15
UNIVERSITY OF TECHNOLOGY SYDNEY
Faculty of Engineering and Information Technology
Energy Planning and Policy Program
49021 Evaluation of Infrastructure Investments
XXXXXXXXXXAutumn Semester 2018
Assignment # 1
Due 16 April
Notes:
1. This assignment is worth 15 percent of the total mark for this subject.
2. Stay within the specified page/line/word limits. There is no tolerance on these limits.
3. The minimum permissible font size for the report is 12 (Times Roman) or equivalent.
4. The Answer Sheet for this assignment should be uploaded using the appropriate link on
UTSOnline.
PART A: EVALUATION OF INVESTMENT PROPOSALS
XXXXXXXXXXmarks)
This part of the assignment is about the evaluation of two project proposals. The main objective
of this analysis is to ascertain the financial and socio-economic viabilities of the two
proposals. The capital cost of each of these proposals is $10billion (bn). Other details are
provided below.
Proposal A
Proposal A envisages generation of electricity from water - a hydro-electric project. The useful
economic life of this project is estimated to be 50 years. This project will generate 20,000
million (mn) units of electricity annually. Electricity will be sold to the public at a tariff of 10
cents per unit for the first twenty years, and 7.8 cents thereafter. The annual operation and
maintenance costs will be 10 percent of the capital cost for the first twenty years and 5 percent
thereafter.
The socio-economic costs and benefits for this project can be estimated from Figure 1.
Proposal B
Proposal B is a thermal project - electricity will be generated from coal. The annual operation
and maintenance cost for this project will be 25 percent of its capital cost. This project will
have a useful economic life of 25 years. It will generate 18,000mn units of electricity annually.
Electricity from this project will be sold at 20 cents per unit. At the end of its useful life, this
project can be sold for 2 percent of its capital cost.
The socio-economic costs and benefits for this project can be estimated from Figure 2.
Task
Your task is simply to summarize the results of your analysis in the answer-sheet provided
separately.
Notes:
• You must provide the background details (i.e., select calculations), for various answers
provided by you in the answer-sheet, in an Annexure (no more than two pages). The
minimum permissible font size for the Annexure is 12 (Times Roman or equivalent).
• The completed answer-sheet must however be a stand-alone document (i.e., the reader
should be able to understand the entire logic behind your reasoning without needing to refer
to the Annexure.
• Please tick (√) only one box wherever multiple choice is provided.
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Assumptions (common to both proposals)
• All capital costs are incu
ed at time t=0 (i.e., ignore project construction time).
• Social costs and benefits (Figures 1 and 2):
- costs and benefits are all inclusive, i.e., costs include capital as well as
operation and maintenance costs, and benefits include revenue and salvage
value;
- costs and benefits remain unchanged throughout the useful economic lives of
the two projects; and
- electricity market is a ‘monopoly’ market.
• The ‘Apparent’ discount rate for hydro projects is 13.3 percent. The ‘Real’
discount rate for thermal project is 10. Inflation – applicable for both projects - is
expected to be 3 percent over the project life. Coal price is likely to escalate by 2
percent.
4
Marginal Cost
ATC
22
17
11.6
18,000
Marginal revenue
Cents/unit
Output (Mn Units/year)
Figure 2: Social Cost and Price Structure: Proposal B
Demand 8
A
C B
D
E
F
G
H I J
O
Marginal Cost
ATC
15
11 11
6
20,000
Marginal Revenue
Cents/unit
Output (Mn Units/year)
Figure 1: Social Cost and Price Structure: Proposal A
Demand
4
A
C B
D
E
F
G
H I J
14
9 K L M
K L M
O
Figures 1 and 2 are Not-to-Scale
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PART B: RATE OF RETURN
(15 marks)
Private electricity utilities often argue that public electricity utilities earn the same rate
of return as their private sector counterparts and that the returns for public utilities be
computed on the basis of the private sector’s cost of capital.
a) Please provide possible reasoning behind this argument (no more than three
lines).
