1 CENG5241:HIGHWAY ENGINEERING-III

Chapter-3:
Economic Evaluation
of Highway Projects

Instructor: Amare T.
amentilahun23@gmail.com
 Lecture Outlines
2

❖ Introduction and overview

❖ Time value of Money

✓ Concept of time value of money

✓ Definition of commonly used terms
✓ Compound interest equation
❖ Highway cost and Benefits
❖ Methods of Economic Evaluation of Highway Projects

✓ Net Present Value(NPV)

✓ Benefit-Cost Ratio
✓ Internal Rate of Interest (IRR)

2
 Introduction and Overview
3

 Aspect of project appraisal:

o Engineering Aspects
o Economic Aspects
Engineering Aspects: deal primarily with the
technical construction process and the operating
of the project after it is completed, as well as
with the estimated of capital and operating costs.
Economic Aspects: deal with the economic costs
and benefits from the point of view of the
country as a whole.

3
 Introduction and Overview
4

Terms:
o Engineering Analysis
o Engineering Economic
o Life Cycle Cost (LCC)
o Methods
Engineering analysis
A proper economic analysis should be conducted for
every pavement construction project. In order to
conduct economic analysis, it is necessary to
understand some key concepts and the techniques that
help us to compare alternatives on the basis of
economics and have reasonable estimates of different
types of costs associated with pavement projects. 4
 Introduction and Overview
5

 Engineering Economics:
Economic analysis can be conducted at two levels:
➢ 1st, at the network level to determine the feasibility and
scheduling of a project and,
➢ second, at the project level to achieve maximum economy within
a specific selected project by comparing different alternatives.
➢ For the second case, all of the alternatives must be able to satisfy
the project requirements and should be considered over the same
time period. The economic evaluation of the different
alternatives must consider accurate (as far as possible) estimates
of economic variables and costs and benefits associated with the
pavement.
➢ Life cycle cost (LCC) analysis provides a rational method of
conducting such economic analysis.
5
 Introduction and Overview
6

Concept of Life Cycle Cost

➢ The cost of highway construction/improvement consists
of total initial capital, cost of construction, the cost of
any delays during the period of construction, and cost
of maintaining the facility for its life and road user
costs. Road costs are commonly expressed as per unit
length in economic analysis.
➢ This includes:
✓ Construction
✓ Maintenance and Rehabilitation costs and
✓ Road user cost.

6
 Time Value of Money
7

❖ Concept of time value of money

❖ Definition of commonly used terms
❖ Compound interest equation
 Time Value of Money
8

Concept of time value of money

➢ Money appreciate in value in course of time due to

the interest it earns.

➢ Consider birr 100 today, which if invested at 4%
compound rate of interest becomes birr 148 at the
end of 10 years. Thus, birr 100 today is worth birr
148 at the end of 10 years.
➢ In other words, birr 148 at the end of 10 years is
worth only birr 100 now.
 Time Value of Money
9

Definition of commonly used terms

Interest:
✓ It is defined as the money paid for borrowed money.

✓ It also indicates the return obtainable by the

productive investment of capital.
Interest Rate:
✓ It is the interest paid or the return obtained at the

end of one year, expressed as a percentage of the

capital at the beginning of the year.
 Time Value of Money
10

Definition of commonly used terms

Present Worth:
✓ It is the present value of a future payment or a series
of future payments at the given rate of interest.
Discounting:
✓ It is the process of calculating the present worth of a
future payment.
Minimum Attractive Rate of Return (MARR):
✓ It is that rate of return which must be ensured in any
project if it has to be selected for implementation.
 Time Value of Money
11

Compound Interest Equations:

✓ The mathematical problems involving compound
interest have been simplified by the use of six
standard equations.
 Time Value of Money
12
 Time Value of Money
13

Example 1:
Find the future worth of birr 100,000 at the end of 20 years
invested at a compound rate of interest of 12% per year.
Solution:
Equation: 𝑭 = 𝑷 𝟏 + 𝒊 𝒏
𝑭 = 𝟏𝟎𝟎, 𝟎𝟎𝟎 𝟏. 𝟏𝟐 𝟐𝟎
=100,000x9.6463
=Birr 964,630
Therefore, future worth at the end of 20 years=Birr
964,630
 Time Value of Money
14

Example 2:
What is the present worth of a sum of Birr 75,000 at the end
of 10 years when the discount rate is 10% per year?
Solution:
𝑭
Equation: 𝑷= 𝒏
𝟏+𝒊
𝟕𝟓,𝟎𝟎𝟎
=
𝟏.𝟏𝟎 𝟏𝟎
𝟕𝟓,𝟎𝟎𝟎
=
𝟎.𝟑𝟖𝟓𝟓
=Birr 28,912.50
Therefore, present worth at the end of 10 years=Birr
28,912.50
 Time Value of Money
15

