Example -19  

There are two alternatives for a water supply project in a city. The details of cash flow of the alternatives are shown below.

Alternative-1

Initial cost = Rs.20000000
Annual operating cost = Rs.1600000
Cost of renovation = Rs.2500000 at the end of every 17 years
One time upgrading cost = Rs.3200000 at the end of 22 year

Alternative-2

Initial cost = Rs.26000000
Annual operating cost = Rs.1200000
Cost of renovation = Rs.3500000 at the end of every 20 years
Compare the alternatives on the basis of capitalized cost and find out the economical alternative if the rate of interest is 9% per year

Solution:

The capitalized cost of Alternative-1 will be equal to initial cost plus the capitalized cost of annual operating cost, periodic renovation cost and one time upgrading cost.
The capitalized cost of Alternative-1 is calculated as follows;

Capitalized cost = -Rs.39008418 (Alternative-1)

The capitalized cost of Alternative-2 will be equal to initial cost plus the capitalized cost of annual operating cost and periodic renovation cost.

The capitalized cost of Alternative-2 is obtained as follows;

Capitalized cost = -Rs.40091666 (Alternative-2)

The capitalized cost of altenative-1 and Alternative-2 are found to be Rs.39008418 and Rs.40091666 respectively. Thus Alternative-1 is the economical as it shows lower capitalized cost (lower negative value) as compared to Alternative-2.