Fillable Printable Social Cost Benefit Analysis
Fillable Printable Social Cost Benefit Analysis
Social Cost Benefit Analysis
59
Project NPV, Positive Externalities, Social Cost-Benefit Analysis
Project NPV, Positive Externalities,
Social Cost-Benefit Analysis—
The Kansas City Light Rail Project
Sudhakar Raju, Rockhurst University
Abstract
e Heartland Light Rail project represents Kansas City’s biggest infrastructural
investment in decades. e ballot initiative for the light rail project was voted down
three times until it was finally approved in November 2006. Using best estimates of
construction costs, operating expenses and federal funding, I estimate the net pres-
ent value (NPV) of the project to be negative $343 million. From a standard NPV
perspective the Kansas City light rail transit (LRT) system is unlikely to break even.
However, if the negative externalities of auto travel and the positive externalities
associated with light rail are properly accounted for in a comprehensive social cost-
benefit framework, investment in the Kansas City LRT system becomes an increas-
ingly feasible option.
Introduction
In November 2006, after several previous failed attempts, voters in Kansas City
approved a measure for the construction of a light rail transit (LRT) system that
would be partly financed by a 3/8-cent sales tax for 25 years. According to the offi-
cial ballot language, the plan proposes the construction of a new $1 billion, 27-mile
Heartland Light Rail system. e plan also proposes enlarging the light rail system’s
service area by employing a green fleet of 60 electric shuttles that would provide
connecting transit service to nearby job and shopping centers.
Journal of Public Transportation, Vol. 11, No. 4, 2008
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Kansas City and Transportation
During the 1990s, Kansas City embarked on a widespread strategic planning ini-
tiative. A key recommendation of the initiative involved the city’s transportation
system. Federal Highway Administration (FHWA) data indicated that the poor
quality of Kansas City roads imposed annual vehicle operation costs of $651 on
Kansas City drivers
1
—the highest in the nation’s major cities outside California.
Data from the 2003 national Consumer Expenditure Survey indicated that among
major metropolitan areas, Kansas City residents spent about 20 percent of their
budget on transportation—the fifth highest in the nation. Kansas City offers no
real alternatives to driving and, with continued growth, transportation is pro-
jected to become even more time-consuming and costly. As a result, a key recom-
mendation of the planning initiative was for the development of a light rail transit
system to “enhance the movement of people, to protect clean air, and to protect
the natural environment … and the promotion of more clustered development
along transit corridors.”
2
Kansas City is actually composed of two cities—Kansas City, Missouri and Kansas
City, Kansas. Kansas City, Missouri is, by itself, the largest city in Missouri. e com-
bined population of the greater Kansas City metropolitan area is close to 2 million.
Once known primarily for agriculture and manufacturing, Kansas City today has
a diversified economic base composed of telecommunications, banking, finance,
and service-based industries. Kansas City is also a transportation hub and a major
national distribution center. Transportation is, therefore, central to the continued
development of Kansas City.
Notwithstanding the importance of transportation for Kansas City’s economic
development, recent investment in transportation infrastructure in Kansas
City has been poor. In a study conducted by the Mid-America Regional Council
(MARC), a regional public policy research organization located in Kansas City,
Kansas City ranked at the bottom of a group of peer cities in terms of public trans-
portation financing. e only public transit offered by the city is bus services. But
even this service is underinvested; in fact, Kansas City would have to double its bus
services to reach the average of its peer cities.
Due to the extensive highway projects implemented in Kansas City during the
1970s and 1980s, Kansas City possesses the most freeway lane miles per capita of
all large urbanized areas in the United States and the fourth highest total roadway
miles per person.
3
Even though Kansas City ranks high in the number of roadway
miles per person, its roads are in worse condition than national and peer city aver-
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Project NPV, Positive Externalities, Social Cost-Benefit Analysis
ages. e Road Information Program’s (TRIP’s) 2004 Bumpy Roads Ahead report
found that Kansas City’s “poor” pavement conditions significantly exceeded
national averages, and Kansas City had a smaller percentage of roads classified as
“good.” In addition, overall pavement conditions have notably deteriorated since
2000.
