Cost Estimation & Economic Analysis

Dr. Suverna Trivedi

Assistant Professor
Department of Chemical Engineering
IIT KHARAGPUR
Topic To be Covered

➢ Project cost estimation

➢ Cost indexes
➢ Net earning
➢ Interest and investment costs
➢ Depreciation
 Cost Estimation

▪ The main motive of starting an industry is to make profits.

▪ Understanding of Process Economics or plant economics is

crucial for process engineer.

▪ The role of Process Economics in chemical plant design involves

➢ Evaluation of designs
❑ Cost data are required to evaluate process designs
➢ Process optimization
❑ Optimizing the process variables plays an important role in
minimizing cost or maximizing profits.
➢ Overall Project Profitability
❑ The economics viability of the project should be assessed at
various stages of the project design.
 Engineering Economics

The decision to construct any plant depends on two major

issues:
▪ Technical feasibility
▪ Economic feasibility

▪ A cost-benefit analysis, rate of return, pay out

period, etc., must be performed before venturing into
a project.
▪ The design engineer must be familiar with the terms
like cash flow, interest rates, depreciation rates,
salvage values of equipment, etc. in order to
understand the economic viability of the project.
 Cost estimation

Approximate estimation Detailed cost estimation

In early stages of design After detailed plant design
(PFD) (design of equipment, PID
diagram)
It is also called budget, Detail estimate is prepared
preliminary estimate with the help of complete
set of contract documents
Quick and approximate Detailed and accurate
estimates estimate
Required for process Required for Project
evaluation and optimization construction and
procedures commissioning before final
tender.
 Capital Investment

▪ Capital is "a stock of accumulated wealth."

▪ Capital is savings that may be used as the owner decides.
▪ One use of the savings is investment; to promote the production
of other goods, to obtain an income or profit.“

▪ Before an industrial plant can be put into operation, a large sum of

money must be available
❑ To purchase Land
❑ To buy required machinery and equipment
❑ To pay for service facilities
❑ To provide piping, controls, and services.
❑ To pay the expenses involved in the plant operation before
sales revenue becomes available
 Capital Investment

❑ Fixed-capital investment (FCI):The capital needed to

supply the required manufacturing and plant facilities is
called the fixed-capital investment (FCI).

❑ Working capital (WC): The capital necessary for the

operation of the plant is termed as the Working Capital.
❑ Total capital investment (TCI)
TCI = FCI + WC
The fixed-capital portion may be further subdivided into:
▪ Manufacturing fixed-capital investment (Direct cost)
▪ Non-manufacturing fixed-capital investment (indirect cost)
 Fixed-Capital Investment
(Direct cost)

▪ Manufacturing fixed-capital investment represents the

capital necessary for the installed process equipment with
all components that are needed for complete process
operation.

▪ It includes expenses for :

❑ Equipment Installation
❑ Transportation And Local Taxes
❑ Instrumentation
❑ Packing Installation
❑ Electrical Assembly
❑ Building (Included Services)
❑ Cost of land
❑ Service facility
 Non-manufacturing fixed-capital investment (Indirect
Cost)
▪ Indirect cost represents the capital required for
▪ All plant components that are not directly related to the
process operation like
❑ Land; processing buildings
❑ Administrative and other offices, Warehouses,
laboratories
❑ Transportation, shipping, and receiving facilities
❑ Utility and waste disposal facilities,
❑ Shops, and other permanent parts of the plant.
▪ The construction overhead cost includes
❑ Field office. supervision expenses,
❑ Home office expenses, engineering expenses,
❑ Miscellaneous construction costs
❑ Contractors' fees, and
❑ Contingencies.
▪ In some cases, construction overhead is proportioned
between manufacturing and nonmanufacturing fixed-
capital investment
 Total capital investment (TCI)

FCI = Direct cost + Indirect cost

TCI = Fixed capital Investment (FCI) + Working capital

(WC)
 Fixed Capital Investment

▪ The fixed capital investment is the total cost of designing,

constructing, and installing a plant and the associated
modifications needed to prepare the plant site.

