of Material Balances

JIMMA INSTITUTE OF TECHNOLOGY

SCHOOL OF CHEMICAL ENGINEERING

PLANT DESIGN AND ECONOMICS : ChEg 5193

BY: MOHAMMED S.

1 10/06/2023
 Chapters Outcomes
This chapter discusses the elements of economics and the

interaction between its various components.

This is followed by an analysis of the need and scope of

engineering economics.
Later, elements of cost and break-even analysis are

presented.

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 Definition of Economics
 Economics is the science that deals with the production and consumption of
goods and services and the distribution and rendering of these for human
welfare.
 Or Economics is the study of how people and society choose to employ
scarce resources that could have alternative uses in order to produce various
commodities and to distribute them for consumption, now or in the future.
• Scarcity: Situation in which the amount of something available is
insufficient to satisfy the desire for it.
 There are an unlimited variety of scarcities, however they are all based on
two basic limitations
Scarce time
Scarce spending power
 Limitations force each of us to make choices

3 10/06/2023
 cont’d…

 The problem for society is a scarcity of resources

 As a society our resources: land, labor, and capital; are insufficient to
produce all the goods and services we might desire.
 The scarcity of resources and the choices it forces us to make is the
source of all of the problems studied in economics
Households allocate limited income among goods and services
Business firms choices of what to produce and how much are
limited by costs of production
Government agencies work with limited budgets and must
carefully choose which goals to pursue
 Economists study these decisions to
Explain how our economic system works
Forecast the future of our economy
Suggest ways to make that future even better
the system

4 10/06/2023
 Cont’d…

Flow in an Economy
 The flow of goods, services, resources and money payments in a simple

economy are shown in below Fig. Households and businesses are the
two major entities in a simple economy. Business organizations use
various economic resources like land, labour and capital which are
provided by households to produce consumer goods and services which
will be used by them. Business organizations make payment of money
to the households for receiving various resources. The households in
turn make payment of money to business organizations for receiving
consumer goods and services. This cycle shows the interdependence
between the two major entities in a simple economy.
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 Cont’d…

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 Cont’d…
Law of Supply and Demand
 An interesting aspect of the economy is that the demand and supply of a
product are interdependent and they are sensitive with respect to the price
of that product. The interrelationships between them are shown in Fig.
• when there is a decrease in the
price of a product, the demand for
the product increases and its
supply decreases.
• Also, the product is more in
demand and hence the demand of
the product increases.
• At the same time, lowering of the
price of the product makes the
producers restrain from releasing
more quantities of the product in
the market. The point of intersection of the supply curve and
7
the demand curve is known as the equilibrium10/06/2023
point.
 Why Financial and Economic Analysis?
 An efficient functioning of any business organization would enable it to

provide its goods/services at a lower price.

 In the process of managing organizations, the managers at different

levels should take appropriate economic decisions which will help in

minimizing investment, maintenance and operation expenditures besides
increasing the revenue, saving and other related gains of the
organization.
 It deals with the methods that enable one to take economic decisions

towards minimizing costs and/or maximizing benefits to business

organization.

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 Engineering Economics
 Is the application of economic principles and techniques to
engineering problems or the evaluation of design and
engineering alternatives.
 It deals with the concepts and techniques of analysis useful in
evaluating the worth of systems, products, and services in
relation to their costs.
 For example in comparing the comparative costs of two alternative
capital projects or in determining the optimum engineering course
from the cost aspect.
 The role is to assess the appropriateness of a given project,
estimate its value, and justify it from an engineering standpoint.

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 Why Financial and Economic Evaluation or
Analysis of Plant Design is needed ?
 Engineering Economics is important for all fields of engineering because
no matter how technically sound an engineering project is, it will fail if it
is not economically feasible.
 Engineering Economic analysis is often applied to various possible
designs for an engineering project in order to choose the optimum
design, thereby taking into account both economic and technical
feasibility.
 A project is economically feasible when it is more profitable than
other competing projects, and financially feasible when management
can raise the capital for its implementation.
 Special Emphasis is placed on the economic and engineering principles
involved in the design of chemical plants and equipment.

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 Cont’d…
The economic evaluation of a process proceeds in several steps.

These are:
1. Preparing A Process Flow Diagram
2. Calculating Mass And Energy Flows
3. Sizing Major Equipment
4. Estimating The Capital Cost
5. Estimating The Production Cost
6. Forecasting The Product Sales Price
7. Estimating The Return On Investment.

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 Why Economics with Design?
 An understanding of engineering and economics principles is a prerequisite

for direct Plant design work as well as plant operation.

 The theoretical and practical aspects of plant engineering are important,

but, in the final analysis, the answer to the question “Will we realize a

profit from this venture?” almost always determines the fate and true value

of design.

 The engineer, therefore, should know that the fate of his plant design is

determined by the financial & economic return and viability. 10/06/2023

12
 Cont’d…
Process Economics has three basic roles in process design:
 Evaluation of Design Option: Cost data are required to evaluate
process design option. Should you use distillation or extraction
for a given separation?
 Process Optimization: the setting of some process variables can
have very strong influence on developing the process flow sheet
and on the overall process profitability. optimization of such
variables is usually required.
 Overall process profitability: the economics of the over all
project should be evaluated at different stages during design to
assess the economic viability of the project.

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 Capital Investment
 Capital: “a stock Of accumulated or saved wealth” that may be

used for investment or financing projects to further the production

of other goods and services.
 Cash flow is the stream of monetary (dollar) values— costs (inputs)

and benefits (outputs)—resulting from a project investment.

 It is the sum of money recorded as receipts or disbursements in a

project’s financial records.

 The difference between several receipts and disbursements that occur

within a given interest period is called the net cash flow.

14 10/06/2023
 Cont’d…
 The total investment required for a new design can be broadly broken
down as:
The Inside Battery Limits (ISBL) investment
Utility Investment
Off-site or OSBL investment
Engineering and Construction Cost
Contingency Charges and
Working Capital
 The Battery Limit is a geographic boundary that defines the manufacturing
area of the plant. ISBL is that part of the manufacturing system that
converts raw materials into products. It includes process equipment and
buildings or structure to house.
 OSBL includes the costs required for modification and improvement of the
site infrastructure (boiler, power generation plants, offices, Laboratories,
workshops, waste water treatment, site security, etc.)
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 Classification of Capital Investment
 Fixed Capital Investment (FCI): the capital needed to supply the
required manufacturing and plant facilities. This represents the total
cost of designing, constructing, and installing a plant and the
associated modification required to prepare plant site. It is a once
only cost that not recovered at the end of the project life, other than
the scrap value.
 Working Capital (WC): the capital necessary for maintaining the
operation of the plant.
 Total Capital Investment (TCI): FCI+WC
 The FCI is further subdivided into:
Manufacturing Fixed Capital Investment (direct cost)
Nonmanufacturing Fixed Capital Investment (indirect cost)

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 Cont’d…
 Manufacturing Fixed Capital Investment: represents the costs necessary
for the installed process equipment with all components that are required
for complete process operation.
 Examples: expenses for
Installation of all process equipment with all components
Site preparation
Foundation
Piping, instrument, insulation
Auxiliary utilities
 Nonmanufacturing fixed capital investment: represents capital needed
for:
 All plant components that are not directly related to the process operation:
Land, processing building, administrative and other offices, ware houses,
laboratories, transportation and shipping, utilities and waste disposals

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 Cont’d…
Construction overhead: Field office, supervision expense,
miscellaneous construction cost, home office expenses, engineering
expenses, contractors’ fee and contingencies.
 Working Capital: maintains the operation of the plant and represents the
total amount of money invested in:
Start-up operation
Maintaining inventories of raw material, products, and spare parts
Accounts receivable (money owed by customer)
Accounts payable (money owed to supplier)
Cash on hand for monthly payment of operating expenses (salaries,
wages, and raw material purchases)
Taxes payable
 WC is required as long as the plant is in operation, but it is recovered if
the plant is shutdown.
 WC can vary from as low as 5% to as high as 30% of FCI.
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 Cash Flow for Industrial Operation
 Think money as a
fluid.
 Visualize flow of
money into or out of
the project.
 The system can be
viewed as pipeline
network with stream
diverging through
multiple channel to
or from sources and Fig. simplified cash flow schemes for a
sinks. manufacturing Process: for profitable venture

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 Cont’d…

Fig. simplified cash flow schemes for a

manufacturing Process: venture operating
at loss

20 10/06/2023
 Cont’d…
Reservoir and Source of Capital
 Inputs: Loan, stoke issues, Bond sells, other capital, and from project

operations
 Outputs: Capital investment in project, dividends to stakeholders, repayment

of loan, and other investments

 Depreciation charge: Decrease in value of facility with change of time (wear

and tear, corrosion, etc.). This is paid in the company’s treasury.