Transportation by automobile is, by far, the preferred mode of transportation in
Kansas City, and recent studies indicate that reliance on automobiles is continuing
to grow. More than 93 percent of all trips are by automobile, of which 83 percent
are single-occupancy trips and 10 percent are carpool trips. About 4 percent work
from home, 1 percent walk to work, and public transit accounts for the remaining
1 percent.
e extensive roadway system in Kansas City offsets the excessive reliance on
automobiles; thus, congestion is not a major problem. However, there is significant
congestion during peak periods, and nearly all studies are in agreement that con-
gestion is growing. e 2001 Travel Time Study conducted by MARC found that
congested travel as a percentage of peak vehicle miles traveled increased from 5
percent in 1982 to 32 percent in 2002. However, this still compares very favorably
to other urban areas in which congested travel increased far more substantially,
from 24 percent in 1982 to 65 percent in 2002. e low-density urban form of Kan-
sas City means that travel distances in Kansas City are longer. e average vehicle
miles of travel (VMT) per person in Kansas City was 28.65, whereas the average for
metropolitan areas of similar size was 24.04 VMT per person each day.
4
However,
the relatively lower congestion in Kansas City results in greater travel speeds and
shorter travel times. e MARC 2001 Travel Time Study found that even though
average travel speeds steadily increased, “there are several routes where conges-
tion is an increasing problem. is is evident in that there is a large percentage of
routes and segments with delay … and several of the most highly traveled routes in
the region have significantly more delay than in previous studies.” A similar study
by the Missouri Department of Transportation found that of the 10 most heavily-
congested sections of the urban Missouri interstate highways, 7 are located in
Kansas City.
5
The Heartland Rail System
Planning for the Kansas City LRT system began in the 1990s. e Technology Work
Team considered six technology options—improved bus service, bus rapid transit
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with dedicated guideway (such as in Ottawa or Curitiba), electrified bus rapid
transit (as in Lille, France or Mexico City), electrified street car, monorail and light
rail—and settled on light rail as the preferred technology with electric bus transit
as a second option.
e Heartland Rail system would serve some of Kansas City’s densest residential
neighborhoods in the mid- and south-town areas. e proposed system align-
ment runs through downtown Kansas City, serving an employment corridor with
250,000 jobs. e primary market that would be served by the proposed light rail
system is work trips though strong connections to cultural and shopping centers
would result in a strong secondary market. During peak weekday morning and
evening periods, service is proposed to be provided every 12 minutes.
Capital Costs, Operating Costs, and Funding for the
Heartland Light Rail Project
e Heartland Rail system, as proposed, would constitute one of the biggest infra-
structural investments in Kansas City history. Detailed estimates of capital costs,
cash inflows, and cash outflows for the project is provided in the Central Business
Corridor (CBC) Transit Plan. e essential features of the project and the underly-
ing project assumptions of the CBC Transit plan are summarized in Table 1.
e CBC plan assumes that the project would be funded by three major sources.
Federal funding of $593 million was assumed to cover 60.50 percent of the capital
costs of the project. A 3/8-cent sales tax for 25 years was assumed to generate $29
million in the first year and a total of $878 million over the 25-year tax period. e
project would also be funded by a $195 million, 19-year, 7.70 percent bond issue,
which would result in interest payments of $19.87 million annually. e funding
for the project would become effective on April 1, 2009.
The Financial Economics of the Heartland Light Rail System—
Project Analysis
While detailed estimates of capital costs, cash inflows, and cash outflows over the
25-year life of the light rail system are provided in the Central Business Corridor
(CBC) Transit Plan, there is no attempt to provide an economic or financial analy-
sis of the project. e project inflow and outflow estimates provided by the CBC
plan over the 25-year life of the project are shown in Table 2.
