The most difficult part of the feasibility evaluation is the economic analysis. This analysis requires estimating equipment costs, installation costs, the amount of waste reduction, cost saving to the process, and economic return.
For projects with significant capital costs, a more detailed profitability analysis is necessary. The three standard profitability measures are:
• Payback period
The payback period is the amount of time needed to recover the initial cash outlay on the project. Payback periods in the range of three to four years are usually acceptable for a low-risk investment. This method is recommended for quick assessment of profitability.
The NPV and IRR are both discounted cash flow techniques for determining profitability. Many companies use these methods to rank capital projects that are competing for funds. Capital funding for a project may hinge on the ability of the project to generate positive cash flows well beyond the payback period and realize an acceptable return on investment. Both the NPV and IRR methods recognize the time value of money by discounting future net cash flows. For an investment with a low-risk level, an aftertax IRR of 12 to 15% is typically acceptable.
Most spreadsheet programs for personal computers automatically calculate the IRR and NPV for a series of cash flows. More information on determining the IRR or NPV is available in any financial management, cost accounting, or engineering economics text.
When the NPV is calculated, the waste reduction benefits are not the only benefits. Most good options offer other benefits such as improved quality, reduced cycle times, increased productivity, and reduced compliance costs (see Table 3.2.4). The value of these additional benefits is often more than the value derived from reducing waste.
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