| description abstract | Concession agreements can be used by governments to induce the private sector to develop and operate many types of infrastructure projects. Under this type of arrangement, several private-sector companies join forces, become project promoters, and form a separate company that becomes responsible for financing, building, and operating the facility. Before this company can be formed, prospective promoters must determine how to fund the associated construction and startup costs. They must decide how much to borrow, how much to infuse from their own funds, and how much to raise from outside investors. Typically, such projects must repay any debt obligations through their own net operating income, and do not provide the lenders with any other collateral (off-balance-sheet financing). Thus, the possibility of a costly bankruptcy becomes much more likely. In this paper, we show that under these circumstances the amount of debt that a project can accommodate (its debt capacity) is less than 100% debt financing. The amount of debt that maximizes the investors' return on equity is less than the project's debt capacity, and the amount of debt that maximizes the project's net present value is even smaller. Exceeding these debt amounts and moving towards debt capacity should be avoided because it can rapidly erode the project's value to the investors. An example illustrates these concepts. | |
