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The step provides a broad outline of the issues, concepts and outputs
associated with economic and financial analyses during the process of
developing a Strategic MSWM Plan. It is not a blueprint to be followed, nor is
it necessary to have an intimate knowledge of all its contents. It does,
however, provide guidance on the range of economic and financial tasks
necessary during the strategic planning process.
How to use this
step?
Guidance in this step has been structured into three
parts:
Part I: Strengthening the financial policy
framework
Part II: Economic evaluation of alternative
strategies
Part III: Financial assessment of the preferred
MSWM Strategic Plan
The linkages between the three components of this step
are illustrated in Figure 4D.1.
Part I focuses on key issues associated with
strengthening the financial policy framework of a
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Step 4 D - 3
municipality. It provides guidance on how to improve
the overall financial sustainability of MSWM systems.
Part II covers the process of undertaking an economic
evaluation of strategy alternatives.. Economic
evaluation should be carried out in tandem with other
technical and environmental evaluations to assist in
the short-listing and selection of feasible options.
Once a preferred MSWM Strategic Plan has been
selected its long-term financial sustainability must be
assessed. Methodologies, tools and examples to guide
this assessment are presented in Part III.
How long will it
take to complete
Step 4D?
Issues covered in Step 4D will need to be addressed
during preparation of both the Strategy and Action
Plan (see Step 5 and Step 6). Work on strategy-level
issues is likely to take 6-9 months, with the Action Plan
requiring a further 6-9 months to complete.
Clearly, the process is often not quite so
straightforward as this, or the differences between the
parts quite so clear-cut. Some overlap is inevitable.
The essential aim should be to establish a
comprehensive framework for MSWM, and provide
timely feedback on the economic and financial viability
of strategic planning proposals at several key stages of
the planning process.
Who should use
this step?
Economics and finance specialists working on the
Strategic MSWM Plan. Where sufficient in house
expertise is not available, specialists may need to be
hired to work under the direction of the Working
Group.
Who else should
read Step 4D for
information?
Step 4D should also prove useful to any specialist with
interest in institutional/policy aspects of MSWM, and
to engineers specialising in technical aspects. By
reading this section, both of these groups will gain
more understanding about why the economist needs
certain data, and how economic information,
particularly in relation to demand, can feed into
technical design.
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Figure 4D.1 Linkage between the Parts of Step 4D
What are the
typical outputs
of the financial
and economic
analysis?
Typical outputs from the analysis are likely to include the
following, normally appearing as sections of reports
prepared during project development.
For Part I: Policy Framework
• analysis of the existing financial policy and management
framework;
• proposals for improving the financial policy and
management framework, including establishing realistic
financial objectives, and an analysis of cost recovery
options
• an affordability analysis; and possibly
• a willingness to pay analysis;
For Part II and Part III: Economic and Financial Assessment
• economic evaluation of alternative strategies
(particularly cost benefit or cost effectiveness analysis);
• financial assessment of the preferred Strategic MSWM
Plan;
• an indicative investment plan (showing sources and
uses of investment finance);
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When would
the services of
the economic
and financial
analyst be
required?
• an indicative recurrent funding plan for the Action Plan
(showing sources and uses of recurrent finance
consistent with cost recovery objectives);
• a sources and uses of funds statement (projected cash
flow analysis for the Action Plan during implementation
and initial years of operation);
• financial statements for the responsible municipal
authority; and
• proposals for physical and financial indicators to
measure performance during and after strategy
implementation.
The services of the economic and financial analyst are thus
required throughout the strategy planning process.
Namely:
• at the outset, to review existing financial arrangements;
• during the early stages to help develop an improved
financial management framework;
• during the early stages to assess affordability and the
demand for various options;
• during the early stages to analyse the appropriateness of
possible plant and equipment options;
• during the middle stages to help formulate and evaluate
alternative options;
• during the later stages to assess the financing
implications of the preferred option and to prepare a
financial assessment;
• during the final stages to assess the implications of
modifications to the preferred MSWM Strategic Plan;
and
• during the final stages to establish physical and financial
indicators by which to monitor performance during and
after strategy implementation.
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4D.2 KEY MESSAGES OF THIS STEP
‘Key Messages’
Part I: Strengthening Financial Policy
1. Strengthening the current financial
management policy for MSWM
services requires the design of a
demand responsive set of services
which are affordable and which are
based on appropriate technology.
4. Responsibility and accountability
for service quality and costs must be
clearly focused within the
management structure. A unified
organisational structure should be
adopted with separate cost and
responsibility centres.
2. Increasing the cost-effectiveness of
existing services (‘doing more for
your money’) and identifying new
revenue sources are essential to
increase service quality and
coverage.
5. Thorough planning for
financing the recurrent costs of the
strategy must be given equal if not
greater weight than for financing
investment costs.
3. Service quality and costeffectiveness
can e improved only if
performance indicators are available
by which these can be measured.
Such performance indicators depend
on the existence of proper financial
and management accounting
systems.
6. The financial sustainability of
MSWM services depends on the
generation of sufficient revenue to
cover equipment replacement and other
long-term liabilities. A move from
cash to ‘accruals’ accounting is
essential.
‘Key Messages’
Parts II and III: Economic and Financial Assessment
1. Municipal decision-makers need to
be aware of the full economic and
financial costs and benefits of the
strategy and of its individual
components
4. The sensitivity of the
economic and financial analyses
to key assumptions should
always be examined
2. A cost benefit or cost effectiveness
analysis should be carried out to
identify the economically preferred
MSWM option. Environmental and
health benefits should be included
where possible.
5. A detailed financial analysis
should be carried out for the
preferred project
3. Undue optimism in each of the cost
and benefit estimates should be
avoided. All cost/benefit assumptions
should be made explicit
6. The Action Plan or project
must be financially sustainable
in the long term.
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PART I: THE FINANCIAL POLICY FRAMEWORK
This part considers a number of financial policy issues that need to be addressed during
the MSWM Strategic Plan development process (see Step 5). The aim is to guide the
process of establishing and then strengthening the policy and management framework.
The following issues are covered:
• Features of the financial policy and management framework typically found in
existing MSWM services;
• Strengthening financial management and control;
• Strengthening cost recovery policy; and
• Taking a demand responsive approach to planning – looking at the issues of
affordability and willingness-to-pay
Begin to establish the financial objectives of the municipal authorities or
MSWM agency (including charging and cost recovery policy), taking into
account the demands of MSWM service customers.
4D.3 REVIEW OF EXISTING FINANCIAL POLICY AND MANAGEMENT ARRANGEMENTS
 The responsibility for providing solid waste management services is usually an essential
function of municipal governments. How the services are actually provided varies from
city to city. In many cities, solid waste management services are provided by a city waste
department that is an integral part of the municipal administration. In others, the
services are provided by a wholly owned municipal enterprise operating to some extent
at arm’s length from the government. In others, although rarely, services are provided
by a fully autonomous enterprise (public or private) operating under contract to the
government. Each of these arrangements reflects a different level of sophistication in
terms of the financing and cost recovery arrangements typically found to be in place.
Where services are provided by a municipal waste department, funds tend to be
provided out of the normal municipal budgetary process. Domestic users may make a
contribution to the cost of providing the services – possibly through a local property tax
or a communal services tax – but the amount of funds raised through such mechanisms
does not usually relate directly to the cost of service. Under these circumstances the
waste department is in the position of having regularly (usually annually) to present its
budget request for the following period. This is then subject to municipal treasury
review, and a decision is made on the amount of funds to be allocated. The outcome
often reflects as much the budgetary circumstances of the municipal government at the
time, and the nature of competing claims on scarce resources, as it does the actual costs
involved in providing an efficient service. It can be an inefficient process, in which
service managers are continually struggling to attract a level of funds adequate to
provide the services. Service quality is often poor and costs high.
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At the next level, where services are provided by a wholly owned municipal enterprise
operating (often ostensibly) at arm’s length, there is often a greater appreciation by
municipal authorities of the need for the enterprise to be allowed to operate on a
financially sustainable basis. In these circumstances – and the arrangements frequently
found in the countries of the former Soviet Union are examples – a monthly tariff is
calculated (based on the estimated cost of service) and charged to individual users, often
as a separate item on a communal services bill. This system can be an improvement on
the typical internal works department approach, although low tariffs and subsidies to
householders often mean that government must still budget for a significant allocation
of funds out of its general revenue funds. This can lead to reduced service quality and
high costs.
At the third level, where government contracts directly with an autonomous enterprise
to provide specified services, a significantly greater obligation is put upon the municipal
authorities to meet the terms of the contract (subject to the contractor performing
according to specification). Under these circumstances there is often a greater imperative
for the municipal government to introduce user charges (or to establish binding
budgetary allocation processes within government) at a level that will permit the
contractual terms to be met. Arrangements such as these place a far greater onus on the
municipality to properly prepare, manage and monitor such contracts. This process
requires it to have a thorough appreciation of the full costs of service provision.
At the beginning of the review it is necessary to establish clearly the existing funding
arrangements, both in terms of payments to the service provider and from service users.
Sometimes it can be useful to show this diagrammatically (Figure 4D.2 gives an example
of the form this might take). The remainder of this section addresses some of the
important issues involved in improving the financial management arrangements
associated with the provision of these services.
Figure 4D.2 Example of financial management and policy framework for MSWM services
Government
Municipality/
City Treasurer
Financial
Request
Allocated
Budget
monthly services tax
City Waste
Dept
direct change
Customer Base
households commerce
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4D.4 STRENGTHENING FINANCIAL MANAGEMENT AND CONTROL
4D.4.1 The Reasons for Poor Financial Management and Control
Reasons for poor financial management and control (commonly reflected in poor service
quality) can be revealed by a review of existing arrangements.. Reasons can include the
following:
• poor organisational arrangements;
• poor budgetary systems;
• a lack of accountability;
• poor accounting systems;
• poor revenue collection systems; and
• a lack of suitably qualified personnel.
4D.4.2 The Need for Sound Financial Management and Information
Sound financial management and information are necessary for the efficient operation of
any MSWM service. Sound management is needed to maintain high quality, costeffective
services, and for the public to have confidence that it is getting value for money
from the services provided. Reliable information is needed to enable management to
make informed decisions about the operation and future development of the service.
Effective financial management and information control systems are necessary for:
• focusing responsibility and accountability for service costs and quality;
• preparing statutory financial statements and accounts;
• establishing full service costs;
• establishing the adequacy of revenue sources;
• establishing the structure and levels of user charges;
• demonstrating a capacity to meet projected financial obligations, such as debt service;
• monitoring and evaluating service quality, costs and performance;
• involving the private sector in the provision of MSWM services; and
• future planning
Service quality and cost-effectiveness can only be improved if indicators are available by
which performance can be measured. The existence of these performance indicators
depends on having effective, reliable and up-to-date financial management information
systems (see Step 7).
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4D.4.3 Mechanisms for Improving Financial Management and Control
Approaches to improving budgetary and accounting systems for solid waste
management are outlined in Box 4D.1 below.
Box 4D.1 Measures to Improve Budgetary and Accounting Systems for MSWM
1. Adopt a unified organisational structure with a parallel budgetary allocation system
2. Create separate cost and responsibility centres, each managed by a senior manager
who is: responsible for service provision; financial control, monitoring and evaluating
performance, and preparing an annual budget; and accountable for service quality and
costs;
3. Structure financial information systems along cost centre lines and establish separate
accounts for each cost centre;
4. Systematically collect the physical and financial performance data needed to estimate
costs and review the performance of each MSWM component (eg, collection, transfer,
disposal);
These can be among the first steps to take in reorganising a MSWM department on a
more (i) functional and (ii) accountable basis (see also Step 4A).
