Suppose a community is considering
installing a supplementary water pumping station
to maintain water pressure at peak demand
periods. Bids have been received for two alternatives. Here we will really be using cost effectiveness
as we assume the two alternatives
are equally effective.
Alternative A:
purchase price and installation cost of $120,000 and estimated
annual maintenance
costs of $10,000.
Alternative B:
initial cost of $190,000 with annual maintenance costs estimated to be
$4000.
Both alternatives
have a 20-year operational life for a common period of comparison.
Based on the
opportunity cost of capital, the appropriate discount rate is accepted to be 8
percent. Which
alternative should be chosen?
Alt. A Alt. B
P = $120,000 +
$10,000 (USPW for P =
$190,000 + $4,000 (USPW for
i = 0.08, n = 20)
i = 0.08, n = 20)
= $120,000 + $10,000
(9.818) = $190,000 + $4,000 (9.818)
= $120,000 + $98,180 = $190,000 + $39,272
= $218,180 = $229,272
Therefore,
alternative A is preferred with a PV savings of $11,092, but oops a third
alternative
appears!!