You have a heat exchanger with a carbon steel shell and tubes in your department that is about to fail due to corrosion. You are considering two options — replacement in kind (carbon steel shell and tubes) or replacement with a unit having 314 stainless steel shell and tubes. The present unit had

Question

You have a heat exchanger with a carbon steel shell and tubes in your department that is about to fail due to corrosion. You are considering two options — replacement in kind (carbon steel shell and tubes) or replacement with a unit having 314 stainless steel shell and tubes. The present unit had a life of 5 years and will cost $90K to replace. The 314 stainless steel unit is expected to have a life of 10 years and will cost $160K. Your company’s tax rate is 37% and its hurdle rate is 15%. Assume maintenance, insurance and taxes, operating supplies, and plant overhead are 11% of capital for both options.

Accepted Answer

After using the cost checklist in Table 10.1,

TABLE 10.1
Cost Variable Checklist

Investments

Capital

Working capital

Startup expenses

Supplier advances and royalties

Production costs

Raw materials

Packaging materials

Manufacturing

Operating labor

Employee benefits

Supervision

Laboratory

Utilities

Maintenance

Insurance and taxes

Operating supplies

Plant overhead

Depreciation

Product delivery

you determine the only costs that must be considered are capital costs, depreciation, maintenance, insurance and taxes, operating supplies, and plant overhead. Because the two units have different lives, we must pick a common life for comparison. In this case, a 10-year life will work for both. No capital investment will be made in year 10 for either option because that is the last year in the comparison period.
Carbon Steel Option:
Capital = $90K every 5 yrs
BT costs = Depreciation + Maintenance, etc.
= –$90K/5yrs + (–0.11 * $90K) = $27.9K/yr
AT cash flow = Production cost difference (1 – Tax rate) + Depreciation (Equation 2.6)
= (–$27.9K/yr)(1 – 0.37) + $18K/yr = $0.4K
Drawing the cash flow diagram:

Find the NPV:
[latex]P_{ ext{capital }}= P_{ ext{capital,yr 0}} + P_{ ext{capital,yr 5}} (P/F, 15 \%, 5) = –90K + [–90K(0.497)] = – \$134.7K[/latex]

[latex]P_{ ext{AT cash flow }}= ext{AT cash flow} (P/A, 15 \%, 10) = 0.4K(5.019) = \$2K[/latex]
NPV = –134.7K + 2K = –$132.7K

314 Stainless Steel Option:
Capital = $160K every 10 years
BT costs = Depreciation + Maintenance, etc.
= –$160K/10 yrs + (–0.11 * $160K) = –$33.6K/yr
AT cash flow = (–$33.6K/yr)(1 – 0.37) + $16K/yr = –$5.2K
Drawing the cash flow diagram:

Find the NPV:
[latex]P_{ ext{capital}} = \$160K[/latex]

[latex]P_{ ext{AT cash flow }}= ext{AT cash flow} (P/A, 15 \%, 10) = –5.2K(5.019) = – \$26.1K[/latex]
NPV = –160K + (–26.1) = $186.1K
Because the carbon steel option has the larger NPV (–$132.7K versus –$186.1K), it is the better, more economic choice.

Question 10.3: You have a heat exchanger with a carbon steel shell and tube...

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