Eval. of Capital Projects for Yorkshire Wind Farm Co.

Evaluation of Capital Projects for Yorkshire Wind Farm Company

Task

You work at the headquarters of the Yorkshire Wind Farm Company and are responsible for the evaluation of capital projects. The business is currently trying to decide between 2 proposed wind farms. One is small and onshore and the other is larger and offshore. Each is expected to have a life of 15 years.

1.Evaluate capital investment projects using a range of techniques including the assessment of risk

The revenue is made up of the amount of electricity generated and the price per Megawatt hour (MGH). Both windfarms are expected to generate 130 MWH per year for the duration of the project.

The changes reflect the expectation that generation costs will reduce in the future and that offshore wind power is less environmentally intrusive but requires more incentives.

It is expected that a full year’s revenue will be available from year 1 onwards.

The following table shows the expected capital costs of each windfarm.

	Onshore	Offshore
Summary of capital costs	£’000	£’000
Preparatory costs (planning, legal etc.)	1,450	2,400
Windturbines (year 0)	7,000	21,000
Windturbines (year 1)	3,000	7,000
Foundations (year 1)	1,000	2,000
Grid connection (year 1)	1,000	1,500
Refurbishment (year 5)	2,000	5,000
Decommissioning (year 15)	3,000	7,000
	18,450	45,900
Less government grant (year 1)	450	900
Net capital cost	18,000	45,000

The accountant has prepared the following forecast Income statements over the life of the projects. They have been prepared on the accruals basis.

Onshore wind farm: projected Income statements (£’000)
Year	1	2	3	4	5	6-14	15	Total
Sales	3,900	3,900	3,900	3,900	3,900	1,950	1,950	39,000
Government grant	30	30	30	30	30	30	30	450
Total revenue	3,930	3,930	3,930	3,930	3,930	1,980	1,980	39,450
Annual operating costs
Maintenance/insurance	250	250	250	250	250	250	250	3,750
Business rates	50	50	50	50	50	50	50	750
Land rental	75	75	75	75	75	75	75	1,125
Annual management fee	25	25	25	25	25	25	25	375
Other energy costs	25	25	25	25	25	25	25	375
Depreciation	1,200	1,200	1,200	1,200	1,200	1,200	1,200	18,000
	1,625	1,625	1,625	1,625	1,625	1,625	1,625	24,375

Profit/(loss)	2,305	2,305	2,305	2,305	2,305	355	355	15,075

Offshore wind farm: projected Income statements (£’000)
Year	1	2	3	4	5	6-14	15	Total
Sales	7,800	7,800	7,800	7,800	7,800	5,850	5,850	97,500
Government grant	60	60	60	60	60	60	60	900
Total revenue	7,860	7,860	7,860	7,860	7,860	5,910	5,910	98,400
Annual operating costs
Maintenance/insurance	500	500	500	500	500	500	500	7,500
Business rates	100	100	100	100	100	100	100	1,500
Land rental	100	100	100	100	100	100	100	1,500
Annual management fee	60	60	60	60	60	60	60	900
Other energy costs	40	40	40	40	40	40	40	600
Depreciation	3,000	3,000	3,000	3,000	3,000	3,000	3,000	45,000
	3,800	3,800	3,800	3,800	3,800	3,800	3,800	57,000

Profit/(loss)	4,060	4,060	4,060	4,060	4,060	2,110	2,110	41,400

a)Payments and receipts arise at the year ends unless otherwise stated.

b)The project is expected to have an anticipated life of 15 years.

c)All costs and revenues are expressed at today’s prices (year zero) with no allowance for inflation.

d)This equipment will have a zero resale value at the end of year 15.

e)The government grant will be received in year 1. However it has been spread over the life of the project in the profit and loss accounts.

f)The preparatory costs have already been incurred.

g)The annual management fees for both projects include a fee of £10,000 which is an apportionment of head office overheads.

h)The refurbishments in year 5 require the use of specialised equipment that will be borrowed from another division of the Company. This will cost the other division additional hire costs of £200,000 per project and is not reflected in the profit and loss accounts.

i)An initial cash reserve is needed for each project. It will be paid back at the end of year 15.

Onshore £1,000K

Offshore £3,000K

j)Ignore corporation tax.

k)The Yorkshire Wind Farm Company has a cost of capital (discount rate) of 10%.

l)They have a current return on capital employed (ROCE) of 12% and this is expected to be met by new projects.

m)They expect projects to have a payback period of no more than 5 years.

a)Enter relevant cash flows into the data input worksheet. Input cash inflows as positive numbers and cash outflows as negative numbers.

b)Perform a sensitivity analysis on both projects. Use the sensitivity worksheet to adjust each variable and enter your results on the sensitivity worksheet. (20 marks)

c)Explain your reasons for any adjustments to the accountant’s figures and as a result of points a) to m) above. You should refer to any relevant accounting concepts. (20 marks)

d)State, with reasons which project you would accept. You should use the figures in the calculations worksheet for Net present value (NPV), Internal Rate of Return (IRR), Accounting rate of return (ARR) and Payback Period (20 marks)

e)Critically evaluate the results of your sensitivity analysis. (20 marks)

f)Discuss critically the contribution expected values could make to the evaluation of the two projects. (You are not expected to do any calculations for this task) (20 marks)

Get instant help from 5000+ experts for