CASH FLOW ANALYSIS Ivan V.

Klumpar Ledgemont Laboratory Kennecott Copper Corporation Lexington, Massachusetts 02173

Computers

in Project

Analysis

Ledgemont Laboratory looked grams that would do the following

for computer jobs:

pro-

The criterion that must be continuously applied to measure the progress of a project is economics. Engineering aspects, though equally important, can usually be reduced to economic criteria. The method of determining the technical and economic feasibility of new or modified processes is called project analysis. It consists of the following steps: A. Engineering 1. 2. 3. 4. Flowsheet preparation Material balance calculations Equipment sizing Determination of operating requirements (raw materials, utilities, labor, etc.)

(a) Fixed investment and depreciation tion based on specified cost of individual ment units or plant sections.

estimaequip-

(b) Working capital and operating cost estimation followed by cash flow and profitability computation based on specified fixed investment cost and operating requirements. (c) Both programs should have the option of applying various depreciation criteria within the same project. They should also include features typical for the mining industry such as investment expense, depletion, etc. (d) The programs should be structured to fit into one of the available sensitivity risk analysis systems. so as and

B.

Economics 5. 6. 7. 8. 9. 10. 11. 12. 13. Sales volume and price forecasting Equipment costing Investment cost estimation Operating cost estimation Profitability computation Sensitivity analysis Risk analysis Optimization Decision analysis

The Ledgemont Investment and Depreciation Program was reported at the AACE St. Louis Meeting last year (6). This paper presents the second program which is called Cash Flow Analysis (CFA). The objectives of the program will be discussed in detail in the following section and the structure to meet these objectives will be explained subsequently. Program Objectives

Computers have been proposed and used for each step or combinations of several steps. Process simulation programs such as FLOWTRAN(l), CAPS, Pool, 'PDA (2), and PEP (3) are particularly popular. These systems encompass steps 2, 3, 4 or 2, 3, 4, 5 or 2, 3, 4, 6, 7, 9. The disadvantage of these programs is in that they are too large and diEficult to use. These problems are overcome by the PROVES system (4,5) which covers steps 2 through 10 but also makes it possible to USC each step separately. However, PROVES is marketed only as a package and was written primarily for the chemical industry. According to R & D and engineering experience, there is an order of magnitude difference in the frequency in which project analysis steps are used. In a given period of time, say one year, roughly ten times as many profitability computations are made as detailed investment cost estimates that involve individual equipment sizing. During the same period, probably only about one tenth as many complex material balances would be calculated that would requir's the use of a process simulation program. 263

As stated above, fixed investment cost is specified by the user rather than estimated by the program. It comprises depreciable capital (equipment, buildings, etc.), non-depreciable capital (e.g., land), investment expense (e.g., cost of overburden removal in mining). Fixed investment is broken down into individual outlays that occur at different times and/or have different depreciation lives and methods of calculation straight line versus double declining bal(e.g., ance). Outlays for replacements should be distinguished from those for plant expansion. The user should also have the option of specifying fixed capital salvage values at the end of the project as well as potential recoveries of any funds such as patent rights or royalties. For each year of the project, operating cost is computed based on production rates and requirements for raw materials, utilities and labor. Raw materials and utilities cost is a sum of individual unit costs times consumption. Operating labor cost is conveniently expressed as the product of the number of operators and the average pay scale rather than using a manning table and labor rates for individual jobs. Other operating cost items can be approximated as percentages of either de-

