Suppose you have an opportunity to invest in a start-up company that builds sola

Question

Suppose you have an opportunity to invest in a start-up company that builds solar power factories. A newly proposed facility just outside of Columbus would generate about 120,000 MWh (1 MWh = 1000 KWh), and cost $25 million to install.

(A) If ENGIE-Axium, the new energy "partner" for Ohio State University, agrees to put up the entire $25 million for the installation of this solar facility, providing Ohio State University gets the entire 120,000 MWh at no additional charge for its sustainability efforts, is this a good deal for the university? Assume the market price for electricity is $48 per MWh and there is a 5-year project horizon. Evaluate this decision using a 3% and a 7% discount rate. For this problem, assume that the costs of installing the solar panels occur at time 0, and the benefits occur at the end of each subsequent year (end of year 1, end of year 2, etc.). The 5 year horizon implies that you only need to evaluate the gains of the solar project over a 5 year period. Solar panels obviously will provide benefits in the future if they remain installed, but you should ignore years beyond the 5th year for this analysis.

(B) Suppose ENGIE-Axium, on behalf of Ohio State University, sells the resulting renewable energy credits from this project on the market at the current price of renewable energy credits in Ohio of $5 per MWh. Show whether and how this changes the benefits and costs of this potential investment in solar power at both interest rates?

(C) Discuss the pros and cons of selling renewable energy credits when there is no regulatory obligation to produce renewable energy.

(D) If the social cost of carbon is $10 per MWh, what is the present value of the social benefit provided by ENGIE-Axium if it undertakes this project? Assume only a discount rate of 3% for this calculation and a 5-year horizon.

(E) Discuss the difference between the two discount rates and which rate you think Ohio State University should use when evaluating projects like this.

Explanation / Answer

a.) Annual Social Benefits per Year=$48x120,000 =$5,760,000

For a 5-Year period horizon and discount rate of 3%,

NPV =-25,000,000 + 5,760,000x{(1-(1+0.03)-5)/0.03}

        = -25,000,000 + 26,379,113

        = 1,379,113

Since, the NPV is >0, the project should be accepted.

For a 5-Year period horizon and discount rate of 7%,

NPV =-25,000,000 + 5,760,000x{(1-(1+0.07)-5)/0.07}

        = -25,000,000 + 23,617,137

        = -1,382,862

Since, the NPV is <0, the project should be rejected.

b.) Receipts from Solar creidts sale=$5x120,000 =$600,000

Annual Social Benefits per Year=$48x120,000 =$5,760,000

For a 5-Year period horizon and discount rate of 3%,

NPV =-25,000,000 + (5,760,000+600,000)x{(1-(1+0.03)-5)/0.03}

        = -25,000,000 + 29,126,938

        = 4,126,938

Since, the NPV is >0, the project should be accepted.

For a 5-Year period horizon and discount rate of 7%,

NPV =-25,000,000 + (5,760,000+600,000)x{(1-(1+0.07)-5)/0.07}

        = -25,000,000 + 26,077,255

        = 1,077,255

Since, the NPV is >0, the project should be accepted.

C.) Pros of Renewable Energy Credits Selling is that it helps you improve your return from the investments in the project. The additional cash flow generated from the sale will help increase IRR for the project.

Cons of Renewable Energy Credit Selling without any regulatory obligation is that the project always faces risk of the cash flows coming from Energy credit sales. The price of Energy Credits may fall steeply owing to no regulation and hence may impact the return in the project.

D.) Additional benefit owing to saving of social cost of Carbon =$10x120,000 =$1,200,000

For a 5-Year period horizon and discount rate of 3%,

NPV =-25,000,000 + (5,760,000+1,200,000)x{(1-(1+0.03)-5)/0.03}

        = -25,000,000 + 31,874,762

        = 6,874,762

Since, the NPV is >0, the project should be accepted.

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