Part G Economic Analysis

Contents

Volume 4 - Analytical Framework & Model

Descriptions: Part G
G1 Economic Analysis
1 Introduction G1-1
2 Background G1-2
2.1 Economic analysis G1-2
2.2 Optimisation G1-2
2.3 Classification of benefits and costs G1-3
3 Benefits and costs considered in HDM-4 G1-4
3.1 Summary of benefits and costs G1-4
3.2 Costs incurred by the road administration G1-4
3.3 Road user costs G1-4
3.4 Environmental effects G1-5
3.5 Other benefits and costs G1-5
3.6 Unit costs G1-5
4 Outline methodology G1-6
4.1 Basic unit of analysis G1-6
4.2 Life cycle analysis G1-6
4.3 Models G1-8
4.4 Analysis sequence G1-8
5 Economic analysis G1-14
5.1 Comparison of investment options G1-14
5.2 Determination of costs and benefits G1-14
5.3 Economic decision criteria G1-19
5.4 Comparison of environmental effects G1-21
5.5 Diverted traffic G1-21
6 Optimisation G1-22
6.1 Total enumeration G1-22
6.2 Incremental benefit/cost ranking G1-24
7 References G1-27

Analytical Framework and Model Descriptions i

Version 1.0
Part G Road Map

Analytical
AnalyticalFramework
Framework
and
andModel
Model
Descriptions
Descriptions

Introduction
Introduction
Part
PartAA

Traffic
Traffic
Part
PartBB

RD
RDModel WE
WEModel RUE
Model Model RUEModel
Model SEE
SEEModel
Model
Part
PartCC Part
PartDD Part
PartEE Part
PartFF

Economic
EconomicAnalysis
Analysis
RD = Road Deterioration Part
PartGG
Nomenclature
Nomenclature
WE = Road Works Effects Part
PartHH

RUE = Road User Effects Glossary

Glossary
Part
PartI I
SEE = Social and Environmental Effects

Figure G Analytical Framework and Model Descriptions Road Map

Analytical Framework and Model Descriptions 1

Version 1.0
 PART G ECONOMIC ANALYSIS

Part G Economic Analysis

G1 Economic Analysis

1 Introduction
HDM-4 caters for three applications levels commonly used in decision making within the road
sub-sector. The different applications, which are described in more detail in the Applications
Guide, are:
1 Strategic planning

For estimating medium and long-term budget requirements for the development and
preservation of a road network under various budgetary and economic scenarios.
2 Programme analysis

For preparing single or multi-year work programmes under budget constraints, in which
those sections of the network likely to require maintenance, improvement, or new
construction, are identified in a tactical planning exercise.
3 Project analysis

For estimating the economic or engineering viability of different road investment projects
and associated environmental effects. Typical projects include the maintenance and
rehabilitation of existing roads, widening or geometric improvement schemes, pavement
upgrading and new road construction.
For all the three applications, the underlying operation of HDM-4 is based on the concept of
life cycle analysis under a user-specified scenario of circumstances. This involves the analysis
of pavement performance, road works effects and costs, together with estimates of road user
costs and environmental effects, and economic comparisons of different project alternatives.
This chapter describes how HDM-4 is used to determine the benefits and costs associated with
a road investment, and how these are applied in economic analysis and optimisation
procedures to find the best use of available resources.

Analytical Framework and Model Descriptions G1-1

Version 1.0
 PART G ECONOMIC ANALYSIS G1 ECONOMIC ANALYSIS

2 Background

2.1 Economic analysis

Economic analysis of the time stream of costs and benefits is used to compare the economic
viability of different alternatives, and to provide the criteria needed for economic decision
making. Decisions can be made about which option to implement, and when is the most
favourable time for implementation. Economic analysis can also be used to investigate the
technical standards and strategies to be followed by a particular investment decision.
Economic analyses involves the following tasks:
1 Identification of the problem to be solved and the formulation of alternatives.
2 Identification and quantification of the life-cycle costs to be incurred and benefits to be
realised.
3 Modelling future impacts of the proposed alternatives on road performance and traffic
flow.
4 Economic comparison of the different alternatives, involving:
(a) discounting the annual costs and benefits streams to a chosen base year
(b) Comparing the time stream of costs for each pair of alternatives
(c) Calculating the economic indicators such as the net present value, internal rate of
return, benefit-cost ratio, and first year benefits
A project analysis usually involves a small number of road links or sections and the results of
economic analysis would provide adequate information for decision making, since a budget
would normally already have been approved for these activities.

2.2 Optimisation
The purpose of the Strategy and Programme applications is to calculate the economic benefits
derived from maintenance or improvement options, and to select the set of investments to be
made on a number of road sections within a network which will optimise an objective
function.
Programme analysis is concerned with short to medium term planning and preparation where
budget levels are known with reasonable certainty and the objective is to select a set of road
sections and road works within the budget constraint.
Strategy analysis involves the analysis of an entire road network (or sub-network). The
objective is either to determine which types of road works should be applied in order to
maximise economic benefits, or it may also be applied to determine the budget required for a
given long term target road network condition. Thus, the problem can be posed as one of
searching for the combination of investment alternatives that optimises the objective function
under a budget constraint or a road network condition constraint. Note that the set of
investment options to be optimised is user-defined and is not the set of all possible options for
the particular network; hence the problem is not true optimisation since all possible solutions
are not normally considered. Note also that the investment options on any one road section are
mutually exclusive.
The three alternative objective functions provided for the Strategy and Programme
applications are:

Analytical Framework and Model Descriptions G1-2

Version 1.0
 PART G ECONOMIC ANALYSIS G1 ECONOMIC ANALYSIS

1 Maximisation of economic benefits (that is, NPV)

This option is used when the problem can be defined as the selection of a combination of
investment options applied on several road sections which maximises the NPV (net
present value) for the whole network subject to the sum of the financial costs being less
than the budget available.
2 Maximisation of the improvement in network condition

The roughness reduction on each road section multiplied by the section length
(∆IRI*Length) is used instead of NPV. Consequently, the arithmetic procedure is similar
to that used for maximisation of economic benefits.
3 Minimise costs of road works to achieve a given target road network condition

This option is used mainly in the Strategy analysis application. The target road condition
defined in terms of the long-term average roughness (IRI) over the whole analysis period
must be specified for each road section. The optimisation procedure is then reduced to a
simple selection of the road work options for which the average IRI (over the analysis
period) is equal to or just below the target IRI and has the lowest total financial cost.

2.3 Classification of benefits and costs

Costs and benefits due to road investments may be classified into the following three broad
categories:
1 Benefits and costs expressed in monetary terms

For example, vehicle operating costs, savings in travel time, accident costs.
2 Quantified benefits and costs not expressed in monetary terms

For example, road safety, pollution from vehicle emissions and traffic noise.
3 Non-quantified benefits and costs

For example, better social welfare, ecological impacts.

An economic analysis considers directly only benefits and costs expressed in monetary terms.
Other costs and benefits may also need to be considered, and this is sometimes done within
the framework of a multi-criteria analysis.

Analytical Framework and Model Descriptions G1-3

Version 1.0
 PART G ECONOMIC ANALYSIS G1 ECONOMIC ANALYSIS

3 Benefits and costs considered in HDM-4

3.1 Summary of benefits and costs

HDM-4 considers quantified benefits and costs that can be expressed in monetary terms, and
has some scope for considering those that cannot be expressed in this way. The benefits and
costs considered are:
! Costs incurred by the road administration (see Section 3.2)

! Road user costs (see Section 3.3)

! Environmental effects (see Section 3.4)

! Other benefits and costs (see Section 3.5)

3.2 Costs incurred by the road administration

These costs are also referred to as road agency costs and include the following:
! Road development
! Pavement maintenance
! Road-side or off-carriageway activities

The cost of works is derived from the product of the physical quantities involved in the
activity and the unit cost. These are determined for each road section and investment option,
and for each year of the analysis period. The resulting costs are assigned to budget categories
that are user-definable. The following default categories are used in HDM-4:
! Capital (or periodic)
! Recurrent (or routine)
! Special

Budget constraints can be applied separately to each category when required by the economic
analysis and optimisation.

3.3 Road user costs

The following components of Road User Costs are modelled:
! Motorised vehicle operating costs

These costs include:

❏ Fuel and lubricant consumption
❏ Tyre and parts consumption
❏ Labour
❏ Capital
❏ Crew

Analytical Framework and Model Descriptions G1-4

Version 1.0
 PART G ECONOMIC ANALYSIS G1 ECONOMIC ANALYSIS

❏ Overheads
! Travel time costs

These costs include passenger travel time costs, and cargo holding time costs.
! Non-motorised transport (NMT)

These costs include time and operating costs.

! Accident costs

These costs are evaluated both in monetary and non-monetary terms, and separated into
several different types (for example, fatal, injury, and damage only, and all accidents). Note
users are allowed the flexibility to include or exclude accident costs from an economic
analysis.

3.4 Environmental effects

The following environmental impacts are determined:
! Vehicle emissions
! Energy use

! Traffic noise (not included in this release)

3.5 Other benefits and costs

The user can specify those benefits and costs that are not modelled for each year of the
analysis period. These benefits and costs are discounted and added to those that are calculated
internally. These other benefits and costs are sometimes termed exogenous.

3.6 Unit costs

Unit costs are applied to the calculated physical and operational quantities to produce the cost
estimates used in investment decisions and budget preparation. Unit costs should be expressed
in economic terms when economic analysis is being undertaken, and in financial terms for
financial analysis. Financial unit costs are the market prices of resources. Economic unit costs
are the real value or opportunity costs of resources, and they are found by removing
distortions such as taxes, subsidies and other miscellaneous costs from the market prices.
Unit costs are required for the following:
! Road development, maintenance and road-side activities

These unit costs are specified by the user (see Part D).
! Road user costs

These unit costs include vehicle resources, travel-time values, and road accident
resources (see Part E).
In most cases, unit costs are specified in units-per-quantity. However, some costs are specified
as a proportion of other costs, or as a lump sum.
In addition to calculating economic costs, financial costs are also computed if the user gives
appropriate inputs (for example, unit costs in financial terms).

Analytical Framework and Model Descriptions G1-5

Version 1.0
 PART G ECONOMIC ANALYSIS G1 ECONOMIC ANALYSIS

4 Outline methodology

4.1 Basic unit of analysis

The basic unit of analysis in HDM-4 is the homogeneous road section. Several investment
options can be assigned to a road section for analysis. One or more vehicle types that use the
road must also be defined together with the traffic volume specified in terms of the annual
average daily traffic (AADT).

