CL-419 Process Economics

Cost Estimation

Reference:
• Max Peters, Klaus Timmerhaus, Ronald West –

Plant Design and Economics for Chemical Engineers

1
 Cost Estimation

 Acceptable plant design must produce a product that will sell

profitably.
 Initially, sufficient capital must be available to construct the
plant along with utilities and other facilities (Fixed Capital
Investment)
 Funds should also be available for operating the plant during
the initial period (Working Capital)
 Once the plant has been commissioned and the operations
commence, it enters a virtuous cycle of generating profits and
repaying capital, paying taxes and paying dividends.

2
Cash Flow for Industrial Operation

3
Cumulative Cash Position of a project

4
 Cumulative Cash Position of a project – (cont’d 1)

 The diagram on the previous slide depicts the cumulative cash

position over the life cycle of a project
 Zero point on the time line represents the point at which plant
construction is complete and ready for start-up
 Total capital cost at zero point includes land cost,
manufacturing and non-manufacturing fixed capital investment,
and working capital
 Cash position is negative at this point of time – equal to total
capital investment
 Thereafter cash starts flowing in from the operation; net profit
(after taxes) + depreciation starts to accumulate and gradually
repays the total capital investment

5
 Cumulative Cash Position of a project – (cont’d 2)

 The diagram assumes a constant cash flow rate from time zero
until the end of operations (not reality)
 At shutdown, the working capital is recovered.
 The relationships presented in the diagram are important to
understand the factors to be considered for cost estimation
 This diagram is highly simplified and neglects the time value of
money and assumes constant annual profit and constant
annual depreciation (not reality)

6
 Business Decision-making
 Why this product
− Buy / make
− Backward integration
− Forward integration
− Unique first of product – leader position in the market
− Government incentives
− Sales demand – local, region, country, world

 Why this raw material

− Ownership of the resource
− Easy availability of raw material

7
 Business Decision-making (cont’d 1)

 Why this technology for manufacture

− Superior product
− Lower cost of product
− Emerging technology

 Why this Plant capacity

− Indian market
− S E Asian market
− World Market
− Dominant market position (market share)

8
 Business Decision-making (cont’d 2)

 Why this Location (Within or outside country)

> Land availability at concessional rates or superior features
> Incentives – excise duty, tax holiday…
 Near raw material or market
> Near port
 Lax environmental regulations

9
 Business Decision-making (cont’d 3)
− Sourcing of equipment
> From within country / outside the country
> Credit facilities
 How much more can be squeezed out existing plant by de-
bottlenecking / add on
 Utilities / facilities
− Shared with neighbouring units
- ETP
- Storages
- Railway siding
- Fire tender
- Grid power or own power
- etc. 10
 Business Decision-making (cont’d 4)

 Funding
− Equity market
− Debt (Banks, financial institutions)

 Business acumen
− Risk taking ability

11
 Investment and Production Costs

 Cost estimates should be of sufficient accuracy to provide

reliable decisions
 Hence the engineer should have a complete understanding of
the many factors that affect costs such as actual prices of raw
material and equipment, company policies, governmental
regulations, and so on.
 Sources of equipment
- Equipment is one of the major costs in any chemical process
- Multiple independent quotes should be obtained from
different manufacturers (for identical specifications!)
- Investigate whether idle equipment /second hand equipment
can be used
12
 Investment and Production Costs (cont’d 1)

• Price fluctuations of raw material and product

− Prices could vary widely over a period of time
− Hence necessity to conduct sensitivity analysis

13
 Investment and Production Costs (cont’d 2)

• Company Policies
‾ Strict safety regulations
‾ Company accounting procedures – e.g., how is corporate
cost allocated among various companies
‾ Preferred mode of setting up a plant
- EPCM
- EPC (LSTK)
- Design / Supply…
‾ Modular Construction

14
 Investment and Production Costs (cont’d 3)

• Operating time and rate of production

‾ Annual maintenance policy for continuous plants
(normally one month per year)
- Annually 8000 hours of operation
‾ Hours & days of operation for batch plants

