Case Study in Finance

Case Study in Finance in Latrobe University. In this case study, we analysis CS energy in Australia. The company now has a tendency to create and operate a nuclear station the town of Mount Isa in Northwestern Queensland after finishing the planning for this project. In this report, we will assess the feasibility of the development and operation of a nuclear station in terms of both qualitative and quantitative analysis. At the same time, a proposal will be prepared with the aim of convincing Australian Federal Government to allow the project to implement

ISSUES IN FINANCE

Coordinators: Dr Dao Thi Thanh Binh & Dr Darren Henry

Group 5 Student Name : Tran Vi Anh - 18778875

Nguyen Minh Anh - 18778970

Bui Linh Phuong - 18779202 Nguyen Hung Tien -

18779248

Subject: Case Studies In Finance – FIN3CSF Semester 2,2017

Date of submit : 18/09/2017

CS energy, a Queensland State Government-owned electricity generation company is located in Fortitude Valley, Brisbane The company now has a tendency to create and operate a nuclear station the town of Mount Isa in North-western Queensland after finishing the planning for this project In this report, we will assess the feasibility of the development and operation of a nuclear station in terms of both qualitative and quantitative analysis At the same time, a proposal will be prepared with the aim of convincing Australian Federal Government to allow the project to implement

Question 1:

A project spreadsheet model is created based on real terms

i Discount rate

 The real discount rate equals a real required rate of return on capital investment project of 7 percent per annum

 The discount factor =

ii Present value of capital expenditure

Present value of annual capital expenditure is calculated by annual construction costs multiple discount factors

Years Annual Construction costs

iii Electricity generated per year

 Assumes that the nuclear station operates 24 hours for 365 days per year

 The average operating capacity factor of the station is expected to be 95%

 Operation of a 1,000 MW generating unit at full capacity for an hour will

generate 1,000 MW hours of electricity per hour

For electricity generated in 2025 equals 1,000×24×365×0.95=8,322,000 MW hours However, electricity generated in 2024 is different and equals a half of electricity generated in 2025 because the station begin to operate on 1st July

2024

iv Electricity Available for Sales

 10 percent of the total electricity generated to operate the nuclear reaction and associated infrastructure and equipment

v Electricity revenue per year

 The average tariff a which electricity is sold to contractual customers or National Electricity Market equals AUD$190 in real terms

Therefore,

vi Operating and maintenance costs

 Account for 40 percent of the annual revenue per year which cover the costs of power station and nuclear reactor operation, staffing and management, water for use in the reactor and the cooling ponds adjacent to the power station,

equipment, vehicles, inventory and supplies required, and other utilities costs

vii Total Uranium used per year

 The station requires 379.6 kilograms of processed uranium pellets for electricity generation

 1 kilogram equals 35.274 ounces

The uranium used per year = ounces

viii Cost of Uranium used per year

 The cost of uranium used per year is estimated to be AUD$45 per ounce

 The USA$ to AUD$ exchange rate is forecast to average 0.74

 Therefore,

ix Depreciation Allocation

 The construction and related costs can be depreciated using straight-line method over the 50-year operating life of the station

x The cost of uranium stored in land

 The CS energy company will be paid AUD$25 per ounce of uranium pellets stored

xi Dismantle cost

The CS Company spends expenditure cost at the end of the operating life of project The cost is estimated to be $1 billion to dismantle the nuclear power station

xii PV of total Capital Expenditure

xiii Operating profit before tax per year

The Annual real operating profit before tax per year = the annual electricity revenue per year – The annual operating and maintenance costs – the costs of uranium used per year – The cost of uranium stored in land – depreciation – the dismantle cost

xiv Taxation expenditure per year

 30% taxation rate

%30 × the operating profit before tax per year

xv The operating profit after tax per year

xvi Present value of net cash flow per year

xvii Project evaluation techniques



 Profitability index

 Payback period = based on calculation in excel file

 Discounted payback period = based on calculation in excel file

 IRR

Internal rate of return is calculated by using the IRR formula in excel According

to the calculation in excel, IRR equals 8.751 percent

Question 2:

Because of the 50-year project (long-term), we may not see all pieces of factors that influence on the project even when having a good plan Some factors have negative or positive impacts on the projects And these factors lead a change to NPV outcome For instance, the average tariff price is expected to be purchased to customers is AUD$190 per megawatt hour However, the price can increase or decrease due to the factors such

as uranium cost, policy from government about electricity and other competitors Therefore, sensitivity and scenario analysis are considered as affective tools to monitor key input factors which influences on changing in NPV and profit for investment Key relevant factor tested here are real required rate of return, the average tariff, the exchange rate, taxation rate, the average capacity factor, generator capacity, cost of uranium stored and used, uranium required, cost of operating and maintenance and the electricity used for facility and equipment

Regarding the sensitivity analysis, we will check impact of a factor on NPV outcome

by substituting a range of possible value for this input factor with base value at the center position and other factors keep stable For example, in order to test impact of real require rate return on NPV, we set a range of input from 5.25% to 8.75% and 7%

of based value at center Sensitivity formula aims to determine quantitatively which factor is more sensitive to NPV It means that when the factor has the highest sensitivity ratio, it is the most sensitive to a change in NPV outcome

It can be clearly that in the above table, NPV outcome is the most sensitive with a change in real required rate of return because of the highest sensitivity ratio (absolute value is greater than 1) When real required rate of return increases by 1 percent, it causes a decrease by 4 percent – 4.89 percent of NPV outcome Otherwise, when required rate return decreases by 1%, NPV outcome increases by 5.26% - 6.64% Sensitivity ratio brings negative value and it indicates that the relationship between NPV and real required rate of return is negative These factors such as the average

tariff, the average capacity factor and generator capacity are more sensitive to NPV outcome because these factors give quite high sensitivity ratio which is 4.37% It means that when 1% changes in the average tariff, the average capacity factor or generator capacity, NPV decreases or increases by 4.37% Other factors also strongly influence on NPV outcome are taxation rate and operating and maintenance cost with absolute sensitivity ratios greater than 1 (1.61% and 2.92% respectively) The rest of factors are the exchange rate, cost of uranium stored, cost of uranium used, uranium required and electricity used for equipment and nuclear reactor which do not have significant impacts on NPV In detail, the sensitivity ratio of the exchange rate, cost of uranium stored, cost of uranium used, uranium required and electricity used for equipment and nuclear reactor are 0.0037%-0.0048%, 0.0017%, 0.00417%, 0.0059% and 0.49% respectively All related calculation is demonstrated in Question 2 Sensitivity analysis sheet In conclusion, real required rate of return, the average tariff, the average capacity factor, generator capacity are the most sensitive to NPV outcome The operating and maintenance cost strongly influence on NPV as well

In term of scenario analysis, we would have two assumptions: the best case and the worst case For the worst case, we assume that some factors have negative relationship

with NPV and strong impacts on NPV such as required rate of return, operating and maintenance costs which increased by 4% and 5% respectively The average tariff and the average capacity factor have strong positive relationship with NPV which decrease

by 6% For the best case, we assume that required rate of return, operating and maintenance cost, taxation rate decreased by 4%, 5% and 5% respectively whereas the average tariff increases by 6% Other factors have a few impact on NPV such as the exchange rate, cost of uranium used and stored we remain unchanged

Relevant

factors

Relationship with NPV The worst case Base Case The Best Case

The average

The average

operating

capacity factor

Operating and

NPV (AUD$) 242,270,123.177 1,214,410,978.948 2,118,891,890.459

It can be clearly seen that the results of NPV after varying key factors are different at both the best and worst case NPV at the best case equals AUD$ 2,118,891,890.459 while NPV at the worst case is AUD$242,270,123.177 At the worst case, NPV decreases by AUD$1,876,621,767.282 The difference between NPV in the worst case and best case indicates that these factors discussed above strongly influence on the financial performance of the nuclear power station

Question 3:

