Part Il. ECONOMICS AND FINANCIAL EVALUA’ OF ENERGY PROJECTS 3nergy-Investment Opportunities may fall in any one of the following cases: - cost of proposed method of energy conversion is to be compared against the cost of another energy conversion methodology. - capital investment is to be evaluated to determine if expected energy savings are worth the investment. - Possible alternative measures are to be compared and evaluated, with energy costs comprising a major portion of the total operating costs. 1.0 CASH FLOW MODEL In evaluating energy-investment opportunities, the timing of cash receipts and expenditures is essential. One can use any of the following: 1,1 End-of-Period Convention All cash flows which occur during any time interval are assumed to occur at the end of the interval. This procedure simplifies computations and ordinarily will not introduce major errors in the results. a Example of Cash Flows Occurring over a 3-year period1.2 Mid=period Convention Cash Flows can be assumed to occur at mid period Example of Cash Flows occur ring over a 3-year period 1.3 Continuous Flow Convention cash Flows for any period are received at a continuous rate Example of Cash Flows occurring over a 3-year period 2.0 ‘TIME VALUE OF MONEY For comparing various options or alternative, it is necessary to convert all cash flows for each measure/schene to an equivalent base. Te is based on the guiding principle that money in hand today is nore valuable than one received at some time in the future qo convert cash from one time to another, any one of the seven standard interest factors can be used: 2.1 Single Payment Compound Amount - SPCA puture.value of wéney, in: “ot periods st/71” intarss= see FORMULA s =P x (SPCA, at n,i) “yse TABLE : SPCA= (1+ i)"ILLUSTRATION: P (Present Value) SPCA = 1.728 S = 100 x 1.728 = $172.8 (Future Value) 2.2 Single Payment Present Worth - SPPW Present Value of Money, "n" periods from now at "i" interest NOTE: This is just the opposite of Single Payment Compound Amount (2.1). FORMULA =: SPPN= _1 e a+" USE TABLE : P= Sx (SPPW, at i, n) pepe tee are G y * $= s100 SPPW = 0.5787 i = 20% a=3 P = 100 x 0.5787 = $ 57:87 (Present Value)‘The payback period of an investment project tells us the 2.3 UNIFORM SERIES COMPOUND AMOUNT - USCA ‘This will determine the amount $ that an equal annual payment R will total in "n" years at "i" interest FORMULA USCA = (1 + i)" = 1 i USE TABLE : $= Rx(USCA, at i, n) $100 $100 $100 z + * > R= 100 n= 3 yeus> USCA = 3.64 i= 20% S = 100 x 3.64 = $ 364 2.4 SINKING FUND PAYMENT - SFP ‘This will determine the equal annual amount R that must be invested for n years at interest to accumulate a specified future amount. This is the opposite of uniform series Compound Amount (USCA). FORMULA 0: SFP = __ i a+ah-1 USE TABLE : R: $x (SFP at i, n years) R? z ° 2 2 Si SFP at 20%, 3 years = 0.27473 R = $300 x 0.27473 = § 82.419 3612.5 UNIEORM SERIES PRESENTS WORTH (USPW) This will determine the present amount P that can be paid by equal payments of R at "i" interest, n years. This is also equal to USCA x SPPW. FORMULA =: ~USPW= (1 +i)" -1 i¢i+a)? USE TABLE : P= R x(USPW at i, n years) R R R $100 $300 s}00 Po? > r 2 > n= 3 years USPW = USCA x SPPW i= 20% = 4.64 x 0.5787 USPW = 2,106 = 2.106 P = $100 x 2,106 $210.6 2,6 CAPITAL RECOVERY ~ CR This will determine an annual payment R required to pay off a present amount P at "i" interest, for-n years, This is also the opposite of Uniform Series Present Worth (usPw). FORMULA R= Px (CR, at i, n years) USE TABLE : CR = i (1 + i)® arin ?-1 $300 ee n= 3 years i= 20% CR = 0.47473 . P = $300 R =$300 x 0.47473 = $142.42 3622.7 GRADIENT PRESENT WORTH (GPW) ‘This will determine the present amount P that can be paid by annual amounts R which escalates at eZ, at "i" interest, mn years. FORMULA : P= Rx (GPW, eZ, i, n years) USE TABLE + ese See red avi 3 cPw = 1-lte T¥ai P=? = t 2 Annual Escalation = 10% Discount Rate = 20% N= 5 years } GPW = 3.8805 P = $100 x 3.8805 = § 388.05 3.0 EQUIPMENT LIFE ‘The Equipment Service Life Statistics is shown in Table 13. For specific equipment, present end-users may be consulted as well as the equipment suppliers. 4.0 EQUIPMENT COST . The attached Figures are presented along with factors to estimate the total installed cost of energy saving measures. It é should be emphasized here that current cost figures for specific applications be used whenever available. 