Guidelines for the Appraisal and Management of Capital Expenditure Proposals in the Public Sector

July 1994

Table of Contents

Introduction

Proposals for public sector investment invariably exceed the resources available. Choice and priority setting are inescapable. The systematic appraisal and professional management of all capital projects helps to ensure that the best choices are made and that the best value for money is obtained.

It is not enough to be satisfied that investment is justified; it is also necessary to ensure that it produces its planned benefits at minimum costs. This cost includes the ongoing current costs generated by the use of capital asset, as well as the initial capital cost.

This guide aims to assist public sector managers dealing with capital projects. It is not a detailed planning and cost control hand book. It sets out the main steps which should be followed in evaluating and managing capital expenditure projects, considers the major issues of principle involved, and describes the principal methods of appraisal. The type and depth of appraisal depend on the size and nature of the project.

The four stages of project appraisal and management are

1. Appraisal

This aims to assess if the project has sufficient merit to justify a full, detailed appraisal.

This aims to provide a basis for a decision on whether to drop a project or to approve it in principle.

2. Planning

This involves detailed planning and costing of the project; no commitment to finance a project should be made until this stage is completed and its results considered.

3. Implementation

This requires clear arrangements for monitoring and cost control.

4. Post-Project Review

A review to ensure experience gained can be used on other projects and possibly in the continued use of the new asset.

The successive stages should follow a realistic time schedule and have clear starting and finishing points. Decision-making takes time and allowance should be made for this in time schedules.

Responsibility for Systems

It is the responsibility of each Sanctioning Authority to draw up its own procedures, applicable to its area of control. These procedures should comply with the principles set out in this document. Each Sanctioning Authority should also ensure that bodies under its aegis follow the procedures laid down by it.

Scope of Guidelines

The project appraisal and sanctioning requirements referred to in these Guidelines should be applied to all forms of capital expenditure, including direct purchase of assets, purchase or acquisition of shareholdings, and capital grants. They should be applied irrespective of how asset acquisition is financed e.g. through sale and leaseback. The requirements also apply where the use of major capital assets is obtained through current payments e.g. rental or charter arrangement.

1.1 Introduction

The appraisal stage involves two separate tasks, preliminary and detailed appraisal. The preliminary appraisal aims to establish whether a sufficiently good prima facie case exists for considering a project in depth. It leads to a recommendation on whether to proceed to the detailed appraisal stage (often a costly exercise).

A detailed appraisal should only be carried out if justified by the outcome of the preliminary appraisal. Detailed appraisal leads to a recommendation on whether to approve a project in principle.

1.2 Avoiding Premature Commitments

All involved in the appraisal and management of expenditure proposals should guard against the danger that when a project is mooted, it is given a degree of premature commitment. This must be avoided. A sequence of considered decisions generally will lead to progressively greater commitment of resources, but an irrevocable commitment to a proposal should only be made after all appraisal stages have been satisfactorily passed, and final approval obtained.

1.3. Responsibilities

Appraisal involves both the Sponsoring Agency and the Sanctioning Authority (see panel overleaf) being clear about the objectives a project aims to meet and consideration of all the options open to the Sponsoring Agency in meeting these objectives. See examples at Figure 2. The Sponsoring Agency should, in making a proposal to the Sanctioning Authority for decision, cover all of realistic options, with a statement of their costs and benefits, and make a recommendation on the most cost effective solution(s). Where possible, objectives should be quantified so as to facilitate comparison with outturns later.

1.4 Scale of Appraisal

Every capital spending proposal should be appraised carefully. However, the resources spent on appraisal should be commensurate with the cost of projects, and with the degree of complexity of the issues involved. Small and routine projects should be appraised with a readily applicable, but thorough, methodology, which is used consistently and which reflects the principles set out in this document.

Sponsoring Agency

The Sponsoring Agency has the overall responsibility for proper planning and management of projects. The Sponsoring Agency must obtain the necessary approvals of the Sanctioning Authority and ensure that the project proceeds along the lines approved by the Sanctioning Authority.

The Sponsoring Agency may be a Government Department, local authority, health board or other State body or agency. It may be the management of a State body, or, where large scale investment is involved, its Board.

If a subsidiary company or agency is set up specially to undertake a project, it is important that the responsibilities of the parent body are not diluted.

Sanctioning Authority

For investment proposals across the public sector, including those attracting private funding, the ultimate authority to sanction expenditure rests with the appropriate Public Authority.

Projects require sanction at different levels. It is important to establish clearly at the outset the appropriate Sanctioning Authority for a particular proposal.

In some cases, Government approval is required. In other cases, the approval of the Department of Finance, a line Department or a local or regional authority or its management, or the board or managers of State or regional bodies and agencies will be required.

The level at which sanction is required usually depends on the scale of the proposal, the complexity of the issues, whether or not policy changes are involved, the experience and expertise of the Departments/agencies involved and whether delegated sanctions covering the cases involved exist.

More complex appraisal should be applied to:

(i) Projects which

• are estimated to have a capital cost in excess of £10 million; or

• involve complex or specialised issues or untried technology; or

• involve issues which have not been previously investigated in-depth; or

• are regarded as pilot projects on which larger programmes may be modelled; or

• which would generate substantial current cost; and

(ii) ongoing programmes consisting of many individual projects (housing, road, sanitary services, educational and health building, etc.).

Proposals may be initiated by bodies other than those which will be responsible for them. Submissions and research documentation coming from such sources may provide some of the information required for a preliminary appraisal. However, the Sponsoring Agency must satisfy itself that such information is accurate and objective.

