A firm that purchases electricity from the local utility for $350,000 per year is considering installing a steam generator at a cost of $270,000. The cost of operating this generator would be $270,000 per year, and the generator will last for five years. If the firm buys the generator, it does not need to purchase any electricity from the local utility. The cost of capital is 13%. For the local utility option, consider five years of electricity purchases. For the generator option, assume immediate installation, with purchase and operating costs in the current year and operating costs continuing for the next four years. Assume payments under both options at the start of each year (i.e., immediate, one year from now,..., four years from now). What is the net present value of the more attractive choice

Option 1:

Purchasing Electricity from the utility:

NPV = -$1391065.

Option 2:

NPV of more attractive alternative = NPV of purchasing generator = -$1343107.

Explanation:

Option 1:

Purchasing Electricity from the utility:

Purchase cost per year = $350000

NPV = -$1391065.

Option 2:

Purchasing generator:

Initial Cash Flow:

Purchase Cost of generator                                                                        -$270000

Operating Cash Flow                                                                                      -$270000

                                  = -$540000

Recurring Cash Flows:

Operating Cost                                                                                                                 -$270000

NPV:

Year          Cash Flow                 PVF (13%)                  PV of Cash Flow

0               -$540000                       1                              -$540000

1-4            -$270000                   2.974471                     -$803107

                                                                                        -$1343107

NPV = -$1343107

Since NPV in the case of purchasing a generator is more than that of purchasing electricity,

NPV of more attractive alternative = NPV of purchasing generator = -$1343107.

An explanation of the pros, cons, and costs.

Explanation:

A direct approach is characterized by a type of communication where the message must be transmitted clearly and accurately, using as much information as possible to make the message understood effectively. In this type of approach, there is no use of softening elements for a message that may contain a criticism or some worrying situation, so there is no use of humor or other elements.

It is a message written in the most direct way possible, so in this matter, if you are using a direct approach, you must include in the report an explanation of the pros, cons and costs.