Economics

$$ PROCESS ECONOMICS $$
Why do we study process economics?

Essential skill for chemical engineers to:
Evaluate feasibility of new projects
Improve performance of existing processes
Make design and operating decisions
Compare alternatives
Decide strategic directions for the company
Establish sound policies for process and product objectives
(e.g., environment, safety, quality)
1
Copyright: M. M. El-Halwagi (2011).
QUESTIONS TO BE ADDRESSED
What are the cost items involved in installing and operating a process?
What types of cost estimation can be carried out and to what level of accuracy?
How to estimate the cost of building a plant or implementing a project?
How to account for the changes in market conditions and for the time value of money?
How to estimate the recurring costs associated with running the plant?
How to assess the economic viability of a project?
How to screen competing projects and select the most attractive alternative(s)?
2
TOPICS TO BE COVERED
Cost types and estimation
Depreciation
Break-even analysis
Time value of money
Profitability analysis
COST TYPES AND ESTIMATION

Two primary costs:
Capital investment ($)
Operating (production) cost
How to evaluate both? Accuracy levels?
What are the key elements in each cost?
How to update the costs?
ELEMENTS OF CAPITAL INVESTMENT

Total Capital Investment (TCI)
Fixed Capital
Investment (FCI)
Manufacturing (Direct) FCI
Working Capital
Investment
Non-Manufacturing (Indirect) FCI
Capital Investment: money needed to purchase and install the plant (including process equipment,
facilities, all buildings, controls, etc.), acquire land, and to provide for expenses needed to start
process operation.
Manufacturing Fixed Capital Investment: money needed to purchase and install process equipment and ancillary units
needed for full operation (e.g., process units, insulation, instrumentation, control, piping, etc.)
Non-Manufacturing Fixed Capital Investment: money needed for plant components not directly related to process
Operation (e.g., land, processing buildings, administrative offices, warehouses, labs, shops, etc.) + construction overhead
(e.g., construction costs, contractors fees)
Working Capital Investment: money needed to pay the bills and start/support operation before product is sold: e.g. Money
needed for stocked (~one month) raw materials, accounts payable, finished products
In stock (~one month) to be shipped to customers. Working capital is recoverable by the end of the project.
5
Working capital in many cases ~ 10-20% of capital investment
Classification of Cost-Estimation Studies

(Adapted and revised from the AACE International; Dysert, 2001; Christensen and Dysert, 2005; and Coker, 2007)
Type/Objective of Cost Accuracy
% of Project Type of Needed
Estimation
Level
Definition
Information
Order-of-magnitude
-50/+100%
0-2%
Experience or cost data of a
estimate
or
concept
similar
plant
or
basic
information on sold product and

capacity
screening
Study
estimate
or -30/+50%
1-20%
preliminary feasibility
Preliminary
or
estimate -20/+30%
Preliminary description of the

process flowsheet and duty data
of the main equipment
10-50%
Equipment sizing and basic
40-80%
Detailed equipment data (e.g.,
simulation
budget
authorization
Definitive estimate or -15/+25%
project
control
sizing,
simulation,
design
specifications, drawings)
estimate
Contractors estimate -5/+10%
or detailed estimate
75-100%
Detailed simulation, complete

engineering drawings,
mechanical
datasheets,
and
electrical
design
specifications, process layout,

site survey
METHODS FOR CAPITAL COST ESTIMATION

Manufactures quotation
Computer-aided tools
Capacity ratio with exponent
Updates using cost indices
Factors based on equipment cost
Empirical correlations
Turnover ratio
1. Manufacturers Quotations: typically require a lot of details

(more than conceptual design, also be careful about revealing details).
Directories for lists of vendors:
Chemical Week
Chemical Engineering
Chemical Processing
Buyers Guides
Hydrocarbon Processing Catalog
2. Computer-Aided Tools:
e.g., ICARUS, SuperPro

3. Capacity Ratio with Exponent
When you have very similar processes but different capacities:
FCIB = FCIA*(Capacity B/Capacity A)x
Exponent x is typically ~ 0.6 0.7
Sixth-Tenths-Factor Rule or Economy of scale!
Table 2.2. Examples of Capacity Exponents

Product
Process
Size Range
Exponent x
Acetaldehyde
Ethylene conversion 25,000 100,000 0.70
Reference
Remer and Chai (1990a)
tonne/yr
Acetic acid
methanol conversion 3,000
75,000 0.59
Garrett (1989)
0.66
Gerrard (2000)
0.64
Garrett (1989)
tonne/yr
Ammonia
Adipic acid
Ethylene
Natural
gas 365,000
reforming
550,000
Cyclohexanol
tonne/yr
7,000 330,000
conversion
tonne/yr
Cracking of ethane
500-2,000
MM 0.60
Towler and Sinnott (2008)
lb/yr
Ethylene oxide
Hydrogen
Polyethylene
Direct oxidation of 20,000 200,000 0.78
Remer
ethylene
Dysert (2001)
tonne/yr
Steam reforming of 10-150
MM 0.79
and
SCF/day
High-pressure
40,000 tonne/yr
0.69
Salem (1981)
of 20,000 tonne/yr
0.60
Salem (1981)
of
ethylene
Polyvinyl chloride
Polymerization
vinyl chloride
(1990a),
methane
polymerization
Chai
10
Example 2.1. Using capacity ratios with exponents for estimating

FCI:
A processing facility is designed to convert waste cooking oil and
vegetable oil to biodiesel. The FCI of the process producing 40 MM
gal/yr is estimated to be $23 MM (Elms and El-Halwagi, 2009).
Estimate the FCI of a similar process producing 20 MM gal/yr. Also,
conduct a sensitivity analysis on the effect of production rate on the
FCI per annual gallon (i.e., FCI per gal/yr).
11
Solution:
Assuming a capacity exponent of 0.6, we have:
FCI of 20 MM gal/yr process =
FCI of 40 MM gal/yr process* (20/40)^0.6
= $23 MM* (20/40)^0.6
= $15 MM
Economy-of-Scale Observations:
When the capacity of the plant is doubled from 20 to 40 MM gal/yr,
the FCI is not doubled. Instead, it increases by about 50% (from $15 to
23 MM)
When two of the 20 MM gal/yr plants are built, they will cost $30
MM which is 30% more expensive than building a single 40 MM gal/yr
process
Cost per annual gallon:
For the 40 MM gal/yr process:
The FCI per annual gallon = ($23 MM/40 MM gal/yr)= $0.58/annual gal
12
Similarly, for the 20 MM gal/yr process,
The FCI per annual gallon = ($15 MM/20 MM gal/yr)= $0.75/annual gal
Sensitivity Analysis for the Biodiesel Example

FCI/annual gallon,
$/(gal/yr)
1.0
Notice the effect of economy of scale
Annual Production (MM gal/yr)
13
METHODS FOR CAPITAL-COST ESTIMATION

4. Cost Indices to Update Capital Investment
To account for inflation and update cost of identical plants
FCI t 2
Cost index at time t 2
FCI t1
Cost index at time t1
Common FCI cost indices are:

Chemical Engineering plant cost index: Published monthly at Chem. Engineering
Eng. News Record construction index: Published weekly at Eng. News Record
Nelson-Farrar refinery construction index: Published monthly at Oil & Gas J.
Try to limit updates to ~10 years

14
Recent Values of the Chemical Engineering Plant Cost Index (Source: Chemical Engineering
www.ChE.com/PCI)
Economic Indicators
(Basis: in 1957-1959, value of index = 100)

Year
Chemical Engineering Plant Cost Index*
*
2001
394.3
2002
395.6
2003
402.0
2004
444.2
2005
468.2
2006
499.6
2007
525.4
2008
575.4
2009
521.9
2010
550.8
15
Example 2.2. Updating the FCI using a cost index

The FCI of a 1,500 ton/day ammonia plant in 2002 is estimated to be
$120 MM (Couper, 2003). Estimate the FCI of a similar plant
producing 2,000 ton ammonia/day in 2009.
Solution:
First, the cost of 1,500 ton/day plant needs to be updated to 2009 then
it should be scaled up to 2,000 ton/day.
Chemical Engineering Plant Cost Index values for 2002 and 2009 are
395.6 and 521.9
FCI of the 1,500 ton/day plant in 2009 =
FCI of the 1,500 ton/day plant in 2002* (521.9/395.6)
= $158.3 MM
Table 2.2. gives a capacity-cost exponent of 0.66 for ammonia plants.
FCI of the 2,000 ton/day plant in 2009 =
FCI of 1,500 ton/day plant in 2009* (2,000/1,500)^0.66
= $191.4 MM
16

5. Ratio Factors Based on Delivered Equipment Cost
Very commonly used for order-of-magnitude estimates
Lang Factors:
FCI = FCI Lang Factor * Equipment Cost
TCI = TCI Lang Factor * Equipment Cost
Original values of Lang Factors (Lang, 1948)
Type of Plant
FCI Lang Factor
Solid
3.10
Solid-Fluid
3.63
Fluid
4.74
17
Revised Values of Lang Factors (Peters et al., 2003)

Type of Plant
FCI Lang Factor
TCI Lang Factor
Solid
4.0
4.7
Solid-Fluid
4.3
5.0
Fluid
5.0
6.0
18
Notice that WCI ~ 15% of TCI
Detailing the Revised Lang Factors (Peters et al., 2003)

Cost category
Solid Processing
Solid-Fluid
Processing
Fluid Processing
Direct costs:
Purchased equipment (delivered)
100
100
100
Equipment installation
Instrumentation & control
Piping
Electrical systems
Buildings
Yard improvements
Service facilities
45
18
16
10
25
15
40
39
26
31
10
29
12
55
47
36
68
11
18
10
70
Total Direct Costs
269
302
360
Engineering and supervision

Construction expenses
Legal expenses
Contractors fees
Contingency
33
39
4
17
32
34
4
19
33
41
4
11
Total Indirect Costs
128
126
144
FCI
WCI (15% of TCI or (15/85)*FCI)
397
70
428
75
504
89
TCI
467
503
593
Indirect costs:
35
37
44
19
The Hand Method (Hand, 1958)
FCI
N Equipment
q 1
f qHand CqDelivered
Values of the Hand Factors for Different Equipment Categories
Equipment Type
Hand Factor
Compressors
2.5
Distillation columns
4.0
Fired heaters
2.0
Heat exchangers
3.5
Instruments
4.0
Miscellaneous equipment
2.5
Pressure vessels/tanks
4.0
Pumps
4.0
20
Example 2.3. FCI estimation based on factors of delivered equipment cost:

The table below gives the type and cost of the units to be used in a retrofitting project
in a fluid-processing facility. Additionally, the instrumentation and control systems for
this project are estimated to have a delivered cost of $3.6 MM. Estimate the FCI using
the Lang factors as revised by Peters et al. (2003) and the Hand method.
Unit
Delivered Equipment Cost ($ MM)
2.0
Fired heater
2.5
Heat exchangers
4.0
Tanks
1.5
21
Solution:
For a fluid-processing plant, the Lang factor (revised by Peters et al.,
2003) for estimating the FCI from delivered equipment cost is 5.0.
FCI (Lang method) = 5.0*(2.0 + 2.5 + 4.0 + 1.5)
= $50.0 MM
Hand Method:
Equipment
Has to be
added
Delivered
Hand Factor
Installed
Equipment
Equipment Cost
Cost ($ MM)
($ MM)
2.0
4.0
8.0
Fired heaters
2.5
2.0
5.0
Heat exchangers
4.0
3.5
14.0
Instruments
3.6
4.0
14.4
Pressure vessels/tanks
1.5
4.0
6.0
Total = $ 47.4 MM
22

6. Empirical Expressions (use cautiously)
Gas-phase plants (adapted with modification from Timm (1980), Gerrard (2000), and Coker (2007)
FCI = 36,000*N*F0.62
where N is the number of functional units (these are major processing steps such as separation,
reaction, finishing but not heat exchange or compression/pumping unless they have substantial dutie
such as refrigeration and liquefaction) and F is the process throughput tonne/yr.
Liquid- and/or solid-phase plants (adapted with modification from
Bridgwater and Mumford (1979), Gerrard (2000), and Coker (2007)):
FCI = 7,000*N*F0.68
For F 60,000 tonne/yr
and
FCI = 458,000*N*F0.30
For F < 60,000 tonne/yr

where N is the number of functional units and F is the process throughput tonne/yr.
23
Example 2.4.: Using an empirical correlation to estimate the FCI:

Ethanol may be produced from lignocellulosic wastes. One of the largest sources of
lignocellulosic wastes in the US is corn stover which is the material left on the surface of the
corn field after harvesting. It contains the stalks, the leave, the husks, and the cobs. sources
such as corn stover. A stover-to-ethanol plant produces 71,000 tonne/yr of ethanol and
contains 8 functional units: feedstock handling, pretreatment, simultaneous
saccharification/fermentation distillation, solid/syrup separation, wastewater treatment,
boilers, and turbogeneration/utilities (McAloon et al., 2000). Estimate the FCI of the plant.
Solution:
FCI = 7,000*N*F0.68
For F 60,000 tonne/yr
FCI = 7,000*8*(71,000)0.68
= $111 MM
The 2010-updated FCI reported by McAloon et al. (2000) is $191 MM. Although the
difference is -42%, it is acceptable for order-of-magnitude estimates
24

7. Turnover ratio (or capital ratio)
For order-of-magnitude estimates
Turnover ratio =
Annual sales
FCI
A very rough (but useful) approximation of turnover ratio ~ 2.0

(typical range 0.5 3.5 but can be 0.4 21.8)
FCI =
Annual sales
2.0
25
Typical Values of Turnover Ratios

Main Product
Process
of
the Production Rate of Main Selling Prices of Annual Sales ($ FCI

Product
Product
MM/yr)
($ MM)
(103 tonne/yr)
$/tonne
Ammonia
300
360
108
66
Ammonium nitrate
360
190
68
28
Acetic Acid
18
880
16
15
Acetic acid
200
880
176
136
Adipic acid
295
1,700
502
195
Alkyl benzene (linear)
73
1,030
75
75
Benzene
141
1,025
145
27
Biodiesel
133
1,130
150
23
Bio-gasoline/Bio-jet fuel
86
1,100
95
131
Butene-1
18
748
13
12
Cumene
273
1,300
355
43
Cumene
300
1,300
390
31
Cyclohexane
182
750
137
11
Diesel (from gas-to-liquid) 5,674
800
4539
9,210
Ethanol (from corn)
71
550
39
39
Ethanol (from corn stover) 71
1,130
80
191
Ethanol (from corn stover) 159
1,130
180
358
Ethylene dichloride
455
400
182
114
Ethylebenzene
1,273
1,200
1,528
114
Ethylebenzene
455
1,200
546
25
Ethylene
568
800
625
691
Ethylene
83
800
66
116
Methanol
5
300
1,500
558
Methanol
300
300
90
59
Nitric acid
636
237
151
71
Paraxylene
750
1,540
1,155
609
Phenol
182
1,320
240
255
Phosphoric acid
1455
500
728
71
Phosphoric acid
18
500
9
9
Propylene
164
1,190
195
28
Styrene
1,136
1,430
1,624
284
Styrene
500
1,430
715
113
Styrene
25
1,430
36
29
Sulfuric acid
1,818
80
145
43
Turnover Ratio
(yr-1)
Reference for FCI
1.6
2.4
1.1
1.3
2.6
1.0
5.4
6.5
0.7
1.1
8.3
12.6
12.5
0.5
1.0
0.4
0.5
1.6
13.4
21.8
0.7
0.6
2.7
1.5
2.1
1.9
0.9
10.3
1.0
7.0
5.7
6.3
1.2
3.4
Garrett (1989)
Seider et al. (2009)
Garrett (1989)
Hydrocarbon Processing
Elms and El-Halwagi
Pham et al. (2010)
Bao et al. (2010)
McAloon et al. (2000)
McAloon et al. (2000)
Kazi et al. (2010)
Garrett (1989)
Garrett (1989)
26
Example 2.5. Using the turnover ratio to estimate the FCI:

A gas-processing facility produces a mixture of ethylene and propylene (production rates are
545,000 and 273,000 tonne/yr, respectively). If the selling prices of ethylene and propylene are
$800 and 1,100/tonne, respectively. Estimate the FCI of the process using the turnover ratio.
Solution:
The annual sales of the plant can be calculated as follows:
Annual sales
= 545,000*800 + 273,000*1,100 = $736 MM
For a quick and rough estimate, let us assume a turnover ratio of 2.0. Therefore,
FCI
= 736/2 = $368 MM.
The cost of this plant as reported by Seider et al. (2009) and updated to 2010 is $440 MM .
27
METHODS FOR EQUIPMENT-COST ESTIMATION

Manufactures quotation
Computer-aided tools
Capacity ratio with exponent
Updates using cost indices
Cost charts
Terminology:
Free on Board (FOB): This is the cost of the equipment at the manufacturers loading
docks, shipping trucks, rail cars or barges at the vendors fabrication facility. The
purchaser still has to pay for equipment freight, installation, insulation,
instrumentation, electric work, piping, engineering work and construction. When there
is a reference to purchased equipment cost, it typically corresponds to the FOB basis.
Delivered equipment cost: This term corresponds to the equipment cost delivered to
the buyer. It is the sum of the FOB and the delivery costs (e.g., freight, transportation
insurance, importation taxes).
Installed equipment cost: This is the sum of the delivered equipment cost plus the
installation costs (e.g., labor, civil structure and foundation work). The installation
costs are typically in the range of 40-50% of the delivered equipment cost.
28

1.
Manufacturers Quotations: Get multiple quotations.

Typically require a lot of design details. Dont always go for lowest
bidder. Check materials of construction, trackrecord, safety, reliability,
operability, etc.
2. Computer-Aided Tools:
Software: e.g., ICARUS, SuperPro
Web resources: e.g., Matches web site: www.Matche.com/EquipCost
29

2. Capacity Ratio (Scaling Factor) with Exponent
(Six-Tenths Factor Rule)
When you have very similar equipment but different sizes:
FOB Equipment CostB = FOB Equipment CostA*(Size B/Size A)x
Exponent x is typically ~ 0.6
Cheaper to have one equipment of size V than 2 units of size V/2 each (2 0.6 = 1.5)
30
Table 6.4, Peters et al. (2003)
Examples of Typical Values of Equipment Cost Exponents

Equipment
Size
Range/Sizing
Exponent x
Reference
Criterion
Blowers (centrifugal)
0.5 4.7 m3/s
0.59
Peters et al. (2003)
Compressor (reciprocating)
150 750 kW
0.80
Garrett (1989)
Cooling tower
5,000 30,000 gpm of
0.77
Brown (2007)
water flow
Ejectors (steam jet)
Steam flowrate, kg/s
0.52
Axtell and Robertson (1986)
Furnaces
Heat duty, kW
0.78 0.80
Axtell and Robertson (1986), Towler and

Sinnott (2008)
Heat exchangers (shell-and-
10 900 m2
0.60
(2004)
tube, floating head)

Heat exchangers (shell-and-
Peters et al. (2003), Ulrich and Vasudevan
10 40 m2
0.44
Jacketed vessel
1 800 m3
0.60
Ulrich and Vasudevan (2004)
Refrigeration units
5 10,000 kW
0.60 - 0.70
Chauvel (1981), Ulrich and Vasudevan
tube, fixed sheet)
(2004)
Tank (floating roof)
200 70,000 m3
0.60
Ulrich and Vasudevan (2004) 31
Tank (spherical 0 5 barg)
100 10,000 m3
0.60 - 0.70
Ulrich and Vasudevan (2004), Towler and

Sinnott (2008)
Trays (sieve)
1 3 m diameter
0.86

4. Cost Indices to Update Equipment Cost
To account for inflation and update cost of identical units
Equipment cost in year y = Equipment cost in year x*
Cost index in year y

Cost index in year x
Most commonly-used equipment cost index is Marshall and Swift cost index
Published at Chemical Engineering magazine
Try to limit updates to ~10 years

32
Recent Values of the M&S Cost Index

Year
M&S
Equipment
Cost Index#
2001
1,093.9
2002
1,104.2
2003
1,123.6
2004
1,178.5
2005
1,244.5
2006
1,302.3
2007
1,373.3
2008
1,449.3
2009
1468.6
2010
1,457.4
(Basis: in 1926, value of index = 100)
33
HOMEWORK ASSIGNMENT
(Due in one week)
Please go to Evans library and copy the charts for the CEPCI and the M&S index.
See the table below to determine the most recent monthly issue of Chemical Engineering
from which you should copy the charts
If your last names starts with
this letter
A, B, or C
D, E, or F
G or H
I or J
K or L
M or N
O or P
Q or R
S or T
U or V
W or X
Then, you should copy the

charts from the issue of
Chemical Engineering
published in the following
month (this year or last year
depending on availability)
January
February
March
April
May
June
July
August
September
October
November
34
EXAMPLE: EQUIPMENT COST ESTIMATION

A shell-and-tube heat exchanger has a surface area of 100 m2. Its
cost in 2003 was $92,000. What was the cost of a similar heat
exchanger with double the surface area in 2009?
Solution:
Two steps:
1. Update: Using the M&S cost index,
Cost of the 100-m2 heat exchanger in 2009 = 92,000*(1468.6/1,123.6)
= $120,248
2. Account for scale: Assuming a capacity exponent of 0.6
Cost of the 200-m2 heat exchanger in 2009 = 120,248*(200/100)0.6
= $182,262
35

3. Equipment Cost Charts (Typically FOB Basis)
Equipment
Cost
Size
Examples is textbooks and vendors publications.
36
Cost of a Floating-Head Shell-and-Tube Heat Exchanger (carbon steel, 1,035 kPa pressure rating)
37
Purchased Cost of a Sieve Tray (carbon steel, when 10 or more trays are purchased)
38
Purchased Cost of a Centrifugal Pump (carbon steel)
39
Purchased Cost of a Steam Turbine
40
Effect of Materials of Construction

Materials Factor for Material M =
Purchased cost of equipment in material of construction M

Purchased cost of equipment in carbon steel
Material of Construction
Materials Factor
Carbon steel
1.0
Cast steel
1.2
Aluminum
1.6
Bronze
1.6
304 stainless steel
1.8
316 stainless steel
2.1
Copper
2.3
Hastelloy C
2.4
Monel
3.2
Nickel
4.5
Inconel
4.7
Titanium
8.0
41
Example 2.7. Including the materials factor in estimating

the cost of a heat exchanger:
Estimate the January 2011 purchased cost of a 60-m 2 floatinghead shell-and-tube heat exchanger made of titanium.
Cost of a Floating-Head Shell-and-Tube Heat Exchanger (carbon steel, 1,035 kPa pressure rating)
Solution:
The purchased cost of the 60-m2 carbon-steel exchanger is
$80,000. To adjust for the materials of construction, the materials
factor of 8.0 for titanium is used.
Purchased cost of titanium exchanger = 8.0*80,00042 =
OPERATING COST
$/yr
Raw materials
Material utilities
Energy utilities
Labor
Maintenance
R&D
43
OPERATING COST
$/yr
Raw materials and material utilities:

Get quotations from manufacturers/vendors
or see ICIS Chemical Business (www.icis.com)
Published weekly
Formerly (until 2006) known as the Chemical Marketing Reporter
Historical data on the prices of key chemicals may also be obtained online
at
http://www.icis.com/StaticPages/a-e.htm
44
OPERATING COST
$/yr
Energy utilities:
Market prices
or EIA's web: http://tonto.eia.doe.gov/oog/info/ngw/ngupdate.asp
Typical Costs of Utilities
Energy Utility
Cost
Natural Gas
$4-8/MM Btu (or per 1000

SCF)
Petroleum
$12-15/MM Btu
Steam
$4 15/ton
Electricity
$0.05-0.10/kWh
Cooling Tower Water
$0.03 0.10/m3
Process Water
$0.50/1.50/m3
Refrigeration
$20 50/MM Btu

45
OPERATING COST
$/yr
Labor:
Estimate how many employees are needed and their expertise
Depends on type of process, production level, extent of automation, number of
shifts
For prevailing wages/salaries, please see Bureau of Labor Statistics
(www.bls.gov)
Maintenance: preventive and responsive. A typical range for annual maintenance
and repairs cost is 5-10% of the FCI.
R&D
46
CONCLUDING THOUGHTS ON COST ESTIMATION