The ease with which this can be done will depend on the structure of the existing
arrangements and the institutional culture on which they are based. In some instances
legislative change may be needed to establish new organisational structures, to sanction
the use of more appropriate accounting systems or to extend powers to impose user
charges. Political will and commitment is an essential ingredient for making such
changes.
The financial management problems facing MSWM services commonly reflect those
faced by the municipal government as a whole. Although change to municipal systems
is unlikely to happen in the short-term, management information systems based on the
concepts of accruals accounting can be introduced specifically for MSWM and (if
necessary) operated in parallel with an existing cash-basis system. This can facilitate
decision making, enable performance to be evaluated and compared, and generate
reports in line with accepted accounting principles. Performance measures and related
management information systems are considered further in Step 7.
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4D.5 STRENGTHENING FINANCING ARRANGEMENTS
4D.5.1 Key Issues
 Two important aspects of financing are addressed in this section:
• how capital investment expenditures are to be financed; and
• how recurrent costs are to be financed.
The financing of capital investment commonly attracts most attention, as a shortage of
capital funds tends to be seen as a principal impediment to development.
However, the financing of recurrent costs is probably the more critical issue, as it is on
this that the financial sustainability of the MSWM system ultimately depends.
Planning the financing of the recurrent costs of the MSWM system must be given
equal weight to planning the financing of the investment costs.
Responsibility for generating the necessary investment and recurrent funding
requirements will depend to some extent on the nature of the service delivery
arrangements. This is best seen in terms of the three organisational structures identified
above.
Where services are provided by a municipal waste department, investment and
recurrent funding arrangements are typically organised by the municipal authorities. A
part of the funding requirement may be raised through specific charges, although it is
commonly provided out of general taxation revenues. Funds tend to be made available
as and when required, often on an ad hoc basis. This can result in inefficiency, high costs
and poor service quality.
Where services are provided by a wholly owned municipal enterprise operating (at least
to some extent) on a commercial basis, part of the investment requirement can possibly
be accumulated through the retained earnings (profit) of the enterprise. The source of
recurrent funds is typically the municipal government, which may raise part of the
requirement through some form of user charges or tariff system and part from general
municipal sources.
Where services are provided under contract by an autonomous agency the responsibility
for providing investment finance will depend on the nature of the contract. The
recurrent funding requirement is usually provided by the municipal government in
accordance with the terms of contract. Establishing and collecting user charges (tariffs) is
generally a responsibility of the municipality. There are instances, however (and
arrangements such as these can be found in Eastern Europe) where the contractor is also
responsible for establishing and collecting charges.
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The ultimate aim might be to establish the service provider on a properly commercial
basis, where it is fully responsible for overall financial performance and service quality.
It will nevertheless remain an agent of the municipal government (which has a statutory
obligation to provide the services) operating under contract to it. The contract would
specify payment terms, and these would be established at the level needed for it to
operate in a commercial manner. This can include provisions for it to recover its
investment costs and to make a return on investment. Retained reserves accumulated in
this manner would then be used to finance asset replacement and long-term liabilities
(such as facility closure and post-closure costs). Establishing the tariffs and user charges
necessary (at least in part) to fund the contract would, however, remain a responsibility
of the municipal authorities.
4D.5.2 Sources of finance for capital costs
MSWM systems involve capital expenditures being made on a wide range of
investments, including landfill development, transfer stations and the procurement of
collection vehicles. The amount of investment funds required is established through the
economic and financial assessments (Parts II and III) and after taking into account
options for private sector involvement..
There are five potential sources of finance for capital investment projects:
1. accumulated internal reserves held by the operating agency;
2. central, state and municipal government grant contributions;
3. domestic or international commercial loans raised by the state or municipal
governments;;
4. international funding agency grants and loans; and
5. private-sector finance.
Internal Reserves
MSWM departments rarely have the accumulated funds necessary to finance asset
replacement or the development of new MSWM systems. Even where such funds are
generated, other priorities often make prior claims on them (eg, to subsidise street
cleaning operations).
Internal sources of retained earnings are rarely available to finance improvements to
MSWM services. . A key aim of the Strategic MSWM Plan should be to establish the
financial management systems and cost recovery mechanisms required to keep pace with
demand and allow sustained improvement to MSWM services over time.
The aim should be for the MSWM department to be given greater financial autonomy, for
it to structure its operations around commercial principles and for it to begin to provide
for its own future financial obligations. This greater autonomy can be coupled with
increased political accountability for service quality and financial performance.
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Government Contributions
The traditional source of investment funds is via transfers from central or state
governments. Because these funds are in short supply they are often made available only
on an ad hoc basis when urgently needed. This makes the introduction of new improved
MSWM systems difficult – there is always a major incentive for decisions to be deferred.
Capital shortages and the inability to routinely replace capital plant at the end of its
useful life are major causes of poor service performance.
The role of central government in financing municipal services is also being reduced in
many countries in response to policies to encourage political decentralisation and
institutional reform.
Commercial Loans
Although commercial loans raised on domestic or international markets are a potential
sources of investment capital, they are rarely used. This is because many municipal
authorities do not have the statutory powers necessary to enter into loan agreements.
Central governments commonly maintain tight controls over foreign borrowings, aiming
to keep these within prudent economic limits. Even when municipal authorities do have
such powers, high commercial interest rates and short repayment periods often make
loan service obligations difficult to meet.
Commercial credits offered by foreign plant and equipment suppliers sometimes enable
a municipality to purchase capital equipment from the supplier. Although the terms and
conditions of these tied credits can be attractive, it is necessary to ensure that the
equipment is appropriate and affordable. There are many instances of a municipality
being seduced by attractive credit terms into the purchase of equipment that is quite
inappropriate for its intended use.
Grants and Loans
Grants and loans from international finance agencies are an important source of finance.
Grants are immediately attractive because neither interest nor capital has to be repaid.
Loans are attractive because interest rates are often lower than market rates and,
importantly, because repayment terms tend to be longer than for commercial loans.
Although grants are attractive - because they enable plant and equipment to be
purchased at no direct cost to the municipality - they should be used only for
implementing systems and technologies that are sustainable under local conditions.
The adoption of inappropriate technologies can lead to a rapid deterioration of the asset
and to a waste of investment finance. Reasons for this can include unexpectedly high
operating and maintenance costs, and a lack of the skilled personnel needed to operate
and maintain the plant properly.
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The important implication of this is that the SWM plan must be shown to be sustainable
in its own right before consideration is given to possible financing arrangements (such as
grant funding).
Grants and soft loans are valuable sources of finance during the transitional period in
which a waste management agency moves towards commercial independence. But the
long-term viability of its operations should not be dependent on the continuation of such
aid. The aim must be to provide services that are sustainable in the longer term. This
means they must be affordable to society, and capable of being financed out of society’s
resources. If, when the time comes to replace grant-funded assets, grant funds are again
required, then it is likely that the service is neither sustainable nor affordable. The
feedback between systems planning and financial planning should aim to avoid such a
dependency culture from becoming established.
Private Sector
Part of the responsibility for financing and operating waste management services can
potentially be shifted from the municipality by contracting with a third-party private
operator. This can reduce the amount of initial investment funds that have to be
provided by the municipality.
This can, however, lead to the erroneous view that the municipality can reduce the costs
of service by involving the private sector. Ultimately, the full costs of the service have to
be paid for by its users, whether the capital is provided by government or by the private
sector. One benefit of using the private sector is that the need for up-front investment
finance can sometimes be avoided. Investment costs, plus a premium for the risk
accepted by the private operator, must, however, be recovered by the private operator
through the contract it signs with the municipality. For its part, the municipality will
want to recover the costs of service from users.
A principal benefit of using the private sector is that it can lead to a reduction in unit
costs. This arises largely through the efficiency improvements encouraged by exposing
public service provision to the competition process. Despite this, involvement of the
private sector can lead to an apparent increase in the costs of service. This is because the
private sector contract forces the municipality to face up to the full costs of service
provision. This is a valuable outcome, as it also forces the municipality to consider the
overall affordability of the proposed services.
A range of potential sources is available to finance MSWM investments.
Extreme care should be taken to ensure that any investments are technically
appropriate and financially sustainable.
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4D.5.3 Strengthening the financing of recurrent costs
Recurrent costs are the costs incurred in operating MSWM services. They can include:
• direct operational expenditures, such as expenditure on wages, fuel and maintenance;
• provisions (accrued expenses) for liabilities such as employee pension obligations and
insurance payments, and long-term closure and after-care costs;
• regular recurrent cash outlays, such as debt repayment, loan interest and service
charges; and
• a provision (depreciation) for recovering the value of the capital assets progressively
used up in delivering the service (with debt repayment being financed out of the
depreciation provision).
Alternatively, loan interest and service charges plus depreciation provisions can be
replaced by an annual amortisation charge designed to recover the value of capital assets
over their useful lives. This has the effect of providing a rate of return to cover the
opportunity cost of the capital employed in the business.
Devising a realistic recurrent revenue plan is a key component of the strategic planning
process.
Service failure can be caused by a lack of proper budgeting procedures. MSWM services
are frequently provided on a day-to-day cash basis, with little provision being made to
ensure the long-term viability of the service. For the service to be viable in the longer
term, provision has to be made for recovering the capital value of assets, for funding
long-term liabilities (such as employee pensions, site closure and after-care), and for
funding routine repair and maintenance programmes. This involves proper budgeting
on an accruals basis and establishing charges at levels that recover annual recurrent costs
in full.
Funding operations on a day-to-day cash basis can result in a steady
deterioration of service quality, an increase in costs, and under-provision for
long-term liabilities. Management effort thus becomes directed towards crisis
management rather than service management. A system of financial
management (including funding) using accruals accounting methods should
therefore be adopted.
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4D.5.4 Traditional Sources of Revenue
These sources are considered below.
Transfer Funds
Central, state or provincial government transfer funds often contribute a significant
proportion of total municipal recurrent funds, but there is usually little scope for this
amount being increased. This funding source is outside the control of the municipality
and can be subject to variations caused by economic or political pressures. It is generally
not a source of revenue that can be relied upon for funding the additional requirements
of improved services. Nevertheless, it is a possible source and should be examined.
Municipal Revenue
Municipal governments also have their own sources of funds, normally from local taxes
and non-specific charges.1 Contributions from these sources are usually paid directly
into consolidated revenue and are not earmarked for specific uses. Local taxes are the
most significant component, of which property and local sales taxes are examples.2
1 The main differences between taxes and charges are as follows. Funds generated by taxes are generally paid directly into the consolidated
revenue account whereas funds generated from user charges are (desirably) allocated to their specified use. Taxes do not relate to the costs
of providing a specific service whereas user charges are designed with a view to their making a specific contribution to the costs of
providing a service.
2 Property taxes are used in many countries and, although their structures may differ, the principles are largely the same. The property tax
has often been regarded as an appropriate basis for funding local government services as it relates to the value of property (thereby acting
as a proxy measure of the capacity of the property owner to pay); and is administratively simple to impose and collect. Property taxes are
usually paid directly into consolidated revenue and are only notionally related to the provision of specific services. Other local government
taxes - such as cleansing or conservancy taxes - are sometimes established in an ad hoc manner with the aim of meeting a particular area of
local government need (such as improved MSWM services). Although referred to as charges they are more like taxes: receipts are typically
paid directly into consolidated revenue and the level of charges bears no direct relationship to the costs of providing the service.