preciable capital or operating labor cost. They include supervision, services, maintenance, materials and supplies, property taxes, insurance, and In operating administrative and general expense. cost computations, allowance for escalation due to inflation should be made. It is convenient to such as selling and diskeep corporate charges, tribution cost and corporate office overhead, etc., separated. They can be estimated as percentages of sales. Irregular costs, such as research and development and startup expense, should also be treated separately. Working capital can be expressed for each year as a sum of accounts receivable and payable, operating cash and inventories of raw materials, finished goods, work-in-progress, and maintenance materials and supplies. The individual items are conveniently approximated as percentages of either annual sales, operating cost, payroll cost, raw material cost or depreciable capital. As an option, the working capital salvage value should be included in the last year of the project. In operating cost and working capital estimations, allowance should be made for extra items not covered by the standard components. Negative items They would represent, for should be admissible. instance, a by-product credit in case of operating cost. Additional data, such as sales revenues and tax, depletion and discount rates, have to be provided for year-by-year cash flow calculations. Operating income is defined as the difference between sales and all annual costs. The latter include operating cost, depreciation, corporate and R & D and startup expenses if any. charges, There are different ways of handling the complex effect of taxes on cash flow. A conservative way, suitable for preliminary economic estimation used in project analysis, considers only tax depreciation. Tax credits are neglected and losses If depletion allowance are not carried forward. applies, it is estimated as a fixed percentage of 15% for copper concentrate) or one sales (e.g., half of the operating income, whichever is less. Taxes are based on the taxable income which is defined as operating income minus depletion. Net income (after taxes) is the difference between Cash flow equals net operating income and taxes. income plus depreciation minus total investment if there is any in the particular year. Among the various proposed profitability inonly net present value (NPV) and discoundicators, ted cash flow (DCF) rate of return are used in the NPV is defined as the sum of annual disprogram. life of the counted cash flows over the financial project. DCF rate of return is the discount rate at which NPV equals zero. It was attempted to make the program as simple and readily usable as possible without sacrificing flexibility. In or,der to do that, two objectives were set up:

(b) Avoid too many zeros in the input. The number of input data required should not be fixed but rather controlled so as to match the requirements of each case. Investment and Operating Cost

The specification of individual fixed investment outlays can't be avoided but, fortunately, as a rule, they do not occur every year. However, separate input for an expansion and replacement outlay is not necessary because the former can be distinguished by a change in plant capacity specified for the same year. Operating cost and working capital are computed from a few basic input data using standard factors as was discussed before. It is advantageous to specify a complete set of values of the standard factors for a regular- year only and allow for adjustments in those years that differ from the regular case. Operating costs can be broken down into the following components: - Production materials - Depreciable maintenance - Operating vision volume capital labor dependent, dependent, such as raw such as

dependent,

such as super-

At this point, it is important to note the difference between plant capacity and prodllction volume changes. Lower volumes usually occur for a few years at the beginning of the economic life as the capacity is not reached because of startup problems or sales restrictions due to lack of demand for a new product. If the lower volumes are specified for the particular years, the program will adjust the volume dependent operating cost component while leaving the other two components constant. On the other hand, any plant expansion will also affect the capital dependent and labor dependent components. For example, maintenance labor cost can be predicted, say, at 3% of depreciable capital. The 3% is the factor and capital is the basis. Obviously, a 100% increase in capital does not necessarily call for the doubling of the maintenance labor force. It is, however, advantageous to make the program use a linear relationship between these variables unless the user specifies a modifier. These modifiers can indicate, for instance, a change in each standard factor. It turns out, however, that the number of input data can be reduced if the factors are kept constant while the basis is modified. For example, if the maintenance labor cost of a $10 million plant is $300,000 a year at 3% and that of a $20 million plant is $540,000, the latter can be expressed as 3% on an $18 million basis which is nine-tenths of the $20 million plant. The modifier of 0.9 is applied to all capital dependent items of opera ting cost. Similar modifiers are also used for the labor dependent and volume dependent components. Modifiers may also be greater than 1.0, for instance, to account for a higher raw materi. al usage per unit production volume during startup 264

Data should (a) Avoid a voluminous input. be normalized so as to eliminate the nec.essity of specifying separate values of input variables for each year.

