1 © unep financing cleaner production and energy efficiency projects presentation of the energy...

1©© UNEP UNEP

Financing Cleaner Production and Energy

Efficiency Projects

Presentation of the Energy Efficiency Guide for Industry in AsiaPresentation of the Energy Efficiency Guide for Industry in Asia

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Hello!

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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

Participant introductions

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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

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WASTE AND CLEANER

PRODUCTION

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Waste and Cleaner Production

What is waste?

• “Anything that leaves the company not as product!”

• It costs money…

and…

• it can be prevented!

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Materials,

Energy,

Water,

Labour,

Capital

Products,By-Products

Solid Waste Waste Energy, Wastewater

Air Emissions


Waste takes many forms

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Exercise 1 (10 min)

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

• Management of a company

• Government

• Investors

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The “Cost of Waste Iceberg”

THE HIDDEN COSTOF WASTE

Company Im

age

Liab

ility

Regulatory Compliance

Treatm

ent &

Disposa

l

Lost Raw

Materials,

Energy,

Labor

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.

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The 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

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Dilute & disperse

Dispersion

Pollution Control

Recycling

Pollution Prevention

Sustainable Development

1960 1980 1990

Complexity of Environmental Issue

Cleaner Production

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“End of Pipe” treatment

Dispersion

Treatment

Recycling



1960 1980 1990


Cleaner Production

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Off site recycling

Dispersion

Pollution Control

Recycling



1960 1980 1990


Cleaner Production

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Prevention

Dispersion

Pollution Control

Recycling



1960 1980 1990


Cleaner Production

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CP 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…

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Reduced material use and waste

Reduced costs & increased profits

Increased productivity

Enhanced reputation

Reduced liability risks


CP benefits: reduced risk!

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CP 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

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COST ENVIRONMENTALPERFORMANCE

COST ENVIRONMENTAL PERFORMANCE

End of pipe Treatment

Cleaner Production


CP versus End of pipe

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Cleaner Production and EMS

CHECK

ACT

DO

REPORT

PLAN

CP

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CP Methodology

Step 1

Step 2

Step 3

Step 4

Step 5

Get organized

Analyzeprocesses

IdentifyCP options

Carry out feasibility analysis

Implement and measure results

At what steps do you need cost data?

Step 6Integrate in business processes

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COST IDENTIFICAITON

AND ESTIMATION

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Cost identification and estimation

Step 2: Analyse processes

• Prepare process flow charts

• Collect baseline data and observations

• Material balance: determine true waste!

• Assign costs to materials, energy and waste

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• 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


Case study: the PLC Company

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Materials flow chart at PLS Company

product

INVENTORY

SLITTING

solvent airemissions

solvent airemissions

printed laminated

filmplastic film, ink

plastic film, aluminium film, adhesive

PRINTING LAMINATION

Liquid wasteink

Solid scrap

to waste management

to waste management

Solid scrapSolid scrap

printed

film

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solid scrapfrom printing,laminating,slitting steps

fuel and fueladditive

fresh water

air emissions

dirty scrubber water

OFF-SITELANDFILL

INCINERATOR WASTEWATER TREATMENT

Waste water treatment chemicals

air emissions

Cleanerwater to a nearbystream

ash sludgeliquid inkwaste from printing step


Materials flow chart at PLS Company

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MANUFACTURINGPROCESSINPUTS

PRODUCT

NON-PRODUCT OUTPUT (WASTE)


Materials 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

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• 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


Other tools

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• 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!


To quantify or not to quantify?

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Cost identification and estimation Exercise 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)

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Costs 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)

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Problematic 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?)

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2%

Material loss perthe accounting

records

52%

Actualmaterial

loss

“Hidden” costs of lost raw materialsManufacture of plastic rear panels for automobiles

(as % of input materials)

Adapted from: Rooney, Charles. “Economics of Pollution Prevention:How Waste Reduction Pays.” Pollution Prevention Review.Summer 1993.

