The advantage of using external financing (leverage) to design/build/operate a new chemical plant

• Profitability level (ROIBT) to justify new plant is shown to be lower via borrowing.
• Potentially profitable projects may be eliminated if the hurdle rate is set too high.
• Use of internal funds is assumed in design, but bonds/stock often are used to build.
• Unfortunately, financial decision is made after the engineering decision (go/no go).

This research note includes a significant theoretical extension and minor errata for an earlier publication [Mellichamp, DA. New discounted cash flow method: estimating plant profitability at the conceptual design level while compensating for business risk/uncertainty. CACE 2013; 48:251–63.]. A closed-form theoretical expression is developed that provides a direct estimate of the financial advantage to be obtained by using outside financing rather than internal (enterprise) funds to build a chemical plant. Emphasis is at the conceptual design level, where the reduction in financial profitability (ROIBT) required to justify further work on a project is developed in terms of the financial parameters (enterprise rate, construction rate, bond rate, etc.). An unexpected outcome is that the reduction in required profitability is independent of any specified risk cushion (NPV%) or long-term profitability (NPV); it is solely a function of background financial market rates and project internal timing assumptions vis-a-vis the enterprise’ historic rate of return.