Chapter 6

Economic Evaluation of Process Project Opportunities

In determining whether a proposed solution to an opportunity is worthwhile, evaluating
the economic impact of the project is always important. This is not just a matter of simply
selecting projects with the lowest upfront (capital) costs. Sometimes a design that has a higher
initial cost will have substantially lower operating costs or will generate more product revenue.
So instead of just looking at capital costs, a good economic analysis considers all of the revenue
and cost factors associated with the project and does so in a manner that accommodates how the
value of money changes with time.
In order to do a good economic analysis, we need to generate our best estimate of each of
the economic factors that are affected by the project. These are summarized in section 6.1.
Section 6.2 is an introduction to the economic measures that are most commonly used to evaluate
the economic impact of a project. In section 6.3 we will look at how to organize capital costs,
operating costs, revenues, taxes, and other economic factors in order to apply these economic
measures. Since there is always uncertainty associated with future economic impact, section 6.4
describes methods we can use to analyze economic hazards and to estimate the economics for
benefits that are difficult or impossible to quantify. Since other factors are also important when
determining the “best” solution to an opportunity, section 6.5 includes a discussion of the other
factors that should be considered in determining the best solution.
6.1 Elements of a project economic analysis
In order to evaluate the economic impact of a potential project, we need estimates, at a
common basis date1, and preferably at comparable levels of accuracy, in four areas:
1. Revenues,
2. Capital costs,
3. Operating expenses, and
4. Taxes.
6.1.1 Revenues
Revenues come from the sale of products and by-products. For a grassroots project the
revenue of a given product/by-product is calculated by multiplying the annual design operating
production rate of that product by the trend line wholesale price2 of the product at the basis date
and by the operating factor, yielding a value in Basis Year Currency Units per Year (e.g.
$2018/yr). Recall that the operating factor is the estimated average fraction of time that the
project will be in operation and generating that product, as described in Chapter 2. Some
companies incorporate the operating factor into their design conditions by using the annual
calendar day production rate instead of the design operating production rate. The calendar day
production rate is simply the design operating production rate multiplied by the operating factor.
Summing up the annual revenues from all products and by-products provides the total annual
revenues.
For retrofit projects, only the incremental increase (or decrease as sometimes happens in
safety or environmental projects) in each product/by-product is included. For example, assume

1
Please see section 5.2 for how to define your project’s basis date
2
Please see section 4.1 for how to determine a trend line (trend) price

1
that the existing facility has a design operating rate of 1000 kg/hr of product A and that the
project you are evaluating will result in a design operating rate of 1100 kg/hr of product A. Then
the revenues from product A sales associated with the project would be:
Product A Annual Revenue= (1100-1000) kg/hr*($trend price in 2018)*Op factor. (6.1)
For retrofit projects, the actual operating factor for the facility should be used, if known, instead
of the ideal operating factor used in the facility’s initial design. This information should be
available from existing plant operating data.
Many times a retrofit project is considered that does not increase the production capacity
of any of the products or by-products from the facility. However, such a project may still have a
positive economic impact if it reduces operating costs. There are two common and equally valid
methods to address this circumstance. The first is to simply calculate the incremental decrease in
operating costs and show this as a “credit” under the operating costs category. The second is to
classify incremental operating cost decreases as a revenue. Either method will result in the same
value for the two most important economic measures described in the following sections. For
purposes of consistency, we will always show these as an operating cost credit in this book.
For some retrofit projects, it may be more appropriate to use the actual operating rate
rather than the design operating rate. If the existing process has three or more years of operating
history, you should be able to obtain the average actual operating rate for the facility. This is
important because some projects may appear to be economically worthwhile when calculated
using the design operating rate, but will not actually provide this economic benefit based on the
actual operating history of the process. For example, let us consider a project that will remove a
constraint in the process and increase the design operating production capacity of the facility by
10%. If the existing process has a design operating product A production rate of 1000 kg/hr then
the modified facility would have a design operating product A production rate of 1100 kg/hr. If
we estimate the revenues on a design operating basis, the incremental revenue would be
calculated based on 100 kg/hr * trend price * theoretical operating factor. However, if the
average actual operating production rate is 600 kg/hr, then the incremental revenue would be
zero since the extra capacity of the process is not required. As such, this project would probably
be judged to not be worth doing until such time as the company has found additional market
share for that product that results in the average actual operating rate that is close to the design
operating rate.
6.1.1.1 Fuzzy benefits
Sometimes, especially for retrofit projects, there are benefits from the project that are
difficult or impossible to quantify. The fuzzy benefits method is a technique that can be used to
provide a conservative value for these benefits. Here is the procedure:
1. Qualitatively identify all of the possible benefits that might occur if the project is
implemented
2. Force rank each benefit in order of probable magnitude of the benefit. Keep the top
3-4 benefits and ignore the rest.
3. Determine how each benefit is achieved.
4. Determine how you would quantify that benefit if you had all of the data you needed
to make the calculation.

2
 5. Identify what data is missing that is preventing you from quantifying the benefit.
6. For each missing data element, make a reasonable estimate of the value. Use these
estimated to calculate the most probable benefit.
7. Discount the quantitative value of the benefit substantially.
8. Do this for the top 3-4 benefits and then use the sum of these values as revenue or
reduced operating costs for the project.