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“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

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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

Cost identification and estimation Direct costs vs. indirect costs

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!!!

35©© UNEP UNEPSource: Green Ledgers: Case Studies in Corporate Environmental Accounting. World Resources

Institute. May 1995.

Indirect Environmental Management Costs “hidden” in an overhead account

Product Manufacturing Cost Statement

Variable CostsRaw MaterialsIntermediatesAdditivesUtilitiesDirect LabourPackagingWastewater 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.

Fixed CostsSupervisorFixed LabourDepreciationDivisional OverheadGeneral Services &

Administration

$4,600$57,800$1,227

$13,662

$1,294

Total Variable CostTotal Fixed Cost

Total Manufacturing CostTotal Cost

• legal expenses• environmentally

driven R&D• permitting time and

fees• environmental

training

Fixed CostsSupervisorFixed LabourDepreciationDivisional OverheadGeneral Services & Administration

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Survey of industry accountantsin 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

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Cost identification and estimation Exercise 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)

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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 allocation

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• Solid scrap waste

• Treatment and disposal costs

Printing

Laminating

Slitting

How would youallocate?

On the basis of:• # of set-up runs?• raw materials use?• machine hours?• amount of scrap?• some other basis?

Allocated from overhead


Cost allocation

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• 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


Fixed vs. variable costs

Cleaner Production aims to reduce variable costs

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• 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?


Fixed vs. variable costs (cont.)

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• 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


Costs missing from accounting records

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

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

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PurchasingMaterials ControlInventoryOperationsQuality ControlShippingMaintenanceEngineering

PurchasingMaterials ControlInventoryOperationsQuality ControlShippingMaintenanceEngineering

Environment, Health, &

Safety

Environment, Health, &

Safety

BoardBoard

LegalLegal

Research & Development

Research & Development

CEOCEO

ProductionProduction Accounting & Finance

Accounting & Finance

Sales & Marketing

Sales & Marketing


So where do we get out data from?

Checklist: Cleaner Production investment data sourcesChecklist: Cleaner Production investment data sources

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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

Cleaner Production at PLS Company

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• 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

Scrap recycling project

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• 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

Quality control (QC) camera project

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CAPITAL BUDGETING AND PROJECT PROFITABILITY

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Step 4: Feasibility analysis

Project Selection

Technical

Organisational

FinancialRegulatory

Today’s Focus

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Financial feasibility analysis1. 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 projects3. Obtain external financing for remaining projects

– Private sector– Government sector

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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

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• 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 practices

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• 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


Typical project types and purpose

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• 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...


Typical project types and purpose (cont)

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The Cash Flow Concept is a common management planning tool.

It distinguishes between:

(a) costs: cash outflows

(b) revenues/savings: cash inflows


Cash Flow concept

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One-time

Annual

Other

Inflow

Equipment salvage

value

Operating revenues & savings

Working capital

Outflow

Initial investment

cost

Operating costs &

taxes

Working capital


Types of cash flow

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• 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


Cash flow: costs and savings

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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


Cash flow: working capital

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


Cash flow: salvage value

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Salvage Value

End of project:

Time zero:

Initial Investment

TIMEYear 1 Year 2 Year 3

Annual Revenues/Savings


Timing of cash flow

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• 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


Cash flow: ‘incremental analysis’

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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)


Profitability indicators

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• 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=


Simple payback (payback period)

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Simple Payback (in years)

Initial Investment

Year 1 Cash Flow=

ROI (in %)Year 1 Cash Flow

Initial Investment=


Simple payback vs ROI

3 years

33%

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Exercise 4 (10 min)

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

Question 2: Calculate simple payback

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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...


