# Government Regulatory Impact Model Operating Principles

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### Table of Contents

1.0 Introduction and purpose
.......................................................................... 1 2.0 Model description.......................................................................................1 3.0 Income statement (1) Inputs to GRIM

....................................................... 5GRIM Operating Principles (Tailored to conductWater Heater Manufacturers' Cash-Flow Analysis)

1.0 Introduction and purpose The purpose ofthe Government Regulatory Impact Model (GRIM) is to help identify the effects ofvarious efficiency regulations and other regulations on manufacturers. The basic mode ofanalysis is to determine the change in value ofthemanufacturers(s) following aregulation or a series ofregulations. The model structure also allows an analysis ofmultiple products withregulations taking effect over aperiod oftime, and of multiple regulations on the same product. Industry value is defined, for thepurposes ofthis analysis as the present value ofcash flows for the manufacturer(s) in question. Cash flow iscalculated by theuser entering shipment volumes and manufacturer prices (i.e., prices frommanufacturers to the first customer, such as awholesaler) and then selecting user-defined regulatory levels. The model calculates the actual cash flows by year and then determines the present value of those cash flowsboth without regulations (the pre-regulation base case) and with regulations (thepost-regulation standards case). Output comes from themodel in terms ofsummary statistics, graphs ofmajor variables, and, when appropriate, access to the complete cash flow calculation.

2.0 Model description The basic structure ofthe GRIM is a standard annual cash flow analysis which uses price and volume information as an input,builds on fundamental base cost information, and accepts a set ofregulatory conditions aschanges in costs and investments. The cash flow analysis is separated into two major blocks: income and cash flow. Theincome calculation determines theprofit after taxes but before financial charges. The cash flow calculation converts profit after taxes into an annual cash flow by including investment and non-cash items. Below are definitions oflisted items on theprintout ofthe output sheet. (see Section 3.0) (1) Income Statement: Overall calculation ofNetIncome Before Financing(17) using revenue and cost items subject to income tax effects as described in (2) through (17). (2) Price/Unit: Actual manufacturer unitprice charged to the first level ofdistribution (distributor, etc.), entered as an input variable by user.

I(3) UnitSales: Annual shipments; entered as an input variable by user. (4) Revenues: Annual revenues; computed by multiplying Price/Unit (2) by UnitSales(3). (5) Base Costs: Costs per unitprior to regulations entered as input (Labor,Material,Overhead) variables by theuser. (6) New Costs: Costs per unit following regulations; entered as (Labor,Material,Overhead) input variables by the user. (7) Labor: Factory direct labor and fringe benefit costs; entered as an input variable by the user. (8) Material: Purchased materials and components; entered as an input variable by theuser. (9) Overhead: Factory overhead excluding depreciation; entered as an input variable by the user. (10) Depreciation: Annual depreciation on pre-regulation assets; computed as a percentage ofRevenues (4). Annual depreciation on post-regulation assets is computed by dividing Capital Expenditures(24) by auseful life from Major Assumptions. For post-regulation years,Depreciationis the sum ofdepreciation on pre- and post-regulation assets. (11) CostofSales: Total cost ofsales, computedby adding Labor(7), Material(8), Overhead(9) and Depreciation (10). (12) R&D: Research and development costs unrelated to regulations; computed as apercentage ofRevenues (4). From Major Assumptions. (13) ProductConversion: Expensable costs related to meeting a regulation, often including product redesign costs and expensable factory conversion expenses. Also includes costs incurred fornew product literature and catalogs, product obsolescence, and various related marketing expenses. GRIM computation based on regulatory level selected by user. (14) SG&A: Selling, general and administrative costs are computed as a percentage ofRevenues (4).