Different levels of accuracy depending on objectives and available information
Various techniques and literature/web resources
For FCI:
-Start with shortcut methods such as turnover ratio and empirical correlations
for a very quick (and rough) estimation
- Search for comparable data to be scaled up and/or updated (using capacity
ratio exponent of 0.6-0.7 and Chem. Eng. Plant Cost Index)
- When sufficient data are available for the equipment, use factor rules (e.g.,
revised Lang factors or Hand method)
For equipment cost:
-Start with cost charts and web resources (e.g., Matches)
- Search for comparable data to be scaled up and/or updated (using capacity
ratio exponent of 0.6 and M&S Cost Index)
For operating cost:
-For raw materials, use ICIS
- For energy, use EIA
Remember, it is estimation (but with rules and bounds)
47
Homework: Problems 2.1 2.12

Due in one week
48
Depreciation
Break-even analysis
Time value of money
49
DEPRECIATION
A process deteriorates and loses value over its useful life period
Causes: physical (wear & tear) and functional
(e.g., technological obsolescence)
Depreciation is an annual income-tax deduction that is intended to
allow the company to recover the cost a property (e.g., a process
equipment) over a certain recovery period.
When the depreciation charges are shielded from the companys
income taxes, the saved money can be used for the replacement of the
process assets or for capital recovery of the initial value of the asset.
Land and the WCI cannot be depreciated because they are
recoverable in principle.
Depreciation does not involve an actual transfer of cash. It is an
accounting tool. However, it has a major impact on the companys
taxes and, therefore, on the cost of the product and the profit of the
company
50
DEPRECIATION METHODS
Linear (straight-line) method
Declining-balance method
Modified accelerated cost recovery system
51
STRAIGHT LINE DPRECIATION METHOD
V0 V s
d
N
d is the annual depreciation
V0 is the initial value of the property
N is the recovery period over which depreciation is made (sometimes
referred to as the useful life period or the service life of the property) in
years.
For most processing equipment, N ranges from 5 to 20 years. For many
chemical process units, a value of 10 years may be used in the linear
depreciation method.
Vs is the salvage value which corresponds to the worth of the property at
the end of the recovery period.
BOOK VALUE
The book value of the property at the end of the year n (Vb,n) is defined as the difference between
the initial value of the property and the sum of the depreciation charges over the n years, i.e.
Vb ,n V0 d t
t 1
where t is the index for time in years, n is specific year for which the book value is
calculated, and dt is the depreciation charge in the tth year.
When the linear depreciation method is used, the annual depreciation charge is
constant every year (dt = d) and the book value is given by:
Vb ,n V0 n * d
When n = N:
V0 V s
N
Vb , N V 0 N *
Vs
At end of recovery period, book value = salvage value

53
ANNUALIZED FIXED COST

The depreciation scheme can be applied to the depreciable FCI (essentially the FCI
minus the cost of the land).
Because the FCI is paid for at the beginning of the project (even if it is financed),
depreciation serves as an equivalent, distributed, and tax-deductible expense to the
companys production cost that accounts for the distribution of the depreciable FCI over
the useful life period of the plant.
In such cases, depreciation is referred to as the annualized fixed cost (AFC) and is
given by:
FCI 0 FCI s
AFC
N
For many conceptual design studies of retrofitting project (when AFC is much larger than other
annual fixed charges), the total Annualized Cost:
TAC = AFC + AOC

54
Example 2.8. A gas-cleaning project requires the installation of two scrubbers whose
FCI is $ 1.2 MM. recovery period of the heat exchangers is taken to be 10 years. The
salvage value of the exchangers is $ 0.2 MM. The scrubbing process uses 1.5*10 5 kg/yr
of fresh solvent purchased at $0.4/kg. The cost of the fresh solvent is considered to be
the dominant operating cost of this scrubbing system. What is the total annualized cost
of the scrubbing system?
Solution:
1.2 *10 6 0.2 *10 6

AFC
10
= $100,000/yr
AOC = $0.4/kg*1.5*105 kg/hr
= $60,000/yr
TAC
= 100,000 + 60,000
= $160,000/yr
55
DECLINING-BALANCE METHOD FOR DEPRECATION

Because of the risks involved in projects and the decline in the value of money over
time, it is desirable to accelerate depreciation by setting aside higher depreciation
charges in the earlier years of the project.
The declining-balance (fixed-percentage) method is an accelerated depreciation
scheme in which the annual depreciation charge is taken as a fixed fraction of the book
value at the end of the previous year.
While this fixed fraction remains constant throughout the life of the project, the
depreciation charges are set aside at higher values in the earlier years of the project.
56
Let:
fixed depreciation fraction

d ==depreciation
charge for the n
Declining-Balance Method for Depreciation
year
n = a specific year in the life of the project
N = the recovery period (or the last year in the recovery period)
V0 = initial value of the property
Vn = book value of the property at the end of year n
Vs = Salvage value of the property at the end of the recovery period (N years)
n
th
In the linear depreciation method, the rate of recovering the capital via depreciation (i.e., d/(V 0
Vs) ) is 1/N.
The tax laws in the US allow higher rates of capital recovery via depreciation provided that
such rates do not exceed twice the rate of the linear method. Therefore,
1
2

N
N
Two common values of

:
1.5 (in the 150% declining-balance method)
and
2.0 (in the double declining-balance (DDB) method.
57
Declining-Balance Method for Depreciation
WORKSHEET FOR THE DECLINING-BALANCE METHOD
Need to guarantee that the book value at the end of year N is salvage value
Use Combined Method (declining-balance then linear method):.
VN = Vs
and
dN = VN-1 Vs
But, what if the book value at the end of a certain year n has dropped below salvage value?
Cannot depreciate beyond salvage value Need to switch from declining-balance to linear method
at beginning of year n (end of year n-1) and use the linear method for the remaining period N (n-1)
dn
Vn 1 Vs
N (n 1)
and
dn = dn+1 = = dN
58
Example 2.9. Depreciation using the double declining-balance method

A new process equipment has an initial cost of $900,000 and a projected salvage
value $90,000. The recovery period for the equipment is taken as 10 years.
a. Using the DDB method, calculate the annual depreciation charges and the book
values over the equipment life.
b. Compare the book value of the equipment over the useful life period using the
DDB method (with linear adjustment in the last year using the combined
depreciation method) versus the straight-line method.
c. If the salvage value of the equipment is projected to be $130,000, re-calculate the
depreciation charges using the DDB method.
Solution:
a. V0 = $ 900,000, VS = $ 90,000, N = 10
For the DDB method, 2 0.2
N
d1 = 0.2*900,000 = $180,000
and
Vb,1 = 900,000 180,000 = $720,000
59
d1 = 0.2*900,000 = $180,000
and Vb,1 = 900,000 180,000 = $720,000
Continue the same procedure for the rest of the recovery period.
Recovery
Year
0
1
2
3
4
5
6
7
8
9
10
d10 = 120,796 90,000

= $30,796
Annual
Depreciati
on Charge
($)
180,000
144,000
115,200
92,160
73,728
58,982
47,186
37,749
30,199
24,159
Book
value at
end of
year
($)
900,000
720,000
576,000
460,800
368,640
294,912
235,930
188,744
150,995
120,796
96,637
Problem: does not match salvage value

Switch to combined method in yr 10
60
d10 = 120,796 90,000 = $30,796

Revised worksheet for the DDB method:
Recovery
Year
0
1
2
3
4
5
6
7
8
9
10
Annual
Depreciati
on Charge
($)
180,000
144,000
115,200
92,160
73,728
58,982
47,186
37,749
30,199
30,796
Book
value at
end of
year
($)
900,000
720,000
576,000
460,800
368,640
294,912
235,930
188,744
150,995
120,796
90,000
61
b. For the linear depreciation method:
900,000 90,000
$81,000 / yr
10
Initially (first four years, see previous table). DDB gives

higher depreciation charges (important for risk and
for time-value of money)
62
c. If the salvage value of the equipment is projected to be $130,000, re-calculate the

depreciation charges using the DDB method.
Recovery
Year
0
1
2
3
4
5
6
7
8
9
10
d 9 d10
Annual
Depreciati
on Charge
($)
180,000
144,000
115,200
92,160
73,728
58,982
47,186
37,749
30,199
30,796
150,995 130,000
10 8
Book
value at
end of
year
($)
900,000
720,000
576,000
460,800
368,640
294,912
235,930
188,744
150,995
120,796
90,000
Problem: less than salvage value

Switch to combined method in yrs 9 & 10
63
150,995 130,000
d 9 d10
= $10,498/yr
10 8
Revised worksheet for the DDB method:
Recovery
Year
0
1
2
3
4
5
6
7
8
9
10
Annual
Depreciation
Charge
($)
180,000
144,000
115,200
92,160
73,728
58,982
47,186
37,749
10,498
10,498
Book value at
end of year
($)
900,000
720,000
576,000
460,800
368,640
294,912
235,930
188,744
150,995
140,498
130,000
64
THE MODIFIED ACCELERATED COST RECOVERT SYSTEM (MACRS)
Used in the US for preparing the corporates tax forms and calculating federal income taxes
MACRS uses a combination of declining-balance and linear depreciation methods starting with the
declining-balance method and switching the linear method when the annual depreciation charge for the
remainder of the depreciable capital using the linear method is higher than that calculated by the
declining-balance method.
The IRS defines a class life for each type of equipment/industry. For each class life, a certain
recovery period (over which the depreciation calculations are made) is allowed. For many pieces of
equipment involved in the chemical process industries, the class life is 10 years and the recovery period
is 7 years.
For equipment with class lives less than or equal to 10 years, the DDB method is used and for those
with class lives greater than 10 years, the 150% declining-balance method is used.
A half-year convention is used initially and towards the end of class life for the declining-balance
calculations. This means that in the first year of the recovery period, when the declining-balance method
is used, only 50% of the depreciation charges can be made (assuming that the operation was started in
the middle of the tax year or that the property was half productive in the first year). Since only half of
the first year was used, the half-year convention leads to the extension of the of the depreciation period
by a half year towards the end of the calculation. For instance, if a seven-year recovery period is used,
then half a year is used initially followed by six full years then half a year towards the end. Therefore,
while the recovery period is seven years, the depreciation calculations are spread over eight years.
Depreciation is made for the full initial value of the property while disregarding the salvage value.
65
Example 2.10. Calculations of the MACRS method

Consider a unit with an initial cost of $100.00 and a recovery period of 7 years
for which the DDB method is used.
Solution:
Year 1: DDB method gives an annual depreciation charge of (2/7)*100 = $28.57.
MACRS allows half of that in the first year
First-year DDB depreciation charge = 0.5*28.57 = 14.29.
If the linear depreciation is used depreciation charge = (100.00/7) = $14.29
Half-year DBB depreciation charge in the first year is used
The book value at the end of the first year = 100.00 14.29 = $85.71
Year 2: DDB method gives an annual depreciation charge of (2/7)*85.71 = $24.49.
Since in the first year, depreciation was carried out over 0.5 year, then for the linear
method, the remaining time is 6.5 years.
The annual depreciation charge for the book value is (85.71/6.5) = $11.30.
Since the DDB method yields a larger depreciation charge, it is selected.
The book value at the end of the second year is 85.71 24.49 = $61.22.
66
Year 3: Depreciation charge using the DDB = (2/7)*61.22 = $17.49

Linear depreciation of the book value for the remaining 5.5 yrs = (61.22/5.5) = $11.13.
DDB method still yields a larger depreciation charge than the linear method.
The book value at the end of the third year is 61.22 17.49 = $43.73
Year 4: DDB-based depreciation charge is (2/7)*43.73 = $12.49 while the
linear-depreciation charge is (43.73/4.5) = $9.72. Therefore, the book value at
the end of the fourth year is 43.73 12.49 = $31.24.
Year 5: The depreciation charge calculated through the DDB method is
(2/7)*31.24 = $8.93 and the linear depreciation gives the same annual charge of
(31.24/3.5) = $8.93.
Book value at the end of the fifth year is 31.24-8.93 = $22.31.
67
Year 6: DDB-based depreciation charge is (2/7)*22.31 = $6.37

Linear-depreciation charge = (22.31/2.5) = $8.92.
The switch is made from the DDB method to the linear depreciation
method.
The book value at the end of the sixth year is 22.31 8.92 = $13.39.
Year 7: The linear depreciation for the seventh year = (13.39/1.5) =
$8.93 The book value at the end of the seventh year is 13.39 8.93 =
4.46.
Year 7.5: There is still 0.5 year remaining in the recovery period. Since
MACRS reaches full depreciation of the capital by the end of the recovery
period, then the annual depreciation charge in the last year is $4.46 (equal
to the book value at the end of the seventh year).
68
General Results of 7-Yr MARCS Depreciation