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Project NPV, Positive Externalities, Social Cost-Benefit Analysis
Table 1. Project Assumptions
Project Life 25 years
•CapitalPeriod 8years(Year1–Year8)
•OperatingPeriod 17years(Year9–Year25)
Estimated (Inflation Adjusted) Capital Costs $981
Base Estimate of Annual Operating/Maintenance Costs $15.20 million
Annual Growth in Operating/Maintenance Cost 4%
AnnualOperating/MaintenanceCostinYear9 $20.80million
($15.20 x [1 + .04]
8
= $20.80)
TotalOperationandMaintenanceCost(Years9-25) $493
Federal Capital Funding Percentage 60.50%
Secondary Funds Base Assumption $1.50 million
(Annual Growth Rate 1.80%)
Base Estimate from Sales Taxes $29 million
Estimated Annual Growth in Taxes 1.80%
Tax Period 25 years
Bond Issue $195 million
Bond Repayment Period 19 years
Bond Interest Rate 7.50%
Annual Bond Interest Payment
$19.87 million
($195 million issue, Effective rate of 7.70%, 19 years)
BaseEstimateofFareRevenue(Year9ofproject) $6.11million
Annual Growth Rate in Fare Revenues 1.80%
Journal of Public Transportation, Vol. 11, No. 4, 2008
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Table 2. Project Cost and Revenue Flows (in millions): Estimates Based on CBC Study
Notes: Total Capital Outflows = Capital Costs + Operation & Maintenance + Bond Payment
Total Capital Inflows = Bond Sales + Federal Funds + Secondary Funds + Other Funding + Sales Tax Revenues + Fare Box Revenues +
Interest Earned
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Project NPV, Positive Externalities, Social Cost-Benefit Analysis
A good starting point for financial analysis is to compute the NPV of the Kansas
City LRT project. For long-term capital projects, the Federal Transit Authority
(FTA) recommends using a project discount rate of 7 percent.
6
Using this as the
applicable discount rate, the NPV of the project based on the CBC Transit Plan
estimates turn out to be about $70 million. However, this NPV value is based on
preliminary estimates provided in the CBC Transit Plan and needs to be readjusted
in the light of recent developments and other factors such as inflationary effects.
e most significant revisions to the preliminary estimates are:
• eCBCTransitPlanestimatesarebasedonoperatingcostassumptionsof
$20.80 million. More realistic estimates suggest that operating costs would
probably be in the range of $25-$30 million annually. e mid-point of this
range is used here with the assumption (as in the CBC study) that operating
costs escalate annually at 4 percent.
• eCBCTransitPlanrevenueestimatesarebasedona½-centsalestax
assumption. e actual amount approved by Kansas City voters was 3/8
cents. (us, actual sales tax revenues earmarked for the project are 25
percent lower.) e lower estimate suggests that a 3/8-cent sales tax would
generate sales tax revenues of $23 million annually. e CBC estimates were
revised to reflect the lower sales tax with the assumption (as in the CBC
study) that sales tax revenues increase by 1.75 percent annually.
e revised estimates are shown in Table 3. e NPV of the project based on the
net cash flows of the project turn out to be -$53.31 million, while the Internal Rate
of Return (IRR) is 10.58 percent
7
—a clear signal that the project has some inherent
problems.
What is clear from an analysis of the cash flow stream is that the project is heavily-
dependent on federal funding. Ironically, the only periods in which the project has
any positive cash flow stream are the initial years—the periods when one would
expect the project to run deficits because of high capital costs. is is due to the
fairly high values assumed for federal funding. While capital costs reach a peak in
years6-8,abondissueinYear7partiallyosetssomeofthesecapitalcosts,result-
inginanetinowinYear7.
e most instructive aspect of the financial analysis is the non-self sustaining
nature of the project in the operating phase covering years 9-25. Net cash flows
in the operating phase of the project are negative in every year of the project. In
principle, the operating phase is somewhat less subject to uncertainty since the
Journal of Public Transportation, Vol. 11, No. 4, 2008
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Table 3. Project Cost and Revenue Flows (in millions): Revised Estimates Based on CBC Study
Notes: Total Capital Outflows = Capital Costs + Operation & Maintenance + Bond Payment
Total Capital Inflows = Bond Sales + Federal Funds + Secondary Funds + Other Funding + Sales Tax Revenues + Fare Box Revenues
Net Cash flow = Total Capital Inflows - Capital Outflows
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Project NPV, Positive Externalities, Social Cost-Benefit Analysis
major uncertainty in infrastructural projects tends to center around the substan-
tial initial investment costs. Four major factors determine the economic viability
of the Heartland Light Rail project in the operating phase of the project: operating
and maintenance costs, bond interest payments, sales tax revenues, and fare box
revenues. e effect of each of these variables are analyzed below.
Operating and Maintenance Costs
e budgeted value for operating and maintenance cost in the first year of the K.C.
Light Rail project is $20.80 million. A more realistic estimate, taking into account
factors such as cost escalation and inflation, is $25-$30 million. Using a mid-range
estimate of operating costs, the NPV of the project, as pointed out earlier, turns
out to be negative. Now, suppose one were to give the operating costs of the
project more latitude. What is the lowest value that one could assume for base
operating costs and still end up with a positive value for NPV? Holding everything
else constant, the effect on NPV for different base year operating and maintenance
cost assumptions is reported below.
