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1. Production Economics 2019 Wk 1 & 2

PRODUCTION ENGINEERING
PIC400S
Lecturer:
Lecture times:
Tutor:
Prof Seun Oyekola
Mon & Wed (17h00-20h00)
Mr Ashton Mpofu
([email protected])
Email:
Office:
[email protected]
Rm. 2.64, New Chem Eng &
Chemistry Bldg
1. Overview & Basic Concepts of
process engineering economics
Feasibility: Risk assessment
Profitability: credits, debits,
inputs, outputs, costs & sales
Quality Control: probability &
statistics
2. COURSE CONTENT
Theory, principle, concepts
Calculations
Implications of calculations
Decision making
3.INTRODUCTION
 The basis of many engineering decisions is an
economic one.
 Engineering economics provides the tools to
evaluate alternatives based on available resources.
 A process must be both technically feasible and
economically viable (?)= SUSTAINABILITY
 Life-cycle costing vs. initial-investment costing
(simple financial transaction) e.g. automatic
manufacturing plants, nuclear power plants
Engineering Economics
 …….a collection of mathematical / analytical
techniques that simplify economic comparison
 …….formulation, estimation and evaluation of the
economic outcomes out of various available
alternatives to accomplish a defined purpose
 …….discipline
that involves the systematic
evaluation of the cost and benefit of proposed
technical projects
4. SUBJECT SCOPE
• Estimation of capital costs
• Estimation of manufacturing costs
• Profitability analysis
• Process optimisation
5. OUTCOME
 Use historical financial data to forecast
 Make simulations to optimise process
 Improved decision making skill
 Maximize profit
 Produce an optimum plant design from
competing designs
6. WORK SCHEME
Topic(s)
Week 1-2
Introduction; Estimation of Capital Costs
Order-of-magnitude (Six-tenth rule); Study estimates (Lang factors); Preliminary estimates (Peters and Timmerhaus);
Week 3
Estimation of Manufacturing Costs
Raw material costs; Utilities; Cost of labour; Waste treatment; Depreciation (SL, DDB, SOYD).
Week 4-5
Profitability Analysis
Net Present Value, Discounted Cash Flow Rate-of-Return, Pay Back Period
Week 6-9
Process Optimisation
Batch Processes: Scheduling; Batch Reactor Optimisation
Continuous Processes: Pump and Piping Systems; Heat Exchangers; Mixed Reactors, Distillation Columns, Adsorption
Columns, Membrane Filtration
Week 10
Measures of Central Tendency and Dispersion
Mean; Mode; Variance; Standard deviation; Quartiles; percentiles; Deciles.
Week 11
Probability Distributions
Gaussian; Poisson; Binomial; Chi-squared distribution.
Week 12-13
Monte Carlo Simulations
Week 14
Health, Safety and the Environment
FISA
Textbooks
 Plant design and economics for chemical engineers
by Peters and Timmerhaus
 Analysis, Synthesis, and Design of Chemical Processes
by Richard Turton
 Process Engineering Economics by James R. Couper
7. ASSESSMENTS
Assessment Type
Weighting
Test 1
15
Test 2
15
Test 3
10
Assignment
10
FISA
50
Date(s)
Rational Decision-Making Process

Recognize the decision
problem

Collect all needed
(relevant) information

Identify the set of feasible
decision alternatives

Define the key objectives
and constraints

Select the best possible
and implementable
decision alternative
12
8. PROCESS DESIGN DEVELOPMENT
Conception
Stage
Preliminary
research
Process
research
phase
Devt. phase
• come up with an idea (product, process) (conception stage) by
identifying a societal or engineering need
• Literature survey, patent search and identify the preliminary data
required
• Laboratory scale experiments are carried out. The potential of the
process is established in relation to the economics.
• A pilot-plant (small-scale which is a replica of the full-scale final
plant) is constructed. A complete market analysis is made and
samples of products are sent to prospective customers.
