Real Options: The Via Dutra Case Luiz Brandao

Via Dutra Case

MSIS 383N University of Texas at Austin 3 Via Dutra  Brazil is about the size of the USA.  Roadways account for over 60% of total freight transportation, compared to 26% in the USA.  Quality of roads is poor.

MSIS 383N University of Texas at Austin 4 Federal Highway Network of Brazil

MSIS 383N University of Texas at Austin 5 Privatization Program  In the 90’s Brazilian Government sold off most of the state owned firms, including steel mills, telephone and public utility firms, mining firms and also granted concessions for some federal and state highways.  The privatized highways were to be operated and maintained through 25 year concession contract.  The President Dutra highway is the most important roadway of the federal network, linking Brazil’s two largest cities, Rio and Sao Paulo, which have a joint population of over 20 million.  The highway is 400km (250 miles) long and was first paved in 1948

MSIS 383N University of Texas at Austin 6 Rio de Janeiro, Brazil

MSIS 383N University of Texas at Austin 7 Rio de Janeiro, Brazil

MSIS 383N University of Texas at Austin 8 Rio de Janeiro, Brazil

MSIS 383N University of Texas at Austin 9 Sao Paulo, Brazil

MSIS 383N University of Texas at Austin 10 The Project  Twenty five year concession  Obligation to invest over US$ 500 million in repairs, upgrading and maintenance.  Bi-directional toll collection at four toll plazas  Bidders were the largest construction firms in Brazil.  Very few roads in Brazil were toll roads at the time.

MSIS 383N University of Texas at Austin 11 Via Dutra, Inauguration, 1948.

MSIS 383N University of Texas at Austin 12 Via Dutra, Inauguration, 1948.

MSIS 383N University of Texas at Austin 13 Via Dutra, 2003

MSIS 383N University of Texas at Austin 14 Via Dutra: Before and After

MSIS 383N University of Texas at Austin 15 Via Dutra: Before and After

MSIS 383N University of Texas at Austin 16 Via Dutra: Before and After

MSIS 383N University of Texas at Austin 17 Via Dutra: Before and After

MSIS 383N University of Texas at Austin 18 Project Risks and Options Risks  Traffic risk  Foreign exchange risk  Political risk  Interest rate risk  Inflation risk  Implementation risk  Operational risk Options  Option to Abandon  Option to Expand

MSIS 383N University of Texas at Austin 19 -2% -1% 0% 1% 2% 3% 4% 5% 6% 7% 8% Ano % de mudança Traffic GDP Correlation between Traffic and GDP - USA

MSIS 383N University of Texas at Austin 20 Real Options Model  Create DCF spreadsheet  Model the stochastic process of each uncertainty  Use Monte Carlo simulation to estimate the project volatility  Model project GBM diffusion process with a binomial lattice  Insert options as decision nodes in tree.  Solve using risk neutral probabilities.

MSIS 383N University of Texas at Austin 21 Binomial Approximation  A lognormal stochastic process can be modeled with a binomial lattice.  This allows us to use a simpler, discrete model

MSIS 383N University of Texas at Austin 22  The binomial parameters are:  Note that volatility is the annualized standard deviation of the project returns. The Δt factor adjusts for time intervals different than a year. Binomial Model

MSIS 383N University of Texas at Austin 23 Sample Model

MSIS 383N University of Texas at Austin 24 Sample Model