1: Since the small island has been hurt by a downshift in tourism, we could help the economy by providing a one-time “tax” for the pollution. This would present an immediate Carbon Offset of $13,000,000. I know some of the senior members of the management would like to use this as a marketing tool and know the money could be used to help the local government fund items that were cut because of previous missed tax revenues from the lack of tourism to the island. 

Option 2: The powerplant could be shut down completely and we could install a power cable that runs from one of the other nearby islands that has a powerplant. This powerplant will still produce just as much pollution as the one on our island, but it is under a different government that does not care about air pollution. This would cost the cost our company $1,000,000 at the end of the year, $3,000,000 at the end of next year and $1,000,000 yearly thereafter for maintenance. 

Option 3: The powerplant can be retrofitted with scrubbers that can reduce the pollution emissions and make the powerplant green. The cost of this project would be $7,500,000 at the end of this year and $100,000 for the next 50-years for maintenance. Market Conditions The current market conditions have a 12 percent market risk premium on the powerplant with the risk-free rate being 5-percent. The local government has a fixed tax rate of 35 percent. Senior management will ask about the cost to raise capital and we will have to calculate the WACC. The current capital structure of the company is as follows: 

Debt – 7,000 outstanding bonds, at 7.5% coupon and 20 years to maturity. 

These bonds pay interest semiannually and quoted a price of 108 percent of par. 

Common Stock -180,000 shares outstanding, selling for $50 per share: Beta .90.

Preferred Stock – 8,000 shares of 5.5 percent preferred stock outstanding, currently selling for $95.00 per share. 

The Decision 

The senior management team will expect me to report the cost of all three projects. I will have to provide the calculations and thoughtful considerations of the three ideas and concepts presented in the case to offer new thoughts and insights relating directly to this topic. I will have to support my answers with calculations and scholarly resources that will provide the best solution to the problem. I know that in the past, senior management has historically chosen the cheapest options to solve problems and will expect to see all financial models in Excel documents while also providing a narrative explaining the different options to solve the problem.

Answer rating: 100% (QA)

Solution Formula for Weighted Average Cost of Capital WACC is EV Re DV Rd 1 Tc where Re Cost of Equi... View the full answer