V401 – Financial and Benefit-Cost Analysis

Case Study Assignment (10% of Final Course Grade)

Assigned: Tuesday, March 24, 2009
Due: Thursday, April 16th, 2009 @ Beginning of Class

We have already covered enough material in this class for you to complete this project.

The case involves a fictional town and a fictional program. The numbers, although intended to be
realistic, are entirely fabricated. This exercise is intended for the sole purpose of providing the
class with experience working through an analysis that is a bit more advanced than the problem
sets students typically work in a class such as this.

You are permitted to work in groups of no more than two people.

You may not discuss this case outside of class or share written or electronic information with
anyone other than your partner.
The Case:

The City of Beetown has an interesting challenge. They have been given a grant by the
Leonardo DiCaprio Foundation (LCF) to invest in some form of renewable energy. The grant
conditions are quite broad stating only that the city must spend the money “on equipment or
programs that will reduce the Beetown city government’s consumption of fossil fuel-based
energy, thereby protecting the environment from pollutants and the depletion of natural
resources.” The grant further directs that the Beetown program should serve as a “model of
sustainability to municipalities, corporations, and individuals who are seeking ways to decrease
their environmental and resource footprints.”

Meanwhile, the City Council is dealing with serious budget challenges. Because of recent
increases in the size of the school system, the city is facing perennial shortfalls. While some of
the liberal members of the council are excited about using this grant to move the city’s
operations in the direction of a “green future,” the more conservative members view this as an
opportunity to reduce the city’s annual deficit. They are quick to point out that the city is
carrying a substantial debt financed through bonds at an eight percent interest rate. There are
even some skeptics in the government who warn that this could be a “Trojan Horse in disguise.”
They are concerned that the city could use these funds from the LCF to purchase renewable
energy equipment and end up actually incurring higher annual costs just to use and maintain the
project. The grant from LDF is for $10 million. There are currently two options under
consideration – solar panels for electricity for City Hall and plug-in hybrid cars to replace aging
vehicles in the Public Works Department’s fleet of automobiles. Here are the details of each
proposal.

Photovoltaic Panels for City Hall

Photovoltaic cells are composed of light absorbing material that turns the Sun’s energy into
electricity. When they are arranged in connected arrays of panels they are capable of providing a
substantial amount of electricity. There are several factors that have limited the diffusion of this
renewable energy technology. First, the photovoltaic panels are quite expensive to manufacture,
although as both the scale of production operations and experience with the manufacturing
process increase, the costs are declining over time. Also, improvements in materials science are
also leading to higher efficiencies in energy conversion, thereby reducing the cost of solar
electricity production.

Second, photovoltaic cells only produce electricity when the sun is shining. That means that on
cloudy days, and of course at night, there is limited electricity production. It also means that for
around-the-clock electricity production, a system needs a rather large (and expensive) system of
batteries. Also, the electricity that PV cells produce is direct current (DC). Most electric lights,
appliances and office equipment run on alternating current. The cost of inverters to convert DC
to AC electricity costs about $0.70/peak watt.

City Hall consumption of electricity for the most recent calendar year is shown in Table
1. The highest power requirement during that time was 710 kW on July 13 at 2:00PM.
The city is currently paying a fixed rate of $0.07/kWh (7 cents per kWh).

The cost of photovoltaic panels is currently $4.80/peak watt. The electricity produced is a
function of the amount of peak watt power installed and the intensity and duration of the sun
light. In the Beetown region, where there are approximately 5.0 full sunlight hours per day on
average, each kW (1000 watts) of installed peak watt capacity will produce approximately 3.75
kWh per day. The typical life expectancy of a photovoltaicpanel (array of cells) is 20 years, after
which the materials have degraded too much to be consistently reliable.

In discussing this project other differences arose among the City Council members and between
the Public Works Department and the members of the city’s Sustainability and Environmental
Integrity Commission. The first issue was whether the system should be designed as a stand-
alone electricity generation project or whether the City Hall should remain hooked up to the
electric grid. If City Hall remained connected to the electricity grid, not only could the Council
avoid the cost of a battery system, but it could actually sell excess electricity to the electric
company during peaking production periods at the regulated utility’s “avoided cost,” estimated
to be about $0.12/kWh. It has been estimated that about 20 percent of the production during July
and August would be surplus. Of course, remaining hooked to the grid also provides security so
that if something happened to the PV system, the municipal government could continue to
function normally.

Costs are a critical factor in the “stand-alone” versus “hooked-to-the-grid” decision. A battery
system would be complex and expensive, involving a cost of $1.86 per kWh of energy storage
capacity. It has generally been agreed that if City Hall is independent of the grid, given the
weather patterns in the Beetown region, it will be necessary to provide storage for five days of
typical energy consumption. Those who argue in favor of remaining connected to the grid point
out that not only are the batteries expensive, but they are relatively short lived – they would have
to be replaced every five years. At the same time, the advocates of an independent system
emphasize that staying attached to the grid after the solar cells have been added to the system
will involve an initial expenditure of $20,000 to allow the two way flow of electricity for sale of
electricity back to the electric power company.
Some environmentalists and members of the Council argued that the symbolic value of “energy
independence” in City Hall was worth the extra expense. This was a chance to show what could
actually be accomplished with renewable energy technology.

