3.2 In general, the Treasury and Authorities have relied on competition to seek efficient pricing of the contract, without systematic information to prove the pricing of equity is optimal. When bidding for a PFI contract, the project company includes details of the projected rate of return to equity investors. Authorities are expected to conduct a full assessment of the project, including reviews of the financial model, and seek financial advice on how the proposed investors' returns compare to market norms. However, investors do not have to demonstrate that their returns are reasonable for the specific risks of the project. There is thus a risk that if competition is not present, or if there are inefficiencies in the PFI equity market, that value for money may not be optimal.
3.3 Investors told us that they do not conduct detailed calculations to determine the rate of return they seek when bidding for a contract. Instead their company boards consider specific risk factors for higher risk projects and for others set minimum rates of return for projects known as hurdle rates, which reflect their cost of capital. These hurdle rates include investors' need to recover their costs for bids they have not won. The hurdle rate, together with any cash flow requirements set by a project's bankers, establishes the minimum equity return that investors propose in their bids.
3.4 The expected return to investors agreed when PFI contracts are signed typically ranges between 12 and 15 per cent. This has been confirmed by a number of different studies over the past decade:
• PricewaterhouseCoopers reported in 2002 that from the mid 1990s to 2001, as market acceptance of PFI increased, the planned pre-tax equity rates of return generally fell from over 15 per cent to around 13.5 per cent.9 Some early PFI deals had included expected returns to investors as high as 20 per cent.10
• We reviewed the private sector's initial financial projections in a sample of 24 PFI projects awarded since 2005. The initial projected rates of return ranged from 12 to 17 per cent (Figure 7). Our sample excluded PFI waste to-power projects, which may have higher rates of return because of their complexity and technical risks. Our sample is supported by our earlier work which showed that 14 PFI school deals let between 2006 and 2008 had projected equity rates of return in the range 12 to 15 per cent.11
• A study published by the Royal Institute of Chartered Surveyors in 2008 of returns to investors from investing in infrastructure companies, using the UBS Global Infrastructure and Utilities Index, shows an average annual return of 12.8 per cent in the ten years to the end of 2006.12
_________________________________________________________________________________________________________
9 These are nominal rates of return based on cash flows uplifted for assumed levels of future inflation.
10 Update on PFI debt refinancing and the PFI equity market, HC 1040, April 2006.
11 Post corporation tax nominal rates of return in Renewing the secondary school estate, HC 135, February 2009. The National Audit Office survey included 18 PFI schools projects. Four of these projects provided financial models as part of the work for this report.
12 G Newell and H W Peng, 'European Infrastructure Investment: A Valuable Addition to the Mixed-Asset Portfolio', Fibre Series, RICS, London.