7. NPV analysis of wind energy (10 points - one page)

A large wind farm is being proposed for eastern Colorado. As designed it will produce 6.0 billion kWh of electricity per year, which is contracted to be sold for $0.12 per kWh. The Federal Production Tax Credit (PTC) will add $0.021 per kWh of revenue, and selling Renewable Energy Certificates (RECs) will add another $0.01 per kWh. The initial investment for the wind turbines, site preparation, linking to the grid, etc. will be $4.2 billion. The project is expected to last for 25 years. Any salvage value from the turbines will exactly offset site rehabilitation costs.

Annual operating costs will be $90 million per year (maintenance, land leases, insurance, GA&S). These costs do NOT include depreciation expense or taxes.

The project qualifies for accelerated depreciation. The entire $4,200,000,000 will be depreciated evenly over 7 years ($600 million per year) to zero book value.

A. Using a 30% tax rate and a 10% discount rate compute the NPV, IRR and payback of this investment. Show in detail the Year 1 and Year 8 calculation of your after-tax cash flows.

B. The PTC is scheduled to expire before the wind farm becomes operational if Congress doesnt renew it. If the PTC is NOT renewed, what will the NPV be? The company will still be able to sell RECs for $0.01 per kWh. Use a 30% tax rate, a 25-year life and a 10% discount rate. Show in detail the Year 1 and Year 8 calculation of your after-tax cash flow.

C. Suppose that lobbyists from the fossil fuel industry are putting pressure on politicians to not renew the PTC and to eliminate the accelerated depreciation provision. Advocates for renewable energy can probably salvage one or the other (the PTC or the 7-year depreciation benefit). If the accelerated depreciation benefit is eliminated, depreciation would be spread evenly over 14 years. The sale of RECs would continue in either case. As an advocate for renewable energy if only one benefit is politically feasible (the PTC or accelerated depreciation) which would you argue for? Support your decision with numbers.

NOTE: For each part, show representative cash flow calculations. Do not show all 30 years, just show one example for each cash flows that has a different result. Typically, this is one with depreciation and one without. Show this in detail, ideally using a simple income statement.