ACC00716 Finance Session 1, 2020

Assessment 3: Business Case Studies 2

Due date: 13 May 2020, 11PM

 

 

This assignment has a 25% weighting in your overall mark for this unit and focuses on content from Weeks 6, 7 and 8. The assignment will be marked out of 25 and marks will be allocated as indicated in the rubric on page 4. Your total assignment submission will consist of a word document and a spreadsheet, submitted via separate links.

The assignment is based on the case information below. While the company and financial data in the case are fictitious, the context is not. Many companies face similar investment decisions as well as challenges and opportunities to run more environmentally and socially responsible businesses.

Case Information

 

ABC Limited is a large agricultural producer that owns around one million hectares of land, most of which is used to run cattle bound for global markets. Recently, the Board and managers of ABC have been closely watching the rapid growth in popularity of meat alternatives, including imitation meat, and see it as a reflection of broader societal trends towards healthier lifestyles and reducing carbon footprint. The Board are concerned about the potential long-term negative impact of these trends on the company’s value and it has led them to reconsider the company’s strategy.

Given the size of the company’s land holdings, several alternative land use options have been considered. A move to the production of non-meat agricultural products has been ruled out because most of the company’s land is not suitable for the viable production of such products. Mining ventures have also been ruled out because none of the land contains a profitable level of resources except coal, which the Board has decided is not appropriate to deal with their aim to become a more environmentally responsible business. Coal is a hotly debated topic in energy and climate policy.

The most recent proposal being examined by ABC is renewable energy production. Renewables are considered crucial in the transition to a low-carbon, sustainable future according to The International Energy Agency:

In 2018, renewable electricity generation rose 7%, with wind and solar PV technologies together accounting for 65% of this increase. Although the share of renewables in global electricity generation reached 25% in 2018, renewable power as a whole still needs to expand significantly to meet the SDS [Sustainable Development Scenario] share of almost half of generation by 2030. This requires the rate of annual capacity additions to accelerate…1

Specifically, ABC are considering a wind farm2. The company is now close to the final investment decision stage and the CEO has asked you to put together a financial analysis of the project. You will submit a summary of this analysis, along with your recommendations on the project, in a short memo.

1 International Energy Agency (2019) Tracking power, https://www.iea.org/reports/tracking-power-2019.

2 A video exemplifying onshore wind farm construction can be found at https://youtu.be/gyHkIDI9CiI.

The company owns several parcels of land that a wind study has indicated are suitable for power generation by wind turbines. One parcel in particular has been singled out as the best based on wind, geology, grid connection access, minimal environmental impact, local government consent and positive community attitudes in the area towards wind towers. Cattle currently run on this land but the company believes this activity would not be severely impacted by the wind farm. The stock would need to be removed during construction of the wind towers but existing stocking rates could be resumed once the wind towers are operational. Costs associated with this disruption in current activities during wind tower construction are estimated to be $0.2million net of tax effects.

In addition to the wind study, the company has incurred other project development costs, including for a geological study and environmental impact assessment, engaging the services of several relevant professionals, holding community consultations and receiving local government development approval. These project development costs have totalled $0.8m.

The wind farm will consist of ten, 2MW turbines, giving the wind farm a total rated capacity3 of 20MW. Each turbine will cost $2.2 million and related installation costs (including construction and grid connection, which are all depreciable) will be an additional $0.5 million for each turbine tower. The plant and equipment will be depreciated to a zero book value on using the prime cost method over 20 years. A proportion of the financing for the plant and equipment will be via a new 20-year debt issue, resulting in interest costs of $2 million payable at the end of each year. At the end of 20 years, the wind farm will be decommissioned and the plant and equipment sold for an estimated market value of $4 million. Estimated decommissioning costs are $3 million.

