Evaluation(Appraisal) of

transport projects
2013E.C.
ODA BULTUM UNIVERSITY
Evaluation(Appraisal) of transport projects
 The aim of the highway appraisal process is to determine the
economic, societal and environmental feasibility of the project
or group of projects under examination.
 The process enables highway planners to decide whether a
project is desirable in absolute terms and also provides a means
of choosing between different competing project options, all
of which have the ability to meet the stated goals and objectives
of the project sponsors.
Evaluation of transport projects (cont’d)
 Appraisal - Assessing whether an alternative solution is
worthwhile clearly involves forecasting the effect it will
have on policy indicators and weighing them up to decide
whether overall the proposal is beneficial.
 Economic efficiency - Projects could be found and undertaken
which would make everyone better off, those projects would
serve to promote economic efficiency.
 A project is economically efficient if the benefits measured
in money terms exceed the costs; the most efficient project
is that for which the difference is greatest.
Evaluation of transport projects (cont’d)
 Transport project expenditures can be readily valued using
monitory terms and maintenance can be computed using
the market price of the nation. Operating cost usually takes the
form:
𝐺=𝑀+𝛾𝑇
where 𝐺 is the generalized cost,
𝑀 is the monitory cost,
T is the journey time and
𝛾 is the value of time.
 Costs of transport projects- pain and grief resulting from
accidents, environmental effects- do not have a market price.
Evaluation of transport projects (cont’d)
Accidents
 Damage to property and vehicles,
 Health service, ambulance and police costs, and
 Loss of production due to victims being unable to work
 Difficult is to place a money value on the pain, grief and suffering caused by
death or injury in an accident.
Environmental
 Property demolition,
 Noise nuisance,
 Visual intrusion and air pollution.
 Consumption of scarce and non-renewable resources such as oil.
Benefits
 Reduction of congestion and travel time,
 Provision of accessibility,
 Enhancement of environment
Evaluation of transport projects (cont’d)
 The time saving can be generally indicated by the change in the
operating cost after the opening of the transport project.
Δ𝐺=𝐺𝑖−𝐺𝑓
 Where Δ𝐺 is the saving in operating cost,
𝐺𝑖 is the initial cost before the project and
𝐺𝑓 is the current cost after the construction of the project.
 The total saving in operating cost is given by

 Where 𝑄𝑖 and 𝑄𝑓 are the initial and final volume of traffic,

𝑚 is the mode and
𝑙 is the link.
 Evaluation of transport projects (cont’d)
Mainly involves financial and social appraisal of the
projects.
• Financial (economic)evalution:- measuring all the effects of the project
on the cash flow of the agent undertaking it.
• Social Appraisal:- measure the benefits and costs whoever receives
them and whatever form they take.
In order to undertake an appraisal, it is necessary to
identify:
• The base case (i.e. what will happen without the project)
• The option (what will happen with it)
Evaluation of transport projects (cont’d)
Economic appraisal of highway schemes Tools
 Net present value (NPV)
 Benefit/cost ratio (B/C)
 Internal rate of return (IRR)
 The NPV will estimate the economic worth of the project
in terms of the present worth of the total net benefits.
 The IRR will give, for each option under consideration,
the rate at which the net present value for it equals zero.
 B/C ratio based on the ratio of the present value of the
benefits to the present value of the costs.
Evaluation of transport projects (cont’d)
Net Present Value (NPV)
 Cash flow are 'discounted' back to the present to find
its Net Present Value (NPV) in financial terms.

 The NPV is simply the difference between the sum of

the discounted costs and the discounted benefits.

 Net cash flow = Benefit – Cost

 (NPV) ≥0
 n
CFt
• Using the formula: NPV  
t 0 (1  R ) t

NPV = -165,000/(1.12)0 + 63,120/(1.12)1 +

70,800/(1.12)2 + 91,080/(1.12)3 = 12,627.41

Capital Budgeting Project NPV

Required Return = 12%
Year CF Formula Disc CFs
0 (165,000.00) =(-165000)/(1.12)^0 = (165,000.00)
1 63,120.00 =(63120)/(1.12)^1 = 56,357.14
2 70,800.00 =(70800)/(1.12)^2 = 56,441.33
3 91,080.00 =(91080)/(1.12)^3 = 64,828.94
12,627.41
Evaluation of transport projects (cont’d)
The net present value method can be used by taking the
following steps by tabulating.
 Step 1. Estimate the cash inflows and outflows on a year-to-
year basis.
 Step 2. Work out the net cash flows for individual years.
 Step 3. Find out for individual years the discount value of 1
at the given discount rate
 Step 4. Multiply the net cash flows for each year by the
corresponding discount factor.
 Step 5. Add up the present values
Example 1
Year Costs Benefits Benefits- Values of 1 at Discounted
(outflo (inflow) costs (Net 12% Discount Net Cash
ws) Cash Flows) Rate Flows

