Capital fixed

Price. The 1993 U.S. price for fluorine in cylinders was 109/kg for 2.2 kg and 260/kg for 0.7 kg cylinders. The price in large volumes is determined by (/) the price of hydrofluoric acid (2) power costs, ca 4.5 kWh electricity is required for each kilogram of fluorine produced (J) labor costs (4) costs to maintain and rebuild cells and (5) amortization of fixed capital. Fluorine production is highly capital intense. In addition, purification, compression, packaging, and distribution in cylinders increase the cost significantly. 

Capital Investment Cost. The capital investment involved in a proposed project is important because it represents the money that must be raised to get the project started, is used in profitabiUty forecasts, and is reflected in the estimated manufacturing cost of a product. The capital investment is classified herein as fixed capital, working capital, and land cost. Sample capital investment estimate forms provide for separate materials (M) and labor (L) categories, or just combined M L figures. 

The fixed capital estimate depends on the definition of the plant. A grass-roots plant is a complete faciUty at a new location, including all utihties, services, storage faciUties, land, and improvements. If a process plant is located at an existing processing complex, it can usually share some of these auxihary faciUties. A battery-limits plant is defined as the process faciUty itself, so that the auxiUaries, off-site, and land-related items are excluded from the fixed capital estimation. However, a battery-limits plant maybe assigned allocated capital charges for the share of common utihty and service faciUties used by the plant. 

The accuracy of a fixed capital estimate tends to be a function of the design effort involved. As the project definition is refined, the estimates evolve from the various preliminary phases, ie, order of magnitude, predesign, factor estimates, etc, into the more detailed estimates used for budget authorization, project control, and contracts. At the same time, the uncertainty in the estimate decreases from 50% to as Htfle as 5%. 

Overall Eactor Estimates. The next level of fixed capital estimate is based on a preliminary design that includes a flow sheet, material balances, energy balances, and enough equipment design to size all of the principal process equipment, including pumps and tanks. 

An overall Lange factor, E- j can be used to relate the battery-limits fixed capital investment Jg to the deHvered equipment cost Eg, so that... 

Methods are available for making detailed estimates of working capital (15). Shortcut ratios for estimating working capital are 15—20% of the fixed capital, 15% of the total capital, or 10—30% of annual sales. 

Annual plant maintenance and repair costs average about 6% of the fixed capital iavestment, but should be calculated directly from person—hour per shift data or estimates. The annual cost for suppHes can be taken as 15% of the total maintenance and repair cost. 

Annual iadirect costs are estimated as percentages of the direct labor and fixed capital costs. Typical direct labor percentage ranges are 25—30% for payroll overhead, 15—20% for stores and suppHes, 10—20% for control laboratory, 10—20% for security, 10% for yard, and 10—15% for process improvements. That is, total iadirect costs are usually 80—115% of the direct labor cost (1). 

The most common approach to fixed cost estimation iavolves the use of a capital recovery factor to give the annual depreciation and return on capital. This factor typically is between 15 and 20% of the total capital investment. Property taxes are taken as 1—5% of the fixed capital and iasurance is assumed to be 1—2% of the fixed capital. If annual depreciation is estimated separately, it is assumed to be about 10% of the fixed capital investment. The annual iaterest expense is sometimes neglected as an expense ia preliminary studies. Some economists even beHeve that iaterest should be treated as a return on capital and not as part of the manufactufing expense. 

The investment consists of the fixed capital, eg, equipment, buildings, and faciUties land cost and working capital. Interest charges during constmction are frequently considered part of the fixed capital. This is called capitalization of the constmction interest expense. Part of the start-up costs are occasionally treated in the same manner. 

The nondepreciable investments, ie, land and working capital, are often assumed to be constant preoperational costs that are fully recoverable at cost when the project terminates. Equipment salvage is another end-of-life item that can represent a significant fraction of the original fixed capital investment. However, salvage occurs at the end of life, can be difficult to forecast, and is partially offset by dismantling costs. Eor these reasons, a zero salvage assumption is a reasonable approximation ia preliminary analysis. 

