United States
            Environmental Protection
            Agency
&EPA
            Technology Transfer
Choosing Optimum
Financial Strategies

Pollution Control
Systems

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                          EPA-625/3-76-005a
                          Revised October 1978
   Choosing Optimum
   Financial  Strategies

Pollution Control Systems
        U.S. Environmental Protection Agency
          Cincinnati, Ohio 45268

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                   ACKNOWLEDGMENTS
     This  seminar publication  contains  materials  prepared  for  the  U.S.
Environmental Protection Agency Technology Transfer Program  and  has
been  presented  at Technology  Transfer  design seminars,  throughout  the
United  States.

    This  publication was prepared by  C. Marshall and J.  Commins  of
JACA  Corporation, Fort  Washington,  Pa.
                                NOTICE
     The  mention of trade  names  or commercial products in  this publication is for
illustration purposes, and does not constitute  endorsement or recommendation for use
by the U.S. Environmental Protection Agency.
                                   ii

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                                   CONTENTS

                                                                                  Page

Chapter I. Introduction   	   1
    Organization of This Publication 	  2

Chapter II. Tax Strategies   	  3
    General Rules for Depreciating Pollution Control Equipment   	  3
    Relationship of Depreciation to Taxes and Cash Flow   	  4
    Net Present Value of Cash Flows As a Decision-Making Tool   	  4
    Sample Analysis of Pollution Control Investment Tax Strategies    	  6
    Comparison of Depreciation Methods   	9
    Ability to Use Investment Tax Credit (Attention  Small Businesses) 	  11
    Summary  	  12

Chapter III. Financing Strategies for Pollution Control Investments  	  13
    Bank Financing     	  15
    Small Business Administration Compliance Loans   	  16
    Small Business Administration Lease Guarantees  	  18
    Industrial  Development Bonds  	  19
    Leasing   	  21
    Comparison of Financing Methods  	  21

Chapter IV. Optimum Financial  Strategy for Pollution  Control  	  24
    Summary   	  29

Chapter V. State Financing and Tax Incentives  	  31
    Alabama    	  32
    California   	  32
    Missouri 	  33
    New York  	  33
    Wisconsin     	  34
    Summary  	  35

Chapter VI.  Financial Decision-Making Analyses for Municipal Versus Private
           Treatment of Water  	    36
    Net Present Value Analysis  	  39
                                         111

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                                                                                 Page

Chapter VII. Summary    	  44

Appendix A. SBA Water Pollution Control Loan Application Procedures    	  47

Appendix B. Types of Contractual Arrangements Between Government Authorities
           and Industries Acquiring Tax-Free Financing  	  52

Appendix C. IRS Definitions and Allocations of Pollution Control Equipment Under
           the IDE Program  	  53

Appendix D. Sources of Information About State Pollution Control Incentives    	  55
                                         IV

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                                       Chapter  I

                                  INTRODUCTION
     As  the  1970's proceed, environment-related  management  decisions  will  continue  to be
complex and  frequent, often requiring the commitment of sizable  amounts  of capital.  The
impact  of these nonremunerative  environmental  expenditures on businesses can be significant,
and  cost recovery  possibilities are  limited or nonexistent.

     Several governmental institutions  provide means to reduce or soften the effect  of these
pollution control  expenditures.  To a certain extent, the government passes industrial pollution
control costs on to the general  public by excusing pollution control devices from certain sales,
use,   and  property   taxes;  by  allowing   companies  to use  tax-exempt  financing  for  the
expenditures; or by special depreciation allowances. Such programs permit  a company to pay
lower  taxes or financing  costs  than it  normally would  if the equipment being purchased were
for a manufacturing or other  business  purpose. In addition, through federal construction grants
to  municipalities,  the  cost  of treating a  company's  wastewater  can  often  be  reduced  if a
municipality treats the wastewater.

     To  put these incentive  or  cost-reduction  programs  into perspective,  it should be pointed
out  that they  do  not significantly reduce  the cost of  the pollution  control investment. They
can, nevertheless, affect a company's cash flow  and profit position.

     Obtaining  control  equipment is new to most companies,  and a considerable body of new
and  involved tax  and  financing regulations exists for such equipment. Consequently, company
financial managers may  not  be as familiar with incentive possibilities as  they would be with
more common  business operations.

     This publication  will alert decision makers to the availability  of and qualifications  for
some  of the  financing   incentives  from  federal,  state,  and  local governments,  and  will
demonstrate that  it is well  worth  spending  time  analyzing the special methods of financing
pollution  control  expenditures  and  the available tax treatments. Obtaining optimum  financial
and  tax benefits  could save a company   tens  of  thousands  of dollars  over  the  life of  the
equipment.  For example,  a  Business Week article  (July 29, 1972, pp. 50-51) calculating  the
cost savings that tax-exempt  pollution control revenue bonds can provide  concluded  that "over
the life of a 20-year, SlO-million issue, the typical interest saving is about $3.6 million."

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     This publication will show the businessman  the  type of financial analysis that should be
accorded  any type of pollution control expenditure in an effort to substantially reduce funds
expended and  to smooth  out what  could develop into a cash flow  trauma. This publication
contains  a  discussion  of the  tax and financing  positions  of  three  hypothetical firms with
different management goals but with  similar capital expenditures for pollution control.

     A  separate financial analysis is presented specifically  for  firms which have  a choice of
wastewater treated onsite or by a  municipality.

     The   net   present   value  financial   analysis  technique  will   frequently  be  used  to
quantitatively  compare  and   select  alternative  tax and financing  strategies. This  is  a very
effective and widely  used technique  which enables the evaluation  of future  income and costs
in terms  of present  dollars.   Using this technique, it is  possible, for example, to  evaluate a
revenue  bond  issue  which might  allow for deferred  repayments  of principal and permit the
largest payments at the end  of a 20-  or  30-year  issue. Meanwhile, the company  could lower
taxes immediately by  taking  depreciation and  using  investment tax credits,  thus building up
cash  flow for  use  in   other  areas  of the  business.  On  that  cash  flow, earnings could be
generated which would  help repay  the  bond principal later. All  of these future incomes, costs,
and  resulting  cash  flows  can be  analyzed  and  combined and the results  compared  to the
results of a similar analysis of an alternate combination of taxing and  financing options.

     The  examples  in   this publication have been simplified to  convey  basic  problems  and
techniques  for  all industries.  They  by no  means exhaust  the variety and   combinations of
available tax and  financing strategies  relating  to pollution  control equipment. Often, financing
and, to  a lesser extent, tax treatment  vary by time  and  by jurisdiction. Consulting the latest
tax  rulings  and legislation  relevant to  each location is necessary  before undertaking the final
decision-making process.
                         ORGANIZATION  OF  THIS  PUBLICATION
     The  remainder of  this publication is  divided  into six  chapters. Chapter  II analyzes the
standard  depreciation  tax methods  and  others  which have  been  established for  pollution
control facilities.  Chapter  III  examines  the  costs of  different  methods of financing pollution
control equipment.  Chapter IV relates  the  financing  and tax strategies for pollution  control
equipment  to  overall  company financial  strategies in  order to select an  optimum financial
strategy  for the  equipment.  It  is  particularly  concerned  with  the  effects  of each  of the
incentives  on a company's cash flow strategy or its  profit maximization strategy. Chapter  V
examines  the availability of federal incentives that also  require  state involvement and examines
examples   of additional  incentive  provided  by  states.  Some  financing  alternatives are, for
practical  purposes,  always available, while  others  are dependent upon  the  source's  budget.
Chapter  VI  examines  the financial benefits  of  private  treatment of  industrial  wastewater and
the costs  and benefits of municipal treatment. Chapter VII is a summary chapter.

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                                      Chapter  II

                                 TAX STRATEGIES
     Normally,  two types of federal tax benefits  exist for  plant equipment expenditures. The
underlying  effects of these benefits are to  reduce the taxes payable  by a company  and  to
improve the  company's cash flow,  thus partially offsetting the original  cost of the equipment.
One set of benefits, depreciation, allows a proportion  of the  equipment cost  to  be deducted
annually  from  income  as  a  non-cash  expense  over  a certain  guideline  period. The period
allowed during  which  the  deductions  can  be  taken changes  with  different  depreciation
techniques. Accelerated techniques  allow  the cost  of  the equipment to be deducted  early in
the life of the equipment;  amortization is the term used to  cover depreciation taken over less
than the full life  of the  equipment. Different proportions can be deducted  over the full life
of the equipment using techniques such as straight-line depreciation, double-declining balance,
and  sum-of-the-years  digits.   The  depreciation  method  chosen  should  conform  with  a
corporation's financial management  strategy.

     The second  type  of tax  benefit, an  investment  tax credit, also  exists  for  all types  of
equipment.  It  was intended  as  a special  incentive to encourage  companies  to  buy capital
equipment  and, in effect, reduces  the cost of the equipment  by providing a permanent tax
reduction.

     This   chapter  will  compare  selected   depreciation  techniques,  including  a  technique
specifically provided for pollution control,  considering  only  the major financial aspects of laws
and regulations. The reader  should consult  specific regulations for more  detail.
      GENERAL RULES FOR DEPRECIATING POLLUTION  CONTROL  EQUIPMENT
     An  analysis  of  depreciation  entails determining the depreciation method to be  used  and
the useful life of the equipment over which depreciation will be taken.

     When  choosing  a  depreciation  method  for  pollution  control equipment, the  normal
requirement that a  company consistently  adhere to one depreciation method is waived.  For
example, if a  company uses the  straight-line depreciation method for its  other assets, it could
still take double-declining balance depreciation for its pollution control equipment.

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     Similarly,  when  determining  the  useful life  of  the  equipment,  it  is  possible,  with
sufficient justification, to  use  one asset  depreciation range (ADR)  for  the normal company
assets and  a different useful life for pollution control  facilities. For  example,  if a company
customarily  uses a guideline  useful life of  12 years  (permitted in the 9.5-  to  14-year ADR),
an 8-year life could  be used for the control device  if the life of the  control equipment  were
less than that of the normal ADR. Having a shorter useful life may be advantageous in terms
of the company's financial management objectives.
            RELATIONSHIP OF  DEPRECIATION TO TAXES AND  CASH FLOW
     The  tax benefits  of  annual depreciation/amortization values result  from  their  being
accounted for as an expense which does not actually involve, any cash  outlays in that  year by
the  taxpayer. (The cash outflows that occur in  connection with the equipment purchase are
covered in chapter III). An expense  means a tax  saving (as well  as  lower  profits). The tax
savings is  a net cash inflow  to the corporation  and is represented by:

                                       NCF  =  TD

where NCF - net  cash flow
          T - the  tax rate, expressed  as a fraction
         D = amount of depreciation/amortization

     Positive  cash  flows (cash inflows) can  be reinvested in the business on the  productive side
of the operation or to  reduce  the need for obtaining cash  from other  sources.  A short period
of depreciation/amortization means faster deductions, tax savings, and cash flow  benefits.
        NET PRESENT VALUE OF CASH  FLOWS AS A DECISION-MAKING TOOL
     Since each tax strategy to be compared in this chapter has a distinct cash  flow  pattern, a
method of comparing  the  cash  flows has  to  be  employed. One useful  method is to compute
the net present value (NPV) of the annual net cash flow (NCF) produced by each  strategy
throughout the depreciable life of the  equipment. This method  of comparison compensates for
differences in cash flow amounts, for differences in the duration  of two strategies,  and takes
into consideration  the  time value of money.

     A  dollar saved  today has a  greater long-term effect on the  financing situation of  an
enterprise  than a  dollar  saved a year from now.  The dollar  saved today has the potential of
yielding a return  (r) if  used  for  profit-making  company operations,  or if saved.  Thus,  the
present  value (PV) of today's  dollar that is saved today  is

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                                          PV = 1

     The present value of a dollar saved a year from now is, on the other hand,

                                        PF = ^-
                                              1 + r

where  1  + r becomes the "discount factor"  which yields a present  value of less than 1.

     The present value  of a  dollar saved i years from now is obtained by discounting annually
                                             (1  + r

     When the present value  of the net cash flow (NCF) of a future year is calculated using
the discount factor, the resulting cash flow is called discounted  cash flow (DCF):

                                              NCFi
                                       DCF- =
                                           1   (1  +
     The sum total  of all such discounted cash flows over the useful life is  the NPV of the
tax savings:

                                     n             n    NCF,
                           NPV   =  y DCF-  =  y
                                                              $
                                                             r)
where n  - total years.
     Since  in this  case  NPV is  the sum  of discounted  cash inflows (tax savings), the higher
the NPV, the more attractive  the depreciation method when the company  financial  objective
is to minimize cash outflows for the overall pollution control project.