14
•Preparation of detailed engineering design: prepare
process flow sheet, integrate and optimize process, check
controllability, equipment size
•Cost Estimation: capital costs estimates for the proposed process
or plant are then made. Probable returns on the required investment
are determined and a complete cost-and-profit analysis is then made
………. USUALLY COST ESTIMATIONS ARE MADE THROUGHOUT ALL THE
EARLY STAGES OF THE DESIGN. Design
project will only
proceed to the final stages after costs have been
considered
15
Engineering Economic Decisions
Needed e.g. in the following (connected) areas:
Manufacturing
Profit! Then continue
at the next stage…
Design
Financial
planning
Investment
and loan
Marketing
9. Two Factors in Engineering
Economic Decisions
The factors of time
and uncertainty are
the
defining
aspects
of
any
engineering
economic decisions
16
A nearby dollar is worth more than a
distant dollar
Today
6-month later
Example 1
A
semiconductor chip manufacturer
produces 10,000 chips a day. Costing 5
dollar each. John optimised the process
to cost 0.50 cents less per chip. It saved
the company 5000 dollar per day, 150000
dollar per month and 1800000 dollar per
year.
19
10. Major Topics in Engineering
Economics
•Cost Estimation
- How do we determine the costs before we
buy?
•Cash flow
•Time value of money
- How do we compare $ at different times?
•Quantitative measures of profitability
- How do we determine the “profit” or
“financial attractiveness” from an
investment?
20
11. COST ESTIMATION
 Net profit vs. Gross profit
 Be aware of different types of costs involved: direct and
indirect
 TCI = FCI+WCI
 FCI= MFCI+nMFCI
 WCI= not fixed
TCI= total capital investment
FCI= fixed capital investment
WCI= working capital investment
MFCI= manufacturing fixed capital investment
nMFCI= non- manufacturing fixed capital investment
i. Fundamental concepts and definitions
21
 If you borrow R 10, 000 today and use it for 10 years
-will you be paying back the same amount in 10 years’
time?
 Capital: investment
 Credit
 Debit
 Interest
 Depreciation
 Salvage value
 Cash flow
ii. Engineering Costs
Classifications of costs
 Fixed - constant, unchanging



Typically includes building leases, insurance, salaries, heating, and
lighting costs.
Rent is constant: Costs for factory floor space and equipment,
remains the same even though the production quantity, number of
employees, or level of work-in-process are varying
Investment that give rise to fixed cost are made in the present with
the hope that it will be recovered with a profit as a result of
reduction in variable cost or increase in the income
 Variable - depend on activity level
 Typically vary with the level of production.

Labor costs are classified as a variable cost because they
depend on the number of employees in the factory
Thus fixed costs are level or constant regardless of output or activity,
and variable costs are changing and related to the level of output
or activity.
Example 2
 An entrepreneur named SO was considering the
profitability potential of chartering a bus to transport
people from his village to an event in Cape Town.
 SO planned to provide transportation, tickets to the
event, and refreshments on the bus for those who
signed up.
 He gathered data and categorized these expenses
as either fixed or variable:
Variable Costs
Bus Driver
$
$
$
$
Total FC
$ 225.00
Bus Rental
Gas Expense
Other Fuels
People
0
5
10
15
20
80.00
75.00
20.00
50.00
Event Tickets
Refreshments
Fixed cost
$ 225.00
$ 225.00
$ 225.00
$ 225.00
$ 225.00
$ 12.50
$ 7.50
Total VC
$
Variable cost
$
$ 100.00
$ 200.00
$ 300.00
$ 400.00
Total cost
$ 225.00
$ 325.00
$ 425.00
$ 525.00
$ 625.00
Total costs
20.00
Cost ($)
Fixed Costs
$700.00
$600.00
$500.00
$400.00
$300.00
$200.00
$100.00
$0
5
10
15
Volume
Total cost
Fixed cost
20
iii. Estimation of capital costs
Total capital investment: includes funds required to purchase land,
design and purchase equipment, structures, and buildings as well
as to bring the facility into operation (Couper, 2003).
 Land
 Fixed capital investment: The fixed capital investment is
significant in developing the economics of a process since this
figure is used in estimating operating expenses and calculating
depreciation, cash flow, and project profitability.
