Economic Guidance for Water Quality Standards 1-1

ECONOMIC GUIDANCE FOR WATER QUALITY STANDARDS

WORKBOOK

1. INTRODUCTION

As presented in the Water Quality Standards Regulation, economic factors are

taken into consideration at various points in the process of setting, enforcing, or

changing Water Quality Standards This guidance is presented to assist States and

applicants in understanding the economic factors that may be considered, and the

types of tests that can be used to determine if a designated use cannot be attained, if a

variance can be granted, or if degradation of high-quality water is warranted. In order

to remove a designated use or obtain a variance, the State or discharger must

demonstrate that attaining the designated use would result in substantial and

widespread economic and social impacts. Likewise, if a degradation in high-quality

water is proposed, it must be shown that lower water quality is necessary to

accommodate important social and economic development. 

This workbook provides guidance for those seeking to remove a designated use

(such as might occur under a Use Attainability), or obtain a variance based on

economic considerations, or to lower water quality in a high-quality water. In

addition, it provides guidance to States and EPA regions responsible for reviewing

requests for variances and modifications to designated uses, and for approval of

antidegradation analyses. The guidance describes the types of information and

analyses that should be considered by applicants and reviewers. The guidance,

however, is not an exhaustive description of appropriate economic impact analyses. 

Additional information and tests may be necessary and/or desirable in certain circumstances.

The economic impacts considered are those that result from treatment beyond that

required by technology-based regulations. Since water quality cannot be lower than

that resulting from technology-based limits applied to direct and indirect point source

discharges and reasonable Best Management Practices (BMP) applied to nonpoint

sources, these are considered to be the baseline. All economic impact analyses of

water quality standards should, therefore, address only the cost of improving the water

to meet water quality standards or the cost of maintaining water quality in high-quality

waters.

Although EPA is responsible for approving a State's water quality standards, the

State is responsible for interpreting the circumstances of each case and determining
Economic Guidance for Water Quality Standards 1-2

where there are substantial and widespread economic and social impacts, or where

important social and economic development would be inappropriately precluded. 

Each analysis of economic impacts must demonstrate:

that the polluting entity, whether privately or publicly owned, would face

substantial financial impacts due to the costs of the necessary pollution controls

(substantial impacts or would interfere with development), and

that the affected community will bear significant adverse impacts if the entity is

required to meet existing or proposed water quality standards (widespread

impacts or important development).

This Workbook supplements the description contained in the Water Quality

Standards Handbook, which should be read first as it contains many important

definitions and descriptions of the regulations. Specific attention should be paid to

Chapters 2 (Designation of Use) and 4 (Antidegradation), which describe the context

in which this guidance is to be used. This Workbook is designed as a series of

worksheets and accompanying guidance to be used when actually calculating the

impacts of pollution control. 

The intent of this workbook is to point States and dischargers in the right direction. 

It does not give definitive answers as to whether or not an entity has demonstrated

substantial, widespread, or important economic and social impacts. If a State or

discharger has difficulty with any part of the analysis presented in this workbook, they

should consider seeking the assistance of a financial expert. In addition, State and

regional EPA water quality staff should feel free to contact EPA headquarters'

Economic and Statistical Analysis Branch in the Office of Water for advice and

assistance.

The remaining sections of Chapter 1 provide an overview of the analysis and

describe various factors and concepts that generally apply to analyzing the economic

impacts of compliance with water quality standards. The following four chapters

provide detailed guidance. 

Throughout this Workbook, the term "financial impacts" refers to impacts on the

entity or party that will pay for the pollution control, whereas the term "socioeconomic

impacts" refers to changes in the social and/or economic conditions of the affected

community. For public-sector entities, such as a publicly owned treatment works

(POTW), substantial impacts include financial impacts on the community, taking into

consideration current socioeconomic conditions. Widespread, on the other hand,

refers to changes in the community's socioeconomic conditions. By contrast, for

private-sector entities, substantial impacts refer to financial impacts and widespread
Economic Guidance for Water Quality Standards 1-3

impacts refer to socioeconomic impacts on the surrounding community. In addition,

the term "applicant" refers to whomever will actually complete the economic impact

analysis, whether it be the State, an individual discharger, a consultant, or some other

organization. 

1.1 Designated Uses, Variances, and Antidegradation

Pursuant to the Water Quality Standards Regulation (40 CFR 131), States must

define statewide water quality goals by: 1) designating water uses and 2) adopting

water quality criteria that protect the designated uses. When designating uses, States

must consider the use and value of the waterbody for public water supplies, protection

and propagation of fish, shellfish and wildlife, recreation in and on the water,

agricultural, industrial, and other purposes including navigation. The designated use

may or may not coincide with the existing use, but it cannot reflect lower water quality

than the existing use. As described in the Water Quality Standards Handbook, if the

designated use of a water body is also an existing use, the designated use cannot be

downgraded to one that requires less stringent water quality criteria. If, however, the

designated use is not an existing use the States may, under certain circumstances,

remove the designated use, create new subcategories of the use, or grant a water

quality standard. 

Before a designated use is removed a State or a discharger must conduct and

submit a use attainability analysis to EPA. Briefly, a use attainability analysis is an

assessment of the physical, chemical, biological and, if necessary, economic factors

affecting the attainment of a use. If the analysis shows that, based on any one of these

factors, conditions exist which make the use unsuitable or impossible to achieve, then

the State may remove the designated use. 

In many cases, a designated but unattained use for a stream segment need not be

removed. Instead, individual dischargers may be granted variances from the water

quality standards for a limited time with the expectation that they will be able to

comply with water quality standards by the time their variance expires. A variance is

preferable to a removal of a designated use since other dischargers, who are capable of

meeting the standards, must comply with the standards through their permits. In cases

where a discharger can meet water quality based permit limits for some parameters, a

variance would not be granted for those parameters. The variance procedure is

designed to encourage compliance with the Clean Water Act within a reasonable

timeframe.

States are also required to adopt an antidegradation policy to protect existing uses,

high-quality waters, and water quality in waters that are considered to be outstanding

national resources. The antidegradation policy allows States to lower water quality in
Economic Guidance for Water Quality Standards 1-4

higher-quality waters only if it is necessary to accommodate important economic or

social development. The use of the term "important" communicates a general sense

of the level of economic and social development. This provision is intended to permit

degradation of high-quality water bodies in only a few extraordinary cases where the

benefits of the economic or social development unquestionably outweigh the costs of

lowering water quality. Under no circumstances, however, may water quality fall

below that required to protect existing or designated uses. 

For each of the circumstances described above, the Water Quality Standards

Regulation allows the applicant to take economic considerations into account. When

applying for a change in a designated use or for a variance, the applicant must

demonstrate that meeting water quality standards will cause substantial and

widespread economic and social impacts. The antidegradation provision requires that

the applicant demonstrate that important economic or social development would be

prevented unless lower water quality is allowed. In all three cases, the same general

tests of impacts are used.

1.2 Pollution Sources

The choice of methods used to evaluate the economic impacts of meeting water

quality standards depend, in part, on whether pollution control is the responsibility of a

privately or a publicly owned entity. Since the polluting entity or party may not be the

one to pay for reductions, the analyses focus on the party that pays for pollution

control. Some of the more common privately owned entities include, but are not

limited to: manufacturing facilities, agricultural operations, shopping centers and

other commercial development, residential developments, and recreational developments. Publicly owned entities include: publicly owned sewage treatment works,

roads, and other municipal infrastructure. 

In an economic impact analysis, the distinction between private-sector and publicsector entities is important as it determines not only who will pay for the necessary

pollution control, but also the types of funding mechanisms available. For example, in

the case of a privately-owned entity, the facility can raise the money through loans

and equity funds but may try to pass some or all of the cost on to the consumer in the

form of higher prices. In the case of a publicly-owned entity, the community can float

bonds to pay for the capital costs, with the cost of the bonds and operating expenses

covered by user fees and/or tax revenues. The different impact measures are

addressed in two separate chapters. Chapter Two provides guidance on public-sector

entities and Chapter Three provides guidance on private-sector entities.

Whether publicly or privately owned, polluting entities can be point (direct

discharge) or nonpoint (runoff and erosion) sources of pollution. Attainment of water
Economic Guidance for Water Quality Standards 1-5

quality standards is not limited to controls placed on point sources. Water quality

standards are applicable to nonpoint sources of pollution despite the fact that there

may be no direct implementation mechanisms for nonpoint sources. Although

pollution control approaches used by nonpoint sources may differ substantially from

approaches typically employed by point sources, analysis of the ensuing economic

impacts still depends upon whether the entity providing the pollution control is

privately or publicly owned. 

1.3 Substantial Impacts

A financial analysis of the discharger should be conducted to determine if the

capital and the operating and maintenance costs of pollution control will have a

substantial impact. This analysis is typically performed by the discharger and

reviewed by the State, although there may be cases where the State or some other

group completes the analysis on behalf of the discharger. The first step is to estimate

the capital and the operation and maintenance costs of the necessary pollution control

(see Figure 1-1). The second step is to determine how the entity will finance the

necessary reductions. If the entity is publicly-owned (e.g. a municipal sewage

treatment plant), the households in the community will bear the cost either through an

increase in user fees, an increase in taxes or a combination of both. The burden to

households resulting from total annual pollution control costs must be estimated. In

addition, the financial impact analysis must consider the community's ability to obtain

financing and the general economic health of the community.

If the entity is privately-owned (e.g. a manufacturing facility), the analysis should

consider factors such as the entity's ability to secure financing and the degree to which

it will be able to pass the cost of pollution control on to its customers in the form of

higher prices. The financial impact analysis of private-sector entities employs a

variety of financial ratios and tests. Some of these ratios and tests include benchmark

values to help in the analysis.

Demonstration of substantial financial impacts is not sufficient reason to modify a

use or grant a variance from water quality standards. Rather, the applicant must also

demonstrate that compliance would create widespread socioeconomic impacts on the

affected community.

1.4 Widespread Impacts

States and dischargers will need to consider the possibility that financial impacts

could cause far reaching and serious impacts to the community. An important factor

in determining the magnitude of these impacts is defining the geographical area
Economic Guidance for Water Quality Standards 1-6

affected. The affected area might be a town, city, region, county or some combination

of these geographical units. 

Equally important are the types of impacts that might occur. There are no

economic ratios or tests per se to evaluate socioeconomic impacts. Instead, the

relative magnitude of a group of indicators should be taken into account. For publicsector entities, the applicant will need to estimate the change in socioeconomic

conditions that would occur as a result of compliance. Of particular importance are 

changes in factors such as median household income, unemployment, and overall net

debt as a percent of full market value of taxable property. For private-sector entities,

the assessment of widespread impacts should consider many of the same

socioeconomic conditions. The analysis should also consider the effect of decreased

tax revenues if the private-sector entity were to go out of business, income losses to

the community if workers lose their jobs, and indirect effects on other businesses.

In some instances, several entities potentially may suffer substantial impacts. For

example, this situation can arise where several facilities are discharging to a stream

segment that is being considered for a change in designated use. While a separate

financial analysis should be performed for each facility, the impacts on all the facilities

should be considered jointly in the analysis of widespread impacts.

1.5 Antidegradation

As with removing a use or granting a variance, eco-nomic impacts are considered

as part of an antidegradation review. While the terminology is different, the tests are

basically the same. In the first case (discussed in Chapters 2, 3, and 4), a finding of

substantial and widespread economic impacts can be the basis for granting a variance

or changing a designated use. In the case of antidegradation, the analysis must show

that maintaining "high-quality waters" will preclude important economic and social

development. As such, the two cases can be thought of as two sides of the same coin. 

Variances and downgrades refer to situations where additional treatment to meet

standards may result in declining economic and social conditions, while

antidegradation refers to situations where lowering water quality may result in

improved social and economic conditions.

When performing an antidegradation analysis, the first question is whether the

costs of the pollution controls needed to maintain the high-quality water will interfere

with the development. If not, then lower water quality is not "necessary" for the

development to take place. If, on the other hand, the costs will interfere with the

development and lower water quality is "necessary" for the development to take place,

then the analysis must show that the development would be an important economic
Economic Guidance for Water Quality Standards 1-7

and social development. These two steps rely on the same test as the determination of

substantial and widespread economic and social impacts.

1.6 Organization of the Rest of the Workbook

The remainder of this Workbook addresses the measurement of economic impacts. 

In Chapter 2, guidance is presented to assist applicants in evaluating financial impacts

on public-sector entities. Chapter 3 presents guidance on evaluating financial impacts

on private-sector entities. Chapter 4 provides a discussion of how to assess whether

impacts are widespread as well as substantial. This discussion includes both publicsector and private-sector entities. Chapter 5 applies the concepts developed in

Chapters 2, 3, and 4 to antidegradation.

Worksheets are included in each chapter that will assist the reader in calculating

potential impacts. Chapters 2 and 3 include worksheets for: 1) estimation of

annualized costs of pollution control, and 2) evaluation of the financial burden of

pollution control. Chapter 4 includes worksheets that can be used in the evaluation of

whether the impacts on the entity(ies) will result in widespread economic and social

impacts. Chapter 5 includes worksheets for determining if important social and

economic development might be lost. 

In addition to presenting step by step guidance on how to estimate impacts, several

of the worksheets provide benchmark comparisons that allow an assessment of the

magnitude and relative importance of potential impacts. These worksheets, however,

should not be used in isolation. Discussion of key sources of information, important

entity and community attributes, and interpretation of results are found only in the

accompanying text. Applicants, and State Water Quality staff charged with reviewing

the application, should be sure to read all text accompanying the worksheets. While

Chapter 2 addresses public-sector treatment requirements, if a substantial portion of

the costs of a public facility is borne by a private entity (such as a manufacturing

facility that pays substantial user charge fees to a POTW), both Chapters 2 and 3

should be referred to.

In all cases, the determination of economic and social impacts must be made on a

case by case basis. This determination, therefore, requires the application of good

judgement as well as use of the guidance provided in this workbook. Additional

information and tests may be required in order to measure the size and extent of the

impacts. Applicants should be aware that they will be required to supply documentation to substantiate their claim of substantial and widespread economic and social

impacts. In addition to background data, however, this documentation should include

a brief written description of why the applicant believes economic and social impacts

will occur.

Economic Guidance for Water Quality Standards

2. EVALUATING SUBSTANTIAL IMPACTS: 

PUBLIC SECTOR ENTITIES

Public entities seeking relief from meeting water quality standard requirements must

demonstrate that the cost of required water pollution control will result in substantial

impacts and that there will be "widespread" adverse social and economic impacts if they

are required to meet these standards. For the purposes of this workbook, a public entity

refers to any governmental unit that must comply with pollution control requirements in

order to meet water quality standards. The most common example is a municipality or

sewage authority operating a publicly owned treatment works (POTW) that must be

upgraded or expanded. Municipalities, however, may also be required to control other

point sources or nonpoint sources of pollution within their jurisdiction. The procedures

outlined in this chapter apply to all types of publicly financed projects that may be

required to meet water quality standards. Throughout this chapter, the term

"State/discharger" refers to whoever will actually conduct the financial and

socioeconomic impact analysis for the public entity, whether it be the State, the

municipality, a consultant or some other organization. 

The remainder of this chapter details methodologies and sources of information for

determining the financial viability of publicly financed projects. Several worksheets are

presented that will assist in demonstrating substantial impacts. States/dischargers are

referred to Chapter 4 for guidance on demonstrating widespread impacts. Readers should

keep in mind that the guidance in this chapter is not meant to be exhaustive. The State

and/or EPA may require additional information or tests in order to evaluate whether

substantial and widespread impacts will occur. In addition, the State/discharger should

feel free to include any additional information they think is relevant.

As mentioned in Chapter 1, the evaluation of substantial impacts resulting from public

entity compliance with water quality standards includes two elements, 1) financial impacts

to the public entity and 2) current socioeconomic conditions of the community.

Governments have the authority to levy taxes and distribute pollution control costs among

households and businesses according to the tax base. Similarly, sewage authorities charge

for services, and thus can recover pollution control costs through users fees. In both

cases, a substantial impact will usually affect the wider community. Whether or not the

community faces substantial impacts depends on both the cost of the pollution control and

the general financial and economic health of the community. 

If the public entity passes a significant portion of the pollution control costs along to

private facilities or firms, then the review procedures outlined in Chapter 3 of this

workbook should also be consulted to determine the impact on the private entities. Both

public and private entities should consult Chapter 4 for guidance on how to estimate

potential widespread impacts on the community. 
Economic Guidance for Water Quality Standards 2-2

This chapter focuses on ways to determine if the costs of the proposed project will

likely result in substantial impacts. To make this determination the State/discharger will

need to complete a five step analysis. As shown in Figure 2-1 the first step in the process

is to estimate the cost of the pollution control project and calculate the annual cost of the

proposed pollution control project. The second step is to calculate the total annual

pollution control cost per household, which includes the cost of the project and existing

pollution control costs. In the third step, the Municipal Preliminary Screener is

calculated, which quickly identifies entities that clearly will not experience substantial

impacts due to the cost of the necessary pollution control. If it is not clear whether there

will be substantial impacts, entities should proceed to the fourth step, which is the

calculation of the Secondary Test. In this step public entities will need to provide

financial and socioeconomic information. For example, the ability of the community to

finance the project may depend on existing financial conditions in the community such

as debt per capita and the community's bond rating. The socioeconomic health of the

community prior to the project's construction will also be an important indicator of

whether the pollution control would impose a substantial impact on the community. The

fifth and final step of determining whether impacts are "substantial" is evaluating where

the community falls in the impacts matrix. This matrix takes into consideration the

Municipal Preliminary Screener and the Secondary Test score. Later, in Chapter 4,

estimated changes in socioeconomic health indicators will be reviewed to evaluate the

extent to which the impacts can be considered widespread. 

The remainder of this chapter is divided into five sections that detail the essential steps

of an evaluation of substantial impacts for publicly financed projects. Figure 2-1

illustrates the steps and decision points in this process. The five steps are:

Verify Project Costs and Calculate the Annual Cost of the Pollution Control

Project - This section discusses factors that should be considered when selecting

a pollution control project. It also describes the type of general information about

the proposed project that should be provided. In addition, it discusses how to

annualize capital costs of the project and calculate total annual costs of the

pollution control project.

Calculate Total Annualized Pollution Control Costs Per Household - This

section outlines the calculation of total annual pollution control costs per

household. The costs of the proposed project and existing pollution control are

included.

