with long lasting
downscaled.
reputation drawbacks.
62
See FORTIN (1995); MIZRACHI (2006).
63
This expression is taken from COLLIER (2007), according to which countries are landlocked if they have no direct access to the sea and heavily depend upon their coastal
neighbor for transport costs. Each country benefits from the growth of neighbors and this is particularly true for landlocked countries, even if wireless devices somewhat soften this
dependence. Land-locked countries could serve as labour resource pools, rather than develop as independent national economies.
Closely linked to country risk, political risk is a

consequence of the complications that businesses and
governments may face as a result of what are
commonly referred to as political decisions or any
political change that alters the expected outcome and
value of a given economic action by changing the
probability of achieving business objectives. This is the
risk of a strategic, financial, or personnel loss for a firm
because of such non-market factors as macroeconomic
and social policies (fiscal, monetary, trade, investment, Similar as above. It should
industrial, income, labour, and developmental) or be noted that both country
events related to political instability (terrorism, riots, and political risk are borne
coups, civil war, and insurrection). A risk of by the private part SPV
expropriation - nationalization is both "country" and shareholders, but especially
Political Private SPV Similar as above.
"politic", with a devastating and long effect on the if it takes place when the
country's reputation. project is still in incubation
Within political risk, conflict risk the risk that a or not completed, even the
projects development, construction or operations may public entity can be
be adversely affected by the outbreak of violent conflict endangered.
- can be a major threat to a projects creditworthiness.
Demonstrations and blockades by local communities;
sabotage of project installations or facilities;
kidnapping or assault to staff; outbreak of violent
clashes between armed groups; demanding of payments
by armed groups to project sponsors all of these
expressions of violence can impose direct costs to an
investment, including reputation and even legal
challenges arising from proximity to these factors64.
Careful planning and monitoring
Demographic Private SPV / Risk of a demographic/socio-economic of demographic trends may give
Revenues below projections.
change shared change affecting demand for contracted service. a (small) contribution to risk
mitigation.
Risk that the value of the payments Private part seeks an appropriate
received during the term is mechanism to maintain real
eroded by inflation. Indexation of costs and revenues value e.g. via linkage to
Diminution in real returns of
Inflation Shared might follow different asymmetric rules, with Consumer Price Index; public
the private part.
subsequent compression or increase of the SPV's entity concern to ensure its
marginality. payments do not
overcompensate for inflation.
64
Http://conflictsensitivity.org/files/publib/Conflict_Project_Finance.pdf.
Recession is a systemic risk that involves both parties,

downsizing demand for commercial services (hitting
the revenues of the SPV) but sometimes also not urgent
health services for which the patient may pay at least
Mitigation measures are difficult
partially on his own.
to put in action, since this
On the other side, inflation and prices of commodities
Decreased commercial external and general
normally decrease and, due to the slow down of the
revenues for the SPV. phenomenon - somewhat similar
Recession Shared general economic activity, the SPV may renegotiate its
Decreased demand for non to 'force majeure' - cannot be
pass-through contracts at better and stricter conditions.
core health services. modified by the players, who
Capital rationing typically occurs, since banks demand
however can benefit of lower
a higher risk premium, somewhat mitigated by often
costs and increased competition.
decreasing nominal risk free interest rates.
Infrastructure investments are a typical anti-cyclical
business which can give a substantial contribution to
the restart of the economy.
APPENDIX 2 - BASIC ASSUMPTIONS AND STATEMENTS OF FINANCIAL AND

ECONOMIC PLAN (see paragraph 8)
Project & Construction Phase (years) 3

Management Phase (years) 25
Fixed Imvestment Sum

Study, Project, Techincal and Service Expenses 2.400.000
Land Consolidation, Internal Roads and Preparatory Buildings 1.600.000
Construction Expenses 77.500.000
Machinery and Equipment Expenses 2.400.000
Furbishing 3.150.000
Motor Vehicles 1.000.000
Commissioning Expenses 850.000
Unexpected Expenses 2.000.000
VAT (10%) 9.100.000
Fixed Investment Sum (VAT Including) 100.000.000
Public Grants 50.000.000

VAT Rate on Public Grants 10%
Public Grants Payment Mode Work in Progress Report
Construction costs and publuc grant distribuition percentage during the construction phase
2010 33,33%
2011 33,33%
2012 33,33%
Financial charges percentage to be capitalized during the contruction phase

