part 3 alternative evaluation methods - bc...

Part 3Alternative Evaluation Methods

Christopher RussellEnergy PathFINDERwww.energypathfinder.com(443) [email protected]

“It’s what you learn after you know it all that counts.”

Harry S. Truman33rd President of the United States of America

(1884 – 1972)

2©2011 Energy PathFINDER.com

Outline for Part 3


1. THINK INVESTMENT, NOT PROJECT

2. MONETIZING ENERGY OUTCOMES

3. OUR BOILER EXAMPLE – SAVE OR BUY?

4. A NEW BUSINESS PROPOSITION

5. CALCULATOR DEMO

Think INVESTMENT, Not PROJECT

PROJECTS: Cost money Take up time Distract from operating goals & procedures

INVESTMENTS: Produce a cash flow Earn a rate of return Grow the business, create wealth


Payback Analysis

If the payback isn’t “good”….

Just WALK AWAY from the proposal.


RIGHT?

6

Can You Walk Awayfrom the Investment?

TYPE 1: NEW INITIATIVE•Facility addition•Expanded production process•New product line

TYPE 2: EXISTING OBLIGATION•Efficiency improvement•Still bear the cost of wasteif no investment is made

©2011 Energy PathFINDER.com

Investment Outcomes

Investors WILL PAY either way: For the energy solution, or For the energy waste

You can’t walk away.

Goal for energy solutions: seek the least cost of meeting an obligation.


Outline for Part 3






5. CALCULATOR DEMO

MONETIZING ENERGY OUTCOMESACCEPT REJECT

GETGross annual

energy savings$$$

Satisfaction of no capital expenditure?

$0

GIVE UPAnnualized project cost

$$$

Annual cost of DOING NOTHING

$$$

ANNUALRESULT

GET – GIVE UP=

+FREE CASH FLOWGET – GIVE UP=

-FORFEITED NET CASH FLOW

PRICE TAG

$Project Invoice $Capitalized Waste Value


Annual energy use, current application

in-place

Annual energy use, efficient alternative

Energy consumptionavoided by investing in an energy-efficient

alternative

COMMITTEDENERGY VOLUME:Buy & useas intended.A

NN

UA

L E

NE

RG

Y

CO

NS

UM

PTI

ON

A B

Energy At-Risk

VOLUME AT-RISK:Buy & waste orPay to avoid buying.PAY FOR IT EITHER WAY.


Continue to BUY energy at-risk from the market? Remain exposed to constant price volatility

SAVE energy by reducing the volume at-risk? Do projects when cost to save a unit of energy is less

than the price to buy it Annualized cost stays fixed over the economic life of

the project

SAVE or BUY?


Outline for Part 3






5. CALCULATOR DEMO

$1,500,000 cost $150,000 rebate (YR1) $200,000 downpayment

Cap. recovery:25 YRS/8%

$1,300,000 borrowed20YRS/4%

25 YR economic life 1.5%/yr energy price escalation Declining balance CCA (4%) $0.17/CM natural gas $0.05/kWh electricity $30,000 O&M saving/yr

BOILER / STEAM UPGRADE

BEFORE AFTERELEC kWh 5 260 000 543 600 000GAS Cu M 4 734 000 542 100 000

Annual O&M $72,000 $42,000


CAPITAL RECOVERY FACTOR (CRF) = i(1+i)n

[(1+i)n]-1Where:i = weighted cost of capital – “velocity” of capital already investedn = economic life (years) of remedy (energy improvement project)

Operating budgets are ANNUAL Energy savings are accounted ANNUALLY Compare ANNUAL cost to ANNUAL benefit Compare 3-yr project to 10-year or 5-year projects….

WHYANNUALIZE?

vsANNUALIZEDPROJECT

COST

NETPROJECT

COST

CAPITALRECOVERY

FACTOR= x

ANNUALIZED COST

ANNUALIZEDPROJECT COST

CRF

=NET

PROJECTCOST

CAPITALIZED COST

A = B x C AC

= B


About the Cost Recovery Factor (CRF)

CRF is a pre-finance measure, screens out the cash flow “noise” created by third-party finance

CRF amortizes capital and interest relative to the investor’s business RoR

CRF is critical for comparing projects prior to external finance

Develop a short-list of projects with adequate RoR. THEN inquire about third-party finance.


CAPITAL RECOVERY FACTORSECONOMIC ANNUAL DISCOUNT RATE or COST OF CAPITAL

LIFE (YRS) 4% 5% 6% 7% 8% 9%

0.5 2.0598 2.0747 2.0896 2.1044 2.1192 2.1340

1 1.0400 1.0500 1.0600 1.0700 1.0800 1.0900

2 0.5302 0.5378 0.5454 0.5531 0.5608 0.5685

3 0.3603 0.3672 0.3741 0.3811 0.3880 0.3951

5 0.2246 0.2310 0.2374 0.2439 0.2505 0.2571

7 0.1666 0.1728 0.1791 0.1856 0.1921 0.1987

10 0.1233 0.1295 0.1359 0.1424 0.1490 0.1558

15 0.0899 0.0963 0.1030 0.1098 0.1168 0.1241

20 0.0736 0.0802 0.0872 0.0944 0.1019 0.1095

30 0.0578 0.0651 0.0726 0.0806 0.0888 0.0973

What happens to the CRF as interest rates go up?

As the economic life increases?