Net Present Value (NPV)

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Money loses purchasing power over time as product/service prices rise, so a dollar today can buy more than a dollar next year.

costs $1 costs $1.05

inflation 5%

nownow next yearnext year69


Inflation

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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

10 % interest, or “return on investment”

Investing $1 now

InvestmentGives you

$1.10 a year from now

70


Return on investment

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Initial Investment

Cost

Annual Operating

Costs

BusinessAs

Usual Annual Savings =

US$38,463The QC Camera Project

0

$ 105,000

$ 2,933,204

$ 2,894,741

(in US$)71


PLS Company’s QC project

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Is the annual savings of$38,463 per year for 3 years

a sufficient returnon the initial investment of

$ 105,000?


QUESTION

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• Money now is worth more than money in the future because of:a) inflationb) investment opportunity

• The exact “time value” of your money depends on the magnitude of the:a) rate of inflation andb) rate of return on investment


Time Value of Money (TVM)

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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

• It is easiest to convert all project cash flows to their “present value” now, at the very beginning of the project


Comparing cash flows from different years

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End of project

Time zero:

Initial Investment = $105,000

TIMEYear 1 Year 2 Year 3

$38,463 $38,463 $38,463

= ??= ??= ??

Annual Savings


Converting PLS cash flows to “present value”

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Discount rate:

• Converts future year cash flows to their present value

• Incorporates:– Desired return on investment

– Inflation

• Reverse of an interest rate calculation

76


Converting PLS cash flows to “present value”

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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


Discount rate vs interest rate

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

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• 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.


Which discount rate?

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Present Value = Future Valuen x (PV Factor)

The value of the cash flow in year n

The value of the cash flow at

“Time Zero,” i.e., at project start-up

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)79


Calculating ‘present value’

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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


The value of a future $1, NOW

Handout: Table with discount rates

Present value factors

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• 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!


Net Present Value (NPV)

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Expected Future Cash

Flows

- $105,000

+ $38,463

+ $38,463

+ $38,463

PVFactor

Present Value of Cash Flows (at time zero)

- $???

$???

$???

$???

$???

Year

0

1

2

3

* =

???

???

???

???

Sum = the project’s Net Present Value = 82


Exercise 5 (5 min)

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Flows

- $105,000

+ $38,463

+ $38,463

+ $38,463

PVFactor


- $105,000

33,447

29,082

25,289

-17,182

Year

0

1

2

3

* =

.8696

.7561

.6575

Sum = the project’s Net Present Value =


Answer 1

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• 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


Sensitivity analysis

Also consider taxes!– Pollution taxes / fees

– Tax deductions for equipment depreciation

– Tax deduction for “environmental projects”

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Flows

- $105,000

+ $38,463

+ $38,463

+ $93,463

PVFactor


- $105,000

33,447

29,082

61,452

+18,981

Year

0

1

2

3

* =

.8696

.7561

.6575

Sum = the project’s Net Present Value =


Answer scenario 2

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• 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

86


Internal Rate of Return (IRR)

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Advantages Disadvantages

Easy to use Neglect TVMNeglect out-year costsDo not indicate project size

Considers TVM Needs firm’s discount rateIndicates project size

Considers TVM Requires iterationDoes not indicate project size

SimplePayback& ROI

NPV

IRR


Profitability indicator summary

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• 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

Project funding

Options for project financing

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Internal funds can be generated from:

• Capital introduced by the owner

• Profits & cash flows generated by the

business and retained within it

Project funding

Internal funds

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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)

Project funding

Private sector financing

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National, state, local governments• Grants• Subsidies• Government-managed development funds

Project funding

Capital from Government

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• 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

Project funding

Barriers & solutions

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• 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

Project funding

Barriers & solutions (cont.)

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• What information will banks and credit

institutions ask for when evaluating PLS

Company’s application for funding for the

QC project?

Project funding

Exercise 6 (10 min)

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• 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

Project funding

Exercise 6: answers

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• 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

Project funding

Exercise 6: answers (cont.)

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• 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

Project funding

Exercise 6: answers

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unep lecture waste

cleaner production exercise

waste cost estimation

cost of waste iceberg

hazardous waste tax

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