LECTURE 7

1
 Preliminary Estimates
Needs:
PFD,
vessel sketches,
preliminary plot plan and elevation diagrams
Accuracy is +25% to -15%
 Chilton Method
• Delivered equipment cost
• Installed equipment cost
• Process piping (solid, fluid or both)
• Instrumentation
• Buildings and site development
• Auxiliaries
• Outside lines
• Engineering and construction
• Contingencies
• Size factor
Problem: A small fluid processing plant is to be built at an existing
plant site. The delivered equipment costs are:
Equipment COST
Distillation tower 500,000
Trays and internals 435,000
Receivers 320 000
Accumulator drum 175 000
Heat Exchangers 62 0 000
Pumps 215 000
Automatic control 300000
Miscellaneous equipment 150000

The equipment is to be installed in an outdoor structure. The

process is heavily instrumented, and auxiliary services and
outside lines are minimal.
Estimate the battery-limits fixed capital investment using the
Chilton method.
 Peters and Timmerhaus Method
• A process is classified according to whether it is a
solid, solid–fluid, or fluid processing plant like
the Lang method.
• 12 factors for direct and indirect costs are
applied is in the Chilton method.
• The authors state that the method applies to an
existing plant site and therefore have included
land.
• They also include 15% of the total capital
investment for working capital so that the
bottom line is the total capital investment.
Problem: Estimate the battery-limits fixed capital investment using the Peter
and Timmerhause method.
Solution: The total delivered equipment cost is $2,715,000
 Definitive method
 Requires preliminary specifications of all
equipments, utilities, instrumentation and
electrical requirements and off sites
 Needs PFD, vessel sketches, preliminary plot
plan and elevation diagrams, utility
balances and P& ID
 +15% to -7%
• Guthrie’s Method:
 SCOPE AND CONTINGENCY
Scope: The document that defines a project is called the scope.
The scope is continually referred to by cost control and
estimating personnel so that the plant constructed will
correspond to the intent of engineering and management.

A scope should answer the following questions clearly:

What product is being manufactured?
How much is being produced?
What is the quality of the product?
Where is the product to be produced?
What is the quality of the estimate?
 What is the basis for the estimate?
Contingency
• The word contingency is probably the most
misunderstood word associated with cost estimates
whether they are fixed capital, working capital, or
operating expense estimates.
• A definition is that “contingency is a provision for
unforeseen elements that experience has shown
are likely to occur”.

There are two types of contingencies:

 process contingency and
 project contingency
Process Contingency
• Process contingency was recognized in the 1970–1980
period when large-scale pioneer energy projects were
considered.
• It is used to deal with uncertainties in
1. Technical uncertainties in equipment and performance
2. Integration of new and old process steps
3. Scaling up to large scale plant size
4. Accurate definition of certain process parameters, such as
Severity of process conditions
Number of recycles
Process blocks and equipment
Multiphase streams
Unusual separations
Project Contingency
No matter how much time and effort are spent
preparing an estimate, there is the likelihood of
errors occurring due to:

 Engineering errors and omissions

 Cost and labour rate changes
 Construction of problems
 Estimating inaccuracies
 Miscellaneous “unforeseens”
 Weather-related problems
 Strikes by fabricator, transportation, and
construction personnel
 OFFSITE CAPITAL
 The offsite facilities include all structures, equipment,
and services that do not directly enter into the
manufacture of a product.
 These costs are estimated separately from the fixed
capital investment.
 Offsite capital would include the utilities and services of
a plant.
Among the utilities are:
1. Steam-generating and distribution
2. Electrical-generating and distribution
3. Fuel gas distribution
4. Water-well, city, cooling tower, and pumping stations for water distribution
5. Refrigeration
6. Plant air
7. Environmental control systems
 The service facilities might include:
1. Auxiliary buildings
2. Railroad spurs
3. Service roads
4. Warehouse facilities
5. Material storage—raw material as well as finished goods
6. Fire protection systems
7. Security systems
As an approximation, the recommended percentage of the FOB
process equipment costs is as follows:
1. Small modification of offsites 1–5%
2. Restructuring of offsites 5–15%
3. Major expansion of offsites 15–45%
4. Grass roots plants 45–150%
 ALLOCATED CAPITAL
When a company proposes to produce a new product, it is wise
to examine various sources of raw materials and their costs.
If the company produces the raw material at one of its locations,
then almost without exception, it is cheaper to use that raw
material rather than buying it on the open market.
In such cases, the raw material is referred to as an intermediate.
If it represents a potential sales item, then a proportion of the
intermediate’s fixed capital investment should be allocated to
the new product’s capital investment.
The benefit to the new product department is that the
intermediate is charged to the intermediate’s
manufacturing expense, in addition to a transfer
price to deliver it to the new product department.
The new department receives a price break for the raw
material since it is being bought at below market
price, but with every benefit there is a penalty.
In this case, the new product department must accept
a proportion of the intermediate’s fixed capital
investment based upon the amount of raw material
to the new department and the total capacity of the
intermediate total capacity.
Problem Statement:
• Ajax Petrochemical is considering the
manufacture of 18MMlb/yr of a specialty
chlorinated hydrocarbon. In the process some
4MMlb/yr of chlorine is required. Ajax has an
older caustic-chlorine facility at the same location
that has a rated capacity of 100 tons/day. The
book value of the chlorine unit’s capital
investment is $20MM. Calculate the amount of
allocated capital to be charged to the chlorinated
hydrocarbon unit if the chlorine is to be
transferred from the existing caustic-chlorine-
plant. Assume 330 operating days per year for
both plants.
 Solution:
1. Calculation of chlorine plant capacity
Chlorine required = 4,000,000 lb/yr x (1 ton)/(2000 lb/yr)
= 2000 tons per year
Yearly capacity of the chlorine plant= 100 tons/day x 330days/yr
= 33,000 tons /yr

