Question

An oil refinery must now begin sending its waste liquids through a costly treatment process before discharging them. The engineering department estimates costs at $450,000 for the first year. It is estimated that if process and plant alterations are made, the waste treatment cost will decline $43,000 each year. As an alternate, a specialized firm, Hydro-Clean, has offered a contract to process the waste liquids for 15 years for $225,000 per year. Either way, there should be no need for waste treatment after 15 years. Use an 10% interest rate and annual cash flow analysis. what is the Hydro-Clean offer that should be accepted?

Answer 1

Considering an annual 10% interest rate and an annual cash flow analysis, the net present value (NPV) of the process using the specialized firm, Hydro-Clean, offering $225,000 per year for 15 years equates to approximately $730,370. This offer from Hydro-Clean should be accepted over the in-house treatment process.

Step-by-step explanation:

To determine the better option, the net present value (NPV) of each alternative must be calculated. For the in-house treatment, the initial cost is $450,000, and the cost declines by $43,000 annually. Using the formula for the NPV with a 10% interest rate over 15 years, the NPV for the in-house treatment is approximately $367,309.

For Hydro-Clean's offer of $225,000 annually for 15 years, the NPV is calculated considering the annual cash flows and the 10% interest rate. The NPV for Hydro-Clean's offer stands at around $730,370. Comparing the NPVs, Hydro-Clean's offer yields a higher NPV, indicating a more financially beneficial option. Therefore, the recommendation is to accept Hydro-Clean's offer over implementing the in-house waste treatment process, as it generates a higher NPV and represents a more cost-effective choice over the 15-year period.

Answer 2

Option A is the cheapest.

Step-by-step explanation:

Giving the following information:

The engineering department estimates costs of $450,000 for the first year. It is estimated that if process and plant alterations are made, the waste treatment cost will decline $43,000 each year. As an alternative, a specialized firm, Hydro-Clean, has offered a contract to process the waste liquids for 15 years for $225,000 per year.

We need to use the following formula and chose the smallest net present value:

NPV= Io +∑ [Cf/(1+i)^n]

Option A:

Io= 407,000

Year cost= 43,000

NPV= 734,061

Option B:

Yearly cost= 225,000

NPV= 1,936,368