Evidence in Public Policy 2019-2020
PPOL5160 Evidence in Public Policy 2019-2020
1. The Project
Assume that you are in the year 2012. The Government of Jambalaya Island (GOJ) is considering a plan to construct a 4-lane high speed, limited access highway network of 233 kilometers, linking Queens Town to Hope Bay and Black Town. The project is to be undertaken in two stages. Stage 1 will begin in 2013 and will complete the section between Queens Town and Williamsburg (85 Km) by the end of 2016. Stage 2 will complete the two stretches of highway between Williamsburg and Hope Bay (85 Km west), and to Black Town (63 Km north) to be constructed between 2016 and 2018. The routes are illustrated in Figure 1.
Figure 1: Map Showing Route of Planned Highway
It is proposed that this project will be undertaken as a Public-Private Partnership (PPP) in terms of which the private contractor (‘concessionaire’) will operate the project under a Build-Operate-Transfer (BOT) Scheme. Under this scheme the concessionaire will be responsible for building, operating and maintaining the highway. It is proposed that the new highway will be operated as a toll road through which the concessionaire is expected to recoup its share of the capital investment and operating and maintenance costs. The concessionaire will operate the highway for 15-years after completion of Stage 2 of the project (2019 to 2033) after which it will hand over the project to the GOJ, at no charge. Thereafter the GOJ assumes responsibility for operations and maintenance until the end of 2058, the assumed end of the project’s life.
You are required to undertake a comprehensive cost-benefit analysis of the project from the perspective of GOJ and the concessionaire. All calculations should be done in millions of US dollars, rounded to two decimal places and expressed in constant 2013 prices. Note that all values reported in this project summary are at 2013 prices and assume an exchange rate of J$80 = US$1.
2. Investment Costs
The investment costs are given in Table 1, which shows the year-by-year breakdown, the allocation between the private and public sectors, and the composition of inputs.
Table 1: Composition of Capital Costs
(all values in J$ millions)
Composition of Construction Costs
2.1 Highway Construction
Land is purchased at the start of each stage of construction. Included in GOJ capital costs are land purchase costs. Assume that in 2013 J$3,200 million (of the J$4,000 million) and in 2016 J$6,400 million (of the J$8,000 million) is for land. The land purchased for the highway has an opportunity cost estimated at approximately 50% of the cost paid to the previous occupants.
Assume local labour consists of 50% unskilled and 50% skilled/managerial, and foreign labour is 100% skilled/managerial. The shadow price of unskilled labour is 20% of the wage and the shadow price of skilled labour (local and foreign) is 100% of their wage.
Assume that all local materials and equipment prices are inclusive of a sales tax of 10% paid to GOJ, and all imported materials and equipment costs include a 5% import duty. Note that no sales tax is levied on imports.
2.2 Toll System Infrastructure
The toll system will require the construction of 6 toll plazas to be installed as new sections of the road are completed. The capital cost of each plaza is estimated at J$150 million (2013 prices). The first two plazas will be installed in 2016, another two in 2017 and two more in 2018.
The composition of this cost is: 40% imported materials, including 5% import duty; 40% local materials including 10% sales tax; 10% skilled labour; and 10% unskilled labour.
3. Operating and Maintenance Costs and salvage Value
It should be assumed that expenditure on highway maintenance (excluding the tolling facilities) will amount to J$300 million per annum, beginning in 2016. Assume the same composition as with total capital construction costs over the period 2013-2018 as shown in Table 1.
3.2 Toll System
Operation of the toll system will require regular maintenance and periodic rehabilitation equal to 5% of the total initial capital cost of the toll utilities, beginning in
2019. For the purpose of efficiency pricing, assume the same composition as for the initial capital costs of the toll plazas.
3.3 Salvage Values
The salvage value of the highway and toll utilities will be approximately 50% of the initial capital cost. For the efficiency analysis assume that the benefits of all salvage values are equal to their value at market prices. If at the end of the 15-year concession GOJ decide to scrap the toll, allow for the 50% salvage value of the toll plazas at the end of 2033, otherwise for toll plazas and highway at the end of 2058. The salvage value of the toll plazas and highway will accrue to GOJ.
4. Benefits from the highway
The main categories of project benefits that should be considered in the project appraisal are:
(i) reduction in vehicle operating costs to road users due to improved road surface
(ii) value of time saved by passengers and drivers
(iii) reduction in road maintenance costs on existing roads due to lower traffic volumes
(iv) reduction of accident costs due to improved safety
(v) reduced pollution due to efficiency gains in vehicle use, and
(vi) toll revenues received by the concessionaire and GOJ.