 In any particular year:

Gross profit before depreciation charge = income from sells – operating costs
Gross profit after depreciation charge =income from sells – operating costs –
depreciation charge
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 Fig: Tree diagram showing cash flow for industrial
operations

22 10/06/2023
 Cont’d…
Cumulative Cash Position:
 The cash flow diagram shown in the above Fig. represents the
steady-state situation for cash flow with Si, Co, and d all based
on the same time increment.
 The following Figure is for the same type of cash flow for an
industrial operation except that it depicts the situation over a
given period of time as the cumulative cash position.
 The time period chosen is the estimated life period of the project,
and the time value of money is neglected.
 Land value is included as part of the total capital investment to
show clearly the complete sequence of steps in the full life cycle
for an industrial process.

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 Cont’d…
Fig. Graph of cumulative cash position showing effects of cash flow with
time for an industrial operation neglecting time value of money.

24 10/06/2023
 Cont’d…
 The zero point on the abscissa represents that time at which the plant
has been completely constructed and is ready for operation.
 The total capital investment at the zero point in time includes land
value, fixed-capital and auxiliaries investment, and working capital.
 The cash position is negative by an amount equivalent to the total
capital investment at zero time, but profits in the ideal situation come
in from the operation as soon as time is positive.
 Cash flow to the company, in the form of net profits after taxes and
depreciation charges, starts to accumulate and gradually pays off the
full capital investment.
 For the conditions shown in Fig., the full capital investment is paid
off in five years.
 Profits accumulate on the positive side of the cumulative cash
position until the end of the project life at which time the project
theoretically is shut down and the operation ceases.
25 10/06/2023
 Cont’d…
 The working capital is still available, and it is assumed that the land
can still be sold at its original value.
 Thus, the final result of the cumulative cash position is a net profit
over the total life of the project, or a cash flow into the company
capital sink (in addition to the depreciation cash flow for investment
payoff) over the ten-year period,
 Fig. has been simplified considerably by neglecting the time value of
money and using straight-line relationships of constant annual profit
and constant annual depreciation.

26 10/06/2023
 4.4 Factors affecting investment and production costs
4.4.1 Sources of Equipment:
 Manufacturer Equipment standard.
 Employing idle equipment or by purchasing second-hand equipment;
substantial reduction in cost can be made.
 Purchasing of new equipment ;
 Independent quotations (prices, specifications, policies and etc) of different
manufacturers.
4.4.2 Price Fluctuations:
o Variation of prices from one period to another.
 Wages rate of different types of industries.
 Equipment price rate of different manufactures.
o Thus, the chemical engineer must keep up-to-date information on price.
4.4.3 Company Policies:
 Policies of individual companies have a direct effect on costs.
 safety regulations
 methods for determining depreciation costs.
 Labor-union polices, because these will affect overtime labor charges and the type of
work the operators or other employees can do.
27 10/06/2023
 4.4.4. Operating Time and Rate of Production:
 The fraction of the total available time during which the process is in
operation has an important effect on the costs.
• When equipment stands idle for an extended period of time, the labor
costs are usually low; however, other costs, such as those for maintenance,
protection, and depreciation, continue even though the equipment is not in
active use..
 Operating time, rate of production, and sales demand are closely
interrelated
 The ideal plant should operate under a time schedule which gives the maximum
production rate while maintaining economic operating methods.
 Thus, the total cost per unit of production is kept near a minimum because the

fixed costs are utilized to the fullest extent.

 Method of operation is based on the assumption that the sales demand is sufficient

to absorb all the material produced.

