NAME GIRMACHEW MEKONEN

PLANT DESIGN AND ECONOMICS EXERCISE BOOK

STAGE OF PLANT DEVELOPMENT

I. Inception Idea generation

II. preliminary evaluation of economic and markets
III. Development of data necessary for final design
IV. Final economic evaluation
V. Detailed engineering design
VI. Procurement (purchasing)
VII. Erection
VIII. Start up and trial
IX. Production

CHEMICAL ENGINERING PLANT DESIGN

Plant design include all engineering aspects involved in the development of either new, modified
or expansion industrial plant. In this development Chemical engineer will be making

 Economic evaluation
 Design new piece of equipment
 Developing a plant layout

Generally overall design consideration some of the factory involved in the development of a
complete design include,

 Plant location
 Plant layout
 Material of construction
 Structural design
 Utilities, Which includes (Cooling water, electricity's, steam, Fuel and the likes)
 Buildings
 Storage
 Materials Handling(cost expense)

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  Safety
 Waste disposal
 Federal, State , Local, laws and codes.
 Patents
 Computer Aided design (CAD) or soft ware Automates
 Record keeping and accounting procedure
TYPES OF DESIGN

1. Preliminary design:- Approximate process method, Rough cost estimate

2.Detailed estimate design: -Detailed analysis and economic evaluation

3. Firm detailed design: When detailed estimate design indicates that the project should be
commercial success, the final step before developing construction plans for the plant is
preparation of firm detailed design.

Feasibility survey(economic evaluation)

Before any detailed work is done on the design technical and economical factors should be
Examined. The following lists should be satisfied feasibility survey.

1. Raw material (Availability, cost, quality, and quantity

2. Thermodynamically kinetic of chemical reaction involved equilibrium rate and optimum
condition
3. Facilities and equipment available at present
4. Estimation of and total investment
5. Facilities and equipment to purchased
6. Profits (return on investment)
7. Materials of construction
8. Safety consideration
9. Market present, future,( demand and supply)
10. Competition (overall production statics processes. comparison of various manufacturing
processes. product specification of competitors.)
11. Properties of product (physical and chemical properties)
12. Sales and sales services (method of distribution)

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 13. Shipping restriction and containers
14. Plant location
15. Patents situation and legal restrictions.

Process development

 preliminary feasibility survey

 Additional survey
 pilot plant data
 Laboratory works
 Material and energy balance (size of equipment)
 Temperatures, pressure Variation, yields rates and grades of raw materials and products
 Batch verses continuous operation
 Operating characteristics
 Pertain design variables (Flow rate, temperature, concentration, string rate, pressure for
gasses)

Design Of Specific Equipment

Example :1, Distillation column

 Number of plate and operating

 Diameter of column
 Material of construction
 Plant layout(Triangular, rotated, circular)

2, Reactors.

 catalyst size and type

 Bed diameter and thickness
 Heat interchange capacity(heat transfer rate)

3:Heat exchanger and furnace

 Long mean temperature difference

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  Heat transfer rate
 Pressure drop (energy loss)
 Material of construction

4.PUMP AND COMPRESSORS

I. Specify type
II. Power requirement
III. Pressure difference
IV. Gravities
V. Viscosities
VI. Working pressure

Before a detailed estimate design is developed the following factors should be considered

 Manufacturing process
 Material and energy balances
 Temp and pressure range should define (equipment safety)
 Raw material and product specification.(Result and discussion)
 Yield, reaction rate, reaction time, Time cycle
 Material of construction
 Utilities required
 Plant lay out

Additional the following must be include:

A. Type of building

B. Heating sources

C. Ventilating

D. Lighting

C. Power

D. Drainage (inside factory)-piping

G. Waste disposal, (outside the factory)

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 H. Safety facility.(both internal and external)

I. Instrumentation (Quality control laboratory)

Firm detailed design can be prepared for purchasing and construction from a detailed estimate
design.

 Detailed design (drawing) are made for the fabrication of equipment

 Specification of equipments are made for purchasing
 complete plant layout is prepared
 Piping diagrams and other construction detail

Specification are given

 Ware house (used equipment)

 Laboratories
 Guard houses
 Change houses
 Transport facility
 Architecture work
 Ventilation
 Civil work
 Environmental safety factor
 Safety condition
 Electricity
 Safety facilities
 Instrumentation (Quality control laboratory) firm detailed
design

Chemical engineers should work closely with construction

 FLOW DIAGRAM

Flow diagrams are used to show the sequence of equipments and operating in the over process
to simplify visualization of the manufacturing procedures and energy transfer.

These diagrams are divided into three.

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 1. Qualitative flow diagram
2. Quantitative flow diagram
3. combined detail flow diagram

1. Qualitative flow diagram: Indicate the flow of material, unit operation involved, equipment
necessary and special information involved about temp and pressure.

2.Quantitative flow diagrams. Shows the quantitative of materials required for the processes.
Process flow diagram:- is a diagram shown by international symbol.

Processes flow sheet:-is the main unit and block diagram

3.Combied detail flow diagram:-Shows the location of temperature and pressure regulator and
indicator as well as the location of critical control valve

1. Technical factor.

a. Processes flexibility

b. Continuous operation

c. Special control involved

d. Commercial yield

e. Technical yield

f. energy requirement

g. Special auxiliaries required

h. possibilities of future development

i. Health and hazards involved

2. Raw material
a. present and future availability
b .processing required
c. storage required
d. material handling problem

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3. waste products and by products
a. Amount used
b. value
c. potential market and use
d. manner of discard
e. Environmental aspect (EIA)
4. Equipment
a. Availability
b. Material of construction
c. initial costs
d. maintenance and installation cost
e. replacement required.
f. special design
5. Plant location
a. Amount of land required
b. Transportation facility
c. Proximity to market.
d, Availability of service and required
e. Availability of labor ultimate
f. Legal restriction and taxes
6. Costs (Expenses.)
A. Raw material
B. Energy
C, Depreciation ( maintenance, salvage value)
D. Other fixed charge(taxes)
E. Processing and over head
F. Special labor requirement
G. Real-estate
H, Patent right
I. Environmental control

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7. Time factor ( time value of money)
 Project completion dead line
 Process development required
 Market time lines
 Value of money
8. Process consideration
 Technology availability
 Raw material common with other process
 Consistence of product within company
 General objective of company

SAFETY FACTORS.

These factors represent the amount of over design that would be used account for the changes
in the operating performance with time. If uncertainties are involved in the design of
equipment a reasonable factory can be applied.

 Fouling
 Thermal expansion
 Mechanical shock are some of reasons for safety factor consideration.

SPECIFICATION

If the equipment is standards, the manufacturer may have the desired size in the stock
preliminary specification for equipment should show the following.

 Identification
 Function
 Operation
 Materials handles
 Basics design data
 Essential control
 Insulation requirement
 Allowable tolerance
 Special information (Materials of construction)

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MATERIALS OF CONSTRUCTION

The effects of corrosion and erosion must be considered in the design of chemical resistance
and physical properties of construction materials. The fore, are important factors in the
choice and design of equipment. Materials should be structurally strong resistance to physical
or thermal shock, less cost, easy to fabricate, easy to maintain of operation pressure and
temperature resistance.

PLANT LOCATION

The geographical location of the final plant can have strong influence on the success of an
industrial venture. The following factors should be considered in selecting planet site.

 Raw material availability

 Markets
 Energy availability.
 Transporting facility (road)
 Water supply
 Climate
 Waste disposal
 Labor supply
 Taxations and legal restriction
 Size characteristics
 Community factor
 (1-5) are most important factors of all listed.

PLANT LAYOUT

After the process flow diagram is considered (completed) and before detailed estimate
design, piping, structural and electrical design can begin, the layout of process units is a plant
and the equipment with in these processes units must be planned. This layout can play an
important role in determining construction and manufacturing costs.

The following issues must be considered

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 i. New site development
ii. Type and quality/ quantity of your products
iii. Type of process and process control
iv. Operational convenience and accessibility
v. Economic distribution of utilities and services
vi. Type of building and building code requirement.
vii. Health and safety consideration
viii. Waste disposal requirement
ix. Auxiliary requirement
x. Space available and used
xi. Roads and rail roads
xii. Possible future expansion

STORAGES

Adequate storage for new materials intermediate raw materials, off grade raw material, Final
products, recycle materials fuels age essential for operational plant.

ENGINEERING ETHICS IN DESIGN

1) Hold pay amount the safety, health and welfares of the public in performance of their
professional duties.

2) Formally advice there employees and clients and (consider further disclosure, if
warranted). If they perceine that a sequence of their duties will adversely affect the present
or future health or safety of colleagues or the public.

