APPENDIX 12B. GOVERNMENT REGULATORY IMPACT MODEL (GRIM)

TABLE OF CONTENTS

12B.1 INTRODUCTION AND PURPOSE

.................................................................................. 2

12B.2 MODEL DESCRIPTION

................................................................................................... 2

12B.3 DETAILED CASH FLOW EXAMPLE

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

12B-1APPENDIX 12B. GOVERNMENT REGULATORY IMPACT MODEL (GRIM)

12B.1 INTRODUCTION AND PURPOSE

The purpose of the Government Regulatory Impa ct Model (GRIM) is to help quantify the impacts of energy conservation standards and ot her regulations on manufacturers. The basic mode of analysis is to estimate the change in value of the industry or 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 mu ltiple regulations on the same products.

Industry 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 actual cash flows by year and then determines the present value of those cash flows both without an 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 th e 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 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 net operatin g 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 pr intout of the output sh eet (see Section 13C.3).

(1) Unit Sales: Total annual shipments for the industry were obtained from the National Energy Savings Spreadsheet;

(2) Revenues: Annual revenues - computed by multiplying products unit prices at each efficiency level by the appr opriate manufacturer markup;

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

(4) Material: The portion of COGS th at includes materials;

(5) Overhead: The portion of COGS that includes indir ect labor, indirect ma terial, energy use, maintenance, depreciation, propert y taxes, and insurance relate d to assets. While included in overhead, the depreciation is shown as a separate line item;

12B-2(6) Depreciation: The portion of overhead that includes an allowance for the total amount of fixed assets used to produce that one unit. Annual depreciation computed as a percentage

of COGS. While included in overhead, the deprecia tion is shown as a separate line item;

(7) Standard SG&A: Selling, general, and administrative costs are computed as a percentage

of Revenues (2) ;

(8) R&D: GRIM separately accounts for ordinary research and development (R&D) as a percentage of Revenues (2) ;

(9) Equipment Conversion Costs: Equipment conversion costs are one-time investments in research, development, testin g, and marketing focused on ma king products designs comply with the new energy conserva tion standard. GRIM allocates these costs over the period between the standard’s announcement and effective dates;

(10) Earnings Before Intere st and Taxes (EBIT): Includes profits before deductions for interest paid and taxes;

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

(12) Taxes: Taxes on EBIT (11) are calculated by multiplying the tax rate contained in Major Assumptions by EBIT (11)

.

(13) Net Operating Profits After Taxes (NOPAT): Computed by subtracting Cost of Goods Sold ((3) to (6))

, SG&A (8)

, R&D (9)

, Product Conversion Expense (10) , and Taxes (13)

from Revenues (2)

.

(14) NOPAT repeated : NOPAT is repeated in the Statement of Cash Flows;

(15) Depreciation repeated : Depreciation and Stra nded Assets are added back in the Statement of Cash Flows because they are non-cash expenses;

(16) Change in Working Capital : Change in cash tied up in accounts receivable, inventory, and other cash investments necessary to suppor t operations is calculated by multiplying working capital (as a percentage of revenues) by the change in annual revenues.

(17) Cash Flow From Operations : Calculated by taking NOPAT (15) , adding back non-cash

items such as a Depreciation (16) , and subtracting out Change in Working Capital (17) ;

(18) Ordinary Capital Expenditures: Ordinary investments in prope rty, plant, and equipment to maintain and replace existing production a ssets, computed as a percentage of Revenues (2) ;

(19) Conversion Capital Costs: Conversion capital costs are one -time investments in property, plant, and equipment to adapt or change existing production facilitie s so that new product designs can be fabricated and a ssembled under the new regulation;

12B-3(20) Capital Investment: Total investments in property, pl ant, and equipment are computed by adding Ordinary Capital Expenditures (19) and Conversion Capital Expenditures (20) ;

(21) Free Cash Flow: Annual cash flow from operations and investments; computed by subtracting Capital Investment (21) from Cash Flow from Operations (18) ;

(22) Terminal Value: Estimate of the continuing value of the industry after 2044. Computed by growing the Free Cash Flow in year 2044 at a constant rate in perpetuity;

(23) Present Value Factor: Factor used to calculate an estimate of the present value of an amount to be received in the future;

(24) Discounted Cash Flow: Free Cash Flows (22) multiplied by the Present Value Factor (24) . For 2044 the discounted cash flow includes the discounted Terminal Value (23) ; and

(25) Industry Value thru 2044: The sum of Discounted Cash Flows (25)

.

12B-412B.3DETAILED CASH FLOW EXAMPLE12B-5