8
Table 4. Project Sensitivity to Base Year Operating &
Maintenance Cost Assumptions
us, operating and maintenance costs would have to be lower than $20.33
million at inception of project operation for NPV to be positive. Given that the
current estimate is $25 million, it seems unlikely that operating and maintenance
costs could go as low as $20.33 million. In addition, if the annual percentage
increase in operating costs were higher than 4 percent, the resulting NPV’s would
be even more unfavorable.
Bond Interest Payments
e base estimates are based on partial funding of the Heartland Light Rail Project
througha$195million,7.70percenteectiverate,19-yearbondissueinYear7of
the project. is results in interest obligations of $19.87 million over 19 years. How
low would interest obligations have to be to result in a break-even NPV?
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e effective interest rate assumed for the Heartland Light Rail bond issue is 7.70
percent. Of course, future interest rates are unknown, but, based on Kansas City’s
current credit rating, an interest rate of 7.70 percent seems reasonable and per-
haps even on the higher side. In 2007, Kansas City issued $138 million of general
obligation “GO series 2007A” bonds at a rate of 4.60 percent. All three credit rating
agencies—Standard and Poor’s, Moody’s, and Fitch Ratings—affirmed their belief
in the City’s financial strength. In Table 5, a19-year bond issue of $195 million is
assumed, and the effect of different interest rates and debt servicing levels on
project NPV is computed.
Table 5. Project Sensitivity to Interest Cost Assumptions
Note: e above is based on a $195 million, 19-year bond issue.
It is clear from the sensitivity analysis above that even if long-term interest rates
were to decline to a historical low of 4 percent, the resulting savings in debt servic-
ing costs is insufficient to result in a non-negative NPV. Since long-term interest
rates have historically been around 7.50 percent, it is improbable for much savings
to be realized from a decline in annual debt servicing costs alone.
Suppose we were to consider two other options—increasing the size of the bond
issue or increasing the maturity of the issue. It is important to recognize that size,
maturity, and annual payments are all simultaneously determined, so that chang-
ing any one variable affects the value of at least one of the other variables. Now
suppose that the size of the issue was increased from $195 million to some higher
value while maturity of the issue is kept constant. What effect would this have on
the NPV of the project? e results are reported in Table 6.
Clearly, increasing the size of the bond issue worsens the NPV of the project. is
isduetothefactthatwhilealargerbondissueincreasesthecashinowinYear
7, it also results in higher debt servicing burdens in the outer years of the project.
In fact, a lower issue size may be the answer, but there may be constraints about
running unacceptably high levels of deficits in the initial years of the project.
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Project NPV, Positive Externalities, Social Cost-Benefit Analysis
Table 6. Project Sensitivity to Bond Issue Size
Note: e above assumes an effective
funding cost of 7.70 percent and a
maturity of 19 years.
Would increasing the maturity of the bond issue and consequently reducing the
annual debt servicing burden improve the NPV of the project? Suppose the size
of the issue and interest rate remained at $195 million and 7.70 percent, but the
maturity of the issue was increased from 19 to 25 years. e annual debt servicing
burden in this case would decrease from $19.87 million to $17.80 million over the
life of the project, and NPV would improve from the base case NPV of -$53.31 mil-
lion to -$45 million.
At an extreme, imagine that Kansas City could issue a perpetual bond. Suppose
the issue size is $195 million and the interest rate is 7.70 percent. In this case, the
annuity payments would decline from the base case estimate of $19.87 million per
annum to perpetual annuity payments of $15.02 million ($195m x .0770). is is
the lowest-possible annual debt servicing burden attainable by increasing bond
maturity. However, this would still result in a negative NPV.
e bottom line is this: Declining interest rates and consequently a lower debt
burden would improve NPV, but even at very low interest rates the project does
not break even. Other solutions, such as increasing the size of the bond issue or
increasing the maturity of the bond issue, are either not helpful or do not impact
the NPV in any substantive manner.
Sales Tax Revenues
Initialestimatessuggesteda½-centsalestaxearmarkedfortheHeartlandLight
Rail project. Anti-tax sentiment is, however, very strong in Kansas City, and
the final amount approved for the light rail project by Kansas City voters was a
3/8-cent tax for 25 years. e possibility for increasing the sales tax rate is remote;