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CMF Secretariat: 7270 4820

CAPITAL MODERNISATION FUND BIDDING GUIDANCE 2 July 2001

Introduction

1.         The 2000 Spending Review allocated a further £2.5 billion funding to continue a Capital Modernisation Fund over the years 2001-02 to 2003-04.  This paper provides guidance for departments on how this fourth round of the Capital Modernisation Fund (CMF) will be allocated and invites indicative bids for CMF funds.

2.         The CMF is a central part of the Government’s drive to renew and modernise the UK’s public sector capital stock.  Its role remains to provide capital resources to fund innovative methods of providing a step change in the quality of public service delivery.

3.         The initial £2.5 billion CMF was set up as part of the Comprehensive Spending Review in July 1998.  It has since been allocated in three rounds that were announced at or after the Budgets in the subsequent three years.  Details of allocations in previous rounds can be found on the treasury web site at www.hm-treasury.gov.uk/cmf/index.html or by contacting the above telephone number.

4.         This guidance refers to the fourth round of bidding.  The process of allocations from the new CMF will continue along similar lines to earlier rounds.  The main change to the CMF is that more detailed evaluation will be required of the impact of the projects and the way in which they are managed and delivered.  These are similar to those used for the Invest to Save budget and are set out in paragraphs 40 and 41 below.

Timing

5.         The timetable for the fourth round is as follows:

• indicative bids to be received by 12 October;
• Treasury to aim to provide results of indicative stage by 9 November;
• formal bids to be submitted to the Treasury by 18 January;
• allocations will be announced at or after the 2002 Budget.

Bidding

6.         The existing allocation for the CMF ends in 2003/04.  The £2.5 billion for SR2000 was allocated over three years, comprising £400 million in 2001/2002, £900 million in 2002/2003, and £1.2 billion in 2003/2004.  However, some £600m has already been committed for 2002/2003 and £460m for 2003/2004 in previous allocation rounds.  CMF funds for 2004/2005 onwards will be determined as part of the next spending review.  Departmental bids should therefore be for two years only.  However, if projects are likely to continue into the third year, this should be indicated in the bid, as funds may be able to be carried over into future years through EYF arrangements.

7.         As in previous years, bids to the Treasury will only be accepted from central Government Departments.  Departments may bid with partners in non-departmental public bodies, agencies, local authorities, public corporations or other bodies that deliver public services but they must lead on the bidding process.  As the CMF focuses on public service delivery as a whole, projects at a local level are very unlikely to succeed unless they have the active support of the central government department with policy lead in this area.  Departmental contact names are available on the above telephone number. Any local scheme would also need to demonstrate that it could have significant benefits as a pilot scheme for other areas. 

8.         Although there is no absolute limit on indicative bids, departments are encouraged to spend time putting together a smaller number of high-quality indicative bids.  As a rule of thumb, we would not expect each central government department to put forward between more than five and ten bids.  We will also generally limit final bids to a maximum of five per central government departmental remit.  There is some flexibility for bids made in partnership (see below). 

9.         Cross-cutting bids are positively encouraged.  The CMF supports innovative approaches to delivery of services.  Bidders should therefore assess whether joint projects offering cross-departmental services to public service delivery are likely to better meet the assessment criteria.  Such projects are more likely to be endorsed at the indicative stage to be worked-up into final bids.  Bids made in partnership (across two or more departmental remits or multiple local authorities) can be made on top of each department’s five final bids, although these too should be limited in number.

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Criteria for assessing bids

10.       Funds will be allocated from the CMF in support of high quality investment projects which improve key public services or public infrastructure.  Particular factors (not in a particular order of priority) which will be taken into account in judging bids will be:

