Transcript Financial feasibility analysis
Financial Feasibility Analysis
Energizing Cleaner Production Management Course
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Session Agenda: Introduction Cash Flow Profitability Indicators
1.
2.
3.
4.
Simple Payback Return on Investment (ROI) Net Present Value (NPV) Internal Rate of Return (IRR)
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But first…
In what step(s) of the methodology is financial feasibility analysis relevant?
• task 1a: Meeting with top management • task 1b: Form a Team and inform staff • task 1c: Pre-assessment to collect general information • task 1d: Select focus areas • task 1e: Prepare assessment proposal for top management approval • task 2a: Staff meeting and training • task 2b: Prepare focus area flow charts • task 2c: Walkthrough of focus areas • task 2d: Quantify inputs and outputs and costs to establish a baseline • task 2e: Quantify losses through a material and energy balance • task 3a: Determine causes of losses • task 3b: Identify possible options • task 3c: Screen options for feasibility analysis • task 4a: Technical, economic and environmental evaluation of options • task 4b: Rank feasible options for implementation • task 4c: Prepare implementation and monitoring proposal for top • task 5a: Implement options and monitor results • task 5b: Evaluation meeting with top management 3
Introduction
Step 4 – Feasibility Analysis
Technical
Company’s priority
Other
- Regulatory - Organizational - Health/safety - Community
Project Selection
Environmental Financial
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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
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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
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Introduction
Capital Budgeting Practices
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Vary widely from company to company
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Larger companies tend to have more formal practices than smaller companies
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Larger companies tend to make more and larger capital investments than smaller companies
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Some industry sectors require more capital investment than others
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Vary from country to country
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Introduction
Typical Project Types and Costs
• • •
Maintenance
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Maintain existing equipment and operations Improvement
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Modify existing equipment, processes, and management and information systems to improve efficiency, reduce costs, increase capacity, improve product quality, etc.
Replacement
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Replace outdated, worn-out, or damaged equipment or outdated/inefficient management and information systems
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Cash Flow
Cash Flow Concept
Common management planning tool
• •
Distinguishes between Costs: cash outflows Revenues/savings: cash inflows
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Cash Flow
Types of Cash Flow
Outflow Inflow One-time Annual Other Initial investment cost Equipment salvage value Operating costs & taxes Operating revenues & savings Working capital Working capital
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Cash Flow
Costs and Savings
•
Initial investment costs
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purchase of the camera system, delivery, installation, start-up
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Annual operating costs (and savings)
– –
Operating input — materials, energy, labour Incineration — fuel, fuel additive, labour, ash to landfill
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Wastewater treatment — chemicals, electricity, labour, sludge to landfill
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Cash Flow
Working Capital and Salvage Value
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Working capital: total value of goods and money needed to maintain project operations
– – – –
Raw materials inventory Product inventory Accounts payable/receivable Cash-on-hand
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Salvage Value: resale value of equipment or other materials at the end of the project
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Year 1
Cash Flow
Timing
Annual Revenues/Savings End of project: Salvage Value
Year 2 Year 3 TIME
Time zero: Initial Investment
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Cash Flow
Incremental Analysis
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Needed for many CP or EE projects
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Compares cash flow of implemented options to the “business as usual” cash flow
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Covers only the cash flows that change
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Profitability Indicators
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Definition: “a single number that is calculated for characterisation of project profitability in a concise and understandable form”
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Common indicators 1. Simple Payback 2. Return on Investment (ROI) 3. Net Present Value (NPV) 4. Internal Rate of Return (IRR)
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1. Simple Payback
• •
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 16
2. Return on Investment
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Definition: the percentage of initial investment that is recovered each year Simple Payback (in years) = Initial Investment Year 1 Cash Flow
3 years
ROI (in %) = Year 1 Cash Flow Initial Investment
33% 17
Workshop Exercise PLS Company: produces rolls of laminated film
plastic film, aluminium film, adhesive
INVENTORY
plastic film, ink
PRINTING
solvent air emissions printed film solvent air emissions
LAMINATION
printed laminated film
SLITTING
Solid scrap Solid scrap Solid scrap Liquid waste ink to waste management to waste management 18
Workshop Exercise
PLS Company installs QC Camera
• • • •
Printing step Printing errors cause high scrap rate Quality Control (QC) 3-camera system
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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
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Workshop Exercise
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Question 1: Calculate annual cash flows using the cash flow worksheet
(15 min)
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Question 2: Calculate simple payback
(5 min)
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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...
