Buenos Aires - Colonia Bridge Project, Financial and Economic Appraisal. Chun-Yan Kuo International Tax Program, Harvard University

Transcription

1 Buenos Aires - Colonia Bridge Project, Financial and Economic Appraisal Chun-Yan Kuo International Tax Program, Harvard University Glenn P. Jenkins HIID Harvard University Development Discussion Paper Number: Abstract The Buenos Aires Colonia Bridge Project is designed to provide a permanent and nonmanaged river crossing under all weather conditions between Punta Lara, located approximately 40 km away from Buenos Aires, the Argentine capital, and Colonia, a city in Uruguay. It is planned to involve a private concessionaire for design, construction, operation and maintenance, and the governments of Argentina and Uruguay in supportive roles. The main objectives of this paper are to assess the project from the viewpoint of the concessionaire by the financial appraisal and the governments of Argentina and Uruguay through the economic and stakeholder appraisals. To evaluate the financial viability from the private point of view, we integrate the engineering cost estimates, the traffic forecasting and financing information into a cash flow statement over the life of the project. Therefore, the financial appraisal draws the estimates of construction and operating costs and sources of supply. The economic appraisal evaluates the project from the viewpoint of the Argentine and Uruguayan economy, respectively. It starts with the financial appraisal of costs and revenues and develops a series of adjustments for the most important externalities to reflect the economic costs and benefits to each of the two countries. After applying scenario techniques to assess this investment project, we undertake sensitivity and risk analyses of the financial and economic performance of the bridge project. The important project variables and outcomes of sensitivity and risk analyses are identified and analyzed. Prepared for: Comisión Binaciónal Puente Buenos Aires Colonia JEL code(s): H43 Key words: Argentina, Uruguay, financial viability, traffic forecasting, economic appraisal, financial appraisal.

2 Buenos Aires - Colonia Bridge Project Financial and Economic Appraisal prepared for Comisión Binaciónal Puente Buenos Aires Colonia as a subcontract to Louis Berger International, Inc. May 19, 1998 By Glenn P. Jenkins and George Kuo International Institute for Advance Studies, Inc. 48 Brattle Street Tel (617) Cambridge, MA Fax (617)

3 Table of Contents Page Chapter 1: OVERVIEW 1-1 Chapter 2: ANALYTICAL FRAMEWORK 2-1 Chapter 3: THE MACROECONOMIC ENVIRONMENT 3-1 Introduction 3-1 Framework 3-3 Empirical Results 3-3 Chapter 4: DEMAND SCENARIOS FOR CONSIDERATION 4-1 Introduction 4-1 Scenarios for consideration 4-4 Outcome of these Scenarios 4-5 Chapter 5: FINANCIAL APPRAISAL 5-1 Introduction 5-1 Methodology 5-2 Key Assumptions and Project Parameters 5-3 Empirical Results 5-6 Conclusions 5-18 Chapter 6: ECONOMIC APPRAISAL 6-1 Introduction 6-1 Methodology 6-2 Economic Costs of Capital and Foreign Exchange 6-7 Economic Costs of Labor and Other Business Inputs 6-7 Results of Economic Analysis 6-10 Distributive Analysis 6-16

4 Table of Contents Chapter 7: SENSITIVITY AND RISK ANALYSES 7-1 Introduction 7-1 Methodology 7-2 Empirical Results 7-2 Chapter 8: CONCLUSION 8-1 IIAS, INC. ii

5 Chapter 1 Overview The Buenos Aires Colonia Bridge Project is designed to provide a permanent and non-managed river crossing under all weather conditions between Punta Lara, located approximately 40 km away from Buenos Aires, the Argentine capital, and Colonia, a city in Uruguay. It is planned to involve a private concessionaire for design, construction, operation and maintenance, and the governments of Argentina and Uruguay in supportive roles. The 41-kilometer BAC Bridge project would cost approximately US$31 million in February 1997 prices. The main objectives of this report are to assess the project from the viewpoint of the concessionaire by the financial appraisal and the governments of Argentina and Uruguay through the economic and stakeholder appraisals. To evaluate the financial viability from the private point of view, we integrate the engineering cost estimates, the traffic forecasting and financing information into a cash flow statement over the life of the project. Therefore, the financial appraisal draws the estimates of construction and operating costs and sources of supply provided by Louis Berger International Inc. (LBII), the quantities of passenger and cargo traffic forecast by Cambridge Systematics, Inc. (CSI) and Science Applications International Corporation (SAIC), as well as information on the financial aspects of potential concessionaires provided by Bear, Stearns & Co. Inc. (BS). It is important to note that the International Institute for Advanced Studies, Inc. (IIAS) is not responsible for verifying the models or the information supplied by these studies, hence, if subsequent changes are made to the information generated from these models and studies, the results of the analysis presented here also will be altered. The economic appraisal evaluates the project from the viewpoint of the Argentine and Uruguayan economy, respectively. It starts with the financial appraisal of

6 Overview costs and revenues and develops a series of adjustments for the most important externalities to reflect the economic costs and benefits to each of the two countries. After applying scenario techniques to assess this investment project, we undertake sensitivity and risk analyses of the financial and economic performance of the bridge project. The important project variables and outcomes of sensitivity and risk analyses are identified and analyzed. The main conclusions are summarized as follows: FINANCIAL ANALYSIS The project appears to be very promising financially, If the bridge can be built and financed at the cost estimates used in the study, it is highly probable that the real rate of return on equity will be in excess of 16 percent (nominal return of 19 percent). In fact there is a 75 percent probability that the real rate of return on equity will by greater than 21 percent. Even with financing that requires the debt to be repaid over 15 years, the debt service ratio in the first 5 years are on average greater than 1.9. Other less onerous financing structures yields financial results that are even more favorable. The analysis of the timing of the completion of the bridge indicates that there is nothing to gain financially by its postponement. In fact, there is an economic cost to the postponement of the opening date of the bridge beyond ECONOMIC ANALYSIS Given the restrictive assumptions that Argentina and Uruguay will not provide any guaranties or accept contingent liabilities, the project makes a substantial contribution to the economies of both countries. The present value of the net economic benefits (in 1998 prices) amounts to approximately $607 million for Argentina and $213 million for Uruguay. In other words, after paying the foreign concessionaire for the investment in the bridge the countries could obtain benefits in excess of the present value of the costs of the bridge. IIAS, INC. 1-2

7 Overview The main beneficiaries of the bridge are the foreign concessionaire, and the passengers in the autos and buses who use the bridge. Under the present fiscal arrangements between the two countries, the bridge imposes a fiscal cost on Argentina of approximately $128 million in present value terms, and a fiscal cost on Uruguay of approximately $1 million. The producers in Brazil would also benefit from the project by an amount of approximately $74 million because of the reduction in shipping costs to Argentina. SENSITIVITY AND RISK ANALYSIS The results of the financial and economic analysis are sensitive to a number of variables such as income growth and the level of the toll. In addition, the alternative ferry competitive strategies have a significant impact on the demand for the services of the Bridge but the effect is not important enough to create losses, even in the most pessimistic case. As one should anticipate, the financial outcome is sensitive to both cost and time over runs. The financial analysis indicates that a cost over run of more than 30 percent would have very serious consequences for the financial outcome, with the set of tolls used in this analysis. An extension of the time of construction by one year reduces the financial net present value by more than 25%. Hence, a doubling of the construction period from 4 to 8 years, but with the same real investment costs, would cause the bridge to have a negative financial net present value. The two truly independent risk variables are the growth rate of GDP and the reaction of the ferry operators. Using a Monte-Carlo risk analysis for these two risk variables, we find that there is little or no probability that either the financial or the economic outcomes of the project would be negative. IIAS, INC. 1-3

8 Chapter 2 Analytical Framework Bridge projects typically have been evaluated as pure public sector infrastructure investments. The desirability of a bridge investment is then determined solely based on its net economic benefits. However, the BAC Bridge is quite different from traditional bridge projects because of two main reasons. First, this project is proposed to be built on a build-operate-transfer (BOT) basis. Hence, the likely financial performance of the investment is critical to its viability. Second, this project is a binational investment. The distribution of the benefits and costs amongst all international and domestic parties is critical to the design of the financial arrangements between the governments and the private operators of the bridge. The analysis is organized around the three major stakeholders in this project: Argentinean residents, Uruguayan residents, and the private Bridge Concessionaire. It is assumed that the bridge is built and operated by foreign investors. If there are local private or public participation in the projects, the relevant benefits and costs must be separately evaluated. The same applies to the different users of the bridge, (e.g. passengers and cargo importers) for each of the countries. This approach to the organization of the analysis of the project is illustrated in Figure 2.1. A multinational BOT project exploited by a foreign concessionaire brings with it important methodological considerations in order to assess its impacts. Under this framework, residents of Argentina and Uruguay will buy bridge services from foreign entrepreneurs, who sell bridge services to them.

9 Analytical Framework Figure 2.1: THE ANALYSIS OF BAC BRIDGE PROJECT FROM ALTERNATIVE POINT OF VIEWS THREE POINTS OF VIEW Economic Financial Economic URUGUAY BRIDGE CONCESSIONAIRE ARGENTINA Figure 2.2 provides a comprehensive picture of the transactions involved between participants in the bridge project. Organizing the analysis in this way is consistent with the desire of the policy makers to undertake this project to as great a degree as possible as a private undertaking without the prior assumption of government subsidies or guarantees. In Figure 2.2, we illustrate the financial and economic relationships between the three principal stakeholders of the BAC Bridge and the rest of the world. The financial analysis of the project is carried out from the point of view of the Concessionaire. This analysis is carried out from both the total investment point of view and from the owner s point of view. To evaluate the project from the point of view of Argentina and Uruguay, we carry out an economic analysis from each of these parties points of view. This analysis considers the benefits and costs that Argentina and Uruguay receive from the services of the bridge and the payments they make to purchase these services. In addition, the Bridge Concessionaire will buy goods and services from the country and will make payments in exchange for these goods and services. The Concessionaire will also buy goods and services, make payments, and sell the bridge services to Brazil and the rest of the world. All these flows enter to the financial analysis of the project from the point of view of the Concessionaire. The net economic benefits accruing to the rest of the world are not included in the economic analysis from the points of view of Argentina or Uruguay. IIAS, INC. 2-2

10 Analytical Framework Given the financial and political risks of such an international infrastructure investment, a clear identification and quantification of the benefits and costs and their distribution, will assist the Bridge Commission in structuring the financial arrangements to maximize the probability of the sustainability of the BAC project agreement. To evaluate the viability of the BAC Bridge, we conducted an integrated approach of financial and economic analysis. An integrated approach allows us to identify groups in Argentina and Uruguay who will benefit from the bridge, and those who will bear the costs. This approach permits a stakeholder analysis of the project s net benefits that accrue to each nation. Details can be found in Appendix J the Financial and Economic Benefits. IIAS, INC. 2-3

11 Analytical Framework Figure 2.2: DETAILED ANALYSIS OF THE PROJECT FROM ALTERNATIVE VIEWPOINTS URUGUAY THREE POINTS OF VIEW BRIDGE CONCESSIONAIRE ARGENTINA Toll Toll Additional Travel Services Transportation Services Payments for Goods & Services Transportation Services Payments for Goods & Services Additional Travel Services Sales of Goods & Services Toll Transportation Services Project Financing Debt Service & Dividends Sales of Goods & Services Payments for Goods & Serv. Sales of Goods & Services Brazil Rest of the World IIAS, INC. 2-4

12 Chapter 3 The Macroeconomic Environment Introduction The key determinants of the financial and economic feasibility of the BAC Bridge are the volumes of traffic (freight and passengers) and the costs of construction. Among the important variables determining the level of traffic demanding the services of the bridge are the current levels of income, the trade flows associated with these countries, and the future growth path of these variables. Of course, due to the time value of money, the current levels of income and trade flows and their growth in the near future will have a much bigger impact on the demand for the bridge services and the feasibility of this investment than the prospective income growth rates 15 to 30 years after the bridge is built. Making a long-term macroeconomic forecast of a country with precision is not easy, and may be unrealistic, because many unknown factors influence the performance of the economy in question. This is especially true when the countries involved are in a transition from being highly protected economies to economies that are opening up to international competition, a process that has been underway for several years. In this situation when the governments are launching major economic policy initiatives, many factors can change the prospect for economic growth rather suddenly. The traditional approach to the financial and economic analysis has been to prepare three or more scenarios representing low, base, and high estimates of income growth and to make the demand forecast on these scenarios. These forecasts are rather inadequate when considering financing decisions, as the probabilities associated with these scenarios are largely unknown.