A preliminary appraisal should be undertaken by the Sponsoring Agency. It involves an initial specification of the nature and objectives of the project and of relevant background circumstances (economic, social, legal, etc.). The reasons why it is thought that public resources should be committed should be set out, having regards to what the private sector is doing or might be willing to do, independently or with State participation or encouragement.

A preliminary appraisal should include a clear statement of the needs which a project is designed to meet and the degree to which it would aim to meet them. It should identify all realistic options, including the option of doing nothing and, where possible, quantify the key elements of all options. It should assess the costs (notably financial costs) and benefits of all options, choose the preferred one, and make a judgement on whether its benefits are sufficient to warrant incurring its costs.

 1.6.2 Decision on foot of Preliminary Appraisal

On the basis of the preliminary appraisal, the Sponsoring Agency should decide whether formulating and assessing a detail appraisal would be worthwhile or whether to drop the project. A recommendation to undertake a detailed appraisal should state the terms of reference of that appraisal. If significant staff resources or other costs would be involved in detailed appraisal, the prior approval of the Sanctioning Authority thereto should be sought.

Detailed appraisal serves four very important functions:

• it provides the Sponsoring Agency with a basis for deciding whether it wishes to proceed further with the project

• it provides the Sanctioning Authority with a basis for deciding whether to approve the proposal in principle, or to reject it;

• it serves as the basic reference document against which to assess the effects of changes that may occur during the development of the project (see Section 2.3 to 2.5 and 3.2);

• and similarly to ensure evaluation of the project after completion (see Section 4).

Detailed appraisal should follow the general approach in the checklist below (This is described in greater detail in Appendix 1):

(i) define clearly the needs the project should meet, and its objective i.e. what the needs to be met are; and what is the planned scale on which those needs will be met, measured as precisely as possible;

(ii) list the options i.e. realistic alternative ways in which the objective can be achieved; include the option of doing nothing, or consider whether an objective could be met by ways other than capital spending;

(iii) list the constraints;

(iv) quantify financial costs, and specify sources of funding. Cost quantification should cover ongoing capital and current costs, and receipts generated by the use of capital assets, as well as the costs involved in their creation;

(v) analyse the main options i.e. value and quantify the costs, and benefits of each option. Types of analysis are:

Ÿ financial analysis

Ÿ cost benefit analysis

Ÿ cost effectiveness analysis

Ÿ Exchequer cashflow analysis

Different forms of analysis provide different kinds of information about investment proposals, and it is important to identify clearly, and to agree with the Sanctioning Authority, which forms of analysis are appropriate. The chief criterion used in deciding on the appropriate forms of analysis is whether or not the project is to be operated on a commercial basis.

(vi) identify the risks associated with each option, the potential impact on the options of adverse circumstances and draw up, if possible, a strategy for dealing with risks.

(vii) decide on the preferred option, specify it, and a clear and detailed time profile for actions, (including time for planning and decision making) and for expenditure. Excessively high quality and cost specifications should be avoided. A balance must be struck between specifications which are excessive relative to needs and low quality specifications which may generate short-term economies but which lead to greater costs in the long-run;

(viii) the Sponsoring Agency should recommend the preferred option - with reasons for its choice and an indication of its sensitivity to changes in key assumptions - for consideration and approval by the Sanctioning Authority.

Important aspects of an appraisal will necessarily be based on assumed future outcomes and events. Realistic assumptions must be made about future prices, costs, market growth, and other relevant factors. Appraisal reports should always clearly state their assumptions. Over-optimism should be avoided. Assumptions should be based on analysis of past performance, bad years as well as good, and careful study of likely future developments.

Realistic assumptions reduce, but cannot eliminate, the element of uncertainty in the decision-making process, and the risk that decisions made on the basis of the analyses may turn out to be wrong. Good project appraisal highlights the elements which are uncertain, so that the Sponsoring Agency and the Sanctioning Authority are aware of the risks involved in proceeding, or not proceeding, with any proposal.

Suitable strategies to minimise risk, and its consequences, should be put in place e.g. in project management organisation, review procedures, information flows, etc.

Sensitivity analysis should always form a part of the appraisal of major projects. This involves evaluating proposals over a range of assumptions about key factors (e.g. prices, costs, interest rates on any borrowed funds, growth rates, demographic changes). If an option yields acceptable results only with particular combinations of circumstances, and the results are very sensitive to variations in these circumstances, then it should probably not be undertaken. If the relative merits of options change with variations in the assumed values of variables, those values should be examined to see whether they can be made more reliable. It may be possible to attach probabilities to ranges of values, to help pick the best option.

1.8 EU Funding

The consideration that the EU may aid a project must not lead to less rigorous appraisal and decision making than if that aid was not forthcoming. Aid from the EU is a national resource and must be used as effectively, and economically, as any other national resource. The EU expects us to ensure this. The availability of EU aid for a project is not a justification for investment in that project; if the project does not go ahead the EU aid can be applied to better effect elsewhere.

In addition to the national project appraisal procedures outlined in this document, projects aided by the EU Structural and Cohesion Funds must meet specific Community appraisal requirements.

The Structural Funds regulations require that the following information be supplied to the European Commission:

(i) for an individual investment of over 25 million ECU in infrastructure

Ÿ analysis of the costs and socio-economic benefits of the project, including an indication of the expected rate of use;

Ÿ the expected impact of the investment on the development of the region (for EU Structural Fund purposes Ireland is one region);

Ÿ an indication of the consequences that Community participation will have on the completion of the project.

