ENVIRONMENTAL PROTECTION AGENCY
TECHNOLOGY TRANSFER SEMINAR
PHILADELPHIA, PENNSYLVANIA - AUGUST 21 -22, 1973
UPGRADING DAIRY PRODUCTION
AND TREATMENT FACILITIES
TO REDUCE POLLUTION
CHOOSING THE OPTIMUM
FINANCIAL STRATEGY FOR POLLUTION CONTROL
J. A. Commins & Associates, Inc. Fort Washington, Pennsylvania 19034
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UPGRADING DAIRY PRODUCTION AND TREATMENT FACILITIES
TO REDUCE POLLUTION
CHOOSING THE OPTIMUM FINANCIAL STRATEGY
FOR POLLUTION CONTROL
ENVIRONMENTAL PROTECTION AGENCY
TECHNOLOGY TRANSFER SEMINAR
PHILADELPHIA, PENNSYLVANIA
AUGUST 21-22, 1973
J. A. GODWINS § ASSOCIATES, INC. FORT WASHINGTON, PA. 19034
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Foreword
Much has been written on how to select pollution control
equipment, but relatively little on how to pay for it. A sound capital
investment strategy, however, can mean the difference between profitable
operation and controlled cash flow, on the one hand, and fiscal chaos on
the other. This is an explanation of how some proven tax and financing
strategies, and their use in various combinations, can help the financial
position of three hypothetical dairy processing firms with differing man-
agement goals who face capital equipment expenditures. For dairy processors
who have a choice of on-site treatment or sending their pretreated wastes
to a municipal system, a method of financial analysis of these alternatives
is also presented.
No matter how adept and capable a financial manager may be, it
is entirely possible that he could overlook some important aspect of
fiscal management of pollution control expenditures, because of the new
and unique nature of the legislation, the high degree of complexity, and
the one-shot nature of the decision. This report was especially prepared
for the EPA Technology Transfer Seminar for dairy processors. It shows
the small businessman the type of financial analysis that should be
accorded a pollution control expenditure, because of the possibilities of
substantially reducing the funds expended, and smoothing out the cash flow
trauma that otherwise «ould develop.
The report has been tailored to the dairy processing industry
which is defined as butter, natural cheese, powder and condensed products,
ice crean and fluid milk. The dairy processing industry is faced with
several federal regulatory programs of which water pollution control represents
the most significant dollar outlay. However, the financial laws and analytical
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techniques have applicability to all air and occupational safety and
health situations for any industry.
The analysis is applicable to dairy processors with their own
treatment facilities and to those connecting with the municipal system.
Available data for those dairy processing establishments using municipal
facilities is limited to large plants processing 20 million or more gallons
per year. Large ice cream and fluid plants being more market oriented
discharge 72 and 76 percent of their wastes respectively into municipal
treatment facilities. Butter, cheese and condensing plants discharge
44, 49 and 30 percent respectively into municipal treatment facilities.
Together the large plants have municipalities treat 58 percent of their
wastes. Facing higher user charges in the future, brought about by the
Federal Water Pollution Control Act (FWPA) and new standards for private
treatment, this mix of those using municipal facilities is subject to
possible changes.
The reader should regard the illustrative situations used in
this presentation as necessarily sinplified, representative examples that
by no means exhaust the variety of available alternative tax and financing
strategies particularly those relating to pollution control equipment.
Much financing, and to a lesser extent, tax treatment varies by juris-
diction. Consultation with the latest tax rulings and legislation governing
in your location is necessary before undertaking the final decision making
process.
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Table of Contents
Page
Introduction 1
Management Summary and Guide iii
Organization of the Report v
Chapter I. Depreciation 1-1
Relationship of Depreciation to Taxes and Cash Flow .... 1-2
Net Present Value 1-3
Water Pollution Control Investment for Dairy Processors 1-5
Rapid Amortization 1-5
Straight Line Depreciation 1-7
Investment Tax Credit 1-7
Double-declining Balance Depreciaon 1-8
Net Present Value Calculations 1-8
Depreciation Comparison 1-9
Ability to Use Investment Tax: Credit 1-13
Chapter II. Financing Strategies for Pollution Control
Investments 2-1
Methods Used in Analyzing Financing Costs 2-1
Bank Financing 2-4
Small Business Administration-Water Pollution Control
Loans 2-5
Government Aid to Financing (Tax-Free) 2-6
Comparison of Financing Methods 2-8
Chapter III. Optimum Financial Strategy for Pollution Control
For Equipment Purchases 3-1
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Table of Contents (Continued)
Page
Chapter IV. State Financing and Tax Incentives 4-1
Maryland 4-6
New Jersey 4-7
New York 4-8
Ohio 4-9
Pennsylvania. 4-10
Review 4-11
Chapter V. Municipal Versus Private Facilities 5-1
Equitable Cost Recovery Systems 5-5
Pre-treatMnt Costs 5-6
By-product Recovery Value 5-7
Operating Cost Differentials. 5-7
Municipal Versus Private Waste Water Treatment 5-7
Sunaary. 5-8
Chapter VI. Illustration of Optimum Financial Strategy For
Pollution Control for Municipal Versus Qn-Site
Treatment 6-1
On-Site... ..6-J
Municipal ..6-3
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List of Figures and Tables
Figure
1. Net Present Value of Tax Savings Through Depreciation 1-10
2. Year-by-Year Tax Savings (Cash Flow Improvements) Through
Different Tax Strategies 1-12
3. Net Present Values of Gash Outflows from Financing 2-9
4. Year-by-Year Cash Outflow from Different Financing Strategies 2-10
5. Illustrative Financial Characteristics of Pollution Control
Equipment for the Dairy Processing Industiy 3-3
6. Comparisons of Peak Annual Cash Drains From Different Tax and
Financing Strategies 3-5
7. Comparisons of Short-Term Profit Impairment from Different
Tax and Financing Strategies.. 3-6
8. Comparisons of Long-Term Profit Impairment From Different
Tax and Financing Strategies 3-7
9. Long-Term Profit Impairment From Various Financing
and Tax Alternatives 3-9
10. Guide to Management For Choosing the Optimum Financial
Strategy For Pollution Control 5-9
Table
1. Example of NPV Calculation For Straight Line Depreciation 1-9
2. Exaraple of NPV Calculation For Bank Financing .2-7
3. Exanple of NPV Calculation for Confcined Cash Inflows and Out flows. 3-2
4. Financial Assistance and Tax Incentives for Industry. 4-3
5. Use of Public Treatment Facilities By Volume
of Wastewater Discharged, 1969 and 1967 v . 5-2
v
6. Use of Public Treatment Facilities by Nunfcers
of Plants Where Public Systems Available,1969. 5-2
7. NPV of Twenty Year On-Site Treatment Plant... ...................6-4
8. NPV of User Charges for Twelve Year Cost Recovery System .6-6
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INTRODUCTION
As the 1970's proceed, environment-related management decisions
will be more complex and frequent. The impact on businesses of non-pro-
ductive environmental expenditures can be significant where by-product
recovery is limited or non-existent. It is clear from provisions of the
1972 FWPCA amendments (PL92-500) coupled with the existing Clean Air Act,
that industry must commit sizable capital to meet the environmental stan-
dards the nation has set.
Many governmental institutions have shown a form of compassion
for the necessary private equipment expenditures and public treatment
facilities by providing means of reducing or softening the financial ex-
penditures for pollution control. There exists a mild governmental prac-
tice of spreading some of industries' pollution control costs over the
general public in place of just the company, and, to some degree, its cus-
tomers. This is accomplished by excusing pollution control devices from
certain sales, use and property taxes, by allowing tax-exempt financing
by the company of the expenditures, or through adjustment in company in-
come taxes by the addition of special depreciation alternatives. All of
these programs involve a coup any paying lower taxes than they normally
would have to pay if that equipment was for some other manufacturing or
service purpose. Another set of incentives provides for the possibility
of government treatment of wastes at lower costs than self-treatment
through federal government grant programs.
To put these incentives or cost reduction practices into per-
spective, it should be pointed out that these incentives do not pay for
the pollution control investment nor do they overwhelmingly reduce the cost.
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They can, however, have a pronounced effect on cash flew and profit posi-
tions depending on what alternatives are selected. Because procurement
of control equipment is a relative unique business occurrence, and because
ef a considerable body of new and involved tax and financing regulations
for such purposes, it is likely that company financial managers are not
as familiar with the many possibilities as they would be with the more
common business operations.
This report will demonstrate that it is well worth spending
time in analyzing the unique added methods of financing pollution expen-
ditures and their equally unique tax treatment. It will alert decision
makers as to the availability of, and qualifications for some of the fi-
nancing incentives that federal, state and local governments have made
available.
Obtaining the optinum financial and tax incentives for your com-
pany could save tens of thousands of dollars over the life of the equip-
ment. For example, a recent Business Week article (July 29, 1972 pp. 50-
51) demonstrated the cost savings that tax exempt pollution control reve-
nue bonds can provide. "Over the life of a 20 year $10 million issue, the
typical interest saving is about $3,6 jnillion." Some revenue bond issues
allow for deferred repayments of principal and permit the largest payments
at the end of a 20-30 year issue. Meanwhile, the company can take depre-
ciations and use investment tax credits which lower taxes. Thus, it can
build up a cash flow which is used in other areas of the business. On
that cash flow, earnings are generated which help to repay the bond prin-
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cipal at the later time.
On balance, more of this report is devoted to the financial
analysis for equipment purchases than for user charge analysis. The
reasons are: first, that most industries will face equipment purchases
for on-site 'treatment or municipal treatment since the latter alternative
requires pre-treatment; second, other regulatory programs, namely the
Clean Air Act, normally show their impact through required capital
equipment expenditures.
The financial techniques utilized in examining pollution con-
trol expenditures are well establihsed; however, the future costs to be
analyzed are only beginning to become apparent. Under the enforcement
provisions of the FWPCA's National Pollutant Discharge Elimination
System (NPDES) effluent guidelines relating to the best practicable tech-
nology are to be specifically issued for many industries treating on-site.
