Civil 522 Project and Construction Economics

FALL 2004 COURSE OUTLINE

Instructor: Alan D. Russell CEME 2014, 822-4753 E-mail: adr@civil.ubc.ca Meeting Days & Time Mondays 1:00 - 3:00 CEME 1212 Wednesdays 3:00 - 4:00 CEME 1212 Note 1 11 October 2004 26 November 2004 Thanksgiving University closed. Last class

Note 2: All assignments must be submitted in hard copy form e-mail attachments are not acceptable. Course Overview The goal is to apply the principles of engineering economics, finance, basic economic concepts and systems analysis techniques to the modeling and analysis of building and civil engineering projects. Emphasis is on capital expenditure modeling, revenue and operating expenditure modeling, project financing, the overall mathematical structure of a project, and risk management (identification, quantification, analysis, aversion, allocation, monitoring). The topic of publicprivate partnership (P3) approaches (finance, design, build, operate, maintain [FDBOM], BuildOperate-Transfer [BOT], Build-Transfer-Operate [BTO], etc.) versus traditional procurement modes for the development and/or replacement of public infrastructure (highways, bridges, rapidtransit facilities, sewage treatment plants, small hydro projects, multi-purpose building facilities, etc) will provide the focus of much of the discussion. (We tend to focus more on civil infrastructure as opposed to industrial facilities.) This will be complemented by the treatment of private sector projects where speed may be of the essence and/or revenue functions are complex. The viewpoints and performance measures of interest to the various players in a project (owner, shareholder, financier, government, contractor, facilities manager, and third party stakeholders) will be examined. Where practical, and depending on class size, the use of problem-base learning will be used to focus discussion, and explore various aspects of the course subject matter. Philosophy of Course Our focus is very much on the realities and practicalities of real projects. Our interest, however, lies with generating insights on projects in general, not one-off situations (although we may attempt to generalize from specific project experiences). Hence, we treat generalized formulations of projects, and in so doing, use continuous (multivariate calculus) and not discrete modelling of project scenarios. This allows us to explore behaviour over a broad range of scenarios and hence develop greater insights. We are well aware that in practice, discrete formulations are almost always adopted for at least two reasons: (i) the mathematical sophistication of those involved in analyzing projects tends to be less than that possessed by engineers (and seemingly even most engineers would like to forget their calculus); and, (ii) discrete formulations are readily compatible with spreadsheet analysis, the main stay of both public and private sector analysis. Significant opportunities exist for engineers to offer valueadded services to public and private sector clients on the front-end analysis of projects for purposes of assessing feasibility, recommending the most desirable procurement mode, etc. To do so, however, they must develop a broad appreciation of the anatomy of a project, and emerse themselves in the vocabulary of engineering (ranging from structures, geotechnical,

transportation, through to construction engineering), statistics, economics, business, finance, accounting, and taxation. We make a start in this course. Background Reading Material *There is no text for the course. A number of handouts will be given, and there will be a photocopy charge of $20. A basic knowledge of engineering economics is presumed. Reference texts to help you review and extend engineering economic concepts include: Contemporary Engineering Economics: A Canadian Perspective, Park, Porteous, Sadler and Zuo, Addison Wesley, 1995 Engineering Economic Analysis - Seventh Edition, Newnan and Johnson, Engineering Press Inc. 1998 Advanced Engineering Economics, Park & Sharp-Bette, Wiley, 1990. (This book comes closest to the kind of modeling pursued in this course.) Marking (Tentative) Assignments & in-class discussion Fact finding & reporting Final Examination

50% (individual 20%, group 30%) 10% 40%

The fact finding and reporting component deals with preparing sharply focused literature and/or data searches and the preparation of briefing notes for distribution to the class. Students will be required to identify the key issues surrounding a narrowly focused topic (e.g. demand functions for tolled transportation project, shadow tolling, etc. ), identify relevant literature, produce a 1 - 3 page synopsis, and share their findings with the class. The assignments are quite demanding, and involve the use of spreadsheets and other computerbased tools such as Mathcad and @Risk (in-class tutorials will be given on the use of these tools). For major assignments, students will work in groups of two. Our approach to assignments will include considerable in-class discussion as they are in progress. So come to class prepared to discuss and share your findings to date. Please note: You may seek clarifications from me by way of e-mail. However, all assignments are to be submitted in hard copy form only. Course Readings (this list is currently being modified so expect changes in the papers distributed interestingly, earlier papers in many cases are still the best) Russell, A.D. , Partial set of Civil 300/403 Course Notes on basic Engineering Economics concepts (time value of money)
These notes are meant to give a quick introduction to the basics, and some useful background. Selected parts will be reviewed briefly in class.

Linzey, M.P.T., Brotchie, J.F., and J.F. Nicholas (1973). "A Systems Approach to Building Planning & Design." Proceedings, Australian and New Zealand Conference on the Planning & Design of Tall Buildings.
This is an old but good paper that provides useful insights, using a highly simplified net present value model, for optimizing and evaluating building projects. It introduces the concepts of continuous modeling and a systems approach. When this paper first appeared, it was way ahead of its time.