Funds available for supporting recurrent expenditures typically come from three
sources:
1. transfer funds assigned by a central, state or provincial government, usually in the
form of non-specific grants;
2. a municipality’s own general revenue sources, consisting mainly of taxes and charges;
and
3. specific charges levied by the municipality on the users of specific services, such as
waste management, water services and electricity supply.
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Specific Charges for the use of a particular service
Some charges, such as those for water and electricity, are intended to recover the costs of
providing these services to individual users. They are usually collected and used directly
by the service provider to finance its operations. The agency normally has a degree of
financial and operational autonomy, and it can be held accountable for service costs and
quality. These funds are thus earmarked to a particular use and do not form part of
consolidated revenue. This concept of ‘ring fencing’ user charges is a crucial element in
improving autonomy and accountability.
In some cases a charge for solid waste services is identified separately on a property tax
or communal services bill, thereby giving users the ability to gauge the quality, value for
money and efficiency of the service. An example is the bill for communal services found
in many of the countries of the former Soviet Union. This itemises separately charges for
the various services provided, including rental payments, water and sewerage charges,
electricity charges, district heating charges, waste management fees, etc.
 Generating Additional Funds to meet Recurrent Expenditures
Opportunities for funding the recurrent costs of improved or expanded MSWM services
can include the following:
a) expanding the use of current sources;
b) releasing funds from current sources by operating existing services more efficiently;
c) maximising the revenue available from existing taxes or charges; and
d) introducing new direct or indirect user charges.
Options (a) to (c) are considered below. Users charges are considered in greater detail in
the following section.
Expanding the use of current sources
Opportunities for increasing allocations from existing sources are normally limited in the
face of tight competition. One reason for poor service quality is often a lack of available
funds from traditional municipal sources.
Releasing Funds from Current Sources
Improvements to the operational and financial management of MSWM services can lead
to significant savings in the costs of providing the existing level of service. Such
efficiency improvements can thereby ‘release’ funds to be used for improving the system
(it being assumed that such funds are not automatically diverted to uses quite unrelated
to MSWM). This is illustrated in the following example (Box 4D.2).
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Box 4D.2 Releasing funds from Current Sources
In many metropolitan areas collection services are reasonably good while
disposal services are poor. Where this is so a main objective is often to
provide better disposal services. Experience suggests that the balance of costs
between sound collection and sound disposal systems is roughly 75% for
collection and 25% for disposal.
It follows that, if a municipality is moving from a position of having a sound
collection service but no disposal service, to one of having a sound collection
and disposal service its total costs might be expected to increase by about
33%.
But note that the additional revenue required for disposal could also be
‘released’ by efficiency improvements leading to a 33% fall in unit collection
costs. Hence the focus on the potential to ‘do more for your money’.
In practice, of course, it is not this simple, but the principle remains, and
scope for improving the efficiency of existing services is important when
considering the introduction of new or improved services.
Maximising revenues available from existing taxes and charges
In addition to releasing funds by operating existing services more efficiently, another
possible source of funds is through the increased mobilisation of resources available
from existing charges or taxes. A review of existing charges (or taxes) will often reveal
that:
• charge rates have not been reviewed recently or are not indexed for inflation;
• the charge base is incomplete and can be expanded;
• charge demands are not sent; and
• the charge collection ratio is low.
Analysis frequently reveals that large amounts of potential revenue remain
uncollected owing to inefficient management and enforcement systems, and an
absence of accountability for revenue collection.
4D.5.5 Cost Recovery Policy and User Charges
Cost Recovery Policy
A cost recovery policy is normally needed to finance the additional costs associated with
improved services. The level of the cost increases can often appear high because
traditional municipal accounting systems fail to reveal the full costs of existing services,
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and because existing services tend to be under-funded, leading to their gradual
deterioration.
 Municipal authorities need to be made aware of the full costs involved in the provision
of comprehensive, healthy and environmentally sound MSWM services. Often, the
apparent cost of these services in the past has been low because service delivery has been
incomplete (eg, restricted collection service), unsustainable (eg, dumping), or not
properly costed or accounted for. Improving the quality of services is a key step in the
development process. Once the broad level of costs has been accepted it is necessary to
establish how these are to be funded.
The traditional approach is for these costs to be funded out of consolidated revenue. This
commonly leads to under-funding of direct operating expenditures, and fails to generate
additional resources by which to fund long-term liabilities, plant replacement or service
improvement.
The extent to which these sources are used for funding the recurrent costs of the
improved strategy depends on their availability, and on the financial objectives and cost
recovery policy of the municipality and the MSWM agency.
A cost recovery policy needs to establish two things:
• the total amount of recurrent funds needed year on year; and
• how these are to be provided.
The minimum amount of recurrent funds required each year is the amount needed to
finance the direct operating expenditures and debt service obligations incurred in
providing the service, i.e. sufficient to cover annual operating cash outflows.
If, on the other hand, a financial objective is for the agency to become self-sustaining
over time, then the annual recurrent funding requirement should also be sufficient to
recover capital expenditures, long-term liabilities and possibly to provide a return on
investment.
 Possible options for cost recovery objectives – typically a responsibility of the municipal
government – are shown diagrammatically in Figure 4D.3.
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Figure 4D.3 Possible options for cost recovery objectives
1. No or very few costs are recovered and revenue is less than direct operating
expenditures.
2. Direct operation and maintenance costs are recovered.
3. Direct operation and maintenance costs plus loan interest payments are recovered.
4. Direct operation and maintenance costs plus debt service requirements (loan
repayment and interest payments) are recovered.
5. Direct operation and maintenance costs plus interest, depreciation and provisions for
long-term liabilities are recovered.
6. Direct operation and maintenance costs plus amortisation (capital plus a return on
investment) and provisions for long-term liabilities are recovered. Equivalent to
long-run marginal cost or full cost recovery3.
7. Long-run marginal cost plus (marginal) environmental cost (possibly reflected in a
landfill tax) – full cost recovery plus.
Cost recovery policy is typically a responsibility of the municipal authorities. It is
necessary to establish:
1. the level of cost recovery to be achieved;
2. whether the required level of cost recovery can progressively be achieved over time;
and
3. whether there is scope for charges to be levied differentially on different sectors of
the population (eg, cross-subsidies to protect those less able to pay).
In establishing its cost recovery policy the municipal authorities will need to consult
closely with the service provider to establish clearly what the full costs of service are. A
key element of the strategic planning process is to shed light on this important aspect.
3 A good indication of the revenue needed per tonne of waste generated to achieve full cost recovery (including a return on investment) is
given by calculating the average incremental cost (AIC) of the service, a concept explained in Parts II and III of this chapter.
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It is rarely politically or socially acceptable to move directly from full service funding
from general municipal resources to a policy of recovering long run marginal costs from
users. Although the objective may be to achieve full cost recovery over time, user
charges for households will normally need to be raised progressively as the service
provider moves towards greater political and financial autonomy. The recovery from
users of operating and maintenance costs, debt service obligations and provisions for
long-term liabilities (level 4 on Figure 4D.3) over a specified period could be an initial
cost recovery target to aim for during transition. This might later be modified to recover
all capital costs via the depreciation or amortisation provisions (levels five and six).
A progressive approach to cost recovery from domestic users means that part of the
recurrent funding requirement must continue to be provided from general municipal
resources during the transitional period. Thus, user charges must be set at a reasonable
level at the outset (subject to the affordability constraints discussed below) with the
balance of recurrent funds coming from general municipal sources. 4
The process of establishing an appropriate tariff structure and tariff levels should be
undertaken in parallel with studies being undertaken into affordability and the
willingness to pay.
Options for introducing new user charges are considered below. The actual level of such
charges will reflect the nature of the operations and the level of cost recovery being
sought.
Cost recovery policies and targets must be realistic and capable of
implementation politically, institutionally and socially.
User Charges
In many cities throughout the world, charges are levied specifically to recover (at least in
part) the costs of MSWM services. There are a number of ways this can be done, the
suitability of which will depend on the particular social, cultural, economic and political
characteristics of the country concerned.
Charges are a preferred means of raising new revenue because they can be presented
and justified to the public on the grounds that they are required for and will be used in
the provision of an important public service. Properly applied, they commit the
municipal authorities to accountability and transparency with respect to the costs and
financing of the services provided.
4Note that under this arrangement total funds available are likely to be sufficient to cover only some of the necessary costs - direct operating
expenses, maintenance, debt service charges and some provision for long term liabilities . The financial viability of the service in the longer
term will depend on sufficient funds being available to cover asset replacement and long-term liabilities, and possible service expansion. If
the waste management agency is to become financially autonomous then users must eventually provide the full costs of the service (at
points 5, 6 and 7 of the cost recovery diagram).
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They can, nevertheless, also meet with public resistance on grounds such as the
following:
• if service quality is currently poor, citizens may be reluctant to pay additional charges
before they experience real improvements in service quality;
• that public services should be provided ‘free of charge’;
• that the services are already being paid for out of general taxes, such as a property
tax; and
• that people do not want the proposed services and are unwilling to pay from them.
Charges can be either direct or indirect.
Direct charges are levied directly on the service user and reflect the level of use. For
example, a direct charge to an industrial customer may be based upon the amount and
characteristics of waste collected; a direct charge to a domestic customer may be based
upon the number of bins collected and the frequency of the service. They tend to reflect
the actual level of demand for the service.
Indirect charges are not directly related to the level of demand for the service. They can
take a number of forms. One approach is for different classes of users (such as people
living in apartment blocks) to pay a charge that reflects the average cost of the service
provided to them. The communal charge system used in many of the former Soviet
Union countries is an example of this, where a fixed waste management charge per
person per month is levied. Another approach is to set charges relative to the demand
for another service, such as water and electricity supply, which thereby acts as a proxy
measure of demand for the waste management service itself. Alternatively, a waste
charge is sometimes added as a separate item on to a property tax bill (which is the
approach used in, for example, the United Kingdom).
Payment of an average charge means that all users pay the same amount (although in
Russia this is subject to minimum income constraints). On the other hand, charges linked
directly to the demand for another service or to a property tax imply that people pay
more according to their consumption of those services or to the value of their property.
This introduces a progressive element into the payment system, although it does not
always follow that those who consume more of a service (such as water) necessarily
have incomes higher that are higher than the average. For example, large families can be
expected both to consume more water and to have relatively lower per capita incomes
than the average. Note also that the billing system used by water or electricity utilities
can sometimes be used as a vehicle for the collection of a fixed waste management
charge from users.
The advantages and disadvantages of direct and indirect user charges are set out in Box
4D.3.
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There is no preferred charging method - the one chosen will depend upon the
practical realities of the existing cultural, legal, political and economic
framework. The amount of revenue to be generated from user charges will
depend upon the financial policy framework, the costs of service and the
availability of funds from traditional municipal sources. Indirect charges tend
to be most applicable to domestic users and direct charges to industrial users.
Note that there may be cases where significant differences exist in the nature of the
service being provided to domestic users in different parts of a municipality (such as in
the frequency of service, in the type of service - communal collection points or individual
bins, or in the quantity of service - number of bins per household). In these cases, a
differentiated indirect charge system can be introduced. This need not be complex, but it
does depend upon good information being available to the municipal provider about the
characteristics of different collection rounds and individual users.
Box 4D.3 Direct and Indirect Charging Mechanisms
Direct charges
Direct charges relate to the level of demand for a service, and involve
service users being charged directly for their use of the service.
Advantages The principal advantage of direct charges is that they relate directly to the
level of demand placed on the service, and therefore conform to the ‘userpays’
and ‘polluter-pays’ principles.
