Excel Man

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Users Guide

Tellus InstituteCopyright 1996

P2/FINANCEVersion 3.0

in Excel Version 5.0 for Windows

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Tellus Institute

P2/FINANCEVersion 3.0

in Excel Version 5.0 for Windows

Users Guide

Tellus Institute11 Arlington StreetBoston, MA 02116-3411USA

Telephone: 617-266-5400Fax: 617-266-8303Email: [email protected]

Copyright 1996 Tellus Institute, Boston, MA USA. All rights reserved. No partof this publication or associated software may be reproduced or transmitted in anyform or by any means, without prior written permission.

November 1996

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Acknowledgments

Tellus Institute developed P2/FINANCE Version 3.0 with funding from the US EnvironmentalProtection Agencys Pollution Prevention Division. We gratefully acknowledge the supportprovided by Susan McLaughlin (EPA Project Manager), Holly Elwood, Kathy Seikel, and AlanEhrlich of EPA.

We thank all of the reviewers of both the software and Users Guide: Cathy Andrews, NavalSurface Warfare Center; Robert Butner, Battelle Seattle Research Center; and Keith Weitz andAarti Sharma, Research Triangle Institute. We also thank users of earlier versions ofP2/FINANCE who provided us with valuable feedback on how to improve the tool.

The Tellus project team included Angela Dierks, Deborah Savage (Project Manager), PabloMartinez, Rob Graff, Katherine Bidwell, David Miller, Dan Smith, Diana Zinkl, and AllenWhite.

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Table of Contents

PREFACE.................................................................................................................................................................. I

1. INTRODUCTION...................................................................................................................................................2

INTRODUCTION....................................................................................................................................................... 3BASIC OPERATIONS................................................................................................................................................. 5GETTING STARTEDIN P2/FINANCE.......................................................................................................................6

Elements of a Financial Analysis..............................................................................................................................6Terminology...............................................................................................................................................................6

Cost Item...............................................................................................................................................................................7Cost Category........................................................................................................................................................................7Scenario.................................................................................................................................................................................7Analysis.................................................................................................................................................................................7Project...................................................................................................................................................................................8

Format Conventions..................................................................................................................................................8P2/FINANCE Administrative Commands ................................................................................................................8

P2/FINANCE Organization...................................................................................................................................................8Moving Between Sheets........................................................................................................................................................9Moving Between Scenarios...................................................................................................................................................9

Printing..................................................................................................................................................................................9Help Function........................................................................................................................................................................9Calc Button..........................................................................................................................................................................10

Excel Tips................................................................................................................................................................10Spreadsheet Protection............................................................................................................................................11

COMPUTERSPECIFICATIONS..................................................................................................................................11Hardware and Software Specifications...................................................................................................................11

INSTALLATION......................................................................................................................................................12

2. STEP BY STEP INSTRUCTIONS : ENTERING DATA ................................................................13

PROJECT TITLE SHEET........................................................................................................................................... 14Accessing Scenarios................................................................................................................................................14Printing Scenarios...................................................................................................................................................14Accessing Help........................................................................................................................................................14

Calculating..............................................................................................................................................................14DEFAULT PARAMETERS SHEET.............................................................................................................................. 16

Time Value of Money...............................................................................................................................................17Global Parameters...................................................................................................................................................17

Inflation Rate.......................................................................................................................................................................18Discount Rate......................................................................................................................................................................18Income Tax Rates................................................................................................................................................................20Depreciation .....................................................................................................................................................................21

Scenario Parameters...............................................................................................................................................24Name.............................................................................................................................................................................. ..... 24Investment Year..................................................................................................................................................................24Lifetime............................................................................................................................................................................ ... 24Start Year............................................................................................................................................................................ 25End Year............................................................................................................................................................... ......... ..... 25

Accessing Scenarios................................................................................................................................................25Printing Scenarios...................................................................................................................................................25Accessing Help........................................................................................................................................................25Calculating..............................................................................................................................................................26

INITIAL INVESTMENT COSTS SHEET.......................................................................................................................27Salvage Value..........................................................................................................................................................29Tailoring the Financial Parameters........................................................................................................................29Working Capital......................................................................................................................................................30

Accessing Scenarios................................................................................................................................................31Printing Scenarios...................................................................................................................................................31

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Accessing Help........................................................................................................................................................31Calculating..............................................................................................................................................................31

ANNUAL OPERATING COSTS SHEET.......................................................................................................................32Escalation Rate........................................................................................................................................................33Tailoring the Financial Parameters........................................................................................................................33

Accessing Other Scenarios......................................................................................................................................33Printing Scenarios...................................................................................................................................................34

Accessing Help........................................................................................................................................................34Calculating..............................................................................................................................................................34

3. CALCULATING THE BOTTOM LINE: GENERATING REPORTS................................35

SCENARIO SUMMARY REPORT...............................................................................................................................37Accessing Other Scenarios......................................................................................................................................38Printing Scenarios...................................................................................................................................................38Accessing Help........................................................................................................................................................38

TAX DEDUCTION SCHEDULE..................................................................................................................................39Accessing Other Scenarios......................................................................................................................................41Printing Scenarios...................................................................................................................................................41Accessing Help........................................................................................................................................................41

INCREMENTAL CASH FLOW ANALYSIS SHEET........................................................................................................42Accessing Other Scenarios......................................................................................................................................43Printing Scenarios...................................................................................................................................................43Accessing Help........................................................................................................................................................44

INCREMENTAL PROFITABILITY ANALYSIS SHEET ...................................................................................................45Net Present Value (NPV).........................................................................................................................................45Internal Rate of Return (IRR).................................................................................................................................45Discounted Payback................................................................................................................................................46Accessing Scenarios................................................................................................................................................47Printing Scenarios...................................................................................................................................................47Accessing Help........................................................................................................................................................47Calculating..............................................................................................................................................................47

4. CASE STUDIES.....................................................................................................................................................48

AN EXAMPLEOFA BASIC ANALYSIS......................................................................................................................49

Conceptualize the Analysis.....................................................................................................................................49Develop a Cost Inventory....................................................................................................................................................49Collect Cost Data ...............................................................................................................................................................50

Enter the Financial Parameters..............................................................................................................................52Default Parameters sheet.....................................................................................................................................................52

Enter the Cost Data.................................................................................................................................................53Initial Investment Costs sheet..............................................................................................................................................53Annual Operating Costs sheet.............................................................................................................................................54

Generate Reports.....................................................................................................................................................54Scenario Summary sheet.....................................................................................................................................................54Tax Deduction Schedule sheet............................................................................................................................................55Incremental Cash Flow Analysis sheet................................................................................................................................55Incremental Profitability Analysis sheet..............................................................................................................................55

Summary of Results.................................................................................................................................................56AN EXAMPLEOFA COMPLEX ANALYSIS................................................................................................................25

Conceptualize the Analysis.....................................................................................................................................25Develop a Cost Inventory....................................................................................................................................................25Collect Cost Data................................................................................................................................................................26

Enter the Financial Parameters..............................................................................................................................32Default Parameters for the Analysis....................................................................................................................................32

Enter the Cost Data.................................................................................................................................................33Initial Investment Costs sheet..............................................................................................................................................33Annual Operating Costs sheet.............................................................................................................................................34

Generate Reports.....................................................................................................................................................34Scenario Summary sheet.....................................................................................................................................................34

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Tax Deduction Schedule sheet............................................................................................................................................35Incremental Cash Flow Analysis sheet................................................................................................................................35Incremental Profitability Analysis sheet..............................................................................................................................35

Summary of Results.................................................................................................................................................35

APPENDICES.............................................................................................................................................................37

APPENDIX A: .......................................................................................................................................................38

COPYOFTHE BLANKSPREADSHEET......................................................................................................................38APPENDIX B: TOTAL COST ASSESSMENT COST INVENTORY..................................................................................39APPENDIX C: GLOSSARYOF FINANCIAL TERMS.......................................................................................................1

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Preface

Welcome to P2/FINANCE Version 3.0 programmed in Excel Version 5.0 for Windows. Thispowerful spreadsheet-based program is designed to assist you in evaluating the profitability ofpollution prevention (P2) and other investments with environmental implications. Version 3.0represents a major upgrade of P2/FINANCE in which flexibility and user friendliness couple tocreate a more versatile financial analysis tool. A grant from US Environmental ProtectionAgencys Pollution Prevention Division supported the development of this version ofP2/FINANCE.