2010 1,00%
2011 1,00%
2012 1,00%
SPV Share Capital 5.000.000

Subordinated Debt 10.000.000
VAT Facility Yes
Senior Debt Repayment (Years) 20

Subordinated Debt Repayment (Years) 4
VAT Repayment Yes
Dividends Payout Ratio 100%

Senior Debt Interest Rate 5,81%
Subordinated Debt Interest Rate 6,06%
VAT Facility Interest Rate 3,12%
Average Inflation Rate 3%

Basic Year for Inflation Application 2009
Availibility Payment 3.000.000

VAT Rate on Availability Payment 20%
Services Revenues 2009

Laboratory 7.500.000
Imaging 3.450.000
Housekeeping 2.700.000
Data Process 875.000
Security 450.000
Catering 150.000
Patient Guilding / Secretariat 700.000
Other Services 230.000
Catering Costs for Personnel and Patients 2.100.000
Sterilization and Disinfection 420.000
Landscaping 100.000
Total Services Revenues 18.675.000
Average VAT Rate on Services and Commercial Revenues / Costs 20%
Average SPV Profit Margin on Services/Commercial Revenues 12%
General Annual SPV Expenses 400.000

VAT Rate on General Annual Costs 20%
Commercial Revenues 2009

Parking Lot 550.000
Hotel and Congress Center 470.000
Shopping Mall / Center 1.250.000
Cafeterias and Restaurant 1.850.000
Nursery 250.000
Taxi Stands 630.000
Total Commercial Revenues 5.000.000
Construction Cost Amortization Yes

Public Grants Deferred Yes
Average Tax Rate 30%
NET WORKING CAPITAL

% Inventories on Revenues 2%
- Costumers days 60
- Suppliers days 90
- Warehouse days 10
WACC INPUTS
Beta 0,9
Market Risk Premium 4,7%
Risk Free Rate 3,8%
PROFIT & LOSS STATEMENT () Construction Phase Management Phase
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026
Revenues for Services 21.018.877 21.649.443 22.298.927 22.967.894 23.656.931 24.366.639 25.097.638 25.850.568 26.626.085 27.424.867 28.247.613 29.095.042 29.967.893 30.866.930
Availability Payment 3.376.526 3.477.822 3.582.157 3.689.622 3.800.310 3.914.320 4.031.749 4.152.702 4.277.283 4.405.601 4.537.769 4.673.902 4.814.119 4.958.543
Commercial Revenues 5.627.544 5.796.370 5.970.261 6.149.369 6.333.850 6.523.866 6.719.582 6.921.169 7.128.804 7.342.669 7.562.949 7.789.837 8.023.532 8.264.238
Total Operating Revenues - - - 30.022.948 30.923.636 31.851.345 32.806.885 33.791.092 34.804.825 35.848.969 36.924.439 38.032.172 39.173.137 40.348.331 41.558.781 42.805.544 44.089.711
Costs for Services 18.766.854 19.329.860 19.909.756 20.507.049 21.122.260 21.755.928 22.408.606 23.080.864 23.773.290 24.486.488 25.221.083 25.977.716 26.757.047 27.559.759
General Costs 412.000 424.360 437.091 450.204 463.710 477.621 491.950 506.708 521.909 537.567 553.694 570.304 587.413 605.036 623.187 641.883 661.139
Commercial Costs 5.024.593 5.175.331 5.330.591 5.490.508 5.655.224 5.824.880 5.999.627 6.179.615 6.365.004 6.555.954 6.752.633 6.955.212 7.163.868 7.378.784
Total Operating Costs 412.000 424.360 437.091 24.241.651 24.968.900 25.717.967 26.489.506 27.284.192 28.102.717 28.945.799 29.814.173 30.708.598 31.629.856 32.578.752 33.556.114 34.562.798 35.599.682
EBITDA - 412.000 - 424.360 - 437.091 5.781.297 5.954.735 6.133.378 6.317.379 6.506.900 6.702.107 6.903.170 7.110.266 7.323.574 7.543.281 7.769.579 8.002.667 8.242.747 8.490.029
Construction Costs Amortization 4.000.000 4.000.000 4.000.000 4.000.000 4.000.000 4.000.000 4.000.000 4.000.000 4.000.000 4.000.000 4.000.000 4.000.000 4.000.000 4.000.000
Capitalized Financial Charges Amortization 28.792 28.792 28.792 28.792 28.792 28.792 28.792 28.792 28.792 28.792 28.792 28.792 28.792 28.792
Public Grants Deferred 1.818.182 1.818.182 1.818.182 1.818.182 1.818.182 1.818.182 1.818.182 1.818.182 1.818.182 1.818.182 1.818.182 1.818.182 1.818.182 1.818.182
EBIT - 412.000 - 424.360 - 437.091 3.570.687 3.744.126 3.922.768 4.106.769 4.296.290 4.491.497 4.692.561 4.899.656 5.112.964 5.332.671 5.558.969 5.792.057 6.032.137 6.279.419
Financial Charges - - - - 3.249.093 - 3.062.525 - 2.926.051 - 2.789.577 - 2.653.104 - 2.516.630 - 2.380.157 - 2.243.683 - 2.107.210 - 1.970.736 - 1.834.262 - 1.697.789 - 1.561.315 - 1.424.842
Pre-tax Result - 412.000 - 424.360 - 437.091 321.594 681.601 996.717 1.317.192 1.643.187 1.974.867 2.312.404 2.655.973 3.005.754 3.361.935 3.724.707 4.094.268 4.470.822 4.854.578
Taxes - - - - 204.480 299.015 395.157 492.956 592.460 693.721 796.792 901.726 1.008.581 1.117.412 1.228.280 1.341.246 1.456.373
Net Income - 412.000 - 424.360 - 437.091 321.594 477.121 697.702 922.034 1.150.231 1.382.407 1.618.683 1.859.181 2.104.028 2.353.355 2.607.295 2.865.988 3.129.575 3.398.204
check - - - - - - - - - - - - - - - - -
BALANCE SHEET () Construction Phase Management Phase

