Question

Pollution Busters Inc. is considering a purchase of 10 additional carbon sequesters for $100,000 apiece. The sequesters last for only 1 year before becoming saturated. Then the carbon is sold to the government. a. Suppose the government guarantees the price of carbon. At this price, the payoff after 1year is $115,000 for sure. What is the opportunity cost of capital for this investment? Opportunity cost of capital b-1. Suppose instead that the sequestered carbon has to be sold on the London Carbon Exchange. Carbon prices have been extremely volatile, but Pollution Busters' CFO learns that average rates of return from investments on that exchange have been about 20% She thinks this is a reasonable forecast for the future. What is the opportunity cost of capital in this case? Opportunity cost of capital % b-2. Is the purchase of additional sequesters a worthwhile capital investment? Yes O No

Answer 1

(a). Opportunity Cost Of Capital = Payoff at year 1 / Current investment

= (115,000 - 100,000)/100,000

= 15%

(b). The opportunity cost in case carbon sequesters can be sold on London Stock Exchange with an average expected return of 20% is 20%.

(c). The purchase of additional sequesters is not a worthwhile capital investment as the same have to be sold back to the government under the agreement and would  fetch lesser returns as compared to other investments.