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Kuliah Ekonomi Teknik Kimia

JTK FT UGM 2015


Cash flow diagram
Cash flow
Cash operating
Revenue expenses
Operation

Operating income
Depreciation
Depletion
Gross profit
Net profit
Income tax
Profitability
The word profitability is used as the
general term for the measure of the
amount of profit that can be obtained from
a given situation.
Total profit alone cannot be used as the
deciding profitability factor in determining if
an investment should be made.
The profit goal of a company is to
maximize income above the cost of the
capital which must be invested to generate
the income.
Profitability Evaluation
1. Rate of return on investment
2. Payout period
3. Net present worth
4. Discounted cash flow based on full-life
performance
Rate of return on investment
annual profit
ROI 100%
total capital investment
annual profit
ROI 100%
FC WC
Example 1 Determination of rate of return on
investment-consideration of income-tax effects

A proposed manufacturing plant requires an initial


fixed-capital investment of $900,000 and $100,000
of working capital. It is estimated that the annual
income will be $800,000 and the annual expenses
including depreciation will be $520,000 before
income taxes. A minimum annual return of 15
percent before income taxes is required before the
investment will be worthwhile. Income taxes
amount to 34 percent of all pre-tax profits.
Example 1 Determination of rate of return on
investment-consideration of income-tax effects

Determine the following:


(a) The annual percent return on the total initial
investment before income taxes.
(b) The annual percent return on the total initial
investment after income taxes.
(c) The annual percent return on the total initial
investment before income taxes based on
capital recovery with minimum profit.
(d) The annual percent return on the average
investment before income taxes assuming
straight-line depreciation and zero salvage
value.
Example 1 Determination of rate of return on
investment-consideration of income-tax effects

(a) Annual profit before income taxes = $800,000 -


$520,000 = $280,000.
Annual percent return on the total initial
investment before income taxes =
[280,000/(900,000 + 100,000)].(100) = 28 percent.

(b) Annual profit after income taxes =


($280,000)(0.66) = $184,800.
Annual percent return on the total initial
investment after income taxes =
[184,800/(900,000 + 100,000)].(100) = 18.5
percent.
Example 1 Determination of rate of return on
investment-consideration of income-tax effects
(c) Minimum profit required per year before income taxes =
($900,000 + $100,000).(0.15) = $150,000.
Fictitious expenses based on capital recovery with
minimum profit = $520,000 + $150,000 = $670,000/year.

Annual percent return on the total investment based on


capital recovery with minimum annual rate of return of 15
percent before income taxes = [($800,000 -
670,000)/(900,000 + 100,000)].(100) = 13 percent.

(d) Average investment assuming straight-line depreciation


and zero salvage value = $900,000/2 + $100,000 =
$550,000.
Annual percent return on average investment before
income taxes = (280,000/550,000).(100) = 51 percent.
Payout period
Other equivalent names are payback period, payback time, payoff period,
payoff time, and cash recovery period
Example 2. POT
Use the data in example 1. In addition, it is estimated
that the salvage value at end of service life is $100,000.
Use straight line depreciation. Determine the minimum
pay-out-time without interest charge.
Solution:
Depreciable fixed-capital investment = FC SV
= $900,000 - $100,000 = $800,000
Depreciation = $800,000 / 5 = $160,000
Profit before tax = $800,000 - $520,000 = $280,000
Profit after tax = ($280,000)(0.66) = $184,800
POT before tax = $800,000 / ($280,000 + $160,000) =
1.8 years
POT after tax = $800,000 / ($184,800 + $160,000) = 2.3
years
Net Present Worth (NPW)

The calculations may be made using discrete or


continuous interest.
Rate of Return Based on
Discounted Cash Flow
Common names of methods of return calculations
related to the discounted-cash-flow approach are
profitability index, interest rate of return, true rate
of return, and investors rate of return.

In principle, the technique is similar to the NPW


method.
NPW calculation uses interest rate set by the company.
IRR is the calculated interest rate that will produce NPW
equal to zero.
Example 3: DCFRR & NPW
Consider the case of a proposed project
for which the following data apply:
Initial fixed-capital investment = $100,000
Working-capital investment = $10,000
Service life = 5 years
Salvage value at end of service life =
$10,000
Example 3: DCFRR & NPW
Year Predicted after-tax cash flow to project
based on total income minus all costs
except depreciation, $
(expressed as end-of-year situation)
0 - 110,000
1 30,000
2 31,000
3 36,000
4 40,000
5 43,000
Example 3: DCFRR & NPW
Determine:
a. Net Present worth if the value of capital to
the company is at an interest rate of 15
percent
b. Discounted-cash-flow rate of return with
discrete interest
c. Discounted-cash-flow rate of return with
continuous interest
a. Computation of net present worth

Year Estimated cash i = 0.15


flow, $ Discount factor: 1 Present value, $
1 i n
0 - 110,000
1 30,000 0.8696 26.100
2 31,000 0.7561 23,400
3 36,000 0.6575 23,300
4 40,000 0.5718 22,900
5 43,000 + 0.4971 31,300
20,000
Total 127,000

NPW = $127,000 $110,000 = $17,000


b. Computation of discounted-cash-flow rate of return
with discrete interest
Year Estimated cash Trial i = 0.15
flow, $ Discount factor: 1 Present value, $
1 i n
0 - 110,000
1 30,000 0.8696 26.100
2 31,000 0.7561 23,400
3 36,000 0.6575 23,300
4 40,000 0.5718 22,900
5 43,000 + 0.4971 31,300
20,000
127,000
total present value
Ratio
total investment 1,155

Trial i, to get ratio = 1 WC + SV


b. Computation of discounted-cash-flow rate of return
with discrete interest
Year Estimated cash Trial i = 0.1763
flow, $ Discount factor: 1 Present value, $
1 i n
0 - 110,000
1 30,000 0.8501 24852
2 31,000 0.7227 21273
3 36,000 0.6143 20465
4 40,000 0.5222 18837
5 43,000 +
0.4440 24577
20,000
110005
total present value
Ratio
total investment 1,0000

DCFRR with discrete interest = 17.63%


c. Cash flow for computation of discounted-cash-
flow rate of return with continuous interest

Year Predicted after-tax cash flow to project


based on total income minus all costs except
depreciation with cash flow occurring
continuously, S (total of
continuous cash flow for year indicated)
1 30,000
2 31,000
3 36,000
4 40,000
5 43,000
c. Computation of discounted-cash-flow rate of return
with continuous interest

Year Estimated Trial i = 0.2249


cash flow, Discount factor: Present value, $
$
Fb Fa
0 - 110,000
01 30,000 0.8955 26,866
12 31,000 0.7152 22,170
23 36,000 0.5711 20,561
34 40,000 0.4561 18,244
45 43,000 0.3642 15,663
5 + 20,000 0.3248 6,496
Total 110,000
Trial i, to get total PW = 110,000
DCFRR with continuous interest = 22.49%
c. Computation of discounted-cash-flow rate of
return with continuous interest

Fa = Discount factor to give present worth for cash


flows which occur in an instant at a point in time
after the reference point.

Fb = Discount factor to give present worth for cash


flows which occur uniformly over one-year periods
after the reference point. (S is the total cash flow
for the nth year.)
References
Peters, M.S., Timmerhaus, K.D., Plant
Design and Economics for Chemical
Engineers, 4th ed., McGraw Hill, New
York, 1991
Couper, J.R., Process Engineering
Economics, Marcel Dekker, Inc., New
York, 2003