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APPENDIX 12A. GOVERNMENT REGULATOR Y IMPACT MODEL (GRIM )
OVERVIEW

TABLE OF CONTENTS

12A.1 INTRODUCTION AND PUR POSE

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12A.2 MODEL DESCRIPTION

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12A.3 DETA ILED CASH FLOW EXAMP LE

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12A.4 USER INPUT SELECTION

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APPENDIX 1 2 A

. GOVERNMENT REGULATORY IMPACT MO DEL (GRIM)
OVERVIEW

12A.1 INTRODUCTION AND PURPOSE

The purpose of the Government Regulatory Impact Model (GRIM) is to help quantify the impacts of energy conservation standards and other regulations on manufacturers. The basic mode of analys is is to estimate the change in the value of the industry or manufacturers(s) following a regulation or a series of regulations. The model structure also allows an analysis of multiple products with regulations taking effect over a period of time, and of m ultiple regulations on the same products.

Industry net present value is defined, for the purpose of this analysis, as the discounted sum of industry free cash flows plus a discounted terminal value. The model calculates the actual cash flows by year and then determines the present value of those cash flows both without an energy conservation standard ( i.e. , the base case) and under different trial standard levels (TSLs) ( i.e. , the standards case).

Output from the model consists of summary financial metri cs, graphs of major variables, and, when appropriate, access to the complete cash flow calculation.

12A.2 MODEL DESCRIPTION

The basic structure of the GRIM is a standard annual cash flow analysis that uses manufacturer selling prices, manufacturing costs, a ship ments forecast, and financial parameters as inputs and accepts a set of regulatory conditions as changes in costs and investments. The cash flow analysis is separated into two major blocks: income and cash flow. The income calculation determines net operat ing profit after taxes. The cash flow calculation converts net operating profit after taxes into an annual cash flow by including investment and non

- cash items. Below are definitions of listed items on the printout of the output sheet (see Section 12A.6.3)

.

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

(2) Revenues: Annual revenues

- computed by multiplying products’ unit prices at each efficiency level by the appropriate manufacturer markup;

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

- time;

(4) Material: The portion of COGS that includes materials;1 2A

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(5) Overhead: The portion of COGS that includes indirect labor, indirect material, energy use, maintenance, depreciation, property taxes, and insurance related to assets. While included in overhead, the depreciation is shown as a separate line item;

(6) Depreciati on: The portion of overhead that includes an allowance for the total amount of fixed assets used to produce that one unit. Annual depreciation computed as a percentage of
COGS. While included in overhead, the depreciation is shown as a separate line item;

(7) Stranded Assets: In the year the standard becomes effective, a one

- time write

- off of stranded assets is accounted for;

(8) Standard SG&A: Selling, general, and administrative costs are computed as a percentage of Revenues (2) ;

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

(10) Product Conversion Costs : Product conversion costs are one

- time investments in research, development, testing, marketing, and other costs focused on maki ng products designs comply with the new energy conservation standard. The GRIM allocates these costs over the period between the standard’s announcement and compliance dates;

(11) Earnings Before Interest and Taxes (EBIT): Includes profits before deductions fo r interest paid and taxes;

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

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

.

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

, SG&A ( 8 )

, R&D ( 9 )

, Product Conversion Costs (10 ) , and Taxes (13)
from Revenues (2)

.

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

(16) Depreciation repeated : Depreciation and Stranded Assets are added back in the Statement of Cash Flows because they are non

- cash expenses;

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

(18) Cash Flow From Operations : Calculated by taking NOPAT (15) , adding back no n

- cash
items such as a Depreciation (16) , and subtracting the Change in Working Capital (17) ;1 2A

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(19) Ordinary Capital Expenditures: Ordinary investments in property, plant, and equipment to maintain and replace existing production assets, computed as a percentage of Revenues (2) ;

(20) Capital Conversion Costs : Capital conversion costs are one

- time investments in property, plant, and equipment to adapt or change existing production facilities so that new product designs can be fabricated and assembled under the new regu lation; The GRIM allocates these costs over the period between the standard’s announcement and compliance dates;