(ii) for individual productive investment of over 15 million ECU

Ÿ an indication of the market outlook for the sector concerned;

Ÿ the effects on employment;

Ÿ an analysis of the expected profitability of the project

Both the Government and the EU Commission attach considerable importance to appraisal and evaluation of the various Structural Funds Programmes. Most of the programmes under the Community Support Framework 1989 - 1993 have been the subject of one or more evaluations, often carried out by independent consultants. There will be an increased emphasis on appraisal and evaluation under the Community Support Framework 1994 - 1999.

The Cohesion Fund provides assistance to projects in the environmental and transport areas. The following criteria (as stated in the relevant Regulation) must be applied in the assessment of individual projects:

Ÿ their medium-term economic and social benefits, which must be commensurate with the resources deployed; an assessment must be made in the light of an analysis of costs and benefits;

Ÿ the priorities established by the beneficiary Member State;

Ÿ the contribution which projects can make to the implementation of Community polices on the environment and trans-European networks;

Ÿ the compatibility of projects with Community policies and their consistency with other Community structural measures.

Applications for Cohesion Fund aid are required to include, inter alia, the information (including cost benefit analyses) to demonstrate consistency with these criteria. Evaluation of approved projects will also take place during and after their implementation to assess the degree of achievement of their original objectives.

1.8.3 Additional Information

EU Section in the Department of Finance is available to assist with any queries and/or additional information requirements relating to EU Funding.

The Sponsoring Agency should assess its in-house capacity to make the detailed appraisal. Where in-house capacity is inadequate, trained analysts and other personnel within the public sector with proven expertise in dealing with major projects/programmes should be involved (if necessary, on a cost recoupment basis). If the necessary resources are not available within the public sector, the employment of outside consultants may be considered.

The Sponsoring Agency is responsible for ensuring that the appraisal is done on an objective basis and not as a ‘case-making’ exercise.

Separate agreements should be made for consultancy tasks at the feasibility stages and the planning and implementation stages. Contracts under which consultants are engaged for particular tasks should make it clear that, if the project proceeds, they may not necessarily be engaged on later tasks. Separate fees should be negotiated for each stage (detailed appraisal, planning and design, implementation, etc.) of the project.

The matter of employing consultants is dealt with in more detail at Appendix 2

‘Approval in principle’ is a decision given by a Sanctioning Authority to a Sponsoring Agency at the end of the appraisal stage. It permits the successive steps in planning a project or scheme to proceed, stopping short of the placement of major contracts or the making of any irrevocable commitments to undertake the project/scheme. It commits relatively limited resources to planning the project. Those resources are expended progressively. If circumstances warrant, it should be possible to revise or drop the proposal during the planning process without incurring all of the planning costs or any of the more substantial liabilities associated with the project itself.

2 Planning Stage

This stage involves seven steps. These are

• establishment of project management structure;

• preparation of a design brief;

• detailed planning and design;

• review of proposal, using information provided by the planning process;

• obtaining approval of the Sanctioning Authority;

• obtaining tenders for projects;

• review of proposal, using tender prices.

The scale and complexity of the project should be reflected in its management structure and information system. Three issues should be carefully considered. These are:

• what kind of management structure would be suitable for the project?;

• who is to be accountable for what aspects of the project?;

• what kind of reporting systems should be installed?

2.1.1 Management Structure

Unless it already exists (e.g. for ongoing capital programmes) the management structure should always be identified and established once approval in principle has been obtained. In some cases, it may be possible to outline the proposed structure, filling some of the roles immediately and leaving others to be filled later on, as appropriate. However, the senior decision-makers for the project, and the senior managers should all be identified clearly at the outset, and their involvement and relative role clearly agreed.

The management of the project should usually be organised along the following lines:

 Sanctioning Authority

The Sanctioning Authority (Government, Department, Local Authority, Board, etc.) is responsible for conveying approval to a project, within specified cost and time limits, etc.

The Sponsoring agency has overall responsibility for the proper management of the project, including its detailed planning; for obtaining necessary approvals from the Sanctioning Authority and for ensuring that the project proceeds along the lines approved by the Sanctioning Authority.

Usually, the Sponsoring Agency is the body with whom the contractor(s)/supplier(s) will have a legal commitment.

A Steering Group has the responsibility for overseeing the execution of the project. A Steering Group will usually be required on a complex and large scale project and particularly where a number of bodies are interested or involved in the project. It should usually be chaired by a representative of the Sponsoring Agency.

The group should include appropriate professional staff e.g. architect/engineer/quantity surveyor. The Group may include a representative from the Sanctioning Authority and/or the Department of Finance.

The Project Co-ordinator is the person who is responsible for the execution, on time and within budget, of the decisions taken by the Steering Group, or by the Sponsoring Agency in the absence of a Steering Group (where the project is small).

For very large projects it may be necessary to appoint a professional firm to take on the task of actually managing the project. It would report to the Project Co-ordinator (who in turn would report to the Steering Group, and/or Sponsoring Agency, as appropriate) and it would be responsible for ensuring that the project came in on time and within cost.

A Design Team Leader should be appointed for every project with more than one technical consultant. The Design Team Leader would report to the Project Co-ordinator or, where a project management firm had been appointed, to that firm.

2.1.2 Information Flows

The following should be established as early as possible:

• The information needs at various levels of the management structure.

• The format that should be used for presenting this information. In this connection the standard forms in National Standard Building Elements and Design Cost Control Procedures 1 should be used wherever these are appropriate. However, particular projects may require special forms which vary from those standard forms

• The frequency of the submission of reports.

