Capital Budgeting MBA

Introduction

Capital budgeting within an governmental organization has evolved over the past decade. The importance of capital budgeting in today's depression has increased two-fold since the mortgage crisis was first mentioned on the television. The government have multiple roles in capital budgets. According to Davina F. Jacobs the roles are "as instruments of fiscal policy and to improve the net worth of government, and particularly in the area of economic infrastructure as vehicles for economic development" (2008, p. 3). This is important to for an organization or governmental entity to define an appropriate balance between current and capital expenditures or become a problem that suffers from overall poor management and performance while reducing the countries overall net worth.

Discuss how the debt capacity of a governmental entity is determined.

To understand how several governmental entities, determine the appropriate debt capacity within their own governmental organization one must understand what debt capacity is. According Business dictionary debt capacity is "the assessment of the amount of debt an individual or firm can repay in a timely manner (from available means or resources) without jeopardizing its financial viability. (2008). For the City of Seattle, State law restricts debit limits. According Brian McCartan, RCW 39.36.020 and 35.45.200 limits "the City's total legal debt capacity under state law is over $3.0 billion, of which $2.6 billion is currently available" (1995, p.3). There is some more restriction under state law though including that only a portion of its total capacity can be in non-voted debt or what is "referred to as Limited Tax General Obligation" (McCartan, 2008, p.3).

 Though the city could issue about "$500 million of new additional debt" (McCarten, 1995, p.2). it would reduce the overall credit rating of the City. As with Seattle, the most important part is meeting the identified short- and long-term capital and financial plans with the defined goal of strategic capital planning while achieving the city's long-range goals in their Comprehensive plan. As with most cities the indicators that determine debt capacity is "population, income, and value of property (assessed value)" (McCarten, 1995, p. 5). With these figures it comes to simple math, by dividing the indicator of debt with the ability to repay the debt. According to McCarren’s example, "Seattle's debt divided by Seattle's populations yields a debt per capita figure which can be compared to other cities or past levels for Seattle" (1995, p. 5). 

Evaluate the effect of refunding or reorganizing existing debt obligations.

Refunding is an option that allows a city government to add new debt to provide funds to pay principal and interest on an old, outstanding debt as it becomes due or at an earlier date determined by the governing body. There are several advantages of refunding including the ability to take advantage of lowering interest rates, extending the maturity date and revising the governments payment schedule. Problems include that now the government has increased the time of the original debt while providing only a short-term budgetary savings. Refunding can also result in higher total debt service requirements.  According to Steven Maguire, "refunding bonds usually do not add to the stock of outstanding bond or the capital stock" (2001, p.11). 

Reorganization of debt is an "agreed or contractual arrangement between the parties involved for altering the terms for servicing an existing debt, usually on more favorable terms for the debtor" (Shepherd, 2005, p.2). There are several ways reorganization can be accomplished. The first is debt assumption which allows for a new organization to takes over the outstanding debt and is now liable for the debt. An example of this would be the State takes over a debt of a City. Even though the State now owes the debt, the State could require City to repay the State for taking over the debt. Another option is debt restructuring where the city has asked for altered terms and conditions. Examples would be "extending repayment periods, reductions in the contracted interest rate, or adding or extending grace periods for the repayment of principal" (Shepherd, 2005, p. 6). The problems lie in what the terms are and how sustainable the entity will be with reorganization of debt. 

Analyze various funding alternatives that be used to support debt obligation

With the City of Oasis bridge needs there are other options to pursue for alternative funding. According the Peter Samuel, " Alternate financial mechanisms promoted as innovative in the 1990s—such as shadow tolls (payments from the government to private road builders/operators based on the number of vehicles using the road), borrowing against future grants, and the creation of nonprofit corporations to operate highways—have demonstrated that they offer little improvement over the traditional government toll agency model" (2007, p.4). Using a non-recourse toll revue financing allows for all future toll revenues to service the debt is one option for the City of Oasis. The problem arises if projections are short which increases the amount owed at the end or it could be positive in the example of the "The Dallas-Fort Worth Turnpike,

which opened in 1957, removed its tolls in 1977, some 17 years ahead of the business plan, because the bonds were paid off so much faster than expected" (Samuel, 2007, p18). Other problems include uncertainty "creates pressure for larger reserve funds, reduces credit ratings, and increases the cost of capital as bond buyers want a larger risk premium in interest charges" (Samuel, 2007, p. 27.) This rules out some projects for full toll financing, and often calls for tax money to share in funding. There is more positive summaries to this type of revenue since "it has allowed over 5,000 miles of major highways and some of the nation's major bridges to be built and maintained without demands on the taxpayer" (Samuel, 2007, p. 18).  

Shadow tolls are another option where the project is designed, constructed and maintained by a privately owned company. According to Samuel, "a major advantage of shadow toll projects, the British say, is that they deliver cost savings of about 15 %, compared with the costs of having the projects built by traditional contractors and maintained by state employees" (2007, p. 29). One major problem with Shadow Tolls is no new revenue to invest into Oasis transpiration system.

Describe how rating agencies evaluate governmental risk.

Cities are measured of the credit worthiness by three rating agencies; Standard and Poor's, Fitch IBCA and Moody's Investor Service. The five areas that are evaluated are (1) Economic Environment dealing with trend information and revenue to support debt, (2) Debt history looking at previous offering and debt position, (3) Administration; what type of management qualities and what is the organizational structure, (4) Financial performance; types of current operations and the history of the city's financial performance, and (5) Debt management; what are city's debt policies and what type of long-term planning does the city have to reduce their debt. The importance as with any agency or individual is to manage and invest in funds with safety, public trust, liquidity and yield. Keeping in mind that they are there to serve the people of their community and survive this recession.          

Conclusion

Capital budgeting is of extreme importance in financial decision making. Special care should be taken in making these decisions. These decision account for the profitability of the organization and related to fixed assets. The association of policy choices and capital budgeting have significant long-term consequences that determine the future of a city and its mission, programs, processes and procedures. The determining factor of how a city will survive in this recession. 

Reference

Business Dictionary. (2008). Debt Capacity. Definition 1. Retrieved on November 21, 2008 from http://www.businessdictionary.com/definition/debt-capacity.html

Jacobs. D.F. (June 2008). A Review of Capital Budgeting Practices. Retrieved on November 21, 2008 from http://www.imf.org/external/pubs/ft/wp/2008/wp08160.pdf

McCartan, B. (1995). City of Seattle, Department of Finance, Debt Capacity. Retrieved on November 21, 2008 from http://www.mrsc.org/govdocs/s42debt.pdf

Maguire, S. (2001). Tax-Exempt Bonds: A Description of State and Local Government Debt. Retrieved on November 21, 2008 from https://www.policyarchive.org/bitstream/handle/10207/1074/RL30638_20011010.pdf?sequence=1

Samuel, P. (2007). The Role of Tolls in Financing 21st Century Highways. Retrieved on November 22, 2008 from http://www.reason.org/ps359.pdf

Shepherd, R. (2005). Debt Reorganization involving Government. Retrieved on November 22, 2008 from http://www.imf.org/external/NP/sta/tfhpsa/2005/09/DebtR.pdf