These guidelines will give companies an idea as to how they will be re-
quired to control by 1977, but final cost estimates may not be ascer-
tainable until compliance terms of a company's specific permit are set
and issued.
For costs of discharging to municipal facilities pre-treatment
guidelines from EPA are expected momentarily as this report goes to print.
The other major cost factor of user charges for those who hook into muni-
cipal facilities which receive federal grants is beginning to unravel
since federal guidelines were suggested in June, 1973. These costs consist
of the equitable cost of capital and operating and maintenance costs assessed
on the conpany by the municipality for municipal treatment costs. Once the EPA
* * •
111
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completes its process, processors and others will then be able to
analyze whether it would be financially preferable to make a capital
equipment investment for their own private treatment facilities, or
whether being hooked into municipal treatments system is better. There
may be regulations, however, that might preclude the exercise of the
results of such a decision. This report will indicate how to proceed
with an analysis once the peimissibility and costs of using municipal
facilities are more adequately defined.
Management Summary and Guide
We have noted that there are a number of new unique alternatives
that have sizable differing financial consequences amounting to tens of
thousands of dollars. Many of the alternatives require, by law, that
once a financial decision is made it can't be changed, or changed in only
one direction. Others are final in that it would be prohibitively costly
to change later on in the program. Therefore, the following financial in-
formation should be analyzed as a minimum before equipment or charge
decisions are made.
1. Determine for all debt financing of pollution control
investments, the most effective combination of rate and
term of the loan. Calculate the negative cash flows in-
volved and their net present values.
2. Calculate the year-by-year cash inflows and the present
values for each available choice of depreciation.
3. Select the management objective by which you would want
iv
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to judge the financial impact of the investment in equip-
ment; for example, lowest short-term profit impairment,
least cash drain, long-term profit impairment, etc. Com-
pare the combinations of financing and depreciation values
calculated in Steps 1 and 2 against the established man-
agement objective, and select the combination best suited
for your company needs.
4. Determine what the municipality's user charge will be for
processing wastes and estimate the capital expenditure
necessary for any pre-treatment facility. Calculate the
present values for the treatment expense and a present lease
value for the user charge payment.
5. Compare the values and year-by-year effects of Step 4, and
and Steps 1 through 3, against the selected financial man-
agement objective. This will allow you to make a choice
between whether to plug into a municipality's waste water
or invest in a private treatment facility, from a financial
point of view.
This analysis presumes that the legal and tax implications of
each financial alternative are fully understood by the analyst in order
that present values and cash flows can be calculated. Likewise, the
analysis does not include the legislative and technical matters which may
preclude a processing plant from being able to have the freedom of choice.
v
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Organization of the Report
The report is divided into six chapters. Chapter I
describes the standard depreciation methods and those which have been
established for pollution control facilities. Chapter II examines the
costs of different methods of financing pollution control equipment.
Chapter III relates the financing and tax strategies for equipment to
normal company financial strategies. In other words, how do the incen-
tives correspond to a company's maximum cash flow strategy or its profit
maximization strategy, etc? Chapter IV is a look at the availability of
the various financing alternatives already discussed, both from the
federal government and from five northeastern states in which a large
amount of dairy processing takes place. Some financing alternatives
are for practical purposes always available, while others are dependent
upon the source's budget. The fifth chapter examines the combination
of the first four sections as opposed to the financial theory of a user
charge system. This alternative analysis sets up a basis for decision
when the costs of the Federal Water Pollution Control Act become
predictable, an example of which follows in Chapter VI.
vi
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CHAPTER I
DEPRECIATION
Many pollution control acquisition incentives are in the form
of special depreciation provisions. Sometimes, these provisions are
called "rapid amortization", except that the amortization period bears
no relation to useful life as in the case of strict depreciation. The
underlying effect of any type of depreciation is on the taxes payable by
a company and its cash flow. Normally, there exist two general kinds of
depreciation incentives for any kind of equipment. One set of depreci-
ation methods provides an annual deduction from income as a non-cash
expense over a certain guideline period. The timing of deduction selec-
tion changes with different depreciation techniques. In other words,
large portions of the cost of the equipment can be deducted early in tht
life of equipment by using one technique, or equal proportions are deduc-
table over the life of the equipment, using another technique. This
gives rise to the familiar terms: straight-line depreciation, double-
declining-balance, sum-of-the-yeais'-digits, etc.
Another kind of equipment depreciation factor exists for all
types of equipment, and that is an incentive to actually buy equipment;
called an investment tax credit (Sections 46-48, 50, Internal Revenue
Code). This provision, in effect, actually reduces the cost of the equip-
ment because it gives a permanent tax credit. All the different depreci-
ation methods noted previously, allow a corporation to adjust its depre-
1-1
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ciation schedule to conform with its financial management strategies.
To add an incentive for the purchase of pollution control
facilities, the IRS permits a pollution control facility to be amortized
over a period of 60 months (Section 169, IRC). Since the 60 month
period may have no relationship to the actual life of the equipment,
which could last 120 to 200 months, the incentive is called rapid amorti-
zation.
Depreciation involves Consideration of both method and useful
life. The ability to take any method of depreciation for pollution con-
trol facilities is not precluded because of the method a company custo-
marily uses. The normal requirement for consistent adherence to class
depreciation method is waived. For example, if a processor uses a foods
manufacturing Asset Depreciation Range, into which all the assets cus-
tomarily fall, and he uses the straight-line depreciation method, he
could still take double-declining depreciation for the pollution control
equipment.
Another nuance is that when an asset class depreciation ragge
is used, a different useful life can be used for pollution control facil-
ities upon sufficient justification. For example, if a processor custo-
marily uses a guideline useful life of 12 years (permitted in the 9.S to
14 year AIR), he could use 8 years for the control device if he could sub-
stantiate. This may be advantageous if the life of the equipment is less
than that of the normal asset range.
Relationship of Depreciation to Taxes and Cash Flow
Hie financial strategy supporting the rapid amortization plan
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is a good entry into the methods of analysis for evaluating which depre-
ciation, amortization and/or investment tax credit method to use. The
incentive is that depreciation/amortization is an expense which does
not actually involve any cash outlays by the taxpayer. The lower pro-
fits from the expense before taxes means a tax savings. The tax savings
is a net cash inflow to the corporation and is represented by:
NCF = D T
where NCF = net cash flow
and D/A = amount of depreciation/amortization
T = the tax rate, expressed as a fraction
Positive cash flows (cash inflows) are able to be reinvested in
the business for the productive side of the operation or to reduce the
needs for obtaining cash from other sources. A shortened period of de-
preciation/amortization means larger deduction, larger tax savings and
more cash flow.
Net Present Value
An analysis of this net cash flow through the depreciable life
of the equipment will yield a Net Present Value. The total effect of
depreciation on a company's cash flow is determined by using the present
value approach which utilizes 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, because the dollar that
was saved today has the potential of yielding a return if invested or
saved. Thus, at the end of the year, the future value of today's dollar
1-3
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IS,
FV = 1 +r
where, r = yield (interest earned) on one dollar.
The present value of the dollar saved a year from now is, on
the other hand,
1
PV = 1 + r
The present value of a dollar saved i years from now is obtain-
ed by discounting annually:
1
PV = (1 + r)i
Thus, the present value of the net cash flow during year i,
termed discounted cash flow, DCF, is,
NCFi
DCF. = (1 + r)i
The sum total of all such discounted cash flows over the use-
ful life is the net present value, NPV, of the tax savings:
n n
DCF. = NCF,
/ 1 ? Trrfcr
NPV -
i ¦ 1
Since NPV is the sum of discounted cash inflows (tax savings), the
higher the NPV, the more attractive the depreciation method. The annual
discount rate, r, is termed the after-tax return on investment for the
enterprise.
For dairy processors, the cost of capital (this is the same
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as the return if funds are reinvested) before tax is estimated to be
about 6.0%. After taxes, this figure reduces to about 3.0%.
Therefore,
r = 3.0 percent
The effect of the net present values from each method of
depreciation is to reduce the effective cost of the capital expenditure
necessary for the pollution control facility.
Water Pollution Control Investment for Dairy Processors
At this time no one can be quite sure as to what the costs are
for best practicable or the best available control technology for
dairy processing or any other industry. For illustrative purposes, we
are going to use an average investment figure of $400,000.
For accounting purposes, the Asset Depreciation Range of
equipment used in the foods manufacturing industry into which a dairy
processor usually falls, is 9.5 to 14.5 years. (Section 167, IRS Code.)
We will select a 12 year life based oh the guideline useful life of the
Asset Depreciation Range.Salvage value is assumed to be zero.
Rapid Amortization
The Tax Reform Act of 1969, provides for rapid amortization of
certified pollution control facilities over a 60-month period, irrespec-
1-S
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tive of the guideline useful life of the equipment. This amortization
is available under certain conditions outlined in Article 169 of the
Internal Revenue Code. Hie accelerated writeoff was provided to encourage
capital investment in pollution control. Note that a process change,
even if it results in lower pollution does not qualify as a pollution
control device, and such costs cannot be rapidly amortized.
The rapid amortization applies to the first fifteen years life
of the equipment. The asset portion value over fifteen years can be de-
preciated by any method under Article 167 and depreciation taken immedi-
ately on that portion. The rapid amortization can begin in the month
after installation and continue for a full 60 months, or it could begin
in the next fiscal year. For the intervening months until the next fiscal
year begins, a traditional depreciation method can be used.
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. Although this
provision is not considered a pollution control incentive, its inclusion
is needed for accuracy of calculations.
For simplistic purposes it will be assumed that the effective
date of purchase of the $400,000 waste treatment facility is the beginning
of the fiscal year and that the corporate income tax rate is 48 percent.
Computation of the net present value of the$400,000 investment using
rapid amortization results in,
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Nearly Cash Flow = T D
= (.48) ($80,000)
n
NPV -m DCF.
i=l X
NCF.
DCF = t- r - 3.0 $
(1 + r)1
NPV = $175,918
Straight Line Depreciation
The base or most simple form of depreciation involves taking an
equal proportion of 8 1/3 percent for each year of the 12 year life of the
depreciable base under the appropriate foods manufacturing depreciation
class. In this case, the depreciable basis could have been reduced to
$398,000 by taking the additional first year bonus depreciation of $2,000
(maximum), but the point of emphasis is to have the straight line method
serve as a base. Using the above formula with the $400,000 basis, the
NPV of cash inflows is $ 159,266.
