SCHOOL OF BIO AND CHEMICAL ENGINEERING

DEPARTMENT OF CHEMICAL ENGINEERING

UNIT – 1 PROCESS DESIGN DEVELOPMENT-SCH1403

Special emphasis is placed on the economic and engineering principles involved in the design of chemical plants and
equipment. An understanding of these principles is a prerequisite for any successful chemical engineer, no matter
whether the final position is in direct design work or in production, administration, sales, research, development, or any
other related field.
The expression plant design immediately connotes industrial applications; consequently, the dollar sign must always
be kept in mind when carrying out the design of a plant. The theoretical and practical aspects are important, of
course; but, in the final analysis, the answer to the question "Will we realize a profit from this venture?" almost
always determines the true value of the design. The chemical engineer, therefore, should consider plant design and
applied economics as one combined subject.

The scope of Design1:

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esign should be viewed as the focal point of chemical engineering practice. Far more than the development
of a set of specifications for a new chemical plant, design is that creative activity through which engineers
continuously improve the operation of facilities to create products that enhance the quality of life.
UNIT 1: PROCESS DESIGN DEVELOPMENT

Why Economics with Design

Special emphasis is placed on the economic and engineering principles involved in the design
of chemical plants and equipment. An understanding of these principles is a prerequisite for
any successful chemical engineer, no matter whether the final position is in direct design
work or in production, administration, sales, research, development, or any other related field.
The expression plant design immediately connotes industrial applications; consequently, the
dollar sign must always be kept in mind when carrying out the design of a plant. The
theoretical and practical aspects are important, of course; but, in the final analysis, the answer
to the question "Will we realize a profit from this venture?" almost always determines the
true value of the design. The chemical engineer, therefore, should consider plant design
and applied economics as one combined subject.

The scope of Design:

Design should be viewed as the focal point of chemical engineering practice. Far
more than the development of a set of specifications for a new chemical plant,
design is that creative activity through which engineers continuously improve the
operation of facilities to create products that enhance the quality of life.
Whether developing the grass roots plant, proposing and guiding process
modifications, or troubleshooting and implementing operational strategies for
existing equipment, engineering design requires a broad spectrum of knowledge
and intellectual skills to be able to analyze the big picture and the minute details
and, most importantly, to know when to concentrate on each.

Plant Design

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Engineering design of new chemical and petrochemical plants and the
expansion or revision of existing ones require the use of engineering principles and
theories combined with a practical realization of the limits imposed by industrial
conditions. A successful engineer needs more than a knowledge and understanding of
the fundamental sciences and the related engineering subjects such as
thermodynamics, reaction kinetics, and computer technology. The engineer must also
have the ability to apply this knowledge to practical situations for the purpose of
accomplishing something that will be beneficial to society. There are three parameters
that must be defined namely:
1- Design: design is a creative activity and is defined as the synthesis, the putting
together of ideas to achieve a desired purpose. Also it can be defined as the creation
of manufacturing process to fulfill a particular need. The need may be public need
or commercial opportunity.
2- Process Design: process design establishes the sequence of chemical and
physical operations; operating conditions; the duties, major specifications, and
materials of construction (where critical) of all process equipment (as distinguished
from utilities and building auxiliaries); the general arrangement of equipment
needed to ensure proper functioning of the plant; line sizes; and principal
instrumentation. The process design is summarized by a process flowsheet.
Process design is intended to include:
1. Flowsheet development.
2. Process material and heat balances.
3. Auxiliary services material and heat balances (utilities requirements).
4. Chemical engineering performance design for specific items of
equipments required for a flowsheet.
5. Instrumentation as related to process performance.
6. Preparation of specifications (specification sheets) in proper form
for use by the project team as well as for the purchasing function.
7. Evaluation of bids and recommendation of qualified vendor.
3- Plant Design: includes items related directly to the complete plant, such as plant
layout, general service facilities, and plant location.

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Design Development Stages:
The stages in the development of a design, from the initial identification of
the objectives to the final design are shown in Fig.(1).

Fig.(1) The design process.

(I) The Design Objectives (The Need)

Engineering projects can be divided into three types:
A. New process development.
B. New production capacity to meet growing sales.
C. Modification and addition to existing plant.
In the design of a chemical process the need is the public need for the product, the
commercial opportunity as foreseen by the sales and marketing organization.
(II) Setting The Design Basis (Data Collection)
The most important step in starting a process design is translating the customer
need into a design basis. The design basis is a more precise statement of the
problem that is to be solved. It will normally include the production rate and purity
specifications of the main product, together with information on constraints that will
influence the design, such as:
1. Information on possible processes and the system of units to be used.
2. The national, local or company design codes that must be followed.
3. Details of raw materials that are available.
4. Information on potential sites where the plant might be located, including
climate data, seismic conditions, and infrastructure availability.
5. Information on the conditions, availability, and price of utility services such as

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fuel (gas), steam, cooling water, process air, process water, and electricity, that will
be needed to run the process.

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(III) Generation of Possible Design Concepts (Solutions)
It is the creative part of the design process. This part is concerned with the
generation of possible solutions for analysis, evaluation, and selection (ways of
meeting objective problems).
Source of solutions:
a- Past experiences.
b- Tried and tested methods.
(IV) Build Performance Model and Fitness Testing
When design alternatives are suggested, they must be tested for fitness of
purpose. In other words, the design engineer must determine how well each design
concept meets the identified need. In the field of chemical engineering, it is usually
prohibitively expensive to build several designs to find out which one works best (a
practice known as ‘‘prototyping’’ which is common in other engineering disciplines).
Instead, the design engineer builds a mathematical model of the process, usually in the
form of computer simulations of the process, reactors, and other key equipment. In
some cases, the performance model may include a pilot plant or other facility for
predicting plant performance and collecting the necessary design data.
The design engineer must assemble all of the information needed to model the
process so as to predict its performance against the identified objectives. For process
design this will include information on possible processes, equipment performance,
and physical property data
If the necessary design data or models do not exist, then research and
development work is needed to collect the data and build new models. Once the data
has been collected and a working model of the process has been established, then the
design engineer can begin to determine equipment sizes and costs. At this stage it will
become obvious that some designs are uneconomical and they can be rejected without
further analysis. From this step a few candidate designs that meet the customer
objective are identified.
(V) Economic Evaluation, Optimization, and Selection
Once the designer has identified a few candidate designs that meet the
customer objective, then the process of design selection can begin. The primary
criterion for design selection is usually economic performance, although factors such
as safety and environmental impact may also play a strong role. The economic

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evaluation usually entails analyzing the capital and operating costs of the process to
determine the return on investment (R.O.I).
The economic analysis of the product or process can also be used to optimize
the design. Every design will have several possible variants that make economic sense
under certain conditions. For example, the extent of process heat recovery is a tradeoff
between the cost of energy and the cost of heat exchangers (usually expressed as a cost
of heat exchange area). In regions where energy costs

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are high, designs that use a lot of heat exchange surface to maximize recovery of
waste heat for reuse in the process will be attractive. In regions where energy costs are
low, it may be more economical to burn more fuel and reduce the capital cost of the
plant.
When all of the candidate designs have been optimized, the best design can be
selected. Very often, the design engineer will find that several designs have very close
economic performance, in which case the safest design or that which has the best
commercial track record will be chosen. At the selection stage an experienced
engineer will also look carefully at the candidate designs to make sure that they are
safe, operable, and reliable, and to ensure that no significant costs have been
overlooked.
(VI) Detailed Design and Equipment Selection
Here the detailed specifications of equipment such as vessels, exchangers,
pumps, and instruments are determined. During the detailed design stage there may
still be some changes to the design, and there will certainly be ongoing optimization as
a better idea of the project cost structure is developed. The detailed design decisions
tend to focus mainly on equipment selection though, rather than on changes to the
flowsheet. For example, the design engineer may need to decide whether to use a U-
tube or a floating-head exchanger, or whether to use trays or packing for a distillation
column.
(VII) Procurement, Construction, and Operation
When the details of the design have been finalized, the equipment can be
purchased and the plant can be built. Procurement and construction are usually carried
out by an EPC firm (Engineering, Procurement, and Construction) unless the project is
very small. Because they work on many different projects each year, the EPC firms
are able to place bulk orders for items such as piping, wire, valves, etc., and can use
their purchasing power to get discounts on most equipment. The EPC companies also
have a great deal of experience in field construction, inspection, testing, and
equipment installation. They can therefore normally contract to build a plant for a
client cheaper (and usually also quicker) than the client could build it on its own.
Finally, once the plant is built and readied for startup, it can begin operation. The
design engineer will often then be called upon to help resolve any startup issues and
teething problems with the new plant.

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Design Constraints
When considering possible ways of achieving the objective the designer will
be constrained by many factors which are called the design constraints.
Design constraints are divided into two types Fig.(2):
A. Internal constraints: over which the designer has some control.
B. External constraints: fixed, invariable.
What is meant by design constraints? What are the different
types? Give examples? What are the main items that should be
included in the process design?
Draw a block diagram showing the main steps involved in the development of
a design process?

Fig.(2) Design constraints.

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Flow-sheeting (special language conveying information)

Process design normally starts with a process scheme (flowsheet). The flowsheet
is the key document or road map in process design. It's a diagrammatic model of the
process describe the process steps in a proper sequence using symbols to represent the
various components (equipment, lines, and control instrumentation) that make up the
unit.
The Flow-sheet Importance
 Shows the arrangement of the equipment selected to carry out the process.
 Shows the streams concentrations, flow rates & compositions.
 Shows the operating conditions.

 During plant start up and subsequent operation, the flow sheet from a basis
for comparison of operating performance with design. It's also used by
operating personnel for the preparation of operating manual and operator
training.

Flowshe
et
Present
ation 1-
Block
diagram
 Represent the process in a simplified form.
 No details involved.
 Don’t describe how a given step will be achieved.
When is it used?
 In survey studies.
 Process proposal for packaged steps.
 Talk out a processing idea.

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Fig.(3) Block diagram.

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2- Pictorial Flow Sheet
The equipments are normally drawn in a stylized pictorial form. For tender
documents or company brochures actual scale drawing of the equipment are
sometimes used.
Types of pictorial flow-sheets
a) Process Flow Diagram (PFD)
A PFD is a simplified flow diagram of a single process unit, a utility unit, a
complete process module. The purpose of a PFD is to provide a preliminary
understanding of the process system indicating only the main items of equipment, the
main pipelines and the essential instruments, switches and control valves.
A PFD also indicates operating variables, such as mass flow, temperatures and
pressures, which are tabulated at various points in the system.
The PFD is a document containing information on:
 Process conditions and physical data of the main process streams.
 Main process equipment with design data.
 Main Process lines.
 Mass (material) balance.
 Heat balance (if applicable).
NOTE: If the PFD doesn’t contain any data about the flow rates, it is called a
qualitative flowsheet, while if the flow rates are involved the PFD is called a
combined flowsheet in which qualitative information and quantitative data are
combined on the basis of one flowsheet.
b) Piping and Instrumentation Diagram (P & ID) (mechanical flow diagram)
A P&ID diagram shows the arrangement of the process equipment, piping, pumps,
instruments, valves and other fittings. It should include:
 All process equipment identified by an equipment number.
 All pipes identified by a line size, material code and line number.
 All valves with an identified size and number.
 Fittings.
 All pumps identified by a suitable code number.
 All control loops and instruments.
c) Utility Flowsheet (Process Engineering Utility Flow Diagram (PEUFD))

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Used to summarize and detail the interrelationship of utilities such as air, water
(various types), steam (various types), heat transfer mediums, process vents and
purges, safety relief blow-down,etc., to the basic process. The amount of detail is
often too great to combine on other sheets, so separate sheets are prepared.
The PEUFD is a document containing information on:
 Main distribution or arrangement of each individual utility system, expect
electrical systems.
PEUFD Function:

A typical process uses utilities such as water, air and electric power. Water may be
used either in the process, or for cooling and/or production of steam. Air may also be
used in the process or for instrument applications. Electric power of course is typically
used at various points in the process and throughout the site.

