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Optimization Application for Financial Viability Evaluation of PPP Toll Road

Projects

Conference Paper · May 2012

DOI: 10.1061/9780784412329.234

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Construction Research Congress 2012 © ASCE 2012 2329

Optimization Application for Financial Viability Evaluation of PPP Toll

Road Projects

Tanaphat JEERANGSUWAN1, Hisham SAID2, Amr KANDIL3, and Satish

UKKUSURI4
1
Research Assitant, Division of Construction & Management, School of Civil
Engineering, Purdue University, 550 Stadium Mall Dr., West Lafayette, Indiana,
47907, email:tjeerang@purdue.edu
2
Postdoctoral Research Associate, Division of Construction & Management, School
of Civil Engineering, Purdue University, 550 Stadium Mall Dr., West Lafayette,
Indiana, 47907, email: hsaid@purdue.edu
3
Assistant Professor, Division of Construction & Management, School of Civil
Engineering, Purdue University, 550 Stadium Mall Dr., West Lafayette, Indiana,
47907, email:akandil@purdue.edu
4
Associate Professor, School of Civil Engineering, Purdue University, 550 Stadium
Mall Dr., West Lafayette, Indiana, 47907, email: sukkusur@purdue.edu

ABSTRACT
The limited financial capabilities of public owners gave rise to the Public-
Private Partnership (PPP) approach as an innovative project finance to attract private
investment to highway projects. Nonetheless, many privately financed road projects
have had difficulties in fulfilling construction debt obligations due to operating
deficits. These difficulties are mainly attributed to incomprehensive evaluation of
project financial viability and poor selection of key concession items. This research
presents a comprehensive framework which provides an optimal set of key
concession items for setting up financial viable PPP toll road projects. These key
concession items include toll rates, a concession length, an equity level, and a rate of
return. The proposed framework utilizes a modified User Equilibrium traffic
assignment algorithm to help estimate revenue from toll road traffic volume
considering its interaction with levels of service. The framework also takes into
consideration the relationships between the deterioration of the pavement
serviceability and required maintenance caused by the traffic volume, which
facilitates the quantification of the toll road maintenance expenditures. From the
estimated cash flow, a Genetic Algorithm (GA) will be applied to search for an
optimal combination of the key concession items that would maximize profit from
private investment in public highway projects.

INTRODUCTION

Increasing demand on the limited resources available for construction and

operation of public highway transportation system necessitates the creation of
innovative project finance mechanisms. As a consequent, public-private partnerships
(PPP) have been created and implemented to attract private investment to the
highway infrastructure projects. Despite promising investment opportunities for the
private investors, several privately-financed projects around the world have had
Construction Research Congress 2012 © ASCE 2012 2330

difficulties in servicing the construction debt obligations due to operating deficits

(Schaufelberger 2005). These difficulties could be mainly attributed to
incomprehensive financial viability evaluation and poor selection of key concession
items during a preliminary phase of a project onset. At a very early stage of a PPP
highway infrastructure project, a concessionaire has to evaluate the project viability
with limited information at hand and make critical decisions on selecting key
concession items including toll rates, a concession length, an equity level, and a rate
of return.
In practice, the stakeholders may utilize qualitative and quantitative analytical
frameworks to support these challenging investment decisions. However, literature
review indicates that previous project financial viability evaluation frameworks
demonstrate critical limitations including: (1) the limited ability to quantify a
continuously changing magnitude of traffic demand risk throughout a project life
cycle; (2) the inability to consider the impact of important factors influencing traffic
demand which are the travel time, pavement serviceability, the user’s trip expenses,
and simultaneous interactions among them; and (3) the limited scope of current traffic
demand estimation models that fail to account for the effects of rehabilitation on
traffic demand (Chen et al. 2006, Chen and Subprasom 2007, Subprasom and Chen
2007, Zhang 2005, Yun et al. 2009). This statement identifies clear necessity to create
a more comprehensive framework that evaluates financial viability of PPP toll road
projects with more accuracy and reliability and provides a quantitative guideline on
selecting optimal key concession items.

FINANCIAL VIABILITY EVALUATION FRAMEWORK

The distinct objectives of the research include: (1) to develop a demand

estimation model that predicts traffic demand with more accuracy and reliability; (2)
to create a method for assessing the impacts of rehabilitation and maintenance
projects on PPP financial viability; (3) to develop a framework for evaluating
financial viability of investments; and (4) to provide a guideline on selecting the key
concession items. The proposed framework is designed to contain four separate
models developed to perform distinct tasks in order to accomplish the research
objectives. These models function together in a cyclic fashion to simulate a
concession period of a PPP toll road project as depicted in Figure 1.