     For manufacturing, r,  the  return  on investment,  averages about 7.0 percent before taxes.
After  taxes,  this  figure is  reduced  to  about  3.5 percent. Therefore, for  our illustrative
purposes,

                                         r = 3.5%

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    SAMPLE ANALYSIS  OF  POLLUTION CONTROL  INVESTMENT TAX STRATEGIES


     An  illustration of  the  use of  NPV  in  comparing  alternative  tax  strategies  is  presented
using water  pollution  control expenditures. As will  subsequently  be  shown,  that area  of
pollution  control involves  the  greatest variety of financing and  tax strategies.

     An  investment figure of  $200,000 will be used and, for accounting purposes,  an ADR  of
9.5 to 14.5  years. From  this  range, a  useful life  of 10 years was  selected.  Salvage  value was
assumed  to be zero.

     The  analysis  will include  a discussion of the four writeoff strategies: rapid amortization,
straight-line   depreciation,  straight-line depreciation  plus  investment tax  credit, and double-
declining  balance   depreciation tax  strategies. The  analysis  will be most  fully  demonstrated
under the first section, Rapid  Amortization, as the analysis techniques for all are similar.

Rapid  Amortization

    The Tax Reform Act of 1969 (modified by the Tax Reform  Act of 1976) provides for the rapid
amortization  of certified pollution control facilities  over  a 60-month  period, irrespective of the
guideline useful life of the equipment. This amortization is available under certain conditions outlined
in Article  169 of the Internal Revenue Code (IRC). The rapid writeoff was  provided to encourage
capital investment in pollution control. Formerly, a process change, even if it resulted  in lower
pollution, did not qualify as a pollution control device and could not be rapidly amortized. The Tax
Reform Act of 1976 now permits process changes to qualify for rapid amortization, however, only to a
very limited degree.  The process  change cannot significantly (greater than 5%) increase the useful life
or capacity, reduce the operating cost, nor alter the nature of production, of the plant. On the  other
hand, equipment which avoids the creation or discharge of pollutants, e.g. fuel  desulfurization, are
fully eligible for rapid amortization (such equipment is not eligible for industrial development  bond
pollution control financing).

     Perhaps  the most significant change made by the Tax Reform Act of 1976 to rapid amortization
was to permit a limited investment tax credit provision.  Now 50 percent of the value of the pollution
control equipment  is eligible for the investment tax credit. Formerly, rapid amortization and the
investment tax credit were  mutually exclusive.

     As originally  legislated, the eligibility  period for rapid amortization would have expired
January 1, 1975. However,  additional  legislation extended the period for one year. The Tax Reform
Act of 1976 made rapid amortization  a permanent tax  provision. It applies  to all pollution control
equipment placed in plants in operation before January 1,  1976.

    The rapid amortization applies to the first 15 years of equipment life. The portion of the asset
value with a  useful life of over  15 years can be depreciated by any method under Article 167 and
depreciation can be taken immediately on that portion. The rapid amortization can begin the month
after installation and continue for a full 60 months, or it can begin in the next fiscal year. For the
intervening months  until the next fiscal year begins, a traditional depreciation method can be used.

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    An additional first year depreciation (Section 179, IRC) amount of 20 percent of a maximum
asset value of $10,000 or a maximum deduction of $2,000 can be taken in the first year of an asset
purchase.  The "bonus" first  year depreciation can be taken if a taxpayer elects to take the rapid
amortization or any other method of depreciation. In order to take the "bonus" depreciation with
rapid  amortization, the taxpayer must elect to begin rapid amortization in the next fiscal  year.
Although  not considered a pollution control incentive, the inclusion of this provision is needed for
accuracy of calculations and will be incorporated into all the analyses in this chapter.

    This illustration will assume that the corporate income tax rate is 48 percent and that the effective
date of purchase of the $200,000 waste treatment facility is the beginning of the fiscal year so that the
amortization period will be entirely within the next 5 fiscal years. The total useful life of the equipment
is 10 years.Computation of the NPV of the $200,000 investment using rapid amortization results in
                   NCF
TD
                                 [(.48) (200,000 - 2,000) * 5] + (.48) (2,000)
                                 n
                   NPV
                   DCF
5)    DCFi  +  10% ITC x .5 ($200,000)
*'=/                         (J+r)
                                 n
                   NPV
                   NPV
                   NPV
         NCFi
i=l     (1 + .035)'

$86,753   +  $9,662

$96,415
$10,000

(1+.035)
     Table II-l shows the annual DCF  calculations and  totals (or NPV)  for a $200,000 piece
of equipment written off by the rapid  amortization  method  over 5 years. The effect  of the
additional  first year  depreciation (AFYD) is also  considered.  Table'II-l  should  be completed
for each of the following tax strategies in order to make comparisons.

Straight-Line Depreciation
     The  basic  or most simple  form  of depreciation  involves reducing  taxes by an  equal
proportion of the depreciable  amount in  each year  of the life of the equipment. In this case,
the  depreciable  base  reduces  to   $198,000  by   taking  the  additional  first  year  bonus
depreciation  of $2,000  (maximum).  Using  the above formula and  table  with  the $200,000
equipment with a life of 10 years, the NPV of cash  inflows or tax savings is $79,969.

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                      Table 11-1.—NPV calculation for rapid amortization
End
of
year
1
1
2
3
4
5

Depreciable
base
$200,000
198,000'
198,000
198,000
198,000
198,000

Depr.
rate
AFYD
20%
20%
20%
20%
20%
Pre-tax
depr.
(D)
$ 2,000
39,600
39,600
39,600
39,600
39,600
After-tax
depr.
(NCF)
$ 960
19,008
19,008
19,008
19,008
19,008
Discount
rate
(1 +/•)
1.0350
1.0350
1.0712
1.1087
1.1475
1.1876
DCF
[NCF +
(1 +r)]
$ 928
18,365
17,745
17,144
16,565
16,006
                                                            NPV = Sum of  DCF = $86,753
        Total  NPV = NPV ($86,753) + NPV of ITC (10% (.5 ($20,000) * 1.035)) = $96,415

    'The $2000 maximum additional first year's depreciation reduces the depreciable base.
Straight-Line Depreciation Plus Investment Tax Credit
     The investment tax credit has been available on an on-again/ off-again basis over the last decade
as a special  incentive for the  business community  to  purchase  capital equipment.  The amount
traditionally allowed has been 7 percent, although in 1975 it was raised to 10 percent to help produce a
turn-around in the national recession. In the investment example being used, this tax credit provides a
tax savings of $20,000. This figure, adjusted to the NPV, should be incorporated into the calculations
of the straight-line depreciation NPV, since the investment tax credit is allowed for the method. It is
adjusted to the NPV by dividing it by the discount rate for the first year and adding the result to the
NPV straight-line depreciation (or $79,969).

     By taking the investment  tax  credit  into  account, the NPV of the straight-line tax strategy
increases to $99,292.
Accelerated Depreciation (Double-Declining Balance Combined With Sum-of-the-Years Digits)
     This is  the most accelerated  of the traditional ways to depreciate equipment.  Although
two  methods are used here  in  combination, they  can  be used  separately and each would be
more accelerated than straight-line depreciation.

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     Double-declining  balance  provides  that  each  year twice  the  straight-line  rate  fin  this
example that would be 2  X  10 percent)  is applied  to  the declining balance  of the equipment
after  deducting  the AFYD.  In this  case,  the  first  year's  depreciation is  541,600  (0.2  X
$198,000 =  $39,600  plus the  $2000  AFYD).  In  the second  year,  the 20  percent  is taken
against  the  reduced value ($200,000   $2,000    $39,600,  or  5158,400), resulting in 531,680.

     The  calculation for  sum-of-the-years  digits  is  more  easily explained by illustration.  The
first year of a  10-year  life  is  represented by  the 10 in the numerator of a fraction, while 55
in  the  denominator is  the  sum-of-the-years digits,  1+2+3+.   .10. The  first  year's amount in
this case  would  be computed by multiplying 10/55  times the initial cost minus the AFYD. In
the second year, $198,000 would be multiplied by 9/55.

     The  quickest  method for accelerating depreciation in this  case is to use double-declining
balance and the  $2000 AFYD in  the first year and  to  switch to  the  sum-of-the-years digits
method  in  the second.  When these two  methods are used  in such  a  combination  and the
investment  tax credit  is  included,  the  NPV,  or tax  savings,  for the  5200,000  equipment  is
$103,561.
                       COMPARISON OF DEPRECIATION METHODS
     Figure II-l is a bar graph showing how the total value of each depreciation method relates to the
overall cost of the equipment. From this figure, it is clear that, when trying to minimize cash outflow
(by increasing tax savings), the optimum strategy for this set of conditions is the double-declining
balance and sum-of-the-years digits methods with the investment tax credit and AFYD.

     The line graph in Figure II-2 indicates the year-by-year after-tax positive cash flows from the
various depreciation alternatives. The rapid amortization cash flows are level for years t\\o through
five and significantly higher in the first year resulting from the AFYD and the ten percent tax credit
on fifty percent of the investment value.

    Curiously, the optimum strategy is not the special pollution control tax strategy, rapid amortiza-
tion. This was introduced in 1969 when the national economy was thought to be in an overheated
condition and the investment tax credit was withdrawn. However, because of the high national priority
put on pollution control, its expenditures were accorded special treatment through rapid amortization.
In 1971, in  a new effort to stimulate the economy, the investment tax credit was reinstated and made
applicable  to all equipment, including pollution control equipment. The tax credit was especially
attractive because it never needed to be repaid, whereas rapid amortization really represented only a
postponement of taxes. In addition, (and until 1976) process changes made to comply with pollution
control regulations were  not eligible for rapid amortization. For these reasons,  rapid amortization
was not used extensively.

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       $200,000
        180,000
       160,000
        140,000
        120,000
        100,000
         80,000
         60,000
         40,000
         20,000
             0 L.
                       EQUIPMENT COST
                                  o
                                  o
D
                                                     RAPID AMORTIZATION
                                                     STRAIGHT-LINE DEPRECIATION
    STRAIGHT LINE DEPRECIATION
    WITH INVESTMENT TAX CREDIT

    DOUBLE-DECLINING BALANCE PLUS SUM-OF-
    THE-YEARS DIGITS DEPRECIATION WITH
    INVESTMENT TAX CREDIT
             Figure  11-1.  Net present value of total tax savings through depreciation.
    As explained earlier, the Tax  Reform Act  of  1976 provided additional benefits for rapid
amortization by including process changes and one-half the investment tax credit. The effect of these
benefits is expected to enhance the use of rapid amortization but only for longer-lived equipment.
Figures II-3 depicts a line of indifference  based on  NPV analysis between the use of accelerated
depreciation and the use of the newest version of rapid amortization. To the right of the line a company
with those useful  lives of pollution control equipment and those return on investment rates will find
rapid  amortization providing the highest NPV.  In the earlier illustration that used a 3.5% rate  of return
on investment, the equipment would have to have been greater than 25 years before rapid amortization
was optimal. Or, given the 10 year  useful life the company  would have to have had  a return on
investment rate of twenty-five percent.
                                             10

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                   $40,000
                   $30,000
                    20,000
                    10,000
RAPID AMORTIZATION
STRAIGHT-LINE DEPRECIATION
STRAIGHT-LINE DEPRECIATION WITH
INVESTMENT TAX CREDIT
DOUBLE-DECLINING BALANCE AND SUM-
OF-THE-YEARS DIGITS WITH INVESTMENT
TAX CREDIT
                                                     8   9  10
               Figure 11-2. Year-by-year tax savings (cash flow improvements)
                              through different tax strategies.
   ABILITY TO USE INVESTMENT TAX CREDIT (ATTENTION -  SMALL BUSINESSES)


    A company must have a sufficient level of pre-tax earnings to be able to fully utilize the invest-
ment tax credit. This is particularly important to small businesses at a low income level. Taking an
investment tax credit which would be greater than the amount of corporate income taxes payable
would defeat some of the advantage of investment tax credit. Calculations based on the new corporate
tax rates of 20 percent of all income before taxes up to $25,000, 22 percent of the next $25,000, and
48 percent above $50,000 show that a company has to have $69,800 in taxable earnings in order to fully
benefit from the $20,000 investment tax credit of our example.

    It is true that unused investment tax credit can  be carried over into the future, under certain
conditions (Section 46b, IRC).  However, the NPV of an investment tax credit carryover is less than
that of the tax credit itself.
                                            11

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                                       SUMMARY

    This chapter has demonstrated the large differences in year-by-year cash flows and NPVs by
using the various depreciation methods. The purpose of using NPV was to have a common standard of
analysis by which the available depreciation methods for pollution control facilities could be compared.
The  example used  for calculations showed the advantage  of the double-declining balance and
sum-of-the-years digits method with investment tax credit  over the other methods, including rapid
amortization. The chapter then showed the conditions of useful life of pollution control equipment
and return on investment rate  where rapid amortization would be advantageous.

