Chapter 5

Economic Analysis for Highway

Highway Engineering 2
 Introduction

Practice of engineering involve many choices among

alternative designs, procedures, plans, and methods.
Question – will the benefit of the project worth the cost?
(Will it pay?)
Basic questions and issues – what approach to be taken,
what data are needed, what analytical techniques to be
used.
Basic issues in analysis

A project to improve safety at railroad

grade crossing because of accident or
time delays at the crossing site.

HOW to solve this problem?

WHAT is another alternatives?

WHICH of the solution/alternatives

worth the cost?
 Alternative 1 Alternative 2
Install gates and flashing light Construct a grade separated overpass
 Objectives

 General objective : to furnish the appropriate information about the outcome of each
alternative so that the selection can be made.
 Some of the specific objectives in carrying out economic evaluation are:

I. To decide whether the scheme under consideration is worth investment at all

II. To rank the scheme competing for scarce resources in order of priority
III. To compare and select the most economic and
IV. To assist in phasing the program
 Basic Principles

 Economic analysis involves choice between alternatives.- do nothing or improvements >>

to select the most attractive solution.
 In economic analysis, all past actions are irrelevant and the prime importance is the future
flow of costs and benefit.
 View point of the nation as a whole – not to any subset i.e highway agencies, truck or
busses operators.
 Economic analysis should not be misunderstood with financial analysis.
 Economic analysis should take place within a set of established criteria, such as minimum
attractive rate of return, interest rate, etc.
 Selecting and measuring evaluation
criteria

Criteria selection is a basic element of the

evaluation process because the measure used
becomes the basis on which project is compared.
 Criteria must be closely related to the stated
objective.
 Criteria not only relevant to the problem but
should have other attributes.
 Criteria should be easy to measure and
sensitive changes made in each
alternatives.
 Evaluation based on economic criteria

 To consider economic worth of improvement : calculate improvement cost & compare

with the cost maintain the facility in its present condition (the do nothing alternative)
 Two approaches:
1. Compare diff in cost and diff in benefit - select project if net increase in benefit > net
increase in cost
 2. Consider total cost each alternatives, including user and facility, -> select project with
lowest total cost
 Need to identify elements of cost:
1. facility costs – construction, maintenance, operation
2. user costs – travel time, accidents, vehicle operating cost (voc)
 Facility Costs

 Two components:
– first cost (design, row (right of way), construction)
- continuing cost (annual maintenance, operation and administration)
 Cost common to both project can be excluded - since the concern
is in cost differences.
 For most capital projects, a service life must be determined and
 Estimate salvage value at end of service life (salvage value is the
worth of an asset at the end of its service life)
 Road User Costs

 Includes – voc, travel time, and accidents

 Sometimes referred as benefits due to the saving or reduction in user cost
 Road user cost factors –
1. VOC – (vehicle operating cost) significant items since improvement that result in major
cost reduction for example a road improvement that eliminates grades, curves and traffic
signals (shortening the route). (fuel, lubricant, tires, parts, maintenance, depreciation, toll,
road tax, insurance, interest)
2. Travel time – increase speed & reduce travel time, how to convert?? Eg. Private &
commercial vehicle (time value, passenger, good, vehicle)
3. Accident costs – need to estimate number and type of accidents -> fatality, injuries,
property damage, injury-related accident valued from insurance data, human life??
4. Society – environment, land value, discomfort & inconvenience
Road User Costs
 Benefit from Highway Scheme

 Represent the difference in cost with new facility compare to the

old facility.
 Can be grouped into, benefit to:
1. Existing traffic, by reducing road user cost
2. Generated traffic
3. Diverted traffic from other routes and modes
4. Traffic operating on other routes and modes via reduction of traffic
by new facility
 Time Value of Money

 Fundamental premise on which all economic evaluation methods rest is that

money earns over a period of time
 RM100 today will be worth RM672.75 at the end of 20 years if invested at 10%
compound interest rate
 Also, RM672.75 which might become due after 20 years from today is worth
RM100 at present, assuming same interest rate
 Therefore, need to devaluing future benefits and cost to present time to
determine present worth
 Process of calculating PW of future known as “discounting” and interest rate used
called “discount” rate
 Formulae

