Shareholder Option Valuation in Mezzanine Financing Applied to CO2 Reduction in Sustainable Infrastructure Projects: Application to a Tunnel Road in Medellin, Colombia

Abstract

This research uses real options analysis (ROA) to examine a lender’s conversion option in a mezzanine debt for a sustainable infrastructure project. We examine a transport infrastructure case in Medellin, Colombia, called “Tunel del Oriente” (Eastern tunnel), which meets sustainable criteria to allow the access to credit through a sustainable bond. This study proposes a model to evaluate the right to exercise the conversion option by employing ROA with a binomial approach under the concept of a call option. The underlying assets are based on revenues from the forecast of estimated demand and the alternative sales of carbon credits as the sustainable factor. The results indicated that the financial captured value (FCV), with one as the conversion ratio, could be up to 39.10% of the investment when the lender decides to become a shareholder. Furthermore, the FCV can increase by 6% more if the project sells TonCO2e saved by the sustainable factor, highlighting that the tax benefits are approximately 11% of the FCV if the project is sustainable. Additionally, the option value is 39.09% of the debt amount. Finally, this study demonstrates that project finance using mezzanine debt proves to be an effective and attractive method for any lender wanting to boost profit while supporting stakeholders and the environment with sustainable projects and responsible investment.