Question

A new space heating system is considered for a small office building at Dragon Ball Inc. The new system can be acquired with an initial cost of 750,000 which requires annual maintenance which will cost about $5,000. The new heating system is expected to reduce power consumption by 400,000 kilowatt-hours per year for the entire investment period. The salvage value of this equipment is considered as $20,000 at the end of a 10-year use. Assuming an electricity cost of $0.25 per kilowatt-hour and MARR value of 12%, should Dragon Ball install the new heating system? Create the cost and benefit cash flow structure and calculate net cash flow values for the investment period.

Conduct a financial feasibility analysis by focusing on the annual worth (AW) of investment and Rate of Return (ROR). Complete your analysis on MS Excel.

Answer 1

Answer-

Step-1: Calculation of Cash Flow from Project:

Year	Capital Outlay	Annual Savings (Energy Efficiency) (II)	Annual Maintenance Cost (III)	Annual Savings (II-III)	Net Cash Flows
0	-750000				-750000
1		100000	-5000	95000	95000
2		100000	-5000	95000	95000
3		100000	-5000	95000	95000
4		100000	-5000	95000	95000
5		100000	-5000	95000	95000
6		100000	-5000	95000	95000
7		100000	-5000	95000	95000
8		100000	-5000	95000	95000
9		100000	-5000	95000	95000
10	20000	100000	-5000	95000	115000

      Note: Annual Savings = Energy Saved in Year * Cost of Energy Saved = 400,000 * $0.25 = $100,000

Step-2: Calculation of Present Worth of Investment:

Now calculate the present worth of cash flow from investment using MARR (Minimum Acceptable Rate of Return) as follow;

a) Use the NPV function in excel as follow;

  

NPV(12%,E7:E16)+E6

b) Calculate Present Worth manually as follow;

Year	Cash Flows (I)	PVF @12% (II)	Present Worth (I * II)
0	-750000	1	-750000
1	95000	0.89286	84821.43
2	95000	0.79719	75733.42
3	95000	0.71178	67619.12
4	95000	0.63552	60374.22
5	95000	0.56743	53905.55
6	95000	0.50663	48129.96
7	95000	0.45235	42973.18
8	95000	0.40388	38368.91
9	95000	0.36061	34257.95
10	115000	0.32197	37026.92
Net Present Worth	$(-206,789.35)

As the Net Present Worth of new heating system is negative, so it is advised not to follow with this project.