Question

Green Batteries Pty Ltd is considering the purchase of a wind turbine generator in order to generate electricity and to reduce the electricity costs for their offices, which are located in Toowoomba. Currently the business uses 40,000 kilowatt hours (kWh) per quarter (3 months) at an average cost of $0.40 per kWh, supplied by the local coal fired power station. The current required rate of return used to evaluate projects is 6%, with a required payback period of 4 years. The Queensland government started a scheme to provide an incentive for business to use alternative sources of renewable power. The incentives are 5% immediate reimbursement of the purchase and installation costs. This reimbursement can be paid to the supplier providing and installing the equipment. Therefore, the net cash flow from Green Batteries Pty Ltd is the purchase cost plus the installation cost less the 5% incentive back from government to offset these costs. Project details: Turbine 1 Turbine 2 Cost of wind turbine generator $10,000 $9,000 Cost to install turbine and generator (by supplier) $750 $850 Expected cash incentive back from government to offset cost of the panels, paid immediately the wind turbine generator installed 5% of total costs 5% of total costs Turbine expected (on average) generated kilowatt 300 kW per month 350 kW per month for first 5 yrs, then 295 kW/month for next 10 years Generator’s expected life (in years) 15 years 15 years Requirements Calculate the total initial investment and the net annual savings from installing the wind generator for each of the 2 projects. Calculate the payback period of each wind generator. Comment on whether either project meets the company’s Payback Period requirements and whether you should base your decision only in the payback period calculation. (1 mark) Calculate the net present value (NPV) of the project with a required rate of return at 6%. Where the savings are the same each year, use the present value table in Appendix 1. Where the savings differ in different time periods, you may need to subtract one NPV factor index from another NPV factor index. Comment on whether Green Batteries should proceed with either project using the Net Present Value method. (1 mark) Comment on one limitation with the payback period method compared to the NPV method. What qualitative, non-financial factors (not included in the quantitative analysis) would influence your opinion on whether the investment in the wind generator should proceed. (2 marks

Answer 1

calculation of total initial investment and net annual savings from installing the wind generator for each of the 2 projects

	Turbine 1		Turbine 2
Cost of turbine	10,750.00		9,850.00
Less Government Incentive	537.50		492.50
Net Total Investment	10212.50		9357.50

Calculation of net Annual Savings for first 5 years

	Turbine 1		Turbine 2
Electricity cost saved	1440.00		1680.00
	(300*12*0.4)		(350*12*0.4)
Less :Amortization	680.83		623.83
	(10212.5/15)		(9357.50/15)
Net Savings	759.17		1056.17

Calculation of net Annual Savings for year 6 to year 15

	Turbine 1		Turbine 2
Electricity cost saved	1416.00		1416.00
	(295*12*0.4)		( 295*12*0.4)
Less :Amortization	680.83		623.83
Net savings	753.17		792.17

Calculation of payback period

	Turbine 1
Yr 0 Outflow	-10212.5
Yr 1 savings -yr 7 savings	10,032.00
Difference	-180.50
To save 180.5 need to generate	451.25 units (180.5/0.4)
Time required to generate 451.25 units	45.89 day [451.25/(295/30)]
Pay back period	7 years 45.89 days

	Turbine 2
Yr 0 Outflow	-9357.5
Yr 1 savings -yr 5 savings	8400
Difference	-957.5
To save 957.50 need to generate	2393.75 units (957.5/0.4)
Time required to generate 2393.75 units	243.43 day [2393.75/(295/30)]
Pay back period	5 years 243.43 days

Both the projects do not meet payback period requirement of the company

one should not decide on basis of payback period alone as

1) Payback period does not consider economic life of the asset it considers only the initial inflow upto cost incurred

2) Does not consider time value of money

Calculation of NPV

		Turbine 1		Turbine 2		DF @ 6%
Yr 0	Cost of turbine	10,750.00		9,850.00		1
	Less Govt Incentive	537.50		492.50
	Net out flow	10,212.50	-10,212.50	9,357.50	-9,357.50	1
Yr 1 - Yr5	Annual Cost saving	1,440.00	6,065.80	1,680.00	7,076.77	4.2124
Yr 6- Yr 15	Annual Cost saving	1,416.00	7,787.84	1,416.00	7,787.84	5.4999
	NPV		3,641.14		5,507.11

Greenbatteries should proceed with turbine 2 project as it has higher positive NPV

Limitation

Payback period does not consider time value of money like NPV method

Quantitative non financial factor

1) Engagement in Non Core activity

2) Compliance of laws & Regulation

3) Customer opinion

4) Investor Opinion

5) Impact on community

6) Social responsibility

7) Improved public image