13 The Macroeconomic Environment In the present study of the financial and economic analysis undertaken to evaluate the BAC Bridge, a project model has been built with sufficient flexibility to enable the decision-makers to consider options across a range of possibilities. This approach gives a much greater value to the analysis carried out, as it is able to incorporate the specific values of the variables that the financial organizations or the project sponsors believe to be relevant for their own decision making. Given the extreme volatility of economic policies in these countries over the past 50 years, it is difficult to derive a consensus (that has a significant probability of occurring) as to what the future economic policies are going to be in the region, and the likely economic outcomes from these policies. Hence, our model is designed to address the forecasts and beliefs of the decision-makers that count in determining the future of this investment. Furthermore, for the bridge project, the forecasts of the real gross domestic product (GDP) for Argentina, Uruguay and Brazil may not be as important as the forecast of trade flows among the three countries. The growth in trade flows in the short run will be highly dependent on both trade and real exchange rate policies. In the longer run, it will depend on the level of integration that reflects an equilibrium situation for these countries. For example, will Argentina move from having a relatively small amount of trade to becoming a country such as France, Italy and Spain? 1 The scenarios presented here would project that Argentina would not be as open to international trade as any of these countries, even by the year For any financial or economic analysis there is a need to develop a series of scenarios or base cases in order to understand the nature of the financial and economic outcomes of the project, and to communicate these interrelationships. To do this there is a need to develop forecasts of GDP that will serve as the basis for the forecasts of the demand for the services of the bridge. In the analysis that follows, the likely range of growth rates in these three countries have been based on the fundamental determinants of economic growth in the countries, tempered by the short-term policy constraints they are now facing. 1 In Argentina, the ratio of imports to GDP was 8.6% and GDP per capita was US$7,950 in Assuming that annual GDP growth rate is 5%, population growth rate is 1%, and annual imports growth rate is 8% for the next 30 years, the potential imports/gdp ratio would become 20.0% and GDP per capita would be US$25,785. This appears to be the situation in 1995 for France (21.2% and US$26,892), Italy (22.2% and US$19,507) and Spain (23.5% and US$14,658). IIAS, INC. 3-2

14 The Macroeconomic Environment Framework Our analytical framework is based on the hypothesis that an increase in GDP can be measured by the sum of the increase in factor incomes -- real wage and capital income -- and a residual item which can be categorized as the reduction in real costs or an increase in factor productivity. To make a forecast of the economic growth rate of a country for future years, one has to obtain the values for each of the above three components. These values must reflect not only the past experiences of the country in question but also its economic expectations in the future. As one can expect, the reduction in real costs may be influenced by many factors other than factor productivity. For example, major economic reforms and political instability are not really captured in the first two components. If there is a counter-productive economic policy or political instability is experienced in the country, it is bound to have an adverse effect on the economic growth of the country. Empirical Results In Appendix A, the detailed analytical framework is developed and an empirical estimation is made for the construction of the bands of low, most likely and high growth rates for Argentina, Uruguay and Brazil. 2 It is our conclusion that for all the three countries the range of growth rates that fit these bands is 3, 4 and 5 percent, respectively. The GDP growth forecasts as well as the growth rates for the past seven years are summarized in Table See also Arnold C. Harberger, Prospects for the Argentinean Economy, (1997). IIAS, INC. 3-3

15 The Macroeconomic Environment Table 3-1: ANNUAL GROWTH RATES OF REAL GDP: ACTUAL AND FORECASTED YEAR ARGENTINA URUGUAY BRAZIL High Base Low High Base Low High Base Low Actual Forecast Sources: Appendix A. IIAS, INC. 3-4

16 Chapter 4 Demand Scenarios for Consideration Introduction The primary factors of the financial and economic viability of the BAC Bridge are the costs of construction and the volumes of freight and passenger traffic. The former has been estimated by LBII, and the latter are the subject of this Chapter. A demand model for freight traffic has been developed by Science Applications International Corporation (SAIC). The concept and analysis was outlined in the report, Freight Mode Split Analysis for the Buenos Aires Colonia Bridge Feasibility Study. 1 This basic model was then used to generate the volumes of freight traffic over the life of the project for a variety of scenarios. Likewise, Cambridge Systematics inc. (CSI) developed a demand model for passenger traffic. The theoretical concept, survey and testing of the model reliability were all outlined in the document, Passenger Demand Forecasts for the Buenos Aires Colonia Bridge. 2 This basic model was then used to forecast the volumes of passenger cars and passenger buses using the bridge over the life of the project for the numerous scenarios being considered here. The robustness of the above forecasts is vital to the determination of the feasibility of the BAC Bridge project. 1 2 SAIC Transportation Consulting Division, Freight Mode Split Analysis for the Buenos Aires Colonia Bridge Feasibility Study, paper prepared for Louis Berger International, (October 1997). Cambridge Systematics, Inc., Passenger Demand Forecasts for the Buenos Aires Colonia Bridge, paper prepared for Comision Binacional Puente Buenos Aires Colonia and Louis Berger International, Inc. (January 1998).

17 Demand Scenarios for Consideration Factors Affecting Bridge Traffic The important variables determining the volumes of freight and passenger traffic may not exactly be the same. There are, however, some common factors which are crucial to the demand forecasts for both traffic and can be used to form our basic scenario and alternative scenarios for consideration in the financial and economic appraisal of the BAC Bridge project. The first variable is the macroeconomic environment in which Argentina, Uruguay, and Brazil are likely to face in future years. Specifically, to what extent will the levels of GDP/income grow in these three countries over the life of the project? This is because income growth is an important determinant of passenger demand growth and the value of timesaving, and the growth in trade flows is the essential element in the demand for freight traffic. The trade flows are, in turn, primarily influenced by the GDP growth rate. As was indicated in the Chapter 3, the annual GDP growth rates range from 3% to 5% for all the three countries, Argentina, Uruguay and Brazil. Second, the improved ferry services in response to the BAC Bridge facility may have a significant impact on the passenger demand for the bridge traffic. Comisión Binacional Puente Buenos Aires Colonia and LBII have conducted a study, Competitive Ferry Scenarios, 3 and subsequently identified three possible ferry reactions to the BAC Bridge. 4 These three scenarios are considered from the viewpoint of the Bridge operator: The base case: ferry operators improve services, operate only fast services between Buenos Aires and Montevideo and between Buenos Aires and Colonia, and price fares at their respective long run marginal costs (LRMC) of US$34 and $24 per passenger in 1997 prices. The pessimistic scenario: all ferry services survive but fares are set below LRMC, i.e., US$27 per passenger in 1997 prices between Buenos Aires and Montevideo, US$31 per passenger between Buenos Aires and Colonia for fast ferry, and US$17 per passenger between Buenos Aires and Colonia for slow ferry. 3 Comisión Binacional Puente Buenos Aires Colonia and LBII, Competitive Ferry Scenarios, (February 1997). 4 Seth Grady, LBII, Competitive Mode Scenarios, memorandum, (February 5, 1998). IIAS, INC. 4-2

18 Demand Scenarios for Consideration The optimistic scenario: the Colonia service is eliminated and fares are set above LRMC, i.e., US$42 per passenger in 1997 prices between Buenos Aires and Montevideo. The key variables assumed for all parameters for all scenarios are outlined in Appendices B and C. In the case of competitive air travel, Bi-National Commission and LBII also carried out the impact analysis. Although the impact was considered less significant than ferries, their reactions are incorporated in the study. The detailed assumptions and parameters associated with three alternative cases are shown in Appendix B. The fares charged on different routes under different ferry options are summarized below along with the frequency of ferry service during the high season (HS) and the low season (LS). Routes Pessimi stic Base Optimis tic Fares (US$) Freq. (HS/LS) Fares (US$) Freq. (HS/LS) fares (US$) Freq. (HS/LS) Ferries: Buenos Aires Montevideo / / /7 Buenos Aires Colonia (Fast) / / Buenos Aires Colonia (Slow) / Air Lines: Buenos Aires Montevideo / / /6 Buenos Aires Punta del Este / / /1 Third, the bridge tolls will be an important expense of crossing the river, hence, the levels of bridge tolls will have a significant impact on traffic demand, especially for passenger traffic. For the purpose of this study, we consider that: IIAS, INC. 4-3

19 Demand Scenarios for Consideration The toll for trucks is set at $225 because at this toll level the number of trucks across the Bridge would be maximized. 5 The base toll rate for autos is determined in such a way that the private concessionaires would earn more than a 16% real rate of return on equity as well as having substantial debt coverage ratios over the life of the project under the pessimistic ferry and the low GDP growth rate scenario. However, the financial return from the project also depends upon how the Bridge is financed. Using these criteria, the break-even toll for autos is determined to be US$60 for an initial debt/equity ratio of 65/35 with 15-year amortization financing. This result is explored in detail in the financial appraisal chapter of this report. The toll for bus is six times the toll for autos. Scenarios for Consideration Given the above considerations, we form the base and alternative scenarios for the financial and economic evaluations. BASE SCENARIO Annual GDP growth rates are 4% for Argentina, Uruguay and Brazil; The bridge tolls are US$60 for passenger car, US$360 for passenger bus and US$225 for truck. These tolls, initially set in dollar terms are then converted to local currencies and inflated at the domestic sales of inflation (Argentina and Uruguay) to maintain their real values. The ferry operators adopt the base case. This means that they will improve the ferry services by cutting their tolls and operate only two routes: one between Buenos Aires and Montevideo and the other between Buenos Aires and Colonia. The ferry fares will be set at the long run marginal cost of US$34 per passenger for the first route and US$24 per passenger for the second route. 5 See the sub-section of this Chapter, Outcomes of these Scenarios and SAIC, Freight Mode Split Analysis for the Buenos Aires Colonia Bridge Feasibility Study, paper prepared for LBII, (October 1997), p. 55. IIAS, INC. 4-4

20 Demand Scenarios for Consideration ALTERNATIVE SCENARIOS The other scenarios under consideration of this appraisal will be variations of the above three components. The variations include: The annual GDP growth rates range the low rate of 3% to the high rate of 5%; The initial bridge tolls range from a package of US$40 for passenger car, US$240 for passenger bus and US$225 for truck to a package of US$80 for passenger car, US$480 for passenger bus and US$225 for truck, and thereafter converted to domestic currencies and maintained in terms of their real values; and There are pessimistic and optimistic ferry scenarios from the viewpoint of the Bridge operators. For the pessimistic case, there would be three routes and their fares are US$27 between Buenos Aires and Montevideo, US$19 for fast ferry between Buenos Aires and Colonia, and US$17 for slow ferry between Buenos Aires and Colonia. For the optimistic case, there will only be one ferry route between Buenos Aires and Montevideo and the fare is US$42. Details are outlined in Appendices B and C. With this coverage, the analysis should provide the potential concessionaires and the governments a wide range of information on which to make their decisions concerning this project. Outcomes of these Scenarios Among other factors, the demand for traffic depends very much upon the three key parameters outlined in the previous section. They are ferry responses to the bridge operation (3 pessimistic-base-optimistic cases), income growth in the economy (3 low-base-high cases), and the levels of bridge tolls charged including zero and the maximum toll for economic analysis (5 cases). There are 45 potential computer runs for each of the 30 operating years. Because of the complexity of the models developed by CSI and SAIC, it takes a great deal of computational time to generate the volume of traffic for one specific scenario and for just a single operating year. Since the life of the BAC Bridge project is 30 years, we estimate the traffic demand for three representative years (2005, 2015, IIAS, INC. 4-5

21 Demand Scenarios for Consideration and 2030) over the life of the project and then use these values to obtain by interpolation the values between these three years. This technique will give us enough information each year over the life of the project to forecast the financial revenues in Chapter 5 for all scenarios. PASSENGER TRAFFIC The total annual passenger traffic is further separated for diverted and induced demand for the economic appraisal in Chapter 6. The steps used to estimate this traffic for each O/D pair are described as follows: Estimate the demand for the quantity of traffic by each existing transportation mode under no Bridge scenario; Estimate the demand for the quantity of traffic by various transportation modes under the Bridge scenario; Compare the above estimated traffic for each transportation mode between with and without the Bridge scenario. The sum of the decreased number of traffic from the existing transportation modes would constitute the diverted traffic. The generated traffic is the difference between the total number of traffic (i.e., autos and bus) across the Bridge and the diverted traffic. We then sum up the results across all O/D pairs to obtain the diverted and generated traffic for Argentina and Uruguay. The economic benefits accrued to the passengers depend upon the country of residency of the demanders for transportation services. We therefore present the origin of the passengers. 6 For illustrative purposes, Table 4-1 presents the volumes of passenger traffic for three representative years for the Basic Ferry Response and the most likely GDP growth rate scenario. Taking the year 2005 as an example, this is also shown in Figure 4-1. The elasticities of demand for car traffic with respect to toll from US$40 to US$80 range from to for Argentina and from to Our estimates of annual total traffic are the same as those generated from the latest CSI models. The numbers, however, differ from the figures presented in the CSI s January 1998 report. There are two factors: first, the underlying assumptions about ferry reactions in their January report are up-dated here to be consistent with their latest findings; second, the ratio of bus toll to auto toll is assumed 6 to 1 in this report and was 8 to 1 in the CSI report. Moreover, the diverted traffic in the CSI report is defined differently from this report. Therefore, our estimates of the split between diverted and generated traffic differ from their estimates. The analysis in this report measures diverted traffic as the difference in the use of the ferry without and with the bridge. The remainder of the traffic on the bridge is therefore the generated and induced. For the economic analysis undertaken in this study, our definition of diverted traffic is conceptually correct, and thus used for the measurement of the economic benefits arising from diverted and generated traffic. IIAS, INC. 4-6

