Capital Appraisal Handbook on

Roads

Prepared for:

Road Agency Limpopo Limpopo Provincial Government

Polokwane South Africa

Prepared by:

A. Klevchuk and G. P. Jenkins Cambridge Resources International

Cambridge, MA USA

August 2004

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CONTENTS Chapter 1. Introduction ......................................................................................................... 5

1.1 Overview of Handbook............................................................................. 6 Chapter 2. Opportunity Cost of Decisions in Absence of a System of Capital

Appraisal ........................................................................................................... 8 2.1 Status Quo................................................................................................. 8

2.1.1 Selection Criteria..............................................................8 2.2 Opportunity Cost of Decisions ................................................................. 9

2.2.1 Estimation of Opportunity Cost .......................................10 2.2.2 Concluding Remarks ......................................................11

Chapter 3. Analytical Framework ....................................................................................... 12

3.1 Feasibility Phase ..................................................................................... 12 3.1.1 Incrementality of Projects ...............................................12 3.1.2 Integrated Analysis .........................................................13 3.1.3 Financial Module............................................................13

Data Requirements .............................................................. 13 Evaluation Criteria .............................................................. 14

3.2 Approach to Economic Analysis ............................................................ 15 3.2.1 Economic Development ..................................................15 3.2.2 Data and Economic Parameters .......................................16 3.2.3 Incremental Economic Resource Flow .............................18

3.3 Economic Benefits.................................................................................. 19 3.3.1 Savings of Maintenance Expenditures..............................19 3.3.2 Reduction in Vehicle Operating Costs..............................19 3.3.3 Time Savings .................................................................22 3.3.4 Accident Reduction ........................................................23 3.3.5 Other Externalities..........................................................24 3.3.6 Case of Penetration Roads...............................................24

3.4 Feasibility of a Road Improvement Projects........................................... 26 3.4.1 Stakeholder Analysis ......................................................27 3.4.2 Sensitivity Tests and Risk Analysis..................................28

Chapter 4. Appraisal of New Roads................................................................................. 30

4.1 Sources of Identification of New/Upgrading Road Project .................... 30 4.2 Pre-feasibility Phase ............................................................................... 31

4.2.1 Traffic Sub-Module ........................................................31 Existing Traffic ................................................................... 32 Traffic Forecast “With” and “Without” New Road/Upgrading .................................................................. 32

4.2.2 Engineering Sub-Module ................................................34 4.2.3 Environmental Sub-Module ............................................35

4.3 Financial Sub-Module............................................................................. 36 4.3.1 Financial Expenditures...................................................36 4.3.2 Real versus Nominal Prices ............................................36 4.3.3 Incremental Cashflow ....................................................39 4.3.4 Findings of Financial Analysis .......................................39

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4.4 Economic Sub-Module ........................................................................... 40

4.4.1 Economic Conversion Factors .........................................41 4.4.2 Conversion of Financial Expenditures into Economic

Costs .................................................................42 4.4.3 Estimation of Economic Benefits.....................................43

Reduction in Maintenance Resource Costs ......................... 43 VOC Savings....................................................................... 44 Time Savings....................................................................... 47

4.4.4 Incremental Economic Resource Flow Statement..............49 4.5 Stakeholder Impact Assessment Sub-Module ........................................ 51

Evaluation of Feasibility ..................................................... 52 4.7 Sensitivity Tests and Risk Analysis........................................................ 52

4.6.1 Sensitivity Analysis ........................................................53 4.6.2 Scenario Analysis ...........................................................55 4.6.3 Monte Carlo Risk Analysis .............................................56

Risk Variables ..................................................................... 56 Simulation Results............................................................... 57

4.7 Concluding Remarks............................................................................... 58 Chapter 5. Case-Study Appraisal of Upgrading a Gravel Road: Flag Boshielo to

Mafefe to Sekororo and Ga Seleka to Mmatladi Road ............................... 60 5.1 Introduction............................................................................................. 60 5.1 Project Description ................................................................................. 60

5.1.1 Objectives of Proposed Project ........................................60 5.1.2 Existing Road Conditions and Traffic Volume..................61

5.2 Traffic Forecast....................................................................................... 62 5.2.1 Passenger Cars ...............................................................63 5.2.2 Tourists 64 5.2.3 Mini-Buses 65 5.2.4 Agriculture and Light Goods Vehicles .............................65 5.2.5 Heavy Goods Vehicles....................................................66

5.3 Project Costs ........................................................................................... 67 5.3.1 Construction Costs..........................................................67 5.3.2 Maintenance Costs..........................................................69

5.4 Project Benefits....................................................................................... 69 5.4.1 Economic Resource Savings............................................69

Maintenance “With” and “Without” Project ....................... 69 Incremental Economic Maintenance Resource Flow Statement............................................................................. 70

5.4.2 VOC Savings 71 VOC “With” and “Without” Project ................................... 72 Valuation of Economic VOC Resource Savings................. 72

5.4.3 Time Savings 73 Time Savings for “Normal” Traffic .................................... 74 Time Savings for “Diverted” and “Generated” Traffic....... 78

5.5 Economic and Distributive Analysis ...................................................... 79 5.5.1 Economic Resource Statement.........................................79

Economic Feasibility of Road Sections............................... 79 5.5.2 Distributive Analysis ......................................................82

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5.6 Sensitivity and Risk Analysis ................................................................. 84

5.6.1 Sensitivity Analysis ........................................................84 5.6.2 Risk Analysis 86

Risk Assumptions................................................................ 86 Simulation Results............................................................... 86

5.7 Case Study Conclusions.......................................................................... 88 Chapter 6. Allocating Funds between Construction of New Roads and

Maintenance of Existing Road Network....................................................... 91 6.1 Current Approach ................................................................................... 91 6.2 Optimization of Budget Allocation Decisions........................................ 92

6.2.1 dTMS CT™ Software.....................................................93 6.2.2 Economic Incremental NPV as Decision Criterion ............94 6.2.3 Optimization Procedure ..................................................95

6.2 Implementation ....................................................................................... 96 Chapter 7. Maintenance Decisions: Selection of a Treatment Strategy .......................... 98

7.1 Maintaining the Existing Road Network ................................................ 98 7.1.1 Assets Management System ............................................98

Model Settings .................................................................... 98 Optimization Variable ......................................................... 98

7.1.2 Strategy Selection.........................................................100 7.2 Direct vs. Indirect Benefits ................................................................... 102

Users and Agency Costs.................................................... 102 7.3 Selection of Treatment Strategies ......................................................... 103

7.3.1 Maximization of Net Present Value ...............................103 7.3.2 Additional Data Inputs ..................................................105

Economic Costs vs. Financial Costs.................................. 105 Definition of User Costs.................................................... 106 The Economic Cost of Capital .......................................... 107

Chapter 8. Conclusion........................................................................................................ 108 Annex A. Estimation of Economic Conversion Factors.................................................. 110

A.1 Infrastructure and Public Works Construction ..................................... 110 A.2 Truck Transportation ............................................................................ 110 A.3 Passenger Car Transportation ............................................................... 111

Annex B. Vehicle Operating Costs and Travel Speeds by Type of Road and

Vehicle Class. ................................................................................................ 112 B.1 Average Vehicle Operating Costs......................................................... 112 B.2 Average Vehicle Speeds ....................................................................... 114

Annex C. Spreadsheet Tables for Case-Study Appraisal of Upgrading a Gravel

Road: Flag Boshielo to Mafefe to Sekororo and Ga Seleka to Mmatladi Road. ............................................................................................ 117

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LIST OF ABBREVIATIONS

AADT - Annual average daily traffic

CF - Conversion factor

CSCF - See “CF”

CRI - Cambridge Resources International, Inc.

DFED - Department of Finance and Economic Development

DTI - Department of Trade and Industry

dTIMS (CT)™ - Deighton Total Infrastructure Management System (Concurrent Transformation), Ltd.