31/12/2010 31/12/2011 31/12/2012 31/12/2013 31/12/2014 31/12/2015 31/12/2016 31/12/2017 31/12/2018 31/12/2019 31/12/2020 31/12/2021 31/12/2022 31/12/2023 31/12/2024 31/12/2025 31/12/2026
Assets
Construction Costs 33.333.333 66.666.667 100.000.000 96.000.000 92.000.000 88.000.000 84.000.000 80.000.000 76.000.000 72.000.000 68.000.000 64.000.000 60.000.000 56.000.000 52.000.000 48.000.000 44.000.000
Capitalized Financial Charges 85.718 374.591 719.790 690.999 662.207 633.415 604.624 575.832 547.041 518.249 489.457 460.666 431.874 403.083 374.291 345.499 316.708
Fixed Assets 33.419.051 67.041.258 100.719.790 96.690.999 92.662.207 88.633.415 84.604.624 80.575.832 76.547.041 72.518.249 68.489.457 64.460.666 60.431.874 56.403.083 52.374.291 48.345.499 44.316.708
VAT on Credit 1.600.582 3.203.636 3.208.654 1.605.600 - - - - - - - - - - - - -

Cash & Banks - 0 0 0 2.398.815 2.939.682 3.703.097 4.469.908 4.767.933 5.072.090 5.382.561 5.699.536 6.023.210 6.353.784 6.691.466 7.036.467 7.389.009 7.749.316
DSRA (Debt Service Reserve Account) - - 5.547.941 5.411.468 5.274.994 5.138.521 5.002.047 4.865.573 4.729.100 4.592.626 4.456.153 4.319.679 4.183.205 4.046.732 3.910.258 3.773.785 3.637.311
Working Capital 1.600.582 3.203.636 8.756.595 9.415.882 8.214.676 8.841.618 9.471.954 9.633.507 9.801.190 9.975.187 10.155.689 10.342.889 10.536.990 10.738.198 10.946.726 11.162.793 11.386.627
Total Assets 35.019.633 70.244.893 109.476.385 106.106.881 100.876.883 97.475.033 94.076.578 90.209.339 86.348.230 82.493.436 78.645.146 74.803.555 70.968.864 67.141.280 63.321.016 59.508.293 55.703.335
Liabilities
Share Capital 5.000.000 5.000.000 5.000.000 5.000.000 5.000.000 5.000.000 5.000.000 5.000.000 5.000.000 5.000.000 5.000.000 5.000.000 5.000.000 5.000.000 5.000.000 5.000.000 5.000.000
Retained Earnings - - 412.000 - 836.360 - 1.273.451 - 951.857 - 474.736 - - - - - - - - - - -
Net Income - 412.000 - 424.360 - 437.091 321.594 477.121 697.702 922.034 1.150.231 1.382.407 1.618.683 1.859.181 2.104.028 2.353.355 2.607.295 2.865.988 3.129.575 3.398.204
Equity 4.588.000 4.163.640 3.726.549 4.048.143 4.525.264 5.222.965 5.922.034 6.150.231 6.382.407 6.618.683 6.859.181 7.104.028 7.353.355 7.607.295 7.865.988 8.129.575 8.398.204
Subordinated Debt 10.000.000 10.000.000 10.000.000 10.000.000 10.000.000 10.000.000 10.000.000 10.000.000 10.000.000 10.000.000 10.000.000 10.000.000 10.000.000 10.000.000 10.000.000 10.000.000 10.000.000
VAT Facility 1.600.582 3.203.636 3.208.654 1.605.600 - - - - - - - - - - - - -
Senior Debt 3.577.947 22.469.951 46.978.861 44.629.918 42.280.975 39.932.032 37.583.089 35.234.146 32.885.203 30.536.260 28.187.317 25.838.374 23.489.431 21.140.487 18.791.544 16.442.601 14.093.658
Public Grants 15.151.515 30.303.030 45.454.545 43.636.364 41.818.182 40.000.000 38.181.818 36.363.636 34.545.455 32.727.273 30.909.091 29.090.909 27.272.727 25.454.545 23.636.364 21.818.182 20.000.000
Sources 30.330.044 65.976.617 105.642.060 99.871.882 94.099.157 89.932.032 85.764.907 81.597.782 77.430.657 73.263.532 69.096.408 64.929.283 60.762.158 56.595.033 52.427.908 48.260.783 44.093.658
Net Commercial Workin Capital 101.589 104.637 107.776 1.030.597 1.061.515 1.093.361 1.126.161 1.159.946 1.194.745 1.230.587 1.267.504 1.305.530 1.344.696 1.385.036 1.426.587 1.469.385 1.513.467
VAT on Debit - - - 1.156.259 1.190.947 1.226.676 1.263.476 1.301.380 1.340.421 1.380.634 1.422.053 1.464.715 1.508.656 1.553.916 1.600.533 1.648.549 1.698.006
Current Liabilities 101.589 104.637 107.776 2.186.856 2.252.462 2.320.036 2.389.637 2.461.326 2.535.166 2.611.221 2.689.558 2.770.244 2.853.352 2.938.952 3.027.121 3.117.934 3.211.472
Total Liabilities 35.019.633 70.244.893 109.476.385 106.106.881 100.876.883 97.475.033 94.076.578 90.209.339 86.348.230 82.493.436 78.645.146 74.803.555 70.968.864 67.141.280 63.321.016 59.508.293 55.703.335
CASH FLOW STATEMENT () Construction Phase Management Phase
2010 2011 2012 2013 2014 2015 2016 2017 2018 2019 2020 2021 2022 2023 2024 2025 2026
Operating Revenues - - - 30.022.948 30.923.636 31.851.345 32.806.885 33.791.092 34.804.825 35.848.969 36.924.439 38.032.172 39.173.137 40.348.331 41.558.781 42.805.544 44.089.711
Operating Costs 412.000 424.360 437.091 24.241.651 24.968.900 25.717.967 26.489.506 27.284.192 28.102.717 28.945.799 29.814.173 30.708.598 31.629.856 32.578.752 33.556.114 34.562.798 35.599.682
EBITDA - 412.000 - 424.360 - 437.091 5.781.297 5.954.735 6.133.378 6.317.379 6.506.900 6.702.107 6.903.170 7.110.266 7.323.574 7.543.281 7.769.579 8.002.667 8.242.747 8.490.029
Fixed Assets - 33.419.051 - 33.622.207 - 33.678.532 0 0 0 0 0 0 0 0 0 0 0 - 0 0 0

