THE TENNESSEE VALLEY AUTHORITY: THE COST OF POWER

THE TENNESSEE VALLEY AUTHORITY: THE COST OF POWER
Read over the case. You may want to research the Tennessee Valley Authority (TVA) at www.tva.gov.
**Please be specific and detailed with answers and show all work. Thank you.

Evaluate the five alternative production projects using traditional discounted cash flow analysis:
a) What is the appropriate cost of capital for this case? Support your reasoning.

Note that the marginal cost of capital is the appropriate input for capital budgeting decisions. This rate should best estimate of the current cost of raising additional debt of similar risk. (The historical average of 5.5% is not correct.)

b) Fill in the following operating characteristics of each of the production alternatives?

I have completed the first one for you – Natural Gas.
Plant Type
Natural Gas
Nuclear
Wind
Solar
Coal

Useful Life
(Years)
20

Cost (In Millions $)
650

Expected Annual Cash Flows
(In Millions $)
85

c) Calculate the net present value (NPV) and internal rate of return (IRR) for each of the alternatives: natural gas plant, nuclear plant, wind plant, solar plant and coal plant. 
Use the excel template to complete this.
The first one is completed for you – Natural Gas. Be sure, however, to enter the cost of capital you determined in part a as the WACC (weighted average cost of capital). This will change the NPV for Natural Gas.

b) Other:

? Address the important question of what mix of projects should be pursued? Explain why. Keep in mind that the total long-term debt funding available to TVA is $30 billion and the current level is almost $9 billion. Also note that the needed additional power generation from new construction is 2,835 MW.

? Might there be additional factors other than cost and return that ought to be considered? Well identify two and speak to them briefly.

Some Helpful pointers:
? This case is rich with information. To assist you get started on the right foot please note that the information you need to complete the discounted cash flow analysis comes largely from page 7. You need to provide for an estimate for appropriate cost of capital, however, in order to complete the analysis. The discussion on funding considerations which starts on page 5 into page 6 should go a long way to assist you with the info.

? Keeping apples with apples, so to speak, the estimation of useful/expected “lives” in this case study are provided in terms of "from the day construction is started" as construction times vary across the five alternatives.

? Keep in mind that TVA is seeking to provide for additional power generation of 2,835MW and looking to the feasibility of 5 production alternatives to meet this need.

? Note that a capital budgeting decision never includes sunk costs in their analysis, meaning that the "values" of TVA's existing facilities are not relevant! It's in the past and should not affect TVA's decision regarding the production alternative to now pursue. That said, one should approach capital budgeting decisions in terms of incremental cash flows. So in other words, if TVA elects to pursue any one of these new construction projects (ie. a natural gas plant), what changes? Answering this question is the upfront cost to take it on as well as the incremental stream of annual cash inflows from the business generated.