Financial Feasibility

Financial Feasibility

Analysis
Analysis

Energizing Cleaner Production

Management Course

1
 Session Agenda:

Introduction
Financial Feasibility

Cash Flow
Analysis

Profitability Indicators
1. Simple Payback
2. Return on Investment (ROI)
3. Net Present Value (NPV)
4. Internal Rate of Return (IRR)
2
 Step 1: Planning and Organization
• task 1a: Meeting with top management
• task 1b: Form a Team and inform staff

But first… •
•
•
task 1c: Pre-assessment to collect general information
task 1d: Select focus areas
task 1e: Prepare assessment proposal for top management approval

In what step(s) Step 2: Assessment

of the •
•
task 2a: Staff meeting and training
task 2b: Prepare focus area flow charts
Financial Feasibility

methodology •
•
task 2c: Walkthrough of focus areas
task 2d: Quantify inputs and outputs and costs to establish a baseline
• task 2e: Quantify losses through a material and energy balance
is financial
feasibility Step 3: Identification of Options
Analysis

analysis • task 3a: Determine causes of losses

• task 3b: Identify possible options

relevant?
• task 3c: Screen options for feasibility analysis

Step 4: Feasibility Analysis of Options

• task 4a: Technical, economic and environmental evaluation of options
• task 4b: Rank feasible options for implementation
• task 4c: Prepare implementation and monitoring proposal for top
management approval

Step 5: Implementation and Monitoring of Options

• task 5a: Implement options and monitor results
• task 5b: Evaluation meeting with top management

Step 6: Continuous Improvement

• task 6a: Prepare proposal to continue with energy efficiency for top
management approval 3
 Introduction
Step 4 – Feasibility Analysis

Company’s priority
Financial Feasibility

Technical
Analysis

Project
Other Financial
- Regulatory Selection
- Organizational
- Health/safety
- Community

Environmental

4
 Introduction
Questions Management Will Ask

1. Is the project profitable?

• Initial investment costs
Financial Feasibility

• Annual operating costs and savings

– Cost of operating inputs
Analysis

– Cost of waste management

– Less tangible costs
– Revenues
2. Determine availability of internal
investment funds for bigger projects
3. Obtain external financing for
remaining projects 5
 Introduction
Capital Budgeting Process

Process by which organisation decides:

Financial Feasibility

• Which investment projects are

– Needed
Analysis

– Possible
– Special focus on projects that require
significant up-front capital investment
• How to allocate available capital
between different projects
• If additional capital is needed

6
 Introduction
Capital Budgeting Practices

• Vary widely from company to company

Financial Feasibility

– Larger companies tend to have more formal

practices than smaller companies
– Larger companies tend to make more and
Analysis

larger capital investments than smaller

companies
– Some industry sectors require more capital
investment than others
• Vary from country to country

7
 Introduction
Typical Project Types and Costs

• Maintenance
Financial Feasibility

– Maintain existing equipment and operations

• Improvement
Analysis

– 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
8
 Cash Flow
Cash Flow Concept

Common management planning tool

Financial Feasibility

Distinguishes between
Analysis

• Costs: cash outflows

• Revenues/savings: cash inflows

9
 Cash Flow
Types of Cash Flow

Outflow Inflow
Financial Feasibility

Initial Equipment
One-time investment salvage value
Analysis

cost

Operating
Annual Operating revenues
costs & taxes & savings

Other Working capital Working capital

10
 Cash Flow
Costs and Savings

• Initial investment costs

Financial Feasibility

– purchase of the camera system, delivery,

installation, start-up
Analysis

• Annual operating costs (and savings)

– Operating input — materials, energy, labour
– Incineration — fuel, fuel additive, labour, ash
to landfill
– Wastewater treatment — chemicals, electricity,
labour, sludge to landfill

11
 Cash Flow
Working Capital and Salvage Value

• Working capital: total value of goods

Financial Feasibility

and money needed to maintain project

operations
Analysis

– Raw materials inventory

– Product inventory
– Accounts payable/receivable
– Cash-on-hand

• Salvage Value: resale value of

equipment or other materials at the
end of the project 12
 Cash Flow
Timing

End of project:
Salvage Value
Financial Feasibility

Annual Revenues/Savings
Analysis

Year 1 Year 2 Year 3 TIME

Time zero:

