DK5739 CH11

11
Feasibility Analysis
A feasibility analysis is prepared for the purpose of determining that a

proposed investment meets the minimum requirements established by
management. This analysis is in sufficient detail and quality to provide
management with the facts necessary to make an investment decision. In this
chapter, a detailed solution for a proposed investment will be presented to
demonstrate the necessary steps in the preparation of a feasibility analysis.
Personnel responsible for the development of this analysis should have an
appreciation of the factors that affect the reliability and the expected accuracy
of the information.
11.1 INFORMATION REQUIRED

The amount of information necessary to prepare a feasibility analysis will depend
upon the intended use and management’s desire. If the analysis is prepared to
determine whether further research and/or pilot plant studies are necessary, then
preliminary capital cost and operating expense estimates may be satisfactory with
their inherent accuracies. However, if the objective is to request appropriation of
funds, then more firm information is necessary to prepare definitive or detailed
estimates.
The minimum information required to prepare a feasibility analysis is:
. Fixed capital investment estimate
. Total capital investment
. Total operating expense estimate
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Copyright © 2003 by Marcel Dekker, Inc. All Rights Reserved.
266 Chapter 11
. Marketing information
. Cash flow analysis
. Estimate of profitability
In addition, management may also require break-even information, sensi-
tivity and uncertainty analyses [1].
11.1.1 Fixed Capital Investment

In order to prepare an estimate of fixed capital, it is recommended that a
form be developed and used as a checklist to be sure that no items have been
omitted. A list including the purchased or delivered equipment costs be
prepared as a first step. From this basic information, it is then a simple
matter to calculate the fixed capital investment using the Lang, Hand, Wroth,
or Brown methods as described in Chapter 4. These methods are used for
study or preliminary estimates. If the Chilton method is to be used for a
preliminary estimate, it is recommended that a form similar to Table 4.14 is
recommended. The use of the Chilton form is illustrated in Example 11.1.
For a definitive or detailed estimate, a code of accounts format similar to that
in Chapter 4 is suggested (Table 4.21).
The forms used in a feasibility analysis should state clearly the dollar
amounts and the date of each estimate. All forms are designed so that data for
other cases of scenarios may be reported by extending the tables to the right of
the page.
11.1.2 Total Capital Investment

The major items constituting the total capital investment are found in Table 11.1.
Blank spaces have been included to allow the user the flexibility to include other
capital items not listed in Table 11.1.
Table 11.2 may be used for estimating the working capital requirements
using the inventory method described in Chapter 4. If the percentage method is
used, the result may be inserted directly into Table 11.1.
11.1.3 Total Operating Expenses

The total operating expenses may be estimated using two forms, Tables 11.3 and
11.4. The first table is for the Total Product Expenses discussed in Chapter 5 and
includes raw material expenses, by-product credits, direct and indirect expenses,
as well as packaging, and shipping expenses. The bottom line in Table 11.3 is the
expense involved in the manufacturing, packaging, and loading a product on a
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Feasibility Analysis 267
TABLE 11.1 Total Capital Investment
Project Name:
Project Number:
By:
Date:
$MM
Land
Fixed capital
Working Capital
Off-site capital
Allocated capital
Start-up expenses
Catalysts & chemicals
Licenses, patents, and royalties
Interest on borrowed funds
Total capital investment
TABLE 11.2 Working Capital (Inventory Method)
Project Name:
Project Number:
By:
Date:
$MM
Raw material inventory
Goods-in-process inventory
Finished goods inventory
Stores & supplies inventory
Cash
Accounts receivable
Accounts payable
Total working capital
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268 Chapter 11
TABLE 11.3 Total Product Expense
Product: Total annual sales:

Rated capacity: Location:
Fixed capital investment: Operating hours per year:
Date: By:
Raw materials:
Material Unit Annual $/unit $/year
amount
Gross material expense:
By-products:
Material Unit Annual $/unit $/year
amount
By-product credit:
Net material expense:
Direct expenses: Unit Annual $/unit $/year
Utilities:
Steam, low pressure
Steam, medium pressure
Steam, high pressure
Gross steam expenses:
Steam credit:
Net steam expenses
Electricity
Cooling water
Fuel gas
City water
Total utilities:
Labor:
Person/shift
Annual labor rate per person
Labor expense:
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TABLE 11.3 (Continued )

Supervision:
% of labor expense
Payroll charges, fringe benefits, etc.:

% of labor plus supervision
Maintenance:
% of fixed capital investment
Maintenance expense:
Supplies:
% of labor
Supplies expense:
Laboratory charges:
Hours per year
Expense per hour
Laboratory expense:
Clothing and laundry:

% of labor
Clothing expense:
Environmental and waste disposal expense:

Tons/year
Charge/ton
Total environmental expense:
Royalties (running):
Other:
Total direct expense:
Total direct and net material expense:
Indirect expenses
Depreciation:
% fixed capital investment
Depreciation expense:
(Continued)
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270 Chapter 11
TABLE 11.3 (Continued )
Plant-indirect expense:
% of fixed capital investment
Plant indirect expense:
Total indirect expenses:
Total manufacturing expense:
Packaging and shipping expense:

Annual production
Expense per ton
Packaging and shipping expense:
TOTAL PRODUCT EXPENSE
conveyance for delivery to the customer. To these expenses in Table 11.3, the
general overhead expenses must be added. Table 11.4 may be used for this
purpose but if the overhead expenses are calculated as a percentage of annual
sales, Table 11.4 may not be needed and the result inserted in the summation of
the total operating expenses at the appropriate place.
TABLE 11.4 General Overhead Expense
Project Name:
Project Number:
By:
Date:
$MM
Sales expense
Administration expense
Research & engineering expense
Finance
Total general overhead expense
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TABLE 11.5 Marketing Data
Profit center: Project title: Appropriation No.:
Basis: Sales and market projections are not inflated (20—dollars)