[Dr. Kolodka will provide you with an example in class]

The fuzzy benefits technique is especially useful for minor retrofit projects. It is very
common to have a project idea that will improve the efficiency, productivity, or reliability of
your process where the benefits cannot be quantified. Many of these projects have the potential
to be very profitable. Discounting the quantitative value of the benefit substantially (step 7)
allows you to acknowledge that the value has a high degree of uncertainty but that the conclusion
(is it worthwhile?) is certain.

6.1.2 Capital costs

The second cost element is a basis date estimate of the capital costs necessary to execute
the project. Please refer to chapter 3 on how to generate this estimate. Large retrofit and
grassroots projects will likely take longer than one year to complete. Therefore, an estimate of
the project schedule should be made (see chapter 7). The fixed capital investment should be
spread across the project schedule. The remaining portion of the capital costs, such as the initial
charge of chemicals and catalysts, should be included in the final year of project execution.
[Dr. Kolodka will provide an example problem in class]
6.1.3 Operating costs
The basis date operating costs must also be estimated. Please refer to chapter 4 on how to
generate these estimates. For most projects, operating costs are estimated on an annual basis,
although for very small retrofit projects a quarterly estimate may be more useful. A theoretical
operational (or production) life (not to be confused with the project execution schedule) should
be estimated. For grassroots projects, the most common convention is to assume that the new
facility has a 20-year operational lifetime. It is recognized that most process plants stay in
operation much longer than 20 years. However, when the time value of money is included in the
analysis, there is very little contribution from economic factors for years beyond year 20 to the
overall economic impact.
The Project Life versus the Operational Life
For retrofit projects, estimating the
operational life is not as straightforward and the The Project life is based on the project
method used varies between companies. If the execution schedule and is the time required
existing facility is less than 20 years old, many to complete the following project life cycle
companies will calculate the retrofit operational phases (a typical life cycle is shown in Table
life to be the remaining theoretical life of the 1.1): detailed specification, procurement,
existing facility based on a total theoretical life implement, and commissioning.
of 20 years (or an alternate value that the
The Operational life is the estimated length
3 of time after commissioning that the facilities
and systems installed by the project will be in
operation prior to decommissioning.
company uses instead of 20). Some companies always use the allowable depreciation period as
the operational life for a retrofit project. For example, if the project is primarily to install a new
or replacement pump and the allowable depreciation period is seven years, the theoretical
operational life is set as seven years regardless of the estimated remaining life of the existing
facility. When no other information is available, a reasonable assumption is that the operational
life for a retrofit project is 10 years (half of the theoretical life of a grassroots facility).
Some of the operating costs may vary from year to year. For example, if the project is
adding a new catalytic reactor or a fixed bed adsorber, the catalyst or sorbent will probably have
to be replaced periodically (typically 3-10 years depending upon the material and the
application). For the cash flow sheet method described in section 6.3, operating costs should be
tabulated for each year of the operational life so that these extra costs can be included at the
appropriate time. Some of the other methods, like the balance sheet method, require that the
average annual operating cost be calculated and used in the economic calculations.
6.1.4 Taxes
The final element of the economic estimate concerns the treatment of taxes and financial
depreciation. Depreciation and its impact on income taxes is covered in section 5.3. At the
scoping study level of accuracy, a full rigorous accounting calculation to determine the tax
burden of a potential project is not usually justified. Therefore, simplified methods are usually
applied that are adequate to estimate the impacts of taxes on project profitability.
How taxes are applied varies for different countries and often for other governmental
organizational entities empowered to levy taxes on industrial installations. Current (since 2018)
U.S. Federal tax law applies a 21% tax rate based on the taxable profit of the company operating
the facility. In the United States a state tax must also be included in this calculation. The way
this is calculated and the rate of the tax varies from state to state. Under the previous US tax law,
Federal taxes were exempt from state taxes and state taxes from Federal tax. However under the
current Federal tax law, state and local municipality taxes are no longer deducted from the gross
profit in determining the taxable profit. The most common method used by U.S. states is
illustrated by the following example the exact method may vary from state to state): from your
project you calculate a gross profit of $15,000 in year 1. After deduction of the allowable value
of depreciation of $3000, the Federal taxable profit, TPF, is $12,000. The Federal tax will then
be:
FT=$12,000*0.21 = $2520.
In most states, the taxable profit for state tax calculations, TPS, is the Federal taxable profit TPF
minus the Federal tax, FT:
TPS=$12,000-$2,520 = $9,480.
If the state tax rate is 7.5% of the state taxable profit, then the state tax is:
ST = $9,480*0.075= $710.
The overall year 1 tax:
Tax1 = FT,1 + ST,1 = $2520 + $710 = $3230.
The net profit, NP, is the gross profit – any non-taxable charges – Tax. In this example:
NP = $15,000 - $0 - $3200 = $11,800  $12,000.

