After ACC management decided to raise the $10.5 million by selling bonds (Problem ST 15.4), the company's engineers estimated the operating costs of the cogeneration project. The annual cash flow is composed of many factors: maintenance, standby power, overhaul costs, and miscellaneous expenses. Maintenance costs are projected to be approximately $500,000 per year. The unit must be overhauled every three years at a cost of $1.5 million. Miscellaneous expenses, such as the cost of additional personnel and insurance, are expected to total $1 million. Another annual expense is that for stand-by power, which is a service provided by the utility in the event of a cogeneration unit trip or scheduled maintenance outage. Unscheduled outages are expected to occur four times annually with each averaging two hours in duration at an annual expense of $6,400. Overhauling the unit takes approximately 100 hours and occurs every three years, requiring another power cost of $100,000. Fuel (spot gas) will be consumed at a rate of $8,000 BTU per kWh, including the heat recovery cycle. At $2.00 per million BTU, the annual fuel cost will reach $1,280,000. Due to obsolescence, the expected life of the cogeneration project will be 12 years, after which Allison will pay ACC $1 million for the salvage of all equipment.
Revenue will be incurred from the sale of excess electricity to the utility company at a negotiated rate. Since the chemical plant will consume (on average) 85% of the unit's 10-MW output, 15% of the output will be sold at $0.04 per kWh, bringing in an annual revenue of $480,000. ACC's marginal tax rate (combined federal and state) is 36%, and the company's minimum required rate of return for any cogeneration project is 27%. The anticipated costs and revenues are summarized in Table ST15.5.
(a) If the cogeneration unit and other connecting equipment could be financed by issuing corporate bonds at an interest rate of 9% compounded annually, with the flotation expenses as indicated in Problem ST 15.4, determine the net cash flow from the cogeneration project.
(b) If the cogeneration unit can be leased, what would be the maximum annual lease amount that ACC is willing to pay?
TABLE ST 15.5

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Initial investment: Cogeneration unit, engineering, design, and site preparation (15-year MACRS class) Interconnection equipment (5-ycar MACRS class) Salvage after 12 years' use Annual expenses: Maintenance Miscellancous (additional personnel and insurance) Stand-by power Fuel Other operating expenses: Overhaul every 3 years Stand-by power during overhaul Revenues: Sale of excess power to Texas Electric $10,000,000 500,000 1,000,000 500,000 1,000,000 6,400 1280,000 1,500,000 100,000 480,000