FM 301
Date of issue: 31 October 2000

ECONOMIC APPRAISAL OF PROJECTS IN PPARC

CANCELLATION OF THE PREVIOUS FM

1.     This FM replaces PPARC FM 44 dated 1 September 1989 which is hereby cancelled.

PURPOSE

2.     This FM sets out the requirements for economic appraisal of large projects within PPARC and describes good practice in appraising cases for the approval of smaller projects. Further guidance can be found in Government Accounting Chapter 29 and the HM Treasury publication "Appraisal & Evaluation in Central Government" (The Green Book). The Green Book gives comprehensive guidance - Chapter 1 is a general introduction; Chapters 2 and 3 provide background for those who are new or have limited experience in this subject; Chapter 4 provides advice on technical matters and is aimed at those who undertake appraisal/evaluations. The guidance contained in this FM is intended as an overview, and detailed guidance should be sought from The Green Book, a copy of which is held in PPARC Finance Division, Swindon Office. (See Appendix A for information on how to obtain copies.) FM 303: Costing and Charging is also relevant.

INTRODUCTION

What is economic appraisal?

4.    In any proposal to commit resources to a project there are always at least two options, one being the "do nothing/do minimum" option, which in itself may have significant cost implications; the other being the spending of significant sums in order to achieve a particular objective. There may be several further options as to how this might be done, for example: different levels of specification; different timescales; different locations; and purchase or lease. Although this FM is concerned mainly with the appraisal of capital projects, many of the principles can be applied equally well to research or development projects.

When should a full economic appraisal be carried out?

6.    This FM should be applied as far as possible to all agreements to commit PPARC to major expenditure. Where decisions are made to build an instrument at an HEI it can be accepted that the appraisal has, by implication, been done within the peer review process. However, where the work is likely to be carried out within PPARC, ie at an Establishment, then a fully documented economic appraisal should be carried out at the same time as the peer review process, to document that this is the most cost effective way in which to proceed. PPARC should be able to show that all options have been evaluated and the chosen way forward represents the best long term value.

7.    The same principles apply to the appraisal of cases to make lower value purchases, both capital and recurrent, and these principles should be considered when completing requisitions although it is not necessary to submit a full statement of economic appraisal with the requisition.

8.    The economic appraisal forms part of the case for proceeding with a project, and so should be retained on the official files for later review and inspection.

What are the main stages which need to be carried out in conducting an economic appraisal?

PROJECT APPRAISAL AND APPROVAL

Step 1 - Planning and Project Specification

11.    On occasions the need for capital expenditure will have been generated by a particular event rather than as the result of following a particular plan. For example, buildings could be damaged by bad weather or equipment damaged by fire or vandalism. Nevertheless, the case for repairing the building or replacing the equipment must still be made in the context of the aims and objectives of the scientific programmes being supported. The question must be asked at this stage, and answered, about whether it is justifiable to replace equipment lost, or can the work proceed in other ways and the money spent more beneficially in some other area.

Step 2 - Formulation of Objectives

13.    The objectives must be consistent with PPARC’s plans and policies as well as legislation. For example, a case to purchase a large piece of equipment must consider health, safety and environmental issues. Can it be accommodated satisfactorily within existing buildings or other facilities?

14.    In formulating the objectives underlying the case for a capital project, conflicts may arise. These could be related to resource constraints, standards (internal or external), and procedures (internal or external). It is important that this part of the case makes any such conflicts explicit, so that they can be considered at the outset, and not later in the project life.

Step 3 - Generation of Options

16.    In considering the range of options it is necessary to ask:

        a.    What is implied by doing nothing or continuing as before?
        b.    Could the operation be ended or scaled down, releasing resources for other use?
        c.    Could the operation be of a different size or quality?
        d.    Could the project be accelerated, slowed down, or phased differently?
        e.    Are alternative locations possible?
        f.    Are there different ways of achieving the same objectives?
        g.    Are there choices of different levels of initial capital expenditure, and what effect do these have on lifetime running costs?
        h.    Are all the elements of the requirement equally important? Could some be removed to improve the effectiveness and efficiency of those remaining?
        i.   Could the operation be combined with another to advantage?
        j.    Could all or part of the operation be contracted out?

