NZDF has also prepared an estimate of the costs of the two options based on the government's accepted accrual accounting methodology used in the standard Departmental Forecast Report. The estimates - for both the A/B option and the C/D option - have been prepared for Output Class D11 (Air-Strike Capability). The two estimates have been prepared with the same underlying assumptions (where appropriate) and so form a useful comparison of the comparative costs of the two options.

In each case, flying hours have been estimated (of A4s, A/Bs and C/Ds) and then estimates of costs in the following broad categories have been given:

Variable operating costs
Other operating costs

• Fixed maintenance support
• Munitions
• Simulator

Depreciation/Obsolescence
Capital charge

Revenue is assumed constant between the two options. However this appears to overlook the value of the C/Ds in the year 2023/2024 (the A/Bs are assumed - at least in this exercise - as having nil value in that year). The impact of including the terminal value of C/Ds is analysed further below.

Given the assumptions embodied in the worksheets, an annual stream of savings (or dissavings) of the A/B option over the C/D option results. In years 4, 5, 7, 8 & 9, the C/D option results in savings relative to the A/B option, but in all other years the A/B option results in savings.

If we discount the savings at a real weighted average cost of capital (WACC) of 10% p.a. (which is the rate used in NZDF's economic value spreadsheets - and noting that a real WACC is appropriate given that all costs are entered as "reals") we obtain the result that the A/B option results in an NPV of savings of $290 million relative to the A4-C/D option. This result is however sensitive to the assumed WACC, especially given that the A/B savings tend to occur in later years. The second column of the table below summarises the NPV of savings for the A/B option relative to the C/D option at different WACCs (but where no disposal value for the C/Ds is factored in).

The third column of the table factors in a disposal value for the C/Ds of $392 million, as per the NZDF's economic valuation spreadsheets (=30% of their purchase cost). The C/D's are assumed to be sold in year 26.

WACC	A/B Savings (no disp.)	A/B Savings (with disp.)
15%	$142 million	$132 million
10%	$290 million	$257 million
5%	$640 million	$530 million

The central estimate of NPV savings (without including disposal value for the C/Ds) is $290 million. Once disposal value of the C/Ds is included, this drops to $257 million. The latter figure is almost $100 million less than that obtained in the NZDF's economic valuation methodology. While still showing a relatively large saving, the difference in calculated saving is substantial. It would be useful for NZDF to explain where the discrepancy arises from.²³

Also noteworthy is the impact of using different WACCs, given the differing time profiles of savings between the two options. Increasing the WACC from the NZDF assumption of 10% to 15% reduces the NPV of savings (without inclusion of C/D disposal value) from $290 million to $142 million (or to $132 million including C/D disposal value). Part of this change is due to discounting future savings at a higher rate; but part is also due to the greater expenditures associated with the A/B option over the next 9 years compared with the C/D option (although the latter option includes an upgrade for the A4s which increases the costs associated with the A4-C/D costs over years 1-3). A smaller WACC (e.g. the 5% shown in the table) correspondingly increases the NPV savings of the A/B option.

A risk-averse government dealing with defence expenditure which possibly has greater than average project risk given the many unknowns (e.g. risk of early obsolescence, costs of future upgrades, etc), may prefer to use a higher WACC than 10%. In this case, taking the 15% WACC, there are still savings pertaining to the A/B option, but these are considerably less than earlier foreshadowed.

A related factor is that government may, for macroeconomic reasons, wish to consider the time profile of its surplus/deficit arising from this (and other) area(s). For years 1-10, the A/B option (using a WACC of 10%) yields a negative NPV savings of $21 million; ie the A4-C/D option yields a lower net fiscal cost over the next decade. This is not surprising given the timing of payments for the two options, but it may need to be considered by a government which will need to ensure that prudent fiscal figures are maintained over coming years.