What is the purpose of valuation in the infrastructure industry?

What is the definition of Infrastructure?

Infrastructure is an important driver for the growth of economy of any region. Infrastructure of an economy includes electricity, roads, water systems, public utilities, airports, railways, and telecommunications.

Therefore, these essential services drive the economic activities channel trade and mobility of a region or a country.

Why the need of valuation for infrastructure?

Growing and urbanizing countries add on infrastructure to adhere with the increasing demands of the population. Which includes transportation, roads, water systems, public utilities, and others.

To fulfill these demands, a country with growing population will need to invest in infrastructure to ensure the nation competitiveness, providing jobs and economic benefits all round.

Increased spending on infrastructure has a multiplier effect on the overall economic growth, as it demands industrial growth and manufacturing. Hence, in turn, boosts the collective demand, by improving living conditions.

For example, a country plans to increase their number of roads, power plants, airports and seaports as demands increases. New industries are emerging too, such as, electric, sustainable and renewable energy giving a broader range of niche asset classes.  

More often than not, nowadays, these projects are undertaken with collaboration with the private sector and/or investors. Generally this is where valuations are required to calculate the value, risk and return for the investors.

What are the methods used for infrastructure valuation?

Traditionally the infrastructure industry uses:

1. Cost method

The cost approach is a real estate valuation method that estimates the price a buyer should pay for a piece of property is equal the cost to build an equivalent building. Unlike the comparison method.

For infrastructure, the cost method is suitable because any market value or income value is dependent upon project standards and completion. Projects are reappraised at various stages of construction to enable the release of funds for the next stage of completion.

The value is appraised on the completed basis where it is potentially be sold to an operator/investor taking the risk and return, say for a period of a concession.

2. Discounted Cash Flow Method (DCF)

This method is widely used in various large asset classes and infrastructure projects as it assesses the time value of money. As large projects take a number of years to complete, the income only will come in sometime in the future. The DCF is used to value an investment based on the expected future incomes or cash flows, today.

This method is also employed for comparison of projects to be undertaken based on the different cash flows, the cost of capital and discount rate and the net present value for the investment market.

However, due to the complexities of a large project valuers may also employ a variation of methods such as the Capital Asset Pricing Model (CAPM). This method also uses the discount rate applicable to the discounting cash flows. CAPM maybe suitable for valuing the new industries in the sustainable and renewable industries in solar and wind power plants.

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