3) Accept responsibility for their actions and recognize the contribution of other . Seek
critical review of their work and after objective criticism of the work of others.

4) Issue statements or presents information only in an objective and truthful manner.

5) Act in professional manner for each employee or client as faithful agents or trusts, and
avoid conflicts of interests.

6) Treat fairly all colleagues and co-workers, recognizing their unique contribution and
capabilities,

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7) Perform professional services only in there are of competence

8) Continue their professional development throughout their careers, and provide

opportunities for their professional development

9) Building their professional reputations on the merits of their services.

SUMMARY OF A MATERIAL SAFETY AND DATA SHEET

1) Product identification
 Precautionary labeling
 Precautionary label statement
 Laboratory equipment (Safety required)
2) Hazardous component identification
3) Physical data
4) Fire and expansion data
 Fire extinguishing media
 Special fire fighting procedure
 Unusual fire and explosion hazards
 Toxic gases produced

5) Health and hazard data

 Effect of over exposure

 Target organs
 Medical conditions generally aggravated by exposure
 Emergence and 1st Aid procedures

6) Reactivity data

7) Spill and disposal procedures

a) Steps to be followed in the events of a spill or discharge

b) Disposal procedures

8) Protective equipment

9) Storage and handling procedures:- Special precautions

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 10) Transportation data and other information

a) Domestic
b) International

INDUSTRIAL SANITATION AND SERVICES

I. Water:- Quality (quantity as needed or standards)

II. Food handling , eating, loge (rest space away from work site)
III. Solid waste collection and in plant handling
IV. Bacterial and insect control
V. Air cooling where required
VI. Sanitary facilities ( Toilets and wash rooms)
VII. Personnel services
VIII. Space and access for 1st aid and medical services
IX. Facilities for industrial hygiene staff. Laboratories and information handling

FACTORS AFFECTING INVESTMENT AND PRODUCT COST

 Source of equipment
 Price fluctuation
 Company police
 Time of production and rate of production
 Government police
 Capital investment Total (income) revenue

breakeven point

Unit cost gross earning (total product cost)

cost

Fixed cost

Rate of production kg/sec

Note: Breakeven point:- the point where the total production cost is equal to the total gross
earning (total income)

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Gross earning:- (gross income) - total income gained before tax.

PROCESS FLOW SHEET

Plant design is made up of words. numbers and pictures thus, to solve material and energy
balance problems. it will be done by doing block diagram to represent the equipment and will
show entering and leaving streams amount and properties.

Mi M2
Process
Ti T2

Pi P2

Composition Composition

Product handling

Reaction rate

Chemistry Reaction type

Time of reaction

Operating temperature and pressure

Material of construction

These diagrams are divided into three

i. Qualitative process flow sheet (PFS)

ii. Quantitative process flow sheet(PFS)
iii. Combined detailed process flow sheet
 Expresses the material and energy balance and sizing of equipment
 Includes all vessel, reactor, heat exchanger, distillation column, and separator.

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A generalized scheme for flow sheet development

Physical
Product Literature Information Chemistry
Chemical definition review
properties

Select Function Identifying Input out put Preliminary

technology diagram sub process diagrams economics
function yes
processes

candidate
Uncertainty
Select Requirement process
Operation specific full field flow sheet
diagram equipment

Economic potential = product value + by product value - raw material cost

 If raw material cost is greater than the product cost and by products cost the project is not
feasible (not profitable)

FUNCTION DIAGRAM

Involves the identification of the major function or sub process (trances terification reaction)

OPERATING DIAGRAM:- Selecting the types of processing equipment or unit operations

necessary to accomplish processes flow sheet (reactors)

MATERIAL AND ENERGY BALANCE

Material balance is used

I. To determine quantities of material(raw material and products)

II. To check performance against design
III. To check instrument calculation
IV. Instrument capacity
V. To locate source of material loss
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Example X kg

0.2 kg Ca(OH2) 2000kg

Mixer
0.8 kg H2O 0.05kg/kg Ca(OH)2

Balance of Ca(OH2)
0.2 * X = 0.05*2000
X = 500kg
Overall balance
X+Y =2000kg
500kg+Y= 2000kg
Y = 1500kg
Example 2:- balance with no chemical reaction (no net of reaction). estimate the steam and
cooling water required for the distillation column shown in the figure below. steam is available at
274 KN/m2. absolute dry saturated. the rise in cooling water is limited to 300C. Column operates
at 1 bar.

(Note all components are weight by weight )

Basis A=acetone
W = Water Qc (cooling)

Feed (F)= 1000kg/hr D = 0.99 kgA/kg

0.1 kg A kg 0.01kgW/kg
0.9kgWkg Td = 250C
TF = 350C Qh (heating<1000ppma

B Tb= 1000C

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Assumption
A----All most zero
Reference temperature = 250c
Material balance
Balance on A (acetone)
0.1*1000 = 0.99*D
D = 101kg/hr
OVER ALL MATERIAL BALANCE
Q = mcp
F=B+D
E = MC^2
1000kg/hr = B+101kg/hr
H = U + PV
B = 899kg/hr
OVER ALL ENERGY BALANCE
Ein = Eout

Overall balance Qc

F
Hf
System HD

Hb QB
Where H = specific enthalpy (per kilogram)
HD * D +Hb *B - F*Hf = Qc + QB
Heat capacity data
Acetone; 25 -1000C = 2.2KJ/kg. k
Water; 25-1000C = 4.2KJ/kg.k
Note:- heat capacity is additive
Feed: 0.1 * 2.2 +0.9*4.2 = 4.0 KJ/kg.k
Distillate:- 0.99*2.2 +0.01*4.2 = 2.2KJ/kg.k

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Bottom product: - 4.2KJ/kg.k.(almost water)
ENERGY BALANCE ON CONDENCER
HV Cooling water +300C Cooling 250c
V
Qc HV Condenser D+L250C
V 56.50c
Cooling water

Cooling water
(V,L,D) m kg/hr.
R = L/D = 1010kg/hr = L
V *HV = D*HD + L*HL + QC
QC = V*HV - D*HD-HL*L
V = L+D = 1010 +101 = 1111 kg/hr
From vapor liquids equilibrium data
Boiling point of 99% acetone/ water system = 56.50c
Note :- latent heat + sensible heat
Latent heat of acetone at (56.50c) = 620kg/kg
latent heat of water at (56.50c) = 2500kg/kg
V*HV = 786.699 KJ/hr
HD*D = 0
L*HL = 0 because, their temperature
Qc = V*HV - D*HD -HL *L = 786.699 - (25-25) is equal reference temperature Qc = -786,699 KJ/hr

 (25-25)0c * HD*D = 0, mcp = D* cp

 (25-25)0c *L*HL = 0, mcp(25-25)0c = L*cp
QC = 786.699KJ/hr loss
Qc = mcp = 786.699 = m*4.2*30
m = 6.244KJ/hr cooling water
D*HD +B*HB - F*HF = QB+QC

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QB +786.699 = 899*4.2 * (100-250C) - (1000*4*(35-25))
QB = 1,029,884KJ/hr
Calculate steam required ?
 Steam is available at 274 KN/m2
Latent heat = 2174 KJ/kg at 274 KN/m2
QB = H steam + m steam
ṁ steam = QB/HSteam = 1029884KJ/hr/2174KJ/kg
ṁ steam = 473.7 kg/hr
fuel used, steam amount, electricity energy, and cooling water.
Example 2.Energy balance on one component system. The exiting stream energy is from the
boiler through a 6cm ID pipe. calculate the required rate input to the boiler in kilojoules per
minute if the emerging steam is saturated at the boiler pressure. Neglect the kinetic energy of
liquid in the input streams.

175 kg/min, H2O at 300C 17 bar, saturated, 2040c, ID of pipe = 6cm

Boilers

295kg/min
175 kg/min of H2O at 650c
Q (required = ?)
Material balance
Out put - input = 0
120kg/min + 175kg/min = 295kg/min
Q - Ws =
Ws --- Shaft work = 0
-- internal energy = 0
-- kinetic energy = ?
From the table we can read at 300c and 650c also at 2400c and 17 bar.
a) 300c = 125.7KJ/kg = H -- specific enthalpy
b) 650c = H = 271.9KJ/kg
c) 2040c = 17bar = 2793 KJ/kg

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 = 295 KJ/min *2793 KJ/kg - (120kg/min +125.7KJ/kg +175kg/min *271.9KJ/kg)
= 7.61 *10^5 KJ/min
= KE out - KE in
KE in is zero because there is no speed when it inter
= KE out
Specific volume@ 2040c, 17 bar = 0.1166m3/kg from table.