(21) Capital Investment: Total investments in property, plant, and equipment are computed by adding Ordinary Capital Expenditures (19) and Capital Conversion Costs (20) ;

(22) Free Cash Flow: Annual cash flow from operations and investments; computed by subtracting Capital Investment (2 1 ) from Cash Flow from Operations (18) ;

(23) Terminal Value: Estimate of the continuing value of the industry after the analysis period. Computed by growing the Free Cash Flow at the beginning of 2045 at a constant rate in perpetuity;

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

(25) Discounted Cash Flow: Free Cash Flows (2 2 ) multiplied by the Present Value Factor (2 4 ) . For the end of 2043, the discounted cash flow includes the discounted Terminal Value (2 3 ) ; and

(26) Industry Value thru the end of 2043 : The sum of Discounted Cash Flows (2 5 )

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12A.3 DETAILED CASH FLOW E XAMPLE1 2A

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12A.4 USER INPUT SELECTION

The GRIM produce s results for a range of industry assumptions. While the model can be altered by editing cells in Excel, m any scenario s can be achieved with the clickable options in the User Inputs section of the GRIM. By selecting different assumptions, the model automatically updates calculations. Result summaries can be generated using the blue button in the User Inputs secti on of the GRIM

1. Scenario Selection In this area of the spreadsheet

, u sers select a set of scenario s to model

. The “Active Mode Trial Standard Level” dropdown allows users to determine how energy efficiency TSLs impact industry valu e

. Seven TSLs and the baseline are available for selection. The “Economic Growth Scenario” dropdown allows users to determine how different forecasts of industry growth and shipments affect industry value. For the central air conditioner and heat pump and fur nace rulemaking, only one economic growth scenario (listed as “Reference”) is available

. The “Markup Scenario” allows users to model different markup assumptions

. Three markup scenarios are available to represent a range of potential impacts on the industr y.

Note that the rulemaking evaluates the impact standby mode and off mode standards and energy efficiency standards independently. When active mode standards, please ensure that the standby mode and off mode TSL is set to “None” in order to reproduce the values reported in the
direct final rule documents. See the bullet titled “Standby Mode and Off Mode Selection” below
for more detail.

2. Financial Parameters1 2A

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In this area of the spreadsheet, users assign the financial parameters applied in the GRIM
calcul ations

. Users can modify the period of analysis, financial metrics , and industry financing assumptions. For the rulemaking analysis , the financial parameters are set to the values derived in chapter 12 of the TSD.

3. Product Selection In this area of the spreadsheet, users can specify the equipments classes being included in
the GRIM results. The direct final rule n otice and the TSD chapters report GRIM results for the industry as a whole as well as for sub

- groups. The conventional prod ucts subgroup includes split

- system air conditioning, split

- system heat pump s , single package air conditioning, single package heat pump s , and non

- weatherized gas furnace s . The niche products subgroup includes
mobi le home furnace s and oil furnace s

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Not e that the electric furnace product class is only intended for use with the sta ndby mode and off mode analysis.

4. Standby Mode and Off Mode Selection In this area of the spreadsheet, users can determine how different standby mode and off mode TSLs impact i ndustry value. Three TSLs and no standard (listed as “None”) are available
for selection. N ote that the rulemaking evaluates the impact standby mode and off mode standards and energy efficiency standards independently. When evaluating standby mode and off mode standards, setting the active mode TSL is set to “Baseline” will reproduce the values reported in the direct final rule documents.

5. Summary Table Buttons In this area of the spreadsheet, there are two macros avai lable. The first macro populates a summary table of INPV results based on the economic scenario, markup scenario, and financial parameters for each active mode TSL. The second macro populates a summary table of INPV results based on the economic scenario, markup scenario, and financial parameters for each standby mode and off mode TSL.

By clicking the blue button labeled “ Calculate INPV r esults for active mode TSLs for the selected markup scenario

, ” results are populated in the table on the tab labeled “Summary Report (RESULTS)”. By clicking the blue button labeled “ Calculate INPV r esults for Standby/Off mode TSLs for the selected markup scenario”, results are populated in the table on the tab labeled

“ Offmode Summary

. ”