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					           Profiting from
        Cleaner Production:
               Day 1


  Prepared by                For UNEP
 Tellus Institute     Division of Technology,
Boston, MA USA       Industry, and Economics


  TELLUS INSTITUTE
                                                1
Introduction




               2
Course Background

     [15 min]




                    3
    Development of the training
            materials
Content has been developed by:
– Tellus Institute
– The Illinois EPA
– The Philippine Institute of CPAs
– The Asian Institute of Management
– UNEP CP financing National Project Coordinators in
  Zimbabwe and Guatemala
– UNEP Cleaner Production financing project team


                                                  4
    UNEP: Financing Cleaner
     Production — Support
 United Nations Environment Programme
  (UNEP); Division of Technology,
  Industry and Economics (DTIE)
 Course support is from the project:
 ―Strategies and Mechanisms For Promoting
 Cleaner Production Investments In Developing
 Countries‖
 Funding provided by the Government of
  Norway
                                           5
Words of welcome

   Introduction
  of Instructors


     [15 min]

                   6
Participant Introductions

         [30 min]




                            7
    Participant introductions
             Who is here today?
 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                         8
     Why are you here?

 What work issues or concerns
  motivated you to come?

 What are your learning goals for
  this course?

 What are your expectations of this
  course?
                                       9
Course Overview

    [15 min]




                  10
      Focus of this course
  Cleaner Production
  Cost Identification & Estimation
  Project Profitability Assessment


Also to incorporate your experiences,
questions, and goals into the
presentation, exercises, and discussions

Case studies of Cleaner Production at
real facilities will be used               11
         Cleaner Production
 The cost of waste
 Profiting from Cleaner Production
 Small group exercise on classifying
  environmental management options
 CP implementation steps
 Where to go for more information
 CP planning at your organization


                                        12
      Cost identification and
            estimation
 Small group exercise on cost
  identification
 Problematic accounting practices
 Potential sources of cost data
 Small group exercise on cost estimation
 Tools for data estimation
 Cost identification and estimation at
  your organization
                                        13
        Project profitability
            assessment
 Capital budgeting (of ―environmental‖
  projects)
 Project cash flows and simple payback
 The Time Value of Money (TVM) and
  Net Present Value (NPV)
 Two small group exercises
 Capital budgeting with inflation and tax
 Sensitivity analysis
 Key profitability indicators           14
               Conclusion

   Where to go for more information
   Brief review of what we learned
   Final questions and comments
   Course evaluation




                                       15
Time for a break!
     [15 min]




                    16
Cleaner Production




                     17
The Cost of Waste

     [15 min]




                    18
          What is waste?
 Some proactive companies view waste
  as: ―any material or energy that leaves
  a process or facility in any form other
  than product‖
 A slightly less strict definition might
  be: ―any material or energy that leaves
  a process or facility without first being
  used as efficiently as possible‖
 Definitions vary — but all companies
  generate waste!
                                         19
      Flow of materials & energy
                  Air Emissions




Materials,
Energy,
Water,                              Products,
Labour,                             By-Products
Capital

             Solid Waste,   Waste
             Energy ,
             Wastewater
                                          20
         Different types of waste
There are many words for different types of waste:

•    allowance             •   greenhouse loss
•    BOD                   •   hidden losses
•    broke                 •   leakage
•    contaminated          •   non-conforming
    solids                     material
•    core loss
                           •   overfill
•    customer returns
                           •   packaging
•    damage
•    drainings             •   process loss
•    dust                  •   rework
•    effluent              •   second quality
•    evaporation           •   stock loss
•    furnace loss          •   washings
Adapted from: The Kaunas Institute of Technology, Kaunas, Lithuania   21
    The true cost of waste
    is often underestimated
 For every $1 of waste cost that companies
  actually measure, another $2-3 of cost
  are‖ hidden‖ in the accounting records, or
  are not on the books at all
 Companies typically underestimate how
  much waste really costs them, sometimes
  by several orders of magnitude
 This applies even to big, well-managed
  companies
                                         22
        The cost of waste ink
      at the 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

                                                     23
                       The ―Cost‖ Iceberg




The true cost of waste                               THE HIDDEN COST
can be like an iceberg,                                 OF WASTE
with only a small part
visible



Adapted from: Bierma, TJ., F.L. Waterstaraat, and J. Ostrosky. 1998. “Chapter 13: Shared Savings and   24
Environmental Management Accounting,” from The Green Bottom Line. Greenleaf Publishing:England.
So how do we melt
the cost iceberg?

    ...through
Cleaner Production!
   Stay tuned...


                      25
Profiting from Cleaner
       Production
       [30 min]




                         26
       Passive environmental
             strategies
Dilute & disperse




                               27
       Reactive environmental
             strategies
end-of-pipe approaches




                                28
Proactive environmental
      strategies:
  Cleaner Production
                Prevention of waste
                    generation:
              - Good housekeeping
              - Input substitution
              - Better process control
              - Equipment modification
              - Technology change
              - On-site recovery/reuse
              - Production of a useful by-
              product
              - Product modification


                                         29
Cleaner Production definition

―The continuous application of an
integrated preventive environmental
strategy applied to processes,
products, and services to increase
overall efficiency and reduce risks
to humans and the environment.‖

    (UNITED NATIONS ENVIRONMENT
                      PROGRAMME)
                               30
Properly implemented CP:

always
   reduces long-term liabilities
    which companies can face many
    years after pollution has been
    generated or disposed at a given
    site


                                       31
      Properly implemented CP:
usually

   increases profitability
   lowers production costs
   enhances productivity
   provides a rapid return on any capital
    or operating investments required
   increases product yield
   leads to the more efficient use of
    energy and raw materials
                                         32
   Properly implemented CP:

often
  avoids regulatory compliance costs
  leads to insurance savings
  provides enhanced access to capital
   from financial institutions and lenders
  is fast and easy to implement
  requires little capital investment