• Government Policies
- Import and export tariffs (equipment, raw materials,
products…)
- Depreciation rates
- Environment and safety regulations
- Labour laws
- Income tax rules 15
 Capital Investment

• Before an industrial plant is put into operation, a large sum of

money must be available
• TCI = FCI + WC
TCI – Total Capital Investment
FCI – Fixed Capital Investment
WC – Working Capital
• FCI = Manufacturing fixed capital investment
+
Non-manufacturing fixed capital investment
+
Construction overhead costs
16
 Capital Investment (cont’d 1)

• Manufacturing fixed capital investment covers complete

process equipment along with piping, instrumentation,
insulation, foundations…

• Non-manufacturing capital investment covers land, admin and

other offices, laboratories, utilities, effluent treatment plants…

• Construction overhead cost includes field offices, supervision

expenses, engineering expenses, contractors’ fees

17
 Capital Investment (cont’d 2)

• Working Capital covers

- Raw material and supplies carried in stock (~ 1 month
value)
- Finished product and semi-finished products (~ 1 month’s
production)
- Cash kept in hand for monthly payment of operating
expenses (such as salaries)
- Accounts receivable (as per credit terms to customers or ~ 1
month)
- Accounts payable
- Taxes payable

18
 Capital Investment (cont’d 3)

• Working Capital (continued)

• Keep in mind exceptions – (e.g., imported raw material…),

company policies

• Ratio of Working Capital to total capital investment varies with

different companies – generally 10 to 20%. Exceptions –
companies producing products of seasonal demand

19
 Estimation of Capital Investment

• Most estimates based on cost of equipment required

• Most significant errors in capital investment due to omissions of

equipment, services or auxiliary facilities rather than gross
errors in costing

• Check list essential – see Table1

20
 Table 1
Breakdown of fixed –capital investment items
for a chemical process plant
Direct Costs
1. Purchased equipment
All equipment listed on a complete P & I diagram
Spare parts aninstalled equipment spares
Surplus equipment, supplies, and equipment allowance
Inflation cost allowance
Freight charges
Taxes, insurance, duties
Allowance for modifications during start-up
2. Purchased-equipment installation
Installation of all equipment
Structural supports, insulation, paint
3. Instrumentation and controls
Purchase, installation, calibration, computer tie-in

21
 Table 1 (Cont’d 1)
4. Piping
Process piping – carbon steel, alloy, cast iron, lead, lined, aluminium,
copper, ceramic, plastic, rubber, reinforced concrete, pipe fittings, valves,etc.,
pipe support / hangers
5. Electrical equipment and materials
Switches, motors, conduit, wire, fittings, feeders, grounding,
Instrument and control wiring, lighting, panels
6. Buildings (including superstructures)
Process buildings-substructures, superstructures, platforms, supports,
Stairways, ladders, access ways, cranes, monorails, hoists, elevators
Auxiliary buildings – administration and office, medical or dispensary,
cafeteria, garage, product warehouse, parts warehouse, guard and safety,
fire station, change house, personnel building, shipping office and platform,
research laboratory, control laboratory
Maintenance shops – electrical, plumbing, sheet metal, machine, welding,
carpentry, instrument
Building services – plumbing, heating, ve3ntilation, dust collection, air
conditioning, building lighting, elevators, telephones, intercommunication
systems, painting, sprinkler system, fire alarm 22
 Table 1 (Cont’d 2)

