Cost Benefit Analysis Report of The Red Line Extension Train Project

(Note: This reflection paper was written in the first quarter of 2019 as part of a cost-benefit analysis course)

Project Description

The Red Line Extension project (subsequently referred to as, “the project”), by the Chicago Transit Authority (CTA), is a 5.3-mile rail extension that would connect the 95th/Dan Ryan Terminal to 130th Street. The project would include four new stations near 103rd Street, 111th Street, Michigan Avenue, and 130th Street. Each new station would include bus and parking facilities. The project would improve mobility and accessibility by connecting residents to opportunities and social services. It would also reduce commute times for residents within and south of the project area, attract new investments into the area, fostering economic development and neighborhood revitalization.[1]

The current population of the area to be served by the project is 200,000. This population is expected to grow at 1.25% per annum. Residents in this area make an average of 5 trips per week and a total average number of miles for each trip is 25 miles. Although, gasoline price is $1.6 and expected to rise by 3.0% annually (Please refer to Appendix Table 1: List of parameters). The Cost Benefit Analysis (CBA) uses a fixed price of $1.6. The time frame for the CBA is 30 years.

This report discusses the financial and economic costs and benefits of the project, the net benefits, Net Present Value for the financial and economic CBA, Benefit Cost Ratio (BCR), Internal Rate of Return (IRR) and their implications. The parameters used for the sensitivity analysis are the discount rate, train fare, and variable operating cost.

Results

Financial Analysis

The construction phase for the project would be for 4 years, with an initial construction cost of $280 million dollars spread equally across the four years. Compensation fee to the tune of 150% of the value of the property is paid to owners of properties affected by the train project at the beginning of the project. It is estimated that 10 commercial buildings worth $1,000,000 and 5000 residential buildings worth $177,000 would receive total compensation worth $147million. Private cars and mini buses are the modes of transportation in the project location that would be most impacted by the project. With the completion of the project at the end of year 3, the assumption is that all mini bus travels are transferred to the train while 90% of private car travels switch to the train. As the population increases at the rate of 1.25% per annum, the total passenger trip increases. This increase is reflected in the miles travelled and fuel consumed.

The costs included in the financial CBA are the initial cost of construction, compensation, fixed and operating costs. The financial benefit is the revenue from passenger trips. The train project has negative financial net benefits for the 30 years’ time frame of the CBA (Please refer to Appendix Table 3: Financial Cost Benefit Analysis). Using a discount rate of 8%, the Net Present Value (NPV) of the financial CBA of the project over the implementation period is -$2.9billion. The Cost Benefit ratio is below 1 (0.55) and the Internal Rate of Return is undefined. With benefits that represent 55% of the costs invested in the project and no breakeven point (negative net benefits for the years CBA conducted for), from a financial standpoint the project is unsustainable. Even when construction and compensation costs are obtained from outside sources and not included in the CBA, the NPV, BCR and IRR values still indicate that the train project is not a profitable investment (Please refer to Table A below).

Economic Analysis

Economic CBA takes account of the additional non-financial costs and benefits of the train project. In addition to the initial cost of construction, compensation, fixed and operating costs, the economic CBA includes the value of time lost as a result of traffic delays during the four years when the project is being constructed. The cost of traffic delay per passenger travel is $0.73. This was calculated by multiplying minutes per passenger travel multiplied by the dollar value to avoid one minute of time spent on traffic. This was further multiplied by the total number of passenger travel from both private cars and minibuses to estimate the cost of traffic delay during the four years the project was being constructed.

Economic benefits included in the analysis include value of travel time saved, reduced gasoline consumption, reduced accident expenditure, and value of improved air quality. The economic benefits from the project set in from year 4 when the project is completed, and passengers move to the faster and more fuel-efficient train. The incidence rates for fatal, serious and minor road accidents was estimated from secondary sources, this was multiplied by the average cost of the accidents (Please refer to Appendix Table 1: List of Parameters) to arrive at benefits for reduction in car accidents for the train project. Estimated willingness to pay for improved air quality was $50 per person per suspended particulate matter (SPM). The train project would increase air quality by 75% with 10% of the population directly benefiting from this. The benefits is highest for Reduced gasoline consumption, followed by value of time saved, improved air quality, value of reduced accidents.