• Who is responsible for supplying and for compiling information?

The information system should reflect the nature of the project but should deal with all of these points.

1 Third edition, published in 1993, available from the Department of the Environment and Local Government.

The design brief is essentially a description of the project option which has been approved in principle, detailing the objectives and parameters to be taken into account by the planning professionals. All the client’s requirements should be set out in appropriate detail (e.g. for buildings, specify schedule of accommodation and room sizes etc.).

The design brief should not call for over-elaborate designs and/or the specification of standards which exceed the minimum necessary to achieve a satisfactory end product. The programme for the completion of the work specified in the detailed appraisal should also be given. The services to be provided by consultants, architects, engineers, etc., should be clearly identified.

Cost limits/targets for the project should be included in the design brief. Estimated costs for the project itself and for project planning will have been included in the detailed appraisal. These should be used as the permitted expenditure limits.

Once design has commenced on the basis of the design brief, changes in the scope or objectives of the project should not be made unless absolutely necessary, or unless the proposed changes could reduce the overall cost of the project. If changes are to be made, the cost implications (including the effects on design costs) and the effects on the timing of the project should be fully appraised, and the express approval of the Sanctioning Authority sought, before an amended design brief is given to consultants.

Depending on the type of project and the availability of skills within the Sponsoring Agency, it may be necessary to engage the services of consulting architects, engineers, quantity surveyors, etc. Procedures to be followed in selecting consultants and agreeing fees are referred to at Section 1.9 above and at Appendix 2

In managing the design process, it is important to consider regularly how the information being produced is likely to affect the estimated cost of the proposed project.

If the designs furnished by consultants to the Sponsoring Agency exceed the cost limit(s) set in the design brief, they should be referred back to the consultants by the Sponsoring agency to ensure that costs are reduced to stay within the said overall cost limit(s). Significant changes in specification to achieve cost reduction should be notified to the Sanctioning Authority for approval, with information on any change in the quality of the works being undertaken.

In situations where specific unit costs for certain types of projects are available (e.g. for school buildings where unit costs norms are in place for a number of years) these should be adhered to when assessing total budget costs.

In cases where cost norms are not in place all areas of project expenditure should be examined to see if the application of unit cost norms/limits is feasible. Where standardised cost norms are available they should be applied consistently across the public sector. For example, the cost of building office accommodation would fall into this category.

Changes which are relevant to a project, and which may make it more or less beneficial for the economy, may occur at any time (e.g. developments in technology, fluctuations in the availability or cost of raw materials or other inputs, changes in the domestic and international economies, legal changes). Such changes may alter radically the needs to be met, the priority which they are to be given, the scale on which they should be met, and the feasibility of possible alternative solutions. Under or over-estimation of relevant factors, notably cost, may be discovered during detailed planning following approval in principle, or when tenders are received. Changes in the time scale of a project can also have very significant effects. Unscheduled delays (due, for example, to time overruns on particular stages, or to delays in reaching decisions) may result in circumstances changing so as to alter radically the case for a proposal. Similarly, decisions to delay a project (i.e. to change the time profile) may result in significant changes in factors affecting decisions made. When significant alteration of the planned time scale occurs, it is particularly important to reassess fully the basis on which earlier decisions were made. 

The detailed appraisal is the framework against which the impact of changes can be assessed. In setting it up, it is important to identify clearly factors which are so significant to the appraisal that unexpected changes in them would warrant speedy reappraisal, and corrective action, if necessary.

If a decision is taken to defer a project indefinitely, then it should be fully reappraised before being started again. For instance, a project deferred indefinitely after architectural or engineering plans have been drawn up should not subsequently be proceeded with, without returning to the detailed appraisal stage.

When plans and designs have been finalised, the project proposal should be reviewed, taking into account any major changes in relevant circumstances and the more precise information generated by the design process. In particular, if the expected total cost of the project has increased, then the proposal should be re-assessed and appropriate steps taken to ensure that the project cost is brought back into line with the sanctioned limit. The Sanctioning Authority should be notified of any significant changes.

The pre-tender review is necessary to provide the information required by the Sponsoring Agency and the Sanctioning Authority to decide whether or not to approve the project.

If a project requires planning permission, a final decision to proceed with it should not be taken until permission is obtained from the appropriate Planning Authority or An Bord Pleanála. The implications of any conditions attaching to the planning permission should be fully assessed, going so far, if warranted, as to consider whether the project should be abandoned. Before these steps are carried out financial exposure in respect of the project arising, for example, out of contracts, should be minimised. Similar considerations should apply to the requirements of various statutory codes operated by local authorities and other bodies, e.g. Building Control (Fire Safety Certificate), Air or Water Pollution Licence, Waste Permit, or Integrated Licence (Environmental Protection Agency).

Tendering should be invited on the basis of the standard guidelines set out in detail in the publication Public Procurement 2

2 1994 Edition, available from Government Publication Sales Office

When a tender price and other relevant information becomes available, the case for proceeding with the proposal should again be reviewed. The analysis contained in the detailed appraisal once again provides the framework for undertaking this review, and also for determining which of the available tenders is likely to be most cost effective.

If tenders exceed the approved budget, the project should be re-examined and reductions achieved without lowering the quality standard of the project below acceptable levels, in order to bring the project within the approved limit. Works should not be omitted so as to achieve reductions if they will have to be reintroduced later as being essential for the completion of the project, or for the generation of its full benefits, or if they significantly change the nature of the project. The Sanctioning Authority must be informed of all significant works omissions.

