Question

In 2022, the California Air Resources Board (CARB) started planning its “Phase 3” requirements for reformulated gasoline (RFG). RFG is gasoline blended to tight specifications designed to reduce pollution from motor vehicles. CARB consulted with refiners, environmentalists, and other interested parties to design these specifications. As the outline for the Phase 3 requirements emerged, refiners realized that substantial capital investments would be required to upgrade California refineries.

Assume a refiner is contemplating an investment of $370 million to upgrade its Californian plant. The investment lasts for 19 years and does not change raw material and operating costs. The real (inflation-adjusted) cost of capital is 7%.

How much extra revenue would be needed each year to recover that cost? (Enter your answer in dollars, not millions, rounded to the nearest whole number.)

	Annuity payment

Answer 1

Given Values:

Present value of cost needed to upgrade the plan: $370 million

Investment Horizon: 19 Years

Cost of capital: 7%

Analysis:

To calulate extra amount company needs to earn, we have to calcuate the yearly payment for $370 million amount.

From given information, we can calculate the Annuity payment (Yearly payment) for the above investment amount.

We have to assume the that after 19 years, investment amount will be zero if we pay annuity amount.

Calcualtion:

Hence, By using BA II Plus calculator where PV=$370 million, N=19 years, I/Y (Yield)= 7%, FV=0, Calculate PMT (Annuity Payment)

Value of PMT = $35,798,615.49 =~ $35,798,616

Solution:

For the upgration of "Phase 3” requirements for reformulated gasoline (RFG), company has to pay $35,798,616 yearly for 19 years to cover the $ 370,000,000 cost.

Hence, company needs to generate revenue of the same amount i.e. $35,798,616 yearly to cover the cost.