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w
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
1 2 3 4 5 6 7 8 9 10 11 12 13 14
Year After Acquisition
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CHAPTER III
QPTIMJM FINANCIAL STRATEGY FOR POLLUTION CONTROL
With the data now available from the calculations discussed
in Chapters I and II, it is now possible to develop the appropriate
manage ire nt 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 examples that follow.
No two seafood processors 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 dif-
ferent management objectives that might exist in a seafood processing
operation. We will show how different strategy combinations affect each
situation.
First, let us look at a 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.
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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 $200,000 capital
investment. Note that the equipment was depreciated in ten 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	$ 23,638	$ 40,436
2	8,872	41,118
3	8,572	41,708
4	8,282	42,209
5	8,003	42,629
$ 208,100
6	7,732
7	7,471
8	7,218	NPV CASH OUTFLOWS	$208,100
9	6,974 less NPV CASH INFLOWS	93,500
10	6,738	TOTAL NPV	$114,600
$ 93,500
First, let us select a seafood 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.
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Figure 5
ILLUSTRATIVE
FINANCIAL CHARACTERISTICS
OF POLLUTION CONTROL EQUIPMENT FOR
THE SEAFOOD PROCESSING INDUSTRY
1.	Equipment Characteristics
Investment Cost
Salvage Value
Useful Life
2.	Tax Status
Corporate Income Tax Rate
Investment Credit
Additional First Year's Depreciation
Effective Cost-of-Capital Rate
3. Financing Terms
(a)	Ordinary Bank Loan
Stated Interest Rate
Effective Interest Rate
Repayment Period
(b)	SBA - Water Pollution
Control Loan
Interest Rate
Present Treasury Rate
Payment Period
(c) Tax-Free Loan
Interest Rate
Initial Cost of Obtaining Loan
Repayment Period
Repayment Schedule
$200,000
-0-
10 years
48 percent
7 percent subject to
a certain maximum
$2,000
6.0 percent annually
6 percent annually
10.84 percent annually
5 years
Weighted average treasury rate
5 3/8W>5.5 percent
As long as 30 years, not
more than life of equipment,
10 years
5 percent
5 percent of capital
15 years
8 percent of principal
annually during years
5 through 14
20 percent of principal
during year 15 (balloon)
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The lowest cash outflow, and the strategy combinations that
permit it, are shown in Figure 6. This value, shown boxed is $15,600
the result of following a combination of Tax Strategy 2 and Financing
Strategy B. It is the best choice for a seafood processor 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 possibly combinations, resulting in the best ^ear-term
profit. The boxed value, $32,300, represents the lowest possible cash
outflow under the circumstances. It is derived from a combination of
Strategies 2 and B.
Finally, there's the seafood 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 ($77,800) are double-declining balance depreciation with investment
credit combined with a tax-free loan (Strategies 3 and C).
The hypothetical examples of Figures 7 and 8 do not represent
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 them all to a coirmon
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
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FIGURE 6
COMPARISONS OF PEAK ANNUAL CASH DRAIN
__	FROM
DIFFERENT TAX AND FINANCING STRATEGIES
Useful life = 10 years
Investment Cost: $200,000
TAX STRATEGY
1.	Straight Line Depreciation
2.	Straight Line Depreciation
with Investment Credit
3.	Double Declining Balance
Depreciation with In-
vestment Credit*
4.	Special Amortization for
Pollution Control Equip-
ment*		.
FINANCING STRATEGY
A.
B.

C.
Conventional
Rank Loan
$41,000(5)*
SBA Water Pollution
Control Loan
Tax-Free
Loan
$16,100(1)

$41,000(1$)
41,100(5]
15,600(2)
41,000(15)
42,800(5)
16,600(6)

41,000(15)
31,400 (5)
22,800(6)

