？？Section A – BOTH questions are compulsory and MUST be attempted？？
The Seal Island Nuclear Power Company has received initial planning consent for an Advanced Boiling Water Reactor. This project is one of a number that has been commissioned by the Government of Roseland to help solve the energy needs of its expanding population of 60 million and meet its treaty obligations by cutting CO2 emissions to 50% of their 2010 levels by 2030.
The project proposal is now moving to the detailed planning stage which will include a full investment appraisal within the financial plan. The financial plan so far developed has been based upon experience of this reactor design in Japan, the US and South Korea.
The core macro economic assumptions are that Roseland GDP will grow at an annual rate of 4% (nominal) and inflation will be maintained at the 2% target set by the Government.
The construction programme is expected to cost $1 billion over three years, with construction commencing in January 2012. These capital expenditures have been projected, including expected future cost increases, as follows:
Generation of electricity will commence in 2015 and the annual operating surplus in cash terms is expected to be $100 million per annum (at 1 January 2015 price and cost levels). This value has been well validated by preliminary studies and includes the cost of fuel reprocessing, ongoing maintenance and systems replacement as well as the continuing operating costs of running the plant. The operating surplus is expected to rise in line with nominal GDP growth. The plant is expected to have an operating life of 30 years.
Decommissioning costs at the end of the project have been estimated at $600 million at current (2012) costs. Decommissioning costs are expected to rise in line with nominal GDP growth.
The company’s nominal cost of capital is 10% per annum. All estimates, unless otherwise stated, are at 1 January 2012 price and cost levels.
Required:
Produce a preliminary briefing note which, on the basis of the above information, includes:
(i) An estimate of the net present value for this project as at the commencement of construction in 2012. (11 marks)
(ii) A discussion of the principal uncertainties associated with this project. (7 marks)
(iii) A sensitivity of the project’s net present value (in percentage and in $), to changes in the construction cost, the annual operating surplus and the decommissioning cost. (Assume that the increase in construction costs would be proportional to the initial investment for each year.) (6 marks)
(iv) An explanation of how simulations, such as the Monte Carlo simulation, could be used to assess the volatility of the net present value of this project. (4 marks)
Note: the formula for an annuity discounted at an annual rate (i) and where cash flows are growing at an annual rate (g) is as follows: