the various entries is of great value as it helps to identify missing data. Also, even
with incomplete information, this type of analysis is especially useful to determine the sensitivity of a project relative to a number of parameters.
Economic analysis over an extended period of time
This analysis, usually known as “cash flow analysis,” is performed by analyzing
the (expected) performance of a project over an extended period of time, usually
a number of years at least equal to the capital depreciation or amortization
period. The value of this type of analysis is that it recognizes the “time value
of money.”
A cash flow analysis does not require more information than an instantaneous
analysis, but it does introduce some additional concepts in the calculation of the
discounted cash flow rate or return or internal rate of return (IRR) and other
discounting parameters. Calculation of the IRR used to be difficult when slide
rules prevailed, since it entails a trial-and-error calculation; it is quite trivial with
just about any computer or even a small programmable calculator. A cash flow
analysis is an absolute necessity to account for the effects of taxation and inflation
since these are usually spread out over a number of years and the effects are carried
over from year to year, especially when deferred taxes accrue out of the different
depreciation and/or amortization methods used for tax accounting as opposed to
financial accounting. However, in order to keep it simple, this introductory economic analysis will not cover multiple depreciation schedules, tax accounting, and
the like.
Indirectly, the cash flow analysis can also be used to decide what the prospective
sale price of a product should be. The price can be calculated so as to yield a desired
discounted cash flow rate of return.
Accounting for Inflation
The effects of inflation, though important in real life, tend to be irrelevant and
misleading for economic evaluations and can best be dismissed by always
performing a constant-dollar analysis.
If inflation needs to be taken into account, it is easy to incorporate inflationary
factors that adjust the numerical values on an annual basis. The formulas provided
in the appendices in general do not apply when variable annual cash flows have to
be accounted for. The calculations are then performed by creating a series of
estimated annual cash flows and conducting the calculations by trial and error.
Some of the trial-and-error calculations are already programmed in the functions
usually available in most PC software packages. Other calculations may require
some simple program coding; half interval splitting (dichotomous search) is usually
suitable for convergence.
The interpretation of the results when inflation is accounted for tends to be
muddied by the additive effect of inflation. The gross returns will increase if
inflation leads to increasing cash flows but may decrease if inflationary pressures
raise the costs faster than the revenues.
Petroleum Refinery Planning and Economics
745
with incomplete information, this type of analysis is especially useful to determine the sensitivity of a project relative to a number of parameters.
Economic analysis over an extended period of time
This analysis, usually known as “cash flow analysis,” is performed by analyzing
the (expected) performance of a project over an extended period of time, usually
a number of years at least equal to the capital depreciation or amortization
period. The value of this type of analysis is that it recognizes the “time value
of money.”
A cash flow analysis does not require more information than an instantaneous
analysis, but it does introduce some additional concepts in the calculation of the
discounted cash flow rate or return or internal rate of return (IRR) and other
discounting parameters. Calculation of the IRR used to be difficult when slide
rules prevailed, since it entails a trial-and-error calculation; it is quite trivial with
just about any computer or even a small programmable calculator. A cash flow
analysis is an absolute necessity to account for the effects of taxation and inflation
since these are usually spread out over a number of years and the effects are carried
over from year to year, especially when deferred taxes accrue out of the different
depreciation and/or amortization methods used for tax accounting as opposed to
financial accounting. However, in order to keep it simple, this introductory economic analysis will not cover multiple depreciation schedules, tax accounting, and
the like.
Indirectly, the cash flow analysis can also be used to decide what the prospective
sale price of a product should be. The price can be calculated so as to yield a desired
discounted cash flow rate of return.
Accounting for Inflation
The effects of inflation, though important in real life, tend to be irrelevant and
misleading for economic evaluations and can best be dismissed by always
performing a constant-dollar analysis.
If inflation needs to be taken into account, it is easy to incorporate inflationary
factors that adjust the numerical values on an annual basis. The formulas provided
in the appendices in general do not apply when variable annual cash flows have to
be accounted for. The calculations are then performed by creating a series of
estimated annual cash flows and conducting the calculations by trial and error.
Some of the trial-and-error calculations are already programmed in the functions
usually available in most PC software packages. Other calculations may require
some simple program coding; half interval splitting (dichotomous search) is usually
suitable for convergence.
The interpretation of the results when inflation is accounted for tends to be
muddied by the additive effect of inflation. The gross returns will increase if
inflation leads to increasing cash flows but may decrease if inflationary pressures
raise the costs faster than the revenues.
Petroleum Refinery Planning and Economics
745