EOCK - Economic opportunity cost of capital

EOCL - Economic opportunity cost of labor

FEP - Foreign exchange premium

FOREX - Foreign exchange

GIS - Geographic Information System

HDM™ - Highway Design and Maintenance Standards Model

HGV - Heavy goods vehicle

IRI - International roughness index

IRR - Internal rate of return

Kph - Kilometers per hour

LGV - Light goods vehicle

MEC - Member of the Executive Council

NPV - Net present value

PV - Present value

RDP - Reconstruction and Development Program

RED - Roads Economic Decision Model (RED) for Economic Evaluation of Low Volume Roads

ROI - Return on investment

SMEDP - Small and Medium Enterprise Development Program

RAL - Roads Agency Limpopo

SACFEA - South African Conversion Factors Easy Access

SDI - Spatial development initiative

VCI - Visual condition index

VOC - Vehicle operating costs

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Chapter 1. Introduction

The eradication of poverty and the acceleration of the pace of economic growth in

Limpopo Province has been the challenge of the Provincial Government over the past

decade. Provision of the basic infrastructure facilities such as roads, water, electricity,

and telecommunication are the key to the development of the region, and are

fundamental for the creation of a strong private sector.

The investment appraisal phase of an infrastructure management and delivery system

is nothing else but an assessment of capital projects to ensure their economic

feasibility and sustainability over time. In the absence of an existing adequate

infrastructure network, the pace of economic growth will be constrained by the

performance of individual capital projects being undertaken or sponsored by the

government’s departments. In such a situation, the survival of individual projects

becomes very important, hence a system should be in place in order to ensure that

their performance and sustainability is correctly addressed from the start.

This handbook is a part of the continuous effort by the Limpopo Provincial

Government to improve the quality of public infrastructure delivery by its

departments. The focus of this handbook is on the process of capital appraisal by the

Roads Agency Limpopo (RAL). The project appraisal methodology employed in this

handbook is based on the comprehensive appraisal manual developed by Cambridge

Resources International (CRI) for the Limpopo Provincial Government.1 The

methodology outlined in the manual and adopted to the South African reality

represents a state-of-the-art tool for conducting an integrated financial, economic,

stakeholder and risk analysis of new investment projects, as well as maintenance, and

expansion decisions.

1 Cambridge Resources International, Inc., Cambridge, USA, “Integrated Investment Appraisal:

Concepts and Practice”, Prepared for Department of Financial and Economic Development, Limpopo Provincial Government, Polokwane, South Africa, March 2004.

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1.1 Overview of Handbook

The mandate of Roads Agency Limpopo is to manage all provincial roads, with

specific functions being defined by its establishing Acts2 as planning, designing,

construction, maintenance, and control over the road network. The objective of this

handbook is to assist the project analysts and decision-makers at the Agency in the

selection of new roads for construction and for the maintenance of the existing

network.

The analysis of project selection in the Limpopo Road Agency will cover three

processes. The processes are listed in the order in which they generally take place:

1) Selecting new roads for construction;

2) Allocating funds between road maintenance and new road construction;

3) Selecting the roads to be maintained, the type, and timing of treatment.

Chapter 2 of this handbook examines the existing framework for prioritarization of

road investments and presents a method to estimate the economic opportunity cost of

meeting the various socio-political objectives pursued by the Roads Agency.

Chapter 3 lays out the analytical framework within which this Handbook operates.

This chapter familiarizes the reader with the basic concepts of financial and economic

analysis for roads. The chapter de-facto applies the appraisal methodology of the

integrated cost-benefit analysis to road construction and management in Limpopo

Province.3

Chapter 4 is devoted to the appraisal of new roads. An integrated financial, economic,

stakeholder and risk analysis must be carried out for new routes on the network in

order to compare the alternative roads, and rank them according to their economic Net

Present Value (NPV), i.e. their incremental contribution to the national wealth.

2 “Northern Province Roads Agency Act”; and “Provincial Roads Act 7”, Pietersburg, South Africa,

1998. 3 Cambridge Resources International, Inc., Cambridge, USA, “Integrated Investment Appraisal:

Concepts and Practice”, Prepared for Department of Financial and Economic Development, Limpopo Provincial Government, Polokwane, South Africa, March 2004.

7

The case of upgrading of an existing gravel type link to a surface road deserves a

special attention. At present, only about 6,000 km of the total 23,000 km of the

provincial road network are surfaced. The rest of the roads are of different gravel type

and condition. The job of tarring the outstanding mileage represents the major

challenge facing the RAL during the coming years.

Then, Chapter 5 examines a particular gravel road upgrading case on the example of

Flag Boshielo to Mafefe to Sekororo and Ga Seleka to Mmatladi road. This chapter,

in fact, develops a template for appraisal of a gravel road upgrade to tar surface that

can be used for appraisal of other provincial roads.

Chapter 6 lays out the basic concepts for allocating the limited budgetary funds

between the construction of new roads and the maintenance of the existing network.

An economical efficient and justified allocation of the total available budget often

poses practical difficulties for the decision-makers. This chapter helps to establish an

economically sound balance between rival spending alternatives.

Once the decision over the allocation between construction/upgrading of new roads

and maintenance of the existing roads has been taken, and the budget for maintenance

is established, then there is a need to formulate the most efficient strategy for road

maintenance. Chapter 7 looks at the maintenance decisions in greater detail. The

following issues are discussed in this chapter: selection of roads for treatment, choice

of a treatment strategy, and the timing of treatment.

The conclusions and comments are presented in Chapter 8. Following that chapter,

Annex A contains estimates of the economic conversion factors for road construction

costs, truck transportation, and passenger car transportation. Annex B has a list of

average vehicle operating costs and estimated vehicle speeds by type of vehicle,

terrain, and road condition. Finally, Annex C contains all spreadsheet tables referring

to the case-study analyzed in Chapter 5. This template, in fact, is a generalized

analysis built on an example of tarring a road. The objective of this template is to

standardize and present a format of an appraisal that could be carried out for all

new/upgraded roads, using the available traffic data and economic parameters.

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Chapter 2. Opportunity Cost of Decisions in Absence

of a System of Capital Appraisal 2.1 Status Quo At present, the roads that are considered key for economic development as per the

formulated development plans and strategies are earmarked for construction. The

prioritization of roads for upgrading is based on a number of criteria: current and

expected traffic volume; population size; existing and potential projects in mining,

tourism, agriculture and manufacturing; access to schools, hospitals, police stations,

workplaces; inter-connectivity of districts; and so on. These consideration are ranked

according to their perceived contribution to the following objectives, in order of

importance.

2.1.1 Selection Criteria

While the detailed quantification of the contribution of a particular road to

achievement of the above stated objectives in the form of a formal benefit-cost

analysis is not currently undertaken, the RAL has managed its selection process

through a system of well-defined priorities. The selection criteria used in

prioritarization roads per district are “a complex interplay of economic development

and future potential, social development, connectivity and access, distance reduction

between places, and traffic volumes”.4

1. Economic Development and Potential. Areas with existing high levels of

development are the starting points. As they are accessed by all in search of

opportunities for work and business, the traffic volumes will be highest in these areas.

At the same time, areas with little existing development but high potential are targeted

in the hope of attracting new investment. Such roads must support the Provincial

Growth and Development Strategy.

4 “Provincial Strategic Tarring Programme”, Roads Agency Limpopo, Polokwane, South Africa

(2000), pp. 9-10.

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2. Social Development. A premium is placed on roads that give access to referral

hospitals, major educational institutions, and government administrative centers.

3. Connectivity and Access. Each district of the Province has its uniqueness in

resource endowness and potential. To enable a full exploitation and to allow the

Province to operate as a single functional unit all parts will have to be linked to ensure

accessibility to all six districts.

4. Reducing Distances. A priority placed on roads that, if tarred, will result in

substantial reduction of the travel times and vehicle operating costs.

5. Traffic Volumes. Roads will higher traffic volumes are prioritarized as they have

already proven their worth.

Given that the funds available are unlikely to meet all the needs for new

construction/upgrading, in the absence of formal project evaluation of the economic

and social impacts, there has to be an element of subjectivity in the present process for

project selection. Moreover, even if the funds were sufficient to finance the required

construction, it is still essential to determine that the social and economic returns to

investments in all roads are positive.