                                         33
           CP versus End-of-Pipe
                 approach
   CLEANER PRODUCTION              POLLUTION CONTROL and
                                    WASTE MANAGEMENT
• Continuous improvement
towards use of closed loop or    • One-off solutions to single
continuous cycle processes       problems
                                 • Processes result in waste
• Partnerships are essential:    materials for disposal Solutions
everyone has a role to play in   are often developed by experts
the community                    in isolation
                                 • Reactive responses to
• Elimination of environmental   pollution and waste after they
problems at source               are generated (e.g. via waste
                                 treatment equipment and
• Involves new practices,        methods)
attitudes and management         • Relies mainly on technical
techniques and stimulates        improvements to existing 34
technical advances               technologies
   What is not CP?
 Off-site recycling
 Transferring hazardous
  wastes
 Waste treatment
 Concentrating hazardous
  or toxic constituents to
  reduce volume
 Diluting constituents to
  reduce hazard or toxicity



                              35
      What are the benefits of
        Cleaner Production?
                  Improving environmental
                         situation

                                              Continuous
Increasing economical                       environmental
       benefits                              improvement




                                               Gaining
                                             competitive
       Increasing                             advantage
       productivity
                                                      36
   CP motivators and drivers
INTERNAL to the
                  - Improvements in
COMPANY:          productivity and
                  competitiveness

                  - Environmental management
                  systems and continuous
                      improvement

                  - Environmental leadership

                  - Corporate environmental
                  reports and Environmental
                  accounting


                                           37
         CP motivators and drivers
    EXTERNAL to the
    COMPANY:
-   Innovative                - Soft loans
    regulation                  from
                                Financial
-   Economic                    institutions
    incentives
                              - Community
- Education                     involvement
    and
    training                  - International
                                trade
- Buyer –                       incentives
    supplier
    relations
                                         38
          Team for CP success
• Managers, engineers and finance people in
  industry and commerce, in particular those
  responsible for business strategy, product
  development, plant operations and finance

• Government officials, both central and
  regional, who play an important role in
  promoting CP

• Media representatives who play an important
  role in disseminating information on good
  environmental practice                    39
 Small Group Exercise:
Classifying Environmental
  Management Options

         [30 min]



                            40
         Exercise instructions

 Introduction (5 min.)
 Read and evaluate the two company
  cases detailed in your handout (10 min.)
 Discuss your answers with the other
  small groups and the instructor (10 min.)
 Lessons learned (5 min.)


   Refers to the handout ―CP3Exercises‖ throughout the course
                                                                41
           Preview:
      Cleaner Production
 at a case study facility called
        ―PLS‖ [5 minutes]
 A medium-sized company selling
  printed food packaging materials (such
  as potato-chip bags)
 They print product labels directly onto
  the film material, and then the
  customers make the final package
                                        42
        Cleaner Production
        at the PLS Company
 PLS implemented two CP projects to
  reduce wasted solid scrap during print
  runs
  – A quality control (QC) camera project to
    reduce waste from errors when printing
  – An on-site scrap recycling project to reduce
    waste from start-up runs



                                               43
  CP projects’ profitability
    at the PLS Company

 The two CP projects in combination
  reduced solid scrap by about 45%
 Total initial investment:
  – US $ 105,000
 The resulting annual savings:
  – US $ 96,900
 More details to come later...
                                       44
Time for lunch!
    [60 min]




                  45
CP Implementation Steps

        [30 min]




                          46
   Planning for Cleaner Production:
         Six steps to savings

 Step 1                        Step 3
                                                                    Step 5
                               Identify and
Get                                                                Implement
                               evaluate CP
organized      Step 2                                              projects
                               alternatives          Step 4
               Analyze                                                                   Step 6
                                                    Secure
               processes                                                                Measure
                                                    project
                                                                                        progress
                                                    financing




          Adapted from: A Guide to Pollution Prevention for New Hampshire Businesses.
                                                                                            47
                 January 1999. N.H Department of Environmental Services.
    Step 1 — Get organized

 Get management support for Cleaner
  Production
 Form a planning team
 Seek input from personnel at all levels




                                        48
 Step 2 — Analyze processes

 Take a close look at each
  production step
 Map flows of materials,
  energy, waste, activities
 Determine the true cost of
  waste generation
 Prioritise losses and target
  your CP efforts
                                 49
Step 3 — Identify & evaluate
         CP options
 Get at the root cause of
  the problem
 Be creative
 Generate lots of ideas
 Determine which
  alternatives are feasible
 Select best alternatives for
  implementation
                                 50
   Step 4 — Secure project
          financing
 Proceed to Step 5 for projects that
  need minimal up-front investment
 Determine availability of internal
  investment funds for bigger projects
 Obtain external financing for
  remaining projects
  – Private sector
  – Government sector
                                         51
Step 5 — Implement projects

   Schedule projects
   Assign responsibilities
   Talk to workers who will be affected
   Get feedback from employees
   Schedule financing payments



                                           52
 Step 6 — Measure progress

 Track waste generation,
  materials usage, and cost
  savings
 Take into account variation
  in production level
 Document your results and
  your cost savings
 Celebrate your successes
 Now go back to Step 2         53
Teamwork is very important!




   Each person brings different,
       but vital, information
                                   54
             Tools:
  The Cleaner Production Team
                              CEO                  Board



Accounting                            Production         Sales &
& Finance             Research &                        Marketing
                     Development
                                                                    Environment,
                                                                      Health, &
                                    Purchasing
             Legal                                                     Safety
                                    Materials Control
                                    Inventory
                                    Operations
                                    Quality Control
                                    Shipping
                                    Maintenance
                                    Engineering
                                                                          55
    Where to go for more
        information
 Click ‗Where to go for more information‖ on this CD-ROM or
to the second last page of any of the UNEP/DTIE publications
        in the ―Profiting from Cleaner Production‖ series




                                                               56
Cleaner Production
Summary and Q&A

      [15 min]




                     57
        Cleaner Production
    Review of what we have done

 The Cost of Waste
 Profiting from Cleaner Production
 Small group exercise on Classifying
  Environmental Management Options
 CP implementation steps
 Where to go for more information