Example 3:
The annual cost of maintenance of a new road thrown open to
traffic is Birr 1,500,000. what is the future worth of this
expenditure at the end of 10 years when the rate of interest is
15% per year?
Solution:
𝐀 𝟏+𝐢 𝐧 −𝟏
Equation: 𝐅 =
𝐢
𝟏, 𝟓𝟎𝟎, 𝟎𝟎𝟎 𝟏 + 𝟎. 𝟏𝟓 𝟏𝟎 − 𝟏
𝐅=
𝟎. 𝟏𝟓
= 𝑩𝒊𝒓𝒓 𝟏, 𝟓𝟎𝟎, 𝟎𝟎𝟎 × 𝟐𝟎. 𝟑𝟎𝟑𝟕
= 𝑩𝒊𝒓𝒓 𝟑𝟎, 𝟒𝟓𝟓, 𝟓𝟓𝟎
 Time Value of Money
16

Example 4:
A major rehabilitation of a pavement will be done 10 years
from hence at a cost of Birr 10 million. What should be the
series of uniform annual payments that must be set apart to
accumulate this amount, if the interest rate is 9% per year.
Solution:
𝒊
Equation: 𝑨 = 𝑭
𝟏+𝒊 𝒏 −𝟏
𝟔
𝟎. 𝟎𝟗
𝑨 = 𝟏𝟎 ×
𝟏 + 𝟎. 𝟎𝟗 𝟏𝟎 − 𝟏
= 𝟏𝟎𝟔 × 𝟎. 𝟎𝟔𝟓𝟖
= 𝑩𝒊𝒓𝒓 𝟔𝟓𝟖, 𝟎𝟎𝟎
 Time Value of Money
17

Example 5:
The annual maintenance cost of a major bridge is Birr 50,000.
what is the present worth of this cost incurred for 10 years
after the opening of this bridge? The discount may be taken as
12% per year.
Solution:
𝟏+𝒊 𝒏 −𝟏
Equation: 𝑷 = 𝑨
𝒊 𝟏+𝒊 𝒏
𝟏+𝟎.𝟏𝟐 𝟏𝟎 −𝟏
𝑷 = 𝟓𝟎, 𝟎𝟎𝟎
𝟎.𝟏𝟐 𝟏+𝟎.𝟏𝟐 𝟏𝟎
= 𝟓𝟎, 𝟎𝟎𝟎𝒙𝟓. 𝟔𝟓𝟎𝟐
=Birr282,510
 Time Value of Money
18

Example 6:
The cost of construction of a new facility is Birr 200 million at
current price and is met with by raising a loan. What is the
annual payment of equal amount of for 20 years to repay the
loan, if the rate of interest is 10% per year.
Solution:
𝟏+𝒊 𝒏 ×𝒊
Equation: 𝑨 = 𝑷
𝟏+𝒊 𝒏 −𝟏
𝟔 𝟏+𝟎.𝟏 𝟐𝟎 ×𝟎.𝟏
= 𝟐𝟎𝟎 × 𝟏𝟎
𝟏+𝟎.𝟏 𝟐𝟎 −𝟏
= 𝟐𝟎𝟎 × 𝟏𝟎𝟔 × 𝟎. 𝟏𝟏𝟕𝟓
= 𝑩𝒊𝒓𝒓 𝟐𝟑. 𝟓 𝒎𝒊𝒍𝒍𝒊𝒐𝒏
 Total Transportation Cost
19

➢ In highway economic analysis, one has to consider the

total transportation cost, which comprises the
following:
1) Cost of construction of the facility initially
2) Periodic cost of maintenance the facility over its
design life
3) Road user cost
➢ The three components are interdependent, and the
designer has to choose that alternative which holds the
sum total of the three to a minimum.
➢ Road user cost is composed of the following main
components:
1. Vehicle operating cost
2. Time cost
3. Accident cost
 Determination of Highway Costs
20

The cost of construction of the facility initially and the

periodic cost maintenance of the facility over its design
life are known collectively by the term “highway costs”.
The cost of construction of the facility includes the
following:
i. Survey, investigation and design costs
ii. Land acquisition costs
iii. Construction costs
iv. Physical contingencies
v. Supervision, quality control and administration
charges
 Determination of Highway Costs
21

The cost of maintenance of the facility includes the

following:
i. Ordinary repair such patch repairs, pot-holes filling,
dressing earth work, etc.
ii. Periodic repairs, such as renewals, and resurfacing
iii. Any emergent or special repair
iv. Operational expense, such as traffic signals, traffic aid
posts, lighting, policing etc.
v. Supervision and administration charges
 Transport cost and Benefits
22

Total Highway
Cost

Construction Cost Maintenance Road User

Cost Cost

Vehicle
Operating Cost

Delay Cost

Accident Cost
 Economic aspect of road construction
23

 Road user cost:

❖ Vehicle operating cost
❖ Delay time cost
❖ Accident cost
Components of vehicle operating costs are the cost of
➢ Fuel
➢ Lubricant
➢ Tyres
➢ Spare parts
➢ Maintenance
➢ Depreciation
➢ wages of crew
➢ fixed cost: interest on capital, taxes, garaging charges, permit
charges, commission on booking, registration fee
 Economic aspect of road construction
24

▪ Delay time cost

✓ Value of occupation time
✓ Values of goods in transit
✓ Value of time of commercial vehicles
▪ Accident cost:
✓ Cost of human fatal accidents
✓ Loss due to injury
✓ Cost of hospitalization
✓ Damage to property vehicle
 Determination of Benefits
25

The quantification of economic benefits from highway projects

is usually much more difficult than determination of costs.
This is because of the following reasons:
o Benefits from highway are varied in nature, some of them
are direct and some indirect. Direct benefits such as reduced
VOC can be easily measured, whereas, indirect benefits
such as improved agriculture and accelerated growth of the
economy cannot be measured easily.
o Even when the benefits are direct, some of them are
difficult to quantify. Examples are: value of passenger time
saving, value of reduced air pollution, value of reduced
noise levels and value of improved aesthetics.
 Determination of Benefits
26

o Benefits which occur in the future are closely

related to future traffic, forecast of which is
difficult.
o Benefits can be determined only when alternatives
are considered.
 Methods of Economic Evaluation of
Highway Projects
27

Three common methods of economic evaluations

normally adopted are as follows:
1. Net Present Value Method
2. Benefit-Cost Ratio Method
3. Internal Rate of Return (IRR) Method
All the three methods are based on the Discounted
Cash Flow (DCF) technique of discounting all future
costs and benefits to a common year.
 Methods of Economic Evaluation of
Highway Projects
28

Net Present Value (NPV) Method

✓ In this method, the stream of costs/benefits
associated with the project over an extended period
of time is calculated and is discounted at a selected
discounted rate to give the present value.
✓ Benefits are treated as positive and coast are
negative and the summation give the Net Present
Value (NPV).
✓ Any project with positive NPV is treated as
acceptable.
 Methods of Economic Evaluation of
Highway Projects
29

❖ For a single project evaluation

✓If NPV>0, accept the investment proposal
✓If NPV<0, reject the investment proposal
✓If NPV=0, remain indifferent to the investment
❖ In comparing more than one project, a project with
the higher NPV should be accepted.
 Methods of Economic Evaluation of
Highway Projects
30

Benefit-Cost Ratio Method

✓ There are a number of variations of this method, but
a simple procedure is to discount all costs and
benefits to their PW and calculate the ration of the
benefits to costs.
✓ Benefits are positive flows, while costs are negative
flows.
✓ Thus, the savings in transport costs are considered as
benefits.
✓ If the benefit-cost ratio is more than one, the project
is justified; otherwise, it is not justified.
 Methods of Economic Evaluation of
Highway Projects
31

Internal Rate of Return (IRR) Method

✓ The IRR is the discount rate which makes the discounted
future benefits equal to the initial outlay.
✓ In other words, it is the discount rate which makes the
stream of cash flows zero.
✓ The IRR is defined as the discount rate at which the
present value of benefits equals the present value of
costs, i.e. NPV =0
 Methods of Economic Evaluation of
Highway Projects
32

Example-1: In a particular locality of a state, the vehicle uses take

a roundabout route to reach certain places because of the
presence of a river. This results in excessive travel time and
increased fuel cost. So, the state government is planning to
construct a bridge across the river. The estimated initial investment
for constructing the bridge is birr 4 million. The estimated life of the
bridge is 15 years. The annual operational and maintenance cost is
birr 150,000. the value of fuel savings due to the construction of
the bridge is birr 600,000 in the first year and it increases by birr
50,000 every year thereafter till the end of the life of the bridge.
Check whether the project is justified based on benefit-cost ratio
method by assuming an interest rate of 12%, compounded
annually.
 Methods of Economic Evaluation of
Highway Projects
33

Solution:
o Initial investment (P) = birr 4,000,000

o Annual operation and maintenance (A) = birr 150,000

o Annual fuel savings during the first year (A) = birr 600,000

o Equal increment in fuel savings in the following year (G) =

birr 50,000
o Life of the project (n) = 15 years

o Rate of interest (i)= 12%

 Methods of Economic Evaluation of
Highway Projects
34

The cash flow diagram of the project:

