Least Present Value of Revenues

Least Present Value of Revenues

 

The Least Present Value of Revenue Mechanism (LPVR Mechanism) was first introduced in 1998 by Engel, Fischer and Galetovic as a new auction mechanism. However, eventually it turned out that the Least Present Value of Revenue is a very good approach to mitigating the traffic risk, which originates from uncertain future traffic demand.

Until that time public-private partnership infrastructure projects were usually granted through fixed-term auctions. In accordance with the fixed-term approach the public partner defines the concession terms and private partners bid on tolls or, alternatively, the public partner sets the toll rate and the concession is granted to the private partner that bids the shortest franchise term. Both versions have severe drawbacks when traffic demand does not meet the estimated traffic. The usual consequence is a renegotiation of the concession contracts between the public and private partners, which in the end affects taxpayers as losses are shifted to them.

In the case of the LPVR Mechanism, the concession is auctioned to the private partner that offers the least present value of revenues from tolls. That approach has several advantages:

 

  • The revenues of the private partner are collected only from the tolls, although this model can also be combined with the minimum revenue guarantee granted by the public partner.

 

  • Furthermore, when there are a lot of bidders, the public partner does not need to know what the construction costs of the specific infrastructure projects are as these costs are revealed through the minimum income required by the private partner to earn a normal profit.

 

  • The Least Present Value of Revenue is a flexible mechanism. If the actual traffic is lower than the estimated one, which means that the actual income is also lower, then the concession period can be automatically prolonged until the least present value of revenue is reached. The same approach can be used when tolls are changed, for instance because the traffic policy of the public partner has been changed or because the traffic growth rates are higher or lower than the anticipated ones.

 

  • In consequence, there is no need for the future renegotiations of the concession contract as this mechanism is flexible regarding the duration of the concession and construction costs are already known before signing the concession agreement, too.

 

  • If the public partner has an option to buy back the concession sometime in the future, then the compensation for the private partner can be easily defined through the non-reimbursed residual value of the Least Present Value of Revenue.

 

Figure 1: The economic balance and flexibility of the duration of the concession

 ECONOMIC BALANCE OF THE CONCESSION

Economic balance of the concession

Flexibility of duration of the concession

Source: Based on J. M. Vassallo, Traffic risk mitigation in highway concession projects, 2005.

As can be seen from Figure 1, the equilibrium is reached and the concession ends when the discounted revenues are equal to the discounted costs. It is anticipated that this balance will be reached at T0 ; however, depending on the actual traffic income it can also be reached before T0 or after T0.

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