A firm that purchases electricity from the local utility is considering installi

Question

A firm that purchases electricity from the local utility is considering installing a steam generator. A large generator costs $270,000 whereas a small generator costs $150,000. The cost of operating the generator would be $150,000 per year for the large and $175,000 for the small. Either generator will last for five years. The cost of capital is 10%. 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? Please round your answer to the nearest dollar. Report the NPV of cost as a negative number.

Explanation / Answer

For large generator Year Initial Cost Annual cost Total Cost PVF at 10% Present Value 0 -270000 -150000 -420000 1      (420,000.00) 1 -150000 -150000 0.9090909      (136,363.64) 2 -150000 -150000 0.8264463      (123,966.94) 3 -150000 -150000 0.7513148      (112,697.22) 4 -150000 -150000 0.6830135      (102,452.02) NPV = sum total            (895,480) For small generator Year Initial Cost Annual cost Total Cost PVF at 10% Present Value 0 -150000 -175000 -325000 1      (325,000.00) 1 -175000 -175000 0.9090909      (159,090.91) 2 -175000 -175000 0.8264463      (144,628.10) 3 -175000 -175000 0.7513148      (131,480.09) 4 -175000 -175000 0.6830135      (119,527.35) NPV = sum total            (879,726) Since NPV of small generator is smaller so its more attractive = $879,726

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