Calculate and Evaluate the Municipal Preliminary Screener Score - This

section explains the "screener" which identifies only those communities that

clearly will not face any substantial impacts. 
Economic Guidance for Water Quality Standards 2-3

Apply the Secondary Test - This measurement incorporates a characterization

of the community's current financial and socioeconomic well-being. 

Assess where the community falls in The Substantial Impacts Matrix - This

matrix evaluates whether or not communities are expected to incur substantial

economic impacts due to the implementation of the pollution control costs. If the

applicant cannot demonstrate substantial impacts, then they will be required to

meet existing water quality standards. If impacts are expected to be substantial,

then the applicant goes on to demonstrate whether they are also expected to be

widespread. 

2.1 Verify Project Costs and Calculate the Annual Cost of the Pollution Control

Project.

Before the impact analysis can be performed, the project costs should be verified and

then annual costs calculated.

2.1.a Verify Project Costs

The first step of an economic analysis of a publicly financed project is an evaluation

of the proposed project. Public entities should consider a broad range of discharge

management options including pollution prevention, end-of-pipe treatment, and upgrades

or additions to existing treatment. Specific types of pollution prevention activities that

should be considered are:

Public Education;

Change in Raw Materials;

Substitution of Process Chemicals;

Change in Process;

Water Recycling and Reuse; and

Pretreatment Requirements.

Many of these approaches are particularly relevant to industrial indirect discharges to

the public system. Whatever the approach, the applicant must demonstrate that the

proposed project is the most appropriate means of meeting water quality standards and

must document project cost estimates. If at least one of the treatment alternatives that

meets water quality standards will not have a substantial financial impact, then the

community should not proceed with the analysis presented in the rest of this workbook.

General information regarding the proposed pollution control project and other projects

considered should be supplied in Worksheet A.

The most cost-effective approach to meeting water quality standards should be

considered. Submissions should include assumptions about excess capacity, population
Economic Guidance for Water Quality Standards 2-4

growth, and consideration of alternative technologies where appropriate. The most

accurate estimate of project costs may be available from the discharger's design engineers.

If site-specific engineering cost estimates are not available, preliminary project cost

estimates can be derived from a comparable project in the State or from the judgement of

experienced water pollution control engineers. (See Appendix A for sources of

engineering cost information.) Capital, operation and maintenance (O&M), and other

project costs can be summarized using Worksheet B. For comparative purposes, cost

estimates (e.g. capital, O&M, other project costs) for each alternative being considered

should be presented in the same units (typically annualized costs, $/yr) and for the same

year. The next section explains how to annualize project costs.

For illustrative purposes, the example of a local government upgrading their existing

wastewater treatment facility in order to meet water quality standards is used throughout

this chapter. Details of this example may differ significantly from other projects

undertaken to meet water quality objectives. Other types of public-sector water pollution

control, however, would be analyzed in a similar fashion using the worksheets included

in this chapter. 

2.1.b Calculate the Annual Costs of the Pollution Control Project

Since capital costs typically will be paid over several years, annualized costs are used

in the evaluation of economic burden to the community. The capital portion of project

costs is typically financed over approximately 20 years, by issuing a municipal debt

instrument such as a general obligation bond or a revenue bond. Local governments may

also finance capital costs using bank loans, state infrastructure loans (revolving funds),

or federally subsidized loans (such as those offered by the Farmers' Home

Administration). 

It should be noted that interest rates used to annualize costs are dependent on the type

of debt instrument used as well as the recipient's credit standing. For example, revenue

bonds typically are financed at a slightly higher interest rate because of their dependence

on revenues from services as opposed to being guaranteed by the full faith and credit of

the jurisdiction. Because interest rates affect the interest payment and thus the annualized

capital cost of the project, it is important that the interest rate used on Worksheet B

reflects the debt instrument (i.e. municipal bond, commercial bank loan, state revolving

fund loan, or other instrument) likely to be used by the municipality. 

The calculation of total annualized cost of the project is presented in Worksheet B.

First, capital costs are summed and the portion of costs to be paid for with grant monies

are deducted, as these costs will not need to be financed. Next, the annualization factor

is calculated using the formula supplied on Worksheet B, or the annualization factor is

found in Appendix B. Annualized capital cost is then calculated by multiplying the total

capital costs to be financed by the annualization factor. 
Economic Guidance for Water Quality Standards 2-5

Next, annual operating and maintenance costs are summed, and the total is added to

the annualized capital cost. These costs should include the costs of monitoring,

inspection, permitting fees, waste disposal charges, repair, administration, replacement,

and any other recurring costs. All recurring costs should be stated in terms of dollars per

year. The sum of the annualized capital cost and total annual operating and maintenance

costs is the total annual cost of the project. In the next section, the annualized costs paid

by households in the community are calculated. 

2.2 Calculate Total Annualized Pollution Control Costs Per Household

In order to assess the burden that total pollution control costs are expected to have on

households, an average annualized pollution control cost per household should be

calculated for all households in the community that would bear project costs. In order to

evaluate substantial impacts, therefore, the analysis must establish which households will

actually pay for pollution control as well as what proportion of the costs will be borne by

households. These apportioned project costs are then added to existing pollution control

costs paid by households.

It is important to first define the affected community. The "community" is the

governmental jurisdiction responsible for paying compliance costs. In practice, pollution

control projects may serve several communities or just portions of a community. In the

case of a sewage agency serving several communities, once project costs are allocated to

each community served, the economic analysis is conducted on a community by

community basis. In the case of a community in which only a portion of the community

is served, the affected community is defined as those who will pay the compliance costs.

In such cases, it may be difficult to obtain socioeconomic data for just part of the

community and data for the entire community may be used instead. The area that is

affected may not be the same as the area that is paying, therefore it may be appropriate

to evaluate widespread impacts, described in Chapter 4, over a community that is defined

differently than the paying community.

If project costs were estimated for some prior year, these costs should be adjusted

upward to reflect current year prices using the average annual national Consumer Price

Index (CPI) inflation rate for the period. The CPI inflation rate is available from the

Bureau of Labor Statistics. An additional source reporting the CPI inflation rate is the

CPI Detailed Report, which is published monthly by the U.S. Department of Labor,

Bureau of Labor Statistics. 

The ratio of the current CPI to the CPI for the year of the cost estimates indicates how

much costs have increased over the period. This ratio can be applied to the cost estimates

to "bring them up to current year costs." Likewise, there are engineering cost indices that

can be used for this purpose.
Economic Guidance for Water Quality Standards 2-6

If project costs are not distributed simply according to wastewater flow or tax

revenues, then consideration should be given to separately analyzing the impacts on users

who pay a disproportionate share of the costs. This situation can arise, for example,

where industrial dischargers to a sewer system are assessed pollutant surcharges to pay

for their share of the cost of advanced treatment necessitated by the presence of their

pollutants. Remaining costs would then be split among households according to

wastewater flow or tax revenues, whichever is appropriate. The total amount of the

pollution control project to be recouped by surcharges should, therefore, be removed from

the total project cost before costs are allocated according to wastewater flow or tax

revenues.

In calculating the total annual cost of pollution control per household, current costs of

pollution control must be considered along with the projected annual costs of the

proposed pollution control project. The existing cost per household usually can be

obtained from the most recent municipal records. For example, it can be found in the

sewer enterprise fund accounts for communities that maintain a separate enterprise fund.

It is not necessary, in such cases, to sum all the cost components. Instead, use the most

recent operating revenues, divided by the number of households served. In cases where

the community does not maintain a separate enterprise fund for sewers, the cost elements

can be summed from the consolidated statement for the community. If the portion of

proposed project costs that households are expected to pay is known or is expected to

remain unchanged, then use Worksheet C to calculate the total annual cost of pollution

control per household. If the portion paid by households is based on flow, then should

refer to Worksheet C: Option A as well. 

The cost per household as a percent of median household income is used in Section

2.3 as a screener to quickly identify those communities that clearly will not face

substantial impacts due to pollution control. For guidance in estimating impacts on nonhousehold users (e.g., industrial, commercial), refer to Chapter 3. 

2.3 Calculate and Evaluate The Municipal Preliminary Screener Value 

Whether or not the community is expected to incur "substantial" economic impacts due

to the pollution control project is determined by jointly considering the results of two

tests. The first test is a "screener" to establish whether the community can clearly pay for

the project without incurring any substantial impacts. The Municipal Preliminary

Screener estimates the total annual pollution control costs per household (existing costs

plus those attributable to the proposed project) as a percentage of median household

income. The screener is written as follows:

Municipal Preliminary Screener = Average Total Pollution Control Cost per Household

Median Household Income
Economic Guidance for Water Quality Standards 2-7

Median household income information for many municipalities is available from the

1990 Census of Population. If median household income is not available for the current

year, it should be estimated for the current year by using the CPI inflation rate for the

period between the year that median household income is available and the current year.

To calculate the inflation rate over the relevant period, use the "percent change from the

previous annual average" (annual inflation rate) presented in the CPI Detailed Report.

For example, if the current year is 1993, 1990 is the most recent year that median

household income is available, and the percentage changes for the 1990, 1991, and 1992

annual averages respectively are: 5.2, 4.1 and 2.9, the adjustment factor equals:

Adjustment Factor = 1.052 * 1.041 * 1.029 = 1.13

Adjusted Median Household Income = 

Median Household Income * Adjustment Factor 

Depending on the results of the screener, the community is expected to incur little,

mid-range, or large economic impacts due to the proposed project (see Worksheet D).

If the total annual cost per household (existing annual cost per household plus the

incremental cost related to the proposed project) is less than 1.0 percent of median

household income, it is assumed that the project is not expected to impose a substantial

economic hardship on households. The screener is therefore set at 1.0 percent of median

household income. Communities with screener results of less than 1.0 but still fairly close

to 1.0, however, may still want to proceed to the Secondary Test. 

Communities are expected to incur mid-range impacts when the ratio of total annual

compliance costs to median household income is between 1.0 and 2.0 percent. If the

average annual cost per household exceeds 2.0 percent of median household income, then

the project may place an unreasonable financial burden on many of the households within

the community. In either case, communities move on to the Secondary affordability Test

to demonstrate substantial impacts. For example, assume that Community XYZ has a

screener of 2.3 percent. Although it appears that the community faces large impacts,

substantial impacts have not necessarily been demonstrated and the community must

proceed to the next step and apply the Secondary Test. Dischargers with screener values

well below 1.0 percent are assumed to be able to pay for pollution control without

incurring any substantial economic impacts and are required to meet existing water

quality standards. They do not need to proceed to the Secondary Test (see Figure 2-1).

2.4. Apply Secondary Test 

The Secondary Test is designed to build upon the characterization of the financial

burden identified in the Municipal Preliminary Screener. The Secondary Test indicates

the community's ability to obtain financing and describes the socioeconomic health of the
Economic Guidance for Water Quality Standards 2-8

community. Indicators describe precompliance debt, socioeconomic, and financial

management conditions in the community. Using these indicators and the scoring system

described below, the impact of the cost of pollution control is estimated. Specifically,

applicants are required to present the following six indicators for the community:

Debt Indicators

Bond Rating (if available) - a measure of credit worthiness of the community;

Overall Net Debt as a Percent of Full Market Value of Taxable Property - a

measure of debt burden on residents within the community;

Socioeconomic Indicators

Unemployment Rate - a measure of the general economic health of the

community;

Median Household Income - a measure of the wealth of the community;

Financial Management Indicators

Property Tax Revenue as a Percent of Full Market Value of Taxable Property - a

measure of the funding capacity available to support debt based on the wealth of

the community; and

Property Tax Collection Rate - a measure of how well the local government is

administered.

A more detailed description of the six indicators, as well as alternative indicators for

states with property tax limitations, are presented below. Table 2-1 summarizes the

indicators and what is considered to be a strong, mid-range, or weak rating.

Debt Indicators

Bond Rating

Current ratings for the community summarize a bond rating agency's assessment of a

community's credit capacity. The ratings generally reflect current financial conditions.

If security enhancements like bond insurance have been used for the bond issue, however,

the bond rating on a particular issue may be higher than local conditions justify. Only

ratings for uninsured bonds, therefore, should be used.

Many small and medium sized communities have not used debt financing for projects
Economic Guidance for Water Quality Standards 2-9

and, as a result, have no bond rating. The absence of a bond rating does not indicate

strong or weak financial health. When a bond rating is not available, this indicator should

not be included in the analysis of substantial impacts. When available, the rating for the

most recent general obligation bond should be used. If a general obligation bond has not

been issued recently, the most recent rating for a sewer bond should be used. Recent

bond ratings are included in municipal bond reports from rating agencies (e.g., Moody's

Bond Record, Standard and Poor's Corporation).

Overall Net Debt as a Percent of Full Market Value of Taxable Property

Overall Net Debt is debt repaid by property taxes. It excludes debt that is repaid by

special user fees (e.g. revenue debt). This indicator provides a measure of debt burden

on residents within the community and measures the ability of local government

jurisdictions to issue additional debt. It includes the debt issued directly by the local

jurisdiction and debt of overlapping entities, such as school districts. It compares the

level of debt owed by the community with the full market value of real property used to

support that debt and serves as a measure of the community's wealth.

Debt information is available from the financial statement of each community. In most

cases, recent financial statements are on file with the State (e.g., State Auditor's Office).

Overlapping debt may or may not be provided in a community's financial statements. The

property assessment data (assessment ratio) should be readily available through the

community or the State Assessor's Office. The boundary of the affected community

generally conforms to one or more community boundaries. Therefore, prorating

community data to reflect specific service area boundaries is not normally necessary for

evaluating the general financial capability of the affected community.

Socioeconomic Indicators

Unemployment Rate

The unemployment rate is defined as the percent of a community's labor force

currently unemployed. If the unemployment rate in the service area is not available, the

encompassing county's rate may be used as a substitute. The Bureau of Labor Statistics

(BLS) maintains current unemployment rate figures for municipalities and counties.

National unemployment data is also needed for comparison purposes. This information

can be obtained from the BLS are available by request at (202) 606-6392. A community's

unemployment rate is considered to be below the national average if it is more than 1%

below the national average. Similarly, a community's unemployment rate is considered

to be above the national average if it is more than 1% above the national unemployment

rate. If the community's employment rate is equal to the national average unemployment

rate, plus or minus 1%, then the community's unemployment rate is assessed as being

equal to the national rate. 
Economic Guidance for Water Quality Standards 2-10

Median Household Income

Median household income (MHI) is defined as the median of the total income dollars

received per household during a calendar year in a given area. It serves as an overall

indicator of community spending capacity. Median household income, which was also

used in the screener process, is available from the 1990 Census or through state data

centers. The state value is also needed for comparison purposes. If a community's median

household income is more than 10% below the state's median household income, then it

is considered to be below the state's median. If a community's median household income

is more than 10% above the state's median, then it is considered to be above the state

median value. If, however, the community's median household income is equal to the

state median, plus or minus 10%, then the community's median household income is

assessed as being equal to the state's median household income. 

Financial Management Indicators

Property Tax Revenues as a Percent of Full Market Value of Taxable Property

This indicator can be referred to as the "property tax burden" since it indicates the

funding capacity to support new expenditures, based on the wealth of the community.

Some states and local jurisdictions may have established legal limits on the amount of

property taxes that can be levied as a percent of full market or assessed value of real

property. Property assessment data should be readily available through the community

or the State Assessor's Office. Property tax revenues are available in communities' annual

financial statements.

Property Tax Revenue Collection Rate

This rate is an indicator of the efficiency of the tax collection system and a measure

of how well the local government is administered. It compares the actual amount

collected from property taxes to the amount levied. Property taxes levied can be

computed by multiplying the assessed value of real property by the property tax rate, both

of which are available from a community's financial statements or the State Assessor's

Office.
Economic Guidance for Water Quality Standards 2-11

Alternative Indicators for States with Property Tax Limitations

Two of the indicators may not be appropriate in states with statutory limits on

property tax collections and/or rates, or where data on full-market value of taxable

property are not available.

The first of these indicators -- The Overall Net Debt as Percent of Full Market Value

of Taxable Property -- can be replaced with:

Overall Net Debt Per Capita

In calculating the Secondary Score, the following ratings for Overall Net Debt Per

Capita should be used:

Greater than $3,000 = weak = 1

$1,000 - $3,000 = mid-range = 2

Less than $1,000 = strong = 3

The second of these indicators -- Property Tax Revenues as a Percent of FullMarket Value of Taxable Property -- has no appropriate substitute in cases where

property taxes are at their limit or where full-market value of taxable property

cannot be estimated. In such cases, this indicator should be dropped and the other

five factors are assigned equal weights.

These six indicators are then used to form a composite assessment of the

community's economic health and the financial impact of the required project.

Worksheet E can be used to record each indicator. For each of the six indicators, the

community is rated as weak, mid-range, or strong, based on the thresholds presented in

Table 2-1. For example, if a community's median household income equals $15,000 and

the state's median household income equals $17,000, the community would be considered

weak on this measure. If, however, the community's median household income were

$19,000, then the community would be considered strong on this measure. 

Next, a Secondary Score is calculated for the community by weighting each

indicator equally and assigning a value of 1 to each indicator judged to be weak, a 2 to

each indicator judged to be mid-range, and a 3 to each strong indicator. A cumulative

assessment score is arrived at by summing the individual scores and dividing by the

number of factors used. Worksheet F,provided at the end of Section 2.4, guides the

applicant through this calculation. The cumulative assessment score is evaluated as

follows:

less than 1.5 is considered weak
Economic Guidance for Water Quality Standards 2-12

between 1.5 and 2.5 is considered mid-range

greater than 2.5 is considered strong

For example, consider a Community XYZ, which has:

a weak ratio of overall net debt to full market value of taxable

property = 1,

a weak bond rating = 1,

a mid-range unemployment rate = 2,

a mid-range median household income = 2,

a strong property tax collection rate = 3, and 

a strong ratio of property tax revenues to full market value of

taxable property = 3.

[(1 + 1 + 2 + 2 + 3 + 3)/6] = 2

The Secondary Score for Community XYZ, equal to 2, falls into the mid-range category.

If the applicant is not able to develop one or more of the six indicators, they must

provide an explanation as to why the indicator is not appropriate or not available. Since

the point of the analysis is to measure the overall burden to the community, the debt and

socioeconomic indicators are assumed to be better measures of burden than the financial

management indicators. Consequently, if one of the debt or socioeconomic indicators is

not available, the State/discharger should average the two financial management

indicators and use this averaged value as a single indicator with the remaining indicators.