Similarly, a set of standard working capital factors is specified for a regular year. Optional modifiers can then br used to allow for nonlinear relationships between depreciable capital outlays and :he corresponding working capital component. Other Annual Varidbles

a particular section of the forms where he needs more information. For type-writer terminals, a conversational front-end subroutine facilitates the loading of input data. The terminal types questions, one at a time, and the user types in yes or no answers or numerical data. Results year and Application in the form of year-byvariables:

The input of other data that may vary on a year-by-year basis is arranged as follows: for plant capacity, the initial value is specified. It can be modified in cast of plant expansion. Regular production volume is defined as equal to initial plant capacity and can be adjusted using modifiers fo,r any particular year. Sales volume Any prois assumed equal to production volume. duct accumul.stion or inventory depletion is treated as a variation in working capital. For the selling .>rice, the initial value is specified and modified for any subsequent year if necessary. The Usually, prilzes do not change every year. product of p,cice and volume gives sales. Corporate charges are expressed as a percentage of sales. This percentage is constant as a rule. Optio,aal modifications are required only at the beginning of economic life in some cases. R & D and startup expenses are lumped together and specified separately for each year to which they Fortunately, they are associated only with apply. the beginning of the project. Adjustments to variations in capacity, volume, price and corporate charges are made only for the year in whicn the change occurs with respect to the previous year. The new value is kept in subsequent years unless adjusted again. In this manto be specified is ner, the number of modifiers minimal. Operating cost and working capital are automatically adjusted to variations in capacity, volume and price as has been explained. These automatic adjustments can be optionally overruled by the user for any year he desires. This option would be used only in rare cases. On specifying - at the beginning of the input data - eight control numbers, the extent of the input is controlled at the minimum level required for the particular task. In other words, the user does not have to type in a fixed number of items, Rather, he the unused being zeros or blanks. specifies only 28 basic data and, beyond that, just the amount of optional data that defines the For example, for a venture with only project. one investment outlay and no year-by-year variathe total number of input data is 44. The tions, maximum amount for any venture is 500. The difference between the minimum and maximum can be used to specify any number of additional investor any number of modifiers for the ment outlays This structure makes the proannual variables. gram very flexible and, at the same time, very economical in terms of typing input data. Input cata forms are available in a compact and detailed version together with an instruction In c#rder to make the instructions less guide. in the form boring to read, the guide is written that follow the input data forms. of questions As the user becomes familiar with the program, he can skip an>' item and read only those pertinent to 265

The output is printed tables of the following 1.

Fixed capital Working capital Working capital increment Investment expense Sales volume Selling price Sales Corporate charges Raw material cost Other volume dependent cost Operating labor dependent cost Capital dependent cost Depreciation Extra Operating Operating cost Operating cost Total investment Sales Annual cost R & D and startup Depletion Taxable income Taxes Net income (after Cash flow Cumulative Discounted Cumulative cost excl. incl.

2.

3.

4.

depreciation depreciation

5.

expense

6.

taxes)

7.

cash flow cash flow discounted

cash flow

Further, the following are related to the project

results are shown that as a whole:

(a) Depreciable capital salvage Working capital salvage Land cost Recovery of other funds (b) Discount rate Net present value DCF rate of return A special version of the CFA program was incorporated in the EAlOOO system of Ebeling Associates which performs sensitivity and risk analyses. The latter is based on the Monte Carlo technique. Probabilities can be assigned to any number of input data. The program will then calculate any number of output data desired in probabilistic form and plot a cumulative distribution curve for any selected variable. Probabilities are expressed in terms of three values of the particular input or output variable. Obviously, there is a 10% chance that a variable might be below a certain

low value and a 10% chance that it might be above a certain high value. These two values correspond to the 10% and !)O% points on the cumulative distribution curve respectively. Further, the variable has a 50% chance of being above or below the value indicated by the midpoint on the curve. The CFA program is written in BASIC and is available on a time-sharing computer system. An illustrative example is displayed in the attached exhibits. Exhibit 1 shows a completed compact version of the input data forms. Exhibit 2 is the reproduction of the first part of the conversational input loading printout. The underlined data were typed by the user. Exhibit 3 shows the regular or "deterministic" output. The essential part of the probabilistic input printout is reproduced in Exhibit 4. Exhibit 5 is an example of the probabilistic output. The CFA program has proven to be a flexible and useful tool in project analysis. It saves time, standardizces computational procedures and provides a uniform manner of presenting results to management. The author would like to acknowledge his debt :o J. C. Agarwal and H. W. Flood who initiated and supported this work. Exhibit 1 Data Form (Compact Value

