There are generally three reasons for businesses to incorporate green technologies in their operations:
To act as a good corporate citizen and demonstrate concern for the environment
To comply with regulatory requirements that mandate environmental actions
To support and implement technologies which can, over time, reduce operating costs.
Due to high initial price premiums, some green technologies, such as hybrid vehicle powertrains, may not provide adequate long-term return on investment (ROI) to justify their purchase on a purely financial basis. Other green initiatives provide an immediate return, such as energy use reduction and recycling. However, as environmental and regulatory compliance costs increase and the various “high-tech” green technologies become more mature, almost all green technologies will ultimately provide a true ROI.
Making an Important Green Business Decision? Here’s What to Consider
When evaluating any business decision, remember that it is not enough to simply regain your initial investment. First, you must consider the “cost” of money. For businesses, this cost, at a minimum, is equal to the weighted cost of debt and equity funding. In many cases, a higher cost is established based on business objectives or alternative opportunity costs. For a government agency, the cost of money can be established by the weighted cost of the agency’s long-term debt (loans, bonds, etc.). In other circumstances, it may be equal to the cost of the bonds issued for a specific purpose. On a purely economic basis, a project can only be justified if it earns a return that is equal to or greater than the cost of the money invested.
You must also consider the impact of income taxes on your investment decisions. Taxes have the effect of reducing the true cost of expenses by creating a “tax shield” and increasing the cost of capital investments through the depreciation process. As a result of these tax factors, alternatives that make good economic sense for a business may not be valid for government agencies and vice versa, depending on the timing of cash flows and the overall life of the asset in question.
Life-Cycle Cost Analysis
Today, both business and government fleets are faced with determining the true cost of a green initiative. The most efficient way to do so is to make a life-cycle cost analysis which evaluates the various cash flows associated with an initiative over its entire life, including the impact of taxes and the cost of capital. These evaluations are typically based on what is referred to as an after-tax, net present value analysis. While this may seem simple, many factors must be considered, including some long-term assumptions that may be difficult to validate.
Consider the following life-cycle factors:
- Initial cost
- Projected life of asset
- Salvage value
- Cost of money
- Operating tax shields
- Available “buy-down” funding
- Changes in operating costs and productivity
- Timing of cash flows
- Regulatory costs
Projected energy costs
Once you have identified all of the life cycle cost factors associated with a green initiative, you can insert the data in a calculator program which will determine the net present value of the initiative. A present value calculation states the discounted value of a future cash flow, either incoming or outgoing, in today’s dollars, based on the stated cost of money. By adding the present values of the incoming and outgoing cash flows (net present value), you can determine the excess or shortfall of cash flows over the life of the asset.
Through NTEA, GTA offers the Vehicle Life Cycle Cost Tool, which enables users to load differing depreciation methodologies to fit the necessary fleet analysis (such as straight-line, accelerated and pool depreciation techniques).