4
(note: I kept one extra digit beyond the level of uncertainty in the numbers during my
calculations to minimize roundoff errors, but report the final value with the correct number of
significant digits (one certain and one uncertain).
For some retrofit projects, the taxable profit may be a negative value for one or more
years of the project. For example if the project is needed to meet a new environmental
regulation, we conduct an economic analysis of project alternatives in order to determine the
least costly way to meet the regulation. Another example is a project where the gross profit for a
given year (usually year 1) is less than the depreciation value allowable for that year, yielding an
annual taxable profit that is less than zero.
A hypothetical “negative tax” or “tax credit” should be calculated in the same way that
the tax on profits is calculated, as described above. For cases where the annual taxable profit is
less than zero, it is assumed that the rest of the facility is making a profit and that the tax credit
can be applied to the annual taxes of the entire facility to reduce the overall tax burden.
Therefore the profitability calculation should include a value for taxes even when the net profit
for a given year is less than zero.
For example if the gross profit in the previous example is changed from +$15,000 to -
$5,000, the following calculations would be made to determine the net profit in year 1. After
deduction of the allowable value of depreciation of $3,000, the Federal taxable profit is -$8,000.
The Federal tax will then be:
FT= -$8,000*0.21 = -$1,680.
In most states, the taxable profit for state tax calculations, TPS, is the overall taxable profit minus
the Federal tax:
TPS= -$5,000-$1,680 = -$6,680.
If the state tax rate is 7.5% of the state taxable profit, then the state tax is:
ST = -$6,680*0.075= -$500.
The overall year 1 tax:
Tax = FT,1 + ST,1 = (-$1,680) + (-$500) = -$2,180.
The net profit is the gross profit – any non-taxable charges – Tax. In this example:
NP = -$5,000 - $0 – (-$2,180) = -$2,820  -$2,800.

6.2 Measures of economic worthiness

There are many different ways to measure the economic worthiness of a project. Each
measure gives a view of the economic impact from a slightly different perspective but all should
provide sufficient information to answer the question, “is this project worthwhile?” In this
chapter we will describe the measures most commonly used to evaluate projects in the process
industries with a brief summary of other commonly used measures.
6.2.1 The Net present value
The net present value (NPV@HR), also often known as the net present worth, represents
the profitability of an investment compared to a hurdle rate (the hurdle rate was defined in

5
section 5.2), reported in currency units at an “evaluation date”. Net present value is a measure of
the productivity of an investment and is the most common economic measure used for grassroots
or major expansion projects. Because the investment is always compared to a hurdle rate, an
NPV value is undefined unless the hurdle used is specified. As such, the correct abbreviation for
this measure is NPV@HR, where HR is replaced by the actual hurdle rate denoted as the
discounting factor percentage (e.g. NPV@20%).
To calculate the NPV@HR, the net profit (cost) for each relevant year (or other time
period) of the project execution schedule and the operational schedule is forecast forward or
discounted backward in time to the evaluation date using the hurdle rate as the discount factor in
the equation:

PVn=NPn/(1+HR)n (6.2)

where: PVn is the value of the net profit in period n discounted by the HR to the
evaluation date; NPn is the undiscounted value of the annual net profit (cost) in
period n, and n represents the number of accounting periods (usually years) since
the evaluation date; HR is the hurdle rate.
The most common evaluation date is the day before the project’s facilities and systems
are completely commissioned. In other words, the first day of full operation after project
completion is typically counted as “year 1, day 1” and the evaluation date is “year 0, day 365.”
When the net profit is calculated annually, the evaluation is dated to year 0 which is the year just
prior to full operation. If the net profit is calculated quarterly (small retrofits), the evaluation is
dated to quarter 0.
For example, to calculate the PV for each year if the project execution schedule is 2
years, the costs in the first year are $1,000,000, the costs in the second year are $1,200,000, the
operational life is 5 years with the following annual profits: years 1-3 = $500,000 per year; year
4=$450,000; year 5 = $550,000, and a hurdle rate is 10%:

n = -1 PV-1 = -$1,000,000/(1+0.10)-1 = -$1,100,000

n=0 PV0 = -$1,200,000/(1+0.10)0 = -$1,200,000
n=1 PV1 = $500,000/(1+0.1)1 = $455,000
n=2 PV2 = $500,000/(1+0.1)2 = $413,000
n=3 PV3 = $500,000/(1+0.1)3 = $376,000
n=4 PV4 = $450,000/(1+0.1)4 = $307,000
n=5 PV5 = $550,000/(1+0.1)5 = $342,000

Note that the value of n is usually negative for years prior to the evaluation date, which are the
years when costs are incurred for project execution. Note also that the evaluation date does not
usually correspond to the basis date of the analysis. The basis date, represents the time at which

6
the currency of all cash flows is valued while the evaluation date represents the time to which all
cash flows are discounted and is usually the projected date at which the project is put into
service.
This sounds a bit confusing. Why not just use the basis date as the evaluation date? You
can, but then all of your cash flows, both those that occur before the project is finished (which
are typically costs), that is those associated with the project execution schedule, and those that
occur after the project is finished (which are typically net profits or revenues), that is those that
occur during the operational life, will all be discounted to an earlier date. For most people, it is
more intuitive to view the project costs as an investment (hence the term capital investment) that
must be recovered before profits are realized. Using an evaluation date that is set at the date the
project is finished reflects this view.
The net present value is the sum of all of the PV’s from both the project’s execution
schedule years (e.g. PV-1 and PV0) and the project’s operational life years (e.g. PV1 through PV5).
For our example:
NPV@10% = -1,100,000+-1,200,000+455,000+413,000+376,000+342,000 = -$710,000
If the NPV@HR is greater than zero, the project is considered to be economically
worthwhile and if the NPV@HR is less than zero, the project is considered to be not worthwhile.
For our example project, the NPV@10% is less than zero, so the project is not worthwhile from
an economic viewpoint. Notice that if we just summed the undiscounted cash flows, the value
would be +$2,500,000. This illustrates the importance of taking into account the time value of
money, the risk tolerance, and the minimum required profitability when analyzing the project.
The NPV@HR measure incorporates all of these factors into the analysis, yet provides a very
simple means to assess the economic worth of the project.

