Public Budgeting and Financial Management

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1. What is cost-benefit analysis? What are the main steps in conducting cost-benefit analysis?
2. A city has learned that by buying larger garbage trucks, it could reduce labor costs for garbage removal. Note: All the dollar amounts below are in this year’s dollars (constant dollars).
a. Cost of the trucks today is $400,000.
b. Annual savings in this year’s constant dollars is $90,000.
c. Trucks will last for 4 years and then will be sold for $100,000.
d. The city can borrow money at a 7% discount rate to purchase the trucks.
e. Inflation (for the next 4 years) is expected to average 3%.
f. Assuming the costs and benefits are incurred at the end of the year, should the city buy the trucks?
3. This assignment extends the garbage truck problem from prompt 2. Two other lenders provide alternative scenarios. Alternate lender 1 suggests that the inflation rate will be 4% and offers an interest rate of 7.5%, while alternate lender 2 suggests that the inflation rate will be 1% and offers an interest rate of 6.5%. For all three sources, the interest rates are guaranteed if the decision is made in the next 90 days. Which of the following decisions should be made and why?
a. The usual lender should be used because she offers a positive NPV.
b. Alternate lender 1 should be used because he offers the highest NPV.
c. The garbage trucks shouldn’t be purchased because there is a possibility of a negative NPV.
d. Alternate lender 2 should be used because most scenarios have a positive NPV and she offers the highest NPV under each scenario.
e. Each solution is as good as any other.

Life Cycle Costing
1. What is life cycle costing (LCC)? What are the main issues in applying LCC in the government context?
2. The city administration is considering refurbishing the lighting system of its administration building. After an initial investigation, the city procurement office has narrowed down the choices to the following two options:
a. Option 1 is an Ergolight system that costs $500,000 to purchase and install. The energy cost for option 1 is $20,000, and its maintenance cost is $2,000.
b. Option 2 is a conventional system that costs $100,000 to purchase and install. The energy cost for option 2 is $50,000, and its maintenance cost is $10,000. Both systems are expected to last for 20 years. Assume that the discount rate is 4% and all future costs are paid at the end of the year.
3. Which lighting system should the city select based on LCC considerations?

Sample Solution

A cost-benefit analysis is a systematic process that businesses use to analyze which decisions to make and which to forgo. The cost-benefit analyst sums the potential rewards expected from a situation or action and then subtracts the total costs associated with taking that action. The broad process for a cost-benefit analysis is to set the analysis plan, determine your costs, determine your benefits, perform analysis of both costs and benefits, and to make a final recommendation. These steps may vary from one process to another.

Sure, here is what I know about cost-benefit analysis:

Cost-benefit analysis (CBA) is a systematic approach to estimating the economic consequences of a project or policy. It is a tool for comparing the costs and benefits of different options in order to make decisions about which option is the most efficient.

CBA is a widely used tool in the public sector, but it can also be used in the private sector to make decisions about investments and projects.

The main steps in conducting a cost-benefit analysis are:

  1. Define the project or policy. The first step is to define the project or policy that you are evaluating. This includes specifying the goals of the project or policy, as well as the costs and benefits that you will be considering.
  2. Identify the costs and benefits. The next step is to identify all of the costs and benefits of the project or policy. This includes both tangible costs and benefits, such as financial costs and benefits, as well as intangible costs and benefits, such as environmental costs and benefits.
  3. Quantify the costs and benefits. Once you have identified all of the costs and benefits, you need to quantify them. This means assigning a monetary value to each cost and benefit.
  4. Discount the costs and benefits. The costs and benefits of a project or policy occur over time, so you need to discount them to present value. This means calculating the present value of the costs and benefits, which takes into account the time value of money.
  5. Perform the analysis. Once you have quantified and discounted the costs and benefits, you can perform the analysis. This involves comparing the net present value of the costs and benefits of each option.
  6. Make a decision. The final step is to make a decision about which option is the most efficient. This decision is based on the results of the analysis.

CBA is a valuable tool for making decisions about projects and policies. However, it is important to note that CBA is not a perfect tool. It is based on a number of assumptions, and the results of the analysis can be sensitive to these assumptions.

Here are some additional thoughts on cost-benefit analysis:

  • CBA is a complex process. It requires a lot of data and analysis, and it can be difficult to quantify all of the costs and benefits of a project or policy.
  • CBA is not always used correctly. Sometimes, CBA is used to justify projects or policies that are not actually in the best interests of society.
  • CBA is not the only tool for making decisions. Other tools, such as risk-benefit analysis and multi-criteria analysis, can also be used to make decisions about projects and policies.

Despite its limitations, CBA is a valuable tool for making decisions about projects and policies. It can help to ensure that decisions are made in a rational and efficient manner.

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