The board of directors at Boulder Corporation is considering two alternate ways of dealing with a deteriorated, demoralizing, and difficult-to-maintain office building. The existing building could be refurbished at a cost of $4 million, or a new building could be built at a cost of $6 million. The old building, even if refurbished, would not be as efficient as the new one, and energy costs would therefore be $200,000 a year higher. Either the new or the refurbished building would be used for 20 years. The salvage value for the new building would be then be $1 million, while the salvage value for the old building would be $500,000. If the new building is acquired, the old building can be sold now for $250,000 in its present deteriorated condition. The required return for Boulder is 12%.
(1) Which alternative should be chosen? (Assume year-end cash flows for simplicity)
(2) Assume that the old building would only last 15 years if refurbished. The salvage value in 15 years would be $500,000. In this case, which building should be chosen?