EVALUATION OF PUBLIC ACTIVITIES/PROJECTS

BYProf. N. N. Panda

GIACR ENGG. COLLEGE, RAYAGADA

By public activities we mean the projects undertaken by the public authorities for investment to increase the general welfare of the citizens. Public activities are measured in terms of public welfare instead of money. Public authorities include Central Govt., State Govt., and Local Self Govt., like municipalities etc.

Public activities may be classified under the general headings of protection, enlightenment & cultural development, and economic benefits.Protection includes the activities such as the military establishments, police forces, flood control, and welfare & health servicesEnlightenment & cultural development includes activities like the public school system, public libraries, postal service, and Govt. supported research &development programmes, etc.Economic benefits include harbors and canals, power development, research and development etc.

It should be noted that evaluations of public activities in terms of the general welfare encompass both the benefits to be received from and the cost of the proposed activity. In fact, cost-benefit analysis is a decision making tool to evaluate the economic desirability of public activity.

Cost-Benefit Analysis (CBA)Cost-benefit analysis is a methodology developed for evaluating investment projects from social point of view. In the control of planned economics CBA helps in evaluating individual projects within the planning framework, which spells out national economic objective and broad allocation of resources to various sectors.

The cost-benefit analysis can be used to evaluate a single public investment project as well as to evaluate mutually exclusive projects also. The procedure of evaluation is outlined below – A) Identification of cost and benefits (Enumeration of cost and benefits).B) Evaluation of the cost and benefits (Quantification of the cost and benefits).C) Choice of interest rate for discounting and period of analysis.D) Criteria for investment comparability (Benefit-Cost Ratio)E) Conclusions.

Enumeration of BenefitsBenefits are advantages, expressed in terms of money, which will happen to the nation. These projects are said to be profitable whose contribution to nation output is greater than those with a smaller contribution. Benefits may be any of the following –

1) Primary and Secondary Benefits 2) Stemming & Induced Benefits 3) Tangible and Intangible Benefits

Enumeration of CostCost is the anticipated expenditures for construction, operation, maintenance, etc. less any salvage value.1) Fixed & Variable Cost 2) Direct & Indirect Cost 3) Associated Cost

Quantification of the Cost and BenefitsAfter enumeration of costs and benefits, the next step is their quantification and evaluation. In this exercise all relevant items should be considered one by one and valued under as a common denominator. This common denominator can be the nation currency or some international currency in the case of international projects.

Choice of Discount RateThe rate at which future benefits must be discounted to make them comparable with present benefits is called discount rate. There are so many discount rates given by the economists, however there is a great controversy regarding the choice of discount rate.

However, a general discount rate is normally adopted while evaluating the public projects is called social discount rate. This rate has been defined as the rate, which is used to evaluate the public projects.

Criteria for investment comparability OR Benefit-Cost RatioThe benefit-cost ratio is a relationship between the relevant benefits and costs. The ratio is given by -

Benefit-Cost Ratio = Relevant Benefits / Relevant Costs If this ratio is at least one, i.e., the equivalent benefits are greater than the costs, the public activity is justified.

But the benefits may occur at different time periods of the activity. For the purpose of comparison, these are to be converted in to a common time base (Present or Future Worth). Similarly the cost also includes the initial investment and the annual maintenance & operation cost. These are to be also converted to a common time base by using the interest factors.

This redefinition gives –  B/C Ratio = Benefits / Initial Investment + Annual Cost If the B/C Ratio is greater than one, then accept the project.If the B/C Ratio is less than one, then reject the project.If the B/C Ratio is equal to one, then remain indifferent.

It is important to note that benefit-cost ratio can be computed on the basis of present worth, future worth of annual equivalent cost also. B/C Ratio =Present Worth of Benefits / Initial Investment +Present Worth of Annual Cost (If calculated on the basis of Present Worth) B/C Ratio =Future Worth of Benefits / Future Worth of Initial Investment +Future Worth Annual Cost (If calculated on the basis of Future Worth)B/C Ratio =AEC of Benefits /AEC of Initial Investment / Annual Cost (If calculated on the basis of Equivalent Cost)

Comparing Mutually Exclusive Public AlternativesWhen using the benefit-cost ratio to compare and evaluate mutually exclusive projects, the benefit-cost ratio must be applied incrementally. The method is given below – 1. Check all the projects individually that the benefit-cost ratio is greater than one ignoring the discounting factor. If the ratio of any of them is less than one eliminate that alternative.2. Arrange the remaining alternatives in the increasing order of denominator (I+C).3. Compute the incremental differences for each term (benefits, Initial Investment &Annual Cost).

4. Compute the Benefit-Cost Ratio for the incremental investment.B/C Ratio = Benefits / Initial Investment + Annual Cost5. Compare the selected alternative with the next one on the list by computing the incremental cost-benefit ratio. Continue the process until you reach the bottom of the list. The alternative selected during the last pairing is the best one.

Question-The Central Govt. is planning to construct dam with an initial investment of Rs. 50,00,000. The estimated life of the dam is 15 yrs. The annual operation and maintenance cost is Rs. 3,00,000. The annual savings in irrigation cost due to construction of dam is Rs. 8,00,000 every yr. Check whether the project is justified by using the cost benefit method assuming a social rate of discount of 10%.