Reference no: EM132597025

Question - You work for the regulatory agency for power companies and have been assigned the task of determining what price they should be allowed to charge customers for electricity. Your mission is to ensure that they do not earn more than their cost of capital and you have been given the following information about a typical power company investment.

The typical power plant takes five years to become operational and requires $50 million in investment each year for those five years.

The life of a plant, after it becomes operational, is 25 years, during which period the revenues and cash flows are expected to remain constant. The plant has the capacity to generate 150 million kwh of power each year.

The annual fixed cost of operating the plant is $ 25 million and the variable cost per kwh of power is 2 cents. Neither of these costs is expected to change over the lifetime of the plant.

The cost of capital for a power plant is 8% and the marginal tax rate is 40%.

You can assume that the plant has no salvage value at the end of its 30-year lifetime and ignore depreciation on the initial investment.

a. Estimate the present value of the investment in the plant - i.e., $ 50 million a year for the next five years.

b. Given the present value of the investment in part a, how much will the plant have to generate in annual after-tax cash flows from years 6-30 for the net present value to be zero?

c. If your objective is to ensure that the net present value is zero, estimate the price per kwh you will allow them to charge.