Division Objective

The objective of this report is to establish whether the investment in the project creating the company Ciudad De la Luz (CDL) can be qualified as State aid. According to the market economy investor principle, the investment undertaken is considered to be State aid if the expected compensation to be received by the State is lower than what a private investor would have requested under the circumstances of that particular project.

A private equity investor^f1 would have been willing to invest in the CDL project if the expected internal rate of return^f2 was higher than or equal to the opportunity cost of equity capital^f3 (i.e. the return that he could have obtained in a similar project).

In the analysis which follows, we calibrate the Capital Asset Pricing Model (CAPM) to obtain the cost of equity capital. This is the relevant measure that determines whether a private investor would have undertaken the CDL project.

The resulting parameter range is then compared to the ex-post performance of a representative sample of CDL’s competitors. This is the approach adopted by LECG in its submission, namely to use ex-post performance to establish a benchmark for the opportunity cost of capital for this type of projects. As will be seen below, the measure of ex-post performance chosen by LECG is not the correct one to establish a benchmark. More importantly, any ex-post performance metric is an imperfect proxy for ex-ante required returns.

We find that the opportunity cost of capital for this project should be around 14,91 %. Hence, a private investor would require an internal rate of return of more than 14,91 %. According to the business plan proposed by CDL in 2004 (which is the most recent financial information on which the present project is based), the internal rate of return for the investment in CDL was 5,74 %^f4.

Consequently, a private investor would not have invested in the CDL project since its internal rate of return is lower than the opportunity cost of capital.