CHAPTER 6: ROAD AND
HIGHWAY ECONOMICS
AND FINANCE
Cost Component of Transportation System
Agency(owner) Cost
Construction cost
Maintenance cost
User Cost
Vehicle operating Cost (VOC)
Cost due to traffic congestion and restraint
Cost due to accident
Cost of travel time
What is Transport Economics?
An applied area of economics which is
concerned with the efficient use of society’s
resources for the movement of people and
goods from an origin to destination.
Components are:
Various cost component of highway projects
The economic feasibility of alternative highway projects
Decision on scheme of investment on a project at its various
stages
Agency Cost
Construction cost involves:
Surveying, planning and design
Acquisition of land
Construction of highway
Installation of traffic control devices
Cost of supervision, quality control and administrative
cost
Installation of other transportation facilities
Agency Cost
Maintenance Cost involves:
Periodic repair/routine maintenance
Major rehabilitation
Operational expenditure of traffic facility
Supervision and installation charges
User Cost
The cost of owning and operating vehicle is called
Vehicle Operating Cost (VOC) which involve variable
and fixed cost
Variable Cost
Distance related like fuel, spare parts, etc
Time related like depreciation, wages of crew, value of
passenger time
Fixed Cost
Capital cost
Registration fees
Insurance and other taxes
User cost
Cost due to traffic congestion and restraint
Congestion due to renovation(restore)
Reduction of speed
Complete restraint to movement
Delay in traffic time is a function of:
Road geometrics
Traffic volume
Time and duration of road renovation
User Cost
Cost due to accident
Cost of human lives and human agony
Loss due to injury
Cost of hospitalization
Damage to property and vehicles
User cost
Cost due to travel time is dependent on:
Better quality of roads
New road diversion
Exclusive expressways
Person’s wage
Beneficiaries
Passenger
Transport operator
Travel time
Factors affecting the quantification of the cost of
travel time
Person’s wage
Purpose
Work trip
Recreation
Non-working time
Benefit Component of Transportation System
The objectives of transportation is to provide an
efficient, quick and safe transportation.
Road user benefits includes
Savings on VOC
Savings of travel time
Savings in terms of accident cost
Savings in the cost of maintenance
Benefit Component of Transportation System
Social benefits includes benefits due to the
improvement of:
Administration
Health
Education
Industry
Trade
Environmental standards and etc.
Concepts in estimating travel time savings
In monetary benefit, the user could choose
whenever desired
Time saved in travelling must be used in another
activity to presents the saving
The choice of activity has direct influence on
determining its value
The more productive the activity, the higher the
value of time
VTTS for non-commercial vehicle
Two classes of non-commercial vehicle
Non-working time
Commercial and leisure time
Working time
Working time saving have higher values than non
working time
The least saving time is reflected on leisure time
Causes of time saving
Improved running speed
Shortened travelling distance
Higher speed limits
Improvement in equipment
Off-peak scheduling in travel movements
Ref( National Highway Cooperative Research Program)
Value of Commercial Vehicle Time Saving
They are the major users of highway network
In some areas almost 10%of traffic volume consists
of commercial vehicles
They spend more time in the network
VCVTS consists of value of time saving for the
driver, vehicle and the types of cargo
Methods of Calculating VCVTS
Net Operating Profit Method (Revenue)
Based on the assumption that resources freed by the
time saving are used to supply additional input
One hour of time saving =one hour of operation =one
hour of net operating profit
Generalized Cost
It may be considered in terms of distance, time,
money or a combination of these.
The generalized cost is a linear function
It includes weighted coefficients
Coefficients attempt to present their relative
importance as perceived by the traveler
The Time Value of Money
The way interest operates reflects the fact that
money has a time value
The amount of interest depends on length of time
and the rate of interest most of the time’ yearly
It is cost to the borrower and an earning to the
lender above and beyond the sum borrowed or
loaned
Cash Flow
21
The estimated inflow (revenues) and the outflow
(Costs) of money are called cash flow.
