1. Analysis of Project Economics © Dr. B. C. Paul 2002

2. Economic Analysis Begins with Project Definition n Project Definition sets parameters for engineering design n Needed for obtaining accurate cost estimates n Also influences how project will be capitalized and amortized – Not always equally sensitive to capital and operating cost.

3. Costs Normally Divided Into Capital and Operating n Cost estimating has given us costs by center n Pneumatic Conveyor – Air Supply Center $1,536,000 – Electric Power Center $430,000 – Pipes and Shafts $849,000 – Feed Injection $564,000 – Solid Air Separation $390,000 – Control System $224,000 – General Costs $653,000 – Total Capital Cost $4,646,000

4. Common Models for Setting Up Capital Costs Initial Capital Cost Annual Operating Costs Annual Savings or Earnings The Straight Discounted Cash Flow Model Decision Point Solution - Discount All Money Back to the Point of Decision and Count up the Total NPV or Calculate an IRR

5. The NPV Model n A positive NPV indicates a good investment n A 0 NPV indicates a satisfactory investment n A negative NPV indicates an unsatisfactory investment n To work you need a good costs, earnings, and savings projection and a discount rate n Discount rate is the cost to get money from investors, credit or both (has form of an interest rate)

6. The Per Unit Cost Model Convert the Initial Capital Cost to an Annual Cost Get a Total Annual Cost Divide by Annual Tonnage to get a cost per ton figure

7. Unit Cost Model Use n NPV model is used for a evaluating investments n Unit cost is often used for a support service needed by an operation but which actually costs something to provide n Often more one evaluation technique is used to allow evaluator to determine what is really important.

8. Unit Cost Model Need n Need to be able to convert a capital cost item into an equivalent annual cost – Requires a life and – An annual cost n Example - Pneumatic Conveyor $4,646,000 – Use 7 year life – Assume cost of money is 9% – $4.646M* A/P 9,7 (0.1987) = $923,160 – Cost/ton $923,160/2,250,000 = 41 cents/ton

9. Increasing Model Sophistication n General Project Costs – Cost Estimate Explained to date had detailed list of costs – There are general costs above this for any specific project n Contingency Cost – If project may lag from estimate time to build time may add contingency for cost increase – May be used to handle specific add ons or system interfaces – May be used to handle omissions

10. The Use and Abuse of Contingency n The omissions problem – Order of Magnitude to Pre-feasibility n may have general idea of ratio of missing systems to those readily costed out by curves and factored cost estimates n Example - Elbows and fittings added to piping as a percentage of the cost of the piping n May have interconnection parts that would require more detailed engineering to place a specific cost – Example some of the steel supports for equipment in pneumatic system

11. Abuse and Omissions n In Feasibility and Budget Authorization Work – People use CYA factor so they won’t come in over budget n Problem with CYA factors – designed to make person look good at the expense of project n People who only want to build slam dunks so they will always look successful n Miss opportunities that owed the company

12. Abuse of Contingency n Why a factor for missed items when list is suppose to be thorough and well thought out – Sloppy work – Inexperience taking engineer beyond level of competence - Ethics problem n Need to identify areas of uncertainty – Contingency linked to something specific with experience and judgement not an abuse – May want to consider it as a line item in a cost center instead general contingency so things don’t get lost or double counted.

13. Contingency for Add ons and Undefined System Interfaces n Usually will have some minor cost items to connect something that not practical to design in detail – Example - Chemical company needs an engineering drawing for a new door handle on a port (build wasteful delays and costs into system) – These things should be linked to cost centers and even line items on cost centers n better as line items than contingency

14. The inflation and cost shift contingency n Type of contingency needed at budget authorization – Project will have delays, expired quotes, field fit problems only seen when you build n Contingency needed because board is voting money – coming up short of being able to finish has major implications for company security n companies fail over payments and costs in wrong spot even when over-all balance is good

15. When to use inflation cost shift contingency n Not really make sense at Pre-feasibility – most quotes too loose to be worried about shifts n Feasibility Study – It may be several years before build – But Feasibility studies are to determine whether something makes sense now – If someone takes 1996 study and uses it for budget authorization in 2002 he/she is stupid enough to deserve what they get

16. The Point n Use the right type of contingency for the right type of study n Do your work right - use contingency to cover legitimate things beyond your control or the depth of the investigation you are charged with doing n Contingency should never be used for personal CYA at the expense of a fair evaluation of a project

17. Try to Put General Contingency on Pneumatic Conveyor n Uncertainties - we don’t know exactly how this conveyor is to lay out relative to mine – we have vendor quotes on major cost items – well checked factored cost estimates on things we can’t design in detail – field fit and things needed by workforce are uncertainties n Self Examination - Are these things fair for this estimate and the likely way it will be used or do they mean we need to do more work?

