How to Employ Nert Present Value

Employing the Net Present Value-Consistent IRR Methods for PFI Contracts

Y. H. Chiang1; Eddie W. L. Cheng2; and Patrick T. I. Lam3

Abstract: The internal rate of return IRR is a common financial indicator for private finance initiative PFI projects. Due to the long and complicated cash flow nature of PFI projects, more plausible IRR techniques are necessary for appropriate project evaluation and ranking. However, not all the published articles researching on IRR techniques are reliable. Given the importance of computing the profitability of PFI projects, this paper is intended to introduce three reliable IRR methods, which are proven to be consistent with net present value. Examples are used to illustrate their utility. The paper is of high value as it guides industry’s practitioners to use proper IRR methods for selecting PFI projects. It also provides academic researchers a platform to explore more robust methods. DOI: 10.1061/ ASCE CO.1943-7862.0000179 CE Database subject headings: Financing; Investments; Decision making; Revenues; Contracts; Project management. Author keywords: Financing; Investments; Decision making; Revenues.

Introduction

According to the Office of Government Commerce OGC 2002 Guidance in the United Kingdom, the internal rate of return IRR is used for calculating the expected rate of return ROR in private finance initiative PFI contracts. This is the case even both the IRR and the net present value NPV are popular discounted cash flow methods applied in cash flow forecasting for construction contracts Hwee and Tiong 2002 including PFI projects e.g., Housing, Planning and Lands Bureau HPLB 2007 . If we use it correctly, the IRR is a preferred method to the NPV Hazen 2003; Hartman and Schafrick 2004; Hajdasinski 2004 . It is because from the practitioners’ perspective, the IRR is the true cost of capital and therefore the real ROR for measuring financial efficiency and project profitability Hartman and Schafrick 2004 . Moreover, business...