CHAPTER 8

PROFITABILITY MEASUREMENTS
AND
PROJECT EVALUATION

167
 CHAPTER 8
PROFITABILITY MEASUREMENTS AND PROJECT EVALUATION

I. Introduction

A thorough economic evaluation of the concept of the feasibility based on the

economic stability of an industrial plant is fundamental to determine whether the proposed

plant will be profitable or not, and thus whether the project should be undertaken. Estimates

of the production cost and the capital required for a proposed process must be taken into

consideration. These factors include the physical equipment and facilities, and all costs

relating to the raw materials used down to the man power needed.

Profitability is the goal of any investment, and profit is defined as the difference

between income and expense. Thus, the profit must be judged relative to the investment.

The objective of the profitability analysis is to give a measure of the attractiveness or

possibility of the project for possible course of action. The estimated total capital

investment of the proposed Vanillin plant having a capacity of 150 MT/year and operating

at 300 days/year is Php 206,967,735.81. The total capital investment of the proposed plant

consists of a fixed capital investment of Php 194,613,456.99 or 94.03% of the TCI and a

working capital of Php 12,354,278.82 or 5.97% of the TCI. The calculated total production

cost of the proposed plant is Php 808.41/kg of Vanillin. In addition, one of the important

factors considered in the calculation and analysis of the profit is the selling price of vanillin.

To become competitive, the proposed selling price of Vanillin will be Php 1, 250.00/kg or

3.85% lower compared to the available selling price of Vanillin in the market which is Php

1, 300.00.

168
II. Profitability Measure

Profit is defined as the positive gain remained for a business after all costs and

expenses have been deducted from total sales. One must know the profitability before a

capital will be invested. It will measure the efficiency and ultimately the success or failure

of business. There are methods to determine the profitability such as Rate of Return of

Investment (ROI), Net Present Worth and Break-Even Point Analysis. Based on records,

there is no existing manufacturing plant of vanillin in the Philippines. The proposed selling

price of vanillin is Php 1, 250.00/kg or 3.85% lower compared to the available selling price

of vanillin in the market which is Php 1,300.00.

169
A. Rate of Return of Investment

The rate of return investment is defined as the ratio of the profit to investment. This

also shows the estimated time that the capital funds will be recovered. A value equal to 1.0

(100%) shows that the capital funds would be returned one year after the start of the

operation. A higher value of ROI is a good indication that the capital funds will be

recovered faster.

From Plant Design and Economics for Chemical Engineers 5 th Edition by Peters

& Timmerhaus:

𝑍 = 𝐺𝑟𝑜𝑠𝑠 𝑆𝑎𝑙𝑒𝑠 − 𝑇𝑜𝑡𝑎𝑙 𝑃𝑟𝑜𝑑𝑢𝑐𝑡 𝐶𝑜𝑠𝑡 = 𝑛𝑆 − 𝑛𝑇𝑃𝐶 = 𝑛𝑆 − (𝑛𝑉 + 𝐹 )

𝑍
%𝑅𝑂𝐼 = 𝑥100
𝐹𝐶𝐼

Where:

n = Plant Capacity. Kg/yr

S = Selling Price, Php/kg

V = Variable Cost, Php/kg

F = Fixed Cost, Php/ kg

Z = Net Annual Profit, Php/yr

FCI = Fixed Capital Investment

170
Given that:

Plant Capacity = 150,000 kg/yr

S = Php 1,250.00/ kg Vanillin

TPC = Php 808.41/kg Vanillin

FCI = Php 194,613,456.99 /yr

150,000 𝑘𝑔 𝑉𝑎𝑛𝑖𝑙𝑙𝑖𝑛 𝑃ℎ𝑝 1,250.00 𝑃ℎ𝑝 808.41

𝑍=( ) [( )−( )]
𝑦𝑟 𝑘𝑔 𝑉𝑎𝑛𝑖𝑙𝑙𝑖𝑛 𝑘𝑔 𝑉𝑎𝑛𝑖𝑙𝑙𝑖𝑛

𝒁 = 𝑷𝒉𝒑 66,238,500.00

𝑃ℎ𝑝 66,238,500.00
%𝑅𝑂𝐼 = 𝑥100
𝑃ℎ𝑝 194,613,456.99

%𝑹𝑶𝑰 = 𝟑𝟒. 𝟎𝟒%

Based on the computation, a 34.04% ROI has been calculated. Therefore, it is possible

that after 2.94 years or 3 years, the capital funds can be recovered.