The Users Guide offers step-by-step instructions for installing and using P2/FINANCE, as wellas an introduction to the principles of financial analysis. We recommend that you read thisGuide while using the software for your first few analyses. The Guide assumes familiarity withWindows and Excel. For further information on these software packages, please refer to anappropriate user guide.

This Guide is organized into three main sections. The Introduction explains the Total CostAssessment framework used by P2/FINANCE, computer requirements for the software, andinstallation procedures. The Step-by-Step Instructionsprovide detailed instructions on how toconduct a financial analysis with P2/FINANCE and define relevant financial analysis concepts.The section on Calculating the Bottom Line: Generating Reports describes the varioussoftware screens that illustrate the calculated results and the printed reports you can generate.The Case Studies demonstrate real world application of the software through two case studies:one basic analysis and a second, more complex, analysis.

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1. Introduction

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P2/FINANCE Version 3.0 Introduction

Introduction

Before you make a modification to an industrial process (e.g., switch to an aqueous cleaneror purchase a solvent still to recover spent raw materials), you need to understand thefinancial impacts of such a modification. P2/FINANCE helps your decision-making byproviding a framework for assessing the profitability of potential investments. In aP2/FINANCE analysis you estimate the costs and revenuesboth Initial Investment Costsand Annual Operating Costs and revenuesof a potential pollution prevention investment orother investment with environmental implications. This information, together with otherqualitative information, provides a solid foundation for making your investment decision.

Pollution prevention (P2) refers to techniques that reduce pollutants at their source rather

than controlling pollutants through end-of-pipe controls after they are generated. Forexample, if you are attempting to minimize volatile organic compound (VOC) emissions, P2techniques may include implementing workplace practices that increase the efficiency of theuse of VOC-containing materials or reducing or eliminating VOC-containing materialsaltogether. A pollution control approach, on the other hand, would limit the release of VOCsinto the atmosphere via control technologies such as carbon adsorption or incineration. P2has several advantages over traditional pollution control approaches:

It may be more effective than pollution control at reducing the amount ofpollution because it reduces in-process emissions;

It reduces legal liability costs by decreasing the possibility of chemical waste

accidents and disposals;

It may reduce costs associated with the procurement, storage, monitoring,permitting, and disposal of hazardous materials;

It may enhance production efficiency, thereby decreasing production costs;

It may allow firms to avoid future regulatory requirements; and

It may enhance corporate image and stakeholder relations.

Companies commonly think of environmental investments from a must-do perspective, asa costly diversion from profit-adding projects. Total Cost Assessment (TCA) is an approachto overcoming these obstacles to P2 investments, putting them on the same footing as otherpotential uses of a firms limited capital resources. TCA differs from conventional practicesin four key ways:

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PollutionPrevention

(P2)

Total CostAssessment

(TCA)

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Expands the inventory of costs, savings, and revenues to include indirect, lesstangible items typically omitted from project profitability analyses;

Highlights the accurate allocation of costs and savings to specific process andproduct lines rather than lumping them into overhead accounts;

Extends the time horizon of the analysis to account for longer-term costs andsavings typical of P2 investments; and

Uses profitability indicators capable of capturing longer-term costs and savingsand the time value of money.

In short, P2/FINANCE helps operationalize TCA concepts by providing a tool for anexpanded cost/savings inventory, accurate cost allocation, longer time horizons, and multiple

profitability indicators.1

Together, these elements help provide a clear picture of the trueprofitability of a P2 project.

In a P2/FINANCE analysis, you define the financial parameters (e.g., tax rate, inflation rate)for the project and then input cost and revenue data for both your business-as-usualoperations (Base Scenario) and a proposed investment (Alternative Scenario). In eachproject, you may define two Alternative Scenarios to compare with a single Base Scenario.

P2/FINANCE generates four reportsScenario Summary, Tax Deduction Schedule,Incremental Cash Flow Analysis, and Incremental Profitability Analysis. Each offers adifferent perspective to assist you in understanding the economics of a potential P2investment.

Version 3.0 of P2/FINANCE contains significant enhancements to Version 2.2 in terms offlexibility and specificity. Using this version, you can define investments that occur overmultiple years, specify an escalation rate for individual Annual Operating Cost categories,and select a different depreciation method for each Initial Investment Cost category.P2/FINANCE provides this flexibility while maintaining a user-friendly structure, enablingfirst-time users to easily input cost data and calculate profitability.

P2/FINANCE contains on-line help screens to walk you through the steps of a TCA analysis.Each sheet of the software contains a help screen that briefly describes the function of thesheet and defines relevant financial analysis concepts. As these help screens provide basicinstructions only, we encourage you to refer to the Users Guide for more detailed

instructions.

1 For a more detailed explanation of TCA, see: 1) Allen White, Accounting for Pollution Prevention, EPAJournal, July-September 1993, pp. 23-25. 2) Deborah E. Savage and Allen L. White, New Applications ofTotal Cost Assessment, Pollution Prevention Review, Winter 1994-95, pp. 7-15. 3) Allen White, MonicaBecker, and James Goldstein, Total Cost Assessment: Accelerating Industrial Pollution Prevention Through

Innovative Project Financial Analysis With Applications to the Pulp and Paper Industry , December 1991.

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AnalysisStructure

EnhancedFlexibility

On-line Help

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Interested parties may request a free copy of P2/FINANCE Version 3.0from the US Environmental Protection Agencys Pollution PreventionInformation Clearinghouse at (202) 260-1023 or [email protected].

The software also is available from EPAs web site: http://es.inel.gov/partners/acctg. Sometechnical support is available from Tellus Institute. To obtain assistance, telephone 617-266-5400 and request P2/FINANCE Technical Support. Email inquiries may be sent [email protected].

Basic Operations

P2/FINANCE helps you make decisions about how to most effectively use limited capitalresources. It calculates the profitability of a potential investment by weighing the initial costof the investment against the revenues or operating cost savings generated by the investment.A typical financial analysis using P2/FINANCE includes the following steps:

Conceptualizethe Analysis; Enter the Financial Parameters; Enter the Cost Data; and Generate Reports.

Your first step in P2/FINANCE is to conceptualize, or design, the analysis. Are youconsidering an expansion of your current capacity? Are you considering a processmodification? As you envision the analysis, consider the broad categories of costs that eitheroccur one time as part of the initial investment (e.g., Site Preparation costs) or might changeon an annual basis as a result of the investment (e.g., Utility costs). To assist you indeveloping this list of cost categories, refer to the generic cost/savings inventory found inAppendix A. Using this generic inventory, ask yourself two questions about each costcategory: 1) Are such costs relevantto the analysis? and 2) Are such costs significant? Foreach cost category that you deem to be both relevant and significant, identify the specificcost items (e.g., electricity, gas) within that cost category related to the analysis. With yourcustomized TCA cost inventory in hand, prioritize the cost items, choosing to mostaccurately quantify those items that make best use of your limited resources. Cost items thatyou decide not to include in the quantitative analysis should be noted as qualitativeconsiderations, so that you continue to keep the broader picture in view.

With a vision of the analysis in mind, your next P2/FINANCE task consists of specifying the

default financial parameters for the analysis. These parameters provide a framework for theanalysis and include parameters related to the project as a whole as well as those specific toindividual scenarios. Many of these default financial parameters can be tailored later for theindividual cost categories within each scenario. Define the Inflation Rate, Discount Rate,Income Tax Rates, default Depreciation Method, and default Depreciation Period for theproject, as well as the Name, default Investment Year, and default Lifetime for eachscenario.

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ObtainingP2/

FINANCE

Concept-ualize theAnalysis

Enter theFinancialParams.

5

Alternative

Steam WatElectricity GasOil Sew

Financial ParametInitial Investm

Annual Operating

Base

Alternative 1 Alte

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Input the relevant initial investment and Annual Operating Costs and revenues for both theBase and the Alternative Scenarios. As you enter cost data, reconfirm that you haveincluded all relevant costs, even those indirectly related to the potential investment. Forexample, a change to painting operations may require a change in upstream degreasingoperations with relevant cost implications. These second order effects can be as significantas, or even more significant than, direct first order effects.

Once you have defined the financial parameters and cost data for an analysis, the next step isto generate reports in P2/FINANCE. You can access Scenario Summaries to review thecontents of each scenario, Tax Deduction Schedules to take a closer look at the taxdeductions allowed for each scenario, Incremental Cash Flow Analyses to calculate thediscounted cash flows of the comparison between a Base and an Alternative Scenario, andthe Incremental Profitability Analysis to review profitability indicators such as Net PresentValue, Internal Rate of Return, and Discounted Payback.

Getting Started in P2/FINANCE

This section sets the stage for the remaining sections of the Guide by detailing the elementsof a financial analysis, defining important terms used throughout the Guide, and providingsome tips on using Excel.

Elements of a Financial Analysis

Financial analysis is used to estimate the profitability of a potential investment. It includestwo types of information: 1) financial parameters and 2) cost and revenue data. Thefinancial parameters include information on depreciation, inflation, income tax rates, yourfirms discount rate, and the timing of the Initial Investment and Annual Operating Costs.(These parameters are discussed in more detail on pages 2-3 through 2-12 of the Guide).The cost and revenue data include both Initial Investment Costs and Annual Operating Costs.

Note: Throughout the Guide cost is used to indicate both costs, cost savings, andrevenues except where noted. Profitability is used throughout the Guide as a measureof the investments performance, not as a formal accounting term.

Terminology

P2/FINANCE combines financial and cost elements together to create a financial analysis.Terms are used consistently to differentiate these elements and their functions. Figures formany of the terms illustrate the relationship between the various P2/FINANCE elements.

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Enter theCost Data

GenerateReports

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Cost Item

Cost item refers to the name of a specific cost or revenue included in the analysis. Costitems can be related to the Initial Investment or to Annual Operating Costs and revenues.Steam, for example, is an operating cost item. Identify the relevant cost items for eachscenario, keeping in mind that they can vary from one scenario to another.

Cost Category

Cost items that are similar to one another are groupedtogether into broader cost categories. Again, there are costcategories for both Initial Investment and Annual OperatingCosts. For example, the cost item Steam would be includedin the Annual Operating Cost category called Utilities. InP2/FINANCE, you can modify the names of the costcategories to be used in the analysis while working onAlternative Scenario 1. These changes to Alternative

Scenario 1 also will carry through to Alternative Scenario 2 and the Base Scenario becausecost category names must remain consistent between the Base and the Alternative Scenariosfor reporting purposes.

Scenario

A scenario contains all cost data and financial parameters related to a potential investment(an Alternative Scenario) or for the current business-as-usual practices (the Base Scenario).

Analysis

An analysis estimates the profitability of an Alternative Scenario in comparison with theBase Scenario. To calculate the profitability of an investment without comparing it tobusiness-as-usual operations, leave the Base Scenario empty.

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Utilities

Scenario

Analysis

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Project

A project comprises all data from the Base Scenario and Alternative Scenarios and isequivalent to an Excel worksheet file.

Format Conventions

Formats such as color and font styles are used consistently throughout P2/FINANCE and its

Users Guide.

P2/FINANCE uses color to indicate areas for user input throughout the software. Only cellswith a yellow background allow user input; all other cells are locked and do not allow usermodifications. Cells with a green or blue background contain important on-screeninformation for the user.

P2/FINANCEs User Guide uses font styles to illustrate certain features of the software.Bold text indicates user input. Similarly, text phrases with the first letter of each wordcapitalized reflect the labels of data entry fields and other on-screen titles. For example, inthe statement, Again, because the vendor disposal cost for both products does not begin

until Year 4, the environmental engineer defines the Start Year for that category as 4, thebold text indicates that the user should input 4 into the field labeled Start Year. Thetitles of all sheets in the software, such as the Default Parameters sheet, are also capitalized.

P2/FINANCE Administrative Commands

P2/FINANCE Organization

P2/FINANCE consists of a series of different worksheets, some of which accept data input,and some of which present data summaries or analyses. The names of these sheets and their

abbreviations follow:

Project Title sheet(Project Title) Default Parameters sheet(Default Parameters) Initial Investment Costs sheet(Initial Investment) Annual Operating Costs sheet(Annual Operating) Scenario Summary sheet(Scenario Summary)

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Project

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Tax Deduction Schedule sheet(Tax Deduction) Incremental Cash Flow Analysis sheet(Cash Flow) Incremental Profitability Analysis sheet(Profitability Analysis)

Each of these sheets is described in detail in Section 2 of this Users Guide.

Moving Between Sheets

When you open P2/FINANCE, you enter the Project Title sheet. To access a differentP2/FINANCE sheet click on the tab buttons at the bottom of the screen. Each tabcorresponds to one of P2/FINANCEs sheets. For example, to access the Initial InvestmentCosts sheet, simply click on the tab titled Initial Investment. In some cases the tab for thesheet you want to access will not be visible on the screen. To locate the desired tab, use thetab scrolling arrows at the bottom left of the screen. The inner set of tab scrolling arrowsscrolls the tab button bar one at a time; the outer set of tab scrolling arrows brings youimmediately to the very beginning or the very end of the tabs button bar.

P2/FINANCE remains in your current scenario (e.g., Base Scenario, Alternative Scenario 1)when you move between sheets. In cases where you move to a sheet that does not havedifferent scenario sections (e.g., Project Title sheet), P2/FINANCE automatically takes youto the top of the sheet.

Moving Between Scenarios

Within a given sheet (e.g., Initial Investment Costs sheet), you can move between scenarios(e.g., Base Scenario and Alternative Scenario 1) by clicking on the relevant scenario buttonat the top of the screen: The buttons say: Alt1, Alt2, and Base. The Project Title, Default

Parameters, and Profitability Analysis sheets apply to all scenarios and therefore no scenariobuttons appear on the screen for those sheets. The Cash Flow sheet has two alternatives: acomparison of Base vs Alt 1 and a comparison of Base vs Alt 2. The scenario buttons onthis sheet therefore say Alt1 vs Base and Alt2 vs Base. The scenario buttons will always bevisible at the top of the computer screen as you scroll through a sheet.