22 Demand Scenarios for Consideration for Uruguay. In the case of bus, it is less elastic, ranging from to for both Argentina and Uruguay. Table 4-1: ESTIMATES OF THE DEMAND FOR PASSENGER CARS AND BUSES (Number of Vehicles) Origin Passenger Car Passenger Bus Year Diverted Generated Total Diverted Generated Tolls: Nil Total ARGENTINA , ,788 1,234,830 12,369 43,751 56, ,061, ,757 1,999,913 16,641 51,897 68, ,773,550 1,988,131 3,761,681 27,094 64,726 91,820 URUGUAY ,536 48, ,986 3,902 12,780 16, ,999 82, ,603 5,948 16,105 22, , , ,190 10,576 21,725 32,301 Tolls: US$40 for Car and $240 for Bus ARGENTINA , , ,920 12,340 38,942 51, , ,767 1,627,824 16,602 37,305 53, ,539,653 1,514,942 3,054,595 27,040 56,991 84,031 URUGUAY ,265 24, ,878 3,899 11,403 15, ,618 66, ,871 5,941 11,808 17, , , ,408 10,571 19,905 30,475 Tolls: US$60 for Car and $360 for Bus ARGENTINA , , ,516 12,327 36,508 48, , ,606 1,452,518 16,585 34,399 50, ,422,747 1,312,676 2,735,423 27,016 53,000 80,015 URUGUAY ,202 15, ,103 3,897 10,700 14, ,908 54, ,073 5,939 11,022 16, ,948 94, ,515 10,568 18,914 29,482 IIAS, INC. 4-7

23 Demand Scenarios for Consideration Table 4-1: ESTIMATES OF THE DEMAND FOR PASSENGER CARS AND BUSES (cont d) (Number of Vehicles) Origin Passenger Car Passenger Bus Year Diverted Generated Total Diverted Generated Tolls: US$80 for Car and $480 for Bus Total ARGENTINA , , ,661 12,315 34,045 46, , ,780 1,287,949 16,569 35,883 52, ,305,882 1,144,740 2,450,622 26,993 48,885 75,878 URUGUAY ,711 10, ,106 3,895 9,984 13, ,678 38, ,841 5,938 11,600 17, ,069 82, ,120 10,564 17,843 28,407 Tolls: US$100 for Car and $600 for Bus ARGENTINA , , ,806 12,304 31,582 43, , ,954 1,123,380 16,553 37,366 53, ,189, ,804 2,165,822 26,971 44,770 71,741 URUGUAY ,221 4, ,109 3,893 9,267 13, ,448 22, ,610 5,936 12,178 18, ,189 69, ,726 10,561 16,772 27,333 IIAS, INC. 4-8

24 Demand Scenarios for Consideration Figure 4-1: THE DEMAND FOR BRIDGE CROSSINGS BY AUTOS IN YEAR Toll (US$) From: Argentina Uruguay , , , , , , , , ,000 1,000,000 1,100,000 1,200,000 1,300,000 Traffic IIAS, INC. 4-9

25 Demand Scenarios for Consideration CARGO TRAFFIC In a similar fashion to the CSI demand model, the volumes of cargo traffic for five representative years are forecasted based on the SAIC model and then interpolated for other years. The separation of the diverted and induced, generated and inter-port traffic is also important for the measurement of economic benefits. As it is explained in the economic analysis, the exporting country will receive all the benefits of freight traffic cost savings if the shipped goods are internationally traded. If the goods are regionally traded, the benefits will be shared between the exporting and importing countries. We therefore will show the origin of the shipments including Brazil because of shipments between Brazil and Argentina cross the bridge. For illustrative purposes, the demand for freight traffic for the most likely GDP growth rate scenario is presented in Table 4-2. This can also be seen in Figure 4-2 for year It is important to note that the demand for bridge crossings is sharply kinked at the $225 toll for Argentina and Brazil traffic and relatively elastic above this toll. This is, however, not the case for Uruguay where the demand for bridge crossing remains completely inelastic. This is because Uruguay does not have competitive alternative modes for shipping goods to Argentina at this range of tolls. Since $225 is the toll level, which would maximize the demand for bridge crossings by cargo, it will be used for truck toll in the financial and economic appraisals. IIAS, INC. 4-10

26 Demand Scenarios for Consideration Table 4-2: ESTIMATES OF THE DEMAND FOR CARGO TRAFFIC (Number of Vehicles) Bridge Toll Year Diverted Induced Generated Daily Traffic Crossing the Bridge Interport Total Total+ Empties Annual Traffic ORIGIN: ARGENTINA NIL , , , , , , ,452 2, , , ,379 4,614 1,684, , , , , , , ,380 2, , , ,272 4,459 1,627, , , , , , , , ,663 3,962 1,446,297 IIAS, INC. 4-11

27 Demand Scenarios for Consideration Table 4-2: ESTIMATES OF THE DEMAND FOR CARGO TRAFFIC (cont d) (Number of Vehicles) Bridge Toll Year Diverted Induced Generated Daily Traffic Crossing the Bridge Interport Total Total+ Empties Annual Traffic ORIGIN: ARGENTINA , , , , , , , , , , , , ,798 ORIGIN: URUGUAY NIL , , , , , , , , , , , ,596 IIAS, INC. 4-12

28 Demand Scenarios for Consideration Table 4-2: ESTIMATES OF THE DEMAND FOR CARGO TRAFFIC (cont d) (Number of Vehicles) Bridge Toll Year Diverted Induced Generated Daily Traffic Crossing the Bridge Interport Total Total+ Empties Annual Traffic ORIGIN: URUGUAY , , , , , , , , , , , , , , , , , ,151 ORIGIN: BRAZIL NIL , , , , ,183 1, , , ,995 2, , , ,418 3,931 1,434,791 IIAS, INC. 4-13

29 Demand Scenarios for Consideration Table 4-2: ESTIMATES OF THE DEMAND FOR CARGO TRAFFIC (cont d) (Number of Vehicles) Bridge Toll Year Diverted Induced Generated Daily Traffic Crossing the Bridge Interport Total Total+ Empties Annual Traffic ORIGIN: BRAZIL , , , , ,146 1, , , ,932 2, , , ,307 3,803 1,388, , , , , ,018 1, , , ,701 1, , , ,918 3,356 1,224, , , , , , , , , , , , ,647 IIAS, INC. 4-14

30 Demand Scenarios for Consideration Figure 4-2: THE DEMAND FOR BRIDGE CROSSINGS BY CARGO IN Toll (US$) ,000 50,000 75, , , , , , , ,000 From: Argentina Brazil Uruguay Traffic IIAS, INC. 4-15

31 Chapter 5 The Financial Appraisal Introduction The financial appraisal deals with the commercial viability of the project from the concessionaire s point of view. The project may be so commercially attractive that it requires no government financial incentive. Alternatively, it may require public support in terms of capital assistance, minimum traffic or revenue guarantee, or loan guarantee in order to induce a private concessionaire to undertake the project. The goal of financial appraisal is twofold. First, the appraisal seeks to determine if the project will be financially sustainable. This is particularly relevant when we consider that the project links two countries with a history of economic instability. Second, the proforma cash flow statements constructed in the financial appraisal serve as the basis for the project s economic appraisal. The central tool of the financial appraisal is the cash flow statement, which predicts annual cash inflows and outflows over the life of the project from the perspective of the concessionaire. The analysis is, therefore, to bring together the construction cost estimates, operating costs, financial revenues and project financing into a financial cash flow to determine whether the initial capital investment is justified from the private perspective. The analysis will be conducted considering both the total investment and the equity holder s viewpoint. As was pointed out in Chapter 4, three alternative ferry reactions are analyzed because of their influence on the demand for bridge crossings by passengers. Alternative bridge tolls and growth rates are also studied for their commercial feasibility. However, only one truck toll at $225 is used in the financial and economic analysis.

32 The Financial Appraisal Methodology The approach of the financial appraisal is to construct cash flow statements for the project covering the options and scenarios outlined above. The analysis is conducted for equity holder viewpoint. It would provide the private concessionaires and the governments of Argentina and Uruguay the essential information in order to make their decisions. The cash flow model estimates the financial cash flow profile of the Bridge investment project which identifies all the receipts and expenditures that are expected to occur during the lifetime of the project. These receipts and expenditures are expressed as annual cash receipts and annual disbursements. All cash flows are initially estimated in nominal prices and then converted to real prices for the viewpoint of total investment. Unlike total investment, the equity holder s point of view includes in the cash flow profile of the project the debt inflows as part of the sources of funds and the loan repayments and interest payments as cash outflows. The financial appraisal also identifies any additional funds that the project may require due to the cash flow deficits during its lifetime. This issue is relevant considering the experiences of volatile economic conditions in the region, which justify some concern in the evaluation of the net cash flows, especially in the first years of the project. In this analysis, the minimum condition for the concessionaire to be willing to undertake this project is that the net present value (NPV) of the project s predicted stream of annual net cash flows should be positive when discounted at the required rate of return on equity. Other criteria such as a minimum debt service coverage ratio must also be fulfilled. The cash flow analysis essentially translates bridge toll revenues, revenues from complementary activities, capital and operating cash disbursements into cash flows over the life of the project. The revenues are tied to the passenger and cargo demand forecasts by the CSI and SAIC models. The capital and operating costs are estimated in the 1997 prices by LBII. The cash flow statements are first developed in nominal terms in order to take into account the effects of inflation and to ensure that variables such as taxes, debt service payments, and exchange rates are expressed in prices consistent with those used to measure revenues and operating costs. In order to carry out the analysis, the cash flow statements are presented in the same currency units. For convenience, the results are expressed in U.S dollars. However, in order to calculate the corporate income tax liabilities to Argentina and Uruguay, income taxes are computed in IIAS, INC. 5-2

33 The Financial Appraisal Argentine and Uruguayan pesos and then converted back to the US currency in the cash flow statements. These nominal dollar cash flows are then deflated to constant dollars in order to remove the effects of inflation. These pro-forma cash flow statements are then used in conjunction with alternative financing plans in order to construct financial cash flows from the concessionaire s point of view. The detailed methodology and procedures are outlined in Appendix D. Key Assumptions and Project Parameters PROJECT COSTS The construction of the BAC Bridge is assumed to begin in The total cost of the project is estimated at approximately US$831 million in February 1997 prices. The construction is assumed to last 4 years in the base case. The project life, for financial and economic analysis purposes, is considered 30 years after the bridge opens to traffic in The annual operating and maintenance costs are about 1.8% of the total construction cost. The main components are labor costs (68.9%), materials (13.7%), equipment (4.4%) and other expenses (13.0%). Although the design life is more than 30 years, salvage values have been ignored because many major repairs are needed after 30 years of services. At this point in time, assigning any net salvage value may be arbitrary and, furthermore, the present value of the salvage value being realized 34 years from now will be a very small number. Nevertheless, treating the salvage values in this way will slightly bias the financial and economic appraisal results downward. Since the Bridge project could have a negative impact on environment, there will be a requirement for the protection of the natural habitat. The costs to mitigate the adverse environmental impacts are estimated to be US$1,345 thousand in the initial year and US$774.5 thousand in future years of the construction phase. Likewise, they will cost approximately US$633.5 thousand per annum during the operation phase. The private concessionaire will be responsible for these expenses. The above project costs and cost estimates for mitigation of the adverse environment effects are provided by LBII. 1 1 Louis Berger International, Inc., Basic Studies for the Rio de la Plata Crossing Buenos Aires, ARGENTINA/Colonia, Uruguay Environmental Report, (November 18, 1997). IIAS, INC. 5-3

34 The Financial Appraisal PROJECT FINANCING The project financing is unknown at this point in time. However, based on the report by Bear, Sterns & Co. Inc. 2 and our extensive consultation with John Schopfer of that firm, we consider the following assumptions, criteria and alternative financing: The initial debt/equity ratio is 65/35. The long-term debt is denominated in US dollars and the interest rate on this debt is set at 7% real (10.21% nominal, assuming a 3% rate of inflation in the country lending the currency). The concessionaire starts to pay interest and/or principal after the first year of the bridge operation. In case there is a negative annual cash flow, additional short loans will be borrowed at the same interest rate as paid on the long term loans to make up the short fall. There are three possible options for loan repayment: 15 years of amortization, 30 years of amortization, and loans where for the first 5 years of operation only interest payments are made, followed by the amortization of the debt over the next 20 years. A realistic target for the equity holder in this project is a 16% real rate of return (net of inflation). In order to get banks interest in financing this project, it would be necessary to have debt coverage ratios in the first 5 years greater than 1.8 and nothing less than 1.6. It may be worth noting that as the loans are repaid over a period of either 15 or 30 years, the debt/equity ratio will vary from year to year. 3 PROJECT REVENUES The main revenue for the project is obtained by multiplying the passenger and freight traffic by their corresponding bridge tolls charged. For example, the toll levels in the basic scenario are assumed to be US$60 per passenger car, US$360 per passenger bus, and US$225 per truck, expressed in February 1997 dollars. The tolls will be adjusted per 2 Bear, Sterns & Co. Inc., Report to the BiNational Bridge Commission Concerning Comparable Projects and Discussions with Lenders/Arrangers, (May 15, 1997), p. 22; and Bear, Sterns & Co. Inc., Report to the BiNational Bridge Commission Concerning Comparable Projects and Discussions with Lenders/Arrangers, (May 15, 1997), p Given the required return on equity funds and the cost of borrowed funds, the implicit required rate of return on the total capital can be calculated over the life of the project. This is calculated as the NPV of the cash flow streams for the total investment point of view equals the NPV for the equity holder s viewpoint plus the NPV from the debtor s point of view. The NPV from the viewpoint of debt holder is equal to zero over the financing period. IIAS, INC. 5-4