If tenders are over the approved limit re-appraisal may be required to determine whether the project should be abandoned or proceeded with. If this re-appraisal suggests proceeding at higher cost the approval of the Sanctioning Authority to a raised financial limit must be sought before contracts are placed. If it is decided that the project should be abandoned at this post-tender stage, and if substantial amounts have already been spent on planning etc. at this stage, the position should be reviewed to determine why the project came to proceed to this stage and was then abandoned.

It is only at this point that spending on the project itself can be sanctioned. (Once this point has been passed, it is often very difficult to withdraw from the project without incurring very large costs.) An explicit amount should be sanctioned. If contracts include price variation clauses, their potential effect on expenditure should be made clear to the Sanctioning Authority in seeking its sanction.

3 Implementation Stage

The implementation stage of a project begins once final approval for the award of a contract has been secured. The critical tasks at this stage are to manage and monitor the project to ensure that it is executed satisfactorily, within budget and on time.

The procedure to be followed in placing contracts is set out in detail in the current edition of Public Procurement.[3]

Depending on the kind of project being undertaken, the Sponsoring Agency may have a choice of engaging in a single contract with one contractor, or of co-ordinating a number of minor or sub-contracts. The task of managing a large number of contracts should not be underestimated; any potential cost savings associated with such an approach should be weighed against the inevitable additional management costs.

All projects must be monitored on an on-going basis to ensure that they are being completed to the required cost, quality and time profiles. In addition, the general background for the project should also be kept under review so that account can be taken of changes in relevant circumstances.

Regular management reports should be prepared by the Sponsoring Agency and submitted to the Sanctioning Authority covering all significant developments relating to the project and its costs. If adverse developments occur, including unforeseen cost increases, which call into question the desirability or viability of the project, the Sponsoring Agency should submit a report at the earliest possible moment to the Sanctioning Authority, detailing the necessary measures proposed to rectify the situation.

Where, despite these measures, increased costs are likely to arise, the approval of the Sanctioning Authority for the extra expenditure should be obtained before any commitment is made to accept cost increases. Any application for such approval should outline the reasons for the excess, along with a detailed explanation of why it was not possible to take appropriate measures to offset the increased cost. The viability of the project, given the changed circumstances, should also be reported on.

If a project is going badly wrong, there should be a willingness to terminate it before completion. Action of this kind can be justified if the cost of the project escalates above earlier estimates or if the benefits expected from it are not likely to be realised. An attitude that, once work on a project commences, it must be completed regardless of changed circumstances, is to be avoided. Before making a final decision to terminate a project that is not going according to plan, the costs of termination (for example, payments that might have to be paid by way of compensation to contractors etc.) should be ascertained and made known to the appropriate authorities.

4 Post Project Review

___________________________________________________________________________

A post-project review aims to draw lessons for the future.

A post-project review should be undertaken once sufficient time has elapsed to allow the project to be properly evaluated with sufficient evidence of the flow of benefits /costs from it.

There are two separate focuses of review namely:

• project outturn and
• appraisal and management procedures.

These reviews may be undertaken at the same time or at different times, but they should be done as soon as is practicable.

The aim here is to determine:

• whether the basis on which a project was undertaken proved correct;
• whether the expected benefits and outcomes materialised;
• whether the planned outcomes were the appropriate responses to actual public needs;
• whether the appraisal and management procedures adopted were satisfactory;
• whether conclusions can be drawn applicable to other projects; to the ongoing use of the asset; or to associated policies.

The detailed appraisal provides the base against which the outturn review is made.

This aims to determine whether experiences shows that any stage of the project could have been done better and any lessons applied elsewhere.

Appendix 1

Elements of Appraisal

___________________________________________________________________________

These guidelines are intended to serve as a broad review of the main features of project appraisal and not as a detailed technical manual on the techniques involved.

The basic purpose of systematic appraisal is to achieve better investment decisions. The following step-by-step approach to the selection and appraisal of investment projects is intended to provide operational guidance to those considering projects involving the use of public resources. Given the wide variety of projects in the public sector, adaptations to suit particular circumstances may be required.

The diverse nature and impact of the wide range of projects across the public sector means that legitimate comparisons on a cross-sectoral basis may be difficult to make. Comparisons within relatively homogeneous areas of investment, such as between alternative courses of action within a programme, are more easily derived.

An important task of any public sector organisation is continually to reassess needs and objectives. New projects should only be undertaken where there in a clearly established public need for the projects or service provided; existing services should be reviewed to ensure that the kind of service provided is the kind of service required, and is on the appropriate scale. The aim should be, subject to resource constraints, to avoid ‘bottlenecks’, and also to avoid costly and wasteful over-supply, and/or under-utilisation of resources.

An objective is the explicit intended result of a particular programme or project, measured as precisely as possible. For example, there may be a need to improve traffic flow on a road. To state the objective of works on that road as being "to reduce average journey times" would be unsatisfactory since it would not provide a basis for judging whether investment proposed to improve the roads would produce sufficient benefit. Something more explicit is needed. "To reduce average journey times between Town A and Town B by X percent by the year 2000" is a precise objective. It assists in addressing such question as what are the various ways in which this objective can be reached; what costs and what results can be expected from each alternative course of action; and are the benefits sufficient to justify the costs.

Project and programme objectives should be expressed in terms of the benefits they are expected to provide and those whom they are intended to benefit. For example, road building programmes are not ends in themselves; they must be seen in the light of the needs of the economy as a whole, and of the target groups for which the programmes cater (for example, freight traffic, tourist traffic, commuters. etc.).