Printing

A Print button will always be visible at the top of the computer screen, even as you scrolldown through a sheet. Clicking on this button will bring up a Print Selection Menu thatcontains brief instructions. Using this menu, you can print any sheet of P2/FINANCE by

clicking on the relevant print boxes. The print box for the sheet you are currently workingon will already be selected, but you can easily un-select it.

Help Function

A Help button always appears at the top of the screen, next to the Print button. Clicking onthe Help button will bring you immediately to the on-line help screen relevant to the sheet inwhich you are working. If you are working in a sheet that does not have different scenarios

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(the Project Title Sheet, the Default Parameters sheet, and the Incremental ProfitabilityAnalysis sheet), you can exit the help screen by clicking on the Return to Top button at thetop of the screen. If you are using a sheet that does have different scenarios, you can exit thehelp screen by clicking on any of the scenario buttons at the top of the screen. In either kindof sheet (with or without more than one scenario), you may also exit help by using the tabbuttons at the bottom of the screen to select a different sheet.

Calc Button

A Calc button always appears at the top of the screen next to the Print and Help buttons.P2/FINANCE has a default setting of manual recalculation. When P2/FINANCE is in thismanual setting, it will automatically recalculate only before you save, print or exit the file,but not every time you enter new data or make changes to existing data. This means that ifyou make any changes in the data you have entered or if you enter new data, these changesare not automatically reflected in the various mathematical sums and calculations shown onthe screens.

To tell the software to update its calculations, using the data changes you have made, youmust click on the Calc button. P2/FINANCE is set this way so that it runs more quickly. If,however, you want to change from manual recalculation to automatic recalculation, click onthe Excel Tools menu, choose Options, and then the Calculate folder. Select automaticrather than manual. If you then close the file and re-open it later, P2/FINANCE willreturn to the default manual setting.

Excel Tips

Although this Guide assumes user familiarity with Excel for Windows, some general tips onExcel operations appear below.

P2/FINANCE rarely requires you to use the Excel menus. Instead, P2/FINANCE containsspecial on-screen buttons for most of the common commands.

The Excel menus, however, do provide some important additional functions. To open aP2/FINANCE file, click on the File menu and then select Open. To save a file, go to theFile menu and then select Save. To close a file, go to File then Close. To quit the software,go to File then Exit. If you have not saved your changes when you Close or Exit, Excel willask you whether you want to save the file. You can also zoom in or out in any given sheetby clicking on the View menu and then selecting Zoom. This will bring up a self-

explanatory zoom menu. P2/FINANCEs default zoom size is set so that the entire width ofa sheet (with the exception of the Tax Deduction and Cash Flow sheets) fits onto the screen.If you change the zoom size, you may want to note the default size so that you can return toit easily. P2/FINANCE will not return automatically to the default zoom size if you havesaved the zoom changes.

In Excel, the status bar at the very bottom of the screen informs you of P2/FINANCEscurrent status. When P2/FINANCE is ready for you to enter data or make other changes, a

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Ready message will appear in the status bar. If P2/FINANCE is working, (e.g., movingbetween sheets & scenarios or recalculating) the Ready message will disappear, indicatingthat you must wait to continue your analysis. [note: if you press F9 to calculate (rather thanclicking on the calculate button), the status bar will for some reason continue to say readyand allow you to keep entering data; if you do enter new data, however, the recalculationwill stop. This is due to a problem in the Excel program. Using the calculate button istherefore recommended.]

If P2/FINANCE is operating in the default manual recalculation setting, the status bar shoulddisplay calculate any time you make a change to your file. This is a reminder that youneed to recalculate to make the various analyses reflect your new inputs. Unfortunately, thecalculate warning does not always appear when it should -- again due to a small bug inExcel. This means that you must be particularly careful about remembering to recalculatebefore using any of the calculated figures.

If you pull down any of the Excel file menus, the status bar will give a brief explanation ofwhatever function you have highlighted.

Spreadsheet Protection

P2/FINANCE is a protected spreadsheet; cells not requiring user input and cells containingformulas are locked and cannot be modified. Additionally, the file cannot be linked to otherfiles. Protection of this type is necessary to maintain quality control over the program.Protection of P2/FINANCE ensures that you receive a high quality tool.

Computer SpecificationsP2/FINANCE was programmed in Excel Version 5.0 for Windows Version 3.1. Othercombinations of Windows and Excel have not been tested.

Hardware and Software Specifications

Certain minimum hardware and software specifications must be met to operateP2/FINANCE. In addition to these minimum specifications, we have defined a set ofrecommended hardware and software specifications that will facilitate your use of

P2/FINANCE, but are not absolutely essential for its operation. Table 1 lists both theminimum and recommended hardware specifications.

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Table 1. Specifications for Operating P2/FINANCE Version 3.0 in Excel Version 5.0 forWindows

Minimum Specifications Recommended Specifications

Computer Chip 386 486 or Pentium

Windows Version 3.11 3.11Memory (RAM) 4 Megabytes 8 or more MegabytesDisk Space 2 Megabytes 2 MegabytesMouse? Yes YesColor Monitor? No Yes

Beyond these minimum requirements, P2/FINANCE runs appreciably faster with morememory (RAM).

Installation

To install P2/FINANCE Version 3.0 programmed in Excel 5.0 for Windows, load theInstallation Disk in your disk drive and type:

[disk drive letter]:\p2fexcel

This action unzips the spreadsheet and copies one file into a C:\P2FEXCEL directory:P2FINAN.XLS. P2FINAN.XLS is an empty template that must be copied for each projectanalysis.

When you are ready to enter data into the spreadsheet, save theP2FINAN.XLSfile under anew

name to use for a particular project. Note that the file extension,XLS, may not be changed.

Note: You may reinstall the software at any time to generate a blank spreadsheet with

the name P2FINAN.XLS

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2. Step by StepInstructions:

Entering Data

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P2/FINANCE Version 3.0 Step by Step Instructions: Entering Data

Project Title Sheet

On the Project Title sheet, enter descriptive information about the project for later reference. Atthe top of the sheet, enter the date of the analysis. For example, to enter January 25, 1996, type:Date: 1/25/96. Enter a name for the project in the yellow field to the right of the words ProjectTitle.

Note: P2/FINANCE automatically copies the project name and date entered here to the top

of other spreadsheet pages.

In the remaining yellow fields, enter your name, the name of your organization, and otherinformation about the analysis. For example, you can enter the analysis assumptions as well asqualitative considerations related to the project in the Comments section.

Accessing Scenarios

The Project Title sheet does not contain different sections for each scenario. Therefore, noscenario buttons appear at the top of the screen.

Printing Scenarios

To print the Project Title sheet, click on the Print button at the top of the screen to access thegeneral Print Selection Menu. From this menu, select the Project Title sheet and then click

Okay. If you are working in the Project Title sheet, it will already be selected for you. You canprint other sheets by selecting them instead of or in addition to the Project Title sheet.

Accessing Help

To access the on-line help screen for the Project Title sheet, click on the Help button at the topof the screen. This help screen describes the information requested on the Project Title sheet andalso provides general information on Total Cost Assessment and financial analysis. To exit thehelp screen, click on the Return to Top button at the top of the screen. You may also use the tabbuttons at the bottom of the screen to select a different sheet.

Calculating

To recalculate totals and other analysis results after entering new data, click on the Calc buttonat the top of the screen. P2/FINANCE has a default setting of manual recalculation. Thismeans that if you make any input changes, they are not automatically reflected in the varioustotals and analyses. To incorporate the changes, you must click on the Calc button. To learn

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how to change the default setting or to read more about the Calculate function, see sections onCalculate Button and Excel Tips on page 1-8.

