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. (Don’t forget the timeline) 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

a)	Payback period = 2620/390 =	6.72	Years
b)	Year	Cash flow	PVIF at 5%	PV at 5%
	0	-2620	1	$       -2,620
	1	390	0.95238	$            371
	2	390	0.90703	$            354
	3	390	0.86384	$            337
	4	390	0.82270	$            321
	5	390	0.78353	$            306
	6	390	0.74622	$            291
	7	390	0.71068	$            277
	8	390	0.67684	$            264
	9	390	0.64461	$            251
	10	390	0.61391	$            239	$     3,011
	10	-890	0.61391	$          -546
				$          -155
	The discounted payback is more than 10 years.
c)	NPV = -2620+390*(1.05^10-1)/(0.05*1.05^10)-890/1.05^10 =			$    -154.91
d)	At IRR, the NPV will be 0.
	NPV = -2620+390*(1.034^10-1)/(0.034*1.034^10)-890/1.034^10 =			$           2.82
				Almost 0
e)	PI = PV of cash inflows/PV of cash outflows = 3011/(2620+546) =			0.95