4.2 Life cycle analysis

The underlying operation of HDM-4 is common for the project, programme or strategy
applications. In each case, HDM-4 predicts the life cycle pavement performance and the
resulting user costs under specified maintenance and/or road improvement scenarios. The
broad concept of the life cycle analysis is illustrated in Figure G1.1. The agency and user costs
are determined by first predicting physical quantities of resource consumption and then
multiplying these by the corresponding unit costs.
Two or more options comprising different road maintenance and/or improvement works
should be specified for each candidate road section with one option designated as the do
minimum or base case (usually representing minimal routine maintenance). The benefits
derived from implementation of other options are calculated over a specified analysis period
by comparing the predicted economic cost streams in each year against that for the respective
year of the base case option. The discounted total economic cost difference is defined as the
net present value (NPV). The average life cycle riding quality measured in terms of the
international roughness index (IRI) is also calculated for each option.

Analytical Framework and Model Descriptions G1-6

Version 1.0
PART G ECONOMIC ANALYSIS G1 ECONOMIC ANALYSIS

INPUTS MODEL OUTPUTS

Vehicle type, volume, growth,

loading, physical parameters,
terrain, precipitation, road Start of analysis loop
geometry, pavement
characteristics, unit costs

Pavement type, strength, age, Cracking, ravelling, pot-holes, rut

condition, and ESAL Road Deterioration depth, faulting (paved); gravel
thickness (unpaved); roughness

Road geometry and roughness; Fuel, lubricant, tyres, maintenance,

vehicle speed, type; congestion Road User Effects fixed costs, speed, travel time, road
parameters; unit costs user costs

Road works standards and Reset cracking, ravelling, pot-

strategies holes, rut depth (paved); gravel
Works Effects thickness (unpaved); roughness,
works quantities and agency costs

Road geometry and surface Social and Levels of emissions and energy
texture, vehicle characteristics Environmental Effects used, and number of accidents

Developmental, accident, Costs and benefits, including

environmental, and other Economic Analysis exogenous benefits
exogenous costs and benefits

Total costs by component; net

Return to start of analysis loop present values and rates of return
by section

Figure G1.1 Life cycle analysis procedure in HDM-4

Analytical Framework and Model Descriptions G1-7

Version 1.0
 PART G ECONOMIC ANALYSIS G1 ECONOMIC ANALYSIS

4.3 Models
Total life-cycle conditions and costs of sections or road networks can be simulated over a
user-defined period into the future. The inter-dependence between the costs incurred by the
road administration and the road user is recognised, and models are used to predict cost
streams under the various headings.
The models incorporated in HDM-4 contain technical relationships for the following
purposes:
1 Calculation of traffic volumes and flows, and vehicle loading over the road section.
2 Prediction of road deterioration, and works effects and costs, that are incurred in response
to traffic flows, time and the surrounding environment.
3 Prediction of the costs of road use incurred as road condition and traffic flow change over
time.
4 Prediction of accident rates as a function of the road and traffic characteristics, and the
evaluation of accident costs.
5 Evaluation of vehicle emissions and energy use due to different road investment projects.
6 Economic analysis by comparison of the impacts or effects of different road investment
project alternatives.

4.4 Analysis sequence

The overall logic sequence for economic analysis and optimisation is illustrated in Figure
G1.2a and represented below by pseudo codes. This shows the following:
1 The outer analysis loop

Enabling economic comparisons to be made for each pair of investment options, using
the effects and costs calculated over the analysis period for each option, and indicates
that generated and diverted traffic levels may vary depending on the investment option
considered.
2 Costs

How annual costs to the road administration and to the road users are calculated for
individual road section options.
3 Optimisation procedures

These are performed after economic benefits of all the section options have been
determined.
The pseudo code that represents the outer analysis loop is given below:

Analytical Framework and Model Descriptions G1-8

Version 1.0
PART G ECONOMIC ANALYSIS G1 ECONOMIC ANALYSIS

START
Define input data
Loop for each option
Loop for each section
Loop for each analysis year
Calculate traffic over the road section

Model annual effects and costs (see Figure G1.2b)

Store results for evaluation and reporting phase

End loop
End loop
End loop
Loop for each pair of options to be compared
Loop for each analysis year
Loop for each section
Calculate non-discounted net benefits
Calculate discounted net benefits
Calculate net environmental effects and energy used
End loop

Calculate total non-discounted net benefits over all the sections (see Figure
G1.2c)
Calculate total discounted net benefits over all the sections (see Figure G1.2c)

Calculate total environmental effects and energy used over all the sections (see
Figure G1.2c)
End loop
Calculate economic indicators (NPV, IRR, BCR, and FYB see Section 5.3.1 and
Figure G1.2c)
End Loop
Perform budget optimisation (for strategy and programme analysis)
Output results
END

Analytical Framework and Model Descriptions G1-9

Version 1.0
PART G ECONOMIC ANALYSIS G1 ECONOMIC ANALYSIS

Define Input Data

LOOP
For each option

LOOP
For each section

LOOP
For each analysis year

CALCULATE
This year’s traffic
over the road section

See Figure G1.2b

MODEL
Annual effects and costs

STORE
Results for evaluation
and reporting phase

Yes
More
Years?

No

Yes
More
Sections?

No

Yes
More
Options?