                                        58
        CP Planning at your
        Organization [15 min]
 Take this time to write down some
  next steps for CP planning at your
  organization
  – What other quality, efficiency, or
    environmental initiatives already in place at
    your organization might fit well with CP?
  – Who should be the members of your CP team?
  – Would you go somewhere for external
    assistance? What kind? Where would you go?
  – What might be some CP barriers at your
    organization, and how can you overcome them?
                                                59
Time for a break!
     [15 min]




                    60
Cost Identification
  and Estimation




                      61
    Introduction to Cost
Identification and Estimation

          [15 minutes]




                                62
     Decision-making factors
                              Today’s focus
               Technical

                Project
Regulatory                         Financial
               selection

             Organizational

                                          63
            The language of business
   Costs are an important aid in translating environmental
   needs to business needs. In addition, they already serve as
   an ―official language‖ in the company.
                          project                ROI
           capital        profitability   market    profit centre
           investment                                            cost allocation
                                          share overhead costs
                          unit price


                                                               CDO
                      regulatory    incinerator ban
                                                          energy wastewater dioxin
                      compliance          recycling       efficiency



     With the cost translation, the business and environmental
     manager can communicate and cooperate more effectively.

Adapted from “Pilot programme for the promotion of environmental management in developing
countries” (P3U). Environmental Cost Management. GTZ-P3U. Bonn, Germany                     64
      Financial Analysis steps
 Cost identification & estimation


We will discuss this now

                      We will discuss these tomorrow



 Project profitability evaluation

                                                65
Cost identification & estimation
 Initial investment costs
  – e.g., equipment, installation, training
 Annual operating costs, savings,and
  revenues
  – current operations, before the project
  – after project implementation
  – e.g., materials, energy, labour
 Need to identify, estimate and
  allocate all relevant and significant
  items impacted by the project               66
  Small group exercise:
Cost Identification at the
      PLS Company


          [75 min]



                             67
         The PLS Company
 A medium-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 annual operating
  costs
                                          68
Manufacturing Steps at the PLS Company
         — Materials flow map
                     plastic film, aluminium film, adhesive

                                   solvent air                solvent air
 INVENTORY                         emissions                  emissions

                                                              printed
                                  printed                     laminated
                                                                                          product
plastic film, ink                 film                        film          SLITTING
                     PRINTING                LAMINATION

                                    Solid scrap          Solid scrap
                                                                            Solid scrap
                Liquid waste
                     ink


                    to waste                     to waste
                    management                   management
                                                                                           69
Waste Management at the PLS Company
       — Materials flow map

                                 air                             air
                              emissions   wwtp chemicals      emissions

                                                                    Cleaner
fresh water                                                         water to
fuel and fuel                                                       a nearby
additive                                                            stream
                INCINERATOR               WASTEWATER TREATMENT
                                                                     liquid ink
                       ash                           sludge          waste from
                                                                     printing step




                                                              OFF-SITE
                                                              LANDFILL

                                                                          70
       Exercise instructions
 Introduction (10 min.), detailed in your
  handout
 Review the written description and flow
  maps for the PLS Company (10 min.)
 Question 1 (15 min.)
 Question 2 (15 min.)
 Discuss your answers with the other
  small groups and the instructor (20 min.)
 Lessons learned (5 min.)
                                        71
    Three broad categories
           of costs
 The cost of manufacturing inputs
  – Materials, energy, labour, capital, etc.
 The cost of waste management
  – Waste handling, regulatory compliance,
    waste treatment and disposal, etc.
 Less tangible costs
  – Production throughput, product quality,
    company image, liability, etc.
                                               72
                  Checklist:

 ―The Investment Decision
  Cost/Savings Checklist‖



Refers to the checklist handout
                                  73
        The cost 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)
                                              74
    Problematic accounting
practices—what might make it
  difficult to estimate costs
           accurately
(Particularly costs related to waste)

       Let’s brainstorm!
              [30 min]


                                        75
     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?)
                                               76
―Hidden‖ costs of lost raw materials
 Manufacture of plastic rear panels for automobiles
       (As a percentage of input materials)

  Material loss per                                Actual
  the accounting                                   material
      records                                       loss
         2%
                                                              52%




      Adapted from: Rooney, Charles. “Economics of Pollution Prevention:   77
    How Waste Reduction Pays.” Pollution Prevention Review.Summer 1993.
       ―Hidden‖ Costs of
       lost raw materials
      at 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
                                          78
 Direct vs. Indirect Costs (1)
 Direct Costs are costs that can be
  easily traced to a unit of product
  – e.g., direct materials, direct labour
 Indirect Costs are costs that cannot be
  traced as easily to a unit of product
  – e.g., facility energy use, insurance,
    maintenance, waste treatment
 A cost considered ―direct‖ at one firm
  may be considered ―indirect‖ at another
  firm
                                            79
 Direct vs. Indirect Costs (2)

 In general, direct costs within an
  industrial firm are assigned directly to
  the process, product, or project
  responsible for generating the cost
 Indirect costs are assigned to
  facility, division, or company overhead
  accounts
 It can be difficult to find costs
  ―hidden‖ in overhead accounts
                                         80
     Environmental Management Costs
     ―hidden‖ in an overhead account
                                   Product Manufacturing Cost Statement



                                 Variable Costs
                                 Raw Materials                     $2.27/lb.
                                 Intermediates           $0.87/lb. $0.41/lb. $0.96/lb.
                                 Additives              $11.32/lb. $10.31/lb. $9.14/lb.
                                 Utilities
                                 Direct Labour
                                 Packaging
                                                           $0.04/kW-h $0.07/kW-h
                                                            $27.40/hr $31.43/hr.
                                                            $0.60/pkg. $0.57/pkg
                                                                                   • legal expenses
      Fixed Costs
                                 Wastewater
                                 Treatment
                                                                  $0.01/gal.
                                                                                   • environmentally
      Supervisor       Fixed Costs
                       Supervisor                                                    driven R&D
                                                                                     $4,600


                                                                                   • permitting time and
                       Fixed Labour                                                 $57,800
      Fixed Labour     Depreciation                                                  $1,227
                       Divisional Overhead                                          $13,662
      Depreciation     General Services &
                        Administration
      Divisional Overhead                                                            fees
                                                                                     $1,294



