Question

6 The chief ranger of the state's Department of Natural Resources is considering a new plan for fighting forest fires in the state's forest ands. The current plan uses eight fire-control stations, which are scattered throughout the interior of the state forest Each station has totals $360,000. Other costs of operating each base amount to $260,000 per year at each base has a current salvage value of $280,000. The buildings at these interior stations have no other use. To demolish them would cost $26,000 each. costs of $460,000. Other operating costs would be $270,000 $660,000 per station. Half of the equipment from the interior stations could be used at the perimeter stations. Therefore, only station would cost The half of the equipment at the interior stations would be sold if the perimeter stations were built Required: 1. Use the incremental-costa indicated by a minus sign.) References

Answer 1

Solution:

Current Plan

Annual cost = Staff Salary + Other cost

Annual cost = $360,000 x 8 + $260,000 x 8

Annual cost = $4,960,000

Net Present value of annual cost = Present value of annual cost - Initial Investment

Net Present value of annual cost = $4,960,000 (PVIFA @ 10%, 10) - $0

Net Present value of annual cost = $4,960,000 [(1.10^10 - 1)/(0.10*1.10^10)] - $0

Net Present value of annual cost = $4,960,000 (6.1446)

Net Present value of annual cost = $30,447,052.84

New Proposed Plan

Initial investment = Building cost + Helicopter & Other equipment + Demolition cost – Salvage value of current equipment

Initial Investment = $360,000 x 4 + $660,000 x 4 + $26,000 x 8 - $140,000 x 8

Initial Investment = $3,168,000

Annual cost = Staff Salary + Other cost

Annual cost = $460,000 x 4 + $270,000 x 4

Annul cost = $2,920,000

NPV = $2,920,000 (6.1446) - $3,168,000

NPV = $14,774,135.9

Hence,

NPV of incremental cost = NPV of new plan - NPV of current plan

NPV of incremental cost = $14,774,135.9 - $30,447,052.84

NPV of incremental cost = -$15,702,916.896

Since the NPV of incremental cost is negative, the new plan should be selected as it will reduce the overall cost by $15,702,917 in present value terms