▪ The fixed capital investment is made up of

❑ The inside battery limits (ISBL) investment—the cost of the

plant itself;

❑ The modifications and improvements that must be made to

the site infrastructure, known as offsite or OSBL investment;

❑ Engineering and construction costs;

❑ Contingency charges
Breakdown of fixed-capital investment items for a chemical
process
Direct costs

1. Purchased equipment (15-40 % of FCI)

▪ All equipment listed on a complete flowsheet
▪ Spare parts and non- installed equipment spares
▪ Surplus equipment, supplies, and equipment allowance
▪ Inflation cost allowance
▪ Freight charges
▪ Taxes, insurance, duties
▪ Allowance for modifications during start-up
2. Purchased-equipment installation (6-14 % of FCI)
▪ Installation of all equipment listed on complete flowsheet
▪ Structural supports
▪ Equipment insulation and painting
3. Instrumentation and controls (2-12 % of FCI)
▪ Purchase, installation, calibration, computer control with
supportive software
Breakdown of fixed-capital investment items for a chemical
process

4. Piping (4-17 % of FCI)

▪ Process piping utilizing suitable structural materials
▪ Pipe hangers, fittings, valves
▪ Insulation
5. Electrical systems (2-10 % of FCI)
▪ Electrical equipment switches, motors, conduit, wire, fittings,
feeders, grounding, instrument and control wiring, lighting,
panels
▪ Electrical materials and labor
6. Buildings and services (2-18 % of FCI)
▪ Process buildings,
▪ Auxiliary buildings
▪ Maintenance shops
▪ Building services
7. Yard improvements (2-5 % of FCI)
▪Site development—site clearing, grading, roads, walkways, railroads,
fences, parking areas, wharves and piers, recreational facilities,
landscaping
Breakdown of fixed-capital investment items for a chemical
process [Direct costs]
8. Service facilities (8-30 % of FCI)

▪ Utilities—steam, water, power, refrigeration, compressed air, fuel,

waste disposal
▪ Facilities—boiler plant incinerator, wells, river intake, water treatment,
cooling towers, water storage, electric substation, refrigeration plant,
air plant, fuel storage, waste disposal plant, environmental controls,
fire protection
▪ Non process equipment—office furniture and equipment, cafeteria
equipment, safety and medical equipment, shop equipment, automotive
equipment, yard material-handling equipment, laboratory equipment,
locker-room equipment, garage equipment, shelves, bins, pallets, hand
trucks, housekeeping equipment, fire extinguishers, hoses, fire engines,
loading stations
▪ Distribution and packaging—raw material and product storage and
handling equipment, product packaging equipment, blending facilities,
loading stations

9. Land (1-2 % of FCI)

▪ Surveys and fees
▪ Property cost
Breakdown of fixed-capital investment items for a chemical
process [Indirect costs]

1. Engineering and supervision (4- 20 % of FCI)

▪ Engineering costs —administrative, process, design and
general engineering, computer graphics, cost engineering,
procuring, expediting, reproduction, communications, scale
models, consultant fees, travel
▪ Engineering supervision and inspection
2. Legal expenses (1- 3 % of FCI)
▪ Identification of applicable federal, state, and local regulations
▪ Preparation and submission of forms required by regulatory
agencies
▪ Acquisition of regulatory approval
▪ Contract negotiations
Breakdown of fixed-capital investment items for a chemical
process [Indirect costs]

3. Construction expenses (4- 17 % of FCI)

▪ Construction, operation, and maintenance of temporary
facilities, offices, roads, parking lots, railroads, electrical,
piping, communications, fencing
▪ Construction tools and equipment
▪ Construction supervision, accounting, timekeeping,
purchasing, expediting
▪ Warehouse personnel and expense, guards
▪ Safety, medical, fringe benefits
▪ Permits, field tests, special licenses
▪ Taxes, insurance, interest
4. Contractor's fee (2- 6 % of FCI)
5. Contingency(5- 15 % of FCI)
 Working Capital

The working capital for an industrial plant consists of the total

amount of money invested in:
▪ Start up operation
▪ Raw materials and supplies carried in stock
▪ Finished products in stock and semi finished products in the
process of being manufactured;
▪ Accounts receivable
▪ Accounts payable
▪ Cash kept on hand for monthly payment of operating expenses
(such as salaries, wages, and raw material purchases)
▪ Taxes payable
 Working Capital

