1、 Valuing the Warranty Ceiling Clause on New Mexico Highway 44 Using a Binomial Lattice Model Abstract: In 1998 the New Mexico State Highway and Transportation Department (NMSHTD) agreed to pay $60 million for a 20-year pavement warranty on their Route 44 project (NM 44, now US 550). The warranty inc
2、ludes a ceiling clause that caps total expenditures at $110 million. As the first long-term highway warranty in the United States, the transaction set a controversial precedent that parties interested in innovative highway contracting, including other state department of transportations (DOTs), the
3、USDOT, sureties, and contractors, view as a test case for evaluating pricing and cost-effectiveness. An interim audit report published by the State of New Mexico Abbey (2004). Rep.to the Legislative Finance Committee, State Highway and Transportation Department. Santa Fe. N.M. provides invaluable fi
4、scal projections and challenges the cost effectiveness of the $60 million expenditure. This paper presents an independent analysis of the effectiveness of the warranty clauses. Based upon NMSHTD data, the analysis contends that $60 million was a fair cost of the 20-year pavement warranty at the time
5、 of acceptance if the expenditure ceiling is not considered. Furthermore. this paper argues that the ceiling on expenditure can be valuable. Using the real options approach, the paper evaluates the warranty ceiling clause on NM 44 and some policy suggestions are discussed. Introduction： State Depart
6、ments of Transportation (DOT) turned increasingly proactive when awarding large highway pavement contracts as a result of the United States Federal Highway Administrations (FHwA) Special Experimental Projects (SEPs). SEP No. 14, implemented in 1990, opened the door for innovative contracting methods
7、 including lane rental, cost-plus-time bidding, design.build techniques, and warranty clauses. The warranty clauses hold contractors liable for reparationfor performance failures within a warranty period that typically extends from 5 to 7 years. Though New Mexico was not among the original eight sta
8、tes that initiated the use of warranties under SEP No. 14. they have since evaluated the option of warranty contracting and success-fully applied it to the New Mexico State Route 44 Project (now U.S. 550), which traverses 118 mi (190 km) from 1-25 at San Ysidro northwest to Bloomfield, near the Four
9、 Corners area. When considering the prospect of infiltrating the northwest corner of New Mexico, New Mexico State Highway and Transportation Department (NMSHTD) renamed New Mexico Deparunent of Transportation (NMDOT) in 2003, determined that the future maintenance and rehabilitation costs of the upg
10、raded 118 mi of roadway would total about $16,000/lane-mi/year over a service life of 20 years (May et al. 2003) totaling just over $15I million. Additionally, they determined that the roadbed and surface upgrades would take almost 27 years to complete using normal contracting methods. In an effort
11、to keep the highway in good condition for the long term, NMSHTD purchased a 20-year warranty agreement from Mesa PDC who in turn guaranteed the pavement performance during the warranty period. Thc NM 44 warranty broke new ground in both length and cost. It was the first long-term highway warranty in
12、 the United States and.,at $62 million, the most expensive. Since conception, its economics and applicability to other projects has been a subject of debate. Moreover, the two ceiling clauses in the warranty agreement that limit cumulative traffic volume and maintenance expenditures have been neithe
13、r examined nor evaluated. In this paper we address the cost effectiveness of the warranty clauses in the NM 44 project. 1 Warranty Provisions for NM 44 Two primary participants, NMSHTD and Mesa Project Development Contractor (PDC), a division of Wichita, Kan.-based Koch Performance Roads, Inc., coop
14、erated on the NM 44 project. The NMSHTD laid out design criteria, performance requirements, and oversight procedures, and estimated a life-cycle cost to establish the overall present value of the expected maintenance during the 20-year warranty period. Through team building and open communications,
15、NMSHTD was able to monitor performance without responsibility for performance, while Mesa PDC was able to gain insight into the development and award process along with the limitations and constraints that had to be addressed. To carry a long-term warranty agreement, a professional services contract
16、 was introduced. Basic items included delineation of responsibilities and appropriate protocol for repairs, costing, and reimbursement. The final price on the warranty was comprised of $60 million for a 2pavement warranty and, $2 million for a 10-year structures warranty to cover bridges, drainage,
17、erosion, etc. for a total of $62 million in warranty liability. Mesa PDC also agreed to a 3.5% inflationary risk on future maintenance costs. Based on these numbers, the warranty pricing was $6,400/lane mi/year, a 60% reduction as compared to the initial evaluation ( Mav et al. 2003). Additionally,
18、the warranty duration was limited by three ceiling clauses: (1) 20 years of service life: (2) 4,000,000 equivalent single axle loads (ESALs)； and (3) $114 million in total expenditures, of which $1 l0 million is the ceiling for the pavement warranty and $4 million is the ceiling for the structure wa
19、rranty. Thus, in return for $62 million. Mesa PDC agreed to provide up to $114 million in repairs over a period of 20 years or 4 million ESALs. To ensure the fiscal liability was met. the warranty was also backed by a performance bond. The parties established what constitutes warranted pavement defe
20、cts based on objective criteria such as smoothness, rutting, transverse crack spacing, crack width, potholes, depressions.bleeding, raveling,and delaminations. Because the warranty provider shoulders the risks associated with performance, they have a strong incentive to assure quality in the design,
21、 composition, and construction of the pavement. The parties also developed plans to monitor performance and perform both preventative and routine maintenance to ensure the highways health. 2 Discounted Cash Flow Analysis In a recent interim report of the NM 44 warranty audit, the state of New Mexico
22、 challenged the cost effectiveness of the $62 million warranty (Abbey 2004). This interim report and its predecessor (Abbey 1999) provide invaluable cost projections on the NM 44 project and the associated warranty. Using these data we conducted our own cost analysis based on the information availab
23、le to the NMSHTD when they made the warranty decision in 1998.So for this analysis,all warrafity benefits and costs incurred during the construction and warranty period were discounted back to the decision time in 1998, and all costs ,and payments were assumed to fall at the end of the year. Additio
24、nally, we considered only the pavement warranty which is valued at $60 million and explains 96.8% of the total warranty cost. Ignoring the structures warranty, which is valued at only $2 million, reduces ambiguity without any significant impact on the results. Farthermore. Abbey (2004) estimates that the structures warranty will expire before the end of the 10-year warranty period, while the pavement warranty probably will remain in effect for the entire 20-year term. 3 Discussion and Policy Suggestions Due to the ceiling clause, the price of the warranty provisions in the NM 44 project