 Methods of Economic Evaluation of
Highway Projects
35

Total PW of costs
= initial investments (P) +Pw of annual O&M cost (Ac)
=Birr 4,000,000+P(P/A,I,n)
=Birr 4,000,000 +Birr 150,000(P/A,12%,15)
=Birr 4,000,000 +Birr 150,000x6.8109
=Birr 5,021,635
Total PW of benefits
=A(P/A,12%,15)+G[(A/G,12%,15)x((P/A,12%,15)]
=Birr600,000(P/A,12%,15)+50,000[(A/G,12%,15)x((P/A,12%,15)]
=Birr600,000x6.8109+50,000[(4.9803)x((6.8109)]
=Birr600,000x6.8109+50,000x(33.9203)
=Birr 5,782,556
 Methods of Economic Evaluation of
Highway Projects
36

Benefit-Cost Ratio method,

𝑻𝒐𝒕𝒂𝒍 𝑷𝑾 𝒐𝒇 𝑩𝒆𝒏𝒆𝒇𝒊𝒕𝒔 𝟓𝟕𝟖𝟐𝟓𝟓𝟔
B/C Ratio = = = 𝟏. 𝟏𝟓𝟐
𝑻𝒐𝒕𝒂𝒍 𝑷𝑾 𝒐𝒇 𝑪𝒐𝒔𝒕𝒔 𝟓𝟎𝟐𝟏𝟔𝟑𝟓
Since the B/C ratio is more than 1, the construction of the
bridge across the river is justified.
 Methods of Economic Evaluation of
Highway Projects
37

Example-2:
1. A proposed highway project requires an initial investment of
€ 10 million and a supplementary investment of € 5 million
at the end of the tenth year. The project will have an useful
life of 50 years, counting from the date of the initial
investment. The interest rate is 6%. The cost of operation
and maintenance is € 200,000 per year. The benefits of the
project has been estimated to begin with € 1.0 million per
year for the first 15 years (at the end of each year),
thereafter increasing at once to € 2.75 million per year and
remaining constant for the remaining 35 years. Determine:
a) Net Present Value (NPV) Method
b) Benefit-cost (B/C) ratio Method
c) Internal Rate of Return (IRR) Method
 Methods of Economic Evaluation
38

Solution
 Methods of Economic Evaluation
39
 Methods of Economic Evaluation
40
 Methods of Economic Evaluation
41

Examples-3:
For an analysis period of 20 years, there are two alternative
pavement designs with equal salvage values. The first alternative
is to reconstruct the pavement when it reaches failure, while the
second alternative is to improve the condition of the pavement at
the 8th, 16th, and 24th years. Assume the interest rate is 4% for both
alternatives.
The costs are as follows:
Alternative-A: initial cost: $18 million; cost to
reconstruct after 20 years: $9 million.
Alternative-B: initial cost: $15 million; cost for
improvement at 8th, 16th, and 24th years: $5 million each
occurrence
Which alternative should be selected?
 Methods of Economic Evaluation
42

Solution:
𝑵𝑷𝑽𝒂𝒍𝒕𝒆𝒓𝒏𝒂𝒕𝒊𝒗𝒆−𝑨
𝟏
= 𝒊𝒏𝒊𝒕𝒊𝒂𝒍 𝒄𝒐𝒔𝒕 + 𝒓𝒆𝒄𝒐𝒏𝒔𝒕𝒓𝒖𝒄𝒕𝒊𝒐𝒏 𝒄𝒐𝒔𝒕
𝟏+𝒊 𝒏
𝟏
= 𝟏𝟖 𝒎𝒊𝒍𝒍𝒊𝒐𝒏 + 𝟗 𝒎𝒊𝒍𝒍𝒊𝒐𝒏
𝟏+𝟎.𝟎𝟒 𝟐𝟎
= 𝟐𝟐. 𝟏 𝒎𝒊𝒍𝒍𝒊𝒐𝒏
𝑵𝑷𝑽𝒂𝒍𝒕𝒆𝒓𝒏𝒂𝒕𝒊𝒗𝒆−𝑩
𝟏
= 𝒊𝒏𝒊𝒕𝒊𝒂𝒍 𝒄𝒐𝒔𝒕 + 𝒊𝒎𝒑𝒓𝒐𝒗𝒆𝒎𝒆𝒏𝒕 𝒄𝒐𝒔𝒕
𝟏+𝒊 𝒏
𝟏 𝟏 𝟏
= 𝟏𝟓 𝒎𝒊𝒍𝒍𝒊𝒐𝒏 + 𝟓 𝒎𝒊𝒍𝒍𝒊𝒐𝒏[ + + ]
𝟏+𝟎.𝟎𝟒 𝟖 𝟏+𝟎.𝟎𝟒 𝟏𝟔 𝟏+𝟎.𝟎𝟒 𝟐𝟒
= 𝟐𝟑. 𝟑 𝒎𝒊𝒍𝒍𝒊𝒐𝒏
 Methods of Economic Evaluation
43
44