Engineering Economic Analysis

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506 ECONOMIC ANALYSIS IN THEPUBLIC SECTOR

Project Politics

Another aspect distinguishing government projects from those in the private sector is the

typical duration or project life of the investment. In the private sector, projects most often

have a projected or intended life ranging between 5 and 15 years. On some occasionsthe

project life is shorter and in others longer,but a majority of projects fall in this interval.Com-

plex advanced manufacturing technologies, like computer-aided manufacturing or flexible

automated manufacturingcells, typically have projects lives at the longer end of this range.

In the 1980ssomecriticized U.S. manufacturingmanagers for short-sightedviewsof capital

investments in such technologies. At that time short-sightedness and lack of investments

were blamed for the overall loss of competitiveness in such key U.S. industries as textiles,

steel, electronics, automotive, and machine tools.

Government projects typically have lives in the range of 20 to 50 years (or longer).

Typical projects include federal highways, city water/sewer infrastructure, county dumps,

and state libraries and museums. These projects, by nature, have a longer useful life than

a typical project in the private sector. There are exceptions to this rule because private

finns invest in facilities and other long-range projects, and government entities also invest

in projects with shorter-term lives. But, in general, investment duration in the government

sector is longer than in the private sector.

Governmentprojects,because they tend to be long range and large scale,usuallyrequire

substantial funding in the early stages. The highway, water/sewer,and library projectsjust

mentioned could each require millions of dollars in design, surveying, and construction

costs. Because of this requirement, it is in the best interest of decision makers who are

advocates of such projects to spread that first cost over as many years as possible to reduce

the annual cost of capital recovery. This tendency to use longer project lives to downplay

the effects of a large first cost can affect the desirability of the project, as measured by the

BICratio. Another aspect closely associated with managing the size of the capital recovery

cost in a BICratio analysis is the interest rate used for discounting. Lower interest rates

reduce the size of the capital recovery cost by reducing the penalty of having money tied up

in a project. Example 16-6 illustrates the effects that project life and interest rate can have

on the analysis and acceptability of a project.

Consider a project that has been approved by local voters to build a newjunior high school, needed

because of increased (and projected)population growth. Information for the project is as follows:

I
L

Building first costs (design, planning, and construction)

Initial cost for roadway and parking facilities

First cost to equip and furnish facilityi!I

Annual operating and maintenance costs

Annual savings from rented space

Annual beqefits to community

$10,000,000

5,500,000

500,000

350,000

500,000

1,500,000