Public Private Partnerships: A licence to print money … or value for money?
6 Evaluation methodologies
There are established and accepted evaluation methodologies (Reilly and Schweihs 1998). It is often case that the mistake made is to use a decision-making tool such as CBA to determine the value of an asset. This is an incorrect application. CBA is a decision-making tool; it does not establish value of the underlying asset.
The stakeholders in a simple form of a PPP are the government, the company, the lender and the consumer. Each has different values that they place on the public asset. In accounting terms, the valuation of any asset can be determined using a variety of different formulae and techniques. However it depends on the characteristics of the asset – they will dictate which technique is fit for purpose. An asset is consumed by a company to deliver a benefit to its shareholders; the benefit is in the form of a dividend which is paid to the shareholders, thus increasing the wealth of the shareholders. The value of such a commercial business is expressed as the book or market value. The financial health of a company is generally accepted as being represented by its balance sheet, cash-flow and profit and loss statements.
The balance sheet contains a list of all the assets and liabilities including shareholders’ equity. These assets can be both tangible (real, physical such as cash, product, buildings and equipment) and intangible (such brands, goodwill and reputation). The balance sheet, in simple terms, lists all assets and liabilities including the cost of equity.
So the 'book' value (BV) of the company is simply
Often, the simplistic gross sales less the total costs is taken as the book value however this may not include all liabilities such as shareholders’ equity which is a cost of capital. Capital is used to generate an asset from which shareholders derive a benefit.
The market value (MV) is defined as:
For example, take the company’s traded share price on the stock market and multiply it by the number of shares. This is the company’s market price, the price that a willing buyer is prepared to pay for a share. The difference between the market price and the book price is a measure of the intangible assets such as goodwill or the potential for future earnings.
Other financial models use future earnings as a proxy to assign a value to an asset. These tools have evolved from Portfolio Theory (MPT) as illustrated by Buehler, Freeman and Hulme (2008). Models and techniques in evaluating a portfolio of assets, such as those developed by Lintner and Sharpe; Millar and Modigiliani, and Black and Scholes, are widely accepted as good tools for measuring risk associated with the valuation of an asset. However, this portfolio theory of asset pricing has been challenged in recent times.