41,000(15)
during which stated peak cash drain is readied.
•	^ -—. T7Q Tntfi-raa'
* Indicates year after acquisition during wuxuii		_
+Also includes effect of additional first year depreciation, Section 179, Internal
Revenue Code.
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FIGURE 7
COMPARISONS OF SHORT-TERM PROFIT IMPAIRMENT
FROM
DIFFERENT TAX AND FINANCING STRATEGIES
Useful life = 10 years
Investment Cost: $200,000
TAX STRATEGY J
FINANCING STRATEGY
A. B. C.
Conventional S13A Water Pollution Tax-Free
Bank Loan Control Loan Loan
1.	Straight Line Depreciation
2.	Straight Line Depreciation
with Investment Credit*
3.	Double Declining Balance
Depreciation with In-
vestment Credit*
4.	Special Amortization for
Pollution Control Equip-
ment*
$53,400 $43,800 $48,700
41,800
32,300
37,100
70,900 61,400 66,200
82,600 73,000 77,900
-	—							 . 			— Mil 		
*Also includes effect of additional first year depreciation, Section 179, Internal
Revenue Code.
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FIGURE 8
COMPARISON OF LONG-TERM PROFIT IMPAIRMENT
			FROM
DIFFERENT TAX AND FINANCING STRATEGIES
~	~~	Useful life - 10 years •
Investment Cost: $200,000
TAX STRATEGY"
FINANCING STRATEGY
A. B. C.
Conventional SBA Water Pollution Tax-Free
Bank Loan Control Loan Loan
1.	Straight Line Depreciation
2.	Straight Line Depreciation
with Investment Credit*
3.	Double Declining Balance
Depreciation with In-
vestment Credit*
4.	Special Amortization for
Pollution Control Equip-
ment*
$128,200 $114,300 $104,700
114,600 100,700 91,000
101.400 87,500 77,800
121,400 107,500 97,800
"Also includes effect of additional first year depreciation, Section 179, Internal
Revenue Code.
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good practice to refer to separate year-by-year projections like those in
Figures 2 and 4. Doing so determinesyear-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 ainoritzation is the optimal
choice.
Figure 9 clearly demonstrates why all this analysis is so im-
portant. From 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 facility
in our example was financed by an ordinary bank loan and rapid amortization
was taken (a fairly traditional choice), the effective cost would have
been $121,400. A tax-free loan and investment tax credit with double
declining balance depreciation resulted in an effective cost of
$77,800, a savings over the former plan of $33,600. It is well worth
devoting 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 possibly
reduce the optimum savings, however, the savings will still be substan-
tial.
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$130,000
With
Investment
Credit
120,000
With
Rapid
-Amortization

110,000
~ H
100,000
90,000
80,000
Figure 9
Long-Term Profit Impairment
From Various Financing and Tax Alternatives
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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 company 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 exanple, although the tax-
exempt financing is generally more attractive than regular bank borrowing,
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 tax-free eligibility ruler is the IRS.
Specific attention must therefore be paid to what each seafood firm*s
state has passed into law as to availability of anti-pollution revenue bonds.
Size also is an inportant factor since there is usually a fixed
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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 attempt to con-
dense and simplify. They are also time-varying so that the reader is
cautioned to obtain a current reading before selecting a course of action.
While discussing the above effects of various state and local
regulations on the outcome of optimal tax and financing shown in Chapter III
it is also appropriate to present here the various state programs that could
modify the outcome of choices analyzed in Chapters V and VI. Those chapters
extend the equipment purchase analysis to a self-treatment versus municipal
treatment analysis.
The cost for a company to have its waste municipally treated are
determined by the technology of treatment and how the municipal treatment
works are financed (we will assume a constant treatment cost). The federal
government will make a grant to eligible waste treatment projects of 75
percent of the construction cost. It is the financing of the 25 percent
portion that will create differences in costs from one community to another.
The nature of cost differences is largely a function of what has
to be repaid and the interest on the repayments. The industrial portion of
the federal 75 percent construction cost must be repaid over a certain
number of years to the government but with no interest.
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The 25 percent portion could be raised through a local or state
bond issue, or a state grant, or a combination of the two. Generally
local or state loans or bond issues must be repaid over the years with an
interest payment. Grants for treatment plant construction costs do not
usually require repayment. Thus the peculiarities of each state's
program for financially assisting waste treatment systems must be
incorporated into the financial analysis.
In addition to the various programs that each state has to aid
the remaining 25 percent local construction cost share, the Federal Water
Pollution Control Act of 1972 set up another financing mechanism. The
Environmental Financing Authority was created to help those municipalities
who would have difficulty securing the financing, and at reasonable rates
and terms. As yet the specific loan details on rates and teims have not
been established. In general language, EFA has stated that if the
only available rate and term for a municipality from its sources was more
costly than what it could obtain from the EFA then it would pass the
first eligibility criteria.
What follows is a brief and simplified overview of several
states1 financial incentives for pollution control which are expected to
be of special interest to this audience, with these words of caution.
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.
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TABLE 4
FINANCIAL ASSISTANCE AND TAX INCENTIVES FOR INDUSTRY

