Question

A power plant for generating electricity is one part of a industrial plant. Two alternative power plants with necessary capacity have been suggested. One uses a boiler and steam turbine while the other uses a gas turbine.

	Boiler and steam turbine	Gas turbine
Initial investiment	$600000	$400000
Fuel costs per year	$16000	$24000
Maintenance per year	$12000	$15000
Insurance per year	$18000	$12000
service life	20 years	10 years
Salvage value at end of life	$0	$0

All other costs are the same for either type of power plant. A 12% return is required on any investiment. If one these plants must be accepted, which one should be recommended?

Answer 1

Boiler and steam turbine:

Initial Investment = $600,000

Annual Costs = Fuel Costs + Maintenance + Insurance = $16,000 + $12,000 + $18,000 = $46,000

Useful Life = 20 Years

Discount Rate = 12%

NPV of Costs = 600000 + 46000 * ((1-(1+12%)^-20)/12%) = $943,594.41

Equivalent Annual Costs = $943,594.41 * 12% * (1+12%)^20 / ((1+12%)^20-1) = $126,327.27

GAS TURBINE:

Initial Investment = $400,000

Annual Costs = Fuel Costs + Maintenance + Insurance = $24,000 + $15,000 + $12,000 = $51,000

Useful Life = 10 Years

Discount Rate = 12%

NPV of Costs = 400000 + 51000 * ((1-(1+12%)^-10)/12%) = $688,161.37

Equivalent Annual Costs = $688,161.37 * 12% * (1+12%)^10 / ((1+12%)^10-1) = $121,793.67

Since, Equivalent Annual Costs are lesser for Gas Turbine, it is recommended.