Correctly Evaluate Project Economics

Use the most appropriate financial measure and consistent prices

By Rajeswar Gattupalli, Clayton Sadler, Laura Leonard and Gavin Towler, UOP LLC

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Economic analysis is a critical step in project evaluation and technology selection. Cash cost of production (CCOP), net present value (NPV) and internal rate of return (IRR), which are defined in Table 1, are the economic variables usually used to assess the multibillion-dollar investments that chemical manufacturers and refiners make. These economic variables can give misleading results if the analysis is based on poor assumptions.


For a producer, CCOP is an important measure to assist in evaluating new investments, producing new products from existing equipment, setting operating budgets or justifying process changes. The biggest drawback of CCOP is that it doesn’t include capital costs; it only is useful to help gauge the effects of process enhancements, operational changes, improvements in efficiency or other process alterations that do not require substantial investment.

NPV allows ranking options according to net profits, which is reasonable when comparing projects of similar size and scope. Any project’s NPV always can be increased by expanding the project’s size or scope; hence, using NPV to compare large and small projects requires caution.

IRR gives a ranking of investments according to their financial yield. IRR enables comparing the performance of capital for different projects, independent of the amount of investment, the life of the plant or the actual interest rates prevailing at any time. IRR is more useful than NPV when comparing projects of different size.

When evaluating different process technologies for a project, the designers select the option that has lowest CCOP, highest NPV or greatest IRR. These methods can be very sensitive to certain starting assumptions, potentially causing a less economical option to be selected. The following example illustrates this.

A TELLING EXAMPLE
Consider two processes to make the same products, A and B, from Feed F. Process 1 has 90% selectivity to A while Process 2 has 60% selectivity to A. Figure 1 shows the feed and product rates for making 90,000 mt/yr of A.

Let’s suppose the capital cost (capex) of Process 1 is $100 million. We then can estimate the capex of Process 2 to be $128 million by applying the 6/10 rule, which assumes the processes have the same capital cost scaled to feed flow rate.

C = C0 (FeedrateProcess 2 /FeedrateProcess 1)0.6
where C0 is the capex of Process 1 and C is the capex of Process 2.
A summary of feed and product flow rates and their respective prices for Process 1 and Process 2 appears in Table 2.

Calculating CCOP, NPV and IRR using the definitions from Table 1 and the prices from Table 2 gives the results summarized in Table 2. Process 2 has lower CCOP and higher NPV than Process 1 but Process 1 has greater IRR than Process 2. Thus, if we used CCOP or NPV as the criterion, we would select Process 2 as superior.

Now, consider the same two processes operated at a constant feed rate of 100,000 mt/yr (Figure 2). Because the feed rates are the same, we can assume the capital costs are as well. Table 3 provides a summary of feed and product flow rates and their respective prices for Process 1 and Process 2.

Table 3 shows the calculated CCOP, NPV and IRR for the constant-feed-rate scenario. Process 1 clearly has higher NPV and IRR than Process 2 but Process 2 still has lower CCOP than Process 1. In this case, we would select Process 1 if either NPV or IRR were the economic criterion.

The IRR results for both feed rates indicate that Process 1 always is a more economical option than Process 2. However, the CCOP results suggest that Process 2 always is preferable to Process 1. The NPV favors Process 1 at a constant feed rate but Process 2 at a constant product rate. These differences underscore that choice depends upon the basis selected for the evaluation process.

WHICH METHOD TO USE?
So, let’s explore what causes these different outcomes and outline the preferred way to choose the basis for economic evaluation during technology selection.

CCOP analysis. In the above example, Process 2, which makes a greater amount of byproduct than Process 1, has lower CCOP because the price of the byproduct ($500/mt) is much higher than that of the feed ($300/mt). In fact, Process 2 will have a better CCOP under any situation in which the byproduct value can offset the higher capital cost of Process 2. As shown in Figure 3, this would be true for any byproduct value greater than $350/mt.

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