State Sponsored Industrial
M 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
Equipment, Machinery
on Excise Tax Exemption
Tax Exemption or Moratorium
^On Land, Capital Improvements
^ Tax Exemption or Moratorium
On Equipment, Machinery
^ Sales/Use Tax Exemption
On New Equipment
Sales/Use Tax Exemption
°Applicable to Lease of
Pollution Control Facilities
Alabama
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
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
X
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TABLE 4 (cont'd)

State Sponsored Industrial
Development Authority
o
w State Authority or Agency
Revenue Bond Financing
&


^ Tax Exemption or Moratorium
ON Land, Capital Improvements
^ Tax Exemption or Moratorium
On Equipment, Machinery
G
o
in
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Alaska
From available records, correspondence and publications it does not
appear that the installers of pollution control equipment in Alaska have state
or local tax incentives available to them. However, there is a state grant
program to provide construction cost financing to the municipalities into
which industries may discharge. The state grant combined with the federal
grant alleviates the municipality from having to publicly finance, and pay
interest on, their new treatment plants. Thus, an industry discharging into
a municipality receiving the state grant for the 25% local portion may be
charged less than the same company located in a state where the municipality
must fund the 25% portion on an interest-bearing public basis.
For all municipal waste treatment systems eligible for the 75%
federal grants, Alaska will provide a grant for the remaining 25%. In
anticipation of federal grants to be received, and as funds are available,
Alaska may also provide interest-free construction loans. These loans are
repaid when the federal grant arrives.
Also, for sewage treatment facilities which do not qualify for
federal grants, the state may make partial grants, as funds are available.
Arizona
Arizona has three programs of interest to the subject matter of
this report: a rapid amortization plan for pollution control equipment;
a revenue bond financing plan; and a state grant program for a portion of the
municipal construction costs of wastewater treatment facilities.
The rapid amortization plan of Arizona permits pollution control
equipment to be written off against state corporate income taxes over a
60-month period. The first month in which amortization can be taken begins
the month after the equipment is installed. This tax feature is very similar
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to the federal government's rapid amortization plan for federal corporate
income taxes. Also a feature of both tax programs is the certification re-
quirement for the equipment as meeting the appropriate control regulations.
Pollution control equipment in Arizona can be financed by industrial
development bonds (pollution control revenue bonds). Companies with adequate
financial needs, therefore can obtain long-term, low interest cost financing
for their capital equipment.
The State of Arizona has appropriated $3 million for local wastewater
treatment plant construction grants. This fund expires June 30, 1974. At the
present time State participation is 5 percent of the eligible project costs.
Eligible costs are similar to those allowed by EPA including planning, construc-
tion and administration. The municipalities do not have to recover the in-
dustrial portion of this grant.
California
The State of California makes available incentives for rapid
amortization, local revenue bonds, and for all new equipment there is no
sales or use tax. Another form of pollution control cost reduction measure
to industry are the repayment conditions by which municipalities repay any
state loan or receive state grants to pay for the local portion of the waste-
water treatment facilities.
The rapid amortization provision (Section 17226, Revenue and Taxa-
tion Code) follows closely the federal tax provisions for rapid amortization
which are described in Chapter I of this report. The equipment's value, net
of the value of recovered materials and excluding buildings or land not re-
lated to pollution control, can be deducted for State corporate income tax
purposes over 60 ncnths. The facilities must be for plants in operation before
January 1, 1971 and for pollution control equipment installed before January 1,
1975. The facilities must also be certified by the appropriate state pollution
control agency.	„
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As explained earlier any wastewater treatment project qualifying for
federal funds will receive 75% of the funding from the federal government. The
remaining 25% must be derived from local or state bonds or grants. The Cali-
fornia Water Bond Law of 1970 raised $250 million from which 12 1/2 percent
grants or 1/2 of the remaining 25 percent will be made. This fund will expire
in 1974 and is expected to be replaced, upon voter approval, by another
$250 million bond issue. Grant funds are approved based upon a system of waste-
water improvement priorities.
The state has the California Pollution Control Financing Authority
for providing pollution control financing to industry. At January , 1974
the Authority had assisted companies to the extent of $182,000,000. The
Authority was also holding the uncommitted balance of the fund until the
needs of small companies who may wish to utilize the program to meet
pollution needs could be determined. A proposal is proposed by
the Authority to issue bonds for an additional $200,000,000 of which
$50,000,000 will be reserved until the needs of small companies can be
determined.
The grant and loan funds are not sufficient to meet all requests but
are reasonably adequate for urgent needs.
As is the case with the federal share of construction grants, in-
dustry in California must also repay their proportionate share of the
locally shared construction costs. The state also has regulations pertaining
to the annual operating and maintenance costs where industry is being serviced.
Oregon
Oregon has a very elaborate program for permitting credits against
either the state income or excise tax, or exemption from certain ad valorem
