Capital investment: fixed and working capital

What makes up total capital investment: fixed capital (direct and indirect costs, land) and working capital, how each is estimated, and which parts are depreciated or recovered.

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Why it matters

Before a board sanctions a plant it wants to know how much money must be committed and when. The total capital investment sets the size of the loan or equity needed, the depreciation that can be charged and the base on which return on investment is judged. Leaving out an item such as engineering fees, contingency or working capital is one of the commonest reasons projects overrun or look better on paper than they are.

Key ideas

Total capital investment (TCI) is all the money needed to bring a plant into operation and keep it running: TCI = fixed capital investment (FCI) + working capital (WC) (start-up expenses are sometimes added separately).

Fixed capital investment is the money for the physical plant, ready to run. It is split into

  • Manufacturing fixed capital (inside battery limits, ISBL): process equipment and its installation.
  • Non-manufacturing fixed capital (offsites, OSBL): buildings for offices and stores, utilities, roads, fire fighting, effluent treatment, warehouses.

For estimating, FCI is broken into direct costs and indirect costs.

  • Direct costs: purchased equipment (delivered), equipment installation, instrumentation and controls, piping, electrical systems, buildings, yard improvements, service facilities (utilities), and land.
  • Indirect costs: engineering and supervision, construction expenses (temporary facilities, construction tools, insurance during construction), legal expenses, contractor's fee, and contingency (an allowance for unforeseen items, often 10–20% of the direct plus other indirect costs at the estimate stage).

Land is part of fixed capital but is not depreciated, and its value is normally recovered at the end of project life. Fixed capital other than land is recovered through depreciation over the plant life.

Working capital is the money tied up in running the plant. It consists of

  • raw materials and supplies in stock (often about one month's use),
  • finished product in stock and semi-finished goods in process (valued at manufacturing cost),
  • accounts receivable (credit given to customers, valued at selling price),
  • cash kept for wages, utilities and purchases, less accounts payable (credit received from suppliers). In accounting terms working capital equals current assets minus current liabilities. It is invested at start-up, stays tied up as long as the plant runs, and is recovered at the end of the project — it is not depreciated and is not an annual expense. For most chemical plants it is 10–20% of TCI, higher for seasonal or high-inventory businesses.

Estimating FCI from equipment cost. At the study stage each direct and indirect item is often taken as a percentage of the delivered cost of major equipment, E. The percentages depend on the type of plant (solid processing, solid–fluid, fluid processing) and come from a design text; in a problem they are given data. Summed, they give a ratio FCI/E — the Lang factor idea treated in the cost-estimation topic.

Accuracy. An order-of-magnitude estimate may be ±30–50%; a study estimate ±25–30%; a definitive estimate ±5–10%. Contingency shrinks as the estimate becomes more detailed.

Formulas

TCI = FCI + WC FCI = D + I (direct + indirect costs) D = E·(1 + Σ fᵢ) and I = E·Σ gⱼ when items are taken as fractions of E If working capital is a fraction w of TCI: TCI = FCI / (1 − w) and WC = w·TCI If working capital is a fraction w′ of FCI: WC = w′·FCI Component estimate: WC = raw-material stock + product and in-process stock + receivables + cash − payables

Symbols: E delivered cost of purchased equipment (₹), fᵢ, gⱼ fractions of E for each direct and indirect item (–), w, w′ fractions (–). All amounts in ₹ at the same cost-index date. Check whether a quoted percentage is of E, of FCI or of TCI before using it.

Worked examples

Example 1 (standard). A fluid-processing plant has delivered equipment cost E = ₹10 crore. Given data, as percentages of E: installation 47, instrumentation 36, piping 68, electrical 11, buildings 18, yard improvements 10, service facilities 70; engineering and supervision 33, construction expenses 41, legal 4, contractor's fee 22, contingency 44. Working capital is 15% of TCI. Find FCI, WC and TCI.

  1. Direct costs: D = E·(1 + Σ fᵢ) = 10 × (100 + 47 + 36 + 68 + 11 + 18 + 10 + 70)/100 = 10 × 3.60 = ₹36.0 crore.
  2. Indirect costs: I = E·Σ gⱼ = 10 × (33 + 41 + 4 + 22 + 44)/100 = 10 × 1.44 = ₹14.4 crore.
  3. FCI = 36.0 + 14.4 = ₹50.4 crore.
  4. TCI = FCI/(1 − w) = 50.4/0.85 = ₹59.29 crore; WC = 59.29 − 50.4 = ₹8.89 crore.
  5. FCI = ₹50.4 crore, WC = ₹8.89 crore, TCI = ₹59.3 crore.

Example 2 (GATE level). A plant has FCI = ₹40 crore. Annual raw-material cost is ₹24 crore, annual manufacturing cost ₹48 crore and annual sales ₹60 crore. Working capital is estimated as one month of raw-material stock, one month of product stock at manufacturing cost, one month of receivables at selling price and one month of manufacturing cost in cash, less one month of raw-material payables. Find WC, TCI and WC as a fraction of TCI.