7. Yard improvements
Site development – cleaning, grading, roads, walkways, railrods, fences, parking
areas, wharves and piers, recreational facilities, landscaping
8. Service facilities
Utilities – steam, water, power, refrigeration, complressed air, fuel, waste disposal
Facilities – boiler, plant incinerator, wells, river intake, water treatment, cooling
towers, water storage, electric substation, refrigeration plant, air plant, fuel
storage, waste disposal plant, environmental controls, fire protection
Non-process equipment – office furniture and equipment, cafeteria equipment,
safety and medical equipment, shop equipment, automotive equipment, yard
material handling equipment, laboratory equipment, locker room equipment,
garage equipment, shelves, bins, pallets, hand trucks, housekeeping
equipment, fire extinguishers, hoses, fire engines, loading stations
Distribution and packaging – raw material and product storage and handling
equipment, product packaging equipment, blending facilities, loading stations
9. Land
Surveys and fees
Land cost
23
 Table 1 (Cont’d 3)
Indirect costs

1. Engineering and supervision

Engineering costs – administrative, process, design and general engineering,
drafting, cost engineering, procuring, expediting, reproduction, scale
models, consultant fees, travel
engineering supervision and inspection
2. Construction expenses
Construction, operation and maintenance of temporary facilities, offices,
railroads, electrical, piping, fencing
Construction tools and equipment
Construction supervision, accounting, timekeeping, purchasing, expediting
Warehouse personnel and expense, guards
Safety, medical, fringe benefits
Permits, field tests, special licenses
3. Contractor’s fee
4. Contingency

24
 Type of Capital Cost Estimates

• Vary from predesign estimate based on little information to

detailed estimate based on complete drawings and
specifications.
‾ Order of magnitude estimate based on previous cost data
‾ Study estimate based on knowledge of major items of
equipment
‾ Preliminary estimate (budget authorization) based on
sufficient data to permit the estimate to be budgeted
‾ Definitive estimate (project control estimate) based on
almost complete data but before completion of all drawings
‾ Detailed estimate – Contractor’s estimate – based on
complete engineering drawings

25
 Predesign Cost Estimate

• Covers order of magnitude, study and preliminary estimate

• Very important to determine whether a proposed project should

be given further consideration or for comparing alternative
designs

• Most of the information covered in this course covers predesign

estimates

26
 Cost Estimating Information Guide

Preliminary estimate

Order of magnitude
Definitive estimate
Detailed estimate

Study estimate

>+30% range
+10% range

+20% range

+30% range
+5% range

Estimate
Next four slides are a guide to the various types of information required for cost
estimates, and the stages at which they are required.

27
 Cost Estimating Information Guide (cont’d 1)

Order-of-magnitude Estimate
Preliminary Estimate
Definitive estimate
Detailed Estimate

> +/- 30% range

Study Estimate
+/- 10% range

+/- 20% range

+/- 30% range

+/- 5% range
Required informtion

Location ʘ ʘ ʘ ʘ

General description ʘ ʘ ʘ

Soil bearing ʘ ʘ ʘ
Site
Location, roads, impounds, fences ʘ ʘ ʘ

Well developed site plot pln & topographical map ʘ ʘ

Rough sketches ʘ

Process Flow Sheet Preliminary ʘ

Engineered ʘ ʘ

Preliminary sizing & material specifications ʘ ʘ

Engineered specifications ʘ ʘ

Equipment List Vessel data sheets ʘ ʘ

General arrangement

(a) preliminary ʘ ʘ

(b) engineered ʘ 28
 Cost Estimating Information Guide (cont’d 2)

Estimate > +/- 30% range

Preliminary Estimate

Order-of-magnitude
Definitive estimate
Detailed Estimate

Study Estimate
+/- 10% range

+/- 20% range

+/- 30% range

+/- 5% range
Required informtion

Approximate size and type of construction ʘ ʘ

Foundation sketches ʘ ʘ
Architectural & construction ʘ ʘ ʘ
Building and structures
Preliminary structural design ʘ
General arrangements & elevations ʘ ʘ

Detailed drawings ʘ

Rough quantities (steam, water, electricity, etc.) ʘ

Preliminary heat balance ʘ

Utility require-ments Preliminary flow sheets ʘ ʘ

Engineered heat balance ʘ ʘ
Engineered flow sheets ʘ

Well developed drawings or specifications ʘ

Preliminary flow sheet & specifications ʘ ʘ

Piping Engineered flow sheets ʘ

Piping layouts & schedule ʘ ʘ

29
 Cost Estimating Information Guide (cont’d 3)

Order-of-magnitude Estimate
Preliminary Estimate
Definitive estimate
Detailed Estimate

