Engineering Economics Theory
Net Present Value (NPV)
NPV represents the difference between the present value of cash inflows and outflows over a project's lifetime. A positive NPV indicates a profitable investment.
NPV = -I₀ + Σ CFₜ / (1 + r)ᵗ
I₀ = Initial investment
CFₜ = Cash flow at time t
r = Discount rate (WACC or hurdle rate)
t = Time period
Internal Rate of Return (IRR)
IRR is the discount rate that makes NPV equal to zero. Projects with IRR greater than the cost of capital are considered acceptable.
0 = -I₀ + Σ CFₜ / (1 + IRR)ᵗ
Payback Period
The time required to recover the initial investment from net cash flows. Discounted payback accounts for the time value of money.
- Simple Payback: Uses undiscounted cash flows
- Discounted Payback: Uses present values of cash flows
Equipment Cost Estimation
Six-Tenths Rule
Cost₂ = Cost₁ × (Size₂ / Size₁)ⁿ
The exponent n typically ranges from 0.5 to 0.8, with 0.6 being a common default (hence "six-tenths rule").
Cost Index Adjustment (CEPCI)
Costcurrent = Costbase × (CEPCIcurrent / CEPCIbase)
The Chemical Engineering Plant Cost Index (CEPCI) adjusts historical costs to current prices, accounting for inflation and material cost changes.
Lang Factors
Lang factors estimate total installed plant cost from equipment purchase cost:
Solids
3.1
Solids-Fluids
3.6
Fluids
4.7
Profitability Index
PI = (NPV + Initial Investment) / Initial Investment
A PI greater than 1.0 indicates a worthwhile investment. It's useful for ranking projects when capital is limited.
References
- Peters, Timmerhaus & West - Plant Design and Economics for Chemical Engineers
- Towler & Sinnott - Chemical Engineering Design
- AACE International - Cost Estimate Classification System
- Chemical Engineering Magazine - CEPCI Index