Economic Analysis Primer

Life-Cycle Cost Analysis

The first systematic economic means of comparing highway investments that will be discussed in this primer is called life-cycle cost analysis (LCCA). It applies the discount rate to the life-cycle costs of two or more alternatives to accomplish a given project or objective, enabling the least cost alternative to be identified.

When to Use Life-Cycle Cost Analysis

LCCA is applied when an agency must undertake a project and is seeking to determine the lowest life-cycle-cost (i.e., most cost-effective) means to accomplish the project's objectives. LCCA enables the analyst to make sure that the selection of a design alternative is not based solely on the lowest initial costs, but also considers all the future costs (appropriately discounted) over the project's usable life.

LCCA is used appropriately only to select from among design alternatives that would yield the same level of performance or benefits to the project's users during normal operations. If benefits vary among the design alternatives (e.g., they would accommodate different levels of traffic), then the alternatives cannot be compared solely on the basis of cost. Rather, the analyst would need to employ benefit-cost analysis (BCA), which measures the monetary value of life-cycle benefits as well as costs (BCA is discussed at length in the next section of this primer, page 17). Accordingly, LCCA should be viewed as a distinct, cost-only subset of BCA. Even with these restrictions, however, LCCA has many useful applications (see box).

Procedures for Best Results

Best-practice LCCA requires that the objective(s) of the project be clearly defined, assumptions about future usage be clearly stated, and all reasonable means of accomplishing the same objective(s) be evaluated. Only when all reasonable alternatives are evaluated can the analyst be confident that LCCA will reveal the most cost-effective transportation solution.

In LCCA, the analyst applies the discount rate to the costs from each year of the project's life cycle. This yields the present value of the project's cost stream. Because the costs of competing alternatives can only be compared fairly if the alternatives yield the same benefits, the analyst must compare the project alternatives over the same operational time period, known as the study or analysis period. As a rule of thumb, the analysis period should be long enough to incorporate all, or a significant portion, of each alternative's life cycle, including at least one major rehabilitation activity for each alternative (typically a period of 30 to 40 years for pavements, but longer for bridges). In some cases, an analysis period long enough to capture the life cycle of one alternative may require that a shorter-lived alternative be repeated during that period.

It is important to capture all costs that differ among the alternatives being compared. Where uncertainty associated with future costs is identified, the analyst should assess its potential impact on the alternative using appropriate risk analysis methods (see section on Risk Analysis, page 30).

Cost Elements to Include

Costs associated with construction, rehabilitation, and maintenance activities of each alternative being compared should be identified, monetized, and then discounted to their present value. Table 1 lists the cost categories and elements generally included in LCCA.

There may be cases where some of the cost elements shown in Table 1 need not be quantified when comparing alternatives using LCCA. This is because alternatives that accomplish identical objectives (a requirement when using LCCA) often have many costs in common (e.g., they occupy the same right-of-way and require the same design effort). Costs that are identical (in terms of both their amount and when they occur) among all alternatives need not be quantified, as they will "wash out" in a cost comparison. In short, the analyst should focus only on those costs that vary among alternatives.

Of agency cost elements, construction and rehabilitation typically vary the most among alternatives and must be quantified. Routine maintenance costs may or may not vary significantly. Different alternatives may be evaluated with and without preservation treatments of different types. The BCA section of this primer (page 17) contains more information about quantifying agency costs.

"User costs" are those costs pertaining to a project alternative that travelers, rather than the agency, would incur. User costs often vary significantly among alternatives, largely due to different work zone requirements for the construction and rehabilitation activities associated with each alternative. Using available models, the analyst can estimate user costs associated with travel delay at work zones with some accuracy. Vehicle operating costs (VOC) in work zones can also be estimated, but these are typically small relative to those for travel delay. Work zones can affect safety, but work zone crash costs are sometimes omitted from LCCA due to inconclusive data about crash rates and severities for specific work zone configurations and traffic management strategies.

User costs under normal facility operating conditions should not vary significantly among the alternatives being compared using LCCA. Significant differences in such costs among alternatives would suggest that the levels of performance (and therefore the benefits) of the alternatives are not equal and that BCA should be used instead of LCCA.

User Cost Controversy

Work zones temporarily reduce capacity and can create significant delays to travelers. Best-practice LCCA should reflect work zone user costs along with agency costs. Many agencies, however, have been reluctant to include work zone user costs with agency costs in LCCA calculations. Project design alternatives that reduce work zone user costs often entail higher agency expenses - not welcome in times of tight highway budgets. This is particularly true because agency costs appear in agency budgets and user costs do not. Agencies may also perceive that there is too much uncertainty in valuing user travel delay time.

It is inadvisable, however, not to assign a value to work zone travel delay when using economic analysis methods such as LCCA or BCA. Highway agencies build roads to accommodate users. If an agency cites benefits to users as a justification for spending agency dollars to build or rehabilitate a road, it should also recognize the costs to users caused by these actions. Most travelers clearly do attach significant value to their travel time - otherwise traffic congestion would not generate so much public concern and irritation. In a national survey conducted in 2000, FHWA found that frustration with construction-related delay ranked among the top items of motorist dis-satisfaction.² Finally, the value of travel time in delay is not arbitrary or uncertain. Economists are able to measure its value with a good degree of accuracy (see section on BCA for information on the valuation of travel time).

Even if user costs are not counted on a dollar-to-dollar basis with agency costs, quantifying them through LCCA informs decision makers about the "level of pain" to road users from any given project design alternative. It also provides an important perspective about the cost-effectiveness of strategies to reduce work zone disruptions (see box).

Tools

A wide variety of proprietary and nonproprietary tools are available with which to analyze the life-cycle costs of highway projects. These tools are usually spreadsheet-based applications, some of which incorporate risk analysis techniques.

FHWA has undertaken several initiatives to promote the application of LCCA in the highway pavement design process. "Life-Cycle Cost Analysis in Pavement Design," an FHWA interim technical bulletin (FHWA-SA-98-079, 1998), is an important resource to LCCA practitioners. It provides guidance on the estimation and treatment of both agency and user costs in pavement design and maintenance. In 2002, FHWA released a primer on LCCA and a spreadsheet software program (RealCost) to do LCCA for pavement designs. The "Life-Cycle Cost Analysis Primer" (FHWA IF-02-047) is available on the Office of Asset Management Web site, http://www.fhwa.dot.gov/infrastructure/asstmgmt/invest.htm. The Web site also provides a link to the interim technical bulletin. FHWA offers a free workshop to highway agencies on the use of its RealCost LCCA software and the methodology underlying it.

² See "Moving Ahead: The American Public Speaks On Roadways And Transportation In Communities," FHWA-OP-01-017, February 1,2001, http://www.fhwa.dot.gov/reports/movingahead.htm.