Table 2 shows the forecast traffic volume on the new highway network. The forecast total includes vehicles travelling in both directions on existing roads and the new highway combined.
Table 2 Forecast of Total Road Usage from 2017
Total forecast (000 vehicles)
Queens Town – Williamsburg
Williamsburg – Hope Bay
Williamsburg – Black Town
It has been estimated that with the toll, 60% of the forecast traffic between the towns along the route of the highway will use the highway, with the other 40% continuing to use the existing road network. Based on recent trends it should be assumed that this forecast traffic volume will increase by 4% each year, starting with year 2018, until the end of the project’s life. Assume that in 2017 and 2018 the usage of the highway is equal to 36% of the forecast total volume of traffic for the complete highway. In 2019 when Stage 2 opens, the highway will operate at 100% of the forecast volume of highway traffic from the first year onwards.
The following sub-sections outline the details necessary for calculation of each component of project benefit.
4.1 Reduced vehicle operating costs (VOCs)
For the purpose of this study it will be assumed that under the ‘without-project’
scenario the existing road network will remain unchanged. It will also be assumed that the total vehicle and passenger kilometers traveled are the same with and without the new highway. Of this traffic volume approximately 60% is expected to be passenger vehicles (private cars, motorbikes, taxis, minibuses and larger buses) and 40% trucks. The expected VOC saving (in 2013 prices) is J$3.50 per km for passenger vehicles and J$20 per km for trucks. For all components of VOC assume that the efficiency price is the same as the market price. Treat VOC savings as external benefits in the project and private analysis.
4.2 Value of Time Saving
Each passenger vehicle is expected to carry, on average, 16 passengers including the driver and each truck carries on average 1.5 passengers including the driver. Passengers travel for different reasons; work, commuting and leisure activities. It has been estimated that time spent traveling on GOJ’s highways can be broken down as follows: 15% work; 52% commuting, and, 33% leisure (these proportions apply to passenger vehicles only). Assume trucks’ drivers and passengers travel exclusively for work purposes. Estimates of the time opportunity cost per person-kilometer on existing roads for the three categories of passenger are: J$6, J$5, and J$4 respectively (2013 prices). All travel time saved should be treated as external non-financial benefits and should be priced at the appropriate shadow prices. It has been estimated that the new highway will reduce travel time by 70% for passenger vehicles and 45% for trucks.
4.3 Reduced Maintenance Costs on Existing Road Network
Since 60% of the traffic moving between the places to be connected by the new highway is expected to shift from the existing roads on to the toll highway, the lower volume of traffic remaining on the existing roads implies both the need for less maintenance and the opportunity to defer scheduled rehabilitation works. It has been estimated that, in the absence of the new highway, annual maintenance costs on these sections of existing roads would be J$4,000 million per annum (in 2013 prices) with effect from 2017. These consist of 95% capital works and 5% operating expenses. It is expected that the lower traffic load will reduce annual capital works by 10% and annual operating expenses by 20%. Treat all reduced maintenance costs as benefits to GOJ.
4.4 Reduced Accident Costs
It has been estimated that total annual costs associated with road accidents will amount to approximately J$4,000 million per annum in 2013 and that these costs can be expected to rise proportionately with the increase in traffic volume, ceteris paribus. If these costs are apportioned over entire country’s road network, it can be estimated that 20% of the total traffic accident costs are incurred on the sections of the road network where the new highway is to be located. With 60% of the traffic expected to shift to the safer highway, it has been estimated that accidents over this section of the network will be reduced by 40% (i.e. 40% of 20% of the annual forecast total cost of traffic accidents). It should be assumed that the shadow price of the cost of accidents is the same as the market price.
4.5 Reduced Pollution Costs
The main form of pollution caused by traffic is air pollution, the main pollutants being: carbon dioxide (CO2), carbon monoxide (CO), hydrocarbons (HC), nitrous oxide (NO), sulphur oxide (SO) and particulates (PM). Drawing on estimates of the costs of these pollutants from studies undertaken in other countries, and, given the composition of entire country’s traffic fleet by type of vehicle, it has been estimated that the pollution cost savings from the new highway will amount to J$0.20 per vehicle kilometer traveled by passenger vehicles on the new highway and J$0.40 per vehicle kilometer traveled by trucks on the new highway. It should be assumed that the full cost of this externality is borne by the residents of the country.
