Chapte 10

Proftabilit Analysi
r
Chemical
Engineering
Department
y
s
West Virginia
University
Copyright - R.Turton and J. Shaeiwitz
2012

Cash Flows for a

1.

2
.
3
.
4
.

5.

Project

New
Build plant (1-3 years typically)
Plan start-up working
Purchase land
t
capital
a. Depreciate
capital
over frst
5 years
Plan
produces
product
and
operates for some period of time
tb Plant
revenue
. time over
At the
endproftability
of the project
working
which
analysis
is performed land,

capital,
and salvageCopyright
value- R.Turton
are and
recovered
J. Shaeiwitz
2012

Cash

for a
Project
life

Flows

New

Plant startup

Project
Lan
La
d
WC
S

Depreciation
period
3

10

11

12

Lan
d

Cumulative
Cash

FCIL

WC

Low revenue 1st yea

in
r

Flow Diagram

after start-up
Copyright - R.Turton and J. Shaeiwitz
2012

Non-discounted
3Proftability
Bases for

Criteri
a

Proftability
Time
Rate
Interes
Cash
t

Copyrig
ht

- R.Turton and J. Shaeiwitz

2012

Non-

Proftabilit Criteri

Time
discounted

Payback Period =

Criterion

PBP
PBP =time required after start- to recove the
FCIL for the project
up
r

Copyright - R.Turton and J. Shaeiwitz

2012

Non-discounted

Criteri

Proftability

Cumulative Cash Position,

Cash
CCP =Criterion
worth of the project at
the end of life

the

project
Because CCP depends on the size of project,
it is

Sum of all Positive Cash

CCP
CCR
1
better
to
use
the
cumulative
cash
ratio, CCR
Flows
Sum of all Negative Cash Flows
Land WC FCI
Copyright - R.Turton and J. Shaeiwitz
2012

Non-discounted Proftability
Criteria
Interest Rate
Rate of Return on Investment =

Criterion
ROROI

Average Annual Net Profit

ROROI
Fixed Capital Investment (FCI )
L

Copyright - R.Turton and J. Shaeiwitz

2012

Non-discounted Profitability
Criteria

CCR

Sum of all Positive Cash Flows

1
Sum of all Negative Cash Flows

CCP
Land WC FCI L

CC
P

Plant startup
Payback period,
PBP
0

S
5

10

11

12

Lan
d

Lan
d

WC
ROROI

FCIL

Average Annual Net Profit

Fixed Capital Investment (FCI L )

Slope of line
FCI L

FCIL
WC

Copyrig
ht

- R.Turton and J. Shaeiwitz

2012

Discounted Proftability

For this type of analysis, we discount

Criteria

the cash flows back to time

This
all
all the investments and other cash
zero.
puts
flows
For large capital projects, e.g., plants
on an equal footing.
new
criteri
or signifcant additions,
discounted

Copyright - R.Turton and J. Shaeiwitz

2012

a
9

Discounted

Criteri

Proftability

FCIL = 150

1 =90 and year2 =60)

Example
10.1 (all fgures in millions
(year
of $)
WC
= 30
Land
= 10
R = 75
COMd = 30
Depreciatio = MACRS over 5 years
t = 45%
n
S = 10

Project
life, n

= 10 years after
start-up

Copyright - R.Turton and J. Shaeiwitz

2012

10

Discounte Proftabilit Criteri

Land

End of
year,

150.00

(90)

150.00

(60)+(30)=(90)

150.00

30.00

120.00

75

30

48.00

72.00

75

30

28.80

43.20

75

30

k
0

FCIL

2
3

(10)

WC

FCIL-dk

Investment

- FCIL
MACRS = % of

dk

COMd

17.28

23.92

75

30

17.28

8.64

75

30

8.64

0.00

75

30

0.00

75

30

0.00

75

30

0.00

75

30

0.00

85

30

11
12

10+30=40

R COMd = 75-30

WC

= 45
-

38.2
5
46.3
5
37.7
1
32.5
3
32.5
3
28.6
4
24.7
5
24.7
5
24.7
5
30.2
5

Land

R+ Salvage

CF

Disc CF

Disc CF

(10)

