Once the hurdle rates has been estimated, i.e. the cost of capital and its components including the cost of equity, it is useful to try to generate estimates of the rates of returns on assets and on equity to get a sense of the extent to which risks are consistent with the returns earned. To do so we rely on accounting data to measure each company’s overall return on the capital invested in each infrastructure project since 1998.<sup>12</sup> In theory, several measures of the effective returns earned by the operators can be used such as the return on assets, the internal rate of return or the return on equity. The first two measures can however not be estimated due to data problems. We have to rely instead on the return on equity (RoE) which is the least complete indicator of the three. The return on equity (RoE) is a measure of the after tax return the company is earning on its equity capital. It reflects the profits a company is able to generate given the resources provided by its shareholders. It is the ratio of the project’s net income divided by the shareholders’ equity investment in the project and can be expressed as: where: Shareholders’ equity = total assets minus total liabilities ; and, Net income = after-tax profit The main problem with this measure is that it is unclear whether it underestimates or overestimates the returns of a business. First, in the short run, it tends to overestimate returns because it assumes that all the income generated by a project represents compensation for shareholders. Indeed, at least in the early years of a project, investors receive only a portion of a project’s net income. The rest is reinvested in the company and produces income for investors only when the company is sold or transferred back to the government—provided that transaction occurs at a market price higher than the initial investment and shareholders are compensated for the value they created by reinvesting what otherwise would have been compensation. Thus the estimates reported here should be seen as a ceiling on shareholders’ potential returns in the short to medium run at least. Second, it is the victim of more subtle accounting conventions which tend to underestimate the actual returns of these infrastructure operations in developing countries. The best known source of underestimation is the fact that many infrastructure operators enjoy implicit or explicit management contracts, in addition to the concession or license to provide a service. These management contracts tend to give rise to fees paid to the headquarters but which appear as cost in the financial accounting of the local companies. These fees provide in fact a lower bound for the return to the operation.

With the limitations pointed out throughout this section, the RoE is likely to be an upper bound of the return on equity-ignoring the return generated by the management fee. In our analysis, we thus compare the RoE of each company to the corresponding Cost of equity, (CE). When the RoE is higher than the appropriate CE, returns are higher than alternative of

> 12 Due to data limitations and because many of the companies in the sample are non-traded companies, the study utilizes book values (in the weighting of cost of capital) instead of market values. As an unintended, and potentially misleading consequence, the resulting WACC may be understated. Conversely, if book values are higher than market values, WACC may be erroneously inflated.

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