Question 10.10: CASE STUDY−−Improving a Railroad Crossing Traffic congestion...
CASE STUDY−−Improving a Railroad Crossing Traffic congestion and vehicle safety are significant concerns in most major cities in the Northeast United States. Amajor metropolitan city in New Jersey is considering the elimination of a railroad grade crossing by building an overpass. Traffic engineers estimated that approximately 2,000 vehicles per day are delayed at an average of 2 minutes each due to trains at the grade crossing. Trucks comprise 40% of the vehicles, and the opportunity cost of their delay is assumed to average $20 per truck-hour. The other vehicles are cars having an assumed average opportunity cost of $4 per car-hour. It is also estimated that the new overpass will save the city approximately $4,000 per year in expenses directly due to accidents. The traffic engineers determined that the overpass would cost $1,000,000 and is estimated to have a useful life of 40 years and a $100,000 salvage value. Annual maintenance costs of the overpass would cost the city $5,000 more than the maintenance costs of the existing grade crossing. The installation of the overpass will save the railroad an annual expense of $30,000 for lawsuits and maintenance of crossing guards. Since this is a public project, there are special considerations and a complete and comprehensive engineering economy study is more challenging than in the case of privately financed projects. For example, in the private sector, costs are accrued by the firm undertaking the project, and benefits are the favorable outcomes achieved by the firm. Typically, any costs and benefits that are external to the firm are ignored in economic evaluations unless those external costs and benefits indirectly affect the firm. With economic evaluations of public projects, however, the opposite is true. As in the case of improving the railroad crossing, there are multiple purposes or objectives to consider. The true owners of the project are the taxpayers! The monetary impacts of the diverse benefits are oftentimes hard to quantify, and there may be special political or legal issues to consider. In this case study, the city council is now in the process of considering the merits of the engineering proposal to improve the railroad crossing. The city council is considering the following questions in its deliberations:
• Should the overpass be built by the city if it is to be the owner and the opportunity cost of the city’s capital is 8% per year?
• How much should the railroad reasonably be asked to contribute toward construction of the bridge if its opportunity cost of capital is assumed to be 15% per year?
The city uses the conventional B–C ratio with AW for its analyses of public projects. The annual benefits of the overpass are comprised of the time savings for vehicles (whose drivers are “members” of the city) and the reduction in accident expenses. The city’s cost engineer makes the following estimates. Annual Benefits:
Cars =\left(\frac{2,000\times 0.6 \ vehicles}{day} \right) \left(\frac{365 days}{year} \right) \left(\frac{hour}{60 \ minutes} \right) \left(\frac{\$4.00}{car − hour} \right) = $58,400
Trucks =\left(\frac{2,000\times 0.4 \ vehicles}{day} \right) \left(\frac{365 days}{year} \right) \left(\frac{hour}{60 \ minutes} \right) \left(\frac{\$20.00}{truck − hour} \right)
= $194,667
Annual savings = $4,000
Total annual benefits = $58,400 + $194,667 + $4,000 = $257,067.
Notice that the estimated $30,000 annual expense savings for lawsuits and maintenance of the crossing guard is not included in the annual benefits calculation. This savings will be experienced by the owners of the railroad, not by the city. The costs of the overpass to the city are the construction of the overpass (less its salvage value) and the increased maintenance costs. The cost engineer makes the following estimates.
Annual Costs:
Capital recovery = $1,000,000(A/P, 8%, 40) − $100,000(A/F, 8%, 40) = $83,474
Increased maintenance = $5,000
Total annual costs = $83,474 + $5,000 = $88,474.
Based on these estimates, the B–C ratio of the proposed overpass is
B–C Ratio =\frac{Annual \ benefits}{Annual \ costs} = \frac{\$257,067}{\$88,474} = 2.91 .
The cost engineer recommends to the city council that the new overpass be built since the B–C ratio is greater than 1.0. The cost engineer also advises the council that since the railroad company stands to directly benefit from the replacement of the existing grade crossing by the overpass, it would not be unreasonable for the city to request a contribution to the construction cost of the overpass. Given the railroad company’s cost of capital of 15% per year and an estimated annual savings of $30,000, the cost engineer calculates that the overpass is worth
PW(15%) = $30,000(P/A, 15%, 40) = $199,254
to the railroad. Any amount contributed by the railroad company would serve to reduce the denominator of the B–C ratio, thereby increasing the value of the ratio. The B–C ratio was computed to be 2.91 without any contribution by the railroad. Therefore, the cost engineer concludes that the city should plan on constructing the overpass regardless of whether or not the railroad company can be persuaded to contribute financially to the project. This case illustrates some of the special issues associated with providing economic evaluations of public-sector projects. While the B–C ratio is a useful method for evaluating projected financial performance of a public-sector project, the quantification of benefits and costs may prove difficult. As the case illustrates, typically, surrogate or proxy measures are used in the estimation of benefits and costs. Also, it is especially important to remember the perspectives of the owners in the evaluation of public projects—not necessarily the elected city council members, but the taxpayers!