Presentation on theme: "Executive Session Office of Asset Management"— Presentation transcript:
1 Life Cycle Cost Analysis in Pavement Design - In Search of Better Investment Decisions - Executive SessionOffice of Asset ManagementFederal Highway Administration2
2 Introduction Who are we Why are we here: Why are we doing that: Jim Walls - Eastern Resource CenterKeith Herbold - Midwestern Resource CenterTom Canick – Office of Asset ManagementWhy are we here:To deliver FHWA’s LCCA probabilisticsoftware workshopWhy are we doing that:FHWA supports application of LCCA in pavementdecisionsContinuation of our prior efforts3
5 Workshop Overview LCCA Review LCCA Process Components and Issues User CostsProbability and RiskInput Recommendations3
6 FHWA LCCA Methodology Steps Establish Design Alternatives Determine Activity TimingEstimate Agency and User CostsCompute Life-Cycle CostsAnalyze the ResultsThese are the steps to performing an LCCA, which will answer the question: “What materials and methods are we going to select to fulfill the objectives?”I will go through them in order, detailing some of the effort required at each pointWe will revisit these steps again and again in this course and will refer back to the material presented here.
7 Workshop OverviewSoftwareCapabilitiesHow to useDemonstration3
8 Workshop Overview Hands-on Software Exercises Class Exercises Interpreting Results3
9 2. Probabilistic LCCA What is it What does it add to the process How to interpret it6
10 Probabilistic Approach Captures the uncertainty in the inputs,Carries that uncertainty through thecomputation process to generate aProbability distribution of result (a range of possible outcomes along with their likely hood of occurrence).Probabilistic LCCA treats inputs as ranges of possible values and assigns a likelihood of occurrence to those values.Just like deterministic inputs, probabilistic inputs are based upon historical data, expert opinion, and research.Probabilistic analysis allows for simultaneous variability among inputs.Probabilistic outputs are also ranges of values with calculated likelihood of occurrence.
12 Deterministic Approach Inputs are discrete or point valuesInitial costs are $11MThe discount rate is 4%Outputs are discreteAlternative “A” total cost = $20.5MAlternative “B” total cost = $26.0MSo far, for the purposes of example, we’ve treated inputs and outputs as specific values.Another way of saying this is that we’ve been looking at LCCA as a deterministic process with fixed, discrete inputs and outputs.Deterministic inputs are based upon historical data, expert opinion, and research.Input data are most likely or expected values.The calculations may be done with pencil, paper and a calculator or on a spreadsheet.A single (or discrete), deterministic output results from these most likely input values.
13 Deterministic Limitations Doesn’t Address:Statistical SignificanceVariabilitySubject to ManipulationLacks Credibility14
14 LCCA Results Deterministic Approach Probabilistic Approach Project cost estimate is $12 millionProbabilistic Approach75 percent chance the projectwill cost $12 million or less.
15 Simulation Modeling $ % Inputs Results M O D E L Net Present Value Animated SlideThe LCCA outputs are a function of several inputs, such as agency costs, user costs and discount rates, which we believe all may vary independently.Probabilistic analysis results are obtained by using simulation software.Probabilistic analysis allows for simultaneous variation of inputs.An entire probability distribution of LCCs is generated for the project alternative along with the mean or average LCC for that alternative.By including all possible values for the analysis inputs in relation to their probability of occurrence, risk analysis elevates the LCCA debate from contesting the validity of results to deciding best public policy.%
16 Role of Probability in LCCA Accounting for variability in inputs:Activity timing, costs, discount rateQuantitatively determines risk in alternativestrategy selectionElevates the decision from questioning theinputs to discussing the merits of eachalternativeProbability, statistics, and risk are used at several points in the probabilistic LCCA process.When collecting data for an LCCA we find that our data has variability: It is easier to correctly predict a range of values than a single correct value.Probabilistic life-cycle costs are calculated using simulation programming.Analysis of the simulation results can describe the variability in the LCCA.However, in order to make and support decisions using probabilistic LCCA, you must understand statistical risk analysis.
