Scrutiny
In the last few days, the Guyana Power and Light Company (GPL) has come under intense press scrutiny for a financial decision that it made about generators used in its operations. From the case presented in the news media, there is the view that GPL should have purchased the generators instead of renting them. The coming together of power and finance in this manner has even attracted the attention of the President, who weighed in with his own concerns about the issue. The way the media is presenting the case suggests that there might be other factors buried in the decision that need to be brought to light. The way GPL has responded to the queries also has not helped and certainly leaves open the possibility that other issues of public concern might lie behind the decision. GPL is nobody’s teddy bear primarily because of the insensitive way in which it has often treated its customers. But, on the face of the information appearing in the newspapers, a proper examination of the situation might favour GPL in this case. The quoted remarks of the President suggest that he might already be aware of this possibility considering that he has access to expert advice on such matters and to the relevant personnel of GPL. Be that as it may, the discomfort of the public would not be so great if there was greater respect for public accountability and the Public Procurement Commission was in place.
Decision
The decision that GPL faced at the time was whether to spend US$900,000 for each generator or to make a series of equal monthly payments for a fixed period of time for the use of the generators. The devil is always in the details of any deal and GPL has not done a good job of providing sufficiently clear details about the factors that went into its decision. It has left much to speculation as if it has no responsibility to answer the public’s concerns. However, the reporting on the matter suggests that GPL saw the decision as a short-term one, which meant that the generators were not needed on a permanent basis. It also implied that there was no intention of using the generators for more than one year since the timeframe for a short-term decision is generally seen as one year or less. If true, this claim allows an objective onlooker to consider critical elements that would go into a decision of that type. At the same time, the short-term nature of the decision tempts one to consider the US$720,000 spent on each generator as US$180,000 less than the cost of the generator. The situation however is not that cut and dried. The primary concern for GPL was determining whether renting the generators for the short period of time was more cost effective than buying them.
Present Value
To do that, GPL had to compare the value of the US$900,000 that would leave its coffers immediately for each generator to the periodic cash flows that would leave its coffers each month for 12 months, if that was the intended duration. To effectively make that comparison, GPL had to bring the 12 monthly payments that it would make in the future to the present. In other words, GPL had to determine what its 12 future cash payments of US$60,000 were worth on the day that it had to make the decision. GPL had to find a rational way to do so. In finance, the logical tool would be the present value concept. A key factor in that decision would be the interest rate that GPL would pay if it had to borrow the money to make the purchase. It could also look at it from the point of view of the interest that it could earn by investing the US$900,000. GPL has already disclosed that it did not have the cash and would have had to borrow the money to make the purchase.
Interest Rate
As a consequence, another key piece of information in that decision would be the interest rate that GPL would pay if it had to borrow the money to make the purchase. In finance, this rate is more commonly described as the discount rate when used to calculate the present value of a stream of payments. The information about the discount rate is missing from the discussion and makes it extremely difficult for anyone to understand what really happened. What is clear, however, is the interest rate of importance would be the one that prevailed at the time that GPL was ready to act. Knowing this piece of information as well could make a big difference as to whether GPL made the correct decision or not.
The 2008 Financial Statement of GPL, the latest that is available online, indicates that the company could obtain an interest rate that was at least three percent below the prime rate. Each loan contract contains its own risk factors so that favourable interest rate situation could have changed by 2011. But with all the money that it makes, GPL must qualify as one of the best customers for the commercial banks in Guyana. The average of the prime rate in 2011 was 14.86 percent, thus giving GPL a potential borrowing rate of 11.86 percent, assuming all things were equal. Using this information, it could be seen that when the present value of the 12 payments of US$60,000 is considered, GPL would have paid the equivalent of US$675,803 for each generator. In other words, when the real value of money is taken into account, GPL would be saving US$224,197 on each generator by making the decision to rent and not to buy. It is quite possible therefore to envision scenarios where the decision to rent was a favourable one when using standard finance practice. Despite being so, the principals at GPL have resorted to explanations that do not address the underlying concerns of the decision, and have left themselves exposed to continuous criticism.
Critical
The present value is a vital concept in some decisions about money. It is used to determine the value of mortgages and insurance contracts. From experience, Guyanese know that a contract has at least two parties. Despite the advantages of free maintenance, and not having to worry about disposing of many assets when not needed, that is not the full picture. The perspective of MACORP, the company that loaned the generators, is also missing from the discussion. The viewpoint of MACORP would never come from GPL, and MACORP has no obligation to say anything. That there is another side to the deal must be kept in mind since it could help with an understanding of what might be driving concerns about this case. Guyanese should wonder why MACORP would bring 12 generators and have them sitting on its hands if it did not believe that the generators would be needed on a long rather than a short term basis. It should be evident that MACORP would have rather collected its US$900,000 and moved on.
Unique Features
GPL has not disclosed if there are other features to the contract that might be unique. Since the transaction might not qualify as a capital lease for GPL, MACORP could still be carrying the assets on its books. GPL might be choking on its reply because there might be other payments to cover other eventualities.
The question has to be asked if GPL had to pay an upfront fee, in addition to its monthly rent, that could have wiped away the savings that it got from renting and not buying the generators. GPL is in the best position to answer the question and it should.
