Most of Indian National and State Highway system comprises of two-lane highways. Two-third length of National Highways and more than 50 percent length of State Highways are still two-lane roads. Roadway factors that influence capacity of a two-lane road include lane width, gradient, lateral clearance, width and type and condition of shoulder. Realizing that grade magnitude (%) is one of the important and less researched roadway factor in India, the present study principally aims at estimating capacity on two-lane undivided hilly roads under prevailing heterogonous traffic conditions. In the present study, four different study sections with varying magnitude of gradient (2% to 7%) are selected between Saputara and Waghai town, area in the State of Gujarat, India. The magnitude of grades of selected roadway sections is found to be in the range of 2% to 7% Fundamental diagrams are developed employing Geenshield’s model for four different sections for estimating capacities using 5-minute flow rate values along with other macroscopic parameters. The study shows that capacity values developed are realistic and consistent with the values given in Highway Capacity manual (HCM) of developing countries like Indonesia and China. Capacity value and operational speeds of vehicles are significantly influenced by various factors like roadway geometry, roadway condition, traffic conditions, etc. Therefore, as an application of the study, the present study proposes a novel approach of developing relationships (i) capacity versus operating speed of cars, and (ii) capacity versus gradient magnitude (%) based on the observed traffic data sets. It is expected that the results may be very useful for the practitioners and for ongoing efforts of developing Indian Highway Capacity Manual.