SECTION 2: TOTAL COST ASSESSMENT (TCA) TIPS FOR MANAGERS

 

TOTAL COST ASSESSMENT (TCA) FOR MANAGERS

Once a technically feasible P2 project has been identified, the next step involves the development of a financial analysis to determine financial viability of the project.  If a project is financially viable as well, both company management decision-makers and, quite often, the providers of funds will need to approve the project.  This section discusses the components of a financial analysis plan or Total Cost Assessment (TCA) for management decision-makers and funders to review.

TCA offers an approach to removing unnecessary financial barriers to investment in pollution prevention and energy efficiency equipment. This approach assists businesses in the development of a comprehensive financial analysis of the true investment return of environmental projects.

TCA financial analysis differs from conventional project analysis in four important ways:

·         identifying an inventory of costs/savings associated with a pollution prevention investment, including factors such as compliance, training, testing, and liability that are often left out of conventional analysis;

·          instead of placing these items in a general overhead account, they are directly allocated to specific process and product accounts;

·         in order to include longer term benefits, the length of time in the financial analysis period is increased;

·         indicators, such as the Net Present Value (NPV) and the Internal Rate of Return (IRR), are used in the financial analysis. These assist in identifying the time value of money and long term costs and savings.

Environmental projects involve a number of costs/savings that are often difficult to quantify, indirect and hidden, and with a long-term horizon. These costs/savings include:

  • environmental management costs – pollution control/waste treatment facilities capital cost, operations (including utilities) and maintenance; waste management and disposal; accidental release prevention and response preparation; insurance;
  • regulatory compliance costs including training, monitoring, documentation, and reporting;
  • employee health and safety monitoring, training, documentation, and equipment;
  • liabilities relating to Superfund, personal injury and property damage;
  • corporate image impact that may affect market share or stock value;
  • production capacity limited by regulatory requirements;
  • value of marketable emission credits;
  • improved market share due to safer, greener products.

Rather than place these costs/savings in a general overhead account, TCA relies on the use of Activity Based Costing (ABC) to allocate costs to processes, products or projects on the basis of activities with direct relationship to cost generation. First, overhead costs are assigned to the activities with a direct relationship to the cost. Then the activities are allocated to processes and products. While ABC will not eliminate overhead accounts, it helps provide more accurate cost information for TCA.  By providing a more complete financial picture of a project, TCA can be used to make better financial decision on P2 projects.

Increasing the time horizon for TCA financial analysis beyond the typical 3-5 years will permit the inclusion of costs and benefits that accrue over the life of the equipment, which could be 10 to 15 years. This will permit the analysis to capture long term costs/savings such as recurring waste disposal savings and future avoided liability savings.

Indicators of profitability should recognize that cash flows in the future are less valuable than cash flows in the present time. The value of present cash is calculated though a discount rate, which for most companies is their weighted-average cost of capital. The profitability indicators, Net Present Value (NPV) and Internal Rate of Return (IRR) use a discount rate to consider the time value of money. Of these two indicators, the NVP is generally the most valuable, problem-free one.

The TCA approach to environmental financial analysis is being promoted by the federal government's Department of Energy (DOE), and may be found at its Internet Web site: http://www.oit.doe.gov/toolbook/, and it is listed as an assistance reference in Section 6 of this guide.