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Presentation Transcript
slide1
Financing Cleaner Production and Energy Efficiency Projects

Presentation of the Energy Efficiency Guide for Industry in Asia

slide3

Participant introductions

  • What type of organization do you work for?
    • e.g., industry, government, other
    • if from industry, which sector and what size
  • What are your job responsibilities and areas of expertise?
    • e.g., management, accounting, finance, engineering, production, environmental
  • What is your investment perspective?
    • e.g., developer of investment proposals, one who funds investment proposals
workshop overview
Lecture

Waste and Cleaner Production

Cost identification and estimation

LUNCH BREAK

Capital budgeting and project profitability

Project funding

Workshop exercise

Risks of waste

Cost identification for waste

Cost estimation for waste

Calculating cash flow and simple payback

Calculating NPV

What the bank will consider

Workshop overview

9.00

10.30

12.30

14.00

16.30

slide6

Waste and Cleaner Production

What is waste?

  • “Anything that leaves the company not as product!”
  • It costs money…
  • and…
  • it can be prevented!
slide7

Waste and Cleaner Production

Waste takes many forms

Air Emissions

Materials,

Energy,

Water,

Labour,

Capital

Products,

By-Products

Solid Waste Waste Energy, Wastewater

waste and cleaner production exercise 1 10 min
Waste and Cleaner ProductionExercise 1 (10 min)

Write down the risks associated with waste from the perspective of:

  • Management of a company
  • Government
  • Investors
waste and cleaner production the cost of waste iceberg

Treatment &

Disposal

Regulatory

Compliance

THE HIDDEN COST

OF WASTE

Lost Raw

Materials, Energy,

Labor

Liability

Company Image

Waste and Cleaner ProductionThe “Cost of Waste Iceberg”

Adapted from: Bierma, TJ., F.L. Waterstaraat, and J. Ostrosky. 1998. “Chapter 13: Shared Savings and Environmental Management Accounting,” from The Green Bottom Line. Greenleaf Publishing:England.

waste and cleaner production the costs of waste ink at southwire company
Waste and Cleaner ProductionThe costs of waste ink at Southwire Company
  • The average disposal cost of a drum of hazardous waste ink was estimated as $50
  • Upon closer inspection, the true cost was discovered to be $1300 per drum:
      • $819 lost raw materials (ink, thinner)
      • $369 corporate waste management activities
      • $50 disposal
      • $47 internal waste handling activities
      • $16 hazardous waste tax
slide11

Waste and Cleaner Production

Dilute & disperse

Cleaner Production

Sustainable Development

Pollution Prevention

Recycling

Pollution Control

Complexity of Environmental Issue

Dispersion

1960

1980

1990

slide12

Waste and Cleaner Production

“End of Pipe” treatment

Cleaner Production

Sustainable Development

Pollution Prevention

Recycling

Treatment

Complexity of Environmental Issue

Dispersion

1960

1980

1990

slide13

Waste and Cleaner Production

Off site recycling

Cleaner Production

Sustainable Development

Pollution Prevention

Recycling

Pollution Control

Complexity of Environmental Issue

Dispersion

1960

1980

1990

slide14

Waste and Cleaner Production

Prevention

Cleaner Production

Sustainable Development

Pollution Prevention

Recycling

Pollution Control

Complexity of Environmental Issue

Dispersion

1960

1980

1990

waste and cleaner production cp definition
Waste and Cleaner ProductionCP definition
  • Integrated, preventative, continuous strategy
  • Products, production processes or services
  • Reduce risks to humans and environment
  • and increase profits!

or waste minimization, pollution prevention, eco-efficiency…

waste and cleaner production cp benefits reduced risk
Waste and Cleaner ProductionCP benefits: reduced risk!

Reduced material use and waste

Reduced liability risks

Reduced costs & increased profits

Enhanced reputation

Increased productivity

waste and cleaner production cp strategies
Waste and Cleaner ProductionCP strategies
  • Prevention of waste generation:
  • Good housekeeping
  • Input substitution
  • Better process control
  • Equipment modification
  • Technology change
  • On-site recovery/reuse
  • Production of useful by-product
  • Product modification
slide18

Waste and Cleaner ProductionCP versus End of pipe

COST

ENVIRONMENTAL

PERFORMANCE

COST

ENVIRONMENTAL PERFORMANCE

End of pipe Treatment

Cleaner Production

waste and cleaner production cp methodology
Waste and Cleaner ProductionCP Methodology