35 The Financial Appraisal annum for domestic inflation in the respective countries. The sensitivity analysis will be carried out for alternative levels of tolls. The concessionaire is also expected to receive complementary revenues from activities such as gas stations, duty free shops, restaurants and telecommunications. Estimates of these ancillary businesses are provided by LBII. The NPV of these complementary net revenues over the life of the project, when discounted at 16% real, is approximately US$46.9 million in 1998 prices. INFLATION Inflation fluctuated significantly in the past several years in Argentina. The GDP deflator was 13.68% in 1992, 6.87% in 1993, 0.76% in 1994, 4.02% in 1995, and 2.03% in A 3% inflation rate for the future was assumed for Argentina in the base case analysis of this study. Uruguay has been historically a high inflation country. Inflation as measured by its GDP deflator was 59.25% in 1992, 51.98% in 1993, 41.64% in 1994, 39.56% in 1995 and 28.29% in It appears that inflation rate has been coming down in the recent years and will be further reduced in years to come. One should keep in mind that a parallel movement should exist over the long term between the ratio of the market exchange rate to the real exchange rate and the ratio of the domestic price level to the price level of the foreign exchange country over time. 4 For the purpose of this study, a 10% inflation rate was assumed for Uruguay in the base case analysis. A sensitivity analysis will be carried out for alternative rates of inflation. The movement of real exchange rate over the life of the project will be important because of the project s use of tradable goods and its repayment of loans in foreign currencies. The movement of the real exchange rate will influence not only the volumes of passenger and freight traffic but also the number of tourists in resort areas, especially in Uruguay. For this purpose, we assume that the real exchange in Argentina is one peso per US dollar in Argentina, 10 pesos per US dollar in Uruguay and 1.08 reais per US dollar in Brazil and will in the base case remain unchanged over the life of the project. This implies that the foreign (US) inflation would also be expected for the base case to remain at 3% per annum. 4 See, e.g., A.C. Harberger, Applications of Real Exchange Rate Analysis, Contemporary Policy Issues, (1989). IIAS, INC. 5-5

36 The Financial Appraisal INCOME AND OTHER TAXES The treaty on the development of the bridge through a binational commission between Argentina and Uruguay states that the concessionaire does not have to pay import duties and value added taxes on machinery, equipment and materials used in the project. However, profits from the bridge operation are subject to corporate income taxes in both countries. The tax rate is 33% in Argentina and 30% in Uruguay. WORKING CAPITAL Working capital in the BAC Bridge project includes accounts payable and transaction cash balances. There are no account receivables as bridge tolls are assumed to be paid immediately in cash. Accounts payable is set equal to one month s purchases excluding labor costs. Cash balances held as working capital are assumed equal to one week s worth of toll revenues. Empirical Results Before presenting the empirical results, one needs to establish a bridge toll for passenger cars. We will therefore address this subject first. BASE TOLL FOR AUTO Given the basic assumptions and criteria outlined in the previous section, we establish the toll levels for auto which enable a private concessionaire to earn at least a 16% real rate of return on equity with a sufficient high debt coverage ratio under the pessimistic ferry and the low growth rate scenario. Setting the base toll in such a conservative scenario should provide a basis for decision-making related to investment in this project. The results suggest that a US$60 toll for passenger car would meet the financial criteria set above. At this toll level, the cash flow profiles of three likely alternative financing structures are presented in Table 5-1. As expected, there are negative net cash flows during the four years of the construction period. After the Bridge opens, the net cash flows for the total investment become positive by more than one hundred thirty-seven million U.S. dollars in the first year and increase considerably thereafter over the life of the project. The main reason for this phenomenon is the steady increase of bridge traffic for both passenger and cargo vehicles. In the case of 15 years terms of amortization, the IIAS, INC. 5-6

37 The Financial Appraisal debt coverage ratios in the first two years (ranging from 1.5 to 1.6) may be considered low side because of the relative short period of amortization. The situation, however, substantially improves for the other two financing packages. The real rates of return to the equity holder are, nevertheless, all higher than 16% per annum for three alternatives financing, ranging from 18.4% to 20.3%. Clearly, project financing has an important implication for the private concessionaires. Our analysis so far has been based on a very conservative assumption that the project would face both the pessimistic ferry and the low economic growth scenario. We can therefore conclude that a US$60 toll for passenger car represents a possible starting point that is likely to meet the requirements by the private investor as well as bankers to finance the project. In order to facilitate the economic analysis in the next chapter, the total traffic by types of vehicles has to be broken down into diverted and generated traffic. Table 5-1B presents the breakdown of the gross traffic revenues between diverted and generated traffic based on the toll levels of US$60 for passenger car, US$360 for passenger bus and US$225 for truck. The gross traffic revenues equal the total toll revenues of the corresponding year shown in the financial cash flow profiles of Appendix E. From Table 5-1B, we see that the proportion of total gross revenues in the low growth pessimistic ferry scenario coming from diverted traffic is approximately 70 percent of total revenues in the year By the year 2015, the proportion is still 69 percent, falling to 67 percent of total revenues by the year The results show that the financial performance of the Bridge is based largely on existing or projected traffic that being diverted when the Bridge is built, not on the generated traffic that the lower cost bridge operation is expected to create. IIAS, INC. 5-7

38 The Financial Appraisal Table 5-1A: NET FINANCIAL CASH FLOW FOR THE PESSIMISTIC FERRY AND LOW GROWTH SCENARIO Financial NCF from Total Investment Viewpoint Ratio on NCF to Interest plus Loan Repayment Year 15 Years Amortization 30 Years Amortization 5 Years Interest Payment Only Plus 20 Years Amortization 15 Years Amortization 30 Years Amortization 5 Years Interest Payment Only Plus 20 Years Amortization (thousands of US Nominal Dollars) (percentage) 1999 (145,338) (145,338) (145,338) (271,464) (271,464) (271,464) (355,857) (355,857) (355,857) (191,757) (191,757) (191,757) , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , Equity Holder Perspective: Real Rate of 18.41% 20.29% 20.33% Return NPV at 16% Real $58.5m $98.0m $97.3m IIAS, INC. 5-8

39 The Financial Appraisal Table 5-1B: GROSS TRAFFIC REVENUES BY TYPES OF VEHICLES AND TYPES OF TRAFFIC FOR THE PESSIMISTIC FERRY AND LOW GROWTH SCENARIO (thousands of US Nominal Dollars) Year Passenger Cars Passenger Buses Trucks Total Diverted Generated Total Diverted Generated Total Diverted Generated Total Diverted Generated Total Div./Total ,456 22,660 51,116 6,081 11,647 17,728 72,500 12,641 85, ,037 46, , % ,740 25,053 55,793 6,443 12,119 18,562 78,036 13,684 91, ,219 50, , % ,134 27,570 60,704 6,821 12,608 19,429 83,838 14,778 98, ,793 54, , % ,645 30,215 65,860 7,216 13,115 20,331 90,771 16, , ,632 59, , % ,277 32,994 71,271 7,629 13,642 21,271 98,045 17, , ,951 64, , % ,034 35,912 76,946 8,060 14,188 22, ,673 19, , ,767 69, , % ,923 38,976 82,899 8,510 14,755 23, ,671 20, , ,104 74, , % ,948 42,192 89,139 8,980 15,343 24, ,053 22, , ,981 80, , % ,114 45,565 95,679 9,470 15,953 25, ,623 24, , ,207 86, , % ,429 49, ,531 9,981 16,586 26, ,658 27, , ,068 92, , % ,897 52, ,709 10,515 17,242 27, ,177 29, , ,589 99, , % ,525 56, ,224 11,072 17,923 28, ,199 32, , , , , % ,320 60, ,092 11,653 18,629 30, ,746 34, , , , , % ,331 65, ,958 12,318 19,328 31, ,838 37, , , , , % ,525 70, ,243 13,012 20,052 33, ,499 40, , , , , % ,909 76, ,965 13,737 20,802 34, ,752 43, , , , , % ,490 81, ,141 14,494 21,579 36, ,619 46, , , , , % ,277 87, ,790 15,284 22,384 37, ,128 49, , , , , % ,279 93, ,931 16,108 23,217 39, ,243 54, , , , , % , , ,584 16,968 24,081 41, ,107 58, , , , , % , , ,770 17,865 24,975 42, ,752 63, , , , , % , , ,510 18,800 25,902 44, ,209 68, , , , , % , , ,826 19,776 26,861 46, ,510 73, , , , , % , , ,743 20,793 27,855 48, ,691 79, , , , , % , , ,282 21,853 28,885 50, ,786 84, , , , , % IIAS, INC. 5-9

40 The Financial Appraisal BASE SCENARIO We first present the results of the base scenario as specified in Chapter 4. That is, 4% of annual GDP growth rates for Argentina, Uruguay and Brazil; the bridge tolls set at US$60 for passenger car, US$360 for passenger bus and US$225 for truck; and the base case ferry response being undertaken by the ferry operators. The tolls will be indexed for domestic inflation in the respective countries. To examine closely the financial sustainability of this scenario, the cash flow profiles of the three possible financing structures are shown in Table 5-2A. As expected, the financial returns are very favorable. The real rate of return net of taxes to the equity holder is 22.9% for 15 years terms of amortization and 24.8% for either 30 years terms of amortization or first 5 years of operation with only interest payment followed by 20 years of amortization of debt. 5 This is about 4.5% higher than the previous results for the case under the pessimistic ferry and the low growth scenario. In terms of financial NPV, it is estimated at about US$132 million in 1998 prices. As regards debt coverage ratio, one can observe the financial cash flow profiles from the viewpoint of the total investment after the bridge opens (see the first three columns of Table 5-2). The net cash flows are approximately one hundred fifty-seven million U.S. dollars in the first year and increase over the life of the project. The main reason for this phenomenon is the steady increase of bridge crossings by both passenger and cargo vehicles. It begins at the first year by more than thousand passenger cars, 31.3 thousand passenger buses, and thousand trucks from each end of the bridge. The results show that the net financial cash flows available to pay interest and loan are equal to about 1.7 times the amount of these expenditures in the first year of operation (2003) and increased thereafter for the 15 years amortization of debt. In the case of other two financing options, the expected net cash flow is higher than 2.0 times interest and loan repayment, a very favorable situation. The gross traffic revenues are broken down into diverted and generated traffic for different types of vehicles. They are presented in Table 5-2B for the base scenario using the toll levels of US$60 for passenger car, US$360 for passenger bus and US$225 for truck. In the base case, we find that ratio of revenues from diverted traffic to total 5 The corresponding real rates of return net of taxes to the total investment are 16.3% and 16.5%. IIAS, INC. 5-10

41 The Financial Appraisal revenues is 72 percent in year 2003 and remains at that level throughout the life of the project. Details of the financial cash flow statement for this base scenario can be found in Appendix E. The detailed balance sheet for the base scenario is also developed and shown in Appendix F. Table 5-2A: NET FINANCIAL CASH FLOW FOR THE BASE SCENARIO Financial NCF from Total Investment Viewpoint Ratio on NCF to Interest plus Loan Repayment Year 15 Years Amortization 30 Years Amortization 5 Years Interest Payment Only Plus 20 Years Amortization 15 Years Amortization 30 Years Amortization 5 Years Interest Payment Only Plus 20 Years Amortization (thousands of US Nominal Dollars) (percentage) 1999 (145,338) (145,338) (145,338) (271,464) (271,464) (271,464) (355,857) (355,857) (355,857) (191,757) (191,757) (191,757) , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , Equity Holder Perspective: Real Rate of 22.90% 24.74% 24.84% Return NPV at 16% Real $190.9m $230.4m $229.7m IIAS, INC. 5-11

42 The Financial Appraisal Table 5-2B: GROSS TRAFFIC REVENUES BY TYPES OF VEHICLES AND TYPES OF TRAFFIC FOR THE BASE SCENARIO (thousands of US Nominal Dollars) Year Passenger Cars Passenger Buses Trucks Total Diverted Generated Total Diverted Generated Total Diverted Generated Total Diverted Generated Total Div./Total ,271 17,759 61,030 6,245 19,851 26,096 82,551 13,980 96, ,067 51, , % ,920 20,820 67,740 6,703 20,370 27,073 90,512 15, , ,135 56, , % ,748 24,049 74,797 7,183 20,902 28,085 98,876 16, , ,807 61, , % ,765 27,452 82,217 7,686 21,447 29, ,726 18, , ,177 67, , % ,976 31,038 90,015 8,212 22,007 30, ,138 20, , ,326 73, , % ,391 34,815 98,206 8,763 22,581 31, ,136 22, , ,290 80, , % ,018 38, ,808 9,340 23,169 35, ,745 24, , ,103 86, , % ,865 42, ,838 9,944 23,772 33, ,990 27, , ,799 94, , % ,942 47, ,313 10,575 24,391 34, ,353 30, , , , , % ,258 51, ,253 11,236 25,025 36, ,614 33, , , , , % ,823 56, ,676 11,926 25,676 37, ,812 37, , , , , % ,646 61, ,603 12,648 26,343 38, ,987 40, , , , , % ,740 67, ,054 13,402 27,027 40, ,180 44, , , , , % ,018 74, ,313 14,420 28,920 43, ,435 48, , , , , % ,703 81, ,335 15,486 30,903 46, ,794 52, , , , , % ,810 89, ,155 16,603 32,978 49, ,306 57, , , , , % ,358 97, ,804 17,774 35,150 52, ,017 61, , , , , % , , ,317 18,999 37,423 56, ,979 66, , , , , % , , ,731 20,283 39,801 60, ,288 73, , , , , % , , ,082 21,626 42,287 63, ,435 81, , , , , % , , ,410 23,031 44,887 67, ,499 88, , , , , % , , ,755 24,502 47,605 72, ,559 97, , , ,038 1,039, % , , ,159 26,040 50,445 76, , , , , ,212 1,119, % , , ,664 27,648 53,413 81, , , , , ,456 1,204, % , , ,317 29,329 56,514 85, , , , , ,816 1,292, % IIAS, INC. 5-12

