W7_BUD_Sensitivity Analysis

1.    Problem Definition

Refer to economic evaluation (W5 and W6 Blog Post), the New Kerosene Treatment Unit Project is economically justified. Project economic evaluation is based on fixed material and product price, and fixed operating cost, while the actual conditions these prices will be fluctuating.

2.    Feasible Alternatives

Run the sensitivity analysis to determine whether this project still acceptable if the following factor changes:

1. Price gap between Kerosene (raw material) and Avtur (product).

2. Operating Cost.

3. Project Capital Investment.

3.    Develop the Outcomes for each Alternative

Project data for most likely values shown in the following table:

Parameters	Unit	Value
Kerosene production	barrel/year	5,000,000
New Treatment Unit Capacity	barrel/year	2,000,000
Kerosene price	USD/barrel	68
Avtur price	USD/barrel	70
Avtur-Kerosene Price Gap	USD/barrel	2
Additional operation cost to produce avtur	USD/barrel	0.25
Additional margin to produce avtur	USD/barrel	1.75
	(x1000) USD/year	3,500
Maintenance Cost (every 4 year)	(x1000) USD	2,000
Capital Investment	(x1000) USD	15,000
Minimum Acceptable Rate of Return (MARR)	%	13
Present Worth (PW)	(x1000) USD	6,690

*) numbers are used only to illustrate economic calculation examples.

 

Fig 1. Project Cash Flow

Sensitivity Analysis:

PW is calculated for each factor within -50% to +50% of the most likely values. The results shown in the Spider Plot bellows:

 

Fig 2. Spider Plot

4.    Selection Criteria

Project become not acceptable (decision reversal) if the Present Worth (PW) < 0.

5.    Analysis and Comparison of the Alternatives

a. Sensitivity Analysis

Based on Spider Plot we can conclude that PW is insensitive to Operating Cost, but sensitive to changes in Price Gap and Capital Investment.

b. Decision Reversal

The intersection of each curve with abscissa (PW = 0) shows the decision reversal point as follows:

• Price Gap < -24%
• Capital investment > 45%

6.    Select the Preferred Alternative

Based on Sensitivity Analysis and Decision Reversal we can conclude that this project is not acceptable if one of the following conditions happen:

• Price gap between Kerosene (raw material) and Avtur (product) less than USD 1.52/barrel
• Capital cost increase to more than USD 21,690,000;

7.    Performance Monitoring & Post Evaluation of Result

Because the project capital investment estimate is considered as Class 3 Estimate (for Budget Authorization) with accuracy range +20% to -60%, capital investment increase more than 45% is less probable to happen. While relating the price gap is necessary to forecasting based on market supply and demand.

References:

1.    Sullivan, W.G., Wicks, E.M. & Koelling, C.P. (2012). Engineering Economic 15^th Edition: Chapter 11, p. 459-469

2. AACE International (2010). Recommended Practice No. 17R-97: Cost Estimate Classification System

3. Practical Optimization Chapter 6: Sensitivity Analysis. Retrieved from http://www.sce.carleton.ca/faculty/chinneck/po/Chapter6.pdf