- The discount rate for calculating the present value of state aid granted in tranches is the reference rate; i.e. base rate plus 100 bp.
- The discount rate for calculating the present value of an investment project is the weighted average cost of capital of the investor.
Introduction
When state aid is granted in instalments, the amount of future tranches has to be discounted to the day the aid is granted in order to ensure that the present value of the total aid does not exceed the maximum permissible aid intensity. If eligible costs are incurred at different points in time, eligible costs must also be discounted to the day the aid is granted.
When the necessary amount of aid is calculated on the basis of the net present value [NPV] of a project or the funding gap between the initial investment and projected revenue, the discounting becomes even more complicated because a different discount rate will have to be used, which is normally the weighted average cost of capital of the investor. A case in point is recent Commission decision SA.118989 authorising state aid for a large investment project in Germany.[1]
Germany notified to the Commission a measure in support of regional investment by Vetter Pharma in Saarland, in the south-west of the country. The region – Saarlouis – where the investment is to be located is a “c” area eligible for aid at a rate of 15% under Article 107(3)(c) TFEU. The project is expected to create 1200 jobs that may increase to 1700 when it operates at full capacity.
Vetter, a large pharmaceutical company, specialises in the development of injectable medicines. It intends to set a new establishment in Saarlouis to manufacture aseptic filling into vials and syringes. The total eligible investment costs for the project amount to EUR 800 million in nominal value and EUR 724.6 million in discounted value. The discount rate is 3.21% [i.e. 2.21% plus 100 bp], as defined in the 2008 Commission Communication on reference and discount rates. The investment comprises acquisition of land, construction of buildings and purchase of equipment and machinery.
The aid is provided in the form of a grant through an already implemented scheme on the basis of the GBER. However, the aid had to be notified individually because it exceeds the threshold of the aid that could be granted to a project of EUR 110 million. The amount of aid is EUR 46.95 million in nominal value, but because it is to be granted in instalments over a six-year period, the discounted value is only EUR 41.20 million. The discount rate is also 3.21%.
Article 4(1)(a) of the GBER states that regional aid is not exempted from notification if, for an investment with eligible costs of EUR 110 million or more in a region with maximum permissible aid intensity of 15%, the aid amount per undertaking per investment project exceeds EUR 12.38 million.
In addition, aid that is individually notified has to be scaled down. In this case, the scaling-down formula for a project with eligible costs of EUR 724.6 million results in a maximum permissible aid of EUR 43.11 million; i.e. higher that the discounted amount of EUR 41.20 million. Therefore, given a total of EUR 724.6 million of eligible costs, aid of EUR 41.2 million is equivalent to aid intensity of 5.69% [= 41.2/724.6], which is much lower than the rate of 15% that applies to Saarland.
Incentive effect
Before deciding on the location in Saarlouis, Vetter examined more than ten alternative locations in Germany and Austria. The final choice was between Saarlouis and two other locations, both in Germany. A number of factors favoured the other locations such as better infrastructure and proximity to transport terminals. By contract, Saarlouis offered a larger plot of land and skilled labour force.
The financial analysis showed “(64) a Net Present Value (‘NPV’) disadvantage for Saarlouis of EUR [30 000 000-40 000 000]. The State aid of EUR 46 950 000 in nominal value was worth EUR [30 000 000-40 000 000] in discounted value, discounted at a weighted average cost of capital of [5-10]%. The remaining cost difference of Saarlouis was therefore EUR [500 000-600 000]. … this was acceptable because of the bigger size of the site in Saarlouis and because of the labour market potential.”
The quoted part of paragraph 64 above is significant in at least one important respect. It is, I believe, probably the first time that a Commission decision on regional investment aid explicitly states that for determining the aid intensity, the amount of aid is discounted at the reference rate, while for determining the NPV of the project, the amount of aid is discounted, like all other costs and incomes flows, at the WACC rate. In all other Commission decisions on large investment projects I have read, there is no similar clarification of the discount rate used, only statements that the aid is discounted.
Counterfactual scenario
The German authorities calculated the amount of necessary aid on the basis of a “scenario 2” situation [i.e. “location decision”; see paragraph 59 of the regional aid guidelines (RAG)]. Without the aid, the investment would have taken place in an alternative location in a non-assisted region in Germany.
“(67) Germany provided the detailed NPV comparison between and Saarlouis.”
“(68) The CAPEX is higher in Saarlouis than in . The difference is based on higher costs for the purchase of the land and the higher costs linked to construction and related project costs (mainly related to the distance from the headquarters in Ravensburg and to the fact that it concerns a brownfield site).” That distance is about 400 km.
“(69) In terms of OPEX, Vetter estimates that as from 2028 Saarlouis will need an additional [management role] as well as management support from Ravensburg that would lead to higher indirect personnel costs (longer distance). In the first years (2027-2035) Vetter’s headquarters will also provide support services such as storage and optic control of batches which causes increased inbound logistics costs.”
“(70) As far as taxes are concerned, the business tax is slightly lower in than in Saarlouis and also the property tax creates a cost disadvantage for Saarlouis.”
“(71) The NPV analysis assumes that the revenues are the same in both locations. For discounting purposes, a discount factor of [5-10]% was used, which corresponds to the weighted average of cost of capital Vetter normally uses for its investment appraisals. The NPV of the investment in Saarlouis without the aid amounts to EUR [50 000 000-60 000 000] compared to the NPV of the investment in of EUR [90 000 000-100 000 000], resulting in a NPV difference between those locations of EUR [30 000 000-40 000 000] in favour of . The aid amount of EUR [30 000 000-40 000 000] (in discounted value)* compensates to a large extent the cost disadvantage of the Saarlouis location, remaining slightly below the difference between the NPV of the investment in the target area with the NPV in the alternative location. The remaining gap is compensated through non-monetary advantages in Saarlouis such as workforce availability and potential expansion possibilities.”
* The discount rate for the state aid in this calculation is the WACC of the company.
Therefore, in both locations, Vetter made a profit. The problem was that the profit was smaller in Saarlouis. Therefore, state aid compensated it not for losses but for a smaller profit.
Assessment of the compatibility of the aid with the internal market
The Commission assessed the notified measure in accordance with the relevant provisions of the RAG. It found, on the positive side, that the aid contributed to the development of an economic activity.
With respect to the incentive effect, it also found that the aid satisfied both the formal effect [i.e. Vetter had applied for aid before the start of works] and the substantive effect [i.e. the aid was necessary for the location of the investment in Saarlouis]. This was because, as explained above, the NPV of the project in Saarlouis would be lower than that in the alternative location, as indicated by the counterfactual scenario.
On the negative side of state aid, the Commission confirmed that the state intervention was necessary to promote regional development, the aid was an appropriate instrument for inducing Vetter to locate in Saarlouis and that the aid was proportional, as it did not exceed the difference in NPV between Saarlouis and the alternative location. In addition, the amount of aid remained below the maximum permissible aid intensity for that area.
The Commission also checked that there was no manifest negative effect on competition. The aid was not expected to create overcapacity in a declining market. There was no counter-cohesion effect, as the alternative location was not an assisted area and was not poorer than Saarlouis. In addition, there was no relocation from another less prosperous region. Lastly, the impact on trade and competition was not expected to be unduly negative.
Conclusion
In view of the fact that the aid was necessary and proportional, that it was not linked to any manifest negative effect and that no undue negative effects on trade and competition were foreseen, the Commission concluded that on balance the positive effects of the aid outweighed the possible negative effects and authorised it.
[1] The full text of the Commission decision can be accessed at:
https://ec.europa.eu/competition/state_aid/cases1/20267/SA_118989_121.pdf
