A firm that purchases electricity from the local utility for

A firm that purchases electricity from the local utility for $250,000 per year is considering installing a steam generator at a cost of $340,000. The cost of operating this generator would be $180,000 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 10%.

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 choice?

Please round your answer to the nearest dollar. Report the NPV of cost as a negative number.

Solution

Incremental Benefit Per year =purchase cost per year - Annual Operating Costs =$250,000 - $ 180,000 =$70,000 The payments for Both options will be made in the beginning of the year, so the incrmental benefit Alos Considered as at beginning of the year Amounts in $ Year Incremenal benefit PV factor at 10% Present value immediate 70,000 1 70000 one year from now 70,000 0.90909 63636.36 Two year from now 70,000 0.82645 57851.24 Three years from now 70,000 0.75131 52592.04 Four years from now 70,000 0.68301 47810.94 291890.58 Less: Cost of the investment 340000 Net present value of Stem generator -48109 Net present value of Instalation of Stem generator is negitive, so it is not recommended. purchasing Electrivity from local utility is best Option