i = an interest rate per interest period

 To find F, given P (F/ P-i-n) : (also sometimes represented by r)
F = 𝑃(1 + 𝑖)𝑛 n = number of interest period
P = present sum of money
 To find A, given P (A/ P-i-n) :
F = a sum of money at the end of n
A=P[
𝑖(1+𝑖)𝑛
] periods from the present date that is
(1+𝑖)𝑛 −1 equivalent to P with interest i
 To Find F, given A (F/ A-i-n) : A = the end of period payment or
(1+𝑖)𝑛 −1 receipt in a uniform series (annual)
F=A[ ]
𝑖 continuing for the coming n periods,
the entire equivalent to P with
interest i.
Cash Flow Diagram

o In solving economic problem, useful to

visualize the cost and revenue
(benefit) that will occur over the life
time of the project using cash flow
diagram.
o In this diagram, time is plotted along
the horizontal axis , while money along
the vertical axis.
o The relationship between actual,
Present [P], future [F], and annual [A] is
illustrate in the cash flow diagram.
 Economic Analysis Methods

Present Worth (PW)/ Present Value

Equivalent Uniform Annual Cost (EUAC)/ Annual Worth
Benefit Cost Ratio (BCR)
Internal Rate of Return (ROR)
All will produce same results but just a matter of
convenience.
 Present Worth

 PW – the most straight forward since represent current value of all the costs that will be incurred
over the lifetime of the project.
𝐶𝑛
PW = 
(1+𝑖)𝑛
𝐶𝑛 = Facility and user costs incurred in year n
n = service life
i = discount rate
Example:
As a routine maintenance work, RM.20 000/- each is to be spent on a particular stretch of a
highway during the 3rd year, 5th year and the 7th year.
Calculate the total present worth of these expenditures, if the annual discount rate is 12%.
 Present Worth

Example:
As a routine maintenance work, RM.20 000 each is to be spent on a particular stretch of a
highway during the 3rd year, 5th year and the 7th year.
Calculate the total present worth of these expenditures, if the annual discount rate is 12%.

 The present worth of the maintenance investment is

 1 1 1 
RM 20,000    
1.12
3
1.12 5
1.12 7 
 Net Present Worth (NPW)

 NPW – present worth of both cost and benefit (net: difference in cost and benefit of a
project)
 Discount rate (i) used to convert money to particular time -> depends on risk and
economic conditions
 Use cash flow diagram to depict costs and revenues (benefit)
 Benefits are treated as + ve and costs are treated - ve
 Select project with a positive NPW or highest NPW

𝐵𝑛 −𝐶𝑛
NPW =  [ ] Or
(1+𝑖)𝑛
where,
Bn is the benefit of the nth year,
Cn is the cost of the nth year,
n is the number of years.
Net Present Worth (NPW)
 Example 1 NPW

 The cost of improving an existing road, 25 km stretch is RM 4 million per km. The costs of
road users, accident and maintenance for with and without improvement are tabulated
below for a 10 year period after the completion of the improvements. Assuming a
discount rate of 10% find out whether the project is economically viable. Use NPW
method.
Year (n) Road User Costs Accident Costs Maintenance Costs Benefit NPW
With Without With Without With Without
0 -100 -100
1 105.5 126.5 1.1 3.1 3.5 2.5
2 110.3 132.2 1.1 3.1 3.5 2.5
3 115.8 138.9 1.2 3.5 3.5 2.5
4 121.6 145.8 1.2 3.7 3.5 2.5
5 127.6 153.0 1.3 3.8 3.5 2.5
 Example 1 NPW

Year (n) Road User Costs Accident Costs Maintenance Costs Benefit NPW
With Without With Without With Without
6 134.0 161.0 1.3 4.0 3.5 2.5
7 140.7 168.9 1.4 4.0 3.5 2.5
8 147.8 177.0 1.5 4.4 3.5 2.5
9 155.1 186.2 1.6 4.7 3.5 2.5
10 162.9 195.2 1.6 4.9 3.5 2.5
Total

…Continued
 Cost of improvements = RM 4 million x 25 km = 100 million
 NPW = RM --- million, since the NPW is positive, the project is economically viable
Net Present Worth (NPW)

NPW = -Co - [𝐶𝑛 - 𝐵𝑛 ] (P/A - i – n)

Co : capital cost / first cost

Cn : continuing costs (maintenance, operating, etc)
Bn : benefits ( saving, salvage, revenues etc)
(1+𝑖)𝑛 −1
(P/A - i – n): P = A [ ]
𝑖(1+𝑖)𝑛
 Example 2 NPW