(10)

(10)

(10)

(90)

(100)

(81.82)

(91.82)

(90)

(190)

(74.38)

(166.20)

38.25

(151.75)

28.74

(137.46)

46.35

(105.40)

31.66

(103.80)

37.71

(67.69)

23.41

(82.39)

32.53

(35.16)

18.36

(64.03)

32.53

(2.64)

16.69

(47.34)

28.64

26.00

13.36

(33.98)

24.75

50.75

10.50

(23.48)

24.75

75.50

9.54

(13.94)

24.75

100.25

8.67

(5.26)

70.25

170.50

22.38

17.1
2

Cash
flow

10

(R-COMd-dk)(1-t)+dk

Copyright - R.Turton and J. Shaeiwitz

2012

Disc CF = CF /
(1+i)k

11

Discounted Proftability
Same
basis for criteria as before except
Criteria
use the discounted cash
and discounte
we
cumulativ cas flow diagra
flows
d
e
h
m

Copyright - R.Turton and J. Shaeiwitz

2012

12

Discounted
Proftability
Cash
CCP
Basis

Net Present Value,

CC
R

NPV

Criteri
a

Present
discountedValue
cash position at the end of the project
NPV Cumulative

Ratio,
Present Value
of allPVR
Positive Cash Flows
PVR
Present Value of all Negative Cash Flows

Copyright - R.Turton and J. Shaeiwitz

2012

13

Discounted Proftability
Criteria
Time
PBP
Basis

Discounted Payback Period,

DPBP
DPBP =time required, after start-up, to recover
the

fxed capital investment, FCIL,

required for
the project, with all cash flows
Copyright - R.Turton and J. Shaeiwitz
14
discounted
2012

Discounted Proftability
Criteria
Interest
RORO
Basis

Discounted Cash Flow Rate

of

Return, DCFROR
DCFRO = interest or discount rate for which
R

the
NPV of the project is equal to
zero.

Copyright - R.Turton and J. Shaeiwitz

2012

15

Discounte Proftabilit Criteri

d

Copyright - R.Turton and J. Shaeiwitz

2012

16

Discounte Proftabilit Criteri

End of
year,

Investment

dk

FCIL-dk

COMd

(R-COMd-dk)(1-t)+dk

Cash

CF

Disc CF

Disc CF

flow

(10)

150.00

(10)

(10)

(10)

(10)

(90)

150.00

(90)

(100)

(81.82)

(91.82)

150.00

(90)

(190)

(74.38)

(166.20)

38.2
5
46.3
5
37.7
1
32.5
3
32.5
3
28.6
4
24.7
5
24.7
5
24.7
5
30.2
5

38.25

(151.75)

28.74

(137.46)

46.35

(105.40)

31.66

(103.80)

37.71

(67.69)

23.41

(82.39)

32.53

(35.16)

18.36

(64.03)

32.53

(2.64)

16.69

(47.34)

28.64

26.00

13.36

(33.98)

24.75

50.75

10.50

(23.48)

24.75

75.50

9.54

(13.94)

24.75

100.25

8.67

(5.26)

70.25

170.50

22.38

17.1
2

(60)+(30)=(90)

30.00

120.00

75

30

48.00

72.00

75

30

28.80

43.20

75

30

17.28

23.92

75

30

17.28

8.64

75

30

8.64

0.00

75

30

0.00

75

30

10

0.00

75

30

11

0.00

75

30

0.00

85

30

12

10+30=40

Copyright - R.Turton and J. Shaeiwitz

2012

17

Discounte Proftabilit Criteri

d

Copyright - R.Turton and J. Shaeiwitz

2012

18

Comparing Several Large

When
comparing projects with large capital
Projects
investments, the question becomes what
criterion should we use to discriminate
between alternatives?
Consider the following
(fgures are in
example
$millions
)
Initial
NP
DCFROR
Project A
Project B
Project C