    In chapter III, the special incentives for financing pollution control equipment will be examined.
The differences in values for these financing methods coupled with the results of the analysis just
performed will be carried into  chapter IV where the tax and financing strategies are combined.
                    Figure 11-3.   Choosing rapid amortization (R.A.)
                         versus accelerated depreciation (A.D.)
           50-t-
           40- -
      LU
I-
z
LU
5
l-
c/)
LLJ
      z
      o
      z
      CC
      z
      LU
      U
      DC
      UJ
      a
           30- -
           20- -
           10- -
                                 A.D.
                                      10           15            20
                                           YEARS OF USEFUL LIFE
                                                                       25
                                                                                    30

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                                    Chapter  II!

              FINANCING STRATEGIES FOR  POLLUTION
                          CONTROL  INVESTMENTS
    Prior to pollution control  legislation, when a plant manager  made a decision to buy  a
piece  of  equipment, and  if money was to be borrowed to pay  for the equipment, he got in
touch  with  his normal  financing  source  to  make  arrangements. With  the  advent  of special
pollution control incentives,  there  are  not only new sources of funds available, but  also lower
than  normal rates for most sources  of financing.  This  situation  requires  a  whole set  of
analyses before  the best source of  funds can be chosen.

    In  this  chapter,  each financial  source  is  described  and.  based  on  rate  and  terms, is
quantitatively analyzed using net present  value (A'PF) as a tool  for evaluating the cash flows.
As in  chapter II, the  example is based  on a  $200,000 waste treatment system.

    In  chapter  II. the  net  cash  inflow as  a  result of tax savings was  a function of the
amount of depreciation  and the tax rate. This  chapter  deals first  with  the net cash outflow
resulting  from interest costs  of the various  fund-raising methods,  and  subsequently with the
loan repayment net cash flow.

    A comparison of the net profits  with and without the  interest costs for  pollution control
equipment  makes it  possible  to quantify the cash outflow from interest.  Net profit, P,  and
the tax liability, L, can be related  to operating parameters by the equations:

                                   P  = P (1   T)

                               and  L  = pT

where  p  - annual  taxable income
       T = the  tax rate, expressed as  a fraction.

For domestic corporations, the new federal tax rate amounts to  20 percent on taxable income
up to 525,000. 22 percent for  the next  S25.000,  and 48 percent on income over 550,000. A
tax rate of 48 percent is  assumed  throughout this analysis.
                                          13

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    The annual taxable income is related  to the interest expense for the year by

                                         P  =  Q   t

where  Q = the operating  income
       / = the interest expense.

Combining the above two equations,

                                P  = (Q  /Ml   T}

                                   = Q (1   T)  I (1   T)

                            and L  = (Q  I) T

                                   = QT  IT

If there was no interest expense during the year, / =  0,  the above  equations would become

                                   P = Q (1   T)

                                   L = QT

Thus, the effect of the interest expense, /, is to reduce the net profit after taxes by / (1   T).
The tax liability is  reduced  by IT.

     If  C is  the amount of principal that  is  paid back  during  a year and  /  is  the  interest
expense  incurred  as a result  of the loan,  the net  cash  outflow, NCF, is  the net  of  cash
outflows and the reduced tax liability:

                                   NCF  =  (C + /)   (IT)

                                         =  C +  I (1   T)

The  above  equation represents  the  net  effect of the  load  on the  company's cash  balance
during a year. (It  must  be kept in  mind that, in this analysis, the  operating  costs resulting
from  the  control  equipment  are  not  considered. Only the effect of  initial investments in
pollution control on the company's  fiscal  position  is analyzed here.)

    The payment  of interest and principal extends  through the term  of the loan. For  long
term  loans such as  those for pollution  control expenditures,  the term would be more than 1
year.  The net  cash  outflow,  NCFj,  during  year  i is

                                  NCFi = Ct + If  (I   T)
                                             14

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where  Cz-  =  principal payback during year i
       fj   =  interest expense during year i
       n   =  term of the loan in years.

     The total effect of the  loan  on the  company's cash  flow  over time is determined by
using the net  present value approach which incorporates the time-value of money as described
in chapter II.

     Thus, the discounted cash flow during year i  is

                                      DCFi =
                                              (1 + r)z

     The sum total of all  such discounted  cash flows over the terms of the loan is the NPV
of the loan:

                                              n

                                     NPV = £  DCFf
                                             i=\
                                                   NCFj

                                              i=l (1 + rY

Since NPV of  loans  is  the  sum of  discounted  outflows,  the  lower the  NPV,  the more
attractive the loan.  The annual discount rate, 1 + r, as in chapter  II, is the after-tax return on
investment  for the manufacturer, averaging 3.5  percent.
                                    BANK  FINANCING
     Some commercial banks  across the country have announced preferential rates  and terms
for certified  pollution control facilities. However, since these bank programs are quite random,
normal  installment bank  financing rates  and terms  were used for this analysis of pollution
control  equipment financing.

     The  terms and  rate suggested here as normal for this type of financing are 5 years and 6
percent  annually,  with the effective  rate of  interest  being  10.84  annually.  The NPV for
financing  the $200,000 waste  treatment system  through  a bank is $208,100, as shown in table
III-l. The cash outflows  for this  financing alternative increase each year because of the bank
repayments system.  Although the  annual payment amounts are the  same,  the proportion of
                                            15

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interest in those payments is higher in  the beginning.  Since this interest  is tax deductible, thus
reducing the net  cash  outflow by approximately half,  the  net cash outflow is  lower in the
beginning of the loan.

     Table  III-l  shows  the  details  of NPV calculations for  a 5-year bank loan for  $200,000,
using a  6  percent interest  rate; the loan  is  repaid  quarterly.  This type of table  should  be
completed for each of the following financing  strategies in order to  make comparisons.
                      Table  111-1.—NPV calculation  for bank financing
Year
1
2
3
4
5

Repayment
interest
/
$21,143
16,571
12,000
7,429
2,857
$60,000
Principal
C
$ 30,857
35,429
40,000
44,571
49,143
$200,000
Total
annual
$ 52,000
52,000
52,000
52,000
52,000
$260,000
Interest
X
(1 T)
$10,994
8,617
6,240
3,863
1,486
Plus
principal
= NCF
$41,851
44,046
46,240
48,434
50,629
Disc.
factor
1 + r
1.0350
1.0712
1.1087
1.1475
1.1877
NCF •*•
(1 + r)
= DCF
$ 40,436
41,118
41,708
42,209
42,629
Total DCF = NPV = $208,100
               SMALL BUSINESS ADMINISTRATION COMPLIANCE  LOANS
     The  Small  Business Administration (SBA) has historically provided loans to businesses if
such loans are not available through normal banking channels and if the applicant meets  SBA
business  size  and  risk  requirements.  The  funds  are provided  in  three  ways:  by the  SBA
guaranteeing  a portion  up to 90  percent  of a bank  loan; by  participation, in which case the
SBA provides a part  of the funds and  the  rest is provided by the  bank;  and by direct loans,
in which  case the SBA  provides funds  on a direct  loan  basis.  All of these  so-called regular
business  loans, in  practice,  have  typical  repayment  periods  of  up to  15 years. Direct  loans
have considerably  lower rates than the  participation rate or the guaranteed rate; however,  such
direct loans are  frequently not available.

     Over  the last decade,  Congress  has  passed  several  significant pieces of  consumer  and
environmental legislation, many of which were expected to significantly impact  certain sectors
                                             16

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of  the  economy.  Those  companies  which  were  expected  to  be most impacted by  the
legislation were  described as substantially  injured.  In  several instances Congress sought to aid
these  companies  through  special loan  and other assistance programs  of the SBA. These special
programs  come  under SBA's general  category  of disaster loans,  rather than regular business
loans. They are similar to regular  business loans in that  the three types of loans are used by
SBA,  but they differ in that the repayment  period is longer and the direct  loans  with  their
lower interest  rates are  somewhat  more  available. Therefore,  such loan programs  should be
carefully examined by a  substantially injured firm.
Water Pollution  Control  Loans
     The Clean Water Act legislated that S800 million be made available under the disaster
loan category  of SBA  to  small businesses for water pollution control capital expenditures
providing the company is substantially injured. The program has been operating since August
1974.  An important part of the  law is  that  it  is necessary for an  applicant  to  obtain a
certification from the  appropriate regional office of  EPA stating that the equipment  is
"necessary and adequate" to meet the Clean Water Act regulations.

     A company qualifies for SBA water pollution control loans if  it  is a "small  business
concern  . .  .  affecting  additions to  or alterations  in  the  equipment, facilities  (including the
construction of pretreatment facilities  and interceptor sewers) or methods  of operation of such
concern  to  meet water pollution  control  requirement   .    if such concern is likely to suffer
substantial  economic  injury without  assistance."  Appendix  A  describes   loan  application
procedures.
Compliance Loans for Other Regulations
     In January 1974, the President approved legislation permitting SBA to  make loans to any
small business concern required to  "meet requirements imposed on such a concern pursuant to
any  Federal  law,"  or  any  state  law  enacted  in  conformity with  the  federal  law.  This
legislation  unified several  earlier enactments (except for  water pollution  control) which had
established specific loan  programs for each regulatory program.  Under the new legislation, SBA
can  now provide a loan  to  any  eligible company  for  compliance to  any federally-imposed
standards (except  for  water  pollution control)  which require alterations in  its plant, facilities,
or methods of operation.

     Because the  compliance loans are relatively  new, it  should  be made clear  to  SBA and
other  financial  officials  at all  steps in the  inquiry  and application process that  inquiries  are
                                             17

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    Because the compliance loans are relatively new, it should be made clear to SBA and other
financial officials at all steps in the inquiry and application process that inquiries are being made for
compliance loans under the disaster fund, rather than for regular business loans. It is also important
that small businesses who might be eligible for SBA compliance loans  begin with the application
process early. Funds for these  loans are limited and considerable effort  is required to complete the
loan application.

    To be eligible  for either of these loan programs, companies must satisfy the SBA  definition of
small   business  and be companies  which would  sustain substantial injury  from   compliance
requirements without the benefit of the loan. Substantial injury consists of a company being refused
financing for pollution control  expenditures; or being offered financing,  but at unreasonable terms.
Such terms could include  interest rates that would cause losses, lack of collateral or too short a
repayment schedule.

    The interest rate for SBA's direct loan bears an interest rate equivalent to the government rate of
borrowing. The 1975 rate was 6.5 percent and is  used in this illustration. Interest rates for guaranteed
loans are generally several percentage points higher than direct SBA  loans.

    Equal annual repayments were chosen as the principal payback method, and the interest rate was
applied to the declining outstanding principal  balance of the loan. SBA loans can extend up to 30
years.  However, in  the example being illustrated here, a 10-year loan term was chosen. Using the
6.5-percent direct loan rate and the  10-year repayment schedule, the NPVis $198,846.
             SMALL BUSINESS ADMINISTRATION  LEASE GUARANTEES


     In June 1976, Congress provided the Small Business Administration (SBA) with a significantly
different mechanism, than was just described for assisting small business in pollution control. While
the former program covers loans, this new mechanism covers leases under qualified contracts. The
area of pollution control financing in which leases occur most is in Industrial Development Bonds
(IDBs).  Therefore, this program is expected to take the form of SBA guarantees of small business
payments to municipalities that issue IDBs for industrial pollution control projects. The budget for
this lease guarantee program is  $15 million.

    The likelihood is that each IDE issued will cover the expenditures of several small businesses. As
will be shown in the next section, IDBs must be of a magnitude where the interest savings to the
company exceed the administrative, sales and legal expenses of obtaining IDBs. This level is generally
$500,000 - $1,000,000. It  may take several small businesses' pollution control expenditures to reach
those levels. Even if small  businesses singularly have expenditures that exceed the minimum level, they
can still benefit from this  program. Their savings of interest over IDB costs will be greater if they can
join a group in the financing. And also, if the company's name and credit reputation is not widely
known they would not be able to issue an IDB unless a guarantor of sufficient credit reputation and
name was also obligated  in the issue.
                                             18

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    The purpose of this legislation was to provide small businesses with access to capital markets on
equal footing with large businesses which frequently finance their pollution control facilities through
tax-free IDBs. However, all small businesses will not be able to use this lease guarantee program,
because of the high costs in obtaining IDBs. SBA expects that companies with loan needs greater than
$250,000 could use the lease guarantee program while companies with lesser needs would use the SBA
compliance loan program.

    It is not necessary that a small business be involved in an IDE for SBA's guarantee to be utilized.
The enabling legislation for the lease guarantee program specifies qualified contracts for the lease as
"a lease, sublease, loan agreement, installment  sales contract or similar instrument entered into
between a small business concern and any person."