363PROJECT BENEFITS AND COSTS In general, industrial firms invest in energy conseryation when the expected resulting benefits exceed investment costs Factors that make investments attractive in the recent years are rising fuel costs and security of fuel supply which prompted change over to renewable energy resources such as coal, agri- wastes, etc. Following are examples of benefits from Energy Conservation: Fuel savings Reduced maintenance cost for existing equipment Very efficient heating/cooling system; High productivity Improved product quality; improved production rate Revenue from sales of recovered heat or energy Short "Downtime" To evaluate the feasibility of an investment, measures of costs are needed to compare against above benefits. Potential costs to consider in investing in energy conservation are shown in Table 14 of the next part (Part IV). EVALUATION OF PROPOSALS Once necessary information is available, the attractiveness of various investment proposals under consideration can now be evaluated. It is presumed that the risk or quality of all investment proposals under consideration does not differ from the risk of existing investment projects of the factory and that the acceptance of any or group of investment proposals does not change the relative business risk of the factory, The investment decision will be either to accept or to reject the proposal. 6.1 Payback Methodinvestment. It is the ratio of the initial investment over the annual cash inflows for the recovery period, INVESTMENT ANNUAL SAVINGS Example 1: EQUAL CASH INFLOWS INITIAL INVESTMENT ON WASTE HEAT RECOVERY SYSTEY = § 53,000 EQUIVALENT ENERGY SAVINGS, YEARLY ‘AVERAGE = § 27,800 PAYBACK PERIOD = § 53,000 27,000/yr = 1.9 years Example 2: If Annual Cash Inflows are not equal. Year Investment Cash Inflows Total Inflows 0 $53,000 - - 1 - $20,000 $20,000 2 = 25,000 45,0 2 cis - 30,000 33,000 30000 4 - 20,000 95,000 5 - 20,000 115,000 PAYBACK = 2.3 years Advantage: Quite simple; if the payback period calculated is less than the maximum acceptable period by the factory, the proposal is accepted; if not, it is rejected. Drawback : Does not consider cash flows after payback period; it'ignores the magnitude or timing of cash flows during the payback period. 3656.2 Average Rate of Return Method The average rate of return is an accounting method and represents the ratio of the average annual profits after taxes to the average investment in the project, i.e., ANNUAL PROFITS AFTER TAKES ‘AVERAGE INVESTMENT i Sometimes original investment is used rather than average investment. Example 1, Annual Profits after Taxes : $ 16,000 Original Investment : § 53,000 Average Investment, say 2 years, straight line depreciation = § 53,000 v1 = § 26,500 Ave. Rate of Return = 16,000 x 100 = 60x (based on Ave. Investment) 26,500 Ave. Rate of Return = 16,000 x 100 = 30% (based on Orig. Investment) 53,000 Advantages: Simple to use; it makes use of readily available accounting information; calculated figures can be compared readily with a required or cut-off rate of return; proposal is acceptable if its average rate of return is bigher than the cut-off rate. Dravback_: The method is based upon accounting income “~~~ rather than upon cash inflows and outflows; the time value of money is ignored. 366Supposing two (2) Investment proposals are considered; each costing $80,000 and each has an economic and depreciable life of 5 years. Assume that these proposals are expected to provide the following book profits and cash flows over the next five years: PROJECT HEAT CONTAINMENT _ PROJECT WASTE HEAT RECOVERY Period Book Profit Net Cash Flow Book Profit Net Cash Flow 10,000 25,000 20,000 45,000 10,000 25,000 15,000 35,000 10,000 25,000 7,500 25,000 10,000 25,000 5,000 15,000 10,000 25,000 2,500 5,000 If straight line depreciation is employed, each proposal will haye the same average rate of return, i.e, 10,000 x 100 = 62.5% 80, 00075 However, most would prefer Project Waste Heat Recovery which provides a larger portion of total cash benefits in the first year. 6.3 Internal-Rate of Return Method (IRR) This method takes account of both the magnitude and timing of expected cash flows in each period of a project's life. The IRR for an investment proposal is the discount rate that equates the present value of the expected cash out flows with the present value of the expected inflows. Uf IRR is greater than the cut-off or hurdle rate, then proposal is accepted, if not, proposal is rejected. Example 1: Using Example 2 of Section 6.2 (PROJECT HEAT CONTAINMENT)