Group Assignment Project
BFF5250 Corporate Treasury Management
Group Q
Genesis Energy, L.P. (GEL)
1 Introduction
The company is considering investing in a wind energy project in a foreign country. The wind energy investment project consists of two phases.
Phase-1 investment involves building an onshore wind farm with a capacity of 500 MW.
The onshore wind farm requires a project development and maturation stage including geographic studies and necessary permit applications in year 0, and additional geographic studies, such as bird collision studies, in years 1-5. In year 0, the onshore wind farm is constructed, turbines purchased, and the power grid connected. The onshore wind farm's fixed assets are depreciated using a straight-line method over the 15-year wind-farm life. There might be a salvage value at the end of year 15. From year 1, the onshore wind farm is expected to operate and generate electricity. Besides, the operation requires an initial investment in net working capital in year 0 that amounts to a fixed rate of year 1's expected gross profit. The required investment in NWC can be fully recovered at the end of the operation (year 15).
After five years of experience in Phase 1, the management considers an expansionary Phase 2 investment—adding to the onshore wind farm capacity additional 750 MW. No additional project development and maturation stage is required. Phase 2 involves capital expenditures in year 5, like farm construction and connection and purchasing turbines. The expanded part of the wind farm has 15 years of operation. At the end of year 20, there may be a salvage value. The onshore wind farm expansion's fixed assets are depreciated using a straight-line method over 15 years. Like Phase-1, the operation requires an initial investment in net working capital up to a fixed rate of the expected year-1 gross profit, which can be fully recovered at year 20.
The market team has identified that the electricity price is a significant risk factor. Although the wind farm's capacity can be fixed due to the business volatility, the future gross profits are uncertain.
See the next section for more details.
2 Project Details
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Country
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Ukraine
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Business risk volatility
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65%
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Phase 1 wind farm details (life: 15 years)
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Expected cost or revenues
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U.S. $ million / year
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Year(s)
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Project development and maturation costs
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35
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0
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Turbines & wind farm construction
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(Q: 3.1)
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Expected annual gross profit
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(Q: 3.1)
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Salvage Value
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(Q: 3.2)
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Bird collision studies
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10
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1-5
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Operations and maintenance costs / gross profit
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15%
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1-15
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NWC/expected gross profit in year 1
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10%
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0
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* Students are required to estimate the relevant figures for Phase – 2 analysis
3 Tasks
3.1 Estimating Project Costs and Revenues
Provide an estimate for the capital expenditure of constructing a wind farm of this size and the gross profits it is expected to generate. Conduct the analysis to both Phase 1 and Phase 2. Support your estimates by researching competitors in this field with references to the sources.
3.2 Estimating the Salvage Value
Provide an estimate for the salvage value for a windfarm of this size. Conduct the analysis to both Phase 1 and Phase 2. Support your estimates by researching competitors in this field with references to the sources.
3.3 Free cash flow analysis
Using data from the EDGAR Annual report and Annual Information filings for the company, calculate and analyze the current (the most recent financial year) free cash flow to the firm and equity. State the group's assumptions and data sources for the free cash flow analysis inputs. Present a short discussion regarding the inputs the group eventually chooses.
3.4 Capital structure analysis
Analyze the company's capital structure, including an overview of its financial instruments for funding purposes.
Calculate the current post-tax WACC for the company. The group needs to estimate the market value of debt and equity, the risk-free rate, the market risk premium, the company beta, and the costs of debt and equity for the WACC calculation.
For all inputs to the WACC calculation, the report must state the assumptions and sources of data. Present a short discussion regarding the inputs the group eventually chooses.
3.5 A project discount rate
The group should derive the project cost of capital, reflecting the business and country-specific risks. The report must state the assumptions and sources of data. Present a discussion regarding the cost of capital and its derivation.
3.6 Estimate FCFs and calculate NPVs
Calculate the project FCF and estimate Phase-1 and Phase-2 NPVs.
The report must state the assumptions and sources of data. Present a discussion regarding the outcomes and whether the company should invest in the project and expand it.
3.7 Risk Analysis and Business Strategy
A significant investment in a foreign country involves dealing with risks and costs that the management team needs to learn and adapt to overtime. Identify significant risk factors that may substantially impact the outcome of the investment project.
Identify the expected, best and worst case scenarios, and conduct an analysis of the most important ingredients affecting the NPV and the decision whether to invest in wind farm and whether to expand (e.g., break-even, sensitivity, or scenario analysis).
Discuss and provide evidence of the company's business strategy. Answer whether this project is compatible with its business strategy and risk appetite. Discuss the project's impact on the company's risk profile.
3.8 Decision Tree Analysis of Phase-2
The management team has the option to expand Phase-1 in year 5. The valuation of Phase-2 reflects the added value of this call option.
Construct the binomial tree for the path of gross profits as illustrated in the graph below. Assume that the annual gross profits are equally likely to increase or decrease by σ (business risk volatility) relative to the previous year's level. After 5 years, gross profits do not change.
Based on the estimates you derived in (3.1) for the expected gross profits, construct the decision tree and value the Phase-2 investment using the decision tree analysis. The report should include
1. An explanation for the rationale of this approach;
2. Discussion of the parameters' values in the formulas;
3. A Drawing of the decision tree with sufficient information;
4. An explanation of the optimal strategy;
5. The calculation and final results;
6. Discuss the real-option valuation versus the DCF approach results.
3.9 Black-Scholes Analysis of Phase 2
Use the Black-Scholes formula to calculate the value of Phase-2. The report should include
1. An explanation for the rationale of this approach;
2. Discussion of the parameters' values in the formulas;
3. The calculation and final results;
4. A Discussion and comparison of the previous results (decision-tree results and DCF results).
The given business risk volatility (σ) is also the standard deviation of returns.
3.10 Recommendations
Based on the company's analysis, its strategic focus, growth strategy, and project analysis, make recommendations to the CEO. The group's recommendation should discuss the return on equity, free cash flow to the firm and equity, the funding of the firm's capital structure, and its cost of capital. The recommendation should be based on the analysis and throughouts conveyed in the report.