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.

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.

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 undelivered beta, adjusted

for cash, then a pure play wind electricity generating company, listed on the same stock market as

ABC. Undelivered 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, summaries

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.