This averaging is necessary so that undue weight is not given to the financial management

indicators.

2.5 Assess Where the Community Falls in The Substantial Impacts Matrix

The results of the two tests are considered jointly in determining whether the

community is expected to incur substantial impacts due to the proposed pollution control

project. 

In the following matrix, the cumulative assessment score for the community is

combined with the estimated household burden. The combination of factors establishes

whether impacts can be expected to be substantial. In the example of Community XYZ,

their screener equaled 2.3 percent and their cumulative assessment score equaled 2. They

are, therefore, in the middle cell in the far right column and thus have a rating of "X" in

the matrix presented below (Table 2-2).

In the matrix, "X" indicates that the impact is likely to be substantial. The closer

the community is to the upper right hand corner of the matrix, the greater the impact.
Economic Guidance for Water Quality Standards 2-13

Similarly, " " indicates that the impact is not likely to be substantial. The closer to the

lower left hand corner of the matrix, the smaller the impact. Finally, the "?" indicates that

the impact is unclear. 

For communities that fall into the "?" category, if the results of both the Secondary

Test and the Municipal Preliminary Screener are borderline, then the community should

move into the category closest to it. Take, for example, a community that falls into the

center box, with a cumulative assessment score of between 1.5 and 2.5 and a percent of

median household income (MHI) between 1.0 and 2.0. If the cumulative score was 1.6

and the percent of MHI was 1.8, then the community should be considered to fall into one

of the adjacent "X" categories. If results are not borderline, other factors such as the

impact on low or fixed income households, the presence of a failing local industry, and

other projects the community would have to forgo in order to comply with water quality

standards should be considered. Relevant additional information might include

information collected from interviews with municipal financial officers, special reports

on industry trends that may affect local employers, and specific financial and economic

indicators. The State/discharger should provide any additional information they feel is

relevant. This additional information will be critical where the matrix results are not

conclusive. 

EPA will interpret a " " rating to mean that the community is not expected to

incur substantial impacts as a result of the pollution control project. Communities falling

into this category will be required to meet existing water quality standards. If the

applicant State/discharger disagrees with the results of the Secondary Test, they may

present additional information to the Regional EPA Administrator documenting the

unique circumstances of the community. Since the impacts are not substantial, there is

no need to demonstrate widespread impacts. EPA will interpret a "X" rating to mean that

the community will incur substantial impacts. Before a water quality standard is modified

or changed, however, communities falling into this category must demonstrate that

impacts are also widespread. For those communities rated "?", EPA's interpretation will

rely on the additional information presented by the State/discharger. It should be noted

that, in this case, there is no "correct" set of information. It will be up to the applicant to

collect whatever information they feel is relevant in describing the unique circumstances

affecting their community. For example, the matrix may suggest that the community's

financial condition is strong. At the same time, however, a local industry may be failing.

In such a case, it is important to determine the importance of that industry to the local

economy (as measured by its contribution to area employment, payroll, and tax revenues)

and whether the industry itself would be affected by the project. Communities falling into

either the "X" or the "?" category should proceed to Chapter 4 to determine whether the

impacts are also expected to be widespread.
Secondary Analysis

Determine whether

municipality will incur

substantial impacts based on

the cost of pollution control

and the characterization of

municipality’s current

financial and socioeconomic

well-being

Screening Process

Is it clear that municipality

will not face substantial

economic impacts?

Allocate Total Pollution

Control Costs

Residential, Industrial,

Commercial, Others

Annualize Total Pollution

Control Costs

Annual Cost of Existing

and Proposed Pollution

Reductions

Estimate Total Pollution

Control Costs

Capital Cost & Annual

O&M Cost of Existing

and Proposed Pollution

Controls

Substantial Impacts

Residentials Costs

Figure 2-1:

Measuring Substantial Impacts

(Public Entities)

Use guidance in 

Chapter 3 if 

non-residential costs 

are anticipated to 

be substantial

Request Rejected

NonResidential

Costs

Yes

Proceed to analysis of

widespread impacts in

Chapter 4

Request Rejected

No Substantial

Impacts

No
Table 2-1

Secondary Indicators

Secondary Indicators

Indicator Weak Mid-Range Strong

Bond Rating Below BBB (S&P) BBB (S&P) Above BBB (S&P)

Below Baa Baa (Moody's) or Baa (Moody's)

(Moody's)

Overall Net Debt as

Percent of Full Above 5% 2%-5% Below 2%

Market Value of

Taxable Property

Unemployment More than 1% National Average More than 1%

above National below National

Average Average

Median Household More than 10% State Median More than 10%

Income below State Median above State

Median

Property Tax

Revenues as a

Percent of Full Above 4% 2%-4% Below 2%

Market Value of

Taxable Property

Property Tax

Collection Rate < 94% 94% - 98% > 98%
Table 2-2

Assessment of Substantial Impacts Matrix

Secondary Municipal Preliminary Screener

Score

Less than 1.0 Percent Between 1.0 and Greater than

2.0 Percent 2.0 Percent

Less than 1.5 ? X X

Between 1.5 and ? X

2.5

Greater than 2.5 ?
Economic Guidance for Water Quality Standards 3-1

3. EVALUATING SUBSTANTIAL IMPACTS: PRIVATE-SECTOR ENTITIES

For facilities owned by the private sector, measuring substantial impacts requires

estimating the financial impacts on the entities that will pay for the pollution controls. For

example, compliance with water quality standards may require that a particular facility,

perhaps a factory, install additional wastewater treatment. After estimating the cost of the

additional wastewater treatment, the next step is to measure the ability of the factory to

pay for the additional treatment. If the analysis shows that the entity will not incur any

substantial impacts due to the cost of pollution control (e.g., there will be no significant

changes in the factory's level of operations nor profit), then the analysis is completed. If,

on the other hand, the analysis shows that there will be substantial impacts on the entity,

then the resulting impacts on the surrounding community must be considered (e.g. the

impact of lost employment on the community's employment base, or the impact on the

overall economy of the community). Impacts to the surrounding community, referred to

as widespread impacts, are addressed in Chapter 4.

The following sections describe the steps involved in evaluating whether impacts will

be substantial. These steps are outlined in Figure 3-1. This chapter explains how to adapt

each of the steps to a range of data sources and provides worksheets to assist the

discharger in working through each step. The analytic approach presented here can be

used for a variety of private-sector entities, including commercial, industrial, residential

and recreational land uses, and for point and nonpoint sources of pollution. The guidance

provided in this chapter, however, is not meant to be exhaustive. The State and/or EPA

may require additional information or tests in order to evaluate whether substantial and

widespread impacts will 

occur. In addition, the applicant should feel free to include any additional information

they feel is relevant. The steps described in further detail in the rest of the chapter are:

Verify Project Costs and Calculate the Annual Cost of the Pollution Control

Project - This section discusses factors that should be considered when verifying

that the proposed pollution control project is the most appropriate solution to the

pollution problem. It also describes the type of general information that should

be provided about the proposed project. In addition, it discusses how to annualize

capital costs of the project and calculate total annual costs of the pollution control

project.

Financial Impact Analysis - This section describes the types of financial tests

that should be applied to measure the impact on the applicant. The primary

measure is profitability. The secondary measures include indicators of liquidity,

solvency, and leverage.

Most of this chapter is written in terms of evaluating whether there will be a substantial

impact on a particular discharger. This type of analysis is necessary whenever there is a
Economic Guidance for Water Quality Standards 3-2

request for a variance. These same tests, however, can be used to analyze the impact on

a group of dischargers, as might be the case in a use attainability analysis. For example,

there may be several facilities that would confront similar requirements to improve their

waste water discharges in order to meet a higher water quality standard under

consideration. The same primary and secondary tests would be used to measure

substantial impacts in the dischargers. The difference would be, however, when the

analysis moved to measuring widespread impacts. Here the impacts on the total group

of dischargers (or all dischargers in the relevant reach) would be used to measure whether

or not the impacts are considered widespread. 

3.1 Verify Project Costs and Calculate The Annual Cost of the Pollution Control

Project

Before the impact analysis can be performed, the project costs should be verified and

the annual costs calculated.

3.1.a Verify Project Costs

The first step in the financial impact analysis is an evaluation of the proposed pollution

control project. Private entities should consider a broad range of discharge management

options including pollution prevention, end-of-pipe treatment, and upgrades or additions

to existing treatment. Specific types of pollution prevention activities to be considered

include:

Change in Raw Materials;

Substitute Process Chemicals;

Change in Process;

Water Recycling and Reuse; and

Pretreatment Requirements.

Whatever the approach, the discharger must demonstrate that the proposed project is the

most appropriate means of meeting water quality standards and must document project

cost estimates. If at least one of the treatment alternatives that allows the applicant to

meet water quality standards would not impose substantial impacts, then they are not able

to demonstrate substantial impacts and should not proceed with the analysis presented in

the remainder of this workbook.

Since the most cost-effective approach to meeting water quality standards should be

considered, submissions should list their assumptions about excess capacity, future

facility expansion, and alternative technologies. The most accurate estimate of project

costs may be available from the discharger's design engineers. These estimates can be

compared to estimates available from EPA.
Economic Guidance for Water Quality Standards 3-3

3.1.b Calculate the Annual Costs of the Pollution Control Project

In order to perform the economic tests, the cost of the pollution control needed to

comply with the Water Quality Standards must be calculated and converted to an

annualized cost. Initially, pollution control costs are expressed in two parts: (1) the

capital costs of purchasing and installing the equipment and (2) the yearly operating and

maintenance (O&M) costs. Both the capital and O&M cost estimates should be provided

by the discharger requesting relief. To assess whether the costs represent the most cost

effective means of meeting the water quality standards, they should be compared to costs

at comparable entities that meet the same standards. For dischargers covered by effluent

guidelines, compliance costs have been calculated by the Agency and are available for

comparative purposes. (See Appendix A.) Costs for nonpoint sources are less readily

available.

Instead of assuming that the total capital costs will be paid in the first year of

operation, these costs are usually annualized. By assuming that costs are spread out over

several years, annualization calculates the amount that will be paid each year, including

the financing costs. In order to allow for comparisons across cases, the analysis should

assume that the applicant will borrow the capital for the pollution control equipment and

repay the loan in even annual installments over a 10 year period. The assumption of ten

years is based on the likely life of the equipment. The assumption of even annual

installments is made for convenience. The interest rate on the loan should be equivalent

to the rate the applicant pays when it borrows money. If it borrows from the parent firm,

the interest charge should be equivalent to the interest charged by the parent firm. If the

parent firm would lend the entity money without interest, then the interest payments

should be equivalent to the interest rate the applicant would pay to borrow from a bank

or on its line of credit. If it is impossible to determine the appropriate interest rate, the

analysis should assume an interest rate equal to the prime rate plus one percent.

The financial tests discussed below compare the costs of compliance to other costs and

revenues of the applicant. Compliance costs and other costs and revenues must, therefore,

be comparable. In other words, they should be calculated for the same year. If

compliance costs are estimated assuming construction several years in the future, they

should be deflated back to the year of the financial data. This can be done by assuming

that the inflation rate over the last five years will continue into the future. See discussion

in Section 2.2, and Appendix A for references to inflation/deflation indices. Likewise,

if costs were estimated for an earlier year, they should be inflated to current year costs.

The Annualized Cost of Pollution Control can be calculated using Worksheet G.

3.2 Financial Impact Analysis

The purpose of the financial impact analysis is to assess the extent to which existing

or planned activities and/or employment will be reduced as a result of meeting the water
Economic Guidance for Water Quality Standards 3-4

quality standards. The tests described in this Workbook are not designed to determine the

exact impact of pollution control costs on an entity. They merely provide indicators of

whether pollution control costs would result in a substantial impact.

Four general categories of financial tests are presented in the following sections. As

indicated below, the four categories are divided into a primary measure of financial

impacts and three secondary measures of financial impacts:

Primary Measure

Profit -- how much will profits decline due to pollution control expenditures?

Secondary Measures

Liquidity -- how easily can an entity pay its short-term bills?

Solvency -- how easily can an entity pay its fixed and long-term bills?

Leverage -- how much money can the entity borrow?

Profit and solvency ratios are calculated both with and without the additional compliance

costs (taking into consideration the entity's ability, if any, to increase its prices to cover

part or all of the costs). Comparing these ratios to each other and to industry benchmarks

provides a measure of the impact on the entity.

For all of the tests, it is important to look beyond the individual test results and

evaluate the total situation of the entity. While each test addresses a single aspect of

financial health, the results of the four tests should be considered jointly to obtain an

overall picture of the economic health of the applicant and the impact of the water quality

standards requirement on the applicant's health. The results should be compared with the

ratios for other entities in the same industry or activity. In addition, the ratios and tests

should be calculated for several years of operations. This will allow long-term trends to

be differentiated from short-term conditions.

The structure, size, and financial health of the parent firm should also be considered.

An important factor, which may not be reflected in the preceding measures, is the value

of an applicant's product or operations to its parent firm. For example, if a facility

produces an important input used by other facilities owned by the firm, the firm may be

likely to support the facility even if it appears to have only borderline profitability. The

results of these tests and other relevant factors, can be used to make a judgement as to the

likely actions of the applicant (e.g. shut down entirely, close one or more product/service

lines, shift to other products/services, not proceed with an expansion, continue operations

at current levels) faced with the pollution control investment.
Economic Guidance for Water Quality Standards 3-5

Each type of test measures a different aspect of a discharger's financial health. The

primary measure evaluates the extent to which an applicant's profit rate will change, and

compares the profit level to typical profits in that industry. The secondary measures

provide additional information about specific impacts that the discharger would bear if

required to meet water quality standards. In some cases, the tests might indicate that the

discharger would remain profitable (Profit) after investing in pollution control, but would

have trouble borrowing the needed capital (Leverage). This situation would indicate a

need to work with the discharger in choosing the technology and schedule used to meet

the regulations. In other cases the tests might show that the discharger has a short-term

problem with meeting the financial obligation imposed by the standards, but could handle

it in the long-run (Liquidity vs. Solvency). This is important information when

considering whether or not to grant a variance so as to allow more time for compliance.

Since it is the discharger that will have to pay for the wastewater treatment, the

financial tests presented in this Workbook use data about the discharger's operations. This

data, however, may not be readily available for the discharger itself, and if available, the

discharger may consider the information to be confidential. It is EPA policy, however,

that applications based on economic considerations must be accompanied by data that

demonstrate the impacts.

If the information is not available at the discharger level, it can be estimated from the

balance sheets or income statements of the firm that owns or controls the discharger.

Estimates can be made in a variety of ways. One commonly used approach is to compare

the discharger's sales or revenues to the firm's sales or revenues and apply this ratio to

other financial factors. For example, if the discharger is responsible for 20 percent of its

firm's revenues, than it is assigned 20 percent of the firm's current assets and current

liabilities. In some cases, particularly with manufacturing facilities, the discharger may

not sell its production directly, but may ship it to another facility owned by the same firm.

In this case, the discharger's share of sales should be calculated by determining the market

value of the goods produced by the discharger, using market prices for the year being

analyzed.

The primary and secondary measures are described below, along with an example of

specific tests to be used. While there are several ratios that could be used for each test,

to simplify the presentation only one ratio per test is described in detail. All four primary

and secondary measures, however, should be used in the analysis.

In most cases, interpreting the results requires comparisons with typical values for the

industry. Among the sources that provide comparative information are: Robert Morris

Associates' Annual Statement Studies, Moody's Industrial Manual, Dun and Bradstreet's

Dun's Industry Norms, and Standard & Poor's Industry Surveys. The Annual Statement

Studies, Dun's Industry Norms , and Standard & Poor's Industry Surveys provide

composite statistics for firms grouped into various manufacturing and service industries.
Profit Test Earnings Before Taxes

Revenues

Economic Guidance for Water Quality Standards 3-6

The Moody's Industrial Manual provides detailed financial information on individual

firms that can be used for comparison purposes. Although benchmarks are available for

most financial tests, EPA emphasizes that the discharger should consider these

benchmarks as indicators of financial health and not as definitive measures.

3.2.a Primary Measure: Profitability

The Profit Test measures what will happen to the discharger's earnings if additional

pollution control is required. If the discharger is making a profit now but would lose

money with the pollution control, then the possibility of a total shutdown or the closing

of a production line must be considered. Greatly reduced, but still positive, profits are

also of concern. Likewise in the case of a proposed facility or proposed expansion; if

estimated profits would drop considerably with pollution control, then the development

might not take place.

Two pieces of information are needed for the Profit Test. The first piece is the total

annual cost of the required pollution control from Worksheet G. The second piece is the

earnings information from the entity's income statement (Worksheet H).

The Profit Test should be calculated with and without the cost of pollution control. In

the former case, the annualized cost of pollution control (including O&M) is subtracted

from the discharger's earnings before taxes (revenues minus costs excluding income

taxes) for the most recently completed fiscal year. Profits before pollution control

investments have been made should be examined to determine whether the discharger was

already in trouble (either not profitable or profits far below industry norms) before

pollution control investments were made. If the discharger is already not profitable, it

may not claim that substantial impacts would occur due to compliance with water quality

standards.

The Profit Test can be calculated using Worksheets H, and I. Earnings before taxes

(EBT) should be calculated for at least the three previous fiscal years in order to identify

any trends or atypical years. Earnings with pollution control costs should be calculated

for the latest year with complete financial information. Arguably, as long as the applicant

maintains positive earnings, it can afford to pay for the pollution control. Over the long

run, however, the owner is likely to shift operations to more profitable facilities, if

possible. The workbook, therefore, guides the applicant through a more thorough

analysis, which compares the EBT, with and without pollution control, to total revenues

to yield a profit rate and change in the profit rate due to pollution control. (Use

Worksheet I.) These profit rates should be compared to those for facilities in similar
Economic Guidance for Water Quality Standards 3-7

lines of business. As with other tests, it may not be possible to compare the discharger's

rate directly with the rates of similar facilities. In such cases the discharger's profit rate

should be compared with that of firms that concentrate in similar businesses, using data

in Moody's Industrial Manual, Dun & Bradstreet's Industry Norms and Key Business

Ratios, Standard & Poor's Industry Surveys, or Robert Morris's Annual Statement Studies.

If the discharger's ratio compares favorably with the median or upper quartile ratio for

similar businesses, the discharger is considered to be financially healthy. A typical

income statement, like those found in Moody's Industrial Manual, has been included in

Exhibit 3-1. The appropriate data have been underlined.

