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The Valuation of Public Projects: Risks, Cost of Financing and Cost of Capital Current

Author

Listed:
  • Marcel Boyer

    (Université de Montréal and CIRANO)

  • Éric Gravel

    (Statlog Consulting)

  • Sandy Mokbel

    (CIRANO)

Abstract
It is often said that the private sector is in a good position to manage project costs and meet deadlines, but not, generally, to fund or finance projects. The underlying argument runs as follows: because the interest rate on government borrowings (the government’s financing cost) is lower than what is available to the private sector, the cost of goods or services will necessarily be lower if it is funded by government. However, there is confusion between the cost of financing and the cost of capital (or discount rate) that stems from an analytical error in assessing the true cost of public funds. This is a subtle but important error that is widespread in both the public and private sectors as well as in academia. This analytical illusion is due to the fact that a significant portion of the government’s cost of capital is unaccounted for or not recognized. This portion is the implicit option granted by taxpayers to their government to require additional funds in order to meet the commitments made to the lenders when a project does not meet the expected level of profitability. Discounting at an essentially risk-free rate is often justified by “the virtually unlimited taxing power of the Crown” – the project appears risk-free to lenders, but is obviously not risk-free for taxpaying citizens. The authors identify the implications for the evaluation of public investments and relevant public policies such as direct subsidies to businesses, government endorsements of corporate borrowings, the comparison of public sector versus private sector delivery of public projects and holding a portfolio of risky investments dedicated to the future repayment of the debt. It goes without saying that other evaluations of government policies and interventions could be similarly challenged.

Suggested Citation

  • Marcel Boyer & Éric Gravel & Sandy Mokbel, 2013. "The Valuation of Public Projects: Risks, Cost of Financing and Cost of Capital Current," C.D. Howe Institute Commentary, C.D. Howe Institute, issue 388, September.
    • Handle: RePEc:cdh:commen:388
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    References listed on IDEAS

    as
    1. Philipp Krüger & Augustin Landier & David Thesmar, 2015. "The WACC Fallacy: The Real Effects of Using a Unique Discount Rate," Journal of Finance, American Finance Association, vol. 70(3), pages 1253-1285, June.
    2. Luc Baumstark & Pierre Ferry & Christian Gollier, 2011. "Le calcul du risque dans les investissements publics," Post-Print halshs-00958501, HAL.
    3. Philipp Krüger & Augustin Landier & David Thesmar, 2015. "The WACC Fallacy: The Real Effects of Using a Unique Discount Rate," Journal of Finance, American Finance Association, vol. 70(3), pages 1253-1285, 06.
    4. Klein, Michael, 1997. "The Risk Premium for Evaluating Public Projects," Oxford Review of Economic Policy, Oxford University Press and Oxford Review of Economic Policy Limited, vol. 13(4), pages 29-42, Winter.
    Full references (including those not matched with items on IDEAS)

    Citations

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    Cited by:

    1. Benjamin Dachis & William B.P. Robson & Nicholas Chesterley, 2014. "Capital Needed: Canada Needs More Robust Business Investment," e-briefs 179, C.D. Howe Institute.
    2. Benjamin Dachis, 2017. "New and Improved: How to Bring Institutional Investment into Public Infrastructure," C.D. Howe Institute Commentary, C.D. Howe Institute, issue 473, March.
    3. Steven Robins, 2017. "Surge Capacity: Selling City-owned Electricity Distributors to Meet Broader Municipal Infrastructure Needs," e-briefs 257, C.D. Howe Institute.
    4. Lauriane Gorce (ed.), 2017. "Parameters influencing the choice of durability of a public infrastructure - a literature review," Rapports, Polytechnique Montreal, Groupe de recherche en Gestion et mondialisation de la technologie, number 2017-02, January-J.
    5. Moore, Mark A. & Boardman, Anthony E. & Vining, Aidan R., 2017. "Analyzing risk in PPP provision of utility services: A social welfare perspective," Utilities Policy, Elsevier, vol. 48(C), pages 210-218.

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    More about this item

    Keywords

    Governance and Public Institutions; Infrastructure; Pension;
    All these keywords.

    JEL classification:

    • H43 - Public Economics - - Publicly Provided Goods - - - Project Evaluation; Social Discount Rate
    • H54 - Public Economics - - National Government Expenditures and Related Policies - - - Infrastructures
    • H81 - Public Economics - - Miscellaneous Issues - - - Governmental Loans; Loan Guarantees; Credits; Grants; Bailouts

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