It is always useful to develop diagrams that show the flow and utilization of each
utility. An example of a water balance/utility diagram is shown below.

The PEUFD shall state characteristics and consumption figures of the particular utility
concerned, cooling water, fire water, drinking water, steam, plant air, instrument air,
fuel oil/gas, inert gas and similar utilities.
d) Process Safeguarding Flow Diagram (PSFD)
The PSFD is a document highlighting information on:
 Types and levels of protection offered by the devices installed and their inter
relation to demonstrate the plant’s safety.
The P&ID contains all information required for a PSFD; however, the PSFD
highlights protection in case of extreme conditions and measures to be taken to
safeguard personnel and environment.
Note: In general these schemes will only be made for complex installations like
offshore process platforms. For simple applications the information shown on the
P&ID is usually sufficient to highlight safety devices and aspects.

 What is meant by the following identifications? PFD, P&ID, PEUFD and

PSFD
 State the information you can get from the following schemes: PFD,
P&ID, PEUFD and PSFD?

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Fig.(4) PFD [Qualitative flow diagram for the manufacture of nitric acid by the ammonia-
oxidation process].

Fig.(5) PFD [Combined flow diagram for the manufacture of nitric acid by the ammonia-
oxidation process].

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Fig.(6) Process and Instrument Diagram (P&ID)

Fig.(7) Typical utility flow

diagram.

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Fig.(8) Engineering P&ID flowsheet

Flowsheet Symbols
To reduce detailed written descriptions on flowsheets, it is usual practice to
develop or adopt a set of symbols and codes which suit the purpose. Many symbols
are pictorial which is helpful in representing process as well as control and mechanical
operations. See Fig.(9)
Line Symbols and Designation
The two types of lines on a flowsheet are (1) those representing outlines and
details of equipment, instruments, etc., and (2) those representing pipe carrying
process or utility liquids, solids, or vapors and electrical or instrument connections.
The latter must be distinguished among themselves as suggested by Figure (10).
The usual complete line designation contains the following: (1) line size
(nominal); (2) material cod; (3) sequence number; and (4) materials of construction.
Examples: 2"-CL6-CS40

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3"-CL6a-CS40
Equipment Designation
Equipment code designations can be developed to suit the particular process,
or as is customary a master coding can be established and followed for all projects. A
suggested designation list (not all inclusive for all processes) for the usual process
plant equipment is given in Table (1). The various items are usually numbered by type
and in process flow order as set forth on the flowsheets. For example:
Item code Designation
S-1 First separator in a process
S-2 Second separator in a process
C-1 First compressor in a process

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Fig. (9.a) Flowsheet symbols.

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Fig. (9.b) Flowsheet symbols contd.

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Fig.(10) piping and connection symbols from different sources(Line symbols)

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Fundamentals of Material Balance
Material balances are the basis of process design

Material balance is also useful tool for the following:

1. The study of the plant operation & troubleshooting.
2. Check performance against design.
3. Check the instrument calibration.

Conservation of Mass:

The general mass balance equation:

Input – output + generation – consumption = Accumulation

For steady-state non reactive system: Input = Output [Number of equations = Number of com

For steady-state reactive system: Input – output + generation – consumption = 0.0

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Some Important Parameters for Reactive System:

Limiting Reactant:

It's the reactant that would be completely consumed if the reaction proceeded to
completion. As it disappears the reaction stops. It's also called the rate determining
component since its concentration determines the reaction rate. All other reactants
must either be fed in stoichiometric proportion to the limiting reactant (the feed rates
are in the ratio of the stoichiometeric coefficients) or in excess of the limiting reactant
(in greater than stoichiometric proportion to it).

Stoichometry:

It's used to balance chemical reaction equations. The stoichiometric equation for
a chemical reaction states the number of molecules of the reactants and products that
take part, from which the quantities can be calculated.
For simple reactions → can be done by inspection. ‫بمجرد النظر‬
For complex reactions → take a base of 1 mole of one component and make an atomic
balance on each element (It's better to choose one with many atoms as possible).

Fractional Conversion:

It's the ratio of amount reacted to amount fed. The fractional conversions of
different reactants are generally different unless the reactants are fed in stoichiometric
proportion.
Fractional Conversion =

Note: In case of reaction process with recycling of unreacted reactants, there are 2
types of conversion:
a- Single pass conversion

= =

b- Overall conversion

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= =

The overall conversion should be >>> single pass conversion [one of the recycle
functions is to maximize conversion]

Selectivity:

It's a measure of the efficiency of the reactor in converting reagent to the desired
product. It is the fraction of the reacted material that was converted into the desired
product. If no byproducts are formed, then the selectivity is 100%.

Selectivity =

Yield:

It's a measure of the performance of a reactor or a plant.

There are 2 types of yield:
a- Reaction yield (Chemical yield)
Reaction yield = Conversion Selectivity

Where moles reagent converted includes that consumed in both main & side reactions.
Note: Reaction yield = conversion when there is no side reactions take place.
b- Plant Yield
Plant yield is a measure of the overall performance of the plant and includes all
chemical & physical losses (during separation process).

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Plant Yield =

Stoichiometric factor = theoretical moles of reagent required per moles of product

produced in the reaction balanced equation.

Excess:

A reagent may be supplied in excess to promote the desired reaction to:

1- Maximize the use of an expensive reagent.
2- Ensure complete reaction of a reagent, as in combustion.

% Excess = ×100

= ×100

Note: Excess component actual feed = Theoretical feed (1+ fraction excess)

Tie Component:

If one component passes unchanged through a process unit (inert component), it

can be used to tie the inlet & outlet compositions. Since its amount is the same in input
& output so the total amount of input & output can be calculated if their compositions
are known. Example: Nitrogen in combustion reactions.

Bypass:

A flow stream may be divided and some part diverted (bypassed) around some
units. This procedure is often used to control stream composition or temperature.

Recycle:

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It's used to send unused raw materials emerging from a process unit back to the
unit. Overall system balances are usually (but not always) convenient starting points
for analyzing process with recycle.

Purge:

A stream that's withdrawn from a process when a species enters in the process feed
and is completely recycled. If this species weren't removed in the purge, it would keep
accumulating in the process system and eventually lead to shutdown.

Purge stream used to:

 Maintain the steady state conditions in the system
 Prevent the accumulation of inert or undesired materials [To rid the process of
the undesired material]

Combustion Reactions:

Excess air is used in combustion to:

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1- Ensure complete combustion.
2- Minimize Co & smoke formation.

Note: % excess air = %

excess oxygen Air
= 79% N2 + 21%
O2 by moles Air
= 77% N2 + 23%
O2 by mass
The calculated amount of excess air doesn't depend on how much material is
actually burned but what can be burned. Excess O2 (air) is calculated from the
complete combustion equation, i.e. based on conversion of all C→ CO 2, S→ SO2 &
H→ H2O.

Choice of a basis for Calculations:

A basis of calculation for a process is an amount or flow rate of one of the

process streams, preferably that stream with known composition. The basis may be a
period of time for example, hours, or a given mass of material.
1- For continuous process (production or feed rate is given as kg/hr, ton/day,
….. etc) ► Basis is1 hr or 1 operating day (unit of Time)
2- For batch process (production or feed rate is given as kg/batch , ton/batch,
… etc ) ► Basis is 1 batch.
3- If the flow rates are not given ►
 For composition given as mass fraction (in case of liquids or solids), basis
is often 1 or 100 lbm or kg.
 For composition given as mole fraction (in case of gases), basis is often 1 or
100 lbmol or kmol.

Note: It's important that your basis be indicated near the beginning of the problem.

General Procedures for Material Balance Problems:

1- Draw a block diagram of the process.

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2- List all the available data.
3- List all the information required from the balance.
4- Write out all the chemical reactions involved.
5- Decide the basis of your calculations.
6- Decide the system boundary.

Types of Designs
The methods for carrying out a design project may be divided into the following
classifications, depending on the accuracy and detail required:
1. Preliminary or quick-estimate designs
Used as a basis for determining whether further work should be done on the
proposed process. This type of design is based on approximate process methods, and
rough cost estimates are prepared. Few details are included, and the time spent on
calculations is kept at a minimum.
2. Detailed-estimate designs
In this type of design, the cost and profit potential of an established process is
determined by detailed analysis and calculations. However, exact specifications are
not given for the equipment, and drafting-room work is minimized. The following
factors should be established within narrow limits before a detailed-estimate design is
developed:
 Manufacturing process
 Material and energy balances
 Temperature and pressure ranges
 Raw-material and product specifications
 Yields, reaction rates, and time cycles
 Materials of construction
 Utilities requirements
 Plant site
i.e the above factors should be determined after a preliminary design.
3. Firm process designs or detailed designs
When the detailed-estimate design indicates that the proposed project should be a
commercial success, the final step before developing construction plans for the plant is

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the preparation of a firm process design. In this type complete specifications are
presented for all components of the plant, without any change in the process flowsheet
and accurate costs based on quoted prices are obtained. The firm process design
includes blueprints and sufficient information to permit immediate development of the
final plans for constructing the plant.

Design Information (literature survey)

General information and specific data required to the development of a design

project can be obtained from many different sources such as:

A. Textbooks
A large number of textbooks covering the various aspects of chemical engineering
principles and design are available. In addition, many handbooks have been published
giving physical properties and other basic data which are very useful to the design
engineer.A primary source of information on all aspects of chemical engineering
principles, design, costs, and applications is “The Chemical Engineers’ Handbook”
published by McGraw-Hill Book Company with R. H. Perry and D. W. Green as
editors and Encyclopedia of Chemical Technology by Kirk Othmer.
B. Technical journals
Regular features on design-related aspects of equipment, costs, materials of
construction, and unit processes are published in Chemical Engineering. In addition to
this publication, there are many other periodicals that publish articles of direct interest
to the design engineer. The following periodicals are suggested as valuable sources of
information for the chemical engineer who wishes to keep abreast of the latest
developments in the field:
 American Institute of Chemical Engineers journal (AICHE)
 Chemical Engineening Progress
 Chemical and Engineering News
 Chemical Engineering Science
 Industrial and Engineering Chemistry Fundamentals
 Industrial and Engineering Chemistry Process Design and Development
 Journal of the American Chemical Society, Journal of Physical Chemisty
 Journal of the American Chemical Society
 Hydrocarbon Processing
 Oil and Gas Journal

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 Engineering News-Record
 Canadian Journal of Chemical Engineering
C. Trade bulletins
Trade bulletins are published regularly by most manufacturing concerns, and these
bulletins give much information of direct interest to the chemical engineer preparing a
design. Some of the trade- bulletin information is condensed in an excellent reference
book on chemical engineering equipment, products, and manufacturers. This book is
known as the “Chemical Engineering Catalog,“ and contains a large amount of
valuable descriptive material. New information is constantly becoming available
through publication in periodicals, books, trade bulletins, government reports,
university bulletins, and many other sources. Many of the publications are devoted to
shortcut methods for estimating physical properties or making design calculations,
while others present compilations of essential data in the form of nomographs or
tables. The effective design engineer must make every attempt to keep an up-to-date
knowledge of the advances in the field.
D. Patents
A patent is essentially a contract between an inventor and the public. In
consideration of full disclosure of the invention to the public, the patentee is given
exclusive rights to control the use and practice of the invention. A patent gives the
holder the power to prevent others from using or practicing the invention for a period
of 17 years from the date of granting. In contrast, trade-secrets and certain types of
confidential disclosures can receive protection under common-law rights only as long
as the secret information is not public knowledge. A new design should be examined
to make certain no patent infringements are involved. If the investigation can uncover
even one legally expired patent covering the details of the proposed process, the
method can be used with no fear of patent difficulties.
THE PRELIMINARY DESIGN
In order to amplify the remarks made earlier concerning the design-project
procedure, it is appropriate at this time to look more closely at a specific preliminary
design. Only a brief presentation of the design will be attempted at this point.
However, sufficient detail will be given to outline the important steps which are
necessary to prepare such a preliminary design. The problem presented is a practical

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one of a type frequently encountered in the chemical industry; it involves both process
design and economic considerations.
Problem Statement
A conservative petroleum company has recently been reorganized and the new
management has decided that the company must diversify its operations into the
petrochemical field if it wishes to remain competitive. The research division of the
company has suggested that a very promising area in the petrochemical field would be
in the development and manufacture of biodegradable synthetic detergents using some
of the hydrocarbon intermediates presently available in the refinery. A survey by the
market division has indicated that the company could hope to attain 2.5 percent of the
detergent market if a plant with an annual production of 15 million pounds were to be
built. To provide management with an investment comparison, the design group has
been instructed to proceed first with a preliminary design and an updated cost estimate
for a non biodegradable detergent producing facility similar to ones supplanted by
recent biodegradable facilities.

Literature Survey
A survey of the literature reveals that the majority of the non biodegradable
detergents are alkyl benzene sulfonates (ABS). Theoretically, there are over 80,000
isomeric alkyl benzenes in the range of C10 to C15 for the alkyl side chain. Costs,
however, generally favor the use of dodecene (propylene tetramer) as the starting
material for ABS.
There are many different schemes in the manufacture of ABS. Most of the
schemes are variations of the one shown in Fig. (11) for the production of sodium
dodecylbenzene sulfonate. A brief description of the process is as follows:
This process involves:
i. Reaction of dodecene with benzene in the presence of aluminum chloride catalyst
(alkylation)
ii. Fractionation of the resulting crude mixture to recover the desired boiling
range of dodecylbenzene.
iii. Sulfonation of the dodecylbenzene.
iv. Neutralization of the sulfonic acid with caustic soda.
v. Blending the resulting slurry with chemical “builders”; and drying.

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Process Description
Dodecene is charged into a reaction vessel containing benzene and aluminum
chloride. The reaction mixture is agitated and cooled to maintain the reaction
temperature of about 115°F maximum. An excess of benzene is used to suppress the
formation of by-products. Aluminum chloride requirement is 5 to 10 wt% of
dodecene. After removal of aluminum chloride sludge, the reaction mixture is
fractionated to recover excess benzene (which is recycled to the reaction vessel), a
light alkylaryl hydrocarbon, dodecylbenzene, and a heavy alkylaryl hydrocarbon.
Sulfonation of the dodecylbenzene may be carried out continuously or batch-
wise under a variety of operating conditions using sulfuric acid (100 percent), oleum
(usually 20 percent SO3), or anhydrous sulfur trioxide. The optimum sulfonation
temperature is usually in the range of 100 to 140°F depending on the strength of acid
employed, mechanical design of the equipment, etc. Removal of the spent sulfuric acid
from the sulfonic acid is facilitated by adding water to reduce the sulfuric acid strength
to about 78 percent. This dilution prior to neutralization results in a final neutralized
slurry having approximately 85 percent active agent based on the solids. The inert
material in the final product is essentially Na2SO4.
The sulfonic acid is neutralized with 20 to 50 percent caustic soda solution to
a pH of 8 at a temperature of about 125°F. Chemical “builders” such as trisodium
phosphate, tetrasodium pyrophosphate, sodium silicate, sodium chloride, sodium
sulfate, carboxymethyl cellulose, etc., are added to enhance the detersive, wetting, or
other desired properties in the finished product. A flaked,

dried product is obtained by drum drying or a bead product is obtained by spray drying.
The basic reactions which occur in the process are the following.
Alkylation:

Sulfonation:

Neutralization:

31
A literature search indicates that yields of 85 to 95 percent have been obtained
in the alkylation step, while yields for the sulfonation process are substantially 100
percent, and yields for the neutralization step are always 95 percent or greater. All
three steps are exothermic and require some form of jacketed cooling around the
stirred reactor to maintain isothermal reaction temperatures.
Laboratory data for the sulfonation of dodecylbenzene, described in the
literature, provide additional information useful for a rapid material balance.
This is summarized as follows:
1. Sulfonation is essentially complete if the ratio of 20 percent oleum to
dodecylbenzene is maintained at 1.25.
2. Spent sulfuric acid removal is optimized with the addition of 0.244 lb of
water to the settler for each 1.25 lb of 20 percent oleum added in the
sulfonation step.
3. A 25 percent excess of 20 percent NaOH is suggested for the neutralization step.
Operating conditions for this process, as reported in the literature, vary
somewhat depending upon the particular processing procedure chosen.
Required:
1- Making material and
energy balances. 2-
Equipment sizing and
selection.

32
Fig. (11) Qualitative flow diagram for the manufacture of sodium dodecylbenzene
sulfonate.

Economic Evaluation
The design project can be economically evaluated through the following steps:
1. Estimmation of the total capital investment.

Total capital investment = fixed capital + working capital

2. Estimation of the total annual product cost.

Total product cost = direct cost + indirect cost

3. Estimation of the expected annual profit.

Annual net profit = (total annual sales – total product cost) (1 – income taxes rate)

33
4. Using profitability estimation methods such as R.O.I to evaluate the
attractivness of the proposed projet.

Safety Factors (Design Margins)

Definition: These factors represent the amount of overdesign that would be
used to account for the changes in the operating performance with time (fouling in
H.X) and potential increases in capacity requirements.
Experienced designers include a degree of over-design known as a ‘‘design
factor,’’ ‘‘design margin,’’ or ‘‘safety factor,’’ to ensure that the design that is built
meets product specifications and operates safely.
Design factors are applied in process design to give some tolerance in the
design. For example, the process stream average flows calculated from material
balances are usually increased by a factor, typically 10%, to give some flexibility in
process operation. This factor will set the maximum flows for equipment,
instrumentation, and piping design. Where design factors are introduced to give some
contingency in a process design, they should be agreed upon within the project
organization and clearly stated in the project documents (drawings, calculation sheets,
and manuals). If this is not done, there is a danger that each of the specialist design
groups will add its own ‘‘factor of safety,’’ resulting in gross and unnecessary over-
design. Companies often specify design factors in their design manuals. When
selecting the design factor, a balance has to be made between the desire to make sure
the design is adequate and the need to design to tight margins to remain competitive
(economic consideration). Greater uncertainty in the design methods and data requires
the use of bigger design factors.
In general design work, the magnitudes of safety factors are dictated by:
 Economic or market considerations,
 Accuracy of the design data and calculations,
 Potential changes in the operating performance,
 Background information available on the overall process.

Each safety factor must be chosen on basis of the existing conditions, and the
chemical engineer should not hesitate to use a safety factor of zero if the situation
warrants it. Some examples of recommended safety factors for equipment design are
shown in Table (2).

34
What is meant by design margins and what are the factors that control its values?
Specification Sheets

Standard specification sheets are normally used to transmit the information

required for the detailed design, or purchase, of equipment items, such as heat
exchangers, pumps, columns, pressure vessels, etc. As well as ensuring that the
information is clearly and unambiguously presented, standard specification sheets
serve as check lists to ensure that all the information required is included. A
generalization for equipment design is that standard equipment should be selected
whenever possible. If the equipment is standard, the manufacturer may have the
desired size in stock. In any case, the manufacturer can usually quote a lower price and
give better guarantees for standard equipment than for special equipment.
Before a manufacturer is contacted, the engineer should evaluate the design
needs and prepare a preliminary specification sheet for the equipment. This
preliminary specification sheet can be used by the engineer as a basis for the
preparation of the final specifications, or it can be sent to a manufacturer with a
request for suggestions and fabrication information. Preliminary specifications for
equipment should show the following:
1) Identification 2) Function 3) Operation 4) Materials handled 5) Basic design data
6) Essential controls 7) Insulation requirements 8) Allowable tolerances
9) Special information and details pertinent to the particular equipment, such as
materials of construction including gaskets, installation, necessary delivery date,
supports, and special design details or comments. Figures 12 and 13 show typical
types of specification sheets for equipment. These sheets apply for the normal type of
equipment encountered by a chemical engineer in design work. The details of
mechanical design, such as shell or head thicknesses, are not included, since they do
not have a direct effect on the performance of the equipment. However, for certain
types of equipment involving unusual or extreme operating conditions, the engineer
may need to extend the specifications to include additional details of the mechanical
design.

35
REFERENCE BOOKS:

1. Schweyer H. E., Process Engineering Economics, Mc Graw Hill, 1969.

2. Max. S. Peters And Klaus D. Timmerhaus, Plant Design and Economics for Chemical
Engineers, 4th Edn., Mc Graw Hill International editions, New York, 1991.

36
SCHOOL OF BIO AND CHEMICAL ENGINEERING

DEPARTMENT OF CHEMICAL ENGINEERING

UNIT – 2 ENGINEERING ECONOMICS FOR PROCESS ENGINEERS, INTEREST &

INVESTMENT COSTS-SCH1403

- -SCH 1403

1
UNIT 2: ENGINEERING ECONOMICS FOR PROCESS ENGINEERS,
INTEREST & INVESTMENT COSTS

VALUATION CONCEPTS

The time value of money establishes that there is a preference of having

money at present than a future point of time. It means

(a) That a person will have to pay in future more, for a rupee received
today.

For example :
Suppose your father gave you Rs. 100 on your tenth birthday. You
deposited this amount in a bank at 10% rate of interest for one year.
How much future sum would you receive after one year? You
would receive Rs. 110
Future sum = Principal + Interest
= 100 + 0.10 × 100
= Rs. 110

2
(b) A person may accept less today, for a rupee to be received in the
future. Thus, the inverse of compounding process is termed as
discounting.

TECHNIQUES OF TIME VALUE OF MONEY

There are two techniques for adjusting time value of money. They
are:
1. Compounding Techniques/Future Value Techniques
2. Discounting/Present Value Techniques

The value of money at a future date with a given interest rate is

called future value. Similarly, the worth of money today that is
receivable or payable at a future date is called Present Value.

3
(b) A person may accept less today, for a rupee to be received in the
future. Thus, the inverse of compounding process is termed as
discounting.

TECHNIQUES OF TIME VALUE OF MONEY

There are two techniques for adjusting time value of money. They
are:
1. Compounding Techniques/Future Value Techniques
2. Discounting/Present Value Techniques

The value of money at a future date with a given interest rate is

called future value. Similarly, the worth of money today that is
receivable or payable at a future date is called Present Value.

4
Compounding Techniques/Future Value Techniques

Suppose you invest Rs. 1000 for three years in a saving account that pays
10 per cent interest per year. If you let your interest income be
reinvested, your investment will grow as follows:

5
A generalized procedure for calculating the future value of a
single amount compounded annually is as follows:

Formula: FVn = PV(1 + r)n

In this equation:

(1 + r)n is called the future value interest factor (FVIF).

where, FVn = Future value of the initial flow n year hence
PV = Initial cash flow
r = Annual rate of Interest
n = number of years

6
If you deposit Rs. 55,650 in a bank which is paying a 12 per cent
rate of interest on a ten-year time deposit, how much would the
deposit grow at the end of ten years?

SOLUTION:
FV = PV(1 + r)n

7
MULTIPLE COMPOUNDING PERIODS

Interest can be compounded monthly, quarterly and half-yearly.

If compounding is quarterly, annual interest rate is to be divided by 4

and the number of years is to be multiplied by 4.

If monthly compounding is to be made, annual interest rate is to be

divided by 12 and number of years is to be multiplied by 12.

8
DISCOUNTING OR PRESENT VALUE CONCEPT

 Present value is the exact opposite of future value.

 The present value of a future cash inflow or outflow is the amount

of current cash that is of equivalent value to the decision maker.

The process of determining present value of a future payment or

receipts or a series of future payments or receipts is called
discounting.

 The compound interest rate used for discounting cash flows is also
called the discount rate.

9
SIMPLE AND COMPOUND INTEREST

In compound interest, each interest payment is reinvested to earn

further interest in future periods. However, if no interest is earned
on interest, the investment earns only simple interest. In such a case,
the investment grows as follows:

Future value = Present value [1 + Number of years × Interest

rate]
For example, if Rs. 1,000 is invested @ 12% simple interest, in 5
years

it will become
1,000 [ 1 + 5 × 0.12] = Rs. 1,600

10
Time Value of Money

Money has a time value because it can earn more money over time. A number of terms involving
the time value of money were introduced in this chapter:

Interest is the cost of money. More specifically, it is a cost to the borrower and an earning to the
lender above and beyond the initial sum borrowed or loaned.

