Question

A large manufacturing company in Jubail is considering an electric power plant project in order to save on their electric power consumption by generating its own power supply. The company currently uses 552,000 kW of electric energy a year and pays an average of $3.05 per kwh. The construction of the power plant would require an initial cost of $1,600,000 now plus an additional $950,000 investment at the end of the first year. It is expected to be operational for 10 years with an estimated residual value of $160,000 at the end of the 11th year. Since the installation of the project would take about one year, the annual benefit (in terms of savings) as well as the annual costs would occur only starting at the end of the second year. At that time, the annual operation and maintenance cost is estimated at $750,000 and expected to increase by 5% annually until the end of its useful life. As the capacity of the power plant would be more than adequate what the company needed, the excess energy could be supplied to the neighboring establishments from the fifth year up to the end of the productive life of the project, thereby creating an additional income of $105,000 per year.
Suppose MARR=15%, evaluate this project proposal using all relevant and applicable project assessment tools and techniques. Based on the analysis results, write a detailed recommendation report explaining and justifying your decision whether the project proposal should be accepted or rejected.

Answer 1

Here,

Current Cost Per Year = 3.05*552000 = $1683600

Now,

	Installation Cost	1600000
	Additional Cost After 1 Year	950000
	O&M	750000	increasing by 5%
	Salvage value after 11 years	160000
	Savings per year	1683600
	Additional Income	105000	After 5 years
	Cash Flow
08-04-2020	Year 0	-1600000
08-04-2021	Year 1	-950000	O&M Cost
08-04-2022	Year 2	933600	75000
08-04-2023	Year 3	896100	787500
08-04-2024	Year 4	856725	826875
08-04-2025	Year 5	920381.3	868218.75
08-04-2026	Year 6	876970.3	911629.6875
08-04-2027	Year 7	831388.8	957211.1719
08-04-2028	Year 8	783528.3	1005071.73
08-04-2029	Year 9	733274.7	1055325.317
08-04-2030	Year 10	680508.4	1108091.583
08-04-2031	Year 11	785103.8	1163496.162
	IRR	26.49%

IRR is found by using XIRR function from excel

The cash flow is after taking care of O&M cost

Since IRR is higher than MARR, we should go ahead with the project