Eschenbach, T.G. (1992). Spiderplots versus Tornado Diagrams for Sensitivity Analysis. Interfaces 22:6 November-December, 40-46.
This simple paper provides a useful overview of sensitivity analysis.

Russell, A.D. Worked example re sensitivity analysis

Examples to demonstrate linear and nonlinear sensitivity analysis.

de la Mare, R.F. (1979). Modelling Capital Expenditure. Engineering and Process Economics, Vol 4, 467-477.
One of the earliest papers that discusses the importance of the accurate modeling of capital expenditures, both for computing rate of return and financial and project management. More generalized models have appeared since, and the search continues for the holy grail of relationships that is both flexible and totally general. Alas, there is no single best form.

Russell, A.D. Some notes on capital expenditure modeling,

Summary of several important relationships.

Bailey, J.B., Spies, P.F. and Weitzman, M. K. (1977). Market Study + Financial Analysis = Feasibility Report. The Appraisal Journal, October, 550 - 577.
This paper provides useful insights on issues that should be treated in the feasibility analysis of a building project. Public infrastructure and industrial projects are considerably more complex, especially given the growth in stakeholders and related issues. Nevertheless, of importance to note is the level of effort required to generate the inputs in order to carry out the analytical part of a feasibility study.

Yaworsky, R.A. (1994). Case Study of the Channel Tunnel BOT Project., Chapter 4, Ph.D. Thesis, Risk Planning for Large and BOT Projects: A Holistic Framework, Ph.D. Thesis, University of British Columbia, January 1994.
This case study demonstrates the kinds of twists and turns and the risks involved in large infrastructure projects. An important observation to make is that it is impossible to be clairvoyant about all of the events that can effect a project. It thus helps to put the limits of formal risk analysis in perspective.

Russell, A.D. and Ranasinghe, M. (1991). Decision framework for fast-track construction: A deterministic analysis. Construction Management and Economics, Vol 9, 467-479.
This paper explores some of the incentives for speeding up project delivery. As will be discussed in class, the model formulation, while correct, could be improved upon for the purpose of providing a better understanding of what time variables are most cost effective to treat in order to shorten the project delivery process.

Rosenfeld, Y. and Geltner, D. (1991). Cost-plus and incentive contracting: Some false benefits and inherent drawbacks. Construction Management and Economics, Vol 9, 481 - 492.
This paper sounds a cautionary note about efforts to speed up project delivery.

Spetzler, C.S. and Stael Von Holstein, C.A.S. (1975). Probability encoding in decision analysis, Management Science, Vol. 22, No. 3, 340 - 358.
A seminal paper that treats how inputs essential for formal risk analysis may be estimated.

Ranasinghe, M. and Russell, A.D. (1993). Elicitation of subjective probabilities for economic risk analysis: An investigation, Construction Management and Economics, Vol. 11, 326-340
Provides a step by step approach for eliciting information from experts. Makes use of moment estimating relationships. Discusses top down versus bottom up estimating aproaches.

Russell, A. D. (1998, 2003). Some notes on Project Performance Modelling and Risk Analysis. Other references will be identified later. Homework Assignments Much of the learning in the course comes from carrying out of the assignments. Several of the readings are in direct support of the assignments. In-class discussions will be held on progress on the assignments so class members dont wander off on the wrong approach. A combination of small assignments to be worked individually and large assignments to be worked in groups of two will be used to illustrate the principles treated in class. Both quantitative and qualitative issues will be treated in the assignments. Group Assignments (Groups of 2) Assignment G1 - In this assignment, we wish to explore the importance of modeling realistically project cash flows (completeness and shape), and the linear and nonlinear sensitivity of economic performance to changes in independent variables. Some insights are provided on forecasting model parameter values as a function of fundamental variables are given. The

importance of project financing is briefly explored, as is the topic of leverage. The context is that of a highrise condominium project. Use is made of a highly aggregated model. Assignment G2 - This assignment provides insights on the significance of fast-tracking and acceleration on economic performance. The importance of carefully defining terms and developing a generalized formulation is emphasized. Three different scenarios are examined: increasing revenue growth vs time; cyclical revenue vs time; and, decaying revenue vs time. definitions of terms is featured. A formulation will be given in order to abbreviate the assignment. Assignment G3 - This assignment will focus on aspects of the proprosed RAV project for the lower mainland. Groups will be responsible for different facets of the project. The goal will be to development a highly aggregated yet complete model of the project in order to assess the risk profile of the project. Use will be made of some aspects of the RFP issued for the project. The fact-finding assignment described below will relate to various aspects of this assignment. Individual Assignments Assignment 1 To familiarize students with the use of spreadsheets and MathCad for the continuous and discrete formulation of project performance measures. Assignment 2 Simplied risk analysis example; fast-tracking; financing. Fact Finding and Reporting Assignment part of G3 - Tentative Topics This year, we will focus on the different facets of the RAV project. Some of the information gathered will be used as part of the Group Assignment 3. Potential topics include: Modeling tunneling construction as a function of ground conditions Modeling elevated transit guideways Generating demand functions for rapid transit projects Forecasting life cycle costs Forecasting long term interest rate and inflation rates