      General Services &                                                           • environmental
                                              Total Variable Cost
      Administration                             Total Fixed Cost
                                        Total Manufacturing Cost                     training
                                                         Total Cost




                                                                                                     81
Source: Green Ledgers: Case Studies in Corporate Environmental Accounting. World Resources
   Institute. May 1995.
 Survey of industry accountants
           in 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
                                                                                             82
       Cost assignment
     at the PLS Company
 The cost of direct materials,
  labour, and energy are assigned
  directly to the manufacturing steps
 In contrast, waste treatment and
  disposal costs are assigned to an
  overhead account in the Office of
  the Business Manager

                                        83
     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?)
                                               84
           Cost 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
                                       85
                   Cost allocation
                at the PLS Company
                                   How would you
Allocated from                     allocate?
                       Printing
overhead
                                   On the basis of:
 Solid scrap
                                   • # of set-up runs?
  waste               Laminating
                                   • raw materials use?
 Treatment and
                                   • machine hours?
  disposal costs
                       Slitting    • amount of scrap?
                                   • some other basis?



                                                   86
     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?)

                                            87
  Fixed vs. Variable Costs (1)
 Fixed Costs are costs that do not vary
  with production level or other factors
  – e.g., equipment depreciation, labour
 Variable Costs are costs that 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                             88
 Fixed vs. Variable Costs (2)
 The goal of Cleaner Production is to
  reduce variable costs
 Therefore, it is important to correctly
  distinguish between fixed and variable
  costs when identifying and estimating
  costs to support CP efforts
 If CP efforts will reduce a cost —
  then it is variable!


                                            89
      Fixed vs. Variable Costs
        at The PLS Company
 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?                              90
  It is important to
      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
                                91
     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?)

                                            92
       Costs missing from
     the accounting records
In general, two types of costs may be
entirely missing from the 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
  – e.g., lost profit from reduced production
    throughput
                                                    93
      Costs missing from
    the accounting records
     at the PLS Company
 Lost profit from reduced production
 Future regulatory costs (e.g., stricter
  wastewater regulations)
 Potential liability
 Negative company image
 (Can you think of others?)

                                        94
     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?)

                                            95
           Ease of identifying
          and estimating costs
In general,
                 LESS        Equipment purchase,
as you go      HIDDEN
                        direct materials, energy, labour
down this
list, costs
are more                         Waste disposal
likely to be
hidden or                  Recycle/rework, treatment,
difficult to
                                waste handling
quantify
(but every                   Regulatory compliance,
case is         MORE           other indirect costs
different!)    HIDDEN
                               Less tangible costs
                                                     96
Potential Sources
  of Cost Data

Let’s brainstorm!

     [15 min]


                    97
Potential sources of cost data
 Internal data sources
  – The accounting system
  – Original data records in different departments
  – Colleagues/employees
 External data sources
  –   Industry colleagues or trade associations
  –   Vendors and consultants
  –   Business Partners (e.g., insurance firm)
  –   Government (e.g., environmental agency)
  –   National Cleaner Production Centre
                                                  98
Review of What We have
     Covered Today
        [15 min]




                         99
        Cleaner Production

 The cost of waste
  – Usually underestimated!
 Profiting from Cleaner Production
  – Cleaner Production as waste prevention and
    on-site recycling
 Cleaner Production
  – Benefits
  – Implementation steps
                                          100
     Cost identification and
           estimation
 Cost identification
  – Introduction to PLS company (will see
    more of PLS tomorrow)
  – Categories of costs (manufacturing
    inputs, waste management, less tangible
    costs)
  – Problematic accounting practices
  – Sources of cost data

                                              101
               Tomorrow...
 Cost estimation tools
  – Process mapping, material flows
 Project profitability assessment
  –   Cash flows
  –   ―Simple Payback‖ indicator
  –   ―Time-value-of-money‖ concept
  –   ―Net Present Value (NPV)‖ indicator
  –   Other indicators
  –   Other profitability assessment issues
                                              102
Final questions or comments?




                           103
           Profiting from
        Cleaner Production:
               Day 2


  Prepared by                For UNEP
 Tellus Institute     Division of Technology,
Boston, MA USA       Industry, and Economics


  TELLUS INSTITUTE
                                                104
  Small group exercise:
Cost estimation at the PLS
         Company


          [60 min]


                             105
       Exercise instructions

 Introduction (5 min.), detailed in
  your exercise handout
 Question 1 (20 min.)
 Question 2 (15 min.)
 Discuss your answers with the
  other small groups and the
  instructor (15 min.)
 Lessons learned (5 min.)
                                       106
Tools For Data Identification
       and Estimation


           [30 min]


                            107
                     Tools:
             Original data records
    Purchase order/invoices
    Production records
    Waste shipment records
    Equipment logs
    Engineering estimates
    Regulatory reports
    Staff interviews

    Source: Northeast Waste Management Officials’ Association   108
    Checklist:

―Cleaner Production
   Data Sources‖



                      109
                                 Tools:
                           Materials flow map
                     plastic film, aluminium film, adhesive

                                   solvent air                solvent air
 INVENTORY                         emissions                  emissions

                                                              printed
                                  printed                     laminated
                                                                                          product
plastic film, ink                 film                        film          SLITTING
                     PRINTING                LAMINATION

                                    Solid scrap          Solid scrap
                                                                            Solid scrap
                Liquid waste
                     ink


                    to waste                     to waste
                    management                   management
                                                                                          110
                Tools:
         The 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


                                      PRODUCT
               MANUFACTURING
INPUTS
                  PROCESS             NON-PRODUCT
                                      OUTPUT (WASTE)


                                                   111
                Tools:
            Cost Checklist
 Consider tailoring a generic checklist
  for routine use with specific industry
  sectors and/or for specific
  process/project types
 Determine if each item on the list is:
  –   Not relevant
  –   Relevant but quantitatively insignificant
  –   Relevant and quantitatively significant
  –   Relevant but not quantifiable
                                             112
        Checklist:

―The Investment Decision
 Cost/Savings Checklist‖



   — We used it yesterday
                            113
         Investment decision
           Costs & savings
 Initial investment costs
 Annual operating costs and savings
  –   The cost of operating inputs
  –   The cost of waste management
  –   Less tangible costs
  –   Revenues



