Question

4. Consumers Energy Inc (CSI) operates a coal fired power plant in Michigan, which has to come in compliance with nitrogen oxide (NOx) standards by reducing its NOx emissions to 50 tons per year from its current level of 150 tons/year. It is considering the following options to come in compliance. A) Install Selective Catalytic Reactor (SCR) on its boiler. SCR reduces NOx emissions by absorbing NOx in exhaust flue gases. SCR requires a capital investment of $600,000 in year zero and has a life of five years. Annual costs of replacing catalysts in the SCR are estimated at $50,000 and other additional operating costs of SCR are estimated at $60,000 per year. B) Install lean burners in the boilers. Lean burners reduce the amount of NOx formed during combustion by reducing the air fuel ratio and the operating temperature. The lean burners cost $200,000 to install and have a life of five years. Installing lean burners reduces the efficiency of electricity generation, which results in increased coal consumption in boilers of 5000 tons/year to supply the same amount of electricity. Coal prices are $ 40/ton and expected to remain at that level for the next five years. Lean burners also increase maintenance costs by $8000 per year. C) Continue to operate as usual, but buy NOx emission permits from the market each year. The permit prices are expected to be $2500 per ton in year 1 and increase at the rate of 10% year. Which option should CSI choose? CSI uses a discount rate of 10% in its decisions. The tax rate faced by CSI is 30%. CSI uses a straight line method in charging depreciation and both SCR and lean

Answer 1

Year 1 Year 2 Year 3 Year 4 Year 5 Total Year 0 600,000 Option 1 - Install SCR Capital Investment Annual Repairing Cost net of taxes Tax saving on depreciation Total Cash Outflow (A) Discounting Factor (B) Discounted Cash Flow (A+B) 600,000 77,000 36,000 113,000 0.91 102,727 77,000 36,000 113,000 0.83 93,388 77,000 36,000 113,000 0.75 8 4,899 77,000 36,000 113,000 0.68 77,181 77,000 36,000 113,000 0.62 70,164 600,000 1,028,359 Year 1 Year 2 Year 3 Year 4 Year 5 Total Year 0 200,000 Option 2 - Install Lean Burners Capital Investment Cost of increased coal consumption Maintenance Cost Tax saving on depreciation Total Cash Outflow (A) Discounting Factor (B) Discounted Cash Flow (A*B) 200,000 140,000 5,600 12,000 157,600 0.91 143,273 140,000 5,600 12,000 157,600 0.83 130,248 140,000 5,600 12,000 157,600 0.75 118,407 140,000 5,600 12,000 157,600 0.68 107,643 140,000 5,600 12,000 157,600 0.62 97,857 200,000 797,428 Option 3 - Permit cost increase by 10% Year 0 Year 1 Year 2 Year 3 Year 4 Year 5 Total Permit Cost net of taxes for 100 units Total Cash Outflow (A) Discounting Factor (B) Discounted Cash Flow (A*B) 175,000 175,000 0.91 159,091 192,500 192,500 0.83 159,091 211,750 211,750 0.75 159,091 232,925 232,925 0.68 159,091 256,218 256,218 0.62 159,091 - 795,455 Option 4. Permit cost increase by 15% Year o Year 1 Year 2 Year 3 Year 4 Year 5 Total Permit Cost net of taxes for 100 units Total Cash Outflow (A) Discounting Factor (B) Discounted Cash Flow (AB) 175,000 175,000 0.91 159,091 201,250 201,250 0.83 166,322 231,438 231,438 0.75 173,882 266,153 266,153 0.68 181,786 306,076 306,076 0.62 1 90,049 871,131 Assumptions 1. It is assumed that permit cost is required to be paid for the excess quantity from the permissible limit.i.e., 100 units (150-50) Conclusions In the first three options given, CSI should continue to operate as usual. Even with the 4th option available, the choice would be the same to operate as usual.