Simulating the effect of risks on equity return for concession‐based public‐private partnership projects

Abstract

Purpose Unlike other project delivery options, a much larger proportion of risks is borne by the private partner in public‐private partnerships, since a large amount of equity is needed to finance the scheme. As a result, it is of paramount importance for the franchisee to analyse the possible project outcomes with due reference to potential risks affecting cash inflow and outflow. The purpose of this paper is to address the shortcomings of deterministic estimations by developing a proposal for a simulation model that aims to unveil the probability distributions of the equity amount and return on equity. Design/methodology/approach In this paper, a simulation model is developed to establish the probability distributions of these two indicators under the influence of risks. A simple case study is also presented to illustrate the concept and application of this model. Findings The simulation model can generate the probability distributions related to the net present value of the equity component as well as the rate of return on equity. Practical implications The method proposed in this paper should help the private investors analyse the amount of equity to be injected to the project and its corresponding return rate. Originality/value By referring to the probability distribution, an equity investor can establish whether they can recover their investment and gain a desired return rate. Based upon the risk attitude of the investor, decision‐makers can then decide whether the scheme should be pursued or not.