There is a need for realism in stating objectives. Where programmes have multiple objectives it is necessary to be clear about the relative importance of each and how this should be reflected in resource allocation and in the appraisal process.

Objectives should be expressed in a way which will facilitate consideration and analysis of alternative ways of achieving them. They should not be so expressed as to point to only one solution. For example, population growth may put pressure on the schools in a particular area and an objective might be expressed as being "to build new schools in the area" to meet this pressure. The objective "to provide school places to meet population growth within the area" would provide a basis for considering alternative ways of achieving this objective, such as the provision of new schools, the expansion of existing schools, on a permanent or temporary basis, or making better use of the existing stock of schools by provision of special transport (school bussing) arrangements.

There will invariably be constraints in reaching objectives. There will normally be resource constraints. There may be technical constraints; for instance, there may be only a limited number of ways in which a product can be made, or a service delivered. Constraints may also arise as a result of previous policy or investment decisions, but these may be amenable to change. Constraints must also be explored, and fully taken account of, because they will limit the range of solutions which are feasible or acceptable.

The following is a checklist of the kinds of constraint which typically should be considered in appraising a proposal:

• financial

• technological

• legal/regulatory

• environmental

• physical inputs/raw material

• availability of manpower and skills

• time

• administrative /managerial ability

• distributional (e.g. between regions, income groups, etc.)

• social

• land use planning

• co-operation required from other interests

• general policy considerations.

All realistic ways of achieving stated objectives should be identified and examined critically. This should be done with a completely open mind, and should always include the option of ‘doing nothing’ or ‘doing the minimum’. Different scales of the same response should be included as separate options, where appropriate. There should be no presumption that public sector responses are the only ones available; options which involve, or rely totally on, the private sector should also be considered. The alternatives should be described in such a way that the essentials of each alternative, and the differences between them, are clear.

Considering the possible alternatives in the light of the constraints will usually lead to the conclusion that some of the alternatives are not feasible. Others may conflict with existing policies. Where a conflict with existing policies occurs, it should be brought to the attention of decision-makers who then have the opportunity to review those policies. This may result in a change of policy, or in the widening of the focus of investigation. It may be inappropriate to proceed further with appraisal of alternatives until the policy issues are reviewed.

Objectivity is important in considering options. There is a danger that the selection of options may be manipulated in order to make a case for a course of action which is already favoured. For example, options for which there is a very weak case may be put forward in order to make a poor option look good. If the poor option is the best available it should be considered alone on its own merits.

Different forms of analysis provide different kinds of information about investment proposals, and it is important to identify clearly, and to agree with the Sanctioning Authority, which forms of analysis are appropriate. The chief criterion used in deciding on the appropriate forms of analysis is whether or not the project is to be operated on a commercial basis. Before discussing these forms of analysis, it is necessary first to consider a number of methodological issues which are common to some or all of them.

For most forms of analysis, a critical issue is how to evaluate costs and benefits which occur at different points in time. Resources are said to have a time value i.e. a given sum of money (cost, benefit or imputed value) is normally perceived to be worth more today than the same amount at a later date, even after taking inflation into account. Money values occurring at different points in time are converted to values at a common point in time through the process of discounting.

A variety of techniques to evaluate options is available. These appraisal techniques can be applied in a variety of forms of analysis. The main techniques used (most of which involve discounting in one form or another) are

Net Present Value (NPV) Method

Revenues of a project are estimated, net of outgoings, and then are discounted and compared with the initial investment. The preferred option is that with the highest positive net present value.

Internal Rate of Return (IRR) Method.

The IRR is the discount rate which, when applied to net revenues of a project sets them equal to the initial investment. The preferred option is that with the IRR greatest in excess of a specified rate of return.

The benefit-cost ratio is the discounted net revenues divided by the initial investment. The preferred option is that with the ratio greatest in excess of 1.

These methods identify how long it will take to pay back the amounts invested.

More details about these methodologies may be found in standard textbooks on financial analysis.

Importance of NPV method

Applying different evaluation techniques to the same basic data may yield contradictory conclusions. In choosing between options A and B, the NPV method may suggest that A is preferable, while the IRR method may suggest that B is preferable. In such cases, the results indicated by the NPV method are more dependable. For this reason, the NPV method should always be used where money values over time need to be evaluated. However, the other techniques yield useful additional information and may therefore be worth undertaking also.

While the main thrust of the evaluation of commercial projects will be the financial appraisal as described below, major investment proposals in commercial State bodies should be considered against their corporate backgrounds. Issues that can usefully be addressed include:

• would the investment involve a change in the overall corporate thrust of the body, and is this advisable? What changes in the body’s policies, organisation and personnel resources would be called for by the investment and is it feasible to put them in place sufficiently quickly?

• would the investment be compatible with the body’s corporate plan, and if not, should the plan, or the investment be changed?

• can the investment be financed without creating undue financial risk for the body? Could gearing (the ratio between debt and equity) become excessive? Could other necessary investment be crowed out?

• are competitors planning or likely to undertake similar investments and what effect could this have on the profitability of and case for the investment?

• what effect will the investment have on the body’s ability to remunerate its shareholders?

Assumptions about market growth, future prices for the firm’s products/services and for its inputs, interest rate, and exchange rates (where relevant) should be closely examined. An assessment of the scale and distribution of the costs and benefits of the investment may also be undertaken, if relevant.

