Modeling the Financial Impact of Regulatory Policy: Practical Recommendations and Suggestions. The Case of World Bank

43 Pages Posted: 24 Aug 2004

See all articles by Ignacio Velez-Pareja

Ignacio Velez-Pareja

Grupo Consultor CAV Capital Advisory & Valuation

Date Written: August 20, 2004

Abstract

World Bank (WB) has played a crucial role in the development of the economies of the world, especially in the emerging countries. We recognize the leadership it has shown and the intellectual authority the WB has on planning offices, practitioners and consultants. For this reason it is very sensitive whatever improvements made in the methodologies it uses in assessing the feasibility of infrastructure projects. This influence affects private practice in valuation and project appraisal as well.

Velez-Pareja in 1999 warned: constant price methodology implies some assumptions and a mixture of items, some deflated, and some others not deflated. Velez-Pareja and Tham 2002 warned again: financial statements at constant prices will be useless when the project is implemented because what occurs in reality (that is what we are interested in) is very different from what is written in the final report of a project evaluation. Some of the items are deflated while others (say depreciation charges and interest payments) are in nominal prices. Hence, for managerial purposes, it is of no use to have this mixed information in the financial statements. In general, both papers warn about the overvaluation of a project when appraised at constant prices. Some reactions to these assertions were that it was the construction of a straw man to destroy it. We have a beautiful case where the constant prices methodology is fully at work: the Financial Modeling of Regulatory Policy by the World Bank.

On the other hand Tham and Velez-Pareja 2004 mentioned the most frequent (and avoidable) mistakes when valuing cash flows.

In this paper we show how in that case they present several conceptual mistakes such as valuation at constant prices, mixing deflated and non-deflated items in financial statements, using constant leverage when in the forecasted financial statements it is not constant, inconsistency in the cash flow and value calculations and some other irregularities that will be described in the body of the paper. This analysis shows an overvaluation of more than 21% when the constant prices methodology is compared with the current prices methodology and using market values to calculate the WACC.

The last two appendixes show the correspondence between the author and officials and consultants from the World Bank.

Keywords: World Bank, regulatory policy for infrastructure, developing countries, project evaluation, project appraisal, firm valuation, cost of capital, cash flows, free cash flow, capital cash flow

JEL Classification: M21, M40, M46, M41, G12, G31, J33

Suggested Citation

Velez-Pareja, Ignacio, Modeling the Financial Impact of Regulatory Policy: Practical Recommendations and Suggestions. The Case of World Bank (August 20, 2004). Available at SSRN: https://ssrn.com/abstract=580042 or http://dx.doi.org/10.2139/ssrn.580042

Ignacio Velez-Pareja (Contact Author)

Grupo Consultor CAV Capital Advisory & Valuation ( email )

Ave Miramar # 18-93 Apt 6A
Cartagena
Colombia
+573112333074 (Phone)

HOME PAGE: http://cashflow88.com/decisiones/decisiones.html

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