Question

An oil company is considering upgrading a reaction furnace in one of its natural gas plants. The company’s engineers have outsourced two alternative systems. The upgrades will be more energy efficient and will save the company money in fuel – since burner technology has improved greatly since the original plant was built. However, the new upgrade will have additional annual operating, maintenance and utility costs. Each of the alternatives (Furnace A and Furnace B) has a 10 year service life and because these are specialized systems, the salvage value will be zero. The capital costs and the annual savings and other annual costs are estimated in Table 1.

Table 1

	Furnace A	Furnace B
Expected additional annual fuel savings	$3,400,000	$3,900,000
Annual operating and maintenance expenses	2,000,000	2,350,000
Annual utility expenses	350,000	280,000
Installed capital cost of equipment	$4,500,000	$6,500,000
Service life	10 years	10 Years

a) Calculate the NPV of each alternative if the MARR is 8%. Which alternative would they choose?

b)   Calculate the IRR of both these furnaces.

(Note: Within 1% is fine) For example, IRR is between 11 and 12%)

Answer 1