Commercial and industrial users offer significant scope for the application
of direct charging systems. This is because:
• the extent and nature of waste generation patterns can differ
considerably between users;
• individual waste quantities can be large; and
• the number of users is relatively small.
These conditions can make it worthwhile to introduce separate direct user
charge arrangements.
The extent to which user charges can be introduced can depend on the
provisions of relevant legislation, such as local government, public health or
environment acts.
Disadvantages Disadvantages of direct charging systems are:
• the difficulty in using withdrawal of service as a sanction to enforce
payment;
• the cost and complexity of establishing and maintaining separate userregisters;
• the limited scope for introducing a progressive element into the charge
system (eg, cross-subsidies between rich and poor users);
• the difficulty in measuring different levels of demand between domestic
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users.
Although direct charges are levied on domestic users for MSWM services in
some parts of the world (most notably in the United States), examples of
this are rare. Some developed countries are experimenting with direct,
voluntary charges for domestic waste, where there amount charged
depends on the volume or weight of waste collected. Examples use prepaid
‘tagged’ bags, or on-vehicle container weighing systems with bar-coded
containers.
Residents in environmentally developing countries are sometimes willing to
pay direct charge for individual services - such as primary collection -
although these are usually organised privately through community
organisations.
It follows that direct charges tend to be used more for commercial and
industrial users than for domestic users.
For example, businesses may be charged directly for the removal and
disposal of waste from their premises. There is a direct relationship between
the level of charge and the level of service provided. The mechanism is
based on the principle that users should pay the full costs of the services
that they use.
Indirect
Charges
Indirect Charges. Under this mechanism charges for MSWM services are
not based on the level of demand for the service. Three approaches are
typically used: (1) for users to be charged the average cost of service, (2) for
charges to be linked to the demand for another service, or (3) for charges to
be linked to some kind of local government property tax.
Approaches 1
& 2
The communal charge system used in many of the former Soviet Union
countries is an example of users being charged the average cost of the waste
service. A waste management charge is identified on a monthly communal
services bill along with items such as rent, water supply, electricity, etc.
An alternative approach is for waste management charges to be identified
on the bill issued by the providers of another service (such as electricity or
water supply). Here, the utility bill can be used either as a vehicle for
imposing a fixed charge (per person or household) or for setting a charge
relative to the consumption of the other service. Although identified
separately as a MSWM charge, customers pay only one bill.
Advantages The principle advantages of indirect user charges are:
• administrative simplicity;
• low collection costs;
• convenience for customers;
• high potential collection ratios;
• the availability of sanctions for non-payment;
• revenue reliability and predictability;
• the scope for a direct transfer of funds from the collecting agency to the
MSWM provider (effectively ‘ring-fencing’ the revenue for its specific
use); and
• scope to index the charge for inflation.
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Disadvantages The principle disadvantages of indirect user charges are:
• related only indirectly to the level of demand for the service being
provided;
• depend on the linkages assumed between the demand for one service
(eg, water) and the demand for the MSWM service;
• is not strictly in accordance with the user-pays principle;
• dependence on another agency to collect and administer the charge
Indirect charging mechanisms tend to be used mostly for domestic MSWM
users, between which the characteristics of demand are broadly similar,
rather than for commercial and industrial users, where the characteristics
are quite different.
Note, however, that differences in the type of service provided can be
reflected in the charge mechanism.
Note also that the ‘progressive’ element introduced through charging users
on the basis of their level of consumption of another service depends on the
assumption that those consuming more of one service are better able to
afford to pay more for another. This is not always so; for example, a large
poor family is liable to consume more water or electricity than a small rich
family.
Approach 3 Another approach is to use an existing mechanism - such as a local
government property tax - as a vehicle for levying an indirect charge. The
advantages of this are similar to those outlined above, but there are
additional disadvantages.
Disadvantages Further disadvantages of this approach are:
• may be seen as another tax, and not linked to the costs of MSWM
services;
• new or amended legislation may be required;
• the flexibility needed to administer the charge over time may be difficult
to write into enabling legislation (eg, to index it for inflation);
• the charge may be prone to political manipulation;
• payment may be difficult to enforce and collection ratios may be low.
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One approach might be for all users to pay a standard charge for a basic minimum
level of service (possibly based on communal collection points) and for a surcharge to
be paid by those choosing to receive a higher-level service (possibly a door-to-door
collection service).
Simple yet innovative charging arrangements can be introduced which reflect the
individual peculiarities of a municipality, which are fair and protect the poor, but
which also seek to ensure that those capable of paying for their services do so.
Some householders may contract independently with private waste management firms
for the removal of their garbage, often as a result of limited, poor or non-existent
municipal services. This leads to ‘cherry picking’ - where private firms provide services
in the more affluent areas to those willing and able to pay - and should be seen as an
adjunct, rather than as an alternative, to municipally provided services (which may
themselves be contracted out directly to the private sector).
Finally, there is an additional economic reason why the government or municipality
should consider implementing or regulating carefully designed user charges. This relates
to the way charges can influence people’s behaviour in making waste management
decisions that benefit society as a whole rather than just themselves. This is illustrated in
the quotation below.
“In developing countries the least costly options for disposal of waste - dumping it in
public spaces or burning it openly – are often the most popular. Although inexpensive in
terms of out-of-pocket costs to those that dump or burn waste, these acts may impose
large costs on society. Aesthetic, environmental and health problems may result.
Households and firms left to their own devices may reap benefits from avoiding paying
for investments in environmentally sound waste disposal, but they leave a legacy of far
greater damage to future generations.
Common property resources and intergenerational externalities provide incentives for
households and firms to under consume MSWM services. Because the benefits of some
MSWM services to private consumers fall short of the benefits to society, optimal
government interventions are those that align the private and social incentive for MSWM
services as closely as possible. A number of policy instruments exist to do so.”
Source: D Beede and D Bloom The Economics of Municipal Solid Waste, World Bank Research Observer Vol 10, No. 2
1995 pp113-50.
4D.5.6 Taking a demand responsive approach
Introduction
This section looks at issues of affordability and willingness-to-pay, and how (and why)
they might be addressed during the design of a MSWM strategy.
Most attempts to improve MSWM services have historically focused on technical supply–
side issues – how to improve different means of collection and disposal, through better
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equipment provision, for example. In fact, between 1974 and 1988, 66 out of 71 World
Bank loans in the MSWM sector followed this supply-side approach, being primarily for
the procurement of waste collection vehicles (Bartone and Olivera 1990). Recently,
however, more attention has been paid to improving institutional arrangements for
service delivery, and also on investigating the demand-side aspects of MSWM.
Indeed, the use of demand led approaches (based on the concepts of affordability and
willingness to pay), to help identify the appropriate level and type of municipal services
(such as water, sanitation and waste) is now endorsed by a number of international
organisations and governments. They are seen as useful and valid ways of estimating
the demand for urban services and the economic value of the environmental changes
that they can bring. Furthermore, because the information obtained from such exercises
can be used to design and provide the types of services that people want, they thereby
also improve cost recovery.
This section discusses the issues of affordability and willingness-to-pay for MSWM
services and how to measure them. The accompanying Annex 4D.3 provides an example
questionnaire and the results from a willingness-to-pay survey.
Affordability
The issue of affordability is crucial to the design of a MSWM strategy. Unless strategies
are designed which are affordable they become, at best, academic or, at worst, weights
that burden the municipality with operating and debt charges that cannot be funded.
Two aspects of affordability need to be addressed. The first is whether or not a proposed
strategic plan is generally affordable to the society in which it is being proposed. The
second is whether user charges proposed to finance the strategy are affordable (or even
appropriate) to all members of society.
First, is the strategy affordable to society? This question relates to the costs of the
proposed service relative to national income. MSWM strategies that are appropriate and
affordable to a high-income country may be inappropriate and unaffordable to a
developing or transition country.
The costs per tonne of waste for the various components of a proposed solid waste
management system can be estimated reasonably accurately (see Parts II and III).j A
useful summary of cost ranges is for MSWM is presented in Annex 4D.1. Once unit costs
have been calculated they can:
• be compared with indicative costs considered appropriate for providing such services
in countries having similar income levels; and
• enable a judgement to be made on whether the estimated costs are affordable or
whether the strategy (or components of it) needs to be rethought.
Typical unit costs for an appropriate collection service in a middle-income country
would be expected to range from US$30 to US$70 per tonne of waste collected. Similar
costs for a low-income country would range from US$15 to US$30 per tonne. (Note that
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these costs reflect what countries need to spend if an appropriate level of services is to be
provided, and not necessarily what they are spending). 5
Since unit cost data can readily be split between capital and operating costs(using the
average incremental cost method described in Part II of this step), more detailed
assessments can be made about the affordability and appropriateness of different
components of a proposed system.
Second, is the strategy affordable to individual users? This question relates to whether
user-charges proposed under the strategy will be affordable to poorer members of
society.
Payment structures can be designed to reflect different levels of affordability. The
question of affordability is likely to be acute if, for example, a full cost recovery policy is
proposed to be introduced and payable equally by all users from the outset. An
affordability analysis is intended to show the effects of such a policy, and particularly its
impact upon the poor.
 Such analysis can lead to the development of more progressive charging structures..
One option might be to introduce and then raise charges progressively over time to full
cost recovery levels (see earlier discussion, Figure 4D.3). Another might be to explicitly
design the structure of charges such that the more wealthy users subsidise the poor.
Further, user charges suitable for the more affluent areas of a city may be inappropriate
in poorer parts. Under these circumstances, differential charging systems (and possibly
different levels of service) may need to be designed.
However, there is a strong argument to suggest that everyone should pay at least
something for MSWM services. That is, the beneficiary pays principle should be adopted,
whereby those benefiting directly or indirectly from a service (ie, those having a stake in
its outcome) should also contribute to its costs. The government’s role is then to use its
regulatory powers to ensure that such a system is implemented equitably and to
minimise the problem of ‘free riding’ by those who aim to avoid payment.
5 Source: S Cointreau-Levine (1994). Private Sector Participation in Municipal Solid Waste Services in Developing Countries. Volume 1 -
The Formal Sector. UMP Technical Paper, No. 13. The World Bank, Washington. ISBN 0-8213-2825-5.
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Assessing Affordability
Affordability studies depend on the availability of information on household income
and expenditure. This is frequently available from national household surveys
undertaken periodically by the statistics agency. Statistics specific to large metropolitan
areas can usually be obtained but, if not, then national-level information must be used
and adjustments made. When using these surveys care must be taken to ensure that the
year to which the data relate is known and that adjustments to the present are made
appropriately. Advice from the statistics agency should be sought when making such
adjustments.
Other relevant information is sometimes available from government agencies, such as a
department of economic development, from international agencies operating in the
country, such as the World Bank, or from NGOs.
Average income statistics provide an indication of the overall affordability of a strategy
to society, but their use can give a distorted picture in a country with a high level of
income variability. Income statistics are particularly useful if they are available for
different income groups (population quartiles or quintiles) from which the broad
characteristics of income distribution can be inferred.
These characteristics can include:
• average per capita disposable income for society as a whole;
• average per capita disposable income of the poorest group;
• the income differential between the richest and the poorest in society;
• the relative shares of the richest and the poorest groups in total disposable income;
and
• changes in the distribution of disposable income between survey periods, providing
an indication of whether income distribution is becoming more equitable or more
skewed;
Data on household income can therefore allow the affordability of proposed charges to
different income groups to be assessed. The proportion of household income represented
by a proposed charge is calculated to assess affordability for each income group. This is
then compared with indicators of the proportion of household expenditure that might
typically be allocated to waste management services in a country having a similar per
capita income.
