Valuation Services and Total Life Cycle Cost Analyses
19-08-2010
Replicon Group has been providing company and project valuation services for traditional growth industries as well as for high-tech sectors for more than 10 years. Besides standard free cash flow based valuations, i.e. discounted cash flow (DCF) models, we also possess know how and tools for some special approaches to projects with significant potential combined with uncertainty. Recently Replicon has started to be more and more active in estimating total life cycle costs in street lighting sector.
In street lighting projects customers typically face only costs and the target is to find the lighting solution that fulfills specified criteria, e.g. certain lighting class, with least costs during the whole life cycle of the project. In order to make the costs from different time periods comparable one has to make present value (PV) calculations for all future costs. Interestingly applied DCF method can be used also in total cost estimations. Cautionary note: analysts should be careful when using constant growth formulas and also when discounting various cost flows into present value because there will be "jumps" e.g. in the efficiency of led technology and because various costs may need different discount rates.
PV of Uncertain Revenues vs. PV of Almost Certain Costs
Below we compare main features of present value estimation methods in two different cases. In the first case there are positive but uncertain future cash flows (net income) and in the second case there are almost certain but negative future cash flows (costs). Bottom line is that discounted cash flow (DCF) model can be used in both cases. This note is aimed for readers that are familiar with basic financial analyses. We are more than happy to give professional help to all interested in this topic.
Free cash flow generated by a company or a project is the revenue generated minus immediate costs and necessary investment needs to keep the company or project going. In free cash flow analyses future cash flows are typically forecasted for a certain growth period, e.g. 3 – 5 years, and after the forecasting period it is assumed that constant growth thereafter will equal inflation. Discount rate that is used to convert future uncertain cash flows to the present depends on the uncertainty of the project. When estimating proper discount rate, one can start from risk free rate and add different premiums on that, e.g. equity risk premium (ranges from 4 – 8 % per annum), illiquidity risk premium (typically 10 % p.a.), and company specific failure rate can range from 0 to even 40- 50 % p.a.
When a project generates only costs, future “free cash flows” are in practice the same as total life cycle costs. Thus the same DCF method can be used in calculating the present value of total life cycle costs. We just have to define all relevant costs, suitable discount rate, and the time span, i.e. life cycle, of the project.
Street lighting project offers very interesting and also challenging total life cycle cost estimation problem. Currently different lighting technologies compete fiercely in street lighting and life span of a project can be 30 years or even longer. Energy consumption during the life time is typically the biggest cost in street lighting. Maintenance costs, i.e. replacing lamps and other electric parts etc., are also important. Naturally also in total life cycle cost analyses one has to discount future costs to their present values. When buyers are typically municipalities or state organizations, their financing costs are very close to risk free rates. This (“WACC”) rate can be used in discounting estimated future costs. Purchasing price is the immediate cost and its present value is of course the same as its current value.
Replicon is very happy to add total life cycle cost analyses of street lighting to its focus valuation services. Based on our analyses so far high quality, upgrade able led street lights are clearly most economical (and also environmental) choice when total life cycle costs are taking into acount.
For further information on Replicon Valuation and Total Life Cycle Cost services, please contact:
Petteri Hirvonen,
CEO, Replicon Group +358 50 552 96 33 (direct)
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About Replicon
Replicon Group is an independent corporate finance and business development house for growth companies and growth investors. Replicon provides strategic and financial solutions that facilitate business activities, efficiency, and increase profitability of corporations and other organizations. Our core competence is in the corporate solutions that facilitate and govern growth of businesses based on innovation. An important part of our activities is continuous learning. We want to find and develop most suitable solutions to our customer needs. Replicon Group’s special focus areas are Cleantech, Life-Science and ICT/Mobile sectors. In these sectors Replicon provides also asset management advisory. The main shareholders in Replicon Group are its key management, holding majority of the company’s shares. Replicon’s homepage is www.replicon.fi.