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Specifications and Feasibility studies HS501a Cost Estimation-Lecture Dr. Mounir Ahmed Arafa
Page 1
Recall
Basic relationships in accounting:
Assets = Equity
Assets = Liabilities + Equity
Total income = Costs + profits
Cost Estimation
Cash flow for industrial operations
Cumulative cash position
Materials costs
The current average method.
The first-in first out method.
The last-in first- out method.
Factors affecting investment and production costs
Source of equipment
Price fluctuation
Company policies
Operating time (rate)
Governmental policies
Specifications and Feasibility studies HS501a Cost Estimation-Lecture Dr. Mounir Ahmed Arafa
Page 2
Materials cost 1. Current average method
2. The first – in first – out method
3. The last – in first – out method
Accumulation Account
Date Received Cost Balance in
hand
Delivered for
use in process
May 2,2001 5000 lb $0.036/lb 5000lb -
May 15 10000lb $0.039/lb 15000lb -
May 17 - - 9000lb 6000lb
Solution
Average method price = $ 0.038/lb
Fifo method price, the price of 6000lb is $0.036/lb for the first 5000lb while
$0.039/lb for the remaining 100 lb
Lifo method price = $ 0.039/lb
(The average method is the best for time interval but misleading if used for
predicting future cost)
Specifications and Feasibility studies HS501a Cost Estimation-Lecture Dr. Mounir Ahmed Arafa
Page 3
Capital Investment Cost
Fixed capital
investment
Working capital
investment
Capital investment
Capital Investment =
Fixed Capital =
Manufacturing Capital
Machines,
equipments,
Building,
Piping,
Instrumentation,
Insulation,
Foundation….,
All of which are directly related to process
Operation
Non- Manufacturing Capital
Laboratory,
Stores,
Sewage,
Administration, restaurant, hospital…,
All not directly related to process
operation
Working capital
The total amount of money invested in raw materials,supplies,finishedproduct in stock and semi finished products in the process of being
manufactured,cash kept on hand for monthly payments,and account
payable.
Specifications and Feasibility studies HS501a Cost Estimation-Lecture Dr. Mounir Ahmed Arafa
Page 4
Types of cost estimates:
1. Cost index
A cost index is an index value for a given point in time showing the cost at that
time relative to a certain base time.
Present cost = original cost (index value at present time / index value at time
original cost).
Cost index is used in fairly accurate for time less than 10 years.
There are many cost indexes
equipments
civil
construction
labors
materials
and others
Marshall and Swift equipment cost indexes:
“Formerly known as Marshall and Stevens.”
The all industry equipment index is simply the arithmetic average of individual
indexes for 47 different types of industrial, commercial, and housing equipments.
The percentages used for the weighting in typical year are as follows:
Cement, 2
Chemical, 48
Clay products, 2
Glass, 3
Paint, 5
Paper, 10
Petroleum, 22
Rubber, 8
The Marshall and Swift indexes value are based of 100 for the yeas 1926.
These indexes take into consideration the costs of machinery and major equipment
plus costs for installation, fixtures, tools, office, furniture and other minor
equipments.
Specifications and Feasibility studies HS501a Cost Estimation-Lecture Dr. Mounir Ahmed Arafa
Page 5
Engineering new-record construction cost index:
show the variation in labor rate and material costs for industrial
construction.
Nelson-Farrar Refinery construction cost index:
Construction for chemical plant are the basis.
2. Estimating equipment cost by scaling
Six-tenth-factor rule:
Cost of equipment a = cost of equipment b (cap . a /cap . b)^0.6
Log – log of capacity versus equipment cost for type of equipment give straight
line relationship with 0.6 slope.
Specifications and Feasibility studies HS501a Cost Estimation-Lecture Dr. Mounir Ahmed Arafa
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The actual capacity factor varies from less than 0.2 to greater than 1.0 as
showing in the previous table. Because of this, the 0.6 factor should only be
used in the absence of other information.
Specifications and Feasibility studies HS501a Cost Estimation-Lecture Dr. Mounir Ahmed Arafa
Page 7
Methods for estimating capital investment
1. Lang factors for approximation of capital investment:
This technique is proposed originally by Lang and used frequently to obtain
order of magnitude cost estimates.
Fixed capital investment
Factor*delivered-equipment cost
Total capital investment
Factor*Delivered-equipment cost
Example
Estimating cost of equipment using scaling factor and cost index:
– The purchased cost of a 50-gal glass-lined, jacketed reactor (without
drive) was $8350 in 1981. Estimate the purchased cost of a similar
300-gal, glass-lined, jacketed reactor (without drive) in 1986. Use
the annual average Marshall and Swift equipment-cost index (all
industry) to update the purchase cost of the reactor.
Solution
Marshall and Swift equipment-cost index (all industry).
– (from table 3) for 1981 721
– (from table 3) for 1986 798
– from table 5, the equipment Vs. capacity exponent is given as 0.45:
In 1986, cost of reactor = ($8350)(798/721)(300/50)^0.45 = $24,300
Specifications and Feasibility studies HS501a Cost Estimation-Lecture Dr. Mounir Ahmed Arafa
Page 8
Lang multiplication factors
Plant
Fixed cap. Total cap.
Solid pro. plant 3.9 4.6
Solid-fluid pro. Plant 4.1 4.9
Fluid pro. plant 4.8 5.7
These factors vary depends upon the process plant being considered. Greater accuracy
of capital investments estimates can be achieved in this method by using not one but
more number of factors.
2. Turn over ratio:
A rapid evaluation method suitable for the order of magnitude estimate is
known as turn over ratio method. It is defined as the ratio of gross annual sales
to the fixed capital investment.
Turn over ratios of up 5 are common for some business establishments and some are
as low as 0.2.For chemical industry ,as a very rough rule of thumb, the ratio can be
approximated as 1.
Turn over ratio
gross annual sales/fixed
capital investment
Example
The total capital investment for a chemical plant is $ 1 million and the working capital is$100000.If
the plant can produce an average of 8000kg of final product per day during a 365-day year ,what
selling price in dollar per kg would be necessary to give turn over ratio of 1?
Solution
Fixed capital investment=$1000000-$100000=$900000
T.O.R=annual sales/fixed capital
1=selling price *8000*365/900000
Selling price=900000/8000*365
=$0.308/kg