                                       114
           Tools:
Activity Based Costing (ABC)
 Under ABC, costs are allocated from
  overhead accounts
  – To the processes, products, or projects that
    actually generated the costs
  – On the basis of activities with a direct
    relationship to cost generation

 ABC will not eliminate overhead
  accounts, but will ensure the
  availability of more accurate cost
  information for decision-making
                                                   115
              Tools:
       External expertise
     for less tangible costs
Examples:
 Insurance sector— liability estimation
 Marketing firms— value of company
  image
 Environmental agencies — estimates
  of current and future regulatory
  compliance costs
                                       116
    Cost identification and
          estimation
     Summary of tools (1)
 Work as a team— talk to everyone
 Do a facility walk-through
 Map process steps, materials flows,
  employee activities, etc.
 Do materials and energy balances
 Use a comprehensive cost/savings
  checklist
 External expertise for less tangible
  costs
                                         117
     Cost identification and
           estimation
      Summary of tools (2)
 Do a check on data from the accounting
  records
  – overhead costs appropriately allocated?
  – accurate characterisation of fixed vs. variable?
 Compare accounting record data to
  information from your maps, materials
  balances, staff interviews
 Go back to the original data sources
 Think creatively
                                                  118
    To 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.
                                          119
    Do a balancing act...
 Don’t spend any more time than
  necessary collecting and analyzing data
                 but
 Make sure you have really included all
  of the most significant costs & savings
  in the analysis
 Make sure that you are not neglecting
  other CP alternatives for the same
  waste stream that might be even more
  profitable!
                                        120
Cost Identification and
      Estimation

  Summary and Q&A

        [15 min]



                          121
Cost identification & estimation


   Problematic accounting practices
   Potential sources of cost data
   Small group exercise on cost estimation
   Tools for data estimation



                                         122
Cost identification and estimation
       at your organization
                     [15 min]

 Take this time to write down some next
  steps for cost identification & estimation
  at your organization
   – What accounting practices might you want to
     understand better?
   – What other data sources might be the most
     valuable?
   – What cost identification & estimation tools might
     be the most useful?
                                                   123
Time for a break!
     [15 min]




                    124
Project Profitability
    Assessment




                        125
      Capital Budgeting
(of ―Environmental‖ Projects)
           [15 min]




                            126
         Capital Budgeting

The process by which an organization:
 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

                                        127
    Capital 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                   128
Typical project types & goals (1)
 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
                                                 129
Typical project types & goals (2)
    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...
                                              130
       The poor reputation of
―environmental‖ investment projects
  Many people in industry view
  ―environmental‖ projects as increasingly
  necessary to stay in business, but as
  automatic financial losers because:
  – they associate ―environmental projects‖ with
    pollution control systems such as wastewater
    treatment plants, which can be quite costly
    (end-of-pipe)
  – they are unaware of the potential financial
    benefits of preventive environmental
    management practices                           131
         We know better!
 We have learned that some environmental
  projects, i.e., Cleaner Production (CP)
  projects, can go hand in hand with:
  – Production efficiency improvements
  – Product quality improvements
  – Production expansion
 So, do not place your project idea into a
  single narrow category — think broadly
  about all the possible benefits

                                         132
     Decision-making factors
                              Today’s focus
               Technical

                Project
Regulatory                         Financial
               selection

             Organizational

                                         133
Project Cash Flows
        and
  Simple Payback

      [15 min]


                     134
   The 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


                                    135
          Cash Flow Analysis

• Relies on every day life principles

• Measures the difference between
        – What we received, and
        – What we paid out


• Only cash receipts and cash payments are
included in the analysis
• Applicable also to forecast cash available 136
    Types of cash flows
            Outflow      Inflow
              Initial   Equipment
One-time   investment    salvage
               cost       value
           Operating    Operating
Annual      costs &     revenues
             taxes      & savings
            Working      Working
 Other      capital      capital

                                    137
     Cash Outflow Analysis (1)

                INITIAL INVESTMENT


• Planning/ Engineering   • Utility Systems &

• Permitting              Connections

• Site Preparation        • Start-up/Training

• Purchased Equipment     • Contingency

• Working Capital         • (Salvage Value)
                                                138
           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                        139
          Salvage Value

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




                                       140
  Cash Outflow Analysis (2)

•Direct costs

•Input costs

•Other costs

•Loan repayments

•Interest on loan application
                                141
         Cash Inflow Analysis
•Sales

•Savings


•Salvage value

•Cash shortfall / surplus


                                142
Cash Flow Forecast/Projection
             (1)
•We are looking at the likely future
cash position.


•We examine the possible effects of
changes in the cash flow components .


                                       143
Cash Flow Forecast/Projection
             (2)
 Make assumptions about likely outcomes
  regarding:

  –   Inflation
  –   Market size
  –   Demand for goods and services
  –   Interest Rates



                                           144
Cashflow Projection Worksheet
 Investment Year                              0   1   2   3
 INITIAL INVESTMENT
     Total Investment Costs

 OPERATING COSTS
     Total Operating Costs

 OPERATING AND MAINTENANCE
     Total Operating and Maintenance Costs

 WASTE MANAGEMENT
     Total Waste Management Costs

 COMPLIANCE AND REG. (Less
 Tangibles)
     Total Compliance Costs

 REVENUES AND SAVINGS
     REVENUES
      Operating Costs
      Less Depreciation
      Taxable Income
      Tax payable                                             145
      Net Income after Depreciation and Tax
Annual Operating Costs & Savings
(see also Cleaner Production Investment Decision: Costs and
                     Savings Checklist)

 Operating         Waste management                  Less tangibles
 inputs            includes waste handling, recycling, • Productivity
                   treatment, disposal, and regulatory • Future regulation
                   compliance
 • Materials                                         • Potential liability
                   • Materials                       • Insurance
 • Energy
                                                     • Company image
                   • Energy
 • Labour                                             Revenues
                   • Labour
 • Floor space                                        • Product sales
                   • Floor space                      • By-product sales
 • Taxes                                              • Pollution credits
                   • Fees
 • Depreciation
                   • Taxes & depreciation
 • Cost of capital • Cost of capital
                                                                       146
      Timing of cash flows
                                         End of project:
                                       Salvage Value
                Annual Revenues/Savings    Working
                                            capital


