Question

A power company is preparing a bid to become the lead contractor on a nuclear

power plant in Japan. The plant will be part of a new generation of smaller-scale “pocket”

power plants. It is estimated it will cost $2,620 million to construct and make operational —

including all the design work, safety testing, hiring and training of staff, and equipment. It is

expected to generate cash of about $390 million per year for 10 years, at which point it will be

shut down. To safely decommission the plant at that point in time will cost an estimated $890

million. Assume the firm has 5% cost of capital.

a) Calculate the payback period.

b) Calculate the pocket power plant project’s discounted payback period.

c) Calculate the system’s NPV.

d) Show that the power plant’s IRR (internal rate of return) is about 3.4%.

e) Calculate project’s profitability index.

Answer 1

Payback Period, Discounted Payback Period and NPV

Let us first go through the given details in the question

1. The cost of construction = $2,620 Million

2. Expected Cash Inflow = $390 million per year for 10 years

3. Shut down cost = $890 million

4. Cost of Capital = 5%

All the calculations can be done either using TVM feature of Financial Calculator or Excel.

I will show all the inputs required to get the solution

I am using BA II Plus Financial Calculator to solve

1. Payback Period – It is the time taken to recover the initial investment

Cash flows:

Note: Cash outflows will be negative and inflows will be positive

1. -2620

2. +390 (Each year for 10 years)

3. -890 (At the end of 10th year)

We will put all the details in the cash flow function of the calculator and go to the NPV function where I = 5% and compute PB (Payback Period)

Hence, PB is 6.7179 years

If you want to calculate it through excel, remember you have to discount all the cash flows as on today.

b) Discounted Payback period - Time taken to recover initial investment considering TVM.

We will use the same inputs as shown in PB calculations

With the help of NPV function, we will calculate DPB (Discounted Payback Period)

Hence, the discounted payback period is 8.3951 years.

c) NPV

Again I have mentioned all the inputs required (Cash flows and discount rate), same will be used to calculate NPV

4. -2620

5. +390 (Each year for 10 years)

6. -890 (At the end of 10th year)

We will put all the details in the cash flow function of the calculator and go to the NPV function where I = 5%

Hence, the NPV is $128.8879 million

In general, positive NPV is good sign and shows the expected increase in the value of the firm.

I hope you find the solution helpful.

I am only allowed to solve first 3 parts of the question.