Net Commercial Working Capital 101.589 3.048 3.139 922.821 30.918 31.845 32.801 33.785 34.798 35.842 36.918 38.025 39.166 40.341 41.551 42.798 44.082
VAT on Credit/Debit - 1.600.582 - 1.603.054 - 5.018 2.759.313 1.640.288 35.728 36.800 37.904 39.041 40.213 41.419 42.662 43.941 45.260 46.617 48.016 49.456
Unlevered Cash Flow - 35.330.044 - 35.646.573 - 34.117.502 9.463.431 7.625.941 6.200.951 6.386.980 6.578.589 6.775.947 6.979.225 7.188.602 7.404.260 7.626.388 7.855.180 8.090.835 8.333.560 8.583.567
Share Capital 5.000.000 - - - - - - - - - - - - - - - -

Reserves (Dividends) - - - - - - - 222.965 - 922.034 - 1.150.231 - 1.382.407 - 1.618.683 - 1.859.181 - 2.104.028 - 2.353.355 - 2.607.295 - 2.865.988 - 3.129.575
Subordinated Debt 10.000.000 - - - - - - - - - - - - - - - -
Senior Debt 3.577.947 18.892.004 24.508.910 - 2.348.943 - 2.348.943 - 2.348.943 - 2.348.943 - 2.348.943 - 2.348.943 - 2.348.943 - 2.348.943 - 2.348.943 - 2.348.943 - 2.348.943 - 2.348.943 - 2.348.943 - 2.348.943
Public Grants 15.151.515 15.151.515 15.151.515 - 0 - 0 - 0 - 0 - 0 - 0 - - - - - - - -
VAT Facility 1.600.582 1.603.054 5.018 - 1.603.054 - 1.605.600 - - - - - - - - - - - -
DSRA - - - 5.547.941 136.474 136.474 136.474 136.474 136.474 136.474 136.474 136.474 136.474 136.474 136.474 136.474 136.474 136.474
Financial Charges - - - - 3.249.093 - 3.062.525 - 2.926.051 - 2.789.577 - 2.653.104 - 2.516.630 - 2.380.157 - 2.243.683 - 2.107.210 - 1.970.736 - 1.834.262 - 1.697.789 - 1.561.315 - 1.424.842
Taxes - - - - - 204.480 - 299.015 - 395.157 - 492.956 - 592.460 - 693.721 - 796.792 - 901.726 - 1.008.581 - 1.117.412 - 1.228.280 - 1.341.246 - 1.456.373
Levered Cash Flow - 0 0 - 0 2.398.815 540.867 763.416 766.810 298.026 304.157 310.471 316.975 323.674 330.574 337.681 345.002 352.541 360.308
Initial Cash & Banks - - 0 0 0 2.398.815 2.939.682 3.703.097 4.469.908 4.767.933 5.072.090 5.382.561 5.699.536 6.023.210 6.353.784 6.691.466 7.036.467 7.389.009
Final Cash & Banks - 0 0 0 2.398.815 2.939.682 3.703.097 4.469.908 4.767.933 5.072.090 5.382.561 5.699.536 6.023.210 6.353.784 6.691.466 7.036.467 7.389.009 7.749.316
Cash & Banks Variation - 0 0 - 0 2.398.815 540.867 763.416 766.810 298.026 304.157 310.471 316.975 323.674 330.574 337.681 345.002 352.541 360.308
Cumulative Cash Flow - 0 0 0 2.398.815 2.939.682 3.703.097 4.469.908 4.767.933 5.072.090 5.382.561 5.699.536 6.023.210 6.353.784 6.691.466 7.036.467 7.389.009 7.749.316