20— 20—b
Amount % Total Amount % Total
Total market:
Units
Average realistic price, $/unit
Value, $M
Estimated product sales (with ARa):
Units
Value, $M
Current product sales (without AR):
Units
Value, $M
Incremental product sales: (with AR):
Units
Average realistic value, $/unit
Value, $M
Current product sales displaced
by improved product sales:
Units
Value, $M
Total improved product sales:
Units
Value, $M
a
AR ¼ appropriation request.
b
Table extends to the right for the number of project years.
11.1.4 Marketing Information

A major part of all feasibility studies is the marketing data so that income projec-
tions may be made. It is essential to have the latest estimate of the company’s
market position for management’s consideration. A tabulation of projected sales
volume, sales price, and share of the market not only domestically but also
globally is considered minimal information. Table 11.5 is a sample of such
marketing information.
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272 Chapter 11
TABLE 11.6 Cash Flow Analysis
Cash flow summary

200X 200Y 200Z, etc.a
Investment
Land
Fixed capital investment
Offsite capital
Allocated capital
Working capital
Start-up expenses
Interest
Catalysts and chemicals
Licenses, patents, etc.
Total capital investment
Income statement
Income
Expenses
Cash operating expenses
Depreciation
Total operating expenses
Operating Income
Net income before taxes
Federal income taxes
Net income after taxes
Cash flow
Capital recovery
Cumulative cash flow
a
Table extended to the right for the number of project years.
11.1.5 Cash Flow Analysis

A cash flow analysis similar to Table 11.6 is useful in presenting the cash flow
items in a clear, concise format. This table may be modified to include a choice
of time zero and to allow management to add or delete certain items.
11.1.6 Measures of Profitability

The profitability of a project may be included as part of the cash flow analysis
or it may be given in a special form like Table 11.7. The classical methods
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TABLE 11.7 Profitability Analysis
Project Name:
Project Number:
By:
Date:
Net present worth (%)

Discounted cash flow rate of return
Payout period
Internal rate of return
Economic value added

Market value added
have been included, but some of the contemporary measures such as economic
value added (EVA) and market value added (MVA) may also be presented.
A company may only compute certain values, so Table 11.7 may be modified for
specific uses. In this table, the interest rate used in the calculation of the net
present worth is noted.
11.1.7 Break-even Analysis

Frequently management requests a break-even chart as part of the feasibility
analysis. Such charts are predicated on numerous assumptions but will give some
indication of the sensitivity of production rates on profitability. The assumptions
should be clearly stated in the analysis. This type plot may be constructed like
Figure 11.1 not only to indicate the break-even and shutdown points but also to be
of use in marketing and production planning.
11.1.8 Sensitivity Analysis

The effect of errors and inaccurate information upon the profitability of a proposed
venture is determined by means of a sensitivity analysis. The author prefers a
graphical format similar to that shown in Figure 11.2, which was developed by
Strauss [2]. At a glance, busy executives can quickly note those variables that
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274 Chapter 11
FIGURE 11.1 Typical break-even plot.
affect profitability the most. If the data are presented in tabular format, searching
through such tables can be time consuming and tedious, whereas a sensitivity plot
clearly indicates the variables that need further attention.
11.1.9 Uncertainty Analysis

Some companies include uncertainty analysis as part of the feasibility analysis
package. The objective is to determine the probability of the risk of receiving a
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FIGURE 11.2 Typical sensitivity analysis plot.
greater (or lesser) return on the investment predicted by the measures of

profitability used. Probabilities are assigned to each variable in the analysis
based upon past experience. For example, what is the probability that the
proposed sales pattern will develop? Some executives believe that such studies
are exercises in futility since little information regarding accurate probability
distribution models for a given variable are known or can be proposed.
The results of an uncertainty analysis may be presented in a plot like Figure
11.3. There are computer programs that are available that do the calculations,
but the person preparing this analysis still must tell the program what
probability distribution fits a certain variable.
11.2 PROCEDURE
It is essential that management establish a procedure for the preparation
of a feasibility analysis to ensure uniformity in reporting. The following outline
of steps that might serve as a guide in gathering information for the analysis:
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276 Chapter 11
FIGURE 11.3 Typical uncertainty analysis plot.
1. Assemble all the necessary forms that company policy requires for a
feasibility analysis.
2. Determine the quality of the fixed capital investment estimate that is
appropriate considering the time frame and funds available for the
preparation of the analysis.
3. Develop or gather the data necessary for substitution in the appropriate
places in the various forms.
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4. From step 3 above, determine the economic feasibility of the venture as

required.
The use of standardized forms cannot be emphasized strongly enough
since they serve as a check to ensure that all requisite items have been
included and that stepwise results are presented in a logical, orderly, and
organized manner.
11.3 FACTORS THAT AFFECT THE ACCURACY

