on such a challenge, make sure you have a good understanding of the requirements of how your company calculates savings, and at what rate they will green-light a project. Learn the ROI and payback requirements, and how they will be calculated.
Return on Investment (ROI) is the most commonly-used measure for investments. ROI is expressed as the percentage of return earned per year. If the yearly income varies, each year can be evaluated separately, or the years can be averaged together (see ARR below).
| ROI of common investments: | Savings account | 3% |
| Money Market | 5% | |
| Mutual Fund | 12% | |
| Small corporate investment | 50% | |
| Capital improvements | 30% |
Formula: ROI (Return on Investment) = Yearly Income / Total Investment
Example: Replacing 2000 old-style fluorescent fixtures in a school with new technology and electronic ballasts requires an investment of $150 per fixture, or $300,000. The reduction in energy, and costs of ballast replacement and lamp replacement, will yield a savings of $75,000 per year. The ROI calculation is:
| ROI = 25% = 75,000 / 300,000 | 25% is below the school’s standard ROI of 33% |
Based on these numbers, the school could not justify the investment until it contacted the utility company, which offered a rebate of $45 per fixture or
Rebate 2000 x $45 = $90,000
Recalculation taking the rebate into account results in a new ROI calculation of:
$210,000 (new investment) = $300,000 (old investment) – $90,000 (rebate)
33% = $75,000 / $210,000 The school was able to make this investment because, with the rebate, the ROI met the guideline.
Average Rate of Return (ARR): This calculation is the same as for the Return on Investment (ROI), but extended over the entire life of the investment. The ROI will vary from year to year, but all the returns and all the investments are added together to determine the ARR.
ARR Formula: ARR = Average Yearly Income after Tax / Investment over life
Example:
Springfield Controls purchased a small alternative-energy source (say a hydro-electric generator on a nearby river), for a total investment of $1.4 million. This investment was paid for entirely with internal funds. The average net income (after all expenses and taxes) over the years of the analysis was $210,000:
ARR = $210,000 (average income) / $1,400,000 (total investment)
ARR = 15%
It’s interesting to note that, by borrowing, you can sometimes significantly improve the ARR (or ROI). Why is this true? Consider the impact of borrowing funds, where the rate you pay is below your ARR or ROI requirement. The organization will earn a return on the borrowed money equal to the spread between the ARR and the loan interest rate. The US government supports this type of decision by allowing the interest to be deducted from the organization’s income tax bill! As companies found out in the late 1980’s and early 1990’s, and again in the late 200Xs, there is significant risk in excessive debt because payments must continue to be made, even if sales go down and profits evaporate.
The ROI can also be improved if the government or utilities have rebates or tax credits for certain types of investments (such as alternative energy). In addition, in most states, a small turbine can be hooked up to a utility network so that, if your plant is closed in the evenings, and the power output exceeds the closed plant’s requirements, you can sell the excess power back to the utility (effectively running the meter backwards). That income also can improve the ROI.
Payback method: The second most common method of evaluating investments is to determine the number of years (or months) it will take to pay off your investment based on the investment’s return. The payback method is frequently used along with ROI, and is the reciprocal thereof.
Formula: Payback in years = Total investment / Yearly Income from the investment
Organizations are vitally interested in how soon their money will come back. In the re-lamping example above, the rebate will improve the payback time from four years to three years.
Interesting savings calculation (phantom unless you can monetize it)
Quick calculation of ROI from time savings:
Consider a project to move the parts room. It is clear that repositioning the parts room would save time, but would it save enough time to make the change worth while? We could estimate the savings in minutes per day for the crew. Let’s say we could reasonably see 20 minutes savings per day, per mechanic. If we have 17 mechanics they will save 340 minutes or 5.67 hours per day.
There is a universal formula to calculate Return on Investment in any currency with any labor rate, from labor savings in minutes! There are two simple assumptions:
1.Any savings should generate a 50% ROI or provide a 2-year payback.
2.The total cost of a worker is 2.5 times their hourly wage. This cost includes wages, benefits, overtime, all leave and vacations, lost time, and all the overhead of that worker.
Answer:
Savings in Local currency = Labor rate per hour in local currency x savings in minutes x 20
So in our example US$20 / hour * 340 minutes a day savings in minutes x 20 = $136,000
Here is the arithmetic behind that quick calculation:
Assuming that 2 years is about 440 days of work
((Labor Rate x 2.5) x 440) / 60 = 18.33 (Cost per minute for 2 years. Round up to 20) x Labor rate
If you do the algebra, pull out the Labor rate and since all that’s left is multiplication
(2.5 x 440) / 60 = 18.33. Put the labor rate back in and that’s the savings per minute. Pretty easy.
Economic Modeling: How do you know an alternative is Lean?
Economic modeling will help you determine the Leanest alternative (economically speaking). Economic modeling simulates the costs and income from a particular maintenance alternative, given the economic ‘facts’ of the case. Models can be as simple as projecting the costs and income, to sophisticated models that include interest rates, tax policies, and other variables. If the consequences warrant it, alternatives can be analyzed using economic modeling.
Many different strategies can be used in maintaining particular assets. Of course, the first choice is to employ an asset that needs no maintenance! If no maintenance is possible, look at that alternative before ‘settling’ on a PM or another maintenance alternative.
Each choice has both economic and non-economic consequences. Economics is important, but other issues
