CB407 Ppde P2

Process Plant Design and Economics
(CB407)
Chemical and Biochemical Engineering

Indian Institute of Technology Patna
Atanu K Metya
atanu.metya@iitp.ac.in
Interest, Time value of money,

Taxes, and Fixed charges
Interest
• Money is Not Free to Borrow
• How Much does it Cost to Borrow Money?
Today Interest Next year

Principal rate 10%
₹1000 ₹1000
Borrower You Bank You Bank

Interest
Lender ₹100
Loan Repayment
This is the idea of Interest and paying for the use of the money
• Interest is the cost of borrowed money, or the earnings on money loaned.
• Interest rate is defined as the amount of money earned by, or paid on, a
unit of principal in a unit of time, expressed as a fraction or % per year.
• Interest paid is an expense of business operation that must be included in
the analysis of business profitability.
• Simple interest:
I = PiN
F = P + I = P(1 + iN)
• A student obtains a simple-interest loan to pay one year of college tuition,

which costs ₹50,000, and the annual interest rate on loan is 6%. The
student repays the loan over three years. Calculate the amount of simple
interest and the total amount paid after three years.
• Compound Interest is the interest earned on accumulated, reinvested

interest as well as the principal amount.
Today Interest Next year
Principal rate 10%
₹1000 ₹1000
Borrower You Bank You Bank Interest

In 2 years
Lender ₹100
₹1100
Loan ₹1100
You Bank You Bank

Interest
₹110
Repayment
• Compound Interest
Period Principal at start Interest earned during Compound amount F at
of period period end of period
1 P Pi P(1+i)
2 P(1 + i) P(1 + i)i P(1+i)(1+i)= P(1+i)2
3 P(1 + i)2 P(1 + i)2i P(1 + i)3
N P(1 + i)N-1 P(1 + i)N-1i P(1 + i)N
• The term (1 + i)N is referred to as the discrete single-payment compound

amount or the discrete single-payment future-worth factor.
Comparison between total amounts accumulated with simple annual interest

and continuously compounded interest
year Loan at start (₹) Interest (₹) Loan at end (₹)

1 ( 0 Now) 100 100 × 5% =
2
3
4
5
Compare that to the Simple Interest

• Comparison between total amounts accumulated with simple annual
Interest
interest and continuously compounded interest

300
C3
3
100 *-
0 4 8 12 16 20
Time, yr
Nominal and Effective Interest Rates
• Nominal interest rate: An interest rate stated as an annual rate but
compounded other than annually
• The effective interest rate ieff is the rate which, when compounded once
per year, gives the same amount of money at the end of 1 year, as does the
nominal rate r compounded m-times per year
#
• !!"" = 1 + &⁄' -1
• A nominal interest rate for compounding periods less than a year is always
lower than the equivalent rate with annual compounding.
Example:
It is desired to borrow ₹1000 to meet a financial obligation. This money can
be borrowed from a loan agency at a monthly interest rate of 2%. Determine
the following:
a. The total amount of principal plus simple interest due after 2 years if no
intermediate payments are made
b. The total amount of principal plus compounded due after 2 years if no
intermediate payments are made
c. The nominal interest rate when the interest is compounded monthly.
d. The effective interest rate when the interest is compounded monthly.
Which interest rate is higher
Continuous Interest Compounding

• If the nominal interest period is gradually decreased from one-year to 1
month to 1 day to 1 h and finally approaches infinity
• For N years mN ( m / r ) ( rN )
æ rö æ rö
F = P lim ç1 + ÷ = P lim ç1 + ÷ = P e rN
m ®¥
è mø m ®¥
è mø
!
lim (1 + )⁄*) % = e = 2.71828 … . .
! →$
• The factor erN is the continuous single-payment compound amount

factor or the continuous single-payment future-worth factor.
Continuous Interest
( F / P, r , N ) = e rN
Þ F = P ( F / P, r , N )
• The factor(F/P,r,N) is the ratio of future-worth F to present worth P, when