6.2.2 The Discounted cash flow rate of return

The economic measure that most people are very familiar with is the rate of return. The
simple, undiscounted version of this economic measure is commonly used in consumer
investment situations. In general, the rate of return is the average (over time) rate at which an
initial investment is recovered using revenues generated by that investment. For example, if you
invest $10,000 in a bank account that has an interest rate of 5% compounded annually, the
annual rate of return is 5% and you will fully recover the investment in 20 years. If the interest
rate were compounded continuously, then applying equation 5.4.12 would yield an annual rate of
return of 5.17%. Note, that the time period of the averaging method must be specified with any
rate of return calculation just as the HR must be specified for an NPV calculation. When the
time period of the averaging method is not specified, the average is assumed to be per year.
The simple rate of return does not take into account the time value of money, risk factor,
and minimum level of profitability that are incorporated into the hurdle rate. To do this, we can
calculate a discounted cash flow rate of return or DCFROR. The DCFROR is the theoretical
hurdle rate that will yield an NPV@DCFROR=0. If the DCFROR is greater than the HR, the
investment is worthwhile and if the DCFROR is less than the HR, the investment is not
worthwhile. While the NPV@HR measures the productivity of an investment, using the
DCFROR measures the efficiency of the investment. As such, DCFROR is commonly used for
retrofit projects. Calculation of the DCFROR is an iterative process. An initial value for the

7
DCFROR is assumed and each of the annual (or other time period) cash flows are discounted
using the DCFROR instead of the HR in equation 6.1. If the NPV calculated is larger than zero,
the next iteration should use a higher value for the DCFROR while if the NPV is less than zero,
the next iteration should use a lower value for the DCFROR.
Returning to the example we used in section 6.2.1. The undiscounted cash flows for the
project execution period were: year -1=-$1,100,000 and year 0 -$1,200,000. The undiscounted
cash flows for the 5 year operational life were: years 1-3=$500,000, year 4=$450,000, year
5=$550,000. We know from the calculation performed in section 6.2.1 that the NVP@10% is
less than zero. Therefore, we know that the DCFROR is less than 10%. For a second guess of
the DCFROR, let’s assume the value is 2%. Then the discounted cash flows would be:
Year Value
-1 -$1,120,000
0 -$1,200,000
1 $ 490,000
2 $ 481,000
3 $ 471,000
4 $ 416,000
5 $ 498,000
NPV@2% = $34,000
Since this value is greater than $0, the DCFROR (HR) of 2% is too low. If we iterate on the
value of the HR, we will find that the HR=2.43% at the point where the NPV@DCFROR=0.
Therefore, the DCFROR for this project is 2.43%.
As can be seen from the paragraphs above, NPV@HR and DCFROR are related. To use
DCFROR to determine if a project is worthwhile, the value of the DCFROR is compared to the
HR. If DCFROR>HR, the project is economically worthwhile and if DCFROR<HR, the project
is not economically worthwhile.
The DCFROR only has meaning when it is a positive value. That is, the NPV@0%>0. A
negative DCFROR can be generated by calculating the discounted rate of loss (DCFROL). This
is done by changing the sign on the annual (or other time period) cash flows. In the example we
used earlier, if the year -1 investment was a -$2,000,000 cash flow instead of -$1,000,000 the
NPV@0%<0. The DCFROL would be calculated by multiplying each annual cash flow by (-1)
and then determining the HR at which the NPV@DCFROL=0. This would yield a DCFROL of
6.9%:
Year Cash Flow PV@HR HR = DCFROL = 6.9%
-1 2000 1871
0 1200 1200
1 -500 -534
2 -500 -571
3 -500 -611
4 -450 -587

8
5 -550 -767

NPV@HR = 0

Thus the DCFROR for this project is -6.9%.

If all of the cash flow values have the same sign (are either all positive or all negative),
the DCFROR cannot be calculated and is undefined. This is most commonly encountered when
we have a project that must be completed for safety or environmental reasons, where there may
be no incremental revenues, only costs. In this case, all of the annual cash flow values are
negative and the DCFROR is undefined. For these projects a different economic measure must
be used.

6.2.3 Discounted payback period measures

Another common measure used to evaluate project worthiness is the discounted payback
period, discounted breakeven period, or as it is more commonly known, the discounted payback
(DPB). The DPB is the time at which the cumulative sum of the present values after the
evaluation time (i.e. the discounted net profits obtained after the project is fully placed into
service) is equal to the total capital investment, where the time is measured from the evaluation
time of full project commissioning, as described previously. The shorter the DPB, the more
profitable the project. Most companies consider a project worthwhile if the DPB is less than four
years for major retrofit and grassroots projects and less than two years for simple retrofit
projects. This method is widely used but has one significant limitation: only the project’s
operational year cash flows are discounted not the cash flows during the project execution time.
A more accurate measure is the fully discounted payback (FDPB). The FDPB is the time
at which the cumulative sum of the present values after the evaluation time is equal to the
cumulative sum of the present values prior to the evaluation time (i.e. those cash flows that occur
during the project execution schedule), where the time is measured from the evaluation time of
full project commissioning, as described previously. In other words, the FDPB is the time at
which the cumulative sum of all prior present values sums to zero. As with the DPB, the shorter
the time, the more profitable the project.
[Dr. Kolodka will provide you with examples in class]
6.2.4 Other economic measures
6.2.4.1 Undiscounted economic measures
For simple projects where the entire project life cycle can be completed in 18 months or
less, many companies use methods to evaluate the worthiness that do not involve discounting to
an evaluation date. The most common of these is the payback time or payback period. The
payback time is the time at which the cumulative net profit is equal to the total capital
investment, where the time is measured from the evaluation time of full project commissioning,
as described previously. The shorter the payback time, the more profitable the project. Most
companies consider a project worthwhile if the payback time is less than two years.

