A city government feels that energy production capacity must be expanded to meet anticipated demands for...

A city government feels that energy production capacity must be expanded to meet anticipated demands for energy. Three alternatives sources are being considered.

a. A nuclear facility with an investment of $250 million, operating costs of $3 million per year and life of 20 years.

b. A coal plant with an investment of $200 million, operating costs of 10 million per year and a life of 20 years.

c. A natural gas plant with a cost of $100 million, operating costs of $18 million per year and a life of 20 years. Use the ROR method to select the best alternative. The cost of capital (MARR) for the city is 9%.

by using rate of returns

i need solution thanks

Solutions

Expert Solution

MARR = 9%

We need to calculate incremental IRR. In order to calculate incremental IRR, first, we arrange the options in the increasing value of their initial cost

We need to find incremental cash flow between lowest and second lowest option first, then use the formula of IRR in excel on the incremental cash flow, if incremental IRR is greater than MARR then select the second lowest option if it is less than the MARR then select the lowest option.

Keep repeating the above until the last option is evaluated

	Power Plant			Incremental IRR Analysis
Year	GAS (G)	COAL (C)	NUCLEAR (N)	C-G	N-G
0	-100000000	-200000000	-250000000	-100000000	-150000000
1	-18000000	-10000000	-3000000	8000000	15000000
2	-18000000	-10000000	-3000000	8000000	15000000
3	-18000000	-10000000	-3000000	8000000	15000000
4	-18000000	-10000000	-3000000	8000000	15000000
5	-18000000	-10000000	-3000000	8000000	15000000
6	-18000000	-10000000	-3000000	8000000	15000000
7	-18000000	-10000000	-3000000	8000000	15000000
8	-18000000	-10000000	-3000000	8000000	15000000
9	-18000000	-10000000	-3000000	8000000	15000000
10	-18000000	-10000000	-3000000	8000000	15000000
11	-18000000	-10000000	-3000000	8000000	15000000
12	-18000000	-10000000	-3000000	8000000	15000000
13	-18000000	-10000000	-3000000	8000000	15000000
14	-18000000	-10000000	-3000000	8000000	15000000
15	-18000000	-10000000	-3000000	8000000	15000000
16	-18000000	-10000000	-3000000	8000000	15000000
17	-18000000	-10000000	-3000000	8000000	15000000
18	-18000000	-10000000	-3000000	8000000	15000000
19	-18000000	-10000000	-3000000	8000000	15000000
20	-18000000	-10000000	-3000000	8000000	15000000
Incremental IRR				4.96%	7.75%

We compare first Gas and Coal, since Gas has the lowest cost, and the second lowest option is Coal, incremental IRR is less than MARR so we select Gas, and reject Coal

Now we find incremental cash flow between Nuclear & Gas, we find incremental IRR<MARR, so we select Gas again and reject Nuclear option

Gas power plant should be selected as per the incremental analysis

Rahul Sunny answered 1 year ago

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