Investment Tax Credit
The Internal Revenue Service (Sections 46-48, 50) allows an in-
vestment tax credit of 7 percent of the equipment cost to be applied to
the reduction of corporate income taxes payable. Investment tax credit
is a special incentive for the business community to purchase capital
equipment. This tax credit is a full and direct tax savings of $28,000
in this example. This figure, adjusted by the NPV, should be added to the
straight line depreciation NPV, since the investment tax credit is allowed
for that method. The resulting NPV is $186,586 Also taken into account
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in this calculation, is the NPV of the after-tax additional first year
depreciation. There is a special caution on investment tax credit.
Rapid amortization and investment tax credit are mutually exclusive. A
choice between the two must be made at the outset.
There are also many other details of these amortization and
tax credit laws which are too detailed or peripheral to present here
and do not change the essence of the calculations.
Double-declining Balance Depreciation
The double-declining balance method is the quickest allowable
way, except for the aforementioned special rapid amortization of depre-
ciating equipment through its useful life. The calculation provides that:
yearly, twice the straight line rate is deducted on the remaining life.
In our case, the first year's depreciation is $68,347, .1667x$398,000 =
$66,347 plus $2,000. In the second year, the 16 2/3% is taken against
($398,000-$66,347) or $331,653 resulting in a figure of $ 55,287.
When year-by-year cash flows are discounted using the rate of
return the NPV for the $400,000 equipment using double-declining depre-
ciation becomes $203,001.
There is, of course,another depreciation method called, "sum
of the years digits", which has results between the straight line and
double declining methods.
Net Present Value Calculation
Mathematically, the table below shows how the NPV is calculated
for a $400,000 piece of equipment depreciated by the straight line depre-
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ciation method over 12 years. The effect of the investment tax credit plus
the additional first year's depreciation is also considered.
TABLE 1
EXAMPLE OF NPV CALCULATION FOR STRAIGHT LINE DEPRECIATION
End
of
Year
Depreciable
Base
Rate
Deprec.
After
Tax
Deprec.
Rate
of
Disc.
NPV
1
$400,000*
Max.
$ 960
1.03
$. 928 ,
1
398,000
8
1/3%
15,920
1.03
15,456
2
398,000
8
1/31
15,920
1.0609
15,006
3
398,000
8
1/31
15,920
1.0927
14,569
4
398,000
8
1/3%
15,920
1.1255
14,145
5
398,000
8
1/3%
15,920
1.1592
13,734
6
398,000
8
1/3%
15,920
1.1940
13,333
7
398,000
8
1/3%
15,920
1.2298
12,945
8
398,000
8
1/3%
15,920
1.2667
12,568
9
398,000
8
1/3%
15,920
1.3047
12,202
10
398,000
8
1/3%
15,920
1.3438
11,847
11
398,000
8
1/3%
15,920
1.3841
11,502
12
398,000
8 1/3%
PLUS: 7%
15,920 1.4256
investment tax credit
11,167
$15$,4W
discounted back to year zero 27,184
Total NPV $186,586
*The $2,000 maximum additional first year's depreciation must reduce the
succeding year's depreciable base by the same amount.
Depreciation Comparisons
Figure 1 is a bar graph of how the value of each depreciation
method relates to the overall cost of the equipment. The values are less
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mooo
mooo
200,000
mooo
mooo
70,000
mooo
150,000
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than the base cost because of the cost-offsetting earnings from the cash
generated by the tax savings from depreciation.
Limiting the consideration to net present value, the optimal
strategy in our example is the double-declining balance method accompanied
by the investment tax credit and additional first year depreciation. The
fact that this form of depreciation is favored over the special pollution
control rapid amortization makes one question how the situation arises.
When the rapid amortization provision was enacted into law, the investment
tax credit, which is historically an on-and-off type of tax incentive,
was not in effect. Later on, the investment tax credit became effective
for equipment installed after March, 1971. Economic resurgence was the
major consideration when the investment tax credit was reinstated, and
not how it would relate to the rapid amortization method.
The investment tax credit plus double-declining preference is
accentuated first by the fact that process changes made to comply with
pollution control regulations do not meet requirements for rapid amor-
tization (only control devices do), and secondly, by the fact that the in-
vestment credit, per se, never needs to be repaid whereas rapid amorti-
zation really represents only a postponement of taxes.
Figure 2 graphically shows the year-by-year after-tax positive
cash flows from the various depreciation alternatives. The difference
between the #l's and #2's is the additional tax investment credit and
additional first year bonus depreciation taken in the first year of the
#2*s.
The rapid amortization plan cash flows #4's are practically
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FIGURE 2
YEAR-BY-YEAR SAVINGS
(Cash Flow Improvements)
THROUGH DIFFERENT TAX STRATEGIES
—4-4-4
1. Straight-Line Depreciation «
2. Straight-Line Depreciation with
Investment Credit
3. Double-Declining Balance with
Investment Credit
4. Rapid Amortization
excludes afyd
\
3—3—3—3—3—2, —3
12 3 4 5678 9 ID II 12
Year After Acquisition
1-J2
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level because of the installation of the equipment at the beginning of
the fiscal year. The slight hump in the beginning results from the addi-
tional first year's depreciation. A mid-year installation with an elec-
tion to begin the 60-month amortization period the next fiscal year would
have resulted, under optimal conditions, in a higher hump in the first
year also with a level amount over the next five years at a very slightly
lower level.
The large hump in the first year of the double-declining balance
method shown by #3's, results from taking the investment tax credit and
the additional first year's depreciation.
Ability to Use Investment Tax Credit
A company must have a sufficient level of pre-tax earnings to
be able to fully utilize the investment tax credit. An investment tax
credit greater than the amount of corporate income taxes payable would
defeat some of the advantage of taking the investment tax credit. Not
in this example, but in actuality, a company has to earn $71,875 before
taxes to use the $28,000 available investment tax credit. This calcula-
tion used the corporate tax rates of 22% of all income and 261 of income
over $25,000.
It is true that unused investment tax credits can be carried
over into future, under certain conditions (Sec. 46b, IRC). However,
the net present value of an investment tax credit carryover reduces, and
its calculation here would present an unnecessarily complex situation.
This chapter demonstrated the large magnitude of differences
in NPV's by using the various depreciation methods. The purpose of using
1-13
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NPV was to halve 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 method with investment tax credit over all other
methods including rapid amortization. The life of the equipment has to
be very long (over 30 years) before another depreciation method becomes
superior in this illustration.
Next we will look at the effect of the special incentives for
financing pollution control equipment. The determination of the differ-
ences in values for these financing methods coupled with the analysis
just performed will carry us into Chapter III where the tax and financing
strategies are combined.
1-14
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CHAPTER II
FINANCING STRATEGIES FOR POLLUTION CONTROL INVESTMENTS
Prior to any special pollution control legislation, a plant
manager would make the decision about a piece of equipment and then, if
money was to be borrowed to pay for the equipment, get in touch with his
normal financing source and request arrangements. With the advent of
special pollution control incentives, there are, in general, not only new
sources of funds available, but lower rates than normal for most sources
of financing. This situation requires another whole set of analyses be-
fore the best source of funds can be chosen.
Generally, two aspects of the financing strategy are covered in
this chapter. The first aspect is the quantitative analysis using NPV as
a tool for valuing each financial source and rate. The second aspect
describes each financial source and based on rate and terms, calculates
and compares the NPV of each. As in Chapter I, the example is based on
a $400»000 waste treatment system.
Methods Used in Analyzing Financing Costs
In order to deteimine the cost to the company of the various
available methods of raising funds, it is necessary to analyze the effect
of such a venture on the company's operating financial position: its
net profits after taxes. The methodology used in the subsequent compari-
sons is described below.
A comparison of the after-tax profits with and without the fi-
2-1
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nancing for pollution control equipment makes it possible to quantify
and analyze such an effect: net annual profit after taxes, P, and the
tax liability, L, can be related to other operating parameters by the
equation:
P =p (1-T) L -p T
where, p = annual taxable income
and, T = the tax rate, expressed as a fraction.
The annual taxable income is related to the interest expense for the year by,
P - Q - I
where, Q = the operating income
and, I = the interest expense
combining the above two equations,
P - (Q - I) (1 - T) L - (Q - I) T
- Q (1 - T) - I (1 - T) - QT - IT
If there was no interest expense during the year, 1=0, and the above equa-
tions become:
P - Q (1 - T) L-QT
Thus, the effect of the interest expense I, is to reduce the net profit
after taxes by I (1 - T). The tax liability is reduced by I*T.
If C is the amount of principal that is paid back during a year,
and I the interest expense incurred as a result of the loan, the net cash
2-2
-------
outflow, NCF, is the net of cash outflows and the reduced tax liability
(or tax savings):
NCF = (C + I) - (I T)
= C + I (1 - T)
The above equation represents the net effect of the loan on the company'
cash balance during a year. (It must be kept in mind that, in this anal
ysis, the operating costs resulting from the control equipment are not
considered. The effect of initial investments in pollution control on
the company's fiscal position is analyzed here.)
Present Value Analysis
The payment of interest and principal payback extends through
the term of the loan, which is defined as more than one year for a long
term loan. The net cash outflow, NCFj during year i is given by:
NCFi - q + Ii (1 - T) i - 1, 2,
where, q * principal payback during year i
Ii ¦ interest expense during year i
n ¦ term of the loan, years.
The total effect of the loan on the company's cash flow is de-
termined by using the present value approach which utilizes the concept
of time-value of money, described in Chapter I.
Thus, the discounted cash flow during year i,
-------
The sum total of all such discounted cash flows over the terms
of the loan is the net present value, NPV, of the loan:
NFV-^ZDCFi -fz
1=1 1=1
Since NPV is the sum of discounted outflows, the lower the NPV, the more
attractive the loan. The annual discount rate, r, as in Chapter I, is
the after-tax cost of capital for the dairy processor = 3.0 percent.