18. A Big or Little Contingency n Numbers like 5 to 20% are often seen in contingency – If they put conveyor in way different from our layout and add other components could get 20% n Should we use 20%? – If we have a good list they can see what we have included - if they alter it they can adjust - not our job to cover others incompetence (especially when we don’t even know it’s a problem)

19. Putting in our contingency n $4,000,000 conveyor – Add 5% contingency to handle uncertainty in how it will be fit to the mine n $200,000 n New Cost with Contingency $4,200,000

20. Other General Costs n Good Feasibility Study line items components – actually building will require additional engineering design work n at feasibility study stage some engineering work still has to be done - it is a cost that can be avoided by not pursuing project - it is therefore appropriate to add n at budget authorization stage some engineering is a sunk cost should not be charged (a cost against companies over-all need to make a “profit”)

21. More General Costs n Project will require supervision to build – most cost centered line item costs relate to that equipment and the people putting it in – There is a real supervision cost n often in range 3% to 30% if there is extensive engineering and supervision n External firms have to build overhead and profit into actual supervision and engineering costs n Going to suggest this internal project with 7% for additional engineering and supervision

22. Adding in Engineering and Supervision Fees n $4,193,000 * 0.07 = $293,000 n Project cost is $4,486,000 n An additional cost sometimes added is for a spare parts inventory – Usually 3 to 7% – $4,000,000 * 0.03 = $120,000 – had a low value because we have built in spares on feeders and blowers – $4,646,000

23. Project Finance Cost n Most projects have to obtain money – If company has internal money available relatively easy to get but requires firms required rate of return be used in discounting n Often high compared to project specific finance – If company must raise new equity then cost of stock or bond issue plus required rate of return – Debt or leveraged financing requires loan initiation often hiring separate engineer - bankers engineer

24. Do I include Finance Cost? n Depends on charge – Engineers often ask to bring well thought out engineered projects - have other people that do money cost evaluation (don’t add it) n Depends on detail available – project finance is often a special manipulation - do you know enough about financial structure to do it – We don’t

25. EPC Cost versus All in Cost n EPC is Engineering, Procurement, and Construction – Engineers often do the EPC cost estimates n Project Financing Costs – All in Cost – Has details and riders from the accountants – Building a new power plant is about $1,100/KW EPC and $1,400 to $1,700/KW all in

26. The Pneumatic Conveyor n We’ll do an EPC cost - project finance is well beyond the scope of this work – We do know that project capital is regularly available for improvements to existing concerns at 7 to 9% – We’ll pick 9% as our annual cost of capital

27. Capital and Operating Costs in a NPV model n In NPV you simply put down costs when they occur – Not directly important which is a capital and operating cost – Money going down before a result is produced is normally the capital cost - it is money that must be put down and placed at risk before any result is returned n Problem with NPV model – What if this is just a cost item - like say handling and moving material

28. NPV model problem n If everything is a cost - money made is from something else it will always be negative – negative NPV means don’t do project – essential support service cannot be dumped as unprofitable without dumping profitable functions n Would force one to look at whole project n Often this is more than the charge for a project to provide specific support to a mine

29. The Life Cycle Cost Trick Point of Decision Discount Everything Back to Decision Point Like Doing an NPV

30. The Life Cycle Cost Trick Equivalent cost at Point of Decision Now Convert this to a series of annual loan payments The Resulting Annual Payment is the Annual Life Cycle Cost

31. Capital and Operating Costs in a Unit Cost Problem n Subtle Change in Capital Cost – Capital Cost normally is the at risk capital placed down to make project ready – Operating Costs are the costs for supplies expended when unit is operated n Problem occurs when an initial cost item is consumed as a function of production – May allow item to appear on both the capital and operating cost list – Double accounting risk or at least confusing

32. Pneumatic Conveyor Example n Pick a Classic Capital Cost – Air supply center and power supply n These items are life of the project - won’t wear out or be consumed from production n Let Life of Western Reserve be 15 years – Capital costs n Anything that has to be bought up front and is used for the life of the project regardless of production n Air Supply $1,536,000 n Power Center $430,000

33. More Capital Costs n Air Shafts and Pipe? – Some of stuff move every 5 years – Permanent Stuff $523,000 n Feed Injection – Have equipment that wears out from use – Equipment that re-installs every 5 years but lasts life of operation – Just life of mine equipment $378,000

34. More Capital Costs n Air Solids Separation – Has 5 year move and replace stuff – Has permanent stuff $333,000 n Control System – Has some sensors that will be replaced every 5 years with move – Other equipment that is life mine - or will it be technology Life? n Say 8 years - $135,000

35. More Capital Cost n General Cost Center $653,000 n Total of 15 year Life Equipment – Air Supply $1,536,000 – Electrical Supply $430,000 – Air Shafts $523,000 – Feed Injection $378,000 – Air Solids Separation $333,000 – General Cost Center $653,000 – Total $3,853,000

