- Prepare a capital budget of the wind turbine proposal and conduct an NPV analysis of the results. Structure the capital budgeting analysis in these components:
- Identify items that comprise initial cost of project (purchase, installation, and any offsets);
- Identify items that generate annual cash flows over life of the project.
- Calculate annual net cash flows after-tax;
- Calculate present value of net cash flows after-tax.
- Calculate present value of renewable energy tax credits and depreciation tax shield.
- Calculate net present value (NPV) of the wind turbine project and identify the investment decision.
- Identify subsidies from renewable energy grants, production tax credits, etc. Remove these subsidies, prepare a capital budget of the wind turbine proposal, and conduct an NPV analysis of the results. Structure the capital budgeting analysis in these components:
- Identify items that comprise initial cost of project (purchase, installation, and any offsets);
- Identify items that generate annual cash flows over life of the project.
- Calculate annual net cash flows after-tax;
- Calculate present value of net cash flows after-tax.
- Calculate present value of the depreciation tax shield.
- Calculate net present value (NPV) of the wind turbine project and identify the investment decision.
Introduction Melissa Banks, president and CEO of Berkshire Mountain Resort, is worried about energy costs. Primarily a ski resort, Berkshire's business is very energy-intensive, mainly because most of the winter snow is manufactured by machines that run on electricity. Strong conservation campaigns over the years have reduced energy consumption by 25 percent, but the resort still consumes about 7.5 million kilowatt hours (kWh) of electricity each year, with about 60 percent used during the peak winter months. Last year, electricity costs were about $0.11 per kWh, but this season, the cost skyrocketed to $0.16 per kWh - an increase of almost 50 percent. Even before the electricity cost increase, Berkshire had tried to operate as efficiently as possible to minimize its electricity consumption. As examples, 1,800 new fluorescent bulbs were installed in the lodge, replacing incandescent bulbs; high-efficiency lights had been installed on the ski runs that automatically dim to half wattage during night maintenance work; half of the snowmaking system had been converted to zero-energy gravity-feed. Berkshire was a test site for the development of revolutionary new high efficiency "guns for the snowmaking machines. This new snowmaking technology uses 40 percent less electricity than the older version. In the 1990s, the resort won an energy conservation recognition award from Massachusetts Electric for saving over one million kWh of electricity from its improvements in snowmaking, lighting, and elsewhere. There is only so much Berkshire is able to achieve in energy conservation with its existing facilities and still offer high quality recreational services. Banks has realized that a more ambitious energy reduction initiative is needed, and so she and resort managers are considering harnessing an abundant renewable green resource readily available to the mountain resort: wind power. The Wind Turbine Project Proposal Banks has been in the ski resort business long enough to know that the Berkshire mountaintops can get very windy in the winter. She has decided to investigate the feasibility of erecting a wind turbine to put the mountaintop wind to profitable and green use to help stabilize the resort's electricity costs. In addition, this would be consistent with Berkshire's corporate mission to protect the environment and should also permit the use of "green marketing" in the hope of attracting even more visitors to its popular ski slopes. Berkshire managers recognize that determining the viability of installing a wind turbine will be a complicated, specialized process, and so they have engaged Sustainable Energy Developments, Inc. (SED) of Ontario, New York, to examine the feasibility of such an investment. SED's fee is $157,000. With SED's help, Berkshire has already received a small grant of $15,000 from the Massachusetts Technology Collaborative to offset part of the cost of the formal feasibility study. The feasibility study is to cover the financial, technical, social, and environmental aspects of the proposed wind turbine. Berkshire's History Berkshire opened in the Berkshire Mountains of western Massachusetts in the early 1950s. By 2005 it was larger than any other skiing and snowboarding resort in the southern New England states. During this period, it evolved into a four-season resort, offering skiing, mountain biking, and other outdoor sporting activities. Berkshire is about 2-1/2 to 3 hours' travel time from New York City and Boston and is only about one hour away from Albany, NY, and Springfield, MA. Through good management and sound development, Berkshire became a popular winter ski destination that covers 170 acres, with 