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A municipal power plant uses natural gas from an existing pipeline at an annual cost of $10,000 per year. A new pipeline would initially cost $35,000, but it would reduce the annual cost to $4000 per year. Assume an analysis period of 20 years and no salvage value for either pipeline. The interest rate is 7%. Using the equivalent uniform annual cost (EUAC), should the new pipeline be built

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Answer: EUAC of new pipeline of $7,303.75 is less than the $10,000 of old pipeline so new pipeline should be built.

Explanation:

Equivalent Uniform Annual cost can be calculated as:

= Reduction in annual cost + (Initial Cost/ Present value interest factor of annuity, 7%, 20 years)

= 4,000 + (35,000 / 10.5940)

= 4,000 + 3,303.75

= $7,303.75

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