Transportation Economics and

Decision Making

Lecture-2
 Cash Flow Diagrams

Estimate Present Worth

0 1 2 3 4 5 6 7 8 9 10

0.9 0.9 0.9 0.9 0.9 0.9 0.9 0.9 0.9 10.9K
A

The Present Worth of the above Payment Plan is

PW  0.9SPW   10PW 
i 9 i 9
n 10 n 10

 0.9  5.995  10  0.461

 10 K
 Cash Flow Diagrams

Estimate Present Worth

0 1 2 3 4 5 6 7 8 9 10

1.9 1.81 1.72 1.63 1.54 1.45 1.36 1.27 1.18 1.09K

The Present Worth of the above Payment Plan is

PW  1.9PW  1.81PW   1.72PW 
i 9 i 9 i 9
n 1 n2 n 3 
 ....................  1.09PW 
i 9
n 10

 10K
 Cash Flow Diagrams

Estimate Present Worth

0 1 2 3 4 5 6 7 8 9 10

1558.2 1558.2 1558.2

A

The Present Worth of the above Payment Plan is

PW  1558.2SPW 
i 9
n 10

 1558.2  6.418
 10K
 Cash Flow Diagrams

Estimate Present Worth

0 10

23673

The Present Worth of the above Payment Plan is

PW  23675PW
i 9
n 10

 23675  0.4224
 10K
 Cash Flow Diagrams
Estimate Present Worth
0 2 4 6 8 10

3881 3504 3129 2754 2376

The Present Worth of the above Payment Plan is

PW  3881PW  3504PW  3129PW
i 9 i 9 i 9
n 2 n 4 n 6 
 ....................  2376PW
i 9
n 10

 3881 0.8417  3504  0.7084  3129  0.5963 

 ....................  2376  0.4224
 10K
 Cash Flow Diagrams F

0 1 2 3 10 17 18 19 20

10K R1=2K/yr R2=3K/yr

Estimate Future Value

Let i  10%
F  10CA n  20  R 1 SCA n 8  CA n 10 
i 10 i 10 i 10

R 2 SCA   CA 
i 10 i 10
n 5 n 5

 10  6.728  2 11.436  2.594  3  6.105 1.611

 156.11 K
 Cash Flow Diagrams F

0 1 2 3 10 17 18 19 20

10K R1=2K/yr R2=3K/yr

Estimate Present Worth

Let i  10%
PW  10  R 1 SPW n 8  PWn  2 
i 10 i 10

R 2 SPW   PW
i 10 i 10
n 5 n 10

 10  2  5.3349  0.8265  3  3.7908  0.3856

 23.204 K
 Cash Flow Diagrams F
Estimate Annuity
0 1 2 3 10 17 18 19 20

10K R1=2K/yr R2=3K/yr

Let i  10%
PW  23.204K (As calculated before)
This present value is equivalent to annuity of
A  PCR n  20  23.204  0.1175
i 10

 2.72647 K
This is also similar to Equivalent Uniform Annual Cost
(EUAC)
 Arithmetic Gradient Series

A+(n-1)G
Amount increases by
“G” each period A+3G
A+2G
A+G
A

This is equivalent to
 Arithmetic Gradient Series

(n-1)G
A A A A A 3G
2G
G
0
+

P’ P’’
Present worth of base amount + Present worth of gradient amount
Arithmetic Gradient
 Example

 A city department of transportation (DOT) expects

cost of maintenance of a midblock to be $5,000 in
the first year and increase annually by $500 until
year 10. At an interest rate of 10% per year,
determine the present worth of maintenance cost.

𝑃 𝑃
𝑃 = 5000 ∗ + 500 ∗
𝐴 10%,10 𝐺 10%,10
= 5000*6.1446 + 500*22.8913
= $42,269
 Geometric Gradient

• g is the geometric gradient over the time period

 (time period: Time 0 to Time n, 1st flow at Time 1)
• P is the present value of the flow at Time 0
 (n periods in the past)
• i is the effective interest rate for each period

Note: cash flow starts with A1 at Time 1, increases by constant g% per period

   (1  g )  n 
P?  1  
  
  (1 i )  
  when i  g
0 1 2 3 n ig
  
( P / A, g , i , n )    

A1 
g=%  n
 when i  g
P = A1(P/A,g,i,n)  (1  i )
 Example

 A state department of transportation has four toll

bridges and combined salaries obtained at the end of
year 1 is $250,000. If the toll booths are expected to
raise revenue 5% each year, what is the present
worth of the revenue in next five years.