45 ski and snowboard trails, three terrain parks, and nine lifts, including a high-speed six-person chairlift. Savvy marketing and attractive mountain facilities have enabled the resort to operate profitably, even in the summer. For summer sport enthusiasts, Berkshire installed the first mountain coaster on the East Coast, an alpine super slide, a giant swing, scenic rides, a rock climbing wall, a "euro-bungy" trampoline, hiking, and, for children, rope adventures, mini-golf, a rope spider web, and an inflatable bouncy bounce" playground. Winter visitors number about a 250,000 annually, while summer visitors average about 100,000. The Economics of Harnessing the Wind The SED team has established that there is enough wind on the west shoulder of Berkshire's mountain to use effectively a wind turbine. Significantly, the wind force on the mountain is strongest during the winter, when Berkshire's demand for electricity is at its greatest for snowmaking, ski lifts, and lighting. Berkshire consumes about 4.5 million kWh of electricity during the winter, which is 60 percent of its total annual needs. GE Energy, a unit of General Electric, is able to provide a 1.5 MW-capacity wind turbine to Berkshire within a year at an estimated total purchase and installation cost on the proposed site of $3.9 million. Subject to a favorable feasibility study, a loan of $3.3 million for 10 years is available from Berkshire's local bank at an annual interest rate of 7.3 percent. A grant of $582,000 is available from the Renewable Energy Trust Fund administered by the Massachusetts Technology Collaborative to complete the financing for the proposed wind turbine purchase and installation. Funding for the Renewable Energy Trust Fund comes from a charge on Massachusetts electric bills Although erecting the wind turbine on the proposed site would partly hide it from the view of skiers, the local bank management would be able to see the wind turbine through a window in the bank's boardroom and, perhaps alarmingly, observe the bank's loan collateral when the blades were not turning because of insufficient wind strength. Berkshire management and the SED team are concerned about general community acceptance and support for the wind turbine project. The local community is very concerned with aesthetic and environmental issues. The proposed GE Energy wind turbine is taller than the Statue of Liberty. Its three 123-foot blades are each longer than three school buses placed end to end. Local residents may not be happy with such a large structure being erected at the top of the mountain. Also, the construction materials would travel noisily through the local community on trucks from the Port of Albany and add to road congestion. One suggested idea to help gain community acceptance and enthusiasm for the project is to invite the public to submit names for the wind turbine in a "Name That Turbine" competition. A well-publicized ceremony could be held to announce the winning name and to tout the environmental and social benefits of the wind turbine. The GE Energy unit would provide about one-third of Berkshire's annual electrical needs. With electricity, the matching of generation with consumption is an important issue because electricity cannot be stored for use later. With sufficiently strong winds, the turbine generates power 24 hours a day, seven days a week, much of the time when Berkshire does not need that level of power. Fortunately, with the winds on Berkshire at their strongest in the winter, the turbine turns faster, generating more electricity. This phenomenon matches up nicely with the resort's higher electricity demand for snowmaking in the winter. The wind turbine is expected to supply up to one-half of Berkshire's winter electricity needs. Electricity generated by the wind turbine is expected to result in cost savings from buying about 2.3 million fewer kWh per year. In addition, excess electricity generated by the wind turbine can be automatically diverted to the power grid and sold for an estimated $161,000 each year. An important financial component of the wind turbine project is the sale of renewable energy credits (RECs) to a third party. There is a ready market for these credits because they certify that the purchaser of the credit purchased renewable energy. Third parties have already agreed to purchase Berkshire's credits for 10 years at $166,667 per year, and it is to be assumed in the feasibility study that sales of RECs will continue at this level for the remaining years of the wind turbine's life cycle. In addition to the RECs, the wind turbine would enable Berkshire to benefit from $46,000 per year in renewable energy production tax credits for 10 years. (Note: Use 6-year straight-line depreciation with ending book value of $0 for calculations in case submission.) Also, the new turbine would enable Berkshire to open from two to four weeks before other area resorts because of the cheaper snowmaking from using wind power. This is