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 The undiscounted version of the net present value is known as the cumulative cash value
or more commonly the cumulative cash position (CCP). This is calculated by summing all of the
individual net profits from the cash flow sheet. CCP is a measure of the undiscounted
productivity of the investment.
Another variation of the cumulative cash position is the cumulative cash ratio (CCR).
This is calculated as shown in equation 6.3:
n

∑ NPi
1
CCR= 0 (6.3)
∑ NP j
m

where: NPi = net profit in year i; NPj = net profit in year j; n = final operational year of
the project; m = first year of the project schedule.
The CCR is the ratio of the profits generated by the project to the total capital investment
required to generate those profits. It is a measure of the undiscounted efficiency of the
investment. The project is worthwhile if the CCR is greater than one.
The undiscounted version of the DCFROR is known as the return on investment (ROI)
and is calculated by equation 6.4:
n n

∑ NPi ∑ NPi
1 1
n n (6.4)
ROI= = o
TCI
∑ NP j
m

where: NPi = net profit in year i; TCI = total capital investment; NPj = net profit in year j;
n = final operational year of the project; m = first year of the project schedule.
ROI measures the undiscounted efficiency of the investment and allows a simple and easy way
to compare small projects for economic worthiness.
Note that some authors use the FCI instead of the TCI in the undiscounted calculations.
For the simple retrofit projects where such calculations are valid, the two values are going to be
very similar if not the same. The one exception and the reason we have specified TCI in this text
is there may be cases where the initial charge of chemicals and catalysts is a significant portion
of the costs incurred in an otherwise simple project. For these projects, using the TCI is a more
accurate measure of project worthiness.
6.2.4.2 Other discounted economic measures
When comparing projects that are capital intensive and have different project execution
schedules and/or operational lifetimes, the NPV@HR can be cumbersome to use to evaluate
relative economic worthiness (see section 6.3.1.1 below). A useful measure for these cases is the
present value ratio (PVR) which is calculated via equation 6.5:

10
 n

∑ PV i
1
PVR= 0 (6.5)
∑ PV j
m

where: PVi = present value in year i; PVj = present value in year j; n = final operational
year of the project; m = first year of the project schedule.
A PVR of 1 represents breakeven and is the equivalent of an NPV@HR = 0. The larger the
value, the more profitable the investment. This allows for a simple comparison of projects
regardless of project execution schedule or operational lifetime.

6.3 Analysis of economic worthiness

In section 6.1 we discussed the various elements that must be assembled to conduct an
economic analysis while in section 6.2 we defined economic measures that can be used to help
assess the economic worthiness of a project. In this section we present methods that are
commonly used to organize and display the economics of a project.
6.3.1 The Cash flow sheet method
The most straightforward way to organize and display the economics of a project is to use
a cash flow sheet. Spreadsheet programs such as Excel™ were designed for these types of
calculations. Table 6.1 provides a template for organizing project economics using the cash flow
sheet method. There are two common conventions when using the spreadsheet. The first
convention is to adjust the value of all entries to the same basis date. This insures that each entry
has the same value basis. The impacts of inflation are assumed to be the same for every revenue
and cost category on the cash flow sheet, that the rate of inflation is relatively constant over the
project life. These assumptions about inflation are valid within the accuracy of the method when
the rate of inflation is relatively low, say less than 5%. The HR used for NPV calculations
should include the assumed rate of inflation.
The second convention is to include inflation for each cost element. When this
convention is used, the appropriate estimated rate of inflation of each revenue and cost item that
goes into the entries on the cash flow sheet should be used to adjust the entries. For example, if
the annual rate of inflation for labor costs is assumed to be 8%/yr, the labor cost estimate would
be inflated by 8% each year over the project life. It is better to use this convention during period
of moderate to high inflation (overall inflation rates higher than 5%) because the different
elements that go on the cash flow sheet may have very different rates of inflation. When using
this convention, the HR should exclude the projected overall average rate of inflation.
[Dr. Kolodka will provide you with an example of how to use the template]

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 Table 6.1 Cash Flow Worksheet
Present
Present Value @
Time Since Value @ DCFROR
Evaluation Overall State Non- HR & &
Date (Yr or Operating Depreciatio Taxable Federal Taxable Taxable Evaluation Evaluation
Mo) Revenue Costs Gross Profit n Profit Taxes Profit State Tax Charges Net Profit Date Date
-3
-2
-1
0
1
2
3
4
5
6
7
8
9
10
11
12
13
14
15
16
17
18
19
20
Basis Date Evaluation Date Hurdle Rate NPV@HR =
DCFROR =

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6.3.1.1 Comparing alternative investments with the cash flow sheet method
The cash flow sheet can be used to compare different investment options, such as
different projects or process alternatives, to determine which is more economically worthwhile.
If the two alternatives have the same project execution schedule and operational life, the method
is straightforward:
1. Calculate the cash flow for each year for each alternative
2. Take the difference between the two alternatives being compared to obtain an
incremental net cash flow
3. Determine the NPV@HR of the incremental cash flow. If the NPV@HR>0, the first
alternative is preferred while if the NPV@HR<0, the second alternative is preferred.
[Dr. Kolodka will provide an example in class.]

