You are the finance team for SafePowerCorp which is considering making an investment in a nuclear project (the “Project”) based in Canada.
The Project would cost $120 million to acquire, the full amount of which would be payable immediately to the seller. The seller is a small power development company, which has completed constructing and commissioning the Project. The assets qualify for a 30% CCA rate. The Project has a capacity of 30 MW, and an average annual capacity factor of 70%. Accordingly, the expected annual energy production from the Project is 183,960 MWh/year.
The energy generated by the Project will be sold to a Provincial utility, Hydro, under a 20-year fixed purchase agreement (the “FPA”). The FPA stipulates that Hydro will pay $105 / MWh in the first year, escalating at 3% per year throughout the 20-year term.
The project is expected to have operating expenses (primarily related to property taxes, maintaining and operating the turbines, fuel, and paying the salaries and benefits for the on-site employees) equal to 32% of revenues in each year. The project is expected to have a pre-tax operating margin of 68%.
SafePowerCorp expects that the Project could be sold at the end of the FPA term for approximately $12 million. SafePowerCorp estimates that the appropriate discount rate for the Project is 9% and SafePowerCorp's corporate tax rate is 28%.
a. Calculate the NPV of the Project. (Consider using an Excel spreadsheet to solve this.):
Hint: There are various approaches to solve this problem. One approach is to calculate the following (assuming that SafePowerCorp owns the project for the entire FPA term):
1. Present Value of the After-Tax Project (Operating) Cash Flows, excluding Salvage Value
2. Present Value of the CCA Tax Shield
3. Assume an expected salvage value at the end of year 20 equal to $12 Million, calculate the present value of the after-tax salvage value of the Project, being sure to take into account any capital gains taxes
b. Estimate the IRR of the Project
c. An analyst has noted that the market price for energy is currently $125 / MWh. Furthermore, suppose that included in the FPA was the option at certain times for the seller to elect to receive an average market price for the electricity, as opposed to the fixed $105 / MWh (escalating at 3% / year) agreed to in the FPA for the remainder of the FPA. The market pricing would be applied as follows: Payments made by Hydro to SafePowerCorp would be based on the monthly market price. What would be your recommendation to SafePowerCorp in regards to this ‘market’ option? What factors would you consider in making this decision?
CCA-menas depreciation rate