Initial Investment 13
 Cash Flow
Incremental Analysis

• Needed for many CP or EE projects

Financial Feasibility

• Compares cash flow of implemented

options to the “business as usual”
Analysis

cash flow
• Covers only the cash flows that
change

14
 Profitability Indicators

• Definition: “a single number that is

Financial Feasibility

calculated for characterisation of

project profitability in a concise and
understandable form”
Analysis

• Common indicators
1. Simple Payback
2. Return on Investment (ROI)
3. Net Present Value (NPV)
4. Internal Rate of Return (IRR)
15
 1. Simple Payback

• Definition: number of years it will take

Financial Feasibility

for the project to recover the initial

investments
Analysis

• Usually a rule of thumb for selecting

projects, e.g. payback must be < 3
years

Simple Investment
=
Payback
(in years) Cash Flow
16
 2. Return on Investment

• Definition: the percentage of initial

Financial Feasibility

investment that is recovered each year

Analysis

Simple Payback Initial Investment

(in years) = 3 years
Year 1 Cash Flow

Year 1 Cash Flow

ROI (in %) = 33%
Initial Investment

17
 Workshop Exercise
PLS Company: produces rolls of
laminated film
plastic film, aluminium film, adhesive
Financial Feasibility

solvent air solvent air

INVENTORY emissions emissions

printed
Analysis

printed laminated
plastic film, ink film film SLITTING
PRINTING LAMINATION

Solid scrap Solid scrap

Solid scrap
Liquid waste
ink

to waste to waste
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management management
 Workshop Exercise
PLS Company installs QC Camera

Printing step
Financial Feasibility

• Printing errors cause high scrap rate

• Quality Control (QC) 3-camera system
Analysis

– Detect printing errors

– Operators halt the operations before too much
solid scrap is generated
• QC camera system costs US$105,000
to purchase and install
• 40% reduced scrap and operating
costs
19
 Workshop Exercise

• Question 1: Calculate annual cash

Financial Feasibility

flows using the cash flow worksheet

(15 min)
Analysis

• Question 2: Calculate simple payback

(5 min)

20
 3. Net Present Value
Money Loses its Value

Question:
Financial Feasibility

If we were giving away money, would you

Analysis

rather have:
(A) $10,000 today, or
(B) $10,000 3 years from now

Explain your answer...

21
 3. Net Present Value
Inflation

Money loses purchasing power over time

Financial Feasibility

as product/service prices rise, so a dollar

today can buy more than a dollar next
year
Analysis

inflation 5%

costs $1 costs $1.05

now next year 22
 3. Net Present Value
Return on Investment

A dollar that you invest today will bring

Financial Feasibility

you more than a dollar next year —

having the dollar now provides you with
an investment opportunity
Analysis

Gives you
Investing Investment $1.10 a year
$1 now
from now

10 % interest, or
“return on investment” 23
 3. Net Present Value
PLS Company’s QC Camera Project

Initial Annual
Financial Feasibility

Investment Operating
Cost Costs

Business
Analysis

As
0 $ 2,933,204
Usual Annual Savings
=
US$38,463
Installing
quality $ 105,000 $ 2,894,741
control
camera

(in US$)
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 3. Net Present Value
Question

Is the annual savings of

Financial Feasibility

$38,463 per year for 3

years a sufficient return
Analysis

on the initial investment

of $ 105,000?

25
 3. Net Present Value
Time Value of Money

• Money is worth more now than in the

Financial Feasibility

future because of
– Inflation
Analysis

– Investment opportunity

• “Time value” of money depends on

– Rate of inflation
– Rate of return on investment

26
 3. Net Present Value
Cash Flows from Different Years

• Before you can compare cash flows

Financial Feasibility

from different years, you need to

convert them all to their equivalent
values in a single year
Analysis

• It is easiest to convert all project cash

flows to their “present value” now, at
the very beginning of the project

27
 3. Net Present Value
Converting Cash Flows to Present
Value

Annual Savings End of project

Financial Feasibility

= ??
= ??
= ??
$38,463 $38,463 $38,463
Analysis

Year 1 Year 2 Year 3 TIME

Time zero:
Initial Investment = $105,000 28
 3. Net Present Value
Converting Cash Flows to Present
Value
Discount rate:
Financial Feasibility

• Converts future year cash flows to

their present value
Analysis

• Incorporates:
– Desired return on investment
– Inflation

• Reverse of an interest rate calculation

29
 3. Net Present Value
Discount Rate & Interest Rate
Invested at an interest rate of 20%, how much will $10,000
now be worth after 3 years?
Financial Feasibility
Analysis

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

At a discount rate of 20%, how much do I need to invest if I

want to have $17,280 in 3 years?