When comparing alternatives that have different project execution schedules and/or
project lifetimes, it can be difficult to properly account for the time value of money. If the
project execution schedules are the only difference, simply follow the procedure outlines above.
If one alternative takes an extra year to complete, add this year as an additional negative year, so
that the entire cash flow sheet is still based on positive years starting when the project is placed
in service. For larger projects, you may want to reflect in the analysis the extra time before the
project generates revenue. One way to accomplish this is to use the evaluation date from the
shorter project as the evaluation date for the longer project. For example, if project 1 will take
two years to complete and project 2 will take three years to complete, you can discount both
project cash flows to the completion date for project 1 as follows:

Project 1 Project 2
Project Discounted cash Discounted Cash
Cash Flow Cash Flow Incremental
Year flow@15% Flow@15%
Cash Flow
-1 ($1,000,000) $ (1,200,000) ($600,000) $ (690,000.00) $ (510,000)
0 ($1,200,000) $ (1,200,000) ($600,000) $ (600,000.00) $ (600,000)
1 $400,000 $ 350,000 ($1,000,000) $ (870,000.00) $ 1,220,000
2 $400,000 $ 300,000 $400,000 $ 300,000.00 $ -
3 $400,000 $ 260,000 $400,000 $ 260,000.00 $ -
4 $400,000 $ 230,000 $400,000 $ 230,000.00 $ -
5 $400,000 $ 200,000 $400,000 $ 200,000.00 $ -
6 $400,000 $ 170,000 $400,000 $ 170,000.00 $ -
7 $400,000 $ 150,000 $400,000 $ 150,000.00 $ -
8 $400,000 $ 130,000 $400,000 $ 130,000.00 $ -
9 $400,000 $ 110,000 $400,000 $ 110,000.00 $ -
10 $400,000 $ 99,000 $400,000 $ 99,000.00 $ -
11 $0 $ - $400,000 86,000 $ (86,000)
Totals $1,800,000 ($401,000) $1,800,000 ($425,000) $ 24,000

Since the incremental NPV@15% is positive, project 1 is preferred economically compared to

project 2. Note that even though the total capital investment and net profits are the same for both

13
projects, the increase of one year in the project execution schedule makes a difference in the
relative profitabilities of the two projects.

When the operational lifetimes are different, the procedure is a bit more complicated.
1. Determine the least common denominator for multiples of the two operational lifetimes.
For example, if one project has an operational lifetime of six years and the other has an
operational lifetime of eight years, the least common denominator is 24 (6x4 or 8x3).
2. Replicate the yearly cash flows for each alternative as required to match the least
common denominator. For the example from step 1, the yearly cash flows for the first
project would be replicated four times and for the second the cash flows would be
replicated three times. This includes the cash flows associated with the project execution
schedules.
3. Calculate the incremental net cash flow for each year.
4. Calculate the incremental NPV@HR. If the NPV@HR>0, the first alternative is preferred
while if the NPV@HR<0, the second alternative is preferred.
[Dr. Kolodka will provide an example in class]

6.3.2 The Cash flow diagram method

Instead of organizing
$1,800,000
the information in a
worksheet or tabular form, $1,400,000

the diagram method $1,000,000

organizes the same $600,000

Annual Net Profit

information graphically, $200,000

where the x axis is time and -$200,000 -1 0 1 2 3 4 5 6 7 8 9 10 11
the Y axis is the -$600,000
parameter(s) of interest. All Payback Period
-$1,000,000
of the economic indicators
-$1,400,000
described in section 6.2.4.2
-$1,800,000
can be displayed
graphically. Examples of the -$2,200,000
Years Since Full Commisioning
most common diagrams are
provided in figures 6.1 and
Figure 6.1 The cumulative cash flow diagram
6.2.
Figure 6.1 shows an
example of an undiscounted cash flow diagram using data from Project 1 of the example shown
in subsection 6.3.1. The net profit in each year is plotted as the Y axis on a bar chart. The dashed
line represents the cumulative cash position (CCP, see section 6.2). The time at which the CCP
crosses the X axis (i.e. has a value of zero) is the payback period. The total CCP is the value at
the end of the operational life of the project ($1,800,000 in figure 6.1).

