Question 9.10: CASE STUDY−−Replacement of a Hospital’s Emergency Electrical...
CASE STUDY−−Replacement of a Hospital’s Emergency Electrical Supply System Sometimes in engineering practice a replacement analysis involves an existing asset that cannot meet future service requirements without augmentation of its capabilities. When this is the case, the defender with increased capability should be competitive with the best available challenger. The analysis of this situation is included in the following case study . The emergency electrical supply system of a hospital owned by a medical service corporation is presently supported by an 80-kW diesel-powered electrical generator that was put into service five years ago [capital investment = $210,000; MACRS (GDS) seven-year property class]. An engineering firm is designing modifications to the electrical and mechanical systems of the hospital as part of an expansion project. The redesigned emergency electrical supply system will require 120 kW of generating capacity to serve the increased demand. Two preliminary designs for the system are being considered. The first involves the augmentation of the existing 80-kW generator with a new 40-kW diesel-powered unit (GDS seven year property class). This alternative represents the augmented defender. The second design includes replacement of the existing generator with the best available alternative, a new turbine-powered unit with 120 kW of generating capacity (the challenger). Both alternatives will provide the same level of service to the operation of the emergency electrical supply system.
The challenger, if selected, will be leased by the hospital for a 10-year period. At that time, the lease contract would be renegotiated either for the original piece of equipment or for a replacement generator with the same capacity. The following additional estimates have been generated for use in the replacement analysis.
| Alternative | |||
| Defender | |||
| 80 kW | 40 kW | Challenger | |
| Capital investment | 90000^{a} | $140,000 | $10,000^{b} |
| Annual lease amount | 0 | 0 | $39,200 |
| Operating hours per year | 260 | 260 | 260 |
| Annual expenses (year zero $): | |||
| expense per hour | $80 | $35 | $85 |
| Other expenses | $3,200 | $1,000 | $2,400 |
| Useful life | 10 years | 15 years | 15 years |
a Opportunity cost based on present MV of the defender (outsider viewpoint).
b Deposit required by the terms of the contract to lease the challenger. It is refundable at the end of the study period.
The annual lease amount for the challenger will not change over the 10-year contract period. The operating and maintenance expense per hour of operation and the other annual expense amounts for both alternatives are estimated in year-zero dollars and are expected to increase at the rate of 4% per year (assume base year, b, is year zero; see Chapter 8 for dealing with price changes). The present estimated MV of the 80-kW generator is $90,000, and its estimated MV at the end of an additional 10 years, in year-zero dollars, is $30,000. The estimated MV of the new 40-kW generator, 10 years from now in year-zero dollars, is $38,000. Both future market values are estimated to increase at the rate of 2% per year.
The corporation’s after-tax, market-based MARR (i_{m}) is 12% per year, and its effective income tax rate is 40%. A 10-year planning horizon (study period) is considered appropriate for this decision situation. (Note that, with income tax considerations and price changes in the analysis, a study period based on the coterminated assumption is being used.) Based on an after-tax, actual-dollar analysis, which alternative (augmentation of the defender or lease of the challenger) should be selected as part of the design of the modified emergency electrical power system?