DecoveTj of Capital. In Figure 1, the annual book depreciation is used to retire the fixed capital investment. Whereas this accounting model does not correspond to the typical money flow, it is one possible model for recovery of capital. This model assumes that the investment is reduced each year by the amount of the annual depreciation. Another model (22) assumes that a uniform yearly book depreciation payment is made to an interest-bear sinking fund that accumulates to the depreciable fixed capital amount at the end of the venture. Using this second model, the investment is outstanding throughout the lifetime of the project. This also does not correspond to the actual money flow in most cases. ProfitabiUty analysis utilizes a third model based on discounted cash flows. 

Possible numerators include the gross income net pretax income net after-tax income gross profit, ie, gross income minus book depreciation cash flow or net income. An average return value is selected by defining a typical or mature proof year as the basis of calculation. The denominator can be the original total investment, depreciated book-value investment, lifetime averaged investment, or fixed capital investment. 

Operating year Discount year, n Fixed capital Land... 

Mfg cost (less depr and int) Capitalized fixed capital Capitalized total capital Operating income Interest on debt Depreciation (Tax basis) Net taxable income Federal income tax Investment tax credit Net income Cash flow... 

For this example, the tax-basis depreciation method in line-item 11 is a straight-line calculation based on the capitalized fixed capital, ie, fixed capital plus interest to the start of operation any salvage should be subtracted from the capitalized fixed capital and the result divided by the number of expected operating years to obtain the aimual tax-basis depreciation. 

Profitability Diagram. The sensitivity of profitabiUty criteria to parameter changes or other effects can also be represented on a profitabiUty diagram. For example, plus 10% change in fixed capital investment for Venture A gives the results shown in Figure 7b. If several other investment levels were plotted, then interpolation would be a simple task and the sensitivity to investment level could be visualized readily. 

Capital Costs The total capital cost Cfc of a project consists of the fixed-capital cost Cpc phis the working-capital cost Cn c, phis the cost of laud and other nondepreciable costs Cp ... 

Working capital may vaty from a very small fraction of the total capital cost to almost the whole of the invested capital, depending on the process and the industiy For example, in jewelry-store operations, the Fixed capital is veiy small in comparison with the working capital. On the other hand, in the chemical-process industries, the working capital is hkely to be in the region or 10 to 20 percent of the value of the fixed-capital investment. 

In the fourth case, a plant or a piece of equipment has a limited use-Ril life. The primary reason for the decrease in value is the decrease in future life and the consequent decrease in the number of years for which income will be earned. At the end of its life, the equipment may be worth nothing, or it may have a salvage or scrap value S. Thus a fixed-capital cost Cpc depreciates in value during its useful life of s years by an amount that is equal to (Cpc S). The useful life is taken from the startup of the plant. 

On the basis of sum-of-years-digits depreciation, the annual amount of depreciation for a specified number of years s for a plant of fixed-capital cost Cpc, scrap v ue S, and service life s is given by... 

A fourth method of computing depreciation (now seldom used) is the sinking-fund method. In this method, the annual depreciation A is the same for each year of the life of the equipment or plant. The series of equal amounts of depreciation Aq, invested at a fractional interest rate i and made at the end of each year over the life of the equipment or plant of s years, is used to build up a future sum of money equal to (Cpc S). This last is the fixed-capital cost of the equipment or plant minus its salvage or scrap value and is the total amount of depreciation during its useful life. The equation relating i Fc S) and Ao is simply the annual cost or payment equation, written either as... 

Figure 9-5 shows the fall in book value with time for a piece of equipment having a fixed-capital cost of 120,000, a useful hfe of 10 years, and a scrap value of 20,000. This fall in value is calculated by using (I) straight-line depreciation, (2) double-declining depreciation, and (3) sum-of-years-digits depreciation. 

Net annual cash income after tax A ci = 25,500 in each of 10 years Fixed-capital cost Cpc = 120,000... 

