Reference no: EM13116148

Problem:

You are required to perform a project appraisal of a proposed new road. The road will be a dual lane by-pass around a town centre on the outskirts of Sydney. The project is estimated to improve journey time for commuters into Sydney and reduce congestion problems in the town. There are some concerns which have been raised by local inhabitants including the increased noise and pollution caused by the new road, and the loss of a small, but ecologically important, area of National Park which the road will cut through. The town council and NSW State Government require an appraisal of the project accounting for time-savings, loss of natural environment and other factors. You have been recommended to use a social discount rate of 3%.

Initial Costs

The site of the new road will need to be purchased at a cost of $5 million, and the project will need to be planned at a cost of around $250,000. Both the purchase of the land and the planning agreement must be in place before construction can begin (i.e. at year 0). Construction is estimated to take three years. Initial construction costs estimated by the contractor, which occur in year 1, include site clearance estimated at around $750,000, and initial ground works at $2.5m. Other construction costs occur in all three years (year 1, 2, and 3) and include building materials at $3.75 million, and plant rental at $900,000. These costs have been fixed with the contractor and so remain the same for each year.

Wage costs are for 150 construction workers at $40 per hour, and a site manager at $60 per hour. Estimated staffing times are 45 hours per week all year (47 weeks) for the site manager, and 40 hours per week all year for the construction workers (47 weeks). Wages are expected to grow at an annual rate of 1%.

The other major cost incurred in the development of the road is the loss of small National Park. This should be valued in the project BCA. To do this you have been recommended to use the simple zonal travel cost method, deriving average usage figures from Table 1 below. Note there is no entry/admission cost for using the park.

Table 1: Zonal Travel Cost Data

Use the zonal travel cost methodology as set out here: The average hourly wage rate is $35, and marginal vehicle operating costs are $0.30 per km.

Ongoing Costs

There is a significant maintenance cost associated with the new road estimated at $250,000 per annum. This cost will begin in year 4 following the completion of the road and is expected to grow at an estimated 1.5% per year.

Benefits

The benefits of the new road include reduced congestion and subsequent time-savings, as well as some estimated accident reduction.

Time savings per year are estimated as follows:

• Private cars and motorcycles - 6500 hours
• Business cars - 3000 hours
• Light commercial vehicles - 9000 hours 
• Buses - 500
• Trucks - 12000

Delay costs for each class of vehicle are given in Table 2.

Table 2: Delay Cost Data

These savings will begin in year 4 once the road is complete, and continue until the end of the CBA appraisal period (year 28).

Estimated benefits in relation to accident reduction are as follows: a reduction in the current rate of fatalities on the road by 0.5 per year, a reduction in serious accidents by 3 per year, a reduction in accidents causing slight injury by 50 per year, and a reduction in damage only accidents of 150 per year. Costs associated with each type of accident are given in Table 3 below. These reductions will all be made in the urban area around the town. The reductions should be included from years 4 to 28.

Table 3: Cost per accident type

Questions

1. Using the data on costs and benefits provided what is the NPV and BCR associated with the project given a BCA period of twenty-eight years? 
2. No value has been included to account for the increased noise and air pollution which will affect inhabitants close to the location of the new road. It is estimated that the average house value will decrease from its current level of $300,000 to around $250,000 as a result of the project. This will affect 150 houses close to the road. How does this affect the outcome in terms of NPV and BCR? (see note (iii) below for further information on how to incorporate this cost).
3. Establish which variables have the biggest impact on the outcome of the analysis using some simple sensitivity analysis.
4. Given the results of the BCA, and with differing values for certain variables, do you think the project should go ahead? Explain your answer, and discuss the limitations of the analysis with reference to your answer to question 3 and in terms of any possible impacts of the project that have not been included in the data you are provided with.