taxes. The other tax exempted for pollution control facilities is property
tax. The state also has a program for assisting municipalities with grants
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for the local portion of municipal sewage treatment plants,
For eligibility in the tax credit program the facility must first
be certified under regulations established in ORS 449.605. The application
for certification is submitted to the Environmental Quality Commission which
certifies what percentage of the value of the equipment qualifies for a tax
exemption rate schedule. In other words, the Environmental Quality Commission
determines whether 20,40, 60 or 80% of the value is actually for pollution
control purposes.
After the certification the taxpayer has within 60 days to irrevoca-
bly decide whether to take the credit against the income or excise tax (ORS
316.480 for personal taxes and ORS 317.072 for corporate taxes) or the ad
valorem taxation (ORS 307.405). For facilities where at least 80 percent of
the value is for pollution control purposes the credit against the income or
excise tax is 51. From there the eligible percent decrease to 41 for 60% value,
and so on down to U for a value of 20% of the equipment qualifying as
pollution control.
Washington •— Sq*-
Washington has a sales and use tax exemption program, a revenue
bond program, and a state grant and loan program for local portions of the
sewage treatment plant construction costs.
Under Section 82.34.050 of Washington Statutes, the holder of a
certificate from the appropriate control agency can be exempt from the sales
tax he may elect not to claim the exemption and apply the paid sales
tax against the business and occupation tax, the use tax or public utility
tax.
The application must have been received by December 31, 1969 or
within one year after the appropriate regulation is established. The deter-
mination of the eligible cost value is net of recovered materials in the
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pollution control process.
The credit on the other taxes if the sales tax exemption is not utilized,
is 2 percent of the cost of the facility for each year the certificate remains
in force. The credit is not to exceed 501 of those taxes and the amount of
the credits over the years cannot exceed 501 of the cost of the facility. The
amount of the credit is reduced by the total amount of any federal investment
or other federal tax credit.
Washington also has a revenue bond program through which eligible
pollution control expenditures can be financed over extended lengths of time at
tax-exempt rates.
Under 90.48.285 of the Water Pollution Control Laws, the Water Pollution
Control Commission can make loans to municipalities if the local costs of sewage
treatment projects cannot be financed at reasonable cost. Also, under 90.48.290,
when state appropriations are available, grants to match local revenue contributions
can be made for the local costs of municipal sewage treatment costs. These local
revenue contributions can be considered to include federal grants. The plant must
also be part of a comprehensive drainage basin water pollution control and abatement
plan. Thus industries paying user charges to recover capital costs may pay less
of the costs they would incur if bond issues were used exclusively for the local
construction costs.
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
discussed.
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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 con-
siderably. Before entering the economic aspects we first want to demonstrate
that seafood processors have had this choice available to them. First we will
describe the extent to which various types of manufacturers use public
treatment facilities. Thai we will explore recent regulatory and economic
programs that will influence changes in the usage of public treatment
facilities by all industry as well as seafood 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 dis-
charge went to public sewers while 92.9 percent went to receiving waters.
This study compares very closely with the Census of Manufacturers study
of 1967 that was five times as large which indicated that 5.4 percent volume
of wastewater was discharged to sewers.
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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 541 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.
The data available for components of the seafood processing
industry portray a vast difference in percentage of plants discharging
their wastes to municipal treatment systems. The data in Table 5 were
admittedly rough estimates made by an EPA contractor; however, there was
no other data available to them.
TABLE 5
Product Category	Estimated Percentage
Catfish	50
Conventional Blue Crabs	50
Mechanized Blue Crabs	50
Alaskan Crab Meat	5
Dungeness and Tanner Crab	10
Southern Shrimp	50
Breaded Shrimp	50
Alaskan Shrimp	5
Northern Pink Shrimp	10
Tuna	20
There are several factors that will influence the mix of companies
being hooked into municipal waste treatment systems, as described above,
for all industry as well as seafood processing.
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•	n»re and more areas are being opened up to public treatment
systems
•	industry will have to pay their equitable costs of treatment
performed by municipalities which in the majority of cases is
more than they previously paid.
more federal construction grant money has been made available
to municipalities for upgrading their plants to secondary treat-
ment or better.
•	effluent guidelines based on best practicable and best available
technology will be imposed upon seafood processing and all other
industries.
•	pre-treatment guidelines will affect the need for preparation
of waste before sewerage for processors and other industries.
From the above listed technological, regulatory and economic
considerations it is fairly safe to say that a major decision-making process
in water pollution control will take place in the United States. As part
of this movement many seafood 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 implications of a capital investment versus higher yearly operating
costs.
Equitable Cost Recovery Systems
The yearly treatment costs to processors using public
facilities arises from the methods that municipalities have available to
them for financing their construction costs. To start with, recent federal
legislation made an assunption 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
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operating, maintenance 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 construction grants will eventually be funneled to munici-
palities; 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 industrial 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 nuirber 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 users. (2) To reduce
administrative 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
5-4
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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 -- pretreatment costs, by -
product recovery value, and two sets of operating costs -- which must be
separately calculated before the final decision phase is consummated.
Pre-Treatment Costs
The first factor is pre-treatment costs for the conditioning of
pre-treating of a company's waste water by a company before the wastes
reach the municipal system. The costs of pre-treatment depend on the nature and
volume 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 soneindustries, where pre-treated costs would consist of chemicals
and other consumable 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 calcu-
lations for this equipment are the same as those used in Chapters I and II.
Further analysis would have to take into account the expected difference
in useful life of a pre-treatment facility from a municipality's.
By-Pxoduct Recovery Value
It is reasonable that pre-treatment will produce by-product
recovery in a processing plant, however, the relativity of the
5-5
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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 seafood processing industry. The emphasis on by-product
recovery here is the very likely increase in extent as events proceed in
the seafood 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 described in Chapter II for a negative cash flow.
Municipal Versus Private Waste Water Treatment
To complete the sequence necessary for constructing a municipal
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 payments are infinite in duration). The set of costs
that we now have to compare in the decision process, have been adjusted
5-6
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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 out-
lined 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 summarizes the entire flow of this Report. Under the previously
defined pollution 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.
They are not quantifiable at this time, and are intended as a guideline
at the time when these costs become firmly known.
5- 7
minus
plus
equals
plus
equals
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Figure 10
Guide to Management For Choosing the Optimum
Financial Strategy for Pollution Control
NPV and
Yearly Cash
Flows for Tax
NPV and
Yearly Cash
Flows for
Available
Financing
Strategies
Assignment of
Management
Objective as
Criteria
Analysis of All Possi-
ble Combinations of Tax
§ Financial Strategies
Under the Management
Qhiactive	
NPV of Pre-
treatment
costs, if any
Adjustment by Incremen-
tal NPV of:
(i)by-product recovery
(ii)operating costs for
Private Facility
Adjusted Effective
Equipment Cost For
a Private Treat-
ment Facility
vs
Adjusted Effective
User Charge Value
For Using Municipal
Facility
Equipment Choice Only
I
Private Treatment Versus Municipal Tie-in
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CHAPTER VI
tt t USTRATIQN OF OPTINSJM FINANCIAL STRATEGY FOR
pht TUTTON CONTROL FOR MUNICIPAL VS ON-SITC 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 compared various strategies in buying and
writing off the equipment. This chapter presents an example of the
application of this financial theory where the comparison 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-
nent 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-tem profit which is primarily
net present value consideration. This method, incidently, is the one
used most frequently by EPA in their economic i^act studies.
Recalling the costs from the previous chapter which were to be
utilized in the con^arison, we find for on-site treatment the capital
costs which include financing and depreciation, the operating costs and
6-1
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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 nuirber of years or length of analysis must be the same
over which the calculations are performed.
Qn-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 impact
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.
We will choose a 10-year analysis for the two alternatives which allows us
to extend the earlier exanple. The processing investment we used earlier
in the report was for 10 years at a cost of $200,000. We will speculate that
even though that equipment could last longer than 10 years, regulatory
obsolescense will require municipal and private updating which limits our
analysis to 10 years.
One of the assunptions 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 analysis 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
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cent of the principal in years five through fourteen and a 20 percent
balloon payment in the fifteenth year. The tax-free loan rate will be
5 percent.
seafood processing plant has to perform all maintenance
and operation, we have to include those costs as wdl as any sludge
handling and disposal costs. We will consider the "0 6 M" costs to be
8 percent of the total facilities investment cost of $16,000 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 (MGD). 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 seafood 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 seafood 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
25% or the local/state share is raised through a tax-exempt
bond issue at 5 percent
6-3
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TABLE 6
NPV OF TEN YEAR ON-SITE TREATMENT PLANT
FINANCED OVER FIFTEEN YEARS







