HVAC is an acronym for “heating, ventilation and air conditioning.”
American Metals operates a foundary in Birmingham, Alabama, where they make aluminum cast parts. Foundaries are hot and require ventilation to keep unpleasant fumes from accumulating. American Metals’ HVAC system is overtaxed, and runs at full load, consuming 400 horsepower (hp) continuously, 24 hours per day, 7 days per week (24/7).
Dixie Controls offers to upgrade American Metals’ HVAC system for “free.” Dixie will not replace the system, but will add variable speed controls, new sensors, and other control logic. Dixie has determined that the upgraded system will run at 300 hp 50% of the time and at only 10 hp the rest of the time.
Instead of asking for payment up front, Dixie wants American to sign a contract to make two annual payments: $15,000 per year for a system maintenance agreement, and second payment based on savings, calculated as follows: American is required to determine the savings in electricity bills due to the upgrade, then pay Dixie half of those savings.
Dixie Controls expects that the cost for them to perform system maintenance under the agreement will be $9,000 per year. Cost to Dixie for buying and installing the system is $250,000. Electricity costs $0.12 per kilowatt hour. There are 748 watts required to produce one horsepower (ignore the losses in the motors, transformers, and controls).
1) Is this a good deal for American Metals?
2) If Dixie Controls has a discount rate of 12%, what is the shortest contract that is a good deal for Dixie?
3) If the system lasts for 10 years, and Dixie signs a contract for eight years, what is the net present value, annual worth, and internal rate of return for Dixie.
4) If American Metals signs a five year contract, and pays $10,000 per year for maintenance for the following five years, what is the net present value and annual worth for American Metals, assuming they have a 15% discount rate?