04 Hine Road Appraisal 08

8/22/2019 04 Hine Road Appraisal 08

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The Economics Of Road

Investment

John Hine

ETWTR

SE197


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Questions and Decisions 1.

Is the project justified ?- Are benefits

greater than costs?

Which is the best investment if we have a

set of mutually exclusive alternatives?

If funds are limited, how should different

schemes be ranked?

When should the road be built?


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Questions and Decisions 2.

Are complementary investments required?

Should stage construction be used? What standards should be applied ?


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Appraisal Framework

All appraisals need a framework or

model for:

a) Forecasting changes

b) Evaluating those changes


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The Costs of Road Investment

SE697

These include:

Supervision

Management Manpower

Machinery

Materials

Land

Environmental Mitigation (e.g. Resettlement)


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Primary Effects 1.

Reduced vehicle operating costs

fuel and lubricants

vehicle maintenancedepreciation and interest

overheads

Reduced journey timedrivers, passengers and

goods


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Primary Effects 2.

Changes in road maintenance costs

Changes in accident rates

Increased travel Environmental effects

Change in value of goods moved


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Secondary Effects

Changes in agricultural output

Changes in services

Changes in industrial output Changes in consumers behaviour

Changes in land values


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Coverage and Double Counting

Any economic analysis should be designedto give maximum coverage of benefits.

But we must avoid double counting. Do not

add primary and secondary benefits (e.g

changes in land values added to changes in

transport costs)

In a competitive economy the consumers

surplus approach (used in HDM) should be

adequate.


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The Economic Comparison

An economic analysis involves a comparison of Withand Without cases.

Traffic forecasts are made for BOTH scenarios - The

analysis should not be based on before and after.

An unrealistic Without case can give a false result. A range of with investment cases should be analysed to

find the best solution. A minimum investment approach

often gives the best economic results and should be

tested.


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Economic and Financial Prices

SE897

The cost to the economy of road

rehabilitation and maintenance may differ

from the financial cost because of :

taxes and duties

shortage of foreign exchange

under-employment

The Government will usually be concerned with

ECONOMIC costs.

Contractors will usually be concerned with

FINANCIAL costs.


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Use of Economic Prices

SE797

In an Economic Appraisal we use ECONOMIC

(orSHADOW) prices NOT FINANCIALprices

Adjust financial prices as follows:

Exclude all taxes and duties and subsidies

Use the planning discount rate not the

financial market rate

If overvalued exchange rate then value

imports and exports more highly Use the opportunity cost of labour

Standard Conversion Factors are now widely used for

road construction costs


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Benefits From Road Investment

Changes in transport costs occurbecause of :

Lower road roughness

Shorter trip distance Faster speeds

Reduced chance of impassability

Reduced traffickability problems Change in mode


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Traffic Categories

Normal traffic: Existing traffic and growth that

would occur on the same road, with and

without the investment

Diverted traffic: Traffic diverted from another

road to the project road as a result of the

investment

Generated traffic: New traffic induced by the

investment


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Benefits from Road Investment

Transport cost savings for existing (ornormal ) traffic

= Traffic x Change in Transport Costs per

km x distanceMain changes in cost from:

a) change in transport MODE

b) reduced journey TIME

c) reduced VOCs

SE297


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Generated Traffic Benefits

Traffic induced by the road investment are traditionallyvalued at:

Half the difference in transport costs

Hence total generated transport cost benefits

= Generated traffic volume x change in costs per kmx distance x 1/2


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Estimating Benefits

Normal traffic benefits: tripsN * d1 * (VOC1- VOC2)

Diverted traffic benefits: tripsD * ((d1 * VOC1)-(d2*VOC2))

Generated traffic benefits: tripsG * d2 * (VOC1- VOC2)/2

d1 = existing road length d2 new road length

VOC1 = vehicle operating costs per km withoutinvestment

VOC2 = vehicle operating costs per km with investment

VOC data relates to each road section and its condition atthe time


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The Consumers Surplus

Approach

TotalBenefits

=

Cost

C1

C2

SE497

Additional benefits from new

traffic and production induced

by new investment

T1 T2 Traffic

+

Transport Cost Savings to existing

traffic and normal growth


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Development Benefits

SE397

Development benefits arise from a

combination of increased traffic and

reduced transport costs.

