Question

(a) The initial investment for a geothermal power plant is $60,000,000 and is to be paid in two years (year 0 and year 1) equally. The electricity generated by the plant is expected to bring revenue of 10,000,000 per year increasing at a rate of 3% annually. The total annual expenses of the plant will be 1,500,000 increasing at a rate 4% annually. The company that owns the plant plans to borrow 50% of the capital expenditure at a rate 6%. The discount rate for this company is 12% and its taxation rate is 35%. A 10 year depreciation period is allowed for this power plant. The plant is expected to generate electricity for 30 years after which it will have zero value. What is the present value of this investment? Should the company undertake the investment?

(b)  What would be the answer to the plant of problem (a) if the company were allowed to borrow 80% of the cost of the geothermal power plant at an annual rate of 5%.

(c) In order to promote the development of alternative energy sources the government allows 5 year depreciation for the project of problem (a) . What is the net present value of the investment?

(d)  In order to accelerate the use of geothermal power, the government allows a 20% tax credit for investment in geothermal energy (in the years the investment is made) as well as 5 year depreciation for the project of problem (a) What is the net present value of the investment now?

(e) ‘‘The government does not need to subsidize energy projects. In a free market economy we should allow the market forces to determine if a project is going to succeed or fail.’’ Comment.