 Offsite capital
 Allocated capital
 Working capital
 Other capital items
 Interest on borrowed funds prior to startup
 Catalyst and chemicals
 Patents, licenses, and royalties
12. Fixed capital investment
Includes:
 manufacturing equipment
 Piping
 Ductwork
 automatic control equipment
 site preparation
 environmental control equipment
 engineering
 contractor’s costs.
13. Capital Cost Estimates
Classification of Estimates
 Economic analysis is future based.
 Costs and benefits in the future require estimating.
 Estimated costs are not known with certainty.
 The more accurate the estimate, the more reliable the decision.
 Estimating is the foundation of economic analysis.
 Based on accuracy/ quality
 Accuracy based on the amount of design detail available
 Time spent on preparing the estimate
14. Types of Estimates
There are three general types of estimates:
1. Rough – order of magnitude, used for high
level planning, inaccurate, range from 30% to +60% of actual values.
2.
Semi-detailed/ preliminary - based on
historical
records,
reasonably
sophisticated and accurate, -15% to +20%
of actual values.
3.
Detailed
based
on
detailed
specifications and cost models, very
accurate, within -3% to +5% of actual.
15. Quality of an Estimate
Quality of an Estimate
Cost info taken from
previously built plant.
Then scaled
accordingly. BFD
required
Major equipment
are sized & costed.
A factor is then
employed. PFD
required
Estimate Type
Accuracy range
Order of Magnitude
-20% to 40%
Study
-20% to +30%
Preliminary Design
-15 to +25%
Major equipment are
sized & costed (more
accurately). Equipment
layout, estimates of
piping, instrumentation,
electrical
requirements, utilities
estimated. PFD
required
Definitive
-7% to +15%
Detailed
-4% to 6%
Preliminary estimation
of all equipment,
utilities,
instrumentation,
electrical & off-sites
required. Final PFD
required, vessel
sketches, plot plan,
utility balances,
preliminary P&ID
Complete engineering,
of the process needed.
Quotes obtained from
vendors. Final PFD
required, vessel
sketches, plot plan,
utility balances, final
P&ID. All diagrams
required
Example 3
The estimated capital cost for a chemical plant
using the study estimate method was calculated to
be $2 000 000. If the plant were to be built, over what
range would you expect the actual capital estimate
to vary ?
Highest Expected cost= ($2.0×106)(1.3) = $2.6×106
Lowest Expected cost= ($2.0×106)(0.8) = $1.6×106
OR
From $0.6×106 over to $0.4×106 under the
estimate
Cost of Project
<$ 2 Million
$ 2-10 Million
$ 10-100 Million
Classification
Estimate Cost
Estimate Cost
Estimate Cost
Order of
magnitude
$3 200
$6 400
$13 900
Study
$21 500
$42 900
$64 400
Preliminary
$53 700
$ 85 800
$139 500
Definitive
$ 85 800
$171 700
$343 400
Detailed
$ 214 600
$558 000
$1 073 000
Greater accuracy in estimate requires greater details through more
accurate estimating techniques. This incurs more time & money. E.g.
check with order of magnitude even with the -20% to +40% range
Accuracy vs. Cost Tradeoff in Estimating
Accuracy is a measure of how actual value may differ from estimated
one
16. ESTIMATING EQUIPMENT COST
• It’s the foundation of a FCI
• Most data state the date of the data. If no date is
available deduct 2 years from the publication of
the textbook for a base date
• Seek the latest cost data
• current quote from a suitable vendor
• cost data from the previously purchased
equipment of the same type
• summary graphs available for common
equipment
Capacity of equipment need to be considered in
adjusting the cost
17. Effect of capacity on capital cost
• It is known as the sixth tenth or 0.6 rule
• Exponent n varies between 0.4 – 0.8 with an
average value of 0.6
• Exponent vary in the range 0.4-0.9 for a given
equipment. The average value for all
equipment if ~0.6
• Most accurate in the middle range of capacity
Equipment cost data & capacity
Example 4
The larger the equipment the lower the cost of equipment per unit of
capacity (82 vs 150). This is referred to as economy of scale
Economy of scale refer to
reduced costs per unit that
arise from increased total
output of a product
18. Effect of time on capital cost
 Based on changing economic conditions (inflation)
with time. There’s a need to update price
information obtained from past records/ public
correlations
 Cost data are given as of a specific date and can
be converted to more recent costs through the use
of cost indices. In general, the indices are based
upon constant dollars in a base year & actual dollars
in a specific year.
