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Pacific Northwest Pollution Prevention Research Center

Analysis of Pollution Prevention and Waste Minimization Opportunities Using Total Cost Assessment: A Case Study in the Electronics Industry Project completed by Lona Badgett, Beth Hawke, and Karen Humphrey University of Washington Environmental Management Program

EXECUTIVE SUMMARY The main objective of this project was to identify an effective decision-making method for small firms evaluating the costs and benefits of pollution prevention opportunities. Six decision-making tools were assessed for their flexibility, resource requirements, and capacity to generate economic data. Research identified Total Cost Assessment (TCA) as the most useful and practical tool for small manufacturers. A case study applying TCA confirmed the method’s effectiveness. Some general findings related to TCA are:

TCA provides a streamlined approach to identifying and quantifying costs and benefits of pollution prevention investments.

TCA expands the scope of capital budgeting to include indirect benefits, increasing the magnitude of savings derived from pollution prevention investments. The five-year savings associated with the investments analyzed in this report totaled more than $95,000.

In most cases, collecting data for TCA analysis requires input from a number of departments. Small businesses using the TCA approach will find it easier to implement if a variety of disciplines are involved in the data collection process.

TCA is flexible; it accommodated analysis of two distinct projects. It seems feasible that the TCA framework could be easily applied to other investments and or industries.

Although small firms have resource constraints, this project demonstrated that the TCA framework is flexible and practical. The small manufacturer studied expects to replicate the TCA analysis to evaluate future pollution prevention opportunities. The TCA framework will help the study subject, as well as other small manufacturers, make better investment decisions, both economically and environmentally.


INTRODUCTION Advocates of pollution prevention are often frustrated by the fact that economically viable investments are frequently overlooked. The reason that opportunities are missed is due, in part, to the fact that not all of the benefits of pollution prevention are included in the financial analysis and investment decision. Traditional capital budgeting methods focus on direct labor and material costs, often ignoring many of the indirect costs and benefits associated with an investment. To demonstrate how application of a decision-making method that incorporates a wider variety of costs into the investment analysis can lead to a better economic and environmental outcome, this project documents the experience of a Northwest circuit board manufacturer whose venture with pollution prevention earned far greater profits than anticipated.

The objective of this project was threefold: 1) to evaluate different decision-making methods that have been developed to recognize the costs and benefits of pollution prevention opportunities; 2) to identify the method best suited to small manufacturers; and 3) to test the effectiveness of the chosen method by conducting a case study of two pollution prevention investments made by a small Northwest circuit board manufacturer.

Six assessment methods were considered and measured for acceptance according to the following criteria: generation of relevant economic data, flexibility, simplicity, and moderate resource requirements. In conjunction with determining the most suitable assessment method, a financial template was designed to assist in the identification of costs and benefits related to pollution prevention. The template is structured so that a small manufacturing firm without significant accounting resources can use it to evaluate the economic feasibility of one or more pollution prevention investment opportunities.

The report is comprised of two main sections:

the first examines the six methods for assessing costs and benefits of pollution prevention opportunities, with the recommended method being highlighted.

the second is the case study of a Northwest circuit board manufacturer, which outlines the application of the selected decision-making tool to two pollution prevention investments and highlights the economic results of the analysis.

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This section examines six decision-making tools that have been developed to better account for the costs and benefits of environmental projects. The methods were assessed for their ability to generate economic data, as well as meet moderate resource requirements. The goal was to determine the method most suitable for helping small manufacturing firms evaluate pollution prevention opportunities.

Traditional capital budgeting and accounting methods often accrue environmental costs at an administrative or overhead level in the company. Because managers are asked to justify investments on economic terms, monetizing environmental benefits and costs at a project level should encourage firms to invest more often in pollution prevention measures that generate savings.

An assessment ofthe six models, in conjunction with a case study of two pollution prevention investments made by a small Northwest electronic circuit board manufacturer, suggests that a “tiered” approach using total cost assessment (TCA), combined with some form of qualitative risk analysis, is the most useful and practical technique. Risk analysis may be particularly relevant when an investment is economically unattractive, but represents significantly less risk. Although environmental risks are often difficult to quantify, the relative risk of one alternative versus another should play a role in the decision to pursue a particular investment. The methods studied are by no means mutually exclusive; certain elements of a number of the methods serve as useful tools for assessing pollution prevention opportunities.

Total Cost Assessment TCA is a capital budgeting method that compares all relevant costs and benefits (i.e., savings or revenues) between two or more alternative investments or process changes. In order for these alternatives to be compared on an equivalent basis, all projected cash flows over the life of each project/change are estimated. Future cash flows are discounted to make them comparable to current, or present, value. Yearly costs/benefits are then combined to arrive at the net present value for each investment alternative. Projects with positive net present values (NPVs) are economically desirable. Alternatively, the difference in costs and benefits between a proposed change and the existing process can be estimated. The differential cash flows are discounted in the same manner to arrive at the NPV of the change.

Traditional capital budgeting methods compare different capital investment alternatives using only labor and equipment costs and, more recently, environmental costs such as energy use and waste disposal. Under TCA, the scope of these environmental costs is expanded to include more indirect and intangible costs for a more complete view ofthe potential environmental impacts of any given change. Indirect but measurable costs include compliance costs (e.g., permitting and manifesting costs), insurance costs, and on-site waste management. An example of an indirect, but difficult to measure, cost would be Superfund liability. While intangible benefits or costs may be difficult to quantify, they may nevertheless be important to a company’s bottom line. Examples of intangible costs/benefits include changes in employee morale and/or the company’s public image.

All capital budgeting methods factor in or calculate a discount (or interest) rate for all future cash flows in recognition of the time value of money. The three most widely used methods are the following:

Net Present Value (NPV or present value): The present value of the discounted future cash flows of an investment less the investment’s current costs/savings. This is the method used in TCA.

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Payback Method: The amount of time required for an investment to generate enough cash flow to cover the initial capital outlay for that investment.

