Chapter - 6
COST ESTIMATION
COST ESTIMATION
• Net profit equals total income minus all expenses, it is essential that the chemical
engineer be aware of the many different types of costs involved in manufacturing
processes.
•The total investment for any process consists of fixed-capital investment for physical
equipment and facilities in the plant plus working capital which must be available to pay
salaries, keep raw material and products on hand, and handle other special items
requiring a direct cash outlay.
CASH FLOW FOR INDUSTRIAL OPERATIONS
Figure 1: Tree diagram showing cash flow for industrial operations
CUMULATIVE CASH POSITION
Cash flow for an industrial operation expect that it depicts the situation over a given
period of time as the cumulative cash position. The time period chosen is the
estimated of the project, and the time value of money is neglected.
Figure 2: Graph of cumulative cash position showing effects of cash flow with time for an industrial operation neglecting
time value of money
• Land value is included as part of the total capital investment to show clearly the
complete sequence of steps in the full life cycle for an industrial process.
• The zero point on the abscissa represents that time at which the plant has been
completely constructed and is ready for operation.
• The total capital investment at the zero in time includes land value, fixed capital and
auxiliaries investment, and working capital.
• The cash position is negative by an amount equivalent to the total capital investment
at zero time, but profits in the ideal situation come in form the operation as soon as
time is positive.
• Cash flow to the company, in the form of net profits after taxes and depreciation
charges, starts to accumulate and gradually pays off the full capital investment.
• The full capital investment is paid off in five years. After that time, profits
accumulate on the positive side of the cumulative cash position until the end of the
project life at which time the project theoretically is shut down and the operation
ceases.
• At that time, the working capital is still available, and it is assumed that the land can
still be sold at its original value.
• Thus, the final result of the cumulative cash position is net profit over the total life of
the project, or a cash flow into the company capital sink (in addition to the depreciation
cash flow for investment payoff) over the ten-year period, as shown in the upper right-
hand bracket.
FACTORS AFFECTING INVESTMENT AND PRODUCTION COSTS
When a chemical engineer determines costs for any type of commercial process,
these cost should be of sufficient accuracy to provide reliable decisions.
Thus the engineer must keep up –to-date on price fluctuations, company policies,
government regulations, and other factors affecting costs.
1. Sources of Equipment
One of the major costs involved in any chemical process is for the equipment. In
many cases, standard types of tanks, reactors, or other equipment are used, and a
substantial reduction in cost can be made by employing idle equipment or by
purchasing second-hand equipment.
2. Price Fluctuations
In our modern economic society, prices may vary widely from one period to
another, and this factor must be considered when the costs for an industrial process are
determined.
One of the most complete sources of information on existing price conditions is the
Monthly Labour Review published by the U.S. Bureau of Labour Statistics. This
publication gives up-to-date information on present prices and wages for different
types of industries.
3. Company Policies
Policies of individual companies have a direct effect on costs. For example, some
concerns have particularly strict safety regulations and these must be met in every detail.
4. Operating Time and Rate of Production
One of the factors that has an important effects on the costs is the fraction of the total
available time during which the process is in operation. When equipment stands idle
for an extended period of time, the labour costs usually low; however, other costs ,
such as those for maintenance, protection, and depreciation, continue even through the
equipment is not in active use.
Operating time, rate of production, and sales demand are closely interrelated.
The ideal plant should operate under a time schedule which gives the maximum
production rate while maintaining economic operating methods.
In this way, the total cost per unit of production is kept near a minimum because
the fixed costs are utilized to the fullest extent.
This ideal method of operation is based on the assumption that the sales demand
is sufficient to absorb all the material produced.
If the production capacity of the process is greater than the sales, the operation
can be carried on at reduced capacity or periodically at full capacity.
The fixed costs remain constant and the total product cost increases at the rate of
production increases. The point where the total product cost equals the total product cost
equals the total income is known as the break-even point.
Figure 3 : Break-even chart for chemical processing plant
5. Governmental Policies
The national government has many regulations and restrictions which have a direct
effect on industrial costs.
CAPITAL INVESTMENTS
Fixed-Capital Investment
Manufacturing fixed-capital investment represents the capital necessary for the
installed process equipment with all auxiliaries that are needed for complete
process operation. Expenses for piping, instruments, insulation, foundations and
site preparation are typical examples of costs included in the manufacturing fixed-
capital investment.
