Highway Agency Costs

Highway Agency Costs:

            Highway agencies are changed with the responsibility of planning, constructing, maintaining, and operating the roads under their jurisdictions. Where appropriate, the costs of these activities are included in economy studies. However, many of these agency costs, particularly those for planning and some of the overhead charges associated with other operations, are not affected by proposed investments and they should be excluded from economic comparisons. The costs per mile to construct and maintain highways vary tremendously. Construction costs may vary from a few thousand to ten of millions dollars. Maintenance costs also vary greatly. However, appropriate values are usually available in the records of highway agencies.

            For economy studies, the accuracy needed for the costs of rights of way, construction, maintenance, and operation will be different, depending on their use for example, it long-range projections are being made for needs studies or advanced planning, only average costs per mile might be considered, based on past experience in similar situations. At the other extreme, if, for example, alternative pavement designs or materials are being compared, the individual cost elements might be developed in considerable detail. Discussions of such estimating procedures are outside the scope of this book.

Interest as a Cost:

            In economy studies for private business, interest is always treated as one of the costs of invested capital. This is logical, since the money for the investment comes either by withholding earnings from owners or stockholders, from borrowing from others and paying interest on the borrowed funds, or by foregoing other investment opportunities that should produce a return. In the past in the public works field some have argued that interest should be charged only where borrowing will finance the proposed project. This viewpoint has now largely disappeared as two concepts have been accepted. These are (a) that capital can and should be productive and (b) that interest is a reward or incentive for deferred consumption, as is the case when money is invested in highways because of anticipated future benefits. Winfrey (op. cit., Chapt. 5) has proposed that the word overcharge be substituted for interest to distinguish those situations where no specific monetary return is anticipated.

            Among highway engineers today, two different viewpoints regarding interest as a cost are advocated and utilized:

1.      Interest should be charges at the current rate at which a particular highway agency can borrow money. The charge is included even though road improvements are financed from current income. If the uncertainty inherent in estimates of future happenings is recognized at all, it is done by adopting a conservative value for future benefits.

2.      Interest should be charged at a rate representing the minimum attractive return. This would e somewhat higher than the cost of borrowed money in order to recognize the risk involved in all predictions of future events. The rate would be set for each agency after representative projects which promise the best use of (usually) limited highway funds are analyzed. In any event, the rate of return would be high enough to discourage investments that do not appear attractive in the light of future uncertainties.

The decision regarding interest rates has a tremendous influence on the results of economy studies. Assume, for example, that interest rates of 0, 3, 6, and 10%, respectively, are employed for a proposal that has a first cost of $1000 and an estimated life of 30 yr. Then the annual return needed to recover the $1000 in 30 yr, using interest at 0%, will be $33.33; at 3%, $51.02; at 6%, $72.65, and at 10%, $106.08.

The first of the two viewpoints outlined above was adopted by the AASHO committee in its report. Several interest rates, ranging from 3 ½ to 6% were used in their illustrative examples. Federal water agencies use the same approach, but indicate that estimates must be conservative to allow for risk.

The second point of view, which comes closer to that found in private enterprise, is favored by a number of writers in the highway and other public works fields. The minimum attractive rate of return, 7% or higher, would include a charge for the use of the invested funds and a safety factor to reflect the risk involved in even the best estimates. The actual rate might be set at a some what higher level for higher risk projects. And, where funds are limited and there are many opportunities for investment in projects showing high rates of return, the rate should be set at the level where funds will be exhausted to avoid error or confusion in interpreting study results.