Recovery Depreciation
Year
Rate
dn
*100%
V0
14.29
(0.5 year)
2
24.49
17.49
12.49
8.93
8.92
8.93
4.46
(0.5 year)
69
Homework: Problems
2.13 2.15
Due in one week
70
Depreciation
Break-even analysis
Time value of money
71
BREAK-EVEN POINT ANALYSIS

Fixed charges: Expenditures that are independent of the production
capacity. Examples include depreciation (or annualized fixed cost
AFC) and fixed annual operating costs Fixed AOC (e.g., salaries,
wages, property taxes, property insurance) that are independent of the
production levels.
Annual fixed charges
= AFC (annual depreciation) + Fixed AOC (e.g., salaries, wages, property taxes, insurance)
Variable charges (variable AOC): Costs that are dependent on the
extent of production (e.g., raw materials, labor, material utilities, energy
utilities, waste handling, royalties).
Typically, the variable AOC is linearly proportional to the production capacity
Total income: Annual gross sales or savings or subsidies
72
BREAK-EVEN POINT ANALYSIS

$/yr
Break-even
point
t al
o
T
inc
e
om
ction
u
d
o
l pr
Tota
cost
rges ng cost)
a
h
c
able operati
i
r
a
V iable
(var
Fixed
Charges
Production rate, tonne/yr
Maximum
Production
Rate
Break-even point: production rate at which total income = total product cost
Below BEP: Plant is losing
73
Example 2.11: A process has a fixed capital investment of $310 MM. The useful
life period of the process is taken to be 10 years. The salvage value of
the process is $ 10 MM. Other fixed charges for the process (property
taxes, insurance, salaries, etc.) are 20 MM/yr.
The operating cost of the process is $ 100/ton.
Maximum production capacity
Of the process is 200,000 ton/yr.
The selling price of the product is $485/ton.
What is the break-even production rate (ton/yr)
Solution
Annualized fixed cost =
(depreciation)
310 MM 10 MM
10
= $ 30 MM/yr
Annual fixed charges = 30 MM + 20 MM = $ 50 MM/yr

At full process capacity (200,000 ton/yr)
Annual variable charges (at full capacity) = 100*200,000 = $20 MM/yr
Annual sales (at full capacity) = 485*200,000 = $97 MM/yr
74
Graphical Solution of the Example on Break-Even Point Analysis

100
97 MM = 485*200,000
MM $/yr
Annual sales
80
Annual
production
cost
60
Break-even
point
70 MM = 50 MM + 20 MM
Annual fixed charges
50 MM
40
Annual
variable
charges
20
20 MM = 100*200,000
0
0
50
100
130
150
200
Production rate, 1000 tonne/yr

75
Algebraic Solution
Annualized fixed cost =

(depreciation)
310 MM 10 MM
10
= $ 30 MM/yr
Annual fixed charges = 30 MM + 20 MM = $ 50 MM/yr

Let x be break-even point production rate (tonne/yr)
At break-even:
Annual variable charges = 100x
Annual sales = 485x
At break-even point:
annual fixed charges + annual variable charges = annual sales
50*106 + 100x = 485x x = 129,870 tonne/yr
76
On-Stream Efficiency
Can never operate without down time.
Need preventive or reactive maintenance (turnaround time)
Market conditions may require reduction in production or temporary shut downs
On-stream efficiency = (Actual operating hours of the process per year/8760)*100%

where 8760 is the total number of hours per year (24*365).
Or
On-stream efficiency = (Actual annual production/Maximum production)*100%
> 95% is operational excellence (tough!)
> 85% more realistically targeted
The lower the on-stream efficiency at BEP, the better!
For previous example, the on-stream efficiency at the BEP is (129,870/200,000)*100% = 65%
77
Applications of Break-Even Analysis
Minimum required on-stream efficiency (see previous example)

Minimum product pricing
Sensitivity analysis of cost/revenue
78
Example 2.12. Using the break-even analysis for product pricing:

A company is launching a new product P. The depreciable FCI of the process is $450
MM and the salvage value is $50 MM. A 10-year linear depreciation scheme is to be
used to calculate the AFC. Other fixed charges for the process (property taxes,
insurance, etc.) are $5 MM/yr. The maximum production capacity of the process is
100,000 tonne/yr of product P. The operating cost of the process is $ 110/tonne. It is
desired to break even at a production rate of 40% of the maximum process capacity.
What should be the selling price of the product?
79
Solution:
450 * 10 6 50 * 10 6
AFC
10
= $ 40 MM
The annual fixed charges of the process = 40*106 + 5*106 = $ 45 MM/yr
At the BEP, the production rate is 0.4*100,000 = 40,000 tonne/yr.

AOC at the BEP = $110/tonne*40,000 tonne/yr = $4.4 MM/yr
Let CP be the selling price ($/tonne) of product P Annual sales at the BEP is 40,000*CP
At the BEP:
45,000,000 + 4,400,000 = 40,000*CP
CP = $1,235/tonne
80
Example 2.13. Sensitivity analysis via the break-even analysis:

In the previous example, it is desired the study the impact of potential fluctuations in the
selling price of product P on the on-stream efficiency at the BEP. Develop a plot showing this
sensitivity analysis for a product selling price range of $600 1600/tonne
Solution:
Let annual production rate at the BEP be XBEP tonne/yr
At BEP:
45*106 + 110*XBEP = CP*XBEP
-Vary CP from $600/tonne to 1,600/tonne
- For each value of CP , calculate XBEP
- To get on-stream efficiency, divide XBEP by XBEP by max production rate of 100,000 tonne/yr
$600/tonne very difficult to survive

~ $800/tonne or higher is more comfortable
81
Example 2.14. Accounting for plant size in determining the minimum product price via
the break even analysis
Hydrogen is to be produced from biomass. The process involves several units including
gasification to syngas (containing primarily CO, H2, CO2, hydrocarbons, and other gases such
as NH3 and H2S) and tars, steam reforming (CnHm + nH2O = (n+m/2)H2 + nCO) and water-gas
shift (CO + H2O = CO2 + H2), gas cleanup and conditioning, and hydrogen separation. The
following data are available for a 2,000 dry tonne biomass/day (mostly adapted with revisions
and updates from Spath et al., 2005):
Hydrogen yield = 70 kg H2 produced from the process/tonne dry biomass fed to the process
Delivered equipment cost = $60 MM
Fixed annual operating costs:
Salaries and wages = $2.1 MM/yr
Plant overheads = $2.0 MM/yr
Maintenance = $3.1 MM/yr
Insurance and taxes = $3.1 MM/yr
Variable operating costs (expressed as $/kg of produced H2):
Biomass feedstock = $0.75/kg of produced H2
Other raw materials = $0.11/kg of produced H2
Catalysts = $0.0.05/kg of produced H2
Waste disposal = $0.03/kg of produced H2
Electricity = $0.08/kg of produced H2
82
Assuming a 100% on-stream efficiency and a 10-year linear depreciation with no salvage
value,
a. Calculate the minimum selling price of hydrogen needed to break even for the 2,000 tonne
biomass/day plant when it runs for full capacity with a 100% on-stream efficiency.
b. If the plant size is unknown, develop a relationship between the plant size and the
minimum selling price of hydrogen. Consider varying the plant size from 2,000
tonne/day to 20,000 tonne/day. For simplicity, assume that:
The FCI is related to capacity through the six-tenths-factor rule
The fixed operating costs (expressed on an annual basis as $/yr) will remain roughly
the same regardless of the plant size
The variable operating costs (expressed as $/kg of produced hydrogen) will remain
the same (which means that the variable annual operating cost will change linearly
with the production rate)
c. As the plant size increases, biomass will have to be transported from farther area. In such
cases, the transportation cost should be included. The first 2,000 tonne/day of biomass
are locally available and, therefore, the feedstock cost ($0.75/kg of produced H 2) includes
the transportation cost. Above 2,000 tonne/day, the biomass will have to be hauled from a
long distance. The higher the biomass demand, the larger the cost of transportation per
tonne of biomass. For flowrates greater than 2,000 tonne/day, the transportation cost is
given by:
Annual transportation cost of biomass ($/yr)
= 0.4*(Flowrate of biomass in tonne/day 2,000)*(Flowrate of biomass in tonne/day)
Resolve part (b) while accounting for the transportation cost.
83
Solution:
a.For the plant processing 2,000 tonne dry biomass/day:
Using the revised Lang factor from Table 2.5. for a solid-fluid process:
FCI = 4.3*60 = $258 MM
Applying a linear depreciation scheme over 10 years, we get:
Annual depreciation charges = 258/10 = $25.8 MM
From the given data,
Fixed annual operating cost = 2.1 + 2.0 + 3.1 + 3.1 = $10.3 MM/yr
Since the variable operating costs are given per kg of produced H 2, we need to calculate
the annual production rate of H2. For a hydrogen yield of 70 kg produced H2/tonne of dry
biomass fed to process:
Annual production rate of H2 =
70 kg H2/tonne biomass*2,000 tonne biomass/day*365 days/yr = 51.1 MM kg H2/yr
Variable operating costs = 0.75 + 0.11 + 0.05 + 0.03 + 0.08 = $1.02/kg of produced H2
At full production rate of 51.1 MM kg H2/yr:
Variable AOC = $1.02/kg of produced H2*51.1 MM kg H2/yr = $52.12 MM/yr
Let Chydrogen min be the minimum selling price of hydrogen ($/kg) needed to break even at
full production rate At BEP:
Chydrogen min *51.1*106 = (25.8*106 + 10.3*106 ) + 52.12*106
Chydrogen min = $1.73/kg H2
84
Alternatively, the minimum selling price can be calculated via the TAC:
TAC = AFC + AOC
AOC = Fixed annual operating cost + Variable annual operating cost
At full production capacity:
AOC
= 10.30 + 51.12 = $ 61.42 MM/yr
TAC = 25.80 + 61.42 = $87.22/yr
The value of the TAC is the total annual production cost of 51.1 MM kg H 2/yr
Chydrogen min = 88.22*106/51.1*106
= $1.73/kg H2
85
b. Let us write the FCI as a function of plant using the sixth-tenths-factor rule:
FCI ($)
= 258*106*(Flowrate of biomass in tonne per day/2,000)0.6
= 2.698*106*(Flowrate of biomass in tonne/day)0.6
Annual depreciation ($/yr) = 0.2698*106*(Flowrate of biomass in tonne/day)0.6
Variable annual operating cost ($/yr) = 1.02*(Product flowrate in kg of produced H2 per year)
Hydrogen yield is 70 kg H2 produced from the process/tonne dry biomass fed to the process
Variable annual operating cost ($/yr)
= 1.02*(70kg H2/tonne biomass)*(Flowrate of biomass tonne biomass/day)*(365 day/yr)
= 26,061*Flowrate of biomass (tonne/day)
Also, for a minimum selling price of hydrogen:
Annual sales ($/yr) = Chydrogen min ($/kg H2)* Product flowrate in kg of produced H2 per year
= Chydrogen min*(70 kg H2/tonne biomass)*(Flowrate of biomass tonne biomass/day)*(365 day/yr)
= 25,550* Chydrogen min * Flowrate of biomass (tonne/day)
Applying the break-even analysis:
25,550* Chydrogen min * Flowrate of biomass (tonne/day) = 0.2698*106*(Flowrate of biomass in
tonne/day)0.6 + 26,061*Flowrate of biomass (tonne/day) + 10.3*106
For a given value of the biomass flowrate,, the minimum selling price of hydrogen can be
determined. For instance, when the flowrate of the biomass feedstock is 2,000 tonne/day, we get:
25,550* Chydrogen min * 2,000 = 0.2698*106*(2,000)0.6 + 26,061*2,000 + 10.3*106
Chydrogen min = $1.73/kg H2 (same answer obtained in part (a)).
When the flowrate of the biomass feedstock is varied from 2,000 to 20,000 tonne/yr, the resulting
86
sensitivity analysis can be plotted (next slide)
Sensitivity Analysis: Minimum Selling Price of Hydrogen vs. Plant Size (No Transportation)
Chydrogen min
($/kg H2)
Notice economy of scale!
87
c. When the transportation cost is added, the break-even equation becomes:

25,550* Chydrogen min * Flowrate of biomass (tonne/day) = 0.2698*106*(Flowrate of biomass
in tonne/day)0.6 + 26,061*Flowrate of biomass (tonne/day)
+ 0.4*(Flowrate of biomass in tonne/day 2,000)*(Flowrate of biomass in tonne/day)
+10.3*106
Vary biomass flowrate (between
2,000 and 20,000 tonne/day) and
solve BEP eq. to get the minimum
selling price of hydrogen.
Increase in the plant capacity leads
to a reduction in the depreciation
charges per kg of product (due to the
economy of scale)
But transportation cost per kg of
product increases (because the
material has to be hauled from
farther areas)
tradeoff causes the nonmonotonic behavior leading to a
minimum selling price of $1.45/kg
H2 when the biomass flowrate is
9,581 tonne/day.
Homework on Break-Even Analysis :

Problems 2.16-2.17
Due in one week
89
Depreciation
Break-even analysis
Time value of money
90
TIME VALUE OF MONEY

Over time, there is always a change in the cost of goods and services.
Topics to be covered under time value of money:
Cost indices and inflation
Compound interest
Cash-flow diagrams
Annuities
91
Cost Indices
Cost indices can be used to account for the time-based variation in cost
Examples for plants and equipment : Chemical Eng. Plant Cost Index, M&S
Cost index
Cost indices are also available for broader categories of goods and services.
Example: Consumer Price Index (CPI) published by the US Department of Labor,
Bureau of Labor Statistics.
CPI at time t 2
CPI at time t1
Price t 2 Pricet1
92
Inflation Rate
Inflation: an increase in the average prices of goods and services over a period of time
Deflation: a decrease in the average prices of goods and services over a period of
time. Annual inflation rate: as annualized percentage change in the value of CPI over
two consecutive years:
CPI in year n - CPI in year n - 1
* 100%
CPI
in
year
n
1
Inflation rate in year n
For example, for 2008 and 2007 when the CPIs were 215.303 and 207.342, the inflation rate for 2008 is
(215.303 207.342)/207.342*100% = 3.8%.
93
ftp://ftp.bls.gov/pub/special.requests/cpi/cpiai.txt
The Producer Prices Index for Chemicals and Allied Products

Published by the US Department of Labor, Bureau of Labor Statistics
Reflects the time-based changes in the average production cost of various chemicals.
Useful in updating
cost of chemical and
operating costs
94
http://data.bls.gov/PDQ/servlet/SurveyOutputServlet?series_id=WPU06&data_tool=XGtabl
TIME VALUE OF MONEY

Compound interest:
Let P = Principal (original amount or remaining unpaid amount of a loan)
N = Number of interest periods (e.g., years)
i = interest rate based on a unit interest period (e.g., annual interest rate)
Period
Interest earned
during period
Compound amount F
at end of period
1
2
3
Pi
P(1+i)i
P(1+i)2i
P + Pi
= P(1+i)
P(1+i) + P(1+i)i = P(1+i)2
P(1+i)2 + P(1+i)2i=P(1+i)3
P(i+i)N-1i
P(1+i)N
F = P(1+i)N
F = future value after N periods
Example 2.15.
A graduating senior has deposited her first-month salary of $5,000 in a bank at an
annual interest rate of 5%. How much will she have in the bank after 50 years?
F = P(1+i)N
P = $5,000
i = 0.05
N = 50
F
= 5,000(1+0.05)50
= $57,000
Example 2.16. Compound interest with a monthly interest rate:

A credit card company charges an interest rate of 1.5% compounded monthly.
What is the equivalent annual interest rate?
Solution:
Let us take a basis of P = $1.
i = 0.015 (compounded monthly)
For one year, N = 12 months
after one year:
F = (1 + 0.015)12 = 1.1956
But,
F = 1 + iequivalent annual
iequivalent annual = 0.1956
equivalent annual interest rate is 19.56% (not 1.5% and not 1.5*12 = 18%).
97
TIME VALUE OF MONEY

Present worth
Value of money deteriorates over time because of inflation
How to calculate present worth of some future amount of money?
Same formula used in calculating interest rate
Let
F = Future value of money
P = Present worth of money
N = Number of interest periods (e.g., years)
i = inflation rate based on a unit period (e.g., annual inflation rate)
P = F(1+i)-N
Example 2.17. Principal of a single payment:

A graduating senior wishes to have $50,000 in her bank account after 50
years by making a single deposit now and leaving it in her account for 50
years while earning an annual interest rate of 5%. How much does she have
to deposit now?
Solution:
F = $50,000
i = 0.05
N = 50 years
P = F(1+i)-N
P = 50,000*(1 + 0.05)-50
= $4,360
Example 2.18. Present worth of a future value

The value of money tends to erode over time because of inflation. Suppose that after
50 years, you will have a fortune of $1 MM. Assuming that the average annual
inflation rate will be 3% for the next 50 years, how much is the million dollars worth
in terms of todays dollars?
Solution:
F = $1.0*106
i = 0.03
N = 50 years
P = F(1+i)-N
P = 106*(1 + 0.03)-50
= $228,107 (almost a quarter millionaire )
100
Cash Flow Diagram

Useful tool in representing financial transactions of a period of time and in
accounting for the time-value of money.
Timeline:
Cash Flow Diagram
101
ANNUITY
Annuity is a series of constant payments deposited at equal time intervals
(e.g., payment of FCI, mortgage, savings as part of a IRS Savings plan, life insurance)
Let
A = annuity installment (constant payment) deposited at the end of each period
N = Number of periods (e.g., years)
i = interest rate based on a unit interest period (e.g., annual interest rate)
A
3
Year
N -1
At end of Nth year, future value of annuity deposited at end of first year
A
A(1+i)N-1
N -1
Year
At end of Nth year, future value of annuity deposited at end of second year
A
A(1+i)N-2
N -1
Year
At end of Nth year, future value of annuity deposited at end of third year
A
A(1+i)N-3
N -1
Year
At end of Nth year, future value of annuity deposited at end of N-1 year
3
Year
A(1+i)
N -1
Final payment A paid at the end of the Nth year, does not earn interest.
Future sum of annuity at the end of the Nth year F =

A(1+i)N-1 + A(1+i)N-2 + A(1+i)N-3++A(1+i) + A
Multiply both sides by (1+i)

F (1+i) = A(1+i)N + A(1+i)N-1 + A(1+i)N-2++A(1+i)2 + A(1+i)
Subtracting both equations:
F (1+i) = A(1+i)N + A(1+i)N-1 + A(1+i)N-2++ A(1+i)2 + A(1+i)
-[F
A(1+i)N-1 + A(1+i)N-2 + + A(1+i)2 + A(1+i) + A]
F i = A(1+i)N - A
F= A
(1+i)N - 1
i
Future Sum of the Annuity
Example
A graduating senior will be investing $12,000 per year in an IRS fund at an annual
interest rate of 5%. How much will she have in the IRS after 50 years?
F=
(1+i)N - 1
i
50
(1+0.05)
-1
F50 = 12,000
0.05
= $2.5 MM
PRESENT SUM OF AN ANNUITY

Recall:
Present worth = Future worth/(1+i)N
But, future sum of the sum of annuity:
F= A
P =
(1+i)N - 1
i
(1+i)N - 1
i(1+i)N
Present Sum of the Annuity
Shorthand Notation by the American National Standards Institute

(F/P, i, N) which represents F/P = (1 + i)N
used to calculate a future value F for a single payment P at an interest rate i after N years.
(P/F, i, N) which corresponds to P/F = (1 + i) -N

discounting of a single amount F to calculate the present value P at an interest/discount
rate i after N years.
(F/A, i, N) which represents
(1 i ) N 1
F / A
i
used to obtain the future worth of multiple amounts of an annuity A recurring N times over N
years at a discount rate i
(1 i ) N 1
(P/A, i, N) which designates P / A i (1 i ) N
used to obtain the present worth P of multiple amounts of an annuity A recurring N times over
N years at a discount rate i
i (1 i ) N
(A/P, i, N) which designates A / P

N
(1 i ) 1
used to calculate the annuity installment A which is to be repeated over N years

to provide a present worth P over N years at a discount rate i
108
AFC and Capital Recovery Ratio

An annuity scheme can be used to annualize the fixed cost by including time-value of money:
i (1 i ) N
AFC FCI
N
(1 i ) 1
AFC/FCI = is called the capital recovery factor or the annual capital charge ratio. Hence,
i (1 i ) N
Capital recovery factor

N
(1 i ) 1
109
Example 2.19. Future sum of annuity:

Some companies offer to provide contributions matching the employees
investment and invest both in a tax-deferred annuity fund (e.g., 401K plans in the
US). A young engineer intends to deposit $12,000 per year in a tax-deferred
annuity fund (half of which will be deducted from the employees salary and the
other half will be contributed by the employer). The fund will earn an annual
interest rate of 5%. How much will engineer have in the annuity fund after 30
years?
Solution:
A = $12,000/yr
(1 i ) N 1
F A
i = 0.05
i
N = 30 years
(1 0.05) 30 1
F 12,000 *
0.05
= $ 797,266
It is worth comparing this result with that of annuity deposits not earning any interest (30*12 = $360,000).
110
Example 2.21. Using an annuity scheme to calculate AFC:

A project has a depreciable FCI of $10 MM. Using an annuity scheme over 10 years with
an interest rate of 10%, calculate the AFC.
Solution:
i (1 i ) N
AFC FCI
N
(
1
i
)
0.1 (1 0.1)10
AFC 10 *10
10
(1 0.1) 1
6
= $1,627,454/yr
Compare with 10-year linear depreciation scheme (no time-value of money)
AFC = ($10 MM 0)/10 = $1 MM/yr.
The additional $627,454/yr is the cost of capital because of the interest involved in borrowing.
The 10-year annuity calculation of the AFC gives almost the same result as a 6-year linear
depreciation scheme the cost of capital in this example prolongs paying off the FCI by about
four years.
111
Example 2.22. Sensitivity of capital recovery ratio

Develop a graph showing the dependence of the capital recovery ratio on the interest
rate and the number of years used in annualization of the FCI over the following
ranges:
10 N 20
0.05 i 0.20
Solution:
i (1 i ) N
Capital recovery factor

N
(1 i ) 1
112
Example 2.20. Present sum of annuity:

In the previous example, what is the present sum of the annuity?
Solution:
(1 i ) N 1
P A
N
i (1 i )
(1 0.05) 30 1
P 12,000 *
30
0
.
05
(
1
0
.
05
)
= $184,469
113
Example
A piece of equipment (or a house) costs $250,000 (in todays dollars, i.e. present worth). Using an annuity
scheme paid at the end of each year for the next 20 years at an 8% interest rate, what should be the annual
annuity payment?
PSum Annuity =
250,000 =
C
C
(1+i)N - 1
i(1+i)N
(1+0.08)20 - 1
0.08(1+0.08)20
C = $25,500/yr
Resolve same example of an annuity scheme over 30 years:
C = $22,200/yr Pay off your debt as fast as you can!
Homework: Problems
2.18 2.20
Due in one week
115
Depreciation
Break-even analysis
Time value of money
116
PROFITABILITY
Consider the following project:
Project
I
Total Capital Investment

MM$
Annual Profit
MM$/yr
50
10
Is it profitable enough?
Consider two candidate projects:
Project
I
II

MM$
Annual Profit
MM$/yr
50
70
Which alternative is more profitable?
10
15
117
PROFITABILITY TOPICS TO BE COVERED

Profitability criteria without the time-value of money:
-Return on investment
-Payback period
Profitability criteria with time-value of money
-Net present value
-Discounted cash flow return on investment
-Discounted cash flow payback period
Comparison of alternatives
-Net present value
-Annual cost/revenue
-Total annualized cost
-Incremental return on investment
118
RETURN ON INVESTMENT ROI

Annual Profit
ROI =
Capital Investment
Units: fraction per year

or % per year
Most common definition:
Annual Net (After Tax) Profit

ROI =
ROI: the higher, the better

Compare ROI with ROI for alternative projects or return from investments
including financial investment (bank, bonds, etc.)
119
RETURN ON INVESTMENT ROI
Annual net (after-tax) profit = Net income per year = Annual after-tax cash flow
How to calculate annual net profit?
Annual net (after-tax) profit = Annual gross profit Annual income taxes
Annual gross profit = Annual income (or savings) Annual operating cost
How to calculate taxes?
Remember: depreciation is tax shielded (write-off)
Taxable annual gross profit = Annual gross profit - Depreciation
Annual income taxes = Taxable annual gross profit*Tax rate
Annual net (after-tax) profit = Annual gross profit (Annual gross profit Depreciation)*Tax rate
Lets subtract and add Depreciation
Annual net (after-tax) profit = (Annual gross profit - Depreciation)
+ Depreciation - (Annual gross profit Depreciation)*Tax rate
= (Annual gross profit Depreciation)*(1 Tax rate) + Depreciation
= (Annual income Annual operating cost Depreciation)*(1-Tax rate) +Depreciation
= (Annual income Total annualized cost)*(1-Tax rate) + Depreciation
120
Example 2.23: A proposed project requires a total capital investment of

$4 MM and provides an annual net (after-tax) profit of $ 20,000/yr.
What is the ROI of the project? Should the company implement it?
ROI =

ROI = (20,000/4,000,000)*100%
= 0.5%
Do not implement. The company is better off saving the money in a bank!
121
Example 2.24: A mass integration project requires piping for recycle and
two mass exchangers. The project results in $3.5 MM/yr of annual savings. The project
requires a fixed capital investment of $2.0 MM. The working capital investment is
taken as 15/85 of the fixed capital investment. The annual operating cost of the project
is $0.3 MM/yr. Depreciation is calculated over 10 years with no salvage value.
The corporate tax rate for the project is 30% of the annual taxable gross profit.
What is the ROI of the project?
FCI Salvage value
Depreciation of FCI =
Useful life period
Annual FCI depreciation (annualized fixed cost) = (2,000,000 0.0)/10 = $200,000/year

Total annualized cost = annualized fixed cost + annual operating cost
= 200,000 + 300,000 = $500,000/year
Annual net (after-tax) profit
= (3,500,000 500,000)*(1 0.30) + 200,000 = $2,300,000/yr
122
Total capital investment = Fixed capital investment + Working capital investment

= 2,000,000 + (15/85)*2,000,000
= 2,000,000*(100/85) = $ 2,353,000
ROI =

ROI = (2,300,000/2,353,000)*100%
= 98%
Very attractive!
123
Example 2.25. Using the ROI for determining environmental subsidies:

A group of engineers is considering the formation of a company to be called Aggies Renewable Engineering
which specializes in the introduction of sustainable sources of energy. A potential project for the company is
the manufacture of biodiesel from several renewable sources including algae and waste cooking oil. The
growth of algae requires carbon dioxide as one of the main nutrients. Therefore, CO2 may be sequestered from
the flue gases of a power plant or an industrial source to be used for algae cultivation. Then, the feedstocks
including the algal oil and the waste cooking oil are pretreated and processed to produce biodiesel.
Substitution of the petro-diesel with the more sustainable biodiesel offers a reduction in the net emission of
greenhouse gases including CO2. On the other hand, a techno-economic study reveals that biodiesel from
algae and other renewable sources is more expensive that petro-diesel. Therefore, to launch this new process,
the company is requesting a government subsidy in the form of a tax credit. The following data are available
for a biodiesel plant with a maximum production capacity of 40 MM gal/yr (Pokoo-Aikins et al., 2010; Elms
and El-Halwagi, 2010); Myint and El-Halwagi, 2009):
- FCI of the plant is $25 MM

-WCI of the plant is $5 MM
- Operating cost = $2.87/gal biodiesel produced
- Selling price of biodiesel = $3.00/gal
-Tax rate = 35%
- Linear depreciation over 5 years , no salvage (i.e., annual depreciation = $5 MM/yr)
-When biodiesel is used in lieu of petro-diesel, the reduction in greenhouse gas
emissions is taken to be of 8 kg CO2 equivalent/gal biodiesel
-The company desires to make a 30% ROI at the maximum production capacity.
What should be the value of the tax credit (or a tax-exempted subsidy) expressed as
124
$/gal biodiesel and $/tonne CO2 equivalent?
Solution: Need to modify the following equation to include tax credit:

Let us add the tax credit ($/yr) to the annual income while noting that the tax credit
is not taxable.
= (Annual income Annual operating cost Depreciation)*(1-Tax rate)
+ Tax credit + Depreciation
Annual net profit =
(40 MM gal/yr*$3.00/gal 40 MM gal/yr*$2.87/gal 5.0*106)(1-0.35) + Tax credit + 5.0*106
= 5.13*106 + Tax credit

5.13 *10 6 Tax credit
ROI
*100%
6
30 *10
when the ROI is 30%, the tax credit should be $3.87 MM/yr.
Since the maximum production is 40 MM gal/yr, then
Tax credit per gallon of biodiesel = 3.87*10 6/40.00*106 = $0.097/gal
And, in terms of CO2 credit,
Tax credit per tonne of CO2 mitigated = ($0.097/gal)/(0.008 tonne CO 2 equivalent/gal)
125
= $12.1/tonne CO2 equivalent
Impact of Carbon Credit on ROI for the Biodiesel-from-Algae Example
126
PAYBACK PERIOD PBP or Simple PBP or PAYOUT PERIOD

PBP (yrs) =
Depreciable Fixed Capital Investment

Annual after-tax cash flow
Indication on how fast the project recovers its initial fixed capital investment
(the shorter, the better)
= (Annual income Annual operating cost Depreciation)*(1-Tax rate) +Depreciation
Notice that annual cash flow excludes depreciation (to avoid double counting
because payback period is aimed at recovering back FCI which is also the aim of
depreciation).
127
Example revisited: A mass integration project requires piping for recycle and two
mass exchangers. The project results in $3.5 MM/yr of annual savings. The project
requires a fixed capital investment of $2.0 MM. The working capital investment is
taken as 15/85 of the fixed capital investment. The annual operating cost of the project
is $0.3 MM/yr. Depreciation is calculated over 10 years with no salvage value. The
corporate tax rate for the project is 25% of the annual gross profit. What is the payback
period of the project?
Depreciation of FCI =
FCI Salvage value

Useful life period
Annual FCI depreciation (annualized fixed cost) = (2,000,000 0.0)/10 = $200,000/yr

Total annualized cost = annualized fixed cost + annual operating cost
= 200,000 + 300,000 = $500,000/yr
= (3,500,000 500,000)*(1 0.30) + 200,000 = $2,300,000/yr
Payback period = 2,000,000/2,300,000 = 0.87 yr
Very attractive!
128
Example 2.27. Sensitivity analysis for the PBP as a function of operating

cost:
Example 2.25 for the production of biodiesel is revisited. The following are
the key data:
FCI of the plant is $25 MM
WCI of the plant is $5 MM
Operating cost = $2.87/gal biodiesel produced
Selling price of biodiesel = $3.00/gal
Tax rate = 35%
A linear depreciation scheme is to be used over 5 years with no salvage value
(i.e., annual depreciation = $5 MM/yr)
The operating cost of the plant is dominated by the cost of raw materials and
may vary from $2.60 to 3.20/gal. No subsidy is given in this example.
Conduct a sensitivity analysis to show the impact of the operating cost on the
PBP.
129
Solution:
Let Cop be the operating cost per gallon of biodiesel. Therefore,
Annual net profit =
(40 MM gal/yr*$3.00/gal 40 MM gal/yr*$Cop/gal 5.0*106)(1-0.35) + 5.0*106
= 79.75*106 26.00*106Cop
Valid expression as long as the taxable income is positive, i.e.
40 MM gal/yr*$3.00/gal 40 MM gal/yr*$Cop/gal 5.0*106 > 0
or
Cop < $2.88/gal
Higher than this operating cost, the taxable income is not positive and no taxes are
collected. Substituting for the tax rate to be zero (assume for simplification that the tax
rate drops from 35% to 0%)
Annual net profit = 40 MM gal/yr*$3.00/gal 40 MM gal/yr*$Cop/gal
25.0 * 10 6
PBP
79.75 *10 6 26.00 *10 6 C op
25.0 * 10 6
PBP
120.00 * 10 6 40.00 * 10 6 C op
PBP
2.88 C op 3.00
Cop < $288/gal

2.88 C op 3.00
Cop $3.00/gal
130
Sensitivity Analysis for PBP vs. Operating Cost
Very sensitive to operating cost which is dominated by cost of raw materials (e.g., soybean
oil).
131
Another reason to stay away from edible feedstocks and to avoid fuel-food feud

-Payback period
-Net present value
-Net present value
132
CASH FLOW DIAGRAM

Represents how much money is earned and spent over the useful life period of a project
Timeline represents the useful life period of the project
Arrows below the timeline represent cost/expenditure (money out -)
Arrows above the timeline represent income/savings (money in +)
Constructing the Timeline

Start of
the project
Useful Life Period

of the project
10
Time (year)
133
CASH FLOW DIAGRAM

Cash
Flow
$/yr
WCI
Salvage
Value
Annual After-Tax Cash Flows
Land
2
3
Land
FCI1
FCI2
10
11
12
Time (yr)
WCI
Cash Flow Diagram with Present Time Taken as the Beginning of Expenditures
Cash
Flow
$/yr
WCI
Salvage
Value
Annual After-Tax Cash Flows
Land
-2
-1
0
0
Land
FCI1
FCI2
10
Time (yr)
WCI
Cash Flow Diagram with Present Time Taken as the Beginning of Operation
Cash
Flow
$/yr
NET PRESENT VALUE (NPV) or Net Present Worth (NPW)
Working Capital
Salvage Value
Land
Annual
After-Tax
Cash Flow
Land
10
Net Present Value (NPV) = sum of present worths of

All annual after-tax cash flows sum of present worths
of capital investments
Fixed
Capital
Working
Capital
Challenge: need to transform all cash flows to present worth
P = F(1+i)-N
NPV
N Final
ACF
N 0
(1 i ) N
Discount factor= (1+i)-N
i = discount rate (usually, the companys minimum acceptable ROI or hurdle rate)
136
Example 2.28. NPV of a Project

A new process will be installed. Land is first purchased for $20 MM. Then, the equipment will
be procured and installed over two years. The corresponding FCI costs for years 1 and 2 are
$120 MM and $180 MM, respectively. The WCI for the project is $45 MM and will be spent at
the end of the second year. Operation is started at the beginning of the third year. The process
is continued for 10 years from the start of operation during which revenue is made on an
annual basis. The annual after-tax cash flows may vary from one year to another. For instance,
in year 3 (which corresponds to the first year of operation), the plant is not operational in full
capacity and incurs some start-up cost. Therefore, its annual after-tax cash flow is less than
that is subsequent years. Also, major maintenance and retrofitting activities in year 8 cause a
reduction in the annual after-tax cash flow. At the end of the useful life period of the plant, the
land and WCI are estimated to be recovered for $20 MM and $45 MM, respectively, and the
salvage value is estimated to be $30 MM. Table 2.19 shows a summary of the annual after-tax
cash flows of the project and their conversion to discounted cash flows. A discount rate of 10%
is to be used.
137
End of Year
Annual (Non-Discounted) Cash Flow (in $ MM)
-20 (Land)
-120 (FCI1)
-225 (-185 for FCI2 and -45 for WCI)
40
65
65
70
75
55
60
10
60
11
75
12
75
13
165 (70 from annual after-tax cash flow, 20 from land, 45 from WCI, 30
from salvage value)
138
NPV Worksheet for Example 2.28

End of Annual
Year
0
1
(Non-Discounted) Discount Factor
Cash Flow (in $ MM)
Discounted Cash Cumulative

Flow (in $ MM)
(1 + i)-n
Discounted Cash
Flow (in $ MM)
-20 (Land)
1.0000
-20.000
-20.000
0.9091
-109.092
-129.092
0.8264
-185.940
-315.032
0.7513
30.052
-284.980
0.6830
44.395
-240.585
0.6209
40.359
-200.226
0.5645
39.515
-160.711
0.5132
38.490
-122.221
0.4665
25.658
-96.563
0.4241
25.446
-71.117
0.3855
23.130
-47.987
0.3505
26.288
-21.699
0.3186
23.895
2.196
-120 (FCI1)
-225
40
65
65
70
75
55
60
10
60
11
75
12
75
13
165
NPV=
Cash Flow Diagram for Example 2.28
140
Example 2.29. Calculate the NPV of a project with the following data:
Year
After-Tax Cash Flow
0 -2,200,000 (TCI)
1 800,000
2 800,000
3 800,000
4 800,000
5 1,000,000
(800,000 annual after-tax cash flow, 200,000 for salvage value & recovered WCI)
The useful life period of the project is five years. Consider an annual discount rate of 15%
200,000 (salvage + working)
800,000
800,000 800,000 800,000 800,000
-2,200,000
141
Example 2.29. Solution:
NPV = -2,200,000 + 696,000 + 605,000 +526,000 + 458,000 + 497,000 = $582,000
142
Special Case for NPV of Uniform After-Tax Cash Flows

(1 i) N 1
P A
N
i (1 i )
800,000
800,000
800,000
800,000
800,000
1
with A = $800,000/yr, i = 0.15,

and N = 5. Hence,
-2,200,000
(1 0.15) 5 1
P 800 ,000
5 = $2,681,724
0.15(1 0.15)
Present worth of the 200,000 salvage value and working capital = 200,000*(1+0.15) -5
= $100,000
NPV = -2,200,000 + 2,682,000 + 100,000 = $582,000
143
Discounted Cash Flow Return on Investment (DCF ROI)

or Internal Rate of Return IRR
A more accurate way of calculating ROI by accounting for the
time value of money
Can be calculated (sometimes trial & error) by evaluating the value of i when
NPV is set to zero
144
Example 2.30. Calculate the discounted cash flow return on investment

for a project with the following data:
Year
After-Tax Cash Flow
-3,150,000 (TCI)
1,000,000
1,000,000
1,000,000
1,000,000
1,400,000
(1,000,000 annual after-tax cash flow, 400,000 for salvage
value and recovered working capital)

The useful life period of the project is five years.
1,000,000 1,000,000 1,000,000 1,000,000
1,000,000
1
-3,150,000
145
Solution:
PSum Annuity =
(1+i)N - 1
i(1+i)N
1,000,000 1,000,000 1,000,000 1,000,000

1,000,000
-3,150,000
Uniform after-tax cash flow $1,000,000/yr for 5 years
PSum Annuity = 1,000,000
(1+i)5 - 1
i(1+i)5
Present worth of the 200,000 salvage value and working capital = 400,000*(1+i) -5
(1 i ) 5 1 400,000
NPV 0 3,150,000 1,000,000
5
i (1 i )
(1 i ) 5
Solving for i (equation solver or trial and error): i = 0.20
146
Compare the 20% DCF ROI with the value of the non-discounted ROI:
Annual Net (After - Tax) Profit

ROI
TCI
1,000,000
*100% 31.7%
3,150,000
The discounted ROI gives a more optimistic estimate than that of the DCF ROI because it does
not account for the time-value of money. Use with caution.
147
Example 2.31. Using the DCF ROI to Determine Minimum Selling Price
We have seen how the break-even analysis can be used to estimate a minimum selling
price of a product when the time-value of money is not considered. Now, we show how the DCF
ROI along with the NPV can be used to calculate a minimum selling price when the time-value of
money and the cash-flow diagram are considered. The case study in this example is an ethanol plant
which uses corn stover as a feedstock. The following data (mostly extracted with revisions and
updates from Kazi et al., 2010) are available:
The plant capacity is 2000 tonnes of corn stover/day
The plant produces 54 MM gal/yr of ethanol as the primary product and sells electricity power ($12
MM/yr) as a co-product
Depreciable FCI = $358 MM (spent 50% then 50% after one and two years, respectively, from
purchasing the land)
Land cost = $25 MM
WCI = $53 MM
Operation starts at the end of the second year and continues for 20 years from the beginning of
operation
Feedstock cost = $58 MM/yr
Cost of other raw materials, enzymes, and catalysts = $55 MM/yr
Waste disposal = $8 MM/yr
Fixed annual operating costs (salaries, property taxes, insurance) = $10 MM/yr
Tax rate = 35% of taxable income
Depreciation using MACRS with a 7-year recovery period is to be used
The plant has a negligible salvage value
What is the selling price of ethanol that will yield a zero value of the NPV of the plant over 20 years
148
of operation using a 10% IRR.
Solution: Let us assume that the annual operating cost will remain constant throughout
the 20 years of the project with:
AOC = Variable annual operating cost + Fixed annual operating cost
= (58 + 55+ 8) + 10 = $131 MM/yr
Depreciation of the $358 MM FCI is carried out over 7 years using the MACRS
scheme:
Recovery
Depreciation
Year
Rate
dn
* 100%
V0
Depreciation Charge
($MM/yr)
14.29
51.16
24.49
87.67
17.49
62.61
12.49
44.71
8.93
31.97
8.92
31.93
8.93
31.97
4.46
15.98
1 (0.5 year)
which is in the third year of the project since
operation starts after two years from
purchasing the land
(0.5 year)
Depreciation is carried out over 7 years. Using the MACRS scheme, the depreciation
charges are shown in Table 2.23. It is important to recall the half-year convention which
spreads the depreciation over 8 years from start of operation.
It is also worth noting that the recovery period for depreciation (7 years) is different
from the useful life period of the project (20 years) over which the NPV calculation will be
done.
Beyond the recovery period (years 9 20 from start of operation or 11 22 from start
of construction), there are no depreciation charges.
Let CEtOH be the selling price of ethanol ($/gal) and assume it to be constant over the
life period of the plant
annual sales ($ MM/yr) of ethanol = 54 MM gal/yr*CEtOH$/gal. :
150
Worksheet for Annual After-Tax (Non-Discounted) Cash Flows for the Ethanol Example
151
152
End
of
Worksheet for NPV for the Ethanol Example
Annual After-Tax (Non-
Discount Factor (1 + i)-n
Year
Discounted) Cash Flow($MM)
-25.00
-179.00
-232.00
(54*CEtOH + 12.00 131.00
1.0000
0.9091
0.8264
Annual After-Tax (Discounted) Cash Flow ($MM)
-25.00
-162.73
-191.74
26.37*CEtOH 44.66
51.16)*(1.00-0.35) + 51.16
= 35.1*CEtOH -59.44
4
35.1*CEtOH 46.66
35.1*CEtOH 55.44
35.1*CEtOH 61.70
35.1*CEtOH 66.16
35.1*CEtOH 66.17
35.1*CEtOH 66.16
10
35.1*CEtOH 71.76
11
(54*CEtOH
0.7513
0.6830
0.6209
0.5645
0.5132
0.4665
0.4241
0.3855
12.00
23.97*CEtOH 31.87
21.97*CEtOH 34.42
19.81*CEtOH 34.83
18.01*CEtOH 33.95
16.37*CEtOH 30.87
14.89*CEtOH 28.06
13.53*CEtOH 27.67
12.30*CEtOH -27.11
131.00)*(1.00 0.35)
= 35.1*CEtOH 77.35
0.3504
12
35.1*CEtOH 77.35
13
35.1*CEtOH - 77.35
14
35.1*CEtOH - 77.35
15
35.1*CEtOH - 77.35
16
35.1*CEtOH - 77.35
17
35.1*CEtOH - 77.35
18
35.1*CEtOH - 77.35
19
35.1*CEtOH - 77.35
20
35.1*CEtOH - 77.35
21
35.1*CEtOH - 77.35
22
35.1*CEtOH 26.65
0.3186
0.2897
0.2633
0.2394
0.2176
0.1978
0.1799
0.1635
0.1486
0.1351
0.1228
11.18*CEtOH 24.65
10.17*CEtOH 22.41
9.24*CEtOH 20.37
8.40*CEtOH 18.52
7.64*CEtOH 16.83
6.94*CEtOH 15.30
6.31*CEtOH - 13.91
5.74*CEtOH 12.65
5.22*CEtOH 11.50
4.74*CEtOH 10.45
4.31*CEtOH 3.27
NPV = 247.11*CEtOH 842.77

For the minimum selling price of ethanol,
the NPV is set to zero and we get:
CEtOH = $3.41/gal
Discounted Payback Period (DPBP)

The DPBP is the time needed to recover the depreciable FCI.
The following steps are used to determine the DPBP:
Develop the discounted cash flow diagram for the project
Calculate the discounted values of the WCI and the land brought back to time zero (present
time). Let us call this value the discounted non-FCI expenses. Since it is an expenditure, it is
assigned a negative sign.
On the discounted cash flow diagram, the time at which the cumulative discounted cash flow
equals the discounted non-FCI expenses defines the DPBP (on the upswing portion of the
curve).
154
Example 2.32. Calculation of the DPBP

What is the DPBP for example 2.28? Compare the result with the simple PBP.
Solution:
The land cost is $20 MM at zero time and the WCI is $45 MM at the end of year 2. Using a
discount rate of 10%,
45
The discounted non-FCI expenses = -20 = $-57.190 MM
2
(1 0.1)
DPBP = 9.6 yrs from start of construction

= 7.6 yrs from start of operation
155
For the simple PBP, the depreciable FCI is not discounted, i.e.,
Depreciable FCI = 120 + 185 = $305 MM
Also, the annual after-tax profit is not discounted and is taken as the average of the operating
years of the project, i.e.
40 65 65 70 75 55 60 60 75 75 70
= $64.55 MM
Average annual after-tax profit =
11
PBP
Depreciable FCI
305 = 4.7 yrs (compare with 7.6 yrs for DPBP)
=
Annual Net (After - Tax) Profit
64.55
156
Example 2.33. Comparison of Different Profitability Criteria

Consider a process for the production of a specialty chemical. The land is
purchased for $30 MM. The FCI is spent over the next two years for a total of $540
MM. The WCI ($ 60 MM) is spent towards the end of the second year. Operation
starts at the beginning of the third year. Table 2.26 shows the estimated annual
production, selling price of the product, and annual operating cost (which accounts
for raw materials, utilities, labor, maintenance, etc.). The project has an anticipated
useful life period of 10 years from the start of operation. The straight-line
depreciation method is used with a 10-year recovery period. At the end of the project,
the WCI and salvage value are estimated to $60 MM and $40 MM, respectively. A
tax rate of 35% is applied. The company uses a discount rate of 10%. Calculate the
NPV, DCF ROI, and discounted PBP for the project.
157
Data for Example 2.33

End
Estimated
Estimated
Estimated
of
Annual
Selling
Annual
Year
Production
Price
Operating
(MM
of Product
Cost
($/tonne)
($ MM/yr)
tonne/yr)
3
1.0
200
130
2.0
210
260
2.0
220
260
2.0
230
270
2.2
240
300
1.5
250
260
2.2
260
320
10
2.2
270
330
11
2.0
280
310
12
1.5
290
280
158
Worksheet to Evaluate Annual After-Tax Cash Flows
End
Land
FCI
of
($ MM) ($ MM)
WCI
Estimated
($ MM) Annual
Year
Production
(MM
tonne/yr)
Estimated
Estimated Estimated
Selling
Annual
Price
of Product
Sales
($MM/yr)
($/tonne)
Annual
Operating
Depreciation
After-Tax
($
Cash
MM/yr)
Flow
Cost
($
($ MM/yr)
MM/yr)
-30
-30.0
-180
-360
-180.0
-60
-420.0
1.0
200
200
130
50
2.0
210
420
260
50
2.0
220
440
260
50
2.0
230
460
270
50
2.2
240
528
300
50
1.5
250
375
260
50
2.2
260
572
320
50
10
2.2
270
594
330
50
11
2.0
280
560
310
50
1.5
290
435
280
50
12
Annual
40
60
63.0
121.5
134.5
141.0
165.7
92.3
181.3
189.1
180.0
183.3
Worksheet for the NPV Calculation of Example 2.33.
End of Year
Annual
(Non- Discount Factor
Discounted)
Cash Flow
(1 + i)-N
Discounted Cash Cumulative

Flow
(in $ MM)
(in $ MM)
0
-30.0
-180.0
-420.0
3
4
5
6
7
8
9
10
11
12
Discounted Cash
Flow
(in $ MM)
1.0000
-30.000
-30.000
0.9091
-163.636
-193.636
0.8264
-347.107
-540.744
63.0
0.7513
47.332
-493.412
121.5
0.6830
82.986
-410.426
134.5
0.6209
83.514
-326.912
141.0
0.5645
79.591
-247.321
165.7
0.5132
85.030
-162.291
92.3
0.4665
43.059
-119.232
181.3
0.4241
76.889
-42.343
189.1
0.3855
72.906
30.563
180.0
0.3505
63.089
183.3
0.3186
58.405
93.652
NPV =
152.057
The land cost is $30 MM at zero time and the WCI is $60 MM at the end of year 2. Using a discount
rate of 10%,
60
= $-79.587 MM
The discounted non-FCI expenses = -30 2
(1 0.1)
DCF PBP = 8.5 yrs from start of construction

