10. The case for PFI rests on the benefits of the PFI approach outweighing the extra financing costs involved. The Committee were therefore interested in quantifying the extra costs in this deal arising from the use of private sector finance.
11. This calculation is not at all straightforward because the timing of the expenditure planned by Modus is likely to have taken into account the costs and nature of the external finance with which Modus would finance it. So, had Modus had access to debt at public sector borrowing rates, it is likely that the pattern of expenditure would have differed.
12. Subject to that very important reservation, some indication of the impact of private sector financing costs on the cost of the deal to MOD can be given by examining how the total cost of the deal is made up when discounted at a rate reflecting public sector borrowing costs. As pointed out above, in a discounted cash flow analysis the figures for financing costs reflect the difference between the costs of finance (in this case private sector finance) and the discount rate (public sector finance). Unfortunately the Treasury's standard discount rate on which Table 1 is based is not a good measure of public sector financing costs because the standard discount rate was set when public sector borrowing costs were much higher than they are now. That means that to make a fair comparison of public and private sector financing costs it is necessary to use a discount rate that is lower than the Treasury's standard discount rate of 6% in real terms: a discount rate of 3.5% is justified.
13. Table 2 shows the way the total costs of the deal are made up at the 3.5% discount rate. The total cost of the deal discounted at 3.5% includes some £160 million of financing costs relative to the 3.5% discount rate. The figure of £160 million is therefore an estimate of the impact of private sector financing costs on the price of the deal.
14. Because Modus may pay tax on profits arising from the deal, the net cost of the deal to the Exchequer could be less than £160 million. Table 2 suggests that the value to the Exchequer of tax revenues would amount to some £50 million (shown as £53 million in the Table). That figure is subject to some very important provisos: first that the deal generates profits to the extent assumed by Modus; and, secondly, that Modus actually pays the tax on those profits. The former would obviously depend upon Modus's success in managing the risks to which it is exposed. The latter would depend upon the scope for Modus and its shareholders to mitigate their overall tax liabilities. There would also be tax revenues to the Exchequer arising from the interest payments on public borrowing. Subject to those provisos, then, the extra cost to the Exchequer of private financing would be likely to be in the range of £110 to £160 million.
TABLE 2: THE IMPACT ON THE DEAL OF USING PUBLIC SECTOR FUNDING
Components of net present cost of the deal using | ||
Project costs |
| 897 |
Total Discounted Unitary Charge |
| 1,004 |
Note 1: Equity includes all equity and subordinated debt.