Two large-scale conduits are under consideration by a large municipal utility di

Question

Two large-scale conduits are under consideration
by a large municipal utility district
(MUD). The first involves construction of
a steel pipeline at a cost of $225 million.
Portions of the pipeline will have to be replaced
every 40 years at a cost of $50 million.
The pumping and other operating
costs are expected to be $10 million per
year. Alternatively, a gravity flow canal
can be constructed at a cost of $350 million.
The M&O costs for the canal are
expected to be $0.5 million per year. If
both conduits are expected to last forever,
which should be built at an interest rate of
10% per year?

Explanation / Answer

You need to consider the NPVs of the two projects. Project one would bring the following costs: $225m in year 1 $10m every year, the NPV of which is (1/0.1)*10 = $100m $50m every 40 years, the NPV of which is about (1/1.1^40)*50 = $1.1m, since later payments are discounted too much to be worth considering. In total NPV of this project is: $326.1 Project 2 would cost $350m in year 1 $0.5m every year, the NPV of which is (1/0.1)*0.5 = $5m In total NPV for this project is: $355m So the first project should be built.

Related Questions

Navigate

• Browse (All)
• Browse T
• Subjects

---

---

Integrity-first tutoring: explanations and feedback only — we do not complete graded work. Learn more.