     Year 1          Year 2         Year 3         TIME




                      Annual Operating Costs
                       Annual Tax Payments
       Time zero:       Annual Financing
      Working Capital       Payments
Initial Investment
                                                           147
 Cash Flow Analysis structure
There are two basic ways to structure
a project financial analysis:
  1) Stand-alone analysis
     Considers only the cash flows of the proposed
     project
  2) Incremental analysis
     Compares the cash flows of the proposed
     project to the ―business as usual‖ cash flows


                                                 148
 Incremental analysis for CP
 For many CP projects, you will need
  to do an incremental analysis —
  compare the CP cash flows to the
  ―business as usual‖ cash flows
 You only need to estimate the cash
  flows that change when you improve
  the ―business as usual‖ operations


                                        149
   Profitability indicators
A profitability indicator, or ―financial
indicator‖, is: ―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)
                                      150
          Simple Payback
This indicator incorporates:
   – the initial investment cost
   – the first year cash flow from the
     project


      Simple         Initial Investment
                 =
    Payback
                     Year 1 Cash Flow
    (in years)

                                          151
        How to interpret
         Simple Payback
The simple payback calculated for a
project is usually compared to a
company rule of thumb called a
―hurdle‖ rate:

e.g., if the payback period is less
than 3 years, then the project is
viewed as profitable

                                      152
    Small Group Exercise:
  Profitability Assessment
at the PLS Company— Part I
  ―Cash Flows & Simple Payback‖

            [30 min]

                                  153
       The PLS Company’s
       QC Camera Project
 PLS decided to purchase and install a
  camera system to monitor quality control
  (QC) 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
 Has reduced generation of full-run solid
  scrap by about 40%
                                         154
         Costs and savings
included in the QC camera analysis
  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
                                               155
        QC camera project
           Cash flows
                     Annual savings = ???




      Year 1            Year 2            Year 3           TIME


         Annual Tax Payments = 0 (PLS has tax holiday)
            Financing Payments = 0 (PLS paid cash)


     Time zero:
    Working Capital = 0 (not important for this project)
Initial Investment = $105,000
                                                              156
           The PLS Company’s
           QC camera project
              Initial      Annual
           Investment     Operating
               Cost        Costs
Business
   As           0           ???
 Usual                                 Annual
                                      Savings =
The QC                                  ???
Camera     US $ 105,000     ???
Project

                                          157
      Exercise instructions
             Part I
 Introduction (5 min.), detailed in
  your handout
 Question 1 (15 min.)
 Question 2 (5 min.)
 Discuss your answers with the
  other small groups and the
  instructor (5 min.)

                                       158
The Time Value of Money
          and
Net Present Value (NPV)
        [30 min]




                          159
          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...
                             160
              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 161
      Investment opportunity
 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                             Gives you
                 Investment          $1.10 a year
  $1 now
                                      from now

                  Interest, or
            “return on investment”
                                              162
 Time 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

                                    163
 TVM and project profitability

 When you invest in a capital project,
  you have:
  (1) An initial investment happening NOW
  (2) A series of future cash inflows, over
    time, that pay back the initial investment

 So, it is important to take the Time
  Value of Money (TVM) into account
  when you are estimating project
  profitability
                                                 164
           The PLS Company’s
           QC camera project
              Initial      Annual
           Investment     Operating
               Cost        Costs
Business
   As           0        $ 2,933,204
 Usual                                  Annual
                                       Savings =
The QC                                 US$38,463
Camera      $ 105,000    $ 2,894,741
Project

                    (in US$)
                                           165
        Question:

  Is the annual savings of
$38,463 per year for 3 years
     a sufficient return
 on the initial investment of
         $ 105,000?



                                166
                Answer?
You might think about adding up the
annual savings over the 3 years:

Savings per year               $38,463
                              x 3 years
Total savings                 $115,389

But: this ignores the Time Value of Money
(the fact that $38,463 in year 1 is not the
same as $38,463 in year 2 or year 3)
                                          167
      Comparing 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

                                         168
 Converting the PLS cash flows
    to their ―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
                                                            169
     Converting cash flows
     to their present value
 You can convert future year cash
  flows to their present value using a
  ―discount rate‖ that incorporates:
  – Desired return on investment
  – Inflation
 The discount rate calculation is simple
  — mathematically, it is the reverse of
  an interest rate calculation
                                         170
        Interest rate calculation
Invested at an interest rate of 20%, how
much will $10,000 now be worth after 3
years?

After
year
 1      $10,000 x 1.20              = $12,000

 2      $10,000 x 1.20 x 1.20       = $14,400

 3      $10,000 x 1.20 x 1.20 x 1.20 = $17,280

Note: these calculations are on a compound basis
                                                   171
      Discounting calculation
The discounting calculation is essentially
the opposite of the interest rate
calculation.

If you want to have $17,280 in 3 years,
how much would you have to invest now?
            $17,280          =     $10,000
        1.20 x 1.20 x 1.20       needed now

In other words, $17,280 in year 3 has a
present value of $10,000
                                              172
    Which discount Rate? (1)
 The discount rate a company chooses
  should be equal to the required rate of
  return for the project investment
 The required rate of return will usually
  incorporate three distinct elements:
  – 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

                                                   173
   Which discount Rate? (2)
 At a minimum, the chosen discount rate
  should cover the costs of raising the
  investment financing from investors or
  lenders (i.e. the company’s ―cost of
  capital‖)
 Often, rather than trying to identify the
  exact source of capital (and its associated
  cost) for each individual project, a firm
  will develop a single ―Weighted Average
  Cost of Capital‖ (WACC) that characterises
  the sources and cost of capital to the
  company as a whole.                        174
                Discounting (1)
                                       The value of the
                                      cash flow in year n


   Present Value = Future Valuen
                      (1 + d)n

 The value of the                        n = the number
   cash flow at          d = the          of years after
“Time Zero,” i.e.,    discount rate      project start-up
at project start-up