compounding is continuous at a nominal rate of r per year for N years.
• The amount given by compounding at the effective rate reff at the end of 1
year is (1+ reff)
reff = e r - 1 Þ r = ln (1 + reff ) \ F = PerN = P(1 + reff ) N
Example:
For the case of a nominal interest rate of 20% per year, determine
a) The total amount to which ₹100 of initial principal would accumulate after
1 year with annual compounding and the effective annual interest rate.
b) The total amount to which ₹100 of initial principal would accumulate after
1 year with monthly compounding and the effective annual interest rate.
c) The total amount to which ₹100 of initial principal would accumulate after
1 year with daily compounding and the effective annual interest rate.
d) The total amount to which ₹100 of initial principal would accumulate after
1 year with continuous compounding and the effective annual interest rate.
How Interest Rates are Determined

• Supply and Demand of money or credit
• Inflation
• Government
1. What total amount of funds before taxes will be available 10 years from
now if ₹10,000 is placed in a savings account earning an interest rate of
6% compounded monthly? How many years will be required for this
amount to double at the same interest rate compounded semiannually?
What is the shortest time in years for the doubling to occur if continuous
compounding is available?
2. An original loan of $2000 was made at 6% simple interest per year for 4
years. At the end of this time, no interest had been paid and the loan was
extended for 6 more years at a new, effective, compound-interest rate of
8% per year. What is the total amount owed at the end of the 10 years if
no intermediate payments are made?
Time Value of Money A
• The calculation of the future worth of a Compoundin^^^^^
present amount of money, known as Qo ^ "-^Kscounting
compounding
>-
• The inverse of compounding that is, obtaining Time
N
the present worth of a future amount, is

designated as discounting. worth of such funds. Put another way, the most app
comparisons is to make all cash flows equivalent. T
The eqn. forThecontinuous discounting

determine the value of investments at any selected tim
The eqn. for discrete discounting time value of money

It has nothing to $%&
is related solely to the c
( = )* do with inflation. Inflation, or defl
( = )(1 + !)$& prices of goods and services, not to the amount of mo

rate of inflation is 4 percent per year and if the cost o
$104 one year from now—regardless of the time valu
Cash Flow Patterns

• The annual cash flow = net (after-tax) profit + allowed depreciation
charges for the year
• Since cash flows of a project occur over the lifetime of a project, it is
necessary to convert them to equivalent values.
• This is done either by discounting future cash flows or by compounding
earlier cash flows to a particular point in time.
etime in the future. It is common, while in the design phase of a project, to select

projected start-up time as the time at which all "present" values are calculated.
screte Cash Flows
h flow patterns are often best perceived graphically. Figure 7-3 shows equal dis-
Cash Flow Pat
• Discrete Cash Flows
e cash flows occurring once per month at the end of the month for a period of
ar; each cash flow is represented by a bar.
25,000
15,000 -
20,000
% 10,000 - — — — — — — — — — — — —
O | 15,000
qi!
-c
/ .c
& 5.000 _ £ 10,000
5,000
1 2 3 4 5 6 7 8 9 10 II 12 0
Time, months I 2 3 4 5 6 7 8 9 10 11 12
Time, months
Figure 7-3
Constant, end-of-month cash flows
Constant, end-of-month cash flows for I yr unequal end-of-month cash flows
Figure 7-4
Series of unequal end-of-monlh cash flows
Exercise: The cash flow patterns are shown in the above Figures. With
Figure 7-4 shows unequal cash flows occurring at the end of each month for 1 y
interest compounded monthly The at cash
a rate of 10%
flows shown in Figs. per
7-3 andyear,
7-4 are calculate the total
equivalent at a discount rate of 10
amount of the cash flow, the present worth at zero time, and the at timefuture
zero, at 12worth
cent per year. That is, they have the same worth at a particular time when calculate
that discount rate, whether that worth is calculated months, or at
at 12 months for both series of cash flows.

other time. It follows that if two different cash flows are equivalent at one interest r
they are not equivalent at any other interest rate.
Discrete Cash Flows