Step 3

Step 5

Step 1

Implement and measure results

Identify

CP options

Get

organized

Step 2

Step 4

Carry out feasibility analysis

Step 6

Analyze

processes

Integrate in business processes

At what steps do you need cost data?

cost identification and estimation step 2 analyse processes
Cost identification and estimationStep 2: Analyse processes
  • Prepare process flow charts
  • Collect baseline data and observations
  • Material balance: determine true waste!
  • Assign costs to materials, energy and waste
cost identification and estimation case study the plc company
Cost identification and estimationCase study: the PLC Company
  • A mid-sized manufacturer of food packaging materials
  • Major manufacturing steps are Printing, Laminating, and Slitting
  • Waste management includes incineration and wastewater treatment
  • Cleaner Production has reduced volume of solid scrap and the annual cost of waste
slide24

plastic film, aluminium film, adhesive

solvent air

emissions

solvent air

emissions

INVENTORY

printed

laminated

film

printed

film

SLITTING

plastic film, ink

PRINTING

LAMINATION

Solid scrap

Solid scrap

Solid scrap

Liquid waste

ink

to waste

management

to waste

management

Cost identification and estimation

Materials flow chart at PLS Company

product

slide25

Cost identification and estimation

Materials flow chart at PLS Company

air

emissions

Waste water treatment

chemicals

air

emissions

Cleaner

water to

a nearby

stream

fresh water

dirty scrubber

water

fuel and fuel

additive

WASTEWATER TREATMENT

INCINERATOR

liquid ink

waste from

printing step

solid scrap

from printing,

laminating,

slitting steps

sludge

ash

OFF-SITE

LANDFILL

cost identification and estimation materials balance
Cost identification and estimationMaterials Balance
  • Physical analogy to financial balance sheet
  • Compares all material inputs and outputs
  • Identifies sources of waste and data gaps
  • Provides basis for cost evaluation

MANUFACTURING

PROCESS

PRODUCT

INPUTS

NON-PRODUCT

OUTPUT (WASTE)

cost identification and estimation other tools
Cost identification and estimationOther tools
  • Walk-through & interviews
  • Cost checklists (generic & sector/process specific) – see handout C2
  • Activity Based Costing (ABC), costs are allocated from overhead accounts
    • To processes, products, or projects that actually generate costs
    • Based on activities with a direct relationship to cost generation
  • Check accounting records
  • External expertise for less tangible costs, e.g.
    • Insurance sector— liability estimation
    • Marketing firms— value of company image
    • Environmental agencies — estimates of current and future regulatory compliance costs
cost identification and estimation to quantify or not to quantify
Cost identification and estimationTo quantify or not to quantify?
  • How do you know if a relevant cost or savings is quantitatively significant before you go ahead and quantify it?

You don’t.

  • Try to do at least a rough, first-cut estimate of all quantifiable costs — then decide whether or not refining the estimate is worth the effort.

Do a balancing act!

cost identification and estimation exercise 2 10 min
Cost identification and estimationExercise 2 (10 min)

List costs of waste management at PLS Company

(There are three categories of costs:

  • The cost of manufacturing inputs
  • The cost of waste management
  • Less tangible costs)
cost identification and estimation costs of waste at the pls company
Cost identification and estimationCosts of waste at the PLS Company

The total cost of waste due to the generation of solid scrap during print runs was estimated to be US$213,000 per year, including:

  • Cost of lost direct manufacturing inputs (e.g, plastic film, ink, energy, labour)
  • Cost of waste management (e.g., incinerator operation, wastewater treatment plant operation, final waste disposal)
cost identification and estimation problematic accounting practices
Cost identification and estimationProblematic accounting practices?

Various costs at a facility might be...

  • “Hidden” in the accounting records
  • Misallocated from overhead accounts
  • Classified as fixed when they are really variable, or semi-variable
  • Not found in the accounting records at all
  • (Can you think of others?)
slide32

“Hidden” costs of lost raw materials

Manufacture of plastic rear panels for automobiles

(as % of input materials)

Material loss per

the accounting records

Actual

material loss

Adapted from: Rooney, Charles. “Economics of Pollution Prevention:

How Waste Reduction Pays.”Pollution Prevention Review.Summer 1993.