The financial restructuring of a commercial State body, involving capital injection or commitments (e.g. loan guarantees) by the State, normally requires a total review of its operations. Circumstances differ so much that this document could not usefully attempt to give guidance save to say that the assumptions made in any restructuring plan on key variables, on targets, and on actions should be realistic.

The key financial element is appraising commercial projects are:

This identifies the amount and timing of the cash inflows and outflows associated with each project option and discounts them to their net present value.

The discount rate should be appropriate to the organisation’s cost of capital, the risk profile of the project and any other relevant factors. The rate used, and the rationale for its use, should be set out clearly in the project documentation.

These should show the impact of the project on the main revenues and costs of the organisation and should include a commentary where necessary.

The period of the projections should be appropriate to the life of the project.

These should show the impact of the project on the finances of the organisation, with particular emphasis on its working capital, debt and reserves. Again, a commentary should be included where necessary.

The period of the projections should be the same as for the profit and loss account projections.

These key elements may be supplemented by other forms of analysis (internal rate of return, benefit/cost ratio, payback period etc.) where appropriate.

Sensitivity analysis of the project should also be undertaken, examining the effect on the key financial elements of varying the main assumptions of the project (including the discount rate) across an appropriate range.

Appraisal of Non-Commercial Projects

In the case of non-commercial projects, two forms on analysis are required. These are (i) either cost-benefit or cost effectiveness analysis and (ii) Exchequer cashflow analysis.

These forms of analysis assist in:

• establishing if there is a sufficient economic or social case for a proposal;

• identifying whether or not the proposal under consideration can be afforded;

• providing a basis for choosing between differing options and

• ranking projects in order within programmes.

There are two basic forms of economic analysis, one of which should be applied in the appraisal of each non-commercial investment proposal:

The general principle of cost-benefit analysis (CBA) is to assess whether or not the social and economic benefits associated with a project are greater than its social and economic costs.

Cost-effectiveness analysis (CEA) compares the costs of different ways of achieving a particular objective. A choice can then be made as to which of these options (which all achieve the same or similar ends) is preferable.

Cost-benefit and Cost-effectiveness analysis are very similar. Ideally, cost-benefit analysis would always be undertaken. However, there are situations where significant costs or benefits associated with a project cannot be quantified or valued, and where this occurs cost-effectiveness analysis may have to be relied on.

Whether undertaking cost-benefit or cost-effectiveness analysis, a number of important considerations arise:

• There may be significant costs or benefits which do not affect the Sponsoring Agency but which are important to other persons or agencies or to society in general. These are usually called ‘externalities’ (i.e. they are external to the sponsor’s direct concerns).

• There may be no market prices available for evaluating some costs or benefits associated with project options as they may not be traded items.

• In some cases, though resources consumed and outputs produced may be traded, the prices may not reflect the real value to society of those resources or outputs.

Externalities arise in a number of ways. For instance, the benefits from a particular investment may make it attractive to the Sponsoring Agency but at a cost to others, due, for example, to the need to provide back-up infrastructure such as roads, water supply or waste treatment facilities.

It is sometimes argued that distortions exist in the market prices for resources used in projects, or for the outputs of projects. The implication is that some other price, usually called a ‘shadow’ price (i.e. a price attributed to a good or factor on the basis that it is more appropriate than its market price) should be used. For example, when there is high unemployment, it could be argued that people employed in a project would not otherwise be employed in a productive way, and that the market cost of employing them should be replaced by a lower shadow price.

However, market prices are generally reliable, normally and verifiable. They generally provide the appropriate basis for valuing a project’s costs and benefits; they should be used, unless there are clear and convincing reasons that they are inappropriate and also that it is possible to derive shadow prices using a sound means of calculation.

If shadow prices are used, market prices, if available, should be applied also. If the analysis on both basis lead to differing conclusion, reliance should be placed on results using shadow prices only where it can be clearly justified.

Test Discount Rate (TDR)

The same basic discount rate (usually called the test discount rate or TDR should be used in all cost-benefit and cost-effectiveness analyses of public sector projects. The recommended TDR is 5 per cent in real terms. By real terms is meant that, before discounting, all nominal flows of costs and benefits should be deflated by the expected level of general price inflation. It may be appropriate from time to time, due to significant changes in real interest rates and in the rate of return on investments in Ireland, to vary the level at which the TDR is set. When such revisions are required, the Department of Finance will notify the Department, Offices and public bodies concerned accordingly.

In cost-benefit analysis all of the relevant costs and benefits, including indirect costs and benefits, are taken into account. Cash values, based on market prices (or shadow prices, where no appropriate market price exists) are placed on all costs and benefits and the time at which these costs/benefits occur is identified. The analytic techniques outlined above (i.e. NPV method, IRR method, etc.) are applied using the TDR.

The general principle of cost-benefit analysis is that a project is desirable if social benefits are greater than social costs. However, meeting this test may not necessarily show that a project should proceed, since other projects competing for the same limited funds may have a higher net present value.

It is vital that cost-benefit analysis is objective. Its conclusions should not be prejudged. It should not be used as a device to buttress a case already favoured for or against a proposal. Factors of questionable or limited relevance to a project should not be brought into an analysis in order to bias the result in a preferred direction.

Cost-Effectiveness Analysis (CEA)

It is difficult to measure the value to society of public investment in social infrastructure (e.g. schools and hospitals) because the outputs may be difficult to specify accurately and to quantify, and are frequently not marketed. In cases like these the cost of the various alternative options should first be determined in monetary terms (although the benefits need not be). A choice can then be made as to which of the options (if they all achieve much the same effects) is preferable. CEA is not a basis for deciding whether or not a project should be undertaken. Rather, it is concerned with the relative costs or the various options available for achieving a particular objective.