Other capital dependent cost, excl. depreciation, $DCC Extra operating cost, $MM Labor cost escalation, %/yr Section C - Working Capital Components Raw materials inventory, days Work -in progress inventory, days at oper. cost excl. depr. Finished goods inventory, days at total operating cost Accounts receivable, days at sales

7 4 2 30 3 30 30

Cash Flow Analysis Variable --

Input

Version) (a)

PART ONE - MANDATORY DATA Section A - General Data Initial plant capacity, M lbs/yr 100.000 (or any consistent units) Selling price, $/lb (or any con0.7 sistent units) Financial life:, yrs (up to 30 incl. R & D and construction (b) First year of production (financial life basis) No. of capital outlays (max. 9 each year) No. of capacity increments (max. 1 each year) No. of sales volume changes 2 (max. 1 each year) No. of price changes (max. 1 each year) No. of operating cost adjustments L (max. 1 each year) No. of work. capital increments (max. 1 each year) No. of R&D or startup expenses 3 (max. 1 each year) No. of G&A + S&D cost changes 1 (max. 1 each year) (c) Section B - Operating Cost Components Raw Materials cost, $/lb 0.1 (consistent units) Other capacity dependent cost, 0.02 $/lb (consistent units) Initial direct labor cost (DLC), $MM 4 Supervision and services, %DLC 40 Plant G&4, %DLC + MLC 40 (MLC = maint. labor cost) Maintenance labor cost, $DCC 3 (direct capital cost) 266

(a) Maximum number of items is 500 (b) Denote first year of financial life as 1 (not zero) (c) G6rA + S&D = corporate general and administrative and selling and delivery cost Cash, days at labor dependent 30 operating cost components Materials and supplies inventory, 3 %DCC Accounts payable, days at operating 30 cost excl. depr. Extra working capital, $MM 0 Section D - Economic Data Land acquisition cost, $MM 1 Corporate G&A and S&D cost, %.sales 4 Tax rate, % 50 Depletion rate, % (enter zero if not 15 applicable) Working capital salvage value, % 10 Non-capital cost recovery, $MM 0 Discount rate, % 15 PART TWO - OPTIONAL DATA For each section, specify as many sets indicated in Section A. Skip sections the corresponding item is zero. of data as for which

111 $12 fi Section E - Investment Outlays Depreciable capital 50 10 50 cost (DCC) $MM Associated investment 5 0 0 expense, $MM Outlay in year no. 1 1 5 (financial life basis) Depreciation life, years 8 3 8 Depreciation type (O=SL, 1 0 2 l=DDB+SL, 2=DDB, 3=1.5DB) . 0 Salvage value, $I& 5 10 100 120 80 Operating cost basis, %DCC Working capital basis, 100 120 80 %DCC Section F - Capacity Increments (New capacity is kept in subsequent years unless changed.) Capacity increment M 100,000 lbs/yr Occurring in year no. 6 (financial life basis) Direct labor cost basis, 7 % capacity Section G - Volume Changes (New volume is kept in subsequent years unless changed.) New volume % capacity 60 100 Occurring in year no. 2 3 (financial life basis)

Exhibit

1 (Cont'd) cost basis, 80 100 years unless

Raw material % capacity Section H (New price changed.) New price consistent Occurring (financial

