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Problem Statement
The Southern Company must determine the least expensive course of action for compliance with the Clean Air Act.
Three Options for the Bowen Plant to conform to the Clean Air Act:
This Act requires coal-burning plants to minimize the amount of sulfur-dioxide emissions it produces (thus regulating a public good: air) and if it does so, it gives incentive for producers of excess emissions to turn their excess into revenue. The fact that all utilities are required to comply with the Act grants buyers and sellers access to information for planning. It also intends to provide a formal rule for the optimal amount of pollution that can be created by utility plants. The rule helps companies internalize the negative externality i.e. pollution leading to deaths. The resulting cleaner air and decrease in acid rain convert the transaction of utilities into a positive externality.
Option 2.2: Postpone installment of scrubbers until 1997, purchase allowances 1995 and 1996
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20-year depreciation schedule: o 1995 1999, 14% of capital costs/year. o 1999 2015, 2% of capital costs/year. No salvageable value.
Figure 1, Contd: 1997 Revenue COGS Operating Expense Expense for Allowance Depreciation Expense Earnings Before Income Taxes Income Tax Expense (37.7%) Net Income Add Depreciation Free Cash Flow Figure 1, Contd: 2002 Revenue COGS Operating Expense Expense for Allowance Depreciation Expense Earnings Before Income Taxes Income Tax Expense (37.7%) Net Income Add Depreciation Free Cash Flow 887.83 553.12 334.71 .00 334.71 880.80 548.74 332.06 .00 332.06 873.06 543.92 329.14 .00 329.14 864.55 538.62 325.94 .00 325.94 855.19 532.79 322.41 .00 322.41 1206.86 248.64 .06 70.33 2003 1206.86 248.64 .06 77.36 2004 1206.86 248.64 .06 85.09 2005 1206.86 248.64 .06 93.60 2006 1206.86 248.64 .06 102.96 954.54 594.68 359.86 .00 359.86 954.17 594.45 359.72 .00 359.72 953.77 594.20 359.57 .00 359.57 900.04 560.72 339.31 .00 339.31 894.22 557.10 337.12 .00 337.12 1206.86 248.64 .06 3.62 1998 1206.86 248.64 .06 3.98 1999 1206.86 248.64 .06 4.38 2000 1206.86 248.64 .06 58.12 2001 1206.86 248.64 .06 63.93
Figure 1, Contd: 2007 Revenue COGS Operating Expense Expense for Allowance Depreciation Expense Earnings Before Income Taxes Income Tax Expense (37.7%) Net Income Add Depreciation Free Cash Flow Figure 1, Contd: 2012 Revenue COGS Operating Expense Expense for Allowance Depreciation Expense Earnings Before Income Taxes Income Tax Expense (37.7%) Net Income Add Depreciation Free Cash Flow Discount Rate Net Present Value 807.41 503.02 304.39 .00 304.39 10% $3,016,327,488.43 807.41 503.02 304.39 .00 304.39 807.41 503.02 304.39 .00 304.39 807.41 503.02 304.39 .00 304.39 807.41 503.02 304.39 .00 304.39 1206.86 248.64 .06 150.75 2013 1206.86 248.64 .06 150.75 2014 1206.86 248.64 .06 150.75 2015 1206.86 248.64 .06 150.75 2016 1206.86 248.64 .06 150.75 844.90 526.37 318.53 .00 318.53 833.57 519.31 314.26 .00 314.26 821.11 511.55 309.56 .00 309.56 807.41 503.02 304.39 .00 304.39 807.41 503.02 304.39 .00 304.39 1206.86 248.64 .06 113.26 2008 1206.86 248.64 .06 124.59 2009 1206.86 248.64 .06 137.04 2010 1206.86 248.64 .06 150.75 2011 1206.86 248.64 .06 150.75
Figure 2, Contd: 1997 Revenue Sell Excess Allowances COGS Operating Expense Capital Outlays Depreciation Expense Earnings Before Income Taxes 20.14 980.02 20.14 986.92 20.14 994.50 0.96 968.73 0.96 972.57 1182.72 68.95 248.64 0.09 1998 1182.72 75.84 248.64 0.09 1999 1182.72 83.43 248.64 0.09 2000 1182.72 38.47 248.64 0.09 2001 1182.72 42.32 248.64 0.09
Income Tax Expense (37.7%) Net Income Add Depreciation Free Cash Flow
