Vernova Corp. is an electricity supplier in the US. The company has historically generated the majority...

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Vernova Corp. is an electricity supplier in the US. The company has historically generated the majority of its electricity using a coal fueled power station, but as a result of the closure of many coal mines and depleted coal resources, it is now considering what type of new power station to invest in. For the past one year, the firm has been conducting feasibility studies and has identified two alternative power generation projects. The alternatives are a gas fueled power station, or a new type of efficient nuclear power station. The cost of feasibility study is $4 million and $7.5 million for gas and nuclear plan respectively. Both types of power station are expected to generate annual revenues at current prices of $800 million. The expected operating life of both types of power station is 25 years. You are provided with the following financial estimates ($ millions) Building costs Annual running costs (at current prices): Labor cost Gas purchases Nuclear fuel purchases Sales and marketing expenses Customer relations Interest expense Gas 600 75 500 38 28.95 40 Nuclear 3,300 , 51 330 5 25 24 132 Other cash outlays (tax deductible) Accounting depreciation Other information: i) ii) iii) iv) v) vi) vii) Whichever power station is selected, electricity generation is scheduled to commence in three years' time (end of year 3). All cash flows arise at the end of each period. If gas is used, most of the workers at the existing coal fired station can be transferred to the new power station. After-tax redundancy costs are expected to total $4 million in year four. If nuclear power is selected, fewer workers will be required, resulting in more lay-offs. The after- tax redundancy costs will total $36 million, also in year four. The cost of building either of the power stations would be payable in two equal installments in one- and two-years' time (end of years 1 and 2). The existing coal fired power station would need to be demolished at a cost of $10 million in three years' time. Both projects would be partly financed with US dollar-denominated bonds priced at par value. The firm would issue 6.914% coupon rate bonds for the gas power project while the coupon rate for the nuclear project would be at 8.429%, reflecting the impact of financial gearing of a larger bond issue. In estimating the cost of equity of each project, the firm has decided to use industrial betas which are known to be more stable than the firm's beta. The gas project would be financed with 25% debt, 75% equity. However, the gas industry has an average gearing of 40% debt, 60% equity. The average beta of the gas generation industry is 1.0707. viii) The nuclear project would be financed with 30% debt, 70% equity. However, the average gearing of listed firms in nuclear power industry is 50% debt, 50% equity. The average beta of the nuclear power industry is 1.569. ix) The interest rate of US Treasury bonds has averaged 3% per year and the market risk premium has historically 10% per year. x) Corporate tax is at the rate of 30%, payable in the same year that the liability arises. xi) xii) xiii) The general Inflation rate is currently 3% per year in the US and is expected to remain at that level in the foreseeable future. Tax deductible depreciation is at the rate of 10% per year on a straight line basis. At the end of twenty-five years of operations, the gas plant is expected to cost $25 million (after tax) to demolish and clean up the site. Costs of decommissioning the nuclear plant are much less certain and could be anything between $500 million and $1,000 million (after tax) depending upon what form of disposal is available for nuclear waste. Vernova Corp. is an electricity supplier in the US. The company has historically generated the majority of its electricity using a coal fueled power station, but as a result of the closure of many coal mines and depleted coal resources, it is now considering what type of new power station to invest in. For the past one year, the firm has been conducting feasibility studies and has identified two alternative power generation projects. The alternatives are a gas fueled power station, or a new type of efficient nuclear power station. The cost of feasibility study is $4 million and $7.5 million for gas and nuclear plan respectively. Both types of power station are expected to generate annual revenues at current prices of $800 million. The expected operating life of both types of power station is 25 years. You are provided with the following financial estimates ($ millions) Building costs Annual running costs (at current prices): Labor cost Gas purchases Nuclear fuel purchases Sales and marketing expenses Customer relations Interest expense Gas 600 75 500 38 28.95 40 Nuclear 3,300 , 51 330 5 25 24 132 Other cash outlays (tax deductible) Accounting depreciation Other information: i) ii) iii) iv) v) vi) vii) Whichever power station is selected, electricity generation is scheduled to commence in three years' time (end of year 3). All cash flows arise at the end of each period. If gas is used, most of the workers at the existing coal fired station can be transferred to the new power station. After-tax redundancy costs are expected to total $4 million in year four. If nuclear power is selected, fewer workers will be required, resulting in more lay-offs. The after- tax redundancy costs will total $36 million, also in year four. The cost of building either of the power stations would be payable in two equal installments in one- and two-years' time (end of years 1 and 2). The existing coal fired power station would need to be demolished at a cost of $10 million in three years' time. Both projects would be partly financed with US dollar-denominated bonds priced at par value. The firm would issue 6.914% coupon rate bonds for the gas power project while the coupon rate for the nuclear project would be at 8.429%, reflecting the impact of financial gearing of a larger bond issue. In estimating the cost of equity of each project, the firm has decided to use industrial betas which are known to be more stable than the firm's beta. The gas project would be financed with 25% debt, 75% equity. However, the gas industry has an average gearing of 40% debt, 60% equity. The average beta of the gas generation industry is 1.0707. viii) The nuclear project would be financed with 30% debt, 70% equity. However, the average gearing of listed firms in nuclear power industry is 50% debt, 50% equity. The average beta of the nuclear power industry is 1.569. ix) The interest rate of US Treasury bonds has averaged 3% per year and the market risk premium has historically 10% per year. x) Corporate tax is at the rate of 30%, payable in the same year that the liability arises. xi) xii) xiii) The general Inflation rate is currently 3% per year in the US and is expected to remain at that level in the foreseeable future. Tax deductible depreciation is at the rate of 10% per year on a straight line basis. At the end of twenty-five years of operations, the gas plant is expected to cost $25 million (after tax) to demolish and clean up the site. Costs of decommissioning the nuclear plant are much less certain and could be anything between $500 million and $1,000 million (after tax) depending upon what form of disposal is available for nuclear waste.