14
 The discounted
$400,000 Fully Discounted Payback Period
cash flow diagram using
data from this same $0
example is shown in

Annual Present Value @15%

-1 0 1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18
Figure 6.2. The present -$400,000

value in each year is -$800,000

plotted as the Y axis on a NPV@15%
bar chart. The dashed line -$1,200,000
represents the cumulative
-$1,600,000
discounted present value
using a 15% hurdle rate up -$2,000,000
to the time indicated on the
X axis. The value of this -$2,400,000
Year Since Full Commissioning
line at the end of the
operational life is the net
present value. If this Figure 6.2 The discounted cumulative cash flow diagram
diagram represents a
typical major retrofit project, that time would most likely be 10 years. Note that since the value
at the end of year 10 is negative, the investment is not worthwhile.
For projects with a positive net present value, the cumulative present value line will cross
the X axis prior to the end of the operational life of the project. The time at which the cumulative
present value equals zero is known as the fully discounted payback period (see subsection
6.2.4.3). For the example shown in figure 6.2, the NPV@15% is -$400,000 at year 10. We can
extrapolate the project’s economics by including additional years of operation beyond the end of
the operational life (as has been done in figure 6.2) until the cumulative present value line
crosses the X axis. This allows us to estimate the fully discounted payback period for
uneconomic projects. This technique is useful for projects that are justified for safety or
environmental reasons, but which are not profitable. In this example the fully discounted
payback period is 17 years.
Comparing figures 6.1 and 6.2 shows the importance of using a discounted measure for
major retrofit and grassroots projects. With a 15% hurdle rate and a ten year project operational
life, this project is not worthwhile despite a total cumulative cash position of $1.8 million and an
undiscounted payback period of 5.5 years.
6.3.3 The Balance sheet method
Some companies prefer to organize and display the economics of a project using a
balance sheet approach. Balance sheets are commonly prepared at the corporation level and
reported in the company’s annual report. Thus, this format is familiar to upper management and
often is the format that must be prepared for decision makers. The balance sheet consists of the
following elements:
1. Revenues (REV, $/yr)
2. Operating Expenses (OE, $/yr)
3. Annualized Capital Costs (ACC, $/yr)
Gross Profit (GP=Rev-OE-ACC))

15
4. Taxes
Net Profit (GP-TAX)
The revenue and operating expenses are calculated as described in section 6.1. The annualized
capital cost is calculated by dividing the total capital investment by the project’s operational life
(in years). For example, if the TCI for a project is $10,000,000 and the operational life is 10
years, the ACC is:
ACC=$10,000,000/10 = $1,000,000/yr
There are three common conventions for using the balance sheet method. The first
convention is to calculate a “year 1” balance sheet. In this case, the revenues and operating
expenses from the 1st year of operation are used. Taxes are often calculated in a simplified
fashion by simply using the gross profit as the taxable profit. However, some companies require
that the taxes be calculated more accurately, which requires use of a more complete method,
such as the balance sheet method to do the tax calculation.
The second convention is to use the average basis date values of the revenues and
operating expenses. This convention has the advantage of incorporating significant changes in
operating expenses into the calculation. For example, if there is a large expense every five years
for a reactor catalyst changeout, the year 1 balance sheet fails to include this cost in the gross
profit calculation, but the “average basis date” balance sheet method includes them.
The third convention is to use the average values of the revenues and operating expenses.
Revenues and operating expenses are escalated using projected rates of inflation (or other
projected changes in value) over the project life. The average of the escalated values is then used
in the average value balance sheet calculations. This method can be considered to be a mid-
project life annual balance sheet.
[Dr. Kolodka will have an example in class]

6.4 Economic hazards analyses

At the scoping study level, the accuracy of the data used to generate the economic
information described in sections 6.1-6.3 is around ±40%. Economic measures such as the
NPV@HR and DCFROR will have this same level of uncertainty. If the economic measure
indicates a very high level of profitability or that the investment is highly unprofitable, a
conclusion about the economic worthiness of the project can be determined just using the
economic measures. However, in most cases using just this single value is not adequate for a
definitive statement about the economics of the project. Sections 6.4.1-6.4.3 describe how to
quantify the uncertainty in our analysis in such a way that better, more confident, conclusions
can be drawn about the project.
6.4.1 Identifying the factors that make the economic measure(s) uncertain
Usually, two or three key elements that go into calculating an economic measure
dominate the calculation. If a cash flow sheet has been developed, these factors can usually be
identified just by observation. For example if the project is “capital intensive”, the net profit for
the years associated with the project execution schedule (years 0, -1, etc.) will be higher (in
absolute value terms) than the net profits for the years associated with the project’s operational

16
life. If the revenues are dominant, it is useful to determine if most of the revenue comes from a
single product, two products, or if the revenues from a suite of products and by-products are
distributed fairly evenly. Similarly, if operating costs are one of the most significant elements on
the cash flow sheet, it is useful to identify which operating cost items makeup the majority of
these costs.
[add examples here]
6.4.2 Use of the gross margin
Often the primary product(s) and primary raw material(s) are economically linked. For
example, when the price of crude oil rises, the prices of gasoline, jet fuel, and diesel rise in
response. These types of facilities are known as “margin processors” because they make their
profit based on the margin between the unit price(s) of the primary product(s) and the unit
price(s) of the raw materials. This margin must be large enough to: 1) cover the on-going
manufacturing costs, 2) payback the original capital investment, and 3) provide an acceptable
level of profit. For these facilities, variations in the absolute values of the unit prices of the
products and raw materials are not as important as variations in the margin between the unit
prices. While product prices will follow the trend in the unit costs for raw materials, other
factors will influence the margin such as the retention or expansion of product market share.
For projects associated with these types of facilities, the gross margin can be used to
assess the uncertainty of product and raw material contributions to the economics. The gross
margin is the difference between the weighted average unit price of the products and the
weighted average unit price of the raw materials at a single time. By calculating the gross
margin for an economically relevant historical time period, the impact of variations in the gross
margin can be evaluated.
[add gross margin example here]

