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Payback Time for Metal Finishers Calculating your ROI before you buy equipment will help you make an informed business decision. By Nat Nickels, Consultant, Nat Nickels Associates, Palo Alto, Calif. W rho can forget that memorable scene as John Wayne, one of the greatest movie actors the world has ever known, bursts through the saloon doors in "Bareback Rider" snarling to the crowd outside, "It's payback time!" Metal finishers also use the word "payback time," but not quite in the same sense as John Wayne. At all the big shows, salespeople urge finishers to buy this drier or that barrel plating unit or self-loading tumbler, and in most cases, the sales pitch is "it'll save you big bucks." The smart finisher will translate this into "pay- back time," in other words, how long will it be before the new equipment pays for itself--and then starts to make real savings. Let's take a closer look at the concept of"payback time." As a hypothetical case, let's take a new drier, with the same capacity as the existing one, but more fuel efficient. Let's assume that the new drier saves $100 per week in energy costs. That's great news except that the drier costs $12,000--50 working weeks in the year, $5,000 sav- ing ssa year. So the drier will pay for itself in two years and 20 weeks, after which it'll be all win-win. A PICTURE IS WORTH A THOUSAND WORDS We can show this in graphical form. Figure I is a cashflow diagram--it initially shows our $12,000 in the bank, then an instant drop to -$12,000 as we spend it on the new drier. Such an outlay constitutes a negative cash flow. From then on, the new drier begins to earn its keep, sav- ing us $100 a week. The simple payback time, at the point the line crosses the zero cash balance basis, is after some two and a half years. We're now into win-win territory. What could be simpler ? But hang on--we had to pay $12,000 to buy that drier. Suppose the money had been in an S&L, earning 3%? That's $360 a year and is another way the same $12,000 could have been used. So we have to go back to the drawing board and subtract, from our savings, the money we might otherwise have earned by leaving the money in the bank. Making this correction is known as "discounted cash flow" or simply "DCF." Going back to Figure 1, the DCF is shown as the lower blue line. We can see the difference-- taking into account the interest foregone shifts the pay- back time by a month or so. Not very much is it? Clearly buying that drier was a smart thing to do. Can we think even smarter? Yes sir! Let's just step inside the S&L and ask them, "what interest are you '~J~X~ ~........ ~ ~, ~: ~ ~-~'~ ..... ~'~ L ................................... ~ ................... L ............... ,.,,,~,'~;J ........... -~ ....................... Figure 1: Simple (upper red line) and discounted (lower blue) cash flow. Horizontal axis: years following purchase. Vertical axis: cash flow in $, paying on deposits?" "Why, sir, we're paying 3%." But we've a real smart finisher here. "What's the RRR?" "Sir?" "RRR--the real rate of return." That $12,000 is sitting in the S&L, paying out 3% interest. Not a lot, is it? But at the same time, the greenback, like all cur- rencies, suffers from inflation. After 12 months, $100 might be only worth around $98. So the RRR is interest rate less inflation rate, maybe 1%, using the sort of numbers we have here. The concept of RRR comes as a bit of a blow to those who haven't considered it before. It's usually positive, so at least our S&L deposit isn't actually losing value, but nor is it making us rich! Put that into the graph in Figure 1 and buying the drier looks even smarter. We're living in an era of "cheap money" and "dear energy" though it hasn't always been that way. USING SPREADSHEETS FOR "WHAT IF?" Any finisher thinking of buying a piece of equipment, which claims to save him money, should run through this sort of exercise. But is it that simple? Two years and 20 weeks is a long time and that's only our break- even time. We should be looking just as far into the future again. And that's where we call in our computer spreadsheet and the "what if?." approach. Let's take the "what if?." first. Here's where we ask ourselves "What if the price of energy halves--or maybe doubles?" What if the S&L starts paying interest at 6% instead of 3%. In recent years, oil prices have swung between $17 and $53 a barrel, so nothing implausible here. Likewise, the S&L interest rates, and the RRR (something banking folk aren't too keen to talk about). Airlines, just like finish- ers, do almost exactly the same calculation. 46 www.metalfinishing.com