Cash flow patterns are often best perceived graphically. Figure 7-3 shows equal dis-
crete cash flows occurring once per month at the end of the month for a period of
Equal monthly cash flows
1 year; each cash flow is represented by a bar.
End of 15,000 -
month j Cash flow
1 10000
% 10,000 - — — — — — — — — — — — —
2 10000 O
qi!
3 10000 -c
/
4 10000 & 5.000 _
5 10000
6 10000
7 10000 1 2 3 4 5 6 7 8 9 10 II 12
Time, months
8 10000
9 10000 -j
Figure 7-3 æ rö
10 10000 Present-worth Constant, end-of-month
facto r = P / F = 1 +cash
ç flows
Constant, end-of-month cash
m
flows
÷ for I yr
11 10000 è ø ( m- j )
æ rö
12 10000 Future-worth factor = F / P = ç1 + ÷
è mø
Unequal monthly cash flows Cash Flow Patterns
End of
month j Cash flow 25,000
1 7000
20,000
2 11000
3 11500 | 15,000
.c
4 9500 £ 10,000
5 10000 5,000
6 7500 0
7 11000 I 2 3 4 5 6 7 8 9 10 11 12
Time, months
8 9500
9 10000 unequal end-of-month cash flows
Figure 7-4 -j
æ r ö
Present-worth r = P / F = cash
factoend-of-monlh
Series of unequal
ç1 + flows
÷
10 6000 è mø
11 8000 ( m- j )
æ month
Figure 7-4 shows unequal cash flows occurring at the end of each r ö for 1 year.
12 19304 Future-worth
The cash flows shown in Figs. 7-3 and 7-4 are fact or = F at/ Pa discount
equivalent = ç1 + rate
÷ of 10 per-
è mø
cent per year. That is, they have the same worth at a particular time when calculated at
Exercise: The cash flow patterns are End of Equal ash
shown in the Table. With interest month j flow Cash flow
compounded monthly at a rate of 10% 1 10000 7000
2 10000 11000
per year, calculate
3 10000 11500
• the total amount of the cash flow, 4 10000 9500
• the present worth at zero time, and 5 10000 10000
• the future worth at 12 months for 6 10000 7500
both series of cash flows. 7 10000 11000
-j
8 10000 9500
æ rö 9 10000 10000
Present-worth factor = P / F = ç1 + ÷
è mø 10 10000 6000
11 10000 8000
( m- j ) 12 10000 19304
æ rö
Future-worth factor = F / P = ç1 + ÷
è mø
• Continuous Cash Flows

• Receipts and expenditures occur continuously over time
• If interest is compounded continuously, rate of earning at any instant consists of two
parts:
• a continuous, constant rate of cash flow 3 per period.
• Compound rate of earning on accumulated amount M that has been invested at rate
r.
dM
= P + rM ( M ® 0 to F ; q ® j - 1 to j )
dq
F is the future worth of the cash flow plus the earnings at the end of a 1-year period
Amount of funds accumulated after one year:

æ er - 1 ö æ er - 1 ö
F = Pç ÷ Þ ( F / P, r, j) = ç
è r ø ÷
è r ø
For a cash flow occurring over a period of N years, starting at time zero,
the future- worth factor is æ e rN - 1 ö

Þ ( F / A, r , N ) = ç ÷
è r ø
the present-worth factor æ e rN - 1 ö - rN

Þ ( P / A, r , N ) = ç ÷e
è r ø
where A is a continuous, equal cash flow occurring in each year (or period) over
N years (or periods).
Example:
• Find the future worth at the end of cash flow period and present worth at
the beginning of the cash flow period of a constant, continuous cash flow
of 450,000$ per year for 6 years using compounded interest rate of 8% per
year.
• Also tabulate the cash flow a year at a time.
Compounding and Discounting factors

• Cash flows and interest compounding can be either discrete or continuous.
interest compounding/Discounting
Cash flow pattern Discreate (Annual) Continuous
Discreate (Annual, Case 1 Case 2
end of year)
Continuous Case 3 Case 4
• Discrete interest and Discrete cash flows

chapter 7 Interest, Time Value of Money, Taxes, and Fixed Charges
Single-amount cash flow Uniform series cash flow
o a
a Q
3 N- 1 N
Period Period
Figure 7-5 Figure 7-6

