Powerco Analysis: New Generator Construction

PowerCo is estimating higher demand of power in the near future and therefore needs to know if it is feasible to build a new power plant. The timeline for building the new plant is two years and the plant is estimated to last at least ten years. The Treasury department has developed financial projections to assist management in making the decision to whether a new plant is financially prudent. It is assumed that the opportunity cost of capital is 8% and the projections are based on after-tax dollars.

To aid in clear financial decision making, the present value of cost formula must be employed. There are multiple ways to come up with present value such as using a financial calculator, using the PV formula or using the present value of one dollar table. For the purpose of all analysis in this project the A x B = C formula will be used with the present value of one dollar table in conjunction with the 8% cost. For example: to calculate the present value of 1 million dollars in year 2 at 8%, 1 million x 0.857(obtained from PVIF table) = $857,000.

Expected cash costs in millions are estimated as:

Year Expected Costs

1 25

2 28

The present value of cost is as follows:

Year Cost PVIF 8% PV

1 25 0.926 23.15

2 28 0.857 23.996

In Millions $ 47.146

To build the plant it will take just over $47 million and two years. Now let’s look at the expected after tax profits:

Year Expected after-tax profits

3 6

4 7

5 8

6 9

7 9

8 9

9 9

10 9

11 9

12 9

The present value of after-tax expected profits is:

Year Profit PVIF 8% PV

3 6 0.794 4.764

4 7 0.735 5.145

5 8 0.681 5.448

6 9 0.63 5.67

7 9 0.583 5.247

8 9 0.54 4.86

9 9 0.5 4.5

10 9 0.463 4.167

11 9 0.429 3.861

12 9 0.397 3.573

In Millions $47.235

Therefore the net present value of the project would be the difference between the cash inflows and cash outflows. The cash outflows are the projects cost when being built in the first two years for $47.146 million. The cash inflows are...