Net





After-Tax
After-Tax
Cash


Yearly
Interest
Principal
Negative
Positive
Flow
Year
0§M
Depreciation
Payments
Payments
Cash Flow
Cash Flow
NPV
1
$16,000
$41,600
$20,000***
-
$18,720
$33,968
$14,732**
2
16,000
31,680
10,000
-
13,520
15,206
1,574**
3
16,000
25,344
10,000
-
13,520
12,165
1,222
4
16,000
20,275
10,000
-
13,520
9,730
3,301
5
16,000
16,221
10,000
$16,000
21,840
7,786
11,834
6
16,000
12,976
9,200
16,000
21,424
6,228
12,363
7
16,000
12,976
8,400
16,000
21,008
6,228
11,618
8
16,000
12,976
7,600
16,000
20,592
6,228
10,909
9
16,000
12,976
6,800
16,000
20,176
6,228
10,234
10
16,000
12,976
6,000
16,000
19,760
6,228
9,594
11


5,200
16,000
19,344

13,250
12


4,400
16,000
18,928

12,528
13


3,600
16,000
10,192

6,517
14


2,800
16,000
9,776

6,040
15


2,000
40,000
21,840

13,038
$106,142
*
**
***
Includes Additional First Year's Depreciation of $2,000
Positive Cash Flows, the remaining thirteen years being negative
Includes 5% underwriting expense for bond issue
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° the yearly "0 § W of the municipal plant is 3 percent of total
investment cost of $72,000.
the seafood processing plant requires pre-treatment equipment
which, for the 10 years cost, is $20,000 and is financed via
a 5 percent tax-free loan and depreciated via the double-declining
balance plus investment credit method.
the "0 5 M" for the pre-treatment facility incurred by the
seafood plant is 8 percent or $1600 per year
The user charge for the seafood processing plant thus consists of
the followint costs:
2%(percentage flow) of 75% of $2,400,000 over 10 years which
equals $3,600. (federal capital proportion)
2% of 25% of $2,400,000 plus yearly interest of 5% 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 ' W 0f $1,440 ^ 600
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 $68,062. It would not be prudent to extend the implications
of this simplified example to a general seafood processing industry prefer-
ence for municipal treatment. As one reason, we excluded the value of by-
6-5
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TABLE 7
NPV OF USER CHARGES FOR TEN YEAR COST RECOVERY SYSTEM
FOR FEDERAL GRANT AND FIFTEEN YEAR FINANCINGS





Pre-Treatment
After
After


Federal

Treatment

Capital

Tax
Tax
Net

Portion
Local*
and

Costs

Positive
Negative
Cash

User
State
Pre-Treatment



Cash
Cash
Flow
Year
Charge
Portion
0$M
Depr.
Int.
Prin.
Flow
Flow
NPV
1
$3,600
$1,400
$3,040
$5,600
$2,000

$4,088
$5,221
$1,095
2
$3,600
1,360
3,040
2,880
1,000

1,382
4,680
3,079
3
3,600
1,320
3,040
2,304
1,000

1,106
4,659
3,205
4
3,600
1,280
3,040
1,842
1,000

884
4,638
3,271
5
3.600
1,240
3,040
1,557
1,000
$1,600
590
5,450
4,092
6
3,000
1,200
3,040
1,557
920
1,600
590
5,387
3,909
7
3,000
1,160
3,040
1,557
840
1,600
590
5,325
3,721
8
3,600
1,120
3,040
1,557
760
1,600
590
5,262
3,548
9
3,600
1,080
3,040
1,557
680
1,600
590
5,200
3,383
10
3,600
1,040
3,040
1,557
600
1,600
590
5,138
3,224
11

