capital budgeting, public infrastructure investment, and project evaluation troy university pa6650-...
TRANSCRIPT
Capital Budgeting, Public Infrastructure Investment, and
Project EvaluationTroy University
PA6650- Governmental Budgeting
Chapter 6
Capital Expenditures
• Purchase of public capital assets– Public infrastructure for private purposes
• Roads, sewers, transportation systems• Crucial for private economic growth
– Public infrastructure for public purposes• Schools, parks, hospitals, jails, police/fire stations,
bases
Capital Budgeting
• Focuses decisions
• Facilitates financial planning
• Smooths tax rates over time
• Regularizes the provision of projects that:• Have a long life (10 or 15 years)• Have a high price tag• Are non-recurring
Why Have a Capital Budget?
• Separate consideration can improve both efficiency and equity of projects– Won’t be cutting capital projects from a tight ops
budget– Big-ticket items don’t make a budget appear abnormal
• Capital budgets can stabilize tax rates• Special review of capital budgets necessary
because projects have high cost and high impact• Capital budgets are a good tool to manage
resources
Capital Budget Process
• 5 steps:– Capital Asset Inventory– Development of the Capital Improvement Plan (CIP)– Development of the financing plan– Implementation of the capital budget– Execution
• Concerned with:– Selection from a multitude of alternatives– Timing of the expenditure of the projects– Impact on total government finances
Capital Asset Inventory
• Assessment of the existing situation
• Inventory of capital facilities including:– Age– Condition– Degree of use– Capacity– Replacement cost
• Repair or build new?
Capital Improvement Plan
• A list of projects for the next 6 years or so
• Includes narrative and cost data
• Screening for costs, interrelationships, priorities
• Scheduling to avoid waste (new sewers precede paving)
• Based on growth
• Based on strategic goals
Financing Plan & Analysis
• Must stay within financial capability
• Review of revenue, debt structure
• Present and anticipated revenue
• Partnering with other governments & agencies
• Recurring expenditures
• Buy it when it is affordable
Implementation of theCapital Budget
• Prioritization process– Functional areas (safety, recreation, health)– Problem severity (alligators in swamp)– Status of support (mandate, referenda)– Formal scoring system
• Legislative review, executive signs
Execution of the Capital Budget
• Special attention to:– Rules (bidding, procurement)– Controls (keep it on schedule)– Monitoring project cost (no overruns)
Problems In Capital Budgeting
• Assumes a continuous cycle of reappraisal due to a dynamic world. Things change.
• Which projects belong in the capital budget?
• Availability of funds can distort priorities– Different pots/colors of money
• A strong bias towards borrowing
• Difficult to establish priorities
Accounting for Time
• Discounting– The process of converting a stream of returns
or costs incurred over time to a single present value (net present value, or NPV)
• Compounding– The time value of money calculating principal
and interest (interest can be compounded annually, semi-annually, quarterly, monthly, weekly, or daily)
Discounting and Compounding
• Examples of discounting– Bond market– Early payment of invoice– Lottery payoffs
• Examples of compounding– IRA– Certificate of Deposit
Time Value of Moneyr = interest rate (usually a decimal…6% = .06)FV = future valuePV = present valuen = number of years
FV = PV (1 + r)
p.258 compounding example:
1050 = $1,000 + ($1,000 x 0.05)
For multiple years, FV = PV (1 + r) n
If compounded semi-annually, then:
FVn = PV (1+ (r/x))2n
Time Value of Moneyr = interest rate (usually a decimal…6% = .06)FV = future valuePV = present valuen = number of years
p.260 discounting example:
PV = FV1
(1+r)
For multiple years,
PV = FVn
(1+r)n
Practice
• R = 6%
• PV = $1000
• FV after 1 year?
• FV after 2 years?
• FV after 1 year compounded semi-annually?
Practice
• R = 6%• PV = $1000• FV @ 1 year? $1000 x (1.06) = $1,060• FV @ 2 years?$1060 x (1.06) = $1,123.60
• FV after 1 year compounded semi-annually?
$1000 +($30 + $30.90) = $1060.90
Discounting
• Works backwards…$1000 next year is worth $952.38 right now assuming 5% interest compounded annually
• NPV Analysis– Used to compare dissimilar projects– Look at page 261– Project A is the best choice at 10% interest– Project B is the best choice at 3% interest
Cost-Benefit Analysis
• A means to prioritize and decide• Does not necessarily outweigh politics• One measure of efficiency• Helps evaluate alternative proposals• 5 steps:
– Categorizing project objectives– Estimating the project’s impact on objectives– Estimating project costs– Discounting cost & benefit flows @ appropriate rates– Summarizing findings for decision makers
Cost-Benefit Analysis
• Project objectives– What desirable benefits and results?– Annual cost, revenue, loss
• Benefits estimation and valuation– Pilot studies for impact– Worth of the impact measured in dollars– Estimation of consumer’s surplus = “What
would a consumer be willing to pay?”– Contingent Valuation Method
Cost-Benefit Analysis
• Estimating project costs– Construction– Operating– Opportunity– Life cycle
• Three adjustments necessary– Undesirable effects (negative externalities)– Unemployed resources with no alternative use– Social costs (other possible uses)
What Discount Rate?
• Cost of borrowed funds (what the government has to pay for borrowing)
• Opportunity cost (what private resources could earn)
• Sidebar 6-2
Decision Criteria
• Summarize the economic case for the project• Benefit/Cost Ratio (BCR) (greater than one
desired)• Cost/Benefit Ratio (CBR) (less than one desired)• Net Present Value (greater than zero desired)• Payback Period (time taken to recover the cost)• Internal-rate-of-return (interest generated
compared to discount rate – it should be higher)
Special Problems ofCost-Benefit Analysis
• Multiple objectives– Economic– Income redistribution– Distribution effects– Social benefits
• Cost of human life
• Can’t account for everything
• Politics