43 The Financial Appraisal ALTERNATIVE SCENARIOS The alternative scenarios for the Bridge project are evaluated in this section. These scenarios can be developed in any combination of the three key parameters: GDP growth rates, toll levels, and ferry strategies. The GDP growth rates range from 3% to 5% per annum for both Argentina and Uruguay. The levels of tolls range from the combination of US$40 for passenger car, US$240 for passenger bus and US$225 for truck to the combination of US$80 for passenger car, US$480 for passenger bus and US$225 for truck. The ferry responses range from pessimistic to optimistic case as specified in Appendix B. They are summarized below. GDP Growth Toll Level Ferry Response Low Low Pessimistic Most Likely Medium Base High High Optimistic We first present the tabulations of the financial NPVs in Table 5-3A with respect to changes in GDP growth rates and the levels of bridge tolls under the base ferry strategy environment. For simplicity, all results refer to the case where the debt is amortized over 15 years. The internal real rates of return net of taxes to equity capital are also displayed in Tables 5-3B. 6 The real rate of return net of tax for the total investment ranges from 13.28% to 19.35%. As expected the higher the economic growth rate, the greater is the financial profitability. It is also important to observe how the toll levels determine the financial viability of the project. The higher the toll level, the more expensive it is to cross the Bridge, hence, there is a negative impact on the demand for bridge crossings. In the range of tolls between US$40 and US$80, the financial NPVs increase with the increase of the tolls, but at decreasing increments as the tolls are increased. 6 The internal rates of return to the total investment made in the Bridge are shown in percentage below: GDP Growth Toll Levels Rates US$40 US$60 US$80 3% % % IIAS, INC. 5-13

44 The Financial Appraisal For all cases, the real rates of return to equity holder are all above 16% real. The BAC project is financially promising. Table 5-3A: THE FINANCIAL NPV FOR THE BASE FERRY OPTION (thousands of 1998 US$) GDP Growth TOLL LEVELS Rates US$40 US$60 US$80 3% 41,680 98, ,691 4% 128, , ,043 5% 256, , ,860 Table 5-3B: THE REAL RATE OF RETURN TO EQUITY FOR THE BASE FERRY OPTION (percentage) GDP Growth Rates TOLL LEVELS US$40 US$60 US$80 3% % % The above analysis was based on the base ferry response scenario. As was mentioned in the previous chapter, two other scenarios were identified, the optimistic and pessimistic cases from the point of view of the Bridge. We calculate the financial NPV from the equity holder s point of view for these two ferry scenarios for different GDP growth rates and different toll levels. The results are presented in Table 5-4 for the pessimistic case and Table 5-5 for the optimistic case. Even with low GDP growth and low level of toll under the pessimistic ferry scenario, the project is financially promising. As expected, the NPV is lower for the pessimistic case and higher for the optimistic case under the corresponding toll levels and growth rates. The difference in NPV between the IIAS, INC. 5-14

45 The Financial Appraisal pessimistic and the base cases ranges from a negative of US$28 to US$63 million (comparison between Tables 5-3A and 5-4) and for the comparison between the optimistic and the base cases the difference is a positive impact of US$42 to US$96 million (comparison between Tables 5-3A and 5-5). Table 5-4: THE FINANCIAL NPV FOR THE PESSIMISTIC FERRY OPTION (thousands of 1998 US$) GDP Growth TOLL LEVELS Rates US$40 US$60 US$80 3% 13,351 58,476 93,026 4% 98, , ,767 5% 221, , ,196 Table 5-5: THE FINANCIAL NPV FOR THE OPTIMISTIC FERRY OPTION (thousands of 1998 US$) GDP Growth TOLL LEVELS Rates US$40 US$60 US$80 3% 84, , ,320 4% 175, , ,877 5% 308, , ,730 Tables 5-6A and 5-6B show the most optimistic ferry scenario under the most favorable macroeconomic environment. The gross toll revenues are significant higher than the base scenario, beginning in the first year of operation by 15%, and then increased to 19% in the second year, 23% in the third year, and so on. As a result, the real rate of return to equity holder is more than 28% and rising to 30%, with debt services coverage ratios are all higher than 1.9. In this case, where the optimistic ferry scenario is combined with a growth of GDP of 5%, we find from Table 5-6B that the toll revenues from the diverted traffic make up IIAS, INC. 5-15

46 The Financial Appraisal approximately 73 percent of total revenues accruing to the Bridge throughout the life of the facility. Table 5-6A: NET FINANCIAL CASH FLOW FOR THE OPTIMISTIC FERRY AND HIGH GROWTH SCENARIO Financial NCF from Total Investment Viewpoint Ratio on NCF to Interest plus Loan Repayment Year 15 Years Amortization 30 Years Amortization 5 Years Interest Payment Only Plus 20 Years Amortization 15 Years Amortization 30 Years Amortization 5 Years Interest Payment Only Plus 20 Years Amortization (thousands of US Nominal Dollars) (percentage) 1999 (145,338) (145,338) (145,338) (271,464) (271,464) (271,464) (355,857) (355,857) (355,857) (191,757) (191,757) (191,757) , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , , ,034,825 1,050,659 1,046, Equity Holder Perspective: Real Rate of 28.20% 29.90% 30.05% Return NPV at 16% Real $402.5m $442.0m $441.3m IIAS, INC. 5-16

47 The Financial Appraisal Table 5-6B: GROSS TRAFFIC REVENUES BY TYPES OF VEHICLES AND TYPES OF TRAFFIC FOR THE OPTIMISTIC FERRY AND HIGH GROWTH SCENARIO (thousands of US Nominal Dollars) Year Passenger Cars Passenger Buses Trucks Total Diverted Generated Total Diverted Generated Total Diverted Generated Total Diverted Generated Total Div./Total ,314 11,636 66,950 6,041 29,181 35,222 93,859 15, , ,214 56, , % ,804 16,581 79,385 6,743 31,196 37, ,959 17, , ,506 64, , % ,694 21,813 92,507 7,481 33,305 40, ,640 18, , ,815 74, , % ,001 27, ,344 8,257 35,513 43, ,738 21, , ,996 84, , % ,743 33, ,928 9,073 37,823 46, ,697 24, , ,513 95, , % ,938 39, ,292 9,931 40,240 50, ,554 26, , , , , % ,605 45, ,468 10,832 42,768 53, ,347 29, , , , , % ,766 52, ,493 11,778 45,412 57, ,118 32, , , , , % ,440 59, ,402 12,771 48,176 60, ,526 37, , , , , % ,650 67, ,232 13,813 51,064 64, ,573 41, , , , , % ,418 75, ,024 14,906 54,083 68, ,331 46, , , , , % ,766 84, ,818 16,053 57,236 73, ,872 51, , , , , % ,721 92, ,656 17,254 60,530 77, ,273 57, , , , , % , , ,518 18,426 64,223 82, ,615 62, , , , , % , , ,569 19,652 68,082 87, ,979 68, , , , , % , , ,861 20,936 72,115 93, ,452 75, , , ,277 1,011, % , , ,444 22,278 76,329 98, ,123 81, , , ,757 1,096, % , , ,372 23,683 80, , ,084 88, , , ,456 1,186, % , , ,702 25,151 85, , ,303 99, , , ,498 1,313, % , , ,492 26,687 90, , , , ,656 1,055, ,108 1,446, % , , ,801 28,292 95, , , , ,055 1,161, ,354 1,587, % , , ,693 29, , , , ,687 1,073,697 1,273, ,300 1,734, % , , ,232 31, , ,551 1,033, ,581 1,184,807 1,390, ,022 1,889, % , , ,485 33, , ,078 1,135, ,184 1,301,617 1,513, ,592 2,052, % , , ,523 35, , ,933 1,242, ,527 1,424,369 1,642, ,086 2,222, % IIAS, INC. 5-17

48 The Financial Appraisal Conclusion We have established a base toll at US$60 for passenger car in a conservative environment under which the private concessionaire will earn more than a 16% real rate of return on the amount of equity involved with a debt service coverage ratios in excess of 1.5. All the scenarios yield a positive net present value at a real (net of inflation) cost of equity funds of 16%. The value of the tax shelter is estimated on the basis of an initial 65/35 debt/equity ratio using a nominal interest rate on the US dollars denominated debt of 10.21%. The BAC Bridge project appears from a financial perspective to have considerable promise. While the financial performance of the bridge is affected by the behavioral response of the ferry operators, it is not critical. Even when GDP is only 3% and the tolls are set at US$40, the real rate of return on the equity is in excess of 16 percent. In order to obtain adequate debt coverage ratios, however, a toll of US$60 must be charged, at least in the initial years of the project. Further sensitivity and scenario analysis can be carried out with the financial model in Chapter 7 to address other issues of potential concern. IIAS, INC. 5-18

49 Chapter 6 The Economic Appraisal Introduction While the financial appraisal is concerned with the commercial feasibility of the project from the concessionaire s viewpoint, the economic appraisal is concerned with the economic costs and benefits to the participating countries. To achieve this objective, the financial costs and revenues have to be converted into economic costs and benefits to the economy of the countries in addition to the net economic benefits specifically generated from changes in the demand for passenger and freight traffic. The BAC Bridge project will have a direct impact on the economy of Argentina and Uruguay and an indirect effect on Brazil. In the present analysis, the economic appraisal is limited to the benefits accruing to the individual economies of Argentina and Uruguay. Nevertheless, the economic benefit accrued to Brazilian, because of savings in transportation costs will also be reported. The objective of this appraisal is to examine the project from the entire economy s point of view to determine whether its implementation will improve the economic welfare of Argentina and Uruguay. At this stage of the analysis, it is assumed that there are no explicit or implicit guarantees of the financial performance of the bridge by the two countries. Hence, if the bridge concessionaire experiences a poor financial outcome for a reason other than a low level of traffic volumes, it will not have a direct effect on the economic benefits received by the countries. In other words, it is assumed that there are no financial market effects on the two countries that are caused by the investment in this project. If in the future contract arrangements are entered with the two countries that imply subsidies or contingent claims on the two

50 The Economic Appraisal countries, then the economic results that are presented in this chapter will need to be altered. It is also important to note that the economic analysis presented here uses the economic values of savings of vehicle operating costs and willingness to pay that is obtained from the demand models prepared by CSI and SAIC. Methodology The measurement of economic benefits and costs is built on the information developed in the financial appraisal from the total investment perspective. However, as was mentioned in the Chapter of the analytical framework, the net economic benefits have to be separated for Argentina and for Uruguay. To begin the economic analysis, each item in the annual financial cash flows is split into two halves, one for each country with the exception of business income taxes. In the financial analysis, the real cash flows are estimated after corporate income taxes have been deducted in order to reflect the real value of cash receipts and disbursements from the perspective of a private sector. To estimate the net economic benefits, corporate income taxes are calculated for each country and are added back to the financial cash flows of the respective country. The countries can benefit from the incremental provision of public goods and services financed by this additional tax revenue. The economic principles developed in the field of welfare economics are extensively utilized in this BAC Bridge project. Under the economic analysis, all prices are measured in economic terms. Conversion factors, used to calculate economic prices as a function of their financial values, are calculated for Argentina and Uruguay, respectively. For example, the economic price of foreign exchange will differ in each country from its market value because of a variety of distortions associated with the markets for traded goods. Likewise, to calculate the net present value of the economic benefits and costs of the bridge, the economic opportunity costs of capital for Argentina and Uruguay are estimated. In the BAC Bridge project, the primary sources of economic benefits are generated by the cargo and passenger traffic. Secondary benefits may also arise due to taxes and other distortions in the markets affected by the construction or IIAS, INC. 6-2

