Cost Estimation

Cost Estimation

• Profit = Total income – All expenses

• All expenses = Direct Expenses + Indirect Expenses
• Raw material, labor and utilities ---- Direct Expenses
• Administrative salaries, product sales & distribution cost and cost
for interplant communications etc. ----------- Indirect Expenses
Cumulative cash position
Factor affecting investment and production cost
• Sources of equipment : second hand and new equipment
• Price fluctuation: comparing prices of equipment at diff. timings
• Company policies
• Operating time and rate of production
 Labor cost low but maintenance, protection and depreciation continue
Break-even point: The point where the total product cost equals the total income is
known as the break-even point.
• Govt. Policies:
 Capital investment
• The capital needed to supply the necessary manufacturing and plant
facilities is called the fixed capital investment, while that necessary for
the operation of the plant is known as working capital. The sum of
both is called the total capital investment.
• Fixed capital investment:
Manufacturing: expenses for piping, instrument, insulation,
foundation and site preparation
Non manufacturing: land, buildings, administrative and other offices,
warehouses, laboratories, transportation, shipping and receiving
facilities, utilities, waste-disposal, shops and construction cost and
etc.
 Working capital
• The total amount of money invested in
1. Raw materials and supplies carried in stock
2. Finished products in stock and semifinished products in the process
of being manufactured
3. Accounts receivable
4. Cash kept on hand for monthly payments of operating expenses,
such as salaries, wages, and raw material purchases
5. Accounts payable
6. Taxes payable
• The ratio of working capital investment varies with different
companies but most chemical plant uses working capital amounting
to 10 to 20 % of the total capital investment. It can be increased upto
50 %.
Total capital investment(TCI)
= fixed capital(FCI)+working capital(WC)
 Estimation of capital investment
• Types of capital cost estimates:
1. Order-of-magnitude estimate (ratio estimate) based on similar
previous cost data, probable accuracy of estimate over ±30%.

2. Study estimate (factored estimate) based on knowledge of major

items of equipment, probable accuracy of estimates up to ±30%.

3. Preliminary estimate (budget authorization estimate, scope

estimate) based on sufficient data to permit the estimate to be
budgeted, accuracy of ±𝟐𝟎%.
Contd…
4. Definitive estimate (project control estimate) based on almost
complete data but before completion of drawings and specifications,
accuracy ±𝟏𝟎%.

5. Detailed estimate (contractor’s estimate) based on complete

engineering drawings, specifications and site surveys, accuracy ±𝟓%.
 Cost indexes
• Most cost data which are available for immediate use in a primary or
predesign estimates are based on conditions at some time in the past.

