Pollution Prevention
and Finance
NATIONAL POLLUTION PREVENTION CENTER FOR HIGHER EDUCATION
'- £?A/-~42/r-'95/012
Green Lights' Economics:
Graphic Design Considers
alighting Upgrade
By, Michael Tucker, Associate Professor of Finance, Fairfield University
A Phone Call Gets the Ball Rolling
Sam Taylor, owner of Graphic Design, had just re-
ceived a call from Bob Jackson of Energy Solutions
.offering a free, no-obligation lighting audit. Using the
audit, Jackson would determine how much electricity
Graphic Design's lights used and propose an alterna-
tive system.
A lighting audit was'n't exactly at the top of Sam's "do-
it-now" list. Although he recognized the importance
of good lighting, it was something that he thought he
had taken care of five years earlier when he redesigned
the building's interior and had the current fixtures and
bulbs installed., It had cost plenty at the time and
seemed to be working finewhy should he replace
anything now? Jackson responded mat Graphic Design's
lighting system was probably using considerably more
electricity than necessary. ,
At nine cents per kilowatt hour (kWh)1, electricity was
, not cheap. Then again, thought Taylor, the expense
wasn't hurting his bottom line. He was also concerned
that the cheaper lighting might be of lower quality.
Jackson assured .him that this was not the case. Finally,
there were rumors, not scientifically substantiated, that
radioactive material in the ballasts could be harmful.
Because Taylor owned the building, a lighting upgrade
sounded more palatable than if his company had been
a. tenant. Still, it was likely to cost more than Taylor
wanted to spend on something that didn't seem to
need fixing. He wondered if that money might be
better spent on new equipment or spftware instead of
high-tech lighting Then Jackson mentioned that South
lFor example, ah appliance that draws 1,000 watts
for one hour has consumed 1 kWh. , .
Norwalk Power and Lighting (SNP&L) would pick up
half the cost of any installation as part of its program
to reduce electricity usage. Taylor sensed a bargain
and his interest went up a notch. He invited Jackson
to inspect his building the following day.
Reducing Greenhouse Gases With
"Green" Lights
When Jackson arrived, he described the United States
Environmental Protection Agency (U.S. EPA) program
from which he had received his training in the energy-
efficient lighting business. Called Green Lights, the
program reduces power plant emissions of carbon
dioxide (the biggest contributor to global warming)
and other greenhouse gases by encouraging partici-
pants to install energy-efficient lighting. * - .
Greenhouse gases prevent or inhibit heat generated
at the surface of the earth from escaping. Venus is an
example of ah extreme greenhouse effect the predom-
inantly carbon dioxide atmosphere traps the planet's
heat, keeping surface temperatures around 800° F.
While Earth is not about to become like Vemis, explained
Jackson, scientists have concluded that human-induced
changes in atmospheric composition (i.e., increasing
emissions and the accumulation of greenhouse gasses)
are creating greenhouse conditions, and global warming
appears inevitable. The degree to which it will occur
depends on what actions humanity takes in the near-
term to reduce emissions! At the 1992 United Nations
Convention on Environment and Development, global
warming concerns prompted major industrial nations
to agree in principle to roll back carbon dioxide emis-
sions to 1990 levels. Changing to energy-efficient
lighting is a small step toward accomplishing this goal.
Lighting Case 1
July 1995
-------
Green Lights participants typically reduce the lighting
portion of their electricity bill by more than half and
often improve lighting quality. Although rebates from
electric utilities have been a big motivator in some areas
of the country, internal rates of return (IRRs) average
47°b this benefit, along with the environmentally posi-
tive nature of the program, is often a sufficient motiva-
tor for another company to participate in Green Lights.
Environmental stewardship was a major focus of inter-
est at the local high school.. Lately, Sam Taylor had
been hearing about it from his teenage son. If he
bought into this Green Lights program, he could show
his son that he was doing more than just talking about
making a difference. Of course, if he could "do well
[financially] by doing good," all the better.
Can Green Lights Save Money Too?
Jackson explained that utilities, for their part, were not
handing out rebates purely out of generosity. Reduc-
tions in peak power usage meant lower construction
budgets for new power plants. A one-kWh reduction
in electricity demand translated into $1,500 of future
construction costs deferred or possibly avoided.