51 The Economic Appraisal operation of the bridge, but these may be small relative to the direct benefits arising from the traffic flows. In what follows, we describe the methodology used to measure the net economic benefits generated by this transportation project as well as the key economic adjustments to reflect the real value to society of the resources used or produced by this project. GROSS ECONOMIC BENEFITS FROM CARGO TRAFFIC The economic benefits from the truck traffic on the bridge are generated by the savings in the total logistic costs (including load/unloading cost, storage cost, and waiting time), plus the savings in transportation costs. The cargo demand model developed by SAIC is set up for receivers of freight to minimize the total delivered cost expressed as an amount per unit of product shipped. The model calculates for a sample of actual shipments and picks the mode and route to minimize the total landed cost. The transportation mode will change when the cost of another mode becomes cheaper. In the model, the most important variables determining the total logistics and transport cost are distance traveled, amount of the toll, fuel cost, wage cost and the waiting time to cross the border (i.e. customs operations). It is the cost minimizing features of the model that determine the quantity of bridge crossings that will be diverted and generated by the introduction of the bridge. The growth in traffic over time is determined by the growth in international trade in the region. The most important independent variables for the financial and economic analysis are the tolls levied on the various types of vehicles crossing the bridge. The work on the demand and total transportation cost savings were carried out by SAIC in their study of the demand for the services of the bridge. 1 The volume of cargo traffic is estimated for a series of toll levels over a relevant range, while keeping all other variables in the model constant. This is necessary to determine the best pricing strategy for the bridge services in order to determine the preferred 1 SAIC, Freight Mode Split Analysis for the Buenos Aires Colonia Bridge Feasibility, paper prepared for LBII, (October 1997). IIAS, INC. 6-3

52 The Economic Appraisal options from the perspective of the financial and economic performance of the bridge. The important question in this regard is whether the exporting or importing country is receiving the economic benefits of cargo traffic across the bridge. When the commodity is internationally traded with third countries by the importing country, the cost savings because of transportation cost reduction will accrue to the producers in the exporting country. This is because the goods will continue to be sold in the importing country at prices based on world prices. A detailed explanation of these relationships is presented in Appendix G. In terms of measurement, the benefits for diverted traffic are equal to the reduction of transportation costs times the volume of the diverted traffic. For induced and generated traffic, the benefits are equal to one half of the transportation cost savings, multiplied by the traffic volumes. However, if goods are not internationally traded but mainly imported from the exporting country in the Mercosur region, the benefits resulting from transportation cost reductions will be shared by producers of the exporting country and consumers of the importing country, depending upon the magnitudes of demand elasticity for imports and supply elasticity of exports. The share of benefits received by importing country (λ) can be measured by: λ = ε s x/[ε s x - η d x] (6-1) where ε s x refers to the elasticity of supply of exports from the exporting country and η d x refers to the elasticity of demand for the same commodity from the perspective of the importing country. Details are explained in Appendix G. It also reveals that the share of benefits received by importing country are likely to range from 37% to 81% of the total. For the purpose of this analysis, we assume the benefits resulting from savings in transportation costs will be shared equally by the importing and exporting countries. From the 1995 trade statistics, we discover that all commodities imported by Brazil from Argentina are internationally traded. However, more than 80% of the coffee and metals are imported by Argentina from Brazil. These two commodities are considered as regionally traded goods for Argentina. Uruguay is situated between two large economies, Argentina and Brazil. Therefore, no single commodity in Uruguay is imported only from Argentina. For the purpose of this IIAS, INC. 6-4

53 The Economic Appraisal study, all imported commodities by Uruguay from Argentina are considered as internationally traded. A summary of trade data is presented in Appendix H. In terms of measurement, the benefits for diverted traffic are measured by the amount of savings in transportation costs times the traffic. For the induced and generated traffic, the benefits are, again, estimated by the multiplication of one half of the transportation cost reduction and the incremental traffic. Furthermore, to determine the net economic effects of the bridge project, the net effect of road toll revenues and maintenance costs of complementary and substitute routes in both Argentina and Uruguay need to be calculated. The proposed bridge will change the pattern of cargo demand causing traffic volumes to increase or decrease in different roads of Argentina and Uruguay. Nevertheless, all of the main roads in Argentina and Uruguay are presently tolled and maintained by private operators. In Uruguay, where the bridge impact would be most significant, the road from Colonia to Punta del Este is already tolled. The roads continuing north to Brazil will also most likely be tolled in the future in order to cover at least maintenance costs. In other words, most of the main accesses in both countries are or will be tolled to cover maintenance costs and therefore, no further economic adjustments are needed. GROSS ECONOMIC BENEFITS FOR PASSENGERS At the present time, passenger traffic between Argentina and Uruguay crossing the La Plata River is primarily served by ferry or airplane. In this context, the bridge will introduce a new mode of traffic in the Buenos Aires-Colonia area. The gross economic benefits of the diverted and induced passenger traffic are measured by the total willingness of the passenger to pay to cross the river using this new mode. In addition to the vehicle operating and time costs saved by using the bridge, there is also a mode preference in terms of such factors as reliability that may cause the bridge to be preferred to the other modes, even if the vehicle operating costs, time costs and tolls or fares are identical. Therefore, given the bridge tolls, the gross economic benefits for diverted, induced and generated traffic on the bridge would be equal to the consumer surplus, plus the value of the tolls (due to the fact the marginal cost of the bridge is for all intents and purposes equal to zero), plus the value of any taxes or distortions associated with the IIAS, INC. 6-5

54 The Economic Appraisal vehicle and time costs incurred to use the bridge. However, the tolls are paid to the foreign concessionaire and are therefore netted out in order to arrive at the net economic benefits. This is illustrated in Appendix I. In addition, economic benefits or costs might arise because of the reduction in activity of the alternative modes due to the quantity of traffic diverted to the bridge. Furthermore, any loss in tax revenues associated with the reduction in vehicle operating costs incurred when using the ferry and airplane or losses in profits due to the reduced level of ferry activity are accounted for. The forecast of the above bridge traffic is based on the assumption that the ferry operators would react to the bridge operation and set fares at their long run marginal costs. Details of parameters associated with each ferry reaction are spelled out in Chapter 4 and Appendix B. 2 If the ferry operators set their fares above the marginal cost, depending upon the number of ferry riders. Under this scenario, there would be favorable bridge traffic and, consequently, would generate a greater economic benefit. OTHER ECONOMIC BENEFITS In addition to the economic benefits accrued to passenger and cargo traffic, one has to identify the project s externalities by subtracting, for each line item, the real financial resource cost from the real economic cost. This is because the analysis considers the benefits that Argentina and Uruguay receive from the sale of goods and services to the foreign bridge concessionaire in exchange for the cost of the resources required to produce those goods and services. This includes the benefits and costs of using foreign exchange, labor, and other business inputs in the project. This will be further explored in the next sub-section. In the economic analysis, the net benefits are performed first in Argentinean and Uruguayan pesos, respectively and then converted to the US dollars in the final empirical results for easy comparison. To calculate the NPV of the economic benefits and costs of the bridge project, the respective economic costs of capital for Argentina and Uruguay are used. These parameters are used to convert the financial values of business inputs and outputs of the bridge project into their corresponding economic values. The estimation of these national parameters is also explained below. 2 See also Seth Grady, LBII, Competition Mode Scenarios, (February 1998). IIAS, INC. 6-6

55 The Economic Appraisal The detailed economic benefits and costs from alternative points of view are also summarized in Appendix J. Economic Costs of Capital and Foreign Exchange The economic cost of capital is estimated to be 11% for Argentina and 10.5% for Uruguay. This cost is determined as a weighted average of the domestic net-oftax saving rates, the gross-of-tax returns on investment, and the marginal costs of foreign borrowing. These national parameters will be used to discount the net economic benefit stream arising from the investment in order to derive the economic net present value. Appendix K provides the assumptions and the computation of the economic cost of capital for Argentina and Uruguay, respectively. The economic cost of foreign exchange is calculated in Appendix L. The economic cost of foreign exchange in 1997 is found to be 11.24% higher than the official exchange rate in Argentina and 12.45% higher for Uruguay. This foreign exchange premium is due partly to the impact of net import tariffs and value added taxes. These premiums will slightly decline over time until 2001 because of Mercosur Treaty and the global trade liberalization. Economic Costs of Labor and Other Business Inputs Investment and operating costs components are made of individual item costs such as labor, tradable machinery/equipment and material, and non-tradable goods. We need to calculate the conversion factors for these individual items so that their financial costs in the annual cash flow statement can be translated to reflect the economic prices of business inputs. ECONOMIC COST OF LABOR The economic cost of labor for the project varies by types of skill required and by types of labor markets. There are six types of construction workers required for the project in terms of skill level during the 4 years of the construction period. Similarly, there are six types of operating workers required over the life of the operating phase. IIAS, INC. 6-7

56 The Economic Appraisal For this project, we are dealing with two different kinds of markets for construction and operating labor. One is a competitive market in Argentina and the other, a protected market in Uruguay. Their impact on the estimation of the economic price of labor is very different because of the distorted taxes and government regulations. The assumptions and the calculation of the economic cost of labor can be found in Appendix M. The results as indicated in Table 6.1 that the economic cost of labor is approximately 90% of the wage bill in Argentina but only about 72% of the wage bill in Uruguay. Table 6-1: CONVERSION FACTORS FOR LABOR IN 1997 (percentage) Categories Argentina Uruguay Helper Assistant Tradesman Tradesman Specialized Tradesman Machine Operator Technician/Professional Foreign Professional The project will also require some foreign technicians and professionals. The economic costs for these workers are the net-of-tax wage paid plus adjustments for the foreign exchange premiums associated with the repatriated portion of their wage. The results of these labor conversion factors are also included in the Table 6-1. ECONOMIC COST OF FUELS Fuel is a major input in providing transportation services. We therefore calculate the conversion factors for passenger cars, passenger buses, and truck transport. For example, the conversion factors in 2001 are summarized in Table 6.2 for Argentina and Uruguay. IIAS, INC. 6-8

57 The Economic Appraisal Table 6-2: CONVERSION FACTORS FOR TRANSPORTATION SERVICES IN 2001 (percentage) Categories Argentina Uruguay Passenger Cars Passenger Buses Heavy Trucks ECONOMIC COST OF TRADABLE INPUTS During the construction period of the BAC Bridge, all inputs used in bridge construction will be exempt from all import tariffs and VAT. Therefore, the financial price of each input is only adjusted for the foreign exchange premium. For example, the foreign exchange premium for Argentina in 1997 was estimated to be equal to approximately 11.24%. Thus, the economic price for a tradable input is 11.24% higher than the financial cost. The conversion factor is then equal to All of the conversion factors for the traded inputs used in the operational period of the bridge are also calculated. These items are mainly related to the vehicle operating costs. All the inputs are now adjusted for the foreign exchange premium, tariff and VAT. For example, gasoline in Argentina is subject to 70% rate of excise tax and 21% rate of VAT. Its conversion factor in 2001 is equal to The detailed conversion factors for tradable goods are presented in Appendix N. ECONOMIC COST OF NON-TRADABLE INPUTS In the case of non-tradable goods, the economic cost is estimated as a weighted average of the value of the resources used in the production of the additional supply and the value of the consumption forgone by the existing demand. At present, since Argentina and Uruguay have a large amount of excess capacity in their economies, a greater weight is placed on the supply. The detailed assumptions and the computation can be found in Appendix N. IIAS, INC. 6-9

58 The Economic Appraisal FERRY AND AIRPLANE OPERATIONS The conversion factors of transportation services provided by ferry and airplane are slightly more than one mainly because ship and airplane are traded goods. Fuels purchased by international ferry and airplane operators are exempt of taxes and the other economic adjustments for pilots, stewardess, crew, and other personnel on the airplanes or ships are relatively small. The conversion factors of these services are calculated accordingly. For example, the conversion factors in Argentina would be 1.04 for ferry services and 1.01 for airplane services in COMPLEMENTARY ACTIVITIES The complementary activities to the bridge that were included in the financial appraisal are not included in the economic analysis of the Bridge. This approach is undertaken because we assume that these concession type activities will be controlled as part of the foreign owned bridge concession. In addition, we have not been able to evaluate the degree of market distortions associated with the goods bought and sold through the activities that might generate economic externalities for the two countries. Even if these externalities could be measured, they are likely to be small and insignificant relative to the economic benefits generated by the Bridge. Results of Economic Analysis The BAC Bridge will have an impact on the economy of Argentina and Uruguay. It will enable passenger traffic to move faster and secure under all-weather conditions. Many Argentineans and Uruguayans would choose the new bridge transportation mode over the traditional alternative modes such as ferry and airplane as well as to divert from the long highway route to the direct and shorter bridge route. The direct benefits accruing to the passenger traffic involve not only the savings of traveling time and vehicle operating costs but also reliability of traveling. This, as explained in the methodology section, is largely reflected in the demand curve for the Bridge services by various types of vehicles. In other IIAS, INC. 6-10