Figure 2, Contd: 2002 Revenue Sell Excess Allowances COGS Operating Expense Capital Outlays Depreciation Expense Earnings Before Income Taxes Income Tax Expense (37.7%) Net Income Add Depreciation Free Cash Flow 0.96 976.80 608.55 368.26 0.96 370.26 0.96 981.46 611.45 370.01 0.96 372.02 0.96 986.58 614.64 371.94 0.96 373.95 0.96 992.21 618.15 374.06 0.96 376.07 0.96 998.41 622.01 376.40 0.96 378.40 1182.72 46.55 248.64 0.09 2003 1182.72 51.20 248.64 0.09 2004 1182.72 56.32 248.64 0.09 2005 1182.72 61.95 248.64 0.09 2006 1182.72 68.15 248.64 0.09
Figure 2, Contd: 2007 Revenue Sell Excess Allowances COGS Operating Expense Capital Outlays Depreciation Expense Earnings Before Income Taxes Income Tax Expense (37.7%) Net Income Add Depreciation Free Cash Flow 0.96 1005.22 626.25 378.97 0.96 380.97 0.96 1012.72 630.92 381.79 0.96 383.80 0.96 1020.96 636.06 384.90 0.96 386.91 0.96 1030.03 641.71 388.32 0.96 390.33 0.96 1030.03 641.71 388.32 0.96 390.33 1182.72 74.96 248.64 0.09 2008 1182.72 82.46 248.64 0.09 2009 1182.72 90.71 248.64 0.09 2010 1182.72 99.78 248.64 0.09 2011 1182.72 99.78 248.64 0.09
Figure 2, Contd: 2012 Revenue Sell Excess Allowances COGS Operating Expense Capital Outlays Depreciation Expense Earnings Before Income Taxes Income Tax Expense (37.7%) Net Income FIGURE 2 CONTINUED: Add Depreciation Free Cash Flow 0.96 390.33 0.96 390.33 0.96 390.33 0.00 389.73 0.00 389.73 0.96 1030.03 641.71 388.32 0.96 1030.03 641.71 388.32 0.96 1030.03 641.71 388.32 1030.99 642.31 388.68 1030.99 642.31 388.68 1182.72 99.78 248.64 0.09 2013 1182.72 99.78 248.64 0.09 2014 1182.72 99.78 248.64 0.09 2015 1182.72 99.78 248.64 0.09 2016 1182.72 99.78 248.64 0.09
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10% $3,081,902,242.70
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Option 2.2: Burn High-Sulfur Coal with Scrubbers (starting in year 2000); Sell Allowances
Net Present Value: $3,099,268,050.02 Figure 3:
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Figure 3, Contd: 1997 Revenue Sell Excess Allowances COGS Operating Expense Capital Outlays Expense for Allowance Depreciation Expense Earnings Before Income Taxes Income Tax Expense (37.7%) Net Income Add Depreciation Free Cash Flow 811.50 505.57 305.94 0.00 306.99 451.74 281.44 170.31 0.00 171.36 883.38 550.35 333.04 0.00 334.09 248.64 0.06 143.85 3.62 248.64 0.06 503.61 3.98 248.64 0.06 71.97 4.38 20.14 949.54 591.56 357.98 20.14 379.17 20.14 953.39 593.96 359.43 20.14 380.62 1206.86 1998 1206.86 1999 1206.86 2000 1182.72 38.47 248.64 0.09 2001 1182.72 42.32 248.64 0.09
Figure 3, Contd: 2002 Revenue Sell Excess Allowances COGS Operating Expense Capital Outlays Expense for Allowance Depreciation Expense Earnings Before Income Taxes Income Tax Expense (37.7%) Net Income 20.14 957.62 596.60 361.02 20.14 962.27 599.50 362.78 20.14 967.39 602.69 364.71 1.20 991.97 618.00 373.97 1.20 998.17 621.86 376.31 1182.72 46.55 248.64 0.09 2003 1182.72 51.20 248.64 0.09 2004 1182.72 56.32 248.64 0.09 2005 1182.72 61.95 248.64 0.09 2006 1182.72 68.15 248.64 0.09
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20.14 382.21
20.14 383.97
20.14 385.90
1.20 376.22
1.20 378.55
Figure 3, Contd: 2007 Revenue Sell Excess Allowances COGS Operating Expense Capital Outlays Expense for Allowance Depreciation Expense Earnings Before Income Taxes Income Tax Expense (37.7%) Net Income Add Depreciation Free Cash Flow 1.20 1004.98 626.10 378.88 1.20 381.12 1.20 1012.48 630.77 381.70 1.20 383.95 1.20 1020.72 635.91 384.81 1.20 387.06 1.20 1029.80 641.56 388.23 1.20 390.48 1.20 1029.80 641.56 388.23 1.20 390.48 1182.72 74.96 248.64 0.09 2008 1182.72 82.46 248.64 0.09 2009 1182.72 90.71 248.64 0.09 2010 1182.72 99.78 248.64 0.09 2011 1182.72 99.78 248.64 0.09