 If the production capacity of the process is greater than the sales demand, the
operation can be carried on at reduced capacity or periodically at full capacity.
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 Cont’d…
Fig: Break-even chart for chemical processing plant

29 10/06/2023
 Cont’d…
 Figure gives a graphical analysis of the effect on costs and profits when
the rate of production varies.
 The fixed costs remain constant and the total product cost increases as the rate
of production increases.
 The point where the total product cost equals the total income is known as the
break-even point.
 By considering sales demand along with the capacity and operating
characteristics of the equipment, the engineer can recommend the
production rate and operating schedules that will give the best economic
results.
4.4.5 Governmental Policies:
 The national government has many regulations and restrictions which
have a direct effect on industrial costs.
Like:
 import and export tariff regulations,
 restrictions on permissible depreciation rates,
30  income-tax rules, and environmental regulations. 10/06/2023
 4.5.1. Estimation of Capital Investment:

 Of the many factors which contribute to poor estimates of capital

investments, the most significant one is usually traceable to sizable
omissions of equipment, services, or auxiliary facilities rather than to
gross errors in costing.
 The following table shows a complete estimation of Fixed capital
investment. (FCI = (Direct Costs) + (Indirect Costs))

31 10/06/2023
 Cont’d…

32 10/06/2023
 Cont’d…

33 10/06/2023
 Cont’d…

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 4.6. Types of Capital Cost Estimates:

a) Order-of-magnitude estimate (ratio estimate) based on similar

previous plant cost data; probable accuracy of estimate over + or -
30 percent.
b) Study estimate (factored estimate) based on knowledge of major
items of equipment; probable accuracy of estimate up to + or - 30
percent
c) Preliminary estimate (budget authorization estimate; scope
estimate) based on sufficient data to permit the estimate to be
budgeted; probable accuracy of estimate within + or - 20 percent.

35 10/06/2023
 Cont’d

d) Definitive estimate (project control estimate) based on almost

complete data but before completion of drawings and specifications;
probable accuracy of estimate within + or - 10 percent.

e) Detailed estimate (contractor’s estimate) based on complete

engineering drawings, specifications, and site surveys; probable
accuracy of estimate within +or - 5 percent

 Pre-design cost estimates (defined here as order-of-magnitude, study, and

preliminary estimates) require much less detail than firm estimates such
as the definitive or detailed estimate.

 Are extremely important for determining if a proposed project should be

36 given further consideration and to compare alternative designs. 10/06/2023

 4.7.Cost Indexes
 Are dimensionless numbers employed to updating capital cost required

to erect a chemical plant from a past date to a later time.

 can be used to give a general estimate, but no index can take into

account all factors, such as special technological advancements or local

conditions.

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 4.7.1 Marshall and Swift Equipment Cost Indexes:
 Divided into two categories;

 all-industry equipment index: is simply the arithmetic average of

individual indexes for 47 different types of industrial, commercial, and
housing equipment.
 process-industry equipment index: is a weighted average of eight of these,

with the weighting based on the total product value of the various process
industries.
cement 2% paint 5%
chemicals 48% paper 10%
clay products 2% petroleum 22%
Glass 3% rubber 8%

 The Marshall and Swift indexes are based on an index value of 100 for the
38 10/06/2023
year 1926.
 4.7.2 Engineering News-Record Construction Cost Index

 Used to estimate relative construction costs at various dates.

 shows the variation in labor rates and materials costs for industrial

construction.
 It employs a composite cost for 2500 lb of structural steel, 1088 lbm

of lumber, 2256 lb of concrete, and 200 h of common labor.

 The index is usually reported on one of three bases: an index value

of 100 in 1913, 100 in 1949, or 100 in 1967.

4.7.3 Nelson-Farrar Refinery Construction Cost Index:

 Basis for Construction costs in the petroleum industry.

39 10/06/2023
 Cont’d…
 The total index percentages are weighted as follows: skilled labor, 30;

common labor, 30; iron and steel, 20; building materials, 8; and
miscellaneous equipment, 12.
 An index value of 100 is used for the base year of 1946.

4.7.4 Chemical Engineering Plant Cost Index (CEPCI):

 Construction costs for chemical plants form the basis of the Chemical

Engineering plant cost index.

