BUSINESS CASE FOR COMPRESSED NATURAL GAS IN MUNICIPAL FLEETS - Natural Gas-powered Cars and Trucks: Options and Issues - page 65

How Do I Know if a CNG Project Makes Financial Sense?
Most investors use three indicators of financial viability, which all stem
from a discounted cash-flow analysis performed by models such as the VICE
model. These indicators are:
1) Net Present Value (NPV). This is the total present value of a CNG
project, including the cost of CNG equipment purchased now along
with future costs and cost savings from fuel and operations throughout
the lifetime of the project. These costs and cost savings are called
"cash flow," with costs being a negative cash flow and savings being a
positive cash flow. Please see the baseline parameters section (pp. 1-
9) for all cash flows that are included in the VICE model. All future
cash flows are discounted at a "discount rate" to compensate for the
fact that money is worth more today than it is in the future because it
can be invested today and increased. If the NPV of the project is
positive or zero at the desired discount rate, the project makes
financial sense. The NPV of the hypothetical investment in Figure 5 is
$7.2 million, where cumulative cash flows stop increasing at the end
of the project life.
2) Rate of Return (ROR). The ROR is the desired annual return on
investment. When choosing a target ROR, many companies compare
it to what they could make if they invested their money in another
project with similar risk. Ten percent is often considered a good
baseline in the private sector because that is what the stock market has
averaged over the long term. In municipal governments, 6% is
generally considered the baseline because that is what it costs a
government to raise money through bonds. ROR is also the discount
rate on money if one sets the NPV to equal zero.
3) Payback Period. This lets an investor know when the investment has
broken even and is starting to turn profits. At this point, an investment
no longer carries the risk of losing money. When assessing the
payback period, the investor uses the same discount rate as used when
looking at the NPV. In Figure 5, it takes the fleet manager 4 years to
pay back the initial investment of $2.6 million. Stable, progressive
fleets can have a target payback of 7 years while more risk-adverse
fleets can require a 3-year payback. The payback period seems to be
the metric of choice for fleet managers despite its drawback of not
being able to quantify losses on a bad investment.