An electrical utility is experiencing a sharp power demand, which continues to grow at a high rate in a certain local area.
Two alternatives are under consideration. Each alternative is designed to provide enough capacity during the next 25 years. Both alternatives will consume the same amount of fuel, so fuel cost is not considered in the analysis.
Alternative A: Increase the generating capacity now so that the ultimate demand can be met without additional expenditures later. An initial investment of $30 million would be required, and it is estimated that this plant facility would be in service for 25 years and have a salvage value of $0.85 million. The annual operating and maintenance costs would be $0.4 million.
Alternative B: Spend $10 million now and follow this expenditure with future additions during the 10th year and the 15th year. These additions would cost $18 million and $12 million, respectively. The facility would be sold 25 years from now with a salvage value of $1.5 million. The annual operating and maintenance costs initially will be $250,000, increasing to $0.35 million after the second addition (from 11th year to 15th year) and to $0.45 million during the final 10 years. (Assume that these costs begin 1 year subsequent to the actual addition.)
If the firm uses 15% as a MARR, which alternative should be undertaken based on the present equivalent criterion?