59 The Economic Appraisal words, the benefits are measured by consumer surplus, which is the amount passengers are willing to pay for crossing the bridge in excess of the bridge tolls they actually pay. It should be noted that a ceiling value of US$150 per auto and US$900 per bus is imposed on the estimate of willingness to pay by passengers and buses using the bridge. The measurement of this economic benefit is equally applied to the diverted traffic as well as to the newly induced and generated traffic. By the same token, as the reduction of transportation cost and logistics cost occur, there are economic benefits accruing to both the producers and consumers of the traded merchandises in the exporting and the importing countries. 3 Nevertheless, the bulk of the benefits will be received by the producers of the exporting country as we have indicated in an earlier section. Only coffee and metals imported by Argentina are considered regionally traded and, thus, the benefits of the shipments associated this import are one half of the savings of transportation costs. 4 In addition to the benefits received by Argentina and Uruguay, Brazilian producers will also benefit from the savings in transportation cost and logistics cost. The other net economic benefits are associated with the economic value in excess of the financial cost of the capital goods and operating goods and services sold by Argentina and Uruguay, respectively, to the foreign concessionaire. This benefit reflects the conversion factors derived in the sub-section of the economic costs of labor, other traded, and non-traded business inputs. The foreign exchange premiums paid for use of the Bridge services by Argentina and Uruguay are treated as the net economic costs of the respective country. The economic cost of capital used to discount the streams of economic benefits and costs over the life of the project is 11% for Argentina and 10.5% for Uruguay. The net NPVs for the base scenario (base ferry response, most likely GDP growth rate and the medium toll levels set at US$60 for passenger car, US$360 for passenger bus and US$225 for truck scenario) would be approximately US$607 million for Argentina and US$214 million for Uruguay, all expressed in the 1998 prices. The benefits received by Brazilian producers, also expressed in 3 Conceptually, for internationally traded goods the benefits are accrued to the producers of the exporting country and consumer surplus as a result of additional demand, which can be measured by one half of the reduction of transportation cost times the incremental demand. 4 The exporting country, i.e., Brazil, receives the other half of the benefits. IIAS, INC. 6-11

60 The Economic Appraisal the 1998 prices, would be US$74 million. 5 Appendix O. Details of the results can be found If the ferry operators operate the base ferry option, a two-way cross tabulation of the economic NPVs for various scenarios is presented for Argentina and Uruguay in Table 6-3. The net economic benefits increase in proportion to GDP growth rates. 6 The economic benefits to the countries, however, decline as the level of bridge tolls increases. This is because the higher the tolls, the higher are the profits accruing to the foreign bridge owners, hence, the lower is the amount of consumer surplus received by the users. This result points to the possibility of having a toll policy that varied over time. For example, in the early years of the bridge operation, one could start with a real US$60 toll. Then after 10 years, a reduction could take place in the real value of the toll to US$40. Nevertheless, the results clearly indicate that the bridge will improve the level of economic well being for both countries. 5 To derive the economic benefits for Brazil, we have assumed 11% as the economic cost of capital for Brazil. Following the same methodology outlined earlier in this report, we have estimated that the foreign exchange premium would be about 9%, which is composed of 4.31% of ρ 1 and 4.65% of ρ 2. 6 This also applies to Brazil. The economic benefits accrued to the Brazilian producers would be US$53 million when annual GDP growth rates are 3% and US$106 million when the growth rates are 5%. IIAS, INC. 6-12

61 The Economic Appraisal Table 6-3: THE ECONOMIC NET PRESENT VALUE FOR THE BASE FERRY OPTION (thousands of 1998 US$) ARGENTINA: GDP Growth TOLL LEVELS US$40 US$60 US$80 3% 726, , ,257 4% 817, , ,740 5% 945, , ,736 URUGUAY: GDP Growth TOLL LEVELS US$40 US$60 US$80 3% 235, , ,002 4% 257, , ,141 5% 296, , ,345 The ferry response could have a significant economic implication for the Bridge project. We simulate the net economic benefits for various scenarios under the pessimistic and the optimistic ferry responses. The results are presented in Tables 6-4 and 6-5, respectively. As expected, the pessimistic ferry option would lower the economic benefits by 22.0% to 28.5% for Argentina and by 20.5% to 21.5% for Uruguay (comparisons between Tables 6-4 and 6-3). In the case of the optimistic ferry response, the net economic benefits would increase considerably for Argentina in the range of 36.0% to 44.5% (comparisons between Tables 6-5 and 6-3). For Uruguay, the benefits would increase by approximately 20% from the base ferry scenario. IIAS, INC. 6-13

62 The Economic Appraisal Table 6-4: THE ECONOMIC NPV FOR THE PESSIMISTIC FERRY OPTION (thousands of 1998 US$) ARGENTINA: GDP Growth TOLL LEVELS US$40 US$60 US$80 3% 565, , ,061 4% 640, , ,257 5% 737, , ,234 URUGUAY: GDP Growth TOLL LEVELS US$40 US$60 US$80 3% 185, , ,696 4% 203, , ,429 5% 234, , ,556 Table 6-5: THE ECONOMIC NPV FOR THE OPTIMISTIC FERRY OPTION (thousands of 1998 US$) ARGENTINA: GDP Growth TOLL LEVELS US$40 US$60 US$80 3% 993, , ,586 4% 1,119, , ,579 5% 1,288, , ,976 IIAS, INC. 6-14

63 The Economic Appraisal Table 6-5: THE ECONOMIC NPV FOR THE OPTIMISTIC FERRY OPTION (cont d) (thousands of 1998 US$) URUGUAY: GDP Growth TOLL LEVELS US$40 US$60 US$80 3% 283, , ,787 4% 309, , ,491 5% 355, , ,986 In summary, under the restrictive assumptions that the countries will incur no guaranties on contingent liabilities, the values of the economic benefits received by the two countries are substantial. For the base toll and the most likely economic growth scenario, the economic surplus that is expected to accrue to Argentina is between US$460 and US$850 million for all range of ferry response. For Uruguay, the net present value of the economic benefits is between US$169 and US$258 million. In this analysis, the financial performance of the bridge is separated from the economic analysis that is done in detail for each of the two countries. It is interesting to note that Brazil would also benefit from the reduction of transportation cost once the Bridge opens. The amount would be in the neighborhood of US$74 million in 1998 prices. IIAS, INC. 6-15

64 The Economic Appraisal Distributive Analysis The above economic benefits and costs are different from the financial appraisal because the project generates externalities. The purpose of the distributive analysis is to establish the gainers and losers of a country from the implementation of the project and to quantify the amounts involved. In case of the BAC Bridge project, we have measured the net economic benefits of the project accrued to Argentina and Uruguay, respectively. What we need to do now is to decompose the net economic benefits among parties within each country. The net economic benefits in this project are considered to be contributed by five actors in the economy, bridge passengers, workers, consumers, producers and the government. The benefits accrued to bridge passengers are measured by their willingness to pay for the bridge services in excess of the bridge tolls. These benefits can be further broken down into passenger cars and passenger buses. Labor benefits are received by workers because of employment during the construction and the operation phases. Consumers refer to those benefited from the reduction of imported goods. Producers include those producing and exporting extra goods resulted from the savings in transportation costs. Airline operators will lose because of the diversion of travelers to the Bridge. The net benefits accrued to the government refer to externalities, including additional taxes generated, less taxes forgone, plus the foreign exchange premiums associated with net earnings of foreign exchange. The results for the base scenario (base ferry response most likely growth base toll level) are presented in Table 6-6. It is very clear that bridge passengers in Argentina and Uruguay are big winners in terms of the economic benefits upon the implementation of the BAC Bridge project. Producers in both countries also gain as a result of the reduction in transportation and logistics costs. Brazilian producers also gain considerably, much more than either Argentinean or Uruguayan producers. Consumers of regionally traded goods in Argentina also gain. There are substantial labor benefits accrued to Argentina and Uruguay. Uruguayan workers, in particular, gain a lot because of their relative low supply prices to the project wages. Finally, the Argentinean and Uruguayan IIAS, INC. 6-16

65 The Economic Appraisal governments are losers because of the amount of taxes forgone, primarily through the use of foreign exchange to pay the tolls to the private concessionaire and because the bridge is exempt for all indirect taxation. It is interesting to note that the results of the distributive analysis do not show the ferry operators as either winners or losers. This is due to the fact that the base scenarios for ferry response to the bridge assume that the ferry operators operate at their long-run marginal costs. This means that they break even at the various levels of demand, both with and without the bridge. This assumption is conservative from the perspective of the bridge concessionaire, since the ferries are presently operating at fares significantly higher than their long-run marginal costs, in an environment that is not perfectly competitive. If the higher fares remain after the bridge is built, the demand for the bridge would be even greater. The assumptions used in this report are also conservative in terms of the calculation of benefits, in that the bridge is not given credit for the gains to the economy by inducing greater competition in the cross-river transportation market. If the ferry operators were assumed to operate at long run marginal costs with the bridge and current fares without, the result would be significant further gains to the users of the both the bridge and the ferries, and losses to the ferry operators. The value of the loss to the ferry owners would be equal to the difference between current fares and ferry long-run marginal costs multiplied by the ferry demand without the bridge. These benefits, however, are a result of the improvement in ferry competition that could occur even without the bridge if the governments were to pursue policies to enhance competition. Hence, to provide a conservative estimate of the economic benefits of the bridge to consumers, the distributional effects of lowering the fares to the long-run marginal costs of operating are not included in the bridge analysis. IIAS, INC. 6-17

66 The Economic Appraisal Table 6-6: DISTRIBUTIVE BENEFITS AND COSTS FOR THE BASE SCENARIO (thousands of 1998 US$) Components ARGENTINA URUGUAY BRAZIL Bridge Passengers: Cars 534,890 91,310 - Buses 156,178 54,056 - Labor Benefits 9,891 30,978 - Consumers of Goods Producers of Goods 46,952 41,767 73,997 Airline Operators (12,983) (3,360) - Government (127,921) (879) - TOTAL 607, ,873 73,997 IIAS, INC. 6-18

67 Chapter 7 Sensitivity And Risk Analyses Introduction A sensitivity analysis is performed to identify, analyze, and interpret the expected variability in the project financial and economic outcomes. The project s outcomes are based on forecasts of many variables. However, the analysis does not take into account the likely impact of simultaneous and random changes in the values of project variables and the correlation that may exist among them. Risk emanates from the uncertainty encompassing important projected variables. Therefore, the evaluation of project risk depends on the ability, to identify and quantify the nature of the uncertainty surrounding the essential project variables, and to apply suitable statistical tools to process its risk influence on the project. The technique requires specifying appropriate range of values and its probability distribution of the critical project variables. Using the specified probability distributions of the essential variables, a computer simulates the project s financial and economic statements on a series of trials. The results from the simulation are used to obtain an estimate of the expected values and their probability distribution of selected outcomes of the analysis. In this report, a series of sensitivity and risk analyses are conducted to determine the impact of changes in key variables on the financial and economic NPV of the BAC Bridge project in addition to the sensitivity analyses already undertaken in the previous two chapters.

68 Sensitivity And Risk Analyses Methodology In the appraisal of the bridge project, a deterministic technique for the sensitivity assessment is used first. In the analysis, the value of one variable is changed at a time to test its impact on the relevant outcome of the project. Sensitivity analysis allows us to identify the variables that most likely affect the outcomes of the bridge project, by quantifying the extent of their impact. Risk analysis, using the Monte Carlo simulation technique, is applied to test how the financial and economic NPV of the Bridge project responds to possible variations in the values of the critical variables. In this analysis, 2,000 simulations are carried out on the spreadsheets of the traffic demand models (both passenger and cargo) as well as the integrated project appraisal model. Empirical Results In the previous two chapters, a sensitivity analysis was conducted for changes in macroeconomic growth rates, changes in bridge tolls, and ferry responses to the bridge implementation. In this chapter, we conduct the further sensitivity analysis for changes in other key parameters. In the case of risk analysis, only the most important variables will be considered because of the nature of complexity. Furthermore, for the purpose of comparison we will only report the results of the sensitivity and risk analyses deviating from the base scenario -- the base ferry response, most likely growth rate, and the base toll scenario. SENSITIVITY ANALYSIS The sensitivity analysis will be carried out on inflation rates, devaluation of real exchange rate, real rates of interest of long term financing, cost overrun, very pessimistic passenger traffic, timing of the project and extended construction period. IIAS, INC. 7-2

69 Sensitivity And Risk Analyses INFLATION In this sensitivity analysis, inflation will vary by two percentage points from 3% to 1% and 5% in Argentina and five percentage points from 10% to 5% and 15% in Uruguay. The financial NPVs of these simulations are presented in Table 7-1. Table 7-1: THE NPV FOR THE BASE SCENARIO AT DIFFERENT INFLATION RATES (thousands of 1998 US$) ARGENTINA: Inflation Financial Economic 1% 193, ,169 3% 190, ,169 5% 189, ,169 URUGUAY: Inflation Financial Economic 5% 190, ,873 10% 190, ,873 15% 191, ,873 In these cases, the financial performance is affected marginally because of the change in costs of maintaining real cash balances and the effect on accounts payable and the impact on tax liabilities. However, the economics is not affected because the real value of the tolls are not changed with higher or lower rates of domestic inflation. IIAS, INC. 7-3

70 Sensitivity And Risk Analyses REAL INTEREST RATE In this sensitivity analysis we change the cost of borrowing from 7% real to a low rate at 5% and to a higher rate of 9%. The financial NPVs of these simulations are presented in Table 7-2. Table 7-2: THE NPV FOR THE BASE SCENARIO AT DIFFERENT REAL INTEREST RATES (thousands of 1998 US$) Real Interest Rate Financial Economic Argentina Economic Uruguay 5% 210, , ,873 7% 190, , ,873 9% 169, , ,873 The results show that an increase in the real cost of borrowing will definitely lower the financial return to equity holder. However, the reduction in return may be smaller than expected because the higher financial cost would also reduce corporate income tax liabilities. DEVALUATION OF REAL EXCHANGE RATE The movement of real exchange rate over the life of the project may be an important factor in affecting this project. The movement of real exchange rates will influence not only the number of passengers but also the volume of cargo traffic. In the case of cargo traffic, the demand is also influenced by more expensive foreign goods and cheaper domestic goods when the domestic currency is devaluated. This factor is not incorporated in the simulation since the SAIC model was not designed to handle this issue. In this sensitivity analysis, we assume a devaluation of the real exchange rates will occur in the first year of the bridge operation in both Argentina and Uruguay. The bridge tolls are initially set in amounts of US dollars in 1998 but for future years are set equal to equivalent real values expressed in Argentinean and Uruguayan pesos. But the project financing is expressed in dollars. Hence, a real devaluation after the bridge is built will IIAS, INC. 7-4