Although complicated, the analysis should consider whether the discharger or firm

would be able to raise its prices in order to cover some or all of the pollution control costs.

In such a case, revenues increase and earnings fall by an amount less than the costs of

pollution control. The degree to which the discharger is able to raise prices is difficult to

predict, and depends on many factors. Considerations should include the level of

competition in the industry, the likelihood of competitors' facilities facing similar project

costs, and the willingness of consumers to pay more for the product.

3.2.b Secondary Measures

The following secondary measures provide additional important information about the

financial health of the discharger. All primary and secondary measures will be included

in the analysis. It is not sufficient to conclude that the discharger will be unprofitable

after pollution control investments. In addition, the applicant should feel free to include

any additional information about the discharger's financial health that they feel is relevant.

Liquidity

Liquidity is a measure of how easily a discharger can pay its short-term bills. One

measure of liquidity is the Current Ratio, which compares current assets with current

liabilities. Current assets include cash and other assets that are or could reasonably be

converted into cash during the current year. The following items are considered to be

current assets:

Inventories-- finished products, products in the process of being manufactured,

raw materials, supplies, fuels, etc.;

Prepaid expenses -- expenses paid in advance of use such as prepaid rent;

Short-term investments -- savings accounts, certificates of deposit;

Accounts receivable;
Current Ratio Current Assets

Current Liabilities

Economic Guidance for Water Quality Standards 3-8

Marketable securities; and

Cash.

Likewise, current liabilities are items that must be paid within the current year. The

following items are considered to be current liabilities:

Accounts payable -- purchases of goods for resale and services received in the

normal course of business;

Wages payable;

Short-term notes payable -- any debt initially incurred and due in the current

year;

Accrued expenses -- expenses that have been incurred but have not yet been paid

at the end of the accounting period;

Taxes; and

Current portion of any long-term debt.

A more stringent test is the Quick Ratio, also known as the Acid Test, which compares

current assets without inventories to current liabilities. It does not include inventories

since they may take time to convert to cash and may be valued on the discharger's books

for more than they could be sold.

The Current Ratio should be calculated for each of the last three full fiscal years for

which there are data. Comparing ratios for three years will identify any trends that are

developing and will ensure that the most recent year is not an unusual year that might

distort the results of the analysis.

The Current Ratio is calculated by dividing current assets by current liabilities.

The Current Ratio can be calculated using Worksheet J. The general rule is that if the

Current Ratio is greater than 2, the entity should be able to cover its short-term

obligations. Frequently, lenders require this level of liquidity as a prerequisite for

lending. While a Current Ratio of greater than 2 indicates that the entity can probably

cover its short-term obligations, the impact of a major capital investment such as the
Beaver s Ratio Cash Flow

Total Debt

Economic Guidance for Water Quality Standards 3-9

pollution control project must be judged in conjunction with the other three financial tests

described in this guidance.

In addition, this rule (Current Ratio > 2) may not be appropriate for all types of private

entities covered by Water Quality Standards. The Current Ratio of the discharger in

question should be compared with ratios for other dischargers in the same line of

business. It may not be possible, however, to compare the discharger's ratio directly with

other similar dischargers because this information frequently is unavailable at the facility

level or is considered confidential. In cases where a direct comparison cannot be made,

the discharger's Current Ratio should be compared with the ratio for firms that concentrate

in similar businesses. If the discharger's ratio compares favorably with the median or

upper quartile ratio for similar businesses, it should be able to cover it's short term

obligations. Among the sources that provide comparison information are: Robert Morris

Associates' Annual Statement Studies, Moody's Industrial Manual, and Dun and

Bradstreet's Dun's Industry Norms. The Annual Statement Studies and Dun's Industry

Norms provide composite statistics for firms grouped by different manufacturing and

service industries. The Moody's Industrial Manual provides detailed financial

information on individual firms. Pages from both of these sources are displayed in

Exhibits 3-2 and 3-3, with the appropriate data indicated.

Solvency

Solvency is a measure of an entity's ability to meet its fixed and long-term obligations.

These obligations are bills and debts that are owed on a regular basis for periods longer

than one year. Solvency tests are commonly used to predict financial problems that could

lead to bankruptcy within the next few years. Since any single year of data can easily be

distorted by unusually high or low net income or by the timing of debt, solvency tests

must be considered over at least three years of data in order to reveal long-term trends.

As with liquidity, there are several possible tests for solvency. One commonly used

solvency test (called Times Interest Earned) compares income before interest and taxes

to interest expenses. Another solvency test, the Beaver's Ratio, compares cash flow to

total debt. This test has been shown to be a good indicator of the likelihood of

bankruptcy.

The Beaver's Ratio can be calculated using Worksheet K. Cash Flow is a measure

of the cash the entity has available to it in a given year. Since depreciation is an

accounting cost -- a cost that does not use any currently available revenues -- it is added

back to reported net income after taxes to get cash flow. Total debt is equal to the current
Debt/Equity Ratio Long Term Liabilities

Owners Equity

Economic Guidance for Water Quality Standards 3-10

debt for the current year plus the long term debt, since current debt includes that part of

long-term debt that is due in the current year.

If the Beaver's Ratio is greater than 0.20 the discharger is considered to be solvent (i.e.,

can pay its long-term debts). If the ratio is less than 0.15 the discharger may be insolvent

(i.e., go bankrupt). If the ratio is between 0.15 and 0.20, then future solvency is uncertain.

The discharger's Beaver's Ratio should be compared with the ratios of similar dischargers.

However, as with other ratios, it may not be possible to compare the discharger's ratio

directly with other similar dischargers. In cases where a direct comparison cannot be

made, the discharger's Beaver's Ratio should be compared with that of firms that

concentrate in similar businesses, using information from income accounts and balance

sheets in Moody's Industrial Manual. If the discharger's ratio compares favorably with

similar businesses, it should be able to meet its fixed and long term obligations. A typical

balance sheet and income statement have been included in Exhibits 3-4 (for calculating

total debt) and 3-5 (for calculating cash flow). The appropriate data from them has been

underlined.

Leverage

Leverage tests measure the extent to which a firm already has fixed financial

obligations and thus indicate how much more money a firm is capable of borrowing.

Firms that rely heavily on debt may find it difficult and expensive to borrow additional

funds. Most leverage tests compare equity to some measure of debt or fixed assets. The

Debt to Equity Ratio is the most commonly used method of measuring leverage. Unlike

the ratios discussed above, the debt to equity ratio cannot be easily calculated for a single

facility; it must be calculated for the firm, since it is usually the firm, not the facility, that

borrows money. The ratio measures how much the firm has borrowed (debt) relative to

the amount of capital which is owned by its stockholders (equity). Since values for the

Debt to Equity Ratio vary widely by the type of enterprise, the ratio should be compared

with the ratio for firms in similar lines of business. The ratio also should be calculated

with at least three years of data.

The Debt to Equity Ratio is equal to Long-Term Liabilities (long-term debt such as

bonds, debentures, and bank debt, and all other noncurrent liabilities like deferred income

taxes) divided by Owners' Equity. Owner's Equity is the difference between total assets

and total liabilities, including contributed or paid in capital and retained earnings. For

publicly held firms, use Net Stockholders Equity (which is the equivalent of Total

Stockholder Equity minus any Treasury Stock).
Economic Guidance for Water Quality Standards 3-11

The Debt to Equity Ratio can be calculated using Worksheet L. Since there are no

generally accepted Debt/Equity Ratio values that apply to all types of economic activity,

the ratio should be compared with the ratio of firms in similar businesses. If the entity's

ratio compares favorably with the median or upper quartile ratio for similar businesses,

it should be able to borrow additional funds. These ratios can be calculated using data in

Robert Morris Associates' Annual Statement Studies, Moody's Industrial Manual, and Dun

& Bradstreet's Dun's Industry Norms. Pages from these sources have been included in

Exhibits 3-6 and 3-7, with the appropriate data indicated.

For entities with special sources of funding, leverage is not an appropriate measure of

their ability to raise capital. Examples are agriculture and affordable housing, where

special loan programs may be available. In these cases, an analysis of the probability that

the project would receive this money is appropriate.

3.3 Interpreting the Results

The financial analysis should be used to determine if there will be a substantial adverse

impact on the applicant. As indicated above, the Profit Test should be considered first.

The Profit Test measures what will happen to the discharger's earnings if additional

pollution control is required. If the discharger is making a profit now but would lose

money with the pollution control, then the possibility of a total shutdown or the closing

of a production line must be considered. Likewise in the case of a proposed facility; if it

would make money without the pollution control but would make much less or even lose

money with it, then the development might not take place. In either case, there is the

chance that employment will be lost and local purchases by the discharger reduced.

Whether or not these impacts will be considered widespread is addressed in Chapter 4.

There are several more complicated scenarios that all involve making a judgement as

to the likely impacts on the discharger, including questions of the timing of compliance.

For example, the Profit Test may indicate that the applicant will continue to maintain

profit levels typical for its industry after compliance, but the Debt/Equity Ratio may

indicate that they will have trouble raising the required capital through debt. This

problem may be solved by giving them more time to meet the regulations (a variance),

so that they can restructure their debt and/or find alternative sources of funds. In another

case, the applicant might argue that while they will still make money and be able to raise

the needed capital, they would alternatively spend those funds on an expansion which

would have resulted in increased employment and income for the community. This is a

more difficult situation to analyze, and will depend on judgments about the relative

importance of water pollution control versus economic growth. These issues are

discussed in more detail in Chapter 4.

Another possible scenario is that the discharger may shift to an alternative economic

activity (e.g., manufacture another product or produce a different crop). While the
Economic Guidance for Water Quality Standards 3-12

applicant will not have gone out of business, this shift may result in reduced profits,

employment, and purchases in the local community that must be considered. In each

case, it is important to take the entire picture presented by the four ratios into account in

judging whether or not the discharger will incur substantial impacts due to the cost of the

necessary pollution reductions.

Using the guidance presented in this chapter, applicants that feel they have

demonstrated substantial impacts should proceed to Chapter 4: Determination of

Widespread Impacts. If dischargers are not able to demonstrate substantial impacts, the

entity must meet existing standards. If a group of dischargers within the community will

experience the substantial impacts resulting from compliance with water quality

standards, these impacts should be considered jointly when assessing whether or not the

impacts will be widespread.
Estimate Costs of

Pollution Control

Necessary to Meet Water

Quality Standards

Capital Cost, Annual

O&M Cost 

Financial Impact

Analysis

Determine whether private

entity will incur substantial

impacts based on primary

and secondary measures of

financial health

Annualize Pollution

Control Costs

Annual Cost of Proposed

Pollution

Reduction

Substantial Impacts

Figure 3-1:

Measuring Substantial Impacts

(Private Entities)

Request Rejected

Proceed to analysis of

widespread impacts in

Chapter 4

No Substantial

Impacts
Economic Guidance for Water Quality Standards
Exhibit 3-1

XYZ, INC.

CONSOLIDATED

STATEMENTS OF

INCOME AND

RETAINED EARNINGS

(DEFICIT)

FOR THE YEARS ENDED SEPTEMBER 30, 1988, 1987, 1986

1988 1987 1986

Net sales $33,294,962 $30,730,768

Cost of sales 26,405,930 24,972,185

Gross profit 6,889,032 5,758,583

Selling, general and administrative expenses 3,876,206 3,824,226

Income from operations 3,012,826 1,934,357

$42,389,957

 35,981,363

6,408,594

 3,957,771

2,450,823

Other income (deductions)

Interest income 347,613 362,295

Interest expense (22,513) (46,467)

Other investment income - net 134,690

Miscellaneous 48,660 93,654

Total other income (deductions) - net 373,760 544,172

Income before income taxes 3,386,586 2,478,529

Provision for income taxes 1,620,012 1,150,949

Net income 1,766,574 1,327,580

441,891

(10,985)

 55,066

 485,972

2,936,795

 1,139,118

1,797,677

Retained earnings, beginning of year 1,726,292 1,983,007

Stock dividend (1,952,645) (1,365,590)

Cash dividend ($.11 per share, 1988; $.08 per share,

1987; $.06 per share, 1986) (300,693) (218,705)

Common stock acquired and retired (82,000) 

Retained earnings (deficit), end of year $ 1,157,528 $ 1,726,292

Weighted average number of shares outstanding 3,630,652 3,637,798

Earnings per common share $.49 $.36 

1,157,528

(2,610,888)

(391,960)

 (2,591)

$ (50,234)

 3,593,048

 $.50 

See accompanying Notes to Financial Statements

INDEPENDENT

AUDITORS'

REPORT

To the Shareholders of XYZ, Inc.:

 We have audited the consolidated balance sheets of XYZ, Inc. at September 30,

1988 and 1987, and the related consolidated statements of income and retained

earnings (deficit), and cash flows for each of the three years in the period ended

September 30, 1988. These financial statements are the responsibility of the

Company's management. Our responsibility is to express an opinion on these

financial statements based on our audits.

 We conducted our audits in accordance with generally accepted auditing standards. 

Those standards require that we plan and perform the audit to obtain reasonable

assurance about whether the financial statements are free of material misstatement. 

An audit includes examining, on a test basis, evidence supporting the amounts and

disclosures in the financial statements. An audit also includes assessing the

accounting principles used and significant estimates made by management, as well as

evaluating the overall financial statement presentation. We believe that our audits

provide a reasonable basis for our opinion.

 In our opinion, the accompanying consolidated financial statements present fairly, in

all material respects, the financial position of the companies at September 30, 1988

and 1987, and the results of their operations and their cash flows for each of the three

years in the period ended September 30, 1988 in conformity with generally accepted

accounting principles.

DELOITTE HASKINS & SELLS

Minneapolis, Minnesota

December 5, 1988
Exhibit 3-2

353

MANUFACTURERS • GAMES, TOYS & CHILDREN'S VEHICLES; EXCEPT DOLLS & BICYCLES. SIC # 3944 

Comparative Historical Data Current Data Sorted by Sales

17 19 19 Type of Statement 4 4 11

11 21 24 Unqualified 1 3 7 10 2 1

2 7 14 Reviewed 3 5 3 1 2

17 20 18 Tax Returns 2 5 2 1 8

1 Compiled

1 # Postretirement 1

Benefits

Other

4/1/90- 4/1/91- 4/1/92-

3/31/91 3/31/92 3/31/93 17(4/1/-9/30/92) 58 (10/1/92-3/31/93)

ALL ALL ALL 0-1MM 1-3mm 3-5MM 5-10MM 10-25MM 25MM & OVER

47 68 75 NUMBER OF STATEMENTS 6 13 9 17 8 22

% % % ASSETS % % % % % % 

7.1 8.9 7.2 Cash & Equivalents 7.4 13.3 5.8

27.0 30.9 31.8 Trade Receivables - (net) 24.5 32.0 36.0

31.9 30.4 35.3 Inventory 47.4 31.0 28.3

2.1 1.9 1.7 All Other Current .6 2.2 2.7

68.1 72.1 76.1 Total Current 79.8 78.5 72.7

19.2 17.5 16.7 Fixed Assets (net) 16.1 14.4 17.2

4.2 3.7 3.1 Intangibles (net) 1.8 2.2 5.4

8.5 6.7 4.1 All Other Non-Current 2.3 4.9 4.7

100.0 100.0 100.0 Total 100.0 100.0 100.0

16.4 12.6 14.0 Notes Payable Short-Term 13.9 12.3 11.8

3.4 2.3 3.0 Cur. Mat.-L/T/D 4.5 3.6 .7

11.7 13.1 14.6 Trade Payables 14.5 12.0 16.5

.7 .9 .6 Income Taxes Payable .5 .5 .7

8.1 9.0 11.1 All Other Current 5.6 10.8 11.9

40.3 38.0 43.2 Total Current 38.8 39.2 41.7

13.2 13.4 12.2 Long Term Debt 15.5 9.4 11.8

1.2 .5 .4 Deferred Taxes .1 .5 .6

2.8 5.3 3.5 All Other Non-Current 2.2 2.1 1.7

42.4 42.9 40.6 Net Worth 43.4 48.8 44.3

100.0 100.0 100.0 Total Liabilities and Net Worth 100.0 100.0 100.0

LIABILITIES

100.0 100.0 100.0 Net Sales 100.0 100.0 100.0

35.5 37.2 36.0 Gross Profit 35.5 33.5 35.8

28.5 29.3 30.2 Operating Expenses 29.9 28.2 28.6

6.9 7.9 5.8 Operating Profit 5.7 5.3 7.2

3.3 1.8 1.2 All Other Expenses (net) 1.1 .4 1.8

3.7 6.1 4.6 Profits Before Taxes 4.6 4.9 5.3

INCOME DATA

2.5 2.8 2.9 4.5 2.8 2.8

1.7 1.9 1.8 Current 2.3 1.9 1.9

1.2 1.3 1.3 1.5 1.3 1.2

RATIOS

1.4 1.7 1.4 1.7 2.0 1.8

.8 1.1 .8 Quick .6 .8 1.0

.6 .7 .6 .5 .6 .7

34 10.6 31 11.6 34 10.8 14 25.2 31 11.9 56 6.5

55 6.6 49 7.4 56 6.5 Sales Receivables 37 10.0 56 6.5 72 5.1

85 4.3 85 4.3 85 4.3 78 4.7 89 4.1 99 3.7

62 5.9 55 6.6 63 5.8 79 4.6 43 8.5 68 5.4

104 3.5 85 4.3 94 3.9 Cost of Sales/Inventory 126 2.9 78 4.7 85 4.3

146 2.5 152 2.4 146 2.5 166 2.2 140 2.6 118 3.1

21 17.0 21 17.7 18 20.1 10 38.1 12 30.2 29 12.5

29 12.4 27 13.3 30 12.3 Cost of Sales/Payables 27 13.3 22 16.4 39 9.4

50 7.3 47 7.8 61 6.0 40 9.1 33 11.0 66 5.5

3.9 3.4 3.3 2.6 3.0 3.3

7.6 6.2 6.3 Sales/Working Capital 4.4 6.5 5.1

17.5 10.8 13.8 14.0 11.5 15.0

(44) 2.4 (66) 3.4 (69) 3.6 EBIT/Interest (12) 1.9 (14) 4.6 (21) 4.3

7.1 10.1 9.0 6.8 9.2 14.5

1.0 1.5 1.5 .8 1.3 2.9

(23) 2.8 3.3 2.8 Amort./Cur. Mat.L/T/D

8.9 (34) 13.3 (24) 13.1 Net Profit + Depr., Dep.,

.5 1.8 1.2

.2 .2 .1 .1 .1 .2

.6 .4 .5 Fixed/Worth .4 .3 .5

.8 .8 1.0 1.2 .7 1.0

.9 .8 1.0 .7 .5 .7

2.0 1.6 1.8 Debt/Worth 1.5 1.1 1.7

3.0 3.3 3.3 3.0 5.5 2.6

(45) 16.2 (65) 26.1 (70) 22.8 Net Worth 9.2 (16) 27.4 (21) 27.9

34.5 52.8 39.9 % Profit Before Taxes/Tangible 51.2 42.8 37.9

1.1 7.0 4.6 2.8 3.2 17.2

11.7 20.5 17.0 % Profit Before Taxes/Total 21.1 18.6 14.2

5.5 10.8 7.6 Assets 3.3 9.6 8.2

.4 1.9 1.5 .8 1.5 3.9

20.1 44.3 35.8 64.6 42.7 21.4

9.8 15.6 17.1 Sales/Net Fixed Assets 35.8 15.1 11.2

6.5 7.3 7.5 9.5 7.3 7.2

2.1 2.5 2.6 2.9 2.6 2.1

1.6 2.0 2.0 Sales/Total Assets 2.0 1.8 1.9

1.3 1.5 1.6 1.7 1.5 1.4

(36) 2.1 (61) 1.7 (61) 1.6 % Depr., Dep., Amort./Sales (11) .8 2.3 2.6

1.1 .8 .7 .4 .8 1.4

2.9 3.3 2.8 2.5 2.9 3.2

(12) 4.3 (23) 4.1 (30) 4.5 Owners' Comp/Sales

1.8 2.4 2.7 % Officers', Directors',

6.7 9.5 7.8

1537661M 1883457M 1840680M Net Sales ($) 3293M 27202M 36782M 116678M 115773M 1540952M 

1092333M 1169085M 1136958M Total Assets ($) 1948M 13736M 20946M 72757M 52973M 974598M 

© Robert Morris Associates 1993 M = $thousand MM = $million

See Pages 1 through 15 for Explanation of Ratios and Data
Exhibit 3-3

XYZ, INC.

