Establishing Baseline Costs

To properly determine the cost of any engineering project, we first need to establish a baseline for comparative purposes. If nothing else, a baseline defines for management the option of maintaining the status quo. If we are faced with meeting a legal discharge limit, then obviously we need to do something other than status quo to remain in business. But here is where we can develop some interesting and very detailed justifications for one water treatment technology or piece of equipment over another. Changes in material consumption, utility demands, staff time, etc., for options being considered can be measured as either more or less expensive than a certain baseline. The baseline may be arbitrary for comparison. For example, we could choose as a baseline a traditional industry average. By starting with those technologies that comprise a conventional treatment plant, we have a baseline for the cost analysis. But to determine true cost benefits to your specific application, you really need to compare technologies and costs. This is an optimization exercise, and one which is well worthwhile in establishing the right level of investment for a water treatment plant or operation.

I highly recommend you follow the methodology of McHugh (McHugh, R.T., The Economics of Waste Minimization, McGraw-Hill Book Publishers, 1990). McHugh defines four tiers of potential costs, which the author applies to pollution prevention, but the principles and methodology are universal:

• Tier 0: Usual or normal costs, such as direct labor, raw materials, energy, equipment, etc.

• Tier 1: Hidden costs, such as monitoring expenses, reporting and record keeping, permitting requirements, environmental impact statements, legal, etc.

• Tier 2: Future liability costs, such as remedial actions, personal injury under the OSHA regulations, property damage, etc.

• Tier 3: Less tangible costs, such as consumer response and confidence, employee relations, corporate image, etc.

Tier 0 and Tier 1 costs are direct and indirect costs. They include the engineering, materials, labor, construction, contingency, etc., as well as waste-collection and transportation services, raw-material consumption (increase or decrease), and production costs. Tier 2 and Tier 3 represent intangible costs. They are much more difficult to define, and include potential corrective actions under the Clean Water Act (CWA); possible more stringent discharge limitations in the future ; and benefits of improved safety and work environments. Although these intangible costs often cannot be accurately predicted, they can be very important and should not be ignored when assessing an equipment or technology option. A present-value analysis that contains such uncertain factors generally requires a little ingenuity in assessing the full merits of an engineering project. When analyzing the financial impact of projects, it is often useful to further categorize costs as either procurement costs or operations costs. This distinction better enables the projection of costs over time, because procurement costs are short-term, and refer to all costs required to bring a new piece of equipment or a new procedure on-line. Conversely, operations costs are long-term, and represent all costs of operating the equipment or performing the procedure in the post-procurement phase.

Tier 2 and 3 costs are difficult to quantify or predict. While Tier 2 costs include potential liabilities, such as changing water discharge limits, Tier 3 costs are even harder to predict - for example, a typical Tier 3 cost could be associated with public acceptance or rejection of a particular technology. In many cases, there is a probability that can be connected with a particular event. This enters into the calculation of expected value. The expected value of an event is the probability of an event occurring, multiplied by the cost or benefit of the event. Once all expected values are determined, they are totaled and brought back to present value as done with any other benefit or expense. Hence, the expected value measures the central tendency, or the average value that an outcome would have. For example, there are a number of games at county fairs that involve betting on numbers or colors, much like roulette. If the required bet is $1, and the prize is worth $5, and there are 10 selections, the expected value of the game can be computed as:

(Benefit of Success) x (Probability of Success) - (Cost of Failure) x (Probability of Failure), or

On the average, the player will lose ~ meaning the game operator will win - 40 cents on every dollar wagered. For tier 2 and 3 expenses, the analysis is the same. For example, there is a great deal of data available from Occupational Safety and Health Administration (OSHA) studies regarding employee injury in the workplace. If one technology poses a higher risk to occupational exposure than another, then the probability of injury and a cost can be found, and the benefit of the project can be computed.

The concept of expected value is not complicated, though the calculations can be cumbersome. For example, even though each individual's chance of injury may be small, the number of employees, their individual opportunity costs, the various probabilities for each task, etc., could mean a large number of calculations. However, if one considers the effect of the sum of these small costs, or the large potential costs of having to replace a technology or consider significant upgrades within 5 years, then the expected value computations can be quite important in the financial analysis.

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