Data Provided in the question:

Two alternative plans are provided for installing water pipes with the following details:

Alternative A:

1. Equipment cost=$2,000,000; Resale value after 48 months=10% of purchase price.
2. Equipment O & M, labour, Materials = $10/lineal foot for the first 12 months, increasing by $0.10/month for each subsequent month.

Alternative B:

1. Contract fee=$25/lineal foot with no increases over the 48-month period.

Additional details:

1. 4000 lineal feet of pipe per month is laid for 48 months
2. Interest rate=9% p.a.

Solution:

To find Net Present cost, total cash outflow of the project is calculated and total cash inflow discounted by the interest rate is subtracted from it.

Total Cash outflow is the sum of Equipment, Labour & Materials and Contract fee.

Contract fee is total lineal feet of pipe laid multiplied with $25 per feet.

4000 feet per month X 48 months =192000 feet

Labour & Materials are calculated as under:

Residual Value of Materials is calculated by discounting the resale value of materials by the interest rate over the given time period,

Residual value= Resale Value/ (1+rate of interest)^No. of years

By substituting values we get,

Residual value= 10% of Purchase price/ (1+0.09)^4 years

Residual value= $ 200,000/ 1.41158

Residual value=$ 141,685.04

By the above comparison, we find that the Net Present cost of Contracting the work is more that executing the work with city employees.

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