     SBA is in the process of developing specific regulations for the lease guarantee program, as well as
conducting a pilot program in California. The most controversial regulation is the fee that SBA can
charge the company for the lease guarantee. The law permits up to 3-1/2 percent per annum of the
minimum annual guaranteed payments. SBA has presently set the fee at 3%. Others argue that much
of the benefit of this program, and therefore, the equal footing with large businesses, will be lost at that
high a rate.

     Other details of the program include a 25 year limit on guarantees and a 100 percent guarantee (as
opposed to  SBA guarantee programs which are 90%). In addition, applicants must have been in
business five years and have a history of profitable operations on average over the last three fiscal
years. These last two conditions are different from the  compliance  loan program.

     Precise  NPV benefits cannot yet be determined from the small businesses that utilize this lease
program. It is only after the program begins market operation that interest rates will become known.
Therefore, for NPV calculation purposes  the lease guarantee program will not be treated separately,
but will be considered  comparable to the illustrated SBA compliance loan NPV
                           INDUSTRIAL DEVELOPMENT BONDS

     Government  aid is  also available  to  corporate borrowers  as  a result  of the  effort to
encourage  industrial  development  in general and in some  cases to encourage industry to install
control equipment on pollution  sources.

     Federal tax provisions  make  it possible to finance  pollution control equipment at  interest
rates  that   are  generally  lower  than usual.  Once  a state declares  that  pollution  control, or
industrial development, serves a public purpose, equipment can be financed with the proceeds
of  industrial  development  bonds  (IDBs)  issued   by  a  municipality  or quasi-governmental
agency1 ;  there is  a limit   on   the amount  that  can  be   funded  by  IDBs  for  industrial
'Appendix B  contains various contractual arrangements a company may have with the government authority through which
 tax-free financing was obtained.
                                             19

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development, but  no limit when pollution control equipment is being funded.

     Because the  interest paid  on  these  bonds  is  exempt  from  federal  income  taxes, IDB
buyers are willing to  accept  an interest rate  that  may  be as much as 25  percent lower than
prevailing interest rates on corporate bond issues of comparable  quality. The advantages to the
company  of this alternative  are  reduced  by  the added fixed  costs  of  issuing  the  bonds,
resulting in an effective lower limit  on the size of issues  that can be financed by  such  means.

     IDBs  are either sold to  an institutional investor or a commercial bank and referred to as
private placements,  or they  are  sold to the public  and referred  to  as  public placements. The
costs  of issuing public placements  are greater  than  those for private  placements  because of the
high  costs  of the  legal  work,  advertising,  and  printing,  as  well  as the  fees  charged by
investment  bankers.  Consequently,  publicly  placed  IDBs  are  generally  utilized  only  in
multi-million dollar  financings;  $500,000  is  the  generally  acknowledged  floor,  or  trade-off
point.

     In  many states  there have  been  a  considerable number of privately placed IDBs issued for
amounts  less than  $500,000.  In the  case of  privately  placed  IDBs,  there  are also costs
resulting  from the  fees  for bond  counsel,  application  fees for  the  industrial development
agencies,  and  other  administrative  expenses.  However, they  are  frequently  considerably below
these of publicly placed issues.  The trade-off point or minimum  practical  size varies from state
to state, and even within a state.

     IDB  financing  is available in all but  a very few states. Most states require a municipal,
county, or  regional  development  authority  or  corporation to  serve  as  the  actual issuer of the
bonds.  While  such  authorities  do not  exist in all locations, it  is generally possible to create
one.  However,  the  expenses  involved  in  such  an effort would be  prohibitive  for a  single
relatively  small borrowing.

     There  have  recently been efforts  by  the Connecticut Development Authority,  the  New
York State  Job   Development  Authority,  and other governmental  agencies  to eliminate  the
handling  costs  that  preclude the  use  of such revenue bonds for small borrowings.  In some
instances, the borrowing  power  of state authorities  was used for large offerings undertaken on
behalf of  several  companies; the  economies  of scale yielded reduced  financing costs for  the
individual companies.

     For  our  example  of IDB financing, the  terms  include  a  6-percent  interest rate with  an
initial underwriting  cost of  2 percent.  The repayment period is 15 years  and  the repayment
schedule is as  follows:  8 percent of  principal annually  during  years  5  through  14, and  the
remaining  20  percent of  the  principal during  year  15.  In  order  to enter  the 2-percent
underwriting expense  into  the  NPV  calculations,  the  amount  is  added  to  the repayment
interest  amount for  year  1.
                                            20

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     As a word of caution about tax-free status, it is prudent  to obtain the advice of counsel.
There  are  a  number of  stipulations  about the  type  of facilities qualifying  for  tax-exempt
financing (see appendix C).

     The NPV of cash outflows  for the tax-free financing method using the terms described in
the $200,000 example is  $195,600.
                                         LEASING


     Leasing involves outside ownership of the equipment but permits the company to use the
equipment  for regular fees,  which are expensed.  In  terms of  cost comparisons, leasing  fees
should  be  compared  to  the depreciation and tax credits the company  would  have  had if  it
purchased the equipment.

     Leasing is attractive when companies cannot benefit  from the tax credits and deductions
of  the  equipment,  or when companies  prefer  not to show long-term debt on their balance
sheets.  The latter  becomes  a preference when  a  bank limits  company  debt,  or  when the
company prefers  to  show  a low debt structure. Whether this form  of accounting will  be
allowed  to  continue will depend on  accounting  standards boards.  It is currently being studied
by  the  Financial  Accounting  Standards Board.

     However,  the  Internal  Revenue  Service  (IRS)  has issued many  rules  which  must  be
adhered  to  for a  leasing  financing  arrangement  to be a  true lease and  not  a disguised sale.
Two  rules  are  most critical for pollution  control. At the termination of  the lease, it  must not
be  impossible or  impractical for  the  lessor  to remove the property. Secondly, where property
is  acquired  specifically for the lessee, the IRS may  contend that the property has no value to
anyone other than  the lessee at  the  end  of the term, thus encouraging  the lessor to abandon
the property to  the lessee.  These are severely limiting restrictions  as far as pollution control
leasing  is concerned since the equipment  is  often tailored  to a  source and not  transferable to
other  sources  and  since  both air and water pollution control equipment often  become so
interwoven  with real estate that  removal is impractical.

     In addition  to  the difficulties in  qualifying for a lease, leasing is more costly over the long
run than any of  the  other  alternatives discussed  here. For these reasons, less than 10 percent
of all  pollution control equipment is  leased,  and a detailed analysis is therefore not included
in  this manual.
                         COMPARISON  OF  FINANCING  METHODS
     Figure III-l  is a  bar graph of  the  net present values  of the negative  cash  outflows in
financing the  $200,000 cost  by the  three alternatives. The graph indicates the superiority  of
                                            21

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the tax-free  method  of financing pollution control equipment under the parameters selected
for the illustration.  There is  a  10-percent  difference between the best and worst  selection.

     Figure III-2 shows the  great differences in year-by-year cash outflow that result  from the
three  financing  strategies. The  conventional  bank loan, for example, leads to  much higher
outflow  during the  first 5 years  than either of the other  strategies. Conversely, a bond  issue
has  the  lowest  cash  outflow  for  an  extended  period. However,  depending  on  the  payoff
                           $200,000
                            180,000
                            160,000
                            140,000
                           120,000
                            100,000
                            80,000
                            60,000
                            40,000
                            20,000
                                                              n
ORDINARY BANK LOAN
                                                                   SBA LOAN
                                                                  TAX-FREE BOND
          Figure  111-1.  Net present  values of cash outflows from financing alternatives.

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method  chosen for the bond,  full repayment  of principal at  the  end or a sinking fund will  be
required. In  the  first instance (illustrated), high  cash outflow  is generated in the final year due
to the ballooning effect.

     Now  that the  financing  and  tax strategies have  been  described  and  analyzed,  we  are
prepared  to  compare  the alternatives for  selection purposes.  In order to make a selection,  the
objectives  by  which  companies  are  managed  must  be  analyzed,  as they impact  possible
combinations of the tax and financing alternatives. These will be  discussed in chapter IV.
            $50,000
             40,000
             30,000
             20,000
             10,000
                                          A. ORDINARY BANK LOAN
                                          B. SBA POLLUTION CONTROL LOAN
                                          C. TAX-FREE BOND
                                    _L
                                        I
                                            I
                                                I
                                                   I
                                                          I
                                    5   6   7  8   9  10  11
                                   YEAR AFTER ACQUISITION
12  13  14  15
          Figure  III-2. Year-by-year cash outflow from different financing strategies.
                                             23

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                                      Chapter IV

                   OPTIMUM  FINANCIAL STRATEGY FOR
                              POLLUTION CONTROL
    No  two   manufacturers  face  the   same  financial  problems,  nor  exactly  the  same
management objectives. However, to  demonstrate the effects of combining the various tax and
financing strategies, we have  selected  three business situations involving different management
objectives  that  might  exist  in  a manufacturing operation.  We  will  show  how  different
combinations of tax and financing affect each situation.

    The data  from the  calculations  discussed in chapters  II  and III  will be  used here to
determine  the appropriate  financing and tax strategies  for a given set of company management
objectives.  The  data  is capsulized in  table IV-1, which  contains  the  price and  life  of the
hypothetical pollution control equipment  and  the  tax status of the companies,  as well as the
key characteristics  of three financing strategies.

    First  let   us  look  at  the  manufacturer  who  has  enough  resources  and  stability to
concentrate  on maximizing  long-term profit.  For  him,  a  financial  management  decision
regarding tax  and  financing  strategies  would  be  based  on  finding the  combination with the
lowest net  present value (NPV). The computation of NPV for  each of the  12 combinations (4
tax and 3  financing strategies)  will be necessary. The combination illustrated in table IV-2 is
rapid  amortization  and  commercial  bank  financing.  This combination  was chosen  since the
illustrations  in  chapters II and  III contained  those  strategies. The figures in  table IV-2 are
identical to  the last columns in the earlier NPV illustrations for each separate  strategy. Note
that the term cash inflows is used to  represent the tax savings of rapid amortization, and the
term cash  outflows is used for the financing costs of the commercial bank loan strategy.

    Table  IV-3 shows the net  NPVs for  all 12 combinations of  tax and  financing  strategies.
Since  the  financial strategy in this case is  to minimize the long-term profit  impairments of the
strategies,   the  optimum  financial strategy  is  to choose  the  tax and   financing strategy
associated  with  the  lowest NPV,  indicated  by the boxed  figure.  In this instance, optimality
($92,000)  is achieved by  using the double-declining  and sum-of-the-years  digits depreciation
method along with a tax-free bond (strategies 3 and C).

    The numbers  for all  combinations of strategies, as shown in table IV-4, were  computed
for those  managers who are concerned about short-term profit impairment  (STPI) because, for
example, they may have  a short-term need to  demonstrate  the  strongest net income  statement
to lenders or stockholders.
                                            24

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Table IV-1.—Illustrative financial characteristics of pollution control equipment  for manufacturers
1.   Equipment Characteristics

     Investment cost
     Salvage value
     Useful  life

2.   Tax Status

     Corporate income tax  rate
     Investment credit
     Additional first year's  depreciation
     Effective cost-of-capital rate

3.   Financing Terms

     (a)   Ordinary bank loan

            Stated interest  rate
            Effective interest rate
            Repayment period

     (b)   SBA water pollution control
          loan or  compliance loan

            Interest rate
            Present treasury rate
            Payment period
     (c)   Tax-free bond

            Interest rate
            Initial cost of obtaining loan
            Repayment period
            Repayment schedule
$200,000
   0
10 years
48 percent
10 percent
$2,000
3.5 percent annually
6 percent annually
10.84 percent annually
5 years
Weighted average treasury rate
6.5 percent
10  years  (could  be as  long  as 30 years,  but
practically   may  not  be  more  than  life  of
equipment)
6 percent
2 percent of capital
15 years
8  percent  of principal  annually  during  years 5
through  14;  20 percent of principal during year
15 (balloon)
                                            25

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              Table  IV-2.—Net NPV  after combining cash inflows  and outflows
                         using rapid amortization and bank financing
Year
1
2
3
4
5
NPV of
year-by-year cash inflows
$28,955
17,745
17,144
16,565
16,006
$96,415
NPV of
year-by-year cash outflows
$ 40,436
41,118
41,708
42,209
42,629
$208,100
NPV cash outflows           $208,100

Less NPV cash inflows         96,415

Net NPV                    $111,685
            Table IV'-3.—Comparison  of long-term profit impairment resulting from
                             different tax and financing strategies
                                    Useful  life  = 10 years
                                  Investment cost:  $200,000
                                                           Financing  strategy
Tax strategy1
1.
2.
3.
4.
Straight-line depreciation
Straight-line depreciation
with investment credit
Double-declining balance depreciation
plus sum-of-the-years digits
with investment credit
Rapid amortization for
pollution control equipment
A.
Conventional
bank loan
$128,100
108,800
104,500
111,700
B.
SBA loan
$118,800
99,500
95,200
101,500
C.
Tax-free
bond
$115,600
96,300

|92,000|
99,100
 'Also includes effect of additional first year depreciation, Section 179, Internal Revenue Code.
                                              26

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           Table IV-4.—Comparisons of short-term profit impairment resulting from
                            different tax and financing strategies
                                    Useful life =  10 years
                                 Investment cost: $200,000
Tax strategy1
1.
2.
3.
4.
Straight-line depreciation
Straight-line depreciation
with investment credit
Double-declining balance depreciation
plus sum-of-the-years digits
with investment credit
Rapid amortization for
pollution control equipment
Financing strategy
A.
Conventional
bank loan
$57,700
37,900
58,800
66,000
B.
SBA loan
$47,700

27,900
51,100
58,300
C.
Tax-free
bond
$53,400
33,600
56,800
64,000
 'Also includes effect of additional first year depreciation, Section 179, Internal Revenue Code.
     The  figures were  derived  by adding each  year's depreciation  amount (D)  to  the  interest
expense  (/) and multiplying the result by (1    T). These computations were performed  for the
first 3 years  of each combination.  Thus the formula  for  STPI of  one of the combinations is

              STPI = (Dl + /p (1   T)  + (D2  + /2) (1   T) + (D3  + 73)  (1   T)

     The  boxed figure in table IV-4 is the optimal strategy  for STPI and results in the use of
straight-line depreciation plus  the  investment tax credit  and a Small Business  Administration
(SBA)  loan.