hidden costs of lost raw materials at the pls company
“Hidden” costs of lost raw materialsat the PLS company
  • The PLS accounting records show:
    • The amount of raw materials used
    • The amount of final product shipped
  • But the records do not show:
    • The amount of solid scrap waste generated
    • The amount of any other lost raw materials
cost identification and estimation direct costs vs indirect costs
Cost identification and estimationDirect costs vs. indirect costs

Direct costs

  • can be easily traced to a unit of product (e.g., direct materials, direct labour)
  • assigned directly to the process, product, or project responsible for generating the cost

Indirect costs

  • cannot be traced as easily to a unit of product (e.g., facility energy use, insurance, maintenance, waste treatment)
  • assigned to facility, division, or company overhead accounts (varies per company)
  • Often ‘hidden’
  • Often include environmental costs!!!
slide35

Indirect Environmental Management Costs “hidden” in an overhead account

Product Manufacturing Cost Statement

Variable Costs

Raw Materials

Intermediates

Additives

Utilities

Direct Labour

Packaging

Wastewater Treatment

$2.27/lb.

$0.87/lb. $0.41/lb. $0.96/lb.

$11.32/lb. $10.31/lb. $9.14/lb.

$0.04/kW-h $0.07/kW-h

$27.40/hr $31.43/hr.

$0.60/pkg. $0.57/pkg

$0.01/gal.

  • legal expenses
  • environmentally driven R&D
  • permitting time and fees
  • environmental training

Fixed Costs

Supervisor

Fixed Labour

Depreciation

Divisional Overhead

General Services & Administration

Fixed Costs

Supervisor

Fixed Labour

Depreciation

Divisional Overhead

General Services & Administration

$4,600

$57,800

$1,227

$13,662

$1,294

Total Variable Cost

Total Fixed Cost

Total Manufacturing Cost

Total Cost

Source: Green Ledgers: Case Studies in Corporate Environmental Accounting. World Resources Institute. May 1995.

survey of industry accountants in the us
Survey of industry accountantsin the US

Findings:

  • Environmental management costs (such as waste handling, treatment, and disposal) predominantly assigned to overhead accounts
  • Even energy and water costs (manufacturing inputs) are usually assigned to overhead accounts

Source: Environmental Capital Budgeting Survey . Tellus Institute, for U.S. EPA, June 1995

cost identification and estimation exercise 3 10 min
Cost identification and estimationExercise 3 (10 min)

Calculate the aluminium and plastic film loss during the slitting step of the process:

  • Amount in km / year
  • Costs in $ / year

(Hint: virgin material input = finished product + waste scrap)

cost identification and estimation problematic accounting practices38
Cost identification and estimationProblematic accounting practices?

Various costs at a facility might be...

  • “Hidden” in the accounting records
  • Misallocated from overhead accounts
  • Classified as fixed when they are really variable, or semi-variable
  • Not found in the accounting records at all
  • (Can you think of others?)
cost identification and estimation cost allocation
Cost identification and estimationCost allocation

Costs initially assigned to overhead accounts are usually allocated back to processes, products, or projects using an allocation basis such as

  • Quantity of raw materials used
  • Production volume
  • Machine hours
  • Labour hours
  • Floor space
cost identification and estimation cost allocation40
Solid scrap waste

Treatment and disposal costs

Cost identification and estimationCost allocation
  • How would you
  • allocate?
  • On the basis of:
  • # of set-up runs?
  • raw materials use?
  • machine hours?
  • amount of scrap?
  • some other basis?

Allocated from overhead

Printing

Laminating

Slitting

cost identification and estimation problematic accounting practices41
Cost identification and estimationProblematic accounting practices?

Various costs at a facility might be...

  • “Hidden” in the accounting records
  • Misallocated from overhead accounts
  • Classified as fixed when they are really variable, or semi-variable
  • Not found in the accounting records at all
  • (Can you think of others?)
cost identification and estimation fixed vs variable costs
Cost identification and estimationFixed vs. variable costs
  • Fixed Costs - do not vary with production level or other factors
    • e.g., equipment depreciation, labour
  • Variable Costs - do (or can) vary with production level or other factors
    • e.g., raw materials use, energy use
  • A cost considered “fixed” at one firm may be considered “variable” at another firm

Cleaner Production aims to reduce variable costs

cost identification and estimation fixed vs variable costs cont
Cost identification and estimationFixed vs. variable costs (cont.)
  • Incinerator operating costs at PLS include:
    • Fuel, fuel additive
    • Operating labour
    • Trucking ash to landfill
    • Equipment depreciation costs
  • PLS views these waste treatment costs as essentially fixed costs — do you agree?
cost identification and estimation problematic accounting practices44
Cost identification and estimationProblematic accounting practices?

