11-22. Extended Learning Exercise

 

Consider these two alternatives for solid-waste removal (11.3, Chapter 7):

 

Alternative A: Build a solid-waste processing facility. Financial variables are as follows:

 

Capital investment              $108 million in 2008

(commercial operation

starts in 2008)

Expected life of facility        20 years

Annual operating                 $3.46 million

expenses

Estimated market value     40% of initial capital cost

at all times

 

 

Alternative B: Contract with vendors for solid-waste disposal after intermediate recovery. Financial variables are as follows:

 

Capital investment               $17 million in 2008 (This is

for intermediate recovery

from the solid-waste

stream.)

Expected contract                 20 years

period

Annual operating                 $2.10 million

expenses

Repair costs to                       $3.0 million

intermediate

recovery system

every five years

Annual fee to vendors         $10.3 million

Estimated market value      $0

at all times

 

Related Data:

 

MACRS (GDS) property class      15 yr (Chapter 7)

Study period                                      20 yr

Effective income tax rate                40%

Company MARR (after-tax)         10% per year

Inflation rate                                      0% (ignore inflation)

            

           How much more expensive (in terms of capital investment only) could Alternative B be in order to breakeven with Alternative A?

 

           How sensitive is the after-tax PW of Alternative B to cotermination of both alternatives at the end of year 10?

 

          Is the initial decision to adopt Alternative B in Part (a) reversed if our company’s annual operating expenses for Alternative B ($2.10 million per year) unexpectedly double? Explain why (or why not).

 

           Use a computer spreadsheet available to you to solve this problem.