𝑃
𝑃 = 250,000 ∗
𝐴 𝑔,𝑖,𝑛10%,10
𝑃
𝑃 = 250,000 ∗
𝐴 5%,10%,10
= 250,000*3.94005
= $985,015
 Example

 You have just begun you first job as a civil engineer and decide to
participate in the company’s retirement plan. You decide to invest the
maximum allowed by the plan which is 6% of your salary. Your
company has told you that you can expect a minimum 4% increase in
salary each year assuming good performance and typical advancement
within the company. Choose a realistic starting salary and estimate the following:
 Assuming you stay with the company, the company matches your 6% investment in
the retirement plan, expected minimum salary increases, and an interest rate of 10%,
how much will you have in your retirement account after 40 years?

1) Assuming a starting salary of $50,000, A1 = .12 x 50,000 = 6000

P = 6000 [(1 – (1.04)^40 * (1.1)^(-40)) / (.1 - .04)] = $89,392.18
F = 89,392.18 (1.1^40) = $4,045,823.50
 Summary of Gradient Growths

 Arithmetic gradient consists of two parts

 A uniform series that has amount equal to the period-1

 A gradient that has value equal to the difference of cash flow

between period 1 and 2
 Gradient factor is preceded by a + sign for increasing
gradient, and –ve sign for decreasing gradient
 Geometric gradients are handled just by one
equation.
 Nominal and Effective Rates of Interest

 Interest rates are nominally quoted on bank and

other loans on the basis of interest per one year, even
though the interest may be paid monthly, quarterly
or twice yearly.

 The interest rate per annum is the nominal rate; the

effective rate is that rate corresponding to
compounding the interest for the conversion periods
less than a year.
 Effective Rates of Interest

 When the interest is paid more frequently than indicated

by the time period attached to the quoted interest rate,
the effective rate will be higher than the nominal
(quoted) rate.

 Let i= interest rate per base period conversion; quoted

interest rate
r = nominal rate per annum
j = effective rate per annum
m= times per year, or base period, the nominal rate
is converted
 Effective Rates of Interest

r
Since i 
m
m
 r
Effective Interest Rate j  1    1
 m
Example :
Find the effective rate of interest for $100 for 1 year
at nominal interest of 12% per year , interest payable
monthly :
12
 0.12 
F  100 * 1    100 * (1 . 01)12
 112.6825
 12 
Effective Interest Rate  (1  .01)12  1  0.1268  12.68%
 Example

 A bank pays 6% nominal interest rate. Calculate the

effective interest with
 a) monthly, b) daily, c) hourly d) secondly
compounding
 i = (1 + i)m – 1
 i monthly = (1 + .06/12)12 -1 = 6.1678 %
 i daily = (1 + .06/365)365 -1 = 6.183 %
 i hourly = (1 + .06/8760)8760 -1 = 6.1836 %
 i secondly = (1 + .06/31.5M)31.5M -1 = 6.18365 %
 Engineering Economy in Highways

 Construction should be planned with an eye for the

future
 Roads should be built only to the extent and of such
types as will pay themselves.
 There must be enough traffic and type of
improvement shall be such that the savings in cost of
transportation is at least equal to the cost of
improvement.
Basic Premise of Transportation Economics

1. Instinctive desire to save

- Save for future use
- Save for different use
2. Conservation of commodities
- Future use
3. Conservation of Labor
- Alternative use
 Basic Premise of Engineering
(Continued)

4. Long range result of conservation of resources

- Growth with least amount of resources
5. Public versus Private
- Public viewpoint - Welfare of everyone
- Private viewpoint - Welfare of one
 Principles of Analysis

1. Complete Objectivity
- Selection of Factors
- Selection of Cost
- Selection of Vest Charge

2. Economic analysis is not a management decision

3. “Hunch” has no place in economic analysis

4. Study all possible alternatives

 Principles of Analysis (Cont..)

5. Always consider the “Do Nothing” alternative

6. Separate market and non-market factors

- Factors of general socio-economic consequences are
excluded from calculations

7. The analysis is a study of future conditions

- Careful forecasting is necessary
 Principles of Analysis (Cont..)

8. Past events and investments are irrelevant.

9. Use same time periods for all factors

10. Analysis period should not extend beyond the period of

reliable forecasts.

11. Same time frame for all factors

12. Differences in alternatives are controlling

13. Common factors of equal magnitude may be omitted

 Principles of Analysis (Cont..)

14. Use the net basis for all costs and consequences

15. Analysis for economy is independent of financing

16. Uncertainties need to be acknowledged

17. Separate decisions are made at separate levels of

management

18. Viewpoints should be established before final decisions

are made
 Principles of Analysis (Cont..)

19. Establish criteria for decision making

20. Consider all consequences to whomsoever they may

accrue

21. Final decision should also consider market factors