     For  table  IV-5, the financial management situation is that of a manufacturer with weak
working  capital. He  needs  pollution  control  equipment, but cannot  "afford"  it, either  now or
in the  foreseeable future. Clearly, the situation calls for the  lowest  possible cash outflow, year
by  year,  over  the  life  of  the  investment.  The  strategy  analysis  for   tins   situation is
accomplished  by determining  the  year-by-year  net  cash outflows  for each combination of tax
and financing strategy and choosing that combination which maintains  the lowest  profile with
the lowest peak outflow  in any one year.
                                             27

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           Table  IV'-5.—Comparisons of peak cash drains in any one year resulting
                          from different tax and financing strategies
                                    Useful life = 10  years
                                  Investment cost:  $200,000
Tax strategy1
1.
2.
3.
4.
Straight-line depreciation
Straight-line depreciation
with investment credit
Double-declining balance depreciation
plus sum-of-the-years digits
with investment credit
Rapid amortization for
pollution control equipment
Financing strategy
A.
Conventional
bank loan
$41,100(5)2
41,100(5)
40,500(5)
31,400(5)
B.
SBA loan
$17,300(1)

16,600(2)
19,000(10)
23,400(6)
C.
Tax-free
bond
$41,200(15)
41,200(15)
41,200(15)
41,200(15)
 'Also includes effect of additional first year depreciation, Section 179, Internal Revenue Code.
 2 Indicates year after acquisition during which stated peak cash drain is reached.
     The  boxed  figure $16,600(2) in table  IV-5 means that the peak net cash outflow in any
one  year  was   $16,600  and  occurred  in  the  second year.  This was accomplished  using
straight-line depreciation plus investment tax credit tax strategy, and an  SBA loan.  To arrive
at the figures, table IV-2 was used,  and a  column was added  to the right to indicate the net
cash outflow  for each year.

     Of  course,  few  business financial  decisions  are  ever made  on  the basis of  only one
objective;  a  number of  objectives are  usually  sought  with varying degrees  of intensity, and
compromises  are reached. For example,  a manager may be particularly concerned with having
the least  STPI but  also be concerned with the long-term profit picture. In that  case, he might
choose  straight-line  depreciation  with  investment   tax credit,  plus tax-free  bond   financing.
Although this was not the most  advantageous combination  under either management  objective,
it  was second  under both and by a fairly  small margin in each case,  as  shown in table  IV-6.
                                             28

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             Table IV-6.—The five most advantageous strategy combinations
                        by  management objective ranked in order
Least long-term
profit impairment
3 + C = $92,000
3 + B = 95,200
2 + C = 96,300
4 + C = 99,100
2 + B = 99,500
Least short-term
profit impairment
2 + B = $27,900
2 + C = 33,600
2 + A = 37,900
1 + B = 47,700
1 + C = 53,400
Least cash drain
in any one year
2 + B = $16,600
1 f B = 17,300
3 + B = 19,000
4 + B = 23,400
4 + A = 31,400
CODE:

Tax Strategies

     1.   Straight-line depreciation
     2.   Straight-line depreciation with investment credit
     3.   Double-declining  balance  depreciation  plus  sum-of-the-years digits  with investment
          credit
     4.   Rapid amortization for pollution control equipment

Financing Strategies

     A.   Conventional bank loan
     B.   SBA  loan
     C.   Tax-free bond
                                        SUMMARY
    Figure IV-1 clearly demonstrates why this analysis is so important. It shows the results of an NPV
analysis for one of the management objectives,  minimizing long-term profit impairment.  If the
pollution control facility in our example were financed by an ordinary bank loan (a fairly traditional
choice) and rapid amortization taken, the effective cost  of a $200,000 investment would have been
$111,700.  A  tax-free bond  with an investment tax credit and double-declining balance and
sum-of-the-years digits depreciation resulted in an effective cost of $92,000, a savings over the former
plan of $19,700. Therefore, it is well worth devoting considerable cost in order to explore the various
alernatives available for making the optimum financial  dicision.
                                            29

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Caution
     The conclusions derived in  this chapter are based  on assumptions about  costs, and about
each  of the  tax  strategies  and  financing  strategies  discussed  in the  previous  chapters.  All
assumptions should be checked  against prevailing conditions  when  a final analysis is made, and
new figures should be determined when those  conditions  change assumptions.
          $130,000 -
           120,000 -
           110,000 -
           100,000 •
            90,000 -
            80,000
                                                   n
DOUBLE-DECLINING BALANCE
+ SUM-OF-THE-YEARS DIGITS + IN-
VESTMENT TAX CREDIT

WITH RAPID AMORTIZATION
                        Figure  IV-1. Long-term profit impairment from
                            various financing and  tax alternatives.
                                             30

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                                     Chapter V
               STATE  FINANCING AND  TAX  INCENTIVES
     In  the  preceding  chapters,  nationally-available  federal  incentive  programs  were discussed;
these included  the federal  tax  programs and  the  Small  Business  Administration  (SBA)
programs, the  availability of which is limited only by funding levels.

     Although  industrial  development  bonds  (IDBs)   are  federally allowed  and  regulated
programs, each  state must pass enabling  legislation  so that IDBs  can  become  available  to
companies within  the  state.  Nearly  all 50  states  have passed  such legislation or have other
programs which accomplish a similar  objective. Therefore, when a choice analysis such as has
been outlined  is performed, it is the  relevant state  laws as  well as federal law  that determines
certain costs and conditions of industrial development financing.

     In  addition to IDBs, there  are a number  of other state programs which permit additional
costs  savings  for  pollution  control  equipment.  State  financing programs  other  than  IDBs
include  state-backed loan  guarantees and state support of municipal waste treatment facilities
through bonds  or state grants.

     State tax  regulations  offering  incentives  for pollution  control  include  real and personal
property tax exemptions,  tax exemptions on the purchase of pollution  control equipment, tax
credits,  accelerated depreciation, and  other programs. If  choices  are necessary,  an analysis
similar to that  described above should be done.

     Although state support of municipal waste treatment facilities may not be considered
directly relevant to industries,  it will be shown in  chapter VI that it becomes an important
aspect of analysis for those companies with industrial water pollution. Under the Clean Water
Act, the federal government will grant 75 percent of construction costs to eligible municipal
waste treatment projects, and as much as 85 percent to those projects using innovative and
alternative technologies. It is the financing of the remaining amount that creates differences in
costs betwee,  arud even within, states for industrial and residential treatment plant users.

     A particular financing program of the  state  in which  the  company  is located should be
included  in a choice analysis among the financing alternatives.

     Since this chapter is intended to alert a company's financial decision-maker to  nonfederal
incentive programs, five states have been chosen to demonstrate the variety  and similarities to
                                           31

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be found from  state to state. It should be noted  that  most incentives of  all states must  be
applied  for and  are not automatically  provided.
                                        ALABAMA
     Alabama has enabling legislation  to permit municipalities and local nonprofit development
corporations  to  issue IDBs, thus permitting tax-free financing  of the pollution control capital
programs of a corporation.

     Alabama provides  a wide variety of tax exemptions  for  pollution control equipment. It
allows a deduction,  for  purposes  of computing  state corporate income taxes,  on "all amounts
invested  in  devices,  parts  of  devices,  systems or facilities  used or placed in operation in the
State of  Alabama .  . . primarily  for the  protection  of  the  public and  the public interest
through the  control,  reduction, or elimination of air and water pollution." This law  results in
a  1-year depreciation writeoff of pollution  control  facilities  or  the election of a customary
depreciation method  for state tax purposes.

     The same types of pollution  control facilities described above are also  exempt  from the
ad  valorem  tax.  All equipment and  materials  to  be  used  in the control of air and  water
pollution are  exempt from sales taxes,  and the storage, use, or consumption of all equipment
and  materials for air and water pollution  control  purposes  is exempt from  the Alabama use
tax.  In  addition, the assessed value of pollution control equipment can be deducted  from the
assessed corporate shares, thus reducing the base on which the  ad valorem tax is computed.
                                       CALIFORNIA
     California has an  IDE  program, supports  municipal  water treatment facilities, has rapid
amortization tax provisions,  and has sales or use tax exemptions for all new pollution control
equipment.

     The  rapid  amortization provision  closely  follows  the  federal tax  provisions for rapid
amortization,  which  are  described in chapter  II of  this manual. The equipment's value (less
the  value  of recovered  materials  and  excluding land,  or  buildings not  related to  pollution
control)  can  be  deducted from state corporate income tax  over 60 months.  The equipment
must be for plants in  operation before January 1, 1971 and must  be installed before January
1, 1976 or  as  extended; information  about  the installation  date  can be obtained  from the
California Franchise Tax  Board. The facilities must also be certified  by the appropriate state
pollution control agency.
                                             32

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     As will be explained later, wastewater treatment projects  qualifying for  federal funds can
receive  75  percent  of the  funding  from  the federal  government. The remaining  25 percent
must be derived from local or state bonds or grants. The California Water  Bond  Law of  1974
raised  funds from  which grants can be  made for  the next  12-1/2 percent. California will also
make loans  with  liberal repayment conditions to  municipalities  that  have difficulty floating
their own issues for the last  12-1/2 percent of construction  cost. Thus, one municipality could
assess lower costs  to  an industry  than another municipality where the local  loan or bond has
less  liberal repayment terms.

     As with the  federal share of construction grants, industry in California must  repay  their
proportionate share of the state-financed portion of the construction  costs. The  state also has
regulations guiding the municipality in recouping annual operating and maintenance  costs.
                                         MISSOURI
     Missouri  provides  for  the  use  of  municipal general obligation  or  revenue  bonds for
industrial development purposes, namely  to  expand  or  upgrade industrial plants and  therefore
to finance pollution control equipment.

     Tax  incentives include a  sales and  use  tax  exemption  for pollution control facilities. A
general  property tax exemption for pollution control equipment is not provided by legislation;
however,  control equipment financed by  IDBs is  municipally owned and  consequently requires
no property tax.

     Under  various chapters  of  the  Missouri  Water  Pollution Law, grants can be  made for
municipal treatment  works.  The state can grant up to 25  percent of the construction cost for
projects  which also qualify for  federal  aid. The state requires a cost recovery system  from the
users  whereby all  costs are recovered,  including  interest, depreciation  for  future replacement,
and maintenance and  operation.
                                        NEW YORK
     New York State has  several  tax incentives and  financing programs for pollution  control
facilities,  including  two  of the  largest public bond  issues in the United  States for municipal
sewage  treatment  plants.  The  tax  incentives  involve  sales,  property,  and corporate  income
taxes for  qualified pollution control  equipment.  A  revenue bond  financing  capability  for
corporations also exists.
                                              33

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     Pollution  control  equipment and  utilities are  exempt  from  state and local  sales  taxes
except for those  of New York City.

     Local municipalities are given the power  by the state to excuse pollution control  facilities
from  real estate taxation and special ad valorem levies.

     An   unusual   feature  of  New  York  State's  tax  incentives  is  its   1-year  depreciation
provision. Corporations can deduct the full  cost of pollution  control facilities in 1 year against
their  state corporate  income  taxes.  For  those who decide  against the 1-year depreciation, a
1-percent tax  credit is allowed on state corporate  income taxes payable.