The cash flow diagram is used to evaluate money
along with its equivalent with time: forward time or
backward time
Cash Flow
22
Engineering projects generally have economic
consequences that occur over an extended period of
time
For example, if an expensive piece of equipment is brought
on credit, the simple process of paying for it may take
several years
The resulting favorable consequences may last as long as
the equipment performs its useful function
Each project is described as cash receipts or
disbursements (expenses) at different points in time
Categories of Cash Flows
23
The expenses and receipts due to engineering projects
usually fall into one of the following categories:
First cost: expense to build or to buy and install
Operations and maintenance (O&M): annual expense,
such as electricity, labor, and minor repairs
Salvage value: receipt at project termination for sale or
transfer of the equipment (can be a salvage cost)
Revenues: annual receipts due to sale of products or
services
Overhaul: major capital expenditure that occurs during the
asset’s life
Cash Flow diagrams
24
The costs and benefits of engineering projects over time
are summarized on a cash flow diagram (CFD).
Specifically, CFD illustrates the size, sign, and timing
of individual cash flows, and forms the basis for
engineering economic analysis
A CFD is created by first drawing a segmented time-
based horizontal line, divided into appropriate time unit.
Each time when there is a cash flow, a vertical arrow is
added pointing down for costs and up for revenues or
benefits. The cost flows are drawn to relative scale
Drawing a Cash Flow Diagram
25
In a cash flow diagram (CFD) the end of period t is the same
as the beginning of period (t+1)
Beginning of period cash flows are: rent, lease, and
insurance payments
End-of-period cash flows are: O&M, salvages, revenues,
overhauls
The choice of time 0 is arbitrary. It can be when a project is
analyzed, when funding is approved, or when construction
begins
One person’s cash outflow (represented as a negative value)
is another person’s inflow (represented as a positive value)
It is better to show two or more cash flows occurring in the
same year individually so that there is a clear connection
from the problem statement to each cash flow in the diagram
Example 1
Mr. Biruk deposited B125,000 in CBE, after 2
years he withdrew B13,600. after another 2
years, he again withdrew B9,500. if he wish to
withdraw all hi savings after 5 years form the
time of his deposits, how much amount he will
receive? at an interest rate of 3%.
Soln use compound interest formula
soln
After two years =b*(1+r)^t=125000*(1+0.03)^2
=132612.5biirr
Net=132612.5-13600=119012.5birr
After another two years = 119012.5*(1+0.03)^2
=126260.36birr
Net =126260.36-9500=116760.36birr
After 5 years =116760.36*(1+0.03)=120263.17birr
Time Value of Money
28
The change in the amount of money over a given
time period is called time value of money; it is the
most important concept in engineering economy
Money has value
Money can be leased or rented
The payment is called interest
If you put $100 in a bank at 9% interest for one time period
you will receive back your original $100 plus $9
Time Horizon
Time span use to determine the investment for
highway construction, maintenance and benefits
Mostly estimated to 20 to 30 years depending on
policy and type of road
Commonly termed as economic analysis period
Interest Rate
30
The time unit of the rate is called the interest
period.
The most common interest period used to state an
interest is one year.
Shorter period such as percent per month is also
used.
If time unit is not stated, it is assumed to be one
year.
Simple Interest
31
Simple interest
It is calculated using the principal only, ignoring any
interest accrued in preceding interest periods
The total simple interest over several periods is computed
as
Interest =(principal)(number of periods)(rate)
compound interest
Interest that is computed on the original unpaid debt and
the unpaid interest
Compound interest is most commonly used in practice
Interest = (principal + all accrued interest)(interest rate)
Future Value of a Loan With Compound Interest
32
Amount of money due at the end of a loan
F = P(1+i)1(1+i)2…..(1+i)n or F = P (1 + i)n
Where,
F = future value and P = present value
P=F(1/(1+i))n=F(1+i)-n is the
single payment present worth factor.
Example 2
33
How long will it take for an investment to double at
5% per year (a) simple interest and (b) compound
interest?
A construction company that specializes in road
construction made an investment 10 years ago that
is now worth $1.3M. How much was the initial
investment at an interest rate of 15% per year (a)
simple interest and (b) compound interest?
