1. Confidential & Proprietary Internal Kaplan Use Only. CAPITAL PROJECT ANALYSIS Unit 7

2. Confidential & Proprietary Internal Kaplan Use Only. WHY PERFORM A CAPITAL ANALYSIS? The purpose of a capital analysis is to provide the proof of the financial profitability and viability of a project -The financial analysis section of a business case shows the expected cash flow implications of the project proposal, in terms of both revenues and expenditures -It includes assumptions, methods and rationale for the estimation of revenues and expenditure

3. Confidential & Proprietary Internal Kaplan Use Only. EXPENDITURES Lifecycle costs to be considered: -Land -Facilities -Equipment -Software -Other non-recurring costs: -Project staff, consultants and contractors including studies, procurement, travel, documentation, etc. -Training costs

4. Confidential & Proprietary Internal Kaplan Use Only. EXPENDITURES Recurring Costs: -Operation -Maintenance -Lease and rental costs

5. Confidential & Proprietary Internal Kaplan Use Only. REVENUES Revenue sources can vary with each capital project -A hydroelectric plant could be funded with revenues generated by selling power -A bridge could be funded by tolls -A government administration building could be funded by user fees charged for the services that are provided from the facility

6. Confidential & Proprietary Internal Kaplan Use Only. METHODS & TECHNIQUES OF CAPITAL ANALYSIS Accounting rate of return (ARR) Pay-back period Net Present Value (NPV) Benefit-to-cost ratio (profitability index) Internal rate of return (IRR)

7. Confidential & Proprietary Internal Kaplan Use Only. ACCOUNTING RATE OF RETURN (ARR) The accounting rate of return measures the return of a project in terms of income, as opposed to using a project cash flow. Accounting rate of return = Average income / Investment

8. Confidential & Proprietary Internal Kaplan Use Only. PAY-BACK PERIOD The time required to recover the original investment Pay-back period = Original investment /Annual cash inflow

9. Confidential & Proprietary Internal Kaplan Use Only. NET PRESENT VALUE (NPV) Net Present Value = difference in the present value of the cash inflows and outflows associated with a project

10. Confidential & Proprietary Internal Kaplan Use Only. BENEFIT TO COST RATIO Benefit-to-cost ratio = Ratio of the present value of the cash inflows to the present value of the cash outflows associated with a project

11. Confidential & Proprietary Internal Kaplan Use Only. INTERNAL RATE OF RETURN (IRR) The discount rate which equates the present value of cash inflows to the present value of cash outflows

12. Confidential & Proprietary Internal Kaplan Use Only. CAPITAL PROJECT ANALYSIS PROCESS Main assumptions and parameters -Project time horizon -Analysis base year -Cost of capital -Efficiency rate -Average operating cost -Cost recovery period

13. Confidential & Proprietary Internal Kaplan Use Only. CAPITAL PROJECT ANALYSIS PROCESS (CONT’D) Project Time Horizon -Determine the project duration from inception to completion Analysis Base Year -For comparative purposes, determine the current condition as a base against which to compare the proposed project

14. Confidential & Proprietary Internal Kaplan Use Only. CAPITAL PROJECT ANALYSIS PROCESS (CONT’D) Cost of Capital -Regardless of the source of the funding, what does it cost to build the project -The simplest consideration would be the cost of interest on a loan or the repayment of debt service -A more complex issue involves understanding what projects are not funded if this project is funded -A good example of this would be if a jurisdiction decides to fund the construction of a new prison the jurisdiction could not make needed improvements to a hospital

15. Confidential & Proprietary Internal Kaplan Use Only. CAPITAL PROJECT ANALYSIS PROCESS (CONT’D) Efficiency Rate -How much more efficient is the facility to operate in terms of: -Energy -Structural integrity -Insurance costs -Occupancy -Environmentally Friendly

16. Confidential & Proprietary Internal Kaplan Use Only. CAPITAL PROJECT ANALYSIS PROCESS (CONT’D) Average Operating Cost -What are the expenditures associated with operating the facility -This analysis should be performed anticipating that as the facility ages, the operating costs increase

17. Confidential & Proprietary Internal Kaplan Use Only. CAPITAL PROJECT ANALYSIS PROCESS (CONT’D) Cost Recovery Period -What is the length of time it will take to recover the cost of the project? -Is there a potential savings in operating the facility even after the project costs are recovered -Recall, the facility becomes more expensive to operate as time passes. -If a building has a 30 year useful life, but the costs of the project are not recovered until 33 years after completion, there is, in essence, no cost recovery

18. Confidential & Proprietary Internal Kaplan Use Only. FUNDING REQUIREMENTS Cash flow analysis provides a forecast of when funding is needed Typically, cash disbursements are high at the beginning of the project life cycle and diminish gradually

19. Confidential & Proprietary Internal Kaplan Use Only. SOURCES OF FUNDS More of the Sources and Management of Funding for Capital Projects will be covered in the seminar -Government funds -Bonds/Certificates of Participation -Loans -Private banks and financial institutions -Equity capital

20. Confidential & Proprietary Internal Kaplan Use Only. OUTCOMES FROM THE ANALYSIS Statement of financing needed -This is a detailed financial proposal of how the project will be funded Amount of funds -This is the total cost of the project delineating direct and soft costs Timing -Project duration from inception to completion Sources and application of funds -Generally multiple funding sources may be utilized on any single project. -This outcome of the analysis would supply the application of sources such as restricted revenue grant funds or unrestricted revenue sources

21. Confidential & Proprietary Internal Kaplan Use Only. SUMMARY In this capital project analysis tutorial, you’ve learned the various components utilized to forecast the total cost, timeframe, and operating costs of a capital project This unit’s seminar provides an in depth look at the funding sources available for government capital projects and how jurisdictions manage capital debt