Question

An electrical utility is experiencing a sharp power demand in a certain local area, and you consider two alternatives. 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.

The first alternative: Increase the generating capacity now so that the ultimate demand can be met without additional expenditures later. An investment of $25 million would be needed, and the plant has an estimated life of 25 years with a value of $0.85 million at the end of 25 years. The annual operating and maintenance costs would be $0.4 million.

The second alternative: You need to spend $15 million now and follow this expenditure with future additions during the 10th year and 15th year. These additions would cost $18 million and $12 million, respectively. The facility would be sold 25 years from now with a value of $1.5 million. The annual operating and maintenance costs will be $250,000 initially and will increase to $0.35 million after the second addition (from 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 15% as a MARR, which alternative should be undertaken?

Answer 1

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