Soln for 1
In simple interest F=b(1+nr)=b(1+0.05*n)=2b
1+0.05n=2, n=1/0.05=20years
In compound interest f=b*(1+r)^t=2b
(1+0.05)^t=2
Log(1.05^t)=tlog1.05=log2
t= log2/log1.05=14.2years
Soln for 2
A. Simple interest
F=1300000, r=0.15, n=10, b=?
F=b(1+nr)=b(1+10*0.15)=b(2.5)=1300000
B=520000
B. Compound interest
F=b(1+r)^t=b(1+0.15)^10=4.046b=1300000
B=321304.99birr
Equivalence
36
Relative attractiveness of different alternatives can
be judged by using the technique of equivalence
We use comparable equivalent values of
alternatives to judge the relative attractiveness of
the given alternatives
Equivalence is dependent on interest rate
Compound Interest formulas can be used to
facilitate equivalence computations
Technique of Equivalence
37
Determine a single equivalent value at a point in
time for plan 1.
Determine a single equivalent value at a point in
time for plan 2.
Both at the same interest rate and at the same time point.
•Judge the relative attractiveness of the
two alternatives from the comparable
equivalent values.
Engineering Economic Analysis Calculation
38
Generally involves compound interest formulas
(factors)
Compound interest formulas (factors) can be
evaluated by using one of the three methods
Interest factor tables
Calculator
Spreadsheet
An Example 4 ( of Present Value)
39
As a routine maintenance work, 200,000 birr each is
to be spent on a particular stretch of a highway
during the 3rd, 5th and the 7th year. Calculate the
total present worth of these expenditures, if the
annual discount rate is 12% compounded annually?
soln
Convert each to present
P1=f(1+r)^-t=200000*(1+0.12)^-3
=142356.049
P2=f(1+r)^-t=200000*(1+0.12)^-5
=113485.37
P3=f(1+r)^-t=200000*(1+0.12)^-7
=90469.84
P=p1+p2+p3=142356.049+113485.37+90469.84
=346311.26
Uniform Present Worth Factor (P/A)
41
P=?
1 2 3 n-1 n
A= given
1 i 1 n
P A n
i 1 i
The reverse of this formula is called the capital recovery factor
Uniform Future Worth Factor(F/A)
42
F=?
0 1 2 3 n-1 n
A= given
1 i n 1
F A
i
The reverse of this formula is called the sinking fund factor
Appraisal and Evaluation
The most sophisticated method of project appraisal
and evaluation have been developed and applied in
transport sector
Appraisal is the assessment before the project
implementation
Evaluation is the assessment after the project
implementation
Appraisal
It is one of the most important applications of
transport economics
It is used to assess whether a given transport
project should be carried out
The assessment is used to compare the cost of the
project with its benefits
This method is applied in transport project when
the funding is constrained
Value of Time Assumptions
Travel time savings must be converted from hours
to money in order for benefits to be aggregated and
compared against cost in analysis.
In this analysis assumption of values of time
(VOT) estimates as percentages of the average
wage rate, which can be taken from review of other
studies
Economic Cost and Assumption Included in the
Evaluation
Initial Project Investment Cost
Annual Operating and Maintenance Cost
Periodic Capital Equipment Replacement Cost
Salvage Value/ Residual Value
Cost- Benefit Analysis
47
It is a systematic process for calculating and
comparing benefits and cost of a project, decision or
policy.
Present and future benefits (income) and costs need
to be estimated to determine the attractiveness
(worthiness) of a new product investment alternative
It has two purposes:
To determine if it is a sound investment/decision
To provide basis for comparing projects
Benefit/Cost Ratio
48
Initially used in the economic analysis of public
sector evaluation by reducing the effect of politics
and special interest
It can use equivalency computation based on PW,
EUAW and FW values.
Benefit Cost Analysis of a Single Project
49
The B/C ratio is calculated using one of these
relations:
B/C=PW of benefits/PW of costs
B/C=AW of benefits/AW of costs
B/C=FW of benefits/FW of benefits
If B/C≥ 1.0, accept the project as economically
acceptable for the estimates and discount rate applied.
If B/C <1.0, the project is not economically acceptable.