In this month’s edition of Prospect, John Kay examines the methods used by the Airport Commission, which compared the merits of an extra runway at London Heathrow or at Gatwick (pictured).
[W]hat figure should be used for the cost of capital? There are several possibilities. First, the risk free rate at which the British government can borrow. The longest dated index-linked gilt, maturing in 2068, currently yields minus 1 per cent. Second, the “green book” rate prescribed by the UK Treasury used in the Commission’s cost-benefit analysis, and fixed arbitrarily in 2003 at 3.5 per cent in real terms. Third, the anticipated cost of the Private Finance Initiative-type deal which it is anticipated will be employed to fund airport developments – around 5 per cent – 6 per cent in nominal terms. The final possibility is to use the weighted average cost of airport capital of between 5 per cent and 6 per cent real terms, as set by the CAA, British’s airport regulator… [A]rguably it is the first… which is the most relevant. Which rate is used makes all the difference. At minus 1 per cent over a life of 60 years, the annual cost of the proposed capital expenditure at Heathrow is about £250m. At 3.5 per cent, the figure is £800m. At and 5.5 per cent the annual cost becomes £1.35bn.