PROBLEM 132
Given
Solution Legend
First Plant
= Value given in problem
Assume perpetual returns
= Formula/Calculation/Analysis required
IRR
13.00%
= Qualitative analysis or Short answer required
Initial investment
$600 million
= Goal Seek or Solver cell
Annual cash flow
$78 million
= Crystal Ball Input
= Crystal Ball Output
Second Plant
Initial investment
$550 million
Additional Plants
Initial investment
$500 million
NPV Calculation
Cost of capital
15.00%
First plant
$(80.00) million
Second plant
$(30.00) million
Additional plant
$(20.00) million
Cost of capital
14.00%
First plant
$(42.86) million
Second plant
$7.14 million
Additional plant
$57.14 million
Solution
a.
b.
We are evaluating an investment strategy.
c.
The above analysis is based on expected cash flows,
i.e., we assume that cash flows from the power plant
are static. In reality, the NPV captures a range of
scenarios. Over time, one would know which one of
those scenarios (in terms of demand and price of
electricity) will occur. Therefore, to analyze the option
value of a power plant investment strategy, one has
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 Spring '12
 SMITH
 Finance, Net Present Value, initial investment, plant Additional plant

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