Net Present Value (NPV) examines financial performance in absolute terms. How does this differ from Benefit/Cost Ratios and Internal Rate of Return (IRR)?

MGT252. Project Finance and Budgeting
Assignment 5

1. Net Present Value (NPV) examines financial performance in absolute terms. How does this differ from Benefit/Cost Ratios and Internal Rate of Return (IRR)?
2. Net Present Value requires the computation of a discount rate. Discuss the challenges this presents to an organization.
3. What is the fundamental premise of Benefit/Cost Analysis? What is the value of this analysis? What are some of the risks?

CASE STUDY: Building a Wind powered electrical generating plant
Background
Integration of wind generation into a wholesale power supply portfolio requires a proper balance between the operating characteristics of base load generation, power purchase agreement flexibility and cost of service objectives. Purchasing or generating wind power has an associated expense that must be addressed as the wholesale power supplier meets its obligation to supply a reliable, affordable and balanced supply of wholesale electric energy and related services to its member systems. The integration of wind generation into a power supply portfolio can be challenging and the “all in” costs associated with this resource must be objectively considered in order to accurately reflect the contribution this resource will make to supply portfolio pricing.
Results of a Feasibility Study
A feasibility study was carried out to see what the costs and consequences would be of building the Wind powered electrical generating plant. Basic data on anticipated costs and benefits are provided in Table A and B respectively.

Table A
Year -> 1 2 3 4 5 6 7 8 9 10
Initial capital costs 300 600 500
Cost of operations 40 42 50 46 52 61 59
Anticipated maintenance 25 42 35 41 27 29 31
Other costs 80 80 65 40 44 24 15 16 19 18

TOTAL 380 680 565 105 128 109 102 95 109 108

Table B
Year -> 1 2 3 4 5 6 7 8 9 10
Income to Cooperative 45 101 122 135 136 175 201 220
Secondary income generation effects 85 119 122 163 201 305 412 415 453 487

TOTAL 85 119 167 264 323 440 548 590 654 707

1. What is the undiscounted Benefit/Cost of the project?
2. If this project could be financed at a rate of 10%, could it be economically justified? Why?
3. What is the Net Present Value of this project using a discount rate of 10%?
4. In what year does this project break even? Is this timeframe acceptable? Why?


 

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