Quote:
Originally Posted by RoadGame
I'm sorry, this is incorrect. The relevant benchmark here is the 5%, not the 1%. The city arrived at an estimated contribution of $316M from CSEC through their rent payments at a discount rate of 5%. Implicitly that's the value to the capital stack of the debt that would be secured by the lease. If they can raise debt at less than 5%, then the CSEC lease will enable a higher amount of upfront debt capital, if rates move against the city then the lease will support a smaller amount of upfront debt capital, which will create a shortfall somebody's got to pay for.
The 1% escalator only serves to shape the payments over time. Capital tariffs like this are often flat nominal, but where there are big differences in cost of capital between the two parties involved it can make sense to shape the tariff. For example, utilities (power companies) often have lower opportunity cost of capital than oil companies, so when the power company builds a cogen for an oil company you can escalate the tariff by a few percent per year. When the utility company looks at that revenue stream and applies their opportunity cost of capital discount factor they see a number, let's call it X. When the oil company uses their opportunity cost of capital to discount that financial commitment (larger discount), they see a number smaller than X. Strike the right balance and everyone's happy.
The 1% could just as easily be set to 2% with a smaller initial payment, and the resulting PV at 5% would be the same.
TL;DR the 1% is not useful to focus on, the city is betting they can finance the loan at 5%.
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This is excellent analysis. The City basically built the debt structure/PV valuation of the CSEC contribution on the premise that their borrowing rate/ability won't change substantially between now and whenever it's paid off. Their rates are *generally* stable, but not immovable.