Using a discount rate of 8%, the Net Present Value (NPV) of the economic CBA of the project over the implementation period is $4.4billion. The economic NPV in a CBA reflects economic efficiency, that is the net gain (or loss) to society. For this project, the economic NPV is positive, the BCR is greater than 1 and IRR greater than our discount rate. Th economic NPV shows that from the standpoint of efficiency and society’s welfare, the project is worth executing (Please refer to Table A below).

Chart 1: Average net benefits, total costs and total benefits for financial and economic CBA

Recommendations for Project Implementation

Sensitivity Analysis and Risk Analysis

Sensitivity analysis was conducted to assess the impact of key parameters on the financial profitability and economic efficiency of the project. The key parameters identified for this project is the discount rate, train fare, and the variable operating cost. The discount rate is an important parameter because the higher the discount rate, the less the net present value of the project will be. The transport fare is included in the sensitivity analysis because it determines the revenue flow for the project. The variable operating cost is also relevant for sensitivity analysis because it is a likely avenue through which project costs might be reduced through reduction in human and other resources needed when the rail project becomes operational.

Since net benefits for financial analysis is negative for all the years CBA was conducted for, there is no break-even point and the financial Net Present Value (NPV) negative. Increasing the train fare to $2.9 or reducing the variable cost to 0.0048 per mile would take the train project to a break-even point. However, increasing the train fare would have welfare implications, and reduce the motivations to use the train. Besides we do not have information on the cost of travel for minibus prior to the project or if all minibuses would be scraped by CTA once the rail extension project is completed. Based on individual considerations, it is possible that any cost higher than cost of other means of transport before the project might make the train unattractive and deter its usage. Reducing initial construction and compensation costs do not flip the negative sign of the financial net benefit to a positive sign. With regards to the percentage of cars and mini buses that move to the train, we have a used a best-case scenario where 90% of cars move to the train and all minibus users move to the train. The CBA assumes that this transfer from other means of transport to the train would be automatic and complete as soon as the train project is completed.

Table B: Sensitivity and switching values for key parameters

Since there is a limit to which train fares can be increased, the CTA should look for ways to reduce initial costs of the project, and most importantly work on finding innovative ways of reducing the variable operating cost to 0.00478 per mile. With a variable operating cost of 0.00478, and train fare and other parameters unchanged, the project has a BCR of 1.0004 and an IRR of 8%. The economic NPV switches to a negative value when variable operating cost is greater than 0.178. When operating costs equal 0.179, BCR for economic CBA is 0.99 and IRR is 8%. In the unlikely case that more than 90% of cars moved to the train, this would increase variable operating cost of train by $2.5 (variable operating cost multiplied by number of miles) compared to $1.6 which is the proposed train fare. More private cars travel moving to the train would lead to increased variable operating costs for the train and a financial NPV that is more negative.

The one-way sensitivity analysis shows that our financial and economic CBA results are robust to changes in the discount rate and train fare. The financial NPV remains negative within the range of recommended discount rate (2% to 12%). The economic NPV was positive within the recommended discount rate. The one-way sensitivity analysis for the financial and economic CBA for the range of transport fares from $1.60–3.60 is negative. For variable operating costs ranging from 0–1, financial NPV remains negative. However, with a variable cost of 0.3 per mile, the economic CBA flips from positive to negative. Increasing the variable operating cost to 0.3 or above would negatively impact the economic Net Present Value. The economic CBA is not robust to changes in the variable operating cost.

The conclusion from all of these tests is that CBA outcomes are fairly robust with respect to the various scenario assumptions. Even rather drastic assumptions, such as a doubled oil price, change the benefits by only a few per cent. The exception seems to be car ownership, where benefits changed appreciably with only a moderate change in the scenario assumption. Despite this the ranking of investments was, however, still found to be robust.

While continuing to look for ways to reduce cost and other avenues to ensure financial sustainability, the CTA can go ahead to implement the rail extension project since economic NPV shows that the project increases society’s welfare. Based on efficiency standards, having the rail extension project is better than not having the project.

References

[1] Red line extension project https://www.transitchicago.com/redext/