Question

Consumers Energy Inc (CSI) operates a coal fired power plant in Michigan, which has to come in compliance with nitrogen oxide (NOx) standards by reducing its NOx emissions to 100 tons per year from its current level of 250 tons/year. It is considering the following options to come in compliance.
A. Install Selective Catalytic Reactor (SCR) on its boiler. SCR reduces NOx emissions by absorbing NOx in exhaust flue gases. SCR requires a capital investment of $800,000 in year zero and has a life of five years. Annual costs of replacing catalysts in operating the SCR are estimated at $50,000 and other additional operating costs of SCR are estimated at $60,000 per year. ners in the boilers. Lean burners reduce the amount of NOx formed during combustion by reducing the air fuel ratio and the operating temperature. The lean burners cost $200,000 to install and have a life of five years. Installing lean burners reduces the efficiency of electricity generation, which results in increased coal consumption in boilers of 8000 tons/year to supply the same amount of electricity. Coal prices are $ 40/ton and expected to remain at that level for the next five years. Lean burners result in additional $10000 to annual maintenance costs.

C. Continue to operate as usual, but buy NOx emission permits from the market each year. The permit prices are expected to be $2500 per ton in year 1 and increase at the rate of 10% year. Which option should CSI choose? CSI uses a discount rate of 10% in its decisions. The tax rate faced by CSI is 30%. CSI uses a straight line method in charging depreciation and both SCR and lean burners are expected to have no salvage values.

Answer 1

Answer:

option A is to be chosen because the net present value of cost is $1,216,986

Explanation:

Company has to choose between 3 options:

We will calculate net present value of costs for each alternative to decide the best:

Option A:

Cost of Investment : $800,000

Annual Operating costs : $50,000 + $60,000 = $110,000

Discount rate 10%

Annuity factor at 10% for 5 Years $= \frac{1}{1.10^1} + \frac{1}{1.10^2} + \frac{1}{1.10^3} + \frac{1}{1.10^4} + \frac{1}{1.10^5} = 3.79078$

Now to get present value on $110,000 for 5 Years at 10% discount rate, we should multiply it by Annuity factor.

= $110,000 × 3.79078 = $416,986

Net present value of cost for Option A = $800,000 + $416,986 = $1,216,986

Option B:

Burner Cost: $200,000

Life = 5 Years

Annuity factor at 10% = 3.79078

Annual Coal Expenses: 8,000 tons at $40 per ton = $320,000

Annual Maintenance costs: $10,000

Net present value of annual costs = $330,000 × 3.79078 = $1,250,957

Net present value of cost for Option B = $200,000 + 1,250,957 = $1,450,957

Option C:

Current NOx emission level: 250 Tons

Required NOx emission level : 100 tons

Permits to be brought = 250 -100 = 150 Tons

Cost of per permit per ton : $2500

Annual Cost of option C for the first Year = $2500 × 150 = $375,000

As annual increase in expense are 10% and the company uses same discount rate for computing present value.

Present value of annual cost for each year is $375,000

So present value of total cost for Option C = $375,000*5 = $1,875,000