For example, World Bank6estimates of the percentage of household expenditure which
would need to be allocated to waste management services in a middle-income country
range from 0.75 to 1.7% of average income. This can be used as a benchmark to assess the
6 S Cointreau-Levine (1994). Private Sector Participation in Municipal Solid Waste Services in Developing Countries. Volume 1 - The
Formal Sector. UMP Technical Paper, No. 13. The World Bank, Washington. ISBN 0-8213-2825-5.
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affordability of a strategy to society in general, and its affordability to specific income
groups in particular.
In the event that household income survey data are not available, or are so old that their
use is questionable, then an alternative approach to establishing affordability can be to
construct a community profile from customer data available from water and electricity
companies. This can provide information on the size of the average bills paid by
households, the variability within these, the coverage of the community, the extent of
bad debts, and so on.
Annex 4D.3 includes an example of an affordability analysis conducted as part of the
wider economic and financial appraisal for a MSWM project in the Black Sea Region of
Turkey which illustrates some of the issues described above.7
Willingness-to-pay
Willingness-to-pay surveys assess what hypothetical MSWM service options different
customers would be willing to pay for and, as a result, can show how much they value
different services. Experience has shown that WTP surveys can provide a range of
valuable economic information about the customer base and its preferences for MSWM
options.
In particular, WTP studies can help:
• estimate people’s willingness to pay for a specific MSWM system, based on the planned
improvements. The results can be fundamental in informing future pricing decisions;
• ascertain consumer satisfaction with the current type and level of MSWM services provided.
This information can help devise a number of service enhancing and remedial
measures;
• identify gaps in public knowledge about a number of MSWM issues that may hinder the
implementation of programmes that would ultimately be in the public interest;
• collect useful information for the design of future MSWM programmes on current practices,
priorities over different services and attributes and levels of those services; and
• minimise the mismatch between what is supplied and what the public wants by increasing
the knowledge about the level of MSWM service that the public wants and is willing
to pay for.8
7 ERM and TÇT (1997). Solid Waste Management Planning and Feasibility Study for Trabzon and Rize Provinces. For GEF, the World Bank and the
Turkish Ministry of Environment.
8 From D Moran, S Mourato, C Y Tan and B Day, Paying for Municipal Solid Waste in Malaysia. A study undertaken for DANCED and the Economic
Planning Unit, Prime Ministers Department, Government of Malaysia, commissioned by CarlBro International and undertaken with assistance from
CSERGE UCL. 1998
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Furthermore, WTP studies can help break down some commonly held views among the
MSWM strategy developers themselves. For example, it is often the belief of planning
officials that households consider the provision of MSWM services to be an obligation of
the government and resent paying for them, and that households consider MSWM
services less important than other municipal services, especially electricity or water and
sanitation services.
 A WTP survey for MSWM options in Gujranwala, Pakistan, showed that MSWM was not a lower
priority for residents, and that there were specific areas of the city where it was the highest
environmental priority. It also showed that just 20% of households considered free provision of
MSWM services to be the responsibility of government. The same study showed that the demand for
specific components of the MSWM services (street cleaning, bin emptying and household pickup)
changed by neighbourhood. This information was used to enable the municipality to develop a
MSWM strategy that reallocated funds between areas to increase overall consumer welfare.
Source: M A Altaf and J R Deshazo. Household Demand for Improved Solid Waste Management: A Case Study of Gujranwala, Pakistan.
World Development, Vol 24 No. 5 pp 857-868, 1996.
Assessing willingness-to-pay
Relatively complicated and specialist economic assistance is required to carry out a
robust and useful WTP study. Annex 4D.3 provides an example and executive summary
of an extensive WTP survey carried out in Kuala Lumpur. Some references are also
supplied which can provide information about how best to design and analyse
contingent valuation surveys, one of the more frequently used types of WTP study.
Furthermore, surveys seeking responses from people living in peri-urban areas to single
issues such as willingness-to-pay for waste services can often meet with little success.
Where it is intended to carry out such a survey the advice of NGOs and CBOs working
in the field should be sought on whether such a survey is appropriate and, if so, how it
might best be structured.
Willingness-to-pay (WTP) surveys are valuable for gaining an understanding
of people’s attitudes towards solid waste management, particularly in the
formal areas, but careful attention must be given to the form of the questions
being asked and the findings must be used with caution.
WTP findings should be given due weight in the strategy formulation process,
as they commonly reflect what it is that people want and are prepared to pay
for, rather than what central planners think they want, but for which they may
not be prepared to pay. For example, people may be prepared to pay for
communal point-to-point collection services (which they want) but not for
door-to-door services (which they don’t want).
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4D.6 PART II: ECONOMIC EVALUATION
4D.6.1 Introduction
This section looks at the economic evaluation methods used for selecting between
MSWM options and strategies. Part III looks at the financial evaluation methods used
once a particular strategy has been chosen.
4D.6.2 The difference between economic and financial evaluation
Economic evaluation is quite separate from financial evaluation. Since there is often
confusion between the two, the differences between the two procedures are explained
below.
Economic evaluation is the principal means for determining whether a proposed
investment is justifiable for society and for selecting between alternatives. The economic
evaluation process asks:
• what is the best way to invest the limited resources available in order to provide
maximum benefit to society; or
• what is the least cost way of investing to reach a given social policy target?
Financial evaluation, on the other hand, is concerned with establishing the sources and
adequacy of funds necessary to meet the financial commitments incurred during the
implementation and operating stages of the particular investment in question. It aims to
ensure that the investment is financially sustainable, both in the short term via capital
financing and in the longer term via the ability to meet the recurrent costs required.
More detailed information on the differences between economic and financial evaluation
is contained in Box 4D.4.
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Box 4D.4 A Summary of Economic and Financial Evaluations
Economic Evaluation:
• takes account of the full costs and benefits of each option to the
national economy;
• is concerned with the overall benefit to the municipality involved;
• is used to compare alternative technologies or strategies;
• is the principal tool for determining whether or not a proposed
investment should be undertaken;
• is concerned with benefit and cost differences between the existing
situation (‘without project case’) and the situation after the new
project has been implemented (‘with project case’);
• is not concerned with financing charges, such as debt-service
requirements or depreciation provisions;
• is not concerned with the sources of funds through which the
investment or recurrent costs are to be financed; and
• should be conducted in constant prices and use shadow prices as
appropriate;
Financial Evaluation:
• is used to establish the sources and adequacy of funds needed to
meet the financial commitments incurred in implementing and
operating the preferred MSWM strategic plan;
• is usually carried out for the preferred MSWM strategic plan only
after this has been established through the economic evaluation
process;
• uses financial prices;
• is used to assess the implications of alternative investment
financing and cost recovery arrangements;
• takes account of the sources and applications of all funds, including
debt service requirements;
• takes account of the financial implications of any proposals for
private sector involvement; and
• is undertaken using current prices (that is, future prices arrived at
after taking account of the projected effects of general inflation).
4D.6.3 Cost effectiveness and cost benefit analysis
MSWM projects are often evaluated using some form of cost-effectiveness analysis (CEA).
This means that a policy or waste strategy target is set (for example, supply x% of
households with waste services by a certain date, or process y tonnes of solid waste per year
within five years), and the economic cost of meeting this objective is sought. Cost
comparisons between different options are subsequently undertaken and a project is
selected. A comprehensive approach towards undertaking a CEA as part of the economic
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evaluation of a MSWM project is presented in Section 4D.6.4 of the text.
Although CEA is a practical and commonly used method for MSWM economic
evaluations, it does suffer from a weakness. Under CEA only an indirect evaluation of
project benefits is made, if at all (Hanley and Spash 1993). This is a particular problem for
MSWM projects, as non-market or environmental and heath benefits can often be left out
of the economic evaluation process. Furthermore, using CEA for MSWM economic
appraisal means that attempts to identify which particular set of MSWM service options, or
combination of options, would create most economic benefit for different sets of customers
are rare. As a result, the least cost option to achieve the MSWM strategy targets may
deliver much lower environmental and health benefits than, say, an option which is only
slightly more costly.
Maximising welfare for society, therefore, requires the option with the highest net benefit
rather than least cost to be selected. Cost-benefit analysis (CBA), though used less
frequently in MSWM project evaluation, seeks to compare the benefits of a project or
strategy with its costs.9 The aim of CBA is to find the project that maximises benefits and
minimises costs, thereby selecting the project that society would most prefer. Ideally,
estimates of the monetary value of benefits are compared with costs. In practice, however,
many environmental and health benefits are difficult to quantify in money terms, but they
should still be taken into account where possible by using physical units of measurement
instead.
As the box below indicates, CBA should be the preferred approach to economic evaluation,
as MSWM projects can have many non-market costs and benefits, which should be
considered as far as possible.
The non-market costs and benefits of MSWM projects
“Decision-makers must take account of environmental and public health issues. For
example, disposing of hazardous waste in hazardous waste landfills or incinerators
instead of ordinary landfills, although more costly in the short term, is highly costbeneficial
in the long term, when issues of public health and/or subsequent landfill
cleanup are taken into account.”
Source: D Beede and D Bloom The Economics of Municipal Solid Waste, World Bank Research Observer Vol 10, No. 2 1995 pp113-
50.
9 A benefit can be defined as anything that increases human well-being and a cost as anything that decreases human well-being. Human
well being is determined by what people prefer.
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A joint approach
However, while CBA may have the identification of a money value of all of the project’s
costs and benefits as its general aim, and is hence the preferable economic evaluation
approach to take, it may not be a practical analysis to embark upon. It is likely that some
benefits and costs can not be given monetary values. This is usually because of data
problems or ‘correspondence’ problems (when, for example, the data from an EIA are
not capable of being interpreted clearly into monetary valuation terms).
In these cases, which can be common within MSWM economic evaluations, a useful
approach is to take the monetarisation within a CBA as far as is credible and to leave the
remaining benefit impacts in non-monetary terms. As it is usually the ‘intangible’
benefits rather than the more tangible costs of the project which prove difficulty to
quantify in monetary terms, the end result of the economic evaluation process will be a
CEA with the potential benefits of the strategy listed alongside, but perhaps not all
monetarised.10
To help this process, a number of economic researchers have developed practical ways
for listing benefits in physical units alongside costs within a CBA framework. These
suggestions can be useful to refer to, if difficulties in valuing benefits arise within the
CBA process.11 Another approach that has been used to deal with the same problem of
benefits valuation within MSWM evaluations, is called multi-criteria analysis. Annex
4D.4 to this section provides some details on this alternative evaluation procedure.
The key steps when undertaking an economic evaluation of MSWM alternative
strategies are outlined in Figure 4D.4 below. It is useful to note how the economic
evaluation process might develop if some of the benefits of the project prove difficult to
quantify.
Whichever approach is chosen, however, it is important that the range of projects
evaluated are always compared in the same way. So, if a CEA approach is decided upon,
all of the project alternatives must be analysed in this way to allow a fair comparison
between them. If, however, it is felt that non-market impacts can be quantified in
monetary terms and a CBA is used, then again this must be used for all of the projects
evaluated.
10 In the case of a “do-nothing” economic evaluation, of course, the costs of doing nothing (continued and worsening environmental health
conditions) will be listed as the intangibles, next to the cost savings benefits of not investing in the project.
