Capacity analysis is required for the correct planning, designing, and operation of the transportation system. The main goal of the current study is to estimate the capacity of a two-lane, undivided hilly road under heterogeneous traffic conditions. The gradient is one of the important parameters in a hilly terrain that changes frequently and affects the traffic flow. For this study, four different sections were taken on NH-7 between Devaprayag and Rudraprayag in the hilly state of Uttarakhand. The gradient value of the four sections ranges from 1 to 5%. The PCU value for study sections was calculated considering the heterogeneous traffic environment. Greenshields’ model was used to develop fundamental traffic flow diagrams to estimate the capacity and other macroscopic parameters like jam density and free flow speed. The study examined the impact of gradient on the speed of different classes of vehicles. Since the capacity and operating speed of vehicles are greatly influenced by gradient, this study presented an appropriate approach to develop the relationship between the capacity of the road and gradient. Moreover, the relationship between operating speed and capacity was also developed to gain deeper insights into traffic behavior. The study results will help transportation engineers and planners to develop guidelines for capacity analysis of hilly roads.