1.3 Summary of Recommended Approach

The Methodology is based upon the following core principles:

• All (or nearly all) projects have Systematic Risk

• That Systematic Risk will be borne by either the Public Sector, the Private Sector or shared

• Only Systematic Risk is reflected in the Discount Rate (ie, not Project Specific Risk which may be reduced, or eliminated through diversification)

• Where Systematic Risk is transferred under the PPP, the Discount Rate used for the PSC and the Discount Rate used to evaluate competing bids under a PPP will differ according to the Systematic Risk borne by each party.

This approach requires the use of the Capital Asset Pricing Model (CAPM) to determine the amount of Systematic Risk in the project. It then uses a modification in the application of CAPM to determine an appropriate Discount Rate to reflect the value to the Public Sector of the Systematic Risk transferred under each of the PSC and the PPP.

In simple terms, an adjustment is made to the Risk Free Rate to reflect the extent to which Systematic Risk is transferred under the PPP option. If the PPP Project Agreement leads to Systematic Risk being transferred from the Public to Private Sector, the Discount Rate needs to be adjusted to reflect the additional risk transferred under the PPP option. This will normally result in the PPP discount rate being higher than the PSC Discount Rate and this Discount Rate is termed the PPP Discount Rate.