Question
In: Accounting
ABC Limited owns several parcels of land that a wind study has indicated are suitable for...
ABC Limited owns several parcels of land that a wind study has
indicated are suitable for power generation by wind turbines. One
parcel in particular has been singled out as the best based on
wind, geology, grid connection access, minimal environmental
impact, local government consent and positive community attitudes
in the area towards wind towers. Cattle currently run on this land
but the company believes this activity would not be severely
impacted by the wind farm. The stock would need to be removed
during construction of the wind towers but existing stocking rates
could be resumed once the wind towers are operational. Costs
associated with this disruption in current activities during wind
tower construction are estimated to be $0.2million net of tax
effects.
In addition to the wind study, the company has incurred other
project development costs, including for a geological study and
environmental impact assessment, engaging the services of several
relevant professionals, holding community consultations and
receiving local government development approval. These project
development costs have totalled $0.8m.
The wind farm will consist of ten, 2MW turbines, giving the wind
farm a total rated capacity3 of 20MW. Each turbine will cost $2.2
million and related installation costs (including construction and
grid connection, which are all depreciable) will be an additional
$0.5 million for each turbine tower. The plant and equipment will
be depreciated to a zero book value on using the prime cost method
over 20 years. A proportion of the financing for the plant and
equipment will be via a new 20-year debt issue, resulting in
interest costs of $2 million payable at the end of each year. At
the end of 20 years, the wind farm will be decommissioned and the
plant and equipment sold for an estimated market value of $4
million. Estimated decommissioning costs are $3 million.
The rated capacity of the wind farm per hour (20MW) will not be
available at all times due to winds that are lighter or stronger
than the optimal wind speed range. Engineers from the turbine
supplier have therefore suggested assuming a capacity factor4 of
40%, which means that the farm would be expected to produce 70,080
MW hours (MWh)5 of electricity each year, assuming continual
operation. However, this is an uncertain estimate due to the
variability of wind and the potential for repair and maintenance
outages. Global capacity factors for onshore wind have been
increasing over time, as seen in the graph on the next page, but
the 2018 global average capacity factor was lower than the estimate
provided by the turbine supplier’s engineers and there has been a
wide range of achieved capacity factors each year.
ABC has negotiated a 10-year Power Purchase Agreement (PPA) that
gives a guaranteed $40 per MWh. After this agreement expires, ABC
assumes it will sell the electricity in the open market, starting
with an estimated average price of $70 per MWh in the first year
and increasing 3% per year after that. However, electricity prices
are extremely volatile with a standard deviation of 40% of average
price.
In addition to revenue from selling electricity, ABC will
qualify for a government scheme providing green certificates at a
rate of one certificate per MWh of renewable energy produced. These
certificates have value in the market for retailers who need to
meet certain renewable targets. ABC will sell their certificates at
the end of each year for an estimated $20 each. Based on expert
opinion, ABC predicts that the government will end the scheme after
10 years when it is forecast to meet its renewable energy
targets.
The contract with the turbine supplier specifies that most service
and maintenance of the turbines will be the supplier’s
responsibility for 20 years. Therefore, operational costs are
expected to be low. Variable operating costs are forecast to be $2
per MWh in the first year and increase at a rate of 2% throughout
the life of the project. An additional $1 million annually in
administration, insurance and general expenses (excluding
depreciation) directly related to the project will also be
incurred.
ABC has a 8% weighted average cost of capital and is subject to a
30% tax rate on its income. After some research and calculations,
you have determined that ABC has a higher unlevered beta, adjusted
for cash, then a pure play wind electricity generating company,
listed on the same stock market as ABC. Unlevered beta adjusted for
cash is a measure of business risk.