A= = Area of the pipe.

A = 3.14 *0.06^2/4 = 2.83*10^-3

V = Mass * specific volume/(Area of pipe) , V = ṁ*V'/A
V = 295 * 0.1166/(2.83*10-3)
V = 202 m/sec
KE out = 1/2*mv2 = 0.5*295*2022, KE out = 6.02*103KJ/sec
 Q - WS =
Q=
Q = 6.02*103KJ/min + 7.61*106KJ/min
Q = mcp for M Liquid = Q/cp
Q = 7.67 * 105KJ/min
Example 4 Balance on reactor
For producing an optimal amount of biodiesel yield the temperature inside the reactor should be
maintained at 550C. The temperature is assumed to be achieved by supplying hot water at 900c
and this temperature inside the reactor is adjusted to the required value of after charging the
alcohol and catalyst at reference temperature. calculate the hot water required?

Hot water at 900c Caustic soda = 12.5kg/day @ 250C

Ethanol = 560.07kg/day Reactor Hot water @ 520C

Cleaned oil Biodiesel + glycerol + ethanol

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1250kg/day @ 250C = 1822.57 kg/day @ 550C
R = (CH3)13----CH2---CH---CH--CH2--CH3
O O
HCO C R + CH3CH2OH NaOH CH3--O--C--R +H2O
Given: - CP (biodiesel + glycerol + ethanol ) = 1.99KJ/kg.k.
C C (1) KJ/mole
O C (2)
C C (3)
C H (4)
Composition reaction
dissociation reaction
Polymerization
heat of reaction = Heat of reaction out - heat of reaction in
H of reaction = H of reaction out - H of reaction in

H of reaction = [2mol* O-H +1mol*C O + 2mol * C-O +9mol*C-C +1mol*C C+32mol*C-H]

- [2mol*O-H +1mol C O + 2mol*C-O +9 mol*C-C+1mol*C C + 32mol*C-H] = 0

 Energy balance
 Out - input = 0

MHw*cp (52-25)0C +1822.57kg/day*1.99(55-25)0c = 12.5Kcp(25-25)0c + MHw*cp(90-25)0C +

560.07*cp(25-25)0c +1250+cp(25-25)0c+MHw*cp(52-25)0c +1822.57kg/day*1.99(55.25)0c =
MHw*cp(90-25)0c

MHw*4.2*270c+1822.57*1.99*300c = MHw*4.2*650c

MHw*4.2*270c - MHw*4.2*650c = 1822.57*1.99*300c

MHw = 743.73kg/day

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Example 5:- Energy balance m2 = component system

Liquid stream containing 60.0wt% ethaane and 40% butane is to heated from 150K to 200K at a
pressure of 5 bar. calculate the required heat input per kilogram of the mixture, neglecting
potential and kinetic energy using tabulated enthalpy data for C2H6 and C4H10 and assuming that
mixture component enthalpies are those of the pure species at the same temperature. Basis =
1kg/sec.

1.0kg/sec , 150k, 5 bar 200 k, 5bar C2H6

0.6 kg C2H6/sec
Heater H = 434.5KJ/kg
0.4 kg C4H10/sec C4H10 = H = 130.2KJ/kg
Q
Data

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 CHAPTER 5
COST ESTIMATION
CAPITAL INVESTMENT
Before an industrial plant can be put in to operation. a large sum of money must be supplied to
purchase and install the necessary machinery and equipment.

 Land and service facility must be obtained

 Plant must be erected, with all piping, controls and services.

The capital needed to supply the necessary manufacturing and plant facility is called fixed
capital investment. While that necessary for the operation of the plant is formed Working capital.
The sum of the fixed capital investment and working capital is called total capital investment.
The fixed portion may be further divided in to manufacturing fixed capital investment and non
manufacturing fixed capital investments.

 Fixed capital required for construction over head and for all plant components that are not

directly related to the processes operation is designed as the non manufacturing fixed capital
investment. it includes

 Land
 Processing building
 Shipping
 Receiving facilities
 Utilities
 Waste disposal facility
 Other permanent parts of the plant

Construction over head costs include

Field office and super vision expense
Home office expense
Engineering expense
Contractors fee
Contingency

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WORKING CAPITAL
Working capital for industrial plant consists of the total amount of moony invested

1) Raw material and supplies carried in the stock

2) Finished product in stock and semi finished products in processing being
manufacturing
3) Accounts receivable
4) Cash kept on hand for monthly payment of operating expense, salaries, wages and
raw materials purchased
5) Account payable
6) Taxes payable

RATIO OF WORKING CAPITAL TO TOTAL CAPITAL INVESTMENT

Varies with different companies but most chemical plants use initial working capital
amounting to 10-20% of the total capital investment. This percentage may increase as much
as 50% or more for companies producing product of seasonal demand because of the large
inventories which may be maintained for appreciable periods of time.

ESTIMATION OF CAPITAL INVESTMENT

A check list of items covering a new facility is available aid in making complete estimation
of the fixed capital investment.

Table: breakdown of fixed capital investment items for chemical plants

Direct cost

1) Purchased equipment cost

All equipment listed on capital flow sheet
Spare parts and non installed equipment spare surplus equipment allowance, inflation
cost allowance, taxes, insurance, duties, allowance of modification during start up
freight charge (transportation expense)
2) Purchased:-equipment installation of all equipment listed as complete flow sheet
structural support, Insulation, paints.

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 3) Instrumentation and control:- Purchase, installation, computer
4) Piping:- Process-piping carbon steel, alloy, cast iron, Lead, lined Al, copper,
ceramics, plastics, rubber, Reinforced concrete, pipe hangers, fitting valve, insulation
pipe, equipment
5) Electrical equipment and materials:- Electrical equipment; Switch. motors, wire,
fittings, feeders, Conduits, grounding instrument and control wiring, lighting, panels.
6) Buildings( including services):- Processes buildings substructures, supper structures,
plate forms, supports, stair ways, ladders, access ways, crones, monorails, hoists,
elevators.
Auxiliary buildings:-Administration office, medical, cafeteria garage, product ware
house, parts ware house, gaud and safety , fire station, change house, personal
buildings, shipping of fice, research, laboratory control rooms.
Maintenances : Shop electric, piping, sheet metals, machine welding, carpentry,
instrument building services, Plumping, heating, Ventilations, dust collector, air
conditioning lighting, elevator, telephone, inter communication system, paintings,
sprinkler system, fire alarm.
7) Yard improvement:- Site development site cleaning, guarding, roads, walk ways,
rail ways, rail road's, fences, parking areas, wharves, recreation as facility, land
scaping.

8) ,Service facility:- Utilities, steam water, power, refrigeration, compressed air, fuel,
waste disposal facility, facilities boilers, plant inclinator, wells, river intake, water treatment,
cooling towers, water storage, electric substation, refrigeration plant, air plant, fuel storage,
waste disposal plant, environmental controls, fire protection.

Non process equipment office, furniture and development; cafeteria equipment, safety and
medical equipment, Shape equipment, Automotive equipment, yard material, handling
equipment, garage equipment, locker room equipment shelves bins, pallets, hand truck,
housekeeping equipment, Fire extinguisher, hoses, Distribution and packing raw material and
product.

Storage and handling equipment, product packing equipment, blending facility, loading stations

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9). land
 Survey and fee
 Property cost
INDIRECT COST
1) Engineering and supervision:- Engineering cost administrative, processes, design and
general engineering drafting, cost engineering procuring expediting, reproduction,
communication sales modes consultant fee, travels
2) Construction fee:- construction operation and maintenance of temporary facility. offices,
roads, parking lot rail road's, electrical, piping, fencing construction tools and equipment,
construction super vision, accounting, time keeping, purchasing, ware house personal and
expense, guards
 Safety and medical
 Contingency
3) Contractors fee
4) Contingency

Cost index's

Most cost which are available for immediate use in a preliminary or pre design estimate are
based on condition at some time in the past. A cost is merely an index value for a given plant in
time relative to a certain base time. If the cost at some time in the past is known. The equipment
cost in the present time can be determined by multiplying the original cost by the ratio of the
present index value of to the index value applicable when the original cost is obtained.

 Cost index ca not consider special technology and local conditions.

Cost factor in capital investment

Typical percentage of fixed capital investment value for direct and indirect cost segments for
multipurpose plants or large additions to existing facilities.

