A Model to Assess Government Guarantees in BOT Toll Road Projects using Optimized Real Options Approach

Build-Operate-Transfer (BOT) project delivery system has long been recognized as an important tool for realizing toll road projects. However, improper risk allocation structure between public and private parties causes difficulties in obtaining finance and thus leads to unsuccessful bids during the tender process. Future traffic demand is perceived as the main risk factor in BOT toll road investments, which directly affects the financial viability of projects. Thus, public parties usually provide some incentives in the form of minimum traffic or revenue guarantees to overcome uncertainties in the traffic forecasts. Nevertheless, the challenges associated with the valuation of these guarantees may constitute a heavy burden on the public budget. In this paper, a real options based optimization model is presented to identify the upper and lower boundaries of the minimum revenue guarantees (MRG). Moreover, revenue transfer mechanism, in the form of maximum revenue cap (MRC), is adopted to the model to prohibit excess profits of the private party. The results show that the optimum upper and lower boundaries of compound MRG and MRC options identified by using the proposed model not only ensure the financial attractiveness of the projects for private parties but also bring governments contingent liabilities under control. This model can be used by both parties to establish a fair bargaining environment and a proper risk allocation mechanism