Process Economics

Motivation
➢ The primary goal for designing any process is to earn money.

➢Proper cost calculation and optimization of cost can save the plant
from unwanted losses.

➢Overall profit must be evaluated to evaluate the feasibility of

establishing a plant.
 Costs involved in process design
➢Battery limits investment

➢Utility investment

➢Offsite investment

➢Working capital
 Battery limits investment
➢ Includes process equipment costs and the infrastructure required to
house the equipment.

➢ Does not include the feed storage facility, product storage facility and
pollution control facility.

➢Battery limit costs helps in setting up responsibility boundaries for the

manufacturing process.
 Cost of a Component
➢Cost with respect to capacity;

𝑀
𝑄
𝐶𝐸 = 𝐶𝐵
𝑄𝐵

Here, 𝐶𝐸 is the equipment cost for capacity , 𝑄

𝐶𝐵 is the base cost of the equipment for capacity, 𝑄𝐵
M is the equipment type constant.
 Time Dependence on cost of equipment
Corrected cost with time;

𝐶1 𝐼1
=
𝐶2 𝐼2
Here, 𝐶1 is the equipment cost in year 1;
𝐶2 is the equipment cost in year 2;
𝐼1 is the equipment cost index in year 1;
𝐼2 is the equipment cost index in year 2;
 Corrections in cost for equipment
𝑀
𝑄
𝐶𝐸 = 𝐶𝐵 𝑓𝑀 𝑓𝑃 𝑓𝑇 ;
𝑄𝐵
➢𝐶𝐸 is equipment cost for carbon steel at moderate pressure and temperature
with capacity 𝑄.
➢𝐶𝐵 is known base cost for equipment with capacity 𝑄𝐵 .
➢𝑓𝑀 is correction factor for material of construction.
➢𝑓𝑃 is correction factor for design pressure.
➢𝑓𝑇 is the correction factor for design temperature.

The standard values of the factors are available in literature.

 Cost other than equipment
Other costs excluding the material costs;
➢Installation Costs
➢Structures for housing the equipment
➢Piping and valves
➢Safety features
➢Contingencies

➢The cost for getting the equipment working is 2 to 4 times the

equipment costs.
 Utility Investment
Required for plant operation but not the main component required for
production.

➢Electricity generation and transmission.

➢Steam generation and cooling water supply.

➢Effluent treatment.
 Offsite Investment
Infrastructure costs which is required for building up of a plant.

➢Office buildings, Medical centre, warehouses etc

➢Roads and vehicles for personnel transportation.

➢ Waste disposal systems.

 Working Capital
Initial cost invested to get the plant in operation.

➢Investment before start of production.

➢Cost of transport before the plant starts operation.

➢Investment on employees before production starts.

 Total Capital Cost
Installation factors are multiplied to the equipment cost to get the total
capital cost;

𝐶𝐹 = ෍ 𝑓𝑖 𝐶𝐸,𝑖 Individual equipment cost.

Installation factor

Fixed Capital Cost for the whole system 𝐶𝐹 = fI ෍ 𝐶𝐸,𝑖

𝑖
Overall Installation factor
 Steps for Calculation of total Capital Cost
1. Estimating the size of each equipment.
2. Calculate the equipment price based on size.
3. Use cost index to correct for time variation.
4. Use appropriate Material cost , Pressure correction, and
Temperature correction factors to get the corrected cost
based on individual equipment.
5. Add the cost for installation and utilities.
➢Piping cost is affected by correction factors.

➢Installation cost is unaffected by correction factors.

 Retrofit Capital Cost
➢Retrofit involves modification of an operational unit.

➢Cost of retrofit depends on the nature of modification.

➢Sometimes cost of a retrofit could be higher than the cost of installing

a new equipment if other equipment need to be moved/modified for
installing a new equipment.

➢It is very difficult to generalize a retrofit cost but preliminary

calculations can be made.
 Annualized Capital Cost
➢Annualized capital cost is dependent on the source of financing.

Here i= interest rate per year.

n= number of years (typically 5 or 10 years).

➢Interest rates vary with varying number of years for which loan is
taken.
 Operating Cost
1. Raw materials cost
➢Largest operational cost.
➢Raw material cost are mentioned in standard trade journals.
➢A contractual buying scheme helps bring stability in raw material costs.

2. Chemicals/catalyst other than raw materials

➢Catalyst required for reaction needs regeneration after a fixed period.
➢Other chemicals required to operate the plant which is not directly involved
in manufacturing of the product.
3. Utility operating cost
➢Most significant cost after raw material cost.
➢Includes fuel, electricity, steam, cooling water etc.
➢Fuel cost is significant and can vary significantly on the type of
process. It can be stabilized by having contractual agreement with the
provider.
➢Cost of cooling water is typically lower than the cost of steam
generation.

4. Labour cost
➢Mainly depends on whether an operation batch or continuous.
➢It also depends on the level of Automation.
5. Maintenance cost

➢The primary criteria to decide on maintenance cost is whether the

processing materials are solids or liquids or gases.

➢Corrosive materials can increase maintenance costs significantly.