2.2 Opportunity Cost of Decisions In the absence of formal cost-benefit evaluation of investments into ugrading of the

provincial roads, the existing system of priorities serves as a guide to the decision-

makers in terms of allocation of resources for tarring. This system is based on a strong

implicit assumption that each and every priority road satisfying the criteria set out in

the previous section has indeed positive economic and social returns. As no formal

project appraisal function has been exercised by the RAL for these new roads, it is

difficult to confirm whether all the priority roads maximize the welfare of the

Province.

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To address this ambiguity in terms of social and economic impact, the Department of

Finance and Economic Development took the lead in assessment of 12 roads on the

priority list. The study examined major roads that should play an important role in

economic development of the Province.5 The results are somewhat surprising because

four out of the 12 evaluated roads have not demonstrated their high economic

feasibility. Two of these prioritarized roads have clearly negative economic NPV’s

and one more road appears to be just breaking-even without an allowance for risk to

recover its investment costs.

As the Public Service Management Act of South Africa requires to spend public funds

in a prudent and transparent way, the opportunity cost of financing the roads based on

the current priority system should be estimated. The financing of roads with low

economic return represents an implicit opportunity cost because these funds could

have been allocated to many alternative projects within the roads sector which have

positive economic returns.

2.2.1 Estimation of Opportunity Cost The following exercise estimates the opportunity cost for the 12 selected projects

included into the cost-benefit study by ARCUS GIBB. The Roads Agency has a much

longer list of prioritorized roads and to estimate the full opportunity cost for all roads,

it would be necessary to evaluate even at a level of a pre-feasibility analysis. Table 1

presents the summary of road improvement projects comprising the scope of available

information.

The financial costs of construction of the roads are shown there along with the

estimated economic return of the roads, as measured by the economic NPV and

benefit-cost ratio. The study by ARCUS GIBB goes into considerable length into the

analysis of these projects, and also states the reasons why certain roads do not appear

feasible and what conditions should be met in order to justify these projects. The net

present value of the economic loss from financing the three identified roads with

negative economic outcome amounts to R 65 million in total. This is the minimum

5 ARCUS GIBB, “Limpopo Integrated Infrastructure Development Plan: Phase II – Benefit Cost

Analysis of Selected Projects”, Final Report, Prepared for Department of Finance and Economic Development, Limpopo Provincial Government, March 2004.

11

amount that the Provincial economy would give up in economic resources and growth

if these projects were implemented to achieve the various social objectives used as a

justification for the prioritarization of these projects. In fact, the loss could be much

bigger because other high return projects will not be done because the shortage of

funds due to the diversion of funds to these negative projects.

Table 1. Estimation of Opportunity Cost.6

Road Construction Costs (R, million) Economic NPV

(R, million) B/C

Ratio A Polokwane to Burgersfort 1,200 1,076 2.1 B N1 – Lephalale 500 63 1.1 C Polokwane / Alldays / Musina 445 320 1.4 D Mokopane – Vaalwater – Marken 105 4.2 1.0 E Acornhoek / Manyeleti / Thulumahashe / Mkhuhlu * 135 (8) 0.9 F Phalaborwa to Giyani 140 71 1.4 G Thohoyandou / Masisi ** 390 2 1.0 H Letsitele - Letaba 90 16 1.1 I Flag Boshielo – Sekororo & Ga Seleka – Mmatladi *** 277 34 1.2 Ia Section Ga Seleka – Mmatladi * 132 (54) 0.7 J Trichardtsdal – Metz 250 698 3.7 M Wolkberg – Tzaneen * 35 (3) 1.0 Total Opportunity Cost (R, million) 65

Notes: * Negative economic NPV. ** Marginal NPV, the project is just breaking even. *** This project is also evaluated in Annex C to this Handbook, and results of

the evaluation are shown here.

2.2.2 Concluding Remarks The economic value of roads come about through their function of lowering the costs

of transportation. There is no doubt that other political and social objectives may add

value to a country. Nevertheless, if only political and social criteria are used to

prioritorize the selection of roads, these could divert scarce budgetary resources from

high economic return investments to projects with low economic returns. There is a

need to systematically measure the costs associated with financing of such low return

projects. Such a system of capital appraisal will assist the planners to be able to select

investments in the road sector that meet both the stated political and social criteria as

well as the economic one. The remaining chapters in this Handbook have been

designed to facilitate such a capital appraisal of investments in the road sector in

Limpopo Province.

6 Ibid., pp. 3-1 to 3-9.

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Chapter 3. Analytical Framework

3.1 Feasibility Phase Over past number of years, the Department of Finance and Economic Development

has used the assistance of consultants for appraisal of certain roads that were selected

to support a specific development corridor or regional initiative. It has been argued

that the government has to build more internal capacity to appraise, audit and monitor

the implementation of infrastructure projects. While the quality of the private

consulting reports on development of new roads is quite good, it is also clear that the

Roads Agency should develop its own appraisal skills.

3.1.1 Incrementality of Projects One of the important concepts when defining a project is to ensure that the project’s

benefits and costs are being measured on an incremental basis. An investment

opportunity entails incremental net benefit flows that occur over and above what

would have been there in the absence of that investment. In application to road

investments, this means that one should carefully identify the benefits and costs that

are only associated with the road project in question, and not include any other

benefits that will exist whether or not this road is undertaken. When conducting a

project appraisal, one should conceptualize two states of nature: one that includes the

project (with) and one that does not include the project (without).

An important element in the appraisal is to ensure that the “without” scenario is

properly defined. The “without” situation does not mean that nothing is done to the

current situation if, for example, a road construction is not undertaken. Even without a

major rehabilitation of that particular road-link, there will be some regular

maintenance performed on the road. In other words, the “without” scenario should be

still technically optimized in order to be compared to the “with” scenario. A simple

before-and-after comparison would not be able to avoid this pitfall.7

7 “Integrated Investment Appraisal: Concepts and Practice”, Chapter 3: An Overview of the

Evaluation Framework, pp. 59-61.

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3.1.2 Integrated Analysis

The approach undertaken in this manual is that of an integrated project analysis. It

incorporates both the financial and the economic analysis into one analytical

framework so that project stakeholders can be identified and their costs and benefits

can be determined in a consistent manner. The financial, economic, stakeholder, and

risk analyses are all measured quantitatively in a systematic manner.8 The economic

distortions that financially subsidize a project, when removed, often become a major

source of failure for these investments.

3.1.3 Financial Module In appraisal of roads, the construction, maintenance and rehabilitation costs are

usually known, but no revenue accrues to the road owners unless a toll is charged to

the users. While private participation in this sector has not been common for the

provincial roads, it is expected that this practice will spread in the future. Financial

analysis represents a powerful tool to aid the government in structuring such

concessions with the private sector.

If the project does not yield the private investors a sufficient return to be attractive to

them, then a related function of the financial analysis is to measure the minimum

amount of assistance that would be needed to induce the private investors to

undertake the investment. The financial analysis is one of the cornerstones of the

methodology for determining the appropriate amount of government financial

assistance for private sector investments.9

Data Requirements

The following financial data are needed to conduct a financial analysis in order to

determine the financial viability of a new road link/upgrade:

8 Ibid, pp. 71-73. 9 Government assistance to a project is warranted only if the project is economically viable.

However, no assistance is necessary if the financial analysis indicates that investors can earn a more than normal rate of return after considering the risks. If the investors cannot earn the normal rate of return, governments may provide assistance up to the amount for the investors to yield the normal rate of return on capital. Nevertheless, the amount of assistance in principle should not be greater than the net economic externalities generated by the project.

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a. Construction, regular maintenance, and rehabilitation costs for the

“without” scenario;

b. Construction, regular maintenance, and rehabilitation costs for the “with”

scenario;

c. Existing and future “normal” traffic volume by type of vehicle for the

“without” scenario;

d. Forecasts of “diverted” and “generated” traffic by type of vehicle for the

“with” scenario;

e. Type and proportion of equity and debt (if any) financing;

f. Forecasts of user charges by type of vehicle (in case of a toll-road);

g. Financial discount rate (in real terms).

Data requirements in (a) and (b) can be reasonably estimated at the Roads Agency,

which has a vast experience and past records for construction, rehabilitation and

maintenance by different types of treatment. The existing traffic load is also available.