Interest rate is a percentage periodically applied to a sum of money to determine the amount of
interest to be added to that sum.

Simple interest is the practice of charging an interest rate only to an initial sum.

Compound interest is the practice of charging an interest rate to an initial sum and to any
previously accumulated interest that has not been withdrawn from the initial sum. Compound
interest is by far the most commonly used system in the real world.

Economic equivalence exists between individual cash flows or between patterns of cash flows
that have the same value. Even though the amounts and timing of the cash flows may differ, the
appropriate interest rate makes them equal.

The following compound-interest formula is perhaps the single most important equation in this
text:

F = P(1 + i)N.

In this formula, P is a present sum, i is the interest rate, N is the number of periods for which
interest is compounded, and F is the resulting future sum. All other important interest formulas
are derived from this one.

Cash flow diagrams are visual representations of cash inflows and outflows along a time line.
They are particularly useful for helping us detect which of the five patterns of cash flow is
represented by a particular problem.

The five patterns of cash flow are as follows:

1. Single payment: A single present or future cash flow.
2.Uniform series: A series of flows of equal amounts at regular intervals.
3. Linear gradient series: A series of flows increasing or decreasing by a fixed amount at regular
intervals. Excel is one of the most convenient tools to solve this type of cash flow series.
4. Geometric gradient series: A series of flows increasing or decreasing by a fixed percentage at

11
regular intervals. Once again, this type of cash flow series is a good candidate for solution by
Excel.
5. Uneven series: A series of flows exhibiting no overall pattern. However, patterns might be
detected for portions of the series.

Cash flow patterns are significant because they allow us to develop interest formulas, which
streamline the solution of equivalence problems. Table 2.10 summarizes the important interest
formulas that form the foundation for all other analyses you will conduct in engineering
economic analysis.

12
13
What is Depreciation?
In accounting terms, depreciation is defined as the reduction of recorded cost of a fixed asset in a
systematic manner until the value of the asset becomes zero or negligible.

An example of fixed assets are buildings, furniture, office equipment, machinery etc.. A land is
the only exception which cannot be depreciated as the value of land appreciates with time.

Depreciation allows a portion of the cost of a fixed asset to the revenue generated by the fixed
asset. This is mandatory under the matching principle as revenues are recorded with their
associated expenses in the accounting period when the asset is in use. This helps in getting a
complete picture of the revenue generation transaction.

14
An example of Depreciation – If a delivery truck is purchased a company with a cost of Rs.
100,000 and the expected usage of the truck are 5 years, the business might depreciate the asset
under depreciation expense as Rs. 20,000 every year for a period of 5 years.

How to calculate depreciation in small business?

There three methods commonly used to calculate depreciation. They are:

1. Straight line method

2. Unit of production method
3. Double-declining balance method

Three main inputs are required to calculate depreciation:

1. Useful life – this is the time period over which the organisation considers the fixed asset to be
productive. Beyond its useful life, the fixed asset is no longer cost-effective to continue the
operation of the asset.
2. Salvage value – Post the useful life of the fixed asset, the company may consider selling it at
a reduced amount. This is known as the salvage value of the asset.
3. The cost of the asset – this includes taxes, shipping, and preparation/setup expenses.

Unit of production method needs the number of units used during production. Let’s take a look at
each type of Depreciation method in detail.

Types of depreciation

1) Straight-line depreciation method

15
This is the simplest method of all. It involves simple allocation of an even rate of depreciation
every year over the useful life of the asset. The formula for straight line depreciation is:

Annual Depreciation expense = (Asset cost – Residual Value) / Useful life of the asset

Example – Suppose a manufacturing company purchases a machinery for Rs. 100,000 and the
useful life of the machinery are 10 years and the residual value of the machinery is Rs. 20,000

Annual Depreciation expense = (100,000-20,000) / 10 = Rs. 8,000

Thus the company can take Rs. 8000 as the depreciation expense every year over the next ten
years as shown in depreciation table below.

Year Original cost – Residual value Depreciation expense

1 Rs. 80000 Rs. 8000

2 Rs. 80000 Rs. 8000

3 Rs. 80000 Rs. 8000

4 Rs. 80000 Rs. 8000

5 Rs. 80000 Rs. 8000

6 Rs. 80000 Rs. 8000

7 Rs. 80000 Rs. 8000

8 Rs. 80000 Rs. 8000

9 Rs. 80000 Rs. 8000

10 Rs. 80000 Rs. 8000

2) Unit of Production method

16
This is a two-step process, unlike straight line method. Here, equal expense rates are assigned to
each unit produced. This assignment makes the method very useful in assembly for production
lines. Hence, the calculation is based on output capability of the asset rather than the number of
years.

The steps are:

Step 1: Calculate per unit depreciation:

Per unit Depreciation = (Asset cost – Residual value) / Useful life in units of production

Step 2: Calculate the total depreciation of actual units produced:

Total Depreciation Expense = Per Unit Depreciation * Units Produced

Example: ABC company purchases a printing press to print flyers for Rs. 40,000 with a useful
life of 1,80,000 units and residual value of Rs. 4000. It prints 4000 flyers.

Step 1: Per unit Depreciation = (40,000-4000)/180,000 = Rs. 0.2

Step 2: Total Depreciation expense = Rs. 0.2 * 4000 flyers = Rs. 800

So the total Depreciation expense is Rs. 800 which is accounted. Once the per unit depreciation
is found out, it can be applied to future output runs.

3) Double declining method

This is one of the two common methods a company uses to account for the expenses of a fixed
asset. This is an accelerated depreciation method. As the name suggests, it counts expense twice
as much as the book value of the asset every year.

17
The formula is:

Depreciation = 2 * Straight line depreciation percent * book value at the beginning of the
accounting period

Book value = Cost of the asset – accumulated depreciation

Accumulated depreciation is the total depreciation of the fixed asset accumulated up to a

specified time.

Example: On April 1, 2012, company X purchased an equipment for Rs. 100,000. This is
expected to have 5 useful life years. The salvage value is Rs. 14,000. Company X considers
depreciation expense for the nearest whole month. Calculate the depreciation expenses for 2012,
2013, 2014 using a declining balance method.

Useful life = 5

Straight line depreciation percent = 1/5 = 0.2 or 20% per year

Depreciation rate = 20% * 2 = 40% per year

Depreciation for the year 2012 = Rs. 100,000 * 40% * 9/12 = Rs. 30,000

Depreciation for the year 2013 = (Rs. 100,000-Rs. 30,000) * 40% * 12/12 = Rs. 28,000

Depreciation for the year 2014 = (Rs. 100,000 – Rs. 30,000 – Rs. 28,000) * 40% * 9/12 = Rs.
16,800

Depreciation table is shown below:

Book value at the Depreciation Book value at the

Year Depreciation rate
beginning Expense end of the year

18
2012 Rs. 100,000 40% Rs. 30,000 * (1) Rs. 70,000

2013 Rs. 70,000 40% Rs. 28,000 * (2) Rs. 42,000

2014 Rs. 42,000 40% Rs. 16,800 * (3) Rs. 25,200

2015 Rs. 25,200 40% Rs. 10,080 * (4) Rs. 15,120

2016 Rs. 15,120 40% Rs. 1,120 * (5) Rs. 14,000

Depreciation for 2016 is Rs. 1,120 to keep the book value same as salvage value.

Rs. 15,120 – Rs. 14,000 = Rs. 1,120 (At this point the depreciation should stop).

Why should small businesses care to record depreciation?

So now we know the meaning of depreciation, the methods used to calculate them, inputs
required to calculate them and also we saw examples of how to calculate them. Let’s find out as
to why the small businesses should care to record depreciation.

As we already know the purpose of depreciation is to match the cost of the fixed asset over its
productive life to the revenues the business earns from the asset. It is very difficult to directly
link the cost of the asset to revenues, hence, the cost is usually assigned to the number of years
the asset is productive.

Over the useful life of the fixed asset, the cost is moved from balance sheet to income statement.
Alternatively, it is just an allocation process as per matching principle instead of a technique
which determines the fair market value of the fixed asset.

Accounting entry – DEBIT depreciation expense account and CREDIT accumulated

depreciation account.

19
If we do not use depreciation in accounting, then we have to charge all assets to expense once
they are bought. This will result in huge losses in the following transaction period and in high
profitability in periods when the corresponding revenue is considered without an offset expense.
Hence, companies which do not use the depreciation expense in their accounts will incur front-
loaded expenses and highly variable financial results.

Final Notes

Depreciation is an important part of accounting records which helps companies maintain their
income statement and balance sheet properly with the right profits recorded.

CONCEPT OF DEPRECIATION

Depreciation is the process of spreading the cost of fixed asset over the different accounting
periods which drive the benefit from their use. The cost of fixed assets apportioned to a given
period from part of the overall cost to be matched with the revenues generated in that. So,
depreciation is of great significance in the concept of income measurement. It measures the
service potential of the fixed assets period.

FIXED ASSETS

They include all assets whose benefit is derived by businessman for a long period of time,
usually more than one year period, Examples : Machinery, Furniture, Buildings, Leases, etc. land
is affixed asset but not subject to depreciation because it has infinite lifetime. Assets are any
property owned by a person or business. Tangible assets include money, land, buildings,
investments, inventory, cars, trucks, boats, or other valuables. Intangibles such as goodwill are
also considered to be assets. Capital Assets, also known as Fixed Assets, are those assets such as
land, buildings, and equipment acquired to carry on the business of a company with a life
exceeding one year. Fixed assets are assets that help companies reap economic benefits over a
period of time. Assets such as land, building, plant and machinery are all fixed assets. The
general consensus is that fixed assets cannot be liquidated easily. This is quite apparent when
compared to current assets such as cash and bank account and inventories, which can be liquated
or converted into cash relatively easily. It may be noted that intangible assets can also be part of
this head as they benefit companies over a long period of time. Few more examples of the same
would be trademarks, designs and patents.

20
MEANING AND DEFINITION OF DPRECIATION

Depreciation is a permanent decline in the value of an asset. The gradual decrease, both in the
value and usefulness, of an asset due to its nature and usage is termed
as depreciation. Depreciation is the measure of wearing out of a fixed asset. All fixed assets are
expected to be less efficient as time goes on. Depreciation is calculated as the estimate of this
measure of wearing out and is charged to the Profit & Loss account either on a monthly or
annual basis. The cost of the asset less the totaldepreciation will give you the Net Book Value of
the asset.

It is common experience that whenever an asset is used it reduces in value. The net result
of depreciation is that sooner or letter, the asset becomes useless. So, it can be stated
that depreciation is that portion of the cost of an asset which is reduced from revenues for the
services of the asset in the operation of a business.

According to Spicer and Pegler “Depreciation is thee measure of the exhaustion of the effective
life of an asset from any cause during a given period.”

According to the Institute Of Chartered Accountants Of India, “Depreciation is a measure of the

wearing out, consumption or other loss of value of a depreciable asset arising from use effluxion
of time or obsolescence through technology and market changes.”

According to International Accounting Standards Committee, “Depreciation is the allocation of

the depreciable amount of an asset over its estimated useful life. Depreciation for the accounting
period is charged to income either directly or indirectly.”

The following important terms from these definitions are important:

• Depreciable Assets: The assets whose lifetime can be estimated and useful during two or more
accounting periods in production or service activities of an organization can be called
depreciable assets.

• Useful life: Useful life is the time during which the asset is helpful in the normal business
activities of a firm. It can be less than the total life time of the asset. It can be exactly
predetermined or it should be estimated on reasonable basis.

• Depreciable Amount: It is the cost of acquisition and installation of an asset after reducing any
realizable value at the end of useful life.

• Realizable value at the end of useful life.

21
• Effluxion of time: It is the passage of time irrespective of actual use of an asset as in the case
of leased assets.

• Obsolescence: It refers to an asset becoming out of date due to improved models or methods.

METHODS OF CALCULATING DEPRCIATION

1. Straight Line Method or Fixed Installment Method.

2. Written Down Value Method or Diminishing Balance Method.

3. Annuity Method.

4. Depreciation Fund Method.

5. Insurance Policy Method.

6. Revaluation Method.

Straightline Method or Fixed Instalment Method or Original Cost Method

Under this method, the same amount of depreciation is charged every year throughout the life of
thee asset. The amount and rate of depreciation is calculated as under.

1. Amount of depreciation = Total cost - Scrap value / Estimated life

2. Rate of depreciation = Amount of depreciation / Original cost x 100

MERITS:

1. Simplicity: It is every simple and easy to understand.

2. Easy to calculate; It is easy to calculate the amount and rate of depreciation.

3. Assets can be completely written off: Under this method, the book value of the asset become
zero or equal to its scarp value at the expiry of its useful life.

DEMERITS: The amount of depreciation is same in all the years, although the usefulness of
the machine to the business is more in the initial years, although the usefulness of the machine to
the business is more in the initial years than in the later years.

22
Written Down Value Method or Dimnishing Balance Method or Reducing Balance Method

Under this method, depreciation is charged at a fixed percentage each year on the reducing
balance (i.e. cost lessdepreciation) goes on decreasing every year.

Merits:

1. Uniform effect on the profit and loss account of different years. The total charge
(i.e.. depreciation plus repairs and renewals) remains almost uniform year after year, since in
earlier year the amount of depreciation is more and the amount of repairs and renewals is more.

2. Recognized by the income tax authorities: This method is recognized by the income tax
authorities.

3. Logical Method: It is a logical method as the depreciation is calculated on the diminished

balance every year.

DEMERITS: It is very difficult to determine the rate by which the value of assets could be
written down to Zero.

Annuity Method

The annuity method considers that the business besides loosing the original cost of the asset in
terms of depreciation and also loses interest. On the amount used for buying the asset. This is
based on the assumption that the amount invested in the asset would have earned in case the
same amount would have been invested in some other form of investment. The annual amount
ofdepreciation is determined with the help of annuity table.

Depreciation Fund Method or Sinking Fund Method

Under this method, funds are mad available for the replacement of asset at the end of its useful
life.th depreciation remains the same year after year and is changed to profit and loss account
every year through the creation of depreciation fund. The aggregate amount of interest and
annual provision is invested every year. When the asset is completely written off or is to be
replaced, the securities are sold and the amount so realized by selling securities is used to replace
the old asset.

Insurance Policy Method

According to this method, an insurance policy is taken for the amount of the asset to be replaced.
The amount of the policy is such that it is sufficient to replace the asset when it is worn out. A

23
sum equal to the amount of depreciation is paid as premium every year. The amount goes on
accumulating at a certain rate of interest and is received on maturity. The amount so received is
used for the purchase of new asset, replacing the old one.

Revaluation Method

Under this method, the asset like loose tools are revalued at the end of the accounting period and
the same is compared with the value of the asset at the beginning of the year. The difference is
considered as depreciation.

Straightline Method or Fixed Instalment Method or Original Cost Method

Under this method, the same amount of depreciation is charged every year throughout the life of
the asset .The amount and rate of depreciation is calculated as under.

1. Amount of depreciation = Total cost - Scrap Value / Estimated life

2. Rate of depreciation = Amount of depreciation / Original Cost x 100

Merits:

1. Simplicity; It is very simple and easy to understand.

2. Easy to calculate; It is easy to calculate the amount and rate of depreciation.

3. Assets can be completely written off; Under this method, the book value of the asset become
Zero or equal to its scrap value at the expiry of its useful life.

DEMERITS:

The amount of depreciation is same in all the years, although the usefulness of the machine to
the business is more in the initial years than in the later years.

Written Down Value Method or Dimnishing Balance Method or Reducing Balance Method

Under this method, depreciation is charged at a fixed percentage each year on the reducing
balance (i.e., cost lessdepreciation) of asset. The amount of depreciation goes on decreasing
every year.

MERITS:

24
1. Uniform effect on the profit and loss account of different years. The total charge (
i.e.… depreciation plus repairs and renewals) remains almost uniform year after year, since in
earlier year the amount of depreciation is more and the amount of repairs and renewals is less,
Whereas in later years the amount of depreciation is less and the amount of repairs and renewals
is more.

2. Recognized by the income tax authorities; this method is recognized by the income tax
authorities.

3. Logical Method: It is a logical method as the depreciation is calculated on the diminished

balance every year.

DEMERITS:

It is very difficult to determine the rate by which the value of asset could be written down to
zero.

Depletion is an accrual accounting technique used to allocate the cost of extracting natural
resources such as timber, minerals, and oil from the earth. Like depreciation and
amortization, depletion is a non-cash expense that lowers the cost value of an asset
incrementally through scheduled charges to income.

REFERENCE BOOKS:

1. Schweyer H. E., Process Engineering Economics, Mc Graw Hill, 1969.

2. Max. S. Peters And Klaus D. Timmerhaus, Plant Design and Economics for Chemical
Engineers, 4th Edn., Mc Graw Hill International editions, New York, 1991.

25
1

SCHOOL OF BIO AND CHEMICAL ENGINEERING

DEPARTMENT OF CHEMICAL ENGINEERING

UNIT – 3 COST ESTIMATION AND ANNUAL REPORTS -SCH1403

1
2

UNIT 3: COST ESTIMATION AND ANNUAL REPORTS

2
3

3
4

4
5

5
6

INTRODUCTION TO THE ACCOUNTING EQUATION

The financial position of a company is measured by the following items:

• Assets (what it owns)

• Liabilities (what it owes to others)

• Owner’s Equity (the difference between assets and liabilities)

The accounting equation (or basic accounting equation) offers us a simple way to
understand how these three amounts relate to each other.

The accounting equation for a sole proprietorship is:

Assets = Liabilities + Owner’s Equity

The accounting equation for a corporation is:

Assets = Liabilities + Stockholders’ Equity

6
7

Assets are a company’s resources—things the company owns.

Examples of assets include cash, accounts receivable, inventory, prepaid insurance,

investments, land, buildings, equipment, and goodwill.

Liabilities are a company’s obligations—amounts the company owes.

Examples of liabilities include notes or loans payable, accounts payable, salaries and wages
payable, interest payable, and income taxes payable (if the company is a regular
corporation).

Owner’s equity or stockholders’ equity is the amount left over after liabilities are
deducted from assets:

Assets – Liabilities = Owner’s (or Stockholders’) Equity.

Owner’s or stockholders’ equity also reports the amounts invested into the company by the
owners plus the cumulative net income of the company that has not been withdrawn or
distributed to the owners.

If a company keeps accurate records, the accounting equation will always be “in balance,”
meaning the left side should always equal the right side.

Assets = Liabilities + Equity

4.2 BALANCE SHEET

 The balance sheet is also known as the statement of financial position and it reflects the
accounting equation.
 The balance sheet reports a company’s assets, liabilities, and owner’s (or stockholders’)
equity at a specific point in time.
 Like the accounting equation, it shows that a company’s total amount of assets equals the
total amount of liabilities plus owner’s (or stockholders’) equity.
 The balance sheet presents a company's financial position at the end of a specified date.
 Some describe the balance sheet as a "snapshot" of the company's financial position at a
point (a moment or an instant) in time.
 For example, the amounts reported on a balance sheet dated December 31, 2006 reflect
that instant when all the transactions through December 31 have been recorded.

Uses of a Balance Sheet

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• Because the balance sheet informs the reader of a company's financial position as of one
moment in time, it allows someone—like a creditor—to see what a company owns as well
as what it owes to other parties as of the date indicated in the heading.

• This is a valuable information to the banker who wants to determine whether or not a
company qualifies for additional credit or loans.

• Others who would be interested in the balance sheet include current investors, potential
investors, company management, suppliers, some customers, competitors, government
agencies, and labor unions.

Types of Balance Sheet

The balance sheet is called classified if assets and liabilities are grouped into
classifications, and consolidated if it contains all divisions and subsidiaries of the firm.

CLASSIFIED BALANCE SHEET

• Accountants usually prepare classified balance sheets.

• "Classified" means that the balance sheet accounts are presented in distinct groupings,
categories, or classifications.

Classifications Of Assets On The Balance Sheet

What are Assets?

• Assets are things that the company owns.

• They are the resources of the company that have been acquired through transactions, and
have future economic value that can be measured and expressed in monetary units.

• Assets also include costs paid in advance that have not yet expired, such as prepaid
advertising, prepaid insurance, prepaid legal fees, and prepaid rent.

Examples of asset accounts that are reported on a company's balance sheet include:

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• Cash
• Petty Cash
• Temporary Investments
• Accounts Receivable
• Inventory
• Supplies
• Prepaid Insurance
• Land
• Land Improvements
• Buildings
• Equipment
• Goodwill
• Bond Issue Costs etc.

Usually these asset accounts will have debit balances. (Assets are shown on the left hand
side of a Balance Sheet).

The “Asset Classifications” and their order of appearance on the balance sheet are:

• Current Assets

• Investments

• Property, Plant, and Equipment

• Intangible Assets

• Other Assets

Classifications Of Liabilities On The Balance Sheet

What are liabilities?

• Liabilities are obligations of the company;

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• they are amounts owed to creditors for a past transaction and they usually have the word
"payable" in their account title.

• Along with owner's equity, liabilities can be thought of as a source of the company's assets.

• They can also be thought of as a claim against a company's assets.

• For example, a company's balance sheet reports assets of Rs.100,000 and Accounts Payable
of Rs.40,000 and owner's equity of Rs.60,000.

• The source of the company's assets are creditors/suppliers for Rs.40,000 and the owners for
Rs.60,000.

• The creditors/suppliers have a claim against the company's assets and the owner can claim
what remains after the Accounts Payable have been paid.

• Liabilities also include amounts received in advance for future services. Since the amount
received (recorded as the asset Cash) has not yet been earned, the company defers the
reporting of revenues and instead reports a liability such as Unearned Revenues or
Customer Deposits.

Examples of liability accounts reported on a company's balance sheet include:

• Notes Payable
• Accounts Payable
• Salaries Payable
• Wages Payable
• Interest Payable
• Other Accrued Expenses Payable
• Income Taxes Payable
• Customer Deposits
• Warranty Liability
• Lawsuits Payable
• Unearned Revenues
• Bonds Payable etc.

These liability accounts will normally have credit balances. (Liabilities are shown on the
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right hand side of a Balance Sheet).

The “liability classifications” and their order of appearance on the balance sheet are:

• Current Liabilities

• Long Term Liabilities etc.

Current vs. Long-term Liabilities

If a company has a loan payable that requires it to make monthly payments for several
years, only the principal due in the next twelve months should be reported on the balance
sheet as a current liability. The remaining principal amount should be reported as a long-
term liability.

Classifications of Owner's Equity On The Balance Sheet

What is Equity?

• There are actually 2 types of Equity, namely owner’s equity and stockholder’s equity.

• Owner's Equity—along with liabilities—can be thought of as a source of the company's

assets. Owner's equity is sometimes referred to as the book value of the company, because
owner's equity is equal to the reported asset amounts minus the reported liability amounts.

• Owner's equity may also be referred to as the residual of assets minus liabilities. These
references make sense if you think of the basic accounting equation:

Assets = Liabilities + Owner's Equity

and just rearrange the terms:

Owner's Equity = Assets – Liabilities

• "Owner's Equity" are the words used on the balance sheet when the company is a sole
proprietorship.

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• If the company is a corporation, the words Stockholders' Equity are used instead of
Owner's Equity.

• An example of an owner's equity account is Mary Smith, Capital (where Mary Smith is the
owner of the sole proprietorship).

Examples of stockholders' equity accounts include:

Common Stock
Preferred Stock
Paid-in Capital in Excess of Par Value
Paid-in Capital from Treasury Stock
Retained Earnings etc.

Both owner's equity and stockholders' equity accounts will normally have credit balances.
(Equities are shown alongwith liabilities on the right hand side of a Balance Sheet).

