Most commercial plants are heavily leveraged; namely, most plant owners
choose to borrow as much capital as possible instead of investing their own
money. Usually, the final investment will consist of a certain amount of debt
(amount borrowed as long-term loans) and the rest equity (investors’ capital). If
the return on capital is calculated relative to equity, its value is distorted by the
relative percentage of debt. For example, if the plant is financed through 100 %
debt, a net return of $1.00 will represent an infinite rate of return for the investors
who have exposed none of their own capital.
Also, the interest paid on capital ultimately is part of the plant return on
investment and should be added back to the usual return on investment calculation
in a traditional analysis.
Finally, if interest on capital must be used, it should be used on an average
interest basis as explained in Appendix 11. The base interest rate, typically the
prime rate applicable to a large long-term loan, will be averaged over the
preestablished life of the loan or calculated on a year-to-year basis if a cash flow
analysis is performed over time.
Interest on Working Capital
Working capital is normally assumed carried as 100 % debt. Because of its nature,
working capital revolves somewhat like a line of credit and, therefore, is more
representative of a short-term loan for which a higher rate of interest applies than
for a long-term loan. Also, there is no interest averaging for working capital loans as
they are assumed renewed on a year-to-year basis.
Reporting Parameters
Several terms are often used for reporting purposes.
Cost Basis
The summation of all costs without capital items leads to what is called the cash
cost of production. The cash cost of production represents the total of raw material
costs, chemicals and catalysts costs, utility costs, operating costs, and overheads.
The net cost of production is obtained by taking the cash cost of production and
adding capital items: depreciation and amortization. As indicated above, interest on
capital should not be used; interest on working capital may or may not be included
at this point depending on individual practice. It is customary to include it, but
others prefer to calculate cash flows on a total equity basis, including working
capital.
Return Basis
The simplest parameter is the return on investment (ROI). This simply is the
difference between product revenue (product value) and net production cost divided
by the total investment. For this purpose, total investment is normally viewed as
total fixed investment or total plant investment. Total fixed investment is the plant
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choose to borrow as much capital as possible instead of investing their own
money. Usually, the final investment will consist of a certain amount of debt
(amount borrowed as long-term loans) and the rest equity (investors’ capital). If
the return on capital is calculated relative to equity, its value is distorted by the
relative percentage of debt. For example, if the plant is financed through 100 %
debt, a net return of $1.00 will represent an infinite rate of return for the investors
who have exposed none of their own capital.
Also, the interest paid on capital ultimately is part of the plant return on
investment and should be added back to the usual return on investment calculation
in a traditional analysis.
Finally, if interest on capital must be used, it should be used on an average
interest basis as explained in Appendix 11. The base interest rate, typically the
prime rate applicable to a large long-term loan, will be averaged over the
preestablished life of the loan or calculated on a year-to-year basis if a cash flow
analysis is performed over time.
Interest on Working Capital
Working capital is normally assumed carried as 100 % debt. Because of its nature,
working capital revolves somewhat like a line of credit and, therefore, is more
representative of a short-term loan for which a higher rate of interest applies than
for a long-term loan. Also, there is no interest averaging for working capital loans as
they are assumed renewed on a year-to-year basis.
Reporting Parameters
Several terms are often used for reporting purposes.
Cost Basis
The summation of all costs without capital items leads to what is called the cash
cost of production. The cash cost of production represents the total of raw material
costs, chemicals and catalysts costs, utility costs, operating costs, and overheads.
The net cost of production is obtained by taking the cash cost of production and
adding capital items: depreciation and amortization. As indicated above, interest on
capital should not be used; interest on working capital may or may not be included
at this point depending on individual practice. It is customary to include it, but
others prefer to calculate cash flows on a total equity basis, including working
capital.
Return Basis
The simplest parameter is the return on investment (ROI). This simply is the
difference between product revenue (product value) and net production cost divided
by the total investment. For this purpose, total investment is normally viewed as
total fixed investment or total plant investment. Total fixed investment is the plant
756
D.S.J. Jones and P.R. Pujado ´