• the extent to which the project is complementary to the Department’s Departmental Investment Strategy.  Where relevant, bids in partnership with LAs should demonstrate the fit with local PSA service delivery targets and initiatives to promote electronic service delivery in local government;
• the measurable impact on public service delivery – how far the project contributes to the Government’s wider objectives for modernising public services;
• how far the project applies genuinely innovative approaches to service delivery.  This might include new forms of joint working within the public or private sector and investments to manage existing assets better, particularly where approaches could be applied more generally if successful.  This includes innovative approaches to the procurement of capital assets;
• the results and quality of the economic appraisal of the project, which should take account of both financial and non financial benefits and costs, including environmental impact and specifically the benefits the project delivers, in terms of both better service delivery and future efficiency savings.  A project will not be funded unless it is projected to deliver benefits significantly in excess of costs, after adjusting for risk. The greater the excess of benefits over costs relative to the funding requested, the greater the likelihood of a bid being successful. The quality of the appraisal will be judged both in terms of its technical compliance with Green Book guidance, and for the robustness of the evidence base upon which the impact assessments are based;
• the impact on the efficiency and effectiveness of the service and in particular whether the project will produce a step change improvement in the quality and effectiveness of the public service and/or reduce the cost of delivering those services;
• how far the project is genuinely additional and would not have gone ahead without funding from the CMF;
• the robustness of arrangements for delivering and managing the project, accounting for spending, monitoring progress and evaluating the impact.

11.       The requirements and process of the indicative bidding stage are set out in paragraphs 21-26.

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12.       Since the CMF is intended to support innovation in public service delivery, it would be unlikely that bids would be funded which are similar to those supported in earlier rounds. 

Electronic service delivery

13.       In seeking innovative ways to deliver services, many departments will consider the use of ICT and switching to electronic service delivery.  The CMF will therefore continue to encourage bid for projects which deliver genuinely new electronic service delivery potential.  This is not a criterion and in no way excludes other forms of capital investment from CMF funding.  The overriding test must be that this electronic service delivery enhances the bidder’s public service delivery.  Projects which should be funded from the ‘dual key’ money awarded in SR2000 are not additional and will not be eligible for CMF funding. 

Financial issues

14.       The CMF only provides capital funding.  The only exception is for PFI project funding (see paragraph 18).  Departments will be expected to meet any associated current costs from within their existing allocations. 

15.       There is no requirement for departments to make a contribution to the capital cost of the project.  However, financial contributions from the department and other funding partners demonstrates commitment to the project.  Bidders should indicate whether it is possible to modify their bid in the event that the level of funding provided from the CMF is less than that requested.

16.       The associated capital charges arising from CMF projects in 2002-03 will be added to non-cash items in AME without recourse to departmental DEL allocations.  It is most unlikely that a CMF project will add to the civil estate and thus to capital charges in administration costs and DEL.  However, from 2003-2004 onwards, all capital charge costs will be incorporated into DEL.  For this round of the CMF, since the results will be known in advance of the spending review, these costs will automatically be reclassified into departmental DEL for 2003-2004.

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PFI and PPP

17.       Public services should be delivered by the sector best placed to provide the service most effectively.  Value for money remains the determinant of choice of public versus private delivery.  Before bidding, departments are encouraged to consider whether the project proposed would be suitable for taking forward under the Private Finance Initiative (PFI), or as a public private partnership (PPP) such as a joint venture.  The Steering Committee will expressly consider whether the project could be better pursued through a private finance or partnership route so this should be specifically addressed.

18.       The CMF will fund PFI and PPP projects.  Where investment is incurred by the private sector, the service delivery charge can be funded by CMF despite the fact that this is classified as current spend.  It should be noted that funding is limited to the years 2002-2003 to 2003-04.  Funding beyond these years will need to be examined as part of the spending review.

What counts as a project?

19.       Each CMF bid should normally be a self-contained project supported by a full appraisal.  However, this will be interpreted flexibly to include groups of related smaller projects and well-defined programmes that meet the criteria of the CMF.  Such an approach might be justified for example for cross-cutting bids where the Department is achieving its objectives through wider public sector partners.  Programme bids should set out clearly:

• the purpose of the programme;
• the criteria to be applied;
• the mechanisms for allocation.

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20.       There are no limitations on the scale of the bids.  We will consider both small and large projects.  In the case of pilot projects, we will give weight to the fact that a more experimental approach is being taken and accept that full detailed appraisal may not be possible.  The following table illustrates the range and size of projects funded in earlier rounds:

 The cost of the smallest project so far funded is £400,000 and the largest is £400million. 

What is the procedure for bidding?