11 See especially Samual Fankhauser “The Costs of Adapting to Climate Change”, GEF Working Paper No. 13, 1997 ISBN 1-884122-14-0
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Figure 4D.4 Key steps when undertaking an economic evaluation of MSWM alternative
 strategies
Cost Benefit Analysis Cost Effectiveness Analysis
Step 1
Identify a range of projects consistent with
meeting overall strategic objectives.
Step 2
Establish the evaluation period
Step 3
Decide on the appropriate discount rate to
use
Step 4
Establish the physical characteristics of the
projects - the resources they require and,
from the EIA, the environmental and health
impacts they might have
Step 5
Establish costs (capital and
operating) for alternative
strategies over the
evaluation period and
undertake monetary
valuations of their key
benefits
if a monetary valuation of
project benefits proves
difficult, evaluate the
project’s costs in economic
terms, and their benefits in
physical units
Step 5 (CEA)
Establish costs (capital and
operating) for alternative
strategies over the evaluation
period and consistent with
estimated resource
requirements
Step 6
Make necessary adjustments to
allow for differences between
financial and economic prices
create a list of the project impacts in
each case that could not be
quantified in money terms and compare
them as part of the ranking procedure
Step 7
Undertake NPV and IRR
analysis
Step 7
Undertake DCF, PV and AIC
analysis
Step 8
Identify the key risks. Carry
out a sensitivity analysis to
estimate their potential
impact on economic
feasibility
Step 9
Rank alternative strategies and make
recommendations on the preferred strategy
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4D.6.4 The Key Steps in Undertaking a Cost Benefit or Cost Effectiveness Analysis
The key steps involved in undertaking an economic evaluation of alternative projects or
strategies using cost benefit analysis (CBA) or cost-effectiveness analysis (CEA) are
discussed in more detail in this section. The term project and strategy are used
interchangeably.
Step 1. Identifying a range of projects consistent with meeting overall strategic objectives
The first step is to ensure that the strategic objectives are clearly defined and that the
ways of meeting those objectives through a selection of potential projects have been
identified.
These technical proposals can then be elaborated in a way that allows all information
required for the economic and financial evaluations to be obtained progressively and
consistently throughout the development process. It also allows for early feedback on
the financial viability of alternative strategies.
A MSWM project or strategic plan involves many interrelated elements, including:
• primary collection;
• secondary collection;
• transfer;
• haulage to landfill; and
• and landfill disposal.
It may also involve the management of growing volumes of waste over time, and
primary and secondary waste collection activities being undertaken at district level.
As a result, the strategic plan may call for more than one transfer station and more than
one landfill site. It might also include:
• waste separation facilities;
• recycling and composting facilities;
• workshop and vehicle maintenance facilities;
• administration buildings; and possibly
• waste treatment technologies.
A MSWM project for a large metropolitan city can therefore involve many interrelated
activities that must be carefully defined and understood before the economic evaluation
can proceed. It is at this point that the total resource requirements of each alternative
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strategy and their costs begin to be methodically assembled. Identification of resource
requirements can be assisted by the use of two tools:
• a schematic diagram to show clearly the component parts of each alternative strategy
and the linkages or flows between them; and
• a table setting out the resource requirements and environmental and health impacts
of each alternative strategy over the planning period.
Step 2 Establishing the Evaluation Period
The evaluation period or project lifetime is normally taken to be the sum of the operating
life of the longest lived major asset created by the strategy plus the implementation
period (although these can sometimes overlap). This establishes the time frame for the
discounting of costs and benefits.
For example, the evaluation period of a MSWM Strategic Plan option involving the
construction over two years of a large transfer station having an expected useful life of
20 years would be 22 years. For a disposal site, the evaluation period should also include
the period required for its safe close-down once full.
Step 3 Decide on the appropriate discount rate to use.
Alternative strategies are compared on the basis of their different cost and benefit
streams projected over time. Because different projects have different cost and benefit
profiles (involving different cash outlays on capital and operating expenditures and
different benefits occurring at different times) it is necessary to find a tool by which these
variable cash flow streams can be compared.
This is done using discounting, a technique which translates all of the future cost and
benefits into their present values. Essentially, discounting reflects peoples (or society’s)
time preferences, or opportunity costs of capital. Most people would prefer to have
benefits occur today rather than tomorrow. Similarly, most people would prefer to deal
with costs tomorrow rather than today. As a result, the present value of benefits and
costs which occur today are larger than those which occur tomorrow. The rate at which
future costs and benefits, measured in monetary terms, become smaller (are discounted)
is called the discount rate.
Cost benefit analysis involves discounting both the cost and benefit streams of a project
to calculate a net present value (NPV). Alternatively, another technique is to identify the
internal rate of return (IRR). This is the discount rate at which the NPV equals zero.
Cost-effectiveness analysis involves discounting costs only to calculate the present value
(PV). Projects can then be compared unambiguously using the same discount rate and
the sensitivity of changes to the rate gauged.
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No one knows exactly what the opportunity cost of capital is, although its size can be
critical to the outcome of an economic evaluation. The World Bank recommends that a
figure in the range 8% to 15% in real terms should be used for developing countries,
although advice from the relevant national economic development agency or
international financing institution should be sought.
Discounting, NPV’s IRR’s and PV’s can be easily calculated using spreadsheet software
on a computer. For more information on discounted cash flow (DCF) analysis see Annex
4D.6.
Step 4. Establish the physical characteristics of the projects - the resources they may use and the
impacts they may have
All the impacts resulting from each project’s implementation need to be identified. This
includes estimating and listing all capital and human resources used in each of their
construction processes, their different effects on employment, impacts on traffic, land
and property prices and on the quality of the environment and public health, etc.
Two important issues here are the concepts of additionality and displacement.
Additionally relates to the net impacts of the project - what extra benefit is the project
going to bring? For example, if the health benefits of a MSWM strategy are being
estimated, these benefits should be measured net of any benefits that would occur
without the project (for example, from a health education campaign). Displacement
relates to ‘crowding out’ – for example, will the new MSWM plant displace existing
informal sector activities? If so, the costs of this displacement on people’s livelihoods
also need to be included, so that the municipality is able to weigh up all the costs and
benefits of the project to society.
Step 5: Establish costs (capital and operating) for alternative strategies over the evaluation period
and undertake monetary valuations of their key benefits
For project costs
Once the overall physical characteristics and resource requirements have been
established these are translated into capital and operating costs. Capital cost items include
items such as land, site development, infrastructure, plant and equipment, and licence
costs. Operating cost items include items such as labour, fuel, materials, chemicals,
utilities, repairs and maintenance, and insurance. Prime costs are the direct capital and
operating expenditures incurred over the planning period, they do not include other
associated cost such as interest payments or depreciation allowances. Key points to note
when preparing costs are summarised in Box 4D.5 below. An example demonstrating
different price categories (constant, real and current) used for such analyses is provided
in Annex 4D.5.
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Box 4D.5 Points to note when preparing costs
The ‘Incremental-Cost Rule’. Economic evaluation is concerned with measuring cost differences
between the existing situation (the ‘without project case’) and the situation after the new project has
been implemented (the ‘with project case’). Only incremental (or additional) costs incurred as a result
of implementing the new service are included.
Prime Cost. Only prime costs - and not financial items such as debt service charges or depreciation
allowances - should be used in the cost assessment.
Market Prices. Cost estimates should be made initially using market prices. If these fairly reflect
economic prices and do not contain any significant distortions then they can be used for both the
economic and the financial analyses. If distortions do exist then adjustments may need to be made,
before they can be used in the economic analysis.
Constant Prices. Capital and operating cost estimates should be made in constant values, with
provisions made for real price increases as appropriate.
Detailed Cost Breakdowns. Cost estimates should be prepared at as desegregated a level as possible,
and the detailed analysis on which they are based should be retained. If imported capital equipment is
required then the basis on which the cost was calculated should also be retained.
Foreign Exchange Requirements. Details of foreign and local investment cost estimates are also
required to be kept separate to be used in the financial analysis to estimate the total foreign exchange
requirement and for contract packaging purposes.
Schedule of Investment Expenditures. A schedule of investment expenditures should be prepared
that relates directly to the table of resource requirements outlined above, although this may need to be
further desegregated to show the components of different cost items. The main cost items are vehicles
(for primary and secondary collection, haulage from transfer stations to landfills, and for on-site
operations at transfer stations and landfills) and facilities (communal disposal sites, transfer stations
and landfill site construction). Other specific cost elements can include incineration facilities (for which
detailed cost analysis will be required), resource recovery facilities, workshop and vehicle maintenance
facilities, and administration buildings.
Care should always be taken to ensure that cost estimates are based on realistic
assessments and that bias - particularly optimistic bias - is avoided. For more
information on constant, real and current prices see Annex 4D.5.
Project benefits
Placing monetary values on environmental or health-related benefits is important, but it
can be quite difficult to identify robust monetary values for some of the non-market
related benefits of MSWM projects. However, this does not mean it should be avoided.
Some of the most important costs or benefits of MSWM projects relate to issues such as
health or environmental quality. Not to include them in the analysis may well
misrepresent the full economic worth (or cost) of the project. At the very least the
benefits of the project - in physical units - should be listed alongside costs when
considering options.
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There are several techniques and many publications that exist to guide the practitioner in
environmental valuation within cost benefit analyses. Some useful references are
presented below.
Some useful references for environmental valuation in MSWM cost benefit analyses
• External Economic Benefits and Costs in Water and Solid Waste Investments, Institute for
Environmental Studies/ EFTEC Report Number R98/11, 1998, sponsored by the European
Investment Bank. ISBN 90 5383 632 2 (particularly for incineration issues).
• Valuating (sic) the Economic Impacts of Urban Environmental Problems: Asian Cities, World
Bank Urban Management Programme, Working Paper Series, paper no. 13, 1997. pp105.
• Cost Benefit Analysis and the Environment, N Hanley and C Spash, Edward Elgar 1993. ISBN
1 85278 947 6
• Economic Values and the Natural World, D Pearce, Earthscan 1993. ISBN 1 85383 152 2
A measure of people’s preferences for environmental or health costs or benefits can be
found through the use of willingness to pay studies, as discussed earlier in this step. For
example, a hypothetical user charge for a MSWM project option could be set equal to
people’s mean or median WTP for the potential project, and, with the population of
beneficiaries established, an estimate for the overall total economic benefit (including the
environmental benefit) of the project could then be calculated. The average tariff
multiplied by tonnage of waste, and discounted over the project lifetime would be equal
to, at least, the minimum benefit of the project. With all assumptions made clear, this
kind of benefits analysis is extremely useful for the economic evaluation process.
However, if the benefits estimation process proves difficult or too controversial, then the
projects can be evaluated on the basis of their costs alone. In this way the monetary
analysis will be one of cost effectiveness (comparing the costs of different projects) rather
than of cost benefit (comparing the net benefits of different projects).
However, it is still important to record the range of non-monetarised benefits each
project offers (for example, thousands of people at risk, or numbers of homes with
proper waste collection services) as part of the evaluation process, so that the final
ranking of options can be made with as much information as possible.
Step 6: Make the necessary adjustments to allow for differences between financial and economic
prices
The prices used in the evaluation of costs and benefits often do not reflect fairly the
value of the resources used in the production of specific inputs to the project. This is
because government policies can sometimes create distortions in market prices to such
an extent that they bear little relation to real economic costs. The adjustment of these
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market prices to reflect the true economic cost of using the input is known as shadow
pricing.12
Establishing shadow prices can be difficult or time consuming, although guidance and
appropriate values can usually be obtained from organisations working in the country,
including the World Bank and other economic development agencies. Often a simple
multiplier - a standard conversion factor - can be obtained from such sources to apply to
costs and benefits expressed in domestic prices which allows for an adjustment to be
made to counter any domestic/world price distortions.