OF A FEASIBILITY ANALYSIS
11.3.1 Capital Cost Estimates
The various types of cost estimates and their purported accuracies are found in
Chapter 4. For example, an order-of-magnitude estimate accuracy is 2 30 to
þ 50%, a preliminary estimate is 2 20 to þ 30%, and a detailed estimate is 2 5
to þ 10%. The basis for any estimate is equipment costs, so it is essential to use
the latest cost information available and to know the data accuracy. The
fixed capital investment estimate is critical since is used in the estimate of
working capital, in certain items of the operating expenses, and in start-up
expenses. In the preparation of this estimate, a well-defined scope must be
developed consistent with the estimate data. A poorly defined scope potenti-
ally contributes to serious errors and considerable uncertainty regarding the
project’s feasibility.
11.3.2 Operating Expense Estimates

In the preparation of this estimate, it is wise to seek the advise of manufacturing
personnel. Their input will help temper the estimates, minimizing guesses.
These people are valuable sources with respect to labor requirements for a
process. Raw material requirements can be obtained with reasonable accuracy
from material balances, research reports, or pilot plant data. Utilities may be
estimated from material and energy balances and the guidance of utilities
supervisors with respect to prices and projected costs at a plant site.
11.3.3 Marketing Data

One of the largest potential sources of error is the quality of marketing
information used in a feasibility estimate. Market volume is sometimes difficult
to predict accurately because customers may change their requirements, use
substitute products, or perhaps purchase a competitor’s product. Any one of these
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278 Chapter 11
items can deal a devastating blow to the estimate of sales volume. Sales price is a
volatile variable since it is affected by sales volume as well as competition in the
marketplace from similar or substitute products. Market volume and market price
affect the return on investment to a great extent. Sensitivity analyses will show
the effect of these variables on the economics of a project. Therefore, a
substantial amount of effort and time should be expended to obtain the best
market data possible.
11.3.4 Inflation
In the mid-to late 1970s, inflation was rampant in part due to the Middle-East oil
crises. If inflation is not handled properly, it can cause considerable errors in
feasibility analyses. Smith [3], Jones [4], and Griest [5] are classical texts
published in the late 1970s and early 1980s that deal broadly with the subject. In
that time period, inflation was double digit as high as 13.5%. In the current period
(2002 –2003) it is 1– 2% and therefore is not a source of serious error.
One school of thought suggests that a specific time be selected and all
economic data for a proposed project be corrected and reported on a constant-
dollar basis as of that date. An alternative would be to project the inflation
rate based upon past experience and near-recent trends, and then to apply to
the economics of the project. Inflation rates are reported by the federal
government and may be found frequently in the Wall Street Journal. One
company the author knows projects inflation rates on a 6-month basis and
then corrects the rate as current data become available using a moving-
average forecasting technique. Whatever approach is used, company policy
will dictate a method, but inflation should not be glossed over as serious
consideration must be given to its affect on capital cost and operating expense
estimates.
Griest [5] summarized the effects of inflation upon evaluations as follows:
. Inflation does affect the profitability of a project, reflecting unfavorably
upon the net present worth.
. Inflation can change the order of preference of project selection in a
capital budgeting decision.
. Inflation may be built into the discount rate used in calculating the net
present worth.
. If inflation is a variable in an analysis, then it can be handled
statistically in an uncertainty analysis.
. High rates of inflation tend to improve the attractiveness of a lease
alternative relative to capital investment in a lease-purchase study.
. Higher rates of inflation, in general, tend to favor lower capital projects.
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11.3.5 Depreciation
Through the years depreciation methods have been revised by Congress and the
Internal Revenue Service. These revisions occurred whenever the economy
was depressed, and the intent of the revisions was to stimulate the economy by
hopefully encouraging capital spending. Write-off periods were shortened, which
increased the cash flow in the early years of a project. The depreciation model
used can drastically alter the cash flow patterns affecting the feasibility analysis.
As of 2003, straight-line or the Modified Accelerated Cost Recovery System
(MACRS) are the methods presently used [6].
11.3.6 Production Rate

The amount of material produced by a company is highly dependent on the
marketing data. From these data, production schedules are prepared. Should
the market volume decrease, the company will quickly build inventories that
may result in an economically unhealthy situation unless the production is
decreased. Such a move may be below an economically attractive operating
rate. Many processes require operation at 50 – 60% of rated capacity to break
even, and operation at 100% of capacity may not always be possible. A
break-even chart is often included in a feasibility analysis so that at a glance
management may observe the effect of changing production rates upon the
profitability of a project.
11.3.7 Tax Credits

Investment tax credits have been allowed by the Internal Revenue Service under
specified conditions at various times. Although tax credits based upon
investment in manufacturing equipment did alter the cash flow of a project, in
many cases it did not have the strong influence that revisions to depreciation
had upon a project’s feasibility. The reader should be aware of the latest tax
credits since they have been allowed and discontinued frequently over the past
several decades.
11.3.8 Concluding Comments

In this chapter, the information needed to prepare a feasibility analysis has
been presented. This information includes a capital cost estimate, operating
expense estimate, cash flow analysis, project profitability, sensitivity and
uncertainty analysis. It should be mentioned that the information may be
modified depending upon management’s requirements, so not every feasibility
study will contain the information in this chapter. One should recognize that
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280 Chapter 11
all the calculations are based upon estimates that are subject to error. It is
therefore essential to determine what affect potential errors have upon the
results of the study. Such information is obtained from sensitivity and an
uncertainty analysis.
As mentioned previously in Chapter 9, besides the quantitative results,
qualitative factors must be considered in the decision-making process.
11.4 EXAMPLE OF A FEASIBILITY ANALYSIS

Example 11.1
Problem Statement:
Nue Chemical, Inc. is a small company that produces a wide variety of
specialty chemicals for various customers. In 1999, it was considering the
manufacture of an additive for use in the plastics industry. At that time, a market
survey indicated that the project did not meet Nue’s profitability requirements so
the project was shelved.
In late 2002, Nue Chemical was acquired by Fusible Plastics, a large
plastics manufacturer. Fusible wanted to integrate backward to raw materials so
that the company could gain a better market and profitability position. Since the
acquisition, Fusible has been reviewing the profit picture for all products in
the acquisition. The marketing department of Fusible has prepared the following
10-year market information for the additive.
Year Potential sales, MM lb/yr Estimated sales price, $/lb
2004 40.0 0.50

2005 42.0 0.50
2006 45.0 0.52
2007 48.0 0.52
2008 50.0 0.55
2009 50.0 0.56
2010 47.0 0.50
2011 45.0 0.48
2012 40.0 0.47
2013 35.0 0.45
The process to manufacture the additive involves fluids only. The delivered
equipment cost of the process equipment as of January 1, 2003 is as follows:
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Item Delivered equipment cost
Tanks $230,000
Pumps 75,000
Heat exchangers 525,000
Filters 120,000
Reactors 1,200,000
Miscellaneous equipment 350,000
Total $2,500,000
(Note: The delivered equipment cost includes cost differentials for materials of
construction).
The company uses the Chemical Engineering cost index to update costs.
For the future, management suggests a 5% per year inflation rate. Land for this
project may be considered negligible but working capital may be taken as 15% of
the total capital investment. Apex Contractors, Inc. has prepared a definitive
estimate of the fixed capital investment of $12 million for a 50MM lb/yr plant.
The equipment is to be purchased and installed over a 2 year period prior to start-
up which is expected to be in early 2004.
Chlorine is used in the manufacture of the additive and is supplied by
Fusible’s old small 200 ton/day plant located adjacent to the proposed new
additive. Ten tons of chlorine per day is used in the manufacture of the additive.
The total capital investment of the chlorine facility is carried on the books at
$10 million.
Operating expenses for the proposed new additive unit are:
TABLE 13
Raw materials $0.12/lb product

Utilities $0.03/lb product through 2007 and $0.045
thereafter
Labor and supervision $0.05/lb product through 2008 and $0.06
thereafter
Maintenance 6%/yr of the fixed capital investment
Other direct expenses $0.01/lb product
Depreciation 7-year straight line for operating expenses
and 7-year MACRS for cash flow
analysis with half-year convention
Other indirect expenses $0.01/lb product
General overhead $0.02/lb product
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282 Chapter 11
You may assume all product made is sold.

At this stage of consideration, unless a project has a positive 25% NPW after
taxes, the venture will not be considered further. The federal income Tax rate is 35%.
To conform to Fusible’s company standard evaluation procedure, the
following components of a feasibility study are required:
a. An estimate of the total capital investment for the venture as of January

1, 2004
b. Annual operating expenses for all production rates
c. An estimate of the profitability by the DCF rate of return method using
the 7-year MACRS depreciation and continuous interest
d. The NPW at 25% for the venture
e. Cash position chart for the proposed project
f. Payout period at 25% interest
g. A sensitivity analysis based upon a 50 MM lb/yr plant capacity to
determine the effect of the following variables upon the rate of return:
1. Sales price with a ^ 15% variation
2. Sales volume with a ^ 15% variation
3. Raw material costs with a ^ 15% variation
4. Fixed capital investment with a ^ 15% variation
Based upon your analysis, what recommendation would you make to

management concerning the proposed venture? Substantiate your answer(s) with
numerical results.
Solution:
a. Estimate of the total capital investment as of January 1, 2004. Apex
Contractors, Inc. have submitted a detailed estimate of the fixed capital investment
in the amount of $12 million that may have an inherent error of 2 5 to þ 15%. As a
matter of policy, it would be wise to also estimate the fixed capital investment
using the Lang, Hand, Brown, and Chilton methods and compare the result with
the Apex figure. (These shortcut methods can be used to obtain a preliminary
figure before the outside contractor submits his estimate.)
LANG METHOD : Because the date of the delivered equipment price was
January 1, 2003, an inflation factor of 1.05 must be included in the following
methods. The Lang factor for a fluid processing plant is 4.74 (Table 4.9) times
the delivered equipment costs. Therefore the fixed capital investment by this
method is
ð$2:5MMÞð4:74Þð1:05Þ ¼ $12:5 MM
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HAND METHOD : This method involves the use of different factors for each
type of equipment. The factors are found in Table 4.10.
Item Delivered price factor Component cost
Tanks $230,000 4.0 $ 920,000

Pumps 75,000 4.0 300,000
Heat exchangers 525,000 3.5 1,838,000
Filters 120,000 4.0 480,000
Reactors 1,200,000 4.0 4,800,000
Miscellaneous 350,000 4.0 1,400,000
Total $2,500,000 $9,738,000
The total component cost is multiplied by the inflation factor to bring costs
to January 1, 2003:
ð$9; 738; 000Þð1:05Þ ¼ $10; 225; 000
The fixed capital investment will be rounded off to $10,200,000.

BROWN METHOD : The Brown method has factors for materials
of construction, but in this problem statement mention was made that the
costs of the materials of construction were included in the delivered equipment
cost. This method is described in Section 4.3.2.4, and the factors are presented
in Table 4.12.
Item Delivered equipment cost Factor Component cost
Tanks $230,000 3.5 $805,000

Pumps 75,000 5.0 375,000
Heat Exchangers 525,000 3.5 1,838,000
Filters 120,000 2.4 288,000
Rectors 1,200,000 4.2 5,040,000
Miscellaneous 350,000 4.0a 1,400,000
Total $2,500,000 $9,746,000
a
Estimated factor.
The fixed capital investment by this method is
ð$9; 746; 000Þð1:05Þ ¼ $10; 233; 000
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284 Chapter 11
CHILTON METHOD :
Item no. Item % of item Factor Component cost
1. Delivered equipment 1 1.0 $2,500,000

2. Installed equipment 1 1.43 3,575,000
3. Process piping (fluid) 2 0.60 2,145,000
4. Instrumentation (extensive) 2 0.20 715,000
5. Buildings and site 2 0.20 715,000
development
6. Auxiliaries (minor) 2 0.03 107,000
7. Outside lines (minor) 2 0.03 107,000
8. Total physical plant cost $7,364,000
9. Engineering (simple) 8 0.25 1,841,000
10. Contingencies (firm) 8 0.15 1,105,000
11. Size . $2.5 MM 8 0.03 221,000
12. Total fixed capital $10,531,000
investment
The fixed capital investment may be rounded to $10,500,000.

The estimates of the fixed capital investment by the various methods are:
Lang $12,500,000
Hand 10,200,000
Brown 10,233,000
Chilton 10,500,000
Apex Contractors 12,000,000
The costs obtained by the Hand, Brown, and Chilton methods produce
similar results and this might be expected as the methods are somewhat similar
in nature. If the errors in each method are considered, the estimates of the
fixed capital investment are close. The Lang method gives a result very similar
to the one from Apex Contractor, but the errors in the Lang method are greater
than the method used by Apex. Because Apex’s is a more detailed estimate, its
figure will be used in the rest of the feasibility study. These results may be a
coincidence.
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Therefore, the total capital investment is
Item Investment
Land $0
Fixed capital investment 12,000,000
Allocated capital
(10/200)($10,000,000) 500,000
Working capital 2,200,000
All other items 0
Total capital investment $14,700,000
b. Operating expenses. The most efficient way to present the results of

these calculations is in an electronic spreadsheet. In this form, it permits the user
to develop many different scenarios. The results may be found in Table 11.8.
c and d. Cash flow analysis and NPW and IRR calculations.
The next step in a feasibility study is to develop a cash flow analysis.
Again, like the operating expenses, it is advisable and more efficient to present this
analysis as an electronic spreadsheet. The cash flow analysis is found in Table 11.9.
Fusible requires a NPW method at a 25% interest rate to consider a
project for funding at this stage. From Table 11.10, the NPW at 25% is a
positive $9,858,000; therefore, the projects meets the company’s profitability
requirements. Also, from Table 11.10, the IRR is 36.40% and this is very
good. Detailed calculations are summarized in Table 11.10.
e. Cash position chart. A cumulative cash position chart can be con-
structed for this project from the cash flow analysis, Table 11.9. The plot is
presented in Figure 11.4.
f. Payout period at 25% interest. The payout period with interest can be
obtained by interpolating in the cumulative cash flow in Table 11.9 or from the
plot, Figure 11.4. The payout period with 25% interest found by interpolation is
2.2 years. A 2 to 3 year payout period is reasonable for this project at this time.
g. Sensitivity analysis. With the aid of electronic spreadsheets for the
operating expenses and the cash flow analysis, a sensitivity analysis can be
prepared. Some companies prefer the results as a plot, similar to the Strauss chart
or as a “tornado” plot [see Chap. 10 for the details of these charts.] Some
companies prefer the results in both tabular and graphical format but Fusible
prefers the result in the form of a sensitivity plot, like the Strauss chart, Figure 11.5.
h. Uncertainty analysis. Fusible does not require a Monte Carlo uncer-
tainty analysis for this problem.
i. Concluding comments. The project meets Fusible’s criteria for invest-
ment with respect to NPW and POP. The recommendation to management is to
confirm the marketing, capital investment, and operating expense estimates and if
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286
TABLE 11.8 Operating Expenses for Example 11.1 (All Monetary Amounts are in $M)
Production (MM lb/yr): 40.0 42.0 45.0 48.0 50.0 50.0 47.0 45.0 40.0 35.0
Fixed capital, $M 12,000
Date: 07/12
By JRC
Year 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Raw materials 4,800 5,040 5,400 5,760 6,000 6,000 5,640 5,400 4,800 4,200
Utilities 1,200 1,260 1,350 1,440 2,250 2,250 2,115 2,025 1,800 1,575
Labor and supervision 2,000 2,100 2,250 2,400 2,500 3,000 2,820 2,700 2,400 2,100
Maintenance 720 720 720 720 720 720 720 720 720 720
Other directs 400 420 450 480 500 500 470 450 400 350
Total directs 9,120 9,540 10,170 10,800 11,970 12,470 11,765 11,295 10,120 8,945
Depreciation 857 1,715 1,715 1,714 1,715 1,714 1,715 856 0 0
Other indirects 400 420 450 480 500 500 470 450 400 350
Total indirects 1,257 2,135 2,165 2,194 2,215 2,214 2,185 1,306 400 350
Total manufacturing 10,377 11675 12,335 12,994 14,185 14,684 13,950 12,601 10,520 9,295
expense
General overhead 800 840 900 960 1000 1000 940 900 800 700
Total operating expense 11177 12515 13235 13,954 15185 15,684 14890 13501 11320 9995
Depreciation 857 1,715 1,715 1,714 1,715 1,714 1,715 856 0 0
Chapter 11
Cash operating expense 10,320 10,800 11,520 12,240 13,470 13,970 13,175 12,645 11320 9995
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Feasibility Analysis
TABLE 11.9 Cash Flow Analysis for Example 11.1 (All Cash Flow Items are in $M)
Year 2004 2005 2006 2007 2008 2009 2010 2011 2012 2013
Production, 40.0 42.0 45.0 48.0 50.0 50.0 47.0 45.0 40.0 35.0
MM lb/yr
Fixed capital $12,000
investment, $M
Sales 20,000 21,000 23,400 24,960 27,500 28,000 23,500 21,600 18,800 15,750
Cash operating 10,320 10,800 11,520 12,240 13,470 13,970 13,175 12,645 11,320 9,995
expenses
Operating income 9,680 10,200 11,880 12,720 14,030 14,030 10,325 8,955 7,480 5,755
Depreciation 1,715 2,939 2,099 1,499 1,072 1,070 1,072 535 0 0
Net profit before 7,965 7,261 9,781 11,221 12,958 12,960 9,253 8,420 7,480 5,755
taxes
Federal income 2,788 2,541 3,423 3,927 4,535 4,536 3,239 2,947 2,618 2,014
tax, 35%
Net profit after 5,177 4,720 6,358 7,294 8,423 8,424 6,015 5,473 4,862 3,741
taxes
Depreciation 1,715 2939 2,099 1,499 1,072 1,070 1,072 535 0 0
Cash flow 6,892 7,659 8,457 8,793 9,495 9,494 7,086 6,008 4,862 3,741
Capital recovery 2,200
End of project 5,941
value
287
TM
288
TABLE 11.10 Profitability Analysis for Example 11.1
Factor at
Factor at 25% Cash Factor at 35% Cash 40% Cash
Time, yr Item Cash flow interest flow 25% interest flow 35% interest flow 40%
22 Fixed capital 212,000 1.297 215,564 1.448 217,376 1.532 218,384

