Guidance on Financial Analysis of
Cleaner Production Options
Presentation 14 – Guidance on Financial Analysis of Cleaner Production Options
1
What will we learn here?
Guidance on Financial Analysis of Cleaner Production Options
Introduction: The Need for Financial Analysis
Objectives of this Presentation
Use of Cost Benefit Analysis in Financial Analysis
Introduction to Cost Benefit Analysis
Elements of Cost Benefit Analysis
Case Study #1
Case Study #2
Criteria for Selection of Projects
Presentation 14 – Guidance on Financial Analysis of Cleaner Production Options
2
Introduction: The Need for Financial Analysis
Next
Slide
Presentation 14 – Guidance on Financial Analysis of Cleaner Production Options
3
Introduction: The Need for Financial Analysis
Cleaner production options not only avoid and
reduce waste generation, but also offer a direct cost
advantage to the business.
However, cleaner production options are typically
long term, involving medium to high investment,
and hence are perceived as a larger business risks
than end-of-pipe solutions. The crux of the problem
is that this risk is often not clearly quantified and
predicted.
Thus, financial analysis of cleaner production
options becomes necessary.
Presentation 14 – Guidance on Financial Analysis of Cleaner Production Options
4
Objectives of this Presentation
Next
Slide
Presentation 14 – Guidance on Financial Analysis of Cleaner Production Options
5
Objectives of this Presentation
To understand the basics of financial analysis
To implement fundamental principles of financial analysis
for cleaner production options
To screen cleaner production options based on financial
aspects
Presentation 14 – Guidance on Financial Analysis of Cleaner Production Options
6
Introduction to Cost Benefit Analysis (CBA)
Next
Slide
Presentation 14 – Guidance on Financial Analysis of Cleaner Production Options
7
Introduction to Cost Benefit Analysis (CBA)
• CBA facilitates the comparison of alternatives
in terms of the monetary costs involved and the
benefits obtained.
• The costs and benefits (environmental, social or economic) must be
quantified in monetary terms to the maximum extent possible.
Typically, CBA is used as a tool in feasibility studies for selection of
an alternative together with for e.g., life cycle assessment, audits, etc.
• Thus, CBA is used in financial analysis to estimate the
profitability of a potential investment for a cleaner production
option.
Presentation 14 – Guidance on Financial Analysis of Cleaner Production Options
8
Elements of CBA
Next
Slide
Presentation 14 – Guidance on Financial Analysis of Cleaner Production Options
9
Elements of CBA
Cash flow
Present value (PV)
Measures of Profitability
Payback Period
Net Present Value (NPV)
Internal Rate of Return (IRR)
Profitability Index
Depreciation
Presentation 14 – Guidance on Financial Analysis of Cleaner Production Options
10
Cash Flow
A Cash Flow is meant to illustrate incomes (“cash inflows”) and expenses (“cash
outflows”). They may be conventional and non-conventional. Each arrow represents the
time period of a year in this case.
Conventional Cash Flow
Cash Inflows
$600
$600 $600 $600
0
$600
5
Cash Outflows
$2,000
Non-Conventional Cash Flow
$7,500. . . . . . . . . . . . . . $7,500
Cash Inflows
-2
-1
0
8
Cash Outflows
$12,000 $10,000 $8,000
$3,900
Presentation 14 – Guidance on Financial Analysis of Cleaner Production Options
$2,600
11
Present Value (PV)
PV is a way of comparing the value of money now with the value of money in
the future. A dollar today is worth more than a dollar in the future, because
inflation erodes the buying power of the future money, while money available
today can be invested to grow.
Calculation of the PV requires the use of “interest rate”. Interest rate is
typically a percentage used to calculate the PV. It reflects the time value of
money. Generally, this interest rate is taken as equal to the prevailing bank
interest rate.
Assuming an interest rate of 10%, the PV of $100 three years from now is
approximately $133.
Presentation 14 – Guidance on Financial Analysis of Cleaner Production Options
12
Payback Period
As the name suggests, the Payback Period is the length of time required to
recover the cost of an investment.
It is calculated with the formula below:
Payback period = $ Invested
$ Return per year
Drawbacks The payback period ignores the time value of money
The payback period ignores cash flows after the initial investment has been
recouped
Presentation 14 – Guidance on Financial Analysis of Cleaner Production Options
13
Payback Period
If the initial cost of the investment or $ invested = $
20,000 and the net savings or $ return per year = $ 2,200;
then
Payback period = 20,000 / 2,200 = 9.09 years
(say 9.1 years)
Presentation 14 – Guidance on Financial Analysis of Cleaner Production Options
14
Net Present Value (NPV)
NPV may be defined as the difference between the total present value of the cash
inflows and the total present value of the cash outflows.