These classifications make the balance sheet more useful.

The following sample balance sheet is a classified balance sheet.

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Snowboarding Components
Balance Sheet (Partial)
January 31, 2008
ASSETS
Current assets
Cash $ 6,500
Short-term investments 2,100
Accounts receivable 4,400
Merchandise inventory 27,500
Prepaid expenses 2,400
Total current assets $ 42,900
Long-term investments
Notes receivable 1,500
Investments in stocks and bonds 18,000
Land held for future expansion 48,000
Total investments 67,500
Plant assets
Store equipment $ 33,200
Less accumulated depreciation 8,000 25,200
Buildings 1,70,000
Less accumulated depreciation 45,000 1,25,000
Land 73,200
Total plant assets 2,23,400
Intangible assets 10,000
Total assets $ 3,43,800
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Snowboarding Components
Balance Sheet (Partial)
January 31, 2008
LIABILITIES
Current liabilities
Accounts payable $ 15,300
Wages payable 3,200
Notes payable 3,000
Current portion of long-term liabilities 7,500
Total current liabilities $ 29,000
Long-term liabilities:
Notes payable (net of current portion) 1,50,000
Total liabilities $1,79,000
EQUITY
T. Hawk, Capital 1,64,800
Total liabilities and equity $3,43,800

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Snowboarding Components
Balance Sheet (Partial)
January 31, 2008
LIABILITIES
Current liabilities
Accounts payable $ 15,300
Wages payable 3,200
Notes payable 3,000
Current portion of long-term liabilities 7,500
Total current liabilities $ 29,000
Long-term liabilities:
Notes payable (net of current portion) 1,50,000
Total liabilities $1,79,000
EQUITY
T. Hawk, Capital 1,64,800
Total liabilities and equity $3,43,800

USEFULNESS OF A BALANCE SHEET

The balance sheet provides information for evaluating:

Capital structure
Rates of return
Analyzing an enterprise’s:
Liquidity
Solvency
Financial flexibility

LIMITATIONS OF A BALANCE SHEET

• Most assets and liabilities are stated at historical cost.

• Judgments and estimates are used in determining many of the items.

• The balance sheet does not report items that can not be objectively determined.

• It does not report information regarding off-balance sheet financing.

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4.3 INCOME STATEMENT

• The income statement is the financial statement that reports a company’s revenues and
expenses and the resulting net income.

• While the balance sheet is concerned with one point in time, the income statement covers a
time interval or period of time.

• The income statement will explain part of the change in the owner’s or stockholders’ equity
during the time interval between two balance sheets.

• The income statement is sometimes referred to as :

 Profit and loss statement (P&L),

 Statement of operations, or
 Statement of income.

An income statement reports on operating activities. It lists sales (revenues), costs, and expenses
over a period of time. The relationship is expressed:

Net Income = Revenues – Expenses

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Net income is the difference between Revenues and Expenses.

Thus, The income statement describes a company’s revenues and expenses along with the
resulting net income or loss over a period of time due to earnings activities.

Importance of Income Statement

• The income statement is important because it shows the profitability of a company during
the time interval specified in its heading.

• The period of time that the statement covers is chosen by the business and will vary.

• For example, the heading may state:

"For the Three Months Ended December 31, 2006" (The period of October 1 through
December 31, 2006.)

The Four Weeks Ended December 27, 2006" (The period of November 29 through
December 27, 2006.)

"The Fiscal Year Ended September 30, 2006." (The period of October 1, 2005 through
September 30, 2006.)

It is to be noted that:

 the income statement shows revenues, expenses, gains, and losses;

 it does not show cash receipts (money you receive) nor cash disbursements (money you pay
out).

People pay attention to the profitability of a company for many reasons.

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• For example, if a company was not able to operate profitably—the bottom line of the
income statement indicates a net loss—a banker/lender/creditor may be hesitant to extend
additional credit to the company.

• On the other hand, a company that has operated profitably—the bottom line of the income
statement indicates a net income—demonstrated its ability to use borrowed and invested
funds in a successful manner.

A company's ability to operate profitably is important to current lenders and investors potential
lenders and investors, company management, competitors, government agencies, labor unions,
and others.

Format of the Income Statement

A. Revenues and Gains
1. Revenues from primary activities
2. Revenues or income from secondary activities
3. Gains (e.g., gain on the sale of long-term assets, gain on lawsuits)

B. Expenses and Losses

1. Expenses involved in primary activities
2. Expenses from secondary activities
3. Losses (e.g., loss on the sale of long-term assets, loss on lawsuits)

If the net amount of revenues and gains minus expenses and losses is positive, the bottom line of
the profit and loss statement is labeled as net income.

If the net amount (or bottom line) is negative, there is a net loss.

A1. Revenues from primary activities

Often referred to as operating revenues or sales revenues. The primary activities of a retailer are
purchasing merchandise and selling the merchandise.

The primary activities of a manufacturer are producing the products and selling them.

A2. Revenues from secondary activities

Often referred to as nonoperating revenues.

These are the amounts a business earns outside of purchasing and selling goods and
services.

For example, when a retail business earns interest on some of its idle cash, or earns rent
from some vacant space, these revenues result from an activity outside of buying and
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selling merchandise.

Both the revenues mentioned above are reported on the profit and loss statement during the
period when they are earned, not when the cash is collected.

A3. Gains

Refers to the gain on the sale of long-term assets, or lawsuits result from a transaction that
is outside of the primary activities of most businesses.

A gain is reported on the income statement as the net of two amounts: the proceeds
received from the sale of a long-term asset minus the amount listed for that item on the
company's books (book value).

A gain occurs when the proceeds are more than the book value.

Consider this example:

Assume that a clothing retailer decides to dispose of the company's car and sells it for
Rs.6,000.

The Rs.6,000 received for the car will not be included with sales revenues since the account
‘Sales’ is used only for the sale of merchandise.

Since this retailer is not in the business of buying and selling cars, the sale of the car is
outside of the retailer's primary activities.

Over the years, the cost of the car was being depreciated on the company's accounting
records and as a result, the money received for the car (Rs.6,000) was greater than the net
amount shown for the car on the accounting records (Rs.3,500).

This means that the company must report a gain equal to the amount of the difference—
in this case, the gain is reported as Rs.2,500.

This gain should not be reported as sales revenues, nor should it be shown as part of the
merchandiser's primary activities.

Instead, the gain will appear in a section on the income statement labeled as "nonoperating
gains" or "other income".

The gain is reported in the period when the disposal occurred.

B1. Expenses involved in primary activities

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These are expenses that are incurred in order to earn normal operating revenues.

e.g., wages earned by employees, employee bonuses and vacations, utilities, and sales
commissions.

B2. Expenses from secondary activities

These are referred to as non-operating expenses.

For example, interest expense is a nonoperating expense because it involves the finance
function of the business, rather than the primary activities of buying/producing and selling.

B3. Losses
Refers to the loss from the sale of long-term assets, or the loss on lawsuits result from a
transaction that is outside of a business's primary activities.

A loss is reported as the net of two amounts: the amount listed for the item on the
company's books (book value) minus the proceeds received from the sale.

A loss occurs when the proceeds are less than the book value.

Let's assume that a clothing retailer decides to dispose of the company's car.

The proceeds from the disposal are Rs.2,800.

This is less than the Rs.3,500 amount shown in the company's accounting records.

Since this retailer is not in the business of buying and selling cars (the sale of the car is
outside of the operating activities of buying and selling clothing), the money received for
the car will not be included in sales revenues, and the loss experienced on the sale of the
car (Rs.700) will not be included in operating expenses.

Instead, the Rs.700 loss will appear in a section on the income statement labeled
"nonoperating gains or losses" or "other income or losses".

The loss is reported in the time period when the disposal occurs.

Thus, we can understand that the income statement or profit and loss statement shows revenues,
expenses, gains, and losses and

It does not show cash receipts and cash disbursements.

Types of Income Statement Formats

1. Single-Step
2. Mult iple-Step

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An income statement can be prepared in either a multiple-step or single-step format.

The single-step format is simpler. The multiple-step format provides more detailed information.

The Single Step Income Statement

This statement presents information in broad categories.

Major sections are Revenues and Expenses.
The Earnings per Share amount is shown at the bottom of the statement.
There is no distinction between operating and non-operating activities.

Format of a single step Income Statement

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The Multiple Step Income Statement

 The presentation divides information into major sections on the statement.

 The statement distinguishes operating from non-operating activities.
 Continuing operations are shown separately from irregular items.
 The income tax effects are shown separately as well.

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Format of a Mult i Step Statements

Multiple-Step Income Statement Sample:

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A detailed view of single-step and multiple-step income statements

 A single-step income statement format uses only one subtraction to arrive at net income.

 Net Income = (Revenues + Gains) – (Expenses + Losses)

An extremely condensed income statement in the single-step format would look like this:

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Single-Step Income Statement Sample

The heading of the income statement conveys critical information.

The name of the company appears first, followed by the title "Income Statement."
The third line tells the reader the time interval reported on the profit and loss statement.
Since income statements can be prepared for any period of time, it must be made to inform the
reader of the precise period of time being covered.
For example, an income statement may cover any one of the following time periods: "Year
Ended May 31," "Five Months Ended May 31," "Quarter Ended May 31," "Month Ended May
31, or "Five Weeks Ended May 31".
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A sample income statement in the single-step format would look like this:

MULTIPLE STEP INCOME STATEMENT

• The multiple-step income statement uses multiple subtractions in computing the net income
shown on the bottom line.

• The multiple-step profit and loss statement segregates the operating revenues and operating
expenses from the nonoperating revenues, nonoperating expenses, gains, and losses.

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• The multiple-step income statement also shows the gross profit (net sales minus the cost of
goods sold).

Here is a sample income statement in the multiple-step format:

Three benefits to using a multiple-step income statement instead of a single-step income

statement:

1. The multiple-step income statement clearly states the gross profit amount.

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• Many readers of financial statements monitor a company's gross margin (gross profit as a
percentage of net sales).

• Readers may compare a company's gross margin to its past gross margins and to the gross
margins of the industry.
2.The multiple-step income statement presents the subtotal operating income,
which indicates the profit earned from the company's primary activities of buying and selling
merchandise.

3.The bottom line of a multiple-step income statement reports the net amount for all the items on
the income statement.

If the net amount is positive, it is labeled as net income.

If the net amount is negative, it is labeled as net loss.

Income statements (whether single-step or multiple-step) report nearly all revenues, expenses,
gains, and losses.

• Sometimes rare or extraordinary events will occur during the income statement's time
interval along with the normally recurring events.

• It is helpful to the reader of the statement if these unique items are segregated into a special
section near the bottom of either the single-step or multiple-step income statement.

• These unique or rare items are:

1. Discontinued Operations
2. Extraordinary Items

1. Discontinued operations

It pertains to the elimination of a significant part of a company's business, such as the sale
of entire division of the company.

2. Extraordinary items

It includes things that are unusual in nature and infrequent in occurrence.

A loss due to an earthquake would certainly be extraordinary.

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Note that the two unique items are shown near the bottom of the income statement.

• The notes (or footnotes) to the income statement and to the other financial statements are
considered to be part of the financial statements.

The notes inform the readers about such things as significant accounting policies,
commitments made by the company, and potential liabilities and potential losses.

The notes contain information that is critical to properly understanding and analyzing a
company's financial statements.

It is common for the notes to the financial statements of large companies to be 10-20 pages
in length.

Usefulness o f Inco me Statement

Evaluate the past performance of the enterprise.

Provide a basis for predicting future performance.
Help assess the risk or uncertainty of achieving future cash flows.

Limitat ions of the Income Statement

Items that cannot be measured reliably are not reported in the income statement.
Income numbers are affected by the accounting methods employed.
Income measurement involves judgment.
4.4 FINANCIAL RATIOS

Definition

Financial ratios are tools for interpreting financial statements to provide a basis for valuing
securities and appraising financial and management performance.

Financial Ratios represent an attempt to standardize financial information in order to

facilitate meaningful comparisons over time (time series) and between firms or firm to
industry (cross section).