Investment
$
60
$12
0
$10
0

V
11.
9
15.
2
15.
9

14.3%
12.9%
13.3%

The capital limit for this year is $120 million

so we
- R.Turton
and
J. Shaeiwitz
may only choose Copyright
A
or
B
or
C.
Which
is best?
2012

19

Comparing Several Large

When comparing projects with large capital

Projects
investments, the question becomes what criterion
should we use to discriminate
between
Consider followin exampl usin a hurdl
the

Project A

After tax
cash
i=1
10

Project B

22

flow in year
i
i=
122 10
22

Project C

12

20

in $millions)

rate

alternative
s?10% (fgure ar
=

Initial

NPV

DCFROR

$ 60

11.9

14.3%

$12
0
$10
0

15.2

12.9%

15.9

13.3%

Investment

The capital
for this year is $120 million so we
limit
or
B or C. Which
may
is only
best?
Copyright - R.Turton and J. Shaeiwitz
2012

choose
A
20

Comparing Several Large

Projects

Compare incremental investment in going from A to Projec C (th

Project
t
e
Start
with lowest
capital
investment Project A NPV is positive
next largest
investment
case)
so this is a viable investment.
investment = $100 $60 = $40
cash flow = $12 - $10 = $2 for year 1
= $20 $12 = $8 for years 2 10
NPV = -40 + 2(P/F, 0.1, 1) + 8(P/A, 0.1, 9)(P/F,
0.1, 1)

= $3.
7

DCFROR
11.9%
Because =
the
incremental investment has a +ve NPV

Project C is

bette
r

than Project A.
Copyright - R.Turton and J. Shaeiwitz
2012

21

Comparing Several Large

Projects

Case 1 Invest $60 in Project A and $40 at a

rate of

10%

Case 2 Invest $100 in Project C

Since
C iswhat
better
A,just
we compared
now
C is
with
next
Basically
wethan
have
the following:
compare
the
largest
investment Project B
investment = $120 $100 = $20

10

cash flow = $22 - $12 = $10 for

9)(P/F, 0.1, 1) = -$0.4
year 1
= $22 $20 = $2 for
years
2
Because the
incremental
investment -ve NPV Project C bette
has
r
NPV a= -20 + 10(P/F, 0.1, 1) + 2(P/A, is
0.1,
DDCFROR = 9.4%
than Project B
Therefore, Project C isCopyright
the best.
- R.Turton and J. Shaeiwitz
2012

22

Comparin Severa Larg Project

g

When comparing large, mutually

exclusive projects the appropriate
criterion is choosing the project
with the highest NPV.

Copyright - R.Turton and J. Shaeiwitz

2012

23

Evaluation of Equipment
Alternatives
Here
we consider equipment alternatives for a
vital
service this means that one of the
always
The
trade-offs
a
alternatives must
beusual
purchased
and are
operated.
available.
capital
investment
higher
for are
a piece of equipment
However,
alternatives
that will
corrosion resistance) or that is
to operate.
either last longer (longer equipment life better
cheaper
lives, a
When comparing equipment with simple
equal
NPV comparison is appropriate.
Copyright - R.Turton and J. Shaeiwitz
2012

24

Evaluation of Equipment Alternatives

Equal
Equipment

an overhead
The service lives for the
alternatives
condenser. are expected
two to be the same (12
Lives
years)
and the
rat of retur for suc compariso is
Example
se
internal
at 10% pa e
n
h
ns
tThe following
.
Alternative
Initial alternatives
Investment Yearly
equipment
areOperating
for
Asuggested
-Air-cooled Condenser
B - Water-cooled
Condenser
Copyrig
ht

$23,00
0
$12,00
0
- R.Turton and J. Shaeiwitz
2012

Cost

$1,50
0
$3,00
0
25

Evaluatio of Equipmen Alternative

n

Alternative

A - Air-cooled Condenser
B - Water-cooled
Condenser

Initial
Investment
$23,000

$12,000

Yearly Operating
Cost
$1,50
0
$3,00
0

Alternative A
NPV =
1,500(P/A, 0.10, 12) -23,000
=
$33,200
Alternative B
NPV =
-12,000

