Reference no: EM131727000

PK Wind Turbine:  An Alternative Energy Proposal

PK is a $50 billion health care company with 175,000 employees that primarily does business in the state of California.  It operates hospitals and medical clinics and offers health care services to its customers on a prepaid basis through its insurance offering.  The company is organized as a 501(c) 3 corporation meaning that it is a not for profit entity. Labor, salaries and other personnel related expenses make up a significant portion of the company's expenses. 

PK 's total energy bill in all facilities totals about $300 million annually and the cost of energy is expected to increase at a rate of 5% annually for the next 20 years.  The company's CEO and Board have approved a goal to have 25% of the company's energy needs generated from renewable sources by the year 2022.  A summary of the company's financial results for the last two years are summarized in the chart below.

($000,000)	2013	2012
Revenue	$53,100	$50,100
Operating Expense	(51,300)	(48,400)
Operating Income	1,800	1,700
Net Non Operating Income	1,000	922
Net Income	$2,800	$2,622
Total Assets	$56,900	$52,800
Total Equity	$23,000	$14,300

 The company is currently finishing the construction of a medical office building in eastern Los Angeles County with a project budget of $95 million.  For a variety of reasons, solar is impractical and not an option for this location, so the company is investigating the possibility of installing a wind turbine on the site. The company has no previous experience with wind turbines.

The wind turbine being considered by the company, is made by Toshiba and has a capacity of 750 kWp  with a cost of $1,400,000.  The cost to install will be an additional $500,000. Toshiba warranties the turbine for 20 years, but it has indicated that it could last for as long as 30 years.

In evaluating alternative energy projects, the economics are as follows:

Cashflow = (Energy Produced by Turbine) x (Avoided Utility Cost - Turbine Energy Cost)

In this location, the current cost (avoided cost) of electricity $0.0832 per kWh and is expected to increase at a rate of 3% annually.  Production from the turbine is estimated at 1,700,000 kWh annually.  The cost to maintain the turbine, operation and maintenance costs (O&M), starts at $22,500 per year and is expected to increase at a rate of 3% annually.

The wind turbine project  qualifies for RECs (Renewable Energy Credits).  A renewable energy credit (sometimes referred to as a renewable energy certificate or "greentag") is an environmental commodity that represents the added value, environmental benefits and cost of renewable energy above conventional methods of producing electricity, namely burning coal and natural gas. RECs help wind farms and other renewable energy facilities grow by making them more financially viable, thereby incentivizing development.  There is a market for RECs in California but it is unclear what their economic value is.

The company estimates that maximum usage of the energy produced from the wind turbine will be  1,300,000 kWh annually.  According to the law of California, excess production from any alternative source can be sold back to the grid at $0.04 per kWh.

Organizationally PK has a very complex organizational structure.  The company's executive management is responsible for developing the strategic direction of the company while the operating units (divided into geographical regions, e.g., Northern California, Southern California, etc.) are responsible for fulfilling the goals established by the executive management and the Board of Directors.  The operating units' performance is measured on a balanced scorecard basis and includes the following performance indicators:

• Minimum profit margin of 4%
• Member (customer) satisfaction as measured by independent survey firms
• Patient safety as measured by California state quality audits
• Employee satisfaction as measured by internal surveys
• Project returns of 11% on invested capital
• Sustainability (measurable metric still under development)

Please answer the following questions in your presentation:

What is annual cost?

1. Is the wind turbine project economical as measured by NPV, IRR and Payback. For this type of project, the company uses a discount rate of 11%.   Would you recommend that this project be approved? Include the average price for electricity per kWh for production by wind turbine and current grid price over the life of the project. Tax free 501c3

2. As an alternative, the company can lease the equipment from Bank US that offers a rate of 12.9% (lease rate factor, which is the periodic lease payment divided by purchase price) of installed cost per year with an option to buy out the turbine at the end of 7 years at 25.6% of original cost. Does the lease option provide superior economics to the company's purchase option in #1 above? For lease versus buy analysis, the company uses a discount rate of 6%.

3. What is the minimum annual production from the wind turbine that would allow the project to be approved, everything else being equal? Use 11% discount rate.  Include the analysis of any other relevant sensitivities in your results.

4. What will be the change to PK's bottom line and profit margin if the company can eliminate all of its energy costs for the entire company? (The point of this question is to evaluate the significance of energy costs to the company's total cost basis.)

5. Do you believe the company's objective of having 25% of its power generated from alternative sources by 2020 is a realistic and worthwhile goal?

6. If this project is approved are there any potential conflicts between executive management and the operating unit? Note that the operating units are tasked with delivering a specific profit margin while executive management is requiring the operating unit to achieve certain sustainability targets without providing additional resources.

7. What impact will being a "green" company have on PK's brand?

8. In what other ways can a company of this size impact sustainability?

9. What is your opinion of using public funds to subsidize the nascent alternative energy industry? Do you believe this is a good use of public money?

Attachment:- Assignment.rar