Corry Energy has three separate investment choices with a 9% corporate hurdle ra
ID: 2647605 • Letter: C
Question
Corry Energy has three separate investment choices with a 9% corporate hurdle rate and $6 million to apply to capital investments in 2014. Choice 1 is to buy a lease on a wood burning electricity generating plant for $2 million that could be used to provide power to an already identified municipality generating net cash flows of $625,000 per year for five years, paid at the end of each year. After five years, the plant will need to be de-commissioned at a cost of $175,000. Choice 2 is to purchase already functioning wind turbines at a cost of $500,000 per turbine. These can each generate incremental annual cash flows of $120,000 per year for the next seven years, after which the turbines can be sold for scrap at $50,000 each. Choice 3 is to refurbish an existing coal burning plant at a cost of $3 million. This will generate additional cash flows of $450,000 per year for seven years, after which time the plant will revert to its current financial performance levels. How should Corry Energy proceed and why?
Explanation / Answer
Calculation of NPV of Choice 1 Year Cash flow (CF) PVF (9%) PV = CF *PVF Lease Cost 0 -2000000 1.00000 $ (2,000,000.00) Annual cash inflow 1 to 5 625000 3.88965 $ 2,431,032.04 De-commissioned cost 5 -175000 0.64993 $ (680,688.97) Net Present value (NPV) = Sum of PVs $ (249,656.93) Calculation of NPV of Choice 2 Year Cash flow (CF) PVF (9%) PV = CF *PVF Purchase Cost of one turbine 0 -500000 1.00000 $ (500,000.00) Annual cash inflow 1 to 7 120000 5.03295 $603,954.34 Scrap value 7 50000 0.54703 $ 194,482.56 Net Present value (NPV) = Sum of PVs $ 298,436.90 Calculation of NPV of Choice 3 Year Cash flow (CF) PVF (9%) PV = CF *PVF Cost of refurbishment 0 -3000000 1.00000 $ (3,000,000.00) Annual cash inflow 1 to 7 450000 5.03295 $2,264,828.78 Net Present value (NPV) = Sum of PVs $ (735,171.22) We can see that the Choice No. 2 (Turbine) has the positive NPV so its better to invest the money in Choice 2