Internal Rate of Return (IRR): The discount rate at which the NPV on a project is equal to zero. The computed IRR of an investment is compared to a company’s weighted average cost of capital (WACC). (Note: the WACC is the cost of the individual sources of capital - debt and equity - weighted according to their importance in the firm’s capital structure. Higgins, 1995)

While the payback method has been widely used due to its perceived simplicity (it is sometimes thought of as the “break-even point”), it is a poor method for comparing many alternatives simultaneously. Payback considers only the time it takes to “recover” an investment, not the total value of the investment. NPV, on the other hand, captures the total value of the investment. For example, one investment of $5,000 may pay back in three years and have an NPV of $20,000 over a five-year period. Another $5,000 investment may pay back in one year, but the NPV may be only $10,000 for the same five-year period.

Another consideration in calculating the present value of an investment is what discount (or interest) rate to use. The higher the discount rate, the lower the future costs and benefits are compared to today’s values. The nature of most pollution prevention investments is such that their benefits are more likely to be realized over a longer period of time compared to the initial investment costs. By calculating the full costs of operation, including all environmental costs, firms may begin to view pollution prevention opportunities differently.

Practical Implementation TCA can be applied in a tiered manner. Firms should begin by accounting for the direct and more easily quantified costs and benefits. If the investment has a positive NPV at this stage, then no further analysis is needed to justify the investment. The key assumption underlying this approach is that the factors not included in pollution prevention analysis tend to be cost savings generated by the investment. If the investment has a negative NPV at this stage, then the analysis should be extended to include more indirect and/or intangible costs and/or benefits. Often, benefits will be less obvious and realized over a longer time horizon.

Because TCA is a useful tool for identifying several benefit categories without requiring substantial resources, it is the recommended approach for small manufacturers. Implementing TCA is discussed in more detail in the case study (see page 10). In addition, some form of TCA is recommended for use by the U.S. Environmental Protection Agency (EPA) and numerous state agencies that encourage pollution prevention and waste minimization. Washington state law requires hazardous waste generators to identify their waste streams, target opportunities to reduce pollution on a periodic basis, and assess the economic feasibility of pollution reduction. Most small electronic firms in the state are generators of hazardous waste, and are encouraged to use some form of this method in preparing their pollution prevention plans (PPPs) for the Washington State Department of Ecology (Washington DOE). Nevertheless, many firms lack the capability or resources to both identify and quantify all changes in costs associated with a proposed process change.

Risk Analysis In the context of environmental accounting, risk analysis is a tool that can be used to account for changes in future liabilities that stem from changes in processes and/or products. Such liability might stem from penalties, fines, personal injury, property damage, or natural resource damage. To date, few firms have incorporated these costs into capital budgeting decisions. This is largely because of the speculative nature of these costs; they are a function of the likelihood of an event and the magnitude of its economic consequences. However, if factored

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Analysis of Pollution Prevention and Waste Minimization Opportunities Using Total Cost Assessment

into the decision-making process, future costs of environmental releases may make a seemingly unprofitable pollution prevention project look profitable. A variety of quantitative and qualitative methods have emerged to assist firms in accounting for the costs of future environmental liabilities.

Quantitative risk analysis methods are based on engineering and actuarial techniques. The engineering-based technique uses a theoretical model to estimate the failure rate of each component in a system to develop the overall risk of an event (e.g., the probability of a chemical spill). Actuarial techniques rely on historical data to determine the probability of an event.

The Washington DOE suggests using a more qualitative approach, which involves conducting risk analysis only if the pollution prevention investment costs are higher than an alternative with fewer or no pollution prevention benefits. (Washington DOE, 1995) In these situations, risk factors associated with a project are listed. Each category is assigned a relative score, (e.g., low risks=l, medium risks=3, and high risks=9). Scores are totaled for each alternative and used to determine whether risk reduction justifies higher costs. Alternatively, some firms have chosen to loosen the financial performance of their projects to account for liability reductions (EPA, 1992a). For example, the required pay back period might be lengthened or the internal rate of return lowered.

Practical Implementation The mathematical complexity and resource intensity associated with quantitative risk analysis methods make the task of calculating the costs associated with future environmental risks foreboding for small firms. In addition, changes in technology, regulations, and operating practices may mean that historical events have little correlation to future events, thus limiting the value of an analysis based on actuarial techniques. While a qualitative approach to risk assessment does not provide a finite tool for accounting for future environmental liabilities, it does allow companies with limited resources to begin to address the importance of recognizing risk reductions that are often encompassed in pollution prevention investments.

Activity-Based Costing Activity-Based Costing (ABC) is an accounting method designed to allocate “indirect” or overhead costs among different product lines or product types. ABC helps highlight the costs of production on a per product, rather than facility, basis. While this method was not developed initially to account for environmental costs, its use may lead to a reduction in negative environmental impacts.

ABC requires identifying a “cost driver” for a given “service” and then using the cost driver as a basis for allocating the costs of that service. Indirect costs, or overhead, are usually collected and allocated in a two-tiered process. First, costs are collected for a given service or cost center (e.g., setup costs, marketing). Under traditional accounting methods, these costs are then allocated to units or batches using volume-based measures, such as labor or machine hours. In applying ABC, a manager first needs to determine whether or not the demand for a service/cost is different for different products or product types. If it is, the next step is to determine whether or not the demand for this service/cost varies with allocation measures such as labor or machine hours. Only if they do not vary would an attempt be made to identify a better cost driver for allocation purposes. Examples of cost drivers might be the number of production runs in a month for setup costs or the number of hazardous materials used in any given process for compliance or disposal costs.

The potential for distortion using the traditional volume-based measures for allocating indirect costs is especially high for companies that produce more than one product. For example, a company manufactures two products, Product A and Product B, that have very different waste disposal costs. Product A uses a relatively “clean”

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process with no hazardous material inputs while Product B uses a relatively “dirty” process with several hazardous material inputs. The same number of units are produced in each process. If the firm allocates its overhead costs based only on total number of units produced, but in fact Process B generates all of the (relatively expensive) hazardous waste disposal costs, then Product A will subsidize the production of Product B.

