Evaluation of Highway Projects under Government Support Mechanisms Based on an Option-Pricing Framework

Abstract

Different features included in public-private partnership (PPP) highway projects such as limited liability of the leveraged firm and government support mechanisms [e.g., price adjustment clauses (PACs)] result in asymmetric project value payoff functions that cannot be properly assessed by traditional methods such as discounted cash flow (DCF) analysis. To overcome this issue, an option-pricing framework is developed that enables financial assessment of different types of road projects in the presence of different government support mechanisms. However, this paper focuses on evaluation of highway projects under the presence of PACs. By providing a framework for calculating the value of government support mechanisms and long-term material and energy contracts, this model can help road agencies and contractors with choosing effective hedging strategies.