17.    For example, a large computer is becoming increasingly costly to maintain and is failing to meet the current and future scientific needs. The initial list of options might include:

Step 4 - Selection of Options

        a.    Write down all criteria which are relevant to the decision as to which option to proceed with.
        b.    Exclude those criteria on which there is no difference between options.
        c.    Work through the criteria one by one, rating each option against each criterion on a scale of 100 or 10) points for the preferred option and zero for the least preferred, with intermediate scores for the relative to the extent to which they meet the criterion.
        d.    Weight the criteria according to importance by giving the least important criteria low weights and the most important high weights, say on a scale of 1 to 3.
        e.    Multiply the scores of each option against each criterion by the criterion weighting.
        f.    Add up the weighted scores of each option; the one with the highest score is the most preferred.
        g.    Test the sensitivity of this analysis by altering the scores or weightings, particularly where the numbers are open to doubt or disagreement.

19.    This exercise is best done by a small group of people who can then compare their conclusions and discuss the relative ranking of options. The likely outcome is that, in the example in paragraph 17, three or four of the options will be clearly unacceptable and so can be rejected at this stage, leaving perhaps three or four options which can be taken forward for more critical appraisal. It should be noted that up to this stage cost is not the determining factor as to whether a project should proceed, although it is possible that some options might be rejected at the crude sift as being unrealistically expensive.

Step 5 - Appraisal of Options

a.    Capital Cost - the estimated capital cost of the option should be identified, at current prices. For projects spanning more than one year the annual incidence of expenditure should be forecast. Estimates must include any special procurement costs, consultants’ fees and VAT, together with any consequential capital costs such as the alteration of or addition to existing accommodation and services.

b.    Running Costs - the estimated annual incidence of recurrent costs or annual changes in recurrent costs should be identified, as should any savings which will result from the capital investment. These costs or savings should also be expressed at current prices. Such costs or savings might include staff, power requirements, maintenance, spares etc.

c.    Benefits - the main improvements and other benefits arising from the investment should be identified and related to the decision criteria established earlier (see paragraph 18). Quantitative estimates of the money values of the benefits, again at current prices, should be made wherever possible. Any objectives which cannot be achieved in full by each option should also be identified. Benefits might include the ability to attract additional repayment work.

d.    Unquantified Benefits - investments in scientific equipment and facilities often depend on projected benefits which are largely unquantifiable in money values. These should be identified as far as possible and explained in the context of the relevant scientific strategy, policies and objectives.

e.    Timing - the timing of the project and the expected benefits must be clear. In the case of equipment the expected lifetime and length of the requirement should be given.

f.    Present Value of Costs and Benefits - in order to make a fair comparison between the cost and benefits of capital investment options, insofar as they can be quantified in money values, it is necessary to discount these values to the present day. This allows costs and benefits occurring at different rates and at different times to be compared in a consistent way. A straightforward method for doing this is explained in Annex A. Further information can be found in The Green Book as referred to in the introduction to this FM. It should be noted that discounting to present values has nothing to do with inflation. Therefore it should not be confused with the procedure for estimating costs at current prices and later, if projects are approved, setting budgets at cash prices after allowing for estimates of future inflation. This is explained further in paragraph 26.

g.    Uncertainty - the degrees of uncertainty contained in the estimated values of costs and benefits must be considered. Options may need to be compared using both pessimistic and optimistic assumptions about values. Does this alter the rank order of the options?

h.    Project Management - consideration should be given at this stage to the method by which the capital project is to be managed. If possible, one individual should be assigned the lead responsibility for project management at this stage in order that s/he acquires ownership of the project from the outset, rather than being handed the task later and having to live with the assumptions about costs, benefits and timescales made by others.

i.    Any other considerations - are there any other significant matters to be taken into account? Will the project impact on any other area of PPARC? Have all the genuinely interested parties been consulted? Have all staffing and personnel issues been considered?

Step 6 - Presentation of Results

22.    The case must state, in a concise way, the outcome of the five steps outlined in paragraphs 10 to 20 above, highlighting:

a.    objectives;
b.    options;
c.    capital costs, and the availability of funds within cash planning figures (see para 26);
d.    running costs, and the availability of funds from baseline budgets;
e.    benefits;
f.    timing;
g.    the net present value or cost;
h.    uncertainties;
i.    any other considerations;
j.    management, monitoring and evaluation arrangements (see paragraphs 30 to 33 below).