Practical Implementation One application of ABC is to simply tag costs associated with different processes or cost centers at a given facility. For example, for all transactions that can be identified as belonging to a single process or cost center (e.g., painting or electroplating), a code could be added as part of the accounting system in order to track each process or cost center’s costs. Even an incomplete tracking of costs can provide valuable information to management. For example, one local firm found that after identifying costs associated with several different steps in a process that one step in particular was expensive and unnecessary. This recognition occurred because the costs of each step in the process were addressed separately. As a result, the entire step was eliminated from the process. (Reuter, 1995)

ABC may be of limited value to small electronics companies producing only a single product or product type. Even if they produce more than one product, it may not be financially feasible to perform the kind of analysis necessary to identify appropriate cost drivers for all of the major service/cost centers and then to allocate those costs on a unit or process level. ABC may be useful for production managers if used on a limited basis. A facility manager could target only the most significant indirect costs for analysis in order to determine whether or not the use of ABC can help generate better cost information, and thus focus the firm on reducing environmental impacts.

Life-Cycle Analysis Life-Cycle Analysis (LCA) is a scientific measurement technique that focuses on quantifying the total environmental impact, or aggregate environmental cost, of a product over the course of its life. Ultimately, the goal of LCA is to encourage new product delivery systems and disposal methods that reduce environmental impacts.

LCA examines the “cradle to grave” environmental impacts of a product in a four-stage process: 1) screening or definition ofpotential impacts and scope of analysis; 2) inventorying of all environmental releases and resource consumption; 3) analyzing the environmental costs of the inventoried components; and 4) assessing the opportunities to improve product and service development, operation, delivery, and disposal.

The importance of conducting each step thoroughly in LCA cannot be overemphasized. The analysis is incomplete without a comprehensive inventory of materials, processes, their known and potential environmental impacts, and an assessment of ways to reduce those impacts and improve all aspects of the product life-cycle. The diagram in Appendix I is a useful tool for outlining how to begin inventorying the inputs, outputs, and impacts of a product’s life.

Practical Implementation The most common use of LCA is to determine the best material input or process change to implement, given two or more alternatives. The cloth versus disposal diaper debate is one well-known example. The data collection requirements for LCA are extremely comprehensive, often expensive, and frequently require the assistance of a consultant familiar with the particular industry and its environmental impacts. In some cases, data concerning the impacts of a particular process or material are not available.

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A handful of large companies have struggled with the requirements of LCA. McDonald’s, for example, made an attempt to inventory all the costs and environmental impacts associated with polystyrene and paperboard packaging. Even though there was extensive information available on the various environmental ramifications concerning these two alternatives, there was a great deal of information missing. No impact or improvement analysis was even attempted. (Svoboda, 1994)

The fact that LCA is so comprehensive has both positive and negative ramifications. If done properly, LCA should lead to a truly sound environmental decision given that, among a number of alternatives, the action least harmful to the environment will be chosen. LCA is not easily simplified, however, so limiting its scope to make it more manageable detracts from its ultimate purpose.

For small firms, the prospect of utilizing LCA as a decision-making tool would be daunting. If a firm ignores the fate of its products or materials once they leave the facility, for instance, after having assessed the impacts related to material extraction, manufacture, and distribution, the LCA conducted is still incomplete. Limiting the depth of analysis, in order to make it more manageable for smaller firms, is detrimental to the method’s overriding goal of calculating a product’s total life environmental impacts.

Pollution- Added Accounting In Pollution-Added Accounting, pollution points (PP) are assigned to each unit of production and compared to the per unit contribution margin (CM) to determine which product/process maximizes CM per PPs. To assign pollution points, amaterial balance is constructed to identify all material and energy inputs and outputs associated with a product. Outputs are then weighted according to their toxicity using environmental emission standards (lower standards are interpreted as being more toxic). Management accounting systems are used to develop contribution margins per unit of production. Finally, CMs per PP are compared across products/processes and those that maximize CM/PP are deemed preferable.

The steps for assigning pollution points include:

A material balance is constructed to identify all material and energy inputs and outputs associated with a product. The scope can be limited to the plant or include the larger life cycle of the product.

All inputs and outputs are converted to kilogram per unit of production (kg/production unit).

Outputs are weighted according to their toxicity using environmental emission standards. Emission standards are converted to milligram of harmful material per mol of environmental medium (mg/mol) to standardize toxins across effluents and media. These weights are applied to the kilogram of effluent produced to obtain the number of PPs per unit of production.

Management accounting systems are used to develop contribution margins per unit of production. Contribution margins should be calculated using fully allocated environmental costs: for example, overhead accounts that capture expenditures for control equipment, reporting, and monitoring should be allocated to products or processes.

CM per PP are compared across products/processes and those that maximize CM/PP are preferable.


Practical Implementation By looking at both economic and ecological costs, this method quantifies environmental aspects that may not be fullv represented in traditional cost accounting systems, and therefore may offer a more complete accounting of the full cost of a product/process. The technique is also useful because it requires companies to map out their production process in the form of amaterial balance, which often points to places where businesses can implement reduction, reuse or recycling. Additionally, the process of assigning pollution points allows companies to track their environmental performance with respect to the reduction in certain types of toxic emissions over time.

Despite these benefits, there are several limitations of the model, which restrict its usefulness for making pollution prevention investment decisions. Since weights are based on emission standards, only regulated substances are represented in pollution-added accounting. Decisions based on maximizing CM/PP may actually increase the overall level of pollution if: 1) the CM is large and, therefore, offsets high levels of pollution, or 2) the PP per unit is relatively small, but the level ofproduction over the life of the product generates PP that are relatively large in absolute terms. Also, the method looks at marginal contributions and, therefore, may misrepresent the total pollution over the full production life. Finally, application of the model is resource-intensive and, therefore, not well suited to small firms.

Design for the Environment (DE) is a product development concept designed to support engineering of environmentally friendly products. DE is an outgrowth of LCA in that it focuses on reducing the environmental impacts of a product, as well as conserving resources over the life of a product. The goal of DfE is to encourage new product development methods that systematically incorporate environmental factors into design. Like LCA, DfE is very useful for comparing among material, packaging or other product feature options.

Practical Implementation DfE relies on the concepts of LCA and TCA as tools for measuring the potential impacts of one design characteristic versus another. Because the development of new products often involves original materials, unique combinations of materials, and new processes, quantifying potential environmental impacts can be extremely difficult. The benefits of DfE, however, include the identification of potential environmental impacts and costs prior to product fabrication and launch. In effect, DfE is a way of thinking about how the product development process can be amended to include environmental impacts in the standard cost equation. The potential to reduce negative environmental impacts is large because of the shift of resources from cleanup to prevention.

