Question

1.       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.

1. 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.
2. Install lean burners 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.
3. 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.

Please show all your intermediate steps and clearly state your assumptions if any.   

Answer 1

Option 3 is the cost effective option

	Option 1
Capital investment	8,00,000
Annual costs	50,000
Addt operating costs	60,000
Tax saving on Annual depreciation	48,000
Total annual cost	1,58,000
Discount factor @ 10% for 5 years	3.7908
Annual costs discounted to T0	5,98,944
Total cost at T0	13,98,944
	Option 2
Capital investment	2,00,000
Coal costs	3,20,000
Annual maintenance	10,000
Tax saving on Annual depreciation	12,000
Total annual cost	3,42,000
Discount factor @ 10% for 5 years	3.7908
Annual costs discounted to T0	12,96,449
Total cost at T0	14,96,449
	Option 3
Purchase NOX for 150 tons		Reducing tax benefit of 30%	Discount factor @10%
T1	3,75,000	2,62,500	0.909091	2,38,636
T2	4,12,500	2,88,750	0.826446	2,38,636
T3	4,53,750	3,17,625	0.751315	2,38,636
T4	4,99,125	3,49,388	0.683013	2,38,636
T5	5,49,038	3,84,326	0.620921	2,38,636
			3.791	11,93,182
Total cost at T0	11,93,182