> +/- 30% range

Study Estimate
+/- 10% range

+/- 20% range

+/- 30% range

+/- 5% range
Required informtion

Rough specifications ʘ

Preliminary list of insulated equipment and piping ʘ

Insulation

Insulation specifications and schedules ʘ ʘ

Well developed drawings or specifications ʘ

Preliminary instrument list ʘ

Instru-mentation Engineered List & flow sheet ʘ

Well-developed drawings & specifications ʘ ʘ

30
 Cost Estimating Information Guide (cont’d 4)

Order-of-magnitude Estimate
Preliminary Estimate
Definitive estimate
Detailed Estimate

> +/- 30% range

Study Estimate
+/- 10% range

+/- 20% range

+/- 30% range

+/- 5% range
Required informtion

Preliminary motor list - approximate sizes ʘ ʘ

Engineered list & sizes ʘ ʘ

Substations, number & sizes, specifications ʘ ʘ ʘ

Distribution specifications ʘ

Preliminary lighting specifications ʘ

Electrical

Preliminary interlock, control & instrument wiring specifications ʘ

Engineered single line diagrams (power & light) ʘ ʘ

Well-developed drawings ʘ

Engineering & drafting ʘ ʘ ʘ ʘ

Man-hours Labor by craft ʘ

Supervision ʘ

Product capacity, location & site requirements. Utility & service

Project scope standard processes requirements. Building & auxiliary requirements. Raw materials & ʘ
finished product handling and storage requirements

31
 Cost Indexes

• Most cost data available for making a predesign estimate are

only valid at the time they were developed
• Using cost indexes, these costs from a previous date can be
updated to a later date
Present cost = (original cost) x (index value at present)
(index value at the time original cost was obtained)
• Cost indexes can be used to give general estimate. No index
can take into account all factors, e.g., technological
advancements, local conditions, etc.
• Common indexes permit fairly accurate estimates if the period
involved is less than ten years.

32
 Cost Indexes (cont’d 1)

• Common indexes:
‾ Marshall and Swift: all Industry and Process Industry
equipment indexes
‾ Engineering News Record Construction index
‾ Nelson Farrar refinery construction index
‾ Chemical Engineering plant cost index

• Marshall and Swift Index not available after 2011

33
Cost Indexes (cont’d 2)

34
 Cost Indexes (cont’d 3)

• All cost indexes are based on limited sampling of the goods and
services in question. Therefore the results can differ
considerably.

• Chemical Engineering plant cost index recommended for

process equipment and chemical plant estimates

• Similar indexes not available for India. Some Engineering

companies have created cost data bases. Quite often they get
budgetary quotes from vendors with whom they do business
regularly. Some companies who have been setting up plants
regularly also have cost data banks.

35
 Cost Components in Capital Investment

• Capital Investment = Total amount of money required to build

the plant
+
Working capital for operations

36
Cost Components in Capital Investment (cont’d 1)

37
 Cost Components in Capital Investment (cont’d 2)

• The table on the previous slide summarises the typical

variations in component costs as % of fixed capital investment
(FCI)

• Applicable for multi-process grass-roots plant or large battery

limit additions.

• Grass roots plant is a complete plant erected on a new site

• Purchased equipment cost in the table refers to delivered

equipment cost i.e., including freight (CIF)

38
 Cost Components in Capital Investment (cont’d 3)

• Purchased Equipment Cost

‾ Purchased equipment cost is the basis of several predesign

methods for estimating capital investment

‾ Sources of equipment prices, methods of adjusting

equipment prices for capacity are essential to prepare
reliable cost estimates

‾ Most accurate method for determining equipment cost is

from fabricators or suppliers.