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Default Parameters Sheet

In addition to cost data, P2/FINANCE requires general information about your firm and theproposed investment in order to calculate profitability. This additional information, referred toas the financial parameters for the analysis, range from the Depreciation Method used for aninvestment, to Income Tax Rates for the firm, to the timing of Annual Operating Costs.Although you can tailor many of these parameters to individual cost categories, P2/FINANCEallows you to define a set of Default Parameters to use as a starting point.

On the left, the Default Parameters sheet lists Global Parameters, those parameters that apply toall scenarios within the project. On the right, the Default Parameters sheet lists ScenarioParameters. You can define defaults for:

Global Parameters Applied ....

Inflation Rate automatically Discount Rate automatically Income Tax Rates (Local, State, Federal) automatically Depreciation Method Apply Defaults button Depreciation Period Apply Defaults button

Scenario Parameters

Name automatically default Investment Year Apply Defaults button default Lifetime Apply Defaults button default Start Year Apply Defaults button default End Year Apply Defaults button

To enter Default Parameters, position your cursor on the appropriate yellow field and enter yourselections. P2/FINANCE applies some of these parametersnamely, Inflation Rate, DiscountRate, and Income Tax Ratesto the analysis in the same way as other data entries are applied,i.e., as soon as you type in the desired value and then hit the Calc button. However, for thoseparameters that can be tailored for individual cost categoriesdefault Depreciation Method,default Depreciation Period, default Investment Year, and default LifetimeP2/FINANCEimplements them only after you click on the Apply Defaults button visible on the sheet. Forthese parameters, selecting Apply Defaults deletes ALL prior tailoring of these parameters forindividual cost categories. For example, suppose you change the default Investment Year for

Alternative Scenario 1 to Year 2. If you had already tailored some Initial Investment Costcategories to Year 3, clicking the Apply Defaults button reverts the Investment Year for all costcategories in the Alternative Scenario 1 to Year 2. As this command has the potential to deleteprevious work, P2/FINANCE asks you twice if you are sure that you want to Apply Defaults.After activating Apply Defaults, you can tailor the Default Parameters for each cost category inthe Initial Investment Costs and Annual Operating Costs sheets.

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Note: Enter percentages as decimals or with a percent sign (%). For example, to define aninflation rate of 3.5%, type: .035 or 3.5%.

P2/FINANCE allows you to define financial parameters at two levels in the software: 1) on theDefault Parameters sheet and 2) for individual cost categories on the Initial Investment Costs andAnnual Operating Costs sheets. Table 2 displays the levels at which each parameter can bedefined.

Table 2. Levels of Parameter Definition

Default ParametersSheet

Initial InvestmentCost Category

Annual OperatingCost Category

Inflation Rate/Escalation X XDiscount Rate XIncome Tax Rates XDepreciation Method X XDepreciation Period X XInvestment Year X XLifetime X XStart Year XEnd Year X

Time Value of Money

Before describing in detail each financial parameter, it is useful to discuss one key concept inproject financial analysisthe time value of money.

Money has two important characteristics: dollar value and time value. Most people are familiarwith dollar value, preferring to have $1000 instead of $50. For many people, however, the timevalue of money remains confusing. The time value of money recognizes that the timing of cashflows is relevant to the profitability of a project. For example, a $200 revenue received in Year1 is worth more than $200 received in Year 10. The time value of money serves as the basis forthe Inflation Rate, Escalation and the Discount Rate.

Inflation and escalation both reflect the fact that money loses value over time as prices increase.Discounting accounts for the opportunity cost of selecting one project over other investmentopportunities. The Inflation Rate, Escalation Rate, and Discount Rate are all described in moredetail in the following section on Global Parameters.

Global Parameters

On the left of the Default Parameters sheet, P2/FINANCE lists Default Parameters that are

defined for the entire projectGlobal Parameters. You can modify some of these GlobalParameters for individual cost categories. A description of each follows.

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Inflation Rate

Inflation reflects the fact that prices rise over time (e.g., one sheet of printing substrate costs $1

in Year 1, whereas in Year 2 a sheet of the same substrate costs $1.05). P2/FINANCE allowsyou to choose between two approaches to financial analysis. In the first (real) approach, youdo not include an Inflation Rate in the analysis and you apply a real Discount Rate that does notincorporate inflation. In the second (nominal) approach, you include an Inflation Rate in theanalysis and apply a nominal Discount Rate that incorporates inflation. You can choose eitherway for your analysis, but make sure that the Discount Rate you choose corresponds to theinflation approach you have selected.

P2/FINANCE allows you to define a global Inflation Rate on the Default Parameters sheet.Simply enter a percentage in the data entry field. P2/FINANCE then applies that percentage toboth the Annual Operating Costs and Initial Investment Costs over time in all scenarios.Applying a 4.5% Inflation Rate to an Annual Operating Cost of $100 inflates that cost to$104.50 in Year 1, $109.20 in Year 2, $114.12 in Year 3, $119.25 in Year 4, and so on.

In addition to this global Inflation Rate, P2/FINANCE allows you to assign an Escalation Rateto Annual Operating Cost categories. Escalation, defined as a percentage, represents costincreases above the Inflation Rate. For example, waste disposal costs often rise at a rate higherthan average inflation. If you predict that inflation will be 5%, but that waste disposal priceswill increase at an annual rate of 7%, then the Escalation Rate for waste disposal costs is equalto 2%, i.e., the difference between the total increase in prices and the Inflation Rate. While theglobal Inflation Rate is defined on the Default Parameters sheet, Escalation is defined on theAnnual Operating Costs sheet for individual cost categories.

Note: Escalation can be a negative percentage, indicating that for a particular costcategory, you expect costs to rise at a rate lower than the global Inflation Rate.

Discount Rate

The practice of discounting is a way of accounting for a second aspect of the time value ofmoney. When a firm invests its money in the purchase of a piece of equipment now, at Yearzero, the firm expects to see a financial return on this investment over a certain period of time,say 3-5 years or even longer. For example, if a printer buys a new printing press, the firmexpects to see increased sales revenues via the new production line. If the printer instead buys a

solvent distillation system, the firm expects to see reduced raw material purchase costs andreduced waste disposal costs.

The practice of discounting acknowledges that there are opportunity costs to using money.For example, when a printer chooses to invest in a solvent distillation system, the firm foregoesthe opportunity to increase production capacity by purchasing a new press with that money. Afirm usually has multiple investment opportunities, each with a different financial benefit for thefirm. In order to choose between the available investment opportunities, the firm should

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determine the rate of financial return that it expects from a typical investment, and compare thefinancial benefits of the specific projects at hand to that expected rate of return and also to eachother.

The expected rate of return for a typical investment is called the firms Discount Rate. TheDiscount Rate, expressed as a percentage, is used to discount dollars received by the firm infuture years as a result of an investment in Year zero, i.e., the Discount Rate is used to accountfor the time value of money as money that a firm invests now brings returns in the future.

The Discount Rate of a firm should approximate the average financial return expected on atypical investment made by that firm. As such, the chosen Discount Rate should, at minimum,ensure that the firm recovers its cost of capital, i.e., the financial return from an investmentshould at least cover the cost of the money required for the investment. For example, the moneyused for an equipment purchase might come from equity capital (e.g., stock funds, on whichthe firm will have to pay dividends) or it might come from debt capital (e.g., a loan from abank, on which the firm will have to pay interest). The financial return on an investment shouldat least recover the cost of these investment funds.