(1) The demand estimation model utilizes a User Equilibrium (UE) traffic assignment
algorithm to estimate the annual number of vehicles which is a major source of
annual revenue throughout a concession period.
(2) The pavement performance and rehabilitation model simulates the changes in
pavement conditions, operating speed, and capacity according to the level of
facility usage and maintenance activities.
(3) Cash flows calculation model constructs project cash flow by calculating cash
flow components that depend on the outcome of the previous two models.
(4) Performance metrics calculation model calculates quantitative metrics which are
used to determine financial and economic efficiency of a toll road project.
Construction Research Congress 2012 © ASCE 2012 2331

The first two models will be implemented in a cyclic fashion to represent the
annual operation of the PPP facility. For every fiscal year during the operation period,
the cash flow model annually calculates all revenue and expenditures of the project.
At the end of the operation period, the performance metrics calculation model is
utilized to determine the financial viability of the PPP highway project investment.
The development of these models is presented in the following sub-sections.

Figure 1 - Conceptual Financial Viability Evaluation Framework

Demand Estimation Model

The demand estimation model serves as a tool to mitigate the impacts of risks
and uncertainties in traffic demand forecasts. The model has a function to estimate
traffic volume for a toll highway facility which will be used to calculate revenue in
evaluating financial viability. It utilizes a modified User Equilibrium (UE) traffic
assignment algorithm to generate link equilibrium flow patterns in a road network
that includes toll road links. Traditionally, the solution of the user equilibrium with
variable demand can be obtained by solving a minimization program as shown below
(Sheffi 1985).

min z , t ω dω D ω dω (1)
∈ ∈

subject to

q f ∀w ∈W (2)
∈

x f δ ∀a ∈A (3)
∈ ∈

f 0 ∀ r ∈ R ,w ∈ W (4)

q 0 ∀w∈W (5)
Construction Research Congress 2012 © ASCE 2012 2332

where = set of the network links; = set of the network OD pairs; = set of the
routes connecting OD pair ; = flow on link ; = flow on route
between OD pair ; = demand of OD pair ; = incidence value of link
on route connecting OD pair ; = equivalent travel time of the link;
and = inverse demand function of an OD pair .

Modified Link Performance Function

Previous studies introduced a performance function for a toll link of which its
level of service was an equivalent travel time (Chen et al. 2006, Chen and Subprasom
2007, Subprasom and Chen 2007). The link performance function used in the
previous UE minimization algorithms represented link levels of service based on
travel time and toll rates, but neglected the other important determinants of the user
route choices such as vehicle operating cost (VOC) and the ride quality.
A new link performance function is formulated in the proposed model to
represent link level of service in terms of travel time and users’ vehicle operating
costs, Equation (6). First, travel time is computed as an increasing function of the link
traffic flow using the Bureau of Public Roads formula (Sheffi 1985). Second, the out-
of-pocket costs are calculated and transferred into a time equivalent using a
transformation parameter that depends on the value of time of the vehicles (cars or
trucks). The out-of-pocket expense term will be separated by vehicle types and
multiplied by the vehicle type percentage on a particular link. Since the flow in a
particular link is the combination of the flows from several routes connecting OD
pairs from which the truck percentages are initially assigned, the truck percentage on
the link must be determined separately.

x
t x t 1 0.15 β toll m VOC tp (6)
c
∈

where = equivalent travel time of the link ; = free-flow travel time on

link ; = flow on link ; = capacity of link ; = toll on link
applied to vehicles with type ; = VOC adjustment multiplier for link ;

= vehicle operating cost for vehicles with type on link ; = vehicle type
percentage of vehicles with type on link ; and = parameter that transforms
the toll into equivalent time unit or the value of travel time for vehicles with type
on link .
The adjustment multiplier ( ) shown in Equation (7) is used to alter vehicle
operating cost according to the change of pavement international roughness index
(Sinha and Labi 2007).

IRI 80 IRI 80
m 0.001 0.018 0.9991 (7)
10 10

where = VOC adjustment multiplier for vehicles traveling on link and =

international roughness index in inch/mile of link .
Construction Research Congress 2012 © ASCE 2012 2333

Demand Function
The demand function quantifies changes in traffic demand or the potential
number of trips generated from an OD pair due to a change in a service attribute. This
attribute is usually the travel time between the OD pair. Therefore, an elastic demand
model as shown in Equation (8) is used as the demand function in the demand
estimation model. The demand function is formulated using the concept of non-linear
demand elasticity which is a function of the travel time between an OD pair (Chen et
al. 2006).

q D e ∀w ∈W (8)

where = demand of OD pair , = potential demand of OD pair , γ =

elasticity of the demand with respect to travel time; = minimum travel time
between OD pair and; = set of the network OD pairs.

