AIR POLLUTION CONTROL TECHNOLOGY HANDBOOK - CHAPTER 9 pot

Profitability and
Engineering Economics

9.1 INTRODUCTION — PROFIT GOAL

A major decision point in process design is the selection of the most technically and
economically feasible solution alternative. All companies set a profit goal. Most
generally it is to maximize profit, i.e., maximize income above the cost of the capital
which must be invested to generate the income. In addition, current governmental
regulations require that processes must be safe and ecologically/environmentally
sound. Others goals sometimes are used. For example:
• Minimize loss
• Minimize operating cost
• Minimize environmental damage
• Zero emissions
• Produce a product that does not cost the company money
Furthermore, companies usually have set a required rate of return on the invest-
ment. In some cases such as with required environmental control equipment, the
process must be built and operated even if it does not meet the rate of return that
has been set.

9.2 PROFITABILITY ANALYSIS

An analysis must be made to provide a measure of the attractiveness of a project
for comparison to other possible courses of action. In some cases, the capital that
would be invested in a process could earn more in some other investment or even
in a savings account. For required environmental control processes there would be
no other alternative investment allowed. It should be remembered, a profitability
standard can only serve as a guide, and the profitability standard must be weighed
against overall judgment and evaluation.

9.2.1 M

ATHEMATICAL

M

ETHODS



FOR

P

ROFITABILITY

E

VALUATION

There are at least five reasonable methods to carry out a profitability evaluation.
These methods are
1. Rate or incremental rate of return on investment
2. Discounted cash flow on full-life performance
9

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3. Net present worth
4. Capitalized costs
5. Payout period
Peters and Timmerhaus

1

present an excellent discussion of all these methods.
Figure 9.1 illustrates the well-known concept in balancing fixed capital charges for
a fabric filter against operating cost to find the minimum of the sum of the two.

9.2.2 I

NCREMENTAL

R

ATE



OF

R

ETURN



ON

I

NVESTMENTS



AS



A

M

EASURE



OF

P

ROFITABILITY

One of the more simple methods of profitability analysis is based on rate of return
and the incremental rate of return. It is assumed that there is a

base case

design that
will provide the desired pollution control and meet the profitability objective set as
the rate of return. As pointed out above, in some cases a pollution control apparatus
must be built even if it does not meet a the profitability objective of a company. The
base case should represent a system operating under nearly optimum conditions. All
other designs are then compared against this base case. Defining the terms:
ROI = percent return on investment
IROI = incremental percent return on investment
P = annual profit from invesment (income – expenses), or incremental profit
or annual savings
I = total investment or incremental investment
(9.1)
The process is as follows:

FIGURE 9.1

Optimization of cost for a typical fabric filter or baghouse.
ROI
P
I
or IROI =

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• Set the base case — the alternative case that meets ROI at the least total
initial cost.
• Check IROI with base case compared to alternative case that meets the
ROI and has the second lowest initial cost.
• Accept the second alternative as base case if IROI is met.

• With this new base case, check ROI compared to alternative that has the
third lowest initial cost and then check the IROI. Set new base case if
IROI is met.
• Repeat process with all alternatives and select one that meets the ROI and
the IROI by balancing the initial cost the ROI and the IROI.

9.2.2.1 An Example

A chemical plant must install a new control system. Four alternatives are being
considered. Each alternative will result in a reduction of emissions from the current
2000 T/year. The emissions fee is $35/T, and, therefore, the new equipment will
reduce the annual emission fee. Furthermore, two of the processes will result in
saving product for which an additional cost saving can be included. The company
is demanding a 15% return on any investment. Which of the processes should be
selected?
Design A serves as the

base case

.
A.
Annual savings = 0 + 31,500 – 5,000 – 10,000 = $16,500

Meets ROI criteria.
B.
Annual savings = 6000 + 42,000 – 10,000 – 15,000 = $23,000

This ROI is acceptable.

DESIGN A B C D

Installed cost ($) 100,000 150,000 200,000 250,000
Operating cost ($) 5000 10,000 15,000 10,000
Fixed charges % of 10% 10% 10% 10%
initial cost ($/yr) 10,000 15,000 20,000 25,000
Emission reduction 900 T 1200 T 1200 T 1500 T
($) 31,500 42,000 42,000 52,500
Product saved ($/yr) 0 6000 8000 21,000
ROI =×=
16 500
100 000
100 16 5
,
,
.%
ROI =×=
23 000
150 000
100 15 3
,
,
.%

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This IROI is acceptable, therefore, this becomes the

base case.

C.
Annual savings = 8000 + 42,000 – 15,000 – 20,000 = $15,000

This is an unacceptable ROI. Design C must be rejected. Design D is now compared
to Design B which is the current base case.
D.
Annual savings = 21,000 + 52,500 – 10,000 – 25,000 = $38,500

This is an acceptable ROI.
In this case, Design B produces nearly the same ROI and results in a better IROI.
Select Design B and get a greater return on the incremental money.

