In order to continue the operation of a small chemical plant at the same capacity, it will be necessary to make some changes on one of the reactors in the system. The decision has been made by management that the unit must continue in service for the next 12 years and the company policy is that no unnecessary investments are made unless at least an 8 percent rate of return (end-of-year compounding) can be obtained. Two possible ways for making a satisfactory change in the reactor are as follows:
(1) Make all the critical changes now at a cost of $5800 so the reactor will be satisfactory to use for 12 years.
(2) Make some of the changes now at a cost of $5000 which will permit operation for 8 years and then make changes costing $2500 to permit operation for the last 4 years.
(a) Which alternative should be selected if no inflation is anticipated over the next 12 years?
(b) Which alternative should be selected if inflation at a rate of 7 percent (end-of-year compounding) is assumed for all future costs?