 Simple Economic Criteria
Cost Independent of the rate of production;
➢Capital cost returns
➢Routine Maintenance
➢Overheads
➢Quality control
➢Taxes
Variable costs dependent on production rate
➢Raw Material cost, Utilities, transportation etc
Simple economic criteria calculation;
➢Economic Potential
EP=value of products-fixed cost-variable cost-taxes

➢Total Annual cost

TAC=fixed cost + variable cost + taxes

➢Simple economic criteria are very useful in comparing different

design proposals.
➢Total annual cost can be used to compare both individual units and the
whole design.
 Project Cash Flow
1. A-B: Design and development.
B-C: Spend on Building, Plant and Equipment.
C-D: Working Capital on Commissioning (final

Economically more feasible

stages of handover before final operation begins).
D-E: Production starts and revenue begins but
production is at lower capacity.
E-F: Full production is achieved. F is called the
breakeven (Profit equals expenditure) point.
F-G: Cash flow exceeds expenditure at a steady rate.
G-H: Cash flow rate decreases because of
maintenance cost or a fall in market price. At H the
Payback time
plant ends operation. Working Capital is recovered after
shutdown.

Payback Time: Time at which cash flow equals zero

(Invested cost equals cash flow because of production.)
 Project Cash Flow

➢ Return on Investment,

Economically more feasible

➢ Net Present Value: Actual value of the project after
accommodating the time effect on money.

Annual Discounted cash flow,

Payback time

Net Present Value,

Discounted Cash flow rate of return;

The discounting rate, i for which NPV = 0 is called DCFRR

➢Higher NPV means higher profit.

➢Negative or Zero NPV means the project is not profitable.

➢Higher DCFRR percentage indicates a more feasible project.

 NPV vs DCFRR
➢ Higher values of both indicate economically feasible and efficient
project.

➢NPV only indicates profit by incorporating time value of money.

➢DCFRR shows how efficient the project is as compared to the initial

investment.
 Income Tax
➢Profit earned by a process plant is subject to taxes.

➢Design engineers should have a basic knowledge of taxes.

➢Tax allowances are provided in certain cases.

 Taxable Income
Taxable income= Gross profit – Tax allowances

Gross profit= Total revenue- total product cost

Tax = Gross profit * Tax rate

 Total Revenue
➢Primary Revenue is obtained from product sales.

➢Sales of supplies.

➢Royalties

➢Other revenues
 Some exceptions from total product cost
➢ Dividends to stakeholders

➢Repayment of loan
 Capital Gains Tax
➢ Applicable on profits made by selling capital assets.
For example; selling of land, buildings, or equipment.

For the sale of land,

Profit= Selling cost of land-purchase cost of land-cost of improvements-
cost involved in selling.

Depreciation is not applicable while calculating profit for selling land.

 Depreciable Assets
➢Buildings

➢Equipment

Profit= selling price-(purchase price-depreciation cost)-cost of selling

 Depreciation
➢Value of assets like equipment and buildings decreases with time.

➢It may be due to;

▪ Physical wear and tear
▪ Technological Advancement
▪ Economic parameters
 Use of Depreciation in tax calculation
➢Depreciation amount is calculated for all assets except land.

➢The total depreciation amount is subtracted from the total revenue.

➢Depreciation accounts for lowering value of plant assets and hence

economic evaluation of the value of the plant.
 Cost Price, Market and Book Value
➢Cost Price
The Price at which the asset was bought.

➢Book Value
For a particular year is the original cost minus the depreciation up to
the year in consideration

➢Market Value
Valuation of the depreciated product in the open market.
➢If an asset is depreciated but still usable, it can be sold at the
depreciated cost minus the cost involved in sales. This money
recovered after deducting depreciation and sale value is called
salvage value.

➢If the asset is not useful, the material of the asset can be sold to
obtain to gain income. The cost recovered by selling the material
when the asset is not useful is called scrap value.

➢Recovery Period is the period over which depreciation is

applicable/charged.
 Depreciable Assets
➢All depreciable assets should have a useful life of more than 1 year.

➢All equipment required in process industries.

➢Inventories held for sale are not depreciable (ready to sell within a
year).

➢Land is not depreciable.

 Depreciation Calculation
➢Time period of depreciation

➢Depreciation rate

➢Shorter time period involves a larger depreciation rate.

 Depreciation Calculation
➢Straight line method

➢Assumes linear performance of the asset over a period of time.

𝐶𝑃 −𝑆𝑉
➢𝐷 = Here Cp is the cost price
𝑇
Sv is the salvage value
T is the depreciation time period
 Sum of Digits Method
➢For a service life of N years, sum of digits is calculated

➢For example,
➢For service life of 10 years;
➢Sum of digits=1+2+3+4+5+6+7+8+9+10

✓Depreciation for 1st year =(10/(Sum of digits))* (𝐶𝑃 −𝑆𝑉 )

Depreciation for 2nd year= =(9/(Sum of digits))* (𝐶𝑃 −𝑆𝑉 )
Depreciation for 10th year= =(1/(Sum of digits))* (𝐶𝑃 −𝑆𝑉 )
 Tutorial Problem
Suppose you have bought a mobile phone for Rs 80,000. The useful life
of the mobile phone is 5 years.
The salvage value is Rs 10000. What is the depreciation and book value
at the end of
1, 2, 3, 4 and 5 years by using
1. Straight line method,
2. Double declining balance method
3. Sum of years digits method.
Plot the book value for 1, 2,3,4 and 5th year by using the three methods
on the same plot.
 Summary of Process Economics
Process economics evaluates different projects based on their economic
merits.
➢Total capital cost is estimated by adding equipment cost, Utilities, Working
capital.

➢Annualized capital cost accounts for the interest on loans taken.

➢Cash flow analysis enables estimation of profit and efficiency of the

process.

➢Although process economics can be uncertain in an absolute sense,

consistent economics analysis is very useful in a relative sense.