What’s the difference between interest & inflation? Is
there a link between the two?
Cost Indices
Choice of index is based on the
company you are working on/in:
Example:
• For general construction ENR (Eng
News Record) is the best
• Petroleum industry might prefer NF
(Nelson Farrar) index
• Chemical industry might use CE (Chem
Eng) or M&S (Marshall & Swift)
Cost Indices
Example 5
A centrifuge cost $95,000 in 1999. What is the cost of
the same centrifuge in third quarter of 2004? Use the
CE index.
Solution:
CE index in 1999= 390.6
CE index in 3rd quarter 2004= 457.4
Cost in 2004= cost in 1999 (CE index in 3rd
quarter 2004/ CE
index in 1999)
Incorporating the 2 factors
N.B: Often you use the cost index & capacity impact concurrently in
your estimation i.e. they’re incorporated in your calculations as
capacity correction & inflation correction factors
Example 6
The capital cost of a 100 ft2 iron leaf pressure filter in 1980
was estimated to be $15 000. estimate the cost of a 450
ft2 iron leaf pressure filter in mid 1996
Solution:
Cost is 1996=(Cost in 1980)(Capacity correction)(Inflation correction)
= ($15 000)(450÷100)0.6(382÷261)
= ($15 000)(2.47)(1.46)= $ 53 997
Impact of inflation
Inflation: increase in price of goods without
increase in corresponding productivity
Example 7
ESTIMATING THE TOTAL COST OF A PLANT
18. Order of Magnitude Estimates
• Estimate validity based on how close new project
is to past similar projects
• a.k.a cost-capacity estimates
• A project scope is essential before preparing an
estimate
• The scope defines the basis of estimate
Does cost of all the purchased equipment used to set up a plant
represent the total cost of the plant?
Total cost of a plant reflects cost of property, cost of delivering
equipment, cost of construction, fixing utilities etc.
 The same principles for updating & scaling-up (effect of time
& capacity) for equipment in the previous sections, apply for
the plant
i. Turnover Ratio
The ratio method will give the
fixed capital investment per gross
annual sales. The turnover ratio
for various businesses ranges from
0.3 to 4. The chemical industry
has an average of about 0.4 to
0.5. The ratio method of obtaining
fixed capital investment is rapid
but suitable only for order-ofmagnitude estimates.
Assumptions
1. All product made is sold
2. Annual gross sales figure is the
product of the annual
production rate
Turnover Ratio
This is a rapid, simple method for estimating the
fixed capital investment, but is one of the most
inaccurate. The turnover ratio (TOR) is defined as
follows:
=Annual Gross sales/ Fixed capital investment
Example 8
ii. Fixed investment per annual ton of capacity
Example 9
Note that Data in 4.7 was obtained in
1999 & your estimation was for year
2001
2. Study Estimates
 Needs a project scope
 Preliminary material and energy balance
 Preliminary flow-sheet
 Rough sizes of equipment
 Rough quantities
 Rough sizes of building and structures
i. Lang Method
 In most cases you do not have cost information for the same process
configuration.
 Method for obtaining quick estimates of the capital investment
based upon information gathered on 14 processing plants of various
sizes and types.
 It represents the cost to build a major expansion to an existing
chemical plant
 Often employed at the early stages of project design, when the
preliminary flow-sheets have been drawn up & main items of
equipment roughly sized
 Delivered equipment cost be multiplied by a factor based upon the
type of processing plant to obtain the fixed capital investment.