     Large corporations  can finance their pollution control  facilities  located  in  New  York
State by means of industrial  development (revenue)  bonds.  Small  corporations can  request
financing for  pollution  control  facilities  from the New  York  Job Development  Authority.  A
1973 bond issue  by  the Authority  is currently  serving  as  a source  of  funds  to  make low
interest,   long-term loans  for  up  to  90  percent  of   the  value  of  the  pollution   control
equipment. Future  funding levels have not yet been determined.

     Municipalities  in New  York can obtain  a considerable amount  of grant  assistance  from
the  state  government  for construction   and   for  operating  and  maintenance  costs of water
treatment  facilities.  Under a  $1.15  billion   1972  Environmental  Quality Bond  Act,  $750
million  was designated for municipal construction  grants  to provide  12.5 percent of construction
costs on top  of  a 75-percent  federal  grant.  However, eligible  construction  costs, by  state
definition, disallow collection systems.  Thus  the  local government can  obtain  75 percent for
collection  system  (since  the  federal  government   does  fund  collection  systems)  and  87.5
percent  for the remainder of  the entire  waste treatment facility. New York has another fund
from which grants  are  made to  municipalities for one-third  the costs  of eligible operating and
maintenance  costs.
                                        WISCONSIN
     Wisconsin has several  tax incentives. Statute  70.11  (21) of Wisconsin exempts the  air and
water  pollution  control  equipment  of  income  producing  properties  from  general property
taxation.  In  addition, pollution  control  equipment was  exempted from sales  taxes as of 1973.
Companies  may  deduct  from   the   Wisconsin   corporate  income  tax  all  of  the  cost  of
depreciable  air and  water pollution control  equipment in 1 year. Or, if a company  so  desires,
the  cost  of pollution  control  equipment can  be amortized  over a  period  of  5  years.  The
election of either  method of depreciation cannot be changed once one  is selected.

     Wisconsin also  allows  that  the cost  of  depreciable pollution control equipment,  less any
federal depreciation  taken,  can be deducted from  gross personal adjusted  income.
                                              34

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     In  addition   to   having  an  IDE  program  for  corporations  as  a  financing  incentive,
state-assisted financing and grant programs are  available  for  municipalities  in Wisconsin. The
percent the state  will  grant varies,  but the municipality cannot  receive more than a total  of
80 percent  from all grant sources.
                                         SUMMARY
     From these examples,  it is clear  that states  influence  the  terms of IDBs in the optimal
choice  analysis in the  earlier  chapters.  The  states also  add incentive programs  of their  own
which further  lower pollution  control  costs. The  reader  is cautioned to obtain a current copy
or interpretation  of  a state  law or regulation, and to discover the  funding  levels  and priorities
of a  loan  program  before selecting a  course  of action. Some sources for this  information are
included in appendix D.

     The  emphasis in the  analysis thus far has been  on a  firm's capital costs. In  chapter VI,
municipal  charges imposed  by  municipalities  for  treatment of  industrial  wastewater will be
discussed   and  optimization  of financial  strategies  for  water pollution control  costs will be
analyzed. This  requires  an analysis of  the  costs of both municipal  waste treatment  and private
treatment.
                                              35

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                                   Chapter VI

           FINANCIAL  DECISION-MAKING  ANALYSES FOR
       MUNICIPAL VERSUS  PRIVATE  TREATMENT OF WATER
    The  analyses completed in  the earlier chapters were for the capital costs of air and water
waste  treatment systems. Companies needing to control air pollution  emissions must undertake
the full responsibility  of  control  themselves.  In  many instances,  companies with waterborne
wastes  have  the choice  of treating  their process, sanitary,  and cooling  wastes  themselves
(on-site  treatment)  or  turning  the  chore  over  to  the  municipality, after  any  prescribed
pretreatment,  by sewering their wastes. Economics  play an integral  part in  this decision  and
the economics of the past are changing considerably.

    Tying into  municipal treatment facilities will have to be carefully analyzed for each  new
discharge  source, and  many established  companies  may  find it necessary to reconsider their
options in the near future. Costs  for most  companies  for municipal or for on-site treatment
will be higher than they may have experienced in  the past because:

    Municipal

    •    Industry  will  now  have  to pay  pro-rated  costs of  the  treatment  performed  by
         municipalities,  which   in   most  cases  is  more   than  previously  paid  to  the
         municipalities.

    •    Pretreatment  costs  for  municipal  discharges may be higher due  to  pretreatment
         requirements.

    On-Site and Municipal

    •    Effluent limitation requirements  are more stringent than before.

    The decision about tying into municipal treatment facilities is largely guided by the types
of pollutants a company would  be discharging into the facility. Incompatible wastes have the
potential to pass through without adequate treatment, interfere with municipal treatment; or
contaminate the municipality's sludge  reducing its usefulness for land  application. The
federal regulations specifically  require that municipalities be responsible for the quality of
their sludge as well as of the wastewater discharged from the municipal treatment facility. In
                                        36

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many cases,  it is  expected that  municipalities will require that  incompatible wastes be
pretreated by companies before discharging to a municipal facility. The level of pretreatment
by  industry  will  be  set  by the  municipality to  assure that the  requirements for the
municipality's wastewater discharge to the stream are not violated. Therefore, pretreatment
costs for an incompatible pollutant are equal to partial, or especially in the case of toxics, full,
private treatment costs for that pollutant.

    Compatible  wastes  are those which  the municipal plant is designed to treat  and
substantially  remove from the  waste stream. For most  organic or suspended solids,
pretreatment  of compatible wastes is not  required before the wastes  are discharged to a
municipality unless there are surges in flow or pollutant concentrations which upset or reduce
the efficiency of the municipal plant.

     Under the Clean Water Act, all  recipients of wastewater treatment plant construction
grants must  charge industry its  proportionate share of grant eligible capital and annual
operating costs for the treatment  and/or conveyance of discharged wastes. These costs may
be determined on the basis of strength or volume characteristics of the wastes. The charges on
industry for proportionate capital costs are referred to as industrial cost recovery charges or
1CR, while the charges for operating costs are referred to as user charges or UC. Both of these
costs together are referred to here as municipal costs.

     To implement industrial cost recovery, a rate is established by the municipalities. The
rate is computed by dividing the applicable construction costs by the design waste capacity
and dividing that figure by the repayment period (municipal plant life—maximum  30 years).
User  charge rates are developed in a similar way, by dividing total annual operating costs by
the total amount of wastewater and pollutants treated. Once the rates for the two charges are
established, each industry is charged  either a variable amount each year on the basis of its
maximum flow, or a fixed amount each year on the basis of a reserved capacity commitment
previously made with the municipality. Peak period discharge amounts (typically based on a
4-week peak period) are used when calculating an industry's maximum annual flow; the peak
amount is used as  the  discharge amount for all periods within a year.

     In addition, under the Clean Water Act:

     •    Seventy-five, and in some cases 85, percent of the eligible total municipal treatment
          construction costs can  be covered by a  Federal grant.

    •     Industry's share of these capital costs must be recovered in 30 years, or  less if the
          facility's intended useful life is less.

    ®     No interest is charged on the federal portion of the capital costs.

    •     Municipal costs for  large users  (typically industry)  no  longer include quantity
          discounts. Savings from economics  of scale must be shared  by all users.
                                         37

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     •     An exemption from industrial cost recovery charges is allowed for those discharg-
          ing less than 25,000 gallons per day of sanitary wastewater or its equivalent.

     •    Companies and  industries with  similar  waste  characteristics can be classed together
          and the  class assessed at  a single rate  to facilitate administration of the program.

     •    Each  user  of more than 10  percent of the municipal  volume must sign a letter of
          agreement  with  the municipality  saying that the user agrees  to pay that portion of
          the grant allotable to the treatment of its wastes.

     •    Should  another  industrial user leave  the municipal system, the remaining industries
          are not responsible for that industry's Federal  industrial  cost share.

     •     Should you leave the system there is no federal requirement for the continuation of
          your individual cost recovery payments.

CAUTION:  The 0- to 25-percent construction  cost portion raised by the municipality need
not conform to the above regulations.

     Municipal  costs should theoretically be lower than the company costs to treat the same
wastes because  of two factors:

     •     The economics of scale that should be available from the large size of the municipal
          treatment system.

     •     Municipal treatment standards which are slightly less stringent than those which
          private dischargers face.

On the other hand, the actual costs for municipal treatment could be higher where the source
has substantial quantities of incompatible wastes requiring pretreatment or has to extend
sewers a considerable distance to join  the municipal system.

     The economic choice to be examined in the following illustration is between (1) the
pretreatment and discharge to municipal sewers and (2) total private on-site treatment which
is discharged directly to a stream.
                           NET PRESENT VALUE ANALYSIS
     In order to compare the costs of private and municipal treatment, and continuing to use
 the  earlier  illustration,  operating and  maintenance costs  have  to be  added  to the effective
 equipment costs computed at the end of chapter IV:
                                           38

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                effective equipment cost (NPV)

         plus   NPV of operating costs

         equals Total Effective Equipment Cost for a Private Treatment Facility.

     The municipal cost  elements  to include in the financial  analysis  are as follows:

                effective municipal industrial  cost recovery and user charges  (NPV)

         plus   NPV of pretreatment capital  and  operating costs  for incompatible pollutants

         equals Total Effective Pollution Control  Cost for Using  a Municipal Facility.

     Because  of the  complexity  of this  analysis and  to avoid repetition  of the preceding
portions of this  publication, we  will  limit  this discussion  to  one  of  the  three  financial
management strategies discussed  in  chapter  IV. Of the three, we  have chosen the  management
objective of maximizing  long-term profit, the analysis of which is  primarily a net present value
(NPV)  analysis.  This method,  incidentally,  is the  one  used most frequently  by EPA in
economic impact studies.

     In developing an NPV  for  the two treatment alternatives, i.e. pretreatment versus  total
on-site  treatment,  we  must take  into  account  the  differing useful lives  of the  technical
alternatives. The industrial cost recovery  guidelines issued by EPA specify municipal plant  cost
recovery from  industrial  clients  for the  shorter  of  30  years or  the  life  of the municipal
equipment.  We have  chosen  a life of 20 years in the following example. Because the preceding
discussion  of treatment  cost used a life of  10 years for the  equipment, it  will be necessary in
the  computation to  show the  effect of buying new  treatment equipment after 10 years. At
the  end of 20 years, both  the municipal equipment  and the second  treatment will be  fully
depreciated.

     (In comparing NPVs  for varying depreciation range  equipments, it is  necessary to  extend
the  analysis to the  point where both  depreciated  values are  zero. This  is accomplished by
renewing the  shorter-lived equipment enough  times so that  its depreciated value  and that of
the longer  lived equipment are equal. An NPV comparison can then be made.)

     The following  analysis  assumes that both  sets of  on-site  equipment  will be  depreciated
and  financed  by the same  methods which were  superior in the long-term  profit analysis of
chapter  IV;  i.e.   double-declining  balance  and   sum-of-the-y ears  digits  depreciation  with
investment  tax  credit and  a tax-free pollution control  bond. The  terms  of the  two tax-free
bonds  will  be  repayments of 10  percent of the principal in 1 through  10 years  and again in
years 11 through 19  for the second  on-site system.

     Table VI-1 shows how  the NPV for the on-site treatment  plant  alternative was derived.
                                            39

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                     Table VI-1.— NPV of 20-year on-site treatment plant



Year
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20

A


O&M
$20,000
20,000
20,000
20,000
20,000
20,000
20,000
20,000
20,000
20,000
20,000
20,000
20,000
20,000
20,000
20,000
20,000
20,000
20,000
20,000

B

Yearly
depreciation
$41,6003
31,680
28,160
24,640
21,119
17,599
14,080
10,560
7,040
3,520
41,6003
31,680
28,160
24,640
21,119
17,599
14,080
10,560
7,040
3,520

C

Interest
payments
$22,0004
10,800
9,600
8,400
7,200
6,000
4,800
3,600
2,400
1,200
22,0004
10,800
9,600
8,400
7,200
6,000
4,800
3,600
2,400
1,200

D

Principal
payments
$ 20,000
20,000
20,000
20,000
20,000
20,000
20,000
20,000
20,000
20,000
20,000
20,000
20,000
20,000
20,000
20,000
20,000
20,000
20,000
20,000
$400,000
E1
After-tax
negative
cash flow
$41,840
36,016
35,392
34,768
34,144
33,520
32,896
32,272
31,648
31,024
41,840
36,016
35,392
34,768
34,144
33,520
32,896
32,272
31,648
31,024
F2
After-tax
positive
cash flow
$33,968
15,206
13,517
1 1 ,827
10,137
8,448
6,758
5,069
3,379
1,690
33,968
15,206
13,517
11,827
10,137
8,448
6,758
5,069
3,379
1,690
G
Discounted
cash flow
(E-FH-d+r)'
$ 7,606
19,427
19,730
19,992
20,213
20,395
20,544
20,658
20,742
20,795
5,315
13,679
13,892
14,077
14,233
14,362
14,466
14,547
14,606
14,645
Total DCF = NPV = $323,924
 1 (A + C)(1  T) + D.
 2BT -t- 10 percent investment tax credit ($20,000) for year 1 and for year  11.
 3 Includes additional first year'? depreciation of $2,000.
 "Includes 5-percent underwriting expense for bond issue.
     The  analysis of  the  municipal treatment  plant  alternative includes the pretreatment  costs
plus the  municipal costs  to  be  paid  by  the manufacturer. The size, capital, and operating
characteristics  of  the  municipal  treatment  plant   directly  influence  the  fee  charged  for
treatment. The type  and  volume of incompatible wastes influence the  pretreatment  costs. This
analysis  assumes  a  municipal treatment plant capable of  handling 16  million gallons  per day
(MGD). At an approximate  capital cost of  $1.2 million per MGD,  the total  plant  cost would
be  approximately  $19  million.  For illustrative purposes,  it is  assumed that the manufacturer
contributes 2 percent of this  total flow or 0.32  MGD.
                                              40

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    In addition, it is assumed that:

    •    Seventy-five percent  of the  construction cost is  provided by  federal grant at no
         interest  and requires industrial cost recovery.

    •    Twenty-five percent (the local/state share) is  raised through a tax-exempt bond  issue
         at  6 percent and also requires industrial  cost recovery.

    •    The  municipal  plant  requires the  manufacturer  to  have  pretreatment  equipment,
         which is $100,000 over the 20-year period  and is financed  by a 6-percent  tax-free
         loan and depreciated by the double-declining  balance and sum-of-the-years digits plus
         investment  credit method.

    •    The operating  and  maintenance   costs (O&M)   incurred  by  the  plant   for  the
         pretreatment facility is  10  percent, or $10,000 per year.

    The municipal costs  for the plant thus consist of the following costs:

    •    Two percent (percentage contribution to the total  municipal flow) of 75 percent of
         $19  million  over 20  years, which equals  $14,250 per  year (to  repay  the  federal
         capital proportion,  i.e., industrial cost recovery).

    •    Two percent of 25 percent of  $19  million  plus yearly interest of 6 percent on the
         unpaid  balance  to  repay the  local/state  capital proportion, which equals  $10,450 in
         year 1  and decreases to $5,035  by the 20th year.

    •    Yearly municipal O&M (2  percent of $760,000) which equals $15,200.

    In order to make a comparison with on-site treatment costs, the following must be added
to the municipal  costs:

    •    The NPV  of the  pretreatment  capital   costs after cash  flow  considerations  from
         depreciation and financing  costs.

    •    Pretreatment O&M  of $10,000.

    This example  of the costs resulting from  using a municipal treatment system with
required pretreatment  is further illustrated in table VI-2.

    When comparisons  are made between table VI-1  (the NPV of 20-year on-site treatment
plant) and table VI-2 (the/VfV of charges for 20-year municipal  treatment cost recovery
system), the financial choice is to treat wastewater on site. Obviously this is an illustrative
finding  based on the parameters of our hypothetical plant. It would not be prudent to extend
the implications  of  this simplified example to industry in  general.

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                              Table VI-2.—A/PI/of charges for 20-year municipal treatment cost  recovery system

Year
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20

A
Federal
industrial
cost
recovery
$14,250
14,250
14,250
14,250
14,250
14,250
14,250
14,250
14,250
14,250
14,250
14,250
14,250
14,250
14,250
14,250
14,250
14,250
14,250
14,250

B
Local/
state
portion
$10,450
10,165
9,880
9,595
9,490
9,025
8,740
8,455
8,170
7,885
7,920
7,315
7,030
6,745
6,460
6,175
5,890
5,605
5,320
5,035

C
Treatment
and
pretreatment
O&M
$25,200
25,200
25,200
25,200
25,200
25,200
25,200
25,200
25,200
25,200
25,200
25,200
25,200
25,200
25,200
25,200
25,200
25,200
25,200
25,200

D
Depreciation
$11,800
8,820
8,355
7,891
7,427
6,963
6,499
6,034
5,570
5,106
4,643
4,178
3,710
3,249
2,786
2,321
1,857
1,393
929
465

E
I nterest
$11,000
6,000
6,000
6,000
6,000
6,000
6,000
6,000
6,000
6,000
5,520
5,040
4,560
4,080
3,600
3,120
2,640
2,160
1,680
1,200

F
Principle









$ 8,000
8,000
8,000
8,000
8,000
8,000
8,000
8,000
8,000
8,000
20,000

G1
After-tax
positive
cash flow
$15,664
4,234
4,010
3,788
3,565
3,342
3,120
2,896
2,674
2,451
2,229
2,003
1,782
1,560
1,337
1,114
891
669
445
223
H2
After-tax
negative
cash flow
$31,668
28,920
28,772
28,623
28,564
28,327
28,179
28,031
27,882
35,734
35,503
34,939
34,541
34,134
33,745
33,347
32,950
32,552
32,154
43,756
I
Discounted
cash flow
(H-G)-HI +/-)'"
$ 15,463
23,045
22,334
21,643
25,052
20,825
19,696
19,088
18,495
23,595
22,790
21,648
20,805
19,988
19,214
18,464
17,744
17,050
16,383
21,794
Total DCF = NPV = $405,116
-p.
to
          1 TD + 10% investment tax credit ($10,000) for year one.


          2(A+B+C+E) (1 - T)+F

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    A number of cost elements could not be quantified and incorporated into the analysis,
such as costs to .extend sewers to a stream or to the public treatment system. A number of
assumptions were made in the illustrated case that can change from situation to situation. For
example, the 25-percent state/local portion of the construction cost portion could be raised
through a local or state bond issue, or a state grant, or a combination of the two. Generally,
local or state loans or bond issues must be repaid over the years with an interest payment as
was assumed in this analysis. However, grants for treatment plant construction costs do not
usually require repayment. Thus, the peculiarities of each  state's program for financially
assisting municipal waste treatment systems must be incorporated into the financial analysis.

    In addition, the present moratorium on collecting industrial cost recovery charges was
not included. The moratorium is to last until mid-1979, pending a study of the ICR system.
However, the results of the study may well be to keep  the basic system intact, while altering
certain details. In that case, any charges which were incurred  during the period but not
collected  will be due, though  spread out over the remaining useful life of the facility.
Obviously this condition introduces an amount of uncertainty into this analysis, and it may be
well,  if possible,  to  delay making a final decision  until the results of the ICR study are
prepared and acted on by Congress. A decision to delay would depend on how sensitive the
overall decision is to the figures generated for column A in table VI-2.

    Nonetheless, with appropriate adjustments as needed, the analysis in this chapter can
serve  as a managment guide to completing a more definitive analysis based on specific plant
situations and company financial posture and, goals.
                                         43

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                                      Chapter VII

                                      SUMMARY
     In  this  era  of  special  financing and tax  programs  associated with  a  multiplicity  of
environmental,  health,  and welfare  regulatory  laws,  it is  important to  perform  a financial
analysis of the  costs  associated  with these regulations  with as much  zeal  as  goes into the
technological  analysis  of the needed equipment.

     There are  a number of new financing and tax alternatives specially  designed for pollution
control  expenditures  that can have  financial consequences amounting to tens of thousands of
dollars.  Many of the  laws covering  these  alternatives require  that  once  a financial decision is
made it  cannot  be changed, or  can be  changed in  only  one  direction.  Even  if  it  can  be
changed, the  cost of  change  would be prohibitive later in  the  program. Some alternatives are
exclusively for  pollution  control  capital  costs or  for  process changes which  also  reduce
pollution, while  others indirectly  affect costs for operating and maintenance.

     The  following financial  information  should be analyzed as a minimum  before pollution
control  expenditure decisions  are  made:

     1.    Calculate the  year-by-year cash  inflows  and the  present  values for  each available
          choice of depreciation.

     2.    Determine the most effective  combination of rate and  term  of  loan for all  debt
          financing of pollution control investments.  Calculate the negative cash  flows involved
          and their net present values.

     3.    Select  the management  objective by which  you would want  to judge the financial
          impact   of  the investment  in   equipment;  for  example,  lowest   short-term profit
          impairment,  least cash drain,  least  long-term  profit impairment,  etc.  Compare the
          results of combining the various financing  and depreciation alternatives  considered in
          steps  1  and 2  against  the management objectives  and select the  combination best
          suited  to your company needs.

     4.    For those with industrial  wastewater,  determine what  the  municipality's  charge will
          be  for  processing  wastes,  estimate  the  capital   expenditure  and operating  costs
          necessary for  any  pretreatment  expense,  and  determine  a present  value  for the
          municipal and  pretreatment costs.
                                            44

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     5.    Compare the  present  values  and year-by-year effects  of  step  4 against  the  selected
          financial  management  objectives and  compare  the  results  to  on-site treatment capital
          and operating costs. This  will provide a financial basis for choosing  between using a
          municipality's wastewater system or investing in a private  treatment facility.

     This analysis presumes that the legal and tax restrictions of each financial  alternative are
fully  understood  by the  analyst  before the present values  and  cash  flows  are  calculated. In
addition,  any state and local technical restrictions which may  preclude  a manufacturer from
having freedom  of choice  must have been determined.

     Figure VII-1  is a  flow  chart  for  the analysis needed in  choosing the optimum financial
strategy  for pollution   control.  The  factors entering the municipal  versus  private  treatment
decision  process are shown at the  right of the broken line.
                                             45

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NPV AND YEARLY
CASH FLOWS FOR
TAX STRATEGIES
  NPV AND
  YEARLY CASH
  FLOWS FOR
  AVAILABLE
  FINANCING
  STRATEGIES
  MANAGEMENT'S
  FINANCIAL
  OBJECTIVE
                  ANALYSIS OF ALL POSSIBLE
                  COMBINATIONS OF TAX AND
                  FINANCIAL STRATEGIES
                  UNDER THE MANAGEMENT
                  OBJECTIVE
LIMITS IMPOSED BY
AVAILABILITY OF
ALTERNATIVES
        EQUIPMENT CHOICE ONLY
  NPV OF PRE-
  TREATMENT COSTS
  IF ANY
ADJUSTMENT BY INCREMEN-
TAL NPV OF:
(i) BY-PRODUCT RECOVERY
(ii) OPERATING COSTS FOR
PRIVATE FACILITY
Ib

ADJUSTED EFFECTIVE
EQUIPMENT COST FOR
A PRIVATE TREAT-
MENT FACILITY
                                                                              vs
ADJUSTED EFFECTIVE
MUNICIPAL COSTS
FOR USING MUNICIPAL
FACILITY
                                                                  PRIVATE TREATMENT VERSUS MUNICIPAL TIE-IN
                            Figure VI1-1. Guide to management  for choosing the optimum
                                        financial strategy for pollution control.

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                                   Appendix A

                   SBA  WATER  POLLUTION CONTROL
                   LOAN  APPLICATION PROCEDURES
                                  WHO IS ELIGIBLE
    Section 8  of the Federal  Water Pollution Control Act  (FWPCA) authorizes the Small
Business Administration (SBA) to make  loans to assist any small business concern in effecting
additions to  or alterations in  the  equipment, facilities, or  methods of operation  of such
concern to meet  water  pollution control  requirements under the FWPCA, if the concern  is
likely   to  suffer substantial  economic  injury without  assistance.  SBA has  defined  a small
business in  standards that  are available at any SBA field office. In  essence, the applicant must
be an independently owned and operated  small business, not  dominant in its field, and must
meet  employment  or sales size  standards  established  by SBA. In  addition,  a  small concern
may be eligible for a loan if its requirement for  a loan is a result of engaging in one  of the
following activities:

    •   The  business has  an  effluent  discharge requiring  a National Pollution Discharge
         Elimination System (NPDES) permit under Section 402 of the FWPCA.

    •   The business emits discharges through a sewer line  into a publicly  owned treatment
         works, and the city  or  town requires the treatment of waste discharge.

    •   The  business  plans  to  discharge   into  a   municipal  sewer system  through  the
         construction of a lateral or  interceptor sewer.

    •   The  business is  subject to  the  requirements  of a  state or regional authority for
         controlling the  disposal of pollutants that may affect groundwater.

    •   The business is  subject to  Corps of Engineers  permit for disposal of  dredged or fill
         material.

    •   The business is  subject to  Coast Guard  or state requirements regarding the  standard
         of performance or marine sanitation devices controlling sewage from  vessels.

