No doubt understanding discounted cash flows isn’t at the top of the NSW Government’s 2011 training program. Public Transport for Beginners, Dummies' Guide to Budgeting and Paul Keating’s Not Even I Could Resurrect This One would surely take precedence.
But a couple of quick lessons wouldn’t go astray.
NSW Opposition Leader Barry O’Farrell has made an election promise to widen Sydney’s M5, the main road out of Sydney towards Canberra and Melbourne. Instead of paying for the new road themselves, O’Farrell’s proposal involves extending the toll concession for four years beyond the current 2023 expiry. In short, the road’s owner, Transurban, would fork out $350m to expand the road in exchange for an additional four years’ tolls.
In evaluating the proposal, incumbent Premier Kristina Keneally’s finance skills were on show. The four years’ tolls ‘represent $680 million for the private sector company’, she said, ‘to build a $350 million road’. The taxpayer would ‘simply not get value for money’.
Fair enough, if it was a straight $680m of revenue on $350m of costs. But Transurban won’t get the money until 2023, 12 years from now. And $680m in 12 years’ time is worth a lot less than $680m today.
For those with a calculator, the return required to turn $380m into $680m over 12 years is 5.69%. (For those without a calculator it’s a nice easy example of how to use the rule of 72. $350m to $680m is roughly double in 12 years. 12 goes into 72 six times, therefore the compound rate is roughly 6% per annum).
Of course, Transurban will also get the benefit of more cars using the widened road between now and then, so the actual return will be somewhat higher. But all in all it seems a perfectly sensible deal for both the taxpayer and Transurban.
Keneally probably knows that. Being a politician, she’s just not allowed to say it.