39
 Cost Components in Capital Investment (cont’d 4)

‾ Next best in reliability are cost values of past purchase orders

corrected with appropriate cost index ratio.

‾ Cost estimates of different types and capacities of equipment

are available in graphs

‾ Wide variety of equipment have about the same cost per unit
weight. Purchase cost of vessels, tanks process and material
handling equipment can often be estimated this way

40
 Example – Estimation of FCI using Table 6-3

• Purchased equipment cost (delivered) is US$ 100,000 for a

process plant handling both solids and fluids with a high degree
of automatic controls. The plant is located outdoors. Do not
include land.

• A percentage is selected within the range in Table 6-3. Select

average values unless plant characteristics suggest lower or
upper values

- e.g. High degree of automatic controls in this example

41
Example – Estimation of FCI using Table 6-3

42
 Graphs of Equipment Cost v/s Capacity

The following slides show graphs for equipment cost for

various equipment

43
44
45
46
47
48
49
50
51
52
53
 Purchased Equipment Cost by Scaling

• Estimating Equipment Cost by scaling

‾ Often cost data is not available for a particular size or
capacity.
‾ Predictions can be made using the “six-tenths factor rule”
cost of equipment a = (cost of equipment b) X0.6
where X = (capacity/size of equipment a)
(capacity/size of equipment b)

‾ 0.6 rule of thumb is an oversimplification. Actual values vary

from 0.3 to greater than 1.0 e.g., exponent is 0.31 for glass
lined jacketed kettle, and 1.2 for bubble cap tray
‾ Refer Table 6-4 of Peters and Timmerhaus
54
Purchased Equipment Cost by Scaling (cont’d 1)

Caution –
> check out the size range for which the exponent is
applicable
> In general it should not be used beyond ten-fold
range.
> Make certain the two pieces of equipment are similar
with regard to type, material of construction,
temperature, pressure, operating range, country of
origin…

55
 Purchased Equipment Cost by Scaling (cont’d 2)

> Purchased equipment prices are usually quoted as FOB

(free on board) which means purchaser pays for freight. For
predesign estimates, a delivery allowance of ten per cent of
purchased cost is recommended to obtain CIF price

56
 Purchased Equipment Cost by Scaling (cont’d 3)

Example Estimating cost of equipment using scaling factor

and cost index :

Purchased cost of a 0.2m3 glass lined jacketed reactor (without

drive) was $ 10,000 in 1991. Estimate purchased cost of a
similar 1.2m3 glass-lined jacketed reactor (without drive) in
1996 including delivery cost. Cost v/s capacity exponent is
0.54. Chemical Engineering plant cost index in 1991 was 361
and in 1996 was 382

57
Purchased Equipment Cost by Scaling (cont’d 4)

Delivered cost of reactor in 1996 =

($10,000) x (382/361) x (1.2/0.2)0.54 x 1.1 = $ 30,630

58
 Methods for estimating capital investment

• Choice of method depends on amount of detailed information

available and accuracy desired
• Which in turn depends on the purpose for which the estimate is
required
• Seven methods will be covered – each method requires
progressively less detailed information and preparation time,
hence, degree of accuracy decreases with each successive
method

59
 Methods for estimating capital investment (cont’d 1)

Method A : Detailed Item Estimate

• Requires careful determination of each individual item shown in
Table 1 – Breakdown of Fixed Capital Investment Items for a
Chemical Process
• Equipment and Bill of Material (BOM) determined from
completed drawing and specifications.
• Priced preferably from quotations or current cost data
• Generally prepared by lump sum Turn Key (LSTK) contractors
• Accuracy +/- 5%

60
 Methods for estimating capital investment (cont’d 2)

Method B : Unit Cost Estimate

• Requires detailed estimates of purchased price obtained from
quotations or cost data banks
• Cost of concrete, steel, pipes, electrical systems, etc., obtained
from drawings and applying unit costs to the material and
labour needs.
• Factor is applied for construction expense, contractor fees and
contingency.
• Accuracy depends on details included; gives +/- 10% to 20%
accuracy
• Rarely used in its entirety in Indian conditions