No
See Figure G1.2c
Economic Analysis and
Comparisons

Optimisation
procedures

Output Results

Figure G1.2a Overall analysis sequence logic – Part A

Analytical Framework and Model Descriptions G1-10

Version 1.0
PART G ECONOMIC ANALYSIS G1 ECONOMIC ANALYSIS

MODEL
Annual effects and costs

CALCULATE
Road Deterioration
[RD Module]

CALCULATE
Road User Effects
(Speeds, VOC, time costs,
NMT, accident costs)
[RUE Module]

CALCULATE
Road Works Effects
[WE Module]

CALCULATE
Social and Environmental Effects
Social
(emissions
and Environmental
and energy balance)
Effects
(emissions andModule]
[SEE energy balance)

ADD
This year’s exogenous
benefits and costs

Return

Figure G1.2b Overall Analysis sequence logic - Part B

Analytical Framework and Model Descriptions G1-11

Version 1.0
PART G ECONOMIC ANALYSIS G1 ECONOMIC ANALYSIS

Economic Analysis and

Comparisons

LOOP
For each comparison

LOOP
For each analysis year

SET NPVsr = 0
Total net effects TNEsn (1, . . .,n) = 0

LOOP
For each section

CALCULATE
non-discounted Net Benefits

CALCULATE
Discounted Net Benefits at different
discount rates (r)

CALCULATE
Net effects (n)

Yes
More
Sections?

No

CALCULATE
Total net benefits and effects

Yes
More
Years?

No

CALCULATE Economic indicators

CALCULATE
Total net effects

Yes
More
comparisons?

No

Return

Figure G1.2c Overall Analysis sequence logic - Part C

Analytical Framework and Model Descriptions G1-12

Version 1.0
PART G ECONOMIC ANALYSIS G1 ECONOMIC ANALYSIS

The procedure for calculating annual road agency costs and road user effects for individual
section options is illustrated in Figure G1.2b and summarised by the following steps:
1 Calculate road deterioration - in the RD module (see Part C)

2 Calculate road user costs

VOC, travel time costs, NMT time and operating costs, and accident costs - in the RUE
module (see Part E).
3 Calculate quantities and costs for road works - in the WE module (see Part D)

4 Calculate environmental effects

For example, emissions and energy use - in the SEE module (see Part F).
5 Add exogenous benefits and costs

Figure G1.2c illustrates the inner analysis loops for economic analysis and comparison of each
pair of road alternatives.

Analytical Framework and Model Descriptions G1-13

Version 1.0
 PART G ECONOMIC ANALYSIS G1 ECONOMIC ANALYSIS

5 Economic analysis

5.1 Comparison of investment options

Economic indicators are computed at different user-specified discount rates using the time
streams of benefits or costs resulting from the various comparative pairs of investment
options. The term investment options has been used in this document to refer to both project
options (or alternatives) and section options (or alternatives).
For each pair of investment options to be compared, the net benefits (or costs) of
implementing one option relative to the other is calculated year by year. The various methods
of comparison are described in sub-sections within Sections 5.2 and 5.3. In all cases,
investment option m is compared against option n (that is, option n is the base case).

5.2 Determination of costs and benefits

5.2.1 Costs to the road administration

The cost differences between a pair of investment options, m and n, in a given year, are
calculated as follows:

 
∆C (m−n)i = 

∑C
s
mis - ∑C
s
nis 

...(5.1)

where:

∆C(m-n)i the difference in road administration cost of investment option m relative to

base option n for budget category i
Cjis the total costs to road administration incurred by investment option j (where j
= n or m) for budget category i, for road section s (see Part D)

The difference in annual costs to road administration is given by the expression:

∆RAC (m −n ) = ∑ ∆C
i
(m −n)i ...(5.2)

where:

∆RAC(m-n) the difference in annual costs to road administration of investment option m

relative to base option n. (The summation is over all the budget categories)

These cost differences provide a relative measure of the increase in costs to the road
administration, of implementing investment option m over base option n.
The difference in the salvage values of works performed under investment options m and n is
a component of the net economic benefits to be included in the last year of the analysis period
(see Section 5.2.4), and is given as:

∆SALVA (m-n) = [SALVA m - SALVA n ] ...(5.3)

Analytical Framework and Model Descriptions G1-14

Version 1.0
 PART G ECONOMIC ANALYSIS G1 ECONOMIC ANALYSIS

where:

∆SALVA(m-n) the difference in salvage value of implementing investment option m

relative to base option n
SALVAj salvage value of the works performed under investment option j (where
j = n or m) (see Part D)

5.2.2 Savings in road user costs

The annual economic benefits in terms of savings in road user costs are calculated separately
by components and traffic categories as follows:
! Savings in motorised vehicle operating costs

Vehicle operating benefits due to normal and diverted traffic is calculated as follows:

 
∆VCN (m−n) = 

∑ VCN - ∑ VCN
s
ns
s
ms 

...(5.4)

VCNns = ∑ TN
k
nsk * UCnsk ...(5.5)

VCN ms = ∑ TN
k
msk * UC msk ...(5.6)

Vehicle operating benefits due to generated traffic is calculated as follows:

 
∆VCG (m−n) = 

∑∑ {0.5 * [TG
s k
msk + TG nsk ] * [UC nsk − UC msk ]}

...(5.7)

The summations are over all the motorised vehicle types (k = 1, 2, ..., K) specified by the
user, and all road sections (s = 1, 2, ... ., S) being analysed.
The annual saving in vehicle operating costs is given by the expression:

∆VOC (m −n ) = [ ∆VCN (m −n ) + ∆VCG (m −n ) ] ...(5.8)

where:

∆VCN(m-n) vehicle operating benefits due to normal and diverted traffic of investment
option m relative to base option n
VCNjs annual vehicle operating cost due to normal and diverted traffic over the
road section s with investment option j
TNjsk normal and diverted traffic, in number of vehicles per year in both
directions on road s, investment option j, for vehicle type k
UCjsk annual average operating cost per vehicle-trip over road section s, for
vehicle type k under investment option j (where j = n or m)
VCGjs annual vehicle operating cost due to generated traffic over road section s
with investment option j

