A. Economic evaluation of a production process Revenue Cost items B. Evaluation of investments 1 Cost of individual equipment C. Evaluation of investments 2 Cost structure for building a new plant The factor method Reliability of estimates D. Profitability analysis The time value of money Comparing investment policies 1 Goal : record expenses and revenues Allocate them to each step in the operation Obtain figures to assess the economic efficiency of the operation Use normalized procedures to allow comparison of different processes Also allow comparison at different periods of time or different locations 2
Difference (hopefully positive) between + Money obtained by selling products - All costs needed to provide the product raw materials, energy salary manufacturing packaging, transportation etc. Some costs are fixed Some costs vary with production (linearly?) 3 Indirect plant cost 15% Investment costs 5%» Depreciation 5-1% of fixed investment» Insurance 1% of fixed investment» Interest on inventories» Taxes Overhead 1%» Technical (engineering)» Non technical (office, plant protection, etc)» Supplies» Rental of equipment, building, etc 4
Management expenses 5% Executives Legal ervice Technical research Market research Selling and distribution expenses 1-2% Cost of selling Packaging Warehouse cost Delivery Technical service (after sale) 3-5% Fixed costs : typically 3 to 4% of total expenses 5 Raw materials Other consumables catalyst make up solvent Direct labor (operators and helpers) (include social security, pension fund, vacations, benefits) Process utilities steam electricity cooling water refrigeration compressed air 6
Maintenance 4-6% of fixed plant investment labor materials Small supplies,5% of fixed plant Direct supervision (foremen) 1% of direct labor Laboratory, process control Royalties (licenses for using patented processes) Packaging and storage 5% of raw mat.+ labor Spoilage, other losses 1-2% of raw materials Credit for by-products (not a cost) Variable costs : typically 6 to 7% of total expenses 7! /t % sales revenue revenue from annual sales 5, 1,% raw materials 22 442, 44,2% catalysts and solvents 172 34,4 3,4% operating labor 255 51, 5,1% operating supervision 5 1, 1,% utilities 55 11, 1,1% operating maintenance 53 1,6 1,1% operating supplies 2,,2% royalties and patents 25 5,,5% direct manuf. expense 283 566, 56,6% Payroll overhead 7 14, 1,4% central laboratory 25 5,,5% general plant overhead 13 26, 2,6% packaging and storage 55 11, 1,1% property taxes 35 7,,7% insurance 15 3,,3% indirect manuf.expense 33 66, 6,6% 8
" # /t % sales revenue revenue from annual sales 5, 1,% direct manuf. expense 283 566, 56,6% indirect manuf.expense 33 66, 6,6% total manuf. expense 316 632, 63,2% excluding depreciation depreciation 17 34, 3,4% administration 185 37, 3,7% sales and shipping 3 62, 6,2% advertising and marketing 2, 2,% technical service 25 5,,5% research and development 15 3, 3,% total overheads 77 154, 15,4% total cost or expense 4 82, 82, % net annual profit 9 18, 18,% less taxes @ 5,% -45-9, -9,% net profit after tax 45 9, 9,% 9 $ Cash flow corresponds to the positive net income resulting from operation, money available for new ventures or for capital retribution Cash flow = Net profit (after tax) + variation of investment value CF = S - C - F - I - (S - C - F - D) t = (S - C - F - D) (1-t) + (D - I)» S : sales revenue» C : operating expenses» F : financial charges Cost of operation» D : depreciation allowance» I : new investments» t : taxation rate 1
%! Basic relationships Z = ns - (nv+f) = n (S-v) - F» Z : gross profit (ECU)» n : production rate (t/yr)» S : net sales price (ECU/t)» V : variable cost (ECU/t)» F : annual fixed cost (ECU) Assuming no interest charge Y = Z (1-t) for Z>» Y : net profit, after tax (ECU)» t : average tax rate 11 % kecu/yr 5 45 4 35 Break-even point Net sales ns Cost of sales nv + F 3 25 Variable cost nv 2 15 5 2 4 6 8 1 Fixed cost F Gross profit Z Net profit Y Capacity % 12
% "& # ECU/t 8 Net sales Cost of sales 6 Variable cost 4 2 Break-even point Fixed cost 2 4 6 8 1 Gross profit Net profit 13 '! 6 5 4 fixed variable 3 cost of sales net sales Gross profit 2 Net profit 2 4 6 8 1 12 14
( )*! 8 fixed variable 6 cost of sales net sales 4 Gross profit 2 Net profit 5 1 15 + 45 4 35 3 25 2 15 5 2 4 6 8 1 8 6 4 2 2 4 6 8 1 fixed variable cost of sales net sales Gross profit Net profit 16
Application 1. The annual fixed costs for a plant are 1,. The variable costs are 14, at 7 % capacity with net sales of 28,. What is the break-even point in units of production if the selling price per unit is 4? 17 To build and operate a production facility, money is needed in the for of capital. Fixed capital pays for the facilities, machines, etc. Working capital pays for the expenses involved in the operation of the plant Since industrial operation involves a risk of failure, the retribution of capital is normally higher than for less risky operations (e.g. bank deposits) Succesfull operation can both benefit to the capital owner in the form of dividend or in the form of increase of the value of the shares. 18
Manufacturing fixed-capital investment installed process equipment auxiliaries piping, instruments, etc site preparation, foundations Nonmanufactu ring fixed-capital investment. construction overhead land buildings, warehouses, laboratories, transportatiom, shipping, and receiving facilities utility and waste-disposal facilities construction overhead» supervision expenses» engineering expenses» contractor's fees, and contingencies 19, - Stock of raw materials Supplies needed for production (solvents, catalysts) Finished products in stock Semifinished products in the manufacturing process Accounts receivable Cash kept for payment of salaries, raw-material, etc. Taxes payable. Order of magnitude : 15-2% of fixed capital 2