Plant Design and Economics

Instructor : Ysacor .M/Surafel .

Year : 2013 E.C

Target group : 5th year chemical Engineering students

Lecture -5
 Course outline
UNIT: INTRODUCTION TO PLANT DESIGN UNIT 4: COST BENEFIT ANALYSIS (CBA)
1.1 The need for professionalism and ethics 4.1 Cash-Flow
1.2 General Design Considerations 4.2 Measures of profitability (PBP, IRR, NPV, PI)
1.3 Nature and function of design 4.3 Interests, Taxes and insurance, Depreciation
1.4 Sources of design information and data
UNIT 2: PROCESS DESIGN DEVELOPMENT UNIT 5: SELECTION AND SPECIFICATION OF EQUIPMENT
2.1 Project conception 5.1 Auxiliaries and utilities
2.2 Preparing flow-sheets, Block diagram, process flow 5.2 Material handling equipment
diagrams and standard symbols 5.3 Mass transfer and reactors equipment
2.3 Piping & Instrumentation Diagrams 5.4 Mechanical unit operation equipment
2.4 Material and Energy Balances 5.5 Materials selection

UNIT 3: FINANCIAL & ECONOMIC ANALYSIS OF A PLANT UNIT 6: SITE SELECTION& PLANT LAYOUT
3.1 Types of Capital Investments
3.2 Cost Estimation and Its Techniques UNIT 7: SAFETY IN PROCESS PLANT DESIGN
3.3 Types of Capital Cost Estimates 7.1 Safety and loss prevention
3.4 Factors Affecting Investment and Production Cost 7.2 Environmental and safety considerations
3.5 Cost indexes 7.3 Waste Minimization

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 Cost-Benefit Analysis

The process of isolating and estimating costs and benefits

- in order to do a cost-benefit analysis, two sides of the
record(commercial accounts) must be considered

- system costs
- benefits from the system

- if a system is economically feasible, then the benefits should be

greater than the system costs within a defined period of time
acceptable to the user/client

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  The costs and benefits (financial, economic, social and
environmental) must be quantified in monetary terms to the
maximum extent possible.
 Typically, CBA is used as a tool in feasibility studies for selection
of an alternative least cost project among other projects
 Thus, CBA is used in financial analysis to estimate the profitability
of a potential investment for a plant design project

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 Cash Flows
 Is the net amount of cash and cash-equivalents being transferred into and out of a
business.
 At the most fundamental level, a company’s ability to create value for shareholders
is determined by its ability to generate positive cash flows, or more specifically,
maximize long-term free cash flow
 A Cash Flow is meant to illustrate incomes (“cash inflows”) and expenses (“cash
outflows”).
 Cash Inflows - amount of funds flowing into the firm
 Cash Outflows – amount of funds flowing out of the firm
 Net Cash Flow - equals cash inflows – cash outflows

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 Time value of money
 Is important when one is interested either in investing or borrowing the money.
 If a person invests his money today in bank savings, by next year
he will definitely accumulate more money than his investment. This
accumulation of money over a specified time period is called as time value of
money.
 Similarly if a person borrows some money today, by tomorrow he has to pay
more money than the original loan. This is also explained by time value of
money.
 The time value of money is generally expressed by interest amount. The
original investment or the borrowed amount (i.e. loan) is known as the
principal.

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 The amount of interest indicates the increase between principal
amount invested or borrowed and the final amount received or
owed
In case of an investment made in the past, the total amount of
interest accumulated till now is given by;
Amount of interest = Total amount to be received – original investment
(i.e. principal amount)

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 Profitability, Alternative Investments, and Replacement
The word profitability is used as the general term for the measure
of the amount of profit that can be obtained from a given situation.

Before capital is invested in a project or enterprise, it is necessary

to know how much profit can be obtained and whether or not it
might be more advantageous to invest the capital in another form of
enterprise.

Thus, the determination and analysis of profits obtainable from the

investment of capital and the choice of the best investment among
various alternatives are major goals of an economic analysis
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 Bases For Evaluating Project Profitability

A certain amount of Birr today is not worth the same amount of Birr in the
future.
Hence when cash flows occur at different points in time, each must be brought to
the same point in time before a comparison is made.
If the purpose is to present the total profitability of a given project, a simple
statement of total profit per year or annual rate of return may be satisfactory.
On the other hand, if the purpose is to permit comparison of several different
projects, the method of analysis should be such that all cases are on the same basis
so that direct comparison can be made among the appropriate alternatives.

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 Steps In Investment Analysis

1. Identify potentially profitable investment alternatives

2. Collect relevant data on:

Capital outlays
Costs
Returns
3. Use an appropriate method to analyze the data.