The forecasts of future traffic flows “without” and “with” project, items (c) and (d),

must be generated by the analyst with the aid of traffic flow software. The issue of

financing, item (e), is largely determined by the nature of the proposal for road

improvement, i.e. if a construction/upgrading of a particular road link is undertaken

entirely by the RAL, then the government finances 100% of the project. In a case of a

public-private partnership, there will be a clear financing plan stating the proportion

of the costs funded by the government, by private investor(s), and by borrowing.

Likewise, the forecasts of user charges by type of vehicle, item (f), could be

developed. The appropriate discount rate, item (g), will be the real private opportunity

cost of equity financing if the owner of the enterprise is a private owner. However, in

case of public road, the appropriate discount rate will be the target financial rate of

return (net of inflation) set by government.

Evaluation Criteria

For roads owned and operated by the RAL, no financial revenues from road users

accrue to the agency, and it should be clear that the financial NPV is, in most cases,

simply the present value of the costs of building and maintaining the road during a

period of time. As a result, the financial NPV for such a road will be negative,

representing the requirement for funds to finance the project.

15

If it is a private sector projects such as PPP and the financial NPV of the project is

greater than zero, the project is potentially worthwhile to implement. But if the

financial NPV turns out to be negative, then the private investor(s) would find it better

to shift the investment elsewhere, to other projects, where they would earn the

minimum required return.

3.2 Approach to Economic Analysis

One of the objectives of project evaluation is to ensure that a project makes efficient

use of a country’s scarce resources. The economic analysis provides a methodological

framework for estimating economic benefits and costs. The benefit is measured by the

NPV of the incremental net economic benefits. Only if this NPV is positive can a

project claim to reallocate resources efficiently.

3.2.1 Economic Development It is often argued that all road improvement stimulates economic development. The

truth is that some do stimulate, while others do not, and it is the task of project analyst

to establish whether this particular road project will spur the economic development

in the area. In order to consider this road upgrading as ground-breaking in terms of

economic potential, three conditions must be met simultaneously:10

1) The economic development would not have taken place in any

circumstances without this road improvement;

2) The resources used in the new development would have been under-

utilized or remained unused;

3) The economic activity stimulated does not replace any other activity that

would have taken place otherwise.

Often, the proposed road improvement is not the only requirement to unlock the

economic potential of a particular area. Other basic factors of production must be

ensured in order to take the best use of available resources. In a very specific case

10 Ibid, p. 29.

16

when all the conditions are effectively satisfied and the road upgrade is the only

barrier to pass, the valuation of road benefits should be linked to the net value of

additional output. Of course, the vehicle operating cost savings for the traffic from

the project must be excluded then to avoid double-counting of benefits of the road.

When the road is not the only new investment to accelerate the increased production,

then the net value of additional output should be allocated among the road and other

investments in proportion to their contribution to the achieved development. When a

road is built specifically for a single project or a group of users, for instance mines or

agriculture farms located in an area, then this road should be treated as a part of that

project, being a necessary investment for least-cost transport solution.11

3.2.2 Data and Economic Parameters In addition to the financial data requirements, described in Section 3.2.3 above, the

following set of additional data and economic parameters are needed to conduct

economic analysis:

h. Economic conversion factors for all construction, maintenance, and

rehabilitation costs (in order to estimate corresponding economic costs);

i. Vehicle operating costs (VOC) of the existing and future traffic volume by

type of vehicle for the “without” scenario;

j. Vehicle operating costs (VOC) of the diverted and generated traffic by

type of vehicle for the “with” scenario;

k. Detailed composition of traffic by vehicle type, and average speeds “with”

and “without” road improvement;

l. Average occupancy of vehicles and cargo content;

m. Average value of time for passengers and cargo;

n. Economic discount rate (in real terms).

The economic conversion factors, item set (h), are required to estimate the economic

costs of the road construction, maintenance, and rehabilitation expenditures. CRI has

compiled a database of economic conversion factors for over 8,000 commodities,

11 Ibid, p. 32.

17

organized into a single database.12 To arrive at economic costs of the road related

expenditures, the analyst should examine the outlays on domestically produced inputs,

imported inputs, cost of services (i.e. design, supervision, etc.), and cost of labor by

skill.13

The economic cost of foreign exchange (foreign exchange premium, or FEP) is

extensively used in the calculation of the economic conversion factors, and it has been

estimated to be 6.0%. FEP represents the value of the difference between the market

and the economic value of expenditures on traded goods .14

Labor markets in South Africa are at the present time characterized by high rates of

unemployment of unskilled labor, close to full employment of skilled labor and are

generally highly regulated, unionized and distorted. In such a situation the wage rate

paid by a project for a particular skill or occupation will usually be significantly

different from its economic opportunity cost. The economic opportunity cost of labor

(EOCL) for unskilled workers is estimated to be only 0.45 of the wage rate, while for

different types of skilled labor, a range of 0.98 to 0.73 of the wage rate has been

established.15

The vehicle operating costs by type of vehicle, items (i) and (j), are estimated from

the traffic forecasts for “without” and “with” with a help of an appropriate road

management software. The resulting product is a set of two annual time-series on

VOC by type of vehicle. The next step would be to take the difference between the

VOC “without” and “with” project by type of vehicle, and then discount the resulting

12 The database has been packaged into user-friendly software “South African Conversion Factors Easy

Access” (SACFEA). The software is available from the Department of Finance and Economic Development, Limpopo Provincial Government. The conceptual framework and actual estimation procedures are presented in “Integrated Investment Appraisal: Concepts and Practice”, Appendix E: Estimation of Economic Prices and Conversion Factors for Tradable Goods and Services, pp. 542-590; and also in Appendix F: Estimation of Economic Prices and Conversion Factors for Non-Tradable Goods and Services, pp. 591-624; and also in Appendix G: Commodity-Specific Conversion Factors for Non-Tradable Goods and Services in South Africa, pp. 625-676; and also in Appendix H: Commodity Specific Conversion Factors for South Africa, pp. 677-727.

13 For methodology underlying the estimation of the economic conversion factors, refer to “Integrated Investment Appraisal: Concepts and Practice”, Chapter 9: Guidelines for the Utilization of Conversion Factors in the Economic Appraisal of Projects, pp. 275-304; and also in Appendix B: The Economic Costs of Tradable and Non-Tradable Goods for South Africa, pp. 478-503.

14 Ibid, Appendix B: The Economic Costs of Tradable and Non-Tradable Goods for South Africa, p. 501. 15 Ibid, Appendix D: Estimation of the Economic Opportunity Cost of Labor in South Africa, pp. 515-540.

18

differentials to the beginning year of analysis in order to estimate a total present value

(PV) of VOC cost-savings, i.e. economic benefit.

The parameters for items (k), and (l) are typically derived from an actual road survey,

which can help establish the composition of road users on a particular section, average

speeds, and their average occupancy. The value of time for passengers and tourists

(m) is usually linked to wages of skilled and unskilled labor in the region. The value

of time savings for cargo is a function of delay costs, and may require an additional

investigation for the particular commodities in question.16

The economic opportunity cost of capital (EOCK) is the appropriate discount rate,

item (n), to use when estimating the economic NPV of a road project.17 This hurdle

rate applies not only to investments financed solely with public funds but for the

economic evaluation of joint public-private ventures and pure private investments.

3.2.3 Incremental Economic Resource Flow When there are distorted markets for the outputs/inputs, or there are other reasons for

economic externalities to exist, market prices will no longer measure economic prices.

These distortions or externalities comprise of taxes, subsidies, trade tariffs, price

controls, monopoly markets, environmental impacts such as pollution or congestion,

and open access or common property situations. The economic analysis requires that a

adjustments be made to convert estimates of incremental cash expenditures into

incremental economic costs. These adjustments are based on the three basic postulates

of applied welfare economics, used to measure economic benefits and costs and then

to add them up and encapsulated in the following principles: willingness to pay,

supply price, and “a Rand is a Rand”.18

16 Adler, H.A., “Economic Appraisal of Transport Projects: A Manual with Case Studies”, Indiana

University Press, London, UK (1971), pp. 33–35. 17 The theoretical arguments have been developed by Harberger, A.C., “On Measuring the Social

Opportunity Cost of Public Funds”, in Project Evaluation – Collected Papers, (Chicago: the University of Chicago, 1972); Sandmo, H. and Dreze, J.H, “Discount Rates for Public Investment in Closed and Open Economies”, Economica, (November 1971); and Sjaastad, L.A. and Wisecarver, D.L., “The Social Cost of Public Fund”, Journal of Political Economy, (June 1977).

