The discounting process is central to the quantitative VfM analysis. It evaluates the cashflows including the effect of any risk adjustments, generated by the procurement, and calculates the overall Net Present Value ("NPV") of the project.
The effect of discounting is to bring a variety of different values and ranges of future cash flows back to today's values so that they can be compared. That is, to produce the NPV of a stream of future cash flows. In the case of the CPAM the NPV is a net cost figure, i.e. all of the costs of the project to the client less the receipts associated with the project. Discounting is particularly important because the cash flow profiles of the CPAM and the private finance / NPD option are very different. An example of a discounted cash flow and NPV calculation is provided at Annex A.
It is important that the discounting assumptions used are consistent to facilitate a valid comparison of NPVs across options. As such, annual cash flows should be assumed to arise mid-period.
The recommended discount rate, in accordance with the HMT Green Book, section 5 "Appraising the Options" is currently 3.5% (real) for the first 30 years of the appraisal period and 3.0% for years 31 - 60. Calculating the present value of the differences between the streams of costs and if applicable benefits provides the net present value (NPV) of an option. If necessary, the effect of expected future inflation in the general price level should be removed by deflating future cash flows by forecast levels of the relevant deflator. Over a long-term period, the Bank of England's annual inflation target is the appropriate measure of prices to use as a general deflator.