                                                    175
                Discounting (2)
                                        The value of the
                                       cash flow in year n


Present Value = Future Valuen x (PV Factor)



 The value of the      Present Value (PV) Factors have
   cash flow at          been calculated for various
“Time Zero,” i.e.,    values of d (discount rate) and n
at project start-up   (number of years) and have been
                           tabulated for easy use.
                       (Also called discount factors)
                                                    176
             Present value factors
              Value of $1 in the future, 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
                                                        177
   Net Present Value (NPV)
 Net Present Value (NPV) = 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
                                             178
                Estimating
             Net Present Value

           Expected                       Present Value of
Year      Future Cash         PV      =     Cash Flows
                         *   Factor
             Flows                         (at time zero)

 0        - $105,000          ???              - $???
 1         + $38,463          ???              $???
 2         + $38,463          ???              $???
 3         + $38,463          ???              $???

     Sum = the project’s Net Present Value =   $???     179
Time for lunch!
    [60 min]




                  180
    Small Group Exercise:
   Profitability Assessment
at the PLS Company— Part II
      ―Net Present Value‖

            [45 min]

                            181
             Also —
  you will need the handout:

―Performing Net Present Value
      (NPV) Calculations‖

      Located in your handout

                                182
 Converting the PLS cash flows
    to their ―present value‖
                                        End of project
= ??
= ??
= ??
                    $38,463       $38,463        $38,463


        Year 1          Year 2      Year 3         TIME




       Time zero:
  Initial Investment = $105,000
                                                         183
      Exercise instructions
            Part II
 Introduction (5 min.), detailed in
  your handout
 Question 3 (15 min.)
 Question 4 (5 min.)
 Discuss your answers with the
  other small groups and the
  instructor (15 min.)
 Lessons learned (5 min.)
                                       184
Capital Budgeting:
  inflation & tax


     [30 min]


                     185
 Discounting and inflation (1)

 even without inflation, money has a
  time value due to supply/demand for
  money
 inflation increases both:
    - future cash flows
    - interest rates (and  discount rates)
 these offset each other

                                              186
  Discounting and inflation (2)

With 10% inflation (say), future cash flows
will  by 10% each year

Investors & lenders will also require a higher
rate to compensate for their loss in
purchasing power

If 15% was acceptable with no inflation, with
10% inflation they will now require

           115% x 110% = 126.5%               187
  Discounting and inflation (3)
PLS Company, now assuming 10% inflation and 26.5%
discount rate:
      Year     Cash flow       PV factor        PV
                  ($)          @ 26.5%          ($)
        1       42,309           0.791        33,466
        2       46,540           0.625        29,088
        3       51,194           0.494        25,289
                                              87,843
      less: initial investment                105,000
               Net Present Value             -17,157

i.e. same NPV* as with zero inflation, 15% discount rate
            * ignoring minor rounding difference
                                                           188
What is the current rate of inflation in
the economy?

What return on their capital will the
lender really earn on their money,
after allowing for the erosion of their
capital over time through inflation?



                                          189
           Tax payments

 Taxes can be an important project
  cash flow
 Depending on a facility’s location, a
  firm may have to pay national and/or
  local income taxes on the revenues or
  savings generated by a project
 Other types of taxes may also be
  relevant - sales taxes, pollution
  taxes, etc.
                                      190
   Tax deductions or credits

 Tax deductions or credits can also be
  important
 One example is the income tax
  deduction often given for equipment
  depreciation, which is the loss in value
  of a physical asset (e.g., a piece of
  equipment) as the asset ages
 Some ―environmental‖ investments can
  receive special tax credits
                                        191
   Tax and project appraisal

 assume 30% rate of taxes of firms’
  profits
 tax is based on accounting profits, not
  on cashflows
 accounting profits are after deducting
  depreciation
 tax is payable 1 year after the
  profits have been realised
                                       192
            Depreciation

 A project needs $12,000 for a new
  machine which will last 3 years
 assume the machine has no residual
  value after 3 years
 depreciation per year:
  initial cost = $12,000 = $4,000 per year
  asset life      3 years

                                         193
   Profit earned by project

 Profit earned by project in each year:
 cash inflow per year       $6,000
 less: depreciation         $4,000
 contribution to profit     $2,000

 tax @ 30%                   $600

                                      194
      NPV of project, with tax
time    cash    tax   net        PV       PV
                               factor

now    -12,000      -12,000    1.000    -12,000
 1      +6,000       +6,000    0.833     +5,000
 2      +6,000 -600 +5,400     0.694     +3,750
 3      +6,000 -600 +5,400     0.579     +3,125
 4             -600    -600    0.482      -289

                  Net Present Value     - $414



                                                  195
Project appraisal with inflation
           and tax

 depreciation (and accounting profits) are
  based on the asset’s original cost

 the asset’s original cost does not increase
  with inflation over the life of the project

 project analysis is then easier using
  nominal (not real) cashflows and discount
  rates
                                                196
    Some good reasons to use a
    longer analysis time horizon
 Some out-year costs may be missed if the
  time horizon is too short, e.g., a required
  wastewater treatment plant upgrade in the
  future
 Some annual operating costs may change
  significantly over time, e.g., disposal fees at
  landfills
 Short time horizons neglect the impact of the
  time value of money, especially in times of
  significant inflation, deflation, changing cost
  of capital, etc.                               197
Profitability assessment tips

Be sure to:
– Include all relevant and significant
  costs/savings in the profitability analysis
– Think long-term (or at least medium-
  term!)
– Incorporate the time value of money
– Use multiple profitability indicators
– Perform sensitivity analyses for data
  estimates that are uncertain
                                            198
Time for a break!
     [15 min]




                    199
Sensitivity Analysis


      [15 min]

                       200
         Sensitivity Analysis
            Introduction
An important management tool questioning
potential project benefit risks.

Assumptions surrounding a project are
computed to produce a base NPV and IRR.

From the base case, changes in the original
assumptions are made to gauge their effect on
the NPV and IRR.