SUMMARY OF FIGURES USED IN RATE OF RETURN INVESTMENT

Vanillin Production Capacity 150,000 kg/year

Selling Price Php 1,250.00/kg

Total Production Cost Php 808.41/ kg

Fixed Capital Investment Php 194,613,456.99

Net Annual Profit Php 66,238,500.00 /year

%Return of Investment 34.04%

171
B. Net Present Worth

The net present worth (NPW) is the total of the present worth of all the cash flows

minus the present worth of all the capital investments. It is the amount of money earned over

and above the repayment of all the investments and the earnings on the investments at the

discount rate. If a positive result is shown when the two value is to be compared for a given

time, it means that the plant is economically profitable. Also, a higher value of net present

worth indicates the plant is more stable. Using 15 years of operation of the plant as a basis and

a minimum attractive rate of return of 9.18% based from the Bangko Sentral ng Pilipinas, the

net present worth is computed.

From Bangko Sentral ng Pilipinas, the loan interest for long term period (15 years) is

9.18%. From Plant Design and Economics for ChE by Peters &Timmerhaus

1 − (1 + 𝑖)−𝑛
𝑃𝑊 = 𝐴 [ ]
𝑖

Where:

PW = Present worth equivalent of net annual profit

A = Net annual profit

i = Annual interest rate

n = Period of operation = 15 years

172
Estimated net annual deficiency is Php 66,238,500.00

Initial investment is Php 194,613,456.99

1 − (1 + 0.0918)−15
𝑃𝑟𝑒𝑠𝑒𝑛𝑡 𝑊𝑜𝑟𝑡ℎ = 66,238,500.00 [ ]
0.0918

𝑷𝑾 = 𝑷𝒉𝒑 𝟓𝟐𝟖, 𝟑𝟎𝟏, 𝟒𝟏𝟕. 𝟑𝟎

𝑁𝑒𝑡 𝑃𝑟𝑒𝑠𝑒𝑛𝑡 𝑊𝑜𝑟𝑡ℎ = 𝑃𝑊 − 𝐹𝐶𝐼

𝑁𝑒𝑡 𝑃𝑟𝑒𝑠𝑒𝑛𝑡 𝑊𝑜𝑟𝑡ℎ = 𝑃ℎ𝑝 528,301,417.30 − Php 194,613,456.99

𝑵𝒆𝒕 𝑷𝒓𝒆𝒔𝒆𝒏𝒕 𝑾𝒐𝒓𝒕𝒉 = 𝑃ℎ𝑝 333,687,960.30

The calculated net present worth above is Php 333,687,960.30 This positive value shows

that the proposed vanillin plant will be economically profitable.

Cash Flow Diagram

Annual Sales = Php187, 500,000.00

End of Year
0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Annual Expenses = Php121,261,500.00

Figure 8.1: Cash Flow Diagram of Annual Sales and Annual Expenses for 15 years

Figure 8.1 shows the cash out flow and cash inflow of the project for a period of 15 years.

The inward cash flow is the annual sales amounting to Php 187,500,000.00 and the outward cash

flow is the annual expense with an amount of Php 121,261,500.00.

173
 Net Annual Profit, A = Php 66,238,500.00

End of Year (EOY)

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Figure 8.2: Cash Flow Diagram Net Annual Profit for 15 years

Present Worth, PW = Php 528,301,417.30

End of Year (EOY)

0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15

Figure 8.3: Cash flow Diagram of Project Present Worth

Figure 8.2 shows the net annual profit of the project for the 15-year period of operation

while the Figure 8.3 shows the net present worth of the project using the interest rate. Since the

revenues are higher than the costs, the project is expected to gain profits.

174
 SUMMARY OF FIGURES USED IN NET PRESENT WORTH CALCULATION

Annual Interest Rate 9.18%

Fixed Capital Investment Php 194,613,456.99

Net Annual Profit Php 66,238,500.00/yr

Period of Operation 15 years

Present Worth Php 528,301,417.30

Net Present Worth Php 333,687,960.30

175
 C. Break-Even Point Analysis

Break-even point analysis shows the relationship of the different parameters in the

production system. The cost, income, production units, and profits are all inter-related to the

production process. This analysis is used to determine the rate of production of the plant

necessary for a plant to be profitable. The success of the project will be based as to how much

product must be produced in order to return the funds that was consumed for the production.