61
 Methods for estimating capital investment (cont’d 3)

Method B : Unit Cost Estimate (cont’d)

Cn = [Σ(E+EL) + Σ(fxMx + fyML) + ΣfeHe + Σfddn ] x fF

Cn = Capital Investment E = Delivered Equipment cost

EL = Delivered Labour Cost
Mx = Specific material Qty
ML = Labour employee hours for
specific material
fe = Unit cost of engineering
fd = Unit cost per drawing or
specification
fx = Specific material unit cost
fy = Specific material labour
unit cost
He = Engineering employee hours
dn = number of drawings or
specifications
fF = Construction or field expense
factor (always > 1) 62
 Methods for estimating capital investment (cont’d 4)

Method C : Percentage of delivered Equipment Cost

• Requires accurate estimate of delivered Equipment Cost
• Other items in capital estimate are based on average
percentages of total delivered equipment cost
Cn = Σ(E + f1E + f2E + …. +fnE)
= E (1 + f1 + f2 + …. +fn)
where f1, f2, …. , fn are multiplying factors for piping,
electricals, indirect costs, etc.

63
 Methods for estimating capital investment (cont’d 5)

Method C : Percentage of delivered Equipment Cost (cont’d)

• Multiplying factors determined on the basis of process involved,

design complexity, required material of construction (MOC),
location of plant, past experience
• Average values of various percentages have been determined
for typical chemical plants as shown in Table 6-9
• Accuracy is +/- 20 to 30%

Examples of various plants:

Solid processing plant – Example coal briquetting plant
Solid-fluid processing plant – Shale oil plant
Fluid processing plant – Distillation separation system
64
Methods for estimating capital investment (cont’d 6)

65
 Methods for estimating capital investment (cont’d 7)

Method D : Lang Factors for Approximation of Capital Investment

• Originally proposed by H J Lang in 1948

• Used quite frequently to obtain order of magnitude cost
estimates
• Recognizes that by multiplying the equipment cost by a factor,
fixed and total capital estimate can be obtained
• Factors depend on type of process plant

66
 Methods for estimating capital investment (cont’d 8)

A coal briquetting plant would be a typical solid processing plant.

A shale oil plant with crushing, grinding, retorting and extraction would be a typical
Solid-fluid processing plant
A distillation separation system would be a typical fluid processing plant

67
 Methods for estimating capital investment (cont’d 9)

• Greater accuracy of Capital Investment can be obtained by

using a number of factors
- Different factors for different types of equipment
- Separate factors for installation, foundation, utilities, piping
- Divide each item of cost into material and labour factors
• Chemical engineer must rely on past experience to decide the
factor used
• Accuracy is +/- 30 to 50%

68
 Methods for estimating capital investment (cont’d 10)
Method E : Power factor applied to plant/capacity ratio
• Provides study or order of magnitude estimate +/- 50%
• This estimate relates fixed capital estimate of a new process plant to
the fixed capital investment of a similar previous constructed plant by
an exponential plant ratio adjusted by a cost index ratio
Cn = CfeRx where
Cn = Capital investment of new plant
C = Capital investment of similar previous plant
fe = Cost index ratio at the time of cost Cn to the time
of the old facility
R = Capacity of new facility / capacity of old facility
x = power factor – averages 0.6 to 0.7 for process
facilities

69
 Methods for estimating capital investment (cont’d 11)

Method E : Power factor applied to plant/capacity ratio (cont’d)

• Table 6-11 in Peters and Timmerhaus gives power factors for

different process plants; they apply roughly within a 3-fold ratio
extended either way
• Further refinement can be made by separating direct and
indirect costs.
• This estimate is often used as a check estimate