The Usefulness of Shadow Pricing
A cost-benefit analysis of the municipal solid waste collection system in Yangon, Myanmar,
employed the principles of shadow pricing. This showed that the least-cost option of three
different waste collection systems offering the same level of kerbside collection service was one
which minimised imported vehicular equipment but optimised system productivity through
considerable labour inputs. 13
Three issues commonly require the use of shadow prices, as they can often have a
particularly important influence on the outcome of economic evaluations. These are the
exchange rate, import duties and other taxes levied on imported goods, and wage rates.
Box 4D.6 below provides a brief outline on each of them.
Box 4D.6 Exchange rates, taxes, wage rates
Exchange Rate. Some countries operate a controlled exchange rate regime in which the exchange rate
is kept artificially high. This makes the prices of imported goods lower than they would otherwise be
when measured in local currency. Unless the exchange rate is adjusted to compensate for this, the
relatively lower prices of imported goods will tend to divert demand away from their locally produced
equivalents. A shadow exchange rate should be used to overcome distortions of this kind.
Import duties and other taxes. Import duties and other taxes (such as value-added tax) imposed on
goods and services merely serve to transfer financial resources between one group and another; they
do not relate to the intrinsic economic value of the goods or services themselves. Where such taxes are
likely to distort project outcomes - high import duties may be levied on foreign equipment - then the
import duty should be removed and the underlying cost-insurance-freight (CIF) price used in the
analysis.
Wage Rates. A country with a surplus of labour will have relatively inexpensive labour cost when this
is measured in terms of other opportunities foregone by its use. In this case, a shadow wage rate can be
used to adjust wage rates that are kept artificially high downwards. This would have the effect of
improving the relative position of labour intensive solutions over more capital intensive ones.
12 The economic evaluation should also be conducted in constant prices. This means keeping prices constant as of a specific date, normally
the year in which the analysis is being undertaken. If the price of a particular commodity (eg, labour) is expected to rise in real terms over
and above the general inflation rate, then allowance should be made for this. General inflation, on the other hand, simply raises all cash
values by a given percentage and should be ignored.
13 Source: Cost Benefits Analysis of the MSW Collection System in Yangon, Myanmar. AM Tinn, et al, Elesevier, Asian Institute of
Technology, Bangkok, Thailand, 1995.
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These are important issues for developing countries. It is essential that the economic
analyst should ensure that the prices used in the evaluation reflect actual resource
scarcities and that the preferred investment will make the best use of a country’s
physical resources.
Step 7: Undertake NPV and IRR analysis for CBA or PV and AIC analysis for CEA
NPV/ PV
The net present value (NPV) of a project is the present value of the eventual benefit
surplus arising to society from the project. A calculated positive value for NPV shows
the present value by which the project has increased welfare for society. Projects with
positive NPV make society better off, while projects with negative NPV make it worse
off. Similarly, all projects with NPVs can be ranked and the one with the highest NPV
selected as best for society.
The NPV of a project can be calculated quite simply on computer spreadsheets. In
conceptual terms:
 T
NPV = PV benefit - PV cost = Σ Bt -Ct
 t=0 (1+r)t
where
B = benefits
C = costs
t = time period (t1 = year 1 for example)
r = discount rate (eg 12%)
PV
The present value (PV) is simply the discounted sum of the costs of the project alone (or
of the benefits alone). It is not a net value, like NPV, hence its use in CEA. Again, the PV
of a project can be calculated quite simply on computer spreadsheets.
IRR
The internal rate of return (IRR) is the discount rate that would produce a NPV of zero
for the project. Hence, if the IRR is greater than the base rate of interest for the country,
then the project could be seen to be a more viable investment than simply investing the
project resources instead. Many agencies use a ‘rule of thumb’ for the IRR. A good IRR
would lie between 10 and 20%. Any higher and it might appear too optimistic. Any
lower and the project could be seen to be delivering marginal benefit to society from the
deployment of the resources in question.
The IRR of a project can be calculated quite simply on computer spreadsheets.
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AIC
Average incremental cost (AIC) analysis can be used to compare the costs of alternative
strategies that provide different levels of service. AIC analysis is a method by which to
establish the average unit cost of a service (eg, average collection costs measured in
US$/tonne), a measure that can be used both for comparing project costs and for
providing a good general indication of the affordability of the proposed measures. It
provides a sound basis for establishing the average tariff level needed to achieve full cost
recovery from users. It is calculated by dividing the PV of a project cash flow by the PV
of its associated waste throughput stream, thereby providing an estimate of the average
cost per tonne of waste treated.
It is useful because:
• it allows strategies (or strategy components) to be compared on the basis of unit costs
of service (a readily understandable measure);
• it allows strategies based on different service levels to be compared;
• it is an indicator of the average tariff needed to achieve full cost recovery;
• it allows the unit costs of the investment and operating components of a strategy to be
calculated separately, thereby enabling the significance of each to be assessed.
For more information and a worked example of an AIC analysis see Annex 4D.6.
Step 8: Identify the key risks. Carry out a sensitivity analysis to estimate their potential impact
on economic feasibility
A decision on the preferred strategy should be taken only after each alternative has been
subjected to a thorough sensitivity analysis based on an identification of the key risks to
which it is likely to be exposed. These can take a number of forms, but important ones
are:
• the possibility of cost overruns;
• components taking longer than projected to implement;
• waste volumes being higher or lower than projected;
• certain key benefits being higher or lower than expected; and
• operating costs being higher than projected.
• the sensitivity of outcomes to changes in the discount rate should also be assessed.
Sensitivity analysis involves calculating the effect that changing the values assigned to
key parameters, costs and benefits has on project outcomes (such as unit costs per tonne)
and hence on the rank ordering of projects. One approach is to compare the effect of a
percentage change in a variable, such as a 20% increase in capital costs, on the rank
ordering of project options.
Another approach is to calculate ‘switching values’. A switching value is the percentage
change in a variable needed to bring about a specific outcome, such as the percentage
change in capital costs needed to switch the rank order of project alternatives. The
likelihood of a change of this magnitude can then be assessed.
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The box below shows possible ways of presenting the results of sensitivity analyses
based on these two approaches.
Example Presentation of the Results of a Sensitivity Analysis
(a) Sensitivity of rankings to changes in key variables (for
alternative strategies yielding identical benefits)
Rank Order Alternative Alternative
 Strategy 1 Strategy 2
Base case 1 2
20% investment cost overrun 2 1
Operating costs increased by 10% 1 2
Discount rate reduced from 10% to 5% 2 1
(b) Switching values (cost >$40/tonne)
Alternative Alternative
 Strategy 1 Strategy 2
Increase in investment costs 15% 30%
Increase in operating costs 50% 40%
Increase in discount rate from 10% to 14% 12%
Step 9: Rank alternative strategies and make recommendations on the preferred strategy
Once the economic evaluation and sensitivity analyses have been completed the
alternative strategies can be ranked, according to their NPVs if a CBA was used, or their
average costs per tonne if a CEA was used. A final decision can then be made taking into
account all other relevant factors. Importantly, if the findings from a CEA approach are
presented, the non monetarised costs and benefits of the options should also be clearly
listed alongside each cost/per tonne finding.
Other general issues within economic evaluation
A useful paper published in the World Bank Research Observer in 1995 also discusses some
issues related to the economics of MSWM and cost benefit analysis. The box below
summaries its findings.
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Some Further Cost Benefit Considerations for MSWM Projects
As well as taking account of non-market costs and benefits where possible, there are
generally three other key significant variables involved in the cost benefit comparisons of
alternative options for MSWM services – the relative costs of labour and other production
factors, the physical characteristics of the waste and efficient scales of operation.
1. Relative costs of labour
Capital-intensive waste management techniques, which may be economically efficient in
developed countries, may not be so in developing countries, especially in relation to
collection and processing activities. Labour-intensive collection and processing of materials
may be more efficient, although more costly equipment that reduces spillage during the
collection process may well be efficient. However, it is still important to promote more
capital intensive landfill management.
2. Physical Characteristics
Food waste is often the largest component in MSW in developing countries. This relates to
poor refrigeration and storage facilities in low-income households and the low cost of food
staples. The high moisture content of such waste can decrease the cost effectiveness of
incineration, for example, as more fuel is required.
3. Scale of Operations
Because the average cost per tonne of collecting, processing or disposing of MSW generally
varies with the amount of waste being handled, the scale of operations may be crucial to the
selection of cost effective management options. In summary, there are limited economies of
scale available in the collection of MSW and greater economies of scale associated with
transfer stations, landfills and other MSWM facilities. This suggests that, broadly speaking,
collection services are best provided on a decentralized basis, whereas it may be more costeffective
for disposal and treatment facilities to be consolidated at a regional or
metropolitan area level.
Source: D Beede and D Bloom. The Economics of Municipal Solid Waste, World Bank Research Observer Vol 10, No. 2 1995 pp113-
50.
4D.7 PART III: FINANCIAL EVALUATION OF THE PREFERRED MSWM STRATEGIC
PLAN
4D.7.1 FINANCIAL PLANNING AND APPRAISAL OF THE PREFERRED MSWM STRATEGIC PLAN
The financial analysis and appraisal is undertaken after the economic evaluation has
been completed, and is usually carried out for the preferred MSWM strategic plan only,
and not for all alternative strategies.
Whereas the economic evaluation uses economic prices to establish the most appropriate
waste management strategy, municipalities and service users are more interested in
financial costs. They need to know what budgetary allocations the new system demands
and how much needs to be recovered from users to sustain it. Financial appraisal is a
means of assessing the costs and revenues associated with SWM investments and is
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concerned with forecasting the effects of investment proposals in financial terms and
with establishing their impact on users.
The financial cost of a SWM strategy and its cost to the user can be influenced
significantly by government policies (unlike economic costing). Financial appraisal is
therefore the basis for measuring municipal affordability and the magnitude of charges
to be transferred to users. The prices used in the financial evaluation are market prices,
which must usually be adjusted for projected inflation in order to establish the actual
amount of investment or recurrent funds required in any year.
The financial evaluation has three aims:
• to demonstrate the financial viability of the strategy;
• to prepare a financing plan to cover investment expenditures during the
implementation phase of the strategy; and
• to ensure that financial resources are available during operations to meet all future
requirements for goods, services and financial obligations (ie, debt service).
Figure 4D.5 shows the principal stages involved in the financial evaluation. Each is
considered further below.
4D.7.2 Step 1: Establish Broad Financial Objectives
The need for the MSWM authority to establish broad financial objectives, and to
establish the institutional and managerial arrangements needed for these to be achieved
effectively, has been addressed in Section 4D.3. Deciding on cost recovery policy is key to
long-term financial viability.
It is crucially important that the preferred MSWM Strategic Plan should be financially
sustainable in the longer-term. Grants can be an important source of investment capital
for municipal services, but only insofar as they are seen as transitional assistance
towards helping the service achieve financial viability over the longer-term. Financial
objectives should be set with this as the goal. If it is felt that this is not achievable - for
whatever reason - then the proposed strategy is unsustainable and a less ambitious one
should be considered.
4D.7.3 Step 2: Calculate Average Incremental Costs Based on Financial Prices
Average incremental costs based on financial prices are a useful indicator of the average
unit cost per tonne of waste which would need to be levied on all users to achieve full
cost recovery, regardless of financing arrangements. Financial AICs differ from those
calculated in the economic analysis only in that financial rather than economic prices are
used, and that the discount rate reflects the average cost of capital to the MSWM agency
rather the opportunity cost of capital to the nation.