Input variables varied adversely by 10%
                                                201
         Sensitivity Analysis
              Example
               Input Variables Varied by 10%

                  Original   10% increase 10% increase 10% decrease
                    Data       in Cost of in Investment in cashflows
                                   Capital         cost

Year 0          -2735000      -11323650    -12456015      -2735000
Year 1         -14978753       12951647    -14978753     -14828965
Year 2          17122990        2592375     17122990      16951760
Year 3           8022274        5151626      8022274       7942051
Year 4            376354         117364       376354      372590.5
Year 5           8203865         374538      8203865       8121826
Year 6             76133        5142598        76133      75371.67
Discount             35%           48,5%         35%           35%
Rate
Project Life      5 years         5 years     5 years        5 years
NPV                 7810     -$2,741,092 -$8,940,009       $745,846
IRR                  39%             54%          9%            39%
                                                                  202
        Sensitivity Analysis
             Summary

 Sensitivity Analysis permits project proposals
to be evaluated simply.



The model can evaluate sensitive variables
without having to input any additional data.




                                                   203
         Sensitivity Analysis
             Conclusion
•By amending the original data, a variable
whose change generates a negative NPV
and /or an IRR lower than the firm’s cost
of capital, is deemed to be sensitive.

•An investigation would need to be
undertaken for a contingent plan. If
results of the investigation are
unfavourable, the project is unacceptable
on economic grounds.
However, development projects with social
aspects may be treated differently.
                                          204
           Key
Profitability Indicators
        [15 min]




                           205
  Profitability Indicators
We have seen so far:
     • Simple Payback
     • Net Present Value (NPV)


But there are others, common
examples are:
     • Return on Investment (ROI)
     • Internal Rate of Return (IRR)


                                       206
        Simple Payback and
    Return on Investment (ROI)
  These indicators incorporate:
     – the initial investment cost
     – the first year cash flow

Simple Payback         Initial Investment
               =
   (in years)          Year 1 Cash Flow

                       Year 1 Cash Flow
     ROI (in %)    =
                       Initial Investment
                                            207
       How to interpret
    Simple Payback and ROI
 The simple payback or ROI calculated
  for a project are usually compared to
  a company rule of thumb called a
  ―hurdle‖ rate:
  – e.g., if the project payback period is less
    than 3 years, then the project is viewed
    as profitable
  – e.g., if the ROI is 33%, then the project
    is viewed as profitable
                                             208
    Net Present Value (NPV)

 NPV is a more reliable profitability
  indicator than Simple Payback or ROI
  as it considers both the time value of
  money and all future year cash flows

 NPV = the sum of the discounted cash
  flows over the lifetime of the project,
  using the company’s cost of capital as
  the discount rate
                                           209
Internal Rate of Return (IRR)

 IRR is similar to NPV in that it
  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)
 It tells you exactly what ―discount
  rate‖ makes the project just barely
  profitable
                                         210
 Profitability Indicator Summary
                 (1)
          Advantage                Disadvantage
Simple
Payback   Easy to use              Neglect TVM
                                   Neglect out-year costs
&                                  Do not indicate project size
ROI
          Considers TVM            Needs firm’s discount rate
NPV       Indicates project size

IRR       Considers TVM            Requires iteration
                                   Does not indicate project size


                                                            211
Profitability Indicator Summary
                (2)
 NPV is generally the most valuable,
  problem-free indicator
 Other indicators that consider the time
  value of money (e.g., IRR) are also
  useful
 Payback and ROI are easy to understand
  and use, but of limited accuracy
 However, Simple Payback is particularly
  useful with uncertain or risky investment
  climates                                212
     Interpret profitability
   indicators with caution...
 We have seen that Simple Payback has
  some limitations as a project
  profitability indicator

 Be aware of the advantages and
  limitations of the indicators you use

 The best approach is to use several
  indicators to give a balanced view of
  project profitability
                                          213
Other Profitability
Assessment Issues
      [15 min]




                      214
            Other Issues

 There are other issues that impact a
  project’s profitability, which we do
  not have time to address today
  – Source and cost of project financing
  – Can you think of others?




                                           215
         Project financing

 Different sources of project financing
  may have differing impacts on project
  profitability
 Be sure to take financing payments
  such as lease payments or payments
  on loan principal and interest into
  account appropriately when estimating
  profitability

                                       216
 Consider attending another
   UNEP course entitled:

CP4: ―The Cleaner Production
    Investment Process‖


                              217
Project Profitability Assessment

      Summary and Q&A
            [15 min]




                              218
        Project profitability
            assessment
 Capital budgeting (of ―environmental‖
  projects)
 Project cash flows and simple payback
 The Time Value of Money and Net
  Present Value (NPV)
 Two small group exercises
 Capital budgeting : inflation and tax
 Sensitivity analysis
 Key profitability indicators            219
Conclusion




             220
    Where to go
for more information




                       221
      Review of
what we have covered
    in this course
       [15 min]




                       222
What we have learned today
           (1)
 The ―Cost of Waste‖ has many
  components and can be much higher
  than companies assume
 Cleaner Production is a proven
  approach that uses preventive
  environmental management to
  reduce the cost of waste, enhance
  competitiveness, and reduce
  environmental impact simultaneously
                                        223
What we have learned today
           (2)
 Although data from the accounting
  records will be important for
  implementing CP, be aware of the
  potential limitations of accounting
  data
 A number of very useful alternative
  cost identification and estimation
  approaches and tools exist - try
  them out!
                                        224
What we have learned today
           (3)

 When doing profitability assessment
  for more complex CP projects, be
  sure to do a comprehensive job of
  cost identification and estimation
 Choose longer analysis time horizons
  and multiple profitability indicators
  for assessing project profitability
 Don’t miss anything important!
                                          225
      And don’t forget...
 Team up - multiply your brainpower!
 Learn about the manufacturing
  process - draw maps!
 Ask questions!
 Use the checklists!
 Start small and build on your
  successes!
 Get outside help if you need it!
                                        226
Final questions and comments?
          [15 minutes]




                           227
Course Evaluation

     [15 min]




                    228
 Thank you for attending!

Please keep in touch with us
   regarding your Cleaner
     Production efforts.


                            229

				
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