Valuing the Warranty Ceiling Clause on New Mexico Highway 44 Using a Binomial Lattice Model
Publication: Journal of Construction Engineering and Management
Volume 134, Issue 1
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 includes 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 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 fiscal 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 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.
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Acknowledgments
The writers gratefully acknowledge the support for this research provided by the University Transportation Center for Alabama (UTCA) and the Alabama Contractors’ Fees Fund.
References
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© 2008 ASCE.
History
Received: Dec 28, 2006
Accepted: Feb 22, 2007
Published online: Jan 1, 2008
Published in print: Jan 2008
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