Compounding and discounting factors for discrete interest compounding and discrete cash flows
Compounding Discounting
Cash flow
pattern Factor name; Symbol Formula Factor name; Symbol Formula
description; units description; units
Single amount at Future worth; multiplies ("/$, &, ' (1 + &)!"# Present worth; $ (1 + &)"#
( , &, ))
end of year, j a single amount at time j − )) multiplies a single "
to give a single amount amount at time j to give
at N; dimensionless a single amount at time
zero; dimensionless
Series of equal Future worth; multiplies " (1 + &)! −1 Sinking fund; multiplies - &
( , &, ') ( , &, ')
amounts from the annual rate of a series - & a single amount at N to " (1 + &)! −1
time 1 to N; of N equal amounts to give the annual rate of a
uniform series give a single amount at series of N equal
N; dimensionless amounts; (years)-1
Series of equal Capital recovery; - &(1 + &)! Present worth; $ (1 + &)! −1

( , &, ') ( , &, ')
amounts from multiplies a single $ (1 + &)! −1 multiplies the annual - &(1 + &)!
time 1 to N; amount at time zero to rate of a series of N
uniform series give the annual rate of a equal amounts to give
series of N equal a single amount at
amounts; (years)-1 time zero; years

3. Compounding and discounting factors for discrete interest compounding
and continuous cash flows
Interest compounding
end of year)
Example:
A cash flow consisting of $10,000 per year is received in one discrete
amount at the end of each year for 10 years. Interest will be at 10% per year
compounded annually. Determine the present worth at time zero and the
future worth at the end of 10 years of this cash flow.
Present worth:
A éë(1 + i ) N - 1ùû 10, 000 éë(1.1)10 - 1ùû
P = A ( P / A, i, N ) = = = 61, 446 $
i (1 + i ) N
0.1(1.1) 10
Future worth:
F = P ( F / P, i, N ) = P(1 + i ) N = 61, 446 (1 + 0.1)10 = 159,375 $

2. Compounding and discounting factors for continuous
interest compounding and discrete cash flows
end of year)
Compounding and discounting factors for continuous interest compounding and discrete cash flows
Cash flow
Factor name; Symbol Formula Factor name; Symbol Formula
pattern
Single amount at Future worth; " / $(!"#) Present worth; $ / "$#
( , ., ' − )) ( , ., ))
end of year, j multiplies a single $ multiplies a single "
amount at time j to amount at time j to give
give a single amount at a single amount at time
N; dimensionless zero; dimensionless
Series of equal Future worth, annuity; " 0'( − 1 Sinking fund; - /$ − 1
( , ., ') ( , ., ))
amounts from multiplies the annual - 0' − 1 multiplies a single " / $! − 1
time 1 to N; rate of a series of N amount at N to give the
uniform series equal amounts to give annual rate of a series
a single amount at N; of equal amounts;
years (years)-1
Series of equal Capital recovery; - / $! (/ $ − 1) Present worth; $ 0'( − 1
( , ., ') ( , ., ))
amounts from multiplies a single $ / $! − 1 multiplies the annual - 0'((0' − 1)
time 1 to N; amount at time zero to rate of a series of N
uniform series give the annual rate of equal amounts to give a
a series of N equal single amount at time
amounts; (years)-1 zero; years
Example:
• A cash flow consisting of 10,000$ per year is received in one discrete
amount at the end of each year for 10 years. Interest will be at 10% per
year compounded continuously. Calculate present and future worth. Do the
calculations in two ways: first using the nominal interest rate r = 0.1, and
then using ieff = 0.1.
æ e rN - 1 ö æ e0.1´10 - 1 ö
Future worth: F = Aç r ÷ = 10, 000 ç 0.1 ÷ = 163,380 $
è e -1 ø è e -1 ø
æ e rN - 1 ö - rN - rN -0.1´10
Present worth: P = Aç r ÷ e = Fe = 163,380e = 60,104 $
è e -1 ø