CONSOLIDATED

BALANCE 

SHEETS

SEPTEMBER 30, 1988 AND 1987

1988 1987

ASSETS Current Assets:

Cash and cash equivalents $ 1,459,475

Cash investments 3,369,289

Trade receivables - less allowance for doubtful

accounts: 1988, $85,352; 1987, $135,353 4,171,421

Inventories 3,335,251

prepaid expenses and other 122,370

Total current assets 12,457,806

$ 2,944,964

2,244,061

5,025,964

4,109,264

 725,964

15,050,217

Property, Plant and Equipment:

Land 296,217

Buildings and Improvements 4,837,392

Machinery and equipment 1,546,476

Transportation equipment 1,705,107

Office furniture and equipment 483,769

Total 8,868,961

Less accumulated depreciation 4,207,598

Property - net 4,661,363

356,217

5,476,155

2,160,671

1,866,005

 463,750

10,322,798

 4,705,580

5,617,218

Other Assets:

Intangible assets - less accumulated amortization: 1988,

$197,437; 1987, $239,281 252,884

Insurance trust 1,066,964

Other 77,778

Total other assets 1,397,626

226,728

1,122,796

 89,287

1,438,811

Total $22,106,246 $18,516,795

LIABILITIES AND Current Liabilities:

SHAREHOLDERS' $ 17,902

EQUITY 5,049,234

Current portion of long-term debt $ 32,405

Accounts payable - trade 2,686,669

Accrued income taxes 21,400

Accrued payroll and employee benefits 678,752

Container deposits 1,199,263

Other accruals 178,736

Total current liabilities 4,797,225

681,369

1,054,373

 198,477

7,001,355

Long-term debt 53,706 71,608

Deferred income taxes 249,900 242,200

Shareholders' Equity:

Common stock - authorized 4,000,000 shares of $.05

par value, issued: 1988, 3,592,673; 1987, 3,268,337

Additional paid-in capital 163,417

Retained earnings (deficit) 12,084,817

Total shareholders' equity 1,157,528

179,634

14,671,885

 (50,234)

14,801,285 13,405,762

Total $22,106,246 $18,516,795

See accompanying Notes to Financial Statements
Exhibit 3-4

XYZ, INC.

CONSOLIDATED

BALANCE 

SHEETS

SEPTEMBER 30, 1988 AND 1987

1988 1987

ASSETS Current Assets:

Cash and cash equivalents $ 1,459,475

Cash investments 3,369,289

Trade receivables - less allowance for doubtful

accounts: 1988, $85,352; 1987, $135,353 4,171,421

Inventories 3,335,251

prepaid expenses and other 122,370

Total current assets 12,457,806

$ 2,944,964

2,244,061

5,025,964

4,109,264

 725,964

15,050,217

Property, Plant and Equipment:

Land 296,217

Buildings and Improvements 4,837,392

Machinery and equipment 1,546,476

Transportation equipment 1,705,107

Office furniture and equipment 483,769

Total 8,868,961

Less accumulated depreciation 4,207,598

Property - net 4,661,363

356,217

5,476,155

2,160,671

1,866,005

 463,750

10,322,798

 4,705,580

5,617,218

Other Assets:

Intangible assets - less accumulated amortization: 1988,

$197,437; 1987, $239,281 252,884

Insurance trust 1,066,964

Other 77,778

Total other assets 1,397,626

226,728

1,122,796

 89,287

1,438,811

Total $22,106,246 $18,516,795

LIABILITIES AND Current Liabilities:

SHAREHOLDERS' $ 17,902

EQUITY 5,049,234

Current portion of long-term debt $ 32,405

Accounts payable - trade 2,686,669

Accrued income taxes 21,400

Accrued payroll and employee benefits 678,752

Container deposits 1,199,263

Other accruals 178,736

Total current liabilities 4,797,225

681,369

1,054,373

 198,477

7,001,355

Long-term debt 53,706 71,608

Deferred income taxes 249,900 242,200

Shareholders' Equity:

Common stock - authorized 4,000,000 shares of $.05

par value, issued: 1988, 3,592,673; 1987, 3,268,337

Additional paid-in capital 163,417

Retained earnings (deficit) 12,084,817

Total shareholders' equity 1,157,528

179,634

14,671,885

 (50,234)

14,801,285 13,405,762

Total $22,106,246 $18,516,795

See accompanying Notes to Financial Statements
Exhibit 3-5

XYZ, INC.

CONSOLIDATED

STATEMENTS OF

INCOME AND

RETAINED EARNINGS

(DEFICIT)

FOR THE YEARS ENDED SEPTEMBER 30, 1988, 1987, 1986

1988 1987 1986

Net sales $33,294,962 $30,730,768

Cost of sales 26,405,930 24,972,185

Gross profit 6,889,032 5,758,583

Selling, general and administrative expenses 3,876,206 3,824,226

Income from operations 3,012,826 1,934,357

$42,389,957

 35,981,363

6,408,594

 3,957,771

2,450,823

Other income (deductions)

Interest income 347,613 362,295

Interest expense (22,513) (46,467)

Other investment income - net 134,690

Miscellaneous 48,660 93,654

Total other income (deductions) - net 373,760 544,172

Income before income taxes 3,386,586 2,478,529

Provision for income taxes 1,620,012 1,150,949

Net income 1,766,574 1,327,580

441,891

(10,985)

 55,066

 485,972

2,936,795

 1,139,118

1,797,677

Retained earnings, beginning of year 1,726,292 1,983,007

Stock dividend (1,952,645) (1,365,590)

Cash dividend ($.11 per share, 1988; $.08 per share,

1987; $.06 per share, 1986) (300,693) (218,705)

Common stock acquired and retired (82,000) 

Retained earnings (deficit), end of year $ 1,157,528 $ 1,726,292

Weighted average number of shares outstanding 3,630,652 3,637,798

Earnings per common share $.49 $.36 

1,157,528

(2,610,888)

(391,960)

 (2,591)

$ (50,234)

 3,593,048

 $.50 

See accompanying Notes to Financial Statements

INDEPENDENT

AUDITORS'

REPORT

To the Shareholders of XYZ, Inc.:

 We have audited the consolidated balance sheets of XYZ, Inc. at September 30,

1988 and 1987, and the related consolidated statements of income and retained

earnings (deficit), and cash flows for each of the three years in the period ended

September 30, 1988. These financial statements are the responsibility of the

Company's management. Our responsibility is to express an opinion on these

financial statements based on our audits.

 We conducted our audits in accordance with generally accepted auditing standards. 

Those standards require that we plan and perform the audit to obtain reasonable

assurance about whether the financial statements are free of material misstatement. 

An audit includes examining, on a test basis, evidence supporting the amounts and

disclosures in the financial statements. An audit also includes assessing the

accounting principles used and significant estimates made by management, as well as

evaluating the overall financial statement presentation. We believe that our audits

provide a reasonable basis for our opinion.

 In our opinion, the accompanying consolidated financial statements present fairly, in

all material respects, the financial position of the companies at September 30, 1988

and 1987, and the results of their operations and their cash flows for each of the three

years in the period ended September 30, 1988 in conformity with generally accepted

accounting principles.

DELOITTE HASKINS & SELLS

Minneapolis, Minnesota

December 5, 1988
Exhibit 3-6

353

MANUFACTURERS • GAMES, TOYS & CHILDREN'S VEHICLES; EXCEPT DOLLS & BICYCLES. SIC # 3944 

Comparative Historical Data Current Data Sorted by Sales

17 19 19 Unqualified 4 4 11

11 21 24 Reviewed 1 3 7 10 2 1

2 7 14 Compiled 3 5 3 1 2

17 20 18 Other 2 5 2 1 8

1 Tax Returns

1 # Postretirement Benefits 1

Type of Statement

4/1/90- 4/1/91- 4/1/92-

3/31/91 3/31/92 3/31/93 17(4/1/-9/30/92) 58 (10/1/92-3/31/93)

ALL ALL ALL 0-1MM 1-3mm 3-5MM 5-10MM 10-25MM 25MM & OVER

47 68 75 NUMBER OF STATEMENTS 6 13 9 17 8 22

% % % ASSETS % % % % % % 

7.1 8.9 7.2 Cash & Equivalents 7.4 13.3 5.8

27.0 30.9 31.8 Trade Receivables - (net) 24.5 32.0 36.0

31.9 30.4 35.3 Inventory 47.4 31.0 28.3

2.1 1.9 1.7 All Other Current .6 2.2 2.7

68.1 72.1 76.1 Total Current 79.8 78.5 72.7

19.2 17.5 16.7 Fixed Assets (net) 16.1 14.4 17.2

4.2 3.7 3.1 Intangibles (net) 1.8 2.2 5.4

8.5 6.7 4.1 All Other Non-Current 2.3 4.9 4.7

100.0 100.0 100.0 Total 100.0 100.0 100.0

16.4 12.6 14.0 Notes Payable Short-Term 13.9 12.3 11.8

3.4 2.3 3.0 Cur. Mat.-L/T/D 4.5 3.6 .7

11.7 13.1 14.6 Trade Payables 14.5 12.0 16.5

.7 .9 .6 Income Taxes Payable .5 .5 .7

8.1 9.0 11.1 All Other Current 5.6 10.8 11.9

40.3 38.0 43.2 Total Current 38.8 39.2 41.7

13.2 13.4 12.2 Long Term Debt 15.5 9.4 11.8

1.2 .5 .4 Deferred Taxes .1 .5 .6

2.8 5.3 3.5 All Other Non-Current 2.2 2.1 1.7

42.4 42.9 40.6 Net Worth 43.4 48.8 44.3

100.0 100.0 100.0 Total Liabilities and Net Worth 100.0 100.0 100.0

LIABILITIES

100.0 100.0 100.0 Net Sales 100.0 100.0 100.0

35.5 37.2 36.0 Gross Profit 35.5 33.5 35.8

28.5 29.3 30.2 Operating Expenses 29.9 28.2 28.6

6.9 7.9 5.8 Operating Profit 5.7 5.3 7.2

3.3 1.8 1.2 All Other Expenses (net) 1.1 .4 1.8

3.7 6.1 4.6 Profits Before Taxes 4.6 4.9 5.3

INCOME DATA

2.5 2.8 2.9 4.5 2.8 2.8

1.7 1.9 1.8 Current 2.3 1.9 1.9

1.2 1.3 1.3 1.5 1.3 1.2

RATIOS

1.4 1.7 1.4 1.7 2.0 1.8

.8 1.1 .8 Quick .6 .8 1.0

.6 .7 .6 .5 .6 .7

34 10.6 31 11.6 34 10.8 14 25.2 31 11.9 56 6.5

55 6.6 49 7.4 56 6.5 Sales Receivables 37 10.0 56 6.5 72 5.1

85 4.3 85 4.3 85 4.3 78 4.7 89 4.1 99 3.7

62 5.9 55 6.6 63 5.8 79 4.6 43 8.5 68 5.4

104 3.5 85 4.3 94 3.9 Cost of Sales/Inventory 126 2.9 78 4.7 85 4.3

146 2.5 152 2.4 146 2.5 166 2.2 140 2.6 118 3.1

21 17.0 21 17.7 18 20.1 10 38.1 12 30.2 29 12.5

29 12.4 27 13.3 30 12.3 Cost of Sales/Payables 27 13.3 22 16.4 39 9.4

50 7.3 47 7.8 61 6.0 40 9.1 33 11.0 66 5.5

3.9 3.4 3.3 2.6 3.0 3.3

7.6 6.2 6.3 Sales/Working Capital 4.4 6.5 5.1

17.5 10.8 13.8 14.0 11.5 15.0

(44) 2.4 (66) 3.4 (69) 3.6 EBIT/Interest (12) 1.9 (14) 4.6 (21) 4.3

7.1 10.1 9.0 6.8 9.2 14.5

1.0 1.5 1.5 .8 1.3 2.9

(23) 2.8 3.3 2.8 Amort./Cur. Mat.L/T/D

8.9 (34) 13.3 (24) 13.1 Net Profit + Depr., Dep.,

.5 1.8 1.2

.2 .2 .1 .1 .1 .2

.6 .4 .5 Fixed/Worth .4 .3 .5

.8 .8 1.0 1.2 .7 1.0

.9 .8 1.0 .7 .5 .7

2.0 1.6 1.8 Debt/Worth 1.5 1.1 1.7

3.0 3.3 3.3 3.0 5.5 2.6

(45) 16.2 (65) 26.1 (70) 22.8 Net Worth 9.2 (16) 27.4 (21) 27.9

34.5 52.8 39.9 % Profit Before Taxes/Tangible 51.2 42.8 37.9

1.1 7.0 4.6 2.8 3.2 17.2

11.7 20.5 17.0 % Profit Before Taxes/Total 21.1 18.6 14.2

5.5 10.8 7.6 Assets 3.3 9.6 8.2

.4 1.9 1.5 .8 1.5 3.9

20.1 44.3 35.8 64.6 42.7 21.4

9.8 15.6 17.1 Sales/Net Fixed Assets 35.8 15.1 11.2

6.5 7.3 7.5 9.5 7.3 7.2

2.1 2.5 2.6 2.9 2.6 2.1

1.6 2.0 2.0 Sales/Total Assets 2.0 1.8 1.9

1.3 1.5 1.6 1.7 1.5 1.4

(36) 2.1 (61) 1.7 (61) 1.6 % Depr., Dep., Amort./Sales (11) .8 2.3 2.6

1.1 .8 .7 .4 .8 1.4

2.9 3.3 2.8 2.5 2.9 3.2

(12) 4.3 (23) 4.1 (30) 4.5 Owners' Comp/Sales

1.8 2.4 2.7 % Officers', Directors',

6.7 9.5 7.8

1537661M 1883457M 1840680M Net Sales ($) 3293M 27202M 36782M 116678M 115773M 1540952M 

1092333M 1169085M 1136958M Total Assets ($) 1948M 13736M 20946M 72757M 52973M 974598M 

© Robert Morris Associates 1993 M = $thousand MM = $million

See Pages 1 through 15 for Explanation of Ratios and Data
Exhibit 3-7

XYZ, INC.

CONSOLIDATED

BALANCE 

SHEETS

SEPTEMBER 30, 1988 AND 1987

1988 1987

ASSETS Current Assets:

Cash and cash equivalents $ 1,459,475

Cash investments 3,369,289

Trade receivables - less allowance for doubtful

accounts: 1988, $85,352; 1987, $135,353 4,171,421

Inventories 3,335,251

prepaid expenses and other 122,370

Total current assets 12,457,806

$ 2,944,964

2,244,061

5,025,964

4,109,264

 725,964

15,050,217

Property, Plant and Equipment:

Land 296,217

Buildings and Improvements 4,837,392

Machinery and equipment 1,546,476

Transportation equipment 1,705,107

Office furniture and equipment 483,769

Total 8,868,961

Less accumulated depreciation 4,207,598

Property - net 4,661,363

356,217

5,476,155

2,160,671

1,866,005

 463,750

10,322,798

 4,705,580

5,617,218

Other Assets:

Intangible assets - less accumulated amortization: 1988,

$197,437; 1987, $239,281 252,884

Insurance trust 1,066,964

Other 77,778

Total other assets 1,397,626

226,728

1,122,796

 89,287

1,438,811

Total $22,106,246 $18,516,795

LIABILITIES AND Current Liabilities:

SHAREHOLDERS' $ 17,902

EQUITY 5,049,234

Current portion of long-term debt $ 32,405

Accounts payable - trade 2,686,669

Accrued income taxes 21,400

Accrued payroll and employee benefits 678,752

Container deposits 1,199,263

Other accruals 178,736

Total current liabilities 4,797,225

681,369

1,054,373

 198,477

7,001,355

Long-term debt 53,706 71,608

Deferred income taxes 249,900 242,200

Shareholders' Equity:

Common stock - authorized 4,000,000 shares of $.05

par value, issued: 1988, 3,592,673; 1987, 3,268,337

Additional paid-in capital 163,417

Retained earnings (deficit) 12,084,817

Total shareholders' equity 1,157,528

179,634

14,671,885

 (50,234)

14,801,285 13,405,762

Total $22,106,246 $18,516,795

See accompanying Notes to Financial Statements
Economic Guidance for Water Quality Standards 4-1

4. DETERMINATION OF WIDESPREAD IMPACTS

The financial impacts of undertaking pollution controls could potentially cause farreaching and serious socioeconomic impacts. If the financial tests outlined in Chapter 2

and 3 suggest that a discharger (public or private) or group of dischargers will have

difficulty paying for pollution controls, then an additional analysis must be performed to

demonstrate that there will be widespread adverse impacts on the community or

surrounding area. There are no economic ratios per se that evaluate socioeconomic

impacts. Instead, the relative magnitudes of indicators such as increases in

unemployment, losses to the local economy, changes in household income, decreases in

tax revenues, indirect effects on other businesses, and increases in sewer fees for

remaining private entities should be taken into account when deciding whether impacts

could be considered widespread. Since EPA does not have standardized tests and

benchmarks with which to measure these impacts, the following guidance is provided as

an example of the types of information that should be considered when reviewing impacts

on the surrounding community.

