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Module 17: Cost-Benefit Analysis

1.            What is the cost-benefit analysis? What are the main steps in conducting a cost-benefit analysis?

2.            A city has learned that buying larger garbage trucks, could reduce labor costs for garbage removal. Note: All the dollar amounts below are in this year’s dollars (constant dollars).

a.            The cost of the trucks today is $400,000.

b.            Annual savings in this year’s constant dollars is $90,000.

c.             Trucks will last for 4 years and then will be sold for $100,000.

d.            The city can borrow money at a 7% discount rate to purchase the trucks.

e.            Inflation (for the next 4 years) is expected to average 3%.

f.             Assuming the costs and benefits are incurred at the end of the year, should the city buy the trucks?

3.            This assignment extends the garbage truck problem from prompt 2. Two other lenders provide alternative scenarios. Alternate lender 1 suggests that the inflation rate will be 4% and offers an interest rate of 7.5%, while alternate lender 2 suggests that the inflation rate will be 1% and offers an interest rate of 6.5%. For all three sources, the interest rates are guaranteed if the decision is made in the next 90 days. Which of the following decisions should be made and why?

a.            The usual lender should be used because she offers a positive NPV.

b.            Alternate lender 1 should be used because the offers the highest NPV.

c.             The garbage trucks shouldn’t be purchased because there is a possibility of a negative NPV.

d.            Alternate lender 2 should be used because most scenarios have a positive NPV and she offers the highest NPV under each scenario.

e.            Each solution is as good as any other.

Module 18: Life Cycle Costing

1.            What is life cycle costing (LCC)? What are the main issues in applying LCC in the government context?

2.            The city administration is considering refurbishing the lighting system of its administration building. After an initial investigation, the city procurement office has narrowed down the choices to the following two options:

a.            Option 1 is an Ergolight system that costs $500,000 to purchase and install. The energy cost for option 1 is $20,000, and its maintenance cost is $2,000.

b.            Option 2 is a conventional system that costs $100,000 to purchase and install. The energy cost for option 2 is $50,000, and its maintenance cost is $10,000. Both systems are expected to last for 20 years. Assume that the discount rate is 4% and all future costs are paid at the end of the year.

3.            Which lighting system should the city select based on LCC considerations?

Module 19: Capitalization and Depreciation

1.            What are the differences in how depreciation is treated by the government and by companies in the private sector?

2.            A city government purchases a new garbage truck for $120,000 this year. It is estimated that the truck will have a residual value of $20,000 and a useful economic life of 20 years. What would be the depreciation expense each year if the straight-line method were used.

3.            Why do organizations, government included, not capitalize all assets that last for more than one budgeting period, despite knowing that doing so would increase the accuracy of the accounting of assets and operations?

4.            City Hospital paid $500,000 for a piece of advanced diagnostic equipment. The total transportation and installation cost to make the equipment operational is $50,000. The staff-training cost to operate the new equipment is about $10,000. What should be the value of this capital asset?

Module 20: Long-Term Financing

1.            Why do public organizations use municipal bonds to finance long-term capital projects?

2.            A major urban center is planning to issue a $100 million, 20-year, semiannual-interest-paying municipal bond for the construction of a stadium.

a.            The interest rate is 5.875%, based on the economic and financial conditions of the city and city government.

b.            The design and issuance costs are estimated to be $10 million and 1%, respectively.

c.             What is the total interest paid if the city decides to adopt a level debt service structure?

d.            How much will the city still owe on this bond at the end of each year?