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Dr. Jigisha Parikh, Course Coordinator

Professor, DoChE, SVNIT-Surat

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 Among several other factors the project director or decision maker must be familiar
with, the cash flow interest on the borrowed money and timely completion of the
project.
 Familiarity with interest rates, depreciation rates, and salvage values of the equipment
are equally important in understanding the economic viability of the project.

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CASH FLOW FOR INDUSTRIAL OPERATIONS

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TREE DIAGRAM SHOWING CASH FLOW

CASH FLOW FOR

INDUSTRIAL
OPERATIONS
Based on a support system serving as the
source of capital or the sink for capital
receipts

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 Sources of Equipment

 Price Fluctuations

 Company Policies

 Operating Time and Rate of Production

 Governmental Policies

 The capital needed to supply the necessary manufacturing and

plant facilities -- the fixed-capital investment,

 Necessary for the operation of the plant -- the working capital.

 The sum of the fixed-capital investment and the working capital

the total capital investment.

 The fixed-capital
 manufacturing fixed-capital investment and
 nonmanufacturing fixed-capital investment.

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FIXED-CAPITAL INVESTMENT
 Manufacturing fixed-capital investment

 The capital necessary for the installed process

equipment with all auxiliaries that are needed for
complete process operation.

 Expenses for piping, instruments, insulation,

foundations, and site preparation are typical examples
of costs included in the manufacturing fixed-capital
investment.

 Fixed capital required for construction overhead and for all

plant components that are not directly related to the process
operation – the nonmanufacturing fixed-capital
investment.

 These plant components include

 The land, processing buildings, administrative, and other offices,

 warehouses, laboratories,
 transportation, shipping, and receiving facilities,
 utility and waste-disposal facilities, shops, and other permanent
parts of the plant.

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 The construction overhead cost consists of

 field-office and supervision expenses, home-office

expenses,
 engineering expenses, miscellaneous construction costs,
contractor’s fees, and
 contingencies.

 In some cases, construction overhead is proportioned

between manufacturing and nonmanufacturing fixed-
capital investment.

 The working capital for an industrial plant consists of the total

amount of money invested in

(1) raw materials and supplies carried in stock,

(2) finished products in stock and semifinished products in the process
of being manufactured,
(3) accounts receivable,
(4) cash kept on hand for monthly payment of operating expenses, such
as salaries, wages, and raw-material purchases,
(5) accounts payable, and
(6) taxes payable.

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1. Order-of-magnitude estimate (ratio estimate)

based on similar previous cost data;
probable accuracy of estimate over + 30 percent.

2. Study estimate (factored estimate)

based on knowledge of major items of equipment;
probable accuracy of estimate up to +30 percent.

3. Preliminary estimate (budget authorization estimate; scope estimate)

based on sufficient data to permit the estimate to be budgeted;
probable accuracy of estimate within +20 percent.

4. Definitive estimate (project control estimate)

based on almost complete data but before completion of
drawings and specifications;
probable accuracy of estimate within + 10 percent.

5. Detailed estimate (contractor’s estimate)

based on complete engineering drawings, specifications,
and site surveys;
probable accuracy of estimate within +5 percent.

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COST INDEXES
 A cost index is merely an index value for a given point in time
showing the cost at that time relative to a certain base time.

 If the cost at some time in the past is known, the equivalent cost
at the present time can be determined by multiplying the
original cost by the ratio of the present index value to the index
value applicable when the original cost was obtained.

 Many different types of cost indexes are published regularly.

 Some of these can be used for estimating equipment costs;

 others apply specifically to labor, construction, materials, or other
specialized fields.

 The most common of these indexes are

 the Marshall and Swift all-industry and process-industry equipment
indexes,
 the Engineering News-Record construction index,
 the Nelson-Farrar refinery construction index, and
 the Chemical Engineering plant cost index.

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NELSON-FARRAR REFINERY CONSTRUCTION COST INDEX

 Construction costs in the petroleum industry are the basis of
the Nelson-Farrar construction index.

 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.

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CHEMICAL ENGINEERING PLANT COST INDEX

 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.

 The major component, equipment, is further subdivided and weighted as follows:

 fabricated equipment, 37; process machinery, 14;
 pipe, valves, and fittings, 20; process instruments and controls, 7;
 Pumps and compressors, 7; electrical equipment an materials, 5; and
 Structural supports, insulation, and paint, 10.

