1. Energizing Cleaner Production
Financial Feasibility Analysis
Energizing Cleaner Production
Management Course

2. Profitability Indicators
Session Agenda:
Introduction
Cash Flow
Profitability Indicators
Simple Payback
Return on Investment (ROI)
Net Present Value (NPV)
Internal Rate of Return (IRR)

3. But first…
In what step(s) of the methodology is financial feasibility analysis relevant?
Ask participants to indicate in what steps of the methodology is financial feasibility relevant?
(Click once) Arrows appear:
Task 4a – technical, economic and environmental feasibility analysis
Task 5a – implement options and monitor results (here the financial costs and savings of implemented options are measured and compared to the calculated values in task 4a)

4. Introduction Step 4 – Feasibility Analysis
Company’s priority
Technical
Project Selection
Other
Regulatory
Organizational
Health/safety
Community
Financial
Environmental

5. Introduction Questions Management Will Ask
1. Is the project profitable?
Initial investment costs
Annual operating costs and savings
Cost of operating inputs
Cost of waste management
Less tangible costs
Revenues
2. Determine availability of internal investment funds for bigger projects
3. Obtain external financing for remaining projects

6. Introduction Capital Budgeting Process
Process by which organisation decides:
Which investment projects are
Needed
Possible
Special focus on projects that require significant up-front capital investment
How to allocate available capital between different projects
If additional capital is needed

7. Introduction Capital Budgeting Practices
Vary widely from company to company
Larger companies tend to have more formal practices than smaller companies
Larger companies tend to make more and larger capital investments than smaller companies
Some industry sectors require more capital investment than others
Vary from country to country

8. Introduction Typical Project Types and Costs
Maintenance
Maintain existing equipment and operations
Improvement
Modify existing equipment, processes, and management and information systems to improve efficiency, reduce costs, increase capacity, improve product quality, etc.
Replacement
Replace outdated, worn-out, or damaged equipment or outdated/inefficient management and information systems

9. Cash Flow Cash Flow Concept
Common management planning tool
Distinguishes between
Costs: cash outflows
Revenues/savings: cash inflows

10. Cash Flow Types of Cash Flow
Inflow
Equipment salvage value
Operating revenues & savings
Working capital
Outflow
Initial investment cost
Operating costs & taxes
Working capital
One-time
Annual
Other

11. Cash Flow Costs and Savings
Initial investment costs
purchase of the camera system, delivery, installation, start-up
Annual operating costs (and savings)
Operating input — materials, energy, labour
Incineration — fuel, fuel additive, labour, ash to landfill
Wastewater treatment — chemicals, electricity, labour, sludge to landfill

12. Cash Flow Working Capital and Salvage Value
Working capital: total value of goods and money needed to maintain project operations
Raw materials inventory
Product inventory
Accounts payable/receivable
Cash-on-hand
Salvage Value: resale value of equipment or other materials at the end of the project

13. Cash Flow Timing Year 1 Year 2 Year 3 Salvage Value
End of project:
Salvage Value
Annual Revenues/Savings
Year 1
Year 2
Year 3
TIME
Time zero:
Initial Investment

14. Cash Flow Incremental Analysis
Needed for many CP or EE projects
Compares cash flow of implemented options to the “business as usual” cash flow
Covers only the cash flows that change

15. Profitability Indicators
Definition: “a single number that is calculated for characterisation of project profitability in a concise and understandable form”
Common indicators
Simple Payback
Return on Investment (ROI)
Net Present Value (NPV)
Internal Rate of Return (IRR)

16. Simple Payback (in years)
Definition: number of years it will take for the project to recover the initial investments
Usually a rule of thumb for selecting projects, e.g. payback must be < 3 years
Simple Payback (in years)
Investment
Cash Flow =

17. Simple Payback (in years)
2. Return on Investment
Definition: the percentage of initial investment that is recovered each year
Initial Investment
Year 1 Cash Flow
Simple Payback (in years) =
3 years
Year 1 Cash Flow
Initial Investment
ROI (in %)
33% =

18. Workshop Exercise PLS Company: produces rolls of laminated film
INVENTORY
SLITTING
solvent air
emissions
printed
laminated
film
plastic film, ink
plastic film, aluminium film, adhesive
PRINTING
LAMINATION
Liquid waste
ink
Solid scrap
to waste
management
The PLS Company is a medium-sized firm that produces rolls of printed, laminated film. The film is sold to food processing companies, who use it to manufacture food packages such as flexible pouches for fruit juices. The acronym PLS reflects the three main manufacturing steps at the facility: Printing, Laminating, and Slitting.

19. Workshop Exercise PLS Company installs QC Camera
Printing step
Printing errors cause high scrap rate
Quality Control (QC) 3-camera system
Detect printing errors
Operators halt the operations before too much solid scrap is generated
QC camera system costs US$105,000 to purchase and install
40% reduced scrap and operating costs
The PLS Company bought a quality control (QC) camera system and installed it on the print line. Full production run printing errors could then be detected earlier than was possible without the cameras. The project reduced the scrap rate from full production runs by about 40% and reduced annual operating costs accordingly.

20. Workshop Exercise
Question 1: Calculate annual cash flows using the cash flow worksheet (15 min)
Question 2: Calculate simple payback (5 min)
Note to the trainer: the 1.5 hour session does not include question 1, so only do this question if you have sufficient time.

21. 3. Net Present Value Money Loses its Value
Question:
If we were giving away money, would you rather have: (A) $10,000 today, or (B) $10,000 3 years from now Explain your answer...

