CHAPTER EIGHT

Evaluation Of Proposed
Public Expenditures

• The evaluation of public spending would aim to

assess its rel­evance.
• Ultimately, the aim is to evaluate the matching
between public spending and the priorities set by
society as well as its relevance to the problems to
be solved.
 8.1 Costs-Benefit Analysis (CBA)
• CBA is a methodology for assessing the net benefits accruing
to society as a whole as a result of a project, programme or
policy.
• CBA is conducted from the point of view of the local country
or possibly the international community as well.
• CBA is a quantitative analytical tool to aid decision-makers in
the efficient allocation of resources.
• It identifies and attempts to quantify the costs and benefits of a
programme or activity and converts available data into
manageable information.
 The Process of Costs-Benefit Analysis

The basic steps for conducting a CBA are discussed below.

1. Determine scope and objectives
• The information presented at this stage should also provide an initial indication
of how appropriate the objectives of the initiative are in relation to current
Government priorities.  
2 .Assess and identify the constraints
The next step is to identify the constraints in meeting the objectives to ensure all
alternatives examined in the analysis are feasible.
Constraints may .be
financial
distributional
 institutional, managerial,
environmental and political in nature.
3 Consider the alternatives

• A CBA involves the identification and specification of a set of

alternatives.
• In most cases, a ‘do nothing’ option should be included as a base
case.
• This option is generally required because costs and benefits are
nearly always measured as incremental to what would have
happened had the project not gone ahead.
• While it is important to provide decision-makers with a range of
options, the process of developing and analyzing these can be
expensive and time consuming.
• For major investments, it may be necessary to outline various
potential options and then to have decision-makers select, after a
preliminary screening, a smaller number for detailed appraisal.
4 Identify, quantify and value the costs and benefits of each alternative

• A critical step in the CBA process involves identifying, quantifying

and valuing the costs and benefits of each alternative.
• The types of benefits and costs will depend on the project.
• Typical costs of a proposal would include:
Initial capital costs;
Capital costs of any buildings,
equipment, or facilities that need to be replaced during the life of the
project;
• Operating and maintenance costs over the period of a programme or
project; and costs which cannot be valued in money terms (often
described as 'intangibles').
Typical costs of a proposal would include:
Initial capital costs;
Capital costs of any buildings, equipment, or facilities that need to be
replaced during the life of the project;
Operating and maintenance costs over the period of a programme or
project; and costs which cannot be valued in money terms (often
described as 'intangibles’).

Typical benefits of a proposal would include:

Benefits which can be valued in money terms, in the form of
revenues, cost savings or non-market outputs; and
Benefits which cannot be valued in money terms (also described as
‘intangibles’).
 5 Calculate the Net Present Value

 Before determining the NPV of a proposal, the costs (C) and benefits (B)
need to be quantified for the expected duration of the project.
NPV is the present value of all benefits, discounted at the appropriate
discount rate, minus the present value of all costs discounted at the same rate.
The NPV is calculated as follows:

Where:
Bt is the benefit at time t;
Ct is the cost at time t; and
r is the discount rate.
• The net social benefit (NSB) of the proposal is
calculated by subtracting the cost stream from
the benefit stream and is represented as follows:
• NSB = B – C
 Decision rule:
If NPV is positive (+): accept the project
If NPV is negative (-): reject the project
1) For example, if the initial investment of project A is
$100 and it will be $70 in benefits and $25 in costs for each
of 3 years, and the discount rate is 10 per cent per annum,
then the NPV will be:
NPV = −$100 + ($70 − $25)/ (1 + 0.1 )1 + ($70 − $25)/
(1 + 0.1)2 + ($70 − $25)/ (1 + 0.1)3
= −$100 + $40.91 + $37.19 + $33.81
= $11.91
2) A firm intends to invest $1,000 in a project that
generated net receipts of $800, $900 and $600 in the first,
second and third years respectively , At the discount rate of
10%.Should the firm go ahead with the project?
The CBA report should include the following information:
Executive summary outlining the critical assumptions, key results and
recommendation(s)
Background to the analysis why it was undertaken
Objectives of the project, programme or activity
Key risks associated with the proposal
Outline of alternatives considered
Time profiles of costs, benefits and net benefits
Key assumptions underpinning the analysis
The discount rate applied
NPV calculations
Sensitivity analysis
Other important information including distributional effects, other quantified costs and
benefits, and intangible costs and benefits
Comparison of the preferred option to alternatives
How the outcome of the proposal could later be evaluated
Concluding comments
8.2 Cost-Effectiveness Analysis (CEA)

CEA is aimed at determining the cost of achieving a specific

physical target.
In relaxing the approach towards benefits measurement, CEA is
useful in areas such as health, accident safety and education where
it is often easier to quantify benefits in physical terms than to value
them in dollars.
For instance, through measuring cost per life saved or child
educated. It offers a priority ranking of programmes or activities on
the basis of a comparative ‘cost per unit of effectiveness’, or
alternatively, of comparative ‘units of effectiveness per dollar’.
It can be particularly useful where benefits are hard to quantify in
monetary terms.
  The cost-effectiveness of a proposal can be measured by
calculating cost-effectiveness ratios. The simplest ratio is to
calculate the average cost per unit of effectiveness. This is
represented mathematically as follows:

Where
CE is the cost-effectiveness of the proposal,
C is the cost (measured in dollars) and
E represents the effectiveness (i.e. the benefit measured in
physical units).
Where this is the case, the incremental cost-effectiveness ratio (ICER)
could be used. This is represented as follows:

or
Where
o Cn is the cost of the new proposal,
o Cc is the cost of maintaining the current programme,
o En is the effectiveness of the new proposal and
o Ec is the effectiveness of continuing with the current programme.
 Example
1) Consider a project for which there are four alternative, the project
involves adding's a safety barrier to the centre reservations of a
major road .the per mile of the barrier doffers depending on the
quality of the material used. Scheme A users a reinforced wooded
barrier .scheme B uses iron ,C uses steel, Uses concrete reinforced
with steel. The costs and effectiveness in terms of lives saved are
shown in the table below
E(lives
Scheme Costs(c) saved per
annum
C/E
C E C/ E

A 9,000 5 1800 - - -
B 15,000 8 1875 6000 3 2000
C 20,000 11 1818 5,000 3 1667
D 30,000 12 2500 10,000 1 10,000
YOUCANASK
•
QUIZZ
End Of Chapter eight
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