1.4  Overview of Methodology

The following summarises the Methodology:

•  Projects with no Systematic Risk in the cash flows, ie, equivalent to the PSC, should be discounted at the PSC Discount Rate

•  For projects with Systematic Risk in the cash flows:

o  The CAPM is then used to assess the level of Systematic Risk associated with the project

o  An assessment is made of the level of Systematic Risk transferred to the private sector under the PPP project

o  The modified form of CAPM is used to quantify the adjustment required to the Risk Free Rate to compensate for systematic risk transferred

o  PPP cash flows should be discounted at the PPP Discount Rate.

This approach requires a project specific Discount Rate to be developed for each project.  The appropriate PPP Discount Rate is a function of the scope of the project, the Systematic Risk it faces and the level of risk transfer required under the project documentation (subject to the private sector's acceptance of those risks).  Therefore it is conceivable that:

•  The PPP Discount Rate for each bidder will be different, depending on the relative level of risk transfer in its submission (some bidders may accept the government's Systematic Risk transfer proposals in full while others may not)

•  More than one PPP Discount Rate may be required for a single bidder.  For example, if a bidder submits two proposals, one using a CPI indexed bond with a fully indexed Service Fee and one with Nominal Debt and a partially indexed Service Fee, the level of CPI risk transfer under the two proposals will be different and a different Discount Rate should be applied to each bid.

The use of CAPM requires data to quantify the Project Rate. The CAPM data is provided on a similar basis to guidance material that this Guidance supersedes.

Projects have been categorised by the level of Systematic Risk and a table is provided against which the Project Rate is identified for projects falling into certain 'Systematic Risk bands'.  This means that the Project Rate does not need to be determined for each project.  Rather, the characteristics of the project should be used to determine which band the project falls within and hence which Project Rate to use.