3,000(P/A, 0.10, 12) =

$32,400
Copyright - R.Turton and J. Shaeiwitz
2012

26

Evaluation of Equipment Alternatives

Unequal
Equipment
Lives

Capitalized Cost Method

When the service lives for alternative
Common
Denominator
equipment
choices are Method
different then NPV
be used. There are three methods
cannot
Equivalent Annual Operating Cost Method
to evaluate alternative equipment with
(EAOC)
ranking of alternatives does
unequalThe
lives:
which method is
So just choose one
not
depend on
chosen.
of
them EAOC

Copyright - R.Turton and J. Shaeiwitz

2012

27

Evaluation of Equipment Alternatives

EAO
C

Unequal

Equipment
= (Capital Investment)
+
EAO
Yearly
(A/P,i,neq)
Lives
C
Operating Cost
i(1 i)n
( A / P, i, n)
(1 i)n 1

The EAOC will be positive because it is a

cost.
Therefore, choose the alternative with the smallest
EAOC

Copyright - R.Turton and J. Shaeiwitz

2012

28

Evaluation of Equipment Alternatives

Unequal
Two pumps are considered
for a corrosive
The
Equipment
service.
yearly operating costs include utility and
costs. Which alternative
maintenance
is if the
hurdl
Lives
bestfor thes type of
rat
internal
8% pa
e
is
Example
e
e
s
projects
?
Alternative
A carbon steel
B stainless
steel

Capita
l
$ 8,000
Investment
$16,000

Yearly
operatin
cost
$ g1,800
$ 1,600

Copyright - R.Turton and J. Shaeiwitz

2012

Equipment
life,
years
4
7

29

Evaluation of Equipment
UnequalEquipmen Live
Alternatives
Exampl
t
s
eAlternative

A carbon steel
B stainless steel

EAOC A 8, 000

Capita
l
Investment
$ 8,000

$16,000

0.08(1.08)4
1.084 1

Yearly
operatin
g cost
$ 1,800

Equipment
life,
years
4

$ 1,600

1, 800 $4, 220 per

year

0.08(1.08)7 1, 600 $4, 670 per

EAOCB 16, 000
1.087 1 year
Copyright - R.Turton and J. Shaeiwitz
2012

30

Retroftting Operations Incremental

Analysis

Non-discounted
methods
(nonRate of Return on Incremental
Investment
ROROII

(ROROII)

Incremental Yearly Savings

discounted)
Incremental Investment

Incremental Payback period (IPBP)

IPBP

Incremental Investment
Increemntal Yearly Savings

Copyright - R.Turton and J. Shaeiwitz

2012

31

Retroftting Operations
Incremental
Analysis (nonth dooptio discounted)
all th other to thi on (bas case)
e nothing n
compare
e s
s e e
.
Example
Alternative
Type
Project
Yearly
Cost for the heating
Savings
The following insulationsofare being considered
(PC)
loop to 1
an endothermic
reactor. If a non-discounted
rate (YS)
of0return
Insulation
Non
0
of 15% (equivalent to a IPBP
= 1/0.15 = 6.67 yrs) is set as the
e thick
2
B 1
$3,000
$1,400
hurdle rate for improvement projects such as this, which
3 is best? Note
B 2that
thick
$5,000
$1,900
alternative
alternative
1 is
4

A 1 thick

$6,000

$2,000

A 2 thick

$9,700

$2,400

Copyright - R.Turton and J. Shaeiwitz

2012

32

Retroftting Operations
Analysi (nonIncremental
Example (cont
s
discounted)
d )
Option #
- Option
1 2-1
3-1
4-1
5-1

ROROII

$1,400/$3,000
(47%)
$1,900/$5,000
(38%)
$2,000/$6,000
(33%)
$2,400/$9,700
(25%)

