Question

An electrical utility is experiencing a sharp power demand that continues to grow at a high rate in a certain local area. Two alternatives are under consideration. Each is designed to provide enough capacity during the next 25​ years, and both will consume the same amount of​ fuel, so fuel cost is not considered in the analysis. bullet Alternative A.  Increase the generating capacity now so that the ultimate demand can be met without additional expenditures later. An investment of ​$34 million would be​ required, and it is estimated that this plant facility would be in service for 25 years and have a sa

An electrical utility is experiencing a sharp power demand that continues to grow at a high rate in a certain local area Two alternatives are under consideration. Each is designed to provide enough capacity during the next 25 years, and both will consume the same amount of fuel, so fuel cost is not considered in the analysis Alternative A. Increase the generating capacity now so that the ultimate demand can be met without additional expenditures later. An investment of $34 million would be required, and it is estimated that this plant facility would be in service for 25 years and have a salvage value of $0.9 million. The annual operating and maintenance costs (including income taxes) would be $0.4 million Alternative B. Spend $11 million now and follow this expenditure with future additions during the 10th year and the 15th year. These additions would cost $14 million and $8 million, respectively. The facility would be sold 25 years from now with a salvage value of $1.5 million. The annual operating and maintenance costs (including income taxes) will be $250,000 initially and will increase to $0.35 million after the second addition (from the 11th year to the 15th 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 17% 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 1-17% per year The present worth of Alternative A is Smillion. (Round to one decimal place.)

Answer 1

If Alternative A is chosen:

    Salvage value of the firm = $0.9 million

    Annual Operating and maintenance cost = $0.4 million x 25

                                                                              = $ 10 million

Cost of setting up the firm / investment = $34 million

The total cost incurred by the company = Total cost – Salvage value

                                                                      =$ 10 million + $ 34 million - $ 0.9 million

                                                                       = $ 43.1 million.

& If Alternative B is chosen:

    Salvage value of the firm = $1.5 million

    Annual Operating and maintenance cost = Sum of the incremental operating cost after each investment.

                                                                            = ($250,000 x 10) + ($0.35 million x 5) + ($0.45 million x 10)

                                                                             = $ 2.5 million + $1.75 million + $ 4.5 million

                                                                             = $ 8.75 million

Cost of setting up the firm / investment in the 1^st, 10^th and 15^th year respectively = $11 million + $14 million + $8 million                                           = $ 33 million

The total cost incurred by the company = Total cost – Salvage value

                                                                      =$ 8.75 million + $ 33 million - $ 1.5 million

                                                                     = $ 40.25 million.

Therefore, it is beneficial for the electrical utility to undertake the Alternative B , as it is less costly , and moreover with the MARR at 17%, Alternative B will prove to be even less costlier as the investment in the case of Alternative B is periodical and not one time investment.