Analytical Framework and Model Descriptions G1-15

Version 1.0
PART G ECONOMIC ANALYSIS G1 ECONOMIC ANALYSIS

∆VCG(m-n) vehicle operating benefits due to generated traffic of investment option m

relative to base option n
TGjsk generated traffic, in number of vehicles per year in both directions on road
s, for vehicle type k, due to investment option j
∆VOC(m-n) savings in vehicle operating costs due to the total traffic of investment
option m relative to base option n

! Savings in travel time costs – motorised vehicles

Vehicle travel time benefits due to normal and diverted traffic are calculated as follows:

 
∆TCN (m−n) = 

∑ TCN - ∑ TCN
s
ns
s
ms 

...(5.9)

TCN ns = ∑ TN
k
nsk * UTnsk ...(5.10)

TCN ms = ∑ TN
k
msk * UTmsk ...(5.11)

Vehicle travel time benefits due to generated traffic are calculated as follows:

 
∆TCG (m−n) = 

∑∑ {0.5 * [TG
s k
msk + TG nsk ] * [UTnsk − UTmsk ]}

...(5.12)

The annual savings in travel time costs are given by the expression:

∆TTC (m −n ) = [∆ TCN (m −n ) + ∆TCG (m −n ) ] ...(5.13)

where:

∆TCN(m-n) travel time benefits due to normal and diverted traffic of investment
option m relative to base option n
TCNjs annual vehicle travel time cost due to normal and diverted traffic over
road section s with investment option j
UTjsk annual average travel time cost per vehicle-trip over the road section s, for
vehicle type k, under investment option j (where j = n or m)
TCGjs annual vehicle travel time cost due to generated traffic over road section s
with investment option j
∆TCG(m-n) travel time benefits due to generated traffic of investment option m
relative to base option n on the given road section in the given year
∆TTC(m-n) savings in travel time costs due to total traffic of investment option m
relative to base option n

! Savings in NMT time and operating costs

Non-Motorised Transport (NMT) time and operating benefits due to normal and diverted
traffic are calculated as follows:

Analytical Framework and Model Descriptions G1-16

Version 1.0
PART G ECONOMIC ANALYSIS G1 ECONOMIC ANALYSIS

 
∆TOCN(m−n) = 

∑ TOCN - ∑ TOCN
s
ns
s
ms 

...(5.14)

TOCNns = ∑ TN
k
nsk * UTOC nsk ...(5.15)

TOCNms = ∑ TN
k
msk * UTOC msk ...(5.16)

NMT time and operating benefits due to generated traffic are calculated as follows:

 
∆TOCG (m−n) = 

∑∑ [0.5 * (TG
s k
msk + TG nsk ) * (UTOC nsk − UTOC msk )]


...(5.17)

The summations are over all the NMT types (k = 1, 2, ..., K) specified by the user, and all
road sections (s = 1, 2, ... ., S) being analysed.
The annual savings in NMT time and operating costs are given by the expression:

∆NMTOC (m −n ) = [∆ TOCN (m −n ) + ∆TOCG (m −n ) ] ...(5.18)

where:

∆TOCN(m-n) NMT time and operating benefits due to normal and diverted traffic of
investment option m relative to base option n
TOCNjs annual NMT time and operating costs due to normal and diverted
traffic over the road section s with investment option j
TNjsk NMT normal and diverted traffic, in number of vehicles per year in
both directions on road s investment option j, for vehicle type k
UTOCjsk annual average NMT time and operating cost per vehicle-trip over road
section s, for vehicle type k, under investment option j (where j = n or
m)
TOCGjs annual NMT time and operating costs due to generated traffic over
road section s with investment option j
TGjsk NMT generated traffic, in number of vehicles per year in both
directions on road s, for vehicle type k, due to investment option j
∆TOCG(m-n) NMT time and operating benefits due to generated traffic of investment
option m relative to base option n
∆NMTOC(m-n) annual savings in NMT time and operating costs due to total traffic of
investment option m relative to base option n

! Reduction in accident costs

The benefits from reduction in total accident costs are given by the expression:

∆ACC (m-n) = [AC n - AC m ] ...(5.19)

Analytical Framework and Model Descriptions G1-17

Version 1.0
 PART G ECONOMIC ANALYSIS G1 ECONOMIC ANALYSIS

where:

∆ACC(m-n) the accident reduction benefits due to implementing investment option

m relative to base option n
ACj the total accident costs under investment option j (where j = n or m)

! Road user benefits

The annual savings in road user costs are given by the expression:

∆RUC (m −n ) = [∆VOC (m-n) + ∆TTC (m-n) + ∆NMTOC (m-n) + ∆ACC (m-n) ] ...(5.20)

where:

∆RUC(m-n) the total road user benefits of investment option m

relative to base option n

5.2.3 Other benefits and costs

The difference in other (exogenous) benefits and costs, for each pair of investment options m
and n in a given year, are calculated as follows:

∆NEXB = EXB - EXC - EXB + EXC  ...(5.21)

y(m - n)  ym ym yn yn 

where:

∆NEXBy(m-n) the annual net exogenous benefits of investment option m relative to base
option n, in year y
EXBjy exogenous benefits for investment option j, in year y, (where j = n or m)

