Evaluation of a Cogeneration Project

Capital cost:

Construction cost $80.00 million

Commitment fees and financing cost 6.00 million

Construction draw-down period 18 months

Total capitalization $86.00 million

Financing arrangement:

Long-term debt Per cent to be determined by the borrowing capacity using = 1.40

Equity capital Sponsors (local utility and engineering firm): 55%

Passive investors: 45%

Capital is to be depreciated on straight-line basis over 10 years.

Debt to be paid back in 10 years in equal amounts

Interest rate on debt: 8 per cent per annum

Cash flow projections:

Assumptions:

1. Capacity utilization: 90 percent
2. Prices at the time the plant is placed in service and contracted growth rates

Electricity $45 per megawatt-hour (MWH), annual increase 5%

Steam $4.50 per thousand pounds; annual increase 5%

Natural gas $3.40 per million BTU; annual increase 6%

3. Predicted volumes at 90 percent capacity

Electricity production: 1,550,000 MWH

Steam production 1,050 million pounds

Gas usage 14,850.1 billion BTU

4. Operating and other expenses:

First year = $6.5 million; annual increase 4%.

5. Tax rate: 40%.
6. Residual value of the project (after tax): $75 million

The project is to be evaluated for 15 years. You have to decide the amount of debt financing by keeping in mind that it has to be within the feasible debt limit as determined by the value.

Calculate the IRR for both sponsors and passive investors.