Instead of detailing the source and cost of available investment capital for every individualinvestment project, firms typically use a weighted average cost of capital for the firm as a whole,a measure that characterizes the balance between the firms use of equity capital and debt capital(including the tax effects of using debt capital) over a longer period of time. This weightedaverage cost of capital is often used as the firms Discount Rate. The use of the weightedaverage cost of capital as the firms Discount Rate for the financial analysis of investmentopportunities allows the firm to select the investment opportunities that are profitable enough, atminimum, to cover the firms average money costs, and hopefully reap a profit above thatminimum.

The value of your companys Discount Rate also depends on the approach to financial analysisyou have chosen: the real approach vs. the nominal approach. As discussed previously, if youhave not included an Inflation Rate in your financial analysis, then you should not incorporateinflation in your Discount Rate, i.e., you should use a real Discount Rate. Alternatively, if youhave included an Inflation Rate in your financial analysis, make sure that your Discount Ratealso incorporates inflation, i.e., use a nominal Discount Rate. The relationship between the twotypes of Discount Rate is shown below:

N = R + I + (R * I)

where:N = Nominal Discount RateR = Real Discount RateI = Inflation Rate

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The typical real Discount Rate for a stable business ranges from 8% to 20%. Because aDiscount Rate is based on your cost of capital, it incorporates financing parameters (e.g., interestand principal) in the analysis, avoiding the need to directly include them in the cash flowcalculations.

The Discount Rate is one way to measure the risk associated with an investment. 2 If the riskassociated with a proposed investment differs from the risk of investments generally made by thefirm, the Discount Rate should be adjusted accordingly. Increase the Discount Rate for thoseinvestments that are riskier than average; decrease the Discount Rate for those investments thatare less risky than average. The amount to vary the Discount Rate to account for risk is often aproduct of intuition rather than quantitative analysis.

Define a Discount Rate for the project on the Default Parameters sheet. P2/FINANCE appliesthis value to the Incremental Cash Flow Analysis (i.e., the comparison of each AlternativeScenario with the Base Scenario) and, thus, the Discount Rate is the same for all scenarioswithin a project. P2/FINANCE uses the Discount Rate to calculate the Discounted Cash Flowon the Incremental Cash Flow Analysis sheet. The Discounted Cash Flow is then used to

calculate Net Present Value and Discounted Payback on the Incremental Profitability Analysissheet.

Income Tax Rates

Taxes can play a major role in the profitability of any project and are calculated at a company-wide level. Define the Local, State, and Federal Income Tax Rates for the project by enteringthe appropriate percentages in the yellow fields on the Default Parameters sheet. Because youcan deduct your state and local taxes from your federal taxable income, P2/FINANCE calculatesan Aggregate Income Tax Rate using the formula:

A = [F * (1 - S - L)] + S + Lwhere:

A = Aggregate Income Tax RateF = Federal Income Tax RateS = State Income Tax Rate

L = Local Income Tax Rate

2 Generally, it is preferable to directly quantify the risk or uncertainty associated with an investment. For example,include an estimate of the legal liability related to an investment directly in the analysis, instead of adjusting theDiscount Rate for this risk.

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P2/FINANCE applies this aggregate value to the Incremental Cash Flow Analysis (i.e., thecomparison of each Alternative Scenario with the Base Scenario) and, thus, the AggregateIncome Tax Rate is the same for all scenarios within a project.

When defining your Income Tax Rates, consider whether the proposed investment would changeyour current tax rates. For example, if the investment would result in an increase in productionwith a corresponding increase in revenues, the firm might jump to a higher tax bracket.

Note: P2/FINANCE does not explicitly include capital gains taxation or investment tax

credits. These tax impacts, where applicable, can be entered into the software as AnnualOperating Costs/savings.

Depreciation

The Internal Revenue Service (IRS) permits firms to shield some of their taxable incomethrough tax depreciation of the Initial Investment Costs. Depreciation is the gradual deductionof the equipment costs over time. IRS specifies the method and time period to calculate thedepreciation for a piece of equipment. The remaining value of the equipment in each year(Initial Investment Cost - cumulative depreciation) is the Remaining Book Value of theequipment.

The calculation of depreciation does not take into account the time value of money. Forexample, suppose you purchase a new dry cleaning machine for $35,000 and depreciate it over7

years. Using the standard IRS Depreciation Methoddouble declining balance switching tostraight line with a half-year convention (DDB)and applying a Discount Rate of 10%(assuming 0% Inflation Rate) would over time generate a tax shield of $26,075 in Year 0dollars. Because depreciation does not account for the time value of money, firms benefit fromdepreciating equipment as quickly as possible. The IRS defines two accelerated schedules forthis purpose.

Although the IRS requires you to depreciate equipment costs over time, firms may directlyexpense (i.e., fully deduct from taxes) some non-equipment costs (e.g., Site Preparation, Start-upTraining) associated with the initial investment. You cannot depreciate or expense WorkingCapital Costs (e.g., inventory expenses) because they do not represent real cash expenses; thesecosts are recovered at the end of the Lifetime of the project. (For further information onWorking Capital, see pages 2-17 and 2-18). P2/FINANCE allows you to select DepreciationMethods for both Expensed Initial Investment Costs and Working Capital Initial InvestmentCosts.

Note: This Guide provides general information on how to estimate the depreciation impactof a potential project. However, when filing your taxes, check with an accountant or theIRS to ensure the use of an appropriate depreciation method and period.

On the Default Parameters sheet, select a default Depreciation Method and default DepreciationPeriod to use as a starting point for the analysis. To define a default Depreciation Method, enterone of the depreciation codes listed on the Default Parameters sheet and below. Similarly, to

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define the number of years over which the equipment is depreciated, enter a number in theyellow field labeled default Depreciation Period.

P2/FINANCE allows you to define depreciation parameters at two different levels in thesoftware:

1. On the Default Parameters sheet as a Global Parameter for the project; and

2. On the Initial Investment Costs sheet for each cost category to override the defaultDepreciation Method and default Depreciation Period for costs in thatparticular category.

Depreciation Methods

P2/FINANCE allows the user to select a Depreciation Method for each Initial Investment Costcategory from several choices:

SL (Straight Line) - The depreciation amount is constant over the DepreciationPeriod.

DDB (200% Declining Balance switching to Straight Line) - An accelerated schedulein which the equipment is depreciated at a higher rate in the beginning of itsLifetime.

1.5DB (150% Declining Balance switching to Straight Line) - Another acceleratedschedule at a lower rate.

P2/FINANCE automatically applies a half-year convention to all depreciation calculations (i.e.,SL, DDB, 1.5DB). Not knowing when in a year the equipment is purchased (or placed intoservice), this IRS convention allows firms to deduct only a half years value of depreciation inthe first year the equipment was placed into service. To recapture the lost half year ofdepreciation, the IRS extends the Depreciation Period by a half year. For example,P2/FINANCE depreciates equipment with a Depreciation Period of five years over six yearswith a half years depreciation taken in the first and sixth years.

If depreciation is not relevant to a particular cost category, P2/FINANCE also allows the user toselect from two non-Depreciation Methods:

EXP (Expensed (tax deductible in the first year)) - These non-equipment costs arefully deducted from the cash flow as operating expenses in the year following theInvestment Year.

WC (Working Capital (not tax deductible)) - Working Capital Costs are neitherdepreciated or expensed. Working Capital Costs are returned to the cash flow atthe end of the projects Lifetime. Marking a category as WC informs

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P2/FINANCE that these costs need to be added back to the cash flow at the endof the cost categorys Lifetime.

DDB is the most commonly used Depreciation Method because it allows the firm to deduct ahigher percentage of the Initial Investment Cost early in the Depreciation Period.

Depreciation Period

The IRS has developed regulations on Depreciation Periods allowed for different types ofproperty. In general, the following Depreciation Periods listed in Table 3 apply.

Table 3. Depreciation Period by Property Type3

Property Period

Small tools 3 yearsAutomobiles, office machinery, computers, and property used for research

and experimentation5 years

Office equipment and most manufacturing equipment 7 yearsMachinery and equipment used for petroleum distilling and refining, and

for milling grain 10 yearsSewage treatment plants, telephone and electrical distribution facilities, and

land improvements 15 yearsService stations and other property with a useful life of less than 27.5 years 20 yearsResidential rental property 27.5 yearsBuildings and real estate placed into service before 5/13/1993. 31.5 yearsBuildings and real estate placed into service after 5/12/1993. 39 years

3 Ray H. Garrison, D.B.A., CPA and Eric W. Noreen, Ph.D., CMA, Managerial Accounting, 7th ed. (Burr Ridge,IL: Irwin, 1994), p. 718.

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Scenario Parameters

Other Default Parameters are defined for each individual scenario. On the Default Parameterssheet, you define the Name, the default Investment Year, and the default Lifetime for the

scenario. P2/FINANCE automatically defines the default Start Year and default End Year forthe scenario.

Name

Define a Name for the scenario here. P2/FINANCE then copies this Name to all sheets for thescenario.

Investment Year

P2/FINANCE allows you to specify a default Investment Year for each scenario. Simply enter anumber in the yellow field for each scenario. You later can tailor the Investment Year forindividual Initial Investment Cost categories. Year 0 is the most common Investment Year. It ispossible to analyze multi-year investments for which you would purchase some equipment at theend of Year 0 and then more equipment at the end of Year 2. For such an investment, enter0 asthe default Investment Year. Then, on the Initial Investment Costs sheet, create two equipment

cost categoriesPurchased Equipment: Year 0 and Purchased Equipment: Year 2.Specify an Investment Year of2 for the latter equipment cost category.

From the default Investment Year, P2/FINANCE identifies the default Start Year for the Annual

Operating Costs as the following year. This relationship between Initial Investment Costs andAnnual Operating Costs stems from financial analysis convention, which assumes thatinvestments occur at the end of the year (e.g., December 31, 1995) and that depreciation andother tax impacts as well as operating costs do not start until the beginning of the following year(e.g., January 1, 1996). For example, if you purchased a paint spray booth in year 0, you wouldnot begin accounting for Annual Operating Costs, revenues, and tax implications (such asdepreciation) until year 1 when you would have a full year of operation. This conventionensures that each year (after Year 0) reflects a full year of costs due to the investment.

Lifetime

P2/FINANCE allows you to define a default Lifetime for each scenario. Simply enter aLifetime value in the labeled yellow field for each scenario. Lifetime affects the InitialInvestment Costs in two ways. First, it defines when the equipment is salvaged (i.e., sold) sothat P2/FINANCE can include the revenue from the sale as well as related taxes in the analysis.Second, Lifetime defines when Working Capital is no longer needed for the project and isavailable for other uses. The return of Working Capital appears as a revenue in the analysis

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because the investment can, in essence, sell the Working Capital to another investment. Youlater can tailor the default Lifetime for individual Initial Investment Cost categories.

In addition to these two uses, P2/FINANCE uses the default Lifetime to define the default EndYear for the Annual Operating Costs. You later can tailor this default End Year value forindividual Annual Operating Cost categories.

Start Year

P2/FINANCE automatically defines the default Start Year for the Annual Operating Costs as theyear after the default Investment Year. According to financial analysis convention, InitialInvestment Costs occur at the end of the year and Annual Operating Costs begin in the followingyear. For example, if you define Year 3 as the default Investment Year, P2/FINANCEautomatically defines Year 4 as the default Start Year for Annual Operating Costs. You latercan modify this default Start Year on the Annual Operating Costs sheet for each cost category.

End Year

P2/FINANCE automatically defines the default End Year for the Annual Operating Costs byadding the Lifetime to the Investment Year. For example, if you define Year 2 as the defaultInvestment Year and 10 as the Lifetime of the investment, P2/FINANCE automatically definesYear 12 as the default End Year for the Annual Operating Costs. You later can modify thisdefault End Year on the Annual Operating Costs sheet for each cost category.

Accessing ScenariosThe Default Parameters sheet does not contain different sections for each scenario. Therefore,no scenario buttons appear at the top of the screen.

Printing Scenarios

To print the Default Parameters sheet, click on the Print button at the top of the screen to accessthe general Print Selection Menu. From this menu, select the Default Parameters sheet and thenclick Okay. If you are working in the Default Parameters sheet, it will already be selected for

you. You can print other sheets by selecting them instead of or in addition to the DefaultParameters sheet.

Accessing Help

To access the on-line help screen for the Default Parameters sheet, click on the Help button atthe top of the screen. This help screen defines each of the financial parameters listed on the

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Default Parameters sheet. To exit the help screen, click on the Return to Top button at the topof the screen. You may also use the tab buttons at the bottom of the screen to select a differentsheet.

CalculatingTo recalculate after entering new data, click on the Calc button at the top of the screen.P2/FINANCE has a default setting of manual recalculation. This means that if you make anyinput changes, they are not automatically reflected in the various totals and analyses. Toincorporate the changes, you must click on the Calc button. To learn how to change the defaultsetting or to read more about the Calculate function, see sections on Calculate Button andExcel Tips on page 1-8.

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Initial Investment Costs Sheet

Once you define both the Global and Scenario Parameters for the project on the DefaultParameters sheet, you can begin entering cost data related to the initial investment. In manycases, only Alternative Scenarios, i.e., changes to your current process, require an initialinvestment. For these cases, enter the Initial Investment Costs under an Alternative Scenario. Incases where the Base Scenario, or business-as-usual activities, also requires an investment, enterInitial Investment Costs in both Alternative and Base Scenarios. For example, a dry cleaningshop may face a regulation that requires it to add pollution control devices to their dry cleaningmachines to meet air emission limits. The shop, however, considers transferring some of itscapacity from dry cleaning to wet cleaning, enabling it to meet air emission limits withoutpollution control devices. To assess the profitability of such an operating change, the shopwould enter the Initial Investment Costs needed to transfer some of its capacity to wet cleaningin Alternative Scenario 1 and input the Initial Investment Costs related to the pollution controldevices in the Base Scenario. P2/FINANCE allows you to define Initial Investment Costs for

any scenarioAlternative or Base.

First, identify the costs required to start up the investment by developing a cost inventory relatedto the initial investment. Total Cost Assessment (TCA) expands the definition of InitialInvestment Costs to include a wider range of costs than typically considered in conventionalfinancial methods. An example of this broader view is P2/FINANCEs use of the term InitialInvestment Costs as a replacement for capital costs. The term capital cost generally refersonly to equipment and other direct material cost items, i.e., those that are depreciable, and thusomits indirect and non-depreciable costs. Indirect costs related to the initial investment, such aslabor associated with planning, engineering, and training, can impact the profitability of theinvestment and thus merit inclusion in the analysis. Keep these other Initial Investment Costs in

mind and, where feasible, include them in your analysis to enhance its accuracy.

Financial analysis estimates the profitability of an investment and as an estimate, is not sensitiveto the precise timing of Initial Investment Costs and Annual Operating Costs within a calendaryear. Instead, financial analysis convention assumes that Initial Investment Costs occur at theend of the year (e.g., December 31, 1995) and that depreciation and other tax impacts as well asAnnual Operating Costs do not start until the beginning of the following year (e.g., January 1,1996). For example, if you purchase a rotary tiller at the end of Year 4, you would not beginaccounting for Annual Operating Costs, revenues, and tax implications (e.g., depreciation) untilYear 5 when you would have a full year of operation. This convention ensures that each year(after Year 0) reflects a full year of cost impacts due to the investment. As a result of this timing

convention, the default Start Year for Annual Operating Costs always is the year following thedefault Investment Year.