Small firms can commit to implementing DfE techniques without taking on an impossible task. In fact, DfE can serve as a management framework that provides guidance to firms on how to maximize the expert input of all disciplines within the organization. DfE brings the engineer, purchaser, and marketer together so that they all may contribute specific knowledge to the product design, packaging, and distributionof a product. (EPA, 1994c)

An inherent obstacle to implementing DfE for a number of small electronics firms is the fact that these firms may have little control over the actual design of a product. As subcontractors or “job shops,” these firms make products to the specifications outlined by a client. Rarely are smaller firms in control of design characteristics typically addressed in DE. There may be opportunities to recommend certain designs that are demonstrably more environmentally benign, but little new product development is actually conducted by subcontractors.

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DfE techniques are helpful, however, in identifying the environmental impacts of one production process versus another and in pricing jobs accordingly. Documentation of the costs of adverse impacts of copper coating, for instance, may encourage clients to accept products with less coating, provided that there is no product quality or performance change. A reduction in copper coating could lower the price for the client, as well as reduce the manufacturer’s hazardous waste disposal fee.

Conclusion The methods and concepts studied all attempt to factor a broader spectrum of costs and benefits, especially environmental ones, into the decision-making process. Because managers often have to justify investments in economic terms, the methods that monetize environmental impacts provide the means for encouraging pollution prevention investments. While the majority ofthe tools meet this objective, the large resource requirements and the need to include costs and impacts incurred outside the firm make a number ofthe methods cumbersome. From the standpoint of small firms, only practical, cost-effective measures are feasible.

As trends in the regulatory arena continue to increase the environmental costs incurred by businesses, it is prudent to investigate and initiate the use of assessment methods that better incorporate these impacts into the capital budgeting process. Because TCA is less resource-intensive relative to the other methods and yet provides valuable economic information, it is the most suitable method for small firms. The fact that TCA focuses on accounting for environmental impacts that a firm can typically measure and control makes it practical to use. TCA also values an investment over its useful life, taking into account many of the long-term costs and benefits of pollution prevention projects, allowing firms to make better investment decisions.

In implementing TCA, firms should incorporate some form of qualitative risk assessment in their decision- making, such as the Washington DOE scoring system. This scoring system can provide information on at least the relative merits of pollution prevention alternatives in terms of risk. A general rule of thumb would assign less risk of liability for hazardous waste cleanup to firms that generate less hazardous waste, in terms of both amount and toxicity. This combination of TCA and qualitative risk assessment for evaluating pollution prevention projects is essentially the approach recommended by Washington DOE. Therefore, it appears to be not only the most practical method for small firms to use, but it also allows Washington firms to comply with state regulatory requirements.

Small firms may also find it useful to incorporate certain aspects of the DfE and ABC methods. For firms that develop their own products, it may be beneficial to bring together the different areas of expertise in the firm (e.g., marketing and production) to consider the design of a product or process and its potential environmental impacts. Simply by considering various perspectives within the firm, new ideas for minimizing negative impacts may emerge. In the case of ABC, it can be useful to track all costs associated with separate processes or cost centers at a given facility. Examining costs on a process, product or cost center basis, rather than grouping them into overhead (the traditional practice), allows small manufacturing firms to focus on the most expensive activities or process steps.

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This section describes both the mechanics of implementing TCA, and the results of its application to two investments made by a small Northwest circuit board manufacturer. The case study exercise was the means for testing the effectiveness of TCA as a decision-making tool, the third objective of the report. A brief description of the manufacturer and the two investments is followed by a general description of how to implement TCA. The TCA implementation section describes 1) how to identify the relevant costs and benefits of an investment; 2) how to calculate the investment’s net present value; and 3) results of applying TCA to the investments studied.

In February 1995, the Pacific Northwest Pollution Prevention Research Center arranged for the project team to meet with a small Northwest circuit board manufacturer, Precision Circuits, Inc. The following case study involved evaluation of two investments made by Precision Circuits. In order to test the effectiveness of TCA, the framework was applied to both investments.

Precision Circuits is a small circuit board manufacturer located in Lynnwood, Washington. The company has approximately 30 employees, one of whom is primarily responsible for environmental compliance. Precision Circuits manufactures circuit boards to varying specifications, depending on client needs. Product runs range considerably in size and type. On average, Precision Circuits manufactures 100,000 square feet of circuit board per year.

Precision Circuits’ management policy statement describes the company’s commitment to protect the environment as well as the health and safety of its workers and neighbors. In accordance with Washington state law, Precision Circuits has prepared and submitted a Pollution Prevention Plan to Washington DOE. In 1993, Precision Circuits’ stated goal was a 50 percent reduction in its use and generation of hazardous materials and waste. The goal was to be met by eliminating the use of hazardous materials and/or using less hazardous substitutions.

Precision Circuits’ commitment to reduce its negative environmental impact is illustrated by a project initiated with the city of Lynnwood in 1989. Precision Circuits signed an agreement with the city of Lynnwood to modify its wastewater treatment system. The modification involved replumbing and/or installing flow meters, timers, new pumps, and tanks to reduce water usage and waste generation. The modified system went into operation in April 1990. Precision Circuits’ water consumption was reduced from more than 10,000 gallons per day to less than 1,000 gallons per day. The volume of wastewater treatment sludge sent off-site for recycling was reduced to a similar degree, from 28,600 pounds in 1989 to 7,860 pounds in 1991.

Continued efforts to improve environmental performance came to fruition in 1994. Precision Circuits initiated two new changes with positive impacts for the environment. The first opportunity, a pollution prevention investment, was outlined in Precision Circuits’s 1993 Pollution Prevention Plan. Writing the plan served as an impetus for evaluating and eventually undertaking the investment. The second opportunity, a waste minimization effort, resulted from a vendor’s recommendation of a new technology and validation of it in the field. The changes, the motivations for the changes, and the environmental impacts of both investments are described below.