Working Capital
The working capital for an industrial plant consists of the total amount of money
invested in:
1. Raw materials and supplies carried in stock.
2. Finished products in stock and semifinished products in the process of being
manufactured.
3. Accounts receivable
4. Cash kept on hand for monthly payment of operating expenses, such as salaries,
wages, and raw-material purchases.
5. Accounts payable
6. Taxes payable.
ESTIMATION OF CAPITAL INVESTMENT
Of the many factors which contribute to poor estimates of capital investments, the most
significant one is usually traceable to sizable of equipment, services, or auxiliary
facilities rather than the gross errors in costing.
Types of Capital Cost Estimates
1. Order-of- magnitude estimate (ratio estimate) based on similar previous cost
data; probable accuracy of estimate over +30 percent.
2. Study estimate (factored estimate) based on knowledge of major items of
equipment; probable accuracy of estimate up to +30 percent.
3. Preliminary estimate (budget authorization estimate; scope estimate) based on
sufficient data to permit the estimate to be budgeted; probable accuracy of
estimate within +20 percent.
4. Definitive estimate (project control estimate) based on almost complete data
but before completion of drawings and specifications; probable accuracy of
estimate within +10 percent.
5. Detailed estimate (contractor’s estimate) based on complete engineering
drawings, specifications, and site surveys; probable accuracy of estimates
within +5 percent.
COST INDEXES
Most cost data which are available for immediate use in preliminary or pre-design estimate
are based on conditions at some time in the past. Because prices may change considerably
with time due to changes in economic conditions, some method must be used for updating
cost data applicable at a past date to costs that are representative of conditions at a later
time.
A cost index is nearly an index value for a given point in time showing the cost at that
time relative to a certain base time.
Present cost = original cost (index value at present time/ index value at time
original cost was obtained)
• Marshall and Swift Equipment Cost Indexes
• Engineering News-Record Construction Cost Index
• Neison- Farrar Refinery Construction Cost Index
• Chemical Engineering Plant Cost Index
Other Indexes and Analysis
There are numerous other indexes presented in the literature which can be used for
specialized purposes. For example, cost indexes for materials and labour for various types
of industries are published monthly by the U.S. Bureau of Labour Statistics in the Monthly
Labour Review. These indexes can be useful for special kinds of estimates involving
particular materials or unusual labour conditions . Another example of a cost index which
is useful for world-wide comparison of cost charges with time is published periodically in
Engineering Costs and Production Economics.
This presents cost indexes for plant costs for various countries in the world including
Australia, Belgium, Canada, Denmark, France, Germany, Italy, Netherlands, Norway,
Japan, Sweden, the United Kingdom, and the United States.
COST FACTORS IN CAPITAL INVESTMENT
1. Purchased Equipment 9. Yard Improvements
2. Estimating Equipment Costs by Scaling 10. Service Facilities
3. Purchased-Equipment Installation 11. Land
12. Engineering and Supervision
4. Insulation Costs
13. Construction Expense
5. Instrumentation and Controls 14. Contractor’s Fee
6. Piping 15. Contingencies
7. Electrical Installation 16. Startup Expense
8. Building Including Services 17. Methods for estimating capital
Investment
ESTIMATION OF TOTAL PRODUCT COST
Manufacturing Costs
General Expenses
DIRECT PRODUCTION COSTS
Raw Materials
Operating Labour
Direct Supervisory and Clerical Labour
Utilities
Maintenance and Repairs
Operating Supplies
Laboratory Charges
Patents and Royalties
Catalysts and Solvents
FIXED CHARGES
1. Depreciation
2. Local Taxes
3. Insurance
4. Rent
PLANT OVERHEAD COSTS
Expenses connected with the following comprise the bulk of the charges for plant
overhead:
Hospital and medical services
General engineering
Safety services
Cafeteria and recreation facilities
General plant maintenance and overhead
payroll overhead including employee benefits
control laboratories
Packaging
Plant Protection
Janitor and similar services
Employment offices
Distribution of utilities
Shops
Lighting
Interplant communications and transportation
Warehouses
Shipping and receiving facilities
ADMINISTRATIVE COSTS
DISTRIBUTIVE AAND MARKETING COSTS
RESEARCH AND DEVELOPMENT COSTS
FINANCING
Interest
GROSS-EARNINGS COSTS
CONTINGENCIES
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