Government

Regulatory Impact

Model Operating

Principles

Notice: U.S. Department of Energy

This report was prepared by Arthur D. Little for the U.S. Office of Energy Efficiency

Department of Energy. This report represents Arthur D. Little's and Renewable Energy

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Reference 38250-12

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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 ....................................................... 5

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GRIM Operating Principles

(Tailored to conduct Water Heater Manufacturers' Cash-Flow Analysis)

1.0 Introduction and purpose

The purpose of the Government Regulatory Impact Model (GRIM) is to help identify the

effects of various efficiency regulations and other regulations on manufacturers. The

basic mode of analysis is to determine the change in value of the manufacturers(s)

following a regulation or a series of regulations. The model structure also allows an

analysis of multiple products with regulations taking effect over a period of time, and of

multiple regulations on the same product.

Industry value is defined, for the purposes of this analysis as the present value of cash

flows for the manufacturer(s) in question. Cash flow is calculated by the user entering

shipment volumes and manufacturer prices (i.e., prices from manufacturers to the first

customer, such as a wholesaler) 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 flows both without regulations (the pre-regulation base case) and with

regulations (the post-regulation standards case).

Output comes from the model in terms of summary statistics, graphs of major variables,

and, when appropriate, access to the complete cash flow calculation.

2.0 Model description

The basic structure of the 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 of regulatory conditions as changes in costs and investments. The cash flow

analysis is separated into two major blocks: income and cash flow. The income

calculation determines the profit 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 of listed items on the printout of the output

sheet. (see Section 3.0)

(1) Income Statement: Overall calculation of Net Income Before

Financing (17) using revenue and cost items

subject to income tax effects as described in (2)

through (17).

(2) Price/Unit: Actual manufacturer unit price charged to the first

level of distribution (distributor, etc.), entered as an

input variable by user.

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(3) Unit Sales: Annual shipments; entered as an input variable by

user.

(4) Revenues: Annual revenues; computed by multiplying

Price/Unit (2) by Unit Sales (3).

(5) Base Costs: Costs per unit prior to regulations entered as input

(Labor, Material, Overhead) variables by the user.

(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 the user.

(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 of Revenues (4). Annual

depreciation on post-regulation assets is computed

by dividing Capital Expenditures (24) by a useful

life from Major Assumptions. For post-regulation

years, Depreciation is the sum of depreciation on

pre- and post-regulation assets.

(11) Cost of Sales: Total cost of sales, computed by adding Labor (7),

Material (8), Overhead (9) and Depreciation (10).

(12) R&D: Research and development costs unrelated to

regulations; computed as a percentage of Revenues

(4). From Major Assumptions.

(13) Product Conversion: Expensable costs related to meeting a regulation,

often including product redesign costs and

expensable factory conversion expenses. Also

includes costs incurred for new 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 of Revenues (4).

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(15) Profit Before Tax: Profit before taxes and any financing costs;

computed by subtracting the Cost of Sales (11) and

SG&A (14) from Revenues (4).

(16) Taxes: Taxes on Profits Before Tax; computed by

multiplying the tax rate contained in Major

Assumptions by Profit Before Tax (15).

(17) Net Income: Profits after taxes; computed by subtracting Taxes

(16) from Profit before Tax (15).

(18) Cash Flow Statement: Overall assessment including net income, other cash

related items and adjustments and investments.

(19) Cash Flow: Determination of cash flow generated from

operations.

(20) Net Income: Net income; identical to Net Income (17).

(21) Depreciation: Depreciation is a non-cash cost and is added back

into Net Income (20) as part of the cash flow

calculation; identical to Depreciation (10).

(22) Change in Working Capital: Additional accounts receivable, inventory, and other

cash investments necessary to support increased

revenues; computed by multiplying a percentage

from Major Assumptions by the change in

Revenues (4).

(23) Cash Flow from Operations: The cash flow from operating activities; computed

by adding Net Income (20), Depreciation (21) and

subtracting Change in Working Capital (22).

(24) Capital Expenditures: Investment to maintain and replace existing

production assets; computed as a percentage of base

year Revenues (4) using a percentage contained in

Major Assumptions. Post-regulation capital

expenditures equal pre-regulation expenditures plus

depreciation on Conversion Expenditures (25).

(25) Conversion Expenditures: Depreciation costs for meeting regulations, typically

including plant, equipment, tooling and the like;

GRIM computation based on regulatory level

selected by user.

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(26) Cash Used in Investments: Cash required for assets; computed by adding

Capital Expenditures (24) and Conversion

Expenditures (25).

(27) Net Cash Flow: Annual cash flow from operations and investments;

computed by subtracting Cash Used in Investments

(26) from Cash Flowfrom Operations (23).

(28) Post-Regulation Value: Value of the relevant industry following adoption

and implementation of the regulatory scenario; the

present value of the annual Net Cash Flow (27)

from the base year to five years after the 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 year Net Cash

Flow (27), excluding any regulation effects, and

treating it as a perpetual annuity.

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3.0 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 of Sales 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) Profit Before 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 in Work 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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