Fine-tuning the value and cost of capital of risky PPP infrastructure projects Andreas Wibowo and Hans Wilhelm Alfen Faculty of Civil and Structural Engineering, Bauhaus University of Weimar, Weimar, Germany Abstract Purpose – The present paper aims to introduce a new methodology taking risk behavior of decision maker into account to fine-tune the value of a risky public-private-partnership (PPP) project and the corresponding cost of capital based on the target rate of return set by the project sponsor and the degree of project risks. Design/methodology/approach – The proposed methodology combines the cumulative prospect theory (CPT) to characterize the risk preference of the project sponsor and the Monte Carlo simulation to assess the project riskiness. The methodology requires a pre-set target rate of return that will define the relative gains and losses for a prospect theory project sponsor. The application was illustrated using a build/operate/transfer toll road project as a case study. Findings – As the project sponsor sets a greater target return, the probability of the project not meeting the target is accordingly greater. Given that losses have greater impact than gains on the decision, other things being equal, a higher target return leads to a higher value correction. It has also been demonstrated that the corresponding project’s cost of capital can be up- or downadjusted depending on the project’s riskiness which may result in a reverse preference to favor a higher risk scenario. Research limitations/implications – The methodology uses the CPT parameters that need to be further confirmed and validated if applied to value large risky projects like PPP investments. Originality/value – The proposed methodology offers a different approach to correctly value a risky PPP project by extending the application of the cumulative prospect theory that well explains the irrationality of human decision behavior under risk into a financial decision-making process. It takes the full benefit of simulation to understand project risks and also assists financial decision-making. Keywords Public-private partnership, Infrastructure, Risk, Cumulative prospect theory, Monte Carlo simulation, Target return, Partnership, Risk assessment Paper type Conceptual paper Introduction The availability of reliable and adequate infrastructure facilities plays a pivotal role in promoting and anticipating the national economic growth. If not as an engine, they can serve at least as the wheel for economic activities (World Bank, 1994). The governments are traditionally responsible for their provision but the fiscal capacities are often extremely limited to make it possible. This requires many governments to seek private financing under a public-private-partnership (PPP) arrangement. The PPP The current issue and full text archive of this journal is available at www.emeraldinsight.com/0969-9988.htm Engineering, Construction and Architectural Management Vol. 20 No. 4, 2013 pp. 406-419 r Emerald Group Publishing Limited 0969-9988 DOI 10.1108/ECAM-11-2011-0097 The material of this paper is part of the research undertaken at the Chair of Construction Economics, Bauhaus University of Weimar. The first author wishes to thank the Alexander von Humboldt Stiftung Germany for the post-doctoral fellowship granted under the Georg-Forster Experienced Researchers Program that supports his long-term research stay at the university. The authors are also grateful to two anonymous reviewers for their valuable comments that improve the quality of the manuscript. 406 ECAM 20,4