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.