▪ The raw material inventory included in working capital usually

amounts to a 1-month supply of the raw materials valued at
delivered prices.
▪ Finished products in stock and semifinished products have a value
approximately equal to the total manufacturing cost for 1 month's
production.
▪ The working capital required for accounts receivable ordinarily
amounts to the production cost for 1 month of operation.
▪ The ratio of working capital to total capital investment varies with
different companies, but most chemical plants , it varies from10 to
20 percent of the TCI.
▪ This percentage may increase to as much as 50 percent or more for
companies producing products of seasonal demand.
 Total product cost

Total product cost (TPC) = Manufacturing cost (MC)

+
General Expenses (GE)
Manufacturing cost =
Direct production cost + Fixed charges+ Plant overheads

[Link]. Direct production cost Fixed charges General expanses

1 Raw materials Depreciation Administrative costs
2 Operating labour Local Taxes Distribution and
selling cost
3 Direct supervisory and clericial Insurances R &D
labour
4 Utilities Rent
5 Maintainance and repairs
6 Operating supplies
7 Labour charges
8 Patent
9 Plant overhead costs
 Estimation of Total Income

Gross earnings/income = Total income – Total product cost(TPC)

Estimation of total income
Wholesale selling price of product per kg = Rs. X /kg
Annual working days = 300 days
The Production of product per day = Z tons/day
Total annual production of product = Z tons/day x 300days
= 300Z tons/ year
Total income = selling price x quantity of production
= X Rs/kg x 300 Z ton/year x 1000 kg/ton
= 300000*X*Z rupees/year
Gross income = Total income - Total product cost
= 300000*X*Z rupees/year- TPC
 Numerical Problem 2
The purchased-equipment cost for a plant which produces pentaerythritol (solid fuel-
processing plant) is $300,000. The plant is to be an addition to an existing
formaldehyde plant. The major part of the building cost will be for indoor construction,
and the contractor’s fee will be 7 percent of the direct plant cost. All other costs are
close to the average values found for typical chemical plants. On the basis of this
information, estimate the following:
(a) The total direct plant cost.
(b) The fixed-capital investment.
(c) The total capital investment.

Given Data:
▪ Purchased-equipment cost=$300,000
▪ Contractor's fee = 7% of DPC.
▪ Typical chemical plant cost proportions are used:
• Installation = 50% of equipment cost.
• Piping = 25% of equipment cost.
• Instrumentation = 15% of equipment cost.
• Building = 20% of equipment cost (for indoor construction).
▪ Fixed capital indirect cost is 30% of Direct cost
▪ Working Capital is typically 15% of FC
 Net Profit

Net Profit = Gross income – taxes

❑ Rate of return(RoR) : is the net gain or loss of an investment

over a specified time period
Net Profit
ROR = Total capital investment x 100

❑ Pay back period: The payback period refers to the amount

of time it takes to recover the cost of an investment.
Total capital investment
Pay back period =
Net Profit
 Problem 3
A chemical plant has the following estimated costs for its
project:
•Equipment cost (installed): ₹10 crore
•Piping, insulation, and electrical: ₹3 crore
•Land and building: ₹2 crore
•Engineering and contingency: ₹1 crore
•Working capital requirement: 20% of the fixed capital
investment
Find:
[Link] fixed capital investment.
[Link] capital investment
 Problem 4
A project involves a total capital investment of ₹20 crore.
The annual net profit (after taxes and depreciation) is ₹4
crore.
Find: The rate of return on investment (ROI).

Problem 5
Problem 3:A company invests ₹15 crore in a new facility.
The annual cash inflow (profit before depreciation) is
estimated to be ₹3 crore. Find out the payback period.
 Types of Capital Cost Estimates

1. Order-of-magnitude estimate {ratio estimate) based on similar

previous cost data; probable accuracy of estimate over ±30 percent.
(Initial Feasibility and concept screening)
2. Study estimate (factored estimate) based on knowledge of major items
of equipment; probable accuracy of estimate up to ±30 percent. (To
chosen design alternatives)
3. Preliminary estimate (budget authorization estimate or scope estimate)
based on sufficient data to permit the estimate to be budgeted;
probable accuracy of estimate within ±20 percent.
4. Definitive estimate (project control estimate) based on almost
complete data but before completion of drawings and specifications;
probable accuracy of estimate within ±10 percent. (baseline against
actual costs and resources)
5. Detailed estimate (contractor's estimate) based on complete
engineering drawings, specifications, and site surveys; probable
accuracy of estimate within ±5 percent.
Influence Of Design Decisions On Project Cost
 Cash Flow For Industrial Operations