 All are based on 1957-1959 = 100.

OTHER INDEXES AND ANALYSIS

 There are numerous other indexes presented in the literature which
can be used for specialized purposes.

 For example, cost indexes for materials and labor for various types of
industries are published monthly by the U.S. Bureau of Labor
Statistics in the Monthly Labor Review.

 These indexes can be useful for special kinds of estimates involving

particular materials or unusual labor conditions.

 Another example of a cost index which is useful for world-wide

comparison of cost charges with time is published periodically in
Engineering Costs and Production Economics.

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 For use with process-equipment estimates and chemical-plant

investment estimates, the Marshall and Swift equipment cost
indexes and the Chemical Engineering plant cost indexes are
recommended.

 These two cost indexes give very similar results, while the
Engineering News-Record construction cost index, relative with
time, has increased much more rapidly than the other two
because it does not include a productivity improvement factor.

 Similarly, the Nelson-Farrar refinery construction index has

shown a very large increase with time and should be used with
caution and only for refinery construction.

From Turton et al., 1998

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From Turton et al., 2009

COST FACTORS IN CAPITAL INVESTMENT

 Purchased Equipment
 The cost of purchased equipment is the basis of several predesign
methods for estimating capital investment.

 Sources of equipment prices, methods of adjusting equipment prices for

capacity, and methods of estimating auxiliary process equipment are
therefore essential to the estimator in making reliable cost estimates.

 The various types of equipment can often be divided conveniently into

 (1) processing equipment, (2) raw-materials handling and storage equipment, and
(3) finished-products handling and storage equipment.
 The cost of auxiliary equipment and materials, such as insulation and ducts, should also be
included.

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 The most accurate method for determining process equipment

costs is to obtain firm bids from fabricators or suppliers.

 Often, fabricators can supply quick estimates which will be very

close to the bid price but will not involve too much time.

 Second best in reliability are cost values from the file of past
purchase orders.

 When used for pricing new equipment, purchase-order prices must

be corrected to the current cost index.

 Limited information on process equipment costs has also been

published in various engineering journals.

COST FACTORS IN CAPITAL INVESTMENT

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 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 4 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 EQUIPMENT COSTS BY SCALING

 It is often necessary to estimate the cost of a piece of equipment when
no cost data are available for the particular size of operational capacity
involved.

 Good results can be obtained by using the logarithmic relationship

known as the six-tenths-factor rule, if the new piece of equipment is
similar to one of another capacity for which cost data are available.

 According to this rule, if the cost of a given unit at one capacity is

known, the cost of a similar unit with X times the capacity of the first is
approximately (X)0.6 times the cost of the initial unit.

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 In general, the cost-capacity concept should not be used beyond a tenfold

range of capacity, and care must be taken to make certain the two pieces of
equipment are similar with regard to
 type of construction,
 materials of construction, temperature and pressure operating range, and
 other pertinent variables

 Purchased-equipment costs for vessels, tanks, and process- and materials

handling equipment can often be estimated on the basis of weight.

 The fact that a wide variety of types of equipment have about the same cost
per unit weight is quite useful, particularly when other cost data are not
available.

 Generally, the cost data generated by this method are sufficiently reliable to
permit order-of magnitude estimates.

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 The purchased cost of a 50-gal glass-lined, jacketed reactor

(without drive) was $8350 in 1981.

 Estimate the purchased cost of a similar 3OO-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.

 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:

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 The installation of equipment involves costs for

 labor, foundations, supports,
 platforms, construction expenses, and other factors directly related to the
erection of purchased equipment.

 Table 6 presents the general range of installation cost as a percentage of the

purchased-equipment cost for various types of equipment.
 Installation labor cost as a function of equipment size shows wide variations
when scaled from previous installation estimates.

 Table 7 shows exponents varying from 0.0 to 1.56 for a few selected pieces
of equipment.

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 When very high or very low temperatures are involved, insulation factors can
become important, and it may be necessary to estimate insulation costs with
a great deal of care.

 Expenses for equipment insulation and piping insulation are often included
under the respective headings of equipment-installation costs and piping
costs.