4. Compounding and discounting factors for continuous
interest compounding and continuous cash flows
end of year)
1 to multiplies a annual rate of
single amount
at time zero Process Plant Design and Economics
a series of
equal amounts
to give the to give a
annual rate single amount
• Continuous interest and Continuous cash flows
of a series at time zero;
of N equal years
amounts;
One-year
(years)-1
continuous constant-rate Series of continuous, constant-rate
cash flow cash flows
Jh t--
"o
Q
/ w
0 N-l N 0 1 N-2 N-\ N
Figure 7-7 Figure 7-8

One-year continuous constant-rate Series of continuous, constant-rale cash
Compounding and discounting factors for continuous interest compounding and continuous cash flows
Cash flow
Factor name; Symbol Formula Factor name; Symbol Formula
pattern
Continuous, Future worth; multiplies " 0' − 1 '((")) Present worth; $ / $ − 1 "$#
( , ., ') 0 ( , ., )) ( )/
constant rate for continuous annual rate to $2 3 multiplies a single $2 .
1 year only, give a single amount at N; amount at time j to give
ending at the end dimensionless a single amount at time
of year j zero; dimensionless
Series of Future worth; multiplies " / $! − 1 Sinking fund; multiplies -̅ .
( , ., ') ( , ., ') / $! − 1
continuous, the annual rate of a series -̅ . a single amount at N to "
constant annual of continuous, equal give the annual rate of a
amounts from amounts to give a single series of equal amounts;
time zero to N. amount at N; years (years)-1
Series of Capital recovery; -̅ 30'( Present worth; $ / $! − 1 "$!
( , ., ') ( , ., ') /
continuous, multiplies a single $ 0'( − 1 multiplies the annual -̅ .
constant annual amount at time zero to rate of a series of
amounts from give the annual rate of a continuous, equal
time zero to N. series of continuous, amounts to give a single
equal amounts; (years)-1 amount at time zero;
years
Example: Use a continuous nominal earning rate of 12% per year.
a. Find the future worth at start-up (time zero) of an investment made
according to this schedule: $3 million is invested continuously at a
constant rate for 1 year, beginning 2 years before start-up; $7 million is
invested continuously at a constant rate for 1 year, beginning Income 1 year before
Taxes
start-up.
b. Convert the worth of the investment at start-up to a continuous, constant
Solution
annualTheseries forandaannual
investment 10-year period.
cash flow patterns can schematically be shown below in Fig. 7-9:
o
Q
-2 -1 0 10
Year
Depreciation and Income Tax
• Physical facilities deteriorate and decline in usefulness with time.
• A deduction for depreciation may be claimed each year for property
with a limited useful life
• This deduction allows tax-payers to recover their costs for the
property over a period of years.
• Physical depreciation: decrease in value of a facility due to changes
in the physical aspects of a property. Wear and tear, corrosion,
accidents, and deterioration due to age

• Functional depreciation: Obsolescence is caused by technological
advances which make an existing property obsolete.
• Other causes of functional depreciation
• decrease in demand for the service rendered by the property
• shifts in population
• changes in requirements of public authority
• inadequacy or insufficient capacity
• abandonment of the enterprise.

• There is no cash outlay for depreciation, and no money is
transferred to any fund or account, so the depreciation charge is
added back to the net income after taxes to give the total cash flow
from operations.
• Depreciable Investments
• In general, all property with a limited useful life of more than one year
that is used in a trade or business, or held for the production of income.
• Physical facilities: design and engineering, shipping, and field erection
• The land is not depreciable, but improvements to the land
• Working capital and start-up costs are not depreciable.
• The costs of maintenance and repairs are not depreciable.
• The total amount of depreciation that may be charged is equal to the
amount of the original investment in a property.
• Depreciation does not inflate or deflate.
• Current value: the value of the asset in its condition at the time of valuation
• Book value: the difference between the original cost of a property and all the
depreciation charged up to a time
• Market value: The price that could be obtained for an asset if it is sold on the
open market
• Salvage value: the net amount of money obtainable from the sale of used
property over and above any charges involved in removal and sale.
• Scrap value: the property is not useful, it can often be sold for material
recovery.
• Recovery Period: The period over which the use of a property is economically
feasible
• Service life: The period over which depreciation is charged.
Example:
P-S-C, (26)
bining Eqs. (5) and (26),
P=
CR
Perpetuities and Capitalized Costs
(1 + i)” - 1
• A perpetuity is an annuity in which the periodic payments continue
The capitalized cost is defined as the original cost of the equipment plus
indefinitely.
present value of the renewable perpetuity. Designating K as the capitalized
• Capitalized
and C, cost cost of the equipment,?
as the original
cl?
K=G+(1+i)n
Example 7 Determination of capitalized cost. A new piece of completely installed