A zero value indicates that a certain number of product would just equalize the funds that was

used and a positive value will show that the operation will be profitable.

From Plant Design and Economics for Chemical Engineers 5th Edition by Peters &

Timmerhaus:

𝑍 = 𝑛𝑠 − (𝑛𝑉 + 𝐹 )

At break-even point, net annual profit (Z) =0

0 = 𝑛𝑆 − (𝑛𝑉 + 𝐹 )

𝐹 = 𝑛 (𝑆 − 𝑉 )

𝐹
𝑛𝐵𝐸𝑃 =
𝑆−𝑉

𝐹
%𝐵𝐸𝑃 = 𝑥100
𝑆−𝑉

Where:

F= Fixed Charges + Plant Overheat Cost+ General Expenses

F= (Php 37.69 + Php 28.24 + Php 163.92)/ kg Vanillin

= Php 229.85/ kg Vanillin

S= Selling Price, Php 1,250.00/kg Vanillin

V= Variable Cost, Php 578.56/ kg Vanillin

176
 𝑃ℎ𝑝 229.85
𝑘𝑔 𝑉𝑎𝑛𝑖𝑙𝑙𝑖𝑛
%𝐵𝐸𝑃 = 𝑥100
𝑃ℎ𝑝 1,250.00 𝑃ℎ𝑝 578.56
𝑘𝑔 𝑉𝑎𝑛𝑖𝑙𝑙𝑖𝑛 − 𝑘𝑔 𝑉𝑎𝑛𝑖𝑙𝑙𝑖𝑛

%𝑩𝑬𝑷 = 𝟑𝟒. 𝟐𝟒%

Breakeven Plant Capacity

150,000 𝑘𝑔 𝑉𝑎𝑛𝑖𝑙𝑙𝑖𝑛
𝐵𝑟𝑒𝑎𝑘𝑒𝑣𝑒𝑛 𝑃𝑙𝑎𝑛𝑡 𝐶𝑎𝑝𝑎𝑐𝑖𝑡𝑦 = 0.3424 ( )
𝑦𝑒𝑎𝑟

51,349 𝑘𝑔 𝑉𝑎𝑛𝑖𝑙𝑙𝑖𝑛
𝐵𝑟𝑒𝑎𝑘𝑒𝑣𝑒𝑛 𝑃𝑙𝑎𝑛𝑡 𝐶𝑎𝑝𝑎𝑐𝑖𝑡𝑦 =
𝑦𝑒𝑎𝑟

From the computation, the calculated breakeven point is 34.24% of the total annual plant

capacity or 51,349 kilograms of vanillin per year to have a profit.

SUMMARY OF FIGURES USED IN BREAKEVEN POINT CALCULATION

Total Fixed Charges Php 37.69/ kg

Plant Overhead Cost Php 28.24/ kg

Total General Expenses Php 163.92/ kg

Selling Price Php 1,250.00/kg

Total Variable Cost Php 578.56/ kg

% Break Even Point 34.24%

Vanillin Production Capacity 150,000 kg

Break Even Plant Capacity 51,349 kg

177
III. Conclusion

One must know the profitability before a capital will be invested. It will measure the

efficiency and ultimately the success or failure of business. There are methods to determine the

profitability such as Rate of Return of Investment (ROI), Net Present Worth and Break-Even Point

Analysis.

This study targets the usage of rambutan peels as its principal raw material in the

production of Vanillin.

A. Rate of Return of Investment

Based on the profitability measurement of the economic evaluation chapter, it shows that

every year there is an annual net profit of Php 66,238,500.00. Also, a positive 34.04% ROI has

been calculated. Therefore, it is possible that after 2.92 years or 3 years the capital funds can be

recovered.

B. Net Present Worth

Using the 15 years of operation as a basis and a minimum attractive rate of return of 9.18%

from the Bangko Sentral ng Pilipinas, the calculated net present worth of Php 333,687,960.30. A

positive net present worth value indicates that the project earnings generated by a project or

investment exceed the anticipated costs. Since the computed net present value is greater than zero,

it implies that an indisputable profit can repay the external sources used.

178
C. Break-Even Point

Based on the break-even point analysis, 51,349 kilograms of vanillin is needed to produce

every year to have a profit which is less than the total production capacity of the proposed Vanillin

plant or 34.24 % of the total annual plant capacity

These data obtained validates that this entire project is economical based on its cost

effectiveness.

Therefore, this project will be profitable and feasible.

179