The decision to seek a franchise extension to October 2015 on the route connecting London to Bristol and Cardiff comes despite Aberdeen-based FirstGroup allowing its current deal to expire in early 2013 rather than 2016 in a move that saved it an estimated £800m in premium payments.
The Department for Transport said operators would not be re-imbursed bid costs as it made a raft of changes to its troubled franchising auction round, including altering proposals for another rail franchise in southern England for which Stagecoach, the Perth-based rail and bus operator, had also been shortlisted.
The Government is also negotiating with FirstGroup over a similar extension to its First Capital Connect London commuter franchise.
Analysts said the development is good for debt-laden FirstGroup because it gives it continued access to the massive season ticket revenues of the Great Western and Capital Connect rail franchises.
It is understood shortlisted bidders for Great Western have spent up to £10m each devising proposals for what is seen as a particularly complex franchise.
The Department for Transport said: "In keeping with the relevant invitations to tender, which made clear that bidders are responsible for their own costs, the Secretary of State does not believe it would be appropriate to reimburse bidders."
A Stagecoach spokesman said: "We put a huge amount of effort into developing detailed plans to deliver the Government's aspirations and improve train services for passengers. It is extremely disappointing that investment has been wasted through no fault of our own."
Alongside FirstGroup and Stagecoach, shortlisted bidders for Great Western included National Express and Arriva, a division of Deutsche Bahn.
The Department of Transport exercised its right to extend the current contract with First Great Western by 28 weeks to October. It will now enter talks with FirstGroup for an additional two-year contract.
The news is a boost to FirstGroup after it was awarded the West Coast franchise, then stripped of it, after the discovery of "significant technical flaws" in the way the process was handled. The debacle led to Virgin Rail, a joint venture with Stagecoach, being handed a contract extension and the Government suspending all franchise bidding.
FirstGroup chief executive Tim O'Toole said: "The extension of First Great Western and First Capital Connect provides continuity and consistency for our passengers and enables us to continue to deliver considerable improvements."
Gert Zonneveld, analyst at Panmure Gordon, said: "We expect the company (FirstGroup) to earn a modest management fee on these franchise extensions. More importantly, the significant season ticket cash balances of First Great Western and First Capital Connect should remain with FirstGroup for another few years, which should support the balance sheet and partly address any short term rights issue speculation."
Stagecoach, run by Sir Brian Souter, is displeased by the Government's decision to change the proposed Thameslink, Southern and Great Northern franchise, of which Capital Connect's routes are a part, to a seven-year management-style contract. These typically pay an operator a fee set slightly above the cost of running the line with less scope for making changes.
Transport Secretary Patrick McLoughlin said: "We have had to take some tough decisions regarding franchising, and while they may provide a challenge, I believe the lessons we have learnt will help deliver a more robust system."
FirstGroup's shares rose 1p to 194p. Stagecoach closed down 1.5p at 306p.