An electric company currently has an oil-fired power plant, and spends $25,000,0

Question

An electric company currently has an oil-fired power plant, and spends $25,000,000 per year on oil. Moreover, the price of oil is expected to increase at a rate of 10% per year. By contrast, a comparable coal-fired power plant would spend only $17,000,000 per year on coal, and the price of coal is expected to increase only at the general inflation rate of 6% per year. Therefore, the company is thinking of converting from oil to coal. Assuming that the plant will run for 25 more years, what is the most that the company could justify paying for the conversion? You can assume that the company’s minimum acceptable rate of return is 3%, in real (i.e., constant) dollars.

Explanation / Answer

the firm should go to coal fired power plant which occurs less invetment in the initial times. but if we consider the inflation rate 6% per annum, it will becomes as

= 17,000,000(1.06)25

it is much higher than the oil fired power plant. so, it is better to be go with oil fire power plant

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