18 Ibid, p. 75.

19

In practical terms, the incremental economic resource flow statement consists of two

parts: economic benefits and economic costs. Ideally, on the benefit side, five types of

benefits should be counted: (1) reduction in resource costs on maintenance by the

Roads Agency; (2) reduction in vehicle operating costs for road users due to improved

road surface; (3) time savings for road users due to increase in the average speed of

vehicles; (4) possible reduction in the costs of accidents; and (5) other externalities.

3.3 Economic Benefits

3.3.1 Savings of Maintenance Expenditures The construction costs of a tarred surface are typically justified by its lower annual

maintenance costs as compared to gravel type surface. The annual savings in

resources used for maintenance is the difference between the amounts of resources

spent on maintenance “without” road improvement minus the maintenance costs

during the life of the road “with” the improvement. However, if for some reason the

expected maintenance costs of a new road are higher than the maintenance costs of

the existing road, then these will be additional economic costs that are measured by

the difference between the two maintenance expenditures.

Savings of maintenance expenditures are estimated as the difference between the

projected expenditures over the periods covered by the analysis of the existing road

(“without” scenario) minus the projected expenditures on an improved road (“with”

scenario). The resulting annual financial savings must be then converted into

economic values to measure the real economic value of resources being conserved.

3.3.2 Reduction in Vehicle Operating Costs The costs incurred by road users in terms of the consumption of gasoline and oil, the

wear-and-tear on tires, the incidence of repair and maintenance expenses are all

combined to a definition of vehicle operating costs. As a consequence of road

improvement these costs will decline.

20

“Normal” Traffic. These road users are those who will be traveling on the road even

without road improvement. Comparing the total VOC “without” the proposed road

improvement and “with” road improvement gives us an estimate of incremental VOC

savings. This annual financial VOC savings must then be converted into economic

values to reflect the value of the resources saved. The resulting annual flow of

incremental VOC savings is really a series of benefits over time, that are generated by

the road improvement. The total amount of such savings depends on the traffic

volume and composition of vehicles, using the route. It will depend also on the degree

of surface improvement. In the case of an earth or gravel road upgrading to a tarred

surface, the value of VOC savings is likely to be substantial, as graphically presented

in Figure 1. Note that figure represents not only VOC reduction but a combination of

VOC and time costs incurred by road users.

Figure 1. Reduction of Total User Costs for Existing and New Traffic.

“Diverted” Traffic. For traffic diverted to the upgraded road from other routes of

modes of transport, the benefits are measured by the difference between the total

VOC, on the alternative route and total VOC on the upgraded road. It is useful to

know what the alternative routes are in terms of distance and surface condition in

order to estimate the vehicle operating costs. In the absence of improved road,

“diverted” users are not willing to incur the current generalized cost, measured in time

C1

C0

V0 V1

A

B D

O Traffic Volume (AADT)

User Costs (VOC plus time Costs) (R/vehicle-km)

D

21

and VOC) but are willing to incur the new generalized cost measured as the sum of

the value of time, VOC and toll rate (if any). Figure 1 illustrates this.

Here, line D represents the demand function for the use of the road by vehicles of a

certain type, let’s say mini-buses. The vertical axis is denotes the price that each

successive unit of traffic would be willing to pay, per vehicle-km, for traveling over

the road. This price should be interpreted as the maximum total cost per vehicle-km

which that unit of traffic would be willing to bear, in order to travel on the road. With

the unimproved road, the cost per vehicle-mile is C0, and the traffic level is V0,

including all those traffic units willing to bear costs of C0 or more. Under the

improvement, costs will fall to C1 and traffic volume will now expand to V1. The net

benefit to the “normal” traffic is described by rectangle C0ADC1, which is simply the

difference between the total VOC plus the time costs “without” and “with” the

project.

However, the gross benefits received by the incremental traffic are measured by

V0ABV1, but the costs they perceive are V0DBV1. Therefore, the triangle ADC

measures their net benefit for a particular year t. They do not receive as much net

benefit as the existing traffic because some of the reduction in costs will necessary to

induce them to travel on the improved road.19

“Generated” Traffic. The reduction in the cost of using the road resulting from lower

vehicle operating costs and faster travel (time savings) will induce more travel on the

road. Note that the additional (generated) users of the road are not willing to incur the

current (without project) generalized cost (measured in time and VOC) but are willing

to incur the new generalized cost measured as the sum of the value of time, VOC and

toll rate. The benefit to the generated users is also measured based on a half of the

per-unit VOC reduction, since this type of traffic would not materialize without this

reduction. Referring to Figure 1, if the additional traffic is entirely of “generated” type

with a volume V1V0, then its per-unit value of benefits is equal to ½(C0-C1).

19 Harberger, A.C., “Chapter 10: Cost-Benefit Analysis of Transportation Projects”, Project

Evaluation: Collected Papers, University of Chicago Press, 1976, pp.3-4.

22

The actual increase in traffic as a result of lower transport costs depends on the

elasticity of demand for transport services, which in turn depends on the elasticity of

demand for the individual commodities involved.20 The traffic model that provides

input to this analysis should incorporate these factors in order to generate a series of

“diverted” and “generated” traffic.

3.3.3 Time Savings The valuation of time savings for passenger and cargo traffic is a sometimes a

controversial issue. Valuation of time savings by different types of vehicles requires a

substantial volume of survey information, often specific to the particular road segment

in question.

“Normal” Traffic. For passenger and tourist “normal” traffic, the improved road

allows their vehicles to travel at a higher speed as compared to the existing road, thus

saving them time. The value of time is typically linked to the wage rates of unskilled

and skilled labor in the region. Once the average occupancy is established for each

vehicle type, the analyst can estimate the value of time savings. The value of time

savings for freight “normal” traffic is discussed in the following sections.

“Diverted” and “Generated” Passenger Traffic. Typically, the value of time savings

per additional vehicle-km traveled for “diverted” and “generated” passenger traffic is

taken as only one half of the value of time savings for “normal” traffic.

“Diverted” and “Generated” Freight Traffic. There are a few approaches to estimate

the value of time savings for cargo transport.21 Ideally, the analyst should know what

the kind of volumes, destinations, and commodities being transported on the road.

This would facilitate an estimation of a delay cost as measured through the

willingness to pay for faster delivery. Another approach is to measure the value of

capital costs savings due to faster turnaround of the heavy vehicles. Given a total

average lifespan of a vehicle and a certain volume of commodity to be transported,

faster travel will allow the vehicle fleet to be used more efficiently. In the long run,

20 Adler, H.A., “Economic Appraisal of Transport Projects: A Manual with Case Studies”, Indiana

University Press, London, UK (1971), pp. 28-29. 21 Ibid, pp. 96-99.

23

fewer vehicles will be needed, economic cost of which represents the economic

resource savings.

3.3.4 Accident Reduction An improved road is an important factor in reduction of the number and degree of

accidents, but there are a number of other influential aspects determining the accident

rate: width and geometric alignment of the road, congestion, volume of slow traffic,

effectiveness of law enforcement, vehicles mechanical condition, and driver behavior.

As a result, the road improvement per se may not automatically imply a substantial

reduction in the rate and severity of accidents. A detailed assessment is needed for

each particular road in question before final conclusions are derived.

Where the economic benefit of accident reduction is an apparent outcome of road

improvement, an effort to estimate this benefit should be taken with caution. Two

main steps must be taken to assess the magnitude of accident reduction. Firstly, the

rate of traffic accident “with” and “without” the proposed improvement must be

established. The rate is typically expressed as number of accidents per million

vehicle-kilometers. Secondly, the value of accident reduction must be estimated.

