Abstract
Many of the drawbacks of existing public-private partnership (PPP) projects can be explained by weak financial analyses. This chapter discusses how to apply capital budgeting tools to infrastructure financing, providing guidance principles for public managers, investors, and financial analysts. It claims that when both the contracting authority and the private counterparts develop sound financial analyses for the project, they are able to better craft the PPP contract and reduce the extent of information asymmetry during the procurement and implementation phases.
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Notes
- 1.
The effect of the Blume adjustment is to reduce the difference between the Beta and the market average (i.e. 1). Blume (1971) found that adjusting estimated Equity Betas toward unity improved their ability to forecast subsequent period stock returns. The most widely held explanation for this is that unusually low or high Betas are subject to measurement error. Blume adjustment is standard in the calculation of Equity Betas by regulators in respect of UK, US, and Australian utilities in determining the appropriate rate of return to investors, and is recommended in the most prominent corporate finance textbooks (e.g. Brealey et al. 2019). Blume-adjusted Betas are available from most commercial databases, such as Bloomberg and the London Business School Risk Management Service. The formula is: Blume-adjusted Equity Beta = (0.67)* βOLS + (0.33)*1.
- 2.
In effect, reversing the process in which the sectoral Asset Betas were derived from the observable Equity Betas, thus: Equity Beta = Asset Beta Ă— 1 + (1 - tax rate) Ă— the amount of debt Ă· the amount of equity.
References
Blume, M. E. (1971). On the Assessment of Risk, The Journal of Finance, March, pp. 1-10.
Brealey, R., Myers, S., & Allen, F. (2019). Principles of Corporate Finance. 13th Edition, McGraw Hill.
Graham, J., & Harvey, C. (2002). The Theory and Practice of Corporate Finance: Evidence from the Field. Journal of Financial Economics, 60, 60–78.
Hellowell, M., & Vecchi, V. (2018). Assessing the Cost of Capital for PPP Contracts. In Public-Private Partnerships in Health (pp. 85–109). Cham: Palgrave Macmillan.
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Vecchi, V., Casalini, F., Cusumano, N., Leone, V.M. (2021). Principles of Capital Budgeting for Infrastructure Financing. In: Public Private Partnerships. Palgrave Macmillan, Cham. https://doi.org/10.1007/978-3-030-65435-1_7
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DOI: https://doi.org/10.1007/978-3-030-65435-1_7
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