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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
now
costs $1.05
next year
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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 Investing $1 now Investment Gives you $1.10 a year from now 10 % interest, or “ return on investment ”
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3. Net Present Value
PLS Company’s QC Camera Project
Initial Investment Cost Annual Operating Costs Business As Usual 0 $ 2,933,204 Installing quality control camera $ 105,000 $ 2,894,741 (in US$) Annual Savings = US$38,463
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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?
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3. Net Present Value
Time Value of Money
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Money is worth more now than in the future because of
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Inflation Investment opportunity
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“Time value” of money depends on
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Rate of inflation
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Rate of return on investment
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3. Net Present Value
Cash Flows from Different Years
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Before you can compare cash flows from different years, you need to convert them all to their equivalent values in a single year
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It is easiest to convert all project cash flows to their “present value” now, at the very beginning of the project
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= ??
= ??
= ??
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
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3. Net Present Value
Converting Cash Flows to Present Value
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Discount rate: Converts future year cash flows to their present value Incorporates:
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Desired return on investment
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Inflation Reverse of an interest rate calculation
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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 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 30
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 31
3. Net Present Value
Calculating “Present Value”
Value of the cash flow in year n Present Value = Future Value n 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
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3. Net Present Value
The Value of a Future $1
Discount rate (d)
:
Years into future (n) 1 2 3 4 5 10 20 30 10% 20% 30% 40%
.9091
.8264
.8333 .7692 .7142
.6944 .5917 .5102
.7513 .5787 .4552 .3644
.6830 .4823 .3501 .2603
.6209 .4019 .2693 .1859
.3855 .1615 .0725 .0346
.1486 .0261 .0053 .0012
.0573
.0042 .0004 .0000
Present value factors
Handout: Table with discount rates
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3. Net Present Value
Net Present Value (NPV)
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Definition: sum of present values of all project’s cash flows
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Negative (cash outflows)
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Positive (cash inflows)
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Characterises the present value of the project to the company
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If NPV > 0, the project is profitable
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If NPV < 0, the project is not
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More reliable than Simple Payback or ROI as it considers
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Time value of money
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All future year cash flows
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3. Net Present Value
Workshop Exercise (15 min)
Question 3: Calculate the NPV Year Expected Future Cash Flows X PV Factor = Present Value of Cash Flows (at time zero) 0 1 2 3 - $105,000 + $38,463 + $38,463 + $38,463 ???
???
???
???
Sum = project’s Net Present Value = - $???
$???
$???
$???
$???
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3. Net Present Value
Workshop Exercise (5 min)
Question 4: compare the Simple Payback and the NPV
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3. Net Present Value
Sensitivity Analysis
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In business as usual scenario PLS Company needs waste water treatment plant in year 3: $150,000 investment
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With QC project: $95,000 Savings: $55,000
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Also consider taxes!
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Pollution taxes / fees Tax deductions for equipment depreciation Tax deduction for “environmental projects”
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3. Net Present Value
Workshop Exercise (answer B)
Year Expected Future Cash Flows X PV Factor = Present Value of Cash Flows (at time zero) 0 1 2 3 - $105,000 + $38,463 + $38,463 + $93,463 .8696
.7561
.6575
Sum = project’s Net Present Value = - $105,000 33,447 29,082 61.452
-18,981
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4. Internal Rate of Return (IRR)
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Definition: discount rate for which NPV = 0, over the project lifetime
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Tells you exactly what “discount rate” makes the project just barely profitable
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Similar to NPV, considers
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Time value of money
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All future year cash flows
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Profitability Indicators Summary
Advantages Disadvantages Simple Payback & ROI NPV Easy to use Neglect TVM Neglect out-year costs Do not indicate project size Considers TVM rate Indicates project size Needs firm ’ s discount IRR Considers TVM Requires iteration Does not indicate project size
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Analysis of Options
Thank you for your attention!
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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). www.energyefficiencyasia.org
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
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