22. 3. Net Present Value Inflation
Money loses purchasing power over time as product/service prices rise, so a dollar today can buy more than a dollar next year
inflation 5%
costs $1
costs $1.05
now
next year

23. 3. Net Present Value Return on Investment
A dollar that you invest today will bring you more than a dollar next year — having the dollar now provides you with an investment opportunity
Gives you $1.10 a year from now
Investing $1 now
Investment
10 % interest, or “return on investment”

24. 3. Net Present Value PLS Company’s QC Camera Project
Initial Investment
Cost
Annual Operating
Costs
Business As Usual
$ 2,933,204
Annual Savings =
US$38,463
Installing quality control camera
$ 105,000
$ 2,894,741
(in US$)

25. 3. Net Present Value Question
Is the annual savings of $38,463 per year for 3 years a sufficient return on the initial investment of $ 105,000?

26. 3. Net Present Value Time Value of Money
Money is worth more now than in the future because of
Inflation
Investment opportunity
“Time value” of money depends on
Rate of inflation
Rate of return on investment

27. 3. Net Present Value Cash Flows from Different Years
Before you can compare cash flows from different years, you need to convert them all to their equivalent values in a single year
It is easiest to convert all project cash flows to their “present value” now, at the very beginning of the project

28. 3. Net Present Value Converting Cash Flows to Present Value
Annual Savings
End of project
= ??
$38,463
$38,463
$38,463
Year 1
Year 2
Year 3
TIME
Time zero:
Initial Investment = $105,000

29. 3. Net Present Value Converting Cash Flows to Present Value
Discount rate:
Converts future year cash flows to their present value
Incorporates:
Desired return on investment
Inflation
Reverse of an interest rate calculation

30. 3. Net Present Value Discount Rate & Interest Rate
Invested at an interest rate of 20%, how much will $10,000 now be worth after 3 years?
$10,000 x 1.20 x 1.20 x = $17,280
At a discount rate of 20%, how much do I need to invest if I want to have $17,280 in 3 years?
$17,280
1.20 x 1.20 x = $10,000
Discount rate is basically the opposite of interest rate

31. 3. Net Present Value Which Discount Rate?
Equal to the required rate of return for the project investment, based on
A basic return - pure compensation for deferring consumption
Any ‘risk premium’ for that project’s risk
Any expected fall in the value of money over time through inflation
At least cover the costs of raising the investment financing from investors or lenders (i.e. the company’s “cost of capital”)
A single “Weighted Average Cost of Capital” (WACC) characterises the sources and cost of capital to the company as a whole

32. 3. Net Present Value Calculating “Present Value”
Value of the cash flow in year n
Present Value = Future Valuen x (PV Factor)
Value of cash flow at “Time Zero,” i.e. at project start-up
Present Value (PV) Factors or “discount factors”
For various values d (discount rate): 10%, 15%, 20%
For various years n (number of years)
Tables available

33. 3. Net Present Value The Value of a Future $1
Discount rate (d): 10% 20% 30% 40%
Years into future (n)
Present value factors
Handout: Table with discount rates

34. 3. Net Present Value Net Present Value (NPV)
Definition: sum of present values of all project’s cash flows
Negative (cash outflows)
Positive (cash inflows)
Characterises the present value of the project to the company
If NPV > 0, the project is profitable
If NPV < 0, the project is not
More reliable than Simple Payback or ROI as it considers
Time value of money
All future year cash flows

35. 3. Net Present Value Workshop Exercise (15 min)
Question 3: Calculate the NPV
Expected Future Cash Flows
Present Value of Cash Flows (at time zero) PV
Factor
Year X = 1 2 3
- $105,000
+ $38,463
- $???
$???
???
Sum = project’s Net Present Value =

36. 3. Net Present Value Workshop Exercise (5 min)
Question 4: compare the Simple Payback and the NPV

37. 3. Net Present Value Sensitivity Analysis
In business as usual scenario PLS Company needs waste water treatment plant in year 3: $150,000 investment
With QC project: $95,000
Savings: $55,000
Also consider taxes!
Pollution taxes / fees
Tax deductions for equipment depreciation
Tax deduction for “environmental projects”
See the answer sheet of the workshop exercise for more background information

38. 3. Net Present Value Workshop Exercise (answer B)
Expected Future Cash Flows
Present Value of Cash Flows (at time zero) PV
Factor
Year X = 1 2 3
- $105,000
+ $38,463
+ $93,463
.8696
.7561
.6575
- $105,000
33,447
29,082
61.452
-18,981
Sum = project’s Net Present Value =

39. 4. Internal Rate of Return (IRR)
Definition: discount rate for which NPV = 0, over the project lifetime
Tells you exactly what “discount rate” makes the project just barely profitable
Similar to NPV, considers
Time value of money
All future year cash flows

40. Profitability Indicators Summary
Advantages Disadvantages
Easy to use Neglect TVM
Neglect out-year costs
Do not indicate project size
Considers TVM Needs firm’s discount rate
Indicates project size
Considers TVM Requires iteration
Does not indicate project size
Simple
Payback
& ROI
NPV
IRR

41. Thank you for your attention!
Financial Feasibility Analysis of Options
Thank you for your attention!

42. Acknowledgements
This training session was prepared as part of the development and delivery of the course “Energizing Cleaner Production” funded by InWent, Internationale Weiterbildung und Entwicklung (Capacity Building International, Germany) and carried out by the United Nations Environment Programme (UNEP)
The session is based on the presentation “Financing Cleaner Production and Energy Efficiency Projects” from the “Energy Efficiency Guide for Industry in Asia” developed as part of the GERIAP project that was implemented by UNEP and funded by the Swedish International Development Cooperation Agency (Sida).
The workshop exercise is taken from “Profiting from Cleaner Production”, in Strategies and Mechanisms For Promoting Cleaner Production Investments In Developing Countries, developed by UNEP