4. Decide whether to accept or reject the investment or select the top ranking
among mutually exclusive projects.
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 Profitability Criteria
• Non-Discounted methods do not account for the time value of
money, and are of little value in comparing alternatives.
• Needed for project evaluation:
– Time (discounted payback period)
– Cash (discounted cumulative cash position, net present value
[NPV], or net present worth)
– Interest rate (discounted cash flow rate of return on
investment, DCFROR)

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 Mathematical Methods for Profitability Evaluation

The most commonly used methods for profitability evaluation,

can be categorized under the following headings:
Pay Back Period (PBP)
Rate of Return(ROR) or Return on Investment(ROI)
Net present worth (NPW) or Present Value(PV)
Discounted Cash Flow Rate of Return (DCFROR)
Profitability index (PI)

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 Payback Period (PBP)
The objective of this method is to calculate the amount of time that will
be required to recover the depreciable fixed capital investment from the
accrued cash flow of a project.

Payout period is often used in conjunction with other measures of

profitability
The denominator may be the averaged annual cash flows or the
individual yearly cash flows.

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 Disadvantage of POP

This method is simple to use and has served as a historical measure of

profitability, comparing POP of proposed projects with those in the past.
There are some disadvantages to using the method:
Since no consideration is given to cash flows that occur after the
capital is recovered; therefore, this method cannot be considered as a
true measure of profitability
It neglects the time value of money and is only accurate when the
interest rate is zero
The method makes no provision for including land or working
capital.

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 Using Payback In Decision Making

Although it is uncommon for firms to make investment decisions based

solely on the payback, surveys suggest that some businesses do in fact use
payback as their primary decision mechanism.
In those situations where payback is used as the primary criterion for
accepting or rejecting projects, a maximum acceptable payback period is
typically set.
Projects that payback their initial investment sooner than this maximum are
accepted, and projects that do not are rejected.
The shorter the PBP/POP, the better.

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 Rate of Return(ROR) or Return on Investment(ROI)
 In engineering economic studies, rate of return on investment is ordinarily expressed on an
annual percentage basis.

ROI

 To determine the profit, estimates must be made of direct production costs, fixed charges
including depreciation, plant overhead costs, and general expenses.
 Profits may be expressed on a before-tax or after-tax basis, but the conditions should be
indicated
 Both working capital and fixed capital should be considered in determining the total
investment

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 Disadvantage of ROI

Although this method is simple to use and relates to accepted accounting

methods, it has some serious disadvantages:
The time value of money is ignored
A basic assumption in this method is that all projects are similar in nature
to each other.
The project will last the estimated life and this is often not true.
Equal weight is given all income for all years and that is not always true.
 The higher the value of ROR/ROI, the better.

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 Interest Rate

When money is borrowed, it has to be paid back.

In addition to the amount of the loan, an extra amount of money is paid to the
lender for the use of money during the period of a loan, just as you pay a rent on a
house or a car.

The rate of interest ‘I’ is the percentage of the money you pay for its use
over a time period. The interest rate is referred to by different names such as rent,
cost of money, and value of money.

In investment terminology, it is called the minimum acceptable rate of return or

MARR.
If you borrow A dollars at yearly interest rate i, at the end of the year, the interest is
Ai, and the total amount you have to pay back to the lender is A+Ai.

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 Present Value (PV)
PV is a way of comparing the value of money now with the value of
money in the future.
A dollar today is worth more than a dollar in the future, because inflation
erodes the buying power of the future money, while money available
today can be invested to grow.

Calculation of the PV requires the use of “interest rate”. Interest rate is

typically a percentage used to calculate the PV. It reflects the time value
of money. Generally, this interest rate is taken as equal to the prevailing
bank interest rate.

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 Birr 100 is the PV of Birr 133.1 of three years from now when the
interest rate is 10%.

Present Value: P,
Future Value: F,
Interest Rate per year: r
Future Value after 1 year: F = P*(1+r)
After 2 years: F2 = P*(1+r)*(1+r) = P*(1+r)2
After n years: Fn = P*(1+r) n
Present Value of F: Pn = Fn / (1+r)n

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 Net Present Value (NPV)
NPV may be defined as the difference between the total present value of the
cash inflows and the total present value of the cash outflows considering the
time value of money.
NPV compares the value of the Birr today versus the value of Money/ Birr in
the future.

Net present value is a more useful economic measure than simple payback
and ROI, since it allows for the time value of money and also for annual variation
in expenses and revenues.

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 Net Present Value (NPV)

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The NPV is the one most companies use since it has none of the disadvantages of other
methods and treats the time value of money and its effect on project profitability properly.
If the NPV is positive (i.e. NPV > 0),Project is accepted.
If the NPV is negative (i.e. NPV < 0), project should be rejected ,because cash flows are
negative.
If the NPV is zero then it should probably be rejected or get a pass mark as it generates
exactly the return that is expected (i.e. NPV = 0)
In general, A project with high NPV will produce a greater future worth to a company.