Cash flow is the money that comes in and goes out of a

business or person’s account.
•Money coming in is cash flow in (like sales or
payments received).
•Money going out is cash flow out (like bills, salaries,
or expenses).
 Cash Flow For Industrial Operations

Net profit after tax

Annua Annual
l sales cash
incom income
e

Income tax
Annual Operating costs
Fig 1. Flow scheme for a project resulting in a net profit

Annual
sales
income Annual cash
Annual
income (-ve)
losses

Annual Operating costs

Fig 2. Flow scheme for a project resulting in a loss

 Cash Flow For Industrial Operations
Reservoir and source of capital

Inputs : Loans, stock issues, bond

sales, and other capital sources, and
the cash flow from project
operations.

Outputs: Capital investments in

projects, dividends to stockholders,
repayment of debts, and other
investments

Depreciation charge: Decrease in

value of a facility with time.

Gross profit before depreciation =

Income from sales- Operating costs

Gross profit after depreciation =

Income from sales- Operating costs-
depreciation charge
 Numerical Problem 6

A company is working on a project with the following details:

[Link] sales (Sy​): $1,000,000
[Link] costs (Cw​): $600,000
[Link] (d): $100,000
[Link] tax rate (Φ): 30% of Gross profit

Questions:
[Link] the gross profit for the project.
[Link] the net profit after taxes.
[Link] the net cash flow, considering depreciation.
Cumulative cash position showing effects of cash flow over
the full life cycle
Breakeven chart for chemical processing plant
 Numerical Problem 7

The annual direct production costs for a plant operating at 70 percent capacity
are $280,000 while the sum of the annual fixed charges, overhead costs, and
general expenses is $200,000. What is the break-even point in units of
production per year if total annual sales are $560,000 and the product sells at
$40 per unit? What were the annual gross earnings and net profit for this plant at
100 percent capacity in 1988 when corporate income taxes required a 15 percent
tax on the first $50,000 of annual gross earnings, 25 percent on annual gross
earnings of $50,000 to $75,000, 34 percent on annual gross earnings above
$75,000, and 5 percent on gross earnings from $100,000 to $335,000?
 COST INDEXES
▪ Cost indexes allow engineers, economists, and project
managers to estimate the current cost of a project or
equipment by using past data. They help in comparing costs
across different time periods.
▪ The prices may vary considerably with time due to changes in
economic conditions.
▪ Therefore, some method must be used for updating old cost
data
▪ This can be done by the use of cost indexes.
▪ A cost index is an index value for a given time showing the
cost at that time relative to a certain base time.
COST INDEXES
 COST INDEXES

▪ Many different types of cost indexes are published regularly.

▪ Some can be used for estimating equipment costs; others apply

specifically to labour, construction, materials, or other
specialized fields.

The most common of these indexes are:

❑ The Marshall and Swift index [Equipment of Chemical industries]

❑ Engineering News Record Construction Index [cost of general
construction projects, such as roads, buildings]
❑ The Nelson-Farrar Refinery Construction Index [oil refining and
petrochemical industries.]
❑ The Chemical Engineering Plant Cost Index [chemical process
industries]
Cost Indexes As Annual Averages
Order of Magnitude Estimate
Order of Magnitude Estimate
Cost curve methods

Processes n
Mechanical work or gas compression 0.8 to 0.9
Petrochemical processes 0.7
Small-Scale, highly instrumented processes 0.4 -0.5
Averaged across the whole chemical industry 0.6

▪ The averaged value (0.6) can be used to get a rough estimate of

the capital cost if there are not sufficient data available to calculate
the index for the particular process.
▪ It is commonly referred to as the ‘‘six-tenths rule
References

1. Max S. Peters, Klaus D. Timmerhaus, Ronald E. West,

Plant Design and Economics for Chemical Engineers, 5th Ed,
Mc Graw hill (2003).

2. G. Towler, R. Sinnot, Chemical Engineering Design,

Principles, Practice and economics of plant and process design,
Elsevier (2009).
Thank you

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