Question

4. The Antelope Elk Energy Center in Abernathy, Texas, a natural gas power generation plant, is considering an upgrade to its fuel distribution system. The upgrade is expected to increase fuel efficiency thus decrease natural gas consumption to create a savings of $6.5 million per year over a 15-year period. Accounts receivable is expected to increase by 5%, inventory is anticipated to decrease by 20%, and accounts payable to decrease by 10%. MasTech, a leading power generation construction company, estimated the upgrade cost to the fuel distribution system will be $28 million. Use Excel.
   
   

1. (10 points) The company’s marginal tax rate is 35% and uses straight-line depreciation. What is the project’s cash flow in year (t=1)? (10 points)
   

2. (10 points) The company’s cost of capital is 8.0%. Calculate the Net Present Value and determine if the Antelope Elk Energy Center should go forward with the project. Why or why not? Use Excel spreadsheet to calculate.
   

Year	0
Accounts Receivable	2,250,000
Inventory	1,500,000
Accounts Payable	1,200,000

Answer 1

Given :
Invenstement in System upgrade	$      28,000,000
Useful life in years	15
Annual SL depreciation	$   1,866,666.67
Tax Rate	35%
Annual Depreciation Tax shield =$186666.67*35%=	$      653,333.33
Ans a.
Cash flow in Year t=1
Annual Savings from Upgrade	$   6,500,000.00
Less Tax @35%	$   2,275,000.00
After Tax savings	$   4,225,000.00
Add: Depreciation Tax shield	$      653,333.33
Total Cash flow in Year t=1	$ 4,878,333.3

Working Capital Investment
Details	Year 0 amt	Year 1 Amt	Change in cash flow	Remarks
A/R	2,250,000	2,362,500	(112,500)	+5% increase
Inventory	1,500,000	1,200,000	300,000	20% decrease
AP	1,200,000	1,080,000	(120,000)	10% decrease
Total	4,950,000	4,642,500	67,500

Ans b.
Given discount aret =8%
PV Annuity factor for 15 years @8%=(1-1.08^-15)/8%=	8.55948
PV factor for 15 years @8%=1/1.08^15=	0.31524

	Let us Find NPV
	Details of cash flow	Amt	PV annuity factor	PV Factor	PV of Cash flow
	Year 0 Investments
	Upgrade cost	(28,000,000)		1	(28,000,000)
	Net Working Capital Release	67,500		1	67,500
a	Net Cash flow Year 0				(27,932,500)
	Year 1 to yr 15 Operating Cash flow each year	4,878,333.33	8.55948		41,755,990.20
b	Total Operating Cash flow				41,755,990.20
	Terminal Cash flow
	Reinvestment in Net Working capital	(67,500)		0.315242	(21,278.82)
c	Net Terminal Cash flow				(21,278.82)
	NPV =Sum of PV of cash flows from a+b+c				13,802,211.38

As the NPV is positive The Antelope Elk Energy should go forward with the project.