October 6, 2005

Edward Cebron, FCS GROUP

Including Interest Costs in Impact Fees: Economics, Equity and Methods

NATIONAL IMPACT FEE ROUNDTABLE

8201 164th Ave. NE, Suite 300, Redmond, WA 98052 (425) 867-1802

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Outline of Discussion

1) Defining the Question

2) Some Rules of the Road

3) Analytical Basics for Incorporating Debt Costs

4) Conclusions and Observations

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Including Interest in Impact Fees:What’s the Question?• Do “Costs of Facilities” include debt

service costs such as interest or issue costs?

– For debt already issued?– For debt to be issued?

• To What End?

– Equity?– Cash Flow?– Sufficiency?

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Aside: How do We Define Equity?

• As a group, to generate a targeted level of revenues; or

• As an individual, to pay a pro rata share of costs

• Growth pays for growth

• Ensure that all related costs are met

• Minimize cash flow risk

suggests equity is defined by a charge fair to the payer

suggests equity is defined by protecting existing customers / users from subsidy

Constraining Law Empowering Law

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Defining Unit Costs of Capacity

…Capital cost divided by capacity served

…Debt Issuance Cost – Not applicable prior to financing– Applicable once financing decision is

reached

…Debt Interest Cost– Accumulated until time of payment– Provision for future net interest

costs

Cost of CapacityIncludes …

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Simple Project Assumptions

Project CostsCapital Cost 1,000,000$ Units of Capacity 1,000 Cost per Unit 1,000.00$

Financing CostsDebt Issuance 2.0%Debt Interest Rate 5.0%Debt Term 20 years

Other FactorsInterest Earnings 3.5%Inflation 3.0%Construction Year 0Debt Issuance Year 01st Debt Payment Year 1

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Summary of Traditional Interest Cost Analysis

YearCapital Costs

Issuance Costs

Annual Interest Cost

Incurred

Net Future Interest Costs

Net Cost for Units Connecting this

YearAnnual Rate of

Escalation0 1,000$ -$ -$ 1,000$ 1 20$ 50$ 1,070$ 7.00%2 54$ 1,124$ 5.00%3 56$ 1,180$ 5.00%4 59$ 1,239$ 5.00%5 62$ 1,301$ 5.00%6 65$ 1,366$ 5.00%7 68$ 1,434$ 5.00%8 72$ 1,506$ 5.00%9 75$ 1,581$ 5.00%

10 79$ 1,660$ 5.00%11 83$ 1,743$ 5.00%12 87$ 1,830$ 5.00%13 92$ 1,922$ 5.00%14 96$ 2,018$ 5.00%15 101$ 2,119$ 5.00%16 106$ 2,224$ 5.00%17 111$ 2,336$ 5.00%18 117$ 2,452$ 5.00%19 123$ 2,575$ 5.00%20 129$ 2,704$ 5.00%

Costs Incurred by Year of Connection

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What About Future Interest Costs for Debt Already Incurred? • Future Interest Costs are real costs

incurred in order to provide needed system expansions

• Cost is defined by cost of debt (interest rate)

• Present Value Analysis defines the equivalent “up-front” cost for a future interest payment stream

• Equivalent lump sum payment• Considers investment value of early payment• Also needs to consider the PV discount of future

principal payments

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Sample Analysis to Incorporate Future Interest Costs

Year

Debt Service Principal

Debt Service Interest

Total Annual Debt Service Payments

Total Cumulative

Payments to Date

Total Cumulative

Future Payments

Present Value of Payments to

Date (1)

Present Value of Future

Payments (2)

Total Present

Value Cost

Annual Rate of

Escalation0 1,000$ 1 31$ 51$ 82$ 82$ 1,555$ 82$ 1,122$ 1,204$ 20.40%2 32$ 49$ 82$ 164$ 1,473$ 168$ 1,080$ 1,247$ 3.60%3 34$ 48$ 82$ 246$ 1,391$ 258$ 1,035$ 1,294$ 3.70%4 36$ 46$ 82$ 327$ 1,310$ 353$ 990$ 1,343$ 3.80%5 37$ 44$ 82$ 409$ 1,228$ 452$ 943$ 1,395$ 3.89%6 39$ 42$ 82$ 491$ 1,146$ 557$ 894$ 1,451$ 3.99%7 41$ 41$ 82$ 573$ 1,064$ 666$ 843$ 1,510$ 4.08%8 43$ 38$ 82$ 655$ 982$ 782$ 791$ 1,572$ 4.16%9 46$ 36$ 82$ 737$ 900$ 902$ 737$ 1,639$ 4.25%

10 48$ 34$ 82$ 818$ 818$ 1,029$ 681$ 1,710$ 4.33%11 50$ 32$ 82$ 900$ 737$ 1,163$ 623$ 1,785$ 4.40%12 53$ 29$ 82$ 982$ 655$ 1,303$ 563$ 1,865$ 4.48%13 55$ 26$ 82$ 1,064$ 573$ 1,450$ 500$ 1,950$ 4.55%14 58$ 24$ 82$ 1,146$ 491$ 1,604$ 436$ 2,040$ 4.62%15 61$ 21$ 82$ 1,228$ 409$ 1,766$ 370$ 2,136$ 4.68%16 64$ 18$ 82$ 1,310$ 327$ 1,936$ 301$ 2,237$ 4.74%17 67$ 15$ 82$ 1,391$ 246$ 2,115$ 229$ 2,344$ 4.80%18 71$ 11$ 82$ 1,473$ 164$ 2,303$ 155$ 2,458$ 4.85%19 74$ 8$ 82$ 1,555$ 82$ 2,500$ 79$ 2,579$ 4.91%20 78$ 4$ 82$ 1,637$ -$ 2,706$ -$ 2,706$ 4.95%

(1) - The present value of past payments is computed based on the cost of debt (5.0%).

(2) - The present value of future payments is computed based on the investment earnings rate (3.5%).

Present Value of Past and Future Payments: by Year of Connection

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General Follow-up Questions & Issues

• Who subsidizes future shortfalls due to artificial limitation?– Existing Customers?

• Initial charge must reflect equitable cost• Future charges would not fully reflect costs

– Today’s Future Customers?• Initial charge must be increased to recognize limits in

escalation rates• Can only be accurate if growth rate and pattern are

known.

• What about corollary contributions/payments?– Past taxes and charges prior to development

– Future taxes and charges after development

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Conclusion and Observations

…should include a provision for interest reflecting net interest costs– Accurate determination reflects both interest and

principal payment structures

…should escalate with accumulating cost burden– Does not conform to inflation-based adjustments

…should be designed to fully recover costs

…cannot be designed to assure adequate and timely cash flow

…could (should?) consider other offsetting revenue benefits

Equitable Impact Fees…