How would this lower capacity factor alter project NPV? 1 answer below »

In December 2005 Mid-American Energy brought online one of the largest wind farms in the world. It cost an estimated $386 million and the 257 turbines have a total capacity of 360.5 megawatts (mW). Wind speeds fluctuate and most wind farms are expected to operate at an average of only 35% of their rated capacity. In this case, at an electricity price of $55 per megawatt-hour (mWh), the project will produce revenues in the first year of $60.8 million (i.e., .35 × 8,760 hours × 360.5 mW × $55 per mWh). A reasonable estimate of maintenance and other costs is about $18.9 million in the first year of operation. Thereafter, revenues and costs should increase with inflation by around 3% a year.

Conventional power stations can be depreciated using 20-year MACRS, and their profits are taxed at 35%. Suppose that the project will last 20 years and the cost of capital is 12%. To encourage renewable energy sources, the government offers several tax breaks for wind farms.

a. How large a tax break (if any) was needed to make Mid-American's investment a positive-NPV venture?

b. Some wind farm operators assume a capacity factor of 30% rather than 35%. How would this lower capacity factor alter project NPV?