NPV compares the value of the dollar today versus the value of that same dollar in
the future, after taking inflation and returns into account.
If the NPV of a prospective project is positive then it should be accepted (i.e. NPV
> 0)
However, if the NPV of a prospective project is negative, then the project should be
rejected because cash flows are negative (i.e. NPV < 0)
If the NPV of a prospective project is zero then it should probably be rejected as it
generates exactly the return that is expected (i.e. NPV = 0)
Presentation 14 – Guidance on Financial Analysis of Cleaner Production Options
15
Net Present Value (NPV)
Let us calculate the NPV from a series of cash flows. The formula is given below.
$100,000
(positive cash flows)
0
$150,000
$200,000
3
$500,000 (negative cash flow)
NPV = -CFo + CF1 + CF2 + CF3 + CFn
(1+r)1 (1+r)2 (1+r)3 (1+r)n
where CFX = cash flow in year x, n = number of periods (n=3), r = interest rate (say,
10%)
NPV = -500,000 + 100,000 + 150,000 + 200,000
(1+0.1)1 (1+0.1)2 (1+0.1)3
= -$134, 861
Presentation 14 – Guidance on Financial Analysis of Cleaner Production Options
16
Internal Rate of Return (IRR)
The IRR method of analyzing a project or option allows one to find the interest rate
that is equivalent to the dollar returns expected from the project or option.
Once you know the IRR, you can compare it to the rates you could earn by investing
your money in other projects or options.
If the IRR is less than the cost of borrowing used to fund the project, the project will
clearly be a money-loser.
However, usually a business owner will insist that in order to be acceptable, a project
must be expected to earn an IRR that is at least several percentage points higher than
the cost of borrowing, to compensate the company for its risk, time, and trouble
associated with the project.
Presentation 14 – Guidance on Financial Analysis of Cleaner Production Options
17
Internal Rate of Return (IRR)
As an example of how IRR works, let us say you are looking at a
project costing $7,500 that is expected to return $2,000 per year for
five years, or $10,000 in total. The IRR calculated for the project
would be 10 percent.
If your cost of borrowing for the project is less than 10 percent,
the project may be worthwhile.
If the cost of borrowing is 10 percent or greater, it will not make
sense to do the project (at least from a financial perspective) because,
at best, you will be breaking even.
Presentation 14 – Guidance on Financial Analysis of Cleaner Production Options
18
Internal Rate of Return (IRR)
The formula used for calculating the IRR is very similar to the formula
used for calculating the NPV.
The main difference is that in the IRR formula, you must solve for the
interest rate “r”.
0 = -CFo + CF1 + CF2 + CF3 + CFn
(1+r)1 (1+r)2 (1+r)3 (1+r)n
where CFX = cash flow in year x, n = number of periods, r = interest rate
(to be solved for)
Presentation 14 – Guidance on Financial Analysis of Cleaner Production Options
19
Profitability Index (PI)
The PI is the ratio of the PV of future cash inflows by the PV of
cash outflows
PI = PV of cash inflows
PV of cash outflows
If the 0 < PI < 1, the project or option should be rejected
If the PI > 1, the project or option should be accepted
Presentation 14 – Guidance on Financial Analysis of Cleaner Production Options
20
Depreciation
Depreciation is defined as the decline in the value of an asset with the
passage of time, due to general wear and tear or obsolescence
Depreciation is a part and parcel of cash flow calculations
Depreciation may be accounted for in the net annual savings of a cleaner
production option
Presentation 14 – Guidance on Financial Analysis of Cleaner Production Options
21
Case study #1
Next
Slide
Presentation 14 – Guidance on Financial Analysis of Cleaner Production Options
22
Case Study #1: Financial Analysis of a Cleaner Production Option
in a Bottle Washing Plant
Background
Bottle washing plant BWP utilizes a large quantity of water and caustic soda
for bottle washing and rinsing operations
As a cleaner production option, a certain percentage of the caustic soda is to
be recovered from the resulting caustic solution, through the use of a
membrane filtration (MF) system
The recovered caustic will then be resold at the prevailing market price
Let us examine the financial feasibility of installing the MF system
Presentation 14 – Guidance on Financial Analysis of Cleaner Production Options
23
Case Study #1 - Calculations for the Value of
Recoverable Caustic ($ / year)
Table 1:
Volume of
caustic (m3)
“A”
Volume of caustic
recovered per run* (m3)
“B” = “A” X 0.65
Mass of caustic recovered
per year** (kg/m3)
“C” = “B” X 4 X 25
Value of caustic
recovered per year***
($ / year) = “C” X 0.5
210
136.5
13,650
6,825
Data
* The overall caustic recovered from the MF system is 65% by volume
** The number of recovery runs at BWP is 4 times a year and the concentration of caustic by
weight is 2.5% or 25 kg/m3
*** The cost of 1 kg of pure caustic solution is $0.5
Presentation 14 – Guidance on Financial Analysis of Cleaner Production Options
24
Case Study #1 – Installation Cost for the MF System
Table 2
System component
Cost ($)
Membrane
7,000
Feed pump
800
High pressure pump
1,600
Cartridge and power
400
Permeate tank
200
Pipes, valves, etc.
8,000
Total investment:
18,000
In addition to the initial investment, the manufacturer states that the membrane for the MF
system will need to be replaced once in 3 years. The associated cost for this will work out to be
$7,500. The total life of the MF system is 12 years.
Presentation 14 – Guidance on Financial Analysis of Cleaner Production Options
25
Case Study #1 - Calculations for the Net Annual Uniform Savings
Net annual uniform savings =
Cost recovered from the sale of caustic annually – annual depreciation
cost of the MF system – annual operating costs
Here, depreciation cost of the MF system (assuming nil salvage value at the
end of the 12 year period = (18,000 – 0) / 12 = $1,500
Also, annual operating costs = cost for power and the cartridge = $400
(from Table 2)
So, net annual uniform savings = 6,825 – 1,500 – 400 = $4,925
(approx.)
Presentation 14 – Guidance on Financial Analysis of Cleaner Production Options
26
Case Study #1 – Cash Flow Diagram for the Proposed MF System
Cash Inflows (Net annual Uniform Savings)
$4,925…………………………………………………………$4,925
0
12
$18,000
$7,500
$7,500
$7,500
Cash Outflows (Initial Investment and Replacement Cost)
Initial one-time investment = $18,000
Membrane replacement cost (once every 3 years) = $7,500
Net annual uniform savings = $4,925 / year
Presentation 14 – Guidance on Financial Analysis of Cleaner Production Options
27
Case Study #1 – Calculation for NPV
Assuming an interest rate of 10% ( r = 10 / 100 = 0.1), PV of cash inflows
12
= 4,925 
1
= $33,557
t=1 (1 + 0.1)t
PV of cash outflows
= 18,000 + 7,500 + 7,500 + 7,500 = $31,049
(1+0.1)3 (1+0.1)6 (1+0.1)9
NPV = PV of cash inflows – PV of cash outflows
= $33,557 - $31,049 = $2,508
Since the resultant NPV > 0, the cleaner production option is financially viable.
Presentation 14 – Guidance on Financial Analysis of Cleaner Production Options
28
Case Study #1 – Calculation for IRR
IRR would need to be solved through iteration:
12
0 = 4,925 
t=1
1
– 18,000 – 7,500 – 7,500 – 7,500
(1+r)t
(1+r)3 (1+r)6 (1+r)9
Taking r = 12% (i.e. 12/100 = 0.12), Left Hand Side (LHS) = 664.63
Taking r = 13% (i.e. 13/100 = 0.13), LHS = -152.49
Presentation 14 – Guidance on Financial Analysis of Cleaner Production Options
29
Case Study #1 – Solving for the Exact Value of IRR
Taking r = 12% (i.e. 12/100 = 0.12), LHS = 664.63
Taking r = 13% (i.e. 13/100 = 0.13), LHS = -152.49
Solving for the exact value of IRR through interpolation:
r – 12
r – 14
=
IRR
=
0 – 664.63
-152.49-664.63
12.63%
Since the IRR is greater than 10% (i.e. the rate of interest that the money
would earn in the bank, investing in this cleaner production option is
worthwhile.
Presentation 14 – Guidance on Financial Analysis of Cleaner Production Options
30
Case Study #1 – Calculating the PI
Calculating for the PI:
PI = PV of cash inflows = 33,557
PV of cash outflows
31,049
= 1.08
Since PI > 1, this cleaner production option can be accepted; i.e. it
is financially viable
Presentation 14 – Guidance on Financial Analysis of Cleaner Production Options
31
Case study #2
Next
Slide
Presentation 14 – Guidance on Financial Analysis of Cleaner Production Options
32
Case Study #2: A Tweak on Case Study #1 (Pessimistic Scenario)
Background
The background for Case Study #2 stays the same as that for Case Study #1.