24.    If the case runs to more than four sides of A4 excluding annexes an executive summary should be provided.

Step 7 - Project Approval

26.    The economic appraisal will have been done at current prices, which will be adequate for setting budgets if the project or purchase is to be completed in the same financial year. Projects spanning more than one financial year must therefore be re-estimated prior to approval in cash prices, that is the prices which will actually apply when the bills are paid. Forecasts of future inflation must be taken into account when establishing such allocations at cash prices using HM Treasury GDP Deflators, available from PPARC Finance Division, Swindon Office. In particular cases, such as building works, specialist advice might be sought from consultants. For example, a capital building project estimated to cost £1M at 2000/01 prices but spread over three years might require a cash allocation determined as follows:

	£k
FY:	00/01	01/02	02/03
Estimate at current prices	200	700	100
Index of forecast inflation	100	105.5	110.5
Cash allocation	200	740	110

This example shows that the actual cash provision which would need to be made in the planning figures should be £1.05M.

28.    It is acceptable that in the financial planning of a project a reasonable level of contingency should be built into the budget. This should be explicit at the approval stage, and should be related to the degree of uncertainty attached to a particular project. For example, the straightforward purchase of an item which has a recommended retail price has little uncertainty and a contingency is unlikely to be justified. Indeed, one might hope to purchase at a discount. On the other hand, more complex projects such as the construction of buildings often need contingency sums of the order of 2% to 5%. Contingencies in excess of 5% imply a high degree of uncertainty and must be fully justified at the approvals stage. Contingencies must not be used as a cushion against poor estimation.

29.    Where it proves necessary to submit a case for re-approval, the reasons why extra costs need to be incurred should be fully explained, and the source of additional funds identified.

Step 8 - Monitoring and performance measurement

31.    It must be clear from the outset of each major capital project:

• who has personal responsibility for the management of the project;
• what level of delegated authority they hold to make decisions within the context of the project;
• from whom they seek decisions in excess of their delegated authority;
• from whom they obtain professional and technical advice (eg the architect on a building project or scientific expert for telescope design and build);
• what are the relationships between the project manager and the other members of the management/consultancy team;
• what the divisions of responsibility are between the contractor, any consultants, and the client/customer (PPARC as represented by the project manager); and
• what is the programme for the completion of the project, along with intermediate targets.

33.    This guidance does not extend to describing the techniques for project management. Advice on training in project management is available from the Research Councils’ Joint Training Service.

Step 9 - Post project evaluation and feedback

35.    It is not necessary to carry out post project evaluation on all projects. As a general rule, all capital projects with a capital value of £5m or more should be evaluated on completion, and a report prepared and made available to those who might be involved in such projects in future. Projects of total value in the range of £1m to £5m will be evaluated by questionnaire (see Annex B) which should be completed within three months of the project completion. On occasions this may result in the need to examine a particular project in greater detail. Projects with a total cost of less than £1m may be subject to dipstick tests, usually initiated by PPARC Finance Division, Swindon Office, to evaluate certain characteristics such as cost or time overruns.

36.    Programmes Directorate, in association with PPARC Finance Division, Swindon Office, will take the lead in initiating post project evaluations of larger projects, that is those costing £5m or more, and will agree the terms of reference of the evaluation with the managers concerned. Such an evaluation would normally take the following form:

• define the objectives of the evaluation, ie the aspects of the project which are to be evaluated;
• establish the original aims and objectives of the project (which should be clear from the original economic appraisal);
• measure the implementation of the project against those aims and objectives; against the approved budget and timescale; against any other significant parameters;
• report the results of the evaluation; and
• promulgate the results and any recommendations.

CONCLUSION

QUERIES

Paul Blackford
Planning & Budgeting
PPARC Finance Division, Swindon Office

Annex A to FM 301

NET PRESENT VALUE OR COST (NPV OR NPC)

1.     This annex describes, in simple terms, the method for calculating the NPV or NPC of the costs and benefits, or savings, associated with options which are being appraised. Further information on the method and the underlying economic theory may be found in Appraisal and Evaluation in Central Government (The Green Book).

3.    Normally people prefer to receive cash sooner rather than later and to pay bills later rather than sooner. This is true even in the absence of inflation. For an individual this preference might be measured by the real interest rate on money lent or borrowed. In the public sector too, more weight is given to earlier rather than later costs and benefits. This is done by applying a discount rate to the costs and benefits. The discount rate defines how rapidly the value today of a future real pound sterling falls away through time, just as a real rate of interest determines how fast the value of a pound sterling invested now will increase.