To Taylor, Green Lights sounded like just the type of
program the country needed to get away from govern-
ment bureaucracy and still make progress on taking
care of the environment. Without being subjected to
any new regulations, laws, or threats of fines, compa-
nies participating in Green Lights, by cutting their
demand for electric power, are reducing future carbon
dioxide emissions from power plants by 1,750 million
metric pounds per year.2 This is the equivalent of taking
165,000 cars off the road annually. Major reductions in
sulfur dioxide and nitrogen oxides are also being accom-
plished. In addition to cleaning up the air and cutting
back on greenhouse gases, the 1,753 participating com-
panies are going to save at least $98.1 million per year
on their future electric bills. This is only the beginning
of what is possible: if all eligible companies invested
in lighting upgrades, potential energy savings could be
as high as $16 billion per year; resulting reductions in
carbon dioxide emissions would equate taking a third of
all cars in the U.S. (44 million) off the road.
Although the big picture sounded great, Taylor needed
to get a handle on what could be done at Graphic De-
sign and what it was going to cost him. The future
savings Jackson talked about would have to be large
enough to overcome any up-front expenditures. There
was also the possibility of selling the old lighting sys-
tem. Jackson had intended to haul it off to the dump
but said it could fetch a few hundred dollars.
One area of savings would be reducing the fixed cost
component of Graphic Design's electric bill. Jackson
explained that once a year SNP&L measured electricity
demand. Based on what a firm was using at that time,
the utility estimated the company's peak kilowatt de-
mand. It was the utility's obligation to have adequate
capacity to meet the highest likely (peak) demand of
Graphic Design and all the other companies and
homes on its power grid. For maintaining this capacity,
SNP&L charged each company a "peak demand charge":
$5.00 per month for every kilowatt measured during
the annual visit. If Graphic Design reduced its peak
demand, its monthly peak demand charge would also
go down. Currently, Graphic Design's annual peak
demand charges alone totaled $271.94 (including 6%
sales tax).
The Proposal and the Decision
After surveying all the fixtures and querying Taylor on
how many hours each light was in use, Jackson briefly
described his proposal. First, he would estimate cur-
rent annual kWh used per fixture and calculate annual
electrical costs based on the nine-cent-per-kWh rate
charged by SNP&L. Next, he would estimate the re-
duction in annual kWh consumption that could be
accomplished through three methods: (1) installing
motion sensor devices that would automatically turn
lights off when no one was in a room, (2) replacing the
ballasts in the fluorescent fixtures with more efficient
ballasts, and (3) replacing the existing fluorescent tubes
with tubes requiring less/lower wattage.
Two days later, Jackson faxed Taylor a proposal out-
lining current usage and potential savings (Table 1), a
guarantee that the reductions would actually be real-
ized (Exhibit 1), and a memo detailing the impact of
those reductions (Exhibit 2). Energy Solutions' total
charge for the installation would be $2,500.
Even though Taylorjwas impressed by the savings and
was looking forward to showing the memo to his son,
he still had a few financial questions:
*Asof March 31,1995; EPA estimate.
2* Lighting Case
July 1995
-------
TABLE. 1: LIGHTING ENERGY ANALYSIS
Current Lighting System
President's Office
Signs
Loading
Kitchen
Bathroom
Workspace 1
Bathroom 2 ' ' .
Entrance ,
Workspaces
Other ,
Number of
fixtures
2.
6
. ' 2
1
1
2
1
1
4
.13
Lamps
per fixture
.4
2 '
4
', 4 , '
2
4 .
1
4
4
4
Wattage '
168 ;
30
168
. . 168 ..;
84
168
. 60
, 168
168
168
kW
0.336
0.180
0.336
0.168
0.084
' 0.336
0.060 '
0.168
0.672
2.184
Annual hours
of use
. : 2,250
8,760
2,250
2,250
1,000
2,250
500
2,250, .
2,250
' 2,250
. Annual kWh
usage
' 756.0
1,576.8'
756.0
378.0
84.0
756.0
30.0
378.0
.1,512:0
4,914.0
total kW demand: 4.524
total kwn consumed: 11,140.8
Proposed Lighting System
Number of Lamps Wattage
fixtures per fixture
President's Office
Signs
Loading ' '..'.