  1. Raw-material stock = 24/12 = ₹2 crore. Product stock = 48/12 = ₹4 crore.
  2. Receivables = 60/12 = ₹5 crore. Cash = 48/12 = ₹4 crore. Payables = 24/12 = ₹2 crore.
  3. WC = 2 + 4 + 5 + 4 − 2 = ₹13 crore.
  4. TCI = 40 + 13 = ₹53 crore; WC/TCI = 13/53 = 0.245.
  5. WC = ₹13 crore, TCI = ₹53 crore, WC ≈ 24.5% of TCI — higher than the usual 10–20% because a month of credit is given on sales.

Common mistakes

  • Treating working capital as an annual operating cost, or depreciating it. It is invested once and recovered at the end.
  • Depreciating land.
  • Applying a percentage of TCI as if it were a percentage of FCI (FCI/(1 − w) is not FCI·(1 + w)).
  • Omitting indirect costs and contingency, which together can be a third of direct costs.
  • Valuing product inventory at selling price instead of manufacturing cost, or receivables at cost instead of selling price.
  • Mixing equipment costs from different years without a cost-index correction.

For GATE CH

Expect short numericals: TCI from FCI and a working-capital fraction, FCI from delivered equipment cost and given percentages or a Lang factor, and conceptual questions on which items are depreciable and which are recovered. Practise reading carefully what each percentage is based on.

Quick check

  1. Name two items of working capital and two indirect costs.
  2. FCI = ₹34 crore and WC = 15% of TCI. Find TCI.
  3. Is land depreciated? Is working capital?
  4. Delivered equipment ₹5 crore; FCI/E = 4.8. Find FCI.

Answers: 1. Raw-material stock and receivables; engineering and supervision, contingency. 2. TCI = 34/0.85 = ₹40 crore. 3. Neither — both are recovered at the end of the project. 4. FCI = 5 × 4.8 = ₹24 crore.

Interview questions

All Plant Design and Economics interview questions

Try answering each one aloud before you open it.

  1. 1.What is fixed capital investment in the context of chemical plant design?Concept

    Fixed capital investment (FCI) is the money needed to supply the plant ready to operate: direct costs (delivered equipment, installation, instrumentation, piping, electrical, buildings, yard improvements, service facilities and land) plus indirect costs (engineering and supervision, construction expenses, legal fees, contractor's fee and contingency). It covers both inside-battery-limits process equipment and offsite facilities. Except for land, FCI is recovered through depreciation over the plant's life; together with working capital it makes up the total capital investment.

  2. 2.Define working capital in the context of a chemical plant.Concept

    Working capital is the money tied up in running the plant: raw materials and supplies in stock, finished and in-process product, accounts receivable and cash on hand, less accounts payable — in accounting terms, current assets minus current liabilities. It is invested at start-up and recovered when the plant shuts down, so it is neither depreciated nor charged as an annual cost. For most chemical plants it is about 10–20% of the total capital investment.

  3. 3.Explain the difference between fixed capital and working capital.Concept

    Fixed capital buys the physical plant — equipment, installation, piping, buildings, utilities, land and the engineering and construction costs to put them in place. Working capital is the money locked up in inventories, receivables and cash so the plant can operate. Fixed capital (except land) loses value and is recovered through depreciation; working capital does not wear out and is recovered in full at the end of the project. Both are invested at the start and together form the total capital investment.

  4. 4.Why is it important to accurately estimate fixed capital investment during the design phase of a chemical plant?Application

    Accurate estimation of fixed capital investment is crucial because it determines the financial feasibility of the project. Underestimating can lead to insufficient funds, project delays, or even failure to complete the plant. Overestimating can result in unnecessary financial burden and reduced profitability. It also affects the plant's return on investment and overall economic viability.

  5. 5.What factors can influence the amount of working capital required for a chemical plant?Application

    Several factors can influence the working capital requirement, including the scale of production, the cost of raw materials, the efficiency of the supply chain, the credit terms with suppliers and customers, and the plant's operational efficiency. Seasonal variations in demand and changes in market conditions can also impact working capital needs.

  6. 6.How does the choice of location affect the fixed capital investment of a chemical plant?Application

    The location of a chemical plant can significantly affect fixed capital investment due to variations in land costs, availability of infrastructure, proximity to raw materials and markets, and local regulations. A strategically chosen location can reduce transportation costs and improve access to resources, thereby optimizing the overall investment.

  7. 7.What happens if a chemical plant operates with insufficient working capital?Application

    Operating with insufficient working capital can lead to cash flow problems, making it difficult to purchase raw materials, pay employees, or cover other operational expenses. This can result in production delays, reduced output, and potential loss of customers. In severe cases, it may lead to insolvency or shutdown of the plant.

  8. 8.A plant needs fixed capital of ₹42.5 crore, and working capital is to be taken as 15% of the total capital investment. Find the working capital and the total capital investment.Numerical

    With WC = 0.15·TCI, FCI = 0.85·TCI, so TCI = 42.5/0.85 = ₹50 crore and WC = 0.15 × 50 = ₹7.5 crore. A common slip is to compute 15% of FCI instead (₹6.375 crore); always check what base the percentage is quoted on.

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