The pollution prevention opportunity was identified in the early 1990s and articulated in Precision Circuits’ 1993 Pollution Prevention Plan. The opportunity involved the elimination of nitric acid from the workplace. The nitric acid was used as a stripping solution to clean stainless steel racks that carried circuit board panels through a series

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of baths and rinses. The double-sided circuit board panels undergo a number of plating and rinsing processes. The first process is called electroless copper plating. Electroless copper plating is a series of rinses and working baths designed to deposit a copper coating on the fiberglass hole walls in the circuit boards. The panels are imaged, inspected, and then “racked” for the next step - electrolytic plating. During electrolytic plating the racks carry the board panels (12 to 18 at a time) through another set of rinses and three working baths to clean and activate the base copper. At this stage, the panels are copper plated, an overplate of tin/lead is applied, and the panels are rinsed and removed from the racks. (Precision Circuits, 1994)

Prior to the installation of the new plastic-coated racks, the stainless racks used in the electrolytic process were rinsed in nitric acid after each plating run. The nitric acid was essential for stripping the racks of any remaining metals from the plating process. The stripping prevented contamination of the baths and boards during the next plating cycle. The properties of stainless steel dictated the use of an extremely strong and hazardous stripping material.

Precision Circuits calculated that an investment of approximately $25,000 for a set of copper splined plastic- coated racks would produce three significant benefits: 1) removal of nitric acid from the workplace; 2) elimination of the need to strip the racks; and 3) production of a better quality final product, the coated racks support a more even distribution of electrical current resulting in a more accurate and consistent plating process.

A less expensive option available to Precision Circuits was to have the existing steel racks plastic-coated for about $30 per rack. This option was not considered because Precision Circuits was interested in realizing the quality improvements that would result from copper splined racks, in addition to the ability to eliminate the nitric acid rack strip bath. Therefore, the change as implemented by Precision Circuits is actually two separately identifiable items - plastic coating to eliminate nitric acid and copper splining to improve product quality.

Wastewater Treatment Process Change The second change implemented in 1994 was a waste minimization effort. A vendor presented Precision Circuits with an opportunity to achieve cost savings and environmental improvement via a new waste treatment process that produces a smaller volume of wastewater sludge, thereby generating savings from reduced disposal and recycling costs. Precision Circuits now employs a different chemical in its wastewater treatment, which changes the composition of wastewater sludge, reduces its overall volume, and generates material with potential resale value. While not a pollution prevention project, this effort still was a good case to use for testing the total cost assessment tool. To qualify as a pollution prevention project, the effort must reduce waste at the source or allow the material to be recycled in a closed-loop process at the facility.

The waste stream generated in Precision Circuits’s manufacturing process is a combination of solids and liquids. Prior to implementing the process change, influent was collected from the manufacturing process, a precipitator (chemical) was added to the waste stream, it was pH-adjusted, a reductant was added, it was pH-adjusted again, and then taken through three more steps. The first two steps involved treatment with floc and clarifier. The third involved the collection and drumming of the sludge (see Appendix 11). This process generated three hazardous waste streams: 1) nitric acid; 2) tin/lead stripper that had to be removed and shipped separately from other wastes; and 3) wastewater sludge material containing approximately 12 percent solids, 34 percent of which was copper. The sludge was collected, drummed, and shipped off-site. The remaining wastewater was discharged to the local water treatment facility.

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Using the new system, the collected influent is pH-adjusted, a different precipitator is added, and use of the reductant is eliminated. The new precipitator, as well as the absence of the reductant, plays a large role in increasing solids in sludge composition, which decreases its volume and reduces disposal costs. The precipitator is added again after the clarifier and collection steps. Currently, the new sludge is 86 percent solids, 34 percent of which is copper. The new process produces only one hazardous waste stream - the wastewater sludge. The volume of wastewater discharge is equivalent to the old process, but the metal content of the effluent is lower. There is still some nitric acid and tin/lead stripper waste; however, it is treated throughout the process in such a way that it no longer has to be separated, collected, drummed, and shipped independently of the sludge. Future regulatory changes may allow reclassification and sale of the material as a nonhazardous waste. This would effectively eliminate disposal costs.

The waste minimization effort involved relatively simple changes. In addition to replacing one chemical and removing another, the various steps in the process were slightly modified to suit the new chemical composition. Overall, the change did not require significant resources, and the downtime to implement the change and train staff was negligible.

Implementing Total Cost Assessment TCA provides companies with a framework to compare the costs and benefits between two or more investments or process changes in order to identify the option that maximizes future cash flows. Within the context of pollution prevention investment decisions, TCA allows companies to capture many of the indirect cost savings not typically accounted for in traditional capital budgeting models. In effect, TCA provides a more complete assessment of the benefits that may be derived from such investments. The process consists of three steps: 1) identifling relevant costs and benefits, 2) calculating the net present value, and 3) taking into account qualitative factors in decision-making.

Identifying Relevant Costs and Benefits The first step in implementing TCA is to account for the relevant costs and benefits associated with the investment(s) being considered. Relevant costs and benefits are those that will change if the investment is pursued. Two approaches can be used for calculating the total change in annual costs and benefits. The first consists of identifying all costs and benefits associated with the existing process, identifling all costs and benefits associated with the new process, and calculating the difference between the two. Alternatively, one can simply ask, “What will change if I make this investment?’ These changes are accounted for either as benefits (e.g., cost savings, added revenue) or costs (e.g., amount of initial investment, new material costs) for each year over the life of the investment.

There are four tiers of potential cost increases or decreases (benefits) that may change with pollution prevention investments:

Tier 0: Usual costs such as direct labor, materials, equipment, etc. Tier 1 : Hidden, or indirect costs such as monitoring, reporting, record keeping, and permit requirements. Tier 2: Future liability costs, such as remedial actions and personal injury. Tier 3 : Less tangible costs such as customer response, employee relations, and corporate image. (McHugh,

1990)

A detailed list of tier 0 - 1 cost categories is included in Appendix 111.

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The cost categories included in Appendix III are further classified as either procurement or operating costs. (EPA, 1993a) It is useful for firms to separate these when projecting costs over time. Procurement costs refer to all costs associated with bringing a new process on line. Such expenditures would include the cost of equipment, installation and testing costs, and lost production time. These costs typically occur in the first year, and therefore do not need to be projected over time. In contrast, operating costs are ongoing and should be estimated over the useful life of the project.

In addition to cost savings, revenue benefits such as increased market share may be realized from pollution prevention investments. For example, elimination of a toxic material in a process may allow a company to target customers who are interested in purchasing “environmentally sensitive” products. To the extent that these can be recognized and quantified during the capital budgeting process, they should be accounted for in the total cost framework.