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 Discounted Cash Flow Rate Of Return (DCFROR)

This is yet another useful method for comparing the financial advantages of alternative
systems using the cash flow diagram.
When the NPV is calculated at various interest rates, it is possible to find an interest rate
at which the cumulative net present value at the end of the project is zero.
This particular rate is called the discounted cash flow rate of return (DCFROR).
Where
 CFn= cash flow in year n;
 t= project life in years;

 i= the discounted cash flow rate of return (percent/100).

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 If this rate is higher than the minimum rate that satisfies the investor or the project manager, then
the project is acceptable.
This minimum rate is also called the Minimum Acceptable Rate of Return (MARR).
The value of ‘i’ is found by trial-and-error calculations or by using the appropriate function in a
spreadsheet.

A more profitable project will be able to pay a higher DCFROR.

So, to determine ROR, we have to try several values for i* and see which one makes
NPW = 0.
DCFROR can also be compared directly with interest rates. Because of this, it is
sometimes known as the interest rate of return or internal rate of return (IRR).

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 Profitability Index (PI)
 The PI is the ratio of the present value of the after-tax cash
inflows to the present value of the cash outflows or capital
items.

PI = PV of cash inflows
PV of cash outflows
 If the 0 < PI < 1, the project or option should be rejected
 If the PI > 1, the project or option should be accepted
It is also called Net Present Worth Index (NPWI)

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 Alternatives
• When only one alternative is to be selected from multiple alternatives,
the alternatives are said to be mutually exclusive.
• When comparing mutually exclusive investment alternatives,
(1) establish the minimum acceptable ROR/ROI,
(2) calculate the NPV for each,
(3) eliminate any projects with negative NPVs, then
(4) chose the alternative with the greatest positive NPV.

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 Summary
There is no single best criterion for economic evaluation of projects.
Each company uses its own preferred methods and sets criteria for the minimum
performance that will allow a project to be funded.
The design engineer must be careful to ensure that the method and assumptions used are in
accordance with company policy and that projects are compared on a fair basis.
Projects should always be compared using the same economic criterion but do not have to
be compared on the exact same basis, since in a global economy there may be significant
regional advantages in feed and product pricing, capital costs, financing, or investment
incentives.

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As well as economic performance, many other factors have to be considered when
evaluating projects, such as the following:
1. Safety
2. Environmental problems (waste disposal);
3. Political considerations (government policies);
4. Location of customers and suppliers (supply chain);
5. Availability of labor and supporting services;
6. Corporate growth strategies;
7. Company experience in the particular technology.

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 DEPRECIATION

Types Of Depreciation
Physical: Wear and Tear, corrosion, accidents,
age deterioration.

Functional: All other causes.

Obsolescence: Due to technological advances.

Depletion: Loss due to materials consumed. Applicable to
Natural Resources (timber, mineral, oil deposits)

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 SERVICE LIFE: The period during which the use of a property is
economically feasible.
SALVAGE VALUE: Salvage value is the net amount of money
obtainable from the sale of used property over and above any charges
involved in removal and sale.
If a property is capable of further service, its salvage value may be
high.

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  If the property cannot be disposed of as a useful unit, it can often be dismantled and sold as
junk to be used again as a manufacturing raw material.
 The profit obtainable from this type of disposal is known as the scrap or junk value.

Methods For Determining Depreciation

In general, depreciation accounting methods may be divided

into two classes:
1. Arbitrary methods giving no consideration to interest costs
(Straight-line, declining-balance, and sum-of-the-years-digits
methods)
2. methods taking into account interest on the investment
(sinking-fund and the present-worth methods)

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 Straight-Line Method

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 Taxes

TYPES OF TAXES
Taxes may be classified into three types:
(1) property taxes
 (2) excise taxes, and
 (3) income taxes.
These taxes may be levied by the Federal government, state
governments, or local governments

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 Property Taxes
 Local governments usually have jurisdiction over property taxes,
which are commonly charged on a county basis
 Vary widely from one locality to another, but the average annual
amount of these charges is 1 to 4 percent
Excise Taxes
 Federal excise taxes include charges for import customs duties, transfer of stocks and
bonds, and a large number of other similar items Manufacturers’ and retailers’ excise
taxes are levied by Federal and state governments on the sale of many products such as
gasoline and alcoholic beverages
Taxes of this type are often referred to as indirect since they can be passed on to the
consumer

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 Income Taxes

 Are based on gross earnings, which are defined as the difference

between total income and total product cost.
 Revenue from income taxes is an important source of capital for
both Federal and state governments

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