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Figure 3, Contd: 2012 Revenue Sell Excess Allowances COGS Operating Expense Capital Outlays Expense for Allowance Depreciation Expense Earnings Before Income Taxes Income Tax Expense (37.7%) Net Income Add Depreciation Free Cash Flow Discount Rate Net Present Value 1.20 1029.80 641.56 388.23 1.20 390.48 1.20 1029.80 641.56 388.23 1.20 390.48 10% $3,106,189,177.49 1.20 1029.80 641.56 388.23 1.20 390.48 1.20 1029.80 641.56 388.23 1.20 390.48 1.20 1029.80 641.56 388.23 1.20 390.48 1182.72 99.78 248.64 0.09 2013 1182.72 99.78 248.64 0.09 2014 1182.72 99.78 248.64 0.09 2015 1182.72 99.78 248.64 0.09 2016 1182.72 99.78 248.64 0.09
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Figure 4, Contd: 1997 Revenue Sell Excess Allowances COGS Operating Expense Expense for Allowance Investment Expense Depreciation Expense Earnings Before Income Taxes Income Tax Expense (37.7%) Net Income Add Depreciation Free Cash Flow .62 974.84 607.32 367.51 .62 368.13 .62 977.47 608.96 368.50 .62 369.12 .62 980.36 610.76 369.60 .62 370.21 .62 892.06 555.75 336.31 .62 336.93 .03 890.82 554.98 335.84 .03 335.87 1206.86 26.30 254.83 2.86 1998 1206.86 28.93 254.83 2.86 1999 1206.86 31.82 254.83 2.86 293.01 2.86 18.30 293.01 2.86 20.13 2000 1206.86 2001 1206.86
Figure 4, Contd: 2002 Revenue Sell Excess Allowances COGS Operating Expense Expense for Allowance Investment Expense Depreciation Expense Earnings Before Income Taxes Income Tax Expense (37.7%) Net Income Add Depreciation Free Cash Flow .03 888.81 553.73 335.08 .03 335.11 .03 886.59 552.35 334.25 .03 334.28 .03 884.16 550.83 333.33 .03 333.36 .03 881.48 549.16 332.32 .03 332.35 .03 878.53 547.32 331.21 .03 331.24 293.01 2.86 22.14 293.01 2.86 24.36 293.01 2.86 26.79 293.01 2.86 29.47 293.01 2.86 32.42 1206.86 2003 1206.86 2004 1206.86 2005 1206.86 2006 1206.86
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Figure 4, Contd: 2007 Revenue Sell Excess Allowances COGS FIGURE 4 CONTINUED: Operating Expense Expense for Allowance Investment Expense Depreciation Expense Earnings Before Income Taxes Income Tax Expense (37.7%) Net Income Add Depreciation Free Cash Flow .03 875.29 545.30 329.98 .03 330.01 .03 871.72 543.08 328.64 .03 328.67 .03 867.80 540.64 327.16 .03 327.19 .03 863.48 537.95 325.53 .03 325.56 .03 863.48 537.95 325.53 .03 325.56 2.86 35.66 2.86 39.23 2.86 43.15 2.86 47.47 2.86 47.47 293.01 293.01 293.01 293.01 293.01 1206.86 2008 1206.86 2009 1206.86 2010 1206.86 2011 1206.86
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Figure 4, Contd: 2012 Revenue Sell Excess Allowances COGS Operating Expense Expense for Allowance Investment Expense Depreciation Expense Earnings Before Income Taxes Income Tax Expense (37.7%) Net Income Add Depreciation Free Cash Flow .03 863.48 537.95 325.53 .03 325.56 .03 863.48 537.95 325.53 .03 325.56 .03 863.48 537.95 325.53 .03 325.56 .03 863.48 537.95 325.53 .03 325.56 863.51 537.97 325.54 .00 325.54 293.01 2.86 47.47 293.01 2.86 47.47 293.01 2.86 47.47 293.01 2.86 47.47 293.01 2.86 47.47 1206.86 2013 1206.86 2014 1206.86 2015 1206.86 2016 1206.86
10% $3,060,818,339.70
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Figure 5:
BOWENS POSSIBLE NET PRESENT VALUES UNDER EACH AFOREMENTIONED OPTION TO ADHERE TO THE CLEAN AIR ACT
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The Small classification will also disregard the Phase One requirements. Bowen will be the standard of clean as well, with emissions of 266,550 tons using high sulfur coal and 167,650 tons when using low sulfur coal. The case mentions that other plants were emitting up to twice the amount of Bowen, representing a pollution ceiling. The analysis will consider a plant as Dirty when polluting 75% more sulfur dioxide than Bowen. Certain factors will have to be held static including: plant efficiency, the plants remaining life, and state revenue allowance. The results are below, showing the adjusted figures by plant type, which were then entered into the above spreadsheets, examining each option the Sothern Company faced, to determine the net present value.
