When you make an NPV analysis of a series of expense options, the NPVs of the various alternatives will be negative. The option with the least negative cost is the best alternative from a purely financial point of view.
Some NPV lifecycle cost spreadsheet programs, such as the NTEA’s Vehicle Lifecycle Cost Analysis Program, will also show your annualized cash flows.
If the NPVs of two options are very close, these annualized cash flows may be more important than the total cost.
In the case of revenue-producing alternatives, the NPV will be positive if the alternative being considered is earning more than the established cost of money, and negative if it is earning less.
An alternative can be revenue-generating even if there is no direct income flows associated with it.
For example, a company may be considering upgrading a new truck in such a way that will be more productive. If the operations associated with the existing truck incur a significant amount of labor overtime, the increased efficiency may eliminate that overtime.
The loaded overtime rate (say $50 per hour), times the total hours of overtime eliminated (say one hour per day x 260 days per year), generates a direct labor savings for the company, which can be treated as additional revenue.
Using the hypothetical numbers stated, the annual savings (revenue) would be $13,000.
If the productivity of a new unit can be increased to the point that it will replace two existing units, the potential savings (revenue) may be even greater since it will be eliminating the total labor costs of a driver, and possibly a helper, as well as the maintenance and operating costs of the second truck.
The opposite of this scenario applies when people in an entity want to downsize a vehicle to reduce fuel costs. If this downsizing increases overtime, or forces the addition of a second vehicle to get the work done, the fuel savings will probably be less than the other costs incurred.
Even replacing a high-cost unit with a new unit that has a lower lifecycle cost can be considered revenue-producing, since it may reduce total lifecycle expenditures.
For example, if a company has a vehicle with a lifetime average operating cost of $1.50 per mile, and the truck runs 15,000 miles per year, the annual costs will be $22,500. A new, more fuel-efficient vehicle may have a projected average annual operating cost of $1.10 per mile or $16,500 per year. Therefore, the cost reductions (revenues) associated with the new unit will be $7,000 per year.
Of course, as we have seen, the actual bottom line in these examples is not without some complexity. If you work for a tax-paying entity, the reduction in labor payments will eliminate a tax shield.
In addition, the cost of the upgraded vehicle must be depreciated over time as opposed to being treated as a one-time expense.
In all cases, the carrying costs (time value of money) must also be taken into account. However, a properly applied NPV lifecycle cost analysis will take all of these factors into consideration and the true costs of each option.
If you have a number of revenue-producing alternatives, and only enough money to fund part of them, you can perform an NPV analysis and determine the actual return for each alternative. The individual rates of return can then be used to rank the alternatives.
For example, let’s say you have five projects, with a total cost of $450,000, but you have only been allocated $360,000. An NPV analysis provides the following information:
In this case, Project 2 has the highest return on investment (ROI) - 20.3 percent - and should be funded first. Next would be Project 1 at 18.2 percent.
The remaining projects are returning less than the desired ROI, but may still be perfectly valid, and necessary.
Unless there are some overriding requirements, such as regulatory compliance, the next project funded should be number 5, at 15.1 percent.
Lacking an ROI analysis, you may have been tempted to fund Projects 3 and 4 which have the same total cost as project 5, but provide a lower ROI.
Although documentation of your operations with accurate NPV cost studies is not something that finance people normally expect from the typical fleet or maintenance manager, it is a means to: