Case Studies in Finance (FIN3CSF) Case Study 3: Financial Modelling And Ethical Issues In Finance
CASE STUDY 3: FINANCIAL MODELLING AND ETHICAL ISSUES IN FINANCE
Engie Group, a French-owned global energy company (formerly known as GDF Suez) which
is the current owner and operator of the Loy Yang B power station precinct and operation
located in the La Trobe Valley in South-Eastern Victoria, is assessing the feasibility of the
development and operation of a new coal-fired power station in the La Trobe Valley region.
The basis for this new project proposal is derived from a number of perspectives: i) the
impending de-commissioning of the Loy Yang B power station at the end of its indicative 30
year operating life in 2025; ii) the availability of coal resources in the La Trobe Valley region
to support ongoing coal-fired electricity generation activity; iii) the experience that the
company has in the Victorian electricity market and expectation of ongoing population growth
and demand for electricity provision; iv) uncertainty regarding the expected availability and
sufficiency of alternative electricity generation sources at the proposed time of de
commissioning of the current Loy Yang B power station and v) perceived ongoing profitability
from coal-fired electricity generation activity.
The company has completed some preliminary project development and planning work. The
proposal involves the construction of the new power station in two stages, based on the
following envisaged construction and operational schedule:
Table 1: Project Construction and Operation Summary
Year
2019
Project Activity
Construction begins on the project (assumed to be continuous until 2025)
2024
Commissioning of Generation Unit A
Commissioning of Generation Unit B
2026
2058
2060
Generation Unit A ceases operation (based on a 35-year expected useful life)
Generation Unit B ceased operation (based on a 35-year expected useful life)
As part of this planning the company has forecast the following specifications, requirements
and parameters for the new project:
• The company would need to acquire access to land adjacent to the current coal open-cut
facility it is operating to supply the Loy Yang B power station, which is owned by the State
Government. The project would also need the overall approval of the State and Federal
Governments to develop the project, as it would have a significant impact on electricity
supply to the national electricity grid and also have major consequences for the future
emission targets and objectives both locally and the overall commitment of the Australian
Government to lower environmental emissions 26-28% relative to 2005 emission levels by
2030.
• Generating Units A and B would both be 250 Megawatt (MW) generating units
representing self-generating energy processors functioning on coal as the primary input and
incorporating a steam-to-turbine production method as the method of electricity generation.
A 250MW generating unit operating at full capacity will produce 250 MW hours of
electricity per hour.
• The useful life of each generating unit is 35 years.
• The average operating capacity factor of the power station is expected to be 90%.
• Expected within-station usage of 5% of the total electricity generated.
• The power station generation units are assumed to operate 24 hours a day, 365 days a year
(ignoring leap years and industrial disputes).
• Due to the on-demand (base-load) nature of the electricity-generation process and the
unavailability of a cost-effective storage source, 10% of the available electricity generated,
on average, is not expected to be transmitted to the distribution grid or sold.
• The average tariff at which electricity can be sold to contractual customers (such as
electricity retailers) or the national electricity regulator is $190.00 per Megawatt hour (in
real terms). This tariff takes into account the cost and delivery of coal for operation of the
power station, the replacement value of power station assets and an emission charge
component.
• Operating and maintenance costs (outlined in Table 3 below) incorporate depreciation
allowances on the capital construction costs, Government land charges and duties, staffing
costs, inventory and supplies, and utilities costs (excluding electricity which is accessed
directly from the operation of the power station).
• The company expects to have to pay company tax on profits created by operation of the
power station at an average future marginal tax rate of 25%.
• The average rate of inflation over the life of the project is assumed to be 2.20% per annum.
• The estimated after-tax cost of capital (WACC) for the power station project based on the
envisaged cash flow risk and target financing structure is 8.50% per annum.
• All figures are expressed in June 30, 2016 real dollars.
• All information is as at June 30, 2016.
• Note that 1 Megawatt hour represents 1,000 Kilowatt hours.
Estimated construction costs for the new power station project are as follows:
Table 2: Forecast Project Capital Construction Costs
Year
2019
Estimated project construction costs
$160.5 million
2020
2021
$167.5 million
$160.0 million
2022
2023
$167.0 million
$152.5 million
2024
2025
$110.0 million
$85.0 million
Estimated operating and maintenance costs for the new power station project are as follows:
Table 3: Forecast Annual Operating and Maintenance Costs
Estimated Operating and Maintenance costs
Year
2024
2025
$70.0 million
$95.0 million
2026
2027 – 2058
$118.5 million
$105.0 million
2059
2060
$80.0 million
$65.0 million
Engie Group has hired your consulting firm to conduct the financial modelling and capital
budgeting assessment of the potential power station project, as well as to act as its adviser in
dealing with the State and Federal Governments in negotiating the project approval process.
Required:
This case study requires the completion of the following tasks:
• The development of a spreadsheet model representing the cash flows associated with
the power station project, and the assessment of the project using a range of capital
budgeting evaluating techniques
• The completion of a risk assessment based on conducting sensitivity analysis of the
project valuation focusing on key parameters impacting on the project’s operation,
feasibility and cash flows.
• Based on the project modelling and sensitivity analysis, a recommendation as to the
feasibility of the project.
• The preparation of a proposal for the respective Governments providing justification
for why approval for the project should be provided.
This case study is due to be submitted to the Board of Directors of Engie Group by 5.00pm
on Monday 12th September 2016, via the FIN3CSF LMS site. This case study contributes
15% to the overall final assessment in the FIN3CSF subject. This case study can be
completed in a group of up to a maximum of four people, and the maximum word limit
is the equivalent of 500 words per group member.