Lecture # 6 Cost Estimation II

Lecture # 6
Cost estimation Capital and Total Product Cost-Part 2
Dr. A. Alim
Material used in this lecture is sourced from "Plant Design and Economics for Chem. Engineers", 5th ed. McGraw Hill, 2003 , by Peters, et al., and also from Engineering Economics 4N04 class notes, McMaster University 2001-2007.
Important: In absence of specific known cost data, the use of the previous tables, 6-3, 6-9 and 6-17 is adequate. However, when the costs of certain items are already known, such known data must be used instead of the percentages given in the tables.
The following example illustrates this concept:
Problem 6-8, Peters book, page 276:
Notes: 1) Indoor construction is the most expensive type of building. 2) Contractors fee is explicitly specified as 7% of direct plant cost.
Solution: Table 6-9 shows the cost components as typical percentages of purchased Equipment cost Q. In this problem, however, two of these components were specified differently. These are: 1) Buildings: stated as expensive. Hence we choose the top of the range in table 6-3. We will assume 18% of fixed capital (FC) Replacing the 29% of Q by 18% of FC, we then have: Total direct cost = (3.02) Q - 0.29 (Q) + 0.18 (FC) With Q = $300,000; total direct costs = 8.19 x 105 + 0.18 (FC) 2) Contractors fee is stated as 7% of direct costs. Replacing the 19% of Q by 7% of direct costs, we have: Total indirect cost = (1.26) Q 0.19 (Q) + 0.07{ 8.19 x 105 + 0.18 (FC)} = 3.78 x 105 + 0.013 (FC)
FC = direct costs + Indirect costs = 1.197 x 106 + 0.193 (FC)

Solving for FC = $ 1.48 x 106 Total direct costs = 8.19 x 105 + 0.18 (FC) Total indirect costs = 3.78 x 105 + 0.013 (FC) = $1.08 x 106 = $0.4 x 106
Solution (contin.)
From table 6-9, working capital (WC) = 0.75 Q = 0.75 (300,000) = $ 225,000 Hence, Total capital investment = Fixed capital + Working capital = $ 1.48 x 106 + $ 0.225 x 106 = $ 1.71 x 106
Summary (in millions of dollars): Direct costs Indirect costs Fixed capital Working capital Total capital (TCI) = 1.08 = 0.4 = 1.48 = 0.225 = 1.71
= 87% of TCI = 13% of TCI
COST ESTIMATION
Analysis of Product costs/Expenses
ANALYSIS OF COST ESTIMATION

Capital Costs Fixed capital Product Costs Manufacturing costs
Manufacturing (direct)
Nonmanufacturing (indirect) Working capital
Variable costs
Fixed costs Overhead costs General expenses
Administrative expenses
Distribution & Marketing costs R&D
Total Product Cost = manufacturing costs + General expenses Red : designates fixed (indirect) costs Green : designates variable (direct) costs
Hence, Total Product Cost = Total direct costs + Total indirect costs
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COST ESTIMATION
MANUFACTURING COSTS - These are incurred with every unit of production and do not include capital items.
Labor
Variable (direct) materials, labor, utilities, supplies, waste treatment, etc. Fixed (indirect) insurance, depreciation, plant administration, etc. Overheads
Material streams
production
production
production
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Total Product Cost (TPC) = Manufacturing Costs + General Expenses

Material used in this lecture is sourced from "Plant Design and Economics for Chem. Engineers", 5th ed. McGraw Hill, 2003 , by Peters, et al., and also from Engineering Economics 4N04 class notes, McMaster University 2001-2007. 12
Typical Breakdown of Total Product Cost (TPC)

Manufacturing Cost:
Variable (direct) manufacturing cost Fixed (indirect) manufacturing cost Overheads 66% 10% - 20% 5% - 15%
General expenses
15% - 25%
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Depreciation is not a cash flow, rather it is a deduction for tax calculation purposes.
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Cash Flow For Industrial Operations
Material used in this lecture is sourced from "Plant Design and Economics for Chem. Engineers", 5th ed. McGraw Hill, 2003 , by Peters, et al., and also from Engineering Economics 4N04 class notes, McMaster University 20012007.
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TI: Taxable income = GI E - D
Taxes = TI (te) NP: Net profit, or Net earnings = TI (1 - te)
GI - E: Gross profit, or CFBT
CFAT: Cash flow after taxes = NP + D = CFBT - Taxes
D: Depreciation
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Gross Profit, Net Profit, and Cash Flows

For any year: Gross Profit = GI E Also called CFBT
Taxable income TI = GI E D
Taxes = TI (te) Net Profit = Np = TI (1-te) Cash Flow = A = Np + D Also called CFAT
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ANALYSIS OF COST ESTIMATION Cumulative Cash Position
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Problem 6-15, Peters book, page 277

A company has direct production costs equal to 50% of total annual sales (GI), and indirect production costs (fixed charges, overhead, and general expenses) equal to $200,000. Annual sales amount to $800,000. If management proposes to increase annual sales to compensate for a 20% increase in indirect costs, and maintain same gross profit. What is the new sales level?
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Problem 6-15, Peters book, page 277

A company has direct production costs equal to 50% of total annual sales (GI), and indirect production costs (fixed charges, overhead, and general expenses) equal to $200,000. Annual sales amount to $800,000. If management proposes to increase annual sales to compensate for a 20% increase in indirect costs, and maintain same gross profit. What is the new sales level? Gross profit = GI E = = = Then 200,000 = = GI (direct costs + indirect costs) 800,000 (0.5) 800,000 200,000 $200,000 new GI (direct costs + 1.2 indirect costs) new GI (0.5)(new GI) 1.2(200,000)
solve for new GI = $880,000

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Problem 6-15, Peters book, page 277 (contin.)