𝒊𝒏𝒅𝒆𝒙 𝒗𝒂𝒍𝒖𝒆 𝒂𝒕 𝒑𝒓𝒆𝒔𝒆𝒏𝒕 𝒕𝒊𝒎𝒆

• Present cost = Original cost ( )
𝒊𝒏𝒅𝒆𝒙 𝒗𝒂𝒍𝒖𝒆 𝒂𝒕 𝒕𝒊𝒎𝒆 𝒐𝒓𝒊𝒈𝒊𝒏𝒂𝒍 𝒄𝒐𝒔𝒕 𝒘𝒂𝒔 𝒐𝒃𝒕𝒂𝒊𝒏𝒆𝒅
• The common indexes permit fairly accurate estimates if the time period
involved is less than 10 years.
1. Marshal and swift equipment cost indexes
2. Engineering news record construction cost index
3. Nelson refinery cost index
4. Chemical engineering plant cost index
5. Other indexes and analysis
 Estimating equipment cost by scaling
• Six-tenths-factor rule
𝑐𝑎𝑝𝑎𝑐𝑖𝑡𝑦 𝑒𝑞𝑢𝑖𝑝.𝑎 0.6
• Cost of equipment a = cost of equip.b ( )
𝑐𝑎𝑝𝑎𝑐𝑖𝑡𝑦 𝑒𝑞𝑖𝑝.𝑏
• Given:
• Cost index in 1991 is 361
• Cost index in 1996 is 382
• Ans—10581.7 for the same capacity reactor
• Ans—31006.1 for 1.2 m3 reactor
 Q. The purchased cost of an equipment of 50-gal capacity was $3000
on January 1, 1987.
1.Estimate the purchase cost of a similar 300-gal capacity equipment
on January 1, 1987.
2. Estimate the purchase cost of a similar 50-gal capacity equipment on
January 1, 1994.
3. Estimate the purchase cost of a similar 300-gal capacity equipment
on January 1, 1994.
• (Cost index in 1987 is 324, Cost index in 1994 is 368)
1. Ans = $ 8790.5 for same year
2.Ans = $ 3407.4
3.Ans = $ 9984.2
 Solution
1. Cost of 300-gal capacity equipment on January 1,1987,
cost of euipment b.= cost of euipment a (capcity of equip.b/ capcity of equip.a)0.6
=3000(300/50)0.6= $ 8790.5
2. Cost of a similar 50-gal capacity equipment on January 1, 1994.
present cost =original cost(index value at present time/index value at time
original cost was obtained)
= 3000(368/324) = $ 3407.4
3. Cost of a similar 300-gal capacity equipment on January 1, 1994
= cost of euipment a (index value at present time/index value at time original
cost was obtained) (capcity of equip.b/ capcity of equip.a)0.6
=3000(368/324)(300/50)0.6 = $ 9984.2
 Purchased Equipment Installation
• The installation of equipment involves costs for labor, foundations,
supports, platforms, construction expenses and other factors which
are directly related to the purchased-equipment.
• Installation labor cost as a function of equipment size
• Insulation cost: When very high or very low temperature are
involved, insulation factor can become important
• Instrumentation and control: 6 to 30% of the purchased cost for all
equipment.
• Piping: The cost for piping covers labor, valves, fittings, pipe,
support and other items involved in the complete construction of all
piping used directly in the process.
• Raw material, intermediate product, finished product, steam, water,
air, sewer and other process piping.
• Process plant piping can run as high as 80% of purchased equipment
cost or 20% of fixed capital investment.
• Labor for installation is estimated as approximately 40-50% of the
total installed cost of piping.
• Material and labor for pipe insulation is estimated to vary from 15 to
25% of the total installed cost of the piping.
• Electrical installation: It consists mainly of installation labor and
material for power and lighting, with building-service lighting usually
included under heating of building and service-costs.
• Electrical installation cost amounts 10 to 15% of the value of all
purchased equipment .
• Service facilities: Utilities for supplying steam, water, power,
compressed air and fuel are part of the service facilities of an
industrial plant.
• Waste-disposal, fire protection and miscellaneous service items such
as shop, first aid and cafeteria equipment and facilities require capital
investment which comes under service facilities.
• Total cost for service facilities in chemical plants ranges from 30 to
80% of the purchased-equipment cost.
• Land: cost of land, surveys and fee depends on location of the
property.
• Cost factor can vary as high as 30 to 50 between rural and industrial
area.
• Cost of land does not decrease with time.
• Engineering and Supervision: The cost of construction and engg.,
drafting, purchasing, accountings, travel, reproductions,
communications.
• Home office expenses including overhead constitute the capital
investment for engg. and supervision.
• Startup expenses: Overall cost analysis, startup expenses may be
presented as a one-time only expenditure in the first year of the plant
operation or as part of the total capital investment depending on the
company policy.
 Method of estimating capital investment
• The choice of any one method depends upon the amount of detailed
information available and the accuracy desired.
• The degree of accuracy decreases with each succeeding method.
• A maximum accuracy within approximately ±5% of the actual investment can be
obtained within method A.
• Method A (Detailed-item estimate): A detailed-item estimate requires careful
determination of each individual item shown in table 1.
• Estimates of installation costs are determined from accurate labor rates,
efficiencies and employer hour calculations etc.
 Methods for estimating capital investment
• Method B (Unit-cost estimate): This method is frequently used for
preparing certain and initial estimates also requires detailed estimates of
purchased price obtained either from quotations or index-corrected cost
records and published data.
• Cost equation summarizing this method—
Cn[𝜮(E+EL)+ Σ(fxMx+fyML,)+ΣfeHe+Σfddn](fF)
where, Cn = new capital investment
E = purchased-equipment cost
EL= purchased equipment labor cost
fx= specific material unit cost, e.g., fp=unit cost of pipe
Mx=specific material quantity
 Methods for estimating capital investment
fy= specific material labor unit cost per employee hour
ML= labor employee-hour for specific material
fe= unit cost for engineering
He= engineering employee-hour
fd= unit cost per drawing or specification
dn= number of drawing or specification
fF= construction or field expense factor always greater than 1
 Methods for estimating capital investment
• Method C (Percentage of delivered-equipment cost):

• Manufacturing cost
• General expenses
• Estimation of total product cost
• Direct production cost
 GROSS PROFIT, NET PROFIT, AND CASH FLOW

• Gross profit
• The product sales revenue minus the total product cost gives the gross
profit, also called gross earnings (g).
• Gross profit is expressed both with and without depreciation included as
follows:
g = s – c0 ---------------------- (1)
where g is gross profit, depreciation not included,s-income from sales,
c0-cost
and G = s — c0 — d ----------------(2)
where G is gross profit, depreciation included,d-depreciation
 GROSS PROFIT, NET PROFIT, AND CASH FLOW

• Net profit
• Net profit, also called net earnings, is the amount retained of the
profit after income taxes have been paid
N = G(l-ø) ---------------(3)
• Cash flow
The cash flow resulting from process operations is
A = N + d ----------------(4)
 GROSS PROFIT, NET PROFIT, AND CASH FLOW