investment
0 Work þ allocation 22,700 1.000 22,700 1.000 22,700 1.000 22,700
capital
1 Cash flow 6,592 0.885 5,834 0.844 5,564 0.824 5,432
2 Cash flow 7,230 0.689 4,981 0.595 4,320 0.552 3,991
3 Cash flow 8,322 0.537 4,469 0.419 3,487 0.370 3,079
4 Cash flow 8,868 0.418 3,707 0.295 2,616 0.248 2,199
5 Cash flow 9,720 0.326 3,169 0.208 2,022 0.166 1,614
6 Cash flow 9,719 0.254 2,469 0.147 1,429 0.112 1,089
7 Cash flow 7,312 0.197 1,440 0.103 753 0.075 548
8 Cash flow 6,120 0.154 942 0.073 447 0.050 306
9 Cash flow 4,862 0.120 583 0.051 248 0.034 165
10 Cash flow 3,741 0.093 348 0.036 135 0.022 82
End 10 yr Capital recovery 2,200 0.082 180 0.030 66 0.018 40
Net present worth: 9,858 1,011 22,539
Internal rate of return: IRR ¼ 35 5[(1,011)/(1,011 þ 2,539)] ¼ 35.0 þ 1.40 ¼ 36.40%
Chapter 11
TM
FIGURE 11.4 Cumulative cash position plot for Example 11.1.
FIGURE 11.5 Sensitivity analysis plot for Example 11.1.
TM
290 Chapter 11
the project is still profitable, a detailed capital investment should be prepared.

If at any time, the estimates fall below Fusible’s criteria for investment, the project
should be terminated.
REFERENCES
1. JR Couper, WH Rader. Applied Finance and Economic Analysis for Scientists and
Engineers. New York: Van Nostrand Reinhold, 1986.
2. R Strauss. Chem Eng 112 – 116, March 25, 1968.
3. GW Smith. Engineering Economy. 3rd ed. Ames, IA: Iowa State University Press, 1979.
4. BW Jones. Inflation in Engineering Economic Analysis. New York: Wiley, 1982.
5. WH Griest. Chem Eng Prog 13 – 18, June, 1979.
6. Publication 946, Internal Revenue Service, Department of Treasury, Washington,
D.C., 1998.
PROBLEMS
11.1 You are employed in the planning and economics section of ROCK
Chemicals, a company that produces large-volume inorganic chemicals. The
marketing department has a customer who will purchase 100 tons per calendar day
of 50% caustic at a price of $200/ton. Since the current caustic production facilities
are operating at 100% capacity, you have been asked to do a feasibility study for a
new unit to produce the 50% caustic. You have gathered the following information:
1. The process is the electrolytic decomposition of a brine solution
according to the following reaction:
2NaCl þ 2H2 O ¼ 2NaOH þ Cl2 þ H2
2. Design capacity shall be 120 tons per calendar day to accommodate
the future needs of customers.
3. The process flow diagram is found in Figure 11.6.
4. The unit will operate 330 days/yr.
5. Fixed capital investment for the complete process is based on total
feed to the dissolver and is given by
feed to dissolver; tons=stream day
FCI ¼ ð5; 000; 000Þ
200 tons=stream day0:7
6. Construction period is 1 year.
7. There is no charge for land, but working capital is $400,000.
8. The electrolytic cells require 2500 kWh/ton Cl2 produced at a cost of
$0.07/kWh.
TM
FIGURE 11.6 Flow diagram for Problem 11.1.
9. The evaporator economy is 0.8 lb water per lb steam. Steam cost is