PROFIT & LOSS STATEMENT () Management Phase
2027 2028 2029 2030 2031 2032 2033 2034 2035 2036 2037 2038
Revenues for Services 31.792.937 32.746.726 33.729.127 34.741.001 35.783.231 36.856.728 37.962.430 39.101.303 40.274.342 41.482.572 42.727.049
Availability Payment 5.107.299 5.260.518 5.418.334 5.580.884 5.748.310 5.920.760 6.098.382 6.281.334 6.469.774 6.663.867 6.863.783
Commercial Revenues 8.512.165 8.767.530 9.030.556 9.301.473 9.580.517 9.867.933 10.163.971 10.468.890 10.782.956 11.106.445 11.439.638
Total Operating Revenues 45.412.402 46.774.774 48.178.017 49.623.358 51.112.058 52.645.420 54.224.783 55.851.526 57.527.072 59.252.884 61.030.471 -
Costs for Services 28.386.551 29.238.148 30.115.292 31.018.751 31.949.314 32.907.793 33.895.027 34.911.878 35.959.234 37.038.011 38.149.151
General Costs 680.973 701.402 722.444 744.118 766.441 789.435 813.118 837.511 862.637 888.516 915.171
Commercial Costs 7.600.148 7.828.152 8.062.997 8.304.886 8.554.033 8.810.654 9.074.974 9.347.223 9.627.640 9.916.469 10.213.963
Total Operating Costs 36.667.672 37.767.702 38.900.733 40.067.755 41.269.788 42.507.882 43.783.118 45.096.612 46.449.510 47.842.995 49.278.285 -
EBITDA 8.744.730 9.007.072 9.277.284 9.555.602 9.842.270 10.137.539 10.441.665 10.754.915 11.077.562 11.409.889 11.752.186 -
Construction Costs Amortization 4.000.000 4.000.000 4.000.000 4.000.000 4.000.000 4.000.000 4.000.000 4.000.000 4.000.000 4.000.000 4.000.000
Capitalized Financial Charges Amortization 28.792 28.792 28.792 28.792 28.792 28.792 28.792 28.792 28.792 28.792 28.792
Public Grants Deferred 1.818.182 1.818.182 1.818.182 1.818.182 1.818.182 1.818.182 1.818.182 1.818.182 1.818.182 1.818.182 1.818.182
EBIT 6.534.120 6.796.462 7.066.674 7.344.993 7.631.661 7.926.929 8.231.055 8.544.305 8.866.952 9.199.279 9.541.576 -
Financial Charges - 1.288.368 - 1.151.894 - 1.015.421 - 878.947 - 742.474 - 606.000 - 606.000 - 454.500 - 303.000 - 151.500 0
Pre-tax Result 5.245.752 5.644.568 6.051.253 6.466.045 6.889.187 7.320.929 7.625.055 8.089.805 8.563.952 9.047.779 9.541.576 -
Taxes 1.573.726 1.693.370 1.815.376 1.939.814 2.066.756 2.196.279 2.287.516 2.426.941 2.569.186 2.714.334 2.862.473
Net Income 3.672.026 3.951.197 4.235.877 4.526.232 4.822.431 5.124.650 5.337.538 5.662.863 5.994.767 6.333.445 6.679.103 -
check - - - - - - - - - - - -
BALANCE SHEET () Management Phase