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Direct cost components Range
Purchased equipment installation 15-40
Instrumentation and control (installed) 6-14
Piping (installed) 3-20
Electrical equipment and materials 2-10

Building (including services) 3-18

Yard improvement 2-5

Instrumentation and control (installed) 2-8

Service facilities (installed) 8-20

Land 1-2

INDIRECT COST RANGE

Engineering and supervision 4-21

Construction expenses 4-16

Construction fee 2-6

Contingency 5-15

Direct cost + Indirect = Total fixed capital investments

 Grass rot plant is defined as a complete plant erected on new site

 A geographical boundary defining the coverage of a specific project is called a battery
limit

Eample1. Estimate of fixed capital investment using range of processes plant components
make study estimate of the fixed capital investment for processes plant. If the purchased
equipment cost is 100,000$ for a processes plant handling both solids and liquid with a high
degree of automatic control and essentially outdoor operation.

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 SOLUTION ASSUME

25/100 *TFCI =100000 , TFCI = 400,000

9/100 *TFCI = 100,000; TFCI = 36,000

Percentage Costs Retained of total (%)

Purchased equipment cost 25 100,000 23.6
Purchased equipment installation 9 36000 8.3
Instrumentation (installed) 7 28000 6.4
Piping (installed) 8 32000 7.3
Electrical (installed) 5 20,000 4.6
Building including (Services) 5 20,000 4.6
Yard improvements 2 8000 1.8
Service facility (installed) 15 60,000 13.8
Land 1 4000 0.9
Engineering and supervision 10 40,000 9.2
Construction expenses 12 48,000 11
Contractors fee 2 8000 1.8
Contingency 8 32000 7.3
Total 109 436000 100
Rationed of total(%) = 25/109 *100 =23.6%

Ranges will vary from $371000 to $50,000 for normal conditions, If inflation will exist $
436,000 above.

Purchased equipment

The cost of purchased equipment is the bases of several pre design methods for estimating
capital investment, sources of equipment prices, Methods of adjusting equipment prices for
capacity, and methods of estimating auxiliary processes equipment are therefore to estimator in
making reliable cost estimate. The various type of equipment can often be divided into

1. Processing equipment
2. Raw material handling and storage equipment

27
 3. Product handling and storage equipments. The costs auxiliary equipment and material
such as insulation and ducts should also be included.

ESTIMATING EQUIPMENT COST BY SCALING

It is often necessary to estimate the cost of piece of equipment when no cost data available for
the particular size of operational capacity. Good results can be obtained by using logarithmic
relationship known as the sixth-tenth factor role. If piece of equipment is similar to one of
another capacity for which cost data are available.

Cost of equipment A= cost of equipment B * ( )0.6

Purchased

equipment cost Slope = 0.6 Shell and tube , internal floating head, 150 Psig
1000
design pressure

6000

January, 1990
100 200 500 1000 2000 5000 ft 2
Heat transfer area .ft2
1. Cost of equipment
2. Cost index
3. Equipment (tabulated)
Heat exchanger
1. Heat transfer area
2. Material of construction
3. Design pressure and temperature
4. Pressure drop
5. Number of tube (Thickness, Diameters)
6. Head (Thickness, type, material of construction)
7. Shell(material of construction, thickness, diameter)
8. Manufacturers

28
Typical Exponents For Equipment Cost Verses Capacity
Range------------------------.------Exponents

Blender------------------------50 - 250ft3------------------------------0.49

Blower-------------------------103 - 104 Ft3----------------------------0.59

Centrifuge--------------------10-100HP drive------------------------0.67

Example 2:- Estimate cost of equipment using scale factors and cost index. The purchased cost
of a 50 gallon glass - lined jacketed reactor (without drive) was $8350 in 1981, Estimate the
purchased cost of a similar 300 gallon glass lined, Jacketed reactor (without drive) in 1986.

Cost B = cost A * ( ) *( )eponent

From table

For 1981 equipment cost index = for 1986 equipment cost index

Equipment VS Capacity = 0.54

Calculate cost B = ?

Cost B = 8350/798

Estimate of fixed capital investment by percentage of delivered equipment cost

Direct cost (D)

1. Purchased equipment cost (delivered) E $ 100,000

2. Purchased equipment installation 25 - 55% E
3. Instrumentation and control 25 - 40% E
4. Piping installed 25 - 35 % E
5. Electrical installation 10 - 15% E
6. Building including services 10-30%

7. Yard improvement 10 - 20%

8. Service facilities 30- 80%
9. Land 4- 8% E

29
 Indirect cost

1. Engineering and supervision--------------------------------30-35%

2. Construction expenses----------------------------------------30-38%
D +I = ((1-9) +(1-2))
3. Contractors fee------------------------------------------------2-6% (D+I)
4. Contingency ---------------------------------------------------5-15% (D+I)

Example : - Estimation of fixed capital investment by percentage of purchased equipment cost

(delivered). Prepare a study estimate of the fixed capital investment for process plant if the
delivered equipment cost is $ 100,000

1. $ 100,000
2. 39% (39,000)
3. 28%(28,000)
4. 31%(31,000)
5. 10%(10,000
6. 55%(55,000)
7. 6%(6,000)

INDIRECT COST

1. 32%(32,000)
2. 34%(34,000)
D+I = 367,000
3. 5%B (18,350)
4. 10%(36,700)

TFCI = $ 422,000

30
Contingency: - Is usually included in an estimate of capital investment to compensate for
un predictable event such as, storm, flood, strikes, price change, small design
modification, errors in cost estimation, and other un for seen events. start up expenses.
After plant construction has been completed. there are reliant frequently changes that has
to be made before the plant can operate at maximum design conditions. these change
involve expenditure for materials and equipment, results in loss of income while the plant
is shut down in operating at only partially quality, In general, However, an allowance of
8-10% of fixed capital investment a rapid evaluation method suitable for order of
magnitude estimate is known as the turnover ratio method. Turnover ratio is defined as
the ratio of gross annual sale to fixed capital investment, Where the product of the annual
production rate and average selling price of the commodities is the gross annual gross
figures, the reciprocal of the turnover ratio is capital ratio or investment ratio for capital
ratio for chemical industry turnover ratio rages from 0.2 to 5.0

Turnover ratio = , before taxes

Capital ratio or investment ratio =

Estimation of total product cost

1. Raw materials
2. Operating labors
3. Steam
4. Electricity
5. Fuel, refrigeration, utilities
6. Water
7. Maintenance and repair
8. Operating supervision
9. Operating supplies
10. Laboratories
11. Royalties (if not lump sum basis) , If there mineral or other raw material in the
plant area
12. Catalyst and solvent
(1-12) Direct production cost

31
13. Depreciation (Building crack cost and the like)
14. Taxes (property)
15. Insurance
16. Rent
(13 -16) Fixed charge
17. Medical
18. Safety and protection
19. General plant over head
20. Pay roll over head
21. Packing
22. Restaurant
23. Recreation
24. Salvage
25. Control laboratories
26. Plant super intendance
27. Storage facility
(17 -27) Plant over head cost
28. Executive salaries
29. Clerical wages
30. Engineering and legal costs
31. Office maintenance
32. Communication
(28-32)Administrative expense
33. Sales office
34. Sales man expense
35. Shipping
36. Advertizing
37. Technical sales service
(33-37)Distribution and marketing expense
38. Research and development
39. Financing ( Interest often considered) as fixed charge

32
 40. Gross earnings expense
A. 1-12 Direct Earnings expense
B. 13-16 Fixed charges
C. 17-27 Plant over head costs
D. 28-32 Administrative expense
E. 33-37 Distribution and marketing expense
F. 1-27 Manufacturing costs ( production cost)
G. 28-39 General expense.
H. 1-39 Total product costs

Manufacturing cost or operating cost or production cost or total production cost

Is commonly calculated on the basis of

 Daily basis
 Units of product basis
 Annual basis

Annual basis is probably the best choice of estimating total product cost, Because,

1) Effects of seasonal variation is smoothed out

2) Plant on stream or equipment operating factors are considered
3) It permits more rapid calculation of operating costs at less than full capacity
4) It provides a covenant ways of considering in frequent occurring but large expense such
as annual turn around cost in a refinery.

Manufacturing cost:- All expense directly connected with the manufacturing operation or
physical equipment of process plant.

I. Direct production cost

II. Fixed charges
III. Plant over head cost

Fixed charges:- Are expense which remain practically constant from year to year and do not vary
widely with charge in production rate.

33
 Distribution and marketing expenses:- Costs incurred in the process of selling and distributing
the various products research and development expenses are incurred by any progressive concern
which wishes to remains a competitive industrial positions. Costs are related to development
new ideas or improved processes.

Financing expenses:- Extra costs involved in procuring the money necessary for the capital
investment (Borrowed money).