$4.50/1000 lb.
10. Depreciation is 7 years straight-line. Project life is 7 years.
11. The total of all other operating expenses including raw materials is
$40/ton of product.
12. The chlorine has a value of $60/ton in another process.
13. The hydrogen may be sold to an adjacent refinery for $5/100 SCF.
14. The tax rate is 35%.
15. Your company requires a 25% IRR for projects.
You have been asked to submit the following information for management’s
consideration:
a. A process material balance based on 100 tons per calendar day
production.
b. An economic analysis in tabular format giving the fixed capital invest-
ment, Revenue in $/yr; operating expenses, in $/yr; cash flow, $/yr.
c. Determine the present worth at 25%.
d. What is your recommendation to management? Discuss a plan of
action.
11.2 You are an engineer in the economics section of AG Products, Inc., and
you are asked to prepare a feasibility study on a new product, FASTGRO,
that is produced as a water slurry. It will then be concentrated in an evaporator
as a 50% thick liquor and sold. A flow sketch of the process is found in
Figure 11.7.
TM
292 Chapter 11
FIGURE 11.7 Flow diagram for Problem 11.2.
The following data apply:

1. The feed is 240 tons/day (330 days/yr) of 20% FASTGRO in water. The
transfer price for this stream is $10/ton (treat as a raw material cost).
2. The feed is at 80 F and has a heat capacity of 0.9 Btu/lb F.
3. The 50% thick liquor is the product.
4. All storage tanks and pumps are available for this project at no cost.
5. The only significant capital cost is the evaporator.
6. The evaporator will operate at 8 psia. At this pressure the boiling
temperature is 227 F, the heat of vaporization is 1000 Btu/lb and the
cost of operating the vacuum equipment is $2.50/ton of condensed
vapor. The evaporator may be assumed as 100% efficient for this study.
7. The overall heat transfer coefficient is 300.
8. The only significant operating expenses are raw materials, steam
expenses, operating expenses for the vacuum equipment, and the
expenses associated with storage, transportation, and sale of the
product. This later expense is estimated to be $12/ton of product.
9. Saturated steam is available at 358 F at a cost of $5.00/1000 lb and has
a latent heat of 863 Btu/lb.
TM
10. Depreciation is 7 years straight line and project life is 7 years. The
combined state and federal tax rate is 40%.
11. The construction period is 6 months with an on-stream date late this year.
Determine the sales price ($/ton) that will be required to achieve a 25% IRR for
this project.
11.3 You are employed as a project manager in the planning section of West
Plaines Refinery. This refinery process sour crude and produces 530 tons/day
of H2S on a continuous round-the-clock basis. Currently, the H2S is sent to
SURCO, a sulfur recovery company located adjacent to our refinery. SURCO
charges West Plaines $80/ton to process H2S under the present contract
which expires 2 years from now. Your assignment is to prepare a feasibility
study of doing our own H2S processing. You have gathered the following
information:
1. West Plaines recently completed a 400 ton/day H2S recovery plant at
one of its other locations. The fixed capital investment for this plant
was estimated to be $21.6MM and the construction period was 1 year.
A new plant could be constructed to go on-stream by the end on the
current contract with SURCO.
2. Operating expenses for a 530 ton/day plant have been estimated to be
$20/ton H2S processed. This figure does not include depreciation.
3. The process chemistry is
H2 S þ 32O2 ¼ H2 O þ SO2 ðaÞ
2H2 S þ SO ¼ 2H2 S þ 3S ðbÞ

Preliminary negotiation have indicated that we will be able to obtain a
3-year contract to sell by-produce sulfur at $12/ton.
4. Equation (a) above is an exothermic reaction with a heat of reaction of
211,000 Btu/lb mole. Equation (b) is exothermic with a heat of reaction
of 101,000 Btu/2 lb mole H2S. The energy may be used to generate steam
at an efficiency of 70%. (Assume that 70% of the energy from the
reaction goes to produce steam with a value of $4.50/MM Btu).
5. We will need 100% backup in H2S recovery facilities. This would
require a duplicate plant to be built. However, SURCO has offered to
provide the backup service for a maximum of 10 days/yr for a fee of
$500,000/yr. This would negate our having to build a second unit to
provide the 100% backup required.
6. Our company requires a 20% IRR for projects of this type. Permission
has been grated from the IRS to use a 3-year straight-line depreciation
and a 35% tax rate.
TM
294 Chapter 11
Please prepare answers to the following questions:

a. Will the proposed H2S recovery plant realize a 20% IRR?
b. Should we build the plant or contract with SURCO?
c. What should be the course of action for West Plaines?
11.4 The Spurious Company is a medium-sized relatively young chemical