EXCjy exogenous costs for investment option j, in year y

5.2.4 Annual net economic benefits

For each pair of investment options, the annual net economic benefits of implementing option
m relative to option n is obtained by combining the differences in costs to the road
administration, road user costs, and other benefits and costs, as follows:

NB y (m-n ) = [∆RUC y(m-n) + ∆NEXB y(m-n) - ∆RAC y(m-n) ] ...(5.22)

where:

NBy(m-n) net economic benefit of investment option m relative to base option n in

year y, and the parameters on the right-hand side are as defined earlier, but
with subscript y added to indicate year

Analytical Framework and Model Descriptions G1-18

Version 1.0
 PART G ECONOMIC ANALYSIS G1 ECONOMIC ANALYSIS

In the last year of the analysis period, the net economic benefits of implementing option m
relative to option n is calculated as:

NB Y (m-n) = [∆RUC Y(m-n) + ∆NEXB Y(m-n) - ∆RAC Y(m-n) + ∆SALVA (m-n) ]

...(5.23)

where:

NBY(m-n) net economic benefit of investment option m relative to base option n in the
last year of the analysis period Y, and the parameters on the right-hand side
are as defined earlier, but with subscript Y added to indicate the last year of
the analysis period

5.2.5 New road sections (or links)

For the analysis of a new road section, the following variables used in the equations given in
Sections 5.2.1 to 5.2.3 are set to zero: Cnis, SALVAn, UCnsk, TNnsk, TGnsk, UTnsk, UTOCnsk,
ACn, EXByn, and EXCyn.

5.3 Economic decision criteria

5.3.1 Indicators determined

The following economic indicators are computed from the time streams of benefits or costs at
the user-specified discount rate:
! Net Present Value - NPV (see Section 5.3.2)

! Internal Rate of Return - IRR (see Section 5.3.3)

! Benefit/Cost Ratio - BCR (see Section 5.3.4)

! First Year Benefits - FYB (see Section 5.3.5)

The determination of these indicators is described in the sections referenced.

5.3.2 Net present value

The Net Present Value (NPV) of investment option m relative to base option n is the sum of
the discounted annual net benefits or costs, calculated from the relationship:
Y

∑ [1+ 0.01 * r]
NB y(m-n)
NPV(m −n) = (y -1)
...(5.24)
y =1

where:

NBy(m-n) net economic benefit of investment option m relative to base option n in

year y
r discount rate (%)
y analysis year (y = 1, 2, ... ., Y)

Analytical Framework and Model Descriptions G1-19

Version 1.0
 PART G ECONOMIC ANALYSIS G1 ECONOMIC ANALYSIS

The higher the NPV, the greater the benefits from investment option m relative to base option
n. If there are no budget constraints, then the choice between the two alternative investments
should be based on NPV. Larger investments will tend to have larger NPVs.

5.3.3 Internal rate of return

The Internal Rate of Return (IRR) is the discount rate at which NPV is zero. It is calculated by
solving the implicit relationship for r°:
Y
NB y(m−n)
∑ [1 + 0.01 * r°]
y =1
(y -1)
= 0 ...(5.25)

This equation is solved for r° by evaluating the NPV at 5 percent intervals of discount rates
between -95 and +900 percent, and determining the zero(es) of the equation by linear
interpolation of adjacent discount rates with NPV of opposite signs. Depending on the nature
of the net benefit stream, NBy(m-n), it is possible to find one solution, multiple solutions, or
none at all.
The IRR gives no indication of the size of the costs or benefits of an investment; it acts as a
guide to the profitability of the investment - the higher the better. If the computed IRR is
larger than the planning discount rate, then the investment is economically justified.

5.3.4 Benefit cost ratio

The Benefit Cost Ratio (BCR) of investment option m, relative to base option n, is the ratio is
calculated as follows:

NPV(m-n)
BCR (m-n) = +1
Cm
...(5.26)

where:

BCR(m-n) benefit cost ratio of investment option m relative to base option n

NPV(m-n) discounted total net benefit of investment option m relative to base option n.
This is the Net Present Value at discount rate r
Cm discounted total agency costs of implementing investment option m

If the NPV(m-n) is zero, then (NPV/C)(m-n) is zero. These ratios give an indication of the
profitability of investment option m relative to base option n at a given discount rate. These
measures eliminate the bias of NPV towards larger project options but, like the IRR, they give
no indication of the size of the costs or benefits involved.

5.3.5 First-year benefits

The First-Year Benefits (FYB) is defined as the ratio, in percent, of the net benefit realised in
the first year after construction (or improvement) completion to the increase in total capital cost:

100 * NB y °(m-n)
FYB (m-n) =
∆TCC (m−n)
...(5.27)

Analytical Framework and Model Descriptions G1-20

Version 1.0
 PART G ECONOMIC ANALYSIS G1 ECONOMIC ANALYSIS

where:

FYB(m-n) first-year benefits of investment option m relative to base option n (%)

NBy°(m-n) net economic benefit of investment option m relative to base option n in

year y°, where:
y° is the year immediately after the last year in which the capital cost
for improvement or construction is incurred in option m
∆TCC(m-n) the difference in total capital cost (non-discounted) of investment option m
relative to base option n

FYB gives a rough guide to project timing: if it is greater than the discount rate, then the
project should go ahead; otherwise it should be delayed until it satisfies the criterion.