Typically, three types of damages are considered: property damage, cargo damage,

and injuries and fatality. That value of property and cargo damage is easily appraised

but the assessment of injury and fatalities will require to put a value on human life or

forgone earning over remaining years of life. Also, in an approach taken by many

analysts is not to express the injuries and fatality in monetary terms, but rather report

a reduction in the number of such accidents.22

22 These can be summarized in the following formula: ( )( )w w/oit it it

t

D * X -X� . Where Dit is the excess of

benefits over costs associated with a unit change of the level of activity Xi at time t, Xw

it is that level in the presence of the project in question, and Xw/oit is that level in the absence of the project. Thus, for example, X1t might be the number of unskilled laborers employed in a particular area, and D1t might be the excess of the wage paid to them over opportunity cost of their labor in alternative employments. Similarly, X2t might be the output of a irrigation scheme, and D2t might be the excise tax collected on the agriculture output, representing the excess of the social benefit over the resource cost of producing it.

24

3.3.5 Other Externalities It is appropriate, in the analysis of any project from the point of view of society as a

whole, to take into account external or indirect benefits and costs. For example, if

owing to the existence of a road project, more or less unskilled labor were to be

employed in the area, indirect benefits as measured by the excess of the amount these

workers were willing paid over the minimum amount they would be willing to work

for to be attributed as an additional benefit to the project.23

3.3.6 Case of Penetration Roads Complications in Analysis. When a road is built into an area to which access by motor

vehicles was previously impossible, significant modifications in this approach may be

required. The difficulties here stem from the fact that there is no existing traffic, hence

the component of benefits represented by C0ADC1 in Figure 1 simply does not exist.

All traffic is newly generated by the presence of the road, and all direct benefits to

users therefore are in principle of the type represented by the triangle ABD. Figure 1

illustrates such a case.

Figure 2. Case of a Penetration Road.

Here, the annual net benefit to users of type i is given by the triangle C1FH, which

corresponds exactly to ABD in Figure 1. The special problems presented by the

23 Harberger, A.C., “Chapter 10: Cost-Benefit Analysis of Transportation Projects”, Project

Evaluation: Collected Papers, University of Chicago Press, 1976, p. 7.

C1

V1

F

H

O Traffic Volume (AADT)

User Costs (VOC plus time

Costs) (R/vehicle-km)

D

25

present case arise because (a) whereas for improvement of existing roads the

increment in volume caused by the improvement is likely to be relatively small in

relation to the “normal” traffic, this increment represents the entire volume of traffic

in the case of a penetration road, and (b) whereas, in the case of road improvements,

the costs per vehicle-km in the existing and improved roads can be rather precisely

estimated, there is no correspondingly precise estimate of the height of the triangle

C1FH in the case of a penetration road.24

Note that the case of penetration road may also occur in cases where new

development, such as mining, takes place in addition to the existing economic

activities. The access road to the mine should be treated as a part of the mine

development as it is one of the necessary components of the project. Then, the

additional benefit of access road, as presented by triangle C1FH in Figure 2 would

correspond to triangle ABD in Figure 1.

Alternative Methods. It is advisable in some cases to use alternative approaches to the

estimation of benefits. The simplest case is that of a remote mine, where the problem

of access to the mine should be thought of within the context of deciding on the

worthwhileness of exploiting it. If the traffic to be carried over the road is to be

exclusively or almost exclusively connected with the operation of the mine, then the

enterprise exploiting the mine should also bear the costs of the road. If under these

circumstances the mine is not an attractive investment, this means that it is not

advantageous to the society as a whole to exploit the mine.25

A more complex case is that of a road which is opening up a new area to agricultural

development. Here, the essence of the problem can best be seen by assuming that the

area to be exploited consists entirely of public lands that have no value at present,

owing to their remoteness. The present value of the benefits attributable to the road

project would then be the total estimated revenues which the government could get

from the sale of the lands once the road was built, assuming that the market for land

would be functioning well. If the land already had a value in its existing state, the

24 Ibid, p. 5. 25 Ibid, p. 6.

26

benefit attributable to the road would be the excess of the prospective sale value of the

land over its present market price.26

Where direct use of land value comparisons is often found to be excessively risky, the

analyst may attempt to assess the benefits of a penetration road opening up a new area

to agriculture on the basis of prospective agricultural production. Here, care must be

taken to deduct from the value of prospective farm output all the relevant associated

costs, including those of clearing and improving the land (capital costs) as well as

such current costs as labor, fertilizer, and transporting the inputs and outputs of

agriculture over the road itself. To the extent that other required investments such as

the provision of electricity or drinking water are entailed in opening up the area to

agriculture, their costs must be deducted from the value of prospective farm output,

before arriving at the benefit due to the road itself.

It is important to recognize that the use of changes in land values, the use of the

present value of changes in agricultural output less costs and the estimation of the

present value of annual triangles C1FH in Figure 2, are the alternative ways of getting

at essentially the same thing. Failure to recognize these three approaches as

alternative ways of measuring the same thing will lead to double-counting of benefits

and even in some cases to triple-counting.27

3.4 Feasibility of a Road Improvement Projects

On the cost side of an incremental economic resource flow, a number of cost items

have to be established. The construction and rehabilitation costs must be converted

into their economic equivalents, and allocated appropriately over the project life,

typically over a 20-year horizon, for both “with” and “without” scenarios. The

difference between the costs of the “with” scenario with the costs of “without”

scenario represents the flow of incremental economic costs that economic sacrifices

for this project.

26 Ibid, p. 6. 27 Ibid, p. 7.

27

The incremental net economic resource flow is simply the difference between the total

benefits and total costs, on year-by-year basis. It is really a summary profile of the

road project. The values of the resulting annual net economic flow is then discounted

to the initial year of analysis at the economic discount rate (EOCK) to compute an

economic NPV of the project. If the economic NPV of the project is greater than zero,

the project is potentially worthwhile to implement. This implies that the project would

generate more net economic benefits than if the resources had been used elsewhere in

the economy. On the other hand, if the NPV is less than zero, the project should be

rejected on the ground that the resources invested could be put to better use if they

were left to be allocated by the capital market.

When selecting among several alternatives, the economic NPV criterion makes it

possible to choose the best combination of roads. Alternative road projects with the

highest NPV’s should be selected first in order to maximize the net economic benefits

over time.

3.4.1 Stakeholder Analysis

The stakeholders’ analysis, also referred to as distributional analysis, asks the

following question: who will benefit from the project and by how much and who will

pay for the project and by how much? Additional net benefits should be attributed to

the project if it provides for one or more of the society’s basic needs. For instance, a

road project in a rural area may not only reduce transportation costs but it may also

allow the children to attend school and the sick to get better health care. Both these

aspects are viewed positively by society and a social net benefit should be attributed

to the project to account for this externality.

The sum of the financial outcome and the externalities generated across the various

groups should add up to the economic analysis of the overall project. In this way, it is

possible to identify those groups that gain and those that lose and the extent of the

gain and loss as a result of a project. It provides a very valuable input to the decision

makers. A distributive analysis is composed of five distinct steps:

28

- Identify the externalities;

- Measure the net impact of the externalities as the real economic values of

resource flows less the real financial values of resource flows;

- Measure the values of the various externalities throughout the life of the

road project and calculate their present values (using the economic cost of

capital or the social discount rate);

- Allocate the externalities across the various stakeholders of the project;

- Summarize the distribution of the project’s externalities and net benefits

according to the key stakeholders in society.

3.4.2 Sensitivity Tests and Risk Analysis

Like everyone else, transportation and road appraisal analysts simply do not know

with certainty what will happen in the future. Since many of the parameters are

uncertain, the results of financial, economic and distributional analyses in terms of the

cash flows and the externalities will yield only one of the several probable values.

What is needed is to arrive at a distribution of values of these outcomes that

incorporate all the possible values that the various parameters were assumed. When

there is no information about the likely probability distributions of prices and

quantities, it is necessary to make informed judgments about the future values of a

project’s variables. In other cases when some knowledge of its probability distribution

is available, it will be possible to calculate the expected values of the variables, or to

make projections based on past data that take account of the historical means and

variances of the error terms. The topic of risk analysis provides the methodology for

dealing with uncertainty when there is some knowledge of probability distributions.