For domestic corporations, the normal federal tax rate amounts to 221
on taxable income, plus a 26% surtax on income over $25,000. A tax
rate of,
T = 48 percent
is assumed throughout this analysis.
Bank Financing
Same commercial banks across the country have announced pre-
ferential rates and teims for certified pollution control facilities.
Since these bank programs are quite random, the basis of analysis used
here for financing pollution control equipment will be the type of normal
equipment borrowing and not a special bank control loan.
Hie terms and rate suggested here as normal for this type of
financing, are five years and 6 percent annually, with the effective rate
of interest being 11.08 annually. The Net Present Value (NPV) analysis
for financing the $400,000 waste treatment system through a bank is
$ 422, 353 The cash flows for this financing alternative are unique be-
2-4
-------
cause of the bank repayments system. Although the repayment amounts
are the same, the proportion of interest in those repayments is higher
in the beginning. This interest is tax deductible, therefore, the net
cash outflow is approximately halved. Since the repayments are equal
and the proportions of the earlier payments have more tax-deductible
interest expense and lower principal repayments, the net cash outflow is
lower in the beginning.
Small Business Administration - Water Pollution Control Loans
Since it could occur that same dairy processors might have
access to the funds legislated under the Federal Water Pollution Control
Act, the cost of such an alternative will be analyzed. Since this fund
was just recently legislated, its implementation has been awaiting some
program details yet to be developed. The fund, however, will be adminis-
tered through the SBA and will most likely bear a rate equal to the weighted
average of all federal government borrowings. Presently, that rate is
5-3/8 percent, and with general interest increasing we have used 5.5 per-
cent in our calculations.
Those who qualify for the SBA loans are "any small business
concern in affecting additions to or alterations in the equipment fac-
ilities (including the construction of pre-treatment facilities and
interceptor sewers) or methods of operation of such concern to meet water
pollution control requirement...if such concern is likely to suffer sub-
stantial economic injury without assistance."
Obviously precarious is any attenpt at determining how many com-
panies in the dairy processing industry will sustain substantial economic
2-5
-------
injury without assistance.
SBA loans are permissible to 30 years, however, we have cho-
sen a 10-year loan term to recognize the guideline useful life of the
Asset Depreciation Range into which dairy processing belongs. Using the
5.5 percent rate and the 10-year repayment schedule, the NPV calculates
to $397, 272
Government Aid to Financing (Tax-Free)
As a result of the effort to encourage industrial development
in general, and in some cases to encourage industry to install control
equipment on sources of pollution, governmental aid is available in the
following areas:
(a) Aids to individual borrowers for low-cost capital, and
(b) tax aids to industry through special regulations and
procedures.
The consequences of the latter will not be described at length, as their
impact is not large and varies from state to state. They include sales,
use and property tax exenptions.
Many states now have financing programs for the purchase and
installation of pollution control facilities. These states, via govern-
mental and/or quasi-governmental agencies, assist in floating attractive
low-interest bond issues and in raising the required funds through indus-
trial mortgages. Such bonds bear a lower interest rate than any of the
aforementioned methods, since the interest payments are presently free
of federal and state income taxes.
2-6
-------
The terms in our example include a 5 percent interest rate with
an initial underwriting cost of 5 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.
As a word of caution about tax-free status, it is prudent to
obtain the advice of counsel. A whole set of provisions exists on the
nature of the facilities qualifying and certified as eligible for tax-
exempt financing.
The NFV of cash outflows for the tax-free financing method for
the terms described above, and in our $400,000 example, is $389;137.
As was shown in Chapter I, the following table is an example
of how NPV would be calculated for a five-year bank loan for $400,000.
The rate of interest is stated at 6% and the loan is repaid quarterly.
TABLE II
EXAMPLE OF NPV CALCULATION FOR BANK FINANCING
Year
Repayment
Interest
Portion
Principal
Repayment
Yearly
Repayment
Interest
X
u-n
Plus
Principal
Discount
Factor
NPV
1
$ 42,286
$ 61,714
$104,000
$21,989
$ 83,703
1.031
$ 81,265
2
33,143
70,857
104,000
17,234
88,091
1.0609
83,034
3
24,000
80,000
104,000
12,480
92,480
1.0927
84,634
4
14,857
89,143
104,000
7,726
96,869
1.1255
86,068
5
5,714
98,286
104,000
2,971
101,257
1.1592
87,352
$120,000
$400,000
$520,000
Total NPV =
$422,353
2-7
-------
Comparison of Financing Methods
Figure 3 is a bar graph of the net present values of the nega-
tive cash outflows in financing the $400,000 cost, by the three alternatives.
This set of alternatives actually represents a range of maximum and mini-
mum financial costs into which fall all methods of financing. In other
words, more alternatives exist, however, the results would fall between
the highest and the lowest bar.
The figure clearly shows the superiority of the tax-free method
of financing pollution control equipment under net present value consid-
erations. As equally important in emphasis, is the magnitude of the range
of values. Just on a $400,000 piece of equipment, the range is approx-
imately $33,000; a substantial cost if all the financing possibilities
had not been fully considered.
Figure 4 shows the great differences in year-by-year cash out-
flow that result from the three financing strategies. The conventional
bank loan, for example, leads to much higher outflow during the first
five years, than either of the other strategies. On the other hand, a
bond issue has the lowest cash outflow for an extended period. Depending
on the payoff method chosen, however, full repayment of principal at the
end or a sinking fund will be required. In the first instance (illus-
trated) , high cash outflow is generated due to the ballooning effect in
the final year.
Now that the ranges of financing and tax strategies have been
fully described and analyzed, we are prepared to relate the choices for
selection purposes. In order to perform selection, the objectives by
which companies are managed will be explained in the next chapter as they
inpact possible combinations of the tax and financing alternatives.
2-8
-------
$*00,000
420,000
mooo
<«o,ooo
mooo
380,000
370,000
$422,W
— m„w
CQ
STATED COST— _
FIGURE 3
Net Present Values of Cash Outflows from Financing
2-9
-------
$100,000
80,000
A
/
/
FIGURE 4
YEAR-BY-YEAR CASH OUTFLOW
FROM DIFFERENT FINANCING STRATEGIES
A. Ordinary Bank Loan
B. SBA Water Pollution Control
Loan
C. Tax-Free Loan
50,000
40,000
6-8.
e
•B-_£
B.
•B.
C-C
¦B.
B-B
-C-
c~~ c—
20,000
\
12 34567 8 9 10 11 12 13 14 15
Year after Acquisition
2-10
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CHAPTER III
OPTIMUM FINANCIAL STRATEGY FOR POLLUTION CONTROL
FOR EQUIPMENT PURCHASES
With the data now available from the calculations discussed
in Chapters I and II, it is now possible to develop the appropriate
management approach to financing and tax strategies. The idea is to
select the right combination of strategies to meet the management ob-
jectives of the company. To illustrate the pronounced effects involved,
we will use a hypothetical plant procurement.
Figure 5 contains the key characteristics of three financing
strategies, as well as fiscal characteristics of the hypothetical pollu-
tion control equipment needed. This will be used as the common base in
developing the three illustrative exanples that follow.
Few dairy processor face the same financial problems.
And no two share exactly the same management objectives. To demonstrate
the cumulative effects of the various tax and financing strategies covered
so far, we have selected three typical business situations involving
different management objectives that might exist in a. dairy processing
operation. We will show how different strategy combinations affect each
situation.
Before discussing the objectives, we will present a table which
shows the calculations for another simplified example. The objective
is to show how the NPV of the combination of tax and financing strategies
was obtained. As we will later see, the term NPV becomes synomyous with
3-1
-------
the lowest long-term profit impairment a project has on a company. The
figures used are those developed in Chapters 1 and 2 for a $400,000 capital
investment. Note that the equipment was depreciated in twelve years and
financed in five - years.
TABLE 3
EXAMPLE OF NPV CALCULATIONS FOR COMBINED
CASH INFLOWS AND OUTFLOWS
NPV of NPV of
Year
Year-by-Year Cash Inflows Year-by-Year Cash Outflows
1
$ 43,568
$ 81,265
2
15,006
83,034
3
14,569
84,634
4
14,145
86,068
5
13,734
87,352
6
13,333
$422,353
7
12,945
8
12,568
NPV Cash Outflows $422,353
9
12,202
less NPV Cash Inflows 186*586
10
11,847
Total NPV $235,767
11
11,502
12
11,167
$186,586
First, let us select a daily processor with a weak working capital.
He needs pollution control equipment, but cannot "afford" it, 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.
3-2
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Figure 5
ILLUSTRATIVE
FINANCIAL CHARACTERISTICS
OF POLLUTION CONTROL EQUIPMENT FOR
THE DAIRY PROCESSING INDUSTRY
1- Equipment Characteristics
$400,000
-0-
12 years
2. Tax Status
Investment Cost
Salvage Value
Useful Life
Corporate Income Tax Rate 48 percent
Investment Credit 7 percent subject to
a certain maximum
Additional First Year's Depreciation $2,000
Effective Cost-of-Capital Rate 3.0 percent annually
3. Financing Terms
(a) Ordinary Bank Loan
Stated Interest Rate
Effective Interest Rate
Repayment Period
(b) SBA - Water Pollution
Control Loan
6 percent annually
11.08 percent annually
5 years
Interest Rate
Present Treasury Rate
Payment Period
Weighted average treasury rate
5-3/8%*" 5.5 percent
As long as 30 years,
not more than life of
equipment, 10 years
(c) Tax-Free Loan
Interest Rate
Initial Cost of Cbtaining
Repayment Period
Repayment Schedule
5 percent
Loan 5 percent of capital
15 years
8 percent of principal
annually during years
5 through 14
20 percent of principal
during year 15 (balloon)
3-3
-------
The lowest cash outflow, and the strategy combinations that
permit it, are shown in Figure 6. This value, shown boxed, is $34,400
the result of following a combination of Tax Strategy 2 and Financing
Strategy B. It is the best choice for dairy processors with weak working
capital acquiring pollution control equipment.
