is the estimated market value of the
remaining concession, which can be
calculated through cash flow analysis,
so it is defined as compensation based
on market value (MV). Compensation
based on retendering is not discussed in
this study because this approach cannot
be quantitatively analyzed, and the specific procedures and rules of retendering are available in HM Treasury (2007).
Compensation Based on Book Value
This approach calculates the compensation based on the book value of the
project’s assets. No matter how much
the project will lose or gain in the future,
the compensation equals the unreim-bursed cost (plus reasonable profits or
default deductions on some occasions)
at the termination date t0. The formula
is shown as Equation ( 12).
ZBV(X) 5 ( 1 r)I
t5t0
t1
dt t
[(PtQt OCt FCt DCt)( 1 T)
DCt S] Equation ( 12)
where ZBV(X) is the compensation to
be paid by the government through
the BV approach. Capital investment,
price, demand, and other variables are
all stated in the financial statements
of the project, except that the reasonable rate of return is determined by
negotiation between two partners. If
the government terminates the concession unilaterally, and the contractor
has no default, r is supposed to be the
expected rate of return to protect the
investor’s interest. However, if the early
termination is caused by the contractor’s default, such as overestimation of
demand, r should be much lower. The
determination methodology of r can be
pre-agreed in the contract.
From the perspective of the contrac-
tor, this approach is more appropriately
used in projects without market value
but with the utility charge set out in
the contract. Similar projects include
prisons, hospitals, schools, sewerage
treatment plants, and so forth. In such
cases, the only way for contractors to
be recouped in early termination is
from government compensation, which
means that contractors have no alterna-
tives, such as selling the project assets
in the open market. Additionally, this
approach is also satisfactory in the
compensation of uncompleted projects.
Without a clear picture of the total construction cost, project assets are very
difficult to be sold out at real values.
The potential new contractors prefer
to offer a much lower price for uncompleted projects to cover construction
risk. Another reason is that without the
historical data on project performance
(e.g., traffic demand), it is impossible
to make a precise prediction for future
revenues.
The main feature of the BV approach
is that there are no uncertainties in calculating compensation because all the
data are stated in the financial statements. The negotiations focus on the
default responsibility and the associated deduction from the rate of return.
Therefore, this approach is procedurally fast, and the project assets can be
transferred to the government or the
new contractor rapidly. However, governments take all of the long-term project risks in this approach because the
compensation is not related to future
performance. It is not value for money
for governments to take over projects
with poor performance.
Compensation Based on Market Value
In the MV approach, the government
can compensate the contractor for the
estimated market value of the remaining concession, in terms of the NPV of
future cash flows. The compensation is
shown as Equation ( 13).
ZMV(X) 5
L
t5t1
dt t [(PtQt OCt FCt
DCt)( 1 T) (DCt S] Equation ( 13)
where ZMV(X) is the compensation to
be paid by the government through the
MV approach. Unlike the BV approach,
there are great uncertainties with the
estimated value of the remaining con-
cession. Qt is one of the biggest sources
of uncertainties, while overestimation
of demand has caused many PPP infra-
structure projects to fail, especially for
transportation infrastructure projects
(Vassallo et al., 2011). In addition, OCt
also fluctuates due to inflation and
other risks. Actually, the compensation
made by the MV approach is more rep-
resentative of the real value of a proj-
ect. When the remaining concession is
sold on the open market, the tenders
are buying a real option for collecting
revenues in the remaining concession,
instead of the project assets. Therefore,
the book value of the contractor cannot
reflect the real value of the project in
this situation.
The MV approach is properly used
in the compensation of PPP infrastructure projects that have substantial tariff revenues, such as traffic projects,
water supply plants, and power plants.
Once the construction is completed,
the project can generate revenue, which
can be used to repay the lenders and
reimburse equity holders. In early
terminations, the project has huge market value because of the revenue in the
remaining concession. Thus, there is
an alternative choice for the contractor offering sale on the open market,
instead of sale to the government. If
the government wants to buy out the
concession, it has to offer a competitive
price for the deal because the contractor has the ability to bargain with the
government (Wilbur Smith Associates
Limited, 2011).
In this approach, contractors take all
long-term risks because the future cash
flows for compensation are estimated
based on project performance before
early termination. Thus, if contractors
do not perform well in construction
or operation, or make severe errors in
demand forecasting, the compensation
from the government should be low.
On the other hand, if the contractor
behaves very well and the market is also
good before the termination, the government has to pay a great amount of
compensation to the contractor in early
termination.
