The role of the discount rate in tendering highway concessions under the LPVR approach

Flexible-term highway concessions are becoming quite popular around the world as a means of mitigating the traffic risk ultimately allocated to the concessionaire. The most sophisticated mechanism within flexible-term concession approaches is the least present value of the revenues (LPVR). This mechanism consists of awarding the concession to the bidder who offers the least present value of the revenues discounted at a discount rate fixed by the government in the contract. Consequently, the concession will come to an end when the present value of the revenues initially requested has been eventually reached. The aim of this paper is to evaluate the effect that the discount rate established by the government in the bidding terms has on the traffic-risk profile ultimately allocated to the concessionaire. To analyze this effect, a mathematical model is developed in order to obtain the results. I found that the lower the discount rate the larger will be the traffic risk allocated to the concessionaire. Moreover, I found that, if a maximum term is established in the contract, the lower the discount rate, the less skewed towards the downside will be the traffic-risk profile allocated to the concessionaire.

Research highlights
► The discount rate to be used in the LPVR should never be higher than the WACC estimated by the concessionaire.
► The lower the value of the discount rate, the higher will be the traffic risk allocated to the concessionaire.
► The establishment of a maximum concession term causes an accentuated asymmetry between the upside and the downside when the concession is awarded on the basis of the LPVR approach.