Question

The Oman National Grid Company ventures to a new project in the southern part of the Sultanate which is a 250-kilometer, 132 kilovolts transmission lines. The company has to choose between an Overhead transmission system and Underground transmission system. Table Q2 shows the initial investment for each type, the expected revenues during its lifetime which includes the cost savings incurred by underground transmission system over the overhead transmission system. The company has estimated a salvage value for each type of transmission to be 5% of the initial investment. As a company policy the minimum attractive rate of return MARR is 8% per year. Determine which of the two alternatives is acceptable to the company using the following methods;

1. Simple payback period;                                                                                                          
2. Benefit cost ratio;                                                                                                                  

2. Net present value NPV;                                                                                                          
3. Internal rate of return IRR.                                                                                                     

Table Q2

Items	Overhead	Underground
	Transmission	System
	System
Initial Investment	8,684	11,784
(million OMR)
Annual revenue + cost savings	1005	1280
(million OMR)
Annual Operating & Maintenance O&M Cost/Depreciation/	254	194
taxes
(million OMR)
Life expectancy, n	40	30
(years)

Answer 1

(1). Payback Period

In Overhead System, For an investment of 8684 and cashflow of (1005-254)=751, payback period will be 8684/751=11.56 Years

In Underground System, For an investment of 11784 and cashflow of (1280-194)=1086, payback period will be 11784/1086=10.85 Years.

So, using simple payback period, Underground system is acceptable.

(2). Benefit Cost Ratio

Benefit Cost Ratio can be calculated by the formula, BCR=Discounted value of Benefits/Discounted value of costs.

In Overhead System, BCR=(1005/1.08+1005/1.08^2+.........1005/1.08^40+(5%*8684/1.08^40))/(8684+254/1.08+....254/1.08^40)=12004/11712=1.025

In Underground System, BCR=(1280/1.08+1280/1.08^2+.........1280/1.08^30+(5%*11784/1.08^30))/(11784+194/1.08+....194/1.08^30)=14468/13968=1.036.

So, using Benefit Cost Ratio, Underground system is acceptable.

(3). NPV

NPV of Overhead System= -8684+(1005-254)/1.08+(1005-254)/1.08^2+.......(1005-254)/1.08^40+(5%*8684/1.08^40)=291.37

NPV of Underground System= -11784+(1280-194)/1.08+(1280-194)/1.08^2+.......(1280-194)/1.08^30+(5%*11784/1.08^30)=500.5

So, using NPV, Underground system is acceptable.

(4). IRR

IRR of Overhead System, -8684+(1005-254)/1+r+(1005-254)/1+r^2+.......(1005-254)/1+r^40+(5%*8684/1+r^40)=0, On calculating, r=8.31%

IRR of Underground System, -11784+(1280-194)/1+r+(1280-194)/1+r^2+.......(1280-194)/1+r^30+(5%*11784/1+r^30)=0, On calculating, r=8.36%

So, using IRR Underground system is acceptable.