Uses of Financial Ratios

Financial Ratios are used as a relative measure that facilitates the evaluation of efficiency
or condition of a particular aspect of a firm's operations and status
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Ratio Analysis involves methods of calculating and interpreting financial ratios in order
to assess a firm's performance and status

Example

(1) (2) (1)/(2)

Year End Current Assets/Current Liab. Current Ratio
1994 Rs.550,000/Rs.500,000 1.10
1995 Rs.550,000/Rs.600,000 0.92

Groups of Financial Ratios

I. Liquidity
II. Activity
III. Debt
IV. Profitability

I. Liquidity Ratios

Liquidity refers to the solvency of the firm's overall financial position, i.e. a "liquid firm" is
one that can easily meet its short-term obligations as they come due.

A second meaning includes the concept of converting an asset into cash with little or no
loss in value.

Three Important Liquidity Measures

1. Net Working Capital (NWC)

NWC = Current Assets - Current Liabilities

2. Current Ratio (CR)

Current Assets
CR = Current Liabilities

3. Quick (Acid-Test) Ratio (QR)

Current Assets - Inventory

QR = Current Liabilities

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II. Activity Ratios:

Activity is a more sophisticated analysis of a firm's liquidity, evaluating the speed with
which certain accounts are converted into sales or cash; also measures a firm's efficiency

Five Important Activity Measures

1. Inventory Turnover (IT)

2. Average Collection Period (ACP)
3. Average Payment Period (APP)
4. Fixed Asset Turnover (FAT)
5. Total Asset Turnover (TAT)
Cost of Goods Sold
IT = -----------------------------------
Inventory

Accounts Receivable
ACP =-----------------------------------
Annual Sales/365

Accounts Payable
APP= ---------------------------------------
Annual Purchases/365

Sales
FAT = ------------------------------------
Net Fixed Assets

Sales
TAT = ------------------------------------
Total Assets

III. Debt Ratios:

Debt is a true "double-edged" sword as it allows for the generation of profits with the use
of other people's (creditors) money, but creates claims on earnings with a higher priority
than those of the firm's owners.

Financial Leverage is a term used to describe the magnification of risk and return resulting
from the use of fixed-cost financing such as debt and preferred stock.

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Measures of Debt

There are Two General Types of Debt Measures

Degree of Indebtedness
Ability to Service Debts

Four Important Debt Measures

1. Debt Ratio (DR)

2. Debt-Equity Ratio (DER)
3. Times Interest Earned Ratio (TIE)
4. Fixed Payment Coverage Ratio (FPC)

IV. Profitability Ratios:

Profitability Measures assess the firm's ability to operate efficiently and are of
concern to owners, creditors, and management

A Common-Size Income Statement, which expresses each income statement item as

a percentage of sales, allows for easy evaluation of the firm’s profitability relative to
sales.

Seven Basic Profitability Measures

1. Gross Profit Margin (GPM)

2. Operating Profit Margin (OPM)
3. Net Profit Margin (NPM)
4. Return on Total Assets (ROA)
5. Return On Equity (ROE)
6. Earnings Per Share (EPS)
7. Price/Earnings (P/E) Ratio

SUMMARY OF FINANCIAL RATIOS

• Ratio analysis is used as a major tool for financial analysis :

– For a meaningful study of information contained in the financial statements

– Ascertaining the overall financial position of a Business Organization
– Ratios are calculated from the past financial statements
– Ratios could also be worked out based on the projected financial statements of the same firm
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• Easiest way of evaluating the performance of a firm is by comparing past and present ratios

• Used to judge operational efficiency, financial health, solvency or soundness

• To find out the liquidity position

• Major categories of ratios

􀀹 Liquidity ratios
􀀹 Debt or Leverage or solvency ratios
􀀹 Activity Ratios
􀀹 Profitability Ratios

Thus, Ratios help to:

– Evaluate performance

– Structure analysis

– Show the connection between activities and performance

Benchmark with

– Past for the company

– Industry

Ratios adjust for size differences

Limitat ions of Ratio Analysis

 A firm’s industry category is often difficult to identify

 Published industry averages are only guidelines
 Accounting practices differ across firms
 Sometimes difficult to interpret deviations in ratios
 Industry ratios may not be desirable targets
 Seasonality affects ratios

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Text Books
1. Schweyer H. E., Process Engineering Economics, Mc Graw Hill, 1969.

2. Max. S. Peters And Klaus D. Timmerhaus, Plant Design and Economics for Chemical Engineers,
4th Edn., Mc Graw Hill International editions, New York, 1991.

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SCHOOL OF BIO AND CHEMICAL ENGINEERING
DEPARTMENT OF CHEMICAL ENGINEERING

UNIT – 4 ECONOMICS OF INVESTMENT ALTERNATIVE -SCH1403

1
UNIT 4: ECONOMICS OF INVESTMENT ALTERNATIVE
Estimation of project profitability

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Break Even Point
 BEP gives the idea whether a company is running under loss or profit.
 At BEP it is assumed that there is no loss or profit.
 Break even analysis revolves around BEP which means at a particular point company just
breaks even without getting any profit or loss.
• BEP depends upon the costs.Variable costs (Depends on rate of production)
• Fixed cost or non variable cost (independent of rate of production)

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Relation between costs and production:
Assumptions for an equation for finding break-even point if variable cost is linearly
dependent on production are:
• Fixed cost is independent of production
• There is no income other than that from operations
• All units produced are sold
All units are sold at the same price per unit

REFERENCE BOOKS

1. Max. S,Peters and Klaus. D Timmerhaus., Plant Design and Economics for Chemical
Engineers, 5th Edition, Mc Graw Hill International Editions, New York, 2004.
2. Schweyer. H.E.,Process Engineering Economics, 1st Edition, Mc Graw Hill, 1955.
3. Jelen F.C and Black J.H.,Cost and Optimization Engineering,3rd Edition, McGraw Hill,
1992.
4. James.R.Couper.,Process Engineering Economics, 1st Edition ,Marcel Dekker Inc, New
York,2003.

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SCHOOL OF BIO AND CHEMICAL ENGINEERING
DEPARTMENT OF CHEMICAL ENGINEERING

UNIT-5 –ECONOMIC BALANCE

SCH1403
The Economic Balance
An engineering cost analysis can be used to find either a minimum total cost or
a maximum benefit, such as a maximum profit for a venture. Such a cost
analysis is frequently called an economic balance because it involves the
balancing of economic factors to determine an optimum design or optimum
operating conditions. In engineering work, correct economic analyses of both
designs and operations are essential skills. An understanding of the underlying
concepts of such analyses is needed for the solution of many problems and
forms the basis for decisions; these can be on-the-spot or detailed investigations.

In the early days of chemical engineering, the process economics course

was a course in economic balance. In recent times, the economic balance part of
a process economics course has been referred to as simple optimization of
process equipment. Peters and Timmerhaus [1] call this topic optimum design.
The goal is to attain the “best” situation by applying simple optimum-
seeking techniques. The major challenge is to recognize the existence of an
economic balance problem and then to formulate the problem for a solution. An
economic balance then is a study of all costs, expenses, revenues, and savings
that pertain to an operation or equipment size.

5.1 GENERAL PROCEDURE

The initial step in the development of an economic balance is to determine what
variable(s) is to be optimized. Before we begin discussing the methodologies,
there is terminology that needs to be defined.
The term cost refers to a one-time purchased price of capital equipment,
such as a heat exchanger. If an item is a recurring “cost,” it is called an expense,
such as utilities or maintenance expense. Although this terminology is different
from that found in some texts, at least it is consistent with the material in this
text.
For the simplest case, all costs and expenses are related to an arbitrarily
selected controllable variable. This variable might be the number of pounds of
product manufactured, the area of a heat exchanger, the number of evaporator
effects, the internal rate of return, etc. Those items in the cost analysis that
increase with an increase in the controllable variable are balanced against those
items that decrease as the controllable variable increases. Any costs or expenses
that are constant, that is, independent of the controllable variable, do not need to
be included in the analysis since they do not affect the final result of the analysis
and only complicate the mathematics. Therefore, in an economic balance, the
analysis is not limited to the sum of the fixed and variable expenses, although
most examples are presented in this manner.

5.2 PRACTICAL CONSIDERATIONS

The various methods for determining optimum conditions described in this chapter
are theoretical and they meet the required conditions for an optimum case. Often the
solution may lead to a result for which industrial equipment is not available in the
optimum size. Some equipment is manufactured in discrete sizes. For example, in
the case of an optimum pipe size, a mathematical or graphical result may indicate
that a pipe diameter of 2.67 in is optimum. If the fluid to be pumped is compatible
with steel and Schedule 40 pipe is suitable, commercially available pipe sizes are
sizes. The engineer would be
confronted with making a choice. The smaller diameter pipe would lead to higher
pumping costs and lower pipe costs while the larger diameter pipe would have lower
pumping costs but slightly higher pipe costs. Now we encounter an “engineering
trade-off” that the engineer must resolve. In the author’s experience, the 3 in pipe
would be recommended since this allows for any potential errors in the theoretical
calculations but also provides for increased production that will surely occur once
the equipment is put in operation. Further, the company may have a standards
program for piping such that only nominal etc. pipe will be
stocked. These are practical considerations that the engineer must recognize.
Some equipment is available or can be manufactured in a continuum of
sizes. In general, it is often cheaper to accept a slightly larger size rather than
incur the expense of a tightly designed equipment item. For example, results of
calculations indicate that a 2250 ft2 is required for specific conditions but a
fabricator has off-the-shelf exchangers of 2000 or 2500 ft2. It is frequently
cheaper to purchase the 2500 ft2 unit rather than have a 2250 ft2 exchanger
designed and manufactured. Further, the larger unit permits more operating
flexibility. An analysis of optimum conditions can only give approximate results
but do serve the purpose of obtaining a minimum cost.
There are other factors that might affect an engineering recommendation,
for example, the physical properties of a material. A material may be too
viscous under the proposed operating conditions and a theoretical optimum may
not attainable. Intangible features may also enter into the analysis like uncertain
design or processing conditions or perhaps uncertain product selling price that
might affect the optimization. Therefore, the economic analysis precludes the
engineer from exercising extreme accuracy.
5.3 GENERAL PROCEDURE FOR FINDING OPTIMUM
CONDITIONS
The first step is to determine what variable is to be optimized, and then it is
necessary to determine what relationships affect the variable. Equipment
designed to provide a specific duty or service should be sized so that the total
annual expense, that is, the sum of the annual fixed and variable expenses, is a
minimum. This ideal must be consistent with operating limitations and provide
some flexibility. The essential elements of an economic balance are:
. Fixed and variable operating expenses
. An allowance for depreciation
. A term for an acceptable return on an investment
Prior to the 1960s, economic balances were performed without a term for
the return on invested capital. Happel [6] identified the need to include such a
term because funds for a proposed venture would have to be obtained from
external sources or internally generated funds. In either case, the return term
represents an expense to the corporation no matter from where the funds are
obtained.
Two kinds of expenses are accounted for in an economic balance, namely,
variable and fixed operating expenses.

5.3.1 Variable Operating Expenses

These expenses are recurring expenses. Table 5.1 is a list of those operating
expenses that affect optimization of equipment size. Only those expenses that
change with equipment size need be included in the analysis. Engineers will
frequently complicate the mathematics by including variables that are of little or
no consequence. A general rule is that as a first attempt, keep the analysis
simple, and if more variables are thought to be required, then include them later.
In the case of equipment optimization, the major operating expenses are
the utilities. Examples are
. Pipe size—electricity required to pump fluids
. Insulation thickness—the value of the condensed steam
. Multiple-effect evaporators—the cost of steam required
Other operating expenses that may be included are maintenance and waste
disposal expense, and in the case of a chemical reactor, chemical raw materials
may be a factor.
Table 5.2 is a guide for maintenance expenses.

