A municipal power plant uses natural gas from an existing, leaky, pipeline at an annual cost of $40,000 per year. A new pipeline would initially cost $100,000, but it would reduce the annual cost of natural gas to $10,000 per year. Assume an analysis period of 25 years and no salvage value for either pipeline. The interest rate is 6%. Using annual equivalent cost (AEC), should the new pipeline be built?

Yes

Explanation:

According to the scenario, computation of the given data are as follow:-

We can calculate the annual equivalent cost by using following formula:-

Annual Equivalent Cost (AEC) = Initial Cost * [Interest Rate * (1 + Interest Rate) ^Number of years : (1 + Interest Rate) ^Number of years - 1} + Annual Cost Per Year

= $100,000 * [0.06 * (1 + 0.06) ^25 : (1 + 0.06) ^25 - 1] + $10,000

= $100,000 * [0.06 * 4.291871 : 4.291871 - 1] + $10,000

= $100,000 * [0.2575123 : 3.291871] + $10,000

= $100,000 * 0.07823 + $10,000

= $7,823 + $10,000

= $17,823

According to the analysis, the annual cost of new pipeline $17,823 is less than 40,000. So the new pipeline should built.