The Code of Conduct recommends that that discount rate should be equivalent to the base case shareholder internal rate of return (IRR). In the case of the Norfolk & Norwich this was 18.94%.
Applying a discount rate of 18.94% per annum to both the pre and post refinancing equity cash flows, produces a refinancing gain (ie the difference) of £115.501 million. The Trust was then entitled to a share of this gain.
Applying a discount rate of 3.5% per annum real to the two cash flow series, produces a refinancing gain of £47.163 million. Again, the Trust would only have been entitled to take a share of this gain.
The variation in the refinancing gain can be explained by looking closely at the profile of the two cash flow series.
In the pre-refinancing scenario much of the shareholder return was at the end of the concession. Discounting these equity cash flows at a high discount rate means that their present value is relatively low. Using the same high discount rate to the post refinancing cash flows has a dramatically different effect. The shareholders have exchanged returns in the future for up-front returns. The acceleration of shareholder returns means that these amounts are relatively unaffected by the high discount rate.
| Pre-refinancing | Post refinancing | Refinancing gain |
Present value at 18.94% of the distributions occurring after December 2003 | £35.372 million | £150.873 million | £115.501 million |
Applying a low discount rate (3.5% real) to the pre-refinancing equity cash flows, and the present value of the back ended returns is maintained at a high level. In the post refinancing scenario the accelerated returns paid up front when combined with the ongoing but lower future returns still exceed the previous level. | |||
| Pre-refinancing | Post refinancing | Refinancing gain |
Present value at 3.5% real of distributions occurring after December 2003 | £162.473 million | £209.636 million | £47.163 million |