Various costs at a facility might be...

  • “Hidden” in the accounting records
  • Misallocated from overhead accounts
  • Classified as fixed when they are really variable, or semi-variable
  • Not found in the accounting records at all
  • (Can you think of others?)
cost identification and estimation costs missing from accounting records
Cost identification and estimationCosts missing from accounting records
  • Future costs
    • Future variable costs, e.g., landfill fees
    • Future fixed costs, e.g., future depreciation costs of new waste treatment equipment
  • Less tangible costs
    • Lost profit from reduced production throughput
    • Managing impact of waste on reputation

Remember:future fixed costs are not fixed yet!Cleaner Production now can reduce the size & cost of treatment equipment that you may have to purchase in the future

slide46

CEO

Board

Production

Sales & Marketing

Accounting & Finance

Research & Development

Environment, Health, & Safety

Purchasing

Materials Control

Inventory

Operations

Quality Control

Shipping

Maintenance

Engineering

Legal

Cost identification and estimationSo where do we get out data from?

Checklist: Cleaner Production investment data sources

cleaner production at pls company
Cleaner Production at PLS Company

PLS implemented two CP projects to reduce the cost of waste in the printing step

  • an on-site scrap recycling project to reduce waste from start-up runs
  • a quality control camera project to reduce waste from errors during full-job runs
scrap recycling project
Scrap recycling project
  • PLS decided to start using solid scrap material for print job start-up runs, rather than using virgin plastic film
  • This would reduce the use of raw materials and the rate of solid scrap generation
  • Since this project did not require any cash outlay, PLS was able to implement it right away
quality control qc camera project
Quality control (QC) camera project
  • PLS decided to purchase and install a 3 - camera system to monitor quality control of the print jobs as they actually occur
  • Allows the operators to detect print errors earlier and halt the operations before too much solid scrap is generated
  • The quality control camera system costs US$105,000 to acquire and install
capital budgeting and project profitability step 4 feasibility analysis
Capital budgeting and project profitabilityStep 4: Feasibility analysis

Today’s Focus

Technical

Project Selection

Regulatory

Financial

Organisational

capital budgeting and project profitability financial feasibility analysis
Capital budgeting and project profitabilityFinancial feasibility analysis

1. Is the project profitable?

  • Initial investment costs
  • Annual operating costs and savings
    • The cost of operating inputs
    • The 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

    • Private sector
    • Government sector
capital budgeting and project profitability capital budgeting
Capital budgeting and project profitabilityCapital budgeting

The process by which an organisation:

  • Decides which investment projects are needed & possible, with a special focus on projects that require significant up-front investment (i.e., capital)
  • Decides how to allocate available capital between different projects
  • Decides if additional capital is needed
capital budgeting and project profitability capital budgeting practices
Capital budgeting and project profitabilityCapital budgeting practices
  • 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
  • Capital budgeting practices may also vary from country to country
capital budgeting and project profitability typical project types and purpose
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

Capital budgeting and project profitabilityTypical project types and purpose
capital budgeting and project profitability typical project types and purpose cont
Expansion

e.g., obtain and install new process lines, initiate new product lines

Safety

Make worker safety improvements

Environmental

e.g., reduce use of toxic materials, increase recycling, reduce waste generation, install waste treatment

Others...

Capital budgeting and project profitabilityTypical project types and purpose (cont)
capital budgeting and project profitability cash flow concept
Capital budgeting and project profitability Cash Flow concept

The Cash Flow Concept is a common management planning tool.

It distinguishes between: (a) costs: cash outflows

(b) revenues/savings: cash inflows

capital budgeting and project profitability types of cash flow
Capital budgeting and project profitabilityTypes of cash flow

Outflow

Initial investment cost

Operating costs & taxes

Working capital

Inflow

Equipment salvage value

Operating revenues & savings

Working capital

One-time

AnnualOther

capital budgeting and project profitability cash flow costs and savings
Capital budgeting and project profitabilityCash flow: costs and savings
  • Initial investment costs
    • purchase of the camera system, delivery, installation, start-up
  • Annual operating costs (and savings)
    • Operating input — materials (plastic film, ink), energy, labour
    • Incineration — fuel, fuel additive, labour, ash to landfill
    • Wastewater treatment — chemicals, electricity, labour, sludge to landfill
capital budgeting and project profitability cash flow working capital
Capital budgeting and project profitabilityCash flow: working capital

