ChE 450 Chemical Process Design and Analysis I Fall, 2012

Washington State University Voiland School of Chemical Engineering and Bioengineering Richard L. Zollars

Problem 10.10, Turton, Bailie, Whiting and Schaewitz The following expenses and revenues have been estimated for a new project: Revenues from sales = $4.1x106/y Cost of manufacturing (excluding depreciation) = $1.9x106/y Taxation rate = 40% Fixed capital investment = $7.7x106 (two payments of $5x106 and $2.7x106 at the ends of years 1 and 2, respectively) Start-up at the end of year 2 Working capital = $2x106 at the end of year 2 Land cost = $0.8x106 at the beginning of the project (time = 0) Project life (for economic evaluation) = 10y after start-up For this project, estimate the NPV of the project assuming an after-tax internal hurdle rate of 11% p.a., using the following depreciation schedules: a. MACRS method for 5 years b. Straight-line depreciation with an equipment life (for depreciation) of 9.5 years Comment on the effect of discounting on the overall profitability of large capital projects. SOLUTION The best way to start is to enter everything into an Excel spreadsheet. The only thing that will change is the depreciation, one spreadsheet for straight-line depreciation and one for MACRS. a. The net present value is a discounted criteria but we will also run the non-discounted figures. For MACRS the first depreciation amount would be ( )( )

where the factor 0.5 accounts for the fact that only one-half year depreciation is claimed the first year. For year 2 the depreciation would be ( )

since this is greater than the remaining straight-line depreciation amount ( )

In year 5 (after start-up) these calculations give ( )

and for the straight-line depreciation ( )

Since the straight-line amount is now greater it is used in year 5. After year 5 you still have time left to depreciate the equipment. The book value is now

This amount is taken in the final year. b. For the straight-line depreciation case (now over a 9.5 year time span) the annual depreciation is

Since the salvage value was assumed to be zero for the MACRS calculations we will use the same for the straight-line depreciation. Notice that after 9 years the book value would be ( )

Since it is to your advantage to take as much depreciation early, take the $0.811x106 starting in the first year. Then in the tenth year you will only be able to take depreciation for $0.405x106 since you cannot depreciate the equipment more than its initial cost. These numbers then are entered into the Excel spreadsheets shown below, the one using the MACRS depreciation scheme first, then the straight-line depreciation after.

Year 0 0 1 2 2 3 4 5 6 7 8 9 10 11 12 12

Capital Invest 0 -0.8 -5 -2.7 -2

Deprec

Book Value

Revenue

Annual Costs

Tax

Net Profit after tax

1.54 2.46 1.48 0.89 0.89 0.44

6.16 3.70 2.22 1.33 0.44 0.00 0.00 0.00 0.00 0.00

4.10 4.10 4.10 4.10 4.10 4.10 4.10 4.10 4.10 4.10

1.90 1.90 1.90 1.90 1.90 1.90 1.90 1.90 1.90 1.90

0.26 -0.11 0.29 0.53 0.53 0.70 0.88 0.88 0.88 0.88

0.40 -0.16 0.43 0.79 0.79 1.05 1.32 1.32 1.32 1.32

2.8

After-tax cash flow (nondiscounted) 0.00 -0.80 -5.00 -2.70 -2.00 1.94 2.31 1.91 1.67 1.67 1.50 1.32 1.32 1.32 1.32 2.80

Cumulative After-tax cash flow 0.00 -0.80 -5.80 -8.50 -10.50 -8.56 -6.26 -4.35 -2.67 -1.00 0.50 1.82 3.14 4.46 5.78 8.58

Discounted Cash Flow 0.00 -0.80 -4.50 -2.19 -1.62 1.42 1.52 1.13 0.90 0.81 0.65 0.52 0.46 0.42 0.38 0.80

Cumulative Discounted Cash Flow 0.00 -0.80 -5.30 -7.50 -9.12 -7.70 -6.18 -5.05 -4.16 -3.35 -2.70 -2.18 -1.72 -1.30 -0.92 -0.12

Interest Rate 0.11

Year 0 0 1 2 2 3 4 5 6 7 8 9 10 11 12 12

Capital Invest 0.00 -0.80 -5.00 -2.70 -2.00

Deprec

Book Value

Revenue

Annual Costs

Tax

Net Profit after tax

0.81 0.81 0.81 0.81 0.81 0.81 0.81 0.81 0.81 0.40 2.80

6.89 6.08 5.27 4.46 3.65 2.83 2.02 1.21 0.40 0.00

4.10 4.10 4.10 4.10 4.10 4.10 4.10 4.10 4.10 4.10

1.90 1.90 1.90 1.90 1.90 1.90 1.90 1.90 1.90 1.90

0.56 0.56 0.56 0.56 0.56 0.56 0.56 0.56 0.56 0.72

0.83 0.83 0.83 0.83 0.83 0.83 0.83 0.83 0.83 1.08

After-tax cash flow (nondiscounted) 0.00 -0.80 -5.00 -2.70 -2.00 1.64 1.64 1.64 1.64 1.64 1.64 1.64 1.64 1.64 1.48 2.80

Cumulative After-tax cash flow 0.00 -0.80 -5.80 -8.50 -10.50 -8.86 -7.21 -5.57 -3.92 -2.28 -0.63 1.01 2.66 4.30 5.78 8.58

Discounted Cash Flow 0.00 -0.80 -4.50 -2.19 -1.62 1.20 1.08 0.98 0.88 0.79 0.71 0.64 0.58 0.52 0.42 0.80

Cumulative Discounted Cash Flow 0.00 -0.80 -5.30 -7.50 -9.12 -7.92 -6.83 -5.86 -4.98 -4.19 -3.47 -2.83 -2.25 -1.73 -1.31 -0.51

Interest Rate 0.11

Cumulative Cash Flow (MACRS)

10.00

5.00

Non-discounted Discounted

Cash FLow ($ million)

0.00

-5.00

-10.00

-15.00 0 2 4 6 Year 8 10 12

Cumulative Cash Flow (SL)

10.00

5.00

Non-discounted
Discounted

Cash FLow ($ million)

0.00

-5.00

-10.00

-15.00 0 2 4 6 Year 8 10 12

The net present value (NPV) for the MACRS is thus -$0.12x106 while that for the straight-line depreciation is -$0.51x106. The effect of discounting is to reduce the NPV over the cumulative cash position you would get for non-discounted figures. Since the value of the money does change with time the discounted values give a better representation of the true value of the project. The assignment also asked for the discounted payback period and the discounted cash flow rate of return. For the discounted payback period you need to find the time when the value of the land and working capital (both discounted to year 0) and the cumulative cash flow are equal. Since the working capital of $2x106 occurred in year 2 this value is

For the MACRS depreciation schedule this will occur between years 8 and 9. Interpolating gives a DPBP of 6.5 years (remembering to subtract the two years prior to start-up). For a straight-line depreciation the DPBP is 7.7 years. The DCFROR is the interest rate that would yield a NPV of zero. Using the Solver routine in Excel to do this gives a DCFROR for the MACRS schedule of 10.7% p.a. and a DCFROR for straight-line depreciation of 9.92% p.a.