 The four major components of this index are weighted by percentage in

the following manner: equipment, machinery, and supports, 61; erection

and installation labor, 22; buildings, materials, and labor, 7; and
 engineering and supervision, 10.
40 10/06/2023
 Cont’d…

41 10/06/2023
 Cont’d…

42 10/06/2023
 Cont’d…

43 10/06/2023
 Cont’d…

Example: The purchased cost of a heat exchanger of 500 m2 area in 1990

was $25,000.

a) Estimate the cost of the same heat exchanger in 2001 using MS and
CEPCI.

b) Compare the results.

From Table 5.4: 1990 2001
Marshal and Swift Index 915 1094
Chemical Engineering Plant Cost Index 358 397
a. Marshal and Swift : Cost = ($25,000)(1094/915) = $29,891
Chemical Engineering : Cost = ($25,000)(397/358) = $27,723
b. Average Difference: ($29,891 -27,723)/($29,891 + 27,723)/2)(100)=
7.5%
44 10/06/2023
 4.8. COST FACTORS IN CAPITAL INVESTMENT

Table A. consider the proportional costs of each major component of fixed-capital investment.
Component Range, %
Direct Cost
Purchased Equipment 15-40 I F
Purchased Equipment installation 6-14 I F
Instrumentation and controls (Installed) 2-8 I F
Piping (Installed) 3-20 I F
Electrical (Installed) 2-10 I F
Buildings (Including Services) 3-18 I F
Yard Improvement 2-5 IF
Service facilities (Installed) 8-20 I F
Land 1-2 IF
Total direct costs
Indirect costs
Engineering and supervision 4-21 I F
Construction expense 4-16 I F
Contractor’s fee 2-6 I F
Contingency 5-15 I F
Total Indirect Costs
Total fixed – capital investment (TFC)
Working Capital (WC) 10-20 TCI
Total Capital Investment (TCI) = TF C + WC
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 Cont’d…

Table A shows typical percentage of fixed-capital investment values for

direct and indirect cost segments for multipurpose plants or large

additions to existing facilities.

Exercise: Estimation of fixed-capital investment using ranges of

process-plant component costs.

Make a study estimate of the fixed-capital investment for a process plant

if the purchased-equipment cost is $100,000. Use the ranges of process-
plant component cost outlined in Table A for a process plant handling
both solids and fluids with a high degree of automatic controls and
essentially outdoor operation.
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 Estimating Purchased Equipment Costs
 Vendor quote
 Most accurate
• based on specific information
• requires significant engineering
 Use previous cost on similar equipment and scale for time and size
 Reasonably accurate
 beware of large extrapolation
 beware of foreign currency
 Use cost estimating charts and scale for time
 Less accurate
 Convenient
47 10/06/2023
 Effect of Size (Capacity)

n
Ca  Aa 
 
Cb  Ab  Cost Exponent

Cost Equipment Cost

Attribute - Size

n
Ca  KAa
Cb
where K
Ab n
48 10/06/2023
 Cont’d…

49 10/06/2023
Cont’d…
Example: Estimating cost of equipment using scaling factors and cost
index.

The purchased cost of a 50-gal glass-lined, jacketed reactor (without drive) was
$8350 in 1981. Estimate the purchased cost of a similar 300-gal, glass-lined,
jacketed reactor (without drive) in 1986. Use the annual average Marshall and
Swift equipment-cost index (all industry) to update the purchase cost of the
reactor.

Solution. Marshall and Swift equipment-cost index (all industry)

(From Table 3) For 1981 721

(From Table 3) For 1986 798

From Table 5, the equipment vs. capacity exponent is given as 0.54:

In
50 1986, cost of reactor = ($8350)(798/721)(300/50) 0.54 = $ 24,300 10/06/2023
4.9. Estimation of Total Product Cost:

 Total Product cost: cost for operating the plant and selling the products.

 And can be divided in to the categories;

 manufacturing Costs – also known as operating or production

costs.
 general expenses

 The largest sources of error in total-product- cost estimation are

overlooking elements of cost.

 commonly calculated on one of three bases: namely, daily basis, unit-

of-product basis, or annual basis.

