Question

The chief ranger of the state's Department of Natural Resources is considering a new plan for fighting forest fires in the state's forest lands. The current plan uses eight fire-control stations, which are scattered throughout the interior of the state forest. Each station has a four-person staff, whose annual compensation totals $200,000. Other costs of operating each base amount to $100,000 per year. The equipment at each base has a current salvage value of $120,000. The buildings at these interior stations have no other use. To demolish them would cost $10,000 each. The chief ranger is considering an alternative plan, which involves four fire-control stations located on the perimeter of the state forest. Each station would require a six-person staff, with annual compensation costs of $300,000. Other operating costs would be $110,000 per base. Building each perimeter station would cost $200,000. The perimeter bases would need helicopters and other equipment costing $500,000 per station. Half of the equipment from the interior stations could be used at the perimeter stations. Therefore, only half of the equipment at the interior stations would be sold if the perimeter stations were built. The state uses a 10 percent hurdle rate for all capital projects. The chief ranger has decided to use a 10-year time period for the analysis. Use Appendix A for your reference. (Use appropriate factor(s) from the tables provided.) Required: 1. Use the incremental-cost approach to prepare a net-present-value analysis of the chief ranger's decision between the interior fire- control plan and the perimeter fire-control plan. (Round your "Discount factors" to 3 decimal places. Negative amounts should be indicated by a minus sign.) Net present value Interior stations/Perimeter stations

Answer 1

Current Plan:

Annual Cost = Staff Salary + Other Cost
= ($200,000 x 8) + ($100,000 x 8) = $2,400,000

Net Present Value = $2,400,000 x 6.145 = $14,748,000

New Proposed Plan:

Initial investment = Building cost + Helicopter & Other equipment + Demolition cost – Salvage value of current equipment
= (200,000 x 4) + (500,000 x 4) + (10,000 x 8) – (60,000 x 8) = $2,400,000

Annual cost = Staff Salary + Other Cost
= (300,000 x 4) + (110,000 x 4) = $1,640,000

Net Present Value = ($1,640,000 x 6.145) – (-2,400,000) = $12,477,800

NPV of incremental cost = NPV of new plan – NPV of current plan
= $12,477,800 -  $14,748,000 = -2,270,200

NPV of incremental cost is negative, the new plan should be selected