Problem 1a: Power Company Can Develop A Hydroelectric Projec

Question

Problem 1a Power Company Can Develop A Hydroelectric Project At One Of A power company is considering developing a hydroelectric project at one of two capacity levels: one megawatt or two megawatts. The costs of construction are $1 billion for the one-megawatt option and $1.75 billion for the two-megawatt option. These costs are incurred immediately. If the company opts for the smaller capacity, it cannot increase capacity later. Revenue from selling one megawatt is $200 million per year, starting three years from now and continuing indefinitely. For the second megawatt, a buyer commits to purchasing power at $300 million per year, but only starting eleven years from now and continuing forever. Assuming an interest rate of 5%, we are asked to find the net present value (NPV) of each option and determine whether the company should invest in 0, 1, or 2 megawatts of capacity.

Dr. Jack HW Helper · Accepted Answer

The decision of whether to develop a hydroelectric project at one or two megawatts involves analyzing the associated costs and revenues through discounted cash flow calculations, considering the time value of money. The NPV criterion helps determine the most financially viable option, considering both initial investments and future cash inflows. This analysis explores the NPVs of constructing zero, one, or two megawatt capacities, guiding strategic investment decisions for the power company. Introduction Hydroelectric projects are critical components of renewable energy strategies, offering sustainable and cost-effective power generation. The scenario presented involves a company choosing among three options: not investing at all (0 MW), investing in a single megawatt (1 MW), or developing a two-megawatt facility (2 MW). Each option entails distinct costs and revenue timings, which must be discounted to present value using a 5% discount rate. This analysis aims to evaluate the NPVs for each capacity level and provide recommendations based on the calculations. Cost and Revenue Structures The initial costs are straightforward: $1 billion for 1 MW and $1.75 billion for 2 MW. If the project is not developed, the company’s investment is zero, and no revenue is generated. The revenue stream for the single megawatt begins three years from now at $200 million annually, with perpetual payments. The potential second megawatt can generate $300 million annually, but only starting eleven years from now. Because revenues are perpetual, they are modeled as perpetuities, and their present values depend on the timing and discount rate. Calculating Present Values of Revenues For the first megawatt, the annual revenue of $200 million starting in year 3 can be modeled as a perpetuity beginning at that time. The present value (PV) of this perpetuity at the current time is: PV = $\frac{Annual\ Revenue}{Discount\ Rate}$ * $ \frac{1}{(1 + r)^{t}} $ But since the perpetuity starts in ye

Problem 1a: Power Company Can Develop A Hydroelectric Projec

Problem 1a Power Company Can Develop A Hydroelectric Project At One Of

Paper For Above instruction

Introduction

Cost and Revenue Structures

Calculating Present Values of Revenues

Calculating NPVs for each option

Discussion and Decision

Conclusion

References