The rated capacity of the wind farm per hour (20MW) will not be available at all times due to winds that are lighter or stronger than the optimal wind speed range. Engineers from the turbine supplier have therefore suggested assuming a capacity factor4 of 40%, which means that the farm would be expected to produce 70,080 MW hours (MWh)5 of electricity each year, assuming continual operation. However, this is an uncertain estimate due to the variability of wind and the potential for repair and maintenance outages. Global capacity factors for onshore wind have been increasing over time, as seen in the graph on the next page, but the 2018 global average capacity factor was lower than the estimate provided by the turbine supplier’s engineers and there has been a wide range of achieved capacity factors each year.

ABC has negotiated a 10-year Power Purchase Agreement (PPA) that gives a guaranteed $40 per MWh. After this agreement expires, ABC assumes it will sell the electricity in the open market, starting with an estimated average price of $70 per MWh in the first year and increasing 3% per year after that. However, electricity prices are extremely volatile with a standard deviation of 40% of average price.

3 Rated capacity is the peak hourly production of a wind turbine when conversion efficiency is near its maximum. This requires optimal wind speed, amongst other conditions.

4 Capacity factor is average power generated divided by rated capacity. For example, if a wind turbine with a 2MW rated capacity produces power at an average of 1MW, its capacity factor is 50% (1÷2).

5 Calculated as rated capacity x 365 days x 24 hours x capacity factor = 2MW x 365 days x 24 hours x 40%. This assumes the wind turbines are always operational.

Source: International Renewable Energy Agency (IRENA) 2019, Renewable Power Generation Costs in 2018, IRENA, Abu Dhabi, p. 19.

In addition to revenue from selling electricity, ABC will qualify for a government scheme providing green certificates at a rate of one certificate per MWh of renewable energy produced. These certificates have value in the market for retailers who need to meet certain renewable targets. ABC will sell their certificates at the end of each year for an estimated $20 each. Based on expert opinion, ABC predicts that the government will end the scheme after 10 years when it is forecast to meet its renewable energy targets.

The contract with the turbine supplier specifies that most service and maintenance of the turbines will be the supplier’s responsibility for 20 years. Therefore, operational costs are expected to be low. Variable operating costs are forecast to be $2 per MWh in the first year and increase at a rate of 2% throughout the life of the project. An additional $1 million annually in administration, insurance and general expenses (excluding depreciation) directly related to the project will also be incurred.

ABC has a 8% weighted average cost of capital and is subject to a 30% tax rate on its income. After some research and calculations, you have determined that ABC has a higher unlevered beta, adjusted for cash, then a pure play wind electricity generating company, listed on the same stock market as ABC. Unlevered beta adjusted for cash is a measure of business risk.

 

Required:

 

Prepare (1) a spreadsheet financial analysis of the proposed project and (2) a memo to ABC’s CEO that briefly explains and justifies your chosen methods, inputs and any assumptions made, summarises your findings, and presents your recommendations on the proposed options. Ensure you not only analyse base case (expected) cash flows but also analyse and discuss potential uncertainty. Recommendations should address the decision to be made, along with any further follow up or other matters the company should consider prior to making a final decision.

Instructions:

 

Submit your spreadsheet separately in the provided spreadsheet submission link in the BCS2 section of the unit site. By submitting the spreadsheet, you are confirming that it is entirely your own work. Save the spreadsheet with your details in the file name using the following format (failure to do so could result in your spreadsheet not being considered in marking):

Student ID_Full_name_ACC00716A3

For example: 13579246_Jennifer_Harrison_ACC00716A3

Submit the memo as a word document via the Turnitin assignment link in the BCS2 section of the unit site. Include your name, student ID, unit code (ACC00716), assessment number (A3) and word count at the beginning of the document. The remainder of the document should be set up as a formal memo and include an appendix with a screen shot(s) of your base case figures from the spreadsheet. To ensure this appendix is readable, show only the first 3 years and last two years of cash flows by hiding the columns in the middle. This will be sufficient to present the key elements in the cash flows without the reader needing to go to the spreadsheet. Also in an appendix, include a table with two columns listing the time period in the first column and your final base case net cash flows in the second column.