Indicative bids

21.       Those considering funding from the CMF should lodge an indicative bid to arrive at the Treasury by close on Friday 12 October 2001.  Indicative bids should be submitted to the CMF Secretariat electronically at the following e-mail address: ian.polin@hm-treasury.gsi.gov.uk (please call the above number if electronic submission is a problem).

22.       The indicative bid should be in the form of a one page summary table (a pro-forma is attached at Annex A) supported by a maximum of three pages of narrative.  The narrative details should address each of the following concisely:

• a brief description of the project;
• the details of the bodies which are party to it;
• a summary of the innovative features of the project – showing genuinely new ideas proposed;
• a preliminary assessment of the project’s benefits to end users of the public service (including the efficiency and effectiveness of delivery); and
• an initial estimate of the funds sought from the CMF, split between the 2 years, and indicating whether the project could continue into the third year, if funds were carried over.

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23.       In addition, Departments making more than one bid should provide a brief analysis of no more than two pages of their overall package of bids, setting out how the bids fit together (including any links and overlaps between them) and how they fit with the Department’s overall investment strategy.

24.       Departments are strongly encouraged to discuss the development of indicative bids with their spending team contact.  Spending teams will be able to advise on the likely prospects of particular bids and how they could best be presented.  In addition, spending teams may suggest alternative bids that could be developed.   

25.       A sift of indicative bids will be carried out to limit the numbers of bids at the formal stage to a realistic level and to reduce bidders’ nugatory time and effort in preparing bids that do not fit the criteria.  The objectives of this sift will be to:

• exclude any bids which do not have the potential to meet the criteria as set out in paragraph 10;
• narrow the field to those bids that offer the most potential in terms of public service benefit and innovation; and
• exclude bids that fail the additionality test.

26.       The secretariat will advise prospective bidders on the results and invite selected projects to be worked-up into formal bids.   This might include advice on how the project can be tailored to be more consistent with the overall CMF criteria.

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Formal bids

27.       Formal bids must be sent to the CMF secretariat by close on 18 January 2002.  These should also be in the format of a summary table and a narrative.  The format for these is set out in Annex B.  Bids should be submitted electronically to the following e-mail address: lindsey.sullivan@hm-treasury.gsi.gov.uk. Examples of previous successful bids are available from the Secretariat.   

Bid assessment

28.       Bids will be assessed against the criteria set out above by an official committee chaired by Adam Sharples, Director, Public Spending, HM Treasury.  Treasury economists will assess the economic appraisals provided by Departments, advice on electronic service delivery will be provided by the Central IT Unit of the Cabinet Office and bids involving local authorities by the Treasury Local Government team.  The Committee will make recommendations to Treasury Ministers who will make final decisions on the bids.

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Accountability and audit

29.       Each project must have a designated Accounting Officer (AO) who is personally responsible for the propriety and regularity of the expenditure incurred, as well as the value for money of the project.  For projects undertaken within central government, this would be the department’s AO as CMF funding will fall within the department’s DEL.

30.       Formal bids should also set out the arrangements for audit of the expenditure on the projects.  The audit arrangements should normally follow from the arrangements for accountability for expenditure.  For example, where projects fall within a department’s DEL, the project would be audited by the National Audit Office along with the rest of the body’s business.

31.       These arrangements become more complicated with cross-departmental projects.  This is an issue that such projects will need to consider.  The simplest solution would be to agree for one partner to take lead responsibility and implementation with accountability falling to that department’s AO who would oversee a transfer of resources from the other organisation(s). 

Appraisal, monitoring and evaluation

32.       All formal bids must be supported by an appraisal of the project. This requirement will only be waived in the case of pilot projects seeking seedcorn funding of £50,000 or less. Annex C provides some summary guidance on the important areas of such an appraisal. This should be carried out in accordance with Appraisal and Evaluation in Central Government (the 'Green Book'). The Green Book is in the process of being updated, but for an electronic version of the current Green Book go to www.hm-treasury.gov.uk/pdf/2000/greenbook.pdf. Hard copies can be obtained from the Stationary Office (tel: 0870 600 5522, e-mail book.orders@theso.co.uk)

33.       The appraisal should contain an analysis of alternative options, including ‘do nothing’ and changes in the mode of service delivery by departments on their own account.

