APPENDIX J. GOVERNMENT REGULATORY IMPACT MODEL (GRIM)

TABLE OF CONTENTS

**J.1 INTRODUCTION**  **AND PURPOSE** 

**............................................................................... J­1** 

**J.2 MODEL**  **DESCRIPTION**

**................................................................................................ J­1** 

**J.3 DETAILED**  **CASH FLOW**  **EXAMPLE.......................................................................... J­4** 

**J­i J­ii** APPENDIX J. GOVERNMENT REGULATORY IMPACT MODEL

J.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.** 

J.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 products**  **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;** 

**J­1**(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) Stranded Assets: **In the**  **year the**  **standard becomes**  **effective, a**  **one time**  **write­off of** 

**stranded assets**  **is accounted**  **for;**

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

**of** Revenues (2) **;**

(9) R&D: **GRIM separately**  **accounts for**  **ordinary research**  **and development**  **(R&D) as**  **a**

**percentage of**  Revenues (2) **;**

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

**investments in**  **research, development,**  **testing, and**  **marketing focused**  **on making**  **product**

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

**period between**  **the standard’s**  **announcement and**  **effective dates;** 

(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 (8)

**,** R&D (9)

**,** Equipment Conversion Expense (10)

**, 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**

**including stranded**  **assets because**  **both are**  **non­cash expenses;** 

(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.**

(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) **;**

**J­2**(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) Capital Investment: **Total investments**  **in property,**  **plant, and**  **equipment are**  **computed by** 

**adding** Ordinary Capital Expenditures (19) **and** Conversion Capital Expenditures (20) **;**

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

**subtracting** Capital Investment (21) **from** Cash Flow from Operations (18) **;**

(23) 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;**

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

**amount to**  **be received**  **in the**  **future;**

(25) Discounted Cash Flow: Free Cash Flows (22) **multiplied by**  **the** Present Value Factor

(24)

**. For**  **2042 the**  **discounted cash**  **flow includes**  **the discounted**  Terminal Value (23) **; and** 

(26) Industry Value thru 2042: **The sum**  **of** Discounted Cash Flows (25)

**.**

**J­3**es0J.3DETAILEDCASHFLOWEXAMPLEStandardCaseIncomeandCashFlowStatementsThistabcomputeskeyparametersfromanincomestatementbasedonunitsales,revenuesandCOGS,andinitialfinancialinputs(parametersasa%ofrevenue).ItalsocomputesanINPVbasedonadiscountedcashflowmodel.Incomestatementsforindividualproductclassesarealsoavailable(below).Individualincomestatementsdonothaveanydatadependentontheirvalue,sotheycanbeStandardSTANDARDCASESCENARIOBaseYearAnn.YearYear2006200720082009201020112012201320142015IndustryIncomeStatementUnitSalesRevenuesCostofSalesLaborMaterialOverheadDepreciationStrandedAssets7.3%65.3%2.1%1.1%**$ ­** **$ ­** **$ ­** **$ ­** **$ ­** **$ ­** **$ ­** **$ ­** **$ ­** **$ ­** Selling,GeneralandAdministrativeStandardSG&AR&DProductConversionExpense1.9%$$$9413­$$$9513­$$$9714­$$$10114­$$$10515­$$$10915­$$$11115­$$$10915­$$$10815­$$$10715­EarningsBeforeInterestandTaxes(EBIT)EBIT/RevenuesTaxes8.9%$$628.9%14$$628.9%14$$648.9%14$$668.9%15$$698.9%15$$718.9%16$$738.9%16$$728.9%16$$718.9%16$$708.9%15NetOperatingProfitafterTaxes(NOPAT)$48$49$50$51$54$56$57$56$55$55**0.142 0.144** **0.147 0.152** **0.159 0.164** **0.167 0.165** **0.163 0.161** **$ 698** **$ 705** **$ 720** **$ 745** **$ 778** **$ 805** **$ 819** **809 $** **798 $** **791 $** 0.00%Labor%increaseEffectivedate**$ 51** **$ 51** **$ 52** **$ 54** **$ 57** **$ 59** **$ 60** **$ 59** **$ 58** **$ 58** **$ 455** **$ 460** **$ 470** **$ 486** **$ 508** **$ 525** **$ 534** **$ 528** **$ 521** **$ 516** **$ 15** **$ 15** **$ 15** **$ 16** **$ 17** **$ 17** **$ 18** **$ 17** **$ 17** **$ 17** **$ 7** **$ 7** **$ 8** **$ 8** **$ 8** **$ 8** **$ 9** **$ 8** **$ 8** **$ 8** NOPATCashFlowStatement$48$49$50$51$54$56$57$56$55$55Depreciation$7 $7 $8 $8 $8 $8 $9 $8 $8 $8ChangeinWorkingCapital**$ ­ $** **(1) $** **(1) $** **(2) $** **(3) $** **(2) $** **(1) $** **1 $** **1 $** **1**Cash Flows from Operations$56$55$56$57$59$62$64$65$64$64OrdinaryCapitalExpenditur1.2%$(8)$(8)$(9)$(9)$(9)$(10)$(10)$(10)$(10)$(9)ConversionCapitalExpenditures**$ ­ $** **­ $ ­ $** **­ $ ­ $** **­ $ ­ $** **­ $ ­ $** **­**CapitalInvestments$(8)$(8)$(9)$(9)$(9)$(10)$(10)$(10)$(10)$(9)Free Cash Flow$47$47$47$48$50$52$54$56$55$54Terminal Value$­ $­ $­ $­ $­ $­ $­ $­ $­ $­PresentValueFactor**1.115 1.000** **0.897 0.804** **0.721 0.647** **0.580 0.520** **0.467 0.419** DiscountedCashFlow$52.56$47.01$42.46$38.74$35.88$33.67$31.41$28.88$25.59$22.65IndustryValuethru2042$516.22**J­4**