estimated to generate an additional $100,000 net cash inflow per year. Berkshire management estimates that a wind turbine service contract, insurance, and other maintenance would cost about $75,000 annually. Based on discussions with Berkshire management, SED has determined that: Berkshire is subject to a 40 percent income tax rate; Berkshire has sufficient taxable income to benefit from any deductions and credits that result from the wind turbine purchase; The after-tax weighted average cost of capital is 11.0 percent for discounting the expected cash flows of the project; and The wind turbine has a 25-year useful life with no terminal disposal value. Introduction Melissa Banks, president and CEO of Berkshire Mountain Resort, is worried about energy costs. Primarily a ski resort, Berkshire's business is very energy-intensive, mainly because most of the winter snow is manufactured by machines that run on electricity. Strong conservation campaigns over the years have reduced energy consumption by 25 percent, but the resort still consumes about 7.5 million kilowatt hours (kWh) of electricity each year, with about 60 percent used during the peak winter months. Last year, electricity costs were about $0.11 per kWh, but this season, the cost skyrocketed to $0.16 per kWh - an increase of almost 50 percent. Even before the electricity cost increase, Berkshire had tried to operate as efficiently as possible to minimize its electricity consumption. As examples, 1,800 new fluorescent bulbs were installed in the lodge, replacing incandescent bulbs; high-efficiency lights had been installed on the ski runs that automatically dim to half wattage during night maintenance work; half of the snowmaking system had been converted to zero-energy gravity-feed. Berkshire was a test site for the development of revolutionary new high efficiency "guns for the snowmaking machines. This new snowmaking technology uses 40 percent less electricity than the older version. In the 1990s, the resort won an energy conservation recognition award from Massachusetts Electric for saving over one million kWh of electricity from its improvements in snowmaking, lighting, and elsewhere. There is only so much Berkshire is able to achieve in energy conservation with its existing facilities and still offer high quality recreational services. Banks has realized that a more ambitious energy reduction initiative is needed, and so she and resort managers are considering harnessing an abundant renewable green resource readily available to the mountain resort: wind power. The Wind Turbine Project Proposal Banks has been in the ski resort business long enough to know that the Berkshire mountaintops can get very windy in the winter. She has decided to investigate the feasibility of erecting a wind turbine to put the mountaintop wind to profitable and green use to help stabilize the resort's electricity costs. In addition, this would be consistent with Berkshire's corporate mission to protect the environment and should also permit the use of "green marketing" in the hope of attracting even more visitors to its popular ski slopes. Berkshire managers recognize that determining the viability of installing a wind turbine will be a complicated, specialized process, and so they have engaged Sustainable Energy Developments, Inc. (SED) of Ontario, New York, to examine the feasibility of such an investment. SED's fee is $157,000. With SED's help, Berkshire has already received a small grant of $15,000 from the Massachusetts Technology Collaborative to offset part of the cost of the formal feasibility study. The feasibility study is to cover the financial, technical, social, and environmental aspects of the proposed wind turbine. Berkshire's History Berkshire opened in the Berkshire Mountains of western Massachusetts in the early 1950s. By 2005 it was larger than any other skiing and snowboarding resort in the southern New England states. During this period, it evolved into a four-season resort, offering skiing, mountain biking, and other outdoor sporting activities. Berkshire is about 2-1/2 to 3 hours' travel time from New York City and Boston and is only about one hour away from Albany, NY, and Springfield, MA. Through good management and sound development, Berkshire became a popular winter ski destination that covers 170 acres, with 45 ski and snowboard trails, three terrain parks, and nine lifts, including a high-speed six-person chairlift. Savvy marketing and attractive mountain facilities have enabled the resort to operate profitably, even in the summer. For summer sport enthusiasts, Berkshire installed the first mountain coaster on the East Coast, an alpine super slide, a giant swing, scenic rides, a rock climbing wall, a "euro-bungy" trampoline, hiking, and, for children, rope adventures, mini-golf, a rope spider web, and an inflatable bouncy bounce" playground. Winter visitors number about a 250,000 annually, while summer visitors average about 100,000. The Economics of