In September 1998, the United States Department of Transportation (DoT) introduced risk analysis, a probabilistic approach to account for the uncertainty of the inputs of the cost/benefit evaluation of pavement projects, into its decision-making policies. The traditional (deterministic) approach did not consider the variability of inputs. Since 1995, United States Congress has been expressing an interest in LCCA and it is now required for projects exceeding $25 million. The DoT aims at establishing best practices rather than rigid rules for NPV computation.
One of the approaches of Net Present Value (NPV) analysis is to incorporate an inflation premium and a project risk premium into the discount rate (i). (i) = risk free rate + risk premium of the project + risk premium of inflation. Each cash flow (CF) is represented in nominal dollars.
The DoT however stipulates another NPV approach: the premiums must be incorporated in each of the individual projected cash flows. Real dollar CF = nominal dollar CF + risk premium + inflation premium. The discount rate is the risk-free rate.
The DoT approach involves the estimation of a larger number of individual values. It allows the decision-maker to visualize, for each of the CF, the impact of each of all three factors:
- financing decision
- risk preference decision
- timing decision and macroeconomic trends (inflation of expected cost and revenues)
The DoT points the analyst must be careful not to double count (for instance enter the inflation premium in both the discount rate and the cash flows.
Actual numerical examples reported by the DoT are:
- User delay cost, associated with queuing: [$10–$20] per vehicle per hour waiting
- User circuity cost, associated with traffic diversion: [$0.31] per vehicle per mile diverted
The first published estimates of these parameters date back to 1970.