Bid Evaluation - Lowest Price Doesn't Always Equal the Best Option

As a follow-up to our previous Learning Center article that we posted on bid evaluation, we have added an example to illustrate the concept that a lower priced bid isn’t always the best option. A more detailed evaluation is required to truly understand the total cost (capital and operating) of the offers. Note that there may be several other operating factors that play into the cost evaluation and that this is a simple calculation to illustrate the point.

As the previous article explains, bid evaluation generally includes a review of scope, operating ease, maintenance and operating costs, service, design features and hardware, construction features, schedule, project management and project team expertise, experience, commercial terms, and price.

The example below provides a comparison between two industrial boiler bids where one bidder has a higher price but with a unit that has higher efficiency. Bid 1 guarantees 86.5% efficiency with a price of $10,400,000. Bid 2 guarantees 87.5% efficiency with a price of $11,200,000.

This economic evaluation example considers the net present value (NPV) of the energy savings compared to the net prices of the two bids.

Note that although the fuel price will vary, the calculations and evaluation process remain unchanged.

Problem
Determine which of two boiler bids provides the most economical system offering.

Given

  1. Boiler produces 600,000 lb/h superheated steam at 1550 psi and 955F (Hg = 1460 Btu/lb from Mollier diagram, Steam 42, Chapter 2)
  2. Boiler feedwater is 400F (Hf = 375 Btu/lb, from Steam 42, Chapter 2)
  3. Fuel cost = $3.00/106 Btu (gas)
  4. Load factor (average annual fraction of maximum continuous rating [MCR]) = 0.9
  5. Use factor (fraction of in-service time) = 0.9
  6. Discount rate = 10%
  7. Constant dollar basis
  8. Expected unit life = 30 years
  9. SPVF (series present value factor) = 9.43 (30 years; 10% discount rate)
  10. Bid No. 1 guarantees 86.5% efficiency with a price of $10,400,000
  11. Bid No. 2 guarantees 87.5% efficiency with a price of $11,200,000
  12. Income tax rate = 38% (composite)
  13. Depreciation tax factor = 0.17


Solution
Equations:
Unit input = (steam flow rate) (delta H) (load factor) / efficiency
Annual fuel cost = (per Btu cost) (annual unit output) (use factor)
Net present value (NPV) of fuel savings = difference in fuel cost x SPVF

(All calculations are rounded for simplicity.)
For bid No. 1
Unit input
= (600,000 lb/h) (1460 – 375 Btu/lb) (0.9) / 0.865
= 677.3 x 106 Btu/h

Annual fuel cost
= ($3.00/106 Btu) (677.3 x 106 Btu/h) (8760 h/yr) (0.9)
= $16,020,000/yr

For bid No. 2
Unit input
= (600,000 lb/h) (1460 – 375 Btu/lb) (0.9) / 0.875
= 669.6 x 106 Btu/h

Annual fuel cost
= ($3.00/106 Btu) (669.6 x 106 Btu/h) (8760 h/yr) (0.9)
= $15,837,000/yr

Evaluation
Difference between bids (savings before tax) = $16,020,000 – $15,837,000 = $183,000/yr

Corporate income tax on savings = $183,000 x 0.38 = $69,540/yr

After tax savings = $183,000 – $69,540 = $113,460/yr

Net PV of savings = $113,460/yr x 9.43 = $1,070,000

Difference in price = $11,200,000 – $10,400,000 = $800,000

Tax savings on depreciation = delta price x depreciation factor = $800,000 x 0.17 = $136,000
(dependent upon government depreciation schedule and discount rate)

Difference in price net of tax savings = $800,000 – $136,000 = $664,000

Result
Because the net present value of the energy savings ($1,070,000) is greater than the net price for the more efficient unit after depreciation tax savings ($664,000), bid No. 2 provides the more economical offering.