3. Georgia Power is contemplating replacing an oil powered generator with a sola

Question

3. Georgia Power is contemplating replacing an oil powered generator with a solar power generator. The old generator was puchased 22 years ago and is being depreciated over its 25 years life to a zero salvage value uisng straight-line depreciation. The old generator has a book value of $4.5 million but could be sold today for $3.0 million. The solar powered generator would cost $10 million and be depreciated over a 3 year life using MACRS (.33, .45, .15, .07). Due to the rapidly changing technology, it is anticipated that the new generator would be sold after 3 years for $1.0 milion . The new generator is expected to save Georgia Energy $10 million a year during its 3 year life. Georgia Energy will need to increase capital by $1.5 million. The company's WACC is 10% and the tax rate is 35%. What is the project's NPV? Should the oil powered generator be replaced? 3. Georgia Power is contemplating replacing an oil powered generator with a solar power generator. The old generator was puchased 22 years ago and is being depreciated over its 25 years life to a zero salvage value uisng straight-line depreciation. The old generator has a book value of $4.5 million but could be sold today for $3.0 million. The solar powered generator would cost $10 million and be depreciated over a 3 year life using MACRS (.33, .45, .15, .07). Due to the rapidly changing technology, it is anticipated that the new generator would be sold after 3 years for $1.0 milion . The new generator is expected to save Georgia Energy $10 million a year during its 3 year life. Georgia Energy will need to increase capital by $1.5 million. The company's WACC is 10% and the tax rate is 35%. What is the project's NPV? Should the oil powered generator be replaced?

Explanation / Answer

As explained below Project NPV is 3.98 mn$. Also, as this NPV is greater than the cash from selling old generater of 3mn $, so oil powered generator should be replaced.

Note 1 : Capital required for solar project at year 0 is $10mn+$1.5mn - $3mn from sale of old plant - Tax saving on loss of sale of old plant $0.525mn = 7.975mn$

Note 2:WDV of solar plant at the end of 3 years is 0.7mn$, sold at 3rd year end 1mn$ so profit is 0.3mn, considering tax@35%, net cash from this is 0.195mn$

Note 3: I have assumed tax on capital gains also at 35%

year Net Capital requirement Annual Savings Depreciation Profit Tax Profit after tax Cash flow Cash from sale of solar plant Net cashflows Discount factor@10% Discounted cashflow 0 -7.975 -7.975 1.000 -7.98 1 10 3.3 6.7 2.345 4.355 7.655 7.655 0.909 6.96 2 10 4.5 5.5 1.925 4.5 4.5 0.826 3.72 3 10 1.5 8.5 2.975 1.5 0.195 1.695 0.751 1.27 NPV 3.98

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