 The department of Traffic is considering three improvement plans for a heavily traveled
intersection within the city. The intersection improvement is expected to achieve three
goals : to improve travel speeds, to increase safety and to reduce operating expenses for
motorists. The annual dollar value of savings compared with existing conditions for each
criterion as well as additional construction and maintenance costs is shown in table. If the
economic life of the road is considered to be 50 years and the discount rate is 3 percent,
which alternative should be selected? Solve the problem using the NPW methods for
economic analysis.
 Example 2 NPW

Alternative Construction Annual Annual Travel Annual Annual

Cost Saving in Time Benefits Operating Additional
accident Savings Maintenance
Cost
I $ 185 000 $ 5 000 $ 3 000 $ 500 $ 1 500
ll $ 220 000 $ 5 000 $ 6 500 $ 500 $ 2 500
lll $ 310 000 $ 7000 $ 6 000 $ 2 800 $ 3 000
 Benefit Cost Ratio

 The ratio of the present worth (PW) of Net project benefits (all of the savings, revenue &
etc) and Capital costs is called the benefit – cost ratio (BCR).
 BCR used to show extend to which investment will result in benefit to society
 Negative flows are considered costs and positives flows as benefits.
 The saving in the transport cost are considered as benefits.
 If the B/C ratio is more than one, the project is worth undertaking.
 Need to do comparison to determine added benefit with added investment
BCR 2/1 = (B2 – B1) / (C2 – C1)

B/C = benefit in the reference year / Capital costs

 Cost and Benefits

 The economic analysis of highway schemes is generally done by computing the total
transport cost which consists of the following components:
I. Cost of construction of the facility
II. Cost of maintenance of the facility
III. Road user cost
IV. Cost to the society
 The agencies providing the facility incurs expenditure in construction which includes land
acquisition, earthwork, road pavement and structures. These agencies also invest money
in maintenance.
 Example 1 BCR

 A single lane road 40 km long, is to be widened. Cost of widening is RM 2 million per km

inclusive of all improvements. The cost of vehicle operation on the single lane road is RM2
per veh per km, whereas RM1.50 per veh per km on the improved road. The average
traffic is 2500 veh/day over the design period of 20 years. The interest rate is 10% per
annum. The cost of maintenance is RM 5 500 per km on the existing road and RM 10 000
per km on the improved road. Check whether the investment is worthwhile.
Solution:
Annual road user cost on existing road

Annual road user cost on improved road

Difference in annual maintenance costs

 Example 1 BCR

Total cost of improvements (present)

Find the annual given present for n = 20, i= 10%

𝑖(1+𝑖)𝑛
A=P[ ]
(1+𝑖)𝑛 −1

B/C = benefit in the reference year / annual cost

= [(Difference road user cost on existing & improved road) - Different in annual maintenance costs ]/
Annual total cost of improvement
 Existing road Improved road Benefits
Annual : RM 2.00 x 2500 x RM 1.50 x 2500 x 365 RM 73 -54.75 = RM
Road user cost 365 x 40 = 73 x 40 = 54.75 millions 18.25 millions
millions
Annual : RM5500 x 40 km = RM10 000 x 40 km = RM 220 000 –
Maintenance costs Rm 220 000 Rm400 000 RM400 000 =
-180 000
18.25 – 0.18 = 18.07
Capital cost of RM 2 000 000 x 40 km = RM 80 millions
improvements
Annual : RM 80 x (A/P – 10 – 20) BCR = 18. 07/9.40
Cost of improvement RM 80 x 0.11746 = RM 9.40 M = 1.92 > 1.0
 Example 2 BCR

 The department of Traffic is considering three improvement plans for a heavily traveled
intersection within the city. The intersection improvement is expected to achieve three
goals : to improve travel speeds, to increase safety and to reduce operating expenses for
motorists. The annual dollar value of savings compared with existing conditions for each
criterion as well as additional construction and maintenance costs is shown in table. If the
economic life of the road is considered to be 50 years and the discount rate is 3 percent,
which alternative should be selected? Solve the problem using the BCR methods for
economic analysis.
Alternative Construction Annual Annual Travel Annual Annual
Cost Saving in Time Benefits Operating Additional
accident Savings Maintenance
Cost
I $ 185 000 $ 5 000 $ 3 000 $ 500 $ 1 500
ll $ 220 000 $ 5 000 $ 6 500 $ 500 $ 2 500
lll $ 310 000 $ 7000 $ 6 000 $ 2 800 $ 3 000
 BCR l/DN = [(-1500 + 5000 + 3000 + 500) / (185 000 x (A/P -3-50)]
 BCR ll/DN = ?
 BCR lll/ll or BCR lll/DN =