Step 1 Step 2 Step 3 Step 4

0 250 0 -250 1.00 -250
1
250 290 40 0.893 35.7
2
250 290 40 0.797 31.9
3
255 300 45 0.712 32
4
260 335 75 0.636 47.7
5
260 335 75 0.567 42.5
6
260 335 75 0.507 38.0
1,185 1,295 -22.2
Step 5
NPV=-22.2 <0 thus, The project, cannot be accepted
Example 2
Benefits-Costs (Net Cash Values of 1 at 8% Discounted Net
Flows) Discount Rate
Year Cash Flows
Step 2 Step 3 Step 4
0 -250 1.00 -250
1 40 0.93 37.2
2 40 0.86 34.4
3 55 0.79 43.5
4 75 0.74 54.8
5 75 0.68 51.0
6 75 0.63 47.2
NPV=18.1

The project can be accepted because NPV is positive.

Evaluation of transport projects (cont’d)
 Benefit-cost Ratio
 BCR is a net measure that relates the net benefits to the
initial investment (I)
 The benefit-cost ratio is a ratio calculated by dividing the
sum of discounted benefits by discounted costs.
𝑆𝑢𝑚 𝑜𝑓 𝐷𝑖𝑠𝑐𝑜𝑢𝑛𝑡𝑒𝑑 𝐵𝑒𝑛𝑒𝑓𝑖𝑡
 𝐵𝐶𝑅 =
𝑆𝑢𝑚 𝑜𝑓 𝐷𝑖𝑠𝑐𝑜𝑢𝑛𝑡𝑒𝑑 𝐶𝑜𝑠𝑡
 Rules are:
 BCR>1 = Accept
 BCR<1 = Reject
 BCR =1 Indifferent
Evaluation of transport projects (cont’d)
 Steps for calculating the benefit-cost ratio are:
 Step 1. Estimate the cash inflows and outflows on a year-to-
year basis
 Step 2. Find out for individual years the discount value of 1 at
the given
discount rate.
 Step 3. Multiply the cash inflows and cash outflows for each
year by the corresponding discount factor.
 Step 4 .Add up the discounted values of cash inflows and
outflows separately.
 Step 5. Divide the discounted values of cash inflows by cash
outflows to obtain the benefit-cost ratio.
 example 3
Ye a r Costs Discount Discounted Values
(outfl ows) Benefits Factor at
(inflows) 8% Costs Benefits

0
Step 1 Step 2 Steps 3 and 4
250 0 1 250 0
1
250 290 0.93 232.5 269.7
2
250 290 0.86 215 249.4
3
255 300 0.76 193.8 228
4
260 335 0.73 189.8 244.55
5
260 335 0.68 176.8 227.8
6
260 335 0.63 163.8 211.05

Total 1421.7 1430.5

Step 5: Benefit Cost Ratio= 1430.5/1421.7 = 1.00619 .

The higher the benefit-cost ratio of a project, the better it is in terms of
profitability.
Evaluation of transport projects (cont’d)
 Internal Rate of Return(IRR)
 The internal rate of return is a rate of discount at which the net present
values of a project are zero. Or, expressed differently, it is a rate at
which the discounted costs and discounted benefits become equal.
 The rate represents the “effective interest earned on the investment in
the project.” In the words of Gittinger.
 It is the maximum interest that a project could pay for the resources
used if the project is to recover its investment and operating costs and
still breakeven.
Internal Rate of Return = A rate at which the discounted costs are equal
to discounted benefits & must greater than discount rate or capital
cost for single project.
 The higher the IRR, the stronger is the project.
Evaluation of transport projects (cont’d)
 Multiple IRRs
 Descartes Rule of Signs
n
CF
 t

t  0 (1  IRR )
t
 0

 Polynomial of degree n→n roots

 When you solve for IRR you are solving for the
root of an equation.