31/12/2027 31/12/2028 31/12/2029 31/12/2030 31/12/2031 31/12/2032 31/12/2033 31/12/2034 31/12/2035 31/12/2036 31/12/2037 31/12/2038
Assets
Construction Costs 40.000.000 36.000.000 32.000.000 28.000.000 24.000.000 20.000.000 16.000.000 12.000.000 8.000.000 4.000.000 -
Capitalized Financial Charges 287.916 259.124 230.333 201.541 172.750 143.958 115.166 86.375 57.583 28.792 - 0
Fixed Assets 40.287.916 36.259.124 32.230.333 28.201.541 24.172.750 20.143.958 16.115.166 12.086.375 8.057.583 4.028.792 - 0 -
VAT on Credit - - - - - - - - - - -
Cash & Banks 8.117.623 8.494.169 8.879.201 9.272.973 9.675.749 12.300.267 12.490.305 12.796.231 13.112.290 13.438.786 16.124.532
DSRA (Debt Service Reserve Account) 3.500.837 3.364.364 3.227.890 3.091.417 2.954.943 606.000 2.954.500 2.803.000 2.651.500 2.500.000 -
Working Capital 11.618.460 11.858.532 12.107.091 12.364.390 12.630.692 12.906.267 15.444.805 15.599.231 15.763.790 15.938.786 16.124.532 -
Total Assets 51.906.376 48.117.657 44.337.424 40.565.931 36.803.442 33.050.225 31.559.972 27.685.606 23.821.373 19.967.578 16.124.532 -
Liabilities
Share Capital 5.000.000 5.000.000 5.000.000 5.000.000 5.000.000 5.000.000 5.000.000 5.000.000 5.000.000 5.000.000 5.000.000
Retained Earnings - - - - - - - - - - -
Net Income 3.672.026 3.951.197 4.235.877 4.526.232 4.822.431 5.124.650 5.337.538 5.662.863 5.994.767 6.333.445 6.679.103
Equity 8.672.026 8.951.197 9.235.877 9.526.232 9.822.431 10.124.650 10.337.538 10.662.863 10.994.767 11.333.445 11.679.103 -
Subordinated Debt 10.000.000 10.000.000 10.000.000 10.000.000 10.000.000 10.000.000 10.000.000 7.500.000 5.000.000 2.500.000 -
VAT Facility - - - - - - - - - - -
Senior Debt 11.744.715 9.395.772 7.046.829 4.697.886 2.348.943 - 0 - 0 - 0 - 0 - 0 - 0
Public Grants 18.181.818 16.363.636 14.545.455 12.727.273 10.909.091 9.090.909 7.272.727 5.454.545 3.636.364 1.818.182 -
Sources 39.926.533 35.759.409 31.592.284 27.425.159 23.258.034 19.090.909 17.272.727 12.954.545 8.636.364 4.318.182 - 0 -
Net Commercial Workin Capital 1.558.871 1.605.637 1.653.806 1.703.420 1.754.523 1.807.158 1.861.373 1.917.214 1.974.731 2.033.973 2.094.992
VAT on Debit 1.748.946 1.801.414 1.855.457 1.911.120 1.968.454 2.027.508 2.088.333 2.150.983 2.215.512 2.281.978 2.350.437
Current Liabilities 3.307.817 3.407.051 3.509.263 3.614.541 3.722.977 3.834.666 3.949.706 4.068.197 4.190.243 4.315.950 4.445.429 -
Total Liabilities 51.906.376 48.117.657 44.337.424 40.565.931 36.803.442 33.050.225 31.559.972 27.685.606 23.821.373 19.967.578 16.124.532 -
View publication stats
CASH FLOW STATEMENT () Management Phase