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34.       Appraisals should normally show a positive net present value (NPV). All the expected costs and benefits, and any value placed upon them, must be made transparent. Benefits could include lessons to be applied in other projects.  As much evidence as possible should be provided to support the scale of the impacts attributed to the project.  If any elements cannot be valued in money terms or cannot easily be quantified, this should be noted and explained - for example the environmental impact.   

35.       Bids should show the proposed project is both deliverable in the time horizon over which it is expected to be procured and is viable in terms of its affordability, risk transfer, scope and project management. Bids should also set out arrangements for monitoring the project, ie routine checking of progress against plan. In practice the monitoring process should highlight where projects are not working as intended as early as possible, and to ensure that unsuccessful projects are swiftly amended or discontinued.

36.       Each bid should also specify arrangements for evaluating the success of each project and disseminating the findings to other parts of government. This will establish how well the investment has performed in relation to the estimated costs and benefits, and the extent to which the objectives set for the project have been met. It will also allow other bodies to benefit from any lessons learned.

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37.       Evaluations should be carried out in accordance with the principles set out in the Green Book and Policy Evaluation: A Guide For Managers (also published by the Treasury). A summary of this is attached at Annex D.

Draw-down of funds

38.       The resources allocated to successful bids will be added as ringfenced additions to the relevant Department's Departmental Expenditure Limits for the years concerned. In those cases where funding is awarded outside central Government, funds will be passed on by the relevant Department to the body concerned. Departments will be able to take advantage of the new arrangements for end year flexibility (EYF).  However, Departments should discuss EYF of CMF funds with their spending team contacts.  Departments will be expected to be able to explain slippage in implementation plans.  There may be some flexibility for Departments to move funds between CMF projects, which will again need to be agreed with spending team contacts.

Scotland, Wales and Northern Ireland

39.       Allocations to the devolved bodies in Scotland, Wales and Northern Ireland (NB this does not include the Northern Ireland Office) will be in the form of a comparable population based share from the total fund calculated on the basis of successful bids. This follows the same format as earlier rounds.

Reporting to HM Treasury

40.       It will be a condition of funding that an implementation plan is drawn up by successful bidders for each project setting out the key milestones for its implementation and the costs incurred at each stage; and for monitoring and evaluating its success.  A proforma implementation plan will be provided to those invited to make formal bids. 

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41.       Further conditions of funding are that:

• pro-forma reports are submitted every six months detailing the progress made to date in implementation;
• an evaluation of the project is carried out in accordance with the principles in Annex D.  As a minimum, an evaluation should be carried out once a project has been implemented.  However, in the case of projects lasting up to three years, an “impact” evaluation should be carried out at a mid-point in the project’s implementation as well.  In both cases, the evaluation should preferably be carried out by an independent third party.  In planning evaluations, Departments should bear in mind that the results may provide important evidence for future bids to the CMF or for plans in spending reviews. 

Unsuccessful bids

42.       Feedback will be available on unsuccessful bids.

Enquiries

43.       Enquiries on this guidance should be addressed to departmental spending team contacts, or to Lindsey Sullivan, General Expenditure Policy (020 7270 4820), e-mail: lindsey.sullivan@hm-treasury.gsi.gov.uk

ANNEX A: PRO FORMA FOR INDICATIVE BIDS

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Indicative Bids should be sent to:

Ian Polin
CMF Secretariat
Room 107/1
HM Treasury
Parliament Street
London SWIP 3AG

E-mail: ian.polin@hm-treasury.gsi.gov.uk

ANNEX B: INFORMATION TO BE INCLUDED IN FORMAL BIDS

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Narrative

The narrative for each bid should be structured under the following headings.

1. The project title

2. The parties

List the departments, Agencies or other bodies involved in the project and who is in the lead.

3. The project

Briefly describe the project

4. Objectives of project

List the objectives of the project (as bullet points) and state how meeting these will make a difference to the delivery of public services

5. Benefits

List the benefits to the end users of the public service concerned;

List benefits to the efficiency and effectiveness of delivery of the service.

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6. Funding requirements for project

a) please fill in the table below:

b) please indicate how bidder's and other sources of finance will be funded.

c) please indicate whether project will continue into third year (i.e. 2004/5) and how much funding would need to be carried over (including changes in capital charges).

