3.64 Instead of reflecting risk in a risk premium on capital, Government investment decisions reflect risk by calculating the present value capital sum it regards as the necessary contingency for the risks inherent in a project. For example, when deciding between procurement options, project managers calculate an expected value of all risks for each option, and consider how exposed each option is to future uncertainty. They then discount the cost of these options in future years at 3.5 per cent per year to a present value, which purely reflects society's preference for consumption now over consumption in the future, rather than discounting the value of project cash flows at a higher rate to make a compensation for risk. (A further explanation of this process is contained in the Green Book.5) Risks are therefore priced individually, for each project option. The discounted costs of these risk-adjusted options can then be compared with each other, or with the cost of a PFI project, in a PSC, to determine which procurement option represents best value for money taking account of risk and uncertainty. This approach is consistent with the fact that in conventional procurement the public sector pays for risk not in its borrowing - which for the public sector is at non-risk rates - but when risks crystallise and must be covered in publicly funded projects.
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5 The Green Book: Appraisal and Evaluation in Central Government.