4.9.1. Manufacturing Cost:

51 10/06/2023
 It includes production costs, Fixed charges and Plant overhead Cost
 Cont’d…

A) Direct Production Cost;

• Raw materials

• Operating labor

• Operating supervision

• Utilities: Steam, Electricity, Fuel, Refrigeration, process and cooling water

• Maintenance and repairs

• Operating supplies

• Laboratory charges

• Patent and Royalties

• Catalysts and solvents

52 10/06/2023
Cont’d…
B) Fixed Charges;
 Costs that are invariant with the amount of production
 about 10 to 20 percent of the total product cost.

 Depreciation

 Taxes (property)

 Insurance

 Rent

C) Plant overhead Cost;

 Expenditures required for routine plant services.

o Medical, Safety and protection, General plant overhead, Payroll

overhead, Packaging, Restaurant, Recreation, Salvage, Control

53 10/06/2023
laboratories, Plant superintendence and Storage facilities.
 Cont’d…

4.9.2 General Expenses:

(1) Administrative expenses (Executive salaries, clerical wages,

engineering and legal costs, office maintenance,

communications)
(2) distribution and marketing expenses (sales offices, salesmen
expenses, shipping, advertising and Technical sales service)
(3) research and development expenses,
(4) financing expenses (interest on borrowed money), and
(5) gross-earnings expenses
 The total income minus the total production cost
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 Estimation of total product cost (showing individual components)

The percentages indicated in the following summary of the various costs

involved in the complete operation of manufacturing plants are
approximations applicable to ordinary chemical processing plants.

It should be realized that the values given can vary depending on many
factors, such as plant location, type of process, and company policies.

Percentages are expressed on an annual basis.

55 10/06/2023
 Cont’d…

I. Manufacturing cost = direct production costs + fixed charges + plant

overhead costs

A. Direct production costs (about 60% of total product cost)

1. Raw materials (l0-50% of total product cost)
2. Operating labor (10-20% of total product cost)
3. Direct supervisory and clerical labor (10 -25% of operating labor).
4. Utilities (10-20% of total product cost).
5. Maintenance and repairs (2-10% of fixed -capital

investment)

56 10/06/2023
Cont’d…

6. Operating supplies (10 -20% of cost for maintenance and repairs, or

0.5-1% of fixed capital investment).
7. Laboratory charges (10-20% of operating labor).
8. Patents and royalties (0-6% of total product cost)

B. Fixed charges (10-20% of total product cost)

9. Depreciation (depends on life period, salvage value, and method of
calculation-about 10% of fixed-capital investment for machinery and
equipment and 2-3% of building value for buildings).
10. Local taxes (1-4% of fixed-capital investment).

11. Insurance (0.4-1% of fixed capital investment).

12. Rent (8-12% of value of rented land and buildings)

57 10/06/2023
 Cont’d…
C . Plant-overhead costs (50-70% of cost for operating labor,

supervision, and maintenance, or 5 - 15% of total product cost).

II. General expenses = administrative costs + distribution and selling costs

+ research and development costs

A. Administrative costs (about 15% of costs for operating labor,
supervision, and maintenance, or 2-6% of total product cost).
B. Distribution and selling costs (2-20% of total product cost).
C. Research and development costs (2-5% of every sales dollar or
about 5% of total product cost).
D. Financing (interest) (0-10 % of total capital investment)

58 10/06/2023
 Cont’d…

III. Total product cost = manufacturing cost + general expenses

IV. Gross-earnings cost (gross earnings = total income - total product

cost; a general range for gross-earnings cost is 30-40% of gross earnings)

59 10/06/2023
Table. Multiplication Factors for Estimating Total Product Cost

1. Direct manufacturing Cost Typical Range of Multiplying Factor

a. Raw material CRM
b. Waste treatment CWT
c. Utilities CUT
d. Operating Labor COL
e. Direct Supervisory and Clerical Labor (0.1-0.25) COL 0.18 COL
f. Maintenance and Repair (0.02-0.1)FCI 0.06 FCI
g. Operating Supplies (0.1-0.2)(Line 1.F) 0.009 FCI
h. Laboratory charges (0.1-0.2)COL 0.15 COL
i. Patents and Royalties (0 - 0.06)COM 0.03COM
Total direct manufacturing costs CRM + CWT + CUT + 1.33COL + 0.069 FCI + 0.03COM
2. Fixed Manufacturing costs
a. Depreciation 0.1FCI
b. Local taxes and Insurance (0.014 – 0.05)FCI 0.032FCI
c. Plant Overhead Costs (0.5 – 0.7)(line 1.d + line 1.e + line 1.f) 0.709 COL + 0.036FCI