Within the memo body, you may provide tables and figures that are discussed in the text and assist decision makers understand your methods, findings and their implications for decision-making. The word document submission must not exceed 1,000 words (excluding the screen shot appendix and reference list).

This is an individual assessment exercise. The unit teaching team is very experienced at marking such assessments and recognising the differences between individual and “group” work, as well as data, facts, statements and ideas of others that have not been appropriately acknowledged. To avoid any potential for academic misconduct investigation, ensure that every aspect of your work is your own and that you acknowledge all sources you have directly drawn upon in your submitted work by referencing. Quotations should be shown with quotation marks and referenced.

Assessment 3: Business Case Studies 2 ACC00716 S1 2020

MARKING

CRITERIA

Excellent

Very Good

Good

Satisfactory

Poor

Accurate estimation of relevant base case cash flows and decision criteria (12 marks)

All relevant base case cash flows have been accurately incorporated into the analysis and net cash flows and decision criteria are correct. (12 marks)
Nearly all relevant base case cash flows have been accurately incorporated into the analysis and decision criteria are correct based on your net cash flows (10 marks)

Most relevant base case cash flows have been accurately incorporated into the analysis and decision criteria are mostly correct based on your net cash flows. (8 marks)
About half the relevant base case cash flows have been accurately incorporated into the analysis and decision criteria are mostly correct based on your net cash

flows. (6 marks)
Less than half the relevant base case cash flows have been accurately incorporated into the analysis and decision criteria may be mostly incorrect based on your net cash flows. (0 to 4 marks)

Accurate and appropriate analysis of uncertainty (5 marks)

You have accurately analysed project uncertainty using appropriate techniques. You have shown insight by judicious input choices that are well-articulated and linked to case facts. The analysis is easy to follow. (5 marks)

You have accurately analysed project uncertainty using appropriate techniques and judicious input choices that are mostly well-articulated and linked to case facts. The analysis is easy to follow. (4 marks)

You have analysed project uncertainty using appropriate techniques and mostly judicious input choices that are mostly well-articulated and linked to case facts. The analysis is easy to follow. (3.5 marks)

You have analysed project uncertainty using at least one appropriate technique.

Input choices lack justification, are unreasonable or the analysis is not easy to follow. (2.5 marks)
You have not analysed project uncertainty using appropriate techniques or have attempted to use at least one appropriate technique but with no demonstrated consideration of input choices in a hard to follow analysis or

there are major inaccuracies. (0 to 2 marks)

Appropriate interpretation and recommendations based on the project analysis (8 marks)
You have accurately interpreted the results of your financial analysis and made appropriate and insightful recommendations with the basis of those recommendations clearly and concisely explained.

Recommendations go further than simply accepting or rejecting the project by recognising the subtleties of project decision making and needed additional analysis or considerations. Use of language makes meaning consistently clear; no or very few grammar, syntax and spelling

errors. (8 marks)
You have accurately interpreted the results of your financial analysis and made appropriate recommendations.

Recommendations go further than simply accepting or rejecting the project by recognising some subtleties of project decision making and/or needed additional analysis or considerations.

Use of language mostly makes meaning clear; no or very few grammar, syntax and spelling errors. (6.5 marks)

You have accurately interpreted most of the results of your financial analysis and made some appropriate recommendations. Subtleties of project analysis and decision making have generally not been recognised. Use of language mostly makes meaning clear; several grammar, syntax and spelling errors. (5.5 marks)

You have accurately interpreted some of the results of your financial analysis and made at least one appropriate recommendation. Use of language mostly makes meaning clear; several grammar, syntax and spelling errors. (4 marks)

You have not correctly interpreted most results from your financial analysis or no recommendations have been made or recommendations do not follow from the results or interpretation. Use of language mostly makes meaning unclear; many grammar, syntax and spelling errors. (0 to 3 marks)

5