Question

A firm that purchases electricity from the local utility is considering installing a steam generator. A large generator costs $280,000 whereas a small generator costs $200,000. The cost of operating the generator would be $200,000 per year for the large and $220,000 for the small. Either generator will last for five years. The cost of capital is 11%. For each 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 generator?

Answer 1

Hello

Evaluation of Both Options

Large Generator

Year	Cash Flow	PVF (11%)	PV of Cash Flow
0	($480,000)	1.000	($480,000)
1	($200,000)	0.901	($180,180)
2	($200,000)	0.812	($162,324)
3	($200,000)	0.731	($146,238)
4	($200,000)	0.659	($131,746)
NPV			($1,100,489)

Small Generator

Year	Cash Flow	PVF (11%)	PV of Cash Flow
0	($420,000)	1.000	($420,000)
1	($220,000)	0.901	($198,198)
2	($220,000)	0.812	($178,557)
3	($220,000)	0.731	($160,862)
4	($220,000)	0.659	($144,921)
NPV			($1,102,538)

Since, the NPV of large generator is more, i.e. ($1,100,489), hence it is more attarctive.

I hope this solves your query.

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