Chiller Replacement Business Case with Soft Downtime Estimates
A food-processing plant is deciding whether to replace a 20-year-old 500-ton chiller. In the last 18 months it has had four unplanned outages per year, averaging 2.5 hours each; lost production is estimated at $9,000 per hour. A new magnetic-bearing chiller costs $620,000 installed and is expected to reduce outages to one event of 1.5 hours per year. It will save $48,000 per year in electricity and $15,000 per year in maintenance. The plant has a 12-year remaining lease, uses a 9% nominal discount rate, and assumes a $50,000 salvage value at the end of year 12. The finance director will only approve projects with a simple payback below five years and positive NPV. The operations manager says the outage cost estimate is soft because some production can be recovered on weekends. The landlord’s green lease requires landlord consent for refrigerant changes; the new unit uses R-513A rather than R-134a.
1. Calculate the simple payback and NPV under the base assumptions, showing your formulas and intermediate values.
Read the worked answer
First quantify the annual downtime saving. Old outage hours = 4 events × 2.5 h = 10 h/year. New outage hours = 1 event × 1.5 h = 1.5 h/year. Avoided hours = 8.5 h/year. At $9,000/h, downtime saving = 8.5 × 9,000 = $76,500/year.
Total annual saving = downtime 76,500 + electricity 48,000 + maintenance 15,000 = $139,500/year.
Simple payback = initial cost / annual saving = 620,000 / 139,500 = 4.44 years. That is below the finance director’s five-year threshold.
NPV at 9% over 12 years: PV annuity factor = [1 − (1.09)^−12] / 0.09 = 7.1607. PV of annual savings = 139,500 × 7.1607 = $998,920 (rounded). PV of salvage = 50,000 / (1.09)^12 = 50,000 / 2.8127 = $17,780. NPV = −620,000 + 998,920 + 17,780 = $396,700.
The project passes both financial tests on the base case. Note that this is a pre-tax, pre-financing calculation; taxes, depreciation, and any shared energy savings with the landlord would change the result.
2. Quantify the operations manager’s concern: what outage cost per hour would make NPV zero, and what value would make payback exactly five years? Recommend whether to approve.
Read the worked answer
Let x be the outage cost in $/hour. The downtime saving is 8.5x per year, so total annual saving = 63,000 + 8.5x.
For NPV = 0: (63,000 + 8.5x) × 7.1607 + 17,780 − 620,000 = 0. Required annual saving = (620,000 − 17,780) / 7.1607 = 84,100. So 8.5x = 84,100 − 63,000 = 21,100, giving x = $2,482/h.
For payback = 5 years: Required annual saving = 620,000 / 5 = 124,000. 8.5x = 124,000 − 63,000 = 61,000, giving x = $7,176/h.
The base estimate is $9,000/h, so NPV remains positive unless the true outage cost falls below about $2,500/h, and payback remains below five years unless it falls below about $7,200/h. A 20% reduction to $7,200/h would put payback at the limit but still leave substantial positive NPV. The operations manager is right that some production may be recovered, but a zero outage cost is unrealistic because overtime, spoilage, and lost margin usually remain.
Recommendation: approve subject to three conditions-validate outage cost with production and sales records, obtain landlord consent before ordering the refrigerant-charged unit, and require a commissioning and leak-test plan. The R-513A unit has lower global-warming potential than R-134a but is still a synthetic refrigerant; document the refrigerant inventory and lease obligations. Do not let the soft estimate alone kill a project with a 4.4-year base payback and a $397k NPV, but do sensitivity-test it.
3. How should the landlord consent and refrigerant change be handled in the approval and contract documents?
Read the worked answer
Treat landlord consent as a condition precedent to purchase, not as an afterthought. The green lease may require prior written approval for refrigerant type, penetration of the building envelope, structural loads, and metering. Submit the equipment schedule, refrigerant safety data, leak-detection arrangements, and expected global-warming-potential reduction. Confirm who owns the chiller at lease end and who bears decommissioning and refrigerant recovery costs.
In the approval package, state that the financial case assumes landlord consent is obtained without material cost or delay. In the purchase order, require the supplier to provide refrigerant quantity, leak-test certificates, commissioning data, and warranty terms. In the installation contract, allocate responsibility for refrigerant recovery, disposal, and any lease reinstatement obligations. If consent is delayed beyond the order lead time, re-run the NPV because the old chiller’s outage risk continues. Do not authorize the order on a verbal assurance from the landlord.