Task：Prepare a spreadsheet financial analysis of the proposed project (NPV, IRR, PI, Payback period)
Solutions
Expert Solution
| Year | Total Initial Investments (A) | Decommissioning Costs (B) | Salvage Value (C ) | Electricity Revenue (D) | Certificate Revenue (E ) | Variable Operating Costs (F) | Other Costs (G) | Depreciation (H) | Interest Cost (I) | Earning Before Tax (J) = (D+E-F-G-H-I) | Tax Amount (K) = (30%*J) | Earning After Tax (L) = (J -K) | Net Cash Flows (M) = (L+I+H+C+B+A) | Cumulative Cash Flows from Year 1 onwards (N) |
| Year 0 | $ (27,000,000.00) | 0 | $ - | $ - | $ - | $ - | $ - | $ - | $ - | $ - | $ - | $ - | $ (27,000,000.00) | $ - |
| Year 1 | 0 | 0 | $ - | $ 2,803,200.00 | $ 1,401,600.00 | $ 140,160.00 | $ 1,000,000.00 | $ 1,150,000.00 | $ 2,000,000.00 | $ (85,360.00) | $ - | $ (85,360.00) | $ 3,064,640.00 | $ 3,064,640.00 |
| Year 2 | 0 | 0 | $ - | $ 2,803,200.00 | $ 1,401,600.00 | $ 142,963.20 | $ 1,000,000.00 | $ 1,150,000.00 | $ 2,000,000.00 | $ (88,163.20) | $ - | $ (88,163.20) | $ 3,061,836.80 | $ 6,126,476.80 |
| Year 3 | 0 | 0 | $ - | $ 2,803,200.00 | $ 1,401,600.00 | $ 145,822.46 | $ 1,000,000.00 | $ 1,150,000.00 | $ 2,000,000.00 | $ (91,022.46) | $ - | $ (91,022.46) | $ 3,058,977.54 | $ 9,185,454.34 |
| Year 4 | 0 | 0 | $ - | $ 2,803,200.00 | $ 1,401,600.00 | $ 148,738.91 | $ 1,000,000.00 | $ 1,150,000.00 | $ 2,000,000.00 | $ (93,938.91) | $ - | $ (93,938.91) | $ 3,056,061.09 | $ 12,241,515.42 |
| Year 5 | 0 | 0 | $ - | $ 2,803,200.00 | $ 1,401,600.00 | $ 151,713.69 | $ 1,000,000.00 | $ 1,150,000.00 | $ 2,000,000.00 | $ (96,913.69) | $ - | $ (96,913.69) | $ 3,053,086.31 | $ 15,294,601.73 |
| Year 6 | 0 | 0 | $ - | $ 2,803,200.00 | $ 1,401,600.00 | $ 154,747.97 | $ 1,000,000.00 | $ 1,150,000.00 | $ 2,000,000.00 | $ (99,947.97) | $ - | $ (99,947.97) | $ 3,050,052.03 | $ 18,344,653.77 |
| Year 7 | 0 | 0 | $ - | $ 2,803,200.00 | $ 1,401,600.00 | $ 157,842.92 | $ 1,000,000.00 | $ 1,150,000.00 | $ 2,000,000.00 | $ (103,042.92) | $ - | $ (103,042.92) | $ 3,046,957.08 | $ 21,391,610.84 |
| Year 8 | 0 | 0 | $ - | $ 2,803,200.00 | $ 1,401,600.00 | $ 160,999.78 | $ 1,000,000.00 | $ 1,150,000.00 | $ 2,000,000.00 | $ (106,199.78) | $ - | $ (106,199.78) | $ 3,043,800.22 | $ 24,435,411.06 |
| Year 9 | 0 | 0 | $ - | $ 2,803,200.00 | $ 1,401,600.00 | $ 164,219.78 | $ 1,000,000.00 | $ 1,150,000.00 | $ 2,000,000.00 | $ (109,419.78) | $ - | $ (109,419.78) | $ 3,040,580.22 | $ 27,475,991.28 |
| Year 10 | 0 | 0 | $ - | $ 2,803,200.00 | $ 1,401,600.00 | $ 167,504.17 | $ 1,000,000.00 | $ 1,150,000.00 | $ 2,000,000.00 | $ (112,704.17) | $ - | $ (112,704.17) | $ 3,037,295.83 | $ 30,513,287.10 |
| Year 11 | 0 | 0 | $ - | $ 4,905,600.00 | $ - | $ 170,854.26 | $ 1,000,000.00 | $ 1,150,000.00 | $ 2,000,000.00 | $ 584,745.74 | $175,423.72 | $ 409,322.02 | $ 3,559,322.02 | $ 34,072,609.12 |
| Year 12 | 0 | 0 | $ - | $ 5,052,768.00 | $ - | $ 174,271.34 | $ 1,000,000.00 | $ 1,150,000.00 | $ 2,000,000.00 | $ 728,496.66 | $218,549.00 | $ 509,947.66 | $ 3,659,947.66 | $ 37,732,556.78 |
| Year 13 | 0 | 0 | $ - | $ 5,204,351.04 | $ - | $ 177,756.77 | $ 1,000,000.00 | $ 1,150,000.00 | $ 2,000,000.00 | $ 876,594.27 | $262,978.28 | $ 613,615.99 | $ 3,763,615.99 | $ 41,496,172.77 |
| Year 14 | 0 | 0 | $ - | $ 5,360,481.57 | $ - | $ 181,311.91 | $ 1,000,000.00 | $ 1,150,000.00 | $ 2,000,000.00 | $ 1,029,169.67 | $308,750.90 | $ 720,418.77 | $ 3,870,418.77 | $ 45,366,591.54 |
| Year 15 | 0 | 0 |
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