Question

ABC spent $ 7,728,750 retrofitting a complex in the Province of Alberta. As a result, the province’s energy bill dropped from $10 million a year to $5 million. Moreover, both parties will benefit from the 10-year life of the contract. During this period, ABC recovers half the money saved in reduced utility costs; Alberta has the other half to spend on other things. What is the rate of return realized by ABC?

Answer 1

ABC’s Initial cost of the project = $ 7,728,750

Total savings per year in energy bills = $ 10 million – $ 5 million = $ 5 million

Life of the project = 10 years

During 10-year life of the contract; ABC recovers half the money saved in reduced utility costs. Therefore savings (cash inflow) for ABC = $ 5 million /2 = $2.5 million or $2,500,000 per year

The rate of return realized by ABC is the internal rate of return of the project and can be calculated in following manner-

Year	Initial Cost	Cash inflow for ABC through saving in energy bills)	Net Cash Flow for ABC
0	-$7,728,750		-$7,728,750
1		$2,500,000	$2,500,000
2		$2,500,000	$2,500,000
3		$2,500,000	$2,500,000
4		$2,500,000	$2,500,000
5		$2,500,000	$2,500,000
6		$2,500,000	$2,500,000
7		$2,500,000	$2,500,000
8		$2,500,000	$2,500,000
9		$2,500,000	$2,500,000
10		$2,500,000	$2,500,000
Internal Rate of Return (IRR)			30.00%

Therefore the rate of return realized by ABC is 30.00%

Formulas used in excel calculation: