Turquoise Energy Limited (TEL) is a company that develops wind farms and harnesses wave energy off the West Coast of Scotland. It is a highly capital intensive and risky business. The government is prepared to grant the company a licence to develop this energy for the next 5 years. TEL will have to pay an annual licence fee to the government of 500,000 payable at the start of each year. This licence fee is an allowable expense when calculating corporation taxation.

TEL effectively has first option and must act quickly otherwise other energy companies will take up the licence.

The first year (2023) will see TEL operating at 50% of capacity. For the rest of the project the company will be operating at full capacity.

The necessary equipment will cost TEL 14 million, which is available for tax depreciation allowances on a straight-line basis over the life of the project. The Board of Directors also commissioned a survey on the suitability of the West Coast of Scotland site for this particular equipment. The cost of this survey was 375,000 and will be paid in 2023.

The CFO has made an estimate of the expected revenues for the five years of the project as follows:

2023: 3,000 '000

2024: 6,500 '000

2025: 7,200 '000

2026:8,100 '000

2027: 7,600 '000

Operating costs are expected to be 800,000 in 2022 and rise each year thereafter by 200,000.

TEL will need to borrow some specialist equipment and personnel from its parent company Green Paradise Limited (GPL) in 2025. Any transactions like this are charged at market rates by GPL and the cost will be 350,000. However, this specialist equipment and personnel are actually needed in GPL in 2024, so GPL will have to seek temporary cover while these resources are being used by TEL in the West Coast.

TEL overheads in relation to the project will be 250,000 and this contains an apportionment of 100,000 per annum for head office costs; the remainder of the costs relate directly to the project.

Initial working capital of 900,000 will be required at the start of the project and a further 450,000 of additional working capital will be required for 2024. The working capital will then be maintained at this level through the remainder of the project and then be returned in 2027.

TEL has a weighted average cost of capital of 11% and pays corporate taxation at a rate of 22% on profits in the same year that the profits are generated

1. Calculate the net present value of the Turquoise Energy Limiteds project and recommend whether it should proceed.

2. Evaluate this announcement, clearly indicating whether you agree with the Boards decision.

The Board of Directors of Turquoise Energy Limited has made the following announcement to its shareholders: From 2023 onwards, your Board of Directors has decided to use the payback period as the preferred method of evaluating future projects as the Board considers this method to be superior to net present value in the current highly uncertain economic climate.