Chapter 4 - Cash Flow and Investment Analysis

Abstract

This chapter focuses on discounted cash flow (DCF) and internal rate of return (IRR) methods of calculations, which are widely used in public–private partnerships (PPPs) projects for financial analysis. DCF and IRR calculations are based only on investment of cash and they do not take account of the risk involved in making a commitment to invest cash in the future, nor of the need (and hence the cost) of setting aside resources to make this future investment. This is of particular relevance in PPPs, where construction and hence investment may take place over several years, or where there may be investments of cash in later stages of a project. The discount rate used for DCF calculations is a combination of two factors, namely, the general time value of money and a premium for the particular risks involved in the investment. The IRR measures the return on the investment over its life and it is the discount rate at which the net present value (NPV) of the cash flow is zero. The use of a single discount rate or IRR to assess investments suggests that the risks involved in a PPP project are the same throughout its life. A DCF calculation may be used to decide whether to proceed with the procurement of a project and evaluate bids for a PPP project. IRR can be used to assess the general financial viability of a project without taking account of its financial structure.