Real Option Approach For Evaluating BOT Highway Projects With Government Minimum Revenue Guarantee Options

As a new cooperation method between government and private, BOT, which is short for built, operate and transfer, has been used widely recently has caused enormous attention around the world. This cooperation method could not only help the government that in the financial crisis to raise the infrastructure, but also a sweet way to operate in term of the private partner, because in this way they could get smooth and solid cash inflow investing opportunity. Since tale of the last century, the BOT operation modern has been used around China covering a lot of industry, including tolls road, sewage treatment plant and waste to energy industry. However, with the development and application of this operation modern, a lot of failure cases according to lack of experience and considerate risk evaluation. The governments were rush to apply this new operation modern to construct infrastructure, which lead the project failure. Due to lack of effective risk measurement and guide, the decision of improper risk valuation and unreasonable concession period of concession price was made. All of this made some projects with BOT operation modern trapped in the financial crisis, which made the projects couldn’t operation any more. These facts made the private investors are hesitated to join the BOT modern. Therefore, for BOT modern’s better development, it is important to find a proper and effective method on how to evaluate the project valuation and risk situation.The deterministic NPV approach was the main evaluation method to prospect the project’s value in the former BOT research. This method’s evaluation approach is that through the NPV method to get project’s IRR, if the IRR is higher than the industry standard that admired by the professional, the project is considered to worth investing. However, this method in fact couldn’t get the project’s value correctly for projects operated by BOT modern. It is because that the uncertainty of project had not been taken into consideration with deterministic NPV approach. As we all know, these uncertainty of project also has much value for the project and should not be ignored. To attract private sector, add the project’s value, government often provide a series of guarantees for the private, such as minimum revenue guarantee, restrictive competition. Minimum revenue guarantee is the most widely used guarantee method and researchers made lots of study on it. It is easily understood that the project with government minimum revenue guarantee could get a value increase but the deterministic NPV approach couldn’t catch this part of project’s value, which must lead the project’s value underestimated. In the context of that, the real option approach was used in the evaluation of BOT projects because real option approach could estimate the uncertainty of project, which make the project’s value evaluation more reasonable.This paper studies the minimum revenue in highway projects with real option method. With the monte carlo simulation method to prospect the traffic and NPV of the project. This study also provides a way to calculate the proper minimum revenue guarantee and how to execute the guarantee.