) Do you agree with this reasoning? (Yes or No)
c) Why? (no more than three lines)
PART C: OPPORTUNITY COST
(20 marks)
Provide a philosophical critique of the concept of ‘Opportunity Cost’ as a means to
determine economic costs while evaluating large electricity infrastructure projects (no
more than two dot points with each dot point no more than two lines).
PART D: APPROPRIATENESS OF ‘NPV’
(20 marks)
Please review the following articles:
Berkovitch, Elazar and Israel, Ronen XXXXXXXXXXWhy NPV Criterion does not Maximize
NPV, The Review of Financial Studies, Spring 2007, Vol.17, No.1, pp XXXXXXXXXX.
Ross, Stephen A XXXXXXXXXXUses, Abuses, and Alternatives to the Net-Present-Value
Rule, Financial management, Vol. 24, No. 3, Autumn 1995, pp XXXXXXXXXX.
Based on your review, please answer the following questions:
a) What is the ‘common theme’ that is discussed in each of these articles? (No
more than two lines.)
) What is the ove
iding perspective offered by each of these articles in
elation to the common themes noted above? (No more than two lines for
each article.)
c) Do you agree with this perspective? (Yes or No – on word only, for each
article.) Provide reasoning in support of your answer. (No more than two
lines for each article.)
PART E: ‘INTEREST’
(20 marks)
In some cultures, charging of ‘interest’ (and its precursor ‘usury’) was historically
considered undesirable. In some cultures, it still is? The use of interest rate is however
commonplace in modern public discourse?
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Why was/is charging of ‘interest’ viewed negatively by some cultures? (no more
than three lines).
What developments may have contributed to the transformation of the viewpoints on
‘interest’ – from being undesirable, to being desirable, to being indeed imperative?
(no more than two ‘dot’ points, with each dot point no more than two lines).
Name
Name:
49021 EVALUATION OF INFRASTRUCTURE INVESTMENTS
Assignment # 1 (Autumn 2018)
ANSWER-SHEET
PART A
1. Please summarize your results in the table below (5 Marks)
Financial
Socio-economic
Proposal A
Proposal B
Proposal A
Proposal B
NPV
IRR
PB
LCC
EAC
B/C
CS
PS
TS
Note: NPV, LCC, and EAC, CS, PS, and TS must be rounded off to the nearest billion dollars (i.e., no decimal places); PB and IRR to the nearest whole numbers (i.e., no decimals), and B/C - to just one decimal place.
2. Which proposal will you recommend from Economic Perspective? (4 Marks)
XXXXXXXXXXA XXXXXXXXXXB Either XXXXXXXXXXNeithe
Why? Because _____________________________________________________________
____________________________________________________ (no more than 10 words)
3. Will your recommendation (based on financial perspective) change if – due to malfunctioning technology - the useful economic life of project A gets reduced to 25 years)? (4 Marks)
Yes No
Why? Because _____________________________________________________________
____________________________________________________ (no more than 10 words)
4. Will your recommendation (based on socio-economic perspective) change if there was hyper-inflation over the useful life of this project (i.e., the discount rate is infinite) and the price of coal escalates by 20 percent instead of the estimated value of 2 percent? (4 Marks)
XXXXXXXXXXYes XXXXXXXXXXNo
Why? Because _____________________________________________________________
____________________________________________________ (no more than 10 words)
5. Will your recommendation (based on socio-economic perspective) change if the construction time for each project is 5 years and the capital cost ($10 bn) is evenly spread over these five years (i.e., $2bn per year)? (4 Marks)
XXXXXXXXXXYes XXXXXXXXXXNo
Why? Because _____________________________________________________________
____________________________________________________ (no more than 10 words)
6. Will your recommendation (based on socio-economic perspective) change if – due to un-anticipated depressed state of the economy – the government decides to provide electricity to consumers (generated by both projects) for free for the first ten