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Capital Budgeting and Finance

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

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Capital Budgeting and Finance

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    1. Capital Budgeting and Finance Lecture 2 September 6, 2005

    2. 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.

    3. 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.

    4. 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.

    6. 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.

    7. Time-value of money: Discounting and Compounding FV = future value, PV = present amount, r = interest rate

    8. If interest is added x times a year:

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