16 PLANT VALUATION & CONSTRUCTION COST 16.1 Plant Valuation Plant Valuation can be determined using a variety of methods. The appropriate method will be determined by the need. For example, for insurance purposes, valuation would be based on fair market value or replacement value. Financial value is based on historical cost. For acqui- sition purposes, an operating plant would be valued as a going concern while a shut down plant would be assessed at the break-up value of the assets. Financial Value is the historical cost of the assets less depreciation and depletion and is the easiest valuation to obtain. As a going concern, asset value can be derived from the standard financial equation: or: CA+FA+OA = CLHLD+E where CA = current assets (cash equivalents & accounts receivable) FA = fixed assets (original cost less depreciation and depletion) OA = other assets (non producing assets & intangible assets) CL. = current liabilities (payables and current portion of LD) LD = long term debt (maturity greater than one year) E = equity or: Valuation = FA+ OA +(CA-CL) = LD+E where (CA-CL) = net working capital For most purposes, excluding financial reporting and return-on-invest- ment calculations, the financial value of an asset is of little use. This is especially true during periods of rising prices when historical cost misrepresents the current cost of the assets being valued. Fair market value of a plant can be determined using several methods Briefly, the fair market value of an asset represents the amount a Cement Plant Operations Handbook * 201 a”) 4 P= = a i Pd << i = fo} r=willing buyer would pay to a willing seller, neither under compulsion to participate in the transaction, and where both have full knowledge of the facts and circumstances regarding the transaction. In practice, of course, this situation rarely exists. Discounted Cash Flow values an asset based upon the net present value (NPV) of all the after tax cash flows the asset produces over a period of time, ideally twenty years or more, including the residual value (RV). Valuation = NPV [R (CFyr1, CFya... CFyrx + RV)] where R = discount (interest) rate The calculation of the cash flow resulting from the asset requires subjective assumptions. This is especially true with the cash flows (rev- enues) due to the uncertainty of projecting volumes and prices into the future. The effect of this uncertainty can be minimized by preparing values based on ‘most likely’ and ‘worst case’ projections. In valuing an asset for investment purposes, the discount rate will equal the investor's after-tax cost of capital. Current Cash Equivalent values an asset at the present realisable price that would be received from the sale of the asset under orderly (non- distress) conditions. The realisable price would be based on recent sales of comparable assets adjusted for known differences such as capacity, technology and location. This value represents a floor price without allowance for goodwill (going concern value). Replacement Value is the current cost to replace the asset adjusted for depreciation to recognise wear-and-tear and obsolescence. Depreciation is based on replacement cost less salvage value divided by useful life. In practice it is desirable to employ all or several of the above valuation methods and apply a sanity test upon completion. Several projects and acquisitions in recent years doubtless resulted from sophisticated eco- nomic analysis but clearly failed the sanity test. Asa going concern, plant valuation can be based upon: @ Replacement value applying depreciation for wear-and-tear and obsolescence to current new replacement cost. For financial reporting 202 » Cement Plant Operations Handbookpurposes (as opposed to tax write-off which may be accelerated), depreciation schedules are typically straight-line over: Mobile equipment 3-10 years Machinery & equipment 10-20 years Buildings 20-40 years & Net earnings (after interest, amortisation, depreciation, and tax) adjusted for the average market P/E ratio of comparable companies and the average acquisition premium of comparable deals. Valuation = Net earnings x P/E + premium P/E ratios and acquisition premiums vary considerably with time and market area. The premium might be 33% and average P/E ratios are: Europe 11.9 United States and Mexico 86 Japan and Taiwan 19.0 (ICR; 5/2001, pg 17). Simple share-price / earning-per-share ratios are considered crude para- meters due to distortions of earnings by items such as depreciation. An alternative measure has been proposed which takes the ratio of enter- prise value (debt + market value of equity — estimated market value of non-relevant assets) to cash flow (annual cash flow from core business before interest, taxes and depreciation). This EV /CF ratio, though more complex to determine, does give a more realistic measure than P/E. If the subject plant is part of a multi-plant company, determination or confirmation of appropriate profit centre figures is necessary as cost allocation or transfer pricing practices may cause distortion. A particular problem is encountered when attempting to value opera- tions or perform cost/benefit analyses in countries subject to subsidies and price controls. ‘Shadow pricing’ is an attempt to impute free mar- ket costs and prices. Foreign exchange risk is nearly always significant in developing coun- tries as local currency finance, if available, is prohibitively expensive. Devaluation will, almost inevitably, be followed by direct or indirect control of product prices while debt service, spare parts, imported sup- plies, and, usually, fuel is payable in hard currency. Hedging is, of course, possible but expensive and a number of companies in South East Cement Plant Operations Handbook * 203 7 P= P= a S a. 5 om oO PadAsia have suffered from this exposure to an extreme degree since 1997. Inherent in the calculation of future earnings is a market projection over the life of the investment. Such long term projections are never easy but are particularly fraught when considering developing markets. A review of long term forecasting methods is given by Joos (ICR; 8/1992, pg 29). 16.2 New Plant Construction New green-field cement plants cost $200-300 per tonne of annual pro- duction, while kiln expansions cost $80-150 depending upon the usable excess capacity of existing ancillary equipment and storage. Permitting of heavy industrial facilities becomes ever more difficult and expensive, so that considerable intangible value may attach to an existing opera- tion and its market, even if the equipment is antiquated and inefficient. Obviously, profitable markets suck in imports from low cost producers and, unless protected geographically, by tariffs or by other regulation, high margins tend to be ephemeral. Also, the lead time for new capac- ity and the cyclical nature of most cement markets enhance both risk and reward for building new cement plants. A typical project cost for adding a new 1.5 million tonne/year line to an existing plant is: Equipment Quarry equipment Us$3,000,000 Raw milling & blending 13,000,000 Kiln, preheater & cooler 18,000,000 Coal system & storage 5,000,000 Clinker storage 3,000,000 Cement milling 9,000,000 Cement storage and packing 3,000,000 Electrical & control 9,000,000 Sub-total $63,000,000 Civil, structural & erection $38,000,000 Engineering, construction management, freight, $19,000,000 commissioning Owner's capitalised cost $5,000,000 Construction interest $14,000,000 Spares $4,000,000 Contingency (5%) 7,000,000 Total project cost $150,000,000 204 * Cement Plant Operations HandbookThere is a considerable variation due to specification, location, degree of local fabrication, labour and materials costs, and cost of capital. There is also considerable variation in schedule for construction. Conventionally, process and preliminary engineering design, and permitting are completed before procurement and contract bidding begin. However, where expedition is essential the risks of overlapping engineering with construction are sometimes accepted though the cost penalty is unpredictable and usually severe. Site preparation is also frequently performed by plant forces or separately contracted. Then, assuming permitting does not impact the critical path, a typical sched- ule would be: "~ ie Pd = =r — Pad me 5 om (2) = Cumulative Start detailed engineering 0 months Issue tender documents 2 Contracts for equipment and construction 5 Ground breaking 7 Complete civil work 12 Major equipment delivered 12 Complete mechanical erection 18 Complete electrical and instrumentation 20 Begin commissioning 21 Commercial operations 24 Cement Plant Operations Handbook * 205