6.4.3 Using uncertainty regions to evaluate financial risk

A simple, yet powerful way to evaluate the financial risk of a project is to analyze the
impact of variations in the most important elements that contribute to the economics of the
project. The first step is to estimate the most likely range of variation of each of the key factors
that make the economics of the investment uncertain (see subsection 6.4.1). Subsection 6.4.2
outlines how to determine this variation for the gross margin when the project is associated with
a margin processing facility. For the capital investment, the variation is based on the accuracy of
the cost estimation method. These are defined in Table 3.1 for various types of cost estimation
methods. The factored broad cost estimating methods most commonly used at the scoping study
level (Chapter 3) have an uncertainty of ±40%. Therefore, the variation range for this element of
the cost estimate would also be ±40%. Many of the operating costs estimated using the methods
in Chapter 4 have a similar uncertainty. However, if better uncertainty data are available, these
should be used instead. For example, if electrical consumption is important, historical variations
in wholesale industrial electricity prices are readily available in the U. S. and many other
countries. The same is true of fuels used in steam production and for fired heaters (most
commonly natural gas). Labor cost variations are usually also readily available.
From the variation data for a given element of the economic analysis, identify the lowest
and highest values that are likely to occur over the project’s operational life (except for capital
17
investment where it is over the project execution schedule). These might be the highest and
lowest values experienced over a reasonable historical time period, for example. Next, calculate
the economic measure(s) you are using based on the lowest value instead of the value you used
originally. The original value is known as the basis point. Now repeat this calculation for the
highest value. For these calculations, you can now construct the region of most probable
economic uncertainty for the project based on the uncertainty in that economic element.
Plot the economic element on the x axis (the independent variable) and the economic
measure on the y axis (the dependent variable). Identify the location (x,y coordinates) of the low
and high values. Now use these values to draw a rectangle. This rectangle represents the region
of most probable uncertainty of the project based on the economic element being evaluated. Now
locate the basis point (x, y coordinates). The basis point should be within the region of most
probable uncertainty. If not, you have performed the analysis incorrectly.
This method is especially effective when the NPV@HR is used as the economic measure.
If the entire region of most probable uncertainty lies above NPV@HR=0, then the economics of
the project are certain and profitable. If the entire region of most probable uncertainty lies below
NPV@HR=0, then the economics of the project are certain and unprofitable. For projects where
the region of most probable uncertainty crosses the NPV@HR=0 line, the likelihood of
profitability is approximately the fraction of the region of most probable uncertainty that lies
above the line and the likelihood of unprofitability is approximately the fraction of the region
that lies below the line.
[add examples here]
6.5 Non-economic hazards analyses
Selecting the most economically attractive project while ignoring other factors may result
in unsafe facilities that are difficult to build, operate, and/or maintain. Some of the other factors
that should go into the decision concerning the best project to execute are summarized below.
 Operability
Processes that are difficult to operate should be avoided. While such processes may look
better economically in theory, in actual practice, a process that is hard to operate will usually
have higher operating costs and may not be able to achieve the desired operating factor due
to unplanned shutdowns. Further, if there are a lot of process excursions or shutdowns, the
process may be unsafe. In addition to considering normal operation, consider the ability to
startup and shutdown the process as well as the ability to change throughput. Well designed
processes have a large turndown ratio (the minimum process throughput divided by the
design operating throughput. Selection between alternatives should not be based on the size
of the project alternatives. Just because a project option has a larger scope than another
project option it does not follow that the process will less operable. This factor is about
complexity not quantity.
[add example of interstage processing in a light ends separation plant]
 Safety

18
 A good process design always maximizes the inherent safety of the facility. This topic is
covered in depth in Chapter 10.
 Sustainability/Environmental Impact
Well designed processes maximize the conversion of raw materials into saleable/useable
products and minimize the generation of wastes. When wastes are generated, they should be
kept segregated and at as high of a concentration as possible to make waste treatment as cost
effective as possible. If your project generates wastes, you must also address how those
wastes are treated/disposed as part of your project scope. Thermal pollution should also be
avoided so that energy resources are maximized. Total life cycle sustainability concepts
should be incorporated into design decisions. This topic is covered in Chapter 11.
 Constructability
No matter how efficient and profitable a project appears, it is a poor choice if it is impossible
or difficult to actually fabricate and assemble. When evaluating project alternatives, ask the
question, “are there any unusual factors that would make this project hard to build?” Note,
just because one project includes more stuff, does not mean it is more difficult to build. This
factor is about complexity than quantity.
 Maintainability
Good projects minimize potential maintenance problems. For example, centrifuges can be
very efficient in separating solids out of a liquid or gas stream. However, these unit
operations typically require substantially greater maintenance than other separation options.
When evaluating project alternatives, ask the question, “are there any unusual factors that
would make this project hard to maintain?” Note, just because one project includes more
stuff, does not mean it is more difficult to maintain. This factor is about complexity than
quantity.
Figure 6.3 is an example of the type of comparison table that can be used to help organize
an analysis of all of the factors that go into selecting the “best” process alternative.
Figure 6.3 A Typical Project Comparison Chart

19
[add an example]

20