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METHANE RECOVERY FROM ANIMAL MANURES: THE CURRENT OPPORTUNITIES CASEBOOK discounting of the investment's annual cash flow with a specified discount rate, then totaling the discounted cash flows over the investment life to arrive at its net value. If NPV is a positive figure, the investment provides a greater return than the alternate choice assumed by the discount rate. If the NPV is a negative figure, the alternate presents the better opportunity. If NPV equals zero, it is said the choices are indifferent. When there is more than one competing investment, the higher NPV is preferred. However, in a capital rationing situation, NPV has an inherent bias in favor of large projects. Internal rate of return (IRR) is related to NPV: it is the percentage figure of the discount rate that yields a zero NPV. IRR allows direct comparison between the returns offered by various investment opportunities. If the IRR from a new investment is greater than the discount rate offered by an alternate choice, the new investment is more worthwhile. However, IRR suffers in two areas. First, if a project has a cash outflow at its end, there are multiple rates of return. Although this is not the case with the data analyzed, the situation occurs, for example, in circumstances where there are abandonment costs. Second, a bias is introduced in the implicit assumption that all positive cash flows are reinvested over the remaining project life at the calculated IRR. “This may be an unrealistic assumption, especially for projects with relatively high Internal Rates of Return. While this does not affect the decision to accept or reject a project, 1 it does affect the relative ranking of projects when comparing their relative profitability.” Although the IRR and NPV methods will lead to the same decision whether to accept or reject a project, they can provide conflicting clues when the decision is a choice between mutually exclusive projects. That is, one project can have a higher IRR but a lower NPV. This problem arises because the IRR is the implied reinvestment rate in the IRR method; the discount rate is the implicit reinvestment rate used in the NPV method. NPV is generally superior because reinvestment will likely occur at a rate close to the cost of capital. One area of potential concern relates to discount rate. Without belaboring the point, the choice of a discount rate is essential to the outcome: what may appear to be justified with a low discount rate may be imprudent at a higher rate. There are a number of problems with estimating a discount rate for farm-based technologies. Basic questions arise; for example, what is a true discount rate for livestock producers? What level of risk, and hence discount rate, does the investment in AD technology really represent? The range could lie between the yield of the risk-free investments made by the Treasury Department to that of a more speculative junk bond. Finally, private sector externalities are not accounted for within the discount rate. Mitigation of environmental externalities, especially odor control, can be the major factors leading to an investment in AD technology. Pro forma economic evaluations of investment decisions can lead to far different conclusions than pro forma evaluations of financing decisions. Although the specific reasons for this are beyond the scope of this paper, this is due to timing of cash flows in an analysis. In an economic evaluation all investment outlays are recorded in “time-zero,” which corresponds to the beginning 1 IL: The Dryden Press; pp. 554-555. McGuigan, J.; Moyer, R. (1975). Managerial Economics: Private and Public Sector Decision Analysis. Hinsdale, 3-2PDF Image | Methane Recovery from Animal Manures The Current Opportunities Casebook
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