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The financial AIC represents the charge per tonne of waste which if applied to all waste
managed over the planning period would generate a revenue stream whose present
value is identical to that of the cost stream. That is, it is the unit charge which would
completely recover all costs and generate a return on investment equal to the average
cost of capital.
The financial AIC is therefore a very useful guide when formulating cost recovery
objectives, possible tariff structures and charge levels. It is again based on prime costs
only, and is calculated using constant values.
The cash flows used to calculate the financial AIC analysis form the basis for the
remainder of the financial evaluation. Since this is concerned with the ability to generate
sufficient revenues to cover future operating costs and debt-service requirements, it is
necessary to project future costs and revenues after taking into account the effects of
inflation.
4D.7.4 Step 3: Private Sector Involvement
Scope for involving the private sector in the provision of MSWM services, and the
different ways by which this can be achieved, has been addressed in Step 4A of this
Planning Guide.
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Figure 4D.5 Principal Steps in the Financial Planning and Evaluation of Action Plans
If the contract with the private firm provides for it to finance physical assets, such as
refuse collection vehicles, then private-sector involvement can result in a reduction in
the total investment required to be funded by the municipality.
The financial implications of involving the private sector have to be taken into account in
the investment financing plan, the recurrent funding plan and the sources and
applications of funds statement. Note the comments on private-sector involvement made
in Section 4D.8.5.
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4D.7.5 Step 4: Preparing the Investment Financing Plan
The investment financing plan is usually a one-page table that summarises total
investment requirements, the proposed sources of investment finance, loan draw down
and debt-servicing schedules. It is a critical part of the project finance documentation.
The stages involved in preparing the financing plan are to
• estimate total investment requirements;
• identify sources of investment funds;
• prepare the financing plan.
The total investment requirement is the total
amount of funds needed over the implementation
period. This amount is determined from the original capital cost estimates in constant
values (including physical contingencies) adjusted for price contingencies (inflation and
exchange rate effects) and any provision for interest incurred and capitalised during the
implementation period.
The analysis should be undertaken for individual project components and then
consolidated to show overall requirements. Keeping information at a desegregated level
allows ready comparisons to be made between components and the effects of sensitivity
analyses to be observed. It is also useful when preparing contract packages for different
components of the strategy.
Cost items should be classified as local or foreign, with price adjustments being made
accordingly. The costs of locally produced items should be adjusted according to
appropriate local inflation indices, which may be a general rate (such as a consumer
price index) or a specific purpose rate (such as a construction cost or manufacturing cost
index). The prices of imported goods quoted in foreign currency should be adjusted
according to the appropriate international inflation index and then converted to local
currency at the projected exchange rate.
Interest incurred during construction is sometimes capitalised to form part of the overall
loan; whether this is done depends on the financing structure and specific loan
conditions. If a loan is specifically earmarked, say, for the construction of a sanitary
landfill, then interest during construction may be capitalised to form part of the specific
loan.
Once all price adjustments have been made to the investment schedule these are set out
in a table showing for each strategy component the total funding requirement split
between local and foreign elements, and the expenditure profile over time. This is the
total investment to be funded over the implementation period. A typical financing plan
is presented in the worked example set out in Annex 4D.2.
Once the total investment requirements and
Estimate Investment Requirements
Identify Sources of Investment Finance
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expenditure profile have been established it is necessary to identify the means by which
this can be funded. Potential sources of investment funds have been reviewed in Section
4D.8. The principal sources are likely to be national, state or local government grants or
loans, commercial loans or international finance agency loans (eg, from the World Bank).
Foreign grants can be another source.
The balance between loans and grants will depend upon the availability of each, the
nature of the investments and, importantly, the amount of debt the strategy can sustain.
Whereas grant funds have no direct effect upon the future recurrent funding
requirement, loans do. Despite this, an over-dependence on grants should be avoided.
• A dependence on grants can indicate the non-affordability of a strategic plan - a
strategy unable to generate recurrent funds sufficient to cover a reasonable level of
debt is, by implication, unable to afford the capital costs associated with it.
• A dependence on grants can also fail to bring about the commercial discipline
associated with loan service obligations, thereby undermining key strategic objectives
of focusing accountability, improving quality, reducing costs and providing value for
money services.
The financing plan sets out the total
financing requirements and
expenditure schedules for the main strategy components, it indicates how these are to be
funded over time from the various sources of investment funds, and establishes probable
debt service schedules.
The debt repayment schedules depend on the specific terms and conditions of a loan.
Loans from international financing agencies, such as the World Bank, will often offer
better terms than those offered by fully commercial institutions. In particular, a World
Bank loan may offer longer loan repayment periods, a grace period before loan
repayments begin, and possibly lower interest rates than a commercial lender. Note that
it is most unusual for the term of a loan to extend beyond the expected economic life of
the assets being funded. An annual commitment fee may also be payable on the amount
of loan outstanding at a specified date.
The financing plan should form part of an integrated financial model. This allows the
effects of changes to the proposed investment financing structure to be observed directly
in the sources and uses of funds table, and reflected in the profile of debt coverage ratios
(refer below). An iterative approach can therefore be used to assess the reasonableness of
different ratios of debt and grants (or retained earnings).
The different sources of investment funds and the debt servicing schedules feed directly
into the sources and uses of funds table.
Note that the investment financing plan does not necessarily have to cover all of a
strategy’s investment funding requirements over the entire planning period, and might
Prepare an Indicative Investment Financing Plan
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only relate, for example, to the initial five year period in which the bulk of investment
expenditures are incurred. If additional major expenditures are projected for the future
then detailed consideration should be given to how these are to be funded.
4D.7.6 Step 5: Identifying Sources for Financing Recurrent Expenditures
Recurrent expenditures consist at a minimum of all operating expenditures
plus expenditures on debt service (interest, commitment fees and capital
repayment).
Where long-term liabilities are being incurred - such as employee pension
entitlements - then these should desirably be treated as recurrent costs and
financed. Provisions for the long-term closure and post-closure maintenance
of disposal facilities should also be made out of the current revenue stream.
If the service is to be operated on a fully commercial basis then a financial
objective should be to amortise and recover over the life of the project the
value of all investments made in the strategy. Implicit in this is a rate of
return on the investment funds employed.
Recurrent expenditures do not include expenditures on capital items not included in the
investment plan (such as vehicle replacement or future landfill site development or
closure) for which additional funding arrangements must be established. Ideally,
however, sufficient recurrent funds should be generated at least to contribute towards
future system development and asset replacement.
As discussed in Sections 4D.6 and 4D.7, the sources of funds available to finance
recurrent expenditures consist primarily of municipal transfers from general revenue or
user-charges. Funds from general revenue have traditionally been used for funding
MSWM services but a new strategy frequently requires additional sources, thereby
forcing the issue of user-charges to be addressed.
It is rarely possible to shift directly from a position of total dependence on municipal
funding to one of full cost recovery from users; user charges are normally introduced
progressively over a period of time.
There are two ways to estimate the amount of revenue to be raised from user charges:
• by calculating the difference between the total recurrent funding requirement and
expected receipts from normal municipal sources (after accounting for inflation); or
• by estimating contributions from user charges according to a realistic schedule for
their introduction (eg, rising to 100% of cost recovery over ten years); the difference
between this and the total recurrent funding requirement is then the contribution
needed from normal municipal sources.
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The amount of funds raised by each of these approaches would be sufficient to cover the
recurrent funding requirement only and would not contribute towards any additional
investment requirements such as plant and equipment replacement or landfill site
coverage on closure. If funds are to be accumulated through revenues to meet these
requirements then the level of user charge will need to be adjusted accordingly.
Sources of funds available from municipal sources and raised through user charges are
reflected in the sources and uses of funds table.
4D.7.7 Step 6: Preparing a Sources and Uses of Funds Statement
The sources and uses of funds table sets out all relevant cash inflows and outflows, and
is used to assess the overall cash position of the operating agency under the proposed
financing arrangements. Specifically, it brings together:
• all sources of funds projected to be used by the strategy, including investment funds
(debt, grants and retained earnings) and recurrent funds (general municipal sources
and user charges); and
• all applications of funds, including capital investments and the recurrent funding
requirement (operating expenditures and debt service). It can also include provisions
for long-term liabilities, such as facility closure and post-closure maintenance costs.
The difference between total sources and total applications is shown as a surplus or as a
deficit. Surplus funds can be accumulated (preferably in an interest bearing account) and
used to finance future liabilities (eg, pension entitlements or facility closure costs),
capital expenditures or deficits. Deficits have to be financed either out of accumulated
earnings (surplus) or from additional sources to be identified.
The sources and uses of funds table not only provides an overview of the total funding
arrangements and cash position of the strategy over time, but can also be used to assess
the financial implications of alternative investment or recurrent funding structures. The
two are closely related.
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A measure of the financial viability of a strategic MSWM plan is the ability of the net income stream to
meet the debt service requirements (loan repayment, interest and commitment fees), where:
Net income = the total of recurrent funding sources minus direct operating expenditures (excluding interest,
depreciation and tax).
The measure used is the debt-coverage ratio (DCR), which is the ratio of annual net income divided by
annual debt-service requirements. This shows the extent to which uncommitted funds cover annual debt
service.
The ratio must be greater than 1 if debt service is to be funded out of income. Financiers will normally
expect to see a debt-coverage ratio of at least 1.3, this providing a cushion against operating expenditures
being higher or user charge collections being lower than expected.
The ratio is important for assessing the outcomes of changes to key financing assumptions. In particular,
close attention should be paid to the DCR when considering the effects of changes to the ratio of loans to
grants, the level of user charges, debt repayment schedules, investment costs, or operating performance.
The ratio is an important financial indicator and is best visualised graphically.
4D.7.8 Step 7: Preparing Financial Statement and Balance Sheet
An income statement and a balance sheet are normally prepared in addition to the
financing plan and the sources and uses of funds statement to complete the framework
for making financial judgements on the strategy. Both should be prepared in line with
normal accounting practice.
The income statement records income and expenditures (including operating
expenditures, overheads, interest and depreciation) over a period of one year, and is
prepared on an accruals basis. Note that expenditure on capital assets is accounted for in
the income statement by a depreciation provision, which allows for the progressive
using up of those assets over time. Neither capital expenditures nor debt repayment
instalments appear in the income statement.
The balance sheet provides a snapshot of the assets and liabilities of an agency at a fixed
point in time.
Both the income statement and the balance sheet support the financing plan and the
sources and uses of funds table, and ratio analysis is used to assess strategy
sustainability. This can have a bearing on investment financing ratios, the conditions and
covenants written into loan agreements, the level of user-charges and overall viability of
the proposed strategic plan.
4D.7.9 Step 8: Identifying Potential Risks by Conducting a Sensitivity Analysis
Sensitivity analyses - including ratio analysis - are undertaken to test the financial
stability of the strategic plan. The aim of the sensitivity analysis is to assess the
implications for financial stability of plausible changes to the major assumptions
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upon which the financial arrangements are based. The impact of these changes on the
viability of the strategy has to be carefully considered.
4D.7.10 Step 9: Assessing Financial Viability and Stability of the Strategic Plan
After consideration of all the analyses a recommendation is made about the overall
financial stability of the strategic plan. It is particularly important that advisers should
be convinced that the Action Plan is financially sound, and that the longer-term strategy
will be sustainable even in the event that the projections on which is based change
within reasonably plausible limits.