However, there will be one change… let us say, that the prevailing market
price of the recovered caustic falls to $0.35 per kg (previously, for Case Study
#1, the said value was $0.5 per kg).
Let us also say that the manufacturer’s claim for membrane replacement does
not hold true, and that the membrane requires replacement once every two
years.
Let us examine the financial feasibility of installing the MF system for
Case Study #2.
Presentation 14 – Guidance on Financial Analysis of Cleaner Production Options
33
Case Study #2 - Calculations for the Value of Recoverable Caustic
(Pessimistic Scenario)
Table 3:
Volume of
caustic (m3)
“A”
Volume of caustic
recovered per run* (m3)
“B” = “A” X 0.65
Mass of caustic recovered
per year** (kg/m3)
“C” = “B” X 4 X 25
Value of caustic
recovered per year***
($ / year) = “C” X 0.35
210
136.5
13,650
4,778
Data
* The overall caustic recovered from the MF system is 65% by volume
** The number of recovery runs at BWP is 4 times a year and the concentration of caustic by
weight is 2.5% or 25 kg/m3
*** The cost of 1 kg of pure caustic solution is $0.35
Presentation 14 – Guidance on Financial Analysis of Cleaner Production Options
34
Case Study #2 - Calculations for the
Net Annual Uniform Savings (Pessimistic Scenario)
Net annual uniform savings =
Cost recovered from the sale of caustic annually – annual depreciation
cost of the MF system – annual operating costs
Here, depreciation cost of the MF system (assuming nil salvage value at the
end of the 12 year period = (18,000–0)/12 = $1,500 (same as Case Study #1)
Also, annual operating costs = cost for power and the cartridge = $400
(from Table 2, same as Case Study #1)
So, net annual uniform savings = 4,778 – 1,500 – 400 = $2,878
(approx.)
Presentation 14 – Guidance on Financial Analysis of Cleaner Production Options
35
Case Study #2 – Cash Flow Diagram for
the Proposed MF System (Pessimistic Scenario)
Cash Inflows (Net annual Uniform Savings)
$2,878…………………………………………………………$2,878
0
12
$18,000
$7,500
$7,500
$7,500
$7,500
$7,500
Cash Outflows (Initial Investment and Replacement Cost)
Initial one-time investment = $18,000
Membrane replacement cost (once every 2 years) = $7,500
Net annual uniform savings = $2,878/ year
Presentation 14 – Guidance on Financial Analysis of Cleaner Production Options
36
Case Study #2 – Calculation for NPV
(Pessimistic Scenario)
Assuming an interest rate of 10% ( r = 10 / 100 = 0.1), PV of cash inflows
12
= 2,878 
1
= $19,610
t=1 (1 + 0.1)t
PV of cash outflows
= 18,000 + 7,500 + 7,500 + 7,500 + 7,500 + 7,500
(1+0.1)2 (1+0.1)4 (1+0.1)6 (1+0.1)8 (1+0.1)10
= $39,945
NPV = PV of cash inflows – PV of cash outflows
= $19,610 - $39,945 = - $20,335 (i.e. negative)
Since the resultant NPV < 0, the cleaner production option is not financially viable.
Presentation 14 – Guidance on Financial Analysis of Cleaner Production Options
37
Case Study #2 – Calculating the PI
(Pessimistic Scenario)
Calculating for the PI:
PI = PV of cash inflows = 19,610
PV of cash outflows
39,945
= 0.49
Since PI > 1, this cleaner production option cannot be accepted;
i.e. it is not financially viable
Presentation 14 – Guidance on Financial Analysis of Cleaner Production Options
40
Other Scenarios
Similarly, it is possible that there may be other pessimistic scenarios
In fact, there could be a permutation-combination of pessimistic scenarios,
depending on the market and in-house conditions
The World Wide Web provides certain tools to calculate the NPV and IRR values
Thus the CBA becomes a very important tool is assessing the financial feasibility of
the cleaner production project / option
Such analysis will help all concerned (CPC, business / enterprise / industry,
financial institution, stakeholders in the option) decide on further steps to be
taken for making a bankable project.
Presentation 14 – Guidance on Financial Analysis of Cleaner Production Options
41
Thank you
Presentation 14 – Guidance on Financial Analysis of Cleaner Production Options
42