Question

1. You are assigned to select a suitable artificial lift pump to be used in oil wells operated by your company. You have been presented with the following two options. Your company's average investment opportunity rate is 12%. Investments occurs at time 0, operating costs occur at the end of each year and salvage value is obtained at the end of pump's life. Ignore the effect of taxes in your calculations. Cost, $ 45,000 33,000 Jack pump Electric submersible pump Operating cost/year, $ 8,300 14,200 Life, yrs 10 Salvage value, $ 4,000 2,000 Which pump would you recommend to the procurement department?

Answer 1

We need to calculate the NPV of each pump to making a decision.
Calculation Of NPV
		Jack Pump	Eletric Submersible Pump
a	Investment	$         -45,000	$                                   -33,000
b	annual cash inflow	$           -8,300	$                                   -14,200
c	PV annuity factor for 10 years and 12 %	5.6502	4.5638
d	PV of Annual Cash Inflow (b*c)	$         -46,897	$                                   -64,805
e	Salvage Value	4000	2000
f	PV factor of year 10	0.3220	0.4523
g	PV Of Salvage Value	$             1,288	$                                           905
h	Net Present Value (d+g-a))	$   -90,608.96	$                             -96,900.64
Since the Negative NPV of Jack Pump is less than Electric Submersible Pump's NPV
Jack Pump should be selected.