Case Study-AW169

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Fuel Cell Electricity: Project
 
Fuel cell technology, that found it first major application in the space program, is a growing electricity source for corporations, universities, cities and homes. Reportedly Toyota and Honda (and probably others) are developing fuel cells for use in automobiles. Fuel cells require hydrogen fuel that can be derived from natural or propane gas, and it costs about 50% as much as burning fossil fuels to generate power. Methane emitted from landfill sites is another source of hydrogen and methane causes a stronger greenhouse effect than carbon dioxide. The references below including a video from “60 Minutes” provide more information, although knowledge of this technology is not needed to complete this project.

 

A company (fictitious), Most Advanced Technology Research (MATR), has its office campus in a large city less than a mile from the city’s massive landfill. The city has asked them if they would be interested in collecting and using the methane gas generated from this landfill to generate their electricity. The city would lease land at no charge for methane collection and fuel cell electricity generation with the condition that the costs that the city now expends to capture and burn the landfill gas be eliminated within five years.
 

Investment
 
The upfront investment required to build a working facility is estimated by MATR as $3.0 million. All needed hardware is commercially available. Of this $3.0 million investment, $2.5 million can be depreciated using 20-year MACRS (The 20-year and 5-year MACRS rates are in the case data block).
 
In addition, in both years 5 and 10 an added investment of $150,000 will be needed to replace and expand the gas collection system. These two investments are to be depreciated using 5 year MACRS starting in years 6 and 11 respectively. (recall that there are six years of depreciation in 5-year MACRS).
 

Gross Margin
 
MATR expects that their electricity needs will be constant at 30,000,000 kWh annually and that all of their electricity needs will be provided by the fuel cell facility starting in year 4. The plan is to have 25% of their year-1 electricity needs provided by the fuel cell technology, 50% of their needs in year 2, 75% in year 3, and 100% in year 4 and following.

 

The cost per kWh of electricity from present sources is forecast as being $0.050 in year 1, and is expected to increase by 5% annually in every year after year 1. The cost per kWh of electricity from fuel cell generation is forecast as being $0.060 in year 1 and is expected to decrease by 10% annually in every year after year 1.

 

The gross margin is the savings resulting from implementing the proposal. The basic logic of the gross margin determination is that the revenue is the value of the electricity received at current (no fuel cell) rates. That is, they receive that much value each year. The COGS is the cost of the fuel cell electricity that replaces this.
 
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The “no change” cost, the revenue, is the total kWh times the cost per kWh. In year 1 it is $0.05 * 30,000,000 kWh = $1,500,000. This amount changes each year depending of the forecasted cost per kWh.

 

If the proposal is accepted, the electricity cost of the first three years will be incurred from a combination of both present sources and fuel cell facility. Therefore, the cost is the sum of the cost of “no change” electricity plus the cost of “fuel cell” electricity. This is recorded as the COGS. For year one, it would be
 

year01
No Change (proposal not approved)
Total Demand KwH30,000,000
Price existing source$0.050
Cost existing source only $1,500,000
Proposal Cost
Existing Fuel portion
Percentage existing source75%
kWh22,500,000
Price existing source$0.050
Cost Existing $1,125,000
Fuel Cell portion
Percent Fuel Cell source25%
kWh Fuel cell7,500,000
Price of fuel cell source$0.060
Cost combined sources $450,000
Total cost Proposed $1,575,000
Income Statement01
Revenue (cost no change) $1,500,000
COGS (cost with change)($1,575,000)
Gross Margin ($75,000)

 

In year 1, this revenue of “no change” minus the COGS (fuel cell) yields a gross margin loss of $75,000. The gross margin will become positive when prices change and more fuel cell electricity is used.

 

Expenses
 
The annual expenses for the collection and fuel cell electricity generating facility are $200,000 for Administrative, $175,000 for Maintenance, $45,000 for non-electrical utilities, and $30,000 for insurance and backup coverage. Since there is minimal inventory, sales and purchases, the working capital will be considered $0.00 for all years.

 

Taxes and Rates
 
Income will be taxed at 25%, but a energy related tax credit of 30% of the total original investment cost can be deducted from taxes in year 1. The tax credit reduces the total taxes incurred by MATR. The capital gains tax rate is 20%.
 
Management at MATR has specified that a MARR of 10% be used with a 15-year time horizon.

 

Ending Asset Values
 

The only ending assets that would be of value is the investment in the fuel cell technology since there is no working capital and it is not expected to add value to the company and its facilities. It is forecast that the fuel cell technology could be sold in year 16 for $1,000,000, possibly to a local utility company.

 
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