70
 Methods for estimating capital investment (cont’d 12)

Method F : Investment cost per unit of capacity

• Data is available giving the fixed capital investment for various

processes per unit of annual production capacity (Refer
Table 6- 11 of Peters and Timmerhaus)
• Order of magnitude estimate for a given process can be
obtained by multiplying the investment cost per unit of capacity
by the annual production capacity of the proposed plant
• Necessary correction for change of costs with time can be
made using cost indexes.
• Can also be used as a check estimate

71
 Methods for estimating capital investment (cont’d 13)

Method G : Turnover ratio

• This is another method suitable for order of magnitude estimate

Fixed Capital Investment = Gross Annual Sales
Turnover ratio

Gross Annual Sales = Annual production x

product selling price

• Turnover ratio for chemical industry is approximately 0.5

• The reciprocal of turnover ratio is sometimes called capital ratio
or investment ratio
72
 Estimation of Revenue

• Determination of capital investment is only one part of a

complete cost estimate – Revenue by plant operation is also
very important.
• Revenue comes from the sale of product or products produced
by the plant

• Annual sales revenue = Σ (sale of product, kg/yr)

x (product price $/Kg)
• In conducting economic analysis of a project, production rates
should be established as a percentage of the design capacity
for each year of operation

73
 Estimation of Revenue (cont’d 1)

• Normally 50% is used for first year of operation to account for

start-up issues. Thereafter annual production capacity is used,
with an allowance for downtime

• Normal practice for continuous process plant is to assume 8000

hours of operation per annum (330 days of production)

• Product prices are generally established by a market study

74
 Estimation of Total Product Cost (Cont’d 1)

Calculation of
Total Product cost:

basis

1 2 3
Daily basis Unit of product Annual basis
basis

Annual basis is the best for economic analysis

Best source of data is from similar or identical projects

75
 Estimation of Total Product Cost

Total Product cost =

Manufacturing costs
(also called production cost + General expenses
or operating costs)

Errors in cost estimation mostly occur by overlooking one or more

elements of cost.
A tabular check list avoids such mistakes

76
 Variable production costs
+
Manufacturing cost = Fixed charges
+
Plant overhead costs

Administrative expenses
+
Distribution and
General Expenses = marketing expenses
+
R & D expenses

77
 Manufacturing cost
Variable production costs Fixed Charges
Raw materials Depreciation
Operating labour Taxes (property)
Operating supervision Financing (interest)
Utilities Insurance
Electricity Rent
Fuel
Refrigeration Plant overhead costs
Steam
Water, process Medical
Water, cooling Safety and protection
Waste treatment and disposal General plant overhead
Maintenance and repairs Payroll overhead
Operating supplies Packaging
Laboratory charges Restaurant
Royalties (if not on lump-sum basis) Recreation
Catalysts and solvents Salvage
Control Laboratories
Plant superintendence
Storage facilities
78
 General Expenses
Administrative expenses Distribution and
marketing expenses
Executive salaries
Clerical wages
Sales offices
Engineering’
Sales personnel expenses
Legal costs
Advertising
Office maintenance
Technical sales service
Communications

Research and Development

expenses

R & D Staffing expenses

R & D Material consumption costs

79
 Raw Materials

• Raw materials is one of the major costs in a production

operation
- Raw materials covers all the materials directly consumed in
making the final products – includes reactants, additives;
catalysts and solvents which do not become part of the final
product are generally listed separately
- Best to get direct quotations for raw materials from
prospective suppliers; when these are not available, prices
published in trade journals are used
- Prices are generally quoted on f.o.b. basis; transport
charges should therefore be added. (Can be estimated at
10% of raw material cost, but highly variable)
80
 Raw Materials (cont’d 1)

- Accurate material balance for the process is essential to

obtain quantity of raw materials. Don’t forget conversion
efficiency
- In chemical plants, raw material costs are usually 10% to
60% of the total product cost

81
 Operating Labour

• Operating Labour
- Divided into skilled and unskilled
- Best estimated from company experience with similar
processes and company policy
- Considerable difference between estimates for US and India
- As automation and controls have increased, labour
requirement has come down substantially

