Process Plant Design and Economics

(CB407)

Chemical and Biochemical Engineering

Indian Institute of Technology Patna

Atanu K Metya
atanu.metya@iitp.ac.in
 Process Plant Design and Economics

Methods for calculating depreciation

• Straight-line

• Declining balance (Fixed Percentage)/ Double-declining balance

• Sum-of-the-Years-Digits Method

• Sinking-Fund Method

• The modified accelerated cost recovery system (MACRS)

 Process Plant Design and Economics

• Straight-line method
• Property value decreases linearly with time over the recovery period.
• With or without scrap value or salvage value.
• Equal amounts are charged for depreciation each year throughout the
entire service life of the property.
• Slower depreciation than MACRS.
• Multiple straight-line depreciation:
• Unit-of-production or Service output method: is particularly applicable
when depletion occurs, as in the exploitation of natural resources.
Process Plant Design and Economics
 Process Plant Design and Economics

• Declining-balance/ Fixed-percentage Method

• The annual depreciation cost is a fixed % of the property value at the
beginning of the particular year.
• The fixed-percentage (or declining-balance) factor remains constant
throughout the entire service life of the property, while the annual cost
for depreciation (d) is different each year.
• Fixed percentage factor f = 1- (Vs /V)(1/n) Matheson formula.
Process Plant Design and Economics

• Combination method: Straight-line +

Declining balance
• The advantage of the declining-balance
and the combination methods is that
they permit greater depreciation
allowances in the early life of the
property than in the later life.
 Process Plant Design and Economics

• Double declining-balance (200%) method

• A fixed-percentage factor giving a depreciation rate equivalent to twice the
minimum rate with the straight-line method.
• Using the straight-line method, the minimum depreciation rate (d) occurs in
the first year
• Depreciation rate equivalent, fd = 2*(d/V)
 Process Plant Design and Economics

Example: Determination of depreciation by straight-line and declining-

balance methods. The original value of a piece of equipment is $22,000,
completely installed and ready for use. Its salvage value is estimated to be
$2000 at the end of a service life estimated to be 10 years. Determine the
asset (or book) value of the equipment at the end of 5 years using:
• Straight-line method
• Textbook declining-balance method
• Double declining-balance
 Process Plant Design and Economics

• Sum-of-the-Years-Digits Method
• Larger costs for depreciation are allotted
during the early-life years than during the
later years.
• the advantage of permitting the asset value
to decrease to zero or a given salvage
value at the end of the service life.
• The yearly depreciation factor is the
number of useful service-life years
remaining divided by the sum of the
arithmetic series.
 Process Plant Design and Economics

Methods for calculating depreciation

• Straight-line

• Declining balance (Fixed Percentage)/ Double-declining balance

• Sum-of-the-Years-Digits Method

• Sinking-Fund Method

• The modified accelerated cost recovery system (MACRS)

 Process Plant Design and Economics

• Sinking-Fund Method
• Accumulate sufficient funds for the
recovery of the original capital
invested in the property.

• At the end of the service life, the sum

of all the deposits plus accrued
interest must equal the total amount of
depreciation.
 Process Plant Design and Economics

• Modified Accelerated Cost Recovery System (MACRS)

• The MACRS method is based up on the classical DDB method, but
with no salvage or scrap value allowed, a switch to straight-line at a
point, and use of the half-year convention.
• The half-year convention indicates that in the first year only one-half of
the DDB method is allowed and the balance remaining after the end of
the recovery period is depreciated in the next year. This leads to that the
MACRS depreciation always requires an additional year over the length
of the recovery period.
• Method assumes that all property is acquired mid-year and hence
assigns half of the full-year depreciation in the first and last years of the
recovery period.
 Declining balance switching to straight-line method
Process Plant Design and Economics
Applicable recovery periods: 3, 5, 7, 10, 15, 20 years
Applicable convention: half-year