Kitchen
Bathroom
Workspace 1
Bathroom 2 '
Entrance
Workspace 2
pther
2
6
2
1
1
2
1 .-
1
4
13
4
2
4
4
2
4
1
4
4
4
Peak Demand Reduction: 1.917 kW
Annual Use Reduction: 5,876 kWh
106
11
60
60
. 60 '
106
15
60
106
106
total kW demand:
utility charge
$5,00* 12 months
$0.09/kWh
kW
0.212
0.066
0.120
0.060
OJ060
0.212
0.015
0.060
0.424
1.378
2.607
tax
0.06
0.06
Annual hours Annual kWh
of use consumption
1,125
8,760
. 750 '
1,125
500
1,800
500
2,250
1,500
2,250
total kWh consumed:
savings
$121.92
560.57
238.5
578.2
90.0
67.5
30.0^
381.6
7.5
135.0
636.0
3,100.5
5,264.8
Total annual sayings $682.50
Lighting Case 3
July 1995
-------
EXHIBIT 1
Energy Reduction Guarantee
Customer: Graphic Design
130 North Avenue
Norwalk, Connecticut
Energy Solutions hereby guarantees a reduction in kilowatt usage,
as outlined in the Lighting Proposal, which, in turn, shall yield
specific financial savings.
Graphic Design is guaranteed that upon completion of the retrofit
there shall be a reduction in lighting energy demand of 1.92 kWh,
plus or minus
Graphic Design agrees that the Current Lighting System as described
in the Lighting Energy Analysis is a correct representation of the
building's present system.
Any disputes as to the effectiveness of the new retrofit system's
ability to reduce Graphic Design's kW load shall be settled by
taking wattage readings from a reasonable number of fixtures to
determine the new kW load. The number shall be compared against
present lighting system kW load. In the event that kW savings
fail to meet those promised (above). Energy Solutions will pay
the difference between savings promised (minus 10%) and savings
attained that would have accrued for the subsequent two years.
, Energy Solutions is not responsible for changes in the financial
analysis due to increases (decreases) in utility rates or customer
operational hours .
Robert Jackson
Energy Solutions
4 Lighting Case
July 1995
-------
EXHIBIT 2
.-, r. t ' - .
Environmental Memo . ".-..
To: Sam Taylor, Graphic Design .
From: Bob Jackson, Energy Solutions'
The EPA estimates that,: on average, installing the proposed lighting
system will accomplish the following environmental goals every year:
Energy Consumption Reduction: 5,876 kWh
Reduction of Coal Consumption 4,701 Ibs.
Reduction of Carbon Dioxide Emissions 3,056 Ibs.
Reduction of Sulfur Dioxide Emissions 53 Ibs.
Reduction of Nitrogen Oxide Emissions 29 Ibs.
This installation is the equivalent of removing 0.28 automobiles from
the road every year savings are achieved.
Lighting Case 5
July 1995
-------
Questions
1. Taylor wanted to know how much his savings
would be if he only installed the motion sensors
(thereby reducing the hours of light usage) com-
pared to the savings he would accomplish by only
installing new ballasts and lamps (thereby reducing
energy consumed per hour of usage).
2. Having been a business major in college, Taylor was
familiar with net present value (NPV) analysis. He
wanted to know the NPV of the 'installation's cash
flows, taking into consideration that any of his sav-
ings would be taxed 31% by the federal government
and 4.5% by the state. The 50% rebate offered by
NP&E would saveAum $1,250, but the 6% state sales
tax would apply to the entire $2,500 cost. For tax
purposes, Taylor intended to expense the entire cost
of the installation. Looking at 10 years worth of cash
flows would be sufficient for the analysis. When
Taylor first prepared a business plan for his company,
he applied a 20% discount rate to projected cash
flows. He recalled from a college finance course
that, in some cases, it was appropriate to apply a
risk-free discount rate to cash flows if there was no
uncertainty attached to their occurrence. Currently
the Treasury Bill rate was 6%. Of course, calculating
the IRR would also be useful, particularly given his
uncertainty about which rate to use; it was also a
calculation that the EPA required of its Green Lights
participants.
