Question

Zephyr Farming Pty Ltd is considering the purchase of a wind turbine generator in order to generate electricity and to reduce the electricity costs for their offices, which are located in Toowoomba. Currently the business uses 60,000 kilowatt hours (kWh) per quarter (3 months) at an average cost of $0.30 per kwh, supplied by the local coal fired power station. The current required rate of return used to evaluate projects is 6%, with a required payback period of 3 years.
The Queensland government started a scheme to provide an incentive for business to use alternative sources of renewable power. The incentives are 5% immediate reimbursement of the purchase and installation costs. This reimbursement can be paid to the supplier providing and installing the equipment. Therefore, the net cash flow from Zephyr Farming Pty Ltd is the purchase cost plus the installation cost less the 5% incentive back from government to offset these costs.
Project details:
Cost of wind turbine generator          $6,000
Cost to install turbine and generator (by supplier)        $450
Expected cash incentive back from government to offset cost of the panels paid immediately the wind turbine generator installed           5% of total costs
Turbine expected (on average) generated kilowatt              300 hours per month
Generator’s expected life (in years)                   15 years

requirements:

6. Comment on two limitations with the payback period method after considering your answers to 2 and 4 above (2 marks)
7. What qualitative, non-financial factors (not included in the quantitative analysis) would influence your opinion on whether the investment in the wind generator should proceed. (2 marks)
8. As the Chief Operating Officer (COO) of Zephyr Farming Pty Ltd, provide [in an internal informal report email] your recommendation(s) about what to implement [use your answers in 1 to 7 to support your recommendation(s)]. You report will be sent directly to Hoang Binh, who is the Chief Financial Officer (CFO). (3 marks)

Answer 1

Amount Cost of wind turbine generator Cost to install turbine and generator Total Cost of Wind turbine Less: 5% Incentive Net cost of the wind turbine $6,000.00 $450.00 $6,450.00 $322.50 $6,127.50 Expected Life of Turbine Required rate of return Turbine expected (on average) generated kilowatt hours per month 300per month Turbine expected generated KWH peryear 3,600 Cost saving due to turbine expected generated KWH 3600KWH $0.30perkWH $1,080/ 15 years 69% Year 10 12 13 14 15 Cost saving on turbine power Present Value Factor @6% p.a Present Value of cost savin Cumulative Present Value of cost savings $1,018.87 $1,980.06 $2,886.85 $3,742.31 $4,549.35 $5,310.71 $6,028.97 $6,706.58 $7,345.83 $7,948.89 $8,517.82 $9,054.55 $9,560.90 $10,038.58 $10,489.23 1,080$1,080$1,0801,080$1,080$1,080 $1,080 $1,080 $1,080 $1,080 $1,080$1,080 $1,080 $1,080$1,080 0.627 $1,018.87 $961.20 $906.79 $855.46 $807.04 $761.36 $718.26 $677.61$639.25 $603.07 $568.93 $536.73 $506.35 $477.69 $450.65 0.943 0.890 0.840 0.792 0.747 0.705 0.665 0.592 0.558 0.527 0.497 0.469 0.442 0.417 back pei od on undiscounted cahs Payback period Cost of the project/ Cash flow pear Payback period $6,127.50 $1,080 Payback period-5.67 years

ahs flows: Payback Period Before year of cumulative PV CF above the cost+ (Cost of wind turbine - Cum. PV cash flow of before year above the cost)/Cash of flow year crossing the cost of turbine Payback Period 7th year($6,127.50 $6,029.97)/$677.61 Payback Period 7th year+($98.53)/$677.61 Payback Period- 7th year +0.15 Payback Period 7.15 years Q. No:6. Limitations of payback period is: 1. it ignores the present value of cash flows. 2. it ignores the cash flow generated after pay back period. 3. It never consider the project's profitability. No: 7. Non financial factor is: Wind turbine mill is a renewable energy source generation of power. This non financial factor influences the investment in the project. Q. No: 8: Report to - Chief Operating Officer (COOl of Zephyr Farming Pty Ltd Expected payback period of the project is 5.67 years Expected payback period of the project is 7. 15years based on discounted cash flow at required rate of return 6% pa But required payback period is 3years for this project. Eventhough, based on financial factor's expected payback period is more than required payback period. We have to consider non-financial factores, which influeces the consideration of this proejct i.e. we have to consider alternative source of renewable power to implement the project.