The template used to collect relevant costs and benefit data associated with Precision Circuits’ pollution prevention investments is included in Appendix IV. Based on a similar template designed by the DOE, the project template includes categories of costs most relevant to pollution investment decisions being considered by small manufacturing firms. In practice, minor modifications may be required. (Washington DOE, 1995) The list of potential costs included in Appendix III should provide the information needed to tailor the instrument to a specific company or process.

For small firms that face resource constraints, a “tiered” approach to accounting for relevant costs and benefits is proposed. Small firms should begin by identifying and quantifying all relevant procurement costs associated with the investment. In accounting for procurement costs, firms should include both the costs associated with getting the new equipment/process on line, as well as the costs and benefits associated with discontinuing the old process. For example, in Precision Circuits’ switch to plastic-coated racks, it was important to account for both the purchase cost and related installation costs of the new racks, as wells as the costs (cleaning) and revenues (sale, or salvage value) associated with retiring the metal racks.

Once procurement costs have been identified, small firms should begin by accounting for the costs and benefits that are readily available through existing accounting/information tracking systems. These costs will generally appear in tiers 0 and 1. Once easily quantifiable costs and benefits are accounted for, small firms should proceed to calculating the NPV associated with the project (see next section, “Calculating the Net Present Value”). At this point, if the NPV is greater than zero, the project is justified without having to expend more resources investigating and quantifying additional benefits. The assumption underlying this approach is that the categories of change most likely to be unaccounted for are those that would produce additional benefits or revenues. Firms using the tiered approach need to be equally careful not to overlook long-term costs that may negate accumulated benefits. For example, pollution prevention opportunities frequently require equipment investments. If the equipment comes into contact with hazardous materials, retirement at the end of its useful life may prove costly. In rare cases, the retirement costs may outweigh the investment’s benefits.

If the NPV value is less than zero, additional tier 1,2, and 3 costs and benefits will need to be considered. Due to their indirect and/or intangible nature, these costs are not often easily quantified but they can be factored into the analysis qualitatively. It is at this point that a qualitative risk assessment can be helpful in considering future liability costs by scoring alternatives in terms of relative risk. For example, managers may know that the investment will afford them a greater amount of worker safety. This improvement can be accounted for qualitatively in the decision-making process by proceeding with a project that has a slightly negative NPV, but

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holds the promise of greatly enhanced worker safety. A related tier 3 benefit might be improved worker morale, which cannot be quantified but can be a very positive benefit to the firm.

Calculating the Net Present Value To calculate the NPV of the investment, two critical decisions must be made: 1) the time period over which to value the investment, and 2) the discount rate to use for calculating costs in present value terms. The time period over which to value the investment is usually based on the useful life ofthe pollution prevention equipment being purchased. In cases where no equipment is being purchased or processes are likely to change, firms should use their judgment and/or historical information to determine the appropriate time period for analysis. Precision Circuits specified that for the projects analyzed a time period of five years should be used. This choice was related to the way Precision Circuits internally evaluates projects, and may not be appropriate for other firms performing a cost assessment.

In theoretical terms, the discount rate used in calculating NPV should reflect the business’s weighted average cost of capital (WACC). When creditors or owners invest money in a firm, they incur an opportunity cost - a forgone opportunity -equal to the return they could have received if they had invested their money elsewhere. This opportunity cost is the firm’s cost of capital; it is the minimum rate of return the company seeks to achieve on existing assets (inventories and plant and equipment) and still meet the expectations of its capital providers (lenders and shareholders). (Higgins, 1995) The WACC is the cost of the individual sources of capital (debt and equity), weighted according to their importance in the firm’s capital structure. (Higgins, 1995) If small firms are accustomed to calculating the WACC in their capital budgeting process, it should be the discount rate used to assess pollution prevention investments as well. For firms unfamiliar with WACC calculations, a reasonable starting point for estimating WACC is to use a nominal discount rate of 15 percent.

To account for uncertainties associated with project variables and or the discount rate, a sensitivity analysis should be performed. Sensitivity analysis is done by changing a variable, such as the discount rate, to calculate the impact on the NPV. Typically, companies will want to test best-, middle-, and worse-case scenarios in their analysis. If NPV remains positive under the worst-case scenario, the company can be reasonably certain that their investment will payoff. NPVs calculated under best-case scenarios may be dramatically better than those derived from middle-of-the-road conditions. In these cases, best-case scenarios can be used to highlight the potential benefits associated with many pollution prevention investments.

Two other variables that must be chosen for the NPV calculations are tax and inflation rates. The company should select the tax rate that it actually pays. If this is unknown, a typically default value is 40 percent. A standard value used for inflation rate is five percent. However, costs for disposing of hazardous waste has risen more quickly than five percent per year during the past decade and it is anticipated to continue to rise more quickly than the standard inflation rate. An assumed inflation value used in this report for disposal costs was 10 percent - an arbitrarily chosen figure based on informal discussions with faculty at the University of Washington. The larger value for disposal costs should be more accurately estimated based on each companies experiences with increases in disposal costs over time.

Because NPV accounts for the costs and benefits accrued over the life of the project, it generates the most accurate reflection ofthe full net benefit of a pollution prevention investment. Using a TCA framework, however, does not preclude the use of other capital budgeting methods, such as payback or IRR. After NPV is calculated, the TCA framework can be used as the basis for calculating payback and other information that may be needed to convince management to adopt pollution prevention investments. IRR is particularly useful for “break-even”

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analysis. The IRR function sets the NPV to zero, illustrating the rate of return at which an investment’s costs and benefits are equivalent. Both of these formulas are standard features in most spreadsheet programs.

Comparing More than Two Approaches The methods described above work when comparing only two approaches to each other. If more than two approaches need to be compared and chosen from, especially when each alternative has a different project lifetime, then the costs and benefits of each alternative should be looked at individually, instead of being subtracted from each other. In order for these alternatives to be compared on an equivalent basis, all projected cash flows over the life of each project/change are estimated. Future cash flows are discounted to make them comparable to current, or present, value. Yearly costs/benefits are then combined to arrive at the net present value for each investment alternative. Projects with positive net present values (NPVs) are economically desirable. The approach with the largest positive NPV is the most economically attractive alternative.

