3.3.3 Determining the Project Rate
The table below presents broad "risk band" data intended to assist practitioners to select an appropriate Project Rate depending on the broad Systematic Risk characteristics of the project (i.e. very Low Risk, Low Risk or Medium Risk).
The indicative Asset Betas are based upon the average of the industries within each broad risk band. Practitioners should use this table, in the first instance, to identify the appropriate Project Rate and Systematic Risk Premium. This table may be updated from time to time.
Table 2:
Risk band | Project sectors and example projects | Asset Beta | Real risk premium* |
Very low | Accommodation and related services | 0.3 | 1.8 |
Low | Water, transport and energy | 0.5 | 3.0 |
Medium | Telecommunications, media and technology | 0.9 | 5.4 |
* Risk premium assumes a market risk premium of 6.0 per cent3. The real risk premium is calculated as market risk premium x Asset Beta.
The categorisations in the second column are provided as a guide only and it is understood that there is no typical 'telecommunications, media and technology' PPP project, for instance. Each project should be assessed on a case-by-case basis to ensure that it is placed in the appropriate band. Also, for large, or high Systematic Risk projects, additional consideration may be warranted as to whether the band rate is the appropriate Discount Rate.
As a general rule, in situations where a project has multiple components, each with a different potential Asset Beta, the risk band that represents the majority of the project should be used. However, if the different components represent significant portions of the project, some adjustment may be required to the above risk bands. For example, in a project where a hospital and a car park was to be constructed, if the risks of the car park and its relative weighting within the project are significant, a blended Beta value in between the very low and low risk bands may be appropriate.
Care needs to be exercised in the evaluation of Asset Betas to ensure a project is categorised in the correct risk band. A detailed analysis of the project is required to understand the Systematic Risks inherent in the project's cash flows. An example of how similar assets can be categorised in different risk bands is discussed below.
Example: Hospital projects |
This example concerns projects of the same asset type, a hospital, but with different outputs purchased by government. |
A hospital project might fit appropriately into the 'very low' category if the emphasis is in providing accommodation and facility services. On the other hand, if the project included the provision of health services, it may not fall into that category and an assessment will need to be made of which band (if any of the above) the project falls within. |
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3 Officer, R. 'The Cost of Capital for the State of Victoria: a Synopsis'. Paper commissioned by the Department of Treasury and Finance, May 2001, p. 6, and confirmed in subsequent discussions.