1. Problem.
The annual variable production costs for a plant operating at 70
percent capacity are $280,000. The sum of the annual fixed charges,
overhead costs, and general expenses is $200,000, and may be
considered not to change with production rate. The total annual sales
are $560,000, and the product sells for $4/kg. What is the breakeven
point in kilograms of product per year? What are the gross annual
profit g, Gj ,net annual profit N, and cumulative cash for this plant at
100 percent capacity if the income lax rate is 35 percent of gross
profit and depreciation is $2,000 per year?
 GROSS PROFIT, NET PROFIT, AND CASH FLOW
Solution
 Find the total quantity of product produced with its variable cost per unit.
total quantity of product produced=560,000/4=140,000 kg
variable cost of product per unit=280,000/140,000 = $ 2/kg
 The breakeven point (BEP) occurs when the total annual product cost equals the total annual sales.
Let it occurs for x quantity of product
The total annual product cost = fixed charges(overhead and general expenses) + variable production costs.
= 200,000 + 2x
total annual sales = 4x
At BEP
total annual product cost= total annual sales
200,000 + 2x = 4x
x=100,000 kg
 GROSS PROFIT, NET PROFIT, AND CASH FLOW

Find the no.of units produced at 100% production capacity

At 70% capacity plant produces = 140,000 kg of product
For 100% capacity,
plant will produce=140,000x100/70 =200,000 kg of product
Find the % of BEP production out of 100% production
=100,000/200,000 = 50% for BEP
Find g gross profit before depreciation for 100% production
g = s-c0
=total annual sales - total annual product cost
=4x200,000-(2x200,000+200,000)= $ 200,000
 GROSS PROFIT, NET PROFIT, AND CASH FLOW

Find G gross profit after depreciation(d) for 100% production

G = s — c0 — d , or
G = g-d
G=200,000-2,000 =$198,000
Find N net profit after income tax deduction(ø)
N = G(1-ø)
=198,000(1-0.35)=$ 128,700
Find cumulative cash flow resulting from process operations
A=N+d
=128,700+2,000=$ 130,700
 GROSS PROFIT, NET PROFIT, AND CASH FLOW

Ans.
1.kilograms of product produced=560,000/4=140,000 kg
2.Variable cost per kg =280,000/140,000=$ 2/ kg
3.BEP Cost = Sales
4.2x + 200,000 = 4x
5. X =100,000 kg—Quantity of product at BEP
6.70% ==140,000 kg
7.100%==140,000x100/70 =200,000 kg
8.BEP=100,000/200,000=50%
9.g= 4X200,000- (2X200,000 + 200,000) =800,000-600,000=$200,000
10.G=200,000-2,000 =$198,000
10.N=198,000(1-0.35) =$ 128,700
11. Cum.cash= 128,700+ 2,000 = $130,700
 GROSS PROFIT, NET PROFIT, AND CASH FLOW

2.Problem.
For a plant operating at 75 percent plant capacity the sum of the
annual fixed charges, overhead costs, and general expenses is
$240,000, and may be considered not to change with production rate.
The annual variable production costs is $450,000.The total annual
sales are $750,000, and the product sells for $5/kg. What is the
breakeven point in kilograms of product per year? What are the gross
annual profit profit g,after depreciation G ,net annual profit after
taxes N, and cumulative cash for this plant at 100 percent capacity if
the income tax rate is 40 percent of gross profit and depreciation is
$4,000 per year?
 GROSS PROFIT, NET PROFIT, AND CASH FLOW

• Ans.
• Kg=150,000
• V cost= $ 3/kg
• BEP=120,000 Kg
• BEP=60% Capacity
• g=160,000
• G=156,000
• N=93,600
• Cum.cash = 93,600+4000=97,600
 GROSS PROFIT, NET PROFIT, AND CASH FLOW

1.kilograms of product produced=750,000/5=150,000 kg

2.Variable cost per kg =450,000/150,000=$ 3/ kg
3.BEP Cost = Sales
4. 3x + 240,000 = 5x
5. X =120,000 kg—Quantity of product at BEP
6. 75% ==150,000 kg
7. 100%==150,000x100/75 =200,000 kg
8. BEP=120,000/200,000=60%
9. g= 5X200,000- (3X200,000 + 240,000) =1000,000-840,000=$160,000
10. G= 160,000-4,000 = $156,000
10. N=156,000(1-0.4) =$93,600
11. A = 93,600+ 4,000 =$ 97,600
 GROSS PROFIT, NET PROFIT, AND CASH FLOW

Q. The purchased cost of an equipment of 40-gal capacity was $2000

on January 1, 1997.
1.Estimate the purchase cost of a similar 280-gal capacity equipment
on January 1, 1997.
2. Estimate the purchase cost of a similar 40-gal capacity equipment
on January 1, 2002.
3. Estimate the purchase cost of a similar 280-gal capacity equipment
on January 1, 2002.
• (Cost index in 1997 is 386, Cost index in 2002 is 390)
 Solution
1. Cost of 280-gal capacity equipment on January 1,1997,
cost of euipment b.= cost of euipment a (capcity of equip.b/ capcity of
equip.a)0.6
=2000(280/40)0.6= $ 6428.2
2. Cost of a similar 40-gal capacity equipment on January 1, 1994.
present cost =original cost(index value at present time/index value at
time original cost was obtained)
= 2000(390/386) = $ 2020.7
3. Cost of a similar 280-gal capacity equipment on January 1, 2002
= cost of euipment a (index value at present time/index value at time
original cost was obtained) (capcity of equip.b/ capcity of equip.a)0.6
=2000(390/386)(280/40)0.6 = $ 6494.7