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Figure 6
Output Revenue (per kwh) Input (million tons) High Sulfur Low Sulfur Cost of Coal High Sulfur Options 1992-1995 1996-2016 Low Sulfur Options 1992-1995 1996-1999 2000-2016 Operating Costs Add. Operating Costs Energy Cons. (% of Rev) Pollution High Sulfur High Sulfur w/ Scrub. Low Sulfur Allowances 1995-1999 2000-2016 Net Present Value Option 1 Option 2 Option 2.2 Option 3
41.46 29.82 41.46 30.37 34.92 0.00281 0.00130 2.00 266,550 26,655 167,650
41.46 29.82 41.46 30.37 34.92 0.00281 0.00130 2.00 466,463 46,646 293,388
41.46 29.82 41.46 30.37 34.92 0.00281 0.00098 1.50 199,913 19,991 125,738
41.46 29.82 41.46 30.37 34.92 0.00281 0.00098 1.50 349,847 34,985 220,041
254,580 122198
254,580 122198
91649
91649
$3,016,327,488.23 $2,754,371,504.46 $2,265,077,229.66 $2,116,870,494.64 $3,081,902,242.70 $3,055,707,037.41 $2,267,092,365.01 $2,252,271,098.42 $3,106,189,177.49 $3,086,398,395.41 $2,331,575,763.30 $2,316,694,496.72 $3,060,818,339.70 $2,897,293,630.13 $2,284,587,630.69 $2,191,371,017.17
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Figure 7:
For all four classification combinations above, Option 2.2 offers the highest potential net present value. Southern Company will still have to treat the plants on a case-by-case basis, mainly due to differences in efficiencies, plant life span, and the individual state regulatory agencies. The net present value analysis shows that Option 2.2 works across multiple variations. It also buys the company time while it sifts through the regulatory nuisances and awaits a decision from the regulatory commission regarding how the costs can be recouped. Additionally, in the event the commission allows the company to recover costs, it provides proof that the company has chosen the overall cost minimizing solutions.
The company should evaluate the proposals based on experience, cost, reputation and estimated time of completion. A fixed price contract would be in its best interest. Once a general contract is selected regular meetings should be held to ensure timely completion. If there is not enough construction expertise within the organization, it would be wise for Southern to hire an owners representative. This person will manage the project with their expertise while ensuring that the best interest of the company is being met.
Once the construction of the scrubbers is complete Southern Company should create a score card and benchmarks to evaluate the effectiveness and efficiency of the new scrubbers. There are several items that they should track. 1. The amount of pollutions that is being created. 2. Revenues and expenses associated with the allowance a. Total Revenue b. Lost Revenue c. Expense associated with selling 3. Operating Margins 4. Expenses associated with running scrubbers a. Energy b. Labor c. Unexpected cost These items should be tracked monthly, quarterly and annually and test for any major variances against expectations set by the Clean Air Act. Also they should be measured against the forecasted revenue streams, sulfur dioxide emissions and net present value calculations. This will allow Southern Company to build a case for potential rate increases with the Public Service Commission as well as monitor efficiencies of the new scrubbers. It is also necessary for the government to measure the effects of the Acts application in order to conclude whether or not the Act is actually helping reduce negative effects of sulfur-dioxide production. The air and rain (water) can be tested to provide this information however, what is unknown to utility companies is whether this analysis of the effects of the Act will be a cost that the government will pass down to utility companies.
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