Financial Management Series Number 14 Cost / Benefit Analysis Alan Probst Local Government Specialist Local Government Center UW-Extension Cost / Benefit

Financial Management SeriesFinancial Management Series

Number 14Number 14

Financial Management SeriesFinancial Management Series

Number 14Number 14

Cost / Benefit AnalysisCost / Benefit Analysis

Alan ProbstAlan ProbstLocal Government SpecialistLocal Government SpecialistLocal Government CenterLocal Government CenterUW-ExtensionUW-Extension

Cost / Benefit AnalysisCost / Benefit Analysis

Alan ProbstAlan ProbstLocal Government SpecialistLocal Government SpecialistLocal Government CenterLocal Government CenterUW-ExtensionUW-Extension

Cost / Benefit AnalysisCost / Benefit AnalysisCost / Benefit AnalysisCost / Benefit Analysis

Performing a Cost/Benefit Analysis is basic Performing a Cost/Benefit Analysis is basic to all financial decision-makingto all financial decision-making

We each do it consciously or unconsciously We each do it consciously or unconsciously every day for every action we take or every day for every action we take or purchase we makepurchase we make

Major expenditures of public funds requires a Major expenditures of public funds requires a more formal processmore formal process


A Cost/Benefit Analysis is most A Cost/Benefit Analysis is most commonly used in local commonly used in local government as part of the Capital government as part of the Capital Budgeting process and the Capital Budgeting process and the Capital Improvements Program (CIP).Improvements Program (CIP).


In local government, the benefit is the In local government, the benefit is the maximizing public welfare versus maximizing public welfare versus maximizing profit in businessmaximizing profit in business

Broader and more complexBroader and more complex

Must estimate the value of benefits and Must estimate the value of benefits and costs that are indirect and intangiblecosts that are indirect and intangible


At its essence, it is a one to one At its essence, it is a one to one comparison of the combined benefits comparison of the combined benefits versus the combined costs of pursuing versus the combined costs of pursuing a course of action or public policya course of action or public policy

Realistically determining the costs and Realistically determining the costs and benefits is the challenge in governmentbenefits is the challenge in government


““A public project is desirable when the A public project is desirable when the present value of its estimated flow of present value of its estimated flow of benefits, discounted at the benefits, discounted at the community’s cost of capital, equals or community’s cost of capital, equals or exceeds the project’s cost”exceeds the project’s cost”

CostsCostsCostsCosts

MoneyMoney OpportunityOpportunity TimeTime Personnel/EquipmentPersonnel/Equipment Public ReactionPublic Reaction IntangiblesIntangibles

MoneyMoneyMoneyMoney

Opportunity cost of using cash on hand or Opportunity cost of using cash on hand or cash reservecash reserve

1.1. Interest or investment potentialInterest or investment potential

2.2. Funds not available for other projectsFunds not available for other projects

3.3. Depleted reserve may affect ability to Depleted reserve may affect ability to borrow or issue bonds in the futureborrow or issue bonds in the future


Financing: Local loans, state loans, Financing: Local loans, state loans, bond issuebond issue

1.1. Interest ratesInterest rates

2.2. Availability of money to borrowAvailability of money to borrow

3.3. Statutory limitsStatutory limits

4.4. Administrative costsAdministrative costs


Tools/ConsiderationsTools/Considerations

Net Present Value determinationNet Present Value determination Bond RatingBond Rating Financial Trend AnalysisFinancial Trend Analysis

OpportunityOpportunityOpportunityOpportunity

What could you do with money if didn’t What could you do with money if didn’t spend it on this projectspend it on this project

What other public need will not be What other public need will not be fulfilled if this project is undertakenfulfilled if this project is undertaken

TimeTimeTimeTime

What is the cost in timeWhat is the cost in time1.1. Staff timeStaff time

2.2. Elected officials timeElected officials time

3.3. Information technology timeInformation technology time

4.4. Other equipment timeOther equipment time

5.5. Other projects postponed timeOther projects postponed time

Personnel/EquipmentPersonnel/EquipmentPersonnel/EquipmentPersonnel/Equipment

In addition to time cost:In addition to time cost:1.1. Will you need to hire additional Will you need to hire additional

personnel?personnel?2.2. How much wear & tear on equipment?How much wear & tear on equipment?3.3. What new equipment will be needed?What new equipment will be needed?4.4. Insurance costsInsurance costs5.5. Fuel costsFuel costs

