A paper company with large land holdings asks your help in evaluating the cost of converting boiler furnaces to the use of peat as fuel. The plant currently consumes the following amount of fuel annually: oil: 2,000,000 barrels per year at $35 per barrel the first year. The conversion to burn peat will cost $40,000,000 and have a life of 20 years, and is estimated to save 50 percent of the cost of the oil now consumed. Salvage value of the conversion at EOY 20 equals $5,000,000. Oil costs are expected to rise at 9 percent per year compounded, and the annual savings will rise proportionally. Use i = 15 percent.
a) What is the amount of anticipated fuel-cost saving for the first year only? (Assume the expenditure for the conversion occurs right now, and the savings accrue during the year and are credited at the end of each year)
b) Find the future worth, F, of the savings in fuel costs over the full 20-year period.
c) Compare the net future worth at EOY 20 of the conversion cost (including salvage value) versus fuel savings and tell whether the fuel savings justify the cost of conversion.