Simple Prediction Formula for Proportion Installment Interest Rate in a Private Finance Initiative Project

Takanori Inoue, Isamu Yoshitake

Department of Civil and Environmental Engineering, Yamaguchi University, Ube, Japan.
Sanyo Consultant Co., Ltd., Ube, Japan.

DOI: 10.4236/jssm.2013.63022                

Abstract

Private Finance Initiative (PFI) projects aim to develop public facilities using private funds. Installment interest payments must be predominant in PFI project costs. The proportion of installment interest depends upon the business period, payment method, interest rate, and other factors. However, prediction of the installment interest is not simple. Cost simulation based on various assumptions has been required for planning PFI finance project. A simplified estimation formula for installment interest rate based on cost evaluations using wide range of comparable conditions is proposed in this paper. The applicability of the proposed formula is also discussed and verified. The proportion of installment interest of a PFI project can be estimated to sufficient accuracy using the proposed formula.

Keywords

Private Finance Initiative (PFI); Installment Interest Rate; Payment; Cost Simulation

1. Introduction

Private Finance Initiative (PFI) project finance generally includes installment interest payment during the business period in addition to design, construction, operation and maintenance (O&M) costs. Prediction of the impact of installment interest rate cost employs simulations based on various assumptions, such as payment frequencies and so on. While several research papers discussing PFI projects have been published, few researches have focused on the effect of installment interest to the project finance.

Darinka and Matthias [1] reported risks faced by financial services providers in the United Kingdom and resolutions of risks based on the fact that most funds in PFI projects are borrowed from financial institutions. Darinka and Matthias [2] detailed the PFI funding process and financial capital using two case studies of recent PFI projects. Hellowell and Pollock [3] investigated the annual expenditure of existing PFI plans in Scotland, and presented the future cost prices arising from an increase in PFI. Kirk and Wall [4] investigated the accounting issue related to PFI projects on balance sheet, and they addressed substantial risk may be transferred to private sector. Hellowell and Vecchi [5] researched returns on investment and evaluated the operation of corporate financing methods for financial models used in 10 PFI projects of the National Health Service (NHS). Coulson [6] investigated constraints on business cost, tax, profitability, and financial investment institutions in PFI projects. Huntingdon and Fitzpatrick [7] verified that tax payers can benefit in the long term if service levels are held to predetermined standards.

Figure 1 shows the proportion of method of installment interest payment and payment frequency in 110 PFI project cases planned in Japan. According to the results, equal principal and interest payment with four payments/ year are most common. Previous researches focused on the installment interest are scarce, though financial and risk management aspects of PFI projects are reported. To estimate the impact of installment interest rate, these factors should be considered. To estimate interest payments, cost simulations considering various conditions such as business period, payment method, interest payment method, and payment frequency are needed. It is not easy to estimate installment interest rate under various conditions via trial cost calculations, even in use of a computer. The variable detailed cost simulations mostly need additional planning cost. The leading planner of PFI project sometimes needs to estimate loans from the financial institution, including the interest payments, at site. A simplified prediction method by a calculator must be useful in such case. Additionally, the simplified method

Conflicts of Interest

The authors declare no conflicts of interest.

References

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