If we use a three-year period as the near term, Figure 7
shows the cumulative profit impacts of the different strategies in
their various possible combinations, resulting in the best near-term
profit. The boxed value, $51,900, represents the lowest possible cash
outflow under the circumstances. It is derived from a combination of
Strategies 2 and B.
Finally there's the dairy processor with enough resources and
stability to concentrate on maximizing its long-term profit. Figure 8
shows that the strategies producing the lowest long-term profit impair-
ment ($186,100) are double-declining-balance depreciation with investment
credit combined with a tax-free loan (Strategies 3 and C).
The hypothetical examples of Figures 6, 7 and 8 do not repre-
sent straightforward totals of year-by-year values, but rather the totals
of present values, attributable at the start of the period to the future
events portrayed in the examples. This replacement is necessary because
a meaningful comparison between financial effects occurring at varying
times in the future can be obtained only by relating than all to a cannon
point in time, such as the present.
Having chosen a combination of tax and financing strategies
based on analyses such as those presented in Figures 6, 7 and 8, it is
3-4
-------
FIGURE $
CQfTARISQNS QF PFAK AfHUAl PASO.DRAIN ¦
DIFFFREMT TAX AND FINANCING STRATFGIFS
USEFUL LIFE = H2yEARS
INVESTMENT COST = $*00,000
TAX STRATEGY
FINANCING STRATEGY
A.
B.
C.
CONVENTIONAL
BANK LOAN
SBA WATER POLLUTION
CONTROL PLAN
TAX-FREE
LOAN
1.
STRAIGHT LINE
DEPRECIATION
$85,300(5)*
$35,000 GL)
$80,00005)
2.
STRAIGHT LINE
DEPRECIATION WITH
INVESTMENT CREDIT+
$85,300(5)
$34,400(2)
$80,000(15)
5.
DOUBLE DECLINING
BALANCE DEPRECIATION
WITH INVESTMENT
CREDIT*
$85,600(5)
$34,900(6)
$80,000(15)
4.
SPECIAL AMORTIZATION
FOR POLLUTION CONTROL
EQUIPMENT*
$63,000(5)
$45,700(6)
$80,000(15).
Indicates year after acquisition during which stated peak cash drain is reached.
+ALSO INCUDES EFFECT OF ADDITIONAL FIRST YEAR DEPRECIATION/ SECTION 179, INTERNAL
REVENUE CODE.
3-5
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FIGURE 7
COMPARISONS OF SHORT-TERM PROFIT IMPAIRIW
FROM
DIFFERENT TAX AND FINANCING STRATEGIES
Useful life = 12 years
Investment Cost: $400,000
TAX STRATEGY
FINANCING STRATEGY
A. B. C,
Conventional SBA Water Tax-Free
Bank Pollution udan
Can Control Loan
1, Straight Line Depreciation
0 Straight Line Depreciation
2, with Investment Credit*
Double Declining Balance
3, JeSeciation with Investment
.redit #
Special Amortization for
CflUIPMENi
$98,000 $78,200 $88,500
$71,700 $51,900 1 $62,200
$90,600 $70,800 $81,100
$168,000 $118,200 $158,500
~Also inc^jdes effect of additional first year depreciation, Section 179, Internal
3-6
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FIGURE 8
COMPARISON OF LONG-TERM PROFIT IITAIRPENT
FROM
DIFFERENT TAX AND FINANCING STRATEGIES
Useful life = 12 years
Investment Cost: $400,000
TAX STRATEGY
FINANCING STRATEGY
A. B. C,
Conventional SBA Water Tax-Free
jank Pollution Loan
Omn Control Loan
1, Straight Line Depreciation
o Straight Line Depreciation
L' WITH INVESTMEOT CREDIT*
Double Declining Balance
3, Depreciation with
Investment Credit*
Special /^jrtization for
*». pollijtion Control
Equipment*
$263,100 $238,000 $229,900
$235,800 $210,700 $202,500
$219,«0 $194,300 $186,100
$246,403 $221,400 $213,200
•Also includes effect of additional first year depreciation, Section 179, Internal
Revenue Code.
-------
good practice to refer to separate year-by-year projections like those in
Figures 2 and 4. Doing so determines year-by-year effects and makes them
fall within acceptable limits.
In all three cases above, the rapid amortization plan
for pollution control equipment was not the optimal choice. By the very
fact that tax incentive exists it is logical to be drawn to its use.
However, as demonstrated, the management objective carries the deciding
weight in determining whether or not rapid amortization is the optimal
choice.
Figure 9 clearly demonstrates why all this analysis is so im-
portant. Fran the consideration of long-term profit impairment, the mag-
nitude of the difference in costs to a company is the height of the dif-
ference in the maximum and minimum costs. If a pollution control faci-
lity in our example was financed by an ordinary bank loan and rapid am-
ortization was taken (a fairly traditional choice), the effective cost
would have been $246,400. A tax-free loan and investment tax credit with
double declining balance depreciation resulted in an effective cost of
$186,100> a savings over the former plan of $ 60,300. It is well worth de-
voting whatever cost is necessary to explore the various alternatives
available to arrive at the optimal choice.
To determine how optimal the choice can be for an equipment
investment, we will further explore in the next chapter just how available
are all of these alternatives. Limitations in the availability may possi-
bly reduce the optimum savings, however, the savings will still be sub-
stantial .
3-8
-------
$260,000
WITH
INVESTMENT
CREDIT
250,000
WITH
RAPID
AMORTIZATION
230,000
220,000
210,000
200,000
190,000
mooo
FIGURE 9
LONG-TERM PROFIT IfPAIRfENT
FROM VARIOUS FINANCING AND TAX ALTERNATIVES
3-9
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CHAPTER IV
STATE FINANCING 5 TAX INCENTIVES
The tax and financing strategies discussed in Chapters I and
II and the simplified examples of how they relate to management objec-
tives (Chapter III) were based on an assumption that all companies
would have access to each alternative. Whether or not this is true
for a conpany depends considerably on size and location. The depreci-
ation methods for tax strategies are available for any size company in
any location.
Financial strategy availability is a much more complex matter
requiring expert legal and tax advice. For example, although the tax-
exempt financing is generally more attractive than regular bank borrow-
ing, smaller companies generally do not have access to this source
throughout the United States, except for a very few states.
A general statement cannot be made concerning tax-free finan-
cing which conveys obvious advantages to the borrower because of the
many variations from state to state, but generally the borrower must
qualify for the credit from either the public or a private source of
capital. Enabling legislation must have also been passed in the state
that permits revenue bond/industrial development financing for pollution
control facilities. The ultimate tak-free eligibility ruler is the IRS.
Specific attention must therefore be paid to what each dairy processors1
state has passed into law as to availability of anti-pollution revenue bonds.
Size also is an iiqportant factor since there is usually a fixed
4-1
-------
portion of any bond underwriting expense. This requires a bond issue
to be large enough to make those initial fixed costs effectively mini-
mal. This limitation cuts off many potential users, or requires that
a state have a form of private placement system for loans of less than
nominally a million dollars.
The possible financing via states varies widely as can be
seen from Table 4. The tax regulations are usually fairly lengthy, and
considerably involved so that they generally defy any atteirpt to con-
dense and sinplify. They are also time-varying so that the reader is
cautioned to obtain a current reading before selecting a course of action.
The above relates to the alternative involving equipment pur-
chases , whereas we also need to be concerned about state and federal
programs for financing the municipal treatment plants into which individual
conpanies connect themselves. As for the federal portion of construction
grants, the monies contained in the 1972 FWPCA were based on a survey of
municipal areas planning to upgrade. Thus the authorization was designed
in nature to satisfy all plants. However, the municipalities then in
question were not necessarily relating their estimates to secondary
treatment, defined as best practicable, nor any advanced treatment. A
new survey will be taken to determine just how suitable was the FWPCA
authorization. Presumably, construction grant money over time will be
available for the vast majority of plants. A major appeal of this
money is that interest is not included in any repayments.
Of quite a varying nature will be the cost and source of the
4-2
-------
monies to finance the remaining minimum 25 percent. Further compli-
cating the situation is the degree to which these funds have to be re-
paid. Obviously, if a bond issue was floated to raise the local por-
tion, the full cost plus interest requires repayment. Funds appropri-
ated from a state public works budget will have different repayment
schemes and degrees depending on the state.
What follows is a brief and simplified overview of several
states' financial incentives for pollution control which are expected to
be of special interest to this audience.
4-3
-------
TABLE 4
FINANCIAL ASSISTANCE AND TAX INCENTIVES FOR INDUSTRY
State Sponsored Industrial
Development Authority
Privately Sponsored
^ Development Credit Corp.
State Authority or Agency
w Revenue Bond Financing
City and/or County
Revenue Bond Financing
State Loans for
1/1 Equipment, Machinery
cr Excise Tax Exemption
Tax Exemption or Moratorium
^On Land, Capital Improvements
Tax Exemption or Moratorium
00On Equipment, Machinery
s
4->
S&
E—i *H
3
a) cr
w w
88
9
Sales/Use Tax Exemption
oApplicable to Lease of
Pollution Control Facilities
Alabfeaa
Alaska
Arizona
Arkansas
California
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
Colorado
Connecticut
Delaware
Florida
Georgia
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
Hawaii
Idaho
Illinois
Indiana
Iowa
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
Kansas
Kentucky
Louisiana
Maine
Maryland
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
Massachusetts
Michigan
Minnesota
Mississippi
Missouri
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
4-4
-------
TABLE 4 (cont'd)
State Sponsored Industrial
Development Authority
Privately Sponsored
Development Credit Corp.
State Authority or Agency
Revenue Bond Financing
^ City and/or County
Revenue Bond Financing
State Loans For
Equipment, Machinery
g
• H
4->
w
n
4) 5*
W
$8
9
Sales/Use Tax Exemption
° Applicable to Lease of
Pollution Control Facilities
Montana
Nebraska
Nevada
New Hampshire
New Jersey
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
New Mexico
New York
North Carolina
North Dakota
Ohio
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
Oklahoma
Oregon
Pennsylvania
Rhode Island
South Carolina
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
South Dakota
Tennessee
Texas
Utah
Vermont
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
Virginia
Washington
West Virginia
Wisconsin
Wyoming
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
X
4-5
-------
Maryland.