8-18
Evaluation of transport projects (cont’d)
 NPV > 0 at 15% required return, so you should
Accept
 IRR =10.11% (using a financial calculator), which
would tell you to Reject
 Recognize the non-conventional cash flows
and look at the NPV profile
I= 15%
YR CF
0 -$90,000
1 $132,000
2 $100,000
3 -$150,000
NPV $1,769.54 >0
IRR-1 10.11% < 15%
IRR-2 42.66% > 15%
8-19
Evaluation of transport projects (cont’d)
Evaluation of transport projects (cont’d)
• Independent
– The cash flows of one project are
unaffected by the acceptance of the
other.
• Mutually Exclusive
– The acceptance of one project
precludes accepting the other.
 Evaluation of transport projects (cont’d)
The calculation of the internal rate of return involves the
following steps for mutually exclusive project.
Step 1. Estimate the cash inflows and cash outflows on a year-to-
year basis
Step 2. Work out the net cash flows for individual years.
Step 3. Select any random discount rate and compute the net
present values.
Step 4. If the NPV thus arrived at is positive, then select a higher
discount rate at which the NPV may come close to zero.
If, however, the NPV is negative, then select a lower discount
rate at which the NPV may come close to zero.
Step 5. Repeat the exercise until a discount rate that reduces the
net present values to zero is found.
Example (mutually exclusive project)
Costs
(Cash Benefits
Year Net Cash Net Present Values
outflow s) (Cash
Flows Discounted
inflows)

Step 1 Step 2 Step 3(A) Step 4(B)

8% 12%
0
250 0 -250 -250 -250
1
250 290 40 37.2 35.7
2
250 290 40 34.4 31.9
3
255 300 45 43.5 32.0
4
260 335 75 54.8 47.6
5
260 335 75 51.0 42.5
6
260 335 75 47.2 38.0
Total
NPV=18.1 NPV=-22.2
Cont’d
 In this example, the initial discounting of the net cash flows
(Step 3) has been done at 8 percent, which gives a positive net
present value of 18.1.
 Step 4, that is, discounting at 12 percent, turns the net values to
a negative figure of 22.2, suggesting that the rate at which the
discounted net values would turn zero must lie somewhere
between 8 and 12 percent.
 An alternative to the use of repetitive computations is
“interpolation”, which is a technique of finding the
intermediate values between any two figures, or any two
discount rates in the present context.
 Project A is selected based on NPV & Project B is rejected.
Cont’d 𝑁𝑒𝑡 𝑝𝑟𝑒𝑠𝑒𝑛𝑡
𝐷𝑖𝑓𝑓𝑒𝑟𝑒𝑛𝑐𝑒 𝑣𝑎𝑙𝑢𝑒 𝑙𝑜𝑤𝑒𝑟
 IRR=Lower Dis. rate+ 𝐵𝑒𝑡𝑤𝑒𝑒𝑛 X 𝑑𝑖𝑠𝑐𝑜𝑢𝑛𝑡 𝑟𝑎𝑡𝑒
𝑆𝑢𝑚 𝑜𝑓 𝑡𝑕𝑒 𝑛𝑒𝑡 𝑝𝑟𝑒𝑠𝑒𝑛𝑡
𝑡ℎ𝑒 𝐷𝑖𝑠𝑐𝑜𝑢𝑛𝑡 𝑟𝑎𝑡𝑒𝑠 𝑉𝑎𝑙𝑢𝑒𝑠 𝑎𝑡 𝑡𝑕𝑒 𝑡𝑤𝑜
𝐷𝑖𝑠𝑐𝑜𝑢𝑛𝑡 𝑅𝑎𝑡𝑒𝑠 (𝑖𝑔𝑛𝑜𝑟𝑒 𝑠𝑖𝑔𝑛)

Internal rate of return = 8+ (12 – 8) X 18.1

(18.1)-(-15.1)
= 8+ (4) x 18.1
40.3
= 8 + (4) (0.45)

= 8 + 1.8
= 9.8 % rate of discount
Evaluation of transport projects (cont’d)
 Example of Mutually Exclusive
Projects
Period Project A Project B The required
0 -500 -400 return for both
projects is 10%.
1 325 325
2 325 200
Which project
IRR 19.43% 22.17% should you accept
NPV 64.05 60.74 and why?