4.6 Revenues from Tolls
Toll charges are expected to be set at J$10 per kilometer for passenger vehicles and J$20 per vehicle kilometer for trucks, in 2013 prices, and indexed for inflation. There is no sales tax on the toll, the concessionaire retains all the proceeds from the tolls until the end of its concession (at the end of 2033).
5. Tax and Financing Arrangements
The concessionaire is required to pay 25% company tax on its earnings. While interest payments on loans can be treated as a tax deductible cost, no provision is made for depreciation allowances as a deduction against income for tax purposes.
The concessionaire will finance its share of the initial capital cost with loans from international banks of US$200 million drawn in 2016 and repayable over the next 15 years at 3% (real) interest rate. The balance of its investment is financed from its own funds (equity) held by its parent company in France. The other investor is the GOJ which borrows the equivalent of US$600 million domestically at 4.5% (real) interest rate in 2016, repayable over 40 years, and finances the balance of its expenditure from its own funds.
6. Arrangements on Termination of the Concession
On termination of the concession at the end of 2033 the highway and its maintenance are handed over to and will become the full responsibility of GOJ. There will be no payment to the concessionaire. Assume that the road is operated for a further 25 years (i.e. until the end of year 2058) and that the salvage value is 50% of the initial highway capital cost. A decision has to be made as to whether the highway should be managed with or without a toll system from 2034 onwards. It has been predicted that removal of the toll would result in a 30% increase of the total forecast traffic flow moving to the highway from the existing road network.
The toll utilities have a salvage value of 50% of initial cost, and will be scrapped either at the end of 2033, if GOJ decides not to continue the toll, or at the end of 2058 if they do. (In either case the salvage value will accrue to GOJ.)
It should be assumed that if the toll is removed in 2034, all benefits, with the exception of the reduced maintenance costs on existing roads (item 4.3 above), increase proportionately with the increase in traffic volume; i.e. by 30%, including avoided accident costs (item 4.4 above).
7. Your Task
Your task is to undertake a complete cost-benefit analysis of the proposed project as detailed above, with and without the toll after 2033. If possible, you can also undertake stakeholder analysis. The results of the analysis should be calculated and discussed.
While GOJ uses a 6% discount rate (real) for public sector investment decision making, you should also undertake a sensitivity analysis at 9% and 12%. It is understood that the concessionaire requires a minimum return of 12% (real) on its equity. Your report should advise the government on whether the project is worthwhile and which scenario (tolls or no tolls after 2033) you consider the best, giving reasons.
You should also conduct and report the results of a sensitivity analysis in which you calculate and comment on, at least, the sensitivity of the results to:
(i) traffic forecasts reported in Table 2 (range between low 2%, base case 4%, and high 5%)
(ii) vehicle operating costs (20% variation each side of the base case estimate) and
(iii) opportunity costs of travel for the different categories of commuters (30% variation each side of the base case estimate).
Initially undertake a sensitivity analysis showing the effects of variability of these inputs individually and jointly on the net benefits. If possible, you can also undertake a risk analysis by using Monte Carlo simulations. In your report you should also indicate if there are any omitted costs and benefits that could be of potential significance to the decision-maker and might warrant further investigation.
In your discussion of your findings you should identify (in 250 words or less) what other variables if any, should be selected for further sensitivity/risk analysis, and explain why. (Please note: it is assumed that import duties and sales tax are fixed and are not subject to change. Hence these variables are not to be used in sensitivity/risk analysis.)
8. The Format of the Report
Your written report should be not more than 10 pages in length, excluding tables. It should be on A4 size pages (portrait orientation only) in PDF format, 12-point Times New Roman font, and 2.5 margins on all sides.
The report should begin with an executive summary of no more than one page in length. The contents of the report usually include introduction, methodology, analysis, and conclusion. The methodology section is expected to explain key variables and assumptions. Results of the sensitivity analyses should be reported in summary tables included in the text, and where necessary, in more detailed tables in an Appendix (not included in 10 pages).
Excel files for all scenarios and sensitivity analysis should be submitted electronically and left unlocked so calculations can be checked. Each Excel file (and/or sheet in a workbook) should be clearly and logically labelled with your name and student number and scenario for reader-friendly identification.
Your report plus all Excel files for all scenarios and sensitivity analysis should be submitted electronically via Canvas by 23:59 on 1 June 2020.