Gross earning expenses:- Are base d on income taxes law. These expenses are a directly
function the gross earning made by all various interests held by the particular company.

MANUFATURING COST

A. . Direct production cost

I. Raw material cost: - Freight or transportation cost charges should be included in the raw
material cost. In chemical industry, raw material cost are usually in the range of 10 % to
50% of total product cost.
II. Operating labor:- Operating labor may be divided into skilled and unskilled labor. For
chemical processes, Operating labor amounts to about 5% of the total production cost
III. Direct super visors and clerical labor:- A certain amount of direct super visor and clerical
labor is always required for a manufacturing operation. It averages about 15% of the total
operating labor cost.
IV. Utilities:- Steam, electricity, process and cooling water, compressed air, natural gas fuel
gas . it costs about 10-20% of total product cost.
V. Maintenance and repair:- Includes for labor materials and super vision. It costs for 2% of
the cost of chemical cost.
VI. Operating supplies:- Item, such as charts, Lubricants, tests chemicals, custodial supplies.
VII. Laboratory charges:- Raw material and product quality control. It costs about 10-20% of
the operating labor costs.
VIII. Patents and royalties:- Paying a set amount for patents right or royalties based on the
amount to 0-6% of total product cost.
IX. Catalysts and solvants:- costs for catalysts and solvents can be significant.

34
B. Fixed charges
Certain expenses are always present in an industrial plant whether or not the a
manufacturing processes is in operation. costs that are invariant charges with the amount
of production are designed as fixed costs or fixed charges. These charges amount to 10-
20% of total product costs.
1. Depreciation:- Equipments, buildings and other material objects comprising
manufacturing plant require an initial investment that must be written off as
manufacturing expenses. The annual depreciation rate for machinery and equipment
ordinary is about 10% the capital (fixed) investment while building are usually
depreciated at annual rate about 3% an initial cost.
2. Local taxes:- The magnitude of local property taxes depend on the particular locality of
the plant and the regional law. annual property taxes for the plants for highly populated
area is 2-4% of fixed capital investments, while in areas where these is less population it
amounts 1-2% of fixed capital investment.
3. Insurance:- an annual basis, the rate amounts to about 1% of fixed capital investment
4. Rent:- Annual cost for rented land and building amounts to about 8-12% of the rented
property.
C. Plant over head cost:- The expenditure require for routine plant services are include in plant
over head costs.
 Hospital and medical costs
 General engineering
 Safety service
 Cafeteria and recreation service
 General plant maintenance over head costs
 Packing
 Payroll over head costs
 Plant protection
 Genitor and similar services
 Employment offices
 Distribution of utilities
 Shops

35
  Lightings
 Inter plant communication and transportation
 Control laboratories

It costs about 50-70% of the total expenses for operating labor. Maintenances and
supervision.

Example:-Breakeven point, gross earning, and net profit for a process plant. The annual
direct production costs for a plant operating at 70% capacity is $280,000.00 whole the sum of
the annual fixed charges over head costs and general expenses is $ 200,000.00. What is the
breakeven point in units of production per year if the total annual sells is $ 560,000.00 and
the product sells 40. per unit?. What are the annual gross earnings and net profit for this
plant at 100% capacity in 1988 when corporate income taxes required a 15% tax on the 1st $
50,000.00 annual gross earning, 25% annual gross earnings of 50,000.00 to 75,000.00, 34%
on annual gross earning about $75,000.00 and 50% on gross earnings from $100,000.00 to
335,000.00?.

Given

Direct

Direct production cost = $ 280,000.00

Fixed charge + over head + general expense cost = $200,000.00

Annual sales = $ 560,000.00

Unite cost = $ 40/unit

Corporate taxes

1. $ 50,000---------------------------------------15%
2. $25,000----------------------------------------25%
3. $ 75,000---------------------------------------30%
4. $100,000 - $335,000------------------------5%
5. $75,000-$100,000---------------------------34%

Total unit cost = $560,000/$40 unit = 14,000 unit

36
Direct production = $280,000.00/$14000 unit = $20 unit

Total annual sell = total product cost + general expenses

 40 *n = 20*n +$200,000

Break even points

40n-20n = 200,000

n=10,000

What is plant capacity at breakeven point= 50%

At break can be calculated

 Plant capacity
 Number of units
 Annual sales

Net income ?

Gross annual earning ?

Gross annual earning = total annual sale - total annual product cost

= $560,000/0.7 -200,000-280,000/07

= $(800,000-400,000-200,000)

= $200,000

Annual net income = annual gross earning - income taxes

Annual net income = $200,000 -(50,000*0.15+25,000*0.25+75,000*0.3+100,000*0.5)

Annual net income= $80,000

37
 Interest and investment cost

Type of interest

The amount of capital on which interest is paid is designated as principal and rate of interest
is defined as the amount of interest earned by an unit of principal in unit of time. The time
unit is usually taken as one year. If 'P' represents the principal in the number of time units or
period and 'i' the interest rate based on the length of one interest period, The amount of
simple interest 'Z' during 'n' interest period is

Z = P *n*i-----------------------*

The principal must be repaid eventually; Therefore entire amount of 's' of principal plus
simple interest due after 'n' interest period is

S = P+Z

S= P +P*i*n

S = P(1+ i*n)

Compound interest

If t the end each time units. The receiver could put this money to use earning returns.
compound interest takes this factor into account by stipulating that interest period. The
compound amount due after any discrete number of interest periods can be determine as
follows.

Period principal at start of interest rate based on compound amount end of period
period length of one period Pi
1 P P1 P +P*n*i = P(i*n+1)
2 P(1+i) P2(1+ni) P(1+n*i) + P(1+n*i)*n*i =P(i+1)2
2
3 P(i+1) P3(i+1)2 P(i+1)2 + P(i+1)2*n*i = P(i+1)3
n-1
4 P(i+1) P n (i+1)n-1 P(1+i)n
S = P(1+i)n = Compound interest
(1+i)n - Discrete single payment compound interest
Nominal and effective interest rate
In common industrial practice the length of discrete period is assumed to be 1 year (i) is based on
1 year. Discrete compound interest factor (1+i)n of various values of 'i' and 'n' tabulated value.
38
Interest rate which will be doubled at half year is called nominal interest rate. It is desirable to
express the exact interest rate based on the original principal and convenient time of 1 year. A
rate of this time known as an effective interest rate. Is more effective than nominal interest rate in
common engineering practice. The only time that nominal interest rate and effective interest rate
are equal when the rate is compound annually.

S = P( i +1)n. Let 'r' be the nominal interest rate under conditions where there are 'm' conversion
or interest periods per year. The interest rate based on the length of one interest period is 'r/m'.
and the amount 's' after one year is,

S after 1 year = P( 1+ r/m)m

Designating the effective interest rate as Ieff, The amount 'S' after 1 year can be expressed in an
alternative as,

S after one year = P (1+ Ieff)

Effective annual interest rate = Ieff = (1 + r/m )m -1

Nominal annual interest rate = m *(r/m) = r

Example1:- Applications of different type of interest ; It is desired to borrow $1000 to meet

financial obligation. Times money can be borrowed from a loon agency at a monthly interest rate
of 2% . Determine the following

A. If total amount of principal plus simple interest due after 2 years if not intermediate
payment are made
B. The total amount of principal plus compound interest due after 2 years if no intermediate
payment are made.
C. The nominal interest rate when the interest compounded monthly.
D. The effective interest rate when the interest rate compounded monthly

Solution

Given P = $ 1,000, n = 24, i = 0.02

A. S = P(1+ni), = 1000(1+0.02*24); S = 1480.00$

B. Given P =1000$ ; i = 0.02; n= 24 ; S = P(1+i)n ; S = 1000(1+0.02)24 = 1608.45$

39
C. r = 12*0.02 = 0.24 or 24% if compounded monthly ( rate = month * interest rate)

r = 4*0.02 = 0.08 or 8%

D. Ieff = (1 + r/m)m -1 = (1+0.24/12)12 - 1; Ieff = 0.268, 0.268*100 = 26.8%

Continuous interest

when the time interval becomes infinite small so that the interest is compound continuously.
Basic equation for continuous compounding Let ''r'' represents the nominal interest rate with 'm'
interest periods per year. If the interest is compounded continuously 'm' approaches infinite.