= 6.5 yrs from start of operation
161
Calculating the DCF ROI = 15%
162

-Payback period
-Net present value
-Net present value
163
Net Present Value (Net Present Worth)

In addition to assessing individual projects, the NPV can also be used to
screen competing projects. The NPV accounts for:
The time value of money
The size of investment and the inflows and outflows of cash over the life of
the project
Different durations of project alternatives
When competing projects are considered, the project with the

highest NPV (within the companys constraints and financial
guidelines) wins.
164
Example 2.34. Comparison of Alternatives Based on NPV:

A company is considering the investment in one of two projects: A and B. Discount
rate = 15%. Which project would you recommend?
Project A
Year
0
1
2
3
4
5
Non-Discounted
Annual After-Tax
Cash Flow ($)
-1,400,000 (TCI)
400,000
800,000
-300,000
800,000
1,000,000
Project B
Year
0
1
2
3
4
5
Non-Discounted
Annual After-Tax
Cash Flow ($)
-1,600,000 (TCI)
700,000
700,000
700,000
700,000
900,000 (of which
$200,000 is
recovered WCI and
salvage value)
165
NPV Worksheet for Project A

End
Annual
Discoun
Discount Cumulative
of
(Non-
t Factor
ed Cash
Discounted
Flow
Cash Flow
($)
($)
Year
Discounted)
Cash Flow
(1 + i)-N
($)
0
1,400,000
1.0000
400,000
0.8696
- -1,400,000
1,400,00
0
347,826 -1,052,174
800,000
0.7561
604,915
-447,259
-300,000
0.6575
-197,255
800,000
0.5718
1,000,000
0.4972
End
NPV Worksheet for Project B

Annual (Non- Discoun Discount
of
Discounted)
Yea
Cash Flow
t Factor
(1 + i)-N
($)
Cumulative
ed Cash
Discounted
Flow
Cash Flow
($)
($)
-1,600,000
-1,600,000
1.0000
-644,514
700,000
0.8696
1,600,000
608,696
457,403
-187,111
700,000
0.7561
529,301
-462,004
497,177
NPV
=310,066
700,000
0.6575
460,261
-1,742
700,000
0.5718
400,227
398,485
900,000
0.4972
447,459
NPV =
845,944
-991,304
Annual Cost/Revenue:
A uniform annual number which distributes the NPV of the project over a given
period.
Annual cost when the NPV of the project is negative (acceptable in cases of
mandatory projects, e.g., safety, environment, etc.)
Annual revenue when the NPV of the project is positive.
i (1 i ) N
Annual Cost/Revenue NPV

N
(1 i ) 1
It converts all the costs/revenues of the project into equal annual installments
(annuities). Therefore, this annual value can be readily included in the companys
financial calculations.
It is used when the TCI is financed via an annuity scheme.
It accounts for the time-value of money.
It accounts for different durations of project alternatives.
In the case of revenue making projects, the project with the highest annual revenue
(within the companys constraints and financial guidelines) wins.
In the case of net-cost projects, the project with the least annual cost (within the
companys constraints and financial guidelines) wins.
167
Example 2.35. Comparison of Alternatives Based on Annual Cost/Revenue:

A company is considering the investment in one of two projects: A and B. Discount
rate = 15%. Which project would you recommend?
Project A
Year
0
1
2
3
4
5
Non-Discounted
Annual After-Tax
Cash Flow ($)
-1,400,000 (TCI)
400,000
800,000
-300,000
800,000
1,000,000
Project B
Year
0
1
2
3
4
5
Non-Discounted
Annual After-Tax
Cash Flow ($)
-1,600,000 (TCI)
700,000
700,000
700,000
700,000
900,000 (of which
$200,000 is
recovered WCI and
salvage value)
168
NPV Worksheet for Project A
NPV Worksheet for Project B

Annual (Non- Discoun Discount
End
Annual
Discoun
Discount Cumulative
of
(Non-
t Factor
ed Cash
Discounted
of
Discounted)
Flow
Cash Flow
Yea
Cash Flow
($)
($)
Year
Discounted)
Cash Flow
(1 + i)-N
End
t Factor
(1 + i)-N
($)
Cumulative
ed Cash
Discounted
Flow
Cash Flow
($)
($)
-1,600,000
($)
0
1,400,000
1.0000
400,000
0.8696
- -1,400,000
1,400,00
0
347,826 -1,052,174
800,000
0.7561
604,915
-300,000
0.6575
800,000
1,000,000
-1,600,000
1.0000
700,000
0.8696
1,600,000
608,696
-447,259
700,000
0.7561
529,301
-462,004
-197,255
-644,514
700,000
0.6575
460,261
-1,742
0.5718
457,403
-187,111
700,000
0.5718
400,227
398,485
0.4972
497,177
NPV
=310,066
900,000
0.4972
447,459
NPV =
845,944
For project A:
0.15(1 0.15) 5
Annual revenue 310,066

5
(1 0.15) 1
= $92,498/yr
For project B:
-991,304
0.15(1 0.15) 5
Annual revenue 845,944

5
(1 0.15) 1
= $252,358/yr
Total Annualized Cost

TAC = AFC +AOC
The TAC is a special case of the annual cost. The key difference is that the
TAC does not account for the time-value of money and assumes that the AFC and
the AOC will remain constant throughout the useful life period of the project.
Particularly useful in comparing alternatives that are not expected to make
revenue (e.g., some of the environmental-compliance projects and safetyenhancement modifications)
Competing alternatives that are mutually exclusive and are designed to meet
the same performance metrics.
The alternative with the lowest TAC (subject to the companys constraints) is
favored.
170
Example 2.36. Using the Total Annualized Cost to Compare Alternatives:

An environmental-compliance project involves the screening of three technologies
to remove 90% of a pollutant from a 150,000 kg/hr wastewater stream containing 10
ppm of the pollutant.
Three competing technologies: stripping, ion exchange, and adsorption
Use a 10-year linear depreciation with no salvage value
Recommend one of the technologies.
Cost Data for the Wastewater Treatment Example (Gabriel and El-Halwagi, 2005)
Technology
FCI
AOC
($)
($/yr)
Stripping
249,700
13,900
Ion Exchange
151,100
31,500
Adsorption
241,800
26,300
171
Solution:
The amount of removed pollutant is the same for the three technologies and,
assuming 8,760 hrs/yr of operation, can be calculated through a component material
balance on the pollutant:
Annual load of pollutant removed = 150,000 kg wastewater/hr*10*10 -6 (kg
pollutant/kg wastewater)*8,760 hr/yr = 13,140 kg pollutant/yr
TAC can be normalized on a per kg-pollutant basis by diving the TAC by the
annual load of the pollutant to be removed.
Technolog
y
FCI
AFC
AOC
TAC
($)
($/yr)
($/yr)
($/yr)
TAC/kg
pollutant
removed
($/kg
removed)
Stripping
249,700
24,970
13,900
38,870
2.96
Ion
151,100
15,110
31,500
46,610
3.55
241,800
24,180
26,300
50,480
3.84
Exchange
Adsorption
172
INCREMENTAL RETURN ON INVESTMENT IROI

Annual Net (After Tax) Profit AATP
ROI =
Total Capital Investment TCI
As a general rule, the project alternative with the least capital investment
which meets the companys ROI (and technical requirements) should be used as
the basis for comparison. Higher TCI project must have an acceptable IROI.
Consider two project alternatives: A & B. Where A is the project with the lesser
TCI.
AATP of B AATP of A
IROI of Project B =
TCI of B TCI of A
IROI must meet the companys minimum hurdle rate to recommend project B.
173
Example : A mass integration study on the conservation of a fresh solvent has

generated the following alternatives:
A. Direct recycle project: total capital investment of $1 MM and provides an annual
net (after-tax) profit AATP of $ 400,000/yr.
B. The addition of an absorber to the direct recycle project will cost an additional $3
MM of total capital investment but the total AATP resulting from direct recycle and
absorption Will be $900,000/yr
C. The addition of an extraction column to the direct recycle and absorption project
will cost an additional $2 MM of total capital investment but the total AATP resulting
from direct recycle, absorption, and extraction will be $1,100,000/yr
The company has a 15% minimum hurdle rate. Which projects should you
recommend?
Solution:
ROI =

For project A:
ROI = (400,000/1,000.000)*100%
= 40%
Attractive!
174
Project B: TCI = 3 + 1 = $ 4 MM and AATP = $900,000/yr
IROI of Project B =
AATP of B AATP of A
TCI of B TCI of A
IROI of Project B = (900,000 400,000)/((4,000,000 1,000,000)*100%

= 16.7%
Meets companys minimum hurdle rate should be recommended
Project C. TCI = 4 + 2 = $ 6 MM and AATP = $1,100,000/yr
IROI of Project B = (1,100,000 900,000)/((6,000,000 2,000,000)*100%
= 10%
Does not meet companys minimum hurdle rate should not be recommended
Final recommendation: direct recycle + absorption
175
If we used ROI for the whole project (direct recycle + absorption + extraction):
ROI = (1,100,000/6,000,000)*100%
= 18.3%
Meets companys minimum hurdle rate we would have recommended it
Misleading
Each addition in capital must be justified by an additional profit that meets the
companys ROI. In this example, the extraction project does not!
176
Homework: Problems 2.21-2.26

Due in one week
177

Economics

Загружено:

Сведения о документе

Авторское право

Доступные форматы

Поделиться этим документом

Поделиться или встроить документ

Параметры публикации

Этот документ был вам полезен?

Это неприемлемый материал?

Авторское право:

Доступные форматы

Economics

Загружено:

Авторское право:

Доступные форматы

$$ PROCESS ECONOMICS $$

Why do we study process economics?

COST TYPES AND ESTIMATION

ELEMENTS OF CAPITAL INVESTMENT

Non-Manufacturing (Indirect) FCI

Classification of Cost-Estimation Studies

Type/Objective of Cost Accuracy

% of Project Type of Needed

Experience or cost data of a

information on sold product and

Preliminary description of the

Equipment sizing and basic

Detailed equipment data (e.g.,

Detailed simulation, complete

specifications, process layout,

METHODS FOR CAPITAL COST ESTIMATION

METHODS FOR CAPITAL COST ESTIMATION

1. Manufacturers Quotations: typically require a lot of details

METHODS FOR CAPITAL COST ESTIMATION

Table 2.2. Examples of Capacity Exponents

Ethylene conversion 25,000 100,000 0.70

methanol conversion 3,000

Towler and Sinnott (2008)

Direct oxidation of 20,000 200,000 0.78

Steam reforming of 10-150

Towler and Sinnott (2008)

Example 2.1. Using capacity ratios with exponents for estimating

Sensitivity Analysis for the Biodiesel Example

Notice the effect of economy of scale

Annual Production (MM gal/yr)

METHODS FOR CAPITAL-COST ESTIMATION

Cost index at time t 2

Common FCI cost indices are:

Try to limit updates to ~10 years

(Basis: in 1957-1959, value of index = 100)

Example 2.2. Updating the FCI using a cost index

METHODS FOR CAPITAL COST ESTIMATION

FCI Lang Factor

5. Ratio Factors Based on Delivered Equipment Cost

Revised Values of Lang Factors (Peters et al., 2003)

FCI Lang Factor

TCI Lang Factor

Notice that WCI ~ 15% of TCI

Detailing the Revised Lang Factors (Peters et al., 2003)

Total Direct Costs

Engineering and supervision

Total Indirect Costs

5. Ratio Factors Based on Delivered Equipment Cost

The Hand Method (Hand, 1958)

Values of the Hand Factors for Different Equipment Categories

Example 2.3. FCI estimation based on factors of delivered equipment cost:

Delivered Equipment Cost ($ MM)

METHODS FOR CAPITAL COST ESTIMATION

For F 60,000 tonne/yr

For F < 60,000 tonne/yr

Example 2.4.: Using an empirical correlation to estimate the FCI:

METHODS FOR CAPITAL COST ESTIMATION

A very rough (but useful) approximation of turnover ratio ~ 2.0

Typical Values of Turnover Ratios

the Production Rate of Main Selling Prices of Annual Sales ($ FCI

Reference for FCI

Example 2.5. Using the turnover ratio to estimate the FCI:

= 545,000*800 + 273,000*1,100 = $736 MM

= 736/2 = $368 MM.

= 545,000800 + 273,0001,100 = $736 MM

1.2 10 6 0.2 10 6