7. Flexibility

State whether it would be possible to:

• proceed with the project on a smaller scale; or

• increase the bodies' total contribution to the project cost and, if so, by how much;

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8. Local/regional impact

State the geographical impact of the project

9. Economic appraisal

Provide a brief summary of the economic appraisal (total costs, benefits and NPV and options considers). Attach a full copy of the economic appraisal and supporting material. This should explain the underlying assumptions, set out the calculation of the net present value of the project and assess the deliverability of the project.

10. Innovation

Describe the innovations which the project will involve or (where applicable) pilot. If the method of service delivery, procurement or management of assets has been tried elsewhere, provide available details of the successes and failures.

11. Additionality test

Provide evidence that the project would have not proceeded in their same form or on the same timescale without support from the CMF.

12. Accountability and audit

Name the proposed Accounting Officer for the project and the arrangements for auditing expenditure on it.

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13. Monitoring and evaluation

Provide details of the arrangements for monitoring and evaluating the project, including proposed dates for ongoing and ex-post reviews and (where appropriate) impact evaluations.

Formal Bids should be sent to:

Lindsey Sullivan
CMF Secretariat
Room 107/1
HM Treasury
Parliament Street
London SWIP 3AG

E-mail: lindsey.sullivan@hm-treasury.gsi.gov.uk

ANNEX C: SUPPLEMENTARY GUIDANCE ON PREPARATION OF ECONOMIC APPRAISALS

 A. INTRODUCTION

A1. This note is intended to provide summary guidance on the most important areas of economic analysis that need to be covered in economic appraisals forming part of round three bids for CMF funding.

A2. It is not intended as a replacement for the general guidance on preparing economic appraisals contained in the 'Green Book'. Rather, it is intended to provide a more focused guide to the essentials that will be considered in evaluating and scoring economic appraisals in the context of CMF bids.

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A3. The Green Book was written to help government departments and agencies appraise and evaluate their activities effectively. It is intended to ensure consistency across government in appraisal and evaluation practice. Departments develop their own guidance which is focused on their own areas of work but which is consistent with the Green Book.

A4. The principles contained in the Green Book apply equally to local and central government. This note is based on the principles set out in the Green Book. These principles provide the basis for everyone undertaking an economic analysis as part of a bid for CMF funding.

A5. Although other forms of guidance can be used by local authorities or health authorities in preparing economic appraisals, we would expect these forms of guidance to be consistent with Green Book principles.

A6. The Green Book (full title; Appraisal and Evaluation in Central Government) is currently under review. An electronic version of the current Green Book is available at www.hm-treasury.gov.uk/pdf/2000/greenbook.pdf. Paper copies can be obtained from The Stationary Office, Telephone orders: 0870-600-5522, Fax orders: 0870-600-5533, e-mail: book.orders@theso.co.uk

A7. This guidance does not cover evaluation of projects. Although this is an important area for CMF bids to cover, it will be considered separately from the assessment of CMF economic appraisals.

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 B. PURPOSE OF ECONOMIC APPRAISAL

(Green Book paras 1.1 - 1.5 and 2.1 - 2.3)

B1. The main purposes of economic appraisal are:

• to provide an assessment of the options available to fulfil the objectives of a project. Hence, the importance of identifying and analysing different options;

• to provide an analysis and comparison of the potential costs and benefits, the risks and uncertainties associated with the project. Hence, the assumptions on which the projected costs and benefits are based are crucial and must be tested (see sensitivity analysis below), and;

• to provide underlying analysis of the relative merits of the options to inform the decision on which is the best option.

 C. KEY AREAS OF ANALYSIS

C1. With the above purposes in mind, six appraisal categories will be used in assessing economic appraisals. Guidance on each category is given below. Throughout the economic appraisal, the objectives identified in the bid will provide the foundation of the analysis.

1. Choice and Definition of Options

(Green Book paras 2.8 - 2.10 and 4.2 - 4.11)

• Options are defined as alternative ways of achieving the objectives of the project.

• The appropriate number of options to be considered depends on the size and scope of the project.

• It will be important not to rule out any options until they have been given due consideration.

• However, it will usually be the case that only a small number of options require full-scale analysis.

