Depreciation, cost references

Fixed capital investments are characterized by the fact that they have to be replaced after a number of years commonly referred to as service life or useful life period. This replacement is not necessarily due to wear and tear of equipment. Other factors include technological advances that may render the equipment obsolete. Furthermore, over the usefiil life of the equipment, the plant should plan to recover the capital cost expenditure. In this regard, the notion of depreciation is useful. Depreciation or amortization is an annual allowance which is set aside to account for the wear, tear, and obsolescence of a process such that by the end of the useful life of the process, enough fund is accumulated to replace the process. The simplest method for determining depreciation is referred to as the straight line method in which... 

To calculate several of the cost items listed in Table 2.1, requires the depreciable and fixed capital costs. The depreciable capital cost is the capital required for equipment and its installation or modification in the process, and all the facilities required to operate the process. There is some variation in the definition of fixed capital cost. References [1-5], define the fixed capital as consisting of the depreciable capital cost, land cost, and site or land development cost. Woods [10], however, omits land cost and land development cost so that that the fixed capital cost equals the depreciable capital cost. We will adopt the first definition here. For now, assume that we know the depreciable capital cost. We will develop a procedure for its evaluation later. In Example 2.1 estimate the production cost using Table 2.1. 

Figure 2.4 divides the depreciable capital costs into several categories. The two major categories are direct and indirect costs. Peters and Timmerhaus [4] and Humphreys [5] list these costs. Reference [3] gives a more detailed breakdown. As Figure 2.4 shows,... 

For use with approximate profitability measures, as applied here to the preliminary calculation of the annual manufacturing cost, depreciation, D, is estimated as a constant percentage of the total depreciable capital, This type of depreciation is referred to as... 

The cost of replacing property without a reduction for depreciation. By this method of value determination, damages for an insurance claim would be the amount needed to replace the property using new materials. Replacement cost refers to the amount that an entity would have to pay to replace an asset at the present time. This may not be the market value of the item. Replacement cost coverage is designed so the policyholder will not have to spend more money to get a similar new item and so that the insurance company does not pay for intangibles. May also be called replacement value. 

The annual depreciation of a fixed capital investment is referred to as annualized fixed cost. It allows the company to set aside an annual portion of profit and use it for purposes of capital-cost recovery and tax deduction. 

Sopt = optimum stripping factor, where treatment costs are a minimum, referenced to costs of utilities, maintenance, depreciation, labor. As economic conditions change one may need to adjust Sopj, see Reference 143. 

Suppose you are asked to evaluate the purchase of the multicone cyclone referred to in Example 3.4. The capital investment is 35,000 (see Example 3.4), and the equipment has a class life of 5 years, after which it will be sold for the salvage value of 4000. The income stream generated by the machine is on line A in Tables EB.5A and EB.5B. As the equipment ages, its operating and maintenance costs increase, and line B lists the expense profile. Assume a tax rate of 35 percent with no investment tax credit. Evaluate two possible scenarios (a) 100 percent use of equity and (b) 100 percent debt financing. Use straight-line depreciation for debt financing, for simplicity assume equal annual payments (principal plus interest) to the lender for the 5 years at a rate of 10.5%. 

Table 2.6 Cost Factors for Estimating Depreciable Capital Cost-Average Factor Method (Adapted from Reference 4.) ...

The money spent to acquire capital equipment and facilities used in research (referred to as capital expenditures) sometimes is not allocated to project-level management cost accounts. How companies allocated these expenses to specific NCEs for the purpose of the survey is unknown. If a responding company estimated only direct expenditures in its clinical period R D, but included R D capital expenditures in its total R D expenditures, the costs in the clinical period would be underestimated, but the ratio of preclin-ical period costs to total R D costs would be overestimated. Because clinical period costs occur later, the total capitalized cost would appear higher using this method. On the other hand, plant and equipment costs are always accounted for with depreciation formulas, which spread costs out for a number of years subsequent to the actual capital expenditure. 19 Because a proper cost estimate should be based on actual cash outlays, the delay in accounting for capital costs will skew expenditures toward the end of the period and will cause the total costs of R D capitalized to the point of market introduction to be underestimated. 

The cost of other investments is recognized overtime through depreciationallowances." The term depreciation refers to the allocation of the cost of a long-lived asset over its useful life. 

One solution to this issue is to use automation wherever possible and to use continuous (more properly referred to as steady-state) reactions rather than batch ones. Doing so, of course, is likely to increase the capital cost of the plant and reduce the versatility of the process and so the optimum balance must be found. The use of hazardous materials or high pressures will also increase the cost of the plant. In the former case, the materials of construction and the safety precautions will add to the cost. In the latter, the vessels must be stronger, hence usually thicker-walled and with additional safety features, again resulting in higher costs. The capital cost is usually depreciated over a set time, determined by the average lifetime of the type of plant in question. For example, if a plant costs 1,000,000 and is expected to last for 10 years, the annual depreciation would be 100,000. If the output is 10 ton per annum, then the capital depreciation will add 10 per kg to the cost of the product. 

The terms can be expressed in different ways, which might create confusion. The annual net profit may be considered before or after tax. Sometimes the net profit in the third year after start-up is used. The invested capital may be referred to the original total capital investment, fixed-capital, depreciated investment, average investment, or something else. The operating costs could include the depreciation in the fixed costs. 

The packaging costs are those for obtaining disposable containers needed for shipping the product to the customers. (See reference 5 for other details.) For products handled in nondisposable containers no separate packaging cost is listed. Depreciation... 

This relationship has been foimd to give reasonable results for individual pieces of equipment and for entire plants. Although, as shown by Williams (1947a,b), the exponent, m, may vary from 0.48 to 0.87 for equipment and from 0.38 to 0.90 for plants, the average value is close to 0.60. Accordingly, Eq. (16.3) is referred to as the six-tenths rule. Thus, if the capacity is doubled, the 0.6 exponent gives only a 52% increase in cost. Equation (16.3) is used in conjunction with Eq. (16.2) to take cost data from an earlier year at a certain capacity and estimate the current cost at a different capacity. As an example, suppose the total depreciable capital investment for a plant to produce 1,250 tonnes/day (1 tonne = 1,000 kg) of ammonia... 

The declining-balance method is also referred to as the fixed percentage or the uniform percentage method because the amount of depreciation each year is a fixed fraction, d, of the book value of the depreciable asset. Let B = the original cost of the asset, which is usually called the basis t = years of service of the asset and BV, = book value at the end of year t. Then, the amount of annual depreciation, D for the year t is given by... 

The heat exchanger costs given by reference [14] appear to be somewhat conservative. Nevertheless the data in Table 10.5, taken overall, should provide a useful approximate guide to the relative capital costs. The combined annual charge for depreciation and return on capital was taken as 16% of the total capital cost and that for maintenance and carbon dioxide replacement as 4%. 

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