Impact of Irreversibility and Uncertainty on the Timing of Infrastructure Projects

Abstract

This paper argues that because of the irreversibility and uncertainty associated with Build-Operate-Transfer (BOT) infrastructure projects, their financial evaluation should also routinely include the determination of the value of the option to defer the construction start-up. This ensures that project viability is comprehensively assessed before any revenue or loan guarantees are considered by project sponsors to support the project. We show that the framework can be used even in the context of the intuitive binomial lattice model. This requires estimating volatility directly from the evolution of the net operating income whilst accounting for the correlation between the revenue and costs functions. This approach ensures that the uncertainties usually associated with toll revenues, in particular, are thoroughly investigated and their impact on project viability is thoroughly assessed. We illustrate the usefulness of our framework with data from an actual (BOT) toll road project. The results show that by postponing the project for a couple of years the project turns out to be viable, whilst it was not, without the deferral. The evaluation approach proposed therefore provides a better framework for determining when and the extent of government financial support, if any, that may be needed to support a BOT project on the basis of project economics. The analysis may also be applicable to private sector investment projects which are characterised by irreversibility and a high rate of uncertainty.

Concession Period Determination for PPP Retirement Village

“…With the help of Monte Carlo simulation, the guarantee option has been applied to determine the concession period for toll-road and water-supply projects (Huang & Lv, 2016;Zhao & He, 2010). In addition to the guarantee option, project evaluation should incorporate the option to defer in order to achieve a comprehensive view, because of the uncertainty and irreversibility of such investment (Doan & Menyah, 2012). If the government prefers to invest immediately and grant the PPP without the option to defer, the investment will only be optimal when the NPV is positive.…”

The Determination of Concession Period for Build-Operate-Transfer Solar Photovoltaic Power Project under Policy Incentives: A Case Study of China

“…The option value to invest in the project F g Eq e t should meet the Bellman Equation [45]. We obtain that rF g Eq e t dt = E dF g Eq e t (18) Then, F g Eq e t must be the solution of the following equilibrium differential equation [46], which can be represented by…”

“…Thirdly, the project investment timing is discretionary. With regard to this characteristic, the concession period determination should take the value of the option to defer into consideration [18]. Nevertheless, among the broader literature on the determination of the concession period in the BOT project (e.g., [19,20]), many studies use the net present value (NPV) method.…”

Significant Factors Affecting Civil Engineering Project Performance

“…Hence, this provides impetus to contribute to study on the performance of civil engineering projects in Malaysia. In literature, the performance of construction projects is discussed mainly focusing on the time, cost and quality [9], [10], and [11] Thus, this study adopted the same performance indicator since these three indicators are universally acceptance as the main performance indicators in all field of studies as well as stated and ranked as the most important indicators for many types of construction projects by many researchers [12], [3], [13] [1] and [14].…”