Evaluating Capital Projects and Budget Decisions

Each year governments receive more funding requests for capital projects from various agencies and departments than the governments can realistically undertake. This makes it necessary for the decision makers to carefully evaluate each project before deciding which ones to accept and which ones to reject. Whether the projects are selected independently or in conjunction with other projects, each must be justified, first and foremost, based on the critical needs of the government. Additionally, the decision must take into consideration the resource base of the government and, more importantly, the costs and benefits the projects will produce for the government and the political jurisdiction it serves, as well as the public. This chapter discusses three of the most frequently used methods for evaluating capital projects: Payback period, cost-benefit analysis, and cost-effectiveness analysis. Of these, cost-benefit analysis has been extensively used in government than any other method because of its ability to deal with multiple projects, analytical soundness, and established history. The chapter also looks at the risk and uncertainty associated with capital projects, briefly introduced in the previous chapter, as well as measures to deal with their attendant problems. Finally, the chapter concludes with a brief discussion of depreciation for capital assets.