A Project Economic Evaluation Model can take the headache out of the economic evaluation and the decision making process. Meg Rosner explains how
Decisions on project capital can easily go astray if economic evaluations are not properly integrated into the decision making process. If project engineers can easily determine the economic impact of alternative engineering solutions, they are more likely to use project capital wisely and accomplish their goals.
The economic impact of alternative designs may not be considered if the economic evaluation occurs after the design stage. This can lead to inefficient use of scarce money, or even worse, the decision not to fund a project that might have been viable if alternatives which improved the economics had been considered.
To help solve these problems, Strand Management Solutions and DHL Associates of the US, have developed the Project Economic Evaluation Model (PEEM). PEEM was developed in the mid-1990s and has been modified more recently to assist both engineering and financial managers in determining the viability of a proposed capital expenditure.
PEEM selects the best alternative for solving a specific problem and also helps to select the optimum set of projects that can be accomplished with the available funds. This makes the project more viable, providing benefits to everyone in the organisation. The project manager gains a tested tool to analyse and present the economics of his project, and the financial personnel are presented with an analysis that is easier to understand. It also benefits executive levels by providing information that can be used to convince shareholders and regulators.
A specific example of where PEEM can be used might be an old station with limited flow. Is it better to re-blade the turbines to increase capacity and reliability, or to build a new gas turbine nearby? How is the result affected by the assumed life of the dam structure? Would it be better to add new turbines at a location just downstream? What is the impact if the cost of oil and electricity escalate more quickly? These are the types of questions that can be easily and definitively addressed by an operational PEEM system tailored to the specific needs of the utility.
An economic model must be easy to use and lead the engineer through the analysis. The tougher problem is that for the model to yield reliable results it must correctly model the economics of the organisation.
All departments must co-ordinate and agree on the rules for cost and benefit analysis and the economic measurements that will be relied upon.
In other words, the ‘rules’ are fixed and the financial analysis is consistent regardless of the department making the request for funds.
As organisations and their engineering and financial needs vary greatly, PEEM’s system offers a wide range of standard analyses, including:
•The ability to analyse three alternatives simultaneously.
•Specific formulae for calculating varied benefits such as manpower savings, radwaste reduction, environmental emissions reduction and services to new customers.
•Escalation parameters for specific formulae.
•Terminology that is familiar to engineers and project managers.
The software was developed to simplify the input of data. Therefore the only data requested are the formulae and parameters that have been selected by the project team.
PEEM allows input to be made for the entire benefit period as in single non-escalated entry, and a typical project can be entered and processed quickly by a novice user. PEEM also allows the project economics to be documented and provides a summary report with information that executive management can use to evaluate the project, for example:
•Present value of project’s net after-tax cash flows.
•Internal rate of return.
•Discounted payback period.
•Benefit/cost ratio, based on hard savings only, and on total saving.
•Net present value of revenue requirements.
•Earnings by year.
PEEM was originally developed for the Public Service Electric & Gas Company of New Jersey, US, but the system can be customised to meet the needs of different companies. Southern California Edison of the US had PEEM modified during implementation
to meet its own requirements. It included:
•Analysis for non-utility projects as well as utility projects.
•Creation of a line-loss formula to calculate the saving in the transmission and distribution networks.
•Major revisions to the formulae that calculate the benefits of generating station improvements, such as heat rate improvements, forced outage reductions, planned outage reductions and capacity increases.
•Conversion to the Windows format from previous DOS-based versions.
•Simultaneous calculation of net present value of cash flow, revenue requirements and shareholder earnings analysis.
•Analysis, using either the risk adjusted cost of capital or the authorised rate of return.
Asking the right questions
The typical PEEM process asks basic questions. For example, to help the user make a decision concerning the replacement of a power plant’s circulating water pump, PEEM would weigh several options for bringing the pump to its expected performance level. Is it best to replace, redesign, or rebuild the pump? Should the pump simply be ‘band-aided’ as a temporary solution? What is the net present value/cost of each alternative; the internal rate of return; the payback? How is the decision affected by the planned life of the unit? Does it make a difference if the unit is base loaded, cycling, or peaking?
By selecting PEEM formulae for heat rate, forced outage, energy production, manpower and materials, these questions can be addressed and quantified.