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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