UNIT-1

Engineering economic analysis (EEA)An analysis of alternatives for a proposed engineering

project or service
to determine the relative worth of net economic gains expected from each alternative in relation to the
net economic costs required to produce those gains, all compared for a designated analysis period.
Engineering economic analysis applies economic concepts and methods to
engineering problems to support decisions on a best course of action. Within highway transportation,
these decisions typically involve selection of the preferred alternative among projects or levels of
service affecting highways, roads, or streets. Engineering economic analysis provides a way of
comparing the economic gains expected from an investment with the cost of that investment;
providing an objective understanding of value to be expected for cost incurred. Because the service
lives of highway facilities that are properly maintained extend for decades, and the value gained from
highway investments and subsequent expenditures may not be fully realized until years after the
actual outlays, engineering economic analyses (EEAs) cover a period of time sufficient to capture these
positive and negative economic flows. In contrast with private-sector investments, public-sector
projects and services, including those analyzed in highway transportation, do not generate tangible
income streams or direct monetary payments as economic gains. Rather, the economic value of a
highway project or service is reflected in benefits to the public, typically gauged as reductions in their
costs of travel, or in potential costs to the highway user or the highway agency that are avoided.
Avoided costs occur, for example, when an existing level of congestion is reduced, when the potential
risk of an accident is removed, when sources of harmful pollution are eliminated, or when
potential deterioration of the highway facility is prevented.
Engineering economic concepts and methods include, but are not limited to, life-cycle cost
analysis (LCCA), benefitcost analysis (BCA), present-worth analysis, measures of cost-effectiveness,
and cost avoidance as a concept of benefit. These may be applied at one or more stages of a project
life cycle, such as planning, project scope development, programming (including ranking, project
selection, and budgeting), resource allocation, best-value procurement, projectdesign and
development [including value engineering (VE) at the preliminary engineering or concept development
stage], construction (e.g., analysis of options for accelerated project delivery), and operation and
maintenance. Engineering economic analysis may also be used as a tool following completion
of a project or service to infer corrected values of key parameters. It can provide the framework to
synthesize information and knowledge from a completed effort, enabling development of a new
analytic tool to analyze similar projects or services in the future. Economic analysis algorithms may be
embedded in an agencys infrastructure management, congestion management, and safety
management systems, or may be part of an overall asset management approach.
Analyses of highway investments benefit from EEAs in
several ways:
Highway investments provide benefits that extend into the future, typically measured in years or
decades.
Engineering economic analysis provides the multi-year framework needed to capture these benefits in
a fair
comparison of benefits to costs.
A level of long-term structural performance can be provided by different patterns of road investment,
varying the purpose, magnitude, and timing of capital and maintenance expenditures. Engineering
economic
analysis provides a way to analyze these alternative investment streams, identifying the most efficient
approach to achieving desired performance and road-user costs or benefits.
Budget limits and other constraints may prompt an examination of what level of performance might
be
sought in a highway investment. Tradeoffs exist among project and corridor location, design concept,
level of
highway development, maintenance policy, operating policy, and costs and benefits accruing to road
users as
well as nonusers. Engineering economic analysis provides a way to sort through these options on a
level playing
field, using the common metric of monetary value.
Highway programs consist of different needs and types of projects and services. Tradeoffs exist in the
funding
of these competing needs, a process state departments of transportation (DOTs) face in programming,
budget

development and recommendation, and resource allocation. Engineering economic analysis can
provide
information on the consequences of different levels of investment among a diverse set of programs in
a consistent,
monetized framework to help in these decisions.
Highway investments also may entail significant impacts in environment, energy, materials usage,
economic vitality, and quality of life, in both monetary and nonmonetary terms. Even when it is not
possible to quantify all
impacts in dollars, the framework provided by an engineering economic analysis can provide a useful
point of
departure for organizing qualitative as well as quantitative information about highway investment
options.
Discounted Cash Flow Methods

Computational methods have been developed to perform EEAs according to the principles described
earlier. These
methods include :
net present value (NPV),
equivalent uniform annual cost (EUAC),
BCA (or B/C), and
internal rate of return (IRR).
Only a brief commentary on these methods is provided in this synthesis, consistent with the study
scope outlined in chapter one. The focus of this report is rather on the application of these methods to
support highway investment decisions as illustrated in the several case examples in chapter three. The
methods are well described in the general engineeringeconomics literature. They are also described
in references providing transportation- and highway-specific guidance. Risk analysis methods are
covered in the next section.
Although the four methods listed entail somewhat different data and procedures, they all will yield the
same decision when applied correctly (Grant et al. 1990, chapters 47).
This synthesis adopts this position, which is based on the following precepts:
All of the engineering economic methods are based on a LCCA of investment alternatives. The LCCA
is a discounted cash flow analysis of monetized cost and benefit streams. The analysis period or
analysis horizon, in
years, is sufficiently long to capture a reasonable representation of the significant costs and benefits of
each
alternative through equivalent periods of performance. The four methods identified previously (NPV,
EUAC,
BCA, IRR) all meet these stipulations. Other methods (such as project payback periods) have their uses
in
other contexts, but generally do not meet these characteristics of LCCA. (Project payback periods may
or
may not depend on discounted cash flows; they do not analyze alternatives through equivalent
performance
periods; and they therefore do not capture the full representation of costs and benefits through a
performance
period.)
Net benefits and net costs are used to assess the differences in consequences among alternatives.
Both
costs and benefits may take on positive or negative values, and bookkeeping conventions could be
established
to treat the respective quantities consistently and correctly. For example, the consequences of highway
investments on passenger and freight travel are measured in road user costs. When comparing
alternative
investments, reductions in these costs (or avoidance of these costs) are treated as benefits.
Conversely, actions
that increase road user costs are said to incur disbenefits. Case examples in chapter three involving
use of the
California DOTs (Caltrans) Cal-B/C model will illustrate how these net-value calculations in tallies of
discounted
agency and road user costs are interpreted for the economic analysis results.
In comparing alternative solutions, BCA and IRR analysis are both properly done on an incremental
basis.

There is considerable literature covering both simple B/C or IRR and incremental B/C or IRR
calculations.
If a project is being compared solely with a No-Build or Do Nothing option, the incremental case
reduces
to the simple case, and both yield the identical result. The same decision on whether or not the
investment
is economically justified will also be produced by the NPV and EUAC methods.
When there are a number of investment alternatives addressing a particular need or problem,
however, the
proper approach is to conduct the B/C or IRR analysis incrementally. The simple B/C result can be used
as a
screen: a simple B/C of less than 1.0 will not bear out on an incremental basis either. However, in the
general
case that is not subject to a budget constraint, a solution with the highest simple B/C may not
necessarily
be the optimal solution. Rather, the theoretically optimal result is the investment with an incremental
B/C
exceeding 1.0.