 The total cost for the labor and materials required for insulating equipment
and piping in ordinary chemical plants is approximately 8 to 9 percent of the
purchased-equipment cost.

 This is equivalent to approximately 2 percent of the total capital

investment.

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 Instrument costs, installation-labor costs, and expenses for

auxiliary equipment and materials constitute the major portion of
the capital investment required for instrumentation.

 This part of the capital investment is sometimes combined with

the general equipment groups.
 Total instrumentation cost depends on the amount of control
required and may amount to 6 to 30 percent of the purchased
cost for all equipment.

 Computers are commonly used with controls and have the effect
of increasing the cost associated with controls.

 For the normal solid-fluid chemical processing plant, a

value of 13 percent of the purchased equipment is normally
used to estimate the total instrumentation cost.

 This cost represents approximately 3 percent of the total capital

investment.

 Depending on the complexity of the instruments and the

service, additional charges for installation and accessories
may amount to 50 to 70 percent of the purchased cost, with
the installation charges being approximately equal to the
cost for accessories.

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 Piping
 The cost for piping covers labor, valves, fittings, pipe, supports, and
other items involved in the complete erection of all piping used
directly in the process.

 includes raw-material, intermediate-product, finished-product, steam,

water, air, sewer, and other process piping.

 Since process-plant piping can run as high as 80 percent of

purchased-equipment cost or 20 percent of fixed-capital
investment, it is understandable that accuracy of the entire
estimate can be seriously affected by the improper application
of estimation techniques to this one component.

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 Electrical Installations
 The cost for electrical installations consists primarily of installation labor and
materials for power and lighting, with building-service lighting usually
included under the heading of building-and-services costs.

 In ordinary chemical plants, electrical-installations cost amounts to 10 to

15 percent of the value of all purchased equipment. However, this may
range to as high as 40 percent of purchased-equipment cost for a specific
process plant.

 Thus, the electrical installation cost is generally estimated between 3 and

10 percent of the fixed capital investment.

 The electrical installation consists of four major components, namely,

 power wiring, lighting, transformation and service, and instrument and control wiring.

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METHODS FOR ESTIMATING CAPITAL INVESTMENT

 Various methods can be employed for estimating capital
investment.

 The choice of any one method depends upon the amount of detailed
information available and the accuracy desired.

 Seven methods are outlined in this chapter, with each method

requiring progressively less detailed information and less
preparation time.

 Consequently, the degree of accuracy decreases with each

succeeding method. A maximum accuracy within approximately ± 5
percent of the actual capital investment can be obtained with
method A.

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 METHOD A DETAILED-ITEM ESTIMATE

 METHOD B UNIT-COST ESTIMATE.

 METHOD C PERCENTAGE OF DELIVERED-EQUIPMENT COST

 METHOD D “LANG” FACTORS FOR APPROXIMATION OF CAPITAL

INVFSTMENT.

 METHOD E POWER FACTOR APPLIED TO PLANT-CAPACITY RATIO

 METHOD F INVESTMENT COST PER UNIT OF CAPACITY

 METHOD G TURNOVER RATIOS

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 The unit-cost method results in good estimating accuracies for fixed-capital

investment provided accurate records have been kept of previous cost
experience.

 This method, which is frequently used for preparing definitive and preliminary
estimates, also requires detailed estimates of purchased price obtained either
from quotations or index-corrected cost records and published data.

 Equipment installation labor is evaluated as a fraction of the delivered-

equipment cost.

 Costs for concrete, steel, pipe, electricals, instrumentation, insulation, etc., are
obtained by take-offs from the drawings and applying unit costs to the material
and labor needs.

 A unit cost is also applied to engineering employee-hours, number of drawings,

and specifications.
 A factor for construction expense, contractor’s fee, and contingency is estimated
from previously completed projects and is used to complete this type of estimate.
 A cost equation summarizing this method can be given as

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 Prepare a study estimate of the fixed-capital investment

for the process plant described in Example 1 if the
delivered-equipment cost is $100,000.

 Solution. Use the ratio factors outlined in Table 17 with

modifications for instrumentation and outdoor
operation.

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 If the process plant, described in Example 1, was erected in the

Dallas area for a fixed-capital investment of $436,000 in 1975,
determine what the estimated fixed-capital investment would have
been in 1980 for a similar process plant located near Los Angeles
with twice the process capacity but with an equal number of
process units?

