APPENDIX I. GOVERNMENT REGULATORY IMPACT MODEL (GRIM)

TABLE OF CONTENTS

I.1 INTRODUCTION AND PURPOSE................................................................................I­2

I.2 MODEL DESCRIPTION .................................................................................................I­2

I.3 DETAILED CASH FLOW EXAMPLE...........................................................................I­1

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APPENDIX I. GOVERNMENT REGULATORY IMPACT MODEL (GRIM)

I.1 INTRODUCTION AND PURPOSE

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

impacts of energy conservation standards and other 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

equipment with regulations taking effect over a period of time, and of multiple regulations on the

same equipment.

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 the complete cash flow calculation.

I.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 operating profit after taxes. The cash flow calculation converts net

operating profit after taxes into an annual cash flow by including investment and non­cash items.

Below are definitions of listed items on the printout of the output sheet (see Section I.3).

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

Energy Savings Spreadsheet. The distribution of shipments by efficiency level was

modified based on feedback from manufacturers regarding the ability to sell baseline and

premium equipment depending on the standard level proposed;

(2) Revenues: Annual revenues ­ computed by multiplying equipment unit price at each

efficiency level by the appropriate 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 up­time;

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

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(5) 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;

(6) Depreciation: Annual depreciation computed as a percentage of Revenues (2). While

included in overhead, the depreciation 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 Expense: Equipment conversion expenses are one­time

investments in research, development, testing, and marketing focused on making equipment

designs comply with the new efficiency standard. GRIM allocates these costs over the

period between the standard’s announcement and effective dates;

(10) R­410A Equipment Conversion Expense: Equipment conversion expenses are one­time

investments in research, development, testing, and marketing focused on making equipment

designs comply with the refrigerant phaseout. GRIM allocates these costs to the year prior

to the effective date of the refrigerant phaseout;

(11) Earnings Before Interest and Taxes (EBIT): Includes profits before deductions for

interest paid and taxes;

(12) EBIT as a Percentage of Sales: GRIM calculates EBIT as a percentage of sales to

compare with the industry’s average reported in financial statements;

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

Assumptions by EBIT (11).

(14) Net Operating Profits After Taxes (NOPAT): Computed by subtracting Cost of Goods

Sold ((3) to (6)), SG&A (7), R&D (8), Equipment Conversion Expense (9), (10) R­410A

Equipment Conversion Expense, and Taxes (13) from Revenues (2).

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

(16) Depreciation repeated: Depreciation is added back in the Statement of Cash Flows

because it is a non­cash expense;

(17) Change in Working Capital: Change in cash tied up in accounts receivable, inventory, and

other cash investments necessary to support operations is calculated by multiplying

working capital (as a percentage of revenues) by the change in annual revenues.

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(18) Cash Flow From Operations: Calculated by taking NOPAT (15), adding back non­cash

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

(19) Ordinary Capital Expenditures: Ordinary investments in property, plant, and equipment to

maintain and replace existing production assets, computed as a percentage of Revenues (2);

(20) Conversion Capital Expenditures: Conversion capital expenditures are one­time

investments in property, plant, and equipment to adapt or change existing production

facilities so that new equipment designs can be fabricated and assembled under the new

regulation;

(21) R­410A Conversion Capital Expenditures: Conversion capital expenditures are one­time

investments in property, plant, and equipment to adapt or change existing production

facilities so that new equipment designs can be fabricated and assembled under the

refrigerant phaseout;

(22) Capital Investment: Total investments in property, plant, and equipment are computed by

adding Ordinary Capital Expenditures (19), Conversion Capital Expenditures (20), and

R­410A Conversion Capital Expenditures (21);

(23) Free Cash Flow: Annual cash flow from operations and investments; computed by

subtracting Capital Investment (22) from Cash Flow from Operations (18);

(24) Terminal Value: Estimate of the continuing value of the industry after 2042. Computed

by growing the Free Cash Flow in year 2042 at a constant rate in perpetuity;

(25) Present Value Factor: Factor used to calculate an estimate of the present value of an

amount to be received in the future;

(26) Discounted Cash Flow: Free Cash Flows (23) multiplied by the Present Value Factor

(25). For 2042 the discounted cash flow includes the discounted Terminal Value (24); and

(27) Industry Value thru 2042: The sum of Discounted Cash Flows (26).