equipment costs $12,000 and will have a scrap value of $2000 at the end of its
useful life. If the useful-life period is 10 years and the interest is compounded at
6 percent per year, what is the capitalized cost of the equipment?
Example:
Determination of capitalized cost. A new piece of completely installed
equipment costs $12,000 and will have a scrap value of $2000 at the end of
its useful life. If the useful-life period is 10 years and the interest is
compounded at 6 percent per year, what is the capitalized cost of the
equipment?
Example:
Comparison of alternative investments using capitalized costs. 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, and the useful-life period will be 3
years. Since stainless steel is highly resistant to the corrosive action of the
liquids, 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. The scrap value at the end of the useful life would be
zero for either type of reactor, and both could be replaced at a cost equal to the
original price. On the basis of equal capitalized costs for both types of reactors,
what should be the useful-life period for the stainless-steel reactor if money is
worth 6% compounded annually?
Example:
A piece of equipment has an initial installed value of $12,000. It is estimated
that its useful life period will be 10 years and its scrap value at the end of the
useful life will be $2000. The depreciation will be charged by making equal
charges each year, the first payment being made at the end of the first year.
The depreciation fund 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 value. Determine the yearly cost due
to depreciation under these conditions.

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Process Plant Design and Economics

Chemical and Biochemical Engineering

Interest, Time value of money,

Today Interest Next year

Borrower You Bank You Bank

• Interest is the cost of borrowed money, or the earnings on money loaned.

• A student obtains a simple-interest loan to pay one year of college tuition,

• Compound Interest is the interest earned on accumulated, reinvested

Borrower You Bank You Bank Interest

You Bank You Bank

• The term (1 + i)N is referred to as the discrete single-payment compound

Comparison between total amounts accumulated with simple annual interest

year Loan at start (₹) Interest (₹) Loan at end (₹)

Compare that to the Simple Interest

interest and continuously compounded interest

Continuous Interest Compounding

• The factor erN is the continuous single-payment compound amount

• The factor(F/P,r,N) is the ratio of future-worth F to present worth P, when

How Interest Rates are Determined

Time Value of Money A

• The calculation of the future worth of a Compoundin^^^^^

present amount of money, known as Qo ^ "-^Kscounting

the present worth of a future amount, is

The eqn. forThecontinuous discounting

The eqn. for discrete discounting time value of money

( = )* do with inflation. Inflation, or defl

( = )(1 + !)$& prices of goods and services, not to the amount of mo

Cash Flow Patterns

Process Plant Design and Economics

screte Cash Flows

at 12 months for both series of cash flows.

Process Plant Design and Economics

• Continuous Cash Flows

Amount of funds accumulated after one year:

the future- worth factor is æ e rN - 1 ö

the present-worth factor æ e rN - 1 ö - rN

Compounding and Discounting factors

• Discrete interest and Discrete cash flows

Figure 7-5 Figure 7-6

Series of equal Capital recovery; - &(1 + &)! Present worth; $ (1 + &)! −1

Compounding and Discounting factors

Compounding and Discounting factors

Compounding and Discounting factors

Figure 7-7 Figure 7-8

Depreciation and Income Tax

Depreciation and Income Tax

Example 7 Determination of capitalized cost. A new piece of completely installed

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