Public Versus Private Cost of Capital with State-contingent Terminal Value

Marian Moszoro (UC Berkeley & Harvard Law School)

Abstract: The choice of infrastructure delivery through public versus private provision is driven by investment and operational efficiency, and cost of capital differentials. While the first two factors are measurable---albeit with mixed results---the appropriate discount rate instigates methodological discussions. Efficient market hypothesis supporters propose a single discount rate, independently of the source of financing; welfare economists advocate for a lower discount rate for public-sector cash flows. I revisit this discussion with attention to the terminal value subject to adaptable discretionary actions of the regulator. I also provide an empirical test of lower price volatility for government-sponsored enterprises. Finally, I propose an integrated approach with a dual discount rate treat: a common discount rate for predictable cash flows and divorced discount rates for terminal cash flows.

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