1,000


520
1,600

1,622
1,111
12

960


440
1,600

1,560
1,032
13

920


360
1,600

1,498
958
14

880


280
1,600

1,435
887
15

840


200
4,000

2,621
1,565
$38,080
* Pre-Calculated
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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 $17,000 in this example, the two alternatives become
equal in value. In addition, the reader will note that this chapter
rife with assumptions since many pertinent regulations are not available
at this writing. Nevertheless, this chapter can serve.
 a general guide
to conpleting a more definitive analysis for your plant when appropriat
data is available.
Completed now are the analytical financial guides necessary
for making the proper choices of treatment alternatives and pollutio
control incentives as soon as they are available, in r.h-ic
n Tms era of regula-
tory programs for health and welfare, it is, as demonstrated herein
important to perform the financial analysis with as much zeal as goes
the choice of proper equipment.
6-7
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APPENDIX a - Distinctions Between Pollution Control
ArrciNuxA Equipment and Process Equipment
For pollution control equipment to be tax-exenpt under the industrial devel-
opment bond program it must meet three tests (Treasury Regulations Section 1.103-8(g) (2)
^ property . • • °£ a character subject to allowance for deprecia-
tion 	or ^¦an^ *
(2)	THe jurisdictional agency must certify that the facility, as designed,
is in furtherance of the purpose of abating or controlling pollutants,
the facility will meet or exceed the appropriate regulations in effect
at the time of issuance.
«.+ in whole, or in part, abate or control water or atmos-
(3)	The property must in wnox ,
or contamination by removing, altering, disposing or
phenc pollution v*
storing pollutants, contaminants, wastes or heat.
• j_c4rable or necessary for a company to coniune its pollution
In many cases, it is de
•	related capital expenditures that reduce the ancunt of
control expenditure with process xw.
1 £„*. ovamnle. process changes to reduce the amount of water
pollution to be treated; for exaji*
c- f certain non-pollution control expenditures do not qualify
utilized in the plant. Since t
, .fallowing distinguishes pollution control equipment from
for tax-exempt finincing» e
equipment which has other significant pulses.
nditure is designed for no significant purpose other than
(1) If a property expe
„ ,T„.Hnn on an existing facility, it qualifies for tax-free
control of pollution u
the
financing
(2)
miditure would not be made but for the purpose of con-
If a property e*Pe
and if the expenditure has no significant purpose
trolling pollution,
	nf pollution control, it satisfies the regulations
other than the purpose or p
serves one or more functions in addition to
even though such property
. a pollution control facility."
its function as P"
pollution control and another significant purpose,
rr\ "Where property se
1 J	, 0f such facility satisfies the tax-free regula-
only the tacre®"*31
rnst is the excess of its total cost over that
tions. The act—1 cost
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portion of its cost expended for a purpose other than pollution control."
(4)] "An expenditure has a significant purpose other than the control of pol-
lution if it results in an increase in production or capacity, or in a
material extension of the useful life of a manufacturing or production
facility or a part thereof."
When an allocation of your planned capital expenditure must be made between the
amounts that qualify for tax-exempt financing and those that do not, there are sev-
eral formulae and methods. These methods center around the determination of re-
maining useful life of the equipment whose capacity or life is being extended com-
pared to its new life after the expenditure is made. In these cases, determination