Cf= fL Ce
Cf= fixed capital cost of the plant,
Ce= the total delivered cost of all major equipment items: storage
tanks, reaction vessels, columns, heat exchangers, etc.,
fL= the Lang Factor
Example 10
A small fluid processing plant is considered for construction adjacent
to a larger operating unit at a large plant site. The present delivered
equipment costs are as follows:
Sum
$2715000
Q: Estimate the battery-limits fixed capital investment, assuming a 15%
contingency factor.
N.B: Contingency factor is often included in cost estimation as a protection
against oversights & faulty information. Unless otherwise stated, you can
assume 15%.
Example 10
 Sum of the delivered equipment cost $2,715,000
 Because this is a fluid processing plant, the Lang factor is 4.74.
 Battery–limits fixed capital investment
N.B: The term “battery limits” is used to describe the
contractor’s responsibility. The main processing plant, within
the battery limits, would normally be built by one
contractor. The utilities & other ancillary equipment would
often be the responsibility of other contractors & would be
said to be outside the battery limits. They are called “offsites”
INDIRECT costs
1. Design & engineering costs: include the cost of design & “engineering” the
plant-purchasing, procurement & construction supervision. Usually 20-30%
of the direct capital costs.
2. Contractor’s fees: if a contractor is employed, his fees (profit) would be
included. 5-10% of the direct capital costs
3. Contingency allowance: to cover unforeseen circumstances (labour
disputes, design errors, adverse weather etc). 5-10% of the direct capital
costs
Other indirect cost factors can also be included apart from the above. See table below
To have a more accurate
estimate, the cost factors are
compounded into the Lang
factor. The contribution of each of
these items is calculated by
multiplying the total purchased
equipment by the appropriate
factor.
All factors are derived from
historical cost data of similar
processes
EQUIPMENT COST DATA
• Purchased cost: is the price of the
equipment FOB (free on board) at the
manufacturer’s plant.
• Delivered cost: is the price of the equipment
plus delivery charges to the purchaser’s
plant.
• Manufacturers
quote
the
prices
of
equipment as FOB, meaning that the
purchaser pays the freight charges.
• Freight charges depend on weight & size of
equipment, distance from manufacturing
location to plant site & method of
transportation.
ii. Hand Method
 The Hand method is a refinement of the Lang method for quick estimates.
 The method begins with delivered equipment costs
 Recommended that equipment be grouped by type, such as heat
exchangers, pumps, compressors, with an appropriate factor applied to
each type for installation.
 Hand determined these multipliers by analyzing several detailed estimates
of plants of the same type.
ii. Hand Method
• A process flow-sheet is essential, along with sizes of
major plant items, to produce the battery-limits fixed
capital investment by this method.
• The delivered equipment cost is multiplied by an
appropriate factor to obtain the investment cost.
• The Hand method does not include a contingency
factor, so the user should apply an appropriate figure.
Like the Lang method, accounting for material of
construction differences requires experience.
• The Hand method has a tendency to produce lower
results than the Lang method.
ii. Hand Method
Example 11
Solve previous example for the battery-limits fixed
capital investment using the
Hand method and a 15% contingency.
Assumed for non-pressure vessels
Assumed for pressure vessels
ii. Wroth Method
The Lang and Hand methods start with delivered equipment costs,
but the Wroth method begins with purchased costs so delivery
charges must be included.
Wroth suggested that if an equipment item is not found in the list,
then “use or modify a factor for a similar unit.” Although the Wroth
method is not as quick as the Lang or Hand method, the results
obtained are more accurate. It does have the same disadvantages
the Lang and Hand methods have with respect to equipment sizes
and materials of construction.
Example 12
Problem Statement:
Solve previous example for the battery-limits fixed capital investment using
the Wroth method. Assume that the delivery charges are 5% of the
purchased equipment cost. A 15% contingency factor is to be used.
Solution:
Since the Wroth method uses purchased equipment costs, the delivered
equipment costs will have to be converted.
 These estimating techniques are insensitive to changes
in process configuration.
 They don’t account for special materials of
construction and high operating pressures.
 Detailed calculations using specific price information
for the individual units/ equipment are required.
 E.g. Equipment
module costing Technique