3. Taylor knew that SNP&L would not be keeping rates
at 9c/kWh forever. Assuming future inflation to be
3.5% per year, he wondered what the installation's
NPV would be, beginning with the following year,
when he would begin realizing savings from the
installation. Concomitant with rate hikes was the
assumption that the local economy would be im-
proving and Graphic Design would be getting more
work. This would lead to expanded hours of opera-
tion, with both workspaces being used up to 5%
more each year for the next seven years, by which
time their use would be maximized. What would
the incremental NPV of Taylor's savings be under
this scenario? It would be useful to take a look at
NPV under a range of possible rate hikes from 0%
to 7% to get a better idea of just how good deal this
mightbe.
4. What are the financial and environmental implica-
tions of selling the old lighting system? By selling it,
does Graphic Design perpetuate the'use of inefficient
equipment?
6 Lighting Casa
July 1995
-------
Pollution Prevention
and Finance
' NATIONAL POLLUTION PREVENTION CENTER FOR HIGHER EDUCATION
For the Instructor:
Teaching Note on
"Green Lights' Economics:
Graphic Design Considers
a Lighting Upgrade"
By Michael Tucker, Associate Professor of Finance, ^airfield University
This case is appropriate for second-level undergraduate
or MBA finance classes, typically financial management.
It is a simple case that could also be employed in a cor-
porate finance course at the beginning of the semester.
Sensitivity analysis may by added (see Question 3) to
, complicate the solution. ,
"Doing well" (making money) and "doing good"
(reducing environmental harm) are the main focus of
this case. While installing more efficient lighting will
not solve the world's environmental problems, it does
reduce energy use, which in turn reduces the carbon
dioxide emissions implicated in global wanning. .The
present value cost of global wanning is enormous. - ,
Multiplying that cost by even a low probability of
occurrence still leaves a rather large present value that
an instructor'may. take a crack at calculating through
class discussion. Of course, the timing of the damage
of global warming is uncertain.
Green Lights is a significant, pollution prevention
program. It shows how the government can step in
to help business do things more efficiently without .
regulation. While rebates from utility companies are
an added sweetener, the savings accrued by reducing
energy use would still make upgrades economically
viable. Typically, however, many firms want payback
in a short period of time, often one year or less. This
means that rebates are the difference between going
ahead and doing nothing.
Teaching Note 1
August 1995
-------
Answers
I. "Taylor wanted to know how much his savings
would be if he only installed the motion sensors
(thereby reducing the hours of light usage) com-
pared to the savings he would accomplish by only
installing new ballasts and lamps (thereby reducing
energy consumed per hour of usage)."
Answer: Table A-l shows the savings under new
ballasts and lamps only (without motion detectors).
Column 1 shows the new hours of usage; Column 2
shows the cost of operating lights ($0.09 kWh) under
reduced hours (1,125) with old fixture usage (0.336)
after taxes (6%) equaling (0.09 * 1,125 * 0.336 * 1.06 =
S36.06) for savings in the President's Office. The savings
from just installing the motion detectors is shown as
the total of Column 2 $168.69 maintaining the
same fixtures but reducing the hours they are in use.
Column 3 shows the reduction in kWh from installing
new fixtures. Using Column 3 and information from
Table 1, one can calculate the savings under old hours
without using sensors, e.g., 2,250 hours for the Presi-
dent's Office at $0.09/kWh, with the 6% tax times the
reduction in kWh usage of 0.124 equaling savings of
$26.62. Summing Column 4 totals $471.91 in savings
from reducing kWh without installing sensors, i.e., no
reduction in hours. Peak demand savings are only
achieved if new fixtures are installed. The savings of
$121.92 ($5.00 per peak hour demand reduction of 1.92,
which is the sum of Column 3, reduction in kWh, times
12 times 1.06 [tax]) is therefore additional and added to
the $471.91, bringing the grand total savings from new
fixtures to $593.83.