2. Allocation of capital to chlorinated HC plant

Therefore the proportion of the chlorine facility capital allocated
to the chlorinated HC facility is
33,000 tons/yr x $ 20 MM =$1,212,00
2000 tons/yr
 WORKING CAPITAL
 Working capital are the “working funds”
necessary to conduct a day-to-day business of the
firm.
 These funds are necessary to pay wages and
salaries, purchase raw materials, supplies, etc.
 Although the initial input of working capital funds
come from the company’s financial resources, it is
regenerated from the sale of products or services.
 Working capital is continuously liquidated and
regenerated but is generally not available for
another purpose, so it is regarded as an
investment item.
• Working capital is a very important aspect of plant
operations, especially for unproven processes and
new products.
• If an adequate amount of working capital is
available, management has the necessary flexibility
to cover expenses in case of delays, strikes, fires, or
recessions.
• Many small firms fail due to an insufficient amount
of working capital to pay the expenses as the new
venture begins to become established.
• Methods for estimation of WC:
 Percentage methods
 Inventory method
 Percentage of Capital Investment
Methods
 The ratio of working capital to total capital
investment varies with different companies and
different types of business.
 If a company manufactures and sells a product at
a uniform yearly rate, then 15–25% of the total
capital investment is an adequate amount of
working capital.
 Some companies are in a seasonal business, such
as agricultural chemicals. If that is the case, then
it would be advisable to provide 20–30% of the
total capital investment for working capital.
Problem Statement:
A company is considering an investment in an aldehyde facility.
The engineering department has estimated that the battery-
limits fixed capital investment to be $19MM. Land allocated
for the project is $500,000 and start-up expenses to be
capitalized are expected to be $900,000. The company
normally uses 15% of the total capital investment for working
capital.

Item Cost ($)

Land 500,000
Fixed capital investment 19,000,000
Start up expenses 900,000
total 20,400,000

Determine the estimated amount of working capital for this

project.
Item Cost ($)
Land 500,000
Fixed capital investment 19,000,000
Start up expenses 900,000
total 20,400,000

• Since the working capital is 15% of the total

capital investment, the subtotal above is 85%,
providing no other capital items are added.
Therefore,
Total capital investment = $20,400,000/0.85
= $24,000,000
And Working capital = $24,000,000- $20,400,000
= $3,600,000
 Percentage of sales method
The estimate of an adequate amount of working capital for
certain specialty chemicals is frequently based upon a
percentage of annual sales.
Products that may fall into this category are fragrances,
cosmetics, flavors, perfumes, food additives, etc.
To illustrate this method, let’s consider the manufacture of a
perfume. The essences and long-chained alcohols used in the
manufacture of a perfume are expensive items. The fixed
capital investment to produce these products is rather small
compared to the manufacture of a petrochemical. A perfume
producer may have considerable money tied up in raw
materials and finished goods inventory and only a modest
amount in fixed capital.
• It is reported that the percentage values vary from 15 to
49% with 30 to 35% being a reasonable value.
Problem Statement:
A perfume manufacturer is planning to produce a new product.
Annual sales are expected to be about $15,000,000. Estimate
the amount of working capital required for this product.

Solution:
Since this is a high-cost product due to the raw materials and the
fact that little fixed capital is required, the working capital
should be based on a percentage of annual sales. A mean value
of 35% of sales will be used.

Annual sales = $15,000,000

Estimated working capital = $15,000,000 x 0.35
= $5,250,000
 Inventory Method
• There are several variations on this method
mentioned in the literature, but they all have
the common basis of inventory.
• This method uses the categories in current
assets and current liabilities from a balance
sheet and is consistent with the accounting
definition of working capital, namely, current
assets minus current liabilities.
• Problem Statement:
• Plastics, Inc. is considering a project to manufacture a
specialty product for the polymer industry. The
expected sales are 10,000,000 lb/yr at 65 cents/lb. In
the manufacture of this product, all raw materials are
delivered by pipeline from other operating
departments except one, so the only on-site storage is
an inorganic compound. It costs 18 cents/lb and is
consumed at a rate of 500,000 lb/month. The total
manufacturing expense is estimated to be 30 cents/lb
of product. Goods-in-process amount to about
$300,000 because of hold tanks in the process. The
fixed capital investment for this process is $8,000,000
and the maintenance is 6% per year of the fixed capital
investment. Estimate the amount of working capital
required by the inventory method.
Solution:
Raw material-2 weeks supply of the inorganic compound
500,000 lb/month x (14 days/30 days) = 233,000 lb
Inventory = 233,000 lb x $ 0.18/lb = $42,000
Good in process =$300,000
Finished product- 2 weeks supply of product
10,000,000 lb/yr x (2 weeks/52 weeks) = 385,000 lb
Value of product = 385,000 lb x $ 0.65/lb = $ 250,000

Stores and supplies

Annual Maintenance cost = $ 8,000,000 x 0.06
=$480,000
10% of total annual maintenance cost = $48,000
Cash- 1 month manufacturing expenses
10,000,000 lb/yr x (1 month/12 month) x ($ 0.30/lb)
= $250,000
Accounts Receivable- 5% of annual net sales
10,000,000 lb/yr x 0.65/lb x $0.05
= $325,000
Items Working capital ($)
RAW MATERIAL 42,000
GOODS IN PROCESS 300,000
FINISHED PRODUCT 250,000
STORES AND SUPPLIES 48,000
CASH 250,000
ACCOUNTS RECEIVABLE 325,000

Estimated working capital = $1,215,000