Pavement Performance and Rehabilitation Model

The second component of the proposed framework establishes a connection
between investment financial viability evaluation and infrastructure rehabilitation.
The pavement performance and rehabilitation model has three main functions: (1) to
predict ride quality in terms of pavement roughness of road sections after
experiencing cumulative damage caused by traffic loading, environmental factors,
and pavement age; (2) to identify the financial requirements of rehabilitation
treatments the during operation period of a toll road facility, and (3) to represent
impacts from rehabilitation construction activities on traffic demand in terms of
changes in the level of service.
Accordingly, three separate modules are developed to carry out the above
functions which include: (1) the performance prediction module; (2) rehabilitation
requirement module; and (3) rehabilitation impact module, respectively. These
modules would collectively represent the interactions between traffic demand and
pavement serviceability, as well as the requirements and impacts of rehabilitation
programs in PPP highway projects.

Performance Prediction Module

The performance prediction module predicts the international roughness index
(IRI) of network links as a function of three major factors that cause pavement
deterioration (Irfan et al. 2009, Khurshid et al. 2009). The performance prediction
module uses the mathematical relationship between these parameters as shown in
Equation (9) to capture continuous changes in IRI during the operation of the toll
facility (Irfan et al. 2009).

IRI e (9)

where = international roughness index in m./km. of link , =

accumulated monthly truck traffic in millions, = average monthly freezing
index in thousands of F° degree-day, = time in years since the rehabilitation
treatment and , , = regression coefficients.
Construction Research Congress 2012 © ASCE 2012 2334

Rehabilitation Requirement Module

The first function of this module is to make comparisons between predicted
IRI of the network links and the IRI threshold for rehabilitation. Once a rehabilitation
requirement is triggered by IRI falling below the threshold, a rehabilitation cost is
identified. Another important function is to estimate the duration of the rehabilitation
activities. When a rehabilitation project is implemented, it will definitely cause
negative impacts on the link levels of service such as link capacity and travel time in
one way or another. The impacts are temporary and last for the rehabilitation
duration, which is defined as a time interval during which the rehabilitation activities
take place and affect the link performance. Estimates of rehabilitation duration can be
acquired from historical data (Irfan et al. 2009 and Khurshid et al. 2010).

Rehabilitation Impact Module

The main function of the rehabilitation impact module is to take into
consideration the positive and negative impacts of rehabilitation treatments on the
network and its traffic flow. These changes in the level of service will be accounted in
the demand estimation model. The present framework considers two adverse
consequences from rehabilitation activities on a particular link. First, the normal
operating capacity of the link will be reduced depending on the number and length of
closed lanes. Second, the traffic speed will be limited due to safety requirements.
These negative impacts remain in effect until the rehabilitation duration ends. Upon
the completion of the rehabilitation activities, the link levels of service will return to
their normal operating level and the pavement performance will be immediately
restored to a pre-specified acceptable level. For positive impacts, Performance jump
is a sudden improvement in pavement performance after rehabilitation treatment. The
performance jump models are utilized for predicting immediate improvement in
pavement performance after rehabilitation treatments (Irfan et al. 2009 and Khurshid
et al. 2010).
PJ a ∙ ln INIa b (10)

where = initial IRI just before the treatments in m./km of link and , =
coefficients

Cash Flow Calculations Model

This model consists of a collection of the detailed calculations for all
necessary cash flow variables that are used in the determination of project financial
and economical metrics. These cash flow variables are calculated based on the
outputs of the demand estimation and pavement performance and rehabilitation
models. Due to limited space, only cash flow components that are directly determined
from the proposed framework will be featured. The detailed calculation of other cash
flow components can be found in Zhang 2005, and Yun et al. 2009.
Construction Research Congress 2012 © ASCE 2012 2335

Annual Net After-Tax Cash Inflows

The annual net after-tax cash inflow, is the net available cash in
current dollars from the toll collection less all expenditures during one year of the
operation period. can be determined through Equation (11) (Zhang 2005).

NATCI PBIT DE DI TAX for j 1, 2, … , n (11)

where = annual net after-tax cash inflow; = profit before tax and
interest; = depreciation; = debt installment; and = tax in the year of
the operation period ( ).

Profit Before Interest and Tax

The profit before interest and tax, is the net profit from the project
operation. It is calculated from the total annual revenue (from toll collection) less all
operation and maintenance expenditure as well as depreciation loss, as shown in
Equation (12) (Zhang 2005).

PBIT RE OM DE for j 1, 2, … , n (12)

where = annual revenue; = annual operation and maintenance expenditures;

and = depreciation in the year of the operation period ( ).

Annual Revenue
The annual revenue, for a toll facility comes from the toll directly charged
on the users at certain rates. The toll rates vary depending upon types of vehicles,
traveling distance, and road sections. Therefore, annual revenue from toll collection
can be expressed in the following equation (Yun et al. 2009).

RE toll x for j 1, 2, … , n (13)

Operation and Maintenance cost

The operation and maintenance cost, is one of the several life cycle cost
categories which involves running and preserving the project. The operation and
maintenance costs in the year of operation can be described in the following
equation.

