Question
JKS Ltd is considering investing in renewable energy technology. JKS Ltd has discovered that a renewable energy centre will cost $42 million today to set
JKS Ltd is considering investing in renewable energy technology. JKS Ltd has discovered that a renewable energy centre will cost $42 million today to set up. Existing tax rules allow for the entire setup costs to be depreciated on a straight-line basis over 7 years, after which no depreciation expense is available. The centre would generate electricity for 14 years and be worthless afterwards. After 7 years, updates to technology will require JKS Ltd to purchase new parts with a cost of $14 million which will be depreciated over the remaining 7 years. Pre-tax revenues from electricity generated by the centre are expected to be $20 million per year. Operating expenses (excluding depreciation) are 5% of revenues before tax with additional fixed expenses of $3 million per year. Assume all cash flows associated with the centre occur at the end of the year and the marginal corporate tax rate for JKS Ltd is 30%. Further, this particular project is in an industry which is 28% more risky than the industry in which JKS Ltd currently operates. JKS Ltd currently has a beta of 1.3, the market risk premium is 10% p.a., and the expected return on the market is 15% p.a. Should JKS Ltd invest in this centre?
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