= 0.47
= 0.38
= 0.33
= 0.25

IPBP (years)
$3,000/$1,400 =
2.1
$5,000/$1,900=
2.6
$6,000/$2,000 =
3.0
$9,700/$2,400 =
4.0

Choose the
with the lowest cost that meets the
option
criterion Optionproftability
2. Then compare the option with the next
highest
capital investment using this as the base case.
Copyright - R.Turton and J. Shaeiwitz
2012

33

Retrofttin Operations

Analysi

Example (cont
d )
Option 3
3-2 2
Option

Incremental
ROROII
(non-discounted)
(1,900-1400)/(5,0003,000)

IPBP (years)
$2,000/$500 = 4

= 0.25 (25%)

Since by moving from Option 2 to Project 3, the

proftability
met,
make Option 3 the new base case. Then

criterion
is option
othe

compare
with the new base case.

Copyright - R.Turton and J. Shaeiwitz

2012

34

Retrofttin Operations

Analysi

Example (cont
d )
Option #
- Option
3 4-3
5-3

Incremental
ROROII
(non-discounted)

IPBP (years)

(2,000-1,900)/(6,0005,000)

$1,000/$100 = 10

= 0.1 (10%)
(2,400-1,900)/(9,7005,000)

$4,700/$500 =
9.4

= 0.106 (10.6%)

Since neither of incremental investments in from Option 3

Options
the
4 or 5 meet
going
the proftability criterion Option
to
3 is
the best.
Note that decisions may be made using either 15% or 6.67
yrs as the proftability criterion.
Copyright - R.Turton and J. Shaeiwitz
2012

35

Retroftting Operations Incremental

Analysis

Discounted
Method
(discounted
Determine the incremental
NPV or EAOC for
each
) highes NP or Lowes
choose the alternative with
option (compared to the do-nothing alternative) and
the (highes negativ value) t
EAO
V
t
C
t
e
.

Copyright - R.Turton and J. Shaeiwitz

2012

36

Retroftting Operations Incremental

Example
revisited
rat
of 10% pa
e

usin a projec lif of 5 year an a discounte hurdl

g
t
e
s
d
d
e

Option # - Option
1
2-1
3-1

Analysis

(discounted
)

INPV = -PC +(P/A, i, n)YS

= - 3,000 + [(1.1)5-1]/[(.1)(1.1)5](1,400) =
$2,307 = -5,000+(3.79)(1900) = $2,201

4-1

= -6,000+(3.79)(2,000) = $1,580

5-1

= -9,700+(3.79)(2,400) = -$ 604

Because
2 has the highest
Option 1, Option
NPV
2 is
best.

with respect to the donothing

Copyright - R.Turton and J. Shaeiwitz

2012

37

Retroftting Operations Incremental

Example
revisited
rat
of 10% pa
e

usin a projec lif of 5 year an a discounte hurdl

g
t
e
s
d
d
e

Option # - Option
1
2-1
3-1

Analysis

(discounted
)

EAOC = PC(A/P, i, n) - YS

= (3,000) [(.1)(1.1)5]/[(1.1)5-1] - 1,400 = -$

609 = (5,000)(0.2638) - 1,900 = - $ 581

4-1

= (6,000)(0.2638) - 2,000 = - $ 417

5-1

= (9,700)(0.2638) - 2,400 = $ 158

Because
2 has the most
EAOC with
Option Option Option
nothing
negative
2 is best. Thisrespect
result is
1,
exactly the

to the
do
same as

obtained with the INPV analysis.

Copyright - R.Turton and J. Shaeiwitz
2012

38

Using CAPCOST for Proftability

Go
to COM summary
Calculations
worksheet
Rework
10.1 using
Example
CAPCOST
(yea 1 = 90 and year = 60)
FCI
=
150
Land
L = 10
r
2
WC = 30
R = 75
COMd = 30

t = 45%
S = 10
Depreciation = MACRS
over 5 years
Copyright - R.Turton and J. Shaeiwitz
2012

39