TCA Implementation at Precision Circuits The project team collected relevant data for the TCA application through meetings and telephone conversations with Precision Circuits’ environmental manager. The environmental manager completed the template independently (see Appendix IV). After reviewing the information, the project team asked for simple clarification on volumes and time periods for particular costs, as well as more detailed explanations for the existence or absence of certain costs or benefits, which the environmental manager provided.

Precision Circuits was able to identify and quantify the majority of the direct (tier 0) benefits/costs in a relatively straightforward way. The elimination and reduction of chemical usage produced easily quantifiable benefits. However, benefits that were indirect and difficult to quantify were discussed in the two meetings with Precision Circuits. Identifying indirect benefits in meetings helped encourage the initiation of a more concerted effort to attach values to them. For example, initially Precision Circuits’ environmental manager did not think that he could estimate the reduction in the number ofrejects associated with the plastic-coated rack investment. Because the investment was being evaluated after its implementation, the environmental manager was ultimately able to produce a fairly accurate estimate of quality improvements by reviewing actual production data. Where hindsight is lacking, a range of estimates can be used to value a project. For other indirect and intangible benefits, such as improved worker safety and morale, no definitive value could be calculated. Therefore, these intangible benefits received qualitative discussion.

For a number of tier 1 costs, such as energy and water, no data was provided by the environmental manager when filling out the cost template shown in Appendix IV. During follow-up meetings it was found than many of these values did change, but were determined to change negligibly by the environmental manager and, therefore, he did not spend the extra time to define these values. These categories were, therefore, left as n/a (no appreciable change) on the costs spreadsheets developed for the project.

Throughout the TCA analysis period the project team sought frequent advice and assistance from Precision Circuits. Fortunately, the environmental manager was able to work with Precision Circuits’ accounting, purchasing, and production departments to confirm costs and impacts. Once the TCA analysis was completed, Precision Circuits’ careful review of the findings helped ensure accuracy.

Discussions with Precision Circuits’s environmental manager after the project indicated that he spent a total of eight hours gathering and organizing information for the cost assessment. Four hours of time was spent by other staff members. Entering the cost data into the computer spreadsheet is not included in this estimate; all computer

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work was done by the University of Washington project team. Other items not included in the Precision Circuits time estimates are initial project scoping meetings and reviewing this report.

The data gathering effort entailed reviewing hard copy office records, as most of Precision Circuits’ information is not computerized. Data for the cost assessment was also quite accurate since numbers were not estimates but actual values based on process performance over the past year. Many of the values provided for the cost assessment would have required estimating or would have been impossible for Precision Circuits to accurately estimate if the project being evaluated was one under consideration instead of one already underway. For example, the decrease in project reject rate that was experienced when Precision Circuits implemented the plastic-coated rack investment could not have been estimated prior to implementation and, therefore, would not have been included in a cost-benefit analysis.

TCA Plastic-Coated Rack Investment In completing its 1993 Pollution Prevention Plan, Precision Circuits estimated the cost savings associated with switching to plastic-coated racks as $555 (in current dollars) over a five-year period. Only the purchase price of the racks and the savings associated with eliminating the purchase and subsequent disposal of nitric acid were included (i.e. no labor, paperwork, permitting or analytical costs were included). The purchase price of the racks was multiplied by a 20 percent contingency factor to account for potential maintenance requirements on the new rack system. These calculations, which did not account for the time value of money, were carried out for five years because it was not until the fifth year that this approach showed the project to have a positive payback.

In contrast, TCA of this investment, discounted at 15 percent, shows a five-year NPV of $33,589 (see Table 1) Additionally, TCA of this pollution prevention investment yields a payback of just over one year, versus the five- year payback that was estimated in the Pollution Prevention Plan. While the numbers calculated in the previous and TCA approaches are not directly comparable, since the previous calculations did not account for the time value of money, the difference is still impressive. Some of the costs and benefits included in this analysis were relatively easy to quantify, because the process has been in place since the beginning of 1994; therefore, actual operating data on cost changes was available.

Performing the analysis in a TCA framework showed that the greatest cost savings for Precision Circuits stemmed from quality improvements associated with the revised process. Reduction in the number of defects produces annual savings of $8,660 (current dollars). In addition to this benefit, product quality is enhanced by a more uniform surface that conducts electricity more evenly. While this quality enhancement was not quantifiable, this anticipated change added to the attractiveness of the investment. The ability to recognize such changes greatly improves the financial attractiveness of many pollution prevention investments. The TCA data collection instrument included in Appendix III is intended to serve as a prompt for identifying some of these less obvious changes. In cases where specific estimates are not available, a range of estimates can be used to value the project.

Many of the tier 1 operating costs, such as regulatory costs, and inventory purchasing and management, did not change, despite the elimination of nitric acid. Frequently, such costs are not a linear function of the number or amount of materials used. Therefore, eliminating one material, or a portion of its volume, does not necessarily result in a proportionate reduction in costs. Rather, these costs are often constant within a range of volumes. For example, Precision Circuits is still classified as a large quantity hazardous waste generator, despite the elimination of its nitric acid waste stream. Therefore, the reporting requirements associated with state and federal hazardous waste laws still apply. Similarly, Precision Circuits purchases 85 percent of its chemicals from one

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supplier. Therefore, eliminating the need to purchase nitric acid simply meant removing one order number from the order form, keeping the labor costs associated with purchasing essentially constant. Despite the fact that many tier 1 costs have this characteristic, it is important to include them in the datacollection instrument. It serves to remind the analyst to verify whether changes will or will not occur.

Tier 2 and 3 costs that did change (improve), but were not all readily quantifiable, included future liability, worker morale, and product quality. Future liability is reduced, due to the decreased risk associated with the storage, handling, use, and disposal of nitric acid. For example, eliminating the need to maintain nitric acid inventories reduces the likelihood of chemical releases at the plant. Also, eliminating disposal associated with the nitric acid waste stream reduces liability exposure that stems from transportation and disposal ofthe residual material. Such improvements enhance the financial attractiveness of a pollution prevention project. When factored into the decision on a qualitative basis, they may provide the justification needed to go ahead with a slightly negative NPV project.

Worker morale and safety improved from eliminating exposure to nitric acid. Nitric acid creates an intense burning sensation when it comes in contact with skin. Eliminating this exposure and subsequently improving worker morale and safety, was a key reason for considering the switch to coated racks. According to the environmental manager at Precision Circuits, these factors alone provided significant motivation to proceed with the investment.