Maryland has a sales and use tax rate reduction for pollution
control equipment and a revenue bond program. To aid in financing con-
struction costs of local wastewater treatment facilities Maryland has
the Maryland Environmental Service for taking over certain treatment
functions at a cost to the user. The state also has created a Sanitary
Facilities Fund for providing local sewage collection and treatment funds.
Under Maryland Annotated Code, Article 81 Section 342 (s),
Section 325 (gO, Section 372(r) and Section 373 (g) pollution control
devices are taxed at a reduced rate for the Sales and Use taxes. In
place of there being a 4 percent sales tax, pollution control equipment
is taxed at the machinery equipment rate of 2 percent.
In 1972 the state of Maryland passed legislation enabling
counties and municipalities to finance pollution control facilities through
the sale of revenue bonds. The municipality can then sell or lease the
facilities to industry. Thus industry can finance their pollution control
facilities at a rate lower than that incurred by other foims of conventional
borrowing.
Companies having waterwastes treated municipally get two fonns
of lower costs. In addition to the 75 percent construction grant for
capital costs for which the municipal waste treatment plants are
eligible, the state also contributes 12.5%. The state raises money for
these grants, which the municipalities do not have to repay to the state,
through bonds that bear the full faith and credit of the state of Maryland.
Presumably the remaining 12.51 to be raised locally will have a repayment
4-6
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contribution to be assessed both industrially and residentially. Thus,
that proportion of capital costs to be repaid by industry is 501 of the
75% (see next chapter for fuller explanation) plus the 12.5% or 50%
in all.
The State of Maryland does not have any grant programs to
reimburse the municipal waste treatment plants for yearly operating and
maintenance costs as does New York, for exanple.
New Jersey
Chapter 127, PL, 1966 (Title 54: 4-3.56 to 3.58) of New Jersey
permits a property tax exemption for pollution control facilities.
Revenue bond provisions are not in effect in New Jersey, and a sales
tax exemption bill did not get out of committee in 1972.
It is still possible that tax-exenpt financing could be
obtained by a company through a local development coiporation even though
the state does not have industrial development authorities. However, the
process requires much legal assistance and is very complex.
New Jersey permits sewage districts to issue bonds for the
local portion of construction costs of treatment plants benefiting one
or multiple municipalities. There is also a state program to provide 15%
grants to municipalities for the portion of construction costs not eligible
for federal grants. The funds were derived through a 1969 $240 million
bond issue under the Water Conservation Bond Act. The funds do not have to
be repaid. As a result of the federal and state construction grant program
the municipality's fund raising amount is reduced to 10%. Thus in New Jersey
the construction cost amount most likely to be assessed industrially (based
only on proportionate flow) is 50% of 75% plus 10% or 47.5%.
4-7
-------
New York
The State of New York has several tax incentives and
financing programs for pollution control facilities including two of
the largest public bond issues in the United States. The tax incentives
refer to sales, property and corporate income taxes for qualified pollu-
tion control equipment. A revenue bond financing capability for corpora-
tions also exists.
Pollution control equipment and utilities are exempt from
state and local sales taxes except for those of New York City.
Local municipalities are also given the power by the state
to excuse pollution control facilities from real estate taxation and
special ad valorem levies (Section 481, Real Property Law)
A feature unique to these five states is New York State's
one-year depreciation provision. Corporations can deduct the full cost
of pollution control facilities in one year against their state corporate
income taxes (Sections 208,602,683, 706 and 1083 of the Tax Law). For
those who decide against the one-year depreciation, a one percent tax
credit is allowed on state corporate income taxes payable (Section 210(12)f,
701(d) (6). The amount of the corporate income tax credit cannot reduce
total state corporate income taxes below a $125 minimum.
Corporations can finance their pollution control facilities
located in New York State via revenue bonds. The I. R. S., is of course
in all states the ultimate ruler on all tax-exempt issues; however, the
state must, in most cases, pass legislation enabling revenue/industrial
bonds to be utilized for pollution control purposes.
Municipalities in the State of New York can obtain a considerable
amount of grant assistance from the state and federal governments for
4-8
-------
construction and operating and maintenance costs. For industries having
their wastes treated by municipalities this assistance means lower costs
assessed to them for recovery of capital and operating and maintenance
costs.
In 1966 and 1972 there were $1 and $1.15 billion bond issues
floated in the state for conservation projects. Under the $1.15 billion
1972 Environmental Quality Bond Act $650 is for construction grants that
will provide 15% on top of the 75% federal grant. Eligible construction
costs, by state definition, however, disallow collection systems. Thus
the local government obtains 751 for collection system since the federal
government does fund collection systems. TTie local municipality obtains
87.51 for the remainder of the entire waste treatment facility. What the
industrial constributors are assessed, based only on proportional flow is
1) 50% of 75% plus 25% for the industrial portion of the collection system,
plus 2) 50% of 75% plus 12.5% of the industrial portion of the remaining
waste treatment costs.
New York also has another grant contribution to tie municipality
of one-third the costs of eligible operating and maintenance costs.
Ohio
The State of Ohio has three tax exenptions and a revenue
bond program for pollution control facilities. There are no grant
contributions by the State of Ohio to municipalities for either construction
or operating and maintenance costs. However, Ohio does have a payment
program which prevents unnecessary delays in treatment plant construction
due to delays in federal appropriations of grant money.
The three taxes for which pollution control equipment is
exempt are the property tax, sales and use tax, and franchise tax. The
4-9
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property tax exemptions are derived from Ohio Revised Code, Section
5709.25(A), Section 6111.34 of the Ohio Water Pollution Control Act -
corporate property, and Section 6111.35 - personal property. Under
Section 6111.36 pollution control equipment is not an asset in deter-
mining value of issued or outstanding shares of property owned and
used for purposes of franchise tax. Section 6111.37 contains the sales
tax exemption. Should any certificate be revoked then all past taxes
are due as if there had been no exenption.
Under the revenue bond program companies can obtain tax-free
financing for pollution control facilities.
The state's financing program consists of paying the construc-
tion costs to the contractor and then having the municipality assign
the federal grant to the state.
Pennsylvania
Pennsylvania has the most unique revenue bond program that
enables all size companies to obtain tax-free financing rates for pollution
control equipment. In most states the company desiring a tax-free rate
must float a public bond issue. Because of initial underwriting costs
the bond issues must usually be one. million dollars or more for the
interest savings to offset the underwriting costs. Therefore, the tax-free
route is not open to all, even if their credit rating is basically good
to excellent.
In Pennsylvania, under the Revenue Bond and Mortgage Act, any
size company with a good credit rating can achieve tax-free financing for
pollution control facilities. Certified pollution control facilities can
be financed by a bank or other financial institution and gain the low rate
without having to go to the bond market. All that is required is an
4-10
-------
application by the company describing the financing source, to an
industrial development corporation which processes and obtains per-
mission from the state Secretary of Commerce.
The tax exemption privileges available in the state for
pollution control equipment are sales and use and franchise.
Pennsylvania had a construction grant program when
municipalities received between 30 and 55 percent federal grants.
However, that program has not been extended to provide state grants
on top of the 75 percent federal amounts. Pennsylvania is considering
a grant program for portions of the local construction costs in low
income areas.
Under Act 339 of Pennsylvania there is a 2 percent contribution
to municipalities for eligible operating and maintenance costs.
The above description of incentives in various states should
strongly demonstrate two aspects:
1. It would be unusual to find the exact condition in two
states, especially where the incentive legislation is time-varying.
2. It is worth the effort to study the tax and financing
schemes available in the pertinent state.
Review
From the above explanation, it becomes clear that the ability
to achieve an optimum financial strategy is highly dependent upon the
size of the firm, and its location. Parameters used in Chapters II and
III in the optimal choice analysis may have to be altered to reflect a
firm's real spectrum of choices. The stress in the analysis thus far has
been a firm's capital costs. In the next and last chapter, the realm of user
charges and their possible modifications in the future will be
4-11
-------
discussed. Complete optimization under long-range management
objectives can then be made by weighing the ramifications of being
a part of a municipal waste water treatment system vis-a-vis con-
structing private treatment facilities.
4-12
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CHAPTER V
FINANCIAL DECISION MAKING THEORY FOR
MUNICIPAL VERSUS PRIVATE FACILITIES
The analysis completed in the first three chapters applies
to air and waste treatment control systems of a capital nature applied by
private industries before the release of their effluents to the public
domain. Companies with requirements to control air pollution emissions
must undertake the responsibilities of control themselves. Companies with
water-borne wastes have in many instances an option to treat their process,
sanitary and cooling wastes themselves or turn the chore over to the
municipality by sewering their wastes. Economics play a very important
part in this decision and the economics of the past are changing considerably.
Before entering the economic aspects we first want to demonstrate that dairy
processors do have this choice available to than. First we will describe
the extent to which large industrial categories use public treatment facilities
and then narrow down to use by dairy processors. Then we will explore recent
regulatory and economic programs that will influence changes in the usage
of public treatment facilities by all industry and dairy processors.
A 1970 survey of seven broad industrial categories essentially
involving all of manufacturing business by The Conference Board of New York
conducted for EPA, showed that only 5.0 percent volume of wastewater discharge
went to public sewers while 92.9 percent went to receiving waters. This
study conpares very closely with the Census of Manufacturers study of 1967
that was five times as large which indicated that 5.4 percent volune of
wastewater was discharged to sewers (Table 5).
5-1
-------
While these studies showed that the vast volume of waste-
water was consigned to receiving water, the story is quite different where
sewer facilities were available,»thus suggesting a high preference for
consignment to sewer systems when such are available. For example, the
Conference Board survey revealed that 63 percent of the companies surveyed
had public sewers available to them and 54% used them. In other words,
418 of the 489 plants or 85.4% utilized the public sewer facility.
However, there is data showing that many of these public sewer connections
may have been for the sanitary portion of wastewater and not process water.
