1. Two commonly used methods of financial analysis are payback and present value. Payback determines the length of time for an investment to return its original cost (1). Using the assumptions stated below the payback of the Jiminy Nick wind turbine with a cost of about $3.3 million would return the investment in about four years time. Net present value summarizes the initial cost of an investment, the estimated annual cash flows, and expected salvage value, taking into account the time value of money (1). A NPV calculation for the scenario SED is reviewing equals $7,697,286 minus the investment costs of $3,318,000 totaling $4,379,286.
The capital budgeting analysis reflects the assumptions stated in the case scenario that the initial investment cost and installation of the wind turbine is $3,900,000 and there is a grant available from the Renewable Energy Trust Fund in the amount of $582,000. A bank loan of $3,300,000 at 7.3% will be obtained leaving an $18,000 difference. The turbine will follow MACRS double-declining balance depreciation schedule for a period of five years including half-year depreciation in the first and last recovery years. Jiminy Peak has an income tax rate of 40%. The company has sufficient taxable income to benefit from any deductions and credits available, and the after-tax weighted average cost of capital of 6%. The turbine’s useful life is 25 years with no terminal disposal value. There will be $100,000 net cash inflow from extended operations and it is referring to after-tax profit, and the $75,000 cost and $166,667 RECs will continue at that level for the remaining years of the wind turbine’s life cycle.
The cash flows for the net present value are stated in Table 1-A attached. According to these calculations the payback should be reached in about the fourth year of operation when the accumulated net savings totals $3,352,921(1).