producer of high-quality organic intermediates. The management of this company
is aggressive in their investment policy. When Spurious enters a new marketing
venture, they evaluate their profitability by cash flow generated, payout period
with interest, and the internal rate of return measures of merit. The engineering
economics staff has prepared a preliminary fixed capital cost estimate by the
Chilton method of $5MM. Land allocated for this project is worth $200,000.
Working Capital is $900,000 and start-up expenses are $400,000.
As a member of staff you have been asked to prepare an economic
evaluation to be acted upon by the executive committee and ultimately by the
board of directors. The following operational guidelines for feasibility studies are:
1. The project must yield a 20% IRR.
2. A payout period must be less than 3 years.
3. MACRS 7-year depreciation is used.
4. Federal income tax rate is 35%.
It is expected that the construction will take 1 12 years and that start-up, if the
project is approved, is to be January 200Y. If the board approves the project at
next month’s meeting, construction could not begin before July 200Y.
After consulting with representatives of manufacturing, marketing, and
engineering, you estimate that the net profit before taxes over a 10-year project life is
Year NPBT, $M
0 0
1 2,100
2 2,500
3 3,000
4 4,000
5 4,200
6 4,200
7 4,200
8 3,800
9 3,600
10 3,000
You must assume that all dollar figures have been corrected for inflation to
January 1, 200Y.
TM
In order for the executive committee to review this project for possible
funding, please prepare the following information:
a. An estimate of the total capital requirements
b. The payout period with interest
c. The NPW of the project
d. A sensitivity analysis of the effect on the NPW for the following
variables:
1. Fixed capital investment with a ^ 20% variation
2. Net profit before taxes with a ^ 20% variation
e. Be sure to substantiate your recommendations to management with
numerical values.
11.5 Tumbleweed, Inc., located in Texas, is considering the manufacture of a
new specialty chemical. The market for this product is in the eastern part of the
United States, but the plant is to be located in the southwestern part of the United
States because of the proximity of raw materials and the availability of a reliable
source of labor. The marketing department has just completed a preliminary survey
which revealed the following sales potential and sales prices:
Sales volume, lb/yr Sales price, $/lb
1,000,000 0.32
2,000,000 0.30
3,000,000 or more 0.26
For intermediate sales volume, a straight-line interpolation of sales price

may be assumed.
On November 1, a preliminary report was issued by the development
department based upon a promising developed by the research department. As a
result of this study, the following expenses were estimated for a plant producing
1,000,000 lb/yr of product based upon 300 days of operation.
Item Operating expense, $/day
Raw materials 200

Labor 170
Sales overhead 40
Depreciation 75
Maintenance 50
Utilities and fixed expenses 40
Total 675
TM
296 Chapter 11
The total fixed capital costs exclusive of land is 3,000,000. The plant
is assumed to have a 10-year technical life. For intermediate plant capacities, the
total fixed capital investment will very directly as the 0.7 power of the capacity.
For this study, you may ignore the cost of land that the company owns. Working
capital is estimated at 15% of the total capital investment.
Raw material expenses will be directly proportional to the amount of
product manufactured. The labor expense will be constant between 1,000,000 and
2,000,000 lb/yr but for mare than 2,000,000 lb/yr the labor expense will be 1.4
times that of the 1 million rate.
Sales and overhead expenses are 1 cent/lb plus $40/day. Maintenance is
6.7% of the fixed capital investment. Depreciation is on a 7-year straight-line
basis. Utilities and fixed operating expenses will be 5.34% of the total fixed
capital costs. Income tax is 35%.
The following information for a feasibility analysis is required to present to
the planning board:
a. Summaries of the total capital requirements, operating expenses, and
profit loss statement for 1.0,1.5,2.0, and 3.00MM lb/yr rates
b. The optimum plant size calculated by the IRR method
c. The break-even point
d. A sensitivity analysis showing the effect on the optimum case of the
following variables:
1. Sales price with ^ 10 and ^ 25% variation.
2. Fixed and working capital investment with ^ 10 and ^ 25%
variation.
(Note: Several variations might be explored on these last two problems. For
example, rather than straight-line depreciation, the MACRS method might be
used to observe the effect on cash flow. Cumulative cash positions charts might be
required. These problems could also be modified to include uncertainty analysis.)
TM

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11

A feasibility analysis is prepared for the purpose of determining that a

11.1 INFORMATION REQUIRED

11.1.1 Fixed Capital Investment

11.1.2 Total Capital Investment

11.1.3 Total Operating Expenses

TABLE 11.1 Total Capital Investment

Total capital investment

TABLE 11.2 Working Capital (Inventory Method)

Total working capital

TABLE 11.3 Total Product Expense

Product: Total annual sales:

Gross material expense:

Net material expense:

Direct expenses: Unit Annual $/unit $/year

Gross steam expenses:

TABLE 11.3 (Continued )

Payroll charges, fringe beneﬁts, etc.:

Clothing and laundry:

Environmental and waste disposal expense:

Total direct expense:

Total direct and net material expense:

TABLE 11.3 (Continued )

Total indirect expenses:

Total manufacturing expense:

Packaging and shipping expense:

TOTAL PRODUCT EXPENSE

TABLE 11.4 General Overhead Expense

Total general overhead expense

TABLE 11.5 Marketing Data

Proﬁt center: Project title: Appropriation No.:

Basis: Sales and market projections are not inﬂated (20—dollars)

11.1.4 Marketing Information

TABLE 11.6 Cash Flow Analysis

Cash ﬂow summary

11.1.5 Cash Flow Analysis

11.1.6 Measures of Proﬁtability

TABLE 11.7 Proﬁtability Analysis

Net present worth (%)

Economic value added

11.1.7 Break-even Analysis

11.1.8 Sensitivity Analysis

FIGURE 11.1 Typical break-even plot.

11.1.9 Uncertainty Analysis

FIGURE 11.2 Typical sensitivity analysis plot.

greater (or lesser) return on the investment predicted by the measures of

FIGURE 11.3 Typical uncertainty analysis plot.

4. From step 3 above, determine the economic feasibility of the venture as

11.3 FACTORS THAT AFFECT THE ACCURACY

11.3.2 Operating Expense Estimates

11.3.3 Marketing Data

11.3.6 Production Rate

11.3.7 Tax Credits

11.3.8 Concluding Comments

11.4 EXAMPLE OF A FEASIBILITY ANALYSIS

Year Potential sales, MM lb/yr Estimated sales price, $/lb

2004 40.0 0.50

Item Delivered equipment cost

Raw materials $0.12/lb product