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

Confidential & Proprietary • Internal Kaplan Use Only.

CAPITAL PROJECT ANALYSISUnit 7


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


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


EXPENDITURES

•Recurring Costs:- Operation- Maintenance- Lease and rental costs


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


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)


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 = Averageincome / Investment


PAY-BACK PERIOD

•The time required to recover the original investment

•Pay-back period = Original investment /Annual cash inflow


NET PRESENT VALUE (NPV)

•Net Present Value = difference in thepresent value of the cash inflows andoutflows associated with a project


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


INTERNAL RATE OF RETURN (IRR)

•The discount rate which equates thepresent value of cash inflows to thepresent value of cash outflows


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


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



•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



•Efficiency Rate- How much more efficient is the facility to operate in terms of:

- Energy- Structural integrity- Insurance costs- Occupancy- Environmentally Friendly



•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



•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


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


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


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


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

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

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