of useful life usually relates to economic useful life, not accounting useful life.
Then the remaining useful life is placed over the new life to obtain a fraction.
The fraction is multiplied against the planned capital expenditure to obtain the
amount eligible for tax-free financing.
For example, if a new boiler with improved controls ccsts $1,000,000 and tripled
the life of the present one, $333,333 would qualify for tax-exempt. The situation
with boilers has arisen frequently enough that 30 years is considered the useful life.
The "Coke oven formula" evolved from an interesting coke oven replacement
situation where the owner said old ones have an infinite life. Applying the above
fraction for an infinite life means that the entire cost could be taxed at tax-free
rate. The compromise worked out was to use a fraction based on costs of existing over
the cost of the new. To find the cost of the existing coke oven, the original
purchase price was inflated at an agreed upon yearly rate and then put over the new
cost to arrive at a fraction that would be multiplied against the new capital cost
program about to be undertaken.
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APPENDIX B: Types of Contractual Arrangements
Between Governmental Authority and
User Under Tax-Free Financing
Depending on the state, a borrower utilizing the industrial develop-
ment bond program may deal with a township, city, town, county, village
or borough, a quasi-governmental authority or a state. Likewise the sources
which loan the funds to the authority to be lent to the borrower may be
a bank, the public at large or some other institutional investor who can
benefit from the tax-free income. Just as variable are the agreements
between the authority and the company installing pollution control equipment,
particularly in the manner of interest and principal repayments.
The interest and principal repayment schedule utilized by the borrower
in the example in this report can be characterized as one that would be
typical of many bond indentures. That is, equal interest payments are paid
each year, but the borrower pays different amounts of principal into a
type of sinking fund during the life of the financing. The sinking fund
plus the interest it earns is repaid at the end of the term of the finan-
cing. As is typical in most situations there is a lien on the property
being financed and a guarantee by the lessee. At the end of the lease,
the lessee purchases the facility from the authority at nominal considera-
tion, which must be less than fair market value. The lessee is treated
as the owner for tax purposes during the lease period, even though, in the
typical financing, bare legal title is in the authority. The lessee can
take depreciation and investment tax credits.
It is also possible for the transaction to be structured as an ordin-
ary financing lease, with lease payments deducted by the business as rental
-------
payments. In this case the authority still retains title at the end of the
financing. Likewise, the lessee does not have the privledge of taking
depreciation and the investment tax credit since he has chosen to deduct
rental payments. The payments in this case would be even over the lease
life.
Another possibility is to establish the relationship as an install-
ment sale with title going to the buyer at the end of the installment
period. This system would also make equal payments and allow the lessee
the ability to take depreciation and the investment tax credit.
The last method is for the agency to issue a bond, the proceeds of
which are reloaned to several companies. Each company negotiates its own
terms and signs a loan agreement or note. The borrower is entitled to de-
precation and the investment tax credit.
A company, in addition to the lien on the leased pollution control
equipment could also secure the payments to the authority by having its
parent company guarantee its payments.
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