When allocating budgets, public bodies have to prioritise their investments, with the aim of maximising the value for money of their spending. This requires the use of appraisal methodologies.
An appraisal of a project should take a view of costs and benefits including:
• Expenditure on the provision of any capital assets and operation of the service
• Any residual value of capital assets at the end of the appraisal period
• Other costs and benefits which can be valued in money terms, in the form of revenues, cost savings and non-marketed impacts
• Quantified measures or at least a subjective evaluation of those costs, benefits or impacts that cannot easily be valued in money terms
• Operational efficiencies of the facility / asset to be provided
• Present and future demand for the facility / asset / service to be provided.
At any stage during the project life-cycle, the project costs and time required to deliver the project benefits are difficult to forecast accurately. Evidence has shown that public sector estimates tend to be optimistic.
It is important that the appraisal of costs, duration and benefits should include assessments of, and allowances for, the associated risks and uncertainties. An appraisal should also assess the risks and uncertainties associated with project risk areas that have not been valued monetarily.
The discount rate, - 6 % (six percent) - formerly recommended by HM Treasury for project and policy appraisal, implicitly included an allowance, over and above the cost of capital and social time preference rate, to reflect the impact of risks in public sector procurement. However, the guidance also recommended that, for the majority of projects, it is not appropriate to increase discount rates in appraisal to take optimism bias into account and reflect project risk. This treatment is too generic as risks will tend to vary from project to project. Also, it is an encouragement to select projects that have a profile of deferred costs.
Similar studies had been carried out previously and a reconciliation of the Mott MacDonald study with these studies is detailed in Appendix G.