A firm that purchases electricity from the local utility for $350,000 per year i

Question

A firm that purchases electricity from the local utility for $350,000 per year is considering installing a steam generator at a cost of $270,000. The cost of operating this generator would be $270,000 per year, and the generator will last for five years. If the firm buys the generator, it does not need to purchase any electricity from the local utility. The cost of capital is 13%. For the local utility option, consider five years of electricity purchases. For the generator option, assume immediate installation, with purchase and operating costs in the current year and operating costs continuing for the next four years. Assume payments under both options at the start of each year (i.e., immediate, one year from now......four years from now). What is the net present value of the more attractive alternative? Please round your answer to the nearest dollar. Report the NPV of cost as a negative number.

Explanation / Answer

Net Present Value of the more attractive alternative:

Conclusion:

If a firm chooses the option that buying generator instead buying electricity from the local utility can save net present value of $47,958 and cn save the value of $130,000.

so it is better to choose buy the generator.

Year Purchase of machine Operating cost Total Cash Out flow-A Saving in purchase of electricity-B Net Cash flow-C(B-A) PV@13%-D NPV-D*C 0                           2,70,000              2,70,000                         5,40,000        3,50,000        -1,90,000      1.0000             -1,90,000 1              2,70,000                         2,70,000        3,50,000              80,000      0.8850                   70,796 2              2,70,000                         2,70,000        3,50,000              80,000      0.7831                   62,652 3              2,70,000                         2,70,000        3,50,000              80,000      0.6931                   55,444 4              2,70,000                         2,70,000        3,50,000              80,000      0.6133                   49,065 5                                      -                       -                         -        0.5428                            -                     47,958

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