There are two common methods of calculating a return on equity. The first is 'valuation on commitment', which treats the whole commitment as if it was invested when a PPP is signed and a special purpose company begins operation (NAO, 2012). It assumes that the entire committed investment is at risk from the time the company begins operating. This is a widely used method and is used in this study.
The rate of return is obtained with the equation:
(Return - capital) divided by capital x 100% divided by the number of years between the date of financial close and the sale of equity.
The second method of calculating a return on equity is 'valuation on cash injection'. This method of calculating the rate of return takes account of the fact that investment is phased during the construction period rather being than a lump sum at the beginning. It is a more accurate method of calculating the rate of return and requires significantly more detailed information that was not available for this study. The 'valuation on commitment' under-estimates the rate of return by 5% - 7% (NAO, 2012). Hence the rate of return figures in this report understate the real level of profit and return.
The financial model that underpins each PPP contract is highly complex, hence the determination of profit/loss in PPP contracts part way through the operational phase can only be indicative, a point stressed in Part 1.