Of the 418 plants using sewers, 342 also maintained their own treatment
facilities. (Table 6)
Table 5
Use of Public Treatment Facilities by Volume of
Wastewater Discharged, 1969 and 1967
Major
Industry
Categories
Food and
Kindred
Products
Industry 1968
Users of
20,000,000 gals,
or more/yr
Dairy Processing
1969 +1967
1967
Plants of all
size in Wisconsin
1967
5.0 - 5.4%
23.0%
58%
39%
Table 6
Use of Public Treatment Facilities by Nunbers
of Plants Where Public Systems Available, 1969
Major
Industry
Categories
Food and
Kindred
Products
85.4
94.2
5-2
-------
Before narrowing in on dairy processors the data shows that the
food and kindred products, dairy's parent industry, category discharges
more volume of wastewater to public treatment facilities than for industry
in general, 23% to 5% (Table 5). Likewise more plants in the food and
kindred products industry use public treatment facilities where the public
facilities are available (94.2 to 85.4% - Table 6).
For the dairy processing industry same data is available
for large plants processing 20 million or more gallons per year and plants
of all sizes in Wisconsin. Large ice cream and fluid plants being market
oriented in their location discharge 72 and 76 percent of their wastes
respectively into municipal treatment facilities. Butter, cheese and
condensing plants discharge 44, 49 and 30 percent respectively into
municipal treatment facilities. Together the large plants across the
U.S. call upon municipalities to treat 58 percent of their wastes. For
the state of Wisconsin, but for all size dairy processing plants, 39 percent
of wastes are treated by municipalities. An indication of why there is a
low percentage of wastes treated by municipalities in Wisconsin is that
70 percent of the dairy processing plants are in coinnunities with popula-
tions of less than 5,500.
There are several factors that will influence the mix of
conpanies being hooked into municipal waste treatment systems, as described
above, for all industry as well as dairy processing.
° more and more areas are being opened up to public treat-
ment systems.
° industry will have to pay their equitable costs of treat-
ment perforated by municipalities which in the majority of
cases is more than they previously paid.
5-3
-------
° more federal construction grant money has been made
available to municipalities for upgrading their plants
to secondary treatment or better.
0 effluent guidelines based on best practicable and best
available technology will be imposed upon dairy
processing and all other industries.
0 pre-treatment guidelines may affect the need for prepara-
tion of waste before sewerage for dairy processors and
other industries.
More geographical areas are being required to provide more
and better treatment which will largely be financed by federal grants. Pre-
sumably, from the data in Tables 5 and 6, more companies will have the
opportunity to have their wastes treated by such facilities. Likewise,
all processes generating wastewater will face more stringent effluent
guidelines which will raise the question of public or private treatment.
The financial outlook for tying into public treatment facilities
contains conflicting aspects which will all have to be analyzed individually
by a company. There will be two higher municipal costs from what might have
been analyzed in the past and one lower cost. The lower cost is that there
are no interest charges for industry on that part of the construction grant
which has to be repaid (more below) to the municipality. The higher costs ensue
from the equitable treatment costs which must be assessed on industry, and
the fact that treatment in general will be more costly. Even with these muni-
cipal costs on balance going up they may not be increasing as rapidly as the
costs of private treatment brought on by the effluent guidelines under the
EPA permit system.
From the above listed technological, regulatory and economic
considerations it is fairly safe to say that a major decision-making process
5-4
-------
in water pollution control will take place in the United States. As part of
this movement many dairy processors will face changing and upgrading of their
plants at different costs than they previously used in their analyses. And
faced with the opportunities of on-site or municipal treatment a company will
essentially be faced with the economics of which costs less and the implica-
tions of a capital investment versus higher yearly operating costs.
Equitable Cost Recovery Systems
The yearly treatment costs to dairy processors using public
facilities arises from the methods that municipalities have available to them
for financing their construction costs. To start with, recent federal legisla-
tion made an assumption that in the past companies were not being charged what
the municipal treatment actually cost. EPA, under the 1972 FWPCA amendment
construction grant program, now requires that all municipalities receiving
a construction grant charge industry equitable costs covering operating, main-
tenance and capital costs.
Under previous amendments to the FWPCA there has always been
a grant system, although comparatively small, through which federal funds
were apportioned to the states. The 1972 FWPCA amendments continue the grant
concept but at a tremendously bolstered dollar level. The fraction of total
municipal treatment construction costs that can be funded by the federal grants
has also been increased: at least $21 billion in future and repayment construc-
tion grants will eventually be funneled to municipalities; provisions of the
FWPCA will permit up to 75 percent of the construction costs to be derived from
the federal grant.
Contrary to past municipal treatment costs, a higher rate struc-
ture is in the offing as the FWPCA requires the municipality to recover, through
charges, the operational costs and replacement value attributable to the in-
dustrial proportion of the federal grant. For certain replacement equipment
-------
based on flow only, a municipal plant devoting 60 percent of its capacity to
the general population and 40 percent to industry, must recover at least 40
percent of the 75 percent federal portion. The number of years over which
industry's share of capital costs must be recovered is 30, or less if the
facility's intended useful life is less. Quite important is the fact that
no interest is charged on the capital costs that are being paid overtime.
There are several other items of interest to municipal users:
(1) Quantity discounts for large flow volumes are discontinued. Savings
from economies of scale must be shared by all i~sers. (2) To reduce adminis-
trative burden companies and industries whose waste characteristics are similar
can be classed together and the class is assessed a rate. (3) Large users 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 allocable to the treatment of its wastes.
The remaining portions of this chapter will construct a type of
analysis for use in making the "user charge versus private facility" decision.
It will pick up from where Chapter III ended in that additional
operating costs have to be added to equipment costs to fully know complete costs
of self-treatment.
There are at least three major factors - pre-treatment costs, by-
product recovery value, and two sets of operating costs - which must be separately
calculated before the final decision phase is consumated.
Pre-Treatment Costs
The first factor is pre-treatment costs for the conditioning of
pre-treating of a company's waste water by a conpany before the wastes reach
the municipal system. The costs of pre-treatment depend on the nature and volune
of the wastes and will vary widely from industry to industry. It is conceivable
that very little in the way of expensive equipment may be needed for some in-
dustries, where pre-treatment costs would consist of chemicals and other con-
5-6
-------
sumable supplies. Certain other industries will require capital investments
for pre-treatment but not quite as large as would be needed for complete private
treatment.
The net present value (NPV) method of analysis will again be used
to calculate a cost for pre-treatment. The financial and tax strategy calcula-
tions for this equipment are the same as those used in Chapters I and II. Fur-
ther analysis would have to take into account the expected difference in
useful life of a pre-treatment facility from a municipality's.
By-Product Recovery Value
It is reasonable that pre-treatment will produce by-product re-
covery in a processing plant, however, the relativity of the subject here is for
its value in a complete private facility. For our purposes, we will describe
the value of annual by-product recoveries as an offset to the equipment costs.
Rather than offset the recovery values against annual operating costs, the reason
for offsetting against capital costs involves the factor that by-product recovery
could effectively have in the initial facility decision.
We purposely did not enter by-product considerations earlier in
the equipment decision phase. Its description here takes note of the fact that
before the 1972 FWPCA, by-product recovery of some degree did exist in the dairy
processing industry. The enphasis on by-product recovery here is the very likely
increase in extent as events proceed in the dairy processing industry.
Operating Cost Differentials
Intuitively, the operating costs for a pre-treatment and muni-
cipal use system will be less than the costs to operate a private facility.
This yearly difference must be assigned a NPV to be added to the NPV of the
private treatment facility. The analytical method is the same as that des-
cribed in Chapter II for a negative cash flow.
Municipal Versus Private Waste Water Treatment
To complete the sequence necessary for constructing a municipal
5-7
-------
versus private treatment analysis the remaining step is the calculation of a
NPV for user charges. Using the formula in Chapter II, the yearly cash flows
for the longest predictable horizon of the user charge system should be valued
at NPV (as that horizon lengthens, the NPV approaches the value that would
have resulted if the present value of an annuity had been used where the pay-
ments are infinite in duration). The sets of costs that we now have to compare
in the decision process, have been adjusted as follows:
effective equipment cost
NPV of by-product recovery
NPV of greater operations cost
Adjusted Effective Equipment Cost for a Private
Treatment Facility
effective use charge value
NPV of pre-treatment costs
Adjusted Effective User Charge Value for Using a
Municipal Facility
The basis for a financial decision between the two alternatives is outlined
above. The financial data can be added to the technical factors that enter
into the final decision.
Summary
Figure 10 is a flow chart of the analytical guides suggested for
choosing the optimum financial strategy for pollution control. The chart
sunmarizes the entire flow of this Report. Under the previously defined pol-
lution control laws we were able, as we did in Chapters I, II and III, to use
quantifiable examples to optimize tax and financial strategies for equipment
decisions. This area of the chart is depicted to the left of the dashed line.
Chapter IV, while not in the flow, showed how these alternatives may be limited
due to specific state programs.
The tradeoffs and factors entering the municipal versus private
treatment decision process are shown on the right of the dashed line.
minus
plus
equals
plus
equals
5-8
-------
Figure 10
Guide to Management For Choosing The Optimum
Financial Strategy For Pollution Control
I *
IP and
Yearly Cash
Flows For
Tax Strategies
Assignment of
Management
Objective as
Criteria
NPV and
Yearly Cash
Flours For
Available
Financing
Strategies
Analysis of All
Possible Combinations
of Tax $ Financial
Strategies Under The
Management Objective
I
Adjustment by
Incremental NPV
of:
(i) by-product recovery
(ii) operating costs
for Private Facility
NPV of
Pre-treatment
Costs,
if any
Adjusted Effective
Equipment Cost
TFor a Private
Treatment Facility
vs
Adjusted Effective
User Charge Value
For Using Munici-
pal Facility
Equipment Choice Only-
Private Treatment Versus Municipal Tie-In
-------
Figure 10
Guide to Management For Choosing The Optimum
Financial Strategy For Pollution Control
I *
vs
NPV of
Pre-treatment
Costs,
if any
Assignment of
Management
Objective as
Criteria
NPV and
Yearly Cash
Flours For
Tax Strategies
Adjusted Effective
Equipment Cost
For a Private
Treatment Facility
NPV and
Yearly Cash
Flows For
Available
Financing
Strategies
Adjusted Effective
User Charge Value
For Using Munici-
pal Facility
Analysis of All
Possible Conciliations
of Tax § Financial
Strategies Under The
Management Objective
Adjustment by
Incremental NPV
of:
(i) by-product recovery
(ii) operating costs
for Private Facility
Equipment Choice Only-
Private Treatment Versus Municipal Tie-In
-------
CHAPTER VI
ILLUSTRATION OF OPTIMUM FINANCIAL STRATEGY FOR
POLLUTION CONTROL FOR MUNICIPAL VS ON-SITE TREATMENT
Chapter III developed various financial decision making pro-
cesses for management use where pollution control equipment is bought.