Plug-in Electric Hybrids for the City’s Automobile Fleet

The city currently runs a fleet of 60 automobiles. Coincidently, 70 percent of the fleet is due to
be replaced during the next 18 months, so a plug-in electric hybrid vehicle (PHEV) project could
be especially timely. If the city does not purchase the PHEVs it will most likely purchase Ford
Tauruses to replace the vehicles it is retiring. Because of a special arrangement with a local
supplier, the city is able to obtain a basic version of the Taurus for $23,000 each. The in-town or
city fuel efficiency for the Taurus is 21 miles per gallon. Based on records it appears that the
average city-owned automobile registers 18,000 miles per year. Under the fleet conditions, it is
also estimated that the Taurus will last 12 years, have resale value at that point of $800, and incur
maintenance costs of approximately $800 per year.

Several of the City Council members are excited about the possibility of substituting PHEVs for
the Tauruses. Under the current approach, a plug-in hybrid is simply a Toyota Prius automobile
that has been retrofitted with a substantial bank of batteries produced by a company called
Hymotion. The base cost of the Prius is $22,325. The retrofit of the Prius with the batteries,
including installation and control equipment, is approximately $14,000 per car.

By itself the Prius will average about 60 miles per gallon around town. With the Lithium-in
battery pack, the first 35 miles each day will be run entirely on the battery, which charges
overnight. To fully charge the battery requires 5.5 kWh. Another advantage of the Prius is that
maintenance costs are lower than with standard internal combustion engines – approximately
$400 per year. Like the Taurus, the Prius (with or without the Hymotion retrofit) is expected to
last 12 years, at which point its resale value will be $1,400.

Your Assignment
The Mayor can see that there are generally three different camps among the City Councilors –
those that want to use the grant for solar photovoltaic equipment, those that want to purchase
PHEVs, and those who are worried that even with the $10 million grant either project is going to
end up hurting the city’s bottom line. She can’t help but wonder whether there is still another
option that no one has spotted.

The Mayor has decided to remain as impartial as possible, to base her decision on objective
criteria as much as possible. She has assigned you the job of assessing the financial and
economic impacts of the alternatives. You are directed to complete an analysis of the options,
clearly document your approach and calculations, draw up recommendations, and submit a one
page memorandum (with attachments if needed).

Because you are new to the city government and also ambitious you want to submit a particularly
professional document – well reasoned and well presented. In informal discussions your
immediate supervisor has suggested that you use a discount rate of 6 percent for any analysis that
you do, although some departments have use 3 percent for long term projects with environmental
implications while the town comptroller has used as much as a 10 percent discount rate for some
of the towns investments.

Your supervisor has also reviewed the Mayor’s assignment with you and suggested that you be
sure to address in your analysis the following issues, among others:
1. If the town adopts the PV project, what is the additional net cost in present value or
annual value terms of going off-grid?
2. Will the $10 million be enough to provide solar electricity equipment for the entire city
hall (on-grid or off-grid)? If not, how much additional capital cost will be involved for
either option?
3. Are the PHEVs a good investment for the town? Will the $10 million allow replacement
of all the retiring vehicles with PHEVs? If not how many can be replaced?
4. Are there other options that you would recommend that the City Council consider?

In some calculations, you will probably find it beneficial to provide a sensitivity analysis to see
how important the assumptions being made are to your recommendations.
Table 1: Electricity Consumption at Beetown City Hall, most recent calendar year,
by month.

Month Days kWh

January 31 194,600
February 28 193,800
March 31 192,000
April 30 148,200
May 31 130,800
June 30 149,400
July 31 180,000
August 31 169,200
September 30 166,200
October 31 168,600
November 30 143,400
December 31 189,000**

** Note: Some are confused by the difference between power and energy.
Power is an instantaneous measure of the flow of energy. So we measure the amount of power a
light bulb uses in terms of kilowatts (kW). We measure the size of a power plant in megawatts
(mW). Energy is a measure of the amount of power that is delivered over a period of time. So we
talk about the kilowatt-hours (kWh) of energy that are consumed when you leave on a light bulb
for a period of time or the amount of megawatt-hours (mWh) of energy that a factory consumes
each year. If an appliance has a power rating of one kW, and you run it for one hour, it consumes
one kWh of energy. Run the same appliance for 10 hours, and it is still only consuming one kW
of power, but it is consuming 10 kWh of energy.

Most households and commercial operations pay for energy, but not for power. That is, their bill
is directly proportional to the kWh they consume. That is the case for Beetown City Hall.
The prefixes on the terms simply indicate orders of magnitude:

Energy: 1 mWh = 1,000 kWh = 1,000,000 Wh

Power: 1mW = 1,000 kW = 1,000,000 W
Peak watts on solar PV panels are the maximum power output that the panels can achieve under
full sunlight. As mentioned each kW of peak power can produce approximately 3.75 kWh of
energy per day on average.