18 Advantages More Informed Decisions Evaluate all possible outcomes Expose areas of uncertainty...Quantify riskDetermine significance of difference between alternativesExamine influence of underlying variables on final resultsProvide those vested with appropriate authority the opportunity to make decisions about risk taking23
25 4. Why Use LCCARequirementsFHWA’s PhilosophyBenefits of LCCA3
26 LCCA Requirements NHS Designation Act (1995) TEA-21 (1998) Required States to conduct LCCA of each NHS high cost ($25M or more) useable project segment.TEA-21 (1998)Eliminated this requirement.4
27 FHWA Philosophy LCCA: Decision support tool Results are not decisions Rigorous analytical process canbe as important as the results6
28 Benefits of LCCA Improved rehabilitation strategies Better information for decisionsImproved rehabilitation strategiesConsideration of user costsSupport for overcoming the“first cost” limitations6
29 FHWA LCCA Guidance LCCA RealCost LCCA Technical LCCA Software Primer Bulletin Advanced DP WorkshopAutomated Slide, click mouse to highlight each word.Here is a definition of LCCA.Let’s review point by point:You have already determined that the project merits being done – you just don’t know how, yet.Analytical tool – LCCA is a structured method with specific steps to follow, inputs to include, and “rules” (that must be obeyed in order to get some useful and usable outputs).Cost comparison – LCCA includes initial costs, future costs, agency costs, and, in best practice, user costs.Competing design alternatives – Different ways to design, construct, maintain traffic around a single project.Equivalent benefits – each alternative being considered will produce the same benefit.The project – LCCA is used within the confines of one project where the alternatives provide different ways of accomplishing the same project.
30 5. Management’s RoleManagement Support for Development and Application of LCCA.Develop LCCA Guidelines including Recommendations on Input Values3
31 Management SupportRequires “buy-in” of risk management by senior executivesTechnical ChampionTop management support24
32 Developing Guidelines Analysis PeriodsType of Dollars…Treatment of InflationType and Value of Discount RatesTreatment of User CostValue assigned to user delay timeChoice of Economic indicatorRemaining service LifeIgnore Sunk Cost10
33 Developing Guidelines Analysis PeriodsType of Dollars…Treatment of InflationType and Value of Discount RatesTreatment of User CostValue assigned to user delay timeChoice of Economic indicatorRemaining service LifeIgnore Sunk Cost10
34 Developing Guidelines Discounting … a mechanism for quantifying the time value of moneyFHWA RecommendsReal dollars and a real discount rate - do not account for inflationA real discount rate range of 3% to 5%Never mix real and nominal (inflation adjusted) costs and discount rateLCCA discounts an alternative’s future costs to their present value in order that they may be compared on the same basis to the present value of the costs of other alternatives.When estimating future cost for an LCCA, it is simplest to develop those costs in real (or constant) dollars. Real dollars do not include an inflation component.For example, the same material and labor costs used to price an activity in the base year of the analysis should be used to value them in any future year of the analysis ($40/ton of hot mix this year and 20 years from now).LCCA should use a discount rate that reflects the opportunity value of time, rather than one that includes an inflation component.Inflation is too difficult and complex to forecast.The discount rate should reflect historical trends.Long term rates, as reflected by nominal interest rates less inflation, are around 4%, and range from 3% to 5%.Public sector projects should be evaluated only on real gains (cost savings or expanded output), rather than purely price effects.Also, if you include an inflation factor in the costs/prices, you must also include one in the discount rate, effectively negating the use of inflation.Don’t mix real and nominal costs or discount rate.
35 Developing Guidelines User Costs are calculated through a capacity analysis.Observations:Traffic grows over timeQueuing cost dominateHourly distributions key$ Value of time has a major influenceNormal VOC between alternatives negligibleProbabilistic LCCA treats inputs as ranges of possible values and assigns a likelihood of occurrence to those values.Just like deterministic inputs, probabilistic inputs are based upon historical data, expert opinion, and research.Probabilistic analysis allows for simultaneous variability among inputs.Probabilistic outputs are also ranges of values with calculated likelihood of occurrence.
36 Developing Guidelines Value of Time Recommendations...Passenger Vehicle $10 - $13Single Unit Truck $17 - $19Combo Truck $21 - $241996 Dollars13
37 Things to Remember NHS LCCA Requirements Document Inputs LCCA Decision Support ToolNHS LCCA RequirementsDocument InputsDispose of all IssuesProvide Confidence Information9