Optimal Capital Structure for Privately-Financed Infrastructure Projects—
Valuation of Debt, Equity, and Guarantees
Antonio Dias, Jr. and Photios G. Ioannou
Civil & Environmental Engineering Department
University of Michigan
Ann Arbor, Michigan 48109-2125, U.S.A.
BOT, BOO, capital, debt, development, government concessions, infrastructure, private promotion, project finance.
Dias, A., and P.G. Ioannou, P.G., Optimal Capital Structure for Privately-Financed Infrastructure Projects — Valuation of Debt, Equity, and Guarantees, UMCEE Report No. 95-10, Civil and Environmental Engineering Dept., Univ. of Michigan, May 1995, 83 pp.
The ability of governments to operate, maintain and finance infrastructure is increasingly being questioned. Many facilities have been inefficiently operated and inadequately maintained, social needs have been neglected, and governments have been spending more on infrastructure than they can manage. The private promotion of infrastructure projects is a key mechanism for providing new facilities that has advantages for the public and private sectors. This study focuses on the participation of private-sector companies in the development, financing, construction, operation, and ownership of infrastructure projects. It provides a thorough discussion of the essential issues and concepts involved in the promotion of projects via concession arrangements or privatization.
A mathematical formulation for determining the value of debt and equity as well as the optimal financial structure for privately-promoted projects is presented. The main decision facing the prospective one-project company is how much to borrow, how much to infuse from the promoters' own funds and how much to raise from outside investors. Typically, such projects must repay any debt obligations through their own net operating income, as they do not provide the lenders with any other collateral (off-balance-sheet financing). Thus, the possibility of a costly bankruptcy becomes much more likely. It is shown that under these circumstances, the maximum amount of debt that a project can service (its debt capacity) is less than 100% debt financing. Furthermore, the amount of debt that maximizes the promoters' return on equity is always less than the project's debt capacity. Exceeding these debt amounts and moving towards debt capacity should be avoided as it can rapidly erode the project's value to the investors. Finally, it is demonstrated that both debt levels as well as the promoters' return increase through the provision of either production or minimum-revenue guarantees.