Question

The following assignment deals with the construction of a 500 MW offshore wind farm. Following the decision to construct the wind farm, it will take 4 years for the design, construction, purchase, production and construction of the turbines until they can go into operation. The time when the turbines begin operation is referred to as time 0, and the costs for the previous 4 years have been:

year -4: 200 million DKK

year -3: 500 million DKK

year -2: 1,500 million DKK

year -1: 2,000 million DKK

After year 20, it is expected to no longer be profitable to operate the turbines, therefore they must be removed at an expected cost of 500 million DKK at the end of operation. The cost of operating and maintaining the turbines is estimated to be 800 million DKK/year for years 1-20.

Energy production from the turbines, of course, depends on the wind speed, which can always vary. Based on detailed measurements of wind velocity in that location, it is estimated that the wind farm should produce 2,300,000 MWh annually. However, the uptime of the turbines is assumed to be only 95%, and it is further assumed that there is a loss of electricity in the cables and substations, so net production is only 2,000,000 MWh/year.

All cash flows are attributable to the end of the years. A discount rate of 10% per year is used.

QUESTION 1

Draw the cash flow diagram for the cash flows above adopting DONG ENERGY A/S’s perspective.

QUESTION 2

If the electricity price starts at 0.90 DKK/kWh at year 1 and drops by 5% every year, would the investment in the offshore wind farm be profitable?

Answer 1

Doing the NPV calculation at discount rate of 10% we have

Since NPV is negative i.e. the investment is not profitable. Hence we reject this project.