~ _. .__ u _. .... --.-. ..- ~,....-_._..-Selecting an Interest Rate 493From the viewpoint of the town, the project is still a good one. If the town puts up half the
cost ($500,000) it will receive all the benefits ($750,000). On the other hand, from anoverall
viewpoint, the revised estimate of $750,000 of benefits does not justify the $1 million expenditure.
This illustrates the dilemma caused by varying viewpoints. For economic efficiency, one does not
want to encourage the expenditure of money, regardless of the source, unless the benefits at least
equal the costs.Possible viewpoints that may be taken include those of an individual, a business firm or
corporation, a town or city district, a city, a state, a nation, or a group of nations. To avoid
suboptimizing, the proper approach is totake a viewpoint at least as broad as those who
pay the costs and those who receive the benefits.When the costs and benefits are totally'
confined to a town, for example, the town's viewpoint seems to be an appropriate basis for
the analysis. But when the costs or the benefits are spread beyond the proposed viewpoint,
then the viewpoint should be enlarged to this broader population.
Other than investmentsin defense and social programs, most of the benefits provided
by government projects are realized at a regional or local level. Projects, such as dams
for electricity, flood control and recreation, and transportation facilities, such as roads,
bridges, and harbors, all benefit most those in the region in which they are constructed.
Even smaller-scale projects, such as the municipal rose garden, although funded by public
monies at a local or state level, provide most benefitto those nearby.As in the case of private
decision making, it is important to adopt an appropriate andconsistentviewpoint and to
designate all the costs and benefits that arise from the prospectiveinvestment based on that
perspective. To shift perspective when quantifyingcosts and benefitscould greatly skew the
results of the analysis and subsequent decision, and thus such changes in perspective are
inappropriate.ELECTINGAN INTERESTRATE
Several factors, not present for nongovernment firms, influence the seJection of an ap-
propriate interest rate for use in economic analysis.in the government sector. Recall that
for private-sector companies the overall objective is wealth maximization. An appropri-
ate interest rate for use in evaluating projects is selected consistent with this goal. Many
nongovernment firms usecost of capitaloropportunity costconcepts when setting an in-
terest rate. The objective of public investment, on the other hand, involves the use of public.
resources topromote the general welfareand to secure the benefits of a given projectto
whomsoevermay accruebenefits,as long as those benefitsoutweighthe costs. The setting of
an interest rate for use in investmentanalysis is less clear-cutin this case. Severalalternative
concepts have been suggested for how governmentshould set this rate; these are discussed
next.