The sensitivity analysis presented in Table 2 shows that the project continues to have a positive NPV at higher discount rates and at higher rates of inflation. The sensitivity analysis also shows that the rack investment continues to generate a positive NPV when either productivity gains or quality improvements are eliminated. While eliminating one of these benefits does not change the investment decision, the sensitivity analysis shows how inclusion of such factors, even at conservative levels, can greatly improve the financial attractiveness of a project. Further, the analysis shows that the initial investment can increase to $68,500 before a negative NPV is realized.

TCA Wastewater Treatment Process Change TCA ofthe wastewater treatment process change, discounted at 15 percent, yields an NPV of $62,824 (see Table 3). The majority of the benefits stem from the change in treatment materials being used in the revised process. The new precipitator is slightly less expensive ($.06/lb), and the daily volume required for treatment is lower. This, combined with the elimination of the precipitator, produce an annual net material benefit of $17,697 (current dollars). The tin/lead waste stream is now treated with the wastewater, eliminating the costs associated with the separate handling and disposal of this waste stream. The total amount of wastewater sludge has been reduced from 60 drums per year to 16. Together, the reduction in the number of waste streams and the amount of wastewater sludge generated produce annual net benefits of $10,526 (current dollars).

The sensitivity analysis presented in Table 4 shows that the project continues to have a positive NPV at higher discount rates and at higher rates of inflation. The sensitivity analysis also shows that the process change continues to generate a positive NPV within a wide range in daily treatment material costs and the number of drums of sludge produced annually.

Given the small investment associated with the process change ($900), this project has a payback period of less than one year. The sensitivity analysis shows that the initial investment can increase to $87,000 before a negative NPV is realized.

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Table 5 repeats the TCA of the wastewater process change using the assumption that the sludge can be sold directly to a smelter to recover the copper content. This scenario requires that the EPA reclassify the sludge as “nonhazardous,” which EPA is currently considering. This analysis improves the NPV to $71,293.

Many of the tier 1 operating costs, such as environmental reporting, did not change, despite the reduction in the types and volume of waste generated. This is largely due to the fact that Precision Circuits is still classified as a large quantity generator, thus its reporting and record-keeping requirements did not change. In contrast, costs associated with chemical purchasing and the related inventory management were reduced. By changing materials, Precision Circuits was able to discontinue business with one supplier. Administrative costs decreased with the elimination of this supplier. Precision Circuits was not able to quantify the savings associated with this change.

The process change reduced both the volume and toxicity of treatment materials and waste generated. These reductions yield tier 2 and 3 benefits; future liability diminishes and worker safety and morale are improved.


The main objective of this project was to identify an effective decision-making method for small firms evaluating the costs and benefits of pollution prevention and waste minimization opportunities. The case study demonstrated that TCA is both easy to use and flexible enough to be applied to a variety of investment opportunities. Equally important, TCA is sophisticated enough to generate valuable economic data for making investment decisions. By focusing users on conditions that change, TCA provides a streamlined approach to identifying and quantifying costs and benefits ofpollution prevention and waste minimization investments. Small firms will find that the tiered approach recommended in this report and by the Washington DOE helps minimize resource requirements. Together these factors make TCA a usable and practical analysis tool for small manufacturers.

The project team found that collecting data for TCA analysis required input from a number of departments. While the environmental manager was able to provide a majority of the data, clarification was required from the accounting and purchasing departments. Small businesses using the TCA approach will find it easier to implement if a variety of disciplines are involved in the data collection process.

Since no two investments are exactly the same, identifying a flexible assessment tool that can be applied to a variety of opportunities is important. The case study showed that TCA was flexible enough to accommodate both a pollution prevention and waste minimization opportunity at Precision Circuits. In addition, the company found that the original investment analysis conducted in its pollution prevention plan was easily extended using the TCA framework. In the future, TCA will help Precision Circuits conduct more timely and accurate evaluations of pollution prevention and waste minimization opportunities. Therefore, it seems feasible that the TCA framework could be applied to other investments and/or industries.

Discussions with Precision Circuits at the project’s conclusion revealed the following:

Analyzing two already implemented projects helped the environmental manager show the benefit of the projects to the company’s owner. The environmental manager hopes to use the same approach to analyze future projects prior to implementation to present to the owner. Having access to an already developed spreadsheet, such as the one developed for the project or a software program such as P2/FINANCE developed by the Tellus Institute, would increase the likelihood of Precision Circuits using TCA in the future. Independent technical support to help develop the TCA or to audit the TCA for completeness would also increase the likelihood of Precision Circuits using it in the future.

The information generated by doing the TCA analysis helped the environmental manager submit more complete information to the Washington DOE as part of the state pollution prevention reporting requirements.

Precision Circuits’ environmental manager found the project experience very positive, as it allowed him to learn quite a bit about TCA; he is interested in participating in future projects of a similar nature.

It was found that TCA helps illustrate the economic benefits ofpollution prevention and waste minimization, and serves as a tool for firms placing more emphasis on reducing environmental impacts. Although many small firms face resource constraints, this project demonstrated that the TCA framework is flexible and practical. Its use can lead to better investment decisions, both economically and environmentally.

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ACKNOWLEDGEMENTS The Pacific Northwest Pollution Prevention Research Center (PPRC) is indebted to Lona Badgett, Beth Hawke, and Karen Humphrey, graduate students in the environmental management program at the University of Washington, for conducting this study, and for their time spent researching the information, analyzing the results, and writing the final report. Without them, this report would not have been possible. Above all, the PPRC wishes to thank Gary Scott, environmental compliance manager at Precision Circuits, for his willingness to participate in the study.

Draft versions of the report were reviewed by Michael Johnson, Washington Department of Ecology, and Mitchell L. Kennedy, Pollution Prevention Cooperative. Funding for this project was provided by the PPRC, the U.S. EPA Environmental Accounting Project, which is part of the Office of Pollution Prevention and Toxics, and EPA Region 10. The opinions, findings, and conclusions or recommendations expressed in this report are those of the authors and do not necessarily reflect the view of the PPRC or its supporters.

Appendix 111

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analysis of pollution prevention and waste minimization ...infohouse.p2ric.org/ref/15/14341.pdf ·...

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