Fuelit (FS, 12/00) Fuelit plc is an electricity supplier in the USA.

The company has historically generated the majority of its electricity using a coal fuelled power station, but as a result of the closure of many coal mines and depleted coal resources, is now considering what type of new power station to invest in. The alternatives are a gas fuelled power station, or a new type of efficient nuclear power station. Both types of power station are expected to generateannual revenues at current prices of $800 million. The Expected operating life of both types of power station is 25 years. Financial estimates: Gas Nuclear $m $m Building costs 600 3,300 Annual running costs (at current prices) 75 20 Labor costs Gas purchases 500 Nuclear fuel purchases 10 Customer relations 5 20 Sales and marketing expenses 40 40 Interest expense 51 330 Other cash outlays 5 25 Accounting depreciation 24 132 Other information: (a) Whichever power station is selected, electricity generation is scheduled to commence in three years' time. (b) 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 and after tax redundancy costs will total $36 million, also in year four. (c) Both projects would be financed by Eurobond issues denominated in Euros. The gas powered station would require a bond issue at 8.5% per year. The bond for the nuclear project would be at 10%, reflecting the impact on financial gearing of a larger bond issue. (d) Costs of building the new power stations would be payable in two equal installments in one and two years' time. (e) The existing coal fired power station would need to be demolished at a cost of $10 million after tax in three years' time. (f) the gas (g) The company's equity beta is expected to be 0.7 if the gas station is chosen and 1.4 if nuclear station is chosen. Gearing (debt to equity plus debt) is expected to be 35% with and 60% with nuclear fuel. The risk free rate is 4.5% per year and the market return is 14% per year. Inflation is currently 3% per year in the US and an average of 5% per year in the member countries of the Euro bloc in the European Union. Corporate tax is at the rate of 30% payable in the same year that the liability arises.

(h)

(i) Tax allowable depreciation is at the rate of 10% per year on a straight line basis. (j) 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) Estimate the expected NPV of each of investment in a gas fuelled power station and investment in a nuclear fuelled power station. State clearly any assumptions that you make. (Note: It is recommended that annuity tables are used wherever possible) (b) (c) (20 marks)

Discuss other information that might assist the decision process. (8 marks) An external advisor has suggested that the discount rate for the costs of decommissioning the nuclear power station should be adjusted because of their risk. Discuss whether or not this discount rate should be increased or decreased. (4 marks) (Total = 32 marks)

Natural (6/08) Natural is a listed company in the Green chili business. You are a senior financial management advisor employed by the company to review its capital investment appraisal procedures and to provide advice on the acceptability of a significant new capital project-the Green Onions. The project is a domestic project entailing immediate capital expenditure of $800 million at 1 July 20X8 and with projected revenues over five years as follows: 30 June 30 June 30 June Year ended 20X9 20Y0 20Y1 20Y2 20Y3 Revenue ($ millions) 680.00 900.00 900.00 750.00 320.00 Direct costs are 60% of revenues and indirect, activity based costs are $140 million for the first year of operations, growing at 5% per annum over the life of the project. In the first two years of operations, acceptance of this project will mean that other work making a net contribution before indirect costs of $150 million for each of the first two years will not be able to proceed. The capital expenditure of $800 million is to be paid immediately and the equipment will have a residual value after five years' operation of $40 million. The company depreciates plant and equipment on a straight-line basis and, in this case, the annual charge will be allocated to the project as a further indirect charge. Preconstruction design and contracting costs incurred over the previous three years total $50 million and will be charged to the project in the first year of operation. The company pays tax at 30% on its taxable profits and can claim a 50% first year allowance on qualifying capital expenditure followed by writing down allowance of 40% applied on a reducing balance basis. Given the timing of the company's tax payments, tax credits and charges will be paid or received twelve months after they arise. The company has sufficient other profits to absorb any capital allowances derived from this project. The company currently has $7,500 million of equity and $2,500 million of debt in issue quoted at current market values. The current cost of its debt finance is $LIBOR plus 180 basis points. $LIBOR is currently 5 40%, which is 40 basis points above the one month Treasury bill rate. The equity risk premium is 3.5% and the company's beta is 1 40. The company wishes to raise the additional finance for this project by a new bond issue. Its advisors do not believe that this will alter the company's bond rating. The new issue will incur transaction costs of 2% of the issue value at the date of issue. Required (a) Estimate the adjusted present value of the project resulting from the new investment and from the refinancing proposal and justify the use of this technique. (14 marks) Estimate the modified internal rate of return generated by the project cash flows, excluding the effects of refinancing. (6 marks) (Total = 20 marks)

(b)