''S''after 1 year = P ( 1+ r/m )mn = P

lim m

The fundamental definition for the base of the natural system of logarithm (e = 2.71828)

P = e = 2.71824

Thus, with continuous interest compounding at nominal interest rate ''r'' the amount ''s'' an initial
principle ''P'' will be compound to n year

S = P*e'''

Ieff = er - 1; (1+r/m)m/r = e-------------------------------------------1

Ieff = (1 +r/m)m - 1---------------------------------------------------2

Ieff = er - 1,-----combining 1 and 2

r = ln (1+ Ieff)---------------------------------------------------------*

ern = (1 +Ieff)n

S = P*e''' = P( 1+ Ieff)n ----continuously compounding

S = P (X +er-x)n, S = Pern

Note:- The annual interest rate compounded daily give result very close to those obtained with
continuous compounding.

40
Example:- calculation with continuous interest compounding for the case of a nominal annual
interest rate of 20% . Determine.

A. Total amount to which one dollar of initial principal would accumulate after 365 days per
year with daily compounding?
B. The total a mount to which one dollar of initial principal would accumulate after one year
with continuous compounding
C. The effective annual interest rate if compounding continuously.

Solution

given

A).P = 1 S = P(1+r/m)mn nominal interest defined rate

r = 20% = 0.2 S = $ 1*(1+0.2/365)365

m = 365 S = $ 1.2213

B). S = Pern

S = 1 * e0.2*1 Infinity (continuous)

S=

S = $ 1.2214

C). Ieff = er-1 = 2.71840.2-1; Ieff = 22.14%

D). compounding by using Ieff for one year if the interest rate is monthly

Givent

P = $ 1, Ieff = 0.2214; n = 12 ; S = P(1+Ieff)n, S = 1*(1 +0.2214)12

S = 11.023

Present worth and discount

Is often necessary to determine the amount of money which must be available at the present time
in order to have a certain amount accumulated at some definite time in the future. Because the

41
element of time is involved interest must be taken into consideration. The present worth (present
value) of a future amount is the present principal which must be deposited at a given interest rate
of yield the desired amount at some future rate.

Present worth (present value) = S/(1+i)n

The factor 1/(1+i)n is commonly referred to as discrete single payment present worth factor.
Similarly, for the case of continuous interest compounding, P = S/(ern).

In business terminology, the difference between the indicated future value and the present value
(present worth) is known as the Discount.

Example:- Determination of present worth and discount. A bond has a maturity value of $ 1000
and is paying discrete compound interest at an effective annual rate of 3%. Determine the
following at a time four years before the bond reaches a maturity value.

1) Present worth
2) Discount
3) Discrete compound rate of effective interest which will be received by a purchaser if the
bond were obtained for $ 700
4) Repeat part (1) for the case where the bond interest is 3% compounded continuously.

Solution.1;

P = s/(1+i)n = 1000/(1+0.03)4 ;P = $888.0

Solution.2;

Discount = S-P = $1000 - $888 = $ 112

Solution.3;

Given :- P = 700; S = 1000; I =?

P = S/(1+I)n , 700 = 1000/(1+i)4 ; I = 9.3%

Solution.4:

P = S/(ern) ; P = 1000/(e0.03*4) = $ 869

42
ANNUITIES

An annuities is a series of equal payments occurring at equal time intervals. Payments of this
type can be used to pay of a debit, accumulate a desired amount of capital, or receiver a limp
sum of capital that is due in periodic installments as in some life insurance plans. The amount of
annuities is the sum of all the payments plus interest if allowed to accumulate at definite rate of
interest from the time of initial payments to the end of the annuity term. The common type of
annuity term. The common type of annuity involves payments which occur at the end of each
interest periodic. This is known as an ordinary annuity. Interest is paid an all accumulated
amounts, and the interest is compounded each payment periods.

Relation between amount of ordinary and the periodic payments. Let 'R' represents' the uniform
periodic payments made during ''n'' discrete periods in an annuity. The interest rate based on the
payment period ''i'' and ''s'' is the annuity. The 1st payment is made at ''n-1'' and the last payment
is made at the last period.

S = R ( 1 + I) n-1 + R ( 1 + I) n-2- - - R( 1 + I) + R

1st Payment at the end of the 1st period Last payment at the end of last payment

To simplify the above equation multiply both sides ( I + 1) and rearranging it

S = R(I + 1 ) n - 1/ I

( 1 + I)n/I - discrete uniform series compound amount factor continuous cash flow and interest
compounding let '' r'' represent the nominal interest rate with conversions or interest periods per
year. So that '' I '' = r/m, and the total number of interest periods in ''n''- periods is ''nm'' for the
case of continuous cash flow and interest flow and interest compounding.

; S = R( e rn -1)/r

Present worth of an annuity

Present worth of the annuity is defined as the principal which would have to be invested at the
present time at compound interest rate ''i'' to yield a total amount at the end of the annuity term
equal to the amount of the annuity, Let ''P'' represent the present value (Worth of an ordinary

annuity) ; P = R -1; ;

43
Discrete uniform series present worthy factor. For the case of continuous cash flow and interest
compounding.

P=

Example:- Application of annuity in determine amount of depreciation with discrete interest

compounding. A piece of equipment has initial installed value of $12,000.00. It is estimated that
its use full life time period will be 10 years and its scalp value at the end of the use full life time
will be $ 2000.00. The depreciation will be charged as by making equal charges each year. The
depreciation found will be accumulated at an annual interest rate of 6%. at the end of the life
period. enough money must have been accumulated to account for the decrease in equipment
use. determine the yearly cost due to depreciation under these conditions.

Solution given

Salvage value/ scrap value = $ 2000.00

Installation cost = $ 12,000.00

Depreciation = $ (12,000.00 - 2,000.00)

Depreciation = $ 10,000.00

R= = $ 10000 * 0.06/(1+0.06)10 -1 , R = $ 759/ year

T o calculate the annuity in each year?

S1 = R(1+I)10 , S1 = 759(1+0.06)10

S2 = R(1+I)9; S2 = 759(1.06)9

S3 = R(1+I)8; S3 = 759(1.06)8

: :

: :

: :

S9 = R(1+I)10-9 = R(1+I)1

44
ST = 10,000.00 = S1 +S2 +S3 - - -S10 = 10,000

Example:- Application of annuities in determining amount of depreciation with continuous cash

flow and interest compounding with the above example.

R= = 10,000 *0.06/(e0.06*10 -1) = $730/year

Calculate the annuity in each year

S1 = R = 730 * (e0.06*10 -1)/0.06 =

S2 = R = 730*(e0.06*9 -1)/0.06 =

S3 = R = 730*(e0.06*8-1)/0.06 =

'

'

'

S10 = R = 730(e0.06*1-1)/0.06 =

10,000 = S1 +S2 + S3+ -------S10

Special type of annuity

One special form of an annuity requires that payments be made at the beginning of each period.
This is known as annuity due annuity in which the 1st payment is due after a definite number of
year is called deferred annuity. perpetuities and capitalized cost.

A perpetuity is an annuity in which periodic payments continue indefinitely. If the perpetuity is

to occur, The amount ''s'' accumulated after ''n'' periods minus the cost for replacement must
equal the present worth ''p'' therefore letting ''CR'' represents the replacement cost.

P=

45
Capitalized cost:- is defined as the original cost of the equipment plus the present value of the
renewable perpetuity. Designating ''k'' is as the capitalized cost and ''CV'' as original cost of the
equipment.

K = CV + present value and original cost of the equipment

Perpetuity = Depreciation - replacement cost.

Example:- Determination of capitalized cost; a new piece of completely installed equipment

costs $12,000 and will have a scrap value of $ 12,000 at the end of its use full life. Its use full life
period is 10 years and the interest is compounded at 6% per year. What is the capitalized cost of
the equipment

Solution; Given

CV = $12,000; n = 10 years, SV = $ 2000;

CR = 12,000 - 2,000 = 10,000

K = CV +

K = 12,000 + 1000/(1+0.06)10-1

K = $ 24650.00

Example:- Comparison of alternative investments using capitalized cost. A reactor, which will
contain corrosive liquids, has been designed. If the reactor is made of mild steel, the initial
installed cost will be $ 5000. The use full life period will be 3years, since stainless steel is highly
resistant to the corrosive action of liquid, stainless steel. as the material of construction, has been
proposed as an alternative to mild steel. The stainless steel reactor would have an initial installed
cost of $15,000.00. The scrap value at the end of the use full life would be zero. For either types
of reactor, and both could be replaced at cost equal to the original price. on the basis of equal
capitalized cost for both types of reactors, what would be the use full life period for the stainless
steel reactor is the money worth 6% compounded annually?

46
Given

Solution

Mild steel---------------------------------------------------------Stainless steel

CV = 5000 CR = 15,000

n=3 CV = 15,000

I = 0.06 n=?

