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Class 27 - Life Cycle Cost and Benefit Analysis

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AND

COST ANALYSIS

ECONOMIC ANALYSIS

Issues and Concepts

• Costs and benefits can be valued in

currency units.

• Project life cycle is basis for

comparison

• To be compared, dollars in different

years must be “discounted” to their

present value amounts

Typical Life Cycle Profile Benefits Costs Initial Capital Cost Dollars 0 1 2 3 4 5 6 7 8 9 10 Year 11 12 13 14 15 16 17 18 19 20 .

Steps for Economic Analysis • • • • • Step 1: Step 2: Step 3: Step 4: Step 5: Establish design alternatives Determine activity timing Estimate costs (Agency and user) Discount life cycle costs Analyze the results .

Adjusting for Present Value where 1 PV = t (1 + r ) At PV = present value at time zero (base year) r = discount rate t = time (number of year) A = amount of benefit or cost in year t .

Example of Discounting • What if we want to determine how much a $ 1.. in dollars with today’s purchasing power) – Discount rate is 3% .e.000 benefit in 30 years is worth to us today? – $1000 is in “real” dollars (i.

03) • Do calculations: PV = $1.000 x 0.Example (continued) • Plug values into discounting formula: 1 $1.41199 = $412 .000 year 30 PV = 30 (1 + .

the lower the present value of a future dollar – At 3%.000 30 years from now is worth only $412 today – Worth $231 at 5% and $57 at 10% • Discount rate can influence project selection or design .Discount Rate Is Important • Higher the discount rate. $1.

Life-Cycle Cost Analysis (LCCA) • Subset of BCA – The “blue bars” on the life cycle profile • LCCA reveals lowest life-cycle cost alternative for a project • Used only when all design alternatives yield same benefits .

LCCA Formula • LCCA is done using the basic multiyear discounting formula: 1 PV = ∑ t ( 1 + r ) t =0 N • Cost t where “Cost” equals the cost for design alternative in year t .

How to Get Best LCCA Results • Evaluate all reasonable design alternatives for the project • Analyze alternatives over identical analysis periods • Evaluate all relevant costs that vary among the alternatives .

Cost Items Used in LCCA Agency Costs Design and engineering Land acquisition Construction Reconstruction/Rehabilitation Preservation/Routine Maintenance User Costs At Work Zones Delay Crashes Vehicle Operating .

Better information for decisions 2. . Support for overcoming the “first cost” limitations.LCCA done in ALL infrastructure cases. 5. Consideration of user costs 4.Benefits of LCCA 1. Expose areas of uncertainty and quantify the risk …. Improved rehabilitation strategies 3.

reconstruct road vs. the project has a positive net present value) . of itself.g.. answer question of whether an improvement is worth pursuing (i.e.Limitations of LCCA • Cannot compare design alternatives that have different benefits (e. reconstruct road with widening) • Cannot.

.Benefit Cost Analysis (BCA) • BCA compares discounted value of project’s benefits to discounted value of its costs – The blue and red bars on the life cycle profile • BCA is the superset of LCCA and focuses on finding out the benefits from different alternatives of the project.

BCA Formula • BCA is done using the basic multi-year discounting formula: 1 PV = ∑ t t = 0 (1 + r ) N ( Benefit t − Cost t ) .

Applications of BCA • BCA is used to address the following resource allocation decisions: – Whether or not to pursue an improvement – Select among design alternatives with different benefits – Select among competing projects in same mode – Select among competing projects in different modes .

and crash rates • Valuation of time and safety is often controversial – Externalities and social impacts resist quantification . delays.Challenges of BCA • Calculation of benefits and costs over life cycle is often difficult – Agency costs associated with projects can be hard to ascertain – User costs and benefits are critical • User benefits are purpose for building the road but may be hard to measure and value • Uncertain forecasts of traffic.

Discounting • Discounting is the backbone of Economic analysis • Use of a discount rate facilitates comparison of the costs and benefits of alternative transportation projects over time • Dollars can be: – Relocated in time – Any combination of flows can be summed into a single value at a single point in time – Lump sums can be converted to annual flows • Discount rate is distinct from inflation rate .

people’s preferences for current over future consumption.Key Role of Discount Rate in BCA • Discount rate reflects the productivity of capital. this means resource allocation is not economically efficient . and the scarcity of investable resources • If an investment doesn’t yield discounted benefits that exceed discounted costs.

Conclusions • EA has an important role in Transportation Asset Management • EA tools are versatile and can accommodate a large number of variables as well as uncertainty • EA informs Decision Makers. about which alternative to choose out of a given alternatives .

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