Public versus Private Cost of Capital with State-Contingent Terminal Value

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.