BOILER EXAMPLE:Annualized Project Cost Per MMBtu Saved


=NET

PROJECT COST

xCAPITAL

RECOVERYFACTOR

$125,034 = $1,350,000 x .0926


PER ANNUALMMBtu SAVINGS

=$125,03454,242 = $2.3051


Boiler Example: Save or Buy Choice

Annual energy use, current application

in-place

Annual energy use, efficient alternative

AN

NU

AL

EN

ER

GY

C

ON

SU

MP

TIO

NREJECT THE

IMPROVEMENT

$5.1860per MMBtuconsumed

$5.1860per MMBtu

wasted

$2.3051per MMBtu

avoided

Committed EnergyEnergy put to

work as intended

Energy At-Risk:You will pay for it either way

$5.1860per MMBtuconsumed

ACCEPT THEIMPROVEMENT


COST-BENEFIT RATIO

COST TOSAVE AN MMBtu

PRICE TOBUY AN MMBtu

$2.3051$5.1860

0.44= =

This project allows the investor to pay $0.44 to avoid buying $1.00’s worth of energy


INTERPRETING ANNUALIZED COST ANALYSIS

ANNUALEXPENDITURE

COMMITTEDEXPENDITURE


ANNUALGROSS

ENERGYSAVINGS

Annualized net savings

Annualized penalty forDOING NOTHING

Free cash flow to: • Working capital(finance your operations)Or • Investment capital(finance your asset base)

?


Boiler Example: 25-YEAR RESULTS


$2,051,437 $2,051,437

$5,058,625

$2,106,480

$2,952,145

REJECT ACCEPT

$5,058,625

$2,051,437 $2,051,437

$1,997,018

$2,952,145

GROSS WASTE

$3,061,607

COMMITTED EXPENSENET SAVINGS

TOTAL CAPITALIZED COST

OR:COST OF DOING

NOTHING

Accept or Reject?

DO DON’T DO

GET

Gross energy savings

$5,984,374Satisfaction of no capital

expenditure?

$0

GIVE UP

Fully amortized project cost

$1,997,018Cost of doing nothing

$3,987,356

GET – GIVE UP=

+$3,987,356GET – GIVE UP=

-$3,987,356/year

Our Boiler Example: 25-Year Results


BREAK-EVEN POINT

TOTAL VALUE OF ANNUAL

ENERGY SAVINGS=ANNUALIZED

PROJECT COST

What’s the MOST that should be paid for the project, given certain investment criteria?


Calculating the Financial Break-Even CostANNUAL VALUE

OF AVOIDED ENERGYPURCHASES

MAXIMUMACCEPTABLEANNUALIZED

PROJECT COST

SHOULD BE NO MORE THAN

ANNUAL VALUEOF AVOIDED ENERGYPURCHASES

MAXIMUMACCEPTABLEANNUALIZED

PROJECT COST

DELIVERED PRICE PER

UNIT OFENERGY

UNITS OFAVOIDEDENERGY

CONSUMPTION= =x


CRF =NET

PROJECTCOST

IF: MAXIMUMACCEPTIBLEANNUALIZED

PROJECT COST

CRF=

MAXIMUMACCEPTIBLE

NETPROJECT

COST

ALSO:ANNUALIZED PROJECT COST

UP-FRONT PROJECT COST

x CRF=

THEN:


MAXIMUMACCEPTABLEINVESTMENT

DELIVERED PRICE PER

UNIT OFENERGY

UNITS OFAVOIDEDENERGY

CONSUMPTION= x = BREAK-EVEN

PROJECT COST

CRF

MAXIMUMACCEPTABLEINVESTMENT

$5.1860 54,242=

x= $3,361,120

0.0926

NOTE: CRF = 0.0926 when n=25 and i=8%Amortized monthly

Break-Even Calculation

Net cost is only $1,350,000… definitely worth it.

Our Boiler Example


+NET

O&M COSTSAVINGS

+ 30,000

Outline for Part 3






5. CALCULATOR DEMO

The Real Business PropositionBoiler Replacement Project

ACCEPT REJECTGROSS ENERGY

SAVINGS $5,984,374 $0

PAYOUTFOR ENERGY

AT-RISK

Annualized project cost(capital + interest)

-$1,997,018

$5,984,374 annual expenditure for energy

waste minus $1,997,018 annualized project cost

avoided“PRICE TAG”: CAPITALIZED

ANNUAL PAYOUT

$1,350,000(per invoice)

$3,361,120($147,861/CRF*)

TOTAL CASH FLOW $3,987,356 -$3,987,356

*CRF: = [i(1+i)^n]/[((1+i)^n)-1] NOTE: CRF = 0.0926 when n=25 and i=8%


PAYBACK vs. ANNUALIZED COST

FEATURE PAYBACKANNUALIZED COST

ANALYSIS

Account for cash flows over the life of the improvement?

NO YES

Incorporate the time-value of money? NO YES

Provide basis for break-even cost evaluation?

SORT OF YES

Compare value of projects with different economic lives?

NO YES

Describe value of free cash flow? NO YES

Provide the “price tag” for NOT taking action?

NO YES


Outline for Part 3






5. CALCULATOR DEMO

Energy PathFINDERChristopher Russellwww.energypathfinder.com

Calculators


BC HYDROMODEL

ENERGY PATHFINDER

ELECTRICITY PRICES FIXED USER-DEFINEDDEPRECIATION SUMMARY ● ●

CASH FLOW SUMMARY ● ●CASH FLOW GRAPHS ● ●

SIMPLE PAYBACK ● ●ACCOUNTING RATE OF RETURN ● ●

LIFE-CYCLE COST ● ●PROFITABILITY INDEX ● ●

UNPROFITABILITY INDEX ●INTERNAL RATE OF RETURN ● ●

SAVE-OR-BUY COST RATIO ● ●MONETIZATION (COST OF DOING NOTHING) ●

BREAK-EVEN COST ●SUMMARY OF OUTCOMES ● ●

QUESTIONS?EAST HASTINGS STREET, VANCOUVER 1967

QUESTIONS?

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