The amount of risk premium included in the cash flows to be discounted will be determined by the private partner's risk tolerance and its desire to be competitive in the bidding process.
Bidders that are more risk averse will include more of the quantified risks in their costs. If they are the successful bidder the result will be a higher ASP that increases the cash flow to the project. This, in turn, reduces the risk to the investors who will require a lower return in order to remain competitive. The lower return will be reflected in a lower WACC, and consequently, a lower discount rate for a project.
If bidders are less risk averse, on the other hand, the opposite will be the case. A bidder that decides to include fewer of the quantified risks in their price will have a lower ASP, potentially resulting in greater uncertainty in their cash flow. This increased uncertainty can be expected to result in investors demanding higher returns. These higher returns will increase the WACC, making the discount rate higher.
Although the discount rate takes into account the overall risk of a project, it is not directly related to the specific risks quantified in the risk analysis, and continues to address several sources of remaining uncertainty (risk) associated with a project. First, although the risk analysis is comprehensive, it is not possible to quantify the potential cost of every risk associated with a project. There remains the potential for unknown unknowns and additional, un-quantified risks that can affect the outcome of a project. Second, with respect to the estimated cost of risks that are quantified, their expected cost is based on a specific probability level (i.e., P50). This estimate, although very useful for determining the potential financial impact of identified risks, still leaves some variability, or uncertainty, regarding the actual outcomes around that value. Finally, correlation can exist between risks. This means that, although the expected cost of individual risks are estimated, additional risk lies in the degree of correlation between these risks (i.e. the extent to which they interact and move together when they occur), which can have the effect of amplifying their outcome. For these reasons it would not be appropriate to use a risk-free discount rate to evaluate project cash flows, even though an estimate of the potential cost of many key risks is included in the cost estimate.