Benefits may also include :

Increased agricultural production

Increased service provision Increased industrial activity


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Ethiopian Statistical Analysis

Transport Tariffs (Derived from

Regression Analysis)

010

2030

4050

60

0 50 100

Distance, km

Tariff,Bir

rperqt.

main road rough road animal transport


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Illustration of Benefits

C1

C2C3

T1 T2 T3Traffic

Costs

Headloading

Track

Improvedroad


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Different Types of Benefit

Normal traffic benefits

= traffic x change in transport costs

Development benefits

- A function of (change in transport costs)2

Social benefits

- A function of population x change intransport costs


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Consumers Surplus Approach:

Advantages: Simple, cost based, traffic

approach dependent on predicting

changes in traffic

Disadvantages: May not address critical

factors promoting either rural development

or social access


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Producers Surplus Approach

Advantages: Draws attention to changes in agricultural

output (key economic activity in rural areas)

Disadvantages: No reliable way of predicting response

- impact studies give widely different answers

it could be based on agricultural supply price

elasticities but this is almost never done; it requires

very careful examination to use.

For most projects benefits are just invented !


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Producers Surplus

Price & Costs per unit

Of output

p2 Increasedfarmgate price

p1

lower input costs

O1 O2

Output


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Indicies and Ranking

Widely used for feeder road planning; there are many

different approaches

e.g. i) cost of improvement / population

ii) estimated trips / cost

Adavantages: Speed , simplicity, transparency, many

factors can be incorporated

Disadvantages: How do we value widely different

factors ? (adding up apples and pears); weightings arenot stable ; cannot easily address questions of road

standards, timing etc, ; possible double counting


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Community Priorities

Community priorities now often form an important

part of feeder road appraisal. It is possible just to

ask communities to rank the investments they

prefer- both within the road sector or between roads

and other investments.

Advantages: Community acceptability, use of

community knowledge

Disadvantages: Sectional interest groups may

dominate voting, community knowledge of area orroad impact may be poor


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Economic Decision Criteria 1.

1. Net Present Value:

NPV = (B1- C1) + (B2- C2) + .. (Bn- Cn)(1 + r) (1 + r)2 (1 + r )n

2. Internal Rate of Return : solve for i, (IRR)

0 = (B1- C1) + (B2- C2) + .. (Bn- Cn)(1 + i) (1 + i)2 (1 + i )n

B1, B2 Bn : Benefits in years 1, 2 n

C1 C2 Cn : Costs in years 1, 2 . nr : Planning discount rate , n : planning time horizon


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Economic Decision Criteria 2.

3. Net Present Value/ Investment CostNPV/ C = NPV/Ci

4. First Year Rate of Return

FYRR = (B1- C1)Ci

B1, C1 : Benefits and Costs in year 1.

Ci : Road investment costs

I t l R t f R t


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Internal Rate of Return

-4000

-2000

0

2000

4000

6000

8000

0.0% 10.0% 20.0% 30.0% 40.0% 50.0% 60.0%

Discount Rate (%)

NetPresentValu

e(M$)

NPV at 12%

Discount Rate

Internal Rate

of Reurn


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Economic Comparison of Alternatives

When comparing project-alternatives,

the Net Present Value (NPV) is used toselect the optimal project-alternative

(alternative with highest NPV)

The Internal Rate of Return (IRR) or theB/C ratio are not recommended to

compare alternatives of a given project

Alternatives NPV0.0

3.7

6.7

5.5

Optimal Alternative:

Highest NPVProject


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Ranking Projects by Economic Priority

When comparing the economic priority

of different projects, a recommendedeconomic indicator is the NPV per

Investment ratio

Projects Selected AlternativeOverlay

Reseal

Overlay

NPV/Investment8.4

5.2

2.1

P

R

I

O

RI

T

Y


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Economic Decision Criteria

NPV IRR NPV/C FYRR

Economic validity v. good v. good v. good poor

Mutually exclusive v. good poor good# poor

projects

Project timing fair## poor poor good

Project screening poor v. good good poor

/robustness

Use with budget fair ## poor v. good poor

constraint

# Need incremental analysis

## Needs continuous recalculations


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Appraisals & Post Evaluations 1.

An Appraisal is carried out before aninvestment is made. Everything isuncertain.

A Post evaluation may be made say 5years after the investment. Theinvestment is known and 5yrs of withcase are known.

The without case is unknown as is theremainder of the with case.


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Appraisals & Post Evaluations 2

In Both Cases forecasting and

evaluation models are required to come

to an answer.

Hence we can never be certain about

the viability of an investment !

Documents

04 Hine Road Appraisal 08