In certain circumstances, the information presented here may not adequately address

all potential impacts. At a minimum, however, the analysis must define the affected

community (the geographic area where project costs pass through to the local economy),

consider the baseline economic health of the community, and finally evaluate how the

proposed project will affect the socioeconomic well-being of the community. Applicants

should feel free to consider additional measures not mentioned here if they judge them

to be relevant. Likewise, applicants should not view this guidance as a check list. In all

cases, socioeconomic impacts should not be evaluated incrementally, rather, their

cumulative effect on the community should be assessed. More detailed guidance on the

factors that should be considered when evaluating the socioeconomic impacts to

communities of meeting water quality standards is given below.

4.1 Define Relevant Geographical Area

One important factor in determining the magnitude of these impacts is defining the

geographical area in which they occur. In some cases, one community's loss may be

another community's gain, as in the case of a plant moving to another community. In the

case of municipal pollution control projects, the affected community is most often the

immediate municipality. There are, however, exceptions where the affected community

includes individuals and areas outside the immediate community. For example, if

business activity in the region is concentrated in a nearby community and not in the

immediate community, then the nearby community may also be affected by loss of

income in the immediate community and should be included in the analysis. If business

activity of the region is concentrated in the immediate community, then outlying

communities dependent upon the immediate municipality for employment, goods, and

services should also be included in the analysis. Similarly, if a large number of workers
Economic Guidance for Water Quality Standards 4-2

commute to an industrial facility that is significantly affected by the costs, then the

affected community should include the home communities of commuters as well as the

immediate community.

The relevant geographic area for evaluating the socioeconomic effects of compliance

by private entities varies with each situation. For impacts from actions by a private entity,

the area will typically be determined by the area in which the majority of its workers live

and where most of the businesses that depend on it are located. There are no simple rules

for defining the relevant area or community; the decision is based on the judgement of the

discharger and state, subject to EPA review.

4.2 Determine Whether Impacts are Widespread: Public-Sector Entities

In demonstrating that impacts will be substantial, the applicant will have shown that

compliance with water quality standards would be burdensome to the community. To

demonstrate that impacts will also be widespread, the applicant must examine the

estimated change in socioeconomic conditions that occur as a result of compliance.

There are no explicit criteria by which to evaluate widespread impacts. It is

recommended, however, that changes in the socioeconomic indicators listed below be

considered. For each indicator listed, the applicant should estimate the potential change

from precompliance conditions if the community were to adopt pollution controls.

Median Household Income;

Community Unemployment Rate;

Overall Net Debt as a Percent of Full Market Value of Taxable Property;

Percent of Households Below Poverty Line;

Impact on Community Development Potential; and

Impact on Property Values.

Precompliance estimates of the first three indicators were considered in Chapter 2 in the

Secondary Test. Estimated changes should be described qualitatively in Worksheet M.

Depending on the size and type of impacts on industrial and commercial discharges, these

estimated changes may be relatively large or small. In addition to changes in income,

unemployment, and debt, affected communities may be faced with impaired development

opportunities if pretreatment requirements or significantly higher user fees are imposed

by the POTW. The municipality should therefore assess the potential for the loss of

future jobs and personal income to the community if businesses would chose not to locate

in the affected community. The potential for impaired development opportunities can be

judged, in part, by comparing post-compliance costs to costs in neighboring communities.

The cost of pollution control may also have an adverse effect on property values. Where

property taxes are used to finance the project, property values may fall in response to

higher taxes. Similarly, if the project will be financed through user fees, demand for
Economic Guidance for Water Quality Standards 4-3

property in the community may fall, thus decreasing the value of property in the

community.

The extent to which estimated changes can be interpreted as significant, however, will

depend on the health of the community before compliance. It is therefore not possible to

identify acceptable or unacceptable estimated changes for each indicator. For example,

if Community XYZ were determined to be in a weak condition before compliance. As

defined in Chapter 2, but the evaluation of widespread impacts suggests that all of the

indicators listed above will remain virtually unchanged, then widespread impacts have not

been demonstrated. Alternatively, if Community XYZ were very healthy, the estimated

change in the indicators listed above would have to be very large in order for widespread

impacts to occur.

In addition, there may be secondary impacts (not captured by the primary and

secondary tests) to the community. Secondary impacts might include depressed economic

activity in a community resulting from loss of purchasing power by persons losing their

jobs due to increased user fees. The next section describes secondary impacts in greater

detail.

4.3 Determine Whether Impacts are Widespread: Private-Sector Entities

If the financial tests suggest that a private entity or group of entities will have difficulty

paying for pollution controls, then an additional analysis must be performed to

demonstrate that there will be widespread adverse impacts on the community or

surrounding area. The current economic condition of the affected community and the role

of the affected entities within the community should first be considered when determining

whether the affected community will be able to absorb the impacts of reduced business

activity or closures. Through property taxes and employment, the entity(ies) may be a

key contributor to the economic base of the affected community. In this situation,

reductions in employment caused by compliance with the water quality standards could

be widespread if workers have no other employment opportunities nearby. Impacts may

also be significant where the entity(ies) is a primary producer of a particular product or

service upon which other nearby businesses or the affected community depend. The

impacts of reduced business activities or closure will be far greater in this case than if the

products are sold elsewhere. These two examples illustrate how the interdependence

between the affected entity(ies) and the affected community is a major factor in

demonstrating that the impacts are not only substantial, but also widespread.

As important as the extent of socioeconomic impacts is the type of impacts that might

occur. A worksheet has been provided to assist applicants in their evaluation of

socioeconomic impacts. Worksheet N is designed as a list of the factors applicants

should consider in determining whether impacts are not only substantial but also

widespread. The worksheet is organized to follow the text below. To make the most
Economic Guidance for Water Quality Standards 4-4

efficient use of this worksheet, applicants should read the remainder of Section 4.3 and

then collect the data suggested in the worksheet. Applicants should feel free, however,

to use anecdotal information to describe any current community characteristics or

anticipated impacts that are not listed in the worksheet.

Potentially, one of the most serious impacts on the affected community's economy is

the loss of employment caused by a reduction in business activity or closure. The size of

this impact is dependent on the number of jobs lost relative to the total number of jobs in

the community, and to the job opportunities available in the community. Typically, a

decline in employment leads to a decline in personal income in the affected community.

The total amount of income lost by the affected community will depend, in part, on the

future job prospects of those losing their jobs. If employees leave the area in search of

opportunities, all of their income will be lost to the affected community. Workers who

are unable to market the full range of their skills to a new employer will receive lower

wages in subsequent jobs. If employees stay in the area and find lower paying jobs or

receive unemployment benefits, the loss of income to the affected community would be

equal to the difference between existing and future income; the cost of unemployment

benefits is calculated as a government expense or an expense borne someplace else,

whichever is appropriate to the situation.

To assess the net impact on employment in the affected community, the existing rate

of unemployment should be considered as an indicator of worker mobility between jobs.

When the unemployment rate is very high in an affected community, workers will have

a difficult time finding other jobs in that community. Where possible, comparisons

should be made between industry employment levels in the community and the nation as

a whole. If employment levels in the industry as a whole are falling, the industry may be

in decline regardless of the burden placed on them by water quality standards regulations.

If it is clear that a private-sector entity will go out of business regardless of water quality

standards, the impact of the pollution controls should not be viewed as substantial. If the

entity is in a marginal position, however, the effect that meeting water quality standards

will have on the entity and the community should be considered. Applicants should also

consider whether the lack of alternative employment opportunities may lead to an

increased need for social services in the affected community. If the costs of increased

social services will be borne by the affected community, they should be included in the

assessment of widespread and substantial impacts.

Socioeconomic impacts may also include effects on the local government(s) such as

loss of property tax revenues. If the financial tests in Chapter 3 suggest that an entity or

group of entities will close, then the assessed value of property and tax revenues will fall.

If the entities are a major source of revenue for the affected community, this loss in tax

revenue may be significant. One example might be water quality standards that affect

farming practices in an agricultural region. Compliance with these standards might lower

the profitability of many farms, even to the point of forcing them to cease operations. To
Economic Guidance for Water Quality Standards 4-5

assess the impact, the loss in property tax revenues should be compared to total property

tax revenues in the affected community to determine the relative size of the loss. In

general, a drop of 1 percent in property tax revenues would be considered significant.

If compliance is evaluated in the context of a public investment for which the private

entity is paying a share (e.g., a factory's share of the cost to upgrade a municipal treatment

plant), then the analysis of widespread impacts is more complicated. If the financial

analysis shows that the entity or group of entities cannot pay their share of the cost, then

the socioeconomic and public entity analysis should include this additional burden on

other users. Likewise, if the entity or group of entities are significant users of the local

utilities, then a reduction in business activity or closure may lead to a lowered demand

and possible decreased efficiency for local utilities. For example, a water supply system

may be designed with a large industrial user in mind. If much of the demand is

eliminated, the system may become excessively expensive for the remaining users.

Affected communities may also be faced with impaired development opportunities if

the need to comply with water quality standards discourages other businesses from

locating in the area. In situations where the affected facility has not been built, additional

expenditures on water pollution controls may delay or cancel the construction. The

applicant should, therefore, consider not only the loss of potential jobs and personal

income to the community if the entity is not built, but the future losses in jobs, personal

income and tax revenues from other businesses that would choose not to locate in the

affected community.

There may be some cases in which the socioeconomic impacts of implementing

pollution controls are large enough that they are felt at the state level. For example, the

State may lose tax revenues from lost production and lost income if a business closes.

This will be of particular importance if the business is a major employer in the State

and/or the State is experiencing a period of high unemployment and fiscal distress. At the

same time, the State may encounter increased expenditures for unemployment

compensation and social services. In reviewing state level impacts, the applicant should

consider the degree to which decreases in employment and personal income in one area

of the State are offset by increases in employment and personal income in other parts of

the State. In most cases, impacts at the state level will be relatively minor. If not, then

impacts are widespread.

4.4 Estimate Multiplier Effect

The effects of increased unemployment, decreased personal income, and reductions

in local expenditures by the entity or group of entities (public and private) will be

compounded as money moves through the local economy. Some portion of the lost

income would have been spent in the local economy for the purchase of other goods and

services and thus for the salaries of other local employees. These local employees, in
Economic Guidance for Water Quality Standards 4-6

turn, would have spent some portion of their income in the local economy. This

multiplier effect means that each dollar lost to an employee results in the loss of more than

one dollar to the local economy.

The U.S. Department of Commerce, Bureau of Economic Analysis (BEA) has

developed several multipliers to estimate the effect of reduced economic activity on

output (sales), earnings, and employment. These multipliers are available by industry

sector for 39 or 531 different industry classifications, depending on the level of detail

required. Applicants that are interested in using these multipliers are advised to consult

a copy of RIMS II Regional Multipliers: A User Handbook of the Regional Input-Output

Modeling System, available from the National Technical Information Service (NTIS). The

NTIS document number is #PB-86-230-216 and orders can be placed by calling NTIS at

(703) 487-4650. Additional information on using multipliers is available from the BEA

at (202) 606-5343.

4.5 Economic Benefits of Clean Water

Benefit-cost analysis is not required to demonstrate substantial and widespread

effects under the Federal Water Quality Standards regulation.

In many cases, there may be economic benefits that accrue to the affected community

from cleaner water. For example, in a rural community where the primary source of

employment is agriculture, the reduction of fertilizer and pesticide runoff from farms

would reduce the cost of treating irrigation water to downstream users. Another example

might be an industrial facility discharging its wastewater into a stream that otherwise

could be used for recreational cold-water fishing. Treatment or elimination of the

industrial wastewater would provide a benefit to recreational fishermen by increasing the

variety of fish in the stream. In both cases, the economic benefit is the dollar value

associated with the increase in beneficial use or potential use of the waterbody. The types

of economic benefits that might be realized will depend on both the characteristics of the

polluting entity and characteristics of the affected community, and should be considered

on a case by case basis.

Since the assessment of benefits requires site-specific information, it will be up to

States to determine the extent to which benefits can be considered in the economic impact

analysis. This determination should be coordinated with the EPA Regional Office. A

more detailed description of the types of benefits that might be considered is given in

Appendix C. This appendix is not intended to provide in-depth guidance on how to

estimate economic benefits; rather, it is intended to give States an idea of the types of

benefits that might be relevant in a given situation.
Economic Guidance for Water Quality Standards 4-7

4.6 Summary of Financial Capability and Determination of Whether Impacts are

Substantial and Widespread

Using the guidance described in this document, the applicant must demonstrate that the

pollution control measures needed to meet water quality standards are not affordable. In

addition, the applicant will have to show that there will be widespread adverse impacts

to the community if it is required to meet standards. A summary checklist of the steps

required in this process is presented in Table 4-1. This checklist also presents the type of

data the applicant will need to collect to support each step. Whether or not the applicant

has successfully demonstrated that substantial and widespread economic and social

impacts would occur, however, will depend upon the EPA Regional Administrator's

review of the application.

If the EPA Regional Administrator determines that substantial and widespread

economic and social impacts have not been demonstrated, then the discharger must meet

the water quality standards. Alternatively, if substantial and widespread economic and

social impacts have been demonstrated, then the discharger will not have to meet the

water quality standards. The discharger will, however, be expected to undertake some

additional pollution control. The criteria outlined in Chapters 2 and 3 should be used to

determine the most protective pollution control technique that would not impose a

substantial impact on the entity. In addition, the discharger should check with EPA and

the State regularly to determine what else will be required of them. It is then up to the

State to revise the standards in the water body to reflect the uses that would be achieved

if the discharger adopts the next most protective pollution control technique. The State

will also have to revise its water quality criteria to protect the newly attainable uses. The

discharger's NPDES permit will then be revised to reflect the new limits associated with

revised criteria. Finally, federal regulations require that water quality standards be

reviewed every three years to determine if there is any new information or technology that

allows attainment of the full designated use without causing substantial and widespread

social and economic impacts.
Table 4-1

Demonstration of Substantial and Widespread 

Economic and Social Impacts of Attainment of Designated Uses

CHECKLIST

STEPS APPLICANT

INFORMATION THAT WILL BE REQUIRED FROM

1. Demonstrate that designated use is a potential use and not an Data from State Water Quality Assessment Documents and water quality

existing use. standards regulations.

2. Demonstrate that entity will incur substantial economic impacts.

a. Identify all reasonable pollution reduction options, Information on end-of-pipe treatment, possible treatment upgrades,

b. Evaluate costs of all reasonable pollution reduction Assumptions about water demand, treatment capacity, expansion plans,

options, population growth, and effectiveness of control in reducing pollution for

c. Identify lowest cost pollution reduction option that allows Information on treatment efficiencies for alternative pollution reduction

entity to meet water quality standards. techniques. Cost estimates for all alternatives.

additions to existing treatment, and pollution prevention activities

including the following:

• change in raw materials,

• substitution of process chemicals,

• change in process,

• water recycling, reuse and efficiency,

• pretreatment requirements, and

• public education.

each option. Estimate of project costs from design engineers, costs of

comparable projects in the State, or judgement of experienced water

pollution control engineers.
Table 4-1 CHECKLIST (Cont'd.)

STEPS INFORMATION THAT WILL BE REQUIRED FROM

APPLICANT

3. Evaluate entity's financial health (Public Entities Only):

a. determine method of financing,

b. annualize pollution reduction project costs,

c. allocate project costs,

d. apply Municipal Preliminary Screener test,

e. Depending on the results of the Municipal Preliminary

Screener test, apply Secondary Test.

4. Evaluate entity's financial health (Private Entities Only):

a. annualize pollution reduction project costs,

b. Primary Measure: 

profitability, 

Information on user fee financing mechanisms such as Revenue Bonds.

Information on tax based financing mechanisms such as General

Obligation Bonds.

Information on appropriate interest rates and period of financing.

Information on user groups, wastewater flow by user group, and

surcharges on industrial users.

Information on average total annual pollution control cost per household

and median household income.

Information on results of Municipal Preliminary Screener test, overall net

debt as a percent of full market value of taxable property, median

household income, bond rating, community unemployment rate, property

tax collection rate, and property tax revenues as a percent of full market

value of taxable property.

Information on appropriate interest rates and period of financing.

Information that will allow evaluation of whether an entity will remain

profitable after incurring the cost of pollution reduction including:

• revenues,

• cost of goods sold,
Table 4-1 CHECKLIST (Cont'd.)

STEPS INFORMATION THAT WILL BE REQUIRED FROM

APPLICANT

• portion of corporate overhead assigned to the entity, and

c. Secondary measures:

solvency, 

liquidity, and

leverage.

5. Determine whether impacts are widespread (Public Entities

Only):

a. Evaluate change in socioeconomic conditions that occur

as a result of compliance.

• total annualized pollution reduction project costs.

Information that will allow evaluation of the entity's ability to meet its

fixed and long-term obligations including:

• long-term debt,

• current debt,

• net income after taxes, and

• depreciation.

Information that will allow evaluation of how easily an entity can pay its

short-term bills such as:

• current assets,

• current liabilities, and

• total annualized pollution reduction project costs.

Information that will allow evaluation of the extent to which a firm

already has fixed financial obligations and therefore how much money

it will be able to borrow including, long-term liabilities and owner equity.

Information on changes in median household income, community

unemployment rate, overall net debt as a percent of full market value of

taxable property, percent of households below the poverty line, impact

on community development potential, and impact on community
Table 4-1 CHECKLIST (Cont'd.)

STEPS INFORMATION THAT WILL BE REQUIRED FROM

APPLICANT

6. Determine whether impacts are widespread (Private Entities

Only):

a. Define community,

b. Evaluate effect on employment,

c. Evaluate effect on tax revenues,

d. Assess impairment of development opportunities,

e. Collect any relevant additional information that

demonstrates widespread socioeconomic impacts.

