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PA 546 Constantine Hadjilambrinos. Capital Budgeting and Finance. Lecture 2 September 6, 2005. PA 546 Constantine Hadjilambrinos. What is a “capital project”?. A capital project purchases assets that can provide services for several years.
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PA 546 Constantine Hadjilambrinos Capital Budgeting and Finance Lecture 2 September 6, 2005
PA 546 Constantine Hadjilambrinos What is a “capital project”? • A capital project purchases assets that can provide services for several years. • Capital assets (infrastructure) often become inputs into private economic production. • Cost of capital projects tends to be high and is not recurrent. • Therefore, their impact on annual budget can be large, especially if financed from current revenue.
PA 546 Constantine Hadjilambrinos Why might we need a separate capital budget? • Separate capital budget can assist in selection between individual projects. • Capital budget useful in distinguishing between obligations that may be deficit financed and those that should be paid for by current revenue. • Capital budget can stabilize tax rates. • Separate capital budget can facilitate special review.
PA 546 Constantine Hadjilambrinos Capital asset inventory: Assesses current capital stock. Data for each facility should include: 1) Its age, 2) its condition, 3) its degree of use, 4) its capacity, 5) its replacement cost. Capital improvement plan: Identifies capital expenditure projects appropriate for the next six years or so. It also will provide a schedule for expenditures for each project. Long-term financial analysis: Keep infrastructure developing program within financial capacity.
PA 546 Constantine Hadjilambrinos Criteria for setting priorities • Cost-benefit ratio: It makes some sense to undertake projects that provide most “bang for the buck” first. • Greatest return: It makes some sense to undertake projects that provide greatest return first. • Functional area: It may be best to spread projects among several functional areas (education, environment, transportation, etc.) • Problem severity: It may be political suicide not to prioritize areas in which perceived problems are the worst? • Status of support: It may be necessary to prioritize projects which are on the agendas of other political players. • Multi-criteria ranked scoring system: Prioritize project on the basis of several (weighted) criteria.
PA 546 Constantine Hadjilambrinos Time-value of money: Discounting and Compounding FV = future value, PV = present amount, r = interest rate For n years into the future:
PA 546 Constantine Hadjilambrinos If interest is added x times a year: where s is the annual interval
