Energy efficient building practices suggest that often a higher initial outlay is returned over time with lower operating costs, particularly energy savings. An area of particular interest is HVAC systems (Heating, ventilation and air conditioning). The same quality of heating and ventilation can be acquired through various configurations of building design, insulation and furnace and AC capacity.

For a given building that is currently in the design phase, a conventional HVAC system would cost $225,000 to purchase and install and have average annual operating costs of $22,000 per year over the buildings 30-year life, assuming no price increases in natural gas and electricity. The system requires major maintenance at the end of Year 10 and Year 20 at a cost of $15,000 each time.

The alternative to the conventional HVAC system proposed by a green building consultant would require upgraded windows, more insulation, slightly different entry configurations but a much smaller HVAC system. The initial cost of the required upgrades, design changes and equipment would be $300,000. The annual operating costs for this system would average $10,000 per year over the buildings 30-year life, assuming no price increases in natural gas and electricity. The system requires major maintenance at the end of Year 10 and Year 20 at a cost of $4,000 each time.

For both systems, all of the operating and major maintenance costs are tax-deductible.

With either system the initial investment would be depreciated over 10 years using the straight-line method to zero salvage value. At the end of 30 years the scrap value of either system would be $5,000. The tax rate to apply to this analysis is 30% and the discount rate is 8%. Again, all operating and maintenance expenses are tax deductible.

Assume that the company has enough income to take full advantage of all tax shields.

A. Which system provides the lowest overall cost? Compute the present value of the total lifetime cost of each system. In terms of todays dollars (i.e., present value) how much does the low-cost system save over the alternative?

B. If natural gas and electricity prices rise, how would this effect the difference between the total costs of the two systems? Specifically, consider a 1% per year increase in energy prices (Assume all operating costs are for energy to simplify things). How will this change the difference in the NPVs of these competing systems?

C. If the discount rate was higher, how would this effect the difference between the total costs of the two systems? You can answer in a single sentence. It is not necessary to show any quantitative work.