Instructions

$1)$Show ALL the formulas and computations

$2)$ In your computations, use the $M scale $($where required$).$ For example, use $$200$ for $$200$M and NOT $$200,000,000.$ Round$-$off your figures$/$numbers to TWO decimal points where necessary.

Vemoxa Corp. is an electricity supplier in the US$.$ The company has historically generated the majority of

its electricity using a coal fueled power station, but as a result of the closure of many coal mines and

depleted coal resources, it is now considering what type of new power station to invest in$.$ For the past

one year, the firm has been conducting feasibility studies and has identified two alternative power

generation projects. The alternatives are a gas fueled power station, or a new type of efficient nuclear

power station. The cost of feasibility study is $$4$ million and $$7\mathrm{.}5$ million for gas and nuclear plan

respectively. Both types of power station are expected to generate annual revenues at current prices of

$$800$ million. The expected operating life of both types of power station is $25$ years. You are provided

with the following financial estimates $($$ millions$)$

Other information:

i$)$ Whichever power station is selected, electricity generation is scheduled to commence in three

years' time $($end of year $3).$ All cash flows arise at the end of each period.

ii$)$ If gas is used, most of the workers at the existing coal fired station can be transferred to the

new power station. After$-$tax redundancy costs are expected to total $$4$ million in year four. If

nuclear power is selected, fewer workers will be required, resulting in more lay$-$offs. The after$-$

tax redundancy costs will total $$36$ million, also in year four.

iii$)$ The cost of building either of the power stations would be payable in two equal installments in

one$-$ and two$-$years' time $($end of years $1$ and $2).$

iv$)$ The existing coal fired power station would need to be demolished at a cost of $$10$ million in

three years' time.

v$)$ Both projects would be partly financed with US dollar$-$denominated bonds priced at par value.

The firm would issue $6\mathrm{.}914\%$ coupon rate bonds for the gas power project while the coupon

rate for the nuclear project would be at $8\mathrm{.}429\%,$ reflecting the impact of financial gearing of a

larger bond issue.

vi$)$ In estimating the cost of equity of each project, the firm has decided to use industrial betas

which are known to be more stable than the firm's beta.

vii$)$ The gas project would be financed with $25\%$ debt, $75\%$ equity. However, the gas industry has

an average gearing of $40\%$ debt, $60\%$ equity. The average beta of the gas generation industry

is $1\mathrm{.}0707.$

viii$)$ The nuclear project would be financed with $30\%$ debt, $70\%$ equity. However, the average

gearing of listed firms in nuclear power industry is $50\%$ debt, $50\%$ equity. The average beta of

the nuclear power industry is $1\mathrm{.}569.$

ix$)$ The interest rate of US Treasury bonds has averaged $3\%$ per year and the market risk

premium has historically $10\%$ per year.

x$)$ Corporate tax is at the rate of $30\%,$ payable in the same year that the liability arises.

xi$)$ The general Inflation rate is currently $3\%$ per year in the US and is expected to remain at that

level in the foreseeable future.

xii$)$ Tax deductible depreciation is at the rate of $10\%$ per year on a straight line basis.

xiii$)$ At the end of twenty$-$five years of operations, the gas plant is expected to cost $$25$ million $($after

tax $)$ to demolish and clean up the site. Costs of decommissioning the nuclear plant are much

less certain and could be anything between $$500$ million and $$1,000$ million $($after tax$)$

depending upon what form of disposal is available for nuclear waste.

Required:

a$)$ Compute the WACC or discounting rate to be used to evaluate the free cash flows $($FCF$)$ of each project. In computing betas and WACC use $4$ decimal points accuracy but the final WACC should be rounded to a whole number.

b$)$ Generate the FCF of each investment alternative. Estimate the expected NPV of EACH investment alternative. $($HINT: It is recommended that annuity FCF be used as much as possible and wherever possible.

c$)$ State $6$ qualitative factors you must consider when making the final decision regarding the two alternatives