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es

I.3 DETAILED CASH FLOW EXAMPLE

Standard PTACs and PTHPs (Standard Case)

STANDARD CASE SCENARIO Base Year Ann. Year

R410A

Phaseout

Standard

Year

2006 2007 2008 2009 2010 2011 2012 2013 

($ in Millions)

Unit SalesRevenuesCost of Sales

Labor 3.2%Material 65.6%Overhead 5.3%Depreciation 1.7%Stranded Assets

Selling, General and Administrative

Standard SG&A $ 27 $ 27 $ 28 $ 29 $ 32 $ 32 $ 33 $ 33 

R&D 1.6% 3$ 3$ 3$ 3$ 4$ 4$ 4$ 4$ 

Equipment Conversion Expense ­$ ­$ ­$ ­$ ­$ ­$ ­$ ­$ 

R­410A Equipment Conversion Expense ­$ ­$ ­$ $ 14 ­$ ­$ ­$ ­$ 

Earnings Befor Interest and Taxes (EBIT) 9.6% $ 16 $ 16 $ 17 3$ $ 19 $ 19 $ 20 $ 20 

EBIT/Revenues 8.5% 8.5% 8.5% 1.5% 8.5% 8.5% 8.5% 8.5% 

Taxes 6$ 6$ 6$ 1$ 7$ 7$ 7$ 7$ 

Net Operating Profit after Taxes (NOPAT) $ 10 $ 11 $ 11 $ 2 $ 12 $ 12 $ 13 $ 13 

Income Statement

0.375 0.383 0.392 0.401 0.409 0.417 0.423 0.428 

$ 189 $ 193 $ 198 $ 202 $ 224 $ 228 $ 231 $ 234 

0.00% Labor % inc

$ 6 $ 6 $ 6 $ 6 $ 7 $ 7 $ 7 7$ 

$ 124 $ 127 $ 130 $ 133 $ 147 $ 150 $ 152 $ 153 

$ 10 $ 10 $ 11 $ 11 $ 12 $ 12 $ 12 $ 12 

$ 3 $ 3 $ 3 $ 3 $ 4 $ 4 $ 4 4$ 

NOPAT

Cash Flow Statement

$ 10 $ 11 $ 11 $ 2 $ 12 $ 12 $ 13 $ 13 

Depreciation $ 3 $ 3 $ 3 $ 3 $ 4 $ 4 $ 4 $ 4 

Change in Working Capital $ ­ $ (0) $ (0) $ (0) $ (1) $ (0) $ (0) $ (0) 

Cash Flows from Operations $ 14 $ 14 $ 14 $ 5 $ 15 $ 16 $ 16 $ 17 

$ 0 $ 0 $ 0 $ 1 $ 0 $ 0 $ 0 

Ordinary Capital Expenditur 1.8% $ (3) $ (3) $ (4) $ (4) $ (4) $ (4) $ (4) $ (4) Conversion Capital Expenditures $ ­ $ ­ $ ­ $ ­ $ ­ $ ­ $ ­ $ ­ R­410A Capital Conversion Expense $ ­ $ ­ $ ­ $ (7) $ ­ $ ­ $ ­ $ ­ 

Capital Investments $ (3) $ (3) $ (4) $ (11) $ (4) $ (4) $ (4) $ (4) 

Free Cash Flow $ 10 $ 10 $ 10 $ (5) $ 11 $ 12 $ 12 $ 12 

Terminal Value $ ­ $ ­ $ ­ $ ­ $ ­ $ ­ $ ­ $ ­ 

Present Value Factor 1.050 1.000 0.952 0.907 0.864 0.823 0.784 0.746 

Discounted Cash Flow $ 10.64 $ 10.21 $ 9.95 $ (4.85) $ 9.72 $ 9.93 $ 9.62 $ 9.29 

Industry Value thru 2042 $ 304.9

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