Public ReactionPublic ReactionPublic ReactionPublic Reaction

A political reality for elected officials is that A political reality for elected officials is that public reaction to pursuing or not pursuing a public reaction to pursuing or not pursuing a project, policy, or course of actions must be project, policy, or course of actions must be consideredconsidered

How the public perceives the cost in tax How the public perceives the cost in tax dollars can be more important than the dollars can be more important than the financial considerationsfinancial considerations

IntangiblesIntangiblesIntangiblesIntangibles

Intangibles are those costs which Intangibles are those costs which cannot readily be assigned a cannot readily be assigned a monetary valuemonetary value

1.1. Loss of historic valueLoss of historic value2.2. Change of appearanceChange of appearance3.3. Decreased economic development Decreased economic development

opportunityopportunity4.4. Loss of green spaceLoss of green space

BenefitsBenefitsBenefitsBenefits

Monetary profitMonetary profit Increase in public safety or accessibilityIncrease in public safety or accessibility Increased capacityIncreased capacity Increased recreational opportunitiesIncreased recreational opportunities Increased economic development Increased economic development

opportunitiesopportunities Improved quality of lifeImproved quality of life More efficient operationsMore efficient operations Lower taxesLower taxes

Other ConsiderationsOther ConsiderationsOther ConsiderationsOther Considerations

Depreciation/amortizationDepreciation/amortization US or state regulationsUS or state regulations PrecedentPrecedent

ExampleExampleExampleExample

The City of Wildwood is considering The City of Wildwood is considering establishing an industrial park to spawn establishing an industrial park to spawn economic development and jobs.economic development and jobs.

The City wants to determine if the benefits of The City wants to determine if the benefits of such an action will outweigh the costs.such an action will outweigh the costs.

The City decides to perform a cost/benefit The City decides to perform a cost/benefit analysis to help facilitate the decision.analysis to help facilitate the decision.

Costs (money)Costs (money)Costs (money)Costs (money) Land costs = $12,000 per acreLand costs = $12,000 per acre

Acreage needed = 50 acresAcreage needed = 50 acresTotal Land Costs = $600,000Total Land Costs = $600,000

Infrastructure costs (streets, lights, water & Infrastructure costs (streets, lights, water & sewer) = $1.4 millionsewer) = $1.4 million

Investment building = $326,000Investment building = $326,000

Total industrial park costs = Total industrial park costs = $2,326,000$2,326,000

Costs (opportunityCosts (opportunity)) Costs (opportunityCosts (opportunity)) Industrial park dollar cost could be Industrial park dollar cost could be

invested at a rate of 2.7% APR for ten invested at a rate of 2.7% APR for ten years for a total interest earned of years for a total interest earned of $710,054$710,054

Industrial park dollar cost could be Industrial park dollar cost could be used to rebuild 9.5 miles of streets.used to rebuild 9.5 miles of streets.

Costs (time)Costs (time)Costs (time)Costs (time)

140 hours of staff time140 hours of staff time

Three workshops and a public hearing Three workshops and a public hearing to consider projectto consider project


If local unemployment is high, there may be a If local unemployment is high, there may be a positive reactionpositive reaction

Some element of the public will invariably Some element of the public will invariably feel this is a misuse of public fundsfeel this is a misuse of public funds

The level of the positive and negative The level of the positive and negative reactions must be considered in doing the reactions must be considered in doing the analysisanalysis

Anticipated BenefitsAnticipated BenefitsAnticipated BenefitsAnticipated BenefitsFor planning purposes we will assume:For planning purposes we will assume: Each acre of the park will produce an Each acre of the park will produce an

additional $1 million in taxable property additional $1 million in taxable property improvements within ten years at an improvements within ten years at an average MIL rate of $11.45 for a benefit average MIL rate of $11.45 for a benefit of of $572,500$572,500 in increased in increased property taxesproperty taxes

Anticipated Benefits (cont.)Anticipated Benefits (cont.)Anticipated Benefits (cont.)Anticipated Benefits (cont.)

