Valuing flexibility in infrastructure developments : the Bogota water supply expansion plan.

This thesis aims to aid in the understanding of capital budgeting techniques for infrastructure developments. In particular, it analyzes: Net Present Value (NPV), Decision Analysis (DA) and Real Options Analysis (ROA), and compares these approaches in terms of their treatment of uncertainty, their acknowledgement of flexibility, and their usefulness for strategic decisionmaking. The comparison of these alternative methodologies is based on a literature review highlighting the advantages and disadvantages of each approach, complemented by a system study of the expansion of the water supply system for Bogota, Colombia. This study illustrates the application of each methodology and identifies the policy challenges relevant to infrastructure investment evaluation in Colombia and other emerging economies. The study confirms the hypothesis that NPV is inadequate for the evaluation of projects in uncertain environments, mainly because it does not account for the value generated by flexibility. The study also recognizes that although the ROA approach is theoretically superior in the pricing of flexibility, its implementation requires information usually not available for infrastructure assets. This rends the results of the analyses imprecise and complicates the process of identifying an optimal strategy. The study finds the Decision Analysis approach preferable for the evaluation of Bogota's water supply expansion projects, based on its practicality and ease of communication. The thesis also sets forth a framework for choosing the most appropriate capital budgeting technique for other infrastructure developments. This framework is based on data quality and availability and the objective function of the analysis to be conducted. Thesis Supervisor: Richard de Neufville Professor of Engineering Systems and of Civil and Environmental Engineering ACKNOWLEDGMENTS This thesis would not have been possible without the help and support of many people. First I would like to thank my advisor, Professor Richard de Neufville, for his ideas, support, guidance constructive comments, and most of all for his encouragement. The production of this thesis was one of the best learning experiences I had in MIT, to a great extent due to his unwavering support. The information for the Bogota Water Company case study came from the generous collaboration of many people in the EAAB and Ingetec. Without their help I could have never completed the analyses. I sincerely thank Humberto Triana, Nestor Garcia, Diego Renteria, and Fernando Manjarrez for making time in their very busy schedules to meet with me whenever I needed, and giving me complete access to all their information. I am especially indebted to Fernando Carrizosa, not only for being my "information gathering coordinator", but also for instilling in me a very special kind of affection for the Bogota Water Company. I also need to thank Felipe Arango, for discussing the ideas that gave birth to this thesis with me, proofreading the document as many times as I thought were needed, and especially for his endless support and his willingness to believe in me. Along the many crises that emerged while writing this document, he was always sure I would finish on time. Finally, I need to thank my family, my parents and my brother. They have been my pride and inspiration for my entire life. I would have never made it this far without their support. I dedicate this work to them.