    •   The business is  implementing a plan  to  control or  prevent the discharge or spill  of
         oil or other hazardous substances.
                                          47

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                                 SMALL BUSINESS SIZE
     Note that only small businesses are eligible for relief under the  provisions  of the FWPCA.
Before you go to  the  time,  trouble,  and expense  of preparing applications, be very sure of
your  size classification.  If there is any  doubt about the  classification  of your business, see
Part  121.3-10  of the  Small  Business  Administration Rules and Regulations or contact your
local SBA office to determine the applicable employee or sales  standard.
                          WHAT COLLATERAL IS NECESSARY
     The applicant must  be  in sound  financial condition and give  reasonable assurance  that the
loan will be  repaid.  The  applicant must  pledge whatever  collateral or give such guarantees as
he  can. When the SBA loan is used to acquire fixed assets,  these must  be pledged as  security.

     Personal  and/or  business assets should be used to the  greatest extent possible, but it  is
not  expected  that  they  will be  needed  to the point  of  curtailing working  capital or reserve
requirements.
                               EPA'S TECHNICAL REVIEW
     Before the SBA  will review your eligibility  for  these loans,  your credit  information, or
your  ability  to repay the loan, EPA  must perform  a  technical review  of the application to
determine  that the  proposed additions or alterations are  necessary  and adequate to comply
with one or more  applicable  standards.

     You  can  obtain this review by submitting  two copies  of the application for Statement of
Compliance to the EPA  Regional SBA Coordinator. Processing  time  at  EPA  should generally
not exceed 45  working days  from the time a complete application is  received.

     The review by EPA may result  in  one of three distinct determinations:

     ©   Approval:  A  written  statement  will  be  provided to  you  attesting  to  this,  with a
         copy sent  directly to the appropriate  SBA office.

     ©   Conditional Approval:  Some  of the  items  were acceptable and  some  were  not.  A
         copy of  the conditional approval will be sent to the  appropriate SBA office.  Appeal
         of the rejected portion may be made  without  prejudice  to the approved portion.
         You may use a conditional approval to secure a loan.
                                            48

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     «   Disapproval:  You  may  make  an appeal  within  60 days directly to the EPA Deputy
         Administrator in Washington,  D.C.

     The EPA  review  is for technical  purposes.  Do  not  send detailed company  financial  and
credit data to  EPA. EPA may empower  states to conduct  this review and to issue  statements.
                                WHEN TO APPLY TO EPA
     Applications  to  EPA  should  be  made  after  a  permit  or  other official  notification
containing  requirements  is issued  to  or  placed upon you by EPA, Corps of Engineers,  Coast
Guard,  state,  municipal,  or  regional management  authority. These  requirements  will specify
certain  conditions or schedules to be met; only after these requirements are known  can  the
determination  of necessity and adequacy be considered.
                        WHAT MUST AN  APPLICATION  INCLUDE
     An  application to  EPA need  not be  in  any particular form but it must  include  the
following:

     ®   Name of applicant
         Mailing  address
         (Address of affected facility, if different, from above)

     ®   Signature  of owner, partner,  or  principal  executive officer requesting  the  Statement
         of Compliance

     ®   Standard Industrial Classification (SIC) number for business for which an application
         is  being submitted (see Standard  Industrial  Classification  Manual, 1972 edition, or
         describe the type of business  activity if  SIC  is not known)

     «   Description  of process or activity generating  the  pollution to be  abated by additions,
         alterations, or methods of  operation covered  by  application

     »   Specific description of additions, alterations,  or methods  of operation  covered by the
         application.  This would include, where appropriate:

         —    Summary  of construction to be undertaken

         —    Listing of major equipment  to be purchased or utilized in operation
                                            49

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         —    Purchase  of any land  or easements necessary to operation of facility

         —    Other items  deemed pertinent (information considered  as a trade secret shall be
              identified as such)

     •   Declaration  or requirement(s)  for compliance for  which  alterations, additions, or
         methods of operations are  claimed to be necessary and adequate

     •   If  you  have received a permit from  a State  Water Pollution  Control Agency within
         the preceding  2 years,  and the permit was not an NPDES permit issued under the
         federal  act, and  where the permit  relates  directly to  abatement of discharge for
         which statement is  sought, a copy of the permit should be included.

     •   Any written information from a manufacturer, supplier, or  consulting engineer, or
         similar  independent  source,   concerning  design   capabilities  of  the  additions  or
         alterations  covered  by   the   applications.   This   would  include   warranties  or
         certifications obtained  from  or provided  by   such  sources  which would bear  upon
         design   or performance  capabilities.  (Requirement  may  be  waived  if  there  is no
         independent source for the information described).

     •   Estimated schedule for construction or implementation of alterations or methods of
         operation

     •   Estimated  cost  of  alterations,  additions, or methods  of  operation  and,  where
         practicable, individual costs of  major elements of construction  to be  undertaken

     •   Information on previously  received SBA loan assistance  for a facility or method of
         operation; description and dates of activity funded

     •   NPDES  permit number, if applicable
                               SBA'S FINANCIAL  REVIEW
     The EPA  approval or conditional  approval  should  be submitted to the appropriate SBA
office  with the  completed  SBA loan  application.  Once  SBA  has  received  your  complete
application package,  you should plan  for a review time of about 4 weeks.
                                             50

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                                FURTHER  INFORMATION
     For further information, contact either the EPA regional or SBA district office. The EPA
regional office  will  also be  able  to  provide  you  with a copy of the  regulations that were
developed for this program,  which should help you in  preparing your application for technical
review.
                                             51

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                                   Appendix  B

        TYPES  OF CONTRACTUAL ARRANGEMENTS BETWEEN
          GOVERNMENTAL AUTHORITIES AND  INDUSTRIES
                   ACQUIRING  TAX-FREE  FINANCING
    Depending on  the  state,  a  borrower  utilizing the  industrial development bond  program
may  deal  with  a township,  city, town,  county,  village,  or borough; a quasi-governmental
authority;  or a state. Also, the sources which loan the  funds to the authority  to be lent to
the borrower may be a  bank, the public at large, or some other institutional investor who can
benefit from the tax-free income. Just as variable are the agreements  between  the authority
and the company installing pollution control equipment, particularly in  the manner of interest
and principal repayments.

    The interest and principal repayment schedule utilized by the borrower in the example in
this manual is essentially similar to  many bond indentures.  That is, equal interest payments
are paid  each  year,  but  the  borrower  pays  different amounts  of principal  into a  type  of
sinking fund during  the life of the financing. The sinking fund plus earned interest is used as
the repayment  source  at the end  of  the  term  of the  financing. As is  typical  in  most
situations,  there is a  lien  on  the property being financed and/or  a guarantee by  the borrower.
At the end of the  financing  period,  the borrower purchases the  facility from the authority at
nominal consideration, which  must be less than fair market value. The borrower is treated as
the owner for  tax  purposes  during the financing period, even though  legal title is in the
authority.  The borrower can take  depreciation and investment tax credits.

    It is  also  possible  for  the  relationship between  the  governmental  authority  and the
industry to be structured as an ordinary financing lease, with lease payments deducted by the
business as rental payments.  In  this case, the  lessee does  not  have  the  privilege of taking
depreciation and  the  investment  tax  credit. The payments would be even over  the lease life.
The authority retains title at the end of the financing. This relationship does  not occur often
because of difficulty in  meeting the same lease tests described in  chapter III.

    Another possibility is to  establish  the relationship as an installment  sale  with title going
to the buyer  at  the  end of  the  installment  period. This  system would have  equal payments
and allow  the  purchaser to take depreciation  and the investment tax credit.

    The last  method is for  the  government agency to issue a bond, the proceeds of which
are reloaned to several  companies. Each  company negotiates its own  terms and signs a loan
agreement  or note. The  borrower is entitled to depreciation and the  investment tax credit.
                                          52

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                                  Appendix C

      IRS DEFINITIONS  AND ALLOCATIONS OF  POLLUTION
       CONTROL  EQUIPMENT UNDER  THE  IDB  PROGRAM
    For the financing of equipment to be tax exempt under the industrial development program.
it must meet  many tests [Treasury Regulations Section  1.103-8 (a) and (g)].

    In mid-1975, the Internal Revenue Service (IRS) promulgated regulations which define pollution
control equipment for industrial development bond (IDB) financing and which allocate its costs
where the equipment also performs a function other than pollution control. The regulations were not
finalized at the date of this printing, but are being used by the IRS. The reader should check for final
regulations when they are adopted.

   The regulations are listed below and  several are followed by examples:

   •   "The property must in  whole, or in part,  abate or  control  water or  atmospheric
       pollution  or  contamination by  removing, altering,  disposing  or  storing pollutants,
       contaminants,  wastes or  heat."  The term pollutant only applies to materials or  heat
       discharges  which  definitely result  in  water  or  atmospheric  contamination.  This
       definition  excludes  "the  release  of  materials  or heat  which  would endanger  the.
       employees ... in  which such  property is used," for  example, as determined under
       the OSHA program.

   •   The  property  must be "of a character subject  to allowance for depreciation   .  .  or
       land."

   •   "The  jurisdictional  agency must  certify  that  the  facility,  as  designed, is  in
       furtherance of the purpose of  abating  or controlling pollutants,  or the  facility will
       meet or exceed the appropriate  regulations in effect at the time of issuance."

   •   Property does not qualify  if used  to avoid the creation of pollutants. For example,
       the  installation  of a   new boiler  which  reduces  pollution  by  more   efficient
       combustion than  the replaced  boiler  does  not qualify. Likewise,  equipment  that
       removes potentially polluting sulfur from fuel does not qualify. However, equipment
       which handles  or  treats the removed sulfur does qualify.  This is one of the more
       controversial regulations.
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     •   Property  does not qualify if it processes  material or  heat  that  was a pollutant, but
         is not upon reaching the process in  question. The  property  must be  "a  unit which is
         discrete   and  which  performs . . .  one   or  more   of  the  (pollution   control)
         functions .  .  . and which cannot be  further  reduced  in size  without losing  one of
         such  characteristics." For example,  consider pollutants converted in a first step to a
         nonpollutant  chemical which  is  subsequently processed to  make  it  saleable.  The
         equipment of the first step qualifies; equipment in  the subsequent steps  does not
         qualify.  The  equipment   in  the first  step  is  the smallest unit  of property  which
         functions  to   control  pollution.  In  addition, by  the time  the  material  reaches
         subsequent steps it is no longer a pollutant.

     •   Property  also does not qualify  if the  polluting materials were  customarily controlled
         for other reasons. For  example, a water system which  discharges heat from cooling a
         turbine  does  not   qualify  since   turbines  require   cooling  to  operate  at  peak
         efficiencies.

     In addition to the above tests, an  exempt issue requires that 90 percent  or more of the
proceeds must  be used  for pollution control  equipment. Therefore,  up  to 111 percent of the
pollution control costs, if exactly known, may be borrowed.

     The second  major component  of the  regulations concerns the allocation  of property  costs
which controls pollution and  serves a purpose other than the  control of pollution.  Allocations
are necessary since it  is only  the  cost of the pollution  control  portion which qualifies for the
financing. The  following ratio should be  applied to the property cost to determine what  costs
do not qualify:

                                             Y
                                           C + E

where  Y -  present  value  of estimated economic benefits  to  be realized  over  the  life of the
            equipment,  such as "gross income  or cost savings  resulting  from any  increase in
            productivity or  capacity,  production  efficiencies,  the production of  a  byproduct,
            the extension of the  useful  life  of other  property .   .  (and) savings resulting
            from the use,  reuse, or recycling of items recovered."

       C =  present  value  of  payments   (excluding  interest  and  minus  salvage  value)  for
            acquiring the property, i.e., capital costs

       E =  present  value  of all expenses,  including interest, incurred during the operation of
            property.

Present values are  computed  using  a 12-1/2 percent discount rate (r).
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                                      Appendix D

                SOURCES OF INFORMATION ABOUT STATE
                      POLLUTION  CONTROL  INCENTIVES
      The Industrial Development Research  Council  (Conway  Research  Inc., Peachtree  Air
  Terminal, 1954 Airport  Road, Atlanta, Georgia)  publishes a list  of pollution control incentives
  available by state.

      The National  Association of  State  Development Agencies (Suite 203,  1925 K Street,
  N.W.,  Washington,  D.C.) maintains a  list of the  directors of state development agencies. These
  directors can  provide  details about state  financing programs relevant to pollution control, as
  well as some tax information.

      State departments of revenue and taxation should be consulted for details about state tax
  exemption and credit programs specifically for pollution  control.

      Information about  state municipal wastewater  construction  grants (including eligibility,
  funding level,  and  priorities for  grant approval) can be found  in the water quality office in
  either a state  health department or a  state environmental department.

      In  addition  to requesting a copy of the laws and any helpful supporting information, the
  names  of other authorities  who will  need to  be  contacted  should  be requested.  This is
  especially true for  those seeking  information on how to proceed when interested in industrial
  development bonds, also referred  to as pollution  control  or municipal  revenue bonds.
. S. GOVERNMENT PRINTING OFFICE: 1978-757-140/1459 Region No. 5-11


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