These took into consideration cash flow, long and short-term profit
management objectives, and conpared various strategies in buying and
writing off the equipment. This chapter presents an example of the
application of this financial theory where the conparison is between
buying equipment for treating your wastes on-site versus municipal
treatment costs. This assumes that the pertinent regulations permit such
choice.
Rather than repeat the theory for all three financial manage-
ment strategies discussed in the previous chapter when buying equipment,
the complexity of each is enough to only make it desirable to limit the
illustration to one strategy. For illustration of the analysis for
economically choosing municipal versus on-site treatment, we will choose
the financial strategy analysis of long-term profit which is primarily
net present value consideration. This method, incidently, is the one
used most frequently by EPA in their economic impact studies.
Recalling the costs from the previous chapter which were to be
utilized in the comparison, we find for on-site treatment the capital
costs which include financing and depreciation, the operating costs and
6-1
-------
by-product values. For municipal treatment, the costs are pre-treatment
plus the associated operating and maintenance costs and the user charge
assessed by the municipality. In order for the costs of each option to
be comparable, the number of years or length of analysis must be the same
over which the calculations are performed.
On-Site
In choosing the length of analysis, the lives of the two alter-
natives must be relatable for proper costs matching. The user charge
cost recovery guidelines issued by EPA in May, 1973, have an inpact
on the length of analysis. One of the guidelines determined the
number of years in which industry's portion of the capital construction
cost granted by the federal government must be repaid. The guideline
specified cost recovery for the shorter of 30 years or the life of the
equipment. Therefore, we will choose a 20-year analysis for the two
alternatives; shorter due to technological obsolescense. The processing
investment we used earlier in the report was for 12 years at a cost of
$400,000. We will speculate that even though that equipment could last
longer than 12 years, regulatory obsolescense will require updating which
will leave us with an $800,000 cost of on-site treatment over 20 years.
One of the assumptions we will make is that the on-site equip-
ment will be depreciated and financed by the same methods which were
superior in the long-term profit anslysis of Chapter III; double-declining
balance depreciation with investment tax credit and a tax-free pollution
control loan. The terms of the tax-free loan will be repayment of 8 per
6-2
-------
cent of the principal in years five through fourteen and a 2Q percent
balloon payment in the fifteenth year. The tax-free loan rate will be
5 percent.
Since the dairy processing plant has to perform all maintenance
and operation, we have to include those costs as well as any sludge
handling and disposal costs. We will consider the "0 5 M" costs to be
8 percent of the total facilities investment cost or $ 8,000 per year.
The table below shows how the NPV for this example was derived.
Municipal Treatment
The size, capital and operating characteristics of the munici-
pal treatment plant directly influence the fee they charge for treatment.
We will assume a municipal treatment plant capable of handling 2 million
gallons per day (MGFD). At an approximate capital cost of $1.2 million
per MGD, the total plant cost would round out to $ 2,400,000. We will
further assume for illustrative purposes that a dairy processing plant
contributes to 2 percent of this total flow. The flow of the on-site
treatment plant for the costs assumed would be a dairy processing plant
with an assumed flow of .04 MGD.
Taking the above assumed costs, we will make the following
additional assumptions:
• 75* of the cost of the construction is provided by federal
grant at no interest
• 251, or the local/state share is raised through a tax-exempt
bond issue at 5 percent
6-3
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TABLE 7
NPV OF TWENTY YEAR ON-SITE TREATMENT PLANT
Net
After-Tax
After-Tax
Cash
Yearly
Interest
Principal
Negative
Positive
Flew
Year
0§M
Depreciation
Payments
Payments
Cash Flow
Cash Flow
NPV
1
$64,000
$161,600*
$80,000***
-
$ 74,160
$133,568
$ 57,678**
2
64,000
127,680
40,000
-
54,080
:61,286
6,792**
3
64,000
102,144
40,000
-
54,080
49,029
4,622
4
64,000
81,715
40,000
-
54,080
39,223
13,200
5
64,000
65,372
40,000
-
54,080
31,379
19,583
6
64,000
52,298
40,000
-
54,080
27,195
22,517
7
64,000
41,838
40,000
-
54,080
21,756
26,284
8
64,000
33,471
40,000
-
54,080
16,066
30,010
9
64,000
11,157
40,000
-
54,080
5,355
37,346
10
64,000
11,157
40,000
$ 64,000
118,080
5,355
83,885
11
64,000
11,157
36,800
64,000
116,416
5,355
80,241
12
64,000
11,157
33,600
64,000
114,752
5,355
76,738
13
64,000
11,157
30,400
64,000
113,088
5,355
73,373
14
64,000
11,157
27,200
64,000
111,424
5,355
70,133
15
64,000
11,157
24,000
64,000
109,760
5,355
67,021
16
64,000
11,157
20,800
64,000
108,096
5,355
64,033
17
64,000
11,157
17,600
64,000
106,432
S,355
61,162
18
64,000
11,157
14,400
64,000
104,768
5,355
58,403
19
64,000
11,157
11,200
64,000
103,104
5,355
55,755
20
64,000
11,157
8,000
160,000
197,440
5,355
106,371
$886,207
* Includes Additional First Year's Depreciation of $2,000
** Positive Cash Flours, the remaining eighteen years being negative
***Includes 51 underwriting expense for bond issue
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• the yearly "0 § M" of the municipal plant is 3 percent of total
investment cost or $ 72,000.
• the dairy processing plant requires pre-treatment equipment which,
for the 12 years cost, is $ 10,000 and is financed via a 5 per-
cent tax-free loan and depreciated via the double-declining
balance plus investment credit method
• the "0 § M" for the pre-treatment facility incurred by the
dairy processing plant is 8 percent or $ 800 per year
The user charge for the dairy processing plant thus consists of
the following costs:
• 2% (percentage flow) of 751 of $ 2,400,000 over 12 years which
equals $3,000. (federal capital proportion]
• 5% of 251 of $ 2,400,000 plus yearly interest of 51 on the un-
paid balance (local/state capital proportion)
• The NPV of the pre-treatment capital costs after cash flow
considerations from depreciation and financing costs
• Yearly municipal and pre-treatment "0§M" of $1,440 and $800
In the example presented here, the financial choice between
buy and treat on-site versus pre-treat and use of municipal facilities,
results in the pre-treat and municipal facility choice by a sizable
margin of $18,937. It would not be prudent to extend the indications
of this simplified example to a general.dairy processing industry prefer-
ence for municipal treatment. As one reason, we excluded the value of by-
6-5
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TABLE 8
NPV OF USER CHARGES FOR TWENTY YEAR COST RECOVERY SYSTEM
Pre-Treatment
After
After
Treatment
Capital
Tax
Tax
Net
Federal
Local*
§
Costs
Positive
Negative
Cash
Portion
State
Pre-Treatment
Cash
Cash
Flow
Year
User Charge
Portion
OSM
Depr.
Int.
Prin.
Flow
Flow
NPV
1
$35,625
$23,750
$36,500
$21,600
$10,000
$17,368
$55,055
$36,589
2
35,625
23,156
36,500
15,680
5,000
7,526
52,146
42,058
3
35,625
22,562
36,500
12,544
5,000
6,021
51,837
41,929
4
35,625
21,968
36,500
10,035
5,000
4,817
51,528
41,503
5
35,625
21,374
36,500
8,028
5,000
3,853
51,219
40,859
6
35,625
20,781
36,500
6,423
5,000
3,083
50,910
40,056
7
35,625
20,188
36,500
5,138
5,000
2,466
50,601
39,140
8
35,625
19,594
36,500
1,581
5,000
759
50,292
39,104
9
35,625
19,000
36,500
1,581
5,000
759
49,983
37,728
10
35,625
18,407
36,500
1,581
5,000
$8,000
759
57,674
42,353
11
35,625
17,814
36,500
1,581
4,600
8,000
759
57,160
40,749
12
35,625
17,220
36,500
1,581
4,200
8,000
759
56,643
39,200
13
35,625
16,626
36,500
1,581
3,800
8,000
759
56,127
37,708
14
35,625
16,032
36,500
1,581
3,400
8,000
759
55,609
36,267
15
35,625
15,438
36,500
1,581
3,000
8,000
759
55,093
34,878
16
35,625
14,845
36,500
1,581
2,600
8,000
759
54,576
33,541
17
35,625
14,251
36,500
1,581
2,200
8,000
759
54,060
32,253
18
35,625
13,658
36,500
1,581
1,800
8,000
759
53,543
31,009
19
35,625
13,064
36,500
1,581
1,400
8,000
759
53,026
29,812
20
35,625
12,470
36,500
1,580
1,000
20,000
758
64,509
35,304
$752,040
* Pre-Calculated
-------
product recovery from the on-site and pre-treatment facilities. Should
the yearly by-product recovery from on-site be greater than that from
pre-treatment by $ 1,578 in this example, the two alternatives become
equal in value. In addition, the reader will note that this chapter is
rife with assumptions since many pertinent regulations are not available
at this writing. Nevertheless, this chapter can serve as a general guide
to conpleting a more definitive analysis for your plant when appropriate
data is available.
Completed now are the analytical financial guides necessary
for making the proper choices of treatment alternatives and pollution
control incentives as soon as they are available. In this era of regula-
tory programs for health and welfare, it is, as demonstrated herein,
inportant to perform the financial analysis with as much zeal as goes into
the choice of proper equipment.
6-7
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