A Cost Comparison Illustration:
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
Alt.
BP = $120,000 + $10,000 (USPW for P = $190,000 + $4,000 (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)
= $190,000 + $4,000 (9.818) = $120,000 + $98,180 = $190,000 + $39,272
= $190,000 + $39,272 = $218,180 = $229,272
= $229,272Therefore, alternative A is preferred
with a PV savings of $11,092, but oops a third
alternative appears!!