2027 2028 2029 2030 2031 2032 2033 2034 2035 2036 2037 2038
Operating Revenues 45.412.402 46.774.774 48.178.017 49.623.358 51.112.058 52.645.420 54.224.783 55.851.526 57.527.072 59.252.884 61.030.471 -
Operating Costs 36.667.672 37.767.702 38.900.733 40.067.755 41.269.788 42.507.882 43.783.118 45.096.612 46.449.510 47.842.995 49.278.285 -
EBITDA 8.744.730 9.007.072 9.277.284 9.555.602 9.842.270 10.137.539 10.441.665 10.754.915 11.077.562 11.409.889 11.752.186 -
Fixed Assets 0 0 0 0 - 0 0 0 - 0 0 - 0 - 0 - 0
Net Commercial Working Capital 45.404 46.766 48.169 49.614 51.103 52.636 54.215 55.841 57.516 59.242 61.019 - 2.094.992
VAT on Credit/Debit 50.940 52.468 54.042 55.664 57.334 59.054 60.825 62.650 64.529 66.465 68.459 - 2.350.437
Unlevered Cash Flow 8.841.074 9.106.306 9.379.495 9.660.880 9.950.707 10.249.228 10.556.705 10.873.406 11.199.608 11.535.596 11.881.664 - 4.445.429
Share Capital - - - - - - - - - - - - 5.000.000

