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**Subject**:**Re: Financial Analysis****From**:**"Burton Hamner" <bhamner@hotmail.com>**- Date: Wed, 24 Feb 1999 17:55:45 -0500 (EST)
- List-Name: P2Tech
- Reply-To: "Burton Hamner" <bhamner@hotmail.com>

I'll expand a little on Tim's comments: P2 financial analysis is essentially the same as any other financial analysis of a capital investment. Most finance textbooks can show you how to set up an analysis in the first chapter. P2 does offer some twists: The cost inventory being considered is a lot larger than the typical analysis, since good P2 drags all the hidden costs out of overhead and includes them in the analysis. In many cases pending or exsiting legislation makes it clear that an existing process will have to be changed several years from now to comply with the new rules. Thus a P2 capital investment analysis needs to have a longer time horizon than most others, like 5 to 10 years, in order to capture the future costs that can be predicted with some reliability (at least you may know WHEN the big hit will come and can factor it in). Most importantly, P2 usually REDUCES RISK. Now in determining discount rates for a net present value analysis, higher risk projects have higher discount rates. If P2 reduces risk compared to a current process, then there are two ways to incorporate this: 1) apply a different, LOWER discount rate to the P2 process alternative's cash flows compared to the current, more risky process. 2) Include in the p2 savings some estimate of the equivalent costs of insurance premiums saved. The idea is that you can set up an analysis where risks are equal for all alternatives, to do so you need to buy insurance to reduce the financial risks of some of the alternatives, so the risks are equal. For example, if I am now using solvents for cleaning, I can insure myself against future risks and liabilities from this process, so I have no or reasonable risk. But if I switch to solvent-free process (assuming all else is equal which it never really is of course), then I don't have to buy insurance to have no or reasonable risk. So the avoided premiums should count as savings from a P2 investment, which makes it look more attractive. Or, just reduce the discount rate being used to evalauate the p2 process, which makes its future savings larger in the net present value summation. Every finance type I have discussed this with agrees with the logic, then they say "But I am not allowed to use anything but the approved corprate rate, and we are not going to buy insurance for our existing process anyway." Once again sound P2 theory founders on the rocks of corporate bureaucracy! There are some case studies out there where companies did get lower insurance premiums from switching to P2, so don't forget to look for such savings. Anyway, start with a primer on NPV and discounted cash flow analysis. NEWMOA has a primer, AIPP has a primer, ECAM has a primer, P2 Finance has a primer. Don't you hate it when people tell you to read the manual? Sorry. Burt Hamner

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