To begin with, a sensitivity analysis tells us which parameters are significant for the

outcome of the project. These become risk variables. Other parameters that do not

vary so much may be ignored for the purpose of the risk analysis. For each risk

variable, a probability distribution and range of values is assigned. Correlation among

variables is also built into the model. Finally, a Monte Carlo simulation is performed

and the model results are analyzed. What the risk analysis yields is not a single

number but a distribution of results, such as expected values of the desired outcomes,

the probabilities of negative returns, and the variability of outcomes. Risk Analysis is

29

then extended to economic and distributive analyses. The results of the risk analysis

enable the decision makers to make a more informed decision about project selection.

In order to manage risk, a way must be found to redesign or reorganize a project in

order to reallocate risk efficiently.

30

Chapter 4. Appraisal of New Roads 4.1 Sources of Identification of New/Upgrading Road Project A new road for construction or for upgrading may be identified in a variety of ways:

- It may be conceived by existing departments or departments in the national

and provincial governments,

- It may emerge out of the process of formulation of plans at national and

regional levels,

- It may be identified by the people’s representatives,

- It may come out as a demand from interest groups or beneficiaries

(communities, water user associations, etc.),

- It may be brought forward by private sponsors and enterprises (mining,

agriculture, tourism, etc.).

The Roads Agency Limpopo has cataloged all existing roads into a single database

that contains a detailed description of roads, their condition, and user traffic. The

database is equipped with a graphical interface, and allows the analyst to examine the

whole network. The location of a particular road link is referenced relative to other

roads. A total count of annual average daily traffic (AADT) is recorded along with the

proportion of heavy vehicles traffic. The condition of a road link is assessed through a

number of criteria: cracks, poth, patching, rutting. Two summary measures of

physical condition are stated: international roughness index (IRI), and visual

condition index (VCI).

The role of this database is to provide the decision-makers and engineers at RAL with

up-to-date information about the condition of the provincial road network. The system

is programed to pinpoint the road links that have a high traffic volume and require

urgent attention of the agency. The database also informs about deterioration of

certain roads and suggests the possible treatment options. In short, the database is a

tool that helps to identify roads for upgrading and rehabilitation. While some of the

sections of the database don’t have current information, it is expected that a major

update of all its contents will be complete by year 2005.

31

4.2 Pre-feasibility Phase The preparation stage should be followed by the pre-feasibility phase. A variety of

studies of projects from different countries have brought out glaring examples of

shortfalls in preparation and pre-feasibility study of projects.28

The pre-feasibility study is the stage for completing all the preliminary steps for going

into a detailed feasibility exercise. Thus, it is the first part of conducting the appraisal

of a project. If a new road does not prove to be promising at this stage, it may be

rejected without investing any additional time and resources into its further

examination and the process of appraisal is over for this project. The pre-feasibility

phase should normally comprise the following sub-modules.29

4.2.1 Traffic Sub-Module

This sub-module examines what the volume of traffic by type of vehicle will be for

the new or upgraded road. The function of this module is not only to assess the

current traffic but also to undertake the more difficult task of forecasting the future

traffic on the route. Also, an assessment should be made about the effect on the

alternative routes and modes of transportation.

For example, in a situation when two alternative gravel roads are currently available

to users, an upgrade of one of these to a tarred surface is likely to draw the traffic

from the second road (diverted traffic) as well as to induce more users to go by this

route (generated traffic). In a case when a gravel road and a rail-link currently exist,

an upgrade of the road will cause some of the passenger and cargo traffic to shift from

the railroad to the improved road.

28 A recent review of a series of evaluations of projects financed by the Overseas Development

Administration, International Development Association, US Agency for International Development and European Development Fund suggests that the reasons for poor performance of projects have been related to weakness in their preparation. See Kirkpatrick (1991) for details of these studies.

29 Adopted from Harberger, A.C. and Jenkins, G.P., Manual on Cost Benefit Analysis for Investment Decisions, Queen’s University, Kingston, Canada (2002) for a discussion of the various aspects of project planning or the pre-feasibility phase.

32

Existing Traffic

The measurement of demand for roads has long been expressed in units of annual

average daily traffic (AADT). The existing level of traffic is obtained either from

mechanical or manual traffic count by type of vehicle. Ideally, it would be preferable

to differentiate the vehicles into several types, such as cars and utilities; light, medium

and heavy buses; and light, medium, heavy and articulated trucks. However, the

practice at RAL has been to record traffic counts for only 2 types of vehicles: light

vehicles and heavy vehicles. The existing database of traffic counts is largely

composed of observations made during year 2000, reporting the total AADT’s and

also a share of heavy vehicles.

Traffic Forecast “With” and “Without” New Road/Upgrading

A projection of future traffic volumes typically incorporates the following factors:

growth in population of the communities en-route; growth of economic activity and

income; number and magnitude of new mining, tourism and agriculture projects in

area; public sector initiatives such as expansion of hospitals/clinics, schools, police

stations; the physical condition of the road segments and the degree of congestion,

and so on. Models based on linear and past traffic growth functions (often linked to

some parameters of general economic activity in the region) may do a reasonable

forecasting job.

A computerized model of regional traffic flow is needed to make reliable forecasts of

future traffic volumes, which would account for all relevant factors affecting the

growth and direction of passenger and cargo traffic. The output of this model will be a

time series of expected traffic volume by type of vehicle. Often, such models are able

to generate several scenarios from the “worst” case to the “best” case. These series

will be the basis of the “without” financial and economic analysis. Similarly, annual

traffic flows in the “with” road project scenario could be simulated by type of vehicle.

An Illustrative Example

In order to illustrate such a projection let’s consider the case of a gravel road

upgrading. Suppose that a 20 km existing gravel road is being considered for tarring

due to a high volume of existing traffic on it, and the expected future increase in the

volume of both passenger and cargo movement. The link is also important in terms of

33

giving an access to a development corridor, number of communities, a hospital and a

police station.

Suppose that two detailed sets of future traffic volumes “without” and “with” road

improvement have been generated for the purpose of this analysis. There are a few

potential sources of such forecasts: a) a study by specialized consultants; b) a traffic

flow movement software system for the province (no such system exist at the RAL as

of now); or c) building own traffic forecast by using all of the available information.

Often, the final choice of an analyst facing this challenge stops at the last alternative,

because a specialized study by consultants may not be an option due to time and

budget constraint, and because there is no generalized traffic flow framework adapted

for the provincial roads.

The traffic count on this segment suggests that in year 2005 there will be an annual

average of 600 vehicles a day, with 10% being heavy vehicles. It is expected that

“normal” traffic will grow at a rate of 2.0% per annum and the share of heavy traffic

will not change over time. It is expected that due to lower user costs some

“additional” traffic will appear on the road in year 2006 with an AADT of 40 vehicles

and 5% of heavy vehicles. This new traffic flow consisting from “diverted” and newly

“generated” users is assumed to grow at 2.0% per annum, as shown in Table 2.

Note that the traffic projections must utilize all available information. This implies

that all identified future demographic movements as well as developments in mining,

tourism, agriculture, manufacturing, and other sectors have been fully accounted for,

and are already included in the traffic forecast. In other words, there is no a single

outstanding piece of information that has not been used.

34

Table 2. Traffic Forecast “With” and “Without” Project (2005-2025). Year “Without” Project “With” Project

Normal Traffic Additional Traffic Total Traffic AADT % Heavy AADT % Heavy AADT % Heavy

2005 600 10.0% 0 0.0% 600 10.0% 2006 612 10.0% 40 5.0% 652 9.7% 2007 624 10.0% 41 5.0% 665 9.7% 2008 637 10.0% 42 5.0% 678 9.7% 2009 649 10.0% 42 5.0% 692 9.7% 2010 662 10.0% 43 5.0% 706 9.7% 2011 676 10.0% 44 5.0% 720 9.7% 2012 689 10.0% 45 5.0% 734 9.7% 2013 703 10.0% 46 5.0% 749 9.7% 2014 717 10.0% 47 5.0% 764 9.7% 2015 731 10.0% 48 5.0% 779 9.7% 2016 746 10.0% 49 5.0% 795 9.7% 2017 761 10.0% 50 5.0% 811 9.7% 2018 776 10.0% 51 5.0% 827 9.7% 2019 792 10.0% 52 5.0% 843 9.7% 2020 808 10.0% 53 5.0% 860 9.7% 2021 824 10.0% 54 5.0% 878 9.7% 2022 840 10.0% 55 5.0% 895 9.7% 2023 857 10.0% 56 5.0% 913 9.7% 2024 874 10.0% 57 5.0% 931 9.7% 2025 892 10.0% 58 5.0% 950 9.7%

4.2.2 Engineering Sub-Module

Once traffic forecasts are formulated in terms of expected traffic load, design of the

road segments can be prepared. The blueprints of road width, drainage, surface

strength, passes, and bridges along all sections are prepared. The outputs of

engineering module are the design plans for all road elements, and estimated costs of

their construction. The future expected maintenance, periodic, and rehabilitation costs

are estimated using the past information from the provincial network and expected

traffic levels. A set of financial costs for gravel and tarred roads used for the analysis

purposes is presented in Table 3. The list has been updated using the average cost

estimates by the RAL for year 2004, and then inflated into their 2005 equivalents.30

30 The costs are based on the effective rates in year 2004. An inflation rate of 6.5% was used to

obtain 2005 estimates. See Section 4.3.4.

