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Poland's A2 Motorway Case Solution

Solution Id Length Case Author Case Publisher
887 1273 Words (5 Pages) Benjamin C. Esty, Michael Kane Harvard Business School :202030
This solution includes: A Word File A Word File

This category of risk comprises all the natural disaster on which humans have almost no or some control at all. It includes but not limited to the explosions, epidemics, contamination, floods, war, revelatory and riots. This category of risk is majorly covered with insurance and government guarantees. However, it is covered to only .65 million Euros p.a. If the losses amount exceed to that amount and not covered by the insurance then AWSA will have to bear the risk.

Following questions are answered in this case study solution

  1. What are the major risks in this project? Have they been properly identified, assessed, and mitigated under the current structure?

  2. Who bears the major risks? What factors determine who should bear the major risks?

  3. What are the various strategies you can use to manage project risks? For example, when is it appropriate to prevent, hedge, insure, allocate, or bear particular risks?

  4. How should Wojciecki Gebicki respond to the banker’s concerns in June 2000?

Case Analysis for Poland's A2 Motorway

i. Government Policy

The duration of the project is very long. As government changes, their policies can also change with time. These changes in policies might bring some risks for the project, and if this happen, government will bear that risk. This risk is effectively hedged.

ii. Model Risk

Revenues are projected through financial modeling. It is very famous about financial models that “Garbage in, garbage out”. In simple words projections depends on assumptions and input. One assumption is that 50% of the traffic capacity would be captured. As seen in some other cases, tolled motor ways has actually captured only 10 to 20% of the total capacity. In this case revenue would be substantially less than the projections. This assumption presents a major risk; even Standard and Poor analyst had concern over the assumption.  Two other key assumptions are that purchasing power parity will hold and corporate taxes would decrease. No doubt these assumptions are consistent with the government assumptions but if the economy was not turned as expected. Government most probably will not decrease the taxes and purchasing power parity will not hold.  All this presents substantial model risks. According to the data present in case this risk is not hedged properly.

iii. Traffic risk

M1 ran about 35% below original projections. Main reasons mentioned in the case for this includes currency weakness, customs delays at the Austrian border, and a good secondary road parallel to the M1." Another reason for such low traffic could be a high price charged by M1. A2 has set up initial price as low as around 50% of the price charged by M1, still there is a chance that traffic might run below the initial forecasts. As mentioned is the case, usually traffic runs 50% below the forecasted figures. This situation happened with M1, and it has to go through near bankruptcy of the operator and debt rescheduling. If same happens with A, this also present a major risk, and it is somewhat hedged with government guarantee.

iv. Cost Overrun and delay Risk

Usually new projects’, with long durations costs exceed substantially, which become a reason of cost over run risk. In this case cost is fixed by Development Company (DC). Only in case of design change, costs will increase. Such increment will be very minor as compared to the total project cost. This risk is properly hedged by AWSA. Another risk in this category can be arisen because of Design Company not being able to complete the construction on time. If the situation arose, Design Company will be responsible for the losses occurred. In the worst case if maximum damages reached, AWSA will have to find out new construction companies that might increase cost and delay the construction. New company first might not be willing to join because an experienced dc could not deliver the project terms. Second even if a company is willing to continue the project, it will delay the project and increase its costs. Even it is the worst case scenario, but this risk is not hedged properly.

v. Exchange Rate Risk

AWSA’s revenue in PLN but loan amount is in Euros. This has created an exchange rate risk, which is not hedged. 

vi. Other risks

Another risk can be revenue projections not met because of various factors. Revenue depends on strengths of the regional economy, trade patterns, and alternative transportation route. All these factors can be the reason of not meeting revenue projections. Some of this risk is managed through commercial insurance. Delivery of lease might not occur on time, which might create an obstacle in the releasing of construction funds. Government may not be able to deliver rights to the property on time. Even though these factors look very minute issues but can be a reason for delay in the project completion. Termination of the contract for a cause or public interest presents another risk for AWSA. Even though, AWSA will get the present value of the future revenue. They will have some reinvestment risk.

Who bears the major risks?  What factors determine who should bear the major risks?

AWSA’s shareholders bear the major risk. One of the main factors is who have first charges on the project assets. Parties with first charge, usually senior debt holders, bear the minimum risks. On the other hand, parties with last charge bear the maximum risks. Another factor is who will receive payment first. AWSA’s shareholders will be the last ones to receive the payments. They will have to wait more than 10 year for receiving their first payment. Also, in case of liquidation, they will be the last ones to receive any leftover amount. If nothing is left after paying senior debt holders and zero-coupon bond holder, equity holders will not get anything. 

What are the various strategies you can use to manage project risks?  For example, when is it appropriate to prevent, hedge, insure, allocate, or bear particular risks?

Main strategies for managing the project risks include:

  1. Risk Prevention

  2. Risk Hedging

  3. Insurance

  4. Risk Sharing/Allocation

  5. Running the risk

Risk Prevention is used when the costs of preventing the risks are lower than the amount at risk. Usually this category includes risks that can be predicted and steps can be taken to prevent them. These are usually minor risks.

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