Harnessing the Wind The SED team has established that there is enough wind on the west shoulder of Berkshire's mountain to use effectively a wind turbine. Significantly, the wind force on the mountain is strongest during the winter, when Berkshire's demand for electricity is at its greatest for snowmaking, ski lifts, and lighting. Berkshire consumes about 4.5 million kWh of electricity during the winter, which is 60 percent of its total annual needs. GE Energy, a unit of General Electric, is able to provide a 1.5 MW-capacity wind turbine to Berkshire within a year at an estimated total purchase and installation cost on the proposed site of $3.9 million. Subject to a favorable feasibility study, a loan of $3.3 million for 10 years is available from Berkshire's local bank at an annual interest rate of 7.3 percent. A grant of $582,000 is available from the Renewable Energy Trust Fund administered by the Massachusetts Technology Collaborative to complete the financing for the proposed wind turbine purchase and installation. Funding for the Renewable Energy Trust Fund comes from a charge on Massachusetts electric bills Although erecting the wind turbine on the proposed site would partly hide it from the view of skiers, the local bank management would be able to see the wind turbine through a window in the bank's boardroom and, perhaps alarmingly, observe the bank's loan collateral when the blades were not turning because of insufficient wind strength. Berkshire management and the SED team are concerned about general community acceptance and support for the wind turbine project. The local community is very concerned with aesthetic and environmental issues. The proposed GE Energy wind turbine is taller than the Statue of Liberty. Its three 123-foot blades are each longer than three school buses placed end to end. Local residents may not be happy with such a large structure being erected at the top of the mountain. Also, the construction materials would travel noisily through the local community on trucks from the Port of Albany and add to road congestion. One suggested idea to help gain community acceptance and enthusiasm for the project is to invite the public to submit names for the wind turbine in a "Name That Turbine" competition. A well-publicized ceremony could be held to announce the winning name and to tout the environmental and social benefits of the wind turbine. The GE Energy unit would provide about one-third of Berkshire's annual electrical needs. With electricity, the matching of generation with consumption is an important issue because electricity cannot be stored for use later. With sufficiently strong winds, the turbine generates power 24 hours a day, seven days a week, much of the time when Berkshire does not need that level of power. Fortunately, with the winds on Berkshire at their strongest in the winter, the turbine turns faster, generating more electricity. This phenomenon matches up nicely with the resort's higher electricity demand for snowmaking in the winter. The wind turbine is expected to supply up to one-half of Berkshire's winter electricity needs. Electricity generated by the wind turbine is expected to result in cost savings from buying about 2.3 million fewer kWh per year. In addition, excess electricity generated by the wind turbine can be automatically diverted to the power grid and sold for an estimated $161,000 each year. An important financial component of the wind turbine project is the sale of renewable energy credits (RECs) to a third party. There is a ready market for these credits because they certify that the purchaser of the credit purchased renewable energy. Third parties have already agreed to purchase Berkshire's credits for 10 years at $166,667 per year, and it is to be assumed in the feasibility study that sales of RECs will continue at this level for the remaining years of the wind turbine's life cycle. In addition to the RECs, the wind turbine would enable Berkshire to benefit from $46,000 per year in renewable energy production tax credits for 10 years. (Note: Use 6-year straight-line depreciation with ending book value of $0 for calculations in case submission.) Also, the new turbine would enable Berkshire to open from two to four weeks before other area resorts because of the cheaper snowmaking from using wind power. This is estimated to generate an additional $100,000 net cash inflow per year. Berkshire management estimates that a wind turbine service contract, insurance, and other maintenance would cost about $75,000 annually. Based on discussions with Berkshire management, SED has determined that: Berkshire is subject to a 40 percent income tax rate; Berkshire has sufficient taxable income to benefit from any deductions and credits that result from the wind turbine purchase; The after-tax weighted average cost of capital is 11.0 percent for discounting the expected cash flows of the project; and The wind turbine has a 25-year useful life with no terminal disposal value