 Use the power-factor method to evaluate the new fixed-capital

investment and assume the factors given in Table 20 apply.

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Results obtained using this procedure have shown high correlation with fixed-capital
investment estimates that have been obtained with more detailed techniques.

Properly used, these factoring methods can yield quick fixed-capital investment
requirements with accuracies sufficient for most economic-evaluation purposes.

METHOD F INVESTMENT COST PER UNIT OF CAPACITY

 Many data have been published giving the fixed-capital investment required
for various processes per unit of annual production capacity such as those
shown in Table 19.

 Although these values depend to some extent on the capacity of the individual
plants, it is possible to determine the unit investment costs which apply for
average conditions.

 An order-of-magnitude estimate of the fixed-capital investment for a given

process can then be obtained by multiplying the appropriate investment cost
per unit of capacity by the annual production capacity of the proposed plant.

 The necessary correction for change of costs with time can be made with the
use of cost indexes.

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METHOD G TURNOVER RATIOS

 A rapid evaluation method suitable for order-of-magnitude estimates is known
as the “turnover ratio” method.
 Turnover ratio is defined as the ratio of gross annual sales to the fixed-capital
investment, where the product of the annual production rate and the average
selling price of the commodities is the gross annual sales figures.

 The reciprocal of the turnover ratio is sometimes defined as the capital ratio or
the investment ratio.
 Turnover ratios of up to 5 are common for some business establishments and
some are as low as 0.2.
 For the chemical industry, as a very rough rule of thumb, the ratio can be
approximated as 1.

METHODS FOR ESTIMATING THE WORKING CAPITAL

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ESTIMATION OF TOTAL PRODUCT COST

 Determination of the necessary capital investment is only one part of a complete
cost estimate.

 Another equally important part is the estimation of costs for operating the plant
and selling the products.

 These costs can be grouped under the general heading of total product cost.

 The latter, in turn, is generally divided into the categories of manufacturing

costs and general expenses.
 Manufacturing costs are also known as operating or production costs.

 Further subdivision of the manufacturing costs is somewhat dependent upon the

interpretation of direct and indirect costs.

Costs involved in total product cost

for a typical chemical process plant

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 Total product costs are commonly calculated on one of three bases:

 daily basis, unit-of-product basis, or annual basis.

 The annual cost basis is probably the best choice for estimation of total cost
because

(1) the effect of seasonal variations is smoothed out,

(2) plant on-stream time or equipment operating factor is considered,
(3) it permits more-rapid calculation of operating costs at less than full capacity, and
(4) it provides a convenient way of considering infrequently occurring but large
expenses such as annual turnaround costs in a refinery.

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 This stoichiometric by-products are generally recovered and sold

otherwise waste disposal cost will be excessive.
 Some examples of stoichiometric by-products are given here:

we can also earn revenue from

some onetime events such as
• Sale of obsolete equipment
• Recovery of working capital
after the plant is shut down or
the lifecycle of the plant is
over.

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ON-STREAM FACTORS
 No plant is capable of running all of the time i.e. 365 days in
a year.

 Because there will be

 mechanical breakdown,
 requirement for maintenance,
 power disruption,
 shortage of feed materials or sales,
 cleaning or catalyst change and so on and so forth.

 These will cause periodic shutdown of the plant.

 The fraction of time that the plant is operating in a calendar

year is known as on-stream factor or stream factor (SF).

• Reliable and well managed plants will typically shut down for 1 to 2 weeks a
year to give high SF.

• Less reliable processes may require more downtime and hence relatively
lower stream factor value.

• Typically stream factor for continuous processes will be around 0.90 to 0.96.

• Stream factor is very useful for calculation of yearly cost of raw materials or
yearly cost of utilities from PFD.

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SOFTWARE FOR DETERMINATION OF

CAPITAL INVESTMENT
 A wide variety of cost estimating software is now available and
are commonly used for making preliminary estimates in industry.

 Aspen capital cost estimator is cost estimating software that is

capable of generating AACE class 4 through class 2 estimates for
capital projects in the oil and gas refining and chemicals
industries.

 Cost Link, Cost Track, Prism Project Estimator, Visual Estimator,

WinEst etcetera.

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 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?

 The break-even point 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

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Let’s start exercise

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