CR = 5000 I = 0.06

Assume K1 = K2

K1 = CV + ;

K1 = 5000 + 5000/(1+0.06)3 -1 = $31,180

K2 = K1 = CV +

$31,180 = 15,000 +

$ 31,180 - 15,000 =

$ 16,180 * (1+0.06)n -1 = 15,000

(1+0.06)n = 15,000 / 16180 +1

log (1+0.06)n = log( 1.9271)

n = 11.3 years

47
 CHAPTER 10

PROFITABILITY, ALTERNATIVE INVESTMENT AND REPLACEMENTS

The word profitability is used as general term for measure of the amount of profit that can be
obtained from a given situation profitability, Therefore, is the common denominator for all
business activities.

Mathematical methods for profitability can be done

1) Rate of return on investment

2) Discount cash flow based on full life performance.
3) Net present worth
4) Capitalized cost
5) Payback period ( pay out period)

Rate of return on investment:- Rate of return on investment is ordinary expressed on annual

percentage basis, The yearly profit divided by total initial investment necessary represents the
fractional return. and this friction time multiples by 100 is the standard percentage return on
investment.

Rate of return on investment =

If return is zero or more, The investment is attractive.

Example:- Determination of rate of return on investment, consideration of income tax effects. A

proposal manufacturing plant requires an initial fixed capital investment of $ 900,000.00 and $
100,000.00 working capital. It is estimated that the annual income will be $ 800,000 and the
annual expense including depreciation will be $ 520,000.00 before income tax. A minimum
annual return of 15% before income tax is required before investment will be worth initial.
Income tax amounts 34% of all pretax profit.

Determine the following

a) The annual percent return on the total initial investment before income tax
b) The annual percent return on the total initial investment after income tax

48
 c) The annual percent return on the total initial investment before income tax based on
capital recovery with minimum profit.
d) The annual percent return on the average investment before income tax assuming straight
line depreciation and zero salvage value.

Given

Fixed capital investment = $ 900,000.00

Working capital = $ 100,000.00

Annual income = $ 800,000.00

Depreciation = $ 520,000.00

Income tax = 34%

Minimum annual return = 15%

Solution

Annual profit = income (annual) - depreciation; $800,000.00 - $520,000.00 = $280,000.00

A. Rate of return on capital investment = ; = 28%

B. Annual net profit = $ 280,000 *(1-tax) = $(280,000*0.66) = $184,800, Rate of return on

capital investment = Annual net profit$(2580,000 *0.66)/$(900,000+100,000) ; rate of
return on investment ROR= 18.5%
C. TCI = FCI +WC; TCI = $(900,000 +100,000) = $1000,000
Minimum profit at 15%
Rate of return on investment = profit/TFCI, Profit = $150,000
Expense + depreciation = $ 520,000
Profit + expense + depreciation = $150,000.00 + 520,000.00 = $670,000
Annual profit = income (annual) - 670,000 = $130,000
D. FCI/2 + $ 100,000 = Straight line method
= $900,000/2 + $ 100,000 = depreciation
= 550,000.00 = depreciation
Annual profit before income tax = $280,000

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Rate of return on investment(ROR) = 280,000*100%/550,000 = 51%
DIS COUNT CASH FLOW
Rate of return based on, discount cash flow, The method of approach for a profitability
evaluation by discount cash flow takes into account time value of money and is based on the
amount of the initial investment that is un returned at the end of each year during the estimated
life of the project rate of return which can be applied to yearly cash flow so that, the original
investment is reduced to zero (salvage value + land value + working capital investment) during
the project life time. Thus , the rate of return by this method is equivalent to the maximum
interest rate (normally after the tax) at which money could be borrowed to finance the project
under conditional where the net cash flow to the project over its life would be just sufficient to
pay all principal and interest at a given interest period. consider, The case of the proposed project
for which the following data will be applied

Initial fixed capital investment = 100,000.00

Working capital investment = $10,000.00
Service life = 5 years
Salvage value at the end of use full life = $20,000.00

Year -------- predicted after tax cash flow to project based on total income minus all costs except
Depreciation, (expressed at the end of period.(10,000+100,000) = 110,000.00
0--------------$ 10,000 +100,000.00 = 110,000
1--------------$ 30,000 110,000 = 30*1000/(1+i)1 + 3*100/(1+i)2 +36,000/(1+i)3
2--------------$31,000 + 40,000/(1+i)4

3--------------$36,000 30,000*0.8996 = 26100

4--------------$40,000 31,000*0.6575 = 23400

5--------------$43,000

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Computation of discount cash flow rate of return

year Estimated cash flow Trial for i = 0.15 Trial i = 0.27

to project Present value
Discount Discount Proposed value
factor factor
0 110,000.00 1/(1+i)0 =
110,000
1 30,000.00 1/(1+i)1 = 26100 1/(1+0.207)1 24900
0.8996 = 0.829
2 31,000.00 1/(1+i)2 = 23400 1/(1+0.207)2 21200
0.7561 = 0.687
3 36,000.00 1/(1+i)3 = 23300 1/(1+0.207)3 20500
0.6575 = 0.570
4 40,000.00 1/(1+i)4 = 22900 1/(1+0.207)4 18800
0.5718 = 0.472
5 43,000.00 1/(1+i)5 = 31300 1/(1+0.207)5 24600
+20,000 0.4971 = 0.391 +20,000
ratio T= 127,000 T = 110,000
127,000/110,000 110,000/110,000
= 1.15 =1
Net present value

The index give the rates of return that includes the profits on the project, pay off the investment,
and the nominal interest on investment, A method of approach is known as the net present value.
The net profit worth of the project is then the different between the present value of the annual
cash flow and the initial investment. for the above example.

Net present value = $ 127,000 - $110,000 = $17,000

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line Items Year ( use full life)
1 Fixed capital investment 1986, 1987, 1988, 1989, 1990

2 WCI
3 TCI = WCI +FCI
4 Annual income (sales)
5 Annual manufacturing costs:- E, Operating supplies,
A, Raw material, F, Laboratory charge,
B, labor, G, Patents and royalties,
C, utilities, H ,Local taxes,
D, maintenance and repair, I, Plant over head
5T T- Total of line 5 - Annual manufacturing costs
6 Annual general expense
A, Administration C, Research and development
B, Distribution and selling, D, Interest
6T Total of line 6 or general expenses
7 Total product cost is the sum of 5T and 6T (5T +6T)
8 Annual operating income = annual sales - total product cost or
(4-7) before tax
9 Annual depreciation
10 Annual Income before tax = annual operating income - annual
depreciation
11 Income after taxes (corporate income tax apply)
12 Annual cash income, the sum of ( 9+11)
13 Annual cash flow, the sum of (3 +12)
14 Discount factor for (i) interest ( dn = )

15 Annual present value (13*14)

16 Total present value of annual cash flows (sum of line 15 not
include 0 year)
17 Net present worth = total present value of annual cash flow -
total capital investment or (line 16 - line 3)

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 Payback period ( pay out period)

Payback (pay out period) or pay out time is defined as the minimum length of time theoretically
necessary to cover the original capital investment in the form of each flow to the project based
on total income minus all costs except depreciations.

Payback period = (No interest is considered)

Payback period by considering interest =

Example:- ABC Soap factory PLC is to be implemented soon, It would have a nominal capacity
of 10,000 tons per year. The total initial investment would be birr 5,400,000. The project
construction will last a year and shall be in operation for 10 years after commissioning with a
salvage value of birr 500,000 at the end of the 10th year of operation. It shall sell soap at 10
birr/kg.

The plant shall operate at 70% and 80% capacity utilization rate during the 1st and 2nd years of
operation and at 100% thereafter. No replacement are required other than repair and maintenance
costs included in factory overheads.

The operating costs assumed are as follows:-

 Raw material: Caustic soda and fatty acids and ingredients and packing material--------5000birr/t soap
 Utilities-------------------------------------2000 birr/t soap
 Factory overhead, Administrative, sales and distribution costs are estimated at 25% of sales

The schedules for long term loan repayment, depreciation and amortization and interest are given
below.

Year 0 1 2 3 4 5 6 7 8 9 10
Loan repayment - 1080 1080 1080 1080 1080 - - - - -
Interest (12) - 650 520 380 260 130 - - - - -
Depreciation and - 540 540 540 540 540 540 540 540 540 540
amortization

53
 Neglect income tax of 35 % paid starting from the 6th year of operation. do not consider also the
10% sales tax that is transferred to consumers.

