A production facility is currently utilizing carbon steel tubing. The current process requires injection of chemicals to control tubing corrosion due to high temperatures, pressure, and corrosive chlorides in the product flow. This injection process is estimated to cost the company $600,000 next year (at the end of year 1). This year 1 amount would escalate 5% per year over the next 5 years (years 2 through 6). The escalation in price behaves just like compound interest accruing on the previous years amount each subsequent year. Assume a zero salvage value of the carbon steel tubing at the end of the 6-year service period.
Year 1 = 600,000
Year 2 = 600,000(1.05)=630,000
Year 3 = 630,000(1.05) = 661,500
Etc.
It is proposed to replace the carbon steel that cost $32 per foot 1 year ago with chrome stainless steel tubing that would cost $80 per foot today at time zero. It is estimated that 20,000 feet of new replacement tubing would be required and installation costs for the new stainless will total $750,000. Assume the installation cost would also be at time zero. Replacing the carbon steel tubing with the stainless would eliminate the need for any injection costs since no corrosion is thought to occur with the new pipe. Neglect any potential salvage value on the stainless tubing.
Assume a MONTHLY .9490% minimum rate of return (compounded monthly), and calculate the present worth cost (PWC) today (time zero) for each option. After interpreting your cost results, compute the incremental cash flows and calculate the incremental NPV of choosing the stainless option. Interpret all of your calculations.