Viento Windmills is a utility that charges customers for their wind generated el

Question

Viento Windmills is a utility that charges customers for their wind generated electricity. With their current technology, they earn a total of $65 million each year to pay out to their 3 million shareholders. While their geographic footprint is fixed and we can't expect the climate to get progressively windier over time, they do have an opportunity to invest in technology that will more efficiently extract the wind energy and thus produce more megawatts to sell to customers. A one-time investment one year from now (t = 1) of $29 million for a state of the art lubricant system for the windmills will lead to extra cash flows that stay constant at $19 million per year starting the following year (t = 2) and lasting forever. If Viento plans to make the investment and cost of equity capital (the discount rate for equity) is 8.5%, calculate the increase or decrease in the share price of Viento as a result of this decision. Draw time line to understand what is going on.

Explanation / Answer

Answer:

Present value of investment of $14 Million on year from now = $14 / (1.115)^1 =$12.56 Million

Value of future benefits at the end of year 2 = $8 Million /11.5% = $69.57 Million

Present value of Future benefits = 69.57 / (1.115)^2 = $55.96

Net Present value of the investment = $55.96 - $12.56 = $43.40 Million

No. of shares = $1 Million

Incrase in the value per share = $43.40 Million/1 million = $43.40

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