Required:

1. Develop a project cash flow of ABC soap factory PLC to obtain gross profits (i.e. profit
before tax based on which you should calculate the payback period of the project.
2. Calculate the break even volume or percentage of production at the end of the 3rd year of
operation
3. Calculation on the basis of gross earning.
i. Present values (PV,)
ii. The net present value (NPV),
iii. The profitability index (PI) or the net present value ratio assuming 12%
opportunity cost of capital
4. What is your opinion about the viability of the project
5. Do you see any risks and uncertainties? Discuss in terms of the critical or parameters.
Solution
Project cash flow of ABC soap factory PLC-------------------------------------------------------000birr

Year 0 1 2 3 4 5 6 7 8 9 10
Capacity utilization% - 70 80 100 100 100 100 100 100 100 100

I. Cash inflow - 70,000 80,000 100,000 100,000 100,000 100,000 100,000 100,000 100,000 100,000
 Revenue - 70,000 80,000 100,000 100,000 100,000 100,000 100,000 100,000 100,000 100,000
 Salvage value - - - - - - - - - - 500

II. Cash out flow 5400 68,770 78140 97,000 96,880 96,750 95,540 95,540 95,540 95,540 95,540

 Investment 5400 - - - - - - - - - -
 RM $ others - 35,000 40,000 50,000 50,000 50,000 50,000 50,000 50,000 50,000 50,000
 Utilities - 14,000 16,000 20,000 20,000 20,000 20,000 20,000 20,000 20,000 20,000
 Factory - 17,500 20,000 25,000 25,000 25,000 25,000 25,000 25,000 25,000 25,000
overheads
 Depreciation $ - 540 540 540 540 540 540 540 540 540 540
amortization
 Capital charges - 1080 1080 1080 1080 1080 - - - - -
 Interest - 650 520 380 260 130 - - - - -
Gross profit (I -II) - 1230 1860 3000 3120 3250 4460 4460 4460 4460 4460
5400

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Method of the above table constructed
 Revenue :- is total annual sales = 70%/100*10unit sales*10,000t *1000kg/t = 70,000,000
 Salvage value is given
 Capacity utilization is given
 Cash inflow is the sum of revenue and salvage value at the end use full life
 Cash out flow is the sum of Investment, RM $ others, Utilities, Factory overheads,
Depreciation $ amortization ,Capital charges and Interest as well as investment at each year
individually
 Capital charge is given
 Interest is given
 Factory over head cost = 25% *annual sales = 25/100 *10,000,000 *70/100
 Raw material and others = 5000*10,000*70/100 = 35,000,000
 Loan payment is given.

Payback period calculation

Year 0 1 2 3

Cumulative cash flow -5400, -5400+1230 = -4170, -4170 +1860 = -2310, -2310 +3000 = 690

Yearly cash flow - 1230 1860 3000

Payback period = 2 years + 2310/3000 = 2.77 years or 2 years and 9 months

B) Breakeven point is the production volume at which there is no loss or profit. at that pointy any
revenue obtained will sufficient to cover only the fixed costs. (unit selling price - unit variable
costs) production volume = total fixed costs

Total fixed costs = (depreciation + loan payments + interest + factory over head cost) at 3rd years

Total fixed costs at 3rd years = 1080,000 +540,000 +25,000,000 +380,000 = 27,000,000

Variable costs = utilities + raw materials and others at the 3rd years

Variable costs at the 3rd years = 20,000,000 + 50,000,000 = 70,000,000

Annual sales = 10*10,000t *1000kg/t = 100,000,000birr

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Breakeven point (BEP) = ,

BEP = = 90%

Production volume quality=90/100*capacity of the plant (10,000t*1000kg/t)=90,000,000kg/soap

Solution c,

Year 0 1 2 3 4 5 6 7 8 9 10

cash flow -5400 1230 1860 3000 3120 3250 4460 4460 4460 4460 4460

discount (

factor at 12% 1 0.893 0.797 0.712 0.636 0.567 0.506 0.452 0.404 0.351 0.322

i. Present value (PV):- It is the product of Discount factor and Cash flow
PV= -5400 1098 1482 2136 1984 1843 2257 2016 1802 1610 1597
ii. Net present value(NPV) = The sum of all present value = 12,425,000, it including initial
investment
iii. Net present value ratio (NPVR) = = = 2.30

Since the present value is positive and net present value ratio is greater than 1 the project is
acceptable and viable for implementation. Moreover, the payback period of only 2.77 years
apparently minimizes any risk in regaining/ recouping the initial investment.

The most critical determinates of the viability of the project are NPV and PI which in this case
are adequate to avoid any doubts about the projects viability.

However, since the BEP is at 90% leaving no safety margin for capacity underutilization, there is
an uncertainty of not operating above 90% throughout the project life and risks associated as a
result . NPV and PI are good indicators only if the assumption made for investment and
operation are also good. Also taxation and replacement ignored could have some effect on the
projects viability.

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Example 2;- From the given data in the following table about a project calculate the approximate
internal rate of return and state whether the project would be acceptable or rejected if opportunity
of cost is capital cost is 14%.

Cut-off rate NPV in - birr

10% 15,000

16% 2,000
17% 10
18% -20
20% -3757

Solution

Interpolation

X1 = 17% Y1 = 10

X = ? Y2 = 0

X2 = 18% Y3 = -20

Using formula to calculate IRR

I1 + PV1( = 17% + 10*(18-17)/(10+20) = 17.33%

IRR > 17.33% > 14% The project is feasible

Depreciation
An analysis of costs and profit for any business operation require recognition of the fact that
physical assets decrease in value of many due to physical deterioration Technological advances,
economical changes or other factors that ultimately will cause retirement of property. The
reduction in value due to any of these cause is called depreciation.

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Type of depreciation

1) .Physical depreciation:- is the term given to the measure of decrease in value due to
physical aspects of the property. Wear and tear, corrosion accidents, and deterioration
due to age or the elements are all cause of physical depreciation.
2) Function depreciation:- one common example of functional depreciation is obsolescence;
This type of depreciation is caused by technological advancements or developments that
make an existing property obsolete. Example of functional depreciation.
a) Change in demand for the service rendered by property
b) shift of the population center
c) Change the requirement of authority
d) In adequacy or insufficient service rendered
e) Termination of the need for the type of service rendered
f) Abandonment of the enterprise

Depletion:- Capacity loss due to materials actually consumed is measured as depletion.

Example:- Natural resources, mineral, oil, natural gas.

Service life:- Use full time

Salvage value:-Salvage value is the net amount of money obtainable from the sales of used
property. If the property cannot be disposed of as a useful unit, It can be dismantled and sold as
junk to be used raw material for other manufacturing industry. This is known as junk value or
scrap value.

Book value/ un amortized cost

The difference between the original cost of the property and all the depreciation charges made to
date is defined as a book value.

Market value:- The price which could be obtained for an asset if it were placed on sale in the
open market is called market value.

Replacement cost:-The cost necessary to replacement existing property at any given time is
called replacement cost.

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Method for determining depreciation

1) Straight line method:- In the straight line method for determine depreciation. It is
assumed that the value of the property decrease linearly with time. Equal amounts are
charged for depreciation each year throughout the enterer life of the property.
d=

Where:- d = depreciation and /year

V= Original cost of equipment, dollar
Vs = salvage value of end of service of dollar
n = service life time /year.
The asset value (book value) un amortized cost of the equipment at any time during the
service life may be determined from the following equation
Va = V - a*d
Va - Asset or book value, dollar
a -The number of years in actual use
Declining balance (fixed percentage) method
When the declining balance method is used the annual depreciation cost is fixed
percentage of property value at the beginning of the particular year. The fixed percentage
factor remains constant throughout the enterer life of the property. While the depreciation
is different each year.

At the end of 1st year, Va = V(1-f), f- declining percentage factor.

At the end of 2nd year,

Va = V(1 - f )2 ,

At the end of 3rd year,

Va = V ( 1 - f )a

At the end of service life of the year.

Vs = V ( 1 - f )n

f = 1 -(

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Example:- Determination of depreciation by straight line and balanced declining method. The
original value of a piece of equipment is $22,000 completely installed and ready for use. Its
salvage is estimated to be $2,000 at the end of a service life estimated to be 10 years. determine
the asset book value of equipment at the end of 5-years using

a. Straight line method

b. Declining balance method
c. Double declining balance 200% method

Solution

Given(a)

n = 10 - years

V = 22,000$

Vs = 2000$

d= , 22000-2000/10; d = 2000$/years

Va = V - a* d = 22000- 2000*5; Va = 12,000$/years

b) f = 1-

f = 1- ; f = 0.2131

Va = V( 1 - f )a

Va = 22000(1-0.2131)5 ; Va = $ 6650

c) f = ;

f= = 0.818

Va = V ( 1- f )a

Va = 22000( 1 - 0.818)5

Va = $ 8060
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