A new municipal power plant is being built in Highfill, AR. The initial installa

Question

A new municipal power plant is being built in Highfill, AR. The initial installation will cost $25 million. Experience shows that major repair and renovation will have to occur every 5 years (beginning at year 5) at a cost of $7.5 million. Annual operating and maintenance costs are $2 million per year, indefinitely. Based on a 5% time value of money, what will be the capitalized cost for indefinite operation of the power plant?

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Explanation / Answer

Step 1: Present worth of non recurring costs CC1= $25000000

Step 2: Convert the recurring cost of $7500000 every 13 years into an annual worth A1 for the first 13 years

A1 = $7500000 x (A/F, 5%, 5) = $7500000 x 0.1810 = $1357500

The same value, A1

$[1]1357500, applies to all the other 5-year periods as well.

Step 3: Annual operating and maintenance cost is $2000000 per year. So the annual cost A2 = $2000000 forever

step 4: The two annual cost series are converted into a capitalized cost CC2 = (A1 + A2) / i = ($1357500+$2000000)/0.05 = $67150000

Total Capitalized Cost = CC1 + CC2 = $25000000 + $67150000 = $92150000

Capitalized cost = $92150000 x 0.05 = $4607500 for operation for the power plant.

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