12 B

- i APPENDIX 12B. GOV ERNMENT REGULATORY I MPACT MODEL

TABLE OF CONTENTS

12B.1 INTRODUCTION AND PUR POSE

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- 1 12B.2 MODEL DESCRIPTION

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- 1 12 B.3 DETAILED CASH FLOW E XAMPLE

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- 1 APPENDIX 12 B

. GOVERNMENT REGULATOR Y IMPACT MODEL

12B.1 INTRODUCTION AND PURPOSE

The purpose of the Government Regulatory Impact Model (GRIM) is to help quantify the impacts of energy conservation standards on manufacturers. The basic mode of analysis is to estimate the change in value of the industry following a regulation or a series of regulations. The model structure also allows a n analysis of multiple products with regulations taking effect over a period of time, and of multiple r egulations on the same products

.
Indu stry net present value is defined, for the purpose of this analysis, as the discounted sum of industry free cash flows plus a discounted terminal value. The model calculates the annual cash flows and then determines the present value of those cash flows bo th without an amended energy conservation standard ( i.e ., the base case) and under different trial standard levels (TSLs).

Output from the model consists of summary financial metrics, graphs of major variables, and, when appropriate, access to the complete cash flow calculation.

12B.2 MODEL DESCRIPTION

The basic structure of the GRIM is a standard annual cash flow analysis that uses manufacturer selling prices, manufacturing costs, a shipments forecast, and financial parameters as inputs and accepts a set of regu latory conditions such as changes in costs and investments. The analysis is separated into two major sections : income and cash flow. The income calculation determines net operating profit after taxes. The cash flow calculation converts net operating profit after taxes into an annual cash flow by including investment and non

- cash items. Below are definitions of listed items on the printout of the output sheet (see s ection 1 2. B .3).

Unit Sales: Total annual shipments for the industry were obtained from the Nat ional Impact Analysis Spreadsheet;

Revenues: Annual revenues

- c omputed by multiplying unit price s at each efficiency level by the app ropriate manufacturer markup;

Labor: The portion of cost of goods sold (COGS) that includes direct labor, commissions, dis missal pay, bonuses, vacation, sick leave, social security contributions, fringe, and assembly labor up

- time;

Material: The portion of COGS that includes materials;12 B

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Overhead: The portion of COGS that includes indirect labor, indirect material, energy use, maintenance, depreciation, property taxes, and insurance related to assets. While included in overhead, the depreciation is shown as a separate line item;

Depreciation: Annual depreciation computed as a percentage of Revenues

. While included in overhead, the depreciation is shown as a separate line item;

Stranded Assets: In the compliance year of the standard, a one

- time write

- off of net property, plant, and equipment ( PPE ) assets to account for the book value of these assets that would have enjoyed a longer life if not for the standard ;

Standard SG&A: Selling, general, and administrative costs are computed as a percentage of Revenues ;

R&D: the GRIM separately accounts for ordinary research and development (R&D) as a percentage of Revenues ;

Product Conversion Costs : Product conversion costs are one

- time investments in research, development, testing, mar ke ting , and other costs focused on making equipment design s comply with the new energy conservation standard. The GRIM allocates these costs over the period between the standard’s announcement and the effective date ;
Earnings Before Interest and Taxes (EBIT): Includes profit before deductions for interest paid and taxes;

EBIT as a Percentage of Sales (EBIT/Revenues) : the GRIM calculates EBIT as a percentage of sales to compare with the industry’s average reported in financial statements;

Taxes: Taxes on EBIT are calculated by multiplying the tax rate contained in Major Assum ptions by EBIT ;
Net Operating Profits After Taxes (NOPAT): Computed by subtracting Cost of Goods Sold

, SG&A

, R&D

, Product Conversion Costs , and Taxes from Revenues ;
NOPAT repeated : NOPAT is repeated in the Statement of Cash Flows;

Depreciation repeated : Depreciation and Stranded Assets are added back in the Statement of Cash Flows because they are non

- cash expense s ;
Change in Working Capital : Change in cash tied up in accounts receivable, inventory, and other cash investments necessary to support operatio ns is calculated by multiplying working capital (as a percentage of revenues) by the change in annual revenues ;
Cash Flow From Operations : Calculated by taking NOPAT , adding back non

- cash items such as a Depreciation , and subtracting out Change in Working Capital ;12 B

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Ordinary Capital Expenditures: Ordinary investments in property, plant, and equipment to maintain and replace existing production assets, computed as a percentage of Revenues ;
Capital Conversion Costs : Capital c onversion costs are one

- time invest ments in property, plant, and equipment to adapt or change existing production facilities so that new product designs can be fabricated and assembled under the new regulation;

Capital Investment: Total investments in property, plant, and equipment are comp uted by adding Ordinary Capital Expenditures and Capital Conversion Costs ;

Free Cash Flow: Annual cash flow from operations and investments; computed by subtracting Capital Investment from Cash Flow from Operations ;

Terminal Value: Estimate of the continuing value of the industry after 204 7

. Computed by growing the Free Cash Flow in year 204 7 at a constant rate in perpetuity;

Present Value Factor: Factor used to calculate an estimate of the present value of an amount to be received i n the future;

Discounted Cash Flow: Free Cash Flows multiplied by the Present Value Factor

. For 204 7 the discounted cash flow includes the discounted Terminal Value ; and

Industry Value thru 204 7 : The sum of Discounted Cash Flows

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12B.3 DET AILED CASH FLOW EXAM PLE