9.3 THE EFFECT OF DEPRECIATION

Depreciation is used to take into account the value of the equipment when it reaches
obsolescence or must be replaced because of new technology. Assets before 1981
could be depreciated using the double declining balance method. From 1981 to 1986,
the accelerated cost recovery system (ACRS) was used. Here all property was
classified in 3-, 5-, 10-, 15-, or 20-year service life groups with no salvage value.
The majority was in the 5-year group. A

½

full-year depreciation in the year placed
in service was allowed; no deduction was granted in the year when property is
disposed. From 1987 on, the modified accelerated cost recovery system (MACRS)
has been used. This is the same as ACRS but also allows

½

of a full-year depreciation
during the year of disposal. A 200% declining balance (i.e., double declining balance)
for class lives of 3, 5, 7, and 10 years and a 150% depreciation for class lives of
15 and 20 years is allowed. A switch to straight-line depreciation at a time appro-
priate to maximize deduction is permitted.
Straight-line depreciation, although no longer permitted, can be used to illustrate
the effect of depreciation. The following definitions apply.
V

R

= initial cost
V

S

= salvage value
IROI =×=
23 000
50 000
100 46 0
,
,
.%
ROI =×=
15 000
200 000
100 7 5
,
,

.%
ROI =×=
38 500
250 000
100 15 4
,
,
.%
IROI =×=
38 500
100 000
100 38 5
,
,
.%

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© 2002 by CRC Press LLC

V

A

= asset value
n = useful service life
a = years in service
d = annual depreciation
(9.2)
As a part of the example below, the declining balance method will be used. This
method is somewhat similar to the ACRS and MACRS, but is easier to see in an

example. Here equipment depreciates rapidly over the first few years to minimize
taxes during the initial period. The annual depreciation is a fixed percentage at the
beginning of the depreciation year.

9.3.1 A

N

E

XAMPLE

Companies P and Q bought identical Venturi scrubbers for $50,000. The service life
of the scrubbers was eight years with no salvage value. The corporate tax rate is
34% for these companies. Company P uses the straight-line method of depreciation,
and company Q uses the double declining-balance method. Compare the tax savings
for these two companies for a period of 3 years.
• Without depreciation, tax would be 0.34

×

50,000 = $17,000/year
3

×

17.000 = $51,000 over the 3 years
d
VV
n

Vnd
V V da or d
VV
a
RS
R
AR
RA
=
−
=
=−
=− =
−
annual depreciation
V
S

f
Vf
VV f
S
n
AR
a
=
=−
()
=−
()

annual depreciation at a fixed percentage factor
V
R
1
1
V
V
n
a
R
S
=
=
=
=
initial cost = $50,000
salvage value = 0
useful service life = 8 years
years in service = 3 years
tax rate — applied at end of year34%

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• Company P — straight-line depreciation
Tax Computation
1st year: 50,000 – 6250 = $43,750 Tax = $14,875
2nd year: 43,750 – 6250 = $37,500 Tax = 12,750
3rd year: 37,500 – 6250 = $31,250 Tax = 10,625
Total $38,250

Savings = 51,000 – 38,250 = $12,750
• Company Q — double declining-balance depreciation
Tax Computation
1st year: V

R

(1 – f) = 50,000

×

0.7500 = $37,500 Tax = $12,750
2nd year: V

R

(1 – f)

2

= 50,000

×

0.5625 = $28,125 Tax = 9563
3rd year: V

R

(1 – f)

3

= 50,000

×

0.4219 = $21.094 Tax = 7172
Total $29,485
Savings = 51,000 – 29,485 = $20,515
Obviously a method like the double declining-balance is favorable when computing
taxes.

9.4 CAPITAL INVESTMENT AND TOTAL PRODUCT COST

Numerous costs are required to build and operate a chemical plant other than installed
equipment costs and operating costs. However, the usual cost estimation technique
is to relate these costs to the installed equipment costs. Guthrie

2

presents a capital
cost-estimating technique which can be useful. Vatavuk

3

also discusses a method
for estimating capital and operating costs. He presents a table of factors which should
be roughly valid at this time.
d year=

−
=
50 000 0
8
6250
,
$
First year factor
First year factor
=
−










=
−











=
=× =
VV
nV
f
RS
R
1
50 000 0
8
1
50 000
0 1250
2 0 1250 0 2500
,
,
.


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9.4.1 D

ESIGN

D

EVELOPMENT

In order to employ cost estimation and profitability analysis, it is suggested that the
following process be used.
1. Select a process to develop from alternative processes.
2. Prepare the process flowsheet.
3. Calculate sizes of all equipment and estimate fixed capital cost.
4. Estimate installed cost.
5. Determine utilities usage and estimate cost.
6. Determine other costs — taxes, buildings, land, insurance.
7. Undertake a profitability analysis.
In carrying out the design, it is recommended to set a budget for pollution control
equipment. Then make as accurate a cost estimate as possible. Keep in mind main-
taining a satisfactory profit structure if alternate choices are available. The following
factors will affect equipment costs.
• Company policies
• Local and federal government regulations
• Design standards
• Union contracts and agreements
• Agreements with fabricators

REFERENCES

1. Peters, M. S. and Timmerhaus, K. D.,

Plant Design and Economics for Chemical
Engineers

, 4th ed., McGraw-Hill, Inc., New York, 1991.

2. Guthrie, K. M., Capital cost estimating,

Chem. Eng.

, pp. 114, March 24, 1969.
3. Vatavuk, W. M. and Neveril, R. B., Factors for estimating capital and operating costs,

Chem. Eng.

, pp. 157–162, November 3, 1980.

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