5.4 Comparison of environmental effects

Where it is not possible to model costs directly, the effects of alternative investments can be
evaluated. This information could be used as a decision tool for screening projects. For
example; investment alternatives can be selected that are more effective in reducing the
number of fatal accidents, or which are more effective in reducing the number of persons
disturbed by a high level of traffic noise. Effects may also be a useful input for multi-criteria
analysis.
The approach to carrying out a comparative study of environmental effects, for a pair of
investment options, is similar to that used for economic analysis (see Section 5.2). The annual
net quantities of vehicle emissions, number of accidents, and levels of traffic noise that are
determined are compared with the benefit of implementing one investment option relative to
the other.

5.5 Diverted traffic

Traffic diversion reduces or increases traffic on the roads that are affected. Therefore, in a
situation where a road works causes traffic to divert significantly to a new or improved road
section, a direct economic comparison of section options is not valid since the normal traffic
flows on the road with and without the works are not identical.
Economic comparisons of investment options involving diverted traffic can only be performed
meaningfully at the project analysis level, if the following conditions are met:
! All the road sections from and to which traffic diverts must be analysed together with the
section(s) being considered under the investment analysis; this implies that a study area
be defined to comprise all the sections that are affected significantly by traffic diversion
as a result of carrying out the road works.
! In any given analysis year, the total traffic volume entering the study area equals the total
traffic volume exiting the area; this implies a fixed trip matrix.
The analysis of a new road section (or link) in an entirely new location always involves
diverted traffic. The normal traffic in the first year of road opening is diverted traffic from
nearby routes (and from other transport modes, which may complicate matters further). The
economic analysis and comparison involving a new road section, therefore, should always
comply with the conditions described above.

Analytical Framework and Model Descriptions G1-21

Version 1.0
 PART G ECONOMIC ANALYSIS G1 ECONOMIC ANALYSIS

6 Optimisation
The two methods for budget optimisation provided for road works programming and network
strategic analysis are:
1 Total enumeration

2 Incremental benefit/cost ranking

[Further methods may be added in later versions of the HDM-4 software.]

If the number of roads to be analysed is less than 100, and there are no more than five budget
periods and 16 alternatives per road, total enumeration (see Section 6.1) can be used. This will
be externally done in the EBM-HS model of HDM-III. If the above mentioned constraints are
exceeded, incremental benefit/cost ranking (see Section 6.2) will be used.

6.1 Total enumeration

This is the method used by the EBM-HS model of HDM-III. It requires the user to specify the
following parameters:
! Name of data set

For example, CAPROG97.

! Length of analysis period

For example, 20 years.

! Budget periods

For example, 1, 2, 3, 4-20 years.

! Objective function

Either: maximise NPV or maximise the improvement in roughness.

! Constraints on resources for each budget period

For example, 10, 10, 10, 200.

The analysis period is given in terms of the number of years over which the overall analysis
should be performed, together with the initial calendar year. Budget periods are shorter time
periods for which the budget constraints are given. The objective function defines which
parameter is to be optimised. The default is the maximisation of NPV over the analysis period,
but the user can also choose the maximisation of the improvement in roughness.
The program is run for all the road sections defined with positive economic return, and for all
budget and investment options. The budget requirements from any committed projects will be
deducted from the available budget and the balance is used for optimisation.
The optimisation problem is then defined as an integer programming problem of maximising
the total objective function (TOBJ) for the network (extracts from EBM documentation):
S Ms
Maximise TOBJ[ Xsm] = ∑∑
s=1 m=1
OBJsm Xsm ...(6.1)

where:

Analytical Framework and Model Descriptions G1-22

Version 1.0
PART G ECONOMIC ANALYSIS G1 ECONOMIC ANALYSIS

s a road section (s = 1, 2, ... , S)

Ms the number of alternatives for road section s
m an investment alternative on a road section
OBJsm the objective function to be maximised which may be the discounted net
present value of economic benefits, or the average reduction in roughness due
to the investment alternative
sm subscript denoting alternative m for road section s
Xsm the zero-one decision variable:
Xsm 1 if alternative m of investment unit s is chosen
Xsm 0 otherwise
m 1,...,Ms

The above is subject to the following resource constraints:

S Ms

∑∑ R
s =1 m =1
smqt X sm ≤ TR qt , q = 1,...., Q; t = 1,...., T ...(6.2)

where:

Rsmqt Non-discounted amount of resource of type q incurred by the sectoral agency

within a budget period t
TRqt maximum amount of resource type q available for budget period t
Q the total number of resource types
T the total number of budget periods (the duration of t may be one or more years
and need not be equal for different budget periods)

The above is subject to the constraint of mutual exclusivity:

Ms

∑m =1
X sm ≤ 1, s = 1,...., S ...(6.3)

that is, for each road section s, no more than one alternative can be implemented.
If M is the average number of alternatives for the roads, the problem then has SM (= S x M)
zero-one variables, QT (= Q x T) resource constraints and S interdependency constraints. The
parameters that define the problem size are S, M and QT. Depending on the solution method
used, different problem-size parameters determine whether the method is suitable for the
problem in terms of the computational effort needed.
The total enumeration method provides the user with an unconditionally optimal solution. It
computes the total net present values of all feasible programme selections, and chooses the
one with the highest value. The computational effort required for this may be considerable, so
the method is only feasible when the number of alternatives per investment unit is relatively
small.

Analytical Framework and Model Descriptions G1-23

Version 1.0
 PART G ECONOMIC ANALYSIS G1 ECONOMIC ANALYSIS

Total enumeration is performed externally in the EBM-HS software of HDM-III. The

procedure is as follows:
1 Create an input file for the EBM-HS in the programme analysis. The format of this file is
defined in the HDM-III EBM documentation.
2 The user starts the EBM-HS, imports the file to the EBM-HS, runs it, and exports results
to an output file.
3 The output file is imported to the programme analysis for reporting.

