Question

A retrofitted​ space-heating system is being considered for a small office building. The system can be purchased and installed for ​$125,000​, and it will save an estimated 250,000 ​kilowatt-hours (kWh) of electric power each year over a five​-year period. A​ kilowatt-hour of electricity costs ​$0.09​, and the company uses a MARR of 15​% per year in its economic evaluations of refurbished systems. The market value of the system will be ​$7,000 at the end of five ​years, and additional annual operating and maintenance expenses are negligible.
Required:
Use the​ benefit-cost method to make a recommendation.

Answer 1

Answer:

Retrofitted Space-Heating System

Benefit-Cost Ratio = $75,420/$121,521

= 0.6206

= 0.62

Benefit is less than 1.  Therefore, project will not deliver positive NPV.

Recommendation:

It is better and cheaper to incur electricity costs than to purchase the retrofitted space-heating system.  The retrofitting benefit does not justify the cost of the project.

Explanation:

a) Data and Calculations:

Purchase cost of system = $125,000

Salvage value (PV of $7,000 in five years) = $3,479

Total cost of project = $121,521 ($125,000 - 3,479)

Benefit of Project = Savings in 250,000 kWh annually

Cost of a kilowatt-hour = $0.09

Total annual cost of electricity = $22,500 (250,000 * $0.09)

Annuity Factor for 5 years = 3.352

Present value of annuity of $22,500 = $75,420 ($22,500 * 3.352)

Benefit-Cost = $75,420/$121,521

= 0.6206

= 0.62