• Supervisory labour
- Depends greatly on the type of plant and company
experience and policy

82
 Utilities

• Utilities
- Required types and quantities are established from flow
sheets
- Cost of utilities such as steam, process and cooling water,
refrigerants, dowtherm, compressed air, fuel oil etc. and
waste water treatment and disposal vary widely depending
on source, plant location, amount needed, etc.
- A utility may be purchased at a predetermined rate from an
external source or generated internally

83
 Utilities (cont’d)

- If produced internally, and the entire production is utilized for

just one process the entire cost of the service installation is
charged to that manufacturing process. If service is utilized
for the production of several products, cost is apportioned
based on amount of individual consumption

- Utility cost for chemical processes amounts to 10% to 20%

of total product cost

84
 Repairs and Maintenance, Operating supplies

• Repairs and Maintenance

- Cost per year for repairs and maintenance ranges from 2%
to 10% of fixed capital investment, with 7% being a
reasonable value

• Operating supplies
- Covers consumables such as lubricants, test chemicals, etc.
- Annual cost is around 15% of cost incurred for repairs and
maintenance

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 Laboratory Charges; Patents and Royalties

• Laboratory charges
- Covers cost of laboratory tests for control of operations and
product quality control
- Can be taken as 10% to 20% of operating labour

• Patents and Royalties

- To use patents owned by others, it is necessary to pay for
patent rights or royalty based on amount of material produced
- Even for own patents, total expense involved in development
and procurement of patent rights is borne by the plant as an
operating expense and amortized over the legally protected
life of the patent
- Rough patent and royalty costs very from 0 to 6% of total
product cost 86
 Catalysts and Solvents

• Catalysts and solvents

- Cost for these items can be significant and should be
estimated based on catalyst and solvent requirements and
prices

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 Fixed Charges

• Fixed charges
- Fixed charges are expenses which are practically
independent of production rate:
 Depreciation
 Property Taxes
 Insurance
 Financing costs (Loan interest)
 Rents
- Depreciation should be calculated separately as per Income
Tax rules
- Fixed charges roughly amounts to about 10% to 20% of
total product cost
88
 Plant Overhead Costs

- Plant overhead costs covers

- General plant maintenance
- Safety services
- Warehouse and storage facilities
- These do not vary much with changes in production rate
- Plant overhead cost for chemical plants is about 50% to
70% of total expenses for operating labour, supervision and
maintenance

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 General Expenses

• In addition to manufacturing costs, other general expenses are

involved in the operation of a company
- Administrative costs – around 15% of operating labour
- Distribution and marketing costs – about 2 to 20% of total
product cost
- Research and Development cost – around 5% of total
product cost

• See Figure 6-1 of Timmerhaus for Cash Flow Tree Diagram for
industrial operations

90
 Gross Profit

• Gross profit is the product sales revenue minus total product

cost
- Gross profit in the year j is
Gj = sj - coj - dj
where Gj = gross profit in year j
sj = sales revenue in year j
coj = Total product cost in year j
(not including depreciation)
dj = Depreciation in year j

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 Net Profit; Cash flow from process

• Net Profit is the amount retained of the profit after income taxes
have been paid
- Net Profit (Npj) in the year j is
Npj = Gj (1 – Φ)
where
Φ = fixed income tax rate as a fraction of annual
gross profits

• Cash flow during the year j (Aj) from process operations is

Aj = Npj + dj

92
 Break Even Point

• Occurs when
Total annual product cost = Total annual sales

• Total annual product cost =

Variable production cost
+ Annual fixed charges (including depreciation)
+ overhead costs and general expenses

93
 Example

• Production capacity of a plant is 200,000 kg/annum.

• Variable product cost is $2 per kg.
• Annual fixed charges (incl. depreciation) + overhead costs
and general expenses is $ 200,000 per annum.
• What is the break even point as a percentage of annual
production capacity if the product selling price is $ 4 per kg?

94