36. Annual Cost of 15 year equipment n 3,853,000 * 0.1241 = $478,000 per year n Also have equipment that is assumed to become obsolete every 8 years – Mostly in the control area. – Cost $135,000 n Getting Annual cost – $135,000 * 0.1807 = $24,400 per year

37. Characteristics of Capital Costs in a Unit Cost Problem n They are expenses for things that last the life of the project and are not used up by production – Our equipment that lasted the life of the Mine – Our controllers that lasted the life span of the technology n Operating costs are costs for equipment and things that are used up by the act of producing coal

38. Operating Costs n Electric Power – Blowers are the main load 6 blowers running at 710 HP each (based on manufacture curves) – Also have 15 HP in rotary feeders - motors on short conveyors and bunkers, and roll crusher (use 100 HP for now) – Total HP = 710*6+115 = 4375 HP – Convert to KW 4375 * 0.746 = 3264 KW n Price per KWH 4.5 cents – 3264 * 0.045 = $147/hr

39. Operating Costs Continued n Conveyor runs at 600 tph – $147/600 = 24.5 cents/ton n Considering other maintenance, electric power is about 75% of operating costs for pneumatic mine conveyors – about 8 cents/ton other maintenance costs n Operating Cost is 32.5 cents/ton n But there are capital goods being used up in the course of production (we mine out panel in 5 years)

40. Problem Child Operating Costs n Have a capital cost character but are consumed in proportion to production n Designed Conveyor for 2.25 M tons/year – 5 years - 11.25 M tons n Some dispute on how to handle – vendors often like to take cost divided by tonnage – problem when several years life is that time value of money becomes an issue

41. This Class Method of Dealing With n Take 5 year costs – New Pneumatic Lift Shafts $325,000 – Eaten up Feed Injection Equipment $186,000 – 5 year footings and supports for air separation equipment $57,100 – Sensors worn out or abandoned with relocation of pneumatic shaft $89,000 – Total $657,100 n Break it into an annual cost – $657,100*0.2571 = $169,000

42. Additional Cost/ton n $169,000/2,250,000 = 7.5 cents n Confusion Issue – I just handled an operating cost exactly like a 5 year capital cost – Big difference 8 year equipment become obsolete in 8 years regardless n Panel was mined out in 5 years only subject to a specific production rate n Do need to add some costs for advancing pipe through mains - doing instead of conveyor

43. Advancing Pipe n Wabash advanced mains about 0.3 miles per year – 1540 ft – Pipe at $51/ft = $78,540 – assume double for install light concrete protect – $157,000

44. Costs for Distributed Pneumatic Conveyor n Capital Cost – 15 year Capital $478,000/year – 8 year Capital $24,400/year n Operating Cost – Power/ Maintenance/ Operation 32.5 cents n 2,250,000 * 0.325 = $732,000 – 5 year consumables $169,000 – Pipe Advance $157,000 n Total $1.56 million/year

45. Cost Offsets from Using Pneumatic Conveyor n Free up 4 mine inspectors – about $120,000 in wages and benefits each – save $480,000 n Stop Rock Dusting Haulage Ways – about 2.5 cents/ton – 2,250,000 tpy * 0.025 = $56,250 n Change in Belt Availability due to access and avoided roof falls

46. Belt Availability n Present Availability about 95% – with pneumatic overland to plant is disconnected with stock piles – about 99% – Marginal coal is about $9.50/ton savings – 250 days per year * 16 hours/day = 4,000 hours – 5% down time is 200 hours – 1% down time is 40 hours – 160 extra hours running at 600 tph – $912,000

47. Other Savings n Savings running slope belt at 10 cents/ton – 2,250,000*0.1 = $225,000 n Savings on buying and advancing main line belt – at $1,000,000/mile for 54 inch underground belt – $292,000/year n Savings on Beltway Support – at 15 cents/ton – $337,000/year n Savings on Surface Conveyer Main over UG at 10 cents/ton – $225,000

48. Cost of Pneumatic System n Savings on processing? n Costs for surface right away compared to UG? n Defined Savings – $480,000 inspectors – $56,250 rock dusting – $912,000 belt availability – $225,000 eliminated slope belt – $292,000 advancing main line belt – $337,000 savings on beltway support – $225,000 savings from surface conveyor over U.G. – Total $2,527,250 per year n Net Cost $455,000/year – $455,000/2,250,000 = 20 cents/ton

49. Impact of System n Offset Costs Exceed Expenditures n Can Evaluate on Payback Period – Direct Operating Cost $732,000 per year – Leaves savings of $1,795,250 per year to offset initial purchase – Payback is $4,000,000/$1,795,250 = 2.22 years – (There are reinvest costs that come into play later)