Lecture # 6 cost estimation ii

Lecture # 6
Cost estimation
Capital and Total Product Cost-Part 2
1 Dr. A. Alim

2
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.

3
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) Contractor’s fee is explicitly specified as 7% of direct plant cost.
4
McGraw Hill, © 2003 , by Peters, et al., and also from Engineering Economics 4N04 class notes,
McMaster University © 2001-2007.

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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) Contractor’s 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) = $1.08 x 106
Total indirect costs = 3.78 x 105 + 0.013 (FC) = $0.4 x 106
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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 = 1.08
Indirect costs = 0.4
Fixed capital = 1.48 = 87% of TCI
Working capital = 0.225 = 13% of TCI
Total capital (TCI) = 1.71
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COST ESTIMATION
Analysis of Product costs/Expenses
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ANALYSIS OF COST ESTIMATION
Capital Costs
• Fixed capital
•Manufacturing (direct)
•Nonmanufacturing (indirect)
• Working capital
Product Costs
• Manufacturing costs
•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.
• Variable (direct) -
materials, labor, utilities,
supplies, waste
treatment, etc.
• Fixed (indirect) –
insurance, depreciation,
plant administration, etc.
• Overheads
production
production
Labor
production
Materialstreams
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Total Product Cost (TPC) = Manufacturing Costs + General Expenses
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Typical Breakdown of Total Product
Cost (TPC)
• Manufacturing Cost:
– Variable (direct) manufacturing cost 66%
– Fixed (indirect) manufacturing cost 10% - 20%
– Overheads 5% - 15%
• General expenses 15% - 25%
13

14
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,
Depreciation is not a cash flow,
rather it is a deduction for tax
calculation purposes.

15

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.
16
Cash Flow For
Industrial Operations

GI - E:
Gross profit, or
CFBT
CFAT:
Cash flow
after taxes
= NP + D
= CFBT - Taxes
TI:
Taxable income =
GI – E - D
D: Depreciation
Taxes =
TI (te)
NP:
Net profit, or
Net earnings =
TI (1 - te)
17

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
18Material used in this lecture is sourced from "Plant Design and Economics for Chem. Engineers", 5th ed.

ANALYSIS OF COST ESTIMATION
Cumulative Cash Position
19
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.

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?
20

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 = GI – (direct costs + indirect costs)
= 800,000 – (0.5) 800,000 – 200,000
= $200,000
Then 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
21

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?
22

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
23Material used in this lecture is sourced from "Plant Design and Economics for Chem. Engineers", 5th ed.

Homework # 2
January 30, 2014
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The following solved examples
from Blank and Tarquin, 7th edition (2012)
Example 15.2 Page 392
Example 15.4 Page 394
The following solved examples
from Peters, et al. 5th edition (2003)
Example 6-1 Page 240
Problems 6-1 and 6-2 Page 275
Problem 6-13 Page 277

(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.
26
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,

27
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,

28
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.

29
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.

30
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) Manufacturing cost per kilogram of product
b) Total product cost per year
c) Taxable income (TI) per kilogram of product.
d) 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

TPC = [Σ (all terms not depending on TPC)]/ [l – Σ (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 =($1.244*106/y)/(3*106 kg/y) = $0.417/kg
cost per kg product
b) Total product = $ 1.427 x 106 per year
cost per year
c) TI per kg = [GI – (E + D)] / production rate $/kg
= selling price, $/kg - TPC/kg
= $0.82 - ($1.427*106)/(3*106)
= $0.344/kg
d) Net profit after tax = NP = {GI – (E + D)}(1 – te)
= ($0.344/kg)(1 - 0.35) = $0.224/kg
TPC including
depreciation
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