Chapter 10 - Profitability Analysis

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
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

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
2012
Non-discounted Proftability
Criteria
Interest Rate
Rate of Return on Investment =
Criterion
ROROI
Average Annual Net Profit

ROROI
Fixed Capital Investment (FCI )
L

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

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

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

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

2012
Disc CF = CF /
(1+i)k
11
Same
basis for criteria as before except
Criteria
use the discounted cash
and discounte
we
cumulativ cas flow diagra
flows
d
e
h
m

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

2012
13
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
14
discounted
2012
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.

2012
15

d

2012
16

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

2012
17

d

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

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?
2012
choose
A
20

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.
2012
21

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.
2012
22
Comparin Severa Larg Project

g
When comparing large, mutually

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

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.
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
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
2012
26

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

2012
27

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

2012
28

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

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
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

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

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.
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.

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.
2012
35

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
.

2012
36

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

2012
37

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.

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
2012
39

Chapter 10 - Profitability Analysis

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Chapte 10

Cash Flows for a

Low revenue 1st yea

- R.Turton and J. Shaeiwitz

Copyright - R.Turton and J. Shaeiwitz

Cumulative Cash Position,

Sum of all Positive Cash

Average Annual Net Profit

Copyright - R.Turton and J. Shaeiwitz

Sum of all Positive Cash Flows

Average Annual Net Profit

- R.Turton and J. Shaeiwitz

For this type of analysis, we discount

the cash flows back to time

Copyright - R.Turton and J. Shaeiwitz

1 =90 and year2 =60)

Copyright - R.Turton and J. Shaeiwitz

Discounte Proftabilit Criteri

Copyright - R.Turton and J. Shaeiwitz

Copyright - R.Turton and J. Shaeiwitz

Net Present Value,

Copyright - R.Turton and J. Shaeiwitz

Discounted Payback Period,

fxed capital investment, FCIL,

Discounted Cash Flow Rate

Copyright - R.Turton and J. Shaeiwitz

Discounte Proftabilit Criteri

Copyright - R.Turton and J. Shaeiwitz

Discounte Proftabilit Criteri

Copyright - R.Turton and J. Shaeiwitz

Discounte Proftabilit Criteri

Copyright - R.Turton and J. Shaeiwitz

Comparing Several Large

The capital limit for this year is $120 million

Comparing Several Large

Comparing Several Large

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

Comparing Several Large

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

Case 2 Invest $100 in Project C

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

Comparin Severa Larg Project

When comparing large, mutually

Copyright - R.Turton and J. Shaeiwitz

Evaluation of Equipment Alternatives

Evaluatio of Equipmen Alternative

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

Evaluation of Equipment Alternatives

Capitalized Cost Method

Copyright - R.Turton and J. Shaeiwitz

Evaluation of Equipment Alternatives

The EAOC will be positive because it is a

Copyright - R.Turton and J. Shaeiwitz

Evaluation of Equipment Alternatives

Copyright - R.Turton and J. Shaeiwitz

1, 800 $4, 220 per

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

Retroftting Operations Incremental

Incremental Yearly Savings

Incremental Payback period (IPBP)

Copyright - R.Turton and J. Shaeiwitz

Copyright - R.Turton and J. Shaeiwitz

Since by moving from Option 2 to Project 3, the

Copyright - R.Turton and J. Shaeiwitz