OM OC AMC RM (14)

where = annual operation cost; = annual (routine) maintenance cost; and

= rehabilitation maintenance cost in the year of the operation period ( ).
Construction Research Congress 2012 © ASCE 2012 2336

Rehabilitation Maintenance Cost

The rehabilitation maintenance cost, is the cost for performing
rehabilitation treatments which is estimated by the rehabilitation requirement module
in the pavement performance and rehabilitation model. The purpose of the
rehabilitation treatments is to functionally and/or structurally improve distressed
pavement (Shahin 1994). This cost includes a series of rehabilitation activities
ranging from pavement surface recycling, overlay placement, to total reconstruction
depending on the rehabilitation strategy selected.
Performance Metrics Calculation Model
The performance metrics calculation model is designed to evaluate the
financial and economical efficiency of PPP projects for the different involved
stakeholders. Certain performance measures known as economic efficiency and
financial performance indicators that are derived from the project cash flows will be
used to investigate the project viability and profitability. In this content, the net
present value (NPV) will be used as a sample indicator to represent financial viability
of a PPP toll road project.

Net Present Value

The reason for selecting NPV as an indicator is that NPV has been frequently
cited as one of the most practical and effective performance measures for a project’s
economic efficiency (Zhang 2005, Sinha and Labi 2007, Yun et al. 2009). A form of
NPV from a concessionaire’s stand point used in this framework is presented in
Equation (15) (Zhang 2005, Yun et al. 2009).

NATCI E
NPV (15)
1 r 1 r

E RC 1 e (16)

where = net present value of the concessionaire’s net profit corresponding to an

equity level discounted to the beginning of the first year of the construction period;
= operation period; = construction duration; = equity needed at the beginning
of the year of the construction period; = construction cost in the year of the
construction period; =discrete inflation rate in the year of the construction
period; and = equity level; and = discount rate.

INTRODUCTION TO OPTIMIZATION FOR FINANCIAL VIABILITY

EVALUATION

The developed framework enables concessionaire and private investors to

accurately evaluate financial viability of investment in a toll road project given an
initial set of key concession items (i.e., toll rates, concession period, equity level and
rate of return). However, in practice, each of these input variables will be selected
from within its feasible range resulting in a numerous possible combinations of these
Construction Research Congress 2012 © ASCE 2012 2337

variables that eventually lead to different project outcomes. From a perspective of

concessionaires or private investors, it is crucial that an optimal combination of these
concession items be identified so that the investment yields the most profitable return.
A Genetic Algorithm (GA) model will be utilized to carry out the optimization
task. GA is a stochastic search method that imitates the process of natural evolution
that has been widely used to search for solutions to complicated optimization
problems. The GA solution searching mechanism is initiated when an initial set of
solutions is randomly generated from feasible solution space and fitness of each
solution will be determined from a fitness function. Fitter solutions with a higher
fitness function evaluation will be given a greater chance to be selected to reproduce a
next generation solutions. This iterative process continues generating offspring
solutions through reproduction, crossover, and mutation processes until an optimal
solution is found (Goldberg 1989, Deb 2001).
The determination of optimal key concession items can be considered a single
objective optimization problem. In this context, the objective function will be to
maximize the net present value of the investment in a PPP toll road project with
problem variables including toll rates, a concession length, an equity level, and a rate
of return. That is, these key concession items will be coded to form a chromosome
representation.

CONCLUSIONS

The objective of the proposed framework is to facilitate a better financial

viability evaluation of investments in PPP highway infrastructure projects. The
framework consists of four main models, each of which performs different tasks and
exchanges interactive information between each other. The framework is expected to
serve as a tool to increase accuracy and reliability in traffic demand estimation and to
account for the positive and negative impacts of rehabilitation on project financial
performance. All the components are combined to formulate a solidified framework
that can be used to not only ensure a financial viability of a PPP highway project, but
also maximize the return on the project investment with an optimal set of key
concession items. Finally, a Genetic Algorithm (GA) model was introduced to
perform an optimization task. The objective function is to search for an optimal set of
key concession items which include toll rates, a concession length, an equity level
and a rate of return that yields the maximum net present value. In summary, the
criticality and the negative impacts of the traffic demand risk on the project’s
economic efficiency could be alleviated by the appropriate utilization of the UE
traffic assignment algorithm and the pavement management systems (PMS). The
framework is expected to serve as a tool to increase accuracy and reliability in traffic
demand estimation and to account for the positive and negative impacts of
rehabilitation on project financial performance. All the research tasks mentioned
above were combined to formulate a solidified framework that can be used to not
only ensure a financial viability of a PPP highway project, but also maximize the
return on the project investment with an optimal set of key concession items.
 Construction Research Congress 2012 © ASCE 2012 2338

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