• If options are ruled out, sensible reasons need to be given.

• First, a "do minimum" option should be constructed. In previous CMF bids where a "do nothing" option has been considered, it has often been dismissed as not viable politically, or as not meeting objectives. However, the real question is "what are the costs and benefits of an option that involves doing the minimum necessary to meet the most important objectives of the project".

• Examples of ways in which options may differ are; (i) the scale of the project: it may be useful to have an option that identifies ways in which the project could be scaled down. This would be useful in helping to identify which parts of the project are most important and which are more marginal; (ii) the timing and/or phasing in of the project, and; (iii) the extent of private sector involvement.

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Checklist

• Is the range of options being considered wide enough?

• Are the reasons for dropping options reasonable?

• Has any potentially promising option been ruled out?

2. Identification of Benefits

• All benefits resulting from the project should be identified. Benefits should be quantified where possible.

• Where this is not possible, benefits should be qualitatively identified and discussed.

• Where benefits can be quantified, the crucial criteria are that;

• the scale of projected benefits should be based on realistic assumptions;

• the assumptions should be stated, and;

• the key assumptions should be tested as part of the analysis in order to determine the impact of changes to them on the overall benefits and costs of the project (see sensitivity analysis below).

• Evidence should be provided in support of the scale of the impacts attributed to the projects.

• The credibility of positive net present value calculations (see net present value calculations below) for different options will be undermined if the assumptions on which projected costs and benefits are based are not given, have not been tested or are not realistic.

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Checklist

• Have all the benefits been identified and profiled?

• Have the benefits been quantified where possible?

• Are the values of the benefits based on realistic assumptions?

3. Identification of Costs

• All expected costs resulting from the project should be identified and quantified where possible.

• If any costs cannot be valued in money terms, or cannot easily be quantified, the reasons should be explained.

• Bidders should also endeavour to give some weighting to these unquantified costs which reflects their importance and which will allow more accurate comparisons to be made between options.

• Where costs can be quantified, the crucial criteria are that;

• the scale of projected costs should be based on realistic assumptions;

• the assumptions should be stated, and;

• the key assumptions should be tested as part of the analysis in order to determine the impact of changes to them on the overall costs of the project (see sensitivity analysis below).

• The credibility of positive net present value calculations (see net present value calculations below) for different options will be undermined if the assumptions on which projected costs and benefits are based are not given, have not been tested or are not realistic.

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Checklist

• Have all the costs been identified and profiled?

• Have the costs been quantified where possible?

• Are the values of the costs based on realistic assumptions?

4. Cost Benefit Analysis

(Green Book paras 4.12 - 4.42)

a) Purpose and Scope of Cost Benefit Analysis

• Cost benefit analysis (CBA) can be defined as a way of seeking to identify and value in money terms as many of the costs and benefits of a proposal as possible.

• This encompasses the costs and benefits associated with each of the options which would fulfil the objectives (or main objectives) of the project.

• The number of options subjected to CBA and the time and effort employed in doing so will vary according to the overall size of the project.

• No option should be dismissed without due consideration, but, usually, only a small number of options will require full scale analysis.

• Costs that have already been incurred (or funds which have already been irrevocably committed to the project) should not be included in CBA. For example, CMF funding received for a pilot project in the previous round should not be included.

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b) Net Present Value or Discounted Cash Flow Calculations

(Green Book paras 4.52 - 4.63)

• The purpose of doing net present value (NPV) or discounted cash flow (DCF) calculations for each of the main options is to allow comparison of the options and identify which yields the greatest net benefits (or is the least costly).

• It is essential therefore to present NPVs for each of the options being considered in order that these can be compared and the option yielding greatest net benefits identified.

• A worked example of how to calculate NPVs follows.

Checklist

• Have the stream of costs and benefits for a number of options been identified and discounted (an explanation of discounting follows)?

• Are the costs and benefits based on realistic assumptions?

• Have the bases for assumptions been stated and have the assumptions been tested (see sensitivity analysis below)?

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c) Cost Effectiveness

• Where the identified objectives of the project preclude valuation of benefits in money terms, the options may be considered in terms of a cost effectiveness analysis.

• For example, the objective may be delivery of a health care service by "virtual" means rather than by conventional means. Since health cannot be easily valued it may be more appropriate to set the required level of service provision and compare the net present costs (NPCs) of the different options being considered for the delivery of this service level. The option yielding the lowest NPC is cost effective.

d) Choice between presenting NPV and DCF Calculations

• Where it is possible, NPV calculations should be presented in preference to DCF calculations.

• In theory, NPVs will provide a more thorough analysis because NPCs simply assume that the benefits outweigh the costs even if this may not be the case.

• However, reliance on NPVs can be misleading in cases where the majority of benefits are of a qualitative nature.

• In these circumstances, NPV calculations can still be produced (provided that there are some quantified benefits).

• It will be particularly important in such cases for the benefits not included in the calculations to be backed up by supporting qualitative information.

• Where a cost effectiveness analysis is used, explanation should be given as to why benefits are assumed to outweigh costs.

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5. Analysis of Risk and Uncertainty

(Green Book 4.43 - 4.51)

• There will usually be uncertainty about some aspects of a project (for example, projected costs and/or savings may not be of the size they were forecast to be).

• There may also be a risk that circumstances surrounding a project will alter and result in material impact on the project (for example, legislative changes may occur which affect the workload of an organisation).

• Risk and uncertainty should be explicitly considered as part of an economic appraisal. For example, it will be important to test the assumptions made about costs and savings in order to gauge the impact of changes in these assumptions on overall returns to a project. The best way of handling this will often be to use sensitivity analysis.

a) Sensitivity Analysis

(Green Book 4.48 - 4.51)

• Sensitivity analysis is the process of gauging the impact of different assumptions (about costs and savings) on overall project returns and costs.

• Sensitivity analysis will help to demonstrate the dependence of project returns and costs on key assumptions.

• For example, a key assumption might be that the project will result in a saving of £30,000 in staff costs in each of the next three years.

• Sensitivity analysis asks how dependant overall project returns and costs are on this particular assumption (and tests the impact on the projected outcome if the savings were, for example, assumed to be only £15,000 per year).

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• If it is found that the overall outcome is very sensitive to changes in an assumption then it will be particularly important to examine the assumption to ensure that it is as reliable as possible. It will also be important to set out fully the basis of the assumption.

• Sensitivity analysis should also include subjective assessment of the likelihood of different scenarios (eg. the likelihood of £15,000 versus £30,000 staff savings).

• Sensitivity analysis should also be used to assess the risks and uncertainties associated with factors that have not been valued in money terms.

• It should be noted that alterations to key assumptions may involve both better and worse returns than the base case. For example, if the base case is £30,000 savings per year, alternatives based on different assumptions may yield savings of £15,000 or £45,000.

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Checklist

• Have all important risks and uncertainties been identified and assessed for each option?

• Has sensitivity analysis been used to assess their impact on project returns?

6. Presentation of Results

• Analyses should be set out clearly and comprehensively covering each of the above categories.

• It should be made clear who will benefit from, and who will bear the cost of each option.

• Although quality of presentation will be given less weight in the overall assessment of economic appraisals, it will be important for the analysis to be set out clearly for each of the five key areas discussed above.

• A guide to the weighting to be given to different aspects of the appraisal follows.

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 D. CALCULATION OF NET PRESENT VALUE

(Green Book paras 4.52 - 4.63 and Annex H)

The following tables give an illustrative example of how to calculate net present values (NPVs) for different options that would fulfil the objectives of a project. This example is intended primarily to give an indication of the mechanics of calculating NPVs. The Green Book should be referred to for further detail. Explanatory notes are given below the tables.

TABLE 1

1. The discount factor is a means of reducing future net benefits to their value in the base year (Year 0).

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Hence, cumulative NPV is £100,500 over four years.

TABLE 2

Hence, cumulative NPV is minus £86,000 over four years.

1,2 Costs and Benefits: these rows relate to the anticipated costs and benefits arising from the options. It can be seen that the options considered have different cost profiles and are expected to yield a different level of benefits. A clear breakdown of the elements making up these costs and benefits should be stated in the analysis, together with the underlying assumptions, and a sensitivity analysis of the key variables.

7. Net Benefits

The sum of the benefits less the sum of the costs in each year gives net benefits for the year in question. Net benefits should be calculated separately for each year (for each option).

