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ACCA · Question 19 · Investment Appraisal

CASE 4: SOLARIS GRID

Solaris Grid is a public utility company evaluating a new 4-year solar infrastructure project. The project requires an initial investment of $8,000,000 in solar panels and equipment.

The equipment will attract tax-allowable depreciation (capital allowances) at 25% per year on a reducing balance basis. The company expects to sell the equipment at the end of Year 4 for $1,500,000.

The project will generate an additional 10,000 MWh of electricity per year. The current price of electricity is $400 per MWh, but this is expected to inflate by 5% per year.
Operating costs are currently $1,200,000 per year and are expected to inflate by 3% per year.

The project requires an initial working capital investment of $500,000 at Year 0, which will be fully recovered at the end of Year 4.

Solaris Grid pays corporate tax at 20%, payable in the year the profit is generated. The company's nominal after-tax cost of capital is 10%.

Required:
(a) Calculate the Net Present Value (NPV) of the solar infrastructure project and recommend whether it should be accepted. (15 marks)
(b) Discuss the concept of 'Real Options' in investment appraisal and identify two real options that Solaris Grid might possess regarding this project. (5 marks)

How to approach this question

For part (a), set up a standard NPV proforma. Inflate revenues and costs separately. Calculate tax on net operating cash flows. Calculate capital allowances and the resulting tax shield (remember the balancing allowance in Year 4). Include working capital and scrap value. Discount at 10%. For part (b), define real options and apply them to the scenario (e.g., expand, abandon, delay).

Full Answer

This is a comprehensive investment appraisal question. It tests the ability to handle specific inflation rates (revenues at 5%, costs at 3%), calculate tax liabilities, compute reducing balance capital allowances with a final year balancing adjustment, and manage working capital cash flows. The real options section tests theoretical understanding of managerial flexibility beyond static NPV.

Common mistakes

Applying inflation to the net cash flow instead of revenues and costs separately. Forgetting the balancing allowance in the final year. Forgetting to recover working capital.
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