Each acre of industrial park land is Each acre of industrial park land is expected to produce an average of five expected to produce an average of five (5) new jobs paying an average wage of (5) new jobs paying an average wage of $12.75 per hour for an annual income of $12.75 per hour for an annual income of $26,520 each. Assuming all acres are $26,520 each. Assuming all acres are filled and jobs created within ten years, filled and jobs created within ten years, the park would increase the local the park would increase the local economy by economy by $6,630,000$6,630,000 per year. per year.

ConclusionConclusionConclusionConclusion

Based on the grossly optimistic benefit Based on the grossly optimistic benefit expectations for the industrial park, the expectations for the industrial park, the financial benefits would greatly outweigh the financial benefits would greatly outweigh the costs of establishing the park.costs of establishing the park.

Benefits = Benefits = $7,202,500$7,202,500

Costs = Costs = $2,326,000$2,326,000

In this analysis, building and industrial park is In this analysis, building and industrial park is a great idea.a great idea.

RealityRealityRealityReality

Industrial parks NEVER fill as fast as Industrial parks NEVER fill as fast as projected so average trends must be projected so average trends must be considered along with holding costsconsidered along with holding costs

The overall national economy trends The overall national economy trends will greatly affect the realistic resultswill greatly affect the realistic results

Wages are decreasing nation-wide. An Wages are decreasing nation-wide. An average wage of $12.75 my be overly average wage of $12.75 my be overly optimisticoptimistic

Intangibles may also have an affectIntangibles may also have an affect

More Likely ScenarioMore Likely ScenarioMore Likely ScenarioMore Likely Scenario

Probably only about 15 acres of the Probably only about 15 acres of the park will be fully developed within 10 park will be fully developed within 10 years. This would produce only an years. This would produce only an additional additional $171,750$171,750 in property tax in property tax income.income.

Those acres will likely only produce an Those acres will likely only produce an average of average of 33 jobs each with an average jobs each with an average wage of wage of $9.75$9.75 for an input to the local for an input to the local economy of only economy of only $912,600$912,600

More Likely ConclusionMore Likely ConclusionMore Likely ConclusionMore Likely Conclusion

Costs =Costs = $2,326,000$2,326,000Ten year benefits =Ten year benefits = $1,084,350 $1,084,350

In this scenario, building the industrial park In this scenario, building the industrial park doesn’t appear to be a sound financial doesn’t appear to be a sound financial decisiondecision

You can see by the difference in cost versus You can see by the difference in cost versus benefits that the assumptions you use in benefits that the assumptions you use in your projections greatly affect your outcomeyour projections greatly affect your outcome


You can safely assume those who support an You can safely assume those who support an industrial park will want to use the first industrial park will want to use the first projections while those who think the money projections while those who think the money would be better spent on a new library will would be better spent on a new library will want to use the latter projections.want to use the latter projections.

No matter what numbers you use, you No matter what numbers you use, you ultimately will have to answer to citizens who ultimately will have to answer to citizens who both support and oppose your decisionboth support and oppose your decision

ConclusionConclusionConclusionConclusion

While business can make decisions based While business can make decisions based solely on whether or not a proposed action solely on whether or not a proposed action will make a profit or minimize a loss, local will make a profit or minimize a loss, local government officials must take into account government officials must take into account other factors other factors

Local government officials must consider Local government officials must consider public opinion and a variety of other public opinion and a variety of other intangibles in addition to cost comparative intangibles in addition to cost comparative data but the cost/benefit analysis can make data but the cost/benefit analysis can make those decisions much easier and defensiblethose decisions much easier and defensible

Documents

Financial Management Series Number 14 Cost / Benefit Analysis Alan Probst Local Government Specialist Local Government Center UW-Extension Cost / Benefit