2(15) ProfitBefore Tax: Profitbefore taxes and any financing costs; computed by subtracting the Costof Sales (11) and SG&A (14) from Revenues (4). (16) Taxes: Taxes on ProfitsBefore Tax; computed by multiplying the tax rate contained in Major Assumptions byProfitBefore Tax (15). (17) NetIncome: Profits after taxes; computed by subtracting Taxes (16) from Profitbefore Tax (15). (18) CashFlowStatement: Overall assessment including net income, other cash related items and adjustments and investments. (19) CashFlow: Determination ofcash flow generated from operations. (20) Net Income: Net income; identical toNetIncome (17). (21) Depreciation: Depreciation is a non-cash cost and is added back intoNetIncome (20) as part ofthe cash flow calculation; identical to Depreciation(10). (22) Changein Working Capital: Additional accounts receivable, inventory, and other cash investments necessary to supportincreased revenues; computed by multiplying apercentage from Major Assumptions by the change in Revenues (4). (23) Cash Flow from Operations: The cash flow from operating activities; computed by adding NetIncome (20), Depreciation(21) and subtracting Changein Working Capital(22). (24) Capital Expenditures: Investment to maintain and replace existing production assets; computed as a percentage ofbase yearRevenues (4) using a percentage contained in Major Assumptions. Post-regulation capital expenditures equal pre-regulation expenditures plus depreciation on ConversionExpenditures(25). (25) ConversionExpenditures: Depreciation costs for meeting regulations, typically including plant, equipment, tooling and the like; GRIM computation based on regulatory level selected by user.

3(26) Cash Used inInvestments: Cash required for assets; computed by adding Capital Expenditures (24) and Conversion Expenditures (25). (27) NetCash Flow: Annual cash flow from operations and investments; computed by subtracting Cash Used inInvestments (26) from Cash Flowfrom Operations (23). (28) Post-Regulation Value: Value ofthe relevant industry following adoption and implementation ofthe regulatory scenario; the present value ofthe annual NetCash Flow (27) from thebase year to five years afterthe regulation goes into effect, plus a terminal value based on the final year's cash flow valued as an annuity, are computed by model and listed. The discounted rate for the present value is the "INTEREST RATE" contained in Major Assumptions. Pre-regulation value is computed by taking the base yearNet Cash Flow (27), excluding any regulation effects, and treating it as a perpetual annuity.

43.0 Income statement (1)

Base Year ______ ___ _1989 1990 1991 1992 1993 1994 1995 1996 1997
Price/Unit (2) 400 400 400 440 440 440 440 440 440 Unit Sales (3) 2 2 2 2 2 2 2 2 2 Revenues (4) 800 800 800 880 (6) (5) New Base (11) Cost ofSales 336.05 316.00 640 640 640 680 680 680 680 680 680 (7) labor 32.30 32.00 64 64 64 65 65 65 65 65 65 (8) Material 228.58 220.00 440 440 440 457 457 457 457 457 457 (9) Overhead 52.58 51.00 110 110 110 113 113 113 113 113 113 (10) Depreciation 22.59 13.00 26 26 26 45 45 45 45 45 45 (14) SG&A 112 157 149 115 114 114 114 114 114 (12) R&D 16 16 16 18 18 18 18 18 18 (13) Product Conversion

_ 45 37 2 (15) ProfitBefore Tax 48 3 11 85 86 86 86 86 86 (16) Taxes (Rate) 19 1 4 34 35 35 35 35 35 (17) Net Income 29 2 7 51 52 52 52 52 52 (18) (19) Cash Flow (20) Net Income 29 2 7 51 52 52 52 52 52 (21) Depreciation

__ 26 26 26 45 45 45 45 45 45 (22) Change inWork 0 0 0 14 0 0 0 0 0 Capital ____. ____ _ (23) Cash Flow from 55 28 33 82 97 97 97 97 97 Operations

_______ ____ ____ _ ______ (24) Capital Expenditures

__ () (32) (32) (51) (51) (51) (51) (51) (51) (25) Conversion (158) (129) Expenditure__

_____ __ (26) Cash Used in Investments

_ _ (32) (190) (161) (51) (51) (51) (51) (51) (51) (27) Net Cash Flow

__ 23 (162) (129) 30 46 46 46 46 46 (28) Others_

__ 46

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