7. Evaluate economic benefits of cleaner water.

8. Public comment and debate period.

property values resulting from compliance.

Information on the geographical boundary of the area in which the

majority of the entity's workers live and where most of businesses that

depend on the entity are located.

Current unemployment, change in unemployment due to investment in

pollution reduction.

Information on the likely effect on assessed value of property tax

revenues if the entity must adopt pollution reductions.

Information on the likelihood that the need to adopt pollution reductions

in the affected community would discourage other businesses from

locating in the area in the future.

Any additional information that suggests that there are unique conditions

in the affected community that should also be considered.

Information on potential benefits of cleaner water including enhanced

recreational opportunities, reduced treatment costs for downstream users

and increased property values.

Be prepared to supply backup information on the application to modify
Table 4-1 CHECKLIST (Cont'd.)

STEPS INFORMATION THAT WILL BE REQUIRED FROM

APPLICANT

9. If substantial and widespread economic and social impacts are or change a designated use to the public.

demonstrated, determine which pollution reduction option should

be implemented. Information on the cost and efficiency of affordable pollution reduction

10. Redesignate uses.

11. Standards will be adopted to protect new uses.

12. Effluent limits and permits will be modified. uses.

13. Re-evaluate water quality standards in three years. the "affordable" pollution reduction technique.

alternatives.

Uses will be determined by the level of "affordable" pollution reduction.

Once uses are established, standards should be revised to protect those

Limits will be modified to reflect effluent concentrations associated with

Per federal regulations, water quality standards must be revised every

three years to determine if there is any new information or technology

that allows attainment of the full designated uses without causing a

substantial and widespread economic and social impact.
Economic Guidance for Water Quality Standards 5-1

5. ANTIDEGRADATION: ROLE OF ECONOMIC ANALYSIS

Under the Water Quality Standards program, each State must develop, adopt and

retain a statewide antidegradation policy and establish procedures for its implementation.

The antidegradation policy is intended to protect current water quality; in only a limited

set of cases can economic grounds be used to allow for a lowering of water quality. In

particular, if the quality of the water exceeds levels necessary to support the propagation

of fish, shellfish, and wildlife and recreation in and on the water (i.e. "high-quality

water"), then economic considerations can be taken into account. Before any lowering

of water quality in high-quality waters, however, an antidegradation review must

determine that the lowering is necessary in order to accommodate important economic or

social development in the area in which the waters are located. 

Antidegradation is not a "no growth" rule and was never designed nor intended to be

one. It is a policy that allows the public to make decisions about important environmental

actions. Where the State intends to provide for development, it may decide that some

lowering of water quality in "high-quality waters" is necessary to accommodate important

economic or social development. Any such reduction in water quality, however, must

protect existing uses fully and must satisfy the requirements for intergovernmental

coordination and public participation. 

While the terminology is different, the tests to determine substantial and widespread

economic impacts (used when removing a use or granting a variance) are basically the

same as those used to determine if there might be interference with an important social

and economic development (antidegradation). As such, antidegradation analysis is the

mirror image of the analyses described in Chapters 2, 3 and 4. Variances and downgrades

refer to situations where additional treatment needed to meet standards may result in

worsening economic conditions; while antidegradation refers to situations where lowering

water quality may result in improved social and economic conditions.

When performing an antidegradation review, the first question is whether the pollution

controls needed to maintain the high-quality water will interfere with the proposed

development. If not, then the lowering of water quality is not warranted. If, on the other

hand, the pollution controls will interfere with development, then the review must show

that the development would be an important economic and social one. These two steps

rely on the same tests as the determination of substantial and widespread impacts. It

should be stressed at the outset that substantial economic impacts does not mean driving

profits to zero, nor precluding all other municipal expenditures.

The following sections describe the steps involved in performing an economic impact

analysis as part of an antidegradation review. These steps are outlined in Figure 5-1. The

analytic approach presented here can be used for a variety of public-sector and privatesector entities, including POTWs, commercial, industrial, residential and recreational land
Economic Guidance for Water Quality Standards 5-2

uses, and for point and nonpoint sources of pollution. The guidance provided in this

chapter, however, is not meant to be exhaustive. The State and/or EPA may require

additional information or tests. In addition, the applicant should feel free to include any

additional information they feel is relevant. The steps described in further detail in the

rest of the chapter are:

Verify Project Costs and Calculate the Annual Cost of the Pollution Control

Project - This section describes the factors considered when verifying that the

proposed pollution control project is the most appropriate solution and the type of

information that should be provided about the proposed project. It discusses how

to annualize capital costs of the project and calculate total annual costs of the

pollution control project.

Determine if Requirements would Interfere with Development (i.e., lower

water quality is "necessary") - This section describes the types of financial tests

that should be used to determine if maintaining the high-quality water would

interfere with the development.

Determine if Economic and Social Development would be Important - This

section presents factors to be considered in determining whether the development

would be important from an economic and social point of view. 

These steps closely parallel the analytic techniques presented in Chapters 2, 3, and 4.

These chapters should be read for more detail.

5.1 Verify Project Costs and Calculate The Annual Cost of the Pollution Control

Project

 

Before the impact analysis can be performed, the project costs should be verified and

the annual costs calculated. Both private-sector and public-sector entities should consider

a broad range of discharge management options including pollution prevention, end-ofpipe treatment, and upgrades or additions to existing treatment.

Whatever approach, the discharger must demonstrate that the proposed project is the

most appropriate means of meeting water quality standards and must document project

cost estimates. If there is at least one of the treatment alternatives that allows the

applicant to maintain high-quality water without incurring substantial impacts, then they

have failed to show that the requirements would interfere with the development. Cost

information, and the assumptions underlying the cost estimates, should be supplied on

Worksheet O.

The following two sections (5.1.a and 5.1.b) discuss analyzing public-sector projects.

Section 5.1.c discusses private sector projects.
Economic Guidance for Water Quality Standards 5-3

5.1.a Public-Sector Developments: Calculate the Annual Costs of the Pollution

Control Project

Since capital costs typically will be paid over several years, annualized costs are used

in the evaluation of economic burden to the community. The capital portion of publicsector project costs is typically financed over approximately 20 years, by issuing a

municipal debt instrument such as a general obligation bond or a revenue bond.

The calculation of total annualized cost of the project is presented in Worksheet P.

First, capital costs are summed and the portion of costs to be paid for with grant monies

are deducted, as these costs will not need to be financed. Next, the annualization factor

is calculated using the formula supplied on Worksheet P, or the annualization factor is

found in Appendix B. Annualized capital cost is then calculated by multiplying the total

capital costs to be financed by the annualization factor.

The interest rates used to annualize costs are dependent on the type of debt instrument

used as well as the issuer's credit standing. Therefore, the interest rate used on

Worksheet P reflects the debt instrument (i.e. municipal bond, commercial bank loan,

state revolving fund loan, or other instrument) likely to be used by the municipality.

Next, annual operating and maintenance costs are added to the annualized capital cost.

O&M costs should include the costs of monitoring, inspection, permitting fees, waste

disposal charges, repair, administration, replacement, and any other recurring costs. All

recurring costs should be stated in terms of dollars per year. The sum of the annualized

capital cost and total annual operating and maintenance costs is the total annual cost of

the project.

5.1.b Public-Sector Developments: Calculate Total Annualized Pollution Control

Costs Per Household

To assess the burden that total pollution control costs are expected to have on

households, an average annualized pollution control cost per household should be

calculated for all households in the community that would bear project costs. In order to

evaluate substantial impacts, therefore, the analysis must establish which households will

actually pay for pollution control and what proportion of the costs will be borne by

households. Then, these apportioned project costs are added to existing pollution control

costs paid by the households.

It is important to define the affected community. The "community" is the

governmental jurisdiction or jurisdictions responsible for paying compliance costs.

If project costs were estimated for some prior year, these costs should be adjusted

upward to reflect current year prices using the average annual national Consumer Price
Economic Guidance for Water Quality Standards 5-4

Index (CPI) inflation rate for the period. The CPI inflation rate is available from the

Bureau of Labor Statistics. An additional source reporting the CPI inflation rate is the

CPI Detailed Report, which is published monthly by the U.S. Department of Labor,

Bureau of Labor Statistics.

In calculating the total annual cost of pollution control per household, current costs

of pollution control must be considered along with the projected annual costs of the

proposed pollution control project. The existing cost per household usually can be

obtained from the most recent municipal records. For example, use the most recent

operating revenues of the sewer enterprise fund, divided by the number of households

served. If the portion of proposed project costs that households are expected to pay is

known or is expected to remain unchanged, then use Worksheet Q to calculate the total

annual cost of pollution control per household. If the portion paid by households is based

on flow, then should refer to Worksheet Q: Option A as well.

5.1.c Private-Sector Entities: Calculate the Annual Costs of the Pollution Control

Project

As with public-sector investments, the total capital costs are usually spread out over

several years. Annualization calculates the amount that will be paid each year, including

the financing costs. In order to allow for comparisons across cases, the analysis should

assume that the applicant will borrow the capital and repay the loan in even annual

installments over a 10 year period. The assumption of ten years is based on the likely life

of the equipment. The assumption of even annual installments is made for convenience.

The interest rate on the loan should be equivalent to the rate the applicant pays when it

borrows money.

The financial tests discussed below compare the costs of compliance to other costs and

revenues of the applicant. Compliance costs and other costs and revenues must, therefore,

be calculated for the same year. See discussion in Section 2.2, and Appendix A for

references to inflation/deflation indices. The Annualized Cost of Pollution Control for a

private-sector entity can be calculated using Worksheet R.

5.2 Financial Analysis to Determine if Lower Water Quality is "Necessary"

The purpose of the financial impact analysis is to assess the extent to which planned

development will be reduced as a result of maintaining water quality. There are two sets

of tests presented in this section: one set for publicly owned developments, such as

POTWs, and another for privately owned developments, such as new manufacturing

facilities. The tests are not designed to determine the exact impact of pollution control

costs on an entity. They merely provide indicators of whether pollution control costs

would result in a substantial impact.
MunicipalPreliminaryScreener

AverageTotalPollutionControlCostperHousehold

MedianHouseholdIncome

Economic Guidance for Water Quality Standards 5-5

5.2.a Public-Sector Developments: Calculate and Evaluate the Municipal

Preliminary Screener Value

Whether or not maintaining high-quality water is likely to interfere with a

development due to additional public-sector costs is determined by jointly considering the

results of two tests. The first test is a "screener" to establish whether the community can

clearly pay for the project. The Municipal Preliminary Screener estimates the total per

household annual pollution control costs to be borne by households (existing costs plus

those attributable to the proposed project) as a percentage of median household income.

The screener is written as follows:

Median household income information for many municipalities is available from the

1990 Census of Population. To estimate median household income for the current year,

use the CPI inflation rate for the period between the year that median household income

is available and the current year.

Depending on the results of the screener, the community is expected to incur small,

mid-range, or large economic impacts (see Worksheet S). If the total annual cost per

household (existing annual cost per household plus the incremental cost related to the

proposed project) is less than 1.0 percent of median household income, then the

requirements are not expected to impose a substantial economic hardship on households

and would not interfere with the development.

Communities are expected to incur mid-range impacts when the ratio of total annual

compliance costs to median household income is between 1.0 and 2.0 percent. If the

average annual cost per household exceeds 2.0 percent of median household income, then

the project may place a large financial burden on many of the households within the

community and the requirements may interfere with the development. In either case,

communities move on to the Secondary Test to demonstrate substantial impacts.

5.2.b Public-Sector Developments: Secondary Test

The Secondary Test is designed to build upon the characterization of community

identified in the Municipal Preliminary Screener. The Secondary Test indicates the

community's ability to obtain financing and describes the socioeconomic health of the

community. Indicators describe precompliance debt, socioeconomic, and financial

management conditions in the community. Using these indicators and the scoring system
Economic Guidance for Water Quality Standards 5-6

described below, the impact of the cost of pollution control is estimated. Specifically,

applicants are required to present the following six indicators for the community:

Debt Indicators

Bond Rating (if available) - a measure of credit worthiness of the community;

Overall Net Debt as a Percent of Full Market Value of Taxable Property - a

measure of debt burden on residents within the community;

Socioeconomic Indicators

Unemployment Rate - a measure of the general economic health of the

community;

Median Household Income - a measure of the wealth of the community;

Financial Management Indicators

Property Tax Revenue as a Percent of Full Market Value of Taxable Property -

a measure of the funding capacity available to support debt based on the wealth

of the community; and

Property Tax Collection Rate - a measure of how well the local government is

administered.

A more detailed description of the six indicators is presented in Section 2.4, including

a discussion of alternative measures to use in States with property tax caps and limitations

on assessed values. Worksheet T can be used to estimate each of the indicators. Table

5-1 summarizes the indicators and what is considered to be a strong, mid-range, or weak

rating.

The Secondary Score is calculated for the community by weighting each indicator

equally and assigning a value of 1 to each indicator judged to be weak, a 2 to each

indicator judged to be mid-range, and a 3 to each strong indicator. A cumulative

assessment score is arrived at by summing the individual scores and dividing by the

number of factors used. Worksheet U guides the reader through this calculation. The

cumulative assessment score is evaluated as follows:

less than 1.5 is considered weak

between 1.5 and 2.5 is considered mid-range

greater than 2.5 is considered strong
Economic Guidance for Water Quality Standards 5-7

If the applicant is not able to develop one or more of the six indicators, they must

provide an explanation as to why the indicator is not appropriate or not available. Since

the point of the analysis is to measure the overall burden to the community, the debt and

socioeconomic indicators are assumed to be better measures of burden than the financial

management indicators. Consequently, if one of the debt or socioeconomic indicators is

not available, the applicant should average the two financial management indicators and

use this averaged value as a single indicator with the remaining indicators. This averaging

is necessary so that undue weight is not given to the financial management indicators.

5.2.d Public-Sector Developments: Assess Whether the Requirements Would

Interfere With the Development

The results of the two tests are considered jointly in determining whether the

community is expected to incur substantial impacts that would interfere with the

development. As shown in Table 5-2, the cumulative assessment score for the community

is combined with the estimated household burden. The combination of factors establishes

whether impacts can be expected to be substantial.

In the matrix, "X" indicates that the impact is likely to interfere with the development.

The closer the community is to the upper right hand corner of the matrix, the greater the

likelihood. Similarly, " " indicates that the impact is not likely to interfere with

development. The closer to the lower left hand corner of the matrix, the smaller the

likelihood. Finally, the "?" indicates that the impact is unclear.

5.2.e Private-Sector Developments: Financial Measures

Four general categories of financial tests are used to determine if maintaining highquality water will interfere with privately owned development. The four categories are

divided into a primary measure of financial impacts and three secondary measures of

financial impacts:

Primary Measure

Profit -- how much would profits decline due to pollution control expenditures?

Secondary Measures

Liquidity -- how easily can an entity pay its short-term bills?

Solvency -- how easily can an entity pay its fixed and long-term bills?

Leverage -- how much money can the entity borrow?

Profit and solvency ratios are calculated both with and without the additional compliance

costs (taking into consideration the entity's ability, if any, to increase its prices to cover
Profit Test Earnings Before Taxes

Revenues

Economic Guidance for Water Quality Standards 5-8

part or all of the costs). Comparing these ratios to each other and to industry benchmarks

provides a measure of the impact on the entity. Since antidegradation reviews involve

new or expanded operations, the ratios often will be calculated using estimated values

from pro-forma income statements and balance sheets prepared for the development.

For all of the tests, it is important to look beyond the individual test results and

evaluate the total situation of the entity. While each test addresses a single aspect of

financial health, the results of the four tests should be considered jointly to obtain an

overall picture. The results should be compared with the ratios for other entities in the

same industry or activity.

The primary and secondary measures are described below, along with an example of

specific tests to be used. While there are several ratios that could be used for each test,

to simplify the presentation only one ratio per test is described. In most cases, interpreting

the results requires comparisons with typical values for the industry. Among the sources

that provide comparative information are: Robert Morris Associates' Annual Statement

Studies, Moody's Industrial Manual, Dun and Bradstreet's Dun's Industry Norms, and

Standard & Poor's Industry Surveys. The Annual Statement Studies, Dun's Industry

Norms , and Standard & Poor's Industry Surveys provide composite statistics for firms

grouped into various manufacturing and service industries. The Moody's Industrial

Manual provides detailed financial information on individual firms that can be used for

comparison purposes. Each of the tests is discussed in more detail in Chapter 3.

5.2.f Private-Sector Developments: Primary Measure

Primary measure is the Profit Test, which measures the development's earnings if it

is required to provide pollution control necessary to maintain the high-quality waters and

if it is not required to do so. If maintaining high-quality water would result in

considerably lower profits, then the development might not take place.

Two pieces of information are needed for the Profit Test. The first piece is the total

annual cost of the required pollution control from Worksheet R. The second piece is the

earnings information from the entity's income statement (Worksheet V).

The Profit

Test should be

calculated with and without the cost of the pollution control. In the former case, the

annualized cost of pollution control (including O&M) is subtracted from the discharger's

estimated earnings before taxes (revenues minus costs excluding income taxes). The

Profit Test can be calculated using Worksheets V, and W. These profit rates should be
Current Ratio Current Assets

Current Liabilities

Economic Guidance for Water Quality Standards 5-9

compared to those for facilities in similar lines of business, using data in Moody's

Industrial Manual, Dun & Bradstreet's Industry Norms and Key Business Ratios,

Standard & Poor's Industry Surveys, or Robert Morris's Annual Statement Studies. 

The degree to which the discharger is able to raise prices is difficult to predict, and

depends on many factors. Considerations should include the level of competition in the

industry, the likelihood of competitors' facilities facing similar project costs, and the

willingness of consumers to pay more for the product.

5.2.g Private-Sector Developments: Secondary Measures

The following secondary measures provide additional important information about the

financial health of the development. All primary and secondary measures should be

included in the analysis.

Liquidity

Liquidity is a measure of how easily a discharger can pay its short-term bills. One

measure of liquidity is the Current Ratio, which compares current assets with current

liabilities. Current assets include cash and other assets that are or could reasonably be

converted into cash during the current year. Likewise, current liabilities are items that

must be paid within the current year.

The Current Ratio is calculated by dividing current assets by current liabilities.