35

Table 3. Financial Costs for Gravel and Tarred Roads (R, million/km).31

Type of Activity Frequency Cost per km (R, million) 2004 2005

Construction - 2.000 2.130 Routine annual 0.035 0.038 Intermediate every 5 years 0.040 0.043 T

arre

d R

oad

Periodic every 10 years 1.113 1.185 Construction - 0.588 0.627 Blading annual 0.043 0.046 Wearing Course every 2 years 0.235 0.251 G

rave

l R

oad

Heavy Regravel every 5 years 0.412 0.439

4.2.3 Environmental Sub-Module

The province has a number of pristine areas. Any road development should basically

avoid spoiling the environment. The modern construction methods attempts to

minimize such negative interactions, however, even the presence of the road and its

traffic movement are likely to pose a danger to the remaining flora and fauna. If the

road improvement is thought to cause a substantial degree of harm, then a proper

environmental assessment should be made on the nature and extent of this damage. In

cases of substantial pollution, the design phase may re-consider the direction of

problematic segment and, perhaps, re-route it elsewhere. If redirection is neither

possible nor technically feasible, then it is important to estimate the amount of

environmental damage caused by this road improvement project. The environmental

assessment team may be able to produce an estimate of the damage in monetary

terms.32

31 Note that the cost estimates presented here are the average values. Actual construction costs vary

substantially, from R 1.8 million to R 2.1 million per kilometer in 2004. The figures already include auxiliary roads, river crossings, professional fees, contingencies, and VAT. Obviously, once terrain survey and design of a proposed road are completed, the cost estimates will have more precision.

32 A number of methods have been developed for valuation of environmental impacts. See the following studies: (a) Asian Development Bank, “Economic Evaluation of Environmental Impacts - A Workbook”, Asian Development Bank, Manila, 1996, Chapter 7, Appendix G and H. (b) Harberger, A.C., and Jenkins, G.P., “Introduction: The Treatment of the Environment Evaluation”, Cost-Benefit Analysis, Edward Elgar Publisher, 2002, pp. 64-67. (c) Arrow, K., et. al, “Appendix I: Report of the NOAA Panel on Contingent Valuation”, Federal Register, 58 (10), 4602-14, January 1993. (d) Carson, R.T., “Contingent Valuation: A User’s Guide,” University of California, San Diego, 1999.

36

4.3 Financial Sub-Module

This module provides the first integration of the financial and technical variables

estimated in the demand, technical and manpower modules. A cash flow profile of the

project is constructed which identifies all the receipts and expenditures that are

expected to occur during the lifetime of the project.

4.3.1 Financial Expenditures For a public untolled road, the cashflow profile will only include the initial investment

costs, regular and periodic maintenance expenditures, and rehabilitation costs. Since

the road users are not charged for passage, no financial receipts are expected. All

these outlays will be borne by the Roads Agency and will be incurred during the

lifespan of the project, typically 20 years. This cashflow profile will belong to the

“with” scenario, and an example of such a profile is presented in Table 4. In a case

when a public road is partially funded by a private organization, for instance, a mining

association, the amounts of the payments received should be included as a cash inflow

in the corresponding time period(s).

Another set of expenditure outlays must be estimated for the “without” road

improvement scenario. It will include all the regular and periodic maintenance

expenditures, and the rehabilitation costs of the existing road if no improvement is

done to it beyond maintenance. This situation does not automatically mean that there

is “no spending”; nor does it imply a “minimum maintenance” strategy. What this

profile really means is that this road will be maintained in a proper physical condition,

according to the overall network maintenance strategy plan, simulated by dTIMS

software.

4.3.2 Real versus Nominal Prices One of the core concepts of the financial modeling is tied up with the differentiation

between the “nominal” and “real” prices. “Nominal” prices are easily observed on the

marketplace while the underlying “real” prices are not. The difference between the

two is the accounting for the movement in the general price level over time.

37

Table 4. Financial Cashflow Profile of Road Improvement Project (R2005, million).

Year With Project Without Project Incremental Flow

Construction Routine Intermediate Periodic Total Construction Blading Wearing Course Heavy

Regravel Total Construction Routine Intermediate Periodic Total

2005 42.60 0 0 0 42.60 0 0.92 0 0 0.92 -42.60 0.92 0.00 0.00 -41.68 2006 0 0.76 0 0 0.76 0 0.92 5.02 0 5.94 0.00 0.16 5.02 0.00 5.18 2007 0 0.76 0 0 0.76 0 0.92 0 0 0.92 0.00 0.16 0.00 0.00 0.16 2008 0 0.76 0 0 0.76 0 0.92 5.02 0 5.94 0.00 0.16 5.02 0.00 5.18 2009 0 0.76 0 0 0.76 0 0.92 0 8.78 9.70 0.00 0.16 0.00 8.78 8.94 2010 0 0.76 0.86 0 1.62 0 0.92 5.02 0 5.94 0.00 0.16 4.16 0.00 4.32 2011 0 0.76 0 0 0.76 0 0.92 0 0 0.92 0.00 0.16 0.00 0.00 0.16 2012 0 0.76 0 0 0.76 0 0.92 5.02 0 5.94 0.00 0.16 5.02 0.00 5.18 2013 0 0.76 0 0 0.76 0 0.92 0 0 0.92 0.00 0.16 0.00 0.00 0.16 2014 0 0.76 0 0 0.76 0 0.92 5.02 8.78 14.72 0.00 0.16 5.02 8.78 13.96 2015 0 0.76 0.86 23.7 25.32 0 0.92 0 0 0.92 0.00 0.16 -0.86 -23.70 -24.40 2016 0 0.76 0 0 0.76 0 0.92 5.02 0 5.94 0.00 0.16 5.02 0.00 5.18 2017 0 0.76 0 0 0.76 0 0.92 0 0 0.92 0.00 0.16 0.00 0.00 0.16 2018 0 0.76 0 0 0.76 0 0.92 5.02 0 5.94 0.00 0.16 5.02 0.00 5.18 2019 0 0.76 0 0 0.76 0 0.92 0 8.78 9.70 0.00 0.16 0.00 8.78 8.94 2020 0 0.76 0.86 0 1.62 0 0.92 5.02 0 5.94 0.00 0.16 4.16 0.00 4.32 2021 0 0.76 0 0 0.76 0 0.92 0 0 0.92 0.00 0.16 0.00 0.00 0.16 2022 0 0.76 0 0 0.76 0 0.92 5.02 0 5.94 0.00 0.16 5.02 0.00 5.18 2023 0 0.76 0 0 0.76 0 0.92 0 0 0.92 0.00 0.16 0.00 0.00 0.16 2024 0 0.76 0 0 0.76 0 0.92 5.02 8.78 14.72 0.00 0.16 5.02 8.78 13.96 2025 0 0.76 0 0 0.76 0 0.92 0 0 0.92 0.00 0.16 0.00 0.00 0.16

SUM -42.60 4.12 47.62 11.42 20.56 Sum of Maintenance Expenditure Savings = 63.2 PV@11% -42.60 2.19 20.04 4.11 -16.3 PV of Maintenance Expenditure Savings = 26.3

38

The nominal price of an item is its real price plus the cumulative effect of inflation. If

the beginning year of analysis is tak