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8. Discount Factor

(Green Book paragraphs 4.52 - 4.63)

Discount factors are a means of reducing future net benefits to their value in the base year (Year 0).

The discount factors given in the above tables are based on a discount rate of 6%. This is the real discount rate which is most commonly used in central Government applications. Exceptions to this general rule are explained in Annex G of the Green Book.

It is recommended that the first year in which the project will run is chosen as the base year, which is in effect the "current" year for the project. On this basis, the discount factor in the base year will be 1 (i.e. costs and benefits which accrue in this year do not need to be discounted further).

In practice, it is usually sufficiently accurate to treat all sums accruing during the course of a year as falling at mid-year.

9. Net Present Value

The discount factor for each year should be multiplied by the net benefits in that year to give a net present value (NPV) for each year of the project.

In cases where calculations are undertaken purely in terms of costs, the sum of the costs in each year should be multiplied by the discount factor to give the net present cost.

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10. Cumulative Net Present Value

The cumulative NPV is the sum of the NPVs up to the year in question. For example, the cumulative NPV for option 1 is minus £319,500 over the first three years but plus £100,500 over the first four years.

This suggests that option 1 would break even during the fourth year. Hence, the cumulative NPV shows in which year the project breaks even. This can be a useful piece of information, particularly in the context of carrying out sensitivity analysis (i.e. changes to assumptions could alter the point in time at which the project breaks even, suggesting that it will be particularly important to ensure that these assumptions are as accurate as possible).

The costs and benefits of alternative options can be properly compared only if they cover the same time period. (See Green Book paragraphs 4.60 and 4.61 for further information).

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 E. WEIGHTING OF THE ELEMENTS OF ECONOMIC APPRAISAL

• The three categories of economic appraisal which will be given greatest (and equal) weight in the assessment of individual bids are analysis of costs, analysis of benefits and cost benefit analysis.

• These elements of appraisal are of central importance. It is crucial accurately to identify the extent and range of costs and benefits and to base projected costs and benefits on realistic and tested assumptions (as described above).

• This does not mean that a bid which presents only a cost effectiveness analysis with DCF calculations (as opposed to a full cost benefit analysis with NPVs) will be disadvantaged by so doing.

• The quality of the analysis following the guidance set out above will be the basis for scoring in each section.

• The analyses of options and of risk/uncertainty will each be given equal but slightly lower weight than the analyses of costs and benefits.

• This is because high quality analyses of options and risks/uncertainty would be outweighed by low quality analyses of costs and benefits.

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• For example, a wide range of options could be identified but the analysis of the costs/benefits associated with each could be of a low quality (eg. lack of information about the assumptions on which cost savings are based). This would undermine the usefulness of the analysis of options to a greater extent than a thorough analysis of costs and benefits for a narrow range of options.

• Presentation of results will be given least weight in the assessment of appraisals.

• The most important thing is the quality of the analysis but good presentation will help to make this quality clear.

ANNEX D

EVALUATION REQUIREMENTS

This guidance summarises requirements for evaluation set out in the ‘Green Book’.

Each formal bid should specify the arrangements for evaluating the success of each project and disseminating the findings to other parts of government. This will establish how well the investment has performed in relation to the estimated costs and benefits, and the extent to which the objectives set for the project have been met. It will also allow other bodies to benefit from any lessons learned. 

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 As a minimum, an evaluation should be carried out once a project has been implemented. However, in the case of projects lasting for up to three years, an “impact” evaluation should be carried out at a mid-point in the project’s implementation as well. In both cases, the evaluation should be carried out by an independent third party.

The scope of evaluations should include the following questions:

• have the objectives been achieved in terms of quality, quantity and time?
• what is the scale of the impacts achieved, when quantified?
• is the achievement measured against a valid baseline of the position at the start of the project and of what would have happened otherwise?
• to what extent was the achievement the effect of external factors?
• if achievement is difficult to measure directly, are their suitable surrogate measures?
• have the inputs been made according to planned amounts, timing and quality?
• has the project provided the most cost effective solution for achieving  the objective?
• what steps are planned to disseminate the conclusions of the evaluation to other public sector bodies?

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