71 Sensitivity And Risk Analyses make the repayment of the financing more expensive (in pesos) relative to the value of the toll. As expected, an devaluation of real exchange rate will have a negative impact on the financial performance. Details of the impact on the financial NPVs are presented in Tables 7-3A and 7.3B. Table 7-3A THE NPV FOR THE BASE SCENARIO IF ARGENTINA S REAL EXCHANGE RATE IS DEVALUATED IN YEAR 2003 (thousands of 1998 US$) Devaluation of Real Exchange Rate Financial 0% 190,925 10% 165,576 20% 144,451 30% 65,169 Table 7-3B THE NPV FOR THE BASE SCENARIO IF URUGUAY S REAL EXCHANGE RATE IS DEVALUATED IN YEAR 2003 (cont d) (thousands of 1998 US$) Devaluation of Real Exchange Rate Financial 0% 190,925 10% 164,157 20% 141,851 30% 122,797 IIAS, INC. 7-5

72 Sensitivity And Risk Analyses COST OVERRUN A higher than anticipated investment cost is often a key factor affecting the overall evaluation of the Bridge investment project. This section examines the sensitivity of investment cost overruns on the financial and economic viability. The results of these simulations are shown in Table 7-4. Table 7-4: THE NPV FOR THE BASE SCENARIO AT DIFFERENT LEVELS OF COST OVERRUNS (thousands of 1998 US$) Capital Cost Overruns Financial Economic Argentina Economic Uruguay -20% 261, , ,453-10% 226, , ,162 Base Case 190, , ,873 10% 155, , ,583 20% 120, , ,293 30% 84, , ,003 The financial NPV is very sensitive to cost overruns. Nevertheless, the project appears to remain financially viable even if cost overrun is as high as 30%. From the economic perspective, cost overruns does not lower the economic benefits in either Argentina or Uruguay. This is because both countries would sell more materials or other project inputs to the foreign concessionaires and earn more foreign exchange premiums. However, the Bridge will not go ahead if the cost overruns are so large as to make the project financially not viable from the private investor s point of view. IIAS, INC. 7-6

73 Sensitivity And Risk Analyses VERY PESSIMISTIC PASSENGER TRAFFIC The volume of passenger traffic appears to be one of the essential factors influencing the financial and economic viability. In this section, a sensitivity analysis is carried out for a case in which the total passenger traffic is lowered by 20% from the model results under the low economic growth rate environment. This may also reflect extremely conservative estimates of generated traffic. The results are presented in Table 7-5 for different toll levels. Table 7-5: THE NPV FOR THE BASE FERRY SCENARIO AT REDUCED PASSENGER TRAFFIC AND LOW GROWTH RATE (thousands of 1998 US$) Reduced Passenger Traffic Financial Economic Argentina Economic Uruguay Toll: US$40 0% 41, , ,736-10% 25, , ,400-20% 9, , ,065-30% (6,842) 655, ,729 Toll: US$60 0% 98, , ,193-10% 76, , ,092-20% 55, , ,990-30% 33, , ,889 Toll: US$80 0% 143, , ,002-10% 117, , ,580-20% 90, , ,157-30% 64, , ,735 The results clearly show that a reduced volume of passenger traffic will lower the financial and economic returns of the project. It is, however, only in the low tariff situation of US$40 and the low growth rate of demand where the NPV to the equity holders is negative. It is also interesting to note that the impact of the reduced traffic on the financial performance would be more severe than its impact on the present value of the net economic benefits to Argentina and Uruguay. Taking the case of US$60 toll as an example, a 20% reduction in traffic would reduce the financial NPV by 44% while the net present value of the economic benefits would only decrease 5% for Argentina and 7% for IIAS, INC. 7-7

74 Sensitivity And Risk Analyses Uruguay. One reason for this result is that both economies benefit substantially from the construction of the bridge and these benefits are not altered by the level of traffic. TIMING OF THE PROJECT In the analysis so far, the project has been assumed to begin its construction in In this section, we assume that the project will delay its construction and the opening of the bridge for one to three years. The financial NPVs of these simulations are presented in Table 7-6. Table 7-6: THE NPV FOR THE BASE SCENARIO AT DIFFERENT BEGINNING YEARS OF CONSTRUCTION (thousands of 1998 US$) Beginning Construction Year Financial Economic Argentina Economic Uruguay , , , , , , , , , , , ,559 The results indicate that there would be a marginal financial less in NPV terms, if the opening of the bridge is postponed beyond the year There would be, however, a substantial reduction in the economic NPV to both countries if the construction of the bridge is postponed. This result arises because of the value of transportation service which are lost forever if the opening of the bridge is delayed. EXTENDED CONSTRUCTION PERIOD For technical or other unforeseen factors, construction of the BAC Bridge may last more than four years. Essentially, this section examines the sensitivity of the financial and economic feasibility if the construction lasts five instead of four years. For simplicity, the capital expenditures in the last two years are spread over three years and the total amount remains unchanged in February 1997 prices. At present, the shares of the total IIAS, INC. 7-8

75 Sensitivity And Risk Analyses capital expenditures incurred in the third and fourth year are about two-thirds and onethird. In this sensitivity, we assume that these total expenditures are spread over the last three years of the construction period as 4/7, 2/7, and 1/7. With the extended construction period, the financial NPV would be reduced by US$53.9 million from US$190.9 million to US$137.0 million because the financial revenues are delayed for one year while the front end capital expenditures, especially in the first two years, remain unchanged. The economic benefits are somewhat interesting. Details are shown in Table 7-7A. Oneyear delay of the Bridge operation will postpone the benefits received from the bridge crossings and the employment in the construction and operating phase. This is the Argentinean case where the economic NPV is reduced by US$138.6 million from US$607.2 million to US$468.6 million. In the case of Uruguay, the net economic benefits are reduced from US$213.9 million to US$194.4 million. Table 7-7A: DISTRIBUTIVE BENEFITS FOR THE BASE SCENARIO WITH AN EXTENDED CONSTRUCTION PERIOD FROM 4 TO 5 YEARS (thousands of 1998 US$) Components ARGENTINA URUGUAY Bridge Passengers: Cars 481,883 82,633 Buses 140,701 48,919 Labor Benefits 9,512 25,929 Consumers Producers 42,299 37,798 Airline Operators (11,696) (3,041) Government (194,230) 2,190 TOTAL 468, ,428 A comparison of Table 7-7A with Table 6-6 indicates the change in the economic benefits and their distribution if the construction period of the bridge is delayed. These results are IIAS, INC. 7-9

76 Sensitivity And Risk Analyses presented in Table 7-7B. It is clear that an extension of the period of construction will have a significant impact on the economic contribution to be made by this project to the two countries. Table 7-7B: CHANGES OF THE DISTRIBUTIVE BENEFITS FOR THE BASE SCENARIO WITH AN EXTENDED CONSTRUCTION PERIOD FROM 4 TO 5 YEARS (thousands of 1998 US$) Components ARGENTINA URUGUAY Bridge Passengers: Cars (53,007) (8,677) Buses (15,477) (5,137) Labor Benefits (379) (5,049) Consumers (16) - Producers (4,653) (3,969) Airline Operators 1, Government (66,309) 3,069 TOTAL (138,545) (19,445) RISK ANALYSIS All the above analyses are based on deterministic values of input variables in the model. This may not be a realistic assumption. The values of input variables will vary depending upon the conditions in their respective markets. From the sensitivity analysis, the most important factors affecting the project s financial and economic viability and over which the concessionaire has no control are the GDP growth rates and ferry responses. These two variables are, therefore, considered for a further risk analysis. Cost overrun is a source of considerable risk, but it is a variable that is under the control of the concessionaire, and will vary depending who is the concessionaire. Hence, while the sensitivity of the financial and economic volumes are studied we do not include this variable in the Monte Carlo risk analysis. IIAS, INC. 7-10

77 Sensitivity And Risk Analyses These risk variables should be modeled and a set of Monte Carlo simulations are carried out. 1 The analysis is conducted both for the financial and economic appraisal. The probabilities for GDP growth rates to occur are assumed to be 30, 40 and 30% for 3, 4 and 5%, respectively. In the case of ferry response to the implementation of the BAC Bridge, the probabilities are assumed 10% for pessimistic, 80% for base, and 10% for optimistic scenario. The outcome of the analysis is presented in Figures 7-1, 7-2, 7-3 and 7-4. The analysis reveals that with respect to the two variables considered to be truly outside the control of the governments and the concessionaire, the probability of having negative financial net present value is nil. In fact, the minimum rate of return to equity holder would be 16.6% real. This is under the assumptions that both Argentina and Uruguay will not provide any guaranties or contingent liabilities. The analysis also shows that there is no probability of having negative economic net present value for either Argentina or Uruguay. The implementation of the project would significantly improve the economic welfare of the Argentinean residents and Uruguayan residents. 1 The risk analysis id done using the risk package called Crystal Ball. IIAS, INC. 7-11

78 Sensitivity And Risk Analyses Figure 7-1: EQUITY FINANCIAL NPV (thousands of 1998 US$) Summary: Entire Range is from 14,381 to 472,404 2,000 Trials Statistics: Value Mean 209,726 Median 198,616 Standard Deviation 98,789 Range Minimum 14,381 Range Maximum 472,404 Probability: Range of Values 25% 14,381 to 130,235 25% 130,235 to 198,616 25% 198,616 to 287,649 25% 287,649 to 472,404 Forecast: Equity NPV 2,000 Trials Cumulative Chart 0 Outliers , , , ,000 IIAS, INC. 7-12

79 Sensitivity And Risk Analyses Figure 7-2: EQUITY FINANCIAL IRR (percentages) Summary: Entire Range is from 16.64% to 29.52% 2,000 Trials Statistics: Value Mean 23.13% Median 23.11% Standard Deviation 2.68% Range Minimum 16.64% Range Maximum 29.52% Probability: Range of Values 25% 16.64% to 21.05% 25% 21.05% to 23.11% 25% 23.11% to 25.31% 25% 25.31% to 29.52% Forecast: Equity IRR 2,000 Trials Cumulative Chart 0 Outliers % 18.75% 22.50% 26.25% 30.00% IIAS, INC. 7-13

80 Sensitivity And Risk Analyses Figure 7-3: ECONOMIC NPV FOR ARGENTINA (thousands of 1998 US$) Summary: Entire Range is from 379,372 to 1,041,179 2,000 Trials Statistics: Value Mean 626,729 Median 607,929 Standard Deviation 111,926 Range Minimum 379,372 Range Maximum 1,041,179 Probability: Range of Values 25% 379,372 to 551,821 25% 551,821 to 607,929 25% 607,929 to 689,698 25% 689,698 to 1,041,179 Forecast: Argentina Economic NPV 2,000 Trials Cumulative Chart 35 Outliers , , , , ,000 IIAS, INC. 7-14

81 Sensitivity And Risk Analyses Figure 7-4: ECONOMIC NPV FOR URUGUAY (thousands of 1998 US$) Summary: Entire Range is from 145,269 to 316,076 2,000 Trials Statistics: Value Mean 219,083 Median 214,136 Standard Deviation 29,386 Range Minimum 145,269 Range Maximum 316,076 Probability: Range of Values 25% 145,269 to 198,979 25% 198,979 to 214,136 25% 214,136 to 240,716 25% 240,716 to 316,076 Forecast: Uruguay Economic NPV 2,000 Trials Cumulative Chart 21 Outliers , , , , ,000 IIAS, INC. 7-15

82 Chapter 8 Conclusions In this study, we have developed an analytical framework to evaluate the BAC Bridge project from the three major stakeholders point of view, the foreign concessionaire, Argentinean residents, and Uruguayan residents. To evaluate the financial viability from the concessionaire s point of view, we integrate the engineering cost estimates, the forecast of passenger and freight traffic and project financing into a financial cash flow statement over the life of the project. The traffic forecasting for passenger cars and buses was based on the demand model developed by CSI while the traffic for freight was based on the model developed by SAIC. These traffic were then translated into project revenues, depending upon the levels of the bridge tolls charged. This study has established a base toll for passenger car at US$60. At this level, a private concessionaire will be able to earn more than 16% real rate of return and to have a high debt coverage ratio over the life of the project. From a financial perspective, the project appears to have considerable promise in all scenarios except for the low economic growth and the low level of tolls charged. The results were estimated on the bases of an initial 65/35 debt/equity ratio and a nominal interest rate of 10.21% per annum. In other words, they would all yield a positive net present value at a real cost of equity funds of 16%, which was considered a reasonable requirement for a concessionaire to undertake the project. The financial performance of the bridge is affected considerably by the behavioral response of the ferry operators. However, the effect is not important enough to create losses even in the most pessimistic ferry case under the low economic growth environment.