Recovery period

• MACRS Recovery
3-year 5-year 7-year 10-year 15-year 20-year

year Depreciation rate, %

1 33.33 20.00 14.29 10.00 5.00 3.750

2 44.45 32.00 24.49 18.00 9.50 7.219
3 14.81 19.20 17.49 14.40 8.55 6.677
4 7.41 11.52 12.49 11.52 7.70 6.177
5 11.52 8.93 9.22 6.93 5.713
6 5.76 8.92 7.37 6.23 5.285
7 8.93 6.55 5.90 4.888
8 4.46 6.55 5.90 4.522
9 6.56 5.91 4.462
10 6.55 5.90 4.461
11 3.28 5.91 4.462
12 5.90 4.461
13 5.91 4.462
14 5.90 4.461
15 5.91 4.462
16 2.95 4.461
17 4.462
18 4.461
19 4.462
20 4.461
21 2.231
 Process Plant Design and Economics

• Example: Calculation of the MACRS Yearly Depreciation Percentage

Calculate the annual % rate of depreciation for a 5-year recovery period
asset, such as a chemical plant, using the double-declining-balance method
and the half-year convention, and switching to the straight-line method on
the remaining balance when it gives a higher annual depreciation than that
obtained with the double-declining-balance method.
 Process Plant Design and Economics
Calculate the % factors for MACRS for a class life of 10
years based on a 200% declining balance for this class life
with a switch to straight-line depreciation at the time
appropriate to maximize the deduction. It is also based on
salvage value being zero. The half-year convention in the
first and last year applies. Use an initial property value of
$22,000.
 Process Plant Design and Economics
A chemical plant with a fixed capital investment of $100
million generates an annual gross profit of $50 million.
Calculate the depreciation charge, taxes paid, and after-tax
cash flows for the first 10 years of plant operation using
straight-line depreciation over 10 years and using MACRS
depreciation with a 7-year recovery period. Assume the plant
is built at time zero and begins operation at full rate in year 1.
Assume the rate of corporate income tax is 35%, and taxes
must be paid based on the previous year’s income.
 Process Plant Design and Economics

Year Gross Depreciation Taxable Taxes Cash Year Gross Depreciation Taxable Taxes Cash
profit charge income paid flow profit charge income paid flow
0 0 0 0 0
1 50 1 50 14.29
2 2
3 3
4 4
5 5
6 6
7 7
8 8
9 9
10 10
 Process Plant Design and Economics
• The original cost for a distillation tower is $50,000, and the
useful life of the tower is esti- mated to be 10 years. How much
must be placed annually in an annuity at an interest rate of 6
percent to obtain sufficient funds to replace the tower at the end
of 10 years? If the scrap value of the distillation tower is $5000,
determine the asset value (i.e., the total book value of the tower)
at the end of 5 years based on straight line depreciation.
 Process Plant Design and Economics
• The initial installed cost for a new piece of equipment is $10,000.
After the equipment has been in use for 4 years, it is sold for $7000.
The company that originally owned the equipment employs a straight-
line method for determining depreciation costs. If the company had
used the MACRS 5-year method for determining depreciation costs,
the asset or book value for the piece of equipment at the end of 4
years would have been $1728. The total income tax rate for the
company is 35% of all gross earnings. Capital gains taxes amount to
20% of the gain. How much net savings would the company have
achieved by using the MACRS method instead of the straight-line
depreciation method?
 Process Plant Design and Economics
Example:
A small company is using the unit-of-production method for
determining depreciation costs. The original value of the property
is $126,000. It is estimated that the company can produce 12,600
units before the equipment will have a salvage or scrap value of
zero; that is, the depreciation cost per unit produced is $10. The
equipment produces 200 units during the first year, and the
production rate is doubled each year for the first 4 years. The
production rate obtained in the fourth year is then held constant
until the value of the equipment is paid off. What would have been
the annual depreciation cost if the straight-line method based on
this same time period had been used?
 Process Plant Design and Economics
HW
A laboratory piece of equipment was purchased for $35,000 and is
estimated to be used for 5 years with a salvage value of $5000.
Tabulate the annual depreciation allowances and year- end book
values for the 5 years by using
• the straight-line depreciation method
• the MACRS 5-yr recovery period depreciation method
• the sum-of-the-digits depreciation method.
 Process Plant Design and Economics

• A piece of equipment with an original cost of $10,000 and no

salvage value has a depreciation allowance of $2381 during its
second year of service when depreciated by the sum- of-the-digits
method. What recovery period has been used?