$17,280
1.20 x 1.20 x 1.20 = $10,000
30
 3. Net Present Value
Which Discount Rate?
• Equal to the required rate of return for the project
investment, based on
Financial Feasibility

– A basic return - pure compensation for deferring

consumption
Analysis

– Any ‘risk premium’ for that project’s risk

– Any expected fall in the value of money over time
through inflation
• At least cover the costs of raising the investment
financing from investors or lenders (i.e. the company’s
“cost of capital”)
• A single “Weighted Average Cost of Capital” (WACC)
characterises the sources and cost of capital to the
company as a whole 31
 3. Net Present Value
Calculating “Present Value”
Value of the cash flow
in year n
Financial Feasibility

Present Value = Future Valuen x (PV Factor)

Analysis

Value of cash flow Present Value (PV) Factors or

at “Time Zero,” i.e. “discount factors”
at project start-up
• For various values d (discount
rate): 10%, 15%, 20%
• For various years n (number of
years)
• Tables available 32
 3. Net Present Value
The Value of a Future $1

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

Financial Feasibility

Years into future (n)

1 .9091 .8333 .7692 .7142
Present
2 .8264 .6944 .5917 .5102
Analysis

value
3 .7513 .5787 .4552 .3644 factors

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

Handout: Table with discount rates 33

 3. Net Present Value
Net Present Value (NPV)

• Definition: sum of present values of all

Financial Feasibility

project’s cash flows

– Negative (cash outflows)
– Positive (cash inflows)
Analysis

• Characterises the present value of the

project to the company
– If NPV > 0, the project is profitable
– If NPV < 0, the project is not

• More reliable than Simple Payback or

ROI as it considers
– Time value of money
– All future year cash flows
34
 3. Net Present Value
Workshop Exercise (15 min)

Question 3: Calculate the NPV

Financial Feasibility

Expected Present Value

Year Future Cash PV = of Cash Flows
X
Factor
Analysis

Flows (at time zero)

0 - $105,000 ??? - $???

1 + $38,463 ??? $???
2 + $38,463 ??? $???
3 + $38,463 ??? $???

Sum = project’s Net Present Value = $???

35
 3. Net Present Value
Workshop Exercise (5 min)

Question 4: compare the Simple Payback

Financial Feasibility

and the NPV

Analysis

36
 3. Net Present Value
Sensitivity Analysis

• In business as usual scenario PLS

Financial Feasibility

Company needs waste water treatment

plant in year 3: $150,000 investment
Analysis

– With QC project: $95,000

– Savings: $55,000

• Also consider taxes!

– Pollution taxes / fees
– Tax deductions for equipment depreciation
– Tax deduction for “environmental projects”

37
 3. Net Present Value
Workshop Exercise (answer B)
Financial Feasibility

Expected Present Value

Year Future Cash PV = of Cash Flows
X
Flows Factor (at time zero)
Analysis

0 - $105,000 - $105,000
1 + $38,463 .8696 33,447
2 + $38,463 .7561 29,082
3 + $93,463 .6575 61.452

Sum = project’s Net Present Value = -18,981

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 4. Internal Rate of Return (IRR)

• Definition: discount rate for which NPV

Financial Feasibility

= 0, over the project lifetime

• Tells you exactly what “discount rate”
Analysis

makes the project just barely profitable

• Similar to NPV, considers
– Time value of money
– All future year cash flows

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 Profitability Indicators Summary

Advantages Disadvantages
Financial Feasibility

Simple Easy to use Neglect TVM

Analysis

Payback Neglect out-year costs

& ROI Do not indicate project
size

NPV Considers TVM Needs firm’s discount

rate
Indicates project size

Considers TVM Requires iteration

IRR Does not indicate
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project size
 
Financial Feasibility

Financial Feasibility
Analysis of Options
Analysis

Thank you for your attention!

41
 Acknowledgements

This training session was prepared as part of the development and

delivery of the course “Energizing Cleaner Production” funded by
Financial Feasibility

InWent, Internationale Weiterbildung und Entwicklung (Capacity

Building International, Germany) and carried out by the United
Nations Environment Programme (UNEP)
Analysis

The session is based on the presentation “Financing Cleaner Production

and Energy Efficiency Projects” from the “Energy Efficiency Guide
for Industry in Asia” developed as part of the GERIAP project that
was implemented by UNEP and funded by the Swedish International
Development Cooperation Agency (Sida).
www.energyefficiencyasia.org

The workshop exercise is taken from “Profiting from Cleaner

Production”, in Strategies and Mechanisms For Promoting Cleaner
Production Investments In Developing Countries, developed by
UNEP
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