The Current Ratio can be calculated using Worksheet X. The general rule is that if the

Current Ratio is greater than 2, the entity should be able to cover its short-term

obligations. Frequently, lenders require this level of liquidity as a prerequisite for

lending. This rule (Current Ratio > 2) may not, however, be appropriate for all types of

private entities. The Current Ratio of the discharger in question should be compared with

ratios for other dischargers in the same line of business.

Solvency

Solvency is a measure of an entity's ability to meet its fixed and long-term obligations.

These obligations are bills and debts that are owed on a regular basis for periods longer

than one year. Solvency tests are commonly used to predict financial problems that could

lead to bankruptcy within the next few years.
Beaver s Ratio Cash Flow

Total Debt

Debt/Equity Ratio Long Term Liabilities

Owners Equity

Economic Guidance for Water Quality Standards 5-10

As with liquidity, there are several possible tests for solvency. One solvency test, the

Beaver's Ratio, compares cash flow to total debt. This test has been shown to be a good

indicator of the likelihood of bankruptcy.

The Beaver's Ratio can be calculated using Worksheet Y. Cash Flow is a measure

of the cash the entity has available to it in a given year. Since depreciation is an

accounting cost -- a cost that does not use any currently available revenues -- it is added

back to reported net income after taxes to get cash flow. Total debt is equal to the current

debt for the current year plus the long term debt, since current debt includes that part of

long-term debt that is due in the current year.

If the Beaver's Ratio is greater than 0.20 the development is considered to be solvent

(i.e., can pay its long-term debts). If the ratio is less than 0.15 the development may be

insolvent (i.e., go bankrupt). If the ratio is between 0.15 and 0.20, then future solvency

is uncertain.

Leverage

Leverage tests measure the extent to which a firm has fixed financial obligations and

thus indicates how much more money a firm is capable of borrowing. Firms that rely

heavily on debt may find it difficult and expensive to borrow additional funds. One

commonly used measure of leverage is the Debt to Equity Ratio.

The Debt to Equity Ratio can be calculated using Worksheet Z. Since there are no

generally accepted Debt/Equity Ratio values that apply to all types of economic activity,

the ratio should be compared with the ratio of firms in similar businesses. If the entity's

ratio compares favorably with the median or upper quartile ratio for similar businesses,

it should be able to borrow additional funds. These ratios can be calculated using data in

Robert Morris Associates' Annual Statement Studies, Moody's Industrial Manual, and Dun

& Bradstreet's Dun's Industry Norms. 

For entities with special sources of funding, leverage is not an appropriate measure of

their ability to raise capital. Examples are agriculture and affordable housing, where

special loan programs may be available. In these cases, an analysis of the probability that

the project would receive this money is appropriate.
Economic Guidance for Water Quality Standards 5-11

5.2.g Private-Sector Developments: Assess Whether the Requirements Will

Interfere With the Development: Interpreting the Results

The financial analysis should be used to determine if there will be a substantial

adverse impact such as to interfere with the development. If the four tests taken together

indicate that the requirements would interfere with the development, then proceed to

Section 5.3 to determine if the development would be considered important in social and

economic terms.

5.3 Determine If Economic and Social Development Would Be Important

There are no economic ratios per se that determine whether a development would be

considered important. Instead, the relative magnitudes of indicators such as increases in

unemployment, losses to the local economy, changes in household income, decreases in

tax revenues, indirect effects on other businesses, and increases in sewer fees should be

taken into account. The term important is intended to convey a general concept regarding

the level of social and economic development used to justify a change in high-quality

waters.

5.3.a Define Relevant Geographical Area

One important factor is defining the geographical area in which the impacts will occur.

In the case of municipal pollution control projects, the affected community is most often

the immediate municipality. The relevant geographic area for evaluating the importance

of a private-sector development varies with each situation. The area will typically be

determined by the area in which the majority of its workers live and where most of the

businesses that depend on it are located. In either case, the geographical area considered

must include "...the area in which the waters are located." (40 CFR 131.12 (a)(2)) There

are no simple rules for defining the relevant area or community; the decision is based on

the judgement of the applicant and state, subject to EPA review.

5.3.b Public-Sector Developments: Determine Whether Important

While there are no explicit criteria, it is recommended that changes in the

socioeconomic indicators listed below be considered. For each indicator listed, the

applicant should estimate the potential change that would result from the development.

Median Household Income;

Community Unemployment Rate;

Overall Net Debt as a Percent of Full Market Value of Taxable Property;

Percent of Households Below Poverty Line;

Impact on Community Development Potential; and

Impact on Property Values.
Economic Guidance for Water Quality Standards 5-12

Estimated changes should be provided, along with supporting discussions, on Worksheet

AA. 

5.3.c Private-Sector Developments: Determine Whether Important

Determination of whether or not a private-sector development will be important to a

community requires exploring more factors than is the case with public-sector

developments. Worksheet AB has been provided to assist applicants in their evaluation

of socioeconomic impacts. It is designed as a list of the factors applicants should consider

in determining whether the development is important. Applicants should feel free,

however, to add anecdotal information to describe any current community characteristics

or anticipated impacts that are not listed in the worksheet.

Potentially, one of the most important impacts on the affected community's economy

is the employment to be gained. The size of this impact is dependent on the number of

new jobs relative to the total number of jobs in the community, and to the other job

opportunities available in the community. Typically, an increase in employment leads to

an increase in personal income in the affected community. The total amount of income

gained by the affected community will depend, in part, on the other job prospects of those

hired. To assess the net impact on employment in the affected community, the existing

rate of unemployment should be considered as an indicator of worker mobility between

jobs. 

The analysis should also consider whether the increase in employment opportunities

may lead to a decreased need for social services in the affected community. If the cost

of savings for decreased social services will be borne by the affected community, they

should be included in the assessment.

The effects of increased employment and personal income will be compounded as the

money moves through the economy. This multiplier effect means that each dollar gained

to an employee results in the gain of more than a dollar to the local economy. Multiplier

effects are discussed in more detail in Section 4.4.

Socioeconomic impacts may also include effects on the local government(s) such as

property tax revenues and the demand for other public services. For example, if the

development would be paying a share of the cost to upgrade a municipal treatment plant,

then the analysis of community impacts is more complicated. If the development is

eliminated, the system may become excessively expensive for the remaining users.

5.4 Summary

Using the guidance described in this document, the applicant must demonstrate that

the pollution control measures needed to maintain the high-quality waters will interfere
Economic Guidance for Water Quality Standards 5-13

with the development. In addition, the applicant will have to show that the development

is important to the community.

The tests used to demonstrate interference and importance are the same as those used

to demonstrate substantial and widespread. The difference is, however, that an

antidegradation review considers situations that would improve the economic condition.
Verify Pollution Control

Costs and Calculate

Annual Costs

Capital Cost, Annual

O&M Costs, Interest Rates

Determine of

Development is

Important

Socio-economic

characteristics of

community

Determine if Maintaining

High-Quality Waters Will

Interfere with

Development

Annual Cost, Median

Household Income,

Financial Data

Figure 5-1:

Antidegradation Review

No Degradation

Allowed

Quality of water may be

reduced as long as existing

and designated uses fully

protected

No 

No Degradation

Allowed

Yes

No 

Economic Guidance for Water Quality Standards
TABLE 5-1

SECONDARY INDICATORS

Secondary Indicators

Indicator Weak Mid-Range Strong

Bond Rating Below BBB (S&P) BBB (S&P) Above BBB (S&P)

Below Baa (Moody's) Baa (Moody's) or Baa (Moody's)

Overall Net Debt as

Percent of Full Market Above 5% 2%-5% Below 2%

Value of Taxable

Property

Unemployment More than 1% above National Average More than 1% below

National Average National Average

Median Household More than 10% below State Median More than 10%

Income State Median above State Median

Property Tax

Revenues as a Percent

of Full Market Value Above 4% 2%-4% Below 2%

of Taxable Property

Property Tax

Collection Rate < 94% 94% - 98% > 98%
Economic Guidance for Water Quality Standards 5-1

TABLE 5-2

ASSESSMENT OF SUBSTANTIAL IMPACTS MATRIX

Secondary Score Percent Percent

Municipal Preliminary Screener

Less than 1.0 Percent Between 1.0 and 2.0 Greater than 2.0

Less than 1.5 ? X X

Between 1.5 and 2.5 ? X

Greater than 2.5 ?
APPENDIX A

DATA RESOURCES AND REFERENCE

MATERIALS
APPENDIX A

Cost Estimation Resources:

U.S. EPA, Construction Costs for Municipal Wastewater Treatment Plants: 1973-1978,

EPA/430/9-80-003, April, 1980.

U.S. EPA, Technical Report: Operation and Maintenance Costs for Municipal Wastewater

Facilities, EPA/430/9-81-004, September, 1981.

U.S. EPA, Construction Costs for Municipal Wastewater Conveyance Systems: 1973-1979,

EPA/430/9-81-003, January, 1981.

U.S. EPA, Quarterly Indices of Direct Costs for Operation, Maintenance and Repair: (a) Waste

Pumping Stations, (b) Gravity Sewers, Office of Municipal Pollution Control, Municipal

Facilities Division, Current.

Municipal Statistics Resources:

Bureau of the Census, U.S. Department of Commerce, County and City Data Book, published

annually.

Financial and Ratio Analysis Resources:

Leopold A. Bernstein, The Analysis of Financial Statements, Dow Jones-Irwin, 1978.

Dun & Bradstreet, Dun's Industry Norms, annual.

J. Fred Weston and Eugene F. Brigham, Managerial Finance, The Dryden Press, several

editions.

Robert Morris Associates, Annual Statement Studies, annual.

Moody's Financial Services, Moody's Industrial Manual, annual.

U.S. Department of Labor, Bureau of Labor Statistics, CPI Detailed Report.

U.S. EPA, EPA Financial Capability Guidebook, Office of Water Programs Operations, 1984.

U.S. EPA, The Municipal Sector Study: Impacts of Environmental Regulations on Municipalities,

EPA 230-09-038, Office of Policy, Planning and Evaluation, September 1988.
Interest Rate

Year 0.5% 1.0% 1.5% 2.0% 2.5% 3.0% 3.5% 4.0% 4.5%

1 1.0050 1.0100 1.0150 1.0200 1.0250 1.0300 1.0350 1.0400 1.0450

2 0.5038 0.5075 0.5113 0.5150 0.5188 0.5226 0.5264 0.5302 0.5340

3 0.3367 0.3400 0.3434 0.3468 0.3501 0.3535 0.3569 0.3603 0.3638

4 0.2531 0.2563 0.2594 0.2626 0.2658 0.2690 0.2723 0.2755 0.2787

5 0.2030 0.2060 0.2091 0.2122 0.2152 0.2184 0.2215 0.2246 0.2278

6 0.1696 0.1725 0.1755 0.1785 0.1815 0.1846 0.1877 0.1908 0.1939

7 0.1457 0.1486 0.1516 0.1545 0.1575 0.1605 0.1635 0.1666 0.1697

8 0.1278 0.1307 0.1336 0.1365 0.1395 0.1425 0.1455 0.1485 0.1516

9 0.1139 0.1167 0.1196 0.1225 0.1255 0.1284 0.1314 0.1345 0.1376

10 0.1028 0.1056 0.1084 0.1113 0.1143 0.1172 0.1202 0.1233 0.1264

11 0.0937 0.0965 0.0993 0.1022 0.1051 0.1081 0.1111 0.1141 0.1172

12 0.0861 0.0888 0.0917 0.0946 0.0975 0.1005 0.1035 0.1066 0.1097

13 0.0796 0.0824 0.0852 0.0881 0.0910 0.0940 0.0971 0.1001 0.1033

14 0.0741 0.0769 0.0797 0.0826 0.0855 0.0885 0.0916 0.0947 0.0978

15 0.0694 0.0721 0.0749 0.0778 0.0808 0.0838 0.0868 0.0899 0.0931

16 0.0652 0.0679 0.0708 0.0737 0.0766 0.0796 0.0827 0.0858 0.0890

17 0.0615 0.0643 0.0671 0.0700 0.0729 0.0760 0.0790 0.0822 0.0854

18 0.0582 0.0610 0.0638 0.0667 0.0697 0.0727 0.0758 0.0790 0.0822

19 0.0553 0.0581 0.0609 0.0638 0.0668 0.0698 0.0729 0.0761 0.0794

20 0.0527 0.0554 0.0582 0.0612 0.0641 0.0672 0.0704 0.0736 0.0769
APPENDIX C

CONCEPTUAL MEASURES 

OF ECONOMIC BENEFITS
Economic Guidance for Water Quality Standards
Economic Guidance for Water Quality Standards

APPENDIX C

CONCEPTUAL MEASURES 

OF ECONOMIC BENEFITS

In valuing benefits associated with an ecological resource such as clean water, a basic

distinction is made between the intrinsic value of the existence of the resource and its

value in use by the human population. Use values are further subdivided into direct or

indirect uses. Other valuation concepts arise from the uncertainty surrounding future uses

and availability of the resource. A classification of these valuation concepts, along with

examples, is presented in Table C-1.

C.1 Use Benefits

Estimating the benefits of clean water will depend upon several variables that describe

the attributes of the resource and its uses. A waterbody might be used for recreational

activities (such as fishing, boating, swimming, hunting, bird watching), for commercial

purposes (such as industrial water supply, irrigation, municipal drinking water, and fish

harvesting), or for both. Where recreational activities are created or enhanced due to

water quality improvements, the public will benefit in the form of increased recreational

opportunities. Similarly, the cost of treating irrigation and drinking water to down stream

users could be reduced if pollutant discharges were reduced or eliminated in a particular

stretch of river.

Direct use includes both consumptive and non-consumptive uses. Consumptive uses

can be distinguished from non-consumptive uses in that the former excludes other uses

of the same resource while the latter does not. For example, water is consumed when it

is diverted from a waterbody for irrigation purposes. With non-consumptive uses,

however, the resource base remains in the same state before and after use (e.g.,

swimming). Human health benefits associated with cleaner water could be consumptive

(reduced illness from eating finfish or shellfish) or non-consumptive (reduced exposure

to infectious diseases while recreating).

When estimating benefits, it is important to determine whether or not the resource and

its uses (in this case clean water) can be considered market or non-market resources and

uses (i.e., does a market exist for the resource or its use). For example, commercial

fisheries have a market value reflected by the financial value of landings of a particular

species. By contrast, no market exists to describe the value individuals receive from

swimming. Where market values are available, they should be used to estimate benefits.

In the case of water supply, there may or may not be a market for clean water. Some

water users may be required to pay for that use as in the case of a farmer paying a regional
Economic Guidance for Water Quality Standards

water board to divert water for irrigation purposes. This will be particularly true in the

arid west. By contrast, a manufacturing facility using water for cooling or process water

may not pay anything for the right to pump and use water from an adjacent river. For

resources with no market value, a number of estimation techniques including the travel

cost, estimation from similar markets, and contingent valuation methods have been

developed.

While they are conceptually distinct attributes, consumptive use is frequently

associated with markets and non-consumptive use is frequently associated with nonmarket situations. Some resources that are considered market resources, however, may

be used non-consumptively. The converse is also true. As an example of the first, a fee

may be charged (other than parking) to gain entrance to a state park, however, while a

swimmer's use of a lake in the park is not consuming any part of the lake.

Commercial activities that are dependent on clean water which is not directly owned

are said to benefit from indirect use. Examples would be a fishing equipment

manufacturer's dependence on healthy fish stocks to induce demand for its products or the

dependence of property values on the pristine condition of an adjacent water body.

Indirect use is also characterized by the scenic views and water enhanced recreational

opportunities (camping, picnicking, birdwatching) associated with the quality of water in

a water body. Indirect use benefits such as enhanced property values can be estimated

using the hedonic price technique. Care should be taken, however, to not double-count

benefits. If property values reflect the proximity to and thus use of water, then the value

of the use should not be included separately.

C.2 Intrinsic Benefits

Intrinsic benefits include all benefits associated with a resource that are not directly

related to the current use of the resource. Intrinsic benefits are represented by the sum of

existence and option values. Existence value indicates an individual's (and society's)

willingness to pay to maintain an ecological resource such as clean water for its own sake,

regardless of any perceived or potential opportunity for that individual to use the water

body now or in the future. Contributions of money to save endangered species such as

the snail darter demonstrate a willingness to pay for the existence of an environmental

amenity despite the fact that the contributors may never use it or even experience it

directly.

Option value is the willingness to pay for having a future opportunity to use resources

such as clean water in known or as yet unknown ways. In a sense it is a combination of

insurance and speculative value. Individuals routinely pay to store or transport something

they are not sure they will use in the future because they recognize it would be more

costly to recreate the item than to preserve it. In an ecological sense, pristine habitats and

wildlife refuges are often preserved under the assumption that plant or animal species
Economic Guidance for Water Quality Standards

which may yield pharmaceutical, genetic, or ecosystem benefits are yet to be discovered.

Option value takes on particular importance when proposed development or

environmental perturbations are largely irreversible or pollutants are persistent. Intrinsic

benefits are difficult to measure due to the level of uncertainty associated with these

benefits. The most common approach to estimating intrinsic benefits, however, is the

contingent valuation method, which cannot be described in detail within this short

overview.

C.3 Summary

Total valuation of clean water benefits includes all use and existence values as well as

option value. The proper framework for estimating the economic benefits associated with

clean water consists of 1) determining when damage first occurs or would occur; 2)

identifying and quantifying the potential physical/biological damages relative to an

appropriate baseline; 3) identifying all affected individuals both due to potential loss of

direct or indirect services or uses, and to potential losses attributable to existence values

(may include projections for growth in participation rates); 4) estimating the value

affected individuals place on clean water prior to potential degradation; and 5)

determining the time horizon over which the waterbody would be degraded or restored

to some maximum reduced state of service (if ever), and appropriately discounting the

stream of potential lost services. If evaluating an improvement in water quality, the

procedures are the same except that benefits gained are measured.
Economic Guidance for Water Quality Standards

TABLE C-1

CATEGORIES OF BENEFITS

Use Benefits

Direct

Consumptive:Market Benefits

Industrial Water Supply

Agricultural Water Supply

Municipal Water Supply

Commercial Fishing

Non-Market Benefits

Recreational Fishing

Hunting

Industrial Water Supply

Agricultural Water Supply

Municipal Water Supply

Non-Consumptive:Swimming

Boating

Human Health

Indirect

Fishing Equipment Manufacturer

Property Values

Aesthetics (scenic views, water enhanced recreation)

Intrinsic Benefits

Option Value (access to resource in future)

Existence Value (knowledge that services of resource exist)