According to Lumen 2017, the NPV indicates that it can determine whether or not financial decision of the firm is smart for investment opportunity If NPV is positive, it means that the value adding to revenues (cash inflows) is larger than the costs (cash outflows) The investment brings profits for investors For the case of CS Energy company, investment in nuclear power station has positive NPV (AUD$1,214,410,978.948) Positive NPV of this project means that this investment should be undertaken because it will increase wealth and add value to the investors In addition, we also see positive signals for this project when we assess this investment by using alternative project evaluation like IRR, Profitability index, discounted payback period and payback period First, the IRR (8.751%) is higher than real required rate of return (7%) It shows that this project is worth pursuing and it gets sufficient return to meet the required rate of return Although the IRR is greater than real required rate of return, IRR is low and earning returns may be low and stead because of long-term project However, this project still can add a larger amount of value to the firm over time Second, the payback period of undertaken project is a significant determinant of whether to invest or not According to calculation in excel file, we get payback period for this investment equal 15.5797 years in comparison with the 50 years of operating life It demonstrates that the time for recovering cost of investment is quite short Regarding the discounted payback period, CS energy takes 27.1928 years with the purpose of breaking even from undertaking initial capital expenditure Last, this project generates profitability index which equals 1.276559674 (greater than 1) If profitability index is greater than 1, the nuclear power project is profitable and it brings a green signal to undertake this project based on the profitability index rules Besides, CS energy should consider controlling some input factors as we discussed above in sensitivity and scenario analysis to avoid dropping in NPV

In term of qualitative aspects associated with project, we also should consider nuclear capability, environmental impacts, policy related to nuclear, safety of workers, political issues as well as location issues As we may know that Australia accounts for 33% of the world’s uranium deposits and is one of three producers of uranium after Canada and Kazakhtan Therefore, uranium used for the station is not CS energy’s concern The firm does not import these materials from overseas and it uses uranium sources from domestic It leads to eliminate cost of logistics However, exploiting uranium for nuclear power is quite risky Uranium enrichment sometimes is used to make more weapon than to do the world better The world will have the third war which is the same as the Second World War in history because the militant and terrorist organizations hold nuclear weapon Furthermore, the radioactive waste coming from nuclear power plants brings a great threat to human and ecosystems Not only Australian people but also all people in the world still remember the Chernobyl event Millions of Ukrainians now face with the health tribulations related to nuclear waste (Conserve-energy-future 2017) Thus, concerning about power plan failure is rising in our humans’ minds According to Conserve-energy-future, they states that the next disadvantage of nuclear energy may belong to storage of depleted uranium materials The waste come from nuclear enrichment must be processed safety and conveniently The reason is that they are tremendous, emits radiation many years and cannot cover radiation when processing radioactive waste in the incorrect ways However, it can be handled by offering remarkable cooling and shielding from water

In general, according to qualitative analysis, CS energy strongly considers the issues from qualitative and ethical when implementing the project However, in terms of quantitative analysis, the firm would like to undertake to operate the nuclear power station because of outperforming outcome

Question 4:

The result of this project convinces that Australian Federal Government should allow

CS Energy to implement this nuclear power station because this project brings many benefits to Australia

In terms of valuation outcome of this project, not only NPV outcome for the project is positive number at base values, but also sensitivity and scenario analysis indicates that NPV still keeps positive number when some major input parameters vary including real required rate of return, the average tariff and costs Furthermore, the initial capital expenditure equals AUD$ 5,750 billion which would cover after 15.5 years according

to the payback period number The discounted payback period (27.1928 years) is also a good signal compared with the 50 years of operating life Specially, the greater internal rate of return in comparison with the real required rate of return demonstrates that the financial performance of this project is quite great and adds more value to investors Furthermore, the taxation contribution that the project will contribute to Federal Government is estimated to AUD$11,237,419,656.41 (not include discounted rate factor)

Net present value of project (NPV) $1,214,410,978.948

Discounted payback period 27.1928 years

In the next part, we will list some evidences below why this project is potential and necessary to Queensland and National Electricity demands in the future