TABLE A-1: BREAKOUT OF SAVINGS FROM REDUCTION IN LIGHTING HOURS FROM MOTION
DETECTION INSTALLATION AND REDUCTION IN WATTAGE FROM FIXTURE CHANGES
President's Office
Signs
Loading
Kitchen
Bathroom 1
Workspace 1
Bathroom 2
Entrance
Workspace 2
Other
Totals:
Reduction
in Hours
1,125
-
1,500
1.125
500
450
-
-
750
-
5,450
Savings at
Old Wattage
$ 36.06
-
48.08
18.03
4.01
14.42
-
.
48.08
-
$168.69
Reduction
inkWh
0.124
0.114
0.216
0.108
0.024
0.124
0.045
0.108
0.248
0.806
1.92
Savings at
Old Hours
$ 26.62
95.27
46.36
23.18
2.29
26.62
2.15
23.18
53.23
173.01
$471.91 savings
121.92 peak demand reduction
$593.83 total saved from
kW reduction
2-Teaching Nota
August 1995
-------
2. "Having been a business major in college, Taylor was
familiar with net present value (NPV) analysis. He
wanted to know the NPV of the installation's cash
flows, taking into consideration that any of his sav-
ings would be taxed 31% by the federal government
and 4.5% by the state. The 50% rebate offered by
NP&E would save him $1,250, but the 6% state sales
tax would apply to the entire $2,500 .cost. For tax
purposes, Taylor intended to expense the entire cost
of the installation. Looking at 10 years worth of cash
flows would be sufficient for the analysis. When
Taylor first prepared a business plan for his company/
he applied a 20% discount rate to projected cash
flows. He recalled from a college finance course
that, in some case's, it was appropriate to apply a
risk-free discount rate to cash flows if there was no
uncertainty attached to their occurrence. Currently
the Treasury Bill rate was 6%. Of course, calculating
the IRR would also be useful, particularly given his
uncertainty about which rate to use; it was also a
calculation that the EPA required of its Green Lights
participants." - '
Answer Pre-tax savings of $682.50 (Table 1) translate
''into after-tax savings of $440.21'{(1-0.045-0.31)* 682.5).
The $2,500 installation is increased by 6% to account for
taxes to $2,650 less the $1,250 rebate, bringing the after-
. tax cost to $1,400. The tax shield on the $1,400 outlay
{(0.31+0.045) * 1,400} of $497 reduces the cash flow cost
to $903. Treating the savings of $440.21 as an annuity
at both 6% and 20% arrives at the present value savings
figures of $3,239.98 (6% discount) and $1,845.57 (20%
discount). Subtracting the after-tax cost of $903 from
both figures gives.NPVs of $2,336.98 (6%) and $942.57
(20%). Payback in years is calculated as 903/440.21 =
2.05 gee Table A-2. (The IER can be calculated with
a financial calculator or a spreadsheet program such as
Excel or Lotus.) . .
The savings from the,installation are virtually certain
and should therefore be discounted at a lower discount
rate than projects involving business risk. The only
risk that is. entailed here is the risk that the firm will
go out of business in less than 10 years; even then, the
building with fixtures could be sold and some of the
sales proceeds attributed to the new fixtures.
TABLE A-2: NPV OF SAVINGS ASSUMING 10-YEAR HORIZON AND NO CHANGE IN USE OR RATES
Pre-Tax Savings
$ .682.50
After-Tax Savings
440.21
Installation Cost w/6% tax
(2,650.00)
Rebate
1,250.00
Cost
(1,400.00)
Tax Shield on Outlay
497.00
After-Tax Cash Outlay
(903.00)
PV of 10-year Savings Annuity
3,239.98
$1,845.57
Discount Rate
6.0%
20.0% .
NPV
2,336.98
942.57
Payback (years)
2.05
Internal Rate of Return
48%
Teaching Note 3
August 1995
-------
3. "Taylor knew that SNP&L would not be keeping
rates at 9e/kWh forever. Assuming future inflation
to be 3.5% per year, he wondered what the installa-
tion's NPV would be, beginning with the following
year, when he would begin realizing savings from
the installation. Concomitant with rate hikes was
the assumption that the local economy would be im-
proving and Graphic Design would be getting more
work. This would lead to expanded hours of opera-
tion, with both workspaces being used up to 5% more
each year for the next seven years, by which time
their use would be maximized. What would the
incremental NPV of Taylor's savings be under this
scenario? It would be useful to take a look at NPV
under a range of possible rate hikes from 0% to 7% to
get a better idea of just how good deal1 this might be.
