Annexure 4 - Summary of Victorian Discount Rate
changes
The purpose of the national methodology
 Discounted cashflow analysis is required to compare differing Public Sector Comparator
(PSC) and bid cashflows on a consistent basis.
 The National PPP Guidance provides a methodology for determining the discount rates to
be used in making this comparison and determining whether PPP delivery offers value for
money.
 This discount rate methodology is not appropriate for use in making the investment
decision - that is, it is not appropriate for deciding at business case stage whether the
investment has merit and should proceed.
Taking account of risk in PPPs with net cash outflows for the State
 In discounting the PSC and bid cashflows, we price the project specific risks into the
cashflows.
 In additional to project specific risks, we also need to take account of market-wide risks
that affect all asset classes and cannot be reduced by diversification (i.e. systematic
risks).
 Systematic risks expose the PPP cash flows to variability in returns. Bidders will price this
variability into their bids.
 This variability in return is compensated through a higher discount rate (reflective of the
level of systemic risk borne).
Discount rates based on CAPM
 Capital Asset Pricing Model (CAPM) says Ra = Rf + βa (Rm − Rf )
– Ra is the required return on assets whose risk class is designated by the Beta or
Systematic Risk (the Project Rate).
– Rf is the Risk-free Rate.
– βa is the Asset Beta, which reflects the degree that asset returns (ie, returns of a
particular project) are expected to vary with returns of the market (ie, a well
Diversified Portfolio of assets or projects).
– (Rm-Rf) is the return over the Risk-free Rate (the market risk premium or equity risk
premium) that investors would need or expect in order to invest in an asset.
 Both the ‘old’ Partnerships Victoria methodology and the National PPP Guidelines
methodology adapt CAPM to derive discount rates that factor in systematic risk when
discounting PSC and bid cashflows for evaluation purposes.
Partnerships Victoria Requirements
Annexure 4 –February 2009
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Discount Rate inputs under the old and new methodologies
Figure 1 Discount Rate inputs
‘Old’ PV Methodology*
Risk Free Rate
Market Risk Premium
Asset Beta
Risk Premium for
Discounting the PSC
Risk Premium for
Discounting Bids
Inflation assumption*
Average of the ten-year
Commonwealth bond rate for the
last 6 months
6% real
Determined from table of
indicative betas or from market
data
Project risk premium
(Asset Beta x Market Risk
Premium)
Project risk premium
(Asset Beta x Market Risk
Premium)
DTF long-term forecast
National PPP Guidelines
Methodology
A jurisdiction specific long term
bond rate (For Victoria, based on
advice from TCV, the one month
rolling average yield on TCV
10 year bonds will be used)
6% real
Determined from table of
indicative betas or from market
data
None
A proportion (can be from 0% to
100%) of the project risk premium,
reflecting to proportion of the
systematic risk that is transferred
‘A balanced view of long-term
inflation’
* The ‘old’ Partnerships Victoria methodology described here is the general methodology applicable to most
projects. The Partnerships Victoria guidance also set out a special methodology for projects where there is
material systematic risk transfer. The special methodology was much the same as the new National PPP
Guidelines methodology.
* This is the inflation assumption to be used (if required) to convert between real and nominal discount rates. It
is not necessarily the inflation assumption used for escalation purposes which is determined in accordance with
Annexure 5. It is expected that the rate determined in accordance with Annexure 5 will be a balanced view of
long-term inflation.
Figure 2 Illustrative comparison of Discount Rates
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Partnerships Victoria Requirements
Annexure 4 – February 2009
Steps in the National PPP Guidelines Methodology
Step 1:
Identify the systematic risks.
[Step 2: Are predominantly all the systematic risks borne by the public sector? (This is
unlikely) – If so, discount bids at the risk free rate.]
Step 3:
Identify the project risk premium.
[Step 4: Are predominantly all the systematic risks borne by the private sector? (This is
unlikely) – If so, discount the bids at the project rate.]
Step 5:
Evaluate the proportion of the systematic risks transferred to the private sector
and include a corresponding proportion of the project risk premium in the
discount rate used for assessing bids.
Figure 3 Determining the bid evaluation rate
Note: figure best viewed in colour
Sensitivity Analysis
 In evaluating bids, two types of sensitivity tests should be performed:
– Uncertainty: Uncertainty is distinct from risk and some of the costs of uncertainty are
normally transferred to the private sector. To assess the impact of uncertainty, an
appropriate sensitivity analysis on the discount rate would likely be +/- 50 to 100 basis
points; and
– Break Even Analysis: The break-even discount rate should be calculated to consider
the overall sensitivity of the VFM proposition to changes in the discount rate.
 In conducting these sensitivity tests, regard should also be had to the extent to which
rates have moved since the risk free rate was determined.
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Published: February 2009
Partnerships Victoria Requirements
Annexure 4 –February 2009
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