TABLE 5.1 Operating Expenses in Equipment Optimization

Item Comments
Raw materials Generally only enters if the equipment
is a reactor
Direct operating labor Seldom affects the optimization
Supervision Seldom affects the optimization
Maintenance Can be a factor; usually expressed
as a fraction of the fixed
capital investment, (0.05 – 0.10) FCI
Plant supplies Usually negligible
Utilities: Usual variables
Steam
Electricity
Water
Fuel
Property taxes Generally expressed as a fraction of
the fixed capital investment, (0.02 – 0.04) FCI
Insurance Generally expressed as a fraction of
the fixed capital investment, (0.01 – 0.02) FCI

TABLE 5.2 Annual Maintenance Expense: Percentage of

the Fixed Capital Investment

Type of equipment Maintenance, %

Simple, light use 2 –5

Average 5 –8
Heavy or complicated 8 – 10

5.3.2 Fixed Operating Expenses

These expenses include depreciation and plant indirect expenses such as
property taxes, insurance, fire protection. All these items are expressed as a
fraction of the equipment cost or the fixed capital investment. The fixed capital
investment represents the total money spent to purchase equipment and place it
in operation. It is customary to include the return on investment on an after-tax
basis using the federal rate but occasionally state and local taxes may also be
included in the expression for the fixed expenses. Table 5.3 is a checklist of
these items. To simplify the mathematics, annual expenses are considered to be
constant, therefore; depreciation is calculated on a straight-line basis.

To estimate the total fixed capital investment, the Hand, Wroth, or Brown
methods suffice for economic balances since most are of a preliminary nature.

As a general rule, variable operating expenses decrease with increasing

equipment size while fixed expenses increase with increasing size, as shown in
Figure 5.1.
TABLE 5.3 Checklist of Fixed Capital Items

Delivered equipment costs

Equipment installation
Automatic control equipment
Installation of automatic control equipment
Piping and ductwork
Insulation
Electrical equipment and installation
Auxiliary equipment
Engineering costs association with equipment installation
FIGURE 5.1 Optimum thickness of insulation—typical results.

5.4 PROCEDURE FOR SOLVING SINGLE-VARIABLE

BALANCES
There are many instances where the optimization is based on a single variable.
In that case, the procedure is simple. In Figure 13.1, the objective is to find the
insulation thickness that gives the least total cost. The single variable then is the
insulation thickness and variable and fixed cost relationships can be developed.
The general procedure for solving single-variable problems consist of the
following steps:
1. Determine all expenses that need to be considered in the balance. These
will be those expenses that vary as the size changes. For checklists, refer
to Tables 5.1 – 5.3. Expenses that do not change need not be included but
it is an error to exclude an expense that varies with equipment size.
2. Determine if any operating limitations exist. Some common
examples are:
. Limiting pressure drop in packed and tray towers above where
flooding occurs.
. Limiting head for pipelines when flow is by gravity.
. A safety margin for reflux ratio in a distillation column above
minimum reflux to ensure some tolerance because of inaccuracies
in design and thermodynamic data
3. Mathematically express the expenses as a function of the variables,
preferably those related to equipment size; otherwise use variables that
define the operation, such as temperature, concentration, pressure. The
final expression should include all pertinent expenses. The variables
next need to be reduced to only those items that are significant.
Frequently, only one variable is used in total expense equations e.g.,
pipe size for economic pipe diameter, number of effects in evaporator
systems, etc.
4. Ascertain if the optimum size must be one of a number of discrete
sizes that are commercially available or whether it can be any size. For
example, pipe insulation as shown in Figure 5.1 can only be purchased
in standard thickness. Distillation towers, heat exchangers, rotary
driers, etc. may be fabricated in any size specified by the design
engineer.
5. Solve the total expense equation by either an analytical or graphical
method. These two methods have certain advantages and disadvantages.

5.4.1 Analytical Method

Common mathematical techniques are used to locate the optimum. For problems
concerned with equipment size, the minimum size is sought; however, in cases
where optimum yield is sought, the objective is to find the maximum. For the
simple case in which all expenses are expressed as functions of a single
variable, the total expense equation can be differentiated with respect to the
single variable, the result set equal to zero and the equation solved for the
optimum. Unless it is obvious from the nature of the expense curves that there is
a true optimum, mathematical tests must be performed as a check.

Total annual expenses ¼ fixed expenses þ variable expenses

where the fixed expenses are depreciation and plant indirect expenses. By
convention, the return on investment term is included with the fixed expenses.
The variable or recurring expenses are utilities, maintenance, etc. Therefore,

eq 5.1
where
TAE = total annual expenses
FE = fixed expenses
VE = variable expenses
If the derivative of Eq. (5.1) is taken with respect to the controllable variable x,
then

Eq. (5.2)

Equation (5.2) is set equal to zero and solved for x,

Eq. (5.3)

The value of x is either a maximum or minimum, depending on the problem

objective.
Advantage of method: It is a quick method.
Disadvantages of method:
1. Does not afford ready comprehension of how different cost elements
vary with size.
2. Final answer does not yield standard sizes.
3. Does not indicate how sharp the maximum or minimum curve is at the
optimum.
4. May result in an equation that is difficult to solve mathematically.

5.4.2 Graphical Method

For a reasonable range of sizes, the fixed and variable expenses in the total expense
equation are calculated and tabulated. For piping and insulation, discrete commercial
sizes are selected. The graphical method is shown in Figure 5.1. For equipment that
is not fabricated in discrete sizes, the selection is dictated by the design engineer or
by common engineering practice. The optimum is found by plotting the fixed
expenses, variable expenses, and the total expense curves as a function of the
controllable variable. From the plot, one may observe the nature of the optimum and
provide a basis for judgment. If the curve has a sharp minimum, the indicated size is
correct; however, if the total expense curve is relatively flat, there is some latitude in
the choice. For instance, if the proposed investment is to be a minimum, the smaller
equipment size is selected, whereas, if a margin for increased capacity is desirable,
then a larger size might be selected provided that there is not a significant increase
in the total annual expenses.

Advantages:
1. Yields an answer for available or approximate sizes that will provide
the desired service at minimum cost or will provide maximum yield.
2. Produces a solution where the analytical method may be difficult or
impossible to solve.
3. Indicates pictorially how the fixed, variable and total annual expenses
vary with size.
Disadvantage: Takes more time to solve:
Example 5.1 is an illustration of the analytical and graphical techniques.
Example 5.1
A food company is concerned is about the conservation of energy in their
baking ovens. New insulation needs to be installed and the information for this
economic analysis is:

Temperature at surface of the 550 F

inside oven wall
Ambient air temperature 70 F
2
Combined ambient air film coefficient 4 Btu/hr ft F
Thermal conductivity of insulation 0.30 Btu/hr ft F
Insulation cost, installed $3.50/board ft
2
(A board foot is 1 ft of area,
3
1 in. thick or 144 in. )
The value of heat $3.00/MM Btu
Estimated oven life 10 yr
Depreciation 7 years straight-line
Maintenance 3% FCI/yr
Insurance and property taxes 1.5% FCI/yr
Combined federal and state taxes 42%
Stream time 8700 hr/yr
Cost of capital 10%
Determine the optimum insulation thickness.
Only the expenses that appear to vary with insulation thickness will be
considered:
. Installed cost of the insulation
. Cost of heat lost through the oven wall
. Maintenance on the insulation
. Depreciation
. Insurance and property taxes
. Return on investment
This solution does not indicate how sharp the minimum is, nor does it indicate
which of the nearest sizes of insulation will be more economical, 4 or 5 in
thickness. This decision must be resolved by calculating the total annual
expense for both sizes, viz. 4 and 5 in, or by preparing a graphical solution.
Probably the 5-in insulation will be selected.
Graphical Solution:

The graphical solution is performed using the same expense equations as

in the analytical solution. The terms for each expense item are calculated and
presented in Table 5.4. In order to complete this solution, the fixed expenses, the
variable expenses and the total annual expenses are plotted as a function of t, the
thickness of the insulation. The resulting total minimum expense is found to be
4.75, as shown in Figure 5.2.

5.5 PROCEDURE WITH MORE THAN ONE CONTROLLABLE

VARIABLE
In some economic analysis problems, more than one controllable variable
affects the optimum cost or maximum yield. The general approach, analytical or
graphical, for solving this type problem is the same; however, determining the
optimum is rather tedious. This situation occurs when technical relations
between design, batch size, or other economic conditions produce a basis
equation such as in Eq. (5.20):

Eq. (5.20)
TABLE 5.4 Tabulated Results of Graphical Solution for Example 5.1

Thickness 3 in 4 in 4.75 in 5 in 6 in 7 in 8 in
Fixed expenses $330.00 $440.00 $522.50 $550.00 $660.00 $770.00 $880.00
Variable expenses
Heat loss $1,035.06 $823.79 $714.42 $684.15 $584.98 $511.07 $454.42
Maintenance 31.50 42.00 49.88 52.50 63.00 73.50 84.00
Taxes & insurance 15.75 21.00 24.94 26.25 31.50 36.75 42.00
Total variable expenses $1,082.31 $886.79 $789.24 $762.90 $679.98 $621.32 $580.42
Total annual expenses $1,412.31 $1,326.79 $1,311.74 $1,312.90 $1,339.48 $1,391.32 $1,460.42
FIGURE 5.2 Optimum insulation thickness—Example
5.1.

For example, in a manufacturing process, the production capacity

may vary with the speed of the equipment and its size. Since both
variables are controlled by management or design personnel, perhaps
the best policy is a combination of optimum speed and optimum size.
The mathematical relationships for a case of two (or more) variables
may be:

Eq. (5.20)
where
CT =annual dollars
x; y =controllable variables
a; b; c; d = constants
The annual cost will pass through a minimum when either x or y is
held constant as found by partial differentiation.

Eq. (5.23)

If cT is plotted as the ordinate with x as the abscissa and y as the third

coordinate, a curved surface results as shown in Figure 5.3. The
minimum cost cT is found by plotting Eq. (5.21) for assumed constant
values of x. The line made where one constant x plane intersects the
surface will give a minimum cost cT and an optimum value. The same
result may be found analytically by setting Eq. (5.23) equal to zero and
solving for y at a constant assumed value of x.
5.6 INTERACTIVE SYSTEMS
Frequently more than one item of equipment influences the
controllable variable(s) and the optimum solution. In this case, when
solving a problem graphically, if only one item of equipment is
selected, the total annual expense curve does not pass through a
minimum but continues to decrease with increasing size or it may
increase with increasing equipment size. If this phenomenon occurs,
then more than one equipment item is affecting the optimization. The
next step is to inspect the flow sheet for equipment directly upstream
or down-stream from the selected item. It may be necessary to group
two or more items together and treat them as a single equipment
item. Such a system is said to be interactive since more than one item
of equipment affects the optimum condi-tions. Example 5.3 is an
illustration of such a system.

5.7 SUMMARY

This UNIT was concerned with the development of an economic

balance to determine a minimum total expense or a maximum
process yield. Methodologies were developed and checklists were
provided for the solution of simple optimization problems.
Analytical and graphical methods of solution were demonstrated for
single or multiple controllable variable cases. In some instances, the
analytical solution may be simpler to use but in other cases, the
graphical solution is more direct and less cumbersome
mathematically but may be more time consuming.

Interactive systems were introduced wherein more than one

equipment item affects the controllable variable.Judgment based
upon an engineer’s experience is necessary in this case because there
may be equipment or process limitations beyond the mathematical
solution that affect the final decision.

REFERENCES
1. MS Peters, KD Timmerhaus. Plant Design and Economics for Chemical
Engineers. New York: McGraw-Hill, 1991.
2. TF Edgar, DM Himmelblau. Optimization of Chemical Processes. New
York: McGraw-Hill, 1988.
3. GS Beveridge, RS Schechter. Optimization Theory and Practice. New
York: McGraw-Hill, 1970.
4. GV Reklaitis, A Ravindran, KM Ragsdell. Engineering Optimization.
New York: Wiley, 1983.
5. RW Pike. Optimization for Engineers. New York: Van Nostrand
Reinhold, 1986.
6. J Happel. Chemical Process Economics. New York: Wiley, 1958.
7. H Schweyer. Analytical Models for Managerial and Engineering
Economics. New York: Reinhold, 1964.