BUDGET EXERCISE 3

The objective of this exercise is to test your understanding of cost-benefit analysis methodology.

Preparation

Make sure you understand the material presented in lessons 7 through 10 and that you have studied the assigned readings for those lessons before attempting to complete this exercise.

Budget Exercise 3 Scenario

You are a budget analyst for the City of Malatia. The budget director has charged you with developing a cost-benefits analysis (CBA) of two versions of a proposed project to provide e-government services to city residents, business owners, city government agencies, non- profit agencies, and city visitors. The city is considering the following two alternatives:

1. e-government basic and (2) e-government plus. The e-government plus alternative would provide an increased level of e-government services at a faster rate to more users than the e-government basic. The basic alternative would have an initial implementation (one- time) cost of $280,000 versus $406,000 for the plus alternative (see costs and benefits below). Both alternatives have an expected useful life of 10 years. Your task is to develop the CBA for these two alternatives and a recommendation to the city based on the net present value decision rule.

Assumptions

For the purpose of this exercise, CBA methodology is grossly oversimplified. In practice, analysts would be challenged by the difficulties of:

• also considering the status quo alternative (not implementing e-government);
• identifying those whose impacts (costs and benefits) should count;
• finding indicators to measure all impacts;
• monetizing all impacts; and
• selecting an adequate social discount rate

Thus for the sake of simplicity, assume that the Project Costs and Project Benefits provided with the exercise (see the Excel spreadsheet in Exercises) address these issues and are adequate measures of all impacts.

The Excel spreadsheet shows the following benefits for years 1 through 10 (worksheet tab titled Project Benefits):

1. Reduced administrative burden (column A)
2. Increased efficiency (column B)
3. Increased customer satisfaction (column C)

Again, for the sake of simplicity assume that no benefits are gained during the implementation year of the project (year 0)

The Excel spreadsheet also shows the following Project Costs for years 0 through 10 (worksheet tab titled Project Costs):

1. Initial or implementation cost, which would happen in year 0
2. Operating costs
3. Maintenance costs

Surely we could think of many other costs that might ensue during the 10 years of the project, but we want to keep it simple.

Discounting

Find the present value (discount) for all Project Benefits and Project Costs for the 10 years of the project at a rate of 7 percent, but dont discount the initial cost to implement the project (year 0 is the present!). You should entirely fill out the worksheet titled NPV included in the Excel spreadsheet before answering the Exercise preview questions.

Answers for questions 1-9 and 13 come directly from the NPV worksheet.

Budget Exercise Questions

1. The present value of maintenance costs for E-government Basic and E. government Plus is:

1. 115,560 (E-government Basic) and 201,445 (E. government Plus)
2. 171,953 (E-government Basic) and 223,538 (E. government Plus)
3. 251,558 (E-government Basic) and 327,025 (E. government Plus)
4. 171,953 (E-government Basic) and 327,025 (E. government Plus)

2. The present value of operating costs for E-government Basic and E. government Plus is:

1. 201,900 (E-government Basic) and 490,538 (E. government Plus)
2. 201,900 (E-government Basic) and 335,305 (E. government Plus)
3. 123,456 (E-government Basic) and 411,521 (E. government Plus)
4. 257,929 (E-government Basic) and 335,305 (E. government Plus)

3. The present value of total costs for E-government Basic and E. government Plus is:

1. 675,907 (E-government Basic) and 899,875 (E. government Plus)
2. 709,881 (E-government Basic) and 964,846 (E. government Plus)
3. 675,907 (E-government Basic) and 964,846 (E. government Plus)
4. 799,780 (E-government Basic) and 876,983 (E. government Plus)

4. The present value of reduced administrative burden (a benefit) for E-government Basic and E. government Plus is:

1. 386,893 (E-government Basic) and 426,970 (E. government Plus)
2. 233,887 (E-government Basic) and 300,345 (E. government Plus)
3. 386,893 (E-government Basic) and 300,345 (E. government Plus)
4. 321,144 (E-government Basic) and 398,877 (E. government Plus)

5. The present value of increased efficiency (a benefit) for E-government Basic and E. government Plus is:

1. 601,875 (E-government Basic) and 798,326 (E. government Plus)
2. 667,822 (E-government Basic) and 616,735 (E. government Plus)
3. 558,846 (E-government Basic) and 616,735 (E. government Plus)
4. 667,822 (E-government Basic) and 701,322 (E. government Plus)

6. The present value of increased customer satisfaction (a benefit) for E-government Basic and E. government Plus is:

1. 214,941 (E-government Basic) and 139,895 (E. government Plus)
2. 201,881 (E-government Basic) and 139,895 (E. government Plus)
3. 123,905 (E-government Basic) and 198,935 (E. government Plus)
4. 214,941 (E-government Basic) and 237,206 (E. government Plus)

7. The present value of total benefits for E-government Basic and E. government Plus is:

1. 1,160,680 (E-government Basic) and 1,280,910 (E. government Plus)
2. 903,981 (E-government Basic) and 1,456,301 (E. government Plus)
3. 678,904 (E-government Basic) and 775,887 (E. government Plus)
4. 1,160,680 (E-government Basic) and 1,456,301 (E. government Plus)

8. The net present value for E-government Basic and E. government Plus is:

1. 450,798 (E-government Basic) and 316,064 (E. government Plus)
2. 350,879 (E-government Basic) and 316,064 (E. government Plus)
3. 211,989 (E-government Basic) and 125,989 (E. government Plus)
4. 350,879 (E-government Basic) and 289,456 (E. government Plus)

9. The benefit-cost ratio for E-government Basic and E. government Plus is:

1. 1.64 (E-government Basic) and 1.10 (E. government Plus)
2. 0.99 (E-government Basic) and 1.10 (E. government Plus)
3. 1.64 (E-government Basic) and 1.33 (E. government Plus)
4. 1.15 (E-government Basic) and 0.98 (E. government Plus)

10. What does it mean to have a benefit-cost ratio greater than 1 (one)?

1. It means that the policy is too costly in comparison to the benefits
2. It means that present value of benefits is greater than present value of costs
3. It means that present value of costs is greater than present value of benefits
4. It means that the policy is inefficient

11. You have to recommend one alternative from two or more alternatives. If your recommendation has to be based on the benefit-cost ratio, you would select the alternative with:

1. the lowest benefit-cost ratio
2. the benefit-cost ratio that is closer to 0 (zero)
3. the highest benefit-cost ratio
4. the ratio that has equal benefits and costs

12. What does it mean to have a net present value greater than 0 (zero)?

1. It means that present value of benefits is greater than present value of costs
2. It means that the policy is inefficient
3. It means that present value of costs is greater than present value of benefits
4. It means that the policy is too costly in comparison to the benefits

13. Make a recommendation based on the net present value of each alternative.

1. E-government Basic
2. E-government Plus

14. The most stable and reliable decision criterion used in recommending a preferred policy alternative is the:

1. Benefit-cost ratio
2. Net present value
3. Internal rate of return
4. The Pareto efficiency criterion

15. All things being equal, lower discount rates produce:

1. Higher future values
2. Lower future values
3. Higher present values
4. Lower present values