Answer The first year of increased electricity costs
occurs in 1995, when rates rise to $0.09315 (1.035 * .09).
First the status quo operating cost is calculated (Panel 1
of Table A-3): Workspaces 1 and 2 are both in use for
2,250 hours in 1994, increasing at a rate of 5% in 1995
to 2,363 hours and continuing increases until the year
2000, when they have reached maximum utilization.
The kWh use for the two workspaces is 2,268 (in 1994)
minus (.336 * 2,250 for Workspace 1 plus .672 * 2,250
for Workspace 2). Other kWh use is held fixed at 8,873
(1994) throughout the scenario as is peak demand of
4.52 (all data from Table 1). The total cost with tax for
operations of $1351 is arrived by multiplying total kWh
usage (11,141) by cost ($0.09), adding peak demand
cost for the year ($5*4.52*12) and boosting the total by
the tax rate (6%). The same analysis is performed us-
ing the proposal figures of hour usage (1,800. and 1,500,
respectively) for Workspaces 1 and 2, other hour usage
of 4,247, and peak demand of 2.61. The savings are
$682 in 1994 (1351-668).
Note: In Year 7, workspace use flattens out and no
longer increases, but savings are still growing because
of utility price hikes. The present value of saving across
the ten years discounted at 6% is $7,235; at 20%, it is
$3,359. Subtracting the cost of $903 arrives at NPVs of
$6,332 (at the 6% discount rate) and $2,456 (at 20%)
with an IRR of 58%.
Note: By placing the 3.5% electricity hike and the 5%
per annum increase in separate cells in the spreadsheet
and relating them in the model with dollar signs (lock-
ing in, the cells), it is possible to look at a number of
different scenarios. Data tables and graphs may then
be added to the analysis.
4. "What are the financial and environmental implica-
tions of selling the old lighting system? By selling
it, does Graphic Design perpetuate the use of ineffi-
cient equipment?"
Answer: While Taylor gets some ready cash from the
sale of the old lighting system, he does perpetuate the
use of inefficient lighting by someone else. Those new
users (and they might be in another country, because
used equipment is routinely exported) save money by
going with used equipment, but the present value of
their savings evaporates when electricity use differen-
tials are accounted for.
The possibility of selling another party "radioactive"
ballasts was also raised in the case. There has been
no scientific proof of the existence of more than back-
ground .radiation being emitted from ballasts or of the
harm that can be done by them. It is a controversy
similar to harm done by power lines. Scientific proof
is inconclusive (i.e., no statistical findings show harm
while anecdotal evidence continues to raise questions).
4? Teaching Note
August 1995
-------
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'-.'.' . , Teaching Note 5
' , ' - ' August 1995
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Published by:
The National Pollution Prevention Center
for Higher Education
University of Michigan, Dana Building
430 East University Ave.
Ann Arbor, Ml 48109-1115
Phone: 313-764-1412
Fax: 313-936-2195
* E-mail: nppcOumich.edu
The mission of the NPPC Is to promote sustainable development
by educating students, faculty, and professionals about pollution
prevention; create educational materials; provide tools and
strategies for addressing relevant environmental problems; and
establish a national network of pollution prevention educators.
In addition to developing educational materials and conducting
research, the NPPC also offers an internship program, profes-
sional education and training, and conferences.
Your Input Is Welcome!
We are very interested in your feedback on these materials.
Please take a moment to offer your comments and communicate
them to us. Also contact us if you wish to receive a documents
list, order any of our materials, collaborate on or review NPPC
resources, or be listed in our Directory of Pollution Prevention
In Higher Education.
We're Online!
The NPPC provides Information on its programs and educational
materials through the Internet's Worldwide Web; our URL is:
http-VAivww.snra.umich.edu/nppc/
Please contact us if you have comments about our Online
resources or suggestions for publicizing our educational
materials through the Internet Thank you! '
§ Ttaching Note
August 1995
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