Integration of Cost-Benefit and Financial Analysis in Project Evaluation

Abstract

The recent profound shift in the financing of American local governments, which are increasingly dependent on user fees and non-traditional revenue sources, justifies consideration of how to integrate cost-benefit analysis (CBA) and cash-flow analysis (CFA) in project evaluation. This paper focuses on establishing the conceptual framework for a two-tiered methodology rather than on technical issues of CBA and CFA. It should be noted that CBA and CFA represent only two of a number of project evaluation tools including cost-revenue analysis (CRA) and cost-effectiveness analysis (CEA).1 Throughout this article, the goods and services under consideration are referred to as projects for simplicity. CBA is an expenditure-evaluation procedure for estimating whether public provision of a good or service maximizes net social welfare (NSW). The goal of CBA is to measure the social gains and losses resulting from a proposed project. A key problem in CBA is how to monetize benefits and costs, and major assumptions often have to be made. Traditionally, it has emphasized expenditure allocation and tended to ignore financing issues.2 Project evaluation cannot be so readily separated from financial analysis under conditions in which opportunities for privatization and partial or full cost recovery through user payments must be considered. CFA is commonly used in business enterprises to make long-term investment decisions. CFA forecasts the cash receipts and cash expenses associated with a proposed project. Like CBA, it involves selection of an appropriate discount rate for converting future to present values. CFA evaluates the financial consequences of project provision, and it may be used for either commercial-feasibility determination or user-fee determination. Since passage of California's Proposition 13 and Massachusetts' Proposition 2?2, a revolution has occurred in the financing of American state and local governments.3 Fiscal austerity has compelled state and local governments to consider a variety of cutback management strategies.4 Among these strategies are innovative financing methods, defined as new tax bases or nontraditional public revenue sources such as lotteries and development impact taxes;5 creative financing methods to attract private funding especially for capital assets;6 alternative service delivery, including franchising, con* This paper proposes a new conceptualframework for integrating cost-benefit analysis (CBA) and cash-flow analysis (CFA) into a two-tiered methodology for evaluating local government activities. The evaluation procedure may be enteredfrom either a CBA or a CFA perspective. The revolution in financing of American state and local governments engendered by fiscal austerity is steadily breaching the traditional separation of revenue and expenditure in CBA. This paper demonstrates that breaching and its implications explain the major issues encountered in developing an integrated, two-tiered methodology for project evaluation, and it applies the methodology to illustrative case studies of a parking garage and an emergency ambulance service.