The first step on the Initial Investment Costs sheet is to define the relevant cost categories for theproject. Cost categories serve two purposes in P2/FINANCE. First, they are used in theScenario Summary, Tax Deduction Schedule, and Incremental Cash Flow Analysis sheets fortracking and organizing cost data. Second, cost categories are used to indicate a set of financialparameters (e.g., Depreciation Method) that differ from the Default Parameters. You can use thecost categories to organize these modifications. For example, an auto manufacturer depreciates

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most equipment over seven years with the exception of small and special tools that depreciateover three years. To accommodate both Depreciation Periods in a single scenario, define two

purchased equipment categoriesone with a 7 year Depreciation Period, titled PurchasedEquipment - 7 Years and the other with a 3 year Depreciation Period, titled PurchasedEquipment - 3 Years.

Within a project, the names of Initial Investment Cost categories must remain consistent fromscenario to scenario because P2/FINANCE tracks costs in the Scenario Summary, TaxDeduction Schedule, and Incremental Cash Flow Analysis sheets by cost category. Therefore,you can modify the names of cost categories only in Alternative Scenario 1; P2/FINANCEautomatically adjusts the names of cost categories in other scenarios to reflect changes made inAlternative Scenario 1.

Having defined the cost categories, enter the relevant cost item names within each cost category.Because the cost items are not used for reporting purposes by the program, they can vary fromscenario to scenario. P2/FINANCE inflates Initial Investment Costs that do not occur in Year 0,using the global Inflation Rate and the Investment Year defined for that cost category.

Note: For each cost item, always enter the Initial Investment Cost in Year 0 dollars

regardless of the year in which the cost occurs. In P2/FINANCE, enter costs as positivevalues and revenues as negative values. The only exception to this sign convention isSalvage Value, a revenue that is entered in the Salvage Value field as a positive value.

P2/FINANCE monitors the parameters defined for each cost category and gives an errormessage (P2F #ERR) in the TOTAL field for a cost category when the defined combination ofparameters is not allowed. For example, the choice of DDB as the Depreciation Method with aDepreciation Period of 0 yields P2F #ERR. Several rules govern parameters defined at thecategory level.

With a Depreciation Method ofDDB, 1.5DB, orSL, the Depreciation Period must begreater than 0.

The Depreciation Period can never be less than 0 or text. The Depreciation Method must be one of the five P2/FINANCE codes. The Investment Year can never be less than 0 or text. The Investment Year can never by greater than 15. The Lifetime can never be less than 1 or text.

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Salvage Value

If your investment has resale potential at the end of its Lifetime, include its Salvage Value (inYear 0 dollars) on the Initial Investment Costs sheet. In the cost category where you havedefined the equipment cost, enter its resale value in the yellow Salvage Value field as a positive

value.

Note: Salvage Value is the only revenue you enter as a positive value in P2/FINANCE.

P2/FINANCE inflates the Salvage Value and includes it on the Incremental Cash Flow Analysissheet as a revenue in the Lifetime year (i.e., Investment Year + Lifetime). For example, youpurchase a printing press in Year 0 for$500,000 and believe that you can sell it at the end of its10 year Lifetime for$50,000 (in Year 0 dollars), assuming an annual Inflation Rate of 5%. InYear 10, P2/FINANCE inflates the Salvage Value to $81,445 and includes this value as arevenue related to the investment.

In addition to its revenue-generating potential, Salvage Value also impacts the taxes related to aninvestment. Because IRS depreciation equations do not account for Salvage Value, any revenuereceived from the resale of fully depreciated equipment is taxable. If the equipment is soldbefore it has been fully depreciated, the Taxable Gain (Loss) on Salvaged Equipment depends onthe difference between the inflated Salvage Value of the equipment and its Remaining BookValue at the end of its Lifetime. If the salvaged equipment is sold for less than its Book Value(i.e., Salvage Value < Book Value), you can reduce your taxable income by the differencebetween the two values. Similarly, if the salvaged equipment is sold for more than its BookValue (i.e., Salvage Value > Book Value), you have to pay taxes on the difference. Thisdifference (i.e., Salvage Value - Book Value) is included in the Tax Calculation on both the TaxDeduction Schedule and Incremental Cash Flow Analysis sheets. Because it is unlikely that theSalvage Value of a piece of equipment would exceed its original purchase price, P2/FINANCEdoes not consider capital gains taxation.

Tailoring the Financial Parameters

For each Initial Investment Cost category, you can change the following Default Parameters tomore accurately reflect the profitability of an investment: Investment Year, Lifetime, defaultDepreciation Method, and default Depreciation Period. Organize cost items that require thesame financial parameters into corresponding cost categories. For example, you are evaluating amulti-year investment in which the majority of Initial Investment Costs occur in Year 0 with theexception of some related equipment costs that will not occur until Year 2. To evaluate such aninvestment, separate the costs first by Investment Year. Then within each of these sets, separateall of the costs by Depreciation Method. Continue this approach with the Lifetime andDepreciation Period parameters until you have groups of cost items that share the same financialparameters. P2/FINANCE only uses Lifetime to determine when to cash in Salvage Value andWorking Capital. If neither of these are relevant for the cost items within a particular costcategory, you do not have to make sure that all cost items share the same Lifetime.

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One example of a situation in which you would want to tailor the Default Parameters for anindividual cost category is when you have Initial Investment Costs that can be directly expensed.Some Initial Investment Costs do not have to be depreciated, such as Site Preparation and Start-up Training. P2/FINANCE allows you to select a Depreciation Method, EXP, for InitialInvestment Costs that should be fully deducted from the cash flow as operating expenses.Because P2/FINANCE adopts the financial analysis convention that investments occur at the endof the year (e.g., December 31), it does not expense these Initial Investment Costs until the yearfollowing the Investment Year. For example, if you incur an expensed cost in Year 2,P2/FINANCE does not expense it for tax purposes until Year 3. When you select the EXPmethod, P2/FINANCE ignores Salvage Value entries because only equipment can be salvaged.P2/FINANCE also ignores the Depreciation Period when you select EXP.

Working Capital

You also may need to tailor the Default Parameters for Initial Investment Cost categories that

denote Working Capital. When beginning a new process, developing a new product, orincreasing production capacity, your firm may need to temporarily set aside funds for projectstart-up. These temporary investments can be recovered by the company at the end of theProjects Lifetime. During the project, though, these investments are tied up in the project andare not available for other investments; however, the time value of money must be accounted forthrough the application of an Inflation Rate and a Discount Rate. An investment in inventoriesis a common Working Capital Initial Investment Cost that is relevant for the financial analysis ofa project. For example, it may be necessary to purchase $3000 worth of inventory in substratesand inks when you bring a new press on-line at the end of Year 0, knowing that you can recoverthese costs by selling the inventory at the end of the projects Lifetime. In this example, youwould incur a cost at the end of Year 0 (included on the Initial Investment Costs sheet) and see arevenue (i.e., a release of the tied-up funds) at the end of the projects Lifetime included as

Recovery of Working Capital on the Incremental Cash Flow Analysis sheet. Because WorkingCapital is recovered by the company, it cannot be depreciated.

Working Capital on a facility-wide basis includes the amount of capital tied up in accountsreceivable, accounts payable, ta

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