1.28 To compare the costs of alternatives, it is important to consider the timing of payments. Future payments are discounted to a present value so that comparisons can be made. Private finance deals allow repayment of the upfront investment to be spread over time - future repayment of debt and interest are reduced through discounting. In our previous work we remodelled the VfM assessment to allow for the fact that the government can also issue debt and spread out repayments. Making this change resulted in a reduction in the costs of the public sector comparator. In the majority of cases this also meant the assessment outcome changed to show that the public finance option was best value.31
1.29 Making changes to the discount rate applied to future costs can also affect which financing route is assessed as VfM. The VfM assessment compares private finance costs with a government discount rate of 3.5%, which is 6.09% with inflation, known as the Social Time Preference Rate (STPR), which is higher than government's actual borrowing costs (Figure 5). The higher the rate applied, the lower the present value of future payments. For example a payment of £100 in 12 years will have a present value of just £49 when discounted by the STPR. Discounting using a lower discount rate, which compares private finance with the actual cost of government borrowing, results in fewer private finance deals being assessed as VfM.32
1.30 Using a fixed discount rate, set in 2003, means that the VfM assessment does not reflect the additional cost of private finance above the prevailing cost of government borrowing. In the current low-interest-rate environment it is possible to privately finance projects below the 6.09% rate. When this is the case private finance will be assessed as costing less than public finance even though the actual long-term cash costs of debt servicing and repayment will be higher than government debt costs. HM Treasury does not consider the cost of government borrowing to be relevant in making financing decisions on PFI and PF2 deals.33 However, other countries, such as Germany and the United States, do compare the cost of private finance with government borrowing costs when assessing financing options like PFI.
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31 See footnote 30, paragraph 3.22, Figure 6.
32 See footnote 30, paragraph 3.21, Figure 6.
33 See footnote 30, paragraphs 10 to 14.