Question

The Charvon oil company is planning to make a large investment in coal-to-liquids (CTL) gasoline. The end product will be a perfect substitute for gasoline made from petroleum, but the feedstock will be coal instead of oil. Two technologies are available to the Charvon Company. The first is called indirect CTL, where the coal is gasified prior to being liquefied. The second is called direct CTL, where the coal is dissolved in a solvent, and the resulting liquid is processed into gasoline. The Charvon Company has hired you as a consultant to help them decide which technology they should choose.

Charvon expects to produce 2 million gallons of CTL gasoline in each of the next twenty years, and they can sell the gasoline for $1.75 per gallon. The capital cost of indirect CTL is $12 million and operating costs for indirect CTL (labor, fuel, and maintenance) are $650,000 per year. The capital cost of direct CTL is $20 million and operating costs for direct CTL are $300,000 per year.

One problem with indirect CTL is that the coal gasification process releases large amounts of CO2 into the atmosphere. Assume that for every gallon of gasoline produced with indirect CTL, 0.01 tons of CO2are released. You have learned that starting in Year 1 the government will implement a tax of $40 per ton of CO2, which is applied as increase in the operating cost. Assume that if you choose direct CTL you will not be subject to the tax on CO2.

Assume capital cost for both technologies can be depreciated using straight line with project life time of 20 years, starting from year 1 to year 20. Consider income tax rate of 30% for the taxable income and discount rate of 8% for all costs and revenues.

• Calculate the NPV and ROR for each of the two CTL technologies and discuss whether the CO2tax changes the decision that Charvon should make.

• Find the ENPVs when the probability of government implementing the carbon tax is 40%.

• Perform a sensitivity analysis of the Expected NPV of direct and indirect CTL on the probability

  of a $40/ton carbon tax that is implemented in Year 1. On a single set of axes, plot the Expected

  NPV for each of the two technologies as a function of the probability of the carbon tax.

• Identify the threshold probability of the tax where an expected-value decision-maker would

  change their decision about what plant to build.

Answer 1

I would like to give Various Suggestions/ Recommendation:

1. On the Basis of Rate of Return, We should Select INDIRECT CTL Plant because

a. Indirect CTL Give 13.125% Rate of Return Whereas Direct CTL Give 7.7% Rate of Return.

b. Even, If We Consider Carbon Tax, This Project give 8.46 % Rate of Return, which is higher than Direct CTL.

2. The Net Present Value of Indirect CTL is Positive:

a. If don't Consider Carbon Tax, it's NPV is (+) $ 93,54,150

b. If Consider Carbon Tax, it's NPV is Also Positive (+) $ 38,56,070

3. Indirect CTL Project' Capital outlay is lower than Direct CTL Project.