1 Price Changes is kept in subsequent $/lb (or any units) in year no. life basis) 0.75 4

Section .I .. Operating Cost Adiustments (Adjustment is kept in subsequent years unless changed.) Adjustment of operating 110 100 cost excl, depreciation, % of value estimated according to Section B 2 3 Occurring :in year no. (financia:! life basis) Section K '- Working Capital Increments (Increment must be specified for each year separately if applicable.) Working capital increment, 1 Sm Occurring in year no. 4 (financia'l life basis) Section L - R&D or Startup Expenses (Expense m3s.t be specified for each year separately if applicable.) R&D and/or startup 10 2 7 expense, jMM Occurring in year no. 1 2 5 (financial life basis) Section M - Corporate G&A and S&D Cost Changes (New value is kept in subsequent years unless changed.) 3 New G&A ani S&D cost, % sales Occurring in year no. 5 (financial life basis)

What is the total number of investment outlays? There may be up to 9 outlays each year of financial life. Within the particular year, different outlays are used for units with different depreciation lives. ? 3 What 7s the number of increments to the initial capacity? The maximum is 1 each year. A capacity increment corresponds to a plant expansion and should be associated with an investment outlay in the previous year. Distinguish it from production volume change that is attained by increased productivity without additional investment. Capacity is kept at the incremented value in the subsequent years unless incremented again. ? 1 What 7s the number of sales (production) volume changes? The maximum is 1 each year. Sales Volume equals production volume. Any accumulation of product or depletion of inventory must be expressed as a positive or negative working capital increment. Initial volume is set equal to capacity by the program unless changed. Any changed volume is kept at the new value in the subsequent years unless changed again. E.G., for a volume that is 50% capacity in the first production year and 100% capacity in the second, enter 2 volume changes. ? 2 What 7s the number of changes of the selling price value indicated previously? The maximum is 1 each year. Any changed price is kept in the subsequent years unless changed again. ? 1 Exhibit --TQTAL Y? FIYED CAPL 61 0 0 0 50 3 0 0 0 3 %klM IXVS I:JCR EY?ENSE 5 0 0 0 0 0 0 0 0

II,JVEST?lE:JT

>JpjR'( CnpL 0 8.01327 10.35 11.773 12.5327 19.9823 20.0134 20.03,91 20.0653

J:( CAPL 3.01327 2.33069 I.42908 0.313665 7.36955 2.81172E-2 2.867345-2

2.12532E-2

Exhibit

What is th,s initial full annual plant or mine Distinguish capacity from production capacity? volume which may be lower in the first few years Express capacity in any units such of operation. as MLbs/Yr or MTonsfYr. 100003 ? -ExWhat is the initial selling price in $/unit? press price in capacity units divided by 1000 such as Lbs or Tons. ? 0.7 What rthe financial life in years? The maximum Year 1 of financial life is the is 30 years. first year in which research and development (R&D) money is spent or the first year of construction if no R&D is considered. 9 ? What 7s the first production year on the financial life basis? E.G. If E&D starts in 1974, construction in 1978 and production in 1980, then first production year is 7. ? 2
267

sfc.c-s,
YR 'J:J I TS/Y? 0
60030

SD+GA,
$:lil

d /Ll;J I T 13. 7 0.7 0.7 0.75 0.75 0.75 0.75 0.75 0.75

SiTI: 0 42. 70 75 75 I50 150 150 150

10c)000 lr3OOc)O 10 0 3 0 0 230300 ?00000 200000 203333

0 1.68 i? . 83 3 2.25 4. 5 4 . ij 4.5 4.5

Exhibit

3 (conid)CIPEQATIN3 0TH CAPY DSP CQST $MM NET INCQME A.T. fMM

RAbJ Y?
MATLS

LA909

DE?

CAPL 0 6.92 6.2372 6.27514 10.3873 10.4522 10.5185 10.5K61 10.655

DEP

YR
1 2 3 4 5 6 7 8 9

DEPLETI0N 0 0 10.5 11.25 11.25 22.5 22.5 22.5 22.5

TAX

INCB4E

TAXES 0 0 7.65913 10.756 6.94982 27.9284 29.3355 30. 3487 31.0659

?JET

INC0?4E

0 8.8
10 10 10 20 20 20 20

0
2.2 2 2 2 4 4 4 4

0
8.7384 8.10238 3. 26494 8.93962 12.2358 12.4805 12.7301 12.9847

8
9

0 0 15.3183 21.512 13.8996 55.8569 58.6709 60.6975 62. 1318

0 0 IS. 1591 22.006 18.1998 50.4234 51.8355 52.8457 53.5659

OPERATING

CBST

6MM

(COJT)