Working Capital is: “the total value of goods and money necessary to maintain project operations”

It includes items such as:

  • Raw materials inventory
  • Product inventory
  • Accounts payable/receivable
  • Cash-on-hand
capital budgeting and project profitability cash flow salvage value
Capital budgeting and project profitabilityCash flow: salvage value

Salvage Value is the resale value of equipment or other materials at the end of the project

capital budgeting and project profitability timing of cash flow
Capital budgeting and project profitabilityTiming of cash flow

End of project:

Salvage Value

Annual Revenues/Savings

Year 1

Year 2

Year 3

TIME

Time zero:

Initial Investment

capital budgeting and project profitability cash flow incremental analysis
Capital budgeting and project profitabilityCash flow: ‘incremental analysis’
  • For many CP projects, you will need to do an incremental analysis
    • compare the CP cash flows to the “business as usual” cash flows
    • only the cash flows that change when you improve the “business as usual” operations
capital budgeting and project profitability profitability indicators
Capital budgeting and project profitabilityProfitability indicators

Definition: “a single number that is calculated for characterisation of project profitability in a concise, understandable form.”

Common examples are:

  • Simple Payback
  • Return on Investment (ROI)
  • Net Present Value (NPV)
  • Internal Rate of Return (IRR)
capital budgeting and project profitability simple payback payback period
Capital budgeting and project profitabilitySimple payback (payback period)
  • Definition: the number of years it will take for the project to recover the initial investments
  • Usually used a rule of thumb for selecting projects, e.g. payback must be < 3 years

Simple Payback (in years)

Investment

Cash Flow

=

capital budgeting and project profitability simple payback vs roi
Capital budgeting and project profitabilitySimple payback vs ROI

Initial Investment

Year 1 Cash Flow

Simple Payback (in years)

=

3 years

Year 1 Cash Flow

Initial Investment

ROI (in %)

33%

=

slide67

Capital budgeting and project profitabilityExercise 4 (10 min)

Question 1: Calculate annual cash flows (use the cash flow worksheet!) for the incinerator operation

Question 2: Calculate simple payback

slide68

Capital budgeting and project profitabilityNet Present Value (NPV)

Question:If we were giving away money, would you rather have:(A) $10,000 today, or(B) $10,000 3 yearsfrom now Explain your answer...

slide69

Capital budgeting and project profitabilityInflation

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 $1.05

costs $1

next year

now

69

slide70

Capital budgeting and project profitabilityReturn 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”

70

slide71

Capital budgeting and project profitabilityPLS Company’s QC project

Initial Investment

Cost

Annual Operating

Costs

BusinessAs Usual

0

$ 2,933,204

Annual Savings =

US$38,463

The QC Camera Project

$ 105,000

$ 2,894,741

(in US$)

71

slide73

Capital budgeting and project profitabilityTime Value of Money (TVM)

  • Money now is worth more than money in the future because of:

a) inflation

b) investment opportunity

  • The exact “time value” of your money depends on the magnitude of the:

a) rate of inflation and

b) rate of return on investment

slide74

Capital budgeting and project profitabilityComparing 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
slide75

Capital budgeting and project profitabilityConverting PLS 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

slide76

Capital budgeting and project profitabilityConverting PLS 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

76

slide77

Capital budgeting and project profitabilityDiscount rate vs 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 1.20 = $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 1.20 = $10,000

slide78

Capital budgeting and project profitabilityWhich discount rate?

  • Equal to the required rate of return for the project investment, which usually incorporate:
    • 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.
slide79

Capital budgeting and project profitabilityCalculating ‘present value’

The value of the cash flow in year n

Present Value = Future Valuenx (PV Factor)

Present Value (PV) Factors have been calculated for various values of d (discount rate) and n (number of years) and have been tabulated for easy use.