Payback Period Another traditional method of measuring profitability is the payback period or fixed-capital-return period. Actually, this is really a measure not of profitability but of the time it takes for cash flows to recoup the original fixed-capital expenditure. 

The payback-period method takes no account of cash flows or profits received after the breakeven point has been reached. The method is based on the premise that the earher the fixed capital is recovered, the better the project. However, this approach can Be misleading. 

Let us consider projects A and B, having net annual cash flows as listed in Table 9-2. Both projects have initial fixed-capital expenditures of 100,000. On the basis of payback period, project A is the more desirable since the fixed-capital expenditure is recovered in 3 years, compared with 5 years for projec t B. However, project B runs for 7 years with a cumulative net cash flow of 110,000. This is obviously more profitable than project A, which runs for only 4 years with a cumulative net cash flow of only 10,000. 

Capitalized Cost A piece of equipment of fixed-capital cost Cpc will have a finite hfe of n years. The capitalized cost of the equipment Ck is defined by... 

Let us consider another project in which the fixed-capital expenditure is spread over 2 years, according to the following pattern ... 

Example 2 Net Present Value for Different Depreciation Methods The following data descrihe a project. Revenue from annual sales and the total annual expense over a 10-year period are given in the first three columns of Table 9-5. The fixed-capital investment Cpc is 1,000,000. Plant items have a zero salvage value. Working capital C vc is 90,000, and cost of land C/ is 10,000. There are no tax allowances other than depreciation i.e., is zero. The fractional tax rate t is 0.50. 

The annual rate of straight-line depreciation of the fixed-capital investment Cfc, from 1,000,000 at startup to a salvage value S, of zero at the end of a productive life s of 10 years, is given hy... 

The capitahzed cost of a piece of fixed-capital cost Cpc is the amount of capital reqiiired to ensure that the equipment may be renewed in perpetuity. For a piece of equipment with no scrap value, Ck is given by... 

The estimated (DCFRR) and the estimated (NPV) are both functions of the estimated cumulative revenue from annual sales X As, the estimated cumulative total annual cost or expense X Ate, and the estimated fixed capital cost Cfc of the plant. The revenue from annual sales for each year is in turn the product of the sales price and sales volume. Initially it is desirable to select those values from the distribution cui ves of X As, X Ate, and Cfc which enable the maximum and minimum (DCFRR) and (NPV) to be calculated. 

The discounted-cash-flow rate of return (DCFRR) and net present value (NPV) are functions of the cumulative revenue from annual sales X AfE and the fixed-capital cost of the plant Cfc, among other factors. 

With a cost of capital of 10 percent the various cash flows can be discounted and summed. Thus for the base cases Z Af = 2,815,600, Z Ajp/d = 754,716, Z Aofd = 614,457, and Z C c/d = 61,446. With corporate taxes payable at 50 percent the aftertax cash flows of the first three items are (1 — 0.50) of the sums calculated above. The discounted working capital and the fixed-capital outlay are not subject to tax. These most probable values are listed and summed in Table 9-11 and, after adjustment for tax, give the modal value of the (NPV) as 276,224. 

The interest-rate equivalent of the cash discounts is 2 percent per month, since this discount could he obtained every month if payment were to he made at the beginning of the month rather than, as at present, at its end. Since the hills are settled monthly, the notional interest is paid monthly and should not he compounded. The discount is equivalent to 12 monthly simple-interest payments per year. Hence, from Eq. (9-31) the effective annual interest rate on discounts = (12)(0.02) = 0.24 = 24 percent. It would, therefore, he a good use of surplus cash to reduce this debt as quickly as possible. This would require cash equivalent to one-sixth of the annual hills due, or 16,700, to he avadahle. It can, therefore, he assumed that this level of liquidity is not available for capital projects, either as working capital to reduce the debt or for fixed-capital projects. Further, since the new project will not increase sales, it cannot generate further debt of this kind. Hence, this source is not available to capitahze the new project. 

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