Page 297 - Analysis, Synthesis and Design of Chemical Processes, Third Edition

expenditure for working capital required to float the first few months of operations is shown. This is a
one-time expense at the start-up of the plant and will be recovered at the end of the project.

After start-up, the process begins to generate finished products for sale, and the yearly cash flows become
positive. This is reflected in the positive slope of the cumulative CFD in Figure 10.1. Usually the revenue
for the first year after start-up is less than subsequent years due to “teething” problems in the plant; this is
also reflected in Figure 10.1. The cash flows for the early years of operation are larger than those for
later years due to the effect of the depreciation allowance discussed in Chapter 9. The time used for
depreciation in Figure 10.1 is six years. The time over which the depreciation is allowed depends on the
IRS regulations and the method of depreciation used.

In order to evaluate the profitability of a project, a life for the process must be assumed. This is not
usually the working life of the equipment, nor is it the time over which depreciation is allowed. It is a
specific length of time over which the profitability of different projects are to be compared. Lives of ten,
twelve, and fifteen years are commonly used for this purpose. It is necessary to standardize the project
life when comparing different projects. This is because profitability is directly related to project life, and
comparing projects using different lives biases the results.

Usually, chemical processes have anticipated operating lives much greater than ten years. If much of the
equipment in a specific process is not expected to last for a ten-year period, then the operating costs for
that project should be adjusted. These operating costs should reflect a much higher maintenance cost to

include the periodic replacement of equipment necessary for the process to operate the full ten years. A
project life of ten years will be used for the examples in the next section.

From Figure 10.1, we can see a steadily rising cumulative cash flow over the ten operating years of the

process, that is, years 2 through 12. At the end of the ten years of operation, that is, at the end of year 12, it
is assumed that the plant is closed down and that all the equipment is sold for its salvage or scrap value,
that the land is also sold, and that the working capital is recovered. This additional cash flow, received
on closing down the plant, is shown by the upward-pointing vertical line in year 12. Remember that in
reality, the plant will most likely not be closed down; we only assume that it will be in order to perform
our economic analysis.

The question that we must now address is how to evaluate the profitability of a new project. Looking at
Figure 10.1, we can see that at the end of the project the cumulative CFD is positive. Does this mean that
the project will be profitable? The answer to this question depends on whether the value of the income
earned during the time the plant operated was smaller or greater than the investment made at the beginning
of the project. Therefore, the time value of money must be considered when evaluating profitability. In the
following sections, we will look at different ways to evaluate project profitability.

10.2 Profitability Criteria for Project Evaluation

There are three bases used for the evaluation of profitability:
1. Time
2. Cash
3. Interest rate