An electrical utility is experiencing a sharp power demand that continues to gro

Question

An electrical utility is experiencing a sharp power demand that continues to grow at a high rate in a certain local area Two alte natives are under consideration Each is designed to provide enough capacity during the next 25 years and both I consume e sa e o n e so u stis n co n e si Alternative A. Increase the generating capacity now so that the ultimate demand can be met without additional expenditures later. An investment of $22 million would be required, and it is estimated that this plant facility woul in service for 25 years and have a salvage value of $0.8 million. The annual operating and maintenance costs (including income taxes) would be $0.4 million. Alternative B. Spend $12 million now and follow this expenditure with future additions during the 10th year and the 15th year. These additions would cost S15 million and 59 million, respectively. The facility would be sold 25 from now with a salvage value of $1.1 million. The annual operating and maintenance costs (including income taxes) will be $250,000 initially and will increase to 0.35 milion after the second addition (from the 11th year to the year) and to $0.45 million during the final 10 years. (Assume that these costs begin one year subsequent to the actual addition.) On the basis of the present-worth criterion, if the firm uses 16% as a MARR, which alternative should be undertaken? Note: Adopt incremental cost approach. Click the icon to view the interest factors for discrete compounding when 16% per year

Explanation / Answer

PW for Alternative A is as folows

PW of Total Cost for A=-22mn-0.4mn[(1/1.16)+...(1/1.16)^25)+0.8mn*(1/1.16)^25=22mn-0.4mn*6.09+0.8mn(0.02446)=-22mn-2.436mn+0.0193mn=-24.436mn+0.0193mn=-24.42mn

PW of Total Cost for B=-12mn-15mn*(1/1.16)^10-9*(1/1.16)^15-0.25[(1/1.16)+(1/1.16)^2+...+(1/1.16)^10]+0.35[(1/1.16)^11+(1/1.16)^12+...+(1/1.16)^15+0.45[(1/1.16)^16+...(1/1.16)^25]-12mn-1.72mn=-13.72mn

PW for B is less than PW for A

Hence B should be opted over A

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