4.    It might be argued that because PPARC cannot invest its cash the discount rate should be zero. That would be wrong. PPARC’s budget, by and large, depends on the current and future pressures on general public expenditure. The marginal cost of carrying out a project, as opposed to not carrying it out, is therefore reflected in the Public Sector Borrowing Requirement (PSBR). This means that money spent today costs more than money spent at some future date. The current Government policy is only to borrow centrally only to fund capital investment - recurrent expenditure being met from revenue, eg taxes.

5.    The discount rate to be used in most PPARC appraisals is 6%. Therefore, taking the base year as 0, the present value of £1 in year 1 is:

£1   x    1       =   £0.943
          1.06
and in year 2:
£1   x    1        =   £0.890
          1.06²
and in year 3:
£1   x     1       =   £0.840
           1.06³
and so on. Discount factors are given in Table 1 to this Annex.

7.    The NPC of Option A would therefore be:

Year	Costs	Discount Factor	NPC	Cumulative NPC
0	0	1.000	0	0
1	70	0.943	66	66
2	70	0.890	62	128
3	70	0.840	59	187
4	70	0.792	55	243
5	70	0.747	52	295
6	70	0.705	49	344
7	70	0.665	47	391

Therefore the NPC (or negative NPV) of Option A is £391k.

Year	Costs	Discount Factor	NPC	Cumulative NPC
0	200	1.000	200	200
1	30	0.943	28	228
2	30	0.890	27	255
3	30	0.840	25	280
4	30	0.792	24	304
5	30	0.747	22	326
6	30	0.705	21	348
7	30	0.665	20	367

Therefore the NPC of Option B is £367k.

10.    The costs and benefits of alternative proposals can be properly compared only if they cover the same time period. For example, if comparing the construction of a building with a 60 year life with one having a 20 year life, one should either assume that the latter will be replaced twice during the 60 years, or alternatively one should show the residual value of the 60 year building as a benefit at the end of 20 years. In such cases further advice should be sought from PPARC Finance Division, Swindon Office.

Annex A to FM 301
Table 1

                                PRESENT VALUE OF £1

Annex B to FM 301

PARTICLE PHYSICS AND ASTRONOMY RESEARCH COUNCIL

POST PROJECT EVALUATION QUESTIONNAIRE

Name of Project _____________________________________________________________

Site _______________________________________________________________________

Approved Budget £k _______________________ Date of approval_____________________

Planned completion date (at time of project approval) _________________________________

Project manager/institute contact _________________________________________________

Please give a brief description of the project, together with its aims and objectives.

Was the project completed within the originally approved budget?         YES/NO

If the answer is No, please provide a brief account of the reasons why the project costs exceeded the originally approved budget.

4.     Was the project completed within the original time-scale?         YES/NO

If No, please state the main factors which caused target date(s) to be missed.

YES/NO

If No, please explain the significant shortcomings.

 

 

 

 

Very satisfactory             [    ]

Fairly satisfactory            [    ]

Not very satisfactory       [    ]

Unsatisfactory                 [    ]

If "Not very" or "Unsatisfactory", please explain serious shortcomings. What steps were taken during the project to overcome such shortcomings? Where appropriate, has any contractual penalty been applied?

 

 

 

 

7.     If the project was carried out wholly or partly by contractors, was their performance:

Very satisfactory             [    ]

Fairly satisfactory            [    ]

Not very satisfactory       [    ]

Unsatisfactory                 [    ]

If "Not very" or "Unsatisfactory", please explain the major shortcomings, the steps taken to rectify these, and any contractual penalties applied.

 

 

 

 

8.     Were the overall project management and implementation arrangements satisfactory? 

        YES/NO

If No, what improvements should be made for similar projects in future?

 

 

 

9.     Please add any general comments which might help in the planning, appraisal and implementation of similar projects in future.

Signed _____________________________________________ Date __________________

Name (block capitals) ___________________________________________ Grade _______

Job Title __________________________________________________________________

Appendix A to FM 301

BIBLIOGRAPHY

Appraisal & Evaluation in Central Government: the Green Book, 1997 ISBN: 011 560034 5
may be purchased direct from:

The Stationery Office
PO Box 276, London SW8 5DT
Telephone orders: 0171873 9090;
Enquiries: 01718730011

or from Stationery Office Bookshops or other accredited agents.

Last updated: 29 June 2001