Reserves (Dividends) - 3.398.204 - 3.672.026 - 3.951.197 - 4.235.877 - 4.526.232 - 4.822.431 - 5.124.650 - 5.337.538 - 5.662.863 - 5.994.767 - 6.333.445 - 6.679.103
Subordinated Debt - - - - - - - - 2.500.000 - 2.500.000 - 2.500.000 - 2.500.000 -
Senior Debt - 2.348.943 - 2.348.943 - 2.348.943 - 2.348.943 - 2.348.943 - 2.348.943 - - - - - 0
Public Grants - - - - - - - - - - - -
VAT Facility - - - - - - - - - - - -
DSRA 136.474 136.474 136.474 136.474 136.474 2.348.943 - 2.348.500 151.500 151.500 151.500 2.500.000 -
Financial Charges - 1.288.368 - 1.151.894 - 1.015.421 - 878.947 - 742.474 - 606.000 - 606.000 - 454.500 - 303.000 - 151.500 0 -
Taxes - 1.573.726 - 1.693.370 - 1.815.376 - 1.939.814 - 2.066.756 - 2.196.279 - 2.287.516 - 2.426.941 - 2.569.186 - 2.714.334 - 2.862.473 -
Levered Cash Flow 368.307 376.546 385.032 393.773 402.776 2.624.518 190.038 305.926 316.059 326.496 2.685.746 - 16.124.532
Initial Cash & Banks 7.749.316 8.117.623 8.494.169 8.879.201 9.272.973 9.675.749 12.300.267 12.490.305 12.796.231 13.112.290 13.438.786 16.124.532
Final Cash & Banks 8.117.623 8.494.169 8.879.201 9.272.973 9.675.749 12.300.267 12.490.305 12.796.231 13.112.290 13.438.786 16.124.532 -
Cash & Banks Variation 368.307 376.546 385.032 393.773 402.776 2.624.518 190.038 305.926 316.059 326.496 2.685.746 - 16.124.532
Cumulative Cash Flow 8.117.623 8.494.169 8.879.201 9.272.973 9.675.749 12.300.267 12.490.305 12.796.231 13.112.290 13.438.786 16.124.532 -

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THE RISK MATRIX OF PROJECT FINANCE IN THE HEALTHCARE SECTOR

THE RISK MATRIX OF PROJECT FINANCE

JEL Classification: D61, D81, G32, H43, H54, L33

Electronic copy available at: http://ssrn.com/abstract=1417289

1. Risks concerning the construction site

Electronic copy available at: http://ssrn.com/abstract=1417289

2. THE INVESTMENT PERIMETER

3. THE RISK MATRIX

Figure 1 - Upside and downside risk, as a consequence of project revenues' volatility

4. A SYNTHETIC FINANCIAL MEASURE OF RISK: WACC

Figure 2 - Standard Beta of assets, debt and equity

Figure 3 - Project finance Beta of assets, debt and equity

Table 1 - Interactions between WACC and other key financial ratios

RATIO FORMULA LINKS AND INTERACTIONS WITH WACC

If WACC < IRRequity, NPVequity > 0 and

Figure 4 - Net Present Value and Internal Rate of Return of a project

IRR interest rate (WACC)

Ke risk premium Kd risk premium

Time span / duration (of the project)

4.1. The cost of subordinated debt

5. INVESTING AND RUNNING (OPERATING) RISKS

5.1. Investment risk (building or restructuring)

5.2. The interactive link between operating and financial leverage

EBIT (EBITDA + Depreciation / provisions)

The factors that influence the operating revenue are:

revenue volumes and margins;

Table 2 - Fixed and variable revenues and costs

Fixed operating revenues (A) Public grant deferred revenues15; availability

EBITDA (E) (E) = (A) + (B) - (C) - (D)

Fixed operating costs (F) Depreciations, amortizations and provisions

EBIT (G) (G) = (E) - (F)

ITEMS FORMULA LINKS WITH OPERATING LEVERAGE

The Operating Leverage is strictly connected with

If the difference ( WACC - kd ) between the weighted

EBITDA should be consistent enough to cover financial

SPV - Balance Sheet

Fixed Assets Equity

Operating Net Financial Debts

Invested Capital Raised Capital

SPV - Profit & Loss account

- Amortizations, depreciations and

- Net Financial Charges

SPV - Cash Flow Statement

+/- Operating Net Working Capital

+/- Financial Debts

Figure 6 - SPV's revenues and net results across time

5.3. Coping with macroeconomic risk, from inflation to interest rates

6. THE PARADOX OF LEVERAGE: IS RISK MITIGATED BY MILDER GOVERNANCE

contractual arrangements made possible by structuring the project company as a single,

Figure 7 - Agency costs of equity and debt when leverage changes

total agency costs (WACC)

From construction to end of management

agency costs of equity Ke

% financed by debt (leverage)

6.1. Information asymmetries, adverse selection and moral hazard

Parameter / situation Corporate debt finance Project finance

the extent that there is an expected repayment.

view, trying to adapt the business to a competitive threats and binding

7. MONITORING A RISKY LONG TERM WEDDING

8. RISK ASSESSMENT AND MITIGATION

the magnitude of the potential loss

Figure 8 Interactive risk matrix

risk* risk* risk*