If the annual depreciation is $70,000, and tax rate is 35%, what is the net profit after tax and the annual cash flow?
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Problem 6-15, Peters book, page 277 (contin.)

If the annual depreciation is $70,000, and tax rate is 35%, what is the net profit after tax and the annual cash flow? NP = TI (1-te) = (GI E D) (1-te) = (200,000 70,000) (1 0.35) = 130,000 (1 0.35) = $ 84,500
Net cash flow (also known as CFAT) = NP + D = 84,500 + 70,000 = $154,500 Also equal to (CFBT taxes) = 200,000 130,000(0.35) = $154,500
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Homework # 2
January 30, 2014
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The following solved examples from Blank and Tarquin, 7th edition (2012)
Example 15.2 Example 15.4 Page 392 Page 394
The following solved examples from Peters, et al. 5th edition (2003) Example 6-1 Example 6-3 Example 6-6 Problems 6-1 and 6-2 Problem 6-13 Page 240 Page 251 Page 264 Page 275 Page 277
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(problems 6-1 and 6-2, page 275, Peters, et al.): The purchased cost of a shell-and-tube heat exchanger (floating-head and carbon-steel tubes) With 10 m2 of heating surface was $4200 in 1990. What was the 1990 purchased cost of a similar heat exchanger with 20 m2 of heating surface if the purchased cost capacity exponent is 0.60 for surface areas ranging from 10 to 40 m2? If the purchased cost capacity exponent for this type of exchanger is 0.81 for surface areas ranging from 40 to 200 m2, what will be the purchased cost of a heat exchanger with 100 m2 of heating surface in 2010? Plot the 2010 purchased cost of the shell-and-tube heat exchanger outlined above as a function of the surface area from 10 to 200 m2. Use the Marshall and Swift process industry installed equipment index and assume the value of this index in 2010 is 1565.
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Spreadsheet calculation of TPC Problem 6-13, page 277

"Plant Design and Economics for Chem. Engineers", 5th ed. McGraw Hill, 2003 , by Peters, et al.
The total capital investment for a conventional chemical plant is $1,500,000, and the plant produces 3 million kg of product annually. The selling price of the product is $0.82/kg. Working capital amounts to 15 percent of the total capital investment. The investment is from company funds, and no interest is charged. Delivered raw materials costs for the product are $0.09/kg; labor, $0.08/kg; utilities, $0.05/kg; and packaging, $0.008/kg. Distribution costs and R&D costs are 5% and 4% of TPC, respectively. Estimate the following: a) b) c) d) Manufacturing cost per kilogram of product Total product cost per year Taxable income (TI) per kilogram of product. Net Profit after tax per kilogram of product if income tax rate is 35%
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Product Costs
Manufacturing costs
Variable costs Fixed costs Overhead costs General expenses Administrative expenses Distribution & Marketing costs R&D
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TPC = [ (all terms not depending on TPC)]/ [l (Factorj)] = (1.244 + 0.055) x 106 / (1 - 0.09) = $ 1.427 x 106 per year The following calculations are made from the spreadsheet results: a) Manufacturing cost per kg product b) Total product cost per year c) TI per kg =($1.244*106/y)/(3*106 kg/y) = $0.417/kg = $ 1.427 x 106 per year
TPC including depreciation
= [GI (E + D)] / production rate $/kg = selling price, $/kg - TPC/kg = $0.82 - ($1.427*106)/(3*106) = $0.344/kg = NP = {GI (E + D)}(1 te) = ($0.344/kg)(1 - 0.35) = $0.224/kg
d) Net profit after tax
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Lecture # 6 Cost Estimation II

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Lecture # 6 Cost Estimation II

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Lecture # 6

Cost estimation Capital and Total Product Cost-Part 2

The following example illustrates this concept:

Problem 6-8, Peters book, page 276:

FC = direct costs + Indirect costs = 1.197 x 106 + 0.193 (FC)

= 87% of TCI = 13% of TCI

Analysis of Product costs/Expenses

ANALYSIS OF COST ESTIMATION

Total Product Cost (TPC) = Manufacturing Costs + General Expenses

Typical Breakdown of Total Product Cost (TPC)

Cash Flow For Industrial Operations

TI: Taxable income = GI E - D

Taxes = TI (te) NP: Net profit, or Net earnings = TI (1 - te)

GI - E: Gross profit, or CFBT

CFAT: Cash flow after taxes = NP + D = CFBT - Taxes

Gross Profit, Net Profit, and Cash Flows

ANALYSIS OF COST ESTIMATION Cumulative Cash Position

Problem 6-15, Peters book, page 277

Problem 6-15, Peters book, page 277

solve for new GI = $880,000

Problem 6-15, Peters book, page 277 (contin.)

Problem 6-15, Peters book, page 277 (contin.)

Spreadsheet calculation of TPC Problem 6-13, page 277

d) Net profit after tax

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