CHAPTER 10

PROFITABILITY ANALYSIS

Dr. Ir. Endah Retno Dyartanti, M.T.

Chemical Engineering Dept
Universitas Sebelas Maret

Copyright - R.Turton and J. Shaeiwitz

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2008

Outline
1. Cash Flow Diagram CFD for a new project
2. Profitability Criteria Non-discounted
3. Profitability Criteria Discounted
4. Comparison of large projects
5. Evaluation of equipment alternatives
6. Retrofiting operations and incremental analysis

Using Capcost for profitability analysis

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 Cash Flows for a New Project
1. Purchase Land
2. Build Plant (1 – 3 years typically)
3. Plant start-up - working capital
4. Plant produces product and revenue
a. Depreciate capital over first 5 years
b. Plant operates for some period of time –
time over which profitability analysis is
performed
5. At the end of the project working capital, land,
and salvage value are recovered
Copyright - R.Turton and J. Shaeiwitz
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2008

Cash Flows for a New Project

Project life
Land

Plant start-up WC
S
Depreciation period

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

Land

FCIL Cumulative
Cash Flow
WC
Low revenue in 1st Diagram
year after start-up
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 Non-
Non-discounted
Profitability Criteria

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Non-discounted Profitability Criteria

3 Bases for Profitability
• Time
• Cash
• Interest Rate

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Non-discounted Profitability Criteria

Time Criterion
Payback Period = PBP

PBP = time required after start-up to recover the

FCIL for the project

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2008

Non-discounted Profitability Criteria

Cash Criterion
Cumulative Cash Position,
CCP = worth of the project at the end of the project
life
Because CCP depends on the size of project, it is
better to use the cumulative cash ratio, CCR
Sum of all Positive Cash Flows CCP
CCR = =1+
Sum of all Negative Cash Flows Land + WC + FCI L

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 Non-discounted Profitability Criteria

Interest Rate Criterion

Rate of Return on Investment = ROROI

Average Annual Net Profit

ROROI =
Fixed Capital Investment (FCI L )

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Non-
Non-discounted Profitability Criteria
Sum of all Positive Cash Flows CCP
CCR = =1+
Sum of all Negative Cash Flows Land + WC + FCI L

CCP
Plant start-up
S
Payback period, PBP

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

Land Land

WC
FCIL Average Annual Net Profit Slope of line 1
ROROI = = −
FCIL Fixed Capital Investment (FCIL ) FCI L n

WC

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 Discounted
Profitability Criteria

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Discounted Profitability Criteria

• For this type of analysis, we discount all the cash

flows back to time zero. This puts all the
investments and other cash flows on an equal
footing.
• For large capital projects, e.g., new plants or
significant additions, discounted criteria are
always used

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 Discounted Profitability Criteria
Example 10.1 (all figures in millions of $)
Land = 10
FCIL = 150 (year 1 = 90 and year 2 = 60)
WC = 30
R = 75
COMd = 30
t = 45%
S = 10
Depreciation = MACRS over 5 years
Project life, n = 10 years after start-up
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Discounted Profitability Criteria

Land

End of (R-COMd-dk)(1- t)+d k Cash ΣCF Disc CF ΣDisc CF

Inv estment dk FCIL-Σd k R COMd
y ear, k flow

0 (10) - 150.00 - - - (10) (10) (10) (10)

FCIL R – COMd = 75-30
1 (90) - 150.00 - - - (90) (100) (81.82) (91.82)
= 45
2 (60)+(30)=(90) - 150.00 - - - (90) (190) (74.38) (166.20)

3 - 30.00 120.00 75 30 38.25 38.25 (151.75) 28.74 (137.46)

WC -
4 48.00 72.00 75 30 46.35 46.35 (105.40) 31.66 (103.80)

5 - 28.80 43.20 75 30 37.71 37.71 (67.69) 23.41 (82.39)

MA CRS = % of FCIL
6 - 17.28 23.92 75 30 32.53 32.53 (35.16) 18.36 (64.03)

7 - 17.28 8.64 75 30 32.53 32.53 (2.64) 16.69 (47.34)

8 - 8.64 0.00 75 30 28.64 28.64 26.00 13.36 (33.98)

9 - - 0.00 75 30 24.75 24.75 50.75 10.50 (23.48)

10 - - 0.00 75 30 24.75 24.75 75.50 9.54 (13.94)

WC
11 - - 0.00 75 30 24.75 24.75 100.25 8.67 (5.26)

12 10+30=40 - 0.00 85 30 30.25 70.25 170.50 22.38 17.12

Land
Disc CF = CF /(1+i) k
R+ Salvage Copyright - R.Turton and J. Shaeiwitz
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Discounted Profitability Criteria

Same basis for criteria as before except we use the

discounted cash flows and discounted cumulative
cash flow diagram

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2008

Discounted Profitability Criteria

Cash Basis
CCP Net Present Value, NPV
CCR Present Value Ratio, PVR

NPV = Cumulative discounted cash position at the end of the project

Present Value of all Positive Cash Flows
PVR =
Present Value of all Negative Cash Flows

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Discounted Profitability Criteria

Time Basis
PBP Discounted Payback Period, DPBP

DPBP = time required, after start-up, to recover the

fixed capital investment, FCIL, required for
the project, with all cash flows discounted
back to time zero.

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Discounted Profitability Criteria

Interest Basis
ROROI Discounted Cash Flow Rate of
Return, DCFROR

DCFROR = interest or discount rate for which the

NPV of the project is equal to zero.

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 Discounted Profitability Criteria

Figure E10.2 Cumulative Cash Flow Diagram for Discounted After-Tax

Cash Flows for Example 10.1
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Discounted Profitability Criteria

End of (R-COMd-dk)(1- t)+d k Cash ΣCF Disc CF ΣDisc CF

Inv estment dk FCIL-Σd k R COMd
y ear, k flow

0 (10) - 150.00 - - - (10) (10) (10) (10)

1 (90) - 150.00 - - - (90) (100) (81.82) (91.82)

2 (60)+(30)=(90) - 150.00 - - - (90) (190) (74.38) (166.20)

3 - 30.00 120.00 75 30 38.25 38.25 (151.75) 28.74 (137.46)

4 - 48.00 72.00 75 30 46.35 46.35 (105.40) 31.66 (103.80)

5 - 28.80 43.20 75 30 37.71 37.71 (67.69) 23.41 (82.39)

6 - 17.28 23.92 75 30 32.53 32.53 (35.16) 18.36 (64.03)

7 - 17.28 8.64 75 30 32.53 32.53 (2.64) 16.69 (47.34)

8 - 8.64 0.00 75 30 28.64 28.64 26.00 13.36 (33.98)

9 - - 0.00 75 30 24.75 24.75 50.75 10.50 (23.48)

10 - - 0.00 75 30 24.75 24.75 75.50 9.54 (13.94)

11 - - 0.00 75 30 24.75 24.75 100.25 8.67 (5.26)

12 10+30=40 - 0.00 85 30 30.25 70.25 170.50 22.38 17.12

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Discounted Profitability Criteria

Figure 10.3 Discounted Cumulative Cash Flow Diagrams using Different Discount Rates for Example 10.3

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