Life Cycle Cost Analysis in Pavement Design - In Search of Better Investment Decisions - Office of Asset Management Federal Highway Administration Executive Session

FHWA LCCA Methodology Steps 1.Establish Design Alternatives 2.Determine Activity Timing 3.Estimate Agency and User Costs 4.Compute Life-Cycle Costs 5.Analyze the Results

Inputs are discrete or point values Initial costs are $11M The discount rate is 4% Outputs are discrete Alternative “A” total cost = $20.5M Alternative “B” total cost = $26.0M Deterministic Approach

Deterministic Limitations n Doesn’t Address: l Statistical Significance l Variability n Subject to Manipulation n Lacks Credibility

 Captures the uncertainty in the inputs,  Carries that uncertainty through the computation process to generate a  Probability distribution of result (a range of possible outcomes along with their likely hood of occurrence). Probabilistic Approach

$ % Inputs Net Present Value Results MODELMODEL Simulation Modeling

Deterministic Approach Project cost estimate is $12 million Probabilistic Approach 75 percent chance the project will cost $12 million or less. LCCA Results

 Accounting for variability in inputs: Activity timing, costs, discount rate  Quantitatively determines risk in alternative strategy selection  Elevates the decision from questioning the inputs to discussing the merits of each alternative Role of Probability in LCCA

Agency NPV B A Frequency Net Present Value

Advantages  More Informed Decisions Evaluate all possible outcomes Expose areas of uncertainty...Quantify risk Determine significance of difference between alternatives Examine influence of underlying variables on final results Provide those vested with appropriate authority the opportunity to make decisions about risk taking

Benefits of LCCA Software  Performs LCCA as per FHWA best practice  Requires same data inputs as manual process  Better, faster & cheaper analysis  Automates user cost process

Software Data Input

Software Outputs

4. Why Use LCCA  Requirements  FHWA’s Philosophy  Benefits of LCCA

LCCA Requirements NHS Designation Act (1995) Required States to conduct LCCA of each NHS high cost ($25M or more) useable project segment. TEA-21 (1998) Eliminated this requirement.

FHWA Philosophy LCCA:  Decision support tool  Results are not decisions  Rigorous analytical process can be as important as the results

Benefits of LCCA  Better information for decisions  Improved rehabilitation strategies  Consideration of user costs  Support for overcoming the “first cost” limitations

FHWA LCCA Guidance n LCCA Software n LCCA Primer, Technical Bulletin DP-115 l

5. Management’s Role  Management Support for Development and Application of LCCA.  Develop LCCA Guidelines including Recommendations on Input Values

Management Support n Requires “buy-in” of risk management by senior executives n Technical Champion n Top management support

Developing Guidelines n Analysis Periods n Type of Dollars…Treatment of Inflation n Type and Value of Discount Rates n Treatment of User Cost n Value assigned to user delay time n Choice of Economic indicator n Remaining service Life n Ignore Sunk Cost

Developing Guidelines n Analysis Periods n Type of Dollars…Treatment of Inflation n Type and Value of Discount Rates n Treatment of User Cost n Value assigned to user delay time n Choice of Economic indicator n Remaining service Life n Ignore Sunk Cost

FHWA Recommends Real dollars and a real discount rate - do not account for inflation A real discount rate range of 3% to 5% Never mix real and nominal (inflation adjusted) costs and discount rate Discounting … a mechanism for quantifying the time value of money Developing Guidelines

Observations : n Traffic grows over time n Queuing cost dominate n Hourly distributions key n $ Value of time has a major influence n Normal VOC between alternatives negligible Developing Guidelines User Costs are calculated through a capacity analysis.

Passenger Vehicle $10 - $13 Single Unit Truck $17 - $19 Combo Truck $21 - $24 Value of Time Recommendations... Developing Guidelines 1996 Dollars

Things to Remember n LCCA Decision Support Tool n NHS LCCA Requirements n Document Inputs n Dispose of all Issues n Provide Confidence Information