Debt Capacity and Optimal Capital Structure for Privately Financed Infrastructure Projects

Abstract

Governments can use concession agreements to induce private sector development and operation of infrastructure projects. In concession agreements, several private sector companies form a separate company that becomes responsible for financing, building, and operating the facility. Before joining forces, though, the prospective players must determine how to fund the associated construction and startup costs. Such projects generally repay any debt obligations through their own net operating income, and do not provide the lenders with any other collateral. Thus, the likelihood of a costly bankruptcy becomes a real issue. This paper, explains that, under these circumstances, the amount of debt that a project can accommodate is less than 100 percent 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 is discouraged because it can quickly erode the project's value to the investors. An example is presented.