CASH

FL0US

BYM

YR

DEPRECTJ

EXTRA 0c

CUMMUL 0C EXC DEPR T0TAL OC

YR I
2 3 4 5 6 7 8 9

CASH

FLOW

CUMMJJL -76.5193 -7 1.4884 -43.7166 -13.3264 -47.7427 19.1127 34.2496 149.055 225.857

CF

DCF -76.5193 4.37471 20.9994 19.6533 -19.3916 33.2389 28.1605 23.337 26.4141

DCF -76.5193 -72. 1446 -51. 1452 -31.4918 -5O.5836 -17.6446 10.5158 34.5028 60.9169

0
14.1667 11.0417 8.69792 5.27344 16.455 13.3301 10.9863 9.22852

0
30.9584 30.3401 30.5401 35.3269 50.6581 50.999 51.3162 5 1.6397

0
45.1251 41.3817 39.235 40.6004 67. 1431 64.3291 62.3025 60.8652

-76.5193 5.03091 27.77 17 29.8903 -33.9163 66.8554 65. 1369 63.8055 50.0012

EXPENDITU2ES

A?ID I'JC0:4E

- $W4

DISC0TJNT RATE - % NET PRESENT VALUE %:?,I DCF RATE OF RETURN - L

15 60.9169 28.9523

R&D

YR
2 3 4 5 6 8 9

1NVEST:ENT 74.0193 2.33069 1. 42908 0.8 13665 57.38Q6 2.81172E-2 2.867?4E-2 2.92532E-2 0

SALES

ANNUAL

C0ST

STAR

0
42. 70 75 75 150 150 150 150

0
46.5051 44.1817 42.238 42.8504 7 1.6431 68.529 66.5025 65.3682

10
2 0 0 7 0 0 0 0 268 C0ST DEPREC -*JBRK LA:JD 0T!-iER REC0VVZRY Id LAST E FI:JA:JCIAL 15 2.00633 1 0 YEAR $;4!4 CAPL SALVA; CAPL SALVAGE C0ST REC 0VERY

Exhibit

I 1 2 13 15 37 53

ASSUMPTI

EWS

ESTIYATES 100000 0.7 0. 1 4 50 50

TYPE 0 I 2 0 0 0

LBlrl 7 0000 0.5 0.07 3 45 40

MID 100000 0.7 0. 1 4 50 50

HIGH 140000 1 0. I5 5 55 62

INITL CAPY :ILBS/Y SEL PRI CE B/LB RA,J XAT CBST S/LB INITL DIR LABS isII?l DEPREC CADL RI %?fi+l DEPREC CAPL x3 BX1

Exhibit

ASOSA 1150 I P9EDI CT1 PV

CASli FL0 J AXALYS RISK AIALYSIS DETERX

I S 30 AVERAGE XC TRIALS PlO% PSOX

2 / 26 13 : 52 P9OX

74

P481 ?4H2

NET D,F

?Q.ES TIATE

VALJE 0F XET

8?l?l 4,

60.917 28.953

73.09 31.62

19.8 17.7

74.24 32.

17

125 42.9

+ +--------0

+ ---------+---------+-10 20 P482 30 DCF

-------+---------+---------+------RATE 40 QF 50 ?.ET X 60

Reference:i 1. 2. 3. Chem. Chem. McAuley, 1969, Paper Eng., Eng., J. May July H., C-4 269 29, 12, Mann, 1972, 1972, A. N.,

page 88
page 84 AACE

4. 5.

Klumpar, Klumpar, page 88

I. I.

V., V.,

Trans. Chem.

AACE Tech.,

1969, February

Paper

F-3 1973,

Trans.

6.

Ebeling, 1973, Paper

D.

G., I-2

Agarwal,

J.

C.,

Trans.

AACE