Evaluating options in CEA is best done by applying the principles of the NPV method to the stream of cash outflows or costs. The recurring costs of using facilities as well as the capital costs of creating them should be taken into account, particularly if they differ between alternative options. Usually, the aim will be to select the option which minimises the net present cost.

There is a particular need for consistency in the assumptions and parameters adopted for CBA and CEA appraisals.

CBA and CEA can significantly assist the process of establishing investment priorities between projects which are similar in nature provided that:

• consistent parameter values are used;

• there is a consistent practice on the factors properly to be taken into account in analysis. (The remarks made above concerning factors of questionable or limited relevance apply here.)

Establishment or parameter values for non-market items (e.g. time savings in respect of transport developments) should be as rigorous as possible.

The comparison across sectors of investment proposals using cost benefits analysis is difficult. However, it is important that the maximum degree of comparability is achieved. It is partly for this reason that the use of market rather than shadow prices is advocated. If shadow prices are used, it is important that the same, or at least not greatly divergent, shadow prices are used in different programme areas. If radically different shadow prices are used, the results of analyses cannot be validly compared, and they provide no guide to investment priorities. Users of shadow prices are encouraged to consult as widely as possible, including consultation with the Department of Finance, in the interests of achieving consistency in the matter.

It is not always possible to quantify and value all benefits or costs of a particular project option. This may result in a situation where one option would be judged preferable if estimated cash values only are taken into account. A different option may have a lower cash value but may bring additional non-cash benefits or have lower non-cash costs. When this occurs, results should be presented in a form which allows the decision-maker to choose whether the additional non-cash benefits (or lower non-cash costs) are worth the loss in cash value which is involved in taking the second option.

An example of this is the treatment of pollution. Pollution involves social costs, which may be impossible to value in monetary terms. Information should be given in analysis to enable decision-makers to judge whether the differences between the costed net social benefits of alternative projects are outweighed by differences in their uncosted pollution effects.

Exchequer cashflow analysis should take into account flows both directly and indirectly associated with proposals, identifying the years in which the flows occur.

Direct cashflows include Exchequer expenditure on building works, employment, planning costs, equity participation, grants and so on, and income from such items as user charges and dividends. Additional expenditures for which the Sponsoring Agency is not responsible, but which a project will necessary involve, should be included. EU finance passing through the Exchequer should be included. EU finance going directly to a body from the EU Commission need not be included in Exchequer cashflow analysis; however, it should be included in a separate cashflow analysis which should also be made available to the Sponsoring Agency.

Indirect Exchequer cashflows (e.g. savings on unemployment payments, additional tax revenues) may be relevant but are not as amenable to reliable costing. For instance, it is normally inappropriate to assume that income tax receipts from the workers employed in a project are attributable to any substantial extent to that project. To do so would overlook the fact that similar Exchequer income would derive form the use of the same resources in alternative ways. Similar considerations apply to savings on unemployment payments.

Any amounts attributed to indirect cashflows should be based on estimates of the extra costs or revenues over and above those that would arise in the absence of the project. The assumptions used in estimating indirect cashflows should be consistent with those used in the economic analysis. Indirect Exchequer income should not be viewed as an important factor in favour of a project given the difficulty in estimating it reliably.

Appendix 2

Employing Consultants

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If the necessary resources are not available within the public sector to fully appraise a project the employment of outside consultants may be considered.

• Management consultants may be required to undertake detailed studies/appraisals.

• Technical consultants may be needed to give technical advice at various stages.

The first priority in engaging consultants is to ensure that the best quality of professional service is provided. It is essential that every authority which engages consultants should establish formal systems for monitoring and assessing the effectiveness and efficiency of consultants in the discharge of their contracts.

A comprehensive brief for consultants is of fundamental importance. All the clients’ requirements should be set out in proper detail, together with a tentative programme for the completion of the work. The service to be provided by each of the consultants must be clearly identified.

Paragraph 1.9 of the Guidelines highlights the requirement that separate agreements for consultancy tasks at the appraisal stage and at the planning and implementation stages of a project are required, and that the contract under which consultants are engaged for particular tasks must make it clear that, if the project proceeds, they may not necessarily be engaged on later tasks. Separate fees should be negotiated for each stage (appraisal, planning, implementation etc.) of the project.

The importance of complying with these requirements in employing consultants can be illustrated in a situation where, for instance, a project has proceeded to the planning stage. If, at this stage, circumstances warrant revising or abandoning the project, it is important that provision has been made in consultants’ contracts for termination without incurring undue costs/liabilities.

Departments should try to anticipate their likely needs for consultancy services for project appraisal and planning purposes. Allowances for such services should be included in annual Departmental Budgets.

Guidelines on the engagement of management consultants for the appraisal of projects in Departments which do not have the necessary expertise are set out in the official booklet entitled Employing Management Consultants - Code of Practice for Government Departments.

Department of Finance Circulars 11/87 and 24/93 deal mainly with procedures for the settlement of fees for consultants engaged in construction contacts. These are designed to ensure better value for money spent on consultants’ fees, to allow for greater flexibility in the determination of fees and to give more consultancy firms the opportunity of being considered for assignments. Further information about the use of consultants is also given in the publication Public Procurement. 1

1 1994 edition, available from the Government Publication Sales Office.