Total Fixed Charges 0.709 COL + 0.068 FCI + depreciation

General Expenses
a. Administration 0.15(line 1.d + line 1.e +line 1.f) 0.177 COL+ 0.009 FCI
b. Distribution and selling Costs (0.02 - 0.2)COM 0.11COM
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c. Research and Development 0.05 COM 10/06/2023
Total General Expenses 0.177 COL + 0.16 COM + 0.009 FCI
 Cont’d…

Example: Break-even point, gross earnings, and net profit for a process
plant.

The annual direct production costs for a plant operating at 70 percent capacity
are $280,000 while the sum of the annual fixed charges, overhead costs, and
general expenses is $200,000. What is the break-even point in units of
production per year if total annual sales are $560,000 and the product sells at
$40 per unit? What were the annual gross earnings and net profit for this plant
at 100 percent capacity in 1988 when corporate income taxes required a 15
percent tax on the first $50,000 of annual gross earnings, 25 percent on annual
gross earnings of $50,000 to $75,000, 34 percent on annual gross earnings
above $75,000, and 5 percent on gross earnings from $100,000 to $335,000?

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 Cont’d…

Solution. The break-even point (Fig. 6-3) occurs when the total annual
product cost equals the total annual sales. The total annual product cost
is the sum of the fixed costs (including fixed charges, overhead, and
general expenses) and the direct production costs for n units per year.
The total annual sales is the product of the number of units and the
selling price per unit. Thus

= $20/unit

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 Cont’d…

And the number of units needed for a break-even point is given by

This is [(10,000)/(14,000/0.7)]*100 = 50% of the plant capacity.

Gross annual earnings = total annual sales - total annual product cost

= (14,000/0.7) units*$40/unit – [200,000 + (14,000/0.7)* ($20/unit)

= $800,000 – $600,000

= $200,000

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 Cont’d…

Net annual earnings = gross annual earnings - income taxes

= 200,000 - [(0.15)(50,000) + (0.25)(25,000) + (0.34)(200,000 - 75,000)

+ (0.05)(200,000 – l00,000)]

= 200,000 - 61,250

= $138,750

Any Questions or/and Comments or/and Suggestions??

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 Exercise
1. The total capital investment for a conventional chemical plant is $1,500,000,
and the plant produces 3 million kg of product annually. The selling price of the
product is $0.82/kg. Working capital amounts to 15 percent of the total capital
investment. The investment is from company funds, and no interest is charged.
Raw materials costs for the product are $0.09/kg, labor $ 0.08/kg, utilities $
0.05/kg, and packaging $0.008/kg. Distribution costs are 5 percent of the total
product cost. Estimate the following:
(a) Manufacturing cost per kilogram of product.
(b) Total product cost per year.
(c) Profit per kilogram of product before taxes.
(d) Profit per kilogram of product after taxes (use current rate).
2. A process plant making 2000 tons per year of a product selling for $0.80
per lb has annual direct production costs of $2 million at 100 percent
capacity and other fixed costs of $700,000. What is the fixed cost per pound at
the break-even point? If the selling price of the product is increased by 10
percent, what is the dollar increase in net profit at full capacity if the income
tax rate is 34 percent of gross earnings?
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 Exercise Cont’d…
1. A company has direct production costs equal to 50 percent of total
annual sales and fixed charges, overhead, and general expenses equal
to $200,000. If management proposes to increase present annual sales
of $800,000 by 30 percent with a 20 percent increase in fixed
charges, overhead, and general expenses, what annual sales dollar is
required to provide the same gross earnings as the present plant
operation?
What would be the net profit if the expanded plant were operated at
full capacity with an income tax on gross earnings fixed at 35
percent? what would be the net profit for the enlarged plant if total
annual sales remained the same as at present? What would be the net
profit for the enlarged plant if the total annual sales actually
decreased to $700,000?

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