3.1 IRRs can be calculated for different cash flow streams of a project, depending upon:
• which category of investor the IRR is being calculated for;
• whether inflation is or is not included in the underlying cash flows; and
• whether tax is or is not included in the underlying cash flows.
3.2 Category of Investor: The Project IRR represents the weighted average cost of capital for a project. It is usually calculated from all of the non-financing project cash flows, including capital costs, operating and maintenance costs, revenues and working capital adjustments. The Equity IRR represents the return to investors after taking account of Senior Debt service. For tax and accounting reasons investors typically provide a mixture of share capital (equity) and Junior Debt: in which case the IRR calculation takes into account all payments received on both equity and Junior Debt, i.e. not just dividends, but also interest and capital repayments on the Junior Debt. This is known as the Blended Equity IRR.
3.3 Inflation: Where the cash flows are in real terms, i.e. based on constant prices,1 the IRR calculation based on these is known as the Real IRR. Where cash flows are in nominal terms, i.e. are based on current prices,2 the IRR calculation based on these is known as the Nominal IRR.
3.4 Taxation: IRR calculations may be done on a pre- or post-tax basis. In either case, the taxation taken into account should only be the tax paid by the SPV, not tax suffered by investors on the payments received from the SPV. Investors may order their tax affairs so as to pay more or less tax on investments, and this is not the concern of the Authority, nor can the Authority check whether or not calculations of the investors' own taxes are correct.
3.5 The table below summarises these different types of IRR calculation:
|
| Category of Investor | |
|
| All |
|
| Tax on SPV excluded | Real Pre-Tax | Real Pre-Tax |
Tax on SPV included | Real Post- | Real Post-Tax | |
| Tax on SPV excluded | Nominal Pre- | Nominal Pre- |
Tax on SPV included | Nominal | Nominal Post- | |
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1 Prices are "constant" when they are expressed by reference to a particular consistent (and usually historic) date. Hence, if sums of money arising after the year 2000 are all to be expressed in "2000 prices " (i.e. "constant" prices as at the year 2000), then each sum of money must be deflated (using RPI) back to 2000 to strip out the effects of inflation (i.e. RPI) on general prices in the economy in the intervening years. Typical constant price items in a PFI cash flow would include the Unitary Charge to the extent it is indexed by RPI. Such items have to be indexed by the projected rate of inflation (RPI) to produce a cash flow in nominal terms.
2 Prices are "current" when they are expressed by reference to the purchasing power of the time period to which they relate. Hence, a sum of money arising in the year 2010 will be assumed to be expressed in 2010 current prices-i.e. nominal terms (sometimes referred to as "money of the day") unless otherwise stated. It naturally follows, therefore, that a price which is fixed in nominal terms across more than one time period will reduce in real terms by the effect of inflation (RPI) during the intervening time periods. Typical fixed nominal price items in a PFI project cash flow would include a fixed-price turnkey construction contract, or the unindexed element of a Unitary Charge. Such items have to be deflated by the projected rate of inflation (RPI) to produce a cash flow in real terms.