(Also called discount factors)

The value of the cash flow at “Time Zero,” i.e., at project start-up

79

slide80

Capital budgeting and project profitabilityThe value of a future $1, NOW

Discount rate (d): 10% 20% 30% 40%

Years into future (n)

1 .9091 .8333 .7692 .7142

2 .8264 .6944 .5917 .5102

3 .7513 .5787 .4552 .3644

4 .6830 .4823 .3501 .2603

5 .6209 .4019 .2693 .1859

10 .3855 .1615 .0725 .0346

20 .1486 .0261 .0053 .0012

30 .0573 .0042 .0004 .0000

Present value factors

Handout: Table with discount rates

slide81

Capital budgeting and project profitabilityNet Present Value (NPV)

  • Definition: the sum of the present values of all of a project’s cash flows, both negative (cash outflows) and positive (cash inflows)
  • NPV 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 both the time value of money and all future year cash flows!
slide82

Capital budgeting and project profitabilityExercise 5 (5 min)

Expected Future Cash Flows

Present Value of Cash Flows (at time zero)

Year

PV

Factor

=

*

0

1

2

3

- $105,000

+ $38,463

+ $38,463

+ $38,463

- $???

$???

$???

$???

$???

???

???

???

???

Sum = the project’s Net Present Value =

82

slide83

Capital budgeting and project profitabilityAnswer 1

Expected Future Cash Flows

Present Value of Cash Flows (at time zero)

Year

PV

Factor

=

*

0

1

2

3

- $105,000

+ $38,463

+ $38,463

+ $38,463

- $105,000

33,447

29,082

25,289

-17,182

.8696

.7561

.6575

Sum = the project’s Net Present Value =

slide84

Capital budgeting and project profitabilitySensitivity 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”
slide85

Capital budgeting and project profitabilityAnswer scenario 2

Expected Future Cash Flows

Present Value of Cash Flows (at time zero)

Year

PV

Factor

=

*

0

1

2

3

- $105,000

+ $38,463

+ $38,463

+ $93,463

- $105,000

33,447

29,082

61,452

+18,981

.8696

.7561

.6575

Sum = the project’s Net Present Value =

slide86

Capital budgeting and project profitabilityInternal Rate of Return (IRR)

  • Similar to NPV: considers both the time value of money and all future year cash flows
  • IRR = the discount rate for which NPV = 0, over the project lifetime (calculated in an iterative fashion)
  • Tells you exactly what “discount rate” makes the project just barely profitable

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Capital budgeting and project profitabilityProfitability indicator 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

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Project fundingOptions for project financing

  • Internal funds
  • Private sector:

1. Commercial banks

2. Development corporations

3. Equipment vendors & subsidiary finance

companies

4. Trade finance (suppliers and customers)

5. Equity

  • Government sector
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Project fundingInternal funds

Internal funds can be generated from:

  • Capital introduced by the owner
  • Profits & cash flows generated by the business and retained within it
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Project fundingPrivate sector financing

Private sector financing options include:

  • Long-term loans to purchase fixed assets: secured or unsecured
  • Short-term loans (including lines of credits without conditions on use)
  • Leasing
  • Equity (issue of shares/stock)
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Project fundingCapital from Government

National, state, local governments

  • Grants
  • Subsidies
  • Government-managed development funds
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Project funding

Barriers & solutions

  • Problem: the project is not considered to be economically feasible
  • Solution: Total Cost Assessment of project
  • Problem: the firm is unable or unwilling to issue more shares or to raise debt
  • Solution: Leasing
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Project funding

Barriers & solutions (cont.)

  • Problem: the firm does not yet have contacts with commercial banks
  • Solution: contact chamber of commerce and/local accountants for assistance.
  • Problem: the firm is in public ownership and private sources of finance are not accessible
  • Solution: contact local national CP centre for institutional assistance
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Project funding

Exercise 6 (10 min)

  • What information will banks and credit institutions ask for when evaluating PLS Company’s application for funding for the QC project?
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Project funding

Exercise 6: answers

  • Business or enterprise
    • Date established
    • Location, short history, structure
    • Names and biographies of owners
  • Key management
    • Age, experience and qualifications management
    • Organisation chart showing responsibilities
  • Market place
    • Position locally, main competitors, description of products / services
    • Level of technology
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Project funding

Exercise 6: answers (cont.)

  • Financial position and performance
    • Current assets and liabilities
    • Latest financial accounts, figures on debtors, creditors and work in progress
    • Inventories, other loans, bank balance
  • Business plan
    • Objectives to be met with the borrowed funds
    • Expenditure budget and cash budget
  • Funds required
    • How much and when, in relation to business size
    • Margin for error and change in circumstances
    • Break-even for profitability and cash
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Project funding

Exercise 6: answers

  • Structure of required finance
    • Short, medium, long term needs
    • Export finance requirements
  • Available collateral
    • Assets already pledged (collaterals) for other loans)
    • Assets available as collateral for this loan
  • Repayment issues
    • Starting date and overall plan
    • Repayment plan