Question

Two routes are under consideration for a new highway that will take two years to complete. The long intervalley route would be 25 miles in length and would have an initial cost of $50 million for the 1^st year and $30 million for the 2^nd year. The short transmountain route would be 10 kilometers long and would have an initial cost of $75 million for the 1st year and $50 Million for the 2^nd year. Maintenance costs are estimated at $2.5 Million per year for the long route and $1.0 Million per year for the short route for the first year. The maintenance cost is expected to rise with estimated US inflation over time. (You can estimate the inflation increase and distribution based on historical information). Based on historical information, the average US inflation rate is 3.22%. Regardless of which route is selected, the initial volume of traffic (start of 3^rd year) is expected to be 400,000 vehicles per year (normally distributed with the std dev at 20,000 vehicles). The estimated driving growth in vehicles is 2% per year starting in the 2^nd year after opening. This increase is uniformly distributed +/- 0.5%. Each option would have to be repaved every 5 years at a cost of $500,000 per mile in today’s cost (assume the same inflation rate at above). Assume a 20 year project window and an interest rate of 6%, what is the least expensive investment using NPV (Monte Carlo simulation of the cost)?

If the vehicle operating expenses are assumed to be $0.20 per mile, how might this analysis differ when considering the public benefit?

Answer 1

By Historical data, US inflation rate is estimated to be at 3.22% per year.

Assumption:

• Maintenance cost starts from year 3, i.e After the highway is constructed
• All investments are assumed to occur at the beginning of the year.
• 1st Repavemnet happens in the 6th year, i.e 5 years after the start of project.

The information provided is as follows:

Based on NPV, Short Trnasmountain Route is better.

When public benefit is considered, Savings per year will be added on shorter Route. that will make this option even better.