Item Investment timing Option 2 Optlon 1 Now 3 years from now Initial investment $6 million $5 million System life Salvage value 8 years $1 million 8 years $2 million $11 million $7 million Annual revenue $15 million Annual O&M costs $6 million
The B&E Cooling Technology Company, a maker of automobile air conditioners, faces an impending deadline to phase out the traditional chilling technique, which uses chlorofluorocarbons (CFCs), a family of refrigerant chemicals believed to attack the earth's protective ozone layer. B&E has been pursuing other means of cooling and refrigeration. As a near-term solution, its engineers recommend a cooling technology known as an absorption chiller, which uses plain water as a refrigerant and semiconductors that cool down when charged with electricity. B&E is considering two options:
1 Option 1: Retrofit the plant now to adopt the absorption chiller and continuing to be a market leader in cooling technology.
2 Option 2: Defer the retrofit until the federal deadline, which is three years
away. With expected improvement in cooling technology and technical knowhow, the retrofitting cost will be cheaper then. But there will be tough market competition, and revenues would be less than that from Option 1.
The financial data for the two options are as follows:
(a) What assumptions must be made in order to compare these two options?
(b) If B&E's MARR is 15%, which option is the better choice according to the IRR criterion?
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