6.2 Incremental benefit/cost ranking

With many applications of HDM-4, a large number of road sections will need to be
prioritised. In these cases, the incremental benefit/cost method is the most appropriate. This
involves searching through investment options on the basis of the incremental NPV/cost ratio
of one alternative compared against another. The incremental NPV/cost is defined as:

  NPV - NPV  
 j i 
E =  ...(6.4)
  cost - cost  
ji
 j i

where:

Eji the incremental NPV/cost ratio

NPVj the net present value of the more expensive alternative j
NPVi the net present value of the cheaper alternative i
costj the economic cost of the more expensive alternative j
costi the economic cost of the cheaper alternative i

In Equation 6.4 above, the incremental NPV/cost can be replaced by the incremental
∆IRI*Length/cost where ∆IRI*Length is the weighted average change in roughness obtained
by comparing the project alternatives using IRI instead of NPV.
The objective of the incremental method is to select road sections successively starting with
the largest NPV/cost ratio (Eji), since this maximises the NPV (net present value) for any
given budget constraint. Where there is more than one investment option on any individual
road section, that with the lowest discounted investment costs is designated the base case
alternative. This method considers all possible options, and compares these incrementally
starting against the base case, by using the incremental algorithm to select the combination
that maximises the selected objective function.
An incremental search technique is used to select the options with successively lower
incremental NPV/cost ratios, ensuring that at any time there is no more than one option per
road section. The process continues until the budget is exhausted for each budget period. The
method is often referred to as the efficiency frontier, which is a line that joins investments
with the highest NPV along the cost axis in a plot of NPV against investment cost (Harral and
Faiz, 1979). In essence, the method seeks out those options that are close to the boundary of
the efficiency frontier. The algorithm is illustrated in Figure G1.3, and is defined in the
following steps:

Analytical Framework and Model Descriptions G1-24

Version 1.0
PART G ECONOMIC ANALYSIS G1 ECONOMIC ANALYSIS

1. Determine the pre-defined investment options for pre-selected sections and deduct the
financial costs of these options from the available budget in corresponding years. Exclude
these sections from any further optimisation.
2. Determine possible investment options for the remaining sections. If the life cycle
analysis option is being used, set the user-defined base alternatives as the do minimum
for each road section. For the multi-year forward programme, the do minimum option is
that with the delayed capital works.
3. If the total financial cost of the do minimum investment alternatives on each section is
greater than the available budget for any period, then the investment options or budget
constraints must be redefined.
4. Deduct the financial cost of the do minimum investments from the available budget to
determine the remaining budget for each period. Set the do minimum as the first Base
option for each section.
5. Calculate the incremental NPV/Cost ratio for all remaining section-options compared
against the Base option, and all other option pairs with higher economic cost. For
example, consider the following investment options for a particular section arranged in the
ascending order of discounted total economic costs:
options: A, B, C, D, E
The incremental NPV/Cost ratios for these are given by:
Eba Eca Eda Eea ; Ecb Edb Eeb ; Edc Eec ; Eed
6 Delete incremental NPV/cost ratios that are less than the user specified minimum
incremental value (MIV).
7 List the remaining incremental NPV/cost ratios in decreasing order (with the associated
section-option pair codes) and, within each incremental NPV/cost, in the order of
decreasing economic cost. For example, if Eeb = Edb then Eeb is ranked higher.
8 Select the next incremental NPV/cost ratio from the top of the list. If the lower cost
section-option is not the current Base Option for that section, continue searching until one
is found.
9 If the remaining budget is insufficient in any of the periods for the financial costs of
works required for the section-option selected in Step 8 above, then the selected option
should be rejected, and continue searching by repeating Step 8.
10 If the section-option can fit within the remaining budgets for all periods, deduct the net
increase in financial cost of capital works from all corresponding budget periods. Set the
Base option for this section to be that corresponding to the lower cost option for the
incremental NPV/Cost ratio chosen in Step 8. Providing that the remaining list is not
empty, return to Step 8.
The process described above continues until the budget is exhausted or there are no more
section-options remaining in the list. The resulting list of selected section-alternatives
constitutes the optimal work programme.

Analytical Framework and Model Descriptions G1-25

Version 1.0
PART G ECONOMIC ANALYSIS G1 ECONOMIC ANALYSIS

NPV

E
D

B
C A, B, C, D, E : Section-Alternatives

Priority for funds:

1. Eba
2. Edb
3. Eed

A
ECONOMIC COST
(relative to Base Option)
Figure G1.3 Efficiency frontier concept

Analytical Framework and Model Descriptions G1-26

Version 1.0
 PART G ECONOMIC ANALYSIS G1 ECONOMIC ANALYSIS

7 References
Harral, C.G. and Faiz, A. (1979)
The highway design and maintenance standards model (HDM): model structure,
empirical foundations and applications. PTRC Summer Annual Meeting, University of
Warwick, 13-16 July 1979. PTRC Education and Research Services, London, UK
PIARC, (1991